Tax Treaty Series

ITQ T-

062

October 23, 2020

Question

ACo (a bank resident in A) enters into equity swaps with individual customers resident in C. The swaps track a portfolio of shares in companies resident in B (BCos), and cash balances held by the customers.

As a hedge, ACo purchases the share portfolio tracked in the swaps.

The swaps exchange the ownership economics of the share portfolio (e.g., dividends, price changes) and the cash balances (e.g., interest). A single payment is made under each swap (either from ACo to the customers, or vice versa) at every quarter end, calculated according to a formula. There is no contractual right to the components in the formula.

Each swap's "force majeure" clause does not cover the failure of BCos to pay dividends which have been declared (other than by virtue of B government action).

A and B each impose a 20% withholding tax on outbound dividends.

The A/B treaty (which was signed and entered into force in 2011), is identical to the 2010 OECD model, except that there is a single rate of 10% in Art. 10(2).

The A/C treaty is identical to the 2001 UN model, except that there is a single rate of 10% in Art. 10(2).

The MLI (including Art. 7(1)) applies to both treaties.

There is no B/C treaty.

Q1: Does the A/B treaty permit B tax on dividends paid to ACo?

Q2: Does the A/C treaty permit A tax on swap payments made by ACo?

Answer

First issue: beneficial ownership

IMHO, the "contractual or legal obligation" requirement (in the 2014 OECD Comm. on beneficial ownership) should not apply to the A/B treaty, because it represents a change in meaning and not a mere elaboration on the previous meaning.

That previous meaning (reflected in the 2010 OECD Comm.) focuses on whether, in the present case, ACo is a conduit company acting as a fiduciary or administrator. The fact that there is no contractual right to the components in the payment formula, that only a single quarterly payment is made (in either direction), and that the payment reflects multiple elements besides dividends, suggests that ACo is the beneficial owner. However, note that the Swiss Supreme Court reached the opposite conclusion in a 2015 case.

On balance, IMHO, ACo is the beneficial owner.

Second issue: PPT

Based on the facts, the PPT would likely be triggered – this would cause the dividends to be subject to 20% B withholding tax.

Unless the A law deems equity swap payments to be dividends, Art. 10 should not apply.

Art. 21(3) might apply, if the individual customers are not carrying on "enterprises" , and thus Art. 7 does not apply. If Art. 21(3) applies, A can impose unlimited tax on the swap payments.

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