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PRINCIPLES OF

INTERNATIONAL TAXATION

Contents
• What you’ll cover and what you’ll gain
• Recommended ways to prepare for your exam
• June 2018 exam questions
• June 2018 exam answers

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GLOBAL

CHALLENGING

PRACTICAL

VALUED

RECOGNISED

ADVANCED

UP-TO-DATE

STRUCTURED

FLEXIBLE

EMPOWERING

RENOWNED

SPECIALIST

THOROUGH

CURRENT

INTERNATIONAL

MODERN

UNIQUE

GLOBAL

ADVANCED
2 ADIT
Principles of International Taxation
What you’ll cover and what you’ll gain

The Principles of International Taxation module is a cornerstone of the ADIT credential. Providing
candidates with the breadth of knowledge they need to demonstrate a strong foundation in international
tax, this compulsory module has been part of the syllabus since ADIT was launched in 2004.

What you’ll cover


This module gives candidates an excellent grounding in the fundamentals of international taxation,
providing a robust base for the more specific areas of tax which are available for study in the various
option modules. Key topics include:
• Principles of international tax law
• Residence
• Double taxation conventions
• Treaty interpretation
• Transfer pricing
• The work of the OECD
• International tax avoidance

What you’ll gain


• A thorough grounding in the international tax principles of the moment
• A robust understanding of theory coupled with practical application, giving you the confidence to
apply these principles to your daily work
• Up to date knowledge of fast-changing developments in tax law, as exams are regularly updated to
cover current tax laws and emerging trends

ADIT 3
Principles of International Taxation
Syllabus

I Basic principles of international tax law 20%


II Double Taxation Conventions (focusing on the current version of the OECD model) 30%
III Transfer pricing and thin capitalisation rules 20%
IV International tax avoidance 25%
V Miscellaneous topics 5%

I Basic principles of international tax law


A Jurisdiction to tax, including limits to tax jurisdiction arising from public international law, and
cross-border enforcement of taxes 1
B Taxes and tax systems
1. Definition and classification of taxes 1
2. Federal systems and local-level taxes 1
C State practice in exercising tax jurisdiction
1. Concepts of source and situs; use of residence, domicile and citizenship as connecting factors 2
2. State practice in determining residence of individuals and corporations 2
3. Implications of the use of citizenship as a connecting factor (especially particular issues
for US citizens) 1
4. State practice in determining the source of income and gains 2
5. Tax issues arising from a change of residence/citizenship 2
D Causes of international double taxation
1. Conflicts of residence and source 2
2. Conflicting definitions of connecting factors 2
3. Other causes of international double taxation (including particular issues for using citizenship
as a connecting factor for taxation) 1
E Methods of relief from international double taxation
1. Relief by credit – including indirect/underlying credit and tax sparing credit 3
2. Relief by exemption – including participation exemption 3
3. Practical difficulties in applying relief by credit and relief by exemption 3
4. Relief by exemption and relief by credit compared:
capital import neutrality vs.capital export neutrality 2
5. Other methods of relief from international double taxation – relief by deduction of foreign tax;
relief by deferral 2
F Private international law and taxation
1. Recognition of foreign legal entities 2
2. Characterisation of entities as transparent or opaque – state practice 2
3. The issue of qualification and international taxation 1
G History of international tax law
1. Work under the League of Nations 1
2. Work of the G20 and OECD 2
3. Work of the UN Group of Experts 1
H European Union law and international taxation
1. EU law and Double Taxation Conventions 2
I Taxation and international human rights instruments
1. The European Convention on Human Rights 2
2. The International Covenant on Civil and Political Rights 2
J State responsibility in international taxation – the development of the concept of harmful
tax competition 2

4 ADIT
Principles of International Taxation
Syllabus

II Double Taxation Conventions (DTCs) focusing on the current version of the OECD Model Tax Convention (MTC)
Candidates are expected to: understand the operation of the provisions of the OECD MTC; show awareness of the
major points in the Commentary to the relevant Article of the OECD MTC; and be aware of key reports of the OECD
Committee on Fiscal Affairs and major international cases on the topic.
A Types of DTCs (limited, multilateral etc.) and negotiation of DTCs 2
B DTCs and domestic law
1. Incorporation of DTCs into domestic law 3
2. Treaty override 3
C Format and structure of a DTC
1. OECD MTC and the Commentaries to the OECD MTC – the work of the OECD Committee
on Fiscal Affairs 3
2. UN MTC 2
3. Specific states’ models: the US MTC; the Dutch MTC 1
D Approach to the application of a DTC: applying a DTC to a concrete scenario 3
E Interpretation of DTCs
1. General approach to interpretation 3
2. Vienna Convention on the Law of Treaties 2
3. Use of external aids for interpretation – the status and use of the OECD Commentaries 2
4. Application of Art. 3(2) OECD MTC 2
5. Resolving interpretation issues by competent authority proceedings – Art. 25(3) OECD MTC 2
F Provisions relating to the scope of a DTC: Arts. 1, 2, 29, 30, 31 and 32
1. Article 1: Persons Covered 3
2. Article 2: Taxes Covered 3
3. Article 29: Entitlement to Benefits 3
4. Articles 30, 31 and 32: Territorial extension, entry into force and termination 2
G Key definitional provisions
1. Meaning of “resident” and resolution of cases of dual residence – Art. 4 OECD MTC 3
2. Permanent establishment concept: determining the existence of a permanent
establishment – Art. 5 OECD MTC 3
3. BEPS Action 7: Preventing the Artificial Avoidance of a Permanent Establishment 3
H DTC provisions relating to businesses
1. Business profits (with or without a permanent establishment) – Art 7 OECD MTC 3
2. Shipping and Air Transport Profits – Art. 8 OECD MTC 3
3. Associated enterprises – Art. 9 OECD MTC: status of Art. 9 and link to transfer pricing legislation 3
I DTC provisions relating to individuals
1. Employment income – Art. 15 OECD MTC 2
2. Pensions – Art. 18 OECD MTC 1
J DTC provisions relating to investment income and gains
1. Income from land – Art. 6 OECD MTC 1
2. Dividends – Art. 10 OECD MTC – including some consideration of the forms of dividend article
used by key states (US, UK, France, Germany) 3
3. Interest – Art. 11 OECD MTC 3
4. Royalties – Art. 12 OECD MTC 3
5. Capital gains – Art. 13 OECD MTC 2
K Relevance of the “other income” Article – Art. 21 OECD MTC 2
L Limitation of Benefit Provisions
1. Approaches to the misuse of DTCs 3
2. Abuse of law doctrines and DTCs 3
3. State practice with respect to LoB provisions 3
4. BEPS Action 6: treaty abuse 3
5. Articles 1 and 29: persons covered and entitlement to benefits 3

ADIT 5
Principles of International Taxation
Syllabus

M Methods of elimination of Double Taxation – Arts. 23A and 23B OECD MTC 3
N The impact of the non-discrimination Article – Art. 24 OECD MTC 2
O The resolution of disputes under DTCs
1. Competent authority/mutual agreement procedures – Art. 25 OECD MTC 2
2. Alternative means of resolving international tax disputes 2
3. BEPS Action 14: Making Dispute Resolution Mechanisms More Effective 2
4. BEPS Action 15: Developing a Multilateral Instrument to Modify Bilateral Tax Treaties 2
P The application of DTCs to electronic commerce
1. The work of the OECD Taxation Advisory Group 2
2. E-commerce and permanent establishments 2
Q The digital economy
1. BEPS Action 1: tax challenges of the digital economy 3
2. Value-added tax / GST Issues 2
3. Nexus issues 2
4. Definition of permanent establishments 3

III Transfer pricing (TP) and thin capitalisation rules


A Various approaches to the determination of profits of branches and associated enterprises
1. Unitary taxation/global formulary apportionment 2
2. Arm’s length approaches 3
B State practice with respect to transfer pricing
1. Consideration of examples of domestic transfer pricing legislation (US, UK, Germany, Australia) 2
C Transfer pricing and DTCs – Art. 9 OECD MTC 3
D Advanced pricing agreements 3
E The OECD Transfer Pricing Guidelines 2017
1. Background to the introduction of 2017 guidelines 3
2. Major amendments to 1995 TP guidelines 3
3. TP methodologies 3
4. Special topics: Hard to value intangibles; low value adding intra-group services;
cost contribution/sharing agreements; revised safe harbour guidance; and documentation 3
5. Resolution of TP disputes and advance pricing agreements 3
6. Attribution of profits to permanent establishments 3
F Transfer pricing and BEPS
1. Awareness of the impact of BEPS on TP 2
2. BEPS actions 8-10: Aligning TP outcomes with value creation 2
3. BEPS Action 13: Documentation and country by country reportingf 2
G Transfer Pricing and developing countries
1. The United Nations Practice Manual on Transfer Pricing for Developing Countries 2017 2
H State practice with respect to thin capitalisation
1. Consideration of examples of thin capitalisation legislation (US, UK, Germany) 3
I Thin capitalisation legislation and DTCs
1. BEPS Action 4: Interest Deductions 3

6 ADIT
Principles of International Taxation
Syllabus

IV International tax avoidance


A Tax havens
1. Approaches to the identification of tax havens – black lists, white lists, grey lists – work of the
OECD Forum on Harmful Tax Practices 2
2. Features of the most commonly used tax havens 2
B Domestic law approaches to international tax avoidance
1. CFC and other controlled foreign entity legislation – examples from state practice 2
2. Foreign personal holding company legislation – examples from state practice 2
3. CFC and equivalent legislation and DTCs 2
C Money-laundering legislation and international tax avoidance
1. Application of money-laundering legislation to foreign fiscal offences 1
D Co-operation between revenue authorities
1. Exchange of information – Art. 26 OECD MTC 3
2. Tax information exchange agreement 3
3. Joint investigations of taxpayers 1
4. Co-operation in the enforcement of tax liabilities/assistance in the collection of taxes
Art.27 OECD MTC 3
E Conventions for administrative assistance in tax administration
1. The OECD/Council of Europe Convention 1
2. Regional arrangements for cooperation in tax administration 1
F Base Erosion and Profit Shifting (BEPS)
1. Awareness of the scope and details of the OECD BEPS Project 3
2. Overview of all BEPS actions (1-15) 2
3. BEPS Action 2: hybrid mismatches 3
4. BEPS Action 3: CFC rules 3
5. BEPS Action 5: harmful tax practices 3
6. BEPS Action 11: Measuring and Monitoring BEPS 3
7. BEPS Action 12: Mandatory Disclosure Rules 3
8. BEPS Action 15: awareness and implications of the multilateral convention to implement
tax treaty related measures to prevent BEPS 3

V Miscellaneous topics
A Indirect taxes and international taxation
1. The origin and destination bases for indirect taxes 2
2. GATT and GATS rules and the limitation on border tax adjustment 2
3. WTO rules and taxes – the WTO dispute resolution regime and taxation 2
B Cross-border mergers
1. Examination of some of the issues and solutions 2
C Estate and gift taxation and international issues
1. The taxation issues of cross-border probate 1
2. The OECD Model Double Taxation Convention on Estates and Inheritances 1

ADIT 7
Principles of International Taxation
Recommended ways to prepare for the exam

Course Provision Essential Reading


There are study options to suit everyone, from OECD. Action Plan on Base Erosion and Profit Shifting
classroom learning to self-study. Whatever your (Paris: OECD, 2013) [ISBN: 9789264202702]
preference, you’ll find a method and providers that Available from the OECD:
work for you. Find out more at www.oecd-ilibrary.org
www.adit.org.uk/courses
Candidates can obtain OECD documents from some
bookshops, or directly from the OECD
Permitted Texts iLibrary at www.oecd-ilibrary.org.

Candidates may take a copy of the following texts into The materials listed above are also included in the
the examination: following permitted book: Van Raad, K. Materials on
International, TP and EU Tax Law 2018-2019. Volume A
OECD. Base Erosion and Profit Shifting Project: 2015
Final Reports, Executive Summaries (Paris: OECD, 2015)
Available from the OECD: Books
www.oecd.org/ctp/beps-reports-2015-executive-
summaries.pdf Unfortunately, there is no single textbook or casebook
for the entire syllabus. There are books which
OECD, Committee on Fiscal Affairs. Model Tax cover parts of the syllabus, but these need to be
Convention on Income and on Capital (Paris: OECD, supplemented by references to articles in periodicals
2017) [ISBN: 9789264287945] (see below).
Available from the OECD:
www.oecd-ilibrary.org Most of the books below are available from
Or available from Turpin Distribution: www.amazon.com. CCH publications are available to
ebiz.turpin-distribution.com order from www.cchinformation.co.uk.

OECD, Committee on Fiscal Affairs. Transfer Pricing Books to which candidates should refer are:
Guidelines for Multinational Enterprises and
Tax Administrations (Paris: OECD, 2017) [ISBN: Baker, P. Double Taxation Conventions (London: Sweet
9789264262737] & Maxwell, 3rd edition, 2001) [ISBN: 9780421673601]
Available from the OECD: Available from Sweet & Maxwell:
www.oecd-ilibrary.org www.sweetandmaxwell.co.uk
Or available from Turpin Distribution:
ebiz.turpin-distribution.com Dixon, J. and Finney, M. Tolley’s International Corporate
Tax Planning (London: Tolley’s Publishing, 2002) [ISBN:
Van Raad, K. Materials on International, TP and EU Tax 9780754513391]
Law 2018-2019. Volume A (Leiden: International Tax Available from Amazon: www.amazon.com
Centre, 2018) [ISBN: 9789082585414]
Candidates with a pre-2016 edition may instead take Harris, P. and Oliver, D. International Commercial Tax
Volume 1 of the earlier edition into the examination. (Cambridge: Cambridge University Press, 2010) [ISBN:
Available from the International Tax Centre at Leiden 9780521853118]
University: Available from Amazon: www.amazon.com
www.itc-leiden.nl or b.bosman@itc-leiden.nl Or available from Google Books: books.google.co.uk
Or available from Wildy & Sons: www.wildy.com

8 ADIT
Principles of International Taxation
Recommended ways to prepare for the exam

Holmes, K. International Tax Policy and Double Shome, P. et al. Base Erosion and Profit Shifting (BEPS):
Taxation Treaties (IBFD, 2nd edition, 2014) [ISBN: The Global Taxation Agenda (New Delhi: Wolters
9789087222574] Kluwer, 2016) [ISBN: 9789351297246]
Available from IBFD: www.ibfd.org Available from CCH: www.cchindiastore.com
Or available from Amazon: www.amazon.com
Reimer, E. and Rust, A (eds) Klaus Vogel On
Li, J. International Taxation in the Age of Electronic Double Taxation Conventions (London: Kluwer
Commerce: A Comparative Study Law International, 4th edition, 2014) [ISBN:
(Canadian Tax Foundation, 2003) [ISBN: 9789041122988]
9780888081841] Available from Amazon: www.amazon.com
Available from Canadian Tax Foundation: www.ctf.ca

Miller, A., Oats, L. and Mulligan, E. Principles of Periodicals


International Taxation (Bloomsbury Professional, 6th
edition, 2017) [ISBN: 9781526501691] Because international taxation is a rapidly developing
Contents catered to ADIT syllabus. subject, and because of the lack of a single textbook,
Available from Bloomsbury Professional: candidates will have to follow much of the course
www.bloomsburyprofessional.com through articles in periodicals. Several periodicals
are devoted to the subject of international taxation.
Ogley, A. Principles of International Taxation: A Unfortunately, only a very good tax library is likely to
Multinational Perspective (London: Interfisc Publishing, have all these periodicals. A number of the journals are
1993) [ISBN: 9780952044208] available electronically from various websites.
Available from Amazon: www.amazon.com
The principal periodicals are:
Qureshi, A. The Public International Law of Taxation: British Tax Review (London: Sweet & Maxwell) [ISSN:
Text, Cases and Materials (London: 00071870]
Kluwer Law International, 1994) [ISBN: 9781853339509] Also known as BTR.
Available from Amazon: www.amazon.com Available from Sweet & Maxwell:
www.sweetandmaxwell.co.uk
Russo, R., Finnerty, C., Merks, P. and Pettricione, M.
Fundamentals of International Tax Planning (IBFD, Bulletin for International Taxation (Amsterdam: IBFD)
2007) [ISBN: 9789087220167] [ISSN: 00074624]
Available from IBFD: www.ibfd.org Available from IBFD:
www.ibfd.org
Schwarz, J. Schwarz on Tax Treaties (Croner-i, 5th
edition, 2018) [ISBN: 9781785400742] Cahiers de Droit Fiscal International (Studies on
Available from Croner-i: www.croneri.co.uk (Discount International Fiscal Law) (Deventer: Kluwer Law
available for registered ADIT students) International)
Also known as Cahiers DFI. Despite its title, most
Schwarz, J. Booth and Schwarz: Residence, Domicile and reports in the Cahiers are published in English.
UK Taxation (Bloomsbury Professional, 20th edition, Available from IFA:
2018) [ISBN: 9781526506160] www.ifa.nl/publications/cahiers/pages/default.aspx
Available from Bloomsbury Professional:
www.bloomsburyprofessional.com
Or available from Amazon: www.amazon.com

ADIT 9
Principles of International Taxation
Recommended ways to prepare for the exam

EC Tax Review (New York: Kluwer Law International) Case Law


[ISBN: 9789880007408]
Published together with Intertax. The syllabus does not examine the rules of any one
Available from Kluwer Law International: state. Decisions of the courts of many
www.kluwerlawonline.com countries are therefore relevant to this subject. Leading
cases are drawn from as far afield as New Zealand,
European Taxation (Amsterdam: IBFD) [ISSN: 00143138] South Africa, Canada, France and Germany. Cases from
Also known as ET. the non-English speaking world are generally from
Available from IBFD: www.ibfd.org the Bundesfinanzhof (German Federal Tax Court), the
Conseil d’Etat (French Supreme Administrative Court) or
Intertax (Deventer: Kluwer Law International) the Hoge Raad (Netherlands Supreme Court). The more
Published together with EC Tax Review. important cases are summarised in European Taxation
Available from Kluwer Law International: or the Bulletin for International Taxation.
www.kluwerlawonline.com
International Tax Law Reports, also known as ITLR,
Tax Notes International (Tax Analysts) [ISSN: 10483306] contains the texts of important international tax cases
Available from LexisNexis: www.lexisnexis.co.uk (including English translations of some cases).
Also available from Tax Analysts: www.taxanalysts.com Available from LexisNexis: www.lexisnexis.co.uk

These law reports are available online as part of the


LexisNexis online service. CCH’s British Tax Cases are
also useful.

10 ADIT
Principles of International Taxation
June 2018 examination questions

Transparent and accessible past papers Other papers available


Real questions and answers from previous exams
PRINCIPLES OF INTERNATIONAL TAXATION
are available to ADIT students to help with their
study. Practice with previous exams helps students AUSTRALIA INDIA
become familiar with the format of the exam,
identify areas for further study and focus on exam BANKING IRELAND
technique.
BRAZIL MALTA
CHINA SINGAPORE
CYPRUS TRANSFER PRICING
EU DIRECT TAX UNITED KINGDOM
EU VAT UNITED STATES
HONG KONG UPSTREAM OIL & GAS

ADIT 11
THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION

June 2018

MODULE 1

PRINCIPLES OF INTERNATIONAL TAXATION

TIME ALLOWED – 3¼ HOURS

This exam paper has two parts: Part A and Part B.

You need to answer four questions in total.

You must answer:


 At least two questions in Part A (25 marks each)
 At least one question from Part B (25 marks each)

Further instructions
 All workings should be made to the nearest month and you must use the appropriate
monetary currency, unless otherwise stated.
 Start each answer on a new page and clearly indicate which question you are answering.
If you are using the on-screen method to complete your exam, you must provide
appropriate line breaks between each question, and clearly indicate the start of each new
question using the formatting tools available.
 Marks may be allocated for presentation.
 The first 15 minutes of the exam consists of reading time. You will be allowed to annotate
the question paper during this time; however, you will not be permitted to start writing or
typing your answer. The Presiding Officer will inform you when you can start answering
the questions.
Module 1 – Principles of International Taxation (June 2018)

PART A

You are required to answer AT LEAST TWO questions from this Part.

1. “Tax sharing is a typical compromise to settle a clash between the state of source and
the state of residence”.

E. Kemmeren, “Preface to Articles 10 to 12” in Reimer and Rust (eds), Klaus Vogel on
Double Taxation Conventions, 4th ed. (Wolters Kluwer, 2015)

Discuss the above quotation in the context of Articles 10, 11 and 12 of the OECD
and UN Model Tax Conventions. (25)

2. Discuss the formation of legal norms in relation to tax competition. (25)

3. Is the notion of tax sovereignty still relevant in the current era of multilateralism?
(25)

4. What does Gordon J mean in Bywater Investments Limited & Ors v. Commissioner
of Taxation [2016] HCA 45 at paragraph 139, when he states that “‘central
management and control’ and ‘place of effective management’ are different
concepts in different instruments”?

In your opinion, how relevant might this statement prove to be in the future? (25)

5. “Taxpayers are justified in being concerned that the relevant tax authorities may misuse
information obtained as a consequence of their governments’ implementation of BEPS
Action 13.”

Discuss this statement. (25)

Page 2 of 4
Module 1 – Principles of International Taxation (June 2018)

PART B

You are required to answer AT LEAST ONE question from this Part.

6. Pine Ltd, a company incorporated and resident in the country of Evergreenia, was
assessed for the 2016/17 tax year and paid taxes on its global income in Evergreenia.
The income was derived from the provision of IT services.

Pine Ltd is a 100% holding company of Oak Ltd, which is tax resident in the country of
Deciduousa. Oak Ltd undertakes some software development activities on behalf of the
group, and also runs a call centre. It has been accepted by all concerned that the dealings
between Pine Ltd and Oak Ltd raise no issues from a transfer pricing perspective. Pine
Ltd has no clients in Deciduousa.

The following facts have been established in relation to the corporate group:

 40% of the group’s employees are based in Deciduousa.

 All of the group’s call centres and software development centres are situated in
Deciduousa.

 Pine Ltd is essentially performing marketing work only, and its contracts with clients
are assigned or sub-contracted to Oak Ltd.

 The master services agreement between Oak Ltd and Pine Ltd gives complete
control to Pine Ltd in regard to personnel employed by Oak Ltd.

 It is only through the proprietary database and software of Pine Ltd that Oak Ltd
carries out its functions for the group. The software and data is provided free of cost
to Oak Ltd.

The Deciduousa Revenue Authority (DRA) contends that some of Pine Ltd’s profits are
attributable to and taxable in Deciduousa, because Pine Ltd had a permanent
establishment (PE) in Deciduousa at all material times. The DRA argues that the income
earned and taxed in the hands of Oak Ltd is materially different from the income
attributable to the PE of Pine Ltd, as the latter includes some of Pine Ltd’s tax base.

Advise Pine Ltd whether, in accordance with the OECD Model Tax Convention, it
might have a taxable presence in Deciduousa. (25)

Page 3 of 4
Module 1 – Principles of International Taxation (June 2018)

7. D Bank is resident in Delphinia. It has entered into an interest-based equity swap


agreement with counterparty banks resident in Countries M, N, O and P. D Bank sells
return swaps on baskets of shares in companies (i.e. total return swaps) listed in another
country, Suritana, to the counterparty banks, and purchases shares of companies listed
in Suritana in order to hedge the swaps.

Under the terms of the arrangement, D Bank is the short total return swap party (i.e. it has
to pay the dividends and any increase in share value but is not exposed to any decrease
in share value) and the counterparty banks M, N, O and P are the long total return swap
parties (meaning that they are required to make periodic payments to D Bank based on
interest rates, and must pay D Bank where the shares decrease in value over the term of
the agreement).

Under the arrangement, D bank is to:

 pay any appreciation in the value of the shares to the counterparty banks;
 be compensated for any depreciation in value of the shares;
 pay any dividends to the counterparty banks; and
 receive a market interest rate plus a margin.

The minimum holding period is three months, with the average holding period being six
months. The shares subject to the swaps agreement were held in various companies
listed on Suritana’s stock exchange.

D Bank received dividends from Suritana shares and then paid these on to the
counterparty banks via the swaps. The purchase and sale of the shares were conducted
using an international broker and were ‘over the counter’ (i.e. tailor-made). D Bank was
issued with a certificate on file, stating that the seller and the parties subject to the swap
agreement are not the same person.

Suritana and Delphinia entered into a Double Taxation Agreement (DTA) soon after the
first draft OECD Model Tax Convention was published in 1963 and have not agreed upon
any amending protocols. Article 10 of the Suritana-Delphinia DTA provides that dividends
are only subject to tax in the contracting state of which the recipient of the dividends is
resident. However, Suritana levied 30% withholding tax on the dividends received by D
Bank under its domestic law. D Bank claimed a refund of the withholding tax levied from
Suritana on the basis that Article 10 of the Suritana-Delphinia DTA only permits taxation
in the resident state of the recipient (i.e. Delphinia). Suritana has denied the refund on the
basis of its own domestic anti-abuse rules.

You are required to write a memo to D Bank, setting out what you consider to be
the major challenges in successfully arguing that Suritana has wrongly denied the
refund of withholding tax levied on the dividends. Your answer should address the
potential weaknesses in any claim that D Bank may bring against Suritana for
reliance on their domestic anti-abuse provisions.

Your answer should be placed within the context of the recent work of the OECD
and G20, with specific regard to the improper use of DTAs and the interaction of
domestic anti-abuse rules and DTAs. (25)

Page 4 of 4
THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION

June 2018

MODULE 1

SUGGESTED SOLUTIONS
Module 1 (June 2018)

PART A

Question 1

This question is designed to identify whether students appreciate the uniqueness of the
mechanism for allocating taxing jurisdiction that is to be found in the passive income articles of
the UN and OECD Model Tax Conventions (MTCs).

The following is one possible schematic.

Introduction

 Articles 10-12 in both the OECD and UN MTCs allocate taxing jurisdiction with regards
to the passive income received by both natural and legal persons.

 Article 10 is concerned with dividends; Article 11 is concerned with interest; and Article
12 is concerned with royalties.

 Tax jurisdiction is shared in relation to dividends and interest in both MTCs. However, in
relation to royalties, only the UN MTC recommends shared jurisdiction. The OECD MTC
allocates taxing jurisdiction in respect of royalties exclusively to the state of residence.

Tax Sharing

 Tax sharing in the context of passive income and DTCs means that the state of source
is granted a limited jurisdiction to tax. This means that the state of residence should credit
the recipient with the tax paid in the state of source, even if the state of residence would
ordinarily apply the exemption method.

 Tax sharing is certainly one way to reach a compromise where both states believe that
they have the right to tax a certain kind of income. It is a compromise in that neither state
need to completely forego revenues from said income.

 From a theoretical point of view, the state of residence is justified in claiming jurisdiction
to tax as the capital that is invested/loaned can be said to originate from the GDP of that
state.

 However, the state of source can also legitimately claim jurisdiction on the basis that the
income itself is produced by means of factors specific to that state (e.g. institutions,
infrastructure and labour). This is particularly true of capital importing (or developing)
countries who only get one shot at extracting revenue from wealth that ultimately flows
abroad.

 From a practical perspective, it is certainly the case that capital importing countries are
in need of the government revenues that could be collected from the taxation of passive
income.

 It is of interest that the 1971 Andean Model exclusively allocates taxing jurisdiction with
regards to passive income to the state of source. However, the UN MTC did not adopt
this approach, and this despite some considerable pressure from developing states for
such exclusive taxing rights. The compromise in evidence in the UN MTC is that it does
not provide for a maximum threshold for rates at which the state of source may tax
passive income.

Drawbacks

 A major drawback of tax sharing arises as a result of tax incentives being granted by the
state of source to the investor. Where this happens, the benefit of the incentive is
effectively transferred to the state of residence. This is because the state of residence is
not required to credit to the taxpayer tax that has not been paid in the state of source.

Page 2 of 17
Module 1 (June 2018)

 Not even the UN MTC provides a treaty solution for this scenario. As a result, capital
importing states do not have this kind of fiscal stimulus available to them in relation to
passive income.

 A tax sparing credit or a matching credit is a potential solution to this problem. In their
DTCs with developing countries (albeit subject to certain conditions), European
countries, Canada and Japan, have included such credits.

 The US does not adopt the tax sparing credit/matching credit approach.

 Although states have the sovereign right to use fiscal policy to incentivise or disincentive
economic activities as they see fit, the incentive/tax sparing issue can be mixed up with
the more theoretical arguments around the legitimacy of using tax incentives to attract
foreign direct investment. There is clearly a fine line between incentivising an economic
activity and harmful tax competition. The result is that many OECD member states allow
tax sparing credits that are time-limited and restricted to certain economic activities.

Conclusion

 Unlike passive income, the MTCs allocate taxing jurisdiction of the other types of income
to one of the contracting states either exclusively or primarily. Thus, these types of
income may well be taxed at the full domestic rate of the particular state concerned. In
relation to these other types of income, both from the perspective of the MTCs and tax
treaty practice generally, tax sharing is clearly not the norm.

 Tax sharing in relation to passive income, as a compromise solution, has not been
without its unique problems. For example, there has been difficulty around the concept
of monies being “paid to … a resident”. Some argue that this ushered in the concept of
beneficial ownership, an anti-avoidance measure, which itself has caused its own
interpretational difficulties.

 In 1892, George von Schanz suggested tax sharing at a tax base level (i.e. allocate a
certain percentage of the income/profits to the state of source and let them apply their
own domestic tax law in relation to that amount, with the remainder (in a two state
scenario) being allocated to the state of residence to do likewise). Despite constituting a
possible alternative to the tax sharing mechanism provided for by the MTCs, his
suggestion was only applied once in Article 15 of the 1939 DTC between France and the
US.

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Question 2

This question relates specifically to the formation of international tax law (ITL) norms and
requires students to consider the formation of these norms in the context of tax competition.

This question has been designed to play to the strengths of some of the more advanced
students. It challenges students in that it requires them to think critically about the knowledge
they have acquired in one of these three areas, in order to extrapolate how ITL norms are
formed.

There is, nonetheless, some flexibility when answering this question. For example, some
students might wish to:

 consider implementation, compliance and effectiveness as aspects of the formation of


ITL norms;

 focus on the development of ITL norms in relation to corporate tax avoidance or individual
tax evasion; or

 consider the issue from an ‘institutional structure’ perspective.

The following is one possible schematic.

Introduction

This answer focuses on the formation of ITL norms in relation to the harmful tax competition
framework. The OECD Base Erosion and Profit Shifting (BEPS) Action 5 report, Countering
Harmful Tax Practices More Effectively, Taking Into Account Transparency and Substance
(OECD, 2015) (hereinafter “the 2015 Report”) continues the work of the 1998 Harmful Tax
Competition report (hereinafter “the 1998 Report”).

Unlike the 1998 Report, the 2015 Report focuses on preferential tax regimes – not tax havens.

The 1998 Report

The 1998 Report arguably contains three key factors:

 no or low effective tax rates;


 ring-fencing of regimes; lack of transparency; and
 lack of effective exchange of information.

More minor factors contained within the 1998 Report are:

 an artificial definition of the tax base;


 failure to adhere to international transfer pricing principles;
 foreign source income exempt from residence country tax;
 negotiable tax rate or tax base;
 existence of secrecy provisions;
 access to a wide network of tax treaties;
 regimes which are promoted as tax minimisation vehicles; and
 regimes which encourage purely tax-driven operations or arrangements.

The 2015 Report

The 2015 Report arguably covers three main areas:

 realigning the taxation of corporate income with the substantial activities that generate
that income, a stronger substantial activity requirement for the assessment of preferential

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regimes (using a nexus approach equating expenditure with activity for the purposes of
substantial activity analysis);

 a compulsory framework exchanging tax rulings in order to improve transparency (the


framework categorizes the types of rulings covered and provides details relevant to the
technicalities of exchange); and

 reviewing 43 preferential regimes in several countries according to the 1998 factors, the
substantial activity factors, and the transparency factors.

The Norms

It can be seen that the norms apparent from these two reports can be classified according to
the following two broad criteria:

1) substantive norms: prescriptive harmonisation (e.g. failure to adhere to international


transfer pricing principles and the substantial activity “nexus approach”); and

2) administrative norms: transparency and cooperation.

Analysis and Conclusion

There is a question to be asked as to whether prescriptive harmonisation is consistent with


encouraging transparency and cooperation. While the former is about telling states what to do,
the latter is about allowing states to exercise their tax sovereignty with the caveat that they must
do so as ‘good neighbours’.

Prescriptive harmonisation clearly embodies the ‘older’ approach of the 1998 Report. In this
regard, there is clearly an attempt to show some ‘continuity’ of thinking in relation to harmful tax
competition generally. However, one wonders whether the need to show such continuity is as
important as the need for logical coherency within the international/emerging global tax regime.
Either international tax policy is going back to the days of seeking to achieve harmonisation
through standardisation or it is moving forward as a variant of fiscal federalism, which allows
sovereign states the freedom to design and implement their own tax systems but with
cooperation and transparency paramount in relation to dealing with other sovereign states.

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Question 3

This question seeks to test students’ understanding of a fundamental tax law concept, tax
sovereignty. It also seeks to test the ability to critically analyse the notion of tax sovereignty in
the face of the global move towards increasing tax cooperation, as evidenced by developments
such as the BEPS Agenda.

Students should have an appreciation of the fact that taxation is at the core of state sovereignty.
They should also have an appreciation that states are increasingly circumscribed in their ability
to maintain their traditional role. Some commentators maintain that there is a disconnectedness
underlying the idea of tax sovereignty, which has made room for tax competition. The net result
being that taxpayers are now effectively allowed to choose the most convenient tax system for
them and that states are sometimes seen to be recruiters of investment (and tax revenues) by
guiding that choice.

Some students might like to go further and argue that the notion of tax sovereignty is now
obsolete.

The following is one possible schematic.

Introduction

Tax sovereignty in general refers to a state’s legitimate power to create taxes and decide upon
its preferred criteria of equality and norms of justice in tax matters. However, globalisation has
meant difficulties in a state establishing its tax sovereignty without the cooperation of others
states and taxpayers. This is in the main due to the persistent interaction of fiscal systems and
tax policies, tax competition, and tax planning by MNEs.

Sovereignty and Jurisdiction

Tax sovereignty arguably has two main elements:

 the power over a territory (‘enforcement jurisdiction’)


 the power over a particular set of subjects (‘political allegiance’).

This duality may well have exercised a significant influence in the fashioning of another
fundamental tax law concept – the jurisdiction to tax – in that taxes ought to be confined to
taxable subjects and objects that have some sort of connection with the state. Hence, the idea
that a legitimate tax claim ought to be either based on a personal or territorial attachment.

Jurisdiction, generally, can be understood as the power (right) of a state to exercise legislative
(prescriptive) jurisdiction and enforcement (executive) jurisdiction. As one kind of a state’s
jurisdiction, tax jurisdiction can therefore be thought of in terms of:

 the power (right) of a state in the taxation field;


 legislative (prescriptive) fiscal jurisdiction (a state’s competence to legislate); and
 enforcement (executive) fiscal jurisdiction (law enforcement).

Constraints

The OECD recognises that:

“Every jurisdiction is free to set up its corporate tax system as it chooses. States
have the sovereignty to implement tax measures that raise revenues to pay for the
expenditures they deem necessary.”

However, this power is not absolute. Certain ‘de facto’ realities include:

 the power to tax of other States or jurisdictions;


 the strategies of taxpayers;

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 supranational and international institutions, and


 market forces which arise at international level from tax competition and at national level
from the black market.

There are also domestic and international juridical constraints. The domestic constraints include
constitutional restrictions and certain juridical principles (e.g. efficiency, safety, equity,
proportionality, ability to pay). The international constraints include DTAs based on the idea of
‘pacta sunt servanda’ and a general or customary consensus on certain taxation principles (e.g.
the right to tax being based on a factor that determines connection to a jurisdiction).

Two Schools of Thought

One school of thought is that there are no limitations of a state’s legislative fiscal jurisdiction
under international law. There is no public international restriction and the state has the freedom
to tax. The only limitations are those related to the territoriality of the enforcement. This school
of thought can be tracked back to the Lotus case, which established that every state is free to
adopt the principles it wants subject to the prohibitive rules which have been agreed, directly or
indirectly, by the states.

The second school of thought considers that there should be a ‘link’ or ‘reasonable connection’
between the state and the taxpayer when a state claims legislative jurisdiction on fiscal matters.
Without the connections, a state is prevented from enacting and enforcing tax jurisdiction on
the taxpayers. An early example of this school of thought can be found in the Cutting case,
where a state could not justify the jurisdiction unless it is permitted by the positive rule of
international law.

Ultimately and most importantly for the purposes of this question, both schools agree that
jurisdiction is limited by enforcement ability: that tax jurisdiction is based on state sovereignty.
Indeed, power over a territory means not only applying its tax law internally but also the power
to prevent the application of foreign tax law inside its frontiers. This jurisdiction to enforce taxes
is arguably the most important side of the tax sovereignty. The power of a jurisdiction to impose
taxes is one of the classical features of tax sovereignty, which also implicates the power to
negotiate and to conclude tax agreements.

Conclusion

Whether conceptualised in terms of sovereignty or jurisdiction, the inescapable fact is that


multilateralism and globalisation have constrained states in the area of taxation. There are
certain legal and practical realities that mean states are curtailed in what they can and cannot
do in terms of taxation, particularly those limits that are determined on a multilateral basis, such
as the recently manifested BEPS Agenda.

This debate is ultimately not an academic one. It is important to remember that after the global
financial crisis, states are persistently seeking to overstretch the connecting factors to tax
jurisdiction in order to maximise their tax collection.

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Question 4

This question confronts the fact that students often confuse the approach taken by the courts
when it comes to determining place of effective management (“POEM”) and central
management and control (“CMC”).

It is important that students realise that CMC is a test that is usually found in the domestic
legislation of common law jurisdictions and pertains to unilateral domestic rules, whereas
POEM is now part of a tie-breaker test that is to be found in Article 4 of the Organisation for
Economic Co-operation and Development’s (“the OECD”) Model Tax Convention on Income
and on Capital (“OECD MTC”).

The way that the courts approach and interpret these two concepts is necessarily informed by
both their origin and purpose.

Students may also mention the fact the tie-breaker test for dual resident companies in the most
recent OECD MTC (2017) has recently changed. Article 4(3) now provides that, inter alia, “the
competent authorities of the CSs shall endeavour to determine by mutual agreement the CS of
which such person shall be deemed to be a resident for the purposes of Convention, having
regard to its POEM, the place where it is incorporated or otherwise constituted and any other
relevant factors.”

This new wording indicates that a determination of a POEM is still relevant to the determination
of residence for DTA purposes of a dual resident company but that other factors associated
with the determination of residence status are also relevant to the determination of residence
status for DTA purposes (e.g. location of: headquarters; day to day senior management; place
of incorporation etc. see [24.1] Commentary on Article 4(3).

The following is one possible schematic.

Introduction

Arguably, one may look to the same matters in order to determine both POEM and the place of
CMC. Indeed, in some cases the result may be the same (see, Wood v Holden). However, they
are nonetheless different concepts. The meaning of POEM (a treaty term) and CMC (a domestic
legal term) turns on the interpretation of each phrase as it appears in the relevant instrument,
which is from an interpretational perspective often different. Each must be examined to
determine its applicability in any given case. It cannot be assumed that if one test is satisfied,
it will follow that the other is also satisfied.

POEM

 Art. 4(4) of the OECD MTC refers to POEM.

 VCLT, Art.31(4) provides that a special meaning shall be given to a term if it is


established that the parties so intended. One issue is therefore whether POEM should
have a treaty meaning or a domestic law meaning in accordance with OECD MTC,
Art.3(2).

 The Commentary to Art.4(3) suggests “a special treaty meaning but it is so qualified that
this is not clear” (Harris and Oliver).

 Vogel supports an autonomous meaning, i.e. disregarding domestic law.

 VCLT, Art.31(1), provides that a “treaty shall be interpreted in good faith in accordance
with the ordinary meaning to be given to the terms of the treaty in their context and in the
light of its object and purpose”. Interpretation of POEM is thus undertaken in relation to
a DTA.

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 The location of the formal organs of a company is not determinative of POEM, which
imposes a requirement that the inquiry go beyond the mere formalities of where the
formal organs of a company are located. This is consistent with the object and purpose
of the OECD MTC.

 Residency is key to the OECD MTC. Art.4(4) comes into its own when residency is
insufficient to answer the following question: in which country should the person be
taxed? Art.4(4) breaks any deadlock. Depending on the domestic laws of the relevant
Contracting States, its ability to break a deadlock would be undermined were it construed
so as to be limited to an inquiry about the location of the formal organs of a company.
That construction is confirmed by VCLT, Art.32, which provides that “[r]ecourse may be
had to supplementary means of interpretation ... in order to confirm the meaning resulting
from the application of article 31”. In Thiel v Federal Commissioner of Taxation, all
members of the Court referred to the Commentaries on the Articles of the OECD MTC in
accordance with Art. 32.

 The Commentary on Art.4 explains that, while POEM may “ordinarily” be the place where
the board of directors makes its decisions, “all relevant facts and circumstances must be
examined to determine [where] the place of effective management” of a company is
located.

CMC

 De Beers Consolidated Mines Ltd v Howe is the usual starting point for understanding
the CMC test.

 CMC centres on the highest level of decision-making:

“A company cannot eat or sleep, but it can keep house and do business. We ought,
therefore, to see where it really keeps house and does business ... [it] resides ...
where its real business is carried on ... I regard that as the true rule, and the real
business is carried on where the central management and control actually abides.”

 In Fundy Settlement v Canada, the court stated that CMC is generally where the board
of directors exercises its responsibilities.

 If the facts of a case show that the exercise of those responsibilities was carried out by
a shareholder or a shadow director, it will be resident where that person makes the
decisions.

Same or Different?

In Wood v Holden, the court stated that it was not clear

“whether the article 4(3) test differs in substance from the De Beers test; and, if
the two tests are not, in substance, the same, I find it very difficult to see how, in
the circumstances which the commissioners had to consider, they could lead to
different answers.”

 Harris and Oliver suggest that a corporation may be centrally managed and controlled in
more than one place and POEM can be in only one place.

 CMC focuses on where strategic decisions are made, while POEM focuses on where the
top-level decisions are formulated.

 Panayi suggests the two tests are similar, not identical. They fulfil different functions and
the onus of proof required to satisfy each test may differ.

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Conclusion

Some authors argue that POEM and CMC are identical (e.g. Owen and Hattingh). Others
disagree (e.g. Harris and Oliver). The last word should probably be given to the Special
Commissioners in the Smallwood case, at para.111:

“[T]he two concepts serve entirely different purposes. CMC determines whether a
company is resident in the United Kingdom or not; POEM is a tie-breaker the
purpose of which is to resolve cases of dual residence by determining in which of
two states it is to be found. CMC is essentially a one-country test; the purpose is
not to decide where residence is situated, but whether or not it is situated in the
United Kingdom … POEM, on the other hand, must be concerned with what
happens in both states since its purpose is to resolve residence under domestic
law in both states, caused for whatever reason, which could include incorporation
in one state and management in the other, or different meanings of management
applied in each state, or different interpretations of the same meaning of
management applied in each state, or divided management.”

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Question 5

There are a number of ways to evaluate this statement and the suggested solution below
constitutes one possible approach. At a general level, students should consider Action 13 and
whether taxpayers may be objectively justified in their concern that information gathered and
exchanged by tax authorities may be misused.

The following is one possible schematic.

Introduction

 General trend towards enhanced transparency, which has culminated with automatic
exchange of information and country by country reporting (CbCR)

 In relation to CbCR there have been some attempts at developing a type of international
tax file (Grau Ruiz, 2014) in, inter alia, some economic sectors in the European Union.

 Students should consider the extent to which taxpayers should be concerned that an
implementation of Action 13 BEPS by countries may have negative externalities for said
taxpayers due to lack of confidentiality, uses for which data gathered may be put etc.

Action 13

 BEPS Action 13 anticipates the development of rules that will enhance transparency
through improved and standardised transfer pricing documentation and effective
exchange of said information, which will, in turn, enable countries to monitor transfer
pricing issues, the global allocation of income and have an indication of the level of tax
being paid by any relevant entities in other countries.

 More specifically BEPS Action 13 provides for tax documentation to contain a master file,
local file and country by country report.

 Whilst all three documents are highly important it is the CbCR report that relates most
directly to the quote in the question as the information to be contained within the report
includes at a general level: (i) information about the global allocation of income (i) global
information about taxes paid (iii) information about the economic activity of the relevant
entity. There has been a concern that a significant amount of this information is highly
sensitive, which supports the claim made in the quote.

 However, the model CbCR report requires less detailed information than that proposed
in Action 13 so whilst taxpayers may have been justified in being concerned about the
proposals in Action 13 BEPS Discussion Draft, arguably there may be less justification
for being concerned about the model report from a sensitivity of information perspective.

 Furthermore, and as noted by Brauner in 2015, the content of the recommended tax
documentation and especially the CbCR report do not include any information about
individual transactions carried out between associated enterprises, which is what is
needed for a transfer pricing analysis based on the arm’s length standard to be effected.
Again, whilst the lack of such information is arguably inconsistent with the arm’s length
standard, the lack of information about individual transactions may allay concerns about
the nature of the information being exchanged and collated.

Use of Information

 Information obtained and exchanged may be used for a number of purposes.

 There is a concern that the information may be used for improper uses.

 Need to consider what proper and improper use involves.

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 Action 13 refers to using the information from the CbCR “appropriately”, which means for
assessing high-level transfer pricing and other BEPS related risks, as well as for
economic and statistical analysis that may be useful in tax audits/investigations.

 It has been suggested that in this context “tax audits” should be narrowly construed such
that these should relate to a relevant transfer pricing inquiry or a relevant BEPS related
risk (with an international dimension).

 Confidentiality safeguards are clearly important (see, the guidelines in Article 6) and it
appears that not all countries are intending to implement this Article. Where this is the
case the quote may become more relevant.

 It appears that the OECD has sought to shut down the possibility that information
gathered and exchanged could be used for a different approach to allocation of income
across borders, namely global formulary apportionment (Borges and Takano, 2017 and
Final Report Action 13, 2015, 22 [59]).

Conclusion

 Students may wish to conclude by reflecting on the wording of Action 13 itself, the
function Action 13 seeks to serve, issues around confidentiality of data collected and
reference any knowledge of domestic implementation of developments in the area.

 In countries where there is less of a tradition of trust between taxpayers and revenue
authorities it is possible that the quote is more likely to be true than where there is such
a tradition (see, Owens, 2008 and Borges and Takano, 2017).

 Where countries have opted out of the relevant guidelines related to confidentiality of
information derived from country by country reporting this may also justify a defensive
position on the part of taxpayers.

 Some countries, such as Brazil, have no express limitation on the uses of the information
gathered (Borges and Takano, 2017) and, thus, the quote may be true for taxpayers in
such countries.

 There is also a view that CbCR raises a sovereignty issue in that (Schoueri and Barbosa,
2013) taxpayers, who have a relevant nexus with one country, may comply with
regulations requiring information to be handed over to the tax authority of that country as
there is an implicit acceptance that said taxpayer acknowledges the jurisdiction of the
relevant country, but that this does not necessarily extend to taxpayers whose
information is obtained by tax authorities that do not have jurisdiction over the taxpayer
without that taxpayer’s acceptance. Again, such a view may lend some support to the
validity of the quote in the question.

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PART B

Question 6

This question raises a number of issues. Is any part of the main business or revenue earning
activity of Pine Ltd carried on in Deciduousa, whether through a fixed base PE, which has been
put at their disposal by Oak Ltd, or otherwise? Or does Oak Ltd only render support services
that enable Pine Ltd to render services to their clients abroad? If it does provide support
services only, can the mere outsourcing of an activity, which enables Pine Ltd to render services
in turn to its clients outside Deciduousa, lead to creation of a PE?

The following is one possible schematic:

Introduction

A principle of international tax law is that a non-resident company can be taxed in the country
where it has a subsidiary, which is also a PE, on the profits attributable to said PE, even if the
subsidiary (in this case Oak Ltd) is being taxed in said country. The subsidiary, being an
independent and a distinct entity, is taxed on its income, whereas the foreign entity (Pine Ltd)
is taxed on the profits it makes and is attributable to the PE in the country where the subsidiary
is situated. The income of the subsidiary is not taxed in the hands of the non-resident principal
and vice-versa. Thus, there is no double taxation. Of course, the above stated principle requires
that a PE be found to exist. In our given fact pattern that means either the establishment of a
fixed base or service PE.

Also, the DRA clearly think that by establishing the existence of a PE the tax base will be bigger,
given that some of Pine’s profits will now also need to be attributed to Deciduousa (see the
point later about adopting a dual-entity approach with regards profit attribution).

Fixed Base PE

One approach to establishing a fixed place PE is to satisfy these three tests:

1) is there is a fixed base?


2) is it at the disposal of foreign enterprise? and
3) is the business of foreign enterprise being carried on in the fixed place?

One approach would be to assert a fixed base due to the outsourcing of activities to Oak Ltd,
relying on factors such as financial dependency, bearing of risk, and provision of free software.
Although Oak Ltd rendered support services only, these, in turn, enabled Pine Ltd to render
services to their clients abroad. Thus, there is a grey area between support services and the
main business activities of Pine Ltd.

The fact that the ‘support services’ were outsourced raises the issue as to whether outsourcing
business to subsidiary generally results in the creation of a PE. The fact that it is a 100%
subsidiary may or may not make a difference, as it is unclear whether Article 5(7) OECD MTC
applies in such situations.

The fact that the outsourced functions were arguably ‘back office’ functions, as opposed to front
office functions, may also indicate that main business activities of Pine Ltd were not being
carried on.

Service PE

The OECD MTC does not require that an enterprise must furnish services within the source
state. However, such a provision can be found in some DTAs.

In relation to who provides the service, it might not be necessary for employees of Pine Ltd to
have been in the jurisdiction for a requisite period. In ABB FZ LLC v DCIT (ITA TP No
1103/Bang/2013)) a Tax Tribunal has held that:

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“in the present age of technology where the services, information, consultancy,
management etc, can be provided with various virtual modes like email, internet,
video conference, remote monitoring, remote access to desktop, etc, through
various software, therefore, the argument of fixed place of business raised by the
assessee that three employees rendered services only for 25 days cannot be
sustained, as the services can be rendered without the physical presence of
employees of the assessee.”

There is also the possibility that the employees of Oak Ltd might also be capable of constituting
a services PE by carrying out the services on behalf of Pine Ltd.

Profit Attribution

One proposition is that once the arm’s length principle has been satisfied for compensating Oak
Ltd, no further profits would be attributable even if there exists a PE in Deciduousa (see, for
example, Morgan Stanley (2007) 9 ITLR 1124). This is the single entity approach. There is not
much commentary on the Authorised OECD Approach propagating a dual-entity approach.

Conclusion

On balance, it is arguable that Pine Ltd would not be found to have a PE in Deciduousa. While
it is seemingly possible, jurisprudentially, to find (i) a fixed base PE on the basis of outsourcing
and ‘control’, and (ii) a service PE given the ‘no fixed time’ and ‘no fixed employer’ ambiguity, it
is unlikely that a supreme court would go so far out on a limb in relation to both finding a PE
and adopting a dual-entity approach with regards profit attribution.

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Question 7

There is no requirement to identify any similarities with the Swiss court in: Federal Supreme
Court decisions 2C_364 and 377/2012 and 2C_895/2012 (although credit will be given if it is
discussed).

At a general level, students should extract the main issues from the fact pattern as involving
access to DTA benefits where a cross-border contract has been entered into. They should
address the contrast between Article 10 Suritana-Delphinia DTA and Article 10 OECD MTC
2017 including the lack of withholding tax and the concept of beneficial ownership (BO). They
should also address the interaction between domestic specific and/or GAARs and access to
the benefits of a DTA.

Marks are available for answers in the context of the OECD/G20’s work in this area including
in the area of improper use of DTAs and hybrid instruments.

The following is one possible schematic.

Introduction

 The nature of the transactions is unlikely to have been envisaged at the time the DTA in
the fact pattern was entered into.

 Derivatives may upset the traditional criterion of BO (Weidmann, 2016 and OECD
Innovative Financial Transactions: Tax Policy Implications, 2001). For example,
derivatives make it possible to fully or partly transfer economic risks and rewards of an
asset or liability without the actual transfer of the legal ownership by using equity swaps
or total return swaps; and in transactions where legal ownership of an asset or liability is
passed, derivatives can be used to retain economic exposure in relation to the asset or
liability.

Interest Based Equity Swaps

 The derivate contract in the fact pattern is an “interest-based equity swap”, which can be
broken down into four payment streams: (i) a dividend stream, (ii) an appreciation
payment or stream of payments, (iii) a depreciation payment or a stream of payments
and (iv) an interest based stream of payments (Fabozzi, 1998).

 The long party (i.e. Counterparty Banks) can replicate the economic effect of holding the
underlying equity without making an actual investment in that the equity swap simulates
a leveraged purchase of stock by the long party.

 The short party (i.e. D Bank) is in a position similar to a short seller of the underlying
stock (in that under a short selling arrangement the seller expects to benefit from an
anticipated depreciation in value of the shares).

Major Issues

 D Bank may not be the beneficial owner of the dividends as it has passed the market risk
to the Counterparty Banks under the swap agreement.

 Beneficial ownership is to be read into all DTAs entered into in spite of those DTAs not
explicitly referencing the term.

 In the fact pattern, there is no mention of the concept of beneficial owner being included
in Article 10 of the relevant DTA. The Commentary [on Article 1, [63]) notes that the
concept of beneficial owner constitutes a specific anti-abuse rule and that it seeks to
clarify the meaning of “paid to a ... resident” in Article 10(1) and thus has an international
fiscal meaning (not a domestic law meaning). Whilst in the fact pattern there is no

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mention of beneficial ownership, the OECD Commentary’s view on a situation where


there is no specific anti-abuse rule in a DTA is considered below.

 If the shares were purchased systematically shortly before the dividend date and sold
after the dividend due date with the aim of transferring dividends free of withholding tax
and the imposition of the broker is viewed as an indicator of the circularity of the
transaction, the purchase and disposal of the shares in Suritana companies might be
considered ‘non-market’. This may point towards a finding that D Bank should be denied
access to DTA benefits arising in respect of this arrangement. This perspective relies
upon the idea that the derivative contract was effected solely or mainly to create a tax
advantage such that access to the relevant DTA should be restricted.

 The transactions might constitute DTA abuse in spite of the fact that there is no anti-
abuse provision in the DTA. The basis for this being that the transactions were, in
combination, highly unusual in size, structure and only motivated by purely fiscal
considerations (they do after all together constitute a circular transaction).

 The Commentary on Article 1, OECD MTC 2017 provides that it is open to contracting
states to rely upon their domestic law or as part of the proper construction of the DTA
itself under Article 31 VCLT even where there is no specific anti-abuse rule in the DTA
[57] – [60] and [75]. The Commentary continues to note that it is important that DTA
benefits are not denied except in certain specified circumstances (i.e. where a main
purpose of the transaction was to secure a more favourable tax position and that this
principle applies independently of Article 29(9) OECD MTC 2017 [61]).

 It is evident that the DTA in the fact pattern is distinct from the OECD MTC 2017 in that
it does not permit any WHT, with the result that dividends paid by residents in Suritana
to a Delphinia resident may only be taxed in Delphinia. This is in contrast to Article 10(2)
OECD MTC 2017, which provides that limited withholding of 15% is permitted in the
source state as the default rule. A concessionary maximum rate of 5% applies in a
situation where the beneficial owner of the dividends is a company that holds directly
25% or more of the capital of the company paying the dividends throughout a 365 day
period that includes the date of payment of the dividend (Article 10(2) OECD MTC 2017).

Challenges

 The Suritana-Delphinia DTA is likely to be several decades old and does not appear to
have been updated. The result is that the current OECD guidance on the application and
interpretation of DTA terms is likely to be far removed from that contained within OECD
MTC 2017. However, students should consider whether the DTA is a “covered tax
agreement” for the purposes of the Multilateral Instrument and whether Delphinia and
Suritana have opted in to using any of the anti-abuse provisions contained therein.

 The introduction of a principal purpose test in the Multilateral Instrument and OECD MTC
2017 lends weight to the fact that it may prove difficult for D bank to successfully contest
Suritana’s denial of a refund of withholding tax.

Conclusion

 There has been a growing awareness that derivatives and innovative financial
instruments more generally create opportunities for tax advantages to be improperly
accessed at the domestic tax and also DTA level.

 Under the Belgium / Netherlands DTA (specifically under the Joint Explanatory
Memorandum on Article 10) both CSs are permitted to apply their own anti-avoidance
rules to challenge the dividend stripping structures between persons not entitled to
benefits of the DTA and those that are so entitled. The focus in that DTA is on either
residents of third countries or persons not enjoying the protection of the B/N DTA.

Page 16 of 17
Module 1 (June 2018)

 The German government introduced legislation to stop dividend stripping in 2016. Only
recently (January 2018), the German Finance Ministry has reported that it is investigating
suspected cases of dividend stripping that may have resulted in $5.3 billion of unpaid tax
(this latter point is included for completeness and students are not expected to include
information pertaining to a period of less than 6 months before the examination).

 Switzerland has responded by having a very wide definition of beneficial ownership that
requires a substance over form approach and an analysis of each case and its relevant
circumstances (Joint Meeting of the Switzerland and USA Branches of the International
Fiscal Association, 2017).

 The work of the OECD / G20 on BEPS was noted in 2014 to have the potential to impact
derivatives and financial instruments under various actions (including DTA access, hybrid
instruments, interest deductions and risk transfers) – see, Collier, 2014.

 The OECD has also conducted a great deal of work on the issue of improper use of
double tax agreements and this has resulted in changes to the OECD MTC (see OECD
MTC 2017) and the inclusion of specific provisions within the Multilateral Instrument
2016.

 Students will be expected to cite the work of the OECD (and the related outputs), which
applies more generally than just to derivatives, and consider it within the context
requirement of the question. This work includes BEPS Action 6 (Granting of Treaty
Benefits in Inappropriate Circumstances) 2015, which identifies treaty abuse and in
particular treaty shopping as one of the most important sources of BEPS. New treaty
anti-abuse rules include: clear statement that CSs entering DTAs do so without the
intention of creating opportunities for reduced or non-taxation through tax evasion or
avoidance including treaty shopping arrangements aimed at obtaining reliefs in the
Convention for the indirect benefit of residents of third States (see Preamble, OECD MTC
2017); the introduction of a specific anti- abuse rule (limitation on benefits rule); see
OECD MTC 2017 – and a general anti-abuse rule known as the “principal purposes test”
(see Article 29 OECD MTC 2017). Students could also cite the extended commentary on
Article 1, OED MTC 2017 on the improper use of the Convention and addressing tax
avoidance through tax conventions [54]-[81].

 The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS
(“Multilateral Instrument”) also includes similarly worded provisions such as the Preamble
to the Convention, which is to be included in CSs’ covered tax agreements; Article 6 on
the Purpose of a Covered Tax Agreement; and Article 7 on the Prevention of Treaty
Abuse.

 Students should therefore mention that it will be necessary to consider whether in a given
situation the relevant DTA is to be interpreted in line with revisions to the Commentary
to OECD MTC 2017 and / or whether the DTA in question is a “covered tax agreement’
such that the relevant provisions of the relevant DTA may need to be interpreted in line
with any relevant provisions of the Multilateral Instrument.

Page 17 of 17
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