Tax Treaty Series

ITQ T-

006

July 26, 2019

Question

XCO is a company which is incorporated in country A, but which has its central management and control in country B. It is a resident under country A tax law, and it is a resident under country B tax law. XCO’s place of effective management is in country B. XCO licenses (for arm’s length royalties) a patent to YCO, which is a company resident in country C. The A/B, A/C and B/C double tax treaties are all identical to the 2014 OECD model treaty, with the exception of the source country tax rate under Art. 12 – the rates are 5% (A/B), 10% (A/C), and 15% (B/C). The MLI does not apply to any of the 3 treaties. XCO is the beneficial owner of the royalties, and XCO does not have a PE in country C. Country C’s domestic law withholding tax rate on outbound royalties is 30%. What tax rate is country C permitted to levy on the royalties paid by YCO to XCO? Why?

Answer

15% : Art. 12, B/C treaty - for these reasons:

Prima facie, XCO is a resident of country A and also a resident of country B, under Art. 4(1) of the A/B treaty. However, under Art. 4(3) of that treaty, it is deemed to be a resident only of country B, for the purposes of the A/B treaty. [Note that Art. 4(3) has no impact on XCO’s status as a resident of country A under the country A domestic tax law.]
The various operative provisions in the A/B treaty (e.g., Art. 7, Art. 12, Art. 21, etc.) therefore have the effect that XCO is exempt from country A tax on income from sources outside country A.
According to the OECD Commentary, XCO is therefore “liable to tax” in country A only in respect of income from sources in country A, and consequently XCO does not satisfy the definition of “resident of [country A]” in Art. 4(1) of the A/C treaty. Paragraph 8.2 of the 2014 Commentary : “[The second sentence of Art. 4(1) in the A/C treaty] excludes companies and other persons who are not subject to comprehensive liability to tax in a Contracting State [i.e., country A] because these persons, whilst being residents of that State under that State’s tax law, are considered to be residents of another State [i.e., country B] pursuant to a treaty between these two States [i.e., the A/B treaty].”
XCO therefore cannot claim benefits under the A/C treaty : Art. 1.
However, XCO does satisfy the definition of “resident of [country B]” under Art. 4(1) of the B/C treaty.
Therefore, country C is permitted by Art. 12 of the B/C treaty to levy tax on the royalties, with a limit of 15% on gross. As country C’s domestic law withholding tax rate on outbound royalties is 30%, country C will therefore levy a 15% tax on XCO’s royalties.

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