United Kingdom Tax Treaty

Transcription

1 19 November 2008 Manager Tax Treaties Unit International Tax and Treaties Division The Treasury Langton Crescent PARKES ACT 2600 Dear Sir/Madam United Kingdom Tax Treaty The Australian Financial Markets Association (AFMA) appreciates the opportunity to submit comments on the revised tax treaty with the United Kingdom (UK). AFMA is the peak industry body representing participants in Australia's wholesale banking and financial markets. Our members include Australian-owned and foreign banks, securities companies, traders and other industry service providers. Several member firms have a UK parent company and many member firms conduct operations both in Australia and the UK. AFMA welcomes the commencement of negotiations to modernise Australia s tax treaty with the UK. London is a major global financial centre, so it will benefit Australia as a capital importing economy, and enhance our competitiveness as an international financial centre in keeping with the Government s policy aspirations, if we have a fully effective tax linkage to the UK financial markets. Against this backdrop, we offer in the attachment comment on specific areas of the tax treaty where the financial services industry has encountered difficulty and where potential improvements can be made. We would appreciate your consideration of these matters during the treaty renegotiation process. Please contact me should you have any queries or wish to discuss any of the matters raised in the attachment. Thank you for your consideration of this submission. Yours sincerely David Lynch Head of Policy & Markets Australian Financial Markets Association ABN Level 3, Plaza Building, 95 Pitt Street GPO Box 3655 Sydney NSW 2001 Tel: Fax: info@afma.com.au Web:

2 ATTACHMENT Issues for Consideration for a Revised Tax Treaty with the United Kingdom 1. Interest Withholding Tax Exemption Article 11 of the current tax treaty specifies the circumstances in which interest payable by an Australian resident is exempt from Australian interest withholding tax (IWT). As stated in paragraph 3(a) of the Article, there is no obligation on the Australian resident to withhold tax for interest paid to an unrelated financial institution in the UK. The requirement for a transaction to be with an unrelated party to qualify for the IWT exemption should be removed. This can be done through an amendment to Article 11 in respect of subsidiaries of a parent company in one Contracting State that operates in the other Contracting State. Part IIIB of the Income Tax Assessment Act 1936 levies IWT on foreign bank branch funding from its parent bank. A similar IWT exemption is required and can be achieved for relevant permanent establishments of each Contracting State by amending the interaction of Articles 7 and 11. There is a strong long term case for IWT reform for both permanent establishments and subsidiaries. Direct access to parent funding on a tax effective basis would facilitate the more effective management of funding for UK-owned business branch and subsidiary operations in Australia; for example, by leveraging more directly off the economic substance and scale of the parent entity s balance sheet. This would increase competitive tension in the domestic financial markets and lower business funding costs. Moreover, this reform would assist in the long term for the development of Australia as an international financial centre, especially as branch operations are a most effective mode for the conduct of regional and global financial business. A fully effective international financial centre would facilitate the efficient movement of funds and delivery of services both out of and into Australia. The removal of IWT from related party funding, particularly for financial intermediaries in Australia with a related company operation in the UK, is especially important given the current global liquidity problems and difficult funding environment. Permanent establishments of UK financial institutions operating in Australia face the same funding challenges and IWT disadvantages as subsidiaries in the current financial markets climate. IWT reform is also required to address this problem. The ongoing credit crisis has emphasised the need for immediate reform in this area because related party funding has become more important for some foreign financial institutions in the face of tightening credit conditions. For 2

3 instance, it has been more difficult to obtain funding from the Australian market, so related party funding helps to support a prudent approach to liability management. However, the funding is more expensive than normal financing due to the interest withholding impost (5% for foreign bank branches and 10% for subsidiaries). This ultimately reduces competition and potentially the amount of credit available in the wholesale banking and securities markets through these entities. 2. Definition of Financial Institution Within the context of the Article 11 IWT exemption on interest payments made to financial institutions, a financial institution is taken to mean a bank or other enterprise substantially deriving its profits by raising debt finance in the financial markets or by taking deposits at interest and using those funds in carrying on a business of providing finance. Whilst Tax Ruling TR 2005/5 provides greater clarity around the types of financial institutions that constitute a bank in the UK, there is some ambiguity surrounding the types of institutions that may be considered other enterprises. Consequently, the application of the Article to non-bank financial institutions is not always clear. In this context we note that when the US renegotiated its tax treaty with Japan in 2005, the relevant authorities entered into a memorandum of understanding to clarify what an "investment bank" is for the purpose of the treaty. 1 An approach that separately identifies investment banks and defines them in this way provides a model that could be adapted to help clarify the scope of the Australian-UK treaty, because it would cover financial institutions that are investment banks and are not typical high street banks. We also suggest that Treasury should give consideration to facilitating the treatment of bank holding companies and wholly-owned subsidiaries of banks as being banks for the purpose of the treaty. In other words, the exemption should apply to bank groups, rather than just individual bank entities. This approach would capture the conglomerate nature of modern banking and the efficient management of risks incurred in conducting banking business through a group structure. It would also be consistent with the approach that financial regulators take to supervising banks. The benefit would be a more certain outcome for banks, taxpayers and tax administrators than the narrow entity approach, which requires the individual assessment of each and every subsidiary (of which there could be many). 3. Alienation of Property There is an issue with the interaction of Articles 7 (Business Profits) and 13 (Alienation of Property), as currently drafted, in relation to disposals by UK residents of certain direct or indirect interests in Australian real estate, mining, quarrying or prospecting rights where the associated natural resources are situated in Australia

4 Australian domestic legislation (Division 855 of the Income Tax Assessment Act 1997) only applies capital gains tax (CGT) to disposals by foreign investors of Taxable Australian Real Property (TARP). A membership interest in an Australian entity that derives its value principally from Australian real property will be TARP in the hands of the investor if the investor holds more than a 10% interest in the entity. So, disposals of 'portfolio' interests in "land-rich" entities do not give rise to CGT for foreign investors. However, if such minority interests are held on revenue account by a UK investor, gains from disposal of those interests may be subject to income tax. Whilst Article 7 would normally exempt business income from Australian tax where the person is not conducting that business through an Australian permanent establishment, the operation of paragraph 6 in Article 7 would seem to give precedence to Article 13 in determining how gains from the disposal of real property interests should be dealt with. The operation of Article 7 (paragraph 6) and Article 13 (paragraph 4) appears to allow Australia to retain taxing rights over income or (revenue) gains arising from the disposal of shares or other interests in companies - and similar interests in partnerships, trusts and other entities - where the value of the assets (held directly or indirectly) of the entity is principally attributable to real property situated in Australia. The better policy approach, and one more consistent with the treatment of investment in shares and units, would be not to tax foreign investors on portfolio holdings of less than 10% deriving value from Australian real property. It would be helpful to have this reflected in the treaty by including a limit in Article 13, paragraph 4, to only apply it to non-portfolio holdings (ie of more than 10%). 4. Scope of Royalties Article 12, paragraph 3(c), applies to the supply of ancillary and subsidiary assistance that is furnished as a means of enabling the application or enjoyment of any item in (a) or (b), being the use of, or the right to use, any copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right; or the supply of scientific, technical, industrial or commercial knowledge or information. This item is ambiguous and open to interpretation by the relevant tax authority. In particular, the application of this section to items in (b) being commercial knowledge or information could give rise to any professional opinions given in a cross border context being subject to royalty withholding tax under this definition or if the advice is seen as ancillary or subsidiary assistance. Currently there is insufficient guidance in the supplementary material with regards to the application of this paragraph. The removal of item 3c from the 4

5 definition of royalties would ensure greater certainty for taxpayers in establishing when they are required to withhold tax from a royalty payment. 5. Scope of Permanent Establishment for Rental Activities Under Article 5, paragraph 3(b), the provision of equipment for rental by an Australian taxpayer to a UK taxpayer for any period greater than 12 months creates a permanent establishment in the UK for that taxpayer. This creates an additional compliance burden for the Australian taxpayer as, absent the location of the equipment; they would not have a permanent establishment in the UK. In addition, the paragraph removes the taxing rights the Australian government would otherwise have from the Australian entity providing the equipment. The provision of equipment for rental by a UK taxpayer to an Australian taxpayer for any period greater than 12 months creates a permanent establishment in Australia for that taxpayer. The additional compliance burden for UK taxpayers reduces their appetite to provide equipment to Australian companies. The Australian company may not wish to purchase the equipment for bona fide commercial reasons such as capital outlay, technological obsolescence and equipment risk. They may need the equipment to grow their business to either enter a new market or test a new product and, given they are unsure of the success of their new venture, they may not wish to purchase the equipment for some length of time often in excess of 12 months. Some companies may seek an operating lease for this period as it is commercially viable to do so. If the venture proves to be successful, they may then seek to enter into an arrangement to purchase the equipment either outright or via a hire-purchase. The effect of the current treaty treatment is that many Australian companies are unable to obtain equipment from the UK to use in their operations for a period of a few years as a means of growing their Australian business because either the UK company does not want to incur the additional costs of compliance or the additional costs of compliance are incorporated into the pricing of the supply of the equipment. Also under Article 5, paragraph 3(b), the inclusion of the or other purposes is ambiguous and creates additional compliance obligations for entities with equipment sitting idle in a country in which they are not a tax resident. This item is harmful to both the Australian and UK economies and should be removed. We note that more recent treaties now have the phrase "operate substantial equipment" which seeks to raise the threshold of there being a PE for treaty purposes. This approach should be applied in the Australia-UK treaty to address the issues identified above, as the term "operate" is intended to mean something more active; for example, see the Explanatory Memorandum to the new Finland treaty which states: 5

6 1.64 The terms 'operation' and 'operates' have been included to clarify that only active use of substantial equipment assets will be captured by subparagraphs 4(b) and (c). This means that an enterprise that merely leases substantial equipment to another person for that other person's own use in a country would not be deemed to have a permanent establishment in that country under these provisions. However, if that other person operates the substantial equipment for or on behalf of the enterprise, the enterprise would be considered to operate the equipment in the country. For example, if a Finnish enterprise itself operates a mobile crane at an Australian port for more than 183 days in a 12 month period, the Finnish enterprise would be deemed to have a permanent establishment in Australia under subparagraph 4(c). If, however, that Finnish enterprise merely leases the mobile crane to another person and that other person operates the crane at an Australian port for its own purposes, the Finnish enterprise would not be deemed to have a permanent establishment in Australia under subparagraph 4(c). (Underlined sentence is our emphasis). 6. Associated Enterprise Profit Adjustment Time Limit Article 9, paragraph 4, of the new Australia-Japan tax treaty in effect places a time limit on the period within which transfer pricing adjustments may be made. Any enquiry into the profits of the enterprise must be initiated within seven years in order to make an adjustment under paragraphs 1 or 2 of Article 9. We believe the inclusion of a time limitation of this type in the Australia-UK treaty would provide a practical benefit to taxpayers, who could then have certainty and finality about their transfer pricing tax outcomes after a specified period of time. A seven year period provides a reasonable period of time for the tax authorities in Australia or the UK to make a relevant enquiry. In addition, we believe the treaty documentation would provide an opportunity to clarify the meaning of the term enquiry for the purpose of a provision of this nature. There is some uncertainty about its meaning in this context. To meet the objectives of the paragraph, the term should be interpreted as covering inquiries that are specific and of substance (eg not a general industry survey) and directly relevant to the assessment. We agree that the time limit should not apply in the case of fraud or willful default, or where the ability to initiate an enquiry is hindered by the enterprise. This would provide significant and appropriate tax revenue protection. ***** 6