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Australian Taxation Office explains interaction between tie-breaker clause in treaty between Australia and New Zealand and domestic tax legislation — Orbitax Tax News & Alerts

The Australian Taxation Office (ATO) issued Interpretative Decision ID 2006/128, in which it explained the application of the Business Profits Article in relation to the Interest Article in the tax treaty between Australia and New Zealand (the tax treaty). Briefly, ID 2006/128 concluded that domestic interest withholding tax will apply to interest payments made by an Australian resident to a company which (a) is a resident in both Australia and New Zealand, (b) is treated as a resident of New Zealand under the tie-breaker clause in the tax treaty, and (c) derives interest income in conducting its business through a permanent establishment in New Zealand. The rate of the interest withholding tax will be capped by the tax treaty.

In reaching this conclusion, the ATO adopted a somewhat unexpected line of reasoning, as shown below.

Firstly, the ATO relied on its previous Taxation Ruling TR 98/17, which states, at Para. 66, that where the tie-breaker test in a tax treaty provides that a dual resident is to be treated solely as a resident of the treaty partner country for the purposes of the agreement, Australian resident status is not lost for purposes of the general operation of the domestic law.

ID 2006/128 then explains that withholding tax can be levied only if the interest payments represent income derived by the dual resident through a permanent establishment outside Australia, as this is the only case when the domestic withholding tax rules apply to payments between Australian residents (Sec. 128B (2A) of the Income Tax Assessment Act 1936).

Finally, ID 2006/128 concedes that the rate of domestic withholding tax should not exceed that in Art. 11 of the tax treaty.

It follows that ID 2006/128 effectively states that the Australian resident status is not lost for the domestic interest withholding tax provisions, disregarding the operation of the tie-breaker clause in the relevant tax treaty.