Bills Digest No. 107  1999-2000 Taxation Laws Amendment Bill (No. 11) 1999


Numerical Index | Alphabetical Index

WARNING:
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.

CONTENTS

Passage History
Purpose
Background
Main Provisions
Concluding Comments
Endnotes
Contact Officer and Copyright Details

Passage History

Taxation Laws Amendment Bill (No. 11) 1999

Date Introduced: 9 December 1999

House: House of Representatives

Portfolio: Treasury

Commencement: Upon Royal Assent. However, the measures contained in the Bill have different application dates, which will be considered in the Main Provisions section of this Digest.

Purpose

The amendments contained in this Bill are:

  • Measures to amend the International Tax Agreements Act 1953 to extend the scope of the alienation of real property article in 31 of Australia s double tax agreements. These measures are designed to overcome the shortcomings in certain double tax agreements revealed in the full Federal Court decision in Commissioner of Taxation v Lamesa Holdings BV(1) (Schedule 1)
  • Measures to remove the tax exemptions currently available to non-resident sportspersons (Schedule 3)
  • Measures to amend the income tax law to extend the period of time within which donations to certain funds are tax deductible (Schedule 2), and
  • Technical amendments to correct unintended consequences arising from the Taxation Law Simplification Project s rewrite of the capital gains tax provisions of the Income Tax Assessment Act 1936 (the 1936 Act) (Schedule 4).

Background

As this Bill has no central theme the background to the various measures is included in the discussion of the main provisions.

Main Provisions

Alienation of real property through interposed entities (Schedule 1)

These measures will amend the International Tax Agreements Act 1953 (the Agreements Act) to extend the alienation of real property articles in Australia s double tax agreements (DTAs) to overcome shortcomings revealed in certain DTAs by the full Federal Court in Commissioner of Taxation v Lamesa Holdings BV (1997) 77 FCR 597 (the Lamesa case). The amendments are designed to extend the scope of the alienation of real property article to situations in which interposed entities are used. The taxpayer in the Lamesa case used two interposed entities to successfully argue that the alienation of real property article was inapplicable to profits from the sale of subsidiaries and that therefore the profits were not assessable in Australia.

Background

Most countries assert the right to tax persons who are resident of that country and non-resident persons who make income from sources within that country. This system may result in double taxation if a taxpayer makes income from a foreign source. In this situation the country in which the taxpayer is resident may seek to tax the taxpayer s worldwide income and the country in which the income is sourced may seek to tax the income. Australia has 44 DTAs with other countries to prevent the double taxation of income and to counter tax avoidance. DTAs are bilateral agreements negotiated between Australia and another country. A DTA modifies each country s taxing rights to prevent double taxation. DTAs generally have an exchange of information article to enable DTA partners to prevent tax avoidance.

A DTA is to be read together with the domestic law of the treaty countries and if a conflict arises, the DTA prevails.(2) This is to ensure that a DTA achieves its aim of allocating taxing rights between the DTA countries to prevent double taxation. The only qualification to this rule is that a DTA does not prevail over Australia s general anti-avoidance provisions.(3)

DTAs generally provide that if a non-resident business operates in Australia through a permanent establishment, the business profits of the permanent establishment will be taxable in Australia. The term permanent establishment is defined in each DTA as a place of business and includes a branch of a non-resident company. If a non-resident company operates in Australia but does not have a permanent establishment in Australia, the business profits are taxable in the country of residence. DTAs generally provide, as an exclusion to the business profits article, that the profits from the alienation of real property are taxable in the country in which the real property is located.

The rules on treaty interpretation have been codified in the Vienna Convention on the Law of Treaties, to which Australia is a party. Article 31 of the Convention requires that ordinary meaning be given to the terms of a treaty, in their context, and in the light of the treaty s object and purpose.

The Lamesa case

The alienation of real property article in the Australia-Netherlands DTA is limited to direct interests in real property and does not apply to indirect interests in real property. The full Federal Court in the Lamesa case accepted the taxpayer s contention that the alienation of real property article does not apply to sales of indirect interests in real property.

In this case a US business decided to acquire an Australian mining company through interposed entities. A US limited partnership was created and it acquired an Australian subsidiary company. A Netherlands company, Lamesa BV (the taxpayer), was interposed between the US partnership and the Australian company. The Australian subsidiary (Australian Resources Limited) then acquired another Australian subsidiary (Australian Resources Mining Pty Ltd). Australian Resources Mining Pty Ltd then acquired all the shares in a listed mining company, Australian Resources and Mining Company NL, through a takeover. Australian Resources and Mining Company NL owned a subsidiary, Arimco Mining Pty Ltd which owned mineral exploration rights. The ownership structure was:

A Netherlands subsidiary was used to enable the principals to use the Australia-Netherlands DTA. The taxpayer sold the shares in Australian Resources Ltd in 1994 and 1996. The profits assessed to Lamesa were $76,693,888 for the 1993-94 income year and $128,022,859 for the 1995-96 income year. The issue was whether the alienation of real property article in the Australia-Netherlands DTA applied to the profits derived by the taxpayer. If the article applied, Australia had the right to tax these profits. If the article did not apply, the taxing right rested with the Netherlands but the Netherlands never asserts its right to tax such profits. Consequently, if the alienation of real property article was held to be inapplicable Lamesa s profits would be tax-free.

The Commissioner of Taxation argued that the taxpayer was subject to tax under the alienation of real property article of the Australia-Netherlands DTA. The Commissioner argued that this article applies to direct and indirect interests in real property. The Commissioner contended that the court should look through the interposed entities and apply the alienation of real property article to Lamesa s indirect interest in the gold mining leases. The difficulty for the Commissioner was that the alienation of income article expressly refers to indirect interests in real property rather than just referring to interests in real property. The central theme of the Commissioner s contentions was that the Federal Court should ignore the restriction of the interests in the real property article to direct interests. The taxpayer contended that the alienation of real property should be literally interpreted and that it did not apply to the taxpayer s indirect interests in the gold mining leases.

The full Federal Court held that the alienation of real property article does not apply to indirect interests in real property. The court also found that it was probably the policy of the agreement to restrict the alienation of real property article to direct interests, because of the complexity that arises from extending the article to several layers of companies. Their Honours said that if the article were to apply to several layers of companies one would have to develop a system for measuring the indirect ownership interests. Such a measure would be complex. Their Honours also stated that another uncertainty is whether indirect interests would apply to wholly owned subsidiaries or partly owned subsidiaries. In considering these issues their Honours concluded that:

It seems to us quite consistent with rational policy that the agreement is intended to assimilate as reality only one tier of companies rather than numerous tiers. Separate legal personality is a doctrine running not only through the common law but the civil law as well. No suggestion is made to the contrary. That is consistent with the plain and quite unambiguous language which the agreement has employed. When legislation speaks of the assets of one company it invariably does not intend to include within the meaning of that expression assets belonging to another company, whether or not in the same ownership group. In Anglo-Australian law the proposition found early illustration in Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89 where Cozens-Hardy MR said (at KB 95-96):

The fact that an individual by himself or his nominees holds practically all the shares in a company may give him the control of the company in the sense that it may enable him by exercising his voting powers to turn out the directors and to enforce his own views as to policy, but does not in any way diminish the rights or powers of the directors, or make the property or assets of the company his, as distinct from the corporation s. Nor does it make any difference if he acquires not practically the whole, but absolutely the whole, of the shares. The business of the company does not thereby become his business. (Emphasis added.)

In these circumstances the language of the agreement should be given effect. This is not to adopt a narrow or 'illiberal' view of the agreement. It is merely to interpret the language of the agreement in light of juridical allocation which the agreement embodies.(4)

DTAs may only be altered with the agreement of both countries. If shortcomings are revealed in a DTA both countries must agree to the amendments. If a country amends its domestic law to alter the effect of a DTA there is a risk that a taxpayer may enforce the DTA in a court of law. The technique of purporting to unilaterally alter a DTA is called treaty override . The OECD made the following comments on treaty override in its 1989 Report on Tax Treaty Overrides:

The certainty that tax treaties bring to international tax matters has, in the past few years, been called into question, and to some extent undermined, by the tendency in certain States for domestic legislation to be passed or proposed which may override provisions of tax treaties. In this note, which looks at the consequences of such action by national legislators, the term 'treaty override' refers to a situation where the domestic legislation of a State overrules provisions of either a single treaty or all treaties hitherto having effect in that State.(5)

In June 1999 the US Court of Federal Claims overturned domestic US legislation which sought to alter the application of the US-UK DTA.(6) The US court held in favour of the taxpayer that the domestic legislation was inconsistent with the DTA and that the DTA prevailed.

The conclusions of their Honours in the Lamesa case that the alienation of real property article should be restricted to direct interests reflects the policy of the Australia-Netherlands DTA.

Proposed amendments

Schedule 1 proposes an amendment to the International Tax Agreements Act 1953 (the Agreements Act). The amendment purports to extend the scope of the alienation of real property article to indirect interests in all Australia s tax agreements settled before 1998. This is an example of treaty override, as the Australian Government is amending Australia s domestic law to overcome a perceived shortcoming in some of Australia s DTAs. Given the recent treaty override case in the US, there is a risk that the proposed unilateral amendments may be challenged by a taxpayer in court.

Item 1 of Schedule 1 proposes the inclusion of section 3A in the Agreements Act. The purpose of the proposed amendment is to extend the scope of the alienation of real property article to indirect interests in land.

The threshold requirements for the application of the provision are:

  • the DTA must make provision for income, profits or gains from the alienation of shares or comparable interests in companies whose assets are principally of real property (proposed paragraph 3A(1)(a)), and
  • the Agreements Act gave that provision the force of law before 27 April 1998.

Each of Australia s DTAs enacted since April 1998 includes an alienation of real property article which expressly applies to both direct and indirect interests in land. Three new DTAs have been enacted since April 1998. These DTAs came into effect in December 1999.

The operative provision is proposed subsection 3A(2) which states that alienation of income provisions in Australia s treaties are extended to indirect interests in real property held through interposed entities. If the value of the interposed entities is principally attributable to real property, this subsection allows the alienation of real property article to apply to any interests in interposed entities.

Proposed subsection 3A(3) limits the application of the proposed provision to real property located in Australia. This feature of the proposed amendment makes the alienation of real property articles in the affected treaties not uniform. The proposed amendment expands Australia s taxing rights under the alienation of property article to include indirect interests in land. If the land is located outside Australia, the other country s taxing right is limited to direct interests in land. The proposed amendment would directly conflict with the statement of principle by the Full Federal Court in the Lamesa case that 'the agreement [DTA] must operate uniformly whether the realty is in the Netherlands or Australia'. This aspect of the proposed amendment indicates that Australia is proposing to engage in treaty override and could potentially lead to double taxation.

For example, if an overseas taxpayer makes a gain from the sale of an indirect interest in land in Australia, the country in which the taxpayer is resident may assert its right to tax the gain under the business profits article of its DTA with Australia. Under the proposed amendment, Australia would seek to tax the same gain because the taxpayer has sold an indirect interest in Australian land. This would result in double taxation. It is this type of double taxation that a DTA is designed to prevent by uniformly allocating taxing rights between the DTA countries.(7)

Proposed subsection 3A(4) directs that if any of the affected alienation of real property articles are amended, then proposed section 3A will no longer apply to that article. This provision reveals the temporary nature of proposed section 3A which seeks to override the effect of the Lamesa case pending the renegotiation of the affected real property articles in Australia s treaties. However, non-resident taxpayers are unlikely to accept that the proposed amendment overrides the principle in the Lamesa case until the affected alienation of real property articles are renegotiated and enacted. Moreover, an overseas investor may use a Netherlands subsidiary to undertake similar activity in Australia and directly enforce the principle in the Lamesa case. This course of action is unlikely to be prevented until the alienation of real property article in the Australia-Netherlands DTA is renegotiated.

Consequences arising from the findings of the full Federal Court in the Lamesa case

The Federal Court in the Lamesa case stated that it was unlikely that the alienation of real property article applies to indirect interests. Firstly, their Honours stated that if the alienation of real property article is to apply to indirect interests complex measurement rules are required. Their Honours stated that an example of the complexity which a comprehensive provision assimilating land rich companies to land may give rise is to be found in the provisions of the Stamp Duties Act 1920 (NSW) Div 30 and comparable provisions in other states. (8) Secondly, their Honours stated that the degree of complexity required would depend on whether the policy was to deal with wholly owned subsidiaries or partly owned subsidiaries. Greater complexity would arise from applying such a rule to partly owned subsidiaries.

Proposed subsection 3A purports to apply to indirect interests in land through interposed companies which are held through either wholly or partly owned companies. Proposed subsection 3A does not contain the complex rules assimilating land rich companies to land which their Honours said would be required. If proposed subsection 3A were held to be valid a court may be unable to determine the attribution for the purposes of the alienation of real property article.

Application

The amendments in Schedule 1 apply to income, profits or gains from the alienation or disposition of shares or interests after 12 noon on 27 April 1998. This measure was announced by Treasurer s Press Release No. 39 of 27 April 1998.

The OECD Model Tax Treaty

The model tax treaty used as a basis for negotiations between developed countries is the OECD Model Tax Convention on Income and Capital (the OECD Model Treaty). In 1980, the United Nations developed a model for developing countries titled the United Nations Model Convention for Tax Treaties Between Developed and Developing Countries. Australia's DTAs are based on the OECD Model.(9)

Article 13 of the OECD Model Treaty deals with the alienation of real property. It only applies to the alienation of direct interests in real property. On the issue of alienation of indirect interests in real property, the OECD made the following comments in its Commentary on the 1992 Model Treaty:

Certain tax laws assimilate the alienation of all or part of the shares in a company, the exclusive or main aim of which is to hold immovable property, to the alienation of such immovable property. In itself para 1 [of article 13] does not allow that practice: a special provision in the bilateral convention can alone provide for such assimilation. Contracting States are of course free either to include in their bilateral conventions such special provision, or to confirm expressly that the alienation of shares cannot be assimilated to the alienation of the immovable property.(10)

This statement was contained in the 1977 OECD Model Treaty.(11) The potential for an alienation of real property to be avoided through the use of interposed entities has been documented by the OECD. The OECD in its 1989 Report on Tax Treaty Override considered the type of problem revealed in the Lamesa case. The OECD in the following statement advocates treaty renegotiation as the only effective way to overcome this problem.

31. State B taxes gains from the alienation of immovable property. Taxpayers have found a way to avoid paying the tax by interposing, in State B, a company between themselves and the property and by selling the shares in the company rather than the immovable property itself. State B cannot tax the gain from the sale of the shares as its tax treaties follow Article 13 of the OECD Model Convention. State B legislates that the sale of shares in any real estate company is deemed to be a sale of immovable property for the purpose of the application of its tax treaties.

32. The effect of such legislation is in contravention of State B's tax treaty obligations, even though the overriding measure is clearly designed to put an end to the improper use of its tax treaties. . . .

33. Override of the kind described in paragraph 31 above could justify termination by State B's tax treaty partners under Article 60 of the Vienna Convention. However, . . . this route may do more harm than good. Partial suspension under that Article (restricted to the provision State B is not respecting) by State B's partners might be an adequate response but it would only leave things as they are. As an alternative, partners of State B could show willingness to solve the problem by an adequate and quick revision of its treaties.(12)

The Explanatory Memorandum to the Bill lists the 31 DTAs to which this amendment applies.(13) The Explanatory Memorandum also states that the result in the Lamesa case is inconsistent with the anti-avoidance provisions of this type, as evidenced by the Commentary on the comparable provision of the United Nations Model Tax Convention. The OECD Model Treaty in the Explanatory Memorandum is not, however, referred to.

Concluding Comments

The Lamesa case highlights one feature of having a network of DTAs — where a shortcoming is revealed in an article, then all the affected DTAs must be renegotiated to correct the shortcoming. The renegotiation and redrafting of treaties is a lengthy and time consuming process. Changes to treaties are not effective until there is a bilateral agreement which is enacted. Unilateral amendments of treaties by domestic legislation are likely to be treated by the courts as treaty override and held to be ineffective. On this issue the OECD stated in its Report on Treaty Overrides that:

The Committee [on Fiscal Affairs] recognizes that treaty negotiations, and renegotiations, are indeed time consuming but this is a factor which is common to all bilateral negotiations where a proper balance of advantage to both sides has to be found. Any unilateral abrogation of specific obligations destroys such balance and must be condemned.(14)

The potential avoidance of alienation of real property articles was first documented by the OECD in 1977. It was also highlighted in 1989 in the OECD's Report on Treaty Override. The principals in the Lamesa case may have used the OECD's comments on the alienation of real property article in its Model Treaty in arranging their acquisition of shares in Arimco Mining.

Another concern is the reaction of Australia s tax DTA partners to the proposed amendments to the alienation of real property article. The Minister's second reading speech states that Australia s DTA partners in the 31 affected treaties have been consulted on the proposed amendments but no reference is made on their views of the proposed amendments. The delay of 20 months between announcement of the measures and introduction of the legislation is curious. While this measure is described as being a response to protect revenue, the significant delay between announcement and introduction of the measures also raises the issue of whether the measures are likely to be effective.

Income of non-resident sportspersons, clubs and associations (Schedule 3)

Schedule 3 proposes to repeal exemptions from income tax for non-resident sportspersons, clubs and associations.

Background

Subparagraph 23(c)(i) of the Income Tax Assessment Act 1936 (the 1936 Act) exempts from income tax the earnings of sportspersons in Australia if the following requirements are satisfied:

  • the sportsperson is a representative of the controlling body of any outdoor athletic sport or game in the person s country, and
  • the sportsperson participates in contests in that sport in Australia.

Subparagraph 23(c)(ii) of the 1936 Act exempts from income tax the earnings of a non-resident sports club or association if the following requirements are satisfied:

  • the association is from a Commonwealth country
  • the club or association represents the controlling body of the sport, and
  • the team representing the club or association plays cricket, football or similar matches.

Paragraph 23(g) of the 1936 Act exempts from income tax non-profit bodies established for the encouragement or promotion of any sport. This provision is not restricted to resident bodies and would therefore be available to non-resident non-profit bodies. Subparagraphs 23(c)(i) and (ii) are original provisions of the 1936 Act. The provisions pre-date professional sport and the development of arenas to play certain sports indoors or outdoors. For example, swimming and tennis may now be played at indoor venues. The Colonial Stadium (Docklands) in Melbourne will provide the opportunity for cricket and football to be played indoors for the first time in Australia.

It should be noted that the exemption from Australian income tax provided by subparagraph 23(c)(i) to certain non-resident sportspersons does not mean that such income is tax-free in the hands of the sportspersons. Non-resident sportspersons will generally be assessable in their country of residence in respect of their income earned overseas.

Repeal of the exemptions

The Explanatory Memorandum states that subparagraph 23(c)(i) leads to inconsistent tax treatment because it is only available for outdoor sports.(15) To resolve this inconsistency Item 1 of Schedule 3 proposes to repeal subparagraph 23(c)(i). The Explanatory Memorandum states that inconsistencies also arise from subparagraph 23(c)(ii) the restriction of the exemption to clubs and associations from Commonwealth countries.

The purpose of the amendments is described in the Explanatory Memorandum as being to provide for all non-resident sportspersons and their clubs or associations to be taxed on a similar basis.(16) No reference is made to the fact that the proposed amendments commence before the Sydney Olympics and that the measure will expand the income tax base. It would be surprising if the Olympics were not the motivating force for the repeal of subparagraphs 23(c)(i) and (ii). Nevertheless, the provisions have been income tax anachronisms at least since the development of professional sport in the 1960s.

Application

The amendments made by Schedule 3 apply to income derived after 30 June 2000.

Extension of period for certain gifts (Schedule 2)

Schedule 2 amends the Income Tax Assessment Act 1997 (the 1997 Act) to extend the period of time in which gifts to certain funds are tax deductible.

Division 30 of the 1997 Act provides deductions for donations of $2 or more to certain funds or organisations. For a fund or organisation to qualify for tax deductible status it must be listed in Division 30. The period of time in which a tax deductible donation may be made to a fund or organisation may be limited. The amendments proposed by Schedule 2 extend the period in which a deductible gift may be made for three specific funds.

The Shrine of Remembrance and Restoration and Development Trust was created for the sole purpose of providing funds for the benefit of the Shrine of Remembrance in Melbourne. Item 1 extends the period in which a tax deductible donation may be made to the fund to 30 June 2005. This extends the tax deductible period by 6 years.

The Australian National Korean War Memorial Trust Fund was established to raise funds for the construction of a memorial on Anzac Parade in Canberra. Item 2 extends the period in which a tax deductible donation may be made to the fund to 1 September 2000. This extends the tax deductible period by 1 year.

St Patrick s Cathedral Parramatta Rebuilding Fund was established to raise funds to rebuild St Patrick s Cathedral in Parramatta. The Cathedral was destroyed by fire in 1996. Item 3 extends the period of time in which a tax deductible donation may be made to the fund to 24 February 2002. This extends the tax deductible period by 2 years.

Technical amendments (Schedule 4)

Schedule 4 will amend the 1936 Act, 1997 Act and Income Tax (Transitional Provisions) Act 1997 to correct errors arising from the redrafting of the capital gains tax provisions. The Explanatory Memorandum states that since the capital gains tax provisions were redrafted certain unintended consequences were identified.(17) The Explanatory Memorandum states that the proposed amendments merely reinstate the position of the 1936 Act and that there is no change in policy.(18)

Endnotes

  1. (1997) 77 FCR 597.

  2. Subsection 4(2) of the International Tax Agreements Act 1953.

  3. Under subsection 4(2) of the International Agreements Act 1953 a DTA does not prevail over Part IVA (the general anti-avoidance provisions) or section 160AO (maximum tax credits) of the Income Tax Assessment Act 1936.

  4. Federal Commissioner of Taxation v Lamesa Holdings BV (1997) 36 ATR 589 at 598 9.

  5. OECD Committee on Fiscal Affairs, Report on Tax Treaty Overrides (1989), para 2.

  6. National Westminster Bank, PLC v United States unofficially reported at 1999 WTD 132-133.

  7. Federal Commissioner of Taxation v Lamesa Holdings BV (1997) 36 ATR 589 at 598.

  8. Federal Commissioner of Taxation v Lamesa Holdings BV (1997) 36 ATR 589 at 597.

  9. The High Court in Thiel v Federal Commissioner of Taxation (1990) 171 CLR 338 stated that the DTA between Australia and Switzerland was based on the OECD Model Treaty, at 348-9 and 357. Enfield J of the Federal Court, the judge at first instance in Lamesa Holdings BV v FCT (1997) 35 ATR 339, stated at 242 that Australia s DTAs are based on the OECD Model Treaty.

  10. OECD Model Tax Convention on Income and Capital, (1992) Commentary on Article 13, para 23.

  11. 1977 OECD Model Convention for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital, para 23.

  12. OECD, Report on Tax Treaty Overrides (1989), paras 31 to 33.

  13. Explanatory Memorandum to Taxation Laws Amendment Bill (No. 11) 1999, para 1.8.

  14. OECD, Report on Tax Treaty Override (1989), para 37.

  15. Explanatory Memorandum to Taxation Laws Amendment Bill (No. 11) 1999, para 3.4.

  16. ibid, para 3.7

  17. ibid, para 4.2.

  18. ibid, para 4.3.

Contact Officer and Copyright Details

Michael Kobetsky
22 February 2000
Bills Digest Service
Information and Research Services

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ISSN 1328-8091
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