Tax Treaty Series

ITQ T-

020

November 8, 2019

Question

XCO is a company resident in country X. It owns a small parcel of shares in YCO, a company resident in country Y. YCO’s shares are listed on the country Y stock exchange.

YCO declares a dividend, and issues dividend vouchers to its shareholders. The dividend vouchers are transferrable. YCO will redeem the dividend vouchers, for cash, on presentation after 30 days.

XCO sells its dividend vouchers to ZCO, a company resident in country Z, for a price equal to 95% of the face value of the vouchers. The sale is unconditional – in particular, XCO does not guarantee that YCO will redeem the vouchers for face value or indemnify ZCO if YCO does not. No shares in YCO are sold by XCO to ZCO. At the end of the 30 days, ZCO receives cash from YCO for the vouchers.

The X/Y treaty and the Y/Z treaty are identical to the 2014 OECD model treaty, except that the tax limit in Art. 10(2)(b) is 20% (X/Y treaty) and 10% (Y/Z treaty). Under domestic law, country Y levies a withholding tax of 30% on outbound dividends.

In regard to the vouchers which are issued to XCO and then sold to ZCO, and assuming the MLI does not apply to the 2 treaties, what rate of country Y tax will apply?

Would your answer be different if the MLI did apply to both treaties?

Answer

(i) Assuming MLI does not apply to both treaties:

The first issue to determine is whether, under the Y domestic tax law, the taxing point is the issue of the vouchers to XCO or ZCO's receipt of cash from YCO on redemption of the vouchers. That will determine who the relevant taxpayer is and thus which treaty is relevant.
If the taxing point is the issue of vouchers to XCO, then the X/Y treaty applies. The issue of vouchers would fall within the definition of "dividends" in Art. 10(3). XCO would clearly be the beneficial owner of the dividends. The word, "paid", in Art. 10(1) & (2) "has a very wide meaning" (OECD Comm.). Art. 10(2)(b) would allow Y tax up to a limit of 20%.
If the taxing point is ZCO's receipt of cash from YCO on redemption of the vouchers, such that ZCO is the relevant taxpayer, the Y/Z treaty applies. The cash would probably fall within the definition of "dividends", on the basis that there is a sufficient connection with the shares to be "income from shares", even though ZCO does not own the shares to which the redeemed vouchers relate (and possibly owns no shares in YCO). ZCO would probably be the beneficial owner of the "dividends": see Royal Dutch Shell case (Hoge Raad, Netherlands, 6 April 1994). Art. 10(2)(b) would allow Y tax up to a limit of 10%.

(ii) Assuming MLI applies to both treaties:

If the X/Y treaty applies, the MLI would not change the analysis.
If the Y/Z treaty applies, Art. 7(1) of the MLI (the principal purposes test, PPT) would be relevant. The facts in this question are based on Example A in para. 182 of the OECD Comm. on Art. 29(9). In the absence of other facts, it is likely that the PPT would apply to deny the treaty benefit to ZCO – which would mean that the domestic tax rate of 30% would apply.

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