Tax Treaty Series

ITQ T-

053

August 14, 2020

Question

ACo, a company resident in A, is the parent company of a multinational group. BCo, a company resident in B, is a member of that group, and is a 100% direct subsidiary of ACo.

BankCo is an unrelated bank resident in B.

BankCo makes a $100 million "bullet" loan to BCo, at a fixed interest rate of 3% per annum.

The loan is guaranteed by ACo.

BCo pays a guarantee fee of $0.5 million per annum to ACo.

The facts indicate that the effect of the guarantee is to permit BCo to borrow a greater amount (i.e., $100 million) than it could in the absence of the guarantee (i.e., $40 million), but the guarantee has no effect on the interest rate.

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

The A and B domestic law transfer pricing rules both follow the 2017 OECD Transfer Pricing Guidelines.

Q1: What adjustments would the B tax authorities be allowed to make under the A/B treaty and the B TP rules?

Q2: What adjustments would the A tax authorities be allowed to make under the A/B treaty and the A TP rules?

Answer

What is the accurate delineation of the transactions (ADT)?

Based on para. 10.161, OECD TPG, it is likely that the ADT is: (i) loan of $40 million (3% p.a. interest) from BankCo to BCo; (ii) loan of $60 million (3% p.a. interest) from BankCo to ACo; and (iii) equity contribution of $60 million from ACo to BCo.

What are the likely or possible consequences of that ADT?

Q1:

Guarantee fee paid by BCo to ACo would need to be assessed under the arm's length principle (ALP), on the basis that the guaranteed loan is $40 million. If the fee exceeds the arm's length price, the excess would likely be non-deductible for BCo and might be treated as a dividend paid to ACo (subject to withholding tax).
Would BCo's interest payments to BankCo (unrelated party) need to be assessed under the ALP, on the basis that the loan from BankCo is only $40 million? Strangely, this issue is not mentioned in para. 10.161, OECD TPG, but it would seem to be a logical conclusion. If the interest payments exceed the arm's length price (on a loan of $40 million), the excess would likely be non-deductible for BCo and might be treated as a dividend paid to ACo (subject to withholding tax), which is paid by direction to BankCo.

Q2:

If B imposes withholding tax on dividends paid to ACo (see above), A would be required to provide a credit: Art. 23A/B.
If A tax law taxes dividends paid by BCo to ACo (i.e., no 100% participation exemption), then the deemed dividends from BCo’s excessive interest payments might cause an increase in ACo's A tax liability.
Would A be required to recognise ACo's interest expense on the $60 million loan from BankCo, in total or to the extent of the deemed dividends? Would ACo obtain a deduction under A law for the interest? Would interest withholding tax apply? And if interest withholding tax applies, would B be required to give BankCo a credit under Art. 23A/B?

More questions than answers! Sorry!

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