Dividens, Interests and Royalties

Question 1

What are dividends?

Answer 1

• Article 10(3)
• General: Distributions of profits of companies title to which is constituted by shares (as opposed to income from debt claims which is interest; Art. 11)
  
  • Limb 1: income from shares
  • Limb 2: income from other rights participating in profits
  • Limb 3: income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident
    
    • E.g. “capital gain” on a stock redemption; distribution of liquidation bonus (e.g. Art. 18 Belgian ITC)

Question 2

What are the taxing rights of dividends?

Answer 2

• Shared taxing rights
  
  • No exclusive right to tax dividends to one State
  • Dividends MAY be taxed in the state of residence of the beneficiary

Question 3

What can the source state do?

Answer 3

• Source State may also tax the dividends:
  
  • But limitations to source State tax
  • 5% withholding tax (WHT) in case of substantial shareholding by parent company (direct holding of 25% or more) of capital of distributing company
  • 15% WHT in all other cases (portfolio investments)
• Some countries do not levy WHT on dividends under their domestic law
  
  • Eg. UK, Belgium but only for parent companies resident of country with a DTC with B
  • Relative effect of DTC

Question 4

What is the effect of BEPS AP 6 on dividends?

Answer 4

• Treaty abuse
• 5% WHT in source state subject to the condition that shareholder (company) holds directly at least 25% of capital of paying company throughout a 365 days period including the day of payment:
  • Eg. company holding less than 25% shortly before distribution of dividend acquires extra shares to meet 25%-test; if it keeps shares after distribution of dividend = no abuse
  • Abuse e.g. company buys the extra shares from an invididual (purchase cum coupon) and sells them back right after the dividend distribution to that same person (sale ex coupon)
  • To stop this: 365 days test added to Art. 10 (2) in 2017 (but not minimum standard)

Question 5

What is the result of the taxation on dividends and what is the ratio?

Answer 5

• Result of Source and Residence State taxation on dividends -> juridical double taxation (but relief under Art. 23)
• Ratio for not having single taxation?
  
  • Investment income should be taxed in Residence State, but unrealistic to hope that source States will agree to abandon taxing rights. Outdated ratio?
    
    • Developments within EU: Parent/Sub Directive
    • Many non EU States willing to abandon source taxing rights on reciprocal basis in tax treaties (part of tax competition between States)

Question 6

How do we handle dividends paid by company resident to a PE in the same state?

Answer 6

• Dividends paid by company resident of a Contracting State (B) to a PE in the same State (B) of shareholder resident in other State (A): above rules do not apply, dividends are considered to be business profit of the PE, in principle no reduction of WHT at source (Art. 10 (4))
• PE: dividend: functionally recaived by PE in state B
  
  • = not cross border dividend payment
  • No reducted WHT: Belgium may ask 30%

Question 7

How do we handle triangular situation wrt dividends?

Answer 7

• Dividends paid by a company resident of C to the PE in State B of a shareholder-resident in A:
  
  • Shares managed by PE in B
• Which treaty applies to determine rate of WHT in Source state?
  
  • Not A/B because company receiving = resident of C
  • B/C: 10% WHT: no, PE is not resident of B
  • A/C: 15% WHT: yes, payment of dividend by resident of C to resident of A
• Which treaty determines whether A or B has taxing rights on dividend? A/B > PE State (art. 7 (2))

Question 8

What is the Parent/Subsidiary directive?

Answer 8

• Purpose: for groups of companies no tax restrictions hampering the grouping of companies and the internal market, necessary to have neutral tax rules to strengthen productivity and competitiveness internationally
• Fact: existing tax provisions vary significantly within EU and treat international groups less favourably than national groups as within national context juridical & economical double taxation on dividends is removed
• Solution:
  
  1. No WHT in source State (avoidance of international juridical double taxation)
  2. Relief for international economic double taxation in residence State of parent

Question 9

What is the scope of the Parent/subsidiary directive?

Answer 9

• Profit distributions between MS subsidiary to MS parent: undefined term. Autonomous EC-law meaning: wider than dividends
• Situations covered:
  
  1. Sub in MS1/Parent MS2
  2. Sub MS1/Parent MS2 with PE in MS3 = covered:
     
     • Dividends paid to a shareholder of State C by a company resident of a Contracting State (A) out of profit made in State B: no taxing rights of State B, only A and C (Art. 10 (5): ban on extra-territorial taxation)
  3. Sub MS1/Parent MS1 with PE in MS2 = covered
• Situations not covered:
  
  • Sub in MS1/Parent in MS2 with PE in MS1

Question 10

Who are the qualifying companies in the parent/subsidiary directive?

Answer 10

• Legal form: annex Directive (broad)
• Tax resident of MS and not a resident outside EU under a tax treaty with a third State (exclusion of dual resident companies with POEM outside EU)
• Subject to corporate tax in MS without option or without being exempt
• Minimum shareholding 10% in capital of company of other MS (more leniency of MS permitted)
  
  • Belgium also for shareholdings of 2,5 mio € or more
• MS have right not to apply Directive to companies not maintaining the shares for uninterrupted period of at least two year (more severe rules of MS permitted) (compare to slide 207)
  
  • Belgium: 1 year

Question 11

What is article 5 of the parent/subs directive?

Answer 11

• No WHT for the source state:
• Relief for international juridical double taxation: shareholder not paying tax on dividend in source state and in residence state
• Implementation in domestic law of MS/relative effect of Tax Treaty
  
  • Tax treaties no relevant anymore where transactions come into scope of Directive

Question 12

When does PSD not apply?

Answer 12

1. Parent/shareholder is outside EU
2. Shareholder less than 10%
3. Shareholders not companies but individuals

Question 13

What is interest?

Answer 13

• Article 11: definition of interest
  
  • Income from debt claims of every kind (loans, bonds, deposits etc.) even when carrying a right to participate in the profits
• Difficult issues:
  
  • Hybrid instruments (profit participating loans, convertible debt, swap payments etc.
  • Interest for late payment

Question 14

What was the case PPL ECJ 2017?

Answer 14

• Regarding interpretation interest
• German bank issued securities acquired by Austrian bank = interest-bearing
• Terms: if no profit/incur loss = payment suspended so the company cannot enter into loss position.
• Treaty GE-AU deviates from OECD MC: interest only taxable = state of recipient (Austria)
  
  • Exemption = income from debt claims participating in profit = taxed in source state @ 10% OECD: PPL loans = interest = general rule.
• Question: security that particpates in profit bank?
  
  • Germany: 10% WHT
  • Austria: interest baring security = fixed interest –> only we can tax
  • Result: double taxation: 10%+30%
• Austrian bank: initiated mutual agreement procedure but no obligation to reach a result: CJEU could make a decision: final binding decision

Question 15

What did the court decide in the case PPL ECJ 2017?

Answer 15

1. Term: “debt claims participate in profits” is not defined in treaty: art. 3(2): interpreted according to domestic tax forces = Germany.
2. Court disagreed: art. 3(2) normally applied by state of source except in 2 cases:
   
   1. State recovers taxing rights through a subsequent change in domestic law after signing of treaty art. 26-27 Vienna Convention = not the case here
   2. If context requires otherwise: problem: what is context?

• CJEU does not refer to either art. 26 Vienna Convention or context but simply states art. 3(2) should not be applied by Germany = leads to double taxation = if source state applies domestic law = double taxation
• Refers to art. 31: “ordinary meaning”: in light of object & purpose of treaty so the interest is not variable but fixed
• So: general rule of art. 11(1): only Austria may tax

Question 16

What are the exceptions to the art. 11?

Answer 16

• Exception:
  
  1. Interest paid by resident of Contracting State (A) to PE in same Contracting State (A) of resident of other State (B) (Art. 11 (4)). Art. 11-rules do not apply. Interest is business profit of PE and in principle no reduced WHT in source State (cfr. Dividend)
  2. Triangular cases: same as under dividends
     
     • If company has a PE in another state that deducts costs = source of interest is not A but PE
     • Shame that this is in the commentary = should have been lex specialis

Question 17

What does it mean to have “interest arising in Contracting State”?

Answer 17

• Source of interest: art. 11(5)
• General: State of which the payor of the interest is a resident (= A)
• Exception:
  
  • If interest-bearing loan is connected to PE of payor and PE bears interest cost (claims deduction of interest expense) –> source: State of establishment of PE (= B)
  • Problem of dual source of interest (A and B): double WHT/ double credit under Art. 23?
    • Solution: alternative wording in treaty between residence State lender and residence State debtor in favor of PE-State

Question 18

What is the rule for excessive interest?

Answer 18

• Excessive interest - between parties “with special relationship” (broader than associated enterprises (Art. 9))
  
  • When interest exceeds the arm’s length interest agreed upon by independent contracting parties, then only the arm’s length interest will be treated as “interest” for treaty purposes
  • Recharacterization of the excess may take place in accordance with national law:
    
    • Double consequence: deduction of excess refused + no reduced WHT
    • But no recharacterization of debt into equity and interest into dividend (“having regard to the debt claim”)
      
      • Tax authority may never recharacterize debt into equity = also for PPL loans but harder to prove that it is not arm’s length = not a market for

Question 19

What is the example of excessive interest?

Answer 19

• Belgian subsidiary borrows from US parent @ 8%
• Article 9: tax authorities: upwards profit shifting of 5% = non-arms length interest
  
  • 5% = non-deductible expense for Belco = tax authorities can deny non-arms length interest
• But: second angle: art. 11(6): tax authorities of harmed state: only reduce wht to 10% under treaty for arm’s length interest
  
  • On the disallowed expense (=5%) = domestic state may apply its domestic tax as 30% not 10%
• Sanctioned 2 times:
  
  1. Arm’s length @ 10%
  2. Non-arm’s length @ 30%
• Special interest = kind of the same as associated companies

Question 20

What are the royalties?

Answer 20

• Article 12(2)
• Consideration for the use of the right to use copyrights or any patent, trademark, design, model plan, secret formula, information concerning industrial, commercial or scientific experience = owned by another person!
• Never in case of transfer of ownership of intangibles = gain comes under Art. 13
• Important: royalties only cover payments for intangibles tangibles: art. 7 = business profits
• Examples:
  
  • Rents for cinematographic films
  • Know how (technical assistance)
  • Computer software
  • Payment for the use of industrial, technical equipment (income from leasing): not longer included in definition. 1992 change of the OECD MC > since 1992 Art. 12 deals with consideration for IP (intangibles)
• Not included: payments for image rights to the person whose image is shown to public (cfr. Belgian JM Saive and Croatian soccer player SK Lokeren-cases contra US Garcia-case)

Question 21

What are the taxing rights for royalties?

Answer 21

• Exclusive right to tax for the State of residence of the beneficiary
• No taxation in the State of source
  
  • Ratio: may be serious hindrance to commercial development of source country, taxation on gross in source State may be an excessive high tax
  • Many exceptions in bilateral treaties (developing countries following UN Model)

Question 22

What is the scope of art. 12?

Answer 22

• Scope of Art. 12: royalties arising in one Contracting State and paid to resident of other Contracting State (Art. 12 (1)):
• Bilateral and triangular cases (not) covered: cfr. Interest and dividends
• But, unlike interest, no definition of source of royalties (exc. in bilateral treaties)
• Exception: Royalty paid by resident of Contracting State (A) to PE in same Contracting State (A) of resident of other State (B) (Art. 12 (4)). Art. 12-rules do not apply. Royalty is business profit of PE and in principle no reduced WHT in source State (cfr. Dividend/Interest)

Question 23

How do we handle excessive royalties?

Answer 23

• When royalty payments exceed the arm’s length interest agreed upon by independent contracting parties, then only the arm’s length royalty will be treated as a royalty for treaty purposes
• Excessive part: internal law of source State:
  
  • No reduction of WHT and non deductibility (cfr. Interest)

Question 24

What is the interest & royalty directive?

Answer 24

• Purpose: in internal market domestic interest payments should not be taxed more favorably than cross-border payments. Not the case: WHT (also under tax treaties not following OECD MC), double tax not entirely removed, administrative burdens)
• Rule: Int & Roy should be only taxed once in a MS of residence of recipient. Exemption of WHT in source State for payments between related enterprises (and PE’s) within EU
• No WHT in same country because the bank will pay corporate tax.
  
  • WHR is only valuable cross border but big administrative burden: EU decided: discrimination: not good for internal market = do away WHT

Question 25

What are the conditions for the interest & royalty directive?

Answer 25

1. Related companies
2. Form of company has to be in a list (more narrow than P/S Directive): subject to corporate tax without option or exemption (cfr. P/S Dir); MS have option to add a 2-year minimum holding period (cfr. P/S Dir)
3. Receiving company must be beneficial owner of the interest and royalty income (see treaty abuse)

Question 26

What are the related companies for the interest and royalty directive?

Answer 26

• Direct participation of at least 25% in the capital of the other company or
• Common parent company holding at least 25% of the capital of both companies
• All companies must be (tax) resident within the EU

Question 27

What is the definition of interest according to interest and royalty directive?

Answer 27

• Definition of “interest”: quite similar to Art. 11 OECD MC, but profit participating loans, interest recharacterized as div under domestic anti-avoidance rules; convertible debt; perpetual debt are excluded
• Definition of “royalties”: cfr. Art. 12 OECD MC + equipment leasing income
• Not applicable to non arm’s length payments
• Implementation in domestic law (0% WHT)/Relative effect of tax treaties

Question 28

What is the rule for capital gains?

Answer 28

• General rule (Art. 13 (5)) “other property”
  
  • State of residence of alienator = exclusive taxing rights
  • What? In particular gains from the alienation of shares, bonds & other securities
• Scope: alienation = all possible transactions whereby assets are transferred from 1 property to another

Question 29

What are the exceptions for capital gains?

Answer 29

1. Exception 1: gains from the alienation of immovable property (whether part of PE assets not) (Art. 13 (1))
   
   • taxed in State where property is located
2. Exception 2: gains from the alienation of movable property connected to PE (Art. 13 (2))
   
   • State of PE
3. Exception 3: gains from ships/aircraft in international traffic:
   
   • Place of effective management of company (Art. 13 (3))
4. Exception 4: gains from the alienation of shares deriving more than 50% of their value (in)directly from immovable property situated in other Contracting State (Art. 13 (4)). Anti-avoidance rule

• State of situs of immovable property