House of Representatives

Explanatory Memorandum

(Circulated by authority of the Minister for Revenue and Financial Services, Minister for Women and Minister Assisting the Prime Minister for the Public Service, the Hon Kelly O'Dwyer MP)

Chapter 3 - Treaty abuse

Outline of chapter

3.1 This Chapter explains the ways in which the Multilateral Convention will modify Australia's Covered Tax Agreements to address treaty abuse concerns, including treaty shopping, where persons seek to inappropriately obtain benefits afforded under a tax agreement.

Context of amendments

3.2 The BEPS Final Report on Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances) identified treaty shopping and other treaty abuse as a significant source of BEPS concerns.

3.3 Treaty shopping involves a person who is not a resident of either of the two jurisdictions that have signed a tax agreement using strategies to attempt to obtain benefits which should only be afforded to residents of the treaty partner jurisdictions.

3.4 Treaty abuse strategies undermine a jurisdiction's tax sovereignty by enabling benefits (such as tax reductions or exemptions) to be granted in situations where those benefits were not intended to be granted, causing a reduction in the jurisdiction's tax revenues.

3.5 The BEPS Final Report on Action 6 recommended the following approach to address treaty shopping:

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include in a tax agreement a clear statement that the partner jurisdictions intend to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance;

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include in the OECD Model a specific anti-abuse rule (the Limitation on Benefits rule) that limits the availability of treaty benefits to entities that meet certain conditions ensuring there is a sufficient link between the entity and the jurisdiction from which the entity is seeking the benefits; and

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include in the OECD Model a more general anti-abuse rule (the Principal Purposes Test) that denies the treaty benefits where one of the principal purposes of transactions or arrangements is to obtain those benefits, unless those benefits would be in accordance with the object and purpose of the tax agreement's provisions.

3.6 Taking action to prevent treaty abuse is a BEPS minimum standard. Jurisdictions have committed to ensuring that at least a minimum standard of protection against treaty shopping is achieved, which means they must include in their tax agreements the clear statement referred to above as well as:

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a Principal Purposes Test;

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a Principal Purposes Test and either a simplified or detailed Limitations on Benefits rule; or

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a detailed Limitations on Benefits rule supplemented by a mechanism (such as a rule in a tax agreement or a domestic anti-abuse rule) that deals with conduit financing arrangements.

3.7 This is reflected in the mandatory nature of Articles 6 and 7 of the Multilateral Convention, which implement most of these Action 6 recommendations.

3.8 To address other forms of treaty abuse, the BEPS Final Report on Action 6 recommended including rules in tax agreements to target:

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situations where an entity is a resident of both jurisdictions of a tax agreement (dual resident);

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certain dividend transfer transactions that are intended to artificially lower withholding taxes on dividends;

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transactions that circumvent tax agreement rules that allow gains arising from the disposal of interests in land-rich entities to be taxed by the jurisdiction where the underlying property is located;

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certain situations where a resident of a partner jurisdiction receives a benefit in relation to income derived through a permanent establishment located in a third jurisdiction that exempts or lightly taxes that income; and

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the possibility that tax agreement provisions may be interpreted in a way that limits a jurisdiction's right to tax its own residents.

3.9 Articles 4 and 8 to 11 of the Multilateral Convention implement these Action 6 recommendations.

Summary of new law

3.10 Article 4 in Part II (Hybrid Mismatches) of the Multilateral Convention expands the criteria for determining a dual resident entity's tax residence to include other factors (in addition to the place of effective management) and require the competent authorities to endeavour to agree on a single jurisdiction of residence. Competent authorities are persons (typically tax officials) identified in tax agreements to represent the respective jurisdictions.

3.11 In the absence of such agreement by the competent authorities, the entity will not be entitled to treaty benefits (e.g. tax reductions or exemptions) except to the extent agreed by the competent authorities.

3.12 Australia has provisionally indicated that it will adopt Article 4 and make the reservation to deny treaty benefits where the two competent authorities have been unable to reach an agreement on the entity's jurisdiction of residence (i.e. the additional line referred to in paragraph 3.11 above that would otherwise allow the competent authorities to agree on the extent of treaty benefits would not apply).

3.13 Part III (Treaty Abuse) of the Multilateral Convention contains rules that aim to address treaty abuse including treaty shopping:

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Article 6 - purpose of a Covered Tax Agreement;

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Article 7 - prevention of treaty abuse;

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Article 8 - dividend transfer transactions;

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Article 9 - capital gains from alienation of shares or interests of entities deriving their value principally from immovable property;

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Article 10 - anti-abuse rule for permanent establishments situated in third jurisdictions; and

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Article 11 - application of tax agreements to restrict a Party's right to tax its own residents.

3.14 Article 6 inserts a new preamble into jurisdictions' Covered Tax Agreements which states that the purpose of a tax agreement is to eliminate double taxation with respect to the taxes covered by the agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in the tax agreement for the indirect benefit of residents in third jurisdictions).

3.15 Adopting Article 6 is mandatory for jurisdictions that ratify the Multilateral Convention. Australia has provisionally indicated that it will also adopt the additional preamble language stating both Parties desire to further develop their bilateral economic relationship and enhance their cooperation in tax matters.

3.16 Article 7 provides new anti-abuse rules to enable revenue authorities to deny treaty benefits (such as tax reductions or exemptions) in cases where one of the principal purposes of an arrangement was to inappropriately obtain such benefits (the Principal Purposes Test).

3.17 The Principal Purposes Test may be supplemented with a Simplified Limitation on Benefits rule, which would limit benefits to 'qualified persons' (i.e. individuals, government entities, listed companies, non-profit organisations, pension funds, entities engaged in active business and entities that meet specified ownership requirements).

3.18 Adopting Article 7 is mandatory for jurisdictions that ratify the Multilateral Convention. Australia has provisionally indicated that it will adopt the Principal Purposes Test only and not the Simplified Limitation on Benefits rule.

3.19 Article 8 inserts a 365 day shareholding period requirement that foreign resident corporate shareholders must satisfy in order to be eligible for any reduced tax rate provided for in a Covered Tax Agreement in relation to non-portfolio intercorporate dividends.

3.20 Australia has provisionally adopted Article 8 without reservation.

3.21 Article 9 introduces a 365 day period for testing whether an entity was land-rich to enable a jurisdiction to tax capital gains made by foreign residents from the disposal of shares or interests in land-rich entities where the underlying property is located in that jurisdiction.

3.22 Australia has provisionally adopted Article 9, and has provisionally indicated that it will make the reservation permitted by Article 9(6)(e) to not modify its Covered Tax Agreements that already contain corresponding rules on the alienation of interests comparable to shares (such as interests in a partnership or trust).

3.23 Article 10 denies treaty benefits where an entity that is a resident of a jurisdiction that is a party to a bilateral tax agreement derives certain income from the other jurisdiction through a permanent establishment located in a third jurisdiction, and that income is exempt in both the entity's jurisdiction of residence and subject to reduced taxation in the third jurisdiction.

3.24 Australia has provisionally indicated that it will not adopt Article 10 for its Covered Tax Agreements. This means that Australia's tax agreements will not be modified to include Article 10 of the Multilateral Convention.

3.25 Article 11 clarifies that a tax agreement does not generally restrict a jurisdiction's right to tax its own residents.

3.26 Australia has provisionally adopted Article 11 without reservation.

Detailed explanation of new law

Determining a single residence for dual resident entities

3.27 Australia has provisionally adopted Article 4, but has indicated it will make the reservation contained in Article 4(3)(e) to deny a dual resident entity's entitlement to any treaty benefits where the relevant competent authorities have not reached an agreement on a single jurisdiction of residence.

3.28 Tax agreements only apply to persons that are a tax resident of one or both jurisdictions under those jurisdictions' respective domestic laws. Where a person is a resident of both jurisdictions (i.e. a dual resident), most tax agreements have tiebreaker rules to determine that the person is a resident of a single jurisdiction for the purposes of the tax agreement.

3.29 The key tiebreaker rule that is generally applied in determining the residence of a dual resident entity (such as a company) is the entity's place of effective management.

3.30 Entities can customise the outcome of applying such a test, and potentially avoid tax in a particular jurisdiction, by relocating their place of effective management.

3.31 In respect of dual resident entities, Article 4 provides for the replacement of a tiebreaker rule (or addition of such a provision if there is no existing provision) in a Covered Tax Agreement so that the two competent authorities would endeavour to determine by mutual agreement which of the jurisdictions the dual resident is deemed to be a resident of by having regard to:

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its place of effective management;

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its place of incorporation or constitution; and

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any other relevant factors.

[Articles 4(1) and (2) of the Multilateral Convention]

3.32 As per paragraphs 24.1 and 24.3 of the Commentary on Article 4 (Resident) of the OECD Model, although the factors on which a determination is based may vary over time it is expected that the relevant factors taken into consideration will include:

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where the meetings of the entity's board of directors or equivalent body are usually held;

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where the chief executive officer and other senior executives usually carry on their activities;

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where the senior day-to-day management of the entity is carried on;

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where the entity's headquarters are located;

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which jurisdiction's laws govern the legal status of the entity;

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where its accounting records are kept; and

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whether determining that the entity is a resident of one jurisdiction but not of the other for the purpose of the tax agreement would carry the risk of an improper use of the provisions of the tax agreement.

3.33 That is, Article 4 expands the criteria for determining a dual resident entity's country of tax residence for tax agreement purposes. It includes other relevant factors in addition to the 'place of effective management' test previously solely relied upon in the OECD Model and allows the two competent authorities to agree on a single jurisdiction of residence.

3.34 Article 4's expansion of the criteria and agreement by the competent authorities is intended to improve the integrity of the tiebreaker rule. Requiring a case-by-case approach will help prevent entities employing a dual residency status to avoid tax.

3.35 In the absence of mutual agreement between the competent authorities, the dual resident entity is not entitled to any relief or exemption from tax provided by the Covered Tax Agreement, except to the extent agreed by the competent authorities. [Article 4(1) of the Multilateral Convention]

3.36 Australia has provisionally made the reservation in Article 4(3)(e) to exclude this exception to allow the competent authorities to agree on the extent to which relief or exemption will be granted. That is, the dual resident is not able to be granted any tax relief or exemption under a Covered Tax Agreement to which Australia is a Party unless the competent authorities agree on a single residency of the dual resident.

3.37 Where the other Party to a Covered Tax Agreement (to which Australia is a Party) has made the reservation in Article 4(3)(f), Article 4 will not modify that Covered Tax Agreement at all. That reservation allows a Party to opt out of the application of Article 4 entirely where another Party has made the reservation in Article 4(3)(e).

3.38 Article 4 will not affect existing provisions of a Covered Tax Agreement that deal with the tax residence of a company that is participating in a dual-listed company arrangement. For example, Article 4 of the Multilateral Convention will not affect paragraphs 5 and 6 of Article 4 (Resident) of the New Zealand convention. [Article 4(2) of the Multilateral Convention]

3.39 The replacement of an existing tiebreaker provision or inclusion of a tiebreaker provision for non-individuals in a Covered Tax Agreement will occur if neither Party to a Covered Tax Agreement makes the reservation in Article 4(3)(a) (or Articles 4(3)(b), (c) or (d) to the extent the Covered Tax Agreement is subject to the reservation) and notifies the Depositary of the affected bilateral provisions to be replaced. [Article 4(4) of the Multilateral Convention]

3.40 Australia has provisionally notified that all of Australia's agreements that it has nominated as Covered Tax Agreements, except those with Turkey and the United States, contain such an existing tiebreaker rule. Australia's tax agreements with Turkey and the United States do not contain tiebreaker rules for entities that are not individuals.

3.41 Otherwise, the tiebreaker rule contained in Article 4(1) will modify Australia's Covered Tax Agreements to the extent of any inconsistency between Article 4(1) and the relevant bilateral provisions, subject to any reservations made by the relevant Parties.

3.42 Based on the known or proposed adoption positions of other Signatories to the Multilateral Convention, Article 4 is expected to modify Australia's tax agreements with: Argentina, China, Fiji, India, Indonesia, Japan, Mexico, the Netherlands, New Zealand, Norway, Poland, Romania, Russia, the Slovak Republic, South Africa and the United Kingdom.

Inserting a clear statement regarding intention to address BEPS

3.43 Article 6 is a mandatory provision of the Multilateral Convention for jurisdictions that ratify it that sets out a new preamble text for Covered Tax Agreements. This Article is to implement the recommendation of the BEPS Final Report on Action 6 for the inclusion of a clear statement that the parties to a tax agreement intend to avoid creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance.

3.44 If a Covered Tax Agreement contains preambular language referring to the intent to eliminate double taxation (regardless of whether the language refers to an intent not to create opportunities for non-taxation or reduced taxation), those words will be replaced with the new preamble text to include the express intention of eliminating double taxation with respect to the taxes covered by the agreement 'without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in the treaty for the indirect benefit of residents of third jurisdictions)'. [Articles 6(1) and (2) of the Multilateral Convention]

3.45 If a Covered Tax Agreement does not contain such preamble language, the new preamble text will be added to the agreement. [Article 6(2) of the Multilateral Convention]

3.46 The replacement of existing preamble language in a Covered Tax Agreement is only effective if both Parties to the Covered Tax Agreement do not make the reservation in Article 6(4) (to not apply Article 6 at all as the tax agreement already contains comparable preamble language to Article 6(1)) and notify the Depositary of the affected preamble words to be replaced. In other cases, the preamble language in Article 6(1) is included in addition to existing preamble language. [Article 6(5) of the Multilateral Convention]

3.47 Australia has provisionally notified that the relevant preambular words (i.e. referring to the intent to eliminate double taxation) are contained in all of Australia's agreements that it wishes to be Covered Tax Agreements, and will thus be replaced by the new preamble text contained in Article 6(1).

3.48 Based on the known or proposed adoption positions of other Signatories to the Multilateral Convention, Article 6(1) is expected to modify Australia's tax agreements with Argentina, Belgium, Canada, Chile, China, the Czech Republic, Denmark, Fiji, Finland, France, Hungary, India, Indonesia, Ireland, Italy, Japan, Malaysia, Malta, Mexico, the Netherlands, New Zealand, Norway, Poland, Romania, Russia, Singapore, the Slovak Republic, South Africa, Spain, Turkey and the United Kingdom.

3.49 If a Covered Tax Agreement does not contain preambular language that refers to the Parties' desire to further develop their economic relationship and enhance their co-operation in tax matters, a jurisdiction may choose to include such words. [Article 6(3) of the Multilateral Convention]

3.50 The inclusion of the additional preamble text is only effective if both Parties to a Covered Tax Agreement choose to do so and notify the Depositary accordingly.

3.51 Australia has chosen to include the additional preamble text contained in Article 6(3) and provisionally notified that the relevant words are not contained in any of Australia's agreements that it wishes to be Covered Tax Agreements.

3.52 Based on the known or proposed adoption positions of other Signatories to the Multilateral Convention, Article 6(3) is expected to modify Australia's tax agreements with: Argentina, Belgium, Chile, China, Fiji, France, Ireland, Japan, Malta, Mexico, the Netherlands, Norway, Romania, Russia, Singapore, the Slovak Republic, South Africa, Spain, Turkey and the United Kingdom.

3.53 The preamble is important for the interpretation of a tax agreement. Consistent with Article 31(1) of the Vienna Convention on the Law of Treaties, a tax agreement is to be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

3.54 Australia's adoption of Article 6 to the fullest extent possible will ensure that the intention to address BEPS concerns, as reflected in its Covered Tax Agreements, will be considered when interpreting a Covered Tax Agreement.

Inserting a general anti-abuse rule

3.55 Article 7 is a mandatory provision of the Multilateral Convention for jurisdictions that ratify it that provides treaty-based anti-abuse rules (i.e. the Principal Purposes Test and the Simplified Limitation on Benefits rule).

3.56 The Principal Purposes Test provides that a benefit will not be granted (such as a tax reduction or exemption) where it is reasonable to conclude having regard to all relevant facts and circumstances that:

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one of the principal purposes of an arrangement or transaction was to obtain the benefit (directly or indirectly); and

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granting such a benefit in the circumstance would not accord with the object and purpose of the provisions of the Covered Tax Agreement.

[Article 7(1) of the Multilateral Convention]

3.57 As per paragraph 174 of the Commentary to Article 29 (Entitlement to benefits) of the OECD Model, the Principal Purposes Test is intended:

...to ensure that tax conventions apply in accordance with the purpose for which they were entered into, i.e. to provide benefits in respect of bona fide exchanges of goods and services, and movements of capital and persons as opposed to arrangements whose principal objective is to secure a more favourable tax treatment.

3.58 In interpreting the various elements of Article 7(1) of the Multilateral Convention, paragraphs 175 to 187 of the Commentary to Article 29 (Entitlement to benefits) of the OECD Model are of particular relevance. Those paragraphs discuss concepts such as 'one of the principal purposes', 'arrangement or transaction' and 'benefit' and provide relevant examples.

3.59 If a Covered Tax Agreement contains a provision that enables the denial of treaty benefits where an arrangement or transaction, or a person concerned with such an arrangement or transaction, had a principal purpose of obtaining the benefits (i.e. an existing principal purposes test), then that provision will be replaced by Article 7(1). [Article 7(2) of the Multilateral Convention]

3.60 If a Covered Tax Agreement does not contain such a provision, then Article 7(1) will be added to the agreement. [Article 7(2) of the Multilateral Convention]

3.61 However, a Party can reserve its right to not adopt the Principal Purposes Test under Article 7(1) if:

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the Party intends to take bilateral action to adopt a detailed Limitation on Benefits rule together with either the Principal Purposes Test or rules to address conduit financing arrangements to meet the minimum BEPS standard; or

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the Party's Covered Tax Agreements already contain a principal purposes test.

[Article 7(15) of the Multilateral Convention]

3.62 The replacement of an existing principal purposes test in a Covered Tax Agreement is only effective if both Parties to the Covered Tax Agreement do not make the reservation contained in Article 7(15)(a) (to not apply Article 7(1) as the Party intends to meet the minimum standard by taking bilateral action) and notify the Depositary accordingly. [Article 7(17)(a) of the Multilateral Convention]

3.63 Australia has provisionally indicated that Australia's tax agreements with Chile, China, Finland, Ireland, Japan, Mexico, New Zealand, Norway, South Africa, Switzerland and the United Kingdom contain provisions with principal purposes tests aimed at specific treaty benefits (see, for example, Articles 10(11) (Dividends), 11(10) (Interest) and 12(8) (Royalties) of the Japanese convention).

3.64 The Principal Purposes Test contained in Article 7(1) will replace these specific anti-abuse provisions and modify Australia's Covered Tax Agreements to the extent of any inconsistency between Article 7(1) and the relevant provisions of those agreements, provided that the relevant Parties to a Covered Tax Agreement have not made the reservation in Article 7(15)(a) or (b). [Article 7(17)(a) of the Multilateral Convention]

3.65 A Party may supplement the Principal Purposes Test with a Simplified Limitation on Benefits rule. This rule would limit treaty benefits to 'qualified persons' (such as individuals, government entities, listed companies, non-profit organisations, pension funds, entities engaged in active business and entities that meet specified ownership requirements). [Article 7(6) of the Multilateral Convention]

3.66 Australia has provisionally adopted the Principal Purposes Test only. This is broadly consistent with Australia's recent treaty practice.

3.67 A Party may also choose to supplement the application of Article 7(1) with an associated rule to enable a competent authority, in consultation with the competent authority of the other Party, to grant treaty benefits to a taxpayer (on request), despite a denial under the Principal Purposes Test, if those benefits would nevertheless have been granted in the absence of the arrangement that attracted that denial. [Articles 7(3) and (4) of the Multilateral Convention]

3.68 The associated rule will modify the application of a principal purposes test in a Covered Tax Agreement. [Article 7(5) of the Multilateral Convention]

3.69 Australia has provisionally adopted the associated rule.

3.70 The associated rule is only effective if both Parties to a Covered Tax Agreement choose to apply the associated rule in Article 7(4) and notify the Depositary of their choice. [Article 7(17)(b) of the Multilateral Convention]

3.71 Based on the known or proposed adoption positions of other Signatories to the Multilateral Convention, Article 7 is expected to modify Australia's tax agreements with: Argentina, Belgium, Canada, Chile, China, the Czech Republic, Denmark, Fiji, Finland, France, Hungary, India, Indonesia, Ireland, Italy, Japan, Malaysia, Malta, Mexico, the Netherlands, New Zealand, Norway, Poland, Romania, Russia, Singapore, the Slovak Republic, South Africa, Spain, Turkey and the United Kingdom.

Addressing dividend transfer transactions

3.72 Australia has provisionally adopted Article 8 without reservation for all of its agreements it wishes to be Covered Tax Agreements.

3.73 In order to encourage cross-border direct investment, many tax agreements provide for reduced tax rates on certain intercorporate dividends paid to foreign shareholders.

3.74 In some cases, foreign shareholders may attempt to secure the benefits of the reduced tax rate by increasing their shareholdings just before dividends are paid.

3.75 Where a provision of a Covered Tax Agreement exempts or provides a concessional tax rate for dividends paid by one company to another, Article 8 provides that the company receiving the dividend must hold the related shares for 365 days or more (including the day of payment) before any such exemption or concession applies. [Article 8(1) of the Multilateral Convention]

3.76 If such a provision in a Covered Tax Agreement includes a minimum holding period, the period will be replaced by the minimum holding period in Article 8(1). Otherwise, the 365 day minimum holding period will be added to the provision in the Covered Tax Agreement. [Article 8(2) of the Multilateral Convention]

3.77 The existing 12 month holding period provisions in the Dividends articles of some of Australia's tax agreements generally require that that period be satisfied at the time the dividend is declared whereas Article 8(1) of the Multilateral Convention provides that the 365 day period includes the day of the payment of the dividends. Thus, under Article 8(1), the holding period may straddle the dividend payment date.

3.78 The 365 day period is not affected by changes in ownership due to corporate reorganisations of either the domestic company paying the dividends or the foreign company receiving the dividends. These corporate reorganisations include mergers, corporate consolidations, and corporate divisions. [Article 8(1) of the Multilateral Convention]

3.79 The replacement or addition of a minimum holding period is only effective if both Parties to a Covered Tax Agreement do not make any of the reservations contained in Article 8(3)(a) and (b) and notify the Depositary accordingly. [Article 8(4) of the Multilateral Convention]

3.80 Australia has provisionally notified that Australia's tax agreements with Argentina, Canada, Chile, Czech Republic, Finland, France, Japan, Malaysia, Mexico, New Zealand, Norway, Philippines, Romania, Russia, South Africa, Switzerland, Taipei, Turkey, the United Kingdom and the United States, contain a provision for a concessional tax rate for certain intercorporate dividends paid to foreign companies.

3.81 Article 8 will help prevent acquisitions and disposals of shares from being eligible for the reduced tax rate on certain intercorporate dividends.

3.82 Article 8 does not affect existing provisions in Covered Tax Agreements that give a preferential rate for dividends without the condition of a certain percentage of shareholding in the company paying the dividends.

3.83 The Article is intended to replace or add a minimum shareholding period to existing provisions in Covered Tax Agreements without modifying other elements of those provisions such as rates of tax, ownership thresholds and the form of ownership.

3.84 Based on the known or proposed adoption positions of other Signatories to the Multilateral Convention, Article 8 is expected to modify Australia's tax agreements with: Argentina, France, Mexico, New Zealand, Romania, Russia and South Africa.

Ensuring shares in land-rich entities are taxed at source

3.85 Australia has provisionally adopted Article 9, but has indicated it will make the reservation contained in Article 9(6)(e) to not modify Covered Tax Agreements that already contain corresponding rules on the alienation of interests in entities other than companies.

3.86 Tax agreements generally preserve a jurisdiction's right to tax capital gains attributable to the disposal of immovable property (primarily land) located in that jurisdiction. This taxing right applies to disposals of both direct holdings in immovable property and holdings held indirectly through interposed land-rich entities.

3.87 A land-rich entity is an entity that derives, directly or indirectly, more than 50 per cent of its value from immovable property.

3.88 In some cases, foreign residents may attempt to avoid the payment of capital gains tax by contributing other assets to a land-rich entity, thereby diluting the total assets within the entity so that it is no longer land-rich, shortly before disposing of their interests in the entity.

3.89 For the purposes of determining whether the 50 per cent threshold has been reached for an entity to be considered land-rich, Article 9 provides for the inclusion of a 365 day testing period. That is, a jurisdiction may tax capital gains arising from the disposal of interests in a land-rich entity if that entity was land-rich at any time during the 365 days preceding the date of disposal. These rules will replace any existing testing period in a Covered Tax Agreement or add such a period if there is no existing provision. [Articles 9(1)(a) and (2) of the Multilateral Convention]

3.90 Furthermore, the types of interests in the entity are expanded beyond shares in a company to include comparable interests in other types of entities. Comparable interests include interests in a partnership or trust in addition to any shares or rights already covered by the provisions of a Covered Tax Agreement. [Article 9(1)(b) of the Multilateral Convention]

3.91 As the relevant articles of many of Australia's tax agreements already apply to comparable interests in non-corporate entities, Australia has provisionally made the reservation allowable in Article 9(6)(e) to opt out of Article 9(1)(b). That is, those existing bilateral rules will continue to apply without modification by Article 9(1)(b).

3.92 Australia has provisionally indicated that its tax agreements with Argentina, Canada, Chile, Finland, France, Ireland, Japan, Malaysia, Mexico, New Zealand, Norway, Romania, Russia, Slovak Republic, South Africa, Switzerland, Turkey, the United Kingdom, and the United States already contain these corresponding rules.

3.93 The replacement of a testing period is only effective if both Parties to a Covered Tax Agreement do not make the reservation contained in Article 9(6)(a) (to not apply Article 9 at all) and notify the Depositary accordingly. [Article 9(7) of the Multilateral Convention]

3.94 Australia has provisionally indicated that it will adopt the 365 testing period for its Covered Tax Agreements.

3.95 A Party may choose to apply Article 9(4) to its Covered Tax Agreements. Article 9(4) would modify a Covered Tax Agreement to include a complete replacement provision that includes the 365 day testing period and covers disposals of comparable interests in non-corporate entities (i.e. Article 9(4) would essentially follow the text of Article 13(4) of the OECD Model). [Article 9(4) of the Multilateral Convention]

3.96 Australia has provisionally indicated that it will not adopt Article 9(4).

3.97 Based on the known or proposed adoption positions of other Signatories to the Multilateral Convention, Article 9 is expected to modify Australia's tax agreements with: Argentina, Belgium, Chile, China, Fiji, France, India, Indonesia, Ireland, Japan, Mexico, the Netherlands, New Zealand, Poland, Russia, the Slovak Republic and Spain.

Addressing permanent establishments in third jurisdictions

3.98 Australia has provisionally made the reservation under Article 10(5)(a) to not adopt Article 10. On this basis, Article 10 will not form part of Australia's domestic laws and thus will not modify Australia's Covered Tax Agreements.

3.99 Tax agreements often limit the amount of tax that can be imposed on income derived from one jurisdiction by residents of another jurisdiction. However, a resident of a jurisdiction may attempt to inappropriately escape tax by attributing certain income (derived from the other jurisdiction partner) to a permanent establishment (a taxable presence) situated in a third jurisdiction that imposes little or no tax on the income. This could occur, for example, if the resident's home jurisdiction exempts the profits of the third jurisdiction permanent establishment.

3.100 Broadly, Article 10 would deny the benefits available under a tax agreement where an entity that is a resident of one jurisdiction derives income from another jurisdiction through a permanent establishment located in a third jurisdiction, and that income is both exempt in the entity's jurisdiction of residence and subject to reduced taxation in the third jurisdiction. The benefits are denied on income on which the tax in the third jurisdiction is less than 60 per cent of the tax that would be imposed in the first jurisdiction if the permanent establishment was a resident. [Article 10(1) of the Multilateral Convention]

3.101 It is possible for Australia to adopt Article 10 in the future by lifting its proposed reservation.

Clarifying ability to tax own residents

3.102 Australia has provisionally adopted Article 11 for all of its tax agreements.

3.103 Most provisions in tax agreements are designed to restrict a jurisdiction's right to tax income derived from within that jurisdiction by foreign residents. Concerns have been raised internationally, however, that some provisions could be interpreted so as to limit a jurisdiction's right to tax its own residents. This has led to the possibility of an entity circumventing its home jurisdiction's anti-avoidance rules.

3.104 Where a provision of a Covered Tax Agreement states that it does not affect the taxation by a jurisdiction of its residents, Article 11 provides for the replacement of such a provision (or the addition of such a provision if there is no existing provision) to clarify that a Covered Tax Agreement does not affect a Party's ability to tax its own residents, subject to the exceptions listed in Articles 11(1)(a) to (j). [Articles 11(1) and (2) of the Multilateral Convention]

3.105 The exceptions in Article 11(1) cover provisions that commonly appear in tax agreements and address:

•

correlative or corresponding adjustments following an initial adjustment in accordance with the Covered Tax Agreement (e.g. Articles 7(3) (Business profits) and 9(2) (Associated enterprises) of the OECD Model);

•

the taxation of income derived from government services (e.g. Article 19 (Government service) of the OECD Model);

•

the taxation of income derived by students and academics (e.g. Article 20 (Students) of the OECD Model);

•

the provision of tax credits or exemptions for income taxed in the other jurisdiction (e.g. Articles 23A (Exemption method) and 23B (Credit method) of the OECD Model);

•

the protection of taxpayers from discriminatory taxation practices (e.g. Article 24 (Non-discrimination) of the OECD Model);

•

rules that permit taxpayers to request that the competent authorities consider tax cases not in accordance with a Covered Tax Agreement (e.g. Article 25 (Mutual agreement procedure) of the OECD Model);

•

the taxation of income derived by members of diplomatic missions and consular posts (e.g. Article 28 (Members of diplomatic missions and consular posts) of the OECD Model);

•

the taxation of pensions (e.g. Article 18 (Pensions) of the OECD Model) and other payments made under the social security legislation of the other jurisdiction;

•

the taxation of payments under family law; and

•

provisions that otherwise explicitly limit a jurisdiction's right to tax its own residents or allocate exclusive taxing rights over income to the source jurisdiction.

[Articles 11(1)(a) to (j) of the Multilateral Convention]

3.106 Article 11 is a saving clause and will codify a widely accepted principle that is already understood to apply to Australia's tax agreements.

3.107 The replacement of a provision in a Covered Tax Agreement stating that it does not affect the taxation by a jurisdiction of its residents is only effective if both Parties to a Covered Tax Agreement do not make the reservations in Article 11(3) (to not apply Article 11 at all or to not apply those that already contains the saving clause) and notify the Depositary of the affected bilateral provisions to be replaced. [Article 11(4) of the Multilateral Convention]

3.108 Australia has provisionally indicated that Australia's tax agreements with Belgium, Canada, Fiji, France, Ireland, Italy, Korea, the United Kingdom, and the United States contain such a provision.

3.109 Article 11(1) will modify Australia's Covered Tax Agreements to the extent of any inconsistency between Article 11(1) and the relevant provisions of those agreements, subject to any reservations made by the relevant Parties to a particular Covered Tax Agreement. [Article 11(4) of the Multilateral Convention]

3.110 Based on the known or proposed adoption positions of other Signatories to the Multilateral Convention, Article 11 is expected to modify Australia's bilateral tax agreements with: Argentina, Belgium, Chile, China, Fiji, India, Indonesia, Mexico, New Zealand, Norway, Poland, Romania, Russia, the Slovak Republic and the United Kingdom.