Edited version of private advice

Authorisation Number: 1052391652463

Date of advice: 5 May 2025

Ruling

Subject: Unfranked dividends

Question 1

Will Article 10(2) of the Convention apply to reduce the withholding rate to x% in respect of unfranked dividends paid from an Australian company to the extent that Government Entity X holds an indirect interest through Investment A?

Answer

Yes.

Question 2

Will Article 11(3) of the Convention apply to prevent taxation in Australia on the interest income paid from an Australian entity to the extent that Government Entity X holds an indirect interest through Investment A?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

1.  Government Entity X has assets which it uses to invest globally.

2.  Government Entity X would be subject to tax in Country X on the income received through Investment A but for the fact that it is exempt from income tax as it is part of the government.

3.  Government Entity X invests a portion of its assets through Investment A.

4.  Country X treats entities in the Investment A structure as fiscally transparent for Country X tax purposes.

5.  Investment A is governed by an Agreement which includes details of its purpose, its investment mandate, the types of investments that are to be made, how distributions are determined and how income types are allocated between investors.

6.  By investing through Investment A, Government Entity X may derive dividends and interest.

Assumptions

1.  The dividends paid by an Australian resident company will be 'dividends' in accordance with Article 10 of the Convention.

2.  The interest paid by the Australian entity will be interest that is paid by a person to whom section 128B of the ITAA 1936 applies and is not an outgoing wholly incurred by that person in carrying on business in a country outside Australia at or through a permanent establishment of that person in that country.

Relevant legislative provisions

Article 10 of the specific Convention

Article 11 of the specific Convention

Reasons for decision

Question 1 - Dividend

Will Article 10(2) of the Convention apply to reduce the withholding rate to x% in respect of unfranked dividends paid from an Australian company to the extent that Government Entity X holds an indirect interest through Investment A?

Summary

For the purposes of the Convention, Government Entity X is the beneficial owner of the unfranked dividend income paid by an Australian company to the extent that Government Entity X holds an indirect interest (and therefore the lower withholding tax rate applies).

Detailed reasoning

Subsection 128B(1) of the Income Tax Assessment Act 1936(ITAA 1936) provides that, subject to certain exclusions, section 128B of the ITAA 1936 will apply to income derived by a non-resident that consists of a dividend paid by an Australian resident company (franked dividends are specifically excluded from the operation of section 128B by paragraph 128B(3)(ga) of the ITAA 1936).

Subsection 128B(4) of the ITAA 1936 provides that a person who derives dividend income to which section 128B of the ITAA 1936 applies, is liable to pay withholding tax on that dividend income. The withholding tax rate applicable is generally 30% of the dividend amount (section 7 of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974).

Unfranked dividends derived by a non-resident from Australian resident companies are therefore subject to withholding tax unless otherwise exempt. However, in determining liability to Australian tax on Australian source income derived by a non-resident, it is necessary to consider not only the income tax laws but also any applicable Convention or Double Taxation Agreement per the International Tax Agreements Act 1953 (Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and the ITAA 1997 so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except for some limited provisions).

The Agreements Act gives the force of law to the provisions of the Convention.

The Convention confirms that the Convention applies to Australian income tax. Withholding tax payable in respect to dividends paid to non-residents is considered to be an Australian income tax and is covered by the Convention.

The Commissioner established based on the facts and circumstances that Government Entity X is entitled to apply the Convention treaty concessions where conditions required in the relevant Articles are satisfied.

Article 10 of the Convention is the relevant article with respect to the taxation of dividend income.

Article 10 of the Convention outlines how dividends are to be taxed. In summary, the Convention provides that dividends paid by an Australian resident company will attract a dividend withholding tax rate of x% if the person who is beneficially entitled to the dividends is a resident of Country X (where the other requirements of the Convention are satisfied).

It is assumed for the purposes of the Ruling that the distributions paid by an Australian resident company to Government Entity X through Investment A will be 'dividends' in accordance with the Convention. Based on the Scheme upon which this Ruling is ruled on, the other paragraphs of Article 10 are not applicable to these circumstances and are not considered below.

An Australian resident company will be pay unfranked dividends. Government Entity X has an indirect interest through Investment A. As such, if it can be concluded that Government Entity X is the beneficial owner of its share of dividends paid, then it may be entitled to the lower withholding tax rate of x% under Article 10 of the Convention.

In order for the lower x% withholding tax rate to apply, it is necessary to determine if Government Entity X is 'beneficially entitled' to unfranked dividends paid by an Australian resident company that are attributable to Government Entity X.

The Commissioner considers, based on the specific facts and circumstances of this Ruling, that Government Entity X is 'beneficially entitled' (in the circumstances contemplated by Article 10 of the Convention) to those unfranked dividends paid by an Australian company.

Conclusion

For the purposes of the Convention, Government Entity X will be beneficially entitled to unfranked dividends paid by an Australian company, proportionate to Government Entity X's indirect interest through Investment A such that for its share of the unfranked dividends, it is entitled to the reduced rate of withholding tax of x% for unfranked dividends as per Article 10(2) of the Convention.

Question 2 - Interest

Will Article 11(3) of the Convention apply to prevent taxation in Australia on the interest income paid from an Australian entity to the extent that Government Entity X holds an indirect interest through Investment A?

Summary

For the purposes of the Convention, Article 11(3) will apply to prevent taxation of the interest income paid from an Australian entity to the extent that Government Entity X holds an indirect interest through Investment A.

Detailed reasoning

Division 11A of the ITAA 1936 imposes withholding tax on dividend, interest and royalty income derived by non-residents in certain circumstances. In relation to interest, subsections 128B(2) and (5) of the ITAA 1936 are relevant:

(2) Subject to subsection (3), this section also applies to income that:

(a)          is derived, on or after 1 January 1968, by a non-resident; and

(b)          consists of interest that:

(i)           is paid to the non-resident by a person to whom this section applies and is not an outgoing wholly incurred by that person in carrying on business in a country outside Australia at or through a permanent establishment of that person in that country; or

(ii)           is paid to the non-resident by a person who, or by persons each of whom, is not a resident and is, or is in part, an outgoing incurred by that person or those persons in carrying on business in Australia at or through a permanent establishment of that person or those persons in Australia.

...

(5) A person who derives income to which this section applies that consists of interest is, subject to subsections (6) and (7), liable to pay income tax upon that income at the rate declared by the Parliament in respect of income to which this subsection applies.

Accordingly, for interest withholding tax to be imposed, the interest must be derived by a 'non-resident'.

Division 11A of the ITAA 1936 imposes withholding tax on interest income derived by non-residents, and subsections 128B(2) and (5) of the ITAA 1936 provide that a non-resident who derives income consisting of interest is liable to pay tax upon that income at the rate declared by Parliament.

Section 7 of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 provides that withholding tax is imposed at the rate of 10% on income covered by subsection 128B(5) of the ITAA 1936. However, as outlined above in determining liability to Australian tax on Australian source income derived by a non-resident, it is necessary to consider not only the income tax laws but also any applicable Convention or Double Taxation Agreement per the Agreements Act.

As established in the reasoning to Question 1, based on the facts provided, the Convention will apply to Government Entity X as the residency requirement of the Convention is satisfied.

Article 11(3) of the Convention includes that interest derived by the Government of a Contracting State or by any other body exercising governmental functions in a Contracting State shall be exempt from tax in the other Contracting State.

Government Entity X is a body exercising governmental functions in Country X and invests monies of the Government of a Contracting State, and this results in interest income arising in Australia for Government Entity X. Accordingly, Article 11(3) is applicable to interest derived by Government Entity X from an Australian entity through Investment A and such interest shall be exempt from tax in Australia.

Conclusion

For the purposes of the Convention, the interest exemption will apply to the interest income (proportionate to Government Entity X's indirect interest) such that for Government Entity X's share of the interest arising in Australia, it shall not be taxed in Australia per Article 11(3) of the Convention.

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