Tax Treaty Series

ITQ T-

096

July 30, 2021

Question

ACo, a company resident in A, owns 100% of the shares in BCo, a company resident in B.

All of BCo's assets consist of land situated in B.

ACo entered into exclusive negotiations with CCo, a company resident in C, in regard to the sale of ACo’s shares in BCo. All of the negotiations were held in A. As a condition for conducting the negotiations on an exclusive basis, CCo was required to pay ACo a significant, non-refundable deposit – i.e., if the negotiations did not result in a sale contract, the deposit would be forfeited by CCo.

That's exactly what happened: no sale contract was entered into, and ACo therefore kept CCo's deposit.

The A/B treaty and the A/C treaty are both identical to the 2017 UN model treaty.

Does the A/B treaty allow B, and does the A/C treaty allow C, to levy income tax on ACo in regard to the deposit?

Answer

(1) Threshold issue:

The term, "alienation", is not defined in either the OECD or UN model treaties. Also, a comprehensive definition is not provided in either the OECD or UN Comm. on Art. 13.

The OECD Comm. (this part is copied into the UN Comm.) states that "alienation" is used to cover various forms of transfer of property. It also says that some countries include, in the term, "alienation", capital appreciation and revaluation of property. The inference is that the term takes its meaning from the domestic law of the source country – i.e., if the source country law treats the transaction as an alienation of property, then that would qualify as an alienation of property for the purposes of Art. 13. This is likely an application of Art. 3(2), although Art. 3(2) is not mentioned.

If that is correct, then the critical threshold issue is: does B law (in regard to the A/B treaty) or does C law (in regard to the A/C treaty) treat the transaction involving the forfeited deposit as an alienation of property?

(2) A/B treaty:

If an alienation is recognised under B law, then Art. 13(4) would allow B to levy income tax on ACo's deposit.

If an alienation is not recognised under B law, then Art. 13 would not apply (all paragraphs in Art. 13 refer to "alienation"). Instead, Art. 7 would provide ACo with an exemption from B tax (if ACo has no PE in B) – subject to one qualification: if B considers that ACo does not carry on an "enterprise" (as defined in Art. 3(1)) (because ACo is a passive holding company), then Art. 21(3) becomes relevant. Under Art. 21(3), the issue is whether the deposit arises in B. According to the UN Comm. on Art. 21, "arises", when applied by B, should be interpreted under B law. Nevertheless, the fact that the payer is not a resident of B (nor has a PE in B), and that the negotiations were held in A, suggest that the deposit does not “arise” in B.

Art. 6 should not apply, as the deposit is not "derived … from immovable property [in B]" – ACo has no ownership or other legal interest in immovable property in B.

(3) A/C treaty:

If an alienation is recognised under C law, then Art. 13(6) would exempt ACo's deposit from C tax.

If an alienation is not recognised, then Art. 13 would not apply. Instead, Art. 7 would provide ACo with an exemption from C tax (if ACo has no PE in C) – subject to one qualification: if C considers that ACo does not carry on an "enterprise" (as defined in Art. 3(1)) (because ACo is a passive holding company), then Art. 21(3) becomes relevant. Under Art. 21(3), the issue is whether the deposit arises in C. According to the UN Comm. on Art. 21, "arises", when applied by C, should be interpreted under C law. The fact that the payer is a resident of C might point to the deposit "arising" in C, although the fact that all the negotiations were held in A points against this.

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