1. European and International Taxation
Double Tax Conventions
© Jean Monnet Module: Managing the EU: Taxation, Governance and Economics
The content does not represent the view of the Erasmus+ project nor the European Commission but only of the author
Jean Monnet Module: Managing the EU: Taxation, Economics and Governance
Cluj-Napoca

2. Overall Structure of a DTC
European and International Taxation
Overall Structure of a DTC
Article 1 & 2
Scope of the convention
Article 3, 4, 5
General Definitions, Residency, Permanent Establishment,
Article 6 to 21
Taxation of various incomes
Article 22
Taxation of capital
Article 23A and 23B
Methods for elimination of double taxation
Article 24 and 29
Special provisions – Non discrimination, MAP, etc.
Article 30, 31
Entry into force, Termination

3. DTC and Dividends Dividends Preliminary remarks
European and International Taxation
DTC and Dividends
Dividends Preliminary remarks
Objective of dividends article: to limit the amount of tax that the source state can charge on a payment of a dividend from a company resident in that state.
“Dividends” - distribution of profits to the shareholders by companies limited by shares, limited partnerships with share capital, limited liability companies or other joint stock companies (legal entities with a separate juridical personality distinct from all their shareholders)
Profits of partnerships - the profits of a business carried on by a partnership are the partners’ profits derived from their own exertions - for them they are business profits. => the partner is ordinarily taxed personally on his share of the partnership capital and partnership profits.

4. Dividends vs. business profits of partner
European and International Taxation
Dividends vs. business profits of partner
The position is different from the shareholder
He is no a trader and the company’s profits are not his
He is personally taxable only on those profits which are distribute by the company (apart from the provisions in certain countries’ laws relating to the taxation of undistributed profits in special cases)
From the shareholders’ standpoint, dividends are income from the capital which they have made available to the company as its shareholders

5. Dividends - refers to the tax of the source state not exceeding:
European and International Taxation
Dividends - refers to the tax of the source state not exceeding:
5% of the gross amount of the dividends where the “beneficial owner” is a company (other than a partnership) and holds at least 25% of the capital paying the dividend, and
not exceeding 15% of the gross amount of the dividends in all other cases (Article 10(2) OECD Model Treaty).

6. European and International Taxation
In practice:
the tax rate % (commonly referred to as the “withholding tax”) and
the beneficial owner threshold % vary (in this respect reference is often made to “voting” shares)
! These percentages may in fact have little impact in the context of some domestic laws, such as in the UK, where there is no “withholding tax” on dividends.

7. European and International Taxation
Beneficial Owner
a key concept => enables a tax authority to deny treaty benefits where in substance a person is not the “true” beneficial owner, but it is not entirely clear what it means
it certainly does not include a nominee or an agent
it broadly refers to the person who has the main or principle ownership rights

8. The purposes of the other paragraphs to the dividends article are:
European and International Taxation
The purposes of the other paragraphs to the dividends article are:
to specify that the residence state of the recipient of dividends may tax the dividends without limit (Article 10(1));
to define what a dividend means. Essentially this term covers income arising from shares in a company, including from “jouissance” rights or shares, founders’ shares, or other rights that are not debt-claims but entitle the recipient to a participation in the profits of a company (Article 10(3));
to deal with the situation where shares are owned through a PE (Article 10(4)); and
to prohibit the “extra-territorial” taxation of dividends (Article 10(5)).

9. Dividends and Permanent Establishments
European and International Taxation
Dividends and Permanent Establishments
Article 10(4) covers the situation where the beneficial owner of the shares in a company has a PE in the other state through which the shares are owned. The state of the PE then has the right to tax any dividends at the normal income or corporate tax rates, rather than the rates set out in Article 10(2).
“Extra-territoriality” applies when a state tries to tax a dividend on the basis that the source of its profits, or part of the source of its profits, arises in that state even though the dividend does not emanate from a company resident in that state. This is strictly prohibited under the terms of a treaty. A state may, however, tax dividends from shares of companies, wherever resident, if the shares are effectively connected with a PE there.

10. The secondary withholding tax
European and International Taxation
The secondary withholding tax
Country A
Country B
Company X
-resident-
Shareholders of company X
Company X
-PE-
Dividends
Dividends
State A is allowed to tax the profits of company X (not resident in state A) in state A only if there is a permanent establishment in state A.
State A cannot tax profits arising in state A when company X distributes them to shareholders in State B.
!This is sometimes referred to as secondary withholding tax.

11. The Parent-Subsidiary Directive 90/435/EEC 2003/123/EC 2015/121/EU
European and International Taxation
The Parent-Subsidiary Directive 90/435/EEC 2003/123/EC 2015/121/EU
Ensure the establishment and effective functioning of the common EU market;
No WHT on dividends in the Source state
Cross-border payments only
Minimum holding of 10% / period of 2 years

12. Royalties – Background
European and International Taxation
Royalties – Background
Royalties arising in a Contracting State (Source State) and beneficially owned by a resident of the other Contracting State (Residence State) shall be taxable only in that other State (Residence State).
How does it work?... “Relief or exemption in respect of an item of income is granted by the State of source to a resident of the other Contracting State to avoid in whole/in part the double taxation that would otherwise arise from the current taxation of that income in the State of residence.”
What does the term “beneficial owner” mean?... The term “beneficial owner” is not used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance.

13. Royalties - definition
European and International Taxation
Royalties - definition
The term “royalties” as used in Article 12 of the OECD Model Treaty includes three main areas of intangible rights in relation to “payments of any kind received as consideration of, or the right to use” such rights.
These are:
“any copyright of literary, artistic or scientific work including cinematograph films”;
“ any patent, trade mark, design or model, plan, secret formula or process”;
“ information concerning any industrial, commercial or scientific experience”.

14. Royalties – some brief examples:
European and International Taxation
Royalties – some brief examples:
1. Will the payments made by a telecommunications network operator to another network operator under a typical “roaming” agreement constitute royalties?
Since these payments are not made in consideration for the use of, or right to use, property, or for information, referred to in the definition, they will not constitute royalties.
2. What about rents in respect of cinematograph films, whether such films are exhibited in cinemas or in television?
These payments may represent royalties. It may, however, be agreed through bilateral negotiations that rents in respect of cinematograph films shall be treated as business profits.

15. Royalties – some brief examples:
European and International Taxation
Royalties – some brief examples:
3. A distributor of clothes resident in one Contracting State pays a certain sum of money to a manufacturer of branded shirts, who is a resident of the other Contracting State, as consideration for the exclusive right to sell in the first State the branded shirts manufactured abroad by that manufacturer. Could this type of payment trigger a royalty?
In this example, the resident distributor does not pay for the right to use the trade name or trade mark under which the shirts are sold; given the fact that he obtains the exclusive right to sell in his State of residence shirts that he will buy from the manufacturer, we cannot consider these types of payments as royalties.

16. Royalties and the concept of know-how
European and International Taxation
Royalties and the concept of know-how
Know – how: payments received as consideration for information - concerning industrial, commercial or scientific experience
What about know-how?
transfer of certain information that has not been patented and does not generally fall within other categories of intellectual property rights
it is related to un-divulged information of an industrial, commercial or scientific nature arising from previous experience,
in the know-how contract, one of the parties - can use the know-how for his own account, his special knowledge and experience which remain unrevealed to the public.
there is the need to distinguish between two types of payments: payments for the supply of know-how and payments for the provision of services.

17. Royalties and the concept of know-how
European and International Taxation
Royalties and the concept of know-how
!computer programming - know-how only where it is made to acquire information constituting ideas and principles underlying the program, such as logic, algorithms or programming language or techniques, where this information is provided under the condition that the customer not disclose it without authorization and where it is subject to any available trade secret protection.
!computer software – know-how only when the user is able to exploit the rights for commercial gains
!copyright - royalty where the consideration is for granting of rights to use the program in a manner that would, without license, constitute an infringement of copyright

18. Royalties – computer software:
European and International Taxation
Royalties – computer software:
Situation 1:
Consider the case for transactions that permit the customer (which may be an enterprise) to electronically download digital products (such as software, images, sound or text) for that customer’s own use or enjoyment.
Could this payment represent a royalty?
Generally, no. Where the consideration is essentially for something other than for the use of, or right to use, rights in the copyright (such as to acquire other types of contractual rights, data or services), and the use of copyright is limited to such rights as are required to enable downloading, storage, performance or display device, such use of copyright should not affect the analysis of the character of the payment for purposes of applying the definition of “royalties”.

19. Royalties – computer software:
European and International Taxation
Royalties – computer software:
Situation 2 Imagine a book publisher who would pay to acquire the right to reproduce a copyrighted picture that it would electronically download for the purpose of including it on the cover of a book that it is producing. Clue: In this transaction, the essential consideration for the payment is the acquisition of rights to use the copyright in the digital product, i.e. the right to reproduce and distribute the picture, and not merely for the acquisition of the digital content. Could this type of payment trigger a royalty? Yes. Transaction where the essential consideration for the payment is the granting of the right to use a copyright in a digital product that is electronically downloaded for that purpose will give rise to royalties.

20. European and International Taxation
Royalties – paragraph 3
where the beneficial owner of the royalty has a PE in the other Contracting State through which the royalties arise => the PE state may tax such royalties at the normal income/corporate tax rates (this is similar to the dividend and interest articles).

21. European and International Taxation
Royalties – paragraph 4
The purpose of this paragraph => to restrict the operation of the provisions concerning the taxation of royalties in cases where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of royalties exceeds the amount which would have been agreed upon by the payer and the beneficial owner had they stipulated at arm’s length.
With regard to the taxation treatment to be applied to the excess part of the royalty, the exact nature of such excess will need to be ascertained according to the circumstances of each case, in order to determine the category of income in which it should be classified for the purpose of applying the provisions of the tax laws of the States and the provisions of the Convention.
Should the principles and rules of their respective laws oblige the two Contracting States to apply different Articles of the Convention for the purpose of taxing the excess, it will be necessary to resort to the mutual agreement procedure provided by the Convention in order to resolve the difficulty.

22. DTC and Other income (Art 21 OECD Model Treaty)
European and International Taxation
DTC and Other income (Art 21 OECD Model Treaty)
It is the article that sweeps up any income that is not covered in any other specific article.
The essence => only taxing the income in the state of the resident owner
The article has two paragraphs:
1. Article21(1) OECD Model Treaty provides that items of income of a resident not otherwise addressed covered in the other articles of the treaty will only be taxable in the resident’s state.
This includes income from other sources and income from other classes.
2. Article 21(2) then goes on to say that if the income (other than from immovable property) is effectively connected to a PE which the resident has in the other contracting state then it will be taxed under the provisions of the business profits article, i.e. it will be taxed in the PE state.

23. Other income (art. 21 OECD Model Treaty) examples
European and International Taxation
Other income (art. 21 OECD Model Treaty) examples
Social securities payments
Liquidation proceeds (if not classified as dividends or capital gains)

24. DTC and Business Profits
European and International Taxation
DTC and Business Profits
sets out the limits of the source state’s taxing rights in relation to business profits
if an enterprise resident in a contracting state has a PE in the other state through which it carries on business => taxable in that other state, as well as the state of residence (subject to double taxation relief). The tax is limited in the source state to no more than the profits attributable to the PE.
if, however, an enterprise does not have a PE in the other state => taxed in the state of residence (Article 7(1) OECD Model Treaty).

25. European and International Taxation
Business Profits
paragraph 2 does not specifically deal with the issue of whether expenses are deductible when computing the taxable income of the enterprise in either State
PEs must be accorded the same right as resident enterprises to deduct the trading expenses
paragraph 3 of the updated Article 7 => reciprocal adjustments to the profits calculated in respect of the PE
paragraph 3 – allows corresponding adjustments to avoid double taxation, on consultation of the two States involved

26. European and International Taxation
Business Profits
Article 7(4) => cedes priority to another specific income article of a treaty, if an item of income (forming a part of the profits of an enterprise) is dealt with under that article. This is the same as the previous Art 7(7).

27. European and International Taxation
DTC and Interest
limit the tax imposed by the source state where the interest arises and counters the treaty benefits available where there is an excessive payment of interest arising from a “special relationship”:
1.The resident state has unlimited taxing rights on the interest (Article 11(1)).
2.There is a limit on the withholding tax that may be imposed by the source state on the interest (maximum 10%). However, the recipient must be the “beneficial owner”
3.Definition of interest - exhaustive definition covering income from debt claims of every kind, whether or not secured by a mortgage and whether or not carrying a right to participate in the debtor’s profits. Income from government securities and income from bonds or debentures are included. Penalty charges for late payment of interest are not to be regarded as interest (Article 11(3)).

28. European and International Taxation
DTC and Interest
4. If the recipient of the interest has a PE in the other state then the other state may tax that interest at the normal income/corporate tax rates (Article 11(4)). 5. The circumstances when interest “arises in” a state. This includes where the payer is resident in a state, or where interest is borne by a PE in that state (whether paid by the PE itself or elsewhere) (Article 11 (5)). 6.Excessive interest payments arising under a special relationship, having regard to the debt claim on which the interest is paid, will not attract the interest article benefits, e.g. limiting withholding taxes. ! It should be noted that a number of treaties do not allow withholding taxes to be imposed on interest and that, within the EU, the Interest and Royalties Directive (Directive 2003/49/EC) may apply to avoid withholding taxes on interest.

29. DTC and capital gains (Art. 13 OECD Model Treaty)
European and International Taxation
DTC and capital gains (Art. 13 OECD Model Treaty)
This article has five paragraphs covering the following:
1. A source state has the right to tax “gains” (not defined in the Treaty and therefore domestic interpretation should be applied) from the “alienation” (again not defined, but certainly relates to actual sales – but it is questionable whether it can relate to deemed disposals under domestic tax laws) of “immovable property” (defined in Article 6 OECD Model Treaty).
2. A source state can tax gains on the sale of immovable property associated with a PE or on the sale of the PE itself (Article 13(2)).
3. In the case of alienation of ships and aircraft only the state of “effective management” has the taxing rights (Article 13(3)).
4. A source state can tax the gains on the sale of shares in a company owning land situated in the source state where the land forms more than 50% of the value of the company (Article 13(4)) (shares are, however, generally regarded as movable property, falling within the ambit of Article 13(3) or 13(5)).
5. In cases not covered by Articles 13(1), 13(2), 13(3) or 13(4), the state of the seller is only able to tax the gain (Article 13(5)).