Tax Treaty Series

ITQ T-

064

November 6, 2020

Question

The X/Y treaty, which is identical to the 2010 OECD model, was signed and entered into force in 2011.

In 2012, Y changed its domestic law definition of "permanent establishment" to be identical to Art. 5 in the 2010 OECD model.

In 2019, Y changed its domestic law to introduce a provision which deems a non-resident to be carrying on business through a fixed place of business in Y, if the non-resident satisfies a "significant economic presence" (SEP) test. If that deeming provision applies to a non-resident (and if the non-resident’s activities are not of a preparatory or auxiliary character), then the non-resident satisfies the domestic law definition of PE and is subject to Y income tax (on a net basis) on income which is derived from that SEP.

XCo, a company resident In X, derives income from online streaming services which are provided to Y residents. Although XCo has no assets or employees in Y, it satisfies the SEP test, and is therefore subject to Y income tax under domestic law.

Is XCo's Y income tax liability permitted under the X/Y treaty?

Answer

Before considering the Y domestic law, it is clear that XCo does not have a PE in Y under the X/Y treaty, and therefore it would be exempt from Y tax under Art. 7.

Does the Y tax law's SEP provision change that conclusion?

The SEP provision deems a non-resident to be carrying on business through a fixed place of business in Y, if the SEP test is satisfied. The concept of a fixed place of business is used in the Art. 5 definition of PE. Although the treaty defines PE, it does not define "fixed place of business". Does Art. 3(2) operate to allow the Y law meaning of "fixed place of business" (under the SEP provision) to be used in interpreting Art. 5?

IMHO: No – Art. 3(2) does not automatically "slot in" a domestic law meaning. A domestic law meaning shall not be used if the context otherwise requires. The X/Y treaty is identical to the 2010 OECD model, and was signed shortly after its release. The X/Y treaty’s "context" should, in my view, include both the 2010 OECD model and the 2010 OECD Comm., the latter of which sets out a detailed description of the meaning of “fixed place of business” – a description which is contrary to the Y law SEP provision. That being the case, the context prevents Art. 3(2) from using the Y law meaning.

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