Tag: expat

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 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

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 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