Double Taxation Agreements

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Double Taxation
Legal double taxation:
same person is taxed in 2 states by comparable taxe
Economic double taxation:
2 persons are taxed in 2 states by comparable taxes (eg transfer prices)
If legal and economic double taxation coincide: triple taxation
E.g. dividends:
taxation of profits in the residence state of company
taxation of shareholder with dividends in the source state
taxation of shareholder with dividends in the residence state
Reasons:
Collision of unrestricted (residence rule) and restricted taxation (source rule)
Conflicts of qualification

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Double Taxation Agreements (DTA)
Tax credit method: Neutrality of capital export
Income of investments is taxed with the tax rate of state of residence of investor: no difference if he invests in his own or in a foreign state
Exemption method: Neutrality of capital import
Income of investments is taxed with the tax rate of the state of investment: no difference if the invested funds come from the state of investment or from abroad

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Double Taxation Agreements (DTA)
Model Agreements (MA):
OECD model agreement and commentary: View of the industrialised countries (equilibrium of capital import and capital export); limitation of source taxation, preference of residence taxation
Examples:
permanent establishment only if strong links (construction only after 12 months; preliminary activities do not constitute a PE)
Reduction/exclusion of withholding taxes on interests, dividends, royalties
In case of doubt: Taxation in State of Residence (Art. 13, 21 OECD-MA)
Additional remark: EC tax law gives preference to residence rule as well by limitation of withholding tax: parent-subsidiary directive, interest-and-royalty directive
UN model agreement/Model Agreement of Andean States: View of less developed countries (capital import prevails): Preference of source taxation
US model agreement

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Model Agreements:
Differences OECD-Model vs. UN/Andean Model
Higher source tax
“attraction power” of permanent establishment
No exemption for royalties
Most DTA`s follow OECD-model
Germany: presently DTA`s with 86 states
Russia: presently DTA`s with 66 states

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Double Taxation Agreement
Completion of DTA
Initialize
Signature
Consent of Parliament (transformation)
Ratification
Exchange of ratification documents
Content of DTA: Text of agreement and Protocol
Effects:
Treaty overriding
depends on national law (Germany yes, Russia no)
Self executing?

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
DTA: Interpretation
Vienna Convention on International Contracts dated 23/5/1969,
Art. 31 - 33
Authentic Interpretation, Art. 31 IV Convention, Art. 25 III OECD-MA
Ordinary meaning rule, Art. 31 I Convention
Interpretation using the context of DTA, Art. 31 I, II Convention
Interpretation according to objectives of DTA, Art. 31 I Convention (principle of efficiency)
Interpretation using contract history, Art. 32 Convention
Authentic language, Art. 33 Convention
Autonomous interpretation, but Art. 3 II OECD-MA
Influence of the Commentary: retroactive effect?

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
DTA: Table of Content
Scope of DTA, Art. 1, 2
Definitions, Art. 3 – 5
Distributive rules, Art. 6 – 22
Methods of Avoidance of Double Taxation, Art. 23
Specific rules, Art. 24 – 29
Non-discrimination, Art. 24
Mutual agreement procedure, Art. 25
Exchange of information, Art. 26
Final provisions, Art. 30, 31

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Persons covered
„Person“, Art. 1, 3 I a, b, 4 OECD-MA
Individuals
Company ? body corporate
Body of persons ? partnerships
Residence in one or both of the Contracting States
„genuine link“, e.g. domicile, residence, management, nationality
Double residence possible
Partnerships are „persons“ but not „resident“, therefore not covered by the DTA
Tie-breaker-rule, Art. 4 II OECD-MA
only one residence allowed

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Taxes covered, Art. 2 OECD-MA
Normally all direct taxes, not VAT/excise duties
New taxes covered as well
Territory covered
Normally the territory of the respective state, but exemptions possible:
UK: not applicable in Channel Islands, Isle of Man, Gibraltar
Denmark: not applicable in Faroer Islands, Greenland
US: Not applicable in Puerto Rico
France: departments in overseas are included (Martinique etc)

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Distributive rules
2 purposes
Define the source country
Define which country has the taxing rights
Basis is unilateral claim of States ? they define what they want to tax, i.e. if in the territory
Business is carried on, services are performed
Title passes
Payer or payee is resident
Contract is concluded
Property is located or used
Owner is resident
Distributive rules limit this claim

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Distributive Rules
Complete distributive rules
Example: Art. 12 I OECD-MA: „shall be taxable only ..“
Article concerning methods not applicable
Incomplete distributive rules
Example: Art. 6 I „may be taxed …“
Method to avoid double taxation to be derived from method article
Art. 23A (taxation right of residence state): Exemption in state of residence, unless sec. 2 applies
Credit method for dividends and interests (sometimes royalties)
Art. 23B: Credit method
Application of method depends on actual DTA

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Distributive Rules: Principles
Priority of source state (strong connection to source state)
Situs rule: taxable where the site is situated, Art. 6 OECD-MA
Rule of permanent establishment: Business profits, Art. 7 OECD-MA
Rule where employment is exercised, Art. 15 OECD-MA
Taxation by both states
Dividends, Art. 10 OECD-MA
interests, Art. 11 OECD-MA
Priority of State of Residence
Royalties, Art. 12 OECD-MA
All other income, Art. 13 IV, 21 OECD-MA

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Type of Income
Own regime of 14 schedules of income
But taxable only if covered by income schedule of national law
Special income schedules have priority over general schedules:
Art. 7 VII, but reference back possible
Attribution of income to a person and calculation of income is subject to national law
Allows “double dips”, eg in leasing cases

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Immovable Property (agriculture/ forestry/sites), Art. 6 OECD-MA
„Immovable property“ includes renting of sites, agriculture and forestry
Includes accessory property, livestock, equipment
Meaning as under national law
Priority over business profits, Art. 6 III OECD-MA
Taxable in the state where the site is situated

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Business profits, Art. 7 OECD-MA
„Person covered“ is not the enterprise but the person carrying on the enterprise, Art. 3 I d OECD-MA
Art. 7 VII OECD-MA: Priority of specific income schedules
Covers professional services as well (formerly: Art. 14 OECD-MA)
Taxable in state of residence of entrepreneur
But: priority of permanent establishment (in pratice the standard)
Includes independent agents
If exemption method applies, included in calculation of tax progression

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Permanent establishment, Art. 5 OECD-MA
Fixed place of business
Through which business is wholly or partly carried out
At the disposal of the enterprise
Used with some regularity (6 months?) ? permanence test
Art. 5 sec. 3 OECD-MA: explanation or extension?
Example: Construction/installation project
Tendency in OECD to extent notion of “permanent establishment”
Place of management:
One or more places of management?
Day-to-day or strategic decisions?
Transfer of mind and management

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Permanent establishment, Art. 5 OECD-MA
Limitation of scope:
Construction or installation project has to last more than 12 months (in some DTA: 6 months), even if carried out by a “fixed place of business”, Art. 5 sec. 3 OECD-MA
No adding-up of several construction projects
Stock of goods and exhibition is excluded, Art. 5 sec. 4 (a-c) OECD-MA
Fixed place to purchase goods is excluded, Art. 5 sec. 4 (d) OECD-MA
Fixed place of preparatory or auxiliary character is excluded, Art. 5 sec. 4 (e) OECD-MA
Professional services
Eg IT services for a company resident in another state
At the disposal of the enterprise?
Permanent establishment if work lasts longer than 12 months?

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Permanent establishment, Art. 5 sec. 5 OECD-MA
Permanent agent constitutes a permanent establishment for enterprise
Only if authority to conclude sales contracts
Not in case of auxiliary activities
Exception for independent agents, Art. 5 VI
Broker, general commission agents are normally independent agents
Other agents:
Independent if personal independency (self-employed, business risk)
Have to act in the ordinary course of their business

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Controlled Companies as permanent establishments
The mere fact that a company is controlled by or controls a company resident in another state does not make the first mentioned company a permanent establishment of the second named company, Art. 5 sec. 6 OECD-MA
Enables the foundation of “control centres”
Enables organisation of a international group according to business lines

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Calculation of income of permanent establishment
No „power of attraction“ of permanent establishment
„separate enterprise“
Relevant business activity? ? Art. 7 sec. 1 OECD-MA
Functionally separate entity? ? Art. 7 sec. 2 OECD-MA
No profit allocation for the mere purchase of goods, Art. 7 sec. 5 OECD-MA ? to be deleted in future DTA’s
Calculation of income as under national law
Realisation of profit by sales to permanent establishment? ? “Dealings”
Profit element?

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Calculation of income
Direct method
Art. 7 sec. 2 OECD-MA: standard method
Limited to „profits of enterprise“ (consolidation of profits and losses)?
Indirect method
In principle applicable, Art. 7 sec. 4 OECD-MA ? to be deleted in future DTA’s
Limited to total profit?
Problem to find an appropriate key
Consistency of methods applied, Art. 7 sec. 6 OECD-MA

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Calculation of Income
Financing
Freedom of financing?
Equal financing within the enterprise?
Arm‘s-length-financing?
Profits and losses arising from currency exchange
Transfer of assets to perm. establishment
Realisation of profits and losses?
Deferred taxation?
Branch profit tax
Withholding tax on profit repatriation
Comparable to withholding tax on dividends ? equal treatment of PE and Affiliate

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Calculation of Income
New OECD-approach: functionally separate entity
Arm’s-length-principle to be applied
Profit allocation to PE according to:
Functions fulfilled
Risks assumed
To be determined according
People functions assumed by PE
Dealings concluded
Other documentations

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Taxation of perm. establishment
Losses
Deduction, if no DTA or DTA with credit method
Deduction, if exemption method?
Rules of thin capitalisation
Rules for CFC‘s
Rules of documentation of transfers of assets/goods

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Partnerships
If transparent, DTA does not apply
Partnership is not entitled to claim benefits under a DTA
Constitutes permanent establishment of partners
Problem: special purpose remunerations
Problem: Foreign tax credits (OECD Partnership Report)
if transparent in both states
if transparent in one state only
if intransparent in both states
three-partite situations: many combinations possible which result in qualification conflicts

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Dividends, Interests, Royalties
Taxed in state of residence
Limited right to tax in source state: withholding tax
Rate of withholding tax limited:
Shareholder is company and owns at least 25 % of shares: 5 %
Portfolio dividends: 15 %
Interests: 10 %
tax credited in residence state
Special case: Royalties
Priority of perm. establishment
Arm‘s-length principle
Proviso for treaty shopping: beneficial owner

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Dividends, Interests, Royalties
Special problem of hybrid loans (loans with profit-related interests)
Possible qualification conflict (“white income”):
State of debtor qualifies as interests
State of creditor qualifies as dividends
In some DTA therefore: qualified as dividends but no limitation of withholding tax if tax deductible in the state of debtor
EU-directive abolishes source tax within a group of companies
Germany as source state: No withholding tax on interests (therefore problem of thin capitalisation)

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Capital gains, Art. 13 OECD-MA
Sites
Taxed in state where situated, Art. 6 IV, 13 I
Applicable for sites of enterprises as well
Applicable for shares of companies whose assets consiss of more that 50 % in immovable property
Permanent establishments:
Profits from business activities ? Art. 7 OECD-MA
Sale of fixed assets resp. of perm. establishment as a whole ? Art. 13 OECD-MA
Any other property (shares): state of residence

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Income from employment
Taxed where the employment is exercised
But taxed in the state of residence of employee, if
Employment in the state where the employment is exercises is less than 183 days, and
Employer is not resident in the state of employment, and
Salary is not borne by perm. establishment in the state of employment
Different rules in different DTA’s
Eg. presence of more than 183 days during
calendar year
tax year
a running 12 month period

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Other income, Art. 21 OECD-MA
All income not dealt with in other articles
Income from source state not dealt with in Art. 6 ff
Income from third countries
Income from state of residence
Income from areas not part of a state
Priority of perm. establishments
If not: Exclusive right to tax of the state of residence

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Non-discrimination clause, Art. 24 OECD-MA
No discrimination on grounds of nationality; however, unequal treatment due to difference in residence is allowed
No discrimination of permanent establishments: shall not be less favourably taxed than a resident enterprise
No discrimination in expense deduction
No discrimination of foreign ownership: A company resident in a state and owned by residents of the other state may not be less favourably taxed than a company resident in one state and owned by residents of the same state
Protects only the company, not the owner of the shares

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Exchange of Information, Art. 26 OECD-MA
2 versions:
Wide version: exchange of information for all tax purposes (eg avoidance of tax fraud)
Narrow version: Only for the purpose of the DTA, i.e. only to avoid double taxation
Exchange max be on request, spontaneously or automatically
Restrictions in Art. 26 III OECD-MA
Information may only be used for tax matters

Master of International Business
21 - 23 November, 2014 St Petersburg
Double Taxation
Treaty shopping
Objective: Use of beneficial DTA: Corporation as intermediate
German law: § 50d III Income Tax Act. Preconditions:
The beneficial owner is not entitled to make use of the benefits of the Treaty if:
There are no sound economic reasons for the role of the corporation as intermediary
The corporation acting as intermediary has no own substantial (more than 10 % of income) and no sound business activities (“substance”