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International Tax
Avoidance
Danny Septriadi SE, M.Si, LL.M Int. Tax
Yusuf Wangko Ngantung LL.B, LL.M Int. Tax, ADIT

Introduction

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Latest news

Saya telah memerintahkan Ditjen Pajak

untuk mempelajari the Panama Papers
Bambang Brodjonegoro BBC Indonesia http://www.bbc.com/
indonesia/berita_indonesia/
2016/04/160405_indonesia_panama_mossack_fonseca

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Examples of improper use of tax treaties

Dual residence and transfer of
residence

Treaty Shopping

Triangular Cases
Attribution of ProUits or income
to a speciUic person or entity
Hiring of labor

Artistes or sportsmen
Transactions that modify treaty
classiUication of income
Transaction that seek to
circumvent thresholds found in
treaty provisions

Time limit for certain PEs
Thresholds for the source
taxation of capital gains on
shares (landrich company)

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What is abuse of tax treaty?

Although there is no clear deUinition of tax avoidance OECD
Commentary states that a a guiding principle is that the beneUits of a
DTT should not be available where:
Main purpose for entering certain transactions or arrangements
was to secure a more favorable tax position; and
Obtaining that more favorable treatment in these circumstance
would be contrary to the object and purposes of the relevant
provisions
Tax avoidance: all illegitimate (not necessary illegal) behaviors aimed
at reducing tax liability; not violate letter of law but clearly violate its
spirit (Avi Yonah, et.al., 2011)

Tax Planning

Tax Avoidance
No clear distinction

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Different approaches to prevent abuse

1. SpeciUic anti-abuse rules found in domestic law
(CFC, Thin Cap etc.)
2. General anti-avoidance rules found in domestic
law
3. Judicial anti-avoidance doctrines that are part of
domestic law (business purpose, substance over
form, step transaction, fraus legis etc.)
4. SpeciUic anti-abuse rules in tax treaties (beneUicial
owner, LOB provision, exclusion provision etc.)
5. General anti-abuse rules in tax treaties
6. Anti-abuse rules read into treaties, based on art
31 VCLT

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Vodafone (India)

HK
Shareholders

Cayman Co 1
(Cayman)


Cayman Co2
(Cayman)

Vodafone UK
Sold Cayman Co
2 shares

Vodafone Dutch

Mauritius Co
(Mauritius)

Hutchison Essar
(India)

Background
Cayman Co 1 sold shares of
Cayman Co 2 to Vodafone Dutch
India Tax Implications
Emergence of a new trend in
Revenues position on taxation
o f c r o s s - b o r d e r M & A
transactions
Look-through concept read into
domestic law source rule
provisions
T a x a b l e i n I n d i a i f t h e
underlying assets are situated in
India

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Google v. the People

Were not accusing you
of being illegal, were
accusing you of being
immoral
Margaret Hodge (Public Accounts
Committee UK)

Prof Dr Hans van den Hurk,

Starbucks versus the People,
Bulletin for International Taxation,
Jan 2014, pp27-34
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Tax structures

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Dual residence and transfer of residence

Company X

Shares
State A
State B

Capital gains on the

sale of shares

Company X

Facts:
Company X, a resident of State A, is
contemplating the sale of shares of
companies that are also residents of State A.
Such a sale would trigger a capital gain that
would be taxable under the domestic law of
State A. Prior to the sale, company X
arranges for meetings of its board of
directors to take place in State B, a country
that does not tax capital gains on shares of
companies and in which the place where a
companys directors meet is usually
determinative of that companys residence
for tax purposes.
Company X claims that it has become a
resident of State B for the purposes of the
tax treaty between States A and B pursuant
to Art 4(3)of that treaty, which is identical to
the UN MC.
It then sells the shares and claims that the
capital gain may not be taxed in State A
pursuant to Art 13(6)of the treaty .

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Dual residence and transfer of residence

Motive: change of residence primarily intended to access
treaty beneUits is an abuse of a tax treaty
1. DifUicult to prove
2. Thus, special rules are recommended
Special rule #1: previously resident provision in A/B tax treaty
Special rule #2: departure tax or exit charge (in domestic law of State A)
Proper interpretation of Art 4 (2) and (3) Tie-breaker rule
Art 4 (3) : Mutual agreement procedure
Example 3 : remittance based taxation special treaty provision
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Treaty Shopping (direct conduit)

Resident C
(Non tax treaty)
State C

Exempt from tax

in State A

Company X

State A
State B

0% WHT based on
A/B treaty
Company Y
Pays dividends,
interest or royalties

Facts:
Company X, a resident of State A, receives
dividends, interest or royalties from company Y,
a resident of State B. Company X claims that,
under the tax treaty between States A and B, it
is entitled to full or partial exemption from the
domestic withholding taxes provided for under
the tax legislation of State B.
Company X is wholly-owned by a resident of
third State C who is not entitled to the beneUits
of the treaty between States A and B. Company
X was created for the purpose of obtaining the
beneUits of the treaty between States A and B
and it is for that purpose that the assets and
rights giving rise to the dividends, interest or
royalties have been transferred to it.
The income is exempt from tax in State A, e.g. in
the case of dividends, by virtue of a
participation exemption provided for under the
domestic laws of State A or under the treaty
between States A and B. In that case, company X
constitutes a direct conduit of its shareholder
who is a resident of State C.

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Treaty Shopping (stepping stone conduit)

Resident C
(Non tax treaty)

Company Z
(Tax exempt)
State D

State C

Pays commission, services fees,

and deductible expenses

Company X
State A
0% WHT based on
A/B treaty

State B

Company Y
Pays dividends,
interest or royalties

Facts:
The income of company X is fully
taxable in State A and, in order to
eliminate the tax that would be
payable in that country, company X
pays high interest, commissions,
service fees or similar deductible
expenses to a second related conduit
company, company Z, a resident of
State D.
These payments, which are deductible
in State A, are tax-exempt in State D
by virtue of a special tax regime
available in that State.
The shareholder who is a resident of
State C is therefore seeking to access
the beneUits of the tax treaty between
States A and B by using company X as
a stepping stone.

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Alternative: back-to-back loan

deposit

Int. Bank

Company X

State A
State B

Company Y

Int. Bank

Facts:
Company X is contemplating to
provide a loan to its afUiliated entity
Company Y
Instead of providing the loan directly
to Company Y (where wht may be due
for interest payments), Company X
decides to arrange with its local bank
(with international network), by
putting an deposit amount equal to
the loan that it is willing to provide as
loan to Company Y
The bank arranges through its
international network, so that a local
bank in State B could provide a loan to
Company Y. Company Y will pay
interest locally to the Bank in country
B and withholding may be avoided.

loan
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Treaty shopping
Various approaches to deal with the situation:
1. SpeciUic domestic anti abuse measure
2. Interpretation of tax treaty (beneUicial owner)*
Developments in tax treaty case law: Indofood,
Prevost, Velcro BeneUicial owner has a low
threshold
3. Domestic GAAR
Most effective SpeciUic tax treaty anti-abuse rules
Particular aspects of treaty shopping:
Look-through approach, subject to tax provision, channel approach
Comprehensive : LOB provision
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Triangular cases
State R

State P

Company X

PE

Facts:
Company X is a resident of State R, Company
X has a branch (PE) in State P, which offers a
favorable tax treatment.
Company X transferred certain assets to the
PE in State P. It therefore derives through PE
in State P, dividends, interest and royalties
form sources in State S
1. S / R tax treaty, reduces withholding tax in
State S on outbound income Ulows (dividends,
interest, royalties

State S
Income:
Dividend, Interest,
Royalties
Relevant articles:
Art 7 Business proUits
Art 10 Dividends
Art 11 Interest
Art 12 Royalties
Art 23 A Exemption method

2. R / P tax treaty, State P may tax the income

(art 7)
3. R / P tax treaty if treaty contains art 23 A,
then exemption in State R
4. Since there is a low tax rate in State P, there
is likely to be a tax rate arbitrage between
State S and State P, with no tax in State R

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Triangular Cases
Approach to dealing with the issue
1. Include speciUic provision in the S / P tax
treaty that an enterprise can only claim
beneUits of the treaty if the income derived by
the branch (PE) is subject to an effective tax
rate above a speciUied level in State P
2. However if similar provisions are not
systematically included in other treaties of
State S. Company X may transfer its assets to
an afUiliate in another State

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Attributing proLits or income to speciLic

person or entity (base companies)
Facts:
Company X is a resident in State R (high tax
jurisdiction). It wholly owns Company Y
which is a resident in State S (low tax
jurisdiction)

Company X
100
%

State R

Company Y is a shell company with no

employees and no substantial economic
activity

Company X uses Company Y with the

purposes of diverting income to State S
where such income will be subjected to
taxes that are substantially lower than those
in State R

State S
Diversion of
income

Company Y
Shell company with no
employees and
substantial economic
activity

Approach to deal with the issue:

Place of effective management

Determine PE
CFC Regulation
UN favors the use of CFC Rules in domestic
law. UN does not consider the use of CFC
rules to be in conUlict with R / S treaty

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Attributing proLits or income to speciLic

person or entity (directors companies)
Company A
100%

State A
State X

State Y

Company B

Company C
Appointment as
director

Facts:
Mr D. (State X resident) is a director in
Company B (State X resident)
State X levies an income tax at progressive
rates up tp 50%, while State Y has similar
income tax system but with lower tax rates
X/Y tax treaty contains art 23 A which
effectively provides that State X must apply
the exemption method to income which may
be taxed in State Y
In order to reduce the tax burden of Mr D.
Company A appoints him as director of
Company C (State Y resident) and arranges
for most of his remuneration to be
attributed to these functions

Approach to deal with the issue:
Properly analyze services rendered by Mr D
to Company B and Company C and compare
his remuneration to that of other directors
of Company C
Domestic law anti-avoidance rules or treaty
based anti avoidance principles

Mr D
Relevant article:
Art 16 Directors Fee

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Attributing proLits or income to speciLic

person or entity (tax exempt government entity)
Company X
100%

interest

Government
agent
State R
State S
Company Y
Relevant article:
Art 11 Interest

interest

Facts:
Company X a resident in State R has a wholly
owned subsidiary Company Y resident in
State S
Applying the R/S treaty, it is possible for
Company X to secure tax exemptions on
payments received from State S through
certain speciUied parties, like government
agencies
Company Y engages in back-to-back
arrangement with a tax exempt or
government entity in State R
The arrangement enable Company X to
enjoy the beneUit of tax exemptions under
Art 11 for payments received through tax
exempt entities

Approach to deal with the issue:
Treaty shopping
Domestic/treaty based anti-abuse rules
SpeciUic tax anti abuse rules regarding backto-back arrangements

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Transaction that modify the treaty classiLication

of income (conversion dividend into interest)
X

Company X
State R

100
%

State S
Company A

interest

Company B
(Holdco)
Relevant article:
Art 11 Interest
Art 10 - Dividend

Facts:
Company X a resident in State R owns shares
of company A which is a resident of State S
In anticipation of the dividend payment from
company A, Company X arranges for
creation of holding Company B, resident of
State S
Company X is the only shareholder of
Company B
Company X the sells shares of Company A to
Company B in return for interest bearing
notes (R / S treaty allows the transfer tax
free)
The payment of interest from Company B to
Company X is made possible by receipt of
dividends from Company A, which is no
taxed in State S under a participation
exemption
Company X thus indirectly receives dividend
paid by Company A in the form of interest
payments on the notes issued by Company B
and will avoid source taxation in State S

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Transaction that modify the treaty classiLication of

income (allocation of price under mixed contract)
Company X
(Franchisor)
Franchising
contract

State R
State S

Services
and knowhow

Company Y
(Franchisee)
Relevant article:
Art 7 - Business proUits
Art 12 - Royalties

Facts:
Franchisor Company X, which is a resident
in State R enters into a franchising contract
with Franchisee Company Y, resident of
State S
Franchising contract involves the transfer of
goods, provision of services, the provision of
know-how and royalties for intellectual
property
Art 7 would not allow State S to tax business
proUits (services and transfer of goods)
assuming that Company X does not have a
PE in State S
Art 12 would permit State S to tax royalties
(including know-how)
Most of the payments would normally be
deductible for Company Y, hence Company Y
may not care about how the overall price is
allocated
The contract is drafted so as to increase the
price for transfer of goods and services and
reduce royalties, thus reducing withholding
tax
(could also be used in ship rental/service
contracts)

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Transaction that modify the treaty

classiLication of income
UN Commentary:
1. Since parties are normally independent,
domestic Transfer Pricing legislation and Art 9
of the treaty would generally not apply
2. Acknowledge the difUiculty in challenging
pricing allocations

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Transaction that modify the treaty classiLication of

income (conversion of royalties into capital gains)
Reacquisition
right
X
(Copyright owner)

State R
State S

Sale agreement
Transfer of
rights

% of total sales

Facts:
X, who is a resident of State R, owns
copyright in a literary work
X wishes to grant Y, who is a resident of
State S, the right to translate and reproduce
the work in State S in consideration for
royalty payments based on % sales
Instead granting a license to Y, which would
attract withholding tax under R/S treaty, X
enters into a sale agreement whereby all
rights related to the translated version of the
work in State R are disposed of by X and
acquired by Y
The consideration for the sale is a
percentage of the total sales of the translated
work by Y
The contract further provides that X will
have an option to reacquire these rights
after a period of Uive years from Y

Relevant article:
Art 12 - Royalties

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Transaction that modify the treaty

classiLication of income
UN Commentary:

1. Some countries have modiUied the deUinition of
royalties to expressly address this issue:
2. US/India, royalties includes gains derived
from the alienation of any such rights or
property which are contingent on the
productivity, use or disposition thereof

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Transaction that modify the treaty classiLication of

income (use of derivative transaction)
interest

State A
Company X

Future contract to
buy each other
shares and bonds

Bonds

Swap arrangement
(swap payment
difference between
dividend and interest)

Company Y

State B

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Shares

dividend

Facts:
Company X, a resident of State A intends to
make a portfolio investment in the shares of a
company resident in State B, while Company Y,
a resident in State B wants to acquire bonds
issued by the government of State A
To avoid cross-border payment of dividend and
interest, which would attract withholding taxes,
Company X instead acquires bonds issued in
State A and Company Y acquires shares of the
company resident in State B that Company X
intends to invest into
Company X and Y would enter into a swap
arrangement by agreeing to make swap
payments to each other based on the difference
the dividends and interest Ulows that they
receive each year
They would also enter into a future contract to
buy from each other the shares and bonds at
some time in the future
As a result Company X and Y have mirrored the
economic position of cross-border investment
in the shares and bonds without incurring
liability to source country withholding tax

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Transaction that modify the treaty

classiLication of income
UN Commentary:

In practice, it may be difUicult to discover and
establish the connection between the
transaction that will be entered into for the
purpose of altering treaty classiUication

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Transaction that modify the treaty classiLication of

income (Art 5 planning)
State R

State A
100%

Company X

Company Y
$

Contract #1

Contract #2

Employees
& other
personnel

Activities
performed

State S

Employees
& other
personnel

Customer

Facts:
Company X (resident in State R) seeks to
provide services to Customer (resident in State
S). These services may required for more than 6
months
Company X enters in Contract #1 with
Customer for the provision of services with a
duration of less than 6 months
Company X arranges for its wholly owned
subsidiary Company Y (resident of State A) to
enter into Contract #2 to provide services to
Customer. Duration of contract #2 is also less
than 6 months
R/S treaty and A/S treaty both provide that a
State R (or A) resident will be deemed to have a
PE in State S if it furnishes services for a period
of more than 6 months or more under the same
or a connected project

Activities performed

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BEPS Action 6 Prevent Treaty Abuse

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Action 6 Prevent Treaty Abuse

Develop model treaty provisions and recommendations regarding the
design of domestic rules to prevent the granting of treaty beneUits in
inappropriate circumstances. Work will also be done to clarify that tax
treaties are not intended to be used to generate double non-taxation and
to identify the tax policy considerations that, in general, countries should
consider before deciding to enter into a tax treaty with another country.
The work will be co-ordinated with the work on hybrids.

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OECD Proposed Anti Abuse Rules

Limitation on BeneUits
QualiUied person; or
Active trade or business test; or
>95% owned by 7 or fewer equivalent
beneUiciaries in other countries and pass a
base erosion test (derivative beneUits rule)
General Anti Abuse Rule
Obtaining the treaty beneUit must not be one of
the main purposes of the arrangement or
transaction

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Example in holding company structure (dividends)

A Co.
(Listed)

A, B, C, D are resident for domestic

tax law and tax treaty purposes
All shareholdings are 100%

Dividend 1

B Co.
(Holdco)
Dividend 2

C Co.
(Holdco)
Dividend 3

D Co.
(Opco)

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Dividend 1
Dividend paid by B Co. to A Co.
A Co.
(Listed)

Tax treaty A/B is applicable

Dividend 1

B Co.
(Holdco)

C Co.
(Holdco)

D Co.
(Opco)

Is A Co. a qualiUied person or

otherwise entitled to treaty beneUits?

QualiLied person

Principal class of shares primarily
traded on a recognized stock exchange
in Country A and

Primary place of management and
control is in Country A

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Dividend 2: QualiLied person test

Dividend paid by C Co. to B Co.
A Co.
(Listed)

B Co.
(Holdco)

Tax treaty B/C is applicable

Is B Co. a qualiUied person or
otherwise entitled to treaty beneUits?

Dividend 2

C Co.
(Holdco)

D Co.
(Opco)

QualiLied person
B is not listed

Active trade or business
B is holding company

Derivative beneLits
See next slide

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Dividend 2: Derivative Business Test

A Co.
(Listed)

B Co.
(Holdco)

Dividend 2

C Co.
(Holdco)

Derivative business test

Is 95% of B co owned by a equivalent
beneUiciary?
Is A co a equivalent beneUiciary?
Equivalent beneUiciary is a resident
of any country and
2 TEST
Would A be entitled to
beneLits under A/C treaty; and
Is the dividend WHT rate
under A/C treaty equal to or
less than the dividend WHT
rate under B/C treaty?

D Co.
(Opco)

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Morality is something which must be the underlying

principle in all walks of life, and taxation is no exception. It is
an additional test for what is right and what is wrong, and,
therefore, just because something is legal, there is no
escape from its meeting the test of morality as well. The
very debate between legality versus morality is a non-issue
because legality and morality are not mutually exclusive
domains.

Pramod Kumar
Member of India s Income Tax Appellate Tribunal

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DANNY DARUSSALAM
Tax Center

DDTC

@DDTCIndonesia

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