Edited version of your private ruling

Authorisation Number: 1012444612819

Ruling

Subject: Dividend Withholding Tax

Question 1

Can the Nominee Company (Nominee Co) apply the reduced 5 per cent rate of withholding tax under Article 10(2)(a) of the United Kingdom convention¹ (the UK convention) in relation to unfranked divided receipts from Australian Company (Aus Co), which were ultimately repatriated to the absolutely entitled beneficial owner of the Aus Co investment, the UK plc in UK (UK Co)?

Answer

No.

This ruling applies for the following periods:

1 January 2012 to 31 December 2012

The scheme commences on:

29 August 2012

Relevant facts and circumstances

Nominee Co acts as a bare nominee (that is, bare trustee) for other group companies to buy, hold and sell shares on their behalf. It otherwise carries on no activities in its own right and is essentially a $2 company.

Nominee companies are often used for strategic purposes by the group when an investment stake is being built up so that the group can retain anonymity for commercial and market sensitivity reasons, so as not to alert the market to the value opportunity which it is seeking to exploit. Alternatively, nominee companies could be used by the group for administrative simplicity.

Aus Co is one such example of an investment interest whereby the group used nominee companies to hold the shares on behalf of another company in the group.

Whilst anonymity was not relevant in the Aus Co acquisition, Nominee Co was used to facilitate the administrative requirements associated with the acquisition.

Specifically, until recently when the Aus Co investment was sold, legal title in the group's Aus Co investment was held by either:

· Nominee Co -an Australian resident nominee company;

· a UK resident nominee company.

Beneficial ownership in the group's Aus Co investment was held by UK Co itself, a listed resident UK company.

UK Co ultimately held a 47.3 per cent interest in the voting power of Aus Co.

UK Co, as the ultimate beneficial owner of Aus Co, had all of the income, capital and voting interests in Aus Co; it had immediate possession to Aus Co and its ownership of Aus Co was not defeasible. Accordingly, UK CO was absolutely entitled to Aus Co as against the nominee companies.

A copy of the Declaration of Trust (the Deed) between Nominee Co and UK Co was provided. The Deed provides that:

· All investment decisions in relation to the Securities are taken by UK CO;

· UK Co acknowledges its participation as beneficial owner hereunder;

· Nominee Co will hold the Securities registered in its name and all rights and benefits in respect of the Securities in trust , as nominee for UK Co, as beneficial owner;

· Nominee Co undertakes to exercise all rights of voting and other privileges attached to the Securities in such manner as UK Co directs or approves;

· Nominee Co has no financial or economic interest in the Securities.

Relevant legislative provisions

International Tax Agreement Act 1953 s3AAA

Income Tax Assessment Act 1936 (ITAA 1936) s128B

Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 s7

Reasons for decision

Subject to certain exceptions, withholding tax is payable under section 128B of the Income Tax Assessment Act 1936 (ITAA 1936) on dividends paid by an Australian resident company and derived by a non-resident.

Section 7 of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 sets the rate of withholding tax on such dividends at 30 per cent. However subsection 17A(1) of the International Tax Agreements Act 1953 provides that this is subject to any lower rates applicable under an agreement (which relevantly includes the UK Convention).

In the present case, liability to Australian withholding tax is subject to the provisions of the UK convention.

Article 10.2(a) of the UK convention provides for present purposes that dividends paid by an Australian resident company, being dividends beneficially owned by a UK resident, may be taxed in Australia. However, the tax so charged shall not exceed:

(a) 5 per cent of the gross amount of the dividends if the beneficial owner of the dividends is a company which holds directly at least 10 per cent of the voting power in the company paying the dividends; and

(b) 15 per cent of the gross amount of the dividends in all other cases.

As UK Co is a company that beneficially owns the dividend paid by Aus Co (an Australian resident company), it is necessary to determine whether UK Co 'holds directly' at least 10 per cent of the 'voting power' in AUS Co such that the lower treaty limit in Article 10.2(a) applies.

Neither of the phrases 'holds directly' or 'voting power' is defined in the UK Convention. Article 3.3 provides that in the application of the Convention by a Contracting State, any undefined term shall, unless the context otherwise requires, have the meaning that it has at that time under the domestic laws of that State (in this case Australia) for the purposes of the taxes to which the Convention applies. Furthermore any meaning under the applicable tax laws will prevail over a meaning given to the term under other laws. For Australia, the meaning may be the statute-defined meaning or, where there is no relevant statutory definition, the 'common law' meaning of the term (see Taxation Ruling TR 2001/13, paragraphs 63 to 71).

Voting power

It is noted that Article 10.2 of the UK Convention differs from the OECD Model in that it uses 'voting power' as the relevant criterion rather than 'capital'. As Counsel for Nominee Co point out, the use of 'voting power' as an alternative to 'capital' is expressly contemplated by the OECD Commentary which states:

15 In sub-paragraph a) of paragraph 2, the term 'capital' is used in relation to the taxation treatment of dividends, i.e. distributions of profits to shareholders. The use of this term in this context implies that, for the purposes of sub-paragraph a), it should be used in the sense in which it is used for the purposes of distribution to the shareholder (in the particular case, the parent company).

a) As a general rule, therefore, the term 'capital' in sub-paragraph a) should be understood as it is understood in company law. Other elements, in particular the reserves, are not to be taken into account.

b) Capital, as understood in company law, should be indicated in terms of par value of all shares which in the majority of cases will be shown as capital in the company's balance sheet.

c) No account need be taken of differences due to the different classes of shares issued (ordinary shares, preference shares, plural voting shares, non-voting shares, bearer shares, registered shares, etc.), as such differences relate more to the nature of the shareholder's right than to the extent of his ownership of the capital.

d) When a loan or other contribution to the company does not, strictly speaking, come as capital under company law but when on the basis of internal law or practice ('thin capitalisation', or assimilation of a loan to share capital), the income derived in respect thereof is treated as dividend under Article 10, the value of such loan or contribution is also to be taken as 'capital' within the meaning of sub-paragraph a).

e) In the case of bodies which do not have a capital within the meaning of company law, capital for the purpose of sub-paragraph a) is to be taken as meaning the total of all contributions to the body which are taken into account for the purpose of distributing profits.

In bilateral negotiations, Contracting States may depart from the criterion of 'capital' used in sub-paragraph a) of paragraph 2 and use instead the criterion of 'voting power'.

This does not provide any express guidance as to the meaning of 'voting power', or why it is suggested as an alternative to 'capital'. However there are a couple of matters worth noting.

First, the Commentary says that, in the context of Article 10 and the taxation treatment of dividends, 'capital' is used in the sense in which it is used for the purposes of distributions to shareholders and should generally be understood as it is understood in company law. Similarly it could be said that the phrase 'voting power' is intended to have the meaning it has under company law. For example, in Avon Downs Pty Ltd v Federal Commissioner of Taxation (1949) 78 CLR 353 Dixon J stated (at 364) in relation to a provision requiring that certain shares of a company carrying voting power be 'beneficially held' that:

[The provision] is concerned with voting. Its purpose is both to exclude nominees from the enumeration of voting power and to take in those who are members of the company and vote independently of control. There is therefore every reason to treat the provision as using the terminology of company law with the meaning attached to it in company law.
(emphasis added)

Secondly, given that there is no express guidance as to the meaning of 'voting power' or an explanation for the suggested change in criterion from 'capital' to 'voting power', it is considered unlikely that it was intended to have a broader or different meaning than it ordinarily has under domestic law. Further, the absence of any indication that voting power should be understood as including control of voting power (or similar) suggests that it is not intended to mean anything other than actual voting power. Presumably, voting power is simply an option for Contracting States that consider it preferable to a test based on 'capital' which, as the Commentary points out, is taken to include all share classes (including non-voting shares) and certain other loans or contributions to a company as described in paragraph (d).

Voting power is consistent with the tests generally used in Australia's domestic law for the purposes of establishing the distinction between portfolio and non-portfolio dividends - a distinction which underlies the different withholding rates applicable under paragraphs (a) and (b) of Article 10.2 (see paragraph 62 of Klaus Vogel on Double Taxation Conventions regarding Art. 10(2)). In that regard, 'non-portfolio dividend' is defined in section 317 of the ITAA 1936 (including for the purposes of section 23AJ of the ITAA36 which provides that certain inbound non-portfolio dividends are non-assessable non-exempt income) by reference to the 'voting power' in the company paying the dividend. Voting power is defined in section 334A for this purpose as:

'the maximum number of votes that can be cast on a poll at, or arising out of, a general meeting of a company as regards all questions that can be submitted to such a poll'. (An identical definition of voting power was contained in former 160AFB(6) of the ITAA 1936).

A person's 'voting power' in a designated body (which includes a body corporate) is also defined in section 610 of the Corporations Act 2001. Although it is found in Chapter 6 relating to corporate takeovers, and therefore includes an associate's votes, the definition is nevertheless based on the

'total number of votes attached to all voting shares in the designated body'.

As mentioned above these domestic law meanings of voting power are relevant to the application of Article 10.2(a) given that the UK Convention does not define voting power. The definition in section 334A is pertinent given that pursuant to Article 3.3 meanings under applicable tax laws prevail over meanings under other laws. The company law definition is also pertinent given the observations made above in relation to the OECD Commentary. Significantly, both definitions make clear that voting power in a company is a measure of the number of votes which can be cast in that Company. There is nothing to indicate that use of the word 'power' in Article 10.2(a) is intended to introduce some broad measure of one's ability to control, direct or exert influence on the manner in which votes, held by another, can be cast.

Accordingly, it is not to the point that UK Co can control the exercise of Nominee Co's votes - the question for the purposes of Article 10.2(a) is whether UK Co holds (directly) the requisite percentage of the total number of votes which can be cast in Aus Co.

Holds directly

There are no relevant statutory definitions of the phrase 'holds directly'. It is therefore necessary to consider the meaning of the phrase under the common law. Consistent with the decision in Dalgety Downs Pastoral Co Pty Ltd v. Federal Commissioner of Taxation (1952) 86 CLR 335; (1952) 10 ATD 55; (1952) 5 AITR 386 (Dalgety Downs), where the High Court considered the phrase 'beneficially held', the proper construction of the phrase 'holds directly' involves a consideration of the meaning of each of the component words in that phrase.

A number of judicial decisions support the view that the use of the word 'holds' in connection with shares refers to legal ownership according to the share register. In Dalgety Downs , the High Court considered the word 'holds' in the context of legislation requiring that shares in a company be 'beneficially held'. In the course of their judgment Webb, Fullagar and Kitto JJ stated (at CLR 341):

Indeed it is not too much to say that the verb "hold" and its variants, when used in relation to shares in companies, normally refers to the legal ownership of the shares according to the register of members. ...

Consistent with Dalgety Downs, the majority of the High Court in Federal Commissioner of Taxation v. Linter Textiles Australia Ltd (in liq) (2005) 220 CLR 592; [2005] HCA 20; 2005 ATC 4255; (2005) 59 ATR 177 held that '[w]hen used in relation to companies, "hold" normally refers to legal ownership established by reference to the register of members' (at CLR 604).

Accordingly, for the purposes of Australian tax law, in order to hold shares in a company an entity must be the legal owner of those shares as established by reference to the register of members.

Article 10.2(a) contains no reference to the beneficial owner holding directly 'shares' or 'voting shares'. This might be explained by the fact that Article 10 can also apply to entities that are not companies limited by shares (but which are companies within the meaning of the UK Convention). Nevertheless, in a case such as this, where the relevant votes are attached to shares, it is necessary to consider who holds those shares in order to determine who holds the votes attached to those shares. The rights attaching to a share (including voting rights) are not distinct items of property - they are part of the chose in action which the shareholder has in the company (see for example Re Russell (dec'd) [1968] VR 285 at 299-300 and the cases cited therein). Therefore the voting rights conferred by a share are held by the shareholder. This is the basis on which ATO ID 2011/14 proceeds.

In the present case, Nominee Co is a separate legal entity that is registered as the legal owner of the shares in Aus Co that carry the right to exercise 47.3 per cent of the votes in Aus Co. Therefore, for the reasons set out in ATO ID 2011/14 (see also FCT v Patcorp Investments Ltd & Ors (1977) 140 CLR 247 in relation to the situation of nominees), it is Nominee Co that 'holds directly' the voting power in Aus Co. UK Co does not legally own the shares carrying the voting power in Aus Co and, as a result, it does not 'hold directly' any voting power in Aus Co. The fact that, pursuant to the Declaration of Trust, Nominee Co must cast its votes in such manner as UK CO directs or approves does not change this conclusion. The Declaration of Trust is only relevant as between Nominee Co and UK CO and does not confer voting power in Aus Co - it is the shares in Aus CO which confer voting power and they are held directly by Nominee Co.

It is also true that the UK Convention focuses on the beneficial owner of the relevant dividend - that is why we are concerned with whether UK CO holds directly the voting power in Aus CO and not whether Nominee Co does. But that is not to say that one can then ignore Nominee CO for the purposes of determining whether UK CO 'holds directly' the voting power (or the shares carrying that voting power).

Accordingly, UK CO, as the beneficial owner of the Aus Co investment, is not a company that 'holds directly at least 10 per cent of the voting power' in Aus Co for the purposes of Article 10.2(a) of the UK convention. Consequently, Nominee Co cannot apply the reduced 5 per cent rate of withholding tax under Article 10(2)(a) of the UK convention in relation to unfranked divided receipts from Aus CO, which were ultimately repatriated to the absolutely entitled beneficial owner of the Aus CO investment, UK CO.

¹ 'United Kingdom convention means:

(a) Convention between the Government of Australia and the Government of the united kingdom of Great Britain and Northern Ireland for avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital gains; and

(b) the exchange of notes relating to the convention;

each done at Canberra on 21 August 2003' (section 3AAA of the International Tax Agreement Act 1953).