Title: Recent initiatives by the Organization for Economic Cooperation and Development OECD
1Recent initiatives by the Organization for
Economic Co-operation and Development (OECD)
2Agenda
- 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
3Background 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
4Evolution 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
5Amendments to OECD Convention / Commentary
6Amendments 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
7Article 5 Permanent Establishment
8Article 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?
9Article 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
10Article 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
11Article 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
12Article 8 International Traffic
13Article 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
14Article 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
15Article 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?
16Article 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
17Article 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
18Article 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
19Article 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
20Article 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
21Article 11 - Interest
22Article 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
23Article 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
24Article 11 Interest
Lender
Borrower
State B
State A
PE beneficiary of loan
State C
Interest
25Article 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
26Article 12 - Royalties
27Article 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
28Article 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?
29Article 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
30Article 26 Exchange of Information
31Article 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
32Other amendments
33Other 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.
34Other 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
35Other 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
36Other 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
37Other key updates
38Other 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)
39Discussion draft on the attribution of profits to
PE
40Attribution 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
41Attribution 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
42Attribution 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
43Attribution 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
44Attribution 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
45Attribution 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
46Attribution 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
47Attribution 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
48Discussion draft on Mutual Agreement Procedures
49Mutual 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
50Taxing business profits arising from e-commerce
transactions
51Taxing 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
52Taxing 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
53Transfer Pricing
54Transfer 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
55Transfer 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
56Thank you