Tax Treaty Series

ITQ T-

068

December 4, 2020

Question

ACo, a company resident in A, has manufacturing and trading branches in a number of other countries.

ACo, through its branch in B, owns inventory (goods) and fixed assets.

Those goods and fixed assets are physically transferred to ACo's branch in C.

Both the goods and the fixed assets have an arm's length value which exceeds their cost.

The A/B treaty, the A/C treaty and the B/C treaty are identical to the 2017 OECD model treaty.

Under those treaties, is B permitted to levy income tax on ACo in regard to the 2 physical transfers?

Answer

ACo has a PE in B, and thus Art. 7 is relevant. Under Art. 7(2), the physical transfers of the inventory and fixed assets would likely be treated as sales to the branch in C. When the arm's length principle is applied to those notional sales, it is likely that both transfers would be deemed to produce a profit for the PE in B.

Art. 13(2) is also possibly relevant. Both the inventory and fixed assets are "movable property forming part of the business property of a [PE]". The issue is whether the physical transfers are alienations, which is not defined in the treaty. If the B domestic law treats the physical transfers as alienations, then it is arguable that those physical transfers should be treated as alienations for the purposes of Art. 13(2): either by applying Art. 3(2), or by reference to the OECD Comm. on Art. 13(2).

If Art. 13(2) applies, the "gains" may be taxed in B. However, can the arm's length principle be applied in determining the amount of the gains? In my view: no, as Art. 9(1) is limited to dealings between (actual) separate enterprises.

If both Art. 7 (which would recognise deemed profits) and Art. 13(2) (which would not recognise deemed gains) apply, then Art. 7(4) indicates that Art. 13(2) must prevail – which would lead to the surprising conclusion that B cannot tax the deemed gains!

However, the contrary argument is possibly provided by the OECD Comm. on Art. 13(2): the taxation under Art. 13(2) in regard to intra-entity transfers must be "in accordance with Article 7".

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