House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon. P.J. Keating, M.P.)

AGREEMENT WITH MALTA

Subject to some minor differences, the agreement accords in substantial practical effect with other comprehensive taxation agreements to which Australia is a party. Like them, the agreement allocates the right to tax some income to the country of source, sometimes at limited rates, while the country of residence is given the sole right to tax other types of income. It contains provisions to the effect that where income may be taxed in both countries, the country of residence, if it taxes, is to allow a credit against its own tax for the tax imposed by the country of source.

Article 1 - Personal Scope

The agreement will apply to persons (which term includes companies) who are residents of either Australia or Malta.

The situation of persons who are dual residents (i.e. residents of both countries) is dealt with in Article 4.

Article 2 - Taxes Covered

This article specifies the existing taxes to which the agreement applies. These are, in broad terms, the Australian income tax and the Maltese income tax. The article will automatically extend the application of the agreement to any identical or substantially similar taxes which may subsequently be imposed by either country in addition to, or in place of, the existing taxes.

Article 3 - General Definitions

This article provides definitions for a number of the terms used in the agreement. Some other terms are defined in the articles to which they relate and terms not defined in the agreement are to have the meaning which they have under the taxation law of the country applying the agreement.

As with Australia's other modern taxation agreements, "Australia" is defined as including external territories and areas of the continental shelf. By reason of this definition, Australia retains taxing rights in relation to mineral exploration and mining activities on its continental shelf. The definition is also relevant to the taxation by Australia of shipping and airline profits in accordance with Article 8 of the agreement.

Article 4 - Residence

This article sets out the basis on which the residential status of a person is to be determined for the purposes of the agreement. Residential status is one of the criteria for determining each country's taxing rights and is a necessary condition for the provision of relief under the agreement. Residence according to each country's taxation law provides the basic test. The article also includes rules for determining how residency is to be allocated to one or other of the countries for the purposes of the agreement where a taxpayer - whether an individual, a company or other entity - is regarded as a resident under the domestic laws of both countries.

Article 5 - Permanent Establishment

Application of various provisions of the agreement (principally Article 7) is dependent upon whether a person resident of one country has a "permanent establishment" in the other, and if so, whether income derived by the person in the other country is effectively connected with that "permanent establishment". The definition of the term "permanent establishment" which this article embodies corresponds closely with definitions of the term in Australia's other double taxation agreements.

The primary meaning of the defined term is expressed in paragraph (1) as being a fixed place of business through which the business of an enterprise is wholly or partly carried on. Other paragraphs of the article are concerned with elaborating on the meaning of the term by giving examples of what may constitute a "permanent establishment" - such as an office, a mine or an agricultural property - and by specifying the circumstances in which a resident of one country shall, or shall not, be deemed to have a "permanent establishment" in the other country.

Article 6 - Income from Real Property

By this article, income from real property, including income from the direct use, letting or use in any other form of any land or interest therein, and royalties and other payments in respect of the working of or the right to work or to explore for, mineral deposits, oil or gas wells, quarries or other places of extraction or exploitation of natural resources, may be taxed in the country in which the land, mine, quarry or natural resource is situated or where the exploration may take place.

Income to which this article applies is excluded from the scope of Article 7 (by paragraph (7) of that article) and is therefore taxable in the country of source regardless of whether or not the recipient has a "permanent establishment" in that country.

Article 7 - Business Profits

This article is concerned with the taxation of business profits derived by a resident of one country from sources in the other country.

The taxing of these profits depends on whether they are attributable to a "permanent establishment" of the taxpayer in that other country. If they are not, the profits will be taxed only in the country of residence of the taxpayer. If, however, a resident of one country carries on business through a "permanent establishment" (as defined in Article 5) in the other country, the country in which the "permanent establishment" is situated may tax profits attributable to the establishment.

The article provides for profits of the "permanent establishment" to be determined on the basis of arm's length dealing. These provisions correspond in their practical effect with comparable provisions in Australia's other double taxation agreements, and with the revised Division 13 that was inserted in the Assessment Act in 1982.

Paragraph (5) of the article allows the application of provisions of the source country's domestic law (e.g. the revised Australian Division 13) where the correct amount of profits attributable to a "permanent establishment" is incapable of determination or the ascertainment thereof presents exceptional difficulties, for example, where there is insufficient information available to determine the profits of the "permanent establishment" on the basis of arm's length dealing.

Paragraph (9) preserves to each country the right to continue to apply any special provisions in its domestic law relating to the taxation of income from insurance with non-residents.

Article 8 - Shipping and Air Transport

Under this article the right to tax profits from the operation of ships or aircraft in international traffic, including profits derived from participation in a pool service, a joint transport operating organisation or an international operating agency, is generally reserved to the country of residence of the operator.

Any profits derived by a resident of one country from internal traffic in the other country may be taxed in that other country. By reason of the definition of "Australia" contained in Article 3 and the terms of paragraph (4) of this Article, any shipments by air or sea from a place in Australia to another place in Australia, its continental shelf or external territories are treated as forming part of internal traffic.

By virtue of Malta's Merchant Shipping Act 1973, a company resident in Malta is not generally liable to income tax on the profits earned from qualifying ships. Paragraph (5) is intended as a safeguarding measure to ensure that there is no unwarranted avoidance of Australian tax by Australian or other non-Maltese shipowners who, by transferring their ships to Malta, would otherwise be able to obtain exemption from Australian tax under Article 8 of this agreement, and from Malta tax under the terms of Malta's merchant shipping law.

By paragraph (5), a Malta company may be taxed in Australia on the profits from the operation of ships in international traffic (as defined in Article 3) where more than 25% of that company's capital is owned by persons who are not residents of Malta, unless the company can prove that the profits are not relieved from Malta tax under the Merchant Shipping Act 1973, or under any identical or substantially similar provision.

Article 9 - Associated Enterprises

This article authorises the re-allocation of profits between related enterprises in Australia and Malta on an arm's length basis where the commercial or financial arrangements between the enterprises differ from those that might be expected to operate between independent enterprises dealing at arm's length with one another.

By virtue of paragraph (2) of the article, each country retains the right to apply its domestic law (e.g. the revised Australian Division 13) to its own enterprises, provided that such provisions are applied, so far as it is practicable to do so, in accordance with the principles of this article.

Where a re-allocation of profits is effected under this article or, by virtue of paragraph (2), under domestic law, so that the profits of an enterprise of one country are adjusted upwards, a form of double taxation would arise if the profits so re-allocated continued to be subject to tax in the hands of an associated enterprise in the other country. Paragraph (3) requires the other country concerned to make an appropriate adjustment to the amount of tax charged on the profits involved with a view to relieving any such double taxation.

Article 10 - Dividends

This article in general limits the tax that the country of source may impose on dividends payable to beneficial owners resident in the other country. Under this article, Australia will reduce its rate of withholding tax on dividends paid to residents of Malta from 30 per cent to 15 per cent of the gross amount of the dividends.

Under the Maltese system of taxing company profits and dividends, the income tax on company profits distributed as dividends is treated, in effect, as tax paid by shareholders on the dividends. Reflecting this, the agreement provides that the Maltese tax payable by Australian residents on the gross amount of dividends received from a Maltese company is to not exceed the company tax chargeable on the profits out of which the dividends are paid. However, where the dividends are paid out of profits of a company which are subject to special Maltese investment incentive measures, the Maltese tax will be limited to such a lower rate as applies by virtue of those measures. Where the Maltese tax payable on the dividends is less than the company tax chargeable on the profits from which the dividends are paid, the difference is refundable to the dividend recipient.

Paragraph (4) provides that the limitation on the source country's tax will not apply to dividends derived by a resident of the other country who has a "permanent establishment" or "fixed base" in the country from which the dividends are derived, if the holding giving rise to the dividends is effectively connected with that "permanent establishment" or "fixed base". In those cases, the dividends will be taxed at normal rates in accordance with the provisions of Article 7 or Article 14, as the case may be.

The purpose of paragraph (5) of this article is to ensure, broadly, that one country will not tax dividends paid by a company resident solely in the other country unless the person deriving the dividends is a resident of the first country or the holding giving rise to the dividends is effectively connected with a "permanent establishment" or "fixed base" in that country.

Article 11 - Interest

This article requires the country of source generally to limit its tax on interest derived by residents of the other country to 15 per cent of the gross amount of the interest. This limitation will not affect the rate of Australian withholding tax on interest derived by residents of Malta which will continue to be imposed at the rate of 10 per cent under Australia's domestic law.

Interest derived by a resident of one country which is effectively connected with a "permanent establishment" or "fixed base" of that person in the other country will form part of the business profits of that establishment or "fixed base" and be subject to the provisions of Article 7 or Article 14. Accordingly, paragraph (4) of Article 11 requires that the 15 per cent limitation is not to apply to such interest.

The article also contains a general safeguard (paragraph (6)) against payments of excessive interest - in cases where there is a special relationship between the persons associated with a loan transaction - by restricting the 15 per cent limitation in such cases to an amount of interest which might be expected to have been agreed upon by persons dealing at arm's length.

Article 12 - Royalties

This article in general limits to 10 per cent of the gross amount of the royalties the tax that the country of source may impose on royalties paid to beneficial owners resident in the other country.

The 10 per cent limitation is not to apply to natural resource royalties, which, in accordance with Article 6, are to remain taxable in the country of source without limitation of the tax that may be imposed.

In the absence of a double taxation agreement, Australia generally taxes royalties paid to non-residents (other than film and video tape royalties which are taxed at the rate of 10 per cent of the gross royalties), as reduced by allowable expenses, at ordinary rates of tax.

As in the case of dividends and interest, it is specified in paragraph (4) that the 10 per cent limitation of tax in the country of origin is not to apply to royalties effectively connected with a "permanent establishment" or "fixed base" in that country.

By paragraph (6), if royalties flow between related persons, the 10 per cent limitation will apply only to the extent that the royalties are not excessive.

Article 13 - Alienation of Property

Under this article, income or gains from the alienation of real property (as defined in Article 6) may be taxed in the country in which that property is situated.

By paragraph (2), income or gains from the alienation of shares or comparable interests in a company, the assets of which consist wholly or principally of real property, may be taxed in the country in which the assets or the principal assets of the company are situated.

Article 14 - Independent Personal Services

At present, an individual resident in Australia or in Malta may be taxed in the other country on income derived from the performance in that other country of professional services or other similar independent activities. The purpose of this article is to ensure that such income will continue to be taxed in the country in which the services are performed where one or more of the following three tests are met, provided that, in all three cases, the income derived is attributable to activities performed in accordance with those three tests. These tests are that:

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the recipient has a "fixed base" regularly available in that country for the purpose of performing his or her activities;

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the income is derived during a period or periods aggregating more than 183 days in a year of income or, in the case of Malta, in the year immediately preceding the year of assessment, in which the recipient is present in that country; or

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the recipient derives from residents of that country, during the relevant income year, gross remuneration exceeding $A12,500, or its Maltese equivalent, from performing his or her activities in that country. This amount may be varied by agreement between the Treasurer of Australia and the Minister responsible for finance in Malta.

If none of the tests mentioned above are met, the income will be taxed only in the country of residence of the recipient.

Remuneration derived as an employee and income derived by public entertainers are the subject of other articles of the agreement and are not covered by this article.

Article 15 - Dependent Personal Services

Article 15 provides the basis upon which the remuneration of visiting employees is to be taxed. Generally, salaries, wages, etc. derived by a resident of one country from an employment exercised in the other country will be liable to tax in that other country. However, subject to specified conditions, there is a conventional provision for exemption from tax in the country being visited where only visits of a short-term nature are involved. The conditions for exemption are that the visit or visits not exceed, in the aggregate, 183 days in the year of income or, in the case of Malta, in the year immediately preceding the year of assessment, of the country visited, that the remuneration is paid by, or on behalf of, an employer who is not a resident of the country being visited, that the remuneration is not deductible in determining taxable profits of a "permanent establishment" or a "fixed base" which the employer has in the country being visited, and that the remuneration is subject to tax in the country of residence. Where these conditions are met, the remuneration so derived will be liable to tax in the country of residence.

By paragraph (3) of the article, income from an employment exercised aboard a ship or aircraft operated in international traffic is to be taxed in the country of residence of the operator.

Article 16 - Directors' Fees

Under this article, remuneration derived by a resident of one country in the capacity of a director of a company which is a resident of the other country is to be taxed in the country where the company is resident.

Article 17 - Entertainers

By this article, income derived by visiting entertainers (including athletes) from their personal activities as such will continue to be taxed in the country in which the activities are exercised, irrespective of the duration of the visit.

Paragraph (2) of this article is a safeguarding provision designed to ensure that income in respect of personal activities exercised by an entertainer, whether received by the entertainer or by another person, e.g., a separate enterprise which formally provides the entertainer's services, is taxed in the country in which the entertainer performs, whether or not that other person has a "permanent establishment" or "fixed base" in that country.

Article 18 - Pensions and Annuities

Under this article pensions and annuities, including government pensions, are with one exception to be taxed only by the country of residence of the recipient.

The exception is that any pensions or allowances in respect of wounds, disabilities or death caused by war, or in respect of war service, which are exempt from tax in the paying country, will also be exempt in the country of residence.

Article 19 - Government Service

Paragraph (1) of this article provides that remuneration, other than a pension or annuity, in respect of services rendered to a government (including a State or local government) of one of the countries will be taxed only in that country. However, such remuneration is to be taxable only in the other country if the services are rendered in that country and the recipient is a citizen of, or ordinarily resides in, that country.

Paragraph (2) provides, in effect, that paragraph (1) does not apply where the services are rendered in connection with a trade or business carried on by a government. In such a case, the provisions of Articles 15 or 16 apply.

By paragraph (3), where the remuneration is paid under a development assistance programme of one country, out of funds exclusively supplied by that country, to a specialist or volunteer seconded to the other country with the consent of that other country, that remuneration is to be taxed only in the country which provides the funds.

Article 20 - Students

This article applies to students temporarily present in a country solely for the purpose of their education at a university, college, school or other similar educational institution who are, or immediately before the visit were, resident in the other country. In these circumstances, the students will be exempt from tax in the country visited in respect of payments received from abroad for the purposes of their maintenance or education.

Article 21 - Income Not Expressly Mentioned

This article provides rules for the allocation between the two countries of taxing rights in relation to items of income not expressly mentioned in the preceding articles of the agreement.

Broadly, such income derived by a resident of one country is to be taxed only in his or her country of residence unless it is derived from sources in the other country, in which case the income may also be taxed in the country of source.

However, the first-mentioned exclusive taxing right of the country of residence does not apply where the income is effectively connected with a "permanent establishment" or "fixed base" which a resident of one country has in the other. In such cases, the provisions of Article 7 or Article 14, as the case may be, will apply.

Article 22 - Sources of Income

Article 22 specifies the source of various classes of income, for the purposes of ensuring that each country is empowered to exercise the taxing rights allocated to it by the agreement over residents of the other country and that, as intended by the agreement, double taxation relief will be given by the country of residence in respect of tax levied by the country of source in accordance with the taxing rights allocated to it under the agreement. The provision obviates any question of income not having, by domestic law rules, a source in the country that is, by the agreement, entitled to tax that income in the hands of a resident of the other country.

Article 23 - Methods of Elimination of Double Taxation

Double taxation does not arise in respect of income flowing between the two countries where the terms of the agreement provide for the income to be taxed only in one country or the other, or where the domestic taxation law of one of the countries frees the income from its tax. It is necessary, however, to prescribe a method for relieving double taxation in respect of other classes of income which are subject to tax in both countries. Australia's other comprehensive taxation agreements provide for a credit basis for the relief of double taxation to be applied by Australia and, usually, the other country. In these cases, the country of residence is required to give credit against its tax for the tax of the country of source. This approach has generally been adopted in this agreement.

By paragraph (1) of the article, Australia will relieve double taxation by allowing a credit against its own tax for Maltese tax on income derived by a resident of Australia from sources in Malta. Credit will be allowed by Australia for the Maltese tax on dividends derived from Malta by individuals and on interest and royalties derived from Malta by individuals and companies in respect of which the tax of that country is limited in accordance with Articles 10, 11 and 12 of this agreement.

Paragraph (2) of the article acknowledges that dividends received by an Australian company from a Maltese company are in effect freed from Australian tax by the rebate under section 46 of the Assessment Act. This is to continue, but paragraph (2) also provides that if this rebate ceased to be allowed, Australia and Malta will enter into negotiations in order to establish new provisions concerning the credit to be allowed by Australia against its tax on the dividends.

Section 23(q) of the Assessment Act will continue to exempt from Australian tax other income of Australian residents that is taxed in Malta. In these cases, since there will be no Australian tax payable, there is no call for allowance of credits.

The agreement contains "tax sparing" provisions which are broadly similar to those included in Australia's agreements with Singapore, the Philippines, Malaysia and Republic of Korea. Under these provisions, which are contained in paragraphs (3) and (4) of this article, Australia will tax an Australian recipient of dividends, interest or royalties on which Malta - under agreed incentive measures - has forgone its tax as if Maltese tax forgone had been paid.

Sub-paragraph (a) of paragraph (3) provides that, for the purposes of the tax sparing credit to be allowed by Australia, the tax forgone by Malta is that tax which, but for the provisions of the Maltese Aids to Industries Ordinance 1959, or any other provisions which are agreed by Australia and Malta in an exchange of letters to be of a substantially similar character, would have been payable on dividends (taxed at the reduced rate applicable under sub-paragraph (2)(b)(ii) of Article 10 of the agreement), interest or royalties, and effectively limits the tax sparing credit for Maltese tax to 15 per cent of the gross amount of the dividends and 10 per cent of the gross amount of the interest and royalties. Proposed sub-section 11N(4) (see notes on clause 5 of the Bill) will provide for particulars of the provisions agreed in the exchange of letters referred to above to be notified in the Gazette.

Where a tax sparing credit is allowed, sub-paragraph (b) of paragraph (3) has the effect that the Maltese income concerned is to be grossed-up, for purposes of calculating the Australian tax thereon, by the amount of tax sparing credit. For example, in the case of interest and royalties received from Malta, in respect of which Maltese tax has been wholly forgone, the amount included in assessable income in Australia will be the amount received, plus 10 per cent of the amount.

By reason of paragraph (4), the tax sparing provisions outlined above will not apply after 30 June 1989 unless Australia and Malta agree to extend them beyond that date. Proposed sub-section 11N(5) (see notes on clause 5 of the Bill) will provide for advice of any such extension to be notified in the Gazette.

For its part Malta will, broadly, allow a credit to Maltese residents, in respect of taxes payable in Australia on their Australian source income, against the Maltese tax payable on that income. Where a dividend is paid by an Australian resident company to a Maltese resident company which controls 10 per cent or more of the voting power in the Australian company, the credit allowed by Malta shall also take into account, in addition to the Australian tax paid in respect of the dividends, the Australian tax paid by the company in respect of the profits out of which the dividend is paid.

Paragraph (6) of the article relates to the Maltese "remittance" basis of taxing certain income. Broadly, this basis results in only that part of the relevant overseas earnings that is remitted to or received in Malta by a resident of Malta being subject to Maltese tax. This paragraph will also ensure that Australia is not to exempt or reduce its tax on income that, because it is not remitted to or received in Malta by the Maltese resident who derives it, is not subject to Maltese tax.

Article 24 - Mutual Agreement Procedure

One of the purposes of this article is to provide for consultation between the taxation authorities of the two countries with a view to reaching a satisfactory solution where a taxpayer is able to demonstrate actual or potential subjection to taxation contrary to the provisions of the agreement. A taxpayer wishing to use this procedure must present a case within three years of the first notification of the action giving rise to the taxation not in accordance with the agreement and if, on consideration, a solution is reached, it may be implemented irrespective of any time limits imposed by domestic tax laws of the relevant country.

The article also authorises consultation between the taxation authorities of the two countries for the purpose of resolving any difficulties regarding the interpretation or application of the agreement and to give effect to it.

Article 25 - Exchange of Information

This article authorises the two taxation authorities to exchange information necessary for the carrying out of the agreement or of domestic laws concerning the taxes to which the agreement applies. The purposes for which this information may be used and the persons to whom it may be disclosed are restricted along the lines of Australia's other comprehensive taxation agreements.

The exchange of information that would disclose any trade, business, industrial or professional secret or trade process or which would be contrary to public policy is not permitted by the article.

Article 26 - Diplomatic and Consular Officials

The purpose of this article is to ensure that the provisions of the agreement do not result in members of diplomatic and consular posts receiving less favourable treatment than that to which they are entitled in accordance with international laws. In Australia, such persons are entitled to fiscal privileges under the Diplomatic (Privileges and Immunities) Act and the Consular (Privileges and Immunities) Act.

The article contains in paragraph (2) a safeguard aimed at ensuring that the officials concerned cannot, by the combined effect of the provisions of the agreement and of the fiscal privileges accorded to diplomatic and consular officials, escape taxation in both countries. A further safeguard in paragraph (3) will ensure that the benefits of the agreement will not apply to international organisations, to organs or officials thereof, or to diplomatic or consular staff of a third country who, although present in one of the countries, are not treated as residents by either country.

Article 27 - Entry into Force

This article provides for the entry into force of the agreement. This will be on the date on which notes are exchanged through the diplomatic channel notifying that the last of such things has been done in Australia and Malta as is necessary to give the agreement the force of law in both countries.

Once it enters into force, the agreement will have effect in Australia, for purposes of withholding tax, in respect of income derived on or after 1 January in the calendar year next following that in which the agreement enters into force and, in respect of tax other than withholding tax, in relation to income of any year of income beginning on or after 1 July in the calendar year next following that in which the agreement enters into force. Where a taxpayer has adopted an accounting period ending on a date other than 30 June, the beginning of the accounting period that has been substituted for the year beginning on 1 July in the year in which the agreement first has effect will be the date from which the agreement will take effect in respect of tax other than withholding tax. In Malta, the agreement will have effect in relation to taxes which are levied for the year of assessment beginning on 1 January in the second calendar year following that in which the agreement enters into force and for any subsequent year of assessment.

Article 28 - Termination

By this article the agreement is to continue in effect indefinitely. However, either country may give through the diplomatic channel written notice of termination of the agreement on or before 30 June in any calendar year beginning after the expiration of five years from the date of its entry into force. In that event, the agreement would cease to be effective in Australia, for withholding tax purposes, in respect of income derived on or after 1 January in the calendar year next following that in which the notice of termination is given and, for tax other than withholding tax, in relation to income of any year of income beginning on or after 1 July in the calendar year next following that in which the notice of termination is given. It would cease to be effective in Malta in relation to taxes which are levied for the year of assessment beginning on 1 January in the second calendar year following that in which the notice of termination is given and for subsequent years of assessment.