Tax Treaty Series

ITQ T-

105

October 15, 2021

Question

XCo, a company resident in X, carries on a business of transporting cargo.

XCo uses one its ships to transport cargo between X and Y. That ship is owned by ZCo (a company resident in Z), which leases the ship on a bare boat charter basis to XCo. ZCo is in the business of leasing ships to ship operators – ZCo does not itself operate ships.

XCo has a small office in Y, with 2 employees based there. The 2 employees solicit orders, and sign contracts, for the transport of cargo between X and Y.

The X/Y, X/Z and Y/Z treaties are identical to the 2017 UN model treaty, with alternative A for Art. 8.

After applying those treaties: (1) which country or countries are permitted to tax XCo on its profits from transporting cargo between X and Y?; and (2) which country or countries are permitted to tax ZCo on the bare boat charter fees which are paid by XCo to ZCo?

Answer

XCo

XCo would have a PE in Y, under both Art. 5(1) and Art. 5(5)(a) of the X/Y treaty.

However, XCo's PE status is irrelevant to XCo's taxation under the treaty: Art. 8(1) would exempt XCo's profits from Y tax, and Art. 7(6) would prevent the application of Art. 7(1). Thus, X would have sole taxation rights.

ZCo

The bare boat charter fees would qualify as "royalties", as defined in Art. 12(3) of both the X/Z treaty and the Y/Z treaty: "payments … for the use of, or the right to use, industrial, commercial or scientific equipment".

X/Z treaty: The royalties would be deemed to arise in X: 1st sentence in Art. 12(5). The 2nd sentence in Art. 12(5) does not apply, as XCo's PE is not in a Contracting State (it's in Y). Thus, X may tax the royalties, subject to the rate limit in Art. 12(2). Z would be required to provide relief from double taxation under Art. 23A/B.

Y/Z treaty: XCo has a PE in a Contracting State (Y): see conclusion above in regard to XCo's PE under the X/Y treaty. However, based on the facts in the question, it is difficult to conclude whether the 2 tests in the 2nd sentence in Art. 12(5) would be satisfied. If the royalties are deemed to arise in Y under the 2nd sentence in Art. 12(5), then: (i) Y may tax the royalties, subject to the rate limit in Art. 12(2); and (ii) Z would be required to provide relief from double taxation under Art. 23A/B (in addition to the relief it must provide under the X/Z treaty – see above). If the royalties are not deemed to arise in Y under the 2nd sentence in Art. 12(5), then: (a) Art. 12(2) would not apply; and (b) ZCo would be exempt from Y tax under Art. 7.

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