Treaty Shopping

21 Nopember 2015

Hampir semua double tax treaty disusun secara bilateral, yang

hanya melibatkan dua negara.
Oleh sebab itu, penurunan tarif pemotongan dan pemungutan Pajak
Penghasilan sesungguhnya ditujukan bagi orang yang merupakan
warga negara dari salah satu treaty partner tersebut (residents of the
contracting states).
Treaty Shopping memanfaatkan kondisi ini dengan menempatkan
perusahaan fiktif di salah satu negara tersebut, dengan harapan bisa
memanfaatkan penurunan tarif pajak dari tax treaty yang ada di
negara tersebut.

Two Aprroaches to Prevent Treaty Shopping:

1. Including in the tax treaty rules which only require the low rates
withholding tax in the treaty to be applied by the paying state, where the
person who is ultimately entitled to spend the money in any way he sees fit
is a resident of the other state
2. By stating exactly which types of person will qualify for the reduced rates
and any tax exemptions available in the tax treaty. Such country will
establishes a series of tests.

Forms of Treaty Shopping

1. Reducing exposure to withholding taxes where a taxpayer wants to invest in
a country which does not have a treaty with his country of residence. For
Example, using the back to back loans.
2. Using equity funds to sidestep the withholding tax requirements for
dividend payments. For example, by setting up controlled foreign
companies in appropriate jurisdictions and routing dividend payments
through these.
3. Setting up conduit companies and stepping stone companies.

Conditions Where Treaty Shopping is Satisfied:

1. The conduit entity itself must enjoy tax exemption in the country where it is
created
2. The income should pass through the conduit entity to the beneficial owner
with the minimum of withholding taxes

Example 1: direct conduit

Interest $100k
Less WHT $25

White Ltd
Resident in Tax
Haven

Country A
Deposit $ 1 million

Example 1
Interest $100k
Less WHT $25

White Ltd
Resident in Tax
Haven

Country A
Deposit $ 1 million

Country that did not charge WHT on interest to nonresident; had a DTT with Country A which provided zero or
low rates of withholding tax on interest payments.

Example 2
Country B
Corporation Tax 20%
Branch Profit $100k
Tax $20k

Branch profits
$80k net
Double tax treaty
exemption method

Country C
Conduit Co.
Income = Branch Profit
$100k gross
$80k net of country B tax
Exempt from Country C tax

Dividend $76

Country A
Taxsave Inc
Corporation Tax 30%
Dividend from conduit co:
Cash Dividend $76
Gross of WHT $80k
Gross of Underlying Tax $100k

Double tax treaty

WHT 5%
Credit Method Applied

Tax Treaties and Treaty Shopping

1. Reliance on general interpretation of the treaties
domestic tax avoidance is required to tackle abusive practice, but it is uncertain and
arguably a better way since treaty should override domestic provisions.

2. Reliance on the beneficial ownership requirements

beneficial owner should be resident in the state to which payment is made, not that the
beneficial owner should be the direct recipient.

3. Reliance on anti conduit clauses

Two main types of conduit:

Direct conduit
Stepping stone

Example 3: beneficial owner, Indofood

Indofood
(Indonesia)
Interest
10% WHT

loans

loans

Mauritius
Finance Subsidiary

Interest
No WHT

Investors
In South East Asia

Example 3: beneficial owner, Indofood

Country B
Corporation Tax 20%
Branch Profit $100k
Tax $20k

Branch profits
$80k net
Double tax treaty
exemption method

Country C
Conduit Co.
Income = Branch Profit
$100k gross
$80k net of country B tax
Exempt from Country C tax

Dividend $76

Country A
Taxsave Inc
Corporation Tax 30%
Dividend from conduit co:
Cash Dividend $76
Gross of WHT $80k
Gross of Underlying Tax $100k

Double tax treaty

WHT 5%
Credit Method Applied

OECD five approaches to tackle conduit

1. Look through approach
Treaty benefits are denied to a company if it is owned directly or indirectly by persons who
are not residents of one of the contracting states. Legal status of the entity will be
disregarded and up to date information on the identity of the shareholders would be
needed.
This approach will only really appropriate when a treaty is being made with a low tax
country, where the risk of conduit activity would be high.

2. Exclusion approach
The conduit company does not pay much tax, treaty benefits will be excluded, if:
These could be met through dividend participation exemption;
by paying out most of the income in the form of deductible expenses;

By setting an exempt entities

OECD five approaches to tackle conduit

3. Subject to tax approach
Conduit company would only be eligible if it was actually subject to tax where it is resident.
But this will not catch the stepping stone structures where perfectly legitimate expenses are
paid to a low tax country, thus reducing the tax bill to virtually nil. Complications occur if
the country offering tax exemption, tax holiday etc.

4. Channel approach
Eligibility provided if:
Less than 50% of the conduits income is paid to the non-resident owners in tax
deductible form
Such approach will not only catch conduit arrangement, might also catch perfectly
innocent commercial arrangement. So that a motive test would also be needed.

OECD five approaches to tackle conduit

5. Motive test
This approach testing the motive of any conduit arrangement, whether to obtain tax
savings or not. Some supplementary test is required here:
General motive test:
Business activity test
Detailed subject to tax
Stock market quotation
Equivalent benefits test

US Style qualifying person approach

US say exactly which persons qualify for benefits rather than to try to specifically identify
situations in which conduit arrangement might be used. The list of tests for this approach are:

1.

Publicly traded corporation

2.

Non-profit organization

3.

Ownership/base erosion

4.

Derivative benefits

5.

Active business test

6.

Multinational corporate group headquarter test

THANK YOU