House of Representatives

Explanatory Memorandum

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

Chapter 2 - Amending protocol to the agreement with Finland

What is the second Finnish protocol?

2.1 The second Finnish protocol, once in force, will amend 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 (1984 Agreement and Protocol).

Why is the second Finnish protocol necessary?

2.2 The second Finnish protocol is required for 3 reasons:

•

to update Finland's list of existing taxes to which the 1984 Agreement and Protocol shall apply;

•

to make provision for a reciprocal dividend withholding tax (DWT) exemption for fully franked dividends and so modify the general 15% DWT tax rate limit in the 1984 Agreement and Protocol as Finland and Australia have both introduced dividend imputation systems since the 1984 Agreement and Protocol entered into force; and

•

to include the latest methods adopted by Finland to eliminate international double taxation.

Main features of the second Finnish protocol

2.3 The second Finnish protocol makes a number of amendments to the 1984 Agreement and Protocol.

2.4 It effectively provides for exemption from withholding tax of fully franked dividends paid by Australian resident companies to Finnish resident shareholders and dividends paid by Finnish resident companies out of profits that have been subject to Finland's corporate income tax to Australian resident shareholders.

2.5 Unfranked dividends paid to Finnish residents will continue to be subject to Australian withholding tax rate limit of 15% and Finland will remain entitled to apply a 15% withholding tax rate limit on dividends paid by Finnish companies out of profits that have not been subject to its corporate income tax.

2.6 It provides for a revised list of Finnish taxes to be covered by the 1984 Agreement and Protocol.

2.7 It provides for the latest methods by which Finland undertakes to eliminate international double taxation.

The second Finnish protocol

2.8 The second Finnish protocol will amend the 1984 Agreement and Protocol to take into account of changed circumstances and current treaty policies of both countries. The second Finnish protocol will form an integral part of the 1984 Agreement and Protocol.

Article I

2.9 Article I of the second Finnish protocol will replace subparagraph (1)(b) of Article 2 of the 1984 Agreement and Protocol with a new subparagraph (1)(b) . The existing subparagraph sets out the Finnish taxes to which the 1984 Agreement and Protocol applies.

2.10 New subparagraph (1)(b) will update the list of the relevant Finnish taxes to reflect the taxes currently imposed under the law of Finland. In particular, it deletes the sailors' tax and specifically includes the corporate income tax and the tax withheld at source from interest.

Article II

2.11 Article II of the second Finnish protocol replaces and updates Article 10 of the 1984 Agreement and Protocol which is concerned with the taxation of dividends flowing between the 2 countries.

2.12 Australia's dividend imputation system was first introduced in July 1987. Following Finland's introduction of a similar scheme in January 1990, negotiations were held between Australia and Finland to reflect the changed treatment of dividends in both countries. Article II now provides for a reciprocal exemption from DWT in cases where those dividends are paid out of fully taxed profits.

2.13 The reciprocal DWT exemption broadly accords with Australia's current Double Taxation Agreements (DTA) negotiating practice of seeking a reciprocal zero rate, or a rate limit not exceeding 5%, in respect of certain non-portfolio dividend flows. Against the background that dividends derived by Australian companies from subsidiaries in listed countries are generally exempt from Australian tax, this approach benefits Australian companies with investments in relevant treaty partner countries by reducing the effective foreign tax rate (and therefore cost) on those investments. For other dividends derived offshore that remain subject to the foreign tax credit system, the Australian revenue may also benefit to the extent that greater after tax profits are remitted to Australia and subject to Australian tax.

2.14 Due to the similarities in the imputation systems of both countries, it has been possible to extend the DWT exemption to portfolio dividend flows.

2.15 DWT will generally remain payable in both countries in respect of dividends which are not paid out of taxed profits (i.e. unfranked dividends in the case of Australia), but consistent with Australia's double tax agreement policy, and the previous Article 10 of the 1984 Agreement and Protocol, the rate is limited to 15% of the gross amount of the dividends.

Article III

2.16 Article III of the second Finnish protocol will replace paragraph (2) of Article 23 of the 1984 Agreement and Protocol with a new paragraph (2) . That paragraph sets out the methods by which Finland eliminates double taxation.

2.17 The new paragraph reflects changes to the methods by which Finland undertakes to eliminate international double taxation under its domestic law.

Article IV

2.18 This article gives effect to a consequential amendment as a result of the new dividends article. Subparagraph (i) of paragraph (a) of the Protocol in the 1984 Agreement and Protocol (which provided that should Australia agree with a third State being an OECD member to a lower rate of DWT than that set out in Article 10(2), Australia would notify Finland of such action and enter into negotiations to reduce the DWT rate in the case of companies to that set out in the DTA with that third State) is no longer necessary because of the zero DWT rate limit in the new dividends article and has therefore been deleted.

Article V

2.19 This article provides for the entry into force of the second Finnish protocol. It will enter into force 30 days after the date of the later of the notifications by the 2 countries advising each other that all domestic requirements to give it the force of law in the respective countries have been completed. Once it enters into force the second Finnish protocol will form an integral part of the 1984 Agreement and Protocol.

2.20 Upon entry into force, the second Finnish protocol will generally have effect in Australia for withholding tax purposes and for other taxes in relation to income derived on or after 1 July in the calendar year next following that in which it enters into force.

2.21 The second Finnish protocol will generally have effect in Finland in respect of withholding tax from 1 January in the calendar year next following that in which it enters into force, and for other taxes on income, for taxes chargeable for any tax year beginning on or after 1 January in the calendar year next following that in which it enters into force.

REGULATION IMPACT STATEMENT

Specification of policy objective

2.22 The policy intention of the second Finnish Protocol is to allow Australia and Finland to exempt from DWT, dividends paid out of fully taxed company profits to a resident of the other country.

2.23 The reciprocal DWT exemption broadly accords with Australia's current DTA negotiating practice of seeking a reciprocal zero rate, or a rate limit not exceeding 5%, in respect of certain non-portfolio dividend flows.

Background

2.24 The Australia/Finland DTA was signed in 1984. The Finnish tax authority first proposed an amendment to the dividends article of the DTA in November 1989. The main change resulting from the Protocol negotiations was agreement for each country to not impose DWT in cases of dividends paid out of fully taxed company profits. As this would provide Australian investors in Finland with reciprocal treatment to Finnish investors in Australia, a draft Protocol to amend the DTA was settled between the 2 taxation authorities by correspondence.

2.25 Other changes made by the Protocol include a revised list of Finnish taxes covered by the DTA and changes to the methods by which Finland undertakes to eliminate international double taxation.

2.26 The Protocol was signed in Canberra on 5 November 1997 by the Treasurer and the Finnish Ambassador.

Identification of implementation option

2.27 In general, renegotiation of the existing DTA is the only way to achieve bilateral agreement in relation to the above objective.

Assessment of impacts (costs and benefits)

Impact group identification

2.28 The Protocol is likely to have an impact on:

•

the Governments of Australia and Finland;

•

Australians and Finns investing in the other country; and

•

the Australian Taxation Office (ATO) and the Finnish tax authority.

Assessment of costs

2.29 The Protocol is not expected to result in increased administration or compliance costs for the ATO.

2.30 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.

2.31 The impact on Australian Government revenue is unknown or not able to be reliably estimated. However given the modest trade and investment relationship between Australia and Finland (in 1998-1999 Australian exports to Finland totalled $191 million and Australian imports from Finland totalled $601 million; no investment figures are available) the revenue cost is not expected to be significant.

Assessment of benefits

2.32 The Protocol will provide certainty for Australian investors in Finland.

2.33 The Protocol will further assist the development of trade and economic cooperation between Australia and Finland.

Consultation

2.34 The ATO was advised by the Department of Foreign Affairs and Trade and Austrade that no peak bodies represent Australian business interests in Finland.

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

2.36 In December 1997, the Protocol was submitted for consideration by the ATO's Advisory Panel of private sector representatives and tax practitioners which reviews proposed treaty action. The Panel, which includes representatives from the Taxation Institute of Australia, Institute of Chartered Accountants, Law Council of Australia, Australian Society of Certified Practising Accountants, Corporate Tax Association, Business Council of Australia, Minerals Council of Australia and Australian Bankers' Association, supported the Protocol going ahead.

2.37 The Protocol was considered by the Parliamentary Joint Standing Committee on Treaties in March 1998 which provided for public consultation in its hearings. The Committee supported ratification of the Protocol.

Conclusion

2.38 The Protocol will result in a reduction of DWT payable by all Australian investors in Finland.

2.39 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.

2.40 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.