The proposed amendment will, however, simply ensure that the existing provisions in the Alienation of Property Article of our DTAs are rendered fully effective in achieving their intended purpose of addressing alienations of Australian real property.  It prevents easy avoidance of the intent of the Article by, for example, insertion of one or more corporations to take advantage of the separate legal personality of corporations. 

To understand this aspect of the proposed measure, it is important to recognise that the Alienation of Property Article in our DTAs provides a taxing right to the country in which real property, as defined in the Agreement, is situated, in cases where the property is alienated.  This right specifically extends, in the DTAs affected by this legislation, to cover effective alienations of ‘incorporated’ real property through the alienation of shares in a company, the assets of which consist wholly or principally of such real property.

The object and purpose of such ‘incorporated real property’ provisions is best expressed in the official Commentary to the comparable provision of the United Nations Model Double Taxation Convention, which provides that:  ‘This paragraph is designed to prevent the avoidance of taxes on the gains from the sale of immovable property.  Since it is often relatively easy to avoid taxes on such gains through the incorporation of such property, it is necessary to tax the sale of shares in such a company.’

It follows that for an ‘incorporated real property’ provision to be fully effective, it must apply to ‘incorporated’ real property held through interposed entities. 

To have taken an approach of renegotiating all the affected DTAs (which number more than thirty) rather than legislating, would have involved major delays and costs.  It could have sent the signal that we will only move with the agreement of all DTA partners, and some countries (especially those lacking the land and mineral wealth of Australia) might, whether they share our understanding of the provision’s intent or not, have sought a ‘quid pro quo’ for the DTA amendment that we could not give.  However, for DTAs concluded subsequent to the Treasurer’s Press Release, it has been Australia’s practice to deal with the matter during negotiations and to ensure that the wording of the DTA is unequivocal on this issue.

Australia has been very open with its DTA partners about the proposed legislation.  They were notified by letters from the Commissioner of Taxation dated 28 April 1998 (following the Treasurer’s Press Release of the previous day announcing the proposed legislation) and from the Acting Commissioner of Taxation dated 15 December 1999 (following the introduction of the legislation in Parliament).  Australia has also outlined its position to the appropriate OECD forum for discussion of tax treaty issues.

Should any of our DTA partners request bilateral treaty renegotiations on the issue, Australia has offered to negotiate an amendment to relevant DTAs to the same effect as the legislation, but with the legislation operating in the meantime, as provided for in paragraph 4 of Clause 3A of the Bill.  This strikes a balance between the bilateral character of the DTA relationship, and the need to act quickly to confirm what we regard as the allocation of taxing rights intended under the DTAs.  While it appears that most countries do not regard renegotiation as necessary, productive negotiations have already commenced with two countries on this basis.

The Committee expressed concern that the four countries who have objected to Australia’s proposed legislative action (Belgium, the Netherlands, Singapore and New Zealand) may seek to terminate their DTAs with Australia as a consequence of the Government’s legislative action.  However, I am advised by the ATO that New Zealand has effectively withdrawn its objection and that it is extremely rare for countries to terminate DTAs given their broad trade and investment effects and the wider impact on international relations.  The ATO is confident that the objections by the other three countries can be satisfactorily dealt with by the offer to renegotiate the relevant provisions of the affected DTAs on a bilateral basis.

Article 27 of the Vienna Convention on the Law of Treaties, which was referred to by the CTA, is designed to ensure that countries do not rely on their constitutions or other domestic laws as the reason why they cannot meet their treaty obligations.  Here there is no failure to meet our DTA obligations, and we are not relying on the legislation in the fashion contemplated by that provision.  Rather, the proposed legislation is simply designed to clarify the intention of the relevant DTA provisions following a decision which was open to the court on the wording of those provisions, but which, it is considered, does not fully reflect the intent of the provisions as negotiated.

I understand that the Committee expressed concerns during the 23 May hearing at the possibility raised by the CTA of the amendment in the Bill being declared invalid by the courts on the grounds of it being in breach of our treaty obligations.

As I have already indicated, however, the amendment is consistent with the intended operation of the relevant provisions of the affected DTAs and is not considered to conflict with our treaty obligations.  In any event, the amendment is to legislation within the power of the Commonwealth Parliament and I am advised by the ATO that there is a series of Australian High Court decisions which establish that the validity at international law of a clearly expressed provision in such legislation will not be questioned in a court of law in Australia.

Six month rule

The CTA have submitted that, in accordance with the ‘six month rule’ regarding the announcement of legislation by press release, the date of the commencement of the Bill should be 9 December 1999.

The proposed legislation was delayed for a number of reasons, most notably the federal election in 1998 and the amount of time required for the Commissioner of Taxation to consult and discuss the proposals with representatives of the 32 affected double taxation agreement partners.  The feedback from these consultations and meetings were factored into the form of the legislation, as was our experience of developments in the OECD and UN fora.

The CTA have also submitted that ‘an effective date of 9 December 1999 should not frustrate the Government’s intention.  The issue of the Press Release has already had the effect of discouraging properly advised taxpayers from commencing a “Lamesa-style” transaction after 27 April 1998.  Accordingly, even if the legislation is introduced with effect from 9 December 1999, the effect of the Press Release will be that, practically speaking, the Government’s intention will have been widely known and regarded as “de facto” law from 27 April 1998.’

I strongly disagree with the CTA’s comments regarding their proposal for the commencement date to be altered to 9 December 1999 in accordance with the Senate’s 6 month rule.  This would allow those who chose not to fall in with the Government’s intention as announced by the Treasurer on 27 April 1998 to escape the application of the amendment.

Retrospectivity and transactions in progress

The CTA have expressed the view that the Bill should not apply where there is objective evidence that a relevant transaction was under way at the date of the Press Release and have submitted a draft application provision reflecting their view.  The CTA argues that ‘during the period prior to 27 April 1998, taxpayers were entitled to act in accordance with settled law, including the decision in Lamesa’.  The CTA also proposes that if the commencement date for the legislation is ultimately later than proposed in the Bill, the legislation should exclude cases where there is objective evidence of the transaction being under way at that later date.

I do not consider that such exceptions should be made.  The Commissioner of Taxation’s position has always been that the taxing right under the DTAs could only be effective if it applies despite the existence of interposed entities, and that the DTA should be interpreted accordingly.  This understanding by the Commissioner would be evident to a reader of the Court’s judgment.

The Lamesa decision created opportunities for relatively easy tax planning to avoid the taxing right accorded to Australia by the relevant provisions of the DTAs, with serious revenue consequences, and the tax profession would have been aware that this was a situation the Government was unlikely to countenance.

Although the CTA have argued that prior to the date of the Treasurer’s Press Release, taxpayers were entitled to act in accordance with settled law, including the decision in Lamesa, the tax profession would have been aware that some form of remedial action in response to the Court’s decision was likely.  Prior to the Treasurer’s Press Release, the media reported an Assistant Commissioner of the Australian Taxation Office stating ‘the ATO was reviewing the decision’.  The decision was also the subject of Parliamentary questions during that period.  In addition, it is not unprecedented for the Government of the day to close off risks to the revenue exposed by an adverse Court decision, and a like precedent to the proposed provision exists in subsection 3(11) of the International Tax Agreements Act 1953 covering permanent establishments of business trusts that was enacted in 1984.

The delay in the Treasurer’s announcement of remedial action was due to the need for careful consideration by the Commissioner and the Government of the various ways in which Australia could act to preserve its taxing rights, which might otherwise be significantly undermined by leaving the effects of the decision unaddressed.  Given the number of Australia’s DTAs involved and the ramifications of the Government’s remedial action, it was essential that the Government’s response be very carefully considered and this took some time.

The approach outlined in the Treasurer’s Press Release of 27 April 1998 was decided upon, as a fair and balanced approach which reflected the intent of the DTA provisions, but did not affect already completed alienations.

It has not been possible to exactly quantify the risk to the Revenue, because of the absence of data due to the transactions occurring offshore and the Australian assets being held indirectly.  However, the Lamesa case involved a revenue loss of approximately $74 million (the tax payable on the $204 million profit) and the Government is also aware of another case involving $79 million tax payable on an alienation that occurred after the 27 April 1998 Press Release.  Those known cases are indicative of the potential revenue risk involved.

To make exceptions where alienations had not occurred, but were in train at the time of the Press Release, would put such arrangements in a privileged position (as compared with later transactions, or transactions without interposed entities) that would not appear to be justified, and would involve a large potential risk to the revenue.  It would also allow for the argument that alienations a long time into the future were set in train prior to the Press Release, even if the alienation did not occur for months or perhaps even years later.  A provision fairly dealing with transitional cases might also have to deal with each case on a factual, case by case, basis that could create uncertainties of its own.

Some of the legislation referred to by the CTA shows the difficulty of constructing a transitional regime that is effective and does not itself give the opportunity for tax avoidance, or preserve a competitive advantage for long periods of time.  The Australian Tax Office advises that it is not aware of any rulings being sought on the issue during the period while consideration was being given to the most appropriate response.  For all these reasons, I consider that a transitional arrangement is not warranted in the proposed legislation.

Certainty

The CTA has also suggested that the terms ‘alienation’ and ‘disposition’ should be defined in the proposed legislation, for the sake of certainty.  The language used (‘alienation or disposition’) does no more than reflect the language of the DTAs themselves.  Some DTAs refer to ‘alienation’ and some refer to ‘alienation or disposition’.  Neither the DTA nor the legislation seek to define what those terms mean, since they have broad international meanings.  The ATO advises that this broad interpretation is well recognised, including by commentators and the OECD Model Tax Convention Commentary.  The DTAs therefore accord a taxing right in respect of legally effective alienations or dispositions broadly defined, and in a practical sense, the domestic taxation laws reflect that broad coverage, whether or not they use those exact terms.

The lack of a definition in the DTAs follows normal international practice (as in the OECD and United Nations Model DTAs, for example) and did not attract criticism in the Lamesa decision.  Nor has it been a point of criticism of our DTA practice.  The CTA has been represented on the ATO’s Tax Treaties Advisory Panel, which advises the Australian Tax Office on proposed new DTAs, and while the ATO advises that the issue has not arisen in that context, it is one that the CTA is certainly entitled to raise in that forum, especially in the context of the current review of DTA policy.  I do not, however, consider that the proposed legislation should address the issue.

In conclusion, then, I do not see the proposed legislation as trespassing unduly on personal rights and liberties, but as effectively confirming Australia’s negotiated taxing rights, and operating in a manner that is fair to taxpayers generally, as well as those directly affected.

I trust that the above information is useful in the Committee’s deliberations in relation to these matters.

Yours sincerely

ROD KEMP

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