ATO ID 2005/191: Right to tax dividends paid to non-resident company: application of Article 10(7) of the Australia-United States Double Tax Convention
Date of decision: 21 June 2005
Year of income: Year ended 30 June 2005
Business line: Public Groups and International

Issue
Are dividends received by the taxpayer, a holding company resident in the United States of America (US), from a US resident subsidiary conducting business in Australia through a permanent establishment (PE) in Australia, included in assessable income under paragraph 44(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Decision
No. Under Article 10(7) of the Australia-United States Double Taxation Convention (US Convention), the dividends received by the taxpayer, a US resident holding company, from a US resident subsidiary which conducts business in Australia through a PE, are not subject to tax in Australia.

Facts
The taxpayer is a US resident company that is the holding company for a group of wholly-owned US resident subsidiary companies. The taxpayer does not have a PE in Australia. One of the taxpayer's US resident subsidiaries carries on business in Australia through a PE by its participation in a joint venture. The profits derived by this subsidiary from its PE in Australia are paid to the taxpayer as dividends. The taxpayer is legally and beneficially entitled to the dividends paid to it by the subsidiary.

Reasons for decision
Summary: Paragraph 44(1)(b) of the ITAA 1936 provides that the assessable income of a non-resident shareholder in a company, whether the company is a resident or a non-resident, includes dividends paid to that shareholder by the company, to the extent to which they are paid out of profits derived by it from sources in Australia. In this respect, paragraph 44(1)(b) operates to include in a shareholder's assessable income the dividends that the taxpayer receives from the company within its group that carries on business in Australia. In determining liability to Australian tax on income derived by the taxpayer, the US Convention contained in Schedules 2 and 2A of the International Tax Agreements Act 1953 (Agreements Act) must also be considered. Subsection 4(1) of the Agreements Act incorporates ITAA 1936 and the Income Tax Assessment Act 1997 (ITAA 1997) into the Agreements Act such that these Acts are read as one. Subsection 4(2) of the Agreements Act provides that the Agreements Act prevails over the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions, except in some limited circumstances that do not apply for present purposes. Article 10(7) of the US Convention provides that, subject to certain exceptions, Australia may not impose any tax on dividends, even if the dividends paid consist wholly or partly of profits or income arising in Australia, where: One of the exceptions contained in Article 10(7) of the US Convention is where the holding in respect of which the dividends are paid, is effectively connected with a PE in Australia. In this case, the taxpayer is not an Australian resident. In addition, the taxpayer is beneficially entitled to the dividends paid to it by a US resident deriving income from a PE in Australia. Accordingly, the dividends that the taxpayer receives are not subject to tax in Australia unless the exception stated above applies. While the profits from which the dividends are paid were derived by the subsidiary through its PE in Australia, the US resident subsidiary paid the dividends to the taxpayer, its US resident parent, not to a PE in Australia. Hence, the taxpayer's holding, in respect of which the dividends were paid, was not effectively connected with a PE in Australia. The exception stated above contained in Article 10(7) does not apply in this case. Article 10(7) of the US Convention is based upon Article 10(5) of the OECD Model. Consequently, the OECD Model and its associated Commentary are important factors in setting the context for Article 10(7) of the US Convention. Paragraph 34 of the Commentary on Article 10 of the OECD Model states: Paragraph 5 rules out the extra-territorial taxation of dividends i.e. the practice by which States tax dividends distributed by a non-resident company solely because the corporate profits from which the distributions are made originated in their territory (for example, realised through a permanent establishment situated therein). There is, of course, no question of extra-territorial taxation when the country of source of the corporate profits taxes the dividends because they are paid to a shareholder who is a resident of that State or to a permanent establishment situated in that State. [emphasis added] Paragraph 34 of the Commentary on Article 10 of the OECD Model is consistent with the position reached above regarding the application of Article 10(7) of the US Convention. Where the exception stated above in Article 10(7) of the US Convention does not apply, Article 10(7) is inconsistent with paragraph 44(1)(b) of the ITAA 1936. By operation of section 4(2) of the Agreements Act, Article 10(7) of the US Convention prevails over paragraph 44(1)(b) of the ITAA 1936. Under Article 10(7) of the US Convention, the dividends received by the taxpayer are not included in its assessable income, notwithstanding paragraph 44(1)(b) of the ITAA 1936. Thus, Australia is prohibited from imposing tax on the dividends that the taxpayer receives from its US resident subsidiary that has a PE in Australia.

Legislative references: International Tax Agreements Act 1953 section 4 subsection 4(1) subsection 4(2) section 6 section 6AA Schedule 2, Article 10(7) Schedule 2A, Article 6
Other references: OECD Model Tax Convention on Income and on Capital Article 10(5)
Subject references: Double tax agreements International tax Non resident dividend withholding tax Permanent establishment Treaties Dividends