Tax Treaty Series

ITQ T-

071

January 8, 2021

Question

XCo, a company resident in X, has a PE in Y.

Services are provided to XCo's PE by Parent Co, which is also a company resident in X. Parent Co is the 100% parent of XCo.

The Y tax authorities consider that the fee charged by Parent Co for the services provided to XCo's PE, exceeds the arm's length price. They therefore propose to deny the PE a deduction for the excessive amount of fee, pursuant to Y's transfer pricing rules.

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

Does the treaty permit the Y tax authorities to deny the deduction for the excessive amount of fee? If yes, does the treaty require any actions to avoid double taxation?

Answer

i. Application of Y's TP rules:

Art. 9(1) does not apply, as both XCo and Parent Co are enterprises of X.

However, in determining the profits attributable to XCo's PE under Art. 7, Y's TP rules would be applicable (provided those rules comply with the arm's length principle, "ALP"). Specifically, the "separate and independent enterprise" assumption which is made under Art. 7(2), is not limited to intra-entity "transactions" between the PE and other parts of XCo. As shown by the words, "in particular", in Art. 7(2), the assumption would also apply to actual transactions between XCo and other entities, such as Parent Co: see para. 24 of OECD Comm. on Art. 7.

ii. Eliminating double taxation of XCo:

The increased amount of the profits attributable to the PE (after Y applies its ALP-compliant TP rules) and the consequential increase in Y tax, would be required to be used for the relief of double taxation in X, under Art. 23A or 23B: Art. 7(2).

If, after the relief of double taxation under Art. 23A or 23B, it is still the case that there is double taxation of XCo in regard to the deductions disallowed by Y under its TP rules, XCo should be entitled to "an appropriate adjustment" of its X tax, "to the extent necessary to eliminate double taxation": Art. 7(3).

iii. Corresponding adjustment in X for Parent Co:

Parent Co would not be entitled to a corresponding adjustment of its taxable profits in X under Art. 9(2), for the same reason that Art. 9(1) does not apply: both XCo and Parent Co are enterprises of X.

No other provision appears to specifically allow a corresponding adjustment for Parent Co. However, it is possible that Parent Co could seek MAP relief under Art. 25(1), by arguing that it has been taxed "not in accordance with the provisions of this Convention" and pointing to the preamble's reference to "the elimination of double taxation". It’s unclear whether that argument would be successful!

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