IATJ 2014 conference Double non-taxation under tax treaties Washington DC, 22-23 October 2014 Double non-taxation under tax treaties 14 10 16b

Members: J. Patrick Boyle (Canada)  Malcolm Gammie (England) Friederike Grube (Germany) James S. Halpern (United States)  Pramod Kumar (India) Petri Saukko (Finland)     Chair:      Kees van Raad                                                          

Three instances of DNT under tax treaties State R has under the R-S treaty the exclusive taxing right but cannot tax under its domestic law State S has under the R-S treaty the taxing right (but cannot tax under its domestic law) and State R (exemption state) must under the treaty give an exemption As a result of a difference in domestic law – non-defined treaty term: 3.2 OECD: domestic law – one state views given entity as taxable entity whereas the other one views it as transparent the two states apply different treaty articles with the result that State S applies a distributive rule that prohibits it to tax, and State R a rule that requires it to provide an exemption.

DNT instance 1 State R has under the R-S treaty the exclusive taxing right but cannot tax under its domestic law Case 1 – State R does not tax the income Examples: – pension payments – investment income of (non-exempt) pension fund >> May/will State S dispute the applicability of the distributive rule? Case 2 – State R does not tax the recipient Example: – exempt pension fund >> May/will State S dispute the applicability of the treaty?

Case 1 – State R does not tax the income One solution: add a not-subject-to-tax exception in distributive rule Example of such a clause in German tax treaties: tax treaty Germany-Portugal Art. 22. Other income – Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention, shall be taxable only in that State. However, if those items of income are not subject to tax in that State, they may be taxed in the other Contracting State.

Case 1 – State R does not tax the income Germany in its domestic tax law also applies `subject-to-tax´ clauses : e.g.: -- in its Individual Income Tax Act: § 50d par. 8 EStG: “Where employment income of a resident taxpayer is under a tax treaty excluded from the basis on which German tax is imposed, the exclusion shall, notwithstanding the convention, be allowed only if the taxpayer proves that the country which may tax under the treaty convention has waived its right to tax or if the foreign country has imposed tax on the income that tax has been paid. …. >> Issue whether this provision violates both tax treaties and the German Constitution -- same Act, § 15d par. 9 EStG (so-called `treaty override´)

Case 1 – State R does not tax the income In the absence of an express exception included in the treaty (see the German example above) for instances where State R does not tax (and consequently State S is not prohibited anymore from taxing), can a court nevertheless through interpretation arrive at the conclusion that in such a case State S?

Case 2 – State R does not tax the recipient Example: exempt pension fund – most states: no issue with income not being taxed; different where recipient person is as such exempt from income tax – what if recipient person is not taxed because treated as tax- transparent in its country of organization ? – may State S verify State R’s application of State R’s domestic law in determining (tax-exempt) entity’s residence under that law? – relevance of a residence certificate issues by State R – treaty residence of a person who is a domestic law resident of one state but is not a treaty resident of a treaty between that state a third state

Case 2 – State R does not tax the recipient Example: Middle East countries – if such a country (like the UAE) does not tax its residents, is under a treaty State S still required to exempt income items which under the pertinent distributive rule of the tax treaty, are taxable only in State R. – India: AAR: Cyril Eugene Pereira decision (2002; 239 ITR 650): > "an individual who is not liable to pay tax under the UAE law cannot claim any relief from the only tax which is payable in India under the agreement" > "the provisions of Double Taxation Avoidance Agreements do not apply to any cases where the same income is not liable to be taxed twice by the existing laws of both the contracting states" >> Was Art. 4 (Residence) of the UAE-India treaty examined?

Case 2 – State R does not tax the recipient – India decision: ITAT 30 November 2005, ADIT vs Green Emirate Shipping and Travels – India decision: ITAT 29 Oct 2009, Meera Bhatia : UAE resident realized capital gain on alienation of shares in Indian company; claimed application of art. 13 UAE-India treaty: taxable in State R (UAE) only

DNT instance 2 State S has under the R-S treaty the taxing right (but cannot tax under its domestic law) and State R (exemption state) must under the treaty give an exemption Example: capital gain on privately held real property This is straightforward application of exemption system: left entirely to the other state: capital import neutrality: residence state does not interfere. If it does not like the full consequences: switch to relief through foreign tax credit: – overall: for all cases – in particular treaties: see next slide

DNT instance 2 switch-over clause in Art. 23 (double taxation relief): See e.g. Germany-US tax treaty (1989): Sec. 21 of Protocol regarding Art. 23 Treaty: The Federal Republic of Germany shall avoid double taxation by a tax credit as provided for in paragraph 2 b) of Article 23, and not by a tax exemption under paragraph 2 a) of Article 23, if … ….

DNT instance 2 BFH, Decision of 19.12.2013 - I B 109/13 The facts A pilot is resident in G and is employed by an Irish Aircraft-Company. According to the treaty (cf. Art. 15.3 OECD) Ireland had the right to tax the salary of the pilot but taxed only a small part of it applying a special ruling in the national law saying that salaries for supplies of services on board of an airplane could only be taxed if there existed a link to the Irish territory . The German tax authorities wanted to tax the „rest“ of the salary of the pilot according to the national provisions in § 50d par. 8, 9 EStG.

DNT instance 2 BFH, Decision of 19.12.2013 I B 109/13 The decision The tax authorities in Germany had no right to tax the salary of the pilot under the treaty with Ireland Further, the conditions for the exemption of § 50d par. 8 EStG were fulfilled and the applicance of § 50 par. 9 EStG neither gave a right to tax the salary

DNT instance 2 BFH, Decision of 19.12.2013 I B 109/13 Aftermath Ireland has changed the national provisions about the taxation of salaries for services supplied on board of airplanes: Now they can be taxed regardless of there being a link to the territory of Ireland or not… Ireland and Germany have introduced a new „subject-to-tax“ clause in Art. 23 par. 2 lit. a in the Convention for the avoidance of double taxation: The salary of a tax payer resident in Germany is only ecluded from taxation in Germany, if the salary has been taxed in Ireland…

DNT instance 2 BFH, Decision of 3. 08. 2008 - I R 54/07, I R 55/07 The facts The taxpayer was the managing director of a Ltd. company established in Germany (G); in the years 2001-2005 he also was the managing director of a company B established in Belgium. The taxpayer had an apartment in Belgium as well as in G and he exercised his work for B partly in Belgium and partly in G. While under the treaty Belgium (cf. Art 16 OECD [director‘s fees]) had the right to tax, Belgium only taxed that part of the salaries which the taxpayer had received for his work exercised in Belgium. The G. tax authorities therefore wanted to tax the „rest“.

DNT instance 2 BFH, Decision of 3. 08. 2008 - I R 54/07, I R 55/07 The decision The tax authorities have no right to tax the salary of the taxpayer. According to Art. 16 and Art. 23 par. 1 of the treaty Belgium had the right to tax the director‘s salary of the taxpayer and G must exempt it from taxation. There was no „subject-to-tax“ - clause in the treaty The conditions to tax of § 50d par. 8 EStG and § 50d par. 9 EStG were not fulfilled

DNT instance 2 Court of 1st instance, Düsseldorf, Decision of 31. 01. 2012 - 13 K 1178/10 E German residents working for the German international organization for technical foreign aid (GIZ) were in the past not taxed by Germany on their salary earned for working in a foreign country. In this case the taxpayer maintained that he was a resident of the country where he worked (Kazakhstan). Germany took now the position that even if he were a K resident, under the treaty (cf. Art. 19 OECD: government salaries taxable only in the paying state) Germany could tax as government (paying) state. The Court that Germany may indeed tax in this case under Art. 19 of the Germany-Kazackstan treaty. And from 1 January 2014 Germany takes the position that GIZ salaries are indeed subject to German taxation.

DNT instance 3 The two states apply different treaty articles with the result that State S applies a distributive rule that prohibits it to tax, and State R a rule that requires it to provide an exemption. In 2000 update of OECD Comm: solution for instances where difference in approach results from difference in domestic law – non-defined treaty term: 3.2 OECD: domestic law [unless …] – one state views given entity as taxable entity whereas the other one views it as transparent If difference in approach results from applying the treaty rule to the facts [e.g. is there a PE?] or from interpretation of the treaty rules then need for new para. 4 to OECD Art. 23A (exemption): `4. The provisions of paragraph 1 shall not apply to income derived … by a resident of a Contracting State where the other Contracting State applies the provisions of this Convention [not to tax] such income … or applies the provisions of paragraph 2 of Article 10 or 11 to such income.´