Dividends, Interest, & Royalties
Pertemuan ke-9
Mata Kuliah Perpajakan Internasional Program Sarjana
Departemen Ilmu Administrasi Fiskal
Fakultas Ilmu Administrasi Universitas Indonesia
April 2024
Taufan Andiko, S.Sos, LLM
Agenda
Article 10 - Dividends Article 11 - Interest Article 12 - Royalties Case Study
01
02
03
04
Article 10, 11, & 12
Article 10 – Dividends
1. 10(3) : definition of dividends 2. 10(1) : restricted scope 3. 10 (2) : BO >> 25%
participation
4. 10 (4) :PE provision (PE of the BO in the same state (State S)) >> ≠reduced rate
Article 11 – Interest
1. 11(3) : definition of interest 2. 11(5) : source rule
3. 11 (1) : restricted scope 4. 11 (2) : BO
5. 11 (4) : PE provision (PE of the BO in the same state (State S)) >> ≠reduced rate 6. 11 (6) ALP
Article 12 – Royalties
1. 12(2) : definition of royalties 2. 12 (1) : restricted scope 3. 12 (1) : BO
4. 12 (3) : PE provision (PE of the BO in the same state (State S)) >> ≠reduced rate 5. 12 (4) ALP
Article 10
Dividends
Definitions of Dividends – Art. 10 (3)
The term“dividends” as used in this Article means
i. Income from shares, “jouissance” shares or “jouissance” rights, mining shares, founder’s shares,
ii. orother rights, not being debt-claims, participating in profits,
iii. as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident
Definitions
Key Points – Art. 10 (3)
i. Income from shares,
• Distribution of profits the title to which is constituted by shares (Comm. Art. 10-24/2) ii. Other rights, not being debt-claims, participating in profits
• ‘The definition assimilates to shares all securities issued by companies which carry a right to participate in the companies’ profits without being debtclaims’ (Comm. Art 10-24/3)
• ‘Distributions of profit by partnerships are not dividends within the meaning of the definition, unless the partnerships are subject, in the State where their place of effective management is situated, to a fiscal treatment substantially similar to that applied to companies limited by shares.’ (Comm Art. 10-27/1)
iii. Income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident
• Income from ‘other corporate rights’: the concept of ‘dividends’ also include income from debt claims insofar as the lender
‘effectively shares the risk’ run by the company (Comm. Art. 10-25)and
• The source state treats it for tax purposes as income from shares
According to Haslehner, the context of Art. 10 indicates that corporat3e rights must entitle the owner not only to a share in the current profit, but also (at least) to a share in the liquidation proceeds of the company (same, Vogel,[2015], pp. 482-502)
However, Pijl argues‘corporate rights’ should not be given any particular meaning. The term “corporate” was only intended to exclude right in business ventures of individuals and partnerships. (See Hans Pijl, Interest from Hybrid Debts in Tax Treatues, in Bulletin for International Taxation, 2011-9, pp. 482-502)
Tax Sharing – Art. 10 (1) & 10 (2)
1) Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.
2) However, dividends paid by a company which is the resident of a Contracting State may also be taxed in that state according to the laws of the state, but if the beneficial owner of the dividends is the other Contracting State, the tax so charged shall not exceed:
a) 5% of the gross amount of the dividends if the beneficial owner is a company which holds directly at least 25% of the capital of the company paying the dividends throughout a 365 day period that include the day of the payment of the dividend (for the purpose of computing that period, no account, shall be taken of changes of ownership that would directly result from a corporate reorganization, such as a merger or divisive reorganization, of the company that holds the share or that pays the dividend);
b) 15% of the gross amount of the dividends in all other cases
Art. 10 (1)
• Scope
o Art. 10 deals only with dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State (Comm. Art. 10 -8)
• ‘paid’
o Wide meaning; fulfilment of the obligation to put funds at the disposal of shareholder (Comm. Art. 10-7)
• ‘company’
o ‘any body corporate or any entity that is treated as a body corporate for tax purposes’ (Art.
3.1.b; Comm. Art. 3-2/2)
• ‘resident’
o Liable to tax (Art. 4(1) & Comm. Art. 4-8 or Comm. Art. 4-8 (3))
Key Points – Art. 10 (1) & 10(2)
Art. 10 (2)
• ‘beneficial owner’
o Agents, nominees or conduit companies cannot be regarded as beneficial owners (Comm. Art. 10- 12 (2), 12 (3))
o Therecipient’s right to use and enjoy the dividend cannot be constrained by a contractual or legal obligation to pass on the payment received to another person (Comm. Art. 10-12 (4))
• ‘…company which holds directly at least 25% of the capital of the company paying the dividends throughout a 365 day period that include the day of the payment of the dividend (for the purpose of computing that period, no account, shall be taken of changes of ownership that would directly result from a corporate reorganization, such as a merger or divisive reorganization, of the company that holds the share or that pays the dividend)’
o Lower tax rate (5%) of the gross amount applied
PE Provision – Art. 10 (4)
Art. 10 (4)
The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident through a permanent establishment situated therein and the holding in respect of which the dividends are paid iseffectively connected with such permanent establishment. In such case the provision of Article 7 shall apply
1. ‘permanent establishment’(Art. 5) 2. ‘ effectively connected with such PE’
• The economic ownership of the holding is allocated to PE (Comm. Art. 10-32 (1) and Art. 7(2))
• No force of attraction (Comm. Art. 10-31) Key Points
Application of domestic tax law and tax treaties
Four steps on how to deal with tax treaty cases
!!! Tax treaty only restricts and DO NOT create tax liability
Step 1 : application of domestic law Check for each of the states involved:
• Does the state under its domestic law want to tax the given income item?
• If yes: in which capacity: as a residence country or as a source country?
Step 2 : which tax treaty/-ies apply?
• Art.1 : is the income recipient ‘ a person’ and treaty resident of either state?
• Art.3 : definition of a ‘person’
• Art.4 : rules to determine whether the recipient is indeed a treaty resident
Step 3 : restrictions imposed by the applicable tax treaty/-ies?
Step 3a : Go to chapters 3 and 4 (distributive rules)
• Which article (distributive rules) could be applicable to the income concerned?
• If indeed more than one articles is possibly applicable, determine the order of priority
• Try to apply the first applicable distributive rule; if it does not apply for whatever reason, go to the next applicable distributive rule, etc.
• Does the ultimate applicable rule prohibit the other (i.e. ‘source’) state to tax?
• If it prohibits: the ‘other’ state may not tax: end of double taxation >> go to Step 4
• If it does not (or not fully) prohibit: go to Step 3b
Step 3b : Go to chapter 5 (double tax relief) : Art. 23 : residence state needs to grant double tax relief Step 4 : Result:
• Domestic law application by residence state OR/ AND
• Source state (Step 1) is restricted by Source State : distributive treaty rule (=Step 3a), OR/ AND by residence state : double tax relief >> Step 3b
Step 1: domestic laws:
• S State wants to tax R Corp as a source state (Div. distribution)
• R State wants to tax R Corp as a residence state (Recipient of dividend)
Step 2: Which tax treaty/-ies apply:
R-S treaty: Arts 1, 3, and 4 -> R Corp is a RR in State R: treaty applies
Step 3: restrictions impose by the applicable tax treaty/-ies Step 3.adistributive rules
• Art. 7(7.4) -> Art 10 (3) -> Art 10(1) -> restricted scope: R State may tax -> Art.
10 (2): BO & Art. 10 (2) letter a: S State may tax up to 5% (R Corp is the BO) ->
Art. 10(4) N/A
Step 3.bdouble taxation relief
• Art. 23 A/B -> R State must grant relief
Step 4: result
S State may tax up to 5% / R state may tax but must grant relief
Step 1: domestic laws:
• A State wants to tax R Corp as source state and residence state
• B State wants to tax R Corp as PE state
Step 2: Which tax treaty/-ies apply:
A-B treaty: Arts. 1, 3, and 4 -> R Corp is a RR in State A: treaty applies
Step 3: restrictions impose by the applicable tax treaty/-ies Step 3.adistributive rules
• Art. 7(7.4) -> Art 10 (3) -> Art 10(1) -> N/A
• Art. 10 (2) first sentence applicable: A State may tax (without restriction)
• 2017 Comm. Art 10 (4)-> Art. 7 also applies: B State may also tax
Step 3.bdouble taxation relief
• Art. 23 A/B: Check 2017 Comm. Art. 23A/B– 9, 9(1)
Step 4: result
A and B State may both tax
Scenario 1 Scenario 2
Application of domestic tax law and tax treaties – Article 10
Step 1: domestic laws:
• S State wants to tax R Corp as source state
• R State wants to tax R Corp as residence state
• PE State wants to tax R Corp as PE State
Step 2: Which tax treaties apply:
• PE-S treaty: Arts. 1, 3, and 4 -> there is no RR (Resident Recipient): N/A
• R-S treaty: Arts. 1, 3, and 4 -> R Co is a RR in State R: treaty applies
• R-PE treaty: Arts 1,3, and 4 -> R Co is a RR in State R: treaty applies
Step 3: restrictions impose by the applicable tax treaty/-ies: R-S treaty Step 3.adistributive rules
• Art. 7(7.4) -> Art 10 (3)
• Art. 10(1) restricted scope: R State may tax -> Art. 10 (2) BO: S State may tax up to 5% & Art. 10 (2) letter a: S State may tax up to 5% (Art. 10 (2)) -> Art. 10(4) N/A
Step 3.bdouble taxation relief
• Art. 23 A/B -> R State must grant relief
Step 3: restrictions impose by the applicable tax treaty/-ies: R-PE treaty Step 3.adistributive rules
• Art. 7(7.4) -> Art 10 (3)
• Art. 10(1) N/A -> Art. 7/21 (assume it is business income) -> Art. 7: R State may tax (residence state) but since PE in PE State also PE State may tax
Step 3.bdouble taxation relief
• Art. 23 A/B -> R State must grant relief in respect of income attributable to PE
Step 4: result
• PE State may tax the PE income attributable to PE
• S State may tax up to 5%
• R State may also tax but must grant relief for tax imposed by PE State and R State
Scenario 3
Application of domestic tax law and tax treaties – Article 10
Step 1: domestic laws:
• S State wants to tax R Corp both as source state and PE state
• R State wants to tax R Corp as residence state Step 2: Which tax treaties apply:
• R-S treaty: Arts. 1, 3, and 4 -> R Corp is a RR in State R: treaty applies Step 3: restrictions impose by the applicable tax treaty/-ies: R-S treaty Step 3.adistributive rules
• Art. 7(7.4) -> Art 10 (3)
• Art. 10(1) restricted scope: R State may tax -> Art. 10 (2) BO (assume yes): S State may also tax
• Art. 10(4) (the shares are effectively connected with the PE)
• Back to Art. 7: Art 7 (1) -> Art. 5 -> 7 (1)/7 (2); R State (residence state) may tax but since PE in S State also S State may tax
Step 3.bdouble taxation relief
• Art. 23 A/B -> R State must grant relief Step 4: result
• S State may tax the PE / R State may also tax but must grant relief
Scenario 4
Application of domestic tax law and tax treaties – Article 10
Article 11
Interest
Definitions of Interest – Art. 11 (3)
The term “interest” as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor’s profits […]
Definitions
• ‘debt claims of every kind’
o Includes cash deposits and securities in the form of money, as well as government securities and bonds and debentures (Comm. Art. 11-18/3)
o Debt claims which carry a right to participate in the debtors profits are nonetheless regarded as loans if the contract by its general character clearly evidences a loan at interest (Comm. Art. 11-18/5)
Key Points
Definitions of Interest – Art. 11 (3)
• ‘debt claims of every kind’ (cont.)
o ‘interest does not include items of income which are dealt with under Art. 10’
(Comm. 11-19/3)
o Where the creditor effectively shares in the risk of the debtor’s business (as set forth in Comm Art. 10-25) and the source State treats it as a dividend, the relevant item of income will be covered by Art. 10
Interaction between Art. 10 (3) and Art. 11 (3)
Tax Sharing – Art. 11 (1) & 11 (2)
1) Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State
2) However, interest arising in a Contracting State may also be taxed in that state, according to the
laws of that State, but if the beneficial owners of the interest is a resident of the other Contracting
State, the tax so charged shall not exceed 10% of the gross amount of the interest […]
Art. 11 (1)
• Scope
o Art. 11 deals only with interest arising in a Contracting State and paid to a resident of the other Contracting State
• ‘paid’
o Wide meaning; fulfilment of the obligation to put funds at the disposal of creditor (Comm.
Art. 11-5)
• ‘arising’
o Art. 11 (5) source rule
Key Points – Art. 11 (1) & 11 (2)
Art. 11 (2)
• ‘beneficial owner’
o Agents, nominees or conduit companies cannot be regarded as beneficial owners (Comm. Art. 11- 10, 10 (1))
o The recipient’s right to use and enjoy the interest cannot be constrained by a contractual or legal obligation to pass on the payment received to another person (Comm. Art. 11-10 (2))
Source Rule on Interest – Art. 11 (5)
Art. 11 (5)
Interest shall be deemed to arise in a Contracting State when the payer is a
resident of that State. [Exception] Where, however, the person paying the
interest, whether he is a resident of Contracting State or not, has in
Contracting State a permanent establishment in connection with which the
indebtedness on which the interest is paid was incurred, and such
interest is borne by such permanent establishment, then such interest
shall be deemed to arise in the State in which the permanent
establishment is situated
Source Rule on Interest – Art. 11 (5)
1stcase: interest sourced in S State and NOT in R State Art.
11 (5) 2ndsentence
2nd case: Interest sourced in R State and NOT in S State Art. 11 (5) 2ndsentence
Where does interest arise?
3rd case: Interest sourced in S State (R-S) and in PE State (R-PE) Art 11 (5) 1stand 2nd sentence
PE provision – Art. 11 (4)
Art. 11 (4)
The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner
of the dividends, being a resident of a Contracting State, carries on business
in the other Contracting State in which the interest arises, through a
permanent establishment situated therein and the debt-claim in respect of
which the interest is paid is effectively connected with such permanent
establishment. In such case the provision of Article 7 shall apply
Interaction Between Art. 11 (4) and Art. 11 (5)
The simultaneous application of the PE provision and the Source rule in Art. 11 (4) and Art. 11 (5)
Art. 11 (4)– PE Provision: Art. 11 (5)– Source rule:
It applies to the PE of the beneficial owner It applies to the PE of the‘payor’
DIVIDENDS / INTEREST / ROYALTIES Only for INTEREST
Restricted Scope (‘a resident of a CS, carries on business in the other CS, where the interestarises’)
No Restricted Scope (‘when the person paying the interest, whether he is a resident or not, has in a contracting state aPE’)
‘effectively connected’ income (‘The debt claim (Holding / Right or property) in respect of which the interest (Dividend/Royalties) are paid is effectively connected (Art 7 (2) with thwPE’)
‘borne by’ (‘PE in connection with which the indebted ness on which the interest is paid was incurred and such interest is borne by suchPE’)
Article 12
Royalties
Residence (Exclusive) – Art. 12 (1)
Art. 12 (1)
Royaltiesarising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State
• Scope
o Art. 12 deals only with royalties arising in a Contracting State and beneficially owned by a a resident of the other Contracting State (Comm. Art. 12-5)
• ‘beneficially owned’
o Agents and nominees cannot be regarded as beneficial owners (Comm. Art. 12-4 (1), 4(2))
o The recipients right to use and enjoy the interest cannot be constrained by a contractual or legal obligation to pass on the payment received to another person (Comm. Art. 12-4 (3))
• ‘arising’
o No definition of‘arising’
Key Points
Definitions of Royalties – Art. 12 (3)
The term “interest” as used in this Article means payment of any kind received as a consideration [i] for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trademark, design or model, plan, secret formula or process, or [ii] for information concerning industrial, commercial or scientific experience.
Definitions
• Definition of‘royalties’(Comm. Art. 12-8)
• ‘payments of any kind’
o Wide meaning; fulfilment of the obligation to put funds at the disposal of the creditor. (Comm. Art. 12-8 (3))
i. ‘for the use of, or the right to use…’
o Distinction between letting and alienation. (Comm. Art. 12-8 (2))
ii. ‘for information concerning industrial, commercial or scientific experience.’
o Concept of know-how (Comm. Art. 12-11)
o Distinction between supply of ‘know how’ and service, and example not considered as supply of‘know-how’ (Comm. Art. 12-11 (3) and 11(4))
Key Points
Text OECD Model (Art 12(2))
UN Model (Art 12(3))
Means payments of any kind received as a consideration for the use of, or, the
right to use √ √
Any copyright of literary, artistic or scientific work including cinematograph films √ √
Any patent, trademark, design or model, plan, secret formula or process √ √
Or for the use of, the right to use, industrial, commercial or scientific
equipment x √
Or for information concerning industrial, commercial or scientific experience √ √
Definitions of Royalties – Art. 12 (3)
Definitions of Royalties – Art. 12 (3)
Information concerning industrial, commercial, or scientific experience. Not any information but:
• Information undivulged and confidential
• Based on previous experience
• Transfer of knowledge
• Not service or consultancy (no activities by the supplier next to transfer) Know-How Definition
OECD Commentary (Paragraph 11 (3))
• Know-howinvolves the provision of information which already exists
• A service contractinvolves the use, not the transfer, of knowledge and skills
• With a service contract, the supplier will generally incur high costs in performing the contract (e.g. Salaries paid to employees). The supplier in a know-how contract would generally not incur high costs in performing the contract.
Know-how vs Services
PE Provision – Art. 12 (4)
Step 1: domestic laws:
• S State wants to tax A Corp as residence state and source state
• R State wants to tax A Corp as residence state Step 2: Which tax treaties apply:
• R-S treaty: Arts. 1, 3, and 4 -> A Corp is a RR in State R: treaty applies Step 3: restrictions impose by the applicable tax treaty/-ies: R-S treaty Step 3.adistributive rules
• Art. 7(7.4) -> Art 12 (2) -> 12 (1) restricted scope: only R may tax
• Art. 12 (3) (assume the right (IP) is effectively connected with the PE) -> back to Art 7: 7(1) -> Art. 5 -> 7 (1) / 7(2): R State (Residence State) may tax but since PE in S State also S State may tax
Step 3.bdouble taxation relief
• Art. 23 A/B -> R State must grant relief Step 4: result
• S State may tax the PE / R State may also tax but must grant relief
Scenario (Dual resident recipient with PE in ‘loser’
state)
Case Study
Case Study 1
G. Inc.
is a company resident of
State Gthat decides to invest in State A by purchasing 20% of the shareholding in A Inc. incorporated in State A, since this is a strategic market in its operations. After consulting with its tax advisor,
G. Inc.decides that such participation shall be managed by its
PEestablished in
State C.Income tax rates in
State Gand in
State Care 40% and 30% respectively. Domestic withholding tax rate in State A is 30%.
State Guses ordinary tax credit method to relieve juridical double taxation under treaties.
Assuming a dividend payment of USD 100 from A Inc. to
G Inc., analyze the relevant tax treaties.Case Study 1
Case Study 1
Case Study 2 (PE Provision)
E Co
is a company resident in
State Gwhich organize events. In order to organize an event in State P, E Co rented an apartment in State P’s capital which has been used as a workplace for the past 8 months.
Additionally,
E Cogranted a loan to John, a resident of State P, who is helping with the organization of the event.
Assuming that both
State Gand P want to tax the interest payment, apply the G-P DTC and explain who
may tax under the DTC.
Case Study 2 (PE Provision)
Case Study 3 (Triangular Situation)
M Co,a successful fruit juice manufacturing company, resident ofState C, took over D Co, a fruit producer inState B by way of merger. It was agreed that the surviving entity should be named M Co. As a result, M Co., a resident of State C had a PE in State B.
In a given year, the company paid a dividend to its 100% shareholder, H Inc, a resident ofState A.
Both State C and State B domestic law applies a withholding tax on dividend paid from sources in those states.
Assuming treaties identical to the OECD mode, determine whether the states involved are restricted under the realty
Case Study 4 (Source Rule on Interest)
P S.r.l,a company resident ofState I, engaged in the business of manufacturing a luxury bags, obtains a loan fromM S.A, a company resident of State C, to finance the purchase of a bag manufacturing plant in State Csince it need to have production unit closer to its main client, JB, a famous pop star of State C. Domestic law of State C and State I respectively provide for a 30% and 20% withholding tax on interest payments, whenever the interest is sourced in that country.
i. Assuming treaties identical to the OECD model, determine whether the states involved are restricted from tax the interest payment under the treaty.
Due to the success of JB in Asia,P’sbags are in huge demand in that continent and P S.r.l decides to set up another manufacturing plant in State Y. Financing of the second manufacturing plant will come from a second loan from M S.A. Domestic law inState Y provides for 25% withholding tax on interest payment, whenever the interest is sourced in that country
ii. Assuming treaties identical to the OECD model, determine whether the states involved are restricted from taxing the interest payment on the second loan under a treaty.
Thank you!
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