Tax Treaty Series

ITQ T-

059

October 2, 2020

Question

XCo, a company incorporated and resident in X, owns 100% of the shares in YCo, a company incorporated and resident in Y.

XCo makes a loan (with an arm's length interest rate) to YCo.

YCo uses the borrowed money in its business in Y.

YCo fails to deduct and remit withholding tax from the interest it pays to XCo.

As a result of the non-payment of withholding tax, the Y tax authorities (acting in accordance with the Y tax law): (i) impose penalties on XCo and YCo; and (ii) deny an income tax deduction to YCo for the interest payments.

Under Y law, no withholding tax is imposed on interest payments to resident lenders.

The X/Y treaty is identical to the 2017 OECD model treaty.

Are the actions taken by the Y tax authorities, permitted under the treaty?

Answer

XCo: Art. 24(1)

The fact that a withholding tax is levied by Y on interest paid to XCo, but not on interest paid to Y-resident lenders, does not breach Art. 24.

Specifically, Art. 24(1) is not breached, because XCo cannot be compared with Y-resident lenders, as they are not "in the same circumstances, in particular with respect to residence".

For the same reason, the penalty imposed on XCo does not breach Art. 24(1).

YCo: Art. 24(5)

I will assume that Y's withholding tax applies to interest paid to non-residents generally, and it is not limited to interest paid to a person which owns or controls the capital of the payer.

Based on that assumption, Art. 24(5) is not breached by either (i) the penalty imposed on YCo, or (ii) the denial of deductions for YCo - see OECD Comm., para. 79.

YCo: Art. 24(4)

The Y tax authorities have denied YCo deductions for interest paid to XCo, because the withholding tax was not paid. If the interest were instead paid to a Y-resident lender, it would be deductible, because there is no withholding tax imposed in that situation.

This is a breach of Art. 24(4).

ITQ Disclaimer

This International Tax Quiz (ITQ) contains general information only, and none of International Insights Pte Ltd, its employees or directors is, by means of this ITQ, rendering professional advice or services. You use the content of this ITQ strictly at your own risk. You should not rely on all or any part of the content of this ITQ in making decisions to take action (including inaction) in regard to tax or other matters. Before making any decision or taking any action (including inaction) that may affect your tax position, your finances or your business, you should consult a qualified professional advisor. None of International Insights Pte Ltd, its employees or directors shall be responsible for any loss whatsoever sustained by any person who relies on the content of this ITQ.