House of Representatives

Explanatory Memorandum

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

General outline and financial impact

What do we mean by double taxation?

Australia's Double Taxation Agreements (DTAs) are primarily concerned with relieving juridical double taxation, which can be described broadly as subjecting the same income derived by a taxpayer during the same period of time to comparable taxes under the taxation laws of 2 different countries.

Why are DTAs necessary?

Relief from double taxation is desirable because of the harmful effects double taxation can have on the expansion of trade and the movement of capital and people between countries. A DTA supplements the unilateral double tax relief provisions in the respective treaty partner countries' domestic law and clarifies the taxation position of income flows between them.

How do the DTAs work?

The DTAs allocate to the country of source, sometimes at limited rates, a taxing right over various income, profits or gains. It is accepted that both countries possess the right to tax the income of their own residents under their own domestic laws and as such, the DTA wording will not always explicitly restate this rule.

However, where the country of residence is to be given the sole taxing right over certain types of income, profits or gains, this sole right is usually represented by the words shall be taxable only in that country . The agreement also provides that where income, profits or gains may be taxed in both countries, the country of residence (if it taxes) is to allow double tax relief against its own tax for the tax imposed by the country of source. In the case of Australia, effect is given to the relief obligations arising under the DTA by application of the general foreign tax credit system provisions of Australia's domestic law, or relevant exemption provisions of the law where applicable.

What is the purpose of Australia's DTAs?

Australia's DTAs are designed to:

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prevent double taxation and provide a level of security about the tax rules that will apply to particular international transactions by:

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allocating taxing rights between the countries over different categories of income;

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specifying rules to resolve dual claims in relation to the residential status of a taxpayer and the source of income; and

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providing, where a taxpayer considers that taxation treatment has not been in accordance with the terms of a DTA, an avenue for the taxpayer to present a case for determination to the relevant taxation authorities;

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prevent avoidance and evasion of taxes on various forms of income flows between the treaty partners by:

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providing for the allocation of profits between related parties on an arm's length basis;

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generally preserving the application of domestic law rules that are designed to address transfer pricing and other international avoidance practices; and

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providing for exchanges of information between the respective tax authorities.

How is the legislation structured?

DTAs to which Australia is a party appear as Schedules to the International Tax Agreements Act 1953 (Agreements Act). The Agreements Act gives the force of law in Australia to those DTAs. The provisions of the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) are incorporated into and read as one with the Agreements Act. In any cases of inconsistency, the Agreements Act provisions (including the terms of the DTAs) generally override the ITAA 1936 and the ITAA 1997 provisions.

What will this Bill do?

This Bill will amend the Agreements Act to give the force of law in Australia to the following treaties:

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the Agreement between Australia and Romania for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income (Romanian agreement); and

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a second protocol (second Finnish protocol), amending the Agreement between Australia and Finland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Protocol of 12 September 1984 (the 1984 Agreement and Protocol).

Who will be affected by the measures in this Bill?

Taxpayers who, for the purposes of:

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the Romanian agreement are residents of Australia or Romania, and who derive income, profits or gains from Romania or Australia; and

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the second Finnish protocol are residents of Australia or Finland, and who derive income, profits or gains from Finland or Australia.

In what way does this Bill change the Act?

This Bill will make the following changes to the Agreements Act:

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it will insert into subsection 3(1) definitions of the Romanian agreement and the second Finnish protocol and amend the definition of the existing Finnish agreement;

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it will insert new sections 11PA and 11ZJ which will give the force of law in Australia to those treaties; and

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it will add the text of each treaty as Schedules 25A and 45 respectively.

When will these changes take place?

The Romanian agreement will enter into force on the last of the dates on which the treaty partners exchange notes through the diplomatic channel advising each other that all domestic requirements necessary to give the respective treaties the force of law in the respective countries have been completed.

The second Finnish protocol will enter into force 30 days after the date of the later notifications on which the treaty partners exchange notes through the diplomatic channel advising each other that all domestic requirements necessary to give the respective treaties the force of law in the respective countries have been completed.

When the treaties enter into force, from what date will they have effect?

The Romanian agreement will have effect:

In Australia:

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for withholding tax on income that is derived by a nonresident, in relation to income derived on or after 1 January in the calendar year next following the year in which the DTA enters into force; and

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for other Australian taxes, in relation to income, profits or gains of any year of income beginning on or after 1 July in the calendar year next following the year in which the DTA enters into force.

In Romania:

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for taxes on income, profits and gains for the taxable period starting from 1 January of the next calendar year following that in which the DTA enters into force.

The second Finnish protocol will have effect:

In Australia:

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for withholding tax on income that is derived by a nonresident, in relation to income derived on or after 1 July in the calendar year next following that in which the protocol enters into force; and

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for other Australian taxes, in relation to income, profits or gains of any year of income beginning on or after 1 July in the calendar year next following that in which the protocol enters into force.

In Finland:

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for taxes withheld at source, on income derived on or after 1 January in the calendar year next following the year in which the protocol enters into force; and

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for other Finnish taxes, for taxes chargeable for any tax year beginning on or after 1 January in the calendar year next following that in which the protocol enters into force.

The financial impact of this Bill

The Romanian agreement and the second Finnish protocol

The Romanian agreement contained in this Bill generally accords with Australia's other modern comprehensive DTAs and is not expected to have a significant effect on revenue. As with DTAs generally, it is not possible to quantify with any degree of precision the likely revenue effect of the second Finnish protocol.

Compliance costs

No significant additional compliance costs will result from the entry into force of the respective treaties.

Summary of Regulation Impact Statement (RIS)

The Romanian agreement

Impact: Low.

Main points: A DTA with Romania is likely to have an impact on Australian residents with business, investment or employment interests in Romania.

Financial impact: Minor.

Assessment of benefits:

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The DWT rate imposed by Australia and Romania shall be limited to 5% of the gross amount of dividends paid by a company which is a resident of one Contracting State to a resident of the other Contracting State who is beneficially entitled to those dividends, if they are paid out of fully taxed profits and if the receiving company holds directly at least 10% of the capital of the company paying the dividends. In any other case the rate will be 15%.

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A source country tax rate limit of 10% will generally apply for both countries in the case of interest and royalties.

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The DTA will also assist in making clear the taxation arrangements for individual Australians working in Romania, either independently as consultants, or as employees.

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The DTA will assist the bilateral relationship by adding to the existing network of commercial treaties between the 2 countries.

Policy objective: The primary objective is to promote closer economic cooperation between Australia and other countries by eliminating possible barriers to trade and investment. The DTA will reduce or eliminate double taxation of income flows between the treaty partner countries caused by overlapping tax jurisdictions. The DTA will also establish greater legal and fiscal certainty within which cross-border trade and investment can be carried on and promoted.

A further objective is to create a framework for exchange of information and cooperation between the respective tax administrations as a means of combating international tax avoidance and evasion.

The second Finnish protocol

Impact: Low.

Main points: A protocol with Finland is likely to have an impact on Australian residents with business or investment interests in Finland.

Financial impact: Minor.

Assessment of benefits:

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Nil withholding tax will be imposed by either Australia or Finland on dividends paid by a company which is a resident of one Contracting State to a resident of the other Contracting State who is beneficially entitled to those dividends, if the dividends are paid out of fully taxed profits. In any other case, the rate remains at the previously agreed limit of 15%.

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The protocol will further assist the development of trade and economic cooperation between the 2 countries and also update the existing DTA in a number of respect.

Policy objective: The primary objective is to ensure reciprocal exemption from dividend withholding tax (DWT) of dividends paid out of fully taxed company profits to a resident of the other country and to update the existing DTA in a number of respects.

The RIS was tabled in Parliament on 3 April 2000.