Tag: tax

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’. 

We are the only multi-disciplinary international CPA firm in the United States that specializes in U.S.– Australia taxation.
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Tie-breaker 2: 

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

The IRS states the following in this regard:

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

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

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

Tie-breaker 3: 

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

The IRS considers the following factors in this regard:

Personal relations:

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

Community relations: 

Determine where the individual has his or her:

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

Economic relations: 

Determine where the individual:

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

CONCLUSION

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

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 3 – General Definitions

Posted on by Peter Harper

GENERAL BACKGROUND

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

INTRODUCTION

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

INTERPRETING ARTICLE 3 OF THE DTA – GENERAL DEFINITIONS

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

Paragraph 1

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

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

We are the only multi-disciplinary international CPA firm in the United States that specializes in U.S.– Australia taxation.
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Paragraph 2

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

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

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

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

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

CONCLUSION

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

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

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 2 – Taxes Covered

Posted on by Peter Harper

GENERAL BACKGROUND

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

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

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

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

INTRODUCTION

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

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

INTERPRETING ARTICLE 2 OF THE DTA – TAXES COVERED

Article 2 of the DTA states the following –

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

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

(b) in Australia:

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

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

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

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Paragraph 1

US Taxes Covered –

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

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

Australian Taxes Covered –

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

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

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

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

Paragraph 2

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

CONCLUSION

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

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

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

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

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

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 1 – Personal Scope

Posted on by Peter Harper

GENERAL BACKGROUND

In this series, we will be discussing the Convention Between the Government of the United States of America and the Government of Australia for the Avoidance of Double Taxation and Fiscal Evasion concerning Taxes on Income 1982 and the 2001 protocol (DTA). 

These series aim to make sure the reader has a comprehensive understanding of the DTA and how to interpret and apply it correctly. 

The only way to get a comprehensive understanding of the DTA is to make sure you understand every article on its own. 

If the reader is anything like my wife, you will probably question the above statement and see it as a way of me dragging it out. Especially considering that the DTA only consists of 29 Articles in a 27-page document. How complicated can it be?

Well just to give you some perspective, the US bases all its DTAs on the US Model Tax Treaty. This model is used as a foundation and guideline on how to draft specific DTAs with various countries. The US Model Tax Treaty also has a Technical Explanation to understand how to interpret and apply a DTA. The technical explanation is 92 pages long. 

Most countries in the world (excluding the US) follow the Organization of Economic Co-operation and Development’s (OECD) Model Tax Convention which consists of 32 Articles. The commentary on the OECD’s Model Tax Convention is 658 pages. 

I would therefore recommend not taking international tax advice from my wife or any advisor who summarizes the DTA in one or two pages. It’s not that simple. 

In this week’s blog, we will discuss Article 1 of the DTA – Personal Scope

INTRODUCTION

The main reason why countries across the world implement DTAs is to avoid the imposition of comparable taxes in two or more countries on the same taxpayer in respect of the same subject matter and for identical periods. The harmful effects of double taxation on the exchange of goods and services and movements of capital, technology, and persons are so well known that it is scarcely necessary to stress the importance of removing the obstacles that double taxation presents to the development of economic relations between countries.

DTAs, therefore, help to clarify, standardize, and confirm the fiscal situation of taxpayers who are engaged in commercial, industrial, financial, or any other activities in other countries through the application by all countries of common solutions to identical cases of double taxation. 

The US and Australia tax their residents on a worldwide basis and non-residents on a source basis. So, these tax systems will seek to levy taxation where there is a source of income in a state/country (state is the term used for the country, either the US or Australia) and/or a person who is a resident in a country. Both source and residence are referred to as ‘connecting factors’ in the world of public international tax. This is where the DTA comes into play, to ascertain whether the US or Australia has taxing rights on a specific type of income.

INTERPRETING ARTICLE 1 OF THE DTA – PERSONAL SCOPE

Article 1 of the DTA states the following – 

Except as otherwise provided in this Convention, this Convention shall apply to persons who are residents of one or both of the Contracting States.

This Convention shall not restrict in any manner any exclusion, exemption, deduction, rebate, credit, or other allowance accorded from time to time: 

by the laws of either Contracting State; or 

by any other agreement between the Contracting States.

Notwithstanding any provision of this Convention, except paragraph (4) of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence)) and individuals electing under its domestic law to be taxed as residents of that state, and because of citizenship may tax its citizens, as if this Convention had not entered into force. For this purpose, the term “citizen” shall, for United States source income according to United States law relating to United States tax, include a former citizen or long-term resident whose loss of such status had as one of its principal purposes the avoidance of tax, but only for a period of 10 years following such loss.

The provisions of paragraph (3) shall not affect: 

the benefits conferred by a Contracting State under paragraph (2) of Article 9 (Associated Enterprises), paragraph (2) or (6) of Article 18 (Pensions, Annuities, Alimony and Child Support), Article 22 (Relief from Double Taxation), 23 (Non-Discrimination), 24 (Mutual Agreement Procedure) or paragraph (1) of Article 27 (Miscellaneous); or 

the benefits conferred by a Contracting State under Article 19 (Governmental Remuneration), 20 (Students) or 26 (Diplomatic and Consular Privileges) upon individuals who are neither citizens of, nor have immigrant status in, that State (in the case of benefits conferred by the United States), or who are not ordinarily resident in that State (in the case of benefits conferred by Australia).

Paragraph 1

This paragraph sets out the scope of DTA’s application. It applies to residents of the US and/or Australia. However, the scope is extended in certain articles of the DTA and can also apply to residents of third countries, for example, Article 10 (Dividends), Article 11 (Interest), and Article 25 (Exchange of Information). A resident is defined in Article 4 of the DTA. 

Paragraph 2

This paragraph goes on further to state that the DTA may not increase tax above the liability that would result under either the US or Australian domestic legislation or any other agreement between the US and Australia. It also provides taxpayers with the option to rather apply domestic law instead of the DTA, if the domestic law provides the more favorable treatment. A taxpayer, however, may not make inconsistent choices between the rules of the Internal Revenue Code and the DTA rules.

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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Paragraph 3

This paragraph is probably one of the most important provisions of the DTA as it lays the foundation of taxing rights for the rest of the DTA. It provides the US with broader powers than what is usually provided to other countries in DTAs. This is due to the US being one of the only countries in the world (the other country is Eritrea) to continue to tax individuals who are US citizens on a worldwide basis irrespective of where they live in the world. 

It contains a ‘saving clause’ which stipulates that the US and Australia reserve the right to tax its residents as if the DTA had not come into effect.  The US and Australia also reserve the right to tax their citizens, individuals electing under their respective domestic laws to be taxed as residents, and in the case of the US, former citizens whose loss of citizenship had as one of its main purposes the avoidance of tax. This reservation was extended in the 2001 protocol to include not only former citizens but also former long-term residents of the US. This was to ensure that the DTA is consistent with US law, more specifically Section 877 of the Internal Revenue Code. 

Section 877(c) provides certain exceptions to these presumptions of tax avoidance. The US defines ‘long-term resident’ as an individual (other than a US citizen) who is a lawful permanent resident of the United States in at least 8 of the prior 15 taxable years. An individual is not treated as a lawful permanent resident for any taxable year if such individual is treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country and the individual does not waive the benefits of such treaty applicable to residents of the foreign country.

The major thing to note here is that even though the right to tax its citizens is reserved for Australia as well, Australia does not tax individuals based on citizenship. Whereas in the case of the US, individuals are taxed based on citizenship. 

Paragraph 4

This paragraph sets out the limitations of the saving clause and where other provisions of the DTA will override the savings clause. The saving clause does not override the benefits provided under paragraph 2 of Article 9 (Associated Enterprises), relating to correlative adjustments of tax liability, or the benefits of paragraphs 2 or 6 of Article 18 (Pensions, Annuities, Alimony and Child Support), relating to social security payments, alimony and child support. 

Social security payments and similar public pensions paid by Australia and alimony, child support, and similar maintenance payments arising in Australia are taxable only by Australia even though the recipient may be a resident of the US. Similarly, social security payments by Australia to a citizen of the US, wherever resident, are taxable only in Australia. 

The benefits provided in Articles 22 (Relief from Double Taxation), 23 (non-Discrimination), and 24 (Mutual Agreement Procedure), and the source rules of paragraph 1 of Article 27 (Miscellaneous) are also available to residents and citizens of the Contracting States, notwithstanding the saving clause.

THE IMPORTANCE OF READING COMPREHENSION 

Although most people can read, the act of reading and the act of comprehending what you read are two very different things.

Reading comprehension is the ability to process text, understand its meaning, and integrate with what the reader already knows. 

Lawyers generally know the importance of reading comprehension. At law school, students are taught how to interpret legislation. So, this is not a gift or talent, lawyers are born with, but rather a skill set you can develop that will be extremely beneficial when looking at the DTA. 

The reason why it is extremely important to understand the DTA and more specifically Article 1 of the DTA, is so that you understand if the DTA even applies to you. We’ve assisted numerous clients who either misinterpreted the application of the DTA or whose advisor misinterpreted the application. 

The key questions you should consider to ensure the correct application of the DTA is – 

  1. What is the scope of the DTA and do I fall within that scope to use the DTA?
  2. Am I a resident of Australia or the US for purposes of the DTA?
  3. What are the benefits available to me in the DTA?
  4. What is the limitation of benefits in the DTA?
  5. What is the interplay between US/Australia domestic legislation and the DTA?
Our team of International Tax specialists at Asena Advisor has an in-depth knowledge of how to interpret international tax treaties and how to ascertain their applicability to your specific circumstances. 

Shaun Eastman

Peter Harper