Tax Treaty Series

ITQ T-

106

October 22, 2021

Question

ACo, a company resident in A, carries on a logistics business on a global basis.

ACo owns a warehouse in B. ACo uses the warehouse to provide logistics services in B.

Under the B domestic tax law, fees paid for logistics services are subject to a withholding tax of 5% on the gross fees. The withholding tax is a final tax – i.e., no deductions are allowed. This final withholding tax regime applies to all logistics services provided in B, regardless of whether they are provided by residents or non-residents.

The A/B treaty is identical to the 2017 OECD model treaty.

In the current year, ACo's logistics business in B has incurred losses.

Does the treaty allow ACo to be exempt from B withholding tax, on the basis that it incurs losses?

Answer

1. Art. 5:

The warehouse would constitute an Art. 5(1) PE for ACo in B. All of the Art. 5(1) tests would be satisfied. Also, the exceptions in Art. 5(4)(a), (b) & (e) would not be satisfied, because: (i) the goods stored in the warehouse do not belong to ACo; and (ii) the provision of logistics services in the warehouse is a direct income-producing activity for ACo – they are not "preparatory or auxiliary".

2. Art. 7:

Art. 7 therefore allows B to impose tax on ACo's profits which are attributable to the PE. This raises 2 issues.

2.1 The first issue is whether Art. 7 allows B to impose tax on ACo only on a "net" basis – i.e., after deducting expenses. In other words, does gross-basis taxation satisfy Art. 7’s reference to “profits”?

The answer is that "gross-basis" taxation is not prohibited by Art. 7 – see paragraph 30 of the 2017 OECD Comm. on Art. 7: “[Art. 7(2)] does not deal with the issue of whether expenses are deductible when computing the taxable income of the enterprise in either Contracting State.”

However, Art. 24(3), which requires that the taxation on a PE is "not less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities", must be considered. Art. 24(3) might be triggered if the gross-basis taxation applied only to non-resident companies. But that’s not the case here: the gross-basis taxation applies to all logistics services provided in B, regardless of whether they are provided by residents or non-residents.

Thus, the B withholding tax levied on ACo would not breach Art. 7 (even though it is gross-basis taxation) or Art. 24(3).

2.2 The second issue is determining how much of the fees received by ACo are attributable to the B PE.

Art. 7 allows B to tax ACo only on its profits which are attributable to the B PE. If the logistics fees are consideration for a freight service which commences in A (or some other country) and finishes in B, it is quite likely that not all of the fees should be attributed to the B PE.

Thus, IMHO: The mere fact that ACo's logistics business in B incurs losses, does not cause the A/B treaty to prevent the imposition of the B withholding tax. However, there might be an opportunity for ACo to reduce the quantum of the withholding tax, on the basis that not all of the fees are attributable to the B PE.

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