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INTERNATIONAL TAX QUIZ
INTERNATIONAL TAX QUIZ
INTERNATIONAL TAX QUIZ 160
ACo, a company located in jurisdiction A, is the UPE of an MNE Group which is
“within scope” of the GloBE rules.
ACo owns 90% of the shares in BCo, a company located in jurisdiction B. The
other 10% of the shares in BCo are owned by third parties. BCo is the only
member of the MNE Group located in jurisdiction B.
BCo owns 100% of the shares in CCo, a company located in jurisdiction C.
Jurisdictions A and B have implemented the GloBE rules (both IIR and UTPR), and
they have also each implemented a QDMTT.
For a Fiscal Year:
* ACo is subject to 4 jurisdiction A taxes: (1) Corporate income tax:100; (2)
CFC tax (in respect of BCo’s profits): 150 (before credit for BCo’s taxes),
30 (after credit for BCo’s taxes); (3) IIR tax (in respect of the
jurisdiction B Top-up Tax): to be determined (“TBD”); and (4) QDMTT: TBD.
* For purposes of both the GloBE rules and the QDMTT, ACo’s GloBE Income is
2,000, and its Substance-based Income Exclusion (“SBIE”) is 1,200.
For the same Fiscal Year:
* BCo is subject to 3 jurisdiction B taxes: (1) Corporate income tax: 50; (2)
CFC tax (in respect of CCo’s profits, which do not include any Passive
Income): 80; and (3) QDMTT: TBD.
* For purposes of both the GloBE rules and the QDMTT, BCo’s GloBE Income is
1,400 (including 400 of Passive Income), and its SBIE is 800.
Based on this information:
* Q1: What is ACo’s IIR tax liability in respect of the jurisdiction B Top-up
Tax?
* Q2: What is ACo’s QDMTT liability?
* Q3: What is BCo’s QDMTT liability?
Answer will be revealed soon on 24 February!
INTERNATIONAL TAX QUIZ 159
XCo, a company located in jurisdiction X, is a Constituent Entity in an MNE
Group which is “within scope” of the GloBE rules. It is the only Constituent
Entity located in X.
YCo, a company located in jurisdiction Y, is a Constituent Entity in the same
MNE Group. It is the only Constituent Entity located in Y. XCo and YCo are
sister subsidiaries.
The UPE is located in jurisdiction U. The UPE has a direct Ownership Interest in
both XCo and YCo of 100%.
The GloBE rules have been implemented in jurisdictions X and Y (in both cases:
IIR and UTPR), but they have not been implemented in jurisdiction U.
In a Fiscal Year:
1. UPE incurs CFC tax (under the jurisdiction U tax law) in respect of the
profits of XCo. For the purposes of the GloBE rules, jurisdiction U’s CFC
tax law is a “CFC Tax Regime”, but it is not a “Blended CFC Tax Regime”.
2. YCo has a Top-up Tax amount, which is allocated (in part) to XCo under Art.
2.6.
3. XCo incurs a tax liability under jurisdiction X’s minimum tax. That minimum
tax has the same rules as the GloBE rules, except that it does not include a
Substance-based Income Exclusion.
Based on this information:
* Q1: Is jurisdiction X’s minimum tax a QDMTT?
* Q2: Assuming the answer to Q1 is “yes”, will UPE’s CFC tax and/or the
jurisdiction X UTPR tax (in respect of YCo’s Top-up Tax) be taken into
account in computing XCo’s QDMTT liability?
Answer:
Q1
Jurisdiction X’s minimum tax will qualify as a QDMTT. The fact that it does not
include a Substance-based Income Exclusion does not disqualify it from QDMTT
status: see paras. 118.36-37 in the Administrative Guidance on the GloBE rules
(AG).
Q2
Neither the UPE’s CFC tax nor the jurisdiction X UTPR tax (in respect of YCo’s
Top-up Tax) will be taken into account in computing XCo’s QDMTT tax liability.
Regarding the CFC tax, see para. 118.30 of the AG.
Regarding the UTPR tax, see para. 118.31 of the AG and the exclusion of UTPR tax
from the definition of “Covered Taxes” in Art. 4.2.2(c).
Do you agree?
INTERNATIONAL TAX QUIZ 158
ACo, a company located in jurisdiction A, is a Constituent Entity in an MNE
Group which is “within scope” of the GloBE rules. ACo is the only Constituent
Entity located in jurisdiction A.
ACo carries on a manufacturing business in jurisdiction A, and is provided with
a tax incentive under the jurisdiction A tax law.
ACo is trying to determine how the tax incentive should be designed in the
future, having regard to the GloBE rules.
For that purpose, ACo assumes: (1) its GloBE Income will be 1,000; (2) its
Substance-based Income Exclusion (SBIE) amount will be 800; and (3) it will not
satisfy a safe harbour or the de minimis exclusion.
Q1: If jurisdiction A provides an income tax exemption for the SBIE amount
(800), and levies a 15% income tax on the remainder of ACo’s GloBE Income (200),
will there be no Top-up Tax?
Q2: If the answer to Q1 is that there would be a Top-up Tax, what rate of tax
should jurisdiction A levy on the remainder of ACo’s GloBE Income (200) to
ensure that the Top-up Tax is zero?
For the purposes of these questions, please assume that (apart from the
exemption of the SBIE amount) there are no permanent or timing differences
between the computation of GloBE Income and the computation of taxable profits
under the jurisdiction A tax law.
Answer:
Q1
Adjusted Covered Taxes: 15% x 200 = 30
GloBE Income: 1,000 (i.e., not reduced by the SBIE amount)
Thus, ETR = 30 / 1,000 = 3% (Art. 5.1)
Top-up Tax Percentage = 12%
Excess Profit = 1,000 – 800 = 200
Thus, Jurisdictional Top-up Tax = 12% x 200 = 24 (Art. 5.2)
Q2
To ensure that the Top-up Tax is zero, jurisdiction A would need to levy a tax
of 150 on the remainder of ACo’s GloBE Income (200).
With Adjusted Covered Taxes of 150, ACo’s ETR would be: 150 / 1,000 = 15%.
The tax of 150 on 200 of income is a 75% tax rate!
Comments
With a 15% jurisdiction A tax rate on the 200, the total tax paid would be: 30
(juris. A tax) + 24 (Top-up Tax) = 54.
Alternatively, with a 75% jurisdiction A tax rate on the 200, the total tax paid
would be: 150 (juris. A tax) + 0 (Top-up Tax) = 150.
Ironically, of the 2 alternatives, the MNE Group would pay less tax by allowing
the Top-up Tax to apply.
An important point to note is that the SBIE amount does not reduce GloBE Income.
Therefore, a low ETR can still occur, even though most of the GloBE Income is
SBIE and the remainder is subject to a 15% tax rate.
Do you agree?
INTERNATIONAL TAX QUIZ 157
XCo, a company located in jurisdiction X, is a Constituent Entity in an MNE
Group which is “within scope” of the GloBE rules. XCo, a small manufacturing
company, is the only Constituent Entity located in jurisdiction X.
YCo, a company located in jurisdiction Y, is also a Constituent Entity in the
MNE Group. YCo is the only Constituent Entity located in jurisdiction Y. XCo and
YCo are “sister subsidiaries”.
The UPE is located in jurisdiction U.
For 2024, the GloBE rules are in effect in jurisdictions X and Y (for both
jurisdictions, both the IIR and UTPR are in effect, but not a QDMTT); however,
the GloBE rules are not in effect in jurisdiction U or in any of the other 8
jurisdictions in which the MNE Group has Constituent Entities.
For 2024, XCo has the following financial information (determined in accordance
with the Acceptable Accounting Standard used by the UPE in preparing its
consolidated Financial Statements) (all in EUR millions):
1. Profit before Income Tax: 1.4
2. Revenue: 9
3. Income tax expense (100% Covered Taxes, no “uncertain tax positions”): 0.2
4. Negative adjustments (i.e., reductions) (under Art. 3.2 and following) in
computing GloBE Income (note: there are no positive adjustments): (0.5)
5. Adjusted Covered Taxes: 0.1
6. Substance-based Income Exclusion: 0.6
And for 2024, YCo has the following financial information (determined in
accordance with the Acceptable Accounting Standard used by the UPE in preparing
its consolidated Financial Statements) (all in EUR millions):
1. Profit before Income Tax: 1.2
2. Revenue: 15
3. Income tax expense (100% Covered Taxes, no “uncertain tax positions”): 0.1
4. Net positive adjustments (i.e., add-back) (under Art. 3.2 and following) in
computing GloBE Income: 2.0
5. Adjusted Covered Taxes: 0.3
6. Substance-based Income Exclusion: 0.4
Based on this information, will either or both of XCo and YCo have a tax
liability under the GloBE rules for 2024?
Answer:
1. Juris. X Top-up Tax
XCo fails the transitional CbCR safe harbour: (i) de minimis test is failed,
because Profit before Income Tax is not less than EUR 1m; (ii) simplified ETR
test is failed, because simplified ETR is: 0.2 / 1.4 = 14.3%; and (iii) routine
profits test is failed, because Profit before Income Tax exceeds SBIE amount.
However, XCo satisfies the de minimis exclusion in Art. 5.5: Average GloBE
Revenue = EUR 9m, and Average GloBE Income = EUR 0.9 (see the Commentary’s
discussion on how to determine the “average” numbers in the first year when
GloBE rules apply).
If the election is made (I will assume that it is), Art. 5.5 requires that the
Top-up Tax for 2024 is zero.
2. Juris. Y Top-up Tax
YCo fails the transitional CbCR safe harbour: (i) de minimis test is failed,
because Total Revenue is not less than EUR 10m, and Profit before Income Tax is
not less than EUR 1m; (ii) simplified ETR is failed, because simplified ETR is:
0.1 / 1.2 = 8.3%; and (iii) routine profits test is failed because Profit before
Income Tax exceeds SBIE amount.
YCo also fails the de minimis exclusion in Art. 5.5: Average GloBE Revenue is
not less than EUR 10m, and Average GloBE Income is not less than EUR 1m.
Calculation of Top-up Tax…
GloBE Income: 1.2 + 2.0 = 3.2
ETR: 0.3 / 3.2 = 9.375%
Top-up Tax Percentage: 5.625%
Excess Profits: 3.2 – 0.4 = 2.8
Top-up Tax: 5.625% x 2.8 = EUR 0.1575m
3. UTPR
Art. 9.3 will not apply to exclude the application of the UTPR in 2024, as the
MNE Group is not “in its initial phase of its international activity”: there are
Constituent Entities in more than 6 jurisdictions.
The UTPR of EUR 0.1575m will be allocated between jurisdictions X and Y,
according to the allocation formula in Art. 2.6. Note that UTPR for 2024 will be
allocated (in part) to jurisdiction X, even though that jurisdiction qualifies
for the de minimis exclusion in 2024.
Do you agree?
INTERNATIONAL TAX QUIZ 156
ACo, a company located in jurisdiction A, is a Constituent Entity in an MNE
Group which is “within scope” of the GloBE rules. ACo is the only Constituent
Entity located in jurisdiction A. Jurisdiction A has a corporate income tax rate
of 20%.
The UPE is a large manufacturing company which is located, and has significant
manufacturing operations, in jurisdiction U. The UPE has 3 subsidiaries
(including ACo) located outside jurisdiction U. The 3 subsidiaries are low-risk
buy / sell distributors of the UPE’s goods: they own no valuable IP, they own no
inventory (they buy goods from the UPE on a “flash title” basis), and they
operate from leased premises.
For the 2024 fiscal year, jurisdiction A is the only jurisdiction (in which the
MNE Group operates) for which the GloBE rules are in effect (IIR, UTPR, and
QDMTT).
UPE enjoys a tax incentive in jurisdiction U, causing its ETR (calculated under
the GloBE rules) to be 10% in 2024. The UPE’s GloBE Income in 2024 is EUR 200
million. The UPE’s Substance-based Income Exclusion is EUR 80 million.
For 2024, ACo has the following financial information (determined in accordance
with the Acceptable Accounting Standard used by the UPE in preparing its
consolidated Financial Statements) (all in EUR millions):
1. Profit before Income Tax: 0.5
2. Revenue: 15
3. Income tax expense (100% Covered Taxes, no “uncertain tax positions”): 0.06
4. Net positive adjustments (i.e., add-back) (under Art. 3.2 and following) in
computing GloBE Income: 0.6
5. Adjusted Covered Taxes: 0.08
6. Substance-based Income Exclusion: 0.4
Based on this information, will ACo have a tax liability under jurisdiction A’s
GloBE rules (IIR, UTPR and/or QDMTT) for 2024?
Answer:
1. Juris. A: de minimis exclusion (Art. 5.5)
Not applicable, as ACo’s GloBE Revenue is not less than EUR 10m and its GloBE
Income is not less than EUR 1m (see the Commentary’s discussion on how to
determine the “average” numbers in the first year when GloBE rules apply).
2. Juris. A: transitional CbCR safe harbour
Not applicable, as none of the 3 tests is satisfied: (1) de minimis test failed,
because Total Revenue is not less than EUR 10m; (2) simplified ETR test failed,
because computation is: 0.06 / 0.5 = 12%, which is less than Transition Rate of
15%; and (3) routine profits test failed, because Profit (Loss) before Income
Tax is not equal to or less than SBIE amount.
3. Juris. A Top-up Tax
ACo’s ETR: 0.08 / 1.1 = 7.2727%.
Thus, Top-up Tax Percentage = 7.7273%.
Excess Profit: 1.1 – 0.4 = 0.7
Thus, Top-up Tax = (7.7273% x 0.7) – QDMTT = 0.054 – QDMTT
Thus, jurisdiction A QDMTT = EUR 0.054m.
4. Juris. U Top-up Tax
UPE’s ETR = 10%.
Thus, Top-up Tax Percentage = 5%.
Excess Profit: 200 – 80 = 120.
Thus, Top-up Tax = 5% x 120 = EUR 6m.
Jurisdiction A is the only jurisdiction (in which the MNE Group operates) for
which the GloBE rules are in effect in 2024. Thus, 100% of the Top-up Tax, prima
facie, should be allocated to jurisdiction A as UTPR. Note that the allocation
percentage would be 100% only if ACo has at least one employee in jurisdiction
A, and at least one “Tangible Asset” in jurisdiction A (e.g., office furniture):
see the formula in Art. 2.6.1.
However, Art. 9.3 (exclusion from the UTPR of MNE Groups in the initial phase of
their international activity) should apply here – which would mean that no
Top-up Tax would be allocated to jurisdiction A under the UTPR.
5. Final answer
The only Top-up Tax which will be imposed for 2024 will be EUR 0.054m of
jurisdiction A QDMTT.
Do you agree?
INTERNATIONAL TAX QUIZ 155
ACo, a company located in jurisdiction A, is a Constituent Entity in an MNE
Group which is “within scope” of the GloBE rules. ACo is the MNE Group’s first
and only Constituent Entity located in jurisdiction A. ACo became a member of
the MNE Group on 1 January 2025, when 100% of its shares were purchased by the
UPE from third parties.
For the MNE Group, the GloBE rules commence operation in 2024.
ACo has the following financial income for 2025 (determined in accordance with
the Acceptable Accounting Standard used by the UPE in preparing its Consolidated
Financial Statements) (all in EUR millions):
1. Profit before Income Tax: 1.5
2. Revenue: 9.5
3. Income tax expense (100% Covered Taxes, no “uncertain tax positions”): 0.25
4. Net positive adjustments (i.e., add-back) (under Art. 3.2 and following) in
computing GloBE Income: 1.8
5. Adjusted Covered Taxes: 0.3
6. Substance-based Income Exclusion: 1.0
Based on this information, does jurisdiction A have a Top-up Tax in 2025?
Answer:
A preliminary point to note is that the de minimis exclusion in Art. 5.5 does
not apply, because ACo’s GloBE Income (EUR 3.3m) exceeds the limit of EUR 1m.
However, the key issue is whether the Transitional CbCR Safe Harbour (“TSH”)
(described in IF Guidance issued in December 2022) will apply:
1. 2025 is within the “Transition Period”.
2. Although the MNE Group did not apply the TSH with respect to jurisdiction A
in 2024, the “once out, always out” rule does not apply because the MNE
Group had no Constituent Entities located in jurisdiction A in 2024.
3. De minimis test: (i) Total Revenue: EUR 9.5m; (ii) Profit before Income Tax:
EUR 1.5m; (iii) Thus, the de minimis test is failed, because the Profit
before Income Tax exceeds the limit of EUR 1m.
4. Simplified ETR test: (i) Simplified Covered Taxes: EUR 0.25m; (ii) Profit
before Income Tax: EUR 1.5m; (iii) “Transition Rate” for 2025: 16%; (iv)
Simplified ETR = 0.25 / 1.5 = 16.7%; (v) Thus, the simplified ETR test is
passed.
5. Routine profits test: (i) Profit before Income Tax: EUR 1.5m; (ii) SBIE
amount: EUR 1.0m; (iii) Thus, the routine profits test is failed, because
the Profit before Income Tax is not equal to or less than the SBIE amount.
Therefore, as the simplified ETR test is passed, the TSH with respect to
jurisdiction A is available to the MNE Group in 2025, provided the election in
Art. 8.2.1 is made and the GloBE Information Return includes the correct
information. If this is the case, there will be no Top-up Tax for jurisdiction A
in 2025.
Do you agree?
INTERNATIONAL TAX QUIZ 154
ACo, a company located in jurisdiction A, is a Constituent Entity in an MNE
Group which is “within scope” of the GloBE rules.
ACo is the owner of valuable IP, which it licenses to group companies throughout
the world, in return for arm’s length royalties. ACo’s carrying value of the IP
in its 2022 financial statements is 100.
Jurisdiction A does not impose a corporate income tax.
BCo, a newly formed company in jurisdiction B, is also a Constituent Entity in
the same MNE Group. BCo currently does not have any business operations, and it
has no employees. Jurisdiction B has a corporate income tax, with a 25% tax
rate. BCo is the only Constituent Entity located in jurisdiction B.
At the start of 2023, ACo sells its IP to BCo for 1,000 (the IP’s fair market
value). BCo finances the acquisition by issuing new shares to the UPE in the MNE
Group (located in jurisdiction U). By virtue of the sale, BCo becomes the
licensor of the IP to the group company licensees.
In its 2023 and later financial statements, BCo amortises the IP at a rate of
10% per annum (i.e., 100 each year). BCo derives 110 of royalty income each year
(please assume that no foreign withholding tax is paid on those royalties). For
jurisdiction B corporate income tax purposes, BCo deducts tax depreciation on
the IP at a rate of 10% per annum (i.e., 100 each year).
The GloBE rules first apply to the MNE Group in 2024.
Based on this information, will the MNE Group have a Top-up Tax for jurisdiction
B in 2024? Please assume that BCo continues to have no employees in 2024.
Answer:
The key issue in this case is whether, in computing its GloBE Income in 2024,
BCo will use a basis in the IP of 1,000 (the fair market value price which it
pays to ACo) or 100 (ACo’s carrying value) – in other words, whether the
intra-group sale of the IP in 2023 (i.e., before the start of the GloBE rules)
achieves a “step-up” in the basis of IP for GloBE purposes.
The answer is: BCo will use 100 – i.e., no step-up will be achieved.
2024 is a “Transition Year” for the MNE Group: see Art. 10.1.1 definition.
Art. 9.1.3: “In the case of a transfer of assets between Constituent Entities
after 30 November 2021 and before the commencement of a Transition Year, the
basis in the acquired assets … shall be based on the disposing Entity’s carrying
value of the transferred assets upon disposition …”.
In 2024:
1. BCo’s Adjusted Covered Taxes: (110 – 100) x 25% = 2.5
2. BCo’s GloBE Income: 110 – (100 x 10%) = 100
3. Jurisdiction B ETR: 2.5 / 100 = 2.5%
4. Jurisdiction B Top-up Tax: 12.5% x 100 = 12.5 (ignoring QDMTT)
Thus, my answer is: Jurisdiction B Top-up Tax = 12.5
Do you agree?
INTERNATIONAL TAX QUIZ 153
ACo, a company located in jurisdiction A, is the UPE of an MNE Group which is
“within scope” of the GloBE rules. Jurisdiction A has a corporate income tax
rate of 20%. ACo has no tax losses.
ACo directly owns 100% of the shares in XCo, a company located in jurisdiction
X. Jurisdiction X has a corporate income tax rate of 25%. XCo has no tax losses.
XCo directly owns 100% of the shares in YCo, a company located in jurisdiction
Y. Jurisdiction Y does not levy a corporate income tax.
In the current year, YCo derives 200 of profits, comprising (1) 100 of interest
income (no related expenses), and (2) 150 of service fees (less 50 of related
expenses). YCo does not incur any foreign withholding taxes.
Jurisdiction X has CFC rules. Under those rules, an amount equal to YCo’s 100 of
interest income is imputed to XCo.
Jurisdiction A also has CFC rules. Under those rules, an amount equal to the
whole of YCo’s profits (i.e., 200) is imputed to ACo. However, ACo will obtain a
credit for the CFC tax paid by XCo on the same amount.
Based on this limited information, what will be YCo’s Adjusted Covered Taxes in
the current year?
Answer:
1. XCo’s CFC tax
XCo’s CFC tax: 25% x 100 = 25
Prima facie, that amount of 25 will be allocated to YCo under Art. 4.3.2(c),
subject to Art. 4.3.3 (see below).
2. ACo’s CFC tax
ACo’s CFC tax: [20% x 200] – credit for XCo’s CFC tax
I will assume that jurisdiction A’s tax law limits the credit to ACo’s CFC tax
on the same income (i.e., 100 of interest income).
Based on that assumption, the credit will be: 20% x 100 = 20
Thus, ACo’s CFC tax: 40 – 20 = 20
Prima facie, that amount of 20 will be allocated to YCo under Art. 4.3.2(c),
subject to Art. 4.3.3 (see below).
3. Art. 4.3.3
YCo’s 100 of interest income is included in “Passive Income” (Art. 10.1.1
definition), but its 100 of profit from service fees is not.
XCo’s CFC tax of 25 is wholly in respect of “Passive Income”.
A question arises as to how much (if any) of ACo’s CFC tax of 20 is in respect
of “Passive Income”. After giving the credit for XCo’s CFC tax in respect of
YCo’s 100 of interest income, is the remainder of ACo’s CFC tax (20) wholly in
respect of the 100 of net service fees – or, alternatively, is it 50% in respect
of the 100 of net service fees and 50% in respect of the 100 of interest income?
The Commentary and the Examples do not answer that question.
I will assume that the answer is that ACo’s CFC tax is wholly in respect of 100
of net service fees – i.e., none of ACo’s CFC tax of 20 is in respect of
“Passive Income”.
Based on that assumption:
Jurisdiction Y’s Top-up Tax Percentage is 15%.
Art. 4.3.3, para. (b) amount: 15% x 100 = 15.
Art. 4.3.3, para. (a) amount: 25 (XCo) + 0 (ACo) = 25.
Thus, Art. 4.3.3 “cap” is 15.
4. Final amounts allocated to YCo under Art. 4.3.2(c)
XCo’s CFC tax (capped under Art. 4.3.3) = 15
ACo’s CFC tax (not capped under Art. 4.3.3) = 20
Total CFC tax amounts allocated to YCo (i.e., YCo’s Adjusted Covered Taxes): 15
+ 20 = 35.
Do you agree?
INTERNATIONAL TAX QUIZ 152
ACo, a company located in jurisdiction A, is the UPE of an MNE Group which is
“within scope” of the GloBE rules.
BCo is a company located in jurisdiction B (which has not implemented a QDMTT).
BCo qualifies as an “Investment Fund” (Art. 10.1.1 definition). BCo has one
class of issued shares.
ACo owns a 60% Ownership Interest in BCo. The other 40% Ownership Interests are
owned by third party investors.
ACo includes BCo’s financial results in its consolidated financial statements on
a line-by-line basis.
In the current year, BCo reports 200 of pretax profits in its financial
statements. Included in those pretax profits are: (1) dividends on long-term
(greater than 12 months) portfolio shareholdings: 65; (2) gains on sale of such
shareholdings: 35; (3) interest on corporate and government bonds: 60; and (4)
gains on sale of such bonds: 40. Please ignore expenses.
BCo is tax-exempt in jurisdiction B. Also, please assume that BCo does not incur
any foreign withholding tax, and it does not have any “Eligible Employees” (Art.
10.1.1 definition) or “Eligible Tangible Assets” (Art. 5.3.4 definition). In
addition, please assume that no election is made under Art. 7.5 or Art. 7.6.
ACo is subject to CFC tax in jurisdiction A with respect to its investment in
BCo. For the purposes of the CFC rules, BCo’s interest income and gains on sale
of bonds, are taxable. The CFC tax rate is 25%.
Based on this information, what is BCo’s Top-up Tax (if any) for the current
year?
Answer:
BCo’s GloBE Income = 200 – 65 (“Excluded Dividends”: Art. 10.1.1 definition) =
135.
The 35 of gains on sale of long-term portfolio shareholdings are not “Excluded
Equity Gain or Loss” (Art. 10.1.1 definition) because of the exception for
Portfolio Shareholdings.
For the purposes of Art. 7.4, the MNE Group’s Allocable Share of BCo’s GloBE
Income is: 60% x 135 = 81.
BCo is tax-exempt in jurisdiction B and does not incur any foreign withholding
tax. Therefore, subject to Art. 4.3, BCo’s Adjusted Covered Taxes would be nil.
However, ACo incurs a CFC tax rate of 25% in regard to BCo’s interest income
(60) and gains on sale of bonds (40). Thus, ACo’s CFC tax is: 25% x 100 x 60% =
15 – i.e., reflecting ACo’s 60% Ownership Interest in BCo.
Prima facie, that 15 is allocated to BCo under Art. 4.3.2(c). However, both the
interest income and the gains on sale of bonds, fall within the definition of
“Passive Income” in Art. 10.1.1. Therefore, the “cap” in Art. 4.3.3 will need to
be applied. The amount in para. (a) is 15. The amount in para. (b) is calculated
as: 15% x 100 = 15. Accordingly, based on the numbers, the cap does not restrict
the tax allocated to BCo. (Note that the 35 of gains on sale of long-term
portfolio shareholdings is excluded from the definition of “Passive Income” by
the closing words in the definition: “but only to the extent …”).
Therefore, BCo’s Adjusted Covered Taxes will be 15.
In calculating BCo’s ETR, Art. 7.4.2 requires us to use the MNE Group’s
Allocable Share of BCo’s GloBE Income – i.e., 81.
Accordingly, BCo’s ETR is: 15 / 81 = 18.5185%. Thus, BCo has no Top-up Tax
Percentage: Art. 7.4.5.
Which means that BCo has no Top-up Tax.
Do you agree?
INTERNATIONAL TAX QUIZ 151
Question 1
UPE 1 is the UPE of MNE Group 1, and UPE 2 is the UPE of MNE Group 2. Both MNE
Group 1 and MNE Group 2 are “within scope” of the GloBE rules.
UPE 1 and UPE 2 each owns 50% of the issued shares in XCo, a company located in
jurisdiction X. XCo has only one class of issued shares.
UPE 1 and UPE 2 each report XCo’s financial results in their respective
consolidated financial statements under the equity method.
XCo is the UPE of MNE Group 3, which is also “within scope” of the GloBE rules.
ACo, located in jurisdiction A, is a 100% subsidiary of XCo. ACo has a Top-up
Tax of 100 in the current year.
What will be the impact, under the GloBE rules, on UPE 1, UPE 2, and XCo, in
regard to ACo’s Top-up Tax? Please assume that all relevant jurisdictions
(except jurisdiction A) have implemented the GloBE rules, and that ACo is the
only Constituent Entity located in jurisdiction A.
Question 2
UPE 3 is the UPE of MNE Group 3; UPE 4 is the UPE of MNE Group 4; and UPE 5 is
the UPE of MNE Group 5. All 3 groups are “within scope” of the GloBE rules.
The 3 UPEs are all shareholders in YCo, a company located in jurisdiction Y. YCo
has only one class of issued shares. The percentages held are: UPE 3: 40%; UPE
4: 30%; and UPE 5: 30%.
UPE 3, UPE 4, and UPE 5 each report YCo’s financial results in their respective
consolidated financial statements under the equity method.
YCo has no subsidiaries or PEs.
If YCo were to compute its position under the GloBE rules, it would have a
Top-up Tax of 200.
What will be the impact, under the GloBE rules, on UPE 3, UPE 4, and UPE 5, in
regard to that Top-up Tax of 200? Please assume that all relevant jurisdictions
(except jurisdiction Y) have implemented the GloBE rules.
Answer:
Question 1
There will be no impact, under the GloBE rules, on either UPE 1 or UPE 2, for 2
reasons: (1) ACo is not a Constituent Entity of either MNE Group 1 or MNE Group
2, because it is not included in either Group’s consolidated financial
statements on a line-by-line basis (see the definition of “Constituent Entity”
in Art. 1.3, and the definition of “Group” in Art. 1.2); and (2) XCo is excluded
from the definition of “Joint Venture” in Art. 10.1.1 by para. (a), and
therefore ACo is not a “JV Subsidiary” (Art. 10.1.1 definition).
An IIR tax liability of 100 will be imposed on XCo in jurisdiction X.
Question 2
There will be no impact, under the GloBE rules, on any of UPE 3, UPE 4 or UPE 5,
for 2 reasons: (1) YCo is not a Constituent Entity of any of the MNE Groups, as
it is not included in any Group’s consolidated financial statements on a
line-by-line basis (see the definition of “Constituent Entity” in Art. 1.3, and
the definition of “Group” in Art. 1.2); and (2) YCo is not a “Joint Venture”
(Art. 10.1.1 definition) as none of the 3 UPEs has an Ownership Interest of at
least 50%.
Thus, no IIR or UTPR tax liability.
Do you agree?
INTERNATIONAL TAX QUIZ 150
XCo 1 is a company located in jurisdiction X. It has 3 shareholders: UPE 1, UPE
2, and UPE 3 (each of which is a UPE of an MNE Group “in scope” of the GloBE
rules).
XCo 1 has only 1 class of issued shares, which are owned in these percentages:
UPE 1 (50%), UPE 2 (25%), and UPE 3 (25%).
All 3 of the UPEs include XCo 1’s financial results in their consolidated
financial statements under the equity method.
XCo 1 owns 80% of the shares in YCo, a company located in jurisdiction Y. The
other 20% is owned by third parties.
UPE 1 owns 100% of the shares in XCo 2, a Constituent Entity located in
jurisdiction X. UPE 1 does not own any other subsidiaries in X, and UPE 2 & 3
own no subsidiaries in X.
In the current Fiscal Year:
(1) XCo 1 has GloBE Income of 100, and Adjusted Covered Taxes of 10.
(2) XCo 2 has GloBE Income of 100, and Adjusted Covered Taxes of 25.
(3) YCo has GloBE Income of 100, and Adjusted Covered Taxes of 5.
Based on this information, what will be the impact, under the GloBE rules, on
UPE 1, UPE 2, and UPE 3? Please ignore any Additional Current Top-up Tax,
Substance-based Income Exclusion, and/or Qualified Domestic Minimum Top-up Tax.
Answer:
XCo 1 and YCo are not Constituent Entities in the respective MNE Group of UPE 1,
UPE 2 or UPE 3, because none of those UPEs consolidate XCo 1 and YCo on a
line-by-line basis: see Arts. 1.2 & 1.3. Thus, except for the “JV” liability
discussed below, there is no impact, under the GloBE rules, for any of the 3
UPEs.
XCo 1 is a “Joint Venture” (defined in Art. 10.1.1) in regard to UPE 1, which
reports XCo 1’s financial results in its consolidated financial statements under
the equity method, and which holds at least 50% of XCo 1’s “Ownership Interests”
(defined in Art. 10.1.1). I have assumed that XCo 1 is not a UPE of an “in
scope” MNE Group, and is not otherwise excluded from being a “Joint Venture”:
see paras. (a) & (b) of the Art. 10.1.1 definition of “Joint Venture”.
XCo 1 is not a “Joint Venture” in regard to either UPE 2 or UPE 3, because
neither holds at least 50% of XCo 1’s Ownership Interests.
YCo is a “JV Subsidiary” (defined in Art. 10.1.1). XCo 1 and YCo together form a
“JV Group” (Art. 10.1.1 definition).
In accordance with Art. 6.4.1(a), the Top-up Tax of XCo 1 and YCo will be
computed as if they were Constituent Entities of a separate MNE Group and as if
XCo 1 was the UPE of that Group. Importantly, this means that, in computing the
jurisdictional Top-up Tax for jurisdiction X, XCo 1’s numbers are not blended
with XCo 2’s numbers.
Thus: (i) XCo 1’s Top-up Tax is: 5% x 100 = 5; and (ii) YCo’s Top-up Tax is: 10%
x 100 = 10.
UPE 1’s “Allocable Share of the Top-up Tax” (defined in Art. 2.2.1) is: (i) in
regard to XCo 1: 50% x 5 = 2.5; and (ii) in regard to YCo: 50% x 80% x 10 = 4.
Those 2 amounts (2.5 and 4) will be included in UPE 1’s IIR tax: Art. 6.4.1(b).
XCo 2’s numbers will not cause a Top-up Tax liability for UPE 1’s MNE Group.
As noted above, there will be no impact, under the GloBE rules, on either UPE 2
or UPE 3.
Do you agree?
INTERNATIONAL TAX QUIZ 149
XCo is a Constituent Entity located in jurisdiction X, which imposes a corporate
income tax with a 20% rate.
100% of the shares in XCo are owned by X Holdco, which is also located in
jurisdiction X.
XCo is a limited liability company (LLC) formed under jurisdiction X corporate
law.
XCo changes its legal form to a corporation, also under jurisdiction X corporate
law.
LLCs and corporations are both taxable entities for the purposes of the
jurisdiction X corporate income tax, and they are both subject to the 20% rate.
Under the jurisdiction X corporate law, the change in legal form: (1)
automatically causes all of the assets and liabilities of XCo (LLC) to be the
assets and liabilities of XCo (corporation), for no consideration; (2) the
issued shares of XCo (LLC) are automatically treated as the issued shares of XCo
(corporation); and (3) XCo (LLC) and XCo (corporation) are deemed to be the same
legal entity.
The change in legal form does not trigger the recognition of a gain or loss, or
any adjustment to the carrying value of assets and liabilities, in XCo’s
financial statements.
Under the jurisdiction X tax law, the excess of (1) the fair value of XCo’s
assets and liabilities, over (2) the tax basis of the assets and the amount of
the liabilities, at the time of the change in legal form, is treated as a
taxable gain for XCo. That gain is subject to a special tax rate of 10%. Also,
under the jurisdiction X tax law, after the change in legal form, the tax basis
of the assets and the amount of the liabilities, are treated as equal to that
fair value.
What will be impact, under the GloBE rules, of XCo’s change in legal form?
Answer:
1. GloBE Reorganisation:
A threshold issue is whether the change in legal form is a “GloBE
Reorganisation”, as defined in Art. 10.1.1. If it is not a “GloBE
Reorganisation”, then Arts. 6.3.2 & 6.3.3 can be ignored.
The opening words and para. (a) in the definition should be satisfied: the
change in legal form is a “transformation”, and no consideration is provided.
In applying para. (b) to a transformation, the “disposing Constituent Entity”
presumably means XCo (LLC). Para. (b) seems to assume that the disposing
Constituent Entity has a “gain or loss”. However, it’s not clear what the “gain
or loss” in para. (b) is referring to, in the context of a transformation (where
no consideration is provided). As noted in the question, XCo does not record a
gain or loss in its financial statements. Moreover, if XCo does have a “gain”,
the whole of that gain is subject to tax, albeit at a reduced tax rate (10%).
For these reasons, para. (b) is probably not satisfied.
Para. (c) is also probably not satisfied. Although XCo derives a taxable gain on
the transformation, that taxable gain is not a “Non-qualifying Gain or Loss”, as
defined in Art. 10.1.1 – because XCo’s financial accounting gain or loss arising
on the transformation is nil.
Thus, IMHO: the change in legal form is not a “GloBE Reorganisation”.
2. XCo: continuity of identity for GloBE rules
The jurisdiction X corporate law deems XCo (LLC) and XCo (corporation) as the
same legal entity.
The GloBE rules, as implemented in the various jurisdictions where XCo’s MNE
Group has Constituent Entities, should accept that jurisdiction X corporate law
treatment.
3. Adjusted Covered Taxes:
XCo’s Adjusted Covered Taxes will increase (ceteris paribus) in the Fiscal Year
it changes legal form (due to the taxable gain); and will reduce (ceteris
paribus) in subsequent Fiscal Years, due to tax depreciation on a higher tax
basis.
4. GloBE Income:
The impact on GloBE Income will depend on whether an election is made under Art.
6.3.4:
1. If election is not made, then the transformation will have no impact on
XCo’s GloBE Income. Thus, XCo’s ETR will be higher (ceteris paribus) in the
Fiscal Year it changes legal form, and will be lower (ceteris paribus) in
subsequent Fiscal Years.
2. If election is made: (a) a gain is recognised in the Fiscal Year it changes
legal form (equal to the difference between fair value and carrying value
immediately before the change in legal form); and (b) higher amounts of
depreciation will be recognised in subsequent Fiscal Years, due to using
fair value as the new base for depreciation. In regard to (a), the MNE Group
can choose to spread the gain over 5 Fiscal Years.
Do you agree?
INTERNATIONAL TAX QUIZ 148
ACo 1 is located in jurisdiction A, and is a Constituent Entity in MNE Group #
1. ACo 1 owns several businesses.
ACo 2 is also located in jurisdiction A, and is a Constituent Entity in MNE
Group # 2.
ACo 1 sells the assets and liabilities in one of its businesses to ACo 2, for
consideration in 2 parts: (1) shares issued by ACo 2 (70% of the value of the
total consideration); and (2) cash (30% of the value of the total
consideration). The issue of shares by ACo 2 does not cause it to leave MNE
Group # 2 or to join MNE Group # 1.
In ACo 1’s financial statements, it reports a profit on the sale, and it records
the ACo 2 shares according to their value.
In ACo 2’s financial statements, it records the assets and liabilities according
to the value of the consideration it provided to ACo 1.
However, under the jurisdiction A tax law: (i) ACo 1 does not recognize any gain
or loss on the sale; (ii) ACo 1’s basis in the ACo 2 shares is equal to its
basis in the transferred assets (minus the amount of transferred liabilities);
and (iii) ACo 2 inherits ACo 1’s basis in the transferred assets.
How will this transaction be treated under the GloBE rules, for each of ACo 1
and ACo 2?
Answer:
The key question is whether the transaction constitutes a “GloBE
Reorganisation”, as defined in Art. 10.1.1.
There are 2 issues:
(1) First issue
Is the transaction “a transformation or transfer of assets and liabilities such
as in a merger, demerger, liquidation, or similar transaction” (the opening
words in the “GloBE Reorganisation” definition)?
It is not a “transformation”, which (according to the Commentary) refers to a
change in the form of an Entity.
It is a “transfer of assets and liabilities” – but what about “such as in a
merger, demerger, liquidation, or similar transaction”?
As ACo 2 does not change its MNE Group from #2 to #1 (i.e., control does not
change), I think the transaction is not a “merger”. And it’s obviously not a
“liquidation”.
The transaction is possibly a “demerger” of the transferred assets or
liabilities, or a “similar transaction” to such a demerger. Nevertheless, there
is a risk that the opening words are not satisfied.
(2) Second issue
Is “the consideration for the transfer …, in whole or in significant part,
equity interests issued by [ACo 2]” (para. (a) in definition of “GloBE
Reorganisation”)?
Does 70% of the value of the total consideration satisfy the “significant part”
condition? The Commentary provides no guidance on the meaning of “significant
part”.
My personal view is that 70% should satisfy that condition.
(3) Conclusion on “GloBE Reorganisation”
The definition will be satisfied, if the transaction is a “demerger, … or
similar transaction”.
If the transaction is a “GloBE Reorganisation”: (i) ACo 1 will exclude the gain
from its GloBE Income or Loss; and (ii) ACo 2 will use ACo 1’s carrying value of
the transferred assets and liabilities in computing its future GloBE Income or
Loss (Art. 6.3.2).
If the transaction is not a “GloBE Reorganisation”: (i) ACo 1 will include the
gain (generally as reported in its financial statements) in its GloBE Income or
Loss; and (ii) ACo 2 will use the value determined under the relevant accounting
standard, as the carrying value of the transferred assets and liabilities in
computing its future GloBE Income or Loss (Art. 6.3.1).
In both situations: ACo 1 will use the value in its financial statements, as the
carrying value of the shares in ACo 2 in computing its future GloBE Income or
Loss.
Do you agree?
INTERNATIONAL TAX QUIZ 147
XCo (located in jurisdiction X) is a Constituent Entity in an MNE Group, which
is “within scope” of the GloBE rules. The MNE Group uses the calendar year as
its fiscal year.
XCo owns 100% of the shares in YCo, which is located in jurisdiction Y.
On 30 June in year 1, XCo sells 100% of the shares in YCo to ZCo, which is an
unrelated company located in jurisdiction Z. ZCo is a member of a group which is
not an MNE Group “in scope” of the GloBE rules.
The consideration for the sale is in 2 parts: (1) the issue of new shares by ZCo
to XCo (this represents 90% of the value of the total consideration), and (2)
cash (this represents 10% of the value of the total consideration). The issue of
shares does not cause ZCo to become a member of XCo’s MNE Group – i.e., the MNE
Group does not control ZCo.
In XCo’s financial statements, it reports a gain of 100 on the sale of the
shares in YCo. The gain is computed as: value of consideration (300) minus
carrying value of shares in YCo (200) = 100. XCo’s carrying value of the shares
is equal to its tax basis in the shares, for X tax law purposes.
Under the jurisdiction X tax law, XCo recognizes a gain of 10, which represents
the gain referable to the cash component of the consideration. XCo is liable for
jurisdiction X Covered Tax of 2.5 on that gain. The remainder of the gain is
exempt.
Under the jurisdiction Y tax law, the sale of the 100% shares in YCo is treated
as a sale, and re-acquisition, of YCo’s assets and liabilities. The deemed sale
price and the deemed re-acquisition price of the assets are both equal to the
value of the consideration paid to XCo (i.e., 300), plus the value of the
liabilities deemed to be transferred and re-acquired (200) – i.e., total
consideration of 500. At the date of the transaction, YCo has assets with a
carrying value (and tax basis) of 250. The jurisdiction Y corporate income tax
rate of 20% applies to any gain deemed to be derived by YCo.
The jurisdiction Y tax law does not impose any tax on XCo in regard to the sale.
Based on these facts, what are the consequences, under the GloBE rules, for
XCo’s MNE Group? Please assume that XCo’s MNE Group does not make an election
under Art. 6.3.4 in regard to YCo.
Answer:
1. XCo:
XCo’s gain of 100 is excluded from its GloBE Income: Art. 3.2.1(c) (Excluded
Equity Gain or Loss), regardless of the cash element of the consideration.
XCo’s jurisdiction X tax of 2.5 is excluded from its Adjusted Covered Taxes:
Art. 4.1.3(a) (current tax) & Art. 4.4.1(a) (deferred tax).
2. YCo:
A threshold issue is whether Art. 6.2.2 applies to the transfer of shares in
YCo. In particular, who is “the seller” referred to the provision – XCo or YCo?
Strangely, para. 64 in the Commentary suggests that “the seller” (i.e., the
entity on which the jurisdiction Y Covered Tax is imposed) is YCo; but para. 68
in the Commentary suggests that “the seller” is XCo.
If “the seller” is XCo:
1. Art. 6.2.2 will not apply, as jurisdiction Y does not impose a Covered Tax
on XCo.
2. There will be no further impact on XCo’s GloBE rules position.
3. For jurisdiction Y tax purposes, YCo incurs a tax liability of 50 on its
deemed gain of 250. That 50 will likely qualify as Adjusted Covered Taxes.
As there should be no impact in YCo’s financial statements (which are used
for the group consolidation), there should be no impact on YCo’s GloBE
Income. Thus, YCo’s ETR in year 1 will be increased.
If “the seller” is YCo:
1. Art. 6.2.2 will potentially apply, as the jurisdiction Y Covered Tax is
imposed on YCo.
2. But there is another issue with Art. 6.2.2: is it correct that the Covered
Tax of 50 which is imposed on YCo is “based on the difference between the
tax basis and the consideration paid in exchange for the Controlling
Interest or the fair value of the assets and liabilities”? The consideration
paid in exchange for the Controlling Interest is 300, reflecting the value
of the assets minus the liabilities. In contrast, the Covered Tax imposed on
YCo uses total consideration equal to (i) the value of consideration paid to
XCo (300), plus (ii) the value of liabilities deemed to be transferred and
re-acquired (200). Possibly, the total consideration of 500 can be accepted
as corresponding to “the fair value of the assets and liabilities”.
3. Assuming Art. 6.2.2 applies: for purposes of the GloBE rules, the share
transfer will be treated as a disposal and acquisition of YCo’s assets and
liabilities.
4. YCo’s GloBE Income: (i) deemed gain of 250 included in GloBE Income (Art.
6.3.1); (ii) carrying value of assets and liabilities based on 500: para. 72
of Commentary.
5. YCo’s Adjusted Covered Taxes: 50 included.
Regardless of whether Art. 6.2.2 applies: The allocation of YCo’s GloBE Income
and Covered Taxes for year 1 to XCo’s MNE Group must be determined, as the share
transfer will cause YCo to leave the MNE Group during the year. I will leave
that issue for another day!
INTERNATIONAL TAX QUIZ 146
XCo is the UPE of an MNE Group which is “within scope” of the GloBE rules. XCo
and all (except one) of the subsidiaries within the group, are located in
jurisdiction X. Jurisdiction X has not implemented the GloBE rules.
Z Sub is one of XCo’s subsidiaries, and is located in jurisdiction Z. Z Sub owns
IP, which it licenses to third parties in return for royalties. Z Sub has no
employees (it receives services from a sister subsidiary located in jurisdiction
X), and it owns no assets other than the IP. Z Sub is not an Investment Entity.
Jurisdiction Z has implemented the GloBE rules, but it has not implemented a
QDMTT.
In year 1, Z Sub derives 100 of royalties, and incurs an IP amortisation expense
of 18 and intra-group service fees of 2, resulting in a pre-tax profit of 80. Z
Sub qualifies for a tax incentive in jurisdiction Z, which is a corporate income
tax rate of 5%. Z Sub is not subject to any royalty withholding tax in other
jurisdictions.
Ignoring any permanent or timing differences between financial accounting net
income, GloBE Income, and taxable profits in jurisdiction Z, Z Sub has GloBE
Income of 80 in year 1, and Adjusted Covered Taxes of 4 in year 1.
On 30 September in year 2, XCo sells 100% of the shares in Z Sub to YCo, which
is the UPE of another MNE Group which is “within scope” of the GloBE rules. YCo
is located in jurisdiction Y. Although jurisdiction Y has not implemented the
GloBE rules, several jurisdictions where the YCo group has subsidiaries have
done so. Z Sub is the YCo group’s only subsidiary in jurisdiction Z.
YCo records Z Sub’s IP at fair value in its consolidated financial statements
for year 2. That fair value is significantly higher than the carrying value of
the IP in Z Sub’s financial statements.
Assume that, in year 2, Z Sub’s financial statements report the same financial
information as in year 1 – i.e., royalty income of 100, amortisation expense of
18 and intra-group service fees (paid to YCo subsidiaries after 30 September) of
2, pre-tax profits of 80, no royalty withholding tax, jurisdiction Z corporate
income tax rate of 5%. Please ignore any permanent or timing differences between
financial accounting net income, GloBE Income, and taxable profits in
jurisdiction Z. Also assume that both XCo and YCo use the calendar year as the
fiscal year.
Based on this information, will Z Sub have a tax liability under the GloBE rules
in year 1 and/or year 2?
Answer:
1. Year 1
Z Sub is the only member of the XCo MNE Group which is located in jurisdiction
Z.
Jurisdiction Z’s ETR (Art. 5.1.1): 4 / 80 = 5%.
Substance-based Income Exclusion (Art. 5.3): zero (Z Sub has no Eligible
Employees and no Eligible Tangible Assets).
Z Jurisdictional Top-up Tax (assuming no Additional Current Top-up Tax) (Art.
5.2): 80 x 10% = 8.
X has not implemented the GloBE rules, but Z has done so.
Can Z’s UTPR apply to the Z Jurisdictional Top-up Tax?
Except for one issue, the answer is “yes”. But that issue might prevent the UTPR
applying. Art. 2.6.1 allocates the UTPR Top-up Tax Amount to UTPR Jurisdictions,
according to a formula which uses “Number of Employees” and “Total value of
Tangible Assets”. However, Z has zero for both of these items. Specifically, the
formula in Art. 2.6.1, in this case, would be: 50% x 0/0 + 50% x 0/0 – which
presumably is equal to zero!
Therefore, Z Sub should not have a UTPR tax liability in year 1.
2. Year 2
2.1 Preliminary point
Z Sub will be a member of both the XCo Group and the YCo Group in Year 2: Art.
6.2.1(a).
2.2 XCo Group
XCo Group’s status as an MNE Group is dependent on the membership of Z Sub,
which is the only group member which is not located in jurisdiction X: Art.
1.2.1. As Z Sub will be included in XCo’s consolidated financial statements for
Year 2, the XCo Group should retain its status as an MNE Group in Year 2,
despite Z Sub’s departure part-way through the year.
It should be unnecessary to compute the Jurisdictional Top-up Tax for Z for Year
2 – because, just as in year 1, the allocation of the UTPR Top-up Tax Amount to
Z in year 2 should be zero.
Thus, in regard to the XCo Group, Z Sub should not have a UTPR tax liability in
year 2.
2.3 YCo Group
In computing the ETR and Top-up Tax for jurisdiction Z in year 2, YCo Group will
take into account only the Financial Accounting Net Income or Loss and Adjusted
Covered Taxes of Z Sub that are taken into account in YCo’s consolidated
financial statements for year 2: Art. 6.2.1(b).
Accordingly, Z Sub’s GloBE Income should be 20 (i.e., 80 x 3/12) and its
Adjusted Covered Taxes should be 1 (i.e., 4 x 3/12). In computing Z Sub’s GloBE
Income, Z Sub will retain the historical carrying value of the IP – i.e., there
will be no step-up to fair value: Art. 6.2.1(c).
Jurisdiction Z’s ETR should be 1 / 20 = 5%.
Substance-based Income Exclusion (Art. 5.3): zero (Z Sub has no Eligible
Employees and no Eligible Tangible Assets; and the YCo Group has no other
Constituent Entities in Z).
Z Jurisdictional Top-up Tax (assuming no Additional Current Top-up Tax) (Art.
5.2): 20 x 10% = 2.
That Top-up Tax will be allocated, as a UTPR Top-up Tax Amount, to the various
UTPR Jurisdictions in which the YCo Group has members – but not jurisdiction Z.
For the same reason as discussed above, the formula in Art. 2.6.1 should
allocate zero UTPR Top-up Tax Amount to Z.
Thus, in regard to the YCo Group, Z Sub should not have a UTPR tax liability in
year 2.
3. Final answer
Z Sub should not have a UTPR tax liability in either year 1 or year 2.
INTERNATIONAL TAX QUIZ 145
A Group
ACo is the UPE of an MNE Group (“A Group”), which includes XCo (100% subsidiary
of ACo).
ACo is located in jurisdiction A, and XCo is located in jurisdiction X.
Jurisdiction X has implemented the GloBE rules, but jurisdiction A has not.
XCo is the parent of a 100% subsidiary, YCo, which is located in jurisdiction Y.
YCo is the only member of the A Group which is located in Y. Jurisdiction Y has
not implemented the GloBE rules.
A Group uses the calendar year as its fiscal year.
B Group
BCo is the UPE of another MNE Group (“B Group”), which includes YCo 2 (100%
subsidiary of BCo).
BCo is located in jurisdiction B, which has implemented the GloBE rules.
YCo 2 is located in jurisdiction Y – it is the only member of the B Group which
is located in Y.
B Group uses the calendar year as its fiscal year.
Sale of XCo
On 30 September in Year 1, ACo sells 100% of the shares in XCo to BCo.
In the 12 months ending 31 December in Year 1, YCo’s financial accounting net
income is 100 and its Adjusted Covered Taxes are 5. Please assume that there are
no differences between the computation of YCo’s financial accounting net income
and GloBE Income.
In the 12 months ending 31 December in Year 1, YCo 2’s financial accounting net
income is 100 and its Adjusted Covered Taxes are 30. Again, please assume that
there are no differences between the computation of YCo 2’s financial accounting
net income and GloBE Income.
Question
For Year 1, will there be one or more tax liabilities under the GloBE rules in
regard to jurisdiction Y? If yes, which entity or entities will be subject to
the liability or liabilities?
Answer:
Preliminary point
XCo and YCo will be members of both the A Group and the B Group in Year 1: Art.
6.2.1(a).
A Group
In computing the ETR and Top-up Tax for jurisdiction Y in Year 1, A Group will
take into account only the Financial Accounting Net Income or Loss and Adjusted
Covered Taxes of YCo that are taken into account in ACo’s consolidated financial
statements for Year 1: Art. 6.2.1(b).
Accordingly, YCo’s GloBE Income should be 75 (i.e., 100 x 9/12) and its Adjusted
Covered Taxes should be 3.75 (i.e., 5 x 9/12).
Jurisdiction Y’s ETR should be 3.75 / 75 = 5%.
If we ignore the Substance-based Income Exclusion and Additional Current Top-up
Tax, the jurisdictional Top-up Tax for jurisdiction Y should be: 10% x 75 = 7.5.
Jurisdiction A has not implemented the GloBE rules. Thus, the IIR will not be
imposed on ACo.
Assuming XCo is not an Investment Entity, it will qualify as an Intermediate
Parent Entity in regard to YCo: Art. 10.1.1 definition. In accordance with Art.
6.2.1(h) and Art. 2.1.2, an IIR of 7.5 will be imposed on XCo.
B Group
In computing the ETR and Top-up Tax for jurisdiction Y in Year 1, B Group will
take into account only the Financial Accounting Net Income or Loss and Adjusted
Covered Taxes of YCo that are taken into account in BCo’s consolidated financial
statements for Year 1: Art. 6.2.1(b).
Accordingly, YCo’s GloBE Income should be 25 (i.e., 100 x 3/12) and its Adjusted
Covered Taxes should be 1.25 (i.e., 5 x 3/12).
Jurisdiction Y’s Net GloBE Income, aggregate Adjusted Covered Taxes, ETR and
Top-up Tax will need to take into account both YCo and YCo 2.
Net GloBE Income: 25 + 100 = 125
Adjusted Covered Taxes: 1.25 + 30 = 31.25
ETR: 31.25 / 125 = 25%
Thus, if we ignore Additional Current Top-up Tax, jurisdiction Y will have no
Top-up Tax in Year 1.
Final answer
A Group: IIR of 7.5 imposed on XCo.
B Group: no IIR.
2 points to note: (i) For B Group, YCo 2’s high ETR shelters YCo’s low-taxed
profits; and (2) B Group should do its tax due diligence carefully: XCo (which
it purchases) has an IIR liability in regard to A Group.
Do you agree?
INTERNATIONAL TAX QUIZ 144
X Group sells 100% of the shares in ZCo (a Constituent Entity located in
jurisdiction Z) to Y Group. ZCo is not an Investment Entity.
Both groups are MNE Groups “within scope” of the GloBE rules, and both use the
calendar year as the fiscal year.
The sale is effective on 31 May of Year 2.
In its consolidated financial statements for Year 2, X Group reports these 2
items in regard to ZCo: (1) 200 of payroll costs incurred in the 5 months to 31
May; and (2) 50 of depreciation incurred in the 5 months to 31 May. The
depreciation relates to a tangible asset (“asset A”) which has a carrying value
(net of accumulated depreciation) at the start of Year 2 of 240.
In its consolidated financial statements for Year 2, Y Group reports these items
in regard to ZCo: (1) 300 of payroll costs incurred in the 7 months to 31
December; and (2) carrying value of asset A (net of accumulated depreciation for
Y Group’s 7 months of ownership of ZCo) of 350 – this reflects the fair value of
asset A, net of Y Group’s 7 months’ depreciation.
Please assume that: (i) ZCo is the only Constituent Entity in jurisdiction Z for
both groups; (ii) the jurisdiction Z corporate income tax law does not treat the
transfer of shares in ZCo as a transfer of ZCo’s assets and liabilities; (iii)
the payroll costs satisfy the conditions for the payroll carve-out in Art.
5.3.3; and (iv) asset A is an Eligible Tangible Asset and it satisfies the
conditions for the tangible asset carve-out in Art. 5.3.4.
For each of X Group and Y Group, what will be the amount of Substance-based
Income Exclusion for Year 2 for jurisdiction Z?
Answer:
1. X Group:
1.1 Payroll carve-out (Art. 5.3.3 & Art. 6.2.1(d)):
5% x 200 = 10
1.2 Tangible asset carve-out (Art. 5.3.4 & Art. 6.2.1(e)):
Carrying value at start of Year 2 (net of accumulated depreciation): 240
Carrying value at end of Year 2 (for X Group) (net of accumulated depreciation):
240 – 50 =190 (see Example 6.2.1-1 in IF’s Examples document)
Thus, carrying value for Year 2 = (240 + 190) / 2 = 215 (Art. 5.3.5)
Adjusted carrying value under Art. 6.2.1(e): 215 x 5/12 = 89.5833
Tangible asset carve-out: 5% x 89.5833 = 4.4792
1.3 Substance-based Income Exclusion for jurisdiction Z:
10 + 4.4792 = 14.4792
2. Y Group:
2.1 Payroll carve-out (Art. 5.3.3 & Art. 6.2.1(d)):
5% x 300 = 15
2.2 Tangible asset carve-out (Art. 5.3.4 & Art. 6.2.1(e)):
Carrying value at start of Year 2 (for Y Group) (net of accumulated
depreciation): 0
Carrying value at end of Year 2 (net of accumulated depreciation): 350 (step-up
to fair value – see Commentary on Art. 6.2.1(e) and Example 6.2.1-1 in IF’s
Examples document)
Thus, carrying value for Year 2 = (0 + 350) / 2 = 175 (Art. 5.3.5)
Adjusted carrying value under Art. 6.2.1(e): 175 x 7/12 = 102.0833
Tangible asset carve-out: 5% x 102.0833 = 5.1042
2.3 Substance-based Income Exclusion for jurisdiction Z:
15 + 5.1042 = 20.1042
Do you agree?
INTERNATIONAL TAX QUIZ 143
ACo Group (with ACo as its parent company) and BCo Group (with BCo as its parent
company) are not under common control. Neither Group has ever been “within
scope” of the GloBE rules.
The 2 Groups report these consolidated revenues in Years 1 to 4 (all in EUR
millions):
* Year 1:
* ACo Group: 450 (including revenue of 150 from sales to BCo Group)
* BCo Group: 350
* Year 2:
* ACo Group: 300
* BCo Group: 400
* Year 3:
* ACo Group: 300
* BCo Group: 420
* Year 4:
* ACo Group: 360
* BCo Group: 500
At the start of Year 5, ACo acquires all of the shares in BCo, for cash
consideration.
In Year 5, the ACo Group reports consolidated revenue of EUR 900 million.
At the start of Year 6, ACo distributes all of the shares in BCo, to ACo’s
shareholders.
In Year 6:
* ACo Group reports consolidated revenue of EUR 200 million
* BCo Group reports consolidated revenue of EUR 760 million
Based on these facts, is the ACo Group and/or the BCo Group “within scope” of
the GloBE rules in Years 1 to 6?
Answer :
(1) Years 1 to 4:
Neither ACo Group nor BCo Group is “within scope” of the GloBE rules because
neither group satisfies the consolidated revenue threshold test in those years:
Art. 1.1.1.
(2) Year 5:
ACo’s acquisition of all of the shares in BCo qualifies as a “merger”, as
defined in Art. 6.1.2(b), despite the fact that the acquisition was for cash
consideration: see Commentary.
Thus, Art. 6.1.1(b) will apply to amend the consolidated revenue threshold test
in Art. 1.1, for Years 1 to 4. Under that amended test, the separate
consolidated revenues of the ACo Group and the BCo Group for Years 1 to 4 are
aggregated (“the sum”). Importantly, the ACo Group revenue of 150 from sales to
the BCo Group in Year 1 is not ignored. Thus, the aggregate revenues are: Year
1: 800; Year 2: 700; Year 3: 720; and Year 4: 860.
Accordingly, the ACo Group will satisfy the “at least 2 years out of the
previous 4 years” amended consolidated revenue threshold test (in Years 1 and
4), and therefore the ACo Group will be “within scope” of the GloBE rules in
Year 5.
(3) Year 6:
ACo’s distribution of all of the shares in BCo, to ACo’s shareholders, qualifies
as a “demerger”, as defined in Art. 6.1.3.
A pre-condition to apply Art. 6.1.1(c) is that there is a single MNE Group which
is “within scope” of the GloBE rules. According to the Commentary, the single
MNE Group must be “within the scope of the GloBE Rules in the Fiscal Year that
the demerger takes place”. That means Year 6. Under the amended consolidated
revenue threshold test (see above), the ACo Group would satisfy the “at least 2
years out of the previous 4 years” standard, in Years 4 & 5.
Subpara. (i) of Art. 6.1.1(c) will apply a consolidated revenue threshold test
to each of the 2 demerged Groups (ACo Group and BCo Group), by considering only
the consolidated revenue of that demerged Group in Year 6. BCo Group will
satisfy this test (i.e., 760). However, the ACo Group will not satisfy the test
(i.e., 200).
Thus, in Year 6, the BCo Group will be “within scope” of the GloBE rules, but
the ACo Group will not.
You will notice that Art. 6.1.1(c) treats the ACo Group in Year 6 differently
(a) before the demerger (when the ACo Group is required to be “within scope”, as
a pre-condition for Art. 6.1.1(c) to apply); and (b) after the demerger (when
the demerged ACo Group has been found to be not “within scope”).
(4) Final answer:
Years 1 to 4: neither Group is “within scope”
Year 5: ACo Group is “within scope”
Year 6: BCo Group is “within scope”
Do you agree?
INTERNATIONAL TAX QUIZ 142
ACo is the only Constituent Entity (within an in-scope MNE Group) which is
located in jurisdiction A. The Fiscal Year for the MNE Group is the calendar
year. The MNE Group has Constituent Entities which are located in 10
jurisdictions.
Jurisdiction A imposes a corporate income tax with a 10% rate.
In 2023:
* ACo incurs a tax loss (for jurisdiction A corporate income tax purposes) of
100, which it can carry forward indefinitely
* If the GloBE rules were applicable to ACo in 2023, ACo would have incurred a
GloBE Loss of 70 in 2023. The difference between the tax loss (100) and the
notional GloBE Loss (70) is due to a “double deduction” for certain
expenditure, which is allowed under the jurisdiction A corporate income tax
law
* The GloBE rules are not effective, in 2023, in any jurisdiction where the MNE
Group operates
In 2024:
* ACo derives taxable income (for jurisdiction A corporate income tax purposes)
of 100, before deducting (in full) the carry-forward tax loss
* If the GloBE rules were applicable to ACo in 2024, ACo would have derived
GloBE Income of 100 in 2024
* The GloBE rules are effective in jurisdiction B, from the start of 2024. The
MNE Group includes BCo, a Constituent Entity which is located in jurisdiction
B (BCo does not own, directly or indirectly, any shares in ACo)
* The GloBE rules are not effective, in 2024, in any other jurisdiction where
the MNE Group operates
In 2025:
* ACo derives taxable income (for jurisdiction A corporate income tax purposes)
of 100
* If the GloBE rules were applicable to ACo in 2025, ACo would have derived
GloBE Income of 100 in 2025
* The GloBE rules are effective in jurisdiction U (where the UPE is located),
from the start of 2025
* The GloBE rules are not effective, in 2025, in any jurisdiction where the MNE
Group operates, other than jurisdictions B and U
Based on these facts, and ignoring the Substance-based Income Exclusion and
Qualified Domestic Minimum Top-up Tax, does ACo have Top-up Tax in 2023, 2024 or
2025?
Answer:
(1) Introduction:
The GloBE rules are first effective, in any jurisdiction where the MNE Group
operates, in 2024 – i.e., in jurisdiction B.
Therefore, 2024 is the “Transition Year” (defined in Art. 10.1.1) for the MNE
Group, in regard to all jurisdictions (including jurisdiction A) where the MNE
Group operates in 2024.
Thus, ACo’s deferred tax balances at the beginning of 2024 must be determined:
Art. 9.1.1.
(2) 2023:
No Top-up Tax in 2023.
(3) 2024:
The first step is to determine the opening balance in the deferred tax asset for
the 2023 tax loss. Prima facie, the deferred tax asset = 100 x 15% = 15 (with
15% recast: Art. 9.1.1). However, under Art. 9.1.2, 30 of the tax loss (i.e.,
the amount which is referable to the “double deduction” for certain
expenditure), is excluded. Thus, the opening deferred tax asset is: 70 x 15% =
10.5
Next, the Adjusted Covered Taxes, ETR and Top-up Tax are calculated:
* Adjusted Covered Taxes: 0 (current tax expense) + 10.5 (Total Deferred Tax
Adjustment Amount – i.e., reversal of deferred tax asset) = 10.5
* GloBE Income: 100
* ETR: 10.5 / 100 = 10.5%
* Top-up Tax: 4.5% x 100 = 4.5 – which would be imposed in jurisdiction B as
UTPR.
(4) 2025:
* Adjusted Covered Taxes: 10 (current tax expense) + 0 (Total Deferred Tax
Adjustment Amount) = 10
* GloBE Income: 100
* ETR: 10 / 100 = 10%
* Top-up Tax: 5% x 100 = 5 – which would be imposed in jurisdiction U as IIR
(nil would be imposed in jurisdiction B as UTPR: Art. 2.5.2).
Do you agree?
INTERNATIONAL TAX QUIZ 141
XCo is a Constituent Entity in an MNE Group, which is “within scope” of the
GloBE rules.
XCo is located in jurisdiction X, which levies a corporate income tax. XCo is
the only Constituent Entity located in jurisdiction X.
In Year 1:
1. XCo purchases (at the start of Year 1) a fixed asset for 150, which it
depreciates for financial accounting purposes at 10% per annum, and which it
depreciates for X corporate income tax purposes at 20% per annum
2. XCo has GloBE Income of 100, after expensing 15 of depreciation for the
fixed asset
3. XCo has taxable income (for the purposes of X corporate income tax) of 50,
after deducting 30 of depreciation for the fixed asset
4. XCo has no other temporary differences between its financial accounting
pretax profit and taxable income
5. The X corporate income tax rate is 25%
In Year 2:
1. XCo has GloBE Income of 220, after expensing 15 of depreciation for the
fixed asset
2. XCo has taxable income of 80, after deducting 30 of depreciation for the
fixed asset
3. XCo has no other temporary differences between its financial accounting
pretax profit and taxable income
4. Jurisdiction X increases its corporate income tax rate to 30% (effective in
Year 2)
Based on these facts, what amounts of Top-up Tax (if any) does XCo have in each
of Years 1 and 2?
Please assume that jurisdiction X has no Substance-based Income Exclusion and no
Qualified Domestic Minimum Top-up Tax.
Answer:
Year 1:
1. Current tax expense: 50 x 25% = 12.5
2. Total Deferred Tax Adjustment Amount: 15 x 15% = 2.25 (i.e., recast at 15%,
no adjustments or exclusions are relevant) (Art. 4.4.1)
3. Adjusted Covered Taxes: 12.5 + 2.25 = 14.75 (Art. 4.1.1)
4. ETR: 14.75 / 100 = 14.75% (Art. 5.1.1)
5. Top-up Tax: 0.25% x 100 = 0.25 (Art. 5.2.3)
Year 2:
1. Current tax expense: 80 x 30% = 24
2. Total Deferred Tax Adjustment Amount: 15 x 15% = 2.25 (again, recast at 15%,
no adjustments or exclusions are relevant) (Art. 4.4.1)
3. Adjusted Covered Taxes: 24 + 2.25 = 26.25 (Art. 4.1.1)
4. ETR: 26.25 / 220 = 11.9318% (Art. 5.1.1)
5. Top-up Tax: 3.0682% x 220 = 6.75 (Art. 5.2.3)
Final answer:
Top-up tax: 0.25 (Year 1) and 6.75 (Year 2), despite fact that jurisdiction X’s
corporate income tax rate is 25% in Year 1 and 30% in Year 2 – the power of
permanent differences!
INTERNATIONAL TAX QUIZ 140
XCo is the only Constituent Entity (within an “in-scope” MNE Group), which is
located in jurisdiction X.
Jurisdiction X’s corporate income tax has a 10% rate and allows the carry back
of tax losses.
In Year 1, XCo derives:
* GloBE Income: 100
* Taxable profits: 100
In Year 2, XCo incurs:
* GloBE Loss: 80
* Tax loss: 100
XCo carries back all of the Year 2 tax loss to apply against the Year 1 taxable
profits.
What amounts of Top-up Tax (if any) will arise for XCo in Year 1 and Year 2?
Answer:
(1) Year 1 (before tax loss carried back):
GloBE Income: 100
Taxable profits: 100
Current tax expense: 10
Total Deferred Tax Adjustment Amount: nil
Adjusted Covered Taxes: 10
ETR: 10 / 100 = 10%
Top-up Tax: 5
(2) Year 2 (before tax loss carried back):
GloBE Loss: 80
Tax loss: 100
Current tax: nil
Total Deferred Tax Adjustment Amount: (80 x 15%) + (20 x 10%) = (14) (i.e.,
deferred tax asset for tax loss at 10% rate, increased to 15% rate to the extent
of GloBE Loss of 80: Art. 4.4.2(c), Art. 4.4.3)
Adjusted Covered Taxes: (14)
As no GloBE Income, there is no ETR (Art. 5.1.1), and thus no Top-up Tax
Percentage (Art. 5.2.1)
Expected Adjusted Covered Taxes (defined in Art. 4.1.5): 80 x 15% = (12)
Thus, Additional Current Top-up Tax: (12) – (14) = 2 (Art. 4.1.5)
Thus, Top-up Tax: 2
(3) Year 1 (after tax loss carried back):
GloBE Income: 100
Taxable profits: nil
Current tax expense: nil (or Reduction to Covered Taxes under Art. 4.1.3(c))
Total Deferred Tax Adjustment Amount: 14
(Amended) Adjusted Covered Taxes: 14
As this is an increase of 4 in Adjusted Covered Taxes, Art. 4.6.1 directs that
this be treated as an adjustment to Covered Taxes in Year 2.
Accordingly, Top-up Tax of 5 in Year 1 remains.
(4) Year 2 (after tax loss carried back):
In Year 2, 4 is added to Adjusted Covered Taxes, which become (10) (i.e., (14) +
4 = (10))
This will cause the Additional Current Top-up Tax in Year 2 to reduce to nil,
because the (amended) Adjusted Covered Taxes are not less than the Expected
Adjusted Covered Taxes.
Thus, (amended) Top-up Tax: nil
(5) Final answer:
Year 1: Top-up Tax = 5
Year 2: Top-up Tax = nil
Do you agree?
INTERNATIONAL TAX QUIZ 139
BCo is the only Constituent Entity (within an “in-scope” MNE Group) which is
located in jurisdiction B.
The jurisdiction B corporate income tax has a 15% rate and allows the indefinite
carryforward of tax losses.
In Year 1, BCo incurs:
* GloBE Loss of 100,
* Pre-tax accounting loss of 100 in its financial statements, and
* Tax loss of 150
For financial accounting purposes, BCo does not recognise a deferred tax asset.
The difference of 50 between the pre-tax accounting loss and the tax loss is due
to a permanent difference: 200% deductions for certain expenses.
In Year 2, BCo derives:
* GloBE Income of 150,
* Pre-tax accounting profit of 150 in its financial statements, and
* Taxable profits of 150 (before deduction of the carried forward tax loss)
Jurisdiction B has no Substance-based Income Exclusion and no Qualified Domestic
Minimum Top-up Tax in either Year 1 or Year 2.
What amounts of Top-up Tax (if any) will arise for jurisdiction B in Year 1 and
Year 2?
Answer:
Year 1
Current tax expense: nil
Total Deferred Tax Adjustment Amount, after applying Art. 4.4.2(c): (150) x 15%
= (22.5)
Adjusted Covered Taxes: (22.5)
No ETR, as no GloBE Income (Art. 5.1)
Expected Adjusted Covered Taxes (defined in Art. 4.1.5): (100) x 15% = (15)
Additional Current Top-up Tax: (15) – (22.5) = 7.5 (Art. 4.1.5)
Thus, Jurisdictional Top-up Tax (Art. 5.2.3): 0 + 7.5 – 0 = 7.5
Year 2
Current tax expense: nil
Total Deferred Tax Adjustment Amount: 22.5
Adjusted Covered Taxes: 22.5
ETR: 22.5 / 150 = 15%
Top-up Tax: nil
Final answer
7.5 (Year 1) + 0 (Year 2)
INTERNATIONAL TAX QUIZ 138
ACo is the only Constituent Entity (within an “in-scope” MNE Group) which is
located in jurisdiction A.
The jurisdiction A corporate income tax has a 5% standard rate and allows the
indefinite carryforward of tax losses.
In Year 1, ACo incurs:
* GloBE Loss of 100,
* Pre-tax accounting loss of 100 in its financial statements, and
* Tax loss of 100
For financial accounting purposes, ACo does not recognise a deferred tax asset.
In Year 2, ACo derives:
* GloBE Income of 100,
* Pre-tax accounting profit of 100 in its financial statements, and
* Taxable profits of 100 (before deduction of the carried forward tax loss)
Jurisdiction A has no Substance-based Income Exclusion and no Qualified Domestic
Minimum Top-up Tax, in either Year 1 or Year 2.
What amounts of Top-up Tax (if any) will arise for jurisdiction A in Year 1 and
Year 2?
Answer:
If the MNE Group does not make a Group Loss Election under Art. 4.5:
Year 1:
Due to the GloBE Loss, jurisdiction A has no ETR (Art. 5.1) and no Top-up Tax
computed under Art. 5.2.
ACo’s Adjusted Covered Taxes:
1. Current tax: nil
2. Total Deferred Tax Adjustment Amount (after 15% recast and applying Art.
4.4.2(c)): (15)
3. Total Adjusted Covered Taxes: (15)
Expected Adjusted Covered Taxes Amount (defined in Art. 4.1.5) is (15).
Thus, Art. 4.1.5 does not apply to determine an amount of Addtional Current
Top-up Tax.
Therefore, no Top-up Tax in Year 1.
Year 2:
ACo’s Adjusted Covered Taxes:
1. Current tax: nil
2. Total Deferred Tax Adjustment Amount: 15
3. Total Adjusted Covered Taxes: 15
GloBE Income: 100
ETR: 15 / 100 = 15%
Thus, no Top-up Tax in Year 2.
If the MNE Group makes a Group Loss Election under Art. 4.5:
Year 1:
Due to the GloBE Loss, jurisdiction A has no ETR (Art. 5.1) and no Top-up Tax
computed under Art. 5.2.
ACo’s Adjusted Covered Taxes:
1. Current tax: nil
2. Total Deferred Tax Adjustment Amount: nil (Art. 4.4 rules do not apply)
3. Total Adjusted Covered Taxes: nil
Expected Adjusted Covered Taxes Amount (defined in Art. 4.1.5) is (15).
Thus, Art. 4.1.5 does not apply to determine an amount of Additional Current
Top-up Tax.
Therefore, no Top-up Tax in Year 1.
Also, under Art. 4.5.1, jurisdiction A has a GloBE Loss Deferred Tax Asset = 15.
Year 2:
All 15 of the GloBE Loss Deferred Tax Asset is used in Year 2 (Art. 4.5.3).
That causes ACo to have an addition of 15 to Covered Taxes in Year 2 (Art.
4.1.2(b)).
ACo’s Adjusted Covered Taxes:
1. Current tax: nil
2. Total Deferred Tax Adjustment Amount: nil
3. Addition to Covered Taxes (Art. 4.1.2(b)): 15
4. Total Adjusted Covered Taxes: 15
GloBE Income: 100
ETR: 15 / 100 = 15%
Thus, no Top-up Tax in Year 2.
INTERNATIONAL TAX QUIZ 137
ACo, a company located in jurisdiction A, is a Constituent Entity in a “within
scope” MNE Group.
ACo is a special purpose company which has been formed to undertake a large
construction project in jurisdiction A.
The project is expected to produce total pretax accounting profits and taxable
income of 10,000 over its 10 years duration (i.e., Years 1 to 10).
For financial accounting purposes, ACo recognizes profit on a “percentage of
completion” (POC) basis. Under the POC basis, ACo expects to recognize 1,000 of
pretax profit in each of Years 1 to 10.
For jurisdiction A corporate income tax purposes, profit on long-term projects
is recognized on a “completed contract” (CC) basis. Under the CC basis, ACo
expects to recognize no taxable income in each of Years 1 to 9, but it will
recognize 10,000 of taxable income in Year 10.
The jurisdiction A corporate income tax rate is 15%.
In each year, ACo’s GloBE Income is equal to its financial accounting pretax
profit.
Q1: What amounts of Top-up Tax (if any) will be triggered in each of Years 1 to
10?
Q2: Would your answer to Q1 be different if the MNE Group made an election under
Article 4.4.7 for each of Years 1 to 4?
Answer:
Q1:
Year 1: (a) GloBE Income (GI): 1,000; (b) Current tax (CT): nil; (c) Deferred
tax (Total Deferred Tax Adjustment Amount under Art. 4.4.1) (DT): 150; (d)
Recaptured deferred tax (Art. 4.4.4) (RDT): (150); (e) Adjusted Covered Tax
(ACT): nil; (f) ETR: 0% (g) Top-up Tax (Additional Current Top-up Tax in Year
6): 150.
Year 2: (a) GI: 1,000; (b) CT: nil; (c) DT: 150; (d) RDT: (150); (e) ACT: nil;
(f) ETR: 0%; (g) Top-up Tax (Additional Current Top-up Tax in Year 7): 150.
Year 3: (a) GI: 1,000; (b) CT: nil; (c) DT: 150; (d) RDT: (150); (e) ACT: nil;
(f) ETR: 0%; (g) Top-up Tax (Additional Current Top-up Tax in Year 8): 150.
Year 4: (a) GI: 1,000; (b) CT: nil; (c) DT: 150; (d) RDT: (150); (e) ACT: nil;
(f) ETR: 0%; (g) Top-up Tax (Additional Current Top-up Tax in Year 9): 150.
For each of Years 5 to 9: (a) GI: 1,000; (b) CT: nil; (c) DT: 150; (d) RDT: nil;
(e) ACT: 150; (f) ETR: 15%; (g) Top-up Tax: nil.
Year 10: (a) GI: 1,000; (b) CT: 1,500; (c) DT: (1,350); (d) RDT: nil; (e) ACT:
150; (f) ETR: 15%; (g) Top-up Tax: nil.
Thus, total tax paid = (1) Jurisdiction A tax: 1,500 + (2) Top-up Tax: 600 =
2,100
Effective tax rate: 2,100 / 10,000 = 21%
Q2:
Assuming an Art. 4.4.7 election is validly made in respect of each of Years 1 to
4 …
For each of Years 1 to 4: (a) GI: 1,000; (b) CT: nil; (c) DT: nil (see Note 1
below); (d) RDT: nil; (e) ACT: nil; (f) ETR: 0%; (g) Top-up Tax: 150.
For each of Years 5 to 9: (a) GI: 1,000; (b) CT: nil; (c) DT: 150; (d) RDT: nil;
(e) ACT: 150; (f) ETR: 15%; (g) Top-up Tax: nil.
Year 10: (a) GI: 1,000; (b) CT: 1,500; (c) DT: (750) (see Note 2 below); (d)
RDT: nil; (e) ACT: 750; ETR: 75%; (g) Top-up Tax: nil.
Note 1: By virtue of the Art. 4.4.7 elections (assuming they are valid), the
increase in deferred tax liability is excluded from the Total Deferred Tax
Adjustment Amount. In regard to validity, note that Art. 4.4.7 refers to “paid”,
not “reversed”!
Note 2: In Year 10, there should be 2 movements in the Total Deferred Tax
Adjustment Amount: (i) reduction of 1,350 as the deferred tax liability in the
financial accounts reverses; and (ii) increase of 600 under Art. 4.4.2(a) (see
Note 3 below). These 2 movements result in a net reduction of 750.
Note 3: Art. 4.4.2(a) refers to “paid”, not “reversed”.
Thus, total tax paid = (1) Jurisdiction A tax: 1,500 + (2) Top-up Tax: 600 =
2,100
Effective tax rate: 2,100 / 10,000 = 21%
Do you agree? In particular, do you agree (in Year 2) with the net reduction of
750 in the Total Deferred Tax Adjustment Amount?
INTERNATIONAL TAX QUIZ 136
XCo is a Constituent Entity in an MNE Group, which is “within scope” of the
GloBE rules.
XCo is located in jurisdiction X, which levies a corporate income tax.
In Year 1:
* XCo purchases (at the start of Year 1) a fixed asset for 100, which it
depreciates for financial accounting purposes at 50% per annum, and which it
claims as a 100% deduction for income tax purposes in Year 1
* XCo has GloBE Income of 500, after expensing 50 of depreciation for the fixed
asset
* XCo has taxable income (for the purposes of X corporate income tax) of 470,
after deducting 100 for the fixed asset
* XCo has no other temporary differences between its financial accounting
pretax profit and taxable income
* The X corporate income tax has a nominal rate of 25%
In Year 2:
* XCo has GloBE Income of 620, after expensing 50 of depreciation for the fixed
asset
* XCo has taxable income of 580
* XCo has no other temporary differences between its financial accounting
pretax profit and taxable income
* Jurisdiction X increases its corporate income tax nominal rate to 30%
(effective in Year 2)
Based on these facts, what are XCo’s Adjusted Covered Taxes and ETR in Years 1
and 2?
Answer:
Year 1:
* Current tax expense: 470 x 25% = 117.5
* Deferred tax expense (financial accounting): 50 x 25% = 12.5
* Total Deferred Tax Adjustment Amount (Art. 4.4.1): 50 x 15% = 7.5 (i.e.,
recast at 15%, no adjustments and no exclusions are relevant)
* Adjusted Covered Taxes: 117.5 + 7.5 = 125
* ETR: 125 / 500 = 25%
Year 2:
* Current tax expense: 580 x 30% = 174
* Total Deferred Tax Adjustment Amount (Art. 4.4.1): (7.5) (i.e., change in X
tax rate is ignored: Art. 4.4.1(d))
* Adjusted Covered Taxes: 174 + (7.5) = 166.5
* ETR: 166.5 / 620 = 26.85%
Do you agree?
INTERNATIONAL TAX QUIZ 135
The UPE of an MNE Group is a sovereign wealth fund which is 100% owned by the
government of jurisdiction U. The UPE’s principal purpose is to invest the
government’s assets through the making and holding of share investments. The UPE
does not carry on a trade or business.
The MNE Group is within scope of the GloBE rules.
The UPE owns 70% of the shares in UCo, a company located in jurisdiction U. The
other 30% is owned by third parties. UCo carries on a manufacturing business.
The UPE also owns 90% of the shares in ACo 1, a company located in jurisdiction
A. The other 10% is owned by third parties.
ACo 1’s only assets are shares in other companies. The shares are held by ACo 1
as long-term investments. None of those other companies is an Investment Entity
(defined in Art. 10.1.1).
ACo 1 owns 100% of the shares in ACo 2, a company which is also located in
jurisdiction A. ACo 2 carries on a manufacturing business.
ACo 1 also owns 90% of the shares in BCo 1, a company located in jurisdiction B.
The other 10% is owned by third parties. BCo 1’s only assets are shares in other
companies. The shares are held by BCo 1 as long-term investments. None of those
other companies is an Investment Entity (defined in Art. 10.1.1).
BCo 1 owns 100% of the shares in BCo 2, a company which is also located in
jurisdiction B. BCo 2 carries on a goods trading business.
All shares in all companies are common shares, with equal right to profit
distributions and capital.
All of the above-mentioned jurisdictions have implemented the GloBE rules.
In the current Fiscal Year, there are amounts of Jurisdictional Top-up Tax in
both jurisdiction A and jurisdiction U.
Which company or companies (if any) within the MNE Group will be subject to IIR
tax or UTPR tax?
Answer:
UPE should satisfy the definition of “Governmental Entity” (Art. 10.1.1), and it
should therefore be an “Excluded Entity” (Art. 1.5.1). UPE should therefore be
exempt from the GloBE rules (Art. 1.1.3).
ACo 1 should satisfy the definition of “Excluded Entity” in Art. 1.5.2(b):
substantially all of its income should be Excluded Dividends or Excluded Equity
Gain or Loss. ACo 1 should therefore be exempt from the GloBE rules (Art.
1.1.3).
BCo 1 does not satisfy the definition of “Excluded Entity” in Art. 1.5.2(b),
despite the fact that its only assets are shares in other companies, and those
shares are held as long-term investments. BCo 1 does not satisfy the “at least
85%” test: UPE’s proportionate interest in BCo 1 is 81%. Note that the “at least
85%” test measures the UPE’s interest, not ACo 1’s interest, in BCo 1. BCo 1 is
therefore not exempt from the GloBE rules.
ACo 2, BCo 2 and UCo are also not exempt from the GloBE rules.
In regard to the total Top-up Tax from jurisdictions A and U: (1) no IIR tax
will apply; (2) UTPR tax will be allocated to jurisdictions A, B, and U (the
allocation will be in accordance with the formula in Art. 2.6.1).
The UTPR tax (i) which is allocated to A will be imposed on ACo 2 (as ACo 1 is
exempt from the GloBE rules); (ii) which is allocated to B will be imposed on
BCo 1 and/or BCo 2, in accordance with the jurisdiction B law; and (iii) which
is allocated to U will be imposed on UCo (as UPE is exempt from the GloBE
rules).
Do you agree?
INTERNATIONAL TAX QUIZ 134
A Real Estate Investment Trust (REIT), located in jurisdiction X, is the UPE of
an MNE Group which is “within scope” of the GloBE rules. The REIT is in the form
of a unit trust.
The REIT is widely-held by unconnected investors (unitholders). One of those
investors is a pension fund, which is also located in jurisdiction X. Most of
the REIT’s assets are in the form of shares in land-rich companies (i.e.,
companies whose assets predominantly consist of immovable property) – these
companies are located in X and other jurisdictions.
Under the X income tax law:
* The REIT is exempt from taxation on all of its taxable profits, provided it
distributes to its unitholders, within 12 months of its year-end, 100% of its
taxable profits.
* The unitholders are generally subject to tax on distributions from the REIT,
regardless of whether they are resident in X or not.
* However, the pension fund is tax-exempt on all income – this includes the
distributions from the REIT.
The GloBE rules have been implemented in jurisdiction X.
If one or more of the Constituent Entities within the REIT’s MNE Group have a
Top-up Tax, will the REIT be subject to an IIR tax?
Answer:
If the REIT qualifies as an “Excluded Entity”, then it will be exempt from IIR
tax: Art. 1.1.3.
The REIT might qualify as an “Excluded Entity” under either para. (e) or para.
(f) of Art. 1.5.1.
I will consider para. (f) first.
Para. (f) applies to a Real Estate Investment Vehicle that is a UPE.
The definition of “Real Estate Investment Vehicle” in Art. 10.1.1 contains 3
conditions, all of which must be satisfied: (1) “the taxation of [the Entity]
achieves a single level of taxation either in its hands or in the hands of its
interest holders (with at most one year of deferral)”; (2) “[the Entity] holds
predominantly immovable property”; and (3) “[the Entity] is itself widely held”.
Based on the facts, condition (3) is satisfied.
Condition (1): The fact that a tax-exempt pension fund is a unitholder in the
REIT would appear to cause condition (1) to be failed, even if the REIT
distributes all of its taxable profits within 12 months of its year-end.
However, the Commentary states that that would not be the case, if the pension
fund satisfies the definition of “Pension Fund” in Art. 10.1.1.
Condition (2): The Commentary states that the holding of securities the value of
which is linked to immovable property, qualifies as the holding of immovable
property for the purposes of condition (2). Thus, condition (2) should be
satisfied in this situation.
Therefore, the REIT should satisfy the definition of “Real Estate Investment
Vehicle” (if it distributes 100% of its taxable profits within 12 months of its
year-end), and accordingly (in that situation) it should be an “Excluded Entity”
under para. (f) of Art. 1.5.1, and thus be exempt from IIR tax.
Alternatively, if the REIT does not satisfy the definition of “Real Estate
Investment Vehicle”, it might qualify as an “Excluded Entity” under para. (e) of
Art. 1.5.1. Para. (e) refers to an Investment Fund that is a UPE. The term,
“Investment Fund”, is defined in Art. 10.1.1. An investment fund which is
focused on the real estate sector can satisfy that definition. However, based on
the facts in the question, it is not possible to conclude whether the particular
REIT in the question satisfies the definition.
Do you agree?
INTERNATIONAL TAX QUIZ 133
ACo, a company located in jurisdiction A, is the parent company of an MNE Group.
The Group includes subsidiaries in several other jurisdictions.
Jurisdiction A has implemented the GloBE rules. A’s implementing legislation
uses the Euro.
ACo prepares Euro-denominated consolidated financial statements for the Group,
in accordance with an Acceptable Financial Accounting Standard (defined in Art.
10.1.1).
ACo’s consolidated financial statements reported these amounts of revenue in the
previous 4 Fiscal Years and the current Fiscal Year (defined in Art. 10.1.1):
* Fiscal Year 1: EUR 700 million
* Fiscal Year 2: EUR 600 million
* Fiscal Year 3: EUR 740 million
* Fiscal Year 4: EUR 760 million
* Fiscal Year 5 (current year): EUR 720 million
All of these Fiscal Years were 12 months in duration, except Fiscal Year 2 which
was 9 months (due to a change in year-end).
For many years, 60% of the shares in ACo have been owned by the B Family Trust,
which is a trust created in jurisdiction X. The trustee and beneficiaries of the
trust are members of the B family, who all reside in X. The remaining 40% of the
shares in ACo are owned by third parties.
Jurisdiction X has not implemented the GloBE rules. Although the trust law of X
requires simple accounting records to be kept by all trusts created in X,
consolidated financial statements are not required. Consequently, the B Family
Trust has not prepared consolidated financial statements.
Q1: For Fiscal Year 5, do the GloBE rules apply to the companies within the ACo
Group?
Q2: If the answer to Q1 is “yes”, will the IIR apply to ACo?
Answer:
Q1:
The B Family Trust is an “Entity”, as defined in para. (b) of Art. 10.1.1.
The B Family Trust would be the UPE of the MNE Group: Art. 1.4.1(a). In
particular, the B Family Trust would own a “Controlling Interest” in ACo, under
para. (b) of the definition of “Controlling Interest” in Art. 10.1.1.
Accordingly, the revenue threshold test in Art. 1.1.1 must be applied to the B
Family Trust’s “Consolidated Financial Statements”, which would be the deemed
consolidated financial statements in para. (d) of the definition in Art. 10.1.1.
Before doing so, we need to adjust the revenue threshold for Fiscal Year 2, to
take into account the 9 months accounting period: Art. 1.1.2. The adjusted
threshold would be EUR 562.5 million (i.e., 750 million x 75%).
The revenue threshold would therefore be satisfied in Fiscal Years 2 and 4: Art.
1.1.1.
Accordingly, the GloBE rules would apply to the companies within the ACo Group
(i.e., the B Family Trust MNE Group) in Fiscal Year 5, despite the fact that the
revenue threshold is not satisfied in Fiscal Year 5 itself.
Q2:
Although the B Family Trust is the UPE of the MNE Group, the IIR will not apply
to the B Family Trust because jurisdiction X has not implemented the GloBE
rules.
ACo would be an Intermediate Parent Entity, and therefore it would be subject to
the IIR in jurisdiction A: Art. 2.1.2. Art. 2.1.3(a) is not applicable, as the
IIR does not apply to the UPE.
Do you agree?
INTERNATIONAL TAX QUIZ 132
ACo, located in jurisdiction A, is the UPE of an MNE Group.
ACo owns 100% of the shares in BCo (located in jurisdiction B) and 100% of the
shares in CCo (located in jurisdiction C). None of ACo, BCo or CCo is an
Investment Entity or a Flow-through Entity.
Jurisdictions B and C have implemented the GloBE rules, but jurisdiction A has
not. None of the 3 jurisdictions has implemented a Qualified Domestic Minimum
Top-up Tax.
For the current year:
* A is a Low-Tax Jurisdiction, with a Top-up Tax of 300. ACo has revenue of 700
and deductions of 450, giving taxable profits of 250. ACo has 200 full-time
equivalent employees, and tangible assets with a net book value of 100.
* B is a Low-Tax Jurisdiction, with a Top-up Tax of 400. BCo has revenue of 500
and deductions of 300, giving taxable profits of 200. BCo has 150 full-time
equivalent employees, and tangible assets with a net book value of 250.
* C is a Low-Tax Jurisdiction, with a Top-up Tax of 200. CCo has revenue of 400
and deductions of 550, giving a tax loss of 150. CCo has 150 full-time
equivalent employees, and tangible assets with a net book value of 150.
* All 3 jurisdictions have the same corporate income tax rate (20%).
* Jurisdictions B and C impose UTPR tax by denying deductions
(across-the-board).
Based on these facts, what amounts of IIR tax and UTPR tax will be imposed for
the current year, and in which jurisdictions?
Answer:
There will be no IIR tax: jurisdiction A has not implemented the GloBE rules,
and BCo has no Ownership Interest in CCo and vice versa.
The Total UTPR Top-up Tax Amount (i.e., the sum of the Top-up Tax calculated for
each Low-Taxed Constituent Entity) = 300 (ACo) + 400 (BCo) + 200 (CCo) = 900:
Art. 2.5.1.
Art. 2.6.1:
1. Jurisdiction A: nil – GloBE rules not implemented in A.
2. Jurisdiction B:
UTPR Percentage = [50% x 150 / 300] + [50% x 250 / 400] = 25% + 31.25% =
56.25%
UTPR Top-up Tax Amount allocated to B = 900 x 56.25% = 506.25
3. Jurisdiction C:
UTPR Percentage = [50% x 150 / 300] + [50% x 150 / 400] = 25% + 18.75% =
43.75%
UTPR Top-up Tax Amount allocated to C = 900 x 43.75% = 393.75
Art. 2.4.1:
1. Jurisdiction B: All of BCo’s deductions of 300 will be disallowed, which
would cause BCo to have an additional cash tax expense of 60 in the current
year – i.e., 300 x 20% = 60. That will leave a remaining UTPR Top-up Tax
Amount of 446.25 – i.e., 506.25 – 60 = 446.25. The 446.25 will be carried
forward for adjustment in Art. 2.4.1 in future years: Art. 2.4.2.
2. Jurisdiction C: All of CCo’s deductions of 550 will be disallowed, which
would cause CCo to move from a tax loss of 150 to a taxable profit of 400.
It would therefore have an additional cash tax expense of 80 in the current
year – i.e., 400 x 20% = 80. That will leave a remaining UTPR Top-up Tax
Amount of 313.75 – i.e., 393.75 – 80 = 313.75. The 313.75 will be carried
forward for adjustment in Art. 2.4.1 in future years: Art. 2.4.2. [Note
that, if the C tax law allows tax losses to be carried forward, the
disallowance of CCo’s 150 tax loss in the current year might cause an
additional cash tax expense of 30 in future years – this might reduce the
UTPR Top-up Tax Amount carried forward by 30.]
Art. 2.6.3 & 2.6.4: Due to Art. 2.6.4, in the next year, B and C will not be
deemed to have a UTPR Percentage of zero under Art. 2.6.3.
Do you agree?
INTERNATIONAL TAX QUIZ 131
ACo, located in A, is the UPE of an MNE Group.
ACo directly owns 100% of BCo (located in B), 70% of CCo (located in C), 100% of
DCo (located in D), and 40% of ECo (located in E).
The other 30% of CCo is directly owned by third parties.
BCo directly owns 15% of ECo, and CCo directly owns 25% of ECo. The other 20% of
ECo is directly owned by third parties.
All of the shares in all of the companies are common shares, with an equal right
to profit distributions and capital.
A, B, C and D have implemented the GloBE rules, but E has not.
ECo is a Low-Taxed Constituent Entity. It has a Top-up Tax for the current
Fiscal Year of 1,000.
Q1: What amount of IIR tax and UTPR tax will be imposed, and on which entity or
entities?
Q2: Same question as Q1, with one change in the facts: A has not implemented the
GloBE rules.
Answer:
Q1:
* ACo: an IIR tax of 725 (reflecting ACo’s 72.5% direct and indirect Ownership
Interest in ECo) prima facie would be imposed on ACo. However, that amount
would be reduced by 175 (reflecting ACo’s 17.5% indirect Ownership Interest
in ECo through CCo, a POPE: Art. 2.3). Thus, final amount of IIR tax imposed
on ACo would be 550.
* BCo (an IPE): the prima facie IIR tax of 150 would be reduced to nil by Art.
2.1.3(a).
* CCo (a POPE): an IIR tax of 250 (reflecting CCo’s 25% Ownership Interest in
ECo) would be imposed on CCo.
* Thus, aggregate IIR tax = 550 (ACo) + 250 (CCo) = 800.
* UTPR: prima facie, UTPR tax of 1,000 would be allocated (in aggregate) to
ACo, BCo, CCo and DCo: Art. 2.4. However, ECo’s Top-up Tax of 1,000 is
reduced to zero, as all of ACo’s 72.5% Ownership Interests in ECo are held
directly or indirectly by ACo and CCo, both of which are required to apply a
Qualified IIR. Thus, no UTPR tax would be imposed.
* Thus, final answer: IIR tax of 550 imposed on ACo, 250 of IIR tax imposed on
CCo, and no UTPR tax imposed – a total tax of 800.
Q2:
* BCo (an IPE): IIR tax of 150 (reflecting BCo’s 15% Ownership Interest in ECo)
would be imposed on BCo.
* CCo (a POPE): IIR tax of 250 (reflecting CCo’s 25% Ownership Interest in ECo)
would be imposed on CCo.
* Thus, aggregate IIR tax = 150 (BCo) + 250 (CCo) = 400.
* UTPR: prima facie, UTPR tax of 1,000 would be allocated (in aggregate) to
BCo, CCo and DCo: Art. 2.4. However, ECo’s Top-up Tax of 1,000 would be
reduced by 400 (the aggregate amount of Top-up Tax that is brought into
charge under a Qualified IIR): Art. 2.5.3. Thus, the reduced UTPR tax of 600
would be allocated (in aggregate) to BCo, CCo and DCo (the amount allocated
to each entity would be determined under Art. 2.6).
* Thus, final answer: IIR tax of 150 imposed on BCo, IIR tax of 250 imposed on
CCo, and aggregate UTPR tax of 600 imposed on BCo, CCo and DCo – a total tax
of 1,000
Note the difference in the total tax in Q1 (800) vs. Q2 (1,000).
Do you agree?
INTERNATIONAL TAX QUIZ 130
An MNE Group has 1 Constituent Entity (ACo) located in jurisdiction A. The UPE
owns a direct or indirect 75% Ownership Interest in ACo, with the balance of 25%
owned by third parties.
In year 1:
* The MNE Group is “within scope” of the GloBE rules.
* A UTPR Top-up Tax Amount of 1,000 is allocated to jurisdiction A.
* That UTPR Top-up Tax Amount relates to the Top-up Tax of XCo, a Low-Taxed
Constituent Entity located in jurisdiction X. ACo has no transactions with,
and no direct or indirect equity investment in, XCo.
* The corporate income tax rate in jurisdiction A is 20%.
* ACo has:
* Revenue: 7,000
* Deductions: 3,000
* Taxable profits: 4,000
Under the jurisdiction A tax law, the UTPR Top-up Tax Amount is imposed by
denial of deductions (across-the-board, not specific deductions).
In year 2:
* The MNE Group is not “within scope” of the GloBE rules.
* At the start of year 2, the MNE Group sells 100% of the shares in ACo to a
third party.
* The corporate income tax rate in jurisdiction A is increased to 25%.
* ACo has:
* Revenue: 6,000
* Deductions: 3,000
* Taxable profits: 3,000
What UTPR Top-up Tax (if any) will be imposed on ACo in years 1 and 2?
Answer:
Introductory point: UTPR will be imposed on ACo, regardless of: (1) the fact
that ACo is 25% owned by third parties; and (2) the fact that ACo has no
transactions with, and no direct or indirect equity investment in, XCo.
Year 1:
* ACo will be denied all of its existing deductions of 3,000: Art. 2.4.1.
* That will cause an additional cash tax expense of 3,000 x 20% = 600.
* And that will leave 400 of UTPR to be imposed.
Year 2:
* Art. 2.4.2 will require there to be a second adjustment under Art. 2.4.1, in
regard to year 2.
* Therefore, ACo will be denied deductions of 1,600: Art. 2.4.1.
* That will cause an additional cash tax expense of 1,600 x 25% = 400.
* This second adjustment will be made in year 2, regardless of: (1) the fact
that the MNE Group is not “within scope” of the GloBE rules; and (2) the fact
that ACo is wholly owned by third parties: Commentary on Art. 2.4. (I hope
the third party acquirers do their tax due diligence thoroughly!)
Do you agree?
INTERNATIONAL TAX QUIZ 129
An MNE Group consists of a UPE (located in U), XCo 1 (located in X), XCo 2 (also
located in X), YCo (located in Y), ZCo (located in Z), and UCo (located in U).
The Ownership Interests are owned as follows:
* XCo 1: 100% owned by UPE
* XCo 2: 60% owned by XCo 1, 10% owned by UPE, and 30% owned by third parties
* YCo: 60% owned by XCo 2, 30% owned by UPE, and 10% owned by third parties
* ZCo: 100% owned by YCo
* UCo: 100% owned by YCo
All shares in all companies are common shares, which carry an equal right to
profit distributions and capital.
None of the Constituent Entities is an Investment Entity or a Flow-through
Entity.
All of the jurisdictions have implemented the GloBE rules.
For the current Fiscal Year:
* ZCo has Top-up Tax of 1,000, and GloBE Income of 25,000
* UCo has Top-up Tax of 3,000, and GloBE Income of 10,000
Based on these facts, what are the amounts of IIR tax imposed on UPE, XCo 1, XCo
2 and YCo for the current Fiscal Year?
Answer:
(1) XCo 1 is an Intermediate Parent Entity (IPE) (100% directly owned by UPE).
No Top-up Tax will be imposed on XCo 1, due to the fact that a Qualified IIR
applies to UPE: Art. 2.1.3(a).
(2) YCo is a Partially-Owned Parent Entity (POPE) (28% directly or indirectly
owned by third parties).
In regard to ZCo: YCo’s Allocable Share is 100%: Art. 2.2. Thus, Top-up Tax of
1,000 is imposed on YCo: Art. 2.1.4.
In regard to UCo: YCo’s Allocable Share is 100%: Art. 2.2. Thus, Top-up Tax of
3,000 is imposed on YCo: Art. 2.1.4. Note that the fact that UCo is located in U
(same as UPE) has no impact on the application of Art. 2.1 to YCo: see Art.
2.1.6.
(3) XCo 2 is a POPE (30% directly owned by third parties).
Art. 2.1.5 does not apply to exclude XCo 2 from IIR tax, as XCo 2 does not
wholly own YCo.
In regard to ZCo: XCo 2’s Allocable Share is 60%: Art. 2.2. Prima facie, Top-up
Tax of 600 is imposed on XCo 2. However, Art. 2.3.1 reduces that Top-up Tax to
nil.
In regard to UCo: XCo 2’s Allocable Share is 60%: Art. 2.2. Prima facie, Top-up
Tax of 1,800 is imposed on XCo 2. However, Art. 2.3.1 reduces that Top-up Tax to
nil.
(4) UPE: In regard to ZCo: UPE’s Allocable Share is 72% (i.e., 30% owned
directly in YCo, plus 42% owned indirectly in YCo through XCo 1 and XCo 2): Art.
2.2. Prima facie, Top-up Tax of 720 is imposed on UPE. However, Art. 2.3.1
reduces that Top-up Tax to nil, due to the fact that all 72% is owned through
YCo, which applies a Qualified IIR.
In regard to UCo: As UCo is located in U (same as UPE), Art. 2.1.6 provides an
exclusion. Note: the Commentary allows jurisdictions to delete Art. 2.1.6 when
they transpose the GloBE rules into domestic law.
(5) Summary: ZCo: Top-up Tax imposed on YCo: 1,000. UCo: Top-up Tax imposed on
YCo: 3,000.
Do you agree?
INTERNATIONAL TAX QUIZ 128
An MNE Group consists of the UPE and 4 other Constituent Entities: ACo 1, ACo 2,
BCo and CCo.
The UPE is located in jurisdiction X, which has not implemented the GloBE rules.
The UPE owns 100% of ACo 1, which is located in jurisdiction A.
The UPE owns a 90% Ownership Interest in ACo 2, which is also located in
jurisdiction A. The other 10% Ownership Interests in ACo 2 are owned by third
parties.
ACo 2 owns an 85% Ownership Interest in BCo, which is located in jurisdiction B.
The other 15% Ownership Interests in BCo are owned by third parties.
BCo owns a 75% Ownership Interest in CCo, which is located in jurisdiction C.
The other 25% Ownership Interests in CCo are owned by ACo 1.
None of the Constituent Entities is an Investment Entity.
Jurisdictions A, B and C have implemented the GloBE rules.
In the current Fiscal Year, CCo has an amount of Top-up Tax.
Which Constituent Entity or Entities will be subject to an IIR tax, under Art.
2.1, in regard to CCo’s Top-up Tax?
Answer:
Each of ACo 1 and ACo 2 is an Intermediate Parent Entity (IPE). Neither ACo 1
nor ACo 2 owns a Controlling Interest in the other – therefore, Art. 2.1.3(b) is
not applicable.
BCo is a Partially-Owned Parent Entity (POPE). More than 20% of its Ownership
Interests are held directly or indirectly by persons that are not Constituent
Entities: (i) 15% Ownership Interests directly held by third parties, and (ii)
8.5% Ownership Interests indirectly held by third parties through ACo 2.
Therefore:
1. UPE: No IIR tax, because jurisdiction X has not implemented the GloBE rules
– therefore, Art. 2.1.3(a) is not applicable.
2. ACo 1: IIR tax is imposed on ACo 1, equal to its Allocable Share of CCo’s
Top-up Tax: Art. 2.1.2. Under Art. 2.2, its Allocable Share is 25%.
3. ACo 2: IIR tax is imposed on ACo 2, equal to its Allocable Share of CCo’s
Top-up Tax: Art. 2.1.2. Under Art. 2.2, its Allocable Share is prima facie
63.75% (but see below).
4. BCo: IIR tax is imposed on BCo, equal to its Allocable Share of CCo’s Top-up
Tax: Art. 2.1.4. Under Art. 2.2, its Allocable Share is 75%.
5. Double taxation between ACo 2 and BCo is relieved by Art. 2.3: ACo 2’s
63.75% Allocable Share is reduced to nil.
6. Thus, final IIR tax liabilities: ACo 1 (Allocable Share = 25%) and BCo
(Allocable Share = 75%).
Do you agree?
INTERNATIONAL TAX QUIZ 127
An MNE Group has 4 Constituent Entities located in jurisdiction X: ACo, BCo, CCo
and DCo.
The UPE’s Ownership Interest in each Constituent Entity is this:
* ACo: 100%
* BCo: 40%
* CCo: 30%
* DCo: 25%
The other Ownership Interests in BCo, CCo and DCo are owned by shareholders who
are unrelated to the UPE.
The UPE holds a Controlling Interest in all 4 Entities. None of the Entities
owns shares in the other Entities.
In the current Fiscal Year
* ACo has:
* Adjusted Covered Taxes: 100
* GloBE Income: 250
* BCo has:
* Adjusted Covered Taxes: 25
* GloBE Income: 100
* CCo has:
* Adjusted Covered Taxes: 20
* GloBE Loss: 200
* DCo has:
* Adjusted Covered Taxes: 50
* GloBE Income: 500
* For jurisdiction X, there is:
* No Additional Current Top-up Tax
* No Domestic Top-up Tax
* No Substance-based Income Exclusion
* No de minimis exclusion
What is the Top-up Tax, if any, for jurisdiction X for the current Fiscal Year?
Answer:
CCo and DCo are each Minority-Owned Constituent Entities. BCo is not, as the
UPE’s Ownership Interest in BCo is 40%. See the definition of “Minority-Owned
Constituent Entity” in Art. 10.1.1.
Thus, Art. 5.6.2 requires separate calculations of ETR and Top-up Tax for (1)
ACo and BCo; (2) CCo; and (3) DCo.
ACo and BCo:
* Adjusted Covered Taxes: 100 + 25 = 125
* Net GloBE Income: 250 + 100 = 350
* Thus, ETR = 125 / 350 = 35.7%
* Top-up Tax Percentage = nil
* Therefore, Top-up Tax = nil
CCo:
* Adjusted Covered Taxes: 20
* Net GloBE Loss: 20
* Thus, Top-up Tax = nil
DCo:
* Adjusted Covered Taxes: 50
* Net GloBE Income: 500
* Thus, ETR = 10%
* Top-up Tax Percentage = 15% – 10% = 5%
* Therefore, Top-up Tax = 500 x 5% = 25
Do you agree?
INTERNATIONAL TAX QUIZ 126
An MNE Group has 3 Constituent Entities (ACo, BCo and CCo) located in
jurisdiction X.
The MNE Group uses the calendar year as its Fiscal Year.
ACo has these financial numbers for Fiscal Years 1 to 3:
* Year 1:
* GloBE Revenue: EUR 5 million
* GloBE Income: EUR 0.8 million
* Year 2:
* GloBE Revenue: EUR 7 million
* GloBE Income: EUR 0.7 million
* Year 3:
* GloBE Revenue: EUR 12 million
* GloBE Loss: EUR 0.1 million
BCo has these financial numbers for Fiscal Years 1 to 3:
* Year 1 (BCo was dormant in Year 1):
* GloBE Revenue: EUR 0
* GloBE Income or Loss: EUR 0
* Year 2:
* GloBE Revenue: EUR 4 million (including EUR 3 million from services
provided to ACo)
* GloBE Income: EUR 0.2 million
* Year 3:
* GloBE Revenue: EUR 3 million (including EUR 2 million from services
provided to ACo)
* GloBE Income: EUR 0.3 million
CCo was formed on 1 April in Year 2, and commenced operations immediately.
CCo has these financial numbers for Fiscal Years 2 & 3:
* Year 2:
* GloBE Revenue: EUR 0.75 million
* GloBE Loss: EUR 0.3 million
* Year 3:
* GloBE Revenue: EUR 1 million
* GloBE Loss: EUR 0.4 million
Note: The “GloBE Revenue” for each Fiscal Year is the Entity’s revenue for that
year, taking into account the adjustments in Chapter 3 of the GloBE model rules.
Is the MNE Group entitled to make a “de minimis exclusion” election for Year 3?
Answer:
Preliminary points:
1. In Year 1, BCo was dormant and CCo had not been formed. Nevertheless, due to
the existence and operation of ACo in Year 1, Year 1 is included in the
calculation of averages. In other words, the second sentence in Art. 5.5.2
does not apply.
2. CCo was formed on 1 April in Year 2 and commenced operations immediately.
Thus, its Year 2 numbers need to be converted into equivalent 12 month
numbers. Thus, CCo’s GloBE Revenue for Year 2 becomes: EUR 0.75 million x
4/3 = EUR 1 million; and its GloBE Loss becomes: EUR 0.3 million x 4/3 = EUR
0.4 million.
3. BCo’s GloBE Revenue for Years 2 & 3 includes significant amounts of revenue
from services provided to ACo. No adjustment is made for such intra-group
revenue.
GloBE Revenue (in EUR millions):
Year 1: 5 + 0 = 5
Year 2: 7 + 4 + 1 = 12
Year 3: 12 + 3 + 1 = 16
Average GloBE Revenue (in EUR millions) = (5 + 12 + 16) / 3 = 11
GloBE Income or Loss (in EUR millions):
Year 1: 0.8 + 0 = 0.8
Year 2: 0.7 + 0.2 + (0.4) = 0.5
Year 3: (0.1) + 0.3 + (0.4) = (0.2)
Average GloBE Income or Loss (in EUR millions) = (0.8 + 0.5 + (0.2)) / 3 = 0.4
(rounded)
As the Average GloBE Revenue is not less than EUR 10 million, Art. 5.5.1(a) is
not satisfied. Thus, the Group is not entitled to make a “de minimis exclusion”
election for Year 3.
INTERNATIONAL TAX QUIZ 125
An MNE Group has one Constituent Entity (ACo) located in jurisdiction A.
For Year 1, the Group reported for jurisdiction A:
* Adjusted Covered Taxes: EUR 5 million
* Net GloBE Income: EUR 100 million
* ETR: 5%
* Substance-based Income Exclusion: nil
* Additional Current Top-up Tax: nil
* Qualified Domestic Minimum Top-up Tax: nil
* Thus, Top-up Tax = (10% x EUR 100 million) + 0 + 0 = EUR 10 million
For the current Fiscal Year (Year 3), the Group plans to report for jurisdiction
A:
* Adjusted Covered Taxes: EUR 20 million
* Net GloBE Income: EUR 100 million
* ETR: 20%
* Substance-based Income Exclusion: nil
* Additional Current Top-up Tax: nil
* Qualified Domestic Minimum Top-up Tax: nil
* Thus, Top-up Tax = (0% x EUR 100 million) + 0 + 0 = 0
However, the Group now identifies a major jurisdiction A corporate income tax
error in regard to Year 1. That error has caused an underpayment of EUR 2
million of tax for Year 1. However, the correction of the error will not cause
any change to the GloBE Income for Year 1.
Q1: What are the adjusted amounts of Top-up Tax for Years 1 and 3?
Q2: Assume the same facts as above, except that the error in Year 1 has caused
an overpayment of EUR 2 million of jurisdiction A corporate income tax for Year
1. Again, the correction of the error will not cause any change to the GloBE
Income for Year 1. What are the adjusted amounts of Top-up Tax for Years 1 and
3?
Answer:
Q1
The correction of the jurisdiction A tax underpayment will cause an increase in
Covered Taxes of EUR 2 million.
Art. 4.6.1 requires an increase in Covered Taxes for a prior Fiscal Year to be
treated as relating to the current Fiscal Year (Year 3). There would thus be no
adjustment to the Top-up Tax (i.e., EUR 10 million) for Year 1.
In Year 3, the Adjusted Covered Taxes are increased to EUR 22 million –
therefore, the ETR becomes 22%. As there was no Top-up Tax in Year 3 prior to
the correction, the correction will not cause any adjustment to the Top-up Tax
(i.e., nil) for Year 3.
Therefore, the increase in the jurisdiction A tax will not any adjustment to
Top-up Tax, in either Year 1 or Year 3.
Q2:
The correction of the jurisdiction A tax overpayment will cause a decrease in
Covered Taxes of EUR 2 million.
Art. 4.6.1 requires a decrease in Covered Taxes for a prior Fiscal Year (Year 1)
to be reflected in a recalculation of the ETR and Top-up Tax for Year 1, unless
an election is available and is made (in this case, the election is not
available, as the decrease amount exceeds EUR 1 million).
For Year 1:
1. the Adjusted Covered Taxes will now be EUR 3 million,
2. the ETR will be 3%, and
3. the Top-up Tax will be: (12% x EUR 100 million) + 0 + 0 = EUR 12 million.
Which means that there will be incremental Top-up Tax of EUR 2 million.
In accordance with Art. 4.6.1 and Art. 5.4.1, the incremental Top-up Tax:
1. is treated as Additional Current Top-up Tax in Year 3,
2. the Year 3 Top-up Tax will be: (0% x EUR 100 million) + EUR 2 million + 0 =
EUR 2 million, and
3. there will be no adjustments to the assessments for Year 1.
Do you agree?
INTERNATIONAL TAX QUIZ 124
An MNE Group has one Constituent Entity, XCo, located in jurisdiction X.
At the beginning of the 2025 Fiscal Year, XCo has these operating assets in its
balance sheet:
* Plant & equipment #1: cost of 20,000 (including capitalised payroll expenses
of 5,000); accumulated depreciation of 4,000
* Plant & equipment #2: cost of 14,000; accumulated depreciation of 2,000
* Land #1: cost of 10,000; impairment adjustment of 3,000
* Land #2: cost of 15,000
During the 2025 Fiscal Year:
* XCo sells plant & equipment #2 for a price of 15,500
* XCo purchases plant & equipment #3 for 5,000
* XCo starts holding Land #2 for sale
At the end of the 2025 Fiscal Year, XCo’s balance sheet shows:
* Plant & equipment #1: accumulated depreciation of 6,000
* Plant & equipment #3: accumulated depreciation of 250
* Land #1: a further impairment adjustment of 1,000 (i.e., total impairment
adjustment is now 4,000)
* Land #2: held for sale
Note: With the exception of Land #2: at year-end, all of these assets are being
used in the production of XCo’s goods.
What is the MNE Group’s tangible asset carve-out for jurisdiction X for the 2025
Fiscal Year?
Answer:
1. P&E #1:
1.1 Beginning of year carrying value: 20,000 – 4,000 = 16,000
1.2 End of year carrying value: 20,000 – 6,000 = 14,000
1.3 Average carrying value: 15,000
Note: The 5,000 of capitalised payroll expenses is not excluded.
2. P&E #2:
2.1 Beginning of year carrying value: 14,000 – 2,000 = 12,000
2.2 End of year carrying value: nil (sold)
2.3 Average carrying value: 6,000
Note: Sale price is irrelevant.
3. P&E #3:
3.1 Beginning of year carrying value: nil (purchased)
3.2 End of year carrying value: 5,000 – 250 = 4,750
3.3 Average carrying value: 2,375
4. Land #1:
4.1 Beginning of year carrying value: 10,000 – 3,000 = 7,000
4.2 End of year carrying value: 10,000 – 4,000 = 6,000
4.3 Average carrying value: 6,500
5. Land #2:
5.1 Beginning of year carrying value: 15,000
5.2 During year, XCo starts holding Land #2 for sale
5.3 End of year: held for sale (Note 1)
5.4 End of year carrying value: nil (Note 2)
5.5 Average carrying value: 7,500
Note 1: Assuming Land #2 satisfies the Commentary’s requirements to be
considered “held for sale”.
Note 2: Art. 5.3.4 states that “the tangible asset carve-out computation shall
not include the carrying value of property (including land or buildings) that is
held for sale, lease or investment”. However, it does not indicate the treatment
of such property which becomes “held for sale” during the year. I think the
logical treatment is to include its carrying value at the beginning of the year
(when it was not “held for sale”), and to include a carrying value of nil at
year-end, and then compute the average carrying value in the same way as for a
disposal during the year.
6. Conclusions:
6.1 Aggregate average carrying values of Eligible Tangible Assets = 15,000 +
6,000 + 2,375 + 6,500 + 7,500 = 37,375
6.2 2025 rate: 7.6%
6.3 Tangible asset carve-out for 2025 = 37,375 x 7.6% = 2,840.5
Do you agree?
INTERNATIONAL TAX QUIZ 123
An MNE Group has 2 Constituent Entities (ACo & BCo) located in jurisdiction X.
ACo is a service company which provides procurement and marketing services to
BCo in X and other Constituent Entities in other jurisdictions.
BCo carries on a manufacturing business in X.
In regard to both companies, all the employees perform their activities in X.
For the 2028 Fiscal Year:
* ACo:
* incurs employee salaries of 20,000, payroll tax of 2,000, and employer
social security contributions of 5,000
* of these amounts, 2,000 is capitalised to Eligible Tangible Assets (as
defined in Art. 5.3.4)
* BCo:
* incurs employee salaries of 30,000, employee medical insurance payments of
5,000, service fees paid to ACo of 10,000 (including 1,000 of VAT), and
employee pension contributions of 3,000
* of these amounts, 4,000 is capitalised to Eligible Tangible Assets (as
defined in Art. 5.3.4), and 5,000 is capitalised to inventory
What is the Group’s payroll carve-out for X in 2028?
Answer:
ACo:
Eligible Payroll Costs (after deducting exceptions) = 20,000 + 2,000 + 5,000 –
2,000 = 25,000
BCo:
Eligible Payroll Costs (after deducting exceptions) = 30,000 + 5,000 + 3,000 –
(4,000 x 38,000 / 47,000) = 34,766
Notes:
(1) 10,000 service fees do not qualify, on the basis that ACo is not a staffing
or employment company (and, therefore, ACo’s employees are not BCo’s “Eligible
Employees”: Art. 10.1.1 definition and Commentary on Art. 5.3.3).
(2) 5,000 capitalised to inventory is not excluded.
(3) 4,000 capitalised to Eligible Tangible Assets is excluded, to the extent
that it represents employee salaries, employee medical insurance payments and
employee pension contributions. In the absence of better information, I have
assumed that it represents those categories plus 9,000 service fees (net of
VAT), on a pro rata basis. I have therefore excluded a pro rata proportion of
the 4,000.
Eligible Payroll Costs (after deducting exceptions) for X = 25,000 + 34,766 =
59,766
In 2028, the Art. 5.3.3 rate is 9.0%: Art. 9.2.1.
Thus, the payroll carve-out for X in 2028 is: 59,766 x 9% = 5,378.94
Do you agree?
INTERNATIONAL TAX QUIZ 122
An MNE Group has 4 Constituent Entities which are located in a jurisdiction. For
the current Fiscal Year:
* ACo has GloBE Income of 9,400 and Adjusted Covered Taxes of 400
* BCo has a GloBE Loss of 2,000 and Adjusted Covered Taxes of 40
* CCo has GloBE Income of 2,200, Adjusted Covered Taxes of 200, and a
Substance-based Income Exclusion of 3,000
* DCo has a GloBE Loss of 1,100, Adjusted Covered Taxes of 160, and a
Substance-based Income Exclusion of 1,300
* The Group does not have any Additional Current Top-up Tax in regard to the
jurisdiction
* The jurisdiction has not introduced a domestic minimum top-up tax
Q1: What is the Group’s ETR and Top-up Tax (if any) for the jurisdiction?
Q2: If the Group has Top-up Tax for the jurisdiction, what is the allocation of
that Top-up Tax amongst the 4 Constituent Entities?
Answer:
Q1:
Calculate ETR:
* Sum of Adjusted Covered Taxes: 400 + 40 + 200 + 160 = 800 (Art. 5.1.1)
* Net GloBE Income: 9,400 – 2,000 + 2,200 – 1,100 = 8,500 (Art. 5.1.2)
* ETR = 800 / 8,500 = 9.4118% (rounded to fourth decimal place: Commentary on
Art. 5.1.1)
Calculate Top-up Tax Percentage:
* Top-up Tax Percentage = 15% – 9.4118% = 5.5882%
Calculate Excess Profit:
* Substance-based Income Exclusion: 3,000 + 1,300 = 4,300
* Excess Profit = 8,500 – 4,300 = 4,200 (Art. 5.2.2)
Calculate Jurisdictional Top-up Tax:
* Jurisdictional Top-up Tax = (5.5882% x 4,200) – 0 – 0 = 234.7044 (Art. 5.2.3)
Q2:
Calculate Aggregate GloBE Income for all Constituent Entities which have GloBE
Income:
* Aggregate GloBE Income: 9,400 + 2,200 = 11,600 (Art. 5.2.4)
Allocation of Top-up Tax (Art. 5.2.4):
* ACo: 9,400 / 11,600 x 234.7044 = 190.1915
* BCo: nil (GloBE Loss)
* CCo: 2,200 / 11,600 x 234.7044 = 44.5129
DCo: nil (GloBE Loss)
INTERNATIONAL TAX QUIZ 121
A general partnership is created under the law of jurisdiction B. The
partnership is treated as fiscally transparent in B.
The partnership has 3 partners:
* Partner #1 (with a 30% share in the partnership) is a company which is
resident in jurisdiction A. A treats the partnership as fiscally transparent.
* Partner #2 (with a 50% share in the partnership) is a company which is
resident in jurisdiction C. C does not treat the partnership as fiscally
transparent.
* Partner #3 (with a 20% share in the partnership) is a company which is
resident in B. As already noted, B treats the partnership as fiscally
transparent.
The partnership’s financial statements show that it has a Financial Accounting
Net Income (FANIL) of 10,000, and an income tax expense in regard to Covered
Taxes (CT) of 3,000. The partnership does not have a PE in another jurisdiction.
All 4 entities (partnership, partner #1, partner #2 and partner #3) are
Constituent Entities within an MNE Group.
Q1: What amounts of FANIL and CT are allocated to each of the 4 Constituent
Entities? Q2: Would your answer to Q1 change if B treated the partnership as a
separate taxable person which was tax resident in B?
Answer:
Q1
1. Characterisation of p/ship: (i) to extent of Partner #1’s 30% share: Tax
Transparent Entity (Art. 10.2.1(a)); (ii) to extent of Partner #2’s 50%
share: Reverse Hybrid Entity (Art. 10.2.1(b)); (iii) to extent of Partner
#3’s 20% share: Tax Transparent Entity (Art. 10.2.1(a)).
2. Partner #1’s 30% share: (i) 30% of FANIL (i.e., 3,000) allocated to Partner
#1 (Art. 3.5.1(b)); (ii) 30% of CT (i.e., 900) allocated to Partner #1 (Art.
4.3.2(b)).
3. Partner #2’s 50% share: (i) 50% of FANIL (i.e., 5,000) allocated to p/ship
(Art. 3.5.1(c)); (ii) 50% of CT (i.e., 1,500) retained by p/ship.
4. Partner #3’s 20% share: (i) 20% of FANIL (i.e., 2,000) allocated to Partner
#3 (Art. 3.5.1(b)); (ii) 20% of CT (i.e., 600) allocated to Partner #3.
Thus: FANIL: (i) Partner #1 = 3,000; (ii) Partner #2 = nil; (iii) Partner #3 =
2,000; (iv) p/ship = 5,000.
And CT: (i) Partner #1 = 900; (ii) Partner #2 = nil; (iii) Partner #3 = 600;
(iv) p/ship = 1,500.
Q2:
1. Characterisation of p/ship: (i) to extent of Partner #1’s 30% share: Hybrid
Entity (Art. 10.2.5); (ii) to the extent of Partner #2’s 50% share: neither
a Flow-through Entity nor a Hybrid Entity (Art. 10.2); (iii) to the extent
of Partner #3’s 20% share: neither a Flow-through Entity nor a Hybrid
Entity. Note: Q2 says that B treats the p/ship as a separate taxable person
– thus, Partner #3’s B treatment of the p/ship is not as a fiscally
transparent entity.
2. Partner #1’s 30% share: (i) no amount of FANIL is allocated to Partner #1;
(ii) no amount of CT is allocated from p/ship to Partner #1 – however, CT
can be allocated from Partner #1 to p/ship (see Art. 4.3.2(d) and Art.
4.3.3).
3. Partner #2’s 50% share and Partner #3’s 20% share: (i) no amount of FANIL is
allocated to Partner #2 or #3; (ii) no amount of CT is allocated to Partner
#2 or #3.
Thus: FANIL: (i) Partner #1, #2 & #3 = nil; (ii) p/ship = 10,000.
And CT: (i) Partner #1, #2 & #3 = nil (although CT can be allocated from Partner
#1 to p/ship – see above); (ii) p/ship = 3,000.
Do you agree?
INTERNATIONAL TAX QUIZ 120
UPE, a company resident in R, is the ultimate parent of an MNE group. The
corporate income tax rate in R is 25%.
UPE owns 100% of the shares in ACo, a company resident in A.
ACo owns 100% of the shares in BCo, a company resident in B.
During the current Fiscal Year:
* ACo pays to UPE a royalty of 200, from which is deducts A royalty withholding
tax of 20
* ACo also pays to UPE a dividend of 600, from which it deducts A dividend
withholding tax of 30
* UPE pays to BCo interest of 400, from which it deducts R interest withholding
tax of 40
* BCo pays to ACo a dividend of 250, from which it deducts B dividend
withholding tax of 25
* UPE includes in its income tax expense: R tax of 250 in respect of BCo’s
income of 1,000 allocated to UPE under the R CFC rules. Of that 1,000, 600 is
“Passive Income” (as defined in Art. 10.1.1). Before taking into account the
R tax of 250, the Top-up Tax Percentage for jurisdiction B is 5%.
Based on these numbers, what are the amounts of Covered Taxes for UPE, ACo and
BCo?
Answer:
1. ACo pays to UPE a royalty of 200, from which it deducts A royalty
withholding tax of 20: not allocated under Art. 4.3.
Thus, UPE’s tax of 20.
2. ACo pays to UPE a dividend of 600, from which it deducts A dividend
withholding tax of 30: allocated under Art. 4.3.2(e) to ACo.
Thus, ACo’s tax of 30.
3. UPE pays to BCo interest of 400, from which it deducts R interest
withholding tax of 40: not allocated under Art. 4.3.
Thus, BCo’s tax of 40.
4. BCo pays to ACo a dividend of 250, from which it deducts B dividend
withholding tax of 25: allocated under Art. 4.3.2(e) to BCo.
Thus, BCo’s tax of 25.
5. (a) UPE includes in its income tax expense R tax of 250 in respect of BCo’s
income of 1,000 allocated to UPE under the R CFC rules: prima facie, 250
allocated to BCo under Art. 4.3.2(c).
(b) However, of that 1,000, 600 is “Passive Income” (as defined in Art.
10.1.1). Before taking into account the R tax of 250, the Top-up Tax
Percentage for B is 5%: Art. 4.3.3 applies a cap to the amount allocated to
BCo under Art. 4.3.2(c) – cap = 600 x 5% = 30.
Thus, BCo’s tax of 30; and UPE’s tax of 220.
Thus, Covered Taxes: (1) UPE = 20 + 220 = 240; (2) ACo = 30; and (3) BCo = 40 +
25 + 30 = 95.
INTERNATIONAL TAX QUIZ 119
ACo, a Constituent Entity resident in A, has these financial items for a Fiscal
Year:
1. Current tax expense: 25,000
2. Country B royalty withholding tax (recorded as debit to royalty income): 100
3. Country C digital services tax (recorded as debit to sales revenue): 500
4. Current tax expense in regard to uncertain tax positions:
a. Accrued during current year: 1,000
b. Paid during current year (accrued in prior year): 1,500
c. Reversed during current year (accrued in prior year): 800
5. Income tax credit (refundable in cash for 3 years): credited to current tax
expense
6. Current tax expense in regard to “Excluded Dividends”: 1,200
Based on these numbers, what is ACo’s Adjusted Covered Taxes for the Fiscal
Year?
Answer:
1. Start with current tax expense: 25,000 (Art. 4.1.1).
2. Country B royalty withholding tax (recorded as debit to royalty income):
addition (Art. 4.1.2(a)).
Thus, add 100.
3. Country C digital services tax (recorded as debit to sales revenue) – If the
DST is levied on gross revenue, if it’s a final tax, and if it is not in
substitution for corporate income tax on net income (e.g., corporate income
tax does not apply to the relevant gross revenue, possibly because of source
rules), then (according to the October 2020 blueprint report – we don’t have
the Commentary yet!), the “in lieu of” test in Art. 4.2.1(c) is not
satisfied. In that situation, the DST is not a Covered Tax. For the purpose
of the calculation, I will assume (for the above reasons) that the Country C
DST is not a Covered Tax.
Thus, ignore.
4. Current tax expense in regard to uncertain tax positions.
a. Accrued during current year (1,000): reduction (Art. 4.1.3(d).
b. Paid during current year (accrued in prior year) (1,500): addition (Art.
4.1.2(c)).
c. Reversed during current year (accrued in prior year) (800): ignore –
because the “paid” condition in Art. 4.1.2(c) is not satisfied (but see
my question below).
Thus, add 500 (i.e., add 1,500 and deduct 1,000).
5. Income tax credit (refundable in cash for 3 years): credited to current tax
expense (300): addition (Art. 4.1.2(d)).
Thus, add 300.
6. Current tax expense in regard to “Excluded Dividends” (1,200): reduction
(Art. 4.1.3(a)).
Thus, deduct 1,200..
Thus, ACo’s Adjusted Covered Taxes = 25,000 + 100 + 500 + 300 – 1,200 = 24,700
Do you agree with ignoring the reversal in the current tax expense in regard to
uncertain tax positions?
INTERNATIONAL TAX QUIZ 118
XCo, a Constituent Entity resident in X, is liable for several taxes imposed in
X:
1. Income tax of 25% imposed on XCo’s taxable income. In computing taxable
income, actual expenses are taken into account, but some expenses are denied
deduction (e.g., entertainment expenses), and some other expenses qualify
for a 200% deduction (e.g., R&D expenses). Also, XCo’s taxable income
includes (under the X CFC rules) its share of certain profits derived by
XCo’s foreign subsidiary.
2. Resource levy of 20% imposed on the value (determined according to a
government schedule) of iron ore extracted in XCo’s mining operations.
3. Withholding tax of 10% imposed on gross amount of rent received from leasing
of X real estate owned by XCo. No deductions are available in calculating
the withholding tax, which is a final tax.
4. A Qualified Domestic Minimum Top-Up Tax.
5. Wealth tax of 5% imposed on XCo’s shareholders’ equity as shown in its most
recent balance sheet.
6. Capital duty of 1% imposed on the issue of new shares.
7. Top-up Tax imposed on XCo by X’s “income inclusion rule”, which is not a
Qualified IIR.
Which of these taxes qualify as Covered Taxes?
Answer:
1. 1. Income tax of 25% imposed on XCo’s taxable income.
a. The denial of deduction for some expenses, and the fact that some
other expenses qualify for a 200% deduction, should not prevent the
income tax from being a tax “with respect to [XCo’s] income or
profits” (Art. 4.2.1(a)). See October 2020 blueprint report
(Commentary to GloBE rules has not yet been released!)
b. The income tax on the CFC inclusion will be a tax “with respect to …
its share of the income or profits of a Constituent Entity in which it
owns an Ownership Interest” (Art. 4.2.1(a)), if the foreign subsidiary
is a direct subsidiary. However, if the foreign subsidiary is
indirectly owned by XCo, it’s doubtful whether the phrase, “owns an
Ownership Interest”, is satisfied.Thus, Covered Tax, subject to the
issue concerning the foreign subsidiary.
2. Special tax of 30% imposed by Y on XCo’s share of Amount A allocated to Y
under Pillar One: This should be a tax “with respect to [XCo’s] income or
profits” (Art. 4.2.1(a)). Also, see October 2020 blueprint report.Thus,
Covered Tax.
3. Resource levy of 20% imposed on value (determined according to government
schedule) of iron ore extracted in XCo’s mining operations: Not a tax
“with respect to [XCo’s] income or profits” (Art. 4.2.1(a)); and not a
tax “in lieu of a generally applicable corporate income tax” (Art.
4.2.1(c)), if it is imposed in addition to, and not in substitution for,
income tax: see October 2020 blueprint report.Thus, not Covered Tax.
4. Withholding tax of 10% imposed on gross amount of rent: If 25% income tax
does not apply to the rent, the withholding tax should be a tax “in lieu
of a generally applicable corporate income tax” (Art. 4.2.1(c)).Thus,
Covered Tax.
5. Qualified Domestic Minimum Top-Up Tax: Excluded by Art. 4.2.2(b).Thus,
not Covered Tax.
6. Wealth tax of 5% imposed on XCo’s shareholders’ equity: This would be a
tax “levied by reference to retained earnings and corporate equity” (Art.
4.2.1(d)).Thus, Covered Tax.
7. Capital duty of 1% imposed on issue of new shares: this does not fall
into any category of Covered Tax.Thus, not Covered Tax.
8. Top-up Tax imposed on XCo by X’s “income inclusion rule”, which is not a
Qualified IIR: Not excluded by Art. 4.2.2(a), which is limited to a
Qualified IIR. This will be a tax “with respect to … its share of the
income or profits of a Constituent Entity in which it owns an Ownership
Interest” (Art. 4.2.1(a)), if XCo directly owns shares in the Constituent
Entity (i.e., direct subsidiary). However, if the Constituent Entity is
indirectly owned by XCo, the same issue as mentioned above applies.Thus,
Covered Tax, subject to the issue concerning the Constituent Entity.
INTERNATIONAL TAX QUIZ 117
ACo 1, a company resident in A, is a Constituent Entity within an MNE Group, for
the purposes of the GloBE rules.
ACo 1 has the following financial information for the current fiscal year:
1. Profit or loss: negative EUR 20 million
2. Income tax expense: EUR 7 million
3. Profit on sale of 8% shareholding in XCo, an unrelated company: EUR 3
million
a. The shares were sold to ACo 2 (another Constituent Entity resident in A)
b. ACo 1 and ACo 2 are members of a tax consolidation group in A
c. MNE Group’s UPE makes an election under Art. 3.2.8 to apply its
consolidated accounting treatment to all Constituent Entities resident in
A
4. Charter fee revenue: EUR 4 million
a. The revenue is from the lease of a ship for 2 years, on a bare boat
charter basis, to BCo (unrelated shipping company resident in B)
b. BCo uses the ship to transport passengers in international traffic
c. ACo 1 incurs EUR 1.5 million of costs directly or indirectly attributable
to this revenue
d. ACo 1 has no other shipping activities
e. ACo 2 has EUR 6 million of charter fee revenue from leasing a ship (to be
used to transport cargo in international traffic) on charter fully
equipped, crewed and supplied; ACo 2 incurs EUR 2 million of costs
directly or indirectly attributable to this revenue
5. ACo 1 has a sales agent in C
a. The sales agent causes ACo 1 to have a “contract-concluding agency” PE in
C, under the A/C double tax treaty (which is identical to the 2017 UN
model treaty)
b. ACo 1 does not prepare separate financial accounts for the PE in C
c. However, if ACo 1 did prepare separate financial accounts for the PE in C
on a standalone basis in accordance with the accounting standard used in
the preparation of the UPE’s consolidated financial accounts, those
separate financial accounts would show a profit of EUR 0.5 million. That
profit of EUR 0.5 million is equal to the profit attributable to the PE,
under Art. 7 of the A/C treaty
d. EUR 0.2 million of ACo 1’s income tax expense relates to the C income tax
for the PE
Based on those numbers, what is the GloBE Income or Loss of ACo 1 (Main Entity)
and the C PE, respectively?
Answer:
The threshold issue is whether the “contract-concluding agency” PE in C (under
the A/C treaty) qualifies as a “permanent establishment” under the Art. 10.1.1
definition.
Under para. (a) of that definition, 2 questions arise: (1) Does the phrase,
“deemed place of business”, apply to a “contract-concluding agency” PE? Note
that Art. 5 of the 2017 UN model merely deems there to be a PE – it does not
deem there to be a place of business. (2) Is Art. 7 of the 2017 UN model similar
to Art. 7 of the OECD model? Note that Art. 7 of the UN model includes both an
attribution rule and a modified force of attraction rule.
If para. (a) does not apply, the only other paragraph which could apply is para.
(d) – but para. (d) will not apply if A does not exempt the profits attributable
to the agency PE.
I suspect that the IF intends that para. (a) should apply in this case – but, if
so, the drafting of para. (a) is loose!
The following assumes that there is an Art. 10.1.1 PE …
1. We need to separate the Main Entity (ME) and the C PE.
2. C PE: (i) Financial Accounting Net Income or Loss (FANIL) = 0.5; (ii) Income
tax expense = 0.2; (iii) thus, C PE’s GloBE Income = EUR 0.7m.
3. ME: profit or loss: negative 20.
4. ME: C PE’s FANIL: deduct 0.5.
5. ME: Income tax expense (after removing C PE’s income tax expense): add 6.8.
6. ME: profit on sale of 8% shareholding: deduct 3: Art. 3.2.8
7. ME: charter fee revenue.
1. Not “International Shipping Income” (ISI), as lease is to an unrelated
party: Art. 3.3.2
2. Prima facie, the revenue satisfies “Qualified Ancillary International
Shipping Income” (QAISI): Art. 3.3.3
3. However, the 50% cap in Art. 3.3.4 applies: ACo 2’s ISI is 4 (after
deducting costs) – the cap is therefore 2.
4. ACo 1’s QAISI is (prima facie) 2.5 (after deducting costs), but is capped
at 2.
Thus, deduct 2.
8. Thus, ME’s GloBE Loss = (20) – 0.5 + 6.8 – 3 – 2 = EUR 18.7m
INTERNATIONAL TAX QUIZ 116
XCo, a company resident in X, is a Constituent Entity within an MNE Group, for
the purposes of the GloBE rules.
XCo has the following financial information for the current fiscal year:
1. Profit or loss: negative EUR 5 million
2. Income tax expense (in regard to Covered Taxes): EUR 2 million
3. Excise duty credit: EUR 4 million
1. The credit can be used to offset future excise duty liabilities for the
next 3 years – to the extent it is not used during that period, it will
lapse
2. Reported as credit to indirect tax expense in profit or loss
4. Loss of EUR 8 million under impairment accounting (included in profit or
loss)
1. XCo has not disposed of relevant asset
2. Filing Constituent Entity makes election under Art. 3.2.5 to determine
loss under realisation principle
5. Dividends of EUR 2.5 million paid on redeemable preference shares issued to
YCo (Constituent Entity resident in Y)
1. MNE Group has jurisdictional ETR of 14.95% in Y in current fiscal year.
However, that jurisdictional ETR would be 15.1% if the dividends of EUR
2.5 million on the redeemable preference shares were excluded.
2. Dividends are non-deductible / tax-exempt (including no withholding tax)
in the 2 jurisdictions
3. Dividends treated as interest expense in computing XCo’s profit or loss
6. Prior period error of EUR 3 million (after tax benefit of EUR 0.8 million)
1. Error was understatement of expenses in prior fiscal year
2. Error correction is reported as a decrease in the opening equity at the
start of the current fiscal year
Based on those numbers, what is XCo’s GloBE Income or Loss for the current
fiscal year?
Answer:
Computation of ACo 1’s GloBE Income or Loss:
1. Start with loss (in P&L) (Art. 3.1): negative EUR 5 million
2. Income tax expense (Covered Taxes): add EUR 2 million (Art. 3.1.1(a))
Thus, EUR 2m is added
3. Excise duty credit:
1. Excise duty credit can be used only to offset future excise duty
liabilities for next 3 years – IMHO: not “refundable”. [Note that it is
possible to take the view that the excise duty credit is “refundable”
(and is therefore a “Qualified Refundable Tax Credit”), based on a
statement in the October 2020 blueprint report (Art. 10.1.1 definition).
In this question, it should not have any effect on the answer: in both
situations, the excise duty credit is not excluded from GloBE Income or
Loss (Art. 3.2.4).]
2. Therefore, the GloBE rules do not require it to be either included or
excluded.
Thus, no adjustment.
1. Loss of EUR 8 million under impairment accounting (included in profit or
loss): due to the election to determine loss under realisation principle,
loss should be added (Art. 3.2.5).
Thus, EUR 8 million is added.
2. Dividends of EUR 2.5 million paid on redeemable preference shares (RPS)
issued to YCo:
1. If YCo is a “High-Tax Counterparty”, then the RPS would likely be an
“Intragroup Financing Arrangement” (Art. 10.1.1 definitions).
2. YCo is a “High-Tax Counterparty”, as (according to the question) Y’s
jurisdictional ETR would be 15.1%, if the dividends on the RPS were
excluded. Note that, for this situation to occur, the dividends are
presumably not “Excluded Dividends” (Art. 10.1.1 definition), because, if
they were, they would already be excluded in computing Y’s jurisdictional
ETR (Art. 3.2.1(b)). This would mean that the dividends fall within
either of the 2 exceptions in the Art. 10.1.1 definition of “Excluded
Dividends”.
3. EUR 2.5 million should be added (Art. 3.2.7).
Thus, EUR 2.5 million added.
1. Prior period error of EUR 3 million (after tax benefit of EUR 0.8 million) –
qualifies as “Prior Period Error and Changes in Accounting Principles” (Art.
3.2.1(h) & definition in Art. 10.1.1). Note that the exception in para. (a)
of definition does not apply, because the “error correction” resulted in a
decrease in Covered Taxes of less than EUR 1 million. As the amount reported
as a decrease in opening equity is after the tax benefit, that “after tax”
amount should, I think, be the amount which is adjusted.
Thus, EUR 3 million is deducted.
Based on the above, XCo’s GloBE Income or Loss = (5m) + 2m + 8m + 2.5m – 3m =
EUR 4.5m.
INTERNATIONAL TAX QUIZ 115
ACo 1, a company resident in A, is a Constituent Entity within an MNE Group, for
the purposes of the GloBE model rules.
ACo 1 has the following financial information for the current fiscal year:
1. Profit (in P&L): EUR 30 million
2. Other comprehensive income: EUR 8 million, including EUR 5 million (after
tax) of gain under fair value accounting in respect of property, plant and
equipment (not subsequently reported through P&L). The tax expense on this
fair value accounting gain is EUR 1.5 million
3. Income tax expense:
1. In regard to Covered Taxes: EUR 9 million
2. In regard to other taxes: EUR 0.8 million
4. Transfer of assets and liabilities in merger transaction with ACo 2 (another
Constituent Entity also resident in A):
1. Gain (included in P&L): EUR 3.5 million (tax-free under A tax law)
2. Consideration received by ACo 1: issue of new shares in ACo 2
(consideration satisfies arm’s length principle)
3. ACo 2 inherits ACo 1’s tax basis in assets (for A tax purposes)
5. Loss (included in P&L) on sale of 8% shareholding (ACo 1 held these shares
for 4 years): EUR 0.7 million
6. Gain (included in P&L) on sale of 10% shareholding (ACo 1 acquired half of
these shares 3 years ago, and it acquired the other half during this current
fiscal year): EUR 2 million
7. Prior period error of EUR 5 million (after tax expense of EUR 2 million) –
This error was an understatement of revenue in a prior fiscal year, and is
reported as increase in opening equity at start of current fiscal year
8. Pensions:
1. Pension liability expense in P&L: EUR 2.5 million
2. Contributed to pension fund for current fiscal year: EUR 3 million
9. Royalties expense:
1. Relates to licence of IP from BCo (Constituent Entity resident in B)
2. Actual expense: EUR 3 million
3. Transfer pricing adjustment by A tax authorities: EUR 1 million (i.e.,
EUR 2 million allowed as income tax deduction)
Based on those numbers, what is ACo 1’s GloBE Income or Loss for the current
fiscal year?
Answer:
Computation of ACo 1’s GloBE Income or Loss:
1. Start with profit (in P&L) (Art. 3.1): EUR 30 million
2. Other comprehensive income: EUR 8 million: ignore.
However, EUR 6.5 million (before tax) qualifies as “Included Revaluation Method
Gain or Loss” (Art. 3.2.1(d))
Thus, EUR 6.5 million added
3. Income tax expense:
* In regard to Covered Taxes: add EUR 9 million (Art. 3.1.1(a))
* In regard to other taxes: to the extent “other taxes” are those described in
para. (c), (d) or (e) of definition of “Net Taxes Expense” in Art. 10.1.1,
the amount will be added; but not otherwise. I will assume that no part of
the “other taxes” falls with para. (c), (d) or (e).
Thus, EUR 9 million is added
4. Transfer of assets and liabilities in merger transaction, which qualifies as
“GloBE Reorganisation”: EUR 3.5 million excluded from GloBE Income (Art.
3.2.1(e) & Art. 6.3.2)
Thus, EUR 3.5 million is deducted
5. Loss on sale of 8% shareholding: not treated as “Excluded Equity Gain or
Loss”, because a portfolio shareholding (Art. 3.2.1(c) & definitions in Art.
10.1.1)
Thus, no adjustment
6. Gain on sale of 10% shareholding: treated as “Excluded Equity Gain or Loss”,
because not a portfolio shareholding (Art. 3.2.1(c) & definitions in Art.
10.1.1)
Thus, EUR 2 million is deducted
7. Prior period error – qualifies as “Prior Period Errors and Changes in
Accounting Principles” (Art. 3.2.1(h) & definition in Art. 10.1.1); note
that the exception in para. (a) of definition does not apply, because the
“error correction” resulted in a material increase (not decrease) in Covered
Taxes of EUR 2 million. As the amount reported as an increase in opening
equity is after the tax expense, that “after tax” amount should, I think, be
the amount which is adjusted.
Thus, EUR 5 million is added
8. Pensions: Contribution to pension fund exceeds pension liability expense by
EUR 0.5 million. Thus, Accrued Pension Expense (Art. 3.2.1(i) & definition
in Art. 10.1.1) is negative EUR 0.5 million. There is nothing to indicate
that Accrued Pension Expense cannot be negative.
Thus, EUR 0.5 million is deducted
9. TP adjustment for royalties expense (Art. 3.2.3)
EUR 1 million is added
Based on the above, ACo 1’s GloBE Income or Loss = 30m + 6.5m + 9m – 3.5m – 2m +
5m – 0.5m + 1m = EUR 45.5 million
INTERNATIONAL TAX QUIZ 114
XCo, a company resident in X, is a Constituent Entity within an MNE Group, for
the purposes of the GloBE model rules.
XCo has the following financial information for a fiscal year:
* Profit or loss: 20,000
* Other comprehensive income: 3,500
* Income tax expense:
* In regard to Covered Taxes: 6,000 (including 200 in respect of “dividend
income minus related expenses”)
* In regard to other taxes: 1,500
* Current and deferred tax shown as a contra to particular revenue items:
* In regard to Covered Taxes: 800
* In regard to other taxes: 700
* Accrued dividend income (gross) in respect of:
* 10% shareholding held for 6 months: 400
* 5% shareholding held for 18 months: 650
* 8% shareholding held for 9 months: 1,200
* Received dividend income (gross) (accrued in P&L in preceding fiscal year,
received in current fiscal year):
* 12% shareholding held for 30 months: 700
* Expenses relating to all dividend income: 350
* Gain (included in P&L) on disposal of 12% shareholding: 1,000
* Loss (included in P&L) on disposal of 10% shareholding: 600
Based on those numbers, what is XCo’s GloBE Income or Loss for the fiscal year?
Answer:
Computation of XCo’s GloBE Income or Loss:
* Start with profit (in P&L) (Art. 3.1): 20,000
* Other comprehensive income: ignore – not part of “Financial Accounting Net
Income or Loss” (Art. 3.1 and definition of “Other Comprehensive Income” in
Art. 10.1.1)
Adjustments (Art. 3.2.1):
* Income tax expense:
* In regard to Covered Taxes: add 6,000 (including 200 in respect of
“dividend income minus related expenses”: see “including …” in para. (a) of
definition of “Net Taxes Expense” in Art. 10.1.1)
* In regard to other taxes: to the extent “other taxes” are those described
in para. (c), (d) or (e) of definition of “Net Taxes Expense” in Art.
10.1.1, the amount will be added; but not otherwise. I will assume that no
part of the “other taxes” falls within para. (c), (d) or (e).
Thus, 6,000 is added
* Current and deferred tax shown as contra to particular revenue items:
* In regard to Covered Taxes: add 800 (first part of definition of “Net Taxes
Expense” in Art. 10.1.1)
* In regard to other taxes: same as above.
Thus, 800 is added
* Accrued dividend income (gross) in respect of:
* 10% shareholding held for 6 months: deduct 400 (not “Short-term Portfolio
Shareholding”, as shareholding is 10% – thus, “Excluded Dividend”)
* 5% shareholding held for 18 months: deduct 650 (not “Short-term Portfolio
Shareholding”, as held for 18 months – thus, “Excluded Dividend”)
* 8% shareholding held for 9 months: no adjustment (“Short-term Portfolio
Shareholding”)
Thus, 1,050 is deducted
* Received dividend income (gross) (accrued in P&L in preceding fiscal year,
received in current fiscal year) in respect of 12% shareholding held for 30
months: definition of “Excluded Dividends” in Art. 10.1.1 says “received or
accrued”. However, it does not make sense to deduct this dividend, which is
not included in this year’s profit to begin with. Commentary needs to
clarify! I will assume that the correct answer is that the dividend is not
included in this year’s “Excluded Dividends”.
Thus, no adjustment.
* Expenses relating to all dividend income: Art. 3.2 does not require an
adjustment for all or part of these expenses.
Thus, no adjustment.
* Gain (included in P&L) on disposal of 12% shareholding: 1,000. This satisfies
Art. 10.1.1 definition of “Excluded Equity Gain or Loss”.
Thus, 1,000 is deducted
* Loss (included in P&L) on disposal of 10% shareholding: 600. This satisfies
Art. 10.1.1 definition of “Excluded Equity Gain or Loss”.
Thus, 600 is added
Based on the above, XCo’s GloBE Income or Loss = 20,000 + 6,000 + 800 – 1,050 –
1,000 + 600 = 25,350
INTERNATIONAL TAX QUIZ 113
ACo, a company resident in A, carries on an engineering consulting business.
ACo has won 3 consulting contracts for 3 different clients, each in a different
city in B. The contracts will be performed in 2022. Each contract will require
ACo to send one or more professional engineers (ACo’s A-resident employees) to B
for several months to supervise a construction project in the particular city.
Specifically: (1) contract #1 will require 2 engineers for February and March;
(2) contract #2 will require 1 engineer for May, June and July; and (3) contract
#3 will require 3 engineers for July, August, September and October. All of the
work by the engineers will be performed “on site”.
ACo has no offices or premises, or employees permanently based, in B.
The A/B treaty is identical to the 2017 UN model treaty.
Question 1: Does the treaty allow B to levy income tax on the fees which will be
paid by the clients to ACo?
Question 2: Does the treaty allow B to levy income tax on the salaries which
will be paid to the engineers by ACo, during the period they are in B?
Answer:
1. Fees paid to ACo
1.1 PE?
Under Art. 5(1), each of the 3 construction sites (each in a separate city) must
be analysed separately. None of the sites would satisfy the “approximately 6
months” time test for Art. 5(1).
Under Art. 5(3)(a), a PE is deemed if there is “a construction, assembly or
installation project or supervisory activities in connection therewith, but only
if such site, project or activities last more than six months”. Each of the 3
construction projects (each in a separate city and for a separate client) must
be analysed separately, and thus the “supervisory activities in connection
therewith” should also be analysed separately – which would mean that none of
the supervisory activities would satisfy the “more than six months” test.
Art. 5(3)(b) was amended in the 2017 UN model treaty to remove the rquirement
that the services must relate to the same or a connected project. Thus, for Art.
5(3)(b), the 3 sets of supervisory activities should be analysed together.
However, 2 issues arise with Art. 5(3)(b): (i) does Art. 5(3)(a) constitute a
more specific provision – and, if so, does it “cover the field” (i.e., exclude
the separate operation of Art. 5(3)(b))?; and (ii) is the “more than 183 days in
any 12 month period …” test in Art. 5(3)(b) satisfied?
Re (i): In my view, Art. 5(3)(a) is a more specific provision: it applies
specifically to supervisory services. However, there is no support in the UN
Comm. for the “cover the field” argument – in my view, it does not apply.
Re (ii): One or more ACo employees furnish the services for a total of 8 months
(i.e., Feb, Mar, May, Jun, Jul, Aug, Sep, Oct). However, it’s unclear on how
many days during those 8 months the services are furnished. If the employees do
not work on weekends or public holidays, it’s likely that the “more than 183
days in any 12 month period …” test in Art. 5(3)(b) is not satisfied.
1.2 Art. 12A:
The fees probably qualify as “fees for technical services” in Art. 12A(3). If
so, then B is allowed (in principle) to levy income tax on the fees, subject to
the gross rate limit in Art. 12A(2). However, if ACo has a PE in B under Art.
5(3)(b) (see above), then Art. 7 will apply instead of Art. 12A(2) – thereby
allowing B to impose income tax on a “net” basis, with no rate limitation.
2. Salaries paid to ACo’s employees
Each employee would qualify for the exemption from B income tax in Art. 15(2)
if: (i) that particular employee was present in B “for a period or periods not
exceeding in the aggregate 183 days in any twelve-month period …”; and (ii) ACo
does not have a PE in B. If either of these 2 conditions is not satisfied, then
Art. 15(1) would allow B to impose income tax on the salary which relates to the
exercise of the employment in B.
Re (i): If an employee was assigned to 2 or more of the contracts, then it’s
possible that that employee was present in B for an aggregate period exceeding
183 days. However, if each employee was assigned to only one contract, it’s
likely that condition (i) would be satisfied.
Re (ii): see Art. 5(3)(b) (above).
INTERNATIONAL TAX QUIZ 112
XCo is a publicly listed company which is incorporated in X, but has its place
of effective management in Y.
Under the domestic tax law of X, XCo is non-resident; and under the domestic tax
law of Y, XCo is resident.
XCo has numerous small shareholders resident in many countries.
XCo decides to relocate its head office from Y to X. After the relocation, XCo’s
place of effective management is in X – this makes XCo resident in X under the X
domestic tax law.
In response to XCo’s relocation, Y changes its law, with this effect: for a
period of 10 years after the relocation, XCo will remain resident in Y under the
Y domestic tax law.
Y imposes a withholding tax of 25% on outbound dividends. X does not impose a
withholding tax on outbound dividends.
The X/Y treaty and the Y/Z treaty are both identical to the 2014 OECD model
treaty.
During the 10 years’ period, what rate of Y withholding tax will apply to
dividends paid to small shareholders who are resident (1) in X; or (2) in Z; or
(3) in a country with which Y has no treaty?
Answer:
1. Shareholders resident in X
Application of X/Y treaty:
After the relocation and the Y law change, XCo satisfies the residence
definition in Art. 4(1), in regard to both X and Y. However, under the residence
tie-breaker rule in Art. 4(3), XCo is deemed to be a resident of X only (based
on place of effective management), for the purposes of the X/Y treaty.
Art. 10(1) & (2) will not apply to allow Y tax; and the dividends will be exempt
from Y tax under Art. 10(5) and Art. 21(1).
Thus, no Y tax.
2. Shareholders resident in Z
2.1 X/Y treaty:
XCo is deemed to be a resident of X only, for the purposes of the X/Y treaty
(see above). Thus, the X/Y treaty should ensure that XCo is not taxable in Y on
foreign sourced income: Art. 7(1), etc. Note that, even if Art. 11 of the MLI
applies to the X/Y treaty (i.e., the so-called “saving clause”), XCo will still
be exempt in Y on foreign sourced income – due to the fact that XCo’s residence
status in X only, will mean that Art. 11 has no effect on Y tax.
2.2 Y/Z treaty:
XCo is excluded from the definition of “resident of [Y]” in Art. 4(1) by the
second sentence. The OECD Comm.: “[The second sentence] excludes companies and
other persons who are not subject to comprehensive liability to tax in a
Contracting State [i.e., Y] because these persons, whilst being residents of
that State under that State’s tax law, are considered to be residents of another
State [i.e., X] pursuant to a treaty between these two States. [i.e., X/Y
treaty]”.
Thus, Art. 10(1), (2) & (5) will not apply to the dividends paid by XCo; and the
dividends will be exempt from Y tax under Art. 21(1).
Thus, no Y tax.
Note: If, contrary to the above, the view is taken that the second sentence in
Art. 4(1) of the Y/Z treaty does not apply to exclude XCo from being a resident
of Y for the purposes of the Y/Z treaty, then Art. 10(2) would allow Y to impose
15% tax on the dividends paid to Z-resident shareholders.
3. Shareholders resident in non-treaty country
XCo’s residence status under the X/Y treaty is irrelevant to shareholders who
are resident in countries with no treaty with Y.
Thus, 25% Y tax will apply.
INTERNATIONAL TAX QUIZ 111
XCo, a company resident in X, carries on an investment consulting business.
YCo, a company resident in Y, enters into a contract with XCo for XCo to
undertake a study of investment opportunities for YCo in several countries,
including Z.
As XCo does not have any personnel in Z, XCo sends 2 of its X-based employees to
Z to perform the Z part of the study. At the start, it was thought that the
employees would be in Z for a continuous period of 4 months. However, due to
their inefficiency, they actually spent a continuous period of 7 months in Z,
working full-time on the study for YCo.
The X/Y, X/Z and Y/Z treaties are all identical to the 2017 UN model treaty,
with Art. 23B.
After applying the 3 treaties:
1. which countries are permitted to impose income tax on the fees paid by YCo
to XCo for the study?
2. which countries are permitted to impose income tax on the salaries paid to
the 2 employees?
Answer:
1. Fees paid by YCo
1.1 X/Y treaty:
The fees would qualify as “fees for technical services” (FTS), as defined in
Art. 12A(3). Thus, Y may tax XCo on the fees, subject to the rate limit in Art.
12A(2). X must give XCo a credit for the Y tax, under Art. 23B(1).
1.2 X/Z treaty:
The threshold issue is whether XCo has a PE in Z under the X/Z treaty. There
probably is no Art. 5(3)(b) PE, due to the fact that the 2 employees do not work
on weekends or public holidays, which would make it unlikely that the “183 days”
condition is satisfied. However, there is probably an Art. 5(1) PE at the WeWork
co-working space, despite the hot desking: this should constitute a specific
geographical place, and the employees’ use of the space means that it is at
their disposal. Although at the start it was thought that the employees would be
in Z for a continuous period of 4 months (which would generally be too short for
Art. 5(1)), the UN Comm. makes clear that it is the actual time which matters: 7
months should be sufficient for Art. 5(1), despite the weekends and public
holidays.
If XCo has a PE in Z, then Z is permitted to tax XCo on the profits attributable
to the PE: Art. 7. In determining those profits: (a) the fees referable to the
work performed at the PE in Z would need to be identified, from the total fees
paid by YCo to XCo; and (b) expenses which relate to the PE (e.g., salaries for
the 2 employees while they were at the PE, plus their travel, accommodation and
living expenses) would need to be deducted: Art. 7(2). Also, in relation to (b),
a “head office” notional charge (set at cost: Art. 7(3)) for head office
supervision of the work, should also be deducted.
It is unclear whether, in determining the Z tax on XCo’s PE, Z must give a
notional credit for the Y withholding tax. Such a notional credit would arise by
virtue of Art. 24(3) of the X/Z treaty, the non-discrimination provision in
regard to PEs. The 2017 UN Comm. on Art. 24(3) reproduces the 2017 OECD Comm.
discussion of this point, but it is limited to dividends, interest and royalties
– FTS is not mentioned. If a credit is required, it will be equal to the lower
of the Art. 12A(2) tax rates in the X/Y and Y/Z treaties, respectively.
X must give XCo a credit for the Z tax paid: Art. 23B(1).
2. Salaries
Salaries for the 2 employees while they were at the PE, may be taxed by Z: Art.
15(1) & (2), X/Z treaty. X must give the employees a credit for the Z tax paid:
Art. 23B(1).
INTERNATIONAL TAX QUIZ 110
ACo, a company resident in A, owns a valuable trade mark.
ACo licenses the trade mark to BCo, a related company resident in B, in return
for annual royalties which are set at 93% of the gross amount of royalty income
to which BCo is contractually entitled to receive from sub-licensing the trade
mark. However, BCo’s contractual obligation to pay the royalties to ACo is not
dependent on BCo actually receiving the royalty income from sub-licensing.
BCo sub-licenses the trade mark to CCo, an unrelated company resident in C, in
return for annual royalties which are calculated as a percentage of CCo’s gross
revenue from using the trade mark in its business.
These 2 transactions are the only transactions which are entered into by BCo.
BCo has no other operations, assets, liabilities or employees.
BCo pays royalties to ACo 3 days after receiving royalties from CCo. BCo uses
its 7% “spread” to pay its administrative expenses and B income tax on its
taxable profits, and the balance is paid as a dividend to the group parent
company.
Withholding tax rates on outbound royalties under domestic law are: 0% (B) and
20% (C).
The B/C treaty is identical to the 2014 OECD model treaty, and was signed and
entered into in 2016. The MLI does not apply to the B/C treaty.
The A/C treaty is identical to the 2011 UN model treaty, with a 10% rate
specified in Art. 12(2). The MLI (including the PPT) applies to the A/C treaty.
There is no A/B treaty.
After applying all treaty benefits, what rate of withholding tax (if any) should
apply to the royalties paid by CCo to BCo?
Answer:
B/C treaty: beneficial ownership
To qualify for the 0% rate under Art. 12(1) of the B/C treaty, BCo must be the
beneficial owner (B.O.) of the royalties. The 2014 OECD Comm. narrowed the
circumstances in which a conduit company would fail the B.O. condition: BCo
would fail the condition, only if its “right to use and enjoy the royalties is
constrained by a contractual or legal obligation to pass on the payment received
to another person [, provided the] contractual or legal obligation [is]
dependent on the receipt of the payment by the direct recipient …”.
As BCo’s contractual obligation to pay royalties to ACo is not contingent on BCo
actually receiving royalties from CCo, it might be thought that BCo satisfies
this narrowed B.O. condition. However, the 2014 OECD Comm. states that the
contractual or legal obligation “will normally derive from relevant legal
documents but may also be found to exist on the basis of facts and circumstances
showing that, in substance, the recipient clearly does not have the right to use
and enjoy the royalties unconstrained by a contractual or legal obligation to
pass on the payment received to another person.”
BCo’s only source of funds to pay the royalties to ACo is the actual receipt of
royalties from CCo. Thus, it can be argued that BCo’s contractual obligation to
pay royalties to ACo is contingent, in substance, on BCo actually receiving
royalties from CCo.
If this argument is accepted, BCo would fail the B.O condition.
B/C treaty: abuse
Even if BCo passes the B.O. condition, it is possible that a C court would take
the view that the conduit arrangement was an abuse of the B/C treaty (based on
the 2014 OECD Comm. on Art. 1), and deny the treaty benefit for that reason
A/C treaty: beneficial ownership
If BCo fails the B.O. condition, can ACo claim the benefit of the 10% rate under
Art. 12(2) of the A/C treaty?
The UN Comm. on Art. 12 allows a “look through” to the B.O. “when an
intermediary, such as an agent or nominee, is interposed between the beneficiary
and the payer”. However, there is no reference to an interposed conduit company.
Also, Art. 12(2) applies to “such royalties” – i.e., the royalties referred to
in Art. 12(1). Art. 12(1) refers to royalties “arising in a Contracting State
[C] and paid to a resident of the other Contracting State [A]”. In our case,
there are 2 different royalty streams, neither of which satisfies the 2
conditions in Art. 12(1).
IMHO: ACo is not entitled to the 10% rate.
Conclusion
If BCo fails the B.O. condition or if the Art. 1 “abuse” rule is applied by a C
court, then the 0% rate would be unavailable.
And, IMHO, ACo is not entitled to the 10% rate, even if BCo fails the B.O.
condition.
INTERNATIONAL TAX QUIZ 109
XCo, a company resident in X, owns 100% of the shares in X Sub, another company
resident in X.
X Sub owns 100% of the shares in YCo, a company resident in Y. YCo operates a
very profitable business in Y, but it owns very little real estate in Y.
X Sub is a pure holding company, which was established by XCo to hold the shares
in YCo – those shares in YCo were acquired by X Sub from third parties many
years ago. X Sub has no other assets, and it has no employees or business
premises.
XCo now sells 100% of the shares in X Sub to a third party purchaser, and
derives a significant profit on the sale.
The X/Y treaty is identical to the 2011 UN model treaty. The MLI does not apply
to the X/Y treaty.
The Y domestic tax law contains a GAAR provision. Applying that GAAR, the Y tax
authorities disregard X Sub’s existence (on the basis that it lacks substance),
and treats XCo as owning and selling the shares in YCo – which causes XCo to
derive a taxable capital gain under Y tax law.
Under the Y law, treaties have superior force over domestic law (including
GAAR).
Does the X/Y treaty allow the Y tax authorities to levy tax on XCo in regard to
the taxable capital gain which (they say) XCo derives?
Answer:
Art. 13
If the actual facts are respected (i.e., X Sub, not XCo, owns and sells the
shares in YCo), none of Art. 13(1)-(5) would apply. Thus, Art. 13(6) would
provide XCo with an exemption from Y tax.
If, however, XCo is treated as the owner and seller of the shares in YCo, Art.
13(5) would allow Y to tax XCo on the gain it derives.
GAAR / Treaty abuse
As treaties have superior force over Y domestic law (including GAAR), it might
be thought that the Y tax authorities would not be permitted to apply GAAR to
change the facts, by disregarding X Sub’s existence.
However, the 2011 UN Comm. on Art. 1 would allow that to occur if the use of X
Sub is considered to be an “abuse” of the treaty: see paras. 20-27, and 38-39.
At paras. 25 & 27, the Comm. states that 2 elements must be present for
transactions or arrangements to be found to be an abuse of the treaty: (1) a
main purpose (determined objectively, based on all relevant facts and
circumstances) for entering into the transactions or arrangements was to secure
a more favourable tax outcome; and (2) obtaining that more favourable treatment
would be contrary to the object and purpose of the relevant provisions. [Yes,
this is very similar to the PPT!]
Applying those 2 elements to this case:
Element (1): The fact that X Sub lacks substance is suggestive that this
structure was put in place to allow Art. 13(6) to apply on eventual sale.
However, it is possible that the use of X Sub could be explained for non-tax
reasons – e.g., (a) to enable a sale of YCo without requiring approval from Y
regulatory authorities; and/or (b) to protect XCo from non-tax legal liabilities
in Y. Such possible reasons would need to be investigated, to determine whether
they are credible or not.
Element (2): The scope of the “second limb” in the PPT is very difficult to
identify. However, if the result in element (1) is that a main purpose of the
use of X Sub was to allow Art. 13(6) to apply on eventual sale, it is likely
that that would be considered to be contrary to the object and purpose of the
relevant provisions.
INTERNATIONAL TAX QUIZ 108
For the last 5 years, ACo, a company resident in A, has owned 24% of the shares
in BCo, a publicly listed company resident in B.
Under B domestic law, a 20% dividend withholding tax is levied on all outbound
dividends, regardless of the level of shareholding.
The A/B treaty, which is the first double tax treaty between A and B, recently
entered into force. The A/B treaty is identical to the 2017 OECD model treaty.
For the purpose of qualifying for the 5% dividend withholding tax rate under
Art. 10 of the treaty, ACo has recently purchased an additional 1% of shares
(giving ACo a total of 25% of BCo’s shares).
B introduced into its domestic tax law a GAAR provision (based on the taxpayer’s
principal purpose) 10 years ago.
BCo will soon pay dividends to all its shareholders. Questions:
1. What dividend withholding tax rate should apply to the dividend to be paid
to ACo?
2. Are the B tax authorities permitted to apply the PPT (Art. 29(9)) to this
situation?
3. Are the B tax authorities permitted to apply GAAR to this situation?
4. If the B tax authorities choose to apply GAAR, but not the PPT, to this
situation, and therefore they claim that a higher dividend withholding tax
rate applies, is ACo entitled to request MAP discussions between the A and B
tax authorities?
Answer:
Dividend withholding tax (DWT) rate
Subject to the possible application of Art. 29(9) and/or GAAR (see below), the
DWT rate should be 5% under Art. 10(2)(a), provided ACo holds the 25%
shareholding throughout the required 365 day period.
Note that Art. 10(2)(a) does not require the 365 day period to be satisfied
before the dividend is paid. However, the provision does not prevent B from
requiring that either 15% (Art. 10(2)(b)) or 20% (domestic law) DWT is withheld
by BCo, and allowing ACo to seek a refund of the difference after it has
satisfied the 365 day period.
PPT (Art. 29(9))
These facts are drawn from Example E in para. 182 of the 2017 OECD Comm. on Art.
29.
According to that example, the “first limb” of Art. 29(9) (i.e., “one of the
principal purposes of any arrangement or transaction”) would be satisfied by
ACo’s purchase of the additional 1% of the shares in BCo; however, the exception
in the “second limb” (i.e., “granting that benefit in these circumstances would
be in accordance with the object and purpose of the relevant provisions of this
Convention”) would also be satisfied.
Therefore, based on that example, the result is that the 5% DWT would not be
denied by Art. 29(9).
GAAR
The question suggests that B’s GAAR would be applicable in this situation –
e.g., because it is based on the taxpayer’s principal purpose, and it does not
include an exception similar to the “second limb” of Art. 29(9).
It would therefore lead to a different outcome than Art. 29(9).
The issue is how that conflict between GAAR and Art. 29(9) should be resolved.
There is support for the view that the conflict should be decided in favour of
ACo – i.e., that the B tax authorities cannot apply GAAR to deny a treaty
benefit, if Art. 29(9) does not do so: (1) see paras. 68 to 77 of the 2017 OECD
Comm. on Art. 1; and (2) the A/B treaty does not include a provision which
expressly allows the 2 parties to apply domestic law anti-avoidance rules
(despite the fact that B’s GAAR was in existence for many years before the
treaty was signed). If the A/B treaty has superior status under B domestic law
(vs. domestic legislation), then, IMHO, GAAR should not apply.
However, the legal status of treaties in the B domestic law might be such that
they do not have automatic superior status over domestic legislation. It is
possible that the B legal position is that the GAAR has paramount force over the
A/B treaty – in which case, GAAR would apply.
MAP
If the B tax authorities apply GAAR, but not Art. 29(9), to deny the 5% rate to
ACo, is ACo entitled to request MAP discussions?
The answer is “yes”: ACo’s taxation would not be “in accordance with the
provisions of this Convention” (Art. 25(1)). Thus, ACO would be entitled to
present its case to the competent authority (CA) of either A or B.
Under Art. 25(2), the obligation on the 2 CAs is to “endeavour … to resolve the
case by mutual agreement”. This is an obligation to negotiate, not an obligation
to reach an agreement. That being the case, although the CA for A might be
supportive of ACo’s position that the GAAR should not deny ACo the 5% rate, the
CA for B might not agree.
In that case, ACo might (after 2 years) initiate the arbitration process (Art.
25(5)). However, if the arbitration decision is in favour of A and ACo (i.e.,
GAAR should not be applied), it is still conceivable that, due to its domestic
legal position in regard to GAAR’s paramount force, the B tax authorities might
still insist on applying GAAR – although this would suggest that the B CA
entered into the arbitration process in bad faith.
Note that the 2017 OECD Comm. on Art. 25 indicates that some States deny the
taxpayer the ability to initiate MAP in cases where the transactions are
regarded as abusive. Also, Australia has made a reservation that it reserves the
right to exclude from Art. 25(5) cases involving the application of Australia’s
GAAR.
INTERNATIONAL TAX QUIZ 107
XCo, a company resident in X, is in the business of generating electricity
through wind turbines.
As part of its business, it purchased land in Y, on which wind turbines and
related assets (“wind farm”) were constructed.
All of the decision-making in regard to the establishment of the wind farm was
made by XCo’s employees in X. In fact, XCo has no employees who are based in Y,
and XCo’s employees do not regularly visit Y.
To construct the wind farm, XCo engaged YCo 1, an unrelated company resident in
Y, to construct the wind farm as a service for it. The components for the
construction were purchased by XCo and physically transferred to YCo 1. Ongoing
maintenance of the wind farm is also performed by YCo 1, as a service for XCo.
Legal and administrative arrangements for the sale of the electricity into the Y
electricity grid, are performed by YCo 2, another unrelated company resident in
Y, as a service for XCo – however, YCo 2 does not conclude contracts on behalf
of XCo.
The X/Y treaty is identical to the 2014 OECD model treaty.
Questions: (1) Does XCo have a PE in Y?; (2) If XCo does have a PE in Y: in
determining the profits attributable to the PE under Art. 7, what functions,
assets and risks would be allocated to the PE, on the assumption that it is a
“separate and independent enterprise”?
Answer:
Q1:
The wind farm would constitute a “fixed place of business” PE for XCo under Art.
5(1).
Q2:
The allocation of XCo’s functions, assets and risks to the PE should be done in
accordance with the OECD Comm. on Art. 7 and the OECD’s 2010 report on
attribution of profits to PEs.
The question indicates that all of the significant people functions (SPFs) are
performed by XCo’s employees in X, that XCo has no employees who are based in Y,
and XCo’s employees do not regularly visit Y.
What impact does that have on the determination of the functions, assets and
risks allocated to the PE?
(i) Functions:
The only function which would be allocated to the PE would be the physical
performance of the wind farm. All of the management functions (including the
appointment and monitoring of YCo 1 and YCo 2) are performed by the head office
employees.
(ii) Risks:
All of the risks which relate to the wind farm (e.g., market risk, currency
risk, credit risk, physical risk) are managed by employees at the head office,
and thus those risks would be allocated to the head office.
(iii) Assets:
If the SPF approach were strictly followed in regard to the ownership of
tangible assets, then the ownership of the wind farm (including the land) would
be allocated to the head office. However, the OECD’s 2010 report advocates a
“pragmatic solution”: ownership of tangible assets (including land) would be
attributed based on use (see para. 75). [Note the contradictory statement in
regard to the ownership of a computer server: para. 66.]
Thus, despite the absence of SPFs, the PE should be allocated the ownership of
the wind farm and land.
In regard to the remainder of “step one” (i.e., hypothesising the PE as a
separate and independent enterprise):
(iv) Contractual rights and obligations:
All of XCo’s contractual rights and obligations in regard to the wind farm (in
particular, the contracts with the Y electricity grid) would be allocated to the
head office.
(v) Capital:
As the PE would be allocated ownership of the wind farm and land, its notional
capital base (equity and interest-bearing debt) should be sufficient to fund
those assets.
(vi) Notional dealings:
Based on the above, the notional dealings between the head office and the PE
should be: (a) head office would own equity and interest-bearing debt issued by
the PE; and (b) the PE should operate the wind farm as a service for the head
office.
INTERNATIONAL TAX QUIZ 106
ACo, a company resident in A, carries on a logistics business on a global basis.
ACo owns a warehouse in B. ACo uses the warehouse to provide logistics services
in B.
Under the B domestic tax law, fees paid for logistics services are subject to a
withholding tax of 5% on the gross fees. The withholding tax is a final tax –
i.e., no deductions are allowed. This final withholding tax regime applies to
all logistics services provided in B, regardless of whether they are provided by
residents or non-residents.
The A/B treaty is identical to the 2017 OECD model treaty.
In the current year, ACo’s logistics business in B has incurred losses.
Does the treaty allow ACo to be exempt from B withholding tax, on the basis that
it incurs losses?
Answer:
1. Art. 5:
The warehouse would constitute an Art. 5(1) PE for ACo in B. All of the Art.
5(1) tests would be satisfied. Also, the exceptions in Art. 5(4)(a), (b) & (e)
would not be satisfied, because: (i) the goods stored in the warehouse do not
belong to ACo; and (ii) the provision of logistics services in the warehouse is
a direct income-producing activity for ACo – they are not “preparatory or
auxiliary”.
2. Art. 7:
Art. 7 therefore allows B to impose tax on ACo’s profits which are attributable
to the PE.
This raises 2 issues.
2.1 The first issue is whether Art. 7 allows B to impose tax on ACo only on a
“net” basis – i.e., after deducting expenses. In other words, does gross-basis
taxation satisfy Art. 7’s reference to “profits”?
The answer is that “gross-basis” taxation is not prohibited by Art. 7 – see
paragraph 30 of the 2017 OECD Comm. on Art. 7: “[Art. 7(2)] does not deal with
the issue of whether expenses are deductible when computing the taxable income
of the enterprise in either Contracting State.”
However, Art. 24(3), which requires that the taxation on a PE is “not less
favourably levied in that other State than the taxation levied on enterprises of
that other State carrying on the same activities”, must be considered. Art.
24(3) might be triggered if the gross-basis taxation applied only to
non-resident companies. But that’s not the case here: the gross-basis taxation
applies to all logistics services provided in B, regardless of whether they are
provided by residents or non-residents.
Thus, the B withholding tax levied on ACo would not breach Art. 7 (even though
it is gross-basis taxation) or Art. 24(3).
2.2 The second issue is determining how much of the fees received by ACo are
attributable to the B PE.
Art. 7 allows B to tax ACo only on its profits which are attributable to the B
PE. If the logistics fees are consideration for a freight service which
commences in A (or some other country) and finishes in B, it is quite likely
that not all of the fees should be attributed to the B PE.
Thus, IMHO: The mere fact that ACo’s logistics business in B incurs losses, does
not cause the A/B treaty to prevent the imposition of the B withholding tax.
However, there might be an opportunity for ACo to reduce the quantum of the
withholding tax, on the basis that not all of the fees are attributable to the B
PE.
INTERNATIONAL TAX QUIZ 105
XCo, a company resident in X, carries on a business of transporting cargo.
XCo uses one its ships to transport cargo between X and Y. That ship is owned by
ZCo (a company resident in Z), which leases the ship on a bare boat charter
basis to XCo. ZCo is in the business of leasing ships to ship operators – ZCo
does not itself operate ships.
XCo has a small office in Y, with 2 employees based there. The 2 employees
solicit orders, and sign contracts, for the transport of cargo between X and Y.
The X/Y, X/Z and Y/Z treaties are identical to the 2017 UN model treaty, with
alternative A for Art. 8.
After applying those treaties: (1) which country or countries are permitted to
tax XCo on its profits from transporting cargo between X and Y?; and (2) which
country or countries are permitted to tax ZCo on the bare boat charter fees
which are paid by XCo to ZCo?
Answer:
XCo
XCo would have a PE in Y, under both Art. 5(1) and Art. 5(5)(a) of the X/Y
treaty.
However, XCo’s PE status is irrelevant to XCo’s taxation under the treaty: Art.
8(1) would exempt XCo’s profits from Y tax, and Art. 7(6) would prevent the
application of Art. 7(1). Thus, X would have sole taxation rights.
ZCo
The bare boat charter fees would qualify as “royalties”, as defined in Art.
12(3) of both the X/Z treaty and the Y/Z treaty: “payments … for the use of, or
the right to use, industrial, commercial or scientific equipment”.
X/Z treaty: The royalties would be deemed to arise in X: 1st sentence in Art.
12(5). The 2nd sentence in Art. 12(5) does not apply, as XCo’s PE is not in a
Contracting State (it’s in Y). Thus, X may tax the royalties, subject to the
rate limit in Art. 12(2). Z would be required to provide relief from double
taxation under Art. 23A/B.
Y/Z treaty: XCo has a PE in a Contracting State (Y): see conclusion above in
regard to XCo’s PE under the X/Y treaty. However, based on the facts in the
question, it is difficult to conclude whether the 2 tests in the 2nd sentence in
Art. 12(5) would be satisfied. If the royalties are deemed to arise in Y under
the 2nd sentence in Art. 12(5), then: (i) Y may tax the royalties, subject to
the rate limit in Art. 12(2); and (ii) Z would be required to provide relief
from double taxation under Art. 23A/B (in addition to the relief it must provide
under the X/Z treaty – see above). If the royalties are not deemed to arise in Y
under the 2nd sentence in Art. 12(5), then: (a) Art. 12(2) would not apply; and
(b) ZCo would be exempt from Y tax under Art. 7.
INTERNATIONAL TAX QUIZ 104
XCo, a company resident in X, carries on an insurance business. XCo has no
employees or offices in Y.
XCo owns 100% of the shares in YCo, a company resident in Y, which also carries
on an insurance business.
XCo provides insurance for many types of risk, including some types of risk
which YCo does not insure.
Occasionally, an existing customer of YCo wishes to buy insurance of a type
which is provided by XCo, but not by YCo. YCo will act as a communication
channel between the customer and XCo. However, it will be clear (including to
the customer) that any resulting insurance contract is between XCo and the
customer, and that YCo has no authority to conclude that contract on behalf of
XCo.
YCo does not provide this “communication service” for any other insurance
companies.
YCo charges XCo an arm’s length fee for the “communication service”, but only if
an insurance contract is entered into between XCo and the customer.
Premiums are paid directly by the customer to XCo.
The X/Y treaty is identical to the 2011 UN model treaty.
Does the X/Y treaty permit Y to levy income tax on the insurance premiums paid
to XCo?
Answer:
Art. 5
XCo does not have a PE in Y under either Art. 5(1) or Art. 5(5).
However, does the deemed PE for insurance companies, in Art. 5(6), apply? There
are 2 alternative tests: (1) XCo “collects premiums in [Y] … through a person
[other than an independent agent]”; and (2) XCo “insures risks situated [in Y]
through a person [other than an independent agent]”.
The relevant person is YCo (see below in regard to the “independent agent”
issue).
Test (1) is not satisfied, because the premiums are paid directly by the
customer to XCo.
However, test (2) might be satisfied. Firstly, the risks might be “situated in
[Y]” – this should be investigated. Secondly, arguably the insurance is
“through” YCo. The word, “through”, in this context, is not explained in the UN
Comm. Presumably, it means something other than the conclusion of a contract,
because that would be covered by Art. 5(5)(a). It is quite possible that a
situation where YCo introduces the customer to XCo and acts as the
“communication channel” between the two, could be viewed as XCo insuring risks
“through” YCo.
Test (2) is subject to the “independent agent” exception in Art. 5(7), which has
2 conditions (both of which must be satisfied to qualify for the exception): (i)
the person is “independent” of the enterprise; and (ii) the person is “acting in
the ordinary course of their business”.
Is YCo “independent” of XCo? Neither XCo’s 100% ownership of YCo, nor the fact
that YCo provides the “communication service” for no other insurance companies,
would definitively lead to a conclusion that YCo is dependent on XCo. As there
is nothing else in the facts which suggests dependence, I would conclude that
condition (i) is probably satisfied.
In regard to condition (ii), the UN Comm. adopts the view expressed in the 2010
OECD Comm. that “acting in the ordinary course of their business” refers to the
activities customarily carried out in the agent’s trade, not the other business
activities carried out by that agent. Thus, the fact that YCo does not provide
this service to other insurance companies is irrelevant. In my view, the issue
is: do insurance companies (possibly, restricted to those in Y) customarily
provide such a “communication service”?
As YCo charges an arm’s length fee to XCo, the second sentence in Art. 5(7) does
not apply.
Thus, IMHO: XCo possibly has a PE in Y.
Art. 7
If XCo has a PE in Y, the profits attributable to the PE may be taxed in Y: Art.
7(1).
Under the “authorised OECD approach”, as described in the 2008 OECD report on
the attribution of profits to PEs, the PE should be hypothesised as a separate
and independent enterprise from the remainder of XCo, and the 2-step analysis
should be used.
Based on the question, it appears that none of the significant people functions
(SPFs) (e.g., deciding on whether or not to accept the insurance risk, deciding
on the premiums) are performed by YCo. Thus, the PE should be treated as a
service provider. As the question states that YCo is paid an arm’s length fee
for its services (which would include the potentially valuable “customer
introduction” service), and as YCo does not perform any SPFs, it is likely that
the arm’s length fee would cause the profits attributable to the PE to be very
low (or, possibly, nil).
INTERNATIONAL TAX QUIZ 103
ACo, a company resident in A, has a branch in B. The branch has office premises
in B and there are 10 employees who are based at the branch.
The branch conducts an investment business – it holds equity and debt
instruments issued by numerous companies which are resident in B. In regard to
several of those companies, 100% of the issued shares are held by the branch.
The branch wanted to acquire all of the shares in BCo, a company resident in B.
Most of BCo’s shareholders were resident in A. The transaction was structured as
a “share for share” exchange – i.e., ACo issued new shares to the BCo
shareholders, in return for 100% of the shares in BCo. After this transaction,
the shares in BCo were held by ACo’s branch in B.
ACo incurred significant costs in the “share for share” exchange (e.g., time of
head office and branch employees, and external costs for capital duty, lawyers,
accountants, valuers, etc.). Those costs are tax deductible under the A income
tax law.
The A/B treaty is identical to the 2008 OECD model treaty.
In determining the profits attributable to the PE under Art. 7 of the treaty,
how should the costs be treated?
Answer:
The profits attributable to the PE should be determined using the “authorised
OECD approach” which is described in the 2008 OECD report on attribution of
profits to PEs. That approach requires the assumption that the PE is an
independent and separate enterprise from the remainder of ACo, and the use of a
2-step analysis.
The starting point is the identification of the signficant people functions in
regard to the “share for share” transaction. The question indicates that the
branch management made the decision to acquire all of the shares in BCo, but
there was also some head office employee time spent on the transaction. This
suggests that the branch management took primary responsibility for the
transaction, but some support was provided by the head office employees – this
would need to be confirmed by a functional analysis.
Assuming it is confirmed, then that would probably lead to a conclusion that the
PE would notionally be considered to have issued all of the ACo shares and to
have incurred all of the costs which relate the transaction. It would also mean
that the PE should pay a service fee to the head office to reward the head
office for its employee time. Due to the fact that the relevant treaty is
identical to the 2008 OECD model treaty (which includes the “old” Art. 7(3) in
regard to expenses), and also due to the fact that the head office (I assume) is
not in the business of providing such services, the service fee should be at
cost.
An important point to note is that there is nothing in the 2008 or 2010 OECD
reports on attribution of profits to PEs, which suggests that the usual approach
for attributing profits to a PE does not apply to so-called “organ costs” –
i.e., costs which relate to the legal entity, such as costs incurred in the
legal entity issuing new shares.
INTERNATIONAL TAX QUIZ 102
XCo, a company resident in X, carries on a share trading business. For financial
accounting purposes, XCo reports the shares it owns as inventory (i.e., trading
stock).
As part of its share trading business, XCo purchased shares in YCo, a company
resident in Y. YCo’s shares are listed on the Y stock exchange. Over 95% of
YCo’s assets (by value) are buildings in Y.
Several weeks later, XCo sold all of its shares in YCo for a profit.
The share purchase and sale transactions were undertaken for XCo by ZCo, an
independent stockbroker in Y.
XCo has never had any employees or office premises in Y.
Under Y domestic law, XCo’s profit on the sale of the YCo shares is subject to
income tax.
The X/Y treaty is identical to the 2017 OECD model treaty.
Does the treaty permit Y to levy income tax on XCo’s profit?
Answer:
Art. 13
As more than 95% of YCo’s assets (by value) are buildings in Y, the shares in
YCo satisfy the “more than 50 per cent” test in Art. 13(4). Therefore, Art.
13(4) permits Y to levy income tax on XCo’s gains derived from the sale of the
YCo shares.
Art. 13(2) is not relevant, as XCo does not have a PE in Y (see below).
Art. 5
XCo does not have either a “fixed place of business” PE in Y or an agency PE in
Y. In regard to agency PE, ZCo’s contract-concluding activities would be
excluded from Art. 5(5), by the independent agent exception in Art. 5(6)
(provided ZCo is acting in the ordinary course of its business).
Art. 7
As XCo does not have a PE in Y, it would (prima facie) be exempt from Y tax,
under Art. 7(1). The conflict between Art. 13(4) (taxable) and Art. 7(1)
(exempt) is resolved in favour of Art. 13(4), due to Art. 7(4). Thus, Y would be
permitted to levy income tax on XCo’s gains derived on the sale of the YCo
shares.
INTERNATIONAL TAX QUIZ 101
ACo, a company resident in A, purchased 60% of the shares in BCo, a company
resident in B.
ACo’s purchase price was $6 million, and its purchase was from an unrelated
party.
During ACo’s ownership of the BCo shares, BCo paid no dividends or other
distributions to its shareholders.
Several years later, ACo sold all of its BCo shares to another unrelated party,
for a price of $2 million. ACo therefore incurred a loss of $4 million on the
sale of the BCo shares.
Under the B domestic tax law, capital gains derived by non-residents on the sale
of shares in B-resident companies are subject to income tax at a 25% rate. In
computing such capital gains, the actual purchase price is ignored; instead, a
capital gain equal to 20% of the sale price is deemed to be derived by the
non-resident seller. Thus, in ACo’s case, ACo is deemed to derive a capital gain
of $400,000 (i.e., $2 million x 20%), and is therefore liable for B income tax
of $100,000 (i.e., $400,000 x 25%).
The A/B treaty is identical to the 2017 UN model treaty. The percentage in Art.
13(5) is 10%.
Does the A/B treaty permit B to levy $100,000 income tax on ACo in regard to its
sale of shares in BCo?
Answer:
Note
This question is based on the Indonesian capital gains tax rules.
Art. 13(5)
Art. 13(5) permits B to levy tax on “gains … derived by [ACo] from the
alienation of shares [in BCo]”. Does ACo have a “gain derived”, in the situation
where it has incurred a loss of $4 million on the sale of the shares in BCo?
Para. 12 of the OECD Comm. on Art. 13 (which is incorporated in the UN Comm.)
states:
“The Article does not specify how to compute a capital gain, this being left to
the domestic law applicable. As a rule, capital gains are calculated by
deducting the cost from the selling price. … Some tax laws prescribe another
base instead of cost, e.g. the value previously reported by the alienator of the
asset for capital tax purposes.”
Although it does not specifically refer to the calculation method used by B, the
Comm. is quite clear that the calculation of a capital gain is solely a domestic
law matter. Therefore, based on the Comm., I would conclude that Art. 13(5)
permits B to levy $100,000 tax on ACo.
Art. 2
A possible issue arises under Art. 2: is B’s tax on ACo’s deemed “capital gain”
a tax on income or a tax on capital? The argument in favour of it being a tax on
capital is that ACo has actually derived a loss (not income). If it is a tax on
capital, then Art. 22 would apply, instead of Art. 13: Art. 22 would not permit
B to levy tax (i.e., there is no equivalent to Art. 13(5) in Art. 22).
However, B’s taxation of ACo’s deemed “capital gain” is part of B’s income tax,
which we can assume (according to its predominant character) is clearly a tax on
income. Although the position might be different if B’s taxation of ACo’s deemed
“capital gain” were pursuant to a separate tax, it is not: it is part of B’s
income tax. Therefore, IMHO: Art. 2 does not cause Art. 22 to apply, instead of
Art. 13.
INTERNATIONAL TAX QUIZ 100
XCo, a company resident in X, sells goods to YCo, a related company resident in
Y.
The income tax rates are 25% (in X) and 20% (in Y).
The X/Y treaty is identical to the 2011 UN model treaty.
In a particular year, XCo derived $100 million of revenue from sales to YCo.
Under the Y transfer pricing rules, the Y tax authorities reduced YCo’s
aggregate consideration for purchases in that year from XCo to $80 million –
i.e., a reduction of $20 million. The Y tax authorities therefore issued an
assessment to YCo for tax of $4 million (i.e., $20 million x 20%). In addition,
the Y tax authorities imposed a 50% “gross negligence” penalty of $2 million on
YCo (i.e., $4 million x 50%). Thus, in total, YCo is required to pay $6 million
in additional Y tax and penalties.
Will the X/Y treaty allow the group to obtain any relief in X for that $6
million?
Answer:
Art. 9(2):
Ignoring for the moment Art. 9(3) (see below), Art. 9(2) would require the X tax
authorities to make a corresponding adjustment only if, and to the extent, they
agree with the primary adjustment made by the Y tax authorities – i.e., the
reduction of $20 million in the purchase price. Therefore, a preliminary issue
is: do the X tax authorities agree with that $20 million reduction? If they
don’t agree with all or part that reduction, then economic double taxation will
be the result, unless (i) YCo can achieve a more favourable assessment in Y, via
the appeals process; and/or (ii) an agreement between the 2 competent
authorities is achieved under Art. 25.
If the X tax authorities do agree with the primary adjustment, then Art. 9(2)
would require them to “make an appropriate adjustment to the amount of [X] tax
charged … on [the $20 million]”. That adjustment might occur under Art. 9(2)
itself – i.e., XCo’s taxable profits would be reduced by $20 million, which
(ironically) would cause a reduction of $5 million in X tax (cf. YCo’s $4
million increase in Y tax). Under this mechanism, there would be no adjustment
in X in regard to the $2 million penalty.
The OECD & UN Commentaries on Art. 9(2) suggest that an alternative mechanism
for the “appropriate adjustment” would be for X to provide XCo with relief from
double taxation under Art. 23. Again, under this mechanism, there would be no
adjustment in X in regard to the $2 million penalty.
Art. 9(3):
However, according to Art. 9(3), Art. 9(2) shall not apply where “judicial,
administrative or other legal proceedings have resulted in a final ruling” that
YCo is liable to a penalty with respect to, inter alia, gross negligence.
In that situation, not only is there no corresponding adjustment in X for the $2
million penalty in Y, there would also be no requirement for X to provide a
corresponding adjustment for Y’s $20 million reduction of the purchase price –
i.e., the full $6 million would not be relieved in X.
An open issue would be whether, in this present case, the “judicial,
administrative or other legal proceedings have resulted in a final ruling” in
regard to the penalty. If, for example, YCo still has time to appeal in regard
to the penalty, the X tax authorities would probably wait for that appeal
process to be completed or time-barred, so that they know whether Art. 9(3) will
be triggered.
INTERNATIONAL TAX QUIZ 99
XCo (a company resident in X) has licensed IP to YCo (a company resident in Y),
in return for arm’s length royalties.
Subject to exceptions mentioned in some scenarios below: (i) X levies income tax
at a flat rate of 25% on resident companies; (ii) XCo’s royalty income is
treated as taxable income for X income tax purposes; and (iii) X does not levy
an “alternative minimum tax”.
The Y domestic tax law levies a final withholding tax of 20% on the gross amount
of outbound royalties.
The X/Y treaty is identical to the 2011 UN model treaty, except that Art. 12(2)
says this:
“However, such royalties may also be taxed in the Contracting State in which
they arise and according to the laws of that State, but if the beneficial owner
of the royalties is a resident of the other Contracting State and is subject to
tax in that other Contracting State in respect thereof, the tax so charged shall
not exceed 5 per cent of the gross amount of the royalties.”
The MLI does not apply to the X/Y treaty.
After applying Art. 12(2), what rate of Y withholding tax would apply to the
royalties paid by YCo to XCo in the current year, in each of these scenarios
(which deal with XCo’s income tax treatment in X):
(1) XCo incurs a tax loss in the current year.
(2) XCo derives a taxable profit in the current year, but it reduces that
taxable profit to nil by deducting its carried forward tax losses.
(3) XCo derives a taxable profit in the current year, but it reduces that
taxable profit to nil by deducting tax losses which are transferred to it by
related X-resident companies.
(4) X income tax is levied on a progressive rate scale starting at 0%, and (in
the current year) XCo is in the 0% band.
(5) XCo derives a taxable profit in the current year, but it reduces its X
income tax payable to nil by claiming foreign tax credits.
(6) XCo derives a taxable profit in the current year, but it is subject to a 2%
rate (or alternatively, 0% rate) because it is based in a “technology zone” in
X.
(7) X levies income tax on foreign sourced income only if and when it is
remitted to X; XCo’s royalty income in the current year is unremitted foreign
sourced income.
(8) XCo derives the royalty income through a PE in Z; XCo pays 30% Z income tax
on the royalty income; the X/Z treaty is identical to the 2011 UN model, with
Art. 23A.
(9) XCo derives a taxable profit in the current year, and it pays X income tax
at the 25% rate on that taxable profit; however, when XCo pays dividends, the
full amount of XCo’s income tax is credited to the shareholders in XCo, under
the X dividend imputation system.
(10) XCo derives a taxable profit in the current year, and it pays X income tax
at the 25% rate on that taxable profit; however, 90% of XCo’s royalty income is
excluded from its gross taxable income.
(11) XCo derives a taxable profit in the current year, and it pays X income tax
at the 25% rate on that taxable profit; however, in computing the taxable
profit, XCo is allowed a 250% deduction (for IP amortisation), which exceeds the
amount of royalty income.
(12) XCo derives a taxable profit in the current year, and it pays X income tax
at the 25% rate on that taxable profit; however, the X government provides a
grant to XCo, equal to the X income tax on its gross royalty income.
Answer:
For XCo to qualify for the 5% rate, Art. 12(2) includes a condition that “the
beneficial owner of the royalties … is subject to tax in [X] in respect thereof”
– i.e., in respect of the royalties.
This “subject to tax” (STT) condition is not included in either the OECD or UN
model treaty, and it is relatively unusual in the dividends, interest and
royalties articles in bilateral treaties. There is very little authority on its
meaning.
Note that the STT condition refers to the royalties – in contrast to, say, the
“liable to tax” condition in Art. 4, which refers to the taxpayer.
Based on the limited authority, IMHO: the STT condition means that the relevant
income is included in the tax base for the tax (i.e., included in the gross
taxable income) – it does not mean that tax is actually paid. This distinction
is critical to my answers below:
(1) 5%.
(2) 5%.
(3) 5%.
(4) This scenario is difficult, because of the 0% tax band. If XCo’s taxable
profits were sufficiently high to move into higher tax bands, XCo would pay
current year income tax. As the STT condition relates to the royalty income, it
would seem strange if that condition depended on whether XCo derived sufficient
other income. Therefore, on balance, I think that the STT condition should be
satisfied here – i.e., 5%.
(5) 5%.
(6) (i) If 2% rate: 5% wht applies. (ii) If 0% rate: I think it would be
difficult to argue that the royalties are subject to tax. Thus, IMHO: 20%.
(7) Unless it is remitted, 20%. If it is remitted at a later time, then a refund
of the excess Y tax might be possible at that time, subject to the time limits
under Y law.
(8) 20% – the STT condition refers to taxation in X, not in third countries.
(9) 5% – the STT condition refers to taxation of XCo – the treatment of other
entities should be irrelevant.
(10) This scenario is difficult. Do you split the royalties into 2 groups (90%)
and (10%), and then Y levies 20% wht on the 90% group and 5% wht on the 10%
group? Or do you say that 100% of the royalties are subject to an effective X
tax rate of 2.5% (10% x 25%), and thus 100% of the royalties satisfy the STT
condition? On balance, I think the latter is the better approach – i.e., 5% wht
on 100% of the royalties.
(11) 5%.
(12) 5%. However, query whether the Y government would be considered to breach
Art. 28, VCLT, to perform the treaty “in good faith”.
INTERNATIONAL TAX QUIZ 98
ACo, a company incorporated in A, has a branch in B.
The branch, which has 10 employees, operates solely to purchase goods for ACo.
B imposes a payroll tax on the total payroll of companies operating in B. For
B-incorporated companies, the payroll tax rate is 4%; for foreign-incorporated
companies, the payroll tax rate is 10%.
Under the respective income tax laws of A and B, a company’s residence status is
determined by incorporation.
The A/B treaty is identical to the 2014 OECD model treaty.
Is ACo liable for the 10% payroll tax?
Answer:
Art. 2:
B’s payroll tax is levied on the total payroll of companies operating in B.
Thus, it should fall within the list of covered taxes in Art. 2(2): “taxes on
the total amount of wages or salaries paid by enterprises”.
Note that if the payroll tax were levied on only some of the payroll, it would
not fall within this description (see below).
Art. 2(2) does not state whether payroll taxes are taxes on income or on
capital. If on income, Arts. 6 to 21 should apply; if on capital, Art. 22 should
apply. Payroll taxes don’t fit neatly into either category! See Michael Lang, ”
‘Taxes Covered’ – What is a ‘Tax’ according to Article 2 of the OECD Model?”,
Bulletin on International Taxation, IBFD, June 2005.
Arts. 6 to 21:
If B’s payroll tax is a tax on income, then ACo should be exempt from the
payroll tax under either Art. 7 or Art. 21. The Art. 7 exemption should apply if
ACo does not have a PE in B – ACo’s branch should be excluded from PE status
under Art. 5(4)(d).
Art. 22:
If B’s payroll tax is a tax on capital, then ACo should be exempt under Art.
22(4).
If B’s payroll tax is not a covered tax in Art. 2(2):
If B’s payroll tax is not a covered tax in Art. 2(2) (e.g., because it is levied
on only some of the payroll), then Arts. 6 to 21 (income) and 22 (capital)
should not apply to the tax.
However, Art. 24 would be applicable: Art. 24(6).
Art. 24(3) should not apply, on the basis that ACo does not have a PE in B (see
above).
Art. 24(1) is relevant. ACo is a “national” of A, under the Art. 3(1)
definition. The 10% vs. 4% rate differential is due to the nationality
difference between ACo and B-incorp. companies. However, Art. 24(1) requires the
comparison to be made against B-incorp. companies “in the same circumstances”:
does that mean that, for the B-incorp. companies to be validly compared with
ACo, the B-incorp. companies and ACo need to have the same tax residence status
(which they don’t)?
According to the OECD Comm, the answer (surprisingly) is “no”: see Example 4 in
para. 23.
Thus, if B’s payroll tax is not a covered tax in Art. 2(2), ACo should be able
to secure the 4% rate by virtue of Art. 24(1).
INTERNATIONAL TAX QUIZ 97
XCo (a company resident in X) has valuable technical knowledge.
YCo (a related company resident in Y) carries on a technical consulting
business.
XCo and YCo enter into a contract, under which XCo agrees to provide its
technical knowledge to YCo, in consideration for a payment equal to 10% of YCo’s
gross technical consulting fees.
YCo’s consulting business includes the provision of consulting services to
clients in Z. YCo does not have an office, or any employees who are based, in Z.
In a particular year, YCo provided consulting services to 20 different clients
in Z. The services were mainly provided by YCo’s Y-based employees being present
at the Z business premises of those clients: planning and conducting interviews,
writing reports, presenting findings, etc. YCo’s employees were present at the Z
business premises for an aggregate of 200 business days during the year.
However, at no single business premises were they present for more than 50
business days during the year.
All the contracts for the consulting services are negotiated and entered into by
the senior management of YCo in Y.
The X/Z treaty is identical to the 2017 UN model (with a 10% rate limit in both
Art. 12 and Art. 12A), and the Y/Z treaty is identical to the 2017 OECD model.
Do those treaties permit Z to levy income tax on YCo and/or XCo?
Answer:
Y/Z treaty
1. XCo:
The Y/Z treaty is not relevant to Z’s taxation of XCo.
2. YCo:
No Art. 5(1) PE, as YCo did not have any of the clients’ premises at its
disposal for a sufficiently long period.
Thus, Art. 7(1) would provide YCo with an exemption from Z tax on its profits.
No other provision in the treaty is relevant – thus, YCo would be exempt from Z
tax.
X/Z treaty
1. XCo:
XCo would not have a PE in Z under Art. 5.
However, the payments made by YCo to XCo should satisfy the definition of
“royalties” in Art. 12(3): payments “for information concerning industrial,
commercial or scientific experience”. Under Art. 12(5), the royalties would be
deemed to arise in Z if (1) the payer (YCo) is resident in Z (which it is not),
or (2) the royalties have a relevant nexus with a PE of the payer (YCo) in Z.
Note that the PE status of YCo for the purposes of Art. 12(5), will be
determined under Art. 5 of the X/Z treaty. It is irrelevant that YCo does not
have a PE in Z under the Y/Z treaty (see above).
YCo would not have an Art. 5(1) PE in Z, as none of the client business premises
was at its disposal for a sufficiently long period. However, the furnishing of
services in Z would satisfy the requirements for an Art. 5(3)(b) PE – note that
the words, “for the same or a connected project”, which appeared in earlier
versions of Art. 5(3)(b), were deleted in the 2017 UN model.
A relevant nexus with the PE will exist under Art. 12(5) if 2 tests are
satisfied: (i) the liability to pay the royalties was incurred in connection
with the PE, and (ii) the royalties are borne by the PE.
Test (i): This test is not explained in the UN Comm. on Art.12. However, a
similar test exists in Art. 11, and the UN Comm. on Art. 11 incorporates the
OECD Comm. on Art. 11 – which says that the test is satisfied only where the
relevant contract (i.e., the provision of knowledge contract, in our case) was
entered into solely for the purposes of the relevant PE. That is unlikely to be
the situation here – e.g., XCo’s knowledge is probably also intended to be used
in YCo’s operation in Y, if not other countries. Thus, it is likely that test
(i) is failed.
Test (ii): This test is not explained in either Comm. on Art. 11 or 12. However,
as YCo does not have an office, or employees who are based, in Z, it is likely
that YCo does not produce any financial statements for its operations in Z. If
that is the case, it is unlikely that the royalties, or any part of the
royalties, are borne by the Z PE.
Thus, Art. 12 should not apply. Also, Art. 12A would not apply, as XCo does not
provide “services” to YCo – it provides information (i.e., knowhow): see para.
62 of UN Comm. on Art. 12A.
That would mean that Art. 7(1) should exempt XCo from Z tax.
However, if XCo does not carry on an active business, it is possible that the Z
tax authorities could claim that it does not carry on an “enterprise” (defined
in Art. 3(1)), thus Art. 7 does not apply, and thus Art. 21(3) allows unlimited
Z tax (if the royalties “arise” in Z). Note that, according to the UN Comm. on
Art. 21, “arising” takes its meaning under Z law. In the circumstances of this
case, it is possible that a proportion of the royalties could be considered to
“arise” in Z under Z law.
2.YCo:
The X/Z treaty is not relevant to Z’s taxation of YCo.
INTERNATIONAL TAX QUIZ 96
ACo, a company resident in A, owns 100% of the shares in BCo, a company resident
in B.
All of BCo’s assets consist of land situated in B.
ACo entered into exclusive negotiations with CCo, a company resident in C, in
regard to the sale of ACo’s shares in BCo. All of the negotiations were held in
A. As a condition for conducting the negotiations on an exclusive basis, CCo was
required to pay ACo a significant, non-refundable deposit – i.e., if the
negotiations did not result in a sale contract, the deposit would be forfeited
by CCo.
That’s exactly what happened: no sale contract was entered into, and ACo
therefore kept CCo’s deposit.
The A/B treaty and the A/C treaty are both identical to the 2017 UN model
treaty.
Does the A/B treaty allow B, and does the A/C treaty allow C, to levy income tax
on ACo in regard to the deposit?
Answer:
(1) Threshold issue:
The term, “alienation”, is not defined in either the OECD or UN model treaties.
Also, a comprehensive definition is not provided in either the OECD or UN Comm.
on Art. 13.
The OECD Comm. (this part is copied into the UN Comm.) states that “alienation”
is used to cover various forms of transfer of property. It also says that some
countries include, in the term, “alienation”, capital appreciation and
revaluation of property. The inference is that the term takes its meaning from
the domestic law of the source country – i.e., if the source country law treats
the transaction as an alienation of property, then that would qualify as an
alienation of property for the purposes of Art. 13. This is likely an
application of Art. 3(2), although Art. 3(2) is not mentioned.
If that is correct, then the critical threshold issue is: does B law (in regard
to the A/B treaty) or does C law (in regard to the A/C treaty) treat the
transaction involving the forfeited deposit as an alienation of property?
(2) A/B treaty:
If an alienation is recognised under B law, then Art. 13(4) would allow B to
levy income tax on ACo’s deposit.
If an alienation is not recognised under B law, then Art. 13 would not apply
(all paragraphs in Art. 13 refer to “alienation”). Instead, Art. 7 would provide
ACo with an exemption from B tax (if ACo has no PE in B) – subject to one
qualification: if B considers that ACo does not carry on an “enterprise” (as
defined in Art. 3(1)) (because ACo is a passive holding company), then Art.
21(3) becomes relevant. Under Art. 21(3), the issue is whether the deposit
arises in B. According to the UN Comm. on Art. 21, “arises”, when applied by B,
should be interpreted under B law. Nevertheless, the fact that the payer is not
a resident of B (nor has a PE in B), and that the negotiations were held in A,
suggest that the deposit does not “arise” in B.
Art. 6 should not apply, as the deposit is not “derived … from immovable
property [in B]” – ACo has no ownership or other legal interest in immovable
property in B.
(3) A/C treaty:
If an alienation is recognised under C law, then Art. 13(6) would exempt ACo’s
deposit from C tax.
If an alienation is not recognised, then Art. 13 would not apply. Instead, Art.
7 would provide ACo with an exemption from C tax (if ACo has no PE in C) –
subject to one qualification: if C considers that ACo does not carry on an
“enterprise” (as defined in Art. 3(1)) (because ACo is a passive holding
company), then Art. 21(3) becomes relevant. Under Art. 21(3), the issue is
whether the deposit arises in C. According to the UN Comm. on Art. 21, “arises”,
when applied by C, should be interpreted under C law. The fact that the payer is
a resident of C might point to the deposit “arising” in C, although the fact
that all the negotiations were held in A points against this.
INTERNATIONAL TAX QUIZ 95
XCo, a company incorporated and resident in X, owns some land in Y.
XCo sells the land to YCo, a related company incorporated and resident in Y, for
a price of $Z. XCo does not own any shares in YCo.
Under the corporate income tax laws of both X and Y, a company is resident only
if its central management and control is located in X or Y, respectively.
In accordance with Y stamp duty law, XCo pays 5% “seller’s stamp duty” on the
price of $Z, and then transfers the balance of the sale price to its bank
account in X. Under Y law, seller’s stamp duty is imposed only on sellers which
are foreign-incorporated companies.
Some months later, the Y tax authorities claim that the price of $Z was less
than the arm’s length price (ALP) of the land. They therefore claim that XCo
owes additional stamp duty on the excess of the ALP over $Z.
XCo currently owns no assets in Y.
The X/Y treaty is identical to the 2017 OECD model treaty.
Will XCo be required to pay the additional stamp duty?
Answer:
(1) Art. 24:
The non-discrimination rules in Art. 24 apply to all taxes, regardless of
whether or not they are “taxes covered” under Art. 2: Art. 24(6). Thus, Art. 24
is applicable to stamp duty.
XCo is a “national” of X, based on incorporation: Art. 3(1) definition of
“national”.
Thus, Art. 24(1) potentially applies to XCo. The comparator in Art. 24(1) is
“nationals of [Y] in the same circumstances, in particular with respect to
residence”. The concept of “residence” probably refers to the definitions in
Art. 4. If so, then the comparator would be a company which is incorporated in Y
(and is therefore a “national” of Y), but which has its central management and
control in X (and is therefore, like XCo, not resident in Y, under Art. 4). Such
a comparator would not be liable for the Y seller’s stamp duty (because it is
incorporated in Y), and therefore Art. 24(1) is breached in regard to XCo.
Thus, subject to the “force of law” issue (see below), XCo would have a right to
avoid paying the Y seller’s stamp duty on the excess of the ALP over $Z; it
would also have a right to obtain a refund of the seller’s stamp duty it had
already paid on the $Z, subject to time limits under Y law.
(2) Art. 27:
If the conclusion on Art. 24 is incorrect, Y would be able to obtain the
assistance of the X tax authorities to collect the outstanding amount of Y
seller’s stamp duty from XCo. Note that Art. 27 is not limited to the “taxes
covered” under Art. 2: Art. 27(1).
(3) Force of law:
Some countries give the force of law to tax treaties for only limited purposes –
e.g., for the purposes of the “taxes covered” in Art. 2.
If Y is such a country, that limited force of law for the X/Y treaty might mean
that XCo could not claim the benefit of Art. 24 to defend against the Y seller’s
stamp duty.
In that case, an interesting question would be whether the Y tax authorities
could obtain the assistance of the X tax authorities to collect the stamp duty
under Art. 27. A threshold issue would be whether the Art. 27 right given to the
Y tax authorities is dependent on X giving the force of law to Art. 27 –
arguably, it is not so dependent, because Art. 27 is a “country-to-country”
obligation under international law. The substantive issue is whether the X tax
authorities would (or legally could) refuse to provide the assistance, due to
Y’s breach of Art. 24.
INTERNATIONAL TAX QUIZ 94
ACo is a publicly listed bank which is resident in A. ACo has a branch in B. The
branch constitutes a PE under the A/B treaty.
A small percentage of ACo’s shares are indirectly listed on the B stock exchange
in the form of B Depositary Receipts (BDRs). The BDRs are structured in this
way: (1) some shares in ACo are owned by CCo, an unrelated bank resident in C,
on bare trust (i.e., as nominee) for the B branch of ACo; and (2) the B branch
of ACo issues BDRs (negotiable instruments listed on the B stock exchange), with
the ACo shares held by CCo as the relevant underlying property.
Some of the BDRs are acquired by DCo, an investment company resident in D.
ACo pays dividends on its shares. In regard to the shares held by CCo, the
dividends are received by CCo, which transfers the cash (less its expenses and
fees) to the B branch of ACo, which in turn transfers the cash (less its
expenses and fees) to the holders of the BDRs (including DCo).
Under the domestic law of each of A and B, a 20% withholding tax is imposed on
outbound dividends and on outbound “dividend equivalent payments” under
Depositary Receipts.
All 6 bilateral treaties (i.e., A/B, A/C, A/D, B/C, B/D and C/D) are identical
to the 2017 UN model treaty.
After applying those treaties, will ACo or DCo have an income tax liability in A
or B on the dividends and the resulting flow of cash?
Answer:
(1) ACo’s A tax liability:
Under A domestic law, a liability for A dividend withholding tax would probably
not arise, due to mutuality.
Nevertheless, the profit (if any) derived by ACo’s B branch on the BDRs might be
taxable under A domestic law (regardless of mutuality), unless that law exempts
profits of foreign branches.
(2) ACo’s B tax liability:
Art. 7 of the A/B treaty would likely allow a profit to be recognised (and
taxed) on the BDRs, based on the “separate enterprise” assumption.
The actual profit (if any) derived by ACO’s B branch might be taxable under B
domestic law (regardless of mutuality).
(3) DCo’s A tax liability:
Under domestic law, A imposes a 20% withholding tax on outbound dividends and
“dividend equivalent payments” under Depositary Receipts.
Thus, under domestic law, the cash paid to DCo should be subject to 20% A tax,
as either a dividend or a dividend equivalent payment.
Under the A/D treaty, if the cash retains the character as a dividend, Art. 10
should apply to permit A to levy tax according to the rate specified in Art. 10
– i.e., if the cash is a dividend, DCo should be the beneficial owner of the
dividend.
However, if, under the A/D treaty, the cash does not retain its character as a
dividend, then Art. 10 would not apply. Instead, Art. 7 should apply to exempt
the cash (in the absence of a PE in A). There would be a risk that the A tax
authorities would claim that Art. 7 does not apply, because DCo is a passive
investor – and that Art. 21(3) would allow A tax (without limit).
(4) DCo’s B tax liability:
Art. 10 does not apply, because the company paying the dividend is not a
resident of B.
Art. 7 should apply to exempt the cash (in the absence of a PE in B). There
would be a risk that the B tax authorities would claim that Art. 7 does not
apply, because DCo is a passive investor – and that Art. 21(3) would allow B tax
(without limit).
(5) Double tax relief in D:
Thus, it is possible that the cash is taxed in both A and B (in A, under Art. 10
or Art. 21(3); in B, under Art. 21(3)). In addition, the cash might be taxable
under D domestic law. If the D tax authorities accept the applicability of the A
and B tax in the 2 treaties, then D would be required to provide relief from
double taxation under Art. 23A/B of the 2 treaties.
Note: The facts are based on the 2021 decision of the Mumbai ITAT in the Morgan
Stanley case.
INTERNATIONAL TAX QUIZ 93
XCo, a company resident in X, owns some IP.
Some years ago, XCo licensed the IP to YCo (a related company resident in Y),
for use in Y.
The royalties paid by YCo to XCo are (1) tax deductible to YCo, (2) subject to
10% Y royalty withholding tax (in accordance with the X/Y treaty), and (3)
taxable to XCo under X income tax law (with a foreign tax credit for the Y
royalty withholding tax). However, due to the calculation of credits under X law
(i.e., allocation of deductions), XCo does not obtain a full credit for the Y
withholding tax.
YCo entered into a unilateral APA with the Y tax authorities. Under the APA, the
royalty rate was reduced. Also, the APA was “rolled back” for 2 years.
YCo has filed amended Y income tax returns covering the last 2 years, to reflect
reduced deductions for royalties, as agreed in the APA.
The APA does not cover the Y royalty withholding tax which has been incurred by
XCo – and, being unilateral, it also does not cover XCo’s X income tax liability
on the royalty income.
The X/Y treaty is identical to the 2017 OECD model treaty, with Art. 23B –
except that Art. 12 permits 10% source country tax on royalties.
What steps can be taken to properly adjust XCo’s tax position (in both X and Y),
to reflect the APA’s reduced royalty rate for the last 2 years?
Answer:
(1) XCo’s tax position in Y:
Although the reduction in YCo’s royalty deductions (“excess royalties”) is
pursuant to Art. 9(1), XCo cannot claim the benefit of Art. 9(2), which is
directed at the X tax authorities making a corresponding adjustment (see below).
However, Art. 12(4) should apply, with the result that the 10% Y tax does not
apply to the excess royalties. Instead, under the 2nd sentence in Art. 12(4),
the excess royalties “shall remain taxable according to the laws of each
Contracting State, due regard being had to the other provisions of this
Convention”. If the Y tax law does not allow secondary TP adjustments, then the
excess royalties should be exempt from Y tax under Art. 7 or 21 (assuming that
XCo does not have a PE in Y). However, if the Y tax law does allow secondary TP
adjustments, then the excess royalties might be treated as a deemed dividend to
YCo’s shareholder, or as a deemed interest-bearing loan to XCo – both of which
might cause further Y tax (wholly or partly compensating for the 10% royalty
withholding tax on the excess royalties).
If the net result would be an amount of reduced Y tax for XCo, XCo could
institute the MAP process under Art. 25 to try to secure the reduction.
Alternatively, the Y domestic law might allow XCo to secure the reduction.
(2) XCo’s tax position in X:
Threshold issue: The X tax authorities are not required to make any
corresponding adjustment except to the extent that they agree with the primary
adjustment made by the Y tax authorities in the APA.
Assuming they do fully agree with the primary adjustment…
Art. 9(2) requires the X tax authorities to “make an appropriate adjustment to
the amount of the tax charged” on XCo’s profits. Art. 9(2) and the OECD Comm. do
not mandate the form of that adjustment – but a common way would be for XCo’s
royalty income from YCo to be reduced. XCo could institute the MAP process under
Art. 25 to try to secure the consequential reduction in X tax.
The amount (if any) of the reduction in X tax should take into account the
amended Y withholding tax position. Also, as XCo is not entitled to a full
foreign tax credit, the impact on XCo’s credit position would need to be
calculated.
INTERNATIONAL TAX QUIZ 92
ACo, a company resident in A, owns 100% of the shares in BCo, a company resident
in B.
ACo formed BCo many years ago to hold real estate in a number of countries.
BCo now owns real estate in B and C. The relative market value of the real
estate is currently 40% in B, and 60% in C.
BCo owns no other assets and it has no liabilities.
ACo is planning to sell 20% of its shares in BCo. ACo will derive a profit of
$10 million on the sale.
The A/B, A/C and B/C treaties are all identical to the 2017 UN model treaty,
with Art. 23B
Questions:
(1) Do the treaties permit B and/or C to levy income tax on ACo’s profit?
(2) If so, is the tax permitted to be on the whole, or only part, of the profit?
(3) Is A required to provide a credit for the tax in B and/or C?
Answer:
1. The A/C treaty (Art. 13(4)) permits C to levy income tax on ACo’s profit.
Also, the A/B treaty (Art. 13(5)) permits B to levy income tax on ACo’s
profit. Although I did not specify the percentage in Art. 13(5) of the A/B
treaty, as ACo owns 100% of the shares in BCo, any percentage in Art. 13(5)
would be satisfied.
2. For each treaty, the tax is permitted to be on the whole of the profit –
i.e., $10 million.
3. Under the A/C treaty (Art. 23B(1)), A is required to provide a credit to ACo
for the tax paid to C on the profit.
Also, under the A/B treaty (Art. 23B(1)), A is required to provide a credit
to ACo for the tax paid to B on the profit.
For each treaty, the credit is limited to the amount of A tax on ACo’s
profit, as computed before the relevant credit. As ACo would be entitled to
2 credits, in practice this would mean that the aggregate of the 2 credits
cannot exceed the A tax on ACo’s profit.
4. The B/C treaty is irrelevant, because ACo is not a resident of either B or C
(Art. 1(1)).
INTERNATIONAL TAX QUIZ 91
XCo, a company resident in X, owns 100% of the shares in YCo, a company resident
in Y.
YCo manufactures goods in Y and sells them to customers in Y and in other
countries.
In Z, YCo’s goods are distributed by ZCo, which is unrelated to XCo and YCo. ZCo
is an independent sales agent, which acts on behalf of many non-resident
vendors. ZCo habitually exercises an authority to conclude sales contracts, with
customers in Z, on behalf of (and legally binding on) YCo. YCo pays ZCo an arm’s
length fee for its services. YCo is not a relatively substantial client for ZCo.
Under Z domestic law, YCo is treated as deriving profits from a source in Z, due
to its use of ZCo as its sales agent. The Z-sourced profits are determined on a
formulaic basis: 40% of YCo’s gross profits (from sales to customers in Z) are
deemed to be derived from a Z source.
YCo pays large dividends to XCo.
All 3 treaties (X/Y, X/Z and Y/Z) are identical to the 2017 OECD model treaty.
After applying the relevant treaties, is Z permitted to levy income tax on (1)
YCo’s profits or (2) YCo’s dividends?
In regard to (2), please assume that Z levies its tax on the dividend-recipient
(XCo).
Answer:
1. YCo’s profits (Y/Z treaty)
1. Although ZCo’s actions would satisfy Art. 5(5), the exception in Art.
5(6) should apply to exclude a contract-concluding agency PE.
2. In the absence of a PE in Z, YCo’s profits would be exempt from Z tax
under Art. 7(1).
2. YCo’s dividends (Y/Z treaty)
1. Art. 10(1)&(2) do not apply, as the dividend-payer (YCo) is not a
resident of Z.
2. Art. 10(5) is apparently satisfied: YCo (a company resident in Y) derives
profits from Z – thus, Z is prevented from taxing the dividends, subject
to 2 exceptions (neither of which is relevant here). But the dividends
are the income of XCo, and XCo is not a resident of either Y or Z. Can
the benefit of Art. 10(5) of the Y/Z treaty be claimed by a taxpayer
which is not a resident of either Y or Z?
3. Art. 1(1) would indicate that XCo cannot claim the benefit of Art. 10(5)
of the Y/Z treaty. However, several academic articles and books have
stated that Art. 10(5) would apply in this situation, regardless of Art.
1(1). For example, see: Madeira & Neves, “Exploring the Boundaries of the
Application of Article 10(5) of the OECD Model”, Intertax, Vol. 35
(2007), Vol. 8/9.
4. This point is not directly addressed in the OECD Comm. However, in the
course of discussing the interaction between Art. 10(5) and CFC rules,
the OECD Comm says that Art. 10(5) “concerns only the taxation of the
company and not that of the shareholder”.
5. IMHO: To conclude that Art. 10(5) is an exception to Art. 1(1) requires
express words to that effect in either the OECD model or the OECD Comm.
In the absence of such express words, my conclusion is that, based on
Art. 1(1), Art. 10(5) does not apply to prevent Z tax on YCo’s dividends.
3. YCo’s dividends (X/Z treaty)
1. Art. 10(1)&(2), and Art. 10(5), do not apply, as the dividend-payer (YCo)
is not a resident of Z.
2. Either Art. 7(1) or Art. 21(1) applies to provide an exemption for XCo.
INTERNATIONAL TAX QUIZ 90
ACo, a company resident in A, is an engineering company.
ACo wins 2 contracts in regard to construction projects in B. One contract is
with BCo1 and the other is with BCo2. BCo1 and BCo2 are both resident companies
in B, but are unrelated.
Both contracts require ACo to send a senior engineer (employed by ACo) to the
respective project site in B, to oversee important aspects of the construction
work. The engineer will not be seconded to BCo1 or BCo2. The engineer will be in
B for a total of 9 months: the first 2 months focusing on BCo1’s project, the
next 2 months on BCo2’s project, then the next 3 months on BCo1’s project, and
then the final 2 months on BCo2’s project.
The A/B treaty is identical to the 2017 UN model treaty.
Does the treaty allow B to levy income tax on ACo in regard to the engineer’s
services?
Answer:
1. Art. 12A / Art. 7(1)
1. Art. 12A will apply to allow B to levy tax of x% on the gross fees paid
to ACo, unless the engineer’s activities cause ACo to have a PE in B (see
below): Art. 12A(4).
2. If ACo does have a PE in B, Art. 7(1) will allow B to tax the profits
attributable to the PE.
2. Art. 5(1)
1. Threshold issue: is Art. 5(1) limited by Art. 5(3)(a) or (b)? IMHO: no.
2. Two possible PEs: BCo1 site and BCo2 site. In regard to each site, all of
the Art. 5(1) conditions (other than the time condition) are satisfied.
3. In regard to the time condition, the engineer’s time at each site, from
start to finish (including time spent at the other site), aggregates to 7
months – which is just over the 6 months “indicative test” set out in the
OECD Comm (and repeated in the UN Comm), if the “recurrent” principle is
applied.
4. IMHO: Each site is a borderline case, but on balance I would conclude
that each site is an Art. 5(1) PE.
3. Art. 5(3)(a)
1. The engineer’s activities should be “supervisory activities”. Those
activities need to be considered in regard to each project separately.
2. Do those activities “last more than six months”? IMHO: in measuring time
for the BCo1 activities, the time spent on the BCo2 activities should not
be counted, and vice versa.
3. Thus, IMHO: the BCo1 activities lasted for 5 months, and the BCo2
activities for 4 months – neither would be a PE under Art. 5(3)(a).
4. Art. 5(3)(b)
1. Threshold issue: does Art. 5(3)(a) “cover the field”, to exclude Art.
5(3)(b)? IMHO: no. This view is supported by the 2017 OECD Comm on Art.
5: see para. 147.
2. Art. 5(3)(b) was amended in the 2017 UN model to remove the “same or
connected project” condition.
3. The engineer spent a total of 9 months in B performing the services. The
time test in Art. 5(3)(b) is “more than 183 days in any 12-month period
commencing or ending in the fiscal year concerned”. IMHO: only days on
which services were performed are counted. Thus, if the engineer did not
perform services on weekends or public holidays, or if he took annual
leave in B during the 9 months, those days should not be counted. That
said, it’s likely that the 183 day test is satisfied.
4. IMHO: Likely PE.
INTERNATIONAL TAX QUIZ 89
XCo, a company resident in X, is a major business consulting company. It has a
representative office in Y, with one employee (Mr S). Mr S’s role is to look for
business opportunities in Y for XCo.
Following a suggestion from Mr S, XCo has sought to obtain consulting contracts
with several specific companies resident in Y. To secure those contracts, senior
executives of XCo have made numerous visits to Y to meet with the Y companies
and discuss opportunities. Also discussed at the meetings were the key terms of
XCo’s proposed contracts. The meetings each lasted up to 3 days and took place
at the Y companies’ respective offices. The XCo senior executives spent very
little time in the premises of the representative office.
Mr S attended all of those meetings, but played no role in the discussions.
Several (assume 4) proposed contracts are now ready for signature by each pair
of parties (XCo and the respective Y company). The plan is that each contract
will be signed at a “signing ceremony” at the Y office of the respective Y
company. It is also planned that the XCo senior executives would not attend
those signing ceremonies – instead, XCo would give Mr S a power of attorney to
sign those contracts on XCo’s behalf.
The X/Y treaty is identical to the 2014 OECD model treaty.
Will XCo have a PE in Y under the treaty? If so, how would the profits
attributable to the PE be determined?
Answer:
1. “Fixed place of business” PE
1. The representative office would satisfy Art. 5(1). However, it would
probably be excluded from PE status under Art. 5(4)(d) (collection of
information) or Art. 5(4)(e) (other preparatory or auxiliary activity):
see OECD Comm.
2. The offices of the Y companies would not satisfy Art. 5(1).
3. Thus, no “fixed place of business” PE.
2. “Contract-concluding agency” PE
1. Subject to the “habitually” issue, Mr S would satisfy Art. 5(5), if (as
is likely) his signature concludes a contract which is binding on XCo
under the relevant contractual law.
2. “Habitually” issue: OECD Comm does not provide a brightline test – it
only says that “habitually” means repeatedly, and does not mean merely
transitory or in isolated cases. IMHO: 4 cases would likely be sufficient
to be “habitually”.
3. Mr S, being XCo’s employee, cannot satisfy Art. 5(6).
4. Thus, a “contract-concluding agency” PE would likely exist. The extent of
the PE would be all of the functions performed by Mr S for XCo (not
merely the signature function).
3. Profit attributable to PE
1. The “separate and independent enterprise” assumption applies: Art. 7(2).
2. Under that assumption, XCo’s functions, assets and risks would be
allocated to the PE, based on the extent of Mr S’s significant people
functions (SPFs).
3. The facts do not indicate that Mr S performs any SPFs. It’s possible that
Mr S has developed important relationships with the senior management of
the Y companies, and these relationships were important in securing
meetings with the Y companies – however, the facts don’t state that.
4. If Mr S did not have important relationships with the Y companies, nil
(or only nominal) profit should be attributed to the PE. If, however, Mr
S did leverage his important relationships to secure meetings with the Y
companies, then those relationships should be attributed as an asset to
the PE, and that asset should then be rewarded in an allocation of profit
to the PE.
INTERNATIONAL TAX QUIZ 88
ACo, a company resident in A, wants to make a loan to a related company, BCo,
resident in B.
However, B domestic law imposes a 30% withholding tax on outbound interest, and
there is no A/B treaty.
ACo therefore forms a new 100% subsidiary, CCo, in C. CCo is resident in C, but
it has very little substance.
ACo injects share capital into CCo, which makes an interest-bearing loan to BCo
(the interest rate is an arm’s length rate).
The B/C treaty is identical to the 2017 OECD model treaty, with the PPT (Art.
29(9)) but not the LOB.
The C corporate income tax rate is 15%.
There is no A/C treaty. The A corporate income tax rate is 25%.
After applying the B/C treaty, what will be the aggregate tax liability on the
interest paid by BCo to CCo?
Answer:
Art. 11(2) will allow B to tax the interest. However, the benefit of the 10% tax
rate limit in Art. 11(2) should not be given to CCo, due to the applicability of
Art. 29(9) (PPT). Thus, 30% B tax should apply.
The C tax rate is 15%. Prima facie, CCo would be entitled to a credit for the B
tax under Art. 23A/B.
However, does Art. 29(9) apply to the credit? If the plan had worked, the B tax
would have been limited to 10% (Art. 11(2)) and a credit for that 10% would be
available (Art. 23A/B), leaving a net 5% C tax. It is possible that CCo would
not obtain a credit for the B tax under C domestic law (i.e., in the absence of
the treaty) – e.g., if the C domestic law does not provide a credit for tax paid
in a treaty jurisdiction. If that is the case, then arguably obtaining of the
credit under Art. 23A/B is “one of the principal purposes” of the plan.
Nevertheless, I think the 2nd limb in Art. 29(9) should apply: it is the “object
and purpose” of Art. 23A/B to provide a credit for B tax which is imposed in
accordance with the treaty, even if that is part of a tax plan. On balance, I
think the credit should be available – thus, the net C tax should be nil.
Would A be able to levy tax on the interest income? I will assume that there are
no CFC rules in A. But what about transfer pricing? CCo has very little
substance: let’s assume that it has no employees who are able to decide to raise
the share capital and make the loan to BCo – all decisions are made by ACo. If
A’s domestic law TP rules apply the 2017 OECD TPG1, then these facts would
indicate that CCo would be entitled to no more than a risk-free return, and ACo
would be allocated the balance. To the extent that the interest income is
allocated to ACo, the A 25% tax rate would apply. As ACo does not incur the B
tax, ACo would likely not qualify for a credit under A domestic law foreign tax
credit rules.
Thus, potentially, the aggregate ETR would be 30% on the full amount of
interest, plus 25% on the amount of interest allocated to ACo.
1See para. 10.25 of Transfer Pricing Guidance on Financial Transactions
(published by the OECD on 11 February 2020), to be included in the next edition
of the OECD TPG.
INTERNATIONAL TAX QUIZ 87
XCo, a company resident in X, is the ultimate parent of an MNE group.
XCo owns 100% of the shares in YCo, a company resident in Y. YCo is a holding
company with very little substance.
YCo owns 100% of the shares in ZCo, a company resident in Z. Under Z domestic
law, a withholding tax (“WHT”) of 20% applies to outbound dividends.
ZCo is a major operating company which generates significant profits. To achieve
2 tax objectives (i.e., (1) to extract dividends from ZCo with zero Z WHT, and
(2) to avoid X tax on dividends paid directly to XCo), YCo was interposed in the
shareholding structure many years ago. Since then, ZCo has paid significant
dividends to YCo. YCo has invested the cash elsewhere in the group in the form
of intragroup loans (with arm’s length interest).
The Y/Z treaty is identical to the 2008 OECD model treaty, but with zero source
country tax on dividends on substantial shareholdings.
The Y domestic law provides an exemption for foreign sourced dividends, and it
does not impose tax on outbound dividends.
There have been 3 recent developments: (1) The MLI has commenced operation in
regard to the Y/Z treaty (the “PPT only” option has been adopted by both Y and
Z); (2) X and Z have entered into their first double tax treaty, which is
identical to the 2017 OECD model treaty, but with zero source country tax on
dividends on substantial shareholdings (the treaty has become effective); and
(3) X has changed its law to introduce an exemption for foreign sourced
dividends.
XCo now wants to implement this plan: ZCo would pay a large dividend to YCo, and
YCo would immediately use the cash to pay the same amount of dividend to XCo.
Will Z WHT apply?
Answer:
(1) Y/Z treaty:
Due to the “conduit” nature of the 2 payments, YCo is probably not the
beneficial owner of the ZCo dividend, under the pre-2014 version of the OECD
Comm’s discussion of beneficial ownership. The 2014 amendments to the OECD Comm
probably do not apply to the Y/Z treaty (identical to 2008 OECD model).
Also, YCo would probably fail the PPT. 1st limb: the arrangement or transaction
(i.e., interposition of YCo) occurred “many years ago” for a principal purpose
of achieving the treaty reduction in Z WHT. 2nd limb: it seems difficult to
argue that the treaty reduction in Z WHT is in accordance with the object and
purpose of the Y/Z treaty, merely because the new X/Z treaty provides for a zero
WHT on dividends. Note that none of the examples in the 2017 OECD Comm on Art.
29(9) is applicable. Also note that Art. 7(4), MLI is inapplicable.
(2) X/Z treaty:
Is XCo the beneficial owner of the ZCo dividend paid to YCo, such that XCo can
claim zero Z WHT under the X/Z treaty? The OECD Comm on Art. 10 allows a “look
through” to the beneficial owner in agency and nominee situations, but it does
not refer to “conduit company” situations. Note that the “look through”
argument, as applicable to “conduit companies”, has been enhanced by the
amendment of Art. 10(2) in the 2014 OECD model treaty: after the amendment,
there is no connection between paras. (1) & (2) of Art. 10.
IMHO:
YCo cannot claim under Y/Z treaty. XCo can possibly claim under X/Z treaty.
INTERNATIONAL TAX QUIZ 86
ACo, a company resident in A, owns 3 assets in B: (i) a block of land; (ii)
shares in BCo 1 (a company resident in B); and (iii) shares in BCo 2 (a company
also resident in B). BCo 1 and BCo 2 are not land-rich. ACo holds all 3 assets
as long-term investments: it does not carry on a business of trading in land or
shares.
During a particular year, ACo sells all 3 assets. It derives a gain of 500 on
the land, and a gain of 300 on the BCo 1 shares; however, it incurs a loss of
200 on the BCo 2 shares.
All 3 assets fall within the B capital gains tax rules. Accordingly, under B
domestic law, ACo’s loss on the sale of the BCo 2 shares (200) can be offset
against its gains (500 + 300 = 800) on the sale of the land and the BCo 1 shares
– giving a net capital gain of 600, which is subject to B tax.
The A/B treaty is identical to the 2017 OECD model treaty.
After applying the treaty, what is the net capital gain which is subject to B
tax?
Answer:
Preliminary comments:
The 500 gain on the land is taxable in B: Art. 13(1); but the 300 gain on the
BCo 1 shares is exempt in B: Art. 13(5).
But what about the 200 loss on the BCo 2 shares? Art. 13 refers only to “gains”
– there are no references to “losses”. Also, there is no discussion of losses in
the OECD Comm. on Art. 13. Should Art. 3(2) apply to supply the B domestic law
meaning of “gains”? – and would that domestic law meaning include losses?
Under B domestic law, ACo is entitled to deduct the 200 loss. Should the treaty
be interpreted so as to deny ACo that domestic law benefit?
Let me change the numbers slightly: the 500 gain on the land and the 300 gain on
the BCo 1 shares remain the same, but ACo incurs a loss of 400 on the BCo 2
shares. This would mean that, under B domestic law, ACo’s net capital gain would
be 400 (500 + 300 – 400). If the treaty were interpreted to deny ACo the benefit
of deducting the 400 loss, ACo’s net capital gain (after applying the treaty)
would be 500: the treaty has increased ACo’s B tax liability!
2 issues:
(1) Should “gains” also include “losses”? In the absence of any treaty or
Commentary support, it is difficult to conclude that “gains” includes “losses”.
(2) Can ACo take inconsistent positions? That is, rely upon the treaty to exempt
the gain on the BCo 1 shares, but claim the benefit of domestic law for the loss
on the BCo 2 shares? Some countries (e.g., Canada and the US) require taxpayers
to rely upon the treaty only, or the domestic law only, in regard to all items
of the same category of income.
INTERNATIONAL TAX QUIZ 85
XCo, a company resident in X, is the parent of a group which carries on a famous
restaurant business in X.
XCo plans to use X-Sub (a newly formed X subsidiary) to open a branch of the
restaurant in Z city in country Y for a period of one month, during the Olympic
Games in Z city. At the end of the Games, the restaurant will close, and X-Sub
will be liquidated.
Under 2 contracts to be signed by XCo and X-Sub in X before the activities at
the branch in Z city are commenced: (i) X-Sub will pay XCo arm’s length fees for
the provision of knowhow and the right to use the restaurant’s name in Z city;
and (ii) a number of XCo chefs and other restaurant staff will be seconded to
X-Sub for the one month, in return for an arm’s length fee which is paid to XCo.
The X/Y treaty is identical to the 2017 OECD model treaty, except that Art. 12
allows a source country tax rate of 10%.
Will the X/Y treaty allow Y to levy income tax on XCo or X-Sub?
Answer:
X-Sub’s branch restaurant in Y should constitute a “fixed place of business” PE
under Art. 5(1), although it will operate for only one month. This is because
the branch will be X-Sub’s only place of operation globally: see para. 30, OECD
Comm.
Thus, Art. 7(1) will allow Y to levy income tax on X-Sub’s profits from the
branch restaurant. In determining those profits, deductions should be given for
the 2 types of fee paid by X-Sub to XCo.
XCo should not have a PE in Y, for 2 reasons: (i) the branch restaurant would
not be at XCo’s disposal (its employees are seconded to X-Sub); and (ii) the
time test in Art. 5(1) would not be satisfied.
XCo’s secondment fee would therefore be exempt under Art. 7(1).
XCo’s fee for the knowhow and the use of the restaurant’s name might be
“royalties” under the Art. 12(2) definition. The knowhow component should be
“royalties” if the knowhow is confidential and valuable (e.g., valuable, secret
recipes). The restaurant’s name component would be “royalties” if the name is
protected (in Y) by a trade mark which is owned by XCo.
To the extent that the fee is “royalties”, will Y be allowed to tax it? Art. 12
applies to royalties “arising” in a Contracting State. However, “arising” is not
defined in the OECD model (cf. UN model); and there is no guidance in the OECD
Comm. on this issue. Thus, the Y domestic law meaning should be used, under Art.
3(2). In the present case, there are factors pointing to both X and Y as the
State in which the fee arises: (i) the fee is paid pursuant to a contract signed
in X; (ii) however, the fee is deductible in computing the profits attributable
to the payer’s PE in Y.
If Art. 12 applies, Y tax of 10% will be allowed. If Art. 12 does not apply, the
fee will be exempt under Art. 7(1).
INTERNATIONAL TAX QUIZ 84
ACo, a company resident in A, owns and operates a gold mine in A.
Under the B income tax law, all resident companies, and non-resident companies
which operate in B via a branch, are subject to a 30% tax rate on their taxable
profits (i.e., after deducting expenses) – subject to one exception. That
exception concerns non-resident companies which conduct mining operations in B –
such companies are subject to income tax at the rate of 20% applied to their
gross mining revenue (i.e., no deductions).
In ACo’s case, the B income tax it pays at the 20% rate applied to gross mining
revenue, significantly exceeds the B income tax it would pay if it were subject
to the “30% on taxable profits” regime.
The A/B treaty is identical to the 2017 OECD model treaty.
ACo asks you whether it can use Art. 7(1) to claim deductions in computing B
income tax.
What do you say?
Answer:
Although ACo’s gold mine would constitute a PE in B, ACo’s B taxation will be
governed by Art. 6, and not by Art. 7: see Art. 7(4). Art. 6 does not provide
any limitation in regard to the B taxation. In particular, Art. 6 does not
prevent B from levying tax on ACo’s gross revenue from the gold mine. Thus, the
short answer to ACo’s question is that Art. 7(1) cannot be used to claim
deductions in computing its B income tax.
However, as ACo’s gold mine would constitute a PE in B, Art. 24(3) is relevant:
see para. 9 of OECD Comm. on Art. 5.
Art. 24(3) requires that B’s taxation of ACo’s PE is not “less favourably
levied” than the taxation levied on B-resident enterprises carrying on the same
activities. Under the B income tax law, a resident company which owns and
operates a gold mine in B would be subject to a 30% tax rate on its taxable
profits (i.e., after deducting expenses). As Art. 24(3) operates in only one
direction (i.e., it refers only to “less favourably levied” – it does not seek
to equalise the tax treatment), it should provide ACo with this outcome in B:
ACo will be subject to B tax which is computed as the LESSER of (i) 20% of gross
revenue, and (ii) 30% of taxable profits.
INTERNATIONAL TAX QUIZ 83
Ms X, a resident of X, is a partner is a major law firm in X. The law firm is in
the form of a general partnership. Ms X specialises in estate planning, and she
has a growing number of clients in X and some nearby countries, including Y.
Ms X’s clients in Y are wealthy individuals, many of whom have built large
businesses in Y.
During the 2019 income year, Ms X spent a total of 180 days in Y, which
comprised 5 separate visits. On all but 20 of those days, she had meetings with
clients and prospective clients – the other 20 days were for rest. During her 5
visits, Ms X stayed at different hotels, and did not use any office facilities.
The meetings with clients and prospective clients occurred in their homes or at
restaurants.
During those meetings, Ms X signed engagement letters with 10 clients.
The X/Y treaty is identical to the 2017 UN model treaty, with a 10% rate
specified in Art. 12A(2).
Ms X’s firm receives significant fees from her clients in Y. Does the X/Y treaty
permit Y to levy income tax on those fees?
Answer:
This question requires a decision as to which of 3 articles applies: Art. 7,
Art. 12A, or Art. 14.
Art. 12A will not apply if “the payment is made…by an individual for services
for the personal use of an individual”: Art. 12A(3). As Ms X’s services involve
estate planning for wealthy individuals, it is likely that Art. 12A would be
excluded. If this is not the case, Art. 12A would allow Y tax, limited to 10% on
gross (Art. 12A has priority over Arts. 7 & 14).
Assuming Art. 12A does not apply…
Ms X’s activities cause a contract-concluding agency PE to exist in Y. However,
Art. 7 will not apply if the income is dealt with in Art. 14: Art. 7(6).
Art. 14 applies to income in respect of “professional services”, the definition
of which would cover Ms X’s services. Ms X does not have a “fixed base” in Y.
Also, her time in Y does not satisfy the 183 days / 12 months test. Thus, Art.
14(1) should provide an exemption from Y tax.
Thus, if Art. 12A does not apply, the treaty should not allow any Y tax.
INTERNATIONAL TAX QUIZ 82
ACo is a company which is incorporated in A, a tax haven. ACo carries on
business in B through a branch.
The B income tax law is a territorial system: only income which is derived from
a source in B is taxable. Under the B income tax law, there is therefore no
concept of residence.
ACo invests some of its funds in interest-bearing corporate bonds issued by CCo,
an unrelated company resident in C. Under the C tax law, outbound interest
payments are subject to 20% withholding tax.
The B/C treaty is identical to the 2017 OECD model treaty. There is no A/C
treaty.
Does the B/C treaty permit C to levy withholding tax on the interest paid by CCo
to ACo? If so, at what rate?
Answer:
Key issue: does ACo satisfy the definition of “resident of [B]” in Art. 4(1)?
The fact that the B tax law is a territorial tax system does not trigger the
second sentence in Art. 4(1): para. 8.3 of OECD Comm.
The first sentence in Art. 4(1) asks whether, under a Contracting State’s tax
law, a person is (i) “liable to tax”, (ii) “by reason of…domicile, residence,
place of management or any other criterion of a similar nature”.
According to the OECD Comm., the “liable to tax” test refers to persons who are
subject to a comprehensive liability to tax (a “full tax liability”) in a
Contracting State. Under the B tax law’s territorial principle, “comprehensive
liability to tax” arguably extends no further than tax levied on B-sourced
profits. If that is the case, then what difference does it make that ACo is not
incorporated in B?
In regard to (ii) (the “by reason of” leg), ACo’s branch in B could be described
as a “place of management”.
A similar situation occurred in the Crown Forest case in Canada (1995). The
court held that Art. 4(1) in the Canada / US treaty was not satisfied by a
Bahamian company which had an office in the US. However, there was a major
difference in that case: the US did not operate a territorial system.
This is a difficult question to answer, because, although my immediate reaction
is to think that Art. 4(1) could not possibly be satisfied, it is difficult to
pinpoint a reason for that conclusion in either the treaty or the Comm. My best
attempt is this: if B were to change its law to replace the territorial
principle with global taxation, ACo would probably not be subject to global
taxation (under orthodox global tax systems). But that’s conjecture – and, in
any event, Art. 4(1) requires the test to be applied to the actual B tax law.
Not surprisingly, jurisdictions with territorial systems (e.g., Hong Kong)
usually don’t use Art. 4(1) from the OECD model!
If it is concluded that ACo is a resident of B under the B/C treaty, it would be
entitled to the 10% limit on C tax in Art. 11. If not, the full 20% domestic law
rate would apply.
INTERNATIONAL TAX QUIZ 81
XCo, a company resident in X, manufactures and sells goods.
YCo, a company resident in Y, is a 100% subsidiary of XCo. YCo provides
marketing services to XCo. Those services include: identifying potential
customers for XCo, showing the potential customers XCo’s standard contract and
price list, convincing potential customers to make orders for XCo’s goods, and
receiving orders from customers. The orders are not accepted by YCo (which has
been given no authority by XCo to accept orders) – instead, YCo sends the orders
to XCo, for XCo’s approval (or otherwise). On almost all occasions, XCo accepts
the order.
YCo plays no role in regard to the delivery of goods to the customers or in
regard to billings and collections.
XCo pays a fee to YCo equal to YCo’s costs plus 5%.
The X/Y treaty is identical to the 2014 OECD model treaty.
Does XCo have a PE in Y under the X/Y treaty? If so, how would its taxable
profit in Y be determined?
Answer:
(1) PE existence:
The key issue is whether YCo exercises an authority to conclude contracts in the
name of XCo (Art. 5(5)). According to the OECD Comm., “in the name of” means
“binding on”.
XCo has not given authority to YCo to accept customer orders.
Nevertheless, if YCo holds itself out as having such authority, it is possible
that a Y court would conclude that, under the relevant contractual law, YCo has
ostensible (apparent) authority to bind XCo. However, the facts do not expressly
indicate that this is the case.
The French Supreme Court in the Valueclick case (2020) effectively held that
paras. 32.1 & 33 in the 2014 OECD Comm. support the view that, if the agent
plays the principal role leading to the conclusion of contracts that are
routinely concluded by the principal, then Art. 5(5) in the 2014 or earlier OECD
model treaties will be satisfied – despite the fact that those words were added
only in the 2017 model.
The facts here are similar to those in Valueclick. Thus, there is a risk that a
Y court would reach a similar conclusion. Nevertheless, IMHO, those paragraphs
in the 2014 OECD Comm. do not support the decision in Valueclick – and, thus, in
the absence of actual authority or ostensible authority, Art. 5(5) should not
apply.
(2) Profit attributable to PE:
Regardless of whether there is a PE, YCo’s fee must be reviewed under Art. 9. As
YCo appears to exercise some risk control functions, it is possible that an
increase should be made to YCo’s fee.
If a PE exists, the profit attributable to the PE must be determined in
accordance with the Authorised OECD Approach (AOA), recognising that the PE and
YCo are 2 separate taxpayers in Y. If YCo does exercise some risk control
functions, it is likely that those functions are “significant people functions”
for Art. 7 purposes. However, the OECD’s 2018 report on Art. 7 warns against
attributing the same functions to both the agent and the agency PE. If YCo’s fee
is increased under Art. 9, it is therefore likely that the profit attributable
to the PE would be low or nil.
INTERNATIONAL TAX QUIZ 80
ACo, a company resident in A, manufactures and sells pharmaceutical products.
For the market in B, ACo sells the products to several unrelated distributors
which are resident in B. These distributors sell the products to hospitals and
medical clinics in B, at prices recommended by ACo.
To increase its sales in B, ACo employs 2 retired doctors to conduct marketing
activities with doctors in those hospitals and medical clinics. The marketing
activities involve face-to-face meetings and telephone discussions with those
doctors, to explain the benefits and price list of ACo’s products and answer any
technical questions. The performance evaluations of the 2 retired doctors, and
therefore their bonuses, place a strong emphasis on increases in ACo’s sales in
B.
The 2 retired doctors perform their marketing activities in visits to the
hospitals and medical clinics, and also via telephone discussions from their
home offices. They also perform some other employment activities (e.g., writing
reports to ACo, liaising with ACo in regard to hospital and clinic visits) from
their home offices. ACo does not provide them with office facilities.
The 2 retired doctors have no interaction with the distributors in B.
The A/B treaty is identical to the 2014 OECD model treaty.
Does ACo have a PE in B under the A/B treaty?
Answer:
The doctors’ home offices probably satisfy the conditions in Art. 5(1). In
regard to the “at the disposal” condition, the fact that ACo has not provided
office facilities to the doctors, and yet the doctors conduct some of their
marketing activities via telephone, indicates that ACo probably requires that
the home offices be used: para. 18, 2017 OECD Comm. (IMHO: this view is relevant
also to the 2014 OECD model treaty). In contrast, the hospitals and medical
clinics would not satisfy the “at the disposal” condition: adapting para. 4.2,
2014 OECD Comm.
The key issue is whether the doctors’ activities at the home offices are solely
of a preparatory or auxiliary character (POAC), from ACo’s perspective:
exception in Art. 5(4)(e). It is true that the doctors have no interaction with
the distributors, and are thus not part of the selling process. However, they do
perform an important marketing activity: if they generate interest in ACo’s
products amongst the hospitals and medical clinics, ACo’s sales to the
distributors will likely increase. Nevertheless, the 2014 OECD Comm. lists as an
example of POAC a place which is used for the purpose of advertising – that
would seem to cover the doctors’ activities in this case.
In a recent Danish case (SKM2021.118.SR), the National Tax Board ruled that
similar activities qualify as POAC.
In regard to the “solely” requirement of POAC, the “other employment activities”
performed by the doctors in their home offices, IMHO, are incidental to the
doctors’ marketing activities, and thus they should have the same character as
those marketing activities.
IMHO: Art. 5(4)(e) is probably satisfied in regard to all of the activities
performed in the home offices – thus, no Art. 5(1) PE.
And, of course, Art. 5(5) is not satisfied.
INTERNATIONAL TAX QUIZ 79
RCo 1, a company resident in R, owns 30% of the shares in BCo, a company
incorporated in B (a tax haven).
BCo’s only asset is a parcel of land in S.
During S’s 2020 tax year, RCo 1’s 30% shareholding appreciated in value. RCo 1
did not dispose of any shares during that year. However, during that year, RCo 1
did grant a call option to RCo 2 (an unrelated company resident in R) in respect
of all of its shares in BCo – RCo 2 paid a fee to RCo 1 for the grant of the
option.
RCo 1 had no other financial connections with S during that year.
The R/S treaty is identical to the 2014 OECD model treaty. There is no treaty
between B and S, or between B and R.
Does the R/S treaty permit S to levy income tax on RCo 1?
Answer:
The key issue is whether Art. 13(4) applies to: (i) the appreciation in value of
RCo 1’s shares in BCo, or (ii) RCo 1’s option fee. If it does, the R/S treaty
would permit S to levy tax on RCo 1’s gain.
Threshold point: Art. 13(4) can apply to the alienation of shares in BCo, even
though BCo is not resident in S.
Appreciation in value of RCo 1’s shares: Is this an “alienation”? The term is
not defined in the treaty. The OECD Comm. suggests (without being definitive)
that mere appreciation in value (possibly reflected in a book revaluation of the
asset) would be covered by “alienation”. If the S domestic tax law deems an
appreciation in value to be an alienation, then possibly Art. 3(2) would enable
that meaning to apply for the purposes of Art. 13(4).
Of course, this discussion is moot unless the S domestic tax law taxes RCo 1’s
gain on appreciation in value – but, if it does, it’s possibly the case that
Art. 13(4) would allow it to do so. The alternative view (i.e., that this is not
an “alienation”) would mean that both Art. 13(4) and Art. 13(5) would not apply
– in which case, RCo 1 would be exempt from S tax (Art. 7 and Art. 21).
Option fee: Is the grant of the call option an “alienation of shares”?
Ordinarily no – but what if the option were “deep in the money” by year-end, and
the S tax law treats such call options as deemed alienations of the underlying
property? Again, an argument can be made (based on the lack of definitive
guidance in the OECD Comm., and Art. 3(2)), that that would also fall within
Art. 13(4).
INTERNATIONAL TAX QUIZ 78
XCo, a company resident in X, owns some redeemable preference shares in YCo, a
company resident in Y. The shares carry a preference right to a 5% per annum
dividend and a preference right to a return of the face value of the shares (in
a liquidation scenario), but they do not otherwise participate in YCo’s profit
distributions or surplus assets.
YCo has paid-up share capital of $10 million, a share premium reserve of $90
million, and retained earnings of $50 million.
Of the $10 million of paid-up share capital, $4 million represents the par value
of common shares issued to numerous shareholders (not including XCo). The
remaining $6 million represents the par value of the redeemable preference
shares issued to XCo.
Under Y law, withholding tax of 25% is levied on outbound dividends, interest
and royalties.
The X/Y treaty is identical to the 2017 OECD model treaty.
Does the X/Y treaty permit Y to levy tax on YCo’s dividends paid to XCo? If yes,
at what rate?
Answer:
Threshold issue: are the dividends treated as “dividends” or “interest” under
Arts. 10 & 11 of the treaty? They will be “dividends” if the redeemable
preference shares (RPS) are “shares” (not defined), and they will be “interest”
if the RPS are “debt-claims” (not defined). Using Art. 3(2), the
characterisation of the RPS under Y domestic tax law will probably determine
their characterisation for treaty purposes. See also the OECD Comm. on Arts. 23A
& 23B: “conflicts of qualification”.
If the RPS dividends are “interest”: Y may levy tax of 10% on gross: Art. 11(2).
If the RPS dividends are “dividends”: Y may levy tax of 5% on gross: Art.
10(2)(a). Para. (a) applies if XCo holds directly at least 25% of the capital of
YCo. According to the OECD Comm., “capital” in para. (a) means the par value of
all shares (whether ordinary, preference or otherwise) – it does not include
reserves. Thus, XCo holds directly 60% of YCo’s capital.
INTERNATIONAL TAX QUIZ 77
XCo (a company resident in X) and YCo (an unrelated company resident in Y) are
planning to form a 50/50 international joint venture.
One of the investments of the joint venture will be to acquire 100% of the
shares in BCo, a company resident in B.
To hold the shares in BCo, XCo and YCo are currently planning to form a 50/50
general partnership under A law. The partnership will elect to be treated as a
resident company for A tax law purposes. The reason for using a partnership is
to allow surplus cash to be easily paid to XCo and YCo (i.e., without the
restrictions of the A corporate law).
The A/B treaty is identical to the 2014 OECD model treaty. The MLI does not
apply to the A/B treaty. There is no treaty between X and B, or between Y and B.
Under B law: (i) a 30% withholding tax is levied on outbound dividends; (ii) the
A partnership is treated as transparent; and (iii) the GAAR does not apply to
treaty benefits.
Under A law, foreign source income of residents is generally taxable. However,
foreign dividends derived by resident companies are exempt.
After applying any treaty benefits, what rate of B withholding tax will apply to
dividends paid by BCo?
Answer:
For the A/B treaty to apply to the partnership (p/s), it must be a “person” who
is a “resident” of one or both of A and B.
The p/s is a “person”, under the Art. 3(1) definition, as it is both a “company”
(as defined in Art. 3(1)) and a “body of persons”.
The p/s has elected to be treated as a resident company for A tax purposes. It
is noted that, under A law, foreign source income of residents is generally
taxable. The p/s should therefore be considered to be liable for comprehensive
taxation in A, and thus should be a “resident” of A under the Art. 4(1)
definition. The fact that the p/s has elected into this position should be
irrelevant.
Under Art. 10(2), the 15% rate under para. (b) should apply instead of the 5%
rate under para. (a), because the p/s does not satisfy the phrase, “company
(other than a partnership)”.
However, there are 2 possible risks with this outcome:
1. There is a risk that the p/s would be viewed as not being the “beneficial
owner” of the dividends, due to the plan to distribute cash to the partners.
However, under the 2014 OECD Comm., “beneficial ownership” status is denied
only if the p/s is subject to a contractual or legal obligation to pass on
the dividends to another person. Applying this rule in the context of a
partnership is difficult!
2. Although the B law GAAR does not apply to treaty benefits, it is possible
that B is a country which views treaty shopping as an abuse of the treaty
itself (see 2014 OECD Comm. on Art. 1). If this were the case, B might deny
the treaty benefit.
If either of these risks is triggered, the withholding tax rate would be 30%.
INTERNATIONAL TAX QUIZ 76
ACo, a company resident in A, conducts an international goods shipping business.
ACo’s ships pick up and deliver goods at the only port in B.
ACo owns an office in B. ACo has numerous employees who are based at the office
– some of these employees perform activities such as booking shipments for
customers in B, while others conduct maintenance of ACo’s ships when they are in
B’s port.
In addition to its fees for transporting goods, ACo derives 3 types of income /
profits from B:
* Interest income from the short-term investment of cash balances
* Fees for maintenance services performed in regard to other companies’ ships
when they are in B’s port
* Profit on sale of ACo’s office in B (due to headcount growth, ACo moved into
a new office and sold its old office)
The A/B treaty is identical to the 2017 OECD model treaty.
Does the A/B treaty permit the B tax authorities to levy income tax on the 3
types of income / profits derived by ACo?
Answer:
Interest: Art. 11(2) would allow 10% B tax. However, according to the OECD
Comm., Art. 8(1) (and not other provisions) would apply to interest from the
investment of cash required in a Contracting State for the carrying on of a
shipping business. This would seem to cover the interest in this case. Thus, the
interest should be exempt under Art. 8(1).
Maintenance service fees: According to the OECD Comm., Art. 8(1) would apply to
the fees (thus, exempt). Note that Art. 7 would not apply to allow B taxation,
despite the fact that ACo’s office would be a PE: Art. 7(4).
Profit on sale of ACo’s office: Art. 13(1) would allow unlimited B tax (note
that Art. 13(2) or (3) will not apply, as the office is immovable property). Is
the profit “from the operation of ships…in international traffic” (Art. 8(1))?
The OECD Comm. does not address the issue of whether Art. 8(1) covers profits
from the sale of fixed assets which are used in an international shipping
business. In 2020, the Danish National Tax Board decided that a profit derived
by an international shipping company on the sale of a house which was used by an
expatriate director, was covered by Art. 13(1), and not Art. 8(1). I agree!
Thus, IMHO: the profit should be taxable by B.
INTERNATIONAL TAX QUIZ 75
YCo, a company resident in Y, has been granted an oil & gas production licence
by the Y government. The licence entitles YCo to produce oil & gas from a
specific field in Y.
XCo, a company resident in X, has provided YCo with $50 million of finance, in
return for annual payments (for 25 years) equal to 1.5% of the value of oil &
gas YCo produces from the field. The contract between XCo and YCo: (i) is not in
the form of a loan; (ii) does not require YCo to repay all or part of the $50
million to XCo; (iii) subjects YCo to several “negative covenants” (e.g., YCo’s
permitted business activities, YCo’s level of borrowing, etc.); and (iv) grants
XCo security over YCo’s licence.
The X/Y treaty is identical to the 2017 OECD model treaty.
Does the X/Y treaty permit the Y tax authorities to levy income tax on the
annual payments made by YCo to XCo? If so, at what rate?
Answer:
XCo’s contract with YCo might constitute a “debt-claim” under Y tax or general
law. If it does, all or part of the payments will probably be “interest” under
Art. 11(3), after applying Art. 3(2). If it does not, the payments will not be
“interest”. To the extent that the payments are “interest”, Y may tax the
payments, but a 10% tax rate limit under Art. 11(2) would apply.
Art. 6:
1. It is possible (but unlikely) that XCo’s contractual rights against YCo
constitute “immovable property” under Y law (see Art. 6(2)), due to the
security over YCo’s oil & gas production licence. If they do, then Art. 6(1)
would allow Y to levy unlimited tax on the annual payments.
2. Do XCo’s contractual rights against YCo constitute “rights to variable or
fixed payments as consideration for the working of, or the right to work,
mineral deposits, sources and other natural resources” (Art. 6(2))? IMHO:
No, they do not – unlike the licence, the contract between XCo and YCo does
not grant YCo a right to work natural resources, and therefore the annual
payments made under that contract cannot be consideration for such working
or right. The opposite conclusion was reached by the UK First-tier Tribunal
in the Royal Bank of Canada case in 2020.
INTERNATIONAL TAX QUIZ 74
ACo, a company resident in A, has conducted business with customers in B for 10
years.
ACo has always taken the position that it does not have a PE in B under the A/B
treaty, and that therefore it is exempt from B tax on its profits. For that
reason, ACo has never filed a B income tax return.
Following a recent tax audit, the B tax authorities have claimed that ACo has
had a PE in B for all of the 10 years. The tax authorities have therefore issued
a tax assessment to ACo (reflecting item (ii) below for 8 of the years) in
regard to the 10 years.
Under B income tax law: (i) the “statute of limitations” (i.e. the time period
in which the tax authorities may issue assessments for an income year) only
starts to run from the time that the taxpayer files an income tax return for the
relevant income year; and (ii) a non-resident taxpayer which fails to file an
income tax return within 24 months after the relevant income year, is denied all
deductions in calculating its taxable profits for that year. Item (i) applies to
both residents and non-residents, but item (ii) applies to non-residents only.
Both items (i) and (ii) were introduced into the B law in 1970.
The A/B treaty, which was signed in 2005 (this is the first treaty between A and
B), is identical to the 2000 OECD model treaty.
Does the treaty permit the tax assessment to reflect item (ii)?
Answer:
Art. 7(3) (2000 OECD model) states that all of the expenses incurred for the
purposes of the PE shall be deducted in determining the profits attributable to
the PE.
However, in the 2008 Update, para. 30 was added to the OECD Comm.: Art. 7(3)
does not deal with whether expenses, after being attributed to the PE by Art.
7(3), are deductible under domestic law – that is “a matter to be determined by
domestic law, subject to [Art. 24].” The interesting issue is whether para. 30
(added in 2008) should be taken into account in interpreting the 2005 A/B
treaty.
If it is taken into account, the conclusion would be that Art. 7 would not
prevent the disallowance of the deductions.
However, Art. 24(3) requires that B’s tax on ACo’s PE shall not be less
favourably levied than the tax levied on B-resident enterprises carrying on the
same activities. Item (ii) under the B law appears to breach this requirement.
That view is supported by para. 24(a) of the 2000 OECD Comm., which states that
PEs must be accorded the same right as resident companies to deduct trading
expenses.
Nevertheless, the US Tax Court has recently held (Adams Challenge case) that a
similar rule to item (ii) does not breach either Art. 7(3) or Art. 24(3). Key to
the court’s decision is that the relevant rule was included in US domestic law
many years before the treaty was signed – thus, the treaty partner was “on
notice”, and did not object. Also, the US does not accord supremacy to treaty
provisions.
If B does accord supremacy to treaty provisions, IMHO: Art. 7(3) might not be
breached, but Art. 24(3) should be breached.
INTERNATIONAL TAX QUIZ 73
XCo 1, a company resident in X, owns some IP.
XCo 1 licenses the IP to XCo 2, a related company also resident in X, for arm’s
length royalties.
The IP is registered in many countries throughout the world, including Y.
XCo 1 and XCo 2 do not have any assets or employees in Y.
Under the Y domestic law, royalties which are paid for the licence of IP which
is registered in Y, are deemed to be sourced in Y. This means that such
royalties are subject to a final Y withholding tax of 25% of the gross amount of
royalties.
The X/Y treaty is identical to the 2017 UN model, with the rate in Art. 12(2)
being 10%.
Does the X/Y treaty permit Y to impose withholding tax on the royalties paid by
XCo 2 to XCo 1? If so, at what rate?
Answer:
1. Y is modeled on Germany.
2. Art. 12(2) will not apply to permit (and limit) the Y tax, as the royalties
do not “arise” in Y (as defined in Art. 12(5)) – regardless of the fact that
the royalties are sourced in Y under Y domestic law.
3. Some folks might then consider Art. 21:
1. Art. 21(3) uses the term, “arising”. According to the UN Comm., that term
should take its meaning under domestic law. This would mean that the
royalties “arise” in Y for the purposes of Art. 21(3), due to the deemed
source in Y under Y domestic law (and regardless of the conclusion under
Art. 12(5)).
2. If Art. 21(3) applies, the treaty would permit Y to impose tax on the
royalties, without limitation – i.e. Y tax of 25% would apply.
4. However, Art. 7 should generally apply in this situation. As XCo 1 has no PE
in Y, Art. 7(1) would provide an exemption. Art. 21(3) would not apply, as
the royalties would be “dealt with” in Art. 7 – i.e., no Y tax would apply.
5. If XCo 1 is a passive IP holding company, and is not considered to carry on
an “enterprise” (as defined in Art. 3(1)), then the Y tax authorities might
take the view that Art. 7 does not apply to the royalties – in which case,
Art. 21(3) should apply (see above).
INTERNATIONAL TAX QUIZ 72
ACo, a company resident in A, has conducted business through a branch in B for
many years. The branch qualifies as a PE under the A/B treaty.
Until recently, the B income tax law included these elements:
* Income tax rate on taxable profits of resident companies and branches of
non-resident companies: 25%
* Withholding tax on dividends paid to non-residents: 15%
* Tax on profit remittances by branches of non-resident companies: nil
The B income tax law was recently changed to impose a branch profits remittance
tax of 20%.
The A/B treaty is identical to the 2017 OECD model treaty.
Does the treaty allow the B branch profits remittance tax to be levied on profit
remittances by ACo’s branch? If yes, at what rate?
Answer:
The branch profits remittance tax (“BPRT”) is a tax on income, and therefore it
would be a tax covered by the treaty: Art. 2(1). It would also probably be
covered by Art. 2(4), but that is unnecessary. Also, note that Art. 24 is not
limited to taxes covered by Art. 2: Art. 24(6).
Art. 7(1) allows B to tax the profits attributable to the PE. It does not
restrict the tax rate, or the manner of imposing tax, on those profits. Thus,
Art. 7(1) should be interpreted as allowing the BPRT to be imposed – subject to
my comments below.
Art. 24(3) is more difficult. The effect of the BPRT is that the total B tax on
the profits attributable to the PE exceeds the B tax which would be levied on a
B-resident company carrying on the same activities. Thus, prima facie, the BPRT
appears to breach Art. 24(3).
However, para. 60 of the OECD Comm. on Art. 24 says this:
“In some States, the profits of a [PE] of an enterprise of another Contracting
State are taxed at a higher rate than the profits of enterprises of that
State…Where such tax is simply expressed as an additional tax payable on the
profits of the [PE], it must be considered as a tax levied on the profits of the
activities of the [PE] itself and not as a tax on the enterprise in its capacity
as owner of the [PE]. Such a tax would therefore be contrary to [Art. 24(3)].”
The phrase, “not as a tax on the enterprise in its capacity as owner of the
[PE]”, suggests (but does not actually state!) that such a tax would not breach
Art. 24(3). B’s BPRT is such a tax, and thus there is some support in the OECD
Comm. that the BPRT would not breach Art. 24(3).
But that then begs the question: if the BPRT is a tax which is imposed on ACo in
its capacity as owner of the PE, and is not a tax on the profits of the
activities of the PE itself, does the BPRT comply with Art. 7(1)?
At least one thing is clear: Art. 24 does not require the BPRT rate to be equal
to the Art. 10 rate on dividends.
But whether Art. 7(1) and Art. 24(3) allow the BPRT to be imposed at all, is
(IMHO) not clear. It’s interesting to note that the 2016 US model treaty
specifically allows the US’s version of B’s BPRT: Art. 10(10).
INTERNATIONAL TAX QUIZ 71
XCo, a company resident in X, has a PE in Y.
Services are provided to XCo’s PE by Parent Co, which is also a company resident
in X. Parent Co is the 100% parent of XCo.
The Y tax authorities consider that the fee charged by Parent Co for the
services provided to XCo’s PE, exceeds the arm’s length price. They therefore
propose to deny the PE a deduction for the excessive amount of fee, pursuant to
Y’s transfer pricing rules.
The X/Y treaty is identical to the 2017 OECD model treaty.
Does the treaty permit the Y tax authorities to deny the deduction for the
excessive amount of fee? If yes, does the treaty require any actions to avoid
double taxation?
Answer:
i. Application of Y’s TP rules:
Art. 9(1) does not apply, as both XCo and Parent Co are enterprises of X.
However, in determining the profits attributable to XCo’s PE under Art. 7, Y’s
TP rules would be applicable (provided those rules comply with the arm’s length
principle, “ALP”). Specifically, the “separate and independent enterprise”
assumption which is made under Art. 7(2), is not limited to intra-entity
“transactions” between the PE and other parts of XCo. As shown by the words, “in
particular”, in Art. 7(2), the assumption would also apply to actual
transactions between XCo and other entities, such as Parent Co: see para. 24 of
OECD Comm. on Art. 7.
ii. Eliminating double taxation of XCo:
The increased amount of the profits attributable to the PE (after Y applies its
ALP-compliant TP rules) and the consequential increase in Y tax, would be
required to be used for the relief of double taxation in X, under Art. 23A or
23B: Art. 7(2).
If, after the relief of double taxation under Art. 23A or 23B, it is still the
case that there is double taxation of XCo in regard to the deductions disallowed
by Y under its TP rules, XCo should be entitled to “an appropriate adjustment”
of its X tax, “to the extent necessary to eliminate double taxation”: Art. 7(3).
iii. Corresponding adjustment in X for Parent Co:
Parent Co would not be entitled to a corresponding adjustment of its taxable
profits in X under Art. 9(2), for the same reason that Art. 9(1) does not apply:
both XCo and Parent Co are enterprises of X.
No other provision appears to specifically allow a corresponding adjustment for
Parent Co. However, it is possible that Parent Co could seek MAP relief under
Art. 25(1), by arguing that it has been taxed “not in accordance with the
provisions of this Convention” and pointing to the preamble’s reference to “the
elimination of double taxation”. It’s unclear whether that argument would be
successful!
INTERNATIONAL TAX QUIZ 70
ACo, a company resident in A, conducts a manufacturing business in A, using
patents and knowhow which ACo owns.
ACo wants to sell its goods in the B market. However, due to customs duties
which are imposed on imports into B, ACo is planning to start a manufacturing
operation in B, with the finished goods being sold to consumers in B.
ACo would like your advice on whether the B manufacturing operation should be
structured as a B-resident subsidiary of ACo or as a branch of ACo.
ACo has told you the following:
* ACo currently has significant tax losses in A. These losses are available for
indefinite carry-forward.
* ACo plans to use its existing cash resources to finance the B manufacturing
operation – i.e., no borrowing will be done.
* ACo wants to minimise B tax.
* ACo wants to retain, in A, the legal and economic ownership of its IP.
* The B market does not discriminate against branches of companies incorporated
in A.
The B corporate income tax law levies the same rate (25%) on resident companies
and branches of non-resident companies.
B does not impose tax on outbound dividends or on branch profit remittances.
However, B imposes a 10% withholding tax on the gross amount of outbound
interest and royalties.
The B tax law does not recognise intra-entity “transactions”.
The A/B treaty is identical to the 2017 OECD model treaty, except that Arts. 11
& 12 allow 10% source country tax (on gross payments) to be levied.
What is your advice?
Answer:
1. The amount of B income tax on profits should be the same for both subsidiary
and branch:
* The same rate is applied to both.
* In regard to tax base, the profits attributable to the PE (i.e., branch)
under Art. 7 should be the same as for a subsidiary, after deducting
notional interest and royalty expenses. Although the B tax law does not
recognise intra-entity “transactions”, such deductions for the branch
should be available by virtue of Art. 7 (i.e., by application of the
“separate and independent enterprise” assumption). Also, Art. 24(3) will
require that outcome.
2. No B tax is imposed on profit remittances by both subsidiary and branch.
3. 10% B withholding tax will apply to actual payments of interest and
royalties in the subsidiary scenario, but no corresponding withholding tax
will apply in the branch scenario: this is because the B tax law does not
recognise intra-entity “transactions”, and the “separate and independent
enterprise” assumption in Art. 7 has no effect on Arts. 11 & 12 or on
expanding ACo’s tax liabilities under B law.
4. ACo’s A tax losses might be reduced by dividends paid by a subsidiary or by
current profits derived by a branch. It is possible that the impact on ACo’s
A tax losses would not be the same for both subsidiary and branch.
IMHO: I would choose a branch, in order to achieve the savings in B withholding
tax (cash and book tax benefit). However, the possibility that a branch might
reduce ACo’s A tax losses to a greater extent than a subsidiary, should be
assessed.
INTERNATIONAL TAX QUIZ 69
Under the X domestic tax law, a resident company which makes income tax
deductible payments to a related company which is resident in a designated
low-tax jurisdiction, is subject to an adjustment. The adjustment is in the form
of deemed income, calculated by a formula which has regard to the amount of
deductible payments to the related company. The designation of a jurisdiction as
low-tax is made annually in respect of a particular MNE Group, based on the
effective tax rate (in that year) of the Group’s members which are resident in
that jurisdiction.
XCo, a company resident in X, makes income tax deductible payments to YCo, a
company resident in Y. Both XCo and YCo are members of an MNE Group. For the
relevant year, Y is designated as a low-tax jurisdiction in regard to the MNE
Group. Accordingly, an amount of deemed income is included in XCo’s taxable
profits for that year.
The X/Y treaty is identical to the 2017 OECD model treaty.
Does the treaty permit the inclusion of the deemed income in XCo’s taxable
profits?
Answer:
This question raises issues under Art. 24 (non-discrimination). Although XCo is
a resident of X, Art. 24 can apply to restrict X’s taxation of XCo: Art. 1(3).
I should note that I’m assuming that the amount of the payments satisfy the
arm’s length principle.
If the X law operated to disallow XCo income tax deductions for the payments to
YCo, then (IMHO) Art. 24(4) would likely be breached. The disallowance of the
deductions would be because the payments are made to YCo, a resident of Y – and
the deductions would not be disallowed if the recipient were not a resident of
Y. That would seem to me to be a clear breach of Art. 24(4).
However, such a provision in the X tax law would be based on the undertaxed
payments rule (UTPR) in Pillar Two, in the context where the adjustment is in
the form of disallowance of deductions. The Pillar Two blueprint report
surprisingly concludes that there would be no breach of Art. 24(4), because the
disallowance is not based on the residence of the recipient (YCo), but instead
on the designation of YCo’s residence jurisdiction (Y) as low-tax. IMHO: that
view has no basis in either the text of Art. 24(4) or the OECD Comm.
But, in our question, the form of the adjustment is deemed income, not
disallowance of deductions. Does that make a difference? Art. 24(4) requires
that “disbursements…shall, for the purpose of determining the taxable profits…,
be deductible under the same conditions…”. That would seem not to cover deemed
income, although (in our question) the deemed income is calculated by a formula
which has regard to the amount of deductible payments to the related company.
The link provided by that formula might be sufficient for a court in X to
conclude, particularly having regard to the requirement of “good faith” in the
Vienna Convention on the Law of Treaties, that the deemed income is a breach of
Art. 24(4). However, on balance, I think that the deemed income form is probably
sufficient to avoid the application of Art. 24(4).
INTERNATIONAL TAX QUIZ 68
ACo, a company resident in A, has manufacturing and trading branches in a number
of other countries.
ACo, through its branch in B, owns inventory (goods) and fixed assets.
Those goods and fixed assets are physically transferred to ACo’s branch in C.
Both the goods and the fixed assets have an arm’s length value which exceeds
their cost.
The A/B treaty, the A/C treaty and the B/C treaty are identical to the 2017 OECD
model treaty.
Under those treaties, is B permitted to levy income tax on ACo in regard to the
2 physical transfers?
Answer:
ACo has a PE in B, and thus Art. 7 is relevant. Under Art. 7(2), the physical
transfers of the inventory and fixed assets would likely be treated as sales to
the branch in C. When the arm’s length principle is applied to those notional
sales, it is likely that both transfers would be deemed to produce a profit for
the PE in B.
Art. 13(2) is also possibly relevant. Both the inventory and fixed assets are
“movable property forming part of the business property of a [PE]”. The issue is
whether the physical transfers are alienations, which is not defined in the
treaty. If the B domestic law treats the physical transfers as alienations, then
it is arguable that those physical transfers should be treated as alienations
for the purposes of Art. 13(2): either by applying Art. 3(2), or by reference to
the OECD Comm. on Art. 13(2).
If Art. 13(2) applies, the “gains” may be taxed in B. However, can the arm’s
length principle be applied in determining the amount of the gains? In my view:
no, as Art. 9(1) is limited to dealings between (actual) separate enterprises.
If both Art. 7 (which would recognise deemed profits) and Art. 13(2) (which
would not recognise deemed gains) apply, then Art. 7(4) indicates that Art.
13(2) must prevail – which would lead to the surprising conclusion that B cannot
tax the deemed gains!
However, the contrary argument is possibly provided by the OECD Comm. on Art.
13(2): the taxation under Art. 13(2) in regard to intra-entity transfers must be
“in accordance with Article 7”.
INTERNATIONAL TAX QUIZ 67
XCo (a company resident in X) makes a loan to YCo (an unrelated company resident
in Y).
YCo uses the borrowed money to acquire commercial real estate (in Y), from which
it receives rent under a long-term lease to ZCo (another unrelated company
resident in Y).
YCo gets into financial difficulties – it defaults on some interest payments and
principal repayments.
YCo assigns to XCo its right to receive rent under the lease, in satisfaction of
its obligations to make overdue and future interest payments and principal
repayments. Please assume that the assignment is legally effective.
The X/Y treaty is identical to the 2010 OECD model treaty, except that Art. 11
provides an exemption from source country tax on interest (provided the
conditions in Art. 11 are satisfied).
Does the X/Y treaty permit Y to levy tax on the rent payments made by ZCo to
XCo?
Answer:
Overdue interest
The assignment of the right to receive rent is, in part, in satisfaction for
YCo’s overdue interest payments and principal repayments.
It would need to be determined, under the law governing the loan, the extent to
which the debt for the overdue interest payments has been satisfied. To that
extent, the assignment should constitute a payment of interest from YCo to XCo,
if the payment has not already arisen under the relevant law: see OECD Comm. on
Art. 11. That interest payment should be exempt under Art. 11.
Future interest
The issue is the character of the payment by ZCo to XCo: is it “income from
immovable property” (and therefore covered by Art. 6) or is it :”interest” (and
therefore covered by Art. 11)? This issue is critical, because Art. 6 allows
unlimited Y tax, whereas Art. 11 provides an exemption from Y tax.
The OECD Comm. on Art. 6 states that Art. 6 applies “where, in the case of an
enterprise, income is only indirectly derived from immovable property”.
From the payer’s (ZCo’s) perspective, the payments are income from immovable
property. However, from the recipient’s (XCo’s) perspective, the payments are
interest.
There is very little authority on this issue. The UK First-tier Tribunal, in a
similar 2020 case concerning the Royal Bank of Canada, reached a decision which
effectively accepted that the Art. 6 characterisation prevailed. However, the
tribunal’s decision was not based on existing authority, and it did not focus on
the characterisation issue: the parties in the case accepted that the Art. 6
characterisation prevailed.
If Art. 6 applies, then there is an issue whether the amount of Y tax (under
domestic law) is limited to the tax on the future interest, or whether it
effectively also applies to the future principal repayments. Art. 6 itself would
allow the full amount of rent to be taxed, without distinguishing between the
“interest” component and the “principal” component.
Conclusion
I don’t know the answer! While I’m sympathetic to XCo’s position, both the OECD
Comm. and the Royal Bank of Canada case suggest that Art. 6 might prevail. Banks
beware!
INTERNATIONAL TAX QUIZ 66
ACo (a company resident in A) carries on a business of collecting, organising
and maintaining various databases, to which it grants access in return for fees.
ACo has 2 clients in B.
The first client (BCo 1) pays a fee to ACo to access its various databases.
The second client (BCo 2) pays a fee to ACo for ACo to create a specialised
database customised for BCo 2’s use only. Some of the information in the
database is provided by BCo 2, and the remainder is collected by ACo.
The A/B treaty is identical to the 2017 UN model treaty.
ACo has no tangible assets, employees or agents in B.
Does the A/B treaty permit B to levy income tax on the fees paid by BCo 1 and
BCo 2 to ACo?
Answer:
This question is based on Example 3 in the 2017 UN Comm. on Art. 12A.
The question raises issues under Art. 12 and Art. 12A. It is clear that ACo does
not have a PE in B.
Art. 12A
Art. 12A(3) relevantly defines “fees for technical services” (FTS) to mean any
payment in consideration for any service of a managerial, technical or
consultancy nature. According to the UN Comm.: “…the fundamental concept
underlying the definition of [FTS] is that the services must involve the
application by the service provider of specialized knowledge, skill or expertise
on behalf of a client or the transfer of knowledge, skill or expertise to the
client, other than a transfer of information covered by the definition of
‘royalties’ in [Art. 12(3)]. Services of a routine nature that do not involve
the application of such specialized knowledge, skill or expertise are not within
the scope of [Art. 12A].”
According to the UN Comm.’s analysis of Example 3:
* BCo 1’s fees are not covered by Art. 12A, because “[although ACo] used its
knowledge, skill and expertise in creating the database, the services that
[ACo] provides to BCo 1 – access to the database – are routine services that
do not involve the application of [ACo’s] knowledge, skill and expertise for
[BCo 1’s benefit].”
* BCo 2’s fees are covered by Art. 12A, because “[ACo] would be applying its
knowledge, skill and expertise for the benefit of [BCo 2].”
Art. 12
The Art. 12(3) definition of “royalties” includes payments “for information
concerning industrial, commercial or scientific experience”.
The OECD Comm. (which is relevantly repeated in the UN Comm.) infers that this
phrase is limited to information which is not in the public domain and which has
significant value. However, there is no clear statement to that effect. Also, it
is known that many developing countries use a wide interpretation of this
phrase.
The question does not indicate whether the information in ACo’s databases is or
is not in the public domain and whether or not it is significantly valuable. If
the information is not in the public domain and is significantly valuable, BCo
1’s fee should be covered by the “royalties” definition.
The question does not suggest that ACo grants BCo 1 a right to use copyright in
the database material.
Conclusion
The A/B treaty allows B to levy tax on BCo 2’s fees (Art. 12A), and might allow
B to levy tax on BCo 1’s fees (Art. 12).
INTERNATIONAL TAX QUIZ 65
The A/B treaty, which was signed and entered into force in 2005, is identical to
the 2001 UN model treaty, with the rate specified in Art. 12(2) being 10%. A 10%
rate is used in the royalties article in most of A’s double tax treaties.
At the time the treaty was signed, A domestic law did not levy a withholding tax
on outbound payments of equipment rentals, although it did levy a 15%
withholding tax on all other outbound payments described in the definition of
“royalties” in Art. 12(3) of the UN model.
In 2010, A changed its domestic law to levy a 10% withholding tax on outbound
payments of equipment rentals which are paid to residents of jurisdictions with
which A has a comprehensive double tax treaty – that would include residents of
B. However, under A domestic law, the withholding tax does not apply to outbound
payments of equipment rentals to recipients which are not resident in such
jurisdictions.
In other words, a non-treaty resident is exempt from the withholding tax on
equipment rentals.
BCo (a company resident in B) has leased an item of equipment to a resident of
A, for use in A.
Does the A/B treaty permit the 10% withholding tax to apply to the equipment
rentals which are paid to BCo?
Answer:
1. Non-discrimination
A’s withholding tax discriminates against residents of treaty countries, in
favour of residents of non-treaty countries. However, none of the paragraphs in
Art. 24 applies to this situation. In particular, it should be noted that Art.
24 is not a “most favoured nation” provision.
Thus, A’s withholding tax on equipment rentals does not breach Art. 24.
2. General principle that treaties cannot increase tax liabilities
Some people assert that there is a general principle that double tax treaties
cannot increase tax liabilities.
It is arguable whether there is such a general principle. However, even if there
is, there is no breach of that principle here: A’s withholding tax on BCo is
levied by the A domestic law, not by the A/B treaty.
3. “Good faith” under Art. 26, Vienna Convention on the Law of Treaties
Art. 26 requires the parties to a treaty to perform it “in good faith”.
Does A’s withholding tax on residents of treaty countries, but not on residents
of non-treaty countries, breach Art. 26?
IMHO: No – The A/B treaty permits A to levy a tax of up to 10% on residents of B
in receipt of equipment rentals, and that is exactly what A’s domestic law has
done. The treaty has been performed in good faith.
4. Example and policy
Korea provides a good example of this type of withholding tax which
discriminates against residents of treaty countries, in favour of non-treaty
countries.
The policy for such a tax is this: the A/B treaty is the result of
“horse-trading” by both countries. A’s rights under the treaty were obtained by
A for the “price” of it relinquishing some tax rights to B. Having so
“purchased” its treaty rights, it would be foolish for A not to levy taxes up to
those treaty rights.
In contrast, with a non-treaty country, there is no “purchase” element.
INTERNATIONAL TAX QUIZ 64
The X/Y treaty, which is identical to the 2010 OECD model, was signed and
entered into force in 2011.
In 2012, Y changed its domestic law definition of “permanent establishment” to
be identical to Art. 5 in the 2010 OECD model.
In 2019, Y changed its domestic law to introduce a provision which deems a
non-resident to be carrying on business through a fixed place of business in Y,
if the non-resident satisfies a “significant economic presence” (SEP) test. If
that deeming provision applies to a non-resident (and if the non-resident’s
activities are not of a preparatory or auxiliary character), then the
non-resident satisfies the domestic law definition of PE and is subject to Y
income tax (on a net basis) on income which is derived from that SEP.
XCo, a company resident In X, derives income from online streaming services
which are provided to Y residents. Although XCo has no assets or employees in Y,
it satisfies the SEP test, and is therefore subject to Y income tax under
domestic law.
Is XCo’s Y income tax liability permitted under the X/Y treaty?
Answer:
Before considering the Y domestic law, it is clear that XCo does not have a PE
in Y under the X/Y treaty, and therefore it would be exempt from Y tax under
Art. 7.
Does the Y tax law’s SEP provision change that conclusion?
The SEP provision deems a non-resident to be carrying on business through a
fixed place of business in Y, if the SEP test is satisfied. The concept of a
fixed place of business is used in the Art. 5 definition of PE. Although the
treaty defines PE, it does not define “fixed place of business”. Does Art. 3(2)
operate to allow the Y law meaning of “fixed place of business” (under the SEP
provision) to be used in interpreting Art. 5?
IMHO: No – Art. 3(2) does not automatically “slot in” a domestic law meaning. A
domestic law meaning shall not be used if the context otherwise requires. The
X/Y treaty is identical to the 2010 OECD model, and was signed shortly after its
release. The X/Y treaty’s “context” should, in my view, include both the 2010
OECD model and the 2010 OECD Comm., the latter of which sets out a detailed
description of the meaning of “fixed place of business” – a description which is
contrary to the Y law SEP provision. That being the case, the context prevents
Art. 3(2) from using the Y law meaning.
INTERNATIONAL TAX QUIZ 63
ACo, a company resident in A, is the parent of an MNE group.
Some years ago, ACo formed a 100% subsidiary, BCo, in B. ACo injected
substantial share capital into BCo.
B has a relatively low corporate income tax rate and a wide treaty network.
Since its formation, BCo has had 1 employee (a bookkeeper) and 2 non-executive
directors (supplied by a secretarial firm in B).
Shortly after B’s formation, ACo and BCo entered into a cost contribution
arrangement (CCA) to undertake R&D in regard to pharmaceuticals. Under the CCA:
* All R&D is performed by ACo’s R&D centre in A
* BCo’s obligation is to partially fund that R&D activity
* The 2 companies will share the output from the R&D activity (i.e., patent
rights for specific geographical areas) proportionate to their relative
contributions (cash and R&D activity)
The R&D activity has led to the registration of several patents. In accordance
with the CCA, ACo granted to BCo an exclusive, royalty-free licence of those
patents (for BCo’s geographical area) for their legal life
BCo has licensed those patents, for arm’s length royalties, to several related
companies – including CCo, a related operating company resident in C.
Following a recent tax audit, the A tax authorities have issued assessments to
ACo which include in ACo’s taxable income an amount equal to the royalties
received by BCo – on the basis that BCo is not a valid participant in the CCA,
under the OECD TPG, and that all of the DEMPE functions are performed by ACo.
The A/B, B/C & A/C treaties are identical to the 2017 OECD model treaty – the
rate in Art. 12 is 0% in the B/C treaty, and 10% in the other two treaties.
Under domestic law, C levies a 20% withholding tax on outbound royalties.
Is C permitted to levy tax on the royalties paid by CCo to BCo?
Answer:
Relevance of A tax authorities’ TP adjustment to ACo
The TP adjustment to ACo is irrelevant to the treatment of royalties under the
B/C treaty: see OECD TPG, para. 6.13.
Beneficial owner (B/O) status
Even if the TP analysis in regard to ACo is that there is a deemed service fee
which is paid by BCo to ACo, that deemed payment would not cause BCo to fail the
B/O conditions in the OECD Comm.
IMHO, BCo is the B/O of the royalties.
Nevertheless, some tax authorities in the position of C (e.g., China) have taken
the position that, if BCo does not perform the DEMPE functions, it is not
entitled to the treaty benefit for royalties. As mentioned above, that view is
not supported by the OECD TPG.
PPT (Art. 29(9))
Based on the facts (in particular, the differential royalty withholding tax
rates), it is possible that the PPT might be triggered by the ACo / BCo
arrangement. Even though CCo is not the only company to which BCo licenses the
patents, the PPT might apply if it can be shown that a reduction in the royalty
withholding tax rate was a principal purpose for BCo licensing the patents to
those companies, instead of ACo.
If the PPT is triggered, 20% C withholding tax would apply.
In that case, economic / juridical triple taxation would likely occur between
the 3 countries (B might not grant a foreign tax credit for the C 20%
withholding tax, on the basis that BCo qualifies for the 0% treaty rate). That
might possibly be resolved under a tripartite MAP.
INTERNATIONAL TAX QUIZ 62
ACo (a bank resident in A) enters into equity swaps with individual customers
resident in C. The swaps track a portfolio of shares in companies resident in B
(BCos), and cash balances held by the customers.
As a hedge, ACo purchases the share portfolio tracked in the swaps.
The swaps exchange the ownership economics of the share portfolio (e.g.,
dividends, price changes) and the cash balances (e.g., interest). A single
payment is made under each swap (either from ACo to the customers, or vice
versa) at every quarter end, calculated according to a formula. There is no
contractual right to the components in the formula.
Each swap’s “force majeure” clause does not cover the failure of BCos to pay
dividends which have been declared (other than by virtue of B government
action).
A and B each impose a 20% withholding tax on outbound dividends.
The A/B treaty (which was signed and entered into force in 2011), is identical
to the 2010 OECD model, except that there is a single rate of 10% in Art. 10(2).
The A/C treaty is identical to the 2001 UN model, except that there is a single
rate of 10% in Art. 10(2).
The MLI (including Art. 7(1)) applies to both treaties.
There is no B/C treaty.
Q1: Does the A/B treaty permit B tax on dividends paid to ACo?
Q2: Does the A/C treaty permit A tax on swap payments made by ACo?
Answer:
Q1
First issue: beneficial ownership
IMHO, the “contractual or legal obligation” requirement (in the 2014 OECD Comm.
on beneficial ownership) should not apply to the A/B treaty, because it
represents a change in meaning and not a mere elaboration on the previous
meaning.
That previous meaning (reflected in the 2010 OECD Comm.) focuses on whether, in
the present case, ACo is a conduit company acting as a fiduciary or
administrator. The fact that there is no contractual right to the components in
the payment formula, that only a single quarterly payment is made (in either
direction), and that the payment reflects multiple elements besides dividends,
suggests that ACo is the beneficial owner. However, note that the Swiss Supreme
Court reached the opposite conclusion in a 2015 case.
On balance, IMHO, ACo is the beneficial owner.
Second issue: PPT
Based on the facts, the PPT would likely be triggered – this would cause the
dividends to be subject to 20% B withholding tax.
Q2
Unless the A law deems equity swap payments to be dividends, Art. 10 should not
apply.
Art. 21(3) might apply, if the individual customers are not carrying on
“enterprises” , and thus Art. 7 does not apply. If Art. 21(3) applies, A can
impose unlimited tax on the swap payments.
INTERNATIONAL TAX QUIZ 61
XCo, a company resident in X, has a branch in Y.
The branch conducts a manufacturing business in Y.
Excess cash generated by the branch is “deposited”, on a short term basis, with
the XCo head office in X. When the cash is needed by the branch, it is “repaid”
by the head office to the branch.
The branch’s financial statements and income tax return do not recognise any
interest income on these “deposits”.
The Y tax authorities impute arm’s length interest income to the branch under
the Y domestic law transfer pricing rules. Those rules apply to “transactions”
between a branch and head office, where one is located in Y and the other is
located in another country. Those rules do not apply if the branch and head
office are both located in Y.
The X/Y treaty, which was signed and entered into force in 2009, is identical to
the 2008 OECD model treaty.
Does the treaty permit the Y tax authorities to impute arm’s length interest
income to the branch?
Answer:
The Y branch is a PE under the treaty.
Under Art. 7(2), and the 2-step approach described in the OECD Comm., it is
likely that the “deposit” would be characterised as a loan from the PE to the
head office in X, and that arm’s length interest may be imputed by the Y tax
authorities under an analogous application of Art. 9(1).
However, Art. 7(2) is subject to Art. 7(3). In the OECD Comm. on Art. 7(3), it
is stated that (except for financial enterprises such as banks) “internal
interest” on “internal loans” between head office and PE need not be recognised.
However, those statements refer to the situation where the “internal loan” is
from the head office to the PE, and the “internal interest” is sought to be
deducted by the PE under Art. 7(2). That is also the situation which is
addressed in Art. 7(3) itself. Neither Art. 7(3), nor the OECD Comm. on Art.
7(3), is directed towards the alternative situation where the “internal loan” is
from the PE to the head office.
The OECD Comm. on Art. 7(3) reflects a qualification on the full implementation
of the OECD PE Reports (2008 & 2010). However, if Art. 7(3) does not apply to
“internal loans” from the PE to the head office, that qualification is not
relevant.
Thus, in my view, Art. 7(2) should allow the imputation of arm’s length interest
by the Y tax authorities.
Note that the Y law allows the imputation of interest between a branch and head
office, but these rules do not apply if the branch and head office are both
located in Y. Is that a breach of Art. 24(3)? No – the OECD Comm. states that
Art. 24(3) is subject to the PE profit attribution rules in Art. 7(2).
INTERNATIONAL TAX QUIZ 60
In 2015, ACo, a company resident in A, formed a new subsidiary called CCo, a
company resident in C. ACo funded CCo with 100% share capital.
CCo lent the funds to BCo, a company resident in B.
The 3 companies are members of an MNE group.
The loan from CCo to BCo carries an arm’s length interest rate. BCo is entitled
to income tax deductions for the interest paid to CCo.
Under C law, CCo is entitled to a notional interest deduction (NID) in regard to
its share capital. The NID has the effect of significantly reducing CCo’s
taxable profits.
The B/C treaty (which entered into force in 2012) is identical to the 2010 OECD
model treaty, except that the rate in Art. 11(2) is 5%. The MLI applies in
regard to the B/C treaty, with both Art. 7(1) & Art. 7(4) (MLI) being
applicable.
The A/B treaty (which entered into force in 2018) is identical to the 2017 OECD
model treaty, except that the rate in Art. 11(2) is 15%. There was no previous
treaty between A and B.
There is no A/C treaty.
B levies a withholding tax of 20% (final tax) on gross outbound interest
payments.
What rate of tax is B permitted to impose on BCo’s interest payments which are
made in 2020?
Answer:
Beneficial ownership
* CCo should be considered the “beneficial owner” of the interest, under Art.
11(2) of the B/C treaty. The NID would not be regarded as a payment by CCo
which could cause it to be characterised as a conduit company acting as a
fiduciary or administrator.
Art. 7(1), MLI, as impacting B/C treaty
* At the time CCo was formed and the loan was made to BCo (2015), the B tax
rate on interest paid to ACo was 20% – which is significantly higher than the
5% rate under the B/C treaty.
* Based on that differential and the other stated facts, it is likely that Art.
7(1) would be triggered in regard to CCo’s 5% rate. That would have the
effect of increasing the rate which B can levy on CCo, to 20%.
* The relevant “arrangement or transaction” was entered into several years
before the MLI entered into effect in regard to the B/C treaty. However,
there is no “grandfathering” rule in regard to Art. 7(1).
Art. 7(4), MLI, as impacting B/C treaty
* Art. 7(4) does not require B to levy a lower rate (than 20%) on CCo. If the
relevant transaction or arrangement had not occurred, BCo would not have paid
any interest to CCo.
Domestic law GAAR
* It is possible that the B tax law contains a GAAR which is applicable to
treaty shopping. If so, the GAAR might operate by “reconstructing” the facts.
In the present case, the “reconstructed” facts would likely be that ACo made
a loan (with arm’s length interest) to BCo. In that situation, ACo would have
been entitled to a 15% rate under the A/B treaty, and CCo would not be liable
for any B tax.
* Two related questions arise: (i) does the existence of Art. 7(1), MLI exclude
the separate operation of the GAAR to the same arrangement or transaction?;
and (ii) if not, can the taxpayers “force” the B tax authorities to pursue
the GAAR route, instead of Art. 7(1), MLI?
* Question (i) depends on the status of treaties vs. domestic legislation under
B law, and on the judicial attitude to “specific vs. general” provisions.
However, in regard to question (ii), even if the B tax authorities can
separately apply the GAAR, it is unlikely that they can be “forced” to do so
(on the assumption that the GAAR provides a discretion to the tax
authorities).
Conclusion
* B can levy 20% tax on interest paid to CCo, by virtue of Art. 7(1), MLI.
INTERNATIONAL TAX QUIZ 59
XCo, a company incorporated and resident in X, owns 100% of the shares in YCo, a
company incorporated and resident in Y.
XCo makes a loan (with an arm’s length interest rate) to YCo.
YCo uses the borrowed money in its business in Y.
YCo fails to deduct and remit withholding tax from the interest it pays to XCo.
As a result of the non-payment of withholding tax, the Y tax authorities (acting
in accordance with the Y tax law): (i) impose penalties on XCo and YCo; and (ii)
deny an income tax deduction to YCo for the interest payments.
Under Y law, no withholding tax is imposed on interest payments to resident
lenders.
The X/Y treaty is identical to the 2017 OECD model treaty.
Are the actions taken by the Y tax authorities, permitted under the treaty?
Answer:
XCo: Art. 24(1)
The fact that a withholding tax is levied by Y on interest paid to XCo, but not
on interest paid to Y-resident lenders, does not breach Art. 24.
Specifically, Art. 24(1) is not breached, because XCo cannot be compared with
Y-resident lenders, as they are not “in the same circumstances, in particular
with respect to residence”.
For the same reason, the penalty imposed on XCo does not breach Art. 24(1).
YCo: Art. 24(5)
I will assume that Y’s withholding tax applies to interest paid to non-residents
generally, and it is not limited to interest paid to a person which owns or
controls the capital of the payer.
Based on that assumption, Art. 24(5) is not breached by either (i) the penalty
imposed on YCo, or (ii) the denial of deductions for YCo – see OECD Comm., para.
79.
YCo: Art. 24(4)
The Y tax authorities have denied YCo deductions for interest paid to XCo,
because the withholding tax was not paid. If the interest were instead paid to a
Y-resident lender, it would be deductible, because there is no withholding tax
imposed in that situation.
This is a breach of Art. 24(4).
INTERNATIONAL TAX QUIZ 58
ACo, a company resident in A, owns 100% of the shares in BCo, a company resident
in B.
BCo owns land in B, with a market value equal to 35% of the aggregate market
value of all of BCo’s assets.
In September 2020, ACo sold all its shares in BCo to CCo (an unrelated company
resident in C).
The A/B treaty, which was signed and entered into force in 2012, is identical to
the 2010 OECD model treaty.
The MLI, which applies to the A/B treaty, entered into effect, for both A and B,
on 1 January 2020.
Both A and B: (i) reserved against Art. 9(1)&(4) for all covered tax agreements
(“CTAs”); but (ii) did not reserve against Art. 11(1) for any CTAs.
In early 2020, B changed its tax law, in regard to the imposition of capital
gains tax on sales of shares in “land-rich” companies. Prior law applied a “more
than 50%” valuation threshold – i.e., the value of land in B had to be more than
50% of the aggregate value of the company’s assets. There were 2 changes : (i)
the valuation threshold was reduced to “more than 25%”; and (ii) the tax
liability was removed from the seller and imposed on the “land-rich” company.
These changes are effective for sales after 30 June 2020.
Does the treaty permit B to levy tax in regard to ACo’s sale of shares in BCo?
Answer:
Art. 11(1), MLI
Art. 11(1), MLI effectively adds, to the A/B treaty, the so-called “saving
clause” in Art. 1(3) of the 2017 OECD model treaty.
Subject to one qualification, this would mean that B’s taxing rights in regard
to BCo are unrestricted by the A/B treaty.
As the B tax liability in regard to ACo’s sale of shares in BCo is imposed on
BCo (and not ACo), this would indicate that the treaty would not impact that
liability.
However, a possible argument under the Vienna Convention on the Law of Treaties
(VCLT) should be considered (see below).
The possible qualification concerns Art. 24(5), which is effectively included in
an exception in Art. 11(1), MLI. Art. 24(5) could be relevant if the B tax law
imposed the tax liability on “land-rich” companies only if their share capital
is wholly or partly owned or controlled by non-residents. I will assume that
that is not the case here.
VCLT
Despite that assumption, it is possible to view the B law change as a device to
avoid the application of Art. 13(5), which would give the exclusive tax right to
A.
That would likely breach Arts. 26 & 27, VCLT.
Depending on the status of legislation in B vs. treaty obligations, a court in B
might conclude that the breach is sufficient to not enforce the tax liability
against BCo. It could possibly do so by interpreting the B tax law change as not
applying in situations where B’s treaty obligations would be avoided (on the
basis that, if the B parliament had intended to avoid the treaty obligations, it
would have expressed that intention clearly).
INTERNATIONAL TAX QUIZ 57
XCo, a company resident in X, owns 100% of the shares in YCo, a company resident
in Y.
YCo carries on a manufacturing business in Y.
XCo makes a loan to YCo, for use in its business. The loan carries an arm’s
length interest rate. Under Y tax law, the interest is fully deductible for YCo.
The Y corporate income tax rate is 30%.
Under X tax law, YCo is treated as a branch of XCo.
YCo is therefore a hybrid entity: it’s treated as a taxable entity (a resident
company) in Y, and as a transparent entity (a branch) in X.
Under domestic law, Y imposes a final withholding tax of 20% on gross outbound
interest payments.
Neither X nor Y has introduced hybrid mismatch rules into domestic law.
The X/Y treaty is identical to the 2017 OECD model treaty, with Art. 23A.
What tax treatment does the X/Y treaty permit or require, in each of X and Y, in
regard to the interest payments from YCo to XCo?
Answer:
Y tax
The key issue is whether Art. 1(2) applies:
* YCo is “an entity or arrangement that is treated as wholly or partly fiscally
transparent under the tax law of either Contracting State”
* However, the interest is not “derived by or through” YCo – it’s derived by
XCo, and paid by YCo
* Thus, Art. 1(2) should not apply
Art. 11(2) would therefore apply: 10% Y tax would be imposed.
X tax
Art. 23A(2) requires X to allow XCo a credit for the Y tax: see the discussion
on “conflicts of qualification” in the OECD Comm. on Art. 23A/B.
However, by virtue of the second sentence in Art. 23A(2), the amount of the
credit is limited to the amount of the X tax on the interest income. If the
interest income is not recognised under X tax law (because YCo is treated as a
branch of XCo), then that amount of X tax is nil.
Thus, no credit.
INTERNATIONAL TAX QUIZ 56
ACo, a company resident in A, sells “Group X” electronic products.
BCo, a related company resident in B, is a buy/sell distributor of the “Group X”
electronic products, which it purchases from ACo on a “consignment” / “flash
title” basis.
BCo has several retail stores in B, at which it displays the full range of
“Group X” electronic products. At those stores, BCo’s employees spend most of
their time demonstrating the products to potential customers. Customers who
decide to purchase “Group X” electronic products, can do so in either of 2 ways:
(i) purchase from BCo at a retail store in B; or (ii) purchase from ACo via its
website (the products would then be delivered to the customers, directly from
offshore, by a logistics company). The price for (ii) is lower than the price
for (i).
The A/B treaty is identical to the 2017 UN model treaty.
Does the treaty permit B to levy income tax on ACo’s profits from the sale of
“Group X” electronic products?
Answer:
Art. 5(4)
ACo owns the products while they are on consignment with BCo at BCo’s retail
stores. It is possible that the exceptions in Art. 5(4)(a)&(b) are not
satisfied, on the basis that the activity (i.e., BCo’s maintenance and display
of the products) is not of a preparatory or auxiliary character, from ACo’s
perspective. It is also possible that Art. 5(4.1) prevents Art. 5(4) from being
satisfied, on the basis that each of BCo’s retail stores is a PE of BCo and the
business activities carried on by ACo and BCo at those stores “constitute
complementary functions that are part of a cohesive business operation”.
However, even if Art. 5(4) is not satisfied, ACo will not have a fixed place of
business PE in B unless the tests in Art. 5(1) are satisfied (see below).
Art. 5(1)
The key issue is whether the “at the disposal” test is satisfied.
It is possible that ACo, pursuant to its distribution contract with BCo, is
permitted to (and does) dictate the layout and style of the retail stores, and
the day-to-day activities of BCo’s employees, to such an extent that ACo is seen
to exercise practical control over the stores and/or the employees – in which
case, BCo’s retail stores could be considered to be “at the disposal” of ACo.
Art. 5(5)(a)
BCo’s employees do not conclude contracts “in the name of” ACo. Also, the fact
that BCo is a buy/sell distributor in regard to ACo, and takes “flash title” to
the products sold via the stores, should not cause Art. 5(5)(a) to be satisfied:
para. 96, OECD Comm.
However, the fact that the employees demonstrate the products to potential
customers, some of whom purchase the products from ACo online, might cause the
“habitually plays the principal role…” limb in Art. 5(5)(a) to be satisfied:
para. 88, OECD Comm.
Conclusions on PE
ACo might have a PE in B under Art. 5(1) or Art. 5(5)(a) or both.
Art. 7(1)
If ACo has an Art. 5(1) PE, the profits attributable to the PE would cover the
store sales (from ACo to BCo), but would possibly not cover the online sales
from ACo to B csutomers. However, the “modified force of attraction” (MFOA) rule
in Art. 7(1) would probably “catch” the profits attributable to the online
sales.
If ACo has an Art. 5(5)(a) PE, the profits attributable to the PE would cover
the online sales, but would possibly not cover the store sales. However, the
MFOA rule would probably “catch” the profits attributable to the store sales.
INTERNATIONAL TAX QUIZ 55
ACo, a company resident in A, makes an interest-free loan to BCo, a related
loss-making company resident in B.
The A tax authorities decide not to impute interest on the loan, because they
take the view that the loan is quasi-equity under A’s TP rules.
However, the B tax authorities impute interest on the loan under B’s TP rules,
and claim that ACo is liable for 10% interest withholding tax (IWT) on the
imputed interest (the B domestic law IWT rate is 25% on gross, but Art. 11 of
the A/B treaty limits the B tax to 10% on gross). The A/B treaty is identical to
the 2017 UN model treaty.
Does the A/B treaty permit B to impose tax on the imputed interest? If so, at
what rate?
Answer:
MAP:
MAP under Art. 25 might result in no imputed interest in B.
However, I will assume that MAP is not initiated or does not result in that
outcome.
Art. 11:
Art. 11(2) allows B to impose 10% tax on “such interest”, i.e., the interest
described in Art. 11(1).
Art. 11(1) describes interest “arising” in a Contracting State (B) and “paid to”
a resident of the other Contracting State (A).
The term, “paid”, is not defined in the treaty. UN Comm. : “paid” has a very
wide meaning – the concept of payment means the fulfilment of the obligation to
put funds at the disposal of the creditor in the manner required by law or by
custom.
Art. 11(5) defines “arising”, by using terms such as “payer”, “the person paying
the interest”, “the indebtedness on which the interest is paid was incurred”,
“such interest is borne by such [PE]”.
Art. 3(2) allows a domestic law meaning of “paid” to be used, if B law contains
such a meaning and if the context does not otherwise require.
IMHO:
1. Art. 11(5) assumes that there is an actual amount of interest. It provides a
context for Art. 11(1), which then prevents a domestic law meaning of “paid”
(assuming one exists) from being used.
2. Art. 11(1) is not satisfied, and thus Art. 11(2) does not apply.
Art. 21(3):
Art. 21(3) should generally not apply, as the imputed interest is “dealt with”
in Art. 7 (see below).
The term, “arising”, as used in Art. 21(3), is not defined. The UN Comm. says
that it should take its meaning under domestic law. Thus, it is possible that
the “arising” condition in Art. 21(3) is satisfied here. Nevertheless, if Art. 7
applies (see below), Art. 21(3) will not.
Art. 7:
If ACo has no PE in B, then the imputed interest should be exempt under Art.
7(1).
However, if ACo is a special purpose company with only one asset (the loan to
BCo), the B tax authorities might argue that ACo does not carry on an enterprise
and thus Art. 7 does not apply – in which case, Art. 21(3) becomes relevant.
INTERNATIONAL TAX QUIZ 54
XCo, a company resident in X, owned a building in Y which it purchased for $1
million.
XCo derived rent from leasing the building to an unrelated lessee.
Some years later, XCo sold the building, to an unrelated purchaser, for $1.5
million.
Under X law, XCo was subject to tax on the rental income, but was able to claim
deductions for tax depreciation on the building. The tax depreciation aggregated
to $0.3 million over the years of ownership. When XCo sold the building for $1.5
million, it derived a capital gain of $0.8 million (i.e., $1.5 million minus the
reduced cost base of $0.7 million).
Under Y law, XCo was subject to tax on the rental income, but was not entitled
to any tax depreciation. When XCo sold the building for $1.5 million, it derived
a capital gain of $0.5 million (i.e., $1.5 million minus cost base of $1
million).
Both capital gains are subject to corporate income tax (at the same rate as
ordinary income) under the domestic tax laws in X and Y.
The X/Y treaty is identical to the 2017 OECD model treaty, with Art. 23A.
Both X and Y use the same currency.
What will be the tax treatment of XCo, in each of X and Y, in regard to the sale
of the building?
Answer:
Y:
Art. 13(1) permits Y to impose tax on XCo’s “gain”, which is not defined – its
computation is left to Y law: para. 12, OECD Comm. on Art. 13.
Under Y law, XCo’s capital gain of $0.5 million is subject to income tax.
X:
XCo’s capital gain of $0.8 million will, prima facie, be subject to income tax.
However, X must provide relief under Art. 23A.
Art. 23A(1): “Where a resident of [X] derives income…which may be taxed in [Y]
in accordance with the provisions of this Convention…,[X] shall…exempt such
income…from tax.”
What amount will be exempt: $0.5 million or $0.8 million?
These facts are similar to the situation described in paras. 14 & 15, OECD Comm.
on Art. 13. The only difference is that, in the situation in those paragraphs,
the treatment of the $0.3 million is described as “the depreciation allowances
granted earlier may be recovered”, whereas (in our facts) XCo’s cost base is
reduced to $0.7 million. As capital gains are subject to corporate income tax at
the same rate as ordinary income, the 2 treatments of the $0.3 million have the
same tax effect. Thus, it would be logical to apply the same approach – i.e.,
$0.5 million would be exempt.
IMHO: $0.5 million will be exempt, and $0.3 million will be taxed.
INTERNATIONAL TAX QUIZ 53
ACo, a company resident in A, is the parent company of a multinational group.
BCo, a company resident in B, is a member of that group, and is a 100% direct
subsidiary of ACo.
BankCo is an unrelated bank resident in B.
BankCo makes a $100 million “bullet” loan to BCo, at a fixed interest rate of 3%
per annum.
The loan is guaranteed by ACo.
BCo pays a guarantee fee of $0.5 million per annum to ACo.
The facts indicate that the effect of the guarantee is to permit BCo to borrow a
greater amount (i.e., $100 million) than it could in the absence of the
guarantee (i.e., $40 million), but the guarantee has no effect on the interest
rate.
The A/B treaty is identical to the 2017 OECD model treaty.
The A and B domestic law transfer pricing rules both follow the 2017 OECD
Transfer Pricing Guidelines.
Q1: What adjustments would the B tax authorities be allowed to make under the
A/B treaty and the B TP rules?
Q2: What adjustments would the A tax authorities be allowed to make under the
A/B treaty and the A TP rules?
Answer:
What is the accurate delineation of the transactions (ADT)?
Based on para. 10.161, OECD TPG, it is likely that the ADT is: (i) loan of $40
million (3% p.a. interest) from BankCo to BCo; (ii) loan of $60 million (3% p.a.
interest) from BankCo to ACo; and (iii) equity contribution of $60 million from
ACo to BCo.
What are the likely or possible consequences of that ADT?
Q1:
* Guarantee fee paid by BCo to ACo would need to be assessed under the arm’s
length principle (ALP), on the basis that the guaranteed loan is $40 million.
If the fee exceeds the arm’s length price, the excess would likely be
non-deductible for BCo and might be treated as a dividend paid to ACo
(subject to withholding tax).
* Would BCo’s interest payments to BankCo (unrelated party) need to be assessed
under the ALP, on the basis that the loan from BankCo is only $40 million?
Strangely, this issue is not mentioned in para. 10.161, OECD TPG, but it
would seem to be a logical conclusion. If the interest payments exceed the
arm’s length price (on a loan of $40 million), the excess would likely be
non-deductible for BCo and might be treated as a dividend paid to ACo
(subject to withholding tax), which is paid by direction to BankCo.
Q2:
* If B imposes withholding tax on dividends paid to ACo (see above), A would be
required to provide a credit: Art. 23A/B.
* If A tax law taxes dividends paid by BCo to ACo (i.e., no 100% participation
exemption), then the deemed dividends from BCo’s excessive interest payments
might cause an increase in ACo’s A tax liability.
* Would A be required to recognise ACo’s interest expense on the $60 million
loan from BankCo, in total or to the extent of the deemed dividends? Would
ACo obtain a deduction under A law for the interest? Would interest
withholding tax apply? And if interest withholding tax applies, would B be
required to give BankCo a credit under Art. 23A/B?
* More questions than answers! Sorry!
INTERNATIONAL TAX QUIZ 52
XCo, resident in X, is a buy-sell distributor of vehicle spare parts. XCo buys
the parts from several unrelated suppliers and sells them to unrelated repair
shops in X. XCo’s annual sales revenue from this activity is $50 million.
XCo also acts as a contract-concluding sales agent for 2 non-resident vehicle
spare parts suppliers: YCo (resident in Y and related to XCo) and ZCo (resident
in Z and unrelated to XCo). XCo enters into sales contracts, on behalf of YCo
and ZCo (respectively), with unrelated repair shops in X. The annual sales
revenue from this activity is $5 million (i.e., this is the aggregate of YCo’s
and ZCo’s revenue from sales concluded by XCo). 95% of that sales revenue is on
behalf of YCo, with 5% on behalf of ZCo. XCo is paid a sales commission by each
of YCo and ZCo.
XCo’s agency contracts require it to identify new business opportunities in X
for YCo and ZCo. This service, which is not commonly performed by similar agents
in X, is not separately remunerated (i.e., it’s covered by the sales
commissions) – and, for that reason, XCo spends little time in performing this
service.
The X/Y treaty and the X/Z treaty are both identical to the 2017 OECD model
treaty.
Does YCo have a PE in X? Does ZCo have a PE in X?
Answer:
There are 2 conditions which must be satisfied for the Art. 5(6) exception to
apply to YCo or ZCo: (a) XCo carries on business in X as an independent agent,
and (b) XCo acts for YCo or ZCo in the ordinary course of that business.
YCo: is XCo an independent agent?
* Art. 5(6), 2nd sentence: is the “exclusively or almost exclusively” test
satisfied?
* OECD Comm.: this test should be interpreted as “90% or more”.
* In applying the test, do you consider all of XCo’s activities or only the
agency activities?
* From the terms of the 2nd sentence, it is clear that you apply the test to
the agency activities only
* XCo satisfies this test (95%) and thus it fails the “independent agent”
condition.
* Thus, YCo has a PE in X under Art. 5(5).
ZCo: does XCo act for ZCo in the ordinary course of that business?
* The analysis of this condition is made difficult by the 2017 changes to Art.
5(6) and the Commentary. Nevertheless…
* XCo performs 2 agency activities for ZCo: (i) concluding sales contracts, and
(ii) identifying new business opportunities. Activity (ii) is not commonly
performed by similar agents in X.
* Arvid Skaar, “Permanent Establishment – Erosion of a Tax Treaty Principle”
(2nd edition, 2020) states that this condition refers to the typical
activities of agents in the relevant industry. On that basis, activity (ii)
is not in the ordinary course of XCo’s agency business.
* A lack of separate remuneration and little time spent on activity (ii)
should, in my view, both be irrelevant.
* IMHO: XCo fails the “ordinary course of business” condition.
* Thus, ZCo has a PE in X under Art. 5(5).
INTERNATIONAL TAX QUIZ 51
ACo, a company resident in A, owns a patent which is registered in B.
BCo, a company resident in B, wants to use that patent to manufacture certain
goods in B.
ACo and BCo are related parties.
ACo sells the patent to BCo, in consideration for an annual fee which is set at
5% of BCo’s annual revenue from sale of the goods manufactured by using the
patent. The contractual obligation to pay the annual fee is for 10 years. The
sale contract calls the annual fee a “royalty”.
Under B tax law:
* BCo is able to claim tax depreciation on the 10 years aggregate of the annual
fee (which is initially estimated, and then “trued up” each year)
* Outbound royalties are subject to 20% royalty withholding tax on gross (final
tax)
The A/B treaty is identical to the 2017 OECD model treaty, except that the
source country tax in Article 12 is limited to 10% on gross.
ACo is in an excess foreign tax credit position in A, which means that it cannot
obtain an effective credit for the B withholding tax.
Does the A/B treaty permit B to impose tax on the annual fee payments?
Answer:
1. Art. 12
1. The key issue is whether the annual fee payments fall within the
definition of “royalties” in Art. 12(2): “consideration for the use of,
or the right to use, any…patent”
2. The answer is no. The annual fee payments are consideration for the
acquisition of the patent, not for its use: see OECD Comm., para. 8.2
(first sentence). The form of consideration (i.e., a percentage of annual
sales revenue for 10 years) and the name given to the consideration
(i.e., “royalties”) are irrelevant.
3. Note, however, that some bilateral and model treaties include in the
definition of “royalties” in Art. 12, gains on the disposal of IP where
the consideration is contingent on the use of the IP – for example, see
the 2006 US model treaty.
2. Art. 13
1. The gain derived by ACo on the sale of the patent should be exempt from B
tax under Art. 13(5) – subject to Art. 29(9) (see below). The fact that
the patent is registered in B is irrelevant.
2. If Art. 12 applies (see 1(iii) above), then an interesting conflict would
arise between Art. 12 (which would allow B tax of 10% on the gross annual
fee payments) and Art. 13(5) (which would exempt the gain from B tax).
3. Art. 11
It is conceivable that B domestic law “carves out” implicit interest from
the series of annual fee payments – despite the fact that the quantum of
each annual fee payment is uncertain at the start. If it does so, the B tax
authorities might claim that that interest is taxable in accordance with
Art. 11. The OECD Comm. probably supports that approach: see “conflicts of
qualification” in regard to Art. 23A/B.
4. Art. 29(9)
1. Based on the facts (in particular, that ACo is in an excess foreign tax
credit position), it is conceivable that Art. 29(9) (the PPT) could be
triggered by this transaction.
2. Art. 29(9) would probably not apply if this were merely a “plain vanilla”
sale of the patent to BCo for a lump sum price – it’s the contingent
consideration which makes the transaction unusual and therefore raises
the risk that, viewed objectively, the avoidance of B withholding tax
under Art. 12 is seen to be a dominant purpose. Nevertheless, no B tax
advantage seems to be achieved from structuring the consideration in
contingent form, rather than a lump sum.
3. On balance, IMHO: Art. 29(9) should not apply.
INTERNATIONAL TAX QUIZ 50
XCo, a company resident in X, manufactures goods in X for a global market.
XCo employs Mr A as its regional sales director in a region of the world. Mr A
lives in Y, but frequently travels to other countries in the region, including
Z. Mr A has been employed in this role for 10 years.
Under his employment contract with XCo:
* Mr A is required to frequently visit existing and prospective customers in
the region, to obtain purchase orders from them (with prices set according to
XCo’s then current price list)
* When Mr A obtains purchase orders, he must send the orders to XCo head office
in X, for its consideration and acceptance (if considered appropriate, after
the head office performs a credit evaluation of the customer). If the order
is accepted, XCo sends a written confirmation to the customer (with a copy to
Mr A)
* Mr A does not have the authority to accept purchase orders on behalf of XCo
* Mr A does have the authority to allow volume discounts to the customers,
within parameters set by XCo head office from time to time
For many years, XCo’s head office has accepted 100% of the purchase orders which
Mr A has sent to it.
The X/Z treaty is identical to the 2014 OECD model treaty.
Does XCo have a PE in Z, under the X/Z treaty?
Answer:
Is Art. 5(5) satisfied?
1. “exercises…an authority to conclude contracts”
1. By virtue of the employment contract, Mr A does not have actual
authority, either express or implied, to conclude contracts on behalf of
XCo.
2. However, does Mr A have apparent (or ostensible) authority to do so?
Apparent authority is recognised in the agency law of common law
jurisdictions and also in some civil law jurisdictions. But before
considering the facts, there is a threshold issue: which agency law
should be applied (X law, Z law or perhaps even Y law)?
3. The facts hint that apparent authority could be an issue: Mr A is the
regional sales director; he has been in that role for 10 years; for many
years, XCo head office has accepted 100% of the purchase orders which Mr
A has sent to it; he has authority to offer discounts; and there is no
indication that XCo has alerted the customers that Mr A does not have
actual authority.
4. XCo probably has no idea what Mr A says to customers during meetings. It
is possible, particularly in the context where Mr A offers a volume
discount, that he says to the customers: “If you give me the order for x
units, I’ll give you a 10% discount. I’ll get the formal paperwork done
at head office, but if you give me that order by the end of the month,
it’s a done deal!”. There is a history of XCo head office always
accepting Mr A’s purchase orders. It could be reasonable for the
customers to believe that Mr A has actual authority.
5. If Mr A does have apparent authority, he might be seen to accept the
customers’ orders – for example, by saying or emailing to them that the
order has been accepted and that formal paperwork will follow from head
office in a few days. That first contract would then probably be
superseded by the formal written contract sent by XCo head office.
2. “habitually exercises in a Contracting State”
The facts state that Mr A frequently travels to Y. This test is likely
satisfied.
3. Art. 5(6) exception
Not applicable – Mr A is an employee and therefore cannot be legally
independent of XCo
INTERNATIONAL TAX QUIZ 49
ACo, a company resident in A, owns a building in A. ACo leases all the offices
in the building to third party lessees.
BCo, an unrelated company resident in B, owns a significant portfolio of B
government securities.
ACo and BCo enter into a total return swap (TRS) in regard to the building and
securities. Thus, each quarter, a payment is made between ACo and BCo (in one
direction only), which reflects the following components (simplified):
* Rent received by ACo (less related expenses incurred by ACo)
* Increase or decrease in assessed market value of building
* Interest received by BCo (less related expenses incurred by BCo)
* Increase or decrease in assessed market value of the government securities
* Changes in the A/B exchange rate
The A/B treaty is identical to the 2017 OECD model treaty.
Q1: If a payment is made (under the TRS) from ACo to BCo, does the A/B treaty
permit A to impose tax on the payment?
Q2: If a payment is made (under the TRS), from BCo to ACo, does the A/B treaty
permit B to impose tax on the payment?
Answer:
Q1:
i. Art.6
* Art. 6(2), 1st sentence, allows the A domestic law meaning of “immovable
property” to apply. If the A domestic law treats rights under this TRS as
“immovable property”, in whole or in part, then (to that extent) that meaning
applies for the purposes of Art. 6. If that were the case, the whole or part
of the payment would be caught by Art. 6(1), which would allow A to tax the
payment (to that extent).
* If that is not the case, then the TRS would not be “immovable property”.
Also, based on the facts, BCo would probably have no rights in regard to the
building (e.g., an ownership or leasehold interest). In that situation, the
payment under the TRS should not be “income…from immovable property”,
although there is no statement in the OECD Comm. to that effect.
ii. Art. 7 & 21:
* If Art. 6(1) does not apply, the payment would be exempt from A tax, under
Art. 7 or 21 – subject to Art. 29(9).
iii. Art. 29(9)
* It’s quite possible that Art. 29(9) (the PPT) would be triggered, on the
basis that the TRS is a transaction to obtain the Art. 7 or 21 benefit.
* It’s also possible that non-tax reasons could be identified for the parties
entering into the TRS – e.g., A law prohibits BCo from owning the building.
Q2:
i. Art. 11
* The payment should not fall within the definition of “interest” in Art.
11(3), on the basis that the TRS is not a “debt-claim”: see OECD Comm.’s
brief discussion of interest rate swaps.
* Thus, Art. 11(2) should not allow B taxation.
ii. Arts. 7, 21 & 29(9): same comments as in Q1, mutatis mutandis.
INTERNATIONAL TAX QUIZ 48
XCo, a company resident in X, is the parent company of a global group.
One of its subsidiaries is YCo, a company resident in Y. YCo carries on a
manufacturing business in Y.
XCo opens a liaison office (“L.O.”) in Y. The L.O. has its own leased office,
and has one employee (Ms. A, a national of X, but resident in Y).
Ms. A’s role is to:
* Identify possible business opportunities for XCo in Y and nearby countries,
and communicate these to XCo
* Promote technical cooperation between XCo and its subsidiaries in Y and
nearby countries, and also between such subsidiaries themselves
* Act as communication channel between XCo and its subsidiaries in Y and nearby
countries
The X/Y treaty is identical to the 2017 OECD model treaty.
Does the treaty permit Y to levy income tax on XCo?
Answer:
Existence of PE:
1. Art. 5(1) satisfied
2. Art. 5(4):
1. Subject to one qualification, Ms A’s role probably falls within para. (e)
or para. (f), on the basis that the activities are of a preparatory or
auxiliary character in regard to XCo.
2. The qualification concerns promoting technical cooperation between XCo’s
subsidiaries themselves. That aspect of her role is arguably not
preparatory or auxiliary from the perspective of XCo, but instead it is a
service performed by XCo for those subsidiaries. If that is the case,
then Art. 5(4) is not satisfied, due to the “solely” requirement in para.
(e) and para. (f).
3. Even if Art. 5(4) is satisfied, Art. 5(4.1) must be considered. YCo, a
closely related enterprise, has a PE in Y (its manufacturing premises).
The issue is: are the business activities carried on by Ms A at the L.O.
and YCo’s activities at its manufacturing premises “complementary
functions that are part of a cohesive business operation”?
4. Note that part of Ms A’s role involves promoting technical cooperation
between XCo and YCo – would that connection cause Art. 5(4.1) to be
satisfied? That’s a difficult question to answer. However, it seems from
the drafting that, to trigger Art. 5(4.1), all of the activities at the 2
places must satisfy the test, “complementary functions that are part of a
cohesive business operation” – not just some (as is the case here). On
balance, I think that Art. 5(4.1) is not triggered.
5. IMHO: Art. 5(4) is not satisfied, due to the above-mentioned service
element in Ms A’s role.
3. Thus, IMHO: the L.O. is a PE.
Profits attributable to PE:
1. Art. 7(1) would allow Y to levy income tax on the profits attributable to
the L.O., determined on the assumption that the L.O. is an independent
enterprise and dealing at arm’s length with the other parts of XCo (Art.
7(2)). Note that the profits attributable to the L.O. would reflect all of
the L.O.’s activities, not merely the above-mentioned service element in Ms
A’s role.
2. In determining the profits attributable to the L.O., the services performed
by the L.O. for XCo’s subsidiaries (even those subsidiaries which are not
resident in Y), would be deemed to be for arm’s length consideration: OECD
Comm. on Art. 7(2) – unless (generally) they are duplicate services (2017
OECD TPG).
INTERNATIONAL TAX QUIZ 47
ACo, a company resident in A, owns 100% of the shares in BCo, a company resident
in B.
The A/B treaty is identical to the 2017 OECD model treaty.
BCo operates a business in B. It is registered for VAT purposes in B.
In response to the COVID-19 economic crisis, the B law has been amended to allow
taxpayer payments of VAT to the tax authorities to be deferred for 6 months.
However, companies which are themselves, or which are subsidiaries of, companies
resident in “low-tax jurisdictions” are excluded from the deferral. A falls
within the definition of “low-tax jurisdiction”.
Can BCo qualify for the VAT deferral?
Answer:
It can be accepted that VAT is not a tax to which the A/B treaty applies, under
Art. 2.
However, Art. 24 is not limited by Art. 2, but instead applies “to taxes of
every kind and description” (Art. 24(6)) – which phrase would include VAT. [Note
that 3 OECD members and 14 non-members have indicated that they “reserve the
right to restrict the application of [Art. 24] to the taxes covered by the
Convention”.]
Would BCo’s inability to qualify for VAT payment deferral, because it is a
subsidiary of a company resident in A, breach Art. 24(5)?
* The key issue is identifying the “other similar enterprises of the
first-mentioned State” – in other words, which hypothetical enterprises
should BCo be compared with?
* One view would be to compare BCo with enterprises of B which are not wholly
or partly owned or controlled, directly or indirectly, by one or more
residents of a “low-tax jurisdiction”. On this view, Art. 24(5) would be
triggered.
* Another view would be to compare BCo with enterprises of B which are wholly
or partly owned or controlled, directly or indirectly, by one or more
residents of a “low-tax jurisdcition”, but not including A. On this second
view, Art. 24(5) would not be triggered.
* Which view is correct? On balance, I think Art. 24(5) would likely be
triggered.
If Art. 24(5) is not triggered, then BCo has no legal basis to object.
However, if Art. 24(5) is triggered, another issue arises – the extent to which
the A/B treaty has been given legal effect in B.
* If the A/B treaty were given full domestic legal effect in B, with paramount
force over any inconsistent B domestic law, then BCo should qualify for the
VAT deferral, by virtue of Art. 24(5).
* However, some countries in B’s position do not give full domestic legal
effect to double tax treaties. Instead, such countries give double tax
treaties domestic legal effect only for the purposes of specific taxes – and
such specific taxes never (IMHO) include VAT. In such countries, although the
denial of the VAT deferral to BCo might be a breach of Art. 24(5), BCo would
have no legal right to enforce that breach against the B tax authorities.
INTERNATIONAL TAX QUIZ 46
XCo, a company resident in X, carries on a construction business.
It has contracted to undertake a construction project in Y. XCo has estimated
that the construction project would take 4 months to complete.
50 of XCo’s employees (all of whom are resident in X) travelled to Y, in
February 2020, to undertake the project.
The emergence of COVID-19 caused the Y government to order, on 15 March 2020,
all construction projects to cease, with immediate effect. On the same date,
without notice, both X and Y prohibited all international travel. Thus, with
effect from that date, the project was halted, and XCo’s employees were stranded
in Y.
XCo currently expects that work on the construction project will re-commence on
1 July 2020. It estimates that the project will be completed on 30 September
2020.
The X/Y treaty is identical to the 2017 UN model treaty. Y’s year-end for income
tax purposes is 30 June.
Q1: Assuming XCo derives a profit from the project, does the treaty permit Y to
tax all or part of that profit?
Q2: If XCo incurs an overall loss on the project, does the treaty permit Y to
tax a profit in regard to the project?
Answer:
Q1:
PE existence:
* Key issue: is the 6 months test in Art. 5(3)(a) satisfied?
* 2017 UN Comm. quotes, with approval, 2014 OECD Comm. which states that
“temporary interruptions” should be included in determining time.
* OECD Secretariat Analysis of Treaties and Covid-19 (3 April 2020) states
that COVID-19 is a temporary interruption for this purpose.
* I agree – the 6 months test should be satisfied (i.e., February – September
2020).
* That raises the issue of the relationship between Art. 5(1) and Art. 5(3)(a):
is Art. 5(3)(a) a separate form of PE, or is it merely a qualification on
Art. 5(1) (i.e., to find a PE, the other conditions in Art. 5(1) must be
satisfied)? Note that the 2017 UN Comm. refers to this issue, but does not
determine it.
* This issue could be relevant in this case, as the project site was possibly
not “at the disposal” of XCo from 16 March to 30 June – Y laws might have
made entry to the site illegal during that period.
* Nevertheless, IMHO: Art. 5(3)(a) is a separate form of PE, due to the
drafting differences between that provision and Art. 5(3) of the OECD
model.
* The fact that the project straddles the Y year-end is irrelevant.
* Thus, XCo has a PE.
Profit attribution:
* The profits attributable to the PE under Art. 7(1) will be based on the
assumption that the PE is a separate and independent enterprise: Art. 7(2).
* Based on the limited facts, it appears that the PE should be characterised as
a service provider to the head office (with its remuneration probably
determined on a cost plus basis), and the head office should be characterised
as an entrepreneur taking the substantive risks. The risk of a “black swan”
event like COVID-19 (and its financial consequences) should be assigned to
the head office. Thus, a profit would likely be attributed to the PE.
Q2:
* The profit attributable to the PE should be determined in the same way,
regardless of whether the project has an overall profit or loss (see Q1
above).
INTERNATIONAL TAX QUIZ 45
ACo, a company resident in A, in 2019 licensed a patent to BCo, a company
resident in B, in return for royalties.
Under B law, outbound royalties are subject to a final withholding tax of 20% on
gross.
Under the A/B treaty, which entered into force in 2005, the source country tax
on royalties is limited by Art. 12 to 15% on gross.
A 2005 protocol to the A/B treaty contains this provision:
“In respect of Article 12, if under any convention or protocol signed after 1
May 2005 between [B] and a third State which is a member of the OECD, [B] limits
its taxation at source on royalties to a rate lower than the rate provided for
in [the A/B treaty], the same rate as provided for in that convention or
protocol on royalties shall also apply under [the A/B treaty], with effect from
the date on which [the A/B treaty] entered into force or that convention or
protocol enters into force, whichever enters into force later.”
That protocol also entered into force in 2005.
Under the B/C treaty, which was signed and entered into force in 2008, the
source country tax on outbound royalties is limited to 10% on gross.
C became a member of the OECD in 2017.
Q1: For royalties paid by BCo to ACo in 2020, what tax rate does the A/B treaty
permit B to impose?
Q2: Would your answer change if the provision in the protocol instead said this:
“In respect of Article 12, if after the entry into force of [the A/B treaty],
any convention or protocol between [B] and a third State which is a member of
the OECD limits the taxation at source on royalties to a rate lower than the
rate provided for in [the A/B treaty], the same rate as provided for in that
convention or protocol shall also apply under [the A/B treaty].”
Answer:
Preliminary points:
* The 2 provisions are “most favoured nation” (MFN) clauses.
* Note the timing: the B/C treaty entered into force AFTER the A/B treaty (and
its protocol) entered into force, but BEFORE C became a member of the OECD.
Q1:
* The wording in this provision suggests that it applies only if the third
State is a member of the OECD at the time the convention or protocol between
B and the third State is signed or enters into force:
1. “…any convention or protocol signed after 1 May 2005 between [B] and a
third State which is a member of the OECD” (emphasis added)
2. “…with effect from the date on which [the A/B treaty] entered into force
or that convention or protocol enters into force, whichever enters into
force later” – this suggests that the third State is a member of the OECD
by the time the convention or protocol enters into force
* C became a member of the OECD 9 years after the B/C treaty was signed and
entered into force.
* IMHO: The MFN provision is not satisfied – thus, the 15% rate limit should
apply.
Q2:
* In contrast, the wording of this provision does not suggest that the third
State is a member of the OECD at the time the convention or protocol between
B and the third State is signed or enters into force.
* There would therefore be a stronger argument that this provision was
triggered when C became an OECD member in 2017. Admittedly, it would be
clearer if the provision instead said: “…if at any time after the entry into
force…”
* Nevertheless, IMHO: The MFN provision is probably satisfied – thus, the 10%
rate limit should apply.
INTERNATIONAL TAX QUIZ 44
Ms X, a resident of X, is an influencer on several social media platforms. She
owns 100% of the shares in XCo, a company resident in X. Ms X is employed by
XCo.
XCo produces videos in which Ms X advertises various goods. For such
advertisements, XCo is paid fees (“advertising fees”) by the manufacturers of
those goods (“advertisers”).
Prior to COVID-19, Ms X also attended public events at which XCo was paid fees
(“appearance fees”), by fashion companies, for Ms X to wear specific clothes at
the event.
Some of the filming and events occurred in Y and other countries outside X.
Also, some of the advertisers and fashion companies are resident in Y. Ms X has
a large fan base in Y.
The X/Y treaty is identical to the 2017 OECD model treaty.
XCo does not have a PE in Y under Art. 5.
Under the X/Y treaty, is Y permitted to levy income tax on advertising and
appearance fees which are received by XCo? Please consider 3 situations: (i)
filming / events occurred in Y, but advertisers and fashion companies are not
resident in Y (and do not have PEs in Y); (ii) filming / events did not occur in
Y, but advertisers and fashion companies are resident in Y; and (iii) filming /
events did not occur in Y, and advertisers and fashion companies are not
resident in Y (and do not have PEs in Y).
Answer:
Threshold issue #1: to what extent are Ms X’s activities those of an
entertainer, and are therefore potentially covered by Art. 17? See OECD Comm.,
para. 3 et. seq.:
* Producing videos: yes, entertainer activities
* Event attendance: OECD Comm. says that “a model performing as such” is not
acting as an entertainer (but several OECD and non-member jurisdictions have
noted their disagreement). Is Ms X acting as a model when she attends events,
at which she is paid to wear specific clothes?
Threshold issue #2: does Y domestic tax law attribute XCo’s income to Ms X?
Situation (i):
* If entertainer activities: income which is referable to filming / events
which occurred in Y is permitted to be taxed by Y, with XCo (Art. 17(2)) or
Ms X (Art. 17(1)) as taxpayer
* If not entertainer activities: Art. 17 is not applicable; the income is
exempt under Art. 7(1) or 21(1), regardless of the taxpayer
* In both cases, Ms X’s salary is exempt (Art. 15(2))
Situations (ii) & (iii):
* Art. 17 is not applicable
* Income is exempt under Art. 7(1) or 21(1), regardless of the taxpayer
* Ms X’s salary is exempt (Art. 15(2))
INTERNATIONAL TAX QUIZ 43
XCo, a company resident in X, carries on a business of manufacturing and selling
goods. XCo is considering establishing a manufacturing plant in a developing
country in order to benefit from lower manufacturing costs.
XCo identifies possible locations in 3 countries, all of which provide a 10-year
tax holiday and impose 20% withholding tax on outbound dividends (DWT).
The only material difference between the 3 countries is that Y has entered into
a double tax treaty with X, and the other 2 countries have not. The X/Y treaty
is identical to the 2017 OECD model treaty.
Based on that difference, XCo decides that Y will be the location. XCo forms a
100% Y-resident subsidiary (YCo) and it subscribes for significant share capital
in YCo (due to the tax holiday in Y, XCo structures its funding in the form of
100% equity). YCo has no other funding. YCo builds and operates the plant. Some
years later, YCo pays dividends to XCo. Under X domestic law, resident companies
are taxable on global profits; however, dividends received from YCo are exempt
under a participation exemption.
Q1: Under the X/Y treaty, what rate of DWT is Y permitted to levy on YCo’s
dividends?
Q2: Does the X/Y treaty permit the X tax authorities to deny the exemption for
XCo’s dividend income?
Answer:
Q1:
* 5%: Art. 10(2)(a).
* Art. 29(9) (PPT) should not apply to deny the benefit of Art. 10(2)(a),
because:
1. Example C in the OECD Comm., para. 182 (on which this question is based)
indicates that the PPT should not apply.
2. The PPT’s second limb (i.e., “unless it is established…”) should be
satisfied, due to the construction and operation of the manufacturing
plant in Y. (Despite the statement in OECD Comm., para. 182, it is
arguable that the PPT’s first limb is also satisfied.)
3. As a practical matter, it would be surprising if the Y tax authorities
were to assert the PPT in this case (which involves a substantial inbound
investment into Y).
Q2:
* Art. 23A or 23B requires X to grant a credit to XCo for Y DWT. The credit is
limited to the amount of X tax on the dividend income from YCo – thus, if the
domestic law participation exemption applies, the credit will be nil.
* YCo is “thickly capitalised” – it has no debt. It is possible that the X tax
authorities would use the X transfer pricing rules or anti-avoidance rules to
recharacterize part of YCo’s equity as an interest-bearing loan. The X/Y
treaty would not prevent such action: Art. 1(3).
* If the X tax authorities impute interest income to XCo, it should obtain a
credit for the DWT under Art. 23A or 23B, subject to the limitation described
above.
INTERNATIONAL TAX QUIZ 42
ACo (a company resident in A) and BCo (a company resident in B) are sister
subsidiaries in the global XYZ group.
ACo is the group’s in-house finance company and BCo carries on a manufacturing
business.
ACo lends money to BCo at an interest rate of 4% per annum.
The B tax authorities determine that the arm’s length interest rate is 3% p.a.
(please assume that that is the correct determination).
Under B domestic law, a final withholding tax of 20% (on gross) is levied on
outbound payments of dividends, interest and royalties. The corporate income tax
rate in B is 25%.
The A/B treaty is identical to the 2014 OECD model treaty.
What actions does the treaty permit the B tax authorities to take in regard to
the 1% of excessive interest?
Answer:
* BCo’s interest deduction:
* Art. 9(1) permits the B tax authorities to use domestic law TP rules to
disallow a deduction for the 1% excessive interest.
* ACo’s interest income:
* Art. 11(6) applies to the 1% excessive interest – with three effects: (i)
Art. 11(2) 10% limit on B tax does not apply to the 1%; (ii) the 1% “shall
remain taxable according to the laws of each Contracting State”; and (iii)
“due regard being had to the other provisions of this Convention”.
* Effect (ii) indicates that the 1% would be subject to 20% B tax.
* However, what is the impact of effect (iii)? Unless the B tax authorities
make a secondary adjustment (see below), it seems that Art. 7(1) should
apply to the 1% – in which case, the 1% would be exempt from B tax
(assuming that ACo does not have a PE in B).
* Secondary adjustment:
* According to the OECD Comm., Art. 9 does not prevent B from applying a
secondary adjustment, if permitted to do so under its tax law.
* 2017 OECD TPG, paras. 4.68 – 4.78: A secondary adjustment might take the
form of a deemed dividend (which would trigger dividend withholding tax) or
a deemed loan to ACo (with deemed arm’s length interest). If a deemed
dividend, then the fact that ACo and BCo are sister subsidiaries might
cause hypothetical dividends and capital contributions up and down the
ownership chain. Alternatively, the B law might allow ACo a time period in
which to repay the cash to BCo.
INTERNATIONAL TAX QUIZ 41
XCo, a company incorporated in X, conducts its business through a branch in Y.
XCo has no assets, operations or employees in X. XCo’s senior management and
board of directors are based in Y.
Under X tax law, XCo is a resident (based on incorporation). Under Y tax law,
XCo is a resident (based on central management and control). Under both
countries’ tax laws, resident companies are subject to income tax on global
profits.
XCo lends money to ACo, an unrelated company resident in X.
The corporate income tax rate in both X and Y is 30%.
X levies an interest withholding tax of 20% (on gross) on outbound interest
payments.
The X/Y treaty is identical to the 2017 OECD model treaty, with Art. 23B.
What rates of X and Y tax does the treaty allow to be imposed on the interest
paid by ACo to XCo?
Answer:
XCo’s residence status under Art. 4(3) requires competent authority (CA)
agreement. If the CAs fail to agree, XCo will generally not be entitled to
treaty benefits.
If XCo is resident in X (under Art. 4(3)):
1. Y would probably be permitted to tax the interest under Art. 7(1) (on the
basis that the interest is part of the profits attributable to XCo’s PE in
Y). Note that Art. 1(3) would not apply in regard to Y, as XCo is not Y
resident under the treaty.
2. Y might be required to provide credit for 10% X tax, under Art. 24(3)
(notional application of Art. 11(2)).
3. X may also tax the interest, but would be required to provide credit for Y
tax: Art. 23B.
If XCo is resident in Y (under Art. 4(3)):
1. X may tax the interest, subject to 10% limit: Art. 11(2). Note that Art.
1(3) would not apply in regard to X, as XCo is not X resident under the
treaty.
2. Y may also tax the interest, but would be required to provide credit for X
tax: Art. 23B.
INTERNATIONAL TAX QUIZ 40
ACo (a company resident in A) and BCo (a company resident in B) are sister
subsidiaries in the global XYZ group.
ACo carries on a mining business in A. It sells (and exports) minerals to BCo
for prices which the XYZ group believes comply with the arm’s length principle
(“ALP”).
A’s tax law includes transfer pricing provisions which deem the price of
exported minerals according to a schedule. The scheduled prices for ACo’s
mineral exports exceed the price which would be determined under the ALP.
The A tax authorities increase ACo’s taxable profits to reflect the scheduled
prices for mineral exports.
Q1: The A/B treaty is identical to the 2014 OECD model treaty. Does the A/B
treaty prevent A from applying the scheduled prices to ACo’s mineral exports?
Q2: Would your answer change if the A/B treaty were identical to the 2017 OECD
model treaty?
Answer
Q1:
* Threshold issue: what is the effect of Art. 9(1) on cross-border transactions
between associated enterprises? Is it:
1. “permissive” only – i.e., it permits Contracting States (CS) to apply
domestic law to adjust taxable profits to satisfy the ALP; or
2. “restrictive” only – i.e., it prohibits CS from applying domestic law to
adjust taxable profits to an amount which exceeds the arm’s length profit;
or
3. both “permissive” and “restrictive”?
* This is a controversial issue. However, the majority support (case law,
academic articles, tax administrations, and the OECD Commentary) is for
either (ii) or (iii). That majority support is catalogued in a recent
article: Georg Kofler & Isabel Verlinden, “Unlimited Adjustments: Some
Reflections on Transfer Pricing, General Anti-Avoidance and Controlled
Foreign Company Rules, and the ‘Saving Clause’ ”, Bulletin for International
Taxation, IBFD, 2020 (Volume 74), No. 4/5.
* Adopting that majority view: Art. 9(1) would prevent A from adjusting ACo’s
taxable profits to an amount which exceeds the arm’s length profit.
Q2:
* Another controversial issue: what is the interaction between Art. 9(1) and
Art. 1(3), in view of the fact that Art. 9(1) is not listed in the exceptions
to Art. 1(3)?
* Arguably, Art. 1(3) prevents the “restrictive” operation of Art. 9(1) in
regard to residents. This point is discussed in the above-mentioned article
by Kofler & Verlinden.
* If that view is correct, Art. 9(1) would not prevent A from adjusting ACo’s
taxable profits to an amount which exceeds the arm’s length profit.
INTERNATIONAL TAX QUIZ 39
XCo, a company resident in X, owns 100% of the shares in YCo, a company resident
in Y.
YCo derives a significant amount of profits, but it does not pay any Y tax on
those profits (as it is in a tax holiday period in Y). YCo does not pay any
dividends to XCo.
The X tax law includes CFC rules. Under those rules:
1. YCo is a CFC.
2. YCo’s total amount of profits is deemed to be paid as a dividend to XCo on
the last day of the current tax year, and therefore that amount is included
in XCo’s taxable profits for that year.
Q1: The X/Y treaty is identical to the 2014 OECD model treaty. Does the treaty
prevent X from applying its CFC rules in regard to YCo’s profits?
Q2: Would your answer be different if the X/Y treaty were identical to the 2017
OECD model treaty?
Answer :
Q1:
* There are conflicting court decisions:
1. The Schneider case (France) and several Brazilian cases held that CFC
rules conflict with a treaty and are therefore not applicable
2. Whereas, the Bricom case (UK) and several Japanese cases held, subject to
conditions, that CFC rules do not conflict with a treaty and are therefore
applicable
* The 2014 OECD Comm. dismisses “pro-conflict” arguments which are based on
Art. 7(1) (i.e., that YCo’s profits cannot be taxed in X, as YCo does not
have a PE in X) and Art. 10(5) (i.e., if YCo’s profits are derived from X).
The Comm. also, in regard to Art. 1, supports the position that there is no
conflict. Five OECD members have registered their disagreement or
reservations.
* X’s CFC rules operate by deeming a dividend paid by YCo to XCo. If Art. 23 in
the X/Y treaty requires X to exempt dividends paid by YCo, the question would
arise whether X’s CFC rules conflict with the treaty: see para. 38, OECD
Comm. on Art. 10.
* Conclusion: depends on the views of X’s courts on the above issues.
Q2:
* Art. 1(3): the treaty cannot affect X’s taxation of XCo (a resident of X).
The 2017 OECD Comm. makes clear that Art. 1(3) applies to CFC rules.
* Conclusion: CFC rules apply
INTERNATIONAL TAX QUIZ 38
ACo, a company resident in A, manufactures and sells branded clothes.
ACo enters into a distribution agreement with BCo, a related company resident in
B.
In this agreement:
1. BCo is appointed, for a period of 5 years, as ACo’s exclusive buy / sell
distributor in B; in consideration for this appointment, BCo agrees to pay
ACo a “royalty” equal to 5% of BCo’s annual sales of the ACo branded clothes
2. BCo is licensed to use the ACo trademark for sales and marketing purposes in
B only – no consideration is assigned to this licence
The A/B treaty is identical to the 2017 UN model treaty.
Does the treaty permit B to levy tax on the “royalty” of 5% paid by BCo to ACo?
Answer:
Art.5 PE:
* BCo is a buy/sell distributor for ACo – i.e., BCo buys goods from ACo and
sells them to BCo’s customers
* ACo should not have a PE in B under either Art. 5(1) or Art. 5(5) (see para.
96, 2017 OECD Comm. on Art. 5(5))
Art. 12 royalties:
* The 5% “royalty”, being consideration for appointment as exclusive
distributor in B, should not fall within the definition of “royalties” in
Art. 12(3): see para. 10.1, 2017 OECD Comm. (contrary views recorded by 5
countries)
* But should some or all of the 5% be re-allocated to the trademark licence?
1. Art. 12(3) “royalties” definition requires identification of contractual
consideration – it thus does not allow re-allocation of consideration.
2. Such re-allocation might be possible under domestic law TP rules, in
accordance with Art. 9(1), on the basis of separate TP analysis of the 2
contractual provisions: see para. 3.9 et. seq., 2017 OECD TPG.
3. However, it is likely that the arm’s length royalty for the trademark
licence, in the situation where BCo is permitted to use the trademark only
to market goods purchased from ACo, is nil: see Example 12, Annex to
Chapter VI, 2017 OECD TPG.
Conclusion: no B tax.
INTERNATIONAL TAX QUIZ 37
XCo, a company resident in X, publishes an online global newspaper on business,
finance and economics news and analysis. The newspaper is regarded as a
pre-eminent global source for such information.
The newspaper is provided to all its customers, in digital form, on a “paid
subscription” basis. The newspaper is written in English. However, it is also
provided in several other languages (customers can choose to read the newspaper
in any of the languages).
XCo has many customers (all individuals) who are resident in Y. The customers
pay for their subscriptions by credit card – usually, a direct monthly charge to
the card. The Y language is one of the languages in which the newspaper is
provided.
XCo is registered for VAT purposes in Y. Its subscription fee for Y customers
includes VAT, which XCo sends to the Y tax authorities. XCo’s quarterly VAT
returns are prepared and filed by an unrelated accounting firm in Y.
XCo has no employees, physical assets or related parties in Y.
The X/Y treaty is identical to the 2017 UN model treaty.
Under the X/Y treaty, is Y permitted to levy income tax on XCo?
Answer:
Art. 5: no PE.
Art. 12(3) “royalties”:
* Subscription fees should not be “onsideration for … copyright”, even if
newspaper downloaded to customer’s computer: para. 17.3, OECD Comm.
(reproduced by UN Comm.)
* Are the subscription fees consideration “for information concerning
industrial, commercial or scientific experience”?
1. OECD Comm. (reproduced by UN Comm.) equates “information…experience” with
know-how, and then “defines” know-how transactions as involving
“undivulged” information, “unrevealed to the public”, and with
“confidentiality” provisions
2. That “definition” should not cover a newspaper, regardless of its
pre-eminence and existence of a paywall
3. Thus, subscription fees should not be “royalties”
Art. 12A(3) “fee for technical services” (FTS):
* 1st issue: is newspaper “managerial, technical or consultancy” in nature?
Probably “technical”
* 2nd issue: is provision of newspaper a service?
1. Key question: to be a “service”, does the newspaper need to be prepared on
a customised basis for a particular customer’s use?
2. UN Comm. provides inconsistent answers to this question: para. 62
(“transfer of knowledge…”) vs. para. 91 example
3. Difficult to conclude on this question
INTERNATIONAL TAX QUIZ 36
ACo, a company resident in country A, is a provider of professional legal
services.
ACo enters into a contract to provide legal advice to BCo (a company resident in
country B) on a possible investment in country C. The contract states that ACo
will engage CCo (a company resident in C and a provider of professional legal
services) to provide it with advice on C law.
ACo’s advice (which includes the advice provided by CCo) is transmitted to BCo
via the internet. None of ACo’s employees, and none of CCo’s employees, visit B.
ACo issues an invoice to BCo in the amount of $100,000. CCo issues an invoice to
ACo in the amount of $60,000.
The A/B and B/C treaties are identical to the 2017 UN model treaty (the MLI does
not apply).
Q1: Under the A/B treaty, is B permitted to levy tax on ACo? If so, does the
treaty permit the tax to be levied on $100,000 or $40,000 or another amount?
Q2: Under the B/C treaty, is B permitted to levy tax on CCo?
Answer:
Q1 (A/B treaty):
* Art. 12 is not relevant – ACo’s fee should not fall within the definition of
“royalties” in Art. 12(3).
* ACo’s fee falls within the definition of “fees for technical services” (FTS)
in Art. 12A(3), and it arises in B: Art.12A(5).
* Thus, B is permitted to levy tax on the fee: Art. 12A(2).
* It appears that ACo has a contract with BCo, and ACo also has a contract with
CCo, but that there is no contract between BCo and CCo.
* It is possible that, in the ACo/CCo contract, ACo’s obligation to pay $60,000
to CCo is dependent on ACo receiving at least $60,000 from BCo. If so, then
ACo is likely the beneficial owner (B/O) of only $40,000 (UN Comm., para.
56): on $40,000, B tax would be limited to x%; but on $60,000, it would be
unlimited!
* If that is not the case, ACo should be the B/O of $100,000: B tax would be
limited to x% of $100,000.
* Characterising $60,000 of ACo’s fee as a reimbursement should not change the
analysis: UN Comm., paras. 74-82.
Q2 (B/C treaty):
* CCo’s fee satisfies the definition of FTS in Art. 12A(3), but it does not
arise in B: Art. 12A(5). Even if ACo is not the B/O of $60,000 of its fee
(see above), the person paying the fee to CCo is ACo, not BCo.
* Thus, Art. 12A(1) & (2) do not apply – CCo is exempt under Art. 7(1).
INTERNATIONAL TAX QUIZ 35
XCo, a company resident in X, acts as toll manufacturer (TM) for related party
YCo, a company resident in Y. XCo has no activities other than acting as TM for
YCo.
Under the TM agreement:
* YCo owns manufacturing moulds, which are transferred to XCo’s premises in X
for use in the TM process
* XCo receives, directly from third party suppliers, materials which have been
sold by those suppliers to YCo (XCo concludes the purchase contracts on
behalf of YCo)
* XCo uses the materials to manufacture finished goods (FG), in accordance with
patents which are owned by YCo and licensed to XCo (royalty-free) solely for
the purposes of the agreement
* At all stages of manufacture, the goods are owned by YCo
* At the end of the manufacturing process, the FG are stored by XCo for an
average of 10 days, and are then transferred to destinations outside X, as
directed by YCO
* YCo pays a fee to XCo for its services
The transfer of the materials from the suppliers to XCo, and the transfer of the
FG from XCo to destinations outside X, are performed by third party logistics
companies, as a service for YCo.
None of YCo’s employees ever visit XCo’s premises.
The X/Y treaty is identical to the 2014 OECD model treaty. The MLI does not
apply to that treaty.
Does YCo have a PE in X?
Answer:
Art. 5(1):
* Key issue: are XCo’s premises “at the disposal” of YCo?:
* Due to the TM activities? No: 2017 OECD Comm., para. 67
* Due to post-manufacture storage of FG? No: 2017 OECD Comm., para. 65
* Due to presence of YCo’s moulds? No – similar to leasing of equipment: 2017
OECD Comm., para. 36
* Due to XCo’s purchasing activities? No: 2017 OECD Comm., para. 118
* Thus, no Art. 5(1) PE
Art. 5(5):
* First part (habitually exercises authority to conclude contracts in YCo’s
name): satisfied
* Second part (exception – notional application of Art. 5(4) – is “combination
of activities” in subpara. (f) satisfied?):
* Maintenance of YCo’s materials for TM purposes? Yes: subpara. (c)
* Post-manufacture storage of FG? Yes: subpara. (a)/(b)
* Presence of YCo’s moulds, for TM purposes? Likely yes: subpara. (e)
* XCo’s purchasing activities? Yes: subpara. (d)
* However, actual TM activity (cf. maintenance of materials for TM purposes) is
not covered in Art. 5(4), but it is an activity which XCo undertakes for YCo
* On balance, I think that Art. 5(4)(f) is not satisfied
* Thus, Art. 5(5) PE
INTERNATIONAL TAX QUIZ 34
ACo, a company resident in country A, manufactures consumer goods. It owns a
warehouse in country B. The warehouse is operated by country B employees of ACo.
BCo is a company resident in B and it is a 100% subsidiary of ACo. BCo is the
exclusive distributor of ACo’s goods in B. BCo takes relatively little risk; it
does not take any market or physical inventory risk. This is achieved by the use
of a “flash title” model: the goods are sold by ACo to BCo only when, and to the
extent, that BCo has contracts to sell the goods to its customers; and the price
is set by reference to the price charged by BCo to its customers, giving BCo a
guaranteed gross margin.
Thus:
* Step 1: ACo physically moves the goods from A to the warehouse in B.
Importation is subject to customs duty and VAT. ACo is the importer of
record.
* Step 2 (days or weeks after step 1): ACo sells some goods to BCo. This sale
contract is concluded between BCo and ACo’s employees in A. ACo’s employees
at the B warehouse play no role with regard to the conclusion of the
contract. Under the contract, title in the goods passes to BCo when
possession of the goods is given to BCo or its agent.
* Step 3 (at same time as step 2): BCo enters into sale contracts with
customers. ACo’s head office gives instructions to ACo’s warehouse employees
to release the required amount and type of goods to BCo’s third party
logistics company (XCo). Acting upon BCo’s instructions, XCo picks up the
goods at ACo’s warehouse (title in the goods passes to BCo at this point),
and delivers them to the customers.
The A/B treaty is identical to the 2017 OECD model treaty.
Does ACo have a PE in B under the treaty? If so, how would you determine the
profits attributable to the PE?
Answer:
Warehouse:
* Art. 5(1) tests satisfied
* Art. 5(4):
* Art. 5(4.1) satisfied: business activities carried on at ACo’s warehouse and
BCo’s business premises “constitute complementary functions that are part of
a cohesive business operation”: see Example B in OECD Comm., para. 81
* Thus, Art. 5(4) not satisfied
* Thus, Art. 5(1) PE
BCo’s premises:
* No indication that ACo’s employees visit BCo’s premises
VAT registration:
* ACo is probably registered for VAT purposes in B. However, this has no
relevance to ACo’s PE status: see OECD Comm., para. 5
Art. 5(5):
* Not satisfied in regard to “flash title” model: see OECD Comm., para. 96
Art. 7(1):
* The profits attributable to the warehouse PE are the profits which an
independent warehouse company would derive from performing the warehouse
activities: see 2018 OECD guidance
INTERNATIONAL TAX QUIZ 33
ACo, a company resident in country A, manufactures consumer goods. It owns a
warehouse in country B. The warehouse is operated by country B employees of ACo.
BCo is a company resident in B and it is a 100% subsidiary of ACo. BCo is the
exclusive distributor of ACo’s goods in B. BCo takes relatively little risk; it
does not take any market or physical inventory risk. This is achieved by the use
of a “flash title” model: the goods are sold by ACo to BCo only when, and to the
extent that, BCo has contracts to sell the goods to its customers; and the price
is set by reference to the price charged by BCo to its customers, giving BCo a
guaranteed gross margin.
Thus:
* Step 1: ACo physically moves the goods from A to the warehouse in B.
Importation is subject to customs duty and VAT. ACo is the importer of
record.
* Step 2 (days or weeks after step 1): ACo sells some goods to BCo. This sale
contract is concluded between BCo and ACo’s employees in A. ACo’s employees
at the B warehouse play no role with regard to the conclusion of the
contract. Under the contract, title in the goods passes to BCo when
possession of the goods is given to BCo or its agent.
* Step 3 (at same time as step 2): BCo enters into sale contracts with
customers. ACo’s head office gives instructions to ACo’s warehouse employees
to release the required amount and type of goods to BCo’s third party
logistics company (XCo). Acting upon BCo’s instructions, XCo picks up the
goods at ACo’s warehouse (title in the goods passes to BCo at this point),
and delivers them to the customers.
The A/B treaty is identical to the 2011 UN model treaty. The MLI does not apply
to the treaty.
Does ACo have a PE in B under the treaty? If so, how would you determine the
profits attributable to the PE?
Answer:
Warehouse:
* Art. 5(1) satisfied
* Art. 5(4)(a) & (b):
* “storage or display” – “delivery” is deliberately omitted from UN model. What
is the difference between “storage” and “delivery”? If a facility is used to
store goods for delivery, does that qualify as “storage”, or is it delivery?
The UN Comm. states that a warehouse used for delivery (i.e., storage for
delivery) is excluded from paras. (a) & (b).
* The goods at ACo’s warehouse are destined for sale to BCo, and that should
qualify as storage for delivery, even though a sale contract for most of the
goods has not yet been concluded. Thus, in my view, paras. (a) & (b) should
not apply.
* The “preparatory or auxiliary character” condition should not apply: see
answer to ITQ29.
* Thus, Art. 5(1) PE
BCo’s premises:
* The facts don’t indicate that ACo’s employees frequently visit BCo’s
premises.
VAT registration:
* ACo is probably registered for VAT purposes in B. However, this has no
relevance to ACo’s PE status: see 2017 OECD Comm.
Art. 5(5)(b):
* Not satisfied: although BCo maintains the goods, it does not deliver them.
Art. 7(1):
* The profits attributable to the warehouse PE are the profits which an
independent warehouse company would have derived from performing the
warehouse services: see OECD, Additional Guidance on Attribution of Profits
to PEs. Those profits do not include any reward for ACo being able to deliver
its goods quickly to BCo.
INTERNATIONAL TAX QUIZ 32
XCo, a company resident in country X, operates a number of large retail stores
in X and other countries. XCo establishes, and maintains for a period of 2
years, an office in country Y for the purposes of researching the local market
and lobbying the government for law changes which would allow XCo to establish
stores in Y.
During that period: (i) the office has 10 employees; (ii) the office manager
routinely enters into various types of contracts (on behalf of XCo) such as
employment contracts, office lease contract, office cleaning contract, contracts
for utilities, contracts for office stationery, and contracts for supply of
economic and business information on the local market; and (iii) the office
manager and other senior employees frequently entertain senior government
officials at football games, restaurants, karaoke bars, etc. That entertainment
is illegal in Y, under “anti-corruption” laws.
The X/Y treaty is identical to the 2017 OECD model treaty. Does XCo have a PE in
Y under that treaty?
Answer:
Art. 5(1):
* The tests in Art. 5(1) should be satisfied in regard to the office: (i)
specific geographical place; (ii) at the disposal of XCo; (iii) for a
sufficiently long period of time; (iv) and through which the business of XCo
is wholly or partly carried on.
* In regard to test (iv): XCo should be considered as carrying on its business
partly through the office, even though the office does not assist in
generating any revenue for XCo – see 2017 OECD Comm. para. 7 in regard to
“productive character”.
* The reference to “office” in Art. 5(2) is irrelevant: see 2017 OECD Comm.
para 45.
* The illegality of the entertainment activities is irrelevant.
Art. 5(4):
* The “preparatory or auxiliary character” exception in Art. 5(4)(f) should
apply.
* The facts are taken from Example 2 in para. 68 of the 2017 OECD Comm, which
states that:
“[para.] f) applies to the activities performed through the office (since
[paras.] d) and e) would apply to the purchasing, researching and lobbying
activities if each of these was the only activity performed at the office) and
the overall activity of the office has a preparatory character”.
* The only material difference in the facts is that our case expressly
indicates that the contracts concluded by the office manager include
contracts for the supply of services, which are not covered by Art. 5(4)(d).
However, that activity should fall within Art. 5(4)(e), and thus there should
be no impact on the conclusion.
Art. 5(5):
* This should not apply, as all the contracts relate to internal operations:
see 2017 OECD Comm. para 97.
Conclusion: No PE.
INTERNATIONAL TAX QUIZ 31
ACo, a company resident in country A, carries on a consulting business. ACo
entered into a contract with BCo (a company resident in country B) to undertake
a consulting project for BCo. Under the contract, two of ACo’s employees would
spend a period of time at BCo’s office in B, undertaking interviews with BCo’s
staff and reviewing BCo’s systems. The two employees would then return to the
ACo office in A to assist in writing the report for BCo.
The plan was that the two employees would spend 4.5 months at BCo’s office in B,
from 11 March 2019 to 31 July 2019.
However, due to poor planning, the employees actually spent 7.5 months at BCo’s
office, from 11 March 2019 to 30 November 2019.
The employees occupied a dedicated room at BCo’s office for the whole of the 7.5
months.
During the 7.5 months, the employees worked only on Mondays to Fridays. They did
not work on country B public holidays (of which there were 9 during the 7.5
months).
B’s year-end for corporate income tax purposes is 30 June.
The A/B treaty is identical to the 2011 UN model treaty.
Does the A/B treaty allow B to impose income tax on ACo for the year ended 30
June 2019 and/or the year ending 30 June 2020?
Answer:
Art. 5(3)(b)
The time test is “more than 183 days in any 12-month period commencing or ending
in the fiscal year concerned”. I will choose the 12-month period from 11 March
2019 to 10 March 2020, which commences in the fiscal year ended 30 June 2019 and
ends in the fiscal year ending 30 June 2020.
In applying the “more than 183 days” test, I must identify those days on which
ACo furnished services within B: “but only if activities of that nature [i.e.,
“furnishing of services”] continue … within a Contracting State …”. ACo
furnished services in B on 180 days during the 12-month period – i.e., all
Mondays to Fridays in the period from 11 March 2019 to 30 November 2019 (189
days), less 9 public holidays = 180 days.
Thus, no Art. 5(3)(b) PE in either fiscal year.
Some countries take the view that the time test in Art. 5(3)(b) should be
applied without counting the specific days on which services are furnished.
Applied to the facts in this case, those countries would say that services were
furnished for a 7.5 months period, and there are more than 183 days in 7.5
months. However, that view is at odds with the specific wording in Art. 5(3)(b),
particularly with the “183 days” test which replaced the former “6 months” test
in the 2011 UN model. Also, see the 2017 OECD Commentary, para. 163.
Art. 5(1)
BCo’s office is a specific geographical place through which ACo is partly
carrying on its business. It is “at the disposal” of ACo (see 2017 OECD
Commentary: “painter example”). The “more or less 6 months” time test, which is
not limited to counting working days, is also satisfied. Although the plan was
for the employees to be there for 4.5 months, their actual stay was 7.5 months:
see 2017 OECD Commentary, para. 34.
Thus, Art. 5(1) is satisfied.
Some have suggested that Art. 5(1) should not apply to the furnishing of
services, due to the presence of Art. 5(3)(b). There is no support for that view
in the UN Commentary, and it is at odds with the opening words of Art. 5(3):
“The term ‘permanent establishment’ also encompasses:”
Art. 5(4)(d) is not satisfied: ACo’s employees are doing more than merely
collecting information.
Thus, ACo has an Art. 5(1) PE in both fiscal years – and, therefore, Art. 7
allows B to levy tax on the profits attributable to that PE in both years.
INTERNATIONAL TAX QUIZ 30
In year 1, XCo, a company resident in country X, formed a branch in country Y to
act as a procurement office (PO) for it. The PO occupies leased premises and has
10 employees. The PO’s employees (acting with XCo’s express authority) identify
potential suppliers of goods in Y, conduct due diligence on those potential
suppliers, negotiate purchase contracts with the suppliers, and conclude those
purchase contracts. All of the contracts require the suppliers to arrange, and
pay for, insurance and freight of the goods to XCo in X. The PO’s employees
perform no activities in regard to payment of the suppliers.
For years 1 to 5, the PO performs the above-mentioned activities solely for XCo.
In year 6, in addition to the activities performed for XCo, the PO starts to
also perform the same activities for XSub, which is a company resident in
country X and is a 100% subsidiary of XCo.
The X/Y treaty is identical to the 2011 OECD model treaty. The MLI covers the
X/Y treaty; however, Arts. 12-15 of the MLI don’t apply.
Questions: (1) In year 5, does the X/Y treaty allow Y to tax XCo? (2) In year 6,
does the X/Y treaty allow Y to tax XCo and/or XSub?
Answer:
Question (1):
Art. 5(1): satisfied.
Art. 5(4)(d): All of the PO’s activities (identification, due diligence,
negotiation, contract conclusion) should fall within “purchasing” – although
there is an alternative argument that identification and due diligence are not
part of the “purchasing” function (the “purchasing alternative argument”). Thus,
Art. 5(4)(d) should be satisfied. The “preparatory or auxiliary character”
(POAC) condition does not apply to Art. 5(4)(d): see answer to ITQ29.
Thus, no PE.
Question (2):
(i) XCo:
The “solely” condition in Art. 5(4)(d) is not satisfied. Also, Art. 5(4)(e) &
(f) are not satisfied, because (inter alia) of the services performed for XSub.
Thus, XCo has an Art. 5(1) PE in Y.
However, the profits attributable to the PE (which Y is allowed to tax) should
be limited to the arm’s length fee charged to XSub, less the costs of deriving
that fee. No profits should be attributable to the PE in regard to the
purchasing activities for XCo: Art. 7(5). Again, the purchasing alternative
argument is relevant.
(ii) XSub:
Art. 5(5) is satisfied. The Art. 5(6) exception probably does not apply.
Thus, XSub probably has a PE in Y.
No profits should be attributable to the PE in regard to the purchasing
activities for XSub: Art. 7(5). Again, the purchasing alternative argument is
relevant.
INTERNATIONAL TAX QUIZ 29
ACo, a company resident in country A, conducts a business of selling its goods
through its website. Under the sales contracts, ACo is required to deliver the
goods to its customers’ addresses. A critical success factor for ACo’s business
is its ability to deliver the goods to the customers, within a relatively short
time period after the sale contract is made.
ACo has customers in several countries, including country B. To enable it to
quickly deliver goods to customers in country B, ACo owns and operates a
warehouse in country B. The warehouse contains stocks of ACo’s goods. When a
contract is made, ACo’s head office in country A instructs ACo’s employees who
are based at the warehouse to select the relevant goods and deliver them to the
customer’s address in country B. Title in the goods passes to the customer upon
delivery.
ACo’s warehouse employees play no role in the marketing process or in concluding
the sale contracts.
The A/B treaty is identical to the 2014 OECD model treaty. The MLI does not
apply to the A/B treaty.
Does ACo have a PE in country B, under Art. 5 of the A/B treaty?
Answer:
ACo’s warehouse satisfies Art. 5(1).
But does an exception under Art. 5(4)(a) or (b) apply?
According to the 2017 OECD Comm., the words, “storage, display or delivery”,
should be interpreted as applying to any combination of storage, display and
delivery. As ACo uses the warehouse solely for the purpose of storage and
(arguably) delivery, and as title in the goods passes to the customers only upon
delivery to the customers, the express words of Art. 5(4)(a) & (b) are
satisfied.
But is there an implicit “preparatory or auxiliary character” (POAC) condition
in the 2014 version of Art. 5(4)(a) & (b)? Due to the fact that quick delivery
is a critical success factor for ACo’s business, the use of the warehouse is
probably not of a POAC.
The 2014 version of Art. 5(4) (in which POAC is mentioned only in paras. (e) &
(f)) strongly suggests that such a condition is not implicit in paras. (a) &
(b). The 2014 & 2017 versions of the OECD Comm. do not directly address this
issue (but see para. 21 in 2014 version). However, some OECD member countries
take the view that that condition is implicit in paras. (a) – (d).
This issue is addressed by Jacques Sasseville in chapter 1 of “New Trends in the
Definition of Permanent Establishment” (IBFD, 2019). Based on the history of
Art. 5(4), he concludes that the POAC condition is not implicit in paras. (a) –
(d), prior to the 2017 changes. I agree!
Therefore, in my view, ACo does not have a PE in B.
INTERNATIONAL TAX QUIZ 28
In year Z, XCo, a company resident in country X, purchased a 5% shareholding in
YCo, a publicly listed company resident in country Y, for $1 million. At the
time of that purchase, YCo’s assets did not mainly consist of immovable property
in country Y.
In year Z + 5, X and Y entered into their first double tax treaty. That first
X/Y treaty was identical to the 1997 OECD model treaty.
In year Z + 15, X and Y replaced that treaty with a second treaty. The second
X/Y treaty is identical to the 2014 OECD model treaty.
In year Z + 17, XCo sold its shares in YCo, for $20 million. At the time of the
sale, YCo’s assets were mainly immovable property in country Y.
XCo’s profit of $19 million is taxable under country Y domestic law. What is the
impact of the X/Y treaties?
Answer:
The key difference between the two X/Y treaties is that the first treaty does
not allow source country taxation of capital gains on sales of shares in
companies resident in the source country (whether or not land-rich), whereas the
second treaty has a land-rich provision (Art. 13(4)) which does allow such
taxation. Based on the facts, Art. 13(4) applies.
However, XCo owned the 5% shareholding for 17 years, which can be divided into 3
periods:
(i) Z to Z+5: no treaty – thus, Y domestic law operates
(ii) Z+5 to Z+15: first X/Y treaty in force – treaty exemption applies
(iii) Z+15 to Z+17: second X/Y treaty in force – Art. 13(4) allows Y domestic
law to apply
Para. 3.1, OECD Comm. on Art. 13: “…where [Art. 13] allows a Contracting State
to tax a capital gain, this right applies to the entire gain and not only to the
part thereof that has accrued after the entry into force of a treaty (subject to
contrary provisions that could be agreed to during bilateral negotiations), even
in the case of a new treaty that replaces a previous one that did not allow such
taxation.” Note the comment by Austria and Germany in regard to the reverse
situation (para. 32.1).
Thus, the full $19 million will be taxable in Y. X must give relief under Art.
23A / 23B.
INTERNATIONAL TAX QUIZ 27
ACo, a company resident in country A, carries on a real estate investment
business.
ACo pays $10,000 to CCo (an unrelated company resident in country C), in
consideration for CCo granting ACo an option to purchase some land in country B.
CCo is the owner of that land. At a later time, ACo sells the option to DCo (an
unrelated company resident in country D), for a price of $1 million.
ACo therefore derives a profit of $990,000 from the acquisition and sale of the
option. That profit is taxable under the income tax laws of countries A & B.
The A/B treaty is identical to the 2014 OECD model treaty. The MLI does not
cover the A/B treaty.
What is the treatment of ACo’s profit under the A/B treaty?
Answer:
Art. 13(1) allows country B to tax the profit, if the option is immovable
property situated in country B. If Art. 13(1) does not so allow, Art. 13(5) will
prevent country B taxation (note that, from the question, it appears that ACo
does not have a PE in country B).
Two issues arise under Art. 13(1): (i) is the option “immovable property”?; and
(ii) if so, is it “situated in” country B?
Issue (i):
* Art. 13(1) uses the definition in Art. 6(2) – the first sentence adopts the
country B general law meaning.
* The option is an “in the money” (ITM) call option at both acquisition and
sale. It would need to be determined whether the country B general law treats
such an ITM call option over immovable property as itself immovable property.
* The OECD Commentary notes that Israel, Latvia & Lithuania want the Art. 6
definition in their treaties to expressly include call options over immovable
property.
Issue (ii):
* It is likely that contracts / consideration for the 2 transactions were
signed / paid (and received) outside country B.
* Although this is not stated by the OECD model treaty or Commentary, the
context would likely require that the “situation” of immovable property is
also determined under the country B general law.
If Art. 13(1) applies, country A must allow relief under Art. 23A / 23B.
INTERNATIONAL TAX QUIZ 26
XCO is a company resident in country X.
XCO owns 100% of the shares in YCO, a company resident in country Y.
XCO has made an interest-bearing loan to YCO. Assume that the interest rate
satisfies the arm’s length principle.
Country Y tax law includes a thin capitalisation rule, which uses a 2:1
non-resident related party debt to equity limit. XCO’s loan to YCO exceeds that
2:1 limit. Accordingly, under the thin capitalisation rule, the interest on the
excess amount of loan is disallowed as a deduction for YCO. However, the
disallowed interest retains its character as interest for withholding tax
purposes.
Country Y levies a 25% withholding tax on outbound dividends, and a 15%
withholding tax on outbound interest.
Country X taxes resident companies on global income.
The X/Y double tax treaty is identical to the 2014 OECD model treaty.
Based on these facts, what is the tax treatment of each of XCO and YCO in
countries X and Y?
Answer:
The question does not indicate the maximum ratio of related party debt to equity
which would satisfy the arm’s length principle (“ALP ratio”).
We need to compare 3 ratios: (i) ALP ratio, (ii) Y’s 2:1 thin cap ratio, and
(iii) actual XCO / YCO debt to equity ratio (“actual ratio”).
YCO’s interest deductions:
* If ALP ratio > actual ratio > 2:1 thin cap ratio, then YCO’s deductions are
allowable under Art. 24(4) (non-discrimination)
* If actual ratio > ALP ratio > 2:1 thin cap ratio, then YCO’s deductions are
disallowed under thin cap rule, to extent that actual ratio exceeds ALP
ratio: Art. 24(4)
Interest withholding tax:
* 10%, under Art. 11(2) (regardless of the extent to which YCO’s deductions are
disallowed)
* Note that Y law does not recharacterize disallowed interest as dividends
* Note also that Art. 11(6) is not applicable, as the interest rate satisfies
the arm’s length principle (“the amount of the interest, having regard to the
debt-claim for which it is paid, exceeds …”)
* X must give credit to XCO for the Y withholding tax: Art. 23A(2) / 23B(1)
INTERNATIONAL TAX QUIZ 25
ACO is a company resident in country A.
3 years ago, ACO purchased, from an unrelated party, a “special security” which
had been issued by Entity B, which was formed under country B law. Entity B is a
“qualifying cooperative foundation” (QCF), a legal form which is found in
country B law, but not in country A law. Under country A law, the only legal
forms which exist are individuals, companies and partnerships.
Several other parties own “special securities” issued by Entity B.
During the last 3 years, Entity B has derived significant profits from business
operations in country B. However, during that period, it has made only a series
of relatively small payments to ACO.
Under country A tax law, ACO is taxable on global profits, although an exemption
is given for foreign source dividends. Country A has no CFC or similar rules, no
entity characterisation rules, and no instrument characterisation rules.
Partnerships are tax-transparent. There is no double tax treaty between
countries A and B.
In calculating ACO’s country A income tax liability: (i) should ACO be taxable
on the series of relatively small payments made to ACO by Entity B?; and (ii)
should ACO be taxable on all or part of the profits derived by Entity B?
Answer:
This question raises 2 characterisation issues: (1) what is the characterisation
of Entity B?; and (2) what is the characterisation of the “special security”?
Regarding (1):
As country A law recognises only 3 legal forms (individuals, companies and
partnerships), it is necessary to characterise Entity B as one of those 3 forms.
In the absence of specific rules, most countries adopt a so-called “similarity
approach” – i.e., identify the rights and obligations of the foreign entity
under the law where it is formed, and then (based on those rights and
obligations) identify the local country legal form which it most closely
resembles (see: OECD Report: “The Application of the OECD Model Tax Convention
to Partnerships”, 1999).
Based on this approach, Entity B would be characterised as either a company or a
partnership for country A tax law purposes.
Regarding (2):
As country A tax law has no instrument characterisation rules, a “similarity
approach” would probably also be used: based on the rights and obligations of
the “special security” under country B law, what characterisation would be given
to the “special security”?
The 2 likely alternatives are: an ownership interest (either shares in a company
or a partner’s interest in a partnership) or a debt interest.
Thus:
The possibilities are: (a) company + shares (no country A tax); (b) company +
debt (country A tax on payments received, on basis that they are “interest”);
and (c) partnership (country A tax on Entity B’s profits; possibly 2 taxable
items, if “special security” is characterised as debt).
INTERNATIONAL TAX QUIZ 24
XCO, a company resident in country X, owns 24% of the shares in YCO, a company
resident in country Y. YCO’s shares are listed on a stock exchange in country Y.
The X/Y treaty is identical to the 2014 OECD model treaty. Also, the MLI applies
to the X/Y treaty – in particular, Arts. 6(1) & 7(1) of the MLI apply, but Art.
8(1) of the MLI does not apply.
Under country Y domestic law, a 30% dividend withholding tax (DWT) is levied on
outbound dividends.
XCO expects YCO to soon declare a large dividend. In order to reduce the rate of
country Y DWT, XCO purchases (on the stock exchange) additional shares in YCO
equal to 1% of YCO’s total shares. A few weeks later, YCO declares and pays a
large dividend. Shortly after its dividend was received, XCO sells (on the stock
exchange) shares equal to 1% of YCO’s total shares.
Under the X/Y treaty, what DWT rate should apply to the dividend paid to XCO?
Please ignore country Y domestic law anti-avoidance rules.
Answer:
5%, under Art. 10(2)(a) – reasons:
* 1. 1. Without the 12-month rule in Art. 8(1) (MLI), Art. 10(2)(a) applies a
“point in time” test: does the dividend-receiving company hold directly
at least 25% of the capital of the company paying the dividends, at the
time the dividends are paid? See para. 16 of 2014 OECD Comm. on Art.
10.
2. XCO directly holds 25% of YCO’s share capital at the time the dividend
is paid.
3. The principal purpose test (PPT) in Art. 7(1) (MLI) is relevant. The
first limb (“obtaining that benefit was one of the principal purposes
of any arrangement or transaction that resulted directly or indirectly
in that benefit”) is clearly satisfied. The issue is whether the
exception in the second limb (“unless it is established that granting
that benefit in these circumstances would be in accordance with the
object and purpose of the relevant provisions of the [treaty]”) is
satisfied.
4. The facts are based on Example E in the BEPS Action 6 2015 Final Report
(page 61), which is stated to satisfy the exception in the second limb.
However, there’s one important difference in the facts: XCO sells the
extra 1% shortly after the dividend is received. Does that make a
difference to the analysis, particularly as Example E refers to “a
taxpayer who genuinely increases its participation in a company in
order to satisfy [the 25% requirement]”?
5. On balance, I think XCO should still fall within the scope of Example
E. Although it presumably had a plan (at the time it acquired the 1%)
to sell the 1% shortly after the dividend receipt, it did not enter
into any form of forward sale or put option transaction to remove its
risk – at the time of dividend receipt, it was fully exposed to the
ownership risks of the 1%. Also, the fact that X and Y chose not to
apply Art. 8(1) (MLI), arguably indicates their acceptance of such “bed
and breakfast” strategies.
6. Final point: should the examples in the Action 6 Report influence the
interpretation of the PPT? I will leave that issue for a later time!
INTERNATIONAL TAX QUIZ 23
ACO is a company resident in country A. It conducts a television content and
broadcasting business. To conduct its business in country B, ACO uses a
satellite which is in a geostationary orbit over country B – in other words, the
satellite is permanently positioned 37,000 kilometres above a specific
geographic point in country B. ACO owns the satellite. It uses the satellite to
transmit signals to ground stations in country B – these ground stations are
owned by country B television operators, which broadcast ACO’s programs in
return for fees paid to ACO.
The A/B treaty is identical to the 2014 OECD model treaty. The MLI does not
apply to that treaty.
Does ACO have a PE in country B under the A/B treaty?
Answer:
1. No, for these reasons:
1. 1. There are 2 issues: (i) is the position of the satellite in space
(35,786 kilometres above country B, well beyond the Karman line)
within the territory of country B?; and (ii) is there a specific
geographic point in country B which is “at the disposal” of ACO?
2. Regarding (i): The satellite is “at the disposal” of ACO. However,
there is no consensus under international law that the position of the
satellite in space would be within the territory of country B. In
fact, such a notion is contrary to the UN’s “Outer Space Treaty”.
3. Regarding (ii): The specific geographic point which is directly below
the satellite and the ground stations to which signals are
transmitted, are within the territory of country B. However, ACO has
no employees or property there, and it does not control the activities
there. Accordingly, those specific points are not “at the disposal” of
ACO.
4. These views are supported by the 2017 OECD Comm. on Art. 5 (at para.
27):
“The question of whether a satellite in a geostationary orbit could
constitute a permanent establishment for the satellite operator
relates in part to how far the territory of a State extends into
space. No member country would agree that the location of these
satellites can be part of the territory of a Contracting State under
the applicable rules of international law and could therefore be
considered to be a permanent establishment situated therein. Also, the
particular area over which a satellite’s signals may be received (the
satellite’s ‘footprint’) cannot be considered to be at the disposal of
the operator of the satellite so as to make that area a place of
business of the satellite’s operator.”
5. India has recorded a contrary position to para. 27.
INTERNATIONAL TAX QUIZ 22
XCO is a company resident in country X. It decided that it would have a concrete
container constructed at its premises in country X. The construction would be in
3 sequential phases: (1) construction of the basement; (2) construction of the
walls; and (3) construction of the roof.
YCO is a construction company resident in country Y. YCO entered into a contract
with XCO for the phase 1 construction, which took 2 months to complete.
Another construction company (unrelated to YCO) performed the phase 2
construction, which commenced at the end of phase 1. Phase 2 took 4 months to
complete.
Towards the end of phase 2, YCO entered into a contract with XCO for the phase 3
construction. Phase 3 commenced at the end of phase 2, and it took 8 months to
complete.
In each of the 3 phases, there was no interruption in the construction
activities.
The X/Y double tax treaty is identical to the 2014 OECD model treaty, and the
MLI does not cover it.
Does YCO have a PE in country X, under Art. 5 of the X/Y treaty, in regard to
its construction activities at XCO’s premises?
Answer:
Apart from the time condition, YCO would satisfy the conditions in Art. 5(1).
In regard to the time condition, Art. 5(3) sets out a special rule: “A building
site or construction or installation project constitutes a permanent
establishment only if it lasts more than twelve months.” The facts indicate a
building site or construction project.
The total time for the site or project is 14 months. However, YCO participated
only in Phases 1 (2 months) and 3 (8 months), which aggregate to 10 months.
There are two issues: (i) is each phase a separate site or project?; and (ii)
(if the 3 phases are a single site or project), are the 4 months of Phase 2
counted in regard to YCO – in other words, should only YCO’s participation in
the project be counted or alternatively is Phase 2 a temporary interruption
(during which the time continues to run) from YCO’s viewpoint?
Although the OECD Comm. on Art. 5(3) discusses both of these issues, it does not
provide definitive guidance to apply to these facts.
These facts are based on a 2019 decision of the Swedish Supreme Administrative
Court (No. 4135-18).
According to the Court:
1. 1. 1. Each phase is not a separate site or project
2. Only YCO’s participation in the project is counted; and Phase 2 is not
a “temporary interruption”, as it does not fall within the instances
of “temporary interruptions” described in para. 55 of the OECD Comm.
Thus, from YCO’s viewpoint, the site or project lasts for 10 months,
and it is therefore not a PE.
This case is discussed in Jerome Monsenego, “The Construction PE and Temporary
Interruptions: Questions Based on a Swedish Case”, Tax Notes Today International
(November 21, 2019) (subscription service).
INTERNATIONAL TAX QUIZ 21
ACO, a company resident in country A, carries on a video streaming business. In
return for monthly subscription fees, customers are able to watch videos online,
and are able to download copies of videos on to their mobile devices in order to
watch the videos offline (for a limited period). ACO is the owner or licensee of
the copyright in its library of videos.
ACO has many individual customers in country B. The individual customers enter
into subscription contracts with ACO on ACO’s website. Monthly subscription
payments are made to ACO by the charging of customers’ credit cards (evidenced
by invoices which ACO sends to customers’ email addresses). ACO has no physical
presence in country B.
ACO is registered for VAT in country B, and has appointed an unrelated
accounting firm (BCO) in country B to act as its VAT agent. In accordance with
country B law, ACO charges VAT on its invoices to country B customers.
The A/B treaty is identical to the 2011 UN model treaty, and the MLI does not
apply to the A/B treaty.
What country B income tax treatment of ACO does the A/B treaty allow?
Answer:
(i) PE status:
1. 1. 1. ACO does not have a PE in B as defined in Art. 5 of the A/B treaty:
(a) BCO’s activities do not cause an agency PE for ACO; and (b) ACO’s
VAT registration does not cause a PE for ACO (see para. 5 of 2017 OECD
Comm. on Art. 5; India has registered a contrary position).
(ii) Royalties:
1. 1. 1. Art. 12(3) defines “royalties” to mean “payments of any kind received
as a consideration for the use of, or the right to use, any copyright
of literary, artistic or scientific work including cinematograph
films, or films or tapes used for radio or television broadcasting,
…”.
2. Watching the videos online does not involve the use of copyright by
the customer.
3. Downloading the videos on to the customer’s mobile device in order for
the customer to watch them offline would not be considered, in many
countries, as a relevant use of copyright, for the purpose of the
definition of “royalties” in Art. 12(3). This view is reflected in
paras. 17.1 to 17.4 of the OECD Comm. on Art. 12; those paragraphs are
reproduced in the 2011 and 2017 UN Comm. on Art. 12. Contrary views
have been registered by some OECD members (Mexico, Portugal, Spain and
Greece) and some non-OECD members (Brazil, India and Colombia).
4. If the OECD Comm. view on customer downloading is accepted in B, then
Art. 12 will not apply. If B takes the opposite view, then Art. 12
would allow B to impose tax on the payments, subject to the limit
expressed in Art. 12(2) – if B law actually imposes such a tax,
collection by customer withholding would be problematic.
(iii) Business profits:
1. 1. 1. If Art. 12(2) does not allow B tax, the payments would be exempt from
B tax under Art. 7(1).
INTERNATIONAL TAX QUIZ 20
XCO is a company resident in country X. It owns a small parcel of shares in YCO,
a company resident in country Y. YCO’s shares are listed on the country Y stock
exchange.
YCO declares a dividend, and issues dividend vouchers to its shareholders. The
dividend vouchers are transferrable. YCO will redeem the dividend vouchers, for
cash, on presentation after 30 days.
XCO sells its dividend vouchers to ZCO, a company resident in country Z, for a
price equal to 95% of the face value of the vouchers. The sale is unconditional
– in particular, XCO does not guarantee that YCO will redeem the vouchers for
face value or indemnify ZCO if YCO does not. No shares in YCO are sold by XCO to
ZCO. At the end of the 30 days, ZCO receives cash from YCO for the vouchers.
The X/Y treaty and the Y/Z treaty are identical to the 2014 OECD model treaty,
except that the tax limit in Art. 10(2)(b) is 20% (X/Y treaty) and 10% (Y/Z
treaty). Under domestic law, country Y levies a withholding tax of 30% on
outbound dividends.
In regard to the vouchers which are issued to XCO and then sold to ZCO, and
assuming the MLI does not apply to the 2 treaties, what rate of country Y tax
will apply?
Would your answer be different if the MLI did apply to both treaties?
Answer:
(i) Assuming MLI does not apply to both treaties:
1. 1. 1. The first issue to determine is whether, under the Y domestic tax law,
the taxing point is the issue of the vouchers to XCO or ZCO’s receipt
of cash from YCO on redemption of the vouchers. That will determine
who the relevant taxpayer is and thus which treaty is relevant.
2. If the taxing point is the issue of vouchers to XCO, then the X/Y
treaty applies. The issue of vouchers would fall within the definition
of “dividends” in Art. 10(3). XCO would clearly be the beneficial
owner of the dividends. The word, “paid”, in Art. 10(1) & (2) “has a
very wide meaning” (OECD Comm.). Art. 10(2)(b) would allow Y tax up to
a limit of 20%.
3. If the taxing point is ZCO’s receipt of cash from YCO on redemption of
the vouchers, such that ZCO is the relevant taxpayer, the Y/Z treaty
applies. The cash would probably fall within the definition of
“dividends”, on the basis that there is a sufficient connection with
the shares to be “income from shares”, even though ZCO does not own
the shares to which the redeemed vouchers relate (and possibly owns no
shares in YCO). ZCO would probably be the beneficial owner of the
“dividends”: see Royal Dutch Shell case (Hoge Raad, Netherlands, 6
April 1994). Art. 10(2)(b) would allow Y tax up to a limit of 10%.
(ii) Assuming MLI applies to both treaties:
1. 1. 1. If the X/Y treaty applies, the MLI would not change the analysis.
2. If the Y/Z treaty applies, Art. 7(1) of the MLI (the principal
purposes test, PPT) would be relevant. The facts in this question are
based on Example A in para. 182 of the OECD Comm. on Art. 29(9). In
the absence of other facts, it is likely that the PPT would apply to
deny the treaty benefit to ZCO – which would mean that the domestic
tax rate of 30% would apply.
INTERNATIONAL TAX QUIZ 19
ACO, a company which is resident in country A, owns the global copyright to a
film.
ACO sells that global copyright to BCO, a company which is resident in country
B.
The sale contract states that the consideration has 2 components: (i) a lump sum
of $10 million (payable upfront), and (ii) a royalty of 3% of annual revenue
which is derived by BCO from commercial exploitation of the copyright (payable
annually for 10 years).
2 years later, BCO discovers that ACO is deriving revenue from the copyright
from third parties in country A. BCO sues ACO, in a country A court, for breach
of copyright. The court awards damages to BCO of $2 million.
The A/B treaty is identical to the 2011 UN model treaty, and it is not covered
by the MLI.
What is the treatment, under the treaty, for the 3 payments?
Answer:
(i) Lump sum of $10 million (payable upfront):
1. 1. 1. This amount will fall within Art. 13(6) (capital gains – residual
paragraph). Thus, it will be exempt in country B.
2. This amount will not be “royalties” within the definition in Art.
12(3), because it is not consideration for the use of, or the right to
use, any copyright.
(ii) Royalty of 3% of annual revenue which is derived by BCO from commercial
exploitation of the copyright (payable annually for 10 years):
1. 1. 1. These 10 annual amounts should also fall within Art. 13(6) (and not be
“royalties” within the Art. 12(3) definition), and therefore should be
exempt in country B, for the same reasons as stated in (i) above.
Regardless of the calculation of the amounts and regardless of the
name given to the amounts in the sale contract, their character is of
payments for the sale of the whole copyright.
2. See paragraphs 15 & 16 in the OECD Commentary on Art. 12 (reproduced
in the UN Commentary on Art. 12). India and Colombia do not accept the
positions stated in those 2 paragraphs.
(iii) Damages of $2 million paid by ACO to BCO, for breach of copyright:
1. 1. 1. This amount should be treated as “royalties” within the Art. 12(3)
definition
2. See paragraph 8 in the OECD Commentary on Art. 12 (reproduced in the
UN Commentary on Art. 12):
“The definition covers both payments made under a license and
compensation which a person would be obliged to pay for fraudulently
copying or infringing the right.”
3. Thus, country A would be entitled to tax the amount up to the limit
described in Art. 12(2) (assuming BCO is the beneficial owner of the
amount and does not have a PE in country A). Country B would be
required to give a foreign tax credit under Art. 23A(2) or Art.
23B(1).
INTERNATIONAL TAX QUIZ 18
ACO is a company which is resident in country A. It is an accredited internet
domain name registrar authorised by Internet Corporation for Assigned Names and
Numbers (ICANN).
BCO is a company which is resident in country B.
BCO pays a fee to ACO to register its internet domain name.
Is the fee a royalty, as defined in Art. 12 of the A/B double tax treaty?
Please provide separate answers for: (i) assuming the A/B treaty is identical to
the 2011 UN model treaty; and (ii) assuming the A/B treaty is identical to the
1996 US model treaty.
Answer:
(i) A/B treaty is identical to 2011 UN model treaty:
1. 1. 1. The relevant part of the “royalties” definition in Art. 12(3) is:
“…consideration for the use of, or the right to use, …
any…trademark…”.
2. The term, “trademark”, is not defined in the treaty. It is also not
defined in either the UN Commentary or the OECD Commentary on Art. 12.
Therefore, it should probably take its meaning from the domestic law
of the source country (B): Art. 3(2).
3. Under the law of most countries, an internet domain name is not a form
of trademark, although it can be legally protected in a similar way to
a trademark – see (ii) below.
4. If the B domestic law is as described in 3. above, then the fee paid
to ACO will not fall within the “royalties” definition.
(ii) A/B treaty is identical to 1996 US model treaty:
1. 1. 1. The relevant part of the “royalties” definition in Art. 12(2) is:
“…consideration for the use of, or the right to use,…any…trademark,
…or other like property or right…”.
2. The terms, “trademark” and “other like property or right”, are not
defined in the treaty. They are also not defined in the US Technical
Explanation on Art. 12. Therefore, those terms should probably take
their meaning from the domestic law of the source country (B): Art.
3(2).
3. Under the law of most countries, an internet domain name is not a form
of trademark, although it can be legally protected in a similar way to
a trademark – for example, an action for passing off (common law).
4. If the B domestic law is as described in c. above, then the fee paid
to ACO should fall within the “other like property or right” part of
the “royalties” definition – subject to one qualification.
5. That qualification is whether part of the fee is consideration for the
use of, or the right to use, the domain name (i.e., registration of
the name), and the remainder of the fee is for BCO’s related services.
Payments for services do not fall within the “royalties” definition.
If the total fee can be split between the 2 components, then only the
first component would be “royalties”. Otherwise, the whole of the fee
would probably fall within the definition of “royalties”, on the basis
that the principal purpose of the contract is the registration: see
the discussion of “mixed contracts” in the OECD Commentary on Art. 12.
INTERNATIONAL TAX QUIZ 17
XCO is a company resident in country X.
XCO places money on a term deposit with an unrelated Bank, which is resident in
country Y.
The deposit carries a fixed negative interest rate – i.e., XCO pays interest to
the Bank.
The X/Y treaty is identical to the 2014 OECD model treaty. Assume that the Bank
is the beneficial owner of the interest, and that it does not have a PE in
country X.
Question 1: What is the treatment of the interest (which is paid by XCO to the
Bank) under the X/Y treaty?
Due to further negative movements in market interest rates, the Bank decides to
terminate the deposit before its maturity date. This triggers a penalty fee
(imposed on the Bank) under the terms of the deposit.
Question 2: What is the treatment of the penalty fee (which is paid by the Bank
to XCO) under the X/Y treaty?
Answer:
Question 1:
1. 1. 1. There is no guidance on this issue from the OECD, either in the
Commentary or elsewhere. Moreover, although there is some guidance
from country tax authorities on aspects of the tax treatment of
negative interest (e.g., tax deductibility), there is very little on
the characterisation of negative interest for treaty purposes.
2. The relevant part of the definition of “interest” in Art. 11(3) is
“income from debt-claims of every kind”. This suggests that the income
must flow from an asset (being a debt-claim) of the income recipient,
and not from a liability. Also, unsurprisingly, the OECD Commentary on
Art. 11(3) is written on the assumption that the interest is paid by
the debtor to the creditor. The reference to “negative interest” in
paragraph 20 of the Commentary refers to bonds which are issued at a
premium, which is arguably a different topic from negative coupon
interest.
3. It has been suggested that negative interest should be characterised,
not as interest, but as a fee charged by the debtor.
4. At present, the better view is that the negative interest is not
“interest” as defined in Art. 11(3).
5. As the creditor is a bank, Art. 7(1) should apply to provide an
exemption from X tax.
Question 2:
1. 1. 1. The penalty fee is paid by debtor to creditor, and thus the issue
considered above does not arise here.
2. But, nevertheless, the question remains: is the penalty fee “income
from debt-claims of every kind” (Art. 11(3) definition of “interest”)?
3. Again, there is no OECD guidance on this topic, and arguments can be
made for and against.
4. If it is “interest”, then Y may tax the fee up to a limit of 10% on
gross (assuming XCO satisfies the conditions in Art. 11(2) & (4)). X
must then provide a credit for the Y tax: Art. 23A(2) or Art. 23B(1).
5. If it is not “interest”, then the fee should be exempt in Y (assuming
XCO does not have a PE in Y), under either Art. 7(1) or Art. 21(1).
INTERNATIONAL TAX QUIZ 16
XCO is a company which is resident in country X. Mr A is the 100% shareholder in
XCO, and he is XCO’s only employee and director. Mr A is resident in country Y.
XCO enters into a secondment agreement with YCO, which is a large company
resident in country Y. XCO and YCO are unrelated and deal with each other at
arm’s length. Under the agreement, XCO seconds Mr A to YCO to work at YCO’s
office in country Y in the role of chief compliance officer, for an indefinite
period. Mr A does not become YCO’s employee (in legal form). However, YCO’s
senior executives control and take responsibility for Mr A’s day to day
activities, and Mr A (in many respects) acts as if he is YCO’s employee. For tax
purposes, country Y applies the “economic employer” approach.
Under the secondment agreement, YCO pays XCO $50,000 per month. Mr A’s salary
from XCO is $10,000 per month.
The income tax rates (for both companies and individuals) in country Y are
significantly higher than the corresponding rates in country X.
The country Y domestic tax law contains an anti-avoidance provision in regard to
schemes to divert personal services income. The country Y tax authorities use
that provision to levy income tax on Mr A on the $50,000 per month which is paid
to XCO (and they do not levy tax on the $10,000 per month salary which is paid
to Mr A). The country Y tax law does not contain any CFC or similar rules.
The country X tax authorities levy income tax on XCO on that same $50,000 per
month which is paid to XCO.
Thus, there is double tax on the $50,000 per month (country X taxes XCO, and
country Y taxes Mr A).
The X/Y treaty is identical to the 2014 OECD model treaty (with Art. 23B). Can
the X/Y treaty remove the double taxation?
Answer:
This is a “conflict of attribution of income” case: under domestic law, X
attributes the $50,000 income to XCO, and Y attributes the $50,000 income to Mr
A, resulting in economic double taxation.
This type of case is controversial – it is discussed in depth in: J.Wheeler,
“The Missing Keystone of Income Tax Treaties”, IBFD, World Tax Journal, 2011
(Volume 3), No. 2. It was also one of the main subjects at the 2007 IFA Congress
– see, in particular, the general report (also written by Wheeler) in Cahiers de
droit fiscal international, Volume 92b.
The better view is that the X/Y treaty cannot resolve the economic double
taxation, for these reasons:
1. 1. 1. 1. 1. In accordance with the domestic law income attributions: (i) X
would view the treaty as applicable (Art. 7 would apply to the
$50,000 income derived by XCO), but (ii) Y would view the treaty
as not applicable (the $50,000 income is derived by a resident
of Y from a source in Y – in Y’s view, there is no connection
with X).
2. The OECD model treaty and Commentary deal with one form of
“conflict of attribution of income” case – i.e., involving
partnerships and other types of fiscal transparency. However,
this present case is not due to fiscal transparency.
3. It could be argued that the OECD Commentary provides some
limited support for Y’s view. The 2017 Commentary on Art. 1
states (at paragraph 79): “… to the extent that the application
of a general anti-abuse rule or a judicial doctrine such as
‘substance over form’ or ‘economic substance’ results in a
recharacterization of income or in a redetermination of the
taxpayer who is considered to derive such income, the provisions
of the Convention will be applied taking into account these
changes.” However, the particular anti-avoidance provision in
this case is probably not a “general anti-abuse rule”, and thus
this statement can be argued to be not applicable.
4. The facts in this case are taken from an Australian case,
Russell v Commissioner of Taxation. The Federal Court held that
the economic double taxation cannot be resolved by the treaty.
However, there is some other case law (e.g., the Padmore case in
the UK) which would support a different view: see Wheeler’s
article cited above.
5. Art. 9 of the X/Y treaty does not apply, for several reasons,
including: (i) Mr A does not carry on an enterprise; and (ii)
the anti-avoidance provision in Y is not based on the arm’s
length principle.
6. For completeness, it should be noted that Mr A’s presence would
not cause XCO to have a PE in Y.
INTERNATIONAL TAX QUIZ 15
ACO is a company which is resident in country A. ACO carries on a dredging
business. ACO was interested in bidding for a dredging contract in regard to a
harbour in country B. As ACO had no office or employees in country B, ACO
engaged a third party consulting firm resident in country B (BCO) to study, and
prepare a report on, the density of the sediment in the country B harbour. Based
on that report, ACO prepared and submitted its bid (to the harbour authority)
for the dredging contract. As ACO’s bid was the lowest price, it won the
contract. According to ACO’s budget, it expected to derive a small profit from
the project.
The performance of the dredging contract was expected to take 3 months. ACO
identified a team of senior, skilled employees in its country A headquarters to
lead the dredging project “on the ground” in country B. Those employees
relocated to country B for the duration of the contract. Those employees hired
additional employees in country B to supplement the project team. The necessary
dredging equipment was hired (by the relocated employees in country B) from
third party providers in country B.
After the dredging work commenced, it became obvious that the BCO report was
deficient in many respects. The report grossly underestimated the density of
sediment in the harbour. As a result, ACO was required to perform a significant
amount of additional work to complete the contract. It took 2 years for the work
to be completed. Instead of achieving the budgeted profit, the dredging contract
caused ACO to suffer a significant loss (due to unbudgeted salaries and hiring
charges, and penalties levied by the harbour authority in accordance with the
contract).
ACO could not seek redress from BCO, as BCO had become insolvent, and its
directors and employees could not be found.
What will be ACO’s tax treatment in countries A and B, under the A/B treaty
(which is identical to the 2014 OECD model treaty, with Art. 23A)?
Answer:
B tax :
1. 1. 1. 1. 1. 1. ACO has a PE in B, at the dredging site in the harbour: Art.
5(1) & (3), A/B treaty.
2. B is permitted to tax the profits attributable to ACO’s PE:
Art. 7(1).
3. Determining the profits attributable to ACO’s PE (in
accordance with 2010 OECD Art. 7 report):
1. Merely because ACO has derived a global loss on the
contract does not mean that a profit cannot be
attributable to the PE.
2. The PE and HQ are assumed to be separate and independent
enterprises: Art. 7(2).
3. Functions allocated to HQ: decision-making in regard to
the bid.
4. Functions allocated to PE: recruitment of B employees,
hiring of equipment, and performance of dredging
contract.
5. Significant risks allocated to HQ: risk involved in
engaging BCO for report on sediment, risk in bidding too
low.
6. Significant risks allocated to PE: risk in performing
contract in inefficient manner.
7. Significant assets allocated to HQ: technical knowhow in
regard to bidding for contract, technical knowhow /
skills of HQ employees relocated to B.
8. Significant assets allocated to PE: technical knowhow /
skills of PE employees who were relocated from HQ.
9. A likely characterisation of the PE is a service
provider, due to the fact that its role was limited to
performing a contract which was won by the HQ.
10. The key issue to determine is to what extent the loss
incurred on the contract was due to the low bid price
(which, in turn, was caused by the incorrect report from
BCO), or alternatively was due to the inefficient
performance of the contract by the PE employees.
11. If it is clear that the loss was wholly or substantially
due to the low bid price, then (to that extent) the loss
should be allocated to the HQ. That would mean that a
profit should be attributed to the PE, to reward it for
the efficient performance of the contract (within the
context of a low bid price).
A tax :
1. 1. 1. 1. 1. 1. If a profit is attributed to the PE, that profit should be
exempt from B tax: Art. 23A(1).
INTERNATIONAL TAX QUIZ 14
XCO is a company which is resident in country A. XCO is a partner in a
partnership which is formed under country B law. The partnership conducts a
trading business from a leased building in country B – its major assets are
inventory, debtors and goodwill. Under country B law, the partnership is viewed
as fiscally transparent. In contrast, under country A law, the partnership is
viewed as a taxable entity (a company), and XCO’s interest in the partnership is
viewed as shares in the company. XCO sells its interest in the partnership for a
profit. That profit is taxable under both the country A tax law and the country
B tax law. Under the country A tax law, a foreign tax credit is available for
foreign tax paid by residents on foreign source taxable profits. XCO’s profit on
the sale of its interest in the partnership is treated as having a domestic
source under the country A tax law. What is the treatment of that profit under
the A/B treaty (identical to the 2014 OECD model treaty, with Art. 23B)? The MLI
does not apply to the A/B treaty.
Answer:
Country B:
1. 1. 1. 1. 1. 1. 1. The partnership’s trading business is an enterprise: Art.
3(1). That enterprise has a PE at the building in country
B: Art. 5(1). Therefore, XCO (a partner in the
partnership) also carries on that enterprise and has a PE
at that building – see paragraph 43 of the 2017 OECD
Commentary on Art. 5.
2. Thus, Art. 13(2) permits country B to tax XCO’s profit on
the sale of its interest in the partnership’s movable
property – i.e., inventory, debtors, goodwill, etc.
Country A:
1. 1. 1. 1. 1. 1. 1. If country B does levy tax on XCO’s profit, Art. 23B(1)
requires country A to grant XCO a credit for the country B
tax, regardless of the fact that, under country A domestic
law:
1. the profit has a domestic source, and
2. country A views the transaction as a sale of shares in
a company (on which view, Art. 13(5) provides that the
profit shall be taxable only in country A).
2. In regard to 1(ii), see the example in paragraph 32.4 of
the 2014 (and 2017) OECD Commentary on Arts. 23A and 23B.
INTERNATIONAL TAX QUIZ 13
XCO is a resident of country A. XCO owns a building in country B. The building
contains 10 residential apartments, all of which are leased to tenants who are
unrelated to XCO. A real estate agent in country B (YCO) manages the building
for XCO. XCO financed its purchase of the building by borrowing money from ZCO,
which is an unrelated bank resident in country C. The loan is secured by a
mortgage on the building. The A/B, A/C, and B/C double tax treaties are
identical to the 2014 OECD model treaty, with Art. 23A. The MLI does not apply
to any of those treaties. ZCO is the beneficial owner of the interest which is
paid by XCO on the loan, and ZCO does not have a PE in country A or country B.
In regard to (i) rent paid to XCO, and (ii) interest paid to ZCO, what is the
treatment under each of the A/B, A/C, and B/C treaties?
Answer:
Rent paid to XCO:
1. 1. 1. 1. 1. 1. 1. 1. 1. Country B may tax the rent, without rate limitation:
Art. 6, A/B treaty. The issue of whether or not
country B tax is imposed on a gross basis or a net
basis (i.e., after allowing deductions for interest
and other expenses) is determined under country B
law – Art. 6 does not require a net basis of
taxation.
2. Country A must exempt the rent : Art. 23A, A/B
treaty.
Interest paid to ZCO:
1.A/C treaty:
(i) The interest satisfies the definition of “interest” in Art. 11(3), despite
the mortgage.
(ii) The interest arises in country A: Art. 11(5), first sentence. The second
sentence does not apply, because (a) XCO does not have a PE (see below), and (b)
in any event, country B is not a Contracting State.
(iii) Art. 11(2) allows country A to impose tax of 10% on gross.
(iv) Country C must allow a credit for the country A tax: Art. 23A(2).
2.B/C treaty:
(i) The building would not be a “fixed place of business” PE under Art. 5(1), as
the building would not be “at the disposal” of XCO.
(ii) YCO would not cause a contract-concluding agency PE under Art. 5(5), even
assuming it concludes contracts on behalf of XCO (which is not clear on the
facts) – it would be an agent of independent status, acting in the ordinary
course of its business: Art. 5(6).
(iii) Thus, the interest would not arise in country B under Art. 11(5).
(iv) Thus, Art. 11(1) & (2) would not apply.
(v) Thus, Art. 7(1) would exempt ZCO from country B tax.
Conclusion – differential tax treatment of rent and interest:
1. 1. 1. 1. 1. 1. 1. 1. 1. Rent taxable in country B, but exempt in country A
2. Interest taxable in country A, but exempt in country
B
INTERNATIONAL TAX QUIZ 12
XCO is a company which is resident in country X. XCO owns 100% of the shares in
YCO, which is a company resident in country Y. XCO is a pure holding company;
its only assets are the shares in YCO. YCO has a “fixed place of business” PE in
country Z, from which it derives profits. YCO also derives profits from its
business operations in country Y. The X/Y, X/Z, and Y/Z treaties are identical
to the 2011 UN model treaty (with the rate in Art. 10(2)(a) being 10%), and the
MLI does not apply to those treaties. YCO pays a dividend to XCO. That dividend
is subject to country Z tax, at the rate of 30% (the country Z corporate income
tax rate) on a “net” basis – i.e., after subtracting allowable deductions. YCO
has no collection obligations, under country Z law, in regard to that dividend;
instead, XCO is required to report the dividend by filing a country Z corporate
income tax return. The dividend is also subject to 20% dividend withholding tax
under the country Y law. XCO is the beneficial owner of the dividend, and XCO
does not have a PE in either country Y or country Z. Can the country Z tax and
the country Y tax on the dividend be reduced or eliminated under a treaty?
Answer:
Country Y tax:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. Domestic law: 20% on gross dividend.
2. Treaty limitation: 10% on gross dividend: Art.
10(2)(a), X/Y treaty.
Country Z tax:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. Domestic law: 30% on “net” dividend.
2. X/Z treaty:
* 10(2) and Art. 10(5) do not apply, as the
dividend-paying company (YCO) is not a
resident of a Contracting State.
* If Art. 7 applies, XCO would be exempt under
Art. 7(1).
* However, a country Z court might take the
view that Art. 7 does not apply, on the
basis that XCO can be viewed as engaged in
only a passive investment activity, which
does not qualify as an “enterprise” (this
term is not defined in the treaty – if it
has a meaning under country Z law, it would
probably take that meaning: Art. 3(2)).
* If Art. 7 does not apply, Art. 21 is
relevant. The default position is Art.
21(1), which would provide exemption from
country Z tax. The critical issue is whether
the dividend is “arising in [country Z]”, in
which case Art. 21(3) would allow unlimited
country Z tax. According to the UN
Commentary, the “arising” issue is to be
determined under the country Z domestic law
– which would mean that there is a
significant risk that a country Z court
would conclude that Art. 21(3) applies.
3. Y/Z treaty:
* Subject to (ii) & (iii) below, Art. 10(5)
would apply to prevent country Z tax.
* On the facts, it appears that the dividend
is paid from a common profit pool,
consisting of profits derived from the
country Z PE and the country Y operations.
The exemption in Art. 10(5) should not be
reduced to the extent that the dividend is
paid from profits from the country Y
operations.
* But can XCO, which is not a resident of
country Y or Z, claim the benefit of Art.
10(5) of the Y/Z treaty? Art. 1 would
indicate that it cannot. However, numerous
academic articles and books have stated that
Art. 10(5) would apply in this situation,
regardless of Art. 1. For example, see:
Madeira & Neves, “Exploring the Boundaries
of the Application of Article 10(5) of the
OECD Model”, Intertax, Vol. 35 (2007), Vol.
8/9.
4. What would happen if (a) Art. 21(3) of the X/Z
treaty (country Z may tax), and (b) Art. 10(5)
of the Y/Z treaty (country Z must exempt),
BOTH apply? In my opinion, the exemption
should prevail.
INTERNATIONAL TAX QUIZ 11
BCO is a limited partnership formed under country B law. It has a general
partner (XCO) which is a company incorporated and resident in country B. It also
has 100 limited partners, who are individuals resident in country A. BCO owns
100% of the shares of CCO, which is a company resident in country C. CCO’s
assets do not consist of land in country C. The A/C double tax treaty is
identical to the 2014 OECD model treaty. The MLI does not apply to that treaty.
Country B has not entered into any double tax treaties. BCO does not have a PE
in country C. Under the country A and country B tax laws, BCO is treated as a
transparent partnership. Under the country C tax law, BCO is treated as a
non-resident company. BCO sells all of the shares in CCO for a significant
profit. Under the country C tax law, BCO is taxable on that profit. What impact
(if any) does the A/C treaty have on the country C tax position?
Answer:
According to the OECD Commentary on Art. 1, each of the limited partners will be
entitled to claim exemption under Art. 13(5) of the A/C treaty in regard to that
partner’s proportionate share of the gain derived on the sale of the shares in
CCO:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. Para. 6.5: “Where a partner is a resident of
one State [A], the partnership is established
in another State [B] and the partner shares in
partnership income arising in a third State
[C] then the partner may claim the benefits of
the Convention between his State of residence
[A] and the State of source of the income [C]
to the extent that the partnership’s income is
allocated to him for the purposes of taxation
in his State of residence [A].”
2. The Commentary also says that the character of
the income does not change, even though it is
derived by the partner through the partnership
(see para. 6.4, 3rd sentence; and para. 6.6,
2nd sentence), thus allowing Art. 13(5) to
apply.
3. The fact that country C treats BCO as a
company (a taxable entity) is irrelevant: see
para. 6.3.
4. Example 10 in the OECD’s 1999 Partnerships
Report is similar to this case study.
However, those paragraphs in the OECD Commentary on Art. 1 are not accepted by 5
OECD members (Chile, Netherlands, France, Portugal, and Mexico), absent an
express provision to that effect. A similar view is taken by 6 non-members
(Gabon, India, Ivory Coast, Morocco, Tunisia, and Argentina). If country C does
not accept those paragraphs, then it will presumably deny treaty benefits to the
limited partners.
Even if country C accepts those paragraphs in the OECD Commentary on Art. 1, the
issue remains as to how to give effect to those treaty benefits, having regard
to the fact that, under the country C tax law, the relevant taxpayer is BCO, not
the limited partners. This issue was briefly discussed by the Australian Federal
Court in the RCF IV case (April, 2019). The court expressed the view that the
treaty claims could not be made in proceedings to challenge an assessment
against BCO, but it could possibly be made (1) in recovery proceedings against
the limited partners, and (2) in proceedings for a court declaration confirming
the treaty benefits.
INTERNATIONAL TAX QUIZ 10
XCO is a company which is resident in country X. XCO has a “fixed place of
business” PE in country Y. The PE carries on an IP licensing business – it
licenses IP to customers in various countries, in return for royalties. One of
those customers is ZCO, which is a company resident in country Z. XCO is the
beneficial owner of the royalties, and it does not have a PE in country Z. The
X/Y, X/Z and Y/Z double tax treaties are identical to the 2014 OECD model treaty
(with Art. 23B), except that the source country tax on royalties is limited by
Art. 12 in each of the 3 treaties to : 15% (X/Y); 5% (X/Z); and 10% (Y/Z). The
MLI does not apply to any of those 3 treaties. Under the domestic tax law of
each of the 3 countries : (i) the corporate income tax rate is 30%; (ii) the
worldwide income of residents, and the domestic source income of non-residents,
is taxed; (iii) a foreign tax credit regime applies, but only to residents; and
(iv) the royalty withholding tax rate is 20%. In calculating foreign tax credits
in each of the 3 countries, please disregard the allocation of deductions or
(notional expenses) against foreign source income. If $100 of royalties are paid
by ZCO to the PE, what amount of tax will be levied on that $100 in each of the
3 countries?
Answers:
Z tax : $5 : Art. 12, X/Z treaty.
Y tax :
Prima facie tax, before applying Art. 24(3), would be $30 : Art. 7(1), 2nd
sentence, X/Y treaty.
24(3), X/Y treaty, requires that : “The taxation on a [PE] which an enterprise
of [X] has in [Y] shall not be less favourably levied in [Y] than the taxation
on enterprises of [Y] carrying on the same activities”
Imagine a hypothetical enterprise of Y (“YCO”) which carries on the same
activities as the PE. YCO would be subject to 30% corporate income tax on its
profits from those activities (same as the PE), and it would be entitled to a
credit for the Z tax under Y domestic law and under Art. 23B(1) of the Y/Z
treaty (not the same as the PE : the non-residence status of the PE means that
it does not satisfy the conditions for credit under Y domestic law and that it
does not satisfy the residence condition in Art. 1 of the Y/Z treaty). YCO’s
credit would reflect the 10% tax rate on royalties under the Y/Z treaty, not the
actual 5% tax imposed under the X/Z treaty. Thus, hypothetically, the Y tax
levied on YCO in regard to the royalties paid by ZCO would be $30 – $10 = $20.
Thus, the Y tax levied on the PE would be $20.
Apart from the issue of credit for Z tax, consider whether the taxable profits
of the PE (determined under the Y domestic law and Art. 7(2), X/Y treaty) and
the taxable profits of the hypothetical YCO (determined under Y domestic law)
would be calculated as the same amount. To the extent that the taxable profits
of the PE would be greater than the taxable profits of YCO, the resulting amount
of excess Y tax would also generally (with some exceptions) trigger Art. 24(3),
causing a reduction in the Y tax on the PE. This issue is not further considered
here.
X tax :
X must grant a credit of $5 under Art. 23B(1) of X/Z treaty, and a credit of $20
under Art. 23B(1) of X/Y treaty.
Thus, X tax = $30 – $5 – $20 = $5
Total tax : $5 (Z) + $20 (Y) + $5 (X) = $30
INTERNATIONAL TAX QUIZ 9
ACO is a company which is resident in country A. BCO is a company which is
resident in country B. BCO has a fixed place of business PE in country C. ACO
lends money to BCO to finance its country C PE. The interest on the loan is
shown as an expense in the PE’s financial statements. ACO is the beneficial
owner of the interest, and it does not have a PE in either country B or country
C. The A/B, A/C and B/C double tax treaties are identical to the 2014 OECD model
treaty. The MLI does not apply to any of those 3 treaties. Under the domestic
tax law of each of the 3 countries : (i) the corporate income tax rate is
30%, (ii) the worldwide income of residents is taxed, and (iii) the interest
withholding tax rate is 20%. In calculating foreign tax credits, assume that ACO
is not required to allocate any deductions against foreign source income. If the
amount of interest which is paid by BCO to ACO is $100, what amount of tax will
be levied on that $100 in each of the 3 countries?
Answer:
Country B:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. A/B treaty: Art. 11(5), 1st sentence
applies (payer is resident in B); Art.
11(5), 2nd sentence does not apply (as
the PE is not in a Contracting State).
Thus, interest arises in B.
2. A/B treaty allows B to impose tax of 10%
on gross interest: Art. 11(1) & (2).
3. Thus, $10 tax paid in B.
Country C:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. A/C treaty: Art. 11(5), 1st sentence
does not apply (payer is not resident in
C); Art. 11(5), 2nd sentence applies
(interest is relevantly connected with
PE in C). Thus, interest arises in C.
2. A/C treaty allows C to impose tax of 10%
on gross interest: Art. 11(1) & (2).
3. Thus, $10 tax paid in C.
Country A:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. Under A/B treaty, A must allow credit
for B tax of $10: Art. 23A(2) or Art.
23B(1).
2. Under A/C treaty, A must allow credit
for C tax of $10: Art. 23A(2) or Art.
23B(1).
3. After gross-up and credit for the B and
C taxes, A tax will be = ($100 x 30%) –
$10 – $10 = $10.
Thus: $10 tax paid in each of A, B and C, giving total tax of $30.
Note: This “double foreign tax / double foreign tax credit” situation occurs
because of the words, “in a Contracting State”, in Art. 11(5), 2nd sentence. See
paragraphs 28-31 in OECD Commentary.
INTERNATIONAL TAX QUIZ 8
XCO is a company which is resident in country A under the country A tax law. XCO
has a branch in country B. The branch carries on an investment business,
investing XCO’s surplus funds. The branch invests in a wide range of financial
and other assets, which are located in country B and elsewhere. XCO’s employees
who are based at the branch have significant investment management skills – they
make all key decisions, and they enter into all contracts, in regard to
investments made through the branch. One of the branch’s investments is a parcel
of land located in country A. The land is leased (for a market rent) to an
unrelated company (YCO), which is also resident in country A under the country A
tax law. The A/B treaty is identical to the 2014 OECD model treaty, with Art.
23A. The MLI does not apply to the A/B treaty. What tax treatment, in each of A
and B, does the A/B treaty allow or require, in regard to the rent paid by YCO
to XCO? Why?
Answer:
This is a controversial and frequently discussed example in academic literature
– for example, see: A. Bosman, “Redefining the Relation Between Articles 6, 7
and 21 of the OECD Model”, Intertax, Vol. 45, Issue 1.
Threshold point: Art. 6 does not apply, as the “bilateral” condition in Art.
6(1) is not satisfied. Thus, Art. 6(4) is irrelevant.
There are then 2 schools of thought:
1. As XCO has a PE in B, and the rent is part of the profits attributable to the
PE, Art. 7(1) allows B to impose tax on the rent. Although Art. 7(4) gives
priority to other articles in which the income is “dealt with”, there is no such
other article in this example – Art. 6 does not apply (above) and Art. 21(1)
should not be interpreted as applying in priority to Art. 7. Art. 23A(1) then
requires A to exempt the rent.
2. The exception in Art. 21(2) evidences an intention that Art. 7(1) does not
apply to income from immovable property in A. If Art. 7(1) does not apply to the
rent, then Art. 21(1) applies to allow exclusive taxation in A. This second view
is supported by the OECD Commentary: para. 74 on Art. 7, para. 4 on Art. 21, and
para. 9 on Art. 23A/B.
INTERNATIONAL TAX QUIZ 7
ACO is a company which is a resident under the country X tax law. ACO conducts a
freight carriage business on a worldwide basis. For that purpose, it uses ships
which it owns. Although ACO has a number of “operating centres” throughout the
world, the key management and commercial decisions for its global business are
made by the senior management and the directors in country X.
ACO has an operating centre in country Y (“Y centre”), which is registered as a
branch in country Y. Y centre is one of 5 such operating centres which ACO has
globally. Y centre consists of 2 floors in an office building (which are leased
by ACO), and 50 employees, including some senior employees. Y centre employees
enter into contracts with customers to carry freight on ACO’s ships which
operate in the region; they enter into contracts with suppliers (e.g., ports in
the region, ship crews, etc.); and they also manage ACO’s shipping operations in
the region.
ACO’s ships carry freight between 2 ports within country Y and ports in 6 other
countries. Some freight is carried from one port in country Y, for unloading at
the other port in country Y.
BCO is a company which is also a resident under the country X tax law. BCO is
part of the ACO group, and it acts as the treasury company for the group. BCO
lends money to ACO as working capital for all of its 5 operating centres.
Country Y law requires the preparation and auditing of financial statements for
the country Y branch. In those financial statements, Y centre’s allocated amount
of the BCO loan is shown as a liability, and its allocated amount of the
interest paid to BCO is shown as an expense. BCO is the beneficial owner of the
interest income, and it does not have a PE in country Y.
Under the X/Y treaty (which is identical to the 2014 OECD model treaty), what is
the country Y tax position of (i) ACO, and (ii) BCO? Why?
Answer:
ACO: exempt in Y under Art. 8(1), X/Y treaty – reasons:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. ACO’s place of effective management is in X.
2. ACO’s profits are from the operation of ships
in international traffic: see definition of
“international traffic” in Art. 3(1).
3. Art. 8 has precedence over Art. 7: Art. 7(4).
4. Although ACO has a PE in Y, there is no
provision in Art. 8 to send the matter to Art.
7.
BCO: exempt in Y under Art. 7(1) – reasons:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. Key issue: where does the interest arise, for
purposes of Art. 11? Under Art. 11(5), sent.
1, the interest arises in X. Does Art. 11(5),
sent. 2, apply to deem the interest to arise
in Y? According to the OECD Commentary, the
answer is no – paragraph 27: “c) The loan is
contracted by the head office of the
enterprise and its proceeds are used for
several permanent establishments situated in
different countries … Case c), however, falls
outside the provisions of [Art. 11(5)]…”.
2. If we follow the Commentary, then Art. 11(1)
and Art. 11(2) do not apply.
3. As BCO has no PE in Y, it is exempt under Art.
7(1).
But BCO’s position is a surprise? Should the Commentary be followed?
INTERNATIONAL TAX QUIZ 6
XCO is a company which is incorporated in country A, but which has its central
management and control in country B. It is a resident under country A tax law,
and it is a resident under country B tax law. XCO’s place of effective
management is in country B. XCO licenses (for arm’s length royalties) a patent
to YCO, which is a company resident in country C. The A/B, A/C and B/C double
tax treaties are all identical to the 2014 OECD model treaty, with the exception
of the source country tax rate under Art. 12 – the rates are 5% (A/B), 10%
(A/C), and 15% (B/C). The MLI does not apply to any of the 3 treaties. XCO is
the beneficial owner of the royalties, and XCO does not have a PE in country C.
Country C’s domestic law withholding tax rate on outbound royalties is 30%. What
tax rate is country C permitted to levy on the royalties paid by YCO to XCO?
Why?
Answer:
15% : Art. 12, B/C treaty – for these reasons:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. Prima facie, XCO is a resident of country A
and also a resident of country B, under Art.
4(1) of the A/B treaty. However, under Art.
4(3) of that treaty, it is deemed to be a
resident only of country B, for the purposes
of the A/B treaty. [Note that Art. 4(3) has no
impact on XCO’s status as a resident of
country A under the country A domestic tax
law.]
2. The various operative provisions in the A/B
treaty (e.g., Art. 7, Art. 12, Art. 21, etc.)
therefore have the effect that XCO is exempt
from country A tax on income from sources
outside country A.
3. According to the OECD Commentary, XCO is
therefore “liable to tax” in country A only in
respect of income from sources in country A,
and consequently XCO does not satisfy the
definition of “resident of [country A]” in
Art. 4(1) of the A/C treaty. Paragraph 8.2 of
the 2014 Commentary : “[The second sentence of
Art. 4(1) in the A/C treaty] excludes
companies and other persons who are not
subject to comprehensive liability to tax in a
Contracting State [i.e., country A] because
these persons, whilst being residents of that
State under that State’s tax law, are
considered to be residents of another State
[i.e., country B] pursuant to a treaty between
these two States [i.e., the A/B treaty].”
4. XCO therefore cannot claim benefits under the
A/C treaty : Art. 1.
5. However, XCO does satisfy the definition of
“resident of [country B]” under Art. 4(1) of
the B/C treaty.
6. Therefore, country C is permitted by Art. 12
of the B/C treaty to levy tax on the
royalties, with a limit of 15% on gross. As
country C’s domestic law withholding tax rate
on outbound royalties is 30%, country C will
therefore levy a 15% tax on XCO’s royalties.
INTERNATIONAL TAX QUIZ 5
Question: ACO is a resident of country A. ACO has a PE in country B. ACO borrows
money from BCO, a bank which is resident in country B. ACO borrows the money for
the purposes of its PE in country B, and the interest on that borrowing is borne
by that PE. BCO does not have a PE in country A. BCO is the beneficial owner of
the interest. The A/B double tax treaty is identical to the UN model treaty. Is
country A permitted (by the A/B treaty) to impose tax on the interest paid to
BCO by ACO? Why?
Answer:
No: Art. 7(1), first sentence.
Art. 7(6) gives preference to Art. 11, if the interest is “dealt with” by Art.
11. However, that is not the case, for the following reasons:
(1) The phrase, “interest arising in a Contracting State”, is defined in Art.
11(5). Under the first sentence, the interest arises in country A. However,
under the second sentence, the interest arises in country B. The second sentence
“trumps” the first, as shown by the introductory words, “Where, however”, in the
second sentence.
(2) Art. 11(1) therefore does not apply: the interest arises in the same
Contracting State as the residence of the recipient.
(3) Art. 11(2) therefore does not apply, as shown by the words, “such interest”
(referring to the interest described in Art. 11(1)), at the start of Art. 11(2).
(4) Thus, taxing rights are not allocated by Art. 11, and accordingly, the
interest is not “dealt with” by Art. 11.
Art. 21(3) should not apply, for the following reasons:
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. It’s possible that the “arising” condition in
Art. 21(3) is not determined by Art. 11(5),
even though that provision does not state that
it is limited to Art. 11. Paragraph 9 of the
2017 UN Commentary indicates that the
“arising” condition will be determined under
the domestic laws of the Contracting States.
Therefore, if country A law says that the
interest is sourced in country A, that might
allow the “arising” condition in Art. 21(3) to
be satisfied
2. However, Art. 21 should not apply if the
interest is “dealt with” by Art. 7. This
raises the issue : which provision is applied
first – Art. 7 or Art. 21? In my view, despite
Art. 7(6), Art. 21 should not be interpreted
as applying before Art. 7, as that would
render the Art. 7(1) exemption (If there is no
PE in the source country) irrelevant – a
bizarre result! However, the existence of Art.
21(2) suggests the opposite result.
INTERNATIONAL TAX QUIZ 4
Question: Article 5(2) of the OECD model double tax treaty commences: “The term
‘permanent establishment’ includes especially:”, and then it sets out 6
paragraphs, (a) to (f). Paragraph (c) is “an office”. RCO (resident of country
R) owns an office in country S. Does RCO have a “permanent establishment” in
country S under the R / S treaty (identical to the OECD model treaty) – yes, no,
or possibly? Why?
Answer:
Possibly.
Preliminary point: According to the OECD Commentary, Article 5(2) is merely a
list of examples which might constitute a PE, but only if the conditions in
Article 5(1) are satisfied. [Disagreement registered by Greece (member) and
India (non-member).]
The insufficient facts contain 3 unresolved issues.
Firstly, are all the conditions in Article 5(1) satisfied? Possibly. It is
unclear whether the office is at the disposal of RCO and whether RCO is wholly
or partly carrying on its business through the office. For example, RCO might
lease the office to a tenant – in which case, according to the OECD Commentary,
the office would not be at RCO’s disposal. [Disagreement registered by Argentina
(non-member) and India (non-member).]
Secondly, even if Article 5(1) is satisfied, does one of the paragraphs in
Article 5(4) apply? Possibly. If the office were used by RCO solely for
activities of a preparatory or auxiliary character, then Article 5(4) (prima
facie) would apply to provide an exception to PE status.
Thirdly, if Article 5(4) prima facie applies, does Article 5(4.1) (the
anti-fragmentation rule) apply to prevent such application of Article 5(4)?
Possibly.
INTERNATIONAL TAX QUIZ 3
Question: XCO is a resident of country A. XCO has a PE in country B. XCO borrows
money from YCO, another resident of country A. XCO borrows the money for the
purposes of its PE in country B, and the interest on that borrowing is borne by
that PE. YCO does not have a PE in country B. YCO is the beneficial owner of the
interest. The country A / country B double tax treaty is identical to the OECD
model treaty. Is country B permitted (by the country A / country B treaty) to
impose tax on the interest paid to YCO by XCO?
Answer:
Yes, with a limit of 10% on the gross amount of interest: Art. 11(2).
The phrase, “interest arising in [country B]”, is defined in Art. 11(5). In the
first sentence, the interest arises in country A. However, under the second
sentence, the interest arises in country B. The second sentence “trumps” the
first, as shown by the introductory words, “Where, however”, in the second
sentence.
INTERNATIONAL TAX QUIZ 2
Question: Is a tax-transparent partnership a “person” for the purposes of the
OECD model double tax treaty?
Answer:
Yes, a tax-transparent partnership is a “person” for the purposes of the OECD
model double tax treaty, at least according to the OECD Commentary.
Art. 3(1) says:
“For the purposes of this Convention, unless the context otherwise requires:
a. the term ‘person’ includes an individual, a company and any other body of
persons;
b. the term ‘company’ means any body corporate or any entity that is treated as
a body corporate for tax purposes; …”
The Commentary says:
“Partnerships will … be considered to be ‘persons’ either because they fall
within the definition of ‘company’ or, where this is not the case, because they
constitute other bodies of persons.”
INTERNATIONAL TAX QUIZ 1
Question: How many countries are members of the G20?
1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 1. 19
2. 20
3. 43
Answer:
The answer is not 20! (That would be too easy!)
Membership of the G20 consists of 19 countries and the EU (which is represented
by the European Commission and the European Central Bank).
So, probably, the answer is 19.
However, the EU consists of 28 countries, 4 of which are G20 members in their
own right. That leaves 24 countries which (arguably) are G20 members indirectly
via the EU. 19 + 24 = 43!
The final answer: 19
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