Tax Treaty Series

ITQ T-

013

September 13, 2019

Question

XCO is a resident of country A. XCO owns a building in country B. The building contains 10 residential apartments, all of which are leased to tenants who are unrelated to XCO. A real estate agent in country B (YCO) manages the building for XCO. XCO financed its purchase of the building by borrowing money from ZCO, which is an unrelated bank resident in country C. The loan is secured by a mortgage on the building. The A/B, A/C, and B/C double tax treaties are identical to the 2014 OECD model treaty, with Art. 23A. The MLI does not apply to any of those treaties. ZCO is the beneficial owner of the interest which is paid by XCO on the loan, and ZCO does not have a PE in country A or country B. In regard to (i) rent paid to XCO, and (ii) interest paid to ZCO, what is the treatment under each of the A/B, A/C, and B/C treaties?

Answer

Rent paid to XCO:

Country B may tax the rent, without rate limitation: Art. 6, A/B treaty. The issue of whether or not country B tax is imposed on a gross basis or a net basis (i.e., after allowing deductions for interest and other expenses) is determined under country B law – Art. 6 does not require a net basis of taxation.
Country A must exempt the rent : Art. 23A, A/B treaty.

Interest paid to ZCO:

1.A/C treaty:

(i) The interest satisfies the definition of “interest” in Art. 11(3), despite the mortgage.

(ii) The interest arises in country A: Art. 11(5), first sentence. The second sentence does not apply, because (a) XCO does not have a PE (see below), and (b) in any event, country B is not a Contracting State.

(iii) Art. 11(2) allows country A to impose tax of 10% on gross.

(iv) Country C must allow a credit for the country A tax: Art. 23A(2).

2.B/C treaty:

(i) The building would not be a “fixed place of business” PE under Art. 5(1), as the building would not be “at the disposal” of XCO.

(ii) YCO would not cause a contract-concluding agency PE under Art. 5(5), even assuming it concludes contracts on behalf of XCO (which is not clear on the facts) – it would be an agent of independent status, acting in the ordinary course of its business: Art. 5(6).

(iii) Thus, the interest would not arise in country B under Art. 11(5).

(iv) Thus, Art. 11(1) & (2) would not apply.

(v) Thus, Art. 7(1) would exempt ZCO from country B tax.

Conclusion – differential tax treatment of rent and interest:

Rent taxable in country B, but exempt in country A
Interest taxable in country A, but exempt in country B

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