US Australia Tax Treaty Provisions Explained

US Australia Tax Treaty Provisions Explained

US Australia Tax Treaty 

Australia Income Tax Treaty with the United States: The United States has entered into several tax treaties with different countries across the globe — including Australia. There are many US taxpayers who are originally from Australia and/or still maintain oversas accounts, assets & investments and/or generate income from Australia. The United States and Australia have several tax agreement in place, including a FATCA Agreement and a Totalization Agreement. The purpose of the tax treaty is so Taxpayers can determine what their tax liability is for certain sources of taxable income. While the treaty is not the final word in how items of income will be taxed, it does help residents better understand how either the IRS and/or Australia will tax certain sources of income – and whether or not the saving clause will further impact the outcome. Let’s review the basics of the US & Australia Income Tax Treaty – and how the income tax treaty between US and Australia works.

What Types of Tax Law Is Included in the Treaty

The Australia Tax Treaty with the United States impacts the taxation of real estate, retirement, pension, & business income (and more) for residents & non-residents. While the U.S & Australia Tax Treaty is highly complicated, our aim is to provide a basic understanding of how the tax treaty works, so that we can help individuals determine their tax status on various issues that may impact U.S. tax liability — and help them assess if they are out of compliance.

General Concept: U.S. Tax Status and Worldwide Income

The U.S is one of the only countries across the globe to implement a worldwide taxation model for individuals.  Therefore, for U.S. Persons, the general proposition is that a U.S. person is subject to U.S. tax and reporting on their worldwide income — despite what their country of residence in, or the source of the income. *A U.S. person can try to show a closer connection or other treaty position to limit, exclude, or eliminate U.S. Tax — but the baseline position is that a U.S. person is subject to U.S. tax and reporting on their worldwide income — despite what their country of residence in.

Saving Clause in the Australia Income Tax Treaty

As we work through the United States-Australia Tax Treaty, one important thing to keep in mind is the saving clause. The saving clause is inserted in tax treaties in order to limit the application of the treaty to certain residents/citizens. With the saving clause, each country retains the right to tax certain citizens and residents as they would otherwise tax under general tax principles in their respective countries — absent the tax treaty taking effect.

What does the Saving Clause Say?

      • Notwithstanding any provision of this Convention, except paragraph (4) of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence)) and individuals electing under its domestic law to be taxed as residents of that state, and by reason of citizenship may tax its citizens, as if this Convention had not entered into force. For this purpose, the term “citizen” shall, with respect to United States source income according to United States law relating to United States tax, include a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of 10 years following such loss.

Limitations on the Saving Clause

      • (4) The provisions of paragraph (3) shall not affect:

        • (a) the benefits conferred by a Contracting State under

          • paragraph (2) of Article 9 (Associated Enterprises), paragraph (2) or (6) of Article 18 (Pensions, Annuities, Alimony and Child Support), Article 22 (Relief from Double Taxation), 23 (Non-Discrimination), 24 (Mutual Agreement Procedure) or paragraph (1) of Article 27 (Miscellaneous); or

        • (b) the benefits conferred by a Contracting State under

          • Article 19 (Governmental Remuneration), 20 (Students) or 26 (Diplomatic and Consular Privileges) upon individuals who are neither citizens of, nor have immigrant status in, that State (in the case of benefits conferred by the United States), or who are not ordinarily resident in that State (in the case of benefits conferred by Australia).

What Does This Mean?

The Saving Clause is inserted into a tax treaty in order to allow each country to reserve the right to tax citizens and residents the way that they would otherwise tax them had the treaty not been in effect. Despite the insertion of the saving clause into a tax treaty, there are exceptions to the saving clause as well —

Residence Under the Australian-U.S. Tax Treaty (Article 4)

When a tax treaty refers to residence, it is not as simple as just living a few weeks in either country during the year.

There are very specific rules involving residence (which is identified in article 4 of the treaty).

Resident of the U.S.

        • A “Person” is a resident of the United States if the person is:

            • a United States corporation; or

            • (ii) any other person (except a corporation or unincorporated entity treated as a corporation for United States tax purposes) resident in the United States for purposes of its tax, provided that, in relation to any income derived by a partnership, an estate of a deceased individual or a trust, such person shall not be treated as a resident of the United States except to the extent that the income is subject to United States tax as the income of a resident, either in its hands or in the hands of a partner or beneficiary, or,

        • if that income is exempt from United States tax, is exempt other than because such person, partner or beneficiary is not a United States person according to United States law relating to United States tax.

Non-Technical Summary & Example (Article 4 Residence)

Determining residence can be difficult, but for the most part if an individual resides, earns income, and has their general day-to-day life in a country, then that country will be deemed their residence.

*Residence (and tax home) may impact the availability of the Foreign Earned Income Exclusion.

Income From Real Property (Article 6)

      • Income from Real Property

      • (1) Income from real property may be taxed by the Contracting State in which such real property is situated.

      • (2) For the purposes of this Convention: (i) a leasehold interest in land, whether or not improved, shall be regarded as real property situated where the land to which the interest relates is situated; and (ii) rights to exploit or to explore for natural resources shall be regarded as real property situated where the natural resources are situated or sought.

Non-Technical Summary & Example (Gains from Real Property Article 6)

 If an Australian Person resides in the U.S., but is earning income from real property generated in Australia, Australia can tax the individual, since Australia would be the “Contracting State in which such real property is situated.”

U.S. Tax on Gains from Real Property Article 6

      • Australia does not have “Exclusive” Tax Rights to real property.

      • Therefore, If the person is a U.S. person, then the U.S. will tax them as well on their worldwide income, but the person can use a Foreign Tax Credit, to reduce or eliminate an duplicate tax already paid in Australia.

Dividend Income (Article 10)

Dividend Income is more complex:

      • (1) Dividends paid by a company which is a resident of one of the Contracting States for the purposes of its tax, being dividends to which a resident of the other Contracting State is beneficially entitled, may be taxed in that other State.

      • (2) However, those dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident for the purposes of its tax, and according to the law of that State, but:
      • (a) the tax charged shall not exceed 5 percent of the gross amount of the dividends, if the person beneficially entitled to those dividends is a company which holds directly at least 10 percent of the voting power in the company paying the dividends; and
      • (b) the tax charged shall not exceed 15 percent of the gross amount of the dividends to the extent to which those dividends are not within sub-paragraph (a), 5 provided that if the relevant law in either Contracting State is varied after the effective date of this provision otherwise than in minor respects so as not to affect its general character, the Contracting States shall consult each other with a view to agreeing to any amendment of this paragraph that may be appropriate

Non-Technical Summary & Example (Dividend Income)

An Australian person receiving dividends from an Australian source, and who is a resident of the other Contracting State (Australian national living in the U.S.), may be taxed by that other state (U.S.) on the income.

Australia can also tax the dividends, but is limited to taxing the dividend income at reduced rates.

**There are several exceptions and limitations.

Interest Income (Article 11)

Interest Income is also very complex:

        • Interest arising in one of the Contracting States, being interest to which a resident of the other Contracting State is beneficially entitled, may be taxed in that other State.
        • (2) However, that interest may also be taxed in the Contracting State in which it arises, and according to the law of that State, but the tax so charged shall not exceed 10 percent of the gross amount of the interest

Non-Technical Summary & Example (Interest Income)

Interest arising from Australia, but paid to a resident of the U.S., may be taxed in the U.S.

Non-Technical Summary (Interest Income Non-Exclusive Taxation)

Continuing from the example above, even though the U.S. can tax the income,Australia is not prevented from levying tax on the same income, although the tax is limited.

*Multiple exceptions apply, with common exceptions including those in which a person has a permanent establishment in the other Contracting State or performs independent personal services

Alienation of Property (Article 13A)

      • Income or gains derived by a resident of one of the Contracting States from the alienation or disposition of real property situated in the other Contracting State may be taxed in that other State.

Non-Technical Summary & Example (Alienation of Property)

An Australian who sold a property in Australia, and who is a resident of the other Contracting State (Australian national living in the U.S.), may be taxed by that other state (U.S.) on the income.

Pensions, Annuities, Alimony and Child Support (Article 18)

This is a heavily reviewed and analyzed section of the treaty, and is subject to interpreation:

We will analyze each paragraph separately:

Article 18, Paragraph 1

      • Subject to the provisions of Article 19 (Governmental Remuneration), pensions and other similar remuneration paid to an individual who is a resident of one of the Contracting States in consideration of past employment shall be taxable only in that State.

Non-Technical Summary & Example (Article 18, Paragraph 1)

This first paragraph is very general. It just explains that unless a Government pension (or other renumeration) is involved an individual who is a resident of the Australia will only be taxed by Australia for pension earned in Australia (This impacts Dual-Citizens who reside in Australia, but could get caught up in U.S. Tax  on worldwide income rules for pension earned in AUS while he is a resident of AUS.

Article 18, Paragraph 2

      • (2) Social Security payments and other public pensions paid by one of the Contracting States to an individual who is a resident of the other Contracting State or a citizen of the United States shall be taxable only in the first-mentioned State.

Non-Technical Summary & Example (Article 18, Paragraph 2)

If an Australian national resides in the U.S., and received Social Security or other public pension from Australia, can only be taxed by Australia on that income.

Article 18, Paragraph 3

(3) Annuities paid to an individual who is a resident of one of the Contracting States shall be taxable only in that State. 

Non-Technical Summary & Example (Article 18, Paragraph 3)

If an Australian National resides in the U,.S., and earns Annuity, then only the U.S. can tax the Annuities.

*Superannuation U.S. Tax Treaty Rules

When it comes to superannuation, on first pass it would seem relatively simple. Superannuation is a foreign retirement plan, and the United States and Australia have entered into a tax treaty, which includes issues involving retirement.  Therefore, the superannuation should be covered by the treaty.

One are the main complications is that the superannuation is not specifically identified in the treaty.  Some people argue a Super is just Social Security, and not taxable in the U.S.  Others disagree, and argue that Australia already has a social assistance program and therefore it is treated as pension or trust — which significantly impacts the income tax rules.

If this is the main issue you have, we have authored a detailed article limited to this specific issue of US tax on a Australia Superannuation.

Governmental Remuneration (Article 19)

      • This Article provides that remuneration, including pensions, paid by one of the Contracting States or a political subdivision, local authority or agency thereof to a citizen of that State for the performance of governmental functions is exempt from tax by the other State.

Non-Technical Summary & Example

If an Australian National resides in the U,.S., and earns government pension from Australia, then that income is EXEMPT from tax in the U.S.

Article 22 Relief from Double Taxation

      • Subject to paragraph (4) and in accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), in the case of the United States, double taxation shall be avoided as follows: (a) the United States shall allow to a resident or citizen of the United States as a credit against United States tax the appropriate amount of income tax paid to Australia; and

      • (b) in the case of a United States corporation owning at least 10 percent of the voting stock of a company which is a resident of Australia from which it receives dividends in any taxable year, the United States shall also allow as a credit against United States tax the appropriate amount of income tax paid to Australia by that company with respect to the profits out of which such dividends are paid.

*Article 22 of the Convention is amended by omitting in paragraph (1) “sub-paragraph (1)(b)” and substituting “sub-paragraph (1)(b)(i)” in each place it occurs.

Non-Technical Summary & Example (Relief From Double Taxation)

The U.S. will allow for a Foreign Tax Credit for citizens or residents of the U.S. on taxes due to the U.S., against any tax already paid to Australia and vice versa

*Exceptions and limitations apply.

Offshore Reporting (FBAR & FATCA) & United States/Australia Tax Treaty

When a US person has various Accounts, Assets or Investments in Australia, they have to reported to the United States each year on various different forms depending on the value of and category of the assets/accounts.

Here are some common forms which may need to be filed:

5 International Tax Forms You May Have Missed

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:

  • Single or Filing Separate (in the U.S.): $50,000/$75,000
  • Married with a Joint Returns (In the U.S): $100,000/$150,000
  • Single or Filing Separate (Outside the U.S.): $200,000/$300,000
  • Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

  • Gift from a Foreign Person: More than $100,000.
  • Gift from a Foreign Business: More than $16,076.
  • Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

  • Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.
  • Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.
  • Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.
  • Category 4: Control of a foreign corporation for at least 30 days during the accounting period.
  • Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company).

The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Receiving a Gift or Inheritance from Australia

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in Australia Report U.S. Account Holders?

As of now, there are nearly 2000 Foreign Financial Institutions, within Australia that report US account holder information to the IRS. The FFI list can be found here:

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

  • Bank Accounts
  • Investment Accounts
  • Retirement Accounts
  • Direct Stock Ownership
  • ETF and Mutual Fund Accounts
  • Pension Accounts
  • Life Insurance or Life Assurance Policies

Totalization Agreement for US & Australia

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the Agreement:

      • An agreement effective September 1, 1993, between the United States and Australia improves Social Security protection for people who work or have worked in both countries. It helps many people who, without the agreement, would not be eligible for monthly retirement, disability or survivors benefits under the Social Security system of one or both countries. It also helps people who would otherwise have to pay Social Security taxes to both countries on the same earnings.

      • The agreement covers Social Security taxes (including the U.S. Medicare portion) and Social Security retirement, disability and survivors insurance benefits. It does not cover benefits under the U.S. Medicare program or the Supplemental Security Income program.

      • This document covers highlights of the agreement and explains how it may help you while you work and when you apply for benefits.

The United States has entered into 26 Totalization Agreements, including Australia.

The Australia Income Tax Treaty with the US is Complex

In conclusion, The US and Australia tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.

Contact our firm for assistance.