PETROLEUM (TIMOR SEA TREATY) BILL 2003 Explanatory Memorandum

2003

THE PARLIAMENT OF THE COMMONWEALTH
OF AUSTRALIA

HOUSE OF REPRESENTATIVES

PETROLEUM (TIMOR SEA TREATY) BILL 2003

EXPLANATORY MEMORANDUM

(Circulated by authority of the Minister for Industry, Tourism and Resources, the Hon. Ian Macfarlane, MP)

The Petroleum (Timor Sea Treaty) Bill 2003 (the Treaty Bill) gives effect to the Timor Sea Treaty between Australia and East Timor. The Treaty provides a framework for the exploration, development and exploitation of the petroleum resources in the Joint Petroleum Development Area (JPDA) created by the Treaty.

East Timor separated from Indonesia on 26 October 1999 (Australian time). Since then, Indonesia has had no jurisdiction over East Timor or the maritime zones generated by East Timorese territory, nor over petroleum operations in the former Zone of Co-operation (now known as the JPDA).

Upon East Timor’s separation from Indonesia, Australia entered into an agreement with the United Nations Transitional Administration in East Timor (UNTAET) that allowed Australia and East Timor to benefit from the continuation of exploration and production activities in an area of overlapping territorial claims in the Timor Sea.

EastTimor became independent on 20 May 2002, and on that date Australia and East Timor signed the Timor Sea Treaty.

The Treaty is a provisional arrangement pending permanent delimitation of maritime boundaries between Australia and East Timor. Main aspects of the Treaty include:

• Sharing of petroleum production and revenue by Australia and East Timor split 90/10 in East Timor’s favour.

Article 4 of the Treaty provides for Australia and East Timor to have title to all petroleum produced in the JPDA, with 10% of that petroleum attributed to Australia. Administrative costs in the JPDA above the level catered for by fees and other income (as provided by Article 6(b)(vi) of the Treaty) are to be in the same proportion.

• A joint three tiered administrative structure involving both Australia and East Timor to govern the day to day running and broader policy issues in the JPDA.

The Treaty Bill gives effect to Article 6 of the Treaty by enabling the Ministerial Council, the Joint Commission and the Designated Authority (DA) to exercise certain rights and responsibilities of Australia in relation to the exploration, development and exploitation of petroleum resources in the JPDA.

The Ministerial Council will consist of an equal number of Ministers from Australia and East Timor. The Ministerial Council will have overall responsibility for petroleum operations in the JPDA. Either East Timor or Australia may refer a matter for consideration by the Ministerial Council at any time.

The Joint Commission shall consist of commissioners appointed by Australia and East Timor. East Timor will have one more commissioner than Australia. It will approve regulations relating to petroleum activities in the JPDA and will approve rules, regulations and procedures for the effective functioning of the DA and give directions to the DA.

The DA will be responsible for the day-to-day management of petroleum operations in the JPDA including the release of exploration acreage, entering into production sharing contracts, approving seismic surveys and the drilling of wells, agreeing project developments, exercising control over the safety and environmental aspects of petroleum operations and distributing to each country its share of the proceeds of the Authority's share of petroleum production from production sharing contracts.

Article 3 of the Treaty makes it an offence for persons not to obtain approval from the DA before engaging in petroleum activities in the JPDA, including exploration. Powers are given to inspectors appointed by the DA to ensure that contractors conduct petroleum operations in a manner consistent with the regulations (including a Petroleum Mining Code) adopted by the Joint Commission and production sharing contract conditions.

• A tax code for the imposition of taxes on income derived from the JPDA.

The Timor Sea Treaty contains three Articles that relate specifically to taxation matters as well as the Taxation Code that forms Annex G to the Treaty. These are Article 5 (Fiscal arrangements and taxes), Article 6 (Regulatory bodies) and Article 13 (Application of taxation law)..

The Taxation Code provides the underlying framework for the imposition of taxes on income arising out of exploration development and exploitation of petroleum in the JPDA. The Taxation Code provides for the allocation of taxing rights between Australia and East Timor over this income and is also designed to avoid double taxation and prevent fiscal evasion on income arising from these activities.

Ineffect, Australia will apply its tax system to 10% of the income derived in the JPDA and East Timor will apply its tax system to 90% of this income. These percentages, together referred to in Article 1 of Annex G to the Treaty as the ‘framework percentage’, reflect the share of petroleum produced in the JPDA which belongs to each Contracting State under Article 4 of the Treaty.

Financial Impact Statement

The principal financial impact resulting from the commencement of this Act will be the prospective revenues from the JPDA. Both Australia and East Timor will receive the benefits of revenue from petroleum activities in the JPDA.

The main projects are currently the Bayu-Undan and Greater Sunrise developments, estimated to collectively contain recoverable reserves of around 11 trillion cubic feet of gas and 700 million barrels of petroleum liquids. However, the first commercial production of petroleum in the former Zone of Cooperation commenced in July 1998 with the development of the Elang-Kakatua oilfield. The field is now nearing the end of its commercial life, producing at a rate of about 6,000 barrels of oil per day. Total revenue to Australia from this source is expected to be about A$0.5 million in 2002-03, and has been in excess of A$40 million to date, in addition to company tax receipts.

Bayu-Undan, which lies wholly within the JPDA, is estimated to contain around $A15 billion worth of petroleum. Australia will also receive substantial benefits from the development and processing of natural gas. Over the life of the project, total revenue to Australia from the liquids and gas phases, and including revenue from the pipeline and LNG plant are expected to total to some A$1.5 billion.

Development of the Greater Sunrise field could provide revenue to Australia of around A$8.5 billion.

The Treaty benefits Australia and provides certainty for investors in establishing an international legal basis for continued development of major oil and gas deposits in the Timor Sea. Both these projects rely on the passage this Bill before they proceed.

Article 6(b)(vi) of the Treaty provides that the DA will be self funding from contract fees collected under the Petroleum Mining Code.

Articles 15 (e) and (f) of the Treaty provide there will be no customs duty for goods used in petroleum operations in the JPDA.

NOTES ON CLAUSES

PART 1 – PRELIMINARY

Clause 1 - Short title

1. This clause provides for the Act to be cited as the Petroleum (Timor Sea Treaty) Act 2003.

Clause 2 – Commencement

2. This clause provides for certain provisions of the Act to have come into effect on 20 May 2002 to coincide with the date of East Timorese independence. Other parts of the Act, such as Sections 6, 7 and Subsection 8(2) which deal with offence provisions, are taken to have come into effect on the day in which this Act receives Royal Assent, in order to remove the possibility of retrospective criminal liability.

Clause 3 - Object of the Act

3. This clause recites the purpose of the Act which is to enable Australia to fulfil its obligations under the Treaty.

Clause 4 - Ministerial Council, Joint Commission and Designated Authority authorised to exercise rights of Australia

4. This clause confers on the Ministerial Council, the Joint Commission and DA the rights and responsibilities of Australia in relation to the exploration, development, and exploitation of petroleum resources in the JPDA in accordance with the Treaty.

Clause 5 - Definitions

5. This clause defines "JPDA"
"Petroleum Mining Code"
"Treaty".

6. To ensure consistency of interpretation, sub-clause 5(2) specifies that unless otherwise stated a word or an expression defined in the Treaty has, in this Act, the same meaning as it has in the Treaty.

PART 2 - GENERAL PROVISIONS

Clause 6 - Prospecting for petroleum

7. This clause makes it an offence to prospect for petroleum in the JPDA without the approval of the DA.

Clause 7 - Petroleum activities

8. This clause makes it an offence to undertake activities to produce petroleum other than under a production sharing contract and within the terms of that contract or with the approval of the DA. It gives effect to Article 3(d) of the Treaty which requires Australia to make it an offence for any person to conduct petroleum activities in the JPDA otherwise than in accordance with this Treaty.

Clause 8 - Powers of Inspectors

9. This clause provides the powers for inspectors appointed under the Petroleum Mining Code to take necessary actions including inspection, testing, and inspection and examination of documentation, to ensure that the Petroleum Mining Code and regulations and directions under it, and contract terms and conditions applying to petroleum activities in the JPDA, are being complied with in the JPDA.

10. This clause also provides that it will be an offence for the person in charge of any structure, vessel, aircraft or building in the JPDA that is being used for petroleum activities, not to provide an inspector with all reasonable facilities and assistance for the effective exercise of the powers of an inspector.

Clause 9 - Jurisdiction of State and Territory Courts

11. This clause is designed to confer Commonwealth jurisdiction on appropriate State and Territory courts to hear civil matters brought by a national or permanent resident of Australia for damages or expenses arising out of an act or omission as a result of activities in the JPDA. The clause does not preclude courts exercising jurisdiction in relation to other claims arising from activities in the JPDA where such jurisdiction would otherwise exist.

Clause 10 - Northern Territory laws to be applied

12. This clause deals with the law to be applied by a court exercising jurisdiction pursuant to Clause 9. It does not prescribe the law that a court might apply when it exercises jurisdiction over matters relating to activities in the JPDA other than those dealt with by Clause 9. In those situations the ordinary choice of law rules will apply.

PART 3 TAX PROVISIONS

DIVISION 1 – TAX PROVISIONS

Clause 11 – Definitions
13. This clause will facilitate the reference to “Australian tax” contained in clause 12 to mean only those taxes imposed by Australia under the respective legislation dealing with fringe benefits tax, income tax or the superannuation guarantee charge.
Clause 12 – Australian tax – Treaty and taxation code have the force of law

14. This clause will give the Treaty, including the Taxation Code, the force of law in Australia insofar as the provisions of the Treaty affect Australian tax.

15. This does not include subparagraphs vii and viii of paragraph (b) of Article 6 of the Treaty, which deal with exemption from certain forms of taxation for the Designated Authority and its personnel. Separate provision is made for this in the Petroleum (Timor Sea Treaty) (Consequential Amendments) Bill 2003.

Clause 13 – Medicare levy and Medicare levy surcharge to be treated as income tax

16. Clause 13 deems the Medicare levy and Medicare levy surcharge to be income tax for the purposes of the Taxation Code. Under the income tax law, Australians who receive income from overseas that is included in their taxable income are entitled to a credit for foreign tax paid on that income. This clause will ensure that these arrangements for relief of double taxation apply to both income tax and Medicare levy consistent with the practice accorded under subsection 3(10) of the International Tax Agreements Act 1953 in relation to Australia’s comprehensive double tax agreements. It also extends relief from double taxation to the Medicare levy surcharge.
Clause 14 – Incorporation of Australian tax laws

17. A number of provisions of the Treaty including the Taxation Code will require interpretation having regard to the provisions of the Income Tax Assessment Act 1936, the Income Tax Assessment Act 1997, the Fringe Benefits Tax Assessment Act 1986 and the Superannuation Guarantee Charge (Administration) Act 1992.

18. Subclause 14(1) accordingly incorporates these Acts with Part 3 of the Bill and the various measures are to be read as a single enactment. [Subclause 14(1)]

19. Subclause 14(2) will apply where provisions of the Bill are inconsistent with the Income Tax Assessment Act 1936 (ITAA1936), the Income Tax Assessment Act 1997, the Fringe Benefits Tax Assessment Act 1986 and the Superannuation Guarantee Charge (Administration) Act 1992 or with an Act imposing “Australian tax”. The provisions of the Bill will override these Acts to the extent of any inconsistency. [Subclause 14(2)]

20. The Taxation Code, as well as Articles 5 and 13 of the Treaty, contain provisions designed to vary the effect of the Acts mentioned in clause 11 and the rates of tax which would otherwise be imposed by the Acts mentioned in clause 11. Subclause 14(2) ensures that the terms of the Treaty and machinery provisions for the practical application of the Taxation Code prevail over conflicting provisions of the various Acts and the various laws imposing rates of tax. This subclause will result in those Acts being applied subject to the provisions of the Bill. [Subclause 14(2)]

21. There is an exception to this treatment for the anti-avoidance provisions of those Acts, such as Part IVA of the ITAA1936. [Subclause 14(2)]

Clause 15 – Calculation of gross tax payable for the purposes of rebate calculations under the taxation code

22. Clause 15 is an interpretive provision which, for the purposes of Articles 5, 12, 13 and 14 of the Taxation Code, provides a formula for calculating the dollar amount of income tax upon which an individual who is not a resident of either Contracting State will be entitled to a 90% rebate for the purposes of Australian income tax.

23. The need for such a formula is due to the fact that a non-resident individual taxpayer may also have non-JPDA Australian source income. In such a case, this additional Australian sourced income could increase the marginal tax rate applied to the JPDA source income. Therefore, the formula arrives at a figure for the gross tax payable on JPDA amounts by applying the average rate of tax on all Australian taxable income to these amounts. This ensures that all Australian source income is pooled together and the average rate of tax is applied consistently, irrespective of whether the income is JPDA or non-JPDA Australian source income.

An individual who is not a resident of Australia or East Timor derives $20,000 from the JPDA in one income year. The gross tax payable on that $20,000 is calculated by using the formula as follows:

The final tax paid in Australia on the JPDA source income is then calculated as follows:

If in the alternative, however, the same individual derives $20,000 from the JPDA and also derives $40,000 in non-JPDA Australian source income in the same income year, the gross tax payable on the JPDA source income by that individual will be a higher amount. The gross tax payable on the JPDA source income is calculated by using the formula as follows:

The final tax paid in Australia on the JPDA source income is then calculated as follows:

24. Subclause 15(1) limits the application of the clause to those Articles of the Taxation Code that provide for a rebate against income tax of 90% of the gross tax payable. [Subclause 15(1)]

25. Subclause 15(2) gives practical effect to this measure by specifying how the gross tax payable is to be calculated and accordingly determines the dollar amount to which the 90% rebate is to apply. [Subclause 15(2)]

Clause 16 – Definitions

26. Clause 16 provides definitions for terms used in the application provisions for Division 2 of the Bill. Subclause 16(1) defines ‘new taxation code’ to have the same meaning as the Taxation Code contained at Annex G of the Timor Sea Treaty. The term ‘old taxation code’ has the same meaning as the Taxation Code had in the Petroleum (Timor Gap Zone of Cooperation) Act 1990 immediately before 20 May 2002. These two terms facilitate referencing when distinguishing between the application of the different Taxation Codes under the two Treaties. The term ‘year of income’ has the same meaning as in the ITAA1936.

27. Subclauses 16(2) and 16(3) contain definitional rules that ensure consistency in the definition of terms used in the application provisions and the respective Taxation Codes. Subclause 16(2) provides that where an expression is used in subsection 17(2) or 18(1) which is also used in the old taxation code, the expression has the same meaning as in the old taxation code. Subclause 16(3) provides that where an expression is used in subsection 17(3) or 18(2) which is also used in the new taxation code, the expression has the same meaning as in the new taxation code.

Clause 17 – Application of taxation codes in relation to business profits and business losses

28. The Taxation Code enters into force at the same time as the rest of the Timor Sea Treaty. The Treaty enters into force upon the day on which Australia and East Timor have notified each other in writing that their respective requirements for entry into force have been complied with. [Article 25(a) of the Treaty]

29. Upon entry into force, the Treaty shall be taken to have effect on and from the date of signature, which is the 20 May 2002 [Article 25(b) of the Treaty].

30. The Taxation Code therefore commences application in the middle of a year of income, the 2001-2002 year of income. Clause 17 provides rules that assist in determining the application of the Taxation Code to business profits derived and business losses incurred in the 2001-2002 year of income as well as later years of income.

31. Subclause 17(1) requires that, for the purposes of clause 17, business profits derived and business losses incurred in the first period (1 July 2001 to 19 May 2002) are to be calculated separately from those business profits and losses incurred in the second period (20 May 2002 to 30 June 2002). This separation is necessary as the amounts calculated in the two periods will receive different treatment under the two Taxation Codes.

32. The Petroleum (Timor Gap Zone of Cooperation) Act 1990 provides for the application of the Timor Gap Treaty and its Taxation Code (the old taxation code). Once the Timor Sea Treaty enters into force, the Petroleum (Timor Gap Zone of Cooperation) Act 1990 will be repealed. Subclause 17(2) ensures that despite the repeal of that Act, the old taxation code continues to apply to business profits derived and business losses incurred up until 19 May 2002.

33. The Petroleum (Timor Sea Treaty) Bill 2003 provides for the application of the Timor Sea Treaty and its Taxation Code (the new taxation code). Subclause 17(3) stipulates that the new taxation code applies to business profits derived and business losses incurred from 20 May 2002 onward. This subclause is subject to the exception to the general rule of application, which is contained in Clause 19.

Clause 18 – Application of taxation codes in relation to dividends etc.

34. Similarly to subclause 17(2), subclause 18(1) ensures that despite the repeal of the Petroleum (Timor Gap Zone of Cooperation) Act 1990, the old taxation code applies to:

• Income in respect of professional services, or other independent activities of a similar character, derived;

• Other income (but not including business profits) derived up until 19 May 2002.

35. Similarly to subclause 17(3), subclause 18(2) stipulates that the new taxation code applies to:

• Income in respect of professional services, or other independent activities of a similar character, derived;

• Other income (but not including business profits) derived from 20 May 2002 onward.

36. This subclause is subject to an exception to the general rule of application which is contained in clause 19.

Clause 19 – Application of new taxation code in relation to individual residents of East Timor

37. In general, the Treaty and all of its provisions, which includes the Taxation Code, will apply from 20 May 2002. Two exceptions to this general rule are the application of the superannuation guarantee charge (SGC) and the taxation of East Timor resident individuals. These provisions will apply from 1 July 2003.

38. The application of the taxation of East Timor resident individuals is permissive rather than binding upon Australia under the Taxation Code. As a result Australia is able to unilaterally vary the application date of the taxation of East Timor resident individuals to operate prospectively rather than from the date of domestic law effect, 20 May 2002. Australia will tax East Timor resident individuals prospectively, from 1 July 2003, because this is a new taxing right that Australia did not have in the JPDA prior to the Timor Sea Treaty. This approach ensures that affected taxpayers are not disadvantaged by being required to comply with a tax with which they had no prior awareness or obligation.

39. The application provisions that ensure that the SGC applies in the JPDA from 1 July 2003 are contained in the Petroleum (Timor Sea Treaty)(Consequential Amendments) Bill 2003.

Clause 20 – Amendment of assessments for 2001-2002 year of income

40. Section 170 of the ITAA1936 sets out the parameters of the Commissioner of Taxation’s power to amend a taxpayer’s assessment. The Timor Sea Treaty is to apply from 20 May 2002. As a result the Commissioner may need to amend assessments for the 2001-2002 year of income to ensure that taxpayers are given treatment in accordance with the Timor Sea Treaty from 20 May 2002 onward. Clause 20 ensures that despite any possible restrictions contained in section 170, the Commissioner has the power to amend assessments made for the 2001-2002 year of income that may be necessary as a result of the new treatment contained in the Timor Sea Treaty.

PART 4 – TRANSITIONAL PROVISIONS

Clause 21 – Definitions

41. This clause defines “former Petroleum Mining Code”
“Joint Authority”
“new Petroleum Mining Code”

Clause 22 – Retrospective effect of authorities and production sharing contracts

42. This clause allows the DA to validate approvals, petroleum activities and production sharing contracts as if they had taken effect on 20 May 2002.

Clause 23– Interim Petroleum Mining Code

43. This clause allows the Ministerial Council to give effect to Article 7(b) of the Treaty which allows the Joint Commission to adopt an interim Petroleum Mining Code in the event that an agreed Code can not be finalised.

Clause 24 – Actions taken under former Petroleum Mining Code

44. This clause deems that any action, regulation or direction by the Joint Authority pursuant to the former Petroleum Mining Code on or after 20 May 2002 shall be taken to have been done or issued by the DA under the new Petroleum Mining Code.

45. Clause 24(3) deems that anything an inspector appointed under the former Petroleum Mining Code purported to do for the purposes of that Code on or after 20 May 2002 shall be taken to have been done by an inspector appointed under the new Petroleum Mining Code for the purposes of the new Code.

PART 5 - REGULATIONS

Clause 25 - Regulations

46. This clause grants the Governor-General power to make regulations. The Clause is inserted because regulations may be desirable in order to facilitate the practical application of the Treaty so far as it relates to taxation matters.

47. Furthermore any regulations prescribed may impose a fine of 10 penalty units for offences against regulations made for Part 3 of this Bill.

SCHEDULE 1 – TIMOR SEA TREATY

48. The Schedule reproduces the Timor Sea Treaty between Australia and East Timor, including its Annexes

TIMOR SEA TREATY - ARTICLE COMMENTARY

Article 5 - Fiscal arrangements and taxes
49. Paragraph 5(b) provides that Australia and East Timor may impose taxes on the revenue from their respective shares of petroleum activities in the JPDA. These activities include exploration, development and exploitation of petroleum and any acts, matters, circumstances and things touching, concerning, arising out of or connected with such exploration and exploitation. [Paragraph (b)]
50. The taxation of revenue from petroleum activities is to be done in accordance with the Taxation Code contained in Annex G of the Treaty and each country’s domestic laws. [Paragraph (b)]
51. Consistent with Article 4 and in accordance with Annex G of the Treaty Australia’s share of taxation revenue from the JPDA is 10% and East Timor’s is 90%. [Paragraph (b)]

Article 6 – Regulatory bodies

52. This article provides that control of the joint Australian/East Timorese development of the JPDA will be exercised by a three tiered administrative structure consisting of the Ministerial Council, a Joint Commission and a DA.

53. The Ministerial Council will consist of an equal number of Ministers from Australia and East Timor and will have overall responsibility for petroleum operations in the JPDA. Either Australia or East Timor may refer a matter relating to the operation of the Treaty to the Ministerial Council. In the event that the Ministerial Council is unable to resolve a matter either East Timor or Australia may invoke the dispute resolution procedure in Annex B of the Treaty.

54. The Joint Commission shall consist of commissioners appointed by Australia and East Timor. East Timor will have one more commissioner than Australia. It will establish and approve regulations relating to petroleum activities in the JPDA, approve rules, regulations and procedures for the effective function of the DA and will give directions to the DA.

55. The DA will be responsible for the day-to-day management of petroleum operations in the JPDA including the release of exploration acreage, entering into production sharing contracts, approving seismic surveys and the drilling of wells, agreeing project developments, exercising control over the safety and environmental aspects of petroleum operations and distributing to each country their share of the proceeds of the Authority's share of petroleum production from production sharing contracts. For a period of three years, or for a different period of time if agreed by Australia and East Timor, the DA will be designated by the Joint Commission. After this period, the DA will be the East Timorese Government Ministry responsible for petroleum activities or an East Timorese statutory authority.

56. This Article provides for a three year exemption for the DA from income tax in both Australia and East Timor, including any identical or substantially similar taxes imposed after the date of signature of the Treaty which are in addition to, or in place of, the existing taxes. [Subparagraph (b)(vii)]

57. In addition, the Article provides for three year exemption from income tax of the personnel of the DA, other than in their state of residence, in relation to their official remuneration received from such employment, as well as entitling the employees to exemptions in certain circumstances from customs duties and other such charges in respect of imports of furniture and other household effects into the Contracting State of which they are not resident. [Subparagraph (b)(viii)]

58. The period of exemption for both the DA and its officers is the first 3 years after the Timor Sea Treaty enters into force unless Australia and East Timor agree on a different period. [Subparagraphs (b)(i), (vii) and (viii)]

59. Article 13 sets out the scope of the application of the taxation laws of each Contracting State. For the purposes of taxation law related to the exploitation of petroleum in the JPDA or acts, matters, circumstances, and things touching, concerning, arising, out of or connected with any such exploration or exploitation the JPDA shall be treated by East Timor and Australia as part of that country. [Paragraph (a)]

60. The Taxation Code is set out in Annex G of the Treaty. [Paragraph (b)]

61. The dispute resolution mechanism at Article 23 is not to apply to disputes covered by the mutual agreement procedure in Article 20 of the Taxation Code. [Paragraph (c)]

ANNEX G under Article 13(b) of this Treaty - Taxation Code for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion in Respect of Activities Connected with the Joint Petroleum Development Area.
TAXATION CODE - ARTICLE COMMENTARY

What is the Taxation Code?

62. The Taxation Code for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion in Respect of Activities Connected with the JPDA (the Taxation Code) forms Annex G under Article 13(b) of the Treaty.

Why is the Taxation Code Necessary?

63. The Taxation Code, together with Articles 4, 5 and 13 of the Treaty provide the underlying framework for the imposition of taxes on income arising out of exploration for, and exploitation of, petroleum in the JPDA. The Taxation Code provides for the allocation of taxing rights between Australia and East Timor over this income and is also designed to avoid double taxation and prevent fiscal evasion on income arising from these activities. The Taxation Code specifies what existing taxes of Australia and East Timor apply in the JPDA.

64. The JPDA is to be treated for tax purposes as part of both Australia and East Timor (also known as the Contracting States). Double taxation is avoided by allocating taxing rights between the Contracting States in relation to certain categories of income and by setting out how relief from double taxation is to be provided where income may be taxed by both Contracting States. The associated procedural and definitional provisions have generally been modelled on equivalent provisions in the United Nations (UN) and Organisation for Economic Cooperation and Development (OECD) model double taxation agreements.

Main Features of the Taxation Code

• In general, Australia will apply its tax system to 10% of the income derived in the JPDA and East Timor will apply its tax system to 90% of this income. These percentages, referred to in Article 1 as the ‘framework percentage’ reflect the share of petroleum produced in the JPDA which belongs to each Contracting State under Article 4 of the Treaty.

• Companies are to be taxed in each Contracting State on the framework percentage of their profits from the JPDA and correspondingly only the framework percentage of their losses from the JPDA is to be allowed for the purposes of the loss carry forward/transfer provisions of the income tax law of each Contracting State. [Article 5]

• Capital gains/losses that accrue to companies in respect of property situated in the JPDA are to be taxed according to the framework percentage. [Article 11(1)]

• In general, individuals will be taxed by Australia in one of three ways:

− In the case of residents of Australia, Australian tax may be applied to 100% of their JPDA income and capital gains at normal resident rates for individuals, with a tax offset being allowed for East Timorese tax on 90% of their JPDA income. [Articles 5(2)(b), 11(3), 12(2), 13(2) and 14(3)]

− In the case of residents of East Timor, Australian tax may be applied to 10% of their JPDA income and capital gains at normal non-resident rates for individuals. [Articles 5(2)(a), 11(2), 12(1), 13(1) and 14(2)]

− In the case of individuals resident in third countries, Australia may tax 100% of their JPDA income and capital gains. They will then receive a rebate of the reduction percentage of their gross tax. In the case of Australia the amount of the reduction percentage (and tax rebate on the gross tax payable) will be 90%. The gross tax payable is calculated according to the formula in Clause 16 of the Petroleum (Timor Sea Treaty) Bill 2003. [Articles 5(3), 11(1), 12(3), 13(3) and 14(4)]

• The Australian superannuation guarantee charge (SGC) may be applied without reduction in respect of employment exercised in the JPDA in a year by Australian residents. The employment income of residents of countries other than Australia will not be subject to SGC. East Timor may not impose a tax equivalent to the SGC on the employment income of Australian residents. [Article 16]

• Australia will treat fringe benefits provided in respect of employment exercised in the JPDA in one of three ways [Article 15(a)]. In respect of fringe benefits provided to employees who are residents of Australia, FBT may be applied in full. In respect of fringe benefits provided to employees who are residents of East Timor, FBT shall not be applied [Article 15(b)]. In respect of fringe benefits provided to employees who are residents of countries other than Australia or East Timor, FBT may be applied to 10% of the fringe benefits provided. [Article 15(c)]

• In addition, the DA established under Article 6 of the Treaty is exempt from income tax in both Australia and East Timor [Article 6(b)(vii) of the Treaty]. Officers of the DA are also exempt from tax on their official remuneration, however, they remain taxable in their state of residence [Article 6(b)(viii) of the Treaty]. The period of the exemption for both the DA and its officers is the first 3 years after the Treaty enters into force. [Article 6(b)(i), (vii) and (viii) of the Treaty]

• Dividends paid out of profits derived in the JPDA by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in the first-mentioned Contracting State. However the tax charged by the first Contracting State is limited to not more than 15% of the gross amount of the dividends [Article 8]. For foreign tax credit purposes such dividends shall be deemed to have their source in the first-mentioned Contracting State [Article 19]. Dividends flowing from such a company to resident of a third country may be taxed in proportion with each Contracting State’s framework percentage. [Article 8(3)]

• Interest paid or credited by a ‘contractor’ in the JPDA to a resident of a Contracting State may be taxed in the other Contracting State but only up to 10% of the gross amount of the interest [Article 9]. For foreign tax credit purposes such interest shall be deemed to have its source in the second mentioned Contracting State [Article 19]. Interest flowing from a contractor to a resident of a third country may be taxed in proportion with each Contracting State’s framework percentage. [Article 9(3)].

• Royalties paid or credited by a contractor in the JPDA to a resident of a Contracting State may be taxed in the other Contracting State but only up to 10% of the gross amount of the royalties [Article 10]. For foreign tax credit purposes such royalties shall be deemed to have their source in the second mentioned Contracting State [Article 19]. Royalties flowing from a contractor to a resident of a third country may be taxed in proportion with each Contracting State’s framework percentage. [Article 10(3)]

• The value of goods and services introduced into the JPDA may be taxed by both Contracting States in accordance with the framework percentage. At present the Australian goods and services tax (GST) does not apply to the JPDA. [Article 18]

• The Taxation Code also provides for exchange of information between the taxation authorities of the Contracting States and a dispute resolution mechanism in the mutual agreement procedure Article. [Article 20]

• It is intended that the Taxation Code will be the responsibility of the Treasurer. The Commissioner of Taxation will be responsible for the administration of the Taxation Code.

• The Taxation Code is to enter into force at the same time as the rest of the Timor Sea Treaty [Article 25]. The Treaty enters into force upon the day on which Australia and East Timor have notified each other in writing that their respective requirements for entry into force have been complied with. [Article 25(a) of the Treaty]

• Upon entry into force, the date of effect of the Treaty is the date of signature, which is the 20 May 2002 [Article 25(b) of the Treaty]. In general, the Treaty and all of its provisions, which includes the Taxation Code, will therefore apply from 20 May 2002. Two exceptions to this general rule are the superannuation guarantee charge and the taxation of East Timor resident individuals. These provisions will apply from 1 July 2003.

• Under the transitional provisions, business losses of a person incurred in the JPDA prior to the date of domestic law effect of the Taxation Code are to be restated on the date of domestic law effect by reducing the full amount of the loss in accordance with the reduction percentage. In the case of Australia, business losses that had been reduced by 50% will, from 20 May 2002, be reduced by 90% [Article 23(1)]. Income, losses and other items derived in the JPDA from the date of domestic law effect of the Taxation Code onward are to be treated according to the framework percentage or reduction percentage as appropriate. [Article 23(2)]

Summary Table of the Extent to which Australia can apply its tax system to income derived from the JPDA

Type of Income	Non-Individuals (including companies)	Australian Residents	East Timor Residents	Third Country Residents
Business Profits	10%	100% with foreign tax credit (FTC)	10%	100% with Rebate
Alienation of Property	10%	100% with FTC	10%	10%
Independent Personal Services	N/A	100% with FTC	10%	100% with Rebate
Dependant Personal Services	N/A	100% with FTC	10%	100% with Rebate
Other Income	10%	100% with FTC	10%	100% with Rebate
Fringe Benefits	N/A	100% *Applied to Australian resident employer	0%	10% *Applied to Australian resident employer
Superannuation Guarantee Charge	N/A	100% *Applied to employer (whether they are an Australian resident or not)	0%	0%

Type of Income	Paid by a Resident Company to a resident of the Other Contracting State	Paid by a Resident Company to a Resident of the Same Contracting State	Paid by a Resident Company where a Third Country Resident is Beneficially Entitled
Dividends	100% taxable in both States, however the resident State of the company paying the dividend must limit its tax rate to 15% (a FTC is provided by the Other Contracting State)	100% taxable only in that Contracting State	10%

Type of Income	Paid by a Contractor where a resident of a Contracting State is Beneficially Entitled	Paid by a Contractor where a Third Country Resident is Beneficially Entitled
Interest	100% taxable in both States, however the State where the beneficiary is not a resident must limit its tax rate to 10% (a FTC is provided by the Contracting State of which the Beneficiary is a resident)	10%
Royalties	100% taxable in both States, however the State where the beneficiary is not a resident must limit its tax rate to 10% (a FTC is provided by the Contracting State of which the Beneficiary is a resident)	10%

DETAILED EXPLANATION OF THE TAXATION CODE

Article 1 - General definitions

66. This Article provides definitions for a number of the terms used in the Taxation Code. Other terms are defined in the particular Articles to which they relate. Terms referred to in the Taxation Code that are not defined in the Treaty (including the Taxation Code) are to have the meaning which they have under the taxation law from time to time in force of the Contracting State applying the Taxation Code.

67. The terms ‘Australian tax’ and ‘East Timor tax’ do not include penalties or interest. Each Contracting State reserves the right to levy penalties and interest relating to taxes covered in this Taxation Code. [Article 4(4)]

68. The term ‘contractor’ is defined in Article 1(b) of the Timor Sea Treaty as “a corporation or corporations which enter into a contract with the DA and which is registered as a contractor under the Petroleum Mining Code”.

69. The terms ‘framework percentage’ and ‘reduction percentage’ are used in the Taxation Code for the purpose of allocating taxing rights between Australia and East Timor. These terms give effect to the general revenue split contained in Article 4 of the Treaty. The term ‘framework percentage’ allocates taxing rights over 10% of the revenue sourced in the JPDA to Australia and 90% to East Timor. The term ‘reduction percentage’ reduces taxing rights by 90% in the case of Australia and 10% in the case of East Timor. The reduction percentage is generally used in Articles where both Contracting States have taxing rights to 100% of the revenue, but are then required to provide a tax offset for the tax paid in the other Contracting State on the reduction percentage amount.

70. The terms “tax offset” and “rebate” are used in the Taxation Code for two separate purposes and therefore have two different meanings. Under the Income Tax Assessment Act 1997 (ITAA1997) the term tax offset includes both a foreign tax credit and a rebate. However, in the Taxation Code, the term tax offset only means a foreign tax credit and does not mean a rebate. The term rebate has the same meaning as it does under Division 17 of the Income Tax Assessment Act 1936 (ITAA1936).

Article 2 - Personal scope

71. This Article establishes the general scope of the Taxation Code and provides for it to apply to persons (including companies) who are residents of either Australia or East Timor as well as persons who are not resident of either Contracting State, but only for taxation purposes related directly or indirectly to the exploration for or the exploitation of petroleum in the JPDA or acts, matters, circumstances, and things touching, concerning, arising out of or connected with any such exploration or exploitation.

Article 3 - Resident

Residential status

72. This Article sets out the basis by which the residential status of a person is to be determined for the purposes of the Taxation Code. Residential status is one of the criteria for determining each Contracting State’s taxing rights and is a necessary condition for the provision of relief under the Taxation Code. The concept of who is a resident according to each Contracting State’s taxation law provides the basic test. [Paragraph 1]

Dual residents

73. The Article also includes a set of tie-breaker rules for determining how residency is to be allocated to one or other of the Contracting States for the purposes of the Taxation Code if a taxpayer, whether an individual, a company or other entity, qualifies as a dual resident. A dual resident is a person who is a resident under the domestic law of both Contracting States.

74. The tie-breaker rules for individuals apply certain tests, in a descending hierarchy, for determining the residential status (for the purposes of the Taxation Code) of an individual who is a resident of both Contracting States under their respective domestic laws.

• if the individual has a permanent home in only one of the Contracting States, the person is deemed to be a resident solely of that Contracting State for the purposes of the Taxation Code; [Subparagraph 2(a)]

• if the individual has a permanent home available in both Contracting States or in neither, then their residential status takes into account the person’s habitual abode; [Subparagraph 2(b)]

• if the person has an habitual abode in both Contracting States, or does not have an habitual abode in either Contracting State the person is deemed to be a resident only of the Contracting State with which they have closer personal and economic relations;

− in determining a person’s economic relations, an individual’s nationality or citizenship shall be a factor; [Subparagraph 2(c)]

• if the residential status cannot be determined under the above rules, the competent authorities of the Contracting States shall consult each other with a view to resolving the matter by mutual agreement. [Subparagraph 2(d)]

76. Dual residents remain, however, in relation to each Contracting State, residents for the purposes of the Contracting State’s domestic law and subject to its tax insofar as the Taxation Code allows.

77. Where a non-individual (such as a company) is a resident of both Contracting States for their domestic tax purposes, the entity will be deemed to be a resident of the Contracting State in which its place of effective management is situated. [Paragraph 3]

Article 4 - Taxes covered

78. This Article specifies the existing taxes of each Contracting State to which the Taxation Code applies. These are, in the case of Australia:

79. The petroleum resource rent tax imposed by the Petroleum Resource Rent Tax Act 1987 is specifically excluded in the Taxation Code and is replaced in the Treaty by Production Sharing Contracts contained in Annex F. [Paragraph 1(a)]

80. Australian income tax includes the Medicare levy and Medicare levy surcharge (subsection 251R(7) of the ITAA 1936).

• the value-added tax on goods and services and sales tax on luxury goods; and

82. East Timor income tax includes the tax on profits after income tax or the additional profits tax. Only one of these taxes may be applied by East Timor at any one time to a specified petroleum project or part of a project. [Subparagraph 1(b)(i)]

83. The application of the Taxation Code will be automatically extended to any identical or substantially similar taxes which are subsequently imposed by either Contracting State in addition to, or in place of, the existing taxes. A duty is imposed on Australia and East Timor to notify each other as soon as possible of any substantial changes to their respective laws to which the Taxation Code applies. [Paragraph 2]

84. The Article permits only those taxes covered by the provisions of the Taxation Code to apply to JPDA income unless the other Contracting State consents to the imposition of additional taxes. [Paragraph 3]

85. Each Contracting State may impose penalties and interest charges under its domestic law relating to taxes covered by the Taxation Code. [Paragraph 4]

Article 5 - Business profits

86. This Article is concerned with the taxation of business profits derived by a person (including individuals, companies and any other body of persons) from sources in the JPDA.

Business profits or losses of persons other than an individual

87. The business profits or business losses of a person other than an individual derived from, or incurred in, the JPDA in a year may be taxed in both Contracting States as reduced by each Contracting State’s reduction percentage. [Paragraph 1]

Business profits or losses of an individual

General explanation

88. Individuals who are residents of a Contracting State may be taxed in both Contracting States on their JPDA business profits or losses, as reduced by each Contracting State’s reduction percentage. [Paragraph 2(a)]

89. Notwithstanding paragraph 2(a), a Contracting State may fully tax the JPDA business profits or recognise the losses of a resident individual. In such a case, the Contracting State must provide a tax offset against the tax payable on the JPDA profits by the individual for the tax paid in the other Contracting State. [Paragraph 2(b)]

90. In the case of individuals who are not residents of either Contracting State, the Article provides for taxation of such remuneration in both Australia and East Timor simultaneously. To eliminate the double taxation that would otherwise occur, the Article allows for a rebate entitlement of the reduction percentage of the gross tax payable in each Contracting State. By this mechanism both Australia and East Timor are ensured an equitable share of the tax revenues generated by residents of third countries in such circumstances. [Paragraph 3]

91. In addition, business losses of individuals who are not residents of either Contracting State that are to be carried forward for deduction against future income shall be reduced by the reduction percentage. [Paragraph 4]

Australian treatment of business profits or losses of an individual

92. Australia will treat business profits or losses of individuals derived from the JPDA in one of three ways. The treatment depends on whether the individual is a resident of East Timor, Australia or a third country.

Residents of East Timor

93. In the case of individuals who are residents of East Timor, Australian tax will be applied to their JPDA business profits as reduced by the reduction percentage. This will mean that 10% of the JPDA business profits of East Timorese residents will be taxed in Australia at normal non-resident rates for individuals. [Subparagraph 2(a)]

Residents of Australia

94. Australian resident individuals are to be taxed in Australia on 100% of their Australian JPDA business profits at normal resident tax rates, subject to a tax offset being given for East Timorese tax on 90% of their East Timorese JPDA business profits. [Subparagraphs 2(a) and (b)]

95. It should be noted that there are likely to be differences in tax rates and differences in the way Australia and East Timor calculate taxable income. In some circumstances tax on 90% of income under East Timorese law may be greater than the tax on 100% of income calculated under Australian law. In these circumstances the excess foreign tax credits can generally be carried forward for five years in accordance with section 160AFE of the ITAA1936.

Residents of third countries

Individuals who are residents of countries other than Australia or East Timor are to be taxed in Australia on 100% of their JPDA business profits. They will then receive a rebate of the reduction percentage of their gross tax. In the case of Australia the amount of the reduction percentage (and tax rebate on the gross tax payable) will be 90%. The gross tax payable is calculated according to the formula in Clause 16 of the Petroleum (Timor Sea Treaty) Bill 2003. [Paragraph 3]

Business losses incurred by such persons will be able to be carried forward in both Australia and East Timor concurrently, but are to be reduced by each Contracting State’s reduction percentage. [Paragraph 4]

Carry-forward losses

96. Paragraph 5 provides a mechanism for the correct calculation of the reduction to be afforded by paragraph 1, subparagraphs 2(a) and 2(b), and paragraph 4 in any case where carry-forward of losses from prior years are involved. The purpose of the provision is to exclude from the calculation of the amount of reduction of business profits or business losses the quantum of carry-forward losses from previous years which may be allowable under the laws of each Contracting State. These losses are nevertheless taken into account when working out the person's overall tax liability. [Paragraph 5]

Profits dealt with under other Articles

97. Where income, gains or losses are otherwise specifically dealt with under other Articles of the Taxation Code the effect of those particular Articles is not overridden by this Article.

98. This Article lays down the general rule of interpretation that categories of income, gains or losses which are the subject of other Articles of the Taxation Code (eg shipping, dividends, interest, royalties and alienation of property) are to be treated in accordance with those Articles. [Paragraph 6]

Derivation of business profits

99. In determining whether business profits are derived from the JPDA, paragraph 7 establishes the basic rule that regard must be had to internationally accepted principles on the source of business profits. The basic rule broadly reflects internationally accepted principles established by the OECD and the UN for attributing business profits of a single legal entity between jurisdictions. [Paragraph 7]

100. Where business profits and losses are apportioned between the JPDA and elsewhere, consideration needs to be given to the extent to which activities and assets in the JPDA contributed to business profits. [Paragraph 7]

101. When establishing whether business profits are derived from the JPDA or elsewhere and when apportioning business profits and losses between the JPDA and elsewhere, particular regard shall be had to:

• any business and financial risks assumed by an entity and which relate to the business profits.

102. The above rules broadly reflect the internationally accepted principles established by the OECD and UN for attributing business profits of a single legal entity between jurisdictions.

103. Paragraph 7 provides the framework for determining whether income is derived within the JPDA or outside the JPDA. While the circumstances of each case must be considered having regard to their particular facts, an example of when income is derived outside the JPDA is where an oil rig is constructed in the United States and then shipped to the JPDA. The profits from the construction of the rig will not be derived in the JPDA because the functions performed, assets used and risks assumed in the construction of the rig are located in the United States. Profits from the operation of the rig within the JPDA will, however, be considered to be derived in the JPDA.

104. Another example is where architectural services for design of an oil rig are conducted in Darwin. The income received for those architectural services is derived outside the JPDA if the location of functions performed, assets used and risks assumed in relation to those services is not within the JPDA.

Regard to be had to Unitisation Agreements

105. Paragraph 8 is concerned with the interaction of Unitisation Agreements (sometimes referred to as International Unitisation Agreements) and the provisions of paragraph 7.

106. A Unitisation Agreement is an agreement between those with jurisdiction over a shared petroleum pool that extends across two or more title boundaries. It enables that pool to be developed as a single unit. The objective of a Unitisation Agreement is to maximise the efficient recovery of the petroleum resource through co-operative exploitation by all stakeholders.

107. Where a Unitisation Agreement exists between Australia and East Timor that relates to activities in the JPDA, the agreement will be used to determine the source of business profits to the extent that its provisions do not conflict with the principles outlined in paragraph 7. [Paragraph 8]

108. In the case where the terms of the Unitisation Agreement conflict with paragraph 7, then paragraph 7 will operate to override the Unitisation Agreement to the extent of the conflict. . [Paragraph 8]

Derivation of business losses

In determining the derivation of business losses, an approach consistent with paragraphs 7 and 8 is to be used. [Paragraph 9]

Apportionment of business profits between the JPDA and elsewhere

In the case where business profits or losses are not fully derived or fully incurred in the JPDA, the relevant portion determined under paragraphs 7, 8 and 9, shall be attributed to the JPDA. [Paragraph 10]

109. In applying paragraph 10, the Contracting States shall seek a consistent approach, including as between the treatment of profits and losses and should consult if necessary to achieve a consistent outcome. [Paragraph 10]

Additional profits tax as a tax on business profits

110. For the purposes of this Taxation Code, the East Timor additional profits tax shall be regarded as a tax on business profits. [Paragraph 11]

Article 6 – Shipping and air transport

111. Profits from all shipping and air transport that commences at a place in the JPDA, to any other place, whether inside or outside the JPDA, shall be regarded as business profits derived from the JPDA. [Paragraphs 1 and 2]

112. Profits from all shipping and air transport where the transport commences outside the JPDA, and ends within the JPDA, shall not be regarded as derived from the JPDA. [Paragraph 3]

Article 7 – Petroleum valuation

113. This Article provides the basic rule that the value of petroleum shall be determined in accordance with internationally accepted arm’s length principles for all purposes under the taxation law of both Contracting States. The basic rule broadly reflects internationally accepted principles established by the OECD and the UN which are based on an examination of what independent parties dealing wholly independently with each other might reasonably be expected to have agreed to in the particular circumstances having regard to functions performed, assets used and risks assumed by the respective parties.

114. The Article makes no distinction on the basis of whether any transactions involving petroleum are between related or unrelated parties. The basic rule applies in all cases for the purpose of determining the value of petroleum.

115. This Article is necessary to ensure that profits relating to petroleum are correctly allocated to the jurisdiction in which they were earned.

116. Each Contracting State retains the right to apply its domestic law relating to the determination of the tax liability of a person to its own enterprises. In particular the Article imposes no constraints on either the scope or application of Australia’s domestic arm’s length provisions (eg Division 13 of Part III of the ITAA 1936) other than in respect of the valuation of petroleum. As both Division 13 and the Article are based on the same internationally accepted arm's length principles, for all practical purposes, there should be no difference in their application in respect of the valuation of petroleum.

117. Amendments contained in the Petroleum (Timor Sea Treaty) (Consequential Amendments) Bill 2003 provide for the application of Australia’s arm’s length provisions in Division 13 of Part III of the ITAA 1936 to transactions between the JPDA and rest of Australia notwithstanding that such transactions may be between two resident taxpayers. This includes the re-calculation of the value of petroleum under this Article.

118. As part of the process for determining an arm's length value for petroleum, arm's length principles may also need to be applied at various intermediate steps along the way. For example, for determining the arm’s length consideration in respect of various petroleum activities including petroleum transport and processing facilities, such as pipelines and LNG plants

119. The Article allows the re-allocation of profits from petroleum between enterprises in the JPDA and Australia and East Timor on an arm’s length basis where the value of petroleum differs from that which might reasonably have been expected if the enterprises had been independent enterprises and dealing wholly independently with each other.

120. The Article would not generally authorise the rewriting of accounts of enterprises where it can be satisfactorily demonstrated that the transactions between such enterprises have taken place on normal, open-market commercial terms.

Interaction of Article 7 with transfer pricing provisions in Australia’s double taxation agreements.

121. Article 7 provides a rule which allows arm’s length calculations of the value of petroleum between the JPDA, Australia and East Timor. This rule operates in conjunction with the transfer pricing provisions in Australia’s double taxation agreements, as these agreements apply between Australia (which includes the JPDA) and other countries.

Article 8 – Dividends

122. This Article requires a Contracting State to limit its rate of tax on dividends paid by a company resident of that State out of profits, income or gains derived from sources in the JPDA to which a resident of the other Contracting State is beneficially entitled. The tax rate is limited to 15% of the gross amount of the dividend. [Paragraph 1]

123. Dividends paid by a company resident in a Contracting State out of profits, income or gains from sources in the JPDA to which a resident of the same Contracting State is beneficially entitled shall be taxable only in that State. [Paragraph 2]

124. Where a dividend is paid by a company resident of a Contracting State to a person who is not a resident of Australia or East Timor, each Contracting State may tax the dividend according to each Contracting State’s framework percentage. [Paragraph 3]

125. It should be noted that paragraph 44(1)(b) of the ITAA36 may apply to tax dividends paid out of profits derived in the JPDA by non-resident companies to non-residents. In most cases, however, the operation of this subsection will be excluded by the application of Australia’s double taxation agreements.

Definition of dividends

126. Dividend means income from shares or other rights participating in profits and not relating to debt claims, as well as other income which is subjected to the same taxation treatment as income from shares by the law of the Contracting State of which the company making the distribution is a resident. [Paragraph 4]

East Timor’s branch profits tax

Paragraph 5 applies to the imposition by East Timor of its branch profits tax, called the tax on profits after income tax. Australia does not currently have a branch profits tax, and this type of tax is not a tax which Australia may impose in the JPDA. [Paragraph 5]

127. East Timor may impose its tax on profits after income tax to companies which are resident of a Contracting State. The imposition by East Timor of the tax on profits after income tax is subject to certain limitations:

• Where East Timor imposes its tax on profits after income tax it may not impose its additional profits tax. [Article 4 subsubparagraph (1)(b)(i)]

• The tax on profits after income tax does not apply to a dividend distribution and a dividend withholding tax does not apply where the tax on profits after income tax applies.

• The tax on profits after income tax is limited to 15% of the gross amount of a company’s profits, income or gains, after deducting from those profits, income or gains the income tax imposed by Australia.

• The tax on profits after income tax is limited to the Contracting State’s framework percentage of the profits after income tax. [Paragraph 5]

• The term ‘derived from’ has the same meaning as in Article 5. [Paragraph 6]

Article 9 – Interest

128. This Article requires a Contracting State to limit its rate of tax on interest to 10% on the gross amount of interest income paid or credited by a ‘contractor’ to which a resident of the other Contracting State is beneficially entitled. This limitation will not affect the rate of Australian withholding tax on interest derived by residents of East Timor which will continue to be imposed at the general rate of 10% applicable under Australia's domestic law. [Paragraphs 1 and 2]

129. Where interest is paid by a contractor to a person who is not a resident of Australia or East Timor, each Contracting State may tax the interest according to the Contracting State’s framework percentage. [Paragraph 3]

130. The term interest includes interest from bonds or debentures, whether or not secured by mortgage and whether or not carrying a right to participate in profits, interest from any form of indebtedness and all other income assimilated to income from money lent by law, relating to tax, of the Contracting State in which the income arises. [Paragraph 4]

Article 10 – Royalties

131. This Article requires a Contracting State to limit its rate of tax on royalties to 10% on the gross amount of royalty income paid or credited by a ‘contractor’ to which a resident of the other Contracting State is beneficially entitled. [Paragraphs 1 and 2]

132. Where royalties are paid by a contractor to a person who is not a resident of Australia or East Timor, each Contracting State may tax the interest according to the Contracting State’s framework percentage. [Paragraph 3]

Definition of royalties

133. The definition of royalties largely reflects the definition in Australia’s domestic income tax law. The definition encompasses payments for the use of, or the right to use industrial, commercial or scientific equipment. It also includes payments for the supply of scientific, technical, industrial or commercial know-how but not payments for services rendered. Payments made for the right to copy or adapt computer software in a manner which would, without the permission of the copyright owner, constitute an infringement of copyright, also constitute royalty payments. [Paragraph 4]

Payments for the supply of know-how versus payments for services rendered

134. It is considered that a German Supreme Court decision (Bundesfinanzhof (No. IR 44/67) of 16 December 1970) provides a definitive test to distinguish between a know-how contract and a contract for services. A know-how contract, it was held, involved the supply by a person of his or her know-how to the paying entity (e.g. teaching a personal expertise), whereas in a contract for services, although it may involve the use of know-how, that know-how is applied by the person in the performance of his or her services.

135. Payments for design, engineering or construction of plant or building, feasibility studies, component design and engineering services may generally be regarded as being in respect of a contract for services, unless there is some provision in the contract for imparting techniques and skills to the buyer.

136. In cases where both know-how and services are supplied under the same contract, if the contract does not separately provide for payments in respect of know-how and services, an apportionment of the 2 elements of the contract may be possible.

Forbearance

137. Consistent with Australian tax treaty practice, subparagraph 4(e) expressly treats as a royalty, amounts paid or credited in respect of forbearance to grant to third persons, rights to use property covered by the royalty Article. This is designed to prevent arrangements along the lines of those contained in Aktiebolaget Volvo v. Federal Commissioner of Taxation (1978) 8 ATR 747; 78 ATC 4316, where instead of amounts being payable for the exclusive right to use the property they were made for the undertaking that the right to use the property will not be granted to anyone else, not being subject to tax as a royalty payment under the terms of Article 10. [Subparagraph 4(e)]

Article 11 - Alienation of property

138. This Article deals with the taxation treatment of capital gains and losses from the alienation of property situated in the JPDA. The Article is necessary from an Australian perspective because, under Australian tax law, capital is distinguished from income and therefore capital gains and losses might not be appropriately covered, if at all, by any other provision of the Taxation Code.

139. It is intended that the term ‘property’ refers to all property and not just real property within the JPDA. Most property within the JPDA that is covered by this Article will not be real property. Such assets as mining and drilling equipment, oil extraction platforms, and pipelines are included in the definition of property. [Paragraphs 1 and 2]

Capital gains and losses of a person other than an individual who is a resident of a Contracting State

140. Gains or losses of a capital nature from the alienation of property of a person other than an individual who is a resident of a Contracting State are to be taxed according to each Contracting State’s framework percentage. This also applies to individuals who are residents of countries other than Australia or East Timor. [Paragraph 1]

Capital gains and losses of an individual who is a resident of a Contracting State

141. Gains or losses of a capital nature from the alienation of property of an individual who is a resident of a Contracting State may be taxed in both Contracting States as reduced by each Contracting State’s reduction percentage. [Paragraph 2]

142. Notwithstanding paragraph 2, a Contracting State may fully tax the gain or recognise the loss of a capital nature of a resident individual. In such a case, the Contracting State must provide a tax offset against the tax payable on the gain in the other Contracting State. [Paragraph 3]

Lamesa provisions

143. This Article also deals with the taxation of capital gains and losses from shares and comparable interests in companies whose assets consist wholly or mainly of property situated in the JPDA. These assets may be held directly or indirectly, including for example through a chain of companies.

144. It is necessary to include such assets within the scope of Article 11 in response to the tax planning opportunities exposed by the decision of the Full Federal Court in Commissioner of Taxation v Lamesa Holdings BV (1997) 77 FCR 597.

145. The inclusion of these assets is designed to protect Australian taxing rights over income or profits on the alienation or effective alienation of Australian property despite the presence of interposed bodies corporate or other entities. [Paragraphs 1 and 2]

Article 12 - Independent personal services

146. This Article applies to income derived by an individual from professional services and other independent activities of a similar character performed within the JPDA (JPDA professional services income).

General explanation

147. Residents of a Contracting State may be taxed in both Contracting States on their JPDA professional services income, as reduced by each Contracting State’s reduction percentage. [Paragraph 1]

148. Notwithstanding paragraph 1, a Contracting State may fully tax the JPDA professional services income of a resident individual. In such a case, the Contracting State must provide a tax offset against the tax payable on the JPDA income by the individual for the tax paid in the other Contracting State. [Paragraph 2]

149. In the case of employees who are not residents of either Contracting State, the Article provides for taxation of such remuneration in both Australia and East Timor simultaneously. To eliminate the double taxation that would otherwise occur, the Article allows for a rebate entitlement of the reduction percentage of the gross tax payable in each Contracting State. By this mechanism both Australia and East Timor are ensured an equitable share of the tax revenues generated by residents of third countries in such circumstances. [Paragraph 3]

Australian treatment of independent personal services income

150. Australia will treat income from professional services paid to employees in respect of employment exercised in the JPDA in one of three ways. The treatment depends on whether the individual is a resident of East Timor, Australia or a third country.

Residents of East Timor

151. In the case of residents of East Timor, Australian tax will be applied to their JPDA professional services income as reduced by the reduction percentage. This will mean that 10% of the JPDA professional services income of East Timorese residents will be taxed in Australia at normal non-resident rates for individuals. [Paragraph 1]

Residents of Australia

152. Australian residents are to be taxed in Australia on 100% of their Australian JPDA professional services income at normal resident tax rates, subject to a tax offset being given for East Timorese tax on 90% of their East Timorese JPDA professional services income. [Paragraph 2]

153. It should be noted that there are likely to be differences in tax rates and differences in the way Australia and East Timor calculate taxable income. In some circumstances tax on 90% of income under East Timorese law may be greater than the tax on 100% of income calculated under Australian law. In these circumstances the excess foreign tax credits can generally be carried forward for five years in accordance with section 160AFE of the ITAA1936.

Residents of third countries

154. Residents of countries other than Australia or East Timor are to be taxed in Australia on 100% of their JPDA professional services income. They will then receive a rebate of tax of the reduction percentage of their gross tax. In the case of Australia the amount of the reduction percentage (and tax rebate on the gross tax payable) will be 90%. The gross tax payable is calculated according to the formula in Clause 16 of the Petroleum (Timor Sea Treaty) Bill 2003. [Paragraph 3]

Article 13 - Dependent personal services

155. This Article applies to salary, wages and other similar remuneration derived by an individual in respect of employment exercised in the JPDA (JPDA employment income).

General explanation

Residents of a Contracting State may be taxed in both Contracting States on their JPDA employment income, reduced by each Contracting State’s reduction percentage. [Paragraph 1]

156. Notwithstanding paragraph 1, a Contracting State may fully tax the JPDA employment income of a resident individual. In such a case, the Contracting State must provide a tax offset against the tax payable on the JPDA employment income by the individual for the tax paid in the other Contracting State. [Paragraph 2]

157. In the case of employees who are not residents of either Contracting State, the Article provides for taxation of such remuneration in both Australia and East Timor simultaneously. To eliminate the double taxation that would otherwise occur, the Article allows for a rebate entitlement of the reduction percentage of the gross tax payable in each Contracting State. By this mechanism both Australia and East Timor are ensured an equitable share of the tax revenues generated by residents of third countries in such circumstances. [Paragraph 3]

Australian treatment of dependent personal services income

158. Australia will treat the salary, wages and other similar remuneration paid to employees in respect of employment exercised in the JPDA in one of three ways. The treatment depends on whether the individual is a resident of East Timor, Australia or a third country.

Residents of East Timor

159. In the case of residents of East Timor, Australian tax will be applied to their JPDA employment income as reduced by the reduction percentage. This will mean that 10% of the JPDA employment income of East Timorese residents will be taxed in Australia at normal non-resident rates for individuals. [Paragraph 1]

Residents of Australia

160. Australian residents are to be taxed in Australia on 100% percent of their Australian JPDA employment income at normal resident tax rates, subject to a tax offset being given for East Timorese tax on 90% of their East Timorese JPDA employment income. [Paragraph 2]

161. It should be noted that there are likely to be differences in tax rates and differences in the way Australia and East Timor calculate taxable income. In some circumstances tax on 90% of income under East Timorese law may be greater than the tax on 100% of income calculated under Australian law. In these circumstances the excess foreign tax credits can generally be carried forward for five years in accordance with section 160AFE of the ITAA1936.

Residents of third countries

162. Residents of countries other than Australia or East Timor are to be taxed in Australia on 100% of their JPDA employment income. They will then receive a rebate of the reduction percentage of their gross tax. In the case of Australia the amount of the reduction percentage (and tax rebate on the gross tax payable) will be 90%. The gross tax payable is calculated according to the formula in Clause 16 of the Petroleum (Timor Sea Treaty) Bill 2003. [Paragraph 3]

Article 14 - Other income

163. This Article applies to items of income derived from sources in the JPDA not expressly mentioned in the preceding Articles of the Taxation Code.

Residents of a Contracting State other than individuals

164. Residents of a Contracting State other than individuals may be taxed in both Contracting States on their JPDA other income, reduced by each Contracting State’s reduction percentage. [Paragraph 1]

JPDA other income of an individual

General explanation for individuals

165. Individuals who are residents of a Contracting State may be taxed in both Contracting States on their JPDA other income, reduced by each Contracting State’s reduction percentage. [Paragraph 2]

166. Notwithstanding paragraph 2, a Contracting State may fully tax the other income of a resident individual. In such a case, the Contracting State must provide a tax offset against the tax payable on the JPDA other income by the individual for the tax paid in the other Contracting State. [Paragraph 3]

167. In the case of individuals who are not residents of either Contracting State, the Article provides for taxation of such other income in both Australia and East Timor simultaneously. To eliminate the double taxation that would otherwise occur, the Article allows for a rebate entitlement of the reduction percentage of the gross tax payable in each Contracting State. By this mechanism both Australia and East Timor are ensured an equitable share of the tax revenues generated by residents of third countries in such circumstances. [Paragraph 4]

Australian treatment of other income of an individual

168. Australia will treat the other income of individuals in one of three ways. The treatment depends on whether the individual is a resident of East Timor, Australia or a third country.

Residents of East Timor

169. In the case of residents of East Timor, Australian tax will be applied to their other income as reduced by the reduction percentage. This will mean that 10% of the other income of East Timorese residents will be taxed in Australia at normal non-resident rates for individuals. [Paragraph 2]

Residents of Australia

170. Australian residents are to be taxed in Australia on 100% of their Australian JPDA other income at normal resident tax rates, subject to a tax offset being given for East Timorese tax on 90% of their East Timorese JPDA other income. [Paragraph 3]

171. It should be noted that there are likely to be differences in tax rates and differences in the way Australia and East Timor calculate taxable income. In some circumstances tax on 90% of income under East Timorese law may be greater than the tax on 100% of income calculated under Australian law. In these circumstances the excess foreign tax credits can generally be carried forward for five years in accordance with section 160AFE of the ITAA1936.

Residents of third countries

172. Residents of countries other than Australia or East Timor are to be taxed in Australia on 100% of their other income. They will then receive a rebate of the reduction percentage of their gross tax. In the case of Australia the amount of the reduction percentage (and tax rebate on the gross tax payable) will be 90%. The gross tax payable is calculated according to the formula in Clause 16 of the Petroleum (Timor Sea Treaty) Bill 2003. [Paragraph 4]

Article 15 - Fringe benefits

173. This Article applies to Australian taxation of fringe benefits provided to an individual in respect of employment exercised in the JPDA.

General explanation of fringe benefits

174. Australia taxes fringe benefits provided to an employee in the hands of the employer paying the fringe benefits. Australia will treat fringe benefits provided in respect of employment exercised in the JPDA in one of three ways. The treatment depends on whether the employee is a resident of East Timor, Australia or a third country.

Residents of Australia

175. In respect of fringe benefits provided to employees who are residents of Australia, fringe benefits tax (FBT) may be applied in full. [Subparagraph (a)]

Residents of East Timor

In respect of fringe benefits provided to employees who are residents of East Timor, FBT shall not be applied. [Subparagraph (b)]

Residents of third countries

176. In respect of fringe benefits provided to employees who are residents of countries other than Australia or East Timor, FBT may be applied to 10% of the fringe benefits provided. Consequently, the employer's obligation to fringe benefits tax in respect of benefits provided to those employees will be reduced by 90%. [Subparagraph (c)]

Article 16 – Superannuation guarantee charge

177. The Australian superannuation guarantee charge (SGC) may be applied without reduction in respect of employment exercised in the JPDA in a year by Australian residents.

178. The Superannuation Guarantee (Administration) Act 1992 is amended by the Petroleum (Timor Sea Treaty)(Consequential Amendments) Bill 2003 so that the Superannuation Guarantee (Administration) Act 1992 applies in the JPDA, but only in respect of salary or wages paid by an employer (whether they are an Australian resident or not) to an Australian resident employee for work done in the JPDA.

179. Therefore the employment income of residents of countries other than Australia will not be subject to SGC.

180. East Timor may not impose a tax equivalent to the SGC on the employment income of Australian residents. There is not, therefore, a need for Australia to provide tax relief in respect of the SGC.

Article 17 - Miscellaneous

181. This Article makes clear that only those parts of income, profits or gains that are derived in the JPDA as defined in Article 5 can be taxed by either Contracting State on a source basis under the Taxation Code.

Article 18 – Indirect taxes

182. This Article applies to the taxation of goods and services introduced into the JPDA from any source.

183. The value of goods and services introduced into the JPDA may be taxed by both Contracting States in accordance with the framework percentage.

184. In the case of Australia, the Australian goods and services tax (GST) may be applied to 10% of the taxable value of goods and services introduced into the JPDA. In the case of East Timor, the Timorese value-added tax on goods and services and sales tax on luxury goods or the East Timorese sales tax may be applied to 90% of the taxable value of goods and services introduced into the JPDA.

Article 19 - Avoidance of double taxation

186. Double taxation does not arise in respect of income derived in the JPDA where either:

• the terms of the Taxation Code provide for the income to be taxed only in Australia or only in East Timor, including as provided by the framework or reduction percentages; or

• the domestic taxation law of Australia or East Timor exempts the income from its tax.

Tax credit

187. It is necessary, however, to prescribe a method for relieving double taxation for other classes of income which, under the terms of the Taxation Code, remain subject to tax in both Contracting States.

188. For this purpose paragraphs 1 and 2 of this Article provide that Australia and East Timor shall allow foreign tax credits for tax paid on income in the form of:

• profits, income and gains that are subject to the East Timorese tax on profits after income tax.

189. Amendments have also been made to the ITAA 1936 to allow individuals to receive foreign tax credits for East Timor tax paid on income derived in the JPDA. These amendments are contained in the Petroleum (Timor Sea Treaty) (Consequential Amendments) Bill 2003.

Australian method of relief

190. Australia’s general foreign tax credit system, together with the terms of this Article and of the Taxation Code generally, will form the basis of Australia’s arrangements for relieving a resident of Australia from double taxation on income that is also taxed by East Timor.

191. Accordingly, effect is to be given to the tax credit relief obligation imposed on Australia by paragraph 1 of this Article by application of the general foreign tax credit provisions (Division 18 of Part III of the ITAA 1936). Under these provisions and in accordance with the provisions of the Taxation Code, Australia is required to provide its residents a credit for East Timor tax paid in respect of income they have derived of the types listed in paragraph 1 which are taxed in both Australia and East Timor. These types of income include dividends, interest, royalties and profits, income and gains that are subject to the East Timorese tax on profits after income tax. [Paragraph 1]

Dividends

192. Where a dividend of the type referred to in paragraph 1 of Article 8 is paid by an East Timor resident company to an Australian resident, the dividend may be taxed in East Timor at a rate not exceeding 15%. In such a case Australia shall allow a foreign tax credit against Australian tax for tax paid in East Timor in respect of that income. [Subparagraph 19(1)(a)]

Interest and Royalties

193. Where interest or royalties of a type referred to respectively in paragraph 2 of Article 9 and paragraph 2 of Article 10 are paid or credited by a ‘contractor’ to an Australian resident, the interest or royalty may be taxed in East Timor at a rate not exceeding 10%. In such a case Australia shall allow a foreign tax credit against Australian tax for tax paid in East Timor in respect of that income. [Subparagraphs (1)(b) and (c)]

Branch Profits Tax

194. Where East Timor imposes a Branch Profits Tax of the type referred to in paragraph 5 of Article 8 it may do so only on an amount equivalent to the framework percentage at a rate not exceeding 15%. In such a case Australia shall allow a foreign tax credit against Australian tax for tax paid in East Timor in respect of that income. [Subparagraph 19(1)(d)]

East Timor relief

195. East Timor is also required to provide to its residents a credit for Australian tax paid where these residents have derived income of the types listed in paragraph 2 which are taxed in both Australia and East Timor. [Paragraph 2]

Source of income from JPDA for foreign tax credit purposes

196. For the purpose of calculating foreign tax credit entitlements under the law of a Contracting State, dividends, interest and royalties referred to in this Article are deemed to be sourced in the other Contracting State.

197. This deeming rule is necessary because under Australian law foreign tax credits are only available when tax has been paid in a foreign country. The JPDA, being part of Australia, would not without this rule be considered a foreign country for the purpose of Australia’s foreign tax credit system.

198. This rule therefore provides that dividends, interests and royalties derived from the JPDA by a resident of Australia, which are taxable in both Australia and East Timor under the Taxation Code, are treated as income derived from East Timor. Accordingly, Australian residents will be able to receive foreign tax credits for the East Timor tax paid on this income. [Paragraph 3]

199. To ensure that a foreign tax credit is available for Australian residents receiving the types of income in Articles 5, 11, 12, 13 and 14 amendments are contained in the Petroleum (Timor Sea Treaty) (Consequential Amendments) Bill 2003 that provide similar treatment to that achieved for dividends, interest and royalties under Article 19(3).

Article 20 - Mutual agreement procedure

Consultation

200. One of the purposes of this Article is to provide for consultation between the competent authorities of the two Contracting States with a view to reaching a satisfactory solution where a person is able to demonstrate actual or potential imposition of taxation contrary to the provisions of the Taxation Code.

201. A taxpayer wishing to use this procedure must present a case to the competent authority of the Contracting State of which the person is a resident within thirty-six months of the first notification of the action which the taxpayer considers gives rise to the taxation not in accordance with the Taxation Code. [Paragraph 1]

202. If, on consideration by the competent authorities, a solution is reached, it may be implemented irrespective of any time limits imposed by the domestic tax law of the relevant Contracting State. [Paragraph 2]

203. The competent authorities will have particular regard to the objects and purposes of the Taxation Code, particularly the avoidance of double taxation, in considering an action brought under this Article. [Paragraph 3]

204. The Article also authorises consultation between the taxation authorities of the two Contracting States for the purpose of resolving any difficulties regarding the interpretation or application of the Taxation Code and to give effect to it. [Paragraph 4]

General Agreement on Trade in Services (GATS) dispute resolution process

205. This Article also discusses the application of paragraph 3 of Article XXII of the World Trade Organisation General Agreement on Trade in Services (GATS). [Paragraph 5]

206. Paragraph 3 of Article XXII of the GATS provides that a disputed measure which falls outside the scope of an "international agreement relating to the avoidance of double taxation" may be resolved under the dispute resolution mechanisms provided by Articles XXII and XXIII of the GATS.

207. If there is a dispute as to whether a measure falls within the scope of the Taxation Code, the consent of both Contracting States is necessary to take the matter to the Council for Trade in Services. [Paragraph 5]

Background

208. Where a Treaty was entered into prior to the entry into force of the GATS (1 January 1995), consent of both Contracting States is required before the issue may be taken to the Council on Trade in Services. This restriction would not ordinarily apply to the Taxation Code which, as part of the Treaty, was concluded after the entry into force of the GATS. However, paragraph 5 of Article 20 specifies that the consent of both Contracting States is required before the issue may be taken to the Council for Trade in Services. [Paragraph 5]

Article 21 - Exchange of Information

Limitations on exchange

209. This Article authorises and limits the exchange of information by the two competent authorities to information necessary for the carrying out of the Taxation Code or for the administration of domestic laws concerning the taxes to which the Taxation Code applies. [Paragraph 1]

210. The limitation placed on the kind of information authorised to be exchanged means that information access requests relating to taxes not within the coverage provided by Article 4 (taxes covered), are not within the scope of this Article.

Purpose

211. The purposes for which the exchanged information may be used and the persons to whom it may be disclosed are restricted consistent with Australia’s tax treaty practice. Any information received by a Contracting State shall be treated as secret in the same manner as information obtained under the domestic law of that Contracting State. [Paragraph 1]

212. An exchange of information that would disclose any trade, business, industrial, commercial or professional secret or trade process or which would be contrary to public policy is not permitted by the Article. [Paragraph 2]

Application

213. This Article applies to all taxes covered by the Taxation Code. Unlike Australia’s normal double taxation agreements, the Taxation Code applies not only to income tax, but also to:

214. As a result, the exchange of information obligations imposed under this Article apply not only to income tax but also to these three taxes.

How secrecy provisions are overridden for the purpose of the exchange of information Article

215. Australia’s double taxation agreements ordinarily apply only to income tax. Secrecy provisions preventing the disclosure of information relating to income tax are contained in section 16 of the ITAA36.

216. Similar secrecy provisions also exist that prevent the disclosure of information relating to FBT and SGC. These provisions are:

• section 45 of the Superannuation Guarantee (Administration) Act 1992 (SGA Act).

217. These secrecy provisions are overridden by Clause 15 of the Petroleum (Timor Sea Treaty) Bill 2003. Clause 15 incorporates the FBTA Act and SGA Act into the Petroleum (Timor Sea Treaty) Bill 2003 and allows the Timor Sea Treaty to override the FBTA Act and the SGA Act to the extent of any inconsistency. Therefore, the exchange of information Article in the Timor Sea Treaty overrides the secrecy provisions contained in the FBTA Act and the SGA Act and allows Australia to provide information to East Timor in relation to these two taxes.

218. This is done in a similar manner to the way the income tax secrecy provision, section 16, is overridden by Australia’s double taxation agreements. Section 16 is overridden for the purpose of exchange of information Articles in Australia’s double taxation agreements by virtue of section 4 of the International Tax Agreements Act 1953. Section 4 incorporates the Assessment Acts (the ITAA36 and ITAA97) into the International Tax Agreements Act 1953 and requires the latter Act to override the former Act to the extent of any inconsistency between the two. As a result, treaties contained in the International Tax Agreements Act 1953 override section 16 of the ITAA36 and information can be exchanged in relation to income tax.

GST secrecy provisions

219. The secrecy provisions relating to GST, however, are contained in the Tax Administration Act 1953 rather than the GST Act. As the Tax Administration Act 1953 is not referred to in Clause 15, the secrecy provisions relating to GST are not overridden under this mechanism. Amendments contained in the Petroleum (Timor Sea Treaty)(Consequential Amendments) Bill 2003 will amend section 68 of the Tax Administration Act 1953 to allow the disclosure of information relating to GST matters. Such disclosure is only permitted for the purpose of complying with an obligation Australia has under an agreement between Australia and another country, in this case the exchange of information obligations contained in Article 21 of the Tax Code to the Timor Sea Treaty.

Article 22 – Interaction with other taxation arrangements

220. This Article makes it clear that the Taxation Code is in no way intended to limit the operation of taxation arrangements between either Contracting State and third countries or territories, unless provided for in such arrangements.

Article 23 – Transitional provisions

221. Under Article 23 business losses of a person incurred in the JPDA prior to the date of domestic law effect of the Taxation Code (20 May 2002) are to be restated on this date by reducing the full amount of the loss in accordance with the reduction percentage. In the case of Australia, business losses that had been reduced by 50% will, on 20 May 2002, be reduced by 90%. [Paragraph 1]

222. Income, losses and other items derived in the JPDA from 20 May 2002 onward are to be treated according to the framework percentage or reduction percentage as appropriate. [Paragraph 2]

Company A is a company operating in the JPDA and derives all of its income from the JPDA. Company A has:

Company A calculates its carry-forward loss in Australia and East Timor during the transitional period as follows:

Company A’s carry-forward loss in Australia at 31 December 2001 will be its company loss calculated under Australian tax law reduced by 50%. This is $200 – (50% x $200) = $100.

Company A’s carry-forward loss in East Timor at 31 December 2001 will be its company loss calculated under East Timor tax law reduced by 50%. This is $200 – (50% x $200) = $100.

Company A earns a profit of $100 in the period 1 January 2002 to 19 May 2002. The $100 profit reduces the company carry forward loss of $200 at 31 December 2001 to an overall company carry forward loss of $100 at 19 May 2002.

If a nominal calculation were made on 19 May 2002, Company A’s profit in Australia calculated under Australian tax law reduced by 50% would be $100 – (50% x $100) = $50. Its nominal carry forward loss in Australia would be $50 ($50 profit - $100 carry forward loss = $50 loss).

Company A’s profit in East Timor calculated under East Timor tax law reduced by 50% would be $100 – (50% x $100) = $50. Its nominal carry forward loss in East Timor would be $50 ($50 profit – $100 carry forward loss = $50 loss).

Company A’s carry forward loss of $100 existing on the 19 May 2002 is re-stated on the 20 May 2002 in accordance with the 90:10 revenue split in the Treaty that flows through to the Taxation Code.

Company A’s carry-forward loss in Australia at 20 May 2002 will be its company loss of $100 reduced by 90%. This is $100 – (90% x $100) = $10.

Company A’s carry-forward loss in East Timor at 20 May 2002 will be its company loss of $100 reduced by 10%. This is $100 – (10% x $100) = $90.

Company A then suffers a loss of $50 in the period between 20 May 2002 and 31 December 2002. Its carry forward loss in Australia is reduced by 90%, $50 – (90% x $50) = $5. This loss of $5 is added to the restated loss of $10 calculated on 20 May, bringing the total carry forward loss in Australia at 31 December 2002 to $15 ($10 + $5).

Its carry forward loss in East Timor is reduced by 10%, $50 – (10% x $50) = $45. This loss of $45 is added to the restated loss of $90 calculated on 20 May, bringing the total carry forward loss in East Timor at 31 December 2002 to $135 ($90 + $45).

Period	Business profit/(loss) for period	Split	Carry-forward loss in Australia at the end of period	Carry-forward loss in East Timor at the end of period
1 Jan 2001– 31 Dec 2001	($200)	50:50	($100)	($100)
1 Jan 2002 – 19 May 2002	$100	50:50	$50	$50
Company balance at 19 May 2002	($100)	50:50	($50) (nominal calculation)	($50) (nominal calculation)
Restated balance at 20 May 2002	($100)	10:90	($10)	($90)
20 May 2002 - 31 Dec 2002	($50)	10:90	($5)	($45)
Total carry forward loss at 31 Dec 2002	($150)	10:90	($15)	($135)

Article 24 – Review Mechanism

223. At the request of either Contracting State, the Contracting States shall review the terms and conditions of the Taxation Code with a view to amending the Taxation Code if necessary.

Article 25 – Entry into Force

224. The Taxation Code enters into force at the same time as the rest of the Timor Sea Treaty. The Treaty enters into force upon the day on which Australia and East Timor have notified each other in writing that their respective requirements for entry into force have been complied with. [Article 25(a) of the Treaty]

225. Upon entry into force, the date of domestic law effect of the Treaty is the date of signature, which is the 20 May 2002. In general, the Treaty and all of its provisions, which includes the Taxation Code, will therefore apply from 20 May 2002. Two exceptions to this general rule are the application of the superannuation guarantee charge and the taxation of East Timor resident individuals. These provisions will apply from 1 July 2003.

Prospective Application

226. The application of the SGC and the taxation of East Timor resident individuals is permissive rather than binding upon Australia under the Taxation Code. As a result Australia is able to unilaterally vary the application date of the SGC and the taxation of East Timor resident individuals to operate prospectively rather than from the date of domestic law effect, 20 May 2002. Australia will apply the SGC and will tax East Timor resident individuals prospectively, from 1 July 2003, because these are new taxing rights that Australia did not have in the JPDA prior to the Timor Sea Treaty. This approach ensures that affected taxpayers are not disadvantaged by being required to comply with a tax with which they had no prior awareness or obligation.

Commonwealth of Australia Explanatory Memoranda