Anti-Treaty Shopping: A Comparative Analysis of the U.S. and OECD Model Tax Conventions

Anti-Treaty Shopping A Comparative Analysis of the U.S. and OECD Model Tax Conventions Duke University Sanford School of Public Policy - International Tax Program Presented By: Festus Akunobera, Esq. Partner, East Legal Services, Uganda akunobera@taxation.east.co.ug January 22, 2010

[object Object],[object Object],[object Object],[object Object],I. Background

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],I. Background

[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping

[object Object],[object Object],[object Object],II. Treaty Shopping U.S. Person SPV (e.g., GBC1) Limited Company United States Mauritius Uganda 15% Dividend and Interest Withholding Tax 10% Dividend and Interest Withholding Tax 0% Dividend and Interest Withholding Tax

[object Object],[object Object],[object Object],II. Treaty Shopping State C Conduit State A Company Limited Company State C State A State B Non-treaty Protected Payments Treaty-protected payments Deductible Payments e.g., commissions, interest, etc. that erode State A’s tax base Payments exempt in State C under a special tax regime Loans, mgt contracts, etc

[object Object],[object Object],II. Treaty Shopping

[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – The U.S. Approach

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – The U.S. Approach

[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – The U.S. Approach

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – The U.S. Approach

[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – The U.S. Approach

[object Object],II. Treaty Shopping – The U.S. Approach Is the Principal Class of its shares (and any disproportionate class of its shares regularly traded on one or more recognized stock exchanges? Is the Principal Class of its shares primarily traded on one or more recognized stock exchanges located in State R? Is the Company’s primary place of management and control located in State R? Eligible for Benefits Not Eligible for Benefits Yes Yes Yes No No No If 5 or fewer companies own ≥50% of the aggregate vote and value of shares (and ≥50% of any disproportionate class of shares) of the Subsidiary), do those companies satisfy criteria set forth in Art. 22(2)(c)(i)? Yes No Art. 22(2)(c)(ii) Art. 22(2)(c)(i)

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – The U.S. Approach

[object Object],II. Treaty Shopping – The U.S. Approach Is ≥50% of the aggregate vote and value of shares (and ≥50% of any disproportionate class of shares) of the Company beneficially owned (directly or indirectly) by qualified persons under Art. 22(2)(a), (b), (c)(i) or (d) for at least half the days of the taxable year? Has <50% of the Company’s gross income for the taxable year, as determined under the tax laws of the State of Residence (“R”), been paid or accrued directly or indirectly to persons not entitled to benefits under Art. 22(2)(a), (b), (c)(i) or (d)? Eligible for Benefits Not Eligible for Benefits Yes No Yes No 2. Ownership and Base Erosion Test - Art. 22(2)(e) (cont’d)

[object Object],II. Treaty Shopping – The U.S. Approach Is the Company or its Associated Enterprise engaged in the active conduct of a trade or business in State R? Is the above business a business of making or managing investments on own account? Eligible for Benefits Not Eligible for Benefits Is the income from U.S. sources derived in connection with or incidental to the trade or business conducted in State R? Is the State R enterprise a Bank, Insurance Company or Registered Securities Dealer? Is the business activity conducted in State R substantial? No Yes No Yes No Yes No Yes No Yes

[object Object],II. Treaty Shopping – The U.S. Approach Individuals Charities, Religious Organizations, etc. No Pension Funds Do individuals resident in State R and the United States collectively own more than 50 percent of the pension, fund? Is the individual resident in State R for purposes of Article 4 of the Convention? Eligible for Benefits Not Eligible for Benefits No Yes Yes Article 22(2)(a) Article 22(2)(d), Article 4(2) Yes

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – The OECD Approach

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – The OECD Approach

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – The OECD Approach

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – Shared Approaches

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – Shared Approaches

[object Object],II. Treaty Shopping – Shared Approaches SPV “ Issuer” Parent Guarantor Noteholders Mauritius Indonesia loan loan Interest subject to DTA WHT of 10% Interest not subject to tax Indofood International Finance Ltd v JPMorgan Chase Bank, N.A., London Branch [2006] EWCA Civ. 158, Court of Appeal. Facts PT Indofood SM ("the Parent Guarantor") , a company incorporated in the Republic of Indonesia, carried on substantial business in the production and distribution of food. It wished to raise capital by issue of loan notes on the international market. If it had done so itself, it would have been obliged under Indonesian law to deduct 20% as withholding tax on interest payable to the noteholders. The rate of withholding tax could be reduced to 10% if the issue of the loan notes was made by a wholly owned subsidiary incorporated in Mauritius and the capital so raised was lent on to the Parent Guarantor on terms which complied with the conditions specified in the Indonesia - Mauritius tax treaty. Accordingly, the Parent Guarantor procured the incorporation in Mauritius of the claimant Indofood International Finance Limited ("the Issuer"). The Issuer raised US$280m loan notes and lent the capital so raised to the Parent Guarantor on the same terms. The issue, servicing and redemption of the loan notes and the loan to the Parent Guarantor were regulated, inter alia, by a Trust Deed under which JPMorgan Chase ("the Trustee") was appointed trustee for the noteholders.

[object Object],II. Treaty Shopping – Shared Approaches SPV “ Issuer” SPV NewCo Noteholders Mauritius Netherlands loan Assignment of Issuer Rights Onward payment of interest paid by Parent Guarantor Interest not subject to tax Parent Guarantor Indonesia Interest subject to DTA WHT of 10% Indofood International Finance Ltd v JPMorgan Chase Bank, N.A., London Branch [2006] EWCA Civ. 158, Court of Appeal (Civil Division) Facts (cont’d) Under terms of the notes, if there was a change in Indonesian law whereby the obligation to withhold tax from interest payable to the Issuer exceeded the rate of 10% for which the Mauritian DTA provided, and "such obligation cannot be avoided by the Issuer taking reasonable measures available to it" , the Issuer might, with the approval of the Trustee, redeem the notes. In 2004, Indonesia issued a notice to terminate the Mauritius DTA effective January 1, 2005, the effect of which would be that the Parent Guarantor would be obligated to withhold at the rate of 20%. Accordingly, the Issuer gave notice to the Trustee of its intention to redeem the loan notes. The Trustee refused approval of the redemption on the grounds that the Issuer had reasonable measures available to reduce the increased liability for withholding tax (i.e., that the Issuer assign the benefit of the loan agreement between the Issuer and Parent Guarantor to a company incorporated in Netherlands ("NewCo"), which, the Trustee argued, would have reduced the rate of withholding tax to 10% under the Indonesia - Netherlands treaty).

[object Object],II. Treaty Shopping – Shared Approaches SPV “ Issuer” SPV NewCo Noteholders Mauritius Netherlands loan Assignment of Issuer Rights Onward payment of interest paid by Parent Guarantor Interest not subject to tax Parent Guarantor Indonesia Interest subject to DTA WHT of 10% Indofood International Finance Ltd v JPMorgan Chase Bank, N.A., London Branch [2006] EWCA Civ. 158, Court of Appeal (Civil Division) Issue Whether the interposition of NewCo between the Parent Guarantor and the Issuer could reduce the rate of withholding tax in respect of interest payable by the Parent Guarantor under the loan agreement to 10% or less - which depended, inter alia, on whether NewCo could be the beneficial owner of the interest payable by the Parent Guarantor. Holding / Observations on Beneficial Ownership A conduit can normally not be regarded as the beneficial owner if, though the formal owner of certain assets, it has very narrow powers which render it a mere fiduciary or an administrator acting on account of the interested parties (most likely the shareholders of the conduit company). One way to test beneficial ownership is to ask: what would happen if the recipient went bankrupt before paying over the income to the intended, ultimate recipient?

[object Object],II. Treaty Shopping – Shared Approaches SPV “ Issuer” SPV NewCo Noteholders Mauritius Netherlands loan Assignment of Issuer Rights Onward payment of interest paid by Parent Guarantor Interest not subject to tax Parent Guarantor Indonesia Interest subject to DTA WHT of 10% Indofood International Finance Ltd v JPMorgan Chase Bank, N.A., London Branch [2006] EWCA Civ. 158, Court of Appeal (Civil Division) Observations on Beneficial Ownership (cont’d) If the ultimate recipient could claim the funds as its own, then the funds are properly regarded as already belonging to the ultimate recipient. If, however, the ultimate recipient would simply be one of the creditors of the actual recipient, then the funds properly belong to the actual recipient. The meaning to be given to the phrase 'beneficial owner' is plainly not to be limited by so technical and legal an approach. Regard is to be had to the substance of the matter. In accordance with the legal structure, Parent Guarantor is obligated to pay interest two business days before the due date to the credit of an account nominated for the purpose of the Issuer and the Issuer is obliged to pay the interest due in one business day before the due date to the account specified by the Principal Paying Agent. In both commercial and practical terms, the Issuer is, and NewCo would be, bound [by the Note Conditions] to pay on to the Principal Paying Agent that which it receives from the Parent Guarantor. In practical terms, the Issuer or NewCo lacked the 'full privilege’ needed to qualify as the beneficial owner, rather the position of the Issuer and NewCo equates to that of an 'administrator of the income‘.

[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – Shared Approaches

[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – Conclusions

[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],II. Treaty Shopping – Recommended Readings

Anti-Treaty Shopping: A Comparative Analysis of the U.S. and OECD Model Tax Conventions

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