What Australian Business Owners Need to Know About Treaty Shopping & the Principal Purpose Test Before Going Offshore

Introduction

If you are an Australian business owner routing royalties or dividends through a treaty country, it is easy to assume the reduced withholding tax rate is yours by default. Treaty benefits can be denied where accessing them was one of the principal purposes of the arrangement — even when genuine commercial reasons also exist.

This article explains what treaty shopping looks like, how the Principal Purpose Test (PPT) operates, & what genuine treaty access actually requires before you commit to an offshore structure.

Interactive Tool: Check Your Risk of Losing Offshore Tax Treaty Benefits

What Is Treaty Shopping & Why It Matters

In plain terms, treaty shopping is structuring through a country primarily to access that country’s tax treaty, without genuine presence or activity there.

The Australian Taxation Office’s (ATO) Taxpayer Alert TA 2022/2 (‘TA 2022/2’) describes treaty shopping arrangements as those designed to obtain reduced withholding tax rates under a double-tax agreement. This is done by interposing an entity in a treaty partner jurisdiction between an Australian resident & the ultimate recipient of royalties or dividends.

Consider an Australian business owner who establishes a Singapore entity solely to receive royalty payments from their Australian company. The royalty would be subject to a 10% withholding rate under the Australia-Singapore DTA, rather than the 30% Australian domestic rate.

If the Singapore entity conducts no genuine operations & employs no staff in Singapore, the ATO will likely view this as a treaty shopping arrangement. The reduced Australia-Singapore DTA rate would be denied, reverting the taxpayer to the full Australian domestic withholding tax position.

Why Tax Treaties Were Never Designed for Treaty Shopping

Australian business owners who treat Australia-Singapore DTA as routing tools for entities with no real presence are building on a foundation the treaties were never designed to support.

Australia-Singapore DTA were built to remove the double layer of tax that hits businesses with genuine economic connections to both contracting countries. A key purpose of Australia’s treaty network is to eliminate double taxation without creating opportunities for tax avoidance practices, such as treaty shopping arrangements.

That founding purpose shapes how the PPT functions. The PPT asks whether the arrangement is consistent with the object & purpose of the relevant Australia-Singapore DTA provisions, not whether technical residency requirements are met on paper. The ATO has made clear in TA 2022/2 that arrangements facilitating genuine investment that obtain treaty benefits consistent with the treaty’s object & purpose are not the target.

What the Principal Purpose Test Is & How It Works

What One of the Principal Purposes Actually Means

The PPT catches something many Australian business owners assume is safe: a structure with genuine commercial substance can still fail if accessing treaty benefits was one of the principal purposes of the arrangement.

Under paragraph 1 of Article 7 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion & Profit Shifting (‘MLI’), which entered into force for Australia on 1 January 2019, the PPT denies a treaty benefit where obtaining that benefit was one of the principal purposes of an arrangement. 

The PPT does not require tax to be the only reason or even the dominant reason for a structure. This threshold is materially lower than Part IVA of the Income Tax Assessment Act 1936 (Cth), which requires dominant purpose. For Australian business owners, this is where a structure that looks defensible under Part IVA can still trip on the PPT’s lower threshold — making it essential to obtain international tax advice before the ATO tests the arrangement.

The Taxpayer Carve-Out Under Article 7(4) of the MLI

Even where the PPT is technically satisfied, there is a narrow pathway that may preserve treaty benefits. Paragraph 4 of Article 7 of the MLI allows the competent authority to grant treaty benefits if granting them accords with the object & purpose of the relevant treaty provisions. The discretion considers what benefits would have been granted in the absence of the impugned arrangement.

However, this is not a general power of reconstruction — it does not permit granting benefits under a different treaty or to a different person. Section 7 of PS LA 2020/2 outlines the referral process, including mandatory consultation with the other jurisdiction’s competent authority before rejecting a request.

The carve-out requires a formal request to the competent authority & cannot be relied upon as a planning tool.

The Structures That Attract PPT Scrutiny

Conduit & Routing Structures

The most common treaty shopping pattern involves an entity in a treaty country receiving royalties or dividends from Australia at reduced withholding tax rates, & then passing most of that income to a connected party in a non-treaty or higher-withholding jurisdiction. 

The interposed entity functions as a channel: income enters at the lower Australia-Singapore DTA rate & exits to the ultimate recipient, who would have paid a higher rate if receiving the payment directly.

TA 2022/2 illustrates this with a restructure where a licence agreement was redirected through a subsidiary in a treaty country, lowering the royalty withholding tax rate from 10% to 5%. The interposed entity’s activities mainly consisted of:

• receiving & on-paying royalties;
• reporting on its investment; and
• complying with corporate obligations.

The ATO concluded that accessing reduced withholding tax rates was one of the principal purposes of the arrangement.

Holding Companies Without Genuine Operations

Australian business owners sometimes insert a holding company into a treaty jurisdiction to capture reduced dividend withholding tax rates, without giving that company genuine staff, assets, or independent decision-making. TA 2022/2 describes an example where an acquisition was structured through a treaty jurisdiction, & the interposed holding company had no substantive commercial operations of its own.

The ATO identifies several features as indicating a higher risk of treaty shopping:

• the treaty company was controlled by directors from the non-treaty parent;
• funding came from the non-treaty jurisdiction; and
• forecast dividends were to be repatriated or kept in passive investments.

Without contemporaneous documentation supporting any commercial rationale, the structure becomes difficult to defend under review.

The Letterbox Entity

An entity with only a registered office, a local nominee director, & no genuine staff or operations in the treaty country will almost certainly fail PPT analysis. The ATO looks directly at what the entity actually does — not what its incorporation documents say it can do. An entity whose activities are limited to receiving & on-paying income while complying with basic corporate obligations is precisely the pattern that attracts scrutiny.

The framing questions in PS LA 2020/2 ask whether the role of any entity in the arrangement is explicable solely by tax reasons. A letterbox entity offers no other credible explanation.

What Genuine Treaty Access Actually Requires

Real Economic Substance in the Treaty Country

Treaty access requires real economic substance in the treaty country — not just a registered office & a local director. This means:

• genuine staff employed in the treaty country;
• real business activities conducted there; and
• strategic decisions made by directors physically in the treaty country, not directed from Australia.

The PPT does not target arrangements where the treaty‑country entity carries real economic substance. PS LA 2020/2 asks whether each entity possesses the necessary competencies & capacity to manage its functions, assets, & risks.

A Credible Commercial Reason Independent of the Treaty Benefit

Accessing treaty benefits requires a credible commercial reason that exists independently of the treaty benefit itself. PS LA 2020/2 frames this by asking whether the arrangement is more complex or contains more steps than necessary to achieve the non‑tax objectives.

An entity established to serve genuine customers in the treaty country, manage real operations there, or raise capital from local investors has a credible commercial reason. By contrast, an entity whose sole function is receiving royalties from Australia & paying them onward does not.

Where no aspect of the form can only be explained by obtaining a treaty benefit — as PS LA 2020/2 puts it, where the arrangement “may be fairly described as an ordinary commercial dealing” — the arrangement will not have the requisite purpose. This is where Australian business owners get caught when a structure exists solely to capture treaty benefits.

Beneficial Ownership of the Income

Australian business owners relying on a treaty‑country entity that simply receives & passes on royalties or dividends face exposure here under the beneficial ownership requirement. Most Australia-Singapore DTA require the recipient of the income to be the beneficial owner — not a conduit or nominee receiving income on behalf of another party. The ATO & courts look through conduit arrangements to identify the ultimate beneficial owner.

TA 2022/2 highlights this pattern in Example 1, where Treaty Co’s activities mainly consisted of receiving & on‑paying royalties to the parent.

The anti‑avoidance rules under Australia’s Australia-Singapore DTA — including the PPT & the MPT in dividend & royalty articles referenced in TA 2022/2 — are tied to beneficial ownership concepts.

A treaty‑country entity that immediately passes income to a non‑treaty parent is unlikely to satisfy this requirement.

Two Questions Australian Business Owners Should Answer Before Relying on a Treaty

Before building a structure that relies on reduced withholding tax rates under the Australia-Singapore DTA, two questions need clear answers:

1. Does the entity have genuine staff, assets, & decision-making in the treaty country? As discussed, treaty access requires real economic substance — not just a registered office & a local director.
2. Is there a credible commercial reason for the structure that exists independently of the treaty benefit? The ATO examines whether the arrangement is more complex than necessary & whether any entity’s role is explicable solely by tax reasons — the PS LA 2020/2 framing explored earlier.

Australian business owners should answer these questions before building a structure & again after it has been operating. The ATO encourages taxpayers to discuss existing or contemplated treaty shopping arrangements, as anti-avoidance rules under Australia’s Australia-Singapore DTA, can apply even years after a structure was established.

Conclusion

The PPT enforces the treaty network’s purpose by denying benefits where obtaining them was one of the principal purposes — not the dominant purpose. Those whose offshore structures lack economic substance face the real prospect of treaty benefits being stripped & the full Australian domestic withholding tax rate applied instead.

If your structure depends on reduced withholding tax rates under the Australia-Singapore DTA, discuss your position with WealthSafe’s advisory team before the ATO reviews it. WealthSafe helps Australian business owners build cross-border structures where treaty benefits rest on genuine operations & defensible commercial purpose — not on a registered office & a local director.

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