ATO Interpretative Decision

ATO ID 2006/128

Income tax

• This ATO ID was amended by replacing the references to paragraphs (8) of Article 7 and (5) of Article 11 to the tax treaty between Australian and New Zealand with paragraphs (5) of Article 7 and (7) of Article 11 contained in the new tax treaty which took effect from 19 March 2010 and updating the reference to the OECD Commentary on the Model Tax Convention on income and on capital (Condensed version 2005) with the Condensed version of 2010
  This ATO ID contains references to repealed provisions, some of which may have been re-enacted or remade. The ATO ID is current in relation to the re-enacted or remade provisions.
  Australia's tax treaties and other agreements except for the Taipei Agreement are set out in the Australian Treaty Series. The citation for each is in a note to the applicable defined term in sections 3AAA or 3AAB of the International Tax Agreements Act 1953.

Issue

Does Australia have the right under the Double Tax Convention between Australia and New Zealand (the New Zealand Convention) to tax interest income paid by an Australian resident to another Australian resident who derives the income in carrying on a business at or through a permanent establishment in New Zealand?

Decision

Yes. Australia has the right under the New Zealand Convention to tax interest income paid by an Australian resident to another Australian resident who derives the income in carrying on a business at or through a permanent establishment in New Zealand.

Facts

The taxpayer is a company incorporated in Australia and is a resident under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

The taxpayer is also a resident of New Zealand under New Zealand tax law. The taxpayer's place of effective management is in New Zealand and is deemed to be a resident of New Zealand for the purposes of the New Zealand Convention.

The taxpayer carries on a business of lending money in New Zealand. The taxpayer's activities in New Zealand amount to a permanent establishment under subsection 6(1) of the ITAA 1936.

The taxpayer is paid interest income by Australian resident borrowers. The taxpayer's activities in Australia do not amount to a permanent establishment under the New Zealand Convention.

The interest income is derived in the course of carrying on the business in New Zealand.

Reasons For Decision

The Commissioner, in Taxation Ruling TR 98/17, accepts that where the tie-breaker test in a double tax agreement provides that a dual resident be treated solely as a resident of the treaty partner country for the purposes of the agreement, Australian resident status is not lost for purposes of the general operation of the domestic law. However the terms of the relevant double tax agreement should be referred to when determining tax liability.

Subsection 128B(2A) of the ITAA 1936 provides that where a resident pays another resident interest income, withholding tax will apply if the recipient derives that interest in carrying on a business at or through a permanent establishment outside of Australia. In the present case, the terms of subsection 128B(2A) are satisfied because interest was paid by Australian residents to the taxpayer (who remains a resident for the purposes of the general operation of the domestic law) who derived the interest through its New Zealand permanent establishment.

However in determining the taxpayer's liability under subsection 128B(2A) of the ITAA 1936, it is necessary to consider the New Zealand Convention contained in Schedule 4 of the International Tax Agreements Act 1953 (the Agreements Act). In interpreting the wording of the Convention, the Commissioner accepts in Taxation Ruling TR 2001/13 that it is appropriate to have reference to the OECD Commentary on the Model Tax Convention on Income and Capital (Condensed Version 2010) (the OECD Commentary).

Article 7 of the New Zealand Convention gives the right to tax business profits to the country of residence, unless the profits are attributable to a permanent establishment, in which case the country where the permanent establishment is situated may tax. In the present case, the taxpayer has derived interest business income. The taxpayer is also deemed to be a New Zealand resident for the purposes of the New Zealand Convention and does not have a permanent establishment in Australia. Accordingly, under Article 7, only New Zealand may tax the interest income.

However Article 11 of the New Zealand Convention deals specifically with interest income. It provides that the country where interest arises may also tax the interest income provided that the tax is not more than 10% of the gross amount. Article 11(7) further provides that interest is deemed to arise in the Contracting State where the payer is a resident. In the present case, interest is paid by Australian residents and arises in Australia. Accordingly, under Article 11, Australia may tax the interest income.

In resolving whether the terms of Article 7 or Article 11 prevail, it is necessary to consider Article 7(5) of the New Zealand Convention, which provides:

5. Where profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article

The OECD Commentary, in dealing with the tiebreaker provision between the business profits article and the specific income article (Model Article 7(4)), states that:

74. ...it has therefore been decided to include a rule of interpretation that ensures that Articles applicable to specific categories of income will have priority over Article 7. It follows from this rule that Article 7 will be applicable to business profits which do not belong to categories of income covered by these other Article s...

This paragraph indicates that where business income belongs in an article covered by a specific category of income (for example, interest or dividends), that article will have priority over the business profits article.

The OECD Commentary goes on to state that:

74. ...This rule does not, however, govern the manner in which the income will be classified for the purposes of domestic law; thus, if a Contracting State may tax an item of income pursuant to other Articles of this Convention, that State may, for its own domestic tax purposes, characterise such income as it wishes (i.e. as business profits or as a specific category of income) provided that the tax treatment of that item of income is in accordance with the provisions of this Convention.

This suggests that Australia can tax interest income although this is subject to any limitation imposed by the relevant specific income article contained in the New Zealand Convention. In this case, Article 11(2) of the New Zealand Convention imposes a limit of 10% of the gross amount.

Pursuant to Article 7(5), the terms of Article 11 will prevail. Therefore Australia has the right to tax the interest income earned by the taxpayer. Accordingly subsection 128B(2A) can operate to impose withholding tax of 10% on the interest income paid by Australian borrowers to the taxpayer.

Year of income:  Year ended 30 June 2006 Year ended 30 June 2007 Year ended 30 June 2008

Legislative References:
Income Tax Assessment Act 1936
   subsection 6(1)
   subsection 128B (2A)

Related Public Rulings (including Determinations)
Taxation Ruling TR 2001/13
Taxation Ruling TR 1998/17

Other References:
OECD Commentary on the Model Tax Convention on Income and Capital (Condensed Version 2010)

Keywords
Double tax agreements
International tax
New Zealand
Permanent establishment
Dual residency

Siebel/TDMS Reference Number:  4984247

Business Line:  Public Groups and International

Date of publication:  19 May 2006

ISSN: 1445-2782