An Australian superannuation fund investing into Europe faces an arithmetic problem unrelated to asset quality. It is taxed lightly at home, and European states tax its income at source. Where the Australian tax on that income is smaller than the foreign tax already deducted, the credit has nothing left to absorb and the foreign tax becomes a permanent cost.
Not a defect in anyone’s system: it is what happens when a concessionally taxed investor meets an ordinary source state, and why these allocations repay structuring.
The Australian rate, and what it does to a credit
Section 26 of the Income Tax Rates Act 1986 sets the rates payable by a trustee of a superannuation fund. For a complying fund, the rate is 15 per cent in respect of the low tax component and 45 per cent in respect of the non-arm’s length component. For a non-complying fund, the rate on the taxable income of the fund is 45 per cent.
The first number governs. A fund taxed at 15 per cent cannot generally absorb foreign tax deducted at a higher rate, because section 770-75 of the Income Tax Assessment Act 1997 limits the foreign income tax offset to the Australian tax attributable to the foreign income, subject to a floor of 1,000 Australian dollars, and reduces the offset by any excess. Where a European state withholds at 15 per cent it may suffice. Where the deduction is higher, or the Australian component bears a lower effective rate because of deductions or because the assets are segregated current pension assets whose income is exempt under section 295-385 of the same Act, the excess is lost.
The second number makes a structuring error expensive. Section 295-545 of that Act splits the taxable income of a complying superannuation entity into a non-arm’s length component and a low tax component, and 45 per cent on the first taxes income failing the arm’s length tests at three times the ordinary rate. Related party terms are therefore a rate question in Australia, not only a transfer pricing question in Europe.
What Europe takes before the money leaves
Take the Netherlands, where many European holding structures sit. Article 5 of the Wet op de dividendbelasting 1965 imposes dividend withholding tax at 15 per cent of the proceeds, on the gross distribution and before payment.
The Agreement between the Kingdom of the Netherlands and Australia, signed at Canberra on 17 March 1976, limits the source charge. Article 10(2) provides that the tax on dividends shall not exceed 15 per cent of the gross amount, and article 11(2) limits the charge on interest to 10 per cent.
It is also a covered tax agreement under the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, which the synthesised text published by the Australian Taxation Office records as having effect for source withholding since 1 January 2020. Neither state notified article 10(2) under article 8, so the dividend limit carries no minimum holding period. Article 7(1) denies a benefit obtained as one of the principal purposes of an arrangement, unless granting it would accord with the object and purpose of the relevant provisions.
The treaty limit therefore matches the domestic rate: not a reduction but a ceiling already respected. The question is whether the fund can recover the withholding otherwise.
Debt, and the lower ceiling that applies to it
The interest limit sits at a different level, and that asymmetry is worth using. It only matters where the domestic charge is higher. Some European states withhold on outbound interest routinely, and there the 10 per cent is operative. Others impose no general charge and instead operate a targeted levy, as the Netherlands does through the Wet bronbelasting 2021, which reaches interest paid to an affiliated body in a designated jurisdiction that does not tax companies on their profits or taxes them at less than 9 per cent, or that the European Union lists as non-cooperative, and also catches conduit and hybrid cases. The question is whether the recipient falls inside it.
Characterization decides which ceiling applies, and can be contested. Debt priced and subordinated like equity invites the source state to treat the return as a distribution and deny the deduction.
The refund route for bodies that are not subject to tax
Article 10 of the Wet op de dividendbelasting 1965 provides a refund mechanism: three tiers of entitlement, and a fourth paragraph that takes a class of claimant back out.
The first paragraph applies to a legal person established in the Netherlands that is not subject to corporate income tax. On request, the inspector refunds by appealable decision the dividend withholding tax withheld from it during a calendar year. It covers only proceeds of which that person is the beneficial owner, which the person must make plausible, with the burden reversed where the tax withheld in the calendar year is 1,000 euro or less. Exempt investment institutions within the meaning of article 6a of the Wet op de vennootschapsbelasting 1969 are outside it.
The second paragraph extends that treatment to a body established in another member state of the European Union or in a state party to the Agreement on the European Economic Area, not subject there to a tax on profits and which, had it been established in the Netherlands, would not have been subject to Dutch corporate income tax.
The third paragraph reaches Australia, extending the first to a body established in a state designated by ministerial regulation, outside the states covered by the second paragraph, with which the Netherlands has agreed an arrangement for the exchange of information, not subject there to a tax on profits, and which, had it been established in the Netherlands, would not have been subject to Dutch corporate income tax. It is confined to tax on the proceeds of portfolio investments, meaning investments falling under the free movement of capital in article 63 of the Treaty on the Functioning of the European Union that are not a direct investment within the meaning of article 64 of that Treaty.
The condition about not being subject to a tax on profits is where an Australian fund usually stops. A complying superannuation fund is subject to such a tax in Australia, at the 15 per cent set by section 26, and the paragraph is written for bodies that are not. The route closes there, before designation, the portfolio test or the fourth paragraph. What it leaves open is narrower: a claimant its own state does not tax on profits at all, a question about the particular vehicle.
The fourth paragraph is next. It disapplies the second and third for bodies performing a function comparable to that of the investment institutions referred to in article 6a or article 28 of the Wet op de vennootschapsbelasting 1969. A pooled vehicle investing members’ money across markets must answer it too.
Article 1c of the Uitvoeringsbeschikking dividendbelasting 1965 designates, for the purposes of article 10(3), every state outside the European Union and the European Economic Area with which the Netherlands can exchange information in line with the international standard. There is no list of named countries, so the standard itself is what a claimant must establish. The order of work follows. A claimant subject to Australian tax on its profits stops at the first condition. One that is not must still show that standard is met, that it would not have been subject to Dutch corporate income tax in the Netherlands, that the holding is portfolio rather than direct, and that the fourth paragraph does not reach it.
Portfolio or direct, and why the distinction bites
The portfolio limitation is not a technicality. It leaves the route open for exposure resembling listed equity held for return, and closed for a controlling stake in an operating company or an infrastructure asset.
That is close to the inverse of a large fund’s European book, which holds considerable capital in unlisted infrastructure, real assets and direct co-investments. The refund analysis therefore runs holding by holding.
For those holdings the question is whether the investment should sit under a European holding company relying on the participation exemption and the directives. That moves where the withholding arises, and brings substance obligations.
The non-arm’s length component, read from Europe
The 45 per cent rate is an Australian rule with entirely European triggers. Section 295-550 of the Income Tax Assessment Act 1997 treats income as non-arm’s length where a scheme between parties not dealing at arm’s length produces more income than the fund might have been expected to derive, and separately treats a dividend paid by a private company as non-arm’s length unless the amount is consistent with an arm’s length dealing. The expenditure limbs reach only regulated funds with no more than six members and self managed funds, so for a large fund the exposure runs through the income side.
The European facts that produce it are ordinary. A shareholder loan priced off nothing returns more than an arm’s length lender would have received. A distribution from a wholly owned holding company is a private company dividend nobody tested against an arm’s length dealing. The European adviser rarely connects either to the Australian rate.
The discipline is the same throughout: price related party terms as third party terms, document the basis at the time, and keep the valuation.
The claim is a process, and it has dates
A refund is not automatic. The Dutch mechanism operates on request and the inspector decides by a decision open to objection. Article 21c of the Uitvoeringsregeling Algemene wet inzake rijksbelastingen 1994 requires the request under article 10 within three years after the end of the calendar year in which the proceeds were made available. Other states have their own periods, some shorter.
Funds investing through custodians frequently assume the custodian is reclaiming. Some do, for standard cases in standard markets. Almost none pursue a claim turning on the claimant’s own tax position rather than the security.
Settling that position is documentary work: the constituent documents, the basis on which the claimant says it is not subject to a tax on profits in Australia, the demonstration that it would not have been subject to Dutch corporate income tax in the Netherlands, and the beneficial ownership evidence the statute requires.
Modelling the net, not the headline
The useful figure is the net of unrelieved foreign tax on the actual structure. Two assets with identical gross yields diverge depending on whether the withholding can be recovered, whether it can be credited, and whether the holding is portfolio or direct.
The conclusion is modest but firm. For listed exposure the work begins with the claimant’s own subjection to tax, and only then a refund analysis with deadlines. For unlisted exposure it is a holding structure with genuine substance, decided before the acquisition, with the Australian rate priced in. Treating the two books alike is where the avoidable cost is.
This article is informational and does not constitute tax or legal advice. The treatment of any structure depends on its facts and on the law of each jurisdiction involved. Each engagement is subject to scope and applicable regulation.