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OECD Clarifies Model DTA Interpretation

by Jason Gorringe,, London

24 October 2012

The Organization for Economic Cooperation and Development (OECD) has released for consultation two updated draft discussion papers to clarify the interpretation of 'beneficial ownership' and 'permanent establishment' used by tax authorities to assess in which nation, and at what rates, corporates should be liable to withholding taxes on prescribed passive income received from cross-border economic activity covered by an OECD model double tax agreement.

On April 29, 2011, the OECD released a public discussion draft entitled Clarification of the meaning of “beneficial owner” in the OECD Model Tax Convention. Proposals contained in this discussion draft have been updated in the latest consultation, released on October 19, taking into account feedback received.

The consultation seeks to clarify when an entity should be deemed to be the beneficial owner of a dividend, royalty or interest payment, as dealt with in Articles 10, 11, and 12 of the Model Convention, respectively. In many double taxation agreements concluded in line with the OECD benchmark agreement, provision is made for a lower rate of withholding tax in cases where the recipient is the 'beneficial owner' of the asset from which the income - be it royalty, dividend or interest income - is derived. Due to the lack of a universally-agreed definition of 'beneficial ownership', the area has historically presented substantial challenges for tax practitioners and tax authorities alike.

Although there is no hard-and-fast interpretation, generally beneficial ownership provisions are incorporated into double tax agreements as an anti-avoidance mechanism, to restrict the provision of lower withholding tax rates to recipients that have the right to the end use of the income, unconstrained by any contractual or legal obligation to transmit this income to a third party, particularly a connected party. The provision was introduced to prevent entities triangulating payments through other nations that have more beneficial double tax arrangements with the country in which the payee resides. The practice, commonly referred to as treaty shopping, is a contentious issue that has most notably soured international relations between Mauritius and India.

The discussion draft does not seek to amend Articles 10, 11 and 12 of the OECD Model Tax Convention but instead proposes to revise the OECD commentary used to interpret these Articles. The OECD has invited comment on the discussion draft before December 15, 2012, for review in February 2013.

In an initial response, PwC welcomed the OECD's efforts to provide clarity given the considerable uncertainty that has historically existed, but said that the updated commentary had fallen short on a number of areas. Richard Collier, tax partner at PwC, said: "The concept of beneficial ownership has been mired in confusion and controversy over recent years. The OECD has provided some clarification on how payments being passed on affect beneficial ownership of income received, but not enough. For instance the new wording refers to 'unrelated payments' without any explanation of what it means for a payment to be related or unrelated. Beneficial ownership is a big issue for many international businesses which must comply with complex international and domestic tax rules. Given the current focus on corporate tax affairs, it is more important than ever that the rules affecting the level of tax paid are clear."

Another consultation to clarify the interpretation of 'permanent establishment' relates to rules in place to determine a recipient's residence for tax purposes. It is proposed that a number of amendments to Article 5, which deals exclusively with the topic, be included in the next revision of the OECD Model Tax Convention due to be released in 2014, with comment welcomed until January 31, 2013.

TAGS: tax | business | double tax agreement (DTA) | India | Mauritius | interest | royalties | Organisation for Economic Co-operation and Development (OECD) | agreements | withholding tax | dividends | triangulation

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