Case study 1

Z AG is a company established in Switzerland. The company developed an app that makes

it possible to exchange messages through mobile phones in an innovative way. The
company grants the right to use this intellectual property to two companies: D Plc (a
company established in the United Kingdom) and E Inc (a company established in the
United States).

Those companies pay a royalty of EUR 500,000 and EUR 750,000 respectively. This royalty
income is taxed in the hands of Z AG at a rate of 20% in Switzerland. The United Kingdom
imposes a withholding tax on royalty of 15% and the United States imposes a withholding
tax on royalty of 25%. The double tax treaties between the mentioned countries are in
accordance with the OECD MC, with one notable exception: Article 12 of the treaties gives
the source state the possibility to tax royalty income at a rate of 10%.

Questions:

a. Under what conditions can Z AG enjoy the benefits of the double tax treaties? Please
also deal with the definition of ‘royalty’.

b. How much tax is due in Switzerland taking into account the method for the avoidance of
double taxation as laid down in the OECD MC?

 Taxation regulated on the basis of the applicable distributive rule. Concerning

taxation of royalties, art 12OM.
  If some term which are not defined within the treaty, and then we need to apply Art
3(2), but in this case art 12(2) contains the definition of royalties (the right to use-art
12; the right to own-art 7)

 Then we have to check the Art 12 (1) to define which state has the taxing right.
According to Art 12 (1), the royalties shall be taxable only in the state of residence, in
our case, in principle means the Switzerland (CH), but there is a exception of their
treaty: “Article 12 of the treaties gives the source state the possibility to tax royalty
income at a rate of 10%.”

 in practice, what the case wants to say is that there is taxation in the state of
residence, but also the state of source as the right. But if Z AG is the beneficial
owner, then the right to tax in the state of source cannot exceed 10%.

 then it will be the state of residence on the basis of art 23, which is chosen in the
specific treaty, then there will be in Switzerland provide a credit or an exemption.
Normally according to art 12(1), there is no taxation in state of source, so no double
taxation problem, but bc in this case, there is a special exception of the state of
source, so need art 23 to solve the double taxation problem.

c. Does this result amount to capital export neutrality or capital import neutrality?

 It depends on whether we apply credit or exemption. if we apply credit, we have

exports neutrality.

Case study 2
Case study 2 X Ltd. is a company established in Bermuda. The company is part of the
American X group and it is managing the (excess) cash of this group. One of the group
companies – X Pty. - is in need of funds and therefore X Ltd. grants a loan of $ 7,000,000 to
this company with an interest rate of 7%.

X Pty. is a company that is a resident of Australia and produces copper. The withholding tax
rate on interest in Australia amounts to 20%. Australia and Bermuda have concluded no
international tax treaty.

Questions:

a. Can Bermuda and Australia subject the interest income to tax?

b. May Bermuda and Australia subject the interest income to tax?

 In this case, we should concern the domestic law, there is taxation of interest in
Australia, Australia can tax interest payment (might have double taxation problem as
well).

 However, in Bermuda, there is no taxation there (And then the may question is not
relevant anymore because we don't need a treaty provision to avoid to avoid double
taxation.).

 In any case, the may question would not be applicable because there is no treaty
because the may question concerns the treaty provisions.

 the state of source can tax the items of income or capital which are produced in the
state of source, the state or residents can tax the items of income or capital
worldwide.
The tax director of X group suggests that it is better to interpose a Dutch company in the
funding arrangement. This would imply that X Ltd. grants a loan of $ 7.000.000 to X BV,
which, in turn, grants a loan of $ 7,000,000 to X Pty.

Questions:

c. Explain the line of reasoning of the tax director. Take into consideration the double tax
treaty between The Netherlands and Australia.

 Art 11 (1), interests may be tax in the state of residence, Art 11(2), the taxes shall not
exceed 10% in the state of source.

 First, Australia can tax according to his domestic tax law which is WHT 20% of the
interest. And then bc of the treaty between AUS and the NL, the WHT rate shall not
exceed 10%.

 Netherlands taxes the interest (Art 11(1)) but the interest can also be tax in the state
of source. It can also be tax in Australia (Art 11(2)). But then there is beneficial
ownership problem. we have to check whether the person receiving the interest is
the beneficial owner or not.

 to see what is the advantage of having the extra X BV. If X BV is BO, the WHT is only
10%, but if X ltd is the BO then the EHT is 20%. There is a bigger advantage is that in
the past the Netherlands does not apply withholding tax on outbound payments of
interest the royalties.
  In 2021, the NL applies a conditional WHT when an affiliated company in a low tax
jurisdiction, like in this case in the Bermuda or in certain case or tax abuse.

Beneficial Owner-the person who has the right to use and enjoy the income they received.

 The concept of BO is not defined in the OM, it mentions in Art 11 but not defined.

 Art 3 OM provides general definition, Art 3(2) said if we have a treaty, if we have a
term which is not defined in the treaty, then we apply domestic law unless the
context otherwise requires all the tax authorities decide as an agreement in the
application of a different term.

 Commentary art 11 para. 9 The requirement of beneficial owner was introduced in paragraph 2 of Article
11 to clarify the meaning of the words paid to a resident as they are used in paragraph 1 of the Article. It makes plain

that the State of source is not obliged to give up taxing rights over interest income merely because that income was

paid direct to a resident of a State with which the State of source had concluded a convention. It means no
matter the payment is to BO or not, the state of source doesn’t have to give up the
taxing right, but the minimum tax rate are not applicable when the receiver is not
BO.

 Commentary art 11 para. 9.1 - we are not interpreting the concept of beneficial
ownership in a narrow technical sense, but rather in a broader sense. Unless for the
purpose of avoiding double taxation, or the prevention of fiscal evasion and
avoidance.

 Commentary art 11 para. 10 - the agent and nominee only take the money and
passes the money to someone else, so the agent is actually not the beneficial owner,
then they will not be taxed in the state of residence on these money. Therefore, it no
need to avoid double taxation and no need to grant the reduction of taxation in the
state of source. This reduction is only justified when the residence in the state of
source is the beneficial owner.

 Not every payment made directly to a resident of the other state implies that we
need to guarantee a reduction at source, only when the payment is paid to the
beneficial owner.

 Commentary art 11 para. 10.2 provides the definition of “not BO”

Normally, recipient’s right to use and enjoy the interest is constrained by a

contractual or legal obligation to pass on the payment received to another person.
 But if there is no contract to prove it, we still can say the agent is not BO on the basis
of facts and circumstances showing that.

In practice it is very difficult to interpret the text and to see whether there is the
status of beneficial owners of the subject that receiving from the state of the source.

 EX: Danish case, judgments really gives the idea or how difficult in practice is to
evaluate whether there is the status of beneficial ownership or not, but also from an
interpretive point of view.- economic interpretive approach.

 Directive 2003/49: interest royalties directive

 Key word: actually benefit; own benefit and not as an intermediary, such as an
agent, trustee …

 always look whether there is a legal or contractual obligation or can I exclude the
status of beneficial ownership even when there is no legal or contractual
obligation but I can use facts and circumstances. The concept of beneficial
ownership it's much broader.
 the court is actually saying that when we are investigating whether there is or not
the beneficial owner, we are investigating whether there is an abuse or not. the
court is saying the elements that we have to use in order to consider whether
there is the beneficial owner or not, are the same elements that we use in order
to check whether there is an abuse.

 A group of companies may be regarded as being an artificial arrangement where

it is not a set up for reasons that reflect economic reality.

 there is a difference between the concepts of beneficial ownership applicable at

EU level compared to the cons of trouble at OECD level. The Court of Justice here
goes clearly beyond the concept of beneficial ownership under the OECD
comment,

 OECD states that we always have to look for a legal or contractual obligation,
restricting the right to use and enjoy. We can use facts and circumstances but
these facts and circumstances can only be instrumental to look at whether there
is a legal or contractual obligation. Here we are not looking for a legal or
contractual obligation here we are looking for an abuse.

 The concept applied by the Court of Justice is an economic concept, which is

much broader than the concept applied applicable under Article 10 (2) of the
OECD. The Court of justice is actually say beyond the existence of legal or
contractual obligation, we need to look at certain circumstances and
circumstances show that there is an abuse and we exclude that there is beneficial
ownership.

 while on the basis of the Court of Justice can go beyond the existence of a legal or
contractual obligation and exclude the existence of the status of beneficial
 ownership on the basis of an analysis which is an analysis concerning abuse, so if
there is abuse, there is no beneficial ownership.

 Peiyu: I think the conclusion is when considering the BO, both OECD and EU law
can use the fact and circumstances. But EU can use the fact and circumstances to
measure there is abuse or not.(if I am wrong plz correct me. QQ….)

Back to case 2

 if the Netherlands just take the money and passes the money to Bermuda, then we
don't have the beneficiary. X BV is not BO, Australia will be no reduction of taxation
to 10%