24th July, 2021 1

25/7 9

31st July 2021 15

01 August 2021 29

7th August 2021 37

8th August 2021 53

14 August 2021 66

August 22 74

5th September 83

11 September 93

12th September 103

18 September 111

19th September 115

September 25th 118

26 September 124

17 October 2021 132

23 Oct 141

24/10 145

24th July, 2021

Class 1

● Taxation is always in news specially at international level - relevant field of study

● We will look at MNC or businesses and how they are taxed.
● Interplay of Law + Economics + Politics + Geo-politics in ICT.

Why is this course relevant?

Taxation controversies : The Rich, the Poor, and the taxes

● In this course, we will see how well placed is the public assumption that MNCs
are exploiting the existing international order in terms of international tax regimes and
bilateral/multilateral treaties. Perception is that rich are getting richer and the
poor are getting poorer
● Example 1: In the US, lots of debate and disagreement within the democratic party
on how to tax the rich and how to make them pay.Turning point came through the
global 2007-2008 economic crisis : it brought taxation, inequality (that large
businesses are not paying their due shares when smaller/local business are made to)
in focus.
○ ProPublica did a series of articles on IRS documents and showed that
billionaires paid minimum to zero federal taxes.

Some examples of strategic tax avoidance from famous companies

● Starbucks faced questions from House of Commons public accounts committee in
UK that why they paid no corporate taxes in certain years (at one point Starbucks
even publicly apologised for this)
[Articles he sent - https://www.theguardian.com/business/2012/nov/12/starbucks-tax-
avoidance-controversy https://www.theguardian.com/business/2012/oct/15/starbucks-tax-uk-
sales
https://www.theguardian.com/business/2019/jun/27/starbucks-emea-pays-183m-tax-but-
348m-in-royalty-payments]

● Similar questions were asked to Google and Amazon about their strategic
movement to low-tax regimes like Ireland, Luxemburg
● Apple-Ireland tax dispute : Ireland has one of the lowest taxes in EU and has been
Apple's home in Europe. They shift their profits in low tax regimes and they shift
their expenses in high tax regimes. EU argued that Ireland had literally allowed all
Apple's EU earned money to be shifted to Ireland. Apple was ordered to pay taxes
but later on EU failed a loss when there was no finding made that Ireland had
allowed such illegal allowance to Apple [Article sent -
https://www.theguardian.com/technology/2020/sep/25/european-commission-appeal-
against-apple-tax-ruling-ireland]

● Similarly, there was a dispute between Amazon and the IRS : Amazon transferred its
intangible assets to European subsidiaries to avoid tax. This allowed its American
businesses to earn in America but report that income in Luxemburg. Amazon
ultimately prevailed.

● How could we stop this?

One option is - Global minimum tax : Biden had proposed this : make sure that the global
economy thrives to bring equality/growth/innovation and level the playing field. Hinting at the
fact that tax havens are tilting the scale in their favour by encouraging MNCs etc to invest in
them. This hurts both the developing and developed countries whose resources are used but
tax is paid elsewhere. “When the US complains, the world listens” and 130+ countries have
provided support to this idea. This would also be good to avoid MNCs pitting countries
against each other and asking them to reduce tax rates.

His rant:
● In India, we do not have much discussions on tax - matters like
tax are left to CA and tax experts. It is a shame as taxation goes to
the root of society's organisation and hence it should be dealt much widely. When
this is the case with domestic tax, international commercial tax sees literally not
much movement/developments here.
● Few years ago, India had too reduced corporate tax rate to incentivise investments
and fight competition with other countries. Other countries have also faced this issue
and corporate tax rates have just fell globally (which sir thinks is a shame)

India-Cairn award : BIT ke under Cairn energy won the arbitral award. India wanted
to tax capital gains made by Cairn energy but lost its case before PCA. India's
argument was it was a classic case of double non-taxation (i.e., Cairn paid tax
neither in India nor in its home country).

Elements/purposes of taxation
• Refers to The ‘Sinews of the State’ Historical Justifications for Taxes and Tax Law by John
Snape, Chapter 1 (Philosophical Foundations of Tax Law, 2017)

● Different ambitions for tax law are highlighted in history and that the modern
conception of tax law as public law is shown to be both historically contingent and
philosophically contestable.
● Argued that 20th century jurisprudence defined taxation to have 4 constituent
elements. To be a tax, a levy must be:
1. Payable under legal compulsion
2. Exacted under legislative authority
3. Assessed and collected either by government itself or by an institution carrying out
functions of a public nature
4. Intended for a public purpose - cardinal
● Justice Miller in 1874 case of Citizens Savings and Loan Association V/s
Topeka, 20 Wall 655,662,664 (1874) : “The power to tax is, therefore, the strongest, the
most pervading of all the powers of government, reaching directly or indirectly to all classes
of people ........To lay with one hand the power of the government on the property of the
citizen and with the other to bestow it upon the favored individuals, to aid private enterprises
and build up private fortunes, is none the less a robbery because it is done under the form of
law and is called taxation. This is not legislation. It is a decree under legislative forms
.......We have established, we think, beyond cavil that there can be no lawful tax which is not
laid for a public purpose.” [https://caselaw.findlaw.com/us-supreme-court/87/655.html]

● Article 265 of apna constitution says : "Taxes not to be imposed save by authority of
law No tax shall be levied or collected except by authority of law". In the case of
Chota Bhai v. UOI 1962 : Article 265 applicable for levy and tax collection
● Schedule 7 (three lists) also has taxation entries
○ Entry 82, 83, 84, 85, 86, 87, 88, 89, 90, 91, 91A, 91B, 96, 97 - union
○ Entry 46, 51, 53, 54, 56, 60, 61, 62 - state
○ 43, 44, 47 - Concurrent

Main book for this course: Book on International Commercial Taxation by Professor
Peter Harris

Chapter 1 : Fundamentals and Sources of International Tax

 ● Taxes are what we pay for civilised society : At some level, if there were no taxes
there there would be no government. In the words of the American judge Oliver
Wendell Holmes, ‘[t]axes are what we pay for civilized society’. The result is an
economic or financial relationship between community members and their
government.
● Difference between taxes and government levies -
○ a. Usually levies mein you pay these when you use a particular service or
receive a personal benefit whereas taxes are general in nature
○ b. Also levies are usually bracket less whereas tax are disproportionately
taken from different people
○ c. Also, levies are often proportional to the services rendered (though the
government can make certain profits from these but not too much). However
there is still a requirement of the government giving something to you,
whereas there is no such requirement in a tax.
● Suggested reading: The Myth of Ownership for sociological questions around
taxation (fuck it, we just need to pass this goddamn course)

● Different taxes on different stages of wealth

1. Creation of wealth : like income tax
2. Holding of wealth : like wealth tax (now abolished), property tax
3. Transfer of wealth : like stamp duties
4. Consumption of wealth : remember that GST is a tax on consumption, not transfer)

● Building blocks of taxation : payments

○ Harris says that income tax only taxes when wealth comes to you or accrues
or realises to you and not otherwise.
○ Payment includes cash payments but also has other modes : transfer of
asset, reducing liability of a person, creating an asset in another person,
granting an use of an asset or provision of services, adjustment of existing
assets (page 11-12 of Harris)
○ Deductions are also allowed for payments involving incurring of a liability or
transfer of asset.
○ Administration of income tax : All payments (accounted positively or
negatively) need to be dealt with

Four main steps:

1. Identification of payment : identify a payment
2. Allocation of payment : from one person to other person
3. Quantification of payment : converted to local currency etc
Govind Saran v. SD 1985 SC : Four components of tax : Nature of taxable event,
person on whom the levy is imposed, rate of taxation, measure of value on which
rate would be applied to compute tax liability
4. Timing of payment : wealth generation etc happens continuous while timing of payment
is done once a year (when income tax is due)

Form of payment v. Character of payment

1. Character : Why is the payment made? Did you get rent or capital gains or salaries etc?
Why are you paying or being asked to pay tax? As character changes, the rates etc all
change
2. Scheduler system and global system of taxation : Scheduler system mein only incomes
that are categorised positively can be taxed (where you need to show different heads of
incomes etc) whereas global system mein all incomes can be taxed unless specifically
excluded. UK system is scheduler whereas Australian system is global
3. Harris gives example of some Country A and Country B - sir asked to read from book

Sources of int'L taxation law

• Law of nations or public international law basics we need to keep in mind. This primarily
came from Roman Law. There were some thinkers too (read from Sir's handwritten notes)
- he has sent them by email on July 22 - jus gentium, (Latin: “law of nations”), in legal
theory, that law which natural reason establishes for all men, as distinguished from
jus civile, or the civil law peculiar to one state or people.
• Between 15-18th century : there was a compelling need to make a body of international
law as there was a growth of national stages, colonialism/imperialism were spreading around
the world, usage of natural resources, and general industrialism
• Treaty of Westphalia : Many consider this the origin of international law whereas some
consider
• Earlier, states and sovereign were solely and exclusively the subjects of international law
but today even individual are being brought under it

SS Lotus case, PCA judgment, para 44 : International law governs relationship between
independent states. The rule of law binding upon states bind from their own free wills
expressed in conventions and usages generally accepted between these co-independent,
coexisting communities for getting to common aims
• 19-20th century saw many BIT, MIT, permanent bodies, bodies to settle international
disputes, conferences etc rising - global cooperation
• Article 38, ICJ gives the general sources of public international law

History of double tax conventions

● Tax treaties and model convection started to be entered into by states by end of 19th
century to avoid double tax
● First treaty was signed between Prussia and Saxony regarding direct taxes. Similar
treaties were entered into by states that were federally related or closely allied 2.
Then another treaty was signed between Austria and Hungary concerning taxation of
business profits
● Convention signed between Prussia and Austria regarding avoidance of double tax
all were primarily aiming to avoid double taxation
● After WWI, extensive treaty network began proliferating in Europe etc (suggested :
Victor Ukmar (see the spelling) : International taxation mein Chapter 6).
● The League of nation ki fiscal committee started drawing up a model convention on
taxation. This work was later continued by the fiscal committee of OEEC (predecessor of
OECD). The fiscal committee submitted various articles and parts of the treaty and official
commentaries too - OECD model convention.
● This remained a model treaty (rather than a compulsory provision) and was geared
towards interests of a certain type of nations (capital-exporting states that were part
of OECD). OECD wanted some uniformity between its member states and wanted
 them to follow the convention in principle. Later it started asking other states to use
similar conventions
● Important: : A tax treaty between Capital exporting state and capital importing state
creates distortion. A treaty creates bilateral obligations and brings in some parity. But
in this situation, in practise, the treaty might end up being titled towards one side (like
India-Mauritius treaty)
● 1963 OECD Model Convention : there was a pushback to it from non-OECD
countries. In answer, the economic and social council came up with its own UN
model (which was centred around the OECD models but deviates majorly from it -
which we will see throughout the course)
● But unlike in past, modern taxation bilateral treaties have more purposes that just
avoiding double tax : they are also there to avoid fiscal evasions + elimination of
discrimination clauses

● OECD Model treaty 2017

Preamble : read
Compare this to UN Model convention 2017
Both mention that they want to avoid fiscal evasions (read BEPS report 2013-2015)

Functions of tax treaties

• There are two broad functions of tax treaties
1. Allocates fiscal jurisdiction
2. Becomes the tax law of each contracting state

• Monism v. Dualism [He has great slides for this sent on July 24th]

Monist theory prioritizes the desirability of a formal international legal order to establish the
rule of law among nations, while dualist theory prioritizes the notions of individual self-
determination and sovereignty at the state level. What is India then?

Court says that India is following dualism but in reality we deviate from this standard - see
the readings sir sent on this issue.

We realise that courts themselves end up interpreting and ruling on certain international
issues in line with international conventions and these end up being enforceable (even when
they were not made so formally)

Monism v. Dualism : What is the Indian stance?

Consider these Articles

a. Article 73 :
b. Article 51(c) :
c. Article 245 (1) :
d. Article 253

1. Jolly George Varghese v. The Bank of Cochin (1980) : "until the municipal law is
changed to accommodate the Covenant what binds the court is the former, not the latter.
A. H. Robertson in "Human Rights-in National and International Law" rightly points that
international conventional law must go through the process of transformation into the
municipal
law before the international treaty can become an internal law. From the national point of
view
the national rules alone count.. With regard to interpretation, however, it is a principle
generally
recognised in national legal system that, in the event of doubt, the national rule is to be
interpreted in accordance with the State's international obligations. "

2. MV Elizabeth v. Harwan Investment & Trading Private Limited (1993) : "India has
also not adopted the International Convention relating to the Arrest of Sea-going
Ships, Brussels, 1952. Nor has India adopted the Brussels Conventions of 1952 on
civil and penal jurisdiction in matters of collision; nor the Brussels Conventions of
1926 and 1967 relating to maritime liens and mortgages. India seems to be lagging
behind many other countries in ratifying and adopting the beneficial provisions of
various conventions intended to facilitate international trade. Although these
conventions have not been adopted by legislation, the principles incorporated in the
conventions are themselves derived from the common law of nations as embodying
the felt necessities of international trade and are as such part of the common law of
India and applicable for the enforcement of maritime claims against foreign ships."
3. Vellore Citizens Welfare Forum v. Union of India (1996) : "the rule of Customary
International Law which are not contrary to the municipal law shall be deemed to
have been incorporated in the domestic law and shall be followed by the Courts of
Law."
4. Vishakha v. State of Rajasthan (1997) : "In the absence of domestic law occupying
the field, to formulate effective measures to check the evil of sexual harassment of
working women at all work places, the contents of International Conventions and
norms are significant for the purpose of interpretation of the guarantee of gender
equality, right to work with human dignity in Articles 14, 15 19(1)(g) and 21 of the
Constitution and the safeguards against sexual harassment implicit therein. Any
International Convention not inconsistent with the fundamental rights and in harmony
with its spirit must be read into these provisions to enlarge the meaning and content
thereof, to promote the object of the constitutional guarantee."
5. Entertainment Network Ltd. V. Super Cassette Industries (2008) : "In interpreting the
domestic/municipal laws, this Court has extensively made use of International law inter alia
for
the following purposes:
(i) As a means of interpretation;
(ii) Justification or fortification of a stance taken;
(iii) To fulfill spirit of international obligation which India has
entered into, when they are not in conflict with the existing domestic law; (iv) To reflect
international changes and reflect the wider civilization;
(v) To provide a relief contained in a covenant, but not in a national law; (vi) To fill gaps in
law."
6. Union of India v. Azadi Bachao Andolan, 2003 : Here the SC made distinctions
between two types of treaties - one requiring legislation and one not requiring
legislation (see para 18) - "When it comes to fiscal treaties dealing with double
 taxation avoidance, different countries have varying procedures. In the United States
such a treaty becomes a part of municipal law upon ratification by the Senate. In the
United Kingdom such a treaty would have to be endorsed by an order made by the
Queen in Council." (para 19) Added : "The principles adopted in interpretation of
treaties are not the same as those in interpretation of statutory legislation...An
important principle which needs to be kept in mind in the interpretation of the
provisions of an international treaty, including one for double taxation relief, is that
treaties are negotiated and entered into at a political level and have several
considerations as their bases."
Held that : treaties cannot levy tax but can give relief (cap taxing liability or reduce
liability)
a. Read the Madras HC ruling of T. Rajkumar and how it found contradictions
between Para 18 and 19
b. Professor Victor had also stated in similar line : "Tax treaties establish boundaries of
double taxation. They neither generate tax claim that does not otherwise exist under
domestic law nor expand the scope or alter the type of an existing claim"

8. State of West Bengal v. Kesoram 2004 : "A treaty entered into by India cannot become
law of the land and it cannot be implemented unless Parliament passes a law as required
under
Article 253"
9. T Rajkumar v. UOI (Madras HC) : "the Parliament empowered the Central Government
under Sub-Section (1) to enter into an agreement and simultaneously it conferred a benefit
upon the assessee under Sub-Section (2). This Section 90 did not say either expressly or by
necessary implication, that the law made by Parliament would stand eclipsed or excluded,
to the extent it is inconsistent with the terms of the Agreement. (DTAA)...No question
arose directly either in Azadi Bachao Andolan or in Kulandagan Chettiar as to whether or
not the Parliament has the power to make a law in respect of a matter covered by a Treaty.
Therefore, the observations found in these two decisions, to the effect that the provisions of
the Treaty will have effect even if they are in conflict with the provisions of the statute,
cannot be stretched too far to conclude that the Parliament does not have the power to
make a law in respect of a matter covered by a Treaty. "
a. Hence, parliament could override a treaty by passing a legislation

So where do tax treaties and BITs fall? -

They do not require legislation. But for arguendo, argue that these affect your fundamental
rights and argue how these might be required to be incorporated using legislation.

He suggest to Read Prabhash Ranjan's article on Wire : Critiqued the SC ruling : Is the
Supreme Court - Confused About the Application of International Law?

Juridical double taxation v. Economic double taxation

1. All treaties try to avoid juridical double taxation
2. Economic double taxation might still happen : So for example, if Starbucks India makes
profits and declares dividends and pays tax on this. Starbucks America (which is holding
company) would still have to pay withholding tax (a tax deducted at source, especially one
levied by some countries on interest or dividends paid to a person resident outside that
country)
25/7
○ Notes he prepared for this class:
https://groups.google.com/g/nalsar2022a/c/RePKeP5SqYg/m/nm9wJidbAQA
J
○ Interpretation of tax codes.
■ They are always a result of compromise.
■ They are constantly adjusted to deal with political pushback.
■ The current battlefield for tax laws is the taxation of digital
companies/economy.
■ Madras HC judgement yesterday- pointed out there were
inconsistencies in reasoning in the Azadi Bachao judgement.
○ Starting today's class by spending longer on this debate.
■ Pushback against India- whether enacting new provisions in the IT act
is treaty overriding.
■ Eg- equalising levy is being challenged as a treaty override.
○ Treaty override and underride
■ This is in Harris Ch1
■ Monist country cannot underride.
■ Override- when a country adopts a treaty then passes a law that is
contradictory to this.
■ T Rajkumar case- new IT provision to close a tax avoidance
problem.
■ There have been high profile examples of override in
the US.
■ Dualist countries can override whenever. Parliament is
sovereign.
■ Domestic laws can alter the situation whenever, because the
treaty only gains power through domestic law in the first place.
■ Article on equalisation levy- instance of treaty override. (will
share link)
■ Another article on this as well

■
■ Some terms that will be relevant
■ Fiscal residence
■ PEs- Permanent establishments. Basically
branches.
○ Azadi Bachao Andolan case (SC Decision)
■ Tax liability arising from connecting factors
 ■
■ Examples of connecting factors
■ Source location
■ Residence of entity
■ Maintenance of permanent establishment.
■ Due to these, same income can be taxed in multiple countries
because of different tests
■ This is juridical double taxation.
■ Example of economic double tax- again he's talking
about withholding tax.

■
●

○
■ A question to think about- do DTAA affect rights of citizens.

○
 ■ Cites 4 HC cases to say that S90 specifically intends to enable and
empower the Central Govt. to issue a notification for the provisions of
a DTAA. This notification can specifically override even the IT act.
■ If this wasn't the aim- then wouldn't need to implement this.
■ Our constitution makes no provision saying that you need legislation
to make a treaty enforceable.
■ Executive power of union is enough. (Art 73).
■ Is reiterating his academic question on whether treaties restrict
the rights of citizens.
■ S90 of IT act- it was enacted because it the normal course of things it
would take too long to make legislation to implement treaties.
■ What would happen if there was a clash b/w the IT act notifications
under S90 and the act- no longer res integra (is reading from his
notes)

■
■ The notification will prevail basically- aka the treaty will prevail
over the domestic tax code.

■
■ The arguments of the Resp

■
■ Both rejected by the SC
■ Why should a delegatee grant exemptions? Many other
statutes have powers to exempt from provisions of the
statute.
○ Then there was something on stare decisis (he didn't delve into it)
○ SC rejected claims of excessive delegation as well.
■ Not possible for court to sit in judgement of the policy and say it
doesn't work.
○ The power under S90 is not for a purpose ultra vires the powers of the central
govt under S90.
○ Now comparing w/ Mad HC Rajkumar
■ Case dealt with S94A- circular way of denying the benefits of a tax
treaty.
■ Here the benefits of the India-Cyprus treaty were being denied.
■ Was claimed to be an anti-avoidance measure.
■ The challenge was on constitutional grounds because it was a
DTAA
■ The claim is that it is virtually a law under A253 under
the consti and they can't take steps to nullify it.
■ Also excessive delegation
■ Indian authorities complained that they weren't being given
information under the exchange of info provision
■ This provision is in all treaties. It is A26 of the OECD
model
■ Thus, was notified as a jurisdictional area under S94A.
■ Mad HC looked at Andolan case-
■ There are effectively two types of treaties- those that need
legislation to be implemented and those that do not.
■ Here, tax treaties that do not affect rights do not need to be
accompanied by an act.
■ Looked at S90- there were some stages
■

■ Ss ii gives benefit to assessee- gives benefit of IT act

where the act is better for him.
■ So basically you get to apply the treaty or the IT
act, whichever is more beneficial.
■ Ss 1 was an enabling provision.
■ S90 did not say that there would be an eclipsing of any law
that is contradictory to a tax treaty.
■ This would compromise the entire principle of
legislative supremacy. It would allow the executive to
override legislative by signing a treaty
■ If anything- Cyprus has been failing to follow the treaty by not
disclosing info.
■ Does this violation allow treaty override/and is there a need for
such a failure by the other party to justify a treaty override- no
real answer.
■ The last two cases didn't actually deal with questions of treaty
override. So you can't rely on those cases to make this
determination.
 ■ SC dismissed the appeal of assessee by saying it didn't opine on
merits.
○ Treaty underride- occurs when a tax treaty is never given full effect in the
domestic law (only possible in dualist)

○ A2 of the OECD model- taxes covered.

■ Very often states do not use this provision of the model convention
■ Looking at India-HK tax treaty- they list taxes that apply
specifically.
■ All political subdivisions are covered.
■ For unlisted taxes- the states need to determine whether it is in
substance an income tax or not.
■ Question- social security levies- are they in substance IT-
(from Harris)- OECD believes not.
■ Direct connection between levy and individual benefits
received.
■ The looser the connection the more likely levies are to
be income tax.
○ Can treaties create or increase a tax
■ Can never create a charge for tax, or increase a rate. These always
have to come from the domestic tax code.
■ Nature of tax treaties- means a taxpayer is entitled to the lower of the
rates in domestic law and tax treaty.
■ You can't cherry-pick though- need to commit to one code and
can't mix and match benefits.
○ The Peter Harris book is the only mandatory thing in the course.
■ Lenient in assessment. Woot
○ Treaty interpretation
■ Harris- interpretation of a tax treaty is a domestic court issue.
■ Basically need to sue in the country where you have the issue.
Can't invoke international arb also normally (treaty can have
this provision eg BIT)
■ Treaty interpretation is kinda like statutory interpretation
■ Anson case in the UK-
■ Lord Reid used the VCLT for interpretation. (A31, 32)
■ A31- Interpretation requires looking at common
intention of both parties- plain meaning of words read in
context along with object and purpose of a treaty.
■ Text, context, object, purpose
■ Subsequent agreement and practice + relevant
rules of Ilaw
■ Aus case- McDermott
■ Text to be given primacy- words to be considered
authentic meaning of party intent.
■ Agreements should be interpreted liberally because
they lack the rigour of domestic legislation.
■ Is now on VCLT- reading art 31
 ■ Context- preamble, annexures and anything made in
conjunction with the treaty
■ Is now reading A32
■ Video by a Singapore judge that explains treaty
interpretation wrt A32.
■ It is supplementary rules of interpretation
■ Used when there is a conflict in the rules.

■ Treaty definitions in Art 3 OECD-

■ Para 1 & 2 makes it two limbs.
■ Read Harris.
■ Context otherwise requires- this is a phrase that is technical
■ This is distinct from the VCLT use
■ It is much broader here.
■ Para 1 defines terms for the whole of the treaty
■ Para 2 is residual interpretation rule- basically use domestic
law rules.
■ Equivalent domestic law concept- so not an exact
match domestically, just that the concept is similar
enough.
■ All model conventions have commentaries with them.
■ Legal status of the commentaries to these are not properly
fixed.
■ They've been suggested to be supplementary, plain meaning
and stuff.
■ OECD does not intend that the concept has a limited role. The
commentary is important (so not A31 VCLT).
■ Victor Upmar- OECD model and commentary should
be a primary part of the context as under A31.
■ Para 35 of the introduction- commentaries are an aid to
interpretation- subsequent additions to commentary shouldn't
override text of existing convention.
■ Indian courts use VCLT in a muddled way
■ Prabhash Ranjan article in the Wire
○ BEPS MLI
■ Practice of eroding the fiscal base of the source country
■ The country where value is added is not the country that can
tax- so the tax base is curtailed in favour of a different country
■ Action 15 of BEPS project-
■ Tax treaties are very rigid- the assessees said the treaties
shouldn't be gone back from.
■ BEPS was thus faced with a challenge- it'd be impossible to
implement amendments to each of the 3k tax treaties. Rather,
the approach they chose was to have an amendment through
a multilateral treaty- called MLI.
■ So you interpret all the tax treaties with the MLI.
■ This is very complex, but still better than amending
each treaty.
 ■ MLI now has 90 countries
■ It deals with things like hybrid mismatch, dispute resolution and
stuff.
■ Some provisions are minimum standards (treaty abuse and
disputes)
■ Options to derogate are limited.
■ Some other are optional and you can opt out of them.
■ If there's a bilateral treaty where one party opts out and
one hasn't- then the provision doesn't apply
■ So both countries need to opt in for an MLI provision to
apply.

31st July 2021

- There is a dual function of tax treaties:-
o Tax treaties become a part of domestic law some way or the other aka in
monist and dualist
o The allocation of tax jurisdiction

Allocation of Tax Jurisdiction

- Jurisdiction to tax
o What does one understand by tax jurisdiction?
o Will first understand the existence of a country's right to tax and then the
extent of the country’s right to tax.

- Can India decide to tax all Australians living in Australia? While this may sound
ludicrous, in the international tax regime, there are instances where foreigners
 are taxed. But this requires an economic nexus which is a connecting
factor.

Doctrine of State Sovereignty

● Doctrine of State Sovereignty is also a part of international law of tax and provides
the conceptual underpinning within which state exercises their taxing power over
cross border economic activities.
 - Economic Allegiance - Connecting Factors
When we started the course, we discussed the very rationale of taxation and the
difference between taxation in gen and levies. How levies are different in nature
from taxes because taxes go towards the general governance function running
electricity, constructing roads, maintaining military, armed forces, police etc.
which are an entire gamut of state functions. Levies whereas are for a specific
function and has a cost plus rationale to it. This is economic allegiance in a
domestic context.
- In an international context, one can ask what is the economic allegiance?
- Example- What is the economic allegiance btw India and IPL players? What is the
Australian players who come to India and play in the IPL for 1.5 months etc. – Is
there a nexus between an Australian cricket player and India? Yes there is an
economic allegiance.
- But an Australian who plays in Dubai for IPL where it has been shifted to, will
there still be an economic allegiance? One will need to look at the entity paying
them. If it is an Indian entity paying then could establish economic allegiance?
(Doesn’t answer this)
- International law requires some connecting factor to tax and now we
understand that there has to be a nexus between the state and the pertinent
income as a taxable object.
- In legal terminology, what is a country’s right to tax is a matter of public
international law. Any study of international taxation requires familiarity with
domestic tax laws and international tax laws. International tax laws here would
mean international tax treaties and customary international law.
- There is no international tax system and bodies such as WTO etc for trade. Each
country has their own system of double taxation treaties which together comprise
the international tax law.
- So, the question is, who should contribute to the treasury?
 - In fiscal terms there is no more fundamental question that this which is whether at
all and under what circumstances where a nation may require a person to
contribute.

Andre Agassi Tax dispute

- Andre Agassi was a famous American tennis player. There was a tax dispute
between Andre and the UK Inland Revenue. He was not a resident of the UK nor
was he domiciled but just used to come and play for matches like Wimbledon etc.
He had an American company whose business included entering into contracts
with sports manufacturers like clothing equipment etc. There were two contracts
 relevant to this case. One was with Nike dated 1st Jan 1995 and the other was
Head sport (Norwegian company). Agassi was not a UK tax resident or domicile
and payments for these contracts were also made by these non UK companies ot
Agassis company. But still UK Inland Revenue believed there was a nexus that
allowed them to tax on this income that Agassi got from these two contracts from
Nike and Head Sport. They served him a notice of 28000 pounds.
- Dispute was over tax charged on earnings from product endorsement while he
was in Britain for a short while. Lower Court Judge found in favour of UK Inland
Revenue. The Court of Appeal overruled this. House of Lords then finally ruled in
favour of the UK Inland Revenue.
- Primary question was whether the UK had the right to tax and if it had jurisdiction
to tax under its domestic law and if there was a nexus between the economic
activity and the UK as a State.
- Rationale behind such a ruling- it was the interpretation of a UK law. He says no
point in going into the specifics of the UK statute. Just need to know that it was
because of the intent behind which the legislation was incorporated that was the
determining factor here. – required economic allegiance which was met.

- Difference between personal tax and in rem tax was discussed the prev week.
- Personal tax requires some connection between the person and the taxing
jurisdiction whereas in rem tax the connection must be between the activity and
the taxing jurisdiction.
- In the Dubai IPL example above, the Indian authorities could still tax the players
as the entity paying was in India and so there is some nexus. He says not going
into the exact aspect of whether it will be taxed or not because that requires
interpretation of the domestic law as well the treaties that exist between the
countries at this point.

- Who is a person?
- What sort of connection suffices for this purpose? Prof Harris discusses there are
numerous connecting factors that could be present based on the person:
o Nationality – there are some jurisdictions that tax only based on nationality
(Formal connection)
o Domicile
o Presence
o Residence (Substantial)
- Will be discussing residence as there is consensus that residence is the most
compelling connecting factor when it comes to taxing jurisdiction. This is
because not as fleeting as Presence as one could travel a lot but that does not
mean each of these places could tax me. Even citizenship would not be
completely reliable as eg- Indians who work in the UK etc. This does not mean
India should be allowed to tax these people.
- Prof Harris also talks about the approach in UK, USK, Mexico etc which one can
read if they want.
- Article 1(1) of OECD is very imp.
- This shows that there is a two step test:
o There is a person
o And the person is a resident of one or both of the contracting states.
Eg- If there is a treaty between India and Mauritius, then the person
must be a resident of India or Mauritius or even both.
“A person may be a natural person (an individual) or a nonnatural entity
granted legal personality (an artificial person or corporation) ”

- On the question of who a person is, in case it is a natural person then it is clear.
But when it is an non- natural entity then it requires some investigation.
- Diff countries have diff positions. Diff tax codes can be looked at and understood.
Different countries have different positions wrt companies, partnerships, clubs,
trusts etc. (For this course however, remember it is the domestic tax law that is
relevant)
- Investigation is on the lines of whether these entities have separate personalities
for general law purposes and whether it is recognized for tax purposes. If
investigation reveals that an entity is transparent, there is a Look through
Doctrine.
- Look though Doctrine is extremely important as tax officers look through the veil
of the entity. If an entity decides to be transparent then there is a look through
doctrine- piercing the veil- who is the person behind the entity? Sometimes they
call it beneficial owners (will be looked at later time in course). They see who is
behind the entity and charge that person or set of persons.
- Domestic characterization of entities is very imp and there are a plethora of cases
but not part of this course. Lot of UK domestic law examples in book.
- Entities organized under foreign is very critical when it comes to determination or
administration of tax treaties. Again, this investigation will be done under
 domestic law. Whether an entity is a corporation, body corporate or transparent
entity.

- These are three approaches that different countries take.

I. Look at the characteristics of the foreign entity- if it was a domestic entity
how would it be treated
II. Rely on foreign commercial law. If it is US entity- how is it treated there
III. Give the taxpayer a choice - whether it wants to be seen as a transparent
entity or a separate taxpayer. The taxpayer decides whether it wants to be
treated as a transparent entity or as a person (approach adopted by the US-
Check the box regime).
- Classification of entities is done under domestic law and there could always
be a mismatch , i.e. If there is DTAA between country A and B, where A treats
it as a separate entity and B treats it as a transparent one- there will be a
mismatch. Many international tax planners deliberately take advantage of this.
- One of the projects of BEPS is specifically dealing with this hybrid entity. Tax
planner is always looking at double non taxation.- Lot of discussion on it and
suggestions at an international level even in regard with MLI as discussed in
last class.
- There is a lot of planning around hybrid entities where are treated as
transparent in one country and not in another.

- Article 3(1) – 3(1) defines persons- individual, company or any other body of
persons. Body corporate is not defined- must resort to 3(2). Purpose of the first
limb is not clear. Both are subject to “unless the context otherwise requires”. We
saw how the term context here has a wider meaning as compared to Article 31 of
VCLT.
- Article 3(2) takes you back to domestic law as it says that any term not defined in
Art 3 would have to be referred back to domestic law. While company and person
is defined, body corporate is not defined. Art 3(2) then says look these up in the
domestic law. So each country applying this treaty would interpret that differently.
- Prof Harris is slightly critical here as this could result in a body corporate e.g. a
partnership that is not a tax subject of both countries still being a potential subject
of a tax treaty due to this differing interpretation of the term. This is an issue also
because it is unlikely that the domestic law would also define it. So, then this
requires one to refer to general law. Example of US, Australia, UK also given and
says the purpose not given and could result in absurd results as people who
should not even come within the purview could be made liable due to differing
understanding in general law of diff countries.
- Harris says don’t read Art 3(2) very literally as tax laws do not treat entities as a
corporation rather it should mean an entity treated in the same way for tax
purposes treated as a corporation. Aka if a person for tax purpose is a
corporation, then even for purpose of treaty should be a corporation.
- Better to see this as a case of non-applicability of tax law.
- Coming back to residence as a connecting factor.
Read “Residence as a connecting factor” from Page 57 of the book under Chapter
Jurisdiction to Tax if poss.
- Why can a country still have the right to tax a non-resident? On the basis of
source jurisdiction.
- Tax residents concept is different from ordinary concept of residence or
sometimes physical concept of residence.

- Now we talk about the extent of jurisdiction . Existence of jurisdiction is

established from Nexus aka connecting factor. When looking at extent of
jurisdiction , then the two principles to be looked are residence and source. There
is no other way one can tax any person.
This is there in the introduction of Prof Harris book. Will keep referring.
- Beth in this is a resident of Country B and Allan is resident of Country A. Beth
owns office in Country A but lives in B. Allan rents office in Country A that is
owned by resident of Country B. Allan pays rent to Beth. Country A is source
country and Country B is resident country. The application and interaction system
of tax system of two countries is the key to administration of international
taxation.
- Has many components that needs to be looked at such as who is the beneficial
owner, source etc.
- Reminds that Art 3 is very imp and that must be constantly referred to.
International tax laws not meant to clear but compromise between diff
jurisdictions.

Residence
- Article 4 must be referred to. Imp.
- Two kinds of persons here as well- Natural and Jural.
- Prof Harris says that once tax subject is identified, the next issue is if the person
has appropriate degree of economic allegiance to justify taxation and the focus is
on the customary form of allegiance. Which in this case is residence.
- Tax treaties respect this classification with some qualifications.
- Income tax imposed yearly, then there is further question that in that particular
year what was the residential status for that person. EG- one could be an NRI for
one year and resident for other.
- Domestic law- different countries adopt different tests for determining whether a
person is a resident. It would depend on the type of resident. Why? Companies
are not as mobile nor do they have the same type of emotional social
connections that an individual will have.
- Several factors – dwelling, income producing activities, familial connections,
domicile, visa status, prolonged physical presence. The 183 day test to determine
if an individual is a resident is used by many countries.
- If one looks at the Indian Tax law, there are 3 time periods. Look up the bare act if
you want but not imp. Point is these are artificial tests- you’re trying to reach
some kind of justification that whether that person owes it to fund that state's
treasury.
- Determining the residence of an entity can be a complex matter beyond the cross
border as well.
- Judicially devised tests to tax artificial entities – first in UK.
- There are two approaches to determine residents for tax purposes of artificial
entities:
o Legal Approach- is basically the place where the company is incorporated
or registered. If people followed only this then many countries would lose
out on revenue.
o Economic Approach- requires more investigation and factors to be taken
into consideration. Factors taken into consideration are:
§ Place of management
§ Where is its principle business location
§ Tax residency of shareowners
The first two factors are what is given more importance and looked into.
- The test developed in UK law is the CMC test- Central Management and Control.
- led to development of the “Place of effective management test”
- Calcutta Jute mills v Nicholsan, 1876 –
oUK company was running a jute mill in India (a colony)
oIndia didn’t charge tax to British firms operating in India- but if company was
found to be tax resident in UK, its Indian income would become taxable in
UK according to the residence principle
oCase imp from the perspective of the UK. Whether Indian income was
taxable in the UK? It wanted Double non taxation
oCompany had a director in India who apparently exercised control of the
company but BOD held meetings in London. From that office all orders
were issued to the Managing Director in Calcutta. All his powers were just
delegated powers from head office.
o This case it was held that the CMC rested with the BOD sitting in London
and thus was tax resident of the UK- it was an interpretation of UK
Domestic tax laws.
- De Beer Consolidated case- 1905
o Mining company which was world's major diamond miner. Registered in
South Africa. Directors Meetings were held in both SA as well as UK.
Under company’s Constitution mandated that 4 directors should be
resident in UK
o Facts- 11 directors were resident in the UK, two were itinerant in London
and South Africa. Four directors plus chairmen were resident in SA.
Others had a home in both countries.
o Director’s meetings held in London were attended by more directors than
those held in SA.
o Courts examined not just frequency of meetings but also the nature of the
decisions being taken in these meetings but also the nature of decisions
in meetings. There were operational decisions taken in SA and
substantive decisions in the UK.
o The residence of the company would be determined by looking at the
relative strategic importance of the company of the decisions taken in
each place. The decisions taken in regard with raising of capital,
functions, operations, all finance etc were all taken in London. The
decision on trade and finance was taken in London.
o Only operational decisions such as the mining was taken in SA whereas
everything else in London.
o Additionally, SA directors were accountable to London directors and not
other way around.
o “The directors meeting in London were the meetings where the real control
was exercised, practically all-important businesses of the company except
the mining operations. London has always controlled the negotiation of
contracts, has determined policy in the disposal of diamonds, the working
and development of mines and the appointment of directors”
o Again South Africa was a colony, they ignored the fact that mining was
done in South Africa
 o It was held to be resident of the UK.
- All colonies like Africa and India had no court to defend. Even though all these
activities such as jute mill in Calcutta and mining in Africa, they still had to pay
taxes to UK.

01 August 2021

Jurisdiction to Tax -- Recap

● Why does a state tax and why does any person or entity owe a duty to fund the govt.
○ Doctrine of economic allegiance - both domestic and intl. [Sovereign right to tax;
intl. community benefitting from taxing intl. trade, cross-border dealings etc. since
individuals derive benefits from more than one state]
● Existence of a country's right to tax v. extent of a country's right to tax
○ Can a country tax foreigners living abroad?
■ Monty Python flying circus 1969- "to boost the British economy, I'd tax all
foreigners living abroad"
○ Economic allegiance - requires some nexus between a state and the entity that the
state wants to tax
○ Andre Agassi Tax Dispute
■ Just because he was playing tennis tournaments in the UK, the UK slapped
tax notices on him and won the case in the House of Lords
● Composite Tax Principle - tax individuals who owe economic allegiance to you and also tax
commercial activities related to your country
● Personal tax - nationality, mere presence, domicile, etc. But residence is the most accepted
justification for imposing tax.
● What does person mean in the context of intl. taxation? - i.e. who does it apply to
○ Art. 1(1) OECD - persons who are residents who are one or both of the contracting
states.
■ Accepts the possibility that a person can be a dual resident
■ Can be a natural person or a non-natural entity granted legal personality
● Characterisation of entities organised under foreign law
○ Domestic entities have to be characterised under domestic tax law.
○ An entity under general law may not be classified as an entity for domestic tax law
and vice versa - so may be confusing
● 3 possible approaches to characterising:
○ Classify foreign entities according to their closest domestic equivalent
■ Basically to see what bracket the entity would have fallen under if it were a
domestic entity
○ Rely on foreign commercial law or foreign tax law classification
○ Give the taxpayer a choice of separate taxpayer or transparent
 ■ Can lead to tax avoidance if the entity is seen as transparent in one country
and not the other.

OECD Model definition of person

● Art. 2 - about taxes covered under the treaty
● Art. 3 - very important, two limbs
○ Art. 3(1) - defines person
■ Individual
■ Company - any body corporate or any other entity that is treated as a body
corporate for tax purposes
■ So, depends on the domestic law of the state applying the treaty
■ Art. 3(2) requires reference back to the law of the state applying the
treaty, unless the term is defined in the treaty or the context
otherwise requires.
■ Body of persons
● So, includes any individual, company, or body of persons
● Body corporate is not defined in the OECD, have to resort to Art. 3(2).
○ The purpose of the first limb of the OECD definition of company [copy the rest from
slide]

Why person does a country have the right to tax

● Tax residency is not the same thing as ordinary or physical residency

Determination of a country's tax jurisdiction

● 2 principles: residence, and source
 ● Here, beth is having rental income from country A [source country] while living in country B
● There is scheduler approach and global approach
○ Global - lumps all the income together
○ Scheduler - deals with different kinds of income differently - royalties, dividends etc.

● Companies - artificial entities. So, how do you define residency of a company?

○ Two approaches:
■ Legal approach - formal approach
■ Where it was incorporated or registered
■ Economic approach - purposive approach
■ Place of management
■ Place of business
■ Tax residence of shareholders
■ Usually, this is not very commonly used. It is generally a
combination of place of management and business.

Evolution of Central Control and Management Test

● Calcutta Jute Mills
 ○ Facts: Indian director who was essentially only a mouthpiece of what is being
decided in London.
○ Held: Was decided that the UK could tax them. The Indian director was held to just
be a delegatee. Company incorporated in India was held to be a tax resident of UK.
■ Not a case of dual residency. Just whether or not an Indian incorporated
company could be held to be a tax resident of the UK
● De Beers - gold standard of the CMT Test
○ Facts: Constitution mandated 4 directors in UK, but there were 11 in UK and 2-3 in
SA.
○ Issue: Whether it was a tax resident of the UK
○ Held: Everything substantial was happening in South Africa, place of business and
day-to-day operations also in South africa. But financial decisions like raising of
capital, decisions on marketing strategy were taken in the decisions taken in London.
So, directors meeting in London was where the real decisions were happening
[except wrt mining which was in South Africa].
○ Was there purely legal decision-making here or was there an element of
imperialism?
● CMC is a one-state test. It is a domestic test.
○ It is not to decide where residence is situation, but whether or not it is situated in
the UK - not a tie-breaker
○ There is nothing impossible in finding CMC in two countries - but just have to see
whether it is also in the UK
○ CMC test forms the basis of the intl. standard of the place of effective management
test
■ POEM is a two-state test - trying to see where residence is situated, and
that state will tax
● New Zealand Shipping Co. case
○ Facts: Co. had two boards of directors, one in the UK and one in NZ.
○ Held: Resident of UK because the NZ board was subject to the powers of the UK
board
■ Sole duty of acquiring ships which was the main financial expenditure was
done in the UK - so, again financial aspect bolstered the fact that it was UK
resident
● Unit Construction Co. case
○ Facts: UK parent had SA subsidiary.
○ The board of the subsidiary must be seen to be independent of the board of the
parent
○ All the subsidiaries in Kenya held to also be UK tax residents.
● Wood v. Holden - v. important
○ Relates to tax havens like the virgin islands
○ Facts: taxpayers were shareholders who wanted to avoid capital gains liabilities, and
entered into schemes of transferring shares to Netherlands company through virgin
islands, the eventual transfer could not be traced (?) back to the shareholders.
Documents signed by Netherlands directors who seemed to have been formally
 consulted. So, they were not rubber-stamping decisions taken by the parent
company.
○ Held: the fact that they acted on this plan involving several countries did not affect
their residency. They do not fail to be residents of their own jurisdiction

● The court made a thin distinction between dictating and advising - difference between
proposing and usurping - between influencing and controlling
● Held: That though the Netherlands directors were only seeking advice, it was not clear that
they clearly followed the advice given by the UK taxpayers or accountants. So, they could not
say that either of the UK parties had exercised CMC
○ Smallwood v. custom commissioner - did he say thing about this except upholding
distinction? (discussed in detail in later class)
● Bywater case
○ Facts: BoD abrogates its decision-making to outsiders. Meetings were held in
Switzerland but merely followed the decisions by a tax person in Sydney [so,
dictating].
■ In the prev., there was no abrogation. Here, abrogation, only noting the
decisions by the outsiders
○ Held: Australian national himself decided every purchase and sale of shares, about
transactions and the course of the business generally. No occasion for the directors
to use any measure of judgement
 ● American Thread Co.
○ Held: issue of raising finance for purchasing cotton. Financing decisions made in UK,
American directors only expected to implement the policy at the shareholders
meeting. So, purse strings in Manchester, could control all policy from there. So co.
was held to be UK tax resident.
● So, summary of important CMC factors:
○ meetings of governing bodies seen,
○ where the decisions to carry out operations from [eg. Financing decisions, where
market strategy is formulated, BoD in Kenya on important business matters etc.];
○ where the fundamental policies are implemented and adopted v. where they are
carried out;
○ who exercises power in true form and
○ whether it has been usurped or abdicated in favour of an outsider

Residence under OECD Model law: Art. 4

 ● Resident of a contracting state - "laws of that state" - domestic law
● Liable to tax - meaning?
○ Difference between liable to tax and subject to tax?
■ Subject to tax - used in the context of chargeability to tax on specific income
■ Requires actual payment - charge on income
■ Liable to tax - conceptual thing to ensure that a person falls within the scope
of a state's taxation even though they may fall under some exemption
■ So, does not require actual payment to tax
■ It is just to see who all can be taxed. Exemptions can change etc., so
just because you are not subject to tax does not mean you are not
liable to tax.
○ OECD - said some entities are nevertheless liable to tax and subject to treaty
benefits etc.
○ Aazadi bachao andolan case - liable to tax argued by Harish salve

Tie-breaker rules
● Arts. 4(2) and 4(3)
● This is the two-state test, not just one state CMC test
○ Whether an individual/ entity is a resident of state A or B, not just whether or not it
is a resident of state X.

● Art. 4(2) - series of progressive / cascading tests

○ All the conditions must be fulfilled for the residency to be decided. Otherwise,
authorities from both states will decide.
 ● So, only if from Art. 4(1), the person has been found to be a resident of two states.
○ Then you apply Art. 4(3)

● Until 2017 - POEM was purely the tie-breaker

○ But problem - it was being abused because it was easy to change place of effective
management to a place where tax is less/ not imposed on certain kinds of income
etc.
● Amendment in 2017 - introduction of provision that leaves it to competent authorities by
mutual agreement.
○ But it also mentions having regard to POEM, place of incorporation, and other
relevant factors. So, authorities to have regard to all these.
● But many treaties still have POEM as tie-breaker

Place of Effective Management

 ● POEM has regard to the substance of where responsibility lies for actual day-today
operations
○ CMC - more disregard for day-to-day operations, more emphasis on financial
decisions etc.

● CMC purpose - end-result could be dual residence

● PEM - if dual residence, then to see whether tax resident of state A or B.
○ For DTA treaties, cannot be resident of more than 1
● OECD Commentary on Art. 4 [para 24]
○ POEM is "the place where the key management and commercial decisions that are
necessary for the conduct of the entity's business as a whole are in substance made"

7th August 2021

Jurisdiction to Tax (continuation)
· Sir recapping previous classes.
· Article 3 & 4 have been discussed in the previous class – Extremely important
· Tie breaker test for individuals and companies to decide which country should tax
them when a person/ company is considered as tax resident under the domestic
laws of both countries. – tie breaker test for individuals discussed in last class
and was pretty straight forward.
In this class will deal with tie-breaker for the companies.
· Always remember that you apply the tie breaker when under the domestic law of
two states, the entity is considered as a tax resident i.e. dual resident
· In the last class we also looked at the historical test of the Central Management
and Control and went through several case laws which dealt with it.
o Central Management and Control test is a single state test – it is not a tie
breaker test
· Place of effective management test, although is still considered while deciding on
the tie breaker, it is not the sole determining factor. The same can also be
observed through the fact that the words “having regards” Is followed by multiple
other things other than the place of effective management. One of them is the
broad phase of any other relevant factors and this includes conduct (conduct of
the company, conduct of the top management)

· There are differences between the CMC and POEM test and one of the difference
is the POEM test lays special emphasis on the place where the day to day
operations of the company occur.
· Reads out the slide - UK is an example of a country which adopts a combination
of test – As we can see from above slide you has both the formal legal test and a
test dependent on the economic or commercial connection
· Smallwood Case –
o Consecutive Residence is where a company for a certain portion of the year
has its POEM in country A and for the remaining part of the year it has POEM
in country B. Both countries have POEM, it is consecutive and not concurrent.
Consecutive (obvio) because it follows from one country to another.
o In the Smallwood case there is a tax planning scheme present – Facts are very
similar to another case (Wood vs Holden) where there was also a tax
planning scheme and the company was a Dutch company with directors who
were Dutch and were resident in the Netherland. These Dutch directors were
advised by UK accountants and the Dutch directors acted on that advice.
English revenue authorities argued that they didn’t apply their mind but the
court held that the company was tax resent in Netherlands
o Gist of the Wood vs Holden case was summed up in the small wood case
where the court said a distinction must be drawn between directors being
‘dictated’ to by an outsider and being advised by an outsider. Thus, an
outsider can set up the entire scheme but still he is not dictating if he is not
the one who dictated the adoption of the scheme.
o In Smallwood an entity became a consecutive tax resident of Mauritius (a
country which doesn’t tax capital gains) and the UK – UK wanted to tax
capital gain for a transaction which happened when the POEM was in
Mauritius. It was being argued by the company that the time when the
transaction took place was important for determining the POEM and not
considering the year as a whole to determine the POEM. While UK tax
authorities wanted to tax capital gain not depending on the period when the
transaction took place but rather by taking the year as a whole. Thus,
Company saying only look at the ‘snapshot’ and not the whole picture and the
UK authorities arguing the opposite.
o Court of Appeal – Rejected the snapshot argument and took the whole picture
argument
o Relevant paragraph from peter Harris - Presume a corporation resident in
country A derives income in the first part of a tax year that under a tax treaty
with country B can only be taxed based on residence. The corporation moves
 its effective management to country B during the second part of the tax year
and, as a result, becomes resident in country B for the whole of the tax year
(including the first part). Can country B argue based on the tiebreaker that for
the purposes of the treaty it is the residence country for the whole year and
so can tax the income derived before the effective management was moved?
This was effectively what happened to a trust in the UK case of 94
Smallwood. The UK wished to tax a capital gain realised during part of a year
in which (arguably) the trust was not effectively managed from the UK. The
Court of Appeal rejected a ‘snapshot’ argument that the capital gains tax
article (see below at 3.1.5) ‘requires one to look no further than where the
trustees were tax resident at the date of the 95 disposal without regard to
subsequent events’. On this basis, the court considered the move of the
effective management of the trust to the UK after the gain was realized and
found that that made the trust resident in the UK for the whole of the tax year.
As this created a ‘“liability to taxation ' in both contracting states’ for the whole
year the tiebreaker must be applied. The majority refused to interfere with the
decision at first instance that application of the tiebreaker resulted in the trust
being resident in the UK for treaty purposes for the whole year (i.e., the
effective management was in the UK), entitling the UK to tax the gain.
o Reads out the last point of the slide.
o So if the court had allowed the snapshot argument – look at what it would have
done policy wise – so companies would avoid being taxed for that particular
period of transaction would shift their POEM from country A to country B. This
shouldn’t be allowed and hence the court sided with the whole picture
argument. (Sir approves this approach)

· So far we have covered residence based taxation, now let’s cover source based
taxation. Always remember that in an international setting an income tax is both a
personal tax and an in-rem tax i.e. a composite tax. Even non-tax residents could
be liable to international commercial tax
· Third point in the slide about locating – connect It to the larger principle of
economic allegiance
· Just like entities needed to be characterized under domestic law even activities
needed to be characterized. As we saw in first class payments are the building
blocks of the international tax and thus we have to characterize the payments.
· Distinction has to be made between activities of personal character and those
which are wealth creating activities. Artificial persons like companies don’t have
such personal needs and hence mostly all their payments are characterized as
wealth creating activities.
· At an essential level, wealth may be created by the provision of labor, the use of
assets or a combination of both
· Active income – Income from labor - Passive income – Income earned as rent,
dividend or interest.
· The combined provision of labour and use of assets is typically identified as
business, but business may be sub-categorised into things like agricultural
business, banking business, insurance business, construction business and so
forth. Income from the use of assets is broadly referred to as ‘passive income’,
and that from the provision of labour or business is broadly referred to as ‘active
income’, with ‘active’ denoting the human involvement.

· Schedular Approach and Global Approach

o Scheduler approach is where main categories of income-producing
activities that are targeted by the tax law are listed. Followed in the UK
and the OECD and UN Model follow this. The main sets of categories
recognized are mentioned in below SS
o US approach is global, with ‘taxable income’ being defined generally as
‘gross income minus . . . deductions’. 109 Gross income is defined by
reference to ‘all income from whatever source derived’, but then
specifically includes fifteen heads of gross income. 110 These heads are
 not arranged in a way that is easily relatable to income from employment,
business and investment.

· Sir emphasized a lot on the point about degree and not absolutes
QUESTION IMPORTANT - WHERE IS VALUE CREATED?

· Thus, it is the domestic laws which have laws which help us determine the source
of activities. The source rules are increasingly being disputed, especially in a
digital age where everything happens on the web and thus making it difficult to
attribute the source of an activity to a geographical location. Equalization levy
being used to solve this problem where the countries with user bases for such e-
commerce activities are now being able tax such companies which don’t have
physical presence in that country.
· Does value get created where R&D is happening? Does value get created where
the product is sold? Does the value get created where the product is
manufactured?
· There will be potential mis-matches between domestic law characterization and
tax treaty characterization. We also have the Residual category under Article 21
and thus whatever doesn’t get covered under the category can be covered by
the residual clause
· As a taxpayer when you are paying the return, it is the domestic law classification
that you would be following.
· In US the statutory rule is where labour or personal services are performed
· UK statute says were duties of employment are performed
· Germany statute says where employment has been exercised or exploited.
· Service or employment for some client in Bombay but I am performing it by
sitting in London – where do you think the service was rendered – This is
specifically a problem in the digital age where services and employment are
being rendered from online and thus don’t have a fixed geographical location
· On this point in the above slide sir goes back to the IPL Example – wherein
whether an English player playing the IPL in UAE can be taxed by the Indian
tax authorities? Playing in UAE and players are not tax residents of India,
then how can Indian tax authorities’ tax that income?
o Beneficiary of the services – BCCI
o Payer of services – BCCI
· Asset being used for some activity and thus a nexus could be established
between the presence of the assets and the activity.
· What about intangibles like intellectual property? Where could they be
considered to be located? Where should they be taxed?
· Let’s take the example of Apple – where is the IP being put to use? Is the IP being
put to use in India where the iPhone is being sold or is the IP being put to use in
Vietnam where the iphone is being manufactured? – No easy answers – He says
this and doesn’t answer the question only and says we will see to this question in
the upcoming classes
· Locating the use of money is another contentious area, although the issues here
are of an earlier date. Remuneration for the use of money will largely be in the
form of interest or dividends. Common law courts typically source interest
where ‘the money was lent’, but this belies the complexity of the process.
More accurately, this involves the balancing of anything up to nine factors. By
contrast, the US and German statutory tests simply focus on the residence of the
payer of interest. These countries use the same rules to source dividends (i.e.,
sourced in the country of residence of the paying corporation). For common law
courts, it may well be that the activity giving rise to a dividend, and so its source
is the same as the activity giving rise to the profits from which the dividend is
paid. This is reflected in an Australian statutory rule for sourcing dividends. The
UK rule is the generic reference to ‘source’ for savings and investment income
noted above.
· Most of the world trade occurs with the MNC’s and the thing is that these MNCs
are present in various different countries. R&D in one country, manufacturing in
another, marketing in another and ultimately sales are also made in many
different countries. Which country should tax these MNCs and for what activities
is a very confusing question.
· Whole tax planning system operates in this way – Book maximum profits in the
low tax jurisdictions and book maximum expenses and as little profit in high tax
jurisdictions.
· Business, as involving both the provision of services and the use of assets,
traditionally followed the style of rules noted above. However, as business is
multifarious, some more distinct rules developed for business. For example,
in the case of manufacture of goods, the focus of common law courts is on
where the manufacturing activity is carried on.
 In the case of dealers in commodities or securities, the focus is on where ‘the
contracts of purchase and sale were effected’.
In the UK, the traditional statutory rule refers to a trade, profession or
vocation ‘carried on . . . in the United Kingdom’.
By contrast, the US refers to ‘the conduct of a trade or business within the
United States
· You have identified activity – You have established a nexus – You have also now
identified payments – Now the question that arises is with regards to the
allocation of payments
o It is one thing to identify the location of an income generating activity and
another to allocate payments to such activity
o A domestic tax law must not only allocate payments made and received to
the earning activity (business, employment or investment), but also
allocate those payments geographically to the part of the activity being
conducted in a particular country. This process determines the
geographical source of the payments.
o A payment’s geographical source is part of its characterization. The
character of a payment is determined by asking why the payment was
made (see above at 1.1). The geographical source of a payment is
determined by asking whether the reason why a payment is made has a
sufficient connection to activity conducted in a particular country (i.e., a
sufficient nexus). Domestic tax laws use various nexus tests, such as
‘derived from’, ‘arising from’ or ‘effectively connected to’. There is little
need to focus here on the nature of those tests. They all focus on a
sufficient connection, and the main issue is whether or not apportionment
is possible, or the allocation is all or nothing

· Source of Income generating activity – Country A – Where the property is situated

· Who’s paying the rent – Resident of Country A - Allan
· Who’s Getting the rent – Resident of Country B - Beth
· A will tax Beth (who is resident of country B) regardless of the fact that she is a
resident of Country B because the source of the income generating activity can
be traced to the property located in country A
· Beth has incurred some expenses which are related to maintaining those assets in
Country A. So should Country A tax Beth on ‘Gross’ Basis (without deductions) or
should Country A tax Beth on ‘Net’ Basis. Whether country A should allow Beth to
deduct the expenses which she incurred in relation to the asset is the question
that sir is asking
· What if Beth has taken a loan in Country B to buy that property in Country A and
she is paying interest on that loan. Should country A take into account the
expenses incurred by Beth in country B to generate the income in Country A
· The domestic law source rules of most countries focus on providing a source for
payments received. This is determined by allocating payments received to
activities located within the jurisdiction according to the rules discussed above.
So, using the Base Case as an example, Allan uses immovable property (owned
by Beth) located in Country A. That use is the relevant activity which has a clear
location in Country A. Allan’s payment for that use has a sufficient nexus with the
activity, and so the payment’s character is not only rent but rent that has a source
in Country A. Focusing source rules on payments received is fine if the source
country only seeks to tax those payments on a gross basis (i.e., without
deductions). This is commonly the case with passive activities. So, in the case of
dividends, interest, rent and royalties, source country tax is often collected by
means of requiring the payer (Allan in the Base Case) to withholding (or deduct)
the tax from the payment and remit the tax to the tax administration.
· So passive activities the rule is withholding the tax. Dividends, interests, rents and
royalties are the passive activities that we usually see.
· However, if a country where an activity is located wishes to tax the return from
that activity on a net basis, then the attribution of a source for payments received
is, without more, insufficient. The country must also allocate payments made by
the activity (e.g., allocate expenses that have a sufficient connection with the
activity so as to be deductible). The result is a net amount of income or profits
that may be considered to have a source in the country. It is important to
distinguish between these two different concepts of source – that is, the source of
gross payments and the source of net income or profits.
· If the expenses are being incurred in some other country (B or C) then should
country A be allowing the deduction of those expenses? Deduction of expenses
is at the center of this base erosion and profit shifting exercise. More expenses
that you book, the lower your income is. There is always a temptation on part of
tax planners to book a lot of expenses where the income is getting sources. So,
Beth’s accountant would advise her to book her expenses in Country A.
· Goes back to the loan example – when she is paying interest on that loan – which
country could she book this as an expense? Also, whose income is this interest –
because one person’s expense is another person’s income.
o The income is that of the banks and country B would be charging tax on
this
o There is a problem of base erosion for country A because if Beth had taken
that loan from a bank in country A, they would give Beth the deduction
 and taxed the bank. However, in this case it is not happening. Thus
country A tax base is getting eroded
· Solution to prevent base erosion - It is possible to take a more holistic and
extreme approach to the allocation of expenses. Expense payments may be
allocated based on the source of those payments rather than their
connection with payments received or activities giving rise to such
payments. Under this approach, in calculating the net source of income in a
country, payments received that have a source in the country may only be
reduced by (have deducted from them) payments made that also have a source
in that country. In both cases, the source of payments would be determined
according to the same rules. Only a few countries adopt such an approach.
· Problem in allocating business profits - it involves a combination of the various
source rules described above and the activities may be spread over more than
one country. And the business may be conducted by one or more related entities
(e.g., as in a corporate group). The difficulty then becomes allocating the source
of income between the various countries concerned based on the above factors.
Take the example of a corporate group that researches and develops intellectual
property in one country, manufactures goods using that property in another
country and sells the goods with a valuable brand name attached in a third
country. How much of the group’s profits should be allocated to each country?
The OECD tells us that this should depend on where the value is created, but
where is that, in what proportions and how do we reach that conclusion based on
the rules noted above?
· In the example, the use of the intellectual property is embedded in the price of
goods that are sold in the third country. The intellectual property is used in the
manufacture of the goods, and the brand name is attached before the goods
reach the sales country. What if only one company in the corporate group has a
right to use the intellectual property and attach the brand name? What if that
company is located in a fourth country (or no country if it is not resident
anywhere), the company has no business presence in any of the other three
countries and the fourth country is a low tax country? The consequence may be
the allocation of low routine profits of the group to the three countries and the
large residual attributable to the intellectual property to the fourth (or nowhere).
· Substantive economic activity (manufacturing, marketing, sale) happening in high
tax jurisdictions but then bulk of the taxing happening in low tax jurisdictions,
which is where the company holds its intangibles
· If the source of direct use of intellectual property is not consistent with the source
of the indirect use of such property (as in the sale of goods), then form matters
and multinational groups have an ability to manipulate the location of the source
of their profits. And this is what has happened. Multinationals have manipulated
their value chains in such a way so that little source of income is allocated to
research and development, manufacture or sales, and a lot is allocated to
coordinating centres in low tax jurisdictions
· A good example of this is the Apple case, which is only an example of the
problems with the traditional methods of allocating business profits. Here much of
Apple’s research and development was in the US, manufacture of products in
China and sales all over the world. Profits were allocated on the basis that only
routine functions were performed in these countries, and the bulk of the profit
 was allocated to a coordinating company established in Ireland, but which was
not resident in Ireland for tax purposes. The overall effect is a very low tax rate
for the group as a whole, and this was achieved by manipulation of the source of
the group’s profits and how that is allocated between the countries concerned
· Sir says that we should read about this ongoing apple -Ireland tax dispute – 1 st
round went to EU and second round went to apple. Case is in court of appeal
o Apple case – Global income in 2016 was 190 billion dollars and apple were
booking 2/3rd of the income in Ireland. In Ireland apple was doing nothing
– it was not doing R&D, it was not doing manufacturing. Basically, nothing
big was happening there i.e. no value was getting created in Ireland. Only
4% of workforce was situated there and only 1% of global customers were
located in Ireland.
o Three of these Apple companies were incorporate in Ireland, but they were
not ‘tax resident’ in Ireland
· Also read about the – GlaxoSmithKline case
· Stateless because in US, you would be tax resident only when you were
incorporate there. In Ireland you would be tax resident only when Ireland was the
POEM. Thus, this way Apple companies escaped being tax resident in both
countries. First point of below slide.
· Ireland didn’t have anything to offer and thus the only way for it was to be a low
tax nation to get some money – Connect to that fact that that’s why Ireland was
very hesitant to become a part of the global minimum tax
· Again, back to the question of Value creation – Place of R&D? But then sir is
saying what is the use of the R&D without sale of those goods where the R&D
was applied. (Last point in the above slide)
 · Should the residual profit be largely allocated to where the decisions are made to
coordinate all of the features that go to make the goods so valuable? This seems
to be the direction in which the OECD travelled in recent decades, but it has
major limitations. Even if that were thought to be the best answer, how would you
identify where these important decisions are made? Even if you could identify
such a location, wouldn’t multinationals be able to manipulate where those
decisions are made? Similarly, allocation of the residual profits to where the
research and development occurs is not straightforward, as its location can also
be manipulated and it can be contracted out, although there have been efforts in
recent years to allocate more value to these function
· There is an increasing view that more should be allocated to the country of sales
(i.e., the country of the consumer of the goods and there are good reasons to
focus on this jurisdiction). Academic literature is full of discussion about where to
locate intangibles for the purposes of allocating profits. At some level, this is as
much a matter of semantics as trying to allocate a residence to a corporation.
Intangibles are, well, intangible, and it is not clear that they can have a ‘location’
as such. They are only of value where they can be used. On this basis, the value
of an intangible is in all of (and only in) the countries where it can be exploited
profitably. This seems to point to the country of sales. It also explains why there
is increasing pressure from some countries, such as China and India, for the
allocation of greater profits based on ‘location specific rents. The idea is that
greater recognition should be given to countries that create the market conditions
in which intangibles can be exploited and this justifies a greater allocation of
profits from the use (or embedding) of intangibles. It is also reflected in proposals
for moving from the traditional source-based income tax to a destinations-based
cash flow tax. Those proposals are also based on resolving the administrative
difficulties (impossibility) of the current approach to allocation of profits.
· Moving the income tax to a destination basis (which is most commonly used in
value added tax) would fundamentally alter the implicit current allocation of taxing
rights between countries. The winner countries from such a move would seem to
be those with large consumer markets.

8th August 2021

Till now, we have covered the basics of International Commercial Taxation – genealogy of
DTAA, Article 1,2,3,4, Vienna Convention on law of treaties, Articles 31, 32 and 26, 27.
Azadi Bachao Case etc.

New topic started:

What is transfer pricing?[1]

As a lawyer, you don’t need to know complete rules of transfer pricing. But you must be
aware of principles of transfer pricing.
Watch this video - https://www.youtube.com/watch?v=IvXQ0QwbyII (mandatory – covered
in class.) Explains what transfer pricing is.

[If you are not watching (similar to example in video): Suppose each part of your phone
comes from a different country. For example, A manufactures screens in Brazil, B
manufactures cameras in China and they are assembled in India by C. A, B and C are owned
by parent company D. How do they transfer the product between themselves and at what
price? Arm’s length price states that transactions must take place like they are two
independent parties and rates also be set like that. It is important to avoid tax manipulation by
multinational companies. For example, if C gives more than market price to B, profit of C
will fall substantially and profit of B will rise. Considering, taxes in China are lower, C will
avoid tax in India. Transfer pricing is necessary to avoid such manipulation]

Watch this video also - https://www.youtube.com/watch?v=TLSYwkWCIzA (mandatory –

covered in class.) – IMPORTANT. There are certain limitations of transfer pricing. This
video makes that.

Loophole of transfer pricing – there are not much developed standards of Transfer pricing wrt
intellectual property. So, if C say that it is getting IP rights from company B (having less tax
rate) situated in another country and transfer a huge amount for royalty, no one can say
anything and C will evade the tax (same example as that used in the video).

Watch this video also - https://www.youtube.com/watch?v=Th4fxMFRIt0 (mandatory –

covered in class.). Points out two tricks for tax planning –

1) Give debt at high price to related party (rather than equity)

2) Give royalty to related party – Already covered in video.

Both will reduce the tax of the company. –

Why is giving debt preferable to providing equity to related parties?

Using the example used in the video. Suppose the parent company in the USA (“A”) provides
capital in the company in England (“B”). If B earns $100 mn dollars in England. First, it will
pay corporate tax on that income. Then, if B wants to send a dividend to A for its investment,
it will have to again pay dividend tax. So, if you invest in equity, it leads to double taxation.
Same income gets taxed – because income is with two different entities – company B and A.
Instead, when A provides debt to B, it will reduce the profit of B because B will have to pay
interest to A. As profit if low, B will have to pay less tax.
Second problem is wrt royalty agreement. A transfers its IPR to B, resident of a low tax
jurisdiction (like Apple in Ireland). It will raise the profit of B, a low tax jurisdiction
company and reduce the profit of a high tax jurisdiction company. By that, A evades the tax.

Criterion for designing tax systems

· Equity: One of the main criteria. It means the tax system should be fair. For example,
if the government charges 30 percent from someone who earns Rs. 10,000, you would say
it is unfair. People should be taxed according to their earning capacity. That’s why you
see tax slabs – and we have progressive taxation. There are two kinds of equity – 1)
Vertical Equity 2) Horizontal Equity.

1. Vertical Equity: Progressive taxation. Example given above.

2. Horizontal Equity: Two people earning the same income should be

taxed equally.

· Economic Efficiency/Neutrality: Taxation should not be a hindrance while taking

commercial decisions. Whether I should set up a business A, B or C, tax consequences
should not be a hindrance. But in practice, there is no neutrality - the government has
different schemes. We have tax exemptions, lower tax rates for certain kinds of
businesses.

· Effectiveness

· Simplicity
 · Flexibility

Design of the International Tax structure

What should be common principles?

Two problems:

· Double taxation

· Under Taxation

Now, this divided allegiance leads to tripartite relationship - Relationship of country A with
Country B. Similarly, there is relationship of country A with its resident.

What principles should govern State-Tax Payer relationship?

· Equity(fairness) – equity between nations. What arrangement state A and B come

into, that must be equitable for both A and B.

· Economic efficiency (Neutrality)

· Simplicity
· Two notions are – Capital Import Neutrality (CIM) and Capital Export Neutrality
(CEM)

· CEM is concerned with neutrality in the location of the investment or location of

activity that gives rise to the income.
· Under this principle the tax system should be designed so that it is neutral
regarding outflows of capital.
· Ex – TATA – Steel plant in India and now wants to expand and put another steel
plant abroad. The Indian tax system treatment of Tatas domestic income and
global income should be such that no matter where TATA wants to set up its
steel plant abroad, Indian taxing policy should not act as a disincentive for it to do
 so. How can you achieve this – 1) By completely exempting TATA’s global
income and 2) by giving TATA tax credits. Let’s assume that its India plant is
being taxed at 20% and in the UK, plant is being taxed at 15%. India now when
its taxes TATA’s UK income should give a tax credit of 15% and should only tax
for the remaining 5%. Then the treatment of the global income and the domestic
income is the same. That way TATA is not made worse than when it would have
made all its investment in India.

· Here the focus is on source-based taxation whereas CEM the focus was on
residence based taxation
· Country A is India and the Tax subject is TATA. TATA has domestic income and
global income. Indian taxing 20% and UK taxing 15%. India will tax only 5% so
that there is no difference in the tax on domestic income and foreign income
· The figure doesn’t make sense to me. Please google and understand these
concepts.
· CEN - Guiding principle which was to ensure that the companies taxing structure
should not come in the way of the flow of investment
· Capital export neutrality (CEN) is the doctrine that the return to capital should be
taxed at the same total rate regardless of the location in which it is earned. If a
home country tax system satisfies CEN, then a firm seeking to maximize after-
tax returns has an incentive to locate investments in a way that maximizes
pre-tax returns. This allocation of investment corresponds to global
economic efficiency under certain circumstances. The CEN concept is
frequently invoked as a normative justification for the design of tax systems
similar to that used by the United States, since the taxation of worldwide
income with provision of unlimited foreign tax credits satisfies CEN.
· Global economic efficiency was sought to be enhanced with this principle.
· The standard analysis further implies that governments acting on their own,
without regard to world welfare, should tax the foreign incomes of their resident
companies while permitting only a deduction for foreign taxes paid
· capital import neutrality (CIN), the doctrine that the return to capital should be
taxed at the same total rate regardless of the residence of the investor. Pure
source-based taxation at rates that differ between locations can be consistent
with CIN, since different investors are taxed (at the corporate level) at identical
rates on the same income.
· CEN is commonly thought to characterize tax systems that promote efficient
production,7 CIN is thought to characterize tax systems that promote efficient
saving. Another difference is that CIN is a feature of all tax systems analyzed
jointly, whereas individual country policies can embody CEN
·

· Going back to the standard example – let’s see what would happen if Country B
adopts nation neutrality. Beth receives 2lakhs and then A country already taxes
20% and she has 1.6 lakh and if country B adopts national neutrality it will not
factor in the point that Beth has already paid 40k in taxes in country A. It will
again tax on 1.6lakh.
· The focus in national neutrality is not on global economic efficiency. The focus is
not on breaking down the barriers for flow of investment. The focus is on ‘national
welfare’. Tax you have paid abroad is only seen as an expense by Country B
(Last point)
· OLI stands for ownership location and internalization
· The framework wanted to investigate why FDI happens and why firms invest
abroad – Why should Toyota instead of manufacturing in japan and shipping to
India, sets up a manufacturing plant in India. What the reasons behind doing
this? –.
· Ownership, location and internalization advantages and that’s why firms undertake
FDI
o Ownership - The framework asserts that firm’s ownership of production
process gives market power to these firms
o Location – By manufacturing in one location there might some deep
locational advantage like less labour cost or export costs
o Internalization advantages from exploiting these benefits from within the
organization instead of licensing it to some domestic company
· Specifically, multinational firms are thought to engage in foreign direct investment
when ownership confers specific advantages relative to arms-length
relationships, so activities are most profitably undertaken within the firm. An
obvious implication of this approach is that multinational firms differ in the
proprietary assets (e.g., brands, production processes, patents) they can exploit
and that these differences are critical to understanding the patterns of FDI and
the productivity of these firms.2 In addition to differences in business practices
contributing to the possible importance of ownership, scholars are paying
increasing attention to differences in institutions (eg. legal regimes) and the ways
in which these variables can influence firm outcomes. These country-level
differences would provide another reason to expect ownership to be associated
with different patterns of FDI and the productivity of that investment.
· Desai, Foley and Hines (2002) analyze the changing ownership decisions of
multinational firms, finding that globalization has made firms more reluctant to
share ownership of foreign affiliates, given the higher returns to
coordinated transactions inside firms. The costs and benefits of ownership
appear to be central, and increasingly so, to the choice between investing in a
country and serving the same market with arm’s-length transactions
· It is useful to consider the importance of ownership with reference to a specific
example. Consider the establishment of an automotive manufacturing plant in a
large emerging market. Why might the productivity of this plant differ depending
on whether a local or multinational firm owns it? One can easily imagine that the
multinational firm may be more productive given the ability to extend a global
brand or to transplant proven production processes to the emerging market.
Similarly, the ability to integrate this plant within a worldwide production process
or to use expatriates with related experience in similar markets could also have
important productivity consequences. Finally, the ability to use incentive contracts
tied to equity where minority shareholders have protections could similarly lead to
productivity differences. While this example emphasizes a productivity advantage
for the multinational firm, the more general point is that ownership is likely to be
associated with significant productivity differences.
· https://poseidon01.ssrn.com/delivery.php?
ID=58702508611200500510401901710612710408107303703403109109509309
0110013078055101008034024029060082109115109078011023025091029029
0740180640840901051220201140150220390771180881040660840201230290
76073114101082027099105073031104105082101000115027009&EXT=pdf&IN
DEX=TRUE– Read this paper for clarity – He is just reading this without
explaining jack

· Germany exemption model and US Tax credit model

· Focus of CON is again on global efficiency
· New concept of neutrality
14 August 2021
Recap
Previous lectures covered the following topics (non-exhaustive) –
- Capital export neutrality
- Capital import neutrality
- National neutrality
- National ownership neutrality
- Capital ownership neutrality
- Market neutrality

We were discussing principles of international taxation – in a purely domestic setting,

principles are more straightforward:
1. equity
a. horizontal
i. similarly situated people, like having same
incomes, should be similar taxed
ii. Chranjeet and F.N.Balsara
1. cases from Article 14 on the ‘theory of classification’ –
2. 7 propositions from Justice Ali on F. N. Balsara – summary
is that legislature can always create a new class, as long
as there is a nexus or rationale, a scientific basis for putting
people under different burdens;
3. thus, for taxation, differently situated people can be taxed
differently – this is the justification for progressive rates of
taxation.
b. Vertical
i. Rate of taxation differing for people with different
incomes
c. Looked at this in the domestic context – it essentially means non-
discrimination – discussed more on next page.
2. economic efficiency neutrality
a. decisions to invest, spend, carry out a particular kind of economic activity,
such pre-tax decisions should not be affected by post-tax policy; only this
will lead to economic efficiency
3. simplicity

For international taxation, principle of economic efficiency is the main principle.

Equity can be an important principle in deciding how are things taxed across
jurisdictions, what reasons do they use, if they are using a source-based principle
then is it creating an inequitable outcome because many countries may intend to tax
the same taxable base, and the leading question of what should be the guiding
principles in avoiding taxation of same tax-base twice.
We saw OECD Model – how it came into picture and how it was a compromise – no
coherent legal or economic principles necessarily justifying it – OECD Model was
developed in brick-and-mortal world, now circumstances and principles have
changed, substantial economic activity (individuals as well as business) takes place
across borders.
Fundamentals of global commerce have changed; we must ask if OECD Model has
kept up with the pace of the change? Critiques say it has not, the BEPS approach
(2013-15) was just a fig leaf because it did not understand the underlying principles.
In first lecture we noted how structure is changing, and next 6-7 lectures we looked
at the most blatant cases of tax evasion and the policy consequences that it brough
through. These principles of neutrality and economic efficiency etc. should then
definitely be understood very accurately. Any taxation system that does not take into
effect who owns the capital basically ignores the underlying realities of global
commerce.

Last Lecture – OLI Framework – coined by Denning – theory of why do MNCs set-up
subsidiaries in foreign jurisdictions and not simply enter into licensing or export
arrangements – looked at the advantages of MNCs to own manufacturing,
advertising etc. activities in foreign countries, rather than licensing it – looked into
this while looking at the novel concept of capital ownership neutrality.

Sir thinks this is true – we are struggling with efficient allocation of resources through
an equitable, simple and economically efficient international taxation model. US also
deals with the same issue, and wants actual usage of the money that is lying in
foreign subsidiaries, possibly due to international taxation structure coming in the
way.

Article 24 of OECD Model: Non-Discrimination Principle

Limited scope
- Attempts to prevent discrimination based (only) on nationality
- Attempts to prevent discrimination of business profits
o (We will discuss how this apply to PEs when we do Article 7)

These rules apply only apply vis-à-vis discrimination of residents of other state, can
apply to actions of the source-country. This shows that OECD Model is leaning in
favour of residents’ tax jurisdiction: taking from source country to resident state. This
essentially means that resident country is free to have higher rate of taxation for
foreign income of its own tax-residents.

Article 24(1)

“Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation
or any requirement connected therewith, which is other or more burdensome than the taxation and
connected requirements to which nationals of that other State in the same circumstances, in particular
with respect to residence, are or may be subjected. This provision shall, notwithstanding the
provisions of Article 1, also apply to persons who are not residents of one or both of the Contracting
States.”

- Wide Scope – Applies to any taxation: not just limited to the scope of Article 2 –
Article 24(6) confirms this.
- National is defined in Article 3(1)(g)
- Three-step approach in this article
o Identify a national in a contracting state, that is taxed by another
contracting state
§ Beth v Allen – Beth is national of contracting State B, taxed in
Contracting State A
o Identify a hypothetical national of the other contracting state and see if they
are in the same circumstances
§ John who is national of State A is in same circumstances/ similarly
situated as Beth
 o Ensure that taxation imposed by State A on Beth is the same as John

[this example is from the book]

Inter-Nation Equity
(has apparently already discussed this)
A fair allocation of taxing rights between source and residence countries.

Source country entitlement is based on where the income arises.

Harmful Tax Competition

Debate since mid-1990s. First report in 1998.
First factor is relevant but is not enough by itself because countries are differently
placed and can have different reasons for not taxing – hence, this factor is only a
starting point. You need to see it with the other three factors. Serious criticism of this
OECD approach [said this but then did not tell what the criticism was].

In 2011-12, exposé where Lichtsteiner account holders (HSBC Bank Account) paper
was leaked, full movement against black money was started in India, when India
sought information there was a lot of resistance from these secretive jurisdictions.
These regimes work because of banking secrecy (hence points (iii) and (iv)).

Video here. The problem of tax havens explained, and how Panama Papers put
spotlight on it recently, but OECD working on it since 1998.

This 1998 report led to establishment of two bodies regarding harmful tax
competition
1. Global Forum on Transparency and Exchange of Information
2. Forum on Harmful Tax Practices

Other relevant resources

- Then came in BEPS Final Report, 2015 – 15 Items – Action 5 was about harmful
tax practices.
- Also See, Progress Report, 2017 and Progress Report, 2019.
- Further, Herzfeld, a tax scholar, in 2017, severely criticized the OECD-BEPS
project, especially Action 5.

What is Harmful Tax Competition?

Tax competition will always exist between countries, but when does it become
harmful, Two years ago, India slashed corporate tax rates by almost 10% in 2019. ?
See this. Excerpts –
Prime Minister Narendra Modi on Friday termed the decision to slash corporate tax as "historic"
while the opposition parties used the announcement to attack the government, with the Congress
linking it with his US visit, saying it was "amazed" at what he will do for a stock market bump
ahead of his Houston speech.

BJP president Amit Shah, senior party leaders as also allies in the government cheered Finance
Minister Nirmala Sitharaman's announcements to boost the economy…. In the biggest reduction
in 28 years, the government slashed corporate tax by almost 10 percentage points as it looked to
pull the economy out of a six-year low growth and a 45-year high unemployment rate by reviving
private investments with a Rs 1.45-lakh crore tax break.

Two-and-a-half-months after presenting her maiden Budget that was hailed as "development-
friendly" and "future-oriented", Sitharaman announced cutting corporate tax rate to 25.17 per cent
to bring them at par with other Asian countries such as China and South Korea but at the expense
of potentially breaching the 3.3 per cent fiscal deficit target.

Is this harmful tax competition? Is this race to the bottom? What can OECD do in a
situation where country wants to reduce taxes to make the jurisdiction more foreign
investment friendly?

Countries are more reliant on immobile sources of income for taxation – sources of
income/ entities which will not change their source of income or nationality due to tax
rates. UN as well as OECD provides for very less withholding tax on passive income
(this includes – dividends of subsidiary of foreign income, OECD model recommends
exempting outgoing income in royalty, and even almost exempts the outgoing
interest paid by subsidiary of a foreign corporation).

This is realization by countries that it is very difficult to tax mobile sources of income
– for instance, if you tax capital, it will shift nationalities and go to low-tax countries.
Thus, reliance on immobile sources – individual income tax (difficult for individuals to
relocate – as against a businessperson with hundreds of crores who is taking the
decision on where to locate their company for rooting money). Convention was that
source countries should focus on taxing active income, while passive income should
be left on residence countries. In taxation of active income – debate is how to locate
it to source, how to identify nexus/ allegiance with one jurisdiction – and then
allocating the payments?

When country is competing on the basis of tax policies, there are two relevant items
–
1. Productive capital (also a mobile source of income: capital is a mobile source of
income)
a. Eg. Indian PM was supposed to meet US leaders and had a speech
coming at Houston, 36 hours before that his government announced
massive tax reduction. Thus, India wanted to attract productive capital.
This slash was especially applicable to manufacturing industries –
providing a competitive and lucrative and preferable tax rate.
2. Paper Profits
 a. Eg. Ireland’s Sweetheart Deal with Apple – taxing income coming into
Irish subsidiary and PE at almost 1% - was trying to attract paper profits/
paper capital – not asking Apple to conduct R&D or manufacturing in
Ireland – just asked to funnel its paper profits in Ireland

BEPS Report largely targeted Paper Profits – right to tax is that of a sovereign nation
and each country will decide a policy according to the advantages to it. BEPS Report
tries to dissuade. The countries from merely trying to attract paper profits – trying to
establish some substantiality between preferred tax regimes and the capital that
flows into them. India trying to attract manufacturing revenues has some sense of
substantive nexus – which is not really present in Ireland.

[He stopped discussing this topic but did not really delve into when does tax
competition become harmful – I think this last discussion on Paper Profits was
indicative of it]

Methods of Allocating Tax Rights

We saw various scenarios in which double taxation can arise, the most usual being
when Country A is trying to tax same income as source country, and Country B is
trying to tax same income as residence country; though there will be times when two
countries are trying to assert source-income, or residence-income etc. For latter, we
saw tie breaker rules and their cascading list, and the earlier test of POEM for non-
natural entities, and the OECD Model to overcome these overlaps.

These two equations provide 6 points of possible relief –

1. Three w.r.t. residence country – Beth’s residence is Country B – she received
rental income from a bungalow owned by her in Country A – Country A taxed it
as 20% as the source country. What are the three reliefs that Country B can
provide to Beth to avoid double taxation – how can Country B acknowledge that
Beth has already paid tax in Country A?
a. Complete exemption
i. Beth could be having other properties, rental
income, or other forms of income in Country B
itself – so Country B recognizes this and that
you have paid taxes in source country – so the
entire rental income sourced from property in
Company A is exempted.
b. Exemption with inclusion in tax base
i. Beth’s tax base is 1 crore, rental income from
Country A is 20 lakh, on which 5 lakh tax is
paid. 20 Lakh will be added to tax base, and
then progressive rate is applied – This is foreign
income differentiation – exemption, but with
progression.
ii. My understanding – the income will be included in
determining which tax rate shall be applicable,
but that will be applied on the base excluding
foreign rental income (i.e. Rs 1 Crore in this
case).
iii. [(a) and (c) are the most important to understand,
(b) is just to be understood for accounting
purposes]
c. Credits
i. Beth paid 5 lakhs on the 25 lakh income from
Country A, rate of taxation there is 20%. But
Country B (residence) is taxing at 25% - so if
Beth had property in Country B she would have
paid more tax (by 5%)
ii. So Country B gives Beth a tax credit of the
difference in percentages – 5% in this case – so
that she is at par with the residents of Country B
who would have owned the property in Country
B itself

Note – What happens when the tax rate is more in Country A

(source state – 20%) than Country B (residence state – 15%) –
will Country B give refund of the extra paid?
1. Principally, she should be given the refund – capital export
neutrality principle (residence country should not be
different – example if Tata sets up a plant in Jamshedpur
or UK, Indian government should have the tax rates on
Tata same irrespective of the location)
 2. But practically, such refund is prima facie absurd – this
shows the inherent contradiction of principles like neutrality
(especially capital export neutrality)
2. Three w.r.t. source country – did not cover this in this class, said will cover in next
class.

[To better understand this – See Chapter 4 of the Harris Book – he said we will work
this out in class later with examples]

Please see – hour-long video of BEPS Report being released – a lot of things in the
video will not be understood at once because we might not have the background –
said that will send that in email but did not find the email anywhere.

August 22

- Article 7 of the OECD is similar to the article 7 of the UN Model. But, before starting
with this, we will discuss GAAR = general anti-avoidance rule.

GAAR

- India adopted GAAR in 2017 and there has been a lot of anxiety around these rules in
India among the investors, tax planners and tax lawyers about the scope of these rules.

-
- Traditionally, GAAR addresses the anti-avoidance tax scheme. There is a difference
between evasion and avoidance. Former is outrightly illegal, whereas GAAR addresses
avoidance. Traditionally, tax treaties or the OECD model did not address anti-avoidance
rules and the domestic laws also did not address them. In 1977, the anti-avoidance
concept made an appearance in the OECD and it implied that domestic anti-avoidance
rules could not be applied to tax treaties, unless they were specifically adopted in the
treaties. So, there was an implied recognition of GAAR. In 1987, the OECD Committee
on Fiscal Affairs published two reports on this. In 1992, there was a revised commentary
on the 1997 commentary and it was the main point of divergence. It introduced the idea
that even in the absence of specific mention of the GAAR in the treaty, then also in
 substance and form rules and specific CFC legislations are NOT affected by tax treaties
and could be applied to strike down the abuse of tax treaties. There was another revision
because the ‘92 commentary was confusing about the domestic GAAR rules and tax
treaties. In 2003 then, another revision happened which made changes in article 1 of the
OECD Model Convention. It stated that within limits, the domestic anti-abuse rules
were not inconsistent with the tax treaties and that such rules may be applied not only to
base companies, but also to conduit companies and more generally to every kind of
perceived treaty abuse. But, in the meantime, a lot of countries have formulated GAAR
rules and there are some TAAR rules (targeted anti-avoidance rules) also which have
been adopted unilaterally. The countries have been trying to prevent treaty abuse and
have been unilaterally trying to formulate GAAR and TAAR rules in their domestic laws.
In 2017, there were amendments made to the OECD Model and some additions were
made (eg: diverted profits’ tax). And the 2017 amendment introduced a. 29 which limits
entitlements under treaties and there are various options available u/a. 29 but the main
choices are between GAAR or LOB (limitation of benefits) clause or a combination of
two.
- Article 29 (9) reproduces GAAR. It says: Notwithstanding the other provisions of this
Convention, a benefit under this Convention shall not be granted in respect of an item
of income or capital if it is reasonable to conclude, having regard to all relevant facts and
circumstances, that obtaining that benefit was one of the principal purposes of any
arrangement or transaction that resulted directly or indirectly in that benefit, unless it is
established that granting that benefit in these circumstances would be in accordance with
the object and purpose of the relevant provisions of this Convention.
- If obtaining benefit was the principal purpose - GAAR will be applied. But all
facts will be looked at.
- Vienna Convention would apply for interpretation. We have discussed a. 31
which deals with the context, object and purpose.
- India has adopted GAAR late because of the anxiety around it. Many believed that it
would undo the genuine and substantive transactions and can give sweeping powers to
some. And finally in 2017, we adopted GAAR. It has been seen as a watershed moment
by many people. But, if we go back to the Azadi Bachao Andolan Case, even there the
Court had held that a transaction, if found colourable or dubious, then it could be
disregarded by applying doctrines like look through doctrines (piercing the veil) and
substance over form approach. In many ways, GAAR was in the making to address
widespread issues of tax avoidance.
 -

- Under the Indian GAAR rules, there is IAA. We had discussed the Apple Case which sir
was saying was a case of tax evasion and some were saying it was avoidance - it is a
question of semantics. There are 3 concepts of tax planning - evasion, avoidance and
mitigation. When there is suppression of facts, misrepresentation, etc. it is evasion. But,
avoidance is when something inequitable is happening but not illegal. Then there is tax
mitigation wherein the taxpayer is simply taking advantage of a fiscal advantage provided
to them by a tax legislation. So, tax mitigation is permissible in a positive way. So, where
does GAAR fit in? What does it do? It is obliterating the difference between evasion and
avoidance and that is why, sir said it was a question of semantics. Under the Indian
GAAR rules, for IAA, the following conditions are to be satisfied. These have been
given in the slide photo attached above - he reads them out. (explains arms length again
= how two independent parties would deal with each other commercially and that
dealing is known as dealing at an arm's length). There is a huge scope of subjectivity
which makes these rules, at times, give a lot of power to the government. This is also
why the industry side wanted very categorical rules so that it does not affect/disregard
genuine business transactions and flowing out of economic activities which are
substantive in nature. There are also some safe harbor rules that only when some
thresholds are reached that GAAR applies. Somebody is asking him to explain this. He
says that you only need to understand it broadly but for example, there are a lot of FIIs
in the Indian market who substantially contribute to our market, so we need to protect
them also. For such purposes, safe harbors play a role. Broadly, this is what we should
know about GAAR because we will be using this in our subject.

INCOME FROM BUSINESS

-
- Biden is trying to implement a global minimum tax of 15%. They are trying to impose a
tax on business income. So you can book your profits ANYWHERE and you will be
made to pay 15% minimum tax. He has linked the idea of tax justice with the idea of
economic equality. We discussed three principles in taxation: equity, neutrality and
simplicity. Why is Biden trying to link tax justice with the idea of income and wealth
disparity? Why was India so keen to tax Vodafone in Cairn Energy? There were 17 cases
which came out of the off-shore indirect transfers (OITs). Why protect the sovereign
right of tax? To revenue and distributive equality. Unless the government has revenue,
the government cannot carry out many of the socio-economic welfare activities. So if the
corporations do not pay their due share of taxes then, the government won’t be able to
raise money and also it is inequitable and unfair for the common and poor man - in order
to escape the vicious cycle of poverty, they need a ladder, and this is what the
government tends to provide using this cyclic structure. “ Hence, we are studying this
course to find the right balance. It should not be inter-nation equity but also intra-nation
equity.”
- Topics to cover now:
- We will introduce article 7
- We will look at taxation of subsidiaries
- The concept of permanent establishments
- The difference between the two
- Article 5
- What are the two definitional articles we have discussed in the OECD Model? He is now
starting the horrific “class exercises”. Please participate.
- Article 3
- Talks about general definitions. Two limbs of article 3 - para 1 and para 2
(I think he has discussed these two limbs b4).
- Para 1: definitions for the whole of the convention
- Para 2: whatever is not defined will take definition from domestic
law
- Article 4
- Resident and contracting state
- Now we will study article 5 which deals with permanent establishment. VERY
IMPORTANT ARTICLE.
- What is a permanent establishment? Is it only about fixed places or there are
other notions of PE as well? There are two forms of PE: physical PE and agency
PE.

-
- Suppose you are starting a fashun company and you are a resident in India and
this fashun company becomes very successful and now you want to expand to
B’desh to test the waters. Now you have a website and any customer can get on
the website. You can dispatch goods from India and the customer will receive the
goods. In such a case, can B’desh tax you on your business profits? To tax
business profits, what does the OECD Model say?
- Article 7(1): 1. The profits of an enterprise of a Contracting State shall be taxable
only in that State unless the enterprise carries on business in the other
Contracting State through a permanent establishment situated therein. If the
enterprise carries on business as aforesaid, the profits of the enterprise may be
taxed in the other State but only so much of them as is attributable to that
permanent establishment.
- Two limbs:
- Exclusive right (uses the word “only”) to taxation to the resident state.
- Shared right (uses the term “ unless”) to taxation to the source state
through the PE situated therein.
- He starts reading all of this:
- Enterprise of a contracting state is defined in article 3(1)(c): the term
"enterprise" applies to the carrying on of any business. Enterprise =
business.
- Article 3(1)(d): the terms "enterprise of a Contracting State" and
"enterprise of the other Contracting State" mean respectively an
enterprise carried on by a resident of a Contracting State and an
enterprise carried on by a resident of the other Con- tracting State.
- Resident definition is again, under article 4. Only persons can be resident
and persons can be individuals or non-natural persons.
- Definition of business: the term "business" includes the performance of
professional services and of other activities of an independent character.
Article 3(1)(h) gives an inclusive definition that was included after
deletion of article 14.
 - Article 3(1)(h) does not define but is only inclusive in nature.
Terms which aren’t defined in the Convention, we look at the
domestic tax law to check for the definition. Thus, we look for a
definition of business there. Para 10.2 of the Commentary on
article 3 also states this thing.
- What does carrying on of business imply? Should there be continuity or
permanence or a systematic business? It implies this. But what is a one shot deal,
does it fall under article 7? Read article 7(1). Isolated transaction of business case:
Steele v. FCT. The Court here said that a single activity can constitute enterprise.
So, “carrying on” is a linking expression that does not imply repetition or
presence of a structured system. Heading of article 7 supports the notion that
one or more transactions entered into business purposes is an enterprise. So, one
shot deal or two deals can be construed as an enterprise for the purposes of this
Convention.

-
- Profit is not defined in the Convention, so domestic law will be looked at. In the
UK and Australia, they use “taxable income” and not profit in their laws. In
Theil Case, the Court said that lack of domestic law on the meaning of profits led
to usage of tax treaty to settle the matter.
- Goes back to the fashun company example. Headquartered in India and
subsidiary set up in B’desh. What would be the residence of the subsidiary -
India/B’desh? B’desh resident (says that we have done this discussion on the
central and effective management test). Any profit that the subsidiary makes, who
would have the exclusive right? The resident state, i.e., B’desh under a. 7.
-
- When we talk about PE, we are talking about the second limb of article 7, i.e., the
shared taxation right. Now, you are not setting up a subsidiary but have formed a
PE in B’desh. Because PE does not have a separate legal form, it is a fictional
concept - PE is deemed to be set up in B’desh. And both the countries will have
a shared right of taxation.
- PE, in its origin, is a German concept. Article 5 contains a comprehensive
definition of PE. PE definition is important for application of a. 7 and other
respects (like dividends clause, interest, royalty, capital gains, other income
article).
- Article 5(1): For the purposes of this Convention, the term "permanent
establishment" means a fixed place of business through which the business of an
enterprise is wholly or partly carried on.
- Important opening words: “for the purposes of this Convention”.
- It requires a non-resident and sufficient direct presence.
- PE is not a formal legal concept, it is a fictional concept.
- This article incorporates express limitations to both - physical and agency
PE.
- Physical PE
- Fixed place of business - how fixed should a place be before calling it a
PE?

-
- Geographical aspect:
 - India-Nepal border is semi-permeable. You have a van. When
you cross over to Nepal and park at some place, the next day you
park at some other place, would it be a fixed place of business?
What if you have designated places? These are questions to be
answered through investigation, interpretation and
characterisation. A lot of guidance has been given in the
commentary. Sometimes the guidance is categorical, sometimes
ambiguous. But it is ALWAYS a question of fact.
- Para 23 of the OECD Commentary gives an example that a
market itself could be a fixed place of business. While your van
cannot be seen as a fixed place of business, the market can be.
- Temporal aspect:
-

- Para 28 of the OECD Commentary states the 6 months test.

- Para 123 of the Commentary on article 5 states that a website is
not sufficient to constitute a PE. The problem here arises because
now we are in a digital world and when these rules were written,
digital transactions were not present.
- Para 11 then says that legal title to occupying a particular location
is not necessary. Suppose you have a warehouse, now even if you
don't have the legal title (ownership/rental agreement) to it, it
would not be necessary and it would be sufficient to have a
certain amount of space for disposal that can be used to carry out
business activities. The test is: Are the premises at your disposal?
If yes, then physical PE. This test is coming from para 10 of the
commentary on article 5.
- Dudney Case: The treaty in question was Canada-US tax treaty. The
taxpayer was a US resident who was providing computer services in
Canada. Almost 300 days of service was provided in Canada by Dudney.
Did the US taxpayer have a fixed base/premises at disposal in Canada?
The Court drew a distinction between a fixed palace of business and a
 place at which business must be carried on. Para 10 of the commentary
blurs this distinction but the Canadian Court did not agree with that. The
Court said that while the US taxpayer was present for almost 300+ days,
but was working at the client’s premises and the place was NOT at his
disposal. So, no fixed PE and place of business.

-
- Knights of Columbus Case: In this case the insurance agent was a
Canadian national who was soliciting services for an American company.
Was the home office at the disposal of the American company? The
Court held that the home office was NOT at the disposal of the US
company whose products the Canadian agent promoted. So, not PE.
- Article 5(2): The term "permanent establishment" includes especially: a
place of management; a branch; an office; a factory; a workshop, and a
mine, an oil or gas well, a quarry or any other place of extraction of
natural resources.

-
- Para 45 states that it is an illustrative list. It includes very visible places.
There is no ambiguity like home office being at disposal. This list should
be interpreted in a way through which the business of enterprise is wholly
or partly carried on (5(1) to be satisfied basically).
- Article 5(3): A building site or construction or installation project
constitutes a permanent establishment only if it lasts more than twelve
months.
 - Specifically, the permanency level is defined. If you cross the
threshold of 12 months, it would be construed as a PE. The UN
Model has reduced this to 6 months while the OECD Model
states 12 months. Historically there was a lot of debate on this
because of manipulation and fragmentation of this requirement.
BEPS now says that such cases/abuse-related cases will be
covered under article 29 of the OECD (anti-abuse article it is).

Last 10 mins he took questions and repeated things that I have added in relevant sections. Now
he is asking us to prepare an attendance sheet lmao bye

5th September
Questions asked on the basis of previous classes:
· Concept of PE – Central to the taxing right of a source jurisdiction over business
profits on a nonresident enterprise. It is the frontier at which the most intense
discussions and battles re being fought with respect to taxing the digital economy
(digital companies, services and transactions).
· Why did the Court decide in Dudney’s case that there was no fixed place of business?
Facts of the case: US-Canada Tax Treaty. The taxpayer was a US resident who was
providing computer services in Canada. The question was whether he had a fixed place
in Canada. He provided services for 300 days in year 1 and 40 days in year 2. However,
the court held that the premises of the client was not freely available to the disposal of
Dudney, thus the Court drew a distinction between a fixed place of business and a place
where the business was carried out. In this case, there was no permanent establishment.
The Court decided that the place where Dudney was working from was not at his
disposal and hence, it was not a fixed place of business. Court was looking at Article 14
of US-Canada tax treaty, which dealt with fixed base (same as PE), which has now been
deleted from the Model Convention. The concept of fixed base has been deleted from
OECD Model since it is indistinguishable from a PE.
The Court asked why there is a fixed place of business through which the business of the
enterprise is carried on. Why does business appear twice in the same article? It must be a
fixed place of business and not just a fixed place.
· How many kinds of PEs does Article 5 of the OECD Model Convention consider?
 Two kinds of PEs: Agency PEs and Fixed Place PEs. Agency PEs are found in Article
5(5). The UN Model also has a services PE. While this was recognized in the OECD
Commentary, the OECD Model does not provide for a services PE.
· What changes were introduced in 2017? The OECD introduced the anti-
fragmentation rule and substantial changes were made to Arts. 5(5) and 5(6). These
changes were made to reflect the fact that there were commissionaire contracts
which operated without contracts existing between the purchaser and the seller. Due
to the absence of PE, the non-resident enterprise (enterprise of the other contracting
state) was avoiding getting taxed. Non-resident enterprise can be taxed only if it has a
PE in the taxing state. This forms the root of conflict in case of digital taxation since
most digital mammoths do not establish PEs to avoid taxation.
· Does the OECD Model provide for the force of attraction rule? This rule has been
out rightly rejected in the OECD Commentary while it is recognized and applied by
the UN Model.
· Knights of Columbus case- Company in the US with insurance agents in Canada. The
agents would conclude contracts in Canada and send them back to the US for
approval. Revenue argued that there should be a fixed PE on the grounds that the
company had complete disposal over the homes of the insurance agents and thus it
was carrying on business through that, forming a PE. Essentially argued that homes
of these agents should be seen as a fixed place of business. However, this argument
was rejected by the Court. It also did not qualify as an agency PE. Even though there
was an approval of 90% of the contracts sent back, this was not an automatic or
mechanical process. The company had control over which contracts were passed.
The court said that even this 90% approval was not enough to establish an agency
PE.

Commentary on Article 5
(Has mostly just read out OECD commentary. Additional comments have been highlighted.)

1.The main use of the concept of a permanent establishment is to determine the right of a
Contracting State to tax the profits of an enterprise of the other Contracting State. Under Article
7 a Contracting State cannot tax the profits of an enterprise of the other Contracting State unless
it carries on its business through a permanent establishment situated therein.

- Main use is to ascertain whether the source state has the right to tax the profits of a
non-resident enterprise. A source state cannot tax the profits of a non-resident
enterprise unless it carries on its business through a PE, under Article 7.

2. Before 2000, income from professional services and other activities of an independent
character was dealt under a separate Article, i.e. Article 14. The provisions of that Article were
similar to those applicable to business profits but it used the concept of fixed base rather than
that of permanent establishment since it had originally been thought that the latter concept
should be reserved to commercial and industrial activities. The elimination of Article 14 in 2000
reflected the fact that there were no intended differences between the concepts of permanent
establishment, as used in Article 7, and fixed base, as used in Article 14, or between how profits
were computed and tax was calculated according to which of Article 7 or 14 applied. The
elimination of Article 14 therefore meant that the definition of permanent establishment became
applicable to what previously constituted a fixed base.

3. In 2017, a number of changes were made to this Commentary. Some of these changes were
intended to clarify the interpretation of the Article and, as such, should be taken into account for
the purposes of the interpretation and application of conventions concluded before their
adoption because they reflect the consensus of the OECD member countries as to the proper
interpretation of existing provisions and their application to specific situations (see paragraph 35
of the Introduction).

- Criticism is always that the OECD does not want to have a holistic approach. It sticks
to the older, archaic ways of allocating tax jurisdictions or dividing fiscal base
between two parties. It follows a very status-quoist approach which does not take
into consideration changing landscapes of commerce and taxation.

- The changes which were merely clarificatory in nature functioned retrospectively,

since in reflects the consensus of OECD members. Substantive changes were
prospective.

4. Changes to this Commentary related to the addition of paragraph 4.1 and the modification of
paragraphs 4, 5 and 6 of the Article that were made as a result of the adoption of the Report on
Action 7 of the OECD/G20 Base Erosion and Profit Shifting Project were, however,
prospective only and, as such, do not affect the interpretation of the former provisions of the
OECD Model Tax Convention and of treaties in which these provisions are included, in
particular as regards the interpretation of paragraphs 4 and 5 of the Article as they read before
these changes (see paragraph 4 of that Report).

- Elective in the MLI Framework.

5. In many States, a foreign enterprise may be allowed or required to register for the purposes of
a value added tax or goods and services tax (VAT/GST) regardless of whether it has in that State
a fixed place of business through which its business is wholly or partly carried on or whether it is
deemed to have a permanent establishment in that State under paragraph 5 of Article 5. By itself,
however, treatment under VAT/GST is irrelevant for the purposes of the interpretation and

6. Paragraph 1 gives a general definition of the term “permanent establishment” which brings
out its essential characteristics of a permanent establishment in the sense of the Convention, i.e.
a distinct “situs”, a “fixed place of business”. (Whole of Article 5 applies to the entirety of the
Convention) The paragraph defines the term “permanent establishment” as a fixed place of
business, through which the business of an enterprise is wholly or partly carried on. ( This is the
wording which the Canadian court caught onto in Dudney. Because business was used twice in a
span of 10-12 words, it had to have a certain meaning. Though the Commentary tried to
obliterate this difference, it was not accepted by Canada) This definition, therefore, contains the
following conditions:
-the existence of a “place of business”, i.e. a facility such as premises or, in certain instances,
machinery or equipment; (Even a single vending machine at the disposal of the enterprise will
meet the requirement)
-this place of business must be “fixed”, i.e. it must be established at a distinct place with a certain
degree of permanence;
-the carrying on of the business of the enterprise through this fixed place of business. ( Thiel case
and even in the Indian F1 case, held that even one-shot deal could constitute the carrying on of
business. Repetition or a pattern of transactions is not necessary) This means usually that
persons who, in one way or another, are dependent on the enterprise (personnel) conduct the
business of the enterprise in the State in which the fixed place is situated.

7. It could perhaps be argued that in the general definition, some mention should also be made
of the other characteristic of a permanent establishment to which some importance has
sometimes been attached in the past, namely that the establishment must have a productive
character, i.e. contribute to the profits of the enterprise. In the present definition this course has
not been taken. (Immaterial whether the PE is contributing to the profits of the enterprise. Profit
and loss is not the yardstick.) Within the framework of a well-run business organisation it is
surely axiomatic to assume that each part contributes to the productivity of the whole. It does
not, of course, follow in every case that because in the wider context of the whole organisation a
particular establishment has a “productive character” it is consequently a permanent
establishment to which profits can properly be attributed for the purpose of tax in a particular
territory (see Commentary on paragraph 4).
8. It is also important to note that the way in which business is carried on evolves over the years
so that the facts and arrangements applicable at one point in time may no longer be relevant after
a change in the way that the business activities are carried on in a given State. Clearly, whether or
not a permanent establishment exists in a State during a given period must be determined on the
basis of the circumstances applicable during that period and not those applicable during a past or
future period, such as a period preceding the adoption of new arrangements that modified the
way in which business is carried on. (Whether PE exists or not depends on the particular
time/period in question. Not dependent on past or future.)

9. Also, the determination of whether or not an enterprise of a Contracting State has a

permanent establishment in the other Contracting State must be made independently from the
determination of which provisions of the Convention apply to the profits derived by that
enterprise. For instance, a farm or apartment rental office situated in a Contracting State and
exploited by a resident of the other Contracting State may constitute a permanent establishment
regardless of whether or not the profits attributable to such permanent establishment would
constitute income from immovable property covered by Article 6; whilst the existence of a
permanent establishment in such cases may not be relevant for the application of Article 6, it
would remain relevant for the purposes of other provisions such as paragraphs 4 and 5 of Article
11, subparagraph c) of paragraph 2 of Article 15 and paragraph 3 of Article 24.

10. The term “place of business” covers any premises, facilities or installations used for carrying
on the business of the enterprise whether or not they are used exclusively for that purpose.
(Fixed place of business does not need to be registered) A place of business may also exist where
no premises are available or required for carrying on the business of the enterprise and it simply
has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or
installations are owned or rented by or are otherwise at the disposal of the enterprise. A place of
business may thus be constituted by a pitch in a market place, or by a certain permanently used
area in a customs depot (e.g. for the storage of dutiable goods). Again the place of business may
be situated in the business facilities of another enterprise. This may be the case for instance
where the foreign enterprise has at its constant disposal certain premises or a part thereof owned
by the other enterprise.

11. As noted above, the mere fact that an enterprise has a certain amount of space at its disposal
which is used for business activities is sufficient to constitute a place of business. No formal legal
right to use that place is therefore required. Thus, for instance, a permanent establishment could
exist where an enterprise illegally occupied a certain location where it carried on its business.

12. Whilst no formal legal right to use a particular place is required for that place to constitute a
permanent establishment, the mere presence of an enterprise at a particular location does not
necessarily mean that that location is at the disposal of that enterprise. Whether a location may
be considered to be at the disposal of an enterprise in such a way that it may constitute a “place
of business through which the

28. Since the place of business must be fixed, it also follows that a permanent establishment can
be deemed to exist only if the place of business has a certain degree of permanency, i.e. if it is
not of a purely temporary nature. A place of business may, however, constitute a permanent
establishment even though it exists, in practice, only for a very short period of time because the
nature of the business is such that it will only be carried on for that short period of time. It is
sometimes difficult to determine whether this is the case. Whilst the practices followed by
member countries have not been consistent in so far as time requirements are concerned,
experience has shown that permanent establishments normally have not been considered to exist
in situations where a business had been carried on in a country through a place of business that
was maintained for less than six months (conversely, practice shows that there were many cases
where a permanent establishment has been considered to exist where the place of business was
maintained for a period longer than six months). (This is where the rule of thumb of six months
for PE comes from)

Paragraph two:

45. This paragraph contains a list, by no means exhaustive, of examples of places of business,
each of which can be regarded as constituting a permanent establishment under paragraph 1
provided that it meets the requirements of that paragraph. As these examples are to be read in
the context of the general definition given in paragraph 1, the terms listed, “a place of
management”, “a branch”, “an office”, etc. must be interpreted in such a way that such places of
business constitute permanent establishments only if they meet the requirements of paragraph 1
and are not places of business to which paragraph 4 applies. (Subject to both paragraph 1 and
para 4)

46. The term “place of management” has been mentioned separately because it is not necessarily
an “office”. However, where the laws of the two Contracting States do not contain the concept
of “a place of management” as distinct from an “office”, there will be no need to refer to the
former term in their bilateral convention.
47. Subparagraph f) provides that mines, oil or gas wells, quarries or any other place of extraction
of natural resources are permanent establishments. The term “any other place of extraction of
natural resources” should be interpreted broadly. It includes, for example, all places of extraction
of hydrocarbons whether on or off-shore.
48. Subparagraph f) refers to the extraction of natural resources, but does not mention the
exploration of such resources, whether on or off shore. Therefore, whenever income from such
activities is considered to be business profits, the question whether these activities are carried on
through a permanent establishment is governed by paragraph 1. (thus exploration is governed by
Paragraph 1.)
Paragraph 3
49. The paragraph provides expressly that a building site or construction or installation project
constitutes a permanent establishment only if it lasts more than twelve months. (Time threshold
in UN Model is 6 months) Any of those items which does not meet this condition does not of
itself constitute a permanent establishment, even if there is within it an installation, for instance
an office or a workshop within the meaning of paragraph 2, associated with the construction
activity. Where, however, such an office or workshop is used for a number of construction
projects and the activities performed therein go beyond those mentioned in paragraph 4, it will
be considered a permanent establishment if the conditions of the Article are otherwise met even
if none of the projects involve a building site or construction or installation project that lasts
more than twelve months. In that case, the situation of the workshop or office will therefore be
different from that of these sites or projects, none of which will constitute a permanent
establishment, and it will be important to ensure that only the profits properly attributable to the
functions performed through that office or workshop, taking into account the assets used and
the risks assumed through that office or workshop, are attributed to the permanent
establishment. This could include profits attributable to functions performed in relation to the
various construction sites but only to the extent that these functions are properly attributable to
the office. (attributability governed under Article 7 Para 2)

50. The term “building site or construction or installation project” includes not only the
construction of buildings but also the construction of roads, bridges or canals, the renovation
(involving more than mere maintenance or redecoration) of buildings, roads, bridges or canals,
the laying of pipe-lines and excavating and dredging. Additionally, the term “installation project”
is not restricted to an installation related to a construction project; it also includes the installation
of new equipment, such as a complex machine, in an existing building or outdoors. On-site
planning and supervision of the erection of a building are covered by paragraph 3. States wishing
to modify the text of the paragraph to provide expressly for that result are free to do so in their
bilateral conventions.
52. The twelve-month threshold has given rise to abuses; it has sometimes been found that
enterprises (mainly contractors or subcontractors working on the continental shelf or engaged in
activities connected with the exploration and exploitation of the continental shelf) divided their
contracts up into several parts, each covering a period of less than twelve months and attributed
to a different company which was, however, owned by the same group. Apart from the fact that
such abuses may, depending on the circumstances, fall under the application of legislative or
judicial anti-avoidance rules, these abuses could also be addressed through the application of the
anti-abuse rule of paragraph 9 of Article 29, as shown by example J in paragraph 182 of the
Commentary on Article 29. Some States may nevertheless wish to deal expressly with such
abuses. Moreover, States that do not include paragraph 9 of Article 29 in their treaties should
include an additional provision to address contract splitting. Such a provision could, for example,
be drafted along the following lines….

Paragraph 4
58. This paragraph lists a number of business activities which are treated as exceptions to the
general definition laid down in paragraph 1 and which when carried on through fixed places of
business, are not sufficient for these places to constitute permanent establishments. (Endeavour
is to say that these activities are not substantial enough to see as participation of the non-resident
enterprise in the economic life of the source state. The activity should have enough substance to
contribute to the economy of the contracting state, and thereby also benefiting from the
resources of the state)The final part of the paragraph provides that these exceptions only apply if
the listed activities have a preparatory or auxiliary character. Since subparagraph e) applies to any
activity that is not otherwise listed in the paragraph (as long as that activity has a preparatory or
auxiliary character), the provisions of the paragraph actually amount to a general restriction of
the scope of the definition of permanent establishment contained in paragraph 1 and, when read
with that paragraph, provide a more selective test by which to determine what constitutes a
permanent establishment. To a considerable degree, these provisions limit the definition in
paragraph 1 and exclude from its rather wide scope a number of fixed places of business which,
because the business activities exercised through these places are merely preparatory or auxiliary,
should not be treated as permanent establishments. It is recognised that such a place of business
may well contribute to the productivity of the enterprise, but the services it performs are so
remote from the actual realisation of profits that it is difficult to allocate any profit to the fixed
place of business in question. Moreover subparagraph f) provides that combinations of activities
mentioned in subparagraphs a) to e) in the same fixed place of business shall be deemed not to
be a permanent establishment, subject to the condition, expressed in the final part of the
paragraph, that the overall activity of the fixed place of business resulting from this combination
is of a preparatory or auxiliary character. Thus the provisions of paragraph 4 are designed to
prevent an enterprise of one State from being taxed in the other State if it only carries on
activities of a purely preparatory or auxiliary character in that State. The provisions of paragraph
4.1 (see below) complement that principle by ensuring that the preparatory or auxiliary character
of activities carried on at a fixed place of business must be viewed in the light of other activities
that constitute complementary functions that are part of a cohesive business and which the same
enterprise or closely related enterprises carry on in the same State.

60. As a general rule, an activity that has a preparatory character is one that is carried on in
contemplation of the carrying on of what constitutes the essential and significant part of the
activity of the enterprise as a whole.

Paragraph 4.1: Anti-Fragmentation Rule

79. The purpose of paragraph 4.1 is to prevent an enterprise or a group of closely related
enterprises from fragmenting a cohesive business operation into several small operations in
order to argue that each is merely engaged in a preparatory or auxiliary activity. Under paragraph
4.1, the exceptions provided for by paragraph 4 do not apply to a place of business that would
otherwise constitute a permanent establishment where the activities carried on at that place and
other activities of the same enterprise or of closely related enterprises exercised at that place or at
another place in the same State constitute complementary functions that are part of a cohesive
business operation. For paragraph 4.1 to apply, however, at least one of the places where these
activities are exercised must constitute a permanent establishment or, if that is not the case, the
overall activity resulting from the combination of the relevant activities must go beyond what is
merely preparatory or auxiliary.

Paragraph 5: Service PE
83. Persons whose activities may create a permanent establishment for the enterprise are
persons, whether or not employees of the enterprise, who act on behalf of the enterprise and are
not doing so in the course of carrying on a business as an independent agent falling under
paragraph 6. Such persons may be either individuals or companies and need not be residents of,
nor have a place of business in, the State in which they act for the enterprise. It would not have
been in the interest of international economic relations to provide that any person undertaking
activities on behalf of the enterprise would lead to a permanent establishment for the enterprise.
Such treatment is to be limited to persons who in view of the nature of their activity involve the
enterprise to a particular extent in business activities in the State concerned. Therefore,
paragraph 5 proceeds on the basis that only persons habitually concluding contracts that are in
the name of the enterprise or that are to be performed by the enterprise, or habitually playing the
principal role leading to the conclusion of such contracts which are routinely concluded without
material modification by the enterprise, can lead to a permanent establishment for the enterprise.
In such a case the person’s actions on behalf of the enterprise, since they result in the conclusion
of such contracts and go beyond mere promotion or advertising, are sufficient to conclude that
the enterprise participates in a business activity in the State concerned. The use of the term
“permanent establishment” in this context presupposes, of course, that the conclusion of
contracts by that person, or as a direct result of the actions of that person, takes place repeatedly
and not merely in isolated cases.

Non-Discrimination Principle

- Article 24, Paras 3 and 5 of OECD Model Convention.

- Unlike domestic tax laws which are based on the principles efficiency, equity fairness,
simplicity, etc, these principles are somewhat alien to the international taxation and
the Model concerns itself only with allocating tax jurisdictions in case of cross border
transactions.
- Tax treaties do not incorporate the principles found in domestic constitutions.
- Only one rule of non-discrimination- Article 24. An exception to the norm, where a
rule based on fairness is present.
- The principle of non-discrimination is concerned with equity, but it is subjected to
the application of other substantive provisions of the treaty. . If the legitimate
application of other rules, leads to discrimination, then so be it.
- Two main objectives: To prevent the discrimination of any kind by one state in taxing
nations of the treaty partner state and to prevent discrimination by one state in
relation to residents of the other state in three cases, all relating to business income.
- Article 24(1) – Nationals of a Contracting State shall not be subjected in the other
Contracting State to any taxation or any requirement connected therewith, which is
other or more burdensome (subjective test) than the taxation and connected
requirements to which nationals of that other State in the same circumstances, in
particular with respect to residence, are or may be subjected. (If the state can show
the circumstances are different, different taxing rules can be applied) This provision
shall, notwithstanding the provisions of Article 1, also apply to persons who are not
residents of one or both of the Contracting States.
 - Countries can discriminate on the basis of residence, but not on the basis of
nationality. An individual does not have to be a resident of either state to allege
breach of non-discrimination, he has to be a national..

- Beth Case: Beth is a national of Country B, where she is also a resident. Country A is
the source state. Suppose Country A decides to tax Beth at 40% while it is taxing its
own residents at 30%. Will this lead to a breach of 24(1) ?
Comaparator in case of 24(1) is the national. In this case, hypothetical comparator will be
national of Country A. He will be in the same circumstances as Beth when he is the tax
resident of Country B. If A is taxing its nationals who are tax residents in country B also
at 40%, then there shall be no breach.
What would be the consequence if Beth was a national of Country B but a tax resident of
Country A? Beth would have to be taxed at the same rate as nationals and tax residents
of Country A.

11 September

Class started abruptly.

In what situation one might apply article 24(3)? It is clear that what is applicable is
orphan approach when it comes to a comparator, we are looking at the independent
enterprise of the source state that is carrying on the same business as the PE. The
group sourcing rules which is the corporate grouping rules do not apply as it is PE.
Commentary makes it clear in Para 41.
Example- some countries tax PE non resident at a higher rate than resident
companies. So you may have a domestic tax rules that says that foreign PE or PE
owned by foreign resident will be taxed 25% on the business profit while domestic
corporation may be taxed at 20%. This kind of discrimination is prohibited by 24(3).

But there could be other general rules or concessions that are applicable to the local
companies which should be extended to PE provided they are conducting the same
kind of activities.

Article 24(5) doesn’t use the term ‘activity’. It talks about taxation of entity itself rather
than actual taxation of activities for the reason that there is formal or juridical entity
so they can talk about the entity and not just activity. In case of PE you don’t have
any entity but you have a fiction so they have to talk about the activities. It talks
about similar enterprises as comparator.

It doesn’t apply any differently than Article 24(3) cause that’s the position of OECD.
And the para 77 of the commentary on article 24 reproduces and uses similar
meaning to what we saw in Para 41. Thus, even OECD uses the orphan approach.

One imp feature of this article is that it protects the subsidiary discrimination in
source country but it doesn’t prevent discrimination of residence parent. It protects
the taxation of subsidiary not the taxation of non-resident parent. So their taxation
may be discriminated in the resident country. it is only applicable on the
discrimination that emanate in source country.

Imp point- discrimination is only applicable to the source country and that’s how
limited the article 24 is in dealing with issues of discrimination.

Cases

Boake Allen- mentioned in professor Peter Harris’s book.

In this case, there was a UK Subsidiary of a German parent. Everything the UK

subsidiary distributes a dividend to German parent, the subsidiary had to pay tax on
its own account called advance corporation tax. It was levied as subsidiary
distributed a dividend but then that tax that had to be paid by the subsidiary with
respect to the dividend, could be credited against the subsidiary’s own tax liabilities.
By comparison if the subsidiary had been owned by a UK Parent, then when it paid
actual dividend to the parent, both the subsidiary and parent would elect for the
payment to be exempted from advance corporation tax. It doesn’t reduce or diminish
the tax liability but cash flow disadvantage. It is the question of timing. No permanent
benefit in either scenario. In corporate world, question of timing can also have
serious consequences as there are huge cash flow advantage especially if the
corporation is big. UK subsidiary of german parent said that this was discrimination
under article 24(5).

Leading judgement was by Lord Hoffman in House of Lords. He said that advance
corporation tax provision did not breach art 24(5) because if we remember art 24(1),
it uses the word ‘solely by reason of nationality’. Lord Hoffman picked on that and
said discrimination cannot be explained by any other ground. If there are other
grounds except nationality to discriminate then it doesn’t breach art 24(1) and he
picked on that commentary and argued that it must be only ground on which
discrimination must be done. OECD commentary doesn’t repeat this observation in
relation to art 24(5) but the principle must be the same. It is a self-contained
provision so the principle that applies to art 24(1) must apply to 24(5).

He noted that on the facts of the case, whether the subsidiary paid advance corp tax
or not in a purely domestic scenario, depended on the joint election of both sub and
parent together. consequence of the election was that if subsidiary doesn’t pay ACT,
then parent will pay when it distributes its own dividend. That will be the
consequence. Whereas if subsidiary paid ACT, when parent redistributed the
dividend, it will not have to pay ACT. Either sub pays or parent pays. Lord Hoffmann
said this is election between two companies in the charge to UK corp tax as to one of
them will pay ACT. Further this rule cannot be applied in a cross-border scenario
when there is foreign parent. There was one option as far as subsidiary was
concerned.

In 2008, OECD commentary was amended to be consistent with Lord Hoffman’s

ruling which is “solely by reason of” test, which now appears in commentary at para
78 and 79 of article 24.
OECD commentary takes orphan approach to the comparator under art 24(5).

FCE Bank case, Court of Appeal, UK

In this case, UK is country in question and two subsidiary of the Ford Motor
Company- one is in loss and other is in profit. If they were owned by UK Parent, they
would have been allowed to transfer losses from the loss company to the profit
company and then the profit company would not have to pay taxes on its profits. But
the right to offset profits against losses in groups was denied if parent was foreign
parent. It is clear discrimination according to sir but still the commentary says orphan
approach has to be taken.

It was held that the effect of 24(5) is to outlaw discriminatory treatment of subsidiary
resident in the UK with a foreign parent when compared to subsidiary directly held by
a UK parent. If you compare the tax treatment of company with profit with another
independent company, then it will not be able to get use of the losses as it doesn’t
have a parent. OECD commentary says there is no question of comparator which is
independent enterprise transferring the losses.

The court compared the FCE with UK subsidiary owned by UK Parent and its ability
to set off loss with another subsidiary. Tax payer won the case and it was found that
the denial to use losses was contrary to 24(5) and the comparator were two UK
subsidiary to UK Parent which according to sir seems contradictory to what OECD
commentary says i.e., independent company has to be compared with subsidiary of
foreign company.

ARTICLE 10
Suppose, there is subsidiary in source country A and parent in resident country B
and source country subsidiary is paying dividend to parent in country B. This article
says that subsidiary in source country is paying dividend to the parent in country may
be taxed in country where parent is located. Resident country can tax or may tax but
it just states general principle that dividend are taxable in country where the parent
shareholder is resident. Commentary states that payment is the fulfilment of the
obligation to put fund at the disposal of the shareholder in the manner required by
the contract accustomed.

Question that arises is whether this article limits the taxation of dividend before they
are paid i.e., prospective dividend. It will be relevant later.

Dividends are sourced where the corporation paying the dividend is resident. This is
implicit source rule.

The article says ‘paid by the company’ but it doesn’t say paid by the profits of the
company.

The tie breaker rule of OECD is place of effective management test which is two
country test. under the old tie breaker rule, you have a company in market
jurisdiction and you are foreign parent. Subsidiary is sitting with profit. under the old
rule, you will transfer the place of effective management to Mauritius or new jersey
and once it has been transferred then you distribute the profits. The dividend will be
sourced in Mauritius. It doesn’t say dividend arising from the profits made. It’s a
fragile source rule which peter harris points out and if we take the tie breaker rule of
pre 2017 type, exactly because of these problems, the rule was changed.

The scope of art 10 of oecd model is limited by its implicit source rule. It only applies
to dividend distributed by corporations that are resident in one of the two contracting
states.

The UN model leaves it blank for the contracting states to negotiate for themselves,
but even the countries who follow the oecd model, they also sometimes opt for
different rates. Resident country of the shareholder receiving the dividend, it can tax
but art 10(2) says that it may also be taxed in that state i.e., state of the source acc
to the laws of the state. It used ‘may’, which means there needs to be a domestic
rule. Treaty doesn’t create charge to tax. treaty puts cap of tax to be charged.

General rule of thumb is that if you control the capital or voting rights 10% more, it is
direct investment and below 10% its portfolio investment. It is the rule of thumb. But
here OECD says 25%.

So this section provides limited right to tax dividend at the source country. that
limitation differs on the degree of shareholding or control of the non-resident
shareholder.

Article 10(2)(b)
This article incorporates a residual rule that the source country may tax dividend
distributed by resident corp at a rate not exceeding 15% of the gross amount of the
dividend. It is flat. Could be burdensome.

There is also principle of reciprocity which means it applies to both the states.

Peter harris says that Often, the limitation on dividend tax rates in treaties is higher
than the 15 per cent in the OECD Model, but more often, it is lower. There are two
reasons for this.

- First, the tax entitlement is on the gross amount of dividends, i.e. without
deduction of expenses in deriving dividends. Where those expenses are
substantial, the tax authorised by the OECD Model can be a substantial
impediment to cross-border investment. Any taxation of gross amount is
impediment. This problem is similarly acute with other forms of withholding tax
such as those imposed on interest and royalties.
- OECD model prevents juridical double taxation but not economic double taxation.
Juridical double taxation means that same entity being taxed by two states on the
same income and economic double taxation means same income being taxed
twice in the hands of 2 different person resident of two different countries. Full
taxation rights to the source country but then the same profits out of which
dividends have been derived are being taxed. This is classical corporate tax
system which is OECD model presuming. A classical system is a corporate tax
system under which corporate profits are taxed and dividends distributed from
those profits are taxed without relief for one tax against the other, i.e. economic
double taxation. The problem is that most countries do not have a full classical
system and so provide at least some relief from the economic double taxation of
corporate income. This is a second reason why source state taxation of dividends
is often reduced below the OECD 15 per cent rate
Tax treaties based on OECD models preserve the source country right to tax and
distribution by resident corporation. There is no limit of taxing for the source state
with respect of taxing corporate profits.
Normally countries provide relief from this double taxation and proff. Harris says
there are 6 different ways in which relief provided. 3 forms of reliefs at the
shareholder level are most common. For eg. Many countries exempt dividends paid
between two corporations which is intra group dividend and inter corp dividends are
exempted. There could also be a system of reduced tax rate wherein dividends are
paid between companies within associated enterprises or it could be a taxcredit.
But it is common that there reliefs apply in domestic scenario. Wherein both the
company and subsidiary are located in same source country. it is also common that
dividend relief granted to resident shareholder is not granted to non-resident
shareholders. Country discriminate on the basis of tax residence, don’t discriminate
on the basis of nationality.
The granting of dividend tax credits (or any other form of dividend relief) to resident
shareholders in resident corporations but denying such a credit to non-resident
shareholders in such corporations constitutes discrimination, at least at some level.
However, the non-discrimination principle in Article 24 of the OECD Model is too
narrow to deal with this situation. The nationality clause in Article 24(1) is usually
inapplicable because source countries inevitably deny the dividend tax credits to
their own non-resident nationals. Article 24(3) (discussed above at 3.1.3.4) applies to
PEs and dividends received by non-residents through a source country PE are
further considered below. Article 24(5) (also discussed above at 3.1.3.4) requires
further consideration.
24(3) and 24(5) they do not prevent discrimination against non-resident
shareholders.
Article 24(5) of the OECD Model prevents discrimination of a resident corporation on
grounds of non-resident ownership. It does not prevent discriminatory taxation of
dividends distributed to non-residents unless that taxation pertains to the resident
corporation.
Prof. Harris says by contrast, some forms of dividend relief operate to grant tax relief
to the distributing corporation, such as a dividend deduction system or a system that
applies a lower corporate tax rate to distributed profits than retained profits (split rate
system). Article 24(5) would be breached if the deduction or lower rate were denied
just because the distribution was to a nonresident shareholder. This anomaly under
Article 24(5), i.e. that it protects against discrimination under corporate level dividend
relief systems but not shareholder level dividend relief systems, has played an
important role in the steady extinction of corporate level dividend relief systems.
This is OECD fixation as prof harris says whether the taxation involves the
shareholder or the distributing corporation and it extend to source country taxation of
dividend that is limited by art 10(2) as we just saw.
Article 10(2)(a)
Its primary purpose is to mitigate the cascading of tax as dividends are distributed
between corporations. Even classical countries typically provide relief from economic
double taxation of inter-corporate dividends. OECD model requires the recipient corp
to hold 25% of the capital. This is conservative as the rule of thumb in int investment
law is that 10% shareholding is good enough to categorize it as FDI. It also has to be
direct.
The article also says ‘throughout a 35 day period’ which is on the day of payment
preceding that, atleast for 365 days the ownership of the shareholding must remain
frozen. This is to prevent dividend stripping arrangements. Shares in a company are
sold before dividends are distributed to a corp resident in a country where it is tax
treaty with low rate in art 10. This is treaty shopping as looking at treaty that provides
least amount of withholding tax and then you pay dividend.

DIVIDEND AND PE

Article 10(4) and (5) of the OECD Model are two provisions that essentially deal with
dividends and PEs. In some senses they deal with opposite scenarios; Article 10(4)
dealing with dividends received by PEs and it is reconciliatory rule because it says in
such scenarios dividend are to be taxed in accordance with Art 7 and not Art 10 as
there are deductions for business incomes. When taxed as business income Article
10(5) covers the taxation of remittances or distributions out of profits derived through
a PE.
Article 10(4) of the OECD Model deals with the situation in which dividends received
by a non-resident from a resident corporation are ‘effectively connected’ with a PE
that the non-resident has in the source state, i.e. the state of the corporation’s
residence. Provision similar to Article 10(4) is found in Article 11 (Interest) and Article
12 (Royalties).
Article 10 of the OECD Model authorises a limited tax on the gross amount of
dividends without any protection against discrimination under Article 24. Article 7, by
contrast, authorises full taxation of dividends but after the allowance of expenses
and with the protection against discrimination provided by Article 24(3).
The OECD in the Commentary notes divergent views of member states as to
whether Article 24(3) of the OECD Model requires the extension of dividend relief to
PEs. It does not state an opinion as to the application of Article 24(3) in this situation
but merely invites states to clarify their position in treaties, including by applying the
taxation authorised by Article 10(2) to dividends received by Pes. The better position
seems to be that Article 24(3) does require the extension of dividend relief where
that is generally available.

The potential of favourable treatment of dividend received through PE arises

because repatriation of profits by PE to head office is not subject to dividend taxation
under art 10 and this is not just an issue with respect to dividend received by PE but
any income derived through PE may be repatriated from source country without
further taxation. Once taxed a PE, any repatriation isn’t subject to any taxation.
This can be contrasted with the situation where the foreign enterprise sets up its
presence in the source state in the form of a subsidiary. The repatriation of profits
from the subsidiary will be subject to dividend taxation under Article 10. In short, the
OECD Model creates a bias in favour of setting up direct investments in the form of
PEs rather than subsidiaries.
There are at least three ways of imposing extra source taxation of PE profits in order
to equalise the treatment with subsidiaries. A simple method is to increase the rate of
tax applied to a PE’s profits. But under 24(3) you are prevented from doing this. The
second and third methods of imposing extra source taxation of PE involve the
taxation of remittances of PEs to head office and the taxation of dividends distributed
out of PE profits by the non-resident corporation holding the PE. Article 10(5) of the
OECD Model prohibits both of these methods. The first part of this provision prohibits
a country from taxing the dividends of a treaty-partner resident corporation just
because those dividends are distributed from profits derived from that country. The
Article applies not just to dividends distributed by a corporation resident in a treaty
state to a resident of the other state but also to dividends distributed by a corporation
resident in one state to a resident of that state.

12th September
● Going to look at some of the other distributive articles - the ones important from the source
country's perspective
 
Recap
● Yesterday, dividends
o OECD Model - recognises the classic corp model and allows for double taxation
o Gets taxed at the level of business profits [Art. 7] and when they are distributed to a
resident parent [Art. 10]
● Art. 10 -
o General principle - residence country of recipient of dividend (shareholder) will have
the right to tax
o But this article also gives a limited right to tax to the source country under 10(2)
● Puts a limit of 5 and 15% depending upon the degree of control and capital
of the subsidiary
● 10(4) - permits the dividends received by a PE or attributed to a PE and allows it to be taxed
as business income
● 10(5) - extends the scope of Art. 3; specifically prohibits tax on all the remittances of the PE
to headquarters [Source country of the PE will not have the right to tax]
o Harris - This will create a distortion - lopsided towards PE's as opposed to
subsidiaries.
 
Interest [Article 11]
 
● 11(1) -
o Implicit source rule [similar to Art. 10]
● Art. 10.1 - where are dividends supposed to be sourced?
▪ Location: Where the paying corporation is resident
● In Art. 11 - "arising" and "paid to a resident"
▪ "arising" - This means the location of the source income (11(5) -
Income is deemed to arise where the payer is resident - similar to
10(1)).
● Change residence of paying corp [esp pre-2017 era when
there was a tie-breaker rule in Art. 4 - POEM becomes tie-
breaker] - this changes source of dividends; so the company
could escape Art. 10 if the new residence country does not
impose tax on withholding tax
● 11.5 - special source rule
▪ This makes it different from 10.5 - 10(5) prohibits the taxation of
dividends paid by PE; 11(5) permits tax on interest
▪ 10(5) prohibits and 11(5) permits
● 11(2) - limited source country taxation
o Interest is arising at the location of the source of interest may be taxed in that state
● Must have a charge to tax in the domestic tax law, otherwise no source
taxation of interest
● Not only is interest taxed lightly, much of the interest is deductible for the payer - inherent
unevenness
o Eg. Foreign corp [Ford America] funding its subsidiary in India, what financing
structure -
● Subsidiary takes a loan from parent, will have to pay interest on the loan -
will at the most have to pay 10% of withholding tax to India
● Will interest be deductible from profits of Ford America - yes [will be an
expense so will bring profits down and tax down]
▪ So, this is better than funding through equity - tax liability of Ford
America is lesser
o In some treaties, it is even lesser than 10%
● Interest is always deductible for payer
● OECD Beps project - can say that this is a case of double non-taxation [as
opposed to dividends where there was double taxation]
 ▪ Eg. if instead of Ford America, it was Ford Mauritius where there is
little to no tax on business income [so barely any tax on interest]
▪ 11(1) - "may" be taxed in the other state - so Mauritius may be
excluding it completely
● 10.4 and 10.6 - exceptions to applications of the limit in Article 2.
 
Interest and PEs

 
● 11(4) - allows for full taxation on interest income of PEs under Art. 7
o Similar to reconciliation rule of 10(4) - if dividend income can be attributed to a PE,
then can tax it as business income of PE.
● This is beneficial because it gets you covered by Art. 24(3) if PE - can claim
deductions if similar enterprises are getting deductions
o Right to full taxation - not necessarily a bad thing for taxpayers because 10% of the
gross amount of interest can be substantially more than full taxation of net interest.
 
● 11(5) - dual sourcing rule

● Unlike 10(5) which prohibits remittances of PE to its headquarters, there is an additional

provision here.
● 11(5) - if there is payment of interest by the PE, the source of interest is the country of the
PE [nearly reverse of 10(5)]
 o So, if sub pays dividend or interest, country of sub can tax;
o If PE pays equivalent of dividend - country of PE cannot tax
o If PE pays interest, country of PE can tax.
● Applies irrespective of whether the PE is owned by country of another contracting state or a
third-party as well
 
Royalties

 
● "shall" - eliminates source taxation of royalties altogether
● Does not incorporate a rule as to where royalties arise [implicit source rule]
o Why? - because it is not giving any right of taxation to source state, only resident
state
● Many treaties do not follow the exemption in Art. 12 of the OECD Model - include both
source country and source rule
● 12(2) - preserved full source state taxation of royalties when connected with PE [on a net
basis under Art. 7 - which is business income]
● 12(4) [follows 11(6)] - preserves source state taxation of the non-arm's length amount of any
royalties paid between parties with a special relationship - incorporates the arms length
principle
 
Article 13 - Capital Gains

 
 ● 13(1):
o Immovable property - full taxing rights to state where the property is situated
o So restating what art. 6 is saying
o Immovable property - takes meaning from 6(2)
o Movable property is not defined. The commentary says all property except
immovable property, includes goodwill etc.
● 13(2): may be taxed in PE business
o Covers all property of PE [including trading stock]; not limited to capital gains
[because it only mentions "gains"]
o Priority rule in 7(4) suggests that 13(2) be given priority over 7
o Deemed independent and separate enterprise approach under 7(2) [authorised
OECD approach] does not apply to Art. 13
● It applies to only 2 articles - 7 and 23
● This approach allows for a lot of deductions; it also restricts operation of the
authorised OECD approach to only 7 and 23
● 13(3) - applicable to airline and shipping
 

● 13(4) - alienation of property

o Not defined in OECD model
o The commentary suggests reading it as "sale or exchange of property and also a
particular alienation, expropriation, transfer to a co. in exchange for stock, sale of a
right, gift, passing of property for death"
● Domestic law might be broader than scope suggested here
▪ Eg. UK - triggered by disposal, includes destruction or expiry of
property or even capital payments received wrt property
● Overlap between Art. 7 and 13
o Some countries, esp civil law jurisdictions, tax capital gains arising in the context of
business as business profits [Apply Art. 7 to business capital gains]
● 13(5) - residual rule for any other property than mentioned
o If you are a Mauritian parent and have Indian subsidiary and sell the shares in the
sub to another co., the capital gains from the alienation of property other than what
was mentioned in previous paragraphs will be taxed only in the state in which they
are resident [i.e. Mauritius, which does not tax capital gains] (that's why you invest
in India through Mauritius)
o This is why there are tax havens
o Problem - it excludes source country taxation even where resident country does not
tax - not fair
 o Rule is important wrt sale of investments like shares, debentures, etc.
● Source countries have a right to tax dividends, interests, and sometimes royalties [not in
OECD but other treaties], but do not have a right to tax the gains from the disposal of the
underlying properties [unless attached to PE]
o Doesn't make sense because instead of giving dividends to non-resident
shareholder, could just sell the shares etc. and avoid paying tax [no withholding tax
or capital gains tax]
● Similar results can be achieved with deferred interest debentures - although they may give
rise to anti-abuse rules where the purchaser is a resident in the source country
 
Article 15 - Employment

● What leads to income of employment [what factor of production?]

o Comes from labour [labour and capital are the two most basic factors]
● This is income from labour excluding assets [purely employment]
● Covers employees
● Independent contractors - covered not under this article, but under article 7 [business
profits, because they are not employees]
● Contract of service v. contract for service
o Contract of service - employment contract
o Contract for service - more consultancy or independent contract
● Calculation of income for employment is under different rules and tax collection is also
different in the case of employment
o Collection - it is deducted at source
● India in 2019 - slashed corp tax rate by 10% points - touted as a major
economic reform. So why has tax on employment income has not been
slashed? Because employees are immobile, but companies can invest in
other countries [can structure their finances in many different ways and shift
from Indian easily] - this is why govts. are increasingly relying on payroll
taxes
● 15(1):
o Who is the source country? - where the employment is exercised (not located) [Eg.
working in the UK so taxed there]
● 15(2): bad drafting so don't read it
o It qualifies the source country taxing right
o If resident employer is in source country, source country will tax. If I do 183 days of work in
the UK, it doesn't matter whether the payment is by employer in the UK or India, UK has a
right to tax.
● Recipient etc. - none of these terms are used so have to look to art. 3(2) [look to domestic
tax law]
o 15, para 8.4 - It is a matter of domestic law to determine whether services rendered
by the individual in that state are provided in the employment relationship
o 15, para 8.5 and 8.6 - domestic tax law may expand the concept of employment to
treat as employment various services which may be given independently
● Fowrler case -
o Facts: SA diver working off the coast of the UK. Under UK tax law, would tax the
diver as carrying on a trade. He was there for 183 days.
o Diver would like to be covered under UK domestic tax law - domestic tax law says he
is involved in a trade, which means he will be covered by Art. 7; and since he is not a
PE, cannot be taxed.
o Upper tier tribunal - for the purposes of the treaty, it is employment, so Art. 15
applied.
o Court of appeal - income was taxable as trade income, so Art. 7 applied.
Employment is not defined so should have checked the relevant national law, and
diving is trade under domestic income.
● Question - what is the limit for domestic tax law to deem what is employment
o Para 8.11 of commentary - gives the limit. Results test - question of employment is a
question of degree not absolutes.
o Para 8.13 - it is important to determine whether services rendered by the individual
constitute an integral part of the business of the enterprise to which the services are
provided
● Key question - which enterprise bears the responsibility for the results
produced by the individual's work
▪ How the work is done, whose equipment is used; who does the
work; exclusivity; continuing relationship; calculation of
remuneration - no factor is determinative
● Eg. Suppose employee of parent corp resident in country B is providing services for
subsidiary in country A less than 183 days - parent to argue that it is the employer so country
A has no right to tax the income under Art. 15
o Two risks for parent corp -
 ● Sub is considered in substance the employer, so the duration becomes
irrelevant
● Employee may create a service PE of the parent corp in country A
▪ OECD Model doesn't provide, UN Model provides. But it is
mentioned in the commentary
 
Independent Services - UN Model Art. 14

 
● This has been deleted from the OECD Model
o Definition of business in art. 3 was expanded to include this when it was deleted.
 

 
● Services PE still requires presence in the country. But what if there is no physical presence
and there is only online work
● Art. 12A UN Model - includes managerial, technical and consultancy nature. Grants the
source country the right to tax the gross amount at an unspecified rate
o Excluded: teaching at educational institute or for personal use
● Is this overreach by UN Model?
o Location of the article is very interesting here.
o It comes after 10,11,12 - passive income
 ● 12A(a) - technical services - leaves rate of taxation blank
● Source is where the resident payer is [or where the PE is deemed to be]
o Service provider does not physically have to be present in the source state -
important to bring online services within the net of taxation
● So, OECD - more for resident state but UN Model - more for source state.
o Resident country is better placed to tax these incomes though.
o But what if resident country is also not taxing - there is no respite for source
state

18 September
Workshop 1
(On Source Country Tax Jurisdiction)

Dr Sarah is a resident of India, employed full-time as a senior lecturer by the University of Delhi,
India. This year, after the end of lectures, she went to the University of Paris, France, for two months
as a visiting professor. Dr Sarah stayed in accommodation provided by the University of Paris, but was
not given an office. During the two months she did the following:

(i) Received and marked the exam scripts of her Indian students and continued to attend to
various administrative duties for the University of Delhi by email. Dr Sarah continued to receive her
normal salary from the University of Delhi.

(ii) She taught a condensed course for the University of Paris under a short-term independent
consultancy agreement. Dr Sarah received payment for this teaching.

There is an OECD Model style treaty in force between India and France (and no specific
provision for visiting academics).

The tax authorities in France have informed Dr Sarah that she is subject to tax both with respect
to wages received from the University of Delhi during her visit to France and the teaching payment
received from the University of Paris.

She seeks your advice as to whether the tax authorities are entitled to tax these amounts. Advise
Dr Sarah.-

How would your advice differ in each of the following cases?

(a) The University of Delhi has a campus in France and Dr Sarah was given an office at this
campus during her stay.
 and

(b) The visit to France was for 6 months.

Notes

Discussion on the problem that has been stated above starts.

The first thing to be done while solving a problem like this is to determine if the treaty is applicable to
the contracting states and if it does, then we go ahead to determine if the person concerned is a citizen
of any of the states in question. It is stated in the problem itself that Dr. Sarah is a citizen of Delhi,
India.

France can tax her based on two parameters –

1) Residency
2) Source based taxation
However, for France to tax her, it needs to be established that there is a charge to tax under the
domestic French laws. Since it has been stated in the question that the authorities approached her with
respect to this, a presumption can be made that there was indeed a charge to tax.

This is where OECD convention comes in. It limits the charge to tax.
Acc to Art. 4(1) of the said treaty, it becomes obvious that she is a resident of India. French authorities
can only tax her if there is any source based taxation provisions under the French laws.

Payment from University of Delhi

Acc to Art 15 (1), income earned from an employment can be taxed in that state where the
employment is being exercised if the assessee is not a resident of the country where they are being
sought to be taxed.
However, Art 15(2)(a) says that for such a person to be taxed, they need to stay for an aggregate of at
least 183 days in one year. Since this requirement is not met, as she stayed for only 2 months, we go
ahead to see if any other provisions are applicable.
Art 15(2)(c) lays out that a person can be taxed in a non-resident state if there is a PE of the entity (DU
in this case) exists there. First of all there is no apparent PE of the DU in Paris as Ms. Sarah was on
independent consultancy project there. More importantly, even if she was to be considered as a PE of
DU, for her or her location of stay is to be considered valid PE for purposes of taxation, she needed to
stay in Paris for a period of 183 days. However, she only stayed for 2 months. Hence no PE as well.

There can two types of PEs-

1) Agency PE – She is not concluding any contracts, so the question of PE being created
there does not arise.
 2) Fixed PE – Whether the place was at DU’s disposal? Obviously not. Columbus case
explains this. Read that on your own for he doesn’t discuss it in this class. Might have done
in an earlier class.

Therefore, as far as Ms. Sarah’s income is concerned, it is not taxable in France.

In this case, we are dealing with Income from Employment. This term has not been defined in the
OECD treaty. However, the Article 3(2) states that in such cases where something has not been
defined, domestic laws shall be referred to.

Session 2

What about her salary coming from payment for her consultancy services by the University of Paris?

Art 3(2) will be referred to as income from employment is not defined anywhere in the OECD treaty.

If it can be established that the income coming from the consultancy fee is not income from
employment, then Article 7 shall be referred to. Dr. Sarah is carrying out an enterprise in France as per
Article 7(1) and Article 3(1). Article 7(1) creates a requirement with respect to having a PE in the
source state if the person is question is not the resident of the state seeking to impose on him.

For the purpose of further analysis, we take a look at the provisions laid in Article 5. Here we shall talk
about Fixed PE and Agency PE and determine whether she has created a PE in France or not.

Fixed Place has been given by the Paris of University which prima facie seems to be at her disposal.
However, it is arguable. Even if it is established that she has created a PE, she has only stayed for 2
months, hence not a PE for the purposes of taxation.

She is not concluding any contracts as well. Hence no agency PE as well. Taking everything into
consideration, it can be concluded that it would be almost impossible for French authorities to tax her
income coming through consultancy fee.

Alternate Facts – 1) DU has a campus in France and 2) Sarah has stayed in France for a period of 6
months.

Now University of DU can be clearly seen as having a fixed PE in France. Acc to art 15, France can
tax her income paid by DU.

Next issue again is wrt taxation imposed on her consultancy fee. Since she is staying in France for 6
months, she can be considered to be a resident of France. Now, she will become residents of both the
states, India and France. Whenever such case of dual residency arises, tie-breaker test is resorted to.
This has been given in Art 4(2) (a), (b) and (c). According to these articles, it can be concluded that her
being Indian resident shall be prioritised as she has a permanent home or habitual abode back in India.
If she had permanent home in both the countries, then it shall be seen which country is she a national
of which is clearly India. Hence under this model and tie-breaker rule, she shall be considered to be
Indian resident.

Next test is to determine if she can be considered to have fixed PE in France. Since she had been
staying in France for 6 months, she can be considered to have fixed PE in France and hence her
income arising out of Consultancy services is not liable to be taxed as per Article 7.
19th September

Article 6 of the OECD Model Convention and commentary

● Income from immovable property- it gives the source country the right to taxation.
● Art 6.2- takes you back to the law of the contracting state, where the immoveable
property is situated.
● What is maybe taxed? a source country can tax only by virtue of its domestic law-
the contracting state should have a domestic charge to tax. What counts as
immovable property and what counts as income therefrom?
● Art 3.2 and 6.2- 3.2 gives preference to tax law (not general law). Art 6.2
apparently on the face of it contains a definition of immovable property, and it
takes the meaning from the domestic law where the property is situated.
● Prof. Harris says that Indian tax laws do not include everything within the
definition of ‘immovable property’. There are certain inherent limits to the
definition. If there are no limits, there will be full taxing right to the source state.
They can read a lot into the definition of immovable property.
● You have to interpret any international bilateral convention in ‘good faith’. The
property has to be immovable, and be capable enough to fall within the definition
of immovable. Australia clarifies the meaning of immovable property through its
domestic law. Under English law it also includes charges and interests over
English india
● It does not give primacy to tax law- the meaning as per the domestic law will take
precedence
● What may fairly be included under immoveable property? Even if its not included
as that under the domestic law, it’ll get taxed in one or the other way (if not rental
income, it’ll be treated as having a house in India as a resident).
● What if the immoveable property is held indirectly, let’s say through a
corporation? Can shares held in a company constitute immoveable property? No.
Application of Art.6
● Income from the Immoveable Property
 ● Definition of this- there has to be a nexus between the income and the property
● Art 21 and meaning of income- does it also include capital gains? or does it include
only the gross concept? Capital gains is exclusively covered under Art. 13.
● Assessee will always want to see income as a net concept, where expenditures can
be deducted.
● Art 21- Residual Article- “other income”
● Para 2 provides an exception and excludes the application of para 1. The source
state of the PE will have the right to tax, and art 7 will apply. But there is an issue.
It refers to income- does this have a special treaty meaning or does it take meaning
from a domestic law?
● Harris says that in old treaties, the clause did not include capital gains. So,
countries can tax capital gains without any issue. Irrespective of any restriction or
exclusion, art 21 includes different types of incomes.
● The other issue is ‘not dealt with by the foregoing articles’- the prior articles dealt
with interest, royalties, gains, immoveable property incomes etc. There is
inconsistency as words like dividends, gains and profits are used by different
articles. There is a structural inconsistency.
Art 21 leans in favour of resident taxation, and denies source country taxation.
● Art 21 of the UN Model includes a para 3, which overrides para 1 and 2.
● Para 3 of art 21 of the UN Model
● Even if the income has escaped the foregoing distributive articles, UN has a
remedy for the source state to tax (this is the difference between the UN and the
OECD Model).
[‘arising’- art 12 of OECD model gives taxing rights to resident state.]

Art 24(4)-
● Payer Deduction and Base Eroding Payments
● OECD model follows a schedular approach and tax treaties following this model
make it clear that some source incomes are taxed less than other types, or not taxed
at all (for ex- royalties is not taxed at all).
● Manipulation of the character of payments with an emphasis on gain- if you’re a
foreign company, you will book a lot of expenses in high tax jurisdictions and most
profits in low tax jurisdictions. This results in base erosion
 ● The OEDC BEPS Action 4 – focus on payments that erode the tax base in the
source state (interest payment and interest substitutes).
● Think (or thin) capitalization- excessive interest outflow. The US Tax Reform of
2017 to address this (it’s a minimum tax). It’s a separate tax from corporate tax
(UK has the Diverted Profit Tax).
● Art 24(4)- suppose that I’m Tata and I have a subsidiary in India, both parent and
subsidiary is India and I can make deductions. But if I’m a foreign company and
have a subsidiary in India, I can’t claim deductions- so its saying do not
discriminate.
● Does 24(4) apply to PEs? discrimination based on foreign ownership. No, it won’t,
because PE is not an enterprise (like a subsidiary). It restricts discrimination on the
deductibility of payments made to treaty party residents. prevents discrimination
on the basis of foreign ownership.
● Before 2008, OECD said 24.5 should take second place to 24.4. But after 2008,
24.5 must be read in its context and must be seen with 9(1) and 11(6).
● Discrimination against PE- be addressed through 24(3).
Session 2
Quantification and Characterization Issues
● Payments are the building blocks of the income tax base. 4 fundamental features of
income tax à two are quantification and characterization.
● Quantification leads to the issue of transfer pricing between associated, when they
don’t behave in an economically independent fashion. Most global commerce
happens through MNCs, and 40% happens between associated enterprises. The
difficulty arises when units from the same group don’t behave in an independent
fashion à happens by manipulation of quantity and fashion of the income derived.
● If all units from the same group are taxed in the same manner regardless of their
residence, there is no incentive to manipulate. But if one jurisdiction doesn’t
charge one, but charges the rest, problems follow.
There is a spectrum of options- one extreme is that each member is separately
recognized and treated as if they are independent; the other extreme is when you treat
them as one large group that is dependent and related.
Situations in MNCs (international): The risk of manipulation becomes particularly
acute, as they are made up of many members, but they are all part of the same
 economic unit. BEPS project was aimed at better aligning the location of taxable
profits from economic activity. Has OECD lived up to its promise as desired?

Approaches to find the Measure of Value Added

● Let market forced determine the price- not always fool proof (Apple and Glaxo
case)
● Arm’s Length Pricing- between related parties. it does not get all the value created
by related parties, as the additional value of economies of scale and the
conglomerate structure, does not get included (ownership and internalization
advantages too, will not get captured by ALP principles). ALP then becomes an
instrument of base erosion. If they are not acting in a bona fide manner and there is
tax planning, ALP is an escape route.
● Main rules are 7(2), 9(1), 11(6), 12(4)

TREATY DOES NOT CREATE A CHARGE TO TAX; IT ONLY PUTS A CAP.

Rules 11(6) and 12(4)

● 7(2) applies to separate independent enterprise - fiction upon fiction - OECD
approach. Look at PE as a separate independent enterprise.
● 11(6)- uses the terms ‘special relationship’: two scenarios- Ford US and Ford India
(subsidiary)- can it be said that Ford US and India have a special relationship? Yes.
If we have Ford India and a Ford associated company ABC Ltd (owned by Ford
US in UK)- is this a special relationship? Yes, as they are owned by the same
company.
● 12(4)- similarly worded as 11(6)- excess amounts gets taxed as per laws of each of
the contracting states.
● 9(1)- associated enterprises- 9.1 talks about source state, it also authorizes an
increase in the profits even if it is not supported by the domestic tax law (11.6 and
12.4 preserve domestic law). if domestic law doesn’t support 9(1), it’ll be seen as
ineffective. 9(1) has to be supported by domestic law.

September 25th
Recap of 7(2):

This provision relates to the attribution of profit to a permanent establishment on the basis of
a separate and independent enterprise. This involves the authorized OECD approach that
came into effect after 2010. Under 7(2) there is a two-step approach to attribute profits to a
PE:

Firstly, we must identify the activities of the enterprise and actions which are carried out
through the PE, and delineate them; second, we must quantify these dealings for tax
purposes, through the transfer pricing approach. Where the dealings are with outsiders,
independent of the PE, then the quantification will be done according to the terms of the
dealings, and if dealings are with the owners of the PE (or their associates), then transfer
pricing rules will affect the quantification of the dealings. The calculation of the profits will
be done based on the domestic tax rules of the PE state based on the attributed dealings.

Article 7(2) treats the deemed separate enterprises as engaged in the same or similar
activities, under the same or similar conditions as the PE. This Article requires that activities
be attributed to the PE and pre-2010 the dealings identified in the PE’s financial accounts
were used as the starting point for determining profits attributable to a PE under a tax treaty.
After the 2010 amendment, less weight is given toa PE’s financial accounts, in accordance
with the Authorized OECD Approach, activities are allocated to the deemed separate
enterprise by taking into account the functions performed, assets used, risks assumed.

For this purpose, a functional and factual analysis should be undertaken. The PE must be
attributed four interconnected elements:

1. Significant people’s function (identify persons authorized to manage risks, assets, etc.
and their connection to the PE)

2. Risks (they are allocated based on the significant people’s function)

3. Assets (these tangible assets are usually allocated to a PE based on location and this is
usually on the basis of the ownership of the PE, rather than leasing; intangible assets are
located with relation to the significant people’s function relevant to the assets)

4. Capital (a certain amount of free capital has to be allocated otherwise it would lead to
a thin-capitalization issue)
The specifics identified in these would be different depending on the type of PE involved.

Now that we’re done with 7(2), he moves on to 9(1). This provision reads as follows:

“1. Where:

a) an enterprise of a Contracting State participates directly or indirectly in the management,

control or capital of an enterprise of the other Contracting State, or

b) the same persons participate directly or indirectly in the management, control or capital
of an enterprise of a Contracting State and an enterprise of the other Contracting State,

and in either case conditions are made or imposed between the two enterprises in their
commercial or financial relations which differ from those which would be made between
independent enterprises, 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.”

This enables the contracting states to adjust profits of associated enterprises. (a) and (b) are
just two ways of identifying associated enterprises. can use this. Consider this illustration:

Car Company A sells a car to Company 1 (a resident of the US) for 10000$, and Company 1
sells this car to Company 2 for 11000$. There is a 1000$ profit. Company 2, being a resident
in Ireland, sells this car to the consumers for 15000$. There is a 4000$ profit in the sale to
consumers. Companies 1 and 2 are associated (either through 9(1)(a) or (b)). What should the
transfer pricing authorities do? Think about it.

Article 9(1) overrides 24(4) (which is one of the non-discrimination principles, which allows
the deductions as we would allow to our own enterprises in our own state – if they were not
at arm’s length). 24(5) says:

“5. Enterprises of a Contracting State, the capital of which is wholly or partly owned or
controlled, directly or indirectly, by one or more residents of the other Contracting State,
shall not be subjected in the first-mentioned State to any taxation or any requirement
connected therewith which is other or more burdensome than the taxation and connected
requirements to which other similar enterprises of the first mentioned State are or may be
subjected.”
Unlike 24(4), 24(5) does not make any caveat for the applicability of Article 9(1). However,
the OECD Commentary says that one can read the provision such that it does. Thus, both
24(4) and 24(5) are subject to Article 9(1), and the applicability of the latter would not be
hindered by the non-discrimination rules enshrined in the former two provisions.

Can 9(1) be restricted on the resident states? What is 9(1)’s exact scope? Even though 9(1)
says “may”, it is argued that one cannot adjust the subsidiary’s profits beyond the arm’s
length – i.e., the provision can be restrictive even though it only uses the term “may”. But we
now have Article 1(3) which says that a country can tax its residents however it wishes, and
thus this controversy involving Article 9(1) would not apply in newer treaties to which 1(3)
applies.

Are the references to profits in Articles 7 and 9 restrictive, since both of these refer to
“profits”? Do they have any limiting effect on how profits are calculated under domestic
legislation? The commonly held view is that they don’t and that these are not restrictive.
However, there are some differing views on this (he doesn’t really go into these – he just
mentions that they exist).

Does applying transfer pricing rules only to international transactions breach 24(4)? Nope,
since – as mentioned earlier – 9(1) overrides 24(4) and 24(5).

What is the difference between a primary adjustment and a secondary adjustment? Illustration
to understand this better – let us assume that there is a subsidiary company in France
manufacturing watches and selling it (at 5$) to the parent company in the UK, which then
distributes them. The French taxman says that the price should be 10$ per watch instead, if
they were to be sold at arm's length, so they make a primary adjustment using 9(1) to adjust
the price to 10$. If there were 10,000 watches sold then the French taxman would essentially
have increased the profits of the subsidiary in France by 50,000$. However, the actual
amount received in the hands of the French subsidiary will still only have been 50,000$ in
this case. Since the subsidiary did not receive this additional amount of 50,000$, we are to
treat it mainly as a sort of a hidden dividend and tax it under Article 10, and a secondary
adjustment would have to be carried out in this regard.

Peter Harris on 9(1):

“Unlike Articles 11(6) and 12(4), which simply preserve the application of domestic tax law,
Article 9(1) authorises an increase in profits that may or may not be supported by domestic
tax law. If domestic law does not support Article 9(1), the risk is that it will be viewed as an
ineffective attempt to create a charge to tax by treaty. Most countries, including the UK,
support Article 9(1) with a domestic law right to adjust prices between related parties for tax
purposes.”

Nigeria was a country where domestic law did not support 9(1) until very recently, but this
was remedied. Under 11(6) and 12(4), only primary adjustments can be made, and secondary
adjustments can’t, but under 9(1) the recharacterization of the adjusted amount is also
permitted, thus enabling secondary adjustments as well.

9(1) has application only in the context of a business, like 24(4) and 24(5). This is reinforced
by the text of Article 9 itself (“commercial or financial relations”).

Lack of independence under 9(1) is the dominant test:

“Indeed, the type of relationship required between the enterprises to trigger Article 9(1) is so
loosely defined that lack of ‘independence’ seems the dominant test. ‘Independence’ plays an
important role in other provisions of the OECD Model. It is the test used in determining
whether an agent can create a PE of their principal under Article 5(5) and (6). It is also used
in the definition of ‘business’ in Article 3(1) due to the deletion of Article 14, which also used
the term in apparent contra distinction to employment where ‘control by the employer is an
important feature’. Article 7(2) also uses the concept. For purposes of determining profits
attributable to a PE, it treats a PE not only as a hypothetical separate enterprise but also on
the assumption that its dealings with the rest of the enterprise are conducted
‘independently’.”

The OECD also believes that the term ‘independence’ is used consistently in Articles 7(2)
and 9(1). They suggest that what is required is a comparison with arm’s length pricing, i.e.,
market value of goods and services. While Article 7(2) refers to ‘dealings’ and Article 9(1) to
‘conditions in commercial and financial relations’, this difference in terminology is a
consequence of the fact that, in legal terms, a PE cannot transact with the enterprise of which
it is a part but, apparently, it can ‘deal’ with it. The same approach to transfer pricing should
be used under both Articles 7(2) and 9(1).
Transfer Pricing isn’t an exact science. In 1979 the OECD published guidelines regulating
transfer pricing, and this was subsequently revised in 1995 and in 2017 new guidelines were
issued. Article 7 adjustments and the TP guidelines have to be relied upon to assess how
entities operating at an “arm’s length” should function. The TP guidelines outline a
comparability analysis for the purposes of 9(1).

The first key aspect of this comparability analysis is accurately delineating the nature of
transactions between associated enterprises. The second step would be to compare the
delineated transactions with comparable arm’s length transactions. When accurately
delineating the transactions, it is necessary to go beyond the contractual terms of a transaction
and engage in a functional analysis of the associated enterprises and their relationship. This
would involve accounting for assets used, risks assumed and the broader relationships of the
parties within a multinational group. 9(1) has moved from a provision merely to engage with
arm’s length prices, to one that can be used to disregard transactions and recharacterize them
(this is the most important contribution of the 2017 guidelines). The entire process of
delineating transactions, etc. is similar to what we saw under 7(2).

A lot of countries have domestic laws which state that the OECD guidelines are what they
will rely on for issues involving transfer pricing. Some domestic laws also carve out
exceptions, wherein they say that normally for transfer pricing issues the OECD guidelines
will be relied upon, but in certain specific instances domestic rules on transfer pricing should
be applied. Thus, the first step for us when we’re approaching a case would be to check for
transfer pricing rules in domestic law.

There are five methodologies, as per the TP guidelines, when assessing whether transactions
are arm’s length transactions or not: three are traditional transaction methods, and two are
transactional profit methods – they used to say that they’d give priority to the Comparable
Uncontrolled Price (CUP) method (this is more relevant to chartered accountants tbh) but the
weight given to this is somewhat less now than it was. The OECD guidelines are now clear
that we must pick the most appropriate method – and this would depend on the facts of the
case.

The OECD takes the orphan approach, which is total independence and separateness, and this
gives rise to the potential to strip down the activities of companies to move tax bases. There
is some pushback against this orphan approach from developing and BRICS countries.
“Location-specific advantages”, though not very well articulated right now, tries to account
for the additional advantages gained by relying on a particular geographical location (a la
Apple in Ireland/China). Brazil has been relying on the cost-plus and resale-minus method to
pushback against this at present.

We now begin studying each of the methods, and this discussion starts with an analysis of the
“CUP Method”. This method involves looking at transactions between one of the parties and
unrelated persons (third parties) with whom a comparison can be conducted, and then
assessing based on that. This is the “Internal CUP” method. “External CUP”, on the other
hand, involves looking at how other parties sell the same product and this can be used for
things like certain commodities, where there is very limited variation. For products like
phones, it would be hard to rely on an external CUP since there is so much variation, so
figuring out what would be “comparable” would be difficult.

A Canadian Glaxo case illustrates how a drug which had a generic place in the market didn’t
count as “comparable” since Glaxo claimed that their product was superior. The Supreme
Court said that generic comparators do not reflect the economic business reality, which is
what is crucial here.

In internal CUPs as well, there are some issues – for instance, market size, market strategies,
etc. would vary based on each country so these might not serve as appropriate situations to
provide a comparison.

Another problem with the CUP approach can be connected to Dunning’s OLI Framework –
this problem is that large MNCs would have a ton of advantages owing to their location
advantages, scaling advantages, etc. so there is an inherent comparative edge that leads to any
comparison between these entities and their prices being problematic. A CUP can thus only
provide limited value.

Australian Chevron case – there was internal debt within the group. US company with
Australian operating subsidiary. The company that was borrowing was getting a guarantee
from the parent and it was getting a great rate of interest (1.2%). This was on-loaned to the
Australian subsidiary at 9%. The problem that arises here is one of excessive debt and the
rate of debt, and this would count as an example of thin capitalisation. The Australian
subsidiary said that if it had gone to the open market and borrowed as an independent entity
also it would’ve got the loan only at 9% so it’s irrelevant if it got the loan from within the
group or from a third party. Australian taxman said nope, paying 9% on a loan obtained at
1.2% is excessive.

26 September
We looked at the ‘Comparable Uncontrolled Price’ CUP method in the transfer pricing
guidelines mentioned in the OECD model and in this class we will be looking at the other 4
methods of transfer pricing. Two traditional methods are cost plus and resale minus. They
target at standard routine functions that should be paid on certain percentage basis. Downside
to it is that if you are just attributing routine rate of return to the activities conducted by one
of the parties. Upside or downside is getting attributed to one party who receives the profits
and the other party gets the remaining of the profits. Often the
● Resale minus- classic example party performance on is simple distribution function.

Sure shot mark-up profit is guaranteed with this approach

Resale minus – residual profit.
When services are put into company which takes construction activities and the services are
provided to a sub by an apparent or elated company, you see the cost and just add the mark
up now. Rather than misusing the markup from the sale price which is the resale minus
method, in cost plus you just add the amt to the cost or the services or cost of the products or
whatever the activity is and that’s your profit. Distributive functions are usually used for
resale minus. While services and inputs are applied on the cost plus method. What is the most
app method? Need to be figured out.
● CUP will be more appropriate method in the case of
● E.g: construction services to third parties as well and they doing it to the group companies as
well. Need to do a factual analysis are they exactly the same kind of services, provided to the
associated party s well or the group company then CUP method will be the right method-
comparable uncontrolled price. But if the scenario is different and the services provided arte
not eh same to the associated party, then cost plus will be the most appropriate method.
Always depends on the facts and circumstances of the case.
● Three traditional methods are done: the comparable uncontrolled price, the resale price and
the cost plus. Within CUP both the internal and external have been looked into and the
challenges associated with identifying the CUP and those challenges could be quite steep for
the developing countries as it is not easy to find one competitor that could be located or
situated in a similar circumstances and hence could be justified as the most appropriate
method of pricing the transaction.
● Three methods: CUP, resale, cost plus
● Transactional methods, profits method: transaction net margin method TNM, transactional
profits split method.
● TNM- comparing a company’s net profitability on a controlled transaction with that of a
similar business enterprise.

Transfer pricing depends on the tax advisers as to how far they can push the price in your
favor.
TNM- look for profit indicators, turn over ration, profit margins and doesn’t have to be
precisely the same products you are dealing with or transaction you are dealing with. Not
same product but similar transactions in similar business enterprises hardly operating in the
similar line of industry.
2nd transactional profit method Profit split method.
● Lot of federal companies in the US uses formulary apportionment to locate profit between the
states.
● How do we know which profits belong to which state? For state income tax purposes, you
take the federal income tax pays and try to actually apportionment to the states but you don’t
do it on the basis of transfer pricing. It is done on the basis of certain factors and they are
formulary apportionment factors it could be assets, it could be turnover, revenue or even work
force on the basis of which you could apportion profits based on where the profits, workforce
and the sales are located and generated from. Profit split method
● Profit split method is not exactly formulary apportionment but it’s quite close to that. You are
in some sort of spectrum between formulary apportionment on one hand and on the way to
apportionment based on individual transactions that are actually priced individually. You go
from one extreme to other. We are slightly towards formulary apportionment method and
profit split method. So OECD doesn’t use the formulary apportionment. In profit spilt we will
not be looking into the individual transactions but more about how the profits to be split b/w
group member especially among cross border. So we can use profit split method if it is
appropriate for individual transactions or group of transactions- OECD says.
● If you got a group of transactions and work on appropriate profit split method between the
two related parties, how do we get a comparable for that? As how related parties share profits
is very often subjective and won’t be publicly available. You would want to have databases
available for profit split. It is mostly used for residual allocation difficult to get a comparator
so you transfer price transactions according to other methods as far ayou can and offer left
with intangible or things don’t have comparables. Because they are so unique and so intrinsic
to the functioning of the group. You can use residual profit split method and you can use
profit split method even for potentially individual transactions or group of transactions or use
it as a residual method after you have split the parts you can actually price appropriately. With
the residual method you are looking at how related parties will split the profits if they were
unrelated. – Rule of thumb that how unrelated parties would have split the profits. If one can’t
get that information, we look at the contributions that the parties have made towards
generating those profits especially towards the intangible assets and you split the profit
generations to the development of the property giving rise to the income. – cost contribution
● Appropriate interest rate can also be a risk the risks that an enterprise A will be different
from the other enterprise will be exposed to.
● Whenever there is a comparator we use CUP
● If you are not providing services to the third parties and these services as a special case within
the associated enterprise, then cost plus might be the only way to values the services.
● E.g: ak running a software company designed specific products and sell in the market in the
US Bangalore based company. Some associated party in Indonesia has asked him for some
specific software services which otherwise is not provided by him to the third party and not in
any market or anywhere in the world. But a special case so put 5 software engineers on the
job and it took 6 months and then lot of documentation is prepared maybe the salaries of the 5
software engineers and the resources put at their disposal add it up the cost of all you will add
the mark up- cost plus.
 ● Use of tangible property most often you will be able to find a CUP- could be machinery,
plants, etc. either on the leasing basis or other CUP shouldn’t be a problem.
● Intangible property – not easy to find a comparative as they are unique in their own ways,
difficult. Rule of thumb- profit split method. E.g.: if you are pharmaceutical company and
found a block buster drug, and filed an IPR. These drugs are drawing a lot of royalties.
● Owner ship of the vaccines- in areas of lower tax jurisdiction – Cayman Islands or Ireland.
Tax planner
● If you are the tax man, then you are going to go after it. The tools that will be used are profit
split.
● OECD transfer pricing guidelines similar to the US which is a very developed tax regulations
and guidelines on cost contribution arrangements. They should be remunerated based on the
exploitation of the drug and he sale of the drug.
● The way in which transfer guidelines identify the intangible assets is very broad. Looking at
the TP Guideline, 2017 the intangible assets are defined in a broad sense in the legal and
accounting perspective. “non- physical non- financial asset that could be controlled for
commercial activities”
● Development, enhancement, maintenance, protection and exploitation. DEMPE
● Legal ownership is not a relevant question. Contract relevant but not decisive. OECD trying
to push away from the contractual analysis in relation to the parties. The people that are
legally independent and do have a contract in place. The tax law is questioning the contract.

You have developed property in a high tax jurisdiction and then you want to transfer it to a
low tax jurisdiction. Is it possible?
OECD- for transfer of intangibles, use CUP or profit split. If no comparable use discounted
cash flow.
● Domestic planning is required for a lot of countries OECD have some union requirements.
● 3 tier global standard for TP documentation. 3dif kind of docs to be maintained. 1. Master file
relates to group activities- group organizational structure, where it is booking profits what
areas is the company is interested in and the general way in which the company behaves. 2.
Local file: controlled transactions, contractual terms, corporations TP Methods for each local
company. 3. Country by country reporting file- this is the info required if ever the company
move towards the the documentation requires the information on the revenue split b/w related
and unrelated parties of the group profits and losses of different members of the group,
income tax paid in each country, etc.

Hour-2
Discussing the problem- workshop 2
 Workshop 2

The ABC group is a multinational corporate group that manufactures and sells
electronics. XYZ Co is a company within the ABC group that is resident in Hungary. Until
recently XYZ was an operating subsidiary within the group which engaged in some
manufacture and assembly of ABC Group stock, but particularly in sales to Hungarian
customers.

At the end of 2019, XYZ’s relationship with the ABC group changed.

Large parts of XYZ's workforce were retrenched. XYZ no longer manufactures or

purchases ABC stock, but rather holds in its warehouse ABC stock that is legally owned
by MNP (Lux) Co, a company resident in Luxembourg.

MNP (Lux) sends sales staff to Hungary to negotiate supply contracts with
various independent retailers throughout Hungary. Contracts of supply are made directly
between MNP (Lux) and the Hungarian retailers. XYZ’s activities are limited to
advertising and other promotion, holding stock on behalf of MNP (Lux), filling orders
placed by retailers with MNP (Lux) and liaising with the retailers and ultimate customers
regarding warranty claims.
There is an OECD style tax treaty in force between Hungary and Luxembourg.

When filing its 2013 Hungarian tax return, XYZ reported a drastic reduction in
taxable income. XYZ calculated its income as 2% of stock that passed through its
warehouse and a fee for ancillary services provided to MNP (Lux) calculated at cost plus
10%.

You work for the Hungarian Revenue Authority (HRA). You have been asked to
advise your superior in the HRA on the Hungarian tax issues arising out of the change in
structure of the operations of the ABC group in Hungary. You are to pay particular
attention to issues under the tax treaty with Luxembourg. Provide that advice.

Issues involved: ABC- multinational corporate group that manufactures and sells electronics.
Resident in Hungary company- operating subsidiary involved in operations, manufacturing,
assembling the group stock for sale within Hungary. At end of 2019 there is some restricting
in the group- large parts of Hungarian company’s workforce were laid off which resulted in
decrease in the group operations. Group stock is also legally owned by a Luxembourg
company. They are just providing a ware house-service to the Luxembourg Company. The
Luxembourg Company sends staff to Hungary to negotiate contracts of supply b/w
Luxermborg Company and other retailers in Hungary. The Hungarian retailers limited to
advertising, licensing with the customers regarding the warranty claims. Some warehouse
services, advertising and some liaisoning
OECD treaty b/w Hungary and Luxembourg and when it filled its 2021 Hungarian tax
reduction, the Hungarian company reported a drastic reduction in its taxable income. It
calculated its income as 2% of the stock that passed through its ware house.
● Summary of the problem is mentioned.
 ● Tax advises by the students.
i.Whether Hungarian tax treaty applies – Since XYZ is a resident in Hungary, it is applicable.
ii.Determine the nature of the entity- is it an independent enterprise or associate enterprise or
permanent establishment of any company- XYZ is trying to pass itself as related to MNP. XYZ not a
permanent establishment of MNP because it is neither a fixed place PE nor an agency PE. The Lux
has no control over the premises of the ware house so there is no fixed place PE per se. y is there no
control over the premises? As MNP is not owned by the company and the company is still owned by
the ABC Company and MNP Company just tow the goods over there. Even if they did own the
company the services of ware house are specifically removed under the definition of PE under the
model convention. The ancillary services provided do not come under PE. It will not be agency PE as
the contracts are computed by the foreign company only and the Hungarian has no role to play in
finalizing the contract and entering into the agreement. It won’t be a PE. If it is associated enterprise-
not as the problem is not specific on the ownership of the MNP Company we assume it as an
independent enterprise. When there is no connection between MNP and Hungarian company it can’t
be considered as an associated enterprise. As a result it should be considered as an independent
enterprise. So the XYZ Company in Hungary cannot really use these transfer pricing methods to cut
down their profits.
· PE cannot be considered as it is stated under article 54 where it states these
following will specifically not be PE and that is warehousing with delivery
activity is going on and it would not be agency as the contracts are finalized on a
principle to principle basis.
· Agency PE we do not know whether they have a say in it, it’s just a matter of
course so if the company is just singing it as a matter of course, then if the
agency has habitually concluding the contracts over there, perhaps an agency PE
can be formed over here.

AK: main problems: restructuring was done to strip down the activities because the taxable
profits have depilated the Hungarian company identification of the problem.
You are bound by the rules of the tax treaty leading to the application of tax treaty. OECD in
2017- believes that it carried out comprehensive changes in the PE definition in 2017. 5.4-
negative list – specifies the list of activities which would not be considered to constitute a PE
Another act of OECD in 2017 is updating of article 5 and 4-
It introduced a focused anti abuse provision targeted at tax planning strategies based on
fragmentation of cohesive business operation.
Article 5 (4): Notwithstanding the preceding provisions of this Article, the term "permanent
establishment" shall be deemed not to include:
a) the use of facilities solely for the purpose of storage, display or delivery of goods or
merchandise belonging to the enterprise;
b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for
the purpose of storage, display or delivery;
c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for
the purpose of processing by another enterprise;
d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or
merchandise or of collecting information, for the enterprise;
e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the
enterprise, any other activity of a preparatory or auxiliary character;
f) the maintenance of a fixed place of business solely for any combination of activities
mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of
business resulting from this combination is of a preparatory or auxiliary character.

5 4.1 fragmentation of a cohesive business operation into several smaller business operations.
It aggregating the overall activity resulting from the comaninationa of two activities carried
bu
OECD in 2017
i.Fixed PE
ii.Agency PE – 5.5 and 5.6 – ecosystem, commissioner arrangements: which can be found in civil law
systems, involves three parties, principle (seller and the commissioner), agent soliciting the sale of
goods and the buyer. The legal relationship b/w the customer and the principle are not constituted.
The principle will deliver the goods.
● The changes that are brought in 5.4 and 5.6 – habitually concludes contract, habitually plays
the principle role leading tot eh conclusion of the contract, that are rooted concluded without
material modification by the enterprise, offer the provision of services, etc
● 5.6 qualified the definition of independent agent which is that if you are acting exclusively or
almost exclusively on behalf of or one or more enterprise to which you are closely related,
considered not to be an independent agent.

Legal answer: yes Hungary tax will be applicable under article 9.1 – test is independence.
Then you will say if it is related party income, then article 9.1 becomes relevant. Transfer
pricing methodologies will be applied and 2017 transfer pricing guidelines issued by OECD
will be used. There are 5 different methodologies. The OECD prescribes most appropriate
methodology. There are two sorts of prices are being paid- 2% of the stock that pass through
the ware house and the fee for ancillary services calculated at cost plus 10%. Which method
should be applied? For the ancillary services the company took the cost plus method and for
the 2% tax, there should be an external CUP (what are the charges for providing ware house
services) as they are providing ware house services, there could be internal CUP if non-
internal CUP is providing exclusively for the company.
Cost plus method for ancillary services, which is warranty services, handling the customer,
stocks and so on. Whether these kinds of services are provided independently in the routine
manner by the enterprise. If they are providing in the routine manner to the external party
there would be an internal CUP straight away if not may be cost plus is the most appropriate
method and the question is 10%n in appropriate mark up that comes down to facts and
documentation and evidence. Hungary wants to know if it can Luxembourg subsidiary. So
the question is where the charge to tax comes from domestic law or the treaty? Domestic law
so does Hungary has the charge in domestic law? In some cases though OECD gives the
charge to tax, the domestic law might not. So assuming that Hungary domestic law sees it as
business income, it is clearly business income under article 7 as everything that Lux is doing
comes under 7.1.
Does it have a PE? Going to article 5 to deal with PE. Is there a fixed place? Yes fixed place
is ware house. Presume it is an ongoing operation, ongoing enterprise; it extends beyond 6
months facts not give so assuming. Test - disposal. It is at the disposal of the Lux Company.
Who own the stocks of the ware house? From the given facts we are summing that they are
owned by Lux Company for which the condition of 5.1 are met.
Does it get knocked down by article 5.4? sub para a of 5(4)- use of the facility is for the
purpose of storage, display or delivery of goods. After 2017 not the only test, now the
resuming words of 5(4) that such activity must be preparatory or auxiliary to be ousted from a
PE creation. From the facts what is preparatory and what is auxiliary the commentary gives
detailed guidelines. The activity is certainly not preparatory because it is the central part of
the business. But he question is it can be auxiliary and that is debatable.
After the 2017 amendment the resuming words gained a lot of importance but there is a lot
more that eh t2017 amendment is the 4.1 anti fragmentation rule how to apply 4.1 here if they
are close related enterprises and for working out whether or not Lux has a PE we take into
account the activities of related enterprises (Hungarian company).
The open question if the warehousing services are auxiliary thorough 4.1 if we add the close
related activities of the enterprises in this case is the Hungarian and Lux company it is very
unlikely the ware housing is seen as auxiliary and therefore we have a PE and it is a disposal
of the Lux company and the activities are certainly not preparatory and also not auxiliary.
After 7.1 and 5.1 comes question arises of 7.2- attribution of profits to the Lux Company.
Factual and functional analysis- authorized OECD approach. Separate and independent
enterprise and then the delineating of the activities, identifying the transaction, characterizing
the transactions and once done with the characterizing, the two step analysis – i) delineating
the activities, identifying the dealings and the transactions, ii) quantifying for which the
transfer pricing guidelines has direct relevance.
Question of whether there is an agency PE. For agency PE article 5(5) and 5(6). We are
looking at the staff as they are physically present at the source state on behalf of the
enterprise. Are they habitually concluding the contracts, no as they are sending it back to the
company? It is an ecosystem. After 2017, the question will be whether they habitually place
the principle role leading to the conclusion of the contracts. Maybe yes. But are the contracts
routinely concluded without material medications? Case knights of Columbus- court found
that even 90% approval was not routine approval. It is unknown as to what extent are the
contracts modified. Ware house is affixed place of business and is a PE so agency PE will be
a separate PE. The fixed PE might be conducting activities very differently from the agency
PE.
SO, there are two PEs one is fixed and the other is agency PE. If there are two fixed places of
business there would be different PEs for tax purposes. Article 7.2 attributed to the PE- how
much remuneration of the commission, the actual wages of the tax depending on the time the
staff are in Hungary. Article 15(2) may be relevant here as if Hungary wants to tax the wages
of the salaries and wages of the employees in addition to the commission that it can attribute
on the domestic law. Why is domestic law involved in 15(2) because employment is not
defined and it gets its definition form domestic law.
17 October 2021
Beatles Song – They were paying 85% of their income in taxation due to progressive taxation bracket
being higher – when Resident country does not provide tax relief, such a scenario is very possible.

Situations where source country may not tax – there is no PE, or income from royalty, or capital
gains, or Article 21. But in this case, let us presume that source country is taxing.
OECD Model – some articles do not explicitly provide that residence country can tax, for instance
Article 6 does not tell you that residence country can tax – but the OECD Model universally presumes
that residence country can tax.

In such a case, how can Beth claim relief from double taxation?
Worst scenario – Both countries tax in full, without relief for the other. In the above
example, if no relief is there, Beth will pay 70% of income in tax. This is full double taxation)

Deduction – This is the minimum benefit that one usually gets by Residence Country’s
domestic laws, where it provides deduction for the tax paid in source-country as a general
expense in deciding the net income in residence country. This is a fallback provision, if no
other specific and more comprehensive relief is present, at least this would be there.
This is the example in above picture – where liability is still turning out to be 58% - this is still
double taxation (not full, though) because Beth is still paying more than the liability in her
residence country (Country A – 40%) as well as source country (Country B – 30%) - this is
contrary to international trade and neutrality principles. The Deduction Method does not
relieve full blown double taxation of foreign income, it’s a partial relief.
However, it can actually be beneficial for the tax payer in the following circumstances –
- used when foreign tax is not sufficiently income tax in nature to qualify for relief which is
more comprehensive – for instance, tax on turnover – use deductions there.
- This is also an issue in foreign tax credit systems because deduction method may be
more beneficial where use of foreign expenses is not very limited (we will see all of this
in later classes).
- When tax payer is in an overall loss person (if you aggregate both foreign and domestic
income) and has no residence tax liability, this method can increase the loss which can
be rolled over and carried forward to the next years.
The UK grants a deduction for foreign tax where the foreign tax credit method is ineffective,
including where the taxpayer elects not to receive the credit.

Exemption & FTC Method – OECD Model Article 23A and Article 23B – Two articles:
- Article 23A – exemption + foreign tax credit method
- Article 23B – foreign tax credit (“FTC”) method
Most countries have domestic provisions for foreign tax relief in the form of exemption and
FTC, though their wordings are not same as OECD Model Articles, relief can still be claimed
under the domestic provisions and there even if no OECD treaty or other international tax
treaty is applicable. If no unilateral tax relief is present in domestic law, then you go for
treaty relief. If both reliefs are present and not the same, then the provisions which are
most beneficial to the tax payer (lowers their taxable income to maximum extent) is
applicable.

- Article 23A
o Provision (1)
§ ‘may be taxed’
· not necessary all source states will tax everything – for instance,
Mauritius does not tax capital income.
· This means that even if the income is not taxed in that particular
source country, but is of the nature that it is generally taxed by
source countries, it would still be exempted from taxation in
residence country – leading to a situation of double non-
taxation.
· Due to this, a lot of states do not use this terminology, and
instead use ‘subject to tax’ in their domestic laws.
· But this provision is also not fool-proof, because many low-tax
countries like Mauritius then impose a token 0.5% tax just to
meet it, and the taxation liability still remains abysmally low –
which the residence country might not like.
· This is a real challenge – question to ask is whose perspective are
we looking at this from, who should decide when would a
particular income may be taxed – source state or residence
state? Restrictive approach is when residence country says that
we will decide whether this requirement of may be taxed in
source country has been met or not.
· OECD does not like the approach; their solution is to ask the
question: whether or not has the source state fairly applied the
tax treaty (including any domestic law of source state)? Hence,
residence state has to look at it from the perspective of source
state, cannot apply its own legal system. Residence state should
put themselves in the position of source state and answer this
question – does not have to take the word of the source state in
deciding so, which gives some leeway to residence state.
o Exemption is limited (in domestic as well as Model Law)
§ Limited to income which the residence country believes would be fully
taxed in the source state.
§ What income is fully taxed in the source state? (non-exhaustive) Article 6
of OECD
· Capital gains from immovable property
· PE
· Income from employment
 § What income is partially taxed in the source state? (non-exhaustive)
· Dividends (not sure about this, he mentioned this at both places,
please refer to earlier classes discussion for clarity on this)
§ What income is not taxed in the source state? (non-exhaustive)
· Royalties (according to OECD Model)
· Provision (4) provides for this provision – Incomes provided in
Article 11 of Article 10(2) – So Residence country will not
exempt incomes such as royalty, or where PE is not found in
source country for business income, interest on dividends etc.
o Provision (3) – Exemption with progression

§ Can foreign income be one of the top slices, bottom slices or

proportionate – Article 23A(3) provides for exemption with progression
§ Example –

· First case (left side) is how normal exemption will work.

· Second case (right side) explains exemption with progression –
nothing to do with exemption of foreign income, but the way of
residence state taxing domestic income if there are progressive
slabs. It is applicable when assessee has domestic as well as
foreign income which is then subjected to progressive tax.
o Beth is subject to 20% in first 100, and 40% in next 100
o Question of slicing – what is the relevance of foreign
income? Can foreign income be top slice or bottom
slice? If it is top slice, then you pay 40% on domestic
income, if it is bottom slice, then you pay 20% on
domestic income – liability and net return changes
depending on which slice it is. Or can it be
proportionate?
o Provision (3) talks about this.
· ‘Remaining income’ – is domestic income
· According to Sir, the effect of Provision (3) is that it allows
residence country to consider the foreign income as any of the
slices, this discretion rests with them. OECD Model Law does not
give any guidance on this.
- Article 23B – Tax Credit Method

o Explanation of the example

§ Here, for the purpose of determining the foreign income – you take the
full foreign income (before tax) – that is 100 in the example with Beth.
§ Apply the domestic tax rate on it (Country B had 40% tax rate)
§ Deduct the tax paid in foreign jurisdiction on that income (30 in the
example) and only take the remaining amount from the assessee as tax
to be paid in the country of residence. So, in this case, tax paid by Beth
would be A.
o Limitation on Credit
§ The provision clearly provides that Deduction cannot exceed the tax which
is anyway payable in the Residence state, it can be less or equal to the
same.
§ For instance, if in this example, assume source state had 40% tax and
residence state had 30% tax. In this case, Limitation on Credit becomes
30.
§ OECD calls this difference between full credit v ordinary credit – this is
Ordinary Credit – if it was full credit, the residence state would have had
to give a deduction of 10 from the tax payable on domestic income.
o Come back to this image
 § If relief is by reducing the Tax Base in the residence country – it is
deduction method.
§ If relied depends on the Tax Paid in the Source Country – it is credit
method. This is usually more beneficial for the assessee.
§ OECD Confuses this.

Burton v Commissioner of Taxation (2017 – Australian Federal Court)

Shows how limited the tax restrictions by treaty can be on the resident state.
Facts – Australian Resident derived capital gains from the US. US applied 15% tax rate to the
whole capital gains. Australian exempts half the capital gain, but then applied 45% to the
remaining half of capital gains (22.5% in effect). Australian tax officer said that assessee will
get tax credit for only half the US tax as only half of the income is being taxed. This is even
though 22.5% is more than what US took (15%), and are giving credit only for 7.5%.
Question is when Article 23B talks about ‘income’ – does it mean income generally, or only
the income which was actually taxed in residence state ‘taxable income’.
Held – Australian Court simply upheld the tax officer’s version, saying that provision does
not explicitly say that credit should be given for the whole tax paid.
Comment – Australia actually benefitted from putting 45% tax on half income rather than
22.5% on full income. No non-discrimination rules are present on residence state as are
placed on source state – shows how limited the restrictions on residence state can be.

o Type of taxes can be eligible for credit –

§ Article 2: which taxes does the treaty apply to; see that. If treaty is not
present, you have to look at laws of the residence country to determine
the same.
§ For instance – when UK is the source country, US is the residence country.
Under unilateral domestic rules of US, which type of UK taxes will US
give credit for. Credit will be given for Corporation tax, income tax,
capital gains tax – but not for VAT, Land Tax, Stamp-Duty etc. In 2008,
UK bailed out banks and imposed a wind-fold tax later, this was also not
covered by the US-UK Treaty, relief could only be sought for US Laws
 and whether it was sufficiently similar to US taxes. USSC said that it was
and the wind-fold tax was also considered eligible for credit.
§ This is similar to exemption (Article 23A) – not applicable when you fall
within Article 10(2) of Article 11

- Article 23(A)(2)

o FTC for income items which are present in Article 10 and 11 – clearly no credit if
the other country cannot tax at all.
o Limitation on credit is here as well.

Controlled Foreign Corporation Rules (CFC)

- Concerned with how to tax the profits made by very profitable foreign subsidiaries (of the
corporations which are resident in the resident country) in the resident country.
- Article 7(1) of OECD provides that exclusive right to taxation of any company is where the
company is incorporated, and not where shareholders are resident. Due to this, CFC Rules
which can provide some power to parent company’s resident state are very important.
- Page 42 onwards Chapter IV (Page 298 of the PDF)
- When Trump became the President, question of deferral became a big question – US
corporations with very profitable foreign subsidiaries, profits of which do not come to US –
question is how to tax it – CFC Rules provide for this.
- If deferral were the sole concern, CFC rules would be limited to foreign tax credit countries
and they would be applied to treat foreign subsidiaries in the same manner as foreign PEs,
i.e. tax them in the parent country jurisdiction on a current basis with foreign tax credits.
Example, New Zealand
- CFC Rules do more than just deferral
o Address harmful tax competition – Pillar 2 of BEPS approach is also trying to
address – Biden is backing this
o Transfer Pricing – shifting of profits to foreign corporations in low tax jurisdictions
using TP methods.
o Corporate Residence
 § From Page 382 (page 298 of book)
· There are conceptual reasons for suggesting that a corporation
should be treated as resident where its controlling shareholders
are resident, but international tax rules do not accept this,
thereby facilitating the CFC problem. CFC rules address this issue
and demonstrate a strong conceptual link with the problem of
corporate residence.
· Often, individual tax rates are higher than corporate tax rates,
and residence country tax rates are higher that source country
tax rates on business profits. Who has the control on the
decision on when/how to give back profits to shareholders?
(Through dividends etc.) CFC Rules address this
o CFC rules are often a residence country’s best (perhaps sole) defence to cross-
border mismatches that generate substantial amounts of tax planning
- Now quite popular, but seldom applied. Every major capital exporting state has adopted it in
some or the other way.
- What are CFC Rules? – CFC rules attribute the profits of a foreign corporation to resident
shareholders and tax those shareholders with respect to their attribution irrespective of
whether the foreign corporation distributes profits. Tax rates for individuals are higher
than corporation tax rates. If I control the company, I will let the profits sit in the
company and not distribute it – the corporate tax shelter company issues.
- Each country has its own version. They can either focus on which country holds the
residence of controlling shareholders. Or, foreign or offshore investment rules for funds
– where these funds are controlling the shares.
- OECD approach to CFC Rules – as long as CFC rules are implemented in domestic law, it is
fine. BEPS Action III outlines OECD’s suggestion on best practice in ideal design of CFC Rules –
Six Building Blocks. There is also an anti-tax avoidance directive of EU (not applicable for our
course) – very narrow – mandates all EU states to adopt CFC Rules.
- Six Building Blocks according to BEPS Action III–
1. What are CFCs?
§ See definition of CFC in Anti-tax avoidance Directive of EU.
2. Exemptions and Thresholds – when will CFC Rules get triggered? – if the
corporate tax paid is less than 50% of the tax that company would have paid if it
were resident in the residence country. There may also be a white-list of
countries where CFC Rules will not apply if that subsidiary is resident in those
countries (considers these countries to be robust-tax economies)
3. What is CFC Income? – active of passive? Clean or tainted? All deferred income
or only certain types which have greatest possibility of abuse? (Passive income,
dividends or interests or royalty etc., can be easily shifted – this is usually
defined as CFC income). Thus, most CFC Rules exempt active or business income,
and only target tainted income
4. How do you compute CFC Income?
§ Calculated using general rules applied in the country which is applying the
CFC Rules assuming that the CFC is resident in that country
§ Article 7 and 8 of EU Anti- tax avoidance directive (beyond this course, just
for reference) for actual mechanics and calculation
5. Attributability of CFC Income
§ Some of the income can be attributable to resident shareholders – it can
be taxed in resident country – but some other can only be attributable
to non-resident shareholders – how do we deal with this?
 6. Relieving double taxation – tax already paid by the corporation is also attributed
to the shareholders to provide some relief.
- OECD maintains that CFC Rules are treaty-compliant, arguments have been raised on this.
- For instance, Article 7(1) of OECD Model gave an exclusive right of tax
subsidiaries to source-state; and it can be argued residence country, through
CFC Rules, is trying to tax business income of subsidiary which was attributable
to source state.
§ In response, OECD posits that tax levied under CFC Rules does not reduce
the profit of subsidiaries, and therefore, cannot be said to be levied on
this.
§ Prof. Harris believes that this is a weak argument.
- In 2003, OECD said that it is recognized that CFC Rules are not contrary, and any
explicit recognition to this effect by any jurisdiction is not necessary.
- In 2017, OECD included Article 1(3) which allows for some residence country
taxation to further this position. This puts to rest most such questions.
- Question remains – what is attempted to be taxed by CFC Rules? Business
income, deemed dividend, value of shares etc. Most CFC Rules exempt active
income/ business profits while defining CFC Income – does this take away the
so-called contradiction and bring in coherence?
§ But Article 7(1) clearly includes business profits from Related Party
Transactions as well – but CFCs usually include RPTs specifically within
their ambit – what to do about this contradiction/ conflict?
- CFC Rules taxing deemed dividend can lead to conflict with Article 10 (which
provides that dividend should be paid before being taxed in parent corporation
jurisdiction) – OECD says that Article 10 does not include deemed dividend
before it is paid – but then should the word ‘paid’ be deleted? Conflicts remain.

In the next class we will discuss – allocation of expenses + thin capitalization (source-country
taxation perspective).

23 Oct
Workshop No. 3

Question: Problem Co is a corporation resident in Bolumbia. It has a PE situated in Elbonia and a Sub
resident there. During the current year the PE received a dividend from an unrelated Elbonian
corporation and the Sub paid a dividend to Problem. The Bolumbian tax administration taxed
Problem on both dividends. The dividend attributed to the PE was taxed at the special rate of 30%, a
rate generally applicable to profits of foreign PE. The dividend from the Sub was taxed at the usual
corporate tax rate of 25%. Bolumbia exempts dividends paid between two resident corporations.
There is an OECD style tax treaty in force between Bolumbia and Elbonia, which adopts Article 23A
for both countries.
● Problem seeks your advice as to the legality of the tax imposed by Bolumbia on the dividends
it received under the tax treaty between Bolumbia and Elbonia. Provide that advice and
include a consideration of any reliefs to which Problem may be entitled.
Discussion
● Preliminary random throughts he had:
○ Had it been a domestic PE - tax rate would have been 25%; now it is a special rate of
30%
■ Is it discrimination?
■ Is there a cure for this in the OECD Model treaty
○ Does this discrimination get covered by Art. 24 of OECD Model
■ Discrimination is by the resident country - so is it covered under this?
○ 23A - is there an exemption for everything?
■ OECD confuses it - it is actually foreign tax credit method, not a deduction.
● Now, discussion begins -

● First issue: whether the treaty is applicable in this situation

○ Art. 1 - resident of one or more of contracting states
■ Resident of Bolumbia [B] so treaty applies
● Second issue: What are the dividends the PE is receiving [presumption that they are
received as business profits]
○ Unrelated E corp - so not related party dividends
■ Applicable article - 7(1) - Profits of an enterprise of a Contracting State shall
be taxable only in that State unless the enterprise carries on business in the
other Contracting State through a permanent establishment situated
therein. If the enterprise carries on business as aforesaid, the profits that are
attributable to the permanent establishment in accordance with the
provisions of paragraph 2 may be taxed in that other State.
■ Limb 1 of this states that B can tax problem co.
■ 10(1) and 11(1) say specifically that resident country can tax. 6 does
not deal with resident country taxation
○ When we get to Art. 23 is when limb 2 of 7(1) becomes relevant for resident state
■ 23 - when it deals only with cross-border transactions
■ B does have preliminary right to tax [Problem co. is not PE], though this is
limited by art. 23.
○ 23A has been adopted - this is the exemption [and not 23B, which is credit method]
■ "may" be taxed - implications of this have been done in a previous class
■ Have to ask whether this may be taxed in E.
■ If so, under which article?
■ Under 23A of treaty, B should exempt dividend received by PE
○ So, right to tax is under 7(1) first limb and 23 limits this by saying you have to give
foreign tax relief. Test is may tax.
○ It may be that E did not tax it. But irrespective, advice - B should exempt.
● Is 10 applicable?
○ Problem co. is a resident in B. Have to see under treaty whether it has a right to tax.
It is applicable [10(1) - Dividends 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].
○ Should not consider subsidiary as a PE - PE dividend was dealt with separately [7 and
23 were the applicable articles]
● What article curtails right to tax of B
○ 23 - how does it do this?
○ 23A - though it says exemption in its title, it is actually exemption + foreign tax credit
method
 ○ Foreign tax credit method will apply. Have to give this for what? - have to go from
23A to Art. 10(2)
■ Have to ask what could E have done [since the problem does not say what it
has done] - could have imposed withholding tax - limit for 5% and 15%
under 10(2) on dividend imposed by E.
■ Can only get a credit for the withholding tax that was imposed, not
underlying foreign tax [corp tax]. OECD allows double taxation so cannot ask
for relief from that tax in E.
● As resident state B, you have to ask whether E has applied treaty correctly
○ B exempts dividend paid between two resident corps. Here, it is discriminating,
because if problem co. had received dividends from B sub, then it would have
exempted; but here it received dividends from a foreign sub, so not exempted.
○ Does 24 help?
■ No, not for B. So, can tax.
● When exemption applies, foreign tax credit method applies.

End of workshop [on applicability of 23A]

Thin Capitalization

- Company founded by a lot of debt rather than equity so that the interest payments can
reduce the amount of tax payable. Creates a problem of base erosion.
- Thin Cap company in country A with 900 debt and 100 equity. Corporate tax rate in
Country A is 30%. Thin company derives 100 as income and then pays 90 as interest to
parent company. Net income becomes 10. Then, itll have to pay a corporate tax of just 3.
It will also have to pay a withholding tax on interest to its parent company at a rate of
10% of the interest. Thus, it’ll be paying a total tax of 12 (30% of 10 + 10% of 90) If the
company had been financed wholly by equity, company would be paying a tax of 30 on
income of 100.
- OECD gives the source country the right to tax corporate profits, subject to non-
discrimination rules. It also gives limited rights to tax base eroding payments such as
interest, royalties, etc. All the deductibles that OECD does not allow you to tax or tax
only limitedly, are effectively subject to some form of manipulation.
- Countries therefore argue that you have deducted too much interest. Revenue
authorities will want to deny this deduction. Returns on debt and equity are not taxed in
the same way. Return on debt is taxed very lightly. The problem gets compounded
because they are easily substitutable.
- Basic principle: disallow interest on excessive debt.
- How can interest be excessive? Either it could be charged at excessive rates or you could
have a very high debt to equity ratio.
- Argument of revenue: So much debt is unrealistic (debt:equity is a subjective standard.
No market standard as such. Varies with sectors and companies)
- Possible Solutions:
· Arm’s length pricing. Subsidiary could not have borrowed 900 as debt on arm’s
length terms. Thus, interest must be limited to the amount it could have
borrowed at arm’s length terms and the rate it would have been borrowed at.
However, there are practical difficulties in applying arm’s length pricing. Article 9
says that the subsidiary company is independent of its parent and if it goes to
the market, risk analysis will determine what the rate of interest it. If the risk
goes past a critical point, there will be no loan. If you want to erode the source
 country’s tax base, you will have the subsidiary borrow as much as possible
based on the highest arm’s length pricing you might get, which will justify the
highest interest rate and the highest volume of debt. Keep pushing the envelope
to deduct as much as possible. Thus, strict application of arm’s length rules will
give the subsidiary more deductions than what it will actually pay. UK relied on
this approach till 2017.
· Debt to equity ratio approach- Alternative to ALP. Looks at what should be the
permissible debt to equity ratio, while leaving interest rate to transfer pricing
rules. Is fixing the debt to equity ratio arbitrary? Difficult to come up with a
scientific analysis of how to fix this ratio. Companies will be situated in different
circumstances (operating in different markets, different business strategies,
different investors.) Thus, the debt: equity ratio limit is usually limited to related
party debt and does not apply to third party debt. Problem with this approach is
back to back arrangements. (Borrowing from a bank to make it seem like it’s a
third-party debt even though the loan is guaranteed by parent company.) Source
company may have rules to prevent back to back arrangements but they are
very difficult to enforce, especially in the case on non-compliant jurisdictions
(eg: Cayman Islands)
· Earnings stripping approach- This approach doesn’t look at the source of debt,
making it easier to apply. Germany in 2008, and US after Trump adopted this
approach. However, this is a very arbitrary approach. How much you can borrow
will depend entirely on the market and specific sector. This approach looks at
the source of the problem- outflowing interest payments, reducing tax base.
Interest is not the problem, but rather the deduction and how much earning you
are stripping. Earnings stripping approach targets both simultaneously. Interest
is not deductible to the extent that it exceeds a percentage of income net of
financing costs (EVITA). Poses problems- for example a startup company will be
able to borrow very little in its first few years of operations. Thus, the earnings
stripping approach becomes oppressive since the start ups get denied interest
expense.
Disallowance may take the form of non-deductibility or reclassification as a
dividend. What are the consequences of this? For domestic tax purposes, it
may be deemed as dividend but this does not mean that it can be classified
as dividend under the international tax treaty. Domestic and tax treaty rules
for classification/treatment of income are different. If both the resident and
payer were in the same country, then the parent company will probably take
into consideration the reclassification of interest as dividend, thereby
avoiding double taxation.
Australia and Canada apply TP rules domestically and thin cap rules for cross
border transactions. Any country within Europe usually applies transfer
pricing rules both domestically and internationally. However, if there are thin
cap rules, that is what the tax authorities will rely on.
 · Source country approach- Apply the domestic rule first, figure out what the
domestic law and tax rates are, then accordingly configure it into your tax treaty.
The limitations available on taxation will then depend on the manner in which
the income has been classified. So, if you’ve taxed it as dividend under domestic
law, apply limitations under Article 11.
[Idk why he brings this up but : discrepancy in OECD Model Convention- 11(6)
[related party] overlaps with 9(1) [Transfer pricing]- Related party
relationships are special relationships. 11(6) has broader application.]

24/10
○ Covered foreign tax relief and A23 so far. (23A and B).
■ Looks hunky dory to get relief from Double Tax under exemption method or
foreign tax credit method.
■ Part of problem is how to calculate profits- part of that is allocating
expenses. This determines from residence country perspective what
your foreign income is.
○ Harris deals with this in page 411 in Ch 4
■ Does OECD regulate expense allocation is the question
■ Very little in the model treaty.
■ 1.3 makes it very clear that tax treaties do not affect taxation of
residents by residence countries.
■ So now need to see how A23 affects this
■ Does not expressly affect allocation of expenses. If it
does so, it is only for the purpose of providing
foreign tax relief.
■ Doesn't do so for the purpose of determining
quantum of profit.
■ 23 requires resident countries to respond to taxing rights granted by
source countries- foreign tax relief.
■ How the country responds by providing relief- can change
based on what type of taxing rights are involved.
■ Eg- can deny deductions for exempted income. (if
you use the exemption method)
■ If you are not allowing exempting of expenses- you
are not interpreting the treaty in good faith.
■ The allocation of expenses is very important for determining what
your profit is, which is important to see what quantum of tax is.
■ Expenses need to be properly attributed. And this is very
imp under foreign tax credit method. This is because there
it's necessary to calculate income net expenses.
■ Using an example
■

■ This is in Harris
■ UK company with two PE- Netherlands and UK.
■ Both have gross profits.
■ Forget 7.2 for the time being.
■ UK company took a loan to fund both PE. It paid interest on this
loan.
■

■ Suppose Netherlands has a 20% income tax.

■ UK company net income-
■ 100 because gross was 200 and 100 interest.
■ But now you need to see how much is foreign
income- this depends on how much expense is
allocated to foreign PE.
■ He's given two scenarios.
 ■ 12 is the limit on credits. You have 8 excess credits.
(scenario 1)
■ Total tax paid under scenario 1- 38
■ (the way you get the limit on credit is the max
amount of tax you'd pay in the home state).
■ Scenario 2 you pay 30 total tax.
■ As a tax advisor in this scenario you'd allocate as much expense as
possible to domestic income. (because foreign is taxed lower)
■ Erode domestic tax base is the best advice.
■ This is for tax credit system
■ Now taking same example with exception system
■ UK will just exempt foreign profits from domestic taxes. So
it'll just be the 20 Dutch tax paid.
■ So even in this situation, you'll allocate as much of expense
to the UK as possible.
■

■ New example- German company that has taken financing from a

German bank. Used this to finance a Dutch subsidiary by way of
equity.
■ Exempted income and deductible expenses are the issue in Q1
■ The Dutch company is a separate corp and it hasn't
borrowed.
■ It is true that the income by dividends is partly due
to the loan it took.
■ Because the amount was borrowed by the German
company- the Netherland tax authorities would never allow
a deduction for this.
■ Germany is already allowing an exemption for the
dividends.
■ If Netherland allowed a deduction- it would erode
its own tax base.
 ■ If you look at it- the Dutch profits are actually skewed
because the interest is actually for activities being taken in
the Netherlands.
■ If instead of equity there was debt used to finance in the
Netherlands-
■ The taxable base of the Dutch subsidiary would
reduce because it pays interest instead of dividends,
and interest is deductible/exempted.
■ Even if Germany exempts dividends, there is a clear case of double
taxation.
■ Interest on loan is being taxed twice.
■ The money used to pay loan is part of profits in Netherlands,
where no deduction is allowed. So the amount is taxed as
profits in Netherlands, and then taxed in Germany in the
hands of the bank.
■ So the same sum of cash is taxed twice (economic
double taxation)
■ So if you have a situation where parent is funding a subsidiary-
structure it as a loan if you have taken a loan.
■ Back-to-back debt financing is best.
■ Risk you run- thin capitalisation rule- cannot use too much
debt to fund the subsidiary.
■ Risk is always excessive interest rules. Need to know
how far you can push it without getting screwed.
■ Another risk- taxation of income in Germany.
■ They may tax it because it's exempt in
Netherlands.
■ They'll go under A11.1
○ Now he's moving to the problem he emailed (4th workshop)
■ https://groups.google.com/g/nalsar2022a/c/mqqmg-
1lTTk/m/5QwcbF0fAwAJ
■ OECD doesn't cure economic double tax- but by allowing tax credits for
underlying tax- it allows for remedying econ double tax.
■ Starting analysis- whether treaty applies- because resident it would.
■ First question- whether resident state has right to tax dividends received
from foreign sub.
■ This is A10.1- does have right, subject to A23
■ Para 22 of A23- whatever tax paid in source is to be deducted before
paying in resident
■ Non-discrimination only applies to source and not resident
countries.
■ In this case- Futonia didn't tax dividends, so no question of foreign
tax relief.
■ There's another aspect- whether Squida's benefit under other
treaties can be claimed despite it not being present in this treaty.
(the underlying foreign tax credit)
■ No MFN treatment here. So other treaties are irrelevant.
■ Even in BITS there are MFN clauses. (took place in White
Industries v India)
■ Second leg
 ■ In a purely domestic situation the source state wouldn't tax such
deals.
■ A13.1 OECD- source state has right to tax capital gains from
immovables.
■ Resident state right to tax- not present at all technically.
However-
■ A6 does not say resident state can tax, but by
presumption resident states can tax.
■ If not under A6, under A21 (income not dealt with)
can argue that this is not dealt with from
perspective for resident state.
■ Residual right to tax.
■ Regardless of where it draws power- curtailed by A23.
(remember to follow this order, go to right to tax of each,
then restrictions)
■ A23- uses phrase 'may be taxed'
■ The resident state should look at whether
the source state applied its own laws
correctly, don't look at it from POV of
resident laws.
■ Write this in exam.
■ Only way the resident can refuse relief- if they believe source
doesn't have right to tax.
■ Here land is held directly by foreign corp and not a
subsidiary (subsidiary would qualify and A24.5 would apply)
■ A24.3 is another non-discrimination article that may apply-
there was a fixed place, but whether if it was a fixed place of
business is a different question.
■ Not sure if there is a passive holding, if it was
passive- then 24.3 doesn't apply.
■ 24.3 would apply to fixed PE.
■ If it was a fixed PE, comparator would be- source
state resident corporations- so there cannot be
discrimination, and source state wouldn't be
allowed to tax.
■ So the answer- if it was a fixed PE, then it is possible for resident
state to tax, otherwise it cannot.
■ Final limb
■ A11.1 resident country can tax foreign interest income.
■ Qualified by A23 again.
■ But there is no tax applied by source state (so no
withholding tax)
■ Can tax resident company under domestic law. Under A1.3
■ No applicability of A24.
○ Mismatches
■

■ He's happy we've learnt this much because it was a 1 year LLM course.
■ Ch V Harris- has written about this in depth, along with gaps in OECD model.
■

■ Hybrid entities- seen as tax paying by one, and pass through by

another.
■ This is something OECD highlights in BEPS project.
■ Hybrid that UK company has in the US. There is also a US sub.
■ Look from source perspective-
■ Royalties are exempted under OECD model.
■ So the US sees it as going to the parent company. So no
withholding tax. So no tax in source state.
■ UK perspective
■ Sees it as a proper entity- the income is not attributed to the
parent co, because it's that of hybrid.
 ■ Effectively the income has disappeared. It's a case of double non-
taxation.
■

■ US perspective-
■ US will allow it to make deduction for depreciation and
interest.
■ UK-
■ UK will see it as deductions that need to be made by the
parent company.
■ Double use of losses/deductions/expenses.
■ If the UK sees it as a PE- the problem will be largely ameliorated.
■ Harris deals w/ at 5.1.1
■

■ Example from TP in A9.1

 ■ If the parent sells for 11 pounds- gets a profit of 6 pounds on the
books, but due to adjustment it is only 1 pound profit.
■ So France is taxing a higher tax base, but the UK isn't
lowering it. So the parent company is paying tax at the
higher level.
■ So the UK needs to allow corresponding adjustment under A9.2
■

■ Secondary adjustment is recharacterizing the amounts.

■ But if you do this late, the tax base has been increased, but the
amount has already been sent to the UK from France.
■ If the amount hasn't been paid to the French company at all-
then it's treated like the French co has paid a dividend to the
UK. This means that the French can impose a withholding
tax on this constructive dividend.
■ The UK response will have to be under A23
●

■ Disjuncture applies at many levels because systems don't work congruently.

■ Foreign tax credit will lead to issues.
■ French gives depreciation fully over 5 years, and UK over 20 years.
■ Risk-
■ UK tax in early years will be followed by excess tax credits in later
years.
■ Vice versa- the French will not have much tax initially, but it'll be
greater later.
■ The tax base in the UK and France is fundamentally mismatched.
■ You can't carry tax credits backwards, so this leads to full double
taxation merely because of a timing mismatch.