Australia Signs New Tax Treaty With Japan

by Mary Swire, Tax-News.com, Hong Kong

08 February 2008

Australia and Japan have signed a new tax treaty to replace the existing treaty, signed in 1969.

The new treaty was signed by the Australian Minister for Foreign Affairs, Stephen Smith and his Japanese counterpart, Masahiko Koumura in Tokyo on February 1.

"The new treaty underlines the modern and sophisticated bilateral ties between Japan and Australia. It will enhance our important investment relationship, further assisting trade and investment flows, while reflecting current tax treaty policies and practices of the two countries," the two governments announced in a joint media release.

Bilateral trade between the two countries is substantial; in 2006 it totalled around AUD55 billion, with the balance of trade in Australia’s favour. Japan has also been Australia’s largest export market for 40 years, and is Australia’s third largest investor, with an investment stock of AUD51 billion as at the end of 2006.

Japanese direct investment continues to play a key role in the development of many of the export industries that have driven Australia’s export performance, and Australia is now one of the largest recipients of offshore investment by Japanese mutual funds. Japan is also the fourth largest destination of Australian investment abroad.

The new treaty provides that dividends, interest and royalties paid from one country (the source country) to a person who is a resident in the other country will generally remain taxable in both countries, but with limits on the tax that the source country may charge on residents of the other country.

These changes are expected to reduce the cost to businesses of accessing intellectual property, equity and finance for expansion. In turn, the new treaty reduces obstacles inhibiting further corporate expansion into Japan.

The new treaty will also broadly update taxation arrangements between Australia and Japan. This includes aligning capital gains tax treatment with Organisation for Economic Cooperation and Development (OECD) practice, and providing for improved integrity measures.

In addition, in response to requests from both Australian and Japanese businesses, the new treaty will streamline taxation arrangements between Australia and Japan.

Below is a summary of the technical changes included in the new treaty:

Dividends

The existing treaty includes a 15% rate limit for all dividends.

Under the new treaty, no tax will be chargeable on intercorporate non-portfolio dividends where the recipient holds directly at least 80% of the voting power of the company paying the dividend, subject to certain conditions. A 5% rate limit applies on all other non-portfolio inter-corporate dividends where the recipient holds directly at least 10% of the voting power of the company paying the dividend.

The new treaty contains a 15% rate limit on:

• distributions from Australian Real Estate Investment Trusts; and
• dividends which are paid by a Japanese company which is entitled to a deduction for dividends paid to its beneficiaries in computing its taxable income in Japan, where more than 50% of that company’s assets consist of real property in Japan.

A general limit of 10% will apply for all other dividends.

Interest

Source country tax on interest will continue to be limited to 10%. However, no tax will be chargeable in the source country on interest derived by:

• a financial institution resident in the other country;
• a body performing governmental functions (including central banks); or
• the Australian Export Finance and Insurance Corporation, any public authority that manages the investments of Australia’s Future Fund, the Japan Bank for International Cooperation and Nippon Export and Investment Insurance.

The exemptions are subject to certain safeguards.

Royalties

The general limit for royalties will be reduced from 10 to 5%. The new treaty also provides that amounts derived from equipment leasing (including certain container leasing) will be excluded from the royalty definition. Such amounts would either be treated as profits from international transport operations or as business profits.

Other features

In modernising the tax treaty arrangements in line with Australia's current tax law and treaty policies and practice, the new treaty contains:

• an expanded list of taxes covered;
• a refined definition of ‘permanent establishment’ including prescribed time limits for the creation of a permanent establishment where an enterprise is engaged in the exploration for, or exploitation of natural resources;
• comprehensive alienation of property provisions which broadly align the capital gains tax treatment with the OECD’s practice while preserving Australia’s taxing rights over Australian assets with a physical connection with Australia, such as mining rights and other interests related to Australian real property;
• improved integrity measures to provide for more effective exchange of information on a broader range of taxes, including goods and services tax;
• provision for income and gains derived by a sleeping partner in a Japanese Tokumei Kumiai arrangement to be taxed in the country where the income arises;
• a time limit of seven years for the commencement of transfer pricing audits, with no limit in the case of fraud or evasion;
• new rules to prevent tax discrimination against nationals and Australian businesses operating in Japan and vice versa; and
• a comprehensive Limitation on Benefits article to prevent abuse of the treaty.

The new treaty will enter into force 30 days after the Australian and Japanese Governments exchange diplomatic notes advising that the constitutional processes required for entry into force have been completed.

In Australia, this process involves tabling the new treaty, and a National Interest Analysis in the Parliament for review by the Joint Standing Committee on Treaties. Legislation will also be required to complete the necessary procedures for entry into force, and a Bill for that purpose will be introduced into Parliament as soon as practicable.

Upon entry into force, the new treaty will have effect according to the tenor of the entry into force provisions.

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