[Senate Executive Report 108-3]
[From the U.S. Government Publishing Office]
108th Congress Exec. Rpt.
SENATE
1st Session 108-3
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PROTOCOL AMENDING THE TAX CONVENTION WITH AUSTRALIA
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March 13, 2003.--Ordered to be printed
_______
Mr. Lugar from the Committee on Foreign Relations,
submitted the following
R E P O R T
[To accompany Treaty Doc. 107-20]
The Committee on Foreign Relations, to which was referred
the Protocol Amending the Convention Between the Government of
the United States of America and the Government of Australia
for the Avoidance of Double Taxation and the Prevention of
Fiscal Evasion with Respect to Taxes on Income, signed at
Canberra on September 27, 2001 having considered the same,
reports favorably thereon and recommends that the Senate give
its advice and consent to ratification thereof as set forth in
this report and the accompanying resolution of ratification.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Summary..........................................................2
IV. Entry Into Force and Termination.................................3
V. Committee Action.................................................4
VI. Committee Comments...............................................5
VII. Budget Impact....................................................8
VIII.Explanation of Proposed Treaty...................................8
IX. Text of Resolution of Ratification...............................8
I. Purpose
The principal purposes of the existing income tax treaty
between the United States and Australia and the proposed
protocol amending the existing treaty between the United States
and Australia are to reduce or eliminate double taxation of
income earned by residents of either country from sources
within the other country and to prevent avoidance or evasion of
the taxes of the two countries. The existing treaty and
proposed protocol also are intended to continue to promote
close economic cooperation between the two countries and to
eliminate possible barriers to trade and investment caused by
overlapping taxing jurisdictions of the two countries.
II. Background
The proposed protocol was signed on September 27, 2001. The
proposed protocol would amend the existing income tax treaty
between the United States and Australia that was signed in
1982.
The proposed protocol was transmitted to the Senate for
advice and consent to its ratification on November 14, 2002
(see Treaty Doc. 107-20). The Committee on Foreign Relations
held a public hearing on the proposed protocol on March 5,
2003.
III. Summary
The proposed protocol modifies several provisions in the
existing treaty (signed in 1982) to make it similar to more
recent U.S. income tax treaties, the 1996 U.S. model income tax
treaty (``U.S. model''), and the 1992 model income tax treaty
of the Organization for Economic Cooperation and Development,
as updated (``OECD model''). However, the existing treaty, as
amended by the proposed protocol, contains certain substantive
deviations from these treaties and models.
The proposed protocol reduces source-country withholding
tax rates under the existing treaty on dividends, interest, and
royalties. First, the proposed protocol replaces Article 10
(Dividends) of the existing treaty with a new dividends
article. This new article eliminates the withholding tax on
certain intercompany dividends in cases in which an 80-percent
ownership threshold is met. The new article preserves the
maximum withholding tax rate of 15 percent on portfolio
dividends, but provides a maximum withholding tax rate of 5
percent on dividends meeting a 10-percent ownership threshold.
The proposed protocol replaces Article 11 (Interest) of the
existing treaty with a new interest article that retains
source-country taxation of interest at a maximum withholding
tax rate of 10 percent, but allows a special zero rate of
withholding for interest paid to financial institutions and
governmental entities. The proposed protocol also retains
source-country taxation of royalties under Article 12
(Royalties) of the existing treaty, but reduces the maximum
level of withholding tax from 10 percent to 5 percent. In
addition, the proposed protocol amends the definition of
royalties to remove the portion of the definition related to
payments for the use of ``industrial, commercial or scientific
equipment, other than equipment let under a hire purchase
agreement.'' Thus, under the proposed protocol, leasing income
is treated as business profits, taxable by the source country
only if the recipient of the payments has a permanent
establishment located in the source country.
The proposed protocol expands the ``saving clause''
provision in Article 1 (Personal Scope) of the existing treaty
to allow the United States to tax former long-term residents
whose termination of residency has as one of its principal
purposes the avoidance of tax. This provision allows the United
States to apply special tax rules under section 877 of the Code
as amended in 1996.
The proposed protocol amends Article 2 (Taxes Covered) of
the existing treaty to include certain U.S. and Australian
taxes. For U.S. tax purposes, the accumulated earnings tax and
the personal holding company tax are covered taxes under the
proposed protocol. In the case of Australia, covered taxes
include the Australian income tax, including tax on capital
gains, and the resource rent tax (although the United States
would not be required to allow a foreign tax credit with
respect to the resource rent tax).
The proposed protocol provides that, for purposes of
Article 4 (Residence) of the existing treaty, a U.S. citizen is
treated as a resident of the United States unless the U.S.
citizen is a resident of a country other than Australia for
purposes of a tax treaty between that third country and
Australia. In such case, the U.S. citizen is precluded from
claiming benefits under the U.S.-Australia treaty and can only
claim benefits under the tax treaty between such third country
and Australia. The proposed protocol also adds a new provision
under Article 7 (Business Profits) of the existing treaty to
clarify the treatment of fiscally transparent entities and
beneficial owners of fiscally transparent entities. The
proposed protocol clarifies that permanent establishment status
flows through a fiscally transparent entity (and thus the
beneficial owner is treated as carrying on a business through
such permanent establishment).
The proposed protocol amends the shipping provisions under
Article 8 (Shipping and Air Transport) and related provisions
under Article 13 (Alienation of Property) of the existing
treaty to more closely reflect the treatment of income from the
operation of ships, aircraft and containers in international
traffic under the U.S. model.
The proposed protocol makes further amendments to Article
13 that allow income or gains from certain business property of
a permanent establishment to be taxed in the country in which
the permanent establishment is located. The proposed protocol
also amends Article 13 to address Australia's imposition of its
mark-to-market regime on individuals who expatriate to the
United States.
The proposed protocol replaces Article 16 (Limitation on
Benefits) of the existing treaty with a new article that
reflects the limitation on benefits provisions included in more
recent U.S. income tax treaties.
The proposed protocol also replaces Article 21 (Other
Income) of the existing treaty with an article that more
closely represents the provision included in the U.N. model tax
treaty.
Article 13 of the proposed protocol provides for the entry
into force of the modifications made by the proposed protocol.
IV. Entry Into Force and Termination
A. ENTRY INTO FORCE
The proposed protocol will enter into force upon the
exchange of instruments of ratification. The effective dates of
the protocol's provisions, however, vary.
With respect to the United States, the proposed protocol
will be effective with respect to withholding taxes on
dividends, royalties and interest for amounts derived by a non-
resident on or after the later of the first day of the second
month next following the date on which the proposed protocol
enters into force or July 1, 2003. With respect to other taxes,
the proposed protocol will be effective for taxable periods
beginning on or after the first day of January next following
the date on which the proposed protocol enters into force.
With respect to Australia, the proposed protocol will be
effective with respect to withholding taxes on dividends,
royalties and interest for amounts derived by a non-resident on
or after the later of the first day of the second month next
following the date on which the proposed protocol enters into
force or July 1, 2003. With respect to other Australian tax, in
relation to income, profits or gains, the proposed protocol
will be effective for any year of income beginning on or after
the first day of July next following the date on which the
proposed protocol enters into force.
The article provides a special rule for certain Real Estate
Investment Trust (REIT) dividends received by a Listed
Australian Property Trust (LAPT). This rule is intended to
protect existing investments in REITs by LAPTs. For REIT shares
owned by an LAPT on March 26, 2001 or acquired by the LAPT
pursuant to a binding contract entered into on or before March
26, 2001 (``grandfathered REIT shares''), dividends from the
grandfathered REIT shares are subject to the provisions of
Article 10 (Dividends) as in effect on March 26, 2001. Thus,
the dividends from the grandfathered REIT shares will be
subject to a maximum withholding tax rate of 15 percent,
regardless of the ownership of the LAPT. REIT shares acquired
by the LAPT pursuant to a reinvestment of dividends (ordinary
or capital) from grandfathered REIT shares are also treated as
grandfathered REIT shares.
B. TERMINATION
The existing treaty, as amended by the proposed protocol,
will remain in force until terminated by either country. Either
country may terminate the treaty by giving notice of
termination to the other country through diplomatic channels.
In such case, a termination is effective with respect to those
dividends, interest and royalties to which Articles 10
(Dividends), 11 (Interest) and 12 (Royalties) respectively
apply, and which are paid, credited or otherwise derived on or
after the first day of January following the expiration of the
6 month period following notice of termination. A termination
is effective with respect to all other income of a taxpayer for
the taxpayer's years of income or taxable years, as the case
may be, commencing on or after the first day of January
following the expiration of the 6 month period following notice
of termination.
V. Committee Action
The Committee on Foreign Relations held a public hearing on
the proposed protocol with Australia (Treaty Doc. 107-20) on
March 5, 2003. The hearing was chaired by Senator Hagel.\1\ The
Committee considered the proposed protocol on March 12, 2003,
and ordered the proposed protocol with Australia favorably
reported by a vote of 19 in favor and 0 against, with the
recommendation that the Senate give its advice and consent to
ratification of the proposed treaty.
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\1\ The transcript of this hearing will be forthcoming as a
separate Committee print.
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VI. Committee Comments
On balance, the Committee on Foreign Relations believes
that the proposed protocol with Australia is in the interest of
the United States and urges that the Senate act promptly to
give advice and consent to ratification. The Committee has
taken note of certain issues raised by the proposed protocol
and believes that the following comments may be useful to the
Treasury Department officials in providing guidance on these
matters should they arise in the course of future treaty
negotiations.
A. ZERO RATE OF WITHHOLDING TAX ON DIVIDENDS FROM 80-PERCENT-OWNED
SUBSIDIARIES
The proposed protocol would eliminate withholding tax on
dividends paid by one corporation to another corporation that
owns at least 80 percent of the stock of the dividend-paying
corporation (often referred to as ``direct dividends''),
provided that certain conditions are met (paragraph 3 of
Article 10 (Dividends)). The elimination of withholding tax
under these circumstances is intended to reduce further the tax
barriers to direct investment between the two countries.
Currently, no U.S. treaty provides for a complete exemption
from withholding tax under these circumstances, nor do the U.S.
or OECD models. However, many bilateral tax treaties to which
the United States is not a party eliminate withholding taxes
under similar circumstances, and the same result has been
achieved within the European Union under its ``Parent-
Subsidiary Directive.'' In addition, the United States has
signed a proposed treaty with the United Kingdom and a proposed
protocol with Mexico that include zero-rate provisions similar
to the one in the proposed protocol.
Description of provision
Under the proposed protocol, the withholding tax rate is
reduced to zero on dividends beneficially owned by a company
that has owned at least 80 percent of the voting power of the
company paying the dividend for the 12-month period ending on
the date the dividend is declared (subparagraph 3(a) of Article
10 (Dividends)). Under the existing U.S.-Australia treaty,
these dividends may be taxed at a 15 percent rate.
Benefits and costs of adopting a zero rate with Australia
Tax treaties mitigate double taxation by resolving the
potentially conflicting claims of a residence country and a
source country to tax the same item of income. In the case of
dividends, standard international practice is for the source
country to yield mostly or entirely to the residence country.
Thus, the residence country preserves its right to tax the
dividend income of its residents, and the source country agrees
either to limit its withholding tax to a relatively low rate
(e.g., 5 percent) or to forgo it entirely.
Treaties that permit a positive rate of dividend
withholding tax allow some degree of double taxation to
persist. To the extent that the residence country allows a
foreign tax credit for the withholding tax, this remaining
double taxation may be mitigated or eliminated, but then the
priority of the residence country's claim to tax the dividend
income of its residents is not fully respected. Moreover, if a
residence country imposes limitations on its foreign tax
credit, withholding taxes may not be fully creditable as a
practical matter, thus leaving some double taxation in place.
For these reasons, dividend withholding taxes are commonly
viewed as barriers to cross-border investment. The principal
argument in favor of eliminating withholding taxes on certain
direct dividends in the proposed treaty is that it would remove
one such barrier.
Direct dividends arguably present a particularly
appropriate case in which to remove the barrier of a
withholding tax, in view of the close economic relationship
between the payor and the payee. Whether in the United States
or in Australia, the dividend-paying corporation generally
faces full net-basis income taxation in the source country, and
the dividend-receiving corporation generally is taxed in the
residence country on the receipt of the dividend (subject to
allowable foreign tax credits). If the dividend-paying
corporation is at least 80-percent owned by the dividend-
receiving corporation, it is arguably appropriate to regard the
dividend-receiving corporation as a direct investor (and
taxpayer) in the source country in this respect, rather than
regarding the dividend-receiving corporation as having a more
remote investor-type interest warranting the imposition of a
second-level source-country tax.
Since both the United States and Australia currently impose
withholding tax on some or all direct dividends as a matter of
domestic law (albeit only on ``unfranked'' dividends in the
case of Australia), the provision would provide immediate and
direct benefits to the United States as both an importer and an
exporter of capital. The overall revenue impact of this
provision is unclear, as the direct revenue loss to the United
States as a source country would be offset in whole or in part
by a revenue gain as a residence country from reduced foreign
tax credit claims with respect to Australian withholding taxes.
Although the United States has never agreed bilaterally to
a zero rate of withholding tax on direct dividends, many other
countries have done so in one or more of their bilateral tax
treaties. These countries include OECD members Austria,
Denmark, France, Finland, Germany, Iceland, Ireland, Japan,
Luxembourg, Mexico, the Netherlands, Norway, Sweden,
Switzerland, and the United Kingdom, as well as non-OECD-
members Belarus, Brazil, Cyprus, Egypt, Estonia, Israel,
Latvia, Lithuania, Mauritius, Namibia, Pakistan, Singapore,
South Africa, Ukraine, and the United Arab Emirates. In
addition, a zero rate on direct dividends has been achieved
within the European Union under its ``Parent-Subsidiary
Directive.'' Finally, many countries have eliminated
withholding taxes on dividends as a matter of internal law
(e.g., the United Kingdom and Mexico). Thus, although the zero-
rate provision in the proposed treaty is unprecedented in U.S.
treaty history, there is substantial precedent for it in the
experience of other countries. It may be argued that this
experience constitutes an international trend toward
eliminating withholding taxes on direct dividends, and that the
United States would benefit by joining many of its treaty
partners in this trend and further reducing the tax barriers to
cross-border direct investment.
Committee conclusions
The Committee believes that every tax treaty must strike
the appropriate balance of benefits in the allocation of taxing
rights. The agreed level of dividend withholding for
intercompany dividends is one of the elements that make up that
balance, when considered in light of the benefits inuring to
the United States from other concessions the treaty partner may
make, the benefits of facilitating stable cross-border
investment between the treaty partners, and each partner's
domestic law with respect to dividend withholding tax.
In the case of this protocol, considered as a whole, the
Committee believes that the elimination of withholding tax on
intercompany dividends appropriately addresses a barrier to
cross-border investment. The Committee believes, however, that
the Treasury Department should only incorporate similar
provisions into future treaty or protocol negotiations on a
case-by-case basis, and it notes with approval Treasury's
statement that ``[i]n light of the range of facts that should
be considered, the Treasury Department does not view
[elimination of withholding tax on intercompany dividends] as a
blanket change in the United States' tax treaty practice.''
The Committee encourages the Treasury Department to develop
criteria for determining the circumstances under which the
elimination of withholding tax on intercompany dividends would
be appropriate in future negotiations with other countries. The
Committee expects the Treasury Department to consult with the
Committee with regard to these criteria and to the
consideration of elimination of the withholding tax on
intercompany dividends in future treaties.
B. INCOME FROM THE RENTAL OF SHIPS AND AIRCRAFT
The present treaty includes a provision found in the U.S.
model and many U.S. income tax treaties under which profits
from an enterprise's operation of ships or aircraft in
international traffic are taxable only in the enterprise's
country of residence.
The present treaty and the proposed protocol differ from
the U.S. model in the case of profits derived from the rental
of ships and aircraft on a bareboat basis (i.e., without crew).
Under the proposed protocol, the rule limiting the right to tax
to the country of residence applies to such rental profits only
if the lease is merely incidental to the operation of ships and
aircraft in international traffic by the lessor. If the lease
is not merely incidental to the international operation of
ships and aircraft by the lessor, then profits from rentals on
a bareboat basis generally would be taxable by the source
country as business profits (if such profits are attributable
to a permanent establishment).
In contrast, the U.S. model and many other treaties provide
that profits from the rental of ships and aircraft operated in
international traffic on a bareboat basis are taxable only in
the country of residence, without requiring that the lease be
incidental to the international operation of ships and aircraft
by the lessor. Thus, unlike the U.S. model, the proposed
protocol provides that an enterprise that engages only in the
rental of ships and aircraft on a bareboat basis, but does not
engage in the operation of ships and aircraft, would not be
eligible for the rule limiting the right to tax income from
operations in international traffic to the enterprise's country
of residence. It should be noted that, under the proposed
protocol, profits from the use, maintenance, or rental of
containers used in international traffic are taxable only in
the country of residence, regardless of whether the recipient
of such income is engaged in the operation of ships or aircraft
in international traffic.
Committee conclusions
The Committee notes that the proposed protocol, while not
entirely consistent with the U.S. Model, moves the treatment of
income from shipping and air traffic closer to the U.S. Model
than the present treaty by providing that profits from the use,
maintenance or rental of containers used in international
traffic are taxable only in the country of residence.
VII. Budget Impact
The Committee has been informed by the staff of the Joint
Committee on Taxation that the proposed protocol is estimated
to cause a negligible change in Federal budget receipts during
the fiscal year 2003-2012 period.
VIII. Explanation of Proposed Treaty
A detailed, article-by-article explanation of the proposed
protocol between the United States and Australia can be found
in the pamphlet of the Joint Committee on Taxation entitled
Explanation of Proposed Protocol to the Income Tax Treaty
Between the United States and Australia (JCS-5-03), March 3,
2003.
IX. Text of Resolution of Ratification
Resolved (two-thirds of the Senators present concurring
therein), That the Senate advise and consent to the
ratification of the Protocol Amending the Convention Between
the Government of the United States of America and the
Government of Australia for the Avoidance of Double Taxation
and the Prevention of Fiscal Evasion with Respect to Taxes on
Income, signed at Canberra on September 27, 2001 (Treaty Doc.
107-20).