Tax Treaty Series

ITQ T-

008

August 9, 2019

Question

XCO is a company which is resident in country A under the country A tax law. XCO has a branch in country B. The branch carries on an investment business, investing XCO's surplus funds. The branch invests in a wide range of financial and other assets, which are located in country B and elsewhere. XCO's employees who are based at the branch have significant investment management skills - they make all key decisions, and they enter into all contracts, in regard to investments made through the branch. One of the branch's investments is a parcel of land located in country A. The land is leased (for a market rent) to an unrelated company (YCO), which is also resident in country A under the country A tax law. The A/B treaty is identical to the 2014 OECD model treaty, with Art. 23A. The MLI does not apply to the A/B treaty. What tax treatment, in each of A and B, does the A/B treaty allow or require, in regard to the rent paid by YCO to XCO? Why?

Answer

This is a controversial and frequently discussed example in academic literature - for example, see: A. Bosman, "Redefining the Relation Between Articles 6, 7 and 21 of the OECD Model", Intertax, Vol. 45, Issue 1.

Threshold point: Art. 6 does not apply, as the "bilateral" condition in Art. 6(1) is not satisfied. Thus, Art. 6(4) is irrelevant.

There are then 2 schools of thought:

As XCO has a PE in B, and the rent is part of the profits attributable to the PE, Art. 7(1) allows B to impose tax on the rent. Although Art. 7(4) gives priority to other articles in which the income is "dealt with", there is no such other article in this example - Art. 6 does not apply (above) and Art. 21(1) should not be interpreted as applying in priority to Art. 7. Art. 23A(1) then requires A to exempt the rent.
The exception in Art. 21(2) evidences an intention that Art. 7(1) does not apply to income from immovable property in A. If Art. 7(1) does not apply to the rent, then Art. 21(1) applies to allow exclusive taxation in A. This second view is supported by the OECD Commentary: para. 74 on Art. 7, para. 4 on Art. 21, and para. 9 on Art. 23A/B.

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