Tag: tax

US-AU DTA: Article 16 – Limitation of Benefits

Posted on by Peter Harper


INTRODUCTION

In this week’s blog we will be discussing the technical Limitation of Benefits (LoB) Article (Article 16) of the US/Australia DTA.

Article 16 states that, in addition to being a resident of the US or Australia, taxpayers need to satisfy the requirements of Article 16 to obtain the benefits of the DTA. 

In particular, the benefits of the DTA are only available if the resident is:

  1. A qualified person (Article 16(2));
  2. Actively engaged in a trade or business (Article 16(3)); or
  3. Entitled to treaty relief because the IRS or ATO makes a determination (Article 16(5)).

The purpose of these restrictions is to prevent residents of third countries from using interposed companies or other entities resident in either Australia or the US to access treaty benefits, also commonly referred to as treaty shopping. 

Treaty shopping is the use by residents of third countries of legal entities established in either the US or Australia with a principal purpose of obtaining the benefits of the US/Australia DTA. 

INTERPRETING ARTICLE 16 OF THE DTA – LIMITATION OF BENEFITS

Article 16(1) stipulates that except as otherwise provided in Article 16 only residents of the US or Australia for the purposes of the DTA that are qualified persons are entitled to the benefits otherwise available under the DTA. 

The benefits otherwise available under the DTA to residents are all limitations on source-based taxation under Article 6 through 15 and Article 17 through 21, the treaty-based relief from double taxation provided by Article 22 (Relief from Double Taxation), and the protection afforded to residents of a Contracting State under Article 23 (Non-discrimination). 

The limitation in Article 16 does however not apply where a person is not required to be a resident in order to enjoy the benefits of the DTA. For example, Article 26 (Diplomatic and Consular Privileges) applies to diplomatic and consular privileges regardless of residence.

Article 16(2) lists the eight categories of resident that will constitute a qualified person for a taxable year and thus will be entitled to all benefits of the DTA provided that they otherwise satisfy the requirements for a particular benefit. It is therefore important to note that the tests must be satisfied for each year that benefits under the DTA are sought.

Article 16(2)(a) – Individuals 

Article 16(2)(a) states that individual residents of a Contracting State will be a qualified person and hence entitled to rely on the DTA. 

However, the definition of US resident in Article 4(1)(b)(ii) excludes citizens who are also a resident of another country with which Australia has a DTA.  In addition, an individual that receives income as a nominee on behalf of a third country resident, may be denied the benefits of the DTA due to the beneficial ownership requirement in Article 10 for example, despite meeting the requirement in Article 16(2)(a).

Article 16(2)(b) – Governmental bodies

Article 16(2)(b) states that the Contracting State, any political subdivision or local authority of the state, or any agency or instrumentality of the state will be a qualified person and hence entitled to rely on the DTA. 

Article 16(2)(c)(i) – Publicly traded companies

Article 16(2)(c)(i) states that a resident company will be a qualified person in the following circumstances:

  • Its principal class of shares is listed on a US or Australian stock exchange; and
  • Those shares are regularly traded on one or more recognized stock exchanges.

Article 16(2)(c)(ii) – Subsidiary companies

Article 16(2)(c)(ii) states that a resident company will be a qualified person if:

  • At least 50% of the aggregate vote and value of its shares are owned directly or indirectly by five or fewer companies that are qualified persons due to Article 16(2)(c)(i); and
  • In the case of indirect ownership, each intermediate shareholder is a resident of either the US or Australia.

Article 16(2)(d) – Other listed entities

Article 16(2)(d) states that certain publicly traded entities (other than companies) and entities beneficially owned by certain publicly traded entities or companies may be qualified persons and hence entitled to rely on the DTA. 

Article 16(2)(d)(i) – Publicly traded entities

 Article 16(2)(d)(i) states that a resident entity that is not an individual or a company is a qualified person if:

  • The principal class of units is listed or admitted to dealings on US or Australian stock exchange; and
  • These units are regularly traded on one or more recognized stock exchanges.

Article 16(2)(d)(ii) – Other Entities

Article 16(2)(d)(ii) states that a resident entity that is not an individual or a company will be a qualified person if at least 50% of the beneficial interests in the entity are owned directly or indirectly by five or fewer companies that are a qualified person due to Article 16(2)(c)(i) or publicly owned entities that satisfy the requirements of Article 16(2)(d)(i).

Article 16(2)(e) – Tax exempt organizations

Article 16(2)(e) states that a resident religious, charitable, educational, scientific or other similar organizations is a qualified person if:

  • It is organized under the laws of the US or Australia; and
  • Was exclusively established and maintained for a religious, charitable, educational, scientific or other similar purpose.

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Article 16(2)(f) – Pension funds

Article 16(2)(f) states that a pension fund is a qualified person if:

  • It is organized under the laws of either the US or Australia;
  • Established and maintained to provide pensions or similar benefits to employed or self-employed persons pursuant to a plan; and
  • More than 50% of the beneficiaries, members or participants are individuals resident in either the US or Australia.

Article 16(2)(g) – Unlisted entities

Article 16(2)(g) states that a person other than an individual that is a resident of either the US or Australia is a qualified person and hence entitled to rely on the DTA if both an ownership and base erosion test are satisfied. 

However, one or more of the following categories of qualified persons must principally own the unlisted entity directly or indirectly:

  • Individuals who are residents in the US or Australia (Article 16(2)(a));
  • Government bodies of the US or Australia (Article 16(2)(b); and
  • Entities resident in either the US or Australia that satisfy public listing and trading requirements in Article 16(2)(c)(i) and Article 16(2)(d)(i)).

Ownership test — companies

Article 16(2)(g)(i) requires that 50% or more of the aggregate voting power and value of the company must be owned directly or indirectly on at least half the days of the company’s taxable year by certain qualified persons.

Ownership test — trusts/partnerships

Article 16(2)(g)(i) requires that 50% or more of the beneficial interests of entities other than companies must be owned directly or indirectly on at least half the days of the entity’s taxable year by certain qualified persons.

Base erosion test

Article 16(2)(g)(ii) disqualifies a person that satisfies the requirement in Article 16(2)(g)(i) if 50% or more of the unlisted entity’s gross income for the taxable year is paid or accrued (directly or indirectly) to a person or persons who are not residents of either Contracting State in the form of payments deductible for tax purposes in the payer’s state of residence. 

Article 16(2)(h) – Headquarters companies

Article 16(2)(h) states that a resident of the US or Australia that is a recognized headquarters company (RHC) for a multinational corporate group (MCG) is a qualified person and hence entitled to rely on the DTA.

A RHC is a US or Australian resident company where:

  • It has a substantial involvement in the supervision and administration of companies forming the MCG.
  • The MCG being supervised is engaged in an active business in at least five countries and each company generates at least 10% of the gross income of the MCG. 
  • The gross income from any single country where a MCG member carries on business activities must be less than 50% of the gross income of the MCG.
  • No more than 25% of the gross income of the RHC can be derived from the other Contracting State.
  • The supervision and administrative activities for the MCG are carried out by the RHC independently of any other person.
  • Generally applicable taxation rules apply in its country of residence.
  • Income derived in the other Contracting State is attributable to the active business activities carried on by MCG members in that state.

Article 16(2)(h)(i) – Supervision and Administration

Article 16(2)(h)(i) requires that to be a RHC, the company must provide in its state of residence a substantial portion of the overall supervision and administration of the MCG. 

Article 16(2)(h)(ii) – Active business

Article 16(2)(h)(ii) requires that the MCG supervised by the headquarters company must consist of corporations that are residents in, and engaged in active trades or businesses in, at least five countries. In addition the business activities carried on in each of the five countries (or groupings of countries) must generate at least 10% of the gross income of the MCG

Article 16(2)(h)(iii) – Single country income limitation

Article 16(2)(h)(iii) requires that the business activities carried on in any one country other than the headquarters company’s state of residence must generate less than 50% of the gross income of the MCG. If the gross income requirement under this clause is not met for a taxable year, the taxpayer may satisfy this requirement by averaging the ratios for the four years preceding the taxable year.

Article 16(2)(h)(iv) – Gross income limitation

Article 16(2)(h)(iv) requires that no more than 25% of the headquarters company’s gross income may be derived from the other Contracting State. 

Article 16(2)(h)(v) – Independent supervision of MCG

Article 16(2)(h)(v) requires that the headquarters company have and exercise independent discretionary authority to carry out the supervision and administration functions for the MCG. 

Article 16(2)(h)(vi) – Taxation rules

Article 16(2)(h)(vi) requires that the headquarters company be subject to the generally applicable income taxation rules in its country of residence.

Article 16(2)(h)(vii) – Income derived from the other Contracting State

Article 16(2)(h)(vii) requires that the income derived in the other Contracting State be derived in connection with or be incidental to the active business activities referred to in Article 16(2)(h)(ii).

Article 16(3) states that a resident of a Contracting State that is not a qualified person under Article 16(2) is a qualified person for certain items of income that are connected to an active trade or business conducted in the other Contracting State.

In broad terms, the benefits of the DTA will be available if the person resident in the US or Australia:

  • Is engaged in the active conduct of a trade or business in their state of residence;
  • The income derived in the other Contracting State is derived in connection with or incidental to the trade or business conducted in their state of residence; and
  • The trade or business activity in the person’s state of residence is substantial in relation to the activity in the state of source of an item of income.

Article 16(3)(a) firstly requires that a resident of the US or Australia must be engaged in the active conduct of a trade or business in their state of residence. However, a business of making or managing investments for the resident’s own personal account is not regarded as an active trade or business unless these activities are banking, insurance or securities activities carried on by a bank, insurance company or a registered, licensed or authorised securities dealer. 

Secondly, the income derived in the other Contracting State must be derived in connection with or incidental to the trade or business conducted in the state of residence.

Article 16(3)(b) states that where a person or an associate carries on a trade or business in the other Contracting State which gives to an item of income the trade or business carried on in the state of residence must be substantial in relation to the activity in the state of source of the income. 

The substantiality requirement is intended to prevent a narrow case of treaty shopping abuses in which a company attempts to qualify for benefits by engaging in de minimis connected business activities in the treaty country in which it is resident. 

The substantiality requirement only applies to income from related parties. 

Article 16(3)(c) states that where a person is engaged in the active conduct of a trade of business then the following will be deemed to be part of that activity:

  • Partnership activities provided the person is a partner, and
  • Activities of connected persons.

There are three circumstances in which a person will be connected to another person are, firstly, if either person possesses at least 50% of the:

  • Beneficial interest of the other;
  • Aggregate vote and value of a company’s shares; or
  • Beneficial equity interests of the company.

Secondly, if another person possesses directly or indirectly, at least 50% of the:

  • Beneficial interest;
  • Aggregate vote and value of a company’s shares; or
  • Beneficial equity interest in the company in each person.

Thirdly, a person is connected to another person if the relevant facts and circumstances indicate that:

  • One has control of the other; or
  • Both are under the control of the same person or persons.

The above rule is of particular importance to holding companies since they will generally not be able to satisfy Article 16(3)(a) due to the fact that they are managing investments for their own account.

Article 16(4) is an anti-avoidance provision and denies the benefits of the DTA where a company has issued shares that entitle the holders to a portion of the income from the other state that is larger than the portion of such income that holders would otherwise receive.

Article 16(5) states that the competent authorities of the US and Australia can grant the benefits of the DTA to a resident of the relevant Contracting State if they are not a qualified person in accordance with Article 16(2). However, to exercise this discretion the IRS or ATO has to determine that the establishment, acquisition or maintenance of such a person and the conduct of its operations did not have the principal purpose of obtaining the benefits of the DTA.

Article 16(6) defines the term “recognized stock exchange” as:

  1. The NASDAQ System owned by the National Association of Securities Dealers and any stock exchange registered with the Securities and Exchange Commission as a national securities exchange for purposes of the Securities Exchange Act of 1934
  2. The Australian Stock Exchange and any other Australian stock exchange recognized as such under Australian law, and
  3. Any other stock exchange agreed upon by the competent authorities of the Contracting States.

Article 16(7) lastly states that nothing in Article 16 restricts, in any manner, the ability of the Contracting States to enact and enforce the anti-avoidance provisions in their domestic tax laws.

CONCLUSION 

The Limitation on benefits clause is drafted with the intention of avoiding treaty shopping.

When planning an international structure it is therefore crucial to ensure compliance with Article 16. Failure to plan properly could result in a loss of valuable benefits and can render the structure ineffective. 

To achieve optimal results, immediate business concerns of the client should be carefully balanced with the long-term goals to ensure the establishment of activities in the most favorable environment. 

Our team of International Tax specialists at Asena Advisors, will be able to assist you with your international tax planning and ensure that Article 16 is adhered to.

Our team of International Tax specialists at Asena Advisors, will be able to assist you with submitting the relevant forms in the US and Australia to get access to these relief measures.  

Shaun Eastman

Peter Harper

US-AU DTA: Article 15 – Dependent Personal Services

Posted on by Peter Harper

INTRODUCTION

In this week’s blog we will be discussing the tax implication of rendering dependent personal services as stipulated in Article 15 of the US/Australia DTA. 

The main purpose of Article 15 is to ensure that income derived by an individual who is a resident of the US or Australia as an employee or director in the other country is taxed appropriately.

In terms of Article 15 the source state will have taxing rights on such income if the individual is present in that state for a certain period of time. 

INTERPRETING ARTICLE 15 OF THE DTA – DEPENDENT PERSONAL SERVICES

Article 15(1) sets out the basis upon which the remuneration derived by employees and directors should be taxed. Pensions, annuities, and remuneration of government employees are covered by Article 18 and 19 of the DTA and therefore not covered in terms of Article 15.

Generally, other salaries, wages, directors’ fees, etc derived by a resident of one country from an employment exercise or services performed as a director of a company in the other country will be taxed in that other country. 

Article 15(2) includes an exemption from tax in the country being visited where the visits are only for a limited period. The conditions for exemption are:

  1. That the visit or visits not exceed, in the aggregate, 183 days in the year of income of the country visited;
  2. That the remuneration is paid by, or on behalf of, an employer or company who is not a resident of the country being visited, and
  3. That the remuneration is not deductible in determining taxable profits of a permanent establishment, fixed base or a trade or business which the employer or company has in the country being visited.

Where these conditions are met, the remuneration derived in the source state will be taxed only in the country of residence.

Article 15(3) stipulates that income derived from employment aboard a ship or aircraft operated in international traffic is to be taxed in the country of residence of the operator. The US Treasury however explained that under US law, the US taxes such income of a non-resident alien only to the extent it is derived from US sources (i.e. in US territorial waters). This paragraph does not confer an exclusive taxing right. 

Article 15(3) does not confer an exclusive taxing right and both countries retain the right to tax their residents and citizens under Art 1(3) of the DTA (Personal scope).

Remuneration derived by US residents from employment in Australia may in terms of Article 15 of the DTA, be taxable in the US rather than Australia if the remuneration is paid in respect of a visit not exceeding 183 days in the year by an employer who is not resident in Australia and has no permanent establishment in Australia.

Asena Advisors is the only multi-disciplinary (Accounting and Legal) international CPA firm in the United States that specializes in U.S. -Australia taxation.
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COVID RELIEF

Both the US and Australia implemented certain relief measures for individuals who inadvertently spent more than 183 days in the source due to the Covid pandemic. 

US Covid Relief Measures

Days that you were unable to leave the US either because of a medical condition that arose while were in the US or where you were unable to leave the US due to COVID-19 travel disruptions, you may be eligible to exclude up to 60 consecutive days in the US during a certain period.

Australia Covid Relief Measures

The ATO recognized that the Covid pandemic has created a special set of circumstances that need to be taken into account when evaluating the source of the employment income earned by a foreign resident who usually works overseas but instead performed that same foreign employment in Australia. If the remote working arrangement is short term (3 months or less), the income from that employment will not have an Australian source. However, for working arrangements longer than 3 months, an individual’s personal circumstances need to be examined to ascertain if the employment is connected to Australia. Employment income (ie salary or wages) is likely to be determined as having an Australian source if:

    • The terms and conditions of the employment contract change;
    • The nature of the job changes;
    • Work is performed for an Australian entity affiliated with the overseas employer;
    • The economic impact or result of the work shifts to Australia;
    • The employing entity is in Australia;
    • Work is performed with Australian clients;
    • The performance of the work depends on the individual being physically present in Australia to complete it;
    • Australia becomes the individual’s permanent place of work;
    • The individual’s intention towards Australia changes.

Income earned from paid leave (such as annual or holiday leave) while in Australia temporarily does not need to be declared in Australia. 

CONCLUSION 

Individuals should therefore make sure that they do not unnecessarily file tax returns in the source state if their stay was extended due to Covid related measures.  

Our team of International Tax specialists at Asena Advisors, will be able to assist you with submitting the relevant forms in the US and Australia to get access to these relief measures.  

Shaun Eastman

Peter Harper

US-AU DTA: Article 14 – Independent Personal Services

Posted on by Peter Harper

INTRODUCTION

In this week’s blog we will be discussing the tax implication of rendering Independent Personal Services as stipulated in Article 14 of the US/Australia DTA. Article 14 is luckily far less complex than our previous blogs. 

The main purpose of Article 14 is to ensure that income derived by an individual who is a resident of the US or Australia from the performance of personal services in an independent capacity in the other country is taxed appropriately.

INTERPRETING ARTICLE 14 OF THE DTA – INDEPENDENT PERSONAL SERVICES

In terms of US domestic legislation, income earned by a non-resident individual for personal services rendered in the US which are of an independent nature is taxed at a flat rate of 30%.

Income derived by an individual who is a resident of either the US or Australia for rendering independent personal services in the other country will be taxed in that other country in which the services are performed if:

Article 14(a) – the recipient is present in that country for a period or periods aggregating more than 183 days in the year of income (or taxable year) of the country visited, or

Article 14(b) – that person has a ‘fixed base’ regularly available in that country for the purpose of performing their activities, and the income is attributable to activities exercised from that base.

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Only the country of residence can tax this income if neither of the 2 tests above are met. The US Treasury Department noted that its understanding of the term fixed base is similar to the term permanent establishment.

Independent personal services include all personal services performed by an individual for their own account which includes any services performed as a partner in a partnership. This however does not include services performed as a director of a company which will be covered by Article 15 of the DTA – Dependent personal services.

Lastly, it is important to note that these personal services include all independent activities and are not limited to specific professions. 

CONCLUSION 

The interpretation by courts of Article 14 post COVID will be quite interesting as the way we conduct business has shifted significantly and could perhaps see an amendment to this article in the new future. 

Our team of International Tax specialists at Asena Advisors, will be able to guide you on how to interpret and apply Article 14 to your specific circumstances.

Shaun Eastman

Peter Harper

US-AU DTA: Article 13 – Alienation of Property

Posted on by Peter Harper

INTRODUCTION

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

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

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

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

INTERPRETING ARTICLE 13 OF THE DTA – ALIENATION OF PROPERTY 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

This rule has two significant consequences –

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

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

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

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

CONCLUSION 

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

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

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

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 12 – Royalties

Posted on by Peter Harper

INTRODUCTION

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

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

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

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

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

INTERPRETING ARTICLE 12 OF THE DTA – ROYALTIES

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

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

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

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

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

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

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

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

Component 1 – Intellectual property 

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

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

  (ii) motion picture films, or

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

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

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

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

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

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

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

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

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

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

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

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

Component 3 – Disposition of property that is contingent

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

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

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

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

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

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

CONCLUSION 

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

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

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

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

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 11 – Interest

Posted on by Peter Harper

INTRODUCTION

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

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

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

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

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

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

INTERPRETING ARTICLE 11 OF THE DTA – INTEREST

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Example:

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

CONCLUSION

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

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

Shaun Eastman

Peter Harper