Tax on Australian-origin Income by Withholding
17.71. The provisions applying withholding tax to certain dividends and interest have been explained in paragraphs 17.61–17.62; and for the reasons expressed in paragraph 17.68, the Committee would approve of the use of withholding tax where such a tax can be conveniently administered. Some comment is appropriate here on the problems of setting the spheres of operation of withholding tax and tax by assessment on Australian-source income. Where withholding tax applies, the person receiving the dividends or interest is not subject to tax by assessment. This is expressly provided in section 128D. But tax by assessment on the basis of source in Australia is not excluded when that person makes a payment of dividends or interest to another. It would make for certainty, in the Committee's view, if the occasions when tax by assessment applies were expressly defined in the Act. Thus tax by assessment—as proposed in paragraph 17.A23 of Appendix A—on interest paid by a permanent establishment abroad of an Australian resident might be expressed to apply only when the interest is received by a tax-haven company or a tax-haven trust. Where dividends or interest have borne Australian tax by withholding when paid to a non-resident company, subsequent distributions of dividends by the company from those dividends or interest will, under the present law, be subject to tax by assessment to the extent that the dividends or interest are from an Australian source. Tax by assessment in these circumstances might be confined to dividends received by a tax-haven company or a tax-haven trust. Tax by assessment is already excluded by a number of double taxation agreements where a non-resident company pays dividends that might have been subject to tax on the basis of Australian source.
17.72. Rates of withholding tax appear modest. The rate on dividends is 30 per cent, unless a lower rate applies under a double taxation agreement. The rate on interest is 10 per cent. Some double taxation agreements preclude a higher rate being imposed on interest in the circumstances specified in the agreements. However, withholding tax is imposed on the gross amount of dividends or interest and may result in higher tax than would be payable if tax by assessment applied and the tax were imposed after deduction of interest paid or other costs of deriving the dividends or interest.
17.73. The rate of withholding tax on interest affords opportunities for tax planning through a tax-haven company or a
tax-haven trust lending to a related company in Australia whose profits, which bear company tax, are made less by the
amount of the interest paid. There is some discouragement to such planning in provisions excluding withholding tax and
applying tax by assessment where income received by a trust would attract tax under section 99A (explained in Chapter
15). However, these provisions are only in part effective since they cannot apply to interest that does not have an
Australian source. There is some correction possible in the reconstruction of the profits of the Australian resident
paying the interest. This is considered in paragraphs
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17.84–17.90. In addition the Committee would
recommend that a special rate of withholding tax be applied to interest paid to a tax-haven company or trust. An
appropriate rate might be the prevailing company tax rate. The tax would be collected from any payment of interest to
a company or trust in the tax-haven country. It would be necessary for any such company or trust that is not, within
the meanings in paragraphs 17.9 and 17.47, a tax-haven company or trust to obtain prior permission to have the normal
rate of withholding tax applied or to seek repayment of the excess withholding tax collected.
17.74. The rate of withholding tax on interest encourages loan capital in preference to share capital as a means of providing finance for an Australian resident subsidiary company. The scope for reconstruction of the profits of the subsidiary when an undue emphasis has been given to loan capital is the subject of observations in Chapter 16.
17.75. The 30 per cent rate of withholding tax on dividends might appear attractive if the dividends paid to a tax-haven company or a tax-haven trust were to satisfy the obligation of an Australian resident private company to make a sufficient distribution so as to avoid undistributed profits tax. The present law, through provisions preventing the distribution being treated as a sufficient distribution, adequately discourages the use of a tax-haven company in this way.
17.76. There is much to be said for extending the withholding tax provisions to cover the gross amount of payments in respect of the use of commercial and industrial property and know-how with an Australian source on the tests proposed in paragraphs 17.A15, 17.A17–17.A18 of Appendix A. There are very real difficulties in determining the deductions allowable in calculating the net income arising from these payments. If a withholding tax on royalties is introduced, it would be appropriate to provide for a special rate on payments to tax-haven companies and trusts in accordance with the provisions in paragraph 17.73.