Tag: property

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 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 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