Doing business overseas

Tax treaties

Research from the Australian Trade Commission (Austrade) shows that close to half of Australian enterprises still see globalisation as a major opportunity for expanding their business – and they have now put the global financial crisis behind them. Many businesses are making significant percentages of their overall income from foreign sources – which of course brings us back to the question of tax.

How international income is treated with regard to tax depends in the first instance on the answer to one question – does the country from which the income is sourced have a tax treaty with Australia, or not.

Tax treaties
Australia at present has treaties with more than 40 countries and includes our significant trade and investment partners such as Britain, the US, New Zealand, Japan, South Africa, Canada, France and Italy and 34 other countries (see the full list here).

One of the main functions of tax treaties is to prevent, or at least deal with, the issue of double taxation.  Why would double taxation arise?  Well, most countries in the world tax on the basis of 'residence' as well as the basis of 'source'.  For example, in Australia an Australian tax resident is taxed on worldwide income.  A non-resident is generally taxed on income that is 'sourced' in Australia.  Many countries have similar basic rules.  So an Australian resident business that 'sets up shop' overseas could find itself being taxed on that overseas income in both countries.

The relevant tax treaty would take care of this unfairness, either by giving the exclusive rights to tax that sort of income to one of the countries (which is good since you only have to fork out one tax payment) or by allowing both countries to tax the income, with the country of residence giving a credit for the foreign tax paid (so you do get at least some of the double tax back, but you have to pay two countries to begin with).

Treaties generally have a separate clause to explain the rules for each type of income – trading income, salaries, interest, dividends and so forth – so the final treatment really depends on the type of income itself. However Australia does not have a tax treaty with all countries.

Generally speaking, most tax treaties contain a clause about 'permanent establishments'.  The definition of a permanent establishment differs between treaties, but basically it is when the Australian business undertakes some of its business activities in a fixed place in the other country – this might include a branch, a management office or a local sales office.

The rule of thumb is that if an Australian business has a permanent establishment in the other country, then the other country gets to tax all the income of that permanent establishment as though it were a local company.  There is generally an Australian tax exemption for that income, so there is unlikely to be any double taxation.

For those countries without a tax treaty with Australia, double taxation is much more likely to occur.  But it's not all bad news – Australia has a system to claim credits for tax paid overseas, and the rules apply equally to treaty countries and non-treaty countries, so chances are good that you'll get at least some of the double tax back.

Reviewed August 8, 2012

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