Private ruling: Assessability of dividends paid to a non-resident company
Date of advice: 16 January 2017
Published: June 2017
Ruling period: 1 January 2017 - 31 December 2021
Date scheme commenced: 1 January 2017

Ruling: Q1: Pursuant to paragraph 44(1)(b) of the Income Tax Assessment Act 1936 (ITAA 1936), will the assessable income of Company A, a non-resident company, include dividends paid to it by Company B which is a 100% owned subsidiary of Company A? | A1: No.

Relevant facts and circumstances: Company A is a Country X incorporated and tax resident company. Company B is a Country X incorporated and tax resident company which is a 100% owned subsidiary of Company A. Its sole purpose is to operate a business in Australia through a permanent establishment. Company B's only profits are those it makes in Australia on which it pays Australian tax. It is anticipated that in the next accounting period, Company B will pay a dividend to Company A.

Relevant legislative provisions: Income Tax Assessment Act 1936 paragraph 44(1)(b) | International Tax Agreements Act 1953 section 4 | International Tax Agreements Act 1953 subsection 4(2) | International Tax Agreements Act 1953 section 5 Convention between the Government of Australian and the Government of the Country X for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income Article 10(7)

Reasons for decision: Summary: In determining liability to tax on Australian sourced income, it is necessary to consider not only the income tax laws but also any applicable tax treaties contained in the International Tax Agreements Act 1953 (Agreements Act). Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and the Income Tax Assessment Act 1997 ITAA 1997 so that all three Acts are read as one. Subsection 4(2) provides that the Agreements Act overrides both the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (except in some limited circumstances). Section 5 of the Agreements Act states that, subject to the provisions of that Act, any provision in an Agreement listed in section 5 has the force of law. The Convention between the Government of Australia and the Country X for the Avoidance of Double Taxation and The Prevention of Fiscal Evasion with Respect to Taxes on Income as amended by the Country X Protocol (No 1) (the Country X Convention) is listed in section 5 of the Agreements Act. 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 the 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 it receives from the company within its group that carries on business in Australia. It is anticipated that during the next accounting period Company A will receive a dividend from Company B, a Country X resident company operating its only business through a PE in Australia. Any dividends issued by Company B will be paid out of profits derived by it from Australian sources. In determining Company A's liability, if any, to Australian tax on the dividend income, the Country X Convention must also be considered. Relevantly, Article 10(7) of the Country X Convention provides: (7) Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company - being dividends to which a person who is not a resident of the other Contracting State is beneficially entitled - except insofar as the holding in respect of which such dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State , nor may it impose tax on a company's undistributed profits, except as provided in paragraph (8), even if the dividends paid consist wholly or partly of profits or income arising in such other State.(emphasis added) Accordingly, the dividends that Company A will receive from Company B are not subject to Australian tax unless the holding in respect of the paid dividends is 'effectively connected' with a permanent establishment in Australia. There is no definition of 'effectively connected' in either the ITAA 1936 or the ITAA 1997, Australia's DTAs or in the OECD Model Tax Convention 2014 on Income and on Capital (OECD Model). In Taxation Ruling TR 2001/13 Income tax: Interpreting Australia's Double Tax Agreements, the Commissioner accepts that in interpreting the wording of a tax treaty it is appropriate to have reference to the OECD Commentary on the Model Tax Convention on Income and Capital (OECD Commentary). Article 10(7) of the Country X Convention is based upon Article 10(5) of the OECD Model, however the phrase 'the holding in respect of which the dividends are paid is effectively connected with such permanent establishment' is found in both Articles 10(4) and 10(5) in the same context. Paragraph 32.1 of the OECD Commentary on Article 10 provides guidance on the meaning of 'effectively connected': 32.1 A holding in respect of which dividends are paid will be effectively connected with a permanent establishment, and will therefore form part of its business assets, if the “economic” ownership of the holding is allocated to that permanent establishment under the principles developed in the Committee's report entitled Attribution of Profits to Permanent Establishments … for the purposes of the application of paragraph 2 of Article 7. In the context of that paragraph, the “economic” ownership of a holding means the equivalent of ownership for income tax purposes by a separate enterprise, with the attendant benefits and burdens ( e.g. the right to the dividends attributable to the ownership of the holding and the potential exposure to gains or losses from the appreciation or depreciation of the holding). According to the OECD Commentary, a holding in respect of which dividends are paid will be effectively connected with a PE if the economic ownership of that holding is allocated to a PE, where 'economic' ownership means the equivalent of ownership for income tax purposes, i.e. with the associated benefits and burdens of such ownership. On the facts, the 'holding' in respect of which the dividends are paid are the shares in Company B. 100% of the shares in Company B are owned by Company A, which has the associated benefits and burdens of such ownership. Accordingly, Company A has the economic ownership of that holding. Company A is not a PE. Therefore, the holding in respect of which the dividends will be paid to Company A is not effectively connected with a PE and so the exception in Article 10(7) will not apply in this case. Where the exception in Article 10(7) of the Country X convention does not apply, Article 10(7) is inconsistent with paragraph 44(1)(b) of the ITAA 1936. By operation of subsection 4(2) of the Agreements Act, Article 10(7) of the Country X Convention prevails over paragraph 44(1)(b) of the ITAA 1936. As a result, the dividends to be received by Company A from Company B are not included in its assessable income, notwithstanding paragraph 44(1)(b) of the ITAA 1936. They are therefore not subject to Australian tax.