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[Senate Executive Report 108-3]
[From the U.S. Government Publishing Office]

108th Congress                                               Exec. Rpt.
                                 SENATE
 1st Session                                                      108-3

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          PROTOCOL AMENDING THE TAX CONVENTION WITH AUSTRALIA

                                _______
                                

                 March 13, 2003.--Ordered to be printed

                                _______
                                

           Mr. Lugar from the Committee on Foreign Relations,
                        submitted the following

                              R E P O R T

                   [To accompany Treaty Doc. 107-20]

    The Committee on Foreign Relations, to which was referred 
the Protocol Amending the Convention Between the Government of 
the United States of America and the Government of Australia 
for the Avoidance of Double Taxation and the Prevention of 
Fiscal Evasion with Respect to Taxes on Income, signed at 
Canberra on September 27, 2001 having considered the same, 
reports favorably thereon and recommends that the Senate give 
its advice and consent to ratification thereof as set forth in 
this report and the accompanying resolution of ratification.

                                CONTENTS

                                                                   Page
  I. Purpose..........................................................1
 II. Background.......................................................2
III. Summary..........................................................2
 IV. Entry Into Force and Termination.................................3
  V. Committee Action.................................................4
 VI. Committee Comments...............................................5
VII. Budget Impact....................................................8
VIII.Explanation of Proposed Treaty...................................8

 IX. Text of Resolution of Ratification...............................8

                               I. Purpose

    The principal purposes of the existing income tax treaty 
between the United States and Australia and the proposed 
protocol amending the existing treaty between the United States 
and Australia are to reduce or eliminate double taxation of 
income earned by residents of either country from sources 
within the other country and to prevent avoidance or evasion of 
the taxes of the two countries. The existing treaty and 
proposed protocol also are intended to continue to promote 
close economic cooperation between the two countries and to 
eliminate possible barriers to trade and investment caused by 
overlapping taxing jurisdictions of the two countries.

                             II. Background

    The proposed protocol was signed on September 27, 2001. The 
proposed protocol would amend the existing income tax treaty 
between the United States and Australia that was signed in 
1982.
    The proposed protocol was transmitted to the Senate for 
advice and consent to its ratification on November 14, 2002 
(see Treaty Doc. 107-20). The Committee on Foreign Relations 
held a public hearing on the proposed protocol on March 5, 
2003.

                              III. Summary

    The proposed protocol modifies several provisions in the 
existing treaty (signed in 1982) to make it similar to more 
recent U.S. income tax treaties, the 1996 U.S. model income tax 
treaty (``U.S. model''), and the 1992 model income tax treaty 
of the Organization for Economic Cooperation and Development, 
as updated (``OECD model''). However, the existing treaty, as 
amended by the proposed protocol, contains certain substantive 
deviations from these treaties and models.
    The proposed protocol reduces source-country withholding 
tax rates under the existing treaty on dividends, interest, and 
royalties. First, the proposed protocol replaces Article 10 
(Dividends) of the existing treaty with a new dividends 
article. This new article eliminates the withholding tax on 
certain intercompany dividends in cases in which an 80-percent 
ownership threshold is met. The new article preserves the 
maximum withholding tax rate of 15 percent on portfolio 
dividends, but provides a maximum withholding tax rate of 5 
percent on dividends meeting a 10-percent ownership threshold. 
The proposed protocol replaces Article 11 (Interest) of the 
existing treaty with a new interest article that retains 
source-country taxation of interest at a maximum withholding 
tax rate of 10 percent, but allows a special zero rate of 
withholding for interest paid to financial institutions and 
governmental entities. The proposed protocol also retains 
source-country taxation of royalties under Article 12 
(Royalties) of the existing treaty, but reduces the maximum 
level of withholding tax from 10 percent to 5 percent. In 
addition, the proposed protocol amends the definition of 
royalties to remove the portion of the definition related to 
payments for the use of ``industrial, commercial or scientific 
equipment, other than equipment let under a hire purchase 
agreement.'' Thus, under the proposed protocol, leasing income 
is treated as business profits, taxable by the source country 
only if the recipient of the payments has a permanent 
establishment located in the source country.
    The proposed protocol expands the ``saving clause'' 
provision in Article 1 (Personal Scope) of the existing treaty 
to allow the United States to tax former long-term residents 
whose termination of residency has as one of its principal 
purposes the avoidance of tax. This provision allows the United 
States to apply special tax rules under section 877 of the Code 
as amended in 1996.
    The proposed protocol amends Article 2 (Taxes Covered) of 
the existing treaty to include certain U.S. and Australian 
taxes. For U.S. tax purposes, the accumulated earnings tax and 
the personal holding company tax are covered taxes under the 
proposed protocol. In the case of Australia, covered taxes 
include the Australian income tax, including tax on capital 
gains, and the resource rent tax (although the United States 
would not be required to allow a foreign tax credit with 
respect to the resource rent tax).
    The proposed protocol provides that, for purposes of 
Article 4 (Residence) of the existing treaty, a U.S. citizen is 
treated as a resident of the United States unless the U.S. 
citizen is a resident of a country other than Australia for 
purposes of a tax treaty between that third country and 
Australia. In such case, the U.S. citizen is precluded from 
claiming benefits under the U.S.-Australia treaty and can only 
claim benefits under the tax treaty between such third country 
and Australia. The proposed protocol also adds a new provision 
under Article 7 (Business Profits) of the existing treaty to 
clarify the treatment of fiscally transparent entities and 
beneficial owners of fiscally transparent entities. The 
proposed protocol clarifies that permanent establishment status 
flows through a fiscally transparent entity (and thus the 
beneficial owner is treated as carrying on a business through 
such permanent establishment).
    The proposed protocol amends the shipping provisions under 
Article 8 (Shipping and Air Transport) and related provisions 
under Article 13 (Alienation of Property) of the existing 
treaty to more closely reflect the treatment of income from the 
operation of ships, aircraft and containers in international 
traffic under the U.S. model.
    The proposed protocol makes further amendments to Article 
13 that allow income or gains from certain business property of 
a permanent establishment to be taxed in the country in which 
the permanent establishment is located. The proposed protocol 
also amends Article 13 to address Australia's imposition of its 
mark-to-market regime on individuals who expatriate to the 
United States.
    The proposed protocol replaces Article 16 (Limitation on 
Benefits) of the existing treaty with a new article that 
reflects the limitation on benefits provisions included in more 
recent U.S. income tax treaties.
    The proposed protocol also replaces Article 21 (Other 
Income) of the existing treaty with an article that more 
closely represents the provision included in the U.N. model tax 
treaty.
    Article 13 of the proposed protocol provides for the entry 
into force of the modifications made by the proposed protocol.

                  IV. Entry Into Force and Termination

                          A. ENTRY INTO FORCE

    The proposed protocol will enter into force upon the 
exchange of instruments of ratification. The effective dates of 
the protocol's provisions, however, vary.
    With respect to the United States, the proposed protocol 
will be effective with respect to withholding taxes on 
dividends, royalties and interest for amounts derived by a non-
resident on or after the later of the first day of the second 
month next following the date on which the proposed protocol 
enters into force or July 1, 2003. With respect to other taxes, 
the proposed protocol will be effective for taxable periods 
beginning on or after the first day of January next following 
the date on which the proposed protocol enters into force.
    With respect to Australia, the proposed protocol will be 
effective with respect to withholding taxes on dividends, 
royalties and interest for amounts derived by a non-resident on 
or after the later of the first day of the second month next 
following the date on which the proposed protocol enters into 
force or July 1, 2003. With respect to other Australian tax, in 
relation to income, profits or gains, the proposed protocol 
will be effective for any year of income beginning on or after 
the first day of July next following the date on which the 
proposed protocol enters into force.
    The article provides a special rule for certain Real Estate 
Investment Trust (REIT) dividends received by a Listed 
Australian Property Trust (LAPT). This rule is intended to 
protect existing investments in REITs by LAPTs. For REIT shares 
owned by an LAPT on March 26, 2001 or acquired by the LAPT 
pursuant to a binding contract entered into on or before March 
26, 2001 (``grandfathered REIT shares''), dividends from the 
grandfathered REIT shares are subject to the provisions of 
Article 10 (Dividends) as in effect on March 26, 2001. Thus, 
the dividends from the grandfathered REIT shares will be 
subject to a maximum withholding tax rate of 15 percent, 
regardless of the ownership of the LAPT. REIT shares acquired 
by the LAPT pursuant to a reinvestment of dividends (ordinary 
or capital) from grandfathered REIT shares are also treated as 
grandfathered REIT shares.

                             B. TERMINATION

    The existing treaty, as amended by the proposed protocol, 
will remain in force until terminated by either country. Either 
country may terminate the treaty by giving notice of 
termination to the other country through diplomatic channels. 
In such case, a termination is effective with respect to those 
dividends, interest and royalties to which Articles 10 
(Dividends), 11 (Interest) and 12 (Royalties) respectively 
apply, and which are paid, credited or otherwise derived on or 
after the first day of January following the expiration of the 
6 month period following notice of termination. A termination 
is effective with respect to all other income of a taxpayer for 
the taxpayer's years of income or taxable years, as the case 
may be, commencing on or after the first day of January 
following the expiration of the 6 month period following notice 
of termination.

                          V. Committee Action

    The Committee on Foreign Relations held a public hearing on 
the proposed protocol with Australia (Treaty Doc. 107-20) on 
March 5, 2003. The hearing was chaired by Senator Hagel.\1\ The 
Committee considered the proposed protocol on March 12, 2003, 
and ordered the proposed protocol with Australia favorably 
reported by a vote of 19 in favor and 0 against, with the 
recommendation that the Senate give its advice and consent to 
ratification of the proposed treaty.
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    \1\ The transcript of this hearing will be forthcoming as a 
separate Committee print.
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                         VI. Committee Comments

    On balance, the Committee on Foreign Relations believes 
that the proposed protocol with Australia is in the interest of 
the United States and urges that the Senate act promptly to 
give advice and consent to ratification. The Committee has 
taken note of certain issues raised by the proposed protocol 
and believes that the following comments may be useful to the 
Treasury Department officials in providing guidance on these 
matters should they arise in the course of future treaty 
negotiations.

  A. ZERO RATE OF WITHHOLDING TAX ON DIVIDENDS FROM 80-PERCENT-OWNED 
                              SUBSIDIARIES

    The proposed protocol would eliminate withholding tax on 
dividends paid by one corporation to another corporation that 
owns at least 80 percent of the stock of the dividend-paying 
corporation (often referred to as ``direct dividends''), 
provided that certain conditions are met (paragraph 3 of 
Article 10 (Dividends)). The elimination of withholding tax 
under these circumstances is intended to reduce further the tax 
barriers to direct investment between the two countries.
    Currently, no U.S. treaty provides for a complete exemption 
from withholding tax under these circumstances, nor do the U.S. 
or OECD models. However, many bilateral tax treaties to which 
the United States is not a party eliminate withholding taxes 
under similar circumstances, and the same result has been 
achieved within the European Union under its ``Parent-
Subsidiary Directive.'' In addition, the United States has 
signed a proposed treaty with the United Kingdom and a proposed 
protocol with Mexico that include zero-rate provisions similar 
to the one in the proposed protocol.

Description of provision

    Under the proposed protocol, the withholding tax rate is 
reduced to zero on dividends beneficially owned by a company 
that has owned at least 80 percent of the voting power of the 
company paying the dividend for the 12-month period ending on 
the date the dividend is declared (subparagraph 3(a) of Article 
10 (Dividends)). Under the existing U.S.-Australia treaty, 
these dividends may be taxed at a 15 percent rate.

Benefits and costs of adopting a zero rate with Australia

    Tax treaties mitigate double taxation by resolving the 
potentially conflicting claims of a residence country and a 
source country to tax the same item of income. In the case of 
dividends, standard international practice is for the source 
country to yield mostly or entirely to the residence country. 
Thus, the residence country preserves its right to tax the 
dividend income of its residents, and the source country agrees 
either to limit its withholding tax to a relatively low rate 
(e.g., 5 percent) or to forgo it entirely.
    Treaties that permit a positive rate of dividend 
withholding tax allow some degree of double taxation to 
persist. To the extent that the residence country allows a 
foreign tax credit for the withholding tax, this remaining 
double taxation may be mitigated or eliminated, but then the 
priority of the residence country's claim to tax the dividend 
income of its residents is not fully respected. Moreover, if a 
residence country imposes limitations on its foreign tax 
credit, withholding taxes may not be fully creditable as a 
practical matter, thus leaving some double taxation in place. 
For these reasons, dividend withholding taxes are commonly 
viewed as barriers to cross-border investment. The principal 
argument in favor of eliminating withholding taxes on certain 
direct dividends in the proposed treaty is that it would remove 
one such barrier.
    Direct dividends arguably present a particularly 
appropriate case in which to remove the barrier of a 
withholding tax, in view of the close economic relationship 
between the payor and the payee. Whether in the United States 
or in Australia, the dividend-paying corporation generally 
faces full net-basis income taxation in the source country, and 
the dividend-receiving corporation generally is taxed in the 
residence country on the receipt of the dividend (subject to 
allowable foreign tax credits). If the dividend-paying 
corporation is at least 80-percent owned by the dividend-
receiving corporation, it is arguably appropriate to regard the 
dividend-receiving corporation as a direct investor (and 
taxpayer) in the source country in this respect, rather than 
regarding the dividend-receiving corporation as having a more 
remote investor-type interest warranting the imposition of a 
second-level source-country tax.
    Since both the United States and Australia currently impose 
withholding tax on some or all direct dividends as a matter of 
domestic law (albeit only on ``unfranked'' dividends in the 
case of Australia), the provision would provide immediate and 
direct benefits to the United States as both an importer and an 
exporter of capital. The overall revenue impact of this 
provision is unclear, as the direct revenue loss to the United 
States as a source country would be offset in whole or in part 
by a revenue gain as a residence country from reduced foreign 
tax credit claims with respect to Australian withholding taxes.
    Although the United States has never agreed bilaterally to 
a zero rate of withholding tax on direct dividends, many other 
countries have done so in one or more of their bilateral tax 
treaties. These countries include OECD members Austria, 
Denmark, France, Finland, Germany, Iceland, Ireland, Japan, 
Luxembourg, Mexico, the Netherlands, Norway, Sweden, 
Switzerland, and the United Kingdom, as well as non-OECD-
members Belarus, Brazil, Cyprus, Egypt, Estonia, Israel, 
Latvia, Lithuania, Mauritius, Namibia, Pakistan, Singapore, 
South Africa, Ukraine, and the United Arab Emirates. In 
addition, a zero rate on direct dividends has been achieved 
within the European Union under its ``Parent-Subsidiary 
Directive.'' Finally, many countries have eliminated 
withholding taxes on dividends as a matter of internal law 
(e.g., the United Kingdom and Mexico). Thus, although the zero-
rate provision in the proposed treaty is unprecedented in U.S. 
treaty history, there is substantial precedent for it in the 
experience of other countries. It may be argued that this 
experience constitutes an international trend toward 
eliminating withholding taxes on direct dividends, and that the 
United States would benefit by joining many of its treaty 
partners in this trend and further reducing the tax barriers to 
cross-border direct investment.

Committee conclusions

    The Committee believes that every tax treaty must strike 
the appropriate balance of benefits in the allocation of taxing 
rights. The agreed level of dividend withholding for 
intercompany dividends is one of the elements that make up that 
balance, when considered in light of the benefits inuring to 
the United States from other concessions the treaty partner may 
make, the benefits of facilitating stable cross-border 
investment between the treaty partners, and each partner's 
domestic law with respect to dividend withholding tax.
    In the case of this protocol, considered as a whole, the 
Committee believes that the elimination of withholding tax on 
intercompany dividends appropriately addresses a barrier to 
cross-border investment. The Committee believes, however, that 
the Treasury Department should only incorporate similar 
provisions into future treaty or protocol negotiations on a 
case-by-case basis, and it notes with approval Treasury's 
statement that ``[i]n light of the range of facts that should 
be considered, the Treasury Department does not view 
[elimination of withholding tax on intercompany dividends] as a 
blanket change in the United States' tax treaty practice.''
    The Committee encourages the Treasury Department to develop 
criteria for determining the circumstances under which the 
elimination of withholding tax on intercompany dividends would 
be appropriate in future negotiations with other countries. The 
Committee expects the Treasury Department to consult with the 
Committee with regard to these criteria and to the 
consideration of elimination of the withholding tax on 
intercompany dividends in future treaties.

            B. INCOME FROM THE RENTAL OF SHIPS AND AIRCRAFT

    The present treaty includes a provision found in the U.S. 
model and many U.S. income tax treaties under which profits 
from an enterprise's operation of ships or aircraft in 
international traffic are taxable only in the enterprise's 
country of residence.
    The present treaty and the proposed protocol differ from 
the U.S. model in the case of profits derived from the rental 
of ships and aircraft on a bareboat basis (i.e., without crew). 
Under the proposed protocol, the rule limiting the right to tax 
to the country of residence applies to such rental profits only 
if the lease is merely incidental to the operation of ships and 
aircraft in international traffic by the lessor. If the lease 
is not merely incidental to the international operation of 
ships and aircraft by the lessor, then profits from rentals on 
a bareboat basis generally would be taxable by the source 
country as business profits (if such profits are attributable 
to a permanent establishment).
    In contrast, the U.S. model and many other treaties provide 
that profits from the rental of ships and aircraft operated in 
international traffic on a bareboat basis are taxable only in 
the country of residence, without requiring that the lease be 
incidental to the international operation of ships and aircraft 
by the lessor. Thus, unlike the U.S. model, the proposed 
protocol provides that an enterprise that engages only in the 
rental of ships and aircraft on a bareboat basis, but does not 
engage in the operation of ships and aircraft, would not be 
eligible for the rule limiting the right to tax income from 
operations in international traffic to the enterprise's country 
of residence. It should be noted that, under the proposed 
protocol, profits from the use, maintenance, or rental of 
containers used in international traffic are taxable only in 
the country of residence, regardless of whether the recipient 
of such income is engaged in the operation of ships or aircraft 
in international traffic.

Committee conclusions

    The Committee notes that the proposed protocol, while not 
entirely consistent with the U.S. Model, moves the treatment of 
income from shipping and air traffic closer to the U.S. Model 
than the present treaty by providing that profits from the use, 
maintenance or rental of containers used in international 
traffic are taxable only in the country of residence.

                           VII. Budget Impact

    The Committee has been informed by the staff of the Joint 
Committee on Taxation that the proposed protocol is estimated 
to cause a negligible change in Federal budget receipts during 
the fiscal year 2003-2012 period.

                  VIII. Explanation of Proposed Treaty

    A detailed, article-by-article explanation of the proposed 
protocol between the United States and Australia can be found 
in the pamphlet of the Joint Committee on Taxation entitled 
Explanation of Proposed Protocol to the Income Tax Treaty 
Between the United States and Australia (JCS-5-03), March 3, 
2003.

                 IX. Text of Resolution of Ratification

    Resolved (two-thirds of the Senators present concurring 
therein), That the Senate advise and consent to the 
ratification of the Protocol Amending the Convention Between 
the Government of the United States of America and the 
Government of Australia for the Avoidance of Double Taxation 
and the Prevention of Fiscal Evasion with Respect to Taxes on 
Income, signed at Canberra on September 27, 2001 (Treaty Doc. 
107-20).

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