Tag: Australia

US-AU DTA: Article 7 – Business Profits

Posted on by Peter Harper

INTRODUCTION

Covid has changed the way business is done globally. Two of the most common changes are 

– Remote working (Employee sitting in Australia could be working for an employer in the US); and

– The increase in e-commerce businesses and being able to grow and expand these businesses globally without actually leaving the house. 

That being said, have you ever as an employer considered what the potential tax implications could be for the company by having employees working remotely?  

And does your e-commerce business create a permanent establishment in another country perhaps? 

Make sure you have taken proper steps to mitigate any unnecessary tax implications due to the ‘new norm’.

Article 7 is one of the more complex and technical articles in the DTA as it has various components to consider. However, I will try and provide a brief summary of its interpretation.

The first overriding principle of double taxation treaties is that a company resident in one country will not be taxed on its business income in the other State unless it carries on that business in the other country through a Permanent Establishment (PE) situated in that country.

The second principle is that the taxation right of the State where the PE is situated does not extend to income that is not attributable to the PE. The interpretation of these principles has differed from country to country. Some countries have pursued a principle of general force of attraction, which means that all income such as other business profits, dividends, interest and royalties arising from sources in their territory was fully taxable in that country if the beneficiary had a PE there, even though such income was clearly not attributable to that PE. 

In this week’s blog we will have a look at Article 7 of the US/AUS DTA and highlight some key aspects. 

INTERPRETING ARTICLE 7 OF THE DTA – BUSINESS PROFITS

Article 7 sets out the limits of the source state’s taxing rights in relation to business profits. If an enterprise resident in a contracting state has a Permanent Establishment (PE) in the other state through which it carries on business it can be taxable in that other state, as well as the state of residence. The tax is limited in the source state to no more than the profits attributable to the PE. 

Article 7(1) states the basic principle which is that the profits of an Australian enterprise may be taxed in the US only if it carries on business in the US through a permanent establishment and vice versa. In the case of an Australian enterprise, the US can only tax the profits of the enterprise to the extent that they are attributable to the permanent establishment.

It should be noted that dual-resident corporations are excluded from the term “enterprise of one of the Contracting States” by reason of the definition of an Australian or a US corporation contained in Article 3(1)(g) and the definition of residence contained in Article 4.  Such dual-resident corporations are treated as a resident of neither country for convention purposes, and therefor denied the benefit of this article and other provisions in the convention. 

The phrase ‘business profits of an enterprise’ is critical to the operation of Article 7.

The term ‘profits’ is not defined in the agreement and the question arises as to whether it includes profits which are ordinarily regarded as capital in nature or which are not derived from the carrying on of a business.

Article 3(2) of the DTA provides that, unless the context otherwise requires, a reference to profits of a business is a reference to the taxable income of the business. As capital gains are included in taxable income, the section arguably supports the view that Article 7 applies to capital gains. 

The 2006 U.S. Model Treaty Technical Explanation attempts to define business profits more generally in Article 7(1), providing that business profits are ‘income derived from any trade or business’.

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Article 7(2), which is subject to Article 7(3), provides that the profits to be attributed to a permanent establishment are those, which it might be expected to make if it were an independent enterprise engaged in similar activities under similar conditions. The profits must reflect arm’s length prices. For example, the profits of a branch must be calculated as if it were a separate entity distinct from its head office and on the basis that the branch was dealing wholly independently with its head office.

The practical application of Article 7(2) is not as straightforward as it seems. Quite often, a functional analysis needs to be done to ensure that arm’s length principles are applied properly. This includes the proper characterization of the transaction and the commercial risks undertaken by the enterprise.

Article 7(3) states that expenses that are reasonably connected with the profits of the permanent establishment and would have been deductible if the permanent establishment were an independent entity are deductible. Further, these expenses are deductible whether incurred in the Contracting State in which the permanent establishment is situated or elsewhere including executive and general administrative expenses.

Article 7(4) states that no profits are to be attributed to a permanent establishment by reason of mere purchase by that permanent establishment of goods or merchandise for that enterprise. 

Article 7(5) states that unless there is a good and sufficient reason to the contrary, the same method of determining the business profits attributable to a permanent establishment shall be used each year.

Article 7(6) states that where business profits include items of income dealt with in other articles of the Convention the provisions of those other articles override the provisions of this Article. 

Categories of income not specifically included in the definition of business profits are subject to the “overlap” rule of Article 7(6), which provides that a treaty article that governs a specific category of income (for example, the article pertaining to interest or dividends) takes precedence over the business profits article. If the item of income is attributable to a permanent establishment, it may ultimately be taxed under the business profits article anyway, because many of the treaty articles addressing specific categories of income (such as dividends and interest) provide that if the income is attributable to a permanent establishment, it is subject to taxation under the business profits article. 

Article 7(7) allows the ATO and IRS to apply any of its domestic laws to determine a person’s tax liability where the information required to make an appropriate attribution of profits to a permanent establishment is inadequate. 

Article 7(8) provides that nothing in Article 7 prevents each country from applying its domestic law to tax insurance business income provided that such law remains the same (or is modified in only minor respects) since the date the Convention was signed. or will tax the net income of a US trade or business. 

Article 7(9) applies where a fiscally transparent entity, such as a trust, has a permanent establishment in a Contracting State and a resident of the other Contracting State is beneficially entitled to a share of the business profits (beneficial owner).

Where the above requirement is satisfied then the beneficial owner is treated as carrying on a business through the permanent establishment in the Contracting State and therefore its share of the business profits of the fiscally transparent entity are taxable due to Article 7(1). 

For example, if a trust with a US beneficiary carries on a business in Australia through its trustee, and that trustee’s actions rise to the level of a permanent establishment then the US beneficiary will be treated as having a permanent establishment in Australia. This has the consequence that the profits of the trust attributable to the US beneficiary will be treated as business profits subject to Australian tax.

Article 7(9) was introduced at the request of Australia because the trustees of a trust, as the legal owner of the trust property, might be regarded as the only person having a permanent establishment.

CONCLUSION 

This article is probably one of the more difficult articles to comprehend in the DTA. For purposes of this blog, it’s important to know that a source country can’t attribute any business profits in terms of Article 7 if there is no permanent establishment in that source country. 

Our diverse team of International Tax specialists at Asena Advisors, will be able to assist you with applying this article correctly and how to accurately attribute profits to a permanent establishment. 

Shaun Eastman

Peter Harper

US-AU DTA: Article 6 – Income from Real Property

Posted on by Peter Harper

INTRODUCTION

Almost everyone dreams of one day owning their own holiday home, which they can use switch off and relax. For those dreamers with aspirations, it usually materializes through hard work and dedication. 

In practice, we often have client who are US residents with real properties situated in Australia or Australian residents with real properties situated in the US. The purpose of investing in foreign real property will not always be the same. 

However, in terms of Article 6 of the US/Australia DTA (Income from Real Property) the tax treatment will be the same. Article 6 is in reality a sourcing provision, which means that the country where the real property is situated, will have the primary taxing rights. This aligns with both Australia and US domestic law, where income from real property is treated as being sourced where the real property is located. 

In this week’s blog we will be looking at the tax implications in the context of Article 6 of the US/Australia DTA when earning income from real property situated in the other jurisdiction. 

INTERPRETING ARTICLE 6 OF THE DTA – INCOME FROM REAL PROPERTY

Article 6 of the DTA states the following: 

Income from Real Property 

(1) Income from real property may be taxed by the Contracting State in which such real property is situated.

(2) For the purposes of this Convention:

 (i) a leasehold interest in land, whether or not improved, shall be regarded as real property situated where the land to which the interest relates is situated; and 

(ii) rights to exploit or to explore for natural resources shall be regarded as real property situated where the natural resources are situated or sought.

The US and Australia taxes their residents on a worldwide basis and hence the reason why Article 6 is heavily relied upon by US and Australian residents with foreign rental properties. 

In the context of Article 6, it is important to understand what constitutes real property, also referred to as immovable property, in other treaties. 

The definition of real property is determined under the law of the country in which the property in question is located. Regardless of source country law, however, the concept of real property includes the following elements:  

  1. Property accessory to real property (immovable property);
  2. Livestock and equipment used in agriculture and forestry;
  3. Rights to which the provisions of general law respecting landed property apply;
  4. Usufruct of real property (immovable property); and
  5. Rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources, and other natural resources.

Ships and aircraft, however, are not regarded as real property (immovable property). 

When relying on a specific provision in a DTA to determine the allocation of the taxing rights between the two countries, one of the most important distinctions to understand is the following – 

  1. ‘income that may be taxed by a contracting state’ and;
  2. ‘income shall only be taxable by a contracting state’.

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Article 6(1) uses the wording may be taxed and therefore does not confer an exclusive right of taxation on the State where the property is located. It simply provides that the situs State (the country where the property is situated) has the primary right to tax such income, regardless of whether the income is derived through a permanent establishment in that State or not. The country where the income producing real property is situated, is obliged to allow a resident of the other country to elect to compute that income on a net basis as if the income were business profits attributable to a permanent establishment in the source country. This is permitted in terms of IRC §871(d) and §882(d) as well in the absence of any treaty provision. 

Article 6(2) incorporates the rule that a leasehold interest in land and rights to exploit or explore for natural resources constitute real property situated where the land or resources, respectively, are situated. Except for those cases, the definition of real property is governed by the internal law of the country where the property is situated.

CONCLUSION 

Even though Article 6 is quite straight forward, there are various other domestic nuances to take into account when calculating your foreign rental income for either US or Australian tax purposes.  

Our team of International Tax specialists at Asena Advisors, will be able to assist you with applying Article 6 correctly and how to implement same in your US or Australian tax returns.

Shaun Eastman

Peter Harper

US-AU DTA: Article 5 – Permanent Establishment

Posted on by Peter Harper

GENERAL BACKGROUND

In the unprecedented COVID-19 environment the temporary displacement of employees has given rise to many concerns from employers that it may unintentionally be creating ‘permanent establishment’ issues for them in foreign jurisdictions. This is especially relevant where employees are working through the pandemic in a different country to where they ordinarily work.

Due to COVID-19, it is common for employees of US employers to be temporarily working in Australia when they would ordinarily work in the US and vice versa. 

Tax authorities around the world are also targeting in particular ‘artificial PE avoidance’ by multinationals on foreign-sourced income.

This blog will highlight some of the key permanent establishment issues facing US and Australian taxpayers with an emphasis on Article 5 of the US/Australia DTA. 

INTRODUCTION

The fundamental rationale behind the PE concept is to allow, within certain limits, the taxation of non-resident enterprises in respect of their activities in the source jurisdiction.

Understanding the rules relating to permanent establishments (PEs) has two steps to it. 

  1. The first step is to understand when a PE exists, and 
  2. The second step is to look at how profits are attributed to that PE.

Broadly speaking, an overseas resident has a substantive presence in a state if he meets the

threshold of having a PE. At the same time, if that person is carrying on business through the PE then tax may be due in the state in which the PE is established as well as in the state of residence.

Therefore, on its own, without a business activity through it, a PE may not of itself

give rise to a tax liability.

In its simplest form a PE exists where a company is resident in one country (referred to as the head office) but also has a business conducted from a fixed base in another country (the branch). The income attributable to the other fixed base usually attracts a tax liability in the second country. 

In its more complex form of deemed PE, it is a tax “fiction” enabling tax authorities to impose corporate taxes on the deemed branch. A third type of PE is again a tax “fiction” where there is a deemed branch providing services.

INTERPRETING ARTICLE 5 OF THE DTA – PERMANENT ESTABLISHMENT

Under the US/Australia PE provision, the business profits of a resident of one treaty country are exempt from taxation by the other treaty country unless those profits are attributable to a permanent establishment located within the host country.

Article 7 of the US/Aus DTA (which will be discussed in detail in the following weeks) states that profits are taxable only in the Contracting State where the enterprise is situated “unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein,” in which case the other Contracting State may tax the business profits “but only so much of them as [are] attributable to the permanent establishment.” 

TYPES OF PERMANENT ESTABLISHMENTS

There are a few common types of permanent establishment to be aware of based on traditional approaches, although these are being modified as more business is conducted virtually over digital mediums.

Fixed Place of Business Permanent Establishment

The historical and easiest test of ‘permanent establishment’ is having a fixed place of business and can include:

    • A branch
    • An office
    • A factory
    • A workshop
    • A mine, or gas/oil well
Sales Agents

Employees that work as sales agents and have the authority to conclude contracts in the name of an enterprise may also be sufficient to create PE.  The determining requirement is that the authority must be exercised habitually, rather than once or twice.  Also, the majority of the negotiation, drafting and signing of contracts must have occurred in the host country.

Service Permanent Establishment

The areas of service PE are expanding in scope and can include situations such as providing technical or managerial services in the country.  

PRACTICAL EXAMPLES OF PERMANENT ESTABLISHMENT

Building and Construction Projects

Since building and construction projects are not “permanent” for the company, the test for PE becomes more time-based.  The time period applicable to the US/Aus DTA is a site which exists for at least 9 months may trigger PE.

Services and Consulting Projects

The analysis for services PE will revolve around the non-physical elements of permanent establishment, since there may be no office or branch in the country.

TYPES OF AGENCY PERMANENT ESTABLISHMENT

If a company uses sales agents inside a country, this type of activity may trigger permanent establishment if the agents are concluding contracts on behalf of the company.  This qualifies for the ‘revenue creation’ element of PE, and those contracts would be subject to corporate tax if the activity is habitual and ongoing.

Digital Sales and e-Commerce

An emerging area of PE is that of revenue created through the digital economy. This is extremely prevalent, especially with online platforms being used to sell goods or services worldwide. 

WHAT IS THE TAX RISK RELATED TO CREATING A PE?

When embarking on global expansion, one of the core considerations is corporate taxation on foreign sourced revenue.  While a company will typically be taxed on profits in its home country, there may be additional taxes owed in other countries of business activity.  This could affect the net profitability of entering a new country and should be part of an overall planning analysis.

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HOW WILL A PE BE TAXED?

If sufficient presence is created in a foreign country, but a multinational, this could make it liable for local corporate taxes or value-added tax (VAT).  This law basically reflects the rights of countries to tax businesses that are generating revenue through local operations, even if they maintain their principal headquarters in the home country.

The reason this becomes important for planning purposes is that a company could be subject to ‘double taxation’ on profits, since the home country could tax those amounts as well.  

The IRS will impose corporate tax on foreign companies that meet the PE criteria.  To avoid any penalties or back payments, a company should file IRS Form 8833 as a proactive claim on any treaty benefits with the US.

CONCLUSION 

To assist in managing PE issues from a US and Australian income tax perspective, taxpayers should ensure they action the following:

  • Carefully monitor and keep track of the geographical working location of employees during the COVID-19 pandemic;
  • Understand what constitutes a PE and a deemed PE;
  • Seek tax advice if due to COVID-19 you have employees temporarily exercising their employment in another country;
  • Seek tax advice if your business tax model has changed due to COVID-19 and could potentially place you at risk of creating a PE; and
  • monitor and carefully consider official guidance in respect of “permanent establishment” issues (ie. from the ATO, IRS, OECD and other relevant foreign authorities);

The global pandemic has changed the way businesses conduct business. It has also created opportunities for new businesses to conduct business exclusively on online platforms, without physically being present in the country the services are provided or goods are sold. 

Our team of International Tax specialists at Asena Advisor, have an in-depth knowledge of how to interpret international tax treaties and how to ensure you mitigate any potential PE risks associated with your business. 

Shaun Eastman

Peter Harper

US-AU DTA: Article 4 – Residence

Posted on by Peter Harper

GENERAL BACKGROUND

In this week’s blog, we will be discussing Article 4 of the DTA (Residence), with a specific focus on its applicability to individuals.

A person’s residence for treaty purposes is a key consideration when applying the DTA. Not only because this allows a person to claim certain treaty benefits, but also because the treaty will allocate taxing rights to the state of residence or the state of source. It is therefore vital to know where a person is resident for such purposes. 

INTRODUCTION

Article 4 contains ‘residency tie-breakers’ to determine residence for both individuals and companies.

When the domestic law of the US and Australia result in claimed residency by both countries, the taxpayer must apply the treaty’s residency tie-breaker provisions. The reason it is important is because residency determines the taxation of many important types of income, such as dividends, interest, royalties, capital gain, pension distributions, retirement pay, annuities, and alimony.

It should be noted that these tiebreakers, for companies and individuals, apply for the purposes of the treaty and so determine a sole state as the place of residence for treaty purposes only. A person does not cease to be resident of either state for domestic law purposes unless the domestic law specifically states this. 

For instance, in South Africa, the definition of ‘resident’ in Article 1 of the Income Tax Act No. 58 of 1962 includes a provision whereby the definition of ‘residence’ contained in any DTA between South Africa and another country overrides the domestic definition of a resident. So, this is an example whereby a person will cease its residency should they be regarded as an exclusive resident of another contracting states. Herewith an extract of the provision – 

‘But does not include any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between the governments of the Republic and that other country for the avoidance of double taxation.’

This however does not apply to Article 4 of the DTA between the US and Australia. One should therefore be careful when applying Article 4 and what limitations apply to the specific DTA’s definition of residence. 

INTERPRETING ARTICLE 4 OF THE DTA – RESIDENCE

The country of residence generally gets the most exclusive taxing rights. When an individual is determined to be a tax resident under the domestic law of two countries that have an income tax treaty with one another, there are a set of factors that ‘break the tie’. When interpreting the specific terms as set out below, one should look at the domestic interpretation of the US/Australia respectively and at the OECD commentary on Article 4 of the Model Tax Convention.

The country of residency for purposes of the DTA is determined by applying the following tie-breaker clauses in the US-Australia DTA.

Tie-breaker 1: 

Permanent home – first, the country in which the individual maintains a permanent home. If the individual has a permanent home in only one of the Contracting States, the individual will be treated as a resident of that State for treaty purposes.

The IRS states that a permanent home is one that is retained for permanent and continuous use and is not a place retained for a short duration. An individual has a permanent home in the US if he or she purchased a home in the United States, intended to reside in that home for an indefinite time, and did reside in that home. Individuals may also have a permanent home where:

    1. a room/apartment is continuously available to them, 
    2. their personal property (e.g., automobiles, personal belongings) is stored at a dwelling, and 
    3. they conduct business (e.g., maintaining an office, registering a telephone), including using such addresses for insurance and a driver’s license.

The OECD describes a permanent home to be a home that the:

‘Individual has arranged to have the dwelling available to him at all times continuously and not occasionally’. 

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Tie-breaker 2: 

Habitual abode – second, if the individual’s permanent home cannot be determined, then the state in which he has a habitual abode. 

The IRS states the following in this regard:

“An individual’s habitual abode is located in the Contracting State in which the individual has a greater presence during a calendar year. Although the length of time is not specified, the comparison must cover sufficient length of time and take into account the intervals at which the stays take place for it to be possible to determine where residence is habitual. For example, an individual who is present in the United States more frequently and at longer intervals than in the other Contracting State during a calendar year likely has a habitual abode in the United States. Determine whether the individual has a habitual abode in the United States by calculating how much time the individual spent in in the United States in a tax year…” 

The OECD explains that a habitual abode refers to the frequency, duration and regularity of stays that are part of the settled routine of an individual’s life and is therefore more than transient. 

There is no specific commentary on the Australian interpretation of the words habitual abode in the context of the Treaty, only the words habitual place of abode in the context of the statutory definition of resident in section 6 ITAA 1936. However, the Courts consider the Commentary on the OECD Model Tax Convention as authoritative guidance on the interpretation of Tax Treaties.  

Tie-breaker 3: 

Closer connections – third, if the individual has a habitual abode in both countries or in neither, then the country in which the individual has closer economic or personal relations, with regard being given to the country of citizenship. 

The IRS considers the following factors in this regard:

Personal relations:

    1. Family location – Includes parents and siblings, and where the individual spent his or her childhood. 
    2. Recent relocation – Whether the family moved from their permanent home to join the individual, or the individual relocated to a second state (for example, as a result of marriage). 

Community relations: 

Determine where the individual has his or her:

    1. health insurance, 
    2. medical and dental professionals, 
    3. driver’s license/motor vehicle registration, 
    4. health club membership, 
    5. political and cultural activities, and 
    6. ownership of bank accounts. 

Economic relations: 

Determine where the individual:

    1. keeps his or her investments or conducts business, 
    2. incorporated his or her business, and retains professional advisors (e.g., attorneys, agents, and The center of vital interests can shift, when an individual retains ties in one State but establishes ties in a second State, and all surrounding facts and circumstances must be considered in determining the individual’s center of vital interests. For example, the IRS states that evidence that an individual has executed contracts relating to his or her business in the second State may indicate that the center of vital interests is in the second State. 

CONCLUSION

It is of utmost importance to ensure that you understand how to apply the tie-breaker provisions set out in Article 4(2) of the US/Australia DTA. Secondly, it is important to note that by being regarded as a resident in terms of the DTA, does not automatically cease your tax residency. Especially if you are a US citizen living in Australia. It should only be applied for purposes of the treaty and allocating the taxing rights accordingly. 

Our team of International Tax specialists at Asena Advisor, have an in-depth knowledge of how to interpret international tax treaties and how to correctly apply the tie-breaker provisions.

Shaun Eastman

Peter Harper

US-AU DTA: Article 3 – General Definitions

Posted on by Peter Harper

GENERAL BACKGROUND

Last week we discussed the taxes covered by the DTA as set out in Article 2. In this week’s blog, we will be discussing Article 3 of the DTA – General Definitions; it is important to understand the application of the defined terms in the DTA and its interpretation by either US or Australian courts. I am not going to explain every definition set out in Article 3, but rather focus on certain specific terms and their interpretation.

INTRODUCTION

Article 3 provides general definitions and rules of interpretation applicable throughout the DTA. Certain other terms are defined in other articles of the DTA. For example, the term “resident” is defined in Article 4 (Residence), the term “permanent establishment” is defined in Article 5 (Permanent Establishment), and the term “royalties” is defined in Article 12 (Royalties).

INTERPRETING ARTICLE 3 OF THE DTA – GENERAL DEFINITIONS

Article 3 of the DTA can be broken down into two parts. Paragraph 1 defines some principal terms used throughout the DTA and Paragraph 2 makes provision for terms not defined in the DTA and how they should be interpreted.

Paragraph 1

The definitions of the terms ‘person’, “company”, “enterprise of a Contracting State”, and “international traffic” are similar to the definitions in the U.S. Model. The “competent authority” for the United States is the Secretary of the Treasury or his delegate and for Australia the Commissioner of Taxation or his authorized representative. The terms “United States” and “Australia” are defined to include the continental shelf areas of the two countries for exploration and exploitation of their natural resources. Definitions are provided for the terms “Contracting State,” “State,” “United States tax,” ”Australian tax,” and “resident of one of the Contracting States.”

The definitions of a ‘United States corporation’ and an ‘Australian corporation’ in terms of the DTA are of importance. The DTA specifically excludes from these definitions, corporations under the laws of the Contracting States are residents of both States. A corporation created and organized under the laws of a state of the United States is considered by the United States to be a United States corporation; but such a corporation could also be considered by Australia to be an Australian corporation if it is managed and controlled in Australia or if it does business there and its voting power is controlled by Australian resident shareholders. If such a situation does arise, the dual resident corporation is not considered a resident of either country for purposes of the Treaty and is therefore not entitled to benefits granted by either State under the Treaty to residents of the other State.

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Paragraph 2

Paragraph 2 provides that terms not defined in the Convention shall have the meaning which they have under the laws of the Contracting State concerning the taxes to which the Convention applies unless the context of the Convention requires a different interpretation.

Under the terms of Article 24 (Mutual Agreement Procedure), the competent authorities may agree on a common definition of an otherwise undefined term. The term “context” includes the purpose and background of the provision in which the term appears. An agreement by the competent authorities for the meaning of a term used in the Convention would supersede conflicting meanings in the domestic laws of the Contracting States. Difficulties arise when international rules of interpretation are applied to a DTA which may differ from a state’s domestic fiscal interpretation. Such a conflict might arise because on an international level the courts would look to the Vienna Convention (for example, the interpretation of matters such as non-defined terms in Article 3(2), multi-lingual versions of the treaty, aids to interpretation such as external materials, etc.), which would then need to be compared with the domestic approach to statutory fiscal interpretation. The domestic approach may differ, for example, the domestic law may require a more literal approach; the natural vs the specific meaning of words in the statute, the use of the OECD commentary; the application of Article 3(2) of the treaty for non-defined terms (and possible conflict between the contracting states as to such definitions); domestic case law precedent etc.

A further issue that should be highlighted is the timing of the enactment of a treaty and the subsequent domestic law of a contracting state which may be applicable under Article 3(2).

The question is whether the “static approach” or the “ambulatory approach” to interpretation should be taken. The static approach means the term has the meaning given under domestic law at the time the treaty was entered into – which may be different from the meaning at the time the term is being applied (due to changes in domestic law, for example). The ambulatory approach means the term has the meaning which it has under the contracting state’s domestic law as that is amended from time to time. So the interpretation of the term can be at a later date from the entering into of the treaty.

These two approaches may give rise to the conflict concerning undefined terms within a treaty, however, it should be noted that the ambulatory approach is generally seen as the more common method of interpretation of undefined terms. (This approach was used in the US case of Kappus v Commissioner, 337 F. 3d 1053 (DC Cir. 2003)). In addition, the OECD commentary itself supports the ambulatory approach to interpretation.

CONCLUSION

Due to the different approaches taken to the rules of interpretation for treaties or conventions and the approaches applied to the interpretation of domestic fiscal legislation, Article 3 (2) could be seen as leading to an apparent dichotomy.

It is therefore recommended to make sure that your international structure does not fall within terms not defined in the DTA as this could lead to an expensive exercise to resolve.

Our team of International Tax specialists at Asena Advisor has an in-depth knowledge of how to interpret international tax treaties and ensure that your international structure is not open to ambiguity.

Shaun Eastman

Peter Harper

US-AU DTA: Article 2 – Taxes Covered

Posted on by Peter Harper

GENERAL BACKGROUND

Last week we discussed the scope and limitations of the DTA as set out in Article 1.

In this week’s blog, we will be discussing Article 2 of the DTA – Taxes Covered.

This DTA is for the avoidance of double taxation and the prevention of fiscal evasion concerning taxes on income.

It, therefore, does not include taxes that fall outside the scope of Article 2. For examples Gift and Estate, Taxes are covered in the Gift Tax and Estate Tax Treaty respectively.

INTRODUCTION

Article 2 is intended to make the terminology and nomenclature relating to the taxes covered by the DTA more acceptable and precise, to ensure identification of the US and Australian taxes are covered by this convention. Further to widen as much as possible the field of application of the DTA by including as far as possible and in harmony with the domestic laws of the US and Australia imposed and to avoid the necessity of concluding a new DTA whenever the domestic laws of either the US or Australia are modified.

Shaun the only point I would add is that to the extent that a DTA is silent then that item is taxed under domestic law.  DTAs are not all-encompassing in that regard.  Otherwise, it is good.

INTERPRETING ARTICLE 2 OF THE DTA – TAXES COVERED

Article 2 of the DTA states the following –

(1) The existing taxes to which this Convention shall apply are:

(a) in the United States: the Federal income taxes imposed by the Internal Revenue Code; and

(b) in Australia:

(i) the Australian income tax, including a tax on capital gains; and

(ii) the resource rent tax in respect of offshore projects relating to exploration for or exploitation of petroleum resources, imposed under the federal law of Australia.”.

(2) This Convention shall also apply to any identical or substantially similar taxes which are imposed by either Contracting State after the date of signature of this Convention in addition to, or in place of, the existing taxes. At the end of each calendar year, the competent authority of each Contracting State shall notify the competent authority of the other Contracting State of any substantial changes which have been made during that year in the laws of his State relating to the taxes to which this Convention applies or in the official interpretation of those laws or of this Convention.

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Paragraph 1

US Taxes Covered –

Sub-paragraph (1)(a) of Article 2 provide that all U.S. income taxes are covered taxes for purposes of the Convention. Thus, the accumulated earnings tax and the personal holding company tax are also covered taxes because they are income taxes, and they are not otherwise excluded from coverage. Under the Code, these taxes will not apply to most foreign corporations because of either a statutory exclusion or the corporation’s failure to meet a statutory requirement.

The DTA excludes social security taxes and excise taxes, such as those imposed on private foundations and foreign insurers, from the taxes covered by the Convention.

Australian Taxes Covered –

Sub-paragraph (1)(b) of Article 2 provides that the covered taxes are the Australian income tax, including a tax on capital gains, and the resource rent tax in respect of offshore projects relating to exploration for or exploitation of petroleum resources (“RRT”), imposed under the federal law of Australia.

The specific reference to the Australian capital gains tax makes it clear that U.S. taxpayers receive a foreign tax credit for Australian capital gains taxes paid.

Concerning the RRT being covered Australian taxes mean that the provisions of the DTA, including Article 5 (Permanent Establishment), Article 7 (Business Profits), and Article 27 (Miscellaneous), generally will apply to the RRT.

However, the effect of the Protocol’s modification to Article 22 (Relief from Double Taxation) is that even though the RRT is a covered tax, the United States is not required by the Convention to grant a U.S. foreign tax credit for RRT paid to Australia. Whether the RRT is creditable therefore is determined under U.S. domestic law.

Paragraph 2

Under paragraph 2, the DTA will apply to any taxes that are identical, or substantially similar, to those enumerated in paragraph 1, and which are imposed in addition to, or place of, the existing taxes after the date of signature of the Convention. The paragraph also provides that the competent authorities agree to notify each other at the end of each calendar year of substantial changes in their income tax laws or the official interpretation of those laws or the Convention.

CONCLUSION

Ensure that you understand the taxes that are covered by this DTA. First and foremost, you need to identify the type of income generated before relying on the DTA.

It is important to note, that to the extent that a DTA is silent on a specific type of tax, that item is taxed under domestic law.  DTAs are not all-encompassing in that regard. 

The DTA only applies to US Federal Income Taxes, which implies that it does not extend to State taxes. You will therefore not be able to claim treaty relief for state taxes paid in the US.

Furthermore, Estate and Gift Taxes are covered in separate treaties and do not fall within the ambit of this DTA.

It will be interesting to see how the US and Australia interpret the taxation of Cryptocurrencies in terms of the DTA. Even though there is sufficient coverage currently we might see some amendments soon.

Our team of International Tax specialists at Asena Advisor has an in-depth knowledge of how to interpret international tax treaties and how to ascertain their applicability to your specific circumstances.

Shaun Eastman

Peter Harper