Worried for the exam? No time to prepare well structured notes to bring with you? No problem. These schemes are intended to provide a step-by-step approach to each and every topic covered. They will enable you to save time and answer comprehensively to all exam questions. They combine: (i) lecture ...
The approach to follow is the following:
1) Application of the DTC and assessment of the distributive rules:
First, consider the DTC. At the treaty level both the term ‘dividends’ (Art. 10(3)) and ‘interests’ (Art.
11(3)) are defined. Accordingly, Art. 3(2) is NOT relevant and there is NO need to rely on domestic law
to define these concepts. Hence, despite of the qualification under domestic law, the treaty definition
shall take precedence in the source state!!
- This is true even for the requalification of an item of income for the purposes of thin-cap rules.
Indeed, ph. 25 (on Art. 10) specifies that an item of income can be regarded as dividend if it is
qualified as such under source domestic law (for the purposes of applying thin-cap rules). Even in
this case, it is the treaty that specifies that such income shall be regarded as divided and not
interest so the qualification is still provided at treaty level and there is no need to rely on Art. 3(2)
and domestic law.
This leads to the conclusion that the source state will be bound to follow the qualifications/
definitions at treaty level even if these conflict with the domestic qualification!!
Second, remember that the residence state is ONLY bound to follow the source qualification in cases
where Art. 3(2) applies. In case of dividends and interests, however, the definitions are provided at
treaty level (hence, Art. 3(2) is NOT applicable). Accordingly, the residence state is not bound to follow
the (treaty) qualification applied by the source state.
There can therefore be a mismatch between the source and residence qualifications that
can (potentially) lead to double (non)-taxation
2) Application of the PSD and IRD (in an EU context):
A. PSD:
Remember: the PSD does NOT have a definition of ‘dividends’. This means that you will have to
look at the domestic law of the Member State in order to determine whether the item of income is
classified as a dividend under domestic law. If this is the case, the PSD will apply.
B. IRD:
The IRD has a definition for both ‘interests’ and ‘royalty’. This means that these will take
precedence over the classification of domestic law. Hence, if an item of income is defined as
interest/royalty under domestic law but does not fall under the definitions of the IRD, the Directive
will not be applicable. The Directive definition takes precedence!!
If the PSD/IRD applies, the outcome will be that NO WHT will be applicable in the source
state (as opposed to what allowed under DTC). Also, see obligations for the residence/PE
state.
3) Qualification in the residence state
Important: always remember that given that Article 3(2) does NOT apply, the residence state is NOT
obliged to follow the qualification applied in the source state.
- This could lead to mismatches where, for instance, the source state regards the income as interest
(and allows deductions) whereas the residence state qualifies the income as dividend and applies
the participation exemption -> double non-taxation
- The source state regards the income as dividend (non-deductible) and the residence state regards
the income as interest (taxed) -> double taxation (ie taxation with no right of deduction)
4) ATAD:
After you have assessed the treatment of the income under EU law, consider the ATAD. Indeed, the
ATAD prevents abusive arrangements resulting in tax avoidance (such as hybrid mismatches). If this is
the case, either the source state (disallow deduction) or the residence state (disallow the exemption)
will have to take action in order to prevent it.
5) Fundamental freedoms:
, As a last resort, consider the EU fundamental freedoms. Indeed, there can be instances where after
considering the distributive rules of the DTC, the PSD/IRD does not apply because their
subjective/objective scope is not met (ie where an investment is made via an exempt investment fund
as opposed to a company subject to tax). In these cases, it is important to assess whether the
application of the domestic WHT in the source state is compatible with EU law. In particular, the focus
will be on whether such treatment is considered to be discriminatory from the perspective of the EU
fundamental freedoms.
Approach:
, 1) Apply DTC and determine which state can tax how much;
2) Apply PSD/IRD to assess whether the outcome is different (in EU context);
3) Apply ATAD to assess whether an abusive/avoidance outcome arises
4) Apply EU freedoms to assess compatibility with EU primary law
A. Taxation under DTCs:
DIVIDENDS
Step 1: Defining ‘dividends’
Article 10(3) -> provides a wide definition for the term ‘dividends’; it covers:
i) “Income from shares” – title giving right to a participation to the benefit of a corporate entity
ii) Income from “other corporate rights” treated as income from shares under paying State’s
domestic laws (not being debt claims, participating in profits)
iii) Sharing of the risk of the enterprise (repayment depends of the success of the enterprise (ph.
(25))1
iv) Includes repatriation of liquidation proceeds if taxed as dividends in source state (ph.(28))
STEP 2: Paragraph 1
According to Art. 10(1) -> Dividends paid by a company which is a resident of State Y to a resident of
State X may be taxed in State X
o Elements:
i) Cross-border element: “paid by Y to X in other contracting state”
ii) “Payment” – wide sense (ph. 7)
Cross-border dividends may be taxed in the resident State of recipient
STEP 3: Paragraph 2
According to Art. 10(2) -> dividends paid by a company in State Y may also be taxed in State Y according
to the laws of State Y, but if the beneficial owner of the dividends is a resident of State X, the tax so
charged shall not exceed X% of the gross amount of the payments if the beneficial owner is a company
(other than a partnership)
o The source state may tax. However, 2 limitations apply:
i) If the other company:
(i) is the beneficial owner;
(ii) 25% holding participation; 5% WHT
(iii) For > 365 days
ii) In all other cases (where the other company is still the BO 15% WHT
o If these limitations are not met (ie if the other company if NOT the BO 2) the source state will be free
to exercise its domestic WHT unconstrained!
o ‘Beneficial owner’ -> (ph. 12) understood in the light of the object and purposes of the
convention (i.e. to avoid the double taxation and to prevent the tax evasion/avoidance)
Right to use and enjoy unconstrained (ph.12.4) -> ‘The recipient (...) is not the
‘beneficial owner’ because that recipient’s right to use and enjoy the dividend is
constrained by a contractual or legal relationship to pass on the payment received
to another person’
Agent or nominee (ph. 12.2) -> suspicious
STEP 4: Paragraph 4 – Exception to Article 10(1)(2)
1
Hybrid financing -> Article 10 deals also with interest if the lender shares the risks run by the company (substance
over form) -> in these cases the financing is covered by Art. 10 and NOT 11!!!!
2
For example -> in a treaty shopping situation.
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