ADIT Paper I 1.

Double tax conventions have many aims like tackling tax evasion, exchange of information and international tax dispute resolution. The two main aims of double tax conventions are the allocation of taxing rights between the contracting states and the elimination of double taxation. These aims are related. If the taxing rights were allocated in a harmonious, unified manner (for example only source taxation would exist) then there would be no need for elimination of double taxation. Tackling double taxation has been a significant topic in international tax since the beginning of the 20th Century. Even the League of Nations had attempted to deal with it, and provided Model Tax Conventions in 1928, 1993 (Mexican) and in 1996 (London). These models focussed on the source based taxation. There has been no dispute over the fact that business activities in a country [even if carried on by an enterprise of the state] and income from immoveable property has to be taxed by the source state. Incomes like interest, royalty, dividends have been in the spotlight. The first OECD Model Tax Convention achieved a breakthrough and allocated the taxing rights mainly to the residence states. The tax rights over immoveable property, PE, director fees and capital gains (mainly) remained with the source state. The Model Tax Convention has two promises. First the residence state has to give relief from double taxation. Second, the source state limits its jurisdiction and lowers it withholding taxes Double taxation has two types. Judicial double taxation and economic double taxation. Judicial double taxation occurs when the same taxpayer is taxed by two or more countries (usually for the identical period, same subject matter and by comparable taxes). Economic double taxation is when the same income is taxed two or more times (usually in the hands of different tax payers, and by different countries). This is the case when a country imposes corporate tax on the on the profits of a company, then it imposes WHT on the dividends distributed from that profit and the dividends are taxed by the residence country in the hands of the shareholder Judicial double taxation can occur when two countries have residence- residence, source-residence or source-source dispute. The basic reason for the debate is that countries use different correcting factors to make a link between the tax payer and the country or a link between the income and the country. The first concept is called in personam and the second is called in rem correcting factor. These correcting factors establish a weighty, real, substantial attachment between the states and the income/person.

In personam correcting factors are in the case of an individual the residence, nationality, citizenship, habitual abode, domicile. In rem correcting factors can be also divided into different groups: where the income is generated, where its source is, where it is kept, where it is consumed. If countries cannot agree about the source of income or the residence of a tax payer, double taxation can occur. Even if they agree with each other double taxation can easily happen in case of incomes like dividends, royalty and interest. According to the OECD MTC both the source state and the residence state can tax those incomes. The OECD MTC requires the residence state to give relief for the tax period in accordance with the DTC in the source state (23/A, 23/B). Countries have many ways t give relief. They can mitigate double taxation unilaterally. They can give relief in accordance with a DTC between the countries. The method they use [credit, exemption deduction] depend son whether they follow the CEN or the CIN method or they combine them. If a country follows the CEN its tax system is based on residence concept and usually offers credit (USA) with the concept of deferral. If a country uses CIN its tax system is based on source taxation with exemption of foreign income. Economic double taxation can occur in case of TP adjustment in accordance with Act 9. The most common case of double taxation are the dual residence, the allocation of income to a PE, and the upward adjustment by a country. The OECD MTC also offers the MAP and the Arbitration to deal with double taxation. It is clear that double taxation must be eliminated. It distorts the flow of capital. It causes compliance burden. It represents an obstacle to cross-border transactions. It discourages internation investments. It lowers the competitiveness of companies. It is also unfair because a company which invests in just one country is not exposed to it while a company which operates in more states are punished by double taxation.

2. Abuse of double tax conventions is a significant and important topic. Its significance is showed by that the OECD Model Tax Convention and its Commentary have contained the beneficial owner and the limitation on residence concepts since 1977. The OECD realised that these two measures are not enough to deal with the improper use of treaties in the Conduit and in the Base company reports in the 1980s. Since then the Commentary has offered several methods to deal with abuse. It offers the look through approach, the channel approach, the subject to tax and the exclusion approach. If these methods cannot hinder the improper use of the DTC, then the countries, then the countries can terminate the DTCs or they should not even negotiate and conclude DTCs (abstinence approach). The USA mainly uses provisions to tackle abusive practices. You have to be a qualified person to get access to the benefits. An individual, a governmental body can easily fulfil these requirements. A company can be a qualified person provided one of the tests listed in the DTC is met.

These tests are: derivative benefit, equivalent beneficiaries, active business income, registered shares (on a recognised stock exchange) or for example the discretion test. Many argue that the provisions are too mechanic and leave no room for motive. Still the USA uses them (good examples are the new provisions in the Malta, New Zealand , Hungary DTCs). Although one can conclude from the above mentioned that there is no dispute and contradiction in relation to treaty abuse, it is not true. Even the concept of improper use of double tax conventions is not clear Many see that phenomena like conduit companies, base companies, transfer of residence, artificial legal structures and many examples given by the OECD Commentary must be combated. Still the OECD MTC and the Country do not provide definition for improper use of DTCs. Improper use can be when one uses the treaty for a purpose outside the scope of the approved aims (balance allocation of taxing rights, exchange of information, MAP, elimination of double taxation). The concept of treaty shopping is more straightforward. The OECD Commentary says that treaty shopping is when a third country resident establishes a company in a contracting state to get access to the benefits of the DTC. [This company would otherwise be eligible for the benefits.] Rosenbloom says that treaty shopping is when a third country residence shops and honours a treaty which provides favourable tax treatment with the source country. The US MTC had a treaty shopping definition until 2006. It said that treaty shopping is when a third country resident gets access to a DTC which is intended to be a reciprocal agreement between the states. The Technical explanation says that treaty shopping is when the principal purpose of a third country is best to obtain the benefits. Many see that treaty shopping is wrong because it is a form of tax avoidance, it reduces tax revenue, it distorts the reciprocity of DTC and, the balance allocation of taxing rights and is a disincentive to include a DTC. Another very important concept is the beneficial ownership. This was addressed in cases like Indofood and Societe-Royal Bank of Scotland. Beneficial ownership is not equal to more residence, a tax payer will not be considered to be a beneficial owner just because he receives the income and he is resident in the other contracting state. As in Indofood the court cited Philip Barker and stated that beneficial ownership has an international fiscal meaning, it must be construed in the light of the objectives of the DTC,it cannot be interpreted in a narrow technical sense. Beneficial owner is a person who/which is not a mere agent, nominee, fiduciary. A person who has narrow power over the received income and has the obligation to pass it on cannot be a beneficial owner. That is why the Netherlands company would have not been regarded as beneficial owner. Thus Indofood won and it could apply the get out clause of the contract.

In Royal Bank of Scotland the UK bank, its dividends were guaranteed, its return was also fixed. The French court declared that the transaction was a loan ad the bank was refused to get access to the benefits. In Revost the tax payer won. This case concerned a Dutch company which received dividends from a Canadian company. Although the tax authority argued that Revost did not have office, premises and did not carry on active business activities these were not enough to persuade the court [mainly because Revost was a holding and cannot be expected to carry on any other activities than holding shares]. In a similar case in Denmark the Danish court concluded that the recipient of the income/dividends did not have to distribute the dividends to its parent so it had the power to reinvest it. In the case Azadi Backer the court did not apply the anti-treaty shopping provisions on the ground that treaty shopping provides long term benefits to developing countries and makes it possible for the to attract investments. In conclusion, it must be said that although there are many arguments against treaty shopping there are also arguments for it.

6. In this case many signs show that Amethyst has a dual residence, it is a resident of both Contracting States, then Amethyst will be deemed to be a resident in the country in which its place of effective management is situated. The situation in respect of Alla is clear. Alla uses the incorporation concept and regards concepts as residents if they are incorporated in Alla. This concept is quite common and used by states like the UK and Canada. The incorporation test is certain and leaves no room for discussion. The facts which point toward that Alla has a residence in Bounty do not matter in this sense. Amethyst will be regarded as resident by Alla. In a similar case, Calcutta Jate Mills, the UK considered a company which was attached to India by many ties to the UK resident because it was incorporated in the UK. Bounty, the other country, uses the seat test to evaluate if a company is resident in Bounty or not. It means if Bounty consider Amethyst to have its central management/control in Bounty it will be regarded as resident. This test is also used by the UK. In De Beers a South African company was considered to be UK resident because the control over it was exercised by the directors in the UK. In a case called Bullock, the UK court declared that the real, effective, ultimate power matters [even if it is exercised by the directors of the parent company illegally/unconstitutionally in the UK.]

There are many facts that show that the control is exercised in Bounty. Most of the directors (two directors plus the chairman) are resident in Bounty. Quarterly brand meetings are held in Bounty. Amethyst has an office in Bounty, it is registered in the stock exchange of Bounty and the substantial minority of the shares are owned by a Bounty resident. Bounty will definitely argue that the strategic decisions are made in the quarterly board meetings. We do not know anything about the advisors of the company so the Wood v. Holden case would not help to decide the question. If Bounty heard about the Swedish Railway case it can argue that a part of the central management is exercised in Bounty and it is enough for the residence for tax purposes. [Furthermore it can argue that the substantial degree of the controlling power matters and it is exercised in Bounty (Union Corp. Ltd)] In this case when two countries consider a company to be resident in their territories, Act 4(3) of the MTC applies. In order to arrive at the residence of Amethyst one should find the place of effective management. One should find the place of effective and positive management. [Smallwood case] Argument for the residence in Alla is that the daily decisions are made there by the two directors. Bounty would argue that the quarterly brand meetings are held in its territory and the two directors cannot decide in matters of exceptional importance. We do not have information on what exceptional importance means but it seems that this concept covers cases which are outside the course of business. One could argue based on New Datacom that in exceptional cases an executive brand is established in Bounty but it is not enough to have the place of effective management there. Still I could argue that key management and commercial decisions that are necessary for the conduct of the entitys business as a whole are made in Bounty during the quarterly board meetings or during the exceptional board meetings. Thus, in my opinion, the place of effective management is in Bounty. 7. There are many provisions of Act 5 of the OECD MTC which have to be examined in this case. The structure of business in the case may trigger application of more than one provision of Act 5. Thus one could argue that Cella has a permanent establishment in Duncandia because of the warehouse or because of the delivery of equipment and the business activity which is carried on through a website. Furthermore the application of Act 5 para 5 maybe invoked when marketing representatives visit the customers in Duncandia. There can also be a debate over the application of the two taxpayer concept of OECD in respect of the remuneration and activity of the dependant agents. Cella can argue if someone takes a closer

look at the case then it becomes clear that Act 5 para 7 excludes the possibility to look at Dux as a PE of Cella Inc. Dux is a subsidiary of Cella in Duncandia. Cella Inc will argue that the fact it has a warehouse in Duncandia falls within the scope of para 4 of Act 5. It would mean that Cella does not have a PE in Duncandia. Equipment is stored in the warehouse before the manufacturing and also after the manufacturing for delivery. Cella will also suggest that the operations through a website do not constitute a PE because the server is situated in Corfe. Although, as I said before, Cella will say that Act 5 para 7 will exclude Dux as a PE, the fact that the website sends messages to Dux which arranges delivery of the equipment from the warehouse to the customers on the behalf of Cella suggests Dux carries on business activity to Cella. If this activity is substantial and requires Dux to maintain staff (employees), technical equipment, premise to work for Cella one may say that this activity falls out of the scope of para 7 and constitutes a PE for Cella either in respect of para 1 or para 5. [The activities carried on by Dux on the behalf of Cella may be examined in the light of the alternative service provisions if the DTC contains those.] The next circumstance which must be examined is the activity of the manufacturing representatives of Cella. The fact that they are employed by Dux does not exclude the application of Para 5. They visit the customers and demonstrate the equipment to them. . Para 5 requires them to act on behalf of Cella and habitually exercise the authority to conclude contracts. From the facts of the case it seems to me that they do not have the authority to negotiate the terms, conditions of the contracts, or to arrange the pricing. They would be regarded as independent agents (para 6) if they act in the ordinary course of their business. On the other hand if they are instructed by Cella (directly or indirectly through Dux) and do not have legal and economic freedom and devote all their time and energy to Cella (and its equipment) then I would say that they constitute a PE for Cella. On the whole, more facts point toward that Cella has a PE in Duncandia. The representatives, the warehouse, the arrangements through the website, the delivery evaluated together suggest that Cella has a PE. Still one must be using caution to declare a PE. If Cella has, then Art. 7 can be applied and (as if PE use a separate, distinct entity, carrying out the same activity under the same circumstances) profits can be attributed to the PE under the arm's length principle based on the separate accounts of the PE. I would recommend the authority to avoid the two taxpayers concept of the OECD (in case of dependent agents) and follow the guidelines established in the case of Morgan Stanley by the Indian Court.