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									                     UNDERSTANDING DOUBLE TAX TREATIES

                                       By Roy Saundersi

The purpose of this article is to review double tax treaties with a view to gaining an
understanding of what they are and how the operate, how they are interpreted and concentrate
on the rationale behind them. In order to meet these objectives it has been necessary to review
in detail the standard treaty format found in the OECD Model Convention and this has been
done by breaking the Convention into separate and distinct parts which have functions of
their own. In addition treaty shopping and limitation of benefits provisions together with a
review of some recent cases involving the interpretation of double tax treaties has been

1. The purpose of double tax treaties
   Double tax treaties are viewed as beneficial by most states because they allow business to
   transact with a degree of certainty both on the part of the individuals, partnerships or
   corporate entities and the government of that state in which that business entity operates. The
   perceived benefits of double tax treaties can be identified as:

   i. Clarification of taxing rights of each State
      Double tax treaties allow elucidation of taxation rights between states. The taxing rights
      under the treaty only apply to residents of a particular country (and some e.g.
      partnerships may not be covered), and only in respect of taxes stated within the treaty.
      There may also be some items of income or capital which are not covered by the treaty
      in which case, without a general article, one falls back again to local law. Once the
      taxpayer is satisfied that the treaty covers them and the taxes for which clarification is
      sought, then the particular article is referred to in order to ascertain tax exemption or
      applicable reductions or exemptions.

   ii. Avoidance of double international juridical taxation
       International juridical double taxation is where the same profits are taxed in two or more
       States on the same person (corporate or individual); this compares with economic double
       taxation where the same State may tax the same profits to two or more persons (eg
       dividends representing taxed corporate profits are taxed again in the individual's hands, ie
       the classical system of taxation as compared to the imputation system).

   iii. Prevention of fiscal evasion with anti-avoidance provision
        The exchange of information provision (see Article 26 below) should enable countries
        to obtain information in order to ensure its taxing rights are preserved, although the
        effectiveness of such provisions for tax avoidance as opposed to tax fraud may be
        limited at present. The various articles then individually legislate wherever possible to
        prevent tax avoidance in clarifying what would be considered business profits,
        acceptable interest deductions, etc., and the views of each State may differ significantly
        in practice on such subjective issues. The Mutual Agreement article attempts to
        provide for such eventualities, but the willingness of the competent authorities to agree
        these issues are currently left to discussion as opposed to specifically legislated for.
   iv. Countries which are parties to double tax treaties
       High tax countries have no reason to enter into double tax treaties with tax havens such as
       Bermuda, British Virgin Islands, Anguilla etc., which do not levy tax on profits. Indeed
       certain countries such as Hong Kong, with a source system of taxation may equally have
       no reason to worry about international juridical double taxation since non-local source
       profits are exempt from tax in any event. However, where their residents are actively
       engaged in business abroad, e.g. South Africa, it would wish to conclude treaties to clarify
       taxing rights and prevent fiscal evasion.

      Low tax countries which are often referred to as tax havens because they offer certain
      concessions, for example, the Channel Islands, Liechtenstein, Malta and Cyprus may have
      double tax treaties but either they are very few in number (for example the Channel
      Islands with UK only, Liechtenstein with Austria only), or the countries with whom they
      negotiate treaties may wish to impose limitations within the treaties (exclusion of offshore
      companies). Cyprus is one of the few countries which have generally been able to
      negotiate a wide range of treaties without such limitations, although they do exist in
      certain treaties (treaties with the UK and the US for example).

      High tax countries need the widest range of double tax treaties to limit international
      juridical double taxation; their residents require clarification of what profits will be taxed
      where, and countries will often permit certain activities to be either exempt from tax or
      suffer a reduced rate of local tax in an effort to stimulate their international trade.
      Equally, such countries will desire the anti-avoidance provisions to enable them to secure
      their tax revenue.

      Over the years since the first treaties were negotiated at the beginning of the century,
      double tax treaties have become more standardised pursuant to the work of the OECD
      which prepared its first draft standard convention on income and capital in 1963, leading
      to a new version in 1977, and as from 1992 a loose-leaf one capable of being updated to
      take account of new developments (eg the Internet). Although the Model Convention and
      its Commentaries are an invaluable starting point in negotiating and subsequently
      interpreting double tax treaties, they are only guidelines and the provisions of the
      individual treaties as they are implemented in local law are the only relevant determining

2. Arrangement of the OECD Model Convention
   The OECD Model Convention is commonly adopted in full or in part by most tax treaties.
   This section of the paper gives consideration to the Articles of the Model Convention and
   gives clarification where necessary. The section groups the Articles into appropriate sets and
   considers the Articles.

   A. Articles to clarify application of the treaty

   Article 1 - Personal Scope
   The treaty is limited in application to persons who are residents so it is necessary to define
   persons (Article 3) and residence (Article 4)
Article 2 - Taxes Covered
These are limited to direct taxes on income and capital of the relevant persons, so direct taxes
based on, say, turnover may not be covered. Generally taxes of a similar nature subsequently
introduced should be covered, but indirect taxes (VAT, registration taxes, net worth taxes)
are not covered, and certain local taxes not imposed by a State or a political subdivision may
not be covered. Direct taxes subsequently introduced which are not similar to those covered
(e.g. UK petroleum revenue tax), may not be covered.

Article 3 - General Definitions
This general provision defines person, company, and enterprise of a contracting State,
international traffic, competent authority and national. Many treaties may extend this general
definition clause to other items. And the definition of terms is not limited to this article;
Article 4 defines Residence, Article 5 defines a permanent establishment, Article 6 defines
immovable property, Article 10 defines dividends, Article 11 interest, Article 12 royalties,
and Article 14 professional services.

When defining persons, transparent entities such as partnerships may not be included, but
semi-transparent entities such as the French GIE may be considered a person and therefore its
foreign members may be subject to local tax under the treaty (see Societe Kingroup court
case before the French Conseil d'Etat dated 4 April 1997ii)

Article 4 – Residence
The first part of the Article states that just because an individual/corporate entity has a source
of income in a given State, does not mean the person is a resident of that State. Therefore the
treaty applies to the person only as far as local source income is concerned. The second part
accepts that two States may each consider a person resident therein, and seeks to establish by
a 'tie-breaker' arrangement which country can claim supremacy over the other - but only for
the purposes of the treaty. The rights of either State to levy say inheritance tax on an
individual is unaffected, since he may still be considered resident therein for all other
purposes; and again if any item of income or capital is not covered by the treaty, domestic
law applies to the individual as if the treaty did not exist.

The tie-breaker clause starts by considering the place where the person has his permanent
home; if in both places the deciding factor is where his centre of social and economic
interests is. If this cannot be determined, or there are no permanent homes in either State, the
next deciding factor is where he spends the major part of his year. If he spends very little
time in either country, then the place where he is a national can claim he is resident there, and
if he is a national of neither State, the competent authorities have to come to a decision. For
companies, the deciding factor in the case of dual residence is where the place of effective
management is situated.

Article 5 - Permanent Establishment
If a company is trading in the other State, then domestic law of that State will probably
legislate for the taxation of profits derived from that trade. This could be a negative factor
for a company undertaking occasional transactions in that State, and since the objective of a
treaty is to encourage international trade, such circumstances must be covered by the treaty.
Thus Article 7 taxes profits from a trade only where there is a permanent establishment, and
then only such profits that can be attributed to the permanent establishment.
Article 5 defines a permanent establishment but also stipulates that certain fixed bases will
not be considered a permanent establishment since their function is either limited in time or
in their material affect on the company's trade itself. Thus building sites or installation
projects of less than 12 months (sometimes as little as six months in some treaties) are not
considered permanent establishments, nor are fixed bases used only to store or display or
deliver goods where the trade is effected abroad.

Additionally, a fixed base merely used to purchase goods locally will not be considered a
permanent establishment (again to encourage international trade). And local agents used by
foreign companies should not create a permanent establishment if they are acting in the
ordinary course of their business in an independent capacity. Neither will the fact that a
foreign company has a local subsidiary mean that the foreign company has a local permanent
establishment of its own; the local permanent establishment belongs to the subsidiary not the

Article 29 - Entry into Force
The stages of a treaty are

   (a) signature

   (b) ratification by each State

   (c) exchange of the ratification instruments and

   (d) implementation into domestic law.

The provisions of the treaty enter into force within a stated time according to this Article of
the exchange of ratification instruments, but not all provisions may be effective as from the
same date; transitional reliefs are often allowed.

Article 30 – Termination
This provision allows the treaty to be terminated by either State giving the appropriate notice,
generally six months before the end of a calendar year although there may be a minimum
period of years duration of the treaty. It would be normal for any changes to be reflected
either in a Protocol or in a new treaty to come into effect on expiry of the old one, but there
have been several instances in recent years where in the absence of an agreement to amend
the treaty or negotiate a new one, one State has unilaterally terminated the treaty under the
provisions of this Article (e.g. Denmark/Malta, US/British Virgin Islands).

B. Articles to avoid double international juridical taxation

Article 6 - Income from Immovable Property
This Article covers income from immovable property (real estate although the definition
given to immovable property under domestic law is the relevant definition). Capital gains
derived from real estate are covered under Article 13, the Capital Gains Tax article, and
generally capital gains on direct interests in real estate (and often on indirect interests through
real estate owning companies) are subject to tax where the real estate is situated.

The Lamesaiii case in Australia determined that indirect interests in real estate through a
chain of companies did not constitute immovable property, even if this means that capital
gains derived thereon may escape taxation at all, which is not the objective of a double tax
treaty. Paragraph 21 of the Commentary to Article 13 suggests that if a particular country is
concerned about such tax avoidance, it should incorporate within the relevant article look-
through provisions for such indirect interests in immovable property.

Article 7 - Business Profits
This Article is an extension of the Permanent Establishment article which clarifies the profits
on which local taxes may be levied.

Article 8 - Shipping, Inland Waterways Transport And Air Transport
Since it is difficult to assess how much of a company's profits should be allocated to the
various permanent establishments engaged in the operation of ships or aircraft in
international traffic, and so as to encourage companies in the transport industry to open local
terminals without fear of heavy tax liabilities, the criterion for assessing such an enterprise is
shifted to its place of effective management of the enterprise. If this is actually aboard a ship
(and there are several treaties which the UK has concluded concerning this pointiv), then the
home harbour of the ship or, if none, the country where the ship's operator is resident shall
determine which country has the right to impose taxation on profits.

Article 10 – Dividends
Many countries levy a withholding tax on dividend distributions, but there are some very
notable exceptions where profits have been subject to primary tax, such as Australia,
Singapore, UK. Also, capital distributions may not attract withholding tax, as for example
liquidation distributions in the US.

Article 10 generally limits the withholding tax that may be charged provided that the
recipient is beneficially entitled to the dividends (ie nominees or agents cannot benefit from
this Article). Such limitation is often to a nil or 5% rate where a substantial interest of say
10% or 25% is held in the payor company, and in other cases the withholding tax rate is
limited to 15%. But each treaty may be different depending upon the effect of local primary
tax coupled with this secondary tax.

If countries have entered into a double tax treaty, but then have subsequently entered into a
multilateral treaty which has supremacy over the double tax treaty, such as the EC
Parent/Subsidiaries Directive which eliminates withholding taxes on dividends to recipient
companies owning more than 25% of the payor, then the provisions of the double tax treaty
may still be relevant if the Directive's provisions are not fulfilled.

As with all Articles, the purpose of a double tax treaty is never to create a tax liability where
none exists under domestic law. Thus whatever the treaty rate permitted, if a lower rate
exists under domestic law, it is the lower rate which is adopted. There may be anti-
avoidance provisions to prevent treaty abuse, such as in the Swiss/Netherlands treaty
discussed below.

Article 11 – Interest
Interest payments to non-residents may also attract a local withholding tax, which is
generally reduced according to treaties to 10% under the Model Treaty, but often to nil.
Again, the requirement for the recipient to be the beneficial owner is relevant sometimes for
its absence under certain treaties, especially the older ones.
There are anti-avoidance provisions in the interest and royalty articles where excessive
payments are made which the payor's country of residence may treat instead as constructive
dividends; however, if they do not fall within the definition of dividends under the dividend
article, they may not be subject to the dividend withholding tax permitted under the treaty.

Article 12 – Royalties
Royalty payments are often exempt from withholding tax, as they are under the OECD
Model. Again excessive royalties may be treated as constructive dividends, and there may
also be anti-avoidance provisions where licences have been created merely for the purpose of
obtaining withholding tax exemption, such as Article 12(5) of the UK/Netherlands treaty.
Each treaty contains the definition of royalties covered under the article, and there may be
different rates or exemptions applicable to patent royalties as compared for example to
copyright royalties or film royalties.

It is also necessary to understand the distinction between licensing activities, which may be
covered under this Article and trading activities covered under Article 7 even if they are
items which may also be licensed under different contractual arrangements eg software
packages. Also, lease rentals of say containers or other equipment need to be differentiated
from licensing agreements for such equipment.

Article 13 - Capital Gains
Generally this Article permits the imposition of local tax on real estate, and this may also
include companies owning real estate. Gains on any other property which may be similar to
having business interests locally, such as movable property attached to a permanent
establishment, as well as the permanent establishment itself, may be subject to local tax, but
the Article generally grants the right to tax all other gains only to the State where the
alienator is resident.

Nevertheless, there may be a period of say 5 years during which the State where an
individual was previously resident continues to have the right to tax such gains which are not
specifically covered under this Article; this is an anti-avoidance article to prevent individuals
moving from one country to another to obtain treaty exemption against the local tax that
would otherwise be payable.

Article 14 - Independent Personal Services
This Article was deleted from the OECD Model Convention on 29 April 2000 but still
appears in many current double tax treaties. It is the parallel article to Articles 5 and 7, but
for individuals who provide professional services or other similar activities in another State;
only if they have a fixed base regularly available there (and even hotel rooms have been held
to create that fixed base if regularly available) will they incur a local tax liability, and then
only in respect of those profits which can be allocated to that fixed base. Article 14 was
deleted from the Model Tax Convention on 29 April 2000 pursuant to a report entitled
"Issues Related to Article 14 of the OECD Model Tax Convention" which was adopted by
the Committee on Fiscal Affairs on 27 January 2000. The reason for this was because
there were no intended differences between the concepts of permanent establishment
(Article 7), and fixed base (Article 14), or between how profits were computed and tax was
calculated according to which of Article 7 or 14 applied. Furthermore, confusion was
caused by the fact that it was not always clear which activities fell within Article 14 as
opposed to Article 7. The effect of the deletion of Article 14 is that income derived from
professional services or other activities of an independent character is now dealt with
under Article 7 as business profits. However, the UK/US treaty of 2001 (which is still
pending) contains a new Article 14 entitled “Income from Employment” which provides
that salaries and remuneration in general derived by a resident of a Contracting State in
respect of an employment will only be taxable in that State unless the employment is
exercised in the other Contracting State and will be taxable there unless:

a) the recipient is present in the other State for a period or periods not exceeding in the
   aggregate 183 days in any twelve-month period commencing or ending in the taxable
   year or year of assessment concerned;

b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the
   other State; and

c) the remuneration is not borne by a permanent establishment which the employer has
   in the other State

In which case the remuneration will be taxable in the first mentioned state.

Article 15 - Dependent Personal Services
Unless personal service income is independently earned and therefore covered under Article
14, or the income comprises directors' fees, pensions or income from government services,
Article 15 dictates which country has the right to tax employment income. However,
exceptionally, artistes and sportsmen are treated separately under Article 17.

Generally employment income is taxed only where the individual is resident in the relevant
country. If the individual exercises his employment in two countries, the right to tax will
remain in the State of the individual's residence unless the employee is physically present in
the other State for more than 183 days in any twelve month period, and the remuneration is
paid by an employer resident there or re-charged to a permanent establishment there of a
foreign employer.

Article 16 - Directors' Fees
Directors' fees are subject to tax where the company is resident, unless it can be shown that
the fees are not for services as a director but in another capacity eg a consultant to the

Article 17 - Artistes and Sportsmen
Article 17(1) states that income derived by a resident of one state as an entertainer (such as a
theatre, motion picture, radio or television artiste, or a musician) or as a sportsman (which
will include for example footballers, golfers, jockeys, cricketers, tennis players, racing car
drivers) as well as any participant in public entertainment (such as snooker, chess or bridge
players), from his personal activities as such exercised in the other state may be taxed in the
other state. The words 'as such' are important to understand in relation to income from non-
performing activities contracted by the entertainers and sportsmen, such as endorsement and
merchandising contracts referred to below.

Article 17(2) extends the right of the local tax administration not only to tax income paid
direct to the above individuals, but also to tax such income even if it is received by
companies or indeed any other entity. Very few treaties still exist which afford protection to
loan out companies from local taxation

Article 18 – Pensions
Usually, pension payments for a past employment are subject to local tax where the
employment was exercised, even if the individual leaves that country. However, double tax
treaties normally confer the taxing rights to the State where the individual has now taken up
tax residence.

Article 19 - Government Service
If an individual works for a State or political sub-division in that particular country, he is
subject to tax there notwithstanding other Articles even if he is not considered a tax resident
there; this includes pension payments notwithstanding the provisions of Article 18.
However, if he resides in the treaty country and is a national of that country, then he will not
be subject to such tax if he doesn't physically perform duties in that country.

Article 20 – Students
Payments received by a student from outside of a country for his maintenance, education or
training shall not be subject to tax, provided that the student was resident in the other country
immediately prior to his arrival.

Article 21 - Other Income
This is one of the most important articles of any treaty, yet is often omitted from even more
recent treaties. It establishes the overriding provision that in the absence of specific
provision, income is only taxed where the person receiving it is resident, unless he has a
permanent establishment or fixed base in the other country.

Article 23 - Methods for Elimination of Double Taxation
Where a State is allowed to impose even a reduced level of local withholding or direct
taxation under the various articles of a double tax treaty, if double taxation is to be avoided,
there must be a mechanism whereby such tax is either credited against domestic taxation on
such income, or the income itself is exempt from domestic tax. If the exemption method
applies, the income may be aggregated with other income to determine the domestic tax rate
that should apply to other income, before it is exempted; this is termed exemption with

C. Articles to prevent tax avoidance/evasion

Article 9 - Associated Enterprises
Where related parties in two countries contract with each other and one State considers that
profits have been effectively shifted out of its jurisdiction to the other, then the State may
make adjustments to the taxable profits reported to reflect this. The 1977 revision to the
OECD Model Treaty introduced a clause requiring the other State to make a corresponding
downward adjustment in such an event, and required the two competent authorities to reach
agreement on this point. However, older treaties have no such requirement so that in effect
double taxation may be permitted.

The sub-provisions of Articles 11 and 12 as they relate to interest and royalties give
additional similar powers to authorities to re-classify excessive interest and royalties paid
between parties with whom a special relationship exists, although the requirement to give
corresponding reliefs falls within this Article.

Article 26 - Exchange of Information
Controlled information exchange between the tax administrations of the two contracting
States is one of the most important ant-avoidance weapons available, although it is
cumbersome and time-consuming to introduce unless information is regularly exchanged
automatically, something which is starting to happen more frequently. If not, then either one
State may voluntarily provide information to the other if it thinks it would be of interest to
the other, but this would only usually be in cases of significant tax fraud. Otherwise, it is up
to the potentially aggrieved tax administration to request information from the other, and
there is a strong reluctance to assist other tax administrations in 'fishing expeditions' when
the tax administration itself is under time pressures to implement its own legislation and
counter tax avoidance of its own laws.

In any event, information can only be given in respect of taxes covered by the Agreement,
and only to secure the correct application of the provisions of the Agreement or the domestic
laws of the other contracting Statev.

D. Miscellaneous Provisions

Article 24 - Non-discrimination
This Article prevents nationals of a contracting State (as opposed to residents as for all other
treaty provisions) from being treated in a more unfair way in the other State than nationals of
that State. Moreover, the typical non-discrimination clause applies to taxes of every kind
imposed by the other State, not just those mentioned in the treaty. The Article is becoming
more and more used by taxpayers in litigation against assessments which would not have
been raised against domestic taxpayers eg a taxpayer subject to the 3% Special Tax on real
estate in France applicable at the time only to non-residents, applied the Swiss treaty with
France successfully in defeating the assessment.

Article 25 - Mutual Agreement Procedure
This Article provides the basis on which disputes between taxpayer and Revenue authorities
may be settled by agreement between the competent authorities of each State, generally
either the Ministry of Finance or the Tax Administration. If a case is presented within the
required three year period of the first date of notification of the action leading to taxation,
there is a duty to consult with each other, but no duty to agree. Thus many cases are
unresolved even after several years (note that the Statute of Limitations is not overridden by
double tax treaties unless specifically provided).
Not all taxes are covered by the mutual agreement clause, and the taxpayer should ensure
that on repatriation of any adjusted revenue, there is no subsequent tax charge. Currency
fluctuations between the original transaction and the final date of agreement of adjusted
profits and their repatriation may have a significant impact on the benefits afforded under
this Article. If possible, the taxpayer should be included in discussions with the competent
authorities, especially since during the course of the competent authority investigation, other
issues may be raised. If interest is payable on outstanding tax due in respect of one
adjustment whilst no tax is receivable on overstated assessments in another country, the
taxpayer can be significantly penalised.
   Article 27 - Members of Diplomatic Missions and Consular Posts
   The privileges of diplomats are preserved, notwithstanding any other provisions of the treaty.

   Article 28 - Territorial Extension
   Territories of either State may be included under the double tax treaty if the State has
   responsibility for its international relations. Thus the original treaties of the United Kingdom
   were extended to its dependencies, and the Dutch treaties were extended to the Netherlands
   Antilles. Because of the fact that many dependencies have a different tax system than their
   parent companies, which is one of the requirements of this Article, the territorial extension is
   not designed to create a back-door to tax evasion.

3. Treaty Shopping and Limitation of Benefits Provisions
   Treaty Shopping involves the use of the protection offered under a particular treaty by
   interposing a person who can claim treaty protection, which would have otherwise been
   unavailable. In this section specific consideration is given to examples of treaty shopping as
   well as focusing on solutions to this provided by individual states.

   i)   1962 Swiss Federal Decree
        Switzerland‟s tax treaty network is available to all Swiss incorporated companies,
        regardless of concessions given at federal or cantonal level. This therefore permits treaty
        shopping by non-residents so that income may be received with low or no foreign
        withholding taxes deducted, even if Swiss taxation subsequently levied may be limited
        by concessions available to certain types of companies. As long ago as 1962, the Swiss
        Federation realised that this would be unacceptable to its treaty partners, and
        comprehensive measures were therefore brought in by the decree of the Federal Council
        in 1962. The principal measures involve limiting the erosion of the tax base as well as
        requiring a minimum profit distribution which would then be subject to the 35% Swiss
        withholding tax on dividends.

        In order to prevent abuse of the Swiss tax system comprehensive measures were
        brought in by the decree of the Federal Council in 1962, as amended by the circular of
        17 December 1998. The principal measures are as follows:

        (a) Article 1 of the decree lays down the major principle for the introduction of anti-
        avoidance legislation, namely that reduction of tax withheld at source because of the
        provisions of a double tax treaty, shall not benefit persons not entitled to such
        reduction. Thus, the formation of a Swiss subsidiary of a foreign company shall be an
        abuse if formed for the purpose of securing the benefits of reduced withholding taxes
        at source (but not other benefits) from the double tax treaty that does exist between
        Switzerland and the third country. In the event of an abuse, the Swiss tax authorities

        i) refuse application made for the reduction of withholding taxes; or

        ii) recover any withholding taxes reduced by treaty provisions; or

        iii) inform the contracting third-party state of the existence of such an abuse.

        Cantonal and federal tax authorities shall keep each other informed of the existence of
        any suspected abuses.
(b) Article 2(2)(a) states that an abuse will occur where a substantial part of foreign
income, for which double tax relief is claimed, is used to pay debt interest, fees,
commissions, salaries, royalties and any other payments other than dividends to
persons not entitled to the tax treaty reliefs if paid directly to them. The substantial
part is in practice 50%, so that at least 50% of the remainder is taxable income in
Switzerland and taxable to federal and possibly cantonal and municipal taxation. This
is as opposed to the normal allowance in respect of the satisfaction of foreign interests
out of income brought into charge from abroad, which is normally 80% of foreign
income (received without the benefit of tax treaty provisions) that may be paid out of
taxable income to third parties.

(c) Article 2(2)(b) sets down further regulations where income from abroad which has
benefited from treaty provisions, is received by a company owned by non-residents.
These are mainly aimed at the prevention of income being accumulated by a Swiss
company which is allowed the concession of a holding company or a domiciliary
company, and therefore pays the very low federal tax only on income retained (the
other 50% which is not paid out to non-residents and deducted from taxable profits);
the regulations are also aimed at companies which are able to claim the participation
deduction and are, therefore, not subject to any Swiss taxation on dividend income

Under the 1962 decree, the first and most important requirement was that a Swiss
company must, for each accounting period, distribute at least 25% of its gross income
received for which a tax convention applies. If these distributions are made to a Swiss
intermediary in the first place, they must be redistributed to the ultimate non-resident
beneficiaries entitled to the income and the 35% withholding tax deducted from the
distribution. This may or may not be refunded in part or in whole depending whether
or not a treaty exists between Switzerland and the country of residence of the
recipient. Under the circular of 17 December 1998, however, an active company,
defined as being a company engaged in an active business in Switzerland, is permitted
to distribute more than 50% of its treaty-protected income to non-residents and the
requirement to distribute at least 25% profits is no longer relevant. However those
companies which act as holding companies but have additional activities, known as
mixed holding companies, are exempt from the 25% profit distribution requirement
under the 1998 circular but are prohibited from distributing more than 50% of their
treaty-protected income to non-residents.

Other provisions are that interest-bearing debts to non-residents must not bear interest
at a rate exceeding 6% pa (this rate is subject to constant revision). Furthermore, the
loans on which interest is payable may not exceed six times the paid up share capital
and reserves of the Swiss company, so that thinly capitalised companies may not be
used as financing vehicles and still pass through the benefits of tax treaty provisions
relating to reduced withholding taxes. The 1998 decree has, however, amended the
rules pertaining to thin capitalisation and the former debt: equity ratio is no longer
applicable. The amendments refer to the domestic thin capitalisation rules as fixed by
the federal tax administration.

Thus if all, or any one of the above regulations is not complied with, the Swiss tax
authorities will consider that an abuse exists, and will either adjust any applicable
refunds in respect of withholding taxes as may be possible, or impose other fiscal
penalties sufficiently to deter the continuation of the considered abuse.
    The importance of the 1962 decree and its adoption by the Swiss tax administration in
    computing taxable profits of Swiss companies owned by non-residents is undoubted,
    so much so that some of Switzerland's negotiated treaties contain a provision based on
    the articles of the 1962 decree. However, where the non-residents are themselves able
    to benefit from a treaty with Switzerland, even though the 50% maximum deductions
    and 25% required distribution will still be applicable, the adverse effect is very
    significantly reduced. The 1962 decree is also only relevant as far as the treaty
    provisions relating to reductions of foreign withholding taxes on dividends, interest
    and royalties are concerned. Thus, a foreign company may still form a Swiss company
    to operate a branch in a treaty country and shelter behind the treaty provisions
    concerning taxation of branches; no forced distribution of income will be necessary
    since the decree is inapplicable.

    Moreover it should be realised that the decree is only applicable where foreign income
    has been subject to a withholding tax which is reduced pursuant to a Swiss treaty.
    Swiss companies may therefore continue to be used in receiving income from, for

    (a) countries which do not impose a withholding tax on that income; or
    (b) countries where the treaty rate and the unilateral rate of withholding tax on that
    income is the same.
ii) Remittance Provision in UK and other treaties
    Since the basic function of a double tax treaty is to avoid double taxation, rather than
    create an opportunity for income and capital gains to be exempt from tax, countries
    which provide certain concessions permitting this to happen may include in their treaties
    a limitation clause restricting the treaty benefits only to those persons who do not enjoy
    such concessions. UK treaties would generally include a limitation of relief provision
    restricting treaty benefits only to amounts remitted to the UK. This is because UK law
    relating to non-domiciled individuals only subjects remittances of non-UK source
    income and capital gains to be UK tax, so there should be no relieving provisions
    relevant if such income is not remitted. This generally relates to the reductions in
    withholding taxes on dividends, interest and royalties, and to the absence of capital gains
    tax charges.

iii) Certain treaties exclude so-called off-shore companies
     Several countries have specific legislation designed to promote their offshore financial
     services industry, such as Switzerland with its domiciliary companies, the Netherlands
     Antilles with it offshore investment companies, Cyprus with its offshore trading
     companies, and even the UK through its non-domicile benefits. Whereas Switzerland
     may have dealt with treaty shopping unilaterally, the UK though limitation of relief to
     remittances, and the Netherlands Antilles by being excluded from the network of double
     tax treaties (except for its important treaty access route through the Dutch treaty),
     Cyprus has accepted a limitation of benefits provision in a few of its treaties to prevent
     treaty benefits from being applied to its offshore companies.

    Cyprus has double tax treaties with 26 countries with another 5 pending finalisation. In
    particular, its treaties with the Eastern bloc give Cyprus incorporated offshore
    companies a considerable advantage over other countries in entering into joint venture
    activities in Eastern Europe, primarily because of the reduction in the impact of
    withholding taxes on the distribution of joint venture profits to the respective parties.

    In the case of its treaties with the UK, US, France, Germany and Canada, however, there
    is a restrictive clause denying the benefits of the reduced rates to Cyprus offshore
    companies. Nevertheless, Cyprus double tax treaties may, in a number of cases, provide
    important tax advantages. Thus, although the UK and French treaties with Cyprus
    exclude offshore companies from benefiting from the lower withholding taxes
    applicable to UK and French dividends, interest and royalties, these treaties still have
    advantages for offshore companies, principally under the business and shipping profits
    articles, as well as for individuals.

iv) US Limitation of Benefits provision
    The US has brought in its own version of a Model US Tax Treaty (as compared to the
    Model OECD Convention) to which the Government adheres in future tax treaties or
    renegotiations of existing ones. The contentious article of this model treaty is Article 16
    which limits treaty benefits to corporations that are owned by local residents. Thus,
    recent treaties state that the recipient of income must be the beneficial owner if the treaty
    benefits are to apply, or at least the recipient may enjoy the benefits only if the ultimate
    beneficial owners would also have been able to enjoy the same benefits if income had
    been paid direct to them. It is also generally required that resident corporations should
    not be able to obtain special treatment in respect of foreign source dividends, interest
    and royalties.

    It was Article 16 that was unacceptable to the British Virgin Islands and Netherlands
    Antilles negotiators, and more recently the Maltese ones, and this resulted in the US
    termination of these treaties. The US Treasury Assistant Secretary for Tax Policy stated
    that the termination „provides an example of Treasury commitment to prevent misuse of
    income tax treaties by third country residents, even if it means termination of
    long-standing relationships‟. The general principle that a double tax treaty overrides
    domestic provisions was a feature of the US internal Revenue Codevi until 1988 when
    the code was amended. IRC §7852(d)(1) no provides that:

    “For purposes of determining the relationship between a provision of a treaty and any
    law of the United States affecting revenue, neither the treaty nor the law shall have
    preferential status by reason of its being a treaty or law. “

    Amendments have also been made which provide for two tests in terms of which a
    foreign entity may be treated as a qualified resident as a prerequisite for claiming
    benefits under any US double tax treaty.

    Thus a foreign entity will only be deemed to be „a qualified resident‟ of a treaty country

    (i) under a Stock Ownership Test, at least 50% of the value of the foreign entity is
        directly or indirectly owned by individuals who are residents of that country, or by
        US citizens or US residents;
     (ii) under a so-called „Base Erosion‟ test, 50% or more of the foreign entity‟s income is
          not either directly or indirectly utilised to meet obligations to non-residents of that

     The Stock Ownership and Base Erosion Tests are to a great extent based upon the 1986
     treaty shopping provisions introduced with regards to branch profits tax. However, if
     interests in the entity are primarily and regularly traded on an established securities
     market based in the other country, or if the Base Erosion Test is met and the entity is
     wholly owned by another entity who would be a qualified resident under these rules,
     then no treaty shopping would be deemed to have occurred.

     In the event of the income of an entity resident in a treaty partner state being subject to a
     tax which is significantly lower than that which is imposed on similar types of income
     derived by residents of the country from domestic sources, then such entities shall not be
     entitled to take advantage of the benefits granted by the US under a relevant double tax

     The first US treaty to be re-negotiated was the US/Netherlands treatyvii. The main
     difference in the new treaty is of course the limitation on benefits Article 26 which
     appears to be the longest article in the history of double tax treaties. In summary, it
     attacks the problem of treaty shopping through two tests, the Stock Ownership Test
     and the Base Erosion Test. There are in fact three additional tests relating to publicly
     traded companies, active businesses and headquarters companies, but the Stock
     Ownership and Base Erosion tests are likely to be the most commonly applied tests.

     It should further be noted that The Tax Reform Act of 1986 contained provisions
     overriding the provisions of US treaties where there was evidence of treaty shopping.
     The then Treasury Secretary, James A. Baker III, conceded that even though domestic
     law took precedence over prior inconsistent treaty provisions, such provisions were in
     conflict with international law. Indeed the OECD issued a report in 1989 (''Tax Treaty
     Overrides''), which criticised treaty overrides and suggested the possible use of
     retaliatory measures by those treaty partners affected.

     Finally, the US has long been wary of its citizens expatriating for the sole purpose of
     avoiding US taxation. Such provisions are contained in section 877 IRC which was
     revised in 1996, the effect of which is to continue taxing a former US citizen/long
     term resident for up to 10 years after expatriation where such expatriation was tax
     driven. The effect of this domestic provision is to override treaty provisions (although
     many current US treaties already contain provisions permitting the United States to
     tax its former citizens who expatriate to avoid taxes) although those that do not
     contain such a provision are overridden. It should be noted however, that no pre-1997
     treaty entered in to by the US permits the claw-back provisions in respect of former
     long-term residents who expatriate by giving up their green cards. This therefore
     overrides all treaties.

v)   1994 Anti-Treaty shopping Law in Germany
     The 1994 Anti-Abuse and Technical Amendment Act has extended the provisions
     applicable to the abuse of law doctrine in order to deny treaty benefits if shareholders
     would not be entitled to those benefits if such income were received directly by them.
     As with most anti-avoidance provisions, there is an exception where a foreign
corporation has been set up for bona fide commercial purposes; the provisions deny
treaty benefits to foreign companies which

   (a) do not engage in a business activity of their own, and

   (b) their interposition has no commercial or non-tax validity, and

   (c) their shareholders would not be entitled to treaty benefits if the income were
       received direct.

However, since this is a threefold test, engaging in business activities would thwart
treaty denial, and there may therefore be an argument that a conduit company is
engaging in business activities. Subsequent to these provisions, several important issues
have been clarified by the Bundesamt:

  i)   Holding companies do not qualify for treaty benefits unless they exercise some
       degree of management and control over their subsidiaries, which denotes the
       holding company having several employees and its own business premises
       (although at present only extreme cases are pursued).

  ii) The provisions apply not only to withholding taxes, but also to any other kind of
      treaty benefits or provisions under the EC Parent/Subsidiaries Directive.

  iii) The Bundesamt may look through a chain of tiered companies to the ultimate
       individual shareholder in order to determine whether he would be entitled to
       similar benefits if he received the income directly.

  iv) The Bundesamt will not entertain requests for advance rulings on structures.

Indeed, the German Federal Tax Court ruled in favour of a withholding tax being levied
on income which is exempt from tax under the German/Poland treaty of 18 December
1972, as amended by the protocol of 24 October 1979. Under Article 16(2) income
derived from German sources by professional artistes and athletes who reside in Poland
is taxed only in Poland; the Court held, however, that Germany may levy withholding
taxes on such income pursuant to s 50d(1) of the Income Tax Law which is in effect an
anti-treaty shopping article under which a foreign corporation is not entitled to take
relief under an applicable double tax treaty if its (foreign) shareholder would not be
entitled to such reduction. The argument that would be put forward by the German tax
administration would be similar to those put forward by the French tax administration
that double tax treaties are not designed to create abusive structures, and therefore the
new provisions are in accordance with the intentions behind the treaties.

The more persuasive argument, however, is that, if this is the case, there should be
provisions in the treaties themselves acknowledging the possibility of introducing such
laws, or including specific anti-treaty shopping provisions. It must therefore be argued
that the appropriate remedy is to renegotiate existing treaties, adding Protocols or
negotiating entirely new treaties, rather than passing internal laws which seem to
conflict with other national laws or the Constitution itself.
     Moreover, international law in the form of the Vienna Convention on the Law of
     Treaties (notably not yet signed by Switzerland nor ratified by the US) suggests that the
     text of double tax treaties must be presumed to be the definitive intentions of the
     contracting parties, so that although unwritten intentions of the parties should be
     considered, the meaning of the text itself coupled with the customary interpretation
     already exercised by the contracting parties, should be of paramount importance.
     Despite this, Article 31(1) of the Vienna Convention requires a treaty to be interpreted in
     good faith in accordance with the ordinary meaning given to the terms of the treaty in
     their context and in the light of its object and purpose. It is here that the French and
     German tax administrations may suggest that literal interpretations are at variance with
     the purposes of the treaty as a whole, although having accepted certain provisions
     hitherto, they would find it difficult to deny their validity because of new interpretations
     they may wish to put on the intentions behind the treaty provisions

 v) Specific anti-avoidance provisions in treaties
    Many US treaties provide that not more than 25% of the gross income of a US paying
    corporation is derived from interest and dividends, other than interest and dividends
    received from its own subsidiary corporations, thus preventing passive income from
    being routed via treaties for tax avoidance purposes. The UK/Netherlands double tax
    treaty contains under Article 12(5) a provision that the reductions in withholding tax on
    royalties will only be relevant if the licence has not been assigned to the recipient for the
    purpose of obtaining the treaty benefits.

     The Swiss/Dutch double tax treaty contains under Article 9(2)(a) an anti-avoidance
     provision denying withholding tax exemption on dividend payments to parent
     companies if the parent has been incorporated primarily for the purpose of obtaining the
     withholding tax exemption.

4.   Reliance to be placed on double tax treaties

     a) Inviolability of Treaties & Vienna Convention
     There are many examples of countries appearing to override the provisions of double tax
     treaties (see below for a review of the compatibility of Article 209B in France with the
     provisions of double tax treaties). However, as far back as the implementation of
     FIRPTA and perhaps before, the US practice of overriding double tax treaties is
     notorious, so much so that the current Swiss/US treaty contains a provision that no treaty
     override will be permitted unless a mutually agreed reciprocal benefit is afforded to the
     contracting party.

     The ability of the US to override treaty arrangements stems from the US constitution in
     which the provisions of international agreements and those of domestic legislation have
     equal status. No superior status is given by treaty legislation over domestic provisions,
     unlike the case, for example, in France and the Netherlands where it is expressly stated
     that international agreements take precedence over subsequent domestic legislation.

     Certain constitutional systems such as Luxembourg and Belgium require international
     agreements to be incorporated into the domestic law of the countries, but limit the ability
     of subsequent domestic legislation to amend the provisions of those agreements, so
     again treaty overrides would not be permitted. In the UK, however, although
     international agreements also have to be incorporated into domestic law before they
become effective, court cases have confirmed that Parliament may take away anything
which it has given i.e. Parliamentary supremacy would permit treaty overrides.

b) Conflict of Treaties with CFC Regulations
The issues regarding the compatibility of CFC legislation with double tax treaties and
the Treaty of Amsterdam (agreed in 1997 and entering into force on 1st May 1999 by the
fifteen member states of the EU, to stand along side the Treaty of Rome) is a subject
which has been largely avoided when discussing the application of CFC legislation to
companies with CFCs in treaty jurisdictions. The standard wording of double tax treaty
provisions concerning the taxation of business profits of a CFC (Article 7(1) of the
OECD Model Convention) reads

       ‘the profits of an enterprise of one of the States shall be taxable only
       in that State unless the enterprise carries on business in the other
       State through a permanent establishment situated therein’.

Thus, the profits of, say, a Dutch company should only be taxable in the Netherlands,
notwithstanding the fact that it is a CFC under UK legislation. However, in recent
OECD recommendations, it is stated that double tax treaty provisions should not take
precedence over unilateral CFC legislation. An argument put forward by the French tax
administration, reluctant to subjugate CFC legislation to double tax treaty provisions, is
that double tax agreements are not entered into for the purposes of defeating unilateral
legislation aimed at taxing profits at just one level, but to prevent profits being taxed at
two levels. Thus, art 209Bviii is not inconsistent with double tax treaties because the
profits of, say, a Dutch company are not taxed in France in the absence of a French
permanent establishment. The French parent may, however, be taxed on such profits,
and double taxation is prevented by allowing a tax credit for any foreign tax incurred on
such profits. The position is of course unclear, and it may be argued that if unilateral law
existing at the time of entering into double tax treaties conflicts with treaty provisions
being negotiated, or creates doubts as to the interpretation of double tax treaties, then it
is the duty of the relevant authorities to make their position clear in the treaty or suffer
treaty override; this is the position adopted by the 1969 Vienna Convention on the
application of treaties, and it is also one of the stated objectives of double tax treaties to
provide clarification of taxing rights. Their argument may then be that, in order to
interpret treaties under the Vienna Convention, statements made leading up to the treaty
plus treaty preambles need to be taken into account, and the fact that the title to the
relevant treaty may include the words „for the Avoidance of Double Taxation . . . and for
the Prevention of Fiscal Evasion‟ may entitle the administration to argue that the
provisions of art 209B are not inconsistent with the intentions behind the relevant treaty.

However, any assessment under art 209B may possibly be rejected by the courts if it
conflicts with the terms of bilateral tax treaties or the Treaty of Amsterdam(Article
87(3), ex Article 92(3) confirms that tax benefits which have been approved within an
EU member state should not be removed by legislative provisions of another state).
Despite this, the French tax administration may claim that, as far as bilateral double tax
treaties are concerned which do not involve EU resident entities, since the stated aims of
such treaties include the elimination of double taxation and the prevention of tax fraud,
internal legislation designed to counteract tax evasion is not in conflict with such stated
A defence against art 209B could be that the double tax treaty protected company does
not have a permanent establishment in France, and therefore should not be taxed on its
trading profits in France; however, it is not the foreign company that is so taxed but the
parent company that is taxed under art 209B as if the profits earned by the foreign
company were earned by the French company. Without any court cases having taken
place, it is difficult to be certain that art 209B will not apply where double tax treaty
entities are involved, but equally it is difficult to accept the justification of the French
tax administration that art 209B is relevant in such cases. Incidentally, new double tax
treaties negotiated by France are now including a specific saving provision enabling art
209B to override other treaty provisions, e.g. Article 24(2)(e)(iii) of the new French/US
double tax treaty. This         would seem more appropriate than allowing unilateral
legislation to override agreements that have been properly negotiated by the relevant
countries, but which have not taken into account the repercussions of the French SLF
(the French tax administration) wishing to invoke a particular provision, as discussed

(c) Conflict of CFC Legislation with the Treaty of Amsterdam Provisions
For CFCs located in the European Union, one has the additional protection, or
confusion, of the Treaty of Amsterdam . One of the most inviolate provisions of the
Treaty is that an entity in one country should be free to establish operations in another
European Union country, without fear of discrimination. A French company establishing
a Belgian co-ordination centre would be discriminated against if the profits of the
Belgian company are subject to French taxation, whereas a Dutch company with a
similar subsidiary may fully benefit from the exemptions afforded to the co-ordination
centre without such profits being subject to taxation in another European Union

Prior to accepting specific rather than general concessions available to various
companies within member states of the European Union, it is a requirement that the
European Commission approves such concessions, and therefore indirectly the various
EU member states accept them. Thus Irish IFSCs have been given European
Commission approval on the basis that these concessions are required to boost the
economy in that particular region or economic element. The unilateral position of one
country imposing tax on such profits by way of CFC legislation eliminates the benefits
to which they have been a party in agreeing that such specific concessions are in the
interests of the European Union as a whole, and therefore there would appear to be a
fundamental violation of European Union law in such cases. However, Dutch holding
companies and Belgian co-ordination centres benefit from legislation which is generally
available to all Belgian or Dutch entities, not to a specific region, and do not therefore
require European Commission approval; the above basic argument of violation of the
freedom of establishing operations within Europe is still relevant, but not perhaps the
additional one that the relevant countries have been a party in agreeing to specific

For art 209B subsidiaries resident in other member states of the European Union, Article
43 Treaty of Amsterdam (ex Article 52 of the Treaty of Rome) permits citizens of a
member state to establish themselves in another member state of their choice and to
benefit from equal treatment with the citizens of that state (who would of course not be
subject to French tax under art 209B). Clearly, a primary concept of the European Union
is to allow freedom of movement of capital and labour within the European Union, and
   it would be contrary to the intentions of the Treaty of Rome, and now Amsterdam, to
   allow the French tax administration to impose French taxation on the profits of another
   EU resident company which is subject to the tax laws of another member state. Thus it
   would seem that Dutch holding companies, Luxembourg SOPARFIs and even, say,
   certain Madeiran and Irish companies should, following this argument, fall outside of
   the scope of art 209B.

   The burden of proof that these exemptions apply rests with the French parent company,
   rather than the tax administration, and the French company should report the existence
   of these foreign base companies to the tax administration, even if the profits of these
   companies are excluded under the territoriality principle. This burden of proof changes
   when other French anti-avoidance provisions are brought into play by the tax
   administration; thus art 238A CGI provides that if a French resident entity or individual
   makes certain payments such as royalties, fees, management fees, interest payments or
   salaries, to an entity in a tax regime which levies substantially lower taxes than the
   French tax (less than two-thirds of the French corporate tax rate), then that payment may
   not be deducted in the computation of taxable income in France unless the payments
   correspond with commercially bona fide transactions and that the payments are neither
   excessive nor abnormal.

(d) Bricomix - The application of the CFC legislation in the UK
    The compatibility between domestic law and international law was raised in case
    involving Article 11 (interest) of the Netherlands/UK double tax agreement. In Bricom
    Holdings Ltd v. IRC the taxpayer was a UK company which held 100% of the issued
    share capital of a Dutch company which operated in Singapore through a branch. The
    branch was subsequently sold and as a result the Dutch company became cash rich; in
    order to utilise the funds from the sale of the branch the Dutch subsidiary made loans to
    the UK group of companies intending to receive the interest free from withholding tax
    under Article 11(1) of the Dutch/UK double tax agreement.

   There was no doubt that the Dutch company was a Controlled Foreign Company for UK
   tax purposes and that because of this an apportionment of the Dutch company‟s
   chargeable profits was permitted under s741(1) TA 1988, nor was there any dispute as to
   the applicability of Article 11 of the double tax agreement. The dispute arose out of the
   fact that the Inland Revenue claimed that the double tax agreement did not override
   domestic CFC legislation and as such the assessment should stand. The taxpayer was
   attributed with all of the profits of the Dutch company including the interest element on
   the loans paid by the UK group of companies and it was this element of the assessment
   that the taxpayer appealed against on the basis that the interest payments were being
   subject to tax in the UK contravening Article 11 of the Dutch/UK double tax agreement.

   The CFC rules, pursuant to s747(4), provide for the amount chargeable to the UK
   company to be computed by applying the appropriate rate of corporation tax to that part
   of the CFC‟s chargeable profits as is apportioned to it, and then by deducting so much of
   the CFC‟s creditable tax (if any) as is apportioned by that company for the same time
   period. Bricom appealed against the assessment to which the Inland Revenue countered
   claiming that the amount attributable to the UK company was no longer “income arising
   in one of the states which is beneficially owned by a resident of another” and as such
   outside the scope of the double tax agreement, but was a sum equal to corporation tax
   computed on a notional profit of the CFC and apportioned to the UK company.
   An argument raised by the taxpayer was that if the income, which would have been
   exempted under the terms of the double tax agreement, was subject to tax under s747
   TA 1988, was that tax corporation tax and if not was it “substantially similar” to
   corporation tax and thus within the remit of the treaty. Whilst the court did not feel it
   necessary to explore this avenue the Special Commissioners did comment that in their
   opinion there was insufficient evidence to show that the charge and corporation tax were
   not substantially similar. This then begs the question of whether the terms of the treaty
   and indeed international law have been breached. Section 788(3)(a) TA 1988 which
   allows tax treaty provisions to be incorporated into domestic law refers only to income
   and corporation tax whereas the double tax agreement refers to these terms and
   “substantially similar” taxes. This being the case, and in light of the views expressed by
   the Special Commissioners is it possible that the Court in Bricom denied the supremacy
   of the international law to have effect as proscribed by Article 26 of The Vienna
   Convention on the Law of Treaties?

   The Court of Appeal held that despite Article 11 of the Netherlands/UK double tax
   agreement the CFC legislation contained in s747 TA 1988 permitted an apportionment
   of profits of the Dutch company to the UK company and that this was not overridden by
   Article 11. A reason for this decision was that a “notional sum”, which was computed
   by reference to the profits made by the Dutch company, could be taxed in the UK. Had
   the sums in question been capital gains as opposed to chargeable profits the outcome of
   the Bricom case would have been different; the gain would have been protected under
   Article 13 of the Netherlands/UK double tax agreement because section 13 TCGA 1988
   taxes actual gains rather than a notional amount. Article 13 of the treaty provides the
   override to UK law by expressly stating that “gains from the alienation of any property
   shall be taxable only in the State of which the alienator is resident”.

   The case is fascinating because it deals with an area many commentators around the
   world have been waiting for. The compatibility of tax treaties and domestic law is never
   put to the test more so than where CFC legislation is involved and it is therefore
   somewhat surprising that more cases such as Bricom do not come before the courts.

5. Summary
   Double tax treaties are of tremendous importance to businesses with an international
   dimension. Without them trade would be stifled and economies would likewise be
   affected. It is because of this that treaties often assume huge importance when
   developing tax strategies; however, the introduction of anti-treaty shopping articles
   (pioneered by the US) in double tax treaties and the exchange of information between
   member states is forcing substance into structure where perhaps a decade ago this would
   not have been an issue. Because of the importance of treaties it is not only necessary to
   understand how they operate but also how they are interpreted.

   Much is likely to change in the field of double tax treaties, both in terms of interpretation
   and anti-avoidance; however, it is the exchange of information which, as noted above, is
   seen as the key to preventing the growth in money laundering (and by extension tax
   evasion) which is likely to become more heavily relied upon than in recent years.
   Indeed, with the recent events in the US, this provision may become one of the main
   focuses of Governmental reviews aimed at the prevention of international terrorism.
Prepared December 2001
   International Fiscal Services Ltd
201 Haverstock Hill
London, NW3 4QG
Tel: 020 7431 2828
Fax:        020 7794 1900
E-mail: info@interfis.com
Web: interfis.com
    In Societe Kingroup a Canadian company (Kingroup) was a partner in a French GIE which derived the
majority of its income from the granting of licenses to French companies. It was assessed to French tax on its
proportion of profits arising to the partnership, and although prior to the assessment Kingroup had submitted a
Canadian tax return declaring its share of the profits, the French authorities however, took the view that French
tax should be levied. Under French law foreign partners of a French partnership are assessed to French tax not
because a permanent establishment has been created but because the income is deemed to accrue to the French
enterprise. This therefore permitted the authorities the benefit of not having first to ascertain that a permanent
establishment does exist before assessing the partner in question to French tax. This case however bears
resemblance to the Bricom case in the United Kingdom in that the supremacy of international law was brought
into question. Under Article 7 of the France/Canada double tax agreement a contracting state may only subject a
resident of the other state to tax if there exists a permanent establishment in the first state and it was Article 7 of
the treaty that Kingroup relied upon in its defence to the assessment. The court held however that the terms of
the tax treaty only applied if the Canadian company had received the income directly and not via a French
partnership; it was the fact that the income had travelled through the partnership which had caused it to change
character thus taking it outside the scope of the treaty. In addition to Article 7 Kingroup also invoked Article 10;
however, the court also rejected this on the grounds that the distribution of the profits of the partnership were not
     (1997/1998) 1OFLR 179. The Court dismissed the Commissioners application on the grounds that the treaty
should be interpreted literally; the fact that a company lower down the chain did own assets which would have
been within the definition of real property for the treaty was irrelevant. The question considered by the court in
coming to its decision was the meaning of the word “direct”. Einfeld J, in giving his judgement reaffirmed the
fact that a double tax agreement overrides domestic law, in this case the Income Tax Assessment Act. Article 7
of the Australia/Netherlands double tax treaty, which Lamesa invoked as its defence to the assessment provides
that profits of a Dutch company may only be subject to Australian tax where the Dutch company carries on a
business in Australia through a permanent establishment, i.e. Article 7 of the treaty provides protection unless
Article 13 applies. This was emphatically not the case; the only property Lamesa had in Australia was the shares
in the underlying company. Einfeld J went on to say that “wholly owned subsidiary companies are separate legal
entities and independent from their parent company” and if the court were to attribute the assets of a far removed
company to the parent as was the hope of the Commissioners, this would result in the lifting of the corporate
veil, something the court would not do.
     See The Netherlands/UK Treaty (1980); Belgium/UK Treaty (1987) and the Poland/UK Treaty (1976)
    It should also be realised that double tax treaties contain exchange of information clauses which permit the IRS to
inquire of foreign tax administrations, transactions and other circumstances relating to an entity within their
jurisdiction. The exchange of information clause has been more heavily relied on in recent years to combat tax
evasion and even where old treaties do not permit such automatic exchanges as take place nowadays, separate
agreements are often entered into to assist tax administrations around the world. Thus an agreement has been signed
between Italy and the US which provided for a simultaneous audit of selected companies operating in both Italy and
the US. Similar simultaneous audits have been undertaken by the IRS with the UK, Canadian, Norwegian, French
and German tax administrations.
Information exchanged under US income tax treaties falls into three main categories, (a) routine information, (b)
specific information on a particular taxpayer made pursuant to a request by a tax treaty partner, and (c) information
concerning any changes which have been made in the treaty countries‟ tax laws.
     See §7852(d)(1)
     It did not enter into force until 1 January 1994. Moreover, taxpayers, e.g. companies in existence before 31
December 1993, could elect to continue applying the provisions of the old double tax treaty for a further one year
after the effective date of the new treaty, i.e. until 1 January 1995 (this was assumed to be the case by the IRS unless
the Dutch company states that the provisions of the new treaty should apply).
      France has adopted a series of provisions similar to US sub-part F principles to prevent income accumulation
in foreign companies. The 1980 Finance Act (codified under article 209B of the French Tax Code), provided
that French companies holding directly or indirectly 25% or more of the share capital of a foreign company
located in a country with a privileged tax system, were liable to French corporate tax on their share of the
earnings of that foreign company.
The 1993 Finance Act has reduced this 25% level to 10% and also extended the CFC provisions to: (i) those
investments whose total cost price exceeds FF 150 million (Euros 22,800,000) and (ii)
to foreign branches.
Until December 30, 1992 Article 209B was only applicable to profits realised abroad by a company or by a
similar entity. Since the entry into force of the 1992 Act, this is also applicable to profits realized abroad by an
entity which has no legal status or by an establishment. This change will be similar to the PFIC legislation in the
However, art 209B CGI does not apply if the main activity of the foreign company located in a tax haven
jurisdiction is in substance industrial or commercial, and if it predominantly carries out operations in the local
market which may be a regional market covering several territories in the region.
   [1996] STC (SCD) 228

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