Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 4 - Preventing double taxation of royalties subject to withholding tax
Outline of chapter
4.1 Schedule 4 to this bill amends the ITAA 1936 to ensure that double taxation does not occur where deductions for royalty payments have been denied as a result of the operation of the transfer pricing provisions.
4.2 The amendment enables the Commissioner to determine that royalty withholding tax is not payable to the extent that the transfer pricing rules have disallowed a deduction to the payer of the royalty.
Context of amendments
4.3 Australia's domestic transfer pricing provisions and the Associated Enterprises Article of Australia's tax treaties authorise the adjustment of profits between related parties to reflect an arm's length profit for taxation purposes.
4.4 Where all or part of a payment is disallowed as a deduction under these rules and the payment is subject to withholding tax, double taxation occurs. The amount is effectively taxed once in the hands of the Australian payer, by reason of a disallowance of the deduction, and again by way of withholding tax in the hands of the recipient. The recipient is usually not an Australian resident.
4.5 Subsection 136AF(3) of the ITAA 1936 operates to remove this double taxation for interest payments. It enables the Commissioner to determine that withholding tax should not have been paid by the (non-resident) recipient, to the extent that the interest amount has been disallowed as a deduction to the Australian payer.
4.6 However, no similar compensating provision applies in relation to royalty payments that have been subject to withholding tax. This was noted in Recommendation 22.14 of A Tax System Redesigned, which recommended that appropriate consequential adjustments be available to avoid double taxation arising from Australian transfer pricing adjustments.
Summary of new law
4.7 Under the proposed amendment, the Commissioner will be able to determine that royalty withholding tax is not payable by a (non-resident) taxpayer to the extent that the transfer pricing rules have disallowed a deduction to the payer of the royalty.
| New law | Current law |
|---|---|
| Where there has been a transfer pricing adjustment, the Commissioner may determine that amounts of withholding tax should not have become payable in respect of certain interest or royalty payments. | Where there has been a transfer pricing adjustment, the Commissioner may determine that amounts of withholding tax should not have become payable in respect of certain interest payments. No such determination can be made in relation to royalties. |
Detailed explanation of new law
4.8 Schedule 4 amends the income tax law so that, following a transfer pricing adjustment, the Commissioner is now able to consider whether royalty withholding tax would have been payable if the property had been supplied or acquired between independent parties dealing at arm's length. [Schedule 4, item 1, paragraph 136AF(3)(b)]
4.9 The amendment will align the treatment of royalty payments to that which currently applies in relation to interest payments where withholding tax has been paid in relation to a transaction that has been subject to a transfer pricing adjustment.
4.10 Therefore, if following a transfer pricing adjustment, the Commissioner considers that an amount of royalty or interest withholding tax should not have been payable, subsection 136AF(3) will authorise the Commissioner to take the appropriate action to give effect to this determination and ensure that there is no double taxation.
Application and transitional provisions
4.11 The amendment made by this Schedule applies to applications of section 136AD of the ITAA 1936 that occur on or after the date of Royal Assent. [Schedule 4, item 2]