Tag: Australia

US-AU DTA: Article 13 – Alienation of Property

Posted on by Peter Harper

INTRODUCTION

When it comes to the alienation of property, it is usually standard practice to give the taxing rights to the state which, under the DTA, is entitled to tax both the property and income derived from it. 

Article 13 provides rules for the taxation of certain gains derived by a resident of a Contracting State. In general, the Article makes provision for the following: 

  1. gains from the alienation of real property may be taxed where the real property is located;
  2. gains derived from the alienation of ships or aircraft or related property may be taxed only by the State of which the enterprise is a resident, except to the extent that the enterprise has been allowed depreciation of the property in computing taxable income in the other State; and
  3. gains from the alienation of property referred to in paragraph 4 (c) of Article 12 (Royalties) are taxable under Article 12. 

Gains with respect to any other property are covered by Article 21 (Income Not Expressly Mentioned), which provides that gains effectively connected with a permanent establishment are taxable where the permanent establishment is located, in accordance with Article 7 (Business Profits), and that other gains may be taxed by both the State of source of the gain and the State of residence of the owner. Double taxation is avoided under the provisions of Article 22 (Relief from Double Taxation).

INTERPRETING ARTICLE 13 OF THE DTA – ALIENATION OF PROPERTY 

Article 13(1) states that income or gains derived by a resident of one country from the alienation of real property in the other country may be taxed in that other country.

For example, if a US resident derived income or gains from the disposal of real property located in Australia, that income or gain may be taxed in Australia.

The meaning of the phrase ‘income or gains’ was clarified by the Protocol. Article 2(1)(b) (Taxes Covered) was amended to include a specific reference to Australian capital gains tax to ensure that capital gains are within the scope of the DTA. 

Article 13(2) defines the term ‘real property’.

For purposes of the US, Article 13(2)(a) provides that the term ‘real property situated in the other Contracting State’ includes a ‘United States real property interest and real property referred to in Article 6 which is situated in the United States’. 

Accordingly, the US retains its full taxing rights under its domestic law.

For purposes of Australia Art 13(2)(b) provides that real property includes the following:

  1. real property referred to in Article 6;
  2. shares or comparable interests in a company, the assets of which consist of wholly or principally of real property situated in Australia, and
  3. an interest in a partnership, trust or estate of a deceased individual, the assets of which consist wholly or principally of real property situated in Australia.

Article 6 includes within the definition of real property a leasehold interest in land and rights to exploit or to explore for natural resources.

Shares or comparable interests in a company, the assets of which consist wholly or principally of real property, and an interest in a partnership, trust or deceased estate are also deemed to be real property in terms of Article 13(2)(b)(ii) and 13(2)(b)(iii).

Article 13(3) states that income or gains arising from the alienation of property (other than real property covered by Article 13(1)) forming part of the business assets of a permanent establishment of an enterprise or pertaining to a fixed base used for performing independent personal services may be taxed in that other state. 

This article also applies where the permanent establishment itself (alone or with the whole enterprise) or the fixed base is alienated and corresponds to the rules for the taxation of business profits and income from independent services in Article 7 and Article 14 respectively. 

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Article 13(4) makes provision for exclusive taxing rights of income and capital gains by the residence country from the alienation of ships, aircraft or containers operated or used in international traffic. It is also important to note, that this applies even if the income is attributable to a permanent establishment maintained by the enterprise in the other Contracting State.

Article 13(5) applies to the taxation of deemed disposals when ceasing your tax residency in a contracting state. This is also referred to as an exit tax. This article states that where an individual, has a deemed disposal event in their residence state due to ceasing residency, they can elect to be treated for the purposes of the taxation laws of the other state as having alienated and re -acquired the property for an amount equal to its fair market value at that time.

This rule has two significant consequences –

  • Firstly, if the individual is subject to tax in the other Contracting State on the gain from the deemed sale of the asset a foreign tax credit for tax on the deemed sale will be available pursuant to Article 22.
  • Secondly, the deemed sale and repurchase will result in the individual resident in the other Contracting State having a “stepped up” cost base equal to the fair market value of the property.

Article 13(6) states that where a resident of one state elects to defer taxation on income or gains relating to property that would otherwise be taxed in that state (upon ceasing to be a resident) only the state where they subsequently become a resident can tax the deferred gain. 

Article 13(7) makes provision for any other capital gains not covered by Article 13. These capital gains are to be taxed in accordance with the domestic laws of each country.

Article 13(8) lastly clarifies the taxation of real property which consists of shares in a company or interests in a partnership, estate or trust as referred to in Article 13(2)(b) is deemed to be situated in Australia.

CONCLUSION 

There have been numerous disputes regarding the application of this Article and reference to case law is extremely important. Especially in relation to limited partnerships and or indirect ownership through a chain of companies of Australian real property.

Make sure you understand how Article 13 can impact your potential liquidity event when planning to dispose of your business.  

We strongly recommend seeking professional advice when it comes to this Article and our team of International Tax specialists at Asena Advisors, will guide you on how to approach and interpret Article 13. 

We strongly recommend seeking professional advice when it comes to Article 12. As always, our team of International Tax specialists at Asena Advisors will guide you on how to approach and interpret Article 12. 

Shaun Eastman

Peter Harper

US-AU DTA: Article 12 – Royalties

Posted on by Peter Harper

INTRODUCTION

This week we will be taking a closer look at how royalties are dealt with in terms of the US/AUS DTA.  

Royalties earned outside of your resident state are generally taxed by the source state on a withholding basis. Under domestic law, a state can require a person to withhold tax on making a payment to another person. 

Royalties that are effectively connected with a permanent establishment are taxed either in terms of Article 7 which deals with business profits or Article 14 which deals with Independent Personal Services. 

The US/AUS DTA Protocol amended the treatment of royalties to:

  1. reduce the general rate of source country tax on royalties from 10% to 5%;
  2. exclude from the scope of Article12(4) payments for the use of industrial, commercial, or scientific equipment, and
  3. extend the royalties definition to cover additional types of broadcasting media (Article 12(4)(a)(iii)).

INTERPRETING ARTICLE 12 OF THE DTA – ROYALTIES

The purpose of Article 12 is to limit the tax that the source country may impose on royalty payments to beneficial owners in the other country to 5%, however, this limit only applies if the payments are at arm’s length. 

Article 12(1) states that royalties may be taxed in the country of residence of the beneficial owner even though derived from sources in the other Contracting State. This confirms Article 1(3) of the DTA that preserves the right of each country to tax its residents.

Article 12(2) stipulates those royalties may also be taxed by the source country but limits the tax to 5% of the gross amount of the royalties. 

Article 12, however, does not apply to natural resource royalties, which are taxable in the country of source in terms of  Article 6 of the DTA.

Article 12(3) sets out the exclusions and that the reduced withholding tax rate does not apply in the following cases:

    1. the beneficial owner has a permanent establishment in the source country;
    2. or performs personal services in an independent capacity through a fixed base in the source country, and the property giving rise to the royalties is effectively connected with the permanent establishment or fixed base. 

In that event, the royalties will either be taxed as business profits (Article 7) or income from the performance of independent personal services (Article 14).

Article 12(4) is important as it defines the word royalties for purposes of the treaty. The definition of royalty in Art 12(4) comprises of the following three components:

Component 1 – Intellectual property 

Article 12(4)(a) includes payments or credits of any kind to the extent that they are considered for the use or right to use any:

  (i) copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right

  (ii) motion picture films, or

  (iii) films or audio or videotapes or disks, or any other means of image or sound reproduction or transmission for use in connection with television, radio, or other broadcasting.

Due to the technological advances made since the DTA was signed, the protocol was amended to reflect these advances more accurately. 

For example, due to the Protocol, Article 12(4)(a)(iii) will apply to a payment made by an Australian broadcaster to a US company for the right to transmit a live feed of an entertainment program through satellite or the Internet. 

However, on the other hand, Article 12(4)(a)(iii) will not apply to payments made by a retail customer who has subscribed to a satellite television service provided by a US company.

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Component 2 – Scientific, technical, industrial, or commercial knowledge or information

Article 12(4)(b)(i) states that royalties include payments or credits for scientific, technical, industrial, or commercial knowledge or information (“know-how”) owned by any person. 

The specific reference to knowledge or information owned is meant to indicate that the term royalties imply a property right as distinguished from personal services.

This is a very important distinction to understand, so let’s use an example – 

An IT specialist who prepares or designs a website for a customer will be considered to perform personal services and the remuneration received will be taxable in terms of either Article 14 (Independent personal services) or Article 15 (Dependent personal services). 

However, should the IT specialist supply a pre-existing design to a customer, this will be considered the furnishing of knowledge (know-how) or information and taxed in terms of Article 12? 

Article 12(4)(b)(ii) provides that consideration for any assistance of an ancillary and subsidiary nature that enables the application or enjoyment of know-how is also a royalty payment. However, if the service is supplied in connection with the sale of property, Article 12 will not apply. 

Article 12(4)(b)(iii) contains a special rule to deal with the situation of a disguised lease of a property right of the type covered Article 12(4)(b). 

Component 3 – Disposition of property that is contingent

Article 12(4)(c) provides that, to the extent that income from the disposition of any property or right described in this paragraph is contingent on the productivity or use or further disposition of such property or right, it is a royalty.

Article 12(5) applies where there is a special relationship between the payer of the royalties and the person beneficially entitled to the royalties or between both of them and some other person. 

Where this requirement is satisfied, the 5% limitation will only apply to the extent that the royalties do not exceed the amount that might be expected to be agreed upon by independent persons acting at arm’s length. The excess amount will therefore be taxable according to the law of each contracting state but subject to any other provisions of the DTA. 

The term special relationship is significantly wider than the term associated enterprise contained in Article 9 and should be read in conjunction with Article 12(5). 

Article 12(6) lastly provides special source rules for royalties. In general, a royalty is considered to have its source in a country if paid by the Government, or a resident of that country, or by a company that under domestic law is a resident of that country. 

The US Treasury Department explained that a royalty paid by a dual resident company may be eligible for the reduced rate provided in Article 12(2), although a royalty beneficially owned by such a company is not.

CONCLUSION 

It is important to take note that a mere accounting entry may be sufficient to attract royalty withholding tax as the definition refers to payments or credits.

To determine whether a payment is a royalty subject to Article 12 or a payment for services within the scope of Article 7, will depend on the purpose of the payment and circumstances of the arrangement been the parties. 

The interpretation of Article 12 is going to take center stage in the near future. Due to the pandemic, numerous people across the world started new business ventures based on models that enable them to generate global income while rendering services remotely. The DTA and Protocol were drafted long before anyone knew the pandemic so neither the US nor Australia took this into consideration when the DTA bilateral instrument was agreed upon. 

Make sure you understand how Article 12 can impact your new start-up, as you do not want to have non-compliance issues, penalties, or additional tax just due to not understanding Article 12. 

We strongly recommend seeking professional advice when it comes to Article 12. As always, our team of International Tax specialists at Asena Advisors will guide you on how to approach and interpret Article 12. 

Shaun Eastman

Peter Harper

US-AU DTA: Article 11 – Interest

Posted on by Peter Harper

INTRODUCTION

This week we will be taking a closer look at how interest is dealt with in terms of the US/AUS DTA.

Interest earned outside of your resident state is generally taxed by the source state on a withholding basis. Under domestic law a state can require a person to withhold tax on making a payment to another person.

An overly simplified example of how Article 11 (Interest) applies in practice is if a US tax resident earns interest income from Australia. The US has the right to tax the interest earned from sources in Australia. This right is however not exclusive. If Australia also wants to also tax the interest income, it is limited to the amount of tax it can levy in terms of Article 11.

Article 11 of the DTA (Interest) has a dual purpose:

– Firstly, to limit the tax imposed by the source state where the interest arises; and

– Secondly prevents the treaty benefits available where there is an excessive payment of interest arising from a “special relationship”.

INTERPRETING ARTICLE 11 OF THE DTA – INTEREST

Article 11 generally limits the withholding tax that the source country may impose on interest payments to beneficial owners in the other country to 10%.

Article 11(1) states that interest from sources in one of the contracting states to which a resident of the other is beneficially entitled may be taxed in that other country. Hence there is no exclusive right.

A person will be beneficially entitled to interest for purposes of Article 11 if they are the beneficial owner of the interest.

Article 11(2) provides that the source state (country where the interest arises) may also tax the interest that the resident of the other state is beneficially entitled subject to a maximum rate of 10%.

Currently the US has a non-treaty interest withholding tax rate of 30% and Australia has a general interest withholding tax rate of 10%.

Article 11(3) however provides an exemption for interest paid to government bodies and financial institutions subject to the restrictions in Article 11(4).

Article 11(3)(a) states that interest derived by a Contracting State or a political or administrative subdivision or a local authority of the Contracting State is only subject to tax in the State of residence. This exemption extends to interest received by any other body exercising governmental functions.

Article 11(3)(b) states further that interest derived by financial institutions that are unrelated to and dealing wholly independently of the payer are only taxed in the State of residence.

An example of the type of financial institutions that will qualify for the exemption in Art 11(3)(b) are investment banks, brokers, and commercial finance companies

A financial institution will be “unrelated and dealing wholly independently” of the payer of the interest if the financial institution and payer are not treated as Associated Enterprises as stipulated in Article 9.

Article 11(4) operates as a restrictive provision on the exemption provided in Article 11(3).

Article 11(4)(a) stipulates that the exemption in Article 11(3)(b) will not apply, and the interest derived will be taxed at 10% of the gross amount if it arises from back-to-back loans or an arrangement that is economically equivalent.

Article 11(4)(b) preserves the application of the domestic tax law of each State regarding anti-avoidance provisions. Nothing in Article 11 limits the ability of the US to enforce existing anti-avoidance provisions.

Similarly, Australia reserves the right to apply its general anti-avoidance rules where there is a conflict with the provisions of a tax treaty and Article 11(4)(b) extends this power to any anti-avoidance rule.

Article 11(4)(b) further does not limit the ability of Australia or the US to adopt new anti-avoidance provisions.

Article 11(5) defines “interest” to mean interest from:

(a) government securities, bonds, debentures, and any form of indebtedness, and

(b) income subject to the same taxation treatment as income from money lent according to the law of the Contracting State in which the income arises.

However, income dealt with in Article 10 (Dividends) and penalty charges for late payment are not treated as interest.

The exclusion of income dealt with by the Dividends Article, clarifies that Article 10 takes precedence over Article 11 in cases where both Articles can apply.

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Article 11(6) simply states that tax is not payable under Article 11 where the interest income of the person beneficially entitled to it is subject to tax under Article 7 (Business Profits) or Article 14 (Independent Personal Services).

Article 11(7) defines the source of interest, which is a necessary pre-requisite for the Contracting State withholding tax under Article 11(2).

Generally, interest is deemed to arise and hence has its source in the Contracting State where the payer is a resident.

Unfortunately, it is not always that simple or straightforward. For example, if a person paying the interest has a permanent establishment in connection with which the interest is attributable, the interest is deemed to arise in that Contracting State if borne by that permanent establishment. This is irrespective of the fact whether or not the payer of the interest is a resident of one of the contracting states.

Article 11(8) states that, in cases involving special relationships between persons, Article 11 applies only to that portion of the total interest payments between those persons that would have been made absent such special relationships. Any excess amount of interest paid remains taxable according to the laws of the US and Australia, respectively, with due regard to the other provisions of the Convention.

Article 11(9) contains two anti-abuse exceptions to the treatment of interest in paragraphs (1), (2), (3) and (4)

Article 11(9)(a) states that interest paid by a resident of one of the Contracting States to a resident of the other Contracting State that is determined by reference to the profits of the issuer, or an associated enterprise may be taxed at a rate not exceeding 15%.

Article 11(9)(b) states that interest paid on ownership interests in securitization entities may be taxed in accordance with the domestic law, but only to the extent that the interest paid exceeds the normal rate of return on publicly traded debt instruments with a similar risk profile.

This article is specifically included to preserve the US taxation of real estate mortgage investment conduits (REMICs). A REMIC is a US entity that holds a fixed pool of real estate loans and issues debt securities with serial maturities and differing rates of return backed by those loans.

The purpose of Article 11(9)(b) is to permit the US to charge purchasers of REIMIC investments the domestic US tax on residual interests in REMICs.

Article 11(10) is only regarded to be relevant to US withholding tax. It states that where interest incurred by a company resident in one of the Contracting States is deductible in connection with a permanent establishment (Article 5), due to Article 6 (Real property) or Article 13 (Alienation of property) in the other Contracting State and that interest exceeds the interest actually paid, the amount of the excess interest deducted will be deemed to be interest arising in that other Contracting State to which a resident of the first-mentioned Contracting State is beneficially entitled.

Example:

An Australian company carries on business in the US via a permanent establishment (Branch). For US purposes this relates to branch profit tax. The branch incurs interest that is deductible in determining its US profits. However, the interest incurred by the branch is more than the amount of interest actually paid by the branch. Article 11(10) gives the US the right to tax the amount of interest not paid.

CONCLUSION

We would recommend seeking professional advice when it comes to Article 11. As always, our team of International Tax specialists at Asena Advisors, will guide you on how to approach and interpret Article 11.

Our team of International Tax specialists at Asena Advisors, advise numerous clients and corporations on their international structuring and how to make sure it is done in the most tax effective way. 

Shaun Eastman

Peter Harper

US-AU DTA: Article 10 – Dividends

Posted on by Peter Harper

INTRODUCTION

For purposes of this week’s blog, it will be beneficial just to recap on the purpose of a DTA. The major purpose of DTA is to mitigate international double taxation through tax reduction or exemptions on certain types of income derived by residents of one treaty country from sources within the other treaty country. Due to the fact that DTAs often modify US and foreign tax consequences substantially, the relevant DTA must be considered in order to fully analyze the income tax consequences of any outbound or inbound transaction.

Article 10 of the US/Australia DTA is a great example of this. 

This week we will be looking at the tax implications of declaring a dividend in the context of Article 10 of the US/Australia DTA.

INTERPRETING ARTICLE 10 OF THE DTA – DIVIDENDS

Dividends are distributions made by a company of something of value to a shareholder. Both the US and Australia levy withholding tax when a dividend is paid to a foreign shareholder. 

Under US domestic tax law, a foreign person is generally subject to 30% US tax on the gross amount of certain US-source income. All persons (‘withholding agents’) making US-source fixed, determinable, annual, or periodical (FDAP) payments to foreign persons generally must report and withhold 30% of the gross US-source FDAP payments, such as dividends.

Under Australian domestic tax law, dividends paid to an Australian non-resident recipient is subject to a flat withholding tax to the extent they are unfranked and are otherwise not assessed in Australia.

Article 10 however limits the tax that the source country may impose on these dividends payable to beneficial owners’ resident in the other country.

Article 10(1) preserves the right of a shareholder’s country of residence to tax dividends arising in the other country by permitting Australia or the US to tax its residents on dividends paid to them by a company that is resident in the other Contracting State.

Article 10(2) allows the Contacting State of the company to tax dividends to which a resident of the other Contracting State is entitled subject to the limitations in Article 10(2) and 10(3). 

Important to note is that Article 10(2) also requires that if either the US or Australia significantly modifies their laws regarding taxation of corporations or dividends they must consult with each other to determine any appropriate amendment to Article 10(2).

Article 10(2)(a) stipulates that where the shareholder who is beneficially entitled to the dividend is a company resident in the other Contracting State and directly owns shares representing at least 10% of the voting power of the company paying the dividend then the withholding tax rate is limited to 5% of the gross dividend.

The term ‘beneficially entitled’ is not defined in the DTA and therefore the domestic law of the country imposing the tax should be considered. 

The term ‘voting power‘ is also not defined but must be determined to ascertain if the 10% shareholding test is satisfied. 

The US Department of Treasury’s technical explanation of the Protocol that replaced Art 10 of the Convention states the following:

“Shares are considered to be voting shares if they provide the power to elect, appoint or replace any person vested with the powers ordinarily exercised by the board of directors of a US corporation.”

In Australia voting power is considered to refer to the voting power on all types of shares and not only in relation to the power to replace members of the board of directors. 

In determining the voting power for the purposes of Article 10(2) only shares that are held ‘directly’ by the beneficial shareholder can be taken into account. 

Accordingly, indirect interests are not to be taken into account. However, the US Department of Treasury’s technical explanation of the Protocol when discussing Article 10(2) states the following:

“Companies holding shares through fiscally transparent entities such as partnerships are considered for purposes of this paragraph to hold their proportionate interest in the shares held by the intermediate entity. As a result, companies holding shares through such entities may be able to claim the benefits of sub-paragraph (a) under certain circumstances. The lower rate of withholding tax applies when the company’s proportionate share of the shares held by the intermediate entity meets the 10 percent threshold. Whether this ownership threshold is satisfied may be difficult to determine and often will require an analysis of the partnership or trust agreement.”

The voting power test in Article 10 is therefore likely to be applied differently in the US and Australia unless the reference to “beneficially entitled” is interpreted to override the requirement that the payee company holds the shares “directly”.

Article 10(2)(b) limits the withholding tax rate on dividends derived by a resident from shares held in a company resident in the other Contracting State to 15%. Accordingly, this rate will apply to individuals, trusts, partnerships and companies that cannot rely on Article 10(2)(a) or the exemption in Art 10(3) discussed below.

Article 10(3) is quite often misinterpreted. This Article stipulates that a shareholder company resident in the US or Australia is exempt from withholding tax on dividends if it owns 80% or more or the voting power of the company paying the dividends for a 12-month period ending on the date the dividend is declared. However, the exemption is subject to the shareholder company being:

  (a) a qualified person as defined in Article 16(2)(c), or

  (b) entitled to benefits under the Limitation of Benefits Article.

In contrast to Article 10(2), voting power for the purposes of Article 10(3) is limited to shares that are held “directly” by the beneficial shareholder and therefore excludes indirect ownership through corporate chains. 

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The shareholder company will be a “qualified person” if:

1. its principal class of shares is listed on a recognized stock exchange and is regularly traded on one or more stock exchanges. A recognized stock exchange is a recognized stock exchange under Australian or US law and any stock exchange agreed by the ATO and IRS as explained in Article 16(6), or

2. at least 50% of the vote and value of the shares in the shareholder company must be owned directly or indirectly by five or fewer companies that are listed on a recognized stock exchange as defined in Article 16(6). Importantly in addition, where the shares in the shareholder company are held indirectly, each intermediate owner must be a resident of either Australia or the US.

Where a shareholder company is not a qualified person the exemption from withholding tax may still be available provided that the ATO or IRS makes a determination under Article 16(5). 

Article 10(4) provides that dividends paid by a Regulated Investment Company (RIC) or Real Estate Investment Trust (REIT) are not eligible for the 5% maximum rate of withholding tax in Art 10(2)(a) or the exemption from withholding tax in Art 10(3). Accordingly, the 15% withholding rate will generally apply to these entities.

Article 10(5) excludes from the general source country withholding tax limitations under Art 10(2), (3) and (4) dividends paid with respect to holdings that form part of the business property of a permanent establishment as defined in Article 5 or fixed base situated in the source country. 

Article 10(6) defines “dividends” to mean income from shares and amounts subject to the same taxation treatment as income from shares under the laws of the country where the company making the distribution is a resident.

In Australia the rules for defining what constitutes equity in a company and what constitutes debt are set out in ITAA97 Div 974 of the ITAA 1997 that apply from 1 July 2001. 

In the case of the US, the term dividends include amounts treated as a dividend under US law upon the sale or redemption of shares or upon a transfer of shares in a reorganisation. Further, a distribution from a US publicly traded partnership, which is taxed as a corporation under US law, is a dividend for purposes of Article 10. However, a distribution by a US LLC is not a dividend for purposes of Article 10 if it is not taxable as a corporation under US law.

Article 10(7) states that where a company which is resident for example in the US and derives profits or income from Australia, Australia is not permitted to tax dividends paid by the company unless either:

1. the person beneficially entitled to the dividends is a resident in Australia; or

2. the shares in respect of which the dividends are paid is effectively connected with a permanent establishment in Australia.

Therefore, Article 10(7) overrides section 44(1)(b) of the ITAA 1936 which permits Australia to tax dividends paid to non-residents to the extent of profits derived from sources within Australia. 

Similarly, it overrides the ability of the US to impose taxes under Code s 871 and Code s 882(a) on dividends paid by foreign corporations that have a US source under Code s 861(a)(2)(B).

Article 10(7) also provides that the Contracting States cannot impose tax on a company’s undistributed profits even if the dividends are wholly or partly paid out of profits in the relevant Contracting State unless Article 10(8) applies.

However, Article 10(7) does not restrict a State’s right to tax its resident shareholders on undistributed earnings of a corporation resident in the other State. The authority of the US to impose the foreign personal holding company tax, the taxes on subpart F income and on an increase in earnings invested in US property, and the tax on income of a passive foreign investment company that is a qualified electing fund is in no way restricted by this provision.

Article 10(8) permits Australia and the US to impose a branch profits tax on a company that is a resident in the other State. This tax is in addition to other taxes permitted by the Convention.

Currently, Australia does not impose a branch profits tax. However, if Australia were to impose such a tax, the base of such a tax would be limited to an amount analogous to the US dividend equivalent amount.

Article 10(9) lastly provides that the branch profits tax permitted by Article 10(8) shall not be imposed at a rate of withholding tax exceeding the maximum direct investment dividend rate of withholding tax of 5% in Article 10(2)(a).

CONCLUSION 

As you can see, Article 10 of the DTA is comprehensive and one should be cautious when applying it to a specific situation. 

Our team of International Tax specialists at Asena Advisors, advise numerous clients and corporations on their international structuring and how to make sure it is done in the most tax effective way. 

Shaun Eastman

Peter Harper

US-AU DTA: Article 9 – Associate Enterprises

Posted on by Peter Harper

BACKGROUND

This week, we will have a closer look at Article 9 of the US/AUS DTA. Article 9 of the DTA incorporates into the treaty the US and Australian arm’s-length principles reflected in the transfer pricing provisions of the Internal Revenue Code Section 482 and in Australia the transfer pricing provisions in ITAA 1997 Division 815.

An arm’s-length transaction is a transaction between independent parties. For the purposes of this blog, a simple example will help in understanding the basic concept of what an arm’s-length transaction is and when transfer pricing provisions will apply to a specific transaction. 

Example: USCO A and B are both US companies and co-shareholders of AusCo, a company in Australia. The directors of both USCO A and B are John and Jane who are married.  Further, each owns 50% of the stock in AusCo. USCO A is considering selling its 50% stake in AusCo and determined that the market related value of the 50% stake is $10m. However, after further consideration and the adverse tax implications on disposal, John and Jane decided that USCO A should rather sell its 50% stake to USCO B. John and Jane decided that it will sell the 50% stake for $100, to avoid the tax implications and streamline their current structure. 

IMPLICATIONS

If USCO A sold the 50% stake for $10million to USCO B it would have been sold at arm’s-length as this is the market related price. 

USCO A however sold it to USCO B for $100. They would not have sold the same stake to an independent party for $100. Hence the transaction is not at arm’s length and a transfer pricing adjustment needs to be made.  

INTRODUCTION

Article 9 provides that when enterprises which are related engaged in a transaction and the enterprises engage in a transaction on terms that are not arm’s length, the Contracting States may make appropriate adjustments to the taxable income and tax liability of such related enterprises to reflect what the income and tax of these enterprises with respect to the transaction would have been had there been an arm’s-length relationship between them. 

INTERPRETING ARTICLE 9 OF THE DTA – ASSOCIATED ENTERPRISES 

Article 9 provides that, where related persons engage in transactions which are not at arm’s length, the Contracting States may make appropriate adjustments to their taxable income and tax liability.

It should be noted that it is generally accepted that Article 9 is intended to be permissive. It allows contracting states to apply the transfer pricing rules that form part of their tax legislation. It is generally considered that; Article 9 does not create a stand-alone right for countries to make transfer pricing adjustments that go beyond what is authorized by their own domestic rules. This is mainly because the basic purpose of a DTA is to relieve double taxation and it would go way beyond this purpose if a DTA imposed harsher tax treatment on a particular transaction between country A and country B than would have applied if the same transaction had taken place between country A and another country,

Article 9(1) sets out the general rule for this Article and when it will be applicable. Where an enterprise of one Contracting State (US) and an enterprise of the other Contracting State (Australia) are related through management, control, or capital and their commercial or financial relations differ from those which would prevail between independent enterprises, the profits of the enterprises may be adjusted to reflect the profits which would have accrued if the two enterprises had been independent. 

Where a reallocation of profits is affected under this paragraph, in such a manner that the profits of an enterprise of one country are adjusted upwards, a form of double taxation would arise if the profits so reallocated continued to be subject to tax in the hands of an associated enterprise in the other country.

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Article 9(2) states that where one of the Contracting States has increased the profits of an enterprise of that State to reflect the amount that would have accrued to the enterprise had it been independent of an enterprise in the other Contracting State, the second State shall make an appropriate adjustment, decreasing the amount of tax which it has imposed on those profits. 

In determining such adjustments, due regard is to be had to the other provisions of the DTA and the competent authorities of the two States (IRS and ATO) shall consult each other if necessary, in implementing this provision.

Article 9(3) states that each Contracting State may apply its internal law in determining liability for its tax. For example, although Articles 9(1) and 2 refer to allocations of profits and taxes, it is understood that such terms also include the components of the tax base and of the tax liability, such as income, deductions, credits, and allowances. 

The US will apply its rules and procedures under section 482 of the IRC and Australia on the other hand will apply the transfer pricing provisions in ITAA 1997 Division 815.  It is important that such determinations must be consistent in each case with the principles of arm’s length transactions.

CONCLUSION 

This Article is a great example of how the domestic transfer pricing provisions of the US and Australia are applied on international transactions. 

At Asena Advisors, we have years of experience in dealing with transfer pricing issues and how to ensure that both domestic transfer pricing provisions and the DTA’s transfer pricing provisions are applied correctly.

Shaun Eastman

Peter Harper

US-AU DTA: Article 8 – Shipping and Air Transport

Posted on by Peter Harper

INTRODUCTION

This week, we will be discussing an Article in the US/AUS DTA which is generally not as relevant to individuals as other Articles in the DTA, but still important to understand. Especially regarding the interrelationship with other Articles in the DTA and how one article can override another in the DTA. 

Article 8 of the DTA governs the taxation of profits of an enterprise of a contracting state from the operation of ships or aircraft in ‘international traffic’, meaning any transport by a ship or aircraft, except when such transport is solely between places in a contracting state. In simple terms, this article does not apply to an enterprise who solely renders services within the US or Australia and provides primary taxing rights to the Country of Residence. 

In this week’s blog we will therefore have a look at Article 8 of the US/AUS DTA and how it interplays with Article 7 of the DTA. 

INTERPRETING ARTICLE 8 OF THE DTA – SHIPPING AND AIR TRANSPORT 

In our previous blog – Article 7- Business Profits , we explained that where profits include items of income dealt with separately in other articles of the DTA, then the provisions of those Articles shall not be affected by the provisions of Article 7. 

Article 8 is such an article, as it deals with profits of an enterprise from the operation of ships or aircraft in international traffic. If Article 8 applies to the profits of an enterprise, it will therefore override the provisions of Article 7.

Article 8(1) stipulates that the profits derived by a resident of one of the Contracting States from the operation in international traffic of ships or aircraft are taxable only in that Contracting State. In addition, this treatment extends to certain items of rental income that are closely related to the operation of ships and aircraft in international traffic.

Article 1(3)(d) of the DTA defines international traffic as any transport by a ship or aircraft, except where such transport is solely between places within a Contacting State.  

In particular, the following is subject to the above treatment:

– Profits from the rental of ships or aircraft on a full time basis (for example with crewmembers) operated in international traffic if the resident either operates ships or aircraft in international traffic or regularly leases ships or aircraft on a full basis. Such income is exempt from tax in the other Contracting State.

– Profits from the lease of ships or aircraft on a bare boat basis (meaning without crewmembers) when the income is ‘merely incidental’ to the operation of ships or aircraft in international traffic by the lessor.

Whether profits from the lease of ships or aircraft on a bare boat basis are merely incidental to operation in international traffic, the operative effect of this phrase is to restrict the application of Article 8 to those bareboat leases where:

– The primary activity of the lessor is the operation of ships or aircraft in international traffic, and

– The lessor’s bareboat leasing activity only makes a minor contribution to, and is so closely related to, this primary activity that it does not amount to a separate business or source of income for the lessor.

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Article 8(2) stipulates that profits of an enterprise of a Contracting State from the use, maintenance or rental of containers (including equipment for their transport) that are used for the transport of goods in international traffic are exempt from tax in the other Contracting State. This applies regardless of whether the recipient of the income is engaged in the operation of ships or aircraft in international traffic. 

Article 8(3) stipulates that Article 8(1) and 8(2) apply to profits derived though participation in a pool service or other profit sharing arrangement entered into by carriers in shipping and air transport in the interest of international cooperation. As an example, airlines from the US and Australia may agree to share profits relating to the transport of passengers between the two countries. They each will fly the same number of flights per week and share the revenues from that route equally, regardless of the number of passengers that each airline transports. Article 8(3) further makes it clear that all of the income arising from the pool service or other profit sharing arrangement and not just the income derived directly by that carrier is taxable in the Contracting State of residence.

Article 8(4) states that the carriage of passengers, livestock, mail, merchandise or goods taken on board in a Contracting State for discharge in that State is not from an operation in international traffic of ships or aircraft and may therefore be taxed in that State (source state). This relates to profits from the transport of goods or passengers picked up and discharged within the same Contracting State and therefore does not fall within the definition of international traffic and may be taxed by that State at source. However, for the Contracting State to impose such tax at source it is considered that the requirements of Article 7 would need to be satisfied.

This can be simplified with the following two examples:

Example 1 – Company A, a US shipping company contracts to carry goods from Australia to a city in the US. Part of the contract includes the transport of the goods by road from its point of origin in Australia to another point in Australia.  The income earned by the US shipping company from the overland leg of the journey would still be taxable only in the US. 

Example 2 – Company B is a US airline company which carries passengers from New York to Hobart, with an intervening stop in Perth. The Perth to Hobart leg of the trip would be treated as international transport of passengers with respect to those passengers and would still only be taxable in the US.

INTERRELATIONSHIP WITH ARTICLE 7 (BUSINESS PROFITS)

Profits from the lease of ships or aircraft that are not covered by the Shipping and Air Transport Article will fall within the scope of Article 7. 

Examples of profits that would fall within Article 7 include the following:

– Full basis leases of ships or aircraft that are not operated in international traffic by the lessee or where the lessor only operates ships or aircraft between places in the source country and does not regularly lease ships or aircraft on a full-time basis; and 

– Bare boat leases not incidental to the lessor’s international transport operations.

More importantly the source country’s taxation is only permitted under the Business Profits Article to the extent the profits are effectively connected with a permanent establishment in that country.

CONCLUSION 

This is a great example of how a specific article in the DTA can override the provisions of Article 7.

At Asena Advisors, our team of International Tax specialists, are able to assist you with applying this article correctly and establishing whether the profits are taxable in terms of Article 7 or Article 8 of the DTA. 

Shaun Eastman

Peter Harper