US Limited Partnership: whether it is a company for the purposes of Article 10 of the US Convention

Is a United States (US) limited partnership (US LP), which is treated as a partnership for US federal tax purposes, a company for the purposes of Article 10 of the Convention between Australia and the US contained in Schedules 2 and 2A to the International Tax Agreements Act 1953 (the US Convention)?

No. A US LP which is treated as a partnership for US federal tax purposes is not a company for the purposes of Article 10 of the US Convention.

For the purpose of the US Convention, US LP is neither a 'body corporate' nor 'an entity which is treated as a company or body corporate for tax purposes'. Consequently it is not a company for the purposes of Article 10 of the US Convention, and does not qualify for either of the reduced rates for certain cross-border inter-corporate dividends flowing between Australia and the US.

US LP is a limited partnership established under US (Delaware) state law (the Delaware Revised Uniform Limited Partnership Act (DRULPA)).

A limited partnership under the DRULPA is formed upon the execution and filing of a certificate of limited partnership under section 17-201 of the DRULPA.

As a limited partnership formed under the DRULPA, US LP is an unincorporated hybrid business entity having features commonly associated with both a business carried on by partners as partners and with a company.

The DRULPA does not incorporate a limited partnership, nor does it provide that a limited partnership is a body corporate.

US LP is a separate legal entity, and exists as such until cancellation of the certificate of limited partnership under paragraph 17-201(b) of the DRULPA. Section 15-201 of the DRULPA also provides that US LP has separate legal personality distinct from its partners.

US LP is 'for all purposes a partnership', per section 15-202 of the DRULPA.

US LP is treated as a partnership (and so is fiscally transparent) for US federal tax purposes and not as a taxable unit.

All income derived by US LP is subject to US tax in the hands of its US resident partners. All partners are US resident corporations.

US LP is a 'person' under Article 3(1)(a) of the US Convention.

US LP is a 'resident' of the US for tax treaty purposes within the meaning of Article 4(1)(b)(iii) of the US Convention, because Article 4(1)(b)(iii) treats a US partnership as a US resident for tax treaty purposes to the extent that the income it receives is subject to US income tax either in its hands or in the hands of a partner.

US LP is not treated as a company by the US for tax treaty purposes because it is treated as a partnership for US federal tax purposes.

US LP owns all the shares in an Australian resident company. During the income year the Australian resident company paid an unfranked dividend (not assessable income and not exempt income) to US LP, which was legally and beneficially entitled to that dividend.

US LP would be taxed as a company under Australian domestic law (Division 5A of the Income Tax Assessment Act 1936 , ITAA 1936) if it derived Australian source assessable income. US LP is not a resident of Australia under section 94T of Division 5A of the ITAA 1936.

US LP is not a 'foreign hybrid limited partnership' under section 830-10 of the Income Tax Assessment Act 1997 (ITAA 1997) as it is not a CFC (per paragraph 830-10(1)(e)) of the ITAA 1997.

To qualify for benefits under the US Convention the claimant must first be a 'person' and a 'resident' for the purposes of the US Convention. In this case US LP, being a US domestic partnership, is both a 'person' and a US 'resident' according to the terms of the US Convention. Note that the US Convention is unusual in that it applies treaty benefits for income derived through fiscally transparent entities such as a partnership, at the level of the entity (in this instance US LP).

Article 10 of the US Convention provides that certain cross-border inter-corporate dividends flowing between Australia and the US are either: • subject to a maximum of 5% rate of source country tax if the person beneficially entitled to those dividends is a company which holds directly at least 10 per cent of the voting power in the company paying the dividends (Article 10(2)(a) of the US Convention); or • exempt from source country tax where the person beneficially entitled to the dividends is a company that has owned shares representing 80 per cent or more of the voting power of the company paying the dividends for a 12 month period ending on the date the dividend is declared, and satisfies certain other conditions (Article 10(3) of the US Convention).

The words of the US Convention are quite specific. For the reduced dividend withholding tax rates under Article 10(2)(a) or Article 10(3) of the US Convention to apply to an unfranked dividend paid by an Australian resident company, the person beneficially entitled to the dividend must be a 'company'. Here, the 'person' beneficially entitled to the dividends paid by the Australian resident company is US LP.

Article 3(1)(b) of the US Convention defines 'company' for the purposes of the Convention 'unless the context otherwise requires', to mean 'any body corporate or any entity which is treated as a company or body corporate for tax purposes'.

Accordingly, for the purposes of our analysis, US LP will be a 'company' for the purposes of the US Convention if: (a) it is a body corporate; or (b) it is an entity that is treated as a company or body corporate for tax purposes -

unless the context of the US Convention otherwise requires.

(a) Is US LP a ' company' for the purpose of the US Convention by virtue of being a ' body corporate' ?

US LP is not a 'company' for the purpose of the US Convention by virtue of being a 'body corporate' for Australian purposes.

The term 'body corporate' is not defined in the US Convention. Thus, in accordance with Article 3(2) of the US Convention, the term will generally take its meaning from the taxation laws of the country applying the tax treaty (being in this case Australia), 'unless the context otherwise requires'. As 'body corporate' is not defined in Australia's domestic income tax law legislation, the ordinary meaning of the term in Australia may then apply (see the tax treaty interpretation principles set out in paragraphs 63 to 71 of Taxation Ruling TR 2001/13 Income tax: Interpreting Australia's Double Tax Agreements).

The Butterworths Australian Legal Dictionary , 1997 defines a 'body corporate' as 'an artificial legal entity having separate legal personality'. The Macquarie Dictionary , Fourth edition, 2005 defines 'body corporate' in its legal context, as 'a person, association or group of persons legally incorporated in a corporation'. Generally a 'body corporate' is established under an Act of Parliament or under a statutory procedure of registration, such as the Corporations Act 2001 (refer to paragraphs 22-23 of Taxation Ruling IT 2634 and paragraphs 30-34 of Miscellaneous Taxation Ruling MT 2006/1).

As US LP is created under Delaware state law and has a legal personality under that law, it should be recognised as a legal entity in Australia in accordance with the principle in Chaff and Hay Acquisition Committee v. Hemphill (1947) 74 CLR 375.

While US LP is a legal entity having legal personality, it is essentially quite different in character from the bodies which are incorporated under corporations law in Australia. For example, while a corporation continues in existence until it is dissolved notwithstanding changes in its membership or business, a limited partnership formed under the DRULPA is usually formed for a limited period of time and terminates in the same way as a partnership. A corporation in Australia has perpetual succession, a personality that is continuous and free transferability of interests. US LP does not. Further, the partners of US LP derive the profits made by US LP, and a partner's individual share of the profits in US LP is ascertained in accordance with its interest in US LP, rather than on the basis of distributions made.

Notwithstanding, as US LP is an artificial legal entity having a form of separate legal personality, it is prima facie a 'body corporate' under the ordinary meaning of the term in Australia. Although, generally a 'body corporate' has the 'ability to continue in existence indefinitely and to keep its identity regardless of changes to its membership' (see paragraph 30 of MT 2006/1) and US LP does not enjoy such a continued existence.

But, as highlighted above, the requirement in Article 3(2) of the US Convention to in this case interpret an undefined term such as 'body corporate' in accordance with Australian taxation law, applies only if the 'context' does not require an alternative interpretation, see paragraphs 72 to 76 of TR 2001/13. Thus, it is essential to derive the meaning of the term 'body corporate' from the 'context' in the relevant tax treaty - including the function of the Article in question. Taxation Ruling TR 2001/12 notes at paragraph 45 that 'the accepted international rules for treaty interpretation focus particularly on the context of a text finalised between negotiating countries'. The meaning of a term must be an accurate representation of the 'bargain' or 'consensus ad idem' which objective evidence shows has been reached by the negotiating countries (see paragraph 74 of TR 2001/13).

Paragraph 75 of TR 2001/13 notes that treaty 'context' should be taken in its broadest sense, and that includes the full range of materials open to consideration under Articles 31 and 32 of the Vienna Convention on the Law of Treaties. In Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; 90 ATC 4717 (at CLR 344, ATC 4720); the judges agreed that the OECD Model Taxation Convention's OECD Model Convention and the associated commentaries are relevant to the interpretation of tax treaties based on the OECD Model, see paragraph 102 of TR 2001/13. Paragraph 104 of TR 2001/13 accordingly provides that the OECD Model Tax Convention and Commentary will often need to be considered in interpreting tax treaties.

Paragraph 12 of the OECD Commentary on Article 3 emphasises that the interpretation set out in the 'undefined terms' provision applies 'only if the context does not require an alternative interpretation'. It adds that the 'context' is determined in particular by the intention of the Contracting States, as well as 'the meaning given to the term in question in the legislation of the other Contracting State (an implicit reference to the principle of reciprocity on which the Convention is based)'. However, US federal tax law does not specifically define the term 'body corporate'.

In this case, the OECD Commentary on the definition of 'company' is particularly relevant to the context of the term 'body corporate'. Paragraph 3 of the OECD Commentary on Article 3 provides the following: 3. The term "company" means in the first place any body corporate. In addition, the term covers any other taxable unit that is treated as a body corporate according to the tax laws of the Contracting State in which it is organised . The definition is drafted with special regard to the Article on dividends . The term "company" has a bearing only on that Article, paragraph 7 of Article 5, and Article 16. [Emphasis added]

It follows from the OECD Commentary's statement that the second limb of the term covers any other taxable unit , that the first limb of the definition of 'company' is designed to deal only with entities which are bodies corporate under general law and also taxable units under tax law (which is a central consideration in applying the terms of Australia's tax treaties).

While the requirement for the entity to also be a 'body corporate' for tax law purposes under the first limb is not explicit, treaties should be interpreted more 'liberally' than domestic legislation to smooth over the gaps, imprecision and ambiguities in the treaty text in a way that addresses the context and meets the object and purpose of the treaty, (see Fothergill v. Monarch Airlines Ltd , [1981] A.C. 251; per Lord Diplock; Thiel v. Federal Commissioner of Taxation (1990) 171 CLR 338; (1990) 90 ATC 4717; (1990) 21 ATR 531 per Dawson J; Commissioner of Taxation v. Lamesa Holdings BV , (1997) 77 FCR 597; (1997) 97 ATC 4752; (1997) 36 ATR 589 per Burchett, Hill and Emmett JJ, Courts Plc [2005] BVC 2003 and paragraphs 90-94 of TR 2001/13). Where the context of a term allows a specific tax law meaning and a non-tax law meaning, the former should prevail (see paragraph 68 of TR 2001/13).

In addition, it is clear from the OECD Commentary on Article 3 that the question of whether a dividend recipient is an entity 'treated as a body corporate' for tax purposes must be made by reference to 'the tax laws of the Contracting State in which it is organised' - and not the state of source. Thus, paragraph 3 of the OECD Commentary on Article 3 provides with regard to the terms 'company' and 'body corporate' that the relevant taxation laws to consider are those of the country in which the entity was created (i.e. being the domestic laws that apply to the entity). The 'context' requires an examination of US taxation law and not Australian taxation law to determine whether a US entity is a 'company' for the purpose of qualifying for the reduced rate of withholding tax on inter-corporate dividends.

Hence, in determining whether an entity is treated as a 'body corporate' for tax treaty purposes, reference is not made to the tax law of the country applying the treaty (in this case Australia), unless the entity was organised there. Specifically, as indicated above, the 'context' surrounding the terms 'company' and 'body corporate' in the US Convention, for the purpose of US LP qualifying for the either of the reduced rates of withholding tax on the unfranked dividends paid by the Australian resident company, requires an examination of US taxation law.

Accordingly, to determine whether US LP is a 'body corporate' under the US Convention, the relevant consideration is where US LP was organised. US LP was not organised in Australia, but in the US. Hence, the potential Australian tax treatment of US LP (that is, that the entity can be treated as a company for Australian tax purposes by virtue of Division 5A of the ITAA 1936) is irrelevant. Rather, only the US tax treatment of US LP is relevant.

US LP is not a taxable unit and so is not treated and taxed as a 'body corporate' for US federal tax purposes - but is treated and taxed as a partnership.

Finally and importantly, paragraph 3 of the OECD Commentary on Article 3 emphasises that the definition of 'company' is ' drafted with special regard to the Article on dividends' and 'the term "company" has a bearing only on that Article, paragraph 7 of Article 5, and Article 16.'

Paragraphs 10-11 of the OECD Commentary on Article 10 explains the rationale behind reduced taxation rates for inter-corporate dividends as follows: 10. On the other hand, a lower rate (5 per cent) is expressly provided in respect of dividends paid by a subsidiary company to its parent company. If a company of one of the States owns directly a holding of at least 25 per cent in a company of the other State, it is reasonable that payments of profits by the subsidiary to the foreign parent company should be taxed less heavily to avoid recurrent taxation and to facilitate international investment. The realisation of this intention depends on the fiscal treatment of the dividends in the State of which the parent company is a resident . ... 11. If a partnership is treated as a body corporate under the domestic laws applying to it, the two Contracting States may agree to modify sub-paragraph (a) of paragraph 2 in a way to give the benefits of the reduced rate provided for parent companies also to such partnership. (Emphasis added)

Paragraph 2 of Article 10 of the OECD Model Tax Convention is not materially different from paragraph 2 of Article 10 in the US Convention, with the exception of the differences in the percentage holding thresholds in the respective treaties.

Klaus Vogel on Double Tax Conventions , Vogel, K et al 1997, 3rd edition, Kluwer Law, The Hague, makes the following statements (at pages 583-584 and 599) about paragraph 2 of Article 10 of the OECD Model Tax Convention: Art. 10 is still completely geared to the 'classical' system of company taxation ... and is, consequently, based on the conception that it is appropriate to subject income derived by a company (within the meaning of Art. 3(1)(b)MC) to a tax of its own distinct and separate from the tax imposed on the distributions received by a company's shareholders ... the maximum rates on inter-company dividends should differ from those on 'all other' dividends. ... Such preferential treatment, however, applies only where direct investments are held by companies and does not apply where a substantial interest is held by an individual or a partnership. ... If, under the law of its State of residence, a partnership is considered a body corporate, but is ... not itself subjected to tax ... there would be no justification for allowing it to benefit from the limited rate of 5 per cent, because its interposition actually does not result in any double taxation.

It is apparent, from all of the above, that the intention of Article 10(2) of the OECD Model Tax Convention is to provide reduced rates of withholding tax for dividends derived by companies from direct investments on a reciprocal basis. It would be contrary to the intention of Article 10(2) if the reduced inter-corporate dividend withholding tax rate was to apply where the tax law of the resident country treated the beneficial owner of the dividends as a partnership.

Specifically, in the case of US LP, it would be inappropriate for a partnership formed under US state law and treated as a partnership for US tax purposes, to be able to access the inter-corporate rate of withholding tax for dividends under either Article 10(2) or Article 10(3) of the US Convention. The purpose behind Article 10(2) and 10(3) is to prevent multiple layers of taxation of corporate economic groups. Where the recipient does not have tax imposed (that is, because it is treated as a partnership in its state of residence), the rationale for granting the reduction in (or exemption from) withholding tax disappears.

The context of Article 10 and the OECD Commentary requires the implicit inclusion in the first limb of the definition of 'company', that a 'body corporate' is a taxable unit under the relevant taxation laws. Further, the relevant taxation laws are clearly the domestic laws affecting the entity - that is, those laws under which the entity is organised or created.

US LP is not a taxable unit and not a 'body corporate' for US tax purposes. Therefore, US LP does not satisfy the first limb of the meaning of the term 'company' in Article 3(1)(b) of the US Convention. It follows that US LP will not be a 'company' for the purposes of Article 10 of the US Convention by virtue of being a 'body corporate' for Australian purposes.

(b) Is US LP a ' company' for the purpose of the US Convention under the second limb of the meaning of the term ' company' - that Is to say, is US LP an entity that is treated as a ' company' or ' body corporate' for tax purposes ?

The OECD Commentary on the definition of 'company' (outlined above) makes it clear that, under the second limb of the definition, the determination is to be made by reference to the laws of the State in which the entity is organised (in this case US federal tax law).

US LP is not taxed as a 'company' or 'body corporate' for US federal tax purposes. Rather it is treated and taxed as a partnership. This is essentially because, although US LP has a form of separate legal personality under Delaware state law, the US federal tax position is that while state law attributes of an entity control various aspects of business relations, they are not controlling under US tax law (unless the tax law so provides) - see Morrissey v. Commissioner of Internal Revenue , 296 U.S. 344 (1935); United States v. R Kintner ; 216 F.2d 418 (9th Cir. 1954); McNamee v. Dept of the Treasury , 2007 U.S. App. LEXIS 12016, 488 F.3d 100, (2nd Cir. 2007).

In general, under the US 'check-the-box' (CTB) Treasury Regulations, any separate business entity other than an incorporated entity may choose its classification for tax purposes. Specifically, US CTB Treasury Regulations §301.7701-2(b)(1) and §301.7701-3(a) do not allow an entity organized under a Federal or State statute, that refers to the organization as 'incorporated', 'corporation', 'body corporate', or 'body politic', to elect its classification. Instead, such an entity is taxed as a corporation; see Checking in on " Check-the-Box ", Loyola of Los Angeles Law Review [Vol. 42:451], by Heather M. Field.

The DRULPA does not refer to a limited partnership created under its provisions as 'incorporated', a 'corporation', 'body corporate' or 'body politic' and US LP is not mandatorily taxed as a corporation. Rather, US LP is taxed as a partnership unless it elects to be taxed as a corporation. As no such election was made by US LP, it is not a taxable unit and is not taxed as a corporation under the tax laws of the US.

Hence, US LP is not an 'entity that is treated as a company or body corporate for tax purposes' and so does not satisfy the second limb of the meaning of the term 'company' for the purposes of the US Convention.

Conclusion

For the purpose of the US Convention, US LP is neither a 'body corporate' nor an 'entity that is treated as a company or body corporate for tax purposes'. Consequently it is not a 'company' for the purpose of Article 10 of the US Convention, and does not qualify for either of the reduced rates for certain cross-border inter-corporate dividends flowing between Australia and the US.

This is consistent with the US position for tax treaty purposes which is that a US partnership which does not elect to be taxed as a corporation will not be a 'company' for US treaty purposes. The Issues in International Taxation No. 6 ' The Application of the OECD Model Tax Convention to Partnerships' report includes the US response to the OECD Partnership Report at page 127. This response states that US partnerships (including limited partnerships such as Delaware limited partnerships, but also US LLCs and LLPs) not electing to be treated as corporations are not considered to be companies for the purposes of US tax treaties. Note. Article 10(2)(b) of the US Convention provides a reduced rate of 15% in some circumstances, and does not require the recipient of the dividend to be a company. US LP will be entitled to the reduced rate of 15% if it satisfies all of the requirements for that reduction.