Tax Treaty Series

ITQ T-

086

May 7, 2021

Question

ACo, a company resident in A, owns 3 assets in B: (i) a block of land; (ii) shares in BCo 1 (a company resident in B); and (iii) shares in BCo 2 (a company also resident in B). BCo 1 and BCo 2 are not land-rich. ACo holds all 3 assets as long-term investments: it does not carry on a business of trading in land or shares.

During a particular year, ACo sells all 3 assets. It derives a gain of 500 on the land, and a gain of 300 on the BCo 1 shares; however, it incurs a loss of 200 on the BCo 2 shares.

All 3 assets fall within the B capital gains tax rules. Accordingly, under B domestic law, ACo's loss on the sale of the BCo 2 shares (200) can be offset against its gains (500 + 300 = 800) on the sale of the land and the BCo 1 shares – giving a net capital gain of 600, which is subject to B tax.

The A/B treaty is identical to the 2017 OECD model treaty.

After applying the treaty, what is the net capital gain which is subject to B tax?

Answer

Preliminary comments:

The 500 gain on the land is taxable in B: Art. 13(1); but the 300 gain on the BCo 1 shares is exempt in B: Art. 13(5).

But what about the 200 loss on the BCo 2 shares? Art. 13 refers only to "gains" – there are no references to "losses". Also, there is no discussion of losses in the OECD Comm. on Art. 13. Should Art. 3(2) apply to supply the B domestic law meaning of "gains"? – and would that domestic law meaning include losses?

Under B domestic law, ACo is entitled to deduct the 200 loss. Should the treaty be interpreted so as to deny ACo that domestic law benefit?

Let me change the numbers slightly: the 500 gain on the land and the 300 gain on the BCo 1 shares remain the same, but ACo incurs a loss of 400 on the BCo 2 shares. This would mean that, under B domestic law, ACo's net capital gain would be 400 (500 + 300 – 400). If the treaty were interpreted to deny ACo the benefit of deducting the 400 loss, ACo's net capital gain (after applying the treaty) would be 500: the treaty has increased ACo’s B tax liability!

2 issues:

(1) Should "gains" also include "losses"? In the absence of any treaty or Commentary support, it is difficult to conclude that “gains” includes “losses”.

(2) Can ACo take inconsistent positions? That is, rely upon the treaty to exempt the gain on the BCo 1 shares, but claim the benefit of domestic law for the loss on the BCo 2 shares? Some countries (e.g., Canada and the US) require taxpayers to rely upon the treaty only, or the domestic law only, in regard to all items of the same category of income.

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