U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

1

85–198 2003 JCS–5–03

[JOINT COMMITTEE PRINT]

EXPLANATION OF PROPOSED PROTOCOL 

TO THE INCOME TAX TREATY BETWEEN 

THE UNITED STATES AND AUSTRALIA

SCHEDULED FOR A HEARING

BEFORE THE

COMMITTEE ON FOREIGN RELATIONS 

UNITED STATES SENATE

ON MARCH 5, 2003

PREPARED BY THE STAFF

OF THE

JOINT COMMITTEE ON TAXATION

March 3, 2003 


E:\Seals\Congress.#13
(II)

JOINT COMMITTEE ON TAXATION 

108TH CONGRESS, 1ST SESSION

HOUSE SENATE 

WILLIAM M. THOMAS, California, 

Chairman 

PHILIP M. CRANE, Illinois 

E. CLAY SHAW, JR., Florida 

CHARLES B. RANGEL, New York 

FORTNEY PETE STARK, California 

CHARLES E. GRASSLEY, Iowa, 

Vice Chairman 

ORRIN G. HATCH, Utah 

DON NICKLES, Oklahoma 

MAX BAUCUS, Montana 

JOHN D. ROCKEFELLER IV, West Virginia 

MARY M. SCHMITT, Acting Chief of Staff 

BERNARD A. SCHMITT, Deputy Chief of Staff 

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C O N T E N T S 

Page 

INTRODUCTION .............................................................................. 1

I. SUMMARY .............................................................................. 2

II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL TRADE

AND INVESTMENT AND U.S. TAX TREATIES ...................... 4

A. U.S. Tax Rules ......................................................... 4

B. U.S. Tax Treaties .................................................... 5

III. EXPLANATION OF PROPOSED PROTOCOL .............................. 8

Article 1. Personal Scope ........................................... 8

Article 2. Taxes Covered ............................................ 9

Article 3. Residence ................................................... 10

Article 4. Business Profits ......................................... 11

Article 5. Shipping and Air Transport ..................... 12

Article 6. Dividends ................................................... 15

Article 7. Interest ....................................................... 20

Article 8. Royalties ..................................................... 23

Article 9. Alienation of Property ............................... 25

Article 10. Limitation on Benefits .............................. 26

Article 11. Other Income ............................................. 36

Article 12. Relief from Double Taxation .................... 36

Article 13. Entry into Force ........................................ 37

IV. ISSUES ................................................................................... 38

A. Zero Rate of Withholding Tax on Dividends from 

80–Percent-Owned Subsidiaries ........................... 38

B. Income from the Rental of Ships and Aircraft ...... 41

C. Capital Gains Tax ................................................... 42

D. Visiting Teachers and Professors .......................... 42

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1This pamphlet may be cited as follows: Joint Committee on Taxation, Explanation of Proposed Protocol to the Income Tax Treaty Between the United States and Australia (JCS–5–03), 

March 3, 2003. 2For a copy of the proposed protocol, see Senate Treaty Doc. 107–20. 

INTRODUCTION 

This pamphlet,1 prepared by the staff of the Joint Committee on 

Taxation, describes the proposed protocol to the existing income tax 

treaty between the United States of America and Australia (the 

‘‘proposed protocol’’). The proposed protocol was signed on September 27, 2001. The Senate Committee on Foreign Relations has 

scheduled a public hearing on the proposed protocol for March 5, 

2003.2

Part I of the pamphlet provides a summary of the proposed protocol. Part II provides a brief overview of U.S. tax laws relating to 

international trade and investment and of U.S. income tax treaties 

in general. Part III contains an article-by-article explanation of the 

proposed protocol. Part IV contains a discussion of issues relating 

to the proposed protocol. 

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I. SUMMARY 

The principal purposes of 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 also is intended 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. 

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 sourcecountry 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. 

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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-tomarket 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. 

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II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL 

TRADE AND INVESTMENT AND U.S. TAX TREATIES 

This overview briefly describes certain U.S. tax rules relating to 

foreign income and foreign persons that apply in the absence of a 

U.S. tax treaty. This overview also discusses the general objectives 

of U.S. tax treaties and describes some of the modifications to U.S. 

tax rules made by treaties. 

A. U.S. Tax Rules 

The United States taxes U.S. citizens, residents, and corporations on their worldwide income, whether derived in the United 

States or abroad. The United States generally taxes nonresident 

alien individuals and foreign corporations on all their income that 

is effectively connected with the conduct of a trade or business in 

the United States (sometimes referred to as ‘‘effectively connected 

income’’). The United States also taxes nonresident alien individuals and foreign corporations on certain U.S.-source income that is 

not effectively connected with a U.S. trade or business. 

Income of a nonresident alien individual or foreign corporation 

that is effectively connected with the conduct of a trade or business 

in the United States generally is subject to U.S. tax in the same 

manner and at the same rates as income of a U.S. person. Deductions are allowed to the extent that they are related to effectively 

connected income. A foreign corporation also is subject to a flat 30-

percent branch profits tax on its ‘‘dividend equivalent amount,’’ 

which is a measure of the effectively connected earnings and profits 

of the corporation that are removed in any year from the conduct 

of its U.S. trade or business. In addition, a foreign corporation is 

subject to a flat 30–percent branch-level excess interest tax on the 

excess of the amount of interest that is deducted by the foreign corporation in computing its effectively connected income over the 

amount of interest that is paid by its U.S. trade or business. 

U.S.-source fixed or determinable annual or periodical income of 

a nonresident alien individual or foreign corporation (including, for 

example, interest, dividends, rents, royalties, salaries, and annuities) that is not effectively connected with the conduct of a U.S. 

trade or business is subject to U.S. tax at a rate of 30 percent of 

the gross amount paid. Certain insurance premiums earned by a 

nonresident alien individual or foreign corporation are subject to 

U.S. tax at a rate of 1 or 4 percent of the premiums. These taxes 

generally are collected by means of withholding. 

Specific statutory exemptions from the 30-percent withholding 

tax are provided. For example, certain original issue discount and 

certain interest on deposits with banks or savings institutions are 

exempt from the 30–percent withholding tax. An exemption also is 

provided for certain interest paid on portfolio debt obligations. In 

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addition, income of a foreign government or international organization from investments in U.S. securities is exempt from U.S. tax. 

U.S.-source capital gains of a nonresident alien individual or a 

foreign corporation that are not effectively connected with a U.S. 

trade or business generally are exempt from U.S. tax, with two exceptions: (1) gains realized by a nonresident alien individual who 

is present in the United States for at least 183 days during the taxable year, and (2) certain gains from the disposition of interests in 

U.S. real property. 

Rules are provided for the determination of the source of income. 

For example, interest and dividends paid by a U.S. citizen or resident or by a U.S. corporation generally are considered U.S.-source 

income. Conversely, dividends and interest paid by a foreign corporation generally are treated as foreign-source income. Special 

rules apply to treat as foreign-source income (in whole or in part) 

interest paid by certain U.S. corporations with foreign businesses 

and to treat as U.S.-source income (in whole or in part) dividends 

paid by certain foreign corporations with U.S. businesses. Rents 

and royalties paid for the use of property in the United States are 

considered U.S.-source income. 

Because the United States taxes U.S. citizens, residents, and corporations on their worldwide income, double taxation of income can 

arise when income earned abroad by a U.S. person is taxed by the 

country in which the income is earned and also by the United 

States. The United States seeks to mitigate this double taxation 

generally by allowing U.S. persons to credit foreign income taxes 

paid against the U.S. tax imposed on their foreign-source income. 

A fundamental premise of the foreign tax credit is that it may not 

offset the U.S. tax liability on U.S.-source income. Therefore, the 

foreign tax credit provisions contain a limitation that ensures that 

the foreign tax credit offsets only the U.S. tax on foreign-source income. The foreign tax credit limitation generally is computed on a 

worldwide basis (as opposed to a ‘‘per-country’’ basis). The limitation is applied separately for certain classifications of income. In 

addition, a special limitation applies to the credit for foreign taxes 

imposed on foreign oil and gas extraction income. 

For foreign tax credit purposes, a U.S. corporation that owns 10 

percent or more of the voting stock of a foreign corporation and receives a dividend from the foreign corporation (or is otherwise required to include in its income earnings of the foreign corporation) 

is deemed to have paid a portion of the foreign income taxes paid 

by the foreign corporation on its accumulated earnings. The taxes 

deemed paid by the U.S. corporation are included in its total foreign taxes paid and its foreign tax credit limitation calculations for 

the year in which the dividend is received. 

B. U.S. Tax Treaties 

The traditional objectives of U.S. tax treaties have been the 

avoidance of international double taxation and the prevention of 

tax avoidance and evasion. Another related objective of U.S. tax 

treaties is the removal of the barriers to trade, capital flows, and 

commercial travel that may be caused by overlapping tax jurisdictions and by the burdens of complying with the tax laws of a jurisdiction when a person’s contacts with, and income derived from, 

6

that jurisdiction are minimal. To a large extent, the treaty provisions designed to carry out these objectives supplement U.S. tax 

law provisions having the same objectives; treaty provisions modify 

the generally applicable statutory rules with provisions that take 

into account the particular tax system of the treaty partner. 

The objective of limiting double taxation generally is accomplished in treaties through the agreement of each country to limit, 

in specified situations, its right to tax income earned from its territory by residents of the other country. For the most part, the various rate reductions and exemptions agreed to by the source country in treaties are premised on the assumption that the country of 

residence will tax the income at levels comparable to those imposed 

by the source country on its residents. Treaties also provide for the 

elimination of double taxation by requiring the residence country 

to allow a credit for taxes that the source country retains the right 

to impose under the treaty. In addition, in the case of certain types 

of income, treaties may provide for exemption by the residence 

country of income taxed by the source country. 

Treaties define the term ‘‘resident’’ so that an individual or corporation generally will not be subject to tax as a resident by both 

the countries. Treaties generally provide that neither country will 

tax business income derived by residents of the other country unless the business activities in the taxing jurisdiction are substantial 

enough to constitute a permanent establishment or fixed base in 

that jurisdiction. Treaties also contain commercial visitation exemptions under which individual residents of one country performing personal services in the other will not be required to pay 

tax in that other country unless their contacts exceed certain specified minimums (e.g., presence for a set number of days or earnings 

in excess of a specified amount). Treaties address passive income 

such as dividends, interest, and royalties from sources within one 

country derived by residents of the other country either by providing that such income is taxed only in the recipient’s country of 

residence or by reducing the rate of the source country’s withholding tax imposed on such income. In this regard, the United 

States agrees in its tax treaties to reduce its 30–percent withholding tax (or, in the case of some income, to eliminate it entirely) 

in return for reciprocal treatment by its treaty partner. 

In its treaties, the United States, as a matter of policy, generally 

retains the right to tax its citizens and residents on their worldwide income as if the treaty had not come into effect. The United 

States also provides in its treaties that it will allow a credit against 

U.S. tax for income taxes paid to the treaty partners, subject to the 

various limitations of U.S. law. 

The objective of preventing tax avoidance and evasion generally 

is accomplished in treaties by the agreement of each country to exchange tax-related information. Treaties generally provide for the 

exchange of information between the tax authorities of the two 

countries when such information is necessary for carrying out provisions of the treaty or of their domestic tax laws. The obligation 

to exchange information under the treaties typically does not require either country to carry out measures contrary to its laws or 

administrative practices or to supply information that is not obtainable under its laws or in the normal course of its administration 

7

or that would reveal trade secrets or other information the disclosure of which would be contrary to public policy. The Internal Revenue Service (the ‘‘IRS’’), and the treaty partner’s tax authorities, 

also can request specific tax information from a treaty partner. 

This can include information to be used in a criminal investigation 

or prosecution. 

Administrative cooperation between countries is enhanced further under treaties by the inclusion of a ‘‘competent authority’’ 

mechanism to resolve double taxation problems arising in individual cases and, more generally, to facilitate consultation between 

tax officials of the two governments. 

Treaties generally provide that neither country may subject nationals of the other country (or permanent establishments of enterprises of the other country) to taxation more burdensome than that 

it imposes on its own nationals (or on its own enterprises). Similarly, in general, neither treaty country may discriminate against 

enterprises owned by residents of the other country. 

At times, residents of countries that do not have income tax treaties with the United States attempt to use a treaty between the 

United States and another country to avoid U.S. tax. To prevent 

third-country residents from obtaining treaty benefits intended for 

treaty country residents only, treaties generally contain an ‘‘antitreaty shopping’’ provision that is designed to limit treaty benefits 

to bona fide residents of the two countries. 

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III. EXPLANATION OF PROPOSED PROTOCOL 

Article 1. Personal Scope 

The proposed protocol expands the ‘‘saving clause’’ provision in 

Article 1 (Personal Scope) of the present treaty to include former 

long-term residents whose termination of residency had as one of 

its principal purposes the avoidance of tax. 

Saving Clause 

The personal scope article describes the persons who may claim 

the benefits of the present treaty. The present treaty generally applies to residents of the United States and Australia, with specific 

modifications to such scope in other articles. Like all U.S. income 

tax treaties and the U.S. model, the present treaty includes a ‘‘saving clause.’’ Under this clause, with specific exceptions, the treaty 

does not affect the taxation by either treaty country of its residents 

or its citizens. Thus, the United States may continue to tax its citizens who are residents of Australia as if the treaty were not in 

force. 

The present treaty contains a provision under which the saving 

clause (and therefore the U.S. jurisdiction to tax) applies for U.S. 

tax purposes to a former U.S. citizen whose loss of citizenship status had as one of its principal purposes the avoidance of U.S. tax; 

such application is limited to the ten-year period following the loss 

of citizenship status. 

The proposed protocol expands the saving clause provision in the 

present treaty to include former long-term residents whose termination of residency had as one of its principal purposes the avoidance of tax. The expansion of this provision makes the treaty consistent with amendments to the U.S. tax rules under Code section 

877 in 1996 related to former citizens and former long-term residents who relinquish citizenship or terminate residency. 

Prior to the enactment of the Health Insurance Portability and 

Accountability Act of 1996, section 877 of the Code provided special 

rules for the imposition of U.S. income tax on former U.S. citizens 

for a period of ten years following the loss of citizenship; these special tax rules applied to a former citizen only if his or her loss of 

U.S. citizenship had as one of its principal purposes the avoidance 

of U.S. income, estate or gift taxes. The Health Insurance Portability and Accountability Act of 1996 expanded section 877 to 

apply also to certain former long-term residents of the United 

States. For purposes of applying the special tax rules to former citizens and long-term residents, individuals who meet a specified income tax liability threshold or a specified net worth threshold generally are considered to have lost citizenship or resident status for 

a principal purpose of U.S. tax avoidance. 

The proposed protocol reflects the reach of the U.S. tax jurisdiction pursuant to section 877 after its expansion by the Health InVerDate Jan 31 2003 22:59 Feb 28, 2003 Jkt 085198 PO 00000 Frm 00012 Fmt 6604 Sfmt 6604 E:\HR\OC\B198.XXX B198
9

surance Portability and Accountability Act of 1996. Accordingly, 

the saving clause in the proposed protocol permits the United 

States to impose the special tax rules on former U.S. long-term 

residents who terminate residency with a principal purpose of 

avoiding U.S. income, estate, or gift taxes. 

The term ‘‘long-term resident’’ is defined under U.S. domestic 

laws. The United States defines ‘‘long-term resident’’ as an individual (other than a U.S. citizen) who is a lawful permanent resident of the United States in at least 8 of the prior 15 taxable years. 

An individual is not treated as a lawful permanent resident for any 

taxable year if such individual is treated as a resident of a foreign 

country under the provisions of a tax treaty between the United 

States and the foreign country and the individual does not waive 

the benefits of such treaty applicable to residents of the foreign 

country. 

Exceptions to the saving clause are provided for certain benefits 

conferred by the articles dealing with Associated Enterprises (Article 9); Pensions, Annuities, Alimony and Child Support (Article 18); 

Relief from Double Taxation (Article 22); Nondiscrimination (Article 23); Mutual Agreement Procedure (Article 24); and certain 

sourcing rules (Article 27). 

In addition, the saving clause does not apply to the benefits conferred by one of the countries under the articles dealing with Governmental Remuneration (Article 19), Students (Article 20), or Diplomatic and Consular Privileges (Article 26), upon individuals (1) 

who are not citizens of that conferring country and (2) who in the 

case of the United States do not have immigrant status, or who in 

the case of Australia are not ordinarily resident in Australia. 

Article 2. Taxes Covered 

The proposed protocol amends Article 2 (Taxes Covered) of the 

present treaty to include certain U.S. and Australian taxes. The 

present treaty provision generally applies to the income taxes of 

the United States and Australia. 

United States 

In the case of the United States, the present treaty applies to the 

Federal income taxes imposed by the Code, but excludes the accumulated earnings tax and the personal holding company tax. This 

treatment is different from the U.S. model, which specifies that 

both the accumulated earnings tax and the personal holding company tax are covered taxes. 

The proposed protocol amends the present treaty to provide that 

all U.S. income taxes are covered taxes for purposes of the treaty. 

Thus, the accumulated earnings tax and the personal holding company tax are covered taxes under the proposed protocol. Under the 

Code, these taxes will not apply to most foreign corporations because of either a statutory exclusion or the corporation’s failure to 

meet a statutory requirement. The proposed protocol continues to 

exclude social security taxes and excise taxes as under the present 

treaty. The U.S. model excludes social security taxes, but covers 

the excise tax on private foundations and (in certain cases) the excise tax on insurance premiums paid to foreign insurers. 

10

Australia 

In the case of Australia, the present treaty applies to the Australian income tax, including the additional tax upon the undistributed amount of the distributable income of a private company. 

The proposed protocol provides that the covered taxes are (i) the 

Australian income tax, including tax on capital gains, and (ii) the 

resource rent tax in respect of offshore projects relating to exploration for or exploitation of petroleum resources (‘‘RRT’’), imposed 

under the federal law of Australia. The clarification with respect to 

the capital gains tax means that U.S. taxpayers will be able to receive a U.S. foreign tax credit for the capital gains tax paid. The 

proposed protocol’s modification to the covered Australian taxes 

will expand the application of certain treaty provisions to include 

the RRT (i.e., Article 5 (Permanent Establishment), Article 7 (Business Profits) and Article 27 (Miscellaneous)). However, other modifications under the proposed protocol to Article 22 (Relief from Double Taxation) provide that the United States is not required to 

grant a foreign tax credit for RRT paid to Australia, even though 

the RRT is considered a covered tax under the treaty. This does not 

preclude U.S. companies from claiming a foreign tax credit for the 

RRT, but requires that a determination of the RRT’s creditability 

be made under U.S. tax law. 

The proposed protocol does not modify the provision contained in 

the present treaty (and generally found in U.S. income tax treaties) 

to the effect that it will apply to substantially similar taxes that 

either country may subsequently impose. 

Article 3. Residence 

The proposed protocol provides that, for purposes of Article 4 

(Residence) of the present 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 an income tax treaty 

between that third country and Australia. If the U.S. citizen qualifies as a resident under an income tax treaty between such third 

country and Australia, the proposed protocol precludes the U.S. citizen from claiming benefits under the U.S.-Australian treaty. 

The assignment of a country of residence is important because 

the benefits of the present treaty generally are available only to a 

resident of one of the countries as that term is defined in the treaty. Furthermore, issues arising because of dual residency, including 

situations of double taxation, may be avoided by the assignment of 

one treaty country as the country of residence when under the internal laws of the treaty countries a person is a resident of both 

countries. 

The present treaty defines a resident of the United States to include any United States corporation (as defined in Article 3 so as 

to exclude corporations with dual residence) and, subject to certain 

exceptions, any other person resident in the United States as determined under U.S. tax laws. 

The proposed protocol provides rules related to the treatment of 

a U.S. citizen who is resident outside the United States. The proposed protocol modifies the present treaty to provide that a U.S. 

citizen is treated as a resident of the United States unless the U.S. 

11

citizen is ‘‘a resident of a State other than Australia’’ for purposes 

of an income tax treaty between that third country and Australia. 

This rule prevents a U.S. citizen who is a resident of a country 

other than the United States or Australia from choosing the benefits of the U.S.-Australia treaty over those provided by the tax treaty between Australia and his or her country of residence. The Technical Explanation gives the example of a U.S. citizen who is a resident of the United Kingdom and entitled to benefits under the 

U.K.-Australia tax treaty. Such individual is precluded from claiming benefits under the U.S.-Australia treaty and could claim only 

the benefits of the U.K.-Australia treaty. 

If a U.S. citizen’s country of residence does not have a tax treaty 

with Australia (or if the U.S. citizen does not qualify as a ‘‘resident’’ of the third State for purposes of the tax treaty between that 

State and Australia), then he or she is treated as a resident of the 

United States and is allowed to take advantage of benefits under 

the U.S.-Australia treaty. If such individual is a resident of both 

the United States and Australia, the appropriate country of residence is determined by the ‘‘tie-breaker’’ rules provided under the 

present U.S.-Australia treaty. 

The Technical Explanation states that such provision, in clarifying the treatment of a U.S. citizen, does not alter the application 

of the ‘‘saving clause’’ (i.e., the U.S. jurisdiction to tax). Thus, the 

fact that a U.S. citizen is not considered a U.S. resident under the 

U.S.-Australia treaty does not prevent the United States from continuing to tax such individual as if the U.S.-Australia treaty never 

went in to force. The Technical Explanation states that a U.S. citizen who, under this rule, is not considered to be a resident of the 

United States still is taxable on his worldwide income under generally applicable U.S. tax laws. 

Article 4. Business Profits 

The proposed protocol adds a new paragraph to Article 7 (Business Profits) of the present treaty to clarify that the permanent establishment status of a fiscally transparent entity flows through 

the entity, resulting in a permanent establishment for the beneficial owners of such entity. 

Under the present treaty, the business profits of an enterprise of 

one of the countries are taxable in the other country if the enterprise carries on business through a permanent establishment within the other country, but only so much of the business profits that 

are attributable to that permanent establishment. 

The taxation of business profits under the present treaty differs 

from United States rules for taxing business profits primarily by 

requiring more than merely being engaged in trade or business before a country can tax business profits and by substituting the ‘‘attributable to’’ standard for the Code’s ‘‘effectively connected’’ standard. Under the Code, all that is necessary for effectively connected 

business profits to be taxed is that a trade or business be carried 

on in the United States. Under the present treaty, on the other 

hand, some level of fixed place of business must be present and the 

business profits must be attributable to that fixed place of business. 

12

The proposed protocol does not change the basic rule for taxing 

business profits under the present treaty. The proposed protocol 

clarifies the treatment of fiscally transparent entities (e.g. certain 

trusts) and beneficial owners of fiscally transparent entities. The 

clarification provision was requested by Australia because, under 

Australian law, the trustees of a trust (instead of the beneficiaries 

of a trust) are treated as carrying on any trade or business conducted by the trust. Thus, any trade or business that results in a 

permanent establishment is attributed to the trustees rather than 

the beneficiaries of the trust. The proposed protocol would clarify 

that permanent establishment status flows through a fiscally 

transparent entity. 

The proposed protocol provides that if a fiscally transparent entity (or trustee) creates a permanent establishment in one of the two 

countries and a resident of the other country is beneficially entitled 

to a share of the business profits generated by the fiscally transparent entity (or trustee) through that permanent establishment, 

then the beneficial owner is treated as carrying on a business 

through a permanent establishment in that country, and its share 

of the business profits are attributed to the permanent establishment. 

The Technical Explanation gives the example of a trust with a 

U.S. beneficiary carrying on a business in Australia through its 

trustee such that if that trustee’s actions rise to the level of a permanent establishment, then the U.S. beneficiary will be treated as 

having a permanent establishment in Australia and the profits of 

the trust associated with that permanent establishment are considered business profits. 

The Technical Explanation clarifies that because such provision 

was added solely to address Australian law relating to trusts, the 

absence of similar language in other U.S. tax treaties does not 

imply that a resident may avoid permanent establishment treatment and business profits by investing through a fiscally transparent entity. 

Unlike some U.S. treaties and the U.S. model, the present treaty 

does not define the term ‘‘business profits.’’ Thus, to the extent not 

dealt with in other Articles, the term is defined under the domestic 

laws of each country. If the definitions cause double taxation, the 

competent authorities agree on a common meaning of the term. 

The present treaty contains a provision, not generally found in 

other treaties, that permits a country to determine the tax liability 

of a person under internal law where the information available to 

the competent authority of that country is inadequate to determine 

the profits attributable to a permanent establishment. However, on 

the basis of available information, the determination of the profits 

of the permanent establishment must be consistent with the principles of the Article. 

Article 5. Shipping and Air Transport 

The proposed protocol amends Article 8 (Shipping and Air Transport) to generally favor residence country taxation of income from 

the operation of ships, aircraft and containers in international traffic. The proposed protocol modifies the rules on the treatment of 

profits from the rental of ships and aircraft in international traffic, 

13

3The rules governing income from the disposition of ships, aircraft, and containers are in Article 13 (Alienation of Property) of the present treaty (as amended by Article 9 of the protocol). 4 ‘‘International traffic’’ is defined in Article 3(1)(d) (General Definitions) as any transport by 

a ship or aircraft, except when the transport is solely between places in the other treaty country. 

the treatment of containers, and the use of profit-sharing arrangements. The proposed protocol also clarifies the treatment of inland 

transport of property and passengers.3

The United States generally taxes the U.S.-source income of a 

foreign person from the operation of ships or aircraft to or from the 

United States. An exemption from U.S. tax is provided if the income is earned by a corporation that is organized in, or an alien 

individual who is resident in, a foreign country that grants an 

equivalent exemption to U.S. corporations and residents. The 

United States has entered into agreements with a number of countries providing such reciprocal exemptions. 

Like the present treaty, the proposed protocol provides that profits that are derived by an enterprise of one country from the operation in international traffic of ships or aircraft are taxable only in 

that country.4 Also, like the present treaty, the proposed protocol 

provides that profits from the operation of ships or aircraft in international traffic include profits derived from the rental of ships or 

aircraft on a full basis (i.e., with crew) if the lessor either operates 

ships or aircraft in international traffic or regularly leases ships or 

aircraft on a full basis. 

The proposed protocol and the present treaty differ with respect 

to treatment of profits from the rental of ships or aircraft on a 

bareboat basis (i.e., without crew). Under the present treaty, if 

such rental activities are incidental to the activities from the operation of ships or aircraft in international traffic and the leased 

ships or aircraft are operated in international traffic, then the profits are treated as profits from the operation in international traffic 

of ships and aircraft and thereby subject to tax only in the resident 

country. The proposed protocol eliminates the requirement that the 

leased ships or aircraft actually be operated in international traffic 

in order to be eligible for resident country only taxation. The Technical Explanation notes that this provision is generally consistent 

with the OECD model but still is narrower than the U.S. Model, 

which also covers rentals from bareboat leasing that are not incidental to the operation of ships and aircraft in international traffic 

by the lessor. 

Tracking the U.S. model, the proposed protocol provides that 

profits of an enterprise of a country from the use, maintenance, or 

rental of containers (including trailers, barges, and related equipment for the transport of containers) used for the transport of 

goods in international traffic is taxable only in that country. Unlike 

the present treaty, this is the result under the proposed protocol 

(and the U.S. model) regardless of whether: (1) the income recipient 

is a lessor; (2) the income is rental income that is incidental to income received from the operation of ships or aircraft in international traffic; and (3) the containers and related equipment are 

used in international traffic by a lessee. The Technical Explanation 

states that, by contrast to the U.S. model and the proposed protocol, the OECD model covers only income from the use, maintenance, or rental of containers that is incidental to other income 

14

from international traffic. In addition, consistent with the U.S. 

model, the proposed protocol changes the reference from ‘‘containers and related equipment’’ in the present treaty to a reference 

to ‘‘containers (including trailers, barges, and related equipment for 

the transport of containers).’’ 

Following the Australian model, the shipping and air transport 

provisions of the proposed protocol apply to profits derived from 

participation in a pool service or other profit sharing arrangement. 

This refers to various arrangements for international cooperation 

by carriers in shipping and air transport. By contrast, the present 

treaty refers only to profits derived from participation in a pool 

service, in a joint transport operating organization, or in an international operating agency. Similar to the present treaty, the U.S. 

model refers to profits derived from a pool, a joint business, or an 

international operating agency. 

The proposed protocol clarifies the treatment of the inland transport of property and passengers. Under the present treaty, the definition of profits from the operation in international traffic of ships 

and aircraft does not include (and therefore the Article does not 

cover) profits derived from the carriage by ships or aircraft of passengers or certain property (livestock, mail, goods, or merchandise) 

that is shipped in one State for discharge at another place in that 

State. This rule has raised questions about the treatment of the domestic leg of an international trip. Accordingly, the proposed protocol provides that the carriage by ships or aircraft of passengers 

or certain property that is taken on board in one State for discharge in that State is not the operation in international traffic of 

ships or aircraft and may be taxed in that State. The Technical Explanation characterizes the protocol as consistent with the OECD 

model, namely that profits derived by an enterprise from the inland transport of property or passengers within either treaty country are treated as profits from the operation of ships or aircraft in 

international traffic (and, thus, governed by this Article) if such 

transport is undertaken as part of international traffic by the enterprise. For example, as described in the Technical Explanation, 

under the proposed protocol, if a U.S. enterprise contracts to carry 

property from Australia to the United States and, as part of the 

contract, it transports (or contracts to transport) the property by 

truck from its point of origin to an airport in Australia, the income 

earned by the U.S. enterprise from the overland leg of the journey 

would be taxable only in the United States. In addition, if a U.S. 

airline carries passengers from Los Angeles to Perth, with an intervening stop in Melbourne, the Melbourne-to-Perth leg of the trip 

would be treated as international transport of passengers with respect to passengers who boarded in Los Angeles (and taxable only 

in the United States) but not with respect to passengers who 

boarded in Melbourne. With respect to passengers who boarded in 

Melbourne, the profits related to such transport would not meet the 

definition of ‘‘international traffic.’’ The Technical Explanation 

states that this Article also would apply to income from lighterage 

undertaken as part of the international transport of goods. 

15

Article 6. Dividends 

The proposed protocol replaces Article 10 (Dividends) of the 

present treaty with a new dividend article that generally provides 

for full residence country taxation and limited source country taxation of dividends. The proposed protocol would retain the maximum rate of withholding at source at 15 percent and would allow 

a 5 percent rate for dividends from 10–percent owned corporations. 

It would also permit a new zero rate of withholding tax on dividends from certain direct investments. Special rules are provided 

for dividends from regulated investment companies and real estate 

investment trusts. 

Internal taxation rules 

United States 

The United States generally imposes a 30–percent tax on the 

gross amount of U.S.-source dividends paid to nonresident alien individuals and foreign corporations. The 30–percent tax does not 

apply if the foreign recipient is engaged in a trade or business in 

the United States and the dividends are effectively connected with 

that trade or business. In such a case, the foreign recipient is subject to U.S. tax on such dividends on a net basis at graduated rates 

in the same manner that a U.S. person would be taxed. 

Under U.S. law, the term dividend generally means any distribution of property made by a corporation to its shareholders, either 

from accumulated earnings and profits or current earnings and 

profits. However, liquidating distributions generally are treated as 

payments in exchange for stock and, thus, are not subject to the 

30–percent withholding tax described above. 

Dividends paid by a U.S. corporation generally are U.S.-source 

income. Also treated as U.S.-source dividends for this purpose are 

portions of certain dividends paid by a foreign corporation that conducts a U.S. trade or business. The U.S. 30–percent withholding 

tax imposed on the U.S.-source portion of the dividends paid by a 

foreign corporation is referred to as the ‘‘second-level’’ withholding 

tax. This second-level withholding tax is imposed only if a treaty 

prevents application of the statutory branch profits tax. 

In general, corporations are not entitled under U.S. law to a deduction for dividends paid. Thus, the withholding tax on dividends 

theoretically represents imposition of a second level of tax on corporate taxable income. Treaty reductions of this tax reflect the view 

that where the United States already imposes corporate-level tax 

on the earnings of a U.S. corporation, a 30–percent withholding 

rate may represent an excessive level of source-country taxation. 

Moreover, the reduced rate of tax often applied by treaty to dividends paid to direct investors reflects the view that the sourcecountry tax on payments of profits to a substantial foreign corporate shareholder may properly be reduced further to avoid double 

corporate-level taxation and to facilitate international investment. 

A real estate investment trust (‘‘REIT’’) is a corporation, trust, or 

association that is subject to the regular corporate income tax, but 

that receives a deduction for dividends paid to its shareholders if 

certain conditions are met. In order to qualify for the deduction for 

dividends paid, a REIT must distribute most of its income. Thus, 

16

a REIT is treated, in essence, as a conduit for federal income tax 

purposes. Because a REIT is taxable as a U.S. corporation, a distribution of its earnings is treated as a dividend rather than income of the same type as the underlying earnings. Such distributions are subject to the U.S. 30–percent withholding tax when paid 

to foreign owners. 

A REIT is organized to allow persons to diversify ownership in 

primarily passive real estate investments. As such, the principal 

income of a REIT often is rentals from real estate holdings. Like 

dividends, U.S.-source rental income of foreign persons generally is 

subject to the 30–percent withholding tax (unless the recipient 

makes an election to have such rental income taxed in the United 

States on a net basis at the regular graduated rates). Unlike the 

withholding tax on dividends, however, the withholding tax on 

rental income generally is not reduced in U.S. income tax treaties. 

U.S. internal law also generally treats a regulated investment 

company (‘‘RIC’’) as both a corporation and a conduit for income tax 

purposes. The purpose of a RIC is to allow investors to hold a diversified portfolio of securities. Thus, the holder of stock in a RIC 

may be characterized as a portfolio investor in the stock held by 

the RIC, regardless of the proportion of the RIC’s stock owned by 

the dividend recipient. 

Australia 

Australia has an integrated tax system and by statute does not 

impose a withholding tax on dividend payments to nonresidents to 

the extent such dividends have born the full rate of Australian 

company tax (i.e., ‘‘franked dividends’’). When dividends are paid 

out of untaxed corporate profits (i.e., ‘‘unfranked dividends’’), withholding tax is imposed at a statutory rate of 30 percent, unless otherwise reduced by treaty. Australia does not currently impose a 

branch profits tax. 

Proposed treaty limitations on internal law 

Under the proposed protocol, dividends paid by a company that 

is a resident of a treaty country to a resident of the other country 

may be taxed in such other country. Such dividends also may be 

taxed by the country in which the payor company is resident, but 

the rate of such tax is limited. Under the proposed protocol, sourcecountry taxation of dividends (i.e., taxation by the country in which 

the dividend-paying company is resident) generally is limited to 15 

percent of the gross amount of the dividends paid to residents of 

the other treaty country. A lower rate of 5 percent applies if the 

beneficial owner of the dividend is a company that owns at least 

10 percent of the voting stock of the dividend-paying company. 

The term ‘‘beneficial owner’’ is not defined in the present treaty 

or proposed protocol and, thus, is defined under the internal law 

of the source country. The Technical Explanation states that the 

beneficial owner of a dividend for purposes of this article is the person to which the dividend income is attributable for tax purposes 

under the laws of the source country. Further, companies holding 

shares through fiscally transparent entities such as partnerships 

are considered to hold their proportionate interest in the shares. 

17

In addition, the proposed protocol provides a zero rate of withholding tax with respect to certain intercompany dividends in cases 

in which there is a sufficiently high (80-percent) level of ownership 

(often referred to as ‘‘direct dividends’’). 

80 percent intercompany ownership for 12 months 

The proposed protocol reduces the withholding rate to zero on 

dividends beneficially owned by a company that has owned directly 

80 percent or more of the voting power of the company paying the 

dividend for the 12–month period ending on the date the dividend 

is declared. 

In general, in order to be eligible for this zero rate withholding, 

the beneficial owner company must be entitled to the benefits of 

the treaty under specified provisions of Article 16 (Limitation on 

Benefits), as modified by the proposed protocol, or have received a 

determination from the relevant competent authority. 

Dividends paid by RICs and REITs 

The proposed protocol generally denies the 5 percent and zero 

rates of withholding to dividends paid by a RIC or REIT. 

The 15 percent rate of withholding is allowed for any dividends 

paid by a RIC. The 15 percent rate of withholding is allowed for 

dividends paid by a REIT only if one of three additional conditions 

is met. First, the dividend may qualify for the 15 percent rate if 

the person beneficially entitled to the dividend is an individual 

holding an interest of not more than 10 percent in the REIT. Second, the dividend may qualify for the 15 percent rate if it is paid 

with respect to a class of stock that is publicly traded and the person beneficially entitled to the dividend is a person holding an interest of not more than 5 percent of any class of the REIT’s stock. 

Third, the dividend may qualify for the 15 percent rate if the person beneficially entitled to the dividend holds an interest in the 

REIT of not more than 10 percent and the REIT is ‘‘diversified’’ 

(i.e., the gross value of no single interest in real property held by 

the REIT exceeds 10 percent of the gross value of the REIT’s total 

interest in real property). 

The Technical Explanation indicates that these restrictions in 

availability of the different rates are intended to prevent the use 

of RICs and REITs to gain unjustifiable source-country benefits for 

certain shareholders resident in Australia. For example, a company 

resident in Australia could directly own a diversified portfolio of 

U.S. corporate shares and pay a U.S. withholding tax of 15 percent 

on dividends on those shares. There is a concern that such a company could purchase 10 percent or more of the interests in a RIC, 

which could even be established as a mere conduit, and, thus, obtain a lower withholding rate by holding a similar portfolio through 

the RIC (transforming portfolio dividends generally taxable at 15 

percent into direct investment dividends taxable under the treaty 

at zero or 5 percent). 

Similarly, the Technical Explanation gives an example of a resident of Australia directly holding real property and required to pay 

U.S. tax either at a 30 percent rate on gross income or at graduated rates on the net income. By placing the property in a REIT, 

the investor could transform real estate income into dividend inVerDate Jan 31 2003 22:59 Feb 28, 2003 Jkt 085198 PO 00000 Frm 00021 Fmt 6604 Sfmt 6604 E:\HR\OC\B198.XXX B198
18

come, taxable at the rates provided in the proposed protocol. The 

limitations on REIT dividend benefits are intended to protect 

against this result. 

Special rules apply to REIT dividends paid to listed Australian 

property trusts (‘‘LAPTs’’). A LAPT is a unit trust registered as an 

investment scheme, listed on a recognized Australian stock exchange, and regularly traded on one or more recognized exchanges. 

In order to encourage collective investment by small unitholders, 

LAPTs receive tax benefits under Australian law that are similar 

to those received by REITs in the United States. The tax benefits 

are intended to replicate the tax treatment of direct investment by 

such unitholders. Thus, the REIT provision included in recent U.S. 

tax treaties was modified to accommodate the Australian domestic 

laws by granting small unitholders generally the same benefits 

with respect to REIT shares that they would receive if they directly 

held such investments. 

The special rules generally allow a 15 percent withholding rate 

for dividends paid by a REIT to a LAPT, notwithstanding the conditional requirements related to REIT dividends mentioned above. 

However, in the case of large unitholders, the 15 percent rate does 

not automatically apply to all the dividends paid by a REIT to a 

LAPT. If the responsible entity for the LAPT knows (or has reason 

to know) that one or more unitholders owns 5 percent or more of 

the beneficial interests in an LAPT, such unitholders will be subject to a look-through rule, whereby they are deemed to hold directly their proportionate interest in the REIT held through the 

LAPT, and they must satisfy one of the three conditional requirements to qualify for the 15 percent withholding rate on REIT dividends. Thus in satisfying one of the three conditional requirements, 

unitholders with an interest of five percent or more in a LAPT 

must take into account the REIT shares they own directly and the 

REIT shares they are deemed to own directly as a result of the 

look-through rule. 

Following the example in the Technical Explanation, assume 

that a LAPT owns 40 percent of a REIT. One LAPT unitholder, individual A, owns 20 percent of the beneficial interests in the LAPT, 

and the responsible entity for the LAPT is aware of A’s percentage 

of ownership interests. All other unitholders in the LAPT hold less 

than a 5 percent beneficial interest. Accordingly, A is treated as 

holding a portion of the LAPT’s direct interest in the REIT equal 

to A’s proportionate interest in the LAPT. Thus, A is treated as 

owning 8 percent of the REIT (.40 x .20) through A’s LAPT investment. In addition to ownership interests in the LAPT, A owns directly 5 percent of the beneficial interests in the REIT. Thus, A’s 

total beneficial interests in the REIT are 13 percent (8 percent 

through the LAPT and 5 percent held directly), preventing A from 

meeting one of the three conditional requirements related to REIT 

dividends and thereby denying A the benefit of the 15 percent 

withholding rate. The LAPT, however, is eligible for the 15 percent 

rate on the remaining 80 percent of the dividends (the portion not 

attributable to A’s ownership interest) paid by the REIT to the 

LAPT. 

19

Special rules and limitations 

The proposed protocol’s reduced rates of tax on dividends do not 

apply if the dividend recipient carries on business through a permanent establishment in the source country, or performs in the 

source country independent personal services from a fixed base located in that country, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such cases, the dividends effectively connected to the permanent establishment or the fixed base are taxed 

as business profits (Article 7) or as income from the performance 

of independent personal services (Article 14), as the case may be. 

The proposed protocol generally defines ‘‘dividends’’ as income 

from shares, as well as other amounts, which are subjected to the 

same taxation treatment as income from shares by the country in 

which the distributing corporation is resident. The Technical Explanation states that the term includes income from shares or 

other corporate rights, which carry the right to participate in profits, if such income is subject to the same tax treatment as income 

from shares by the country in which the distributing corporation is 

resident. The term also includes income from arrangements, including debt obligations, to the extent such income is so characterized 

under the laws of the country in which the income arises. 

The proposed protocol prevents the United States from imposing 

a tax on dividends paid by an Australian company unless such dividends are paid to a resident of the United States or attributable 

to a permanent establishment or fixed base situated in the United 

States. Thus, this provision generally overrides the ability of the 

United States to impose a ‘‘second-level’’ withholding tax on the 

U.S.-source portion of dividends paid by an Australian corporation. 

The proposed protocol also restricts the United States from imposing corporate level taxes on undistributed profits, other than a 

branch profits tax. 

The United States is allowed under the proposed protocol to impose the branch profits tax on an Australian corporation that either 

has a permanent establishment in the United States, or is subject 

to tax on a net basis in the United States on income from real 

property or gains from the disposition of interests in real property. 

The tax is imposed on the ‘‘dividend equivalent amount,’’ as defined 

in the Code (generally, the dividend amount a U.S. branch office 

would have paid to its parent for the year if it had been operated 

as a separate U.S. subsidiary). In cases where an Australian corporation conducts a trade or business in the United States but not 

through a permanent establishment, the proposed protocol completely eliminates the branch profits tax that the Code would otherwise impose on such corporation (unless the corporation earned income from real property as described above). Australia currently 

does not impose a branch profits tax. If Australia were to impose 

such tax, the base of such a tax would be limited to an amount 

analogous to the ‘‘dividend equivalent amount.’’ 

The imposition of the branch profits tax by the United States is 

precluded if an Australian company is considered a qualified person by reason of it being a publicly-traded company or a subsidiary 

of a publicly-traded company under Article 16 (Limitation on BeneVerDate Jan 31 2003 22:59 Feb 28, 2003 Jkt 085198 PO 00000 Frm 00023 Fmt 6604 Sfmt 6604 E:\HR\OC\B198.XXX B198
20

fits), or if a such company is granted treaty benefits by the competent authorities under Article 16. 

Article 7. Interest 

The proposed protocol replaces Article 11 (Interest) with an article that retains source-country taxation of interest at a maximum 

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 contains certain provisions that more 

closely conform the present treaty to the U.S. model and to recent 

changes to U.S. domestic law. 

Internal taxation rules 

United States 

Subject to several exceptions (such as those for portfolio interest, 

bank deposit interest, and short-term original issue discount), the 

United States imposes a 30–percent withholding tax on U.S.-source 

interest paid to foreign persons under the same rules that apply to 

dividends. U.S.-source interest, for purposes of the 30–percent tax, 

generally is interest on the debt obligations of a U.S. person, other 

than a U.S. person that meets specified foreign business requirements. Interest paid by the U.S. trade or business of a foreign corporation also is subject to the 30–percent tax. A foreign corporation 

is subject to a branch-level excess interest tax with respect to certain ‘‘excess interest’’ of a U.S. trade or business of such corporation. Under this rule, an amount equal to the excess of the interest 

deduction allowed with respect to the U.S. business over the interest paid by such business is treated as if paid by a U.S. corporation 

to a foreign parent and, therefore, is subject to the 30–percent 

withholding tax. 

Portfolio interest generally is defined as any U.S.-source interest 

that is not effectively connected with the conduct of a trade or business if such interest (1) is paid on an obligation that satisfies certain registration requirements or specified exceptions thereto, and 

(2) is not received by a 10–percent owner of the issuer of the obligation, taking into account shares owned by attribution. However, the 

portfolio interest exemption does not apply to certain contingent interest income. 

If an investor holds an interest in a fixed pool of real estate 

mortgages that is a real estate mortgage interest conduit 

(‘‘REMIC’’), the REMIC generally is treated for U.S. tax purposes 

as a pass-through entity and the investor is subject to U.S. tax on 

a portion of the REMIC’s income (generally, interest income). If the 

investor holds a so-called ‘‘residual interest’’ in the REMIC, the 

Code provides that a portion of the net income of the REMIC that 

is taxed in the hands of the investor—referred to as the investor’s 

‘‘excess inclusion’’—may not be offset by any net operating losses 

of the investor, must be treated as unrelated business income if the 

investor is an organization subject to the unrelated business income tax, and is not eligible for any reduction in the 30–percent 

rate of withholding tax (by treaty or otherwise) that would apply 

if the investor were otherwise eligible for such a rate reduction. 

21

Australia 

Australian-source interest payments to nonresidents generally 

are subject to withholding tax at a rate of 10 percent. 

Proposed protocol limitations on internal law 

The proposed protocol generally provides that interest arising in 

one of the treaty countries (the source country) and paid to a resident of the other treaty country generally may be taxed by both 

countries. This provision is similar to paragraphs (1) and (2) of Article 11 of the present treaty, but is contrary to the position of the 

U.S. model, which provides an exemption from source country tax 

for interest earned by a resident of the other country. 

Like the present treaty, the proposed protocol limits the rate of 

source country tax that may be imposed on interest income. Under 

the proposed protocol, if the beneficial owner of interest is a resident of the other treaty country, the source country tax on such interest generally may not exceed 10 percent of the gross amount of 

such interest. This rate is the same as the present treaty rate, but 

is higher than the U.S. model rate, which is zero. 

The proposed protocol provides a complete exemption from source 

country tax in the case of interest arising in a treaty country and 

(1) derived and beneficially owned by the Government of the other 

treaty country, including political subdivisions and local authorities 

thereof, or (2) derived and beneficially owned by a financial institution resident of the other treaty country which is unrelated to and 

dealing at arm’s-length with the payer of the interest. For purposes 

of this provision, the proposed protocol defines the term ‘‘financial 

institution’’ to include a bank or other enterprise that derives substantially all of its profits by issuing indebtedness or by taking interest-bearing deposits and using proceeds from such indebtedness 

or deposits to carry on the business of providing finance. 

The proposed protocol provides an anti-conduit provision under 

which the exemption from source country tax with respect to interest derived by a financial institution does not apply if such interest 

is paid as part of an arrangement involving back-to-back loans or 

an arrangement that is economically equivalent and intended to 

have a similar effect to back-to-back loans. The Technical Explanation states that the economic equivalent of back-to-back loans 

would include transactions that serve the economic purpose of 

back-to-back loans but do not meet the legal requirements of a 

loan. For example, the Technical Explanation states that the economic equivalent of back-to-back loans would include securities 

issued at a discount and certain swap arrangements that are intended to operate economically as back-to-back loans. The proposed 

protocol also provides that this anti-conduit provision does not restrict the right of a treaty country to apply any anti-avoidance provisions of its internal law. Accordingly, the Technical Explanation 

states that this provision does not limit the ability of the United 

States to enforce existing anti-avoidance provisions under U.S. domestic law, including in particular the rules of Treas. Reg. sec. 

1.881–3, regulations adopted under the authority of section 7701(l) 

of the Code, and any other anti-avoidance provision of broad application (e.g., section 267). Similarly, the anti-conduit provision does 

22

5This is consistent with the source rules of U.S. law, which provide as a general rule that 

interest income has as its source the country in which the payer is resident.

not limit the ability of a treaty country to enact or adopt new antiavoidance provisions under its internal law. 

The proposed protocol defines the term ‘‘interest’’ as interest from 

government securities, bonds, debentures, and any other form of indebtedness, whether or not secured by mortgage and whether or 

not carrying a right to participate in the debtor’s profits. The term 

includes premiums attaching to such securities, bonds, or debentures. The term also includes all other income that is treated as interest under the internal law of the country in which the income 

arises. Interest does not include income covered in Article 10 (Dividends). Penalty charges for late payment also are not treated as interest. 

The reductions in source country tax on interest under the proposed protocol do not apply if the beneficial owner of the interest 

carries on business through a permanent establishment in the 

source country and the interest paid is attributable to the permanent establishment. In such an event, the interest is taxed under 

Article 7 (Business Profits). The reduced rates of tax on interest 

under the proposed protocol also do not apply if the beneficial 

owner is a treaty country resident who performs independent personal services from a fixed base located in the other treaty country 

and such interest is attributable to the fixed base. In such a case, 

the interest attributable to the fixed base is taxed under Article 14 

(Independent Personal Services). 

The proposed protocol provides that interest is treated as arising 

in a treaty country if the payer is a resident of that country.5 However, if the interest expense is borne by a permanent establishment 

or a fixed base, the interest will have as its source the country in 

which the permanent establishment or fixed base is located, regardless of the residence of the payer. Thus, for example, if a 

French resident has a permanent establishment in Australia and 

that French resident incurs indebtedness to a U.S. person, the interest on which is borne by the Australian permanent establishment, the interest would be treated as having its source in Australia. In the case of interest that is incurred by a U.S. branch of 

an Australian resident company, the Technical Explanation indicates that the interest expense allocation rules under U.S. law determine the amount of interest expense that is considered to be 

borne by the U.S. branch for purposes of this article. 

The proposed protocol addresses the issue of non-arm’s-length interest charges between related parties (or parties having an otherwise special relationship) by stating that this article applies only 

to the amount of arm’s-length interest. Any amount of interest paid 

in excess of the arm’s-length interest is taxable according to the 

laws of each country, taking into account the other provisions of 

the present treaty and the proposed protocol. For example, excess 

interest paid to a parent corporation may be treated as a dividend 

under local law and, thus, entitled to the benefits of Article 10 

(Dividends). The Technical Explanation provides that if the amount 

of interest paid is less than the amount that would have been paid 

in the absence of the special relationship, a treaty country may 

23

characterize a transaction to reflect its substance and impute interest under the authority of Article 9 (Associated Enterprises). 

The proposed protocol provides two anti-abuse exceptions to the 

general source-country reductions in tax. The first exception relates 

to ‘‘contingent interest’’ payments. If interest is paid by a sourcecountry resident and is determined with reference to the profits of 

the debtor or a related person, such interest may be taxed in the 

source country in accordance with its internal laws. However, if the 

beneficial owner is a resident of the other treaty country, such interest may not be taxed at a rate exceeding 15 percent (i.e., the 

rate prescribed in paragraph 2(b) of Article 10 (Dividends)). 

The second anti-abuse exception provides that the reductions in 

source country tax do not apply to interest paid with respect to 

ownership interests in a vehicle used for the securitization of real 

estate mortgages or other assets, to the extent that the amount of 

interest paid exceeds the normal rate of return on comparable publicly-traded debt instruments as specified by the domestic law of 

the source country. The Technical Explanation states that this provision ensures that the source country reductions in tax do not 

apply to excess income inclusions with respect to residual interests 

in a REMIC. This provision is analogous to the U.S. model, but is 

drafted reciprocally, presumably to apply to similar Australian 

securitization vehicles. 

The proposed protocol provides that the reductions in source 

country tax apply to interest payments that are deemed to be received by a treaty country resident and allocated as interest expense for purposes of determining income that is attributable to a 

permanent establishment of such resident in the other treaty country or taxable on a net basis in the other treaty country as income 

from real property or gain on real property, to the extent such 

deemed interest payments exceed the actual interest paid by the 

permanent establishment or trade or business in the other treaty 

country. The Technical Explanation states that this provision extends the reduction in source country tax to include allocable excess interest that is determined under the branch-level interest tax 

provisions of U.S. internal law (sec. 884(f)). 

Article 8. Royalties 

The proposed protocol retains source-country taxation of royalties, but reduces the maximum level of withholding tax from 10 

percent to 5 percent under Article 12 (Royalties) of the existing 

treaty. In addition, the proposed protocol amends the definition of 

‘‘royalties’’ to treat certain leasing income as business profits and 

updates such definition to reflect technological advances since the 

present treaty was signed. 

Internal taxation rules 

United States 

Under the same system that applies to dividends and interest, 

the United States imposes a 30–percent withholding tax on U.S.-

source royalties paid to foreign persons. U.S.-source royalties include royalties for the use of or the right to use intangible property 

in the United States. 

24

Australia 

Australia generally imposes a withholding tax on royalties paid 

to nonresidents at a rate of 30 percent. 

Proposed treaty limitations on internal law 

The U.S. model exempts royalties beneficially owned by a resident of one country from source-based taxation in the other country. The present treaty differs from the U.S. model in that it allows 

the country where the royalties arise (the ‘‘source country’’) to tax 

such royalties. The proposed protocol maintains source country taxation of royalties, but reduces the present treaty withholding tax 

rate from 10 percent to 5 percent. The proposed protocol’s 5 percent 

rate does not provide the full exemption found in many U.S. tax 

treaties and the U.S. model with respect to royalties, but Australia 

has not to date agreed to any treaty providing a rate lower than 

5 percent. 

The present treaty defines the term ‘‘royalties’’ to include any 

consideration for the use of, the right to use, or the sale (which is 

contingent on the productivity, use, or further disposition) of any 

copyright, patent, design or model, plan, secret formula or process, 

trademark or other like property or right; motion picture films; or 

films or video tapes for use in connection with television or tapes 

for use in connection with radio broadcasting. The definition also 

includes consideration for the use of ‘‘industrial, commercial or scientific equipment, other than equipment let under a hire purchase 

agreement.’’ 

The proposed protocol amends the definition of ‘‘royalties’’ in two 

ways. First, it removes 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, the leasing income related to such equipment is treated as 

business profits and taxable by the source country only if the recipient of the payments has a permanent establishment in the 

source country and such income is attributable to the permanent 

establishment. This treatment is consistent with the U.S. model, 

which treats such income as business profits and not as royalties. 

Second, the proposed protocol updates the definition of royalties to 

reflect technological advances since the present treaty was signed. 

The proposed protocol expands the provision to cover films, audio, 

video tapes, and disks, as well as any other means of image or 

sound reproduction or transmission, pursuant to television, radio, 

or other broadcasting. The Technical Explanation states that the 

provision would apply to a payment by an Australian broadcaster 

to a U.S. company for the right to transmit a live feed of an entertainment program over the airwaves or through cable, satellite, or 

the Internet. It would not however, apply to payments made by a 

retail customer who has subscribed to satellite television service 

provided by a U.S. company. 

The proposed protocol’s reductions in source country tax on royalties do not apply if (1) the beneficial owner of the royalties carries 

on business in the source country through a permanent establishment located in that country or performs in the source country 

independent personal services from a fixed base located in that 

country, and (2) the royalties are attributable to such permanent 

25

establishment or fixed base. In such cases, the income is taxed as 

business profits (Article 7) or as independent personal services income (Article 14), as the case may be. 

Article 9. Alienation of Property 

The proposed protocol amends Article 13 (Alienation of Property) 

of the present treaty to modify the taxation of gains from the alienation of ships, aircraft, or containers operated or used in international traffic and from property pertaining to the operation or 

use in international traffic of ships, aircraft, or containers. The proposed protocol amends Article 13 of the present treaty to provide 

that income or gains from the alienation of certain business property of a permanent establishment or fixed base may be taxed in 

the country in which the permanent establishment or fixed base is 

located. The proposed protocol also amends Article 13 to provide for 

the taxation of gains of individuals who emigrate from one country 

to the other. 

Ships, aircraft, and containers 

Under the present treaty, gains with respect to ships, aircraft, or 

containers that are part of the business of a resident of one country 

are taxable in that country except to the extent that the business 

was allowed depreciation with respect to the ships, aircraft, or containers in the other country. The proposed protocol would provide 

that gains with respect to ships, aircraft, or containers are taxable 

only by the country in which the business owning the property is 

resident. Thus, the gains that might be realized with respect of 

international traffic in the United States would not be subject to 

income tax in United States if the owner of the property giving rise 

to the gain were a resident of Australia. Likewise, the gains that 

might be realized with respect of international traffic in the Australia would not be subject to income tax in Australia if the owner 

of the property giving rise to the gain were a resident of the United 

States. 

Certain gains on business property 

Article 13 of the present treaty generally makes provision for the 

taxation of income or gains of a resident of one country from the 

alienation or disposition of real property located in the other country. The proposed protocol would provide that certain gains from 

the alienation of property, other than real property, forming part 

of the business property of a permanent establishment or fixed 

base in one country of a business resident in the other country may 

be taxed only by the country in which the permanent establishment or fixed base is located. The Technical Explanation provides 

an example of a resident of Australia that is a partner in a partnership doing business in the United States. The Australian partner will have a permanent establishment in the United States as 

a result of the activities of the partnerships. Under the proposed 

protocol, the United States may tax the Australian partner’s distributive share of income realized by the partnership on the disposition of personal property forming part of the business property 

of the partnership in the United States. 

26

Emigrating Individuals 

The proposed protocol provides for the taxation of gains of an individual who emigrates from one country to the other and, as a result, becomes subject to special tax rules in the country from which 

the individual emigrated. The Technical Explanation observes that 

under present law, this provision applies only to a resident of Australia who terminates his or her residency in Australia and becomes resident in the United States. Under Australian law, an individual who terminates Australian residence generally is treated 

as recognizing gain as though he or she disposed of all non-Australian assets. However, subject to certain conditions, an Australian resident may elect to defer the taxation of income or gain 

from this deemed sale. 

The proposed protocol provides that where the individual who 

terminates residency pays tax on the deemed sale, the other country (the United States under present law) shall treat the property 

as sold and re-acquired before the individual became resident in 

the United States. The effect of this provision is to step up the individual’s basis to the fair market value of the assets deemed to have 

been sold in the other country (Australia under present law). Thus, 

regardless of whether any U.S. tax was triggered by the deemed 

sale, the individual’s basis for future computation of gain under the 

U.S. income tax will be the fair market value of the asset immediately before taking up residency in the United States. In the case 

where the individual who terminates residency in one country for 

residency in the other country, but elects to defer the tax from that 

first country’s deemed disposition rule (Australia under present 

law), the proposed protocol provides that only the other country 

(the United States under present law) may tax the gain realized 

upon subsequent disposition of the assets. 

Article 10. Limitation on Benefits 

The proposed protocol replaces Article 16 (Limitation on Benefits) of the present treaty with an article that reflects the limitation 

on benefits provisions included in more recent U.S. income tax 

treaties. These provisions are intended to limit the benefits of the 

treaty to qualified residents of the United States and Australia. 

The income tax treaty between the United States and Australia 

is intended to limit double taxation caused by the interaction of the 

two countries tax systems as they apply to residents of the two jurisdictions. At times, however, residents of third countries attempt 

to use the treaty. Such use is known as ‘‘treaty shopping’’ and refers to the situation where a person who is not a resident of either 

country seeks certain benefits under the income tax treaty between 

the two countries. Under certain circumstances, and without appropriate safeguards, the nonresident is able indirectly to secure these 

benefits by establishing a corporation (or other entity) in one of the 

countries which, as a resident of that country, is entitled to the 

benefits of the treaty. Additionally, it may be possible for the third 

country resident to repatriate funds to that third country from the 

entity under favorable conditions (i.e., it may be possible to reduce 

or eliminate taxes on the repatriation) either through relaxed tax 

provisions in the distributing country or by passing the funds 

27

through other treaty countries (essentially, continuing to treaty 

shop), until the funds can be repatriated under favorable terms. 

Qualified Person 

The proposed anti-treaty shopping article provides that a treaty 

country resident is entitled to all treaty benefits only if it is in one 

of several specified categories. Generally, a resident of either country qualifies for the benefits accorded by the proposed protocol if 

such resident is within one of the following categories of ‘‘qualified 

persons’’ (and satisfies any other specified conditions for obtaining 

benefits): 

(1) An individual; 

(2) One of the two countries or a governmental entity of one 

of the two countries; 

(3) A company that satisfies a public company test and certain subsidiaries of such companies; 

(4) An entity other than a company that satisfies a public 

ownership test and certain subsidiaries of such entities; 

(5) A tax-exempt organization operated exclusively for religious, charitable, educational, scientific, or similar purposes; 

(6) A tax-exempt pension scheme or employee benefit arrangement that meets an ownership test; 

(7) An entity that satisfies an ownership test and a base erosion test; or 

(8) A recognized headquarters for a multinational corporate 

group. 

Alternatively, a resident that does not fit into any of the above 

categories may claim treaty benefits with respect to certain items 

of income under an active business test. In addition, a person that 

does not satisfy any of the above requirements may be entitled to 

the benefits of the treaty if the source country’s competent authority so determines. 

Individuals 

Under the proposed protocol, individual residents of the United 

States and Australia are entitled to all treaty benefits. However, if 

such an individual receives income as a nominee on behalf of a 

third country resident, and thus is not the beneficial owner of such 

income, benefits may be denied. 

Governmental entities 

The proposed protocol provides that the United States and Australia, any political subdivision or local authority of the two countries, or any agency or instrumentality of the two countries is entitled to all treaty benefits. The proposed protocol departs from the 

language used in most U.S. income tax treaties and the U.S. model 

with respect to governmental entities, but there is no material difference between the provisions with respect to limiting benefits.

Public company tests 

A company that is a resident of the United States or Australia 

is entitled to treaty benefits if the principal class of its shares is 

listed on a recognized U.S. or Australian stock exchange and is regularly traded on one or more recognized stock exchanges. Thus, 

28

such a company is entitled to the benefits of the treaty regardless 

of where its actual owners reside. 

The term ‘‘recognized stock exchange’’ means the NASDAQ System owned by the National Association of Securities Dealers; any 

stock exchange registered with the U.S. Securities and Exchange 

Commission as a national securities exchange under the U.S. Securities Exchange Act of 1934; the Australian Stock Exchange and 

any other stock exchange recognized under Australian law; and any 

other stock exchange agreed upon by the competent authorities of 

the two countries. 

The term ‘‘principal class of shares’’ is not a defined term under 

Article 3 (General Definitions). Accordingly, such term is defined by 

reference to the domestic laws of each country from which treaty 

benefits are sought, generally the source country. Under U.S. tax 

law, the term is generally defined as the common shares of the 

company representing the majority of the aggregate voting power 

and value of the company. The Technical Explanation states that 

if the company does not have a class of ordinary or common shares 

representing the majority of the aggregate voting power and value 

of the company, then the ‘‘principal class of shares’’ is the class (or 

any combination of classes) of shares that represent, in the aggregate, a majority of the voting power and value of the company. The 

term ‘‘shares’’ includes depository receipts for shares or trust certificates for shares. 

The term ‘‘regularly traded’’ is also not a defined term for purposes of the treaty. In accordance with Article 3 (General Definitions), such term is defined by reference to the domestic laws of 

each country from which the treaty benefits are sought, generally 

the source country. The Technical Explanation states that for U.S. 

tax purposes the term is to have the meaning it has under Treas. 

Reg. sec. 1.884–5(d)(4)(i)(B), relating to the branch tax provisions 

of the Code. Under these regulations, a class of shares is considered to be ‘‘regularly traded’’ if two requirements are met: (1) 

trades in the class of shares are made in more than de minimis 

quantities on at least 60 days during the taxable year and, (2) the 

aggregate number of shares in the class traded during the year is 

at least 10 percent of the average number of shares outstanding 

during the year. (The Technical Explanation states that Treas. Reg. 

sec. 1.884–5(d)(4)(i)(A), (ii) and (iii) will not be taken into account 

for purposes of defining the term ‘‘regularly traded’’ under the treaty.) The Technical Explanation also provides that the regularly 

traded requirement can be met by trading on any recognized exchange or exchanges located in either country and that trading on 

one or more recognized stock exchanges may be aggregated for purposes of this requirement. Thus, a U.S. company could satisfy the 

regularly traded requirement through trading, in whole or in part, 

on a recognized stock exchanges located in Australia or on a stock 

exchange in a third country (if agreed upon by competent authorities). Authorized but unissued shares are not considered for purposes of this test. 

In addition, a company that is a resident of the United States or 

Australia is entitled to treaty benefits if at least 50 percent of the 

aggregate vote and value of the company’s shares is owned (directly 

or indirectly) by five or fewer companies that satisfy the test preVerDate Jan 31 2003 22:59 Feb 28, 2003 Jkt 085198 PO 00000 Frm 00032 Fmt 6604 Sfmt 6602 E:\HR\OC\B198.XXX B198
29

viously described, provided that each intermediate owner used to 

satisfy the control requirement is a resident of the United States 

or Australia. This rule allows certain subsidiaries of publicly traded 

companies to take advantage of all benefits under the treaty. 

To further illustrate this rule, the Technical Explanation provides an example of an Australian company all of the shares of 

which are owned by an Australian parent company such that the 

Australian company would qualify for benefits under the treaty if 

the principal class of shares of the Australian parent company were 

listed on the Australian Stock Exchange and regularly traded on 

a recognized U.S. or Australian stock exchange. Under the same 

example, the Australian company would not qualify for benefits 

under this provision if the publicly traded parent company were 

resident in Canada, instead of the United States or Australia. Furthermore, if the Australian parent indirectly owned the Australian 

company through a chain of subsidiaries, each such subsidiary in 

the chain, as an intermediate owner, must be a resident of the 

United States or Australia for the Australian company to meet the 

requirements of such provision. 

Public entity tests 

Under the proposed protocol, a person other than an individual 

or company that is a resident of the United States or Australia is 

entitled to treaty benefits if the principal class of units in that entity is listed or admitted to dealings on a recognized U.S. or Australian stock exchange and is regularly traded on one or more recognized stock exchanges. Alternatively, the entity is entitled to 

treaty benefits if the direct or indirect owners of at least 50 percent 

of the beneficial interests in the entity are public entities under the 

preceding sentence or public companies described below. 

The Technical Explanation provides that this provision generally 

applies to trusts if their shares of ownership are publicly traded 

and to trusts that are owned by publicly traded entities. The 

United States generally would consider such entities to be companies covered by the public company tests described above, making 

this provision redundant for U.S. tax purposes. 

The Technical Explanation provides an example of an Australian 

trust, where the majority of shares of ownership are owned by a 

second Australian trust such that if the principal class of units of 

the second Australian trust are listed and regularly traded on the 

Australian Stock Exchange, the first Australian trust would meet 

the requirement of a qualified person under such provision. However, if the second Australia trust was a resident of Japan, and not 

the United States or Australia, the first Australian trust would not 

qualify for benefits under the provision. 

Tax-exempt and charitable organizations 

Under the proposed protocol, an entity is entitled to treaty benefits if it is organized under U.S. or Australian law and established 

and maintained exclusively for religious, charitable, educational, 

scientific or similar purposes (notwithstanding that all or part of 

its income is tax-exempt). There is no requirement that specified 

percentages of the beneficiaries of these organizations be residents 

of the United States or Australia. 

30

Pension Funds 

Under the proposed protocol, certain pension funds are entitled 

to benefits under the treaty. An entity qualifying under this provision is one that is organized under U.S. or Australian law and established and maintained in the country of residence to provide, 

pursuant to a plan, pensions or other similar benefits to employed 

and self-employed persons (notwithstanding that all or part of its 

income is tax-exempt). For the entity to be a qualified person, however, more than 50 percent of the entity’s beneficiaries, members, 

or participants, must be individuals resident in either the United 

States or Australia. The term ‘‘beneficiaries’’ refers to individuals 

receiving benefits from the organization. 

Ownership and base erosion tests 

Under the proposed protocol, an entity that is a resident of the 

United States or Australia is entitled to treaty benefits if it satisfies an ownership test and a base erosion test. Under the ownership test, on at least half the days of the taxable period, shares or 

other beneficial interests representing at least 50 percent of the entity’s aggregate voting power and value is owned (directly or indirectly) by certain qualified persons described above (i.e., individuals, governmental entities, companies that meet the public company test, and entities that meet the public entity test). 

The Technical Explanation states that trusts may be entitled to 

the benefits of this provision if they are treated as residents of one 

of the countries and they otherwise satisfy the requirements of the 

provision. Under the ownership test, the beneficial interests in a 

trust are considered to be owned by its beneficiaries in proportion 

to each beneficiary’s actuarial interest in the trust. The interest of 

a remainder beneficiary will be equal to 100 percent less the aggregate percentages held by income beneficiaries. A beneficiary’s interest in a trust is not considered to be owned by a person entitled 

to benefits under other ‘‘qualified person’’ categories under this provision if it is not possible to determine the beneficiary’s actuarial 

interest. Consequently, if it is not possible to determine the actuarial interest of any beneficiaries in a trust, the ownership test 

cannot be satisfied, unless all beneficiaries are persons entitled to 

benefits under other ‘‘qualified person’’ categories. 

The base erosion test is satisfied only if less than 50 percent of 

the person’s gross income for the taxable period is paid or accrued, 

directly or indirectly, in the form of deductible payments, to persons who are not residents of either treaty country. The term 

‘‘gross income’’ is not defined in the treaty. Thus, in accordance 

with Article 3, such term is to ascribe the meaning it has under 

U.S. tax law. The Technical Explanation states that in the case of 

the United States, the term ‘‘gross income’’ has the same meaning 

as under section 61 of the Code and the regulations thereunder. To 

the extent they are deductible from the taxable base, trust distributions are deductible payments. In addition, for purposes of this 

test, deductible payments do not include arm’s-length payments in 

the ordinary course of business for services or tangible property 

and payments in respect of financial obligations to a bank; provided 

that, if the bank is not a resident of one of the countries such payVerDate Jan 31 2003 22:59 Feb 28, 2003 Jkt 085198 PO 00000 Frm 00034 Fmt 6604 Sfmt 6602 E:\HR\OC\B198.XXX B198
31

ment is attributable to a permanent establishment of that bank located in one of the countries. 

Headquarters company 

Under the proposed protocol, a resident of the United States or 

Australia is entitled to treaty benefits if that person functions as 

a headquarters company for a multinational corporate group. A 

person is considered a headquarters company for this purpose only 

if each of several criteria is satisfied. 

Overall supervision and administration 

The person seeking such treatment must provide a substantial 

portion of the overall supervision and administration of the group. 

The Technical Explanation provides that a person will be considered to engage in supervision and administration if it engages in 

a number of the following activities: group financing, pricing, marketing, internal auditing, internal communications, and management. However, such company cannot be principally involved group 

financing. The above-mentioned functions are not an exhaustive 

list, but intended to be suggestive of the types of activities in which 

a headquarters company will be expected to engage. Furthermore, 

it is understood that in determining if a substantial portion of the 

overall supervision and administration of the group is provided by 

the headquarters company, the activities it performs as a headquarters company for the group must be substantial in comparison 

to the same activities for the same group performed by other entities within the multinational group. 

For example, a Japanese corporation establishes a subsidiary in 

Australia to function as a headquarters company for its Asia-Pacific operations. The Japanese corporation also has two other subsidiaries functioning as headquarter companies—one for the African operations and one for the North American operations. The 

Australia headquarters company is the parent company for the 

subsidiaries through which the Asia-Pacific operations are carried 

on. The Australian headquarters company supervises the bulk of 

the pricing, marketing, internal auditing, internal communications 

and management for its group. Although the Japanese overall parent sets the guidelines for all of its subsidiaries in defining the 

worldwide group policies with respect to each of these activities, 

and assures that these guidelines are carried out within each of the 

regional groups, it is the Australian headquarters company that 

monitors and controls the way in which these policies are carried 

out within the group of companies that it supervises. The capital 

and payroll devoted by the Japanese parent to these activities relating to the group of companies the Australian headquarter company supervises is small relative to the capital and payroll devoted 

to these activities by the Australian headquarters company. Moreover, neither the other two headquarter companies, nor any other 

related company besides the Japanese parent company, perform 

any of the above-mentioned headquarter activities with respect to 

the group of companies that the Australian headquarters company 

supervises. In the above case, the Australian headquarters company would be considered to provide a substantial portion of the 

overall supervision and administration of the group it supervises. 

32

The proposed protocol does not require that the group that is supervised include persons in the other country. However, the Technical Explanation makes clear that it is anticipated that in most 

cases the group will include such persons, due to the requirement 

that the income derived by the headquarters company be derived 

in connection with or be incidental to an active trade or business 

supervised by the headquarters company (described below). 

Active trade or business 

Either for the taxable year concerned, or as an average for the 

preceding four years, the activities and gross income of the corporate group that the headquarters company supervises and administers must be spread sufficiently among different countries. To 

satisfy the active trade or business requirement, the group must 

consist of corporations resident in, and engaged in an active business in, at least five countries, and the income derived in the treaty 

country of which the headquarter company is not a resident must 

be derived in connection with, or be incidental to, that active business. The business activities carried on in each of the five countries 

(or five groupings of countries) must generate at least 10 percent 

of the gross income of the group. 

Single country limitation 

The business activities carried on in any one country other than 

the country where the headquarter company resides cannot generate 50 percent or more of the gross income of the group. As mentioned above, the proposed protocol states that if the gross income 

requirement under this clause is not met for a taxable year, the 

taxpayer may satisfy this requirement by averaging the ratios for 

the four years preceding the taxable year. The Technical Explanation provides an example of such application: 

Example: AHQ is a corporation resident in Australia. AHQ functions as a headquarters company for a group of companies. AHQ 

derives dividend income from a U.S. subsidiary in the 2004 taxable 

year. The state of residence of each of these companies, the situs 

of their activities and the amounts of gross income attributable to 

each for the years 2004 through 2008 are set forth below:

Company Situs 2008 2007 2006 2005 2004

United States ...................... U.S. ..... $100 $100 $95 $90 $85

United States ...................... Mexico 108500

United States ...................... Canada 20 18 16 15 12

United Kingdom .................. U.K. ..... 30 32 30 28 27

New Zealand ....................... N.Z. ..... 40 42 38 36 35

Japan ................................... Japan .. 35 32 30 30 28

Singapore ............................. Singapore.25 25 24 22 20

Total .............................. .............. 260 257 238 221 207

Because the United States’ total gross income of $130 in 2007 is 

not less than 50 percent of the gross income of the group, the provision is not satisfied with respect to dividends derived in 2007. HowVerDate Jan 31 2003 22:59 Feb 28, 2003 Jkt 085198 PO 00000 Frm 00036 Fmt 6604 Sfmt 6602 E:\HR\OC\B198.XXX B198
33

ever, the United States’ average gross income for the preceding 

four years may be used in lieu of the preceding year’s average. The 

United States’ average gross income for the years 2004–2007 is 

$111.00 ($444/4). The group’s total average gross income for these 

years is $230.75 ($923/4). Because $111.00 represents 48.1 percent 

of the group’s average gross income for the years 2004 through 

2007, the United States satisfies such provision.

Other country gross income limitation 

No more than 25 percent of the headquarter company’s gross income may be derived from the treaty country of which it is not a 

resident. Thus, if the headquarters company’s gross income for the 

taxable year is $100, no more than $25 of this amount may be derived from the other country. As with the single country limitation 

calculation, the proposed protocol provides that if the gross income 

requirement under this clause is not met for the taxable year, the 

taxpayer may satisfy this requirement by averaging the ratios for 

the four years preceding the taxable year. 

Independent Discretionary Authority 

The headquarters company must have and exercise independent 

discretionary authority to carry out the overall supervision and administration functions mentioned in the overall supervision and administration requirement, above. The Technical Explanation states 

that this determination is made separately for each function. Thus, 

if a headquarters company is nominally responsible for group financing, pricing, marketing, and internal auditing functions, and 

another entity is actually directing the headquarters company as to 

the group financing function, the headquarters company would not 

be deemed to have independent discretionary authority for group financing, but it may have such authority for the other functions. 

Income taxation rules 

The headquarters company must be subject to the generally applicable income taxation rules in its country of residence. The Technical Explanation states that this reference should be understood 

to mean that the company must be subject to the income taxation 

rules to which a company engaged in the active trade or business 

would be subject. Thus, if one of the countries introduced special 

taxation legislation that would impose a lower rate of income tax 

on headquarter companies than was imposed on companies engaged in the active conduct of a trade or business, or would provide 

for an artificially low taxable base for such companies, a headquarters company subject to these rules would not be entitled to 

the benefits under such provision. 

In connection with or incidental to a trade or business 

The income derived in the other country must be derived in connection with or be incidental to the active business activities referred to in the active trade or business requirement, above. For 

example, if an Australian company that satisfied the other requirements of this sub-section acted as a headquarters company for a 

group that included a United States corporation, and the group was 

engaged in the design and manufacture of computer software, but 

34

the U.S. company was also engaged in the design and manufacture 

of photocopying machines, the income that the Australian company 

derived from the United States would have to be derived in connection with or be incidental to the income generated by the computer 

business in order to be entitled to treaty benefits under this subsection. Similarly, interest income received from the U.S. company 

also would be entitled to the benefits of the treaty under this paragraph as long as the interest was attributable to a trade or business supervised by the headquarters company. Interest income derived form an unrelated party would normally not, however, satisfy 

the requirements of this clause. 

Active business test 

Under the active business test, residents of one of the countries 

are entitled to treaty benefits with respect to income, profit, or gain 

derived from the other country if (1) the resident is engaged in the 

active conduct of a trade or business in its residence country, (2) 

the income is derived in connection with, or is incidental to, that 

trade or business, and (3) the trade or business is substantial in 

relation to the trade or business activity in the other country. The 

proposed protocol provides that the business of making or managing investments for the resident’s own account does not constitute an active trade or business unless these activities are banking, insurance, or securities activities carried on by a bank, insurance company, or registered securities dealer. 

The term ‘‘trade or business’’ is not defined in the treaty. However, as provided in Article 3 (General Definitions), undefined 

terms are to have the meaning which they have under the domestic 

laws of each country. In this regard, the Technical Explanation 

states that the U.S. competent authority will refer to the regulations issued under Code section 367(a) to define the term ‘‘trade or 

business.’’ In general, a trade or business will be considered to be 

a specific unified group of activities that constitute or could constitute an independent economic enterprise carried on for profit. 

The Technical Explanation provides that for purposes of this test, 

income is derived ‘‘in connection’’ with a trade or business if the income-producing activity in the source country is a line of business 

that forms a part of or is complementary to the trade or business 

conducted in the country of residence by the income recipient. A 

business activity generally will be considered to ‘‘form a part of’’ a 

business activity conducted in the other country if the two activities involve the design, manufacture or sale of the same products 

or type of products, or the provision of similar services. In order for 

two activities to be considered to be ‘‘complementary,’’ the activities 

need not relate to the same types of products or services, but they 

should be part of the same overall industry and be related in the 

sense that the success or failure of one activity will tend to result 

in success or failure of the other. The Technical Explanation provides several different examples of the application of this rule. 

The Technical Explanation also provides that income derived 

from a country will be ‘‘incidental’’ to a trade or business conducted 

in the other country if the production of such income facilitates the 

conduct of trade or business in the other country. An example of 

35

incidental income is the temporary investment of working capital 

derived from a trade or business. 

The proposed protocol provides that whether a trade or business 

is substantial is determined on the basis of all the facts and circumstances. The Technical Explanation states that such determination takes into account the comparative sizes of the trades or 

businesses in each country (measured by reference to asset values, 

income and payroll expenses), the nature of the activities performed in each country, and the relative contributions made to that 

trade or business in each country. This treatment differs from some 

recent U.S. tax treaties (i.e., Luxembourg, Netherlands) that include percentage thresholds that provide a safe harbor for determining the substantiality of a trade or business. 

The proposed protocol provides that in determining whether a 

person is engaged in the active conduct of a trade or business, activities conducted by a partnership in which that person is a partner and activities conducted by persons connected to such person 

will be deemed to be conducted by such person. For this purpose, 

a person is connected to another person if (1) one person owns at 

least 50 percent of the beneficial interest in the other person (or, 

in the case of a company, owns shares representing at least 50 percent of the aggregate voting power and value of the company or the 

beneficial interest in the company), or (2) another person owns, directly or indirectly, at least 50 percent of the beneficial interest in 

each person (or, in the case of a company, owns shares representing at least 50 percent of the aggregate voting power and 

value of the company or the beneficial interest in the company). 

The proposed protocol provides that in any case, persons are considered to be connected if on the basis of all the facts and circumstances, one has control of the other or both are under the control of the same person or persons. 

Disproportionate interests 

The proposed protocol denies benefits to the disproportionate 

part of income earned by certain companies. Under the proposed 

protocol, a company that is a resident of one of the countries or a 

company that controls such a company has outstanding a class of 

shares: (1) that is subject to terms or other arrangements that entitle its holders to a portion of the income, profit, or gain of the company derived from the other country that is larger than the portion 

such holders would receive in the absence of such terms and arrangements, and (2) in which 50 percent or more of the voting 

power and value is owned by persons who are not equivalent beneficiaries (as defined above), then the benefits of the proposed treaty 

will apply only to that proportion of the income which those holders 

would have received in the absence of those terms or arrangements. 

Grant of treaty benefits by the competent authority 

The proposed protocol provides a ‘‘safety-valve’’ for a person that 

has not established that it meets one of the other more objective 

tests, but for which the allowance of treaty benefits would not give 

rise to abuse or otherwise be contrary to the purposes of the treaty. 

Under this provision, such a person may be granted treaty benefits 

36

if the competent authority of the source country determines that 

the establishment, acquisition, or maintenance of such resident and 

the conduct of its operations did not have as one of its principal 

purposes the obtaining of benefits under the treaty. 

The Technical Explanation provides that if the competent authority determines that benefits are to be allowed, they will be allowed retroactively to the time of entry into force of the relevant 

treaty provision or the establishment of the structure in question, 

whichever is later. 

The proposed protocol provides that the competent authority of 

the source country must consult with the competent authority of 

the residence country before refusing to grant benefits under this 

provision. 

Article 11. Other Income 

The proposed protocol replaces Article 21 (Other Income) with an 

article that more closely represents the provision included in the 

U.N. model tax treaty. 

This article is a catch-all provision intended to cover items of income not specifically covered in other articles, and to assign the 

right to tax income from third countries to either the United States 

or Australia. 

Under the proposed protocol, this rule gives the United States 

the sole right to tax income derived from sources in a third country 

and paid to a U.S. resident. This article is subject to the saving 

clause, so U.S. citizens who are residents of Australia will continue 

to be taxable by the United States on their third-country income. 

The general rule just stated does not apply to income (other than 

income from real property as defined in Article 6 (Income from 

Real Property) if the beneficial owner of the income is a resident 

of one country and carries on business in the other country through 

a permanent establishment, or performs services in the other country from a fixed base, and the right or property in respect of which 

the income is paid is effectively connected with such permanent establishment or fixed base. In such a case, the provisions of Article 

7 (Business Profits) or Article 14 (Independent Personal Services), 

as the case may be, will apply. Such exception also applies where 

the income is received after the permanent establishment or fixed 

base is no longer in existence, but the income is attributable to the 

former permanent establishment or fixed base. 

The proposed protocol provides that notwithstanding the foregoing rules, items of income of a resident of a country not dealt 

with in the other articles of the proposed treaty and arising in the 

other country, may also be taxed by that other country. This rule, 

which is not contained in the U.S. and OECD models, is similar to 

the corresponding rule in the U.N. model. 

Article 12. Relief from Double Taxation 

The proposed protocol makes a conforming change to Article 22 

(Relief from Double Taxation) of the present treaty to reflect 

changes made by the protocol to Article 2 (Taxes Covered) of the 

present treaty. Under the proposed protocol, the United States is 

not required to allow a foreign tax credit with respect to the reVerDate Jan 31 2003 22:59 Feb 28, 2003 Jkt 085198 PO 00000 Frm 00040 Fmt 6604 Sfmt 6602 E:\HR\OC\B198.XXX B198
37

source rent tax (‘‘RRT’’). The determination of whether the RRT is 

a creditable tax will be made under U.S. tax law. 

Article 13. Entry into Force 

Article 13 of the proposed protocol relates to the entry into force 

of the modifications provided in the protocol. 

The article provides that the proposed protocol is subject to ratification in accordance with the applicable procedures of each country, and that instruments of ratification will be exchanged as soon 

as possible. The proposed protocol will enter into force upon the exchange of instruments of ratification. 

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 July 1 next following the date on which the proposed 

protocol enters into force. 

The article provides a special rule for certain REIT dividends received by a 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. 

(38)

IV. ISSUES 

A. Zero Rate of Withholding Tax on Dividends from 80–

Percent-Owned Subsidiaries 

In general 

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 (subparagraph 3(a) 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 current U.S.-Australia treaty, these dividends may be 

taxed at a 5–percent rate. 

Issues 

In general 

Given that the United States has never before agreed bilaterally 

to a zero rate of withholding tax on direct dividends, the Committee may wish to devote particular attention to the benefits and 

costs of taking this step. The Committee also may want to determine whether the inclusion of the zero-rate provision in the proposed protocol (as well as in the proposed treaty with the United 

Kingdom and the proposed protocol with Mexico) signals a broader 

shift in U.S. treaty policy, and under what circumstances the 

United States may seek to include similar provisions in other treaties. Finally, the Committee may wish to note the ramifications of 

including this provision in the U.S.-Australia treaty in view of a 

39

6See, e.g., Code sec. 904. 

‘‘most favored nation’’ provision relating to this subject in the current U.S.-Mexico treaty. 

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,6 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 

40

7More broadly, since the U.S. Model has not been updated since 1996, the Committee may 

wish to ask whether the Treasury Department intends to update the model to reflect all relevant developments that have occurred in the intervening years. A thoroughly updated model 

would provide a more meaningful and useful guide to current U.S. tax treaty policy and would 

thereby increase transparency and facilitate Congressional oversight in this important area. See 

Joint Committee on Taxation, Study of the Overall State of the Federal Tax System and Recommendations for Simplification, Pursuant to Section 8022(3)(B) of the Internal Revenue Code 

of 1986 (JCS–3–01), April 2001, Vol. II, at 445–47 (recommending that the Treasury Department revise U.S. model tax treaties once per Congress). 

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. 

General direction of U.S. tax treaty policy 

Looking beyond the U.S.-Australia treaty relationship, the Committee may wish to determine whether the inclusion of the zerorate provision in the proposed protocol (as well as in the proposed 

treaty with the United Kingdom and the proposed protocol with 

Mexico) signals a broader shift in U.S. tax treaty policy. Specifically, the Committee may want to know whether the Treasury Department: (1) intends to pursue similar provisions in other proposed treaties in the future; (2) proposes any particular criteria for 

determining the circumstances under which a zero-rate provision 

may be appropriate or inappropriate; (3) expects to seek terms and 

conditions similar to those of the proposed treaty in connection 

with any zero-rate provisions that it may negotiate in the future; 

and (4) intends to amend the U.S. Model to reflect these developments.7

‘‘Most favored nation’’ agreement with Mexico 

The adoption of a zero-rate provision in the U.S.-Australia treaty 

relationship may have particular ramifications for the U.S.-Mexico 

treaty relationship. Under the current U.S.-Mexico income tax treaty, dividends beneficially owned by a company that owns at least 

10 percent of the voting stock of the dividend-paying company are 

subject to a maximum withholding rate of 5 percent (paragraph 

2(a) of Article 10 of the U.S.-Mexico treaty), which is the lowest 

rate of withholding tax on dividends currently available under U.S. 

treaties. Under Protocol 1 to that treaty, as modified by a formal 

understanding subject to which the treaty and protocol were ratified, the United States and Mexico have agreed, if the United 

41

8This formal understanding was a response to an objection raised by the Committee to the 

original language of the treaty protocol, under which the ‘‘most-favored nation’’ provision would 

have been self-executing—i.e., immediately upon U.S. agreement to a lower rate with another 

treaty partner, the United States and Mexico would have begun applying that lower rate in 

their treaty. 

States adopts a rate on dividends lower than 5 percent in a treaty 

with another country, ‘‘to promptly amend [the U.S.-Mexico treaty] 

to incorporate that lower rate.’’ 8

Adopting the zero-rate provision in the proposed protocol with 

Australia would trigger this obligation to amend the current treaty 

with Mexico. The recently signed proposed protocol with Mexico 

would amend that treaty to incorporate a zero-rate provision substantially identical to that of the proposed treaty with the United 

Kingdom, and substantially similar to that of the proposed protocol 

with Australia, and thus would seem to fulfill the U.S. obligation 

under the ‘‘most favored nation’’ agreement. Thus, if the Senate 

were to ratify both the proposed protocol with Australia and the 

proposed protocol with Mexico, no issues of interaction between the 

two treaty relationships would need to be confronted. 

If, on the other hand, the Senate were to ratify the proposed protocol with Australia, but not the proposed protocol with Mexico, 

then the possibility would arise that the United States eventually 

could be regarded as falling out of compliance with its obligations 

under the U.S.-Mexico treaty. This would raise difficult questions 

as to the exact nature of this obligation and whether and how the 

United States would come into compliance with it.

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 

42

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. 

The Committee may wish to consider whether the proposed protocol’s rules treating profits from certain rentals of ships and aircraft 

on a bareboat basis less favorably than profits from the operation 

of ships and aircraft (or from the rental of ships and aircraft with 

crew) are appropriate. 

C. Capital Gains Tax 

Unlike the U.S. model, the proposed protocol does not provide 

significant limits on Australia’s ability to impose its capital gains 

tax on U.S. persons. In the United States, at death certain individuals are subject to the estate tax on the net value of assets in their 

estate, but accrued, but unrealized, capital gains are not subject to 

income tax. An heir’s basis of an asset received by bequest is 

stepped up to the fair market value of the asset at the time of the 

decedent’s death. Australia does not impose an estate tax, but an 

heir’s basis of an asset received by bequest generally is the decedent’s basis in the asset (carryover basis). Thus, if an heir sells the 

bequeathed asset upon receipt, there is a capital gains tax liability. 

As a consequence, a U.S. person’s Australian assets could be subject to estate taxation in the United States upon his or her death 

and the heir could be liable for capital gains tax in Australia upon 

the sale of the bequeathed asset, creating a substantial aggregate 

tax liability without relief under the treaty. Australia enacted the 

carryover basis regime, in part, as a replacement for Australia’s 

previous estate tax. Because the Australian capital gains tax serves 

some of the role of the U.S. estate tax, the Committee may want 

to consider the proper manner for coordination of treaty provisions 

relating to the taxation of capital gains under the proposed protocol 

with estate taxation in light of the present treaty in force with Australia with respect to estate taxes. 

D. Visiting Teachers and Professors 

The proposed protocol maintains the present treaty’s treatment 

of visiting teachers and professors, in which an individual visiting 

in the host country to engage in teaching or research at an educational institution is subject to income tax in the host country on 

any remuneration received for his or her teaching or research. The 

treatment of the present treaty conforms to the U.S. model. While 

this is the position of the U.S. model, an exemption for visiting 

teachers and professors has been included in many bilateral tax 

treaties. Of the more than 50 bilateral income tax treaties in force, 

30 include provisions exempting from host country taxation the income of a visiting individual engaged in teaching or research at an 

educational institution, and an additional 10 treaties provide a 

more limited exemption from taxation in the host county for a visiting individual engaged in research. Although the proposed protocol with Mexico would not include such a provision, the proposed 

treaty with the United Kingdom does include such a provision, and 

three of the most recently ratified income tax treaties did contain 

43

9The treaties with Italy, Slovenia, and Venezuela, each considered in 1999, contain provisions 

exempting the remuneration of visiting teachers and professors from host country income 

taxation. The treaties with Denmark, Estonia, Latvia, and Lithuania, also considered in 

1999, did not contain such an exemption, but did contain a more limited exemption for 

visiting researchers. 

such a provision.9 The Committee may wish to satisfy itself that 

the inclusion of such an exemption is not appropriate.

Æ