By Mark Atkinson, Stephan Baumann, Maurice Emmer, John Henshall, Giles Hillman and Hans Pijl
The OECD published the draft updated 2008 Model Treaty on its website on 21 April 2008. Last updated in 2005, the OECD Committee on Fiscal Affairs plans to finalize the draft in June after reviewing comments from the public.
Although not included in the recently released draft, the updated Model Treaty will include changes and additions to the observations, reservations and positions of both OECD and non-OECD member countries. These items will appear in the final version.
The 2008 draft Model Treaty reflects changes to the Commentary in a number of topical areas that were published in earlier discussion drafts:
An arbitration process to ensure that the competent authorities reach a mutual agreement on unresolved issues;The attribution of profits to a permanent establishment (PE);The introduction of an alternative service PE paragraph in the PE article;Several changes to the non-discrimination article; andThe tax treatment of REITs.Notably, however, the draft also contains some new, unexpected topical contents areas in the Commentary, described as “technical changes”:
The concept of “place of effective management” in respect of the tiebreaker rule for companies;Dual residents in triangular situations;Definition of royalties;Computation of the 183-day rule; andRelief from double taxation.Place of Effective Management
In 2001, the Business Profits TAG formulated two alternatives to the tiebreaker rule, which the OECD Member countries ultimately were unable to agree to because the TAG proposals focused on the place where the board of directors meet, instead of the place where senior executives make the key managerial decisions.
The 2008 draft eliminates from the existing Commentary “the place where the most senior person or group of persons (for example, a board of directors) makes its decisions”, and repeats that “all relevant facts and circumstances” are to be taken into account in determining where key management and commercial decisions for the conduct of the entity’s business as a whole are in substance made.
Dual Resident Companies in Triangular Situations
The OECD explicitly expresses its views on a protracted dispute about dual resident companies in triangular situations. At issue is whether a company that has unlimited liability to tax under the domestic law of State A, and that liability is eliminated (because the company is effectively managed in treaty State B) can invoke the benefits of a tax treaty that State A has concluded with a third state. The OECD believes the answer is no. Companies (and persons in general) that are subject to worldwide taxation under the domestic tax law of State A, but whose comprehensive liability to tax disappears as a result of a tax treaty with State B, are not considered “resident” for purposes of State A’s other tax treaties. This change would, amongst other things, have an effect on withholding taxes from the third state.
Definition of Royalties
The clash involving the business profits article, royalty article and the capital gains article (articles 7, 12 and 13, respectively) continues. The origin of the dispute is that articles 7 and 13 allocate the taxation right to the recipient state, whereas the country from which the payment is made prefers article 12 because of the ability to withhold tax. The new Commentary to the Model Treaty contains the OECD’s position on the tax treatment of certain payments in specific cases:
Payments made for a less than full transfer of a property right mentioned in article 12 (for example, to benefit a limited geographic area or an exclusive right for a specific period of time) are business profits or capital gains rather than royalties.Payments made for obtaining the exclusive distribution rights of a product (with a strong trade name connected to it) do not constitute payments for the right to use the trade name, but rather the purchase of the right to sell, which falls under the business profits article.Payments for the “right to use” must relate to pre-existing property to fall under the royalties article. Payments for the development of such property fall under the business profits article (a separate paragraph in the Commentary also applies this rule to know-how).Payments made for a potential new customer list would fall within the scope of the business profits article, but payments made for an existing customer list would fall within the royalties article.Payments made by a distributor to acquire and distribute software copies in an arrangement between a software copyright holder and a distribution intermediary fall under the business profits article.Computation of 183-Day Rule
The increasing mobility of employees requires regular updates to article 15. Accordingly, the 2008 draft discusses how to count the days of presence in the work state for purposes of the 183-rule. Under the general rule in article 15, the residence state of the employee has the exclusive right to tax remuneration for dependent services unless the employment is exercised in another state, in which case the work state is granted the right to tax (provided certain conditions are satisfied). One of these conditions is that the work state should not tax if the employee is not present for more than 183 days in the work state during any 12-month period commencing or ending in the fiscal year concerned. For example, when an employee who is resident in State A moves to State B and becomes resident in State B but then is seconded from State B to State A (i.e. the former residence state) for a short period of time, are the days present in State A as a resident taken in calculating the 183 days? The OECD suggests that the period of residence in State A is not to be taken into account.
Relief from Double Taxation
A new rule was included in the Commentary to article 23A and B in 2000 to effectively relieve double taxation in cases of conflicts of qualification. Roughly, this rule states that in such cases, the residence state follows the qualification of the source state and grants double taxation relief accordingly. The 2000 Commentary also applies this rule in the reverse situation, i.e. when the source state did not tax because of its interpretation of the provisions of the treaty, the residence state is not under any obligation to grant relief. The 2008 draft is better worded to reflect that it is independent of the source state’s domestic law tax treatment.
Article 21
The Committee on Fiscal Affairs is no longer studying the taxation of non-traditional financial instruments.
Effect of the Changes
A question that inevitably arises when changes are made to the Commentary to the Model Treaty is how the changes will affect the interpretation of tax treaties concluded under a previous version of the Commentary. Countries can adopt an “ambulatory” or a “static” approach in such situations. Under the ambulatory approach, treaties can just accommodate changes to the Commentary. In countries that use the static approach, however, a determination must be made as to whether changes to the Commentary are a clarification of the previous Commentary or fundamental change. In the latter case, the interpretative effect of the changes could be limited.
The draft treaty is available on the OECD web site.
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