Tax Treaty Series

ITQ T-

112

December 10, 2021

Question

XCo is a publicly listed company which is incorporated in X, but has its place of effective management in Y.

Under the domestic tax law of X, XCo is non-resident; and under the domestic tax law of Y, XCo is resident.

XCo has numerous small shareholders resident in many countries.

XCo decides to relocate its head office from Y to X. After the relocation, XCo's place of effective management is in X – this makes XCo resident in X under the X domestic tax law.

In response to XCo's relocation, Y changes its law, with this effect: for a period of 10 years after the relocation, XCo will remain resident in Y under the Y domestic tax law.

Y imposes a withholding tax of 25% on outbound dividends. X does not impose a withholding tax on outbound dividends.

The X/Y treaty and the Y/Z treaty are both identical to the 2014 OECD model treaty.

During the 10 years' period, what rate of Y withholding tax will apply to dividends paid to small shareholders who are resident (1) in X; or (2) in Z; or (3) in a country with which Y has no treaty?

Answer

1. Shareholders resident in X

Application of X/Y treaty:

After the relocation and the Y law change, XCo satisfies the residence definition in Art. 4(1), in regard to both X and Y. However, under the residence tie-breaker rule in Art. 4(3), XCo is deemed to be a resident of X only (based on place of effective management), for the purposes of the X/Y treaty.

Art. 10(1) & (2) will not apply to allow Y tax; and the dividends will be exempt from Y tax under Art. 10(5) and Art. 21(1).

Thus, no Y tax.

2. Shareholders resident in Z

2.1 X/Y treaty:

XCo is deemed to be a resident of X only, for the purposes of the X/Y treaty (see above). Thus, the X/Y treaty should ensure that XCo is not taxable in Y on foreign sourced income: Art. 7(1), etc. Note that, even if Art. 11 of the MLI applies to the X/Y treaty (i.e., the so-called "saving clause"), XCo will still be exempt in Y on foreign sourced income – due to the fact that XCo’s residence status in X only, will mean that Art. 11 has no effect on Y tax.

2.2 Y/Z treaty:

XCo is excluded from the definition of "resident of [Y]" in Art. 4(1) by the second sentence. The OECD Comm.: "[The second sentence] excludes companies and other persons who are not subject to comprehensive liability to tax in a Contracting State [i.e., Y] because these persons, whilst being residents of that State under that State's tax law, are considered to be residents of another State [i.e., X] pursuant to a treaty between these two States. [i.e., X/Y treaty]".

Thus, Art. 10(1), (2) & (5) will not apply to the dividends paid by XCo; and the dividends will be exempt from Y tax under Art. 21(1).

Thus, no Y tax.

Note: If, contrary to the above, the view is taken that the second sentence in Art. 4(1) of the Y/Z treaty does not apply to exclude XCo from being a resident of Y for the purposes of the Y/Z treaty, then Art. 10(2) would allow Y to impose 15% tax on the dividends paid to Z-resident shareholders.

3. Shareholders resident in non-treaty country

XCo's residence status under the X/Y treaty is irrelevant to shareholders who are resident in countries with no treaty with Y.

Thus, 25% Y tax will apply.

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