Issue
Does Article 11(3)(a) of the Australia - United States Double Taxation Convention (US Convention) apply to interest income derived by a limited liability company incorporated in the United States (US LLC), that is owned by an exempt US pension fund set up by a US local government body for the purpose of providing retirement, survivor and disability benefits to local government employees?
Decision
No. Article 11(3)(a) of the US Convention does not apply to the interest income. The pension fund is not 'one of the Contracting States ... a political or administrative sub-division or local authority thereof, or ... any other body exercising governmental functions' for the purposes of Article 11(3)(a). Accordingly, the interest income is subject to interest withholding tax in Australia.
Facts
The LLC is a company with a single owner incorporated under US state law. It is 'disregarded as an entity separate from its owner' for US federal tax purposes under Treasury Regulations Subchapter F, sec. 301.7701-3(b)(ii). The LLC does not, therefore, pay US tax itself. Rather, it is treated as part of the owner for the purposes of US domestic tax law.
The LLC distributes all of its income to a US pension fund. The pension fund was set up by a US local government body for the purpose of providing retirement, survivor and disability benefits to local government employees.
The pension fund is exempt from tax in the US under US law. The pension fund is a resident of the US for the purposes of US tax and the US Convention.
The LLC is a company under Australian domestic tax law.
The LLC derives interest income from Australia.
Reasons for Decision
Interest withholding tax is payable under subsection 128B(5) of the Income Tax Assessment Act 1936 (ITAA 1936) on interest derived by non-residents that falls within subsection 128B(2) of the ITAA 1936. Section 7 of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 sets the rate of withholding tax on interest payments to non-residents to which subsection 128B(2) of the ITAA 1936 applies at 10%.
This liability to Australian withholding tax is subject to any applicable tax treaty provisions in the US Convention contained in Schedules 2 and 2A of the International Tax Agreements Act 1953 (Agreements Act).
As established in ATO ID 2010/188, the LLC is not a resident of the US for the purposes of the US Convention because it is an entity disregarded as separate from its owner. However, the pension fund, as the single owner, is a resident under Article 4(1)(b)(iii) of the US Convention and is therefore entitled to treaty benefits, subject to the pension fund satisfying any other applicable requirements in the US Convention.
Article 11(3)(a) of the US Convention provides that Australia may not tax interest derived by the US or by a political or administrative subdivision or a local authority or by any other body exercising governmental functions in the US, or by a bank performing central banking functions in the US. If the pension fund is one of the types of bodies listed in Article 11(3)(a) that is exercising governmental functions, Australia is therefore prevented from taxing interest that is paid to the LLC.
In relation to Article 11(3)(a) of the US Convention, the phrase 'any other body exercising governmental functions' is not defined. Article 3(2) of the US Convention provides that any term not defined shall, unless the context otherwise requires, have the meaning it has under the law relating to taxes of the country applying the US Convention.
Australian domestic tax law does not statutorily define what governmental functions are. Taxation Ruling TR 2005/8 interprets the terms 'governmental functions' and 'in discharge of governmental functions' in the Government Service Article (Article 19) of the US Convention but is of no real assistance in interpreting the different terminology in Article 11. The meaning given to those terms in TR 2005/8 reflects subsequent practice and the context in which those terms are used; that of a person being paid wages etcetera, by government 'for labour or personal services as an employee'.
Therefore, in determining the meaning for Article 11 of the US Convention purposes, it is necessary to examine the words of the provision itself ( Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 90 ATC 4717; (1990) 21 ATR 531). The term 'any other body exercising governmental functions' in Article 11(3)(a) of the US Convention in concert with the other types of bodies listed indicates that denial of the taxing right in Article 11(3)(a) is limited to bodies exercising government functions, being those that are identifiable as being government or that are a statutory authority (that is, an entity of public character created by the laws of a Contracting State in which no other person other than the State itself, or a subdivision thereof, has an interest).
Despite the pension fund being set up by a local government to benefit government employees, the fund itself is not identifiable as a body of government in the US or a statutory authority there nor set up to benefit only a body of government. Accordingly, Article 11(3)(a) of the US Convention will not apply.
As there is no inconsistency for the purposes of subsection 4(2) of the Agreements Act between the application of the Article 11(3)(a) of the US Convention and subsections 128B(2) and 128B(5) of the ITAA 1936, the interest income is subject to interest withholding tax.