Question 1 Answer Financial crisis and related increase of taxes in most countries around the world brought the question at international level of how much tax multinational companies (MNCs pay, how much do they contribute to public revenues and state budgets in general?) The common perception to this question was that MNCs pay very little taxes compared to their profit making. This question initiated a long discussion which gained much of media attention and resulted in broad publicising of certain "standard" techniques that huge MNCs with valuable intangibles, such as Apple, Google, Amazon and Starbucks use in order to reduce their tax liability. A very standard practice such companies use is to place high value intangibles in subsidiaries established in low-tax jurisdictions such as Ireland. Apple and Google for example had their most valuable intangibles in subsidiaries in Ireland and then charged royalties to other group companies. Another famous technique used by Google, amongst other, is the now "notorious" Dutch Sandwich where royalty payments were routed between the Irish and the Bermuda companies through an interposed Dutch company. This way by using tax benefits of no withholding tax on royalty payments due to the DTC between Ireland and the Netherlands and the fact that payments from the Dutch company were also free from withholding tax due to domestic law exemption resulted in elimination of taxes due. A main problem of intangible and especially unique high value intangibles such as the ones developed by Apple is that it is very difficult to identify and evaluate. This fact provided further room for MNVs to determine relevant compensation for use of the intangibles. In light of this technique along with other similar techniques caused public disapproved States decided to take actions in order to tackle this phenomenon. In this respect the following actions should be mentioned: 1) 2012 OECD Discussion Draft "Revision of the special considerations for intangibles in Chapter IV of the OECD Transfer Pricing guidelines and related provisions. In this text the OECD discusses in depth and analyses issues related to the determination, definition, and evaluation of intangibles as well as problematic areas. 2) Action Plan on Base Erosion and Profit Shifting and in particular Action 8. Action 8 refers to intangibles and puts emphasis on the development of rules to prevent BEPS by moving intangibles among group members. In particular the need to adopt a definition is identified, to ensure that profits associated with the transfer and use of intangibles area appropriately allocated in accordance with value creation and to develop transfer pricing rules or special measures for high value intangibles and update the guidance on cost contribution arrangements. Timetable for the Action is to make changes to the TPGL and possibly the Model Tax Convention by September 2014 and make further changes to these texts by September 2015. To be noted that the intangibles is one of the areas that there are already outcome on the BEPS project in the sense that this spring the relevant Report was issued. This is an indication of the level of political will and consensus of states and of the OECD to find means to tackle the phenomenon.
To sum up, taking the above into consideration, one could say that it seems that in the future MNC will have difficulties in adopting techniques to eliminate their tax liability by making use of the inherent difficulties in identifying, evaluating and holding intangibles. It is evident that there is a strong political consensus and will to tackle this phenomenon. However, it should be born in mind that the inherent difficulties in the area of intangibles will render rather difficult in practice to eliminate the phenomenon completely. Even after adoption of standards and techniques at the level of OECD documents and even and domestic rules. Also, it will be difficult to ensure proper implementation and application of the rules by each domestic tax authority, especially in developing countries where tax authorities lack the sophistication and resources to apply the rules.
Question 4 Answer Countries usually have a connecting factor in order to impose taxes on businesses. Connecting factors are usually either residence or source. Usually, countries tax residence for their worldwide income, (unlimited right to tax) while they tax non-residents for the income that is sourced in this country. (limited right to tax) Usually countries deem businesses resident when either they are incorporated there or the place of management is there. As to source taxation of business profits, according to article 7 of the OECD Model Tax Convention, (OECD MTC) profits of a non-resident are taxed only if this enterprise has a permanent establishment (PE) in that State and these profits are attributable to the PE. Application of these principles in businesses engaged in cross-border activities can lead in double taxation meaning that a company that is resident in State A and thus liable to tax in State A for its worldwide income and generating profits in State B through a PE there, it would be liable to pay taxes for the same income in both States A and B (combination of residence and source taxation.) Other forms of double taxation can arise when both States consider a particular business as resident in both states (concurrent unlimited liability to tax) or when both states consider that a particular income is sourced in their state (concurrent limited liability to tax), though this is more rare in practice and outside the scope of the DTCs (since DTCs apply to residents). What is common in the past years is that businesses could be deemed to be residents in both contracting states, meaning that one State can apply the principle of incorporation while the other state can apply the principle of management and control. In such cases the OECD provides rules (tie-breaker rules) to resolve disputes in cases where a person is in principle deemed as resident in both States. (See Art. (3)) In particular, according to Art. 4 (3) of the OEC MTC, a person other than individual if is resident in both Contracting States (CS) it shall be deemed to be resident ONLY of the State in which its place of effective management is situated. The place of effective management is the place where all "key management and commercial decisions that are necessary for the conduct of the entire business as a whole are in substance made. All relevant facts and circumstances must be examined to determine the place of effective management." (Commentary para 24 on art. 4(3)) In other words, it is the place where the strategic decisions, all the vital decisions for the company, are made. A company can have many places of management but ONLY 1 place of effective management and control. Usually factors to be taken into account are the place where the BoD meetings take place, the employees are resident etc. As to the right of a State to tax business profits of a non-resident business, as stated above according to Art. 7(2) of the OECD MTC, it is necessary that this business has a PE in that State. This principle has been adopted because it is generally acknowledged that in order to tax companies' profits, these companies should have a certain degree of participation of the economic life of that State. Otherwise, companies would be discouraged from investing/engaging in trade in a State. Article 4 OECD MTC sets the general rules according to which a PE is created. According to such rules, in brief a company should have a fixed place of business, at its disposal, through which the business of the enterprise is whole or partially carried on. A degree of permanence is required. Furthermore, according to Art. 5(5) a company could have a PE even if no fixed place exists when such company acts through a dependent agent. In general article 5 and its commentary are very detailed given that these rules determine the power of the source state to impose taxes on business profits.
In general, there are 2 types of double taxation; juridical double taxation where the same income or capital is taxable in the hands of the same person by more than one State. And economic double taxation, where 2 different persons are taxable in respect of the same income or capital. The OECD Model, in principle, seeks to eliminate juridical double taxation. It also provides rules on relief from economic double taxation in cases of transfer pricing adjustments. In general, there are 3 ways to eliminate double taxation; The deduction method, where foreign taxes are deducted. (It used to be applied in the past and some states, e.g. the UK still partially apply it) The credit method, where a credit is granted for any taxes paid abroad on the relevant income. c) The exemption method, where income derived abroad is exempt from taxation in the home state. The credit method can take the form of: A full credit where the home state allows a deduction of the full amount of tax paid abroad even if such tax is higher than taxes due in home. The ordinary credit where the home state allows a deduction of the foreign tax to the extent it does not exceed relevant tax that would be due in the home state for this type of income. Most states adopt the ordinary credit The exemption method can take the form of: Full exemption where foreign sourced income is not taken into account at all. Exemption with progression where foreign source income is taken into account insofar as to determine the tax rates applicable to the rest of the income. OECD approves the use of exemption with progression. There is also the exemption with participation or exemption with active business clause where the exemption is granted only for foreign active investment (where the company has some participation/ control over the investment) as opposed to passive investment where the company is just an investor with no active participation. Usually the level of participation is critical to determine whether active or passive investment (usually 10% participation qualifies for active investment). The OECD in Art. 23 A-B of the OECD MTC adopts the credit and exemption method but it leaves it to CS to decide which method each is going to use. Furthermore, states can use a combination of these methods. In general terms the credit looks at the tax while the exemption looks at the income. The OECD MTC sets the general rules while it is up to CS to implement and determine how exactly the method will apply. (E.g. calculation of credit, which taxes to be taken into account, treatment in cases of losses etc.) In specific, with regard to credit, a question arises in credit of taxes on foreign dividends on which taxes will be taken into account. It is possible to grant a credit for the withholding taxes suffer but also for the corporate income taxes due corresponding to the amount of the
dividend (underlying tax credit). Some treaties provide for both credits others not. In an EU context the EU Parent Sub directive provides for both. Usually 3 factors play role in the decision of a State to choose between these methods: Capital Export Neutrality (CEN) vs Capital Import Neutrality (CIN) Protection of the taxable basis c) Administrative costs and procedural burden related to implementation of these methods. In general, credit method is considered to favour CEN and to better protect the tax basis compared to the exemption method. On the other hand the exemption method is usually thought to be easier to apply and less burdensome. However, such assumption may differ from case to case (e.g. depending on whether the tax rates abroad are higher than in home state, whether which form of credit or exemption has been opted etc.) Finally, another significant issue with regard to business profits is when a partnership is considered as fiscally transparent in home state while it is considered as a company in host state. In such cases according to the commentary it is appropriate for the home state to take into account taxes paid abroad.
Question 5 Answer Double tax treaties (DTCs) are governed by public international law. Therefore, principles of interpretation relevant to international and NOT domestic law should be followed. In this respect, the Vienna Convention on the Law of Treaties (VCLT), and in particular articles 31-33 provide guidance as to the rules of interpretation of tax treaties. To be noted that VCLT codifies generally accepted principles of interpretation of international law, thus even if a country is not signatory to VCLT, rules reflected in VCLT can be used. (As accepted in the Thiel case where Switzerland was not a signatory country.) Thus courts should take into account VCLT when interpreting tax treaties. According to Art. 31 (1) of VCLT 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 light of its object and purpose. This principle has been interpreted by courts around the world as meaning that a liberal and broad interpretation should be adopted when interpreting DTCs, and not a strict interpretation that usually applies to domestic tax law. In the Commertzbank case, UK courts ruled that English law and precedent is of no relevance when interpreting tax treaties. Furthermore, focus should be placed on the "ordinary meaning" of the words, this means that terms should have the normal meaning. This includes internationally accepted terms and definitions (e.g. the definition of beneficial ownership in Indofood case). Furthermore, pursuant to Art 31(2, 3), the context of the treaty is the text including preamble and annexes, agreements related to the treaty which were made between ALL parties in connection with the conclusion of the treaty and any instrument made by 1 or more parties and accepted by the others in connection with the conclusion of the treaty. These include the context of the treaty. In addition, subsequent agreements and practice, relevant rules of international law should also be taken into account. Art. 31 in general, emphasises the interpretation of the letter of the law while the intention of the intention of the parties/ aim of the convention is to be taken into account when expressly decided so by the parties. (See Art. 31 (4)) Art. 32 provides that supplementary means of interpretation (e.g. letters of exchange, accompanying materials) should be taken into account by the court only if the meaning (according to the rules of Art. 31) is ambiguous/obscure or unreasonable). Other materials of interpretation (e.g. Technical Explanations of US - which is a unilateral material, Memorandum of Germany, use of experts) have a persuasive value for courts (see Xerox case). However, when such unilateral materials become part of the Treaty (e.g. Technical Explanations in US-Canada treaty) they should be used by the court as a part of the treaty. In the Fiji case, a use of tax expert was also allowed. A great discussion takes place in legal theory and practice as to the role of the Commentary in interpreting DTCs. According to a party in legal theory the Commentary could be classified as a legal instrument falling within the scope of Art. 31 (3, c), another party considers that it falls within the scope of Art. 31 (2) while another party considers that it falls outside the scope of both articles.
OECD Commentary is a soft law instrument. CECD member countries have a "loose obligation, an obligation nonetheless" to follow interpretation adopted in the Commentary. This loose obligation arises from Art. 5 of the OECD convention that obliges member states to follow its recommendations. The OECD Recommendation of 1997 recommends OECD member states' tax authorities when applying and interpreting the provisions of their bilateral tax conventions based on the Commentary to follow the OECD Commentary. OECD promotes the principle of common interpretation of tax treaties, because with a common international interpretation it is achieved better the goal of the DTCs. (E.g. balanced allocation of taxing rights, relief from double taxation, avoidance of tax evasion.) Furthermore, this is also stated in Para. 29 of the Commentary on Art. 3 (2) (Commentaries can be of great assistance in the application and interpretation of the convention.) In any event, in practice tax administration and courts place much emphasis on the Commentary. (E.g. Thiel Case, Nat West case etc.) An important question raises when tax authorities and courts have to interpret a treaty and the relevant Commentary has been amended. The OECD favours ambulatory over static interpretation of tax treaties. This is evident in OECD's Model Tax Convention in article 3(2) and especially by the use of the term "at any time". Also it is stated in Para. 35 of the Commentary on article 3(2). To be noted that Para. 35 sets the limits of ambulatory interpretation meaning courts cannot adopt an ambulatory interpretation when there is a difference in "substance" from the Amended Articles. "However other changes or additions to the Commentaries are normally applicable to the interpretation and application of the conventions." To be noted that Courts have accepted in the past the ambulatory interpretation of tax treaties, e.g. in the Texaco case where a Commentary after the conclusion of the treaty was used. Finally, it should be stated that the Commentary has a pivotal role in application and interpretation of tax treaties even by non OECD countries. For example, in the Ketoya-Parayah case, the court recourse to the OECD Commentary for the interpretation of the Malaysian-Singapore DTC, despite the fact that they are not OECD countries.
Question 7 Answer Memorandum. To whom it may concern, This is an analysis related to the questions posed with regard to question part 1: the tax consequences of the four suggested models of operation in State B as well as the tax and the question part 2: the tax consequences for Powerco and for the technicians of the visits. Part 1 If Powerco stabilises a fully owned subsidiary (to be referred to as Su in state B, this Sub will be resident in State B and thus fully liable to taxes in State B. Profits generated by the Sub will be subject to Corporate Income Tax (CIT) of State B, which is higher than State A s. Such profits will be distributed to Powerco in the form of dividends. Dividends distributed should be subject to 5% tax according to article 10(2, of the DTC between State A and B. Therefore the profits that you will receive will have been subject to CIT at a higher rate and also at withholding tax. Powerco should be eligible for relief from double tax on such corporate profits (economic double taxation) and credit/exemption should be provided depending on which form of relief from double taxation (either Art. 23 A or B of the OECD MTC) State A has adopted. In essence, if State A has opted for the ordinary credit method and also grants an underlying tax credit, then profits generated in State B will be subject to the higher taxes of State B. the same will happen if State A applies an exemption method. The only way not to be burdened with higher tax rates of State B is if State A grants a full credit which is highly likely. Please note in this respect that usually Multinational Companies turn to have their manufacturing subsidiaries in high tax jurisdiction as contract manufacturers and not as fully fledged manufacturers. (See Zimmer case, OECD TPGL etc.) This way the profitability of the Sub is reduced and accordingly the profits liable to high Corporate Income Tax. In this case the Sub would manufacture under a licence agreement, thus profitability should be low. In such cases there is a risk that tax authorities could challenge the structure and consider that the Sub constitutes a dependent agent PE of the principal. This issue has been addressed by courts in various recent decisions. (Zimmer, Dell France, Dell Spain and Roche Vitamins) If Powerco sets up a factory in state B and performs sales through its local sales team there, then Powerco will be considered to have a PE in State B since according to Art. 5 of the DTC it will have a fixed place of business. (The factory, through which the business of the enterprise will be carried on) In particular, according to Art. 5(2, d) a factory is a characteristic example of the existence of a PE. Given that Powerco has a PE in State B, sales performed through its own local team will be taxed in State be as business profits according to art. 7 (2) and provided such profits are attributable to the PE. To be noted that as regards attribution of profits to a PE, the authorized OECD approach is to apply the fiction of functionally separate legal entity, i.e. when determining profits of a PE to be subject to tax a 2 step analysis - following Transfer Pricing Principles by analogy- is necessary to be done, especially with regard to the dealings between the PE and the head office.
In particular, it is necessary to determine the profits the PE would have realized if it had been a separate and distinct enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the rest of the enterprise. (Commentary Para 17 of Art. 7 (2)) The 2-step approach includes: A functional and factual analysis. Attribution of assets, risks and capital. This issue is discussed in detail in 2010 OCED's Report on Attribution of profits to Permanent establishments. c) Initially, the fact that Powerco stores products in warehouses in State B and performs just sales should not give rise to the creation of a PE according to Art. 5 (4, of the DTC since the storage of goods is considered an auxiliary activity. Therefore, where Powerco would not have a PE, then profits generated in State B would not be subject to tax in State B according to Art. 7 of the DTC. d) Performance of sales in State B through independent agents normally should not lead to the creation of a PE for Powerco in state B, according to article 5 (6) of the DTC and provided as expressly stated in the law "such persons are acting in the ordinary course of their business". Whether an agent is independent there various factors to take into consideration, described in detail in paras 36-39 of the Commentary on Article 5 (6) of the OECD MTC. Given that the DTC is identical to the OECD MTC the Commentary should be used in order to interpret the notion of independence. An indication of independence is whether the agent works for other principals. In such a case, where Powerco would not have a PE, then profits generated in State B would not be subject to tax in State B according to art. 7 of the DTC. Part 2 Apart from the analysis of question (1) the following should be taken into account with regard to the existence and operation of technicians to State B. If the presence of the technician on a recurrent basis is of such an extent and degree it could create a permanent establishment for Powerco. The condition of the existence of a "fixed place of business" for the existence of PE could be met since the technicians will carry out their work on the customer's premises. In this respect it should be noted that in order to have a PE Powerco is not necessary to legally own a space, the critical issue would be whether the space in the customer's premises will be at its disposal or not. Courts have ruled in this respect in a similar case that there was no PE when representatives of the foreign company where at the premises at the customers BUT they had no control of the premises in the sense that they were there only in hours of operation of the client, used the equipment of the client only for the particular transactions etc. Thus, it is a factual matter whether the presence of the technicians would create a PE or not. Tax implications for the creation of a PR for Powerco are considered above. Another important tax issue for the technicians is that if their presence there exceeds 183 in State B then State B would be able to tax any income from employment of the technicians pursuant to Article 15 of the DTC.
Furthermore, one should keep in mind, apart from the above analysis that techniques of artificial avoidance of PE status have been identified as abusive by the Action Plan on Base Erosion and Profit Shifting (BEPS) in actions 6 and 7. Therefore, this is a factor to take into account once deciding on the form of business activity to be undertaken in State B.