Tax Treaty Series

ITQ T-

075

February 5, 2021

Question

YCo, a company resident in Y, has been granted an oil & gas production licence by the Y government. The licence entitles YCo to produce oil & gas from a specific field in Y.

XCo, a company resident in X, has provided YCo with $50 million of finance, in return for annual payments (for 25 years) equal to 1.5% of the value of oil & gas YCo produces from the field. The contract between XCo and YCo: (i) is not in the form of a loan; (ii) does not require YCo to repay all or part of the $50 million to XCo; (iii) subjects YCo to several "negative covenants" (e.g., YCo's permitted business activities, YCo's level of borrowing, etc.); and (iv) grants XCo security over YCo's licence.

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

Does the X/Y treaty permit the Y tax authorities to levy income tax on the annual payments made by YCo to XCo? If so, at what rate?

Answer

XCo's contract with YCo might constitute a "debt-claim" under Y tax or general law. If it does, all or part of the payments will probably be "interest" under Art. 11(3), after applying Art. 3(2). If it does not, the payments will not be "interest". To the extent that the payments are "interest", Y may tax the payments, but a 10% tax rate limit under Art. 11(2) would apply.

Art. 6:

It is possible (but unlikely) that XCo's contractual rights against YCo constitute "immovable property" under Y law (see Art. 6(2)), due to the security over YCo's oil & gas production licence. If they do, then Art. 6(1) would allow Y to levy unlimited tax on the annual payments.
Do XCo's contractual rights against YCo constitute "rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources" (Art. 6(2))? IMHO: No, they do not – unlike the licence, the contract between XCo and YCo does not grant YCo a right to work natural resources, and therefore the annual payments made under that contract cannot be consideration for such working or right. The opposite conclusion was reached by the UK First-tier Tribunal in the Royal Bank of Canada case in 2020.

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