Tax Treaty Series

ITQ T-

079

March 12, 2021

Question

RCo 1, a company resident in R, owns 30% of the shares in BCo, a company incorporated in B (a tax haven).

BCo's only asset is a parcel of land in S.

During S's 2020 tax year, RCo 1's 30% shareholding appreciated in value. RCo 1 did not dispose of any shares during that year. However, during that year, RCo 1 did grant a call option to RCo 2 (an unrelated company resident in R) in respect of all of its shares in BCo – RCo 2 paid a fee to RCo 1 for the grant of the option.

RCo 1 had no other financial connections with S during that year.

The R/S treaty is identical to the 2014 OECD model treaty. There is no treaty between B and S, or between B and R.

Does the R/S treaty permit S to levy income tax on RCo 1?

Answer

The key issue is whether Art. 13(4) applies to: (i) the appreciation in value of RCo 1's shares in BCo, or (ii) RCo 1's option fee. If it does, the R/S treaty would permit S to levy tax on RCo 1's gain.

Threshold point: Art. 13(4) can apply to the alienation of shares in BCo, even though BCo is not resident in S.

Appreciation in value of RCo 1's shares: Is this an "alienation"? The term is not defined in the treaty. The OECD Comm. suggests (without being definitive) that mere appreciation in value (possibly reflected in a book revaluation of the asset) would be covered by "alienation". If the S domestic tax law deems an appreciation in value to be an alienation, then possibly Art. 3(2) would enable that meaning to apply for the purposes of Art. 13(4).

Of course, this discussion is moot unless the S domestic tax law taxes RCo 1's gain on appreciation in value – but, if it does, it's possibly the case that Art. 13(4) would allow it to do so. The alternative view (i.e., that this is not an "alienation") would mean that both Art. 13(4) and Art. 13(5) would not apply – in which case, RCo 1 would be exempt from S tax (Art. 7 and Art. 21).

Option fee: Is the grant of the call option an "alienation of shares"? Ordinarily no – but what if the option were "deep in the money" by year-end, and the S tax law treats such call options as deemed alienations of the underlying property? Again, an argument can be made (based on the lack of definitive guidance in the OECD Comm., and Art. 3(2)), that that would also fall within Art. 13(4).

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