Withholding Tax: entitlement to reduced treaty rate for unfranked dividends passing through an entity that is a resident of a non treaty country

Will the taxpayer, an entity which is resident in a treaty country and which is beneficially entitled to unfranked dividends from Australian companies, be subject to withholding tax under subsection 128B(4) of the Income Tax Assessment Act 1936 (ITAA 1936) on those dividends at the rate stipulated in the double tax agreement (DTA) that Australia has with that treaty country, when those dividends pass through an arm's length interposed entity that is not a resident of a treaty country?

Yes. Even though the withholding tax rate for the purposes of subsection 128B(4) of the ITAA 1936 would have been 30%, section 17A of the International Tax Agreements Act 1953 (Agreements Act) operates to limit the withholding tax rate to that stipulated in the DTA. The reduction in the rate of withholding tax will occur because only the taxpayer (not the interposed entity) is beneficially entitled to the dividends and the taxpayer is a resident of a country to which Australia has entered a double tax agreement (DTA).

The taxpayer, a non-resident entity, has invested in Australian company shares through an arm's length entity in a third country.

The taxpayer is beneficially entitled to unfranked dividends.

The taxpayer is a resident of a country with which Australia has a DTA.

The investment vehicle is not a resident of a country with which Australia has a DTA.

The investment vehicle is treated as a 'look through' entity and is not taxed on the dividends.

The investment vehicle is not beneficially entitled to the unfranked dividends.

Subsection 128B(1) of the ITAA 1936 provides that, subject to certain exclusions, section 128B of the ITAA 1936 will apply to income derived by a non-resident that consists of a dividend paid by an Australian resident company (franked dividends are specifically excluded from the operation of section 128B by paragraph 128B(3)(ga) of the ITAA 1936).

Subsection 128B(4) of the ITAA 1936 provides that a person who derives dividend income to which section 128B of the ITAA 1936 applies, is liable to pay withholding tax on that dividend income. The withholding tax rate applicable is generally 30% of the dividend amount (section 7 of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 ).

Unfranked dividends derived by the taxpayer from Australian resident companies are therefore subject to withholding tax.

However, in determining liability to Australian tax on Australian source income derived by a non-resident, it is necessary to consider not only the income tax laws but also any applicable DTA contained in the Agreements Act .

Section 4 of the Agreements Act incorporates that Act with the ITAA 1936 and the Income Tax Assessment Act 1997 (ITAA 1997) so that those Acts are read as one. The Agreements Act effectively overrides the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except for some limited provisions).

The Article in the DTA that deals with dividends provides that dividends derived from an Australian resident company which are beneficially owned by a resident of the foreign country may be taxed in Australia, but the tax is not to exceed 15% of the gross amount of the dividends.

As the taxpayer beneficially owns the dividends, the Article in the DTA will apply, notwithstanding that the dividends flow through an interposed arm's length entity.

Subsection 17A(1) of the Agreements Act further provides that the amount of withholding tax imposed shall not exceed the tax limit specified in the DTA, if a limit is so specified. Therefore, section 4 of the Agreements Act will operate to override the general rate of withholding tax that would apply under subsection 128B(4) of the ITAA 1936.

Accordingly, the unfranked dividends derived by the taxpayer are subject to withholding tax under subsection 128B(4) of the ITAA 1936. The rate of withholding tax that will apply to the dividends will be limited to 15% even though the dividends pass through an interposed arm's length entity that is not a resident of a treaty country because only the taxpayer beneficially owns the dividends.