Tax Treaty Series

ITQ T-

077

February 26, 2021

Question

XCo (a company resident in X) and YCo (an unrelated company resident in Y) are planning to form a 50/50 international joint venture.

One of the investments of the joint venture will be to acquire 100% of the shares in BCo, a company resident in B.

To hold the shares in BCo, XCo and YCo are currently planning to form a 50/50 general partnership under A law. The partnership will elect to be treated as a resident company for A tax law purposes. The reason for using a partnership is to allow surplus cash to be easily paid to XCo and YCo (i.e., without the restrictions of the A corporate law).

The A/B treaty is identical to the 2014 OECD model treaty. The MLI does not apply to the A/B treaty. There is no treaty between X and B, or between Y and B.

Under B law: (i) a 30% withholding tax is levied on outbound dividends; (ii) the A partnership is treated as transparent; and (iii) the GAAR does not apply to treaty benefits.

Under A law, foreign source income of residents is generally taxable. However, foreign dividends derived by resident companies are exempt.

After applying any treaty benefits, what rate of B withholding tax will apply to dividends paid by BCo?

Answer

For the A/B treaty to apply to the partnership (p/s), it must be a "person" who is a "resident" of one or both of A and B.

The p/s is a "person", under the Art. 3(1) definition, as it is both a "company" (as defined in Art. 3(1)) and a "body of persons".

The p/s has elected to be treated as a resident company for A tax purposes. It is noted that, under A law, foreign source income of residents is generally taxable. The p/s should therefore be considered to be liable for comprehensive taxation in A, and thus should be a "resident" of A under the Art. 4(1) definition. The fact that the p/s has elected into this position should be irrelevant.

Under Art. 10(2), the 15% rate under para. (b) should apply instead of the 5% rate under para. (a), because the p/s does not satisfy the phrase, "company (other than a partnership)".

However, there are 2 possible risks with this outcome:

There is a risk that the p/s would be viewed as not being the "beneficial owner" of the dividends, due to the plan to distribute cash to the partners. However, under the 2014 OECD Comm., "beneficial ownership" status is denied only if the p/s is subject to a contractual or legal obligation to pass on the dividends to another person. Applying this rule in the context of a partnership is difficult!
Although the B law GAAR does not apply to treaty benefits, it is possible that B is a country which views treaty shopping as an abuse of the treaty itself (see 2014 OECD Comm. on Art. 1). If this were the case, B might deny the treaty benefit.

If either of these risks is triggered, the withholding tax rate would be 30%.

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