TAX NEWS - april 2010
Australia Tax Alert: ATO rules U.S. limited partnership not treated as company under Australia - U.S. treaty
The interpretative decision is of interest not only for its conclusion, but also for the process of treaty interpretation adopted by the ATO. The decision also includes some brief comments about treaties and fiscally transparent entities.
Reduced withholding tax rate
Under article 10 of the Australia - U.S. treaty, certain cross-border intercorporate dividends flowing between Australia and the U.S. are either:
- Subject to a maximum 5% rate of source country tax if the person beneficially entitled to the dividends is a company that holds directly at least 10% of the voting power in the company paying the dividends; or
- Exempt from source country tax where the person beneficially entitled to the dividends is a company that has owned shares representing 80% or more of the voting power of the company paying the dividends for a 12-month period ending on the date the dividends are declared, and satisfies certain other conditions.
If neither test is met, the default rate of source country tax is 15%. To qualify for the reduced tax rates, the person beneficially entitled to the dividend must be a "company." The ATO proceeds on the basis that U.S. LP is beneficially entitled to the dividend.
Definition of company
Under article 3(1)(b) of the treaty, unless the context of the treaty otherwise requires, a company means:
a) A body corporate; or
b) An entity that is treated as a company or body corporate for tax purposes.
The term "body corporate" is not defined in the treaty. The interpretative decision begins with an analysis of the ordinary meaning of the term in Australia, and concludes that a U.S. limited partnership is, prima facie, a body corporate under the ordinary meaning of the term in Australia, on the basis that it is a separate legal entity.
Furthermore, for Australian domestic tax purposes, a U.S. LP broadly will be treated as a company for tax purposes. For U.S. tax purposes, the term body corporate is not specifically defined.
The ATO asserts that the definition should be interpreted in light of the context of the treaty. The interpretative decision refers to the OECD Commentary on the definition of company, which provides as follows:
The term 'company' means in the first place any body corporate. In addition, the term covers any other taxable unit that is treated as a body corporate according to the tax laws of the Contracting State in which it is organized. The definition is drafted with special regard to the Article on dividends. The term "company" has a bearing only on that Article, paragraph 7 of Article 5, and Article 16.
Based on the OECD Commentary, the ATO concludes that the first limb of the test (i.e. whether it is a body corporate) carries an implied test that the entity is treated as a "taxable unit."
According to this approach, the relevant tax laws will be those of the state in which the entity is organized, which will be the U.S., and not Australia. For U.S. federal tax purposes, a U.S. LP is neither a body corporate nor a taxable unit. As a result, the ATO considers that a U.S. LP is not a body corporate and, therefore, should not qualify for the reduced withholding tax rate under the treaty.
As noted in the interpretative decision, this technical interpretative approach is in line with the rationale underlying the reduced tax rates for intercorporate dividends under the treaty. There is arguably no rationale for granting the reduction in (or exemption from) source country withholding tax where the recipient of the dividend is not taxed as a company in the country of residence.
The ATO also notes that this conclusion is consistent with the U.S. position for tax treaty purposes, which is that a U.S. partnership that does not elect to be taxed as a corporation will not be a company for U.S. treaty purposes.
Fiscally transparent entities
The interpretative decision notes that U.S. LP is a "resident" of the U.S. for tax treaty purposes within the meaning of article 4(1)(b)(iii) of the treaty, because that article treats a U.S. partnership as a U.S. resident for treaty purposes to the extent the income it receives is subject to U.S. income tax either in its hands or in the hands of a partner. The determination also comments that the U.S. treaty is unusual, in that it applies treaty benefits for income derived through fiscally transparent entities, such as a partnership at the level of the entity (in this instance, U.S. LP).
ATO Interpretative Decision 2010/81 concludes that, for the purposes of Australia-U.S. tax treaty, a U.S. limited partnership that is treated as a partnership for U.S. tax purposes is not a company under article 10 of the treaty and does not qualify for either of the reduced rates for cross-border dividends flowing between Australia and the U.S.