House of Representatives

Explanatory Memorandum

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

Chapter 5 - Regulation Impact Statements

Australia-South Africa Double Taxation Agreement

1. Specification of policy objective

5.1 The 2 key objectives of an Australia-South Africa Double Taxation Agreement (DTA) are to:

•

promote closer economic cooperation between Australia and South Africa by eliminating possible barriers to trade and investment caused by the overlapping taxing jurisdictions of the 2 countries. A DTA would provide a reasonable element of legal and fiscal certainty within which cross-border trade and investment can be carried on; and

•

create a framework through which the tax administrations of Australia and South Africa can prevent international fiscal evasion.

2. Background

How a DTA operates

5.2 A DTA is usually based on the OECD Model Tax Convention on Income and Capital (OECD Model), with some influences from the United Nations' Model Double Taxation Convention between Developed and Developing Countries (UN Model). In addition, both countries propose variations to reflect their economic interests and legal circumstances.

5.3 A DTA reduces or eliminates double taxation caused by the overlapping taxing jurisdictions because treaty partners agree (in specified situations) to limit taxing rights over various types of income. The countries also agree on methods of reducing double taxation where both countries have a right to tax. For example, a DTA contains a standard tax treaty provision that neither country will tax business profits derived by residents of the other country unless the business activities in the taxing country are substantial enough to constitute a permanent establishment and the income is attributable to that permanent establishment.

5.4 In negotiating the sharing of taxing rights, Australia seeks an appropriate balance between source and residence country taxing rights. Generally the allocation of taxing rights under a DTA is similar to international practice as set out in the OECD Model, but (consistent with Australian practice) there are a number of instances where it leans more towards source country taxing rights: the definition of `permanent establishment' is wider in some respects than the OECD Model, and the Business Profits, Ships and Aircraft , Royalties , Alienation of Property and Other Income Articles also give greater recognition to source country taxing rights.

5.5 In addition, a DTA provides an agreed basis for determining whether the income returned or expenses claimed on related party dealings by members of a multinational group operating in both countries can be regarded as acceptable. This is an example of how a DTA is used to address international profit shifting.

5.6 To prevent fiscal evasion, a DTA includes an exchange of information facility. The 2 tax administrations can also use the mutual agreement procedures to develop a common interpretation and resolve differences in application of the DTA. There is also provision for residents of either country to instigate a mutual agreement procedure.

Australia's Investment and Trade Relationship with South Africa

5.7 South Africa is Australia's 21st largest trading partner. As at June 1998, Australia exported goods worth $A1.097 billion to South Africa and imported goods worth $A586 million from South Africa. South Africa is Australia's 24th largest investment destination. As at June1998, the level of Australian investment in South Africa totalled $A203 million while South African investment in Australia totalled $A472 million (making South Africa Australia's 18th largest source of investment income).

5.8 DTAs generally assist in improving the bilateral framework for investment and trade with South Africa and hence, generally provides a further incentive to investors.

South Africa's tax treaty practices

5.9 As at May 1999, South Africa had concluded bilateral tax agreements with 43 countries. In general, South Africa adheres to the OECD Model. In addition to the income tax treaties, South Africa has concluded 7 agreements that provide for an exemption from South African income tax on income earned from international aircraft and/or vessel operations.

South Africa's income tax system

5.10 The South African income tax system is source-based meaning that only those amounts received from a source within, or deemed to be within, South Africa are subject to South African income tax.

5.11 Individuals are taxed at progressive rates ranging between 17% and 45%. Corporations are subject to corporate income tax at the rate of 35% and are also subject to a secondary tax on any distributed profits.

5.12 South Africa imposes withholding tax at the rate of 12% of the gross amount of royalty and know-how payments to nonresidents. South Africa does not, however, currently impose either a dividend withholding tax or interest withholding tax on such payments to nonresidents.

5.13 Fees for independent services rendered in South Africa are taxable in South Africa. Employment income earned by nonresidents from rendering services in South Africa is also taxable in South Africa.

5.14 Pensions derived from a source within, or deemed within, South Africa are taxable in South Africa.

5.15 Branches are taxable at the corporate income tax rate on income derived from South African sources.

5.16 Nonresident individuals and companies incorporated or managed and controlled outside South Africa are taxable on 10% of the amount payable to them in respect of the embarkation of passengers, livestock, mail or goods in South Africa.

3. Identification of implementation option(s)

5.17 The implementation options for achieving the policy objectives are:

1.

no further action rely on existing unilateral measures; or

2.

conclude the DTA.

Option 1: No further action rely on existing unilateral measures

5.18 It could be argued that many of the abovementioned policy objectives will be achieved regardless of whether or not a DTA was concluded. Many of the policy objectives have already been met to a significant extent through the internal tax laws of both the Australian and South African Governments (although both countries are of course free to amend their internal laws). For example, unilateral enactment of foreign source income measures by Australia already provides substantial relief from juridical double taxation. Likewise, South Africa's income tax law provides general unilateral relief from double taxation both in the form of a deduction from, or a rebate of, the normal income tax payable by a South African resident, or by way of income tax exemptions.

Option 2: Conclude the Double Taxation Agreement

5.19 The internationally accepted approach to meeting the above policy objectives is to conclude a bilateral DTA. ^[F1] A DTA would regulate the way the 2 countries will reduce double taxation, by agreeing to restrict their taxing rights in accordance with its terms. A DTA would also record important bilateral undertakings in relation to exchange of information.

5.20 For investors, a DTA has the advantage of providing some degree of legal and fiscal certainty unlike domestic laws which can be amended unilaterally.

5.21 As mentioned earlier, the DTA would be largely based on the OECD Model and the UNModel with some variations reflecting the economic, legal and cultural interests of the 2 countries.

4. Assessment of impacts (costs and benefits) of each option

Impact group identification

5.22 A DTA with South Africa is likely to have an impact on:

•

Australian residents doing business with South Africa, including principally;

-

Australian residents investing directly in South Africa (especially by way of subsidiary or a branch);

-

Australian banks lending to South African borrowers;

-

Australian residents supplying technology and know-how to South African residents;

-

Australian residents exporting goods to South Africa; and

-

Australian residents supplying consultancy services to South African residents;

•

Australian employees working in South Africa;

•

people receiving pensions from the other country (although the number of cross border pension payments is understood to be minimal); and

•

the Australian Taxation Office (ATO).

Assessment of costs

Option 1: No further action rely on existing unilateral measures

5.23 As this option represents a continuance of the current position, it would be expected that the administration and compliance costs of this option would be minimal. Revenue costs would also be expected to be very small.

5.24 On the other hand, even though both countries have unilaterally introduced measures to prevent double taxation of cross-border investments, this option will not resolve all areas of difference. For example, even if both countries had very similar foreign source income measures, there could remain important differences of views over details such as source of income and residence of taxpayers. Furthermore, this option does not protect against further unilateral changes to the internal laws and does not limit source country taxing of, for example, dividends, interest and royalties. Similarly, so far as the tax administrations are concerned, unilateral rules do not provide a dependable long term framework for information exchange.

Option 2: Conclude the Double Taxation Agreement

5.25 The negotiation and enactment of this DTA will cost approximately $110,000. Most of these costs would be borne by the ATO, although other agencies, such as the Treasury, the Department of Foreign Affairs and Trade and the Australian Government Solicitor would bear some of these costs. There will also be an unquantified cost in terms of Parliamentary time and drafting resources in enacting the proposed DTA. In the case of this DTA, the overall costs were reduced due to the fact that the treaty was concluded only in the English language (i.e. no foreign language text required verification) and the relative speed at which both sides were able to agree on a satisfactory text.

5.26 There is a `maintenance' cost to the ATO associated with DTAs in terms of dealing with enquiries, mutual agreement procedures and Advance Pricing Agreements, and OECD representation. In some cases arrangements have emerged to exploit aspects of DTAs which have required significant administrative attention. Of course it is unknown whether such arrangements will emerge in relation to this particular DTA. There is therefore an unquantified cost in administering a DTA. There will also be minor implementation costs to the ATO relating to changes in withholding tax rates.

5.27 A DTA is not expected to result in increased compliance costs for taxpayers.

5.28 There might be some reduction in Australian Government revenue from the taxation of South African investments and other business activities in Australia (because, for example, a DTA restricts source country taxation of certain items of income). On the other hand, limitation of South African taxation rights in circumstances where Australia may have given credit for South African taxation may lead to increased Australian tax revenue.

5.29 A further consequence of the DTA is that the taxing right limitations agreed to by the 2 countries will place limits on each country's policy flexibility in relation to cross-border taxation. However, because Australia already has a substantial treaty network, the effect of concluding a DTA, in terms of a reduced policy flexibility, will only be marginal.

Assessment of benefits

Option 1: No further action rely on existing unilateral measures

5.30 This option represents the status quo. By adopting this option there would be no need for further action and resources could be devoted to other issues. In the domestic context, the 2 Governments would be free to act without being restricted by tax treaty obligations.

Option 2: Conclude the Double Taxation Agreement

5.31 A DTA with South Africa would have the following broad effects:

•

Where Australians invest directly in South Africa, South Africa would not generally be able to tax an Australian resident unless the resident carries on business through a permanent establishment in South Africa. A DTA would, to some extent, establish a basis for allocation of profits to that permanent establishment. A DTA would also establish specific rules for taxation of shipping profits and income from real property.

•

Likewise, for Australians investing through a South African subsidiary, a DTA would set out an internationally accepted framework for dealing with parent-subsidiary transactions and other transactions between associated enterprises. In this regard, a DTA clearly offers superior protection to the domestic rules of the 2 countries because it would provide for mutual agreement to be reached between the 2 taxing authorities.

•

To some extent, the rules embodied in a DTA would reduce the risks for Australians investing in South Africa (and vice versa) because a DTA records agreement between the 2 Governments on a framework for taxation of cross-border investments. Especially in the case of mining investments which cannot easily be relocated, this reduction in risk may be quite important. ^[F2]

•

A DTA would reduce South African taxation on royalties thereby making Australian suppliers of technology more competitive. Reduction in source country taxation would also be likely to result in timing advantages for such investors, because the source country taxation is generally withheld when the income is derived, whereas residence taxation is generally taxed after the close of the financial year. The Australian Revenue might also benefit to the extent that greater after tax profits are remitted to Australia and subject to Australian tax. Of course there would be similar advantages in relation to South African investment in Australia. Again, a DTA would assist Australian investors by increasing the certainty of the taxation rules applying to cross-border investment.

•

A DTA would limit the dividend withholding tax (DWT) and interest withholding tax rates which may be imposed by each country. However, each country's current domestic treatment of such payments means that the practical effect of such limits for Australian suppliers of capital would be minimal. (Under its domestic law, South Africa does not currently impose a DWT ^[F3] and only imposes tax on interest accruing to nonresidents from South African sources in very limited circumstances. In Australia's case, the main practical effect would be the lowering of the DWT rate imposed on unfranked dividends.)

•

Commodity exporters would be assisted in some respects because of the way a DTA would restrict the circumstances in which Australians trading with South Africa are taxed by requiring the existence of a permanent establishment in South Africa before South African taxation could take place.

•

A DTA would also assist in making clear the taxation arrangements for individual Australians working in South Africa, either independently as consultants or as employees. Income from professional services and other similar activities provided by an individual would generally be taxed only in the country in which the recipient is resident for tax purposes. However, remuneration derived by a resident of one country in respect of professional services rendered in the other country might be taxed in the latter country, where derived through a fixed base of the person concerned in that country, or if the person was present for more than 183 days in that country.

•

Employees' remuneration would 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 would generally be exempt in the country visited.

•

There are important impacts on the Governments which are party to a DTA. A DTA would assist the bilateral relationship by adding to the existing network of commercial treaties between the 2 countries. As mentioned, a DTA would also promote greater cooperation between taxation authorities to prevent fiscal evasion and tax avoidance.

5. Consultation

5.32 Information on the DTA has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties' Schedule of Treaty Action.

5.33 The ATO recently established an Advisory Committee of private sector representatives and tax practitioners to review draft treaties. The DTA was submitted to this Committee for review in February 1998.

5.34 The DTA will be considered by the Parliamentary Joint Standing Committee on Treaties, which will probably provide for public consultation in its hearings.

5.35 The Treasury and the ATO monitor DTAs, as part of the whole taxation system, on an ongoing basis. In addition, the ATO has consultative arrangements in place to obtain feedback from professional and small business associations and through other taxpayer consultation forums.

6. Conclusion and recommended option

5.36 Present unilateral arrangements for elimination of double taxation go much of the way to satisfying the policy objectives of this measure. However, while these arrangements provide some measure of protection against double taxation, it is clear a DTA will further reduce the possibility of double taxation especially in relation to associated enterprises. By establishing an internationally accepted framework for taxation of cross-border transactions it will also reduce investor risk. In addition, the DTA reduces source country withholding taxes. The DTA is unlikely to result in increased compliance costs for business.

5.37 There will be benefits to both Australia and South Africa in terms of improved bilateral relationships and information exchange. On the other hand, the DTA will reduce the government's policy flexibility.

5.38 On balance, the benefits of the proposed DTA outweigh the costs. Option 2 is therefore recommended as the preferred option.

Protocol to the Australia-Malaysia Double Tax Agreement (DTA) and the Exchange of Letters to extend tax sparing

1. Specification of policy objective

5.39 The 2 key objectives of the Protocol to the Australia-Malaysia Double Tax Agreement (the DTA) are to:

•

overcome the double taxation situation currently facing Australian residents who are in receipt of fees for technical services paid by Malaysian residents; and

•

ensure the tax sparing provisions of the existing DTA reflect changes in Malaysian tax incentive legislation and to extend tax sparing relief for a further period of time. Tax sparing occurs where the tax forgone by a country in providing certain tax concessions to Australian investors is deemed to have been paid for the purposes of Australia's foreign tax credit system (FTCS). In the absence of tax sparing, such concessions may, in some circumstances, be negated by the FTCS which `tops up' foreign taxes paid to the level of tax that would be due on an equivalent amount of domestic income.

5.40 The Protocol will also update the existing DTA in a number of respect to bring it into line with Australia's current law and treaty policies and practices.

Background

5.41 The DTA was signed in 1980. It contains tax sparing provisions under which Australia undertook to provide tax sparing for certain business and non-business income tax incentives provided by Malaysia under its investment promotion measures. The DTA provided for the tax sparing provisions to apply for an initial 5 year period (which expired at the end of the 1983-1984 year of income) and for that period to be extended for any further period that may be agreed by the respective Governments in an Exchange of Letters for that purpose.

5.42 During negotiations held in July 1989, Malaysia sought Australia's agreement to an extension of the operation of the tax sparing provisions for a further 10 years. Those negotiations also discussed the treatment of fees for technical services income under the DTA. Australia's position on the taxation of fees for technical services is that such fees represent business profits and under a DTA should be taxed only by the country of residence of the recipient unless the profits are attributable to a business carried on through a permanent establishment or fixed base in the other country. Malaysia, on the other hand, has been imposing a withholding tax of 15% (recently reduced to 10%) on the gross payments made to Australian resident taxpayers for certain managerial, technical or consultancy services utilised in Malaysia, irrespective of where the services are performed. This impasse has led to a number of cases of unrelieved double taxation for some Australian resident taxpayers.

5.43 In order to meet the position of Australian residents who invested in Malaysia post 1983-1984, the negotiating package approved by the former Government for the July 1989 talks provided for a `tidy up' of tax sparing for the income years prior to commencement of the foreign tax credit system (i.e. for the 1985, 1986 and 1987 years of income) under the existing Exchange of Letters mechanism of the DTA. In addition, it authorised the provision of tax sparing for the revised tax incentive measures nominated by Malaysia for a further 5 year period (i.e. until the 1991-1992 year of income) as part of an amending Protocol provided that a satisfactory result could be reached with Malaysia on the fees for technical services issue.

5.44 A draft Exchange of Letters and amending Protocol to that effect resulted from the July 1989 talks but were not able to be implemented earlier because the Malaysian Cabinet did not formally approve of the fees for technical services provision of the draft Protocol until November 1992. Further discussions were held in May 1995 in an attempt to overcome the delays and misunderstandings that had arisen in relation to earlier efforts to finalise the Exchange of Letters. The resolution of these issues was further delayed by the sensitive diplomatic situation then existing between Australia and Malaysia. The settlement of the last of the drafting and technical adjustments to the amending Protocol has now been settled by correspondence.

5.45 The Protocol is scheduled for signature on 2 August 1999. An Exchange of Letters under the existing agreement to extend the operation of the tax sparing provisions until 30 June 1987 is proposed before the end of 1999.

2. Identification of implementation option(s)

5.46 An Exchange of Letters between Australia and Malaysia and the renegotiation of the existing DTA is the only way to achieve bilateral agreement in relation to all the above objectives.

3. Assessment of impacts (costs and benefits) of option

Impact group identification

5.47 The Protocol is likely to have an impact on:

•

Australian residents doing business with Malaysia, including principally;

-

Australian residents supplying consultancy services to Malaysian residents (at least 20 cases of double taxation of such services have been brought to the ATO's attention);

-

Australian residents supplying technology and know-how to Malaysian residents; and

-

Australian residents investing in, lending to and receiving royalty income from Malaysia;

•

the Governments of Australia and Malaysia; and

•

the ATO and the Malaysian tax authority.

Assessment of costs

5.48 The Protocol is not expected to result in increased administration costs for the ATO because the protocol further clarifies the taxing rights of Australia and Malaysia under the existing DTA.

5.49 The Protocol is unlikely to result in increased compliance costs for business because no extra burden to comply is placed on them by the protocol.

5.50 In relation to the fees for technical services, it is unlikely there will be a cost to the Australian Revenue because in most cases the affected Australian residents will continue to be liable to tax in Australia (if they do not have a permanent establishment in Malaysia) on the fees for technical services that they provide to Malaysian residents.

5.51 It is not possible to quantify with any degree of precision the tax likely to be forgone by the Australian Revenue in providing tax sparing credits for the Malaysian tax incentives. Much is dependent on the amount of the income subject to tax sparing, the amount of the Malaysian tax reduction or exemption applicable in respect of the particular income, the nature of the investment income, the legal structures used by Australians to make these investments, their need to remit or reinvest the income and their ability to utilise the tax spared foreign tax credits. The presently available information and statistics are of little help in these regards.

5.52 A further complication relates to the fact that the tax sparing provisions of the protocol relate only to tax sparing granted by Malaysia for years of income up to and including the Australian year ended 30 June 1992. The amount of likely revenue forgone will to some extent be subject to taxpayers making a claim for amendment of tax assessments issued several years ago. The taxpayers that are likely to do this cannot be determined with any great certainty.

5.53 In relation to the period covered by the Exchange of Letters (i.e. the period from 1 July 1984 to 30 June 1987 inclusive) most foreign income was exempt from Australian tax and therefore little revenue loss would be expected to arise in relation to this period.

5.54 Subject to the above qualifications, an annual cost to Australian Revenue of around $A1 to 2million is estimated, with the greatest cost likely to occur towards the end of the period covered by the tax sparing provisions (i.e. 30June1992).

5.55 It is relevant that the tax sparing measures in the proposed Exchange of Letters and amending Protocol with Malaysia were found necessary during negotiations to secure its agreement to other measures in the Protocol. These include Malaysia limiting its taxing rights over fees derived by Australian companies for services utilised in Malaysia which will resolve a long standing dispute over unrelieved double taxation of such fees.

Assessment of benefits

5.56 Australian residents who are in receipt of fees for technical services paid by Malaysian residents will benefit because such fees will no longer be double taxed.

5.57 Clarification of which Malaysian tax laws qualify for tax sparing will reduce compliance costs for Australian investors, seeking to take advantage of the tax sparing provisions.

5.58 General improvements to the text of the DTA consistently with international best practice is expected to assist the 2 governments and their residents in interpreting the DTA.

5.59 The Protocol will further assist the development of trade and economic cooperation between Australia and Malaysia.

5.60 Resolution of the issues on fees for technical services and tax sparing in the Protocol is likely to reduce the administration costs of the ATO.

Consultation

5.61 The issues of fees for technical services and tax sparing have been consistently brought to our attention over the years by various Australian enterprises doing business in Malaysia.

5.62 Information on the Protocol and Letters has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties' Schedule of Treaty Action.

5.63 The ATO recently established an Advisory Committee of private sector representatives and tax practitioners to review draft treaties. The Protocol was submitted to this Committee for review in February 1998.

5.64 The Protocol will be considered by the Parliamentary Joint Standing Committee on Treaties, which will probably provide for public consultation in its hearings.

4. Conclusion

5.65 The Protocol would stop the double taxation of Australian residents who are in receipt of fees for technical services paid by Malaysian residents.

5.66 The Protocol will clarify the operation of the tax sparing provisions of the existing DTA.

5.67 The Protocol is unlikely to result in increased compliance costs for business because no extra burden to comply is placed on them by the Protocol.

5.68 The Treasury and the ATO will monitor this Protocol, as part of the whole taxation system, on an ongoing basis. In addition, the ATO has consultative arrangements in place to obtain feedback from professional and small business associations and through other taxpayer consultation forums.

Australia-Slovak Republic Double Tax Agreement

1. Specification of policy objective

5.69 The 2 key objectives of the Australia-Slovak Republic Double Tax Agreement (DTA) are to:

•

promote closer economic cooperation between Australia and the Slovak Republic by eliminating possible barriers to trade and investment caused by the overlapping taxing jurisdictions of the 2 countries. A DTA would provide a reasonable element of legal and fiscal certainty within which cross-border trade and investment can be carried on; and

•

create a framework through which the tax administrations of Australia and the Slovak Republic can prevent international fiscal evasion.

2. Background

How a DTA operates

5.70 Australian tax treaties are usually based on the OECD Model. There are also some influences from the UN Model. In addition, both countries have proposed some minor variations to reflect their economic interests and legal circumstances.

5.71 A DTA reduces double taxation caused by the overlap of taxing jurisdictions because treaty partners agree to limit their taxing rights over various types of income. The countries also agree on methods of reducing double taxation where both countries have a right to tax. For example, a DTA contains a standard tax treaty provision that neither country will tax business profits derived by residents of the other country unless the business activities in the taxing country are substantial enough to constitute a permanent establishment and the income is attributable to that permanent establishment.

5.72 In negotiating the sharing of taxing rights, Australia seeks an appropriate balance between source and residence country taxing rights. Generally the allocation of taxing rights under a DTA is similar to international practice as set out in the OECD Model, but (consistent with Australian practice) there are a number of instances where it leans more towards source country taxing rights: the definition of `permanent establishment' is wider in some respects than the OECD Model, and the Business Profits, Ships and Aircraft , Royalties, Alienation of Property and Income Not Expressly Mentioned Articles also give greater recognition to source country taxing rights.

5.73 In addition, a DTA provides an agreed basis for determining whether the income returned or expenses claimed on related party dealings by members of a multinational group operating in both countries can be regarded as acceptable. This is an example of how a DTA is used to address international profit shifting.

5.74 To prevent fiscal evasion, a DTA includes an exchange of information facility. The 2 tax administrations can also use the mutual agreement procedures to develop a common interpretation and resolve differences in application of the DTA. There is also provision for residents of either country to instigate a mutual agreement procedure.

Australia's Investment and Trade Relationship with the Slovak Republic ^[F4]

5.75 So far as Australia is concerned, the main impact of the DTA will be on Australian enterprises investing in and trading with the Slovak Republic. In 1998-1999 Australia exported products totalling $A4.2 million, with the major exports being wool, bovine meat and computers. In the same period Australia's imports from the Slovak Republic totalled $A8.2 million, with the major imports being computer parts, nitrogen-function compounds and articles of plastics. Even though Australia's current investment and trade relationship with the Slovak Republic is not substantial, this treaty should assist in improving the bilateral framework for investment and trade with the Slovak Republic.

3. Identification of implementation option(s)

5.76 The implementation options for achieving the policy objectives are:

1.

no further action rely on existing unilateral measures; or

2.

conclude the DTA.

Option 1: No further action rely on existing unilateral measures

5.77 If a DTA is not concluded with the Slovak Republic, some of the policy objectives sought to be achieved by means of a DTA may nevertheless be achieved through the domestic tax laws of both the Slovak and Australian Governments although both countries are free to amend their internal laws. Essentially, DTA policy objectives are achieved by:

•

allocating taxing rights over various classes of income, profits and gains between the Contracting States on the basis of source or residency;

•

specifying the methods to be used in providing relief from double taxation where both countries have a taxing right;

•

facilitating the prevention of fiscal evasion by specifying the circumstances in which information may be exchanged while at the same time according that information the same protection from disclosure that applies under the relevant domestic law; and

•

providing a mechanism to allow taxpayers who consider that the taxation treatment has not been in accordance with the terms of a DTA to invoke procedures which require the relevant tax authorities to try to agree on resolving the issue.

5.78 Where the domestic law provides a credit for foreign tax paid on foreign income, the double tax relief can be substantially achieved without a DTA. For example, where income derived by a taxpayer is subject to tax in both the country of residence and the source country Australia's foreign tax credit system provides relief from such juridical double taxation. However, a DTA guarantees that double tax relief will continue to be provided by both countries.

Option 2: Conclude the DTA

5.77 The internationally accepted approach to meeting the above policy objectives is to conclude a bilateral DTA. ^[F5] A DTA would regulate the ways in which 2 countries will reduce double taxation by agreeing to the terms under which they will restrict their taxing rights over various types of income. A DTA may also record important bilateral undertakings in relation to exchange of information which can be of considerable assistance in preventing fiscal evasion.

5.80 For business and investors generally a DTA has the advantage of providing some degree of legal and fiscal certainty unlike domestic laws which can be amended unilaterally.

5.81 As mentioned earlier, a DTA would be largely based on the OECD Model Tax Convention and the UN Model, with some mutually agreed variations reflecting the economic, legal and cultural interests of the 2 countries.

4. Assessment of impacts (costs and benefits) of each option

Impact group identification

5.82 A DTA with the Slovak Republic is likely to have an impact on:

•

Australian residents doing business with the Slovak Republic, including principally;

-

Australian residents investing directly in the Slovak Republic (either by way of a subsidiary or a branch);

-

Australian banks lending to Slovak borrowers;

-

Australian residents supplying technology and know-how to residents of the Slovak Republic;

-

Australian residents exporting to the Slovak Republic; and

-

Australian residents supplying consultancy services to residents of the Slovak Republic;

•

Australian employees working in the Slovak Republic;

•

people receiving pensions from the other country (although the number of cross border pension payments is understood to be minimal); and

•

the ATO.

Assessment of costs

Option 1: No further action rely on existing unilateral measures

5.83 As this option represents a continuance of the current position, it would be expected that the administration and compliance costs of this option would be minimal. Revenue costs would also be expected to be very small.

5.84 On the other hand, even though both countries have unilaterally introduced measures to prevent double taxation of cross-border investments, this option will not resolve all areas of difference. For example, even if both countries had very similar mechanisms for allowing credit for foreign tax paid differences could arise over fundamental matters such as the source of income and residence of taxpayers. Furthermore this option does not protect against further unilateral changes to the internal laws and does not limit source country taxing of, for example, dividends, interest and royalties.

5.85 In addition, investors are concerned that unilateral tax laws do not provide the longer term certainty desirable for making substantial long term investments offshore. This is because the Governments of either State can vary key tax conditions unilaterally. Similarly, so far as the tax administrations are concerned, unilateral rules do not provide a dependable long term framework for the exchange of information.

Option 2: Conclude the DTA

5.86 The negotiation and enactment of this DTA will cost approximately $120,000. Most of these costs would be borne by the ATO, although other agencies, such as Treasury, the Department of Foreign Affairs and Trade and the Australian Government Solicitor would bear some of these costs. There will also be an unquantifiable cost in terms of Parliamentary time and drafting resources in enacting the proposed DTA.

5.87 There is a `maintenance' cost to the ATO associated with DTAs in terms of dealing with enquiries, mutual agreement procedures and advance pricing agreements, and OECD representation. In some cases arrangements have emerged to exploit aspects of DTAs which have required significant administrative attention. Of course it is unknown whether such arrangements will emerge in relation to this particular DTA. There is therefore an unquantified cost in administering a DTA. There will also be minor implementation costs to the ATO in relation to changes in withholding tax rates.

5.88 A DTA is not expected to result in increased compliance costs for taxpayers.

5.89 There might be some reduction in Australian Government revenue from the taxation of Slovak investments and other business activities in Australia (because, for example, the DTA restricts source country taxation of certain items of income). On the other hand, limitation of Slovak taxation rights in circumstances where Australia may have given credit for Slovak taxation may lead to increased Australian tax revenue. Given the small investment and trade relationship between our 2 countries, the revenue cost is not expected to be significant.

5.90 However, it should also be recognised that the limitations agreed to by the 2 Contracting States, places limits on their policy flexibility in relation to cross-border taxation. But because Australia already has a substantial treaty network, the cost of a DTA in terms of reduced policy flexibility will only be marginal.

Assessment of benefits

Option 1: No further action rely on existing unilateral measures

5.91 This option represents the status quo. If this option were adopted there would be no need for further action and resources could be devoted to other issues. In the domestic context the 2 Governments would be free to act without being restricted by treaty obligations.

Option 2: Enter into a DTA

5.92 A DTA with the Slovak Republic would have the following broad effects:

•

Where Australian businesses invest directly in the Slovak Republic or provide services in that country, the Slovak Republic will not generally be able to tax the profits unless the Australian enterprise carries on business through a permanent establishment in the Slovak Republic. In the case of the furnishing of services this will generally be the case where the services are provided for longer than 6 months. A DTA would, to some extent, establish a basis for the allocation of profits to that permanent establishment. A DTA would also establish specific rules for taxation of airline and shipping profits and income from real property.

Similarly, for Australians investing through a Slovak subsidiary, a DTA would set out an internationally accepted framework for dealing with parent-subsidiary transactions and other transactions between associated enterprises. In this regard a DTA clearly offers superior protection compared to the domestic rules of the 2 countries, because it provides for mutual agreement to be reached between the 2 taxing authorities.

To some extent, the rules embodied in a DTA will reduce the risks for Australians investing in the Slovak Republic (and vice versa) because a DTA records agreement between the 2 Governments on a framework for taxation of cross-border investments.

Furthermore, it is only in the context of a DTA ^[F6] that the Slovak Republic will agree to limit domestic withholding taxes on interest and royalties. (Australia reduces royalty and certain dividend withholding taxes under its DTAs.)

•

A DTA would reduce Slovak taxation on interest and royalties thereby making Australian suppliers of capital and technology more competitive. Reduction in taxation at source would also be likely to result in timing advantages for such investors because source country taxation is generally imposed at the time the income is derived, whereas residents are generally taxed by assessment on income derived during a financial year after the end of that financial year. The Australian revenue might also benefit to the extent that greater after tax profits are remitted to Australia and subject to Australian tax. Of course, there are similar advantages in relation to Slovak investments in Australia. Again a DTA would assist Australian investors by increasing the certainty of the taxation rules applying to cross-border investment.

•

Commodity exporters would be assisted in some respects because of the way a DTA would restrict the circumstances in which Australians trading with the Slovak Republic are taxed by requiring the existence of a permanent establishment in the Slovak Republic before Slovak taxation could take place. However, in practice this benefit would not be great because the Slovak Republic's domestic taxing rules adopt a similar approach and, existing commodity exports to the Slovak Republic are only modest.

•

A DTA would also assist in making clear the taxation arrangements for individual Australians working in the Slovak Republic, either independently as consultants or as employees. Income from professional services and other similar activities provided by an individual would generally be taxed only in the country in which the recipient is resident for tax purposes. However, income derived by a resident of one country in respect of professional services rendered in the other country might be taxed in the latter country where the services are attributable to a fixed base that is regularly available in that country.

•

Employees' remuneration would 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 would generally be exempt in the country visited.

•

There are important impacts on the countries which are party to a DTA. As mentioned the revenue impact for the Australian Government is not expected to be significant. A DTA would assist the bilateral relationship by adding to the existing network of commercial treaties between the 2 countries. As mentioned, a DTA would also promote greater cooperation between taxation authorities to prevent fiscal evasion and tax avoidance.

5. Consultation

5.93 Information on the DTA has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties' Schedule of Treaty Action.

5.94 The ATO recently established an Advisory Panel of private sector representatives and tax practitioners to review draft treaties. The DTA was submitted to this Committee for review in February 1998.

5.95 The DTA will be considered by the Parliamentary Joint Standing Committee on Treaties, which will probably provide for public consultation in its hearing.

5.96 The Treasury and the ATO monitor DTAs, as part of the whole taxation system, on an ongoing basis. In addition the ATO has consultative arrangements in place to obtain feedback from professional and small business associations and through other taxpayer consultation forums.

6. Conclusion and recommended option

5.97 Present unilateral arrangements for elimination of double taxation go much of the way towards satisfying the policy objectives of this measure. However, while these arrangements provide some measure of protection against double taxation, it is clear a DTA will further reduce the possibility of double taxation, especially in relation to associated enterprises. By establishing an internationally accepted framework for the taxation of cross-border transactions it will also reduce investor risk. In addition, a DTA will also reduce source country withholding taxes on dividends, interest and royalties. A DTA is unlikely to result in increased compliance costs for business.

5.98 There will be benefits to both Australia and the Slovak Republic in terms of improved bilateral relationships and information exchange. On the other hand the DTA will reduce the governments' policy flexibility.

5.99 On balance, the benefits of the proposed DTA outweigh the costs. Option 2 is therefore recommended as the preferred option.

Australia-Argentina Double Tax Agreement

1. Specification of policy objective

5.100 The 2 key objectives of the Australia-Argentina Double Tax Agreement (the DTA) are to:

•

promote closer economic cooperation between Australia and Argentina by eliminating possible barriers to trade and investment caused by the overlapping taxing jurisdictions of the 2 countries; and

•

create a framework through which the tax administrations of Australia and Argentina can prevent international fiscal evasion.

5.101 In the pursuit of these objectives, the DTA will provide a reasonable element of legal and fiscal certainty within which cross border and trade investments can be carried on.

2. Background

How the DTA operates

5.102 The proposed treaty is based on the OECD Model. There are also some influences from the UN Model. In addition both countries have proposed variations to reflect their economic interests and legal circumstances.

5.103 The DTA will reduce or eliminate double taxation caused by the overlapping taxing jurisdictions, because under the treaty Australia and Argentina agree (in specified situations) to limit taxing rights over various types of income. The countries also agree on methods of reducing double taxation where both countries have a right to tax. For example, the DTA contains the standard tax treaty provision that neither country will tax business profits derived by residents of the other country unless the business activities in the taxing country are substantial enough to constitute a permanent establishment and the income is attributable to a permanent establishment (Article 7).

5.104 In negotiating the sharing of taxing rights, Australia seeks an appropriate balance between source and residence country taxing rights. Generally the allocation of taxing rights under the DTA is similar to international practice as set out in the OECD Model, but (consistently with Australian practice) there are a number of instances where it is biased more towards source country taxing rights: the definition of `permanent establishment' is wider in some respects than the OECD Model, and the Business Profits, Royalties , Ships and Aircraft , Alienation of Property and Other Income Articles also give greater recognition to source country taxing rights. Furthermore, Argentine taxing rights over certain fees for technical services are wider than the OECD or UN standards.

5.105 In addition, the DTA provides an agreed basis for determining whether the income returned or expenses claimed on related party dealings by members of a multinational group operating in both countries can be regarded as acceptable. (Articles 7 and 9)

5.106 The operation of Articles 7 and 9 in this respect, also provides an example of how the DTA is used to address international profit shifting. To prevent fiscal evasion, the DTA includes an exchange of information facility. In addition, the 2 tax administrations can use the mutual agreement procedures to develop a common interpretation and resolve differences in application of the DTA.

Australia's Investment and Trade Relationship with Argentina ^[F7]

5.107 So far as Australia is concerned, the main impact of a DTA will be on Australian enterprises investing in and trading with Argentina. While trade between the 2 countries remains modest, 2 way trade at around $A244 million in the 1998 year, Australian investment in Argentina is significant.

5.108 Australian investors have mainly targeted mining resulting in Australia being the third largest investors in the industry. There are numerous Australian companies involved, working under exploration leases and evaluating projects, with the most significant operation being a $US1 billion MIM/North project to develop copper and gold deposits in the province of Catamarca.

5.109 Australian investors are also active in upgrading and operating the largest container terminal in the port of Buenos Aires, as well as being involved in cold storage, ship brokering, multiplex cinema complexes and banking. Qantas has initiated direct flights from Australia to Buenos Aires and Prime television has become the first foreign investor in Argentine free-to-air television through their joint venture with a local media group which purchased Argentina Channel 9. Other companies currently engaged in trade and investment in Argentina are: BHP, ANZ, Western Mining, LIAG, P & O Australia, Village Roadshow, Hoyts and the Australian Geographical Survey Organisation. ^[F8]

3. Identification of implementation option(s)

5.110 In analysing the advantages and disadvantages of the proposed tax treaty, 2 implementation options are considered below:

1.

no further action rely on existing unilateral measures; or

2.

conclude the double tax agreement

Option 1: No further action rely on existing unilateral measures

5.111 If nothing was done i.e. the DTA was not concluded it could be argued that many of the above policy objectives will nevertheless be achieved. Many of the policy objectives have already been met to a significant extent through the internal tax laws of both the Argentine and Australian Governments. For example unilateral enactment of foreign source income measures by Australia already provides substantial relief from juridical double taxation. Likewise it can be argued that Australian law already permits exchange of information with the Argentine tax administration.

Option 2: Conclude the Double Taxation Agreement

5.112 The internationally accepted approach to meeting the above policy objectives is to conclude a bilateral DTA. ^[F9] The DTA regulates the way the 2 countries will reduce double taxation, by agreeing to restrict their taxing rights in accordance with its terms. The DTA also records important bilateral undertakings in relation to exchange of information.

4. Assessment of impacts (costs and benefits) of each option

Impact group identification

5.113 The DTA is likely to have an impact on:

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Australian residents doing business with Argentina, including principally;

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Australian residents investing directly in Argentina (either by way of subsidiary or a branch);

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Australian banks lending to Argentine borrowers;

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Australian residents supplying technology and know-how to Argentine residents;

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Australian residents exporting to Argentina; and

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Australian residents supplying consultancy services to Argentine residents;

•

Australian employees working in Argentina;

•

people receiving pensions from the other country (although the number of cross border pension payments is understood to be minimal.); and

•

the ATO.

Assessment of costs

Option 1: No further action rely on existing unilateral measures

5.114 Because this option can be largely achieved by doing nothing, it would be expected that the administration and compliance costs of this option would be minimal. Revenue costs would also be expected to be very small. On the other hand, even though both countries have unilaterally introduced measures to prevent double taxation of cross-border investments, this option will not resolve all areas of difference; for example, Argentina imposes a tax on technical services income sourced in Australia, which, in the absence of a DTA will be double taxed. Furthermore, investors are concerned that unilateral tax laws do not provide the longer term certainty desirable for making substantial long term investments offshore. This is because the Governments of either State can vary key tax conditions unilaterally. Similarly, so far as the tax administrations are concerned, unilateral rules do not provide a dependable long term framework for information exchange.

Option 2: Conclude the Double Taxation Agreement

5.115 The negotiation and enactment of this DTA will cost approximately $130,000. Most of these costs will be borne by the ATO, although other agencies, such as Treasury, the Department of Foreign Affairs and Trade and the Australian Government Solicitor will bear some of these costs. There will also be an unquantified cost in terms of Parliamentary time and drafting resources in enacting the proposed DTA.

5.116 There is a `maintenance' cost to the ATO associated with DTAs in terms of dealing with enquiries, mutual agreement procedures and advance pricing agreements, and OECD representation. In some cases arrangements have emerged to exploit aspects of DTAs which have required significant administrative attention. Of course it is unknown whether such arrangements will emerge in relation to this particular DTA. There will also be minor implementation costs to the ATO in relation to changes in withholding tax rates.

5.117 The DTA is not expected to result in increased compliance costs for taxpayers.

5.118 There may be some reduction in Australian Government revenue from taxation of Argentine investments and other business activities in Australia (because the treaty restricts source country taxation of certain items of income and certain Argentine taxes which are not currently creditable will be deemed creditable following the conclusion of a DTA). On the other hand, limitation of Argentine taxation rights in circumstances where Australia may have given credit for Argentine taxation may lead to increased Australian tax revenue especially in relation to interest and fees for technical services.

5.119 However, it should also be recognised that the limitations agreed to by the 2 Contracting States under the DTA, limits flexibility of their policy in relation to cross-border taxation. However, as Australia already has a substantial treaty network the conclusion of the proposed DTA, in terms of a reduced policy flexibility, will only be marginal.

Assessment of benefits

Option 1: No further action rely on existing unilateral measures

5.120 This option represents the status quo. By adopting this option there would be no need for further action and resources could be devoted to more significant issues. In the domestic context the 2 Governments would be free to act without being restricted by treaty obligations.

Option 2: Conclude the Double Taxation Agreement

5.121 The proposed DTA will have the following broad effects:

•

As mentioned, the current level of Australian investment in Argentina is substantial and mainly concentrated in the mining sector.

•

Where Australians invest directly in Argentina, Argentina will not generally be able to tax the Australian resident unless the resident carries on business through a permanent establishment in Argentina. The treaty will, to some extent, establish a basis for allocation of profits to that permanent establishment. The DTA also establishes specific rules for taxation of shipping profits and income from real property.

Likewise for Australians investing through an Argentine subsidiary, the treaty will set out an internationally accepted framework for dealing with parent-subsidiary transactions and other transactions between associated enterprises. In this regard the DTA clearly offers superior protection to the domestic rules of the 2 countries, because it provides for mutual agreement to be reached between the 2 taxing authorities.

To some extent, the rules embodied in the DTA will reduce the risks for Australians investing in Argentina (and vice versa) because the DTA records agreement between the 2 Governments on a framework for taxation of cross-border investments. Especially in the case of mining investments which cannot easily be relocated, this reduction in risk may be quite important. ^[F10]

The treaty will reduce Argentine taxation on royalties thereby making Australian suppliers of technology more competitive. Most royalty withholding taxes will fall from 24% to 10% or 15%. The DTA will limit taxation of dividends paid to Australian shareholders.

In practice no dividend withholding taxes are currently imposed in Argentina, but there are proposals to introduce a tax on dividends. Thus, Australian suppliers of capital will remain competitive if dividend withholding taxes are introduced. Reduction in source country taxation is also likely to result in timing advantages for such investors, because the source country taxation is generally withheld when the income is derived, whereas residence taxation is generally taxed after the close of the financial year. It is anticipated that the Australian revenue may also benefit to the extent that greater after tax profits are remitted to Australia and subject to Australian tax. Of course there are similar advantages in relation to any Argentine investment in Australia. Again the DTA will assist Australian investors by increasing the certainty of the taxation rules applying to cross-border investment.

•

Commodity exporters are assisted in some respects because of the way the treaty will restrict the circumstances in which Australians trading with Argentina will be taxed by requiring the existence of a permanent establishment in Argentina before Argentine taxation will take place. Although it should be noted that existing commodity exports to Argentina are only modest at $A118 million in the 1997 year.

•

The treaty will also assist in making clear the taxation arrangements for individual Australians working in Argentina, either independently as consultants or as employees. Income from professional services and other similar activities provided by an individual will generally be taxed only in the State in which the recipient is resident for tax purposes. However, remuneration derived by a resident of one State in respect of professional services rendered in the other State may be taxed in the latter State, where derived through a fixed base of the person concerned in that State, or if the person is present for more than 183 days in that State.

Notwithstanding the above, the DTA permits Argentina to impose a contractors withholding tax on payments of technical services fees by Argentine residents. This right extends to payments for services which may technically be Australian sourced. However, the DTA reduces the (monetary) rates from 18% to 27% of gross payments to 10% of net fees.

Employee's remuneration will generally be taxable in the State where the services are performed. However, where the services are performed during certain short visits to one State by a resident of the other State, the income will generally be exempt in the State visited.

•

Similar to other DTAs, the treaty contains the facility by which in an exchange of letters between relevant ministers of the 2 Governments, individual Argentine tax incentives may be tax-spared. Tax sparing is a system of relief under which Australia would recognise tax forgone by Argentina under its development incentives for foreign tax credit purposes. No incentives have been nominated by Argentina and it is current Australian Government policy generally not to agree to tax sparing.

•

The most favoured nation clause of the DTA ensures that if Argentina were to subsequently enter into another treaty with a third party with more favourable tax rates for dividends, interest, royalties or contractors withholding taxes, the corresponding tax rate in the DTA would automatically be reduced to coincide with the greater of the lower rate or the set minimum limit.

•

There are important impacts on the Governments which are party to the DTA. The DTA will assist the bilateral relationship by adding to the existing network of commercial treaties between the 2 countries. As mentioned the DTA will promote greater cooperation between taxation authorities to prevent fiscal evasion and tax avoidance.

5. Consultation

5.122 Information on the DTA has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties' Schedule of Treaty Action.

5.123 The ATO established an Advisory Panel of private sector representatives and tax practitioners to review draft treaties before enactment. In February and March 1999 members of the Panel provided comments on this DTA and issues of concern were later clarified by the ATO via email and telephone communications.

5.124 The DTA will be subject to scrutiny by the Joint Standing Committee on Treaties, which will probably provide for public consultation in its hearing. This body is charged with the task of examining and reporting to the Parliament on matters arising from treaties or other international instruments.

5.125 The Treasury and the ATO will monitor this DTA, as part of the whole taxation system, on an ongoing basis. In addition the ATO has consultative arrangements to obtain feedback from professional and small business associations and through other taxpayer consultation forums.

6. Conclusion and recommended option

5.126 Present unilateral arrangements for elimination of double taxation go much of the way to satisfying the policy objectives of this measure. However, while these arrangements provide some measure of protection against double taxation, it is clear the DTA will further reduce the possibility of double taxation especially in relation to associated enterprises and consultancy fees. By establishing an internationally accepted framework for taxation of cross-border transactions it will also reduce investor risk. It also reduces certain Argentine withholding taxes. The DTA is unlikely to result in increased compliance costs for business.

5.127 There will be benefits to both Australia and Argentina in terms of improved bilateral relationships and information exchange. On the other hand the DTA will reduce the governments' policy flexibility.

5.128 On balance the benefits of the proposed DTA outweigh the costs. The DTA should be enacted.