Professional Documents
Culture Documents
CHAPTER 3
DOUBLE TAX TREATIES
This chapter looks in detail at the provisions contained in the OECD model convention. The
following main areas are covered:
definitions;
exemption and credit relief.
3.1
Introduction
The UK has entered into bilateral international tax agreements, known as double
tax treaties, with over 100 countries. Many, but not all, of the tax treaties entered
into by the UK follow the OECD model tax convention. The model treaty provides a
basis that can be used to draw up a bilateral agreement between two
contracting states that seeks to eliminate double taxation. In addition, it deals with
tax evasion and non discrimination. Double tax treaties also help to encourage
cross border trade.
Note above the terminology that we will use in this chapter.
The model treaty is divided into chapters and articles and we will look at each of
these in turn.
3.2
3.3
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A salesman who regularly visits a major customer to take orders and meets the
purchasing director in his office to do so. The commentary states:
In that case, the customer's premises are not at the disposal of the enterprise
for which the salesman is working and therefore do not constitute a fixed
place of business through which the business of that enterprise is carried on
(depending on the circumstances, however, paragraph 5 could apply to
deem a permanent establishment to exist).
ii.
The fact that a PE is a fixed place of business suggests that there is some
permanency and that there is a space of some kind taken up by the business. If it
is possible to demonstrate that there is a temporary nature to an operation, it may
not be a PE. However, if the intent at the outset is one of permanence, then even
in circumstances of a sudden curtailing of the operation in unforeseen
circumstances (such as a death), there is more likely to be a PE. Frequent use of an
office/premises for short periods of time is suggestive of permanence.
Broadly, use of different premises in a locality may also constitute a PE. Even the
use of movable (but substantially fixed and solid) premises may constitute a PE.
The latter is illustrated by the fact that a drilling rig used in the exploration of oil
may move from place to place but is still considered to be a PE.
Offshore activities raise important questions as to what constitutes a PE. Often in
practice there are separate articles dealing with offshore activities. Extraction
activities are covered in Article 5(2)(f). Arguably, exploration should be considered
preparatory in nature (i.e. within Article 5(3)) but drilling rigs do give rise to a PE in
many situations.
The OECD commentary makes reference to automated vending machines as
constituting a PE if there are persons setting up and operating the machines if
not, it may not be a PE.
Equipment leased to a lessee in a state should not create a PE for the lessor, even
where staff operate the equipment, provided that the staff are not under the
direction and control of the lessor. See paragraph 8 of the commentary.
Article 5(2) of the OECD Model Treaty tells us that the term Permanent
Establishment includes:
a place of management;
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a branch;
an office;
a factory;
a workshop, and
a mine, an oil or gas well, a quarry or any other place of extraction of natural
resources.
b.
c.
d.
e.
the maintenance of a fixed place of business solely for the purpose of carrying
on, for the enterprise, any other activity of a preparatory or auxiliary character;
or
f.
Even if the enterprise does not fall under para 1 and 2 there may still be a PE under
Article 5(5) where:
a person other than an agent of an independent status to whom paragraph 6
applies is acting on behalf of an enterprise and has, and habitually exercises, in a
Reed Elsevier UK Ltd 2015
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If head office itself has as its main purpose these activities then they cannot be
considered auxiliary.
The UK has made clear that, of itself, a web-site and server will not give rise to a PE
for domestic direct tax purposes. Clearly, if there are other operations/activities
then there may be a PE. (See UK HMRC press releases dated 11 April 2000 and 12
February 2001.)
The OECD published a discussion draft in November 2011 (revised in October 2012)
with regard to updating the commentary to Article 5 on PEs. Overviews of the
responses received to the original discussion draft and the revised draft were
published in February 2012 and in February 2013 respectively, with regard to
possible amendments to the commentary being made in due course.
The key areas related to clarification of the following:
Meaning of at disposal of a three-pronged test is proposed, looking at
effective power to use the location, the extent of actual presence and the
nature of the activity concerned.
Degree of permanency - the 6 month rule new exceptions to this general
practice activity of a recurrent nature, for example, a stand at a trade fair 5
weeks a year, but for 15 years in row, will create a PE.
Contractors and deemed PEs where a main contractor undertakes a
comprehensive project overseas and subcontracts all (or part) of a contract to a
subcontractor then the subcontractor creates a deemed PE of the main
contractor so for building sites, time spent by a subcontractor at the site is
counted towards the 12 months applicable to the main contractor.
Meaning of to conclude contracts in name of the enterprise the commentary
will expressly provide that a PE arises if there are arrangements where the
enterprise is not named as principal nor mentioned at all in the contract, but
where the enterprise is economically bound.
It was announced in June 2013 that the OECDs work on revising the commentary
to Article 5 had been put on hold, pending the outcome of its initiative on Base
Erosion and Profit Shifting (BEPS), since this outcome could itself affect the
commentary on Article 5. The latest discussion draft on the Base Erosion and Profit
Shifting Action Plan was published in March 2014.
In July 2014 the OECD model DTC was updated; however the update did not
include the proposed changes to Article 5.
3.4
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Step 2:
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Article 8 tackles the taxation of shipping, inland waterways transport and air
transport. Generally such activities are taxed where the effective management of
an enterprise is situated.
Article 9 is the associated enterprises article and links into the transfer pricing issues,
requiring arm's length prices.
Article 10 looks at dividends. It allows dividends paid by a company resident in a
contracting state to residents of another contracting state to be taxed in that
other state i.e. where they are received. In addition, they may also be taxed
(normally by way of withholding tax) in the contracting state of the payer.
However there are limits on withholding tax as follows:
a.
b.
Illustration 1
Torrence Ltd, a UK resident company, receives a dividend of 95,000 from its
wholly-owned overseas subsidiary, Parnavik SA.
Parnavik SA is resident in a country which has a double tax treaty based on the
OECD model convention. Its domestic law imposes withholding tax of 10% on
dividends.
Calculate the gross dividend received by Torrence Ltd.
Under the terms of the double tax treaty, Parnavik SA is allowed to withhold a
maximum amount of 5% of the gross dividend. Thus the gross dividend will be
100,000.
This 100,000 will be taxable on Torrence Ltd in the UK, subject to DTR, unless the
dividend falls into one of the exemptions at Part 9A of CTA 2009.
Article 11 deals with interest, stating that interest is taxable in the contracting state
where the recipient is resident. However, it may also be taxed in the state where it
arises, and a withholding tax (WHT) of up to 10% is allowed.
It is important to note that the benefits of this article are only available to the
beneficial owner of the interest; thus if the recipient is not the beneficial owner he
will not be able to claim the reduced rate of WHT. There is a similar reference to
beneficial owner in Articles 10 and 12.
The meaning of the term beneficial ownership is not spelt out in the treaty. In April
2011 the OECD published a discussion draft aimed at clarifying the meaning for
the purposes of Article 10, 11 and 12.
Prior to the 2014 update to the Model Treaty there was a lack of clarity as to how
the term beneficial owner should be interpreted. Should the interpretation be
based on domestic law or given an international meaning? The 2014 update to
the commentary aims to settle this debate. The revised commentary states that it is
not intended to refer to any technical meaning that it could have under the
domestic law of a specific country; rather, it should be understood in its treaty
context.
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The revised commentary to the 2014 Model Treaty also states that the recipient of
a dividend, interest, or royalty is the beneficial owner of the payment when he
has the right to use and enjoy the dividend, interest, or royalty, unconstrained by a
contractual or legal obligation to pass on the payment received to another
person; this in effect rules out the possibility of considering as beneficial owners
persons acting as fiduciaries, agents, or nominees. The new commentary also
distinguishes between the legal owner of the property giving rise to the income
(such as shares, debt claims or property rights) and the beneficial owner of such
income, which may be different in some cases.
The changes also indicate that whilst the beneficial ownership concept may
address some forms of tax avoidance, it does not deal with other cases of treaty
shopping which will need to be addressed through other means, such as specific
and general anti-abuse provisions, substance-over-form approaches, and
economic substance approaches. It is notable that the introduction to the 2014
update to the MTC specifically states that the changes to beneficial owner
contained in the document do not prejudge in any way the outcome of the work
on Action 6 (Prevent Treaty Abuse) of the BEPS project.
Article 11 also includes a paragraph which seeks to limit the reclassification of
interest as equity under the thin capitalisation rules. The article limits the
reclassification to the amount of interest charged and does not provide for a
consideration of the amount lent.
Article 12 deals with income from royalties. Income from royalties is taxable in the
state of residence of the beneficial owner. This does not apply if the royalties are
part of a PE in the other state, in which case they will be taxed as part of the
business profits of the PE. The interest article also treats interest earned through a PE
in a similar way.
Again the recipient must be the beneficial owner of the royalty to benefit from this
article.
The term royalty is defined at Article 12(2) as:
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, any patent, trademark, design or model, plan, secret formula or process, or
for information concerning industrial, commercial or scientific experience.
Thus payments for the use of software can come within this definition. However, this
is not a straightforward area and will depend on the facts. The commentary to the
convention gives some guidance. The payment for the acquisition of partial or full
rights to the copyright on software will be a royalty. However, payments for the
right to copy the software on to the user's hardware alone will not constitute a
royalty. Likewise payments for site licences, enterprise licences and network
licences which allow multiple copying, but only to the extent necessary for the
operation of the user's network will not be royalties. In each case it will depend on
the facts.
The commentary clarifies that payments for the electronic ordering and
downloading of goods may give rise to a royalty. This will arise where the ordering
and downloading is for commercial exploitation by the recipient.
Where the customer is paying for acquisition of data that is transmitted digitally, a
royalty does not arise. However if a book publisher purchases the right to
reproduce a picture, and that picture is digitally downloaded, then he has paid
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for the right to reproduce the picture, rather than just acquiring the digital content.
As a result a royalty will arise.
Article 13 deals with capital gains. Gains from immovable property are taxable in
the state where the property is situated. Gains from movable property are taxable
in the state where the owner is resident, unless they are part of a PE in another
state, in which case they are taxed in that other state.
In the 2014 update it was made clear that a redemption of shares is included
within this article.
3.5
3.6
3.7
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3.8
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A double tax treaty will terminate in accordance with Article 30 when either
contracting state gives notice through diplomatic channels of the termination, at
least 6 months before the end of any calendar year. It is left open for the
contracting states to give an earliest year by which termination can be given.
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EXAMPLES
Example 1
Which of the following statements is TRUE?
1.
2.
The OECD model tax convention covers taxes on income and capital.
3.
The OECD model convention covers taxes on income, capital and VAT.
Example 2
McGinley Ltd, a UK resident company, has won a contract to install thermal
insulation in all government buildings in Ruritania. The company will send a team of
8 men to Ruritania in January 2017. They envisage that all installation work will be
complete by November 2017.
Will McGinley Ltd have a permanent establishment in Ruritania under the terms of
the OECD Model Treaty?
Example 3
Clarke Limited, a UK resident company, has 10% of the share capital in Overseas
Ltd, a company resident in a country that has a tax treaty with the UK in line with
the model convention.
Overseas Ltd declares a dividend of 500,000.
You are required to explain the rules set out in Article 10 of the double tax treaty in
relation to the taxing of this dividend.
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ANSWERS
Answer 1
Only the second statement is true.
Answer 2
Provided the installation is completed within 12 months there will not be a PE.
(Article 5(3)).
Answer 3
Article 10 provides that the dividend will be taxable in the UK, as this is where the
recipient Clarke Ltd is resident. In addition the dividend may also be subject to tax
where it arises the withholding tax permitted for a 10% holding is up to 15%.
Thus Clarke Ltd may receive its share of the dividend net of 15% withholding tax.
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