House of Representatives

Explanatory Memorandum

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

Chapter 2 - The Mexican agreement

What is the Mexican agreement?

2.1 The Mexican agreement is an Agreement between the Government of Australia and the Government of the United Mexican States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income , and the Protocol thereto (referred to as 'tax treaty' or 'treaty' for the purposes of this chapter), signed in Mexico City on 9 September 2002.

Why is the treaty necessary?

2.2 The new treaty, which is the first tax treaty between Australia and Mexico, will facilitate trade and investment between the two countries by:

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preventing double taxation and providing 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 two countries over different categories of income;

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specifying rules to resolve dual claims in relation to the residential status of taxpayers, who are residents of the treaty countries, and their source of income; and

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providing taxpayers, who are residents of the treaty countries, with an avenue to present a case for determination by the relevant taxation authorities where the taxpayers consider there has been taxation treatment contrary to the terms of the tax treaty; and

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preventing avoidance and evasion of taxes on various forms of income flows between the two countries 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 Australian and Mexican taxation authorities.

Main features of the tax treaty

2.3 The tax treaty between Australia and Mexico will facilitate trade and investment between the two countries by preventing double taxation and reducing tax obstacles to cross-border movement of capital, technology and people.

2.4 The tax treaty accords substantially with other Australian comprehensive tax treaties concluded prior to the review of Australia's international tax arrangements.

2.5 The features of the tax treaty include:

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Dual resident persons (i.e. persons who are residents of both Australia and Mexico according to the domestic law of each country) are, in accordance with specified criteria, to be treated for the purposes of the tax treaty as being residents of only one country. Where a non-individual such as a company is resident in both countries for their domestic tax purposes, the entity will be deemed to be a resident of the country in which its place of effective management is situated [Article 4].

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Income from real property may be taxed in full by the country in which the property is situated. Income from real property for these purposes includes natural resource royalties [Article 6].

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Business profits are generally to be taxed only in the country of residence of the recipient unless they are derived by a resident of one country through a branch or other prescribed permanent establishment in the other country, in which case that other country may tax the profits. Sales of similar goods and merchandise not through a permanent establishment may in certain circumstances be subject to Article 7 [Article 7].

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Profits from the operations of ships and aircraft are generally to be taxed only in the country of residence of the operator [Article 8].

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Profits of associated enterprises may be taxed on the basis of dealings at arm's length [Article 9].

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Dividends, interest and royalties may generally be taxed in both countries, but there are limits on the tax that the country in which the dividend, interest or royalty is sourced may charge on such income flowing to residents of the other country who are beneficially entitled to that income. These limits are 10% for royalties and 10% or 15% for interest. No tax is payable on dividends which have been fully taxed at the corporate level and where the dividend recipient is a company that holds directly at least 10% of the voting power of the company paying the dividend. A 15% limitation applies to other dividends [Articles 10 to 12].

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Income or profits from the alienation of real property may be taxed in full by the country in which the property is situated. Subject to that rule and other specific rules in relation to business assets and some shares, capital gains are to be taxed in accordance with the domestic law of each country [Article 13].

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Income from independent personal services provided by an individual will generally be taxed only in the country of residence of the recipient. However, remuneration derived by a resident of one country in respect of professional services rendered in the other country may be taxed in the other country, where derived through a fixed base of the person concerned in that country, or if the person is present for more than 183 days in that country [Article 14].

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Income from employment, that is, employee's remuneration, will 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 will be exempt in the country visited [Article 15].

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Directors' fees and other similar payments may be taxed in the country of residence of the paying company [Article 16].

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Income derived by entertainers and sportspersons may generally be taxed by the country in which the activities are performed [Article 17].

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Pensions and annuities (including for public service) may be taxed only in the country of residence of the recipient [Article 18].

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Income from government service will generally be taxed only in the country that pays the remuneration. However, the remuneration may be taxed in the other country in certain circumstances where the services are rendered in that other country [Article 19].

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Payments to visiting students will be exempt from tax in the country visited insofar as they consist of payments made from abroad for the purposes of their maintenance or education [Article 20].

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Other income (i.e. income not dealt with by other Articles) may generally be taxed in both countries, with the country of residence of the recipient providing double tax relief [Article 21].

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Double taxation relief for income which, under the tax treaty, may be taxed by both countries, is required to be provided by the country in which the taxpayer is resident under the terms of the tax treaty as follows:

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in Australia by allowing a credit for the Mexican tax against Australian tax payable on income derived by a resident of Australia from sources in Mexico;

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in Mexico, by allowing a credit against Mexican tax for the Australian tax paid on income derived by a resident of Mexico from sources in Australia; and

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both Australia and Mexico are required to give credit for underlying taxes on incoming non-portfolio intercorporate dividends should they tax such dividends.

[Article 23]

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In the case of Australia, effect will be given to the double tax relief obligations arising under the tax treaty by application of the general foreign tax credit provisions of Australia's domestic law, or the relevant exemption provisions of that law where applicable [Article 23].

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Consultation and exchange of information between the two taxation authorities is authorised by the tax treaty [Articles 24 and 25].

Detailed explanation of the provisions

Article 1 - Personal Scope

2.6 This Article establishes the scope of the application of the tax treaty by providing for it to apply to persons (defined to include individuals, companies and any other body of persons) who are residents of one or both of the countries. It generally precludes extra-territorial application of the treaty.

2.7 The application of the tax treaty to persons who are dual residents (i.e. residents of both countries) is dealt with in Article 4 ( Residence ).

Article 2 - Taxes Covered

Taxes covered

2.8 This Article specifies the existing taxes of each country to which the tax treaty applies. These are, in the case of Australia:

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the Australian income tax; and

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the resource rent tax in respect of offshore petroleum projects.

2.9 In the case of Australia, income tax (including that imposed on capital gains) and resource rent tax are covered by the tax treaty. Goods and services tax, fringe benefits tax, wool tax and levies, customs duties, Australian State taxes and duties and estate tax and duties are not covered by the tax treaty. [Article 2, subparagraph 1(b )]

2.10 It is specifically stated that this Article applies only to taxes imposed under the federal law of Australia. This is to ensure that the tax treaty does not bind Australian States and Territories and applies only to federal taxes. [Article 2, subparagraph 1(b ) and paragraph 2]

2.11 For Mexico, the tax treaty applies to the federal income tax ( el impuesto sobre la renta federal ). [Article 2, subparagraph 1(a )]

Identical or substantially similar taxes

2.12 The application of the tax treaty will be automatically extended to any identical or substantially similar taxes which are subsequently imposed by either country in addition to, or in place of, the existing taxes. The two countries are required to notify each other within a reasonable time of any significant changes in their respective laws to which this tax treaty applies. [Article 2, paragraph 2]

Article 3 - General Definitions

Definition of Australia

2.13 As with Australia's other modern taxation agreements, Australia is defined to include certain external territories and areas of the continental shelf. By reason of this definition, Australia preserves its taxing rights, for example, over mineral exploration and mining activities carried on by non-residents on the seabed and subsoil of the relevant continental shelf areas (under section 6AA of the ITAA 1936, certain sea installations and offshore areas are to be treated as part of Australia). [Article 3, subparagraph 1(b )]

Definition of company

2.14 The definition of company in the tax treaty accords with Australia's tax treaty practice. It reflects the fact that Australia's domestic tax law does not specifically use the expression body corporate for tax purposes.

2.15 The Australian tax law treats certain trusts (public unit trusts and public trading trusts) and corporate limited partnerships as companies for income tax purposes. These entities are included as companies for the purposes of the tax treaty. [Article 3, subparagraph 1(e )]

Definition of international traffic

2.16 In this tax treaty, this term is only relevant in relation to the alienation of ships and aircraft (paragraph 4 of Article 13 ( Alienation of Property )) and wages of crew (paragraph 3 of Article 15 ( Dependent Personal Services )). [Article 3, subparagraph 1(i )]

Definition of tax

2.17 For the purposes of the tax treaty, the term tax does not include any amount of penalty or interest imposed under the respective domestic law of the two countries. This is important in determining a taxpayer's entitlement to a foreign tax credit under the double tax relief provisions of Article 23 ( Methods of Elimination of Double Taxation ) of the tax treaty.

2.18 In the case of a resident of Australia, any penalty or interest component of a liability determined under the domestic taxation law of Mexico with respect to income that Mexico is entitled to tax under the tax treaty, would not be a creditable 'Mexican tax' for the purposes of paragraph 2 of Article 23 ( Methods of Elimination of Double Taxation ) of the tax treaty. This is in keeping with the meaning of foreign tax in the ITAA 1936 (subsection 6AB(2)). Accordingly, such a penalty or interest liability would be excluded from calculations when determining the Australian resident taxpayer's foreign tax credit entitlement under paragraph 2 of Article 23 (pursuant to Division 18 of Part III of the ITAA 1936 - Credits in Respect of Foreign Tax). [Article 3, subparagraph 1(k )]

Terms not specifically defined

2.19 Where a term is not specifically defined within this tax treaty, that term (unless used in a context that requires otherwise) is to be taken to have the same interpretative meaning as it has under the domestic taxation law of the country applying the tax treaty at the time of its application, with the meaning it has under the taxation law of the country having precedence over the meaning it may have under other domestic laws.

2.20 If a term is not defined in the tax treaty, but has an internationally understood meaning in tax treaties and a meaning under the domestic law, the context would normally require that the international meaning be applied. [Article 3, paragraph 2]

Article 4 - Residence

Residential status

2.21 This Article sets out the basis by which the residential status of a person is to be determined for the purposes of the tax treaty. 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 tax treaty. The concept of who is a resident according to each country's taxation law provides the basic test. [Article 4, paragraph 1; Protocol, Item 1]

Special residency rules

2.22 Paragraph 2 specifies that a person is not a resident of a country (for purposes of the tax treaty) if that person is liable to tax in that country in respect only of income from sources in that country. This paragraph deals with a person who may not be domiciled in a country, but who may be considered to be a resident according to its domestic laws and may only be subject to taxation on income from sources in that country, for example, foreign diplomatic and consular staff. In the Australian context this means that Norfolk Island residents who are generally subject to Australian tax on Australian source income only, will not be residents of Australia for the purposes of the tax treaty. Accordingly, Mexico will not have to forgo tax in accordance with the tax treaty on income derived by residents of Norfolk Island from sources in Mexico (which will not be subject to Australian tax). [Article 4, paragraph 2]

Residency of Governments

2.23 Item 1 of the Protocol clarifies the residential status of the Government and a political subdivision or a local authority thereof.

2.24 The commentary to the OECD Model was amended in September 1995 to add wording similar to item 1 of this Protocol to the OECD Model. The OECD Model commentary makes it clear that it has always been the understanding of OECD member countries that the OECD Model nevertheless applied to treat governments as residents and the addition of these words merely confirmed that understanding.

2.25 In the case of Australia, the formulation for paragraph 1 of this Article (which incorporates the residency rules of the tax laws of each country) would in any event ensure that Australian governments and tax-exempt entities are treated as residents for the purposes of the tax treaty. This is because a government or tax-exempt entity is a resident of Australia for tax law purposes - even though it may be exempt from tax. [Protocol, Item 1]

Dual residents

2.26 This Article also includes a set of tie-breaker rules for determining how residency is to be allocated to one or other of the countries for the purposes of the tax treaty if a taxpayer, whether an individual, a company or other entity, qualifies as a dual resident, that is, as a resident under the domestic law of both countries.

2.27 The tie-breaker rules for individuals apply certain tests, in a descending hierarchy, for determining the residential status (for the purposes of the tax treaty) of an individual who is a resident of both countries under their respective domestic laws.

2.28 These rules, in order of application, are:

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if the individual has a permanent home in only one of the countries, the person is deemed to be a resident solely of that country for the purposes of the tax treaty; or

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if the individual has a permanent home available in both countries or in neither, then the person's residential status takes into account the person's personal or economic relations (including habitual abode) with Australia and Mexico, and the person is deemed to be a resident only of the country for the purposes of the tax treaty with which the person has the closer personal and economic relations. An individual's citizenship or nationality is a factor in determining the degree of the person's personal and economic relations with that country.

[Article 4, paragraph 4]

2.29 Dual residents remain, however, a resident for the purposes of Australian domestic law, and subject to Australian tax as such, insofar as the tax treaty allows.

2.30 Where a non-individual (such as a company) is a resident of both countries for their domestic tax purposes, the entity will be deemed to be a resident of the country in which its place of effective management is situated. [Article 4, paragraph 5]

2.31 Three categories of persons - partnerships, estates of deceased individuals and trusts - are treated as residents of a country only to the extent that the entity's income is subject to that country's tax as the income of a resident, either in that entity's hands or in the hands of its partners or beneficiaries. Where income is not subject to tax in that country (either in the entity's hands or the hands of a resident partner or beneficiary), the partnership, estate or trust may also be treated a resident of that country to the extent that the entity's income is exempt from tax in that country only because it is subject to tax in the other country. Paragraph 3 of this Article is consistent with Mexico's observations to Article 4 ( Residence ) of the OECD Model. Trusts whose income is always exempted from tax in a country under the tax laws of that country (e.g. a public charitable trust) are unaffected by this provision. [Article 4, paragraph 3]

Article 5 - Permanent Establishment

Role and definition

2.32 The application of various provisions of the tax treaty (principally Article 7 ( Business Profits )) is dependent upon whether a person who is a resident of one country carries on business through a permanent establishment in the other country, and if so, whether income derived by that person is attributable to, or effectively connected with, that permanent establishment. The definition of the term permanent establishment which this Article embodies, corresponds generally with definitions of the term in Australia's more recent tax treaties.

Meaning of permanent establishment

2.33 The primary meaning of the term permanent establishment is expressed as being a fixed place of business through which the business of an enterprise is wholly or partly carried on. To be a permanent establishment within the primary meaning of that term, the following requirements must be met:

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there must be a place of business;

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the place of business must be fixed (both in terms of physical location and in terms of time); and

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the business of the enterprise must be carried on through this fixed place.

[Article 5, paragraph 1]

2.34 Other paragraphs of this Article elaborate on the meaning of the term by giving examples (by no means intended to be exhaustive) of what may constitute a permanent establishment - for example:

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an office;

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a workshop; or

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a mine.

As paragraph 2 of this Article is subordinate to paragraph 1, the examples listed will only constitute a permanent establishment if the primary definition in paragraph 1 is satisfied. [Article 5, paragraph 2]

Agricultural, pastoral or forestry activities

2.35 Most of Australia's comprehensive tax treaties include as a permanent establishment an agricultural, pastoral or forestry property. This reflects Australia's policy of retaining taxing rights over exploitation of Australian land for the purposes of primary production. This approach ensures that the arm's length profits test provided for in Article 7 ( Business Profits ) applies to the determination of profits derived from these activities. This position is also reflected in this tax treaty. [Article 5, subparagraph 2(g )]

Deemed permanent establishment

Building site or construction or installation project

2.36 Under paragraph 3, an enterprise is deemed to have a permanent establishment and to be carrying on business through that permanent establishment in a country if it has a building site or construction or installation project in that country which exist for more than six months. Building sites and construction and installation projects lasting less than six months, which nevertheless meet the requirements of a fixed place of business, will also be permanent establishments.

2.37 It is consistent with Mexico's and Australia's preferred treaty practice to treat any building site, construction or installation project that lasts more than six months as a permanent establishment. [Article 5, paragraph 3]

Supervisory and consultancy activities

2.38 Supervisory and consultancy activities carried on for more than six months in connection with a building site, a construction or installation project are deemed to constitute a permanent establishment. This accords with Mexico's treaty practice and broadly aligns with Australia's reservation to Article 5 ( Permanent establishment ) of the OECD Model.

2.39 The term 'building site or construction or installation project' includes not only the construction of buildings but also the construction of roads, bridges or canals, the renovation (involving more than mere maintenance or redecoration) of buildings, roads, bridges or canals, the laying of pipelines and excavating and dredging. Planning and supervision are considered part of the building site if carried out by the construction contractor. However, planning and supervision carried out by another unassociated enterprise will not be taken into account in determining whether the construction contractor has a permanent establishment in Australia. [Article 5, paragraph 3]

Heavy equipment

2.40 Under subparagraph 4(a), an enterprise is deemed to have a permanent establishment in a country if heavy equipment is being used in that country by, for or under contract with the enterprise.

2.41 This provision reflects Australia's reservation to the OECD Model concerning the use of substantial equipment and is designed to further protect Australia's right to tax income from natural resources. Australia's experience is that the permanent establishment provision in the OECD Model may be inadequate to deal with high value activities involved in the development of natural resources, particularly in offshore regions.

2.42 Some examples of heavy equipment are:

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large industrial earthmoving equipment or construction equipment used in road building, dam building or powerhouse construction;

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manufacturing or processing equipment used in a factory;

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oil and drilling rigs, platforms and other structures used in the petroleum or mining industry; and

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grain harvesters and other large agricultural machinery.

2.43 For the purposes of the tax treaty the enterprise is deemed to carry on business through the heavy equipment permanent establishment. [Article 5, subparagraph 4(a )]

Cost-toll operations

2.44 The inclusion of subparagraph 4(b) is consistent with another of Australia's reservations to the OECD Model. It deals with so-called 'cost-toll' situations, under which a mineral plant, for example, refines minerals at cost, so that the plant operations produce no Australian profits. Title to the refined product remains with the mining consortium and profits on sale are realised mainly outside of Australia.

2.45 Subparagraph 4(b) deems such a plant to be a permanent establishment because the manufacturing or processing activity (which gives the processed minerals their real value) is conducted in Australia, and therefore Australia should have taxing rights over the business profits arising from the sale of the processed minerals to the extent that they are attributable to the processing activity carried on in Australia. This subparagraph prevents an enterprise which carries on very substantial manufacturing or processing activities in a country through an intermediary from claiming that it does not have a permanent establishment in that country.

2.46 The inclusion of this subparagraph is insisted upon by Australia in its tax treaties and is consistent with Australia's policy of retaining taxing rights over profits from the exploitation of its mineral resources. [Article 5, subparagraph 4(b )]

Preparatory and auxiliary activities

2.47 Certain activities do not generally give rise to a permanent establishment (e.g. the use of facilities solely for storage, display or delivery).

2.48 These activities would ordinarily be of a preparatory or auxiliary character and not likely to give rise to substantial profits. Where this is the case, the necessary economic link between the activities of the enterprise and the country in which the activities are carried on does not exist.

2.49 Unlike the OECD Model, which provides that the listed activities are deemed not to constitute a permanent establishment, the tax treaty incorporates the Australian tax treaty approach of stating that an enterprise will not be deemed to have a permanent establishment merely by reason of such activities. This is to prevent the situation where enterprises structure their business so that most of their activities fall within the exceptions when - viewed as a whole - the activities ought to be regarded as a permanent establishment.

2.50 Another feature consistent with Australia's tax treaty practice is that subparagraph 4(f) of Article 5 of the OECD Model - dealing with combinations of the activities in subparagraphs 5(a) to (f) of this treaty - is not included. Australia does not consider that an enterprise undertaking multiple functions of the kind indicated in subparagraphs 5(a) to (f) could reasonably be regarded as only engaged in preparatory or auxiliary activities. [Article 5, paragraph 5]

2.51 Australian banks which maintain a 'representative office' in Mexico, where that office only undertakes preparatory or auxiliary work, will not give rise to a permanent establishment. Under current Mexican banking law, representative offices are not allowed to accept deposits or otherwise conduct a banking business in Mexico. These banks are only permitted to conduct 'preparatory or auxiliary' activities. [Article 5, subparagraph 5(f )]

Dependent agents

2.52 Paragraph 6 reflects Australia's tax treaty practice in relation to a person who acts on behalf of an enterprise of another country of deeming that person to constitute a permanent establishment if that person has and habitually exercises an authority to conclude contracts on behalf of the enterprise.

2.53 A person who substantially negotiates all essential parts of a contract on behalf of an enterprise will be regarded as exercising an authority to conclude contracts on behalf of that enterprise within the meaning of this provision, even if the contract is subject to final approval or formal signature by another person.

2.54 Consistent with the OECD Model and Mexico's treaty practice, this paragraph excludes the excepted activities of paragraph 5 from the scope of dependent agency. A dependent agent will not constitute a permanent establishment where that agent's activities are limited to the preparatory and auxiliary activities mentioned in paragraph 5. [Article 5, paragraph 6]

Independent agents

2.55 Business carried on through an independent agent does not, of itself, constitute a permanent establishment, provided that the independent agent is acting in the ordinary course of that agent's business as such an agent.

2.56 While this paragraph generally follows the OECD Model and Australia's usual treaty practice, it contains the additional requirement that the person act at arm's length. While Australia would normally take this approach in any event, this provision was included to reflect Mexico's observation to the OECD Model commentary. [Article 5, paragraph 7]

Subsidiary companies

2.57 Generally, a subsidiary company will not be a permanent establishment of its parent company. A subsidiary, being a separate legal entity, would not usually be carrying on the business of the parent company but rather its own business activities. However, a subsidiary company gives rise to a permanent establishment if the subsidiary permits the parent company to operate from its premises such that the tests in paragraph 1 of this Article are met, or acts as an agent such that a dependent agent permanent establishment is constituted. [Article 5, paragraph 8]

Other Articles

2.58 The principles set down in this Article are also to be applied in determining whether a permanent establishment exists in a third country or whether an enterprise of a third country has a permanent establishment in Australia (or in Mexico) when applying the source rule contained in:

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paragraph 6 of Article 11 ( Interest ); and

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paragraph 6 of Article 12 ( Royalties ).

[Article 5, paragraph 9]

Article 6 - Income from Immovable (Real) Property

Where income from immovable (real) property is taxable

2.59 This Article provides that the income of a resident of one country from real ('immovable') property situated in the other country may be taxed by that other country. Thus, income from real property in Australia will be subject to Australian tax laws. [Article 6, paragraph 1]

Definition

2.60 Income from immovable (real) property is effectively defined as extending, in the case of Australia, to income from:

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the direct use, letting or use in any other form of real property, a lease of land and any other interest in or over land (including exploration and mining rights); and

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royalties and other payments relating to the exploration for or exploitation of mines or quarries or other natural resources or rights in relation thereto.

2.61 In the case of Mexico, the definition of immovable ( real ) property generally follows the OECD Model definition of immovable property and includes:

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property accessory to immovable property;

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livestock and equipment used in agriculture and forestry;

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rights to which the provisions of the general law respecting landed property apply including direct use, letting or use in any other form of such property;

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usufruct of immovable property (generally, a right to use property without degrading it and to retain any profits derived from it); and

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rights to variable or fixed payments either as consideration for or in respect of the exploitation of, or the right to explore for or exploit, mineral deposits, oil or gas wells, quarries or other places of extraction or exploitation of natural resources.

[Article 6, paragraphs 2 and 4]

Deemed situs

2.62 Under Australian law the situation (situs) of an interest in land, such as a lease, is not necessarily where the underlying property is situated - there may not necessarily be a situs. This paragraph puts the situation of the interest or right beyond doubt. [Article 6, paragraph 3]

Real property of an enterprise and of persons performing independent personal services

2.63 The operation of this Article extends to income derived from the use or exploitation of real property of an enterprise and income derived from real property that is used for the performance of independent personal services.

2.64 Accordingly, application of this Article (when read with Articles 7 ( Business Profits ) and 14 ( Independent Personal Services )) to such income ensures that the country in which the real property is situated may impose tax on the income derived from that property by:

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an enterprise of the other country; or

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an independent professional person resident in that other country,

irrespective of whether or not that income is attributable to a permanent establishment of such an enterprise, or fixed base of such a person, situated in the firstmentioned country. [Article 6, paragraph 5]

Article 7 - Business Profits

2.65 This Article is concerned with the taxation of business profits derived by an enterprise that is a resident of one country from sources in the other country.

2.66 The taxing of these profits depends on whether they are attributable to the carrying on of a business through a permanent establishment in the other country or to sales of similar goods to those sold through such a permanent establishment.

2.67 If a resident of one country carries on a business through a permanent establishment (as defined in Article 5 ( Permanent Establishment )) in the other country, the country in which the permanent establishment is situated may tax the profits of the enterprise that are attributable to that permanent establishment. [Article 7, paragraph 1]

2.68 According to Item 2 of the Protocol, this Article applies to business profits derived by an enterprise that are attributable to a permanent establishment, notwithstanding that the enterprise has ceased to carry on a business through that permanent establishment in the other country. This provision was included at Mexico's suggestion to confirm the countries' understanding that this Article does not prevent source country taxation of attributable profits after a permanent establishment has ceased business. Australia's domestic law allows such attribution of business profits irrespective of this specific provision because the essential requirement under this Article is that income should be attributable to a permanent establishment. Therefore, a temporal nexus is not required. [Protocol, Item 2]

2.69 Consistent with Mexico's reservation to the OECD Model, a 'limited force of attraction' rule is included in the treaty to ensure, where a permanent establishment exists in one country, business profits derived by an enterprise of the other country from the sale of goods or merchandise carried out directly by its head or home office situated in that other country may be taxed in the first country, provided that those goods and merchandise are of the same or similar kind as the ones sold through that permanent establishment.

2.70 Mexico has explained to the OECD that this is a safeguard against abuse and not a broad 'force of attraction' rule. Subparagraph 1(b) makes it clear that the rule will not apply when the enterprise proves that the sales have been carried out in that manner for bona fide commercial reasons and not merely to obtain a benefit under the treaty. [Article 7, subparagraph 1(b )]

2.71 If an enterprise which is a resident of one country derives business profits in the other country other than profits attributable to a permanent establishment in that other country or to sales of similar goods, the general principle of this Article is that the enterprise will not be liable to tax in the other country on its business profits (except where paragraph 5 of this Article applies - see the explanation in paragraphs 2.75 and 2.76). [Article 7, paragraph 1]

Determination of business profits

2.72 Profits of a permanent establishment are to be determined for the purposes of this Article on the basis of arm's length dealing. The provisions in the tax treaty correspond to international practice and the comparable provisions in Australia's other tax treaties. [Article 7, paragraphs 2 and 3]

2.73 Paragraph 3 further provides that no deductions are allowed in respect of amounts paid (other than towards reimbursement of actual expense) by the permanent establishment to the head office of certain amounts, except in the case of a banking enterprise, by way of interest on funds lent to the permanent establishment. The specific inclusion of this further provision accords with Mexico's treaty practice and reflects the approach that Australia adopts even in the absence of a specific provision. [Article 7, paragraph 3]

2.74 No profits are to be attributed to a permanent establishment merely because it purchases goods or merchandise for the enterprise. Accordingly, profits of a permanent establishment will not be increased by adding to them any profits attributable to the purchasing activities undertaken for the head office. It follows, of course, that any expenses incurred by the permanent establishment in respect of those purchasing activities will not be deductible in determining the taxable profits of the permanent establishment. [Article 7, paragraph 4]

Profits dealt with under other Articles

2.75 Where income or gains are otherwise specifically dealt with under other Articles of the tax treaty, the effect of those particular Articles is not overridden by this Article.

2.76 This provision lays down the general rule of interpretation that categories of income or gains which are the subject of other Articles of the tax treaty (e.g. shipping, dividends, interest, royalties and alienation of property) are to be treated in accordance with the terms of those Articles (except where otherwise provided, e.g. by paragraph 6 of Article 10 ( Dividends ) where the asset in respect of which the income is paid is effectively connected to a permanent establishment). [Article 7, paragraph 5]

Inadequate information

2.77 The domestic law of the country in which the profits are sourced (e.g. Australia's Division 13 of the ITAA 1936) may be applied to determine the tax liability of a person, consistently with the principles of the Article. This is of particular relevance where, due to inadequate information, the correct amount of profits attributable on the arm's length principle basis to a permanent establishment cannot be determined, or can only be ascertained with extreme difficulty. This is consistent with Australia's treaty practice. [Protocol, Item 2]

Insurance with non-residents

2.78 Each country has the right to continue to apply any provisions in its domestic law relating to the taxation of income from insurance. However, if the relevant law in force in either country at the date of signature of the tax treaty is varied (otherwise than in minor respects so as not to affect its general character), the countries must consult with each other with a view to agreeing to any amendment of this paragraph (i.e. paragraph 6) that may be appropriate. An effect of this paragraph is to preserve, in the case of Australia, the application of Division 15 of Part III of the ITAA 1936 (Insurance with Non-Residents).

2.79 For the purposes of paragraph 6, an insurance enterprise of Australia shall, except in regard to reinsurance, be deemed to have a permanent establishment in Mexico if it collects premiums in Mexico or insures risks situated in Mexico through a dependent agent (to whom paragraph 7 of Article 5 ( Permanent Establishment ) applies).

2.80 For reasons of its internal law, Mexico finds it useful to deem a non-resident to have a permanent establishment in respect of its insurance activities. On the other hand, Australia's treaty policy is to preserve the internal law treatment of non-resident insurance without reference to the permanent establishment concept. A solution was reached whereby taxing rights concerning non-resident insurance are allocated in accordance with the domestic laws of both countries, but for the purposes of Mexican tax law a permanent establishment is deemed to exist in relation to non-resident insurance activities. [Article 7, paragraph 6]

Trust beneficiaries

2.81 The principles of this Article will apply to business profits derived by a resident of one of the countries (directly or through one or more interposed trust estates) as a beneficiary of a trust estate. [Protocol, Item 2]

2.82 In accordance with this Article, Australia has the right to tax a share of business profits, originally derived by a trustee of a trust estate (other than a trust estate that is treated as a company for tax purposes) from the carrying on of a business through a permanent establishment in Australia, to which a resident of Mexico is beneficially entitled under the trust estate. Item 2 of the Protocol ensures that such business profits will be subject to tax in Australia where, in accordance with the principles set out in Article 5 ( Permanent Establishment ), the trustee of the relevant trust estate has a permanent establishment in Australia in relation to that business.

Article 8 - Profits from the Operation of Ships and Aircraft

2.83 The main effect of this Article is that the right to tax profits from the operation of ships or aircraft in international traffic, including profits derived from participation in a pool service or other profit sharing arrangement, is generally reserved to the country in which the operator is a resident for tax purposes. [Article 8, paragraphs 1 and 3]

2.84 However, this Article reflects Australian and Mexican treaty policy in reserving to the source country the right to tax profits from internal traffic and profits from other coastal and continental shelf activities, including the provision of accommodation and other non-transport shipping and aircraft activities, within its own waters and airspace. [Article 8, paragraph 2; Protocol, Item 3]

2.85 Thus, the term transport is not used in the title of this Article, as the Article applies to survey ships, oil drilling ships, where transport is not necessarily involved.

2.86 Contrary to subparagraph 8(d) and paragraph 9 of the OECD Model commentary on Article 8 ( Shipping, inland waterways transport and air transport ), Australia and Mexico agreed that for the purposes of the tax treaty, the international operation of ships and aircraft does not include inland transportation such as road transport. Profits from such transportation is not covered by paragraph 1 of this Article. [Protocol, Item 3]

Internal traffic

2.87 Paragraph 4 of this Article clarifies that any shipment by sea or air from a place in Australia (including the continental shelf areas and external territories) for discharge at another place in Australia or for return to that place in Australia, is to be treated as constituting internal traffic. [Article 8, paragraph 4]

Example 2.1

Profits that are derived from the transport of goods between Sydney and Perth, that were uploaded in Sydney onto a ship operated by a Mexican enterprise making that stopover as part of an international voyage from Manzanillo to Perth, would be profits from internal traffic. As such, 5% of the amount paid in respect of the internal traffic carriage would be deemed to be taxable income of the operator for Australian tax purposes pursuant to Division 12 of Part III of the ITAA 1936.

Article 9 - Adjustments to Profits of Associated Enterprises

Reallocation of profits

2.88 This Article deals with associated enterprises (parent and subsidiary companies and companies under common control). It authorises the reallocation of profits between related enterprises in Australia and Mexico 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 unrelated enterprises dealing wholly independently with one another.

2.89 This Article would not generally authorise the rewriting of accounts of associated enterprises where it can be satisfactorily demonstrated that the transactions between such enterprises have taken place on normal, open market commercial terms. [Article 9, paragraph 1]

2.90 Each country retains the right to apply its domestic law relating to the determination of the tax liability of a person (e.g. Australia's Division 13 of the ITAA 1936) to its own enterprises, provided that such provisions are applied, so far as it is practicable to do so, consistently with the principles of the Article. [Protocol, Item 4]

2.91 Australia's domestic law provisions relating to international profit shifting arrangements were revised in 1981 in order to deal more comprehensively with arrangements under which profits are shifted out of Australia, whether by transfer pricing or other means. The broad scheme of the revised provisions of the domestic law is to impose arm's length standards in relation to international dealings, but where the Commissioner cannot ascertain the arm's length consideration, it is deemed to be such an amount as the Commissioner determines. Item 4 of the Protocol is designed to preserve the application of those domestic law provisions and is consistent with Australia's treaty practice.

Correlative adjustments

2.92 Where a reallocation of profits is made (either under this Article or, by virtue of Item 4 of the Protocol, 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 reallocated continued to be subject to tax in the hands of an associated enterprise in the other country. To avoid this result, the other country is required to make an appropriate compensatory adjustment to the amount of tax charged on the profits involved to relieve any such double taxation, if that country agrees with the initial adjustment made by the country where the enterprise is situated. This proviso reflects the general understanding that the treaty country is only obliged to make the compensatory adjustment if it considers that the initial adjustment by the other country is in accordance with the tax treaty, that is, where that adjustment was made in accordance with arm's length principles.

2.93 It would generally be necessary for the affected enterprise to apply to the competent authority of the country not initiating the reallocation of profits for an appropriate compensatory adjustment to reflect the reallocation of profits made by the other treaty partner country. If necessary, the competent authorities of Australia and Mexico will consult with each other to determine the appropriate adjustment. [Article 9, paragraph 2]

Fraud

2.94 In a reservation to Article 9 ( Associated enterprises ) of the OECD Model, Mexico reserves the right not to include paragraph 2 of that Article in its tax treaties. While Mexico has agreed to include an equivalent of that paragraph in this treaty, it considers that the correlative relief benefits of paragraph 2 should not be extended to cases of fraud, for example, where a correlative adjustment was sought by an enterprise in a non bona fide situation. Paragraph 3 ensures that correlative relief is not available in cases of fraud. [Article 9, paragraph 3]

Article 10 - Dividends

2.95 This Article broadly allows both countries to tax dividends flowing between them, but in general limits the rate of tax that the country of source may impose on dividends payable by companies that are residents of that country to residents in the other country who are beneficially entitled to the dividends. [Article 10, paragraph 1]

Rate of tax

2.96 This Article provides that Australia will not tax franked dividends flowing to Mexican companies who directly hold at least 10% of the voting power in the Australian company paying the dividends. Reciprocally, Mexico will not tax dividends fully taxed at the corporate level (i.e. dividends that have been paid from the 'net profit account'). [Article 10, subparagraphs 2(a ) and 3(a )]

2.97 In all other cases, the tax treaty provides that Australia and Mexico will generally limit their tax to 15% of the dividend. In the case of Australia, this will mean that the normal withholding tax rate imposed on unfranked dividends will be reduced from 30% to 15%. [Article 10, subparagraph 2(b )]

2.98 There is also provision for flexibility if there is a change to either country's general approach to taxing dividends, such as a change to Australia's domestic law arrangements for franked dividends flowing overseas. In such a case, the two countries are obliged to consult to consider appropriate amendments to this paragraph. [Article 10, paragraph 2]

Profits not paid out of the Mexican 'net profit account'

2.99 Item 5 of the Protocol refers to Mexican dividends which have not been paid out of the 'net profit account'.

2.100 Mexico currently taxes corporate profits at 35% (reducing to 32% by 2005). Once a company has paid its income tax, after-tax earnings may be distributed to shareholders without any further tax. Such earnings are normally paid out of the 'net profit account'. However, if the company makes a distribution out of earnings that for any reason have not been subject to company tax, it will have to pay 35% out of those earnings. In Mexico, dividends are not subject to any tax at the shareholder level, only at the corporate level and Mexico currently imposes no withholding tax on dividends paid to residents or non-residents.

2.101 Item 5 of the Protocol was included at Mexico's request. Its purpose is to clarify that, notwithstanding subparagraph 2(b) of Article 10, which applies a maximum dividend withholding tax rate of 15% on all dividends which are not within subparagraph 2(a), the profits out of which previously untaxed dividends are paid may be taxed at the corporate tax rate rather than the dividend withholding tax rate. [Protocol, Item 5]

Exception to limitation

2.102 The limitation on the tax of the country in which the dividend is sourced does 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.

2.103 Where the holding is so effectively connected, the dividends are to be treated as business profits or income from independent personal services and therefore may be subject to the full rate of tax applicable in the country in which the dividend is sourced (in accordance with the provisions of Article 7 ( Business Profits ) or Article 14 ( Independent Personal Services ), as the case may be). In practice, however, under the full imputation system of company taxation in Australia's domestic law, such dividends, to the extent that they are franked dividends, remain exempt from Australian tax. Unfranked dividends that are effectively connected with a permanent establishment in Australia will be subject to withholding tax at the rate of 15% instead of being taxed by assessment. [Article 10, paragraph 6]

Extra-territorial application precluded

2.104 The extra-territorial application by either country of taxing rights over dividend income is precluded by providing, broadly, that one country (the first 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 shareholding giving rise to the dividends is effectively connected with a permanent establishment or fixed base in the first country.

2.105 An example of the effect of this paragraph is that Australia may not tax dividends paid by a Mexican company to a resident of Mexico out of profits derived from Australian sources, unless the Mexican shareholder has a permanent establishment or a fixed base in Australia with which the holding is effectively connected. [Article 10, paragraph 7]

Definition of 'dividends'

2.106 The term dividends in this Article means income from shares and other income assimilated to income from shares by the law, relating to tax, of the country of which the company making the distribution is a resident. Item 6 of the Protocol clarifies that an issue of bonus shares is included in the term 'dividends'. Bonus shares are generally treated as dividends for Australian tax purposes to the extent to which the paid-up value represents a capitalisation of profits. [Article 10, paragraph 5; Protocol, Item 6]

Article 11 - Interest

Rate of tax

2.107 This Article provides for interest income to be taxed by both countries but requires the country in which the interest arises to generally limit its tax to either 10% or 15% of the gross amount of the interest where a resident of the other country is beneficially entitled to the interest. [Article 11, paragraphs 1 and 2]

2.108 Paragraph 2 limits the taxation by the country in which the interest arises to either 10% or 15% of the gross amount of interest. The lower 10% rate limit applies where the interest is derived by or from a bank, from certain bonds or securities, or from credit sales of machinery or equipment.

2.109 The 10% tax rate limit applies to interest derived from bonds and securities that are regularly and substantially traded on a recognised securities market. Item 7(a) of the Protocol defines the meaning of the term recognised securities market and generally covers stock exchanges authorised under the law of Australia or Mexico.

2.110 The 15% rate limit applies in all other cases. [Article 11, paragraph 2; Protocol, Item 7(a )]

Back-to-back loan arrangements

2.111 The treaty limits on interest withholding tax will not apply to interest derived from back-to-back loans. In such cases, the interest paid shall be taxable in accordance with the domestic law of the source country. [Protocol, Item 7(b )]

2.112 The treaty rate limits on interest withholding tax will only be denied for interest paid on the component of a loan that is considered to be back-to-back. This provision was inserted at Mexico's request. In practice, this provision will have no effect in Australia, since the domestic law withholding tax rate on interest (currently 10%) does not exceed the lower rate limit provided under the treaty.

Definition of interest

2.113 The term interest is defined for the purposes of this Article in a way that, in relation to Australia, encompasses items of income such as discounts on securities and payments under certain hire purchase agreements which are treated for Australian tax purposes as interest or amounts in the nature of interest. [Article 11, paragraph 4]

Interest effectively treated as business profits

2.114 Interest derived by a resident of one country which is paid in respect of an indebtedness which is effectively connected to a permanent establishment or fixed base of that person in the other country, will form part of the business profits of that permanent establishment or fixed base and be subject to the provisions of Article 7 ( Business Profits ) or Article 14 ( Independent Personal Services ). Accordingly, the relevant tax rate limitations (10% or 15% tax rate limitation) in paragraph 2 do not apply to such interest in the country in which the interest is sourced. [Article 11, paragraph 5]

Deemed source rules

2.115 Interest source rules are set out in paragraph 6. These rules operate to allow Australia to tax interest to which a resident of Mexico is beneficially entitled where the interest is paid by a resident of Australia. Australia may also tax interest paid by a non-resident to which a Mexican resident is beneficially entitled if it is an expense incurred by the payer in carrying on a business in Australia through a permanent establishment or fixed base.

2.116 However, consistent with Australia's interest withholding tax provisions, an Australian source is not deemed in respect of interest that is an expense incurred by an Australian resident in carrying on a business through a permanent establishment or fixed base outside Australia. [Article 11, paragraph 6]

2.117 Indebtedness under one loan contract, where part of the loan is attributed to a permanent establishment or a fixed base, may be apportioned between the head office and a permanent establishment or fixed base. The inclusion of this clarification accords with Mexico's treaty practice and reflects Australia's general understanding of the position. [Protocol, Item 8]

Related persons

2.118 This Article also contains a general safeguard against payments of excessive interest where a special relationship exists between the persons associated with a loan transaction - by restricting the 10% or 15% source country tax rate limitation to an amount of interest which might have been expected to have been agreed upon if the parties to the loan agreement were dealing with one another at arm's length . Any excess part of the interest remains taxable according to the domestic law of each country but subject to the other Articles of the tax treaty. [Article 11, paragraph 7]

2.119 Examples of cases where a special relationship might exist include payments to a person (either individual or legal):

•

who controls the payer (whether directly or indirectly);

•

who is controlled by the payer; or

•

who is subordinate to a group having common interests with the payer.

2.120 It also covers relationships of blood or marriage and, in general, any community of interests.

For whatever reason

2.121 The inclusion of the words 'for whatever reason' in paragraph 7 of this Article reflects a former reservation by Mexico to the OECD Model. The inclusion of these additional words permits interest and other payments in respect of certain loans to be dealt with as distributions in a range of circumstances provided for in Mexico's domestic law, including those where the amount of the loan or the rate of interest or other terms relating to it are not what would have been agreed in the absence of a special relationship. This paragraph permits not only the adjustment of the rate at which interest is charged but also the reclassification of the excess interest in such a way as to give it the character of a distribution. The current OECD Model commentary to Article 11 ( Interest ) recognises that this addition is appropriate to enable recharacterisation of the excess interest. [Article 11, paragraph 7]

Limitation of benefits

2.122 At the time of negotiation, Mexico had a reservation to the OECD Model concerning interest on debt claims created or assigned mainly for the purpose of taking advantage of the Interest Article and not for bona fide commercial reasons. While, in general, Australia considers such non bona fide transactions would be re-characterised under the tax treaty according to their true nature, it was agreed to include a specific provision to preserve the operation of domestic law in such cases. [Article 11, paragraph 8]

Article 12 - Royalties

Rate of tax

2.123 This Article in general allows both countries to tax royalty flows but limits the tax of the country of source to 10% of the gross amount of royalties paid or credited to residents of the other country beneficially entitled to the royalties. [Article 12, paragraphs 1 and 2]

2.124 The 10% rate limitation does not to apply to natural resource royalties, which, in accordance with Article 6 ( Income from Immovable ( Real ) Property ), are to remain taxable in the country of source without limitation of the tax that may be imposed.

2.125 In the absence of a tax treaty, Australia taxes royalties paid to non-residents at 30% of the gross royalty.

Definition of royalties

2.126 The definition of royalties in the tax treaty largely reflects the definition in Australia's domestic income tax law. The definition encompasses payments for the use of, or the right to use industrial, commercial or scientific equipment. It also includes payments for the supply of scientific, technical, industrial or commercial know-how but not payments for services rendered, except as provided for in subparagraph 3(d). Payments for reproduction or broadcasting rights, where modern technology such as satellite, cable, fibre optics or similar technology including the Internet is used for transmission, also constitute royalty payments. [Article 12, paragraph 3; Protocol, Item 9]

Payments for the supply of know-how versus payments for services rendered

2.127 It is considered that a German Supreme Court decision ( Bundesfinanzhof (No. IR 44/67) of 16 December 1970) provides a definitive test for distinguishing between a know-how contract and a contract for services. A know-how contract, it was held, involved the supply by a person of their know-how to the paying entity (e.g. teaching a personal expertise), whereas in a contract for services, although it may involve the use of know-how, that know-how is applied by the person in the performance of their services.

2.128 Payments for design, engineering or construction of plant or building, feasibility studies, component design and engineering services may generally be regarded as being in respect of a contract for services, unless there is some provision in the contract for imparting techniques and skills to the buyer.

2.129 In cases where both know-how and services are supplied under the same contract, if the contract does not separately provide for payments in respect of know-how and services, an apportionment of the two elements of the contract may be appropriate.

2.130 Payments for services rendered are to be treated under Article 7 ( Business Profits ) or Article 14 ( Independent Personal Services ).

Spectrum licences

2.131 A provision has been included in the Protocol that deems radiofrequency spectrum licence payments to be royalties for the purposes of the tax treaty. [Protocol, Item 9(c )]

Forbearance

2.132 Consistent with Australian tax treaty practice, subparagraph 3(f) expressly treats as a royalty, amounts paid or credited in respect of forbearance to grant to third persons, rights to use property covered by the Royalties Article. This is designed to address arrangements along the lines of those contained in Aktiebolaget Volvo v. Federal Commissioner of Taxation (1978)
8 ATR 747 ;
78 ATC 4316 , where instead of amounts being payable for the exclusive right to use the property they were made for the undertaking that the right to use the property will not be granted to anyone else. This provision ensures that the amounts are subject to tax as a royalty payment under the terms of this Article. [Article 12, subparagraph 3(f )]

The disposition of property or rights

2.133 The tax treaty provides that the term royalties includes income derived from the sale, exchange or other disposition of any property or right described in this Article to the extent to which the amount realised on such sale, exchange or other disposition are contingent on the productivity, use or further disposition of such property or right. The purpose of this paragraph is to prevent the conversion of royalties into long-term payments for the 'sale' of the underlying property. This provision ensures that the payment continues to fall within the scope of this Article. [Article 12, paragraph 4]

Other royalties effectively treated as business profits

2.134 As in the case of interest income, the withholding tax rate limitation does not apply to royalties paid in respect of property or rights which are effectively connected with a permanent establishment or fixed base in the country in which the income is sourced - such income being subject to full taxation under either Article 7 ( Business Profits ) or Article 14 ( Independent Personal Services ), as the case may be. [Article 12, paragraph 5]

2.135 Contracts under which royalties are paid, where part of the royalties is attributed to a permanent establishment or a fixed base, may be apportioned between the head office and a permanent establishment or fixed base. The inclusion of this clarification accords with Mexico's treaty practice and reflects Australia's general understanding of the position. [Protocol, Item 8]

Deemed source rule

2.136 The royalties source rule provided for in the tax treaty effectively corresponds in the case of Australia with the deemed source rule contained in section 6C (source of royalty income derived by a non-resident) of the ITAA 1936 for royalties paid to non-residents of Australia. It broadly mirrors the source rule for interest income contained in paragraph 6 of Article 11 ( Interest ). [Article 12, paragraph 6]

Related persons

2.137 If royalties flow between the payer and the person beneficially entitled to the royalties as the result of a special relationship between them, the 10% source country tax rate limitation will apply only to the extent that the royalties are not excessive. Any excess part of the royalty remains taxable according to the domestic law of each country but subject to the other Articles of this tax treaty. [Article 12, paragraph 7]

Limitation of benefits

2.138 Consistent with Mexico's treaty practice, royalties arising from the rights or property created or assigned mainly for the purpose of taking advantage of this Article are excluded from the scope of this Article and domestic law taxation over such payments is preserved. [Article 12, paragraph 8]

Article 13 - Alienation of Property

Taxing rights

2.139 This Article allocates between the respective countries taxing rights in relation to income, profits or gains arising from the alienation of real property and other items of property.

2.140 The reference to 'income, profits or gains' in this Article is designed to put beyond doubt that a gain from the alienation of property which in Australia is income , or a profit under ordinary concepts, will be taxed in accordance with this Article, rather than Article 7 ( Business Profits ), together with relevant capital gains.

Real property

2.141 Income, profits or gains from the alienation of real property may be taxed by the country in which the property is situated. The term immovable ( real ) property is defined for the purposes of this Article as it is under paragraph 2 of Article 6 ( Income from Immovable ( Real ) Property ). Where the property is situated is determined in accordance with paragraph 3 of Article 6. [Article 13, paragraphs 6 and 7]

Shares and other interests in land-rich entities

2.142 Paragraph 2 applies to situations involving the alienation of shares or other interests in companies, and other entities, where the value of the assets is principally attributable to the real property, which is situated in the other country. Such income, profits or gains may be taxed by the country in which the real property is situated. This paragraph complements paragraph 1 of this Article and is designed to cover arrangements involving the effective alienation of incorporated real property , or like arrangements.

2.143 This is to be the case whether the real property is held directly or indirectly through a chain of interposed entities. While not limited to chains of companies, or even chains of entities only some of which are companies, the example of chains of companies is used to make clear that the corporate veil should be lifted in examining direct or indirect ownership.

2.144 This provision responds to the tax planning opportunities exposed by the decision of the Full Federal Court in the Commissioner of Taxation v. Lamesa Holdings BV (1997)
77 FCR 597 . It is designed to protect Australian taxing rights over income, profits or gains on the alienation or effective alienation of Australian real property (as defined) despite the presence of interposed bodies corporate or other entities. [Article 13, paragraph 2]

Permanent establishment

2.145 Paragraph 3 deals with income, profits or gains arising from the alienation of property (other than real property covered by paragraph 1) forming part of the business assets of a permanent establishment of an enterprise or pertaining to a fixed base used for performing independent personal services. It also applies where the permanent establishment itself (alone or with the whole enterprise) or the fixed base is alienated. Such income, profits or gains may be taxed in the country in which the permanent establishment or fixed base is situated. This corresponds to the rules for taxation of business profits and income from independent personal services contained in Articles 7 ( Business Profits ) and 14 ( Independent Personal Services ) respectively. [Article 13, paragraph 3]

Disposal of ships or aircraft

2.146 Income, profits or gains from the disposal of ships or aircraft operated in international traffic, or of associated property (other than real property covered by paragraph 1), are taxable only in the country in which the enterprise alienating the ships or aircraft is resident. This rule corresponds to the operation of Article 8 ( Ships and Aircraft ) in relation to profits from the international operation of ships or aircraft. [Article 13, paragraph 4]

2.147 For the purposes of this Article, the term 'international traffic' does not include any transportation which commences at a place in a country and returns to that place or another place in that country, after travelling through international waters or airspace but not visiting another country (e.g. 'voyages to nowhere' by cruise ships). [Article 3, subparagraph 1(i )]

Capital gains

2.148 This Article contains a sweep-up provision in relation to capital gains which enables each country to tax, according to its domestic law, any gains of a capital nature derived by its own residents or by a resident of the other country from the alienation of any property (including shares or other rights in a company). It thus preserves the application of Australia's domestic law relating to the taxation of capital gains in relation to the alienation of such property. [Article 13, paragraph 5]

Exemption from former residence country taxation

2.149 Australia's law provides for taxation of individuals who cease to be a resident of Australia on gains arising from the deemed disposal of assets (other than those having the necessary connection with Australia) (subsections 104-165(2) and (3) of the ITAA 1997).

2.150 The taxation of unrealised gains can give rise to cash flow problems because proceeds from the gains are not available to pay the tax. Australia's domestic law provides relief by allowing departing individuals to defer tax on unrealised gains if they elect to treat assets to which the gains relate as having the necessary connection with Australia (subsections 104-165(2) and (3) of the ITAA 1997). The effect of the election is that a gain on the subsequent disposal of the property will be taxable in Australia even though the individual is not an Australian resident.

2.151 Paragraph 8 of this Article provides an exemption from taxation in the former country of residence for gains deferred by an individual on ceasing to be a resident of that country, if the individual is a resident of the other country when the gains are crystallised. [Article 13, paragraph 8]

2.152 An individual departing Australia who defers tax by electing for an asset to have the necessary connection with Australia will, for instance, be exempt in Australia on a gain arising from a subsequent disposal of the asset if the individual is a resident of Mexico at the time of the disposal. This will reduce compliance difficulties for departing residents, ensure post-residence change gains on foreign assets are not taxable in Australia and ensure that appropriate relief is provided from double taxation.

2.153 Paragraph 8 will not affect the taxation of gains derived from the disposal of assets that, prior to a residence change, already have the necessary connection with Australia. A requirement of paragraph 8 is that an individual must elect to defer tax on a residence change gain. This requirement will not be satisfied for assets that have the necessary connection with Australia because there is no deemed disposal of these assets when an individual ceases to be an Australian resident. Australia may therefore continue to tax gains realised on the disposal of these assets.

2.154 Similarly, paragraph 8 will not affect the inclusion in assessable income of a discount on a qualifying share or right that has been deferred under an employee share acquisition scheme. Again, this is because there is no taxation deferred as a result of a residence change. Paragraph 8 can operate, however, to exempt gains accrued on shares after allocation where an individual ceases to be a resident of Australia and elects to defer the residence change gain.

Double tax relief

2.155 In the event that the operation of this Article should result in an item of income or gain being subjected to tax in both countries, the country of which the person deriving the income or gain is a resident (as determined in accordance with Article 4 ( Residence )) would be obliged by Article 23 ( Methods of Elimination of Double Taxation ) to provide double tax relief for the tax imposed by the other country.

Article 14 - Independent Personal Services

Taxing rights

2.156 Under this Article, income derived by an individual in respect of professional services or other activities of an independent character will be subject to tax in the country in which the services or activities are performed if either:

•

the recipient has a fixed base regularly available in that other country for the purposes of performing their activities; or

•

the individual is present in the other country for a period or periods exceeding in the aggregate 183 days in any 12 month period commencing or ending in the fiscal year or year of income.

2.157 If either of these conditions is met, the country in which the services or activities are performed will be able to tax so much of the income as is attributable to the activities performed during such period or periods or that are exercised from that fixed base. [Article 14, paragraph 1]

2.158 If the above tests are not met, the income will be taxed only in the country of residence of the recipient.

2.159 Remuneration derived as an employee and income derived by public entertainers are the subject of other Articles of the tax treaty and are not covered by this Article.

2.160 Item 10 of the Protocol provides that this Article will also apply to income derived by an Australian company from the furnishing of personal services through a fixed base in Mexico. In such a case, Mexican tax on the income of the Australian company from such services may be computed on a net basis as if the income were attributable to a Mexican permanent establishment. This provision is necessary because under Mexican law, a personal service company is not considered to earn business profits. The provision therefore allows Mexico to tax such a company in accordance with subparagraph 1(a) of Article 14. In practice this will provide for the same treatment as if the profits of the company had been taxed in accordance with Article 7 ( Business Profits ). [Protocol, Item 10]

Article 15 - Dependent Personal Services

Basis of taxation

2.161 This Article generally provides the basis upon which the remuneration of visiting employees is to be taxed. However, this Article does not apply in respect of income that is dealt with separately in:

•

Article 16 ( Directors' Fees );

•

Article 18 ( Pensions and Annuities ); and

•

Article 19 ( Government Service ).

2.162 Generally, salaries, wages and similar remuneration 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 visits of only a short-term nature are involved. [Article 15, paragraph 1]

Short-term visit exemption

2.163 The conditions for this exemption are that:

•

the period of the visit or visits do not exceed, in total, 183 days in any 12 month period commencing or ending in the fiscal year or year of income of the visited country;

•

the remuneration is paid by, or on behalf of, an employer who is a resident of the same country as the employee; and

•

the remuneration is not deductible in determining the taxable profits of a permanent establishment or a fixed base which the employer has in the country being visited.

2.164 Where all of these conditions are met, the remuneration so derived will be liable to tax only in the country of residence of the recipient. [Article 15, paragraph 2]

2.165 Where a short-term visit exemption is not applicable, remuneration derived by a resident of Australia from employment in Mexico may be taxed in Mexico. However, the Article does not allocate sole taxing rights to Mexico in that situation.

2.166 Accordingly, Australia would also be entitled to tax that remuneration in accordance with the general rule of the ITAA 1997 that a resident of Australia remains subject to tax on their worldwide income. In common, however, with other situations where the tax treaty allows both countries to tax a category of income, Australia would be required in this situation (pursuant to Article 23 ( Methods of Elimination of Double Taxation )), as the country in which the income recipient is resident for tax purposes, to relieve the double taxation that would otherwise occur.

2.167 Although Article 23 provides for the double tax relief to be provided by Australia to be in the form of the grant of a credit against Australian tax for the Mexican tax paid, the exemption with progression method of providing double tax relief in relation to employment income derived in the situation described would normally be applicable in practice pursuant to the foreign service income provisions of section 23AG of the ITAA 1936. This method takes into account the foreign earnings when calculating the Australian tax on other assessable income the person has derived.

Employment on a ship or aircraft

2.168 Income from an employment exercised aboard a ship or aircraft operated in international traffic may be taxed in the country of which the enterprise is a resident. [Article 15, paragraph 3]

2.169 For the purposes of this Article, the term 'international traffic' does not include any transportation which commences at a place in a country and returns to that place or another place in that country, after travelling through international waters or airspace but not visiting another country (e.g. 'voyages to nowhere' by cruise ships). [Article 3, subparagraph 1(i )]

Article 16 - Directors' Fees

2.170 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, may be taxed in the latter country. In the case of Mexico, similar treatment is given to an 'administrador' or 'comisario' who are essentially statutory auditors appointed under Mexican law.

Article 17 - Entertainers and Sportspersons

Personal activities

2.171 Under this Article, income derived by visiting entertainers (which has a reasonably wide meaning in international tax treaty usage) and sportspersons from their personal activities as such may generally be taxed in the country in which the activities are exercised, irrespective of the duration of the visit. The application of this Article extends to income generated from promotional and associated kinds of activities engaged in by the entertainer or sportsperson while present in the visited country. [Article 17, paragraph 1]

Safeguard

2.172 Paragraph 2 is designed to ensure that income in respect of personal activities exercised by an entertainer or sportsperson, where derived by another person (e.g. a separate enterprise which formally provides the entertainer's or sportsperson's services), is taxed in the country in which the entertainer or sportsperson performs, whether or not that other person has a permanent establishment in that country. [Article 17, paragraph 2]

Article 18 - Pensions and Annuities

2.173 Pensions and annuities (the term annuity as used in this Article is defined in paragraph 2) are taxable only by the country of which the recipient is a resident. This Article extends to government pensions and annuity payments made to dependants, for example, a widow, widower or children of the person in respect of whom the pension or annuity entitlement accrued where, upon that person's death, such entitlement has passed to that person's dependants. [Article 18, paragraphs 1 and 2]

2.174 The taxing right in respect of alimony and other maintenance payments is allocated solely to the country of residence of the payer. The purpose of this paragraph is to remove any possibility of double taxation of such payments arising by reason of the treatment accorded such payments under the respective domestic law of the two countries. In the case of Australia, those payments will generally remain exempt from Australian tax under the ITAA 1936 and the ITAA 1997 in the hands of the recipient and non-deductible to the payer. [Article 18, paragraph 3]

Article 19 - Government Service

Salary and wage income

2.175 Salary and wage type income, other than government service pensions or annuities, paid to an individual for services rendered in the discharge of governmental functions to a government (including a political subdivision or local authority) of one of the countries, is to be taxed only in that country. However, such remuneration will be taxable only in the other country if:

•

the services are rendered in that other country; and

•

the recipient is a resident of that other country, who is either:

-

a citizen or national of that country; or

-

did not become a resident of that other country solely for the purpose of rendering the services.

[Article 19, paragraph 1]

Business income

2.176 Remuneration for services rendered in connection with a business, such as trading activities, carried on by any governmental authority referred to in paragraph 1 of the Article is excluded from the scope of this Article. Such remuneration will remain subject to the provisions of Article 15 ( Dependent Personal Services ) and Article 16 ( Directors' Fees ). [Article 19, paragraph 2]

Article 20 - Students

Exemption from tax

2.177 This Article applies to students temporarily present in one of the countries solely for the purpose of their education if the student is, or immediately before the visit was, resident in the other country. In these circumstances, payments from abroad received by the students solely for their maintenance or education will be exempt from tax in the country visited. This will apply even though they may qualify as a resident of the country visited during the period of their visit.

2.178 The exemption from tax provided by the visited country is treated as extending to maintenance payments received by the student that are made for maintenance of dependent family members who have accompanied the student to the visited country.

Employment income

2.179 Where, however, a student from Mexico who is visiting Australia solely for educational purposes undertakes any employment, for example:

•

part-time work with a local employer; or

•

during a semester break undertakes work with a local employer,

the income earned by that student as a consequence of that employment may, as provided for in Article 15 ( Dependent Personal Services ), be subject to tax in Australia. In this situation the payments received from abroad for the student's maintenance or education will not however be taken into account in determining the tax payable on the employment income that is subject to tax in Australia. No Australian tax would be payable on the employment income if the student qualifies as a resident of Australia during the visit and the taxable income of the student does not exceed the tax-free threshold applicable to Australian residents for income tax purposes.

Article 21 - Other Income

Allocation of taxing rights

2.180 This Article provides rules for the allocation between the two countries of taxing rights to items of income not dealt with in the preceding Articles of the tax treaty. The scope of the Article is not confined to such items of income arising in one of the countries - it extends also to income from sources in a third country.

2.181 Broadly, such income derived by a resident of one country is to be taxed only in the country of residence unless it is from sources in the other country, in which case the income may also be taxed in the other country. Where this occurs, the country of residence of the recipient of the income would be obliged by Article 23 ( Methods of Elimination of Double Taxation ) to provide double taxation relief. This is consistent with Australia's reservation to Article 21 ( Other Income ) of the OECD Model. [Article 21, paragraphs 1 and 3]

2.182 This Article does not apply to income (other than income from immovable (real) property as defined in paragraph 2 of Article 6 ( Income from Immovable ( Real ) Property )) where the income is effectively connected with a permanent establishment or fixed base which a resident of one country has in the other country. In such a case, Article 7 ( Business Profits ) or Article 14 ( Independent Personal Services ), as the case may be, will apply. [Article 21, paragraph 2]

Article 22 - Source of Income

Deemed source

2.183 This Article effectively deems income, profits or gains derived by a resident of one country which, in accordance with the tax treaty, may be taxed in the other country to have a source in the latter country for the purposes of the tax law of that country. It therefore avoids any difficulties arising under domestic law source rules in respect of, for example, the exercise by Australia of the taxing rights allocated to Australia by the tax treaty over income derived by residents of Mexico. [Article 22, paragraph 1]

Source of income - double taxation relief

2.184 This Article also ensures that where an item of income, profits or gains is taxable in both countries, double taxation relief will be given by the taxpayer's country of residence (pursuant to Article 23 ( Methods of Elimination of Double Taxation )) for tax levied by the other country in accordance with the tax treaty. In this way, income derived by a resident of Australia, which is taxable by Mexico under the tax treaty, will be treated as being foreign income for the purposes of the ITAA 1936 and the ITAA 1997, including the foreign tax credit provisions of the ITAA 1936. [Article 22, paragraph 2]

Article 23 - Methods of Elimination of Double Taxation

2.185 Double taxation does not arise in respect of income flowing between the two countries:

•

where the terms of the tax treaty provide for the income to be taxed only in one country; or

•

where the domestic taxation law of one of the countries exempts the income from its tax.

Tax credit

2.186 It is necessary, however, to prescribe a method for relieving double taxation for other classes of income which, under the terms of the tax treaty, remain subject to tax in both countries. In accordance with international practice, Australia's tax treaties provide for double tax relief to be provided by the country of residence of the taxpayer by way of a credit basis of relief against its tax for the tax of the country of source of the income. This Article also reflects that approach.

Australian method of relief

2.187 This Article requires Australia to provide Australian residents a credit against their Australian tax liability for Mexican tax paid in accordance with the tax treaty on income derived from Mexican sources which is taxable in Australia. [Article 23, subparagraph 2(a )]

2.188 Where a dividend is paid by a Mexican company to an Australian resident company which controls 10% or more of the voting power in the Mexican company, this Article requires Australia to allow a credit for the underlying Mexican tax paid by the company paying the dividend (i.e. the tax paid on the portion of its profits out of which the dividend is paid). This credit is in addition to any credit allowable for the Mexican tax paid in respect of the dividends themselves. [Article 23, subparagraph 2(b )]

2.189 Australia's general foreign tax credit system, together with the terms of this Article and of the tax treaty generally, will form the basis of Australia's arrangements for relieving a resident of Australia from double taxation on income arising from sources in Mexico. As in the case of Australia's other tax treaties, the source of income rules specified by Article 22 ( Source of Income ) for the purposes of this tax treaty will also apply for those purposes.

2.190 Accordingly, effect is to be given to the tax credit relief obligation imposed on Australia by paragraph 2 of this Article by application of the general foreign tax credit provisions of the ITAA 1936 (Division 18 of Part III). This will include the allowance of underlying tax credit relief in respect of dividends paid by Mexican resident companies that are related to Australian resident companies, including for unlimited tiers of related companies, in accordance with the relevant provisions of the ITAA 1936 and the ITAA 1997.

2.191 Notwithstanding the credit basis of relief provided for by paragraph 2 of this Article, the exemption with progression method of relief will be applicable, as appropriate, in relation to salary and wages and like remuneration derived by a resident of Australia during a continuous period of foreign service (as defined in subsection 23AG(7) of the ITAA 1936) in Mexico. [Article 23, paragraph 2]

2.192 Dividends and branch profits derived in Mexico by an Australian resident company that are exempt from Australian tax under the foreign source income measures (e.g. sections 23AH or 23AJ of the ITAA 1936) will continue to qualify for exemption from Australian tax under those provisions. As double taxation does not arise in these cases, the credit form of relief will not be relevant.

Mexican relief

2.193 In the case of a resident of Mexico who is taxable in Mexico on income which is also taxable in Australia under this tax treaty, this Article requires Mexico to allow the Mexican resident a credit for the amount of Australian tax paid on that income. [Article 23, subparagraph 1(a )]

2.194 Where a dividend is paid by an Australian company to a Mexican company which owns at least 10% of the capital of that Australian company, this Article requires Mexico to allow a credit for the underlying Australian tax paid by the company paying the dividends (i.e. the tax paid on the portion of its profits out of which the dividend is paid). This credit is in addition to any credit allowable for the Australian tax paid in respect of the dividends themselves. [Article 23, subparagraph 1(b )]

Article 24 - Mutual Agreement Procedure

Consultation

2.195 One of the purposes of this Article is to provide for consultation between the competent authorities of the two countries with a view to reaching a satisfactory solution in cases where a person is able to demonstrate actual or potential imposition of taxation contrary to the provisions of the tax treaty.

2.196 A taxpayer wishing to use this procedure must present a case to the competent authority of the country of which the person is a resident within three years of the first notification of the action which the taxpayer considers gives rise to taxation not in accordance with the tax treaty. [Article 24, paragraph 1]

2.197 If the competent authority cannot resolve the case unilaterally, the competent authorities of the two countries shall endeavour to resolve the case. Where such a case has been presented to the Australian competent authority, the Mexican competent authority must be notified of the mutual agreement proceedings within four and a half years from the due date of the date of filing the return in Mexico, whichever is the later. If a solution is reached, it shall be implemented in the case of Mexico, within 10 years from the due date or the date of filing of the return in Mexico, whichever is later, or a longer period of permitted under the domestic law of Mexico. The conditions imposed by Mexico regarding the implementation of reliefs and refunds following a mutual agreement are consistent with its treaty practice and its reservation to Article 25 ( Mutual agreement procedure ) of the OECD Model. In the case of Australia, the solution shall be implemented irrespective of any time limits imposed by its domestic taxation law. [Article 24, paragraph 2]

Resolution of difficulties

2.198 This Article also authorises consultation between the competent authorities of the two countries for the purpose of resolving any difficulties regarding the interpretation or application of the tax treaty and to give effect to it. They may also consult together regarding the elimination of double taxation in cases not provided for in the treaty. [Article 24, paragraphs 3 and 4]

General Agreement on Trade in Services dispute resolution process

2.199 Paragraph 5 of this Article deals with disputes that may be brought before the Council for Trade in Services in accordance with paragraph 3 of Article XXII ( Consultation ) of the World Trade Organisation General Agreement on Trade in Services. [Article 26, paragraph 5].

Background

2.200 Australia and Mexico are both parties to the General Agreement on Trade in Services. Article XVII ( National Treatment ) of this treaty requires a party to accord the same treatment to services and service suppliers of other parties as it accords to its own like services and service suppliers.

2.201 Articles XXII ( Consultation ) and XXIII ( Dispute Settlement and Enforcement ) provide for discussion and resolution of disputes. Paragraph 3 of Article XXII provides that a party may not invoke Article XVII ( National Treatment ) with respect to a measure of another party that falls within the scope of an international agreement between them relating to the avoidance of double taxation. However, if there is a dispute as to whether a measure actually falls within the scope of a tax agreement, either country may take the matter to the Council on Trade in Services for referral to binding arbitration.

2.202 Notwithstanding paragraph 3 of Article XXII, Australia and Mexico have agreed that the consent of both countries is required before a dispute as to whether a measure falls within the scope of this tax treaty may be brought before the Council on Trade in Services. This is seen as the most effective way of dealing with such disputes, and avoids difficult questions as to when a disputed issue falls within the dispute resolution mechanism of this tax treaty or of the General Agreement on Trade in Services.

2.203 This provision is based, in all essential respects, on an OECD Model commentary recommendation, and is common in recent international treaty practice. [Article 26, paragraph 5]

Article 25 - Exchange of Information

Limitations on exchange

2.204 This Article authorises and limits the exchange of information by the two competent authorities to information necessary for the carrying out of the provisions of the tax treaty or for the administration of domestic laws concerning the taxes to which the tax treaty applies. The exchange of information is not limited by Article 1 ( Persons Covered ) of this tax treaty, and may therefore cover persons who are not residents of Australia or Mexico. [Article 25, paragraph 1]

2.205 The limitation placed on the kind of information authorised to be exchanged means that information access requests relating to taxes not within the coverage provided by Article 2 ( Taxes Covered ), for example, Australia's GST, are not within the scope of this Article.

2.206 Item 11(c) of the Protocol provides that, if Australia in a subsequent tax treaty with a third country agrees that the Exchange of Information Article may be used for the purposes of value added taxes imposed by either country, such a clause shall automatically apply for the purposes of the Mexican tax treaty. [Protocol, Item 11(c )]

Purpose

2.207 The purposes for which the exchanged information may be used and the persons to whom it may be disclosed are restricted consistently with Australia's other tax treaties. Any information received by a country shall be treated as secret in the same manner as information obtained under the domestic law of that country. [Article 25, paragraph 1]

2.208 Paragraph 2 of the Article makes it clear that a country is not obliged to supply information that would disclose any trade, business, industrial, commercial or professional secret or trade process or to supply information the disclosure of which would be contrary to public policy. [Article 25, subparagraph 2(c )]

Article 26 - Members of Diplomatic Missions and Consular Posts

2.209 The purpose of this Article is to ensure that the provisions of the tax treaty do not result in members of diplomatic missions and consular posts receiving less favourable treatment than that to which they are entitled in accordance with international conventions. Such persons are entitled, for example, to certain fiscal privileges under the Diplomatic Privileges and Immunities Act 1967 and the Consular Privileges and Immunities Act 1972 which reflect Australia's international obligations towards members of diplomatic missions and consular posts.

Article 27 - Entry into Force

Date of entry into force

2.210 This Article provides for the entry into force of the tax treaty. This will be on the last date on which notes are exchanged notifying that the last of the domestic processes to give the tax treaty the force of law in the respective countries has been completed. In Australia, enactment of the legislation giving the force of law in Australia to the tax treaty, along with tabling the treaty in Parliament and review by the Parliamentary Joint Standing Committee on Treaties, are prerequisites to the exchange of diplomatic notes.

Date of application for withholding taxes

2.211 Once it enters into force, the tax treaty will apply to taxes under Articles 10 ( Dividends ), 11 ( Interest ), and 12 ( Royalties ) on either of two dates depending on the date the treaty enters into force:

•

if the treaty enters into force prior to 1 July, the treaty will apply in respect of taxes imposed under those Articles for amounts paid or credited on or after the first day of the second month next following the date on which the treaty enters into force; or

•

otherwise, if the treaty enters into force on or after 1 July, the treaty will apply in respect of taxes imposed under those Articles, for amounts paid or credited, on 1 January of the year following the year the treaty enters into force.

Date of application for other Australian taxes

2.212 In Australia, the treaty will first apply to other Australian taxes on income, profits or gains of the Australian year of income beginning on or after 1 July in the calendar year next following that in which the tax treaty enters into force.

2.213 Where a taxpayer has adopted an accounting period ending on a date other than 30 June, the accounting period that has been substituted for the year of income beginning on 1 July of the calendar year next following that in which the tax treaty enters into force will be the relevant year of income for the purposes of the application of other Australian tax. For this purpose, 'year of income' takes its meaning from section 6 of the ITAA 1936.

Date of application for other Mexican taxes

2.214 In Mexico, this tax treaty will first have effect, in relation to other Mexican taxes, on or after 1 July in the calendar year next following that in which the treaty enters into force.

Article 28 - Termination

2.215 The tax treaty is to continue in effect indefinitely. However, either country may give written notice of termination of the tax treaty through the diplomatic channel on or before 30 June in any calendar year beginning after the expiration of five years from the date of its entry into force.

Cessation in Australia

2.216 In the event of either country terminating the tax treaty, the treaty would cease to be effective in Australia for the purposes of withholding tax on income derived by a non-resident in relation to income derived on or after 1 July in the calendar year next following that in which the notice of termination is given.

2.217 For other Australian tax, the treaty would cease to be effective 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 notice of termination is given.

Cessation in Mexico

2.218 The tax treaty would correspondingly cease to be effective in Mexico on or after 1 July in the calendar year next following that in which the notice of termination is given.

Protocol, Item 11(a) - Asset tax imposed in Mexico

2.219 The Mexican assets tax operates as an alternative minimum income tax under which resident and non-resident companies are obliged to pay the tax if, and to the extent that, it exceeds the companies' income tax liability for a given tax year.

2.220 Mexican domestic law requires resident companies and non-resident companies which maintain assets in Mexico to calculate the assets tax on those assets. The assets tax rate is currently 1.8% and is applied to the net asset balance. The net asset balance is the total value of the taxpayer's business assets, minus any debts to Mexican companies.

2.221 Under Item 11(a) of the Protocol, Australian residents who do not have a permanent establishment in Mexico, and therefore are not taxable on their business profits in Mexico in accordance with Article 7 ( Business Profits ), are not subject to the assets tax. However the exclusion does not apply to assets covered by the definition of royalties, that are used by a Mexican resident. In this case, Mexico would grant a credit against the assets tax for the withholding tax that would have been paid on the royalties under the domestic law, rather than the amount payable under the treaty. [Protocol, Item 11(a )]

Example 2.2

Under the Protocol, an Australian taxpayer would have to calculate their assets tax liability on intangibles at the rate of 1.8%. However, that taxpayer would be entitled to a credit against the assets tax liability for royalty withholding tax paid at the higher domestic royalty withholding tax rate even though a royalty withholding tax of 10% is actually paid in accordance with the treaty.

2.222 Australia is not required to give a credit for Mexican assets tax paid by Australian residents.

Protocol, Item 11(b) - Non-discrimination

2.223 The Protocol provides that, if Australia agrees to include a Non-Discrimination Article in a subsequent tax treaty with another country (which is given effect under the International Tax Agreements Act 1953 ), then Australia will enter into negotiations with a view to providing Mexico the same treatment as is provided for in that other tax treaty. The United Kingdom treaty (which is proposed to be given the force of law in this bill) includes such an Article.

Protocol, Item 11(c) - Exchange of Information and value added taxes

2.224 The Protocol provides that, if Australia in a subsequent tax treaty with a third country agrees that the Exchange of Information Article may be used for the purposes of value added taxes imposed by either country, such a clause shall automatically apply for the purposes of the Mexican tax treaty.