Tax Treaty Series

ITQ T-

085

April 30, 2021

Question

XCo, a company resident in X, is the parent of a group which carries on a famous restaurant business in X.

XCo plans to use X-Sub (a newly formed X subsidiary) to open a branch of the restaurant in Z city in country Y for a period of one month, during the Olympic Games in Z city. At the end of the Games, the restaurant will close, and X-Sub will be liquidated.

Under 2 contracts to be signed by XCo and X-Sub in X before the activities at the branch in Z city are commenced: (i) X-Sub will pay XCo arm's length fees for the provision of knowhow and the right to use the restaurant's name in Z city; and (ii) a number of XCo chefs and other restaurant staff will be seconded to X-Sub for the one month, in return for an arm's length fee which is paid to XCo.

The X/Y treaty is identical to the 2017 OECD model treaty, except that Art. 12 allows a source country tax rate of 10%.

Will the X/Y treaty allow Y to levy income tax on XCo or X-Sub?

Answer

X-Sub's branch restaurant in Y should constitute a "fixed place of business" PE under Art. 5(1), although it will operate for only one month. This is because the branch will be X-Sub’s only place of operation globally: see para. 30, OECD Comm.

Thus, Art. 7(1) will allow Y to levy income tax on X-Sub's profits from the branch restaurant. In determining those profits, deductions should be given for the 2 types of fee paid by X-Sub to XCo.

XCo should not have a PE in Y, for 2 reasons: (i) the branch restaurant would not be at XCo's disposal (its employees are seconded to X-Sub); and (ii) the time test in Art. 5(1) would not be satisfied.

XCo's secondment fee would therefore be exempt under Art. 7(1).

XCo's fee for the knowhow and the use of the restaurant's name might be "royalties" under the Art. 12(2) definition. The knowhow component should be "royalties" if the knowhow is confidential and valuable (e.g., valuable, secret recipes). The restaurant's name component would be "royalties" if the name is protected (in Y) by a trade mark which is owned by XCo.

To the extent that the fee is "royalties", will Y be allowed to tax it? Art. 12 applies to royalties "arising" in a Contracting State. However, "arising" is not defined in the OECD model (cf. UN model); and there is no guidance in the OECD Comm. on this issue. Thus, the Y domestic law meaning should be used, under Art. 3(2). In the present case, there are factors pointing to both X and Y as the State in which the fee arises: (i) the fee is paid pursuant to a contract signed in X; (ii) however, the fee is deductible in computing the profits attributable to the payer's PE in Y.

If Art. 12 applies, Y tax of 10% will be allowed. If Art. 12 does not apply, the fee will be exempt under Art. 7(1).

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