<DOC>
[Joint Comm. on Taxation]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:85198.wais]
[JOINT COMMITTEE PRINT]
EXPLANATION OF PROPOSED PROTOCOL
TO THE INCOME TAX TREATY BETWEEN
THE UNITED STATES AND AUSTRALIA
Scheduled for a Hearing
Before the
COMMITTEE ON FOREIGN RELATIONS
UNITED STATES SENATE
ON MARCH 5, 2003
__________
Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
[GRAPHIC] [TIFF OMITTED]CONGRESS.#13
March 3, 2003
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U.S. GOVERNMENT PRINTING OFFICE
85-198 WASHINGTON : 2003 JCS-5-03
JOINT COMMITTEE ON TAXATION
108th Congress, 1st Session
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HOUSE SENATE
WILLIAM M. THOMAS, California, CHARLES E. GRASSLEY, Iowa,
Chairman Vice Chairman
PHILIP M. CRANE, Illinois ORRIN G. HATCH, Utah
E. CLAY SHAW, Jr., Florida DON NICKLES, Oklahoma
CHARLES B. RANGEL, New York MAX BAUCUS, Montana
FORTNEY PETE STARK, California JOHN D. ROCKEFELLER IV, West
Virginia
Mary M. Schmitt, Acting Chief of Staff
Bernard A. Schmitt, Deputy Chief of Staff
C O N T E N T S
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Page
Introduction..................................................... 1
I. Summary...........................................................2
II. Overview of U.S. Taxation of International Trade and Investment and
U.S. Tax Treaties.................................................4
A. U.S. Tax Rules........................................ 4
B. U.S. Tax Treaties..................................... 5
III.Explanation of Proposed Protocol..................................8
Article 1. Personal Scope............................... 8
Article 2. Taxes Covered................................ 9
Article 3. Residence.................................... 10
Article 4. Business Profits............................. 11
Article 5. Shipping and Air Transport................... 12
Article 6. Dividends.................................... 15
Article 7. Interest..................................... 20
Article 8. Royalties.................................... 23
Article 9. Alienation of Property....................... 25
Article 10. Limitation on Benefits....................... 26
Article 11. Other Income................................. 36
Article 12. Relief from Double Taxation.................. 36
Article 13. Entry into Force............................. 37
IV. Issues...........................................................38
A. Zero Rate of Withholding Tax on Dividends from 80-
Percent-Owned Subsidiaries........................... 38
B. Income from the Rental of Ships and Aircraft.......... 41
C. Capital Gains Tax..................................... 42
D. Visiting Teachers and Professors...................... 42
INTRODUCTION
This pamphlet,\1\ prepared by the staff of the Joint
Committee on Taxation, describes the proposed protocol to the
existing income tax treaty between the United States of America
and Australia (the ``proposed protocol''). The proposed
protocol was signed on September 27, 2001. The Senate Committee
on Foreign Relations has scheduled a public hearing on the
proposed protocol for March 5, 2003.\2\
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\1\ This pamphlet may be cited as follows: Joint Committee on
Taxation, Explanation of Proposed Protocol to the Income Tax Treaty
Between the United States and Australia (JCS-5-03), March 3, 2003.
\2\ For a copy of the proposed protocol, see Senate Treaty Doc.
107-20.
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Part I of the pamphlet provides a summary of the proposed
protocol. Part II provides a brief overview of U.S. tax laws
relating to international trade and investment and of U.S.
income tax treaties in general. Part III contains an article-
by-article explanation of the proposed protocol. Part IV
contains a discussion of issues relating to the proposed
protocol.
I. SUMMARY
The principal purposes of the existing treaty between the
United States and Australia are to reduce or eliminate double
taxation of income earned by residents of either country from
sources within the other country and to prevent avoidance or
evasion of the taxes of the two countries. The existing treaty
also is intended to promote close economic cooperation between
the two countries and to eliminate possible barriers to trade
and investment caused by overlapping taxing jurisdictions of
the two countries.
The proposed protocol modifies several provisions in the
existing treaty (signed in 1982) to make it similar to more
recent U.S. income tax treaties, the 1996 U.S. model income tax
treaty (``U.S. model''), and the 1992 model income tax treaty
of the Organization for Economic Cooperation and Development,
as updated (``OECD model''). However, the existing treaty, as
amended by the proposed protocol, contains certain substantive
deviations from these treaties and models.
The proposed protocol reduces source-country withholding
tax rates under the existing treaty on dividends, interest, and
royalties. First, the proposed protocol replaces Article 10
(Dividends) of the existing treaty with a new dividends
article. This new article eliminates the withholding tax on
certain intercompany dividends in cases in which an 80-percent
ownership threshold is met. The new article preserves the
maximum withholding tax rate of 15 percent on portfolio
dividends, but provides a maximum withholding tax rate of 5
percent on dividends meeting a 10-percent ownership threshold.
The proposed protocol replaces Article 11 (Interest) of the
existing treaty with a new interest article that retains
source-country taxation of interest at a maximum withholding
tax rate of 10 percent, but allows a special zero rate of
withholding for interest paid to financial institutions and
governmental entities. The proposed protocol also retains
source-country taxation of royalties under Article 12
(Royalties) of the existing treaty, but reduces the maximum
level of withholding tax from 10 percent to 5 percent. In
addition, the proposed protocol amends the definition of
royalties to remove the portion of the definition related to
payments for the use of ``industrial, commercial or scientific
equipment, other than equipment let under a hire purchase
agreement.'' Thus, under the proposed protocol, leasing income
is treated as business profits, taxable by the source country
only if the recipient of the payments has a permanent
establishment located in the source country.
The proposed protocol expands the ``saving clause''
provision in Article 1 (Personal Scope) of the existing treaty
to allow the United States to tax former long-term residents
whose termination of residency has as one of its principal
purposes the avoidance of tax. This provision allows the United
States to apply special tax rules under section 877 of the Code
as amended in 1996.
The proposed protocol amends Article 2 (Taxes Covered) of
the existing treaty to include certain U.S. and Australian
taxes. For U.S. tax purposes, the accumulated earnings tax and
the personal holding company tax are covered taxes under the
proposed protocol. In the case of Australia, covered taxes
include the Australian income tax, including tax on capital
gains, and the resource rent tax (although the United States
would not be required to allow a foreign tax credit with
respect to the resource rent tax).
The proposed protocol provides that, for purposes of
Article 4 (Residence) of the existing treaty, a U.S. citizen is
treated as a resident of the United States unless the U.S.
citizen is a resident of a country other than Australia for
purposes of a tax treaty between that third country and
Australia. In such case, the U.S. citizen is precluded from
claiming benefits under the U.S.-Australia treaty and can only
claim benefits under the tax treaty between such third country
and Australia. The proposed protocol also adds a new provision
under Article 7 (Business Profits) of the existing treaty to
clarify the treatment of fiscally transparent entities and
beneficial owners of fiscally transparent entities. The
proposed protocol clarifies that permanent establishment status
flows through a fiscally transparent entity (and thus the
beneficial owner is treated as carrying on a business through
such permanent establishment).
The proposed protocol amends the shipping provisions under
Article 8 (Shipping and Air Transport) and related provisions
under Article 13 (Alienation of Property) of the existing
treaty to more closely reflect the treatment of income from the
operation of ships, aircraft and containers in international
traffic under the U.S. model.
The proposed protocol makes further amendments to Article
13 that allow income or gains from certain business property of
a permanent establishment to be taxed in the country in which
the permanent establishment is located. The proposed protocol
also amends Article 13 to address Australia's imposition of its
mark-to-market regime on individuals who expatriate to the
United States.
The proposed protocol replaces Article 16 (Limitation on
Benefits) of the existing treaty with a new article that
reflects the limitation on benefits provisions included in more
recent U.S. income tax treaties.
The proposed protocol also replaces Article 21 (Other
Income) of the existing treaty with an article that more
closely represents the provision included in the U.N. model tax
treaty.
Article 13 of the proposed protocol provides for the entry
into force of the modifications made by the proposed protocol.
II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL TRADE AND INVESTMENT AND
U.S. TAX TREATIES
This overview briefly describes certain U.S. tax rules
relating to foreign income and foreign persons that apply in
the absence of a U.S. tax treaty. This overview also discusses
the general objectives of U.S. tax treaties and describes some
of the modifications to U.S. tax rules made by treaties.
A. U.S. Tax Rules
The United States taxes U.S. citizens, residents, and
corporations on their worldwide income, whether derived in the
United States or abroad. The United States generally taxes
nonresident alien individuals and foreign corporations on all
their income that is effectively connected with the conduct of
a trade or business in the United States (sometimes referred to
as ``effectively connected income''). The United States also
taxes nonresident alien individuals and foreign corporations on
certain U.S.-source income that is not effectively connected
with a U.S. trade or business.
Income of a nonresident alien individual or foreign
corporation that is effectively connected with the conduct of a
trade or business in the United States generally is subject to
U.S. tax in the same manner and at the same rates as income of
a U.S. person. Deductions are allowed to the extent that they
are related to effectively connected income. A foreign
corporation also is subject to a flat 30-percent branch profits
tax on its ``dividend equivalent amount,'' which is a measure
of the effectively connected earnings and profits of the
corporation that are removed in any year from the conduct of
its U.S. trade or business. In addition, a foreign corporation
is subject to a flat 30-percent branch-level excess interest
tax on the excess of the amount of interest that is deducted by
the foreign corporation in computing its effectively connected
income over the amount of interest that is paid by its U.S.
trade or business.
U.S.-source fixed or determinable annual or periodical
income of a nonresident alien individual or foreign corporation
(including, for example, interest, dividends, rents, royalties,
salaries, and annuities) that is not effectively connected with
the conduct of a U.S. trade or business is subject to U.S. tax
at a rate of 30 percent of the gross amount paid. Certain
insurance premiums earned by a nonresident alien individual or
foreign corporation are subject to U.S. tax at a rate of 1 or 4
percent of the premiums. These taxes generally are collected by
means of withholding.
Specific statutory exemptions from the 30-percent
withholding tax are provided. For example, certain original
issue discount and certain interest on deposits with banks or
savings institutions are exempt from the 30-percent withholding
tax. An exemption also is provided for certain interest paid on
portfolio debt obligations. In addition, income of a foreign
government or international organization from investments in
U.S. securities is exempt from U.S. tax.
U.S.-source capital gains of a nonresident alien individual
or a foreign corporation that are not effectively connected
with a U.S. trade or business generally are exempt from U.S.
tax, with two exceptions: (1) gains realized by a nonresident
alien individual who is present in the United States for at
least 183 days during the taxable year, and (2) certain gains
from the disposition of interests in U.S. real property.
Rules are provided for the determination of the source of
income. For example, interest and dividends paid by a U.S.
citizen or resident or by a U.S. corporation generally are
considered U.S.-source income. Conversely, dividends and
interest paid by a foreign corporation generally are treated as
foreign-source income. Special rules apply to treat as foreign-
source income (in whole or in part) interest paid by certain
U.S. corporations with foreign businesses and to treat as U.S.-
source income (in whole or in part) dividends paid by certain
foreign corporations with U.S. businesses. Rents and royalties
paid for the use of property in the United States are
considered U.S.-source income.
Because the United States taxes U.S. citizens, residents,
and corporations on their worldwide income, double taxation of
income can arise when income earned abroad by a U.S. person is
taxed by the country in which the income is earned and also by
the United States. The United States seeks to mitigate this
double taxation generally by allowing U.S. persons to credit
foreign income taxes paid against the U.S. tax imposed on their
foreign-source income. A fundamental premise of the foreign tax
credit is that it may not offset the U.S. tax liability on
U.S.-source income. Therefore, the foreign tax credit
provisions contain a limitation that ensures that the foreign
tax credit offsets only the U.S. tax on foreign-source income.
The foreign tax credit limitation generally is computed on a
worldwide basis (as opposed to a ``per-country'' basis). The
limitation is applied separately for certain classifications of
income. In addition, a special limitation applies to the credit
for foreign taxes imposed on foreign oil and gas extraction
income.
For foreign tax credit purposes, a U.S. corporation that
owns 10 percent or more of the voting stock of a foreign
corporation and receives a dividend from the foreign
corporation (or is otherwise required to include in its income
earnings of the foreign corporation) is deemed to have paid a
portion of the foreign income taxes paid by the foreign
corporation on its accumulated earnings. The taxes deemed paid
by the U.S. corporation are included in its total foreign taxes
paid and its foreign tax credit limitation calculations for the
year in which the dividend is received.
B. U.S. Tax Treaties
The traditional objectives of U.S. tax treaties have been
the avoidance of international double taxation and the
prevention of tax avoidance and evasion. Another related
objective of U.S. tax treaties is the removal of the barriers
to trade, capital flows, and commercial travel that may be
caused by overlapping tax jurisdictions and by the burdens of
complying with the tax laws of a jurisdiction when a person's
contacts with, and income derived from, that jurisdiction are
minimal. To a large extent, the treaty provisions designed to
carry out these objectives supplement U.S. tax law provisions
having the same objectives; treaty provisions modify the
generally applicable statutory rules with provisions that take
into account the particular tax system of the treaty partner.
The objective of limiting double taxation generally is
accomplished in treaties through the agreement of each country
to limit, in specified situations, its right to tax income
earned from its territory by residents of the other country.
For the most part, the various rate reductions and exemptions
agreed to by the source country in treaties are premised on the
assumption that the country of residence will tax the income at
levels comparable to those imposed by the source country on its
residents. Treaties also provide for the elimination of double
taxation by requiring the residence country to allow a credit
for taxes that the source country retains the right to impose
under the treaty. In addition, in the case of certain types of
income, treaties may provide for exemption by the residence
country of income taxed by the source country.
Treaties define the term ``resident'' so that an individual
or corporation generally will not be subject to tax as a
resident by both the countries. Treaties generally provide that
neither country will tax business income derived by residents
of the other country unless the business activities in the
taxing jurisdiction are substantial enough to constitute a
permanent establishment or fixed base in that jurisdiction.
Treaties also contain commercial visitation exemptions under
which individual residents of one country performing personal
services in the other will not be required to pay tax in that
other country unless their contacts exceed certain specified
minimums (e.g., presence for a set number of days or earnings
in excess of a specified amount). Treaties address passive
income such as dividends, interest, and royalties from sources
within one country derived by residents of the other country
either by providing that such income is taxed only in the
recipient's country of residence or by reducing the rate of the
source country's withholding tax imposed on such income. In
this regard, the United States agrees in its tax treaties to
reduce its 30-percent withholding tax (or, in the case of some
income, to eliminate it entirely) in return for reciprocal
treatment by its treaty partner.
In its treaties, the United States, as a matter of policy,
generally retains the right to tax its citizens and residents
on their worldwide income as if the treaty had not come into
effect. The United States also provides in its treaties that it
will allow a credit against U.S. tax for income taxes paid to
the treaty partners, subject to the various limitations of U.S.
law.
The objective of preventing tax avoidance and evasion
generally is accomplished in treaties by the agreement of each
country to exchange tax-related information. Treaties generally
provide for the exchange of information between the tax
authorities of the two countries when such information is
necessary for carrying out provisions of the treaty or of their
domestic tax laws. The obligation to exchange information under
the treaties typically does not require either country to carry
out measures contrary to its laws or administrative practices
or to supply information that is not obtainable under its laws
or in the normal course of its administration or that would
reveal trade secrets or other information the disclosure of
which would be contrary to public policy. The Internal Revenue
Service (the ``IRS''), and the treaty partner's tax
authorities, also can request specific tax information from a
treaty partner. This can include information to be used in a
criminal investigation or prosecution.
Administrative cooperation between countries is enhanced
further under treaties by the inclusion of a ``competent
authority'' mechanism to resolve double taxation problems
arising in individual cases and, more generally, to facilitate
consultation between tax officials of the two governments.
Treaties generally provide that neither country may subject
nationals of the other country (or permanent establishments of
enterprises of the other country) to taxation more burdensome
than that it imposes on its own nationals (or on its own
enterprises). Similarly, in general, neither treaty country may
discriminate against enterprises owned by residents of the
other country.
At times, residents of countries that do not have income
tax treaties with the United States attempt to use a treaty
between the United States and another country to avoid U.S.
tax. To prevent third-country residents from obtaining treaty
benefits intended for treaty country residents only, treaties
generally contain an ``anti-treaty shopping'' provision that is
designed to limit treaty benefits to bona fide residents of the
two countries.
III. EXPLANATION OF PROPOSED PROTOCOL
Article 1. Personal Scope
The proposed protocol expands the ``saving clause''
provision in Article 1 (Personal Scope) of the present treaty
to include former long-term residents whose termination of
residency had as one of its principal purposes the avoidance of
tax.
Saving Clause
The personal scope article describes the persons who may
claim the benefits of the present treaty. The present treaty
generally applies to residents of the United States and
Australia, with specific modifications to such scope in other
articles. Like all U.S. income tax treaties and the U.S. model,
the present treaty includes a ``saving clause.'' Under this
clause, with specific exceptions, the treaty does not affect
the taxation by either treaty country of its residents or its
citizens. Thus, the United States may continue to tax its
citizens who are residents of Australia as if the treaty were
not in force.
The present treaty contains a provision under which the
saving clause (and therefore the U.S. jurisdiction to tax)
applies for U.S. tax purposes to a former U.S. citizen whose
loss of citizenship status had as one of its principal purposes
the avoidance of U.S. tax; such application is limited to the
ten-year period following the loss of citizenship status.
The proposed protocol expands the saving clause provision
in the present treaty to include former long-term residents
whose termination of residency had as one of its principal
purposes the avoidance of tax. The expansion of this provision
makes the treaty consistent with amendments to the U.S. tax
rules under Code section 877 in 1996 related to former citizens
and former long-term residents who relinquish citizenship or
terminate residency.
Prior to the enactment of the Health Insurance Portability
and Accountability Act of 1996, section 877 of the Code
provided special rules for the imposition of U.S. income tax on
former U.S. citizens for a period of ten years following the
loss of citizenship; these special tax rules applied to a
former citizen only if his or her loss of U.S. citizenship had
as one of its principal purposes the avoidance of U.S. income,
estate or gift taxes. The Health Insurance Portability and
Accountability Act of 1996 expanded section 877 to apply also
to certain former long-term residents of the United States. For
purposes of applying the special tax rules to former citizens
and long-term residents, individuals who meet a specified
income tax liability threshold or a specified net worth
threshold generally are considered to have lost citizenship or
resident status for a principal purpose of U.S. tax avoidance.
The proposed protocol reflects the reach of the U.S. tax
jurisdiction pursuant to section 877 after its expansion by the
Health Insurance Portability and Accountability Act of 1996.
Accordingly, the saving clause in the proposed protocol permits
the United States to impose the special tax rules on former
U.S. long-term residents who terminate residency with a
principal purpose of avoiding U.S. income, estate, or gift
taxes.
The term ``long-term resident'' is defined under U.S.
domestic laws. The United States defines ``long-term resident''
as an individual (other than a U.S. 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.
Exceptions to the saving clause are provided for certain
benefits conferred by the articles dealing with Associated
Enterprises (Article 9); Pensions, Annuities, Alimony and Child
Support (Article 18); Relief from Double Taxation (Article 22);
Nondiscrimination (Article 23); Mutual Agreement Procedure
(Article 24); and certain sourcing rules (Article 27).
In addition, the saving clause does not apply to the
benefits conferred by one of the countries under the articles
dealing with Governmental Remuneration (Article 19), Students
(Article 20), or Diplomatic and Consular Privileges (Article
26), upon individuals (1) who are not citizens of that
conferring country and (2) who in the case of the United States
do not have immigrant status, or who in the case of Australia
are not ordinarily resident in Australia.
Article 2. Taxes Covered
The proposed protocol amends Article 2 (Taxes Covered) of
the present treaty to include certain U.S. and Australian
taxes. The present treaty provision generally applies to the
income taxes of the United States and Australia.
United States
In the case of the United States, the present treaty
applies to the Federal income taxes imposed by the Code, but
excludes the accumulated earnings tax and the personal holding
company tax. This treatment is different from the U.S. model,
which specifies that both the accumulated earnings tax and the
personal holding company tax are covered taxes.
The proposed protocol amends the present treaty to provide
that all U.S. income taxes are covered taxes for purposes of
the treaty. Thus, the accumulated earnings tax and the personal
holding company tax are covered taxes under the proposed
protocol. 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
proposed protocol continues to exclude social security taxes
and excise taxes as under the present treaty. The U.S. model
excludes social security taxes, but covers the excise tax on
private foundations and (in certain cases) the excise tax on
insurance premiums paid to foreign insurers.
Australia
In the case of Australia, the present treaty applies to the
Australian income tax, including the additional tax upon the
undistributed amount of the distributable income of a private
company.
The proposed protocol provides that the covered taxes are
(i) the Australian income tax, including tax on capital gains,
and (ii) 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 clarification with respect to the capital gains
tax means that U.S. taxpayers will be able to receive a U.S.
foreign tax credit for the capital gains tax paid. The proposed
protocol's modification to the covered Australian taxes will
expand the application of certain treaty provisions to include
the RRT (i.e., Article 5 (Permanent Establishment), Article 7
(Business Profits) and Article 27 (Miscellaneous)). However,
other modifications under the proposed protocol to Article 22
(Relief from Double Taxation) provide that the United States is
not required to grant a foreign tax credit for RRT paid to
Australia, even though the RRT is considered a covered tax
under the treaty. This does not preclude U.S. companies from
claiming a foreign tax credit for the RRT, but requires that a
determination of the RRT's creditability be made under U.S. tax
law.
The proposed protocol does not modify the provision
contained in the present treaty (and generally found in U.S.
income tax treaties) to the effect that it will apply to
substantially similar taxes that either country may
subsequently impose.
Article 3. Residence
The proposed protocol provides that, for purposes of
Article 4 (Residence) of the present treaty, a U.S. citizen is
treated as a resident of the United States unless the U.S.
citizen is a resident of a country other than Australia for
purposes of an income tax treaty between that third country and
Australia. If the U.S. citizen qualifies as a resident under an
income tax treaty between such third country and Australia, the
proposed protocol precludes the U.S. citizen from claiming
benefits under the U.S.-Australian treaty.
The assignment of a country of residence is important
because the benefits of the present treaty generally are
available only to a resident of one of the countries as that
term is defined in the treaty. Furthermore, issues arising
because of dual residency, including situations of double
taxation, may be avoided by the assignment of one treaty
country as the country of residence when under the internal
laws of the treaty countries a person is a resident of both
countries.
The present treaty defines a resident of the United States
to include any United States corporation (as defined in Article
3 so as to exclude corporations with dual residence) and,
subject to certain exceptions, any other person resident in the
United States as determined under U.S. tax laws.
The proposed protocol provides rules related to the
treatment of a U.S. citizen who is resident outside the United
States. The proposed protocol modifies the present treaty to
provide that a U.S. citizen is treated as a resident of the
United States unless the U.S. citizen is ``a resident of a
State other than Australia'' for purposes of an income tax
treaty between that third country and Australia.
This rule prevents a U.S. citizen who is a resident of a
country other than the United States or Australia from choosing
the benefits of the U.S.-Australia treaty over those provided
by the tax treaty between Australia and his or her country of
residence. The Technical Explanation gives the example of a
U.S. citizen who is a resident of the United Kingdom and
entitled to benefits under the U.K.-Australia tax treaty. Such
individual is precluded from claiming benefits under the U.S.-
Australia treaty and could claim only the benefits of the U.K.-
Australia treaty.
If a U.S. citizen's country of residence does not have a
tax treaty with Australia (or if the U.S. citizen does not
qualify as a ``resident'' of the third State for purposes of
the tax treaty between that State and Australia), then he or
she is treated as a resident of the United States and is
allowed to take advantage of benefits under the U.S.-Australia
treaty. If such individual is a resident of both the United
States and Australia, the appropriate country of residence is
determined by the ``tie-breaker'' rules provided under the
present U.S.-Australia treaty.
The Technical Explanation states that such provision, in
clarifying the treatment of a U.S. citizen, does not alter the
application of the ``saving clause'' (i.e., the U.S.
jurisdiction to tax). Thus, the fact that a U.S. citizen is not
considered a U.S. resident under the U.S.-Australia treaty does
not prevent the United States from continuing to tax such
individual as if the U.S.-Australia treaty never went in to
force. The Technical Explanation states that a U.S. citizen
who, under this rule, is not considered to be a resident of the
United States still is taxable on his worldwide income under
generally applicable U.S. tax laws.
Article 4. Business Profits
The proposed protocol adds a new paragraph to Article 7
(Business Profits) of the present treaty to clarify that the
permanent establishment status of a fiscally transparent entity
flows through the entity, resulting in a permanent
establishment for the beneficial owners of such entity.
Under the present treaty, the business profits of an
enterprise of one of the countries are taxable in the other
country if the enterprise carries on business through a
permanent establishment within the other country, but only so
much of the business profits that are attributable to that
permanent establishment.
The taxation of business profits under the present treaty
differs from United States rules for taxing business profits
primarily by requiring more than merely being engaged in trade
or business before a country can tax business profits and by
substituting the ``attributable to'' standard for the Code's
``effectively connected'' standard. Under the Code, all that is
necessary for effectively connected business profits to be
taxed is that a trade or business be carried on in the United
States. Under the present treaty, on the other hand, some level
of fixed place of business must be present and the business
profits must be attributable to that fixed place of business.
The proposed protocol does not change the basic rule for
taxing business profits under the present treaty. The proposed
protocol clarifies the treatment of fiscally transparent
entities (e.g. certain trusts) and beneficial owners of
fiscally transparent entities. The clarification provision was
requested by Australia because, under Australian law, the
trustees of a trust (instead of the beneficiaries of a trust)
are treated as carrying on any trade or business conducted by
the trust. Thus, any trade or business that results in a
permanent establishment is attributed to the trustees rather
than the beneficiaries of the trust. The proposed protocol
would clarify that permanent establishment status flows through
a fiscally transparent entity.
The proposed protocol provides that if a fiscally
transparent entity (or trustee) creates a permanent
establishment in one of the two countries and a resident of the
other country is beneficially entitled to a share of the
business profits generated by the fiscally transparent entity
(or trustee) through that permanent establishment, then the
beneficial owner is treated as carrying on a business through a
permanent establishment in that country, and its share of the
business profits are attributed to the permanent establishment.
The Technical Explanation gives the example of a trust with
a U.S. beneficiary carrying on a business in Australia through
its trustee such that if that trustee's actions rise to the
level of a permanent establishment, then the U.S. beneficiary
will be treated as having a permanent establishment in
Australia and the profits of the trust associated with that
permanent establishment are considered business profits.
The Technical Explanation clarifies that because such
provision was added solely to address Australian law relating
to trusts, the absence of similar language in other U.S. tax
treaties does not imply that a resident may avoid permanent
establishment treatment and business profits by investing
through a fiscally transparent entity.
Unlike some U.S. treaties and the U.S. model, the present
treaty does not define the term ``business profits.'' Thus, to
the extent not dealt with in other Articles, the term is
defined under the domestic laws of each country. If the
definitions cause double taxation, the competent authorities
agree on a common meaning of the term.
The present treaty contains a provision, not generally
found in other treaties, that permits a country to determine
the tax liability of a person under internal law where the
information available to the competent authority of that
country is inadequate to determine the profits attributable to
a permanent establishment. However, on the basis of available
information, the determination of the profits of the permanent
establishment must be consistent with the principles of the
Article.
Article 5. Shipping and Air Transport
The proposed protocol amends Article 8 (Shipping and Air
Transport) to generally favor residence country taxation of
income from the operation of ships, aircraft and containers in
international traffic. The proposed protocol modifies the rules
on the treatment of profits from the rental of ships and
aircraft in international traffic, the treatment of containers,
and the use of profit-sharing arrangements. The proposed
protocol also clarifies the treatment of inland transport of
property and passengers.\3\
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\3\ The rules governing income from the disposition of ships,
aircraft, and containers are in Article 13 (Alienation of Property) of
the present treaty (as amended by Article 9 of the protocol).
---------------------------------------------------------------------------
The United States generally taxes the U.S.-source income of
a foreign person from the operation of ships or aircraft to or
from the United States. An exemption from U.S. tax is provided
if the income is earned by a corporation that is organized in,
or an alien individual who is resident in, a foreign country
that grants an equivalent exemption to U.S. corporations and
residents. The United States has entered into agreements with a
number of countries providing such reciprocal exemptions.
Like the present treaty, the proposed protocol provides
that profits that are derived by an enterprise of one country
from the operation in international traffic of ships or
aircraft are taxable only in that country.\4\ Also, like the
present treaty, the proposed protocol provides that profits
from the operation of ships or aircraft in international
traffic include profits derived from the rental of ships or
aircraft on a full basis (i.e., with crew) if the lessor either
operates ships or aircraft in international traffic or
regularly leases ships or aircraft on a full basis.
---------------------------------------------------------------------------
\4\ ``International traffic'' is defined in Article 3(1)(d)
(General Definitions) as any transport by a ship or aircraft, except
when the transport is solely between places in the other treaty
country.
---------------------------------------------------------------------------
The proposed protocol and the present treaty differ with
respect to treatment of profits from the rental of ships or
aircraft on a bareboat basis (i.e., without crew). Under the
present treaty, if such rental activities are incidental to the
activities from the operation of ships or aircraft in
international traffic and the leased ships or aircraft are
operated in international traffic, then the profits are treated
as profits from the operation in international traffic of ships
and aircraft and thereby subject to tax only in the resident
country. The proposed protocol eliminates the requirement that
the leased ships or aircraft actually be operated in
international traffic in order to be eligible for resident
country only taxation. The Technical Explanation notes that
this provision is generally consistent with the OECD model but
still is narrower than the U.S. Model, which also covers
rentals from bareboat leasing that are not incidental to the
operation of ships and aircraft in international traffic by the
lessor.
Tracking the U.S. model, the proposed protocol provides
that profits of an enterprise of a country from the use,
maintenance, or rental of containers (including trailers,
barges, and related equipment for the transport of containers)
used for the transport of goods in international traffic is
taxable only in that country. Unlike the present treaty, this
is the result under the proposed protocol (and the U.S. model)
regardless of whether: (1) the income recipient is a lessor;
(2) the income is rental income that is incidental to income
received from the operation of ships or aircraft in
international traffic; and (3) the containers and related
equipment are used in international traffic by a lessee. The
Technical Explanation states that, by contrast to the U.S.
model and the proposed protocol, the OECD model covers only
income from the use, maintenance, or rental of containers that
is incidental to other income from international traffic. In
addition, consistent with the U.S. model, the proposed protocol
changes the reference from ``containers and related equipment''
in the present treaty to a reference to ``containers (including
trailers, barges, and related equipment for the transport of
containers).''
Following the Australian model, the shipping and air
transport provisions of the proposed protocol apply to profits
derived from participation in a pool service or other profit
sharing arrangement. This refers to various arrangements for
international cooperation by carriers in shipping and air
transport. By contrast, the present treaty refers only to
profits derived from participation in a pool service, in a
joint transport operating organization, or in an international
operating agency. Similar to the present treaty, the U.S. model
refers to profits derived from a pool, a joint business, or an
international operating agency.
The proposed protocol clarifies the treatment of the inland
transport of property and passengers. Under the present treaty,
the definition of profits from the operation in international
traffic of ships and aircraft does not include (and therefore
the Article does not cover) profits derived from the carriage
by ships or aircraft of passengers or certain property
(livestock, mail, goods, or merchandise) that is shipped in one
State for discharge at another place in that State. This rule
has raised questions about the treatment of the domestic leg of
an international trip. Accordingly, the proposed protocol
provides that the carriage by ships or aircraft of passengers
or certain property that is taken on board in one State for
discharge in that State is not the operation in international
traffic of ships or aircraft and may be taxed in that State.
The Technical Explanation characterizes the protocol as
consistent with the OECD model, namely that profits derived by
an enterprise from the inland transport of property or
passengers within either treaty country are treated as profits
from the operation of ships or aircraft in international
traffic (and, thus, governed by this Article) if such transport
is undertaken as part of international traffic by the
enterprise. For example, as described in the Technical
Explanation, under the proposed protocol, if a U.S. enterprise
contracts to carry property from Australia to the United States
and, as part of the contract, it transports (or contracts to
transport) the property by truck from its point of origin to an
airport in Australia, the income earned by the U.S. enterprise
from the overland leg of the journey would be taxable only in
the United States. In addition, if a U.S. airline carries
passengers from Los Angeles to Perth, with an intervening stop
in Melbourne, the Melbourne-to-Perth leg of the trip would be
treated as international transport of passengers with respect
to passengers who boarded in Los Angeles (and taxable only in
the United States) but not with respect to passengers who
boarded in Melbourne. With respect to passengers who boarded in
Melbourne, the profits related to such transport would not meet
the definition of ``international traffic.'' The Technical
Explanation states that this Article also would apply to income
from lighterage undertaken as part of the international
transport of goods.
Article 6. Dividends
The proposed protocol replaces Article 10 (Dividends) of
the present treaty with a new dividend article that generally
provides for full residence country taxation and limited source
country taxation of dividends. The proposed protocol would
retain the maximum rate of withholding at source at 15 percent
and would allow a 5 percent rate for dividends from 10-percent
owned corporations. It would also permit a new zero rate of
withholding tax on dividends from certain direct investments.
Special rules are provided for dividends from regulated
investment companies and real estate investment trusts.
Internal taxation rules
United States
The United States generally imposes a 30-percent tax on the
gross amount of U.S.-source dividends paid to nonresident alien
individuals and foreign corporations. The 30-percent tax does
not apply if the foreign recipient is engaged in a trade or
business in the United States and the dividends are effectively
connected with that trade or business. In such a case, the
foreign recipient is subject to U.S. tax on such dividends on a
net basis at graduated rates in the same manner that a U.S.
person would be taxed.
Under U.S. law, the term dividend generally means any
distribution of property made by a corporation to its
shareholders, either from accumulated earnings and profits or
current earnings and profits. However, liquidating
distributions generally are treated as payments in exchange for
stock and, thus, are not subject to the 30-percent withholding
tax described above.
Dividends paid by a U.S. corporation generally are U.S.-
source income. Also treated as U.S.-source dividends for this
purpose are portions of certain dividends paid by a foreign
corporation that conducts a U.S. trade or business. The U.S.
30-percent withholding tax imposed on the U.S.-source portion
of the dividends paid by a foreign corporation is referred to
as the ``second-level'' withholding tax. This second-level
withholding tax is imposed only if a treaty prevents
application of the statutory branch profits tax.
In general, corporations are not entitled under U.S. law to
a deduction for dividends paid. Thus, the withholding tax on
dividends theoretically represents imposition of a second level
of tax on corporate taxable income. Treaty reductions of this
tax reflect the view that where the United States already
imposes corporate-level tax on the earnings of a U.S.
corporation, a 30-percent withholding rate may represent an
excessive level of source-country taxation. Moreover, the
reduced rate of tax often applied by treaty to dividends paid
to direct investors reflects the view that the source-country
tax on payments of profits to a substantial foreign corporate
shareholder may properly be reduced further to avoid double
corporate-level taxation and to facilitate international
investment.
A real estate investment trust (``REIT'') is a corporation,
trust, or association that is subject to the regular corporate
income tax, but that receives a deduction for dividends paid to
its shareholders if certain conditions are met. In order to
qualify for the deduction for dividends paid, a REIT must
distribute most of its income. Thus, a REIT is treated, in
essence, as a conduit for federal income tax purposes. Because
a REIT is taxable as a U.S. corporation, a distribution of its
earnings is treated as a dividend rather than income of the
same type as the underlying earnings. Such distributions are
subject to the U.S. 30-percent withholding tax when paid to
foreign owners.
A REIT is organized to allow persons to diversify ownership
in primarily passive real estate investments. As such, the
principal income of a REIT often is rentals from real estate
holdings. Like dividends, U.S.-source rental income of foreign
persons generally is subject to the 30-percent withholding tax
(unless the recipient makes an election to have such rental
income taxed in the United States on a net basis at the regular
graduated rates). Unlike the withholding tax on dividends,
however, the withholding tax on rental income generally is not
reduced in U.S. income tax treaties.
U.S. internal law also generally treats a regulated
investment company (``RIC'') as both a corporation and a
conduit for income tax purposes. The purpose of a RIC is to
allow investors to hold a diversified portfolio of securities.
Thus, the holder of stock in a RIC may be characterized as a
portfolio investor in the stock held by the RIC, regardless of
the proportion of the RIC's stock owned by the dividend
recipient.
Australia
Australia has an integrated tax system and by statute does
not impose a withholding tax on dividend payments to
nonresidents to the extent such dividends have born the full
rate of Australian company tax (i.e., ``franked dividends'').
When dividends are paid out of untaxed corporate profits (i.e.,
``unfranked dividends''), withholding tax is imposed at a
statutory rate of 30 percent, unless otherwise reduced by
treaty. Australia does not currently impose a branch profits
tax.
Proposed treaty limitations on internal law
Under the proposed protocol, dividends paid by a company
that is a resident of a treaty country to a resident of the
other country may be taxed in such other country. Such
dividends also may be taxed by the country in which the payor
company is resident, but the rate of such tax is limited. Under
the proposed protocol, source-country taxation of dividends
(i.e., taxation by the country in which the dividend-paying
company is resident) generally is limited to 15 percent of the
gross amount of the dividends paid to residents of the other
treaty country. A lower rate of 5 percent applies if the
beneficial owner of the dividend is a company that owns at
least 10 percent of the voting stock of the dividend-paying
company.
The term ``beneficial owner'' is not defined in the present
treaty or proposed protocol and, thus, is defined under the
internal law of the source country. The Technical Explanation
states that the beneficial owner of a dividend for purposes of
this article is the person to which the dividend income is
attributable for tax purposes under the laws of the source
country. Further, companies holding shares through fiscally
transparent entities such as partnerships are considered to
hold their proportionate interest in the shares.
In addition, the proposed protocol provides a zero rate of
withholding tax with respect to certain intercompany dividends
in cases in which there is a sufficiently high (80-percent)
level of ownership (often referred to as ``direct dividends'').
80 percent intercompany ownership for 12 months
The proposed protocol reduces the withholding rate to zero
on dividends beneficially owned by a company that has owned
directly 80 percent or more of the voting power of the company
paying the dividend for the 12-month period ending on the date
the dividend is declared.
In general, in order to be eligible for this zero rate
withholding, the beneficial owner company must be entitled to
the benefits of the treaty under specified provisions of
Article 16 (Limitation on Benefits), as modified by the
proposed protocol, or have received a determination from the
relevant competent authority.
Dividends paid by RICs and REITs
The proposed protocol generally denies the 5 percent and
zero rates of withholding to dividends paid by a RIC or REIT.
The 15 percent rate of withholding is allowed for any
dividends paid by a RIC. The 15 percent rate of withholding is
allowed for dividends paid by a REIT only if one of three
additional conditions is met. First, the dividend may qualify
for the 15 percent rate if the person beneficially entitled to
the dividend is an individual holding an interest of not more
than 10 percent in the REIT. Second, the dividend may qualify
for the 15 percent rate if it is paid with respect to a class
of stock that is publicly traded and the person beneficially
entitled to the dividend is a person holding an interest of not
more than 5 percent of any class of the REIT's stock. Third,
the dividend may qualify for the 15 percent rate if the person
beneficially entitled to the dividend holds an interest in the
REIT of not more than 10 percent and the REIT is
``diversified'' (i.e., the gross value of no single interest in
real property held by the REIT exceeds 10 percent of the gross
value of the REIT's total interest in real property).
The Technical Explanation indicates that these restrictions
in availability of the different rates are intended to prevent
the use of RICs and REITs to gain unjustifiable source-country
benefits for certain shareholders resident in Australia. For
example, a company resident in Australia could directly own a
diversified portfolio of U.S. corporate shares and pay a U.S.
withholding tax of 15 percent on dividends on those shares.
There is a concern that such a company could purchase 10
percent or more of the interests in a RIC, which could even be
established as a mere conduit, and, thus, obtain a lower
withholding rate by holding a similar portfolio through the RIC
(transforming portfolio dividends generally taxable at 15
percent into direct investment dividends taxable under the
treaty at zero or 5 percent).
Similarly, the Technical Explanation gives an example of a
resident of Australia directly holding real property and
required to pay U.S. tax either at a 30 percent rate on gross
income or at graduated rates on the net income. By placing the
property in a REIT, the investor could transform real estate
income into dividend income, taxable at the rates provided in
the proposed protocol. The limitations on REIT dividend
benefits are intended to protect against this result.
Special rules apply to REIT dividends paid to listed
Australian property trusts (``LAPTs''). A LAPT is a unit trust
registered as an investment scheme, listed on a recognized
Australian stock exchange, and regularly traded on one or more
recognized exchanges. In order to encourage collective
investment by small unitholders, LAPTs receive tax benefits
under Australian law that are similar to those received by
REITs in the United States. The tax benefits are intended to
replicate the tax treatment of direct investment by such
unitholders. Thus, the REIT provision included in recent U.S.
tax treaties was modified to accommodate the Australian
domestic laws by granting small unitholders generally the same
benefits with respect to REIT shares that they would receive if
they directly held such investments.
The special rules generally allow a 15 percent withholding
rate for dividends paid by a REIT to a LAPT, notwithstanding
the conditional requirements related to REIT dividends
mentioned above. However, in the case of large unitholders, the
15 percent rate does not automatically apply to all the
dividends paid by a REIT to a LAPT. If the responsible entity
for the LAPT knows (or has reason to know) that one or more
unitholders owns 5 percent or more of the beneficial interests
in an LAPT, such unitholders will be subject to a look-through
rule, whereby they are deemed to hold directly their
proportionate interest in the REIT held through the LAPT, and
they must satisfy one of the three conditional requirements to
qualify for the 15 percent withholding rate on REIT dividends.
Thus in satisfying one of the three conditional requirements,
unitholders with an interest of five percent or more in a LAPT
must take into account the REIT shares they own directly and
the REIT shares they are deemed to own directly as a result of
the look-through rule.
Following the example in the Technical Explanation, assume
that a LAPT owns 40 percent of a REIT. One LAPT unitholder,
individual A, owns 20 percent of the beneficial interests in
the LAPT, and the responsible entity for the LAPT is aware of
A's percentage of ownership interests. All other unitholders in
the LAPT hold less than a 5 percent beneficial interest.
Accordingly, A is treated as holding a portion of the LAPT's
direct interest in the REIT equal to A's proportionate interest
in the LAPT. Thus, A is treated as owning 8 percent of the REIT
(.40 x .20) through A's LAPT investment. In addition to
ownership interests in the LAPT, A owns directly 5 percent of
the beneficial interests in the REIT. Thus, A's total
beneficial interests in the REIT are 13 percent (8 percent
through the LAPT and 5 percent held directly), preventing A
from meeting one of the three conditional requirements related
to REIT dividends and thereby denying A the benefit of the 15
percent withholding rate. The LAPT, however, is eligible for
the 15 percent rate on the remaining 80 percent of the
dividends (the portion not attributable to A's ownership
interest) paid by the REIT to the LAPT.
Special rules and limitations
The proposed protocol's reduced rates of tax on dividends
do not apply if the dividend recipient carries on business
through a permanent establishment in the source country, or
performs in the source country independent personal services
from a fixed base located in that country, and the holding in
respect of which the dividends are paid is effectively
connected with such permanent establishment or fixed base. In
such cases, the dividends effectively connected to the
permanent establishment or the fixed base are taxed as business
profits (Article 7) or as income from the performance of
independent personal services (Article 14), as the case may be.
The proposed protocol generally defines ``dividends'' as
income from shares, as well as other amounts, which are
subjected to the same taxation treatment as income from shares
by the country in which the distributing corporation is
resident. The Technical Explanation states that the term
includes income from shares or other corporate rights, which
carry the right to participate in profits, if such income is
subject to the same tax treatment as income from shares by the
country in which the distributing corporation is resident. The
term also includes income from arrangements, including debt
obligations, to the extent such income is so characterized
under the laws of the country in which the income arises.
The proposed protocol prevents the United States from
imposing a tax on dividends paid by an Australian company
unless such dividends are paid to a resident of the United
States or attributable to a permanent establishment or fixed
base situated in the United States. Thus, this provision
generally overrides the ability of the United States to impose
a ``second-level'' withholding tax on the U.S.-source portion
of dividends paid by an Australian corporation. The proposed
protocol also restricts the United States from imposing
corporate level taxes on undistributed profits, other than a
branch profits tax.
The United States is allowed under the proposed protocol to
impose the branch profits tax on an Australian corporation that
either has a permanent establishment in the United States, or
is subject to tax on a net basis in the United States on income
from real property or gains from the disposition of interests
in real property. The tax is imposed on the ``dividend
equivalent amount,'' as defined in the Code (generally, the
dividend amount a U.S. branch office would have paid to its
parent for the year if it had been operated as a separate U.S.
subsidiary). In cases where an Australian corporation conducts
a trade or business in the United States but not through a
permanent establishment, the proposed protocol completely
eliminates the branch profits tax that the Code would otherwise
impose on such corporation (unless the corporation earned
income from real property as described above). Australia
currently does not impose a branch profits tax. If Australia
were to impose such tax, the base of such a tax would be
limited to an amount analogous to the ``dividend equivalent
amount.''
The imposition of the branch profits tax by the United
States is precluded if an Australian company is considered a
qualified person by reason of it being a publicly-traded
company or a subsidiary of a publicly-traded company under
Article 16 (Limitation on Benefits), or if a such company is
granted treaty benefits by the competent authorities under
Article 16.
Article 7. Interest
The proposed protocol replaces Article 11 (Interest) with
an article that retains source-country taxation of interest at
a maximum rate of 10 percent, but allows a special zero rate of
withholding for interest paid to financial institutions and
governmental entities. The proposed protocol also contains
certain provisions that more closely conform the present treaty
to the U.S. model and to recent changes to U.S. domestic law.
Internal taxation rules
United States
Subject to several exceptions (such as those for portfolio
interest, bank deposit interest, and short-term original issue
discount), the United States imposes a 30-percent withholding
tax on U.S.-source interest paid to foreign persons under the
same rules that apply to dividends. U.S.-source interest, for
purposes of the 30-percent tax, generally is interest on the
debt obligations of a U.S. person, other than a U.S. person
that meets specified foreign business requirements. Interest
paid by the U.S. trade or business of a foreign corporation
also is subject to the 30-percent tax. A foreign corporation is
subject to a branch-level excess interest tax with respect to
certain ``excess interest'' of a U.S. trade or business of such
corporation. Under this rule, an amount equal to the excess of
the interest deduction allowed with respect to the U.S.
business over the interest paid by such business is treated as
if paid by a U.S. corporation to a foreign parent and,
therefore, is subject to the 30-percent withholding tax.
Portfolio interest generally is defined as any U.S.-source
interest that is not effectively connected with the conduct of
a trade or business if such interest (1) is paid on an
obligation that satisfies certain registration requirements or
specified exceptions thereto, and (2) is not received by a 10-
percent owner of the issuer of the obligation, taking into
account shares owned by attribution. However, the portfolio
interest exemption does not apply to certain contingent
interest income.
If an investor holds an interest in a fixed pool of real
estate mortgages that is a real estate mortgage interest
conduit (``REMIC''), the REMIC generally is treated for U.S.
tax purposes as a pass-through entity and the investor is
subject to U.S. tax on a portion of the REMIC's income
(generally, interest income). If the investor holds a so-called
``residual interest'' in the REMIC, the Code provides that a
portion of the net income of the REMIC that is taxed in the
hands of the investor--referred to as the investor's ``excess
inclusion''--may not be offset by any net operating losses of
the investor, must be treated as unrelated business income if
the investor is an organization subject to the unrelated
business income tax, and is not eligible for any reduction in
the 30-percent rate of withholding tax (by treaty or otherwise)
that would apply if the investor were otherwise eligible for
such a rate reduction.
Australia
Australian-source interest payments to nonresidents
generally are subject to withholding tax at a rate of 10
percent.
Proposed protocol limitations on internal law
The proposed protocol generally provides that interest
arising in one of the treaty countries (the source country) and
paid to a resident of the other treaty country generally may be
taxed by both countries. This provision is similar to
paragraphs (1) and (2) of Article 11 of the present treaty, but
is contrary to the position of the U.S. model, which provides
an exemption from source country tax for interest earned by a
resident of the other country.
Like the present treaty, the proposed protocol limits the
rate of source country tax that may be imposed on interest
income. Under the proposed protocol, if the beneficial owner of
interest is a resident of the other treaty country, the source
country tax on such interest generally may not exceed 10
percent of the gross amount of such interest. This rate is the
same as the present treaty rate, but is higher than the U.S.
model rate, which is zero.
The proposed protocol provides a complete exemption from
source country tax in the case of interest arising in a treaty
country and (1) derived and beneficially owned by the
Government of the other treaty country, including political
subdivisions and local authorities thereof, or (2) derived and
beneficially owned by a financial institution resident of the
other treaty country which is unrelated to and dealing at
arm's-length with the payer of the interest. For purposes of
this provision, the proposed protocol defines the term
``financial institution'' to include a bank or other enterprise
that derives substantially all of its profits by issuing
indebtedness or by taking interest-bearing deposits and using
proceeds from such indebtedness or deposits to carry on the
business of providing finance.
The proposed protocol provides an anti-conduit provision
under which the exemption from source country tax with respect
to interest derived by a financial institution does not apply
if such interest is paid as part of an arrangement involving
back-to-back loans or an arrangement that is economically
equivalent and intended to have a similar effect to back-to-
back loans. The Technical Explanation states that the economic
equivalent of back-to-back loans would include transactions
that serve the economic purpose of back-to-back loans but do
not meet the legal requirements of a loan. For example, the
Technical Explanation states that the economic equivalent of
back-to-back loans would include securities issued at a
discount and certain swap arrangements that are intended to
operate economically as back-to-back loans. The proposed
protocol also provides that this anti-conduit provision does
not restrict the right of a treaty country to apply any anti-
avoidance provisions of its internal law. Accordingly, the
Technical Explanation states that this provision does not limit
the ability of the United States to enforce existing anti-
avoidance provisions under U.S. domestic law, including in
particular the rules of Treas. Reg. sec. 1.881-3, regulations
adopted under the authority of section 7701(l) of the Code, and
any other anti-avoidance provision of broad application (e.g.,
section 267). Similarly, the anti-conduit provision does not
limit the ability of a treaty country to enact or adopt new
anti-avoidance provisions under its internal law.
The proposed protocol defines the term ``interest'' as
interest from government securities, bonds, debentures, and any
other form of indebtedness, whether or not secured by mortgage
and whether or not carrying a right to participate in the
debtor's profits. The term includes premiums attaching to such
securities, bonds, or debentures. The term also includes all
other income that is treated as interest under the internal law
of the country in which the income arises. Interest does not
include income covered in Article 10 (Dividends). Penalty
charges for late payment also are not treated as interest.
The reductions in source country tax on interest under the
proposed protocol do not apply if the beneficial owner of the
interest carries on business through a permanent establishment
in the source country and the interest paid is attributable to
the permanent establishment. In such an event, the interest is
taxed under Article 7 (Business Profits). The reduced rates of
tax on interest under the proposed protocol also do not apply
if the beneficial owner is a treaty country resident who
performs independent personal services from a fixed base
located in the other treaty country and such interest is
attributable to the fixed base. In such a case, the interest
attributable to the fixed base is taxed under Article 14
(Independent Personal Services).
The proposed protocol provides that interest is treated as
arising in a treaty country if the payer is a resident of that
country.\5\ However, if the interest expense is borne by a
permanent establishment or a fixed base, the interest will have
as its source the country in which the permanent establishment
or fixed base is located, regardless of the residence of the
payer. Thus, for example, if a French resident has a permanent
establishment in Australia and that French resident incurs
indebtedness to a U.S. person, the interest on which is borne
by the Australian permanent establishment, the interest would
be treated as having its source in Australia. In the case of
interest that is incurred by a U.S. branch of an Australian
resident company, the Technical Explanation indicates that the
interest expense allocation rules under U.S. law determine the
amount of interest expense that is considered to be borne by
the U.S. branch for purposes of this article.
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\5\ This is consistent with the source rules of U.S. law, which
provide as a general rule that interest income has as its source the
country in which the payer is resident.
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The proposed protocol addresses the issue of non-arm's-
length interest charges between related parties (or parties
having an otherwise special relationship) by stating that this
article applies only to the amount of arm's-length interest.
Any amount of interest paid in excess of the arm's-length
interest is taxable according to the laws of each country,
taking into account the other provisions of the present treaty
and the proposed protocol. For example, excess interest paid to
a parent corporation may be treated as a dividend under local
law and, thus, entitled to the benefits of Article 10
(Dividends). The Technical Explanation provides that if the
amount of interest paid is less than the amount that would have
been paid in the absence of the special relationship, a treaty
country may characterize a transaction to reflect its substance
and impute interest under the authority of Article 9
(Associated Enterprises).
The proposed protocol provides two anti-abuse exceptions to
the general source-country reductions in tax. The first
exception relates to ``contingent interest'' payments. If
interest is paid by a source-country resident and is determined
with reference to the profits of the debtor or a related
person, such interest may be taxed in the source country in
accordance with its internal laws. However, if the beneficial
owner is a resident of the other treaty country, such interest
may not be taxed at a rate exceeding 15 percent (i.e., the rate
prescribed in paragraph 2(b) of Article 10 (Dividends)).
The second anti-abuse exception provides that the
reductions in source country tax do not apply to interest paid
with respect to ownership interests in a vehicle used for the
securitization of real estate mortgages or other assets, to the
extent that the amount of interest paid exceeds the normal rate
of return on comparable publicly-traded debt instruments as
specified by the domestic law of the source country. The
Technical Explanation states that this provision ensures that
the source country reductions in tax do not apply to excess
income inclusions with respect to residual interests in a
REMIC. This provision is analogous to the U.S. model, but is
drafted reciprocally, presumably to apply to similar Australian
securitization vehicles.
The proposed protocol provides that the reductions in
source country tax apply to interest payments that are deemed
to be received by a treaty country resident and allocated as
interest expense for purposes of determining income that is
attributable to a permanent establishment of such resident in
the other treaty country or taxable on a net basis in the other
treaty country as income from real property or gain on real
property, to the extent such deemed interest payments exceed
the actual interest paid by the permanent establishment or
trade or business in the other treaty country. The Technical
Explanation states that this provision extends the reduction in
source country tax to include allocable excess interest that is
determined under the branch-level interest tax provisions of
U.S. internal law (sec. 884(f)).
Article 8. Royalties
The proposed protocol retains source-country taxation of
royalties, but reduces the maximum level of withholding tax
from 10 percent to 5 percent under Article 12 (Royalties) of
the existing treaty. In addition, the proposed protocol amends
the definition of ``royalties'' to treat certain leasing income
as business profits and updates such definition to reflect
technological advances since the present treaty was signed.
Internal taxation rules
United States
Under the same system that applies to dividends and
interest, the United States imposes a 30-percent withholding
tax on U.S.-source royalties paid to foreign persons. U.S.-
source royalties include royalties for the use of or the right
to use intangible property in the United States.
Australia
Australia generally imposes a withholding tax on royalties
paid to nonresidents at a rate of 30 percent.
Proposed treaty limitations on internal law
The U.S. model exempts royalties beneficially owned by a
resident of one country from source-based taxation in the other
country. The present treaty differs from the U.S. model in that
it allows the country where the royalties arise (the ``source
country'') to tax such royalties. The proposed protocol
maintains source country taxation of royalties, but reduces the
present treaty withholding tax rate from 10 percent to 5
percent. The proposed protocol's 5 percent rate does not
provide the full exemption found in many U.S. tax treaties and
the U.S. model with respect to royalties, but Australia has not
to date agreed to any treaty providing a rate lower than 5
percent.
The present treaty defines the term ``royalties'' to
include any consideration for the use of, the right to use, or
the sale (which is contingent on the productivity, use, or
further disposition) of any copyright, patent, design or model,
plan, secret formula or process, trademark or other like
property or right; motion picture films; or films or video
tapes for use in connection with television or tapes for use in
connection with radio broadcasting. The definition also
includes consideration for the use of ``industrial, commercial
or scientific equipment, other than equipment let under a hire
purchase agreement.''
The proposed protocol amends the definition of
``royalties'' in two ways. First, it removes the portion of the
definition related to payments for the use of ``industrial,
commercial or scientific equipment, other than equipment let
under a hire purchase agreement.'' Thus, the leasing income
related to such equipment is treated as business profits and
taxable by the source country only if the recipient of the
payments has a permanent establishment in the source country
and such income is attributable to the permanent establishment.
This treatment is consistent with the U.S. model, which treats
such income as business profits and not as royalties. Second,
the proposed protocol updates the definition of royalties to
reflect technological advances since the present treaty was
signed. The proposed protocol expands the provision to cover
films, audio, video tapes, and disks, as well as any other
means of image or sound reproduction or transmission, pursuant
to television, radio, or other broadcasting. The Technical
Explanation states that the provision would apply to a payment
by an Australian broadcaster to a U.S. company for the right to
transmit a live feed of an entertainment program over the
airwaves or through cable, satellite, or the Internet. It would
not however, apply to payments made by a retail customer who
has subscribed to satellite television service provided by a
U.S. company.
The proposed protocol's reductions in source country tax on
royalties do not apply if (1) the beneficial owner of the
royalties carries on business in the source country through a
permanent establishment located in that country or performs in
the source country independent personal services from a fixed
base located in that country, and (2) the royalties are
attributable to such permanent establishment or fixed base. In
such cases, the income is taxed as business profits (Article 7)
or as independent personal services income (Article 14), as the
case may be.
Article 9. Alienation of Property
The proposed protocol amends Article 13 (Alienation of
Property) of the present treaty to modify the taxation of gains
from the alienation of ships, aircraft, or containers operated
or used in international traffic and from property pertaining
to the operation or use in international traffic of ships,
aircraft, or containers. The proposed protocol amends Article
13 of the present treaty to provide that income or gains from
the alienation of certain business property of a permanent
establishment or fixed base may be taxed in the country in
which the permanent establishment or fixed base is located. The
proposed protocol also amends Article 13 to provide for the
taxation of gains of individuals who emigrate from one country
to the other.
Ships, aircraft, and containers
Under the present treaty, gains with respect to ships,
aircraft, or containers that are part of the business of a
resident of one country are taxable in that country except to
the extent that the business was allowed depreciation with
respect to the ships, aircraft, or containers in the other
country. The proposed protocol would provide that gains with
respect to ships, aircraft, or containers are taxable only by
the country in which the business owning the property is
resident. Thus, the gains that might be realized with respect
of international traffic in the United States would not be
subject to income tax in United States if the owner of the
property giving rise to the gain were a resident of Australia.
Likewise, the gains that might be realized with respect of
international traffic in the Australia would not be subject to
income tax in Australia if the owner of the property giving
rise to the gain were a resident of the United States.
Certain gains on business property
Article 13 of the present treaty generally makes provision
for the taxation of income or gains of a resident of one
country from the alienation or disposition of real property
located in the other country. The proposed protocol would
provide that certain gains from the alienation of property,
other than real property, forming part of the business property
of a permanent establishment or fixed base in one country of a
business resident in the other country may be taxed only by the
country in which the permanent establishment or fixed base is
located. The Technical Explanation provides an example of a
resident of Australia that is a partner in a partnership doing
business in the United States. The Australian partner will have
a permanent establishment in the United States as a result of
the activities of the partnerships. Under the proposed
protocol, the United States may tax the Australian partner's
distributive share of income realized by the partnership on the
disposition of personal property forming part of the business
property of the partnership in the United States.
Emigrating Individuals
The proposed protocol provides for the taxation of gains of
an individual who emigrates from one country to the other and,
as a result, becomes subject to special tax rules in the
country from which the individual emigrated. The Technical
Explanation observes that under present law, this provision
applies only to a resident of Australia who terminates his or
her residency in Australia and becomes resident in the United
States. Under Australian law, an individual who terminates
Australian residence generally is treated as recognizing gain
as though he or she disposed of all non-Australian assets.
However, subject to certain conditions, an Australian resident
may elect to defer the taxation of income or gain from this
deemed sale.
The proposed protocol provides that where the individual
who terminates residency pays tax on the deemed sale, the other
country (the United States under present law) shall treat the
property as sold and re-acquired before the individual became
resident in the United States. The effect of this provision is
to step up the individual's basis to the fair market value of
the assets deemed to have been sold in the other country
(Australia under present law). Thus, regardless of whether any
U.S. tax was triggered by the deemed sale, the individual's
basis for future computation of gain under the U.S. income tax
will be the fair market value of the asset immediately before
taking up residency in the United States. In the case where the
individual who terminates residency in one country for
residency in the other country, but elects to defer the tax
from that first country's deemed disposition rule (Australia
under present law), the proposed protocol provides that only
the other country (the United States under present law) may tax
the gain realized upon subsequent disposition of the assets.
Article 10. Limitation on Benefits
The proposed protocol replaces Article 16 (Limitation on
Benefits) of the present treaty with an article that reflects
the limitation on benefits provisions included in more recent
U.S. income tax treaties. These provisions are intended to
limit the benefits of the treaty to qualified residents of the
United States and Australia.
The income tax treaty between the United States and
Australia is intended to limit double taxation caused by the
interaction of the two countries tax systems as they apply to
residents of the two jurisdictions. At times, however,
residents of third countries attempt to use the treaty. Such
use is known as ``treaty shopping'' and refers to the situation
where a person who is not a resident of either country seeks
certain benefits under the income tax treaty between the two
countries. Under certain circumstances, and without appropriate
safeguards, the nonresident is able indirectly to secure these
benefits by establishing a corporation (or other entity) in one
of the countries which, as a resident of that country, is
entitled to the benefits of the treaty. Additionally, it may be
possible for the third country resident to repatriate funds to
that third country from the entity under favorable conditions
(i.e., it may be possible to reduce or eliminate taxes on the
repatriation) either through relaxed tax provisions in the
distributing country or by passing the funds through other
treaty countries (essentially, continuing to treaty shop),
until the funds can be repatriated under favorable terms.
Qualified Person
The proposed anti-treaty shopping article provides that a
treaty country resident is entitled to all treaty benefits only
if it is in one of several specified categories. Generally, a
resident of either country qualifies for the benefits accorded
by the proposed protocol if such resident is within one of the
following categories of ``qualified persons'' (and satisfies
any other specified conditions for obtaining benefits):
(1) An individual;
(2) One of the two countries or a governmental entity
of one of the two countries;
(3) A company that satisfies a public company test
and certain subsidiaries of such companies;
(4) An entity other than a company that satisfies a
public ownership test and certain subsidiaries of such
entities;
(5) A tax-exempt organization operated exclusively
for religious, charitable, educational, scientific, or
similar purposes;
(6) A tax-exempt pension scheme or employee benefit
arrangement that meets an ownership test;
(7) An entity that satisfies an ownership test and a
base erosion test; or
(8) A recognized headquarters for a multinational
corporate group.
Alternatively, a resident that does not fit into any of the
above categories may claim treaty benefits with respect to
certain items of income under an active business test. In
addition, a person that does not satisfy any of the above
requirements may be entitled to the benefits of the treaty if
the source country's competent authority so determines.
Individuals
Under the proposed protocol, individual residents of the
United States and Australia are entitled to all treaty
benefits. However, if such an individual receives income as a
nominee on behalf of a third country resident, and thus is not
the beneficial owner of such income, benefits may be denied.
Governmental entities
The proposed protocol provides that the United States and
Australia, any political subdivision or local authority of the
two countries, or any agency or instrumentality of the two
countries is entitled to all treaty benefits. The proposed
protocol departs from the language used in most U.S. income tax
treaties and the U.S. model with respect to governmental
entities, but there is no material difference between the
provisions with respect to limiting benefits.
Public company tests
A company that is a resident of the United States or
Australia is entitled to treaty benefits if the principal class
of its shares is listed on a recognized U.S. or Australian
stock exchange and is regularly traded on one or more
recognized stock exchanges. Thus, such a company is entitled to
the benefits of the treaty regardless of where its actual
owners reside.
The term ``recognized stock exchange'' means the NASDAQ
System owned by the National Association of Securities Dealers;
any stock exchange registered with the U.S. Securities and
Exchange Commission as a national securities exchange under the
U.S. Securities Exchange Act of 1934; the Australian Stock
Exchange and any other stock exchange recognized under
Australian law; and any other stock exchange agreed upon by the
competent authorities of the two countries.
The term ``principal class of shares'' is not a defined
term under Article 3 (General Definitions). Accordingly, such
term is defined by reference to the domestic laws of each
country from which treaty benefits are sought, generally the
source country. Under U.S. tax law, the term is generally
defined as the common shares of the company representing the
majority of the aggregate voting power and value of the
company. The Technical Explanation states that if the company
does not have a class of ordinary or common shares representing
the majority of the aggregate voting power and value of the
company, then the ``principal class of shares'' is the class
(or any combination of classes) of shares that represent, in
the aggregate, a majority of the voting power and value of the
company. The term ``shares'' includes depository receipts for
shares or trust certificates for shares.
The term ``regularly traded'' is also not a defined term
for purposes of the treaty. In accordance with Article 3
(General Definitions), such term is defined by reference to the
domestic laws of each country from which the treaty benefits
are sought, generally the source country. The Technical
Explanation states that for U.S. tax purposes the term is to
have the meaning it has under Treas. Reg. sec. 1.884-
5(d)(4)(i)(B), relating to the branch tax provisions of the
Code. Under these regulations, a class of shares is considered
to be ``regularly traded'' if two requirements are met: (1)
trades in the class of shares are made in more than de minimis
quantities on at least 60 days during the taxable year and, (2)
the aggregate number of shares in the class traded during the
year is at least 10 percent of the average number of shares
outstanding during the year. (The Technical Explanation states
that Treas. Reg. sec. 1.884-5(d)(4)(i)(A), (ii) and (iii) will
not be taken into account for purposes of defining the term
``regularly traded'' under the treaty.) The Technical
Explanation also provides that the regularly traded requirement
can be met by trading on any recognized exchange or exchanges
located in either country and that trading on one or more
recognized stock exchanges may be aggregated for purposes of
this requirement. Thus, a U.S. company could satisfy the
regularly traded requirement through trading, in whole or in
part, on a recognized stock exchanges located in Australia or
on a stock exchange in a third country (if agreed upon by
competent authorities). Authorized but unissued shares are not
considered for purposes of this test.
In addition, a company that is a resident of the United
States or Australia is entitled to treaty benefits if at least
50 percent of the aggregate vote and value of the company's
shares is owned (directly or indirectly) by five or fewer
companies that satisfy the test previously described, provided
that each intermediate owner used to satisfy the control
requirement is a resident of the United States or Australia.
This rule allows certain subsidiaries of publicly traded
companies to take advantage of all benefits under the treaty.
To further illustrate this rule, the Technical Explanation
provides an example of an Australian company all of the shares
of which are owned by an Australian parent company such that
the Australian company would qualify for benefits under the
treaty if the principal class of shares of the Australian
parent company were listed on the Australian Stock Exchange and
regularly traded on a recognized U.S. or Australian stock
exchange. Under the same example, the Australian company would
not qualify for benefits under this provision if the publicly
traded parent company were resident in Canada, instead of the
United States or Australia. Furthermore, if the Australian
parent indirectly owned the Australian company through a chain
of subsidiaries, each such subsidiary in the chain, as an
intermediate owner, must be a resident of the United States or
Australia for the Australian company to meet the requirements
of such provision.
Public entity tests
Under the proposed protocol, a person other than an
individual or company that is a resident of the United States
or Australia is entitled to treaty benefits if the principal
class of units in that entity is listed or admitted to dealings
on a recognized U.S. or Australian stock exchange and is
regularly traded on one or more recognized stock exchanges.
Alternatively, the entity is entitled to treaty benefits if the
direct or indirect owners of at least 50 percent of the
beneficial interests in the entity are public entities under
the preceding sentence or public companies described below.
The Technical Explanation provides that this provision
generally applies to trusts if their shares of ownership are
publicly traded and to trusts that are owned by publicly traded
entities. The United States generally would consider such
entities to be companies covered by the public company tests
described above, making this provision redundant for U.S. tax
purposes.
The Technical Explanation provides an example of an
Australian trust, where the majority of shares of ownership are
owned by a second Australian trust such that if the principal
class of units of the second Australian trust are listed and
regularly traded on the Australian Stock Exchange, the first
Australian trust would meet the requirement of a qualified
person under such provision. However, if the second Australia
trust was a resident of Japan, and not the United States or
Australia, the first Australian trust would not qualify for
benefits under the provision.
Tax-exempt and charitable organizations
Under the proposed protocol, an entity is entitled to
treaty benefits if it is organized under U.S. or Australian law
and established and maintained exclusively for religious,
charitable, educational, scientific or similar purposes
(notwithstanding that all or part of its income is tax-exempt).
There is no requirement that specified percentages of the
beneficiaries of these organizations be residents of the United
States or Australia.
Pension Funds
Under the proposed protocol, certain pension funds are
entitled to benefits under the treaty. An entity qualifying
under this provision is one that is organized under U.S. or
Australian law and established and maintained in the country of
residence to provide, pursuant to a plan, pensions or other
similar benefits to employed and self-employed persons
(notwithstanding that all or part of its income is tax-exempt).
For the entity to be a qualified person, however, more than 50
percent of the entity's beneficiaries, members, or
participants, must be individuals resident in either the United
States or Australia. The term ``beneficiaries'' refers to
individuals receiving benefits from the organization.
Ownership and base erosion tests
Under the proposed protocol, an entity that is a resident
of the United States or Australia is entitled to treaty
benefits if it satisfies an ownership test and a base erosion
test. Under the ownership test, on at least half the days of
the taxable period, shares or other beneficial interests
representing at least 50 percent of the entity's aggregate
voting power and value is owned (directly or indirectly) by
certain qualified persons described above (i.e., individuals,
governmental entities, companies that meet the public company
test, and entities that meet the public entity test).
The Technical Explanation states that trusts may be
entitled to the benefits of this provision if they are treated
as residents of one of the countries and they otherwise satisfy
the requirements of the provision. Under the ownership test,
the beneficial interests in a trust are considered to be owned
by its beneficiaries in proportion to each beneficiary's
actuarial interest in the trust. The interest of a remainder
beneficiary will be equal to 100 percent less the aggregate
percentages held by income beneficiaries. A beneficiary's
interest in a trust is not considered to be owned by a person
entitled to benefits under other ``qualified person''
categories under this provision if it is not possible to
determine the beneficiary's actuarial interest. Consequently,
if it is not possible to determine the actuarial interest of
any beneficiaries in a trust, the ownership test cannot be
satisfied, unless all beneficiaries are persons entitled to
benefits under other ``qualified person'' categories.
The base erosion test is satisfied only if less than 50
percent of the person's gross income for the taxable period is
paid or accrued, directly or indirectly, in the form of
deductible payments, to persons who are not residents of either
treaty country. The term ``gross income'' is not defined in the
treaty. Thus, in accordance with Article 3, such term is to
ascribe the meaning it has under U.S. tax law. The Technical
Explanation states that in the case of the United States, the
term ``gross income'' has the same meaning as under section 61
of the Code and the regulations thereunder. To the extent they
are deductible from the taxable base, trust distributions are
deductible payments. In addition, for purposes of this test,
deductible payments do not include arm's-length payments in the
ordinary course of business for services or tangible property
and payments in respect of financial obligations to a bank;
provided that, if the bank is not a resident of one of the
countries such payment is attributable to a permanent
establishment of that bank located in one of the countries.
Headquarters company
Under the proposed protocol, a resident of the United
States or Australia is entitled to treaty benefits if that
person functions as a headquarters company for a multinational
corporate group. A person is considered a headquarters company
for this purpose only if each of several criteria is satisfied.
Overall supervision and administration
The person seeking such treatment must provide a
substantial portion of the overall supervision and
administration of the group. The Technical Explanation provides
that a person will be considered to engage in supervision and
administration if it engages in a number of the following
activities: group financing, pricing, marketing, internal
auditing, internal communications, and management. However,
such company cannot be principally involved group financing.
The above-mentioned functions are not an exhaustive list, but
intended to be suggestive of the types of activities in which a
headquarters company will be expected to engage. Furthermore,
it is understood that in determining if a substantial portion
of the overall supervision and administration of the group is
provided by the headquarters company, the activities it
performs as a headquarters company for the group must be
substantial in comparison to the same activities for the same
group performed by other entities within the multinational
group.
For example, a Japanese corporation establishes a
subsidiary in Australia to function as a headquarters company
for its Asia-Pacific operations. The Japanese corporation also
has two other subsidiaries functioning as headquarter
companies--one for the African operations and one for the North
American operations. The Australia headquarters company is the
parent company for the subsidiaries through which the Asia-
Pacific operations are carried on. The Australian headquarters
company supervises the bulk of the pricing, marketing, internal
auditing, internal communications and management for its group.
Although the Japanese overall parent sets the guidelines for
all of its subsidiaries in defining the worldwide group
policies with respect to each of these activities, and assures
that these guidelines are carried out within each of the
regional groups, it is the Australian headquarters company that
monitors and controls the way in which these policies are
carried out within the group of companies that it supervises.
The capital and payroll devoted by the Japanese parent to these
activities relating to the group of companies the Australian
headquarter company supervises is small relative to the capital
and payroll devoted to these activities by the Australian
headquarters company. Moreover, neither the other two
headquarter companies, nor any other related company besides
the Japanese parent company, perform any of the above-mentioned
headquarter activities with respect to the group of companies
that the Australian headquarters company supervises. In the
above case, the Australian headquarters company would be
considered to provide a substantial portion of the overall
supervision and administration of the group it supervises.
The proposed protocol does not require that the group that
is supervised include persons in the other country. However,
the Technical Explanation makes clear that it is anticipated
that in most cases the group will include such persons, due to
the requirement that the income derived by the headquarters
company be derived in connection with or be incidental to an
active trade or business supervised by the headquarters company
(described below).
Active trade or business
Either for the taxable year concerned, or as an average for
the preceding four years, the activities and gross income of
the corporate group that the headquarters company supervises
and administers must be spread sufficiently among different
countries. To satisfy the active trade or business requirement,
the group must consist of corporations resident in, and engaged
in an active business in, at least five countries, and the
income derived in the treaty country of which the headquarter
company is not a resident must be derived in connection with,
or be incidental to, that active business. The business
activities carried on in each of the five countries (or five
groupings of countries) must generate at least 10 percent of
the gross income of the group.
Single country limitation
The business activities carried on in any one country other
than the country where the headquarter company resides cannot
generate 50 percent or more of the gross income of the group.
As mentioned above, the proposed protocol states that 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. The Technical Explanation provides an example of such
application:
Example: AHQ is a corporation resident in Australia. AHQ
functions as a headquarters company for a group of companies.
AHQ derives dividend income from a U.S. subsidiary in the 2004
taxable year. The state of residence of each of these
companies, the situs of their activities and the amounts of
gross income attributable to each for the years 2004 through
2008 are set forth below:
----------------------------------------------------------------------------------------------------------------
Company Situs 2008 2007 2006 2005 2004
----------------------------------------------------------------------------------------------------------------
United States................................ U.S........................... $100 $100 $95 $90 $85
United States................................ Mexico........................ 10 8 5 0 0
United States................................ Canada........................ 20 18 16 15 12
United Kingdom............................... U.K........................... 30 32 30 28 27
New Zealand.................................. N.Z........................... 40 42 38 36 35
Japan........................................ Japan......................... 35 32 30 30 28
Singapore.................................... Singapore..................... 25 25 24 22 20
----------------------------------
Total.................................... .............................. 260 257 238 221 207
----------------------------------------------------------------------------------------------------------------
Because the United States' total gross income of $130 in
2007 is not less than 50 percent of the gross income of the
group, the provision is not satisfied with respect to dividends
derived in 2007. However, the United States' average gross
income for the preceding four years may be used in lieu of the
preceding year's average. The United States' average gross
income for the years 2004-2007 is $111.00 ($444/4). The group's
total average gross income for these years is $230.75 ($923/4).
Because $111.00 represents 48.1 percent of the group's average
gross income for the years 2004 through 2007, the United States
satisfies such provision.
Other country gross income limitation
No more than 25 percent of the headquarter company's gross
income may be derived from the treaty country of which it is
not a resident. Thus, if the headquarters company's gross
income for the taxable year is $100, no more than $25 of this
amount may be derived from the other country. As with the
single country limitation calculation, the proposed protocol
provides that if the gross income requirement under this clause
is not met for the taxable year, the taxpayer may satisfy this
requirement by averaging the ratios for the four years
preceding the taxable year.
Independent Discretionary Authority
The headquarters company must have and exercise independent
discretionary authority to carry out the overall supervision
and administration functions mentioned in the overall
supervision and administration requirement, above. The
Technical Explanation states that this determination is made
separately for each function. Thus, if a headquarters company
is nominally responsible for group financing, pricing,
marketing, and internal auditing functions, and another entity
is actually directing the headquarters company as to the group
financing function, the headquarters company would not be
deemed to have independent discretionary authority for group
financing, but it may have such authority for the other
functions.
Income taxation rules
The headquarters company must be subject to the generally
applicable income taxation rules in its country of residence.
The Technical Explanation states that this reference should be
understood to mean that the company must be subject to the
income taxation rules to which a company engaged in the active
trade or business would be subject. Thus, if one of the
countries introduced special taxation legislation that would
impose a lower rate of income tax on headquarter companies than
was imposed on companies engaged in the active conduct of a
trade or business, or would provide for an artificially low
taxable base for such companies, a headquarters company subject
to these rules would not be entitled to the benefits under such
provision.
In connection with or incidental to a trade or business
The income derived in the other country must be derived in
connection with or be incidental to the active business
activities referred to in the active trade or business
requirement, above. For example, if an Australian company that
satisfied the other requirements of this sub-section acted as a
headquarters company for a group that included a United States
corporation, and the group was engaged in the design and
manufacture of computer software, but the U.S. company was also
engaged in the design and manufacture of photocopying machines,
the income that the Australian company derived from the United
States would have to be derived in connection with or be
incidental to the income generated by the computer business in
order to be entitled to treaty benefits under this sub-section.
Similarly, interest income received from the U.S. company also
would be entitled to the benefits of the treaty under this
paragraph as long as the interest was attributable to a trade
or business supervised by the headquarters company. Interest
income derived form an unrelated party would normally not,
however, satisfy the requirements of this clause.
Active business test
Under the active business test, residents of one of the
countries are entitled to treaty benefits with respect to
income, profit, or gain derived from the other country if (1)
the resident is engaged in the active conduct of a trade or
business in its residence country, (2) the income is derived in
connection with, or is incidental to, that trade or business,
and (3) the trade or business is substantial in relation to the
trade or business activity in the other country. The proposed
protocol provides that the business of making or managing
investments for the resident's own account does not constitute
an active trade or business unless these activities are
banking, insurance, or securities activities carried on by a
bank, insurance company, or registered securities dealer.
The term ``trade or business'' is not defined in the
treaty. However, as provided in Article 3 (General
Definitions), undefined terms are to have the meaning which
they have under the domestic laws of each country. In this
regard, the Technical Explanation states that the U.S.
competent authority will refer to the regulations issued under
Code section 367(a) to define the term ``trade or business.''
In general, a trade or business will be considered to be a
specific unified group of activities that constitute or could
constitute an independent economic enterprise carried on for
profit.
The Technical Explanation provides that for purposes of
this test, income is derived ``in connection'' with a trade or
business if the income-producing activity in the source country
is a line of business that forms a part of or is complementary
to the trade or business conducted in the country of residence
by the income recipient. A business activity generally will be
considered to ``form a part of'' a business activity conducted
in the other country if the two activities involve the design,
manufacture or sale of the same products or type of products,
or the provision of similar services. In order for two
activities to be considered to be ``complementary,'' the
activities need not relate to the same types of products or
services, but they should be part of the same overall industry
and be related in the sense that the success or failure of one
activity will tend to result in success or failure of the
other. The Technical Explanation provides several different
examples of the application of this rule.
The Technical Explanation also provides that income derived
from a country will be ``incidental'' to a trade or business
conducted in the other country if the production of such income
facilitates the conduct of trade or business in the other
country. An example of incidental income is the temporary
investment of working capital derived from a trade or business.
The proposed protocol provides that whether a trade or
business is substantial is determined on the basis of all the
facts and circumstances. The Technical Explanation states that
such determination takes into account the comparative sizes of
the trades or businesses in each country (measured by reference
to asset values, income and payroll expenses), the nature of
the activities performed in each country, and the relative
contributions made to that trade or business in each country.
This treatment differs from some recent U.S. tax treaties
(i.e., Luxembourg, Netherlands) that include percentage
thresholds that provide a safe harbor for determining the
substantiality of a trade or business.
The proposed protocol provides that in determining whether
a person is engaged in the active conduct of a trade or
business, activities conducted by a partnership in which that
person is a partner and activities conducted by persons
connected to such person will be deemed to be conducted by such
person. For this purpose, a person is connected to another
person if (1) one person owns at least 50 percent of the
beneficial interest in the other person (or, in the case of a
company, owns shares representing at least 50 percent of the
aggregate voting power and value of the company or the
beneficial interest in the company), or (2) another person
owns, directly or indirectly, at least 50 percent of the
beneficial interest in each person (or, in the case of a
company, owns shares representing at least 50 percent of the
aggregate voting power and value of the company or the
beneficial interest in the company). The proposed protocol
provides that in any case, persons are considered to be
connected if on the basis of all the facts and circumstances,
one has control of the other or both are under the control of
the same person or persons.
Disproportionate interests
The proposed protocol denies benefits to the
disproportionate part of income earned by certain companies.
Under the proposed protocol, a company that is a resident of
one of the countries or a company that controls such a company
has outstanding a class of shares: (1) that is subject to terms
or other arrangements that entitle its holders to a portion of
the income, profit, or gain of the company derived from the
other country that is larger than the portion such holders
would receive in the absence of such terms and arrangements,
and (2) in which 50 percent or more of the voting power and
value is owned by persons who are not equivalent beneficiaries
(as defined above), then the benefits of the proposed treaty
will apply only to that proportion of the income which those
holders would have received in the absence of those terms or
arrangements.
Grant of treaty benefits by the competent authority
The proposed protocol provides a ``safety-valve'' for a
person that has not established that it meets one of the other
more objective tests, but for which the allowance of treaty
benefits would not give rise to abuse or otherwise be contrary
to the purposes of the treaty. Under this provision, such a
person may be granted treaty benefits if the competent
authority of the source country determines that the
establishment, acquisition, or maintenance of such resident and
the conduct of its operations did not have as one of its
principal purposes the obtaining of benefits under the treaty.
The Technical Explanation provides that if the competent
authority determines that benefits are to be allowed, they will
be allowed retroactively to the time of entry into force of the
relevant treaty provision or the establishment of the structure
in question, whichever is later.
The proposed protocol provides that the competent authority
of the source country must consult with the competent authority
of the residence country before refusing to grant benefits
under this provision.
Article 11. Other Income
The proposed protocol replaces Article 21 (Other Income)
with an article that more closely represents the provision
included in the U.N. model tax treaty.
This article is a catch-all provision intended to cover
items of income not specifically covered in other articles, and
to assign the right to tax income from third countries to
either the United States or Australia.
Under the proposed protocol, this rule gives the United
States the sole right to tax income derived from sources in a
third country and paid to a U.S. resident. This article is
subject to the saving clause, so U.S. citizens who are
residents of Australia will continue to be taxable by the
United States on their third-country income.
The general rule just stated does not apply to income
(other than income from real property as defined in Article 6
(Income from Real Property) if the beneficial owner of the
income is a resident of one country and carries on business in
the other country through a permanent establishment, or
performs services in the other country from a fixed base, and
the right or property in respect of which the income is paid is
effectively connected with such permanent establishment or
fixed base. In such a case, the provisions of Article 7
(Business Profits) or Article 14 (Independent Personal
Services), as the case may be, will apply. Such exception also
applies where the income is received after the permanent
establishment or fixed base is no longer in existence, but the
income is attributable to the former permanent establishment or
fixed base.
The proposed protocol provides that notwithstanding the
foregoing rules, items of income of a resident of a country not
dealt with in the other articles of the proposed treaty and
arising in the other country, may also be taxed by that other
country. This rule, which is not contained in the U.S. and OECD
models, is similar to the corresponding rule in the U.N. model.
Article 12. Relief from Double Taxation
The proposed protocol makes a conforming change to Article
22 (Relief from Double Taxation) of the present treaty to
reflect changes made by the protocol to Article 2 (Taxes
Covered) of the present treaty. Under the proposed protocol,
the United States is not required to allow a foreign tax credit
with respect to the resource rent tax (``RRT''). The
determination of whether the RRT is a creditable tax will be
made under U.S. tax law.
Article 13. Entry into Force
Article 13 of the proposed protocol relates to the entry
into force of the modifications provided in the protocol.
The article provides that the proposed protocol is subject
to ratification in accordance with the applicable procedures of
each country, and that instruments of ratification will be
exchanged as soon as possible. The proposed protocol will enter
into force upon the exchange of instruments of ratification.
With respect to the United States, the proposed protocol
will be effective with respect to withholding taxes on
dividends, royalties and interest for amounts derived by a non-
resident on or after the later of the first day of the second
month next following the date on which the proposed protocol
enters into force or July 1, 2003. With respect to other taxes,
the proposed protocol will be effective for taxable periods
beginning on or after the first day of January next following
the date on which the proposed protocol enters into force.
With respect to Australia, the proposed protocol will be
effective with respect to withholding taxes on dividends,
royalties and interest for amounts derived by a non-resident on
or after the later of the first day of the second month next
following the date on which the proposed protocol enters into
force or July 1, 2003. With respect to other Australian tax, in
relation to income, profits or gains, the proposed protocol
will be effective for any year of income beginning on or after
July 1 next following the date on which the proposed protocol
enters into force.
The article provides a special rule for certain REIT
dividends received by a LAPT. This rule is intended to protect
existing investments in REITs by LAPTs. For REIT shares owned
by an LAPT on March 26, 2001 or acquired by the LAPT pursuant
to a binding contract entered into on or before March 26, 2001
(``grandfathered REIT shares''), dividends from the
grandfathered REIT shares are subject to the provisions of
Article 10 (Dividends) as in effect on March 26, 2001. Thus,
the dividends from the grandfathered REIT shares will be
subject to a maximum withholding tax rate of 15 percent,
regardless of the ownership of the LAPT. REIT shares acquired
by the LAPT pursuant to a reinvestment of dividends (ordinary
or capital) from grandfathered REIT shares are also treated as
grandfathered REIT shares.
IV. ISSUES
A. Zero Rate of Withholding Tax on Dividends from 80-Percent-Owned
Subsidiaries
In general
The proposed protocol would eliminate withholding tax on
dividends paid by one corporation to another corporation that
owns at least 80 percent of the stock of the dividend-paying
corporation (often referred to as ``direct dividends''),
provided that certain conditions are met (subparagraph 3(a) of
Article 10 (Dividends)). The elimination of withholding tax
under these circumstances is intended to reduce further the tax
barriers to direct investment between the two countries.
Currently, no U.S. treaty provides for a complete exemption
from withholding tax under these circumstances, nor do the U.S.
or OECD models. However, many bilateral tax treaties to which
the United States is not a party eliminate withholding taxes
under similar circumstances, and the same result has been
achieved within the European Union under its ``Parent-
Subsidiary Directive.'' In addition, the United States has
signed a proposed treaty with the United Kingdom and a proposed
protocol with Mexico that include zero-rate provisions similar
to the one in the proposed protocol.
Description of provision
Under the proposed protocol, the withholding tax rate is
reduced to zero on dividends beneficially owned by a company
that has owned at least 80 percent of the voting power of the
company paying the dividend for the 12-month period ending on
the date the dividend is declared (subparagraph 3(a) of Article
10 (Dividends)). Under the current U.S.-Australia treaty, these
dividends may be taxed at a 5-percent rate.
Issues
In general
Given that the United States has never before agreed
bilaterally to a zero rate of withholding tax on direct
dividends, the Committee may wish to devote particular
attention to the benefits and costs of taking this step. The
Committee also may want to determine whether the inclusion of
the zero-rate provision in the proposed protocol (as well as in
the proposed treaty with the United Kingdom and the proposed
protocol with Mexico) signals a broader shift in U.S. treaty
policy, and under what circumstances the United States may seek
to include similar provisions in other treaties. Finally, the
Committee may wish to note the ramifications of including this
provision in the U.S.-Australia treaty in view of a ``most
favored nation'' provision relating to this subject in the
current U.S.-Mexico treaty.
Benefits and costs of adopting a zero rate with Australia
Tax treaties mitigate double taxation by resolving the
potentially conflicting claims of a residence country and a
source country to tax the same item of income. In the case of
dividends, standard international practice is for the source
country to yield mostly or entirely to the residence country.
Thus, the residence country preserves its right to tax the
dividend income of its residents, and the source country agrees
either to limit its withholding tax to a relatively low rate
(e.g., 5 percent) or to forgo it entirely.
Treaties that permit a positive rate of dividend
withholding tax allow some degree of double taxation to
persist. To the extent that the residence country allows a
foreign tax credit for the withholding tax, this remaining
double taxation may be mitigated or eliminated, but then the
priority of the residence country's claim to tax the dividend
income of its residents is not fully respected. Moreover, if a
residence country imposes limitations on its foreign tax
credit,\6\ withholding taxes may not be fully creditable as a
practical matter, thus leaving some double taxation in place.
For these reasons, dividend withholding taxes are commonly
viewed as barriers to cross-border investment. The principal
argument in favor of eliminating withholding taxes on certain
direct dividends in the proposed treaty is that it would remove
one such barrier.
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\6\ See, e.g., Code sec. 904.
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Direct dividends arguably present a particularly
appropriate case in which to remove the barrier of a
withholding tax, in view of the close economic relationship
between the payor and the payee. Whether in the United States
or in Australia, the dividend-paying corporation generally
faces full net-basis income taxation in the source country, and
the dividend-receiving corporation generally is taxed in the
residence country on the receipt of the dividend (subject to
allowable foreign tax credits). If the dividend-paying
corporation is at least 80-percent owned by the dividend-
receiving corporation, it is arguably appropriate to regard the
dividend-receiving corporation as a direct investor (and
taxpayer) in the source country in this respect, rather than
regarding the dividend-receiving corporation as having a more
remote investor-type interest warranting the imposition of a
second-level source-country tax.
Since both the United States and Australia currently impose
withholding tax on some or all direct dividends as a matter of
domestic law (albeit only on ``unfranked'' dividends in the
case of Australia), the provision would provide immediate and
direct benefits to the United States as both an importer and an
exporter of capital. The overall revenue impact of this
provision is unclear, as the direct revenue loss to the United
States as a source country would be offset in whole or in part
by a revenue gain as a residence country from reduced foreign
tax credit claims with respect to Australian withholding taxes.
Although the United States has never agreed bilaterally to
a zero rate of withholding tax on direct dividends, many other
countries have done so in one or more of their bilateral tax
treaties. These countries include OECD members Austria,
Denmark, France, Finland, Germany, Iceland, Ireland, Japan,
Luxembourg, Mexico, the Netherlands, Norway, Sweden,
Switzerland, and the United Kingdom, as well as non-OECD-
members Belarus, Brazil, Cyprus, Egypt, Estonia, Israel,
Latvia, Lithuania, Mauritius, Namibia, Pakistan, Singapore,
South Africa, Ukraine, and the United Arab Emirates. In
addition, a zero rate on direct dividends has been achieved
within the European Union under its ``Parent-Subsidiary
Directive.'' Finally, many countries have eliminated
withholding taxes on dividends as a matter of internal law
(e.g., the United Kingdom and Mexico). Thus, although the zero-
rate provision in the proposed treaty is unprecedented in U.S.
treaty history, there is substantial precedent for it in the
experience of other countries. It may be argued that this
experience constitutes an international trend toward
eliminating withholding taxes on direct dividends, and that the
United States would benefit by joining many of its treaty
partners in this trend and further reducing the tax barriers to
cross-border direct investment.
General direction of U.S. tax treaty policy
Looking beyond the U.S.-Australia treaty relationship, the
Committee may wish to determine whether the inclusion of the
zero-rate provision in the proposed protocol (as well as in the
proposed treaty with the United Kingdom and the proposed
protocol with Mexico) signals a broader shift in U.S. tax
treaty policy. Specifically, the Committee may want to know
whether the Treasury Department: (1) intends to pursue similar
provisions in other proposed treaties in the future; (2)
proposes any particular criteria for determining the
circumstances under which a zero-rate provision may be
appropriate or inappropriate; (3) expects to seek terms and
conditions similar to those of the proposed treaty in
connection with any zero-rate provisions that it may negotiate
in the future; and (4) intends to amend the U.S. Model to
reflect these developments.\7\
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\7\ More broadly, since the U.S. Model has not been updated since
1996, the Committee may wish to ask whether the Treasury Department
intends to update the model to reflect all relevant developments that
have occurred in the intervening years. A thoroughly updated model
would provide a more meaningful and useful guide to current U.S. tax
treaty policy and would thereby increase transparency and facilitate
Congressional oversight in this important area. See Joint Committee on
Taxation, Study of the Overall State of the Federal Tax System and
Recommendations for Simplification, Pursuant to Section 8022(3)(B) of
the Internal Revenue Code of 1986 (JCS-3-01), April 2001, Vol. II, at
445-47 (recommending that the Treasury Department revise U.S. model tax
treaties once per Congress).
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``Most favored nation'' agreement with Mexico
The adoption of a zero-rate provision in the U.S.-Australia
treaty relationship may have particular ramifications for the
U.S.-Mexico treaty relationship. Under the current U.S.-Mexico
income tax treaty, dividends beneficially owned by a company
that owns at least 10 percent of the voting stock of the
dividend-paying company are subject to a maximum withholding
rate of 5 percent (paragraph 2(a) of Article 10 of the U.S.-
Mexico treaty), which is the lowest rate of withholding tax on
dividends currently available under U.S. treaties. Under
Protocol 1 to that treaty, as modified by a formal
understanding subject to which the treaty and protocol were
ratified, the United States and Mexico have agreed, if the
United States adopts a rate on dividends lower than 5 percent
in a treaty with another country, ``to promptly amend [the
U.S.-Mexico treaty] to incorporate that lower rate.'' \8\
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\8\ This formal understanding was a response to an objection raised
by the Committee to the original language of the treaty protocol, under
which the ``most-favored nation'' provision would have been self-
executing--i.e., immediately upon U.S. agreement to a lower rate with
another treaty partner, the United States and Mexico would have begun
applying that lower rate in their treaty.
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Adopting the zero-rate provision in the proposed protocol
with Australia would trigger this obligation to amend the
current treaty with Mexico. The recently signed proposed
protocol with Mexico would amend that treaty to incorporate a
zero-rate provision substantially identical to that of the
proposed treaty with the United Kingdom, and substantially
similar to that of the proposed protocol with Australia, and
thus would seem to fulfill the U.S. obligation under the ``most
favored nation'' agreement. Thus, if the Senate were to ratify
both the proposed protocol with Australia and the proposed
protocol with Mexico, no issues of interaction between the two
treaty relationships would need to be confronted.
If, on the other hand, the Senate were to ratify the
proposed protocol with Australia, but not the proposed protocol
with Mexico, then the possibility would arise that the United
States eventually could be regarded as falling out of
compliance with its obligations under the U.S.-Mexico treaty.
This would raise difficult questions as to the exact nature of
this obligation and whether and how the United States would
come into compliance with it.
B. Income from the Rental of Ships and Aircraft
The present treaty includes a provision found in the U.S.
model and many U.S. income tax treaties under which profits
from an enterprise's operation of ships or aircraft in
international traffic are taxable only in the enterprise's
country of residence.
The present treaty and the proposed protocol differ from
the U.S. model in the case of profits derived from the rental
of ships and aircraft on a bareboat basis (i.e., without crew).
Under the proposed protocol, the rule limiting the right to tax
to the country of residence applies to such rental profits only
if the lease is merely incidental to the operation of ships and
aircraft in international traffic by the lessor. If the lease
is not merely incidental to the international operation of
ships and aircraft by the lessor, then profits from rentals on
a bareboat basis generally would be taxable by the source
country as business profits (if such profits are attributable
to a permanent establishment).
In contrast, the U.S. model and many other treaties provide
that profits from the rental of ships and aircraft operated in
international traffic on a bareboat basis are taxable only in
the country of residence, without requiring that the lease be
incidental to the international operation of ships and aircraft
by the lessor. Thus, unlike the U.S. model, the proposed
protocol provides that an enterprise that engages only in the
rental of ships and aircraft on a bareboat basis, but does not
engage in the operation of ships and aircraft, would not be
eligible for the rule limiting the right to tax income from
operations in international traffic to the enterprise's country
of residence. It should be noted that, under the proposed
protocol, profits from the use, maintenance, or rental of
containers used in international traffic are taxable only in
the country of residence, regardless of whether the recipient
of such income is engaged in the operation of ships or aircraft
in international traffic. The Committee may wish to consider
whether the proposed protocol's rules treating profits from
certain rentals of ships and aircraft on a bareboat basis less
favorably than profits from the operation of ships and aircraft
(or from the rental of ships and aircraft with crew) are
appropriate.
C. Capital Gains Tax
Unlike the U.S. model, the proposed protocol does not
provide significant limits on Australia's ability to impose its
capital gains tax on U.S. persons. In the United States, at
death certain individuals are subject to the estate tax on the
net value of assets in their estate, but accrued, but
unrealized, capital gains are not subject to income tax. An
heir's basis of an asset received by bequest is stepped up to
the fair market value of the asset at the time of the
decedent's death. Australia does not impose an estate tax, but
an heir's basis of an asset received by bequest generally is
the decedent's basis in the asset (carryover basis). Thus, if
an heir sells the bequeathed asset upon receipt, there is a
capital gains tax liability. As a consequence, a U.S. person's
Australian assets could be subject to estate taxation in the
United States upon his or her death and the heir could be
liable for capital gains tax in Australia upon the sale of the
bequeathed asset, creating a substantial aggregate tax
liability without relief under the treaty. Australia enacted
the carryover basis regime, in part, as a replacement for
Australia's previous estate tax. Because the Australian capital
gains tax serves some of the role of the U.S. estate tax, the
Committee may want to consider the proper manner for
coordination of treaty provisions relating to the taxation of
capital gains under the proposed protocol with estate taxation
in light of the present treaty in force with Australia with
respect to estate taxes.
D. Visiting Teachers and Professors
The proposed protocol maintains the present treaty's
treatment of visiting teachers and professors, in which an
individual visiting in the host country to engage in teaching
or research at an educational institution is subject to income
tax in the host country on any remuneration received for his or
her teaching or research. The treatment of the present treaty
conforms to the U.S. model. While this is the position of the
U.S. model, an exemption for visiting teachers and professors
has been included in many bilateral tax treaties. Of the more
than 50 bilateral income tax treaties in force, 30 include
provisions exempting from host country taxation the income of a
visiting individual engaged in teaching or research at an
educational institution, and an additional 10 treaties provide
a more limited exemption from taxation in the host county for a
visiting individual engaged in research. Although the proposed
protocol with Mexico would not include such a provision, the
proposed treaty with the United Kingdom does include such a
provision, and three of the most recently ratified income tax
treaties did contain such a provision.\9\ The Committee may
wish to satisfy itself that the inclusion of such an exemption
is not appropriate.
<greek-d>
\9\ The treaties with Italy, Slovenia, and Venezuela, each considered in
1999, contain provisions exempting the remuneration of visiting
teachers and professors from host country income taxation. The
treaties with Denmark, Estonia, Latvia, and Lithuania, also
considered in 1999, did not contain such an exemption, but did
contain a more limited exemption for visiting researchers.