Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 3 - Exclusion of certain royalties from the royalty withholding tax provisions
What will the amendments do?
3.1 The amendments will exclude domestic law royalty payments from the scope of the RWT provisions in cases where the payments are not treated as royalties under the Royalties Article definition in a tax treaty. This will be achieved by extending existing rules that apply where a tax treaty excludes royalties derived through a permanent establishment from the Royalties Article . [New subsection 17A(5) to the Agreements Act]
Commencement
3.2 The amendments will apply to royalties paid from the day this bill receives Royal Assent. [Item 5 of Schedule 2 and clause 2 to the bill]
Reason for the amendments
3.3 Australias tax treaties generally allow Australia to charge 10% tax on the gross amount of royalties paid to a person resident in a treaty partner country. Different treatment applies, however, where the person derives royalties through a permanent establishment (e.g. branch) or fixed base in Australia. Such royalties are included in the calculation of profits attributable to the permanent establishment or fixed base and may be taxed in Australia at full rates. Outgoings must, however, be allowed in determining the profits and thus the profits are only taxable on a net basis. Rules currently apply to exclude these royalties from taxation on a gross basis under the RWT provisions (subsection 17A(4) of the Agreements Act).
3.4 The US Protocol will exclude equipment royalties paid to US residents from the treaty definition of royalties and thus result in the payments being either exempt or, where derived through a permanent establishment, taxable on a net basis. The current exclusion from the RWT provisions will not apply because the payments, while royalties for domestic law purposes, are not treated as royalties for treaty purposes.
3.5 The amendments will address collection difficulties that could arise if amounts taxable on a net basis were subject to the RWT provisions. Such difficulties can arise because the correct amount of tax to be withheld on net amounts generally cannot be determined when the withholding obligation arises. Payers are also likely to withhold too much tax because they are personally liable for any shortfall. Overpayment of withholding tax can lead to compliance and administrative costs in processing claims for tax refunds.
3.6 Example 3.1 illustrates collection difficulties that could arise as a result of the US Protocol and how they would be addressed by the amendments.
Example 3.1
Payments derived by a US resident through an Australian permanent establishment from the lease of industrial equipment may currently be taxed on a net basis under the Business Profits Article of the US tax treaty. These payments, while treated as royalties for the purposes of the treaty, would not be covered by the Royalties Article because the payments are connected with a permanent establishment (Article 12(3)). Collection difficulties do not currently arise because the royalties are excluded from the RWT provisions (subsection 17A(4) of the Agreements Act). The exclusion also has the effect that the royalties become taxable on a net basis under general assessment provisions.
The payments will continue to be taxable on a net basis under the Business Profits Article following the US Protocol. Changes to the royalty definition will, however, mean that the payments will cease to be royalties for the purposes of the US tax treaty. Section 17A(4) would not apply in this case and the payments would not be excluded from the scope of the RWT provisions. The lessee would therefore be obliged to withhold tax on the payments but would have difficulty determining the amount to withhold at the time the obligation arises. The proposed amendments will continue current arrangements and exclude the payments from the RWT provisions.
Amendments to have general application
3.7 The exclusion from the RWT provisions is expressed in general terms to deal with other cases where domestic law royalties may not be treated as royalties for the purposes of a tax treaty. Legislation expressed in general terms would, in addition, deal with royalty payments excluded from the royalty definition in future tax treaties.