Introduction to Tax Treaties in EU and

Transfer Pricing

Sudin Sabnis
February 2019
Contents

• EU – Introduction

• Introduction to tax treaties

• Model Tax Conventions

• Tax Treaty v EU Law

• Basics of Treaty Interpretation

• Types of Income

• Foreign Tax Credit

• Non Discrimination

• MAP / Arbitration

• Transfer Pricing – An Overview

2
EU - Introduction

3
European Union

❖ 28 Countries

❖ One common market

❖ Unity in diversity –
Official EU slogan

❖ European Economic
Community: Remove
protectionism, ring in
harmonisation

4
EU Legislative Framework – The Constitution

• Treaty on European Union (TEU); Treaty on Functioning of European Union

(TFEU) - forms the detailed basis of EU Law,

• Maastricht Treaty (1993) - Creation of an Economic and Monetary Union –

birth of Euro.

Primary • Amsterdam Treaty (1997) - Abolished physical barriers across the internal
market – birth of Schengen Area - abolition of border controls between
most member states, common rules on visas etc.

• Directives (e.g. Parent Subsidiary Directive, Merger Directive, Interest

Royalty Directive etc.), Regulations, Recommendations etc.

Secondary

5
Pillars of EU Legislation

Free Movement
of Capital

Free Movement Free Movement

of Goods of Services

Free Movement
of Citizens

6
EU Freedoms

• No entry tax on goods imported from other Member state

(i.e. no Customs)
Free
• Full VAT credit on goods manufactured in other Member
Movement State
of Goods • Prohibition on levy of incremental duty on goods of other
Member State

• All kinds of capital controls prohibited (e.g. no limits in

Free acquiring shares of company located in other Member State,
Movement no limit on making investments etc.)
of Capital

• In the taxation of Rum case (Customs), the ECJ stated that:

The purpose of Article 90 EC as a whole, is to ensure the free movement of goods between the
member states under normal conditions of competition, by eliminating all forms of protection which
might result from the application of discriminatory internal taxation against products from other
member states, and to guarantee absolute neutrality of internal taxation as regards competition
between domestic and imported products

7
EU Freedoms

Free • Services can be provided without any restriction to

Movement of recipient of any Member State, from any Member
Services State

• Free movement of citizens guaranteed to live, work,

Free study and retire in any Member country.
Movement of • Citizens can travel to other country to travel or work.
Citizens • Discrimination on grounds of nationality prohibited

ECJ in Van Binsbergen case

A Dutch lawyer moved to Belgium while advising a client in a social security case, and was told he could not
continue because Dutch law said only people established in the Netherlands could give legal
advice. The Court of Justice held that the freedom to provide services applied, it was directly effective, and
the rule was probably unjustified: having an address in the member state would be enough to pursue the
legitimate aim of good administration of justice

8
EU Directives

1. Interest Royalty Directive – No withholding on interest / royalty payments

2. Parent Subsidiary Directive (Dividend) – No withholding / taxation of dividends received

from firms in member states

3. Merger Directive – Cross border merger tax exempt, subject to conditions

- No withholding tax on cross border payments – encourages free

movement of capital
- Recipient to be beneficial owner of such payments
- Applicable to EU tax residents / presence in member countries
- Limited applicability to third countries

9
EU Directives – Case Study

Interest Payment
German Entity

100%
shareholding

Dividend
Payment 95%
shareholding US entity

• Will there be withholding on

dividend payment?
French Entity • What would be the taxation of
dividend payment in the hands of
German entity?
• Would the interest payment suffer
withholding tax?
10
Introduction to tax treaties

11
Introduction to tax treaties

• What are tax treaties – Treaties are the agreements entered into between countries with
respect to taxes on income and on capital, wherein the countries agree to:
− Be restricted from taxing
− Provide relief for taxes paid in the other treaty country
• Types of Treaties -
− Bilateral (between two countries) - most EU countries have bilateral tax treaties in place
with each other to relieve double taxation when it occurs
− Multilateral (between 3 or more countries – e.g. Nordic treaty)
• Why are tax treaties
− Promotion of cross border trade through elimination of double taxation
− Providing clarity of fiscal situation of a taxpayer
− Exchange of information to combat tax avoidance / tax evasion
− Sharing of tax revenues
− Allow easy transfer of technology
• Legal effect of tax treaty
− Treaties do not impose taxation since they are not given the function of being tax
instruments.
− Treaty are given effect by domestic legislations. Hence, applicability of Tax Treaty is
conditional to the applicability of the Domestic legislations.

12
Introduction to tax treaties

• Basic principles of tax treaties

− Residence – connects to Tax Payer
− Source – connects to income
− State R (Resident) has basic rights to tax global income of its Resident
− State S (Source) shall also levy tax, however, generally lower than normal tax

• Stages in life of a Tax Treaty

− Entry into Force
o Date of Convention
o Date of Ratification
o Date of Notification
o Date of entry into force
o Effective date
− Exchange of Notes, Protocols, MoUs, etc.
− Termination (generally followed by revised treaty)

13
Introduction to tax treaties

• Allocation of taxation rights to countries

− Full rights to tax only in one jurisdiction either to Source state or Residence State
− Full rights to tax by both jurisdictions but with tax in the source state limited to a
specified level and residence state give credit for tax paid in Source state
− Full right to tax by both jurisdictions without limitation and the Residence state
giving a credit for tax paid in the Source State
• Treaties can be Limited or Comprehensive
− Comprehensive Double Taxation Avoidance Agreement (‘DTAA’) cover all income
flows
− Limited DTAA covers only shipping / transport related income
− Contents of Comprehensive DTAA (DTAA are divided into Articles):
o Definition of the scope of DTAA
o Definition of taxing rights for all types of income or gains
o Methods of elimination double taxation
o Special provisions

14
Juridical Vs Economic Double Taxation

• Double taxation is Juridical when the same person is taxed twice on the same income
by more than one state.
• Double taxation is Economic if more than one person is taxed on the same item.
Juridical Double taxation Economic Double Taxation

R R Co Co A

X
Income Co B

Income is subject to tax in two countries Two legal entities are subject to tax on
–Shared taxing rights same income in two countries –

E.g., Fess for technical services, E.g., Unilateral Transfer Pricing adjustment
Royalty
15
 Overview of Tax Treaty – Articles of Treaty
Scope Definition
Provisions Provisions
Article 1 : Personal Scope Article 3: General
Definitions
Article 2 : Taxes Covered
Article 29: Entry into force Article 4: Residence
Article 30: Termination
Article 5: Permanent
Establishment
Elimination of double
Anti -
taxation avoidance
Article 9: Associated
Article 23 : Elimination of
Enterprise
double taxation Article 26: Exchange of
Information
Article 25: Mutual agreement
Article 24: Non –Discrimination
Miscellaneous
Provisions Article 27: Diplomats
Article 28: Territorial Extension
Substantive Provisions
Article 6 : Immovable Property
Article 7 : Business Profits
Article 8: Shipping etc
Article 10: Dividend
Article 11: Interest
Article 12: Royalty & FTS
Article 13: Capital Gains
Article 14: Independent Personal Services
Article 15: Dependent Personal Services
Article 16: Directors
Article 17: Artists & Sports persons
Article 18: Pensions
Article 19: Government Service
Article 20: Students
Article 21: Other Income
Article 22: Capital
16
Model Tax conventions

17
Model Tax Conventions
OECD Model
• Organisation for Economic Co-
operation and Development
(‘OECD’)
• Established in 1961 with
developed countries as its
members
• Essentially a model treaty
between two developed nations
• Advocates residence principle
• Lays emphasis on the right of
state of residence to tax
• EU countries' DTAA are generally
based on the OECD Model
Convention.
UN Model
• Tax Treaties between developed
and lesser developed countries,
or between developing countries
• Drafted in 1980, designed to
encourage flow of investments
from the developed to
developing countries
• Compromise between source
principle and residence principle
• Gives more weightage to source
principle, i.e. income should be
taxed where it arises
18
Model Tax Conventions

• Nordic Model
− Drawn up by Sweden, Norway, Finland and Denmark (collectively Nordic countries).
− The Nordic Convention on Mutual Administrative Assistance in Tax Matters
concluded by Finland, Sweden, Norway, Denmark and Iceland, is a pioneering
measure regarding multilateral convention in mutual tax assistance.

19
Interpreting a Treaty (Vienna Convention)

• The purpose of the Vienna Conventions is basically to codify existing rules of

international law rather than create new provisions.
• Article 31 and 32 of Vienna Convention, provides a broad guideline as to what could be
an appropriate manner of interpreting a tax treaty.
• A Treaty shall be interpreted “in good faith in accordance with the ordinary meaning to
be given to the terms of the treaty in their context and in light of its object and
purpose.” (Art. 31(1)) (Look for object and purpose in preamble & overall structure)
• The context for the purpose of the interpretation of a treaty includes Preamble,
annexes, text itself, agreements, treaty instrument, other international law provisions,
etc.
• Parties’ own interpretations reflected in subsequent agreements
• History of the negotiation of the treaty (as supplementary means of interpretation)

20
Tax Treaties and EU Law

21
European Law vs Tax treaties
• Purpose: Treaty law is to regulate interstate relations through the allocation of powers of taxation
between the contracting States, whereas Community tax law serves the major project of establishing a
single market without internal borders

• Scope: The tax treaties are designed primarily to eliminate (or at least restrict) international juridical
double taxation, and the elimination of juridical and economic double taxation within the Community is, a
Community objective.

• Tax treaties concluded for this purpose must, under Community law, comply with internal market
requirements on non-discrimination and the four basic freedoms laid down in the Treaty establishing the
European Community. [Saint Gobain case, ECJ]

Schumacher Case -ECJ

The Court did not object in principle to States designating, in their bilateral double taxation agreements,
the State of residence as the State subject to the obligation to take account of the personal and family
circumstances of cross-border workers and to grant the associated tax benefits, in line with the rule
suggested by the OECD Model. However, according to the Court this solution may lead to discrimination –
and thus be in breach of Community law – as no alternative solutions are provided in the treaty itself or
in national legislation for workers who do not receive significant income In their State of residence.

• Tax treaty law as well as Conventions (e.g. OECD MC) have evolved taking into account the community
law

• The Community is not subject to the bilateral treaty law of which its Member States are, individually,
signatories.

• Tax treaties in internal market - cover only taxes on income and capital. As there is almost no Community
legislation on this subject, the Member States are more or less free to determine the tax rules they
consider appropriate.

EU law / Tax Treaty – which prevails?

22
Basics of Treaty Interpretation

23
Basics of Treaty Interpretation

• Article 1 of OECD / UN Model Convention:

“This convention shall apply to persons who are residents of one or both of the
Contracting States.”

• Article 2 of OECD / UN Model Convention defines ‘person’:

− The term “person” includes an individual, a company and any other body of
persons which is treated as a taxable unit under the taxation laws in force in the
respective Contracting State

• Article 4 of OECD / UN Model Convention usually considers with minor modifications,

the term “resident of a Contracting State” means
− any person
− who under the laws of that state
− is liable to tax therein
− by reason of his domicile, residence, place of management, nationality or
− any other criterion of similar nature.

Partnership qualifies for treaty benefits?

24
 Basics of Treaty Interpretation – Tie Breaker Rule
Closer with
one state Both In one state

Centre
Permanen R
R of Vital
t home
interest

Not
determinable

Both or
Both
none
Dispute
Habitual Nationalit
Resolutio
abode y
n

In one In one
state state

To be decided by
R mutual agreement or
R by competent
authority

25
4
Case study – Residency

French National employed

French National
in Spanish company

He has permanent home in

France and Spain

He has center of vital

interest in France and
Spain

He has habitual abode in

Employed in Spain third country

Tax Resident of which country?

26
Types of Income

27
Business Income - Concept of Permanent Establishment (‘PE’)

• History of PE is as long as history of double taxation conventions itself - can be dated

to the second half of 19th Century
• Expansion of Central European countries into neighboring states leading to double
taxation of entities
• First provisions of PE - German Double Taxation Act (1909) included following
criteria's:
− Existence of place of business
− At specific geographical spot
− Permanence of business (with regard to business activity)
• Key test which determines the right to tax business profits in the source state
• Relevance of PE - In most DTAA’s, ‘business profits’ arising in another State are taxable
in that State only if the activity is carried out through a PE
• Existence of PE is a fact based issue

Relevant in present age of digitalization?

SEP

28
Concept of Permanent Establishment (‘PE’)

• Allocation of taxing jurisdiction for business profits (Art 7(1)):

− Business profits taxed exclusively in the State of residence of the enterprise unless
there is a “permanent establishment” in the State of Source
− If a PE exists, profits attributable to the PE taxable in the PE State
• Attribution of profits to PE
− Income taxable in other state only if PE is constituted in other state
− Only income attributable to PE is taxable in other state.
− Expenses can be claimed deductible subject to provisions of domestic law of the
other state.
− Income attributable to PE would be determined on arm’s length basis.

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Types of PE

❑ Article 5 (1) : Fixed Base PE ❑ Article 5 (4) : Exclusions of PE

❑ Article 5 (2) : Inclusive ❑ Article 5 (5) : Dependent
Definition, PE includes: Agent PE
−Branch ❑ Article 5 (6) : Independent
−Office Agent

−Place of management ❑ Article 5 (7) : Subsidiary PE

−Factory
−Workshop
−A store or premises used as a
sales outlet etc.
❑ Article 5 (3) (a) : Installation PE
❑ Article 5 (3) (b) : Service PE

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Case study – PE – Austria – Ireland Treaty

Irish Co (Advisory risk

• Contract Terms: Conducting
management services)
advisory projects on patient
security and clinical risk
management in hospitals and
giving trainings, seminars and
lectures.

• Uses his own office - No fixed

place of business for Irish
company in Austria,

• Activities performed in the

office were limited to project
preparation, the creation of
quotes using templates, the
Austrian assessment of preventive
Proprietor measures etc.

Office of service provider regarded as PE?

31
Case study - Business profits – Germany Belgium Treaty

• Germany Co providing
Germany Company installation services in
Belgium

• Provision of supply of
goods and services not
connected to installation
services

• Provision of warranty
support services conducted
directly by German
Company in connection
with installation services
Belgian PE

What will be attributed to PE in Belgium?

32
Royalty – Definition under the treaties

• OECD Model (Article 12) – Payments of any kind received as a consideration for:

Use of or right to use Information concerning

• Copyright of literary, artistic or • industrial, commercial or

scientific work including scientific experience
cinematograph films
• Patent, trademark design or
model, plan, secret formula or
process,

• UN Model – Payments of any kind received as a consideration for:

Use of or right to use Information concerning

• Copyright of literary, artistic or • industrial, commercial or
scientific work including scientific experience
cinematograph films or films or
tapes used for radio or television
broadcasting
• Patent, trademark design or
model, plan, secret formula or
process
• industrial, commercial or
scientific equipment
33
Fees for Technical Services (‘FTS’)

• OECD Model Convention (‘MC’), US MC or the UN MC - FTS not defined

− Accordingly FTS forms part of business profits

• Some Countries have broadened the concept of Article – 12 i.e. Royalty by adding FTS

• General definition of FTS under the Treaty

− Payments of any kind to any person, other than payments to an employee of the
person making the payments and to any individual for independent personal
services, in consideration for services of a managerial, technical or consultancy
nature, including the provision of services of technical or other personnel

• Managerial, technical or consultancy services not defined

− Dictionary meaning / OECD Technology Technical Advisory Group (‘TAG’) Report
− Meaning as understood in common parlance

34
Dividend income – OECD MC Article 10

• First right to tax dividend is with the country where recipient resides. However,
dividend may also be taxed where the company paying the dividend resides as per the
law of that country.
• The term ‘dividends’ as used in this Article means income from shares, mining shares,
founders’ shares or other rights, not being debt claims, participating in profits, as well
as income from other corporate rights which is subjected to the same taxation
treatment as income from shares by the laws of the State of which the company
making the distribution is a resident.

Interest income – OECD MC Article 11

• Interest is taxed where the recipient of the interest resides (i.e. Residence state).
However, the interest can be taxed by the contracting state where it arises as per the
laws of that country (i.e. Source state).
• The term ‘interest’ as used in Article 11 means income from debt-claims of every
kind, whether or not secured by mortgage and whether or not carrying a right to
participate in the debtor’s profit, and in particular, income from government securities
and income from bonds or debentures, including premiums and prizes attached to such
securities, bonds or debentures. Penalty charges for late payment shall not be
regarded as interest for the purpose of Article 11

35
Foreign Tax Credit

36
Foreign Tax Credit

• Tax payable in a Country S (Source) is allowed as a credit in the Country R (Residence)

• Method of credit

Exemption method Credit method

• Full exemption • Full credit

• exemption with • Ordinary credit
progression

37
Foreign Tax Credit - Example

• Example

Particulars Country R Country S

Income 100,000 + 50,000 50,000

Tax Rate Upto 100,000 - 30% 40% flat

from 100,000 to
200,000 - 35%
Tax Payable 47,500 20,000

• Full Exemption Method – Country R will tax only its domestic income of 1,00,000 @
30% = 30,000

38
Foreign Tax Credit - Example

• Full credit method

Particulars Country R
Tax payable in Country R 47,500

Less: Credit for tax paid in state of (20,000)

source
Tax Liability in Country S 27,500
• Partial Credit Method

Particulars Country R
Tax payable in Country R 47,500

Less: Credit for tax paid in state of (17,500)

source (restricted to 35% of INR
50,000)
Tax Liability in Country S 30,000

39
Non-Discrimination

40
Non- discrimination (Article 24)

• Neither of the contracting states gives preferential tax treatment in taxing

its own residents or citizens vis-à-vis foreign persons in the same
circumstances

• Article 24 of the OECD convention deals with certain cases of non-

discrimination (ND)
− Based on nationality
− Based on PE
− Based on deductibility of interest, royalties and other disbursements for
determining taxable profits
− Based on ownership

• Regulated primarily on community law

41
Mutual Agreement
Procedure / Arbitration

42
Mutual Agreement Procedure (‘MAP’) / Arbitration

− MAP provided in tax treaty can involve matters containing juridical double taxation,
as well as inconsistencies in the interpretation or application of a DTAA
− MAP only binding on the taxpayers
− MAP does not oblige the Competent Authorities to arrive at a solution
• European Commission announced the proposal on double taxation dispute resolution
mechanisms in the European Union which was adopted by the Council in 2017 -
− The new rules to cover issues related to double taxation which occurs when two or
more countries claim the right to tax the same income or profits of a company or
person.
− Set an obligation to achieve a result (enforcement) which was not in existence
earlier
− Provisions are included in an EU directive instead of an intergovernmental
convention
− A broader scope including all cross-border double corporate tax situations (instead
of transfer pricing and allocation of profits to permanent establishments only)

Aim for more certainty and predictability

43
Transfer Pricing – Brief
Overview

44
Transfer Pricing (‘TP’)

• Meaning
− Transfer pricing refers to value attached to transfer of goods or services between
related parties.
− Thus, transfer pricing can be defined as the price paid for goods transferred from
one economic unit to another, assuming that the two units involved are situated in
different countries, but belong to the same multinational firm.
• Aims and objective
− Transfer pricing minimizes the tax burden or arranging direction of cash flow
− Transfer pricing results in shifting profits
− Transfer between the enterprises under the same control and management,
dictated by considerations such as
o To reduce profits artificially so that tax effect is reduced in a specific country;
o To facilitate decentralization of production so that efforts are directed to
concentrate profits in the State of production where there is no or least
competition;
o To remit profits more than the ceilings imposed for repatriation;
o To use it as an effective tool to exploit the fluctuation in foreign exchange to
advantage.

45
Transfer Pricing (‘TP’)

• Arm’s Length Principle Applied to Transfer Pricing And Attribution of Profits to

PE - The arm’s length principle is applied both in the context of transfer pricing and
attribution of profits. Such an application makes no distinction between a branch or a
subsidiary through which an MNE carries on business in a country. A functionally
separate entity approach as a working hypothesis underlying the application of the
arm’s length principle, is found in almost all tax treaties.
• Transfer Price is Not Arm’s Length Price –
− Transfer price is the price charged in a transaction. The term ‘transfer price’ is used
to describe the actual price charged between the associated enterprises in an
international transaction.
− Transfer pricing issues arise when entities of multinational corporations resident in
different jurisdictions transfer property or provide services to one another. These
entities do not deal at arm’s length and, thus, transactions between these entities
may not be subject to ordinary market forces.
− Where the transfer price is different from the price which would have been charged
if the enterprises were not associated and the difference gives rise the tax
advantage, the tax is calculated on the basis of arm’s length price.

46
Transfer Pricing (‘TP’)
Is it a cross border No
(International) Transaction?
TP does not apply
Yes

Is it between related No
(Group) Company?

Yes

TP
Applies

Whether price comparable to

Price adjustment
transaction with unrelated No
party (arms length price)? required

Yes

No adjustment required 47
Case study – Why TP

48
Thank you!

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