Tax Treaty Series

ITQ T-

028

January 17, 2020

Question

In year Z, XCo, a company resident in country X, purchased a 5% shareholding in YCo, a publicly listed company resident in country Y, for $1 million. At the time of that purchase, YCo's assets did not mainly consist of immovable property in country Y.

In year Z + 5, X and Y entered into their first double tax treaty. That first X/Y treaty was identical to the 1997 OECD model treaty.

In year Z + 15, X and Y replaced that treaty with a second treaty. The second X/Y treaty is identical to the 2014 OECD model treaty.

In year Z + 17, XCo sold its shares in YCo, for $20 million. At the time of the sale, YCo's assets were mainly immovable property in country Y.

XCo's profit of $19 million is taxable under country Y domestic law. What is the impact of the X/Y treaties?

Answer

The key difference between the two X/Y treaties is that the first treaty does not allow source country taxation of capital gains on sales of shares in companies resident in the source country (whether or not land-rich), whereas the second treaty has a land-rich provision (Art. 13(4)) which does allow such taxation. Based on the facts, Art. 13(4) applies.

However, XCo owned the 5% shareholding for 17 years, which can be divided into 3 periods:

(i) Z to Z+5: no treaty – thus, Y domestic law operates

(ii) Z+5 to Z+15: first X/Y treaty in force – treaty exemption applies

(iii) Z+15 to Z+17: second X/Y treaty in force – Art. 13(4) allows Y domestic law to apply

Para. 3.1, OECD Comm. on Art. 13: "…where [Art. 13] allows a Contracting State to tax a capital gain, this right applies to the entire gain and not only to the part thereof that has accrued after the entry into force of a treaty (subject to contrary provisions that could be agreed to during bilateral negotiations), even in the case of a new treaty that replaces a previous one that did not allow such taxation." Note the comment by Austria and Germany in regard to the reverse situation (para. 32.1).

Thus, the full $19 million will be taxable in Y. X must give relief under Art. 23A / 23B.

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