21 June 2008
The draft of the 2008 Model Tax Convention (MTC) was released on 21 April 2008. Details regarding the proposed changes to the Commentary to Art. 12 are reported below.
New additions have been proposed, relating to the definition of royalties. They clarify that payments made in consideration for the transfer of the full ownership of an element of property referred to in the definition of royalties cannot be treated as royalties under Art. 12 of the MTC, as such payments are not made in consideration for the use of, or the right to use, that property.
The same rationale would be applicable to payments that are solely made for obtaining the exclusive distribution rights of a product or service in a given territory, or to payments for the development of a design, model or plan that does not already exist, even if the designer retains all intellectual rights in that design, model or plan.
An addition to the commentary clarifies that payments made by a software distributor to the copyright holder to acquire and distribute software copies (without the right to reproduce the software) should be treated as commercial income rather that royalty income.
Draft of 2008 Model Tax Convention – Proposed changes to Commentary to Art. 13 (REITs)
The draft of the 2008 Model Tax Convention (MTC) was released on 21 April 2008. Details regarding the proposed changes to the Commentary to Art. 13 are reported below.
The 2008 draft update proposes the addition of 3 new paragraphs in respect of the tax treaty consequences of alienation of an ownership interest in a REIT.
In general, the alienation of such an interest should be treated as a sale of shares of an immovable property company, dealt by Art. 13(4) of the MTC. However, an alternative provision that may be included during bilateral negotiations would consider the alienation of a small investor's ownership interest in a REIT as income from the alienation of securities dealt by Art. 13(4) of the MTC.
Draft of 2008 Model Tax Convention – Proposed changes to Commentary to Art. 24 (non-discrimination)
The draft of the 2008 Model Tax Convention (MTC) was released on 21 April 2008. There are no significant differences between the proposals set out in the 2008 draft update, and those first published on 3 May 2007 in a public discussion draft "Application and Interpretation of Art. 24 (Non-Discrimination)". The main proposals are summarized below.
General remarks concerning scope of Art. 24
The 2008 draft update proposes to include general remarks before tackling the relevant paragraphs of the non-discrimination clause. The proposed general remarks would clarify, for example, that the scope of Art. 24 does not cover the so-called indirect or covert discrimination, and that Art. 24 cannot be interpreted so as to require a most-favoured nation treatment.
The introductory remarks also make clear that whilst Art. 24 seeks to eliminate discrimination that is based solely on certain grounds, the intention is not to afford better tax treatment to foreign nationals, non-residents, enterprises of other states, or domestic enterprises owned or controlled by non-residents.
Specific issues concerning groups of companies
An important issue is whether Art. 24(3) could be interpreted so as to treat as discrimination the failure to allow consolidation of the earnings or losses of a host PE with the results of other group enterprises in that host country. The 2008 draft update proposes an amendment to state that Art. 24(3) does not require the extension to PEs of domestic group regimes that are restricted to resident companies. The justification for this is that the PE non-discrimination clause only relates to the tax treatment of the PE itself, and as such, it does not apply to rules regarding groups of related companies. These include rules regarding group consolidation, or the transfer of losses or tax-free assets between companies under the same common ownership.
Likewise, with regard to the ownership non-discrimination clause (Para. 5), an amendment is proposed so as to clarify that Art. 24(5) is similarly restricted to the taxation of the enterprise itself, and generally excludes issues relating to the taxation of the group to which the enterprise belongs.
Nationality non-discrimination clause
On the question whether Art. 24(1) should apply to companies, or if Paras. 3, 4 and 5 already provide companies with sufficient protection against discrimination, the OECD proposes to clarify, by the inclusion of examples, that resident and non-resident companies are not in the same circumstances, except where residence is totally irrelevant for purposes of the domestic rule under scrutiny.
As to the issue of whether taxpayers are in the same circumstances for the purposes of Art. 24(1), a proposed amendment would clarify that taxpayers with limited tax liability are usually not in the same circumstances as those with unlimited tax liability.
PE non-discrimination clause
The OECD proposes to insert a paragraph to the effect that, for the purposes of Art. 24(3), the tax treatment in the PE country should be compared with that of an enterprise of the PE country that has a legal structure similar to that of the enterprise to which the PE belongs.
The draft also considers whether Art. 24(3) restricts the application of branch taxes, to the extent that such taxes result in a higher rate of tax being applied to the profits of the PE than that applied to those of a local enterprise. A proposed amendment states that a branch tax that is simply expressed as an additional tax payable on the profits of a PE would constitute a violation of Art. 24(3). Further, a distinction is made between such a branch tax and one that would be imposed on amounts deducted as interest in computing the profits of a PE (e.g. "branch level interest tax"). In that case, the tax would not be levied on the PE itself, but on the enterprise to which the interest is considered to be paid, and would therefore be outside the scope of Art. 24(3).
A proposed paragraph clarifies that the application of the arm's length principle between the enterprise and its PE is not contrary to Art. 24(3) as this is required by Art. 7(2) of the MTC and forms part of the context in which that article must be read.
Deduction non-discrimination clause
A new paragraph is proposed so as to clarify that Art. 24(4) does not prohibit additional information requirements with respect to payments made to non-residents, as such requirements are only intended to ensure similar levels of compliance between payments to residents and non-residents.
Ownership non-discrimination clause
The 2008 draft update addresses the relationship between thin capitalization rules, and Arts. 9 and 24. An amendment is proposed so as to clarify that Art. 24(5) would generally not be relevant for most thin capitalization rules because those rules are focused, not on the relationship between an enterprise and the persons who own its capital (i.e. a company-shareholder relationship), but on the payment of interest from a resident enterprise to a non-resident related creditor (i.e. a debtor-creditor relationship). It would also be clarified that even in cases where thin capitalization rules apply only to enterprises owned or controlled by non-residents, to the extent that they result in adjustments to profits made in accordance with Arts. 9(1) and 11(6) of the MTC, these rules do not violate Art. 24(5).
Draft of 2008 Model Tax Convention – Proposed changes to Commentary to Art. 25 (tax treaty disputes)
The draft of the 2008 Nodel Tax Convention (MTC) was released on 21 April 2008. Details regarding the proposed changes to the Commentary to Art. 25 are reported below.
New Para. 5
The 2008 draft update sets out the proposed Art. 25(5), as published in the OECD Report of 8 December 2006, "Improving the Resolution of Tax Treaty Disputes". The changes to the MTC included in that report were approved, on 30 January 2007, by the OECD Committee on Fiscal Affairs.
The proposed paragraph, and related footnote, read as follows:
(a) under paragraph 1, a person has presented a case to the competent authority of a Contracting state on the basis that the actions of one or both of the Contracting states have resulted for that person in taxation not in accordance with the provisions of this Convention, and
(b) the competent authorities are unable to reach an agreement to resolve that case pursuant to paragraph 2 within two years from the presentation of the case to the competent authority of the other Contracting state,
any unresolved issues arising from the case shall be submitted to arbitration if the person so requests. These unresolved issues shall not, however, be submitted to arbitration if a decision on these issues has already been rendered by a court or administrative tribunal of either state. Unless a person directly affected by the case does not accept the mutual agreement that implements the arbitration decision, that decision shall be binding on both Contracting states and shall be implemented notwithstanding any time limits in the domestic laws of these states. The competent authorities of the Contracting states shall by mutual agreement settle the mode of application of this paragraph. 
1.] In some states, national law, policy or administrative considerations may not allow or justify the type of dispute resolution envisaged under this paragraph. In addition, some states may only wish to include this paragraph in treaties with certain states. For these reasons, the paragraph should only be included in the Convention where each state concludes that it would be appropriate to do so based on the factors described in paragraph 47 of the Commentary on the paragraph. As mentioned in paragraph 54 of that Commentary, however, other states may be able to agree to remove from the paragraph the condition that issues may not be submitted to arbitration if a decision on these issues has already been rendered by one of their courts or administrative tribunals.
Amendments to the Commentaries
Accordingly, the draft proposes the addition of a new paragraph to Part I (Preliminary Remarks) of the Commentaries. This explains that the new Art 25(5) is necessary in order to resolve cases where the competent authorities are unable to agree that the taxation by both states is in accordance with the Convention. The new arbitration process would allow an independent decision on the unresolved issues, thereby enabling mutual agreement to be reached. The process would be an integral part of the mutual agreement procedure, and not an alternative way to resolve disputes arising in the application of the Convention. The Preliminary Remarks also provide for a sample mutual agreement, set out in an annex to the Commentaries.
The introduction of the new arbitration process would reinforce the position of those who, based on the assumption that the procedure takes place within the framework of a joint commission, consider the mutual agreement procedure as a whole, as having a jurisdictional nature. Although the Commentaries do not take a position on this, the draft recognizes that this could be another element to be taken into account.
The draft also proposes the deletion of Part IV of the Commentaries (Final Observations), and apart from the renumbering of the paragraphs, maintains the other proposals published in the earlier report.
Report from Belema Obuoforibo, Roberto Bernales and Luis Nouel, IBFD Senior Research Associates
Draft of 2008 Model Tax Convention – Proposed changes to Commentary to Art. 4 (place of effective management, dual residence)
The draft of the 2008 Model Tax Convention (MTC) was released on 21 April 2008. Details regarding the proposed changes to the Commentary to Art. 4 are reported below.
Place of effective management
The Working Party 1 (WP) studied different proposals and alternatives to the concept of place of effective management. It was concluded that previously proposed solutions to the issue of double residency of legal persons would not be in line with the views of the majority of OECD member countries, as it was recognized that cases encountered in practice did not justify replacing the current concept of place of effective Management.
On the other hand, some OECD member countries indicated that they have adopted a bilateral approach, solving cases of dual residence of legal persons by using a mutual agreement procedure, based on the facts and circumstance of each case. In view of the number of countries that are willing to adopt this approach, the WP decided to add alternative wording to the commentary to Art. 4, which would allow the use of the mutual agreement procedure as an alternative to the concept of place of effective management.
Dual-resident persons who are treaty non-residents under tie-breaking rules
Tie-breaking rules established in Arts. 4(2) and 4(3) of the MTC are intended to deal with situations where a person is regarded as resident in both contracting states under their domestic laws, granting residence status for tax treaty purposes only in one of the contracting states, which would be considered as the "winning state".
Some of the proposed changes are primarily intended to clarify that the status of tax residency for treaty purposes in the "losing state" will be lost even with regard to treaties concluded by that state with third countries, as the person will not be subject in that losing state to the most comprehensive tax liability, as required by Art. 4.
An additional paragraph was included in the commentary to Art. 21 of the MTC, clarifying that that article will prevent taxation in the losing state derived from activities carried on by the person in third countries, hence limiting the formation of triangular cases.
Draft of 2008 Model Tax Convention – Proposed changes to Commentary to Art. 5 (PE – services)
The draft of the 2008 Model Tax Comvention (MTC) was released on 21 April 2008. The 2008 draft update makes a few changes to the proposals set out in the public discussion draft (The Tax Treaty Treatment of Services) published on 8 December 2006. The main proposals (as set out by both documents) are summarized below.
The 2008 draft update proposes the inclusion of new Paras. 42.11 to 42.48 to the Commentary on Art. 5. These address permanent establishment (PE) aspects of the taxation of services. Under the MTC, services performed in the territory of a state by an enterprise of the other state are generally only taxable in the resident state, unless they are attributable to a PE situated in the source state.
The amendments attempt to address the concerns of states that do not accept the principle of exclusive residence taxation for services. The draft suggests an alternative provision for Art. 5, the purpose of which is to secure source taxation rights where certain conditions are met.
The alternative provision would have the effect of creating a deemed PE in circumstances where, under the main provisions of Art. 5, a PE would not exist.
The alternative OECD PE clause for services reads as follows:
Notwithstanding the provisions of paragraphs 1, 2 and 3, where an enterprise of a Contracting state performs services in the other Contracting state
(a) through an individual who is present in that other state during a period or periods exceeding in the aggregate 183 days in any twelve month period, and more than 50 per cent of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other state through that individual, or
(b) for a period or periods exceeding in the aggregate 183 days in any twelve month period, and these services are performed for the same project or for connected projects through one or more individuals who are present and performing such services in that other state,
the activities carried on in that other state in performing these services shall be deemed to be carried on through a permanent establishment of the enterprise situated in that other state, unless these services are limited to those mentioned in paragraph 4 which, if performed through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph. For the purposes of this paragraph, services performed by an individual on behalf of one enterprise shall not be considered to be performed by another enterprise through that individual unless that other enterprise supervises, directs or controls the manner in which these services are performed by the individual.
With respect to Condition (a) above, "active business activities" are not restricted to those activities related to the provision of services. In addition, there is scope for states to use a different test in ascertaining whether an enterprise derives most of its revenues from services performed by an individual on their territory. Examples suggested are: "50% of the business profits of the enterprise during this period or periods is derived from the services"; and "the services represent the most important part of the business activities of the enterprise".
With respect to Condition (b) above, the concept of "connected projects" is necessary for cases where an enterprise carries on separate projects that are nonetheless adjudged to have "commercial coherence". There is no hard and fast rule for determining whether such coherence exists in any particular case, but the following factors may be indicative:
whether the projects are covered by a single master contract;
where the projects are covered by different contracts, whether these were concluded by the same person, or with related persons, and whether the conclusion of the additional contracts would reasonably have been expected when concluding the first contract;
whether the nature of the work involved under the different contracts is the same; and
|-||whether the same individuals are performing the services under the different projects.|
Draft of 2008 Model Tax Convention – Proposed changes to Commentary to Art. 7 (attribution of profits to PE)
The draft of the 2008 Model Tax Convention (MTC) was released on 21 April 2008. The 2008 draft update includes all the changes to the Commentaries published in the public discussion draft of 10 April 2007 with some additions reflected below.
First, it includes a reference to Part IV of the Report on "Attribution of Profits to Permanent Establishments", which deals with permanents establishments (PEs) of enterprises carrying on insurance activities.
Changes are proposed so as to emphasize the rejection of the "force of attraction principle". It is recognized that that principle is now totally outdated and that, in fact, was only followed not by "some", but only by "few" countries "some time ago".
Interpretation of Para. 1 of Art. 7
Regarding the Commentary on Para. 1 of the Art., a new paragraph would clarify that the directive of Para. 2 may result in profits attributed to the PE even though the enterprise as a whole has never made profits and that conversely (and here is the novelty respect to the public discussion draft), the directive may result in no profits, even though the enterprise as a whole has made profits.
Interpretation of Para. 2 of Art. 7
The 2008 draft update proposes the addition of several new paragraphs.
It is proposed that a new paragraph would state clearly that the application of the "separate entity" approach in order to attribute income to the PE, does not mean that the amount taxed in the source state will, for a given period of time, be exactly the same as the amount with respect to which the other state must provide relief. The differences between the domestic laws of the two countries regarding matters such as depreciation, time-recognition of income and the possible restrictions on the expenses that may be deductible, will usually result in a different amount of taxable income in each state.
Additional paragraphs are proposed to deal with the issue of the attribution of income to the PE depicted in Art. 5(3) (building site, construction or installation project, the so-called Project PE). It is recognized that problems arise especially when goods are provided, or services performed, by the other parts of the enterprise, or by a related party in connection with this kind of PE. The proposed changes explain that in those cases, the profits arising from the supply of goods or services to the PE are not attributable to it because income is only attributable to the PE so long as it results from activities carried on by the enterprise through that PE.
Interpretation of Para. 3 of Art. 7
Regarding the deductibility of expenses attributed to the PE, the public discussion draft had recommended that that issue be determined by the domestic law of the PE state. The 2008 draft update adds that this faculty cannot be exercised against the rules on non-discrimination as set out in Art. 24 of the Model Convention, particularly in Paras. 3 and 4 thereof.
We’re here to answer any questions you have about the Orbitax products and services.
We’re committed to providing high value, low cost tax research and management solutions.
Our Twitter account is where you can find latest information, news updates, offers and lots more.