Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 4 - Regulation impact statement
THE RUSSIAN AGREEMENT
Specification of policy objective
4.1 Two key objectives of an Australia-Russia DTA are to:
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- promote closer economic cooperation between Australia and Russia 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
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- create a framework through which the tax administrations of Australia and Russia can prevent international fiscal evasion.
Background
4.2 Australian tax treaties are usually based on the OECD Model with some influences from the UN Model. In addition, both countries propose variations to these Models to reflect their particular economic interests and legal circumstances.
4.3 DTAs reduce or eliminate double taxation caused by overlapping taxing jurisdictions because treaty partners agree (in certain situations) to limit taxing rights over various types of income. The respective countries also agree on methods of reducing double taxation where both countries have a right to tax. For example, DTAs contain 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 (usually Article 7).
4.4 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 Australias DTAs is similar to the international practice as set out in the OECD Model, but 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, Profits from the Operation of Ships and Aircraft , Royalties, Income from Alienation of Property and Other Income Articles also give greater recognition to source country taxing rights.
4.5 In addition, DTAs provide 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 (usually Articles 7 and 9). This also provides an example of how a DTA is used to address international profit shifting.
4.6 To prevent fiscal evasion DTAs normally include an exchange of information facility. The 2 tax administrations can also use the mutual agreement procedures to develop a common interpretation and resolve differences of application of the DTA. There is also provision for residents to instigate a mutual agreement procedure.
Australias investment and trade relationship with Russia [F1]
4.7 Concluding a DTA would also assist in improving the bilateral framework for investment and trade with Russia and hence would provide a further incentive to Australian investors.
4.8 In 2000, Australian exports to Russia were approximately $A267 million (mostly alumina, meat and dairy) and imports were $A27 million. As at April 2001, Russia was Australias 47th largest trading partner, was ranked 39th amongst our export destinations and was our 64th largest source of imports.
4.9 Australian investment in the Russian Federation is estimated at $A25 million and Russian investment in Australia is estimated at $A36 million. Given the size of the Russian economy and its import dependency, there is considerable potential for future growth in these areas.
Identification of implementation options
4.10 The implementation options for achieving the policy objectives are:
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- no further action - rely on existing unilateral measures; or
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- conclude the DTA.
Option 1: No further action - rely on existing unilateral measures
4.11 If nothing was done - that is, the DTA was not concluded - it could be argued that many of the above policy objectives have already been met to a significant extent through the internal laws of both Australia and Russia. For example, unilateral enactment of foreign source income measures by Australia already provides substantial relief from juridical double taxation. While Australian and Russian tax administrators can contact each other at an official level, Australian law strictly limits the sharing of taxpayer specific information between the ATO and foreign tax administrations, such as the Russian tax administration.
4.12 The internationally accepted approach to meeting the above policy objectives is to conclude a bilateral DTA [F2] . A DTA regulates the way the 2 countries will reduce double taxation, by agreeing to restrict their taxing rights in accordance with its terms and to provide double taxation relief. A DTA would also record important bilateral undertakings in relation to exchange of information.
4.13 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.
4.14 As mentioned in paragraph 2.2, the DTA would be largely based on the OECD Model and the UN Model, with some mutually agreed variations reflecting the economic, legal and cultural interests of the 2 countries.
Assessment of impacts (costs and benefits) of each option
4.15 A DTA with Russia is likely to have an impact on:
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- Australian residents doing business with Russia, including principally:
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- Australian residents investing directly in Russia (either by way of a subsidiary or a branch);
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- Australian banks lending to Russian borrowers;
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- Australian residents supplying technology and know-how to Russian residents;
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- Australian residents supplying consultancy services to Russia; and
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- Australian residents exporting to Russia;
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- Australian employees working in Russia;
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- people receiving pensions from the other country (although the number of cross-border pension payments is understood to be minimal);
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- the Australian Government; and
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- the ATO.
Option 1: No further action - rely on existing unilateral measures
4.16 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.
4.17 On the other hand, even though both countries have unilaterally introduced measures to relieve 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 subsequent unilateral changes to the internal laws of either country, nor does it place a maximum limit on source country taxing of, for example, dividends, interest and royalties.
4.18 In addition, investors are concerned that unilateral tax laws do not provide the certainty desirable for making substantial long term investments offshore. This is because the Governments of either country can vary key tax conditions unilaterally. Similarly, so far as the tax administrations are concerned, unilateral rules do not provide a broad or dependable long term framework for information exchange.
4.19 The negotiation and enactment of a DTA will cost approximately $A150,000. Most of these costs will be borne by the ATO, although other agencies, such as the 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.
4.20 There is a maintenance cost to the ATO associated with DTAs in terms of dealing with enquiries, mutual agreement procedures (including 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. Accordingly, there is a small unquantified cost in administering a DTA. There will also be minor implementation costs to the ATO relating to changes in withholding tax rates.
4.21 The DTA is not expected to result in increased compliance costs for taxpayers.
4.22 There might be some reduction in Australian Government revenue from taxation of Russian investments and other business activities in Australia (e.g. the DTA restricts source country taxation of certain types of income). On the other hand, limitation of Russian taxation rights in circumstances where Australia may have otherwise been required to give credit for Russian taxation may lead to increased Australian tax revenue. Given the modest investment and trade relationship between our 2 countries, the revenue cost is not expected to be significant.
4.23 It should also be recognised that the limitations agreed to by the 2 countries, will place limits on their policy flexibility in relation to cross-border taxation. However, as Australia already has a substantial tax treaty network, the cost of the proposed DTA in terms of reduced policy flexibility will only be marginal.
Option 1: No further action - rely on existing unilateral measures
4.24 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 treaty obligations.
The effects of a DTA with Russia
4.25 Where Australians conduct business activities in Russia, Russia would not generally be able to tax an Australian resident unless that Australian resident carries on business through a permanent establishment in Russia. A DTA would establish a basis for allocation of profits to that permanent establishment. A DTA also establishes specific rules for taxation of shipping profits and income from real property.
4.26 Likewise for Australians investing through a Russian subsidiary, a DTA will 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 as to the methodology to be applied for taxing the profits of the respective enterprises.
4.27 To some extent, the rules embodied in a DTA would reduce the risks for Australians investing in Russia (and vice versa) because a DTA records agreement between the 2 Governments on a framework for taxation of cross-border investments. In the case of mining investments which cannot easily be relocated, this reduction in risk may be quite important.
4.28 Furthermore, it is only in the context of a DTA that Russia will agree to limit domestic withholding taxes on dividends, interest and royalties. This is the internationally accepted practice, which Australia also follows by reducing royalty and certain dividend withholding taxes under its DTAs. This is to ensure that only residents of treaty partner countries are entitled to the benefit of reduced source country taxation of such income.
4.29 A DTA would reduce Russian taxation on interest, dividends and royalties, thereby making Australian suppliers of capital and technology more competitive. Reduction in source country taxation 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 Russian investment in Australia. Again, a DTA would assist Australian investors by increasing the certainty of the taxation rules applying to cross-border investment.
4.30 Commodity exporters would be assisted in some respects because of the way a DTA would restrict the circumstances in which Australians trading with Russia are to be taxed by requiring the existence of a permanent establishment in Russia before Russian tax will be imposed.
4.31 A DTA would also assist in making clear the taxation arrangements for individual Australians working in Russia, 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 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 may be taxed in the latter country, where the services are attributable to a fixed base of the person concerned in that country.
4.32 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.
4.33 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, and would also promote greater cooperation between taxation authorities to prevent fiscal evasion and tax avoidance.
Consultation
4.34 Information on the DTA has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties Schedule of Treaty Action.
4.35 The DTA was reviewed and approved by the ATOs Tax Treaties Advisory Panel of industry representatives and tax practitioners on 5 May 2000.
4.36 On 10 October 2000, the DTA was considered by the Parliamentary Joint Standing Committee on Treaties which provides for public consultation in its hearings. The Committee supported the proposed DTA with the Russian Federation.
4.37 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 to obtain feedback from professional and small business associations and through other taxpayer consultation fora.
Conclusion and recommended option
4.38 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, 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.
4.39 There will be benefits to both Australia and Russia in terms of improved bilateral relationships and information exchange. On the other hand, the DTA will reduce the Governments policy flexibility.
4.40 On balance, the benefits of the proposed DTA outweigh the costs. Option 2 is therefore recommended as the preferred option.
US PROTOCOL AMENDING THE AUSTRALIA-USA DOUBLE TAXATION CONVENTION
Specification of policy objective
4.41 The key objective in updating Australias tax treaty with the United States is to make a significant advance in providing a competitive tax treaty network for companies located in Australia by reducing the rate of DWT on US subsidiaries and branches of Australian companies. An important secondary goal is to prevent double taxation of capital gains derived by US residents on the disposal of interests in Australian entities while retaining Australian taxing rights.
Background
4.42 The stated purpose of tax treaties is to avoid double taxation and prevent fiscal evasion with respect to taxes on income, but their wider function is to facilitate investment, trade, movement of technology and movement of personnel between countries. They are widely used to develop and strengthen bilateral relationships between countries, especially in commercial areas. Tax treaties also provide certainty and protection regarding the level of taxation on investments abroad which may, for instance, be valued by business when deciding on the location of a regional headquarters. The impact of new tax treaties and the amendment of existing tax treaties on tax policy flexibility is marginal because Australia already has a substantial tax treaty network.
Review of Business Taxation: A Tax System Redesigned
4.43 The Government agreed in its Stage 2 response to the Review of Business Taxation: A Tax System Redesigned recommendations that priority be given to renegotiating Australias aging tax treaties with major trading partners (in particular, with the United States, the United Kingdom and Japan) and that Australian investment offshore would significantly benefit from a lowering of DWT on non-portfolio dividends (i.e. dividends paid on 10% or greater shareholdings) under these older tax treaties.
4.44 Australian tax treaties are usually based on the OECD Model with some influences from the UN Model. In addition, countries propose variations to these Models to reflect their particular economic interests and legal circumstances.
4.45 Tax treaties reduce or eliminate double taxation caused by the overlapping taxing jurisdictions because treaty partners agree (in certain situations) to limit taxing rights over various types of income. The respective countries also agree on methods of reducing double taxation where both countries have a right to tax.
4.46 Australia seeks an appropriate balance between source and residence country taxing rights. Generally the allocation of taxing rights under Australias tax treaties is similar to international practice as set out in the OECD Model, but there are a number of instances where it leans more towards source country taxing rights.
4.47 In addition, tax treaties provide 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. Tax treaties are therefore an important tool in dealing with international profit shifting.
4.48 To prevent fiscal evasion, tax treaties normally include an exchange of information facility. The 2 tax administrations can also use the mutual agreement procedures to develop a common interpretation and resolve differences of application of the tax treaty. There is also provision for residents of either country to instigate a mutual agreement procedure.
Background to the US tax treaty
4.49 The current tax treaty with the United States was signed on 6 August 1982 and had effect from 1 December 1983 (for Australian income tax purposes) replacing an earlier tax treaty signed in 1953. The current tax treaty, although signed in 1982, largely reflects the positions agreed by both countries in the early 1970s.
4.50 Talks to update the US tax treaty were held in March and June 2001 following scoping talks in November 2000.
Australias investment and trade relationship with the United States [F3]
4.51 As at 1999-2000, the United States was Australias second largest merchandise trading partner after Japan and our second largest export destination, with 2-way trade totalling $A33 billion or 16% of total trade.
4.52 Exports to the United States in 1999-2000 totalled $A9.68 billion. The United States remains Australias largest market for services ($A4.6 billion in 1999-2000). The major services exports were transportation and travel.
4.53 Australias imports from the United States amounted to $A23.34 billion in 1999-2000.
4.54 As at 1999-2000, the United States was the largest foreign investor in Australia ($A215 billion). US investment in Australia is diversifying, with many US firms establishing regional headquarters and other operations here. The United States is the largest investment destination for Australian investment abroad, with investment of $A156.7 billion as at 1999-2000, of which $A90 billion is direct equity investment (with earnings in 1999-2000 of $A3 billion) that would benefit from reduced US DWT. The level of Australian investment in the United States has increased rapidly in recent years. Australias direct equity investment in the United States, for instance, exceeded US direct equity investment in Australia during 1999-2000 by $A27.7 billion (US direct equity investment in Australia was $A62.3 billion).
Identification of implementation option(s)
4.55 The policy objectives can realistically only be achieved by updating the US tax treaty.
Option 1: Update the tax treaty
4.56 The proposed Protocol would update the tax treaty to:
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- reduce the rate of DWT on US subsidiaries and branches of Australian companies; and
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- prevent the double taxation of capital gains derived by US residents on the disposal of Australian entities while retaining Australian source country taxing rights.
Option 2: Do not update the tax treaty
4.57 Unless the tax treaty is updated, the rate of DWT on US subsidiaries and branches of Australian companies will continue to be higher than for competitors from many other countries that have negotiated lower rates of DWT with the US. There is also a risk that double taxation could arise on capital gains. The tax treaty generally does not cover taxes on capital gains and thus provisions in the treaty that provide relief from double taxation in respect of such gains may not be available.
Assessment of impacts (costs and benefits) of each option
4.58 Broadly, both sides had particular policy objectives to achieve in updating the tax treaty and some major departures from Australias long standing treaty practice were required to reach a mutually acceptable agreement. These departures include reductions in withholding tax on royalties and for certain dividend and interest income. While the withholding tax reductions involve a cost to revenue, the benefits are much more widely spread in the economy, with the most direct benefits accruing to business. Indirect revenue benefits may arise from increased trade and investment between the countries and reduced tax credit obligations for US taxes.
Difficulties in quantifying the impacts of tax treaties
4.59 Only a partial analysis of costs and benefits can be provided because the impacts of tax treaties cannot be quantified in a number of important areas. Estimates of the expected growth in trade and investment, for instance, tend to be speculative because of a lack of information and difficulties associated with determining the range and impacts of behavioural responses with any certainty. Benefits that flow to business are generally equally difficult to quantify. Some impacts can be determined with greater authority, for instance, the direct revenue impact of reducing rates of withholding tax.
4.60 The Protocol is likely to impact on Australian residents who derive income or capital gains from the United States and on US residents who derive such amounts from Australia. The main groups affected by a reduction in the rate of US DWT and from comprehensively covering the taxation of capital gains are likely to be the approximately 70 publicly listed Australian companies with investments in the United States and 200 publicly listed US companies with investments in Australia. Australian persons that have or are seeking debt finance from US financial institutions or know how from US persons may benefit from the interest withholding tax exemption for interest paid to US financial institutions or the reduced royalty withholding tax rate. Persons may also be indirectly affected by the facilitation of investment flows between the countries (e.g. persons may benefit from a growth in economic activity that improves employment opportunities). Some tax entities (e.g. certain discretionary trusts which do not have a substantial connection with either Australia or the United States) may cease to be eligible for treaty benefits where they do not satisfy the requirements of the new Limitation on Benefits Article. The Article is intended to prevent residents of third countries from inappropriately accessing treaty benefits.
4.61 The ATO will need to administer the changes to the tax treaty.
Option 1: Update the tax treaty
4.62 The net yearly cost to revenue of the Protocol is estimated to be $A190 million. This cost is largely attributable to:
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- a reduction in DWT to nil or 5% on non-portfolio dividends derived by US companies (down from 15% for unfranked dividends, franked dividends are already exempt from DWT under Australias domestic law);
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- an IWT exemption for interest paid to US financial institutions (down from 10%); and
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- a reduction in the general RWT rate to 5% (down from 10%).
4.63 Some potential offsetting gains to the Australian revenue have been unable to be quantified as discussed later in the section on (offsetting) revenue benefits.
4.64 Over time the lower withholding tax rates may be extended to other countries, for instance, as a result of most favoured nation clauses in Australias tax treaties with the Netherlands, France, Switzerland, Italy, Norway, Finland, Austria and Korea. As noted above this will come at a cost to the revenue in relation to countries exporting capital and technology to Australia but will lower the cost of capital to Australian businesses seeking funding in those countries and reduce the cost of accessing new technologies. The amount by which costs to Australian businesses will be reduced depends on the extent to which those businesses currently bear the costs of the relevant withholding taxes.
4.65 No DWT rate limit will apply in the US for dividends paid on certain substantial holdings in US REITs. These dividends may therefore be taxed at the US domestic law rate which is currently 30% for companies (up from 15%). The negative impact of this increase is significantly reduced because non-portfolio REIT dividends derived by certain publicly listed Australian unit trusts (the main group potentially impacted) will generally continue to qualify for the 15% DWT rate. Others affected will have until at least 1 July 2003 to reduce their holding in a REIT.
4.66 There would be a small unquantifiable cost in administering the changes made by the Protocol, including minor implementation costs to the ATO in educating the taxpaying public and ATO staff concerning the new arrangements. Some additional administrative costs may arise for the ATO in considering applications for treaty benefits from persons who do not qualify based on the general tests in the Limitation on Benefits Article . The need to make an application would also increase compliance costs for the applicant.
Option 2: No further action - rely on the existing tax treaty
4.67 This option represents a continuance of the current position. Continuing higher rates of US DWT, uncertainty on the taxation of capital gains and the potential for double taxation could have an ongoing negative but unquantifiable impact on investment between the countries. Uncertainty regarding the taxation of capital gains is currently giving rise to major interpretive issues resulting in compliance and administrative costs (and the possibility of litigation).
Option 1: Update the tax treaty
4.68 Major Australian companies have for many years raised concerns about the lack of competitiveness of Australias tax treaty with the United States, and in particular the high level of US DWT permitted under the current tax treaty. They have welcomed the reduction in withholding tax rates made by the Protocol, particularly on non-portfolio dividends.
Dividends
4.69 The 15% rate of US DWT currently applying to non-portfolio dividends paid to Australian companies is a significant impediment to the expansion of the activities of Australian companies in the United States, with these companies facing an effective US tax rate of around 50% on repatriated earnings. Given companies from other countries generally face a significantly lower US DWT rate (5%), the 15% rate of US DWT is a significant penalty on multinationals operating out of Australia and adversely affects their cost of capital.
4.70 The importance of this issue has recently been brought to public attention by James Hardies restructuring that involved moving its parent company from Australia to the Netherlands. While the move was not aimed solely at reducing rates of US DWT, the high level of US DWT was said to have been a contributing factor.
4.71 The achievement of a nil or 5%US DWT rate for non-portfolio dividends paid to Australian companies will also significantly improve the ability of Australian multinationals to manage their capital base by freeing capital flows from tax. In some cases this could see a return of capital to Australia.
4.72 A nil Australian DWT rate would make the treatment of subsidiaries and branches of US businesses in Australia more consistent in that branches in Australia are not subject to DWT on distributions of profits. Economic efficiency may be improved by this reduction to the extent in which taxation considerations are a factor in deciding whether to structure operations through a branch or a subsidiary.
Interest
4.73 A nil Australian IWT rate on interest derived by US financial institutions would be consistent with the exemption currently provided for interest derived from widely distributed arms length debenture issues and recognises that a 10% IWT rate on gross interest derived by financial institutions may be excessive given their cost of funds. The cost to Australian business of raising capital from US financial institutions may also be reduced making this source of capital more affordable and increasing competition in capital markets.
Royalties
4.74 Australian residents required to meet the cost of Australian RWT on royalty payments made to US residents will benefit from the reduced RWT rate. Consultations with business representatives have indicated that such gross-up obligations are commonly imposed.
4.75 Australian residents who derive royalty income from the United States may also benefit from the reduced US RWT rate. Additional tax payable in Australia due to a reduced credit for US RWT will generally result in imputation credits that can be passed on to shareholders.
Alienation of property
4.76 Changes to the Alienation of Property Article will ensure Australian taxing rights are retained and facilitate investment between the countries by making the taxation treatment of capital gains more certain and reducing the risk of double taxation. The Protocol also addresses widespread business concerns about the potential for double taxation arising from the application of Australias CGT to expatriates departing Australia. These concerns have negatively affected the ability of Australian located companies to attract and retain skilled expatriate staff, and has the potential to affect headquarters location decisions to Australias detriment. The Protocol will improve arrangements for taxing gains accrued on assets held by departing residents by reducing compliance difficulties and ensuring appropriate relief is provided from double taxation.
Compliance and administration cost reduction benefits
4.77 Compliance costs would be significantly reduced by clarifying Australias right to tax US companies on capital gains derived from the disposal of an Australian subsidiary. Interpretative issues relating to the extent Australia can tax these gains under the existing treaty have resulted in considerable uncertainty and costly legal arguments. Administrative costs in explaining the ATO view and responding to legal arguments would also be significantly reduced.
(Offsetting) revenue benefits
4.78 A lower US DWT rate on non-portfolio dividends would not directly result in additional tax revenue for Australia because Australian companies are exempt on dividends they derive from their US subsidiaries. Some (unquantifiable) additional revenue may however be collected when unfranked profits referable to US dividends are distributed to shareholders, and if Australian multinationals reduce the capitalisation of their US subsidiaries. A reduced US DWT rate would also result in a comparable reduction in the imputation credit available for foreign DWT (once implemented). There may also be an (unquantifiable) increase in CGT collections if improved post-tax profits boost the market value of shares in Australian companies that have US operations.
Option 2: No further action - rely on the existing tax treaty
4.79 The existing tax treaty would continue to provide relief from double taxation and limitation of source country taxation in relation to most income, but high US DWT and uncertainty over capital gains would remain. Failure to deal with these issues would be a serious retrograde step in achieving an internationally competitive business tax system.
Consultation
4.80 Information on the revision of the existing tax treaty has been provided to the States and Territories through the Commonwealth-State Standing Committee on Treaties Schedule of Treaty Action.
4.81 The ATOs Tax Treaties Advisory Panel of industry representatives and tax practitioners was consulted on the changes along with the American Chamber of Commerce in Australia. Industry representatives of parties that may be negatively affected by the changes to the taxation of REIT dividends indicated that they were satisfied with the REIT provision in the Protocol. The Protocol will also be considered by the Parliamentary Joint Standing Committee on Treaties which provides for public consultation in its hearings.
4.82 The Treasury and the ATO monitor tax treaties, 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 fora.
Conclusion and recommended option
4.83 The reduction under the Protocol in rates of DWT in particular, as well as RWT and IWT, will provide significant benefits to Australian business, and mark a major step forward in providing Australian located companies with an internationally competitive treaty network and business tax system. It will also directly help facilitate trade and investment between the countries.
4.84 These benefits come at a direct cost to revenue. The revenue costs are considered to be outweighed by the overall benefits of updating the tax treaty. In addition, clarifying Australias right to tax US residents in respect of capital gains is an important tax base protection measure.
4.85 The Protocol is unlikely to significantly increase compliance costs for business and the clarification of the taxation of capital gains will reduce compliance and administrative costs (as well as the potential for double taxation).
4.86 The benefits of a Protocol outweigh the costs. Option 1 is therefore recommended as the preferred option.
EXCLUSION OF CERTAIN ROYALTIES FROM THE ROYALTY WITHHOLDING TAX PROVISIONS
Specification of policy objective
4.87 To align the domestic law treatment of equipment royalties paid to US residents with treatment permitted under Australias tax treaty with the United States following changes to that treaty made by a Protocol signed in Canberra on 27 September 2001. The changes made by the Protocol will exclude equipment royalties from the scope of the royalties definition in the US treaty.
4.88 A secondary objective is to deal with other cases where domestic law royalties are not treated as royalties under a tax treaty and to provide for this outcome in future tax treaties.
Background
4.89 Equipment royalties paid to US residents are currently taxable on a gross basis under the withholding tax provisions unless derived through an Australian permanent establishment or fixed base. The changes made by the Protocol to the royalties definition in the US tax treaty will result in these royalties being either exempt or taxable on a net basis.
4.90 Collection difficulties could arise unless royalties taxable on a net basis are excluded from the scope of the RWT provisions. Such difficulties can arise because tax to be withheld on a net amount generally cannot be determined when the obligation to withhold arises. Persons are thus likely to withhold too much tax because they are personally liable for any shortfall. Overpayment of withholding tax can lead to compliance and administrative costs in processing claims for tax refunds.
4.91 These collection difficulties can arise whenever domestic law royalties are not also treated as royalties for the purposes of a tax treaty.
Identification of implementation option(s)
4.92 The policy objectives can only be achieved by amending the law.
4.93 The law could be amended to exclude domestic law royalties from the RWT provisions where the royalties fall outside the royalty definition of a tax treaty. This would ensure there is no obligation to withhold tax on these royalties and allow them to be taxed on a net basis under the general income tax assessment provisions unless made exempt by a tax treaty.
Option 2: Do not amend the law
4.94 Royalties are currently excluded from the RWT provisions when derived by treaty residents through an Australian permanent establishment or fixed base. An indirect result of changes to be made by the US Protocol is that the current domestic law exclusion will cease to apply to equipment royalties derived by US residents. Collection difficulties could arise unless the law is amended to continue the exclusion for these royalties.
Assessment of impacts (costs and benefits) of each option
4.95 The amendments will affect residents of treaty partner countries who derive domestic law royalties that are not treated as royalties for the purposes of an applicable tax treaty. They will also affect persons who would otherwise be obliged to withhold tax on the royalties and the ATO which would be required to process refunds for overpaid RWT.
4.96 The amendments will align the domestic law treatment of royalties with treatment permitted under tax treaties and thus will not give rise to revenue or other costs.
Option 2: Do not amend the law
4.97 Persons obliged to withhold RWT would face compliance difficulties in determining the amount to withhold and persons liable for the RWT may incur costs when seeking refunds of overpaid tax. The ATO would also incur administrative costs in processing tax refunds. These compliance and administrative costs are unquantifiable.
4.98 The amendments will result in a continuation of current arrangements for taxing equipment royalties derived by US residents through an Australian permanent establishment or fixed base. Collection difficulties that could arise from the application of the RWT provisions to these royalties taxable on a net basis would thus be avoided. As discussed above, such difficulties can result in the overpayment of withholding tax and lead to compliance and administrative costs in processing claims for tax refunds.
4.99 The amendments will deal with other cases where domestic law royalties are not treated as royalties under a tax treaty. These cases are uncommon in practice. The amendments will also provide for future changes to the royalties definition in tax treaties without the need for further amendments.
Option 2: Do not amend the law
4.100 No benefits.
Consultation
4.101 The issue was identified by an affected taxpayer. There has not been wider consultation.
Recommended option
4.102 The benefits of Option 1 outweigh the costs and the amendments are therefore recommended.
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