Tax Treaties I. Mag. Vanessa E. Englmair, LL.M. Univ.-Prof. DDr. Georg Kofler, LL.M.

Transcription

1 Mag. Vanessa E. Englmair, LL.M. Univ.-Prof. DDr. Georg Kofler, LL.M. Tax Treaties I Internationales Steuerrecht Do, 2 Dezember 2010, 15:30 18:45 Uhr Fr, 3 Dezember 2010, 15:30 18:45 Uhr 1

2 Overview Structure and Terminology Five Rules of Treaty Application Distributive Rules Business Profits and Permanent Establishments Dividends, Interest and Royalties Capital Gains Employment Income Methods for Elimination of Double Taxation Special and Final Provisions Special Issues Current OECD-Developments: Update 2010 Authorized OECD Approach: Old and New Art 7 and Commentary Beneficial Ownership and Abuse of Treaties Domestic Tax Abuse Standards and EU Obligations Conflicts of Qualification ( Partnership Report ) Collective Investment Vehicles Commissionaire Structures: Subsidiary as Permanent Establishment? Triangular Situations

3 Part I Structure and Terminology

4 Source versus Residence Taxing Jurisdiction Nationality (citizenship of individuals, incorporation of companies) Territory Persons E.g., domicile, residence, place of management Income Source Form of Taxation Residence Principle of Universality = Taxation of Worldwide Income ( Unlimited Tax Liability ) Source Principle of Territoriality ( Limited Tax Liability ) Exercise of Taxing Rights Normal Taxation (net base, regular progressive rate) versus Withholding Taxation (gross base, flat rate) Taxing Threshold Existence of a permanent establishment, duration of stay (183 days) etc

5 Double Taxation Elimination of Double Taxation Double Taxation Conventions (DTCs) = Tax Treaties Unilateral Measures Forms of Double Taxation Juridical ( Real ) Double Taxation Unlimited tax liability in two countries Tie Breaker -Rules in DTCs Unlimited tax liability in one country, limited tax liability in the other country Distributive Rules and Methods in DTCs Limited tax liability in two countries Triangular Situations Economic Double Taxation E.g., Transfer Pricing and Art 9 OECD-MC

6 Subsidiary versus PE Subsidiary versus Permanent Establishment Income in State B /. Tax in State B = After-Tax Income in State B Dividend - 70./. Tax on Dividend in State B (e.g., 25%) - 17,5 = Distributed Income - 52,5./. Tax in State A (40% on 100/70) = After-Tax Income 30 24,5

7 Elimination of Double Taxation Elimination of Double Taxation Distributive Rules Credit of Exemption Method CEN versus CIN Capital Export Neutrality (CEN) Neutrality on the Home Market (eg, USA, UK) Credit Method Capital Import Neutrality (CIN) Neutrality on the Host Market (eg, Austria, Germany) Exemption Method Income Exemption Tax Exemption Progressivity

8 Elimination of Double Taxation Credit Method versus Exemption Method Double Taxation Tax in Residence State Worldwide Income (200 in R in S =) 40% 120 Tax in Source State Source Income 30% + 30 Tax on Worldwide Income Without Relief = 150 Relief From Double Taxation Exemption Credit Tentative Tax in Residence State (120) 120 Exemption of Source State Income Credit for Source State Tax -./. 30 Tax in Residence State - = 90 Tax in Source State Tax on Worldwide Income After Relief = 110 = 120

9 Elimination of Double Taxation Income Exemption versus Tax Exemption Example 1 Income Exemption Tax Exemption Worldwide Income (200 in R in S) Income Exemption 40% 80 - Tax Exemption 40% Minus tax attributable to source State income: (100/300)x120 -./. 40 Tax in Residence State = 80 = 80 Example 2 Income Exemption Tax Exemption Worldwide Income (200 in R + [-100] in S) Income Exemption 40% 80 - Tax Exemption 40% Minus tax attributable to source State income -./. 0 Tax in Residence State = 80 = 40

10 Objectives of Tax Treaties Eliminate Double Taxation and Prevent Tax Avoidance and Evasion Remove Tax Obstacles and Distortions to Cross-Border Trade and Investment Flows Maximize Global Wealth by Ensuring an Efficient Allocation of Resources

11 Objectives of Tax Treaties Main Objectives Eliminate the most common forms of juridical and economic double taxation Eliminate some forms of tax discrimination Provide a standardized set of rules for dividing tax revenues between countries Address tax evasion and avoidance Provide a framework for settling tax disputes Provide a stable tax environment to foreign investors And increase the international competitiveness of the economy

12 Operation of Tax Treaties Restriction of Domestic Taxing Rights ( Stencil ) Unlimited Taxation in the Source State and Relief in the Residence State (e.g., immovable property) Limited Taxation in the Source State and Relief in the Residence State (e.g., dividends, interest) Exclusive Taxation in the Residence State (e.g., buisiness income, pensions, other income) Exclusive Taxation in the Source State (e.g., government income) Relationship Between Domestic Law and Tax Treaty Law Lex Posterior versus Lex Specialis Treaty Override Treaty Underride

13 Legal Nature of Tax Treaties There are currently around 3000 bilateral tax treaties These are part of the infrastructure of our global economy in the same way as the WTO agreements that regulate cross-border trade the bilateral investment agreements that regulate cross-border investment Contract between Two States Vienna Convention on the Law of Treaties (Art 2) International agreement (in one or more instruments, whatever called) concluded between States and governed by International Law Only creates rights and obligations for the States, not third parties In some countries tax treaties are also enacted as statutes Once implemented, they create rights for taxpayers Treaty Underride

14 OECD Model Tax Convention DTCs generally follow the structure of the OECD Model Tax Concentions, with variations to take account of national (e.g., US Model Tax Convention) and developing country requirements (e.g., UN Model Tax Convention) OECD Model Convention Chapter I. Scope Of Convention (Art 1 and 2) Chapter II. Definitions (Art 3 to 5) Chapter III. Taxation Of Income (Art 6 to 21) Chapter IV. Taxation Of Capital (Art 22) Chapter V. Methods Of Elimination Of Double Taxation (Art 23A and 23B) Chapter VI. Special Provisions (Art 24 to 29) Chapter VII. Final Provisions (Art 30 and 31)

15 Part II Five Rules of Treaty Application

16 Rules of Treaty Application Rule 1 Tax Treaties Restrict the Application of Domestic Tax Law ( Stencil ) Rule 2 Tax Terms Can Have a Different Meaning in Domestic Tax Law and Treaty Law Rule 3 Correct Understanding of the Terms in Distributive Rules Residence versus Source Rule 4 Correct Understanding of the Scope of Distributive Rules Rule 5 Issues Not Covered by Tax Treaties

17 Restriction of Domestic Tax Law Tax treaties restrict the application of domestic tax law in the residence state and in the source state Residence State Source State Full Taxation in Both States Unilateral Relief in Residence State Application of DTC Restriction of Source State Taxation and Relief in Residence State

18 Restriction of Domestic Tax Law Distributive Rules Articles 6-22 allocate taxing rights Exclusive Taxation... shall be taxable only... (generally in the residence State), e.g. Art 8. Concurrent taxation... may be taxed in... (generally in the source State) - Two types: Source tax with no limits (e.g. Art 7) Source tax with limits (e.g. Art 11) Double Tax Relief Art 23 provides obligation to grant double tax relief... income which, in accordance with the provisions of the Convention, may be taxed in the other [State].

19 Restriction of Domestic Tax Law Scope of Restriction Interplay of Domestic Law and Tax Treaty Law Domestic Law Tax Treaty Tax Base Tax Rate 40% 15% 40% 15% 15% = 20 = 15 = 7,5

20 Restriction of Domestic Tax Law Tax treaties restrict domestic taxation The issue is therefore not whether a tax treaty permits taxation, but rather whether it prohibits taxation Nevertheless, tax treaties may result in a higher tax burden

21 Rules of Treaty Application Rule 1 Tax Treaties Restrict the Application of Domestic Tax Law ( Stencil ) Rule 2 Tax Terms Can Have a Different Meaning in Domestic Tax Law and Treaty Law Rule 3 Correct Understanding of the Terms in Distributive Rules Residence versus Source Rule 4 Correct Understanding of the Scope of Distributive Rules Rule 5 Issues Not Covered by Tax Treaties

22 Interpretation Vienna Convention on the Law of Treaties Signed May 23, 1969; entered into force January 27, 1980 Codification of customary international law Art 26 Pacta sunt servanda Art 31 Interpretation (1) A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose. Ordinary meaning of terms, subject to Art 31(4) special meaning and subject to Art 3(2) OECD Model Context (text, contemporaneous agreements, subsequent agreements) Purpose (part of context) (2) The context for the purpose of the interpretation of a treaty shall comprise in addition to the text, including its preamble and annexes: (a) any agreement relating to the treaty which was made between all the parties in connection with the conclusion of the treaty; (b) any instrument which was made by one or more parties in connection with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty.

23 Interpretation Art 31 Interpretation (3) There shall be taken into account, together with the context: (a) any subsequent agreement between the Parties regarding the interpretation of the treaty or the application of its provisions; (b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation; (c) any relevant rules of international law applicable in the relations between the parties. (4) A special meaning shall be given to a term if it is established that the parties so intended. Art 32 Supplementary Means of Interpretation "Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of Article 31, or to determine the meaning when the interpretation according to Article 31: (a) leaves the meaning ambiguous or obscure; or (b) leads to a result which is manifestly absurd or unreasonable Includes travaux préparatoires and circumstances of conclusion of treaty Should include any relevant material, but unilateral, unpublished, or subsequent material should have less weight

24 Interpretation OECD Model Commentary Theory Use of the OECD Commentary as a Tool for Treaty Interpretation? Ordinary meaning under Art 31(1) VCLT? Part of the context of the treaty under Art 31(1) VCLT? Instrument related to the treaty under Art 31(2)(b) VCLT? Special meaning under Art 31(4) VCLT? Supplementary means of interpretation under Art 32 VCLT? Practice Courts, negotiators, competent authorities and practitioners use the OECD Model Commentary

25 Interpretation Relevant Version of the OECD Model Commentary? Current version? Intro Paras 3, OECD Comm tax authorities should follow these Commentaries, as modified from time to time and subject to their observations thereon, when applying and interpreting the provisions of their bilateral tax conventions that are based on the Model Convention. Version availabe when the tax treaty was concluded? Canada Specialty Manufacturing Ltd. v. Her Majesty the Queen, 97 D.T.C (1999); MIL (Investments) S.A. (Appellant) v. Her Majesty the Queen, 2006 DTC 3307 Netherlands Hoge Raad der Nederlanden, 11 October 1978, BNB 1978/300, and 2 September 1992, BNB 1992/379 UK Fothergill v. Monarch Airlines [1981] AC 251 (HL) US National Westminster Bank v. U.S., 44 Fed. Cl. 120 (1999) But: Later versions may have persuasive force Prévost Car Inc. v. The Queen, 2009 DTC 5053), IRC v. Commerzbank AG [1990] STC 285 (Ch); Trevor Smallwood Trust v. Revenue & Customs [2008] UKSPC SPC00669

26 Interpretation Relevant Version of the OECD Model Commentary? Differentiate between Commentaries that fill a gap in the existing commentary by covering matters not previously mentioned; those that amplify the existing commentary by adding new examples or arguments to what is already there; those that record what states have been doing in practice; and those that contradict the existing commentary.

27 Interpretation Art 3(2) Domestic Law Meaning for Undefined Treaty Terms As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State. What are undefined terms? What if there are multiple domestic meanings? Undefined terms used in treaty definitions? When does a state apply the treaty? What does context mean?

28 Interpretation Domestic Law Meaning under Art 3(2) Timing Issues At the time the treaty was concluded? At the time the treaty is applied? Since 1995: at that time Art 3 Para 11 OECD Comm However, the question arises which legislation must be referred to in order to determine the meaning of terms not defined in the Convention, the choice being between the legislation in force when the Convention was signed or that in force when the Convention is being applied, i.e. when the tax is imposed. The Committee on Fiscal Affairs concluded that the latter interpretation should prevail, and in 1995 amended the Model to make this point explicitly.

29 Rules of Treaty Application Rule 1 Tax Treaties Restrict the Application of Domestic Tax Law ( Stencil ) Rule 2 Tax Terms Can Have a Different Meaning in Domestic Tax Law and Treaty Law Rule 3 Correct Understanding of the Terms in Distributive Rules Residence versus Source Rule 4 Correct Understanding of the Scope of Distributive Rules Rule 5 Issues Not Covered by Tax Treaties

30 Residence and Source Residence versus Source Main Principle DTC applies only to residents of contracting states (Art 1) and definition of resident of a Contracting State in Art 4 Residence under Art 4 OECD-MC Para 1 Resident of a contracting state is defined as a person (individual or company) who is liable to comprehensive taxation in the state on the basis of certain criteria Provides a definition of resident of a contracting state for the purposes of applying other provisions of the DTC (e.g., Art 1) Full tax liability Based on the taxpayers personal attachment to the State concerned Existence of a permanent establishment does not result in residency status (Crown Forest Industries Ltd. v. Canada, [1995] 2 S.C.R. 802) Para 2 Tie-Breaker Rule for Individuals Para 3 Tie-Breaker Rule for Other Persons Provides solutions for cases where a person is considered as a resident of both treaty countries ( tie-breaker rules for dual residents )

31 Residence and Source Residence under Art 4(1) OECD-MC For the purposes of this Convention, the term resident of a Contracting State means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof. Based on domestic law Person is resident of a country if liable to tax in the country by reason of his domicile, residence, place of management or similar criterion Exemption under domestic law, e.g. for pension funds, charities and other organisations Sovereign Wealth Funds Art 1 Para and Art 4 Para 8.5 OECD Comm (Update 2010) This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein. Foreign diplomatic and consular staff serving in a State s territory Not meant to cover countries adopting a territorial principle in their taxation (Art 4 Para 8.3 OECD Comm) Relevance for Dual Resident Companies? Art 4 Para 8.2 OECD Comm

32 Residence and Source Art 4(1) OECD-MC Residency of Corporations Fiscal Court Niedersachsen, 29 March 2007, 6 K 514/03 Dividend Co. (GER) SICAV (FR) Under FR-GER treaty, GER exempts dividends paid by a company resident in FR to a company resident in GER (10% minimum holding) SICAV is exempt and hence not subject to tax and no resident for treaty purposes, irrespective of how the entity would have been treated in GER, hence no exemption of dividends

33 Residence and Source Art 4(1) OECD-MC Residency of Corporations Austrian Treaty Practice (EAS 1075, EAS 2415; aligned with Germany and Switzerland) Isolated treatment of each group company, i.e., group taxation regimes leave treaty residence and entitlement to treaty benefits unaffected Members of a foreign group will be entitled to claim treaty benefits, including a withholding tax reduction, even though income is attributed away from them Dividend Organschaft Co. (GER) Co. (GER) Co. (AUT)

34 Residence and Source Tie Breaker Rule for Dual Resident Individuals (Art 4(2) OECD-MC) Permanent Home Permanent Homes in both States No Permanent Home in either State Centre of Vital Interests Centre of Vital Interests cannot be determined Habitual Abode Habitual Abode in both States or in neither of them Nationality National of both States or of neither of them Mutual Agreement

35 Residence and Source Tie Breaker Rule for Dual Resident Companies Art 4(3) OECD-MC Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, then it shall be deemed to be a resident only of the State in which its place of effective management is situated. OECD and UN Models adopt Place of Effective Management as Tie Breaker Where the key management and commercial decisions are in substance made, where the actions to be taken by the entity as a whole are taken Facts and circumstances! Common alternatives Place of incorporation or Mutual Agreement Procedure ( MAP ) 2008 OECD Alternative (Art 4 Para 24.1 OECD Comm) MAP No treaty benefits until a solution is found! Suggested Criteria Board of directors, where CEO and other senior executives usually carry on their activities, where the senior day-to-day management of the person is carried on, where the person s headquarters are located, which country s laws govern the legal status of the person, where its accounting records are kept, improper use of the Convention

36 Residence and Source Tie Breaker Rule for Dual Resident Companies Art 4(3) OECD-MC Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, then it shall be deemed to be a resident only of the State in which its place of effective management is situated. Art 4(1) second sentence OECD-MC This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein. Art 4 Para 8.2 OECD Comm (2008) Art 4(1) second sentence also excludes companies [ ] who are not subject to comprehensive liability to tax in a Contracting State because these persons, whilst being residents of that State under that State's tax law, are considered to be residents of another State pursuant to a treaty between these two States.

37 Residence and Source The Other State Source State Art 1 OECD-MC This Convention shall apply to persons who are residents of one or both of the Contracting States. Refers to the Recipient of the Income, not to the Payor (= Source)! Sources are defined in the DTC E.g., Art 6(1) OECD-MC: Income derived by a resident of a Contracting State from immovable property [ ] situated in the other Contracting State may be taxed in that other State. Relevant is the situs of the property, not the residence of, e.g., the lessee. Art 11(1) OECD-MC ( Interest arising in a Contracting State ) Art 11(5) OECD-MC: Interest shall be deemed to arise in a Contracting State when the payer is a resident of that State.

38 Residence and Source The Other State Source State Different source rules in different tax treaties Example: A Dutch bank gives a loan to S Co. for use in its Canadian permanent establishment and enters a mortgage on Israeli real property as a collateral - NL-US DTC Payor - NL-CAN DTC PE - NL-ISR DTC Real Property

39 Rules of Treaty Application Rule 1 Tax Treaties Restrict the Application of Domestic Tax Law ( Stencil ) Rule 2 Tax Terms Can Have a Different Meaning in Domestic Tax Law and Treaty Law Rule 3 Correct Understanding of the Terms in Distributive Rules Residence versus Source Rule 4 Correct Understanding of the Scope of Distributive Rules Territorial Scope Substantive Scope Scope of Legal Ramifications Rule 5 Issues Not Covered by Tax Treaties

40 Scope of Distributive Rules Territorial Scope Bilateral Scope Art 6 Immovable Property Art 10 Dividends Art 11 Interest Art 12 Royalties Art 16 Directors' fees Art 17 Artistes and Sportsmen Worldwide Scope Art 7 Business Profits Art 13 Capital Gains Art 15 Income from Employment Art 18 Pensions Art 21 Other Income E.g., Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State (Art 10), Interest arising in a Contracting State and paid to a resident of the other Contracting State (Art 11) E.g., The profits of an enterprise of a Contracting State shall be taxable only in that State (Art 7), Items of income of a resident of a Contracting State, wherever arising, [ ] shall be taxable only in that State (Art 21)

41 Scope of Distributive Rules Territorial Scope If items of income are in principle covered by a distributive rule with bilateral scope and are derived from sources in a third state or from the recipient s residence state, then such items of income are not covered by this distributive rule! Such items of income are covered by Art 7 (for business profits) or by Art 21 (for other income) Exclusive taxing right for the taxpayer s residence state!

42 Scope of Distributive Rules Substantive Scope One Article is completely covered by the scope of another Article Lex specialis vs lex generalis Examples: Art 7 vis-á-vis Art 8, Art 15 vis-á-vis Art 18 Generally solved by the DTC: Art 8 before Art 7 (Art 7(7)); Art 18 before Art 15 (Art 15(1)) Two Articles overlap without one being clearly narrower or wider in scope Examples: Art 6 vis-á-vis Art 7, Art 17 vis-á-vis Art 18 In some cases solved by the DTC: Art 6 before Art 7 (Art 6(4) and Art 7(7))

43 Scope of Distributive Rules Substantive Scope Solved by OECD-MC Not Solved by OECD-MC

44 Scope of Distributive Rules Scope of Legal Ramifications Closed Distributive Rules Exclusive Taxation shall be taxable only in that State Exclusive Taxation usually in the Residence State Art 7(1), Art 12(1), Art 13(5), Art 15(1) 1st sentence, Art 18, Art 19(1)(b) and (2)(b), Art 21(1) Sometimes in the Source State: Art 8(1) and (2), Art 13(3), Art 19 (1)(a) and (2)(a) Income exempt in the other State (but may be included to calculate progressive rate Art 23A(3)) Open Distributive Rules Concurrent Taxation... may be taxed... may also be taxed Source tax with limits Art 10(2), Art 11(2) Source tax with no limits Art 7(1) 2nd part, Art 13(1), (2) and (2), Art 15(1) 2nd sentence and (3), Art 16, Art 17(1) Relief via Credit or Exemption in the Residence State (Art 23A or Art 23B) Art 23 provides an obligation to grant double tax relief (... income which, in accordance with the provisions of the Convention, may be taxed in the other Contracting State ).

45 Scope of Distributive Rules Scope of Legal Ramifications Article Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State. 2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed: [ ] b) 15 per cent of the gross amount of the dividends in all other cases. Article Where a resident of a Contracting State derives items of income which, in accordance with the provisions of Articles 10 and 11, may be taxed in the other Contracting State, the firstmentioned State shall allow as a deduction from the tax on the income of that resident an amount equal to the tax paid in that other State. Such deduction shall not, however, exceed that part of the tax, as computed before the deduction is given, which is attributable to such items of income derived from that other State.

46 Scope of Distributive Rules Scope of Legal Ramifications Overview 7 13 Article Income Rule Residence State Source State 6 Immovable Property ALSO Relief Art 23 Situs (1) Business Profits ONLY Residence (2) PE in the Source State ALSO Relief Art 23 PE 8 Shipping, Air Transport ONLY POEM 10 Dividends ALSO Relief Art 23 5%/10% 11 Interest ALSO Relief Art 23 10% 12 Royalties ONLY Residence (1) Gains Immovable Property ALSO Relief Art 23 Situs (2) Gains Business Assets ALSO Relief Art 23 PE (3) Gains Ships, Planes ONLY POEM (4) Gains Shares in Real Estate Companies ALSO Relief Art 23 Situs of Real Estate (5) Gains All Other Property ONLY Residence

47 Scope of Distributive Rules Scope of Legal Ramifications Overview Article Income Rule Residence State Source State (1) Employment ALSO Relief Art 23 Exercise (2) < 183 days employment without sufficient nexus ONLY Residence 16 Director s Fees ALSO Residence 17 Artistes and Sportsmen ALSO Relief Art 23 Residency of Company Exercise ( look through ) 18 Pensions ONLY Residence (1)(a) Active Government Service ONLY Paying State (1)(b) Active Government Service if Taxpayer is a Resident and National of Activity State ONLY Residence (2)(a) Government Pensions ONLY Paying State (2)(b) Government Pensions if Taxpayer is a Resident and National of the other State ONLY Residence

48 Scope of Distributive Rules Scope of Legal Ramifications Overview Article Income Rule Residence State 20 Students ONLY Residence Source State [Exception: Payments from Source State] 21 Other Income ONLY Residence

49 Rules of Treaty Application Rule 1 Tax Treaties Restrict the Application of Domestic Tax Law ( Stencil ) Rule 2 Tax Terms Can Have a Different Meaning in Domestic Tax Law and Treaty Law Rule 3 Correct Understanding of the Terms in Distributive Rules Residence versus Source Rule 4 Correct Understanding of the Scope of Distributive Rules Rule 5 Issues Not Covered by Tax Treaties

50 Issues Not Covered To obtain most of the benefits of a tax treaty Taxpayer must be a resident of a Contracting State (Art 1 and 4), the tax must be covered by the convention (Art 2) and is not excluded by specific provisions (e.g., a Limitation-of-Benefits-Clause) But: Tax treaties generally do not determine who the taxable subject is derived Art 6(1), Art 13, Art 14, Art 15, Art 16 and Art 17 paid Art 10, Art 11, Art 12, Art 18, Art 19 receives Art 20 profits of an enterprise or income of a resident Art 7, Art 21 Consequences Domestic rules on the attribution of income Domestic anti-abuse rules (e.g., GAARs, CFC, etc) Beneficial Ownership and Abuse of Treaties

51 Part III Distributive Rules

52 Overview Article 6 Income from immovable property Article 7 Business profits Article 8 Shipping, inland waterways transport and air transport Article 9 Associated enterprises Transfer Pricing Article 10 Dividends Article 11 Interest Article 12 Royalties Article 13 Capital gains Article 14 [Deleted] Article 15 Income from employment Article 16 Directors fees Article 17 Artistes and sportsmen Article 18 Pensions Article 19 Government service Article 20 Students Article 21 Other income

53 Business Profits Art 7 OECD-MC Old Principle Source country has a prior unlimited right to tax business profits earned by a nonresident to the extent that those profits are attributable to a PE situated in the source country Art 7(1) OECD-MC Only Residence State may tax business profits unless PE in the Source State Head Office Art 5 OECD-MC Definition of PE Art 7(2) OECD-MC Source State may only tax profits attributable to PE PE

54 Business Profits Art 7 OECD-MC Old Structure of Art 7 OECD-MC Para 1 Residence country has exclusive right to tax business profits, unless there is a PE in the source country. No force of attraction in OECD-MC, limited force of attraction in UN-MC. Para 2 Central directive for attribution of profits to PEs The Distinct and Separate Entity Principle AOA New Art 7 through Update 2010 Para 3 Expenses wherever incurred for the purposes of the PE shall be deductible in computing the profits of that PE Para 4 Apportionment of total profits of an enterprise is allowed to attribute profits to a PE in source country provided it is customary (insurance/banking industry). Para 5 No profits shall be attributed to a PE by reason of the mere purchases of goods by the PE for the non-resident enterprise. Para 6 Unless there is a compelling reason for the contrary, the same method should be used each year for allocating profits to PEs. Para 7 Art 7 is lex generalis, other distributive rules take precedence, such as Art 10, 11 and 12

55 Business Profits Art 7 OECD-MC Old Art 7(1) OECD-MC Overview The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment. Taxation in residence State only, unless there is a PE If so, so much of the profits attributable to PE taxable in PE State Two Approaches Relevant Business Activity Approach... so much of them... sometimes interpreted as limiting right to tax of PE State to overall enterprise profits As paragraph 2 is part of the context in which the sentence must be read, that sentence should not be interpreted in a way that could contradict paragraph 2, e.g. by interpreting it as restricting the amount of profits that can be attributed to a permanent establishment to the amount of profits of the enterprise as a whole. (Art 7 Para 11 OECD Comm) Functionally Separate Entity Approach Art 7(2) The Distinct and Separate Entity Principle AOA

56 Business Profits Art 7 OECD-MC Old Art 7(1) OECD-MC Force of Attraction OECD MC rejects force of attraction (Art 7 Para 10 Comm and AOA I/A Para 10) UN MC contains limited force of attraction (Art 7(1)(b) and (c)) Sales in that other State of goods or merchandise of the same or similar kind as those sold through that PE or other business activities carried on in that other State of the same or similar kind as those effected through that PE

57 Business Profits Art 7 OECD-MC Old Art 7(2) OECD-MC General Directive Attribution to PE of profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.

58 Business Profits Art 7 OECD-MC Old Art 7(2) OECD-MC Problem No consistent application of the attribution of profits under the terms of Art 7 OECD-MTC Scope of the fiction of a separate enterprise and the autonomy of the PE Result Double taxation or double non-taxation Solution OECD Report on the attribution of profits to permanent establishments ( AOA ) Objective: Finding one uniform method for the attribution of profits to PE Working hypothesis : Application of the arm s length principle of Art 9 OECD-MC and the OECD Transfer Pricing Guidelines to the attribution of profits to PE

59 Business Profits Art 7 OECD-MC Old Art 7(2) OECD-MC General Directive Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment. Profits that can be attributed to a permanent establishment are not limited to the amount of profits of the enterprise as a whole (Art 7 Para 11 OECD Comm) Trading accounts of the PE are the starting point for profit allocation. If they are prepared symmetrically, they reflect real economic functions, and hey are in accordance with the arm s length principle These trading accounts could be accepted by tax authorities (Art 7 Para 19 OECD Comm) PE State may tax notional profits when an asset leaves the State, because concept of realization depends on domestic law. Residence State must seek a bilateral solution on a case by case basis (Art 7 Para 21 OECD Comm).

60 Business Profits Art 7 OECD-MC Old Art 7(3) OECD-MC Cost Deduction In determining the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment, including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere. Clarifies, in relation to the expenses of a permanent establishment, the general directive laid down in Art 7(2). The deduction allowable to the permanent establishment for any of the expenses of the enterprise attributed to it does not depend upon the actual reimbursement of such expenses by the permanent establishment (e.g., general administrative expenses; Art 7 Para 27 OECD Comm) Prices between the permanent establishment and the head office Arm s length or actual cost?

61 Business Profits Art 7 OECD-MC Old Art 7(3) OECD-MC Cost Deduction Exceptions to the Arm s Length Principle Temporary transfer of assets (Art 7 Para 33 OECD Comm) Intangibles (Art 7 Para 34 OECD Comm) Services (Art 7 Para OECD Comm) Good management (Art 7 Para Comm) Transfer of funds (Art 7 Para Comm) UN-MC No deduction for internal royalties, fees, other similar payments, commissions, interest etc (Art 7(3) UN-MC)

62 Business Profits Art 7 OECD-MC New Structure of Art 7 OECD-MC Update 2010 Art 7 and Commentary Update 2010 and Report Attribution of Profits to Permanent Establishments (2010) Para 1 Residence country has exclusive right to tax business profits, unless there is a PE in the source country. Para 2 For Art 7 and Art 23: Separate entity approach for profit attribution, in particular for its dealings with other parts of the enterprise Para 3 Corresponding adjustments, MAP Para 4 Profits that are covered by other Articles of the convention. Additions concerning economic ownership Dividends Art 10 Paras 32.1 and 32.2 OECD Comm Update 2010 Interest Art 11 Paras 25.1 and 25.2 OECD Comm Update 2010 Royalties Art 12 Paras 21.1 and 21.2 OECD Comm Update 2010 Gains Art 13 Paras 27.1 and 27.2 OECD Comm Update 2010 Other Income Art 21 Paras 5.1 and 5.2 OECD Comm Update 2010

63 Permanent Establishment The PE Concept The key test which determines the right to tax business profits in the source state Art 5 OECD-MC Allocation of taxing rights for business profits (Art 7(1)) Business profits taxed exclusively in the State of residence of the enterprise unless there is a permanent establishment in the other State If a permanent establishment exists, profits attributable to the permanent establishment taxable in the PE State

64 Permanent Establishment The PE Concept in Art 5 OECD-MC Overview Para 1 Primary Rule For the purposes of this Convention, the term permanent establishment means a fixed place of business through which the business of the enterprise is wholly or partly carried on. Para 2 Illustrative (not Exhaustive) List of PEs Examples of typical fixed places of business (requirements of Art 5(1) must be met) Para 3 Construction/Installation Projects Para 4 Activities not PEs E.g., preparatory or auxiliary character Para 5 Dependent Agents may be a PE Para 6 Independent Agents not a PE Para 7 Control of a Subsidiary not a PE of the Parent (and vice versa)

65 Permanent Establishment The PE Concept Art 5(1) Primary Rule For the purposes of this Convention, the term permanent establishment means a fixed place of business through which the business of the enterprise is wholly or partly carried on. Checklist place of business Any premises, facilities or installation used for carrying on the business whether or not used exclusively for that purpose Space is at its disposal Immaterial whether owned, rented or at the disposal of the enterprise fixed Location Test Duration Test carried on Any situation where business activities are carried on at a particular location at the disposal of the enterprise for that purpose through which Art 5 Para OECD Comm Painter ( ), paving a road ( ), regular use of use a delivery dock at a customer s warehouse ( ), office in the headquarters of another company ( )

66 Permanent Establishment The PE Concept Art 5(1) Fixed A Specific Geographical Spot (the Location Test ) Link between the place of business and a specific geographical point Geographical fixedness has to be understood in the context of the business concerned Mobile and Recurrent Activities Coherent Whole Commercially and Geographically Commercial Coherence E.g., a single contract (plus connected contracts), complementary functions Geographic Coherence E.g., limited geographic area, distinct place (mine, offices of a client) Another factor: A place regularly returned to, e.g., a street market A Certain Degree of Permanence (the Duration Test ) 6-Months-Test (Art 5 Para 6 OECD Comm)

67 Permanent Establishment The PE Concept Art 5(3) Construction Activities A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months. Building Site Construction (Renovation) of buildings, roads, bridges or canals, the laying of pipe-lines and excavating and dredging Installation Project Includes the installation of new equipment, such as a complex machine, in an existing building or outdoors The Twelve-Month-Threshold Applies to each individual site or project, but regarded as single unit if it forms a coherent whole commercially and geographically (even if based on several contracts) From the date on which the contractor begins his work (including any preparatory work) until the work is completed or permanently abandoned (temporary or seasonal interruptions or discontinuations are included in determining the life of a site)

68 Permanent Establishment The PE Concept Art 5(4) Activities Deemed Not to Be a PE Concept Remote from profit making and attribution of income would therefore be problematic and artificial The term "permanent establishment" shall be deemed not to include: The use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise (Art 5(4)(a)) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery (Art 5(4)(b)) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise (Art 5(4)(c)) The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise (Art 5(4)(d)) The maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character (Art 5(4)(e)) The maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character (Art 5(4)(e)) Subpara (4)(f) added to the OECD-MC in 1977 and is now also in the UN Model Concern that it permits too substantial a business presence without taxation

69 Permanent Establishment The PE Concept Art 5(5) and (6) Agents

70 Permanent Establishment The PE Concept Art 5(5) Dependent Agent Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 6 applies is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise,. No requirement for the dependent agent to have a fixed place of business But: Agent s place of business not necessarily a permanent establishment of the head office (Knights of Columbus v. Her Majesty The Queen, 2008TCC307, Tax Court of Canada, 16 May 2008)

71 Permanent Establishment The PE Concept Art 5(5) Dependent Agent Criteria habitually exercises To be understood in the context of the business concerned, nature of the contracts, presence should be more than merely transitory (Art 5 Para 33.1 OECD Comm) an authority to conclude contracts Negotiation of all details of the contract in a manner binding on the enterprise is sufficient (even if the contract is actually signed by someone else in the other contracting state (Art 5 Para OECD Comm) Not, e.g., in case of insurance approval by head office (90% approval rate) (Knights of Columbus v. Her Majesty The Queen, 2008TCC307, Tax Court of Canada, 16 May 2008) in the name of the enterprise Not only when the contract is concluded literally in the name of the enterprise, but also where contract is binding on the principal (Art 5 Para OECD Comm) Subsidiary as a PE?

72 Permanent Establishment The PE Concept Art 5(6) Independent Agent An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. Criteria Legally Independent The agent s commercial activities are not subject to detailed instructions or comprehensive control Economically Independent Number of clients Acting in the Ordinary Course of his Business Broker, commission agent

73 Permanent Establishment The PE Concept Services PE Fees for technical services are not dealt with separately in either the OECD or UN Model Tax Convention Usually taxed under the Business Profits Article Taxation in source State to the extent that there is a PE (Art 5) in the source state and the fees are attributable to it UN-MC deems a PE to exist in respect of services performed for more than 6 months in respect of a single or connected projects (Art 5(3)(b) UN-MC) OECD Alternative Provision Art 5 Para OECD Comm

74 Dividends Art 10 OECD-MC Dividends Distribution of profits to the shareholders by companies limited by shares, limited partnerships with share capital, limited liability companies or other joint stock companies Legal entities with a separate juridical personality distinct from all their shareholders ( transparent partnerships) Structure of Art 10 OECD-MC Para 1 Residence state may tax Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State. Para 2 Maximum Source State Taxation Rate Beneficial Ownership - Requirement Relief in the Residence State (Art 23A or Art 23B OECD-MC) 5% Corporate Shareholder with a Capital Holding of at least 25% Capital under company law, but consideration of domestic tax law (e.g., thin capitalisation, or assimilation of a loan to share capital; Art 10 Para 15 OECD Comm) 15% All other cases No Minimum Holding Period in the OECD-MC, but Alternative Provision in Art 10 Para 17 OECD Comm provided that this holding was not acquired primarily for the purpose of taking advantage of this provision. Para 3 Definition of Dividends Para 4 Art 10 does not apply to dividends from holdings connected with a permanent establishment in the source country Art 7 Para 5 Extraterritorial Taxation

75 Dividends Art 10 OECD-MC Art 10(3) OECD-MC Definition of Dividends The term dividends as used in this Article means income from shares, jouissance shares or jouissance rights, mining shares, founders shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident. Not only open distributions of profits decided by annual general meetings of shareholders, but also other benefits in money or money s worth, such as bonus shares, bonuses, profits on a liquidation and disguised distributions of profits (Art 10 Para 28 OECD Comm). Also: Loans if the lender effectively shares the risks run by the company E.g., repayment of the loan is subordinated to claims of other creditors or to the payment of dividends, the level or payment of interest would depend on the profits of the company, the loan contract contains no fixed provisions for repayment by a definite date (Art 10 Para 25 OECD Model Commentary). Not included E.g., debt-claims participating in profits (Art 11 Para 19 OECD Comm)

76 Dividends Art 10 OECD-MC Art 10(4) OECD-MC Dividends Connected with a PE The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident through a permanent establishment situated therein and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment. In such case the provisions of Article 7 shall apply.

77 Dividends Art 10 OECD-MC Art 10(5) OECD-MC Extraterritorial Taxation Situation 1 Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment situated in that other State, nor subject the company s undistributed profits to a tax on the company s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.

78 Dividends Art 10 OECD-MC Art 10(5) OECD-MC Extraterritorial Taxation Situation 2 Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment situated in that other State, nor subject the company s undistributed profits to a tax on the company s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State. Shareholder s State may tax under Art 10(1) OECD-MC

79 Dividends Art 10 OECD-MC Art 10(5) OECD-MC Extraterritorial Taxation Situation 3 Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment situated in that other State, nor subject the company s undistributed profits to a tax on the company s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State. PE State may tax under Art 7 OECD-MC (Art 21(2) OECD-MC)

80 Interest Art 11 OECD-MC Structure of Art 11 OECD-MC Para 1 Residence state may tax Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. paid Fulfillment of the obligation arising Art 11(5) OECD-MC Para 2 Maximum Source State Taxation Rate (10%) Beneficial Ownership - Requirement Relief in the Residence State (Art 23A or Art 23B OECD-MC) Para 3 Definition of Interest Para 4 Art 11 does not apply to interest from debt-claims connected to a permanent establishment in the source country Art 7 Para 5 Sourcing rule Residence of the Payer, State of the PE Para 6 Special Relationship Clause The restriction on the source country right to tax does not apply to the excess amount which has its basis in a special relationship ( Arm s Length )

81 Interest Art 11 OECD-MC Art 11(3) OECD-MC Definition of Interest Income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in profits E.g., cash deposits and security in the form of money, government securities, bonds and debentures (including premiums or prizes attaching thereto) Not covered Penalty charges for late payment Optional Exclusion from Source Taxation, e.g., Interest paid to a State, its political subdivisions and to central banks (Art 11 Para 7.4 OECD Comm) Interest paid by a State or its political subdivisions (Art 11 Para 7.5 OECD Comm) Interest paid pursuant to export financing programmes (Art 11 Para 7.6 OECD Comm) Interest paid to financial institutions (Art 11 Para 7.7 OECD Comm) Interest paid to some tax-exempt entities (e.g. pension funds) (Art 11 Para 7.10 OECD Comm)