Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon. Phillip Lynch, M.P.)Introductory Note
The purpose of this memorandum is to explain the provisions of the Income Tax Laws Amendment (Royalties) Bill 1976, which will amend the Income Tax Assessment Act and the income Tax (International Agreements) Act. The main features of the Bill are:
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- The definition of "royalties" in the Income Tax Assessment Act is to be amended to remove doubts as to its application to payments made to residents of all overseas countries (clause 4).
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- The Income Tax (International Agreements) Act is to be amended to eliminate any doubt that the test in the Australian income tax law for determining whether payments are "royalties" operates in the application of those double taxation agreements which do not have their own definition of the term, but instead provide that terms not defined are to have the meaning given them in the tax law of the country applying the agreement (clause 7).
The income tax law was amended in 1968 in relation to royalties paid to residents of foreign countries. Before the amendments, royalties and amounts in the general nature of royalties paid to non-residents usually escaped Australian tax even though the property or rights giving rise to the payments were used in Australia. This was in part because relevant transactions could be so arranged that the payments had a technical legal "source" outside Australia. A resident of another country is not subject to tax in Australia on income that does not have its "source" in this country.
Another difficulty concerned residents of countries with which Australia had double taxation agreements. While those agreements, in general, sanctioned the imposition of Australian tax on royalties derived by enterprises "resident" in the other countries they provided that Australia was, on a basis of reciprocity, not to tax ordinary business profits of an enterprise which did not have a "permanent establishment" (e.g., branch) in Australia. It was contended that many payments in the general nature of royalties fell into this category of business profits which Australia could not tax.
Payments to non-residents for know-how and as machinery and film rentals were typical of the payments that, for one or other of these reasons, escaped Australian tax before the law was amended in 1968.
The 1968 amendments set out to overcome these deficiencies by adopting a statutory definition of "royalties" and by giving "royalties" as so defined a statutory "source" in Australia. The definition, which was along lines that had by then achieved wide international recognition, was put into the Australian income tax law in the form of a provision that stated that the word "royalties" was to have the meaning that it had in the then newly renegotiated double taxation agreement with the United Kingdom. That definition declared to be royalties a range of payments, including those made as film rentals and for industrial know-how. The statutory source rules - these were also the subject of wide international acceptance - provided that royalties are to be viewed as having a source in Australia when they are paid as an expense of an Australian business.
In subsequent years, double taxation agreements concluded with Japan, Singapore, New Zealand, the Federal Republic of Germany, the Netherlands and France - and given the force of law by the Parliament - adopted the same definition of "royalties" and the same tests of "source" as had the 1968 royalty legislation.
In a recent court case it became necessary to consider the application of the 1968 legislation to know-how payments paid by an Australian company to a company resident in Canada. The Court decided that the payments were not covered by the 1968 law. Although they fell within the description contained in the royalty definition and would, if they had been "royalties", have been given a "source" in Australia by that law, the Court noted that the definition of royalties was that contained in the agreement with the United Kingdom and could not find a clearly expressed intention of the Parliament that the 1968 legislation was to apply to the taxpayer, a resident of Canada. This, of course, carries implications for royalties paid to residents of countries other than Canada and the United Kingdom.
The main purpose of this Bill is, in these circumstances, to re-express the law so as to make it clear in relation to payments to residents of all overseas countries that the law requiring payment of tax on royalties is to operate in the way intended when the 1968 amendments were made.