Private ruling: Interest withholding tax and the Convention between the Government of Australia and the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income [1983] ATS 16, and Protocol [2003] ATS 14, (the US Convention).
Published: October 2013
Ruling period: 01 July 2013 - 30 June 2014 | 01 July 2014 - 30 June 2015 | 01 July 2015 - 30 June 2016 | 01 July 2016 - 30 June 2017 | 01 July 2017 - 30 June 2018

Ruling: Q1: Will Article 11(3)(b) of the US Convention apply to interest arising in Australia and paid to a single owner US limited liability company (LLC) incorporated in the United States in relation to the Proposed Transaction? | A1: Yes. | Q2: Will the LLC be liable to interest withholding tax under s.128B (5) of the Income Tax Assessment Act 1936 (Cth) in respect of interest it receives under the Proposed Transactions? | A2: No

Relevant facts and circumstances: 1. The LLC derives the majority of its income from raising debt finance in the financial markets and using those funds in carrying on a business of providing finance, and is a financial institution for the purpose of Article 11(3)(b) of the US Convention. 2. The LLC has not elected to be treated as a corporation for US income tax purposes. 3. The LLC is 'disregarded as an entity separate from its owner' for US federal tax purposes under US Treasury Regulations, Subchapter F, § 301.7701-3(b)(ii). 4. US Treasury Regulations, Subchapter F, § 301.7701-2(a) provides that, if an entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner. 5. For US federal tax purposes the LLC's income and expenses are aggregated with the other income and expenses of its owner and the owner is taxed in the US as a resident of the US. 6. The single owner of the LLC is a resident of the US for the purposes of the US Convention. The single owner undertakes no other activities. 7. The LLC will be paid interest income arising in Australia in relation to the Proposed Transaction.

Relevant legislative provisions: The Convention between the Government of Australia and the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income [1983] ATS 16, and Protocol [2003] ATS 14, Article 11(3). | Income Tax Assessment Act 1936 subsection 128A(1AB). | Income Tax Assessment Act 1936 subsection 128B(2). | Income Tax Assessment Act 1936 subsection 128B(5). | Income Tax Assessment Act 1936 subsections 128B(6) and 128B(7). | International Tax Agreements Act 1953 subsection 4(2). | US Treasury Regulations , Subchapter F, subparagraph 301.7701-3(b)(ii). | US Treasury Regulations Subsection 301-7701-2(a). Commentary on Article 11 of the OECD Model Tax Convention Paragraphs 7.1 and 7.7. | International Tax Agreements Amendment Bill (No. 1) 2002.

Reasons for decision: Detailed Reasoning - Article 11(3)(b) of the US Convention states that:: (3) Notwithstanding paragraph (2), interest arising in one of the Contracting States to which a resident of the other Contracting State is beneficially entitled may not be taxed in the first-mentioned State if: … (b) the interest is derived by a financial institution which is unrelated to and dealing wholly independently with the payer. For the purposes of this Article, the term "financial institution" means a bank or other enterprise substantially deriving its profits by raising debt finance in the financial markets or by taking deposits at interest and using those funds in carrying on a business of providing finance. (emphasis added) The LLC is 'disregarded as an entity separate from its owner' for US federal tax purposes under US Treasury Regulations, Subchapter F, § 301.7701-3(b)(ii) and is not subject to US tax in its own right. For the reasons set out in ATO ID 2010/188, a disregarded LLC is not a resident of the US for the purposes of the US Convention. | Detailed Reasoning - The object and purpose of Article 11(3)(b) of the US Convention: Paragraph 94 of Taxation Ruling TR 2001/13 comments, in relation to the interpretation of tax treaties, that: … the rules of construction will not be as detailed and rigid as they might be if the courts were to interpret domestic legislation or domestic instruments F72 , and gaps, imprecision and ambiguities should be accepted as sometimes inevitable in such a text, and to some extent accommodated or 'smoothed over' in a way that addresses the context and meets the object and purpose of the DTA. Article 11(3)(b) of the US Convention was introduced by the International Tax Agreements Amendment Bill (No. 1) 2002. The House of Representatives Explanatory Memorandum to that Bill explains the purpose of Article 11(3)(b) as follows: 2.46 The exemption for interest paid to financial institutions reflects that the current 10% rate on gross interest can be excessive given their cost of funds. Where, because of domestic tax laws, the taxing point is shifted from one entity to another, such that the entity which is the financial institution is not taxed but another entity, a resident for treaty purposes, is taxed, it is consistent with the object and purpose of the above exemption to allow the exemption to apply to the interest income paid to the financial institution in appropriate circumstances. | Detailed Reasoning - Treatment of the interest paid to the LLC: Under US tax law, where an entity is disregarded, 'its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner' (see US Treasury Regulations, Subchapter F, § 301.7701-2(a)). The IRS Instructions for the LLC Reference Guide Sheet further state '[a]lthough the LLC may be disregarded as a separate entity, it is not disregarded as an activity of its sole owner. Rather, the disregarded LLC's activities are treated as the activities of the owner.' In applying the US Convention, Australia should take into account the US treatment of the interest paid to the LLC. Where it is necessary to do so in order to give effect to the object and purpose of a treaty, Australia may give due recognition to the fact that under US tax law, the activities and income of the LLC are treated as the activities and income of the US resident owner. Hence, where: · interest income is paid to a single owner LLC which is disregarded as an entity separate from its owner for US tax purposes, and · the LLC meets the definition of 'financial institution' in Article 11(3)(b), and · the single owner is a resident of the US for the purposes of the US Convention and is beneficially entitled to the interest income; and · the single owner undertakes no other activities it can be accepted that the interest income is income to which a resident of the US is beneficially entitled and is derived by financial institution for the purposes of Article 11(3)(b). Therefore, subject to the other requirements in Article 11 also being met, the interest income is not taxable in Australia. | Detailed Reasoning - Question 2: Pursuant to subsection 128B(5) of the ITAA 1936, the interest income would normally be liable for interest withholding tax. However, subsection 4(2) of the International Tax Agreements Act 1953 (ITA Act 1953) provides: The provisions of this Act have effect notwithstanding anything inconsistent with those provisions contained in the Assessment Act (other than Part IVA of the Income Tax Assessment Act 1936 ) or in an Act imposing Australian tax. This means that subsection 4(2) of the ITA Act 1953 has the effect of disregarding provisions in the Income Tax Assessment Act where there are inconsistencies between the two. Therefore, the application of Article 11(3)(b) of the US Convention to the interest arising in Australia, overrides the application of domestic taxation law, namely, in this case subsection 128B(5).