How do tax treaties work?
Outlined below are some basic principles that apply to all of Australia's tax treaties. They relate to a person's residency status and how tax applies to income and business profits they earn, or tax relief they receive in the other country.
Residency versus source
Tax treaties give the source country a taxing right over selected types of income, profits or gains, sometimes at limited rates.
Each country has the right to tax the income of its own residents under their own domestic laws, so the tax treaty will not always restate this rule.
If the country of residence has the sole taxing right over certain types of income, profits or gains, this is usually expressed as 'shall be taxable only in that country'.
Where the country of source imposes a limited rate of tax on selected types of income profits or gains – for example, a withholding tax – this is usually expressed as 'may be taxed in that other state'.
The principal factor considered in relation to taxation of business profits is the presence of a 'permanent establishment'. This refers to a fixed place of business through which the taxpayer either fully or partly carries on their business enterprise.
Under the Business Profits Article of most tax treaties, the profits of an enterprise in one country may be taxed in the other country only under both of the following circumstances:
- if the enterprise carries on business in that other country through a permanent establishment
- to the extent that the profits are attributable to the permanent establishment.
The tax treaty also allows the country of residence to provide tax relief against its own tax if the income has been taxed in the country of source. In Australia, we apply the general foreign tax credit provisions of our domestic law or specific exemption provisions where applicable.