House of Representatives

Income Tax (International Agreements) Bill 1974

Income Tax (International Agreements) Act 1974

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon. Frank Crean, M.P.)


The protocol contains a number of provisions varying or extending parts of the main body of the agreement. The protocol itself provides that its provisions are to form an integral part of the agreement.

Paragraph 1 of the protocol operates to extend the definition of "permanent establishment" in article 5 (in particular, paragraph (2)(g)) to include supervisory activities carried on in one country by a resident of the other for more than six months in connection with a building site, or a construction, installation or assembly project which is being undertaken in that country. This gives the country in which the activities are carried on the right to tax income arising from them.

Paragraph 2 of the protocol deems income from a lease of land (the lease being, strictly, personal property) to be income from real property for the purposes of article 6.

Paragraph 3 of the protocol provides authority for Australia to deem, or the purposes of its domestic income tax law, that income derived by a resident of the Federal Republic of Germany which, under articles 6 to 8 and 10 to 16 of the agreement, may be taxed by Australia, to be income from sources in Australia. A more detailed explanation of this matter is contained in the notes on clause 4 of the Bill (page 2 above).

Paragraph 4(a) of the protocol will allow either country, insofar as it is customary for it to do so, to determine the profits of a permanent establishment on the basis of an apportionment of the total profits of the enterprise to its various parts. The method must be applied in such a way that the result accords with the principles of article 7.

Paragraph 4(b) of the protocol provides that article 7 shall not apply to the profits of an enterprise from carrying on a business of general insurance, each country being left to apply the provisions of its domestic taxation law.

Paragraph 5 of the protocol covers the situation where there is insufficient information available to enable proper application of the arm's length basis of determining profits for purposes of articles 7 and 9 of the agreement.

In effect, the paragraph will authorise the Commissioner of Taxation, in an appropriate case, to apply the provisions of section 136 of the Income Tax Assessment Act. That section provides, under defined conditions, for assessment on the basis of such portion of the total receipts of a business as the Commissioner determines.

Paragraph 6 of the protocol modifies in one respect the provisions of article 10 of the agreement under which the tax on dividends flowing to the other country is limited to 15 per cent. The Federal Republic of Germany has a system of taxing company profits under which the company tax on distributed profits is at a much lower rate than the tax on undistributed profits (effectively, 24.55 per cent on distributed profits and 52.53 per cent on undistributed profits). Thus, although the Federal Republic (like Australia in the converse situation) must otherwise limit its withholding tax on dividends paid to Australian residents to 15 per cent, it is entitled under paragraph 6, as a means of preventing exploitation of its system, to charge dividend withholding tax at a rate of 25.75 per cent where the Australian recipient company has a substantial holding in the company paying the dividend. The Australian tax rebate on inter-corporate dividends will free the dividends from Australian tax. The Federal Republic's right to charge this higher rate only exists so long as there is a margin between the rates of tax it charges on distributed and undistributed profits of 20 percentage points or more.

In a case where a dividend is paid by one of its companies to an Australian company in respect of a substantial holding the company tax on distributed profits plus withholding tax of 25.75 per cent results in total tax in the Federal Republic on distributed profits of 43.98 per cent. In the converse situation, a dividend paid from Australia to a company in the Federal Republic of Germany out of profits subjected to company tax of 47.5 per cent, and taxed at a withholding tax rate of 15 per cent, results in total Australian tax of 55.4 per cent.

Paragraph 7 of the protocol provides that, in order to obtain the benefits of the limited rates of tax under articles 10 to 12 of the agreement, the recipient resident in the other country must be beneficially entitled to the dividends, interest or royalties received. The limitations are not to apply, for example, where the recipient is the nominee of a resident of a third country.

Paragraph 8 of the protocol provides that, for the purposes of articles 10 to 12 and 22 of the agreement, the term "tax" does not include any amount which, under the laws of either country, may be imposed as a penalty or interest in relation to the taxes to which the agreement applies.

Paragraph 9 of the protocol requires each country to exempt interest received by the Government of the other country or by its central bank.

Paragraph 10 of the protocol contains a number of provisions which bear on article 22 of the agreement - the article which deals with the relief of double taxation.

Sub-paragraph (a) in effect specifies the source of various items of income for the purposes of the credit provisions of article 22. It obviates any difficulties which might arise should each country, by the application of the source rules under its domestic law, claim to be the source of the income. The broad principle of sub-paragraph (a) is that, if the agreement gives a country the right to tax income of a resident of the other country, the other country must regard the income as having a source in the first country.

Sub-paragraph (b) provides that, for the purposes of article 22(1) (which provides for the allowance of credit to Australian residents against the Australian tax payable on income derived from sources in the Federal Republic of Germany for the tax paid there on that income) that the term "German tax" as defined in the agreement shall only include the trade tax (a municipal tax) levied by the Federal Republic on a basis other than capital or pay-roll. In its practical effect, this will mean that credit is only allowed in Australia for trade tax which is imposed on income.

Sub-paragraph (c) provides, in effect, that the Federal Republic of Germany is not required to exempt, in accordance with article 22, any income received by its residents from Australia's external territories or continental shelf if that income is not subject to Australian tax.

Sub-paragraph (d) further defines the circumstances in which the Federal Republic of Germany will exempt from its tax, in accordance with article 22 (2), income derived by its residents from sources in Australia. Broadly, exemption will apply to profits of a permanent establishment in Australia of an enterprise from the Federal Republic or to dividends paid by an Australian company to a company in that country, if such profits, or the income of the company (or its subsidiaries), are derived from active business operations. The exemption for dividends paid by an Australian company is conditional on the foreign company owning at least 25 per cent of the shares in the Australian company.

If the conditions for exemption are not met, the Federal Republic will tax the income and allow credit for Australian tax in accordance with article 22(2)(b).

Sub-paragraph (e) provides for the allowance of a proportionate deduction, when computing the "trade" tax levied by the Federal Republic on income, of any Australian tax paid in accordance with the agreement on dividends, interest or royalties, to the extent that the Australian tax is not allowed as a credit against the income or corporation tax of the Federal Republic, because it exceeds that tax.

Sub-paragraphs (a) and (b) of paragraph 11 of the protocol provide that, in the event of certain alterations to either country's taxation laws or, in the case of the Federal Republic of Germany, the inclusion of certain provisions in its double tax agreements with other countries, the country concerned will immediately advise the other and enter into negotiations in order to establish appropriate new provisions for the taxation arrangements between them.

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