Priority Rules in Tax Treaties PDF

This eBook is licensed to Michael Siaw Larbi, [email protected] Priority Rules in Tax Treaties This eBook is licensed to Michael Siaw Larbi, [email protected] This eBook is licensed to Michael Siaw Larbi, [email protected] Priority Rules in Tax Treaties The Relationship between the Different Distributive Rules in the OECD and the UN Models Editors: Georg Kofler Michael Lang Pasquale Pistone Alexander Rust Josef Schuch Karoline Spies Claus Staringer Rita Szudoczky Volume 28 WU Institute for Austrian and International Tax Law European and International Tax Law and Policy Series This eBook is licensed to Michael Siaw Larbi, [email protected] IBFD Visitors’ address: Rietlandpark 301 1019 DW Amsterdam The Netherlands Postal address: P.O. Box 20237 1000 HE Amsterdam The Netherlands Telephone: 31-20-554 0100 Email: [email protected] www.ibfd.org © 2023 IBFD All rights reserved. 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Where the use of parts of this publication for the purpose of anthologies, readers and other compilations (article 16 of the 1912 Copyright Act) is concerned, one should address the publisher. ISBN 978-90-8722-848-4 (print) ISBN 978-90-8722-849-1 (eBook, ePub); 978-90-8722-850-7 (eBook, PDF) ISSN 2451-8360 (print); 2589-9694 (electronic) NUR 826 This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents Preface xix List of Abbreviations xxi Chapter 1 The Role of and the Relationship between the Distributive Rules in Tax Treaties 1 Stefano Castagna 1.1. Beginning a journey into distributive rules: A primer on the main issues 1 1.2. The structure of the OECD Model 2 1.2.1. Personal scope 2 1.2.2. Substantive scope 2 1.2.3. Distributive rules 2 1.2.4. The methods to avoid double taxation 3 1.3. Identifying distributive rules 3 1.3.1. Articles 6-22 of the OECD Model 3 1.3.2. Article 9 of the OECD Model 3 1.3.3. Article 20 of the OECD Model 4 1.3.4. Definitions 7 1.4. The role of the distributive rules 9 1.4.1. Exclusion of taxation rights in the source state 9 1.4.2. Limited taxation rights of the source state 10 1.4.3. Unlimited taxation rights of the source state 10 1.4.4. Exclusion of taxation rights in the residence state 11 1.5. The concepts behind distributive rules 11 1.5.1. Principle of universality 11 1.5.2. Rules needing a cross-border connection to apply 12 1.5.3. Avoiding overlaps through explicit priority rules 13 1.5.4. Avoiding overlaps through interpretation 14 1.6. The different types of distributive rules 14 1.6.1. Business income 14 1.6.2. Non-business income 14 v This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents 1.6.3. Dual type income 15 1.7. Conclusions 15 Chapter 2 The Relevance of Article 7(4) of the OECD Model 17 Daniel W. Blum and Marcelo H.B. Moura 2.1. Objective and scope of the chapter 17 2.2. Historical development of article 7(4) of the OECD Model 18 2.3. Constituent elements and legal consequence of article 7(4) of the OECD Model 21 2.3.1. Starting point: Broad understanding of the term “profits” 21 2.3.2. Business profits according to article 7(1) of the OECD Model 22 2.3.3. Definition of “dealt with separately” 26 2.3.3.1. Introduction 26 2.3.3.2. Concrete test if income covered in specific case 26 2.3.3.3. Abstract test if income generally covered by another article 27 2.3.4. Legal consequences 28 2.3.4.1. Allocation of taxing rights according to the specific rule: Article 7(4) as codification of the lex specialis principle 28 2.3.4.2. Qualification of income 29 2.3.4.3. Avoidance of double taxation as a corollary to the qualification of income 31 2.4. Types of overlaps addressed by article 7(4) of the OECD Model 32 2.4.1. Systematic role of article 7(4) of the OECD Model 32 2.4.2. Specialty relationship 33 2.4.2.1. Immovable property 34 2.4.2.1.1. General rule 34 2.4.2.1.2. Function of article 6(4) of the OECD Model 34 2.4.2.2. Two examples for the delineation of material scopes of articles 6 and 7 of the OECD Model 36 2.4.2.2.1. Introductory remarks 36 2.4.2.2.2. Agricultural activities and livestock 36 vi This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents 2.4.2.3. International shipping and air transport 39 2.4.2.3.1. General precedence 39 2.4.2.3.2. Constituent elements of article 8 and selected examples of open issues 41 2.4.2.3.2.1. Constituent criteria 41 2.4.2.3.2.2. Selected examples of disputed borderline cases 42 2.4.2.3.3. Investment income 43 2.4.2.4. Entertainers and sportspersons 44 2.4.3. Conflict between specialty and telos principles 45 2.4.4. Relationship with article 21: Other income 45 2.4.4.1. Interplay between articles 7(4), 6 and 21 of the OECD Model 47 2.4.4.2. Role of article 21(2) of the OECD Model 49 2.5. Conclusion and policy observation 50 Chapter 3 The Relevance of Article 21(2) of the OECD and UN Models 53 Georg Kofler and Erika Scuderi 3.1. Introduction and delimitation of the scope of the chapter 53 3.2. Overview of article 21 of the OECD and UN Models 56 3.2.1. Article 21(1) of the OECD and UN Models 56 3.2.2. Article 21(2) of the OECD and UN Models 59 3.2.2.1. Overview and scope 59 3.2.2.2. “The provisions of paragraph 1 shall not apply to income, other than income from immovable property … ” 60 3.2.2.3. “ … if the recipient of such income … carries on business in the other Contracting State through a permanent establishment situated therein … ” 64 3.2.2.4. “ … the right or property in respect of which the income is paid is effectively connected with such permanent establishment … ” 68 3.2.3. Article 21(3) of the UN Model: A compromise approach? 69 3.3. The role of article 21(2) of the OECD and UN Models: Is article 21(2) of the OECD Model even needed? 70 3.4. Conclusions 76 vii This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents Chapter 4 The Relevance of Article 6(4) of the OECD and UN Models 81 Josef Schuch and Nathalia Oliveira Costa 4.1. Introduction 81 4.2. The interaction of articles 6, 7 and 21 83 4.2.1. Triangular scenarios involving permanent establishments 84 4.2.2. Proposed approach 86 4.2.2.1. Article 6(4) vs. article 7(4) and “dealt with separately” 86 4.2.2.2. Function of article 21(2) in light of article 6 (clarifying vs. independent meaning) 88 4.3. Interactions of article 6 with other articles 90 4.3.1. Article 8: International shipping and air transport 90 4.3.2. Articles 10, 11 and 12: Dividends, interest and royalties 91 4.3.3. Article 13: Capital gains 92 4.4. Conclusion 92 Chapter 5 The Relevance of Articles 10(4), 11(4) and 12(3) of the OECD Model 95 Daniel W. Blum and Belisa Ferreira Liotti 5.1. Introduction 95 5.2. The PE proviso 97 5.2.1. The rule under the OECD Model and its consequences 97 5.2.2. The rule under the UN Model 99 5.2.3. Relevance and purpose 100 5.2.4. Historical development 102 5.2.4.1. Development of the wording 102 5.2.4.2. Relevant changes to the Commentary 104 5.2.5. Consequences for classification of income by virtue of application of the PE proviso 106 5.3. Constituting elements of the rule 110 5.3.1. Application of the PE proviso 110 viii This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents 5.3.2. Criteria for application 112 5.3.2.1. General criteria 112 5.3.2.1.1. Beneficial owner 112 5.3.2.1.2. “Carries on business” 114 5.3.2.2. Specific criteria 116 5.3.2.2.1. Income arising in the other (PE) contracting state 116 5.3.2.2.2. Effectively connected with the PE 120 5.4. Interplay with other provisions in the OECD Model 123 5.4.1. General comments 123 5.4.2. Article 6 124 5.4.3. Article 8 126 5.5. Policy outlook 129 5.6. Conclusion 130 Chapter 6 The Relationship between Articles 7, 8 and 14 of the OECD and UN Models 133 Abhishek Padwalkar and Camilo Rodriguez Peña 6.1. Introduction 133 6.2. Historical background of articles 7, 8 and 14 135 6.3. Scope of articles 7, 8 and 14 138 6.3.1. Scope and applicability of article 7 138 6.3.2. Scope of article 8 139 6.3.2.1. General rule 140 6.3.2.1.1. Operation of ships or aircraft 141 6.3.2.1.2. International traffic 142 6.3.2.1.3. Enterprise resident of a contracting state 143 6.3.3. Scope of article 14 144 6.3.3.1. Personal scope 145 6.3.3.2. Material scope 147 6.3.3.3. Threshold 148 6.4. The relationship and points of conflict between articles 7, 8 and 14 149 6.4.1. Borderline cases between articles 7 and 8 149 6.4.1.1. Leasing 149 6.4.1.2. Code sharing 151 ix This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents 6.4.1.3. Investment income 152 6.4.1.4. Other activities 152 6.4.1.5. Method of taxation 154 6.4.2. Borderline cases between articles 7 and 14 154 6.4.2.1. Source taxing rights 155 6.4.2.2. Double tax relief 156 6.4.2.3. Application of the non-discrimination clause 158 6.5. Conclusion 158 Chapter 7 The Relation between Article 12A and Article 12B of the UN Model (2021) and the Other Distributive Rules of the UN Model (2021) 161 Christian Knotzer 7.1. The taxation of services in the UN Model (2021): Overview and general considerations 161 7.2. Articles 12A and 12B of the UN Model (2021): New distributive rules for certain cross-border services 164 7.2.1. General considerations on articles 12A and 12B of the UN Model (2021) 164 7.2.2. Article 12A of the UN Model (2021): Technical services 165 7.2.3. Article 12B of the UN Model (2021): Automated digital services 171 7.3. The relation between articles 12A and 12B of the UN Model (2021): Mutually exclusive? 176 7.4. The relation of articles 12A and 12B of the UN Model (2021) to article 7 of the UN Model (2021) (business profits) 181 7.4.1. Income covered by article 7 of the UN Model (2021) and priority rules 181 7.4.2. The relation of article 12A of the UN Model (2021) to article 7 of the UN Model (2021) 186 7.4.3. The relation of article 12B of the UN Model (2021) to article 7 of the UN Model (2021) 189 x This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents 7.5. The relation of articles 12A and 12B of the UN Model (2021) to article 8 of the UN Model (2021) (international shipping and air transport) 191 7.5.1. Income covered by article 8 of the UN Model (2021) 191 7.5.2. The relation of article 12A of the UN Model (2021) to article 8 of the UN Model (2021) 193 7.5.3. The relation of article 12B of the UN Model (2021) to article 8 of the UN Model (2021) 194 7.6. The relation of articles 12A and 12B of the UN Model (2021) to article 12 of the UN Model (2021) (royalties)195 7.6.1. The definition of “royalties” and challenges in the distinction to “services” 195 7.6.2. The relation of article 12A of the UN Model (2021) to article 12 of the UN Model (2021) 199 7.6.3. The relation of article 12B of the UN Model (2021) to article 12 of the UN Model (2021) 204 7.7. The relation of articles 12A and 12B of the UN Model (2021) to article 14 of the UN Model (2021) (independent personal services) 211 7.7.1. Income covered by article 14 of the UN Model (2021) and source country taxing rights 211 7.7.2. The relation of article 12A of the UN Model (2021) to article 14 of the UN Model (2021) 213 7.7.3. The relation of article 12B of the UN Model (2021) to article 14 of the UN Model (2021) 216 7.8. The relation of article 12A of the UN Model (2021) to article 16 of the UN Model (2021) (directors’ fees and remuneration of top-level managerial officials) 218 7.9. The relation of article 12A of the UN Model (2021) to article 17 of the UN Model (2021) (artistes and sportspersons) 222 7.10. Concluding remarks 225 xi This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents Chapter 8 The Relationship between the Different Distributive Rules for Employment Income 229 Pasquale Pistone and Stefanie Stöcklinger 8.1. Introduction 229 8.2. The “umbrella function” and the closed system of article 15 of the OECD Model 230 8.3. Dependent versus independent services (article 7, article 14 or article 16) 234 8.3.1. Qualification conflicts due to domestic law 234 8.3.2. Freelancers – self-employed or employed? 235 8.3.3. The role of article 16 of the OECD Model in the “closed system” of income from employment 237 8.4. Income generated as an entertainer or sportsperson (article 17) 239 8.4.1. General remarks on the relationship between articles 15 and 17 of the OECD Model 239 8.4.2. Income generated as an influencer 240 8.4.3. No-show payments and lack of activity 244 8.4.3.1. Various forms of (in)activity 244 8.4.3.2. Qualification of the income of a substitute player 244 8.4.3.3. Qualification of the income of a second-class player 245 8.4.3.4. Allocation of income without public performance 247 8.4.4. The third remuneration for former entertainers or sportspersons 248 8.5. Classification of termination payments (article 18) 250 8.5.1. Possible provisions applicable 250 8.5.2. Severance payments as a third remuneration 252 8.5.2.1. Allocation on the merits 252 8.5.2.2. Applying article 15 or article 18 of the OECD Model? 253 8.6. Income from government service (article 19) 255 8.6.1. Relationship to articles 7, (former) 14, 15, 16 and 21 of the OECD Model 255 8.6.2. Relationship to article 17 of the OECD Model 256 8.6.3. Relationship to article 18 of the OECD Model 257 xii This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents 8.6.4. Relation between the provisions contained in article 19 of the OECD Model 257 8.7. Income arising out of other relations (articles 10-13 and 21) 258 8.7.1. Implicit relationships 258 8.7.2. How are employee stock options handled? 258 8.7.2.1. Delimitation issues between articles 13 and 15 of the OECD Model 258 8.7.2.2. Further relevant provisions 259 8.7.3. To what extent do royalties matter? 260 8.7.4. “Other income” in the context of article 21 of the OECD Model 263 8.8. Conclusion 263 Chapter 9 The Relationship between Article 16 of the OECD Model and the Other Distributive Rules of the OECD and UN Models 265 Pasquale Pistone, Siddhesh Rao and Jürgen Romstorfer 9.1. Introduction 265 9.1.1. The history of article 16 of the OECD Model 265 9.1.2. Difference between article 16 of the OECD Model and article 16 of the UN Model 266 9.2. The relationship of article 16 of the OECD Model to other distributive rules 267 9.2.1. Express provisions 267 9.2.1.1. Article 7 of the OECD Model 267 9.2.1.2. Article 15 of the OECD Model 269 9.2.1.3. Article 19(3) of the OECD Model 272 9.2.2. Implicit relationships 275 9.2.2.1. Article 10 of the OECD Model 275 9.2.2.2. Articles 11 and 12 of the OECD Model 277 9.2.2.3. Article 13 of the OECD Model 278 9.2.2.4. Article 14 of the OECD Model (until 2000) 280 9.2.2.5. Article 18 of the OECD Model 281 9.2.2.6. Article 19(1) and (2) of the OECD Model 285 9.2.2.7. Article 21 of the OECD Model 288 9.3. Conclusion 290 xiii This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents Chapter 10 The Relation between Article 17 of the OECD Model and the Other Distributive Rules of the OECD and UN Models 293 Monique T. Malan and Alexander Rust 10.1. Introduction 293 10.2. Scope of article 17 295 10.2.1. Income covered 295 10.2.1.1. Type of income 295 10.2.1.2. Category of income 295 10.2.2. Personal scope 296 10.2.3. Taxable person and income category 297 10.3. Legal ramifications 298 10.3.1. International law (specifically, treaty) ramifications 298 10.3.1.1. The residence contracting state 298 10.3.1.2. The “other contracting state” 298 10.3.1.3. Territorial scope 298 10.3.1.4. Extraterritorial activities 299 10.3.1.5. Concurrent taxation 299 10.3.1.6. Relief provided by the residence contracting state 299 10.3.1.7. Rationale for source state taxing priority 300 10.3.2. Domestic law ramifications 301 10.3.2.1. Tax levied under domestic law 301 10.3.2.2. Timing issues 301 10.4. Relation with other distributive articles 302 10.4.1. Articles with explicit or implicit priority 302 10.4.1.1. Article 17’s priority over articles 7, 14 (UN Model) and 15 302 10.4.1.2. Article 7: Business profits 302 10.4.1.3. Article 15: Income from employment 307 10.4.1.4. UN Model articles 308 10.4.1.4.1. Article 12A: Fees for technical services (UN Model) 308 10.4.1.4.2. Article 14 – Independent personal services (UN Model) 309 10.4.2. Articles with a mutually exclusive scope 309 10.4.2.1. Article 16: Directors’ fees 309 10.4.2.2. Article 20: Students 309 10.4.3. Articles with seemingly overlapping scope 310 xiv This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents 10.4.3.1. Article 12: Royalties 310 10.4.3.2. Article 19: Government service 312 10.4.3.3. Pension income 316 10.4.3.3.1. General remarks 316 10.4.3.3.2. Article 18: From private employment 317 10.4.3.3.3. Article 19(2): From government service 318 10.4.3.3.4. Article 21: Other 318 10.5. Conclusion 319 Chapter 11 The Relation between Article 20 of the OECD and UN Models and the (other?) Distributive Rules of the OECD and UN Models 321 Rainer Borns and Alexander Rust 11.1. Overview 321 11.1.1. The unique character of article 20 of the OECD Model 321 11.1.2. Scope 322 11.2. Can article 20 of the OECD Model be considered a distributive rule? 322 11.2.1. Introduction 322 11.2.2. Arguments in favour of considering article 20 of the OECD Model a distributive rule 323 11.2.3. Arguments to consider article 20 of the OECD Model much closer to an exemption rule 324 11.2.4. Consequences of the non-recognition of article 20 of the OECD Model as a distributive rule 326 11.2.4.1. Parallel applicability with “real” distributive rules? 326 11.2.4.2. Example 328 11.2.5. Consequences of considering article 20 of the OECD Model a real distributive rule 330 11.2.6. Relation to article 21 of the OECD Model 332 11.3. Relation between article 20 of the UN Model and the other distributive rules in the UN Model 333 11.3.1. Scope and history 333 11.3.2. Relation to the other distributive rules of the UN Model 334 11.4. Conclusion 336 xv This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents Chapter 12 The Different Distributive Rules for Capital Gains (Article 13 of the OECD Model) and for Taxes on Capital (Article 22 of the OECD Model) and their Relation to the Other Distributive Rules of the OECD Model 339 Michael Gleiss 12.1. Articles 13 and 22 of the OECD Model and the principle of symmetry 339 12.1.1. The unique character of article 13 of the OECD Model 339 12.1.2. The unique character of article 22 of the OECD Model 340 12.1.3. The distributive rules of articles 13 and 22 of the OECD Model: The principle of symmetry and its deviations 341 12.2. Immovable property: Articles 6, 13(1) and 22(1) of the OECD Model 343 12.2.1. Are articles 13(1) and 22(1) of the OECD Model only applicable if the immovable property in question generates income according to article 6 of the OECD Model? 343 12.2.2. The relevance of the term “owned” as established by article 22(1) of the OECD Model 345 12.3. Movable property of a PE: Articles 7, 13(2) and 22(2) of the OECD Model 347 12.3.1. Indirect alienation of a PE: Symmetry breaks apart 347 12.3.2. Fictional gains: Is article 13(2) of the OECD Model applicable? 349 12.3.3. Appropriate and necessary adjustments: No equivalent provision of article 7(3) of the OECD Model in articles 13(2) and 22(2) of the OECD Model 351 12.4. Ships or aircraft operated in international traffic: Articles 8, 13(3) and 22(3) of the OECD Model 353 12.4.1. “Directly connected” or “ancillary” activities: Application of articles 13(3) and 22(3) of the OECD Model possible? 353 xvi This eBook is licensed to Michael Siaw Larbi, [email protected] Table of Contents 12.4.2. Internal use of ships and aircraft operated in international traffic: Are articles 13(3) and 22(3) of the OECD Model applicable? 354 12.4.3. Partial performance of activities that are (not) in the scope of article 8: Partial application of articles 13(3) and 22(3) of the OECD Model possible? 359 12.5. Digression: Why is there no provision equivalent to article 13(4) of the OECD Model in article 22(4) of the OECD Model? 360 12.6. Conclusions 361 Chapter 13 The Different Distributive Rules of the OECD Model Convention on Estates, Inheritances and Gifts 365 Yasmin Lawson 13.1. The OECD Model Convention on Estates, Inheritances and Gifts 365 13.2. The distributive rules 368 13.2.1. Ships and aircraft 368 13.2.2. Article 5: Immovable property 369 13.2.3. Article 6: Movable property of a PE or a fixed base 370 13.2.4. Article 7: Other property 373 13.3. Article 8 on the deduction of debts 375 13.3.1. Functioning and effect of the deduction of debt clause 375 13.3.2. Comparison with the treatment of debt in the OECD Model 379 13.4. The relationships between the distributive rules 380 13.4.1. Articles 5 and 6 380 13.4.2. Articles 5, 6, and 7 382 13.4.3. Articles 5, 6, 7 and 8 382 13.4.4. Comparison with the OECD Model 383 13.5. Summary 384 List of Contributors 385 xvii This eBook is licensed to Michael Siaw Larbi, [email protected] This eBook is licensed to Michael Siaw Larbi, [email protected] Preface Tax treaties have both a personal and substantive scope. If a tax treaty is applicable, all covered elements of income and capital of a resident must be assigned to a single distributive rule. This assignment can lead to dif- ficulties for various reasons, one of which is that the scopes of application of the various distributive rules overlap. A detailed analysis of the relations between the distributive rules is required to resolve these difficulties. Some of these relations are explicitly addressed in the OECD and UN Models, where priority is given to a specific distributive rule, whereas others are implicit. Determining which distributive rule is applicable is of utmost prac- tical relevance. The right of source states to tax and the question of which method is applicable to avoid double taxation depends on this determina- tion. Thus far, little research has focused on the relationships between the different distributive rules. To address these and other important and current issues concerning the rela- tionships between the distributive rules, the 29th Viennese Symposium on International Tax Law was held on 13 June 2022 at WU (Vienna University of Economics and Business). Renowned Professors from Austrian and for- eign universities, tax researchers from WU and tax experts from various countries participated in the symposium. The speakers have since completed papers using input received during the symposium, and these have become the chapters of this book. Each author offers an in-depth analysis, along with the most recent scientific research on their topic. The editors would like to thank Caroline Ristic, Nina Nimmerrichter, Myriam Pereira de Milinic and Christian Knotzer who were the main people responsible for the organization of the symposium and made essential con- tributions to the preparation and publication of this book. The editors would also like to thank all of the authors who have patiently revised their contri- butions to enhance the quality of the book and Jenny Hill who contributed greatly with her linguistic editing of the authors’ texts. Above all, sincere thanks to the IBFD publishing house for agreeing to include this publication in its catalogue. Georg Kofler Josef Schuch Michael Lang Karoline Spies Pasquale Pistone Claus Staringer Alexander Rust Rita Szudoczky xix This eBook is licensed to Michael Siaw Larbi, [email protected] This eBook is licensed to Michael Siaw Larbi, [email protected] List of Abbreviations AOA Authorised OECD Approach arg. Argumentum art. Article ATO Australian Taxation Office B2B Business to Business B2C Business to Consumer BEPS Base Erosion and Profit Shifting BFH Bundesfinanzhof Bull. Intl. Taxn. Bulletin for International Taxation ch. Chapter DBA Doppelbesteuerungsabkommen DIRs Dividends, interest and royalties DIT Indian Director of Income Tax DTA Double taxation agreement DTT Double tax treaty e.g. Exempli gratia etc. Et cetera FB Fixed base HC High Court i.e. Id est IBFD International Bureau of Fiscal Documentation id. Idem ITAT Income Tax Appellate Tribunal ITO Income Tax Officer IWB Internationales Steuer- und Wirtschaftsrecht (journal) MAP Mutual agreement procedure MNE Multinational enterprise n. Number OECD Organisation for Economic Co-operation and Development OECD Commentary OECD Model Tax Convention on Income and on Capital: Commentary OECD MEIG OECD Model on Estates, Inheritances and on Gifts OECD Model OECD Model Tax Convention on Income and on Capital OEEC Organisation for European Economic Co-operation p. Page PE Permanent establishment PoEM Place of effective management Sec. Section xxi This eBook is licensed to Michael Siaw Larbi, [email protected] List of Abbreviations seq. Sequens StuW Steuer und Wirtschaft (journal) SWI Steuer und Wirtschaft International (journal) UN United Nations UN Committee UN’s Committee of Experts on International Coope ration in Tax Matters UN Model United Nations Model Double Taxation Convention between Developed and Developing Countries US United States USD United States Dollar VCLT Vienna Convention on the Law of Treaties VfGH Verfassungsgerichtshof (Constitutional Court of Austria) VwGH Verwaltungsgerichtshof (Supreme Administrative Court of Austria) WG28 OECD Working Group Number 28 WP Working Party WP14 Working Party 14 xxii This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 1 The Role of and the Relationship between the Distributive Rules in Tax Treaties Stefano Castagna 1.1. Beginning a journey into distributive rules: A primer on the main issues This chapter will introduce the basic inherent and implied concepts behind and the characteristics of distributive rules in order to provide guidance throughout the journey and strengthen the bounty of the analyses presented in the following sections. This will allow the introduction of the most fun- damental definitions and understandings of how such rules operate and their nature. This chapter will briefly outline the structure of the OECD Model Tax Convention on Income and on Capital (OECD Model); the main rules and discussions surrounding the identification of distributive rules; their role and the concepts behind them, as well as suggest their primary classes and characteristics. In so doing, it will clarify where distributive rules can be found within the models, the functioning of distributive rules and their relationship with respect to the sovereign power of source and residence states; the ways that the drafters of the models have regulated the relation- ship between them; and the different types of income that are regulated through them. Usually, there are only minor – albeit, at times, important – differences between the OECD Model and United Nations Model Double Taxation Convention between Developed and Developing Countries (UN Model) and an actual treaty;1 however, they both have a very similar struc- ture. Consequently, the analysis of the actual treaties can depend on that of the respective models, as will be done in this chapter. 1. Compare with S. Castagna, Essential Elements of Taxation – Investment Protection and Dispute Settlement, in International Arbitration and EU Law (J.R. Mata Dona & N. Lavranos eds., Elgar 2021). 1 This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 1 - The Role of and the Relationship between the Distributive Rules in Tax Treaties 1.2. The structure of the OECD Model 1.2.1. Personal scope The first thing to ensure when applying a tax treaty is that it covers the inter- ested taxpayers. The personal scope of tax treaties is typically enshrined in article 1, which states that the convention applies to “persons who are residents of one or both of the Contracting States”. Article 4(1) defines the term “resident of a Contracting State”. 1.2.2. Substantive scope The second element to take into consideration is the substantive scope of a tax treaty that is found in article 2, which is structured in four different paragraphs. Paragraph 1 states the general principle that “[t]his Convention shall apply to taxes on income and on capital”. Its meaning and scope are further defined in paragraph 2.2 Article 2 then enables the contracting states to specify which taxes are included in the scope of the convention “in par- ticular”. The article concludes with paragraph 4, which ensures that the treaty will apply to “identical or substantially similar” taxes imposed after the date of signature in addition to or as a replacement of the taxes already existing at the time of signature. This last provision has likely been inserted to ensure, among other reasons, that there is no need for amendment of the list in paragraph 3.3 1.2.3. Distributive rules There can be different views on what constitutes distributive rules. One perspective might be that distributive rules in tax treaties could be defined depending on their proximity to an average overall set of characteristics between those provisions in articles 6-22 of the OECD Model. Otherwise, it is possible to consider them as “rules which provide a total or partial tax exemption on a given possible tax claim to avoid double taxation”. This is because they allocate taxing powers between the contracting states by grant- ing an exemption from taxation.4 2. P. Baker, Double Tax Conventions, sec. 2B.04 (Sweet & Maxwell 2021). 3. Id., at 2B.06. 4. M. Lang, Verteilungsnormen, in Doppelbesteuerung: Festgabe : zum 75. Geburtstag von Prof. Dr. Dr. h.c. Franz Wassermmeyer : 75 Beiträge zum Recht der DBA (1. Auflage.) m.no. 1 (W. Wassermeyer ed., C.H. Beck 2015). 2 This eBook is licensed to Michael Siaw Larbi, [email protected] Identifying distributive rules 1.2.4. The methods to avoid double taxation There might still be the need for a rule that coordinates how double taxation will be relieved even if the distributive rules are perfectly applied.5 Both the OECD and the UN Models provide two different articles that could be cho- sen to apply alternatively and possibly in combination within a treaty, and both are directed to the country of residence. These are found in article 23A (exemption method) and article 23B (credit method). 1.3. Identifying distributive rules 1.3.1. Articles 6-22 of the OECD Model As noted above, this is the part of the two model conventions that contains most of the distributive rules. Whether all of them can be classified as such is up for debate. However, the model treaties just label each article with their respective title based on the class of taxes or the matters that they address. The function of distributive rules is to create an exemption or limitation to the right to tax6 so that there is at least a limited overlap in the power to tax between the two states. In principal, they are addressed in the source state and decide whether and how much it may tax. Consequently, the rights to tax are divided between the two contracting states. Whether the right to tax will be exercised will depend on whether the source state wants to exercise it through national legislation.7 As a consequence, double non-taxation is always possible.8 1.3.2. Article 9 of the OECD Model Article 9 is placed within the block of distributive rules but is peculiar. It ensures that when, between associated enterprises: [C]onditions are made or imposed […] in their commercial or financial rela- tions which differ from those which would be made between independent enter- prises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. 5. Baker, supra n. 2, at 23B.01. 6. Lang, supra n. 4, at m.no. 2. 7. Id. 8. Id., at m.no. 3. 3 This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 1 - The Role of and the Relationship between the Distributive Rules in Tax Treaties The function and purpose of article 9 is to limit the capability of the con- tracting states to assess business profits of multinational enterprises only to a maximum amount to be determined according to terms and conditions that would have differed had the parties to a given transaction been unrelated.9 This principle is commonly known as the arm’s length principle. The differ- ent features of article 9 are clear and follow the different purpose that it has with respect to distributive rules. It has likely been positioned here so that it can systematically be placed next to articles 7 and 8.10 Its objective is not to partially or totally exclude the power to tax a given tax claim of one state. 1.3.3. Article 20 of the OECD Model Article 20 is another strange type of article within the model convention. Its text is quite brief, and it simply states: Payments which a student or business apprentice who is or was immediately before visiting a Contracting State a resident of the other Contracting State and who is present in the first-mentioned State solely for the purpose of his education or training receives for the purpose of his maintenance, education or training shall not be taxed in that State, provided that such payments arise from sources outside that State. If one wants to consider distributive rules only those who have similar char- acteristics to the rest of the group, one should consider the different anoma- lies of article 20. As noted by relevant literature,11 there are many peculiari- ties in this brief text. Surely the article is within the majority of those that address payments (such as articles 6(2), 10(1), 11(1), 12(2), 15(2)(b), 16, 18, 19 and 21(2)). However, the “payments” it refers to do not necessarily constitute income as mentioned above. The lack of mention of a particular category to which “payments” refer is proper only for article 16 in addition to article 20, which refers to “fees”. Some conclude that article 20’s refer- ence to payments and not “income” would suffice for settling the matter 9. G. Kofler, Article 9 – Associated Enterprises, in Klaus Vogel on Double Taxation Conventions m.no. 5, p. 596 (4th ed., A. Rust & E. Reimer eds., Wolters Kluwer Law & Business 2015). 10. Id. 11. L. De Broe, Students (Art. 20 OECD Model Convention), in Source Versus Residence: Problems Arising from the Allocation of Taxing Rights in Tax Treaty Law and Possible Alternatives p. 357 (M. Lang et al. eds., Kluwer Law International 2008); M. Herm, Student Article in Model Conventions and in Tax Treaties, 32 Intertax 2, pp. 69 and 74 (2004); and Baker, supra n. 2, at 20B.01. 4 This eBook is licensed to Michael Siaw Larbi, [email protected] Identifying distributive rules negatively.12 However, this should not be the case since the term “income” can have several different meanings (and therefore include “payments”) such as profits, gains and remuneration.13 Another element that could be considered is the absence of an explicit pri- ority rule that refers to it. As will be seen in section 1.5.3., explicit prior- ity rules are typical of distributive rules, and it is rare for an article not to refer to or be referred to by another. However, there are also other articles, such as article 8, that are never mentioned and do not expressly indicate any other distributive rule even though there is no doubt that article 8 is a distributive rule. In addition, consideration should also be made to the fact that articles 20 and 15 may overlap in their application, which results in the need to resort to an interpretation of the treaty.14 This is the case, for example, when the activity of studying or training is a component of the duties under an employment contract, and the employer is also paying a sal- ary for the maintenance of the student during this period of time.15 However, as will be discussed later, this also occurs in many other rules in the OECD Model, and article 20 has a broader scope than article 15 as the former also encompasses items of income, such as scholarships, that would not necessarily fall under article 15. Furthermore, even if every item of income falling within the scope of article 20 was to fall within article 15 or other articles rendering article 20 inoperable, the nature of article 20 under the second definition provided would not change since it would not alter what constitutes article 20 but whether it is effective. It would therefore still be a distributive rule under this view – albeit ineffective. It should also be considered that article 20 does not require the payee to be a resident of one of the contracting states since the student could move residence to a third state after beginning to live in the state where they are studying.16 However, it must be noted that article 19(1)(a) and 19(2)(a) do not necessarily apply expressly to residents. Consequently, article 20 would 12. According to M. Lang, Does Art. 20 of the OECD Model Convention Really Fit into Tax Treaties?, in Tax Polymath: A Life in International Taxation footnote 7 (P. Baker & C. Bobbett eds., IBFD 2010), Books IBFD, the following authorities sustain the position: F. Wassermeyer, Art. 20 Studenten, in Doppelbesteuerung art. 20, m.no. 15 (H. Debatin & F. Wassermeyer eds., C.H. Beck 1997); S. Meurer, Artikel 20 Studenten, in Doppelbesteuerungsabkommen art. 20, m.no. 4 (5th ed., K. Vogel & M. Lehner eds., C.H. Beck 2008); and J. Bauer, Studenten, Gastlehrer und Gastprofessoren im DBA Recht, in Arbeitnehmer im Recht der Doppelbesteuerungsabkommen p. 231 (W. Gassner et al. eds., Linde 2003). 13. Lang, id., at p. 259. 14. Id., at p. 260. 15. Id. 16. Id., at p. 261. 5 This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 1 - The Role of and the Relationship between the Distributive Rules in Tax Treaties not be the only one to do so. Whether article 1 restricts the scope of the treaty regardless of the wording of the distributive rules in this respect is another matter to ponder. A further matter is the fact that article 20 does not expressly address the source or resident state. In fact, it explicitly excludes its application if the source of the payments is the state in which the student is present.17 It does not mention whether the other contracting state in which the student is or was a resident immediately before the educational visit has any power to tax at all. This is a unique feature of article 20 with respect to all other dis- tributive rules. It seems that, for this and other reasons (such as encouraging double non-taxation),18 article 20 should not be seen to “completely fit into the system of application rules”.19 In fact, the likely consequence would be double non-taxation of the student if he changes residence to the country in which the study activity is performed.20 Under the second definition of “distributive rule” that is given, there might instead be little doubt that article 20 is a distributive rule. It excludes the pos- sible taxation of payments that can constitute a taxable element and prevent double taxation as a consequence by excluding the possibility of one state to tax. The other state retains any power to tax that it had, although it might decide to not use it. If the student’s permanence is of such a duration that their residence is changed to that of the study state, then the consequence of such a change of residence is that there is the impossibility of the state of origin to tax the student as stated above. The effect of this is non-taxation. This might not always be the case, especially since states have often disal- lowed the application of article 20 for income derived from employment or services.21 However, the fact that the application of article 20 might often lead to double non-taxation could not necessarily be considered an issue if the view is adopted that the above definition of “distributive rules” is to be applied: double non-taxation is the avoidance of double taxation per se. Therefore, under the given definition of “distributive rules”, article 20 just seems to be the simplest distributive rule currently in the model. The difference in definition therefore determines the outcome of whether article 20 is a distributive rule or not. However, it must be noted that even 17. OECD Model Tax Convention on Income and on Capital: Commentary on Article 20 (23 Nov. 2017), Treaties & Models IBFD. 18. Lang, supra n. 12, at p. 267. 19. Id. 20. Lang, supra n. 4, at m.no. 19. 21. Compare with Baker, supra n. 2, at 20B.04. 6 This eBook is licensed to Michael Siaw Larbi, [email protected] Identifying distributive rules a proponent of the definition that is considered could agree that article 20 does not easily fit into the system of distributive rules, even though it is one because of its very narrow scope and objective. In this context, it would be an atypical distributive rule. Article 20 could be inserted in an ad hoc treaty for students or directly inserted in legislation.22 1.3.4. Definitions As mentioned above, there are several definitions within both the UN and OECD Models that will be discussed in turn. There are special definitions at times within distributive rules and other articles, such as (i) article 6, which defines “immovable property” in para- graph 2; (ii) article 9, which indirectly defines what constitute “associated enterprises”; (iii) article 10(3) (“dividends”); (iv) article 11(3) (“interests”); and (v) article 12(2) (“royalties”), which also contains definitions. A further article that does so is article 29, which contains the definition of “qualified person”. One important matter that arises with all of these definitions can be found both in ad hoc articles written that contain definitions and those dedicated to the discipline of the allocation of a given class of income. It is whether the latter definitions also apply with respect to other articles of the convention. This might not be a trivial matter, especially if there are devia- tions from the OECD Model that incorporate terms defined in specialized articles in other articles of the same convention. The practical consequence in such a case is that the interpretative outcome may or may not change in favour of the taxpayer. As with the case of many other issues of international taxation, there are two different theories that have opposing views on the matter.23 The fact of the matter is that, in any event, there are some defini- tions that articles will have used other than those in which they have been defined due to an expressed reference. For example, article 13(4) expressly refers to “immovable property, as defined in Article 6”, while article 13(1) states that the scope of application of the paragraph is the “alienation of immovable property referred to in Article 6”. Another matter pertains not to a distributive rule but to article 24(4), which particularly reads: Except where the provisions of paragraph 1 of Article 9, paragraph 6 of Article 11, or paragraph 4 of Article 12, apply, interest, royalties and other 22. Insertion in legislation has been suggested by Lang, supra n. 12, at p. 267. 23. Compare with a discussion on the issue J.F. Avery Jones et al., Whether the Definition of Dividend Limited to the Dividend Article Applies to the Double Taxation Relief Article Granting Underlying Credit, 53 Bull. Intl. Taxn. 3 (1999), Journal Articles & Opinion Pieces IBFD. 7 This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 1 - The Role of and the Relationship between the Distributive Rules in Tax Treaties disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State. There is clearly an explicit reference to the articles that define interest and royalties in addition to article 9 on transfer pricing. All of these definitions may interact with the distributive rules but are not by themselves distribu- tive rules. Many definitions are also contained in an article drafted for the purpose of providing definitions, such as article 3. It contains a list of the following terms and their respective standard definitions for the purpose of the con- vention: “person”, “company”, “enterprise”, “enterprise of a Contracting State”, “enterprise of the other Contracting State”, “international traffic”, “competent authority” (to be specified by the respective parties), the term “national”, “business” (in a limited way by indicating what it will also include within its meaning) and “recognised pension fund”.24 Although these definitions are expressly listed within article 3, it is fundamental to note that they apply “unless the context otherwise requires” under the first sentence of article 3(1). This clause limits the application of the definitions within article 3(1) in order to grant a national judge more discretion “in countries that adhere to a strict constructionism”.25 However, article 3 is not the only article of the models that contains defi- nitions. These are also found in article 4 that, as noted above, defines the meaning of “resident” and in article 5, which defines a permanent establish- ment (PE). Some distributive rules directly refer to and need the support of such definitions in order to be properly understood, especially with regards to those contained in article 3. “Person” is used in articles 11, 12 and 17. “Company” is found in articles 10 and 16, and “enterprise”, “enterprise of a Contracting State” and/or “enterprise of the other Contracting State” are in articles 7, 8, 13 and 22. “International traffic” is in articles 8, 13, 15 and 22. “Competent authority” is not in any distributive rule, while the term “national” can be found in article 19 and “business” is in articles 7, 8 10, 11, 12, 19, 20, 21 and 22. In addition, the expression “recognised pension fund” is not in any distributive rule. 24. OECD Model: Commentary on Article 3 (2017). 25. A.P. Dourado et al., Article 3 – General Definitions, in Klaus Vogel on Double Taxation Conventions, vol. 1, m.no. 15, p. 183 (4th ed., A. Rust & E. Reimer eds., Wolters Kluwer Law & Business 2015). 8 This eBook is licensed to Michael Siaw Larbi, [email protected] The role of the distributive rules 1.4. The role of the distributive rules 1.4.1. Exclusion of taxation rights in the source state An exclusion of the source state’s taxation rights typically occurs through explicitly granting taxation to the residence state. Tax treaties aim at elimi- nating double taxation, and distributive rules operate so that the areas of overlapping jurisdiction of the contracting states are eliminated, or at least diminished. One of the possible ways with which this can be done is through the exclusion of the source state’s taxation rights. To do so, different legal techniques are used, and each will now be analysed. There can be exclusions through a main distributive rule. In this regard, one the first articles that can be considered as belonging to this category is article 7(1), wherein the first part of the first sentence concerning business profits states that they can be taxed “only in that State” unless there is a PE in the other state. Consequently, under article 7, income of a resident of that particular state cannot be taxed by the source jurisdiction. Article 8(1) indicates that profits from the operation of ships or aircraft in international traffic can be taxed “only in that State” to which the enterprise belongs. Therefore, the income of a company resident in State A and owning ships that operate in international traffic by shipping goods around the world will be taxed exclusively in the country of residence; articles 12(1) and 13(3) are similar. There are also exceptions to other distributive rules found within the same article. This is the case of article 15(2), which ensures that income “shall be taxable only in the first-mentioned State” which is the residence state as an exception to article 15(1). As a consequence, if an employee is present in the state where they work for a period not exceeding an aggregated 183 days in any 12-month period commencing or ending in the fiscal year; the employer is not a resident of the source state; and the remuneration is not borne by a PE of the employer in the source state, then the resident state has exclusive taxation of the amounts. Finally, also article 19 addressing government ser- vices contains some relevant provisions in 19(1)(b) and 19(2)(b). Both of them constitute exceptions to the respective letters (a). Article 19(1)(b) deals with salaries, wages and “other similar remuneration” and imposes that the income “shall be taxable only in the other Contracting State” in the case that an individual is a national of the resident state or he has acquired resi- dency not just because of the government services rendered. Article 19(2) (b) instead addresses pensions if an employee is a national or resident of that state, and it provides that the income “shall be taxable only in that State”. 9 This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 1 - The Role of and the Relationship between the Distributive Rules in Tax Treaties Therefore, if an individual receives a pension from a contracting state for services rendered to that state but the individual is a resident and national of the other state, only this other state has the right to tax the amounts. There might also be an exclusion through a residual rule, albeit being within the same article. This is the case of article 13(5), which further continues to exclude the source state’s taxation rights by providing that gains deriving from the alienation of property that has not been dealt with the previous paragraphs “shall be taxable only in the Contracting State of which the alienator is a resident”. The article therefore begins by specifying distribu- tive rules but then has a residual provision in order to include and discipline any other possible factual occurrence. 1.4.2. Limited taxation rights of the source state In addition to providing a total limitation of rights of the source state, there are also articles or parts of articles in the model conventions that limit taxa- tion rights. Typically, such a limitation will be expressed in a percentage of a base that will constitute the grounds of justification of the use of tax sovereignty. There are a few articles that limit the source state’s taxation rights, including article 10 and article 11. Article 10(2) introduces a withholding tax that is of a limited amount (5% or 15%), while 11(2) instead stipulates that if the “beneficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the interest”. As can be noted, they mainly consist of a percentage up to which the source state may be able to tax. 1.4.3. Unlimited taxation rights of the source state When addressing unlimited taxation rights that are allocated to the source state, it should be noted that there are also a number of applicable pro- visions. There are also a variety of ways through which this is granted. Articles 6, 13(1), 13(2), 13(4), 16 and 17 state that the source state “may” tax the class of income identified. Article 7(1) indicates that those prof- its that are attributable under the convention to the PE “may be taxed” in the PE’s state. There are, however, other ways with which it is possible for the model to assign unlimited taxing rights to the source state or limit such power. One example of this is article 15(1), which has an identical 10 This eBook is licensed to Michael Siaw Larbi, [email protected] The concepts behind distributive rules structure to article 7(1) as mentioned above. The second part of the first period ensures the impossibility of the source state to tax by stating “unless the employment is exercised”. The second sentence in paragraph 15(1) then specifies under which condition this right is not exclusive. 1.4.4. Exclusion of taxation rights in the residence state Since double tax treaties originally grant the residence state taxing rights, the exclusion of such rights must be exceptions to the general rule or excep- tions to the exception. There are only two instances in which the exclusion of taxation rights in the residence state occur in the distributive rules of the OECD Model. In particular, the exclusion of rights of the residence state can only be found in article 19(1)(a) and 19(2)(a), which provide that “[s]alar- ies, wages and other similar remuneration” and pensions and similar items of income “shall be taxable only in that State” that has paid the amounts. It should be noted that there will always be an unlimited right to tax for the source state if taxation rights are excluded in the residence state. 1.5. The concepts behind distributive rules 1.5.1. Principle of universality26 The first element to clarify is the principle behind the way that tax treaties are structured with regard to distributive rules. As will have been noted, they collectively allocate taxing power of all possible classes of income that fall within the scope of a tax treaty. Whenever articles 1 and 2 are met, there is one distributive rule that applies to the facts of the matter. Stated differ- ently, distributive rules are meant to cover the “universality” of the classes of income within the operation of the relevant tax treaty. In the absence of specific provisions, article 21(1) or 21(3) will apply. In this context, it might also be stated that the approach of tax treaties is comprehensive. In particu- lar, the scope of article 21(1) must therefore be determined by exclusion,27 and it particularly includes third pillar pensions, unemployment benefits and 26. “The quality or state of being universal” (Merriam-Webster online, available at https://www.merriam-webster.com/dictionary/universality), intending with this the “in- clusion of all (or most) individuals, cases, or instances”. The Oxford English Dictionary, Universality, n. 2.a. 27. A. Rust, Article 21 – Other Income, in Klaus Vogel on Double Taxation Conventions m.no. 29, p. 1542 (4th ed., A. Rust & E. Reimer eds., Wolters Kluwer Law & Business 2015). 11 This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 1 - The Role of and the Relationship between the Distributive Rules in Tax Treaties possibly alimony payments, in addition to punitive damages and payments under non-competition covenants.28 Article 21(1), however, is more funda- mentally important to alleviate deficiencies created by distributive rules, such as articles 6, 10, 11 and 12, that address income arising in the other contracting state and not a residence state or a third state.29 The scope of application is, in fact, so broad that it includes items of income “wherever arising”.30 An exception to the rule of article 21(1) is provided in the UN Model, which reads: “Notwithstanding the provisions of paragraphs 1 and 2, items of income of a resident of a Contracting State not dealt with in the foregoing Articles of this Convention and arising in the other Contracting State may also be taxed in that other State.” The resident state would then lack exclusive taxing rights and be required to grant relief under article 23. 1.5.2. Rules needing a cross-border connection to apply There are many norms that need a cross-border connection to apply in addi- tion to residence. Article 6 requires that property is located in the other state that is not that of the resident.31 For the article to apply, there must be immovable property in State A while the residence of the person deriving in- come from said property must be in the other contracting state, e.g. State B. Another set of such articles are articles 10, 11 and 12, which need a cross- border element to operate, as there is the need for a cross-border relationship to occur where the beneficiary is a resident of the other state. For example, the general principle of article 10(1) “[d]ividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State” entails that there must be a company resident in one state (for example, State A) and a person residing in another country, State B. In such a case, the article would be applicable. However, if both residents were residents of State A, then the article could not apply because the factual background falls outside the scope of the article. However, when distributive rules do not require cross-border activity, they will be applicable through residence only as is the case of article 7(1). The article simply establishes, as noted above, that the residence state has the exclusive right to tax if no PE is present in the source state. This implies that the resident state will have the exclusive jurisdiction to tax regardless of whether there is a cross-border connection and, therefore, article 7 does not 28. Id., at pp. 1542-1543, m.no. 29. 29. Id., at p. 1546, m.no. 32. 30. Art. 21(1) OECD Model. 31. Lang, supra n. 4, at m.nos. 8 and 9. 12 This eBook is licensed to Michael Siaw Larbi, [email protected] The concepts behind distributive rules need one to apply; this is always applicable in any case. Similarly, articles 8, 15, 18 and 21(1) also do not need a cross-border connection to apply. 1.5.3. Avoiding overlaps through explicit priority rules There are also different articles, as mentioned previously, that contain “explicit” priority rules. These are rules for which interpretation is not nec- essary since the norm is sufficiently clear and expressed.32 The first are general rules of priority. This is the case of article 7(4), “[w]here profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article”. It provides a general rule of priority with regards to the application of the more specific distributive rule. This makes it a general rule of priority because it provides a broad rule that applies to different cases. For the same reason, another rule of general priority is art- icle 21(1) since it also refers to a multiplicity of possible situations.33 Another group that contrasts in its way of operation to the one previously described is that of special priority rules between articles. This is the case of article 15(1) mentioned above, which is superseded by articles 16, 18 and 19. Article 17 then inherently imposes its priority over article 15. Article 18 then makes its provisions “[s]ubject to the provisions of paragraph 2 of art- icle 19”. Article 19, in turn, makes articles 15 to 18 apply in the event that a contracting state, one of its political subdivisions or a local authority carries on a business that remunerates its services with wages, salaries, pensions and similar types of remunerations. There are other articles, such as article 19(1)(b), 19(2)(a) and 19(2)(b), that give priority rules between distributive rules in the same article. In particu- lar, article 19(2)(a) begins by stating “notwithstanding the provisions of paragraph 1”; thus, the matters disciplined therein will be treated differ- ently and give priority to the other part of the sentence in the paragraph. This means that the priority rule will apply to a given part of the article in certain conditions restricting the application of the distributive rule in favour of another. 32. At least from the point of view of the author. Compare with S. Castagna, Inherent and Implied Powers of International Arbitral Tribunals: Characteristics and Limits, 82 Arbitration: Int’l J. Arb., Med. & Disp. Manag. 4 (2016). 33. The article, in fact, reads: “Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be tax- able only in that State.” 13 This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 1 - The Role of and the Relationship between the Distributive Rules in Tax Treaties 1.5.4. Avoiding overlaps through interpretation Many conflicts between distributive rules occur as they must be applied through interpretation necessarily because there are no explicit priorities given. In this context, the drafters of the models may have left open-ended issues either willingly (for the lack of a possible solution at the negotiation table) or unwillingly because of vacuums that are unexpected. One matter of relevance is the relationship between articles 7 and 15 that depends on the understanding of the term “employment”, especially in the context in which a partner in a partnership that has an employment contract with it (for example, as a manager).34 Interpretation is therefore required to understand which article to apply and whether to treat the income as deriving from employment or as income from independent activities. 1.6. The different types of distributive rules 1.6.1. Business income As the title of the OECD Model states, double tax treaties deal with in- come and capital. In particular, business capital takes the lead in terms of the number of distributive rules that exclusively address business income. The first is because it is within its nature and scope to address only busi- ness income, and the second is due to its scope being limited to only that of “[p]rofits of an enterprise”.35 Article 13(2) instead relates to income for which one resident has a PE in the source state, and it can be imagined that this possibility can only occur in the presence of a business activity. The further two articles, 13(3) and 22(3), exclusively pertain to the taxation of capital gains or capital of enterprises. Additionally, article 17 likely refers to only business income. 1.6.2. Non-business income There are more articles that wholly address income that can only be derived by individuals than those that can exclusively refer to companies or business activities. These are articles 15, 18 and 19. Only human beings, for now, 34. E. Reimer, Article 7 – Business Profits, in Klaus Vogel on Double Taxation Conventions m.no. 40, p. 508 (4th ed., A. Rust & E. Reimer eds., Wolters Kluwer Law & Business 2015). 35. OECD Model: Commentary on Article 8 (2017). 14 This eBook is licensed to Michael Siaw Larbi, [email protected] Conclusions can receive a salary, wage or pension for services. It has to be further added that the fundamental essence is not necessarily that these articles address income that only a person might obtain but also that only a natural person not carrying out business activities can gain; employment cannot per se be considered as business activity. The same can be stated for the other activi- ties/type of income addressed here. 1.6.3. Dual type income There are also provisions that can address both business income and income that can be earned through the private activity of a person, such as a loan, a small investment in a company or a portfolio of companies. These are a less popular, albeit important, set of articles and provisions. One example is article 6 since income from immovable property may be generated by both private individuals and within the context of the operation of a business. Income from immovable property can be created by a rent payed through a commercial lease between companies, and it could also be derived by a private individual occasionally renting out property just as a favour to a friend. Another example is article 10(1) in relation to dividends that can be the fruit of personal investments in addition to investments as part of a business operation. Article 11(1) is also an additional example since interest can also be owed for personal loans and article 12 if royalties are not to be classified as business income. 1.7. Conclusions In the conclusion of this chapter, it would be helpful to underline that the complexity of the international economy poses challenges to the application of such a comprehensive and detailed legal framework constituted by the distributive rules, notwithstanding the clear and fundamental principles on which they develop. There are still many issues and matters that have been left unaddressed that have high practical relevance and those that the drafters of the models have not expressly addressed. After the prior analysis, it should be noted that the role and relationship of distributive rules constitute the heart and core of international tax treaties. They are the fundamental pillars upon which modern economies operate from a tax perspective. Changes to this ecosystem, which has been nurtured throughout the past century, have to be well thought through but must be made in light of the above highlighted gaps and the everyday needs of a complex society where important and complex transactions must be decided in a relatively brief amount of time. 15 This eBook is licensed to Michael Siaw Larbi, [email protected] This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 2 The Relevance of Article 7(4) of the OECD Model Daniel W. Blum and Marcelo H.B. Moura 2.1. Objective and scope of the chapter Beyond preventing (primarily) juridical double taxation, a key objective of double tax treaties is to allocate taxing rights.1 They do so by attributing the right to tax between the residence and source state on an item-by-item basis and requiring a conclusive decision as to which distributive rules apply.2 Overlaps and conflicts among them may arise depending on the concrete definition of “income covered”. This is particularly valid for article 7 of the OECD Model Tax Convention on Income and on Capital (OECD Model), which is inherently designed as a broad “catch-all” provision for income from entrepreneurial activities. Given its practical importance in allocating taxing rights between residence and source states, the question of its relation to other distributive rules of the OECD Model are of particular relevance. Fully aware of the allocational consequences accorded to establishing the hierarchy between article 7 and other distributive rules, the OECD Model has entailed an explicit priority rule since its initial 1963 version, which reads as follows: “Where profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.” In the following section, this chapter explains the rule’s historical devel- opment and relevance while assessing its necessity both from a doctrinal and interpretational standpoint. Moreover, it attempts to offer insights into the priority rule’s conceptual role within the OECD Model in ensuring the prevalence of the lex specialis principle while simultaneously allowing for deviation from it if the object and purpose of the treaty require. 1. E.C.C.M. Kemmeren, Preface to Articles 10 to 12, in Klaus Vogel on Double Taxation Conventions m.no. 3 (E. Reimer & A. Rust eds., Wolters Kluwer Law International 2022). 2. A. Rust, Article 1: Persons Covered, in Klaus Vogel on Double Taxation Conventions p. 1, m.no. 34 (E. Reimer & A. Rust eds., Wolters Kluwer Law International 2022); OECD Model Tax Convention on Income and on Capital (27 Nov. 2017), Treaties & Models IBFD [hereinafter OECD Model (2017)]; and OECD Model Tax Convention on Income and on Capital: Commentary on Article 1(11) (23 Nov. 2017), Treaties & Models IBFD [hereinafter OECD Commentary on Art. 1 (2017)]. 17 This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 2 - The Relevance of Article 7(4) of the OECD Model 2.2. Historical development of article 7(4) of the OECD Model The current article 7(4) of the OECD Model3 was introduced by the OECD already in the 1963 version4 and has remained textually5 unchanged since then. It is the result of the political consensus reached within the proceed- ings of the Organisation for European Economic Co-operation (OEEC)6 Fiscal Committee that is responsible for delivering the 1963 OECD Model.7 The key to understanding its role and why the delegates decided article 7(4) of the OECD Model to be a necessary element of article 7, however, is the definition of the term “business profits” that ultimately defines its material scope. The delegates active in Working Party 14 (WP14) of the OEEC’s Fiscal Committee in January 1961 drafted a first version of an article on definitions that became the known article 3 of the OECD Model.8 According to this ini- tial suggestion, profits would have included income derived from the direct exercise of a business; the letting of the business to others; and the alienation of the business or parts thereof or of objects used in it.9 Regarding the lat- ter, however, profits would not have included income from the operation of ships or aircraft in international traffic; the operation of boats engaged in inland waterways transport; in respect of independent and dependent per- sonal services; immovable property; nor in the form of dividends, interest, rents or royalties.10 The intention of WP14 when defining profits was to narrow the scope of the business profits article only to industrial and commercial profits already by 3. Art. 7(4) OECD Model (2017). 4. OECD Draft Double Taxation Convention on Income and Capital 1963 art. 7(7) (30 July 1963), Treaties & Models IBFD [hereinafter OECD Model (1963)]. 5. After the 2010 update of the OECD Model that introduced the concept of the Authorised OECD Approach, the provision was placed from art. 7(7) to the current art. 7(4); see p. C(7)-3 OECD Model (2017). 6. The predecessor of the OECD. 7. To a great extent, the current 2017 version of the OECD Model along with the introductions brought by the entry into force of the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (7 June 2017), Treaties & Models IBFD reflects the structure defined in the 1963 version of the OECD Model. 8. OEEC, Working Party No. 14 of the Fiscal Committee - Report on the Article Definitions [FC/WP14(61)1], p. 1 (9 Jan. 1961). 9. Id. 10. Id. 18 This eBook is licensed to Michael Siaw Larbi, [email protected] Historical development of article 7(4) of the OECD Model means of defining the term “business profits”.11 The drafters even acknowl- edged that other items of income could be considered as business profits, referring explicitly to profits arising from the alienation of immovable prop- erty; nevertheless, the underlying rationale would exclude “expressively all income other than industrial and commercial income”.12 Additionally, the drafters considered the option of treating income arising from business activity in a uniform approach as far as it was related and, thus, allocated to a permanent establishment (PE).13 Hence, they proposed considering the future inclusion of special provisions in the articles dealing with divi- dends, interest and royalties to the extent that the article regulating indus- trial and commercial profits shall apply when such items of income (e.g. dividends, interest and royalties) were attributable to a PE of the recipient of the income.14 Five months later, however, the proposed definition of “profits” stood at stake in the 25th session held by the Fiscal Committee of the OEEC in July 1961. Accordingly, the Dutch delegation raised the point that the cur- rent structure would create difficulties due to the different meanings given by national legislations to the concept of “business profits”.15 Following that, the Austrian delegation suggested the inclusion of a provision similar to the rationale of the current article 7(4) within the general definition art- icle as a sub-paragraph of the definition of “profits: “This provision does not affect the Articles concerning income from the operation of ships or aircraft in international traffic or from the operation of boats engaged in inland waterways, income in respect of independent and dependent personal services, income from immovable property and income in the form of divi- dends, interest, rents or royalties.”16 Remaining an unresolved issue as a consequence of the respective definition of the term “business profits”, the potential overlap of the business profits article with other articles of the convention still raised concerns among the country delegates of WP14 as indicated in its second report. WP14’s response was to rely on a broad definition of the term “profits” without excluding elements potentially covered by other distributive rules from the notion, but rather emphasizing that the other distributive rules would not be 11. Id., at p. 3 et seq. 12. Id., at p. 4. 13. Id. 14. Id. 15. OEEC, Fiscal Committee - Minutes of the 25th Session [FC/M(61)4], p. 7 (8 July 1961). 16. Id. 19 This eBook is licensed to Michael Siaw Larbi, [email protected] Chapter 2 - The Relevance of Article 7(4) of the OECD Model affected.17 Therefore, WP14 envisaged an extensive definition of “profits” while expressly foreseeing the priority of allocation rules that are more specific within the convention.18 Eventually, WP14 decided to set aside its attempt to define the term business profits for treaty purposes in its third report on the article on definitions due to the “widely differing tax laws of Member States” in early 1962.19 Instead, the conclusion was reached that, in the absence of a treaty definition, the term “profits” should reflect the national legislation of the countries con- cerned.20 With regard to the concept of business profits, paragraph 29 of the 1963 OECD Commentary holds: Although it has not been found necessary in this Convention to define the term “profits”, it should nevertheless be understood that the term when used in this Article and elsewhere in the Convention has a broad meaning including all in- come derived in carrying on an enterprise. Such a broad meaning corresponds to the use of the term made in the tax laws of most Member States. Nonetheless, the report concluded that any potential overlap of article 7 of the OECD Model with another distributive rule stemming from a broad meaning of “business profits” under domestic law should be addressed by a priority rule.21 This was laid down by the report as an additional para- graph to the article dealing with business profits22 as follows: “Where profits include items of income which are dealt with in Articles V, VI, VII, XII, XX, XXI or XXII (alt. … dealt with separately in other Articles of this Convention), then the provisions of those Articles shall apply with respect to those items of income.”23 In this context, WP14 resumed its work and delivered a report on priority rules in the spring of 1962 containing the further refined wording express- ing the prevalence of the other distributive rules over article 7 of the OECD 17. OEEC, Working Party No. 14 of the Fiscal Committee - Second Report on the Article Definitions [FC/WP14(61)2], p. 8 et seq. (18 Sept. 1961). 18. The following definition was adopted: “The term ‘profits’ […] includes income derived from the direct exercise of business as well as income from the letting of the whole business or parts thereof and income from the alienation of the business or parts thereof or of objects used in the business. This provision does not affect Articles V, VI, VII, XIII, XXl, XXI and XXII.”; see id., at p. 9. 19. OECD, Working Party No. 14 of the Fiscal Committee - Third Report on the Article Definitions [FC/WP14(62)1], p. 7 (8 Jan. 1962). 20. Id. 21. Id. 22. Although the report only suggested this placement and left the question open for the upcoming work; see id. 23. Id., at p. 11. 20 This eBook is licensed to Michael Siaw Larbi, [email protected] Constituent elements and legal consequence of article 7(4) of the OECD Model Model. It used the expression “not affected by”, ultimately leading to the fol- lowing wording that was included in the 1963 OECD Model as article 7(7):24 “Where profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of these Articles shall not be affected by the provisions of the present Article”25 [emphasis added]. The report did not explain the reasons for the changes in the wording of the priority rule as opposed to the version proposed in the previous report, although it may be argued that the changes are of merely clarifying char- acter. After all, the commentary accompanying the provision remained unchanged. 2.3. Constituent elements and legal consequence of article 7(4) of the OECD Model 2.3.1. Starting point: Broad understanding of the term “profits” As shown above, the key to understanding the perceived necessity to include an explicit priority rule in article 7, according to which distributive rules that are more specific should prevail over the application of article 7(1) of the OECD Model, is the extensive scope of the term “profits”. This is also reflected by the wording of article 7(4) of the OECD Model, according to which it applies “where profits include items of income which are dealt with separately in other Articles of this Convention”. In an initial step, it must be analysed whether the income in question falls within the ambit of “business profits” in order to then assess whether the priority rule applies and eventually determine another distributive rule to govern the allocation of taxing rights with respect to that income. The OECD Model, as a delib- erate choice,26 does not contain a specific definition of the term “business profits”. However, the OECD Commentary maintained the original wording of the January 1962 report27 and – seen together with the admittedly vague 24. Art. 7(7) reads as follows: “Where profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article” [emphasis added to the changes in relation to the report of April 1962]; see art. 7 OECD Model (1963). 25. OECD, Working Party No. 14 of the Fiscal Committee - Report on Priority Rules [FC/WP14(62)3], p. 3 (13 Apr. 1962). 26. See sec. 2.3.2. 27. OECD, Working Party No. 14 of the Fiscal Committee - Third Report on the Article Definitions [FC/WP14(62)1] (8 Jan. 1962), p. 11.

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