Tax Treaty Series

ITQ T-

049

July 10, 2020

Question

ACo, a company resident in A, owns a building in A. ACo leases all the offices in the building to third party lessees.

BCo, an unrelated company resident in B, owns a significant portfolio of B government securities.

ACo and BCo enter into a total return swap (TRS) in regard to the building and securities. Thus, each quarter, a payment is made between ACo and BCo (in one direction only), which reflects the following components (simplified):

Rent received by ACo (less related expenses incurred by ACo)
Increase or decrease in assessed market value of building
Interest received by BCo (less related expenses incurred by BCo)
Increase or decrease in assessed market value of the government securities
Changes in the A/B exchange rate

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

Q1: If a payment is made (under the TRS) from ACo to BCo, does the A/B treaty permit A to impose tax on the payment?

Q2: If a payment is made (under the TRS), from BCo to ACo, does the A/B treaty permit B to impose tax on the payment?

Answer

Q1:

i. Art.6

Art. 6(2), 1st sentence, allows the A domestic law meaning of “immovable property” to apply. If the A domestic law treats rights under this TRS as “immovable property”, in whole or in part, then (to that extent) that meaning applies for the purposes of Art. 6. If that were the case, the whole or part of the payment would be caught by Art. 6(1), which would allow A to tax the payment (to that extent).
If that is not the case, then the TRS would not be “immovable property”. Also, based on the facts, BCo would probably have no rights in regard to the building (e.g., an ownership or leasehold interest). In that situation, the payment under the TRS should not be “income…from immovable property”, although there is no statement in the OECD Comm. to that effect.

ii. Art. 7 & 21:

If Art. 6(1) does not apply, the payment would be exempt from A tax, under Art. 7 or 21 – subject to Art. 29(9).

iii. Art. 29(9)

It’s quite possible that Art. 29(9) (the PPT) would be triggered, on the basis that the TRS is a transaction to obtain the Art. 7 or 21 benefit.
It’s also possible that non-tax reasons could be identified for the parties entering into the TRS – e.g., A law prohibits BCo from owning the building.

Q2:

i. Art. 11

The payment should not fall within the definition of “interest” in Art. 11(3), on the basis that the TRS is not a “debt-claim”: see OECD Comm.’s brief discussion of interest rate swaps.
Thus, Art. 11(2) should not allow B taxation.

ii. Arts. 7, 21 & 29(9): same comments as in Q1, mutatis mutandis.

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