097

Y/Z treaty

1. XCo: 

The Y/Z treaty is not relevant to Z's taxation of XCo. 

2. YCo: 

No Art. 5(1) PE, as YCo did not have any of the clients’ premises at its disposal for a sufficiently long period. 

Thus, Art. 7(1) would provide YCo with an exemption from Z tax on its profits. 

No other provision in the treaty is relevant – thus, YCo would be exempt from Z tax. 

X/Z treaty

1. XCo: 

XCo would not have a PE in Z under Art. 5. 

However, the payments made by YCo to XCo should satisfy the definition of "royalties" in Art. 12(3): payments "for information concerning industrial, commercial or scientific experience". Under Art. 12(5), the royalties would be deemed to arise in Z if (1) the payer (YCo) is resident in Z (which it is not), or (2) the royalties have a relevant nexus with a PE of the payer (YCo) in Z. 

Note that the PE status of YCo for the purposes of Art. 12(5), will be determined under Art. 5 of the X/Z treaty. It is irrelevant that YCo does not have a PE in Z under the Y/Z treaty (see above). 

YCo would not have an Art. 5(1) PE in Z, as none of the client business premises was at its disposal for a sufficiently long period. However, the furnishing of services in Z would satisfy the requirements for an Art. 5(3)(b) PE – note that the words, "for the same or a connected project", which appeared in earlier versions of Art. 5(3)(b), were deleted in the 2017 UN model. 

A relevant nexus with the PE will exist under Art. 12(5) if 2 tests are satisfied: (i) the liability to pay the royalties was incurred in connection with the PE, and (ii) the royalties are borne by the PE. 

Test (i): This test is not explained in the UN Comm. on Art.12. However, a similar test exists in Art. 11, and the UN Comm. on Art. 11 incorporates the OECD Comm. on Art. 11 – which says that the test is satisfied only where the relevant contract (i.e., the provision of knowledge contract, in our case) was entered into solely for the purposes of the relevant PE. That is unlikely to be the situation here – e.g., XCo's knowledge is probably also intended to be used in YCo's operation in Y, if not other countries. Thus, it is likely that test (i) is failed. Test (ii): This test is not explained in either Comm. on Art. 11 or 12. However, as YCo does not have an office, or employees who are based, in Z, it is likely that YCo does not produce any financial statements for its operations in Z. If that is the case, it is unlikely that the royalties, or any part of the royalties, are borne by the Z PE. 

Thus, Art. 12 should not apply. Also, Art. 12A would not apply, as XCo does not provide "services" to YCo – it provides information (i.e., knowhow): see para. 62 of UN Comm. on Art. 12A. 

That would mean that Art. 7(1) should exempt XCo from Z tax. 

However, if XCo does not carry on an active business, it is possible that the Z tax authorities could claim that it does not carry on an "enterprise" (defined in Art. 3(1)), thus Art. 7 does not apply, and thus Art. 21(3) allows unlimited Z tax (if the royalties "arise" in Z). Note that, according to the UN Comm. on Art. 21, "arising" takes its meaning under Z law. In the circumstances of this case, it is possible that a proportion of the royalties could be considered to "arise" in Z under Z law. 

2.YCo: 

The X/Z treaty is not relevant to Z's taxation of YCo.