Hybrid Entities; avoidance of double (non-) taxation under ... seminar.pdf · Paragraph 6.4 of the...
Transcript of Hybrid Entities; avoidance of double (non-) taxation under ... seminar.pdf · Paragraph 6.4 of the...
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www.europesefiscalestudies.nl
29 September 2015
Seminar:
Hybrid Entities; avoidance of
double (non-) taxation under the
Parent-Subsidiary Directive and
the OECD Model Tax Convention
Conference chairman: Prof. A.J.A. (Ton) Stevens
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Page 2
Application of the Parent Subsidiary
Directive to hybrid entities
mr. dr. G.K. Fibbe
EFS seminar
29 September 2015
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Agenda
1. Application of the PSD to hybrid entities in outbound situations
2. Application of the PSD to hybrid entities in
inbound situations
3. Conclusions
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State B
Application Parent Subsidiary Directive
to hybrid entities
Hybrid
1
2
2
State C
State A
Hybrid
Company Company
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Agenda
1. Application of the PSD to hybrid entities in outbound situations
2. Application of the PSD to hybrid entities in inboundsituations
3. Conclusions
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State B
Hybrid
2
State C
State A
Hybrid
Parent Subsidiary Directive only addresses
outbound situations (no. 1)
1 2
CompanyCompany
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State B: (non-)transparent
Hybrid
State A: (non-)transparent
Parent Subsidiary Directive only addresses
outbound situations (no. 1)
1
Company
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State B: non-transparent
Hybrid
State A: transparent
Parent Subsidiary Directive only addresses
application to hybrid entities in outbound
situations (no. 1)
1
Company
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Council Directive 2003/123/EC of 22 December 2003
amending Directive 90/435/EEC on the common system
of taxation applicable in the case of parent
companies and subsidiaries of different Member States
“Member States treating non-resident corporate taxpayers as fiscally
transparent on this basis should grant the appropriate tax relief in
respect of revenue which forms part of the tax base of the parent
company.”
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Secondary EC Law
Art. 4(1, sub a) Parent Subsidiary Directive
“Nothing in this Directive shall prevent the State of the parent company from considering a subsidiary to be fiscally transparent […] and therefore from taxing the parent company on its share of the profits of its subsidiary as and when those profits arise.
In this case the State of the parent company shall refrain from taxing the distributed profits of the subsidiary.
When assessing the parent company's share of the profits of its subsidiary as they arise the State of the parent company shall either exempt those profits or authorise the parent company to deduct from the amount of tax due that fraction of the corporation tax related to the parent company's share of profits and paid by its subsidiary …”
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State B: non-transparent
Hybrid
State A: transparent
Parent Subsidiary Directive only addresses
application to hybrid entities in outbound
situations (no. 1)
1
Company
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Hybrid
Outbound situations and reverse hybrid
entities – not addressed in the PSD!
State B: transparent
State A: non-transparent
Company
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Following clause suggested addressing the application
of the PSD to reverse hybrid entities in outbound
situations:
‘In the case of an item of income, gain or capital derived through an
entity established in a Member State that is fiscally transparent under the
laws of that Member State where the Member State of the receiving
company qualifies such entity as non-transparent, such item of income,
gain or capital shall be considered to be derived by a company of the
latter Member State from an entity liable to one of the taxes mentioned in
Article 3 of the PSD provided – and to the extent that - the receiving
company is liable to tax for that item of income, gain or capital in the
former Member State to one of the taxes mentioned in Article 3 of the
PSD.’
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Agenda
1. Application of the PSD to hybrid entities in outbound situations
2. Application of the PSD to hybrid entities in inboundsituations
3. Conclusions
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State B
Hybrid
1
2
2
State C
State A
Hybrid
Parent Subsidiary Directive in inbound
situations (no. 2)
Company Company
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2
2
Hybrid
State B: (non-)transparent
State A: (non-)transparentDividend
Company
Parent Subsidiary Directive in inbound
situations (no. 2)
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2Hybrid
Application Parent Subsidiary Directive to
hybrid entities in inbound situations
State B: transparent
State A: non-transparent
Dividend
State C
Company
Company
?
?
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Parent Subsidiary Directive 90/435/EEC of 23 July 1990
Article 2
For the purposes of this Directive 'company of a Member State' shall
mean any company which:
(a) takes one of the forms listed in the Annex hereto;
(b) according to the tax laws of a Member State is considered to be
resident in that State for tax purposes;
(c) moreover, is subject to one of the following taxes, without the
possibility of an option or of being exempt:
- impôt des sociétés/vennootschapsbelasting in Belgium
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Parent Subsidiary Directive 90/435/EEC
of 23 July 1990
Article 5, paragraph 1, PSD
Profits which a subsidiary distributed to its parent company shall […] be
exempt from withholding tax.
How to interpretate
the term ‘distributed
to’?
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European Commission, 17 april 2009, no. (COM(2009)179,
punt 3.3.5.2. re the Interest and Royalty Directive
“It is conceivable that one or more of the entities listed in the Annex
could be regarded as fiscally transparent by a [Member State] other than
that in which the entity is registered or incorporated. The Directive does
not contain any provision allowing [Member States] to ‘look through’ non-
resident qualifying entities. It follows that a [Member State] has no legal
basis for refusing tot apply the Directive to a non-resident entity which
meet the requirements of Article 3.” However, even if it were permissible
to apply a look-through approach, the logic of that approach would require
the MS in question to extend the benefits of the Directive to the partner/
shareholder. That view would be consistent with the position taken in the
OECD Partnership Report and the Commentary on Article 1 of the MTC.”
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2Hybrid
Application Parent Subsidiary Directive to
hybrid entities in inbound situations
State B: transparent
State A: non-transparentDividend
State C
Company
Company
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2Hybrid
Application Parent Subsidiary Directive to
reverse hybrid entities in inbound
situations
State B: non-transparent
State A: transparent
Dividend
Company
Company
?
?
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Parent Subsidiary Directive 90/435/EEC
of 23 July 1990
Article 5, paragraph 1, PSD
Profits which a subsidiary distributed to its parent company shall […] be
exempt from withholding tax.
How to interpretate
the term ‘distributed
to’?
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Paragraph 6.4 of the OECD Commentary on Article 1 of
the OECD Model Tax Convention
6.4 Where…income has "flowed through" a transparent
partnership to the partners who are liable to tax on that
income in the State of their residence then the income is
appropriately viewed as "paid" to the partners
Source State follows allocation Residence State
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OECD, ‘Neutralising the Effects of Hybrid
Mismatch Arrangements’, 16 September
2014.
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OECD Tax Treaty approach to reverse
hybrid entities in inbound situations
2Hybrid
State B: non-transparent
State A: transparent
Dividend
Company
Company
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Following clause suggested addressing the application
of the PSD to both hybrid entities and reverse hybrid
entities in inbound situations:
‘In the case of an item of income, gain or capital derived through an entity
established in a Member State that is fiscally transparent under the laws
of a Member State, such item of income, gain or capital shall for purposes
of this Directive considered to be derived by a company of a Member
State provided such item of income, profit or gain is treated for purposes
of one of the taxes mentioned in Article 3 of the PSD as the item of
income, profit or gain of such company in a Member State’.
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2Hybrid
Application Parent Subsidiary Directive
to (reverse) hybrid entities in inbound
situations
Dividend
Company
Company
2Hybrid Dividend
Company
Company
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Questions?
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Prof.dr. Arnaud de Graaf
EU approach regarding hybrid entities
September 29, 2015
EFS Conference on Hybrid Entities
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Classification of ‘foreign’ entities
• Countries classify entities, domestic and foreign, autonomously for tax purposes
• As to ‘foreign’ entities, they in principle don’t take note of how other countries classify their entities
• As the tax classification of other countries is not taken into account, differences in classification of entities occur
• Those differences my have as an outcome situations of non-taxation and double taxation
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How do countries classify ‘foreign’ entities?
Three approaches are applied by countries:
1.Similarity approach (corporate resemblance test, application of same criteria to classify foreign entities)
2.Elective approach (so-called check-the box in US and Aruba)
3.Fixed approach (all ‘foreign’ entities are being treated as non-transparant, Italy)
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Effects of not applying a symmetrical tax classification
• If a symmetrical tax classification approach would be applied, situations of double and non-taxation could be avoided
• The non-symmetrical tax classification approaches of countries, might be (ab)used by taxpayers to optimize their tax structure
• They might (ab)use differences in classification in order to create situations of:
– Deduction and no inclusion (D/NI)(fig. 1 and 2; or
– Double deduction (DD)(fig. 3)
• Especially, the elective approach enables taxpayers to minimize their tax burden
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A Co.
Country CCountry A
Country B
B Co. C Co.
Interest
+ -Loan
Figure 1. D/NI (Payment to a
(Reverse) Hybrid)
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Figure 2. D/NI (Payment made by
hybrid, disregarded by Country A)
A Co.
B Co.
Country A
Country B
B Sub 1
+
-
LoanInterest
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Figure 3. DD (Payment made by
hybrid to a third party)
A Co.
B Co.
+-
Interest
Bank
Country A
Country B
Loan
B Sub 1
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Effects of not applying a symmetrical tax classification
• One should also realize that differences in classification of entities might not just have as an outcome double non-taxation but also double taxation
• Taxpayers might be unaware of a possible difference in classification
• Figure 4 is an example of a situation of double taxation
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Figure 4. economic double taxation
because of difference …
LP
Income
form
immovable
property
Limited
partner
Box II-levy
and no
credits
US individual
income tax
NL
US
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MAP
• Taxpayers invoked the MAP-article of DTC (taxation not in accordance with DTC)
• Claim rejected by Dutch CA. DTC only tries to avoid situations of international juridical taxation
• Outcome: international economic double taxation
• No solution, US and NL exercise their power to levy tax in parallel
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HMAs: differences in tax treat-ment
• It is not just differences in classification of entities that create HMAs but all kinds of differences in classification between countries
• Hybrid element:
– Taxable subject, transparent v. non-transparent
– Tax base (broad v. narrow), e.g. financial instrument, transferal (operating v. capital lease), and permanent establishment
– Tax rate (high v. low, for example: payment made by company in high-tax jurisdiction to a company in a tax haven)
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BEPS no 2 – Recommendations
for Domestic Laws
• Action 2 is only targeted at mismatches that rely on a hybrid element to produce D/NI AND DD outcomes
• Hybrid element is based on a difference in classification of entities, (financial) instruments, and transfers
• Effects of HMAs should be neutralized
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2012 HMA-Report
• Policy options to neutralise HMAs:
1. Harmonization of domestic laws;
2. GAARs;
3. Specific anti-avoidance rules; or
4. Linking rules
OECD Recommendation: linking rules, good experiences
• BEPS Action plan (2013) and 2014-Deliverable addressing the ‘problem’ whereas at the same time accepting each other’s classification
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2014 Deliverable
Type Arrangement
Specific recommendations
on improvements to
domestic law
Recommended hybrid mismatch rule
Response Defensive rule Scope
D/NI Hybrid financial
instrument
No dividend exemption for deductible payments
Proportionate limitation of withholding tax credits
Deny payer
deduction
Include as ordinary income
Related parties and structured arrangements
Disregarded
payment made by a hybrid
Deny
payer deduction
Include as
ordinary income
Related parties and structured
arrangements
Payment made
to a reverse hybrid
Improvements to offshore
investment regime Restricting tax transparency of
intermediate entities where non-resident investors treat
the entity as opaque
Deny
payer deduction
- Controlled group and
structured arrangements
DD Deductible payment made
by a hybrid
Deny parent
deduction
Deny payer deduction
No limitation on response, defensive rule applies to
related parties and structured arrangements
Deductible
payment made by dual
resident
Deny
resident deduction
- No limitation on response
Indirect
D/NI
Imported
mismatch arrangements
Deny
payer deduction
- Members of controlled group
and structured arrangements
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Principle of mutual recognition
• ECJ case law: Prohibited are obstacles caused by distinctions based on nationality and between domestic and cross-border situations
• What about obstacles resulting from disparities? Elimination only through harmonization or unification?
• Issuance by ECJ of its ruling in the Cassis de Dijon case, see figure 5
• If a product is lawfully produced and traded in a MS, than other MS should take account of
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Figure 5. Cassis de Dijon, case 120/78
REWE
Cassis de Dijon 15 to 20%
Fruit liqueurs should contain at
least 25%
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Principle of mutual recognition
• Principle was also applied by ECJ in other areas, for instance
– The recognition of diplomas (Gebhard)
– The recognition of companies (Centros and Inspire Art)
• Also applicable in the area of direct taxation?
• Is double taxation arising from autonomous tax classification of ‘foreign’ entities incompatible with EU freedoms?
• Would it be possible for taxpayers to invoke the freedom of capital in figure 4?
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Columbus Container Services, C-298/05
LP
Passive
income
Obligation to recognize the Belgium classification?
Limited
Partners
Coordinationcentre
General
Partner
BVBA
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Key par. ECJ in Columbus
5. This assignment of the profits of a partnership to its partners applies even ifthe partnership is liable, as such, to corporation tax abroad, namely in theState in which it is registered.
53. In this respect, it must be recalled that the fiscal autonomy … also means that the Member States are at liberty to determine the conditions and thelevel of taxation for different types of establishments chosen by nationalcompanies or partnerships operating abroad, on condition that thosecompanies or partnerships are not treated in a manner that is discriminatoryin comparison with comparable national establishments.
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End
• EU freedoms do not offer a solution to differences in classification causing double taxation
• Only harmonizing domestic laws would offer a solution
• This path has not been taken
• Missed opportunity
• In future, international policy makers should develop entity classification rules in order to avoid all kinds of mismatches
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Coffee BreakInterested in the Post-Master International and European Tax Law?
Ask for a brochure at the registration desk or sent an e-mail to:
www.europesefiscalestudies.nl
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International aspects of fiscal transparency:
-classification of foreign entities
-application of double tax conventions
Prof. dr. Bart Peeters
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Structure of the presentation
I. General context of classification
II. Conflicts with (reverse) hybrid entities
III. Solution for P/R –conflict ?
IV. Conclusions
Bart Peeters (UGent, ULg, Uantwerpen)
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I. General context of classification
Financial
supportGeneral purpose
Entrepreneurial
risk
Entity
Taxable
income
Tax payer
Tax payer
Bart Peeters (UGent, ULg, Uantwerpen)
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Classification of an entity
General purpose
Entrepreneurial
risk
EntityTaxable
income
Tax payer
Tax payer
Classification: -Fiscally transparent: 1 flow of income
-Fiscally non-transparent: 2 separate taxable
flows of income
Bart Peeters (UGent, ULg, Uantwerpen)
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3 classifications to be fulfilled
General purpose
Entrepreneurial
risk
EntityTaxable
income
State S:
source of
the income
State P:
state of the location
of the entity
State R:
residence state
of the partner
Bart Peeters (UGent, ULg, Uantwerpen)
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Classification from the point of view of S
EntityTaxable
income
State S: -Taxing the entity or its partners ?
-Which treaty limitations have to be respected ?
(analysis for ‘inbound operations’ ?)
S P R
Bart Peeters (UGent, ULg, Uantwerpen)
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Classification from the point of view of P
EntityTaxable
income
State P: -Taxing the entity and distribution to the partners
or immediately the partners (entity as PE?) ?
-Unilateral remedies for foreign income ?
-Which conventions should be applied ?
S P R
Bart Peeters (UGent, ULg, Uantwerpen)
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Classification from the point of view of R
EntityTaxable
income
State R: -When can the partners be taxed and how to
qualify their income?
-Unilateral remedies for foreign income ?
-Which conventions should be applied ?
S P R
(analysis for ‘outbound operations’ ?)
Bart Peeters (UGent, ULg, Uantwerpen)
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Classification from the point of view of P
Entity
Taxable
income
If S = R: simultaneously inbound and outbound ?
E.g. Dutch lawyers working for an English firm, earning
domestic income
S P R
Bart Peeters (UGent, ULg, Uantwerpen)
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Classification of an entity
=> Domestic tax legislation has to be applied on
-a domestic entity (State P)
-a foreign entity (States S – R)
Classification NEEDS to be in line with
domestic tax law
Dealing with conflicts is a SECOND STEP
Bart Peeters (UGent, ULg, Uantwerpen)
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II. Conflicts with (reverse) hybrid entities
Two different classification topics:
-Which treaty limitations does a source state
has to apply ? (State S vs … )
-How to attribute income between conflicting
residence states ? (P vs R)
Bart Peeters (UGent, ULg, Uantwerpen)
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Source vs residence state(s)
Entity
Taxable
income
Partner
S P / Rvs
Suppremacy of a residence state compared to a clear
source state: Treaty is applicable for the source state
- if a residence state attributes income to its own residents
Bart Peeters (UGent, ULg, Uantwerpen)
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S P R
T/NT T T Treaty S-R
T/NT T NT No treaty
T/NT NT T S-P and S-R
T/NT NT NT Treaty S-P
-Implicit solution in Partnership report
-Explicitly in art. 1, 6 Belgian – US treaty (2006)
-Explicit in art. 1, 2 Belgian Model convention (2007)
-No longer in Belgian Model convention (2010)
-New art. 1, 2 OECD Model ?
State S has to respect
Bart Peeters (UGent, ULg, Uantwerpen)
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Conflict between residence state(s)
EntityTaxable
income
Partner
P Rvs
TNT HYBRID
T NTREVERSE
HYBRID
Bart Peeters (UGent, ULg, Uantwerpen)
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-A conflict between two residence states cannot be solved by way of a predominating classification
=> Partnership report: state R recognizes the correct
autonomous application of the treaty by state P,
based on its own classification-if P considers it may tax, state R has to grant an exemption
-if P considers himself obliged to exempt, state R does not have
to grant any exemption anymore
Bart Peeters (UGent, ULg, Uantwerpen)
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Taxable
income
Entity
If state P: NT and state R: T Hybrid entity
=> state P taxes income at the level of the entity
=> state R has to avoid double taxation through the correct application of
the treaty P-R, because state P taxes the income in accordance with
the terms of the convention P-R (as interpreted by state P)
S P R
Bart Peeters (UGent, ULg, Uantwerpen)
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Taxable
income
Entity
S P R
If state P: T and state R: NT Reverse hybrid entity
=> state P immediately attributes the income to the partners and considers
not being able to tax according to the treaty (unless PE)
=> state R does no longer have to exempt the income, as it would do based
on its autonomous interpretation of the treaty P-R
Bart Peeters (UGent, ULg, Uantwerpen)
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*solution only looks at the initial acquiring of income at the
level of the entity
=> no particular treatment for the subsequent
distribution from the entity to its partners
*in case of a reverse hybrid entity (P:T and R: NT) state R
does not have to exempt under the treaty
=> But there will be no taxation under internal
income tax regulations
Treaty P-R cannot solve the problem !!
Bart Peeters (UGent, ULg, Uantwerpen)
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III. Solution for P/R-conflict ?
=> needs to consider all potential taxable events in
both states
How to deal with the acquisition of the income ?
How to deal with distribution of the income to the
partners ?
Bart Peeters (UGent, ULg, Uantwerpen)
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Hybrid entity
State P (NT) State R (T)
Acquiring income
at the entity levelTaxes the entity
Taxes each
individual partner
Distribution to the
partners
Taxes each
individual partner/
Bart Peeters (UGent, ULg, Uantwerpen)
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Reverse hybrid entity
State P (T) State R (NT)
Acquiring income
at the entity level
Possible taxation of
the partners/
Distribution to the
partners
No separate
taxation,
unless potential
branch profits tax
Taxation of the
partners
Particular clause in Belgian Model convention
Exemption of the distribution because the initial acquiring of the
income has been taxed in P (art. 22, 2, b) )
Bart Peeters (UGent, ULg, Uantwerpen)
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IV. Conclusions
-Necessary to clearly distinguish the topic of classification of an
entity (internal tax law) from application of tax treaties
(with possibly contrasting classifications)
-Any search for a solution needs to accept the fundamental
triangular character of the topic
(solutions are possible in bilateral double tax treaties, but need to
take in mind possible taxations in a third country)
-Recent treaties do admit the problem of conflicting classifications,
but actual clauses do not solve all the problems.
Bart Peeters (UGent, ULg, Uantwerpen)
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Any questions / commentaries ?
Bart Peeters (UGent, ULg, Uantwerpen)
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OECD BEPS ACTION 2:New Article 1(2) of the
OECD Model Tax Convention
EFS Seminar – 29 September 2015
Edward Barret
Tax Treaties Unit
OECD Centre for Tax Policy and Administration
www.europesefiscalestudies.nl
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BEPS Action 2: Neutralise the effects of hybrid mismatch
arrangements
“Develop model treaty provisions and recommendations regarding the design of domestic rules
to neutralise the effect (e.g. double non-taxation, double deduction, long-term deferral) of hybrid
instruments and entities. This may include: (i) changes to the OECD Model Tax Convention to
ensure that hybrid instruments and entities (as well as dual resident entities) are not used to
obtain the benefits of treaties unduly; …. Special attention should be given to the interaction
between possible changes to domestic law and the provisions of the OECD Model Tax
Convention....”
www.europesefiscalestudies.nl
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Conclusions of September 2014 Action 2 Report• A number of the treaty provisions resulting from the work on BEPS
Action 6 (Prevent Treaty Abuse) may play an important role in ensuring
that hybrid entities and instruments are not used to obtain the benefits
of treaties unduly –
LOB rules;
Rules aimed at arrangements one of the principal purposes of which is to obtain
treaty benefits;
Rule aimed at dividend transfer transactions;
Rule concerning a Contracting State’s right to tax its own residents;
Anti-abuse rule for PEs situated in third States.
• Change to Article 4(3) resulting from the work on Action 6 will address
some BEPS concerns related to dual-resident entities.
• New Article 1(2): Treaty provision on transparent entities.
www.europesefiscalestudies.nl
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New paragraph 2 of Article 1:
2. For the purposes of this Convention, income derived by or
through an entity or arrangement that is treated as wholly or partly
fiscally transparent under the tax law of either Contracting State
shall be considered to be income of a resident of a Contracting
State but only to the extent that the income is treated, for purposes
of taxation by that State, as the income of a resident of that State.
www.europesefiscalestudies.nl
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New Article 1(2) is intended to ensure that
the income of transparent entities is treated,
for treaty purposes, in accordance with the
provisions of the Partnership Report.• Addresses the income of entities or arrangements that one or both
Contracting States treat as wholly or partly transparent for tax
purposes.
• Extends application of the conclusions of the Partnership Report to
situations not directly covered by the Report.
• Provision is similar to Article 1(6) of the U.S. Model.
www.europesefiscalestudies.nl
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Applying a Convention where there is a conflict of classification:
A two-country example
Facts
P is a partnership established in State P. A and B are P’s partners who reside
in State P. State P treats P as a transparent entity while State S treats it as a
taxable entity. P derives royalty income from State S that is not attributable to a
permanent establishment in State S.
www.europesefiscalestudies.nl
EXAMPLE 4STATE P STATE S
A B
ROYALTIES
P
EXAMPLE 4
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Applying a Convention where there is a conflict of classification:
A two-country example
Facts
P is a partnership established in State P. A and B are P’s partners who reside
in State P. State P treats P as a taxable entity while State S treats it as a
transparent entity. P derives royalty income from State S that is not attributable
to a permanent establishment in State S.
www.europesefiscalestudies.nl
EXAMPLE 6STATE P STATE S
A B
ROYALTIES
P
EXAMPLE 5
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Applying a Convention where there is a conflict of classification:
An example where benefits are not due
Facts
P is a partnership established in State P. A and B are P’s partners who reside
in State R. State P treats P as a transparent entity while State R treats it as a
taxable entity. P derives royalty income from State P that is not attributable to a
permanent establishment in that State.
www.europesefiscalestudies.nl
EXAMPLE 7STATE R STATE P
A
B
ROYALTIES
P
EXAMPLE 6
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BEPS Action 2: Example (¶ 26.7 Commentary on Art. 1):
www.europesefiscalestudies.nl
Member 2
Interest
(100) -
year 1
trustees
Example 4 – Yr 3 Distribution
State T State S
Trust
(taxpayer
in Yr 1)
40
i n
yr 3
Beneficiary A
State T taxes
Trust in year 1.
In year 3 -
distribution to
beneficiaries,
(Bs) who are
each entitled to
one half of the
trust's income
of year 1 after
deduction of
administration
expenses.
State T taxes
Bs on
distributions
but provides
credit for tax
paid at the
level of the
trust.
or
Beneficiary B
40
in
yr 3
Interest
(100) -
year 1
trustees
Example 4 – Yr 3 Distribution
State T State S
Trust
(taxpayer
in Yr 1)
40
i n
yr 3
Beneficiary A
State T taxes
Trust in year 1.
In year 3 -
distribution to
beneficiaries,
(Bs) who are
each entitled to
one half of the
trust's income
of year 1 after
deduction of
administration
expenses.
State T taxes
Bs on
distributions
but provides
credit for tax
paid at the
level of the
trust.
or
Beneficiary B
40
in
yr 3
Interest
(100) -
year 1
trustees
Example 4 – Yr 3 Distribution
State T State S
Trust
(taxpayer
in Yr 1)
40
i n
yr 3
Beneficiary A
State T taxes
Trust in year 1.
In year 3 -
distribution to
beneficiaries,
(Bs) who are
each entitled to
one half of the
trust's income
of year 1 after
deduction of
administration
expenses.
State T taxes
Bs on
distributions
but provides
credit for tax
paid at the
level of the
trust.
or
Beneficiary B
40
in
yr 3
State A State B
INTEREST
INCOMEEntity
Member 1
Interest
(100) -
year 1
trustees
Example 4 – Yr 3 Distribution
State T State S
Trust
(taxpayer
in Yr 1)
40
i n
yr 3
Beneficiary A
State T taxes
Trust in year 1.
In year 3 -
distribution to
beneficiaries,
(Bs) who are
each entitled to
one half of the
trust's income
of year 1 after
deduction of
administration
expenses.
State T taxes
Bs on
distributions
but provides
credit for tax
paid at the
level of the
trust.
or
Beneficiary B
40
in
yr 3
Third State 50%
50%
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Treatment of the interest income under the A-B
treaty?
• “income derived by or through an entity or
arrangement that is treated as wholly or partly
fiscally transparent”
• State B taxes Member 1 on half of the interest
• Half of the interest shall be considered, for
purposes of Article 11, to be income of a
resident of State B
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2006 U.S. Model Article 1(6):“An item of income, profit or gain derived through an entity
that is fiscally transparent under the laws of either
Contracting State shall be considered to be derived by a
resident of a State to the extent that the item is treated for
purposes of the taxation law of such Contracting State as
the income, profit or gain of a resident. ”
Identical provision in Article 4(1)(d) of the 1996 U.S. Model.
Since the 1970s most U.S. treaties have contained provisions on
partnerships/fiscally transparent entities.
Compare paragraph 4 of Article 24 (Basis of Taxation) of the
Netherlands-U.S. treaty (2004 Protocol).
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Discussion
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