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Tax Treaties: United States And Australia



Tax Treaties: United States And Australia

Quick Summary.  Located “down under” in the Southern Hemisphere and covering the Indian and Pacific Oceans, Australia consists of a mainland continent, the island of Tasmania, and several smaller islands. Australia comprises six states and 10 territories, with its capital at Canberra. Australia boasts the world’s 14th-largest economy and one of the highest per-capita incomes in the world.

Australia is a parliamentary, federal constitutional monarchy.  Its system of government combines elements of the systems of the United Kingdom and the United States.  Its constitution provides for a bicameral Parliament, with a Senate and House of Representatives, as well as a monarch.  Its executive branch, the Federal Executive Council, is comprised of a prime minister and other ministers.  In addition, its judicial branch is headed by the High Court of Australia.

Australia is a member of the United Nations, G20, OECD, and World Trade Organization.

Treaty.  

Currency. Australian Dollar (AUD)

Common Legal Entities.  Public company (“Limited” or Ltd), private company (“Proprietary Limited” or Pty Ltd), partnership, corporate limited partnership, trust, superannuation fund, and branches.

Tax Authorities.  Australian Taxation Office, States and Territories Revenue Offices, Foreign Investment Review Board

Tax Treaties. Australia is party to more than 40 tax treaties and is a signatory to the OECD MLI.  

Corporate Income Tax Rate.  30%

Individual Tax Rate.  Up to 45%

Corporate Capital Gains Tax Rate.  30%

Individual Capital Gains Tax Rate. Taxed at marginal ordinary income rates.  Exclusions may apply based upon holding term.

Residence.  Individual tax residence is based upon domicile, physical presence test, or contributions to certain superannuation funds.  Australia also implements a “temporary resident” concept.

Withholding Tax.

            Dividends.  0% / 30%

            Interest.  0% / 10%

            Royalties.  0% / 30%

Transfer Pricing. Australia applies transfer pricing rules, generally based upon comparable uncontrolled price, resale price and other methods.  

CFC Rules.  Yes, Australia applies a controlled foreign company (CFC) regime under certain circumstances.

Hybrid Treatment.  Effective 2019, Australia has implemented hybrid mismatch rules that adhere to action 2 of the OECD/G20 Base Erosion and Profit Shifting (BEPS) project.

Inheritance/estate tax. No.


Tax System, Generally

Australian resident corporations are subject to income tax on a worldwide basis, at a marginal rate reaching 30 percent. Various exclusions, credits, and other special rules operate to provide a participation exemption for certain categories of foreign-source income. Income that may be entirely or partially exempt include dividends paid out of active earnings of a foreign affiliate, capital gains from a foreign permanent establishment, and foreign branch profits.

The scope of the exemption for foreign-source dividends encompasses dividends from non-portfolio investments in which the Australian company owns at least a 10-percent voting interest, without any required holding period, as well as dividends paid by controlled foreign companies out of income that was previously taxed. These exemptions parallel the result applicable to most dividends under the imputation system since 1987, which is intended to avoid the imposition of tax on corporate earnings both at the corporate level when earned and at the shareholder level when distributed. Under the imputation system, an Australian resident receives credit for the tax previously paid on the income underlying the dividend from an Australian corporation. Dividends are “franked” to identify the amount of tax paid with respect to the underlying income funding the dividend. The recipient reports the dividend, grossed-up by the amount of the tax paid, and claims a credit in the “franked” amount.

Deductions for expenses incurred in generating the profits that result in exempt nonportfolio foreign dividends and foreign branch profits are not generally allowed, nor are credits permitted for foreign income tax paid with respect to the foreign exempt income. Expenses incurred in financing debt are excepted from the general rule of disallowance, provided that the expenses satisfy the thin capitalization rules. Those rules limit the portion of debt expenses that may be deducted when the entity’s debt-to-equity ratio exceeds certain limits. The limits vary depending on whether the investing entity is inbound, outbound, or both, and whether the investing entity is an approved deposit-taking institution, with a safe harbor debt-to-equity ratio of three-to-one available in most cases. The rules apply economic substance principles to determine whether instruments are to be treated as debt or equity. The expenses that may be limited under these rules include interest payments or loan fees that an entity would otherwise be entitled to deduct, but not rental expenses on certain leases and some foreign currency losses.

The thin capitalization rules affect both Australian and foreign entities that have multinational investments, regardless of whether they hold the investments directly or through Australian entities. Under the thin capitalization rules, the amount of debt used to fund the Australian operations of both foreign entities investing into Australia (inbound) and Australian entities investing overseas (outbound) is limited. The thin capitalization rules for any given income year do not apply to Australian resident entities that have no cross-border investments, to foreign entities that have no investments (such as assets) or permanent establishments in Australia, or to entities that meet any of the threshold tests described below.

There are three threshold tests. The first two ensure entities with relatively small debt deductions or small overseas investments (an outbound investor that is not foreign controlled and whose Australian assets are at least 90 percent of worldwide assets) are not subject to the thin capitalization rules. A third threshold test provides that debt deductions incurred by special purpose entities, established to manage certain risks, are not limited by these thin capitalization rules.

Controlled Foreign Company Rules

Australia currently has an accruals taxation system, similar to the anti-deferral regime under the subpart F rules in the United States. Under the accruals taxation system, most foreign-source income of a controlled foreign company is taxed, if at all, on the basis of a notional dividend to an Australian owner or shareholder. The portion taxable to the owner or shareholder is determined by reference to the ownership share attributed to the shareholder, known as an attributable taxpayer. An attributable taxpayer is an Australian entity that has a controlling interest, inclusive of interests held by associates, of a specified level. Controlled foreign company status is determined by one of three control tests: strict control, assumed controller test or the de facto control test. Strict control exists if at least 50 percent of the company is owned or may be acquired by a group of five or fewer Australian one percent entities (resident Australian entities that own at least one-percent of the foreign company), including their associates or members. The assumed controller test is met if an Australian entity and its members or associates own or are entitled to acquire at least a 40 percent interest in the company, and the remaining interest is not controlled by an unrelated party or parties. The de facto control test is met if a group of five or fewer Australian entities effectively controls the company.

The holder of a 10-percent interest is an attributable taxpayer, regardless of which of the three control tests is met for controlled foreign company status. In addition, an Australian one percent entity may be an attributable taxpayer if it is one of a group of five or fewer owners holding de facto control of the foreign company. The attributable taxpayer is deemed to have received a dividend equal to its pro rata share of assessable earnings in the tax year accrued.

When those earnings are actually distributed, the dividend is exempt from taxation as previously taxed income.

The amount of assessable income of a controlled foreign company under the accruals taxation system depends upon the conduct of an active business, the character of the income as “adjusted tainted income,” and whether the company is resident in a listed country. Adjusted tainted income includes all passive income as well as income from sales or services transactions with related parties. Listed countries are defined by statute as foreign jurisdictions that impose income tax on a basis comparable to that of Australia. The listed countries are Canada, France, Germany, Japan, New Zealand, the United Kingdom, and the United States. Income derived from a company in a listed country that operates an active business in that country is eligible for exemption from Australian tax unless the income was both tainted and eligible for a tax concession in the listed country. Income derived by a company resident in an unlisted country qualifies for exemption from accruals taxation only if the company conducts an active business in that jurisdiction and the income is not “adjusted tainted income.”

Gain Or Loss On The Sale Of Foreign Subsidiary Stock

Gain from the disposition of stock in certain foreign companies is subject to exemption if the following conditions are met. The company whose stock is being sold must have operated an active business abroad. The taxpayer must hold at least a 10-percent voting interest in the company. Finally, the taxpayer must meet a holding period of 12 months within the two-year period preceding the sale of stock.

In addition, a capital loss with respect to the disposal of a branch asset may be nondeductible if the gain from disposal of such an asset would have been exempt.

Foreign Branches

Active business income earned by a foreign branch or permanent establishment of an Australian resident company is generally exempt from accruals taxation, depending upon the character of the income as “adjusted tainted income” and whether the company’s residence is in a listed country. Adjusted tainted income includes all passive income as well as income from sales or services transactions with related parties. Income of branches in a listed country that operate an active business in the listed country is exempt from Australian tax unless the income was both tainted and eligible for a tax concession in the listed country. Branches that reside in unlisted countries qualify for exemption of income from accruals taxation only if they conduct an active business in that jurisdiction and the income is not “adjusted tainted income.”

Intangible Property Income

Australia does not have a special regime governing the taxation of foreign-source income from intangible property. Resident companies are taxable on royalties from all sources. Both the controlled foreign company rules and the exemption for foreign branch profits provide that tainted royalty income is treated as passive income, and is thus currently taxable. Tainted royalty income is royalty income derived from assigning any intangible property or right to such property other than an assignment by a foreign branch or subsidiary of property it substantially developed to an unrelated party in the course of carrying on the business of the branch or subsidiary.

Have a question? Contact Jason Freeman, Freeman Law.

Jason Freeman

Mr. Freeman is the founding and managing member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney. Mr. Freeman has been recognized multiple times by D Magazine, a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service.
He was honored by the American Bar Association, receiving its “On the Rise – Top 40 Young Lawyers” in America award, and recognized as a Top 100 Up-And-Coming Attorney in Texas. He was also named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas” by AI.

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