ARTICLE 7

Business Profits

This Article provides rules for the taxation by a Contracting State of income from business activity carried on by a resident of the other State.

Paragraph 1 provides that business profits of an enterprise of one Contracting State shall be taxable only in that State except to the extent that such profits are attributable to a permanent establishment through which the enterprise carries on business in the other Contracting State. (The term "enterprise of one of the Contracting States," used here and elsewhere in this Convention, excludes dual-resident corporations that are treated as residents of neither Contracting State for purposes of the Convention.)

Paragraph 2 provides that the profits to be attributed to a permanent establishment are those which it might be expected to make if it were an independent enterprise engaged in similar activities under similar conditions. The profits must reflect arm’s length prices. The profits so attributed may be from income described in section 864(c)(4)(B) of the Internal Revenue Code which are attributable to a permanent establishment in the United States may be subject to tax by the United States. In addition, the limited "force of attraction" rule in I.R.C. section 864(c)(3) does not apply for U.S. tax purposes under the Convention.

Paragraph 3 provides that deductions shall be allowed for expenses incurred for the purposes of the permanent establishment, including, inter alia, executive and general administrative expenses, wherever incurred, if such expenses are reasonably connected with the profits of the permanent establishment and would be deductible if it were an independent entity.

Australia and the United States will each allow an allocation to a permanent establishment of a portion of research and development and interest expenses incurred by the U.S. home office or elsewhere, provided that the expenses are reasonably connected with the profits of the permanent establishment.

Paragraph 4 states that no profits shall be attributed to a permanent establishment by reason of the mere purchase by it of goods or merchandise for the enterprise.

Paragraph 5 provides that, unless there is good and sufficient reason to the contrary, the same method of determining profits attributable to the permanent establishment shall be used each year.

Paragraph 6 provides that, where business profits include items of income dealt within other articles of the Convention, the provisions of those other articles override the provisions of this Article. For example, the taxation of income of international shipping and aircraft operations is governed by Article 8 (Shipping and Air Transport) and not by this Article. Similarly, the taxation of dividends, interest, and royalties is controlled by Articles 10, 11, and 12, respectively; however, the terms of those Articles provide that where dividends, interest, or royalties derived by a resident of a Contracting State are attributable to a permanent establishment in the other Contracting State, the provisions of this Article do apply and the item of income is taxed as business profits.

Paragraph 7 was inserted at the request of Australia to permit the tax authorities of a Contracting State to apply the provisions of internal law in determining tax liability in cases where the information available to the competent authority is not adequate to measure accurately the profits of a permanent establishment. The Internal Revenue Service would have this power even in the absence of such a specific provision. The determination of profits in such cases, based on the available information, must be done consistently with the principles of this Article, i.e., it must seek to reflect arm’s length pricing and appropriate deductions of expenses.

Notwithstanding the other provisions of this Article, paragraph 8 allows each State to apply its domestic law in taxing income from the insurance business, provided that such law remains the same as on the date the Convention was signed or is modified only in minor respects. In the case of a nonresident general insurance company which insures risks in Australia, Australia imposes its ordinary corporate tax rate (now 46 percent) on a deemed profit equal to 10 percent of the gross premiums from such insurance. The company may elect instead to be taxed on a net basis. The United States will apply its excise tax on insurance and reinsurance premiums of Australian insurers or will tax the net income of a U.S. trade or business of an Australian insurer, as appropriate.

Unlike the U.S. Model, this Convention does not provide that business profits include income from the rental of tangible personal property and films. In this Convention those types of rentals are treated as royalties under Article 12 (Royalties). However, the maintenance of substantial equipment in the other Contracting State for more than 12 months (other than equipment leased under a "hire-purchase" agreement) constitutes a permanent establishment

covered by this Article.