ATO Interpretative Decision
ATO ID 2007/172
Income Tax
Withholding Tax: dividends paid in respect of redeemable preference shares - rate of withholding tax determined under the United States ConventionFOI status: may be released
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This ATO ID contains references to repealed provisions, some of which may have been re-enacted or remade.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.
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If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Pursuant to the terms of the Double Tax Convention entered into between Australia and the United States (US Convention), should the rate of withholding tax applicable to dividend payments in respect of redeemable preference shares (RPS) made after 1 July 2003 and prior to 5 December 2003, be determined in accordance with Article 10 (Dividends) of the US Convention?
Decision
Yes. Although the dividend payments in respect of the RPS are characterised as returns on a 'debt interest' under domestic law, Article 10 (Dividends) of the US Convention applies to determine the rate of withholding tax on dividends paid in respect of the RPS after 1 July 2003 and before 5 December 2003.
Note that subsection 3(2A) of the International Tax Agreements Act 1953 (Agreements Act) only became effective on 5 December 2003. Subsection 3(2A) provides that a reference in a double tax agreement to 'income from shares, or to income from other rights participating in profits', does not apply to an amount that is 'a return on a debt interest (as defined in Subdivision 974-B of the Income Tax Assessment Act 1997)'.
Facts
The taxpayer is an Australian resident company.
In November 2003, the taxpayer company declared and paid dividends on RPS. The recipient of these dividends was a United States resident company.
The United States resident company, which is a qualified person by reason of Article 16(2)(c) of the US Convention, owns shares representing 100% of the voting power of the taxpayer, and owned those shares for more than 12 months prior to the date the dividend was declared.
The RPS constitute a 'debt interest' under the debt and equity rules in Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997) and are non-equity shares for income tax purposes (see the definition of 'non-equity share' in section 995-1 of the ITAA 1997).
Reasons for Decision
For the purposes of Division 11A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936), 'interest' is defined to include 'an amount...that is a dividend paid in respect of a non-equity share' (paragraph 128A(1AB)(d) of the ITAA 1936).
Consequently, the dividends paid in respect of the RPS will be treated as income derived by a non-resident that consists of 'interest' to which section 128B of the ITAA 1936 applies.
The taxpayer company's obligation to withhold is therefore, prima facie, determined by section 12-245 of Schedule 1 to the Taxation Administration Act 1953 (TAA). Section 12-245 of the TAA imposes an obligation on an entity to withhold an amount from interest (within the meaning of Division 11A of the ITAA 1936) it pays to a recipient who has an address outside Australia.
The rate of withholding determined under regulation 41 of the Taxation Administration Regulations 1976 is 10% of the amount of the interest.
However, in determining liability to Australian tax on Australian sourced income derived by a non-resident, it is necessary to consider not only the domestic income tax laws, but also any applicable double tax 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.
Schedule 2 to the Agreements Act contains the US Convention, which operates to avoid double taxation of income to which the Convention applies, that is received by Australian or United States residents.
Article 11(1) of the US Convention provides that interest arising in Australia, being interest to which a resident of the United States is beneficially entitled, may be taxed in the United States. Article 11(2) of the US Convention provides that such interest may also be taxed in Australia, but the tax so charged shall not exceed 10 percent of the gross amount of the interest.
Article 11(5) of the US Convention defines the term 'interest' in Article 11 of the US Convention to include:
income which is subjected to the same taxation treatment as income from money lent by the law of the Contracting State in which the income arises.
Returns on the RPS, being non-equity shares, are included in the paragraph 128A(1AB)(d) of the ITAA 1936 definition of 'interest' and are subjected to the same taxation treatment as other amounts of interest in Australia. The returns on the RPS therefore satisfy the definition of 'interest' in Article 11 of the US Convention.
However, Article 11(5) of the US Convention also provides that 'Income dealt with in Article 10 (Dividends) ... shall not be regarded as interest for the purposes of this Article'.
Article 10(6) of the US Convention provides that the term 'dividends' as used in Article 10 of the US Convention means:
income from shares, as well as other amounts which are subjected to the same taxation treatment as income from shares by the law of the State of which the company making the distribution is a resident for the purposes of its tax.
The returns on the RPS are treated as interest under Australian domestic law. However, the RPS are shares, albeit non-equity shares, such that the returns satisfy the definition of 'dividends' in Article 10(6) of the US Convention, being 'income from shares'. Although the returns on the RPS also satisfy the definition of 'interest' in Article 11(5) of the US Convention, the latter sentence in Article 11(5) applies to limit the returns to the scope of Article 10 of the US Convention when determining the respective taxing rights between Australia and the United States in respect of the returns.
Accordingly, withholding tax imposed under section 128B of the ITAA 1936 is limited by paragraphs (2) and (3) of Article 10 of the US Convention.
Article 10(1) of the US Convention provides that dividends paid by a company that is a resident of Australia, being dividends to which a resident of the United States is beneficially entitled, may be taxed in the United States.
Article 10(2) of the US Convention provides that such dividends may also be taxed in Australia, at a rate dependent on the percentage of voting power that the recipient of the dividend holds in the company paying the dividend. However, Article 10(3) of the US Convention provides that dividends may not be taxed in Australia if:
...the person who is beneficially entitled to the dividends is a company that is a resident of the other Contracting State that has owned shares representing 80 percent or more of the voting power of the company paying the dividends for a 12-month period ending on the date the dividend is declared and:
The requirements of Article 10(3) of the US Convention are met, such that the returns on the RPS, being dividends for the purposes of Article 10 of the US Convention, may not be taxed in Australia.
The resident taxpayer is therefore not required to withhold any tax in respect of the dividends on the RPS which were paid to the US resident company in November 2003.
Date of decision: 20 August 2007Year of income: Year ended 30 June 2004
Legislative References:
Income Tax Assessment Act 1997
subsection 974-15(1)
subsection 974-70(1)
section 995-1
subsection 128A(1AB)
paragraph 128A(1AB)(d)
section 128B Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974
section 7 International Tax Agreements Act 1953
subsection 3(2A)
section 4
Schedule 2, Article 10(1)
Schedule 2, Article 10(2)
Schedule 2, Article 10(3)
Schedule 2, Article 10(6)
Schedule 2, Article 11(1)
Schedule 2, Article 11(2)
Schedule 2, Article 11(5)
Schedule 2, Article 16(2)(c) Taxation Administration Act 1953
section 12-245 of Schedule 1 Taxation Administration Regulations 1976
regulation 41 Related ATO Interpretative Decisions
ATO ID 2003/527
ATO ID 2003/529
ATO ID 2003/530
Keywords
Debt interest
Double tax agreements
Dividend income
Interest income
International tax
Non-equity share
Non resident interest withholding tax
Non resident dividend withholding tax
Redeemable preference shares
United States
Withholding taxes
ISSN: 1445-2782