ARTICLE 12

Royalties

This Article limits the tax which may be imposed by either Contracting State on royalties derived and beneficially owned by a resident of the other Contracting State.

Paragraph 1 states that such royalties may be taxed in the State of residence of the beneficial owner. This provision, which comes from the OECD Model, confirms the provision of paragraph 2 of Article 1 (Personal Scope) that each Contracting State reserves the right to tax its residents.

Paragraph 2 provides that such royalties may also be taxed by the State in which they have their source, but the tax is limited to 10 percent of the gross amount of the royalties. Under the 1953 Convention, copyright royalties (other than those related to films) are exempt from tax at source, but other royalties are taxable at the statutory rates. Australia's statutory tax on royalties paid to nonresidents, other than for films or video tapes, is withheld by the payer at the full corporate or individual tax rate on the gross amount less allowable expenses necessarily incurred in deriving the royalty. The Convention preserves the net basis of taxation by Australia, except that the amount of tax liability may not exceed 10 percent of the gross amount of the royalty paid. Payments for the use of films and video tapes are taxed by Australia at 10 percent of the gross amount. This practice is confirmed by this Article. On the U.S. side the statutory rate of 10 percent will be reduced to 10 percent.

Paragraph 3 provides that when royalties beneficially owned by a resident of one Contracting State are attributable to a permanent establishment or fixed base maintained by that resident in the other State, the royalties will not be taxed in accordance with the provisions of this Article but in accordance with the provisions of Article 7 (Business Profits) or Article 14 (Independent Personal Services).

Paragraph 4 contains a definition of the term "royalties." The definition is broader than the one in the U.S. Model. For purposes of this Convention, payments for the use of, or right to use, industrial, commercial or scientific equipment are treated as royalties, except when such equipment is leased under a "hire-purchase" agreement. Payments for the use of, or right to use, motion picture films and certain tapes are also taxed as royalties. And royalties, for purposes of this Article, include payments or credits for scientific, technical, industrial or commercial knowledge or information owned by any person, and payments or credits for ancillary assistance furnished to enable the application of any property or right to which this Article applies. The reference to knowledge or information "owned" is meant to indicate that the term "royalties" implies a property right as distinguished from personal services. An engineer or architect who prepares a design for a customer is considered to perform personal services, the remuneration for which is covered under Article 14 (Independent Personal Services) or 15 (Dependent Personal Services).

An engineer or architect who supplies a preexisting design or blueprint is considered to be furnishing knowledge or information, the payment for which constitutes a royalty governed by this Article. The supply of ancillary services does not give rise to a royalty when supplied in connection with the sale of property, but does give rise to a royalty when supplied in connection with the leasing of any of the property or rights covered by this Article.

In some cases, income covered by this Article gives rise to a permanent establishment if the income-producing activity continues long enough. For example, payments for the leasing of industrial, scientific or commercial equipment (other than under a "hire-purchase" agreement) are taxable as royalties, but if the enterprise deriving the royalties maintains the equipment for rental in the other State for longer than 12 months, it is considered to have a permanent establishment in that other State under paragraph 4(b) of Article 5 (Permanent Establishment). In such a case the income is taxable from the beginning in accordance with Article 7 (Business Profits), as

provided in paragraph 3 of this Article. Similarly, payments for the supply of supervisory services could in some cases constitute royalties; but if the services are furnished for more than 9 months in a 24-month period, the enterprise has a permanent establishment under paragraph 4(c) of Article 5 (Permanent Establishment), and the income is taxable in accordance with Article 7 (Business Profits), as provided in paragraph 3 of this Article.

Subparagraph (b)(iii) of paragraph 4 provides a special rule to deal with the situation of a disguised lease of a property right of the type covered by this paragraph. If, for example, an Australian company were to use in Australia a copyright or patent held by a U.S. company without paying a royalty to the U.S. company and the U.S. company were to forebear from selling the protected products in Australia in return for payment, the U.S. company would be treated as having received a royalty from the Australian company.

Subparagraph (c) of paragraph 4 provides that, to the extent that income from the disposition of any property or right described in this paragraph is contingent on the productivity or use or further disposition of such property or right, it is a royalty.

Paragraph 5 states that the provisions of this Article shall not apply to royalty payments between related persons in excess of the amount which would have been agreed upon at arm’s length. Such excess amount shall be taxed according to the laws of each Contracting State, with regard also to the other provisions of this Convention.

Paragraph 6 defines the source of royalties. In general, a royalty is considered to have its source in a Contracting State if paid by the Government or a resident of that State or by a company which under internal law is a resident of that State. (Thus, a royalty paid by a dual resident company may be eligible for the reduced rate provided in paragraph 2, although a royalty beneficially owned by such a company is not.) However, if a permanent establishment or fixed base in one of the Contracting States or in a third State incurs the liability to pay the royalties and bear the payment (deducts it in computing taxable income), the royalty is considered to have its source in the State where the permanent establishment or fixed base is located. Moreover, if under these rules a royalty is not considered to have a source in either State but it relates to the use of property or the right to use property in one of them, the royalty is considered to have its source where the property is used or where there is a right to use it. Thus, for example, if an Australian resident were to license a patent to a third country company, which in turn sublicenses the patent for use in the United States, the United States would tax the sub-license payment by the U.S. user to the third country company in accordance with U.S. law, or with the provisions of a U.S. Treaty with that country, if applicable, and would also tax the license payment by the third country company to the Australian resident, subject to the limitation in paragraph 2. Third country residents cannot obtain the rate reduction provided in paragraph 2, since this Article applies only to royalties derived by residents of a Contracting State.