Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon. Frank Crean, M.P.)
The main purpose of this Bill is to give the force of law in Australia to a comprehensive double taxation agreement between Australia and the Federal Republic of Germany that was signed in Melbourne on 24 November 1972.
The Bill specifies that interest and royalties derived from the Federal Republic by residents of Australia, and in respect of which, under the new agreement, the Federal Republic limits its tax to 10 per cent, will not, by reason of the payment of that limited tax, be exempt from Australian tax. Australia will instead allow credit for the limited tax against the Australian tax on this income.
The Bill also contains amendments of a technical character made necessary by the proposed surcharge of tax that is to be payable for the 1974-75 income year in respect of property income.
Notes on the clauses of the Bill are given below and these are followed by explanations of the articles of the agreement and the paragraphs of the protocol to the agreement.
INCOME TAX (INTERNATIONAL AGREEMENTS) BILL 1974.
Clause 1: Short title and citation.
This clause formally provides for the short title and citation of the Amending Act and of the Principal Act as amended.
Clause 2: Commencement.
Section 5(1A) of the Acts Interpretation Act 1901-1973 provides that unless the contrary intention appears every Act shall come into operation on the twenty-eighth day after the day on which it receives the Royal Assent. By this clause the Amending Act will come into operation on the day on which it receives the Royal Assent, thus enabling early implementation of the agreement.
Clause 3: Interpretation.
Section 3 of the Principal Act contains a number of definitions for the more convenient interpretation of the Act. Clause 3 will insert in section 3 a definition of the comprehensive agreement with the Federal Republic of Germany (which is being incorporated as a schedule to the Principal Act by clause 7 of the Bill). The agreement comprises a main agreement of 29 articles and a protocol of 11 paragraphs.
Clause 4: Agreement with the Federal Republic of Germany.
This clause will give the force of law in Australia to the agreement with the Federal Republic. This will be achieved by inserting a new section - section 11 - in the Principal Act.
Sub-section (1) of the new section will give the force of law in Australia to the agreement, with effect from the time (broadly, 1 July 1971) indicated in the agreement itself (see the explanation of article 28 of the agreement on page 13).
The agreement is to enter into force on the 30th day after the date of exchange of formal instruments of ratification (article 28). As it is not possible to indicate in this Bill when this will occur, sub-section (2) of section 11 provides for notification of the relevant date in the Gazette. This will provide a readily available and authoritative reference to the fact and date of entry into force of the agreement.
In Australia's other double taxation agreements, there are various provisions which provide that particular income which, under the agreement, Australia may tax in the hands of a resident of the other country, is to be deemed to have a source in Australia. These provisions have been carried into the Australian domestic taxation law in such a way that the agreed "source" rule clearly establishes that Australia is able to tax the non-resident concerned. No provision in such terms was included in the agreement with the Federal Republic of Germany, but protocol (3) to the agreement provides that Australia may legislate to give the income a source in Australia for purposes of Australia's domestic income tax law. Sub-section (3) of section 11 will give effect to this arrangement.
Sub-clause (2) of clause 4 of the Bill will empower the Commissioner of Taxation to amend assessments for the purpose of giving effect to sub-section (1) of new section 11. It is necessary to give the Commissioner this power because, although the agreement will not enter into force until thirty days after the instruments of ratification have been exchanged, its provisions will have effect - pursuant to sub-section (1) of new section 11 - in relation to income in respect of which assessments have already been made.
Clause 5: Provisions relating to certain income derived from sources in the United Kingdom, Singapore, Japan, New Zealand and Germany.
The purpose of this clause is to ensure that the credit system, rather than the exemption system, of relief of double taxation will apply to interest and royalties that are derived by residents of Australia from the Federal Republic of Germany and in respect of which tax in that country is limited by the agreement to 10 per cent. Section 12 of the Principal Act, which is to be amended by this clause, already achieves a corresponding result for interest and royalties derived by residents of Australia from the United Kingdom, Singapore, Japan and New Zealand, where the double taxation agreements with those countries limit the foreign tax on the income.
Paragraph (a) of sub-clause 5(1) will effect a formal drafting amendment consequent on the addition to sub-section 12(1) of the Principal Act of a new paragraph (ad).
Paragraph (b) of sub-clause 5(1) will insert a new paragraph (ad) in sub-section 12(1) of the Principal Act. This will mean that section 23(q) of the Income Tax Assessment Act - which provides a general exemption from Australian tax for foreign-source income (other than dividends) of residents of Australia that is taxed in the country of source - is not to apply to interest or royalties derived from the Federal Republic of Germany by a resident of Australia. This change will have effect for income derived after the commencement of the year of income to which the agreement is to first apply (1971-72) where, under the agreement, the tax of the Federal Republic is limited to 10 per cent of the gross amount of the interest or royalties. The interest and royalties will thus be assessable income for the general purposes of the Income Tax Assessment Act and the agreement (article 22) will require a credit for the limited tax to be allowed against the Australian tax on the income. Existing sections 14 and 15 of the Principal Act will govern the allowance of credit.
Sub-clause (2) of clause 5 is designed to avoid any retrospective increase in overall tax liability that might result from the application of the credit method of relief to relevant interest and royalty income derived by Australian residents after the commencement of the 1971- 72 income year, but on or before the date of announcement of signature of the agreement on 24 November 1972. That announcement indicated that the credit method of relief was to be applied to this income. The sub-clause provides, in effect, that any increase in the Australian tax payable in respect of the interest or royalties, resulting from the change from the exemption system to the credit system, is not to exceed the amount by which the tax of the Federal Republic of Germany on the income is reduced by reason of the agreement.
Sub-clause (3) of clause 5 has a similar purpose to that of sub-clause 4(2) of the Bill. It will empower the Commissioner to amend assessments that have already issued, to apply the credit method of double taxation relief in accordance with sub-clause 5(1) and (2).
Clause 6: Ascertainment of Australian tax.
The amendments to section 15 of the Principal Act proposed by this clause arise from proposals, in the Income Tax Bill 1974 and the Income Tax Assessment Bill (No. 2) 1974, to impose a surcharge of tax on property income of individuals and to allow a rebate of tax to low-income taxpayers who maintain dependants.
Section 15 contains provisions for determining, for purposes of the Principal Act, the amount of Australian tax on particular income. The amount of Australian tax is relevant in cases where the assessable income of a taxpayer includes foreign income on which foreign tax has been paid. The credit allowable for the foreign tax cannot exceed the amount of Australian tax on the income (sub-section 14(4)). The amount of Australian tax is also relevant under section 16 of the Principal Act. If, for example, a non-resident individual receiving a royalty from Australia is entitled under a double taxation agreement to have the Australian tax on that income limited to, say, 10 per cent, section 16 allows a rebate of the amount by which the Australian tax on the royalty, determined under section 15, exceeds the limit specified in the agreement.
Sub-clause (1) of clause 6 will amend the definition in section 15 of "the average rate of Australian tax". Very broadly, the amount of Australian tax on particular income, for the purposes outlined above, is ascertained by applying the average rate of Australian tax to the amount of that income included in the taxable income.
In calculating the average rate of tax, rebates of tax allowable under the Act declaring the rates of tax, but not other rebates, are taken into account (paragraph (a) of the definition). The revised paragraph (a) of the definition being inserted by sub-clause 6(1) will also take into account the new rebate of tax to be allowed under section 160AA of the Assessment Act (clause 35 of the Income Tax Assessment Bill (No. 2) 1974) as a factor that reduces the overall amount of tax. The new rebate will give effect to the policy that a taxpayer is to be entitled to a tax-saving of at least 40 per cent of the amount of concessional deductions for the maintenance of dependants.
The revised paragraph (b) of the definition of "the average rate of Australian tax" will exclude from the calculation of the average rate any surcharge payable by the taxpayer in respect of property income. If the surcharge were taken into account in the calculation this would average-out the surcharge over the whole of the taxable income and this would be inappropriate where part only of the taxable income is from property. A more direct method of taking the surcharge into account is proposed by the next sub-clause.
Sub-clause (2) of clause 6 inserts two new sub-sections, sub-sections (3A) and (3B), in section 15 of the Principal Act. As just mentioned, they arise from the proposed tax surcharge on property income of individual taxpayers.
Sub-section (3A) will apply where a "relevant part" of a person's income (i.e., the part of the person's income in respect of which the amount of Australian tax is to be determined) includes property income (paragraph (a)) and a tax surcharge is payable by the person in respect of income from property (paragraph (b)).
In this situation Australian tax will be the amount that, in the absence of the surcharge, would have been the amount of Australian tax (paragraph (c)) plus an amount in respect of the surcharge determined in accordance with paragraph (d).
Paragraph (d) of the proposed sub-section 15(3A) is designed to produce the amount of surcharge that may fairly be regarded as relating to property income included in the "relevant part" of a taxpayer's income. If there is only one relevant part of a person's income that includes property income the amount under paragraph (d) will, by sub-paragraph (d)(i), be a proportionate part of the surcharge payable by the person. The proportion will be based on the ratio borne by the "net property component" of the relevant part (see proposed sub-section 15(3B)) to the amount of taxable income from property.)
Sub-paragraph (d)(ii) applies the same principle of apportionment to the more complicated cases in which more than one "relevant part" of a person's income includes property income.
Sub-section 15(3B) specifies how, for purposes of subsection 15(3A), "the net property component", i.e., the amount of property income comprised in a relevant part that is included in a person's taxable income, is to be determined. It will be the amount of property income reduced by the allowable deductions that relate exclusively (paragraph (a)), or may appropriately be related (paragraph (b)), to that income.
Sub-clause (3) will amend sub-section 15(4) of the Principal Act consequential on the insertion of sub-sections 15(3A) and (3B).
By sub-clause (4) the amendments to section 15 apply in relation to the 1974-75 income year and subsequent years.
AGREEMENT WITH FEDERAL REPUBLIC OF GERMANY.
By and large, the agreement corresponds with other such agreements to which Australia is a party. Like those, it limits the tax that the country of source may charge on some types of income and reserves to one or other country the sole right to tax other types. It also contains the usual provisions to the effect that where both countries may levy tax on income the country of residence, if it taxes, is to give credit for the tax of the country of source.
Article 1 - Persons covered by the agreement.
This article provides, in effect, that the agreement will apply to persons (which term includes companies) who are residents of either Australia or the Federal Republic.
The term "resident of a Contracting State" and the question of persons who are residents of both countries (i.e., dual residents) are dealt with in article 4 below.
Article 2 - Taxes covered.
This article specifies the existing taxes of each country to which the agreement will apply. It also provides that the agreement will apply to any identical or substantially similar taxes which may subsequently be imposed by either country in addition to, or in place of, the existing taxes.
Article 3 - Definitions.
This article defines a number of the terms used in the agreement. Definitions of some other terms are contained in the articles to which they relate and terms not defined in the agreement are to have the meaning which they have under the taxation law of the country applying the agreement.
It will be noted that, as in Australia's other recent double taxation agreements, "Australia" is defined as including external territories (other than Papua New Guinea) and areas of the continental shelf. One purpose of the definition is to enable Australia to retain taxing rights in relation to the latter areas, particularly as regards mineral exploration and mining activities. The definition also has relevance to Australia's right to tax shipping and airline profits under article 8 of the agreement.
Article 4 - Residence.
This article sets out the basis on which, in cases of difficulty, the residential status of a person is to be determined for the purposes of the agreement. It provides rules for determining how residency is to be allocated to one or other of the countries for the purposes of the agreement where a taxpayer - whether an individual, a company or other entity - is regarded as a resident under each country's domestic law. (Residential status is one of the criteria for determining taxing rights, and the provision of relief, under the agreement.)
Article 5 - Permanent establishment.
The application of various provisions of the agreement (principally article 7) is dependent upon whether a resident of one country has a "permanent establishment" in the other, or whether income the person derives in the other country is effectively connected with a "permanent establishment" located there. The article defines the term for the purposes of the agreement. Its primary meaning in paragraph (1) is that of a fixed place of business in which the business of an enterprise is wholly or partly carried on. The other paragraphs elaborate on and refine the general definition by giving examples of what constitutes a permanent establishment and defining the circumstances in which a resident of one country shall, or shall not, be deemed to have a permanent establishment in the other.
Article 6 - Income from real property.
This article provides that income from real property, including royalties and similar payments in respect of the exploitation of mines, quarries or other natural resources, may be taxed in the country of source - this being the country in which the property is situated. The scope of the article is extended by paragraph 2 of the protocol to cover also income from a lease of land (see page 14 of these notes).
Income to which this article applies is specifically excluded from the scope of article 7 (by paragraph (4) of that article) and is therefore taxable in the country of source regardless of whether or not the recipient has a permanent establishment in that country.
Article 7 - Business profits.
This article sets out the general basis of taxation of business profits derived by a resident of one country from sources in the other. Broadly, for a country to be able to tax the profits of an enterprise resident in the other country, that enterprise must carry on business in the first country through a permanent establishment situated therein.
Article 7 has practical effect comparable with corresponding articles in Australia's other double taxation agreements. As with those agreements, the article provides an "arm's length" basis for ascertaining the amount of profits fairly attributable to a permanent establishment.
Paragraphs 4 and 5 of the protocol also relate to this article and contain provisions that are normally found in the article itself. For example, paragraph 4(a) of the protocol preserves the application of the special provisions of each country's law relating to income from general insurance. (See Division 15 of Part III of the Assessment Act.)
Article 8 - Shipping and aircraft.
Under this article the right to tax profits from the operation of ships or aircraft in international traffic, including profits received through participation in a pool service, in a joint transport operating organisation or in an international operating agency, is reserved to the country of residence of the operator. However, any profits derived by a resident of one country from internal traffic in the other country may be taxed in that other country. In such cases, the tax shall not exceed 5 per cent of the net amount paid or payable in respect of carriage in internal operations. By reason of the definition of "Australia" in article 3 and the terms of paragraph (4) of article 8, any shipments from a place in Australia to another place in Australia, its continental shelf or external territories are to be treated as forming part of internal traffic.
Article 9 - Associated enterprises.
This is a conventional provision which authorises the re-allocation, on an arm's length basis, of profits between associated enterprises where the commercial or financial arrangements between them differ from those that might be expected to exist between independent enterprises.
Article 10 - Dividends.
The broad scheme of this article is to limit to 15 per cent of the gross amount of dividends the tax imposed by the country of source on dividends payable by companies resident in that country to shareholders resident in the other country. This is in line with Australia's other comprehensive agreements. Under this article, Australian withholding tax on dividends paid to residents of the Federal Republic of Germany will be at the rate of 15 per cent, rather than at the general rate of 30 per cent. Correspondingly, withholding tax of the Federal Republic of Germany on dividends paid to Australian residents will be reduced from the general rate of 25.75 per cent to 15 per cent. However, the operation of this article is modified by the provisions of paragraph 6 of the protocol to the agreement. In short, paragraph 6 of the protocol (which is discussed in more detail later), provides that the Federal Republic of Germany may, consistently with all its recently concluded agreements, impose tax at the rate of 25.75 per cent where the Australian recipient of the dividends is a company which owns 25 per cent or more of the company paying them.
Paragraph (4) of article 10 ensures that the country of source will remain free to impose its normal rate of tax where the holding giving rise to the dividends is effectively connected with a permanent establishment that the recipient has in that country.
Article 11 - Interest.
This article requires the country of source generally to limit its tax on interest income derived by residents of the other country to 10 per cent of the gross amount of the interest. The 10 per cent limitation accords with the Australian interest withholding tax rate of 10 per cent but requires the Federal Republic of Germany to reduce its withholding tax from its present level of 25.75 per cent.
The 10 per cent limitation does not apply where the person deriving the interest has in the country of source a permanent establishment with which the indebtedness giving rise to the interest is effectively connected. The article contains a general safeguard (paragraph (5)) against payments of excessive interest - in cases where there is a special relationship between the persons associated with a loan transaction - by restricting the 10 per cent tax limitation in such cases to an amount of interest which might be expected to have been agreed upon by persons dealing at arm's length.
Article 12 - Royalties.
In Australia, gross royalties as reduced by allowable expenses are, in the absence of an agreement, taxed by assessment at ordinary rates of tax. In the Federal Republic of Germany, gross royalties are normally subject to a withholding tax of 25.75 per cent. This article requires the country of source generally to limit its tax on royalties derived by residents of the other country to 10 per cent of the gross royalties. The 10 per cent limitation is not to apply to natural resource royalties, which, in accordance with article 6, are to remain taxable in the country of source without limitation of the tax that may be imposed.
There are other cases in which the limitation on the tax of the country of source is not to apply in respect of royalties. One is where the asset giving rise to the royalties is effectively connected with a permanent establishment which the recipient has in the country of source. The other is where the royalties are paid by a person not independent of the payee. In the latter case the limitation will not apply to any amount of royalty that is in excess of what might be expected to have been agreed upon by independent persons acting at arm's length.
Article 13 - Income from professional services or similar independent activities.
At present, an individual resident in Australia or in the Federal Republic of Germany may be taxed in the other country on remuneration derived from the performance in that country of professional services or other similar independent activities. This article provides that such remuneration will continue to be subject to tax in the country in which the services are performed if the recipient has a fixed base regularly available to him in that country for the purposes of performing his activities, and the remuneration is attributable to that base. If the tests mentioned are not met the remuneration will be taxed only in the country of residence.
Remuneration derived as an employee and income derived by public entertainers are the subject of other articles of the agreement and will not be covered by this article.
Article 14 - Income from an employment.
This article sets out the basis for taxing remuneration derived by visiting employees. A resident of one country will generally be taxed in the other country on salaries, wages, etc. from an employment where the services are rendered during a visit to the other country but, subject to specified conditions, there is a conventional exemption from this rule for short-term visitors which, where it applies, provides an exemption from the tax of the country being visited.
The article also provides that income from an employment exercised on ships or aircraft operated in international traffic may be taxed in the country of residence of the operator.
Article 15 - Directors' fees.
This article relates to remuneration received by a resident of one country in his capacity as a member of the board of directors of a company which is a resident of the other country. To avoid difficulties in such cases of ascertaining in which country a director's services are performed, and his remuneration is to be taxed, the article provides that the remuneration may be taxed in the country of residence of the company.
Article 16 - Public entertainers.
This article provides that income derived by visiting entertainers (including athletes) from their personal activities as such may be taxed by the country in which the activities are exercised, no matter how short their visit to that country.
The article also contains a safeguard against attempts by entertainers to circumvent its general purpose by, e.g., having fees paid to a separate enterprise which the performer controls, and which arranges the provision of his services.
Article 17 - Governmental remuneration.
This article provides for a reciprocal exemption from tax by each country in respect of remuneration of government (including local government) employees of the other country. The article is subject to the provisos, however, that exemption will not apply where the services are rendered in connection with a trade or business carried on by the government or where, in broad terms, the employee is a citizen of, or normally resides in, the country where he performs his governmental duties for the other country. In the latter case the remuneration is to be taxed only by the country in which the services are performed.
Article 18 - Pensions and annuities.
This article, like corresponding articles in Australia's other agreements, provides that pensions and annuities may be taxed only by the recipient's country of residence.
Article 19 - Visiting professors, teachers, and students.
This article applies in respect of professors or teachers resident in one country who visit the other country for a period of not more than two years for the purpose of advanced study or research or of teaching at an educational institution. In these circumstances, the remuneration of the professor or teacher for his teaching, study or research work is to be exempt from tax in the country visited, although it will remain taxable in the home country.
The article also applies to students resident in one of the countries who are temporarily present in the other country solely for the purposes of their education. A student meeting these tests will be exempt from the tax of the country visited in respect of payments made to him from abroad for the purposes of his maintenance or education.
Article 20 - Income of dual residents.
This article relates to individuals and companies that are residents both of Australia and the Federal Republic of Germany under the general income tax laws of both countries.
For the purposes of the agreement, the residential status of such a person is established by application of the rules set out in article 4, and article 20 reserves to the country to which the person's residence is allotted the sole right to tax income from sources in that country or from a third country.
Article 21 - Capital taxes.
This article provides for the taxing of capital represented by real property and other business property. It is relevant only for, and has been included at the request of, the Federal Republic of Germany which levies a "net worth" tax. As Australia does not impose any comparable taxes, the article has no application in this country. In effect, the article merely provides that the Federal Republic of Germany may continue to apply its capital worth tax to certain property located there and ships and aircraft owned there.
Article 22 - Double taxation relief.
Double taxation does not arise in respect of income flowing between the two countries where the terms of the agreement provide for the income to be taxed only in one country or the other, or where the domestic taxation law of one of the countries exempts the income from its tax. It is necessary, however, to prescribe a method for relieving double taxation in respect of other classes of income which remain subject to tax in both countries. Australia's other double taxation agreements provide a credit basis for the relief of double taxation in these cases - the country of residence gives credit against its tax for tax of the country of source - and the same basis has been adopted in this agreement.
When the Income Tax Assessment Act and the Income Tax (International Agreements) Act (as amended by the present Bill) are read together the measures that will operate to relieve double taxation of income derived from the Federal Republic of Germany by Australian residents are as follows. Australia will allow credit for the tax on dividends derived by individuals from the Federal Republic of Germany and on interest and royalties derived by individuals and companies in respect of which the tax of that country is limited to 10 per cent by articles 11 and 12. (See the notes above concerning clause 5 of the Bill.) Other income of Australian residents that is taxed in the Federal Republic will continue to qualify for exemption from Australian tax under section 23(q) of the Income Tax Assessment Act, while section 46 of that Act will continue to free from Australian tax dividends derived by Australian resident companies. In these cases, since there will be no Australian tax payable, there will be no question of allowance of credits.
For its part, the Federal Republic of Germany will, depending on the class of income concerned and on other circumstances, either allow its residents a credit for Australian tax on Australian-source income or will exempt the income from tax. More information about this aspect is contained in the notes relating to paragraph 10(d) of the protocol (page 16 of these notes).
Article 23 - Consultations between taxation authorities.
One of the purposes of this article is to provide for the taxation authorities of both countries to consult with a view to reaching a satisfactory solution where a taxpayer is able to demonstrate that he has been, or will be, subjected to taxation contrary to the provisions of the agreement.
The other object of the article is to authorise consultation between the authorities for the purpose of implementing the agreement and assuring its consistent interpretation and application.
Article 24 - Exchange of information.
This article authorises the usual exchange between the two taxation authorities of information necessary for carrying out the provisions of the agreement, or for the prevention of fraud, or in relation to provisions of the respective tax laws directed against avoidance of tax. The restrictions which it contains in relation to the information which may be exchanged, the purposes for which this information may be used and the persons to whom it may be disclosed are along the lines of Australia's other double taxation agreements.
The article does not permit the exchange of information that would disclose any trade, business, industrial, commercial or professional secret or trade process or which would be contrary to public policy.
Article 25 - Diplomatic and consular officials.
The purpose of this article is to ensure that members of diplomatic and consular posts will, under the provisions of the agreement, receive no less favourable treatment than that to which they are entitled in accordance with international law. In Australia, fiscal privileges are conferred on such persons by the Diplomatic (Privileges and Immunities) Act and the Consular (Privileges and Immunities) Act.
The article contains a safeguard, however, to ensure that the agreement will not confer any unintended taxation benefits by providing that where, in accordance with international law, such persons are not subject to tax in the receiving State, the right to tax is reserved to the sending State.
Article 26 - Extension to Land Berlin.
This article relates to the special status of Berlin. The purpose of this article (which is a standard feature of the Federal Republic's double taxation agreements) is to apply the agreement in relation to West Berlin in the same way that it applies to the Federal Republic.
Article 27 - Extension to territories.
The purpose of this article is to provide for extension of the agreement, either as it stands or with modifications, to any territory for whose international relations Australia is responsible. Any extension would be on conditions which might be agreed between Australia and the Federal Republic of Germany.
Article 28 - Entry into force.
This article provides for the entry into force of the agreement. It provides for formal ratification of the agreement by the Government of each country and for the agreement to enter into force on the 30th day after the exchange of instruments of ratification. As mentioned earlier in this memorandum it is proposed that there will be a notification inserted in the Gazette of the day on which the agreement will enter into force.
Once it enters into force, the agreement will in general have effect for purposes of Australian tax as from 1 July 1971, although where a taxpayer has adopted an accounting period ending on a date other than 30 June, the beginning of the accounting period that has been substituted for the year ending on 30 June 1972 will be the date from which the agreement takes effect. In the Federal Republic of Germany, the agreement will have effect for withholding tax on dividends, interest and royalties as from 1 July 1971 but otherwise it will apply as regards taxes levied for the 1971 calendar year and for subsequent assessment periods.
Article 29 - Termination.
This article declares that the agreement is to continue in effect indefinitely but either country may give written notice of termination on or before 30 June in any calendar year. In that event, the agreement would cease to apply to the fiscal year commencing in the calendar year following the year in which the notice is given.
PROTOCOL TO THE AGREEMENT WITH THE FEDERAL REPUBLIC OF GERMANY.
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.