Understanding Double Tax Treaties

1
Understanding Double Tax Treaties

• Richard Dukes
• Partner

2
Purpose of Treaties

• To avoid double taxation
• Places restrictions on taxing rights of States by
  requiring exemption or tax credit that would
  otherwise be subject to double taxation
• Prevent avoidance of taxation
• Exchange of information
• Does not extend to enforcements, generally

3
Avoidance of Double Taxation

• How is this achieved?
• Establishes residence of taxpayer
• Divides taxing rights between country of
  residence and country of source for items of
  income
• Limited to certain taxes

4
Avoidance of Double Taxation (cont)

• If item of income, or tax, not covered then
  domestic law prevails
• Incorporation of treaty into domestic law?
• Interpretation of treaties

5
Avoidance of Double Taxation (cont)

• Business profits - only taxable where enterprise
  is resident, except where connected with a
  permanent establishment
• Non arms length dealings
• Dividends (income from shares)
• Interest (income from debt claims)
• Royalties (consideration for right to use certain
  property)

6
Residence - Enterprise

• Companies - place of residence under domestic
  law
• Tie breaker - place of effective management
• Individual - place of residence under domestic
  law
• Tie breaker - permanent home then
• - habitual abode
• - personal and economic relations are closer
  (look to citizenship)
• (e.g. Australia/Malaysia treaty)

7
Residence - Enterprise (cont)

• Enterprise - carried on by a resident
• Thiels case - no element of repetition
• - but some substance required
• Residence of a Labuan company?
• If managed and controlled in Malaysia then a
  resident of Malaysia under MITA. Requires board
  meetings in Malaysia
• But can it ever be required to lodge a tax return
  under MITA?

8
Business Profits

• Business profits of an enterprise may only be
  taxable in the State in which resident except
  where connected with a permanent establishment
• Determine profits of permanent establishment as
  if it were an independent entity
• Is this an allocation of overall profit of the
  enterprise? What if it makes a loss? No profit
  to allocate, or is it a hypothetical profit as if
  it were an independent entity?

9
Business Profits (cont)

• Does it include passive gains?

10
Permanent Establishment

• Fixed place of business through which the
  business is carried on
• Includes office, factory, building site gt 6
  months
• Includes agent who habitually exercises an
  authority to conclude contracts
• Excludes agent of an independent status eg.
  stockbroker acting in ordinary course of business

11
Non-Arms Length Dealings

• Transfer pricing where non-arms length dealings
• Allows adjustment to profits in both
  jurisdictions
• e.g. - Interest free loans
• - Sales of goods at cost/low mark-up
• Competent Authority - mutual agreement procedure

12
Lamesa Case - Article 13
TH Co

• Business profits not argued
• Article 13 - income from alienation of real
  property?
• Amendments - where value principally attributable
  to real property
• Amendments to DTAs

BV
Sale of shares
A Co
A Sub 1
A Sub 2
A Sub 3
Land
13
Dividend, Interest, Royalties

• Generally the State of residence may tax
• Source State may tax but sets a limit except
  where connected with a permanent establishment
• e.g. - dividends - 15
• - interest - 10
• - royalties - 10-15

14
Dividend, Interest, Royalties

• US/Australia
• - dividends to 0 where 80 shareholder or 5
  where gt 10 shareholder
• - interest 10 except where independent
  financial institution where is 0

15
Dividend Withholding Tax
THC
L Co
0
Dividends30
M Co
A Co
Dividends 15
A Co
16
Dividend Withholding Tax - Treaty shopping

• Limitation of benefits articles e.g.
• recipient of dividend listed on stock exchange
• at least 50 ultimately owned by residents of
  recipient
• engaged in active conduct of a trade or business
• Anti-avoidance
• Part IVA extends to withholding tax

17
Financing Arrangements

• Lux/CH treaty
• Lux gives exemption for CH activities
• US Sub part F
• Check the box regulations
• Low DWT from Lux to US

US Co
Lux Co
CH branch
loan
Op Co 1
Op Co 2
Op Co 3
18
Commissionaire Agreements

• Agent receives commission
• Most profits derived by Swiss Co
• Ensure no p.e. for Swiss Co due to activities of
  C Co

Swiss Co
100
Customers
C Co
Sales of goodsowned by Swiss Co
19
Australia/Malaysia Protocol

• Removal of tax sparing from 30 June 2003
• Prior to then, not available where scheme to
  exploit foreign tax credits
• LOBAT entities not entitled to any benefits
• Other income can be taxed in source country

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Hybrid Instruments
L Co
M Co
Dividends
A Co

• Redeemable preference shares issued by A Co
• Debt characteristics eg. fixed term, redeem for
  FV, coupons akin to interest
• Dividends deductible. DWT or IWT?