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Recent initiatives by the Organization for Economic Cooperation and Development OECD

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Title: Recent initiatives by the Organization for Economic Cooperation and Development OECD


1
Recent initiatives by the Organization for
Economic Co-operation and Development (OECD)
2
Agenda
  • Background of the OECD
  • Evolution of the OECD Model Convention
  • Key amendments to OECD Convention / Commentary
  • Article 5 - Permanent Establishment
  • Article 8 - International traffic
  • Article 11 - Interest
  • Article 12 - Royalties
  • Article 26 - Exchange of Information
  • Other amendments to OECD Convention / Commentary
    (Articles 3, 10, 13, 15, 16, 18, 19, 20, 23A and
    23B)
  • Other key updates
  • Discussion draft on the attribution of profits to
    PE
  • Discussion draft on Mutual Agreement Procedures
  • Public comments invited on issues relating to
    application of the transactional profit methods
    (1995 Transfer Pricing Guidelines)
  • Discussion draft on taxing business profits
    arising from e-commerce transactions

3
Background of the OECD
  • Forum of 30 democracies
  • Key member countries include major European
    economies, USA, Canada, Japan and Korea. India
    has agreed to join the fiscal affairs committee
    of the OECD as an observer
  • Seeks to promote trade between member countries
  • Promotes rules of the game on areas where
    multilateral understanding on issues is essential

4
Evolution of the OECD Model Convention
  • Potential double taxation of income identified as
    a significant barrier for trade in a global
    economy
  • Importance of having a uniform solution across
    different member countries to counter the problem
    of double taxation
  • OECD Model Convention developed as a basis for
    setting, in a uniform manner, certain commonly
    encountered problems in the field of
    international and domestic taxation, tax policy,
    administration, etc
  • First Convention published in 1963 which was
    revised in 1977
  • 1992 publication of Model convention was the
    first step of an ongoing revision process to
    produce periodic updates

5
Amendments to OECD Convention / Commentary
6
Amendments to OECD Convention / Commentary
  • During 2005, OECD has
  • Amended the OECD model convention (Articles 15,
    19 and 26)
  • Amended the OECD model commentary to
  • Article 3 General Definitions
  • Article 5 Permanent establishment
  • Article 8 Shipping, Inland waterways transport
    and air transport
  • Article 10 Dividends
  • Article 11 - Interest
  • Article 12 - Royalties
  • Article 13 Capital Gains
  • Article 15 Income from employment
  • Article 16 Directors fees
  • Article 18 - Pensions
  • Article 19 Government Service
  • Article 20 - Students
  • Article 23A, 23B Exemption and Credit method
  • Article 26 Exchange of information

7
Article 5 Permanent Establishment
8
Article 5 Permanent Establishment
  • Ministry of Finance (Tax Office) v Philip Morris
    (GmBH) 7682/02 (25 May 2002)
  • Facts

Various Nonresident Group Companies
Royalties And Gross Sales Proceeds
Licensing and Distribution Agreements
Fees
Services
Offshore
Italy
Intertaba
AAMS
Issue Whether Italian subsidiary constitutes a
PE in Italy?
9
Article 5 Permanent Establishment
  • Principles enunciated by the Italian Supreme
    Court
  • A subsidiary can constitute a multiple PE of its
    non-resident group companies
  • Supervision or control of performance of a
    contract between a resident entity and a
    non-resident entity not an auxiliary activity
    under Article 5(4)
  • Participation of representatives or employees of
    a resident company in a phase of conclusion of a
    contract between a non-resident entity and a
    resident entity could fall within the concept of
    authority to conclude contracts
  • Entrusting management of business transactions to
    subsidiary by a non resident company may result
    in the subsidiary constituting a PE even if
    entrusting limited only to a certain area of
    business
  • Substance over form approach to be used in
    determining the existence of a PE

10
Article 5 Permanent Establishment
  • Amendments to OECD commentary
  • Rejection of the Multiple PE Principle
  • Distinction between foreign enterprise carrying
    on business through a fixed place located in
    premises of a group company and foreign
    enterprise providing services to a group company
    from its own premises
  • Indeed, the fact that a companys own
    activities at a given location may provide an
    economic benefit to the business of another
    company does not mean that the latter company
    carries on its business through that location
    clearly, a company that merely purchases parts
    produced or services supplied by another company
    in a different country would not have a permanent
    establishment because of that, even though it may
    benefit from the manufacturing of these parts or
    the supplying of these services. Para 42 of
    OECD commentary to Article 5
  • Attendance/ participation in negotiations not
    conclusive but determinative of functions
    performed on behalf of an enterprise

11
Article 5 Permanent Establishment
  • Analysis
  • Amendments are clarificatory in nature
  • Italy has inserted an observation stating that
    Italian jurisprudence should not be ignored when
    dealing with situations as stated earlier
  • Amendments do not address substance over form
    principle
  • Morgan Stanley and Co Inc AAR No 661 of 2005
  • UPS AAR 542 CTR 328

12
Article 8 International Traffic
13
Article 8 International Traffic
  • Key amendments
  • Profits from operation of ships or aircrafts in
    international traffic to include profits from
    activities
  • directly connected to international traffic
    operations and
  • ancillary to international traffic operations

14
Article 8 International Traffic
  • Typical examples of directly connected /
    ancillary activities
  • operation of a bus service connecting a town with
    an airport primarily in relation to international
    flights
  • sale of tickets by an enterprise on behalf of
    other enterprises at a location maintained for
    its own sales
  • advertising in magazines distributed on board
    ships or aircraft or at ticket offices
  • leasing of containers
  • activities carried out on the basis of pooling
    agreements with other enterprises engaged in
    international transport, for example, to provide
    spare parts or maintenance services in certain
    locations

15
Article 8 International Traffic
  • British Airways Plc v DCIT 80 ITD 90 (Del)
  • Facts
  • British Airways Plc (BA) rendered
    technical/engineering/traffic handling services
    to other airlines in India
  • BA had a separate engineering set up in
    metropolitan cities of India
  • The engineers certified airworthiness of
    aircrafts of BA and other airlines before take
    off
  • Payments for services were made on per flight
    basis and cleared through IATA clearance house as
    per agreements between airlines
  • Issue
  • Whether payments received by an airline from
    other airlines for certifying the airworthiness
    of the aircraft before take off is in the nature
    of receipts from international traffic under
    Article 8 of OECD model convention?

16
Article 8 International Traffic
  • British Airways Plc v DCIT 80 ITD 90 (Del)
  • Held
  • Payments received by an airline from other
    airlines in India for provisions of a certificate
    for airworthiness before their take off, are not
    in nature of receipts from international traffic
    under Article 8 on account of following
  • Imparting such service was separate planned
    activity not covered under Air Transport
    Services
  • Non rendering of such service will not have any
    impact on working of assessees own airline
  • Revenues were not insignificant that can be
    overlooked
  • Analysis
  • Revised OECD commentary contrary to the above
    decision

17
Article 8 International Traffic
  • Lufthansa German Airlines v Deputy CIT 90 ITD 310
    (Delhi)
  • Facts
  • Lufthansa German Airlines (Lufthansa), engaged
    in operation of aircrafts in the international
    traffic, operates in India through a branch
  • Lufthansa is a member of the International
    Airlines Technical Pool (IATP)
  • As an IATP member, Lufthansa extends line
    maintenance facilities to other IATP members in
    India

18
Article 8 International Traffic
  • Lufthansa German Airlines v Deputy CIT (90 ITD
    310) (Delhi)
  • Issue
  • Whether payments received by Lufthansa from other
    airlines for line maintenance facilities under
    IATP agreement are in the nature of receipts from
    international traffic under Article 8?
  • Held
  • Income derived by Lufthansa from participation in
    a pool not taxable in view of Article 8(4) of tax
    treaty
  • Analysis
  • Controversy in the above judgment set at
    rest as a specific clarification inserted in OECD
    commentary to state
  • Where an airline enterprise agrees under an
    IATP agreement, to provide spare parts or
    maintenance services to other airlines landing at
    a particular locationactivities carried on
    pursuant to that agreement will be ancillary to
    the operation of aircraft in international
    traffic

19
Article 8 International Traffic
  • AP Moller Maersk Agency India (P) Ltd v DCIT 89
    ITD 563 (Mum)
  • Facts
  • A.P.Moller, Maersk Agency India (P) Ltd (AP
    Moller) receives slot charges and ancillary
    charges from other shipping company in India.
  • Issue
  • Whether slot charges received by AP Moller from
    other shipping companies are covered under
    Article 9 (International Traffic) of the India-
    Denmark Tax Treaty?
  • Held
  • DTAA is silent over taxing the profits of
    shipping company derived otherwise than from the
    operation of ships. In such eventuality, the
    profits can be taxed in India as per the
    provisions of the Income Tax Act, 1961

20
Article 8 International Traffic
  • AP Moller Maersk Agency India (P) Ltd v DCIT (89
    ITD 563) (Mum)
  • Analysis
  • Specific insertion in revised commentary to
    include code-sharing and slot-chartering
    arrangements in the definition of directly
    connected and ancillary activities
  • Amendment to OECD commentary contrary to above
    decision

21
Article 11 - Interest
22
Article 11 Interest
  • In case of an overseas borrowing, interest income
    becomes liable to be taxed twice, first by the
    Source State and then by the Resident State which
    could in certain cases result in partial double
    taxation and lead to adverse economic
    consequences. To illustrate

23
Article 11 Interest
  • Amendment to the OECD commentary
  • Contracting State may provide for exclusive
    taxation in the Resident State of the beneficiary
    of categories of interest stated below
  • Interest paid to State, its political subdivision
    and to central banks
  • Interest paid by a State or its political
    subdivision, a local authority or statutory body
    thereof
  • Interest paid pursuant to export financing
    programs
  • Interest paid to financial institutions
  • Interest on credit sales
  • Interest paid to tax exempt entities such as
    pension funds

24
Article 11 Interest
  • Triangular cases

Lender
Borrower
State B
State A
PE beneficiary of loan
State C
Interest
25
Article 11 Interest
  • Triangular cases
  • Amendment to the OECD commentary
  • Use of multilateral convention or alternative
    formulation of second sentence of Article 11(5)
    stated below
  • Where however, the person paying the interest,
    whether he is a resident of a Contracting State
    or not, has in a State other than that of which
    he is a resident a permanent establishment in
    connection with which the indebtedness on which
    the interest is paid was incurred, and such
    interest is borne by such permanent
    establishment, then such interest shall be deemed
    to arise in the state in which the permanent
    establishment is situated

26
Article 12 - Royalties
27
Article 12 Royalties
  • Amendment to OECD commentary
  • Supplier to abstain from granting information /
    property to anyone else other than the licensee
  • Payment for exclusivity of information / property
    considered as royalty
  • Qualifies as any kind received as consideration
    for.the right to use the property or
    information

28
Article 12 Royalties
  • Aktiebolaget Volvo v Federal Commissioner of
    Taxation 78 ATC 4316 (1978)
  • Facts
  • Volvo Australia Pty Ltd (ACo), an Australian
    Resident company is a subsidiary of a Sweden
    company (SCo)
  • ACo imports products manufactured by SCo for
    resale
  • As per agreement between ACo and SCo, ACo has
    exclusive rights to sell SCos products in
    Australia
  • Issue
  • Whether payments made by ACo to obtain exclusive
    rights of sale in Australia is royalty?

29
Article 12 Royalties
  • Aktiebolaget Volvo v Federal Commissioner of
    Taxation 78 ATC 4316 (1978)
  • Held
  • Payments made by ACo are not royalty.
  • Analysis
  • Specific insertion in revised commentary to
    include payments made to secure exclusivity of
    information or an exclusive right to use property
    constitutes royalties
  • Amendment to OECD commentary contrary to the
    above decision

30
Article 26 Exchange of Information
31
Article 26 Exchange of Information
  • Amendments to Model Convention
  • Para 4 introduced requested State to provide
    information even if it has no domestic interest
  • Para 5 introduced Contracting State cannot
    decline from supplying information solely because
    information held by bank, financial institution,
    etc
  • Amendments to OECD commentary
  • Necessary information vis-à-vis forseeably
    relevant information

32
Other amendments
33
Other amendments
  • Article 3 General Definitions
  • Commentary to definition of international
    traffic amended to clarify that the definition
    is not applicable to an enterprise having its
    place of effective management in one Contracting
    State (say India) when its the ship/ aircraft is
    operated between two places in another
    Contracting State (say US)
  • Article 10 - Dividends
  • Insertion to commentary on Article 10 to provide
    that States may agree bilaterally to exempt from
    source taxation dividend income derived by
    pension funds and similar entities.
  • Article 13 Capital Gains
  • Insertion to commentary on Article 13 to provide
    that States may agree bilaterally to exempt
    capital gains on shares, derived by pension funds
    and similar entities, from source taxation.

34
Other amendments
  • Article 15 Income from employment
  • Clarified that the term salaries wages and other
    similar remuneration includes stock options
  • Clarifications regarding issues arising in
    relation to taxability of employee stock-options
    inserted
  • Clarified that income from exercise of employment
    in a Contracting State would be taxable in that
    State irrespective of when that income is paid,
    credited or definitively acquired by the employee
  • Clarification inserted regarding the term in any
    twelve month period commencing or ending in the
    fiscal year concerned

35
Other amendments
  • Article 16 Directors fees
  • Clarified that the term fees and other similar
    payments includes employee stock-options
  • Clarifications regarding issues arising in
    relation to taxability of employee stock-options
    inserted
  • Article 18 Pensions
  • Significant amendments made to the commentary
  • Article 19 Government Service
  • Model convention amended to make Article 19
    applicable to remuneration similar to pension

36
Other amendments
  • Article 20 Students
  • Clarification inserted that payments to students
    for any independent services covered under
    Article 15 and 7 are not covered under Article 20
  • Where the recipient's training involves work
    experience, there should be a distinction between
    payment for services and payment for maintenance,
    education and training
  • Article 23A and 23B Exemption and credit method
  • Commentary amended to clarify the following
  • Situations where same item of income is subject
    to full tax liability in two countries at
    different times
  • Relief of double taxation of income or capital by
    the State of residence would be available even
    though the State of source taxes it in an earlier
    or later year

37
Other key updates
38
Other key updates
  • OECD has issued certain drafts for discussion on
  • Article 7 - Attribution of Profits to PE (Parts I
    to IV),
  • Article 25 - Mutual Agreement Procedure,
    (Discussion draft on proposal for improving
    mechanisms for the resolution of the tax treaty
    disputes)
  • Are current treaty rules for taxing business
    profits appropriate for e-commerce?
  • Issues relating to application of the
    transactional profit methods (1995 Transfer
    pricing guidelines)

39
Discussion draft on the attribution of profits to
PE
40
Attribution of profits to PE
  • Key principles relating to attribution of profits
    to a PE
  • Two step Analysis
  • Step I Determining the profits of an
    enterprise
  • Relevant business activity approach
  • Functionally separate entity approach

Step II Attribution of profits of enterprise to
PE
41
Attribution of profits to PE
  • Key principles relating to attribution of profits
    to a PE
  • Analysis
  • Functionally separate entity approach is the
    preferred approach
  • Reliance on 1995 Transfer Pricing Guidelines for
    determination of arms length profit
  • Arms length principles between associated
    enterprise in Article 9 to be applied by analogy
  • Attribution of profits primarily dependent on
    facts
  • Advisable to maintain appropriate documentation

42
Attribution of profits to PE
  • Symmetrical application of authorised OECD
    approach
  • Accounts prepared on symmetrical basis used as
    basis for attribution
  • Values of transactions or methods of attributing
    profits or expenses in books of PE exactly
    correspond to values / methods in books of head
    office
  • Issues addressed
  • Taxpayers who produce symmetrical accounts should
    in principle be able to satisfy both tax
    administrations that an arms length amount of
    profits have been attributed to the PE
  • Problems relating to two countries applying
    different approaches to capital attribution can
    be resolved by application of Article 23 that
    obliges the home state to give relief by way of
    exemption or credit in relation to profits
    attributed to the host state

43
Attribution of profits to PE
  • Symmetrical application of authorised OECD
    approach
  • Issues not addressed
  • Limitation concerning as to how the countries
    define the term profits
  • The methods of computing profits may be
    different under the domestic laws of the home and
    host country
  • Elimination of double taxation requires changes
    to be made in domestic laws of the home country
    on double taxation relief and Article 23 of the
    OECD Model Tax convention

44
Attribution of profits to PE
  • Key principles relating to attribution of profits
    to a PE
  • Step II - Attribution of profits of enterprise to
    PE

Determination of profits attributable to PE
Functional and Factual analysis
Applying arms length principle to determine
profits attributable to the PE
Hypothesize PE as a distinct and separate person
Recognition of dealings
Determination of functions / activities
Determination of arms length compensation by
applying transfer pricing methods
Attribution of assets
Attribution of profits in respect of dealings by
reference to comparable transaction between
independent enterprises
Attribution of risks
Attribution of capital
Determination of free capital
Determination of funding costs
45
Attribution of profits to PE
  • Attribution of profits to a dependent agent
  • In case of dependent agent PE host country
    technically has rights to tax two different legal
    entities
  • the agent, and
  • the PE
  • Generally, profits attributed to a dependent
    agent PE on the same basis as for other types of
    PEs ie as per the authorised OECD approach
  • Single taxpayer approach
  • Payments of an arms length reward to a dependent
    agent enterprise extinguishes profits
    attributable to dependent agent PE

46
Attribution of profits to PE
  • Attribution of profits to a dependent agent
  • Single taxpayer approach
  • Criticism
  • This approach does not consider risks and rewards
    which although legally belonging to the non
    resident enterprise, are attributable to the PE
    as a result of the activity of the PE
  • This approach distinguishes between a fixed place
    of business PE and a dependent agent PE
  • This approach renders Article 5(5) redundant as
    there would not be any profit consequences for a
    dependent agent PE

47
Attribution of profits to PE
  • Attribution of profits to a PE
  • Analysis
  • When the PE of the enterprise in India is
    remunerated for its services at arm's length by
    the enterprise and as long as all its actual
    income is brought to tax, no further income can
    be attributed in the hands of the PE of the
    enterprise - Morgan Stanley and Co. 661 of 2005
    (AAR)
  • Where a non-residents sales to Indian customers
    are secured through the services of an agent in
    India, the assessment in India of the income
    arising out of the transaction will be limited to
    the amount of profit which is attributable to the
    agents services..if the agents commission
    fully represents the value of profit attributable
    to his service it should prima facie extinguish
    the assessment Circular 23 of 1969

48
Discussion draft on Mutual Agreement Procedures
49
Mutual Agreement Procedure
  • Key recommendation of OECD
  • Use of additional dispute resolution techniques,
    in particular arbitration process
  • Other issues addressed by OECD
  • Time limit for submission of request of MAP
  • Meaning of probability of taxation
  • Denial of access to MAP
  • Suspension of collection of tax
  • Suspension or remission of interest and penalties
  • Manual on Effective Mutual Agreement Procedure

50
Taxing business profits arising from e-commerce
transactions
51
Taxing business profits arising from e-commerce
transactions
  • Discussion draft relating to taxability of
    business profits arising from e-commerce
    transactions
  • Critically evaluates the current treaty rules for
    taxing business profits with respect to
    e-commerce transactions
  • Examines various possible alternatives for taxing
    e-commerce transactions
  • Significant conclusions
  • E-commerce and other business models resulting
    from the new communication technologies do not
    justify a dramatic departure from current rules
  • Any attempt to change fundamental aspects of
    current international rules for taxing business
    profits would create difficult transition rules,
    could result in widespread disagreement and would
    require a long period of time
  • None of the suggested alternatives can be
    considered superior to the existing rules

52
Taxing business profits arising from e-commerce
transactions
  • Significant conclusions
  • Based on comments received on the discussion
    draft, following conclusions drawn by the OECD
  • Certain alternatives suggested in the discussion
    draft need not be considered further
  • Application of current rules in respect of the
    following to be monitored to determine whether a
    further study of alternatives suggested is
    required
  • Functions performed with the use of servers and
    software
  • Application of exceptions in Article 5(4) to
    e-commerce transactions
  • Supplementary nexus rules

53
Transfer Pricing
54
Transfer Pricing
  • Public comments on following issues relating to
    application of the transactional profit methods
    invited by OECD
  • Appropriateness of transactional profit method as
    last resort method
  • Use of transactional profit methods either in
    conjunction with a traditional transaction method
    or as a sanity check to test the plausibility of
    the outcome of a traditional transaction method
  • Application of transactional profit methods to
    intangibles
  • Application of transaction profit methods and
    consideration of risks
  • Need for tax administrations to have access to
    all information needed to apply or review the
    application of transactional profit methods

55
Transfer Pricing
  • Public comments on following issues relating to
    application of the transactional profit methods
    invited by OECD
  • Issues relating to determination of profits to be
    split
  • In which cases would a residual analysis and in
    which cases would a contribution analysis be more
    reliable? In which cases should other types of
    approaches be considered and how would they
    apply?
  • Issues relating to splitting of profits
  • Issues relating to applicability of a
    comparability standard to transactional net
    margin method
  • Issues relating to selection of a net margin
    indicator to apply the transactional net margin
    method
  • Other methods that may be used in practice

56
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