Principles and Practice of Double Taxation Agreements: A Question and Answer Approach

Contents

List of abbreviations About the authors Preface 1

General 1.1 Introduction 1 1.1.1 What kind of tax agreements (also known as treaties or conventions) are there? 1 1.1.2 What are double tax agreements (DTAs)? 1 1.1.3 How are DTAs designed and structured? 2 1.1.4 Wha t are the key functions of DTAs? 3 1.1.5 What is international double taxation? 3 1.1.6 What is the history and relevance of the OECD Model DTA? 4 1.1.7 What DTAs have Australia, China, France, Germany, the UK and the US entered into? 5 1.1.8 What are most favoured nation clauses and what happens if they are triggered? 5 1.1.9 What rules apply to the interpretation of DTAs? 6 1.1.10 How do DTAs deal with undefined terms? 6 1.1.11 Can DTAs be used by taxing authorities to avoid an outcome of double taxation? 8 1.1.12 Can a DTA create a tax liability in circumstances where no such liability exists under domestic non-DTA law? 9 1.1.13 Can DTAs override the application of international attribution measures such as the CFC and FIF rules? 1.1.14 How, if at all, are DTAs incorporated into domestic tax law? 13 1.1.15 How do DTAs work? 14

XIV

xv XVlI

1

10

VI

Contents

Contents

3.1.8

1.1.16 In broad terms what types of Allocation Articles are to be found in DTAs? 15 How is priority between the Allocation Articles 1.1.17 determined? 16 1.1.18 Is there a practical approach to the application of DTAs that creates a coherent conceptual framework? 16 The Broad Principles applied under the Allocation 1.2 Articles 16 Division of taxing rights 16 1.2.1 1.2.2 Income taxed by the residence jurisdiction only 17 1.2.3 Income may be taxed by both the residence and source jurisdictions 18

2

2.1.3 2.2 2.2.1 2.2.2 2.3 2.3.1 2.3.2 2.3.3 2.3.4

3

Taxpayers covered 21 What taxpayers are covered by the DTA? 21 How do DTAs generally and the sample DTAs in particular resolve cases involving dual residency? What about other "entities" such as partnerships and trusts? 24 Taxes covered 24 What are the "taxes covered" by the DTA? 24 How do the sample DTAs in particular define "taxes covered"? 25 Timing matters 27 What are the start dates and termination arrangements in relation to the DTA? 27 When does a DTA start to operate? 27 When is a DTA terminated? 29 The sample DTAs 30

3.1.6 3.1. 7

3.1.11

3.2 3.2.1 3.2.2 3.2.3

3.3 3.3.1 3.3.2

3.3.3 3.4 3.4.1 3.4.2 3.5 3.6

21

The allocation rules 3.1 3.1.1 3.1.2 3.1.3 3.1.4 3.1.5

3.1.10

21

The three qualifying questions 2.1 2.1.1 2.1.2

3.1.9

Active income: business profits 31 What is the allocation rule? 31 What are business profits? 33 What is an enterprise? 34 What is a "permanent establishment"? 35 How are permanent establishments dealt with in the context of electronic commerce? 38 What sort of presence can a taxpayer have without creating aPE? 40 May the definition of a PE differ between developing and developed countries? 41

3.6.1 3.6.2 3.6.3 3.6.4

3.6.5

31

3.6.6 3.6.7

3.6.8 3.6.9

3.6.10

3.6.11

How have the OECD and UN Models influenced PE articles in DTAs? 44 If there is a PE in the form of a branch, how are the profits attributable to the PE calculated? 45 If there is a PE in the form of an agency, how are the profits attributable to the PE calculated? 48 What about joint venture operations? 50 Active income: associated enterprises profits 51 What is the allocation rule? 51 Are compensating adjustments provided for? 52 What if there is inadequate information available to determine profits? 53 Active income: dependent personal services 53 Background 53 What is the allocation rule - DTAs? 54 How do the sample DTAs deal with these issues? 55 Active income: independent personal services 56 Background 56 How do the sample DTAs deal with these issues? 56 Active income: fringe benefits 58 Passive income articles 60 What types of income are dealt with by the passive income articles? 60 Under what general circumstances are these articles relevant? 60 Why do countries operate a system of withholding taxes on passive income? 61 Does the payment necessarily need to have a source in the country of source? 61 Do passive income articles generally allocate the taxing rights to one country? 62 Can the articles apply even where there is no taxation in the country of residence? 62 What if there is no DTA in place between the country of source and the country of residence? 63 !'low is tax relief given for amounts still subject to mternational double taxation? 63 What if the DTA and domestic provisions of the count.ry of residence do not provide for any method of unilateral double tax relief? 63 How does a credit method of unilateral double tax relief generally operate? 63 Can .relief for underlying tax be available for royalty and mterest payments? 64

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Contents

3.8.3 3.8.4

4

4.4 4.4.1 4.4.2 4.4.3 4.4.4 4.4.5 4.4.6 4.4.7 4.5 4.6 4.7 4.8

5.2 5.2.1 5.2.2 5.2.3 5.2.4

8

81

What is treaty shopping? 81 How can treaty shopping be prevented? 82 How effectively has the concept of beneficial ownership been used to prevent the practice of treaty shopping? 82 How do the comprehensive Limitation on Benefits (LOB) provisions work to prevent treaty shopping? 88 What is a qualified person? 89 What is a regional headquarters company ("RHC" ) 90 What is the active business test? 92 What is the anti-avoidance test? 92 What is the Equivalent Beneficiary test? 92 What are deductible payments? 93 Who are Equivalent Beneficiaries? 93 How do limited LOB provisions work? 94 How do the anti-conduit provisions work? 94 Is there room for the application of GAAR to treaty shopping arrangements? 96 What is the difference between treaty shopping and basket shopping? 96

What is the purpose and effect of non-discrimination clauses in DTAs?

97

7.1.1 7.1.2 7.1.3

Article Article Article Article Article Article Article Article

1 2 2.1 2.2 3 3.1 3.2 3.3

Article Article Article Article Article Article Article Article Article Article Article Article Article

4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 4.12 4.13

Article 4.14 Article 4.15 Article 4.16 Article 4.17

103

What procedures are in place to assist in the effective administration of cross-border taxation? Mutual agreement procedure ("MAP") 105 Binding arbitration procedure ("BAP" ) 105 Exchange of information 106

105 105

Article Article Article Article

4.18 4.19 4.20 5

Article 5.1 Article 5.2 Article 5.3

xi

107

The reconstructed alternative AustraliaJUK DTA

103

Procedures 7.1

Collection procedures

Article 4

What methods are there in place to avoid double taxation? 97 What is tax sparing and how does it work? 99 Illustration 99 Solutions 99 Example 1: Tax sparing vs. no tax sparing 100 Example 2: Interposing intermediary company 100

Non-discrimination 6.1

7

7.1.4

Avoiding double tax 5.1

6

How does the "other income" article allocate the taxing rights? 79 What if there is no "other income" article? 80

Restrictions on the availability of DTA benefits 4.1 4.2 4.3

5

Contents

Is the person covered? 109 Is the tax covered? 110 Existing taxes 110 Identical and substantially similar taxes 110 Is the convention in force? 110 Entry into force 110 Termination 111 Special termination arrangements for entertainers and sports persons 112 Is the item of income or gain covered and, if so, how is the item dealt with? 112 Business profits 112 Shipping and air transport profits 114 Associated entities profits 115 Income from employment 116 Income from independent personal services 117 Fringe benefits 118 Government Service 118 Dividends 119 Interest 122 Royalties 124 Pensions and Annuities 126 Income from real property 127 Income or gains from the alienation of property 128 Income or gains from the alienation of ships or aircraft, etc. 129 Deferred property income or gains 129 Entertainers and sports persons - income earned 130 Entertainers and sportspersons - income accrued in a third person 130 Students 131 Professors and teachers 13 1 Other income 131 How is the operation of the Convention excluded or limited? 133 Remittance based taxing states 133 Temporary residents based taxing states 133 Partnerships 134

109

Article 5.4 Article 6 Article 6.1 Article 6.2

Article 6.3 Article 6.4

Article 6.5 Article 7 Article 8

Article 8.1 Article 8.2 Article 9 Article Article Article Article

9

9.1 9.2 9.3 9.4

Members of diplomatic missions or permanent missions and consular posts 134 How is double taxation eliminated? 135 Credit for United Kingdom tax against Australian tax 135 Credit for United Kingdom tax on profits out of which a dividend is paid against Australian tax 135 Credit for Australian tax against United Kingdom tax 135 Credit for Australian tax on profits out of which a dividend is paid against United Kingdom tax 136 Source 136 I low is non-discrimination dealt with? 136 What procedures are there in the Convention to allow for mutual agreement and exchange of information? 138 Mutual agreement procedures 138 Exchange of information procedures 139 What are the Convention definitions and deernings? 140 General 140 Residence 142 Permanent establishment 143 Deemed source for Australian domestic tax purposes 145

Some leading DTA cases 9.1 9.1.1

9.1.2 9.1.3 9.1.4

9.1.5

9.2 9.2.1 9.2.2 9.2.3

Australian cases 147 Federal Commissioner of Taxation v. Lamesa Holdings BV 147 Max Factor & Co. v. Federal Commissioner of Taxation 149 McDermott Industries (Aust) Pty Ltd v. Commissioner of Taxation 150 Thiel v. Federal Commissioner of Taxation 152 Unisys Corporation v. Federal Commissioner of Taxation 154 US cases 156 Cudd Pressure Control Inc. v. The Queen [1998] 156 The North West Life Assurance Company of Canada v. Commissioner of Internal Revenue 157 Qantas Airways Limited v. United States 159

9.2.4 9.2.5 9.3 9.3.1 9.3.2 9.3.3 9.3.4 9.3.5 9.3.6

9.3.7 9.3.8 9.3.9

9.4

147

Podd et at. v. Commissioner 160 Terry Haggerty Tire Co. Inc. u. United States 161 Other cases 163 The QlIeen (I. Crown Forest Industries Limited 163 Association of Mouth and Foot Painting Artists Pty Ltd v. Commissioner of Taxation 164 The Queen u. Dudney 165 Gulf Offshore N.S. Limited u. The Queen 167 Specialty Manufactllring Ltd v. The Queen 168 Sumner u. The Queen 169 M and Mme Robert Gilly 1'. Directeur des Seruices Fiscallx dl{ Bas-Rhin 171 "Pipeline" decision 174 Re Sti Schneider Electric 175 Additional cases involving DTAs 178

10 Double taxation agreements table

181

Appendix: Sample DTAs

191

AustralialUK Convention 193 AustralialUK Exchange of Notes 221 ChinalUK DTA 231 ChinalUK protocol 253 France/China DTA 257 France/China protocol 276 Germany/China DTA 277 Germany/China protocol 298 UKIUSA DTA 301 UKlUSA Exchange of Notes 344 US/Australia DTA 365

Bibliography

Index

399 401

Abbreviations

ATO BAP BFH CFC CGT DTA EB FBT FIF GAAR GST GTC ITAA ]V LOB MFN PE

QP RHC

Australian Tax Office binding arbitration procedure Bundesfinanzhof controlled foreign corporation capital gains tax double taxation agreement equivalent beneficiary fringe benefits tax foreign investment fund general anti-avoidance rules goods and services tax General Taxation Code (France) Income Tax Assessment Act (Australia) joint venture limitation on benefits most favoured nation permanent establishment qualified person regional headquarters company

A bout the authors

Robert L. Deutsch BEe LLB (Hons) Syd LLM (Hons) Cantab, FTIA Bob Deutsch is one of Australia's leading tax lawyers, with extensive experience as a tax practitioner both with professional bodies and tax authorities and some 14 years in academe. His research fields include international taxation, superannuation, GST and CGT. Bob is currently a Director with KPMG in an advisory capacity and was appointed inaugural KPMG Professor of Taxation at ATAX (the Australian Taxation Studies programme in the Faculty of Law at the University of New South Wales) in May 2007. Previously he was a tax partner with Mallesons Stephen Jaques. Before that, he was a Senior Lecturer in Law at the University of Sydney. He was a private sector representative on the Tax Law Improvement Project and a member of the Australian Tax Office's Part IVA and Public Rulings Panels. Bob is a past Chairman of the Australian branch of the International Fiscal Association and a former Governor on the Board of the Australian Tax Research Foundation. He has acted as a consultant to the Thin Capitalisation Project Team and an external referee for the Dividend Taxation and Globalisation in Australia Project (Bureau of Industry Economics). Bob has published widely, with articles and books in the area of international tax and derivatives. He is co-author of the standard reference Guidebook to Australian International Tax (Legal Books, 2002), Australian Tax Handbook (2008) and Fundamental Tax Legislation (2008) and The Income Tax and GST Strategies Manual. He has presented extensively at seminars and conferences over a number of years and is on the Editorial Board of eJournal of Tax Research.

R~is~n M. Arkwright BA (Hons), MSc, CTA, MCIPD, FTIA ROlS m has 16 years' experience in UK and Australian taxation with approximately ten years spent in a tax technical training environment. She is a qualified Chartered Tax Adviser (CTA) from the UK, but has spent the last eight years in the ongomg tax reform environment in Australia.

Raisin is a member of the Taxation Module Advisory Committee for the Chartered Accountants Programme of the Institute of Chartered Accountants in Australia (ICAA) and a member of the Education, Examinations and Quality Assurance Board of the Taxation Institute of Australia (TIA). Raisin is also a Fellow of the TIA and a full member of the UK Chartered Institute of Personnel and Development (MCIPD). Raisin is currently the National Director of KPMG's Tax Business School® in Australia responsible for the development and delivery of tax technical training programmes to KPMG staff across Australia. Before joining KPMG in Australia, Raisin developed and delivered tax training for the Association of Taxation Technicians (ATT) and the Chartered Tax Adviser (CTA) exams for staff of KPMG in the UK. Daniela Chiew BComm UNSW MTax Syd Daniela Chiew is a Partner in the Corporate Taxation Services group at KPMG. Daniela has 17 years' experience providing corporate and international tax advice to a range of Australian based and multinational organisations particularly in the information technology, media and services industries. Daniela has experience with the co-ordination of tax services in the Asia Pacific region for global clients and is regularly involved in advising on tax structuring issues and conducting tax due diligence for acquisitions. Daniela is a member of the Taxation Institute of Australia and is an adjunct lecturer in the University of NSW ATAX programme.

Preface

This book is the culmination of many years of work in analysing, researching and teaching in relation to double taxation agreements (DTAs). While there have been numerous books written on this topic (see in particular the bibliography) we have taken a different perspective in this book, looking more at the conceptual underpinnings of DTAs and the way in which we believe they operate in practice. We have also sought to bring into the analysis actual DTAs rather than referring continuously to the OECD or UN Model Conventions. In addition, we have included a number of critical DTA cases decided throughout the world, particularly where those cases have an important principle which can be applied more generally to DTAs. We have dealt with a wide geographic spread of countries but inevitably in an initial edition of such a book, our focus has been restricted to a number of specific countries at this early stage. In this book, while our focus is worldwide, at times our key initial observations are in respect of Australia, China, France, Germany, the United Kingdom and the United States. In future editions our analysis and discussion will include a number of other countries and we are particularly mindful of the need to include further developing countries such as India and Brazil and key financial centres such as the Netherlands and Singapore. These countries, in particular, will be in sharper focus in the next edition of this book. A creative aspect of this book is the inclusion in Chapter 8 of a reconstructed version of the AustralialUK DTA, which is designed to bring into sharper relief the conceptual underpinnings of DTAs as we see it. In particular, we have re-arranged the terms of that DTA so as to more directly reveal the critical elements of the DTA as being: Art~cles 1,2 and 3 - an analysis of the three key preliminary questions; ArtIcle 4 - a detailed series of various allocation rules each dealt with in a separate sub-article. Each sub-article deals with a different type of income basket such as business profits, dividends, interest, royalties, income from

---......--. services, etc. These various allocation sub-articles are schematically structured in an identical fashion so as to more immediately reveal the likely benefits and flaws in each of them; . Article 5 - exclusions and limits that operate in the application of this particular DTA; and a Article 6 - the method for eliminating double taxation. In our view this more properly reflects the way in which the DTAs should be approached - both in teaching and in practice. Naturally a production of this breadth requires a collaboration of minds and we would particularly like to thank all those who have assisted in enabling us to reach this stage. While there are many people who have been involved in this process we would specifically like to mention Dave Corbin, Michael Moldrich and Elizabeth Scott of KPMG and Cindy Chan from ATAX at the University of New South Wales. All these individuals provided input to various aspects of the book. Invaluable administrative assistance was also provided by Narelle Robinson (KPMG), in the preparation and finalisation of the manuscript. In addition we would also like to thank the key personnel at BNA International in the production of this book, in particular Deborah Hicks, for all her efforts in bringing this into existence in a timely fashion and for her faith in the project. We trust that readers will find both the content of the book and the conceptual approach adopted of interest and we look forward to receiving feedback so that we can improve future editions. Professor Robert Deutsch, ATAX UNSW, Director KPMG R6isfn Arkwright, Director KPMG Daniela Chiew, Partner KPMG

General

1.1

Introduction

1.1.1

What types of tax agreement (also known as treaties or conventions) are there?

There are over twenty different types of tax agreements, including agreements on income and capital, agreements on estates and gifts, agreements on administrative assistance on tax matters, agreements on shipping and airline profits. Many countries have also entered into multilateral agreements to coordinate their tax policies and promote regional economic development. The focus in this book is on the comprehensive double tax agreements (DTAs) that have been entered into in respect of income and capitaL All of these agreements, which exist throughout the world, follow an internationally accepted format which is prescribed by the Organisation for Economic Co-operation and Development (OECD model) or the version as modified by the United Nations (UN model). There is also a US Model Income Tax Convention, which was finalised in 1996 and which forms the basis of all US bilateral DTAs. This Model is quite different from the other models, as it more cogently reflects the position of the United States as a capital-exporting country. Taxation rights in respect of residents are more strongly defended in this Model, sometimes at the expense of the source country. It is the thesis of this book that the format currently adopted globally is in need of.refinement, and the structure put forward in Chapter 8 in respect of the AustraltalUK DTA is a possible way forward. 1.1.2

What are double tax agreements (OTAs)?

A double taxation agreement - a term often used interchangeably with "double tax . "-.IS an agreement entere d mto . b y two countnes, . d . treaty" 0 r " conventiOn eSlgned primarily to control the way in which income is taxed by the two countne~ where both countries claim the right to tax the same income. This is usually achieved by a series of articles (also known as "provisions") which clarify the

way in which the domestic tax rules of the two treaty partners apply in relation to a specific item of income or specific type of taxpayer (see Article 4 in the reconstructed AustraliafUK DTA in Chapter 8). In this book the term used will be "double tax agreements" or the abbreviation DTA unless quoting from a specific source where a different term is used . ~ost DTAs are "comprehensive" in the sense that they deal with all types of mcome. However, some are limited in their application, e.g. there is an agreement between Australia and Greece that deals only with airline profits. Some DTAs also extend beyond "income", e.g. the UKJUS DTA extends to cover certain excise taxes and the AustralialNZ DTA covers fringe benefits (being benefits received as an employee otherwise than in cash) as well as cash. The structure of DTAs is, broadly speaking, the same but the content is often different. Even though two DTAs may look identical, the wording of specific articles will often differ in a material way. Thus, caution should be exercised in assuming that the same conclusions can be derived about the application of different DTAs. 1. 1.3

How are DTAs designed and structured?

The comprehensive DTAs that currently exist throughout the world are designed and structured in broadly similar ways. Sequentially, the DTAs are simply ordered from Article 1 through to the final article, usually somewhere around 28. Whilst this numerical sequencing covers the field in a logical sequential order, the ordering (in the authors' respectful opinion) fails to reflect adequately the true conceptual nature of DTAs. In particular, DTAs are constructed around a series of conceptual steps primarily consisting of the following: 1. 2. 3. 4.

5. 6. 7.

Rules dealing with the time covered by the DT A - i.e. commencement and termination dates. (Chapter 2) Rules dealing with the taxes covered by the DTA. (Chapter 2) Rules dealing with the taxpayers covered by the DTA. (Chapter 2) Rules applicable to different types of income, etc., allocating tax capacity to one or other of the two jurisdictions which are parties to the DTA or sharing tax capacity between them. (Chapter 3) Rules excluding the operation of the beneficial aspects of the DT A in certain circumstances. (Chapter 4) Rules providing for double tax relief. (Chapter 5) Rules providing for procedural measures to assist in the resolution of disputes and in the collection of taxes. (Chapter 6)

The first three matters are preliminary issues to the application of a DTA and should be grouped together for that reason. The other four aspects are standalone matters that should be dealt with separately.

This book is largely structured a.ro~nd the framework given above, with ling with the three prellIrunary matters and Chapters 3, 4, 5 and 6 C hapter 2 dea . wI·th each of the remaining matters sequenttally. · 1 eamg . . . h 8fl d s· ·1 ly the reconstructed verSIOn of the AustraliafUK DTA m C apter 0 lo:rh:rs ame framework, with Articles 1,2 and 3 dealing with the t~ee p~e.. matters Article 4 dealmg with allocatIOn rules, ArtIcle 5 dealmg with hmmary, . .. . . . exclusions and limitations on t~e availab~Ity of DTA benefits, ArtIcle 6 dealmg . h double tax relief, and ArtIcle 7 dealmg with procedural matters. WI~n the view of the authors it would be sounder if DTAs were designed and structured around these six broad steps to enable readers to more Immediately comprehend the operation of DTA~. . . In the drafting of DTAs, harmoOlsatton of the deSIgn and structure would be of enormous benefit. It would be most helpful if the same ordering of articles was adopted and, where a particular DTA does not cover a particular aspect, this should be highlighted by retaining the sub-article but without any content. Thus, for example, in the AustraliafUK DTA there is no allocation article dealing with professors and teachers. Nonetheless, Art~cle 4.19 has been retained albeit with no content, so that thIS becomes an explicit exclUSIOn m the context of that treaty. It would be helpful if this style were adopted across treaties generally, so that one could be compared with the other with much greater ease than is currently the case. 1.1.4

What are the key functions of DTAs?

The key functions of a DTA are to • alleviate international double taxation; • eliminate international tax avoidance by prescribing rules for the allocation of income and deductions between related parties, for the exchange of information and for assistance in collection; and • provide procedural rules for the resolution of tax objections and inconsistencies (the "mutual agreement procedure"), which are considered later. 1. 1.5

Wh at is international double taxation?

International double taxation in a legal sense occurs where comparable taxes (typically taxes on income or gains) are levied by more than one country on the same taxpayer in respect of the same subject matter for identical periods. This can happen where a taxpayer who is treated as a resident of Country A under Country A tax law derives income which is treated by Country B as having a SOurce in Country B, and any of the following applies: (a)

Country A imposes tax on its residents on their worldwide income and Country B imposes tax on non-residents on income sourced in Country B;

(b) (c)

both countries impose tax by reference 10 source, but each country considers the income derived as having a "source" within its jurisdiction; both countries impose tax by reference to residence, but A and B both consider the taxpayer to be "resident" within its jurisdiction for the same period.

For example, an Australian incorporated company with income arising from activities carried out in Singapore would be subject to tax in Australia as it is taxresident in Australia by virtue of its place of incorporation, and would be subject to tax in Singapore by virtue of its Singapore-sourced income (point (a) above). Similarly, a company incorporated in Singapore might carryon limited activities in Australia; Australia and Singapore might both argue that the income produced from such activities is sourced in Singapore and Australia under their respective source rules, thus giving rise to tax in both jurisdictions (point (b) above ). Finally, a US-incorporated company which is centrally managed and controlled in Australia would be tax-resident in the Uni ted States for US tax purposes by virtue of the US incorporation, and tax-resident in Australia for Australian tax purposes by virtue of its central management and control in Australia (point (c) above). Australia's DTAs seek to resolve such conflicts by a llocating rights to tax and providing relief from double taxation in accordance with the rules contained in the agreement. 1. 1.6

What is the history and relevance DTA?

of t he O E CD Model

To encourage a uniform approach, a draft model do uble taxation convention was presented to the Council of the OECD in 1963; rev isions of the Model Convention were released in 1977 and 1992. An official O ECD commentary on the articles in the 1977 Model has been published, and tile OECD itself has published an official commentary on the 1992 Model Co n vention and revisions of that convention. Members of the OECD are expected, when entering into new agreements or revising existing ones, to conform to the Model Conve ntion, subject to any formal reservations made. Although it is necessary to care fully examine the precise wording of each DTA, the Model Conventions have been influential and, for example, Australia's recent DTAs adopt the general format of the Model Convention. Because of the increase in the volume of electronic commerce, the OECD has reviewed its Model Convention to ensure that: it can adequately deal with changes in business transactions. It has concluded that no major reforms are necessary at this stage, but it will continue t:o monitor e-commerce developments.

Wh

DTAs have been entered into by Australia, China, at G nnanv the United Kingdom and the United States? France, e " . 42) China (85), France (115), Germany (85), the United Kingdom Australia ( U' . d St tes (66) have entered into a broad range of DTAs, as set a (116) and the rute . or ble 10.1 in Chapter 10. out 10 .1a f the comprehenslve . DTAs between COples 0 the United Kingdom and the United States, the United States and Australia, . United Kingdom and Austraha, t he . d K· d China (PRCl and the Urute mg om, China (PRC) and France, and China (PRC) and Germany 1.1.7

· the Appendix. These DTAs are referred to extensively in the discan be foun d m cussions that follow in this book. . . In addition the reconstructed version of the AustrahaIUK DTA IS to be found in Chapter 8. 1. 1. 8

What are most favoured nation clauses and what happens if they are t riggered?

Some DTAs contain "most favoured nation" (MFN) clauses that require the DTA partner to renegotiate the terms of a DTA if that country subsequently enters into a DTA with another country on more favourable terms. This article can take one of two forms, as follows: • The first is an article in which there is an agreement between the DTA partners (Countries A and B) that if specified rates in respect of specif~ed types of income are negotiated between one of the DTA partners and a third country that are lower than those applicable in the DTA between A and B, those lower rates in respect of those items of income shall apply in respect of A and B. II The second is a more common article, which provides that If elther Country A or Country B enters into a DTA with a third country on terms that are more favourable in some respects than the terms specified in the Country AlB DTA, Country A and Country B are required to enter into immedi~te negotiations to amend the relevant articles of the Country AlB DTA to brmg it into line with the more favourable terms of that third country DTA. Thus, for example, the reduction in withholding tax rates in the revi~ed AustraliafUS DTA triggered MFN obligations for Australia with the followmg countries: France, Italy, Switzerland, Finland, Norway, The Netherlands and South Korea. In the November 2005 Protocol to the AustralialNZ DTA, New Zealand agreed to an MFN clause in relation to Australia.

6

Double Taxation Agreements

, . 1.9

What rules apply to the interpretation of DTAs?

Although DTAs are incorporated into the domestic law of the DTA partner countries, typically with broad overriding effect subject only to particular exceptions, they retain their status as international treaties. As a result they are subject to the general international law on DTAs as codified in the Vienna Convention on the Law of Treaties. Some general rules of construction may be identified. • DTAs for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and gains should be construed liberally. In this context, Article 25 of the Vienna Convention provides that the treaties are binding and should be performed in good faith. T he principle of good faith would seem to imply that the literalist or narrow interpretation should not be adopted where it would overcome the intended effect of a treaty. Article 27 of the Vienna Convention provides that a treaty party may not invoke the provisions of its internal law as justification for failure to perform a treaty. How this sits with the legislative amendments to Australia n domestic law post the decision in Lamesa v. FCT (see section 1.1.11 below and Chapter 9) is an open question. • Each bilateral agreement must be construed individually (although it might adopt many of the common principles and terms laid down in the OECD Model Convention). • The effectiveness of the DTAs is enhanced if the judicial decisions of a country concerning its provisions are recognised as persuasive authority by the courts of the other country, or of other countries, when construing comparable provisions: Canadian Pacific v. The Queen (1976) CCT 221. Ill ustrations of a failure to implement this policy may be found in ES & A Bank v. FCT (1969) 1 ATR 104 and Ostime v. AMP Society [1960] AC 459 . • Uniformity is increased to the extent the DECD commentaries on the articles to the Model Conventions are accepted as aids to construction. 1. 1. 10

How do DTAs deal with undefined terms?

DTAs, almost without exception, include an article that specifically deals with undefined terms. Thus, for example, in the UKlUS DTA, Article 3(2) provides as follows: As regards the application of this Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, or the competent authorities agree on a common meaning pursuant to the provisions of Article 26 (Mutual Agreement Procedure) of this Convention, have the meaning which it has at that time under the law of that State for the purposes of the taxes to which this Convention applies, any

. under the applicable tax laws of that State prevailing over a meaning given to the meaning der other laws of that State term un

The result of the application of ~he unde~ined terms subparagraph is that an undefined term will normally take ItS meamng from the relevant tax l~ws of the state applying the DTA subject only to the context requmng otherWise. 1. 1. 10. 1 Issue 1 - Context otherwise requires When the "context would so otherwise require" is an open question, but clearly whether or not the context is strong enough to dictate a different conclusion from that which might be gained from a domestic law definition is a matter which can only be decided on the facts of each individual case. Rather than focusing on the word "context", it might be appropriate to consider the word "requires". "Requires" is a word of some force. Non-English language versions of DTAs may be instructive in understanding the true force of the word "requires" in this context. Thus, in the French language the word used is demander and in the German erfordern. These words are all words of considerable force, so it would seem that the context must be reasonably strong for the internal law meaning to be ousted by the context. Otherwise the phrase tha t might have been adopted might have been "unless the context otherwise suggests" or possibly "unless the context otherwise implies". These are words of less force and would easily accommodate other meanings merely suggested or implied rather than required by the context. The only place where this issue has been ventilated in Australia is in the High Court. In Thiel v. FCT (1990) 21 ATR 531 the High Court held that the terms and expressions "enterprise", "enterprise of one of the Contracting States" and "enterprise carried on by" in the Swiss DTA have no particubr or settled meanings in Australian income tax law. The meanings of those terms and expressions must therefore be ascertained from the Swiss agreement itself. The court held that the Swiss DTA is to be interpreted in accordance with the r~es of interpretation recognised by international lawyers, now codified by the Vienna Convention on the Law of Treaties. As that DTA reflects those custom~ry rules, the court considered it proper to have regard to its terms in interpretmg the Swiss Agreement, even though Switzerland is not a party to that convention. Since the expression "enterprise" in the Swiss agreement is ambiguous, the court believed it was proper to have regard to any supplementary means of interpretation. In this case, the supplementary means of interpretation were the OECD Model Convention and commentaries thereon.

1. 1. 10.2 Issue 2 - Static v. ambulatory

There is a further and subsidiary issue which needs to be considered in the context of the undefined terms clause, and that is whether DTAs have a static or an

ambulatory operation. A static approach would take the meaning of the term from the time at which the DTA is entered into, as opposed to an ambulatory approach where the meaning of the term would vary depending on changes in domestic law meaning from time to time. Interestingly, in Australia the Asprey Committee Full Report of 1995 assumed an ambulatory approach, since it raised the concern that a "country applying the agreement may in effect re-write the Agreement unilaterally by changing a definition of source in its own law". This would only be possible if an ambulatory approach were taken to the interpretation of DTAs. In Australia, DTAs appear to have specifically adopted an ambulatory approach since the signing of the Austrian Treaty on July 8, 1986. The undefined terms article since that time has provided that the meaning of the relevant term is to be taken from its meaning "at any time" when the DTA is applied. Clearly, this gives an ambulatory interpretation to the definition.

1.1.11

Can DTAs be used by taxing authorities to avoid an outcome of double taxation?

Courts throughout the world have recognised from time to time the importance of the object and purpose in interpreting tax treaties. In particular there seems to be a general acceptance that Article 31 of the Vienna Convention requires a holistic approach to treaty interpretation. Notwithstanding this general position, it is readily apparent that it is the text of the DTA that matters and not some presumed or anticipated intent. This is not to say that the object and purpose of the DTA is not relevant quite the contrary, it is highly relevant as it may throw light upon the meaning of the text of a DTA. However, critically, it does not replace the fundamental proposition that it is the text that counts and the text needs to be determined and interpreted in an independent manner. These comments are particularly apposite in regard to the issue expressed in the question proposed. The issue arose directly in an Australian case, namely Commissioner of Taxation v. Lamesa Holdings BV (1997) 785 FCA (August 20,1997). In this case the Federal Court of Australia in a decision on appeal from a single judge expressed hesitancy towards accepting the direct relevance of the object and purpose of a DTA in ensuring that tax would be paid in at least one jurisdiction. In that particular case the fact that no tax would be paid in the Netherlands because of a unilateral exception available in that country could not of itself affect the interpretation of Australia's taxing rights, which were arguably restricted by virtue of the AustralialNetherlands DTA. The first instance judge in Lamesa more explicitly rejected the proposition that the object and purpose of a DTA "is not only to avoid double taxation, but also to ensure that tax is paid somewhere". Neither Court accepted the proposition that the object and purpose of

. d ble taxation was to be extended to include an object and purpose . eff l pre ventlllgh ou ld be paid somewhere, so as to gIve ect at east on · one VIew to hat taX s ou I . t . d purpose of preventing fisca evaSIOn. . I. I . th e obJect an Courts recognised that double non-taxatIOn may u tImate yanse The Lamesa . . . h of the DTA parties chooses not to exerCIse ItS ng ts to tax . ly because one . . SImp h DTA and it is accepted that countries need not exerCIse theIr full taxunder t e , . . . ri hts under a DTA. g lllgT h us It - see ms that the only appropriate conclusIOn IS _that _ DTAs do not and -11 not endorse the view that tax must be paId III at least one of the - I seemlllg y WI two taxing jurisdictions. _. _ If there is concern on the part of the DTA cou~tne~ that thIS wIll be an outthis will need to be explicitly recognIsed eIther III the terms of the treaty come, h bsence 0 f suc h exp I-IClt - recognItIon, -- domestic laws of the countries. In tea ~~rI~xample see section 23AG ITAA 1936 (in the Australi~n co~te_xt), there will be no requirement that tax be paid in at least one of the JUrISdICtIOns.

1.1.12

Can a DTA create a tax liability in circumstances where no such liability exists under domestic non-DTA law?

Although occasionally questioned, the guiding principle that underpins the application of DTAs is that they should not and cannot give rise to a higher liability to taxation than that which would arise by application of the domestic law alone. This accords with the broad principle that the DTA does not of itself impose taxation. If one accepts that general proposition, the imposition of taxation should always be left to the individual Contracting State and, if the individual Contracting State does not wish to impose tax in respect of a particular trans1ction, the DTA should not be used so as to achieve an outcome where tax is impJsed. Thus, if the domestic law of a DTA country does not seek to impose tax because the income in question is derived by a person· not resident in that DTA country and is income not sourced in that DTA country, that should be the end of the matter, with no tax being imposed by that DTA country. Some confusion can arise on this point, as some DTAs have subparagraphs that suggest that, if income may be taxed in a country under the DTA, such income is deemed to have a source in the DTA country. By parity of reasoning, this would seem to imply that in such a case the DTA, by permitting taxation, is requiring it by changing the character of the income to income sourced in the DTA country. Usually this can be explained away on the basis that the DTA deeming of ~ource in the DTA country is only for the purposes of allowing foreign tax credIts under the DTA provision. In other words, as foreign tax credits can only be gIVen in respect of tax paid on income sourced in the DTA country, it is necessary to make this deeming to achieve the correct outcome. A good example of such a provision is to be found in the UKJUS DTA Article

24(5), where it is made explicitly clear that the deeming of source prescribed in that subparagraph is only "For the purposes of paragraph 4 of this Article ... " In other words the deeming is only for DTA foreign tax credit purposes. That i~ the usual construction provided for in DTAs. More problematic is Article 27(1)(a) in the AustralialUS DTA, which provides that: Income derived by a resident of the United States which , under this Convention, may be taxed in Australia shall for the purposes of the income tax law of Australia and of this Convention be deemed to be income from sources in Au stralia.

The reference to "for the purposes of the income tax law of Australia " is problematic, as it seems to suggest that the source deeming transcends the DTA and effectively deems source in Australia, such that Australia's right to tax is conferred by the DTA even though no such right exists under the domestic Australian law in the absence of Australian-sourced income. An alternative reading may well be that even this article should be read narrowly, such that it is interpreted as merely deeming Australian source in such a case for Australian domestic foreign tax credit purposes and not more generally for the purposes of Australian jurisdiction to tax. This interpretation can only be accepted if one accepts that the DTA principle that DTAs can limit, but not confer, taxing rights is a broad overarching concept. If that is not the case, this article may well be a rare but important case where a DTA has conferred taxing rights in circumstances where no such right may otherwise exist under domestic Australian law. 1.1. 13

Can 0 TAs override the application of international attribution measures such as the CFC and FIF rules?

There are two cases in particular dealing with this issue, one a 2002 decision of the French Conseil d'Etat and the other a 2007 decision of the Tokyo High Court. The French case, known as Schneider Electric (Re Ste Schneider Electric French Supreme Tax Court, 28 June 2002, No. 232276), is discussed in section 9.3.9 and is to the effect that Article 7(1) of the France/Switzerland DTA prevented the operation of Article 209B of the French General Taxation Code ("GTC"). That article in the GTC was to the effect that where a French enterprise (such as Schneider Electric) holds at least 25 percent of the shares in a foreign company that is subject to favourable tax treatment in the foreign country (such as the Swiss resident entity known as Paramer), the French enterprise is subject to tax on the profits of the foreign company in proportion to the interests that it holds. Article 7(1) of the relevant DTA provided that the profits of an enterprise can only be taxed in another country when the enterprise carries on business through a permanent establishment (PE) in that other country.

if ·vely the court concluded after an extensive analysis of the relevant proviE ectl nd their purposes that it was the profits of Paramer that were being taxed 5~O;:a:ce and, as it did not have a permanent establishment in France, this was I ermiss ible under the terms of the relevant DTA. nO~~imi1ar issue arose in the Tokyo High Court in 2007 (Tokyo High Court 7007 (Gyoko), No. 148) where the court ruled against a taxpayer's claim that -h Japanese-controlled foreign corporation rules in Articles 66-6 to 66-9 of ~h: Special Taxation Measures Law violated Article 7(1) of the Japan! SingapOre DTA. . .. .. . Under the Japanese CFC legislatIOn, If the und1stnbuted lOCO me of a foreignresident Japanese-controlled company attracts a tax burden that is significantly less than the tax burden on corporate income in Japan, the undistributed income is attributed to and taxed in the hands of the Japanese-resident controlling shareholders in proportion to each shareholder's direct and indirect interest in the foreign company. More specifically, attribution to a resident corporation occurs where three conditions are met: A Japanese resident owns at least 5 percent of the stock of the foreign company; • More than 50 percent of the total stock of the foreign company is owned by Japanese residents; and The tax burden on taxable income of the foreign company is 25 percent or less than the corresponding Japanese tax burden. There is in addition a series of requirements which, if satisfied, preclude Ihe application of the Japanese attributions rules. These requirements, which are cumulative in nature, are as follows: • the foreign company has a fixed facility such as an office, shop or factory that is deemed necessary to conduct its business in the country or area where its head office is situated (i.e. Singapore in this case); and the foreign company conducts the management, control and operation of 1ts business by itself in the country or area where its head office is situated; and when the main business of the foreign company is wholesaling, banking, t~ust management, securities, insurance, shipping or air transport, the fore1gn company conducts its business mainly with persons other than related persons; and ~hen the main business of the foreign company does not involve the activi~~: described above, the foreign com~an~ c~nducts its business mainly in COuntry or area where itS malO offlCe 1S situated· and the main business of the foreign company is not holding stocks, exploiting patents Or copyrights, or leasing vessels or aircraft.

In the usual parlance of international tax, what this essentially is highlighting

is that the foreign company, in this case a Singapore company, should be COnducting a real active business rather than merely holding passive assets and/or dealing with related parties. The taxpayer in this case argued that Articles 66-6 to 9 of the Special Taxation Measures Law (known colloquially as the japanese CFC measures) imposed japanese tax on the profits of a Singapore-resident company. However, the taxpayer observed that the Singapore company did not carryon activities through a PE in japan, and accordingly Article 7(1) of the japan/Singapore DTA, which in all material respects is identical to Article 7( 1) of the OECD Model Tax Convention, would prevent the taxation of the profits of the Singapore-resident company unless that company had a PE in Japan. In ruling against the taxpayer in this case, the Tokyo High Court observed that it was obvious from the provisions that the CFC meas ures did not directly impose japanese tax on the profits of the foreign company. Rather they adopted a form of deeming in which the undistributed income of a foreign company will, after it meets certain detailed criteria (see above), be attributed to certain j apanese-resident shareholders. In particular, the High Court noted that this deeming was subject to a number of constraints, not least of which was meeting the requirements referred to above. In addition, it was not a general deeming but merely one in which the scope of the foreign company's activities which were subject to the CFC rules was directly proportional to the amount of stock held in the Singapore-resident company. In this way, the Tokyo High Court concluded that all that the CFC rules sought to do was to tax an amount which in substance would ordinarily have been an amount repatriated by way of dividends to the Japanese-resident controllers if a dividend had been properly declared. Merely imposing a japanese tax on the Japanese shareholders by deeming those profits to have been repatriated for the purpose of preventing international tax evasion and a voidance was not considered by the Court to conflict with Article 7(1) of the japan/Singapore DTA. The Tokyo High Court also dismissed reliance upon the French Conseil d'Etat decision in Schneider, noting in particular that, under the French r ules, taxation was directly imposed as a separate tax on the undistributed profits of the foreign company if it was regarded as being situated in a tax haven country. It al~o noted that the French system could not cope with a deemed dividend concept in this regard since the French tax system uses a territorial basis and would thus exclude most foreign dividends from taxation. Clearly in those circumstances a deemed dividend regime of the kind that was said to operate in Japan could not be influenced by the decision of a French court operating in the context of a fundamentally different taxing regime. Thus, it was considered that the French CFC rules were materially different from those that applied in Japan and were distinguishable on that basis. The Tokyo High Court also noted the existence of a Finnish decision of the Supreme Administrative Court of Finland regarding the same issue under the

. rnJFlllI nd DTA, which indicated that Schneider may not be a wellBelglU. h d aternauonal view on this question (see in particular 20.03.02/596; abhs e In est .2002: 26 , Supreme Administrative Court, March 20, 2002 ). KHO. ly the OECD Model Tax Convention commentary takes a someInterestlllg , h off nt tack to that which was adopted III the Tokyo Hlg Court. Rather ~tl~ d W n focusing on the deemed dividend nature of the rules, It focuses on the fact tha based on CFC principles which IS leVied by a State on itS reSidents that a tax . t actually reduce the profItS of the enterpnse of the other State. It may 0 d 0 0 I does no b re be said to have een IeVle on suc h pro fOItS ( see III partlcu ar not t herefo 01 of the Commentary on Article 7 of the OECD Model Tax paragra ph 1 . con vention). 0 0 0 With respect, that would seem to be a highly techmcal argument, particularly o ce in a genuine controlled case the profits in the foreign-resident-contro lled ~:mpany would ordinarily be used sp~cifically to pay the referrable tax by ca using a dividend to be paid by that foreign CFC so as to put the shareholder III a position to pay the relevant ta~. To suggest that this IS not taxlllg the profits of the CFC IS arguably a matter of semantics and nothing more. The position obviously remains somewhat unclear, but there is no doubt that revenue authorities throughout the world will prefer the position of the Tokyo High Court and the Finnish Special Administrative Court; however, as a mattd of strict technical analysis it is not certain that view is entirely correct. 0

0

0

0

0

0

0

1. 1.14

0

How, if at all, are DTAs incorporated into domestic tax law?

In most cases, one way or another, DTAs are read into and read as one with the domestic law of the DTA partner country. Broadly there seem to be two methods by which DTAs become part of domestic law: • the direct adoption method; or • the indirect adoption method. Under the direct adoption method DTAs are self-executing, automatically becoming part of domestic law upon ratification. Thus, such DTAs are enforceable ~nder the domestic law without requiring further legislation, although in some lllstances parliamentary approval (but with no legislative enactment) may be required. Country examples where such a direct adoption method is used lllclude France, Germany, Japan and the United States. . Under the indirect adoption method a specific domestic legislative enactment IS reqUired to bring the DTA into and make it part of the domestic law. Country ~xamples where such an indirect adoption method is used include Australia, :n~da, India and the United Kingdom. Unless and until a DTA is made part o t e domestic law, it remains merely an international agreement between

sovereign states. Sovereign states may be bound morally to comply with such international agreements. Further, they may be pursued legally in an interna_ tional forum by the other sovereign state (being the other party to the interna_ tional agreement) but, in practice, this is unlikely to happen in relation to a DTA. Beyond all that there is little that an aggrieved private citizen could do to force a sovereign state to comply with its obligations. In other words, private citizens have no capacity to enforce such international agreements until they are incorporated into domestic law. From that point on they are enforceable by the courts of the domestic jurisdiction at the behest of a private citizen. AUSTRALIA

In Australia, section 4( 1) of the Agreements Act ensures that the Income Tax Assessment Acts 1936 and 1997 are incorporated into and read as one with the Agreements Act including its Schedules of DTAs. Most importantly, provisions of the Agreements Act declare that the DTAs, which are set out as schedules to the Agreements Act, have the force of law in Australia from their respective commencement dates. However, except for Part IVA of the ITAA 1936 and the ITAA 1936 statutory limit on foreign tax credits (currently being re-written into the ITAA 1997 in a modified form), section 4(2) of the Agreements Act declares that the provisions of the Agreements Act override any inconsistent provisions of ITAA 1936.

to be found in Articles 6 to 22; in the reconstructed version . I II atlon ru es are ~ DC ter 8 they are all to be found in Article 4. '" ' ' tn Chap " designated by DTAs (e.g. business profits, dividends, InterT es ot iI1Come , YP I' ) hould not be confused with those types of Income under domesest, roya tles s tic la w· , ' t'on of its domestic law by a contracting state may consist of the The IIIIllta I ' I ' state (app ymg an " tax claim in favour of the other contractmg waiver ,0 t Its thod) or the grant of a cre d it agamst " f Its tax or taxes pal'd'm t h e , method). If an AII ocatton ' A' exemptlon me lying a credIt rtIC Ie provl'd es t hat a , "h h h other state (a pp 'ul type of income "shall be taxable only m... t en t e ot er state may partI c ar , not tax that mcome. If on the other hand, the rule provides that the income "may be taxed in ... " "h ou t the word "only") - this formula" always refers to the state of source (Wit are not determmed by the rule hen the consequences in the state ,of residence titself ' , but may depend on the operation 0 f ot h er provISIons suc h as t h ose d ea I'mg with methods of elimination of double tax. The requirement to apply the Allocation Articles is an additional requirement for establishing tax liability over and above the rules in the domestic law of each Contracting State. To use an analogy, the DTA acts like a stencil placed over the pattern of domestic law and covers over certain parts of that domestic law. The taxpayer's liability is then determined by reference to the new, more limited, version of the domestic law.

UNITED KINGDOM

Similarly in the United Kingdom, section 788 of the Income and Corporation Taxes Act 1998 gives legislative effect to any arrangements made with other countries that provide for relief from double taxation, which will include DTAs negotiated by the United Kingdom. This section also invokes the United Kingdom provisions dealing with unilateral double tax relief where a DTA anticipates relief for foreign taxes by way of credit against tax payable in the UK. 1.1.15

1.1. 16

In essence, there are normally four different types of Allocation Article:

Active income articles This classification can cover business profits, shipping and air transport profits, associated entity profits, income from independent personal services, income from dependent personal services, fringe benefits and government service. Passive income articles This classification can cover income from certain assets such as dividends, interest, royalties, income from immovable property, capital gains, pensions, annuities and related payments. Articles relating to the nature of the taxpayer ~his classification could cover artistes and sportsmen, students, and protessors and teachers. "Other income" article This article deals with income not dealt with in the foregoing categories.

How do DTAs work?

DTA rules do not allocate jurisdiction to tax between the contracting states even less so do they attribute the right to tax. States have original jurisdiction to tax and this is recognised by public international law. By concluding DTAs the states agree to restrict their substantive tax law reciprocally. In those situations where substantive tax law is expected to overlap, the contracting states decide which of them will be bound to withdraw or limit its tax claim. A DTA neither generates a tax claim that does not otherwise exist under domestic law nor expands the scope or alters the type of an existing claim. The method adopted by DTAs to avoid double taxation is the classification of items of income and their assignment to one or other of the contracting states. The treaty rules that perform this particular function may be referred to as the" Allocation Articles". In the six DTAs examined later in this book, the

In broad terms what types of Allocation Article are to be found in DTAs?

, This format is reflected both in Chapter 3, dealing with the Allocation Articles DTAs, and in Article 4 of the AustralialUK DTA to be found in Chapter 8.

10

I0

\Jeneral

LJOUDle I axatlon Agreements

t. t. t 7

How is priority between the Allocation Articles determined?

Sometimes there are explicitly stated priority rules declaring that one article applies in priority to another. This priority or lack of it, however, is not always explicit. In the reconstructed version of the AustralialUK DTA (see Chapter 8) these priority articles are made explicit by the inclusion in each Allocation Article of a separate heading "Priority Among Classes". Where no priority rule exists, the lack of such a rule is made explicit. If a given item of income meets the requirements of more than one Allocation Article, those referring to passive income take priority over those referring to active income. Thus, if the business assets of an enterprise include shares in a company, dividends derived from those shares will be treated in general under the dividend article rather than the business profits article. The same would apply if an enterprise grants a loan or a patent licence to a person in the other Contracting State or if it holds immovable property in the Contracting State. In each case the relevant passive income article rather than the active income article would apply. There is, however, an important exception to this principle. Where dividends, interest or royalties are received via a permanent establishment or fixed base in the source jurisdiction and if the right in respect of which such payments are received is an asset of the permanent establishment or fixed base, then their taxation is determined under the active income article rather than the relevant passive income article. 1. 1. 18

Is there a practical approach to the application of DTAs that creates a coherent conceptual framework?

From a practical perspective the steps shown in Table 1.1 are recommended to assist in determining how a relevant DTA might apply in a given situation.

-

Table 1.1

The broad principles applied under t he allocation articles

1.2.1

Division

Step 2: Step 3:

Step 4:

law in the absence of the DTA Determine how the situation would be dealt with under the relevant foreign law in the absence of the DTA Examine the DTA start date and termination arrangements to see whether the situation is covered. If yes, go to Step 4. If no, DTA does not apply; apply domestic laws only. Examine the DTA to see whether the tax under consideration is covered. If yes, go to Step 5. If no, DTA does not apply; apply domestic laws only.

Step 5:

Examine the DTA to see whether the taxpayer is covered. (This usually entails an analysis of the DTA residence rules to see if the taxpayer is a resident of either Contracting State.) If yes, go to Step 6. If no, DTA does not apply; apply domestic laws only.

Step 6:

Examine the DTA to see whether the taxpayer or the type of income concerned is dealt with in any of the allocation articles of the DTA If yes, go to Step 7. If no, DTA does not apply; apply domestic laws only.

Step 7:

Apply the DTA article to determine the allocation of taxing rights.

Step 8:

Examine the DTA to see if any Article or benefit conferred by an Article is excluded or limited.

Step 9

Apply the DTA double tax relief mechanism.

Step 10:

If double tax is not avoided, consider whether the Mutual Agreement Procedure could be invoked.

1.2.2

Income taxed by the residence jurisdiction only

A number of income classes are usually taxed solely by the country of residence of the recipient. In broad terms these are:

III

of taxing rights

DTAs adopt certain broad rules whereby the rights to tax may be either exclusively allocated to one of the countries or divided between the countries with provision for relief from double taxation. Where an exclusive right to tax is conferred, it is generally given to the country of the taxpayer's residence. Where both the country of residence and the country of source of the income are given a right to tax, generally the country of residence is required to grant relief against double taxation, by way of either the credit or exemption method.

Steps to test relevance of a DTA

------------------------------------Determine how the situation would be dealt with under the relevant domestic

Step 1:

iii

1.2

1/

Ii

Profits of an enterprise carried on in one country, unless those profits are derived in part from a business in the other country which is conducted through aPE. Profits derived from the operation of ships or aircraft, unless the profits are derived from the operation of ships or aircraft solely within the confines of the other country. Remuneration derived by an employee who is present in the other country for a period not exceeding in aggregate 183 days in a year of income. In some cases, this exclusion is subject to the proviso that the employer is resident in the country in which the employee is normally resident and the remuneration is not an allowable deduction in determining the taxable profits of a PE or fixed base of the employer deduction in determining the taxable profits of a PE or fixed base of the employer in the country in which the employee rendered the services.

.. Income from professional services or independent activities of a similar nature except public entertainers, unless the person concerned has a fixed base regularly available in the country in which the person is not normally resident (see, for example, Australian Tax Office ID 2006/140). a Pensions and annuities. Remuneration received in rendering services to government bodies (including both country and local government authorities) unless the person concerned is a citizen or national of the other country or, alternatively, did not become a resident of that country solely for the purpose of performing the serVICes . • Remuneration of professors and teachers present in the country in which they are not normally resident for the purpose of teaching or carrying Out advanced study or research, unless their presence in that other country exceeds two years. • Payments made to students for their maintenance or education where they are temporarily present in the country other than that in which they are normally resident only for the purpose of their education. Income derived by a resident of a country from sources outside both COuntries. In the case of persons who are dual residents, the provisions relating to such persons, which are present in many of the agreements, should be considered to determine the country in which they are deemed to be resident for the purpose of the DTA. That country is the country authorised to treat income derived from third countries as taxable income. The items listed above are not included in all DTAs. In particular, the remuneration of professors, teachers and students is often omitted from a number of the agreements. Where there is no article specifically dealing with professors and teachers, such income is governed by the dependent personal services (employment) article. In any particular case, reference should be made to the particular agreement that is applicable. f .2.3

Income may be taxed by both the residence and source jurisdictions

DTAs commonly provide for some classes of income to be taxed by both the source country and the residence country, with relief to be granted, where required, by the country of residence by the allowance of a credit in respect of taxation suffered in the country of source. Types of income treated this way include: income derived from real property, which includes royalties and other payments from the operation of mines or quarries or the exploitation of any natural resources (some of the more recent agreements provide that income derived from debts secured by mortgage of real property or from any other direct or indirect interest in or over land is also to be taxed on this basis);

. • lOCO ness

me derived by an enterprise of one of the countries that carries on busi. t hat ot h er in another country through a permanent esta bl·IS hm ent m

country; . . . .. . . • certain income of public entertamers (mcludmg entities WIth which the entertainer or aSSOCIates are connected);. ... . . • income derived from rendering of personal serVIces where It has ItS ongm m fixed base used by the person concerned; ~come derived from salary or wages where the person concerned is present • ·n the other country for more than 183 days, the remuneration received is ~aid by a resident of the other country and the remuneration is deductible in determining the profIts of a permanent establIshment of the employer m that other country; and • fees and remuneration of directors and persons holding similar appointments .

/

The three qualifying questions

2.1

Taxpayers covered

2.1.1

What taxpayers are covered by the DTA?

Whether a taxpayer is covered by the terms of a DTA is not always an easy question to resolve. The starting point is usually Article 1 of a DTA, which almost always states that the agreement "shall apply to persons who are resident of one or both of the Contracting States". However, each Allocation Article covering a basket of income will usually refer back to a particular party. For example, the business profits article will normally make reference to an enterprise of one of the Contracting States. The way in which "an enterprise of one of the Contracting States" is defined will be critical to the issue of what taxpayers are covered by the DTA. In most cases the definition will restrict the availability of the Allocation Article to a taxpayer who is a resident of one but not both Contracting States. In that way dual-resident entities will be excluded from the DTA benefits unless the DTA itself eliminates the dual residency for the purposes of the DTA. In most instances DTAs do attempt to eliminate such dual residency through a tie-breaker article. However, if there is no such article or there is such an article but it fails to break the dual residency, the DTA Allocation Article will not apply. 2.1.2

How do DTAs generally and the sample DTAs in particular resolve cases involving dual residency?

DTAs generally contain "tie-breaker" rules for resolving conflicts caused by taxpayers having dual residence status. It is clear that dual residency can arise in many and varied circumstances. 2.1.2.1

China/France DTA

~or ~xample, an individual who has their centre of economic interests in France Ut IS actually physically present in China for more than a year is most likely to

be treated as a resident of both jurisdictions under the respective domeStIc tax laws. Such a person will need to rely on Article 4(2) of the China/France DTA t break the dual residency. This is a very simple and clumsy tie-breaker, simplo calling on the competent authorities in the two jurisdictions to settle by mutu~ agreement the state where such person is a resident. For companies there is no reference to the competent authorities, but a mOre straightforward allocation of residence to that Contracting State in which the head office is situated. 2.1.2.2

US/UK OTA

This more modern DTA provides a more robust solution to this problem for individuals (Article 4(4) by providing a detailed list of tie-breakers on the basis that: if the person has a permanent home in one but not both Contracting States he is a resident of that Contracting State where he has his permanent home; (b) otherwise he is a resident of that Contracting State to which he has closer personal and economic relations (his centre of vital interests) if that can be established; (c) otherwise he is a resident of the Contracting State in which he has an habitual abode if he has one in one but not both Contracting States; (d) otherwise he is a resident of the Contracting State of which he is a national if he is a national of one but not both Contracting States; (e) otherwise he is a resident of the Contracting State agreed by the competent authorities of the two Contracting States if such agreement can be reached. (a)

As can be seen, this provides an order for determination that is more definitive than is the case with the China/France DTA but can still lead to no resolution if one reaches the final stage under the USIUK DTA and the competent authorities are unable to agree. For companies, Article 4(5) refers resolution to the competent authority to resolve the residence issue. Interestingly failure to resolve the matter is specifically contemplated, such that the benefits of the DTA will not apply with certain limited but important exceptions. 2.1.2.3

China/Germany OTA

For individuals (Article 4(2)) the regime is adopted as for the USIUK DTA with the final paragraph (e) above not applying. For companies (Article 4(3)) the tie-breaker is in favour of that Contracting State in which its place of head office is situated.

t.2.4 China/UK OTA . ' 2. . dividuals (Article 4(2)) the sa~e regIme ~pphes as for the USIUK DT~. For tn p nies (Article 4(3)) the ue-breaker IS III favour of that Contractlllg a the place of effective management IS . SItuate . d unI ess t h For. comhich at p i ace'IS W State tnC tracting State but the place of the head office is in the other Con. one .. nee d to d etermllle . t h e mat1ll . Son te In that case the competent aut h orltles tracung ta . ter by mutual agreement. . . 2. 1.2. 5 Australia/US OTA . d 'vt'duals (Article 4(2)) the ordenng IS as follows: For In I (a) He is a resident only of that Contracting State where the person maintains his permanent home if that is in one but not both Contracting States; otherwise; (b) He is a resident only in that Contracting State in which he has a habitual abode if that is in one but not both Contracting States; otherwise (c) He is a resident only in that Contracting State with which his personal and economic relations are closer. It is expressly provided in this DTA that, in determining the permanent home, regard shall be had to the place where the individual dwells with his family, and, in determining personal and economic relations, regard shall be gIven to citizenship. Interestingly in this DTA there is no tie-breaker for companies. Thus, a company incorporated in the US state of Delaware but which is centrally managed and controlled in Australia and carries on business in Australia is a dualresident company which cannot obtain the benefit of any DTA concessions. 2.1.2.6 Australia/UK OTA For individuals (Article 4(3)) this DTA follows the permanent home, then the centre of vital interests and then immediately shifts to mutual agreement between the competent authorities. For companies (Article 4(4)) this DTA allocates residence purely on the basis of where the place of effective management is situated. There is a special rule dealing with participants in a dual-listed company arrangement. 2.1.2.7

General comment

As can be seen from the above, there are many possible ways of dealing with dual-resident individuals and companies. Usually both are dealt with in the DTAs, but there are occasional exceptions such as the AustralialUS DTA, where ~ual-~esident companies are not mentioned. The consequence is critical, as DTA enefas are denied in such cases. b The Structures of the dual-residency tie-breakers bear some common features ~t each DTA seems to be different and requires careful analysis. Assumptions a out what they provide as tie-breaker provisions are dangerous.

2. 1.3

What about other " entities" such as partnerships and trusts?

Interestingly there are no tie-breaker provisions in DTAs de.4' del in the tollowmg wa ys: .v~o The UN Model expands upon paragraph 3 of the OECD Model, which vers building and construction sites, by both: . 00 . d . I reducing the period of time, or term, reqwre to tngger t he cause to SIX nths or three months in special cases (rather than 12 months); and mO , d . I ubstantially broadening the scope by including s . the broa . . .er . termlOO ogy . of "assembly or installation project or supervisory activIties m connection with ... ". Consequently, assembly projects and supervisory activities may be able to create a PE - situations which are not specified under the OECD Model. • The UN Model includes a new subparagraph in paragraph 3 of the O~CD Model whereby the furnishing of services, including consultancy serVICes, for a period of time may trigger the presence of a PE. The UN Model Convention acknowledges that there is no general agreement between developing countries as to the appropriate time limit or whether separate projects should in fact be aggregated together. • The UN Model substantially amends the PE exclusions in subparagraphs (a) and (b) of paragraph 4 of the OECD Model by eliminating the term "delivery". Consequently, the use of facilities or the maintenance of stock for the purpose of delivering goods will create a PE and any income properly attributable will beoome taxable. The UN Model does not include the provision contained in subparagraph 4(f) of the OECD Model, which excludes a combination of activities from constituting aPE. The UN Model augments paragraph 5 of the OECD Model by including another situation where a dependent agent can create a PE - other than one having the authority to conclude contracts. That is, a dependent agent who habitually maintains a stock of goods from which goods are regularly delivered on behalf of the enterprise will be sufficient to constitute aPE. The UN Model includes a new paragraph whereby the collection of insurance premiums can constitute a PE. This appears to be an unpopular provision internationally, and none of Australia's tax treaties, for example, have adopted this provision. The UN Model strengthens paragraph 6 of the OECD Model, which deals with independent agents and ensures that agents cannot be considered as independent where the activities of the agent are devoted wholly or almost wholly to an enterprise, or, as refined in 1999, where conditions re imposed that do not reflect a relationship between independent enterprises.

3.1.8

How have the OECD and UN Models influenced PE articles in DTAs?

Clearly the influence has been substantial and is briefly tested below in the Context of the Australian experience. A detailed consideration of the PE articles within Australia's 42 DTAs reveals that they have been heavily influenced by the OECD Model, particularly those which Australia has negotiated with other developed countries. Some key points to note include: All 42 DTAs incorporate the OECD clause whereby dependent agents who have the authority to conclude contracts will create aPE. • All 42 DTAs include the OECD clause under which the presence of a building or construction site may create a PE with the passing of time. Additionally, 20 of the 42 treaties so negotiated still prescribe the minimum period of 12 months as recommended by the OECD Model. ill Of the 42 DTAs, 36 have not sought to adopt the UN Model recommendation to extend the scope of the PE concept by treating an agent who acts wholly or almost wholly for one enterprise as a dependent agent. 1'/1 Of the 42 DTAs, 29 have not sought to adopt the UN Model recommendation to include the furnishing of services as constituting aPE. I\! Of the 42 DTAs, 32 have not sought to adopt the UN Model recommendation to amend the delivery clauses in the PE articles. III

However, it is also clear that, since its publication in 1980, the UN Model Convention has had significant influence on the PE articles negotiated by Australia, particularly on those concluded with developing countries. Some key points to note include: III

!III

III

D

11

Of the 42 Australian DTAs, 22 prescribe a shorter period of time for the minimum period before construction sites will constitute a PE, including all of the treaties that Australia has negotiated with low developing countries; although the bulk of these are with developing countries, there are still treaties which have been negotiated with developed countries which provide for a shorter period than recommended by the OECD Model. Without exception, all of Australia's 42 DTAs have explicitly included supervisory activities connected with building and construction sites as recommended by the UN Model. All but two of Australia's DTAs have also broadened the scope of the building site clause by including the broader UN definition allowing assembly projects to create a PE with the mere passing of time. Of the 42 DTAs, 40 have adopted the UN Model approach and removed the combination of activities exclusion which can be found in subparagraph 4(e) of the OECD Model. Although the furnishing of services and the amendment to the delivery

clusion were not as widespread, the increasing adoption of those clauses by low developing countries is particularly eVI'dem.

eX

Therefore, the widespread inclusion of UN Model clauses in each of Austra . , PE clauses does demonstrate that the impact of the UN Model on the PE jja ~ les of Australia's DTAs has been significant, particularly in considering artlC eaties AustralIa . has negotiate . d WIt . how i deveI ' countnes. . opmg t hose tr . These findings corroborate a paper prepared by the InternatlOnal Bureau of F cal Documentation for the United Nations in the late 1990s which examined ~: impact that the UN Model had on 811 international tax treaties concluded ~etween 1980 and 1997, including consideration of a number of the PE clauses . The study also concluded that the OECD Model would have to acknowledge the influence of the UN Model and adopt some of its recommendations. Although the OECD Model has made some changes to its own Model Convention and Commentary in recent years as a result of the UN Model influence, including some amendments to its commentary to Article 5, the recent release of the 2005 version of the OECD Model Convention with no change to the PE article itself suggests that no such explicit acknowledgment is likely to be forthcoming in respect of the PE concept in the near future. It is also evident that one of the critical factors that will affect the outcome of any future negotiations in concluding tax treaties is the stage of development of the other contracting states. It is to be expected that low developing countries will be increasingly more likely to seek to adopt the UN Model approach when negotiating tax treaties in the future, with the aim of maximising the benefits that will flow from the DTA for the developing country. 3.1.9

If there is a PE in the form of a branch, how are t he profits attributable to the PE calculate d?

The first point to note in this regard is that, certainly in Anglo-Saxon jurisprudence, an entity in the form of a company (or corporation) which has a branch in another country only constitutes one taxpayer. In other words, even though for accounting purposes a branch is often treated as a separate entity from the head office of the entity, in a legal sense, a branch and its head office are part and parcel of the one entity. It follows therefore that it is not possible for the head office and a branch to enter into a proper legal relationship for goods to be sold or money to be lent by the company to its branch, or patents or know-how to be licensed in some way by the company to its branch. It is axiomatic that the person cannot enter into contractual or other legal relations with itself. Notwithstanding that, DTAs generally contain the key central directive on which the allocation of profits of a PE is intended to be based. That directive is clearly to the effect that the profits to be attributed to a PE are those which that PE would have made if, instead of dealing with its head office, it had been

dealing with an entity entirely separate from the head office under conditions and prices prevailing in the ordinary market. Although this seems a simple application of good accounting practice, there are many problems that tlow from the idea that a branch is for this purpose to be treated as a separate legal entity. Even though there can be no transactions in a strict legal sense between head office and branch, it is nevertheless necessary to establish the costs to the branch of goods supplied to it by the head office of the enterprise in order to ascertain how much profit of the enterprise is attributable to the branch. The question here becomes whether, in referring to the profits of the PE of an enterprise, the DTAs are merely referring to the proportion of the overall profit made by the enterprise as a whole out of the relevant activities that should be attributed to the branch in question, or whether they are endeavouring to esta blish an independent profit for the branch, which profit will exist whether or not the activities concerned will overall have resulted in profits to the enterprise. The first approach (i.e. the overall profits approach) requires it to be established if the enterprise has made an overall profit out of the relevant activities (some of which have been carried out by the branch) before any profit can be attributed to the branch. By contrast, the second approach (i.e. the independent entity approach) enables the relevant revenue authority to levy tax on the profits of the branch notwithstanding that the enterprise has, overall, made a loss in respect of the relevant activities. To illustrate the distinction, assume the case of a company (China Inc.) which is a resident of China for the purposes of the ChinalFrance DTA. China Inc. manufactures computers which it sells worldwide. China Inc. sells its computers in France through a sales organisation made up of its own employees which operates from leased accommodation in France. The French sales organisation (i.e. the French branch) holds a stock of computers at all times and makes sales on the French retail market which it fulfils from the stock of computers held. Sales in France are always made for the best price that can be obtained on the market. Assume further that China Inc. is experiencing considerable difficulties with its manufacturing operations in China as a result of experimenting with fully automated production techniques, which have been found to be less than satisfactory. As a result, China Inc. 's manufacturing costs are much higher than the average across the industry and indeed are higher than the normal arm's length wholesale price for similar computers manufactured by other Chinese companies. Nevertheless China Inc. invoices the computers shipped to its French sales organisation. The invoice price is equal to the costs of manufacture to China Inc. plus an agreed 20 percent mark-up. The best price for which the computers can be sold on the French retail market is $95, which is less than the invoiced price of the computers to the French sa les organisation ($120) and less than the manufactured costs of the computers to China Inc. ($ 100). However, the price is above the wholesale price for which the French sales organisation might be expected to purchase the

'f I't were a distinctive and separate enterprise engaged in the same mputers I . . . . . cO "1 ctivities under the same Or slmJiar conditions and dealmg wholly or Simi ar a $ ' . . . . . I I . de endently with C.hina Inc. ( 90.). The dlstortlo.n m pncmg IS c ear y In Pd bv the difficulties Chma Inc. IS expenencmg 10 ItS productIOn tech" cause .'th the consequence t hat th e Frenchsai es organIsation cou Id have pur. . h l' h . . ruques, WI e product more cheaply troln an arm's lengt supp ler t an trom Its chase d th head office. '. . If the overall approach is ad?pted then, since no ?verall protlt has ansen to h terprise conducted by Chllla Inc. from the sale III France of the computers, ~h:re:will be no profit to be apportioned or allocated between the head office in China and the French sales organisation. . . On the other hand, if the independent entity approach IS adopted, t~e. POSItion would be quite different, since the arm's length whole.sale pnc.e ot Similar computers sold in the open market was less than the pnce obtam~d by the French sales organisation on the sale of the computers m the retaIl market. Thus, a profit on the sale was made by the French sales organisation, which profit would be attributable to that organisation (PE) and thus taxable In France. The fact that China Inc. experienced a loss overall on sale of the computers would be irrelevant. The preferred view is clearly the overall profits approach, at least where the analysis is based on the strict wording of the relevant DTA. More specifically, the China/France DTA stipulates that "if the enterprise carries on business in the other Contracting State through a PE situated therein, the profits of the enterprise may be taxed in the State of the PE". This clearly has a quantitative element embedded within it, namely that the profits attributable to the PE must at the same time be profits made by the enterprise. This understanding of the situation leads to the conclusion that, as a matter of principle, profits from intra-enterprise sales should not be attributed to a PE unless such sales also generate benefit for the enterprise as a whole. Or, to put it another way, the first and foremost guideline for a division of profits in accordance with Article 7 (of the OECD Model Convention) must be the principle that all that can be apportioned and attributed to the PE of a multi-national enterprise must come out of the "profits of the enterprise" as a whole. It is only within this framework that the arm's length principle may be applied. The aim of this principle is to ensure that the element of profits of a multi-national enterprise is attributed to its PE in a manner taking into account who generated the profits. Accordingly, Article 7 does not base the apportionment of the profits between head office and PE on an absolute, unrestricted arm's length principle. Attribu tions of profits under Article 7 can, consequently, be made under the arm's length rule only to the extent that this is compatible with the fact that the enterprise is one single legal and economic entity

(see Vogel para 68, p. 342) which must in that unified sense have an overall profit.

3.1.10

, len th price equal to an independent dealer's price and the resale by the ar!l1 s d in the source jurisdiction of the relevant goods to the customer m the , ' ' dee!l1 e ur junsdJCnon" ' SO cehi way in calculating the profit attributable to the sale of the goods m the s ' f h In t 'urisdictio n through the agent (the deemed PE 0 the company), t e mansource l'ng costs of the goods, any manufacturing profit and any selling profit ufacturl ' State would be exclude d . 'b table to activities in the other Contractmg attn u b ' ' ' 1 scertaining the expenses that may e ta k en mto account ' md etermmmg h n ;ofitS of the company one would only be concerned with expenses incurred ~ye ~e company and not wit~ expenses incurred by the dependent agent on the t'S own behalf in carrymg on Its busmess. The expenses of the company en of course, inc1u d e t h e comrrusSlOn ag " " agent m would, pal'd by t h at company to ItS

pi

If there is a PE in the form of an agency, how are the profits attributable to the PE calculated?

The previous question addressed the issue as to the potential attributio tpr~fIts t~ a PE where that PE is a branch of a parent company in nho JunsdlCtlon_ anot er part of entl-ty for all intents and purposes,ism h-Clearly h" a branch, b r the es p-e c t f w IC ,It IS a ranch_ In another words, a branch is merely a segment of all entlty_ an Over-

°

By w~y of contrast, where an agent is deemed under the terms of the DTA to be a PE m the other Contr,actmg State of an enterprise of the other Contractin Sta~e, the agent IS, for all mtents and purposes, a separate legal entity from th~ entity conductmg the enterpnse_ In particular, the agent will in these c' sta nc_es b~ con d ' t h e agent's own business with a view to profit. Ircumuctmg This will ?e the case whether the agent is an agent of dependent or independent,status, smce m legal t~rms eve~ an agent of a dependent status is a separate en~lt~, unless of course his work IS so intricately interwoven with that of the p~I,nClpal that the,agent in fact becomes an employee. Excluding that last possibility, an agent m all other circumstances (whether of an independe t dependent nature) will be treated as a separate entity from the princi;al respect of whom the agency IS operating. An ,agent (again wh~ther dependent or independent) would ordinarily be c~argmg a commiSSIOn m respect of the sale of the company's goods or the proVISIOns of the company's servICes. That commission would be the inflow which the agent would se,cure for the provision of his services and would be designed to meet the agent s own expenses m conducting that agency activity. These expenses would extend, for example, to salaries and wages which the agent would pay to ItS employees, rent, and other expenses associated with the conduct of the agency business. E,ve~ ~hough the agent is intending to operate the agency on a profitable basIs, It IS clear that none of the profits made by the agent in carrying on that busI~ess could be ~een as the profit of the company attributable to the company ~ deemed PE I,n t,he ,so,urce jurisdiction and therefore taxable to the company m the source Junsd,lctlOn. Rather, the idea that underpins the DTA in the context of an agency PE IS that ,:"e are seeking to tax profits arising to the company from the sale of the goods m the source jurisdiction. This is not the profits den:ed by the agent but rather the profits derived by the company th t seek mg t 0 tax. Th'IS WI'11'mc 1u d e an amount that is determined as the a we are selling profit whICh should be taxed ill the source J' uris diction . Of course , th e commis' _ _d h sIOn pa~ to t e, agent should b~ deducted from that profit so as to ascertain the net sellmg profit to be taxable m the source jurisdiction. Thus, in order to arrive at the relevant figure, one must treat a sale by the company, through an agent, to a customer m the source jurisdiction as if it h d been a sale by the company to its deemed PE in the source jurisdiction at :n

~~

the source jurisdiction. This approach has the advantage of producing much the same result whether the goods of the company are sold in the source jurisdiction through a branch organisation or a dependent agent contracting on behalf of the company. The above may well be illustrated by way of an example. A company which is a resident of the United Kingdom markets its goods in China through an agent that carries on its own business but has and habitually exercises in China an authority to conclude contracts for the sale of the company's goods on behalf of the company. The agent acts for no other principal, and it would seem that as a result the agent is an agent of dependent status and therefore is likely to constitute a deemed PE in China within the meaning of Article 5(5) of the China/UK DTA. However, although the agent is a dependent agent, it would still be carrying on its own agency business. The agent's business does not, it is submitted, necessarily become part of the business of the company merely because the agent is an agent of dependent status. If the UK company derived a profit in relation to the manufacture and ultimate sale of the product in China of $1M and paid the Chinese agent $100,000, the question is whether any of the $900,000 net profit is attributable to the PE. Of course, the fact that the Chinese agent has been paid $100,000 may well be the end of the matter, since this may represent an arm's length full consideration for the activities carried out in China and consequently China would have no additional claim in relation to any of the net profits. However, it may well be the case that the profits of the UK company that are derived from the activities in China are not adequately reflected in the commission paid to the Chinese agent, and some amount other than the $100,000 commission should be taxed in China. This would be determined by considering what would have been paid on an independent dealer basis to the deemed PE in China on an arm's length calculation. If this amount differs from the $100,000 amount, then that additional amount will need to be taxed in China as if it were the profit attributable to the PE. In other words, while the payment of a commission to the Chinese agency is

1\50

The allocation rules

Double Taxation Agreements

51

relevant, it is not conclusive in determining whether profits are attributable to the Chinese PE. This can only be determined by making a proper calculation on lenomenon known generally as economic doubl4.e taxation. T li could arise, for t11 example, where an enterprise of one Contracti nng State (Stat Al has its profits roJ"evised upwards as a result of the "associated entQerprises" artiJrand is therefore '.e liable for tax on an amount of profit that has anlready been med in the hands t of its Associated Enterprise in the other Contr ~acting State 6ute B). In such a la case, State B is in some DTAs required to maloce an appropLa:e adjustment so (0 a s to relieve that double taxation. This is usual lly provided rin a second pro vision in the "associated enterprises" article - - see for exarrrJe Article 9(2) dl o f the US/UK DTA, Article 9(3) of the AustraliaAIUK DTA an( icle 9(2) of the'le AustralialUS DTA.

53

of these sub-articles requires State B to make an appropriate adjustment Each t of the tax charged therein on those profits. In each case, the pro[ 0 the ~mounh effect that in determining the adjustment, due regard shall be , IS to t e , viSIon h ther provisions of each DTA and the competent authorities of the , necessary consu It eac h ot h er. ha d to teo ting States shall if tW~ ~~:tr~~ina!France, China/Germany and ChinaIUK DTAs, there is no , t procedure provided for. In such cases, the affected taxpayer may tmen ' Ie 25 0 f adJus d Iy upon the mutual agreement procedure (for examp I e Artlc nee to re k I' f . I ' . ' Agreement) to see re Ie 10 re ation to secunng an appropnate [he China!UK adjustment. ... . . . Even where an adjustment proVISiOn IS proVIded, the adJust~ent IS not.auto. nd will only be made if State B conSIders the ftgure of adjusted proftt cormatlC a " recdy reflects what the profits would have been If the transactiOn had been at arm's length. 3.2.3

W hat if there is inadequate information available to determine profits?

In some DTAs there is further provision (see for example Article 9(2) of the AustralialUK DTA and Article 9(3) of the AustraliaJUS DTA) which deals with a situation where inadequate information is available to the competent authority of the Contracting State to determine the profits accruing to an enterprise. In that situation, that Contracting State can apply its laws to determine the tax liability of the person concerned without being affected by the "associated enterprises" article, and that law shall be applied having regard to the information that is available consistently with the principles contained in the "associated enterprises" article. In the reconstructed AustralialUK DTA, the authors have included the "associated enterprises" article as an allocation article in its own right and have recast its structure and design more in accordance with the analysis provided above.

3.3

Active income: depe ndent personal services

3.3. 1

Background

Where a taxpayer derives income from personal services through employment, the domestic tax law of the jurisdiction where the services are performed will ~r~ally seek to impose tax. This will invariably be based on the premise that t e tncome generated from services is sourced where the services are performed. Where such personal services income is derived from services performed in o~e country by a person who is a resident of another country, double taxation o the personal services income could arise if the residence jurisdiction imposes ~ tax on worldwide income in respect of residents and the source jurisdiction IInpOses tax on the same income by reference to the source of the income.

54

Double Taxation Agreements The allocation rules

In order to avoid this double taxation, a number of possibilities arise: • The r~sidence country might unilaterally provide double tax relief, through a foreIgn tax credit mechamsm (e.g. United Kingdom); • The do.mestIC tax law of the residence jurisdiction could provide unilateral tax relIef by exempting certain types of foreign personal service income (e.g. Australian section 23AG ITAA 1936); • A double tax agreement may exist between the two Countries under which the Source ~ou~try is not permitted to tax the personal services income unless certaIll mIllImum requirements are met (e.g. USfUK DTA article)· or • There is a ~ouble tax agreement between the two Countries under which bot~ countr~es may tax but the residence country must give relief through a fOfelgn credIt tax mecharusm (e.g. Article 23 of the OECD Model DTA). 3.3.2

What is the allocation rule - DTAs?

The mechanism chosen under most model double taxation agreements is similar structure.

III

Under most model DTAs the residence country is given the sole right to tax unless the employment is exercised in the source country. However, thIS genera! rule is overrid?en by a subsequent provision which preserves the sole taxIllg nghts of the resIdence jurisdiction unless a certain minimum atta~hment to the source state prevails. Essentially, this is achieved by an artIcle whICh reads along the following lines: ':Notwithstanding ~he provisions of paragraph 1, remuneration derived by a resIdent of co.untry X III respect of an employment exercise in country Y shall be taxable only III country X if: a.

b. c.

The.recipient is present in country Y for a period or periods not exceedIllg III the aggregate 183 days in any 12-month period commencing or ending in the fiscal year concerned; and The remuneration is paid by, or on behalf of, an employer who is not a resIdent of country Y; and The remuneration is not borne by a permanent establishment ("PE") which the taxpayer has in Country Y."

It is worth noting in particular that these are cumulative conditions which must all be satisfied if the employee's personal services income is not to be taxed III country Y in the paragraph referred to above. 3.3.2.1

Paragraph a

In analysing the three con~itions referred to above, it is worth noting that paragraph a IS a purely objective test which hinges upon the length of presence in count~y Y. The terms of this paragraph require careful consideration. Sometimes It. refers to "any 12-month period", sometimes to a specific year of income - the dIfference can be critical.

3.3.2.2

55

Paragraph b

Paragraph b can be more problematic in practice since commonly the remuneration is paid in a formal sense by a local employer, and arguments will often be put that it was made on behalf of a non-resident employer so as to fall within the terms of the seco nd condition. The veracity of such claims will need to be tested more fully by an examination of the precise factual circumstances. In particular, if paid by a local employer, there will need to be tangible evidence that there has been an on-charging to the non-resident employer or a reimbursement of the expenses by the non-resident employer to the local employer. 3.3.2.3

Paragraph c

Paragraph c is also problematic in that, as drafted in the paragraph above, the question arises as to whether the remuneration is "not borne by a PE which the employer has in country Y'·. The exact meaning of "borne by" has been questioned, and differing views appear to exist. In Commissioner or Inland Revenue v. JFP Energy (1990) 12 NZTC 71 76, the New Zealand Court of Appeal held that, in order for a New Zealand PE to have borne the remuneration, it must have actually allocated the remuneration expense to the New Zealand PEin the books of account. It was not sufficient to interpret the concept "borne by" simply as "attributable to" the PE. The same approach has also been adopted by the Supreme Court of the Netherlands: December 9, 1998, No. 32700, bI999/267. That view has not received unanimous endorsement. In an article published in 2000, De Broe et al. argued that if "the salary cost is correctly attributable to the PE, we believe that the country where the PE is situated can impose tax on the salaries by virtue of (condition C) whether or not the salaries were actually charged to the PE ... and regardless of whether the PE chooses to claim the deduction to which it is entitled," see De Broe et al., "Interpretation of Article IS(2)(b) of the OECD Model Convention", 54 Bulletin for International Fiscal Documentation (10) October 2000,383,392-3. It would seem from a review of the provisions that De Broe et al. failed to recognise the words used in the relevant DTAs are "borne by" and not "attributable to". Each phrase has a quite different meaning from the other, and it does not seem unreasonable for courts in arriving at their conclusion to adopt the well-founded principle of statutory interpretation of placing the ordinary natural meaning upon words which are not otherwise statutorily defined. 3.3.3

How do the sample DTAs deal with these issues?

In the AustraliafUS DTA the equivalent provision is Article 15 and it is worth noting that the equivalent to condirion c discussed above says "the remuneration is

56

The allocation rules

Double Taxation Agreements

not deductible in determining taxable profits of a PE, a fixed base or a tradeable business which the employer or company has in that other state". The distinction between "not borne by" and "not deductible" should not be overlooked. The AustralialUS DTA sets a higher benchmark since it is conceivable that an amount would not be borne by a PE but could be deductible to it in a conceptual sense. This would apply even if it were not in actuality deducted in determining the taxable profits of the PE. In that situation, source country taxation is permissible under the AustralialUS DTA but not under the provision discussed above. In the AustralialUK DTA the broad equivalent article in this DTA is Article 14 and it is drafted in broadly similar terms to the AustralialUS DTA. In the UKlUSA DTA the equivalent article in this DTA is to be found in Article 14, and the relevant paragraph c says "the remuneration is not borne by a PE which the employer has in the other state".

personal services. Each DTA also defines "business" in the nlore expansive manner as in the OECD Model (see AustrahalUK DTA Article 3(1)(m) and UKIUSA DTA Article 3(1 )(d)) Thus in these DTAs such activities will be covered by the "business profits" article of the respective DTA (Article 7 in both cases). Interestingly, the AustralialUS DTA, which was negotiated and concluded after the change to the OECD Model Tax Convention, includes within its terms a specific independent personal services article in the form of Article 14. This article follows the conventional format whereby only the residence state can tax income that is derived by an individual from the performance of personal services in an independent capacity unless such services are performed in the other Contracting State and either: a)

b)

3.4

Active income: independent personal services

3.4.1

Background

Dependent personal services are usually distinguished in DTAs from independent personal services. The "independent personal services" article has been deleted from the OECD Model Convention as from 29 April 2000. The rationale for this deletion arose from a report entitled "Issues related to Article 14 of the OECD Model Tax Convention". The decision was based on the view tha t there were no intended differences between the concept of PE as used in the "business profits" article and fixed base as used in the "independent persona l services" article or between how profits were computed and tax was calculated according to which of the business profits or independent personal services articles applied. In addition, it was not always clear which activities would fa ll within the business profits article as opposed to the independent personal services article. In addition, in order to reflect this change, the definition of business in Article 3(1)(h) of the OECD Model Convention (i.e. the general definitions article) was amended to include "the performance of professional services and other activities of an independent character". Thus, the effect of the deletion of the "independent personal services" article is that, in such cases, income derived from professional services or other activities of an independent character is now dealt with under the "business profits" article. 3.4.2

How do t he sample DTAs deal with these issues?

Both the AustralialUK and the UKIUS DTA have adopted the OECD Model Tax Convention methodology, and they have no provision dealing with independent

57

the individual is present in that other State for a period or periods aggregating more than 183 days in the taxable year or year of income of that other State; or the individual has a fixed base regularly available to him in that other State for the purpose of performing his activities, in which case so much of the income as is attributable to that fixed base may be taxed in such other State.

It should be noted that the article only deals with individuals as opposed to companies or other artificial entities. The title to the article is "Independent Personal Services" but the actual text refers to "personal services in an independent capacity". Either way, it would seem that the type of services covered would be professional services or other activities of an independent character. Clearly this would not cover professional services which are performed in an employment capacity. For example, a physician working as an employee of a hospital would provide what one would view traditionally as professional services but, in view of the employment relationship, Article 15 dealing with dependent personal services is the more applicable provision. This also raises overlap issues as to the relationship between the "business profits" Article (Article 7) and the "independent personal services" Article (Article 14). It would seem that Article 14 would override Article 7, particularly having regard to the provision in Article 7( 6) to the effect where business profits include items of income which are dealt with separately in other articles of this convention, then the provisions of those articles shall not be affected by the provisions of this article. The concept of a "fixed base" has given rise to much debate in the past. Thus, for example, where a US resident being a professional person goes to Australia to perform certain professional work in an independent capacity, that person might rent a self-contained service apartment from which he or she regularly Works while in Australia. Whether it can be said that the person has a "fixed base regularly available to him in Australia" would depend on the circumstances. However, where the person only visited Australia on one occasion and only

58

Double Taxation Agreements

rented the apartment for the length of that stay, it would seem that there is unlikely to be a fixed base regularly availa ble even if the stay lasted for a considerable period of time, such as four months. It ~s worth noting i~ this context that where, for example, a US-resident person IS benefICially entitled to dividend interest or royalties having a source in Australia and that person performs professional services from a fixed base in Australia and the holding is in respect of which the dividend is paid, the indebted~ess III respect of which interest is paid or the property or right in respect of whICh the royalties are paid or credited, is effectively connected with the fixed base, Articles 10, 11 and 12 of the US/Australia DTA dealing with dividends interest or royalties respectively do not apply. In such a case Article 14 (inde~ pen~ent p~rson.al services~ (or Article 7, business profits) will apply to give Aus~ralIa taxlllg nghts. As It is Article 14 that is appropriate in view of the Illdependent personal services that are being performed and in relation to which there is a relevant connection, Australia will be entitled to tax so much of the income as is attributable to that fixed base without restrictions imposed by Articles 10, 11 and 12. These outcomes are dictated by Articles 10(5) 11(6) and 12(3) respectively. ' .With respect, ~t would seem that the OECD Model Convention approach of elImlllating the Ill~ependent personal services article and leaving the taxing nghts to be determilled solely by reference to the business profits article is eminently more practical and significantly less complicated.

3.S

Act ive income: fringe benefits

"Fringe benefits", generally speaking, refers to benefits, provided in the context of an employment relationship, that are provided otherwise than in cash. This would cover items such as cars used at least partially for private p urposes, low- or nO-lllterest loans and the like. Most countries that tax such "income" do so broadly on the basis that the cash equivalent or deemed cash equivalent amount is included as wages and taxed as such. Some of these countries often fail to capture the full value of the benefit, as it can be difficult to quantify precisely and apply ordinary income tax. However, where that process is followed, the international tax consequences are relatively straightforward, since the dependent personal services (I.e. employment) income allocation article should normally apply. The general effect Isthat, If the employee is a resident of one of the Contracting States and the servICes to whICh the benefit relates are performed in the other Contracting State, that latter state may tax the benefit unless: the employee is present in that other State for less than 183 days in any consecutive 12-month period; and • the remuneration derived by the employee is paid by a party who is not a resident of the Contracting State in which the services are performed; and

The allocation rules

59

the fee associated with the performance of the services is not deductible to a permanent estab lishment ("PE") of the payer of the fee in the Contracting State in which the services are performed. However, for some years a number of jurisdictions (most notably Australia and New Zealand) have applied a formalised fringe benefits tax (FBT) to the derivation of fringe benefits. Under this relatively unusual tax arrangement, the FBT is levied directly on the employer at a Hat rate broadly equal to the top marginal tax rate applicable in the relevant country. The benefit is then exempted in the hands of the employee. This process is somewhat counter-intuitive since the person who receives the benefit of the FBT, being the employee, is not the person who is being directly taxed in respect of the receipt. Nonetheless, this process has a huge administrative advantage at the domestic level since an employer with, say, 1,000 employees lodges only one FBT return. The responsible revenue authority would be required to deal with one return not 1,000 returns in respect of the FBT provided. Of course there may be cross-checking against other returns, but the primary information required is contained in one document alone . In the international context, dealing with fringe benefits through a separately articulated FBT raises multiple issues. This would cover, for example, certain jurisdictional issues such as: Does it matter if the employer or the employee or both are not resident in the jurisdiction? Is the only relevant consideration the fact that the services are performed in the local jurisdiction? Without answering these questions, the response has been to incorporate a special allocation rule in DTAs where countries that have adopted FBT in this manner are involved. Thus the AustralialUK DTA specifically provides in Article 15 that where. except for the application of this Article. a fringe benefit is taxable in both Contracting States. the benefit will be taxable only in the Contracting State which would have the primary taxing right over that benefit if the value of the benefit were paid to the employee as ordinary employment income

. Effectively this means that Australia can impose its FBT on benefits if AustralIa ha s t h · .. . respect 0 f the associated salary or wages. e pnmary taxlllg ng h ts III Under the terms of the DTA, Australia would have that primary taxing right if AustralIa has taxing rights under the DTA in respect of the remuneration for the relevant employment, and the United Kingdom is required under this DTA to allow relief for any taxes imposed in respect of sllch remuneration by Australia. Thus,1I1 a case where a UK resident performs services in Australia where the

60

The allocation rules

Double Taxation Agreements

person is in Australia for a period in excess of un days, Australia can tax the lI1come generated from the performa nce of those services under Article 14. Therefore for FBT purposes, under Article 15 Australia has the primary taxing right and is then entitled to tax fringe benefits connected with those services. In such a case the United Kingdom cannot tax those benefits either to the employer or to the employee. Australia's FBT has also been tackled in the DTA with New Zealand, but no other. Thus, with no FBT provision in the AustralialUS DTA, leaving it completely outside that agreement, FBT does not appear to be a tax covered by that DTA. Therefore a US resident deriving Australian-source fringe benefits may find himself subject to US income tax and his employer may be subject to Australian FBT without any relief for the resulting double taxation. This may be the outcome for aU DTAs between, on the one hand, countries that impose "employer level" FBT and, on the other hand, countries that impose "employee level" income tax on fringe benefits.

3.6

Passive income articles

3.6.1

What types of income are dealt with by the passive income articles?

The remaining "basket of income" articles immediately following the active income articles generally deal with specific types of passive income received by a taxpayer from a foreign source. These passive income articles generally deal with dividends, interest and royalty amounts that are received by a non-resident of a source country, and that are not effectively connected to a PE in the source country; annuities and pensions; and various types of income from the holding and alienation of real property. These are discussed further below.

3.6.2

Under what general circumstances are these articles relevant?

A recipient taxpayer will generaUy wish to access DTA relief contained within the passive income articles where dividends, royalties or interest have been paid to a non-resident of a source country; the domestic law of the source country imposes withholding taxes on payments of such passive income paid by a resident to a non-resident; and the income is not exempt or excluded from taxation in the hands of the

61

recipient taxpayer in the country of residence (e.g. the country of residence operates a worldwide jurisdictional nexus for residents, and no relevant exemption exists). Consequently, withholding taxes will have been suffered in the country of source, and the gross amount of the income will also be included in the assessable income of the taxpayer in the country of residence. This is an example of the incidence of international double taxation where the same income has been taxed twice in the hands of the same person: once by way of withholding taxes on a payment to a non-resident entity from an entity resident in the other country; and once on the worldwide basis of taxation in the country of residence.

3.6.3

Why do countries operate a system of withholding taxes on passive income?

Payments of passive income to non-residents often attract tax by deduction at source. The practical reason for this treatment is that, if coUection were effected on an assessment basis, the revenue authorities in the source country would be seeking to collect tax from a non-resident over whom the authority would have little or no effective coUection capability. For that reason the tax charged at source usually constitutes a payment of final tax paid in advance. Many DTAs were negotiated before the more sophisticated "exchange of information " and "assistance with collection" articles were anticipated and included in DTAs. These measures may now provide greater assistance to detect and collect unpaid taxes, but there is no doubt that a final withholding tax at source remains the most tax-efficient and effective way of imposing and collecting tax in circumstances where the recipient is non-resident. 3.6.4

Does the payment necessarily need to have a source in the country of source?

Not always, although the OEeD Model does, for example, anticipate that the lOterest article will apply only to interest arising in the country of residence of the paying entity. .Although non-residents generally are often taxed on a source basis, most Withholding tax regimes are not dependent on source, and a payment by a resident in the country where the payment originates to a non-resident may be a Sufficient requirement for the withholding tax rules to operate. For example, the withholding tax regime in Australia is not dependent on an ~ust~alian source, with some exceptions for royalties. Withholding tax must e .wIthheld merely where a resident makes a relevant payment to a nonreslde~t in circumstances where there are no applicable specific exceptions or exclUSions.

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Double Taxation Agreements

3.6.5

Do passive income articles generally allocate the taxing rights to one country?

~o.

Most bilaterally negotiated passive income articles generally adopt special DTA revenue-sharing rules as accepted by the OECD Model. That is, these passive income articles will generally • allow the country of residence taxing rights over the income; and limit or reduce the rates of withholding tax that would otherwise be imposed by the domestic laws of the source country.

These rules therefore generally still permit the country of source to impose withholding tax, albeit at a limited or reduced rate, on passive income paid to non-residents. The recipient will receive the passive income net of the tax withheld after applying the (potentially reduced) relevant DTA rate. These DTA rules do not prevent the country of residence also subjecting the gross amount of the income to taxation in the hands of the recipient, but may result in a lower incidence of international double taxation (before any other credit or exemption relief). Of course where withholding tax in the country where the payment originates is reduced to 0 percent, sole taxing rights are effectively conferred on the residence jurisdiction. This has become somewhat of a trend in recent times in relation to dividends paid by a DTA country company to a DTA partner company that owns 80 percent or more of the paying company. Some restrictions apply (for example, the recipient may be required to be owned predominantly by residents of the two DTA countries), but this is effectively a ceding of taxing rights to the residence country. 3.6.6

Can the articles apply even where there is no taxation in the country of residence?

Yes. The articles do not specifically require the country of residence actually to impose taxation on the income received. For example, under the Australian domestic taxing provisions, dividends received by companies in respect of a foreign shareholding of 10 percent or greater (non-portfolio dividends) are currently excluded from taxation in Australia. This, however, does not prevent the reduced DTA rate of withholding taX being applied by the country where the dividend originates, since DTAs are usually read as one with the domestic taxing laws of a country. This represents a case where there may be recourse to a DTA without the incidence of international double tax.

The allocation rules

3.6.7

63

What if there is no DTA in place between the country of source and the country of residence?

The withholding rates of tax in the domestic tax law of the country of source must be applied to the payment to the non-resident without restriction. 3.6.8

How is tax relief given for amounts still subject to international double taxation?

Where there is no DTA relief at all, or the reduced DTA withholding rate is greater than nil, an incidence of international double taxation remains. In such circumstances, the recipient taxpayer must rely on the "elimination of double taxation" article in the DTA, which generally requires the country of residence to provide a form of relief against international double taxation. The OECD Model DTA anticipates that the two countries involved will conduct bilateral negotiations to establish whether either a credit method or an exemption method is accepta ble or appropriate to provide international double tax relief. These DTA provisions are generally negotiated to be read in conjunction with the unilateral double taxation relief provisions (if any) that exist in the domestic tax law of the country of residence. As such, the DTA relief will generally allow access to the double tax relief anticipated within the domestic laws of the country of residence. 3.6.9

What if the DTA and domestic provisions of the country of residence do not provide for any method of unilateral double tax relief?

If there is no elimination of double taxation by way of a credit or exemption method, the taxpayer must resort to an application to the competent authority of the country of residence under the procedures available under the mutual agreement procedure article. 3.6.10

How does a credit method of unilateral double tax relief generally operate?

A cr~dit method of unilateral double tax relief generally allows a credit for the

for~ign withholding taxes paid in the source country against the tax paid in the

reSidence COuntry on the same amount of income. This form of credit relief is often restricted to the lower of the foreign tax paid Or the domestic tax attributable to the foreign income. For example, where the Withholding tax rate is 10 percent but the tax payable in the country of residence amounts to 8 percent, the foreign tax credit will be restricted to the lower amount with an "excess foreign tax credit" of 2 percent.

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Double Taxation Agreements

The domestic provisions of some countries may allow such "excess foreign tax credits" to be carried forward to set against future foreign income, but not all countries allow this. The provisions adopted by different countries may differ substantially. For example: • In the United Kingdom, foreign tax credits are generally available equal to the lower of the foreign tax paid and the UK tax attributable to the foreig n income. Excess foreign tax credits may be carried forward. In the case of dividends, where a taxpayer has a greater than 10 percent shareholding, foreign tax credit relief may also be available for the "underlying tax" paid on the profits out of which the dividends were paid. • In France, the application of credit relief will either be the adjustment of the effective rate of tax or the calculation of a tax credit amounting to the tax paid outside France. • In Australia, revised foreign tax offset rules took effect from July 1, 2008 and allow a foreign tax offset for foreign tax paid in an income year up to a certain limit. Excess foreign tax credits arising that are not used in the income year may no longer be carried forward. 3.6. 11

Can relief for underlying tax be available for royalty and interest payments?

No. Unlike dividends, interest and royalty payments do not suffer from economic double taxation. That is, they are not taxed in both the hands of the payer and in the hands of the recipient. It is only dividends which are paid from distributable profits upon which income tax or corporate tax has already been paid. 3.6. 12

How does an exemption method of unilateral double tax relief generally operate?

The exemption method, which is generally more unusual within DTAs, exempts the income from taxation in the country of residence. However the OECD Model does anticipate the country of residence taking into account the exempted amount for the purposes of calculating the tax payable on all other remaining income subject to tax in the country of residence - a concept known as "exemption with progression". 3.6.13

Under what sort of circumstances may DTA relief be unavailable?

The incidence of international double taxation may only be dealt with under a relevant DTA article where the following conditions are also satisfied:

The allocation rules

65

the source country and residence country have negotiated a relevant bilateral OTA which is in force at the time of the payment; the taxpayer IS covered by the DTA; and the tax is covered by the OTA. Where each of these conditions is satisfied, the taxpayer may generally apply the provisions of the relevant article (unless specific exclusions apply). 3.6.14

May there also be specific provisions within the articles precluding DTA relief?

Yes. There may also be specific provisions within the relevant DTA itself that limit or preclude the application of the DTA relief otherwise available. For example: The royalties article within the UK/France DTA contains an anti-abuse clause precluding the application of the other provisions of the article if the right or property giving rise to the royalties was not created for bona fide commercial reasons. The royalty and interest articles within the UK/Australia DTA preclude the application of the DTA benefits if the main purpose of the creation or assignment of the debt claim, or the rights on which the royalties are paid, was to take advantage of the articles. The interest and royalties articles within the UK/Australia and the US/ Australia DTAs contain clauses which restrict DTA relief where there is a "special relationship" between the payer and beneficial payee only to the amount that would be expected to be paid in the absence of the special relationship. Tlus type of provision is anticipated in Article 12(4} of the OECD Model Tax Convention. 3.6.15

How can all t hese steps be summarised?

The following steps summarise the approach to be adopted: Establish the application of the domestic laws of both countries to the amount of income received, without considering any modifications that the relevant DTA may apply (and determine the appropriate domestic rates of withholding tax of the country of source). • Establish whether a relevant bilateral DTA is in force between the country of Source and the country of residence, and if so: whether the DTA covers the tax; whether the DTA covers the recipient taxpayer (usually a resident of one country but not both); and under what article the income should properly be dealt with (discussed further below);

66

Double Taxation Agreements

The allocation rules

whether the relevant article or any other DTA provision Limits or excludes the application of the DTA relief. Apply the provisions of the article, with the passive income articles generally reducing the rate of withholding tax. Where still required, apply the DTA provision for the elimination of double tax in conjunction with the domestic unilateral foreign tax relief provisions of the country of residence (if any) to any remaining amount subject to international double taxation. Where double taxation has not been fully addressed by the application of DTA and unilateral double tax relief (if any), resort may need to be made to the mutual agreement procedure article.

3.6.18

What are the general rates

of withholding taxes?

The rates of withholding tax within the domestic taxing provisions of the country of source will differ. For example: • In the United Kingdom, a payee making a payment to a non-resident is obliged to withhold at the appropriate rate contained in the UK taxation laws, depending on the type of payment. Australia's income tax laws contain a specific withholding tax regime for payments to non-residents which subjects dividends and royalties to a withholding tax of 30 percent and interest to a withholding tax of 10 percent. Traditionally the reduced DTA rates are 15 percent for dividends and royalties and 10 percent for interest. However the DTA withholding rates are likely to differ between and within DTAs according to: \I

whether the payment is a dividend, interest or royalty as defined in the relevant DTA article; for interest, the type of security and the nature of the lender; and for dividends, the level of shareholding.

Specific examples of these passive articles, DTA rates and such variations are discussed further below. 3.6.17

Can related deductions be set against the passive income before applying the rate of domestic or DTA withholding tax?

No. Generally the rate of Withholding tax is set against the gross amount of passive income with no deduction for any related expenses.

What happens if the passive income could also be classified as a business profit?

A royalty receipt, for example, could properly be classed as either a royalty or a business profit. Although not specifically anticipated by the OECD Model Tax Convention, the business profits article of a DTA may contain a clause which gives priority to the passive income articles by stating that the provisions of those articles remain unaffected by the provisions of the business profits article (for example, Article 7(6) of the AustraliaIUK DTA). 3.6.19

3.6. 16

67

What if the passive income is «effectively connected to a PE.'?

Notwithstanding the priority clause above, where the amount of passive income is "effectively connected with a PE" in the source country, the passive income article will generally state that the income is to be properly dealt with under the business profits article. Consequently the amounts will not be subject to withholding taxes but taxable in the country of source free of limitation, often on a net income assessment basis, and the beneficial DTA withholding tax rates will not apply. So, in practical terms, the business profits article may direct the taxpayer to the more specific passive income article in priority. However the passive income articles and revenue-sharing rules will not apply if the income that would otherwise be classed as passive income is "effectively connected" to a PE in the source country. 3.6.20

What does «effectively connected to a PE." really mean?

What is meant by "effectively connected" is not defined in a DTA or in the OECD Model Convention commentary. As guidance, the US domestic rules for the taxation of foreign income, which make use of an "effectively connected" test for US source income, employ: an "asset-use test" where the criterion is whether the income is derived from assets used in, or held for use in, the conduct of a trade or business in the United States; and • a "business activities test" where the criterion is whether the activities of the US trade or business are a material factor in the realisation of the income. 3.6.21

Are there any other DTA circumstances in which the concept of «effectively connected" is relevant?

Yes. The concept of "effectively connected" may also be relevant in establishing

68

Double Taxation Agreements

whether certain amounts of income are effectively connected to a fixed base of an individual performing independent personal services. As such, it may be taxed by the country of source on a net basis as income from the performance of such services. 3.6.22

Are there any situations where it would be more beneficial for passive income to be "effectively connected" to aPE?

Yes. Where there are significant deductions connected to the derivation of the passive income which can be set against the passive income before applying the rate of business taxation, the incidence of tax may be less if the income is treated as effectively connected income. Even though lower DTA rates of withholding tax are applied against gross passive income, as there is no ability to deduct expenses when withholding tax is imposed, the effectively connected rule may be preferable for tax purposes. For example, suppose a non-resident derived a gross amount of income of $100,000 and associated deductions of $70,000. The rate of withholding in the source country is 30 percent reduced to 15 percent by the relevant DTA. T he rate of business taxation in the source country is 30 percent. Under a withholding tax regime, the final tax assessable would be $15,000 (reduced from $30,000). Alternatively, if the income was effectively connected to a PE, the tax assessable would be $9,000. 3.6.23

What is the general tax treatment fo r dividends not effectively connected to a PE?

Traditionally the typical DTA withholding tax rate for dividends has been 15 percent. However, a recent trend towards the negotiation of lesser rates is apparent and been embraced by the United Kingdom, the United States and Australia. These include: a zero rate of dividend withholding tax applicable where the recipient is a company that holds directly at least 80 percent of voting power in the paying company; and a 5 percent rate applicable where there is control of at least 10 percent in voting power. The detailed provisions of each bilateral DTA must be carefully perused to establish the correct treatment. A general source rule may apply such that dividends are deemed to have a source in the country of residence of the paying entity in circumstances where a right to tax is given both to the country of residence of the person who beneficially derives the dividends and the country of residence of the paying entity.

The allocation rules

3.6.24

69

How is interest generally treated when not effectively connected to aPE?

The majority of bilaterally negotiated DTAs set the rate of interest withholding taX at 10 percent. However, a number of interest w ithholding exemptions may also exist in the domestic law of the country of source, or otherwise within each bilaterally negotiated DTA. Notable exceptions within many modern DTAs are that tax is often not chargeable on interest derived by a government body of the other country, or an unrelated financial institution resident in the other country. Many modern DTAs will also include an anti-avoidance provision targeted at arrangements involving back-to-back loans to take advantage of the above exceptions. Again, a general source rule may apply, such that interest will be deemed to have a source in the country of residence of the paying entity in circumstances where a right to tax is given both to the country of residence of the person who beneficially derives the interest and th e country of residence of the paying entity. 3.6.25

What if a DTA states a rate of interest withholding tax higher than the domestic rate of the source country?

The rate of withholding tax cannot be greater than that specified under the domestic law. Thus the domestic law rate would apply in such a case. A DTA can only moderate or allocate taxing rights, and cannot impose a higher rate of taxation (see however the general discussion on this point in section 1.1.12). 3.6.26

What if the domestic provisions of the country of origin of the payment treat an amount of interest as a distribution?

There may be provisions within the domestic laws of a country under which the payment of an amount that would otherwise be treated as interest is reclassified as a distribution. Examples include the United Kingdom, Australia, France and Canada. Under many DTA articles, such amounts may be excluded from being dealt with under the interest article by virtue of being treated as a dividend in the domestic laws of the DTA country in which the payment originates. In such circumstances the payment would be properly dealt with under the dividend article of the applicable DTA. The definitions of interest and dividends and the provisions of each interest and dividends article in the relevant DTA must be carefully traced to ensure that the correct provisions are applied.

The allocation rules 70

71

Double Taxation Agreements

Interestingly, the ~rance .DTA interest article provides an override of any domestic reclasSIfIcation pr~vlSlon. This provision, however, does not apply where there IS a dIrect or llldirect holding of more than 50 percent of the vot" power. mg 3.6.27

What amounts are royalties for the purposes of a DTA?

It is critical to ensure when dealing with royalties that the amount is in fact a royalty for the purposes of the relevant DTA. Many countries reserve the right to amend the definition of royalty to include certalll . payments or c~edits .th~t are treated either as royalties under their domestic laws (Austraha) or m ItS conventional definitions (Spain). As suc~, the conc~pt of a "royalty" is specifically defined in each DTA. Royalties, as speCIftcally defined in each DTA must then be dealt 'th d h 'f ' I. , W I un er t e speCI IC roy a tIes articl~ of the DTA unless they are effectively connected to a PE, and therefore dealt with under the business profits article.

3.6.28

How are royalties treated when not effectively connected to a Pf.?

Although the curren~ OECD Model recor.nmends that royalties be taxable only m the .country of re~ldence, .many countnes reserve the right to tax all or some royalties at source m the bIlateral DTAs they negotiate, resulting in the DTA revenue-shanng method discussed above. . For example, Australia rese~ves the ri~ht to tax all royalties at source (includI?g amounts treated ~s royalties under ItS domestic laws). Turkey reserves the n~ht to tax at source mcome from the leasing of industrial, commercial or scientifIc eqUIpment. Whe~e . the roy~lties article does apply to a particular payment and there are no speCIfIC excluslOns, th.e reduced DTA rate of withholding tax is normally 15 percent or 10 percent, WIth some exceptions. The recently revised US/Australia and UKlAustralia DTAs have further reduced the DTA rate for royalties to 5 percent. . The UKIFrance DTA has no provision for royalty withholding tax, since there IS no ~xposure to French mcome tax for non-resident individuals in receipt of royalties. 3.6.29

Does the recipient of passive income subject to withholding tax need to pay addit ional tax?

Generally not. Withholding taxes, both domestic and DTA, in the majority of cases con~tlt~te a fmal tax such that, provided the non-resident in receipt of such paSSIve lllcom~ has no other lllcome derived in the country of source, there IS no need to subrrnt a tax return or pay additional tax.

3.6.30

Can a taxpayer be indemnified against the imposition of foreign withholding taxes?

Yes. It is possible for a clause to be included in an interest or royalty contract such that the payer will indemnify the non-resident recipient against foreign withholding taxes such that they will receive a net amount equal to the gross amo unt intended. This can be achieved either by the payer repaying an amount equal to the withholding tax to the recipient, or the payer paying the withholding tax itself. 3.6.31

Does withholding tax need to be withheld from the indemnification amounts themselves?

The treatment of these additional payments for tax purposes will depend on the type of passive income in question and how this income is defined within the domestic taxing law of the source country. If the indemnification amount in question is itself considered to be an amount paid in the nature of interest or royalty then it must be subjected to the appropriate withholding tax treatment. For example, in Australia, the payment of an amount to indemnify an amount of interest withholding tax was held not to be an amount in the nature of interest as defined under the Australian income tax law. In contrast, the view of the Australian competent authority is that similar royalty indemnification payments are royalties as defined within the domestic law, and therefore the royalty withholding tax rules would apply to the additional payment. 3.6.32

What is the difference between an escalation clause and an indemnification clause?

In practice, great care must be taken to distinguish between the following types of clauses: • Indemnification clauses - these types of clauses include the agreement of the payer to meet the withholding tax costs by repayment or self-payment. The indemnification payment itself must be separately identified and treated correctly for tax purposes. • Escalation clauses - these types of clauses merely increase the amount payable to the recipient to recompense or account for the withholding taxes. The relevant rate of withholding taxes must be applied to the full amount. 3.6.33

How will an indemnification amount be assessed in the hands of the recipient?

The assessability of the indemnity payment in the country of residence may depend on the business of the payer and whether a DTA covers the arrangement.

72

The allocation rules

Double Taxation A greements

Where a DTA is not in place, the taxing righ ts of the country of residence will depend on the nature and source of the payment. W here a DTA does cover the arrangement, the taxation of the amount will depend on whether the amount falls into the business profits, interest, royalty or "other income" article.

73

. d f om the ownership of such property, not any proceeds from sale, the , ' Ies d'ISdenve rwhich are dealt with under the "alIenation . . 0 f property , artlc . gaInS on ssed further below. . ell Under the OECD Model, the right of the cou.rmy of source to tax the mcome o rlOty over the nght of the country of reSIdence, because of the close ecohas pno nomic connection. However, the commentary also stat~s thaot thIS does not prejudge the applIcao f the domestic laws to the taxatIOn nghts of the rental mcome. It IS very ' were h [lon rk I 0 that international double taxation wIIIanse a res I°d ent 0 f a country ley d on a worldwide basis and derives foreign-sourced renta l mcome. IS taxe I h' 1 to d bl Consequently the taxpayer will need to re ~ on t e '0 e Iml~atlOn 0 ou e Oon" articles and unilateral double tax relief proVISIOns (If any) to address t mUI incidence of international double taxation. anY I h h It is notable that France also reserves the right to app y t ese provlslOn~ to t e taxation of shares and rights, which are treated by its domestic laws as mcome from immoveable property. 0

0

3.6.34

How are annuities and pensions generally dealt with under a double tax treaty?

Most treaties have special provisions providing for the taxation of annuities and pensions. As recommended by the OECD Model, annuities and pensions are taxable only in the country in which the recipient is resident, notwithstanding the fact that the conventional source r ules may well deem the income to have had a source in the country in which the recipient is not resident. Examples of exceptions to this genera l rule include: Government pensions paid to citizens of the country of source are exempt from tax in the country of residence under the US/Australia DTA. The Canada/Australia DTA provides for a limited withholding tax on pensions paid. 3.6.35

How is income derived from real property categorised for DTA purposes?

T here are different types of income that can be derived from real property and each may need to be considered under the following categories: • income from real or immoveable property (rental income); • capital gains (on alienation of real property); indirect alienation of real property. Different DTA articles may apply, and care must be taken to esta blish w hether a specific DTA article is dealing only with real property or whether it is dea ling with "property". Certain articles and paragraphs may specifically deal with real property, whereas others may deal with a wider concept of property.

0

0

0

0

0

0

0

0

0

3.6.37

0

When will an "alienation of property" article be relevant?

The taxation of capital gains or income arising on the alienation (disposal or sale) of property may differ substantially from country to country. For example: • Some countries assess capital gains realised by an enterprise but not by an individual. • Some countries impose a separate capital gains tax or impose a separate rate of taxation, whi le others merely add any realised capital gains to other sources of income . • Some countries (for example, New Zealand, Hong Kong and Singapore) have not to date introduced a capital gains regime at all, and capital gains escape the charge to tax. Whether or not there has been a taxable realisation should be determined under the domestic taxing rules of each country and, again, problems only arise when both the country of residence and the country of source seek to tax the gains arising, either as ordinary income or as a capital gain. Depending on the operation of the domestic laws of both the country of resIdence and the country of source, international double taxation is most likely to arise where 0

3.6.36

How is rental income derived from reol property dealt with under a DTA?

Article 6 of the OECD Model Tax Convention deals with the situation where a resident of one country derives rental income from real property or immoveable property in another country. Real property may be defined according to the domestic laws in which the property is situated and may be further specified in the wording of the article itself. It is critical to note that this article deals only with the revenue streams

• a resident of one country has been taxed on their worldwide capital gains in the country of residence; and • the country of source does seek to tax a capital gain on the sale of the property situated in that country.

74

Double Taxation Agreements

Whether the relevant OTA will moderate either of these taxing rights will depend on • whether the income or gain falls to be dealt with under the business profits article or the "alienation of property" article of the specific OTA; • if relevant, whether there is a comprehensive "alienation of real property" article; and • how the provisions in the relevant article have been negotiated bilaterally. 3.6.38

What if a capital gain also falls within the business profits article?

Where the capital gain is part of the taxable income of a business or businesslike activity or enterprise, it may fall within the business profits article rather than the alienation of property article. As with ordinary income, if there is no PE in the source country, the source country will be precluded from taxing the capita l gain. An important Australian tax case, Thiel v. FeT (1990) 21 ATR 531, involved a Swiss resident who derived a profit subject to international double taxation from an isolated transaction and was held to be undertaking activities that were in the nature of trade. It was agreed that the Swiss resident did not have a PE in Australia. The Australian High Court held that the activities constituted an enterprise and were an "enterprise of one of the Contracting States" for the purposes of the relevant business profits article. The protection of the business profits article was thus available to the taxpayer and the relevant activities were not subject to Australian tax. The court held that, for the purpose of the Australia/Switzerland OTA, the term "enterprise" may cover both an activity itself and the means by which or framework within which an activity is engaged. The court noted that, having regard to the nature of the taxpayer's activity, it would have been inappropriate to regard his gain as being by way of income from the alienation of capital assets within the meaning of the OTA. 3.6.39

Can an "alienation of real proper't"f' article override t he business profits article?

Yes. The "alienation of real property" articles in some OTAs may include a "sweep-up" provision, which suggests an intention by the parties to the OTA to eliminate the applicability of the business profits article and deny source country taxation where the relevant capital gain is not covered by the other provisions of the "alienation of real property" article itself. Some recently negotiated OTAs and explanatory materials specifically state

The allocation rules

75

that such gains falling within the "alienation of property" article are not affected by the business profits article. 3.6.40

How does an "alienation of property" article generally operate?

The wording of the OECO Model Tax Convention "alienation of property" article is wide enough to ensure that the article may apply to all kinds of taxes levied by a country on capital gains, regardless of how they are taxed under the domestic rules. The article does not seek to determine how such gains should be taxed by a countrv nor give any right to tax capital gains if such a right does not exist in its domestic law. A comprehensive "alienation of property" article, in line with the OECO Model Tax Convention article, may generally allow the country of origin the right to tax gains derived from the alienation of real or immoveable property located in that country; the alienation of property or moveable property used in a PE in that country; the alienation of shares where more than 50 percent of their value directly or indirectly is derived from immoveable property in that country. There may also be special rules dictating how the alienation of ships and aircraft is dealt with. 3.6.41

When mayan "alienation of property" article not be relevant?

Where the country which generally has a right to tax does not exercise that right, no incidence of international double taxation arises. For example, Australia has a CGT participation exemption rule exempting capital gains arising on the disposal of a greater than 10 percent shareholding in a company which carries on an active foreign business. 3.6.42

When may there not be a comprehensive "alienation of property" article?

When considering the application of any OTA to a capital gain, the "taxes covered" article must be carefully reviewed to establish whether the tax is in fact covered by the OTA. Where a OTA pre-dates the introduction of a capital gains tax regime, the issue may not be dealt with under the OTA. For example, a capital gains tax regime was only introduced in Australia in 1985, so the many Australian bilateral OTAs that pre-date the introduction of this regime generally do not make special provision for capital gains. However, a number do contain limited articles dealing with gains from the

76

The allocation rules

Double Taxation Agreements

alienation of real property and interests in land-owning companies. It is still a controversial issue whether Australia's taxing rights over capital gains can be precluded by the application of some DTAs. 3.6.43

When is the concept of "indirect alienation of property" relevant?

As indicated above, the OECD Model and many treaties in practice incl ude the words "directly or indirectly" to capture the effective disposal of real property situated in the country of source through, for example, a chain of companIes. An example of the importance of this wording was demonstrated in the Australian tax case FCT v. Lamesa Holdings BV (1997) 36 ATR 589 (see section 9.1. 1). A Netherlands company held an Australian subsidiary which was the parent of another Australian company which, in turn, held a 100 percent interest in an Australian-listed mining company. The Netherlands company sold its shares in the Australian holding company, generating a taxable gain in Australia. Initially, the Australian Commissioner of Taxation sought to argue that the relevant alienation of property article did not preclude Australia's taxing rights. However the Australian Full Federal Court held that the "alienation of property" article of the AustralialNetherlands agreement did not apply because it did not permit Australia to tax profits realised indirectly through a share sale. Consequently, the Netherlands had the exclusive right to tax the profits. Australia has subsequently enacted a domestic override to ensure tha t, as from April 27, 1998, profits arising from the indirect alienation of real property situated in Australia by a non-resident are subject to tax in Australia, and now includes an "indirect alienation of property" article that seeks to counter that decision in its new DTAs. 3.6.44

Do withholding taxes apply to capital gains realised by non-residents?

No. The concept of withholding taxes on capital gains realised by non-residents has been raised by a number of competent authorities, but has not yet been implemented by any jurisdiction. Currently the transactional requirements and documentation associated with real property dealings should allow a competent authority to date-match transactions effectively to assist in the assessment and collection of taxes from non-residents. 3.6.45

Do DTAs deal with tax or capital losses?

No. Where a tax loss is in point, or a capital loss has resulted from the alienation

77

of property, there is no incidence of international double taxation and therefore no need to access the relief afforded by a DTA.

3.7

"Nature of the taxpayer" articles

3.7.1

Might a taxpayer fall into a special category depending on their occupation?

Yes. There are a number of occupation categories which may be dealt with separately and provide exceptions to the other articles. Under the OECD Model, these include directors, artistes and sportsmen, government service employees, and • students. Other double tax agreements may also set out specific treatment for professors and teachers. 3.7.2

What if a particular DTA does not deal with the specific occupation or category?

The taxpayer will need to resort to the following articles, depending on the structure and content of each particular DTA: dependent personal services (Article 15 of the OECD Model); • independent personal services (former Article 14 of the OECD Model) or business profits article (Article 7 of the OECD Model); • income from employment (for example, Article 14 of the UK!Australia DTA). 3.7.3

How are directors' fees generally treated by relevant double tax agreements?

The OECD Model provides that where directors' fees and other similar payments are paid to a director of a company, the services are treated as being performed in the country where the company is resident. 3.7.4

How are artistes or sportsmen treated by countries where they perform or tour?

Clearly the source of the income of public entertainers and sportsmen is the ?lace where the activities take place, irrespective of the short period of time tnvolved in carrying out those activities.

The allocation rules 78

79

Double Taxation Agreements

The OECD Model therefore provides that, as an exception to the general rules in the articles covering business profits and independent personal serv ices, artistes and sportsmen may be taxed in the country of source on income of a business or employment nature. Some DTAs (for example, the AustraliafUK DTA Article 16(2)) have a furthe r provision which may tax enterprises that provide the services of an entertainer and to which the income accrues. The United States has reserved the right to limit the taxing rights of the country of source to situations where the taxpayer earns a specified amount. 3.7.5

How are government service employees treated?

The OECD Model generally provides that the paying country or state retains the exclusive right to taxation which is in conformity with accepted international courtesy and the appropriate provisions of the Vienna Convention. Some DTAs will exclude the payment of pensions or annuities from these prOVISiOns.

of the person's teaching and would exclude, for example, any remuneration from publication.

3.8

"O ther income" article

3.8. 1

What amo unts of income fall into the "other income" article?

The "other income" article applies specifically to items of incomed"n°lt dife~lt . " The OECD Mo el car Ies with in the foregoing articles 0 f t h e C onventIon. that the income concerned is both income of a class not expressly dealt with under another article, and income from sources not expressly mentioned. That is, if an amount of income has fallen to be conside~ed under ~nother Jrticle and the provisions of that article have been appropnately appbed, the. "other income" article should never be considered for that particular amount ot income.

3.7.6

How are students generally treated by the relevant double tax agreements?

The OECD Model provides for an exemption in the country of residence of income derived by a student who is temporarily present in the resident country solely for the purpose of her or his education, and who was a resident in the other country to the relevant agreement immediately beforehand. The exemption is restricted to income paid for the purposes of the student's maintenance or education, and the payment must originate from sources o utside the country in which the student is temporarily resident. The exemption does not therefore extend to income derived from sources in the country, including remuneration fro m work experience; income that is unrelated to the student's maintenance or education; or income that exceeds the level of expenses likely to be incurred to ensure the recipient's maintenance, education or training. 3.7. 7

Where present, how do professor and teacher articles generally operate?

DTAs may include an article dealing with professors and teachers - many treaties negotiated with Australia exempt professors and teachers from taxation in the host country if they are present for a period of less than two years and are taxable in the home country. The exemptions generally relate only to the remuneration received in respect

What ;s meant by the phrase "not dealt with"?

3.8.2

For example, if an item of income is classified as a business profit, then the.way in which that business profit is derived will determI.ne whether ~he b~sI~es~ profits article will apply to give rise to a liability to tax m the source JUrIsdIctIon.

If there is a permanent establishment, then t~e .bu~i~ess profits article would ordinarily permit taxation in the source JUrIsdICtIon. . . . . If however there is no permanent establishment m the source Junsd~ctIon, tl~e amoun; will not be subject to tax in the source country. In such Clrcum. proper ly be said that the income has been dealt WIth under the stances, can It business profits article? It is evident that absurd results would arise if thi.s was n,?t t~e case, but i.t is not entirely clear from the phrase used in the "ot~er mcom~ artIcle. In practIc~, it is accepted that if an amount is classed as a busmess p~of1t but there IS. nO PE;:e the source jurisdiction that income has been dealt With and accorddm gly th . deme . d taxmg . ng . h ts. R ecourse cannot then be rna e to t e source country IS "other income" article. 3.8.3

How does the "other income" article allocate the taxing rights?

\formallv the "other income" article allocates the right to tax amounts falling . . under th~ "other income" article to the country of residence. This is consistent with the policy of the OECD Model Convention, which

80

Double Taxation Agreements

favours the country of residence rather than the country of source (unless the lIlcome is derived by way of a PE in the country of source ). Ilowever some countries, for example, Portugal, Australia, Canada and Slovakia, reserve their position in this regard and maintain the right to tax such income where it is derived from sources in their own country. Additionally, Ireland and the United Kingdom both maintain the right to tax income paid by their residents to non-residents in the form of income from a trust or from estates of deceased persons in the course of administration. Once again, as a result of these constructs there will be a likelihood of international double taxation. Such income will be taxed by both the country of residence and the country of source. Again such international double taxation will have to be dealt with under the "elimination of double taxation" article and unilateral double tax provisions contained within the domestic laws of the country of residence (if any). 3.8.4

What if there is no "other income" article?

If an amount of income has not been dealt with under a particular "basket of income" article and the DTA in question does not contain an "other income" article, then the DTA cannot apply to that income amount to allocate or moderate the taxation rights of either country. As in the case where a source country reserves its right to taxation, the taxpayer must resort to the "elimination of double taxation" article and the unilateral domestic provisions of the country of residence to seek relief for any incidence of international double taxation.

4

Restrictions on the availability of DTA benefits

4.1

What is treaty shopping?

An increasingly important issue in the sphere of DTAs is the practice of "tr~aty shopping". In broad terms, the activity involve~ ~eeking out the most benefIcIal provisions of DTAs and conspicuously explOltmg the~ . The most common form of treaty shopping involves the use of DTA prOVISIons by reSIdents. of a third country, whereas the intention of the parties was to limit treaty benefitS to genuine residents of their respective countries. . Here is a simple illustration of how DTAs could be used to achIeve a reduction in tax. The hypothetical case involves Andrew, who is a resident of Country X. Andrew owns industrial property, being a patent, which he WIshes to license to IP Development Co., a company which conducts a business in Country Y. The return to Andrew will be in the form of royalties per unit sold by IP Development Co. There is no DTA between Countries X and Y, so ordinarily Andrew would not be entitled to a reduced rate of withholding tax ordinarily imposed on the outgoing royalties by Country Y. . Andrew could, however, arrange for the incorporation of a company which he controls in, say, the Netherlands to hold the patent and that Netherlands company could then sublicense to IP Development Co .. The newly mcorporated entity would be a resident of the Netherlands. There is a DTA between Country X and the Netherlands and Country Y and the Netherlands. Royalties flowing to the Netherlands from Country Y would be entitled to the benefit of the royalties article of the Netherlands/Country Y DTA, which provides for a maximum rate of 5 percent on the gross royalty imposed by Y. It may then be arranged that the Netherlands company would pay a royalty to the resident of Country X under a head licence arrangement. Only a small profit would be retained in the Netherlands company which would be exposed to Netherlands taxation. In order for this arrangement to work, the DTA between the Netherlands and COuntry X would be similarly utilised to limit Netherlands withholding tax to a low rate such as 5 percent.

82

Double Taxation Agreements

The difference between the arrangement described in the preceding paragraphs and what would have happened in the absence of such treaty shopping arrangements would be that Andrew (a resident of Country X) would license IP Development Co. directly to Country Y, and any royalties flowing to Country X would be taxed at the domestic withholding tax rate imposed by Country Y, which might be as high as 30 percent (in the absence of an applicable DTA).

4.2

How can treaty shopping be prevented?

Tax authorities throughout the world have been focusing on issues related to treaty shopping for over 50 years, with mixed success. The key initiatives that have occupied the minds of administrators have focused essentially on one of four approaches: the insertion of a beneficial ownership requirement in the dividends, interest and royalties articles of DTAs; • the insertion of a comprehensive "limitation on benefits" article in DTAs; • the insertion of a more limited treaty shopping provision, dealing only with dividend interest and royalty treaty benefits and focusing on the purpose of the relevant taxpayer or taxpayers; the insertion of anti-conduit provisions in DTAs.

4.3

How effectively has the concept of beneficial ownership been used to prevent the practice of treaty shopping?

Some attempt to prevent the most blatant abuse of DTA provisions by residents of third countries can be found in the provisions which limit a treaty benefit in respect of certain classes of income to cases where the income is beneficially owned by the resident of the other Contracting State. This applies, for example, in DTA provisions dealing with dividends, interest and royalties. This technique could arguably prevent the use of trustees, agents, nominees or other similar entities in attempts to gain treaty benefits. Although the beneficial ownership concept was introduced into DTAs largely as a mechanism to deal with anti-treaty abuse, there are no relevant references in the dividend, interest and royalties articles to the purpose or the motivation of the taxpayer or taxpayers concerned. Thus, it could be said that there is some disconnect between the purpose of the introduction of the beneficial ownership requirement and the way in which it must be dealt with in practice. In practice, the question of who is the beneficial owner of the underlying asset is a matter of legal interpretation and not a question of subjective or even objective purpose of the relevant taxpayer. The problem with the concept of beneficial ownership is that the concept has its origins in common-law jurisdictions (in particular, the United Kingdom),

Availability of DTA benefits

83

hich has for centuries distinguished between the rights held in the same prop:rty by different persons. Thus, a distinction has traditionall~ been drawn between a legal owner and a benefICial owner of the one asset, With the beneficial owner having the ultimate right or entitlement t~ the property and the legal owner only being the legal holder of property, effectively for documenta~y puroses. The beneficial owner has always been regarded as the person With the ~reatest ownership characteristi~s and it is that person who has the relevant rights to the income and ~he capI~al ?f ~h~ assets. The difficulty is that cIvil law JunsdlctlOns such as France generally do not make this distinction of ownership in the same manner. The problem comes into sharpest relief when dealing with a DTA betwe~n, on the one hand, a common-law jurisdiction, and on the other hand, a CiVil ~aw ·urisdiction. W here this occurs, the difficulty is that one jurisdiction recogmses ~he ownership distinction between legal and beneficial ownership and the other does not. This critical issue can arise in a number of situations. A good example arises as follows: 1.

2. 3.

4.

5. 6. 7.

Dividends flow from Country B Co. to Country A Co. in circumstances where there is no DT A between Country A and B. The level of withholding tax imposed in Country B in the absence of the DTA is 30 percent. There is a DT A between Country B and Country X and a DTA between Country X and Country A. Under both DT As the maximum level of withholding tax that can be imposed by Country B is 0 percent. The domestic laws of Country X and Country A do not tax the receipt of foreign dividends, and there is no withholding tax on the payment of dividends to other non-residents. The parties interpose a company resident in Country X (Country X Co.) to which Country A Co. transfers its shareholding in Country B Co. The net consequence is reduction of withholding tax on the payment from Country B Co. to Country X Co. from 30 percent to 0 percent. Further , there is no tax in Country X on the receipt, no withholding. tax in Country X on the payment and no tax in Country A on the receipt.

If that is the right outcome, a reduction in withholding tax from 30 percent to

o percent has been achieved without any additional costs. This is precisely the type of transaction which will need to be examined in the cold hard light of the beneficial ownership test, and the outcome is not always clear or consistent. The beneficial ownership issue turns on whether Country X Co. as an intermediary is the beneficial owner of the dividends which it receives from Country Y Co. Alternatively, it may well be the case that revenue authorities and courts may seek to look through the intermediary to Country A Co. as the beneficial Owner because Country A Co. controls Country X Co. Does control operate at Such a level that the intermediary - in this case, Country X Co. - must under all

84

Availability of DTA benefits

Double Taxation Agreements

circumstances pay the dividend to Country A Co. and thus deprive the intermediary entity of the ownership attributes which are normally associated with the dividend. It is clearly arguable that, since the intermediary (Country X Co.) does not receive the dividend on behalf of Country A Co. in an agency or other representative capacity, Country A Co. is not the beneficial owner of the dividend. Practically,. it ~ust be asked whether the parent's control of the intermediary subsIdIary IS so overwhelming as to give rise to an agency relationship. The better view would appear to be that in the absence of substantial and compelling evidence to the contrary, a parent does not normally have such COntrol that the relationship with its subsidiary in relation to any dividends which might be paid to the parent is transformed into an agency relationship. More commonly, the position would seem to be that the intermediary (Country X Co.) acts in a capacity as a separate legal entity, and while it is an intermediary III the sense that dividends pass through it, provided that there are no facts to suggest an agency relationship (which would rarely appear to be the case), the dividends would at all times be in the beneficial ownership of the intermediary resident Country X Co. Having said that, there are three interesting tax decisions on this issue where differing conclusions have been reached. The first is a relatively old US case, the second a more recent Canadian case and the third a UK case with very unusual facts. I~ Aiken Industries Inc v. Commissioner of Inland Revenue (1971) 56 TC 925 (US), the Ulllted States Internal Revenue Service was able to prove that a Honduran company was not the beneficial owner of interest which it received from a US company, where a back-to-back promissory note arrangement had been put in place. In return for receiving interest under a promissory note assigned to it by its ultimate parent company, which was resident in the Bahamas, the Honduran company was contractually obliged to pay a corresponding amount of interest back to the Bahaman assignor under separate promissory note commitments that the Honduran company made to it. In the absence of this structure the United States could have levied withholding tax of 30 percent on interest payments made directly to the Bahaman parent company. The arrangement was clearly intended to avoid the withholding tax expense by taking advantage of the zero-rate withholding tax restriction under the now terminated 1956 HonduraslUS DTA. The US tax court held that the Honduran company had no actual beneficial interest in the interest payments which it had received from the US company because it was in turn committed to pay the interest to its ultimate parent company. According to the court, because of its obligation to transmit the interest to a third party, it could not be said that the intermediate entity had complete dominion and control over that interest income. By way of contrast, a Canadian Court in Prevost Car Inc. v. the Queen (Tax Court of Canada) (April 22, 2008) has held that Revenue Canada was not entitled to

Volvo Bussar AB (Sweden)

Henlys Group PLC

(UK)

I

85

J I Provost Holdings BV (Netherlands)

1 Provost Car Inc (Canada)

Fig. 4.1

Prevost Car Inc. ownership

look through a Dutch resident company which held the shares in a Canadian resident company in order to impose a higher rate of withholding tax on the basis that the Dutch company was not the beneficial owner of the dividends for the purposes of Article 10, paragraph 2 of the CanadalNetherlands Double Tax Agreement. . . More specifically, the case involved Prevost Car Inc., a corporatIon reSIdent in Canada, which declared and paid dividends to its shareholder Prevost Holdings BV, a corporation resident in the Netherlands. The Minister of National Revenue issued assessments under Part XIII of the Income Tax Act against Prevost in respect of the dividends. The Minister assessed on the basis that the beneficial owner of the dividends was not Prevost Holdings BV but the shareholders of that company, who were in turn two companies, one resident in the United Kingdom (Henlys Group PLC - "Henlys" as to 49 percent) and the other resident in Sweden (Volvo Bussar AB - "Volvo" as to 51 percent). The facts can be depicted diagrammatically as in Fig. 4.l. When Prevost Car Inc. paid the dividends, it withheld tax by virtue of subsections 212 (1) and 215 (1) of the Act but as a resul t of the a pplication of Article 10 of the DTA, the rate of withholding tax was a reduced rate of 5 percent (6 percent for 1996). Revenue Canada indicated in the relevant notice of appeal that the appellant should have withheld and remitted to the Crown at the statutory non-DTA rate of 25 percent of the dividends paid to the Dutch company. However, as a concessionary measure the Crown sought to apply the reduced rate of taxation of 15 percent and 10 percent under the Canada/Sweden and CanadalUK DTAs respectively. Revenue Canada did this as a concession, since the Canada/Sweden and CanadalUK Treaties would have no application. Quite simply the position in the absence of treaty protection conferred by the CanadalNetherlands DTA is that the ordinary rate of withholding applied by Canada should apply to the dividends in the absence of a treaty, and thus a 25 percent rate should have . been applied.

86

Double Taxation Agreements

In a wide-ranging judgment, the Court looked carefully at the French concept (beneficiaire effectif) and Dutch concept (uiteindelijk gerechtigde) of beneficial ownership and their meaning under French and Dutch law. The survey of these concepts and the related cases led the judge to conclude that as the Dutch company was the registered owner of the shares in Prevost Car Inc. and it paid for the shares, it was the full legal and beneficial owner of the shares. Furthermore, when the dividends were received by the Dutch company in respect of the shares it owned, the dividends became the property of the Dutch company. Until such time as the management board declared an interim dividend and the dividend was approved by the shareholders, the monies represented by the dividend continued to be the property of and to be owned solely by the Dutch company. The dividends were at all times an asset of the Dutch company and they were available to its creditors if any. No person other than the Dutch company had an interest in the clividends received from Prevost Car Inc. The Dutch company could use the dividends as it wished and it was not accountable to its shareholders except by virtue of the laws of the Netherlands. The shareholders only obtained a right to the dividends that were properly declared and paid by the Dutch company itself. This was the case notwithstanding the fact that the payment of dividend had been mandated. The Court added that if any amount had been paid by the Dutch company to its shareholders before a dividend was properly declared and paid, it would have constituted a loan from the Dutch company to its shareholders. The judge noted that this was not an uncommon practice when dealing with corporate funds. Counsel for the Revenue in Prevost sought support for the view that the intermecliate Dutch company was not the beneficial owner of the dividends from an unusual non-tax case that arose in the England and Wales Court of Appeal. In Indofood International Limited v. JP Morgan Chase Bank in a London branch [2006 ] EWCA Civ 158, STC 1195 an Indonesian company by the name of Indofood set up a Mauritian special-purpose company to issue loan notes ("the notes"). A back-to-back loan arrangement was put in place. The notes contained a grossup clause and provided for an early redemption in the event that, because of tax or treaty changes, the Mauritian company had to pay additional tax. The notes also contained a clause requiring the Mauritian company to try to mitigate any additional tax liability by "taking reasonable measures available to it" before seeking to redeem the notes. The financing was structured via Mauritius to take advantage of the beneficial withholding tax rates which prevailed under the Indonesia/Mauritius DTA. In particular, Mauritius had no outbound withholding taxes. As a result of ongoing abuse of the Indonesia/Mauritius DTA, Indonesia terminated its tax treaty with Mauritius effective from January 1,2005. The effect was to increase the withholding on the interest payments made by the Indonesian company to the Mauritian company from 10 percent to 20 percent under domestic Indonesian law. Since the issue of the notes in 2002, both interest and exchange rates had moved against Indofood and in favour of the noteholders.

Availability of DTA benefits

87

Indofood sought to redeem the notes and refinance more cheaply. However, JP Morgan Chase, acting as trustee for the noteholders, was not satisfied that the "best endeavours" clause referred to above had been complied with, and alleged that lndofood could have chosen to interpose a Dutch entity ("NewCo") into their structure and avail itself of the preferential rates that would apply under the NetherlandslIndonesia DTA. On this basis, the defendant, JP Morgan Chase, refused to approve the redemption. Thus, the substantive issue at trial in the case was an unusual hypotheticalnamely, if NewCo had been inserted as a Dutch company and had been paid interest by an Indonesian company in circumstances where it would be obliged to on-pay interest to third parties not resident in the Netherlands, would NewCo be treated as the beneficial owner of the interest payable to it by the Indonesian company for the purposes of obtaining the reduced withholding tax rate that would be applicable under Article 11 of the IndonesialNetherlands DTA? While the issue was hypothetical in one sense, the resolution of that hypothetical issue would determine whether JP Morgan Chase would be in a position to prevent Indofood from redeeming the notes on the basis that the "best endeavours" clause had not been satisfied. In the High Court, Justice Evans-Lombe found largely in favour of JP Morgan Chase, and held that NewCo would be the beneficial owner of the interest received from Indofood. In particular, he noted that NewCo was not a nominee or agent for any other party and, not being any sort of trustee or fiduciary, would have power to clispose of the interest, when received, as it wished. It is true that it would be constrained by its contractual obligation to the issuer to apply the proceeds of the interest payments in performance of its obligations, but that, according to the judge, in itself was not enough to defeat NewCo's beneficial ownership. More specifically the judge added: "It is clear to me that in the absence of any trust or fiduciary relationship between NewCo and the issuer, in an insolvency of NewCo undistributed interest received from the parent company would be an asset of NewCo for distribution amongst its creditors generally, including the Issuer, pari passu." Indofood took its case to the Court of Appeal, which found unanimously in its favour. Their decision was to the effect that, if interposed, NewCo could not be the beneficial owner of the interest received from the parent for the purposes of Article 11(2) of the Indonesia/Mauritius DTA or the IndonesialNetherlands DTA. The Court took the view that the fact that NewCo was not a trustee, agent Or nominee for the noteholders or anyone else in relation to the interest receivable from Indofood is by no means conclusive. Nor is the absence of any entitlement of a noteholder to security over or a right to call for the interest receivable from the parent. The court added that the term "beneficial owner" was to be given an international fiscal meaning not derived from the domestic laws of Contracting States. The concept of beneficial ownership is incompatible with ~hat of the formal owner who did not have the full privilege to benefit directly rom the income.

88

Availability of DTA be nefits

Double Taxation Agreements

The court added that the phrase "beneficial owner" was plainly not to be limited by so technical and legal an approach. Regard had to be given to the substance of the matter. In this case both commercial and practical considerations would suggest that the issuer and NewCo would be bound to pay on to the principal paying agent that which it received from the parent guarantor. In practical terms, it was impossible to conceive of any circumstances in which either of the issuer or NewCo could derive any "direct benefit" from the interest payable by the parent except by funding of its liability to the principal paying agent or issuer respectively. Such an exception can hardly be described as the full privilege needed to qualify as the beneficial owner. Rather the court suggested that the position of the Issuer and NewCo was more akin to that of an Administrator of the income. Clearly, the decisions in Aiken Industries and Indofood on the one hand and Prevost on the other provide a degree of conflict in interpretation of the concept of beneficial owner. Indofood can be too easily dismissed as an unusual case dealing with a hypothetical circumstance which did not relate specifically to English law, but such a dismissive response may well underestimate the importance of the reasoning in the court. The Prevost decision may yet be appealed, and that appeal will be watched with interest. It should be noted that both Aiken and Indofood dealt with interest, whereas Prevost dealt with dividends, and there may be a point of distinction to be drawn between the cases on that basis.

4.4

How do the comprehensive Limitation on Benefits (LOB) provisions work to prevent treaty shopping?

This way of dealing with treaty shopping is more comprehensive than all other methods, but has only been adopted in a comprehensive way by the United States. Other countries are beginning to expand their use of LOBs (see Australia/Japan DTA), but these efforts do not appear to be a coordinated policy as appears to be the case in the United States. Two examples of comprehensive DTA LOB provisions can be found in two of the six DTAs in the Appendix. There is no LOB DTA provision in the Australia/ UKDTA. The effect of Article 16 of the AustralialUS DTA is that a resident of the United States or Australia is only entitled to the benefits of the convention if it is a qualified person, • it passes the active business test, or • it passes the anti-avoidance test. The effect of Article 23 of the UKIUS DTA is that a resident of the United Kingdom or the United States is only entitled to the benefits of the convention if

Table 4.1

89

Qualified persons: limitations on benefits provisions in DTAs

Australia/US DTA

UK/US DTA

A resident of a Contracting State that is:

A resident of a Contracting State that is:

An individual (Article 16(2)(a))

An individual (Article 23(2)(a»

2

A Government entity (as defined) (Article 1 6(2)(b»

A qualified Government entity (Article 23(2)(b»

3

A listed company majority owned by five o r fewer listed companies (Article 16(2)(c»

A listed company majority owned by five or fewer listed companies (Article 23(2)(c»

4

A listed unit trust majority owned by listed companies or unit trusts (Article 16(2)(d»

A listed unit trust majority owned by listed companies or unit trusts (Article 23(2)(d»

5

A pension providing entity majority owned by DTA residents (Article 16(2)(f»

A pension scheme majority owned by OTA residents (Article 23(2)(e» and 4(3)(a»

6

No equivalent

An exempt employee benefits plan etc. majority owned by OTA residents (Article 23(2)(e» and 4(3)(b»

7

An entity for "public benefit" purposes (Article 16(2)(e))

An organisation for "publiC benefit" purposes (Article 23(2)(e» and 4(3)(c»

8

A non-individual person majority owned by QPs and base erosion test met (Article 16(2)(g»

A non -individual person majority owned by QPs or EBs and base erosion test met (Article 23(2)(f))

9

No equivalent

A trust or trustee of a trust majority owned by APs or EBs and base erosion test met (Article 23(2)(g»

A RHC for a multinational group (Article 16(2)(h»

No equivalent

10

it is a qualified person, it passes the active business test, it passes the Equivalent Beneficiaries test, or it passes the anti-avoidance test. Looked at in these stark terms, there is a clear commonality, with three tests broadly overlapping although the detail is quite different in some material respects. The only broad difference is the presence of the Equivalent Beneficiaries test in the UKlUS DTA . 4.4.1

What is a qualified person?

Ta ble 4 .1 highlights the way this concept is defined in the two DTAs.

90

Availability of DTA benefits

Double Taxation Agreements

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consular posts 218 deemed source of income or gains 213 diplomatic missions, members of 218 dividends 203-5, 222 dua I residency 23 elimination of double taxation 213-14 employment income 209-10, 223-4 entertainers and sportspersons 211 entrv into force 218-19 exchange of information 217-18 Exchange of Notes 221-30 tixed base 221 fringe benefits 59-60, 210-11 general definitions 194-6,221 government service employees 211-12 Independent persona I services covered by business profits article 56-7 interest 65, 205-7, 222-3 limitation of relief 214 mutual agreement procedure 216-17, 224 non-discrimination 104,215-16,224 other income 212-13 partnerships 24, 214-15 pensions and annuities 211 permanent establishments 198-200,221 persons covered 193 real property 200 residence 196-7 royalties 65, 207-8, 223 shipping and air transport profits 201-2 ships or aircraft, income or gains from alienation of 209 special occupation categories 211-12 students 212 taxes covered 25- 6, 193-4 termination 219-20 territorial application 194 text 193-230 AustralialUK OTA (reconstructed ver~on) 109-45 active income 112-19 alienation of property 128-9 allocation rules 112-33 associated entities profits 115-16 business profits 112-14 consular posts 134 deemed source of income or gains 145 deferred property income or gains 129-30 definitions general 140-2 permanent establishments 143-5 residence 142-3 diplomatic missions, members of 134 dividends 119-22 elimination of double taxation 135-6 employment income 116-17 entertainers and sportspersons 112, 130--1 entry into force 11 0-11

exchange of information procedures 139-40 exclusion or limitation on benefit provisions 133-4 fringe benefits 118 government service employees 118-19 independent personal services 117 interest 122-4 mutual agreement procedures 138-9 non-discrimination 136-8 other income 131-3 partnerships 134 passive income 119-30 pensions and annuities 126-7 persons covered 109 priority of allocation rules 16, 112-33 professors and teachers 131 real property 127-9 royalties 124-6 shipping and air transport profits 114 ships or aircraft, income or gains from alienation of 129 special occupation categories 130-1 students 131 taxes covered 110 temporary residents 133-4 termination 111-12 territorial application 140 AustralialUS OTA see US/Australia OTA bank secrecv tax infor~ation exchange 106 basket shopping distinct from treaty shopping 96 beneficial ownership concept cases 84-8 treaty shopping 82-8 Berlin Clause Germanv/China OTA 296 binding arbitration procedure (BAP) 105-6 branches attribution of profits where PE in form of a branch 45-7 business profits allocation rules 31-51 arm's length principle 32, 47 attribution rules 32, 34, 45-51 AustraliaIUK Convention 200-1, 222 AustralialUK OTA (reconstructed version) 112-14 capital gains 74 ChinalUK OTA 236-7 definition in OTAs 33-4, 35 France/China OTA 261-2 Germany/China OTA 282-3, 298 UK/US OTA 311-12, 347 US/Australia OTA 373-4 where passive income could also be classified as business profit 67

403

Canada see also CanadalUK OTA; US/Canada OTA cases 163-4, 165-71, 179 CanadaIUK OTA Gulf Offshore N.S. Limited u. The Queen case 167-8 capital Germany/China OTA 292 capital gains alienation of property 73-5 Australia 75 AustralialUS DTA 25 business profits 74 ChinaIUK DTA 243 France/China OTA 267 Germany/China OTA 287-8 UK/US OTA 319-20 withholding tax on capital gains realised b,· non-residents 76 capital losses 76 cases AATCase 8775 (1993)36- 7 Aiken Industries Inc v. Commissioner o( Inland Reuenue (1971) 84. 88 Association of Mouth and Foot Painting Artists Pty Ltd and Commissioner of Taxation [1987]164-5 Caron v. The Queen (1998) 179 CIR v. Commonwealth Development Corporation [1995] 37 Commerzbank (The Queen v. Inland Revenue Commissioners, ex parte Commerzbank AG (1991)) 104 Commissioner of Inland Revenue v. iFP Energy (1990) 55 Commissioner of Taxation v. Lamesa Holdings BV (1997) 8-9, 76, 147-9 Cudd Pressure Control Inc. v. The Queen [1998]156-7 GE Capital Finance Pty Ltd v. Commissioner of Taxation (2007) 179 Grohn v. The Queen (2002) 179 Gulf Offshore N.S. Limited v. The Queen (2006) 167-8 Indofood International Limited v. iP Morgan Chase Bank in a London branch (2006) 86-8 M and Mme Robert Gilly v. Directeur des Services Fiscaux du Bas-Rhin [1998] 171-4 McDermott Industries (Aust) Pty Ltd v. FCT (2005)37,150--2 Max Factor & Co v. Federal Commissioner of Taxatiol1 (1984) 149-50 The North West Life Assurance Company of Canada v. Commissioner of Internal Revenue (1996) 157-9 Pipeline decision (1997) 38, 174-5

404

Index

cases (cont.) Podd et af. v. Commissioner 160--] Prevost Car Inc. v. the Queen (2008) 84--6, 88 Qantas Airways Limited v. United States (1994) 159-60 The Queen v. Crown Forest Industries Limited [1995]163--4 The Queen v. Dudney [2002]165-6 Re Sti Schneider Electric (2002) 10-11, 12-13,175-8 Specialty Manufacturing Ltd v. The Queen [1999]168-9 Sun-mer v. The Queen (2000) 169-71 Terry Haggerty Tire Co. Inc. v. United States 161-3 Thiel v. FCT (1990) 7, 31, 32, 34--5, 74, 152--4 Tokyo High Court 2007 (GyoOKo), No 148 11-13 treaty shopping 84-8 Unisys Corporation v. Federal Commissioner of Taxation (2002) 154-5 CFC see controlled foreign corporations child support UKIUS DTA 321-2, 349 US/Australia DTA 390 China see also China/Australia; DTA; ChinalUK DTA; France/China DTA; Germany/China DTA DTAs 5,181-90 China/Australia DTA limitation on benefit provisions 94 ChinalFrance DTA see France/China DTA China/Germany DTA see Germany/China DTA ChinalUK DTA 231-56 air transport profits 251 associated enterprises 238 business profits 236-7 capital gains 243 consular officials 251 dependent personal services 243--4 diplomatic agents 251 directors' fees 244 dividends 238-9 dual residency 23 elimination of double taxation 247-8, 254--6 entertainers and athletes 244--5 entry into force 251-2 exchange of information 250 general definitions 232-3, 253--4 government service employees 245-6 immoveable property 236 independent personal services 243 interest 239--40 mutual agreement procedure 249-50 nationality 232-3 non-discrimination 249

Index pensions 245 permanent establishments 234--6 persons covered 231 Protocol 253--6 resident 233--4, 254 royalties 240--1, 254 shipping and air transport profits 237-8 special occupation categories 244-7 students, apprentices and trainees 246-7 taxes covered 27, 231-2, 253 teachers and researchers 246 technical fees 242-3 termination 252 territorial application 232 text 231-56 collection procedures 61, 107 Association of Mouth and Foot Painting Artists Pty Ltd and Commissioner of Taxation case 164--5 OECD Model Tax Convention 107 UKlUS DTA 339--40,353 companies dual residency treatment in DTAs 22-3 consular officials AustralialUK Convention 218 AustraliaIUK DTA (reconstructed version) 134 ChinalUK DTA 251 France/China DTA 274 Germany/China DTA 296 UKlUS DTA 341 US/Australia DTA 395-6 controlled foreign corporations (CFCs) France/Switzerland DTA 10--11, 12-13 interaction of CFC rules with DTAs 10--13 Japan/Singapore DTA 11-13 country of residence see residence jurisdictions country of source see source jurisdictions da tes see effective da te; entry into force; termination De Broe, L. et al. 55 definitions AustraliaIUK Convention 194--6,221 AustraliaIUK DTA (reconstructed version) 140--5 ChinaIUK DTA 232-3, 253--4 France/China DTA 258-9 Germany/China DTA 278-9 UKlUS DTA 304--7,347 US/Australia DTA 366-8 dependent personal services . see also fringe benefits; government serVICe employees allocation rules 53-6 AustralialUK Convention 209-10, 223--4 AustraliaIUK DTA (reconstructed version) 116-17