Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 3 - Miscellaneous
What will the amendments do?
3.1 Schedule 3 to this bill will amend subsection 170(14) of the ITAA 1936 to reflect the replacement of the existing United Kingdom tax treaty (signed in 1967) text in the Agreements Act. This Schedule will also update references in the Taxation ( Interest on Overpayments and Early Payments ) Act 1983 to the Agreements Act. In addition, this Schedule will clarify the application of Australia's tax treaties with respect to returns on debt interests.
3.2 These amendments will:
- •
- substitute a new paragraph (a) into the definition of relevant provision in subsection 170(14) of the ITAA 1936 and omit the definition of United Kingdom agreement from the same subsection;
- •
- replace the cross-references to the Agreements Act within the definitions section of the Taxation ( Interest on Overpayments and Early Payments ) Act 1983 with the correct short title of the Agreements Act; and
- •
- clarify that a reference in a tax treaty to either income from shares or income from other rights participating in profits does not include a reference to a return on a debt interest (as defined in Subdivision 974-B of the ITAA 1997) [Schedule 3, item 3, new subsection 3(2A ) of the Agreements Act].
Commencement
3.3 The amendments will apply from the day this bill receives Royal Assent.
Reasons for the amendments
New definition of 'relevant provision'
3.4 This is a consequential amendment following the replacement of the 1967 United Kingdom tax treaty with the new United Kingdom tax treaty and the Exchange of Notes.
3.5 Subsections 170(9B) and (9C) of the ITAA 1936 deal with time limits for amending income tax assessments for the purpose of giving effect to a relevant provision . Paragraph (a) of the definition for relevant provision in subsection 170(14) defines relevant provision as paragraph (3) of Article 5 or paragraph (1) of Article 7 of the existing tax treaty with the United Kingdom (currently defined as United Kingdom agreement within subsection 170(14)), or a provision of any other tax treaty that corresponds with either of those paragraphs. These paragraphs in Australia's tax treaties allow for adjustments to the profits of permanent establishments or associated enterprises on an arm's length basis.
3.6 This amendment replaces the references to the provisions in the existing tax treaty with the United Kingdom with a broad, generic description of the relevant provisions found in Australia's tax treaties. Examples of such provisions in Australia's tax treaties are paragraph 2 of Article 7 ( Business profits ) and paragraph 1 of Article 9 ( Associated enterprises ) of the new tax treaty with the United Kingdom [Schedule 1, item 14] ). Substituting this general description will reduce the need to amend the definition of relevant provision as a result of future tax treaty changes.
3.7 As a consequence of the change to a generic description of paragraph (a) of the definition of relevant provision , the definition of United Kingdom agreement in subsection 170(14) is no longer necessary and will be repealed by this bill.
Cross-references to Agreements Act
3.8 These amendments are technical corrections to update the cross-references to the Agreements Act in subsection 3(1) of the Taxation ( Interest on Overpayments and Early Payments ) Act 1983 .
References to income from shares and to income from other rights participating in profits
3.9 This is a consequential amendment following the enactment of Australia's debt and equity rules in 2001. Broadly, the debt and equity rules determine whether a financial interest constitutes equity in a company (an equity interest , as defined in Subdivision 974-C of the ITAA 1997) or constitutes debt (a debt interest , as defined in Subdivision 974-B of the ITAA 1997). This then determines the tax treatment of a return on a financing interest issued by a company - that is, whether it is frankable or may be deductible.
3.10 Broadly, an interest in a company will be a debt interest if, at the time of its issue, there is a scheme that is a financing arrangement (as defined in section 974-130 of the ITAA 1997) under which the company is obliged to pay an amount to the holder of the interest at least equal to its issue price. Shares that give rise to debt interests (e.g. compulsorily redeemable preference shares that satisfy the debt test under subsection 974-20(1) of the ITAA 1997) are called non-equity shares (defined in subsection 6(1) of the ITAA 1936 as a share that is not an equity interest in a company).
Domestic withholding tax definitions of 'interest' and 'dividend'
3.11 The debt and equity concepts also apply to Division 11A of Part III of the ITAA 1936, which imposes withholding tax on Australian sourced dividends, interest and royalties paid to non-residents.
3.12 For the purposes of determining the boundary between interest and dividend withholding tax, the definition of interest in paragraph 128A(1AB)(d) of the ITAA 1936 includes an amount that is a 'dividend paid in respect of a non-equity share'. For consistency, the definition of dividend in paragraph 128A(1)(b) excludes 'a dividend paid in respect of a non-equity share'. This ensures that interest withholding tax applies to these amounts, rather than dividend withholding tax.
Tax treaty definitions of 'interest' and 'dividends'
3.13 Most Australian tax treaties include a definition of interest that extends to income which is subjected to the same domestic tax treatment as income from money lent (see, for instance, paragraph 5 of Article 11 ( Interest ) of the new tax treaty with the United Kingdom [Schedule 1, item 14] ). In Australia's case, this would cover those amounts encompassed by the paragraph 128A(1AB)(d) of the ITAA 1936 definition of interest - including a dividend paid in respect of a non-equity share. This extended definition of interest is intended to align the treaty definition with the domestic law definition of interest.
3.14 With the exception of the existing tax treaty with the United Kingdom, all of Australia's tax treaties include a definition of dividends which refers to 'income from shares'. Some of these treaties also include a reference to 'other rights participating in profits'. Most of Australia's tax treaties also extend the definition of dividends to other amounts which are subjected to the same domestic tax treatment as income from shares (see, for instance, paragraph 4 of Article 10 ( Dividends ) of the new tax treaty with the United Kingdom). This extended definition of dividends is intended to align the treaty definition with the domestic law definition.
3.15 The change to the Agreements Act confirms that the provisions of Australia's tax treaties dealing with dividends and interest are to be interpreted in accordance with the internationally accepted view that the Dividends Article in tax treaties apply to equity interests and the Interest Article applies to debt interests.
3.16 This amendment clarifies that a payment that is treated as a return on a debt interest, under Australia's domestic law, is not treated as a dividend for the purposes of Australia's tax treaties. The amendment does this by clarifying that the references to income from shares and to income from other rights participating in profits, which commonly occur in the dividends definition in Australia's tax treaties, do not include a reference to a return on a debt interest. Such a return on a debt interest would generally be treated as an interest payment for the purposes of Australia's tax treaties.
3.17 The amendment ensures alignment between the treaty treatment and the domestic law treatment, so that such returns on debt interests are generally only subjected to the terms of the Interest Articles in Australia's tax treaties (including the tax rate limits specified in those Articles), as intended.
3.18 The debt interest amendment has been expressed in general terms to deal with all cases where an agreement includes a reference to income from shares or to income from other rights participating in profits (including the new tax treaties with Mexico and with the United Kingdom). Legislation expressed in general terms will, in addition, deal with these references in future tax treaties.
3.19 The provision applies to amounts paid after commencement of this section. However, as the inclusion of this provision is intended to clarify, rather than change, the treatment of returns on debt interests under Australia's tax treaties, such amounts paid before the commencement of this section will generally also be subject only to the terms of the Interest Articles in Australia's tax treaties.