Tax Treaty Series

ITQ T-

019

November 1, 2019

Question

ACO, a company which is resident in country A, owns the global copyright to a film.

ACO sells that global copyright to BCO, a company which is resident in country B.

The sale contract states that the consideration has 2 components: (i) a lump sum of $10 million (payable upfront), and (ii) a royalty of 3% of annual revenue which is derived by BCO from commercial exploitation of the copyright (payable annually for 10 years).

2 years later, BCO discovers that ACO is deriving revenue from the copyright from third parties in country A. BCO sues ACO, in a country A court, for breach of copyright. The court awards damages to BCO of $2 million.

The A/B treaty is identical to the 2011 UN model treaty, and it is not covered by the MLI.

What is the treatment, under the treaty, for the 3 payments?

Answer

(i) Lump sum of $10 million (payable upfront):

This amount will fall within Art. 13(6) (capital gains – residual paragraph). Thus, it will be exempt in country B.
This amount will not be "royalties" within the definition in Art. 12(3), because it is not consideration for the use of, or the right to use, any copyright.

(ii) Royalty of 3% of annual revenue which is derived by BCO from commercial exploitation of the copyright (payable annually for 10 years):

These 10 annual amounts should also fall within Art. 13(6) (and not be "royalties" within the Art. 12(3) definition), and therefore should be exempt in country B, for the same reasons as stated in (i) above. Regardless of the calculation of the amounts and regardless of the name given to the amounts in the sale contract, their character is of payments for the sale of the whole copyright.
See paragraphs 15 & 16 in the OECD Commentary on Art. 12 (reproduced in the UN Commentary on Art. 12). India and Colombia do not accept the positions stated in those 2 paragraphs.

(iii) Damages of $2 million paid by ACO to BCO, for breach of copyright:

This amount should be treated as "royalties" within the Art. 12(3) definition
See paragraph 8 in the OECD Commentary on Art. 12 (reproduced in the UN Commentary on Art. 12):
"The definition covers both payments made under a license and compensation which a person would be obliged to pay for fraudulently copying or infringing the right."
Thus, country A would be entitled to tax the amount up to the limit described in Art. 12(2) (assuming BCO is the beneficial owner of the amount and does not have a PE in country A). Country B would be required to give a foreign tax credit under Art. 23A(2) or Art. 23B(1).

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