Tag: taxpayer

US-AU DTA: Article 18 – Pensions, Annuities, Alimony and Child Support

Posted on by Peter Harper

Background

The background of this week’s blog is a bit different from the previous ones due to the unique nature of the topic. This week we will be looking at Article 18 of the DTA – Pensions, Annuities, Alimony, and Child Support, which affects a much broader demographic than other articles. The background focuses more on the global economy and financial markets, but there is a reason for this.

Most people start saving for their retirement when they earn their first salary. Contributions are made monthly (either by yourself or on your behalf) towards a Pension Fund (IRA, 401k, super, etc.) and are invested in various classes of assets. We diversify investments to reduce risk and maximize continuous growth, and it gives people a sense of comfort and security to invest in their future via a Pension Fund. 

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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In recent months, the world has contended with the emergence of the Omicron variant, central bank policy tightening, and persistent inflation. And most recently, Russia’s invasion of Ukraine has ignited a geopolitical crisis that is shaking global financial markets to their core.

As tensions continue to mount in Eastern Europe, the concern about what is to come has led to some people impulsively cashing out their retirement portfolios or reviewing them. 

I’ve always been a great admirer of Warren Buffet and his quotes on investments. 

So just to lay the foundation for this week’s blog, I thought I would share two relevant quotes about the current economic climate.

“The most important quality for an investor is temperament, not intellect.” 

“Uncertainty actually is the friend of the buyer of long-term values.”

Humans are, by nature, irrational beings and are often tempted to make trades when they think the market is working against them, whereas in contrast, it is the well-tempered investor that learns not to watch the market. This person ultimately ends up reaping the most rewards over the long term. 

Their investment philosophy is that you don’t need to have an extremely high I.Q. to build more wealth, but rather that you should be more disciplined with your reaction toward the market’s irrationality. 

Now to link the background with the rest of the blog to follow, if you are a U.S. resident with an Australian pension or vice versa, prior to considering whether to cash out your pension or not, make sure you take a step back and instead make sure you understand the potential adverse tax implications of having an international pension fund. 

Introduction

The purpose of the Australian treaty is to prevent double taxation and fiscal evasion.

Because the U.S. does not tax contributions or accumulated earnings, and Australia does not tax the distribution of benefits, a U.S. resident could perceivably relocate from the U.S. to Australia and never pay income tax on contributions, accumulated earnings, or the payment of pension benefits that accrued while the employee worked in the U.S. To prevent this issue, the two countries formed a double taxation agreement.

Interpreting Article 18 of The DTA – Pensions, Annuities, Alimony, and Child Support

Article 18 addresses the taxation of cross-border pensions and annuities. Subject to Article 19, pensions and other similar remuneration paid to an individual who is a resident of one Contracting State in connection with past employment shall be taxable only in that State. 

Article 18(4) 

defines the term’ pensions and other similar remuneration, as used in this Article, to mean ‘periodic payments made by reason of retirement or death, in consideration for services rendered, or by way of compensation paid after retirement for injuries received in connection with past employment.’ 

Article 18(5) 

defines the term ‘annuities,’ as used in this Article, to mean ‘stated sums paid periodically at stated times during life, or during a specified or ascertainable number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered or to be rendered).’ 

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Article 18 is critical to any U.S. person who is a beneficiary of an Australian Superannuation Fund for the following reasons:

  • The U.S. has taxing authority over vested Australian superannuation benefits pursuant to Article 18 of the DTA; and
  • In the absence of a specific Article dealing with contributions and the annual income derived by pension schemes (as exist in the U.K. treaty), the U.S. retains the right under Article 1 of the DTA to tax contributions and accumulated earnings under its domestic tax laws.

In terms of the IRC, most foreign retirement plans are not considered “qualified plans” under Section 401(a), which means the plans generally do not qualify for tax-deferral treatment. 

For a pension plan to be tax-exempt, the plan must satisfy the requirements contained in § 401 Internal Revenue Code 1986 (IRC). Section 401(a) IRC specifically provides that, for a pension plan to be a “qualified plan” (and therefore exempt from tax under § 501 IRC), it must be organized in the U.S. Accordingly, this means that no Australian superannuation plan (whether retail or self-managed) can be a “qualified plan.” (Read our Whitepaper on Taxation of Foreign Pensions for more details)

There are essentially three phases of U.S. tax treatment that need to be looked at when dealing with the taxation of an Australian superannuation plan. I will provide a brief summary of the three phases for this blog, but please review our Whitepaper for more information.

Phase 1 – Contributions 

Suppose contributions are made to an Australian superannuation fund after an Australian citizen becomes a U.S. person (or a U.S. citizen becomes an Australian resident). In that case, the contributions will be taxable in the U.S. under § 402(b)(1) IRC. 

Phase 2 – Earnings Derived Within A Superannuation Plan After An Australian Citizen Becomes A U.S. Person

Subchapter J contains the general rules concerning estates, trusts, beneficiaries and decedents, specifically the grantor trust rules. While it is critical that an individual assessment of the circumstances of every taxpayer be undertaken, most superannuation plans (or portions thereof) in Australia could be classified as grantor trusts for U.S. tax purposes. 

Phase 3 – Distribution of benefits 

In our opinion, there are two possible ways in which accrued Australian superannuation benefits (contributions and earnings) may be taxed in the U.S.

The first is that Australian superannuation benefits of a U.S. person will be taxable upon such a person attaining 60 years of age (the Australian retirement age). The taxpayer will first be liable for tax in Australia, but receive foreign tax credits in the U.S. (creditable only against U.S. federal income tax) for the Australian tax paid (which will be nil if the account is in the benefits phase). In the event of any shortfall, they will pay further federal, state, and city income tax (where applicable).

The second view (the alternate view) concerns highly compensated employees (HCE) and the application of § 402(b)(4) IRC. If an employee is a highly compensated U.S. person who is also a member of a foreign pension plan (i.e., an Australian superannuation plan), technically, on a literal reading of § 410(b)(3)(C) IRC, there is a high likelihood that the foreign pension plan will fail the minimum coverage tests because contributions made in favor of non-resident aliens with no US-source income are not included for the purposes of determining whether the coverage tests have been satisfied.

Conclusion

Both Australia and the U.S. recognize the need for their citizens to be able to self-fund their retirement and the importance of having a globally mobile workforce. This is evident when looking at the concessional tax treatment for individuals who maximize superannuation and pension contributions, and the current impact government-supported pension plans have on federal and state budgets.

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The inadequacies in the DTA arise because it approaches Australian superannuation and U.S. pensions as though they are only taxed at one point, which is on distribution.

Unfortunately, unless Article 18 is amended, the adverse tax implications of U.S. migration on a taxpayer’s superannuation benefits may become a determining factor in whether an executive migrates between Australia and the U.S.

So, the current global economic turmoil might be the perfect opportunity to focus on reviewing the tax exposure of your pension fund instead of considering cashing it out.

 

Our team of International Tax specialists at Asena Advisors will be able to assist you with these complex tax rules that could apply to your pension fund. In times of adversity, you need proper guidance to your specific needs, and our Multi-Family Office will help you find opportunities in uncertain times. 

Shaun Eastman

Peter Harper

US-AU DTA: Article 17 – Entertainers

Posted on by Peter Harper


INTRODUCTION

In this week’s blog we will be discussing Article 17 of the US/Australia DTA which relates to entertainers and how they are taxed from an international perspective. 

In general, Article 17, provides that if a resident of one country derives income in the other country as an entertainer or sports person, some of the income earned may be protected from tax in that other country, but usually not to the same degree as other individuals who are not entertainers or sports person.

What distinguishes entertainers and sportspersons from other individuals who receive income from employment is that by the nature of their work, some entertainers and sportspersons may have the opportunity to earn a large amount of income in a very short period of time.

INTERPRETING ARTICLE 17 OF THE DTA – ENTERTAINERS

Article 17 states that income derived by visiting entertainers and sportspersons from their personal activities as such will be taxed in the country in which the activities are exercised, irrespective of the duration of the visit. 

However, where the gross receipts derived by the entertainer from those activities, including expenses reimbursed to the entertainer or borne on the entertainer’s behalf, do not exceed $10,000 or its equivalent in Australian dollars in the year of income, the income will be subject to tax in accordance with Article 14 or Article 15, which deals with independent or dependent personal services, as the case may be.

It should be noted that income derived by producers, directors, technicians and others who are not artists or athletes is taxable in accordance with Article 14 or 15, accordingly. The commentary to the OECD Model Convention indicates that the word “entertainer” extends to activities which involve a political, social, religious or charitable nature, provided entertainment is present. 

It does however not extend to a visiting conference speaker or to administrative or support staff. The commentary acknowledges that there may be some uncertainty about whether some persons are entertainers or not, in which case it will be necessary to consider the person’s overall activities.

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Article 17(2) is a safeguarding provision to ensure that income in respect of personal activities exercised by an entertainer, whether received by the entertainer or by another person, is taxed in the country in which the entertainer performs. This is irrespective of whether or not that other person has a “permanent establishment” or “fixed base” in that country. 

If it is however established that neither the entertainer nor any person related to him/her participates in any profits of that other person in any manner, the relevant income accruing to that other person shall be taxed in accordance with the provisions of Article 7, 14 or 15, dealing respectively with business profits and income from independent or dependent services, as the case may be.

A legislative instrument has removed the PAYG withholding requirement in relation to entertainers and sportspersons who are US residents when working in Australia. This only applies where the payments relate to entertainment or sports activities carried on in Australia and where the combined payments do not exceed $10,000 or its equivalent in Australian dollars in the year of income.. 

This legislative instrument applies from 3 April 2014 until 1 October 2024.

A US entertainer who fulfils the contractual obligations of a US employer by performing in Australia, for a salary paid by the employer, is considered to derive “income from personal activities”, within Article 17 of the US/Aus DTA. This is irrespective of the fact whether or not the entertainer is at arm’s length from the US employer. Where the entertainer is paid an annual salary, an apportionment will be necessary to determine the amount applicable to the period of time spent in Australia.

Where the contract for the personal services of a US entertainer in Australia is made between a US resident and an Australian resident, and Article 17(2) of the DTA applies, both the US resident and the entertainer may be taxable in Australia. 

The US resident will be liable to tax under Article 17(2) on the taxable income derived by it, and the entertainer may be taxed under Article 17(1) on remuneration derived from the US resident in respect of the personal activities in Australia.

CONCLUSION 

For any person interested in tax planning, Article 17 could be a good motivator to start exercising to ensure this Article applies to you. However, that is easier said than done. 

Our team of International Tax specialists at Asena Advisors, will be able to assist you with your international tax planning needs to ensure that Article 17 is adhered to by entertainers. Lastly, we will never say no to an autograph.

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 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

US-AU DTA: Article 10 – Dividends

Posted on by Peter Harper

INTRODUCTION

For purposes of this week’s blog, it will be beneficial just to recap on the purpose of a DTA. The major purpose of DTA is to mitigate international double taxation through tax reduction or exemptions on certain types of income derived by residents of one treaty country from sources within the other treaty country. Due to the fact that DTAs often modify US and foreign tax consequences substantially, the relevant DTA must be considered in order to fully analyze the income tax consequences of any outbound or inbound transaction.

Article 10 of the US/Australia DTA is a great example of this. 

This week we will be looking at the tax implications of declaring a dividend in the context of Article 10 of the US/Australia DTA.

INTERPRETING ARTICLE 10 OF THE DTA – DIVIDENDS

Dividends are distributions made by a company of something of value to a shareholder. Both the US and Australia levy withholding tax when a dividend is paid to a foreign shareholder. 

Under US domestic tax law, a foreign person is generally subject to 30% US tax on the gross amount of certain US-source income. All persons (‘withholding agents’) making US-source fixed, determinable, annual, or periodical (FDAP) payments to foreign persons generally must report and withhold 30% of the gross US-source FDAP payments, such as dividends.

Under Australian domestic tax law, dividends paid to an Australian non-resident recipient is subject to a flat withholding tax to the extent they are unfranked and are otherwise not assessed in Australia.

Article 10 however limits the tax that the source country may impose on these dividends payable to beneficial owners’ resident in the other country.

Article 10(1) preserves the right of a shareholder’s country of residence to tax dividends arising in the other country by permitting Australia or the US to tax its residents on dividends paid to them by a company that is resident in the other Contracting State.

Article 10(2) allows the Contacting State of the company to tax dividends to which a resident of the other Contracting State is entitled subject to the limitations in Article 10(2) and 10(3). 

Important to note is that Article 10(2) also requires that if either the US or Australia significantly modifies their laws regarding taxation of corporations or dividends they must consult with each other to determine any appropriate amendment to Article 10(2).

Article 10(2)(a) stipulates that where the shareholder who is beneficially entitled to the dividend is a company resident in the other Contracting State and directly owns shares representing at least 10% of the voting power of the company paying the dividend then the withholding tax rate is limited to 5% of the gross dividend.

The term ‘beneficially entitled’ is not defined in the DTA and therefore the domestic law of the country imposing the tax should be considered. 

The term ‘voting power‘ is also not defined but must be determined to ascertain if the 10% shareholding test is satisfied. 

The US Department of Treasury’s technical explanation of the Protocol that replaced Art 10 of the Convention states the following:

“Shares are considered to be voting shares if they provide the power to elect, appoint or replace any person vested with the powers ordinarily exercised by the board of directors of a US corporation.”

In Australia voting power is considered to refer to the voting power on all types of shares and not only in relation to the power to replace members of the board of directors. 

In determining the voting power for the purposes of Article 10(2) only shares that are held ‘directly’ by the beneficial shareholder can be taken into account. 

Accordingly, indirect interests are not to be taken into account. However, the US Department of Treasury’s technical explanation of the Protocol when discussing Article 10(2) states the following:

“Companies holding shares through fiscally transparent entities such as partnerships are considered for purposes of this paragraph to hold their proportionate interest in the shares held by the intermediate entity. As a result, companies holding shares through such entities may be able to claim the benefits of sub-paragraph (a) under certain circumstances. The lower rate of withholding tax applies when the company’s proportionate share of the shares held by the intermediate entity meets the 10 percent threshold. Whether this ownership threshold is satisfied may be difficult to determine and often will require an analysis of the partnership or trust agreement.”

The voting power test in Article 10 is therefore likely to be applied differently in the US and Australia unless the reference to “beneficially entitled” is interpreted to override the requirement that the payee company holds the shares “directly”.

Article 10(2)(b) limits the withholding tax rate on dividends derived by a resident from shares held in a company resident in the other Contracting State to 15%. Accordingly, this rate will apply to individuals, trusts, partnerships and companies that cannot rely on Article 10(2)(a) or the exemption in Art 10(3) discussed below.

Article 10(3) is quite often misinterpreted. This Article stipulates that a shareholder company resident in the US or Australia is exempt from withholding tax on dividends if it owns 80% or more or the voting power of the company paying the dividends for a 12-month period ending on the date the dividend is declared. However, the exemption is subject to the shareholder company being:

  (a) a qualified person as defined in Article 16(2)(c), or

  (b) entitled to benefits under the Limitation of Benefits Article.

In contrast to Article 10(2), voting power for the purposes of Article 10(3) is limited to shares that are held “directly” by the beneficial shareholder and therefore excludes indirect ownership through corporate chains. 

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The shareholder company will be a “qualified person” if:

1. its principal class of shares is listed on a recognized stock exchange and is regularly traded on one or more stock exchanges. A recognized stock exchange is a recognized stock exchange under Australian or US law and any stock exchange agreed by the ATO and IRS as explained in Article 16(6), or

2. at least 50% of the vote and value of the shares in the shareholder company must be owned directly or indirectly by five or fewer companies that are listed on a recognized stock exchange as defined in Article 16(6). Importantly in addition, where the shares in the shareholder company are held indirectly, each intermediate owner must be a resident of either Australia or the US.

Where a shareholder company is not a qualified person the exemption from withholding tax may still be available provided that the ATO or IRS makes a determination under Article 16(5). 

Article 10(4) provides that dividends paid by a Regulated Investment Company (RIC) or Real Estate Investment Trust (REIT) are not eligible for the 5% maximum rate of withholding tax in Art 10(2)(a) or the exemption from withholding tax in Art 10(3). Accordingly, the 15% withholding rate will generally apply to these entities.

Article 10(5) excludes from the general source country withholding tax limitations under Art 10(2), (3) and (4) dividends paid with respect to holdings that form part of the business property of a permanent establishment as defined in Article 5 or fixed base situated in the source country. 

Article 10(6) defines “dividends” to mean income from shares and amounts subject to the same taxation treatment as income from shares under the laws of the country where the company making the distribution is a resident.

In Australia the rules for defining what constitutes equity in a company and what constitutes debt are set out in ITAA97 Div 974 of the ITAA 1997 that apply from 1 July 2001. 

In the case of the US, the term dividends include amounts treated as a dividend under US law upon the sale or redemption of shares or upon a transfer of shares in a reorganisation. Further, a distribution from a US publicly traded partnership, which is taxed as a corporation under US law, is a dividend for purposes of Article 10. However, a distribution by a US LLC is not a dividend for purposes of Article 10 if it is not taxable as a corporation under US law.

Article 10(7) states that where a company which is resident for example in the US and derives profits or income from Australia, Australia is not permitted to tax dividends paid by the company unless either:

1. the person beneficially entitled to the dividends is a resident in Australia; or

2. the shares in respect of which the dividends are paid is effectively connected with a permanent establishment in Australia.

Therefore, Article 10(7) overrides section 44(1)(b) of the ITAA 1936 which permits Australia to tax dividends paid to non-residents to the extent of profits derived from sources within Australia. 

Similarly, it overrides the ability of the US to impose taxes under Code s 871 and Code s 882(a) on dividends paid by foreign corporations that have a US source under Code s 861(a)(2)(B).

Article 10(7) also provides that the Contracting States cannot impose tax on a company’s undistributed profits even if the dividends are wholly or partly paid out of profits in the relevant Contracting State unless Article 10(8) applies.

However, Article 10(7) does not restrict a State’s right to tax its resident shareholders on undistributed earnings of a corporation resident in the other State. The authority of the US to impose the foreign personal holding company tax, the taxes on subpart F income and on an increase in earnings invested in US property, and the tax on income of a passive foreign investment company that is a qualified electing fund is in no way restricted by this provision.

Article 10(8) permits Australia and the US to impose a branch profits tax on a company that is a resident in the other State. This tax is in addition to other taxes permitted by the Convention.

Currently, Australia does not impose a branch profits tax. However, if Australia were to impose such a tax, the base of such a tax would be limited to an amount analogous to the US dividend equivalent amount.

Article 10(9) lastly provides that the branch profits tax permitted by Article 10(8) shall not be imposed at a rate of withholding tax exceeding the maximum direct investment dividend rate of withholding tax of 5% in Article 10(2)(a).

CONCLUSION 

As you can see, Article 10 of the DTA is comprehensive and one should be cautious when applying it to a specific situation. 

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 9 – Associate Enterprises

Posted on by Peter Harper

BACKGROUND

This week, we will have a closer look at Article 9 of the US/AUS DTA. Article 9 of the DTA incorporates into the treaty the US and Australian arm’s-length principles reflected in the transfer pricing provisions of the Internal Revenue Code Section 482 and in Australia the transfer pricing provisions in ITAA 1997 Division 815.

An arm’s-length transaction is a transaction between independent parties. For the purposes of this blog, a simple example will help in understanding the basic concept of what an arm’s-length transaction is and when transfer pricing provisions will apply to a specific transaction. 

Example: USCO A and B are both US companies and co-shareholders of AusCo, a company in Australia. The directors of both USCO A and B are John and Jane who are married.  Further, each owns 50% of the stock in AusCo. USCO A is considering selling its 50% stake in AusCo and determined that the market related value of the 50% stake is $10m. However, after further consideration and the adverse tax implications on disposal, John and Jane decided that USCO A should rather sell its 50% stake to USCO B. John and Jane decided that it will sell the 50% stake for $100, to avoid the tax implications and streamline their current structure. 

IMPLICATIONS

If USCO A sold the 50% stake for $10million to USCO B it would have been sold at arm’s-length as this is the market related price. 

USCO A however sold it to USCO B for $100. They would not have sold the same stake to an independent party for $100. Hence the transaction is not at arm’s length and a transfer pricing adjustment needs to be made.  

INTRODUCTION

Article 9 provides that when enterprises which are related engaged in a transaction and the enterprises engage in a transaction on terms that are not arm’s length, the Contracting States may make appropriate adjustments to the taxable income and tax liability of such related enterprises to reflect what the income and tax of these enterprises with respect to the transaction would have been had there been an arm’s-length relationship between them. 

INTERPRETING ARTICLE 9 OF THE DTA – ASSOCIATED ENTERPRISES 

Article 9 provides that, where related persons engage in transactions which are not at arm’s length, the Contracting States may make appropriate adjustments to their taxable income and tax liability.

It should be noted that it is generally accepted that Article 9 is intended to be permissive. It allows contracting states to apply the transfer pricing rules that form part of their tax legislation. It is generally considered that; Article 9 does not create a stand-alone right for countries to make transfer pricing adjustments that go beyond what is authorized by their own domestic rules. This is mainly because the basic purpose of a DTA is to relieve double taxation and it would go way beyond this purpose if a DTA imposed harsher tax treatment on a particular transaction between country A and country B than would have applied if the same transaction had taken place between country A and another country,

Article 9(1) sets out the general rule for this Article and when it will be applicable. Where an enterprise of one Contracting State (US) and an enterprise of the other Contracting State (Australia) are related through management, control, or capital and their commercial or financial relations differ from those which would prevail between independent enterprises, the profits of the enterprises may be adjusted to reflect the profits which would have accrued if the two enterprises had been independent. 

Where a reallocation of profits is affected under this paragraph, in such a manner that the profits of an enterprise of one country are adjusted upwards, a form of double taxation would arise if the profits so reallocated continued to be subject to tax in the hands of an associated enterprise in the other country.

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Article 9(2) states that where one of the Contracting States has increased the profits of an enterprise of that State to reflect the amount that would have accrued to the enterprise had it been independent of an enterprise in the other Contracting State, the second State shall make an appropriate adjustment, decreasing the amount of tax which it has imposed on those profits. 

In determining such adjustments, due regard is to be had to the other provisions of the DTA and the competent authorities of the two States (IRS and ATO) shall consult each other if necessary, in implementing this provision.

Article 9(3) states that each Contracting State may apply its internal law in determining liability for its tax. For example, although Articles 9(1) and 2 refer to allocations of profits and taxes, it is understood that such terms also include the components of the tax base and of the tax liability, such as income, deductions, credits, and allowances. 

The US will apply its rules and procedures under section 482 of the IRC and Australia on the other hand will apply the transfer pricing provisions in ITAA 1997 Division 815.  It is important that such determinations must be consistent in each case with the principles of arm’s length transactions.

CONCLUSION 

This Article is a great example of how the domestic transfer pricing provisions of the US and Australia are applied on international transactions. 

At Asena Advisors, we have years of experience in dealing with transfer pricing issues and how to ensure that both domestic transfer pricing provisions and the DTA’s transfer pricing provisions are applied correctly.

Shaun Eastman

Peter Harper

US-AU DTA: Article 8 – Shipping and Air Transport

Posted on by Peter Harper

INTRODUCTION

This week, we will be discussing an Article in the US/AUS DTA which is generally not as relevant to individuals as other Articles in the DTA, but still important to understand. Especially regarding the interrelationship with other Articles in the DTA and how one article can override another in the DTA. 

Article 8 of the DTA governs the taxation of profits of an enterprise of a contracting state from the operation of ships or aircraft in ‘international traffic’, meaning any transport by a ship or aircraft, except when such transport is solely between places in a contracting state. In simple terms, this article does not apply to an enterprise who solely renders services within the US or Australia and provides primary taxing rights to the Country of Residence. 

In this week’s blog we will therefore have a look at Article 8 of the US/AUS DTA and how it interplays with Article 7 of the DTA. 

INTERPRETING ARTICLE 8 OF THE DTA – SHIPPING AND AIR TRANSPORT 

In our previous blog – Article 7- Business Profits , we explained that where profits include items of income dealt with separately in other articles of the DTA, then the provisions of those Articles shall not be affected by the provisions of Article 7. 

Article 8 is such an article, as it deals with profits of an enterprise from the operation of ships or aircraft in international traffic. If Article 8 applies to the profits of an enterprise, it will therefore override the provisions of Article 7.

Article 8(1) stipulates that the profits derived by a resident of one of the Contracting States from the operation in international traffic of ships or aircraft are taxable only in that Contracting State. In addition, this treatment extends to certain items of rental income that are closely related to the operation of ships and aircraft in international traffic.

Article 1(3)(d) of the DTA defines international traffic as any transport by a ship or aircraft, except where such transport is solely between places within a Contacting State.  

In particular, the following is subject to the above treatment:

– Profits from the rental of ships or aircraft on a full time basis (for example with crewmembers) operated in international traffic if the resident either operates ships or aircraft in international traffic or regularly leases ships or aircraft on a full basis. Such income is exempt from tax in the other Contracting State.

– Profits from the lease of ships or aircraft on a bare boat basis (meaning without crewmembers) when the income is ‘merely incidental’ to the operation of ships or aircraft in international traffic by the lessor.

Whether profits from the lease of ships or aircraft on a bare boat basis are merely incidental to operation in international traffic, the operative effect of this phrase is to restrict the application of Article 8 to those bareboat leases where:

– The primary activity of the lessor is the operation of ships or aircraft in international traffic, and

– The lessor’s bareboat leasing activity only makes a minor contribution to, and is so closely related to, this primary activity that it does not amount to a separate business or source of income for the lessor.

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Article 8(2) stipulates that profits of an enterprise of a Contracting State from the use, maintenance or rental of containers (including equipment for their transport) that are used for the transport of goods in international traffic are exempt from tax in the other Contracting State. This applies regardless of whether the recipient of the income is engaged in the operation of ships or aircraft in international traffic. 

Article 8(3) stipulates that Article 8(1) and 8(2) apply to profits derived though participation in a pool service or other profit sharing arrangement entered into by carriers in shipping and air transport in the interest of international cooperation. As an example, airlines from the US and Australia may agree to share profits relating to the transport of passengers between the two countries. They each will fly the same number of flights per week and share the revenues from that route equally, regardless of the number of passengers that each airline transports. Article 8(3) further makes it clear that all of the income arising from the pool service or other profit sharing arrangement and not just the income derived directly by that carrier is taxable in the Contracting State of residence.

Article 8(4) states that the carriage of passengers, livestock, mail, merchandise or goods taken on board in a Contracting State for discharge in that State is not from an operation in international traffic of ships or aircraft and may therefore be taxed in that State (source state). This relates to profits from the transport of goods or passengers picked up and discharged within the same Contracting State and therefore does not fall within the definition of international traffic and may be taxed by that State at source. However, for the Contracting State to impose such tax at source it is considered that the requirements of Article 7 would need to be satisfied.

This can be simplified with the following two examples:

Example 1 – Company A, a US shipping company contracts to carry goods from Australia to a city in the US. Part of the contract includes the transport of the goods by road from its point of origin in Australia to another point in Australia.  The income earned by the US shipping company from the overland leg of the journey would still be taxable only in the US. 

Example 2 – Company B is a US airline company which carries passengers from New York to Hobart, with an intervening stop in Perth. The Perth to Hobart leg of the trip would be treated as international transport of passengers with respect to those passengers and would still only be taxable in the US.

INTERRELATIONSHIP WITH ARTICLE 7 (BUSINESS PROFITS)

Profits from the lease of ships or aircraft that are not covered by the Shipping and Air Transport Article will fall within the scope of Article 7. 

Examples of profits that would fall within Article 7 include the following:

– Full basis leases of ships or aircraft that are not operated in international traffic by the lessee or where the lessor only operates ships or aircraft between places in the source country and does not regularly lease ships or aircraft on a full-time basis; and 

– Bare boat leases not incidental to the lessor’s international transport operations.

More importantly the source country’s taxation is only permitted under the Business Profits Article to the extent the profits are effectively connected with a permanent establishment in that country.

CONCLUSION 

This is a great example of how a specific article in the DTA can override the provisions of Article 7.

At Asena Advisors, our team of International Tax specialists, are able to assist you with applying this article correctly and establishing whether the profits are taxable in terms of Article 7 or Article 8 of the DTA. 

Shaun Eastman

Peter Harper

US-AU DTA: Article 7 – Business Profits

Posted on by Peter Harper

INTRODUCTION

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

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

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

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

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

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

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

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

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

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

INTERPRETING ARTICLE 7 OF THE DTA – BUSINESS PROFITS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CONCLUSION 

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

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

Shaun Eastman

Peter Harper

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

Posted on by Peter Harper

INTRODUCTION

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

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

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

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

INTERPRETING ARTICLE 6 OF THE DTA – INCOME FROM REAL PROPERTY

Article 6 of the DTA states the following: 

Income from Real Property 

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

(2) For the purposes of this Convention:

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

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

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

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

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

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

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

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

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

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

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

CONCLUSION 

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

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 5 – Permanent Establishment

Posted on by Peter Harper

GENERAL BACKGROUND

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

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

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

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

INTRODUCTION

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

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

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

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

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

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

give rise to a tax liability.

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

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

INTERPRETING ARTICLE 5 OF THE DTA – PERMANENT ESTABLISHMENT

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

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

TYPES OF PERMANENT ESTABLISHMENTS

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

Fixed Place of Business Permanent Establishment

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

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

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

Service Permanent Establishment

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

PRACTICAL EXAMPLES OF PERMANENT ESTABLISHMENT

Building and Construction Projects

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

Services and Consulting Projects

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

TYPES OF AGENCY PERMANENT ESTABLISHMENT

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

Digital Sales and e-Commerce

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

WHAT IS THE TAX RISK RELATED TO CREATING A PE?

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

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HOW WILL A PE BE TAXED?

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

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

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

CONCLUSION 

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

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

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

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 4 – Residence

Posted on by Peter Harper

GENERAL BACKGROUND

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

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

INTRODUCTION

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

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

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

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

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

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

INTERPRETING ARTICLE 4 OF THE DTA – RESIDENCE

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

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

Tie-breaker 1: 

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

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

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

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

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

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Tie-breaker 2: 

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

The IRS states the following in this regard:

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

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

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

Tie-breaker 3: 

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

The IRS considers the following factors in this regard:

Personal relations:

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

Community relations: 

Determine where the individual has his or her:

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

Economic relations: 

Determine where the individual:

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

CONCLUSION

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

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 3 – General Definitions

Posted on by Peter Harper

GENERAL BACKGROUND

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

INTRODUCTION

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

INTERPRETING ARTICLE 3 OF THE DTA – GENERAL DEFINITIONS

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

Paragraph 1

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

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

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Paragraph 2

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

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

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

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

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

CONCLUSION

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

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

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

Shaun Eastman

Peter Harper

US-AU DTA: Article 2 – Taxes Covered

Posted on by Peter Harper

GENERAL BACKGROUND

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

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

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

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

INTRODUCTION

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

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

INTERPRETING ARTICLE 2 OF THE DTA – TAXES COVERED

Article 2 of the DTA states the following –

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

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

(b) in Australia:

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

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

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

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Paragraph 1

US Taxes Covered –

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

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

Australian Taxes Covered –

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

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

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

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

Paragraph 2

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

CONCLUSION

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

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

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

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

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

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

Shaun Eastman

Peter Harper

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