In my last blog post, I noted that, according to the OECD’s treaty commentary, there are several purposes for which the tax treaty was written. The two specifically mentioned are to promote the “exchanges or goods and services and the movement of capital and persons.” The treaty also has an anti-avoidance and anti-evasion policy. It is to this point that we now turn.
The anti-avoidance test is found in the treaty commentaries:
9.5 It is important to note, however, that it should not be lightly assumed that a taxpayer is entering into the type of abusive transactions referred to above. A guiding principle is that the benefits of a double taxation convention should not be available where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions
This is a two prong test. First, the taxing authority must prove one of the main reasons for entering into the transaction was to obtain a more favorable tax treatment. This is a subjective inquiry. Next, the taxing authority must prove obtaining that benefit would contrary to the “object and purpose of the relevant provisions.” This is an objective inquiry into the section's purpose. It’s important to remember that both elements must be present. Let’s take this in the order presented.
Determining whether securing tax benefits was a main purpose for entering into the transaction is an inquiry into the participant’s subjective intent. Under US law, this requires a very in-depth treatment of the relevant facts, where all material is used to make the determination. Sales literature is a very popular method of proof, as is contemporaneously prepared documentation (reports, memos etc..) used to communicate with others in an organization. Email can also be very revealing, as the informality of this medium may encourage more freedom to say exactly what is on the writer’s mind.
In addition to determining the taxpayer’s subjective intent, we must also rule if granting the benefits of a particular section (which probably means beneficial tax treatment) under conditions proposed by the taxpayer’s transactions would violate that sections purpose. For example, sections 10, 11 and 12 of the treaty allow for preferential tax treatment of cross-border flows, the purpose of which is to promote the remittances between counties. But inherent in each of these sections is the requirement of actual and meaningful activity. For example, a dividend is paid after a company has excess earnings and profits. Interest is paid after one company negotiates a loan and another company agrees to extend credit. Royalties are paid after an intellectual product is developed and the rights to use it are sold to a third party.
These are very complex questions to answer. If you have any questions regarding this, please contact me domestically at 832.330.4101 or over Skype at the name bonddad.
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