Tax Treaty Series

ITQ T-

041

May 8, 2020

Question

XCo, a company incorporated in X, conducts its business through a branch in Y. XCo has no assets, operations or employees in X. XCo’s senior management and board of directors are based in Y.

Under X tax law, XCo is a resident (based on incorporation). Under Y tax law, XCo is a resident (based on central management and control). Under both countries' tax laws, resident companies are subject to income tax on global profits.

XCo lends money to ACo, an unrelated company resident in X.

The corporate income tax rate in both X and Y is 30%.

X levies an interest withholding tax of 20% (on gross) on outbound interest payments.

The X/Y treaty is identical to the 2017 OECD model treaty, with Art. 23B.

What rates of X and Y tax does the treaty allow to be imposed on the interest paid by ACo to XCo?

Answer

XCo's residence status under Art. 4(3) requires competent authority (CA) agreement. If the CAs fail to agree, XCo will generally not be entitled to treaty benefits.

If XCo is resident in X (under Art. 4(3)):

Y would probably be permitted to tax the interest under Art. 7(1) (on the basis that the interest is part of the profits attributable to XCo's PE in Y). Note that Art. 1(3) would not apply in regard to Y, as XCo is not Y resident under the treaty.
Y might be required to provide credit for 10% X tax, under Art. 24(3) (notional application of Art. 11(2)).
X may also tax the interest, but would be required to provide credit for Y tax: Art. 23B.

If XCo is resident in Y (under Art. 4(3)):

X may tax the interest, subject to 10% limit: Art. 11(2). Note that Art. 1(3) would not apply in regard to X, as XCo is not X resident under the treaty.
Y may also tax the interest, but would be required to provide credit for X tax: Art. 23B.

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