House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon. Peter Costello, M.P.)

Main features of the notes

Under the terms of the Exchange of Notes:

•

The Notes list the Vietnamese tax incentives to be tax spared, both in terms of the relevant Vietnamese laws and a description of the activities to be tax spared. Listed incentives are targeted towards fostering genuine economic development and relate to active business income (eg the construction of power production infrastructure, the development of ports to facilitate export processing, the expansion of heavy industry and the planting of new forests for commercial exploitation). Provision is made for new or additional incentives to be tax spared after evaluation and acceptance by Australia.

•

As is customary in Australian tax sparing arrangements, tax sparing is provided for a limited period. The tax sparing benefit is provided to Australian residents for the 10 years commencing on the date of effect, in relation to income tax, of the 1992 Agreement - that is, from the commencement of the year of income beginning on or after 1July1993. There is provision for a subsequent extension of this period.

•

Tax sparing is not available for banking, insurance, consulting, accounting, auditing and commercial services. Shipping and aircraft operations are only tax spared to a limited extent. A general anti-avoidance provision is also included.

Exchange of notes between the Government of Australia and the Government of Vietnam

General

On 13 April 1992 the Government of Australia and the Government of the Socialist Republic of Vietnam signed an agreement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income.

On 22 November 1996, diplomatic notes were exchanged between the Department of Foreign Affairs and Trade and the Embassy of the Socialist Republic of Vietnam. The exchange of Notes constituted an Agreement between the Government of Australia and the Government of Vietnam to amend the 1992 Vietnamese Agreement, to provide tax sparing in respect of certain Vietnamese incentives.

Initiating note

Calculation of "Vietnamese tax forgone"

Under Articles 23.1 and 23.2 of the 1992 Vietnamese Agreement, Australian residents may be entitled to a credit of Vietnamese tax paid against Australian tax payable on income from Vietnamese sources. Article 23.3 provides the tax sparing benefit by deeming "Vietnamese tax forgone" (under a Vietnamese tax concession) to be considered as Vietnamese tax paid.

A new Article 23.4 is substituted into the 1992 Vietnamese agreement by these Notes. It provides a new definition of "Vietnamese tax forgone". In essence, Vietnamese tax forgone is the difference between Vietnamese tax normally payable on income (consistently with the terms of the Vietnamese agreement) and the Vietnamese tax actually payable on that income after the application of relevant Vietnamese tax concession(s).

20% ceiling

The new Article 23.4 also sets a ceiling on the amount of the Vietnamese tax applicable to the income which is subject to the Vietnamese tax concession. That amount is 20% of the Vietnamese taxable income that relates to the income which is the subject of the exemption or reduction. The reason for this ceiling is that at the time the Notes were negotiated, under Vietnamese tax law, a variety of nominal tax rates were applicable to foreign investors ranging from 25% down to 10%. As a consequence, it was essential to establish an underlying tax rate to act as a benchmark for determining the amount of tax forgone by Vietnam under the relevant tax concession. A basic tax rate of 20% was duly adopted as the benchmark for these purposes.

[New paragraph 23.4]

Tax sparing tests

These Notes then insert three new paragraphs into the 1992 Vietnamese Agreement, which establish further tests to determine whether an exemption or reduction of Vietnamese tax under one of Vietnam's tax concessions qualifies for tax sparing:

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the concession must be granted under one of the Vietnamese laws specified in new Article 23.5.

•

the relevant income must be from an activity which meets the conditions set out in at least one of the subparagraphs in new Article 23.6.

•

the relevant income must not be from an activity or arrangement that is described in any of the subparagraphs in new Article 23.7.

Vietnamese incentives laws specified

Certain Laws, Decrees and Circulars by which Vietnam provides tax incentives to foreign investors and which are to be tax spared under by these Notes, are listed in new Article 23.5.

The effect of the proviso in the new paragraph is that if there is significant modification to the general character of those laws after the date of the Notes, then tax sparing will not be available to the extent of that modification. Minor modifications, which do not affect the general character of the listed laws will not affect tax sparing.

These provisions ensure that the various requirements contained within the Vietnamese laws (at the time of the exchange of Notes) must be met in order for tax sparing to be granted.

[New paragraph 23.5(a)]

Provision is made for additional Vietnamese incentive laws to be specified by exchange of letters between the Treasurer of Australia and the Vietnamese Minister of Finance.

[New paragraph 23.5(b)]

Activities to be tax spared

The Notes identify those activities which may be tax spared. To qualify for tax sparing, the relevant Vietnamese exemption or reduction must relate to income from an activity which meets the criteria described in at least one of the subparagraphs in new Article 23.6.

These activities are confined to activities which generate "active" income, and qualify for tax concessions under the Vietnamese laws specified in new Article 23.5. Generally they paraphrase the terminology and conditions described in those laws.

[New paragraph 23.6]

Activities excluded from tax sparing

Income derived from any of the activities or arrangements described in Article 23.7 is excluded from the tax sparing concession.

Finance sector

Subparagraph (a) of new Article 23.7 excludes income from banking, insurance, consulting, accounting, auditing and commercial services of any kind from the scope of tax sparing. These exclusions reflect the fact that under Vietnamese incentive laws most of the finance sector is not eligible for tax incentives. This subparagraph restates the exclusions - other than for certain hotel projects - which are found in Article 68 of Decree No. 18-CP on implementing regulations of the Law on Foreign Investment in Vietnam dated 16 April 1993 .

Ships and aircraft

Subparagraph (b) excludes income from shipping and aircraft operations from tax sparing - other than income from business operations carried on within Vietnam. Tax sparing of concessions relating to income from highly mobile assets such as ships and aircraft is susceptible to exploitation and so has been specifically excluded.

General anti-avoidance provision

Subparagraph (c) is designed to prevent abuse of tax sparing, under schemes where Vietnam-based intermediaries are used as conduits for flows of income, profits or gains, or where property is located in Vietnam. If the scheme is entered into to avoid Australian tax through the exploitation of the Australian foreign tax credit provisions (which includes tax sparing under the 1992 Vietnamese Agreement) or to confer a benefit on a resident of a third country, then under this subparagraph, Vietnamese tax forgone is not deemed to be paid and thus tax sparing is not available.

The reference in this provision to a scheme having the purpose of using Vietnam as a location of property would not apply to genuine loans nor to the provision of assets effectively connected with the carrying on of a business.

[New paragraph 23.7]

Tax sparing period

Tax sparing is not available in respect of income derived in any year of income after the year of income that ends on 30 June 2003, although provision is made for tax sparing to be extended for a further agreed period by an exchange of letters between the Treasurer of Australia and the Minister of Finance of Vietnam.

[New paragraph 23.8]

Conclusion

The initiating Note from the Australian Department of Foreign Affairs and Trade proposes that the initiating Note and the Vietnamese Embassy's confirmatory Note in reply shall constitute an "Agreement" between the two Governments to amend the 1992 Vietnamese Agreement. It further proposes that the "Agreement" enter into force after the relevant domestic requirements have been completed. It is also proposed that the amendments to the 1992 Vietnamese Agreement (referred to in the Notes as the "Head Agreement") have effect from the time the 1992 Vietnamese Agreement had effect.

Note in reply

General

The Note in reply confirms the Vietnamese Government's acceptance of the proposals set out in the Initiating Note.

The Note in reply as set out in the Bill has been abridged. After the introductory paragraph, the Vietnamese Note as is usual in these cases, repeated the text of the initiating Note. The Note in reply then advised acceptance of the proposal. The text of the initiating Note was not repeated in this Schedule.