U.S. income tax treaty with Australia

The United States and Australia tax each other's residents under a 1982 convention as amended by a 2001 protocol. The saving clause keeps U.S. citizens taxable on worldwide income, and the current dividend, interest and royalty ceilings and the limitation on benefits article follow the amended text.

The convention and its 2001 protocol

The IRS lists the 1982 income tax convention and its technical explanation, together with the 2001 protocol and its technical explanation.^[1] The two documents have to be read together. The protocol replaced Articles 10 (dividends), 11 (interest), 16 (limitation on benefits) and 21 (other income) and amended Articles 1, 2, 4, 7, 8, 12, 13 and 22.^[4]

Convention article titles

The convention has 29 articles, from Personal Scope to Termination. The list below follows the 1982 numbering; the 2001 protocol replaced or amended several of these articles.^[2]

Article 1, Personal Scope; Article 2, Taxes Covered; Article 3, General Definitions; Article 4, Residence; Article 5, Permanent Establishment; Article 6, Income from Real Property.^[2]
Article 7, Business Profits; Article 8, Shipping and Air Transport; Article 9, Associated Enterprises; Article 10, Dividends, and Article 11, Interest; Article 12, Royalties.^[2]
Article 13, Alienation of Property; Article 14, Independent Personal Services; Article 15, Dependent Personal Services; Article 16, Limitation on Benefits; Article 17, Entertainers; Article 18, Pensions, Annuities, Alimony and Child Support.^[2]
Article 19, Governmental Remuneration; Article 20, Students; Article 21, Income Not Expressly Mentioned; Article 22, Relief from Double Taxation; Article 23, Non-Discrimination; Article 24, Mutual Agreement Procedure.^[2]
Article 25, Exchange of Information; Article 26, Diplomatic and Consular Privileges; Article 27, Miscellaneous; Article 28, Entry into Force; Article 29, Termination.^[2]

Dividends, interest and royalties after the 2001 protocol

Article 10, as replaced by the 2001 protocol, lets the source country tax dividends at up to 5 percent of the gross amount when the beneficial owner is a company holding directly at least 10 percent of the voting power of the payer, and at up to 15 percent in other cases.^[4] A company that has held at least 80 percent of the voting power for the 12 months ending on the declaration date pays no source-country tax, provided it is a qualified person under Article 16 or is granted benefits by the competent authority.^[4] Dividends paid by a regulated investment company or a real estate investment trust are outside the 5 percent and 0 percent rates, and a REIT dividend reaches the 15 percent rate only for the smaller holdings the article lists.^[4]

None of these ceilings apply if the beneficial owner carries on business through a permanent establishment in the payer's country, or performs independent personal services from a fixed base there, and the shareholding is effectively connected with it. Business profits or independent personal services rules then govern.^[4]

Article 11, also replaced in 2001, caps source-country tax on interest at 10 percent of the gross amount. Interest derived by a government, a political subdivision or a central bank, or by a financial institution that is unrelated to and dealing independently with the payer, is not taxed at source, although 10 percent can still apply to back-to-back loan arrangements. Interest determined by reference to the issuer's profits can be taxed at source at up to 15 percent, and some mortgage securitization income is left to domestic law.^[4] Where a special relationship pushes the interest above an arm's length amount, the article applies only to the arm's length amount and the excess stays taxable under each country's law.^[4]

Article 12, as amended in 2001, lowers the source-country ceiling on royalties from the 10 percent in the 1982 text to 5 percent of the gross amount.^[4] Royalties cover payments for copyrights, patents, designs, secret processes, trademarks and similar rights, film and broadcast recordings, provided know-how and related assistance, and sale proceeds that depend on productivity or use.^[4]^[2] The permanent establishment and fixed base exception works as it does for dividends and interest.^[2]

Residence and dual residence

Article 4 defines residence separately for each country for purposes of the convention. For the United States, it includes a U.S. corporation and, with stated qualifications, a person resident in the United States for tax purposes. For Australia, it includes an Australian corporation and, with qualifications, a person who is resident there under Australian tax law.^[2]

When an individual is a resident of both states under the article's definitions, the convention assigns residence first to the state where the individual maintains a permanent home. If a permanent home exists in both states or neither, the next stated test is habitual abode. If that test also does not resolve the question, the article looks to the state with which the individual's personal and economic relations are closer. The individual is treated as a resident only of the assigned state for that income or taxable year and for convention purposes.^[2]

Limitation on benefits

Article 16 was replaced by the 2001 protocol. A resident of one country that derives income from the other gets treaty benefits only if it is a qualified person. Individuals, the two governments, publicly listed companies whose principal class of shares is regularly traded on a recognized stock exchange, certain charities and pension funds, and entities at least half owned by qualified persons that do not pay out more than half of their gross income to non-residents all qualify. A recognized headquarters company for a multinational group can also qualify.^[4]

An entity that is not a qualified person can still claim benefits on an item of income connected with an active trade or business in its home country, other than managing its own investments. Failing that, the other country's competent authority can grant benefits if it finds that the establishment, acquisition or maintenance of the entity and the conduct of its operations did not have as one of their principal purposes the obtaining of treaty benefits.^[4] A trust or foundation that only holds investments generally cannot use the active business test, which leaves the ownership and base erosion test or a discretionary ruling. The older 1982 article, with its 75 percent ownership test and its anti-avoidance paragraph for trustees, no longer applies.^[2]

Saving clause and U.S. citizens

Article 1 contains the convention's saving clause. It states that, subject to an exception in the same article, either state may tax its residents and people electing under domestic law to be taxed as residents as if the convention had not entered into force. It also states that a state may tax its citizens on the basis of citizenship in the same manner. The provisions whose benefits are unaffected by this rule include relief from double taxation and mutual agreement procedures. As amended in 2001, the saving clause also treats a former U.S. citizen or long-term resident as a citizen, for U.S.-source income and for 10 years, when avoiding tax was one of the principal purposes of losing that status.^[2]^[4]

The convention text specifically preserves a U.S. credit rule when a U.S. citizen is resident in Australia. Article 22 says the United States allows a credit against U.S. tax for Australian income tax paid after the credit described in Article 22(2), subject to the stated limit on reducing the portion creditable against Australian tax.^[2]

Questions and answers

What source-country rate applies to dividends?

As amended in 2001, the convention caps source-country tax on dividends at 5 percent of the gross amount for a company holding at least 10 percent of the payer's voting power and 15 percent in other cases. A company holding at least 80 percent for 12 months can receive dividends free of source-country tax if it meets the limitation on benefits article. The ceilings do not apply when the shareholding is effectively connected with a permanent establishment or fixed base.^[2]^[4]

What source-country rates apply to interest and royalties?

Source-country tax on interest is capped at 10 percent of the gross amount, with no source tax for governments, central banks and unrelated financial institutions. Royalties are capped at 5 percent after the 2001 protocol. Both ceilings give way to business profits rules when the income is effectively connected with a permanent establishment or fixed base.^[2]^[4]

How does the convention resolve an individual's dual residence?

Residence is assigned first by permanent home, then by habitual abode if the home test does not decide the issue. If habitual abode also does not decide it, the text uses the closer personal and economic relations test.^[2]

Does the convention have a limitation on benefits article?

Yes. Article 16 addresses when a resident person other than an individual may receive convention relief in the other state. Its conditions concern ownership and trading activity, as well as purpose.^[2]

Related glossary terms

Limitation on benefits: A limitation on benefits article sets conditions for entities in a treaty country to qualify for certain treaty benefits under the applicable U.S. tax treaty.
Treaty rate table: A treaty rate table summarizes income categories and tax rates or exemptions under U.S. income tax treaties. The IRS explains the tables' scope and limits.
Tax residence: Tax residence describes a person's status in a country for tax purposes. Treaty texts address how it affects income items and applicable treaty requirements.