Tax Treaty Series

ITQ T-

098

August 13, 2021

Question

ACo, a company incorporated in A, has a branch in B.

The branch, which has 10 employees, operates solely to purchase goods for ACo.

B imposes a payroll tax on the total payroll of companies operating in B. For B-incorporated companies, the payroll tax rate is 4%; for foreign-incorporated companies, the payroll tax rate is 10%.

Under the respective income tax laws of A and B, a company's residence status is determined by incorporation.

The A/B treaty is identical to the 2014 OECD model treaty.

Is ACo liable for the 10% payroll tax?

Answer

Art. 2:

B's payroll tax is levied on the total payroll of companies operating in B. Thus, it should fall within the list of covered taxes in Art. 2(2): "taxes on the total amount of wages or salaries paid by enterprises".

Note that if the payroll tax were levied on only some of the payroll, it would not fall within this description (see below).

Art. 2(2) does not state whether payroll taxes are taxes on income or on capital. If on income, Arts. 6 to 21 should apply; if on capital, Art. 22 should apply. Payroll taxes don't fit neatly into either category! See Michael Lang, " 'Taxes Covered' – What is a 'Tax' according to Article 2 of the OECD Model?", Bulletin on International Taxation, IBFD, June 2005.

Arts. 6 to 21:

If B's payroll tax is a tax on income, then ACo should be exempt from the payroll tax under either Art. 7 or Art. 21. The Art. 7 exemption should apply if ACo does not have a PE in B – ACo's branch should be excluded from PE status under Art. 5(4)(d).

Art. 22:

If B's payroll tax is a tax on capital, then ACo should be exempt under Art. 22(4).

If B's payroll tax is not a covered tax in Art. 2(2):

If B's payroll tax is not a covered tax in Art. 2(2) (e.g., because it is levied on only some of the payroll), then Arts. 6 to 21 (income) and 22 (capital) should not apply to the tax.

However, Art. 24 would be applicable: Art. 24(6).

Art. 24(3) should not apply, on the basis that ACo does not have a PE in B (see above).

Art. 24(1) is relevant. ACo is a "national" of A, under the Art. 3(1) definition. The 10% vs. 4% rate differential is due to the nationality difference between ACo and B-incorp. companies. However, Art. 24(1) requires the comparison to be made against B-incorp. companies "in the same circumstances": does that mean that, for the B-incorp. companies to be validly compared with ACo, the B-incorp. companies and ACo need to have the same tax residence status (which they don't)?

According to the OECD Comm, the answer (surprisingly) is "no": see Example 4 in para. 23.

Thus, if B's payroll tax is not a covered tax in Art. 2(2), ACo should be able to secure the 4% rate by virtue of Art. 24(1).

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