Tax Treaty Series

ITQ T-

045

June 12, 2020

Question

ACo, a company resident in A, in 2019 licensed a patent to BCo, a company resident in B, in return for royalties.

Under B law, outbound royalties are subject to a final withholding tax of 20% on gross.

Under the A/B treaty, which entered into force in 2005, the source country tax on royalties is limited by Art. 12 to 15% on gross.

A 2005 protocol to the A/B treaty contains this provision:

"In respect of Article 12, if under any convention or protocol signed after 1 May 2005 between [B] and a third State which is a member of the OECD, [B] limits its taxation at source on royalties to a rate lower than the rate provided for in [the A/B treaty], the same rate as provided for in that convention or protocol on royalties shall also apply under [the A/B treaty], with effect from the date on which [the A/B treaty] entered into force or that convention or protocol enters into force, whichever enters into force later."

That protocol also entered into force in 2005.

Under the B/C treaty, which was signed and entered into force in 2008, the source country tax on outbound royalties is limited to 10% on gross.

C became a member of the OECD in 2017.

Q1: For royalties paid by BCo to ACo in 2020, what tax rate does the A/B treaty permit B to impose?

Q2: Would your answer change if the provision in the protocol instead said this:

"In respect of Article 12, if after the entry into force of [the A/B treaty], any convention or protocol between [B] and a third State which is a member of the OECD limits the taxation at source on royalties to a rate lower than the rate provided for in [the A/B treaty], the same rate as provided for in that convention or protocol shall also apply under [the A/B treaty]."

Answer

Preliminary points:

The 2 provisions are “most favoured nation” (MFN) clauses.

Note the timing: the B/C treaty entered into force AFTER the A/B treaty (and its protocol) entered into force, but BEFORE C became a member of the OECD.

Q1:

The wording in this provision suggests that it applies only if the third State is a member of the OECD at the time the convention or protocol between B and the third State is signed or enters into force:

“…any convention or protocol signed after 1 May 2005 between [B] and a third State which is a member of the OECD” (emphasis added)
“…with effect from the date on which [the A/B treaty] entered into force or that convention or protocol enters into force, whichever enters into force later” – this suggests that the third State is a member of the OECD by the time the convention or protocol enters into force

C became a member of the OECD 9 years after the B/C treaty was signed and entered into force.

IMHO: The MFN provision is not satisfied – thus, the 15% rate limit should apply.

Q2:

In contrast, the wording of this provision does not suggest that the third State is a member of the OECD at the time the convention or protocol between B and the third State is signed or enters into force.

There would therefore be a stronger argument that this provision was triggered when C became an OECD member in 2017. Admittedly, it would be clearer if the provision instead said: “…if at any time after the entry into force…”

Nevertheless, IMHO: The MFN provision is probably satisfied – thus, the 10% rate limit should apply.

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