Tax Treaty Series

ITQ T-

087

May 21, 2021

Question

XCo, a company resident in X, is the ultimate parent of an MNE group.

XCo owns 100% of the shares in YCo, a company resident in Y. YCo is a holding company with very little substance.

YCo owns 100% of the shares in ZCo, a company resident in Z. Under Z domestic law, a withholding tax ("WHT") of 20% applies to outbound dividends.

ZCo is a major operating company which generates significant profits. To achieve 2 tax objectives (i.e., (1) to extract dividends from ZCo with zero Z WHT, and (2) to avoid X tax on dividends paid directly to XCo), YCo was interposed in the shareholding structure many years ago. Since then, ZCo has paid significant dividends to YCo. YCo has invested the cash elsewhere in the group in the form of intragroup loans (with arm's length interest).

The Y/Z treaty is identical to the 2008 OECD model treaty, but with zero source country tax on dividends on substantial shareholdings.

The Y domestic law provides an exemption for foreign sourced dividends, and it does not impose tax on outbound dividends.

There have been 3 recent developments: (1) The MLI has commenced operation in regard to the Y/Z treaty (the "PPT only" option has been adopted by both Y and Z); (2) X and Z have entered into their first double tax treaty, which is identical to the 2017 OECD model treaty, but with zero source country tax on dividends on substantial shareholdings (the treaty has become effective); and (3) X has changed its law to introduce an exemption for foreign sourced dividends.

XCo now wants to implement this plan: ZCo would pay a large dividend to YCo, and YCo would immediately use the cash to pay the same amount of dividend to XCo.

Will Z WHT apply?

Answer

(1) Y/Z treaty:

Due to the "conduit" nature of the 2 payments, YCo is probably not the beneficial owner of the ZCo dividend, under the pre-2014 version of the OECD Comm's discussion of beneficial ownership. The 2014 amendments to the OECD Comm probably do not apply to the Y/Z treaty (identical to 2008 OECD model).

Also, YCo would probably fail the PPT. 1st limb: the arrangement or transaction (i.e., interposition of YCo) occurred "many years ago" for a principal purpose of achieving the treaty reduction in Z WHT. 2nd limb: it seems difficult to argue that the treaty reduction in Z WHT is in accordance with the object and purpose of the Y/Z treaty, merely because the new X/Z treaty provides for a zero WHT on dividends. Note that none of the examples in the 2017 OECD Comm on Art. 29(9) is applicable. Also note that Art. 7(4), MLI is inapplicable.

(2) X/Z treaty:

Is XCo the beneficial owner of the ZCo dividend paid to YCo, such that XCo can claim zero Z WHT under the X/Z treaty? The OECD Comm on Art. 10 allows a "look through" to the beneficial owner in agency and nominee situations, but it does not refer to "conduit company" situations. Note that the "look through" argument, as applicable to "conduit companies", has been enhanced by the amendment of Art. 10(2) in the 2014 OECD model treaty: after the amendment, there is no connection between paras. (1) & (2) of Art. 10.

IMHO:

YCo cannot claim under Y/Z treaty. XCo can possibly claim under X/Z treaty.

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