Tax Treaty Series

ITQ T-

005

July 19, 2019

Question

ACO is a resident of country A. ACO has a PE in country B. ACO borrows money from BCO, a bank which is resident in country B. ACO borrows the money for the purposes of its PE in country B, and the interest on that borrowing is borne by that PE. BCO does not have a PE in country A. BCO is the beneficial owner of the interest. The A/B double tax treaty is identical to the UN model treaty. Is country A permitted (by the A/B treaty) to impose tax on the interest paid to BCO by ACO? Why?

Answer

No: Art. 7(1), first sentence.

Art. 7(6) gives preference to Art. 11, if the interest is “dealt with” by Art. 11. However, that is not the case, for the following reasons:

(1) The phrase, “interest arising in a Contracting State”, is defined in Art. 11(5). Under the first sentence, the interest arises in country A. However, under the second sentence, the interest arises in country B. The second sentence “trumps” the first, as shown by the introductory words, “Where, however”, in the second sentence.

(2) Art. 11(1) therefore does not apply: the interest arises in the same Contracting State as the residence of the recipient.

(3) Art. 11(2) therefore does not apply, as shown by the words, “such interest” (referring to the interest described in Art. 11(1)), at the start of Art. 11(2).

(4) Thus, taxing rights are not allocated by Art. 11, and accordingly, the interest is not “dealt with” by Art. 11.

Art. 21(3) should not apply, for the following reasons:

It’s possible that the “arising” condition in Art. 21(3) is not determined by Art. 11(5), even though that provision does not state that it is limited to Art. 11. Paragraph 9 of the 2017 UN Commentary indicates that the “arising” condition will be determined under the domestic laws of the Contracting States. Therefore, if country A law says that the interest is sourced in country A, that might allow the “arising” condition in Art. 21(3) to be satisfied
However, Art. 21 should not apply if the interest is “dealt with” by Art. 7. This raises the issue : which provision is applied first – Art. 7 or Art. 21? In my view, despite Art. 7(6), Art. 21 should not be interpreted as applying before Art. 7, as that would render the Art. 7(1) exemption (If there is no PE in the source country) irrelevant – a bizarre result! However, the existence of Art. 21(2) suggests the opposite result.

ITQ Disclaimer

This International Tax Quiz (ITQ) contains general information only, and none of International Insights Pte Ltd, its employees or directors is, by means of this ITQ, rendering professional advice or services. You use the content of this ITQ strictly at your own risk. You should not rely on all or any part of the content of this ITQ in making decisions to take action (including inaction) in regard to tax or other matters. Before making any decision or taking any action (including inaction) that may affect your tax position, your finances or your business, you should consult a qualified professional advisor. None of International Insights Pte Ltd, its employees or directors shall be responsible for any loss whatsoever sustained by any person who relies on the content of this ITQ.