Edited version of private advice

Authorisation Number: 1052214928999

Date of advice: 1 February 2024

Ruling

Subject: Withholding tax - interest and dividends

Question 1

Does subparagraph 4d) of Article 10 of the (Country X Convention) apply to the dividend income derived by The Fund from its Australian investments held through Entity A and its Sub-Fund 1 such that the dividends shall not be taxed in Australia?

Answer

Yes.

Question 2

Does subparagraph 3d) of Article 11 of the Country X Convention apply to the interest income derived by The Fund from its Australian debt investments held through Entity1 and its Sub-Funds 2 and 3 such that the interest shall not be taxed in Australia?

Answer

Yes.

This ruling applies for the following period:

1 July 20xx to 30 June 20yy

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

The Fund

The Fund is a foundation, created by Entity B, in accordance with Country X law.

The Fund's objective is to insure Entity B's personnel against the economic impact of retirement, disability and death by providing its members with occupational pension insurance in accordance with the requirements set out in Country X law.

The Fund is entered in the relevant Country X register.

The Fund is a pension scheme within the Country X Convention.

The Fund is a foundation with a pension plan open to new members.

The Fund holds investment interests in various countries.

The Fund was established in and is domiciled in Country X.

The Fund's sole Governing Body is the Foundation Board.

The Foundation Board enacts plan rules (the Plan Rules) covering the benefits, the financing, the auditing and organisation of the Foundation, the rights and obligations of the Foundation's beneficiaries, and the use and management of the Fund's assets.

All of The Fund's management and investment decisions are undertaken in Country X by the Foundation Board.

The assets of The Fund may not, under any circumstance, devolve to entity B, as founder, its affiliated companies or to their legal successors; nor can they be used for any other means than the provision of pension benefits.

There is no intention to wind up The Fund.

The members of the Foundation Board are all non-residents of Australia. Additionally, the executive managers of The Fund are all non-residents of Australia.

The Fund is treated as a company for Country X tax purposes.

The Certificate of Residence from the Tax Authorities (Certificate of Residence) states that The Fund is a resident of Country X for tax purposes.

The Fund is exempt from corporate and income tax in Country X.

Entity A and its Sub-Funds

The Fund holds investment interests in numerous countries, including Australia, through entity A and its Sub-Funds.

Entity A is governed by Country X law

Entity A is an open-ended collective investment scheme in the form of a contractual fund where The Fund as the sole investor has either a direct or indirect legal entitlement, at the expense of collective assets, to redeem their units at the net asset value (NAV).

The Fund Contract for Entity A (Fund Contract) embodies Entity A and the rights and duties of the Fund Management Company (FMC), the custodian bank (the Custodian) and the sole investor, The Fund, by way of contractual arrangement.

The FMC drafted the Fund Contract and, with the consent of the Custodian, had it approved by the Country X regulator.

The FMC's investment objective is to achieve an appropriate return of each particular Sub-Fund by investing in the various instruments listed in the Fund Contract.

Under Country X law and the Fund Contract, the FMC's role is to issue investors with the number and type of units in the investment fund and manage the fund's assets.

The FMC holds legal title to the assets.

For each of the Sub-Funds, within the scope of each Sub-Fund's specific investment policy and the FMC manages the investment of assets, at its own discretion and in its own name, for the account of The Fund. In particular, it decides the issue of units, the investments and their valuation. It calculates the NAVs of the Sub-Funds, sets the issue and redemption prices and also determines the distribution of income. The FMC exercises all rights associated with Entity A and the Sub-Funds.

As contractual arrangements, Entity A and its Sub-Funds do not have separate legal personalities, are fiscally transparent and are not subject to tax in Country X. The incomes of Entity A and the Sub-Funds are considered to be the income of The Fund as the sole investor in Entity A.

The rationale for the investments through Entity A and its Sub-Funds is primarily for organisational reasons. Firstly, the specific expertise of an external fund manager is more considerable. Secondly, investments being held via Entity A and Sub-Fund structure allow greater flexibility and independence in the definition of the investment strategy, ensuring enduring quality and efficiency, and reducing the coordination effort of The Fund. Thirdly, investing through Entity A and its Sub-Funds provides increased oversight of the funds of The Fund.

Auditors examine whether the FMC and the Custodian have acted in accordance with the Fund Contract, and Country X law.

The FMC and its agents are subject to the duties of loyalty, care and information, or, in other words, they do not hold the assets for their own benefit. They act independently and safeguard only The Fund's interests.

The Custodian safeguards the assets of the Sub-Funds, deals with the issue and redemption of fund units and the payment transactions for the Sub-Funds. The Custodian and its agents are subject to the duties of loyalty, care and information.

The Fund can terminate the Fund Contract at any time by requiring payment of its share in the Sub-Funds in cash. The Fund Contract does not otherwise interfere with this right. The fund manager can consent to a transfer of part of the portfolio at market value.

The Fund holds the units of the Sub-Funds for its members (beneficiaries) and represents their interests.

The Fund's Australian investments via the Entity A and its Sub-Funds

Entity A holds corporate and government bonds, units and common stock investments in various Australian entities.

Entity A's investments are held under Sub-Funds with their own respective asset managers to whom the investment decisions have been delegated.

The Sub-Fund 1 holds shares in Australian resident Australian Securities Exchange (ASX) listed companies which pay dividends in relation to those investments.

The Sub-Fund 1 holds no more than 10% of the voting power in the Australian resident companies paying dividends from the investments.

The Sub-Fund 2 holds Australian government bonds, which pay interest in relation to those investments.

The Sub-Fund 3 holds Australian corporate bonds, which pay interest in relation to those investments.

The Australian payers with respect to The Fund's Australian investments have no special relationship with The Fund.

The Fund does not carry on a business through a permanent establishment situated in Australia and does not perform independent personal services from a fixed base in Australia.

The Fund does not participate directly or indirectly in the management, control or capital, or have an existing or contingent right to participate in the financial, operating or policy decisions, of the issuer of the debt-claim.

Assumption

The Australian resident companies that pay dividends from the investments held through Entity A and its Sub-Funds are not dual residents of both Australia and Country X, pursuant to paragraph 1 of Article 4 of the Country X Convention.

Relevant legislative provisions

Country X ConventionArticle 10

Country X ConventionArticle 11

Reasons for decision

Question

Does subparagraph 4d) of Article 10 of the Country X Convention apply to the dividend income derived by The Fund from its Australian investments held through entity A and its Sub-Fund 1 such that the dividends shall not be taxed in Australia?

Summary

The Fund is considered to be a person who is a resident of a Contracting State and is therefore subject to the Country X Convention.

Dividends paid from investments in Australian resident companies held through Entity A and its Sub-Fund 1 meet the requirements of subparagraph 4d) of Article 10 of the Country X Convention and as such, shall not be taxed in Australia.

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 excluded.

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 contained in the International Tax Agreements Act 1953 (Agreements Act).

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and the Income Tax Assessment Act 1997 (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).

Withholding tax payable in respect of dividends paid to non-residents, is considered to be an Australian income tax that is covered by the County X Convention. As such, Consideration of the Country X Convention is outlined below.

Country X Convention - application to The Fund

In order for the Country X Convention to apply, Article 1 of the Country X Convention states:

This Convention shall apply to persons who are residents of one or both of the Contracting States.

The Fund must therefore be considered both a 'person' and a 'resident of a Contracting State' for the Country X Convention to apply.

Person

Subparagraph 1c) of Article 3 of the Country X Convention:

...an individual, a company, a trust and any other body of persons.

Subparagraph 1d) of Article 3 of the Country X Convention defines a 'company' to mean:

...any body corporate or any entity which is treated as a company or body corporate for tax purposes.

The Fund is a foundation undertaken in Country X and is treated as a company for tax purposes in Country X.

Therefore, The Fund satisfies the definition of a 'company' pursuant to subparagraph 1d) of Article 3 of the Country X Convention. It is, therefore, considered to be a 'person' in accordance with Subparagraph 1c) of Article 3 of the Country X Convention for the purposes of applying the Country X Convention.

Resident of a Contracting State

Paragraph 1 of Article 4 of the Country X Convention provides the following:

For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax as a resident of that State, and also includes the Government of that State and any political subdivision or local authority thereof. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State.

In addition, sub-subparagraph 3a)(i) of the Protocol to the Country X Convention states that, in relation to paragraph 1 of Article 4 of the Country X Convention, it is understood that the term 'resident of a Contracting State' includes, in particular, a person that is a pension scheme established in that State.

Accordingly, The Fund must be a pension scheme established in Country X to satisfy the definition of a 'resident of a Contracting State' for the purposes of the Country X Convention.

Country X Convention provides the following in respect of the term 'pension scheme':

...the term "pension scheme" means any plan, scheme, fund, foundation, trust or other arrangement established in a Contracting State or, in the case of Australia, that is an Australian superannuation fund for the purposes of Australian tax, which is:

(i)   regulated by that State; and

(ii)   operated principally to administer or provide pension or retirement benefits or to earn income for the benefit of one or more such schemes.

Country X Convention defines pension schemes to be those created under Country X law.

The Fund is a foundation was created by Entity B in accordance with Country X law. The Fund was established in and is domiciled in Country X.

The Fund's objective is to insure Entity B's personnel against the economic impacts of retirement, disability and death by providing its members with occupational pension insurance in accordance with the requirements set out in Country X law.

The Fund is entered in the relevant Country X register.

Given The Fund is a foundation representing pension funds established in Country X pursuant to the deed of foundation and Country X law and operates principally to provide pension related benefits, The Fund satisfies the definition of a 'pension scheme' under the Country X Convention.

This view is supported by the Certificate of Residence and The Fund's inclusion in the relevant Register.

The Fund is deemed to be a person and a pension scheme established in Country X. As such, pursuant to the Country X Convention, The Fund is a resident of a Contracting State.

Conclusion on the application of the Country X Convention

The Fund meets the requirements of Article 1 of the Country X Convention and is therefore subject to its application.

Country X Convention - application to taxes

Paragraphs 1 and 2 of Article 2 of the Country X Convention, in respect to taxes covered, provides the following:

1.    This Convention shall apply to taxes on income imposed on behalf of a Contracting State and, in the case of Country X, on behalf of its political subdivisions or local authorities, irrespective of the manner in which they are levied.

2.    There shall be regarded as taxes on income all taxes imposed on total income or on elements of income, including taxes on gains from the alienation of movable or immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation.

In addition, subparagraph 3a) of Article 2 of the Country X Convention provides the following:

The existing taxes to which this Convention shall apply are in particular:

a)    in Australia:

the income tax, the fringe benefits tax and resource rent taxes imposed under the federal law of Australia;

(hereinafter referred to as "Australian tax");

Based upon the above, the Country X Convention applies to all taxes imposed on income and in particular applies to Australian income tax.

Section 128B of the ITAA 1936imposes liability to withholding tax on dividend, interest and royalty income derived by non-residents. As such, withholding tax payable in respect to dividends to non-residents is considered to be an Australian income tax and is covered by the Country X Convention.

Dividend income

Article 10 of the Country X Convention is the relevant provision in relation to dividend income. The provision states relevantly:

1.    Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

2.    However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed:

a)    5 per cent of the gross amount of the dividends if the beneficial owner is a company which, in the case of Australia, holds directly at least 10 per cent of the voting power in the company paying the dividends, or in the case of Country X, holds directly at least 10 per cent of the capital in the company paying the dividends

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

3.    ....

4.    Notwithstanding the provisions of subparagraph 2b), dividends shall not be taxed in the Contracting State of which the company paying the dividends is a resident if the beneficial owner of the dividends holds, in the case of Australia, directly no more than 10 per cent of the voting power in the company paying the dividends, or in the case of Country X, directly no more than 10 per cent of the capital of the company paying the dividends, and the beneficial owner is:

a)    A Contracting State, or political subdivision or a local authority thereof (including a government investment fund);

b)    a central bank of a Contracting State;

c)    in the case of Australia, a resident of Australia deriving such dividends from the carrying on of complying superannuation activities; or

d)    in the case of Country X, a pension scheme whose investment income is exempt from Country X tax.

5.    Paragraphs 2, 3 and 4 shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

6.    ....

7.    The provisions of paragraphs 1, 2, 3 and 4 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply.

8.    ....

9.    Notwithstanding paragraph 8, dividends paid by a company that is deemed to be a resident only of one Contracting State pursuant to paragraph 3 of Article 4 may be taxed in the other Contracting State, but only to the extent that the dividends are paid out of profits arising in that State. Where such dividends are beneficially owned by a resident of the first-mentioned State, paragraph 2 of this Article shall apply as if the company paying the dividends were a resident only of the other State.

For subparagraph 4d) of Article 10 of the Country X Convention to apply to the Fund, to the effect that the dividend income shall not be taxed in Australia, it must satisfy each of the following:

•         There are dividends that are paid by companies that are residents of Australia.

•         The Fund derives and is the beneficial owner of the dividends.

•         The Fund holds directly no more than 10 per cent of the voting power in the companies paying the dividends.

•         The Fund is a pension scheme and its investment income is exempt from Country X tax.

•         The Fund does not carry on a business through a permanent establishment in Australia or perform independent personal services from a fixed base in Australia.

•         The Australian resident companies that pay dividends from the investments are not dual residents of both Australia and Country X, pursuant to paragraph 1 of Article 4 of the Country X Convention.

1.    There are dividends that are paid by companies that are residents of Australia

Entity A's Sub-Fund 1 holds shares in Australian resident companies which pay dividends in relation to those investments.

Therefore, there are dividends that are paid by companies that are residents of Australia from the investments held by The Fund through entity A and its Sub-Fund 1.

2.    The Fund is the beneficial owner of the dividends

The term 'beneficial owner' is also not defined in the Country X Convention.

Paragraph 2 of Article 3 of the Country X Convention provides the following:

As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.

As such, the definition of the term 'beneficial owner' in relation to dividends derived from an Australian source shall be guided by the context of its use in the Country X Convention or, without such context, by the laws of Australia for the purposes of taxation.

ATO Interpretive Decision ATO ID 2011/13 Income Tax: Interest withholding tax: interest arising in Australia paid to a New Zealand Limited Partnership - 'beneficially owned' (ATO ID 2011/13)provides guidance in relation to the use of relevant context for interpreting Australian tax treaties and is therefore instructive in considering the application of paragraph 2 of Article 3 of the Country X Convention. It further provides guidance in relation to the definition of 'beneficial owner.

ATO ID 2011/13 states the following:

Relevant context for the purposes of interpreting an Australian tax treaty includes the Commentaries on the OECD Model Tax Convention on Income and on Capital (the OECD Commentary). Paragraph 104 of Taxation Ruling TR 2001 / 13 states that the OECD Commentary provides important guidance on interpretation and application of the OECD Model Tax Convention and will often need to be considered as a matter of practice, in interpreting tax treaties, at least where the wording is ambiguous.

Paragraph 12.1 of the 2017 OECD Commentary on Article 10 of the Model Tax Convention (OECD Commentaries) states:

... The term "beneficial owner" is therefore not used in a narrow technical sense (such as the meaning it has under the trust law of many common law countries), rather, it should be understood in its context, in particular in relation to the words "paid ... to a resident", and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance.

Therefore, the term 'beneficial owner' should be used in a purposive sense in light of the operation of the Country X Convention.

Paragraph 12.4 of the OECD Commentaries informs that the 'beneficial owner' can be found through identifying the entity which has the unconstrained right to use and enjoy the dividend income:

... Where the recipient of a dividend does have the right to use and enjoy the dividend unconstrained by a contractual or legal obligation to pass on the payment received to another person, the recipient is the "beneficial owner" of that dividend. It should also be noted that Article 10 refers to the beneficial owner of a dividend as opposed to the owner of the shares, which may be different in some cases.

Further, the OECD Commentaries at paragraphs 12.2 to 12.3 provides examples of situations where agents, nominees, and conduit companies acting as a fiduciary or administrator on account of the interested parties would not be the 'beneficial owner' of the income despite being the direct recipient of the income. In particular, paragraph [12.4] states:

In these various examples (agent, nominee, conduit company acting as a fiduciary or administrator), the direct recipient of the dividend is not the "beneficial owner" because that recipient's right to use and enjoy the dividend is constrained by a contractual obligation to pass on the payment received to another person.

In terms of Australian tax, ATO Interpretive Decision ATO ID 2008/61 Income Tax: Withholding Tax Exemption: interest and dividends paid by an Australian resident and received by a Country B Stichting as unitholder in an Country C Common Contractual Fund (ATO ID 2008/61) is relevant. ATO ID 2008/61 provides that, in respect of the particular arrangement in that decision, the relationship between the manager, custodian and the unitholder constitute a trust relationship.

ATO ID 2008/61 refers to French J in Harmer & Ors v. FC of T 89 ATC 5180; (1989) 20 ATR 1461 who stated that a trust 'is notably a definition of a relationship by reference to obligations'.

Further, ATO ID 2008/61 provides the following:

His Honour went on to state that the four essential elements of a trust are:

1.    the trustee who holds a legal or equitable interest in the trust property

2.    the trust property which must be property capable of being held on trust and which includes a chose in action

3.    one or more beneficiaries other than the trustee, and

4.    a personal obligation on the trustee to deal with the trust property for the benefit of the beneficiaries, which obligation is also annexed to the property.

ATO ID 2008/61 states the following:

All four elements of a trust are present in the relationship between the manager, custodian and the unitholder of the CCF. The manager of the CCF, and in some cases the custodian, holds legal title to the assets of the CCF. The assets are not held by the manager and the custodian for their own benefit, but rather the deed obliges the manager and custodian to deal with the assets of the CCF on behalf of and in the best interests of the unitholder in the CCF. Accordingly, both the manager and the custodian are acting in a trustee capacity with respect to the assets of the CCF, being the trust property which initially arose from the unitholder's contributions to the CCF. A unitholder is beneficially entitled to a proportion of the underlying assets of the CCF in accordance with their unit holding ...

In applying these principles to The Fund, Entity A and its Sub-Funds,

•         The FMC as manager holds legal title to the assets.

•         The Custodian acts to safeguard the assets.

•         The assets are not held by the FMC or the Custodian for their own benefit, but they act for the interests of The Fund, which is the only unitholder of Entity A and its Sub-Funds.

•         The Fund is beneficially entitled to the income of Entity A and its Sub-Funds and can at any time require payment of its interest in Entity A and its Sub-Funds.

•         There are no other provisions of the Fund Contract that affect the operation of the previous paragraph.

•         Based upon the above rights and obligations, a trust relationship exists between The Fund, entity A, the FMC and the Custodian.

The trust relationship outlined above has the same characteristics as the examples provided in the OECD Commentaries at paragraph 12.4, being the Sub-Funds, are the direct recipients of the dividend income paid by Australian residents, and the right to use and enjoy the dividend income is constrained by the contractual obligations of the entity A to hold the payment for the sole benefit of, and reinvest it on behalf of The Fund, as the only unit holder in the Sub-Funds of entity A for The Fund to access if and when it requires those funds.

Therefore, The Fund is the 'beneficial owner' of the dividend income paid by the Australian resident companies for the purposes of the Country X Convention.

This is further supported by the Country X tax treatment of The Fund and the income arising through Entity A and its Sub-Funds. Entity A and its Sub-Funds are not subject to Country X income tax and are fiscally transparent. The income of the relevant Sub-Funds is considered to be the income of The Fund as the sole investor in Entity A.

As such, it can be concluded that The Fund is the beneficial owner of the dividends paid from Australia to entity A's Sub-Funds for the purposes of the Country X Convention.

3.    The Fund holds directly no more than 10 per cent of the voting power in the companies paying the dividends

The Fund holds directly no more than 10 per cent of the voting power in the Australian resident companies paying dividends from the investments held through Entity A and its Sub-Fund 1.

Based upon the above, this condition is satisfied.

4.    Pension scheme and investment income is exempt from Country X tax

As established above, The Fundis a pension scheme, pursuant to the Country X Convention, and is exempt from tax in Country X.

5.    The Fund does not carry on a business through a permanent establishment in Australia or perform independent personal services from a fixed base in Australia.

Paragraph 7 of Article 10 of the Country X Convention operates to limit the application of subparagraph 4d) of Article 10 of the Country X Convention in circumstances where the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base.

The Fund does not carry on a business through a permanent establishment situated in Australia and does not perform independent personal services from a fixed base in Australia.

As such, the application of subparagraph 4d) of Article 10 of the Country X Convention will not be limited by paragraph 7 of Article 10 of the Country X Convention in these circumstances.

Therefore, this condition is satisfied.

6.    The Australian resident companies that pay dividends from the investments are not dual residents of both Australia and Country X, pursuant to paragraph 1 of Article 4 of the Country X Convention.

Paragraph 9 of Article 10 of the Country X Convention operates to limit the application of subparagraph 4d) of Article 10 of the Country X Convention in circumstances where the company paying the dividend is a dual resident under the Country X Convention.

The Australian resident companies that pay dividends from the investments held through Entity A and its Sub-Funds are not dual residents of both Australia and Country X, pursuant to paragraph 1 of Article 4 of the Country X Convention.

As such, the application of subparagraph 4d) of Article 10 of the Country X Convention will not be limited by paragraph 9 of Article 10 of the Country X Convention in these circumstances.

Therefore, this condition is satisfied.

Conclusion

The Fundis a Country X pension scheme whose investment income is exempt from Country X tax. In addition, The Fund is the beneficial owner of dividends paid by Australian resident companies held through Entity A and its Sub-Fund 1. Furthermore, The Fund holds directly no more than 10 per cent of the voting power in the Australian resident companies paying dividends.

Therefore, subparagraph 4d) of Article 10 of the Country X Convention will apply to the dividends paid to The Fund by Australian resident companies from the investments held through Entity A and its Sub-Fund 1 such that the dividends shall not be taxed in Australia.

Question 2

Does subparagraph 3d) of Article 11 of the Country X Convention apply to the interest income derived by The Fund from its Australian debt investments held through entity A and its Sub-Funds 2 and 3 such that the interest shall not be taxed in Australia?

Summary

The Fund is considered to be a person who is a resident of a Contracting State and is therefore subject to the Country X Convention.

Interest paid in relation to the Australian debt investments held through Entity A and its Sub-Funds 2 and 3 meets the requirements of subparagraph 3d) of Article 11 of the Country X Convention and as such, shall not be taxed in Australia.

Detailed reasoning

A non-resident is liable to pay withholding tax under subsection 128B(5) of the ITAA 1936 if the 'non-resident' derives income that consists of interest and the requirements of subsection 128B(2) of the ITAA 1936 are satisfied in relation to that income. Subsection 128B(2) of the ITAA 1936 provides that:

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

(a) is derived... by a non-resident; and

(b) consists of interest that:

(i) is paid to the non-resident....

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 contained in the 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).

Withholding tax payable in respect of interest paid to non-residents, is considered to be an Australian income tax that is covered by the Country X Convention. As such, consideration of the Country X Convention is outlined below.

Country X Convention - application to the Fund

As determined above, The Fund is deemed to be a person and a pension scheme established in Country X As such, pursuant to sub-subparagraph 3a)(i) of the Protocol to the Country X Convention, The Fund is a resident of a Contracting State.

Furthermore, The Fund meets the requirements of Article 1 of the Country X Convention and is therefore subject to its application.

Country X Convention - application to taxes

Paragraphs 1 and 2 of Article 2 of the Country X Convention, in respect to taxes covered, provides the following:

1.    This Convention shall apply to taxes on income imposed on behalf of a Contracting State and, in the case of Country X, on behalf of its political subdivisions or local authorities, irrespective of the manner in which they are levied.

2.    There shall be regarded as taxes on income all taxes imposed on total income or on elements of income, including taxes on gains from the alienation of movable or immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation.

In addition, subparagraph 3a) of Article 2 of the Country X Convention provides the following:

The existing taxes to which this Convention shall apply are in particular:

a)    in Australia:

the income tax, the fringe benefits tax and resource rent taxes imposed under the federal law of Australia;

(hereinafter referred to as "Australian tax");

Based upon the above, the Country X Convention applies to all taxes imposed on income and in particular, applies to Australian income tax.

Section 128B of the ITAA 1936imposes liability to withholding tax on dividend, interest and royalty income derived by non-residents. As such, withholding tax payable in respect to interest to non-residents is considered to be an Australian income tax and is covered by the Country X Convention.

Interest income

Article 11 of the Country X Convention is the relevant provision in relation to interest income. The provision states the following:

1.    Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

2.    However, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the interest.

3.    Notwithstanding paragraph 2, interest arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall not be taxed in the first-mentioned State if the interest is derived by:

...

(d)  in the case of Country X, a pension scheme whose investment income is exempt from Country X tax.

For subparagraph 3d) of Article 11 of the Country X Convention to apply to The Fund, such that the dividend income shall not be taxed in Australia, it must satisfy each of the following:

•         There is interest that arises in Australia.

•         The Fund is the beneficial owner of and derives the interest.

•         The Fund is a resident of Country X.

•         The Fund is a pension scheme, and its investment income is exempt from Country X tax.

•         The operation of subparagraph 3d) of Article 11 of the Country X Convention is not limited by paragraphs 4, 6, 7 and 8 of Article 11 of the Country X Convention.

Interest that arises in Australia

Interest income arises from the Australian investments held by The Fund through Entity A and its Sub-Funds 2 and 3.

Additionally, all interest income arising from the Australian investments is paid by Australian residents for the purposes of Australian tax, and all such income is not connected to a permanent establishment or a fixed base situated outside Australia. Accordingly, pursuant to paragraph 7 of Article 11 of the Country X Convention, interest income arises in Australia.

Therefore, interest arises in Australia from the Australian investments held by The Fund through Entity A and its Sub-Funds 2 and 3 in accordance with subparagraph 3d) of Article 11 of the Country X Convention.

The beneficial owner of the interest and derives the interest

For the purposes of the Country X Convention, the OECD Commentaries on the term 'beneficial owner' used in Article 11 at paragraphs 9.1-10.1 largely mimic the commentaries on Article 10. Therefore, for the same reasons as previously outlined, The Fund is the beneficial owner of the interest income received by the FMC or the Custodian under the Entity A and its Sub-Funds 2 and 3.

The term 'derive' is not defined in the Country X Convention or the OECD Commentaries; as outlined above, paragraph 2 of Article 3 of the Country X Convention states that where a term is not defined, interpretation shall be guided by the context of its use in the Country X Convention or, without such context, by the laws of Australia for the purposes of taxation.

Under Australian taxation law, where interest income is initially received by a manager and/or custodian prior to it being paid to the beneficial owner, the beneficial owner will be deemed to have derived the income at the time it became presently entitled to the income where a trust relationship exists.

As established above, the FMC, or in some cases the Custodian, is the direct recipient of the interest income paid by Australian residents, and the right to use and enjoy the dividend income is constrained by the contractual obligations of the Entity A to hold the payment for the sole benefit of, and distribute it to, The Fund as the only unit holder in the EntityA and its Sub-Funds 2 and 3. This is therefore also sufficient to establish, for the purposes of the Country X Convention, that The Fund has derived the interest income.

Therefore, The Fund is the beneficial owner of the interest income and will be considered to derive the interest income for the purposes of Article 11 of the Country X Convention.

Resident of Country X

As determined above, The Fund is a resident of Country X as it satisfies the definition of a 'resident of a Contracting State' and was established in Country X.

Pension scheme and investment income is exempt from Country X tax

As determined above, The Fund is a pension scheme, pursuant to the Country X Convention, and is exempt from tax in Country X.

The operation of subparagraph 3d) of Article 11 of the Country X Convention is not limited by paragraphs 4, 6, 7 and 8 of Article 11 of the Country X Convention.

Paragraphs 4, 6, 7 and 8 of Article 11 of the Country X Convention operate to limit the application of subparagraph 3d) of Article 11 of the Country X Convention in certain circumstances. These include where:

a)    the member of a contracting state is operating through a permanent establishment whether or not that permanent establishment is situated in that other contracting state (paragraphs 6 and 7 of Article 11 of the Country X Convention). The Fund does not operate through or have any permanent establishments, within the meaning of Article 5 of the Country X Convention, in Australia through which its investments are made or managed.

b)    the beneficial owner of the interest participates in the management, control or decision-making of the issuer of the debt-claim (paragraph 4 of Article 11 of the Country X Convention). The Fund, being the beneficial owner of the interest, does not and will not participate in the management, control or decision-making of any of the issuers of the debt instruments upon which it derives interest income.

c)    there exists a special relationship between the payer and the person beneficially entitled to the interest which results in the amount being paid exceeding the amount that would otherwise have been expected to have been paid had such a special relationship not been in existence (paragraph 8 of Article 11 of the Country X Convention). In the present circumstances, the Australian debt instruments in which The Fund has invested in are such that the payer has no special relationship with The Fund.

Consequently, the restrictions discussed above, will not be applicable in respect of the interest income derived by The Fund on its Australian debt instrument investments.

Conclusion

The Fund is a Country X pension scheme whose investment income is exempt from Country A tax. In addition, it derives interest income from Australian debt investments held via Entity A and its Sub-Funds 2 and 3.

As none of the restrictions prescribed in paragraphs 4, 6, 7 or 8 of Article 11 of the Country X Convention apply to The Fund, subparagraph 3d) of Article 11 of the Country X Convention will apply to the interest paid to The Fund from the Australian debt investments via Entity A and its Sub-Funds 2 and 3 such that the interest shall not be taxed in Australia.