Tax Treaty Series

ITQ T-

009

August 16, 2019

Question

ACO is a company which is resident in country A. BCO is a company which is resident in country B. BCO has a fixed place of business PE in country C. ACO lends money to BCO to finance its country C PE. The interest on the loan is shown as an expense in the PE’s financial statements. ACO is the beneficial owner of the interest, and it does not have a PE in either country B or country C. The A/B, A/C and B/C double tax treaties are identical to the 2014 OECD model treaty. The MLI does not apply to any of those 3 treaties. Under the domestic tax law of each of the 3 countries : (i) the corporate income tax rate is 30%, (ii) the worldwide income of residents is taxed, and (iii) the interest withholding tax rate is 20%. In calculating foreign tax credits, assume that ACO is not required to allocate any deductions against foreign source income. If the amount of interest which is paid by BCO to ACO is $100, what amount of tax will be levied on that $100 in each of the 3 countries?

Answer

Country B:

A/B treaty: Art. 11(5), 1st sentence applies (payer is resident in B); Art. 11(5), 2nd sentence does not apply (as the PE is not in a Contracting State). Thus, interest arises in B.
A/B treaty allows B to impose tax of 10% on gross interest: Art. 11(1) & (2).
Thus, $10 tax paid in B.

Country C:

A/C treaty: Art. 11(5), 1st sentence does not apply (payer is not resident in C); Art. 11(5), 2nd sentence applies (interest is relevantly connected with PE in C). Thus, interest arises in C.
A/C treaty allows C to impose tax of 10% on gross interest: Art. 11(1) & (2).
Thus, $10 tax paid in C.

Country A:

Under A/B treaty, A must allow credit for B tax of $10: Art. 23A(2) or Art. 23B(1).
Under A/C treaty, A must allow credit for C tax of $10: Art. 23A(2) or Art. 23B(1).
After gross-up and credit for the B and C taxes, A tax will be = ($100 x 30%) - $10 - $10 = $10.

Thus: $10 tax paid in each of A, B and C, giving total tax of $30.

Note: This "double foreign tax / double foreign tax credit" situation occurs because of the words, "in a Contracting State", in Art. 11(5), 2nd sentence. See paragraphs 28-31 in OECD Commentary.

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.