House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 1 - The 2003 United Kingdom convention

What is the 2003 United Kingdom convention?

1.1 The 2003 United Kingdom convention is a Convention between the Government 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 on Capital Gains signed in Canberra on 21 August 2003 (referred to as 'tax treaty' or 'treaty' for the purposes of this chapter). An Exchange of Notes associated with this tax treaty was carried out at the time of signature of the treaty (referred to as 'Notes' for the purposes of this chapter).

1.2 Once in force, the tax treaty will replace:

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the Agreement between the Government 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 signed on 7 December 1967 (referred to as 'the existing treaty' for the purposes of this chapter); and

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the Protocol to the existing treaty as signed on 29 January 1980 (referred to as 'the 1980 protocol' or 'protocol' for the purposes of this chapter).

Why is the tax treaty necessary?

1.3 The new tax treaty and Notes are required to reflect modern business practice and changes to both countries' tax law and tax treaty practice since the existing treaty and its later amending protocol were negotiated.

1.4 In terms of comparison with the existing treaty, the new tax treaty will serve to facilitate trade and investment between Australia and the United Kingdom by:

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extending the coverage of the new treaty to Australian tax on capital gains and the Australian FBT;

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clarifying in light of the United Kingdom decision in Padmore v Inland Revenue Commissioners (1989) Simon's Tax Cases 493, that partnerships, other than Australian limited partnerships, are not persons covered by the treaty;

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providing residency rules for dual listed company arrangements;

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extending the coverage of Article 7 ( Business profits ) in the new treaty to:

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business trusts; and

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spectrum licence payments;

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taxing payments for leasing of industrial, commercial, or scientific equipment that are subject to royalty withholding tax on the gross amount under the existing treaty, on a net basis under the new treaty, as either business profits, or profits from international transport operations;

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specifying nil or 5% source country taxation for certain cross-border intercorporate dividends;

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exempting from source country taxation interest payments to government bodies and financial institutions;

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reducing the withholding tax rate on royalties from a maximum of 10% to 5% of the gross royalty payment;

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providing distributive rules for taxation of capital gains including providing for source country taxation where capital gains are not otherwise dealt with in the new treaty and dealing with capital gains derived by departing residents;

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clarifying the tax treatment of income or gains from employee share option schemes;

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providing that fringe benefits will only be taxable in the country which would have the primary taxing right if the benefit had been paid as ordinary employment income;

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including an Other income Article (Article 20) and a Source of income Article (Article 21);

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including Article 23 ( Limitation of relief ) that will ensure that double non-taxation will not arise where either the United Kingdom or Australia exempts certain income from residence country taxation;

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including Article 25 ( Non-discrimination ) that ensures that nationals of one country are generally subject to no less favourable tax treatment than nationals of that other country;

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modifying the Exchange of information Article (Article 27) to remove United Kingdom impediments to the exchange of relevant information; and

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updating all the Articles, having regard to Australian, United Kingdom and OECD tax treaty developments since the existing treaty was entered into and later revised in 1980.

Main features of the new tax treaty

1.5 The new tax treaty between Australia and the United Kingdom, and the Notes, accords with the directions in Australia's treaty policy announced by Government in Treasurer's Press Release No. 032 of 13 May 2003. The treaty and Notes include additional provisions on employee share option schemes, partnerships, dual listed companies and a Non-discrimination Article. The Notes contain a number of operative provisions which apply to the tax treaty, as well as an explanatory clause.

1.6 The main features of the tax treaty and the Notes are as follows:

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Dual resident persons (i.e. persons who are residents of both Australia and United Kingdom according to the domestic law of each country) are, in accordance with specified criteria, to be treated for the purposes of the tax treaty as being residents of only one country. Where a non-individual such as a company is resident in both countries for their domestic tax purposes, the entity will be deemed to be a resident of the country in which its place of effective management is situated. A special provision has been included to deem a participant in a 'dual listed company arrangement' to be resident only in the country of incorporation, provided that the participant has its primary stock exchange listing in the same country [Article 4, paragraphs 3 to 5].

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Income from real property may be taxed in full by the country in which the property is situated. Income from real property for these purposes includes natural resource royalties [Article 6].

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Business profits (including income derived from professional services or other activities of an independent nature) are generally to be taxed only in the country of residence of the recipient unless they are derived by a resident of one country through a branch or other prescribed permanent establishment in the other country, in which case that other country may tax the profits. These rules also apply to:

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business trusts; and

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payments for spectrum licences. [Article 7; Exchange of Notes, Item 7(a)]

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Profits from the operations of ships and aircraft are generally to be taxed only in the country of residence of the operator [Article 8].

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Profits of associated enterprises may be taxed on the basis of dealings at arm's length [Article 9].

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Dividends, interest and royalties may generally be taxed in both countries, but there are limits on the tax that the country in which the dividend, interest, or royalty is sourced may charge, on such income flowing to residents of the other country who are the beneficial owners of the income [Articles 10 to 12].

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In the case of dividends:

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no source country tax is payable on intercorporate dividends where the dividend recipient is a company that holds directly at least 80% of the voting power of the company paying the dividend, subject to certain conditions [Article 10, paragraph 3];

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a 5% rate limit applies to other intercorporate dividends where the dividend recipient is a company that holds directly at least 10% of the voting power of the company paying the dividend [Article 10, subparagraph 2(a )]; and

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a 15% limitation applies to all other dividends [Article 10, subparagraph 2(b)].

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The dividend rate limits apply to both franked and unfranked dividends.

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Source country taxation on interest is limited to 10% [Article 11, paragraph 2]. However, exemptions from source country taxation have been provided for interest paid to:

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certain government bodies [Article 11, subparagraph 3(a)]; and

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financial institutions [Article 11, subparagraph 3(b)].

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The rate limit on source country taxation of royalties is 5% [Article 12, paragraph 2].

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Income or gains from the alienation of real property may be taxed in full by the country in which the property is situated. Subject to that rule and other specific rules in relation to business assets and some shares, capital gains remain taxable in accordance with the domestic law of each country. A specific provision deals with the alienation of property by departing residents [Article 13].

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Income from employment, that is, employee's remuneration, will generally be taxable in the country where the services are performed. However, where the services are performed during certain short visits to one country by a resident of the other country, the income will be exempt in the country visited [Article 14]. The same principles apply to:

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the taxation of directors' remuneration;

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teaching income derived by visiting professors or teachers, (although transitional arrangements allow such professors or teachers to continue to access the special rules that applied under the existing treaty) [Article 29, paragraph 3]; and

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certain income or gains derived by employees from share option schemes [Exchange of Notes, Item 8].

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Fringe benefits that would otherwise be subject to tax in both countries, will be taxable only in the country which would have the primary taxing right if the benefit had been paid as ordinary employment income [Article 15].

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Income derived by entertainers and sportspersons may be taxed by the country in which the activities are performed [Article 16].

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Pensions and annuities (including for public service) may be taxed only in the country of residence of the recipient [Article 17].

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Income from government service will generally be taxed only in the country that pays the remuneration. However, the remuneration may be taxed in the other country in certain circumstances where the services are rendered in that other country by a resident of that other country [Article 18].

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Payments made from abroad to visiting students for the purposes of their maintenance or education will be exempt from tax in the country visited [Article 19].

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Other income (i.e. income not dealt with by other Articles) may generally be taxed in both countries, with the country of residence of the recipient providing double tax relief [Article 20].

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Source rules are prescribed in the new treaty to the effect that income or gains derived by a resident of the United Kingdom which, under provisions of the treaty, may be taxed in Australia, shall be treated as having an Australian source for Australian tax law purposes [Article 21].

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Double taxation relief for income which, under the tax treaty, may be taxed by both countries, is required to be provided by the country of which the taxpayer is a resident under the terms of the tax treaty as follows:

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in Australia, by allowing a credit for the United Kingdom tax against Australian tax payable on income derived by a resident of Australia from sources in the United Kingdom [Article 22, subparagraph 1(a )];

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in the United Kingdom, by allowing a credit against United Kingdom tax for the Australian tax paid on income or chargeable gains derived by a resident of the United Kingdom from sources in Australia [Article 22, subparagraph 2(a )]; and

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both Australia and the United Kingdom are required to give credit for underlying taxes on incoming non-portfolio intercorporate dividends should they tax such dividends [Article 22, subparagraphs 1(b ) and 2(b )].

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In the case of Australia, effect will be given to the double tax relief obligations arising under the tax treaty by application of the general foreign tax credit provisions of Australia's domestic law, or the relevant exemption provisions of that law where applicable.

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Limitations on the benefits that a country is obliged to provide, apply where income or gains are taxed in the other country on a remittance basis or where income or gains of temporary residents are exempted from tax [Article 23].

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Partnerships (other than Australian limited partnerships) are not persons covered by the treaty and neither country is prevented from taxing their resident partners on the partners' share of income or gains [Article 3, subparagraph 1(f ) and paragraph 2; Article 24].

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A Non-discrimination Article has been included that protects nationals from tax discrimination in the other country and gives them private rights of appeal. However, the Article does not preclude either country from applying its anti-avoidance rules (including thin capitalisation measures), research and development concessions, consolidation rules or capital gains deferral rules [Article 25; Exchange of Notes, Items 1(d ) and 9].

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Consultation and exchange of information between the two taxation authorities is authorised by the tax treaty. The treaty clarifies that information can be exchanged in relation to relevant transactions or chargeable periods, which predate the date that the treaty entered into force [Articles 26 and 27; Exchange of Notes, Item 10].

1.7 To ensure that the treaty continues to serve its purpose and remains aligned with current practice, the Governments of Australia and the United Kingdom have committed to consult at regular intervals of not more than five years regarding the treaty's terms, operation and application. [Exchange of Notes, Item 12]

Article 1 - Persons covered

Scope

1.8 This Article establishes the scope of the application of the tax treaty by providing for it to apply to persons (defined to include individuals, companies and any other body of persons but generally not including a partnership other than an Australian limited partnership) who are residents of one or both of the countries. It generally precludes extra-territorial application of the treaty.

1.9 The application of the tax treaty to persons who are dual residents (i.e. residents of both countries) is dealt with in Article 4 ( Residence ).

Article 2 - Taxes covered

Taxes covered

1.10 This Article specifies the existing taxes of each country to which the tax treaty applies. These are, in the case of Australia:

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the Australian income tax (including that imposed on capital gains);

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the resource rent tax in respect of offshore petroleum projects; and

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the FBT.

1.11 The new treaty extends the operation of the treaty to Australian tax on capital gains, which are not covered in the existing treaty. Its operation is also extended to cover Australia's FBT. Australia's tax treaty with New Zealand is the only other tax treaty at this time that covers Australian FBT. [Article 2, subparagraph 1(b )]

1.12 Although Australia considers the resource rent tax to be encompassed by the term 'Australian income tax', a specific reference to this has been included in the tax treaty to put beyond doubt that it is a tax covered. [Article 2, subparagraph 1(b )]

1.13 As with the existing treaty, the new treaty does not cover Australia's GST, wool tax and levies, customs duties, State taxes and duties and estate tax and duties.

1.14 It is specifically stated in both paragraphs of this Article that the tax treaty applies only to taxes imposed under the federal law of Australia. This is to ensure that the tax treaty does not bind Australian States and Territories and applies only to federal taxes. [Article 2, subparagraph 1(b ) and paragraph 2]

1.15 For the United Kingdom, the tax treaty applies to:

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the income tax;

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the corporation tax; and

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the capital gains tax.

[Article 2, subparagraph 1(a)]

1.16 The United Kingdom surtax that is included in the taxes covered by the existing treaty was abolished in 1973 and therefore has not been retained as a tax covered under the new tax treaty.

Identical or substantially similar taxes

1.17 The application of the tax treaty will be automatically extended to any identical or substantially similar taxes which are subsequently imposed by either country in addition to, or in place of, the existing taxes. The competent authorities (i.e. the Commissioner in Australia and the Commissioners of Inland Revenue in the United Kingdom, or their authorised representatives) are required to notify each other in the event of a significant change in the taxation law of the respective countries, within a reasonable period of time after those changes. [Article 2, paragraph 2]

Article 3 - General definitions

Definition of Australia

1.18 As with Australia's other modern tax treaties, Australia is defined to include certain external territories and areas of the continental shelf. By reason of this definition, Australia preserves its taxing rights, for example, over mineral exploration and mining activities carried on by non-residents on the seabed and subsoil of the relevant continental shelf areas (under section 6AA of the ITAA 1936, certain sea installations and offshore areas are to be treated as part of Australia). The definition is also relevant to the taxation by Australia and the United Kingdom of shipping profits in accordance with Article 8 ( Shipping and air transport ) of the tax treaty. [Article 3, subparagraph 1(b )] Definition of United Kingdom

1.19 The definition remains unchanged from that in the existing treaty. The defined term United Kingdom covers Great Britain and Northern Ireland (including areas of the continental shelf). As United Kingdom domestic law excludes British possessions (e.g. the Channel Islands of Alderney, Guernsey, Jersey and Sark, and the Isle of Man) from the domestic law definition of Great Britain and Northern Ireland, such possessions are implicitly also excluded from the definition of United Kingdom for treaty purposes. [Article 3, subparagraph 1(a )] Definition of person

1.20 The definition of person includes individuals, companies and any other body of persons. This would normally include a partnership (as a body of persons). However, the treaty with the United Kingdom specifically excludes partnerships, other than limited liability partnerships, from the definition of person. [Article 3, subparagraph 1(f )]

1.21 The exclusion of partnerships, other than limited liability partnerships, from the definition of person is aimed at removing any difficulties that might exist as a result of the decision of the United Kingdom courts in Padmore v Inland Revenue Commissioners (1989) Simon's Tax Cases 493. The treaty ensures that, as a partnership is not a person for treaty purposes, the partnership cannot be a resident of either country. Accordingly, such a partnership cannot be an 'enterprise of a Contracting State' or an 'enterprise of the other Contracting State'. However, the treaty will apply to the partners of such a partnership. The partners in a partnership, other than a limited liability partnership, may, to the extent they are persons and residents of a country, constitute an 'enterprise of a Contracting State' and may be taxed on their share of the partnership profits in accordance with the terms of the treaty.

1.22 Under Australian law, a general law partnership is treated as a resident of Australia for the purpose of calculating the partner's share of partnership income but is not itself a taxable unit. Accordingly, the partnership (as distinct from the partners) is not considered to be a resident of Australia for the purposes of Australian tax. It follows that, even without the specific exclusion of partnerships from the definition of person, a partnership would not be regarded as a resident of Australia for treaty purposes.

1.23 A limited liability partnership is treated as a company for Australian tax purposes where it is a resident of Australia. A limited liability partnership is a resident of Australia where it carries on business in Australia. As a taxable unit, a limited liability partnership will continue to be a 'person', a resident and an 'enterprise of a Contracting State' for the purposes of the treaty. [Article 3, paragraph 2] Definition of company

1.24 The definition of company in the tax treaty accords with Australia's tax treaty practice.

1.25 The Australian tax law treats certain trusts (public unit trusts and public trading trusts) and corporate limited partnerships (limited liability partnerships) as companies for income tax purposes. These trusts and partnerships are included as companies for the purposes of the tax treaty. [Article 3, subparagraph 1(g )] Definition of international traffic

1.26 In this tax treaty, this term is of relevance for taxation of profits from shipping and air transport operations (Article 8 ( Shipping and air transport )), income or gains from the alienation of ships and aircraft (paragraph 4 of Article 13 ( Alienation of property )) and wages of crew (paragraph 3 of Article 14 ( Income from employment )).

1.27 International traffic , as defined, covers international transport by a ship or aircraft operated by an enterprise of one country, as well as domestic transport within that country. However, it does not include transport where the ship or aircraft is operated solely between places in the other country, that is, where the place of departure and the place of arrival of the ship or aircraft are both in that other country, irrespective of whether any part of the transport takes place outside that country. For example, a 'voyage to nowhere' which begins and ends in Sydney on a ship operated by a United Kingdom enterprise would not come within the definition of international traffic, even if the ship travels through international waters in the course of the cruise. [Article 3, subparagraph 1(j )] Definition of tax

1.28 For the purposes of the tax treaty, the term tax does not include any amount of penalty or interest imposed under the respective domestic tax law of the two countries. This is important in determining a taxpayer's entitlement to a foreign tax credit under the double tax relief provisions of Article 22 ( Elimination of double taxation ) of the tax treaty.

1.29 In the case of a resident of Australia, any penalty or interest component of a liability determined under the domestic taxation law of the United Kingdom with respect to income that the United Kingdom is entitled to tax under the tax treaty, would not be a creditable 'United Kingdom tax' for the purposes of paragraph 1 of Article 22 ( Elimination of double taxation ). This is in keeping with the meaning of 'foreign tax' in subsection 6AB(2) of the ITAA 1936. Accordingly, such a penalty or interest liability would be excluded from calculations when determining the Australian resident taxpayer's foreign tax credit entitlement under paragraph 1 of Article 22 (pursuant to Division 18 of Part III of the ITAA 1936 - Credits in respect of Foreign Tax). [Article 3, subparagraph 1(n )] Clarification of other terms and phrases

1.30 Item 1 of the Notes clarifies the meaning of certain terms used in the treaty.

1.31 Australia and the United Kingdom agreed that for the purposes of applying the treaty, the terms (or phrases):

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income or gains includes profits;

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laws includes the full body of law (e.g. the common or general law) and is not limited to statutory law provisions; [Exchange of Notes, Items 1(a) and (b)];

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paid or credited and payments or credits do not include the recording of any internal transactions between a permanent establishment and another part of the same enterprise. This is consistent with Australia's reservation to Article 7 ( Business profits ) of the OECD Model that Australia does not recognise intra-entity transfers for tax purposes [Exchange of Notes, Item 1(c)]; and

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any provision of the laws of a Contracting State which is designed to prevent the avoidance or evasion of taxes is taken to include:

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measures designed to address thin capitalisation, dividend stripping and transfer pricing;

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controlled foreign company, transferor trust and foreign investment fund rules; and,

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measures designed to ensure that taxes can be effectively recovered.

[Exchange of Notes, Item 1(d)]

Terms not specifically defined

1.32 Where a term is not specifically defined within this tax treaty, or clarified in the Notes, that term (unless used in a context that requires otherwise) is to be taken to have the same interpretative meaning as it has under the domestic taxation law of the country applying the tax treaty at the time of its application, with the meaning it has under the taxation law of the country having precedence over the meaning it may have under other domestic laws.

1.33 It is recognised by both Australia and the United Kingdom that the same term may have a differing meaning and a varied scope within different Acts relating to specific taxation measures. For example, GST definitions are sometimes broader than income tax definitions. The definition more specific to the type of tax should be applied in such cases. For example, where the matter subject to interpretation is an income tax matter, but definitions exist in either the ITAA 1936 or the ITAA 1997 and the A New Tax System ( Goods and Services Tax ) Act 1999 , the income tax definition would be the relevant definition to be applied.

1.34 If a term is not defined in the tax treaty, but has an internationally understood meaning in tax treaties and a meaning under the domestic law, the context would normally require that the international meaning be applied. [Article 3, paragraph 2]

Article 4 - Residence

Residential status

1.35 This Article sets out the basis by which the residential status of a person is to be determined for the purposes of the tax treaty. Residential status is one of the criteria for determining each country's taxing rights and is a necessary condition for the provision of relief under the tax treaty. The concept of who is a resident according to each country's taxation law provides the basic test. [Article 4, paragraph 1]

Residency of Governments

1.36 The Article specifically provides that a country, a political subdivision or a local authority of the country are residents for the purposes of the treaty. This means that the Federal Government, the State Governments and local councils will be residents for the purpose of the treaty. This does not necessarily mean that income, profits or gains derived by these bodies from sources in the United Kingdom will be subject to tax in the United Kingdom as sovereign immunity principles may apply. [Article 4, paragraph 1]

1.37 The OECD Model commentary makes it clear that it has always been the understanding of member countries that the OECD Model applied to treat governments as residents even in the absence of an express reference to that effect.

1.38 The formulation for paragraph 1 (which incorporates the residency rules of the tax laws of each country) ensures that, even in the absence of a specific inclusion, Australian governments and tax-exempt entities are treated as residents for the purposes of the Agreement. This is because a government or tax-exempt entity is a resident of Australia for tax law purposes - even though it may be exempt from tax.

Special residency rules

1.39 Paragraph 2 specifies that a person is not a resident of a country (for purposes of the tax treaty) if that person is liable to tax in that State in respect only of income from sources in that State. This paragraph deals with a person who may be considered to be a resident of a State according to its domestic laws but is only subject to taxation on income from sources in that State, for example, foreign diplomatic and consular staff. In the Australian context, this means that Norfolk Island residents who are generally subject to Australian tax on Australian source income only, will not be residents of Australia for the purposes of the tax treaty. Accordingly, the United Kingdom will not have to forgo tax in accordance with the tax treaty on income derived by residents of Norfolk Island from sources in the United Kingdom (which will not be subject to Australian tax). [Article 4, paragraph 2]

Dual residents

1.40 This Article also includes a set of tie-breaker rules for determining how residency is to be allocated to one or other of the countries for the purposes of the tax treaty if a taxpayer, whether an individual, a company or other taxable unit, qualifies as a dual resident, that is, as a resident under the domestic law of both countries.

1.41 The tie-breaker rules for individuals apply certain tests, in a descending hierarchy, for determining the residential status (for the purposes of the tax treaty) of an individual who is a resident of both countries under their respective domestic laws.

1.42 These rules, in order of application, are:

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If the individual has a permanent home in only one of the countries, the person is deemed to be a resident solely of that country for the purposes of the tax treaty.

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If the individual has a permanent home available in both countries or in neither, then the person's residential status takes into account the person's personal or economic relations with Australia and the United Kingdom, and the person is deemed for the purposes of the tax treaty to be a resident only of the country with which the person has the closer personal and economic relations.

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Residency will be determined on the basis of an individual's citizenship or nationality where the foregoing test is not determinative.

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If the individual is a national (as defined) of both countries or of neither, the competent authority will endeavour to resolve the question by mutual agreement.

[Article 4, paragraph 3]

1.43 Dual residents remain, however, in relation to Australia, a resident for the purposes of Australian domestic law, and liable to tax as such in Australia, insofar as the tax treaty allows.

1.44 Where a non-individual (such as a body corporate) is a resident of both countries for their domestic tax purposes, the entity will be deemed to be a resident of the country in which its place of effective management is situated. [Article 4, paragraph 4]

Dual listed companies

1.45 Special rules are included in the treaty to deal with public companies where two such companies enter into a dual listed company arrangement . Where, as a consequence of entering into such an arrangement, a company becomes a dual resident then it will be deemed to be resident in the State in which the company is incorporated and has its primary stock exchange listing. [Article 4, paragraph 5]

1.46 The term dual listed company arrangement is defined exhaustively to refer to an arrangement consisting of two public companies which, while retaining their status as separate legal entities, seek to broadly operate as one company. While the companies retain separate shareholdings and stock exchange listings the arrangement provides for alignment of the strategic directions of the two companies involved and the economic interests of their respective shareholders. The treaty sets out various, cumulative criteria by which such an arrangement may be identified.

1.47 The criteria are:

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common (or almost identical) boards of directors for both companies;

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unified management;

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provision for the payment of equalised distributions as determined by an equalisation ratio (though this ratio may change over time) and applying to distributions on winding up of either company to this contractual arrangement;

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voting in effect as a single electorate on substantial issues; and

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cross-guarantees or similar financial arrangements to support each company's material ongoing financial obligations under the dual listing arrangement.

The final criterion does not apply to dual listed company arrangements where the companies which are a party to the arrangement are prevented from providing such guarantees or financial support under a regulatory framework applicable to one or both companies, for example, if providing such cross-guarantees would breach the Australian Prudential Regulation Authority's capital adequacy standards for approved deposit institutions. This definition closely aligns with that used in subsection 125-60(4) of the ITAA 1997. [Article 4, paragraph 6]

Article 5 - Permanent establishment

Role and definition

1.48 The application of various provisions of the tax treaty (principally Article 7 ( Business profits )) is dependent upon whether a person who is a resident of one country carries on business through a permanent establishment in the other country, and if so, whether income derived by that person is attributable to, or assets of that person are effectively connected with, that permanent establishment.

1.49 The definition of the term permanent establishment in this Article corresponds generally with definitions of the term in Australia's more recent tax treaties. The term also fully encompasses the concept of 'fixed base', which is used in the existing treaty in a separate Article dealing with independent personal services. As such services will now be dealt with under Article 7 ( Business profits ), it is intended that places that constitute a fixed base for purposes of the existing treaty would come within the meaning of permanent establishment for purposes of the new treaty. [Exchange of Notes, Item 2]

Meaning of permanent establishment

1.50 The primary meaning of permanent establishment is expressed as being a fixed place of business through which the business of an enterprise is wholly or partly carried on. To be a permanent establishment within the primary meaning of that term, the following requirements must be met:

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there must be a place of business;

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the place of business must be fixed (both in terms of physical location and in terms of time); and

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the business of the enterprise must be carried on through this fixed place.

[Article 5, paragraph 1]

1.51 Other paragraphs of this Article elaborate on the meaning of the term by giving examples (by no means intended to be exhaustive) of what may constitute a permanent establishment - for example:

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an office;

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a factory; or

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an agricultural property.

1.52 Consistent with Australia's modern treaty practice, the definition also extends to places relating to the exploitation of and exploration for natural resources.

1.53 As paragraph 2 of this Article is subordinate to paragraph 1 of this Article, the examples listed will only constitute a permanent establishment if the primary definition in paragraph 1 is satisfied. [Article 5, paragraph 2]

Agricultural, pastoral or forestry activities

1.54 Most of Australia's tax treaties include as a permanent establishment an agricultural, pastoral or forestry property. This reflects Australia's policy of retaining taxing rights over exploitation of Australian land for the purposes of primary production. This approach ensures that the arm's length profits test provided for in Article 7 ( Business profits ) applies to the determination of profits derived from these activities. This position is also reflected in this tax treaty. [Article 5, subparagraph 2(g )]

Deemed permanent establishment

Building site or construction or installation project

1.55 Under paragraph 3, an enterprise is deemed to have a permanent establishment and to be carrying on business through that permanent establishment in a country if it has a building site or construction or installation project in that country which exists for more than 12 months. [Article 5, subparagraph 3(a )]

Supervisory and consultancy activities

1.56 Supervisory and consultancy activities carried on for more than 12 months in connection with a building site or a construction or installation project are deemed to constitute a permanent establishment. This provision broadly aligns with Australia's reservation to Article 5 ( Permanent establishment ) of the OECD Model.

1.57 The term 'building site or construction or installation project' includes not only the construction of buildings but also the construction of roads, bridges or canals, the renovation (involving more than mere maintenance or redecoration) of buildings, roads, bridges or canals, the laying of pipelines and excavating and dredging. Planning and supervision are considered part of the building site if carried out by the construction contractor. However, planning and supervision carried out by another unassociated enterprise will not be taken into account in determining whether the construction contractor has a permanent establishment in Australia. [Article 5, subparagraph 3(a )]

Anti-avoidance provision

1.58 Given that this Article contains certain time frames, an anti-avoidance rule is included to ensure that where associated enterprises carry on connected activities the periods will be aggregated in determining whether the enterprises have a permanent establishment in the country in which the activities are being carried on. Activities will be regarded as connected where, for example, different stages of a single project are carried out by different subsidiaries within a group of companies.

1.59 This provision is an anti-avoidance measure aimed at counteracting contract splitting for the purposes of avoiding the application of the permanent establishment rules.

1.60 The treaty provides that an enterprise shall be deemed to be associated with another enterprise if one enterprise is controlled directly or indirectly by the other or if both are controlled directly or indirectly by a third person or persons. It also provides that a period of concurrent activities by such associated enterprises is only counted as one period for aggregation purposes. [Article 5, paragraph 4]

Substantial equipment

1.61 Under subparagraph 3(b), an enterprise shall be deemed to have a permanent establishment if it has substantial equipment in a country for rental or other purposes for longer than 12 months, unless the equipment is leased under a 'hire-purchase' agreement. Under Australian law, the lessee under a 'hire-purchase' agreement (a lease accompanied by certain lessee purchase options or rights) is broadly treated for tax purposes as the owner of the leased property.

1.62 This provision reflects Australia's reservation to the OECD Model concerning the use of substantial equipment and is designed to further protect Australia's right to tax income from natural resources. Australia's experience is that the permanent establishment provision in the OECD Model may be inadequate to deal with high value activities involved in the development of natural resources, particularly in offshore regions.

1.63 The meaning of the term 'substantial' depends on the relevant facts and circumstances of each individual case. However, some examples of substantial equipment would include:

•

large industrial earthmoving equipment or construction equipment used in road building, dam building or powerhouse construction;

•

manufacturing or processing equipment used in a factory;

•

oil and drilling rigs, platforms and other structures used in the petroleum/mining industry; and

•

grain harvesters and other large agricultural machinery.

1.64 For the purposes of the tax treaty the enterprise is deemed to carry on business through the substantial equipment permanent establishment. [Article 5, subparagraph 3(b )] Cost-toll operations

1.65 The inclusion of subparagraph 3(c) is consistent with another of Australia's reservations to the OECD Model. It deals with so-called 'cost-toll' situations, under which a mineral plant, for example, refines minerals at cost, so that the plant operations produce no Australian profits. Title to the refined product remains with the mining consortium and profits on sale are realised mainly outside of Australia.

1.66 Subparagraph 3(c) deems such a plant to be a permanent establishment because the manufacturing or processing activity (which gives the processed minerals their real value) is conducted in Australia, and therefore Australia should have taxing rights over the business profits arising from the sale of the processed minerals to the extent that they are attributable to the processing activity carried on in Australia. This subparagraph prevents an enterprise which carries on very substantial manufacturing or processing activities in a country through an intermediary from claiming that it does not have a permanent establishment in that country.

1.67 The inclusion of this subparagraph is insisted upon by Australia in its tax treaties and is consistent with Australia's policy of retaining taxing rights over profits from the exploitation of its mineral resources. [Article 5, subparagraph 3(c )]

Preparatory and auxiliary activities

1.68 Certain activities do not generally give rise to a permanent establishment (e.g. the use of facilities solely for storage, display or delivery).

1.69 Generally these activities are of a preparatory or auxiliary character and are unlikely to give rise to substantial profits. The necessary economic link between the activities of the enterprise and the country in which the activities are carried on does not exist in these circumstances.

1.70 Unlike the OECD Model, which provides that the listed activities are deemed not to constitute a permanent establishment, the tax treaty incorporates the Australian tax treaty approach of stating that an enterprise will not be deemed to have a permanent establishment merely by reason of such activities. This is to prevent the situation where enterprises structure their business so that most of their activities fall within the exceptions when - viewed as a whole - the activities ought to be regarded as a permanent establishment.

1.71 Another feature consistent with Australia's tax treaty practice is that subparagraph 4(f) of Article 5 ( Permanent establishment ) of the OECD Model - dealing with combinations of the activities of the kind referred to in subparagraphs 5(a) to 5(e) of this treaty - is not included. Australia does not consider that an enterprise undertaking multiple functions of the kind indicated in subparagraphs 5(a) to 5(e) could reasonably be regarded as only engaged in preparatory or auxiliary activities. [Article 5, paragraph 5]

Dependent agents

1.72 Paragraph 6 reflects Australia's tax treaty practice in relation to a person who acts on behalf of an enterprise of another country of deeming that person to constitute a permanent establishment if that person has and habitually exercises an authority to conclude contracts on behalf of the enterprise.

1.73 A person who substantially negotiates all essential parts of a contract on behalf of an enterprise will be regarded as exercising an authority to conclude contracts on behalf of that enterprise within the meaning of this provision, even if the contract is subject to final approval or formal signature by another person.

1.74 Consistent with the OECD Model and the United Kingdom's treaty practice, this paragraph excludes the excepted activities of paragraph 5 from the scope of dependent agency. Activities of a dependent agent will not give rise to a permanent establishment where that agent's activities are limited to the preparatory and auxiliary activities mentioned in paragraph 5. [Article 5, paragraph 6]

Independent agents

1.75 Business carried on through an independent agent will not, of itself, give rise to a permanent establishment, provided that the independent agent is acting in the ordinary course of that agent's business as such an agent. [Article 5, paragraph 7]

Subsidiary companies

1.76 Generally, a subsidiary company will not be a permanent establishment of its parent company. A subsidiary, being a separate legal entity, would not usually be carrying on the business of the parent company but rather its own business activities. However, a subsidiary company gives rise to a permanent establishment if the subsidiary permits the parent company to operate from its premises such that the tests in paragraph 1 of Article 5 are met, or acts as an agent such that a dependent agent permanent establishment is constituted. [Article 5, paragraph 8]

Article 6 - Income from real property

Where income from real property is taxable

1.77 This Article provides that the income of a resident of one country from real property situated in the other country may be taxed by that other country. Thus, income from real property in Australia will be subject to Australian tax laws. [Article 6, paragraph 1]

Definition

1.78 Income from real property (which is primarily defined as having the meaning which it has under the domestic law of the country where the property is situated) also extends to income from the direct use, letting or use in any form of real property including:

•

any other interest in or over land (including exploration and mining rights);

•

property accessory to real property;

•

livestock and equipment used in agriculture and forestry; and

•

usufruct of real property (generally, a right to use property without degrading it and to retain any profits derived from it).

1.79 Royalties and other payments relating to the exploration for, or exploitation of mines or quarries or other natural resources, or rights in relation thereto are also covered by the Article. However, ships and aircraft are excluded from the definition of real property, so this Article does cover income from their use. [Article 6, paragraph 2]

Deemed situs

1.80 Under Australian law the situation (situs) of an interest in land, such as a lease, is not necessarily where the underlying property is situated - there may not necessarily be a situs. This paragraph puts the situation of the interest or right beyond doubt by deeming the situs to be where the real property is situated or where any exploration may take place. [Article 6, paragraph 3]

Real property of an enterprise

1.81 Paragraph 5 extends the application of this Article to income derived from the use or exploitation of real property of an enterprise.

1.82 Accordingly, this Article (when read with Article 7 ( Business profits )) ensures that the country in which the real property is situated may impose tax on the income derived from that property by an enterprise of the other country, irrespective of whether or not that income is attributable to a permanent establishment of such an enterprise situated in the first-mentioned country. [Article 6, paragraph 5]

Article 7 - Business profits

1.83 This Article is concerned with the taxation of business profits derived by an enterprise that is a resident of one country from sources in the other country.

1.84 The taxing of these profits depends on whether they are attributable to the carrying on of a business through a permanent establishment in the other country. If a resident of one country carries on business through a permanent establishment (as defined in Article 5) in the other country, the country in which the permanent establishment is situated may tax the profits of the enterprise that are attributable to that permanent establishment. [Article 7, paragraph 1]

1.85 If an enterprise which is a resident of one country derives business profits in the other country other than profits attributable to a permanent establishment in that other country, the general principle of this Article is that the enterprise will not be liable to tax in the other country on its business profits (except where paragraph 6 of this Article applies - see the explanation in paragraphs 1.90 and 1.91).

Determination of business profits

1.86 Profits of a permanent establishment are to be determined for the purposes of this Article on the basis of arm's length dealing. The provisions in the tax treaty correspond to international practice and the comparable provisions in Australia's other tax treaties. [Article 7, paragraphs 2 and 3]

1.87 In respect of paragraph 3, no deductions are allowed in respect of expenses which would not be deductible if the permanent establishment were an independent enterprise which incurred the expense. [Exchange of Notes, Item 3(a )]

1.88 No profits are to be attributed to a permanent establishment merely because it purchases goods or merchandise for the enterprise. Accordingly, profits of a permanent establishment will not be increased by adding to them any profits attributable to the purchasing activities undertaken for the head office. It follows, of course, that any expenses incurred by the permanent establishment in respect of those purchasing activities will not be deductible in determining the taxable profits of the permanent establishment. [Article 7, paragraph 5]

Inadequate information

1.89 The domestic law of the country in which the profits are sourced (e.g. Australia's Division 13 of the ITAA 1936) may be applied to determine the tax liability of a person, consistently with the principles of the Article. This is of particular relevance where, due to inadequate information, the correct amount of profits attributable on the arm's length principle basis to a permanent establishment cannot be determined, or can only be ascertained with extreme difficulty. Paragraph 4 explicitly recognises the right of each country to apply its domestic law in these circumstances. This is consistent with Australia's reservation to Article 7 ( Business profits ) of the OECD Model. [Article 7, paragraph 4]

Profits dealt with under other Articles

1.90 Where income or gains are specifically dealt with under other Articles of the tax treaty, the effect of those particular Articles is not overridden by this Article.

1.91 This provision lays down the general rule of interpretation that categories of income or gains which are the subject of other Articles of the tax treaty (e.g. Article 8 ( Shipping and air transport ), Article 10 ( Dividends ), Article 11 ( Interest ), Article 12 ( Royalties ) and Article 13 ( Alienation of property )) are to be treated in accordance with the terms of those Articles (except where otherwise provided e.g. by paragraph 6 of Article 10 ( Dividends ) where the asset in respect of which the income is paid is effectively connected with a permanent establishment). [Article 7, paragraph 6]

Insurance with non-residents

1.92 Each country has the right to continue to apply any provisions in its domestic law relating to the taxation of income from insurance. However, if the relevant law in force in either country at the date of signature of the treaty is subsequently varied (otherwise than in minor respects so as not to affect its general character), the countries must consult with each other with a view to agreeing to any amendment of this paragraph that may be appropriate. An effect of this paragraph is to preserve, in the case of Australia, the application of Division 15 of Part III of the ITAA 1936 (Insurance with Non-residents). [Article 7, paragraph 7]

Trust beneficiaries

1.93 The principles of this Article will apply to business profits derived by a resident of one of the countries (directly or through one or more interposed trust estates) as a beneficiary of a trust estate other than a trust estate which is treated as a company for tax purposes. [Exchange of Notes, Item 3(b )]

1.94 In accordance with this Article, Australia has the right to tax a share of business profits, originally derived by a trustee of a trust estate (other than a trust estate that is treated as a company for tax purposes) from the carrying on of a business through a permanent establishment in Australia, to which a resident of the United Kingdom is beneficially entitled under the trust estate. Item 3(b) of the Notes ensures that such business profits will be subject to tax in Australia where, in accordance with the principles set out in Article 5 ( Permanent establishment ), the trustee of the relevant trust estate has a permanent establishment in Australia in relation to that business.

Article 8 - Profits from the operation of ships and aircraft

1.95 The main effect of this Article is that the right to tax profits from the operation of ships or aircraft in international traffic, including a share of profits attributable to participation in a pool, a joint business or an international operating agency, is generally reserved to the country in which the operator is a resident for tax purposes. [Article 8, paragraphs 1 and 4]

1.96 However, this Article reflects Australian treaty policy of reserving to the source country the right to tax profits from internal traffic and profits from other coastal and continental shelf activities, including non-transport shipping and aircraft activities, within its own waters and airspace. Profits derived by a United Kingdom enterprise from the operation of ships or aircraft, to the extent that they relate to operations confined solely to places in Australia, may thus be taxed in Australia. [Article 8, paragraph 2]

1.97 Australia's taxing rights are specifically preserved over profits from the carriage by ships or aircraft of passengers or cargo (including mail) where the passenger or cargo is shipped and discharged in Australia. [Article 8, subparagraph 5(a )]

Example 1.1

A ship operated by a United Kingdom enterprise, in the course of an international voyage from Southampton to Melbourne, makes a stop in Perth to pick up cargo. Profits derived from the transport of the goods loaded in Perth and discharged in Melbourne would be profits from operations confined solely to places in Australia. Australia would therefore have the right to tax the profits relating to such transport. Accordingly, 5% of the amount paid in respect of the transport of those goods would be deemed to be taxable income of the operator for Australian tax purposes pursuant to Division 12 of Part III of the ITAA 1936.

Example 1.2

A United Kingdom enterprise operates sightseeing flights to observe whales in the Southern Ocean. Passengers board the aircraft in Hobart and disembark at the same airport later on the same day. These operations would be regarded as operations confined solely to places in Australia, notwithstanding that the aircraft passes through international airspace. Australia would therefore have the right to tax the profits relating to the carriage of these passengers.

1.98 Operations involving the use of ships or aircraft, such as haulage, survey or dredging activities, or other activities relating to exploration or extraction of natural resources, that are undertaken in Australia (including coastal waters, the continental shelf areas and external territories) are also regarded as operations confined solely to places in Australia. [Article 8, subparagraph 5(b )]

1.99 Profits from leasing a ship or aircraft on a full basis (i.e. fully equipped, crewed and supplied) are treated in the same way as profits from the carriage of passengers and cargo. Such profits will generally be taxable only in the country of residence of the lessor, unless the ship or aircraft is used for operations confined solely to places in the other country. The Article extends exclusive residence country taxation to profits from bare-boat leases of ships or aircraft, and profits from the use, maintenance and rental of containers used for the transport of goods or merchandise, provided the rental or use is directly connected or ancillary to the operation by the enterprise of ships or aircraft in international traffic. [Article 8, paragraph 3]

1.100 Profits from the lease of ships, aircraft or containers, or from the use or maintenance of containers, that are not covered by Article 8 ( Shipping and air transport ) will come within the scope of Article 7 ( Business profits ). Source country taxation is only permitted under Article 7 ( Business profits ) to the extent that the profits are attributable to a permanent establishment in that country.

Article 9 - Adjustments to profits of associated enterprises

Reallocation of profits

1.101 This Article deals with associated enterprises (parent and subsidiary companies and companies under common control). It authorises the reallocation of profits between related enterprises in Australia and the United Kingdom on an arm's length basis where the commercial or financial arrangements between the enterprises differ from those that might be expected to operate between unrelated enterprises dealing wholly independently with one another.

1.102 This Article would not generally authorise the rewriting of accounts of associated enterprises where it can be satisfactorily demonstrated that the transactions between such enterprises have taken place on normal, open market commercial terms. Consistent with Australia's modern treaty practice, the inclusion of the expression 'dealing wholly independently with one another' in paragraph 1 recognises dealings on a truly independent basis as the appropriate benchmark for determining whether the transactions have taken place on normal, open market commercial terms. [Article 9, paragraph 1; Exchange of Notes, Item 4]

1.103 Australia's domestic law provisions relating to international profit shifting arrangements were revised in 1981 in order to deal more comprehensively with arrangements under which profits are shifted out of Australia, whether by transfer pricing or other means. The broad scheme of the revised domestic law provisions is to impose arm's length standards in relation to international dealings, but where the Commissioner cannot ascertain the arm's length consideration, it is deemed to be such an amount as the Commissioner determines.

1.104 Paragraph 2 of this Article specifically recognises the right of each country to apply its domestic law relating to the determination of the tax liability of a person (e.g. Australia's Division 13 of the ITAA 1936) to its own enterprises in cases where the available information is inadequate, provided that such provisions are applied, so far as it is practicable to do so, consistently with the principles of the Article. This reflects Australia's reservation to Article 9 ( Associated enterprises ) of the OECD Model. [Article 9, paragraph 2]

Correlative adjustments

1.105 Where a reallocation of profits is made (either under this Article or, by virtue of paragraph 2, under domestic law) so that the profits of an enterprise of one country are adjusted upwards, a form of double taxation would arise if the profits so reallocated continued to be subject to tax in the hands of an associated enterprise in the other country. To avoid this result, the other country is required to make an appropriate compensatory adjustment to the amount of tax charged on the profits involved to relieve any such double taxation.

1.106 It would generally be necessary for the affected enterprise to apply to the competent authority of the country not initiating the reallocation of profits for an appropriate compensatory adjustment to reflect the reallocation of profits made by the other treaty partner country. If necessary, the competent authorities of Australia and the United Kingdom will consult with each other to determine the appropriate adjustment. [Article 9, paragraph 3]

Article 10 - Dividends

1.107 This Article allocates taxing rights in respect of dividends flowing between Australia and the United Kingdom. The Article, in conjunction with the Notes, provides that:

•

certain cross-border intercorporate dividends will be either exempt or subject to a maximum 5% rate of source country tax;

•

a maximum 15% rate of source country tax may be applied on all other dividends;

•

dividends paid in respect of a holding which is effectively connected with a permanent establishment are dealt with under Article 7 ( Business profits ); and

•

the extra-territorial application by either country of taxing rights over dividend income is not permitted.

1.108 However, no such relief is available in cases that have been designed with a main purpose of taking advantage of this Article.

Permissible rate of source country taxation

Exemption for certain cross-border intercorporate dividends

1.109 No tax will be payable in the source country on dividends where a company that is the beneficial owner and is resident in the other country:

•

holds 80% or more of the voting power of the company paying the dividend; and

•

satisfies a 12 month holding requirement at the time of the declaration of the dividend in relation to the shares on which the dividend is payable.

[Article 10, paragraph 3]

1.110 To qualify for the exemption, the company that is the beneficial owner of the dividends must either be:

•

a company that has its principal class of shares;

-

listed on specified Australian or United Kingdom stock exchanges; and

-

regularly traded on one or more recognised stock exchanges (as defined under Article 3 ( General definitions ) of the treaty); or

•

a company that is owned either directly or indirectly by such a company.

1.111 Dividends which are beneficially owned by a company that does not meet the conditions in the previous paragraph will also be exempt from tax in the source country if the competent authority determines, in accordance with its domestic law, that the recipient company was established, acquired, or maintained for reasons other than obtaining benefits under the treaty. Before concluding that a company is not entitled to benefits under this subparagraph (e.g. because the arrangements had a principal purpose of obtaining such benefits), the competent authority is required to consult with the other competent authority. [Article 10, subparagraphs 3(a ) to ( c )]

1.112 For the purpose of the above tests, a recognised stock exchange includes:

•

in Australia's case, the Australian Stock Exchange or any other Australian stock exchange recognised under Australian domestic law; and

•

in the United Kingdom, the London Stock Exchange or any other investment exchange recognised under United Kingdom domestic law.

1.113 Under sub-subparagraph 1(o)(iii) of Article 3 (General definitions), provision has been made to allow the competent authorities to reach agreement that other exchanges constitute a recognised stock exchange for the purpose of the treaty. [Article 3, sub-subparagraph 1(o )( iii )]

1.114 The principal class of shares will generally be the ordinary or common shares of the company where such shares constitute the majority of both the voting power and value of the company. [Article 10, paragraph 8]

5% rate limit on source country tax of certain cross-border intercorporate dividends

1.115 This Article allows both countries to tax other dividends flowing between them but limits the rate of tax that the country of source may impose on dividends payable by companies that are residents of that country under its domestic law to residents in the other country who are the beneficial owners of the dividends. [Article 10, paragraphs 1 and 2]

1.116 A rate limit of 5% will apply for dividends paid in respect of company shareholdings that do not qualify for the intercorporate dividend exemption under paragraph 3 of this Article, but constitute a direct voting interest of at least 10%. [Article 10, subparagraph 2(a )]

15% rate limit for all other dividends

1.117 In all other cases, the treaty provides that the source country will generally limit its tax to 15% of the gross amount of the dividend. In the case of Australia, this will mean that the domestic rate of withholding tax imposed on unfranked dividends will be reduced from 30% to 15%. [Article 10, subparagraph 2(b )]

1.118 The above limits do not distinguish between franked and unfranked dividends. However, the dividend withholding tax exemption provided by Australia under its domestic law for franked dividends paid to non-residents will continue to apply.

Future changes to either country's domestic tax treatment of dividend

1.119 If there is a material change to either country's general approach to taxing dividends (e.g. a change to Australia's domestic law arrangements for franked dividends flowing overseas), the two countries are obliged to consult to consider whether any amendment to paragraphs 2 and 3 of this Article would be appropriate as a consequence of the change to domestic law. [Exchange of Notes, Item 5]

Dividends effectively treated as business profits

1.120 The limitation on the tax of the country in which the dividend is sourced does not apply to dividends derived by a resident of the other country who has a permanent establishment in the country from which the dividends are derived, if the holding giving rise to the dividends is effectively connected with that permanent establishment.

1.121 Where the holding is so effectively connected, the dividends are to be treated as business profits and therefore subject to the full rate of tax applicable in the country in which the dividend is sourced in accordance with the provisions of Article 7 ( Business profits ). In practice, however, under the full imputation system of company taxation in Australia's domestic law, such dividends, to the extent that they are franked dividends, remain exempt from Australian tax. Unfranked dividends that have the relevant connection with a permanent establishment in Australia will be subject to withholding tax at the rate of 15% instead of being taxed by assessment. [Article 10, paragraph 5]

Extra-territorial application precluded

1.122 The extra-territorial application by either country of taxing rights over both dividend income and undistributed profits is precluded. Broadly, one country (the first country) will not tax dividends paid by a company resident solely in the other country, unless:

•

the person deriving the dividends is a resident of the first country; or

•

the shareholding giving rise to the dividends is effectively connected with a permanent establishment in the first country.

1.123 For example, Australia may not tax dividends paid by a United Kingdom company to a resident of the United Kingdom out of profits derived from Australian sources, unless the United Kingdom shareholder has a permanent establishment in Australia with which the holding is effectively connected. Similarly, a country is precluded from imposing an undistributed profits tax on a company which is a resident of the other country, even if those undistributed profits arose in the first country. Australia does not impose an undistributed profits tax.

1.124 These preclusions do not apply when the company is a resident of both Australia and the United Kingdom for Australian tax purposes. [Article 10, paragraph 6]

Definition of dividends

1.125 The term dividends in this Article means income from:

•

shares or other rights which participate in profits and are not debt-claims;

•

corporate rights which are subject to the same taxation treatment as income from shares in the country of which the distributing company is resident; and

•

any other item that is treated as a dividend or company distribution by the laws of the country of which the paying company is a resident.

The inclusion of 'any other item which, ... , is treated as a dividend or distribution of a company' within the definition is consistent with the observation lodged by the United Kingdom to Article 10 ( Dividends ) of the OECD Model, which indicates that certain interest payments are treated as distributions under its domestic law and are therefore subject to the Dividends Article in preference to the Interest Article. [Article 10, paragraph 4]

Limitation of benefits

1.126 The source country rate limits and exemptions available under this Article will not apply where a creation or assignment of shares or other rights in respect of which dividends are paid, has been made with the main objective of, or one of the main objectives of accessing the relief otherwise available under this Article. [Article 10, paragraph 7]

Article 11 - Interest

1.127 This Article allocates taxing rights in respect of interest flows between Australia and the United Kingdom. The Article, in conjunction with the Notes, provides that:

•

an exemption from source country tax applies to cross-border interest flows to:

-

government bodies; and

-

financial institutions;

•

a maximum 10% rate of source country tax may be applied on all other interest income;

•

interest paid on an indebtedness which is effectively connected with a permanent establishment shall be subject to Article 7 ( Business profits );

•

interest payments are deemed to have an Australian source (and may therefore be taxed in Australia) where:

-

the interest is paid by an Australian resident to a United Kingdom resident;

-

the interest is paid by a non-resident to a United Kingdom resident and it is an expense of the payer in carrying on business in Australia through a permanent establishment; and

•

relief will be restricted to the gross amount of interest which would be expected to be paid on an arm's length dealing between independent parties.

1.128 However, no such relief is available in cases that have been designed with a main purpose of taking advantage of this Article.

Permissible rate of source country taxation

10% rate limit

1.129 This Article provides for interest income to be taxed by both countries but requires the country in which the interest arises to generally limit its tax to 10% of the gross amount of the interest where a resident of the other country is the beneficial owner of the interest. [Article 11, paragraphs 1 and 2]

Exemptions for interest paid to government bodies

1.130 The exemption for interest paid to government bodies reflects the principle of sovereign immunity and will apply to interest derived in the course of exercising governmental functions. It will not extend to interest derived by a government body from the conduct of a trade or business. Similar exemptions apply in a number of Australia's tax treaties. [Article 11, subparagraph 3(a )]

Exemptions for interest paid to financial institutions

1.131 The exemption for interest paid to financial institutions recognises that the agreed 10% withholding tax rate on gross interest can be excessive given their cost of funds. The exemption will also broadly align the treatment of interest paid to United Kingdom financial institutions with the Australian domestic law exemption for interest paid on widely distributed arm's length corporate debenture issues (section 128F of the ITAA 1936). [Article 11, subparagraph 3(b )]

1.132 The term financial institution means a bank or other enterprise substantially raising debt finance in the financial markets or by taking deposits at interest and using those funds in carrying on the business of providing finance. It does not include a corporate treasury or a member of a group that performs the financing services of the group. [Article 11, subparagraph 3(b ); Exchange of Notes, Item 6(b )]

1.133 The exemption will not be available for interest paid as part of an arrangement involving back-to-back loans or other arrangement that is economically equivalent and structured to have a similar effect. The denial of the exemption for these back-to-back loan type arrangements is directed at preventing related party and other debt from being structured through financial institutions to gain access to a withholding tax exemption. The exemption will only be denied for interest paid on the component of a loan that is considered to be back-to-back. [Article 11, paragraph 4]

1.134 A back-to-back arrangement would include, for instance, a transaction or series of transactions structured in such a way that:

•

a United Kingdom financial institution receives or is credited with an item of interest arising in Australia; and,

•

the financial institution pays or credits, directly or indirectly, all or substantially all of that interest (at any time or in any form, including commensurate benefits) to another person who, if it received the interest directly from Australia, would not be entitled to similar benefits with respect to that interest.

1.135 However, a back-to-back arrangement would generally not include a loan guarantee provided by a related party to a United Kingdom financial institution.

Definition of interest

1.136 The term interest is defined for the purposes of this Article to include income from debt-claims of every kind, including:

•

income from government securities;

•

income from bonds and debentures;

•

income from any other forms of indebtedness; and

•

any income that is subject to the same taxation treatment as income from monies lent in the country in which the interest arises.

1.137 The use of the term debt-claims in this Article of the treaty rather than the more commonly used 'indebtedness' in Australia's other treaties reflects the preferred tax treaty practice of the United Kingdom and is of no practical consequence for the purposes of Australian law. The two terms are intended to encompass the same kinds of debt.

1.138 Consistent with the United Kingdom's observation on Article 11 ( Interest ) of the OECD Model, the definition of 'interest' excludes any amount that satisfies the definition of 'dividend' under paragraph 4 of Article 10 ( Dividends ). Under United Kingdom domestic law, certain interest payments are treated as distributions and would therefore be dealt with under Article 10. [Article 11, paragraph 5]

Interest effectively treated as business profits

1.139 Interest derived by a resident of one country which is paid in respect of an indebtedness which is effectively connected with a permanent establishment of that person in the other country, will form part of the business profits of that permanent establishment and be subject to the provisions of Article 7 ( Business profits ). Accordingly, the rate limitation of 10% and the exemption for financial institutions do not apply to such interest in the country in which the interest is sourced. [Article 11, paragraph 6]

Deemed source rules

1.140 Interest source rules are set out in paragraph 7. Those rules operate to allow Australia to tax interest of which a resident of the United Kingdom is beneficial owner where the interest is paid by a resident of Australia. Australia may also tax interest paid by a non-resident, being interest which is beneficially owned by a United Kingdom resident, if it is an expense incurred by the payer of the interest in carrying on a business in Australia through a permanent establishment.

1.141 However, consistent with Australia's interest withholding tax provisions, an Australian source is not deemed in respect of interest that is an expense incurred by an Australian resident in carrying on a business through a permanent establishment outside both Australia and the United Kingdom (i.e. the permanent establishment is in a third country). [Article 11, paragraph 7; Exchange of Notes, Item 6(b )]

1.142 In determining whether a permanent establishment exists in a third country, the principles set out in Article 5 ( Permanent establishment ) apply.

Related persons

1.143 This Article includes a general safeguard against payments or credits of excessive interest where a special relationship exists between the persons associated with a loan transaction - by restricting the 10% source country tax rate limitation to an amount of interest which might have been expected to have been agreed upon if the parties to the loan agreement were dealing with one another at arm's length. Any excess part of the interest remains taxable according to the domestic law of each country but subject to the other Articles of the tax treaty. [Article 11, paragraph 8]

1.144 Examples of cases where a special relationship might exist include payments to a person (either individual or legal):

•

who controls the payer (whether directly or indirectly);

•

who is controlled by the payer; or

•

who is subordinate to a group having common interests with the payer.

1.145 It also covers relationships of blood or marriage and, in general, any community of interests.

'For whatever reason'

1.146 The words 'for whatever reason' in paragraph 8 of Article 11 were the subject of a former reservation by the United Kingdom to Article 11 ( Interest ) of the OECD Model. The inclusion of these additional words permits interest and other payments in respect of certain loans to be dealt with as distributions in a range of circumstances provided for in its domestic law, including those where the amount of the loan, or the rate of interest, or other terms relating to it are not what would have been agreed in the absence of a special relationship.

1.147 The addition of these words clarifies that this paragraph permits not only the adjustment of the rate at which interest is charged but also the reclassification of the excess interest in such a way as to give it the character of a distribution. The current OECD Model commentary to Article 11 ( Interest ) recognises that this addition is appropriate to enable recharacterisation of the excess interest. [Article 11, paragraph 8]

Limitation of benefits

1.148 The source country rate limit and exemptions available under this Article will not apply where a creation or assignment of the debt-claim in respect of which interest paid has been made with the main objective, or one of the main objectives, of accessing the relief otherwise available under this Article. [Article 11, paragraph 9]

Article 12 - Royalties

1.149 This Article allocates taxing rights in respect of royalties paid or credited between Australia and the United Kingdom. The Article, in conjunction with the Notes, provides that:

•

a maximum 5% rate of source country tax may be levied on the gross amount of the royalties;

•

royalties paid in respect of a right or property which is effectively connected with a permanent establishment are subject to Article 7 ( Business profits );

•

equipment royalties are not included within the definition of royalties and are subject to either Article 7 ( Business profits ) or Article 8 ( Shipping and air transport );

•

payments for spectrum licences are subject to Article 7 ( Business profits );

•

royalties are deemed to have an Australian source (and may therefore be taxed in Australia) where:

-

the royalties are paid by an Australian resident to a United Kingdom resident;

-

the royalties are paid by a non-resident to a United Kingdom resident and are an expense of the payer in carrying on business in Australia through a permanent establishment; and

•

relief will be restricted to the gross amount of royalties which would be expected to be paid on an arm's length dealing between independent parties.

1.150 However, no such relief is available in cases that have been designed with a main purpose of taking advantage of this Article.

Permissible rate of source country taxation

1.151 This Article in general allows both countries to tax royalty flows but limits the tax of the country of source to 5% of the gross amount of royalties beneficially owned by residents of the other country. [Article 12, paragraphs 1 and 2]

1.152 In the absence of a tax treaty, Australia taxes royalties paid to non-residents at 30% of the gross royalty.

1.153 The 5% rate limitation does not apply to natural resource royalties, which, in accordance with Article 6 (Income from real property), remain taxable in the country of source without limitation of the tax that may be imposed.

Definition of royalties

1.154 The definition of royalties in the tax treaty reflects most elements of the definition in Australia's domestic income tax law. It includes payments for the supply of scientific, technical, industrial or commercial know-how but not payments for services rendered, except as provided for in subparagraph 3(c). The definition also includes payments for the use of video or audio disks or any other means of image or sound reproduction or for transmission for use in connection with television, radio or other broadcasting (e.g. satellite and Internet broadcasting). [Article 12, paragraph 3]

1.155 Payments for the use of, or the right to use industrial, commercial or scientific equipment have been removed from the definition under the new treaty. Such amounts will either be treated as business profits under Article 7 ( Business profits ) or as profits from international transport operations (for certain leases of ships, aircraft and containers) under Article 8 ( Shipping and air transport ). The exclusion of payments for the use of equipment from the Royalties Article reflects common international tax treaty practice and recognises that source country taxation on a gross basis may be excessive given low profit margins.

1.156 The definition does not include payments made for the use of spectrum licences: Article 7 (Business profits) applies to such payments. [Exchange of Notes, Item 7(a )]

Payments for the supply of know-how versus payments for services rendered

1.157 It is considered that a German Supreme Court decision (Bundesfinanzhof (No. IR 44/67) of 16 December 1970) provides a definitive test to distinguish between a know-how contract and a contract for services. A know-how contract, it was held, involved the supply by a person of their know-how to the paying entity (e.g. teaching a personal expertise), whereas in a contract for services, although it may involve the use of know-how, that know-how is applied by the person in the performance of their services.

1.158 Payments for design, engineering or construction of plant or building, feasibility studies, component design and engineering services may generally be regarded as being in respect of a contract for services, unless there is some provision in the contract for imparting techniques and skills to the buyer.

1.159 In cases where both know-how and services are supplied under the same contract, if the contract does not separately provide for payments in respect of know-how and services, an apportionment of the two elements of the contract may be appropriate.

1.160 Payments for services rendered are to be treated under Article 7 ( Business profits ).

Forbearance

1.161 Consistent with Australian tax treaty practice, subparagraph 3(e) expressly treats as a royalty, amounts paid or credited in respect of forbearance to grant to third persons, rights to use property covered by this Article. This is designed to address arrangements along the lines of those contained in Aktiebolaget Volvo v Federal Commissioner of Taxation ( 1978 )
8 ATR 747 ;
78 ATC 4316 , where instead of amounts being payable for the exclusive right to use the property they were made for the undertaking that the right to use the property will not be granted to anyone else. This provision ensures that such payments are subject to tax as a royalty payment under the terms of the Royalties Article. [Article 12, subparagraph 3(e )]

Other royalties effectively treated as business profits

1.162 As in the case of interest income, it is specified that the withholding tax rate limitation does not apply to royalties paid in respect of property or rights which are effectively connected with a permanent establishment in the country in which the income is sourced - such income being subject to full taxation under Article 7 ( Business profits ). [Article 12, paragraph 4]

Deemed source rules

1.163 The royalties source rules provided for in the new treaty and the Notes effectively correspond, in the case of Australia, with the deemed source rule contained in section 6C (Source of royalty income derived by a non-resident) of the ITAA 1936 for royalties paid to non-residents of Australia. They broadly mirrors the source rule for interest income contained in paragraph 7 of Article 11 ( Interest ).

1.164 Consistent with Australia's royalty withholding tax provisions, royalty payments that are an expense incurred by an Australian resident in carrying on a business through a permanent establishment outside both Australia and the United Kingdom (i.e. the permanent establishment is in a third country) will not be subject to tax in Australia. [Article 12, paragraph 6; Exchange of Notes, Item 7(b )]

1.165 In determining whether a permanent establishment exists in a third country, the principles set out in Article 5 ( Permanent establishment ) apply.

Related persons

1.166 Where a special relationship exists between the payer and the beneficial owner of the royalties, the 5% source country tax rate limitation will apply only to the extent that the royalties are not excessive. Any excess part of the royalty remains taxable according to the domestic law of each country but subject to the other Articles of this tax treaty.

1.167 Examples of special relationships have been provided in respect of the corresponding paragraph in Article 11. [Article 12, paragraph 6]

Limitation of benefits

1.168 The source country rate limit available under this Article will not apply where a creation or assignment of the rights in respect of which royalties paid has been made with the main objective, or one of the main objectives of accessing the relief available under this Article. [Article 12, paragraph 7]

Article 13 - Alienation of property

Taxing rights

1.169 This Article, in conjunction with the Notes, allocates between the respective countries taxing rights in relation to income or gains arising from the alienation of real property and other items of property. [Article 13, paragraph 1]

1.170 The reference to 'income or gains' (which is specified in Item 1(a) of the Notes to include profits) in this Article is designed to put beyond doubt that a gain from the alienation of property which in Australia is income or a profit under ordinary concepts, will be taxed in accordance with this Article, rather than Article 7 ( Business profits ), together with relevant capital gains.

Real property

1.171 Income or gains from the alienation of real property may be taxed by the country in which the property is situated. For the purpose of this Article, the term real property has the same meaning as it has under paragraph 2 of Article 6. Where the property is situated is determined in accordance with paragraph 3 of Article 6. [Article 13, paragraphs 1, 7 and 8]

Permanent establishment

1.172 Paragraph 2 deals with income or gains arising from the alienation of property (other than real property covered by paragraph 1) forming part of the business assets of a permanent establishment of an enterprise. It also applies where the permanent establishment itself (alone or with the whole enterprise) is alienated. Such income or gains may be taxed in the country in which the permanent establishment is situated. This corresponds to the rules for taxation of business profits contained in Article 7 ( Business profits ). [Article 13, paragraph 2]

Disposal of ships or aircraft

1.173 Income or gains derived by a resident of a country from the disposal of ships or aircraft operated in international traffic, or of associated property (other than real property covered by paragraph 1), are taxable only in that country. This rule corresponds to the operation of Article 8 ( Shipping and air transport ) in relation to profits from the international operation of ships or aircraft. [Article 13, paragraph 3]

1.174 For the purposes of this Article, the term 'international traffic' does not include any transportation which commences at a place in a country and returns to that place or another place in that country, after travelling through international airspace or waters (e.g. so-called 'voyages to nowhere' by cruise ships). [Article 3, subparagraph 1(j )]

Shares and other interests in land-rich entities

1.175 Paragraph 4 applies to situations involving the alienation of shares or other interests in companies, and other entities, where the value of the assets is principally attributable to the real property situated in the other country. Income or gains from alienation of such shares or interests may be taxed by the country in which the real property is situated. This paragraph complements paragraph 1 of this Article and is designed to cover arrangements involving the effective alienation of incorporated real property , or like arrangements.

1.176 Such treatment applies whether the real property is held directly or indirectly through a chain of interposed entities. While not limited to chains of companies, or even chains of entities, only some of which are companies, the example of chains of companies is used to make clear that the corporate veil should be lifted in examining direct or indirect ownership.

1.177 This provision responds to the tax planning opportunities exposed by the decision of the Full Federal Court in the Commissioner of Taxation v Lamesa Holdings BV (1997)
77 FCR 597 . It is designed to protect Australian taxing rights over income or gains on the alienation or effective alienation of Australian real property (as defined) despite the presence of interposed bodies corporate or other entities. [Article 13, paragraph 4]

Exemption from former residence country taxation

1.178 Australia's law provides for taxation of individuals who cease to be a resident of Australia on gains arising from the deemed disposal of assets (other than those having the necessary connection with Australia) (subsections 104-165(2) and (3) of the ITAA 1997).

1.179 The taxation of unrealised gains can give rise to cash flow problems because proceeds from the gains are not available to pay the tax. Australia's domestic law provides relief by allowing departing individuals to defer tax on unrealised gains if they elect to treat assets to which the gains relate as having the necessary connection with Australia (subsections 104-165(2) and (3) of the ITAA 1997). The effect of the election is that a gain on the subsequent disposal of the property will be taxable in Australia even though the individual is not an Australian resident.

1.180 Paragraph 5 of this Article will provide an exemption from taxation in the former country of residence on gains in respect of which an individual has elected to defer taxation on ceasing to be a resident of that country, if the individual is a resident of the other country when the gains are crystallised. [Article 13, paragraph 5]

1.181 An individual departing Australia who defers tax by electing for an asset to have the necessary connection with Australia will, for instance, be exempt in Australia on a gain arising from a subsequent disposal of that asset if the individual is a resident of the United Kingdom at the time of the disposal. This will reduce compliance difficulties for departing residents, ensure post-residence change gains on foreign assets are not taxable in Australia and precludes the need to relieve double taxation.

1.182 Paragraph 5 will not affect the taxation of gains derived from the disposal of assets that, prior to a residence change, already have the necessary connection with Australia. A requirement of paragraph 5 is that an individual must elect to defer tax on a residence change gain. This requirement will not be satisfied for assets that have the necessary connection with Australia because there is no deemed disposal of these assets when an individual ceases to be an Australian resident. Australia may therefore continue to tax gains realised on the disposal of these assets.

1.183 Similarly, paragraph 5 will not affect the inclusion in assessable income of a discount on a qualifying share or right that has been deferred under an employee share acquisition scheme. Again, this is because there is no taxation deferred as a result of a residence change. Paragraph 5 could operate, however, to exempt gains accrued on shares after allocation where an individual ceases to be a resident of Australia and elects to defer the residence change gain.

Capital gains

1.184 This Article contains a sweep-up provision in relation to capital gains which enables each country to tax, according to its domestic law, any gains of a capital nature derived by its own residents or by a resident of the other country from the alienation of any property, except where different treatment is provided in the preceding paragraphs of the Article. Thus, except where Australia's right to tax capital gains is limited by the other paragraphs (e.g. paragraphs 3 and 5), the provision preserves the application of Australia's domestic law relating to the taxation of capital gains. Australia will thus continue to be able to tax, for instance, capital gains derived by United Kingdom residents on the disposal of Australian entities. [Article 13, paragraph 6]

United Kingdom residents - residence during a six year period prior to alienation of property

1.185 Paragraph 9 protects the United Kingdom taxing right in respect of income or gains from the alienation of any property of a person who is, or has been, a resident of the United Kingdom during the year in which the property is alienated or during the six years immediately preceding that year. [Article 13, paragraph 9]

Double tax relief

1.186 In the event that the operation of this Article should result in an item of income or gain being subjected to tax in both countries, the country of which the person deriving the income or gain is a resident (as determined in accordance with Article 4 ( Residence )) would be obliged by Article 22 ( Elimination of double taxation ) to provide double tax relief for the tax imposed by the other country.

Article 14 - Income from employment

Basis of taxation

1.187 This Article generally provides the basis upon which the remuneration of visiting employees is to be taxed. However this Article does not apply in respect of income that is dealt with separately in:

•

Article 15 (Fringe benefits);

•

Article 16 (Entertainers);

•

Article 17 (Pensions and annuities); and

•

Article 18 (Income from government service).

1.188 Generally, salaries, wages and similar remuneration derived by a resident of one country from an employment exercised in the other country may be taxed in that other country. However, subject to specified conditions, there is a conventional provision for exemption from tax in the country being visited where visits of only a short-term nature are involved. [Article 14, paragraphs 1 and 2]

Short-term visit exemption

1.189 The conditions for this exemption are that:

•

the period of the visit or visits does not exceed, in the aggregate, 183 days in any 12 month period commencing or ending in the fiscal year or year of income of the visited country;

•

the remuneration is paid by, or on behalf of, an employer who is not a resident of the country being visited; and

•

the remuneration is not deductible in determining taxable profits of a permanent establishment which the employer has in the country being visited.

1.190 Where all of these conditions are met, the remuneration so derived will be liable to tax only in the country of residence of the recipient. [Article 14, paragraph 2]

1.191 Where a short-term visit exemption is not applicable, remuneration derived by a resident of Australia from employment in the United Kingdom may be taxed in the United Kingdom. However, this Article does not allocate sole taxing rights to the United Kingdom in that situation.

1.192 Accordingly, Australia would also be entitled to tax that remuneration in accordance with the general rule of the ITAA 1997 that a resident of Australia remains subject to tax on worldwide income. However, in accordance with Article 22 ( Elimination of double taxation ) Australia would be required to in this situation relieve the double taxation.

1.193 Although that Article provides for the double tax relief to be provided by Australia to be in the form of the grant of a credit against the Australian tax for the United Kingdom tax paid, the exemption with progression method of providing double tax relief in relation to employment income derived in the situation described would normally be applicable in practice pursuant to the foreign service income provisions of section 23AG of the ITAA 1936. This method exempts the income from foreign employment from tax in Australia, but takes into account the foreign earnings when calculating the Australian tax on other assessable income the person has derived.

Employment on a ship or aircraft

1.194 Income from an employment exercised aboard a ship or aircraft operated in international traffic may be taxed in the country of which the enterprise operating the ship or aircraft is a resident. [Article 14, paragraph 3]

1.195 For the purposes of this Article, the term 'international traffic' does not include any transportation which commences at a place in a country and returns to that place or another place in that country, notwithstanding that the vessel travels through international waters (e.g. so-called 'voyages to nowhere' by cruise ships). [Article 3, subparagraph 1(j )]

Remuneration of company directors

1.196 The treatment provided under the Article for income from employment also applies to remuneration of a director of a company derived from a company. This provision is identical to paragraph 4 of Article 12 of the existing treaty. [Article 14, paragraph 4]

Exchange of Notes - Employee share option schemes

1.197 The Notes specifically address the treatment of income or gains derived by employees in relation to certain employee share option schemes where the options are granted in respect of an employment which is partly or wholly exercised in the other country. [Exchange of Notes, Item 8]

1.198 The Notes make it clear that the income or gains derived under employee share option plans are 'other similar remuneration' for the purposes of Article 14 ( Income from employment ). Such benefits accruing up until the time when the option is exercised will be treated as income from employment, and will therefore be subject to the rules in Article 14 of the treaty. Any increase in the value of any shares acquired as a result of the exercise of the options will fall for consideration under Article 13 ( Alienation of property ). [Exchange of Notes, Item 8(a )]

1.199 There is a rebuttable presumption that the period of employment to which the option relates is the period between the grant of the option and the date on which all the conditions for its exercise have been satisfied (the vesting of the option). It follows that, unless the facts indicate that the option was granted in respect of another period, the income or gains derived under the option - whenever derived - will be treated as remuneration from employment exercised during this period. [Exchange of Notes, Item 8(b )]

1.200 Where certain conditions are met, the Notes provide a rule for determining the part of the income or gain which should be treated as attributable to employment exercised in the other country. The conditions are:

•

the relevant period of employment is the period between grant and vesting of the option;

•

the employee remains in that employment at the date of alienation or exercise of the option; and

•

the employee, being a resident of one country, has exercised the employment in the other country at some time during the period between grant and vesting of the option.

1.201 If these conditions are met, then, for the purposes of Article 14, the amount of the income or gain that will be treated as attributable to employment exercised in one country (the employment country) by a resident of the other country (the residence country) will be calculated in accordance with the following formula:

1.202 The amount so calculated may be taxed in the employment country, regardless of when the benefit is treated as derived for purposes of the domestic law of that country and regardless of whether the benefit is characterised under that law as income or a capital gain. Thus, for example, if Australia is the employment country, Australia may tax the proportion of income or gain derived under an option attributable to employment exercised in Australia, irrespective of whether the relevant amount is included in the taxpayer's assessable income in the year in which the option is acquired, or is deferred until a later year in accordance with Division 13A of ITAA 1936. Where any benefit accruing prior to exercise of the option is taxed as a capital gain under Australia's domestic law (e.g. where the employee disposes of the option), then that part of the capital gain which is attributable to employment exercised in Australia may be taxed in Australia in accordance with the provisions of Article 14. [Exchange of Notes, Item 8(c )]

1.203 The option benefit may also be taxed in the residence country. Consistent with Article 22 ( Elimination of double taxation ), the tax on the proportion of the income or gain attributable to the employment country will be eligible for double tax relief in the residence country.

1.204 Where the above conditions are not satisfied, Article 14 continues to apply to the taxation of the option benefits. However, no method of apportionment is prescribed. In such cases, the matter could be resolved by the competent authorities of the two countries in accordance with Article 26 ( Mutual agreement procedure ).

Article 15 - Fringe benefits

1.205 This Article deals with fringe benefits which, in the absence of the Article, would be taxable in both Australia and the United Kingdom. Under this Article, the country which would have the primary taxing right if the benefit were ordinary employment income will have the sole taxing right in relation to the fringe benefit. This would generally be determined in accordance with Article 14 ( Income from employment ) or Article 18 ( Government service ). [Article 15, paragraph 1]

Definition of primary taxing right

1.206 This Article provides that the primary taxing right lies with the country that may, in accordance with the treaty, impose tax on the employment remuneration, being tax in respect of which the other country is required to provide relief under Article 22 ( Elimination of double taxation ). [Article 15, subparagraph 2(b )]

Example 1.3

A United Kingdom resident employee of a United Kingdom company is sent to work in Australia. The employee, who is present in Australia for more than 183 days, receives both employment income and fringe benefits. Under paragraph 1 of Article 14 ( Income from employment ), Australia has the right to tax the employment income. The United Kingdom may also tax but, under Article 22 ( Elimination of double taxation ), would be obliged to give credit for the Australian tax paid on the fringe benefit if it was ordinary employment income. Therefore, Australia would have the primary right to tax.

Operation of the provision in respect of fringe benefits tax law

1.207 Both Australia and the United Kingdom impose taxation on certain 'fringe' or employee benefits. In Australia, the relevant law is the Fringe Benefits Tax Assessment Act 1986 . Under the Fringe Benefits Tax Assessment Act 1986 , an employer who provides a fringe benefit to an employee or to an associate of an employee (which includes a family member) may have a FBT liability. FBT is separate from income tax and is calculated on the grossed-up taxable value of the fringe benefits provided. In the United Kingdom, many benefits provided to employees are taxed in the hands of the employee under the rules relating to earnings.

1.208 There may be circumstances in both countries where a resident of one country working in the other country would be liable to tax in both countries on the fringe benefit. Regardless of whether the benefit is taxed under the ordinary income tax law or under a separate enactment (as is currently the case in Australia), or whether the tax is liable to be paid by the employer or the employee, this Article will ensure that liability to tax on the fringe benefit will be taxed in only one of the countries.

Example 1.4

An Australian employee is seconded to the United Kingdom to work for the permanent establishment of his Australian resident employer for two months. During that time, the employer continues to pay the salary and provides the employee with a car that is available for the employee's use in the United Kingdom.

The employee remains an Australian resident and as such is taxable on his worldwide income. The employee's United Kingdom sourced remuneration from his employment is not exempt from Australian tax under section 23AG of the ITAA 1936 (because he is not employed in the United Kingdom for a continuous period of 91 days or more).

Accordingly, the employee is a person who receives (or is entitled to receive) payments subject to pay as you go withholding and an employer/employee relationship exists for the purposes of the Australian Fringe Benefits Tax Assessment Act 1986 . Therefore, the employer will be liable for FBT in Australia on the taxable value of the car fringe benefit.

The employee's United Kingdom sourced remuneration will also be subject to United Kingdom tax as the exemption from United Kingdom tax in respect of short visits provided for under paragraph 2 of Article 14 ( Income from employment ) is not available because the permanent establishment deducts the employee's remuneration in determining the taxable profits of the permanent establishment for the purposes of United Kingdom income tax. In the United Kingdom, the car fringe benefit may be taxed to the employee as ordinary employment income under the income tax system.

The fringe benefit is therefore taxable under the domestic law of both countries. However, under the terms of this Article, the taxing right over the benefit will be allocated solely to the United Kingdom as the United Kingdom has the primary taxing right over the employee's remuneration. Accordingly, no Australian FBT will be payable by the employer but the employee will be subject to tax in respect of the benefit in the United Kingdom under the United Kingdom's income tax system.

Definition of fringe benefit

1.209 Fringe benefit is given the meaning which it has under the Fringe Benefits Tax Assessment Act 1986 . A fringe benefit is a benefit that is provided to an employee or an associate of an employee in respect of the employment of the employee. Fringe benefits may include property, rights, privileges or services but payments of salary or wages, eligible termination payments or contributions to complying superannuation funds are excluded. For example, a fringe benefit is provided when an employer allows an employee to use a work motor vehicle for private purposes, gives an employee a subsidised loan, or pays an employee's private health insurance costs. Benefits arising from employee share option schemes are excluded from the treaty definition of fringe benefit. Such option benefits are treated as remuneration from employment for the purposes of Article 14 ( Income from Employment ). [Article 15, subparagraph 2(a )]

Article 16 - Entertainers and sportspersons

Personal activities

1.210 Under this Article, income derived by visiting entertainers (which has a reasonably wide meaning in international tax treaty usage) and sportspersons from their personal activities as such may be taxed in the country in which the activities are exercised, irrespective of the duration of the visit. The application of this Article extends to income generated from promotional and associated kinds of activities engaged in by the entertainer or sportsperson while present in the visited country. [Article 16, paragraph 1]

Safeguard

1.211 Paragraph 2 is designed to ensure that income in respect of personal activities exercised by an entertainer or sportsperson, where derived by another person (e.g. a separate enterprise which formally provides the entertainer's or sportsperson's services), is taxed in the country in which the entertainer or sportsperson performs, whether or not that other person has a permanent establishment in that country. [Article 16, paragraph 2]

Article 17 - Pensions and annuities

1.212 Pensions (including government pensions) and annuities (the term annuity as used in this Article is defined in paragraph 2) are taxable only by the country of which the recipient is a resident. The application of this Article extends to pensions and annuity payments made to dependants, for example, a widow, widower or children of the person in respect of whom the pension or annuity entitlement accrued where, upon that person's death, such entitlement has passed to that person's dependants. [Article 17, paragraphs 1 and 2]

Article 18 - Government service

Salary and wage income

1.213 Salary and wage type income, other than government service pensions or annuities, paid to an individual for services rendered in the discharge of governmental functions to a government (including a political subdivision or local authority) of one of the countries, is to be taxed only in that country. However, such remuneration will be taxable only in the other country if:

•

the services are rendered in that other country; and

•

the recipient is a resident of that other country, who is either:

-

a national of that country; or

-

did not become a resident of that other country solely for the purpose of rendering the services.

[Article 18, paragraph 1]

Business income

1.214 Remuneration for services rendered in connection with a trade or business carried on by any governmental authority referred to in paragraph 1 of this Article is excluded from the scope of the Article. Such remuneration will remain subject to the provisions of Article 14 ( Income from employment ), Article 15 ( Fringe benefits ) or Article 16 ( Entertainers and sportspersons ). [Article 18, paragraph 2]

Article 19 - Students

Exemption from tax

1.215 This Article applies to students who are temporarily present in one of the countries solely for the purpose of their education if the students are, or immediately before the visit were, resident in the other country. In these circumstances, payments from abroad received by the students solely for their maintenance or education will be exempt from tax in the country visited. This will apply even though the student may qualify as a resident of the country visited during the period of their visit.

1.216 The exemption from tax provided by the visited country is treated as extending to maintenance payments received by the student that are made for maintenance of dependent family members who have accompanied the student to the visited country.

Employment income

1.217 Where, however, a student from the United Kingdom who is visiting Australia solely for educational purposes undertakes any employment in Australia, for example:

•

some part time work with a local employer; or

•

during a semester break undertakes work with a local employer,

the income earned by that student as a consequence of that employment may, as provided for in Article 14 ( Income from employment ), be subject to tax in Australia. In this situation, the payments received from abroad for the student's maintenance or education will not, however, be taken into account in determining the tax payable on the employment income that is subject to tax in Australia. No Australian tax would be payable on the employment income if the student qualifies as a resident of Australia during the visit and the taxable income of the student does not exceed the tax-free threshold applicable to Australian residents for income tax purposes.

Article 20 - Other income

Allocation of taxing rights

1.218 This Article provides rules for the allocation between the two countries of taxing rights with respect to items of income not dealt with in the preceding Articles of the tax treaty. The scope of the Article is not confined to such items of income arising in one of the countries - it extends also to income from sources in a third country.

1.219 Broadly, such income derived by a resident of one country is to be taxed only in the country of residence unless it is from sources in the other country, in which case the income may also be taxed in the other country. This is consistent with Australia's reservation to Article 21 ( Other income ) of the OECD Model. [Article 20, paragraphs 1 and 3]

1.220 Where the income may be taxed in both countries in accordance with this provision, the country of residence of the recipient of the income is obliged by Article 22 ( Elimination of double taxation ) to provide double taxation relief.

1.221 This Article does not apply to income (other than income from real property as defined in paragraph 2 of Article 6 ( Income from real property )) where the right or property in respect of which the income is paid is effectively connected with a permanent establishment which a resident of one country has in the other country. In such a case, Article 7 ( Business profits ) will apply. [Article 20, paragraph 2]

Related persons

1.222 The paragraph restricts the operation of this Article in cases where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of other income paid exceeds the amount which would have been agreed upon by parties operating at arm's length. The paragraph generally mirrors paragraph 8 of Article 11 ( Interest ) and paragraph 6 of Article 12 ( Royalties ), and ensures that any excess part of the income remains taxable according to the domestic law of each country. However, other relevant provisions of the treaty, such as Article 22 ( Elimination of double taxation ), Article 23 ( Limitation of relief ), Article 26 ( Mutual agreement procedure ) and Article 27 ( Exchange of information ), will continue to apply to such income. [Article 20, paragraph 4]

Limitation of benefits

1.223 Relief from taxation which would otherwise be available under this Article will not apply where a creation or assignment of rights in respect of which the income is derived has been carried out with the main objective of, or one of the main objectives of, taking advantage of the relief available under this Article. [Article 20, paragraph 5]

Article 21 - Source of income

Deemed source

1.224 This Article effectively deems income or gains derived by a resident of the United Kingdom which, in accordance with the tax treaty, may be taxed in Australia, to have a source in Australia for the purposes of the tax law of Australia. It therefore avoids any difficulties arising under domestic law source rules in respect of the exercise by Australia of the taxing rights allocated to Australia by the tax treaty over income derived by residents of the United Kingdom.

Article 22 - Elimination of double taxation

1.225 Double taxation does not arise in respect of income flowing between Australia and the United Kingdom:

•

where the terms of the tax treaty provide for the income to be taxed only in one country; or

•

where the domestic taxation law of one of the countries exempts the income from its tax.

Tax credit

1.226 It is necessary, however, to prescribe a method for relieving double taxation for other classes of income or gains which, under the terms of the tax treaty, remain subject to tax in both countries. In accordance with international practice, Australia's tax treaties provide for double tax relief to be provided by the country of residence of the taxpayer by way of a credit basis of relief against its tax for the tax of the country of source. This Article also reflects that approach.

Australian method of relief

1.227 This Article requires Australia to provide Australian residents a credit against their Australian tax liability for United Kingdom tax paid in accordance with the tax treaty on income or gains derived from United Kingdom sources which are taxable in Australia. [Article 22, subparagraph 1(a )]

1.228 Where a dividend is paid by a United Kingdom company to an Australian resident company which controls 10% or more of the voting power in the United Kingdom company, this Article requires Australia to allow a credit for the underlying United Kingdom tax paid by the company paying the dividend (i.e. the tax paid on the portion of its profits out of which the dividend is paid). This credit is in addition to any credit allowable for the United Kingdom tax paid in respect of the dividends themselves. [Article 22, subparagraph 1(b )]

1.229 Australia's general foreign tax credit system, together with the terms of this Article and of the tax treaty generally, will form the basis of Australia's arrangements for relieving a resident of the United Kingdom from double taxation on income or gains arising from sources in the United Kingdom.

1.230 Accordingly, effect is to be given to the tax credit relief obligation imposed on Australia by paragraph 1 of this Article by application of the general foreign tax credit provisions (Division 18 of Part III) of the ITAA 1936.

1.231 This will include the allowance of underlying tax credit relief in respect of dividends paid by United Kingdom resident companies that are related to Australian resident companies, where that Australian resident company controls directly or indirectly not less than 10% of the voting power of the United Kingdom company, including for unlimited tiers of related companies, in accordance with the relevant provisions of the ITAA 1936 and the ITAA 1997.

1.232 Notwithstanding the credit basis of relief provided for by paragraph 1 of this Article, the exemption with progression method of relief will be applicable, as appropriate, in relation to salary and wages and like remuneration derived by a resident of Australia during a continuous period of foreign service (as defined in subsection 23AG(7) of the ITAA 1936) in the United Kingdom.

1.233 Dividends and branch profits derived in the United Kingdom by an Australian resident company that are exempt from Australian tax under the foreign source income measures (e.g. sections 23AH or 23AJ of the ITAA 1936) will continue to qualify for exemption from Australian tax under those provisions. As double taxation does not arise in these cases, the credit form of relief will not be relevant.

United Kingdom relief

1.234 In the case of a resident of the United Kingdom who is taxable in the United Kingdom on income or chargeable gains which are also taxable in Australia under this tax treaty, this Article requires the United Kingdom to allow the United Kingdom resident a credit for the amount of Australian tax paid on that income or chargeable gains. [Article 22, subparagraph 2(a )]

1.235 Where a dividend is paid by an Australian company to a United Kingdom company which controls 10% or more of the voting power in the Australian company, this Article requires the United Kingdom to allow a credit for the underlying Australian tax paid by the company paying the dividend (i.e. the tax paid on the portion of its profits out of which the dividend is paid). This credit is in addition to any credit allowable for the Australian tax paid in respect of the dividends themselves. [Article 22, subparagraph 2(b )]

Source of income - double taxation relief

1.236 Paragraph 3 of this Article deems income or gains of a resident of one country, to have a source in the other country for the purposes of paragraph 1 and 2 of this Article, where the income or gains may be taxed in that other country under the rules contained in the tax treaty.

1.237 This provision is variously included in Article 21 ( Source of income ) or Article 22 ( Elimination of double taxation ) of Australia's tax treaties and has the operative effect of ensuring that where an item of income or gain is taxable in both countries, double taxation relief will be given by the recipient's country of residence in accordance with paragraphs 1 and 2 of this Article. In this way, income or gains derived by a resident of Australia, which is taxable by the United Kingdom under this treaty, will be treated as being foreign income for the purposes of the ITAA 1936 and the ITAA 1997, including the foreign tax credit provisions of the ITAA 1936. [Article 22, paragraph 3]

Article 23 - Limitation of relief

1.238 The treaty provides that where income or gains derived by a resident of a country are taxed in that country only to the extent that such income or gains are remitted to the country, then any relief (such as exemption from taxation or reduction in tax rates) that the other country may be required to provide under the treaty will only apply to the amount remitted. [Article 23, paragraph 1]

1.239 The United Kingdom operates a remittance-based system in respect of the income of taxpayers who are resident but not ordinarily resident in the United Kingdom. Under the United Kingdom's domestic law, such taxpayers are only subject to tax in the United Kingdom on the amount actually remitted to the United Kingdom. An example of the operation of this Article might be where only half of a dividend is remitted to the United Kingdom. In these circumstances, as the recipient is taxed in the United Kingdom only on that part of the dividend that is remitted to the United Kingdom, Australia would only be called on to limit its tax to the appropriate tax rate limitation specified in the treaty on half the dividend.

1.240 The treaty also provides that where an individual is a temporary resident of a country and is, for that reason, exempt from tax in that country on certain income or gains in that country, then the other country will not be required to provide any relief specified in the treaty in respect of such income or gains. [Article 23, paragraph 2]

Article 24 - Partnerships

1.241 This provision is a complementary measure to the exclusion of a general law partnership from the definition of 'person' (see subparagraph 1(f) of Article 3 ( General definitions )). It seeks to address possible implications of the decision in Padmore v Inland Revenue Commissioners (1989) Simon's Tax Cases 493 by ensuring that a country is not prevented from taxing a partner who is resident in that State on the partner's share of the income or gains of a partnership.

1.242 This Article clarifies that where a partnership is subject to tax as a resident of one country and income or gains derived in the other country are relieved from tax in that country under the treaty, the latter country may nevertheless tax any resident partner on their share of the partnership income or gains. However, the country of residence of the partner is required under Article 22 ( Elimination of double taxation ) to provide relief for tax imposed on that income or those gains in the other country. For this purpose, the income or gains are deemed to have a source in the country of which the partnership is a resident. [Article 24]

Article 25 - Non-discrimination

1.243 Australia has to date only ever agreed to the inclusion of a Non-discrimination Article in its tax treaty with the United States (i.e. Article 23 ( Non-discrimination ) of Schedule 2 to the Agreements Act). The Non-discrimination Article in the United States treaty has limited operation, not having been given the force of law in Australia. Accordingly, it does not confer on taxpayers private rights of appeal.

1.244 Recommendation 22.22 of A Tax System Redesigned proposed that Non-discrimination Articles be agreed to in future Australian tax treaties. The new United Kingdom tax treaty gives effect to this recommendation. It will provide private rights of appeal for those coming within its terms.

1.245 The Australian tax system is generally non-discriminatory and as such it has not been seen as necessary in the past to include a Non-discrimination Article in Australia's tax treaties. As part of Australia's first such Article which provides taxpayers with private rights of appeal, it was agreed that certain pillars of the tax systems of Australia and the United Kingdom should not be seen as coming within the Article's terms. The measures identified can be characterised as being an integral part of today's administration of a country's economic and tax policy and the collection of its taxes. As such it has been recognised that the measures carved out do not offend the spirit or intendment of a Non-discrimination Article based on the OECD Model Article 24 ( Non-discrimination ).

Discrimination based on nationality

1.246 This Article prevents discrimination on the grounds of nationality by providing that nationals of one country may not be less favourably treated than nationals of the other country in the same circumstances. [Article 25, paragraph 1]

1.247 The discrimination that the Article precludes applies to both taxation and any requirement connected therewith. Accordingly, discrimination in the administration of the tax law is also precluded.

1.248 The term national is defined under Article 3 ( General definitions ) of the tax treaty and covers both individuals who are citizens of one country or the other and companies which 'derive their status as such from the laws in force in a country'. Accordingly, a company that is incorporated in Australia would be a national of Australia while a company that is incorporated or otherwise constituted under a law of the United Kingdom would be a national of the United Kingdom for the purposes of this paragraph. [Article 3, subparagraph 1(l )]

1.249 The term national also includes in the case of Australia any individual who has been granted permanent residency status. This provision covers those individuals who reside in Australia for extended periods of time without taking out Australian citizenship, for example, the holder of a permanent visa under the Migration Act 1958 .

In the same circumstances/in particular with respect to residence

1.250 The expression 'in the same circumstances' refers to persons who, from the point of the application of the ordinary taxation laws and regulations, are in substantially similar circumstances both in law and in fact.

1.251 Where a person operates in an industry that is subject to government regulation such as prudential oversight, another person operating in the same industry but not subject to the same oversight, would not be in the same circumstances.

1.252 The inclusion of the further clarification 'in particular with respect to residence' makes clear that the residence of the taxpayer is one of the factors that are relevant in determining whether taxpayers are placed in similar circumstances. Therefore, different treatment accorded to a United Kingdom resident compared to an Australian resident will not constitute discrimination for purposes of this Article. A potential breach of paragraph 1 of this Article only arises if two persons who are residents of the same country are treated differently solely by reason of one being a national of Australia and the other a national of the United Kingdom.

Other or more burdensome

1.253 The words 'more burdensome' taxation refer to the quantum of taxation while 'other' taxation may refer to some form of income tax other than the form of income tax to which a national of the country is subject ( Woodend Rubber Co. v Commissioner of Inland Revenue [1971] A.C. 321 at 332).

1.254 The phrase is also applicable to administrative or compliance requirements that a taxpayer may be called upon to meet where those requirements differ based on nationality grounds.

Non-residents of Australia/United Kingdom

1.255 Unlike paragraph 1 of Article 24 ( Non-discrimination ) of the OECD Model, paragraph 1 of this Article does not apply to persons who are not residents of either Australia or the United Kingdom. It follows that residents of third countries cannot seek the benefits of this provision. The provision also does not extend to residents of either country who are not nationals (as defined in Article 3 ( General definitions )) of either country.

Non-discrimination and permanent establishments

1.256 Paragraph 2 of this Article provides that the tax on permanent establishments of enterprises of the other country shall not be levied less favourably than on the country's own enterprises carrying on the same activities in similar circumstances. This provision applies to all residents of a treaty country, irrespective of their nationality, who have a permanent establishment in the other country. [Article 25, paragraph 2]

1.257 Unlike paragraph 2 of Article 24 ( Non-discrimination ) of the OECD Model, paragraph 2 of this Article contains the additional proviso that, for this paragraph to apply, the enterprises of both countries must be 'in similar circumstances'. Therefore, the comparison must be made between a permanent establishment and local enterprises which are not only carrying on the same activities but are also carrying on those activities 'in similar circumstances'. This is to address situations where resident and non-resident enterprises may be carrying on the same activities but the circumstances in which they do so are very different. For example, one may be conducting dealings on a non-arm's length basis and the other on an arm's length basis. The provision recognises that appropriate differences in taxation treatment are not precluded because of the differing circumstances.

1.258 Permanent establishments of non-resident enterprises may be treated differently from resident enterprises as long as the treatment does not result in more burdensome taxation for the former than for the latter. That is, a different mode of taxation may be adopted with respect to non-resident enterprises, to take account of the fact that they often operate in different conditions to resident enterprises. The provision would not affect, for example, domestic law provisions that tax a non-resident by withholding, provided that calculation of the tax payable is not greater than that applying to a resident taxpayer.

Deductions paid to non-residents

1.259 Paragraph 3 of this Article requires the treaty partner countries to allow the same deductions for interest, royalties and other disbursements paid to residents of the other country as it does for payments to its own residents. However, the paragraph allows the treaty countries to reallocate profits between related enterprises on an arm's length basis under Article 9 ( Associated enterprises ) and to limit deductions in accordance with paragraph 8 or 9 of Article 11 ( Interest ), paragraph 6 or 7 of Article 12 ( Royalties ) or paragraph 4 or 5 of Article 20 ( Other income ). [Article 25, paragraph 3]

Companies owned or controlled abroad

1.260 Paragraph 4 of this Article prevents a country from giving less favourable treatment to an enterprise, the capital of which is owned or controlled, wholly or partly, directly or indirectly, by one or more residents of the other country. That is, Australian companies owned or controlled by United Kingdom residents may not be given less favourable treatment than locally owned or controlled Australian companies. [Article 25, paragraph 4]

1.261 Differential tax treatment based on residency is not affected by this paragraph. Nor does the paragraph require the same treatment of non-resident shareholders in the company as resident shareholders. Accordingly, there is no obligation under this provision or any other provision of the Article to allow imputation credits to non-resident shareholders. This position is made explicit in the Notes. [Exchange of Notes, Item 9(b )]

1.262 In relation to paragraph 4 of this Article, the Notes provides that a reference to capital being owned or controlled 'directly or indirectly' is to be taken as including cases where the capital is held through a chain of companies or other entities. [Exchange of Notes, Item 9(a )]

Exclusions

1.263 Non-resident individuals do not have to be granted the personal allowances, reliefs or reductions available to residents of the tax treaty countries. [Article 25, paragraph 5]

1.264 This means that Australia will continue to be able to tax non-resident individuals according to a different tax rate scale to residents.

1.265 Unlike paragraph 3 of Article 24 ( Non-discrimination ) of the OECD Model, paragraph 5 of this Article is not just limited to those benefits conferred by a country relating to civil status or family responsibilities of the individual. For Australian tax purposes, it also extends, for example, to the tax-free threshold which may be considered not to be based either on civil status or family responsibilities.

1.266 Paragraph 6 of this Article excludes from the operation of the Article certain provisions of the law of both countries that are important for purposes of economic regulation and integrity of the tax system. Although most are generally recognised by the international community as not being discriminatory, the specific exclusion of these provisions will ensure that they can continue to operate for their intended purpose. The provisions of the law of Australia and the United Kingdom to be excluded are those that:

•

prevent the avoidance or evasion of taxes;

•

defer tax where an asset is transferred out of the jurisdiction;

•

provide for consolidation of group entities;

•

provide for deductions for research and development expenditure;

•

are agreed in an Exchange of Notes between the two Governments to be unaffected by the Article.

[Article 25, paragraph 6]

Avoidance or evasion provisions

1.267 Subparagraph (6)(a) of this Article ensures that the operation of domestic measures to combat avoidance and evasion is not affected by this Article. The Notes provide that the reference to laws designed to prevent avoidance or evasion of taxes includes thin capitalisation, dividend stripping, transfer pricing and controlled foreign company, trust and foreign investment fund provisions. Although it is commonly accepted by most OECD member countries that such provisions do not contravene Non-discrimination Articles, this outcome is specifically provided for in this treaty by the exclusion of such rules from the operation of this Article. [Exchange of Notes, Item 1(d )]

1.268 The Notes also provide that references in the treaty to laws of a country 'designed to prevent the avoidance or evasion of taxes' covers measures designed to ensure that taxes can be effectively recovered (conservancy measures). [Exchange of Notes, Item 1(d )( iii )]

1.269 The enforcement and operation of the various aspects of the withholding tax provisions relating to non-residents are preserved by the operation of this provision. For example, section 221YRA ( Recovery of amounts by the Commissioner ) of the ITAA 1936 provides that where interest or royalties are paid to a non-resident and the payer fails to deduct withholding tax that the interest or royalty cannot be claimed as a deduction. No similar measure exists in relation to payments from a resident to another resident.

Capital gains roll-over relief

1.270 This Article will not affect the operation of any provision of domestic tax legislation which does not permit the deferral of tax arising on the transfer of an asset where the transfer of the asset by the transferee would take the asset beyond the taxing jurisdiction of the country. [Article 25, subparagraph 6(b )]

1.271 Under Australia's domestic tax legislation permanent establishments generally enjoy the same tax treatment as resident enterprises. However, roll-over relief is denied to a permanent establishment where an asset with the necessary connection with Australia is transferred to a non-resident if the asset is not an asset with the necessary connection with Australia in the hands of the transferee. Subparagraph 6(b) ensures that Australia will be able to continue to deny roll-over relief in these circumstances.

Consolidation

1.272 Domestic law rules which provide for single entity treatment of a group of entities are excluded from the operation of this Article, provided that there is no discrimination regarding access to consolidation treatment between Australian resident companies on the basis of ownership of the company.

1.273 The Business Tax Reform consolidation measures are restricted to wholly-owned Australian resident groups. The Article will not apply to these measures, with the result that domestic law provisions continue to operate to preclude permanent establishments of non-resident companies from consolidating with resident entities that may be wholly-owned by a non-resident. [Article 25, subparagraph 6(c )]

Research and development expenditure

1.274 The domestic law research and development provisions are excluded from the operation of this Article. It follows that Australia will be able to continue to apply its domestic law rules concerning access to concessions in respect of research and development expenditure. Currently, these concessions are only available to companies that are incorporated in Australia. [Article 25, subparagraph 6(d )]

Power to carry out an Exchange of Notes

1.275 Subparagraph 6(e) of this Article provides a mechanism for the two Governments to exclude other provisions of domestic law from the operation of the Article. The two Governments may agree in an Exchange of Notes that other domestic law provisions will not be affected by the requirements of the Article. [Article 25, subparagraph 6(e )]

Taxes to which the Non-discrimination Article applies

1.276 Paragraph 7 of this Article provides that this Article shall only apply to taxes which are covered by the tax treaty as specified in Article 2 ( Taxes covered ). [Article 25, paragraph 7]

1.277 In the case of Australia, the relevant taxes are the income tax (including the petroleum resource rent tax and tax on capital gains) and the FBT. Other federal taxes, such as the GST, are not affected by this Article. The provisions of this Article also do not apply to taxes imposed by the Australian States and Territories (see also commentary to Article 2 ( Taxes covered )).

More favourable treatment

1.278 Nothing in this Article prevents either country from treating residents of the other country more favourably than its own residents.

Article 26 - Mutual agreement procedure

Consultation on specific cases

1.279 This Article provides for consultation between the competent authorities of the two countries with a view to reaching a solution in cases where a person is able to demonstrate actual or potential imposition of taxation contrary to the provisions of the tax treaty. [Article 26, paragraph 2]

1.280 A person wishing to use this procedure may present a case to the competent authority of the country of which the person is a resident. If the case comes under paragraph 1 of Article 25 ( Non-discrimination ) of this tax treaty, the person must present a case to the competent authority of the country of which the person is a national. Presentation of a case by a person to a competent authority does not deprive them of access to, or affect their rights in relation to, other legal remedies available under the domestic laws of the countries. [Article 26, paragraph 1]

1.281 If, after consideration by the competent authorities, a solution is reached, it shall be implemented, subject to the domestic law time limits of each country.

Time limits

Presentation of the case

1.282 Unlike most Australian tax treaties, this Article does not specify a time limit within which a case must be presented to the competent authority. Generally, Australian tax treaties provide that the case must be presented within three years from the first notification of the action resulting in taxation not in accordance with the provisions of the treaty.

1.283 The omission of this sentence from the paragraph 1 of this Article means that a taxpayer wishing to make use of this procedure must present their case to the competent authority of the country of which the person is a resident, or of which they are a national, within the time period stipulated under the domestic law of the country of residence or nationality. The applicable time limits under domestic law need not specifically refer to the competent authority process. [Article 26, paragraph 1; Exchange of Notes, Item 11]

1.284 In the case of an Australian resident or national, the objection process under section 175A of the ITAA 1936 and the time limits prescribed under Division 3 of Part IVC of the Taxation Administration Act 1953 will apply. The time for lodging an objection is generally four years from the date of assessment. An Australian resident or national may also lodge a request for an extension of time to lodge an objection under section 14ZX of the Taxation Administration Act 1953 . These time limits will also apply for the purpose of presenting a case to the Australian competent authority under this Article.

1.285 The omission of this sentence was agreed to by Australia on the basis of the United Kingdom's consistent treaty practice. The United Kingdom has lodged a reservation to Article 25 ( Mutual Agreement Procedure ) of the OECD Model that reserves the United Kingdom's position on the inclusion of the sentence on the grounds that the three year limit conflicts with the longer six year limit prescribed by its domestic law.

Implementation of a solution

1.286 No time limit is specified for implementation of any solution reached between competent authorities. This is a departure from Australia's usual treaty practice of including at the end of paragraph 2 an additional sentence which provides that the solution so reached shall be implemented notwithstanding any time limits in the domestic laws of the tax treaty countries.

1.287 The omission of this sentence from paragraph 2 of this Article means in Australia's case, that the normal domestic time limits contained in section 170 ( Amendment of assessments ) of the ITAA 1936 would apply to the implementation of any solution reached by the competent authorities.

1.288 In practice, the absence of a specific provision in the Article to override Australian domestic law time limits on amendments has no material effect on the Commissioner's ability to implement a solution reached on a transfer pricing case with a treaty partner (administrative practice for the implementation of a solution in transfer pricing cases is summarised at paragraphs 4.30 to 4.35 of Taxation Ruling TR 2000/16 (Income tax: international transfer pricing - transfer pricing and profit reallocation adjustments, relief from double taxation and the Mutual Agreement Procedure)).

1.289 The time limits under Australian domestic tax law for implementation of a solution in non-transfer pricing cases are either four years from the date of assessment or two years in the case of a shorter period of review taxpayer as defined in section 6AD of the ITAA 1936 for an amendment to effect a reduction in a taxpayer's liability (subsection 170(3) of the ITAA 1936). However, if the taxpayer lodges an objection to their assessment within the required time, their assessment can be amended at any time to give effect to a successful objection (subsection 170(7) of the ITAA 1936).

1.290 While the lodging of an objection to an assessment in Australia is not a condition for access to the mutual agreement procedure process, by doing so, either within:

•

the prescribed time limits for lodgment; or

•

such later period as the Commissioner allows,

the person can ensure that, if a solution is reached between competent authorities on their non-transfer pricing case, the solution can be implemented in Australia, notwithstanding the absence of a specific provision in the Article to override Australian domestic law time limits on amendments.

1.291 The omission of the sentence concerning time limits with respect to the implementation of reliefs and refunds following a solution reached under the mutual agreement procedure is consistent with the United Kingdom's treaty practice. The United Kingdom has lodged a reservation to Article 25 ( Mutual Agreement Procedure ) of the OECD Model on the grounds that the implementation of reliefs and refunds should remain linked to the time-limits prescribed under the United Kingdom's domestic law.

Consultation on general problems

1.292 This Article also authorises consultation between the competent authorities of the two countries for the purpose of resolving any difficulties that arise regarding the interpretation or application of the treaty and to give effect to it. They may also consult together regarding elimination of double taxation in cases not provided for in the tax treaty. [Article 26, paragraph 3]

Methods of communication between competent authorities

1.293 The competent authorities are able to communicate directly with each other without having to go through diplomatic channels. This may be done by letter, facsimile transmission, telephone, direct meetings or any other convenient means. [Article 26, paragraph 4]

Application of Article without regard to the date of the relevant transactions

1.294 The Notes confirm that consultation under this Article may be conducted once the treaty enters into force, irrespective of when the relevant transactions to which the issue relates took place. For example, this allows a case presented by a taxpayer after the date of entry into force of the new treaty, but relating to an income year prior to entry into force, to be the subject of consultation under this Article. [Exchange of Notes, Item 10]

General Agreement on Trade in Services dispute resolution process

1.295 This Article deals with disputes that may be brought before the Council for Trade in Services in accordance with paragraph 3 of Article XXII ( Consultation ) of the World Trade Organisation GATS. [Article 26, paragraph 5]

Background

1.296 Australia and the United Kingdom are both parties to the GATS. Article XVII ( National Treatment ) of this treaty requires a party to accord the same treatment to services and service suppliers of other parties as it accords to its own like services and service suppliers.

1.297 Articles XXII ( Consultation ) and XXIII ( Dispute Settlement and Enforcement ) provide for discussion and resolution of disputes. Paragraph 3 of Article XXII provides that a party may not invoke Article XVII ( National Treatment ) with respect to a measure of another party that falls within the scope of an international agreement between them relating to the avoidance of double taxation. However, if there is a dispute as to whether a measure actually falls within the scope of a tax agreement, either country may take the matter to the Council on Trade in Services for referral to binding arbitration.

1.298 Notwithstanding paragraph 3 of Article XXII, Australia and the United Kingdom have agreed that the consent of both countries is required before a dispute as to whether a measure falls within the scope of this tax treaty may be brought before the Council on Trade in Services. This is seen as the most effective way of dealing with such disputes, and avoids difficult questions as to when a disputed issue falls within the dispute resolution mechanism of this tax treaty or of the GATS dispute.

1.299 This provision is based, in all essential respects, on an OECD Model commentary recommendation, and is common in recent international treaty practice. [Article 26, paragraph 5]

Article 27 - Exchange of information

Limitations on exchange

1.300 This Article authorises and limits the exchange of information by the two competent authorities to information foreseeably relevant to the administration or enforcement of the provisions of the treaty or of the domestic laws concerning the taxes to which the tax treaty applies. The exchange of information is not limited by Article 1 ( Persons covered ) of this tax treaty, and may therefore cover persons who are not residents of Australia or the United Kingdom. [Article 27, paragraph 1]

1.301 The standard of foreseeable relevance is intended to provide for exchange of information in tax matters to a wide extent. However, competent authorities would not be entitled to request information from the other country which is unlikely to be relevant to the tax affairs of a taxpayer, or to the administration and enforcement of tax laws.

1.302 The limitation placed on the kind of information authorised to be exchanged means that information access requests relating to taxes not within the coverage provided by Article 2 ( Taxes covered ) of the treaty, for example Australia's GST, are not within the scope of the Article.

Purpose

1.303 The purposes for which the exchanged information may be used and the persons to whom it may be disclosed are restricted consistent with Australia's tax treaty practice. Any information received by a country must be treated as secret in the same manner as information obtained under the domestic law of that country. [Article 27, paragraph 1]

1.304 When requested, a country is required to obtain information in the same manner as if it were administering its domestic tax system, notwithstanding that the country may not require the information for its own purposes. There is no requirement that the country receiving the request must require the same information for the purposes of administering its domestic law. [Article 27, paragraph 2]

1.305 This provision was included in accordance with the United Kingdom's observation on Article 26 ( Exchange of information ) of the OECD Model. It is intended to overcome limitations in their domestic law on collection of information in cases where no liability to United Kingdom tax arises. Australia would recognise the obligation to obtain relevant information in these cases for treaty partner countries, even in the absence of an explicit provision to this effect.

1.306 The country requested to provide information under this Article is not obliged to provide such information where:

•

it would be required to carry out administrative procedures incompatible with its own law or the administrative practice in that country or the country requesting the information; or

•

such information is not obtainable within the limitations imposed under its domestic law or in the normal course of administration in that country or the country requesting the information.

[Article 27, subparagraphs 3(a) and (b)]

1.307 Also, in no case is the country receiving the request obliged to supply information under this Article that would:

•

disclose any trade, business, industrial, commercial or professional secret or trade process; or

•

be contrary to public policy.

[Article 27, subparagraph 3(c )]

Application

1.308 This Article applies to all taxes covered by the tax treaty. In the case of Australia these are:

•

the income tax (including that imposed on capital gains);

•

the petroleum resource rent tax in respect of offshore petroleum projects; and

•

the FBT.

Application of Article without regard to the date to which the information on relevant transactions refers

1.309 The Notes confirm that information on relevant transactions, irrespective of the period to which the information relates, may be exchanged under this Article, once the treaty enters into force.

1.310 For example, where a request for information is made in accordance with this Article after the new treaty enters into force, information relating to an earlier period may be exchanged. [Exchange of Notes, Item 10]

Article 28 - Members of diplomatic missions or permanent missions and consular posts

1.311 The purpose of this Article is to ensure that the provisions of the tax treaty do not result in members of diplomatic missions, permanent missions and consular posts receiving less favourable treatment than that to which they are entitled in accordance with international conventions. Such persons are entitled, for example, to certain fiscal privileges under the Diplomatic Privileges and Immunities Act 1967 and the Consular Privileges and Immunities Act 1972 which reflect Australia's international diplomatic and consular obligations. [Article 28]

Article 29 - Entry into force

Date of entry into force

1.312 This Article provides for the entry into force of the tax treaty. The treaty will enter into force on the last date on which diplomatic notes are exchanged notifying that the domestic processes to give the tax treaty the force of law in the respective countries has been completed. In Australia, enactment of the legislation giving the force of law in Australia to the tax treaty along with tabling the treaty in Parliament are prerequisites to the exchange of diplomatic notes. [Article 29, paragraph 1]

Date of application for Australian taxes

Withholding taxes

1.313 Once it enters into force, the treaty will apply in Australia in respect of withholding tax on income that is derived by a non-resident in relation to income derived on or after 1 July next following the date on which the tax treaty enters into force. [Article 29, sub-subparagraph 1(a )( i )]

Fringe benefits tax

1.314 The treaty will apply in Australia in respect of fringe benefits provided on or after 1 April next following the date on which the tax treaty enters into force. [Article 29, sub-subparagraph 1(a )( ii )]

Other Australian taxes

1.315 The treaty will first apply to other Australian taxes on income or gains of the Australian year of income beginning on or after 1 July next following the date on which the tax treaty enters into force.

1.316 Where a taxpayer has adopted an accounting period ending on a date other than 30 June, the accounting period that has been substituted for the year of income beginning on 1 July next following the date on which the tax treaty enters into force will be the relevant year of income for the purposes of the application of such Australian tax. [Article 29, sub-subparagraph 1(a )( iii )]

Date of application in the United Kingdom

Taxes withheld at source

1.317 In the United Kingdom, the treaty will first have effect, in relation to taxes withheld at source, for amounts paid or credited on or after 1 July next following the date on which the tax treaty enters into force. [Article 29, sub-subparagraph 1(b )( i )]

Capital gains tax and income tax (excluding those taxes withheld at source)

1.318 The treaty will first have effect, in relation to CGT and income tax (excluding those taxes withheld at source for which the date of effect is 1 July next following the date on which the tax treaty enters into force), for any United Kingdom year of assessment commencing on or after 6 April next following the date on which the tax treaty enters into force. [Article 29, sub-subparagraph 1(b )( ii )]

Corporation tax

1.319 In the United Kingdom, the treaty will first have effect, in relation to the corporation tax, for any financial year commencing on or after 1 April next following the date that the tax treaty enters into force. [Article 29, sub-subparagraph 1(b )( iii )]

Termination of the existing treaty as amended by the protocol

Taxes covered under paragraph 1 of Article 29

1.320 The existing treaty shall cease to have effect from the dates on which the new treaty commences application for the respective taxes. [Article 29, paragraph 2]

Tax credits for dividends paid by United Kingdom resident companies to Australian resident beneficial owners

1.321 The existing treaty will cease to have effect in respect of tax credits on dividends paid by United Kingdom resident companies for dividends paid on or after 1 July next following the date on which the new tax treaty enters into force. [Article 29, paragraph 2]

Transitional arrangements for visiting teachers and professors

1.322 At the date of entry into force of the new treaty, an individual who is entitled to benefits under Article 16 of the existing treaty, as amended by the 1980 protocol, shall continue to have access to the benefit provided for a limited period.

1.323 To qualify for the exemption under Article 16 of the existing treaty for remuneration from specified teaching activities, the visit must be 'for a period not exceeding two years'. This effectively limits these transitional arrangements to a maximum of two years from the date of entry into force of the new treaty. The actual period that a particular individual will qualify for the exemption will depend on their circumstances and the date they became eligible for the exemption under Article 16 of the existing treaty. [Article 29, paragraph 3]

Article 30 - Termination

1.324 The tax treaty is to continue in effect indefinitely. However, either country may give written notice of termination of the tax treaty through the diplomatic channel on or before 30 June in any calendar year beginning after the expiration of 5 years from the date of its entry into force. [Article 30]

Cessation in Australia

1.325 In the event of either country terminating the tax treaty, the tax treaty would cease to be effective in Australia for the purposes of:

•

withholding tax on income derived by a non-resident in relation to income derived on or after 1 January in the calendar year next following that in which the notice of termination is given;

•

FBT, in respect of fringe benefits provided on or after 1 April in the calendar year next following that in which the notice of termination is given; and

•

other Australian taxes in relation to income or gains in the Australian year of income commencing on or after 1 July in the calendar year next following that in which the notice of termination is given.

[Article 30, subparagraph (a)]

Cessation in the United Kingdom

1.326 The tax treaty would correspondingly cease to be effective in the United Kingdom for the purposes of:

•

taxes withheld at source, for amounts paid or credited on or after 1 January in the calendar year next following that in which the notice of termination is given;

•

CGT and income tax (excluding those taxes withheld at source and subject to clause (i)), for any United Kingdom year of assessment commencing on or after 6 April in the calendar year next following that in which the notice of termination is given; and

•

corporation tax, for any financial year commencing on or after 1 April in the calendar year next following that in which the notice of termination is given.

[Article 30, subparagraph (b)]

Item 1(3) of the Exchange of Notes - Tax treaty does not take precedence over domestic provisions designed to prevent the avoidance or evasion of taxes

1.327 Tax treaty provisions generally prevail over inconsistent provisions in the domestic law. In Australia, this principle is recognised in subsections 4(2) and 4AA(2) of the Agreements Act. However,

•

subsection 4(2) of the Agreements Act preserves the operation of Part IVA (Schemes to reduce income tax) of the ITAA 1936; and

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subsection 4AA(2) of the Agreements Act preserves the operation of section 67 (Arrangements to reduce or avoid FBT) of the Fringe Benefits Tax Assessment Act 1986 .

1.328 Item 1(e) of the Notes ensures that nothing in the treaty shall be construed as restricting or limiting in any way the general application of any provisions under Australian or United Kingdom domestic law that are designed for the purpose of preventing the avoidance or evasion of taxes. Such provisions would include, in the case of Australia, the provisions noted in the previous paragraph. [Exchange of Notes, Item 1(e )]

1.329 Item 1(d) of the Notes further elaborates that the phrase 'any provision of the laws of a country which is designed to prevent the avoidance or evasion of taxes' includes:

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measures designed to address thin capitalisation, dividend stripping and transfer pricing;

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controlled foreign company, transferor trust and foreign investment fund rules; and

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measures designed to ensure that taxes can be effectively recovered.

[Exchange of Notes, Item 1(d)]

Item 12 of the Exchange of Notes - Regular consultation

1.330 To ensure that the treaty continues to achieve its purposes of avoiding double taxation and preventing fiscal evasion, the exchange of Notes provides for regular consultation between the two countries regarding the treaty's terms, operation and application. Such consultations are to take place at intervals of not more than five years, with the first such review occurring no later than the end of the fifth year after the entry into force of the new treaty in accordance with the provisions of Article 29 ( Entry into force ). Such consultations will enable both countries to consider whether any further action - such as resolving matters of interpretation or application of the treaty through agreement between competent authorities, or negotiating amendments to the treaty - are required to ensure that the treaty remains appropriate and effective. Neither country is under a formal obligation to enter into negotiations to amend or replace the treaty. [Exchange of Notes, Item 12]