Tax Treaty Series

ITQ T-

047

June 26, 2020

Question

ACo, a company resident in A, owns 100% of the shares in BCo, a company resident in B.

The A/B treaty is identical to the 2017 OECD model treaty.

BCo operates a business in B. It is registered for VAT purposes in B.

In response to the COVID-19 economic crisis, the B law has been amended to allow taxpayer payments of VAT to the tax authorities to be deferred for 6 months. However, companies which are themselves, or which are subsidiaries of, companies resident in “low-tax jurisdictions” are excluded from the deferral. A falls within the definition of “low-tax jurisdiction”.

Can BCo qualify for the VAT deferral?

Answer

It can be accepted that VAT is not a tax to which the A/B treaty applies, under Art. 2.

However, Art. 24 is not limited by Art. 2, but instead applies “to taxes of every kind and description” (Art. 24(6)) – which phrase would include VAT. [Note that 3 OECD members and 14 non-members have indicated that they “reserve the right to restrict the application of [Art. 24] to the taxes covered by the Convention”.]

Would BCo’s inability to qualify for VAT payment deferral, because it is a subsidiary of a company resident in A, breach Art. 24(5)?

The key issue is identifying the “other similar enterprises of the first-mentioned State” – in other words, which hypothetical enterprises should BCo be compared with?
One view would be to compare BCo with enterprises of B which are not wholly or partly owned or controlled, directly or indirectly, by one or more residents of a “low-tax jurisdiction”. On this view, Art. 24(5) would be triggered.
Another view would be to compare BCo with enterprises of B which are wholly or partly owned or controlled, directly or indirectly, by one or more residents of a “low-tax jurisdcition”, but not including A. On this second view, Art. 24(5) would not be triggered.
Which view is correct? On balance, I think Art. 24(5) would likely be triggered.

If Art. 24(5) is not triggered, then BCo has no legal basis to object.

However, if Art. 24(5) is triggered, another issue arises – the extent to which the A/B treaty has been given legal effect in B.

If the A/B treaty were given full domestic legal effect in B, with paramount force over any inconsistent B domestic law, then BCo should qualify for the VAT deferral, by virtue of Art. 24(5).
However, some countries in B’s position do not give full domestic legal effect to double tax treaties. Instead, such countries give double tax treaties domestic legal effect only for the purposes of specific taxes – and such specific taxes never (IMHO) include VAT. In such countries, although the denial of the VAT deferral to BCo might be a breach of Art. 24(5), BCo would have no legal right to enforce that breach against the B tax authorities.

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