House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Rt. Hon. William McMahon.)

Notes on Clauses

INCOME TAX (INTERNATIONAL AGREEMENTS) BILL 1968

The principal features of this Bill have already been mentioned in this memorandum and the following notes relate to each clause of the Bill.

Clause 1: Short title and citation

This clause formally provides for the short title and citation of the Amending Act and of the Principal Act as amended.

Clause 2: Commencement

Section 5 (1A.) of the Acts Interpretation Act 1901-1966 provides that every Act shall come into operation on the twenty-eighth day after the day on which the Act receives the Royal Assent, unless the contrary intention appears in the Act. By this clause it is proposed that the Amending Act will come into operation on the day on which it receives the Royal Assent. This will enable the new agreement with the United Kingdom to be put into practical effect in both countries as soon as Assent is given.

Clause 3: Interpretation

Section 3 of the Principal Act contains a number of definitions for the more convenient interpretation of the Act. It is proposed by paragraphs (a) to (d) of clause 3 to amend section 3 to insert a number of new or amended definitions.

Notes on the new definitions are -

agreement: Under the existing definition, this term means a convention or agreement a copy of which is set out in a schedule to the Principal Act. The previous United Kingdom agreement will no longer appear in a schedule to the Act, being replaced there by the new agreement. It is necessary, therefore, to amend this definition to include the previous United Kingdom agreement will continue to have effect.

the Assessment Act: This expression is at present defined as the Income Tax and Social Services Contribution Assessment Act 1936-1953. The proposed definition brings the citation of the Assessment Act up to date.

the previous United Kingdom agreement: This term means the 1946 double taxation agreement between the United Kingdom and Australia. Although this agreement is being replaced by the agreement signed in December 1967, it may in certain circumstances continue to have effect for a limited period after the new agreement enters into effect and this definition provides a convenient means of referring to the 1946 agreement.

the United Kingdom: This expression means the United Kingdom of Great Britain and Northern Ireland.

the United Kingdom agreement: This means the new double taxation agreement between Australia and the United Kingdom signed on 7 December 1967. A copy of this agreement is set out in the schedule to this Bill.

United Kingdom tax: This term has the same meaning as in the United Kingdom agreement. There the expression is defined as tax imposed by the United Kingdom, being tax to which the agreement applies by virtue of article 1, that is, the income tax (including surtax), the corporation tax and the capital gains tax.

Paragraph (e) of clause 3 proposes the insertion of four new sub-sections - sub-sections (3.), (4.), (5.) and (6.) - in section 3 of the Principal Act. These new sub-sections relate to the proposal to alter the basis on which double taxation relief is granted to residents of Australia in respect of certain interest and royalties derived from the United Kingdom and to the proposed new basis for the ascertainment of Australian tax for purposes of double taxation agreements.

Before explaining the new sub-sections it is necessary to give some explanation of the context in which the provisions are to apply.

Under the existing law, interest and royalties derived by residents of Australia from the United Kingdom and taxed there are exempt from Australian tax. It is proposed that where the new United Kingdom agreement operates to limit the United Kingdom tax on this income to 10% of the interest or royalties, the income will not be exempt from Australian tax because of the payment of United Kingdom tax. Subject to any specific exemption, the income will be taxed here and a credit for United Kingdom tax will be allowed.

Under the new United Kingdom agreement, the Australian tax on dividends, interest and royalties derived by a United Kingdom resident is generally not to exceed, in the case of dividends, 15%, and in the case of interest and royalties, 10%, of the gross amount of the income. Where this income is subject to Australian tax by assessment processes it is necessary to have machinery by which effect is given to the agreement. Under provisions now in section 17 of the Principal Act (which is being re-enacted with modifications by clause 6 of the Bill as section 16 of the Principal Act) the means adopted is to give a tax rebate of the amount by which the Australian tax on the particular income (calculated by a special formula) exceeds the limitation specified in the agreement.

Where credit for foreign tax is to be allowed against Australian tax on any income, the allowance of credit is subject to an overriding principle that the amount of the credit is not to exceed the Australian tax on the particular income. Section 14 of the Principal Act and the proposed section 14 of that Act give expression to this principle. For the purpose of determining the credit allowable, a formula for ascertaining the Australian tax on the particular income is thus necessary.

Up to the present time it has only been necessary, for the purposes expressed in sections 14 and 17 of the Principal Act, to ascertain the Australian tax in respect of dividends. The new United Kingdom agreement, and the proposed changes in the Australian law consequential on that agreement, will make it necessary in future to ascertain, for these purposes, the Australian tax on interest and royalties also.

The existing formula for ascertaining Australian tax is expressed to apply separately in relation to each dividend derived by a taxpayer. With the necessity to ascertain the Australian tax on interest and royalties as well as dividends, it is proposed to keep the required number of calculations to a minimum, in order to simplify the practical operation of the law. Accordingly, it is proposed that instead of making separate calculations of the Australian tax on each dividend or each amount of interest or royalties, there should, broadly speaking, be only one calculation in respect of all income of a particular kind that is derived from any one country. For an Australian resident deriving dividends and interest from the United Kingdom that are taxed there at 15% and 10% respectively, there would thus be one calculation in respect of all the United Kingdom dividends and another calculation in respect of all the interest derived by him from the United Kingdom.

The following are notes on the new sub-sections proposed to be inserted in section 3 of the Principal Act.

Sub-section (3.) relates to the proposed changes in the law concerning interest and royalties derived by residents of Australia from sources in the United Kingdom. It is being inserted to provide a convenient description, for purposes of the Principal Act - particularly paragraph (b) of sub-section (1.) of the proposed new section 12 - of interest and royalties derived by a person through a trustee or nominee. An amount of interest or royalties derived in this way is given the description of an amount of income attributable to the interest or royalties. Corresponding provisions in relation to dividends are contained in section 6B of the Assessment Act.

Under paragraph (a) of sub-section (3.), an amount of interest or royalties derived by a person through a nominee will be treated as attributable to interest or royalties, as the case may be. Paragraph (b) has the same effect where interest or royalties are derived by a beneficiary through a trust estate, or series of trust estates.

Sub-section (4.) is identical with sub-section (3.) of section 6B of the Assessment Act. It is designed to make it clear that references in the Principal Act to income being derived by a beneficiary are to be taken as relating to income of a trust estate to which a beneficiary is presently entitled for the purposes of Division 6 of Part III of the Assessment Act.

The proposed sub-section (5.) is a definition measure necessary to give effect to the proposed method of ascertaining the Australian tax in respect of dividends, interest and royalties on a 'class of income' basis.

Paragraph (a) of the sub-section provides that all dividends shall be deemed to be income of the same class and paragraphs (b), (c) and (d) provide correspondingly in respect of government loan interest to which section 160AB of the Assessment Act applies, other interest and royalties.

Paragraph (e) refers to amounts of income that are deemed to be attributable to income of one of the abovementioned classes and provides that such income shall be deemed to be income of the same class as the income to which it is so attributed. In other words, it has the effect that income derived through a trustee or nominee is treated in the same way as income derived directly. For example, under section 6B of the Assessment Act, income derived by a person as a beneficiary in a trust estate is deemed to be an amount attributable to a dividend where the income arises from a dividend derived by the trustee of the trust estate. The effect of paragraph (e) is that such income in the hands of the beneficiary will be deemed to be income of the same class as any other dividend beneficially derived by him as a shareholder.

Sub-section (6.) is designed as an aid to drafting of other provisions in the Bill. In effect, it is a definition of a 'relevant part' of a person's income. The term means broadly all that part of a person's income of a year of income that is to be the subject of a separate calculation of the amount of Australian tax for the purposes mentioned earlier. Accordingly, all income of the same class that:

•

is derived by the one person in the one year of income from sources in the one country;

•

is income in respect of which a credit for foreign tax is allowable or a provision of an agreement limits the amount of Australian tax payable; and

•

is included in the assessable income of the person of that year,

is to be treated as a relevant part of his income of the year.

To illustrate the application of the sub-section, there could be a taxpayer who derives dividends and interest from the United Kingdom and dividends from the United States in the one year of income. In his case there would be three relevant parts, that is, the dividends from the United Kingdom, the interest from that country and the dividends from the United States.

Clause 4: Incorporation.

By clause 4 it is proposed to make a drafting amendment to sub-section (2.) of section 4 of the Principal Act.

Sub-section (2.) of that section provides that the terms of Australia's double taxation agreements and machinery provisions of the Principal Act for the practical application of the agreements prevail over any conflicting provisions of the general income tax law. Although all four agreements provide for allowance of credits against Australian tax, this is expressly stated in the agreements to be subject to provisions of the Australian law. One such provision is section 160AO of the Assessment Act which provides (as did corresponding earlier provisions) that credits for overseas tax are not to exceed the tax payable in respect of the person's taxable income. Section 160AO is expressed to apply notwithstanding anything in the Principal Act and the proposed amendment will ensure that this is the position.

Clause 5: Agreement with United Kingdom.

This clause is the major provision of the Bill. It proposes to give the force of law in Australia to the new United Kingdom agreement. It will also have the effect that the previous United Kingdom agreement ceases to have the force of law in Australia. This is to be achieved by the repeal of section 5 of the Principal Act which gave the force of law to the previous United Kingdom agreement and by the insertion of a new section 5 giving the force of law to the new agreement.

Article 23 of the new United Kingdom agreement provides that the agreement shall enter into force on the date when the last of all such things shall have been done in the United Kingdom and Australia as are necessary to give the agreement the force of law in the United Kingdom and Australia. In the United Kingdom, the new agreement was given the force of law on 4 March 1967 by the Double Taxation Relief (Taxes on Income) (Australia) Order 1968.

Sub-section (1.) of the new section 5 will, subject to the Principal Act, give the new United Kingdom agreement the force of law in Australia as required by the terms of the agreement.

Under article 23, the agreement, on entering into force, is to have effect in Australia as set out in paragraph (1)(b) of the article. Paragraphs (a), (b) and (c) of sub-section (1.) correspond with what is in paragraph (1)(b) of the article.

Under paragraph (a) of sub-section (1.) the new United Kingdom agreement has effect in relation to dividends derived by non-residents on or after 1 July 1967. The agreement will have effect in relation to these dividends whether they are subject to Australian tax by withholding or by assessment processes.

Paragraph (b) of the sub-section provides that the agreement has effect in relation to interest subject to withholding tax that is derived on or after the 1 January 1968. The corresponding provision in the agreement - article 23(1)(b)(ii) - specifies 1 July 1967. As the withholding tax on interest did not come into operation until 1 January 1968 it is, however, only necessary to specify that date in paragraph (b) of sub-section (1.).

Under paragraph (c) of sub-section (1.) the new United Kingdom agreement will commence to have effect in respect of income, to which neither paragraph (a) nor paragraph (b) applies, of the year of income commencing on 1 July 1967, i.e., the 1967/68 income year. For a taxpayer who has adopted a substituted accounting period ending on a date other than 30 June, the new agreement will, under paragraph (c), first apply to income of the accounting period that is in lieu of the year commencing on 1 July 1967.

Sub-section (2.) of the proposed new section 5 provides for the previous United Kingdom agreement to continue to have the force of law in certain circumstances. These are specified in article 23 of the new United Kingdom agreement.

Paragraph (2) of article 23 of the new United Kingdom agreement provides that the previous United Kingdom agreement shall terminate and cease to have effect in relation to income in respect of which the new agreement comes into effect. The repeal of existing section 5 of the Principal Act will give effect to this paragraph.

Paragraph (3)(a) of article 23, however, requires that the previous United Kingdom agreement is to continue to have effect for a transitional period. It provides, so far as Australian tax is concerned, that where any provision of the previous agreement would have afforded any greater relief from Australian tax than is afforded by the new agreement, that provision shall continue to have effect in Australia, as follows:

•

in respect of income subject to withholding tax that is derived on or before 30 June 1968;

•

in respect of other income derived during (or prior to) the income year that commenced on 1 July 1967, or the accounting period, if any, adopted under the Assessment Act in lieu of that year.

(These dates are on the assumption that this Bill receives the Royal Assent before 1 July 1968.)

There is one qualification to the rules just outlined for giving taxpayers the benefit of the previous United Kingdom agreement in the transition period. This concerns paragraph (2) of article VI of the previous agreement which, broadly speaking, exempted from Australian tax dividends paid to a United Kingdom parent company by its wholly owned Australian subsidiary. By reason of article 23(3)(c) of the new United Kingdom agreement article VI(2) will continue to have effect only in respect of dividends declared before the date of publication of the new agreement, that is, before 15 December 1967.

The overall effect of the proposed sub-section (2.) of section 5 is that the previous United Kingdom agreement will continue to have the force of law to the extent required by article 23(3) of the new agreement.

Sub-clause (2.) of clause 5 is being inserted to permit the Commissioner of Taxation to amend certain assessments to give effect to the new United Kingdom agreement. As has been explained, paragraph (a) of sub-section (1.) of the proposed section 5 of the Principal Act will give the new agreement the force of law in relation to dividends derived by non-residents on or after 1 July 1967. Dividends that were paid in the latter part of 1967 could in some cases fall to be assessed as income of an accounting period adopted in lieu of the standard income year that ended on 30 June 1967. If an assessment is raised in any such case before the new agreement receives the force of law, sub-clause (2.) will enable the assessment to be amended to give the taxpayer any benefit conferred by the new agreement in relation to the dividends.

Clause 6:

By this clause it is proposed to repeal sections 12, 13, 14, 16 and 17 of the Principal Act and insert five new sections - sections 12, 13, 14, 15 and 16 - in their stead. Notes on the existing sections 12 and 13 will be found in the explanation of the proposed section 13. The new sections 14, 15 and 16 are re-expressions of the present sections 14, 16 and 17.

Section 12: Provisions relating to interest, royalties and dividends derived from sources in the United Kingdom.

Introductory Note:

The main purpose of this section is, in effect, to apply the credit system of relief of double taxation to interest and royalties that are derived by residents of Australia from the United Kingdom and are subject to reduced United Kingdom tax under the new agreement with that country.

Hitherto, section 23(q) of the Assessment Act has exempted from tax all income (other than dividends) that is derived from outside Australia and the Territory of Papua and New Guinea by an Australian resident and is subject to income tax in the country in which it is derived. Exemption of the income from Australian tax ensures that it is not doubly taxed as the exemption means that the only tax on the income is the overseas tax.

A different system of relief of double taxation of income derived from overseas applies to dividends. Dividends derived by residents of Australia from overseas companies are subject to Australian tax, but a credit for overseas tax on the dividends is allowable against any Australian tax on the dividends. If the dividend flows from a country with which Australia has a double taxation agreement, the agreement provides for credit to be given. Otherwise, section 45 of the Assessment Act provides for the allowance of credit.

The new section 12 will provide that the exemption under section 23(q) is not to apply to interest and royalties derived by residents of Australia from the United Kingdom if, under the new United Kingdom agreement, the interest or royalties are not to suffer United Kingdom tax of more than 10% of the gross amount of the interest or royalties. The interest and royalties will then be assessable income for income tax purposes to the extent provided by the general provisions of the Assessment Act and the new United Kingdom agreement will require that credit for the United Kingdom tax be allowed against Australian tax on the interest and royalties. The proposed sections 14 and 15 of the Principal Act will govern the allowance of credit for the United Kingdom tax.

The change proposed will have effect in relation to interest and royalties derived after 14 December 1967, but interest and royalties that remain subject to full United Kingdom tax - that is, where the interest or royalties are effectively connected with a trade or business carried on by an Australian resident through a permanent establishment in the United Kingdom - will continue to be exempt under section 23(q).

Sub-section (1.) of the proposed new section 12 provides that the exemption under section 23(q) of the Assessment Act will not be available in respect of interest and royalties derived on or after 15 December 1967 (that is, from the date on which this change in the law was announced) by residents of Australia from United Kingdom sources in those cases where the new United Kingdom agreement limits the amount of United Kingdom tax to 10%. Paragraph (a) expresses this general proposition while paragraph (b) will, with the aid of the proposed sub-section (3.) of section 3 of the Principal Act make it clear that interest and royalties derived through a trustee or nominee are to be treated in the same way as interest and royalties derived without the interposition of a trustee or nominee.

The object of sub-section (2.) is to make it clear that the amount that is treated as an amount of income attributable to United Kingdom interest or royalties derived by a beneficiary through a trust estate is not diminished by United Kingdom tax that has been paid in respect of the interest or royalties. This will ensure that the beneficiary is treated on the same basis as a person who derives such interest or royalties direct and who is required to include in his assessable income the gross amount of the interest or royalties before deduction of the United Kingdom tax.

Paragraphs (a), (b) and (c) of sub-section (2.) set out the circumstances under which an amount attributable to interest or royalties is to be treated as including United Kingdom tax in respect of the interest or royalties. These follow broadly the provisions of section 6B of the Assessment Act which applies in relation to dividends. The proposed sub-section (3.) of section 3 of the Principal Act specifies when an amount of income is attributable to interest or royalties.

Paragraph (a) of sub-section (2.) requires that, for the sub-section to come into operation, the beneficiary must derive an amount of income attributable to interest or royalties to which the agreed limitation on the amount of United Kingdom tax applies. Paragraph (b) of the sub-section requires that United Kingdom tax must have been paid in respect of the interest or royalties or an amount attributable thereto, either directly or by deduction from the interest or royalties or amounts attributable thereto. Paragraph (c) makes it necessary that the amount derived by the person be, by reason of the payment of United Kingdom tax, less than it otherwise would have been.

Where the tests of paragraphs (a) to (c) are satisfied, the sub-section provides that the amount attributable to the interest or royalties that is derived by the beneficiary is to be treated as increased to the amount that it would have been if the United Kingdom tax had not been paid. This 'grossing-up' procedure is necessary to ensure that the full amount of the relevant income, in respect of which credit is to be allowed for United Kingdom tax, is included in the Australian assessment of the beneficiary.

Sub-section (3.) provides for the same 'grossing-up' procedure in relation to income attributable to United Kingdom dividends as is provided by sub-section (2.) in relation to income attributable to interest or royalties. Sub-section (3.) is an adaptation, in relation specifically to dividends derived from the United Kingdom, of sub-section (2.) of section 6B of the Assessment Act.

Section 6B provides that where a dividend is derived through a trust estate, the income so derived is to be deemed to be an amount attributable to the dividend. Sub-section (2.) of section 6B ensures that a beneficiary is taxed on the amount of his share of a foreign dividend before deduction of the foreign tax, but it is necessary, however, that the foreign tax on the dividend be the personal liability of a person who derived the dividend or an amount attributable to the dividend.

As the United Kingdom tax on dividends is paid by the paying company, (although deducted from dividends paid), the tax may not be the personal liability of the recipient of the dividend and in these circumstances sub-section (2.) of section 6B may not apply to amounts attributable to United Kingdom dividends. As credits for United Kingdom tax are to be allowed on 'grossed-up' dividends it is necessary to have a provision corresponding to sub-section (2.) of section 6B but which takes account of the way in which the United Kingdom tax on dividends is levied. The proposed sub-section (3.), therefore is a re-expression of section 6B(2.) in relation to dividends from the United Kingdom.

Section 13: Deductions for United Kingdom tax not to be taken into account in calculating amount of dividend, interest or royalty.

Introductory Note:

This section is designed to give effect to the intention that where interest and royalties subject to reduced amounts of United Kingdom tax or dividends are derived from the United Kingdom by a resident of Australia, the amount of the income for the purposes of Australian tax will automatically be the amount before deduction of United Kingdom tax. The need for specific 'grossing-up' provisions arises from the way in which the United Kingdom law is framed.

There were 'grossing-up' procedures under the previous United Kingdom agreement in relation to dividends. These are covered by sections 12 and 13 of the Principal Act which are being repealed as being inappropriate in relation to the new agreement. The two sections will, however, continue to apply in relation to the 1966-67 year of income and prior years.

Section 12 of the Principal Act provides a right of election to have the amount of foreign (that is United Kingdom) tax in respect of a dividend included in assessable income of the year of income in which the dividend was paid. This section is related purely to article XII of the previous United Kingdom agreement which provided that credit for United Kingdom tax payable in respect of a dividend paid by a United Kingdom company to a resident of Australia was to be allowed against Australian tax only if the recipient elected to have the amount of the United Kingdom tax included in his assessable income for purposes of Australian tax. In the absence of such an election to 'gross-up', only the net amount of the dividend from a British company, after deduction of United Kingdom tax, could be included in the assessable income of an Australian shareholder and no credit was allowed for United Kingdom tax. Section 13 was designed to make the previous United Kingdom agreement effective in relation to dividends paid without deduction of United Kingdom tax.

The procedure provided for in the previous United Kingdom agreement arose under the United Kingdom system of taxation of company profits that applied prior to 1965. Under the former system the income tax on company profits was treated as being tax on dividends paid out of those profits and Australia assumed an obligation to give credit for this tax when taxing dividends of Australian shareholders in United Kingdom companies. The position was further complicated by former methods of calculating United Kingdom tax in relation to dividends paid by companies with income from outside the United Kingdom. In these circumstances, an election to 'gross-up' was made a pre-condition for the allowance of credit by Australia.

Under the new United Kingdom taxation system there is a separate tax on dividends in addition to the corporation tax on the profits out of which the dividends are paid. This also is the position in the other countries - the United States, Canada and New Zealand - with which Australia has double taxation agreements. Under those agreements credit is allowed by Australia for the tax imposed by the other country on dividends, the gross amount of the dividends (before deduction of the foreign tax) being included in assessable income.

Negotiations with the United Kingdom proceeded on the basis that a corresponding practice would apply in relation to dividends derived by residents of Australia from companies resident in the United Kingdom. That is, the inclusion in assessable income of the gross amount of the dividends and the allowance of credit by Australia was not to be dependent on an election to 'gross-up'. Negotiations on this point were, of course, against the background of a general limitation to 15% of the amount of United Kingdom tax on these dividends. There was no such limitation in the previous United Kingdom agreement.

The United Kingdom law that imposes tax on dividends paid by United Kingdom companies is, however, framed in such a way that it is not clear, in the light of judicial interpretation of relevant provisions of the Australian income tax law, whether the gross amount of such dividends before deduction of United Kingdom tax would be subject to tax in Australia in the absence of any special provision to that effect. Sub-section (1.) of the proposed section 13 is designed to make the position clear.

The other main purpose of the proposed section 13 concerns interest and royalties derived by residents of Australia from the United Kingdom in cases where the income is taxed in the United Kingdom. As has already been explained, this income is being made liable to Australian tax for the first time, subject to a credit for the United Kingdom tax. Again because of uncertainties arising from the inter-relation of the Australian and United Kingdom tax laws, it is proposed by sub-section (3.) to specifically ensure that calculations of Australian tax on the interest and royalties are based on the amount of this income before deduction of United Kingdom tax.

Sub-section (1.) deals with dividends that are paid by United Kingdom companies and in respect of which United Kingdom tax is payable. It provides that, for the purposes of the Principal Act and the Assessment Act, the amount of such a dividend is to be deemed to be the amount in respect of which, under United Kingdom law, the paying company is required to account for and pay tax. This follows the wording of the relevant United Kingdom law and will ensure that the amount on which United Kingdom tax is levied in respect of the dividend will be taken as the amount of the dividend for purposes of tax in Australia. United Kingdom tax based on this amount will, of course, be creditable against the Australian tax.

Sub-section (2.) is consequential on sub-section (1.). It provides that section 26A of the Assessment Act is to be inapplicable to United Kingdom dividends. Section 26A, which originally related primarily to the pre-1965 United Kingdom taxation system, applies in cases where a foreign taxing system is such that, under the general Australian law, only the net amount of a dividend after deduction of foreign tax is treated as assessable income in Australia. It provides that any refund of the foreign tax is to be taxed in Australia as a dividend. As the proposed sub-section (1.) of section 13 provides for the 'grossed-up' amount of United Kingdom dividends to be included in assessable income, it is necessary to ensure that section 26A does not operate to tax any refund of United Kingdom tax that has been deducted. Sub-section (2.) does this.

Sub-section (3.) contains provisions relating to interest and royalties derived from the United Kingdom after 14 December 1967 and in respect of which the new agreement limits the United Kingdom tax to 10%. The sub-section provides that where an amount in respect of United Kingdom tax has been deducted from the interest or royalties, the amount of the interest or royalties is to be deemed to be the amount that would have been the amount of the interest or royalties if the deduction had not been made.

By clause 11 of the Bill, the new section 13 will first apply in relation to the 1967/68 year of income

Section 14: Provisions relating to credits for foreign tax.

The main purpose of the new section 14, as of the section 14 being repealed, is to provide that where credit for foreign tax in respect of any income is allowable under the provisions of an agreement, the amount of that credit is not to exceed the amount of Australian tax payable in respect of the income.

Because of the exemption under section 23(q) of the Assessment Act, credits were, in practice, previously allowable only in the case of dividends and the existing section 14 requires the calculation of a separate credit in respect of each dividend derived from each country with which Australia has a double taxation agreement.

Following the new United Kingdom agreement credits will now be available also in respect of United Kingdom interest and royalties. With this extension of the area in which credits are allowable it is proposed to keep to a minimum the number of credit calculations required.

The proposed section 14 will apply on the basis of a separate credit for all income of a particular class that is derived from any one country with which Australia has a double taxation agreement. The limitation on the amount of credit will, therefore, be applied separately to each class of income derived from each such country.

Sub-section (1.) of section 14 states that the section has effect for the purpose of the determination of the credits allowable under an agreement for foreign tax paid or payable by a person in respect of any income. Accordingly, if a taxpayer is entitled to credits under more than one agreement, for example, if he derives dividends from the United Kingdom and the United States, the credits are to be determined separately under each agreement.

Sub-section (2.) will apply where a taxpayer derives only one amount of income in respect of which a credit is allowable (for example, one dividend) from a particular country with which Australia has a double taxation agreement. In this case, as under the present section 14, only one credit will be allowable against Australian tax.

Sub-section (3.) applies where a taxpayer derives more than one amount of income, in respect of which credits are allowable, from a country with which Australia has a double taxation agreement.

Paragraph (a) of sub-section (3.) applies where these amounts of income are all of the same class, for example, all dividends or, in the case of income from the United Kingdom, all interest or all royalties. In this case it is proposed that the one credit will be allowable in respect of all of those amounts.

Paragraph (b) of sub-section (3.) applies where the amounts of income comprise two or more classes of income. As credits in respect of income other than dividends will only be allowable in respect of interest and royalties derived from sources in the United Kingdom, this paragraph will, in practice, only apply to the calculation of credits under the new United Kingdom agreement. The paragraph provides that a separate credit is to be allowable in respect of the whole of the income included in each class of income.

Sub-section (4.) provides that the amount of credit allowable in respect of any income shall not exceed the amount of Australian tax payable in respect of that income. The amount of Australian tax for this purpose will be calculated under the proposed section 15 of the Principal Act. Section 160AO of the Assessment Act further provides that the sum of all credits is not to exceed the total tax payable by the taxpayer in respect of his taxable income.

An example of the practical working of the new section 14 is contained on page 19 of this memorandum. The revised section will, by clause 11 of the Bill, first apply in relation to the 1967/68 year of income.

Section 15: Ascertainment of Australian tax.

Introductory Note:

This clause proposes the repeal of the section of the Principal Act - section 16 - that specifies the basis on which Australian tax is to be ascertained for purposes connected with Australia's double taxation agreements. A revised section for this purpose - section 15 - is proposed to be inserted.

As mentioned in relation to section 14 of the Principal Act, the amount of a credit allowable in accordance with a double taxation agreement is restricted to the amount of the Australian tax on the income in respect of which the credit is allowable. (Credits under section 45 of the Assessment Act in respect of foreign tax paid on dividends received from countries with which Australia does not have a double taxation agreement are similarly restricted.) In addition, Australia's double taxation agreements contain provisions limiting the amount of Australian tax payable on dividends and, in the case of the new United Kingdom agreement, on interest and royalties.

For these purposes it is necessary to provide a statutory basis for ascertaining the amount of Australian tax on the amounts of income concerned. The present section 16 provides a basis for ascertaining the amount of Australian tax in respect of a dividend but, as mentioned earlier, it will also be necessary now to ascertain the amount of Australian tax in respect of interest and royalties under the new United Kingdom agreement. As a result, the existing section 16 will no longer be adequate and this clause proposes its repeal and the re-enactment, with appropriate modifications, of substitute provisions.

The proposed new provisions are, with necessary modifications, modelled on the provisions that apply for purposes of credits for tax paid in the Territory of Papua and New Guinea. Those provisions, which were enacted in 1960, are contained in Division 18 of Part III of the Assessment Act.

The object of the provisions in the new section 15 is broadly to ascertain the portion of the overall tax payable by the taxpayer that may appropriately be regarded as being the tax referable to the income concerned. The basic scheme is to take the gross amount of the particular income that is included in the assessable income, reduce that gross amount by an appropriate share of deductions allowable against income and then apply to the final net amount the average rate of Australian tax payable by the taxpayer. In ascertaining the amount of Australian tax, calculations are to be made on the class of income basis already mentioned.

Examples of calculations under the new section 15 which, by clause 11 of the Bill, will first apply in relation to the 1967/68 income year, are on pages 19 to 22 of this memorandum.

Sub-section (1.) includes definitions of terms used in the new section 15.

'Company' is defined as not including a company in the capacity of a trustee. This definition is being inserted as a drafting expedient to avoid the necessity of repeating the qualification whenever the word 'company' is used in the section.

'Dividend' is defined as including a part of a dividend, so as to ensure that the section applies to income consisting of part of a dividend in the same way as it applies to the whole of a dividend.

'Public loan interest' means, as in the present section 16, interest to which section 160AB of the Assessment Act applies. That is, it refers to government loan interest in respect of which the special rebate of 10% of the amount of the interest applies.

'The adjusted net amount', 'the apportionable deductions' and 'the net amount' are inter-related definitions and for purposes of explanation it is convenient to depart from the alphabetical order in which they appear in the sub-section.

'The apportionable deductions' are defined in relation to a person as the apportionable deductions allowable in his assessment in respect of income of the year of income.

The concept of apportionable deductions as defined in section 6 of the Assessment Act is used to describe a number of deductions of a concessional or semi-concessional nature which are not, strictly speaking, directly related to income-producing activities, and cannot therefore be said to relate to any particular part or class of a taxpayer's income.

'The net amount' is defined in relation to a 'relevant part' of a person's income of the year of income. The term 'relevant part' has been explained in the notes at pages 5 and 6 of this memorandum and means broadly the total amount of income of a particular class included in the person's assessable income that is derived from sources in the one country and in respect of which a credit for foreign tax is allowable or a provision of an agreement limits the amount of Australian tax payable. A 'relevant part' thus does not include exempt income or income subject to withholding tax, and it is a gross amount before taking into account any deductions allowable on assessment.

In accordance with the definition, the 'net amount' is ascertained by deducting from the 'relevant part' the sum of any deductions allowable on assessment that relate exclusively to that part and so much of any other deductions so allowable, not including apportionable deductions, as may appropriately be related to that part. A taxpayer will, of course, have the usual rights of objection and reference to a Board of Review where he is dissatisfied with an apportionment of deductions by the Commissioner.

Once the 'net amount' in relation to a relevant part of a person's income has been ascertained, the next step is to calculate 'the adjusted net amount' in relation to that part.

'The adjusted net amount' is, briefly stated, 'the net amount' as defined above, reduced by a proportionate part of the taxpayer's apportionable deductions and, in certain isolated cases, other deductions. The result obtained is, in effect, the part of the taxpayer's taxable income that, for purposes of the section, is to be treated as attributable to a relevant part of his income.

Paragraph (a) of the definition covers cases (that are expected to be few in number) where the sum of the net amounts respectively ascertained in relation to all the relevant parts of a taxpayer's income exceeds the sum of his taxable income and the apportionable deductions. This situation could arise, for example, where a loss is incurred in a business. Because the loss is taken into account in determining the taxable income, it has the effect of reducing the amounts of income from other sources included in the taxable income.

Paragraph (a), which corresponds with a provision in the present law, has the effect of apportioning ratably against each net amount the sum of -

(a)

the apportionable deductions, and

(b)

any other deductions (other than those allowed in calculating the net amounts) to the extent that they exceed income in respect of which a 'net amount' has not been ascertained.

Paragraph (b) will apply in the generality of cases. It applies where the sum of the net amounts does not exceed the sum of the taxable income and the apportionable deductions. In this case each 'net amount' is, in effect, reduced by a proportionate part of the apportionable deductions. The actual formula is:

(Adjusted net amount) = (net amount) * ((taxable income)/((taxable income) + (apportionable deductions)))


The overall effect of the definitions of 'the net amount' and 'the adjusted net amount' is broadly that each class of income is to be reduced by three categories of deductions -

(i)

those that relate exclusively to the income;

(ii)

those that may appropriately be related to it;

(iii)

apportionable deductions.

The existing provisions of section 16 of the Principal Act provide for ascertainment of Australian tax on dividends on a basis that does not take into account deductions in category (ii) and does not attribute to public loan interest deductions other than those in category (i). In treating all items of income alike in the allocation of the three categories of deductions, the proposed new provisions follow the provisions adopted in 1960 in relation to Papua-New Guinea tax, and provide as simple a system as is practicable for ascertaining the Australian tax on dividends, interest and royalties.

'The average rate of Australian tax' means broadly an amount per dollar ascertained by calculating the income tax (other than additional tax payable by a private company on undistributed profits) that would be payable by the taxpayer in respect of his taxable income if he were not entitled to any rebate or credit, and dividing the amount so obtained by the number of dollars in his taxable income. A somewhat more complicated formula is laid down in section 16 at present in relation to dividends derived by non-resident public companies.

Sub-section (2.) of section 15 formally provides that the amount of Australian tax payable in respect of a relevant part of a person's income is to be ascertained in accordance with the proposed new section 15.

Sub-section (3.) provides the general basis for ascertainment of the Australian tax payable in respect of a relevant part of a person's income. The Australian tax will be ascertained by applying the average rate of Australian tax to the amount that is the adjusted net amount in relation to the particular relevant part. The calculation of the 'adjusted net amount' and the 'average rate of Australian tax' have been explained above. If the relevant part consists of public loan interest, the tax so ascertained is to be reduced by the amount of the rebate allowed under section 160AB of the Assessment Act in respect of the interest. However, nothing in the new section 15 will affect the calculation of the amount of the rebate under section 160AB.

The amount of Australian tax ascertained in accordance with this sub-section may, in some cases, be modified by the provisions of the succeeding sub-sections of section 15.

Sub-section (4.) will apply to companies that are residents of Australia. It provides that where a relevant part of a company's income consists of dividends in respect of which a rebate is allowable under section 46 of the Assessment Act, the amount of Australian tax in respect of that relevant part is to be deemed to be nil. This provision, which will have the same practical effect as the existing law, reflects the position that the rebate under section 46 effectively frees the dividends from Australian tax. The next sub-section covers cases where a private company is not entitled to a full rebate under section 46 of the Assessment Act.

Sub-section (5.) will apply in somewhat unusual cases where it is impracticable to determine the amount of Australian tax by a formula. In relation to cases falling under section 94 of the Assessment Act, (partner not having real control of his share of partnership income) or under section 102 of that Act (revocable trusts and trusts for minor children) sub-section (5.) will operate in the same way as the present law. The new sub-section will also apply where a private company's taxable income includes private company dividends in relation to which the company is not allowed a full rebate under section 46 of the Assessment Act.

In cases covered by it, the sub-section authorises the Commissioner to determine the amount of the Australian tax that is reasonably attributable to a relevant part of the income of the person, trustee or company concerned.

Sub-section (6.) applies where a private company is liable to pay undistributed profits tax. In this case the amount of Australian tax payable in respect of a relevant part of the company's income is the amount ascertained in accordance with the preceding sub-sections plus a proportion of the undistributed profits tax. The proportion of the undistributed profits tax for this purpose will be determined in the same way as it is under the existing law.

The following are two examples of the practical application of the proposed new section 15.

In this case, paragraph (b) of the definition of 'the adjusted net amount' applies, as the sum of the net amounts does not exceed the sum of the taxable income and the apportionable deductions ($4,300, i.e., $3,800 + $500).

The adjusted net amounts are ascertained by means of the formula:

(adjusted net amount) = (net amount) * ((taxable income)/((taxable income) + (apportionable deductions)))


i.e.,

(United States dividends) = 780 * (3,800)/(4,300) = $689


(United Kingdom dividends) = 600 * (3,800)/(4,300) = $530


(United Kingdom interest) = 280 * (3,800)/(4,300) = $247


The Australian tax payable in respect of each relevant part is found by applying to the adjusted net amount the average rate of Australian tax. The average rate of Australian tax is ascertained from the formula:

(gross tax)/(taxable income) = $(705.50)/(3,800) = (18.566 cents per dollar)


.

The Australian tax payable in respect of:

(United States dividends) = 689 * (18.566 cents) = $127.92


(United Kingdom dividends) = 530 * (18.566 cents) = $ 98.40


(United Kingdom interest) = 247 * (18.566 cents) = $ 45.86


The Australian tax on the United States dividends and the United Kingdom dividends being less than the United States and United Kingdom taxes paid thereon, the credits in those cases are restricted to the amounts of Australian tax. On the other hand, the Australian tax on the United Kingdom interest exceeds the United Kingdom tax thereon and a credit equal to the amount of the United Kingdom tax is allowed.

(Adjusted net amount) = (net amount) * ((taxable income)/((taxable income) + (apportionable deductions))) = 3,800 * (13,600)/(13,800) = $3,745


((The average rate of Australian tax) = (gross tax)/(taxable income) = ($5,280)/(13,600) = (38.824 cents per dollar))


The Australian tax payable in respect of the royalties is:

(adjusted net amount) * (average rate of Australian tax) = 3,745 * 38.824 cents = $1,453.96


Section 16: Rebates of excess tax on income included in assessable income.

This clause proposes the repeal of section 17 of the Principal Act and its replacement by a modified section - section 16.

The existing section 17 provides for the allowance of a rebate to give effect to provisions in Australia's double taxation agreements limiting the amount of Australian tax payable by assessment processes in respect of dividends flowing to countries with which Australia has double taxation agreements. Where the amount of Australian tax on the dividend, as ascertained in accordance with the present section 16, exceeds the amount to which the Australian tax is limited, a rebate is to be allowed in the shareholder's assessment.

It is necessary to extend the provisions now contained in section 17 because the new United Kingdom agreement, in addition to limiting the amount of Australian tax payable on dividends derived by United Kingdom residents, also provides for limitations on the Australian tax on interest and royalties paid to United Kingdom residents. The new section 16 will operate for these purposes.

The section will not apply in relation to income that is subject to withholding tax. Where United States, Canadian and New Zealand taxpayers derive dividends in respect of which the Australian tax is limited to 15%, the dividends will in general be subject to withholding tax and section 16 will accordingly not be applicable. Except in isolated cases, therefore, section 16 will in practice apply only in relation to United Kingdom residents.

Sub-section (1.) specifies the amounts of income to which the section will apply. The section will apply in relation to each relevant part of a taxpayer's income in respect of which the amount of Australian tax is limited under the provisions of an agreement. Notes on the term 'relevant part' will be found at page 6 of this memorandum.

Sub-section (2.) provides for the calculation of a separate rebate in respect of each relevant part of a taxpayer's income to which the section applies. In each case the amount of the rebate will be the amount (if any) by which the Australian tax ascertained in accordance with the new section 15 in respect of the particular relevant part exceeds the limit applicable to that part under the terms of the relevant agreement. The present law provides for a separate rebate in respect of each dividend and the new provisions will thus bring about a reduction in the number of calculations necessary.

Sub-section (3.) makes it clear that a rebate under the section is part of an assessment and taxpayers will accordingly have the usual rights of objection and appeal if they are dissatisfied with the amount of a rebate determined by the Commissioner.

Sub-section (4.) applies where a private company liable to pay undistributed profits tax is entitled to a rebate under this section.

In such a case the Australian tax payable in respect of a relevant part of the company's income, as ascertained in accordance with the new section 15, will include an appropriate share of the undistributed profits tax payable. Accordingly, the amount of the rebate under section 16 will be the excess over the limitation provided in the agreement of the total of the primary company tax and the undistributed profits tax attributable to the particular relevant part. Under sub-section (3.) of section 16 the rebate is to be allowed in the assessment of primary tax. Sub-section (4.) provides that where the rebate exceeds the amount of primary tax payable, the balance is to be allowed in the assessment of undistributed profits tax.

Sub-section (5.) will give continued effect to a principle embodied in the present law. It will limit the sum of the rebates allowable under the section to so much of the Australian tax (including undistributed profits tax) in respect of the taxable income as remains after all other rebates of, and deductions from, that tax have been taken into account. In other words, the sum of the rebates allowable under the section is not to exceed the tax actually payable and, accordingly, a taxpayer will not be entitled under section 16 to have an amount paid to him by the Commissioner.

Clause 7: Interest paid by a company to a person resident in the United Kingdom

This clause proposes the insertion in the Principal Act of a new section - section 17B.

Under paragraph (2) of article 9 of the new United Kingdom agreement, the Australian tax on interest that is derived by a United Kingdom resident after the commencement of the 1967-68 income year is not to exceed 10% of the gross interest. The purpose of section 17B is to give effect to paragraph (2) as it affects interest subject to tax under section 125 of the Assessment Act in cases where the interest was derived before that section ceased to operate on 1 January 1968 as a consequence of the coming into operation of the withholding tax of 10% on interest paid to non-residents.

Section 125 of the Assessment Act imposed tax on companies that paid or credited certain interest to non-residents. The tax payable under the section was 42.5% of the gross interest paid to a company and 42.5% of the excess over $416 of the gross interest paid to an individual. The company had a right to recoup itself for the tax out of the interest payable to the non-resident lender, with the result that the tax was borne by the non-resident.

The proposed section 17B will give effect to the new agreement as it affects this interest. It provides for a refund of tax where the section 125 tax exceeds the limitation applicable under the new United Kingdom agreement.

Sub-section (1.) lists the tests which must be satisfied if a refund is to be allowed under section 17B.

Paragraph (a) requires that interest must have been paid by a company after the commencement of the 1967-68 income year. The interest must also have been paid before 1 January 1968.

Paragraph (b) makes it necessary for section 125 tax to have been deducted and retained from any of the interest by the interest paying company.

Paragraph (c) requires that the amount of section 125 tax on the interest concerned exceed the limit on the Australian tax in respect of that interest that is applicable under the United Kingdom agreement. As that limitation is only applicable in respect of interest paid to United Kingdom residents, section 17B does not apply to interest paid to residents of other countries.

Paragraph (d) provides that claims for a refund under section 17B must be made before 1 January 1970 or within such further period as the Commissioner allows.

Where the requirements of paragraphs (a) to (d) are satisfied, the taxpayer is entitled to a refund under the proposed section of an amount equal to the amount by which the section 125 tax exceeds the 10% limit under the new United Kingdom agreement.

Sub-section (2.) provides that the deduction to which the taxpayer is entitled under section 127 of the Assessment Act in respect of any interest is to be reduced by the amount of any refund to which he is entitled under the preceding sub-section in respect of that interest.

Section 127 provides that where interest in respect of which a company has paid section 125 tax is included in the recipient's assessment, the tax so paid by the company in respect of that interest is to be deducted from the tax payable by the recipient. The purpose of sub-section (2.) is to ensure that the deduction allowable to a taxpayer under section 127 does not exceed the amount of section 125 tax effectively borne by him in cases where, under sub-section (1.), a refund of the section 125 tax is made.

Clause 8: Certain dividends paid to United Kingdom residents.

This clause will repeal section 19 of the Principal Act.

Section 19 relates to paragraphs (2) and (3) of article VI of the previous United Kingdom agreement which provided for exemption from, or limitation of, Australian tax on dividends derived by United Kingdom residents. A condition of the concession was that the shareholder be subject to United Kingdom tax in respect of the dividend. Section 19 deems a resident of the United Kingdom to be subject to United Kingdom tax in respect of a dividend paid by a company that is a dual resident of Australia and the United Kingdom.

There is no equivalent 'subject to tax' test in the dividend provisions of the new United Kingdom agreement and section 19 is therefore redundant. By clause 11 of the Bill it will, however, continue to apply in the transitional period in which the previous United Kingdom agreement continues to have effect.

Clause 9: Collection of tax due to the United States of America.

This clause proposes to amend section 20 of the Principal Act by substituting the words "a Second Commissioner" for the words "the Second Commissioner". This is a purely drafting amendment as section 6A of the Taxation Administration Act 1953-1966 provides that references to the Second Commissioner of Taxation are to be read as references to a Second Commissioner of Taxation.

Clause 10: United Kingdom agreement.

This clause proposes the repeal of the First Schedule to the Principal Act and the insertion in its stead of the Schedule set out in the Schedule to this Bill. In other words, the new United Kingdom agreement is to be substituted in the First Schedule to the Act for the previous United Kingdom agreement.

Clause 11: Application.

Sub-clause (1.) of this clause specifies the commencing date for the application of the proposed new sections 13, 14, 15 and 16 of the Principal Act. As explained in earlier notes, these sections are to apply in relation to the 1967-68 income year and subsequent years of income.

Sub-clause (2.) provides for the continued operation for the 1966-67 income year and prior years of sections 12, 13, 14, 16 and 17 of the Principal Act.

Sub-clause (3.) will ensure that section 19 of the Principal Act will continue to apply for as long as the previous United Kingdom agreement remains effective.

Clause 12: The Schedule.

Clause 12 of the Bill will insert, as the first schedule to the Principal Act, a copy of the new United Kingdom agreement. The agreement is set out as a schedule to the Bill and, by clause 5 of the Bill, is being given the force of law in Australia.

The new agreement was signed in Canberra on 7 December 1967 and was published in Australia and the United Kingdom on 15 December 1967. The agreement is designed to avoid double taxation, and to prevent fiscal evasion, with respect to taxes on income and capital gains.

The agreement replaces an earlier agreement that was signed on 29 October 1946 and appears as the present first schedule to the Principal Act.

Agreement between the Government of the Commonwealth of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains.

Notes on Articles

Introductory Note:

The agreement adopts two methods of relieving double taxation.

Under the first method, certain income is exempt from tax in the country of origin, the sole right to tax that income being reserved to the country of residence of the recipient.

Under the second method, the country of origin of income levies its tax and, if the country of residence of the recipient also taxes the income, that country (under article 19) allows against its tax a credit for the tax paid in the country of origin. As explained on page 9 of this memorandum Australia, under its general law, exempts its residents from tax on certain income derived from the United Kingdom and subject to tax there.

In association with the second method, certain income may not be taxed in the country of origin to any greater extent than is specified in the agreement.

Under the agreement, the following income flowing between Australia and the United Kingdom may be taxed only in the country of residence of the recipient (For the conditions of exemption in the country of origin the relevant articles of the agreement should be consulted):

•

Industrial or commercial (business) profits not attributable to a permanent establishment in the country of origin (Articles 4 and 5).

•

Shipping and air transport profits derived from operations in international traffic (Article 6).

•

Dividends paid by companies 90% of whose income is derived from a business carried on in the country of residence of the shareholder (Article 8(4)).

•

Pensions and purchased annuities (Article 14).

•

Remuneration of visiting employees if the visit does not exceed 183 days in a taxation year (Article 12).

•

Income derived from professional services or other independent activities (other than as an employee) not attributable to a fixed base in the country of origin (Article 11).

•

Remuneration of government employees (Article 15).

•

Remuneration of visiting professors and teachers (Article 16).

•

Payments for the maintenance and education of visiting students (Article 17).

Income in respect of which the tax of the country of origin is limited by the agreement comprises:

•

Dividends, the limit being 15% (Article 8).

•

Interest, the limit being 10% (Article 9).

•

Royalties, the limit being 10% (Article 10).

Income that is not to be exempt in the country of origin, and in respect of which the country of origin is not to limit its tax, may be taxed at full rates in that country. The country of residence may also tax this income.

Other provisions of the agreement are:

•

Dual residents of both countries are to be treated for purposes of the agreement as being residents of only one country (Articles 3 and 18).

•

Associated enterprises may be taxed on the basis of dealings at arm's length (Article 7).

•

Public entertainers may be taxed in the country in which they perform (Article 13).

•

The taxation authorities of each country may consult and exchange information (Articles 20 and 21).

As the agreement is drafted, it will, in practice have little effect in relation to the taxes imposed on capital gains by the United Kingdom. The principal effect will be in relation to article 19 - see the notes on that provision. On the Australian side, the agreement applies only to income tax imposed by the Commonwealth, the withholding tax on dividends and interest being within the description 'income tax'.

The new agreement will have the force of law only when sanctioned by the Parliaments of Australia and the United Kingdom (Article 23). When given the force of law it will apply in Australia generally as from 1 July 1967 and for purposes of United Kingdom income tax as from 6 April 1967. The agreement will apply for purposes of the United Kingdom capital gains tax and the corporation tax as from their inception, 6 April 1965, and 1 April 1964, respectively.

The following paragraphs explain the provisions of the new agreement and note variations of substance from the corresponding provisions of the previous agreement.

Article 1: Taxes the subject of the agreement.

Paragraph (1) of this article lists the existing taxes to which the agreement applies. These are:

in the United Kingdom:

•

the income tax payable by individuals and in respect of dividends paid by United Kingdom companies;

•

the surtax payable by individuals;

•

the capital gains tax payable by individuals;

•

the corporation tax on income and capital gains payable by companies;

in Australia:

•

the Commonwealth income tax including the undistributed income tax payable by private companies.

Paragraph (2) will extend the application of the agreement to any future taxes imposed by either Government in addition to or in place of the existing taxes if the taxes are of an identical or substantially similar character.

Article 2: Definitions.

This article contains a number of definitions of terms used in the agreement. Other definitions will be found in article 3 (residence), article 4 (permanent establishment), article 5 (industrial or commercial profits), article 8 (dividends), article 10 (royalties) and article 14 (annuity). These definitions will be explained in the notes on the appropriate articles.

Definitions in paragraph (1) of article 2 that are of particular note are set out below.

'Australia': For the purposes of the Australian income tax law, 'Australia' means the area comprising the Commonwealth of Australia, but does not include external territories that are not part of the Commonwealth. It has been traditional in Australia's double taxation agreements to define 'Australia' as including, for purposes of the agreements, Australian external territories. The agreement accordingly provides that the territories named in the definition are to be treated as included in 'Australia'. One effect of this is that the Commonwealth will be entitled to tax profits earned by United Kingdom owned ships from voyages solely between Australia proper and one of the named territories. Another effect concerns isolated cases of taxpayers who are resident in both Australia and the United Kingdom and who derive income from the territories.

The Territory of Papua and New Guinea is not within the definition of Australia. Since 1959 the Territory has had its own tax system and it would be inappropriate for it to be treated as part of Australia.

'Australia' is also defined to include areas outside territorial limits in respect of which there is in force a law dealing with exploitation of any of the natural resources of the sea-bed and sub-soil of the continental shelf. (There is a corresponding provision in the definition of 'United Kingdom'). This will mean that the agreement will, for example, allow Australia to tax income earned by United Kingdom residents in activities relating to the exploitation of petroleum on the continental shelf area.

'Resident in the United Kingdom' and 'Resident of Australia': These terms mean, respectively, a person who is resident in the United Kingdom for the purposes of United Kingdom tax, whether or not also a resident of Australia for the purposes of Australian tax, and a person who is a resident of Australia for the purposes of Australian tax, whether or not also resident in the United Kingdom for the purposes of United Kingdom tax. These terms are to be contrasted with the terms 'United Kingdom resident' and 'Australian resident' as defined in article 3. A person may under each country's internal law be resident in the United Kingdom and at the same time a resident of Australia. Article 3 sorts out such cases of dual residency with the result that a person cannot be a United Kingdom resident and an Australian resident at the same time. Further explanations are in the notes on article 3.

'Company' is defined to mean only bodies corporate.

Paragraph (2) provides that the terms 'Australian tax' and 'United Kingdom tax' do not include amounts payable by way of penalty or as interest, for example, charges for late lodgment of a return of income or for late payment of tax that has become due. This will mean, for example, that the country of residence is not required to give credit for these penalties charged in the country of source.

Paragraph (3) relates to a provision of the United Kingdom income tax law under which, in certain circumstances, income derived by a person resident in the United Kingdom from sources abroad is taxed in the United Kingdom only when remitted to, or received in, the United Kingdom. The paragraph ensures that income of a United Kingdom resident that is not taxed in the United Kingdom because it is not remitted there is not to be entitled to exemptions or other concessions under the agreement. For example, if the income is dividends, it would be taxed at the general rates of Australian tax, rather than be subject to the limited tax of 15% provided in article 8.

Paragraph (4) settles questions as to the meaning to be given to terms used in the agreement but not defined there. Each country will, in applying the agreement, give to those terms the meanings they have under the taxation law of that country.

Article 3: Residence.

This article is concerned with specifying the circumstances in which a person (whether an individual, a company or some other entity) is to be treated for purposes of the agreement as a resident of one country or the other.

Problems arise because both the United Kingdom and Australia have their own internal laws for determining whether a person is, for taxation purposes, a resident. The tests for residency vary between each country with the result that each may regard a particular taxpayer as its own resident. The taxpayer is then resident in both countries or, to use a convenient term, a dual resident. An example is of a company incorporated in Australia but managed and controlled in the United Kingdom. Individuals can also be dual residents.

The previous United Kingdom agreement dealt with this problem by, in general, excluding dual residents from reliefs under it. Such a person was not entitled to any exemption under the agreement or to have the Australian tax on dividends limited as provided by article VI of the agreement.

The new agreement takes a different approach. It sets out to resolve dual residency by providing that a dual resident taxpayer is, for purposes of the agreement, to be treated as if he were solely a resident of only one of the countries. Article 3 states the rules for solution of dual residency. The article also applies in the great majority of cases in which taxpayers are, in any event, residents of one country only.

The term 'Australian resident' and 'United Kingdom resident' are the terms chosen to describe throughout the agreement a person who is, or is treated as being, solely a resident of one or other of the two countries. As mentioned in the notes on article 2 these terms contrast with 'resident of Australia' and 'resident in the United Kingdom', which are the terms used in each country's internal laws. For the purpose of defining the terms 'Australian resident' and 'United Kingdom resident' it was convenient to define also the terms 'Australian company' and 'United Kingdom company'. These terms refer to companies that are (or are treated as) resident solely in one or the other country. The terms are mutually exclusive and an 'Australian company' cannot at the same time be a 'United Kingdom company'.

Paragraph (1) defines certain terms.

Sub-paragraph (a) defines 'Australian company'. This is a company which under the Australian income tax law is a 'resident of Australia' and which:

•

is incorporated in Australia and has its centre of administrative or practical management (broadly, its day to day management) in Australia; or

•

is managed and controlled in Australia.

In contrast, the definition of 'resident of Australia' in section 6 of the Assessment Act provides that a company is a 'resident of Australia' if it is:

(i)

incorporated in Australia;

(ii)

not incorporated in Australia but carries on business in Australia and has its central management and control in Australia; or

(iii)

not incorporated in Australia but carries on business in Australia and is controlled by shareholders who are residents of Australia.

Thus, a company will not be an 'Australian company', even though it is incorporated in Australia, if neither its centre of administrative or practical management nor its overriding management and control is in Australia. A company will not be an 'Australian company' if it is a 'resident of Australia' only under the third test mentioned.

Nevertheless, a company that is a 'resident of Australia', though not an 'Australian company', will be an 'Australian resident' under the definition of 'Australian resident' provided it is not a 'United Kingdom company' as defined in sub-paragraph (b) of paragraph (1), i.e., if it is not managed and controlled in the United Kingdom.

Sub-paragraph (b) of paragraph (1) defines 'United Kingdom company'. This is a company that is managed and controlled in the United Kingdom (the sole test of residence of a company under United Kingdom law). However, a company that is an 'Australian company' will not be a 'United Kingdom company'.

Sub-paragraph (c) of paragraph (1) defines 'United Kingdom resident'. This term means:

•

a 'United Kingdom company' (as defined in sub-paragraph (b));

•

any other person, other than a company, who is 'resident in the United Kingdom' (This, however, is subject to paragraphs (2) and (3) of the article.).

An individual who is not ordinarily resident in the United Kingdom and who is not subject to United Kingdom tax on income from sources outside the United Kingdom is not to be treated as a United Kingdom resident. This exclusion has been made for reasons broadly corresponding with those outlined in the explanation later in these notes of the comparable provision in the definition of 'Australian resident'.

Sub-paragraph (d) defines 'Australian resident'. This means:

•

an 'Australian company' (as defined in sub-

•

a company (not being an 'Australian company') that is a 'resident of Australia' and is not a 'United Kingdom company'; and

•

any person, other than a company, who is a 'resident of Australia' (This, however, is subject to paragraphs (2) and (3) of the article.).

The definition further provides that certain individuals who are not ordinarily resident in Australia are not to be treated as Australian residents. This qualification was inserted to cover cases such as the following. A British civil servant is appointed to the staff of the United Kingdom High Commission in Australia. His appointment is for, say, three years and he receives dividends from United Kingdom companies. As the official is resident (but is not ordinarily resident) in Australia he would, in the absence of a special provision, be an 'Australian resident'. This would mean that the United Kingdom would have to reduce its tax on the dividends to 15% even though, under the Diplomatic Privileges and Immunities Act 1967, they are exempt from Australian tax. The qualification is designed to ensure that the United Kingdom tax need not be reduced in these circumstances.

The effect of paragraph (1) of article 3 is to resolve the dual residency of companies. For taxpayers other than companies, paragraph (1) does not resolve dual residency. For these taxpayers it is necessary to turn to paragraphs (2) and (3) of the article.

Under paragraph (2) a dual resident individual will be treated as solely a 'United Kingdom resident' or an 'Australian resident' according to the tests set out in sub-paragraphs (a) and (b). These tests look firstly to the country in which the individual has a permanent home, secondly to the country in which he has an habitual abode and thirdly to the country with which his personal and economic relations are closest. The second and third tests will need to be applied only if the preceding test or tests fail to allocate his residency to one country or the other.

Paragraph (3) applies in practice to persons other than individuals and incorporated companies, for example, an unincorporated association. A person within this paragraph will be treated as resident solely in the country in which it is managed and controlled.

Paragraph (4) carries the concept of residence or deemed residence solely in one country into the terms 'resident of one of the territories' and 'resident of the other territory'. These terms mean an 'Australian resident' or a 'United Kingdom resident', as the context requires.

Paragraph (5) correspondingly provides that the terms 'United Kingdom enterprise', 'Australian enterprise', 'enterprise of one of the territories' and 'enterprise of the other territory' mean an industrial or commercial enterprise or undertaking carried on by a person who is, as the case may be, treated as a 'United Kingdom resident' or an 'Australian resident'.

Article 4: Permanent establishment.

This article defines the term 'permanent establishment', the corresponding definition in the previous United Kingdom agreement being contained in article II of that agreement. The new definition is somewhat wider than the old and has an important bearing on the taxing of business profits, certain shipping and air transport profits, dividends, interest and royalties derived by a resident of one country from sources in the other country. For example, business profits not attributable to a permanent establishment in that other country are exempt from tax there.

Paragraph (1) sets out the main proposition. A permanent establishment means a fixed place of trade or business in which the trade or business of an enterprise is wholly or partly carried on.

Paragraph (2) lists a number of examples of permanent establishments. The list is not exhaustive and in cases not listed there may, nevertheless, be a permanent establishment under the general rule in paragraph (1), or by paragraphs (4), (5) or (8) of this article.

The items listed as permanent establishments include a management, branch, factory, a mine, and an agricultural or pastoral property. Specific inclusions not mentioned in the previous United Kingdom agreement are an office, a workshop, a quarry or other place of extraction of natural resources, a forestry property, and a building site or a construction, installation or assembly project which exists for more than six months.

Paragraph (3) lists a number of situations that are not, standing alone, to be considered as permanent establishments. Where the activities of an enterprise go beyond the bare situations described in the paragraph, it would have to be considered whether there was a permanent establishment under other paragraphs of the article.

Paragraph (4) is a new provision relating to the example of a permanent establishment in sub-paragraph (h) of paragraph (2). An enterprise that provides supervisory activities for more than six months on a building site or a construction, installation or assembly project is deemed to have a permanent establishment in the country where those activities are provided.

Paragraph (5) relates to a trade or business carried on through an agent. If an agent acts in the manner indicated in the paragraph, his principal will, so long as the agent is not an agent to whom paragraph (6) applies, be deemed to have a permanent establishment where the agent carries on the business.

Sub-paragraphs (a) and (b) of paragraph (5) correspond with provisions in the previous agreement. They provide, broadly, that a principal will have a permanent establishment in one country when an agent exercises an habitual authority to conclude contracts (other than for the purchase of goods only) on behalf of the principal, or habitually fills orders from a stock of goods maintained in that country by the principal.

Sub-paragraph (c) is new. It provides that a person who manufactures or processes goods as agent is to be treated as a permanent establishment of his principal.

Paragraph (6) specifies that a principal will not have a permanent establishment for the reason only that he carries on business in a country through a broker, general commission agent or other agent of independent status who acts in the ordinary course of his business as such.

Paragraph (7) states that a company does not have a permanent establishment in one country merely because of its relationship to an associated company.

Paragraph (8) (which has no corresponding provision in the previous United Kingdom agreement) applies, in the case of Australia, where a United Kingdom enterprise sells to a person in Australia goods that are manufactured, assembled, processed, packed or distributed in Australia for the United Kingdom enterprise by an enterprise associated with it. Profits arising to the United Kingdom enterprise from these activities would, but for an agreement, generally be taxed in Australia. Article 5 of the agreement, however, would exempt the profits from Australian tax if the United Kingdom enterprise were not treated as having a permanent establishment in Australia. The paragraph accordingly deems the United Kingdom enterprise to have a permanent establishment in Australia and to carry on business in Australia through that permanent establishment, thus allowing Australia to tax. The paragraph has a corresponding application in the United Kingdom in converse circumstances.

Article 5: Industrial or commercial profits.

This article governs the taxing of industrial or commercial (i.e., business) profits derived by a resident of one country from sources in the other. In general, these profits will be taxed in the other country only if attributable to a permanent establishment in that country. The article preserves the application of special areas of the income tax laws of both countries and provides for the case where there is insufficient information to determine profits on the basis of the arm's length principle followed in the article.

The broad principles adopted in this article were established in article III of the previous United Kingdom agreement and were followed with minor differences in Australia's double taxation agreements with the United States, Canada and New Zealand.

In one respect, article 5 represents a departure from earlier agreements. Under those agreements 'industrial or commercial profits' did not include income in the form of dividends, interest, royalties or rents. This was so even where the income formed part of the business income of an enterprise as, for example, in the case of interest derived by a bank. Under this article, however, industrial or commercial profits include dividends, interest, royalties or rents that are effectively connected with a trade or business carried on through a permanent establishment. This income will be taxed in the country of its origin in the same manner as business profits. The tax in that country on dividends, interest and royalties not so effectively connected will be limited as provided in articles 8, 9 and 10. Notes on the meaning of 'effectively connected' will be found in the explanations of article 8(5).

Paragraph (1) of article 5 exempts from Australian tax industrial or commercial profits derived by a United Kingdom enterprise if the enterprise does not carry on trade or business through a permanent establishment in Australia.

If the enterprise carries on a trade or business through a permanent establishment in Australia, Australia may tax so much of the profits as are attributable to the permanent establishment.

The profits taxed in Australia will be taxed also in the United Kingdom but that country will be required to relieve the double taxation by the allowance of a credit for the Australian tax under article 19.

Paragraph (2) applies in converse circumstances to exempt from United Kingdom tax industrial or commercial profits derived by an Australian resident unless the profits are attributable to a trade or business carried on through a permanent establishment of the Australian resident in the United Kingdom.

Industrial or commercial profits (other than dividends) taxed in the United Kingdom will be exempt from Australian tax under the terms of paragraph (q) of section 23 of the Assessment Act.

Paragraph (3) lays down a basis for ascertaining the amount of industrial or commercial profits attributable to a permanent establishment. This is generally the amount a permanent establishment might be expected to derive if it were an independent enterprise in the country in which it is located and its dealings with its head office or other branches were at arm's length.

Profits attributable to a permanent establishment on this basis are deemed to be derived from sources in the country in which the permanent establishment is located.

Paragraph (4) provides that in ascertaining the profits attributable to a permanent establishment, there will be allowed as deductions all expenses incurred by an enterprise, whether in or out of the country in which the establishment is situated, that are reasonably connected with the income derived by the permanent establishment. Only those expenses that would be deductible under the income tax law of that country if the permanent establishment were an independent enterprise may be deducted.

A qualification of this general rule may apply where goods manufactured in one country by the enterprise are imported into and sold by it in the other country. In place of the process of deducting connected expenses from income attributed to the permanent establishment in the other country, it is permissible to ascertain the profits by deducting from the sale price of the goods the wholesale selling price of the same or similar goods in the country of manufacture and the costs of transporting them to and selling them in the other country. This procedure accords with the provisions of section 38 of the Assessment Act and, in effect, permits that section's continued application.

Paragraph (5) provides for the case where there is insufficient information available to enable profits to be attributed to a permanent establishment on the basis of arm's length dealings as provided in paragraph (3). In such a case, provisions of the general income tax law that permit the taxation authority to estimate taxable profits, or give a discretionary power to do so, may be applied. The paragraph thus authorises the Commissioner of Taxation in Australia, in an appropriate case, to apply the provisions of section 136 of the Assessment Act which, under certain conditions, provides for assessment on the basis of such portion of the total receipts of a business as the Commissioner determines. The application of those provisions must be made, however, so far as is practicable, in accordance with the arm's length principle set out in the article.

Paragraph (6) provides that an enterprise of one country will not be taxed in the other country on profits from the sale of goods for the reason only that the goods were purchased in the other country. This provision accords with practice under the Australian income tax law.

Paragraph (7) defines the term 'industrial or commercial profits' to mean primarily income from the conduct of a trade or business. Whether income, in a particular case, is income from a trade or business will depend, by reason of paragraph (4) of article 2, on the meaning given to that expression under the income tax law of the country concerned. Broadly, however, the term 'industrial or commercial profits' will correspond with accepted concepts of 'business profits'.

The term will include the following income:

•

dividends, interest, royalties (as defined in later articles) and rents that are effectively connected with a trade or business carried on through a permanent establishment; and

•

income derived from furnishing the services of employees or other personnel.

The term will not include -

•

dividends, interest, royalties or rents not effectively connected with a trade or business carried on through a permanent establishment;

•

remuneration for personal (including professional) services; or

•

income derived from, or in relation to, the furnishing of the services of public entertainers or athletes.

Articles 8, 9 and 10 deal with the taxation of dividends, interest and royalties while the taxation of remuneration for personal and professional services is dealt with in articles 11 and 12. Income derived from, or in relation to, the furnishing of the services of public entertainers and athletes may be taxed in the country of source whether or not the particular enterprise has a permanent establishment in that country. Although income derived from the operation of ships or aircraft is 'industrial or commercial profits' the application of this article to income of that kind is governed by paragraph (9).

Paragraph (8) preserves the application of the special provisions of the Australian income tax law relating to film businesses controlled abroad and insurance with non-residents of Australia. These provisions, which are found in Divisions 14 and 15 of Part III of the Assessment Act, will continue to apply notwithstanding anything in article 5.

Correspondingly, special provisions of the United Kingdom income tax law that relate specifically to the taxation of insurance businesses conducted by non-residents of the United Kingdom will apply notwithstanding the article.

The paragraph is intended to apply only while the special provisions remain substantially in their present form. Should they be amended in any material respect the two Governments are to consult as to the future operation of the paragraph.

Paragraph (9) relates to income from the operation of ships and aircraft. The taxing of this income under the agreement is dealt with more fully in article 6 and is explained in the notes on that article.

One purpose of paragraph (9) is to remove from the scope of article 5 shipping and air transport profits that are exempt from tax in the country of origin in accordance with paragraph (1) of article 6, i.e., profits derived in the course of international voyages. Another purpose is to exclude from the operation of article 5 any shipping profits in respect of which the tax of the country of origin is limited to 5% of gross receipts by paragraph (2) of article 6. In other words, paragraph (9) will have the result that article 5 will govern the taxing of shipping and aircraft profits derived by a resident of one country from operations solely in the other country, except (in relation to shipping profits) where the other country, except (in relation to shipping profits) where the other country is Australia and the principal place of business of the operator of the ship is not in Australia.

Article 6: Shipping and air transport profits.

This article deals with the taxation in one country of profits derived from the operation of ships and aircraft by a resident of the other country.

These profits will be exempt from tax in the first country except where they arise from voyages or operations confined solely to that country. In other words profits from voyages of ships in international traffic will be subject to tax only in the country of residence but the other country may tax income arising from coastal voyages. A corresponding situation will apply in relation to aircraft. This is in contrast with the position under the previous United Kingdom agreement which, in practice, required that all profits from the operation of ships or aircraft be taxed only in the country of residence.

Paragraph (1) of article 6 expresses the general rule. A resident of one country is exempt from tax in the other country on profits from the operation of ships or aircraft except profits that relate to voyages or operations confined solely to places in that other country. For this purpose, a voyage between a place in Australia (as defined in article 2) and a place in the Territory of Papua and New Guinea will be treated as a voyage between places in Australia.

A United Kingdom resident, for example, will be exempt from Australian tax on profits that relate to a voyage of a ship between the United Kingdom and Australia. But if a United Kingdom-owned ship makes a voyage solely between Australian ports Australia will be entitled to tax the income arising from that voyage.

It is not a condition of exemption under article 6, as it was under the corresponding provision of the previous United Kingdom agreement (Article V), that a ship have its port of registry in the country in which its operator is resident. This qualification was not in practice effective under the previous agreement as article III of that agreement would generally operate to require exemption in the country of source in cases where article V did not.

Paragraph (2) applies where, for example, a United Kingdom resident derives profits from voyages of ships solely between Australian ports. As already mentioned, paragraph (1) does not exempt these profits from Australian tax. If the principal place of business of the operator is outside Australia, the amount on which Australian tax may be charged is limited, broadly, to 5% of the gross receipts from the carriage of passengers, livestock, mails or goods shipped in Australia. This corresponds with and confirms the practical operation of section 129 of the Assessment Act.

Paragraph (3), which reflects the provisions of section 129, limits the operation of paragraph (2) in the case of Australia to cases where the principal place of business of a United Kingdom resident is not in Australia. Where a United Kingdom resident has his principal place of business in Australia, profits from the operation of ships in Australia will be taxed in Australia in accordance with article 5 and paragraph (2) of article 6 will not apply.

Paragraph (3) also ensures that there is no double taxation of shipping profits in Australia and the Territory of Papua and New Guinea in these circumstances. If a United Kingdom resident whose principal place of business is in Australia is subject to Australian tax under article 5 on income from voyages between Australia and the Territory, Australia will exclude from the profits attributable to the Australian business any amount charged to tax in the Territory in respect of those voyages.

Article 7: Associated companies.

This article is supplementary to paragraphs (3) and (5) of article 5 which sets out the basis on which profits are to be attributed to a permanent establishment of an enterprise in one country.

Article 7 closely corresponds with article IV of the previous United Kingdom agreement and with provisions in Australia's other double taxation agreements.

Paragraph (1) applies the provisions of article 7 where a company resident in one country participates in the management, control or capital of a company resident in the other country or the same persons participate in the management, control or capital of both companies. A further test is that the commercial or financial arrangements between the enterprises differ from those that might be expected to exist between independent enterprises that deal at arm's length. If, because of these circumstances, one company discloses profits less than might have been expected had it been independent of the other company, and had dealt at arm's length with that company or an independent enterprise, there may be allocated to the former company the profits it might have been so expected to derive.

Paragraph (2) provides that profits allocated to a company under paragraph (1) are deemed to be derived in the country in which the company is resident and may be taxed accordingly.

Paragraph (3), which corresponds to paragraph (5) of article 5, provides for cases where there is insufficient information available to a taxation authority to allocate profits on the basis provided in paragraph (1). The taxation authority of the particular country may in such a case apply provisions of its own income tax law that authorise the ascertainment of taxable profits by the making of an estimate or the exercise of a discretion. In the case of Australia, section 136 of the Assessment Act may thus be applied. So far as practicable, however, the arm's length principle must be adhered to.

Article 8: Dividends.

This article is concerned primarily with the taxation by one country of dividends paid by companies that are resident in it to persons who are resident in the other country.

Fundamental changes in the United Kingdom taxation law in 1965 are one reason why this article has been drafted somewhat differently from the corresponding article - article VI - of the previous United Kingdom agreement.

Before the 1965 changes, a United Kingdom company was subject to income tax on its profits and when it distributed the profits as dividends it could recoup itself for this tax by deducting from the dividends amounts equal to the tax. It retained these deductions for its own use. Shareholders were credited with having paid the amount deducted by the company. In other words, the income tax on company profits was treated as tax on dividends paid out of those profits.

In these circumstances, the previous United Kingdom agreement did not contain any limitation on the amount of United Kingdom income tax on dividends paid by United Kingdom companies to Australian residents. These dividends were only entitled to exemption from surtax, i.e., the tax imposed on higher-level incomes of individuals. The agreement did, however, require that Australia reduce by half the tax otherwise payable on dividends paid by Australian companies to United Kingdom shareholders. Dividends paid by an Australian company wholly owned by a United Kingdom company were, subject to certain tests, exempt from Australian tax.

The United Kingdom in 1965 introduced a new system of taxing company profits and dividends. This system is broadly comparable to the Australian system of separate taxes on company profits and on dividends. Until such time as the agreement with Australia was re-negotiated the United Kingdom unilaterally imposed on itself the same restrictions in the taxing of dividends paid by United Kingdom companies to residents of Australia as the previous United Kingdom agreement imposed on Australia in converse circumstances.

The new agreement provides reciprocal limitations on the tax one country may levy on dividends derived by residents of the other country. The tax in the country of origin generally may not exceed 15% of the dividends, but this will not affect the taxation of company profits out of which dividends are paid. This limitation is consistent with corresponding provisions in Australia's agreements with the United States, Canada and New Zealand.

Paragraph (1) provides (subject to paragraph (5)) that United Kingdom tax may not exceed 15% of the gross amount of dividends derived and beneficially owned by an Australian resident. The normal rate of United Kingdom income tax on dividends paid to non-residents is (currently) 41.25%.

Paragraph (2) is complementary to paragraph (1.). It provides (subject to paragraph (6)) that Australian tax may not exceed 15% of the gross amount of dividends derived and beneficially owned by a United Kingdom resident. This is the rate that presently applies under the previous United Kingdom agreement, namely, one-half of the general rate of withholding tax of 30% on dividends paid to non-residents.

Upon the application of the paragraph, profits earned by an Australian public company and paid as a dividend to a United Kingdom resident will bear Australian taxes approximating 51.125% at present rates of tax. In other words, on $100 of profits the Australian company tax would, broadly, amount to $42.50. If the remaining $57.50 were distributed as a dividend to a United Kingdom shareholder Australian withholding tax on the dividend would amount to $8.62, giving total Australian taxes of $51.12. Were the dividends subject to the full rate of withholding tax the Australian taxes on profits and dividends would total $59.75.

Paragraph (3) defines the term 'dividend' as used in article 8. In Australia the term will take the meaning it has under the Assessment Act.

In the United Kingdom income tax law 'distribution', rather than 'dividend', is the term used to describe dividend payments by companies. In applying the agreement the United Kingdom will treat as a 'dividend' any amount its taxation law classes as a 'distribution'. In some circumstances the United Kingdom law treats 'distribution' as including interest and royalties but paragraph (3) ensures that if any such interest or royalties fall within articles 9 or 10 they will not be treated as dividends for the purposes of article 8.

Paragraph (4) applies to dividends paid by companies that are resident only in one country but derive 90% or more of their income from a business carried on in the other country. Where the paragraph applies, the country in which the company is resident will exempt from its tax dividends derived and beneficially owned by persons resident in the other country.

For example, a company resident in the United Kingdom (and not also a resident of Australia) may carry on business in Australia through a branch or other permanent establishment. (By reason of article 5 profits attributable to the Australian permanent establishment will be taxed in Australia at normal rates of tax.) If, in each of the three accounting periods immediately prior to the payment of a dividend, the company derived 90% or more of its income from the Australian business, the United Kingdom will exempt from its tax dividends paid by the company that are derived and beneficially owned by Australian residents. The dividends will, of course, be subject to tax in Australia.

The paragraph would not require the United Kingdom to exempt the dividends if the Australian profits of the company were subject to a tax to which they would not be subject if the company were a resident of Australia. Under the present Australian law this qualification will not in practice apply.

Under paragraph (5) the limitation on United Kingdom tax on dividends provided by paragraph (1), and the exemption provided in paragraph (4), do not apply where the shares on which the dividends are paid are effectively connected with a permanent establishment of the Australian resident in the United Kingdom and, where the recipient is a company, a profit on the sale of the shares would be a (taxable) trading receipt.

The term 'effectively connected', which is commonly found in modern international taxation agreements, is not defined. Whether or not there is an effective connection between income, or an income-producing asset, and a business carried on through a permanent establishment is to be determined according to the facts of each particular case. There would, for example, be an effective connection between certain shares and the business of a branch if the business of the branch was to deal in the shares. There would also be an effective connection where branch investments, and transactions in them, are part and parcel of the particular kind of business carried on through the branch.

Where the paragraph applies, dividends will be subject to normal rates of tax in the United Kingdom.

Paragraph (6) is complementary to paragraph (5). It denies the tax limitation in paragraph (2), and the exemption in paragraph (4), if the relevant shares are effectively connected with a permanent establishment of the United Kingdom resident in Australia and, where the recipient is a company, the proceeds of sale or a profit on the sale of the shares would be assessable income for purposes of Australian tax.

One instance in which such a profit would be so assessable is where the shares were acquired for the purpose of profit-making by sale - section 26(a) of the Assessment Act. Another is where transactions in shares are part and parcel of a particular kind of business, such as banking or life insurance.

Paragraph (7) has no application for Australian tax purposes. It relates to anti-avoidance provisions of the United Kingdom income tax law which have no counterpart in the Australian income tax law.

In the absence of the paragraph, United Kingdom shareholders in a United Kingdom company with substantial reserves of undistributed profits could attempt to avoid the full United Kingdom tax that would be payable on the distribution of those profits. The shareholders could sell the shares to an Australian resident who would not be taxed in Australia on the distributions, the price being fixed at a level which would involve a sharing between the parties to the arrangement of the difference between the ordinary United Kingdom tax and the tax as limited by paragraph (1) of article 8.

Paragraph (7) will not affect Australian acquisitions of shares in United Kingdom companies that are made for bona fide commercial reasons.

Paragraph (8) exempts from Australian tax dividends paid by a United Kingdom company where the dividends are beneficially owned by a person who is not a resident of Australia. Conversely, dividends paid by an Australian company that are derived by a person who is not resident in the United Kingdom will be exempt from United Kingdom tax. Corresponding provisions are contained in Australia's double taxation agreements with Canada and New Zealand.

Section 44(1.)(b) of the Assessment Act includes in the assessable income of a non-resident of Australia dividends paid by a non-resident company to the extent that the dividends are paid out of profits of the company derived from sources in Australia. This was overridden to some extent by the previous United Kingdom agreement which provided that a dividend paid by a United Kingdom resident company to a United Kingdom resident was exempt from Australian tax. Paragraph (8) extends the exemption to shareholders who are not resident in either Australia or the United Kingdom. In practice, it is seldom possible to enforce payment of the tax otherwise nominally payable in these cases and the wider exemption under paragraph (8) will have little, if any, effect on Commonwealth revenue.

The proviso to the paragraph has the effect that Australia will not be required to exempt from tax dividends paid by a company resident in the United Kingdom if it is also a resident of Australia even though the company is, for the purposes of the agreement, treated as a 'United Kingdom resident'.

Paragraph (9) relates to taxes on undistributed profits. In Australia, companies that are owned by comparatively few shareholders may be liable to pay tax on undistributed profits if they fail to make a sufficient distribution of their profits to shareholders. This paragraph provides that a non-resident company is not to be charged such a tax on a basis that is less favourable than that applied to resident companies. The paragraph will not have any effect on the practical application of the existing law.

Article 9: Interest.

This article limits to 10% of the gross amount of the interest, the tax Australia and the United Kingdom may, in general, charge on interest derived by a resident of the other country. There is no comparable provision in the previous United Kingdom agreement or in the agreements Australia has with the United States, Canada or New Zealand.

Under paragraph (1) the United Kingdom tax on interest derived and beneficially owned by an Australian resident is, subject to paragraph (3), limited to 10% of the gross amount of the interest.

Under the present United Kingdom law, the interest is taxed by deduction, at the rate of 41.25%. This represents the full charge to United Kingdom tax where the recipient is an Australian company. In the case of an Australian resident individual, adjustments may be called for - either to decrease the United Kingdom liability below 41.25% or to increase it above that level. In general, paragraph (1) will involve a substantial reduction in United Kingdom tax on interest derived by Australian residents from the United Kingdom.

As explained at pages 9 and 10 of this memorandum, interest to which this paragraph applies will be taxed in Australia and credit allowed for the reduced United Kingdom tax.

Paragraph (2) imposes (subject to paragraph (3)) a corresponding limitation on Australian tax on interest derived and beneficially owned by a United Kingdom resident. In general, interest to which the paragraph applies will be subject to the newly introduced withholding tax on interest and, as the rate of that tax is 10%, paragraph (2) does not generally require Australia to reduce its tax on interest paid to United Kingdom residents. The paragraph may, however, operate to reduce the Australian tax on government loan interest to which section 160AB of the Assessment Act applies where the particular securities were issued prior to 1 January 1968. This interest is not subject to withholding tax but is taxed by assessment processes.

Paragraph (3) provides that Australian or United Kingdom tax on interest derived by a resident of the other country will not be subject to the limitations provided in paragraphs (1) and (2) if the indebtedness in respect of which the interest is paid is effectively connected with a permanent establishment of the person deriving the interest situated in the country of origin of the interest.

Paragraph (3) corresponds in practical effect with section 128B(3.)(h)(ii) of the Assessment Act which provides that interest derived by a non-resident in carrying on business in Australia through a permanent establishment in Australia is not subject to withholding tax. That interest is, under both the general Australian taxation law and the agreement, subject to the ordinary rates of Australian tax that apply under assessment processes.

Paragraph (4), though expressed in reciprocal terms, in practice only relates to provisions of the United Kingdom income tax law that define what is to be treated as a 'distribution' (i.e. a dividend) of a company for taxation purposes. In some circumstances those provisions treat payments of interest as a distribution and hence it is not allowed as a deduction to the company making the payment.

Paragraph (4) provides that, except where more than 50% of the voting power of the recipient Australian company is controlled by persons resident in the United Kingdom, those provisions of the United Kingdom law will not apply to treat interest as a distribution where the interest is paid to an Australian resident company. The interest may, therefore, qualify as a deduction in arriving at the United Kingdom paying company's taxable profits.

Paragraph (5), while expressed in reciprocal form, in practice will operate only to prevent exploitation of paragraph (1) of the article. It is directed against transactions in interest-bearing securities where an owner arranges to sell just before interest becomes payable and to re-acquire the securities shortly afterwards. If the purchaser were a tax-exempt organisation, the selling and re-purchasing prices could be adjusted so that both parties shared in the tax gain that flowed from the reduction in the United Kingdom tax on the interest.

The paragraph will ensure that the United Kingdom tax on interest will not be limited to 10% in the case of interest on securities sold by a United Kingdom resident to, and re-purchased from, a tax-exempt organisation resident in Australia where the securities are of a kind dealt with on a stock exchange and the time between sale and re-purchase does not exceed three months.

Paragraph (6) may restrict the application of paragraphs (1) and (2) where the loan transaction has been effected by persons not at arm's length with one another. Where interest in such a case exceeds the amount that would have been agreed upon by persons at arm's length, the limitation of the tax of the country of source will apply only to the lower amount.

Article 10: Royalties.

The purpose of this article is to limit to 10% of the gross royalties the tax Australia or the United Kingdom, as the country of origin, may charge on royalties, other than natural resources royalties, derived by a resident of the other country.

Under the previous United Kingdom agreement (article VII), copyright, patent and other industrial royalties were exempt from tax in the country of origin unless the recipient carried on business through a permanent establishment in that country.

Under article 10, the country of origin may tax such royalties but the tax may not exceed 10% of the gross royalties. The limitation of tax in the country of origin does not apply to royalties effectively connected with a permanent establishment in that country.

'Royalty', for the purposes of the article, has been extensively defined and covers a much wider field than did the corresponding definition in the previous United Kingdom agreement.

Paragraph (1) provides that the United Kingdom tax on royalties derived and beneficially owned by an Australian resident is not to exceed 10% of the gross royalties. The paragraph is subject to the provisions of paragraph (3) of this article.

As explained on page 9 of these notes, it is proposed that royalties to which paragraph (1) applies will be subject to Australian tax, a credit for the United Kingdom tax being allowable.

Paragraph (2) correspondingly limits to 10% of the gross royalties the Australian tax on royalties derived and beneficially owned by a United Kingdom resident. This paragraph is also subject to paragraph (3).

Paragraph (3) provides that the limitations in paragraphs (1) and (2) are not to apply where the knowledge, information, assistance, right or property from which the royalties arise is effectively connected with a permanent establishment that the owner of the royalties has in the country of origin of the royalties.

Paragraph (4) will in practice apply only in relation to United Kingdom tax. It arises from provisions of the United Kingdom income tax law under which royalties paid by a United Kingdom resident company are in some circumstances treated as a 'distribution' of the company and hence not allowable as a deduction in arriving at the taxable income of the company.

The paragraph specifies that royalties that would, under those provisions, be treated as distributions will not be so treated when paid to an Australian resident, except where the case concerns a payment between associated companies and more than 50% of the voting power in the Australian resident company deriving the royalties is controlled by a United Kingdom resident.

Paragraph (5) defines the term 'royalties' as used in the agreement. The definition will correspond with the definition proposed to be inserted in the Assessment Act - see the notes at pages 60 to 63 of this memorandum. The term as defined in paragraph (5) includes all copyright and industrial royalties as well as other payments that may appropriately be treated as royalties. Examples are amounts paid for the hire of machinery and know-how payments. Also specifically included in the term are payments for the use of, or the right to use, motion picture films and films or tapes for use in television broadcasting. Royalties or other amounts paid in respect of the operation of mines or quarries, or of the extraction or removal of natural resources, will not be treated as royalties and hence the tax on them in the country of origin will not be limited by paragraphs (1) and (2).

Paragraph (6) provides that paragraphs (1) and (2) will not apply to royalties flowing between persons not at arm's length to the extent that the royalties paid exceed the amount that would have been paid in the absence of a special relationship between the parties.

Article 11: Income from independent professional activities.

This article introduces a provision new to Australia's double taxation agreements. Under it, income derived, otherwise than as an employee, from the performance of professional services or other similar independent activities (e.g., as an architect, doctor or engineer) will be taxed in much the same manner as industrial or commercial profits (Article 5). Article 11 will not apply to income derived by public entertainers and athletes, that income being dealt with by article 13.

Under the previous United Kingdom agreement, remuneration for professional services rendered by a resident of one country on a visit to the other country was generally subject to tax in that other country. The remuneration might have been exempt from tax in that other country, however, under a provision (Article IX) broadly corresponding with article 12 of the new agreement if the visit did not exceed 183 days in a taxation year.

Under article 11, the professional income of a resident of one country will be taxed in the other country only if the recipient has a fixed base regularly available to him in that other country and then only on so much of the income as is attributable to the fixed base. To the extent that the income is so attributed, the article deems it to have a source in that other country. The term 'fixed base' is not defined but would include, for example, the office of an architect.

Article 12: Income from an employment.

This article relates to remuneration derived by visiting employees. Its purpose is to provide a clear basis for the taxing of remuneration of employees derived in the course of a short visit from one country to the other. The article corresponds with article IX of the previous United Kingdom agreement.

Article 12 does not cover the remuneration of public entertainers, Government officials or professors and teachers. These classes of persons are dealt with by articles 13, 15 and 16 of the agreement.

Paragraph (1) of article 12 provides that a resident of one country may not be taxed in the other country on remuneration for services rendered as an employee unless the services are performed in the other country, in which case the other country may, subject to paragraph (2), levy its tax. Remuneration for services performed in the other country is deemed to have a source in that country.

The right of Australia under paragraph (1) to tax remuneration for services performed in Australia by United Kingdom residents will not affect existing provisions of the Australian law which exempt from Australian tax remuneration derived by visitors assisting in the development of Australian industry.

Paragraph (2) provides an exception to the rule contained in paragraph (1) that the country in which a visiting employee performs services may tax the remuneration for those services.

Remuneration derived by an Australian resident will, for example, be exempt from United Kingdom tax where the conditions mentioned in paragraph (2) are satisfied, that is, where -

•

the Australian resident is present in the United Kingdom for not more than 183 days in a year of assessment (taxation year);

•

his employer is not a United Kingdom resident; and

•

the remuneration is not deductible in determining the profits of a permanent establishment or fixed base of the employer in the United Kingdom.

There is, of course, a corresponding exemption from Australian tax for British employees who visit here.

Paragraph (3) operates notwithstanding the provisions of paragraphs (1) and (2) of the article. Where a ship or aircraft is operated in international traffic paragraph (3) will permit the country in which the business of the operator is effectively managed to tax remuneration for services rendered aboard the ship or aircraft.

Paragraph (4) applies the foregoing provisions of this article to remuneration derived by a person in his capacity as a director of a company.

Article 13: Public entertainers.

This article provides that remuneration derived by a person from his personal activities as a public entertainer or athlete may be taxed in, and is to be treated as having a source in, the country where the activities are carried on. Under the article, Australia will be entitled to tax remuneration derived by United Kingdom entertainers from performances in this country. The comparable provision in the previous United Kingdom agreement was article IX(3) of that agreement.

Article 14: Pensions and annuities.

This article provides that a pension or a purchased annuity derived by a resident of one country from sources in the other country may be taxed only in the country of residence of the recipient.

Article X of the previous United Kingdom agreement made similar provision. Exemption in the country of source was, however, in that agreement conditional on the pension or annuity being taxed in the country of residence. Because of this condition some pensions received from the United Kingdom by Australian war widows were taxed in the United Kingdom (the general United Kingdom law does not exempt these pensions) since, under the general Australian income tax law, those pensions are exempt from tax.

Under article 14, pensions paid from the United Kingdom to Australian residents will be exempt from United Kingdom tax whether or not they are taxed in Australia.

Article 15: Governmental remuneration.

This article provides for the reciprocal exemption of Australian and United Kingdom government employees stationed in the other country. Corresponding provisions were included in article VIII of the previous United Kingdom agreement.

Paragraph (1) exempts from United Kingdom tax remuneration paid for services rendered in the discharge of governmental functions by the Commonwealth or a State of the Commonwealth. Exemption extends only to individuals who are not ordinarily resident in the United Kingdom or are so resident solely for the purpose of rendering the services.

Paragraph (2) provides a corresponding exemption from Australian tax of remuneration paid by the United Kingdom government or the government of Northern Ireland to an official who is not a resident of Australia, or is resident in Australia solely for the purposes of rendering his official services.

Paragraph (3) provides that the exemptions conferred by paragraphs (1) and (2) will not apply where the services are performed in connection with a trade or business carried on by one of the governments.

Article 16: Visiting professors and teachers.

This article provides an exemption of remuneration for teaching derived by professors or teachers from one country who visit the other country for the purpose of teaching at a university, college, school or other educational institution in the country visited. Exemption will apply in the country visited only where the visit does not exceed two years and the remuneration is subject to tax in the other country. A corresponding provision appeared in article XI of the previous United Kingdom agreement.

Article 17: Visiting students.

Under this article each country will exempt from its tax payments received from abroad by a student for his education or maintenance, if the student is present in that country solely for the purpose of his education and is, at the time, or was immediately before visiting that country, a resident of the other country. No comparable provision is included in any of Australia's other double taxation agreements.

Article 18: Income of dual residents.

The purpose of this article is to overcome problems that could otherwise arise in taxing certain income derived by individuals and companies that are residents both of Australia and the United Kingdom under the general income tax laws of both countries.

It will be recalled that where a person is so resident in both countries, article 3 lays down a set of rules which determine in which of the two countries the person is, for purposes of the agreement, to be treated as solely resident. Such a person nevertheless remains a resident of each country for the purposes of the application of the general income tax law of each country. In these circumstances, each country would be entitled to tax income of a dual resident from sources in the other country or from a third country.

Under the previous United Kingdom agreement each country was entitled to tax income derived by dual residents from sources in the other country or from a third country and, if it did, it was required by article XII of the agreement to allow a credit which had the broad effect that the overall tax on the income was equivalent to the higher of the taxes imposed by the United Kingdom and Australia.

Article 18 deals with these problems in a different way, and one which is consistent with the general solution adopted by article 3 for resolving dual residency problems. If the country to which a dual resident's residency is allotted taxes the income, the other country is to exempt from its tax income from the first country or from a third country.

Article 19: Relief from double taxation.

This article provides for the relief of double taxation where income that is derived by a resident of one country from sources in the other country is taxed in both countries. It corresponds in principle with article XII of the previous United Kingdom agreement.

As outlined in the notes on page 27 of this memorandum some income flowing between the two countries may be taxed only in the country of residence of the recipient. All other income may be taxed in the country of source. If the country of residence of the recipient also taxes income that is taxed in the country of source, this article requires the country of residence to relieve the ensuing double taxation.

Relief is required to be granted by way of tax credit, that is, by deducting the tax of the country of source from the tax imposed by the country of residence. This method of relieving double taxation is adopted in each of Australia's other double taxation agreements and is the method of relieving international double taxation under the general taxation law of the United Kingdom.

Under the general Australian income tax law, however, relief by way of tax credit has applied in practice only to dividends. All other income derived by a resident of Australia from sources overseas has been exempt from tax under section 23(q) of the Assessment Act if taxed in the overseas country.

Elsewhere in this memorandum (at pages 9 and 10) a proposal to amend this exempting provision has been explained. The amendment proposes the removal from the scope of section 23(q) of interest and royalties in respect of which, under articles 9 and 10 of this agreement, the United Kingdom tax is not to exceed 10% of the interest or royalties. Once section 23(q) has been made inapplicable to this income it will be subject to tax in Australia in accordance with the general principles of the Assessment Act, but article 19 will require Australia to allow credit for the United Kingdom tax. All other United Kingdom - source income taxed in that country (excluding dividends) will continue to be exempt from Australian tax. If the law were to be changed to subject this income to Australian tax, article 19 would require the allowance of credit for United Kingdom tax.

Paragraph (1) sets out the general rules requiring the United Kingdom to allow credit for Australian tax. Detailed rules for the computation of the credit may be provided in the United Kingdom law but these cannot affect the general principle that Australian tax is to be allowed as a credit against United Kingdom tax. The main restrictions under the United Kingdom law are that the amount of the credit is limited to the United Kingdom tax on the Australian source income and that credit is only allowed to persons resident in the United Kingdom.

Sub-paragraph (a) of paragraph (1) requires the United Kingdom to allow credit for Australian tax imposed directly on income from sources in Australia. The credit will be allowed against United Kingdom income tax, corporation tax or capital gains tax (as the case may be) charged on the same income as is taxed in Australia.

A credit for Australian income tax would be allowable against United Kingdom capital gains tax in any case in which a particular gain is treated as income in Australia (for example, profits from the sale of Australian real estate purchased for purposes of re-sale at a profit) but for United Kingdom tax purposes is treated as a capital gain and charged to capital gains tax.

Sub-paragraph (b) of paragraph (1) ensures the continued application of provisions of the United Kingdom law which allow against the United Kingdom tax on dividends paid by an Australian company a credit for the Australian company tax on the profits out of which the dividends are paid. This credit for 'underlying tax' is only available where the recipient of a dividend is a company that holds 10% or more of the voting power in the Australian dividend-paying company. In recognition of the changes made to the United Kingdom taxation law in 1965, the new agreement does not (as did article XII of the previous United Kingdom agreement) require the allowance of credit for underlying tax to all United Kingdom residents, both individuals and companies.

Paragraph (2) provides for the allowance against Australian tax of credit for United Kingdom tax on income from sources in the United Kingdom. The amount of the credit will be calculated in accordance with the provisions of the Income Tax (International Agreements) Act. The provisions of that Act that limit the amount of credit to the Australian tax payable on the United Kingdom source income have been explained earlier in this memorandum. These do not affect the general principle of allowance of credit for United Kingdom tax.

Sub-paragraph (a) of paragraph (2) expresses the general rule. In practice, as has been explained, credit will be allowed in Australia only in respect of United Kingdom tax on dividends and on interest and royalties taxed in the United Kingdom in accordance with paragraph (1) of articles 9 and 10. The amount of the United Kingdom tax eligible for credit is the amount of that tax as reduced by the amount of any relief or repayment of that tax (for example, reliefs in respect of personal allowances) that is attributable to the doubly taxed income. Where the income is a dividend, credit is not to be allowed for the United Kingdom 'underlying' corporation tax on the profits out of which the dividend is paid.

Unlike the position under article XII of the previous United Kingdom agreement, a resident of Australia will not need to elect to have the gross amount of United Kingdom dividends included in his assessable income in order to be eligible for a credit. The notes on pages 11 to 13 of this memorandum give further explanations of this matter.

Sub-paragraph (b) of paragraph (2) provides for possible revision of the basis on which Australia is to allow credit for United Kingdom tax in relation to dividends received by companies that are residents of Australia.

Under section 46 of the Assessment Act, an Australian resident company is entitled to a rebate of the tax payable on dividends it receives from non-resident (as well as resident) companies. The broad practical effect of the rebate is that no Australian tax is payable on the dividends and hence no credit is allowed for United Kingdom tax imposed directly on dividends.

Sub-paragraph (b) provides that if the rebate under section 46 is ever withdrawn in relation to dividends from the United Kingdom, so that the dividends effectively become liable to Australian tax, the two Governments will enter into negotiations to establish appropriate credit provisions in relation to the dividends.

Paragraph (3) overcomes, in relation to the allowance of tax credits under paragraphs (1) and (2) of the article, difficulties that may otherwise arise out of conflicting concepts of 'source' of income.

The broad effect of the paragraph in relation to the kinds of income specified in it is that, irrespective of what the position might be under its own income tax law, each country will allow credit for the other country's tax if the income tax law of the other country treats the income as arising in that country.

The provision is of particular importance to Australia because by it the United Kingdom recognises, for purposes of tax credits, such things as the basis on which the new withholding tax on interest is levied and the basis on which it is now proposed to tax royalties paid to non-residents (see pages 61 to 63 of this memorandum).

Provision in other articles attributing a source to particular income will, of course, apply for purposes of tax credits under article 19.

Sub-paragraph (a) of paragraph (3) provides a source rule in relation to dividends. Each country will allow credit to its residents in respect of tax of the other country which the residents bear on dividends paid by companies that are residents of that other country.

Sub-paragraph (b) treats as income from a source in one country, interest and royalties which, under the law of that country, are derived from sources in that country or are subject to withholding tax imposed by that country on non-residents. By reason of this sub-paragraph, the United Kingdom will allow credit for the recently enacted interest withholding tax as well as tax on royalties on the basis concurrently proposed.

Sub-paragraph (c) specifies that the country of source of remuneration for services aboard a ship or aircraft in international traffic will be the one in which the employing enterprise is effectively managed.

Sub-paragraph (d) relates to special provisions of the law of either country governing the taxing of income derived in connection with a business of insurance or a film business controlled abroad. Paragraph (8) of article 5 permits the application of these special provisions and amounts taxed under them in one country will be treated as income from sources in that country by the other country.

Under this sub-paragraph the United Kingdom will be required to allow credit for Australian tax imposed under the provisions of Division 14 (film business controlled abroad) and Division 15 (insurance with non-residents) of Part III of the Assessment Act.

Sub-paragraph (e) has the effect, in relation to Australia, that tax imposed in relation to Australian coastal voyages under section 129 of the Assessment Act will be allowed as a credit against United Kingdom tax on profits from those voyages.

Paragraph (4) relates to article 7 of the agreement which allows reconstruction, for income tax purposes, of accounts of associated companies. Where, for example, through the application of article 7 profits are treated as having been derived by an Australian company and taxed in Australia, the same profits may be taxed in the United Kingdom to an associated company on the basis of returns lodged by it there. In such a case this paragraph will require the United Kingdom to allow against its tax on those profits a credit for the tax paid (by a different, though associated, taxpayer) in Australia.

Article 20: Implementation of agreement.

The main purpose of this article is to provide means by which the agreement is implemented and is applied in a consistent way by the taxation authorities of the United Kingdom and Australia.

Paragraph (1) provides for a taxpayer to present a case to a taxation authority that the agreement has not been correctly applied to him. If the taxpayer's claim is regarded by one taxation authority as having substance, the two taxation authorities are to endeavour to come to a satisfactory agreement as to the application of the agreement.

This provision does not cut across any taxpayer's rights of appeal against assessments made. It may be, however, that a taxpayer would prefer to have a particular matter dealt with by consultations between the taxation authorities.

Paragraph (2) authorises the taxation authorities to communicate directly with one another for the purpose of implementing the agreement or assuring its consistent application. Particular matters mentioned are disputes arising out of the application of the arm's length basis of attributing business profits to permanent establishments and associated enterprises, and as to the source of income.

Article 21: Exchange of information.

This article authorises the exchange between the two taxation authorities of information necessary for carrying out the provisions of the agreement, or for the prevention of fraud, or in relation to provisions of the respective income tax laws directed against legal avoidance of tax.

Provisions of each country's taxation laws (for example, section 16 of the Australian Assessment Act) require secrecy to be maintained concerning the affairs of taxpayers but it is necessary that these limitations be overcome by the agreement if it is to operate effectively. The taxation authority receiving information under this article may not disclose information obtained from the other country other than to persons or tribunals concerned in assessment, collection, enforcement or prosecution matters in respect of the taxes that are the subject of the agreement.

The article does not permit information that would disclose a trade, business, industrial or professional secret or trade process to be furnished by either taxation authority to the other.

Article 22: Territorial extension.

Under this article, the agreement may be extended to any territory, which imposes taxes comparable to those to which the agreement applies, and for whose international relations the Government of one of the countries is responsible. The two Governments would need to agree on the terms of any extension before it could take place.

Article 23: Commencement.

This article provides for the coming into operation of the agreement and for the termination of the previous United Kingdom agreement. It contains special provisions to smooth the transition from the old to the new agreement. So far as Australian tax is concerned, these matters have been commented on in the notes on pages 7 and 8 of this memorandum.

Paragraph (1) provides firstly for the entry into force of the agreement. The agreement will enter into force on the day on which both countries have completed all formalities to give it the force of law. As the agreement has been given the force of law in the United Kingdom, the date of entry into force will be the day on which the Income Tax (International Agreements) Bill 1968 receives the Royal Assent.

When the agreement receives the force of law it will first apply -

in the United Kingdom:

•

to income tax and surtax for the 1967/68 year of assessment;

•

to capital gains tax for the 1965/66 year of assessment; and

•

to corporation tax for the 1964/65 financial year;

in Australia:

•

to tax on dividends derived by non-residents on 1 July 1967;

•

to withholding tax on interest derived on 1 January 1968; and

•

to tax levied by assessment in respect of the 1967/68 year of income.

Paragraph (2) terminates the previous United Kingdom agreement with effect in respect of tax to which the new agreement applies. This termination is by way of mutual agreement between the respective Governments and does not bring into operation the termination provisions (Article XVI) of the previous United Kingdom agreement. Paragraph (2) is subject to the transitional provisions contained in paragraph (3) of the article.

Paragraph (3) contains provisions designed to afford relief to taxpayers in the transition from the previous United Kingdom agreement to the new agreement.

Sub-paragraph (a) of paragraph (3) states the general rule. A provision of the previous United Kingdom agreement that affords greater relief from tax of one country than the corresponding provision of the new agreement is to continue to have effect for a limited period. In general, the provision will continue to apply in that country to income derived up to the end of the taxation year that commenced before the date of entry into force of the new agreement.

In the United Kingdom, the taxation year is described as a 'year of assessment', for purposes of income tax, surtax and capital gains tax and as a 'financial year' for purposes of corporation tax. A year of assessment ends in the United Kingdom on 5 April and a financial year on 31 March. The transitional period for purposes of United Kingdom tax will, therefore, in any event include the year of assessment ending 5 April 1968 and the financial year ending 31 March 1968. If the date of entry into force falls after those dates the transitional period in that country will include also the year of assessment ending 5 April 1969, and the financial year ending 31 March 1969.

Sub-paragraph (b) of paragraph (3) provides an exception to the general rule in the case of United Kingdom tax. It limits the application in the United Kingdom of article XII of the previous United Kingdom agreement to Australian dividends paid before the date of entry into force of the new agreement. Its effect is to terminate on that date those provisions of article XII that require the United Kingdom to allow credit for Australian (underlying) company tax where the recipient is an individual or is a company that controls less than 10% of the voting power in the Australian dividend paying company.

Sub-paragraph (c) of paragraph (3) provides, in relation to Australian tax, an exception to the general rule stated in sub-paragraph (a). The sub-paragraph terminates the exemption under article VI(2) of the previous United Kingdom agreement in respect of dividends paid by wholly-owned Australian subsidiaries of United Kingdom parent companies where the dividends are declared after the date that fell seven days after the signature of the new agreement, that is, in respect of dividends declared on or after 15th December 1967.

Paragraph (4) relates to withdrawal of a corresponding exemption under the United Kingdom income tax law.

Following the changes made to its taxation law in 1965 the United Kingdom unilaterally imposed on itself as a temporary measure (by section 31 of the Finance Act 1966) limitations corresponding to those imposed on Australia's taxing rights by article VI of the previous United Kingdom agreement. Dividends paid by wholly-owned United Kingdom subsidiaries of Australian parent companies were accordingly exempt from United Kingdom tax.

This paragraph ensures the continued application of that exemption until 15 December 1967.

Article 24: Termination.

This article provides that the agreement is to continue indefinitely. However, either Government may terminate it by notice given to the other Government in the course of the first six months of any calendar year after 1973. Upon notice being given in any year the agreement will cease to apply from a stated time in the succeeding calendar year.

Nothing in the new agreement would prevent its termination or variation at any time by mutual agreement of the two Governments.

INCOME TAX ASSESSMENT BILL 1968

This is the second of the two Bills explained in this memorandum. The principal features of the Bill have already been mentioned and the following notes relate to each clause of the Bill.

Clause 1: Short title and citation.

This clause formally provides for the short title and citation of the Amending Act and of the Principal Act as amended.

Clause 2: Commencement.

Section 5(1A.) of the Acts Interpretation Act 1901-1966 provides that every Act shall come into operation on the twenty-eighth day after the date on which the Act receives the Royal Assent, unless the contrary intention appears in the Act.

Sub-clause (1.) of clause 2 proposes that, subject to the succeeding sub-clause, the Amending Act will come into operation on the day on which it receives the Royal Assent.

Sub-clause (2.) proposes that amendments made by clauses 3(b), 4, 5, 12 and 13 shall have effect as from 1 July 1968. These amendments are related to the taxation of royalties paid to non-residents on or after that day and are explained later in this memorandum.

Clause 3: Interpretation.

This clause proposes to amend section 6 of the Principal Act which contains definitions of words and phrases used in that Act.

Paragraph (a) of clause 3 will insert a definition of the phrase 'permanent establishment'. The concept of a permanent establishment is significant in the imposition of withholding tax on dividends and interest paid from Australia to non-residents. It will also have effect for the purposes of the proposals in this Bill relating to the taxation of royalties paid from Australia to non-residents.

Section 128A of the Principal Act at present contains provisions in sub-sections (5.), (6.) and (7.) which determine the circumstances in which a place of business in a country is regarded as a permanent establishment for the purposes of the withholding tax on dividends and interest derived by non-residents. As a drafting measure, these provisions are being repealed by a later clause of the Bill (Clause 8) and replaced by a definition in section 6 of the Principal Act. This will not make any change in the basis on which the withholding tax on dividends and interest is now applied. In the future, however, the definition will also have effect for the purposes of taxing royalties paid to non-residents.

As to royalties the definition is necessary for two reasons. By later provisions of the Bill royalties paid by a resident of Australia to a non-resident will, in effect, be deemed to have a source in Australia except to the extent they relate to a business carried on by the Australian resident in another country through a permanent establishment there. Royalties paid by a non-resident to another non-resident will be deemed to have a source in Australia to the extent they are related to a business carried on by the non-resident payer in Australia through a permanent establishment here.

Stated briefly, a permanent establishment will mean any place of business in a country at or through which a person carries on business in that country. It includes a place where a person carries on business through an agent, where he is using or installing substantial equipment or machinery, or where he is engaged in a construction project.

The permanent establishment of a person engaged in selling goods that are manufactured, assembled, processed, packed or distributed in a country by an enterprise associated with that person will be the place in that country where the associated enterprise is engaged in those activities.

The proposed definition also makes clear that a person who is not otherwise engaged in business in a country will not be regarded as having a permanent establishment in that country merely by reason of the fact that -

(a)

he maintains a place of business there solely for the purchasing of goods or merchandise;

(b)

he engages in business transactions in that country through a commission agent or broker who receives commission at the rate customary for that class of business; or

(c)

he conducts business through an agent who does not regularly fill orders from a stock of goods in that country or who does not habitually exercise authority to negotiate and conclude contracts on his behalf.

Paragraph (b) of clause 3 will insert in section 6 of the Principal Act a new definition - of the word 'royalty' - that is designed to apply for the general purposes of the income tax law.

Hitherto this word, which has not previously been defined in the Principal Act, has been used in its ordinary sense in relation to payments made to grantors and licensors for certain rights including those relating to the extraction of minerals from land, the cutting and removal of standing timber and the exploitation or use of industrial property in the form of patents, copyrights and similar monopolies.

Under the proposed definition, 'royalty' is to be given a wider meaning to include any payment that will be treated as a royalty under the definition in article 10 of the new double taxation agreement with the United Kingdom.

In the expanded sense in which the word is proposed to be defined it will also embrace payments - received in the form of income - relating to the use of tangible property such as machinery, equipment, blue prints and models and payments relating to the supply of 'know-how' such as scientific, technical, industrial or commercial knowledge, information or assistance. The definition will specifically include payments received in an income form for the use of or the right to use motion picture films, television films or tapes or tapes used for radio broadcasting.

The proposed definition will have particular relevance in the taxation of non-residents in receipt of income of the kinds mentioned from sources in Australia. For this purpose, clause 4 proposes amendments which will specify the circumstances in which a royalty paid to a non-resident is to be treated as having an Australian source.

Paragraph (c) of clause 3 proposes to include a new sub-section - sub-section (6.) - in section 6 of the Principal Act. The sub-section is complementary to the definition of 'permanent establishment' to be inserted in that section by paragraph (a) of this clause and will re-enact provisions now contained in sub-section (7.) of section 128A of the Principal Act which are to be omitted from that section by clause 8.

Under paragraph (d) of the definition of 'permanent establishment' a person engaged in selling goods that are manufactured, assembled, processed, packed or distributed for him by an associated person is deemed to have a permanent establishment at the place where the goods are manufactured etc.

This sub-section will, in appropriate circumstances, enable new section 6C (which is to be inserted by clause 4) to attribute an Australian source to a royalty payable to a non-resident where it is an expense of a business of selling goods that have been manufactured etc. in Australia for the vendor by a person associated with him.

Clause 4: Source of royalty income derived by a non-resident.

Clause 4 proposes the insertion in the Principal Act of a new section - section 6C.

The amendments proposed by this clause and by clause 3 are concerned with the taxation of income in the form or general nature of royalties payable by Australian businesses etc. to non-residents.

Under the general provisions of the present law income that is within the definition of 'royalty' proposed by paragraph (a) of clause 3 is assessable income in Australia where it has a source in this country. In brief what the new section is designed to do, in specified circumstances, it to ascribe an Australian source to royalties for the purposes of the income tax law. When the section applies, royalties will have a source in Australia for income tax purposes irrespective of such factors as where the contract or agreement giving rise to them has been made or where the amounts have to be paid. The section thus follows the same principles as those on which the interest withholding tax is based.

One effect of the new section 6C is that royalties will be treated as having an Australian source where they are paid to a non-resident by a resident of Australia and are not an expense incurred by the resident in a business carried on outside Australia through a permanent establishment. Another effect is that royalties paid by a non-resident to another non-resident will have a source in this country to the extent that they are an expense of a business conducted by the non-resident payer through a permanent establishment in Australia.

Sub-section (1.) of section 6C provides that the section is to apply to royalty income of a non-resident derived on or after 1 July 1968 that is -

(a)

paid by the Commonwealth, a State, an Australian governmental authority or an Australian resident (including a partnership of which any member is a resident) provided that the royalty is not wholly incurred by the payer in a business carried on outside Australia through a permanent establishment; or

(b)

is paid by a non-resident, or a partnership of non-residents, residents, and the royalty is incurred, wholly or in part, in a business carried on by the payer in Australia through a permanent establishment.

Sub-section (2.) formally provides that royalty income to which section 6C applies shall, for the purposes of sections 25 and 255 of the Principal Act, be deemed to have been derived from a source in Australia.

Section 25 of the Principal Act is a general provision which provides, inter alia, that the assessable income of a non-resident taxpayer includes the gross income derived directly or indirectly from all sources in Australia. The practical effect of sub-section (2.) of section 6C will therefore be to bring royalties paid to non-residents within the scope of section 25 where the requirements of section 6C, and in particular the provisions of sub-section (1.) explained above, are met. Broadly, a royalty paid by a resident to a non-resident will be included in the non-resident's assessable income under section 25 unless it is an outgoing incurred by the payer in carrying on an ex-Australian business. If a royalty paid by one non-resident to another non-resident is an outgoing incurred by the payer in carrying on business in Australia through a permanent establishment here, it will be included in the assessable income of the recipient.

Section 255, which relates to the retention in Australia of moneys due to a non-resident for the purpose of meeting a taxation liability of the non-resident, is explained in the notes on clause 12.

Sub-section (3.) covers the case where a royalty paid by an Australian resident to a non-resident is in part an expense incurred in a business carried on by the payer through a permanent establishment in a country outside Australia. It will ensure that, to the extent that the royalty relates to the business carried on overseas, it will not be treated by section 6C as having originated from a source in Australia.

Sub-section (4.) applies where a royalty is paid by one non-resident to another non-resident and is attributable in part to an Australian business carried on through a permanent establishment in Australia by the payer. In these circumstances only so much of the royalty as is attributable to the Australian business will be treated as having an Australian source under section 6C.

Clause 5: Certain items of assessable income.

This clause proposes a drafting amendment to section 26 of the Principal Act which is consequential upon the proposed insertion of the definition of royalty in section 6 of that Act by clause 3.

Section 26 of the Principal Act expressly provides that specified categories of receipts by a taxpayer are to be included in his assessable income and, to this extent, extends the operation of the general provisions of section 25 of that Act. Section 25 provides, broadly, that the assessable income of a taxpayer shall include his gross income.

Paragraph (f) of section 26 includes in the assessable income of a taxpayer any amount received as or by way of royalty. The amendment will not disturb this position in relation to any amount that is a royalty within the general meaning of that word. Where, however, a receipt which would not fall within that category is, by virtue of the proposed definition of royalty, to be treated as a royalty for the general purposes of the Principal Act the question whether the receipt is income of the taxpayer will, as in the past, be determined under the provisions of section 25 of that Act.

Clause 6: Credit in respect of tax paid abroad on ex-Australian dividends.

This clause proposes a technical amendment of section 45 of the Principal Act that is consequential upon the change in the basis for the ascertainment of Australian tax under the proposed new section 15 of the Income Tax (International Agreements) Bill 1968.

Section 45 provides for the allowance of credit for foreign tax paid on a dividend derived by a resident of Australia from a country other than one with which Australia has concluded a double taxation agreement. The amount of the credit, like credits under the Income Tax (International Agreements) Act, is limited to the amount of the Australian tax payable in respect of the dividend and for this purpose the provisions of that Act relating to the ascertainment of the amount of Australian tax are adopted.

Features of the credit under section 45 make it necessary to provide for a separate credit in relation to each dividend and the amendment will ensure that credits continue to be allowed on this basis notwithstanding that credits under double taxation agreements are in future to be allowed on the basis of aggregating dividends derived from the one country.

The proposed alteration to the expression of section 45(1.)(a)(ii) will first apply in relation to the 1967-68 year of income.

Clause 7: Interpretation.

By this clause it is proposed to amend the definition of "the distributable income" contained in section 103(1.) of the Principal Act by omitting paragraph (a) and inserting a new paragraph in its stead. Calculation of the distributable income is a step in determining whether a private company is liable to pay additional tax on undistributed profits.

The existing paragraph (a) provides that the primary income tax payable by a private company is to be deducted from the company's taxable income for the purpose of arriving at the company's distributable income. The proposed paragraph (a) will provide that the amount to be deducted from the company's taxable income is to be the primary income tax payable before the allowance of any rebate under section 16 of the Income Tax (International Agreements) Act.

The need for the amendment arises out of the new double taxation agreement with the United Kingdom as, prior to that agreement, a private company liable to pay the tax on undistributed profits was not entitled to a rebate under the Income Tax (International Agreements) Act. As the amount of this tax is a factor in determining the amount of rebate allowable to a private company that is a United Kingdom resident it is necessary to ignore the amount of the rebate in calculating the distributable income.

The amendment proposed by this clause will first apply in relation to the 1967-68 year of income.

Clause 8: Interpretation.

This clause proposes to omit sub-sections (5.), (6.) and (7.) from section 128A which contains definitions of words and expressions used in Division 11A of Part III. of the Principal Act. The Division imposes a liability for withholding tax on certain dividends and interest paid to non-residents.

The sub-sections to be omitted determine the circumstances in which a taxpayer who engages in business in a country is to be regarded as having a 'permanent establishment' in that country.

As explained in the notes on clause 3(a) and (c), the present effect of sub-sections (5.), (6.) and (7.) of section 128A is to be achieved by amendments proposed to section 6 of the Principal Act. The retention of these sub-sections of section 128A will then be unnecessary.

Clause 9: Reduction of credits in certain circumstances.

This clause proposes the repeal of section 160AG of the Principal Act and the re-enactment of the section with some technical modifications.

The purpose of section 160AG is to place an appropriate limitation on the amount of the credit that may be allowed under Division 18 of the Principal Act in respect of tax paid in the Territory of Papua and New Guinea if tax is payable on a dividend both in the Territory and in an overseas country. This situation could arise, for example, if an Australian shareholder received from a United Kingdom company a dividend paid out of profits derived from sources in the Territory.

In such a case, this section operates to limit the amount of the credit under Division 18 to the amount by which the Australian tax on the dividend exceeds the credit allowable under the Income Tax (International Agreements) Act or under section 45 of the Principal Act.

By this clause section 160AG is being re-expressed to take into account the changes proposed by the Income Tax (International Agreements) Bill in the basis for ascertaining the amount of Australian tax on dividends. The new section will also apply to dividends derived through a trustee or nominee in the same way as dividends derived by a person as a shareholder.

The amended section will first apply in relation to the 1967-68 year of income.

Clause 10: Definitions.

By this clause it is proposed to amend the definition of 'non-Australian tax' appearing in section 160AH of the Principal Act. Paragraph (a) of that definition at present refers to tax, other than Australian tax, that is the subject of a convention or agreement a copy of which is set out in a schedule to the Income Tax (International Agreements) Act. The proposed definition follows the amended definition of 'agreement' proposed in the Income Tax (International Agreements) Bill which covers, in addition to conventions or agreements appearing in schedules to the Income Tax (International Agreements) Act, the previous United Kingdom agreement.

Clause 11: Information for credit to be furnished within three years.

The amendment to section 160AM of the Principal Act proposed by this clause relates to provisions of the new United Kingdom agreement concerning the amount of United Kingdom tax for credit purposes. Under section 160AM a person claiming a credit is required to furnish information about any relief or repayment of foreign tax eligible for credit.

Under the previous United Kingdom agreement, the amount of United Kingdom tax eligible for credit was reduced by the amount of any relief or repayment of United Kingdom tax to which the person deriving the income was entitled. These provisions created difficulties where, under the United Kingdom law, a husband was entitled to a repayment of United Kingdom tax in relation to dividends derived by his wife.

The corresponding provision of the new United Kingdom agreement requires the United Kingdom tax on particular income to be reduced by any relief or repayment of United Kingdom tax in respect of that income, no matter who is entitled to the relief or repayment. The existing section 160AM reflects the position under the previous agreement and the proposed amendment will alter it to take account of the situation under the new agreement.

The amendment proposed by this clause will first apply in relation to the 1967-68 year of income.

Clause 12: Person in receipt or control of money for non-resident.

This clause proposes an amendment to section 255 of the Principal Act under which the Commissioner of Taxation is empowered to collect income tax payable by a non-resident from any person who has the receipt, control or disposal of money belonging to the non-resident.

Briefly stated the section provides that any person who has the receipt, control or disposal of money belonging to a non-resident is authorised and required to retain so much of that money as is necessary to pay the tax that is owed, or will be owed, by the non-resident. When called upon to do so, he is required to pay the income tax due and payable by the non-resident.

The section indemnifies such a person for all payments made by him in accordance with the requirements of the Principal Act and also imposes a personal liability on him to the extent of any amount that he is required to retain out of moneys of the non-resident.

The amendment proposed will make it clear that, except in regard to the personal liability on a failure to retain, section 255 will apply to the Commonwealth and State Governments and to governmental authorities having the receipt, control or disposal of money belonging to a non-resident.

Clause 13: Person paying royalty to a non-resident taxpayer.

By this clause it is proposed to amend the provisions of section 256 of the Principal Act under which a person liable to pay money as or by way of royalty to a non-resident is required, before making payment of the royalty, to advise the Commissioner of Taxation of the amount payable to the non-resident and to ascertain from him what amount, if any, is to be retained on account of income tax due, or which may become due, by the non-resident.

Paragraph (a) of the clause amends sub-section (1.) to provide that the reference in the section to a 'person' liable to pay a royalty will include also a reference to the Commonwealth or a State Government or a governmental authority that is liable to pay a royalty to a non-resident.

Paragraph (b) will amend sub-section (2.) of section 256 to ensure that, where a person who is liable to pay a royalty has ascertained from the Commissioner the amount to be retained in respect of tax which may become due by the non-resident, that person is authorised and required to retain that amount from the royalty pursuant to section 255 of the Principal Act.

Clause 14: Application of amendments.

This clause specifies the commencing date for the application of proposed amendments. These dates have been referred to in the notes on the relevant clauses.