INTERNATIONAL TAXATION

Introduction to International Taxation

Taxes
An involuntary fee levied (imposed) on corporations or individuals that is enforced by a level of government in
order to finance government activities. In case of failure the payment of taxes is punished by law.

The governments impose taxes on individuals and corporations for three main reasons:
● To collect money for public expenses, in order to finance services that cannot be afforded individually. Ex:
building roads.
● To correct negative externalities. Ex: taxes penalizing pollution, noise or smoke.
● To redistribute wealth and equalize the economic situation for all citizens.

Classifications

● Direct taxes: are levied over persons/individuals/legal entities or properties based on their capacity to
pay (income or wealth). They usually fell over income and net worth or wealth. Ex: Personal Income
Tax (IRPF), Corporate Income Tax (IS), Real Estate Tax (IBI), Net Wealth Tax (IP).

o Example: Tax on increase in value of increase of property value, during the subprime
mortgage, the value of the property decreased value, so the supreme court ruled that if a
property is sold at loss, then the seller does not need to pay the tax, because it is against the
principle of considering the capacity to pay.

o Social security: it is not a tax even though it is levied on the salary, but it does not consider
the personal situation of the payer.

o Inheritance tax: it’s a direct tax although it happens when there is a transaction
● Indirect taxes: are levied over transactions, consumption and foreign trade. The connecting point is
the operation, not the person involved. Ex: Value Added Tax (VAT - IVA), Transfer Tax/Capital
tax/Stamp Duty (ITP), Custom Duties (for imports). 🡪 A millionaire and a beggar pay the same tax on a
can of beer.

In direct taxes:

● Residence = Personal(principle) tax: implies that residents in one country are subjected to taxation in
the country of residence for the world-wide income or wealth. Meaning, you have to pay taxes in your
residence country on all your income and wealth.
● Source(principle)Tax: Non-residents may be subject to taxation on income obtained in a country other
than their residence country and/or on property located in such a country. Different regimes apply
depending on whether the taxpayer acts or not through a permanent establishment.

The conflict between these two principles, leads to double taxation or non-taxation. Therefore, in order to
incentivize global trade, the main objective of the international taxation is to avoid them and to create a fair
environment.

Developing countries tend to apply the source principle because they are recipients of foreign
investment. They build their tax income from the taxes paid by those non-resident investors that
 invest in their territory. While developed countries tend to apply the personal principle because their
residents tend to make investments abroad, so by taxing them on the world-wide income, they are
somehow capturing all that investment made by residents abroad. But most countries have mixed
criteria. What happens to main countries in Europe, they apply the world-criteria on residence and
non- residence they have to pay taxes on income create in the territory.
Residence is one of the main criteria in order to determine where a person is going to pay their taxes.
There are countries like in the US where they also apply nationality criteria, where they tax nationals
even if they are non-residents. Other countries, like UK, have tax registry based on tax domicile.

● Global jurisdiction: Tax residence for the world-wide income.

● Territorial jurisdiction: Tax residence and non-residence for the income generated in that country.
 ● Progressive taxation: the tax rate of the tax you have to pay increases together as your income
increases.
● Proportional taxation: you pay more in absolute terms but not on relative terms. The tax rate is the
same.

Non-residence taxation
Taxing non-residents is a difficult for tax administrations. And even more difficult when they are acting without
a permanent establishment (have a physical presence in the other country on a permanent bases) and there is
no incentive to accept the tax burden, it is like a feeling for residents so that the payment of taxes is for a real
reason (like free hospitals), while non-residents do not have this feeling because they are not receiving nothing
in exchange. So, countries have developed sets of rules to endure non- residents taxation in their territory, i.e.
withholding tax obligation born by the payer of income who also becomes responsible for the tax.

The key elements on taxation on non-residents entities or individuals are:

● Having no tax residency in a given territory → tax residency is the most important factor

● Deriving income deemed as obtained in such territory → obtaining income from that territory

● Acting or not through a permanent establishment

● Existence and applicability of the Double Tax Treaty between the source and the residence country.
o Bilateral treaties

Typology of economic relations affected by international tax:

● A person lives and works in one country but generates income in another country. Ex: renting a house
in South-France being resident in Spain.
● A person living in one country but working in another.
● An expatriate (seconded employee) Ex: you work for a company in France and they send you to a new
subsidiary in the Netherlands. Theoretically you will continue paying taxes in France.
● A person who retires in a country different than the one he lived in while working.
● A sale of goods.
● Rending services
● An international investment: in real estate, companies, or other assets
● Transfer of an asset
● Collecting on dividends, interest, royalties
● The performance of an artist or athlete
● A teacher or student scholarship to study outside the country

International Taxation
As globalization spread, international tax issues have become more relevant because now economies are more
open, and transactions usually involve two or more countries. This is why old international tax rules have
become obsolete and are not applicable anymore. So, projects like the BEPS one, are responsible for reviewing
those traditional rules and adapting them to the current environment. The effects of international taxation
have to be evaluated on a global basis because i.e. a firm can pay taxes in the two countries where it operates.
There should be specific connecting points for transactions either residency or territoriality or payment in order
to determine the subjection to paying taxes.
As we are applying laws of different countries and each country considers both the residency principle and the
territorial principal, this makes international transactions a collision with different laws of the countries
involved, and this may lead to double taxation or even non-taxation.
Key issue when analyzing international tax:

1. Determine the scope of each state’s fiscal sovereignty (Double Tax Treaties)
2. Determine the connection points.
a. Territoriality
b. Residence
c. Payment
Conflict of interest between developing country and developed country
Developing country receives investment while developed country’s resident invest abroad, thus, for developing
country’s government, they prefer source principle while for developed countries, they prefer personal principle.

Governing law
There is no international law which can be applied in all countries, nor international tax courts dealing with
international cases, with the exception of the European Court of Justice. But there are no global organizations
setting up global rules applicable in all countries, before the OECD made some recommendations but now the
situation is changing, and countries are very involved to the project and try to apply all these rules, but at the
end this means that countries have to develop specific rules following this principles or recommendations
proposed by the OECD. So, we are talking about national laws being applied to people/organizations doing
business in that specific territories.

● Bilateral or multilateral treaties

● Domestic law on non-residents taxation

● Soft laws: How does OECD interpret the international taxation, what are their guidelines?

● Some domestic laws are build based on those guidelines/principles

[[According to Roy Rohatgi national taxation is based on the principle of:

● Tax equity: tax revenues from international economic activities have to be shared equitably by
nations. Domestic rules cannot create preferential tax regimes or create unfair tax competitiveness
with other countries.
● Tax neutrality: tax systems are neutral when they don’t influence the economic choice of tax payers.
The fairness and efficiency of tax systems depends not only on tax laws affecting one country but the
commutative effects of the tax laws of all the countries. This is the basis for the BEPS project, countries have to
strength their cooperation in order to exchange information in order to know what my residents are doing in
other countries. Also, they want to reinforce the collection of taxes.]]

Residence Tax (New OECD model in 2017 due to the BEPS PROJECT)
● Liability to direct taxes is determined by most countries through the tax residency criterion: residents are
taxed over worldwide income. (global taxation) while non-residents are taxed on income in that specific
country (limited taxation)

o For tax residents: they are taxed on worldwide income, and for non-residents they are taxed
on income in that country.
● Tax residence is determined under the domestic law of each country.

● Some countries also take into account other criteria such as nationality or domicile to determine liability
to tax.

Tax residency is the main criteria to determine whether a person, an individual or a company is subject to
taxation in one country or another. Some countries like the US also use other criteria like nationality. There are
several rules in order to determine tax residence, so we wouldn’t find any general international rule
determining how residence needs to be determined. Tax residency is going to be determined by every country.
So, each country will specify the rules under which a person or an entity will be considered as tax residency.
The BEPS criteria will be different depending on the country.
For individuals:
Most used criteria:
● Habitual abode: stay in a country for more than 183 days a year. This is starting to change, this is a
traditional criterion to determine tax residency, which is the number of days a person stayed in one
country. With the OECD tax model of 2017, they try to find if there are some other stronger criteria
that can be used to determine the tax residency of a person.
● Centre of economic interest: the place where a person obtains most of its economic interest (income
or properties).
● Availability of a permanent dwelling place: having a permanent home available for that person.
● Family ties: personal centre of interest, the fact that a person has his family, personal relationships or
personal links like political ones, social ones, friends… Basically the vital surrounding of a person.
● Nationality: also used in the OECD model convention in order to solve conflicts of residency.
● Permanent residence visas: it is important to say that tax residency in principle has nothing to do with
administrative residency. So, administrative residency has to do with having permit or visa to work or
stay in another country for a period of time.
● Work permit
● Location of the primary residence
The rules generally provided to establish tax residency for legal persons (companies) are:
● Incorporation under the laws of a country: we can consider that if a company is incorporated in a
given territory, and are under the laws of this territory, it will be qualified as residence of that country.
● Having most of the assets (in terms of volume or in terms of quantity) in one country or having the
main centre of activities or the head-offices in that country. So, where most of the activities are
carried out, is which is going to determine the tax residency.
● Regardless of the above, having their place of effective management in a given country. Where the
decisions are really taken by a company. Where the headquarters, the general manager, the board of
directors are acting on a permanent basis and the decisions are taken.
These traditional criteria are also being shifted to a new vision because countries not always reach an
agreement when determining the tax residency of a company.

The Spanish criteria in order to determine tax residency of individuals or entities. According to Spanish law a
person will be under the tax residence criterion if:
● He is in the Spanish territory for more than 183 days (= habitual abode). This has been a traditional
criterion under Spanish law. They take 183 days because it is more than half a year, so if a person stays
in Spain for more than a half of a year can be considered as a tax resident in Spain.
*In Spain once you are determined tax residency you have to pay taxes for the whole year, even if you
stayed just 184 days.
● A second criterion will be the center of economic interest, if they have the main assets or the main
source of income in the Spanish territory.
● Family ties: it implies that if a person has the spouse or the children under the Spanish residence, it
will be considered as being resident in Spain, even though it may prove the contrary. The other ones
don’t admit any proof to the contrary but this one does admit proof to the contrary.
They don’t have to happen together, with just one of them the individual will be considered as tax residence.
But if a person can prove that he is a tax resident in another territory, this presumption will not be accepted.
There are some rules also regarding people living in Spain and trying to obtain tax residency in other territories.
Normally countries have anti-abuse laws in order to prevent shifting tax residence from a country to another.
Ex: sportsmen shifting tax residence to tax havens. So, there are specific rules preventing these practices and
they imply that in case a person shifts tax residence to a tax haven, it will continue to be subject under Spanish
tax law during a certain period of time.
In case of companies Spain also provides for several rules:
● Incorporation of a company under Spanish law
● Having the registers address, the corporate domicile under the Spanish territory
● Having the effective place of management in Spain
It is really aligned to the general criteria of tax residence, which most countries have (because there is no
international criterion).
With these rules and depending on how these rules are applied in different countries will make it very easy to
handle a situation in which a person meets the taxation criterion in two or more countries at the same time.
Example: There is a Spanish individual that normally lives in Spain, so, under the Spanish criterion he will be a
tax resident because he spends more than 183 days in the territory. But he has a house in France, and in France
(imagine) one criterion for tax residence is to have an available house in the territory. So, this person will fit
under both, the Spanish and the French criterion.
This is what we call conflict of residence. Fortunately, there are rules (Acticle 4 DTC) in order to solve this
residency conflict. However, if there is no double taxation convention, it may well happen that a person
qualifies as a tax resident in more than one country, and this will imply double taxation. Because when a person
has tax residence in one country he has to pay the taxation according to the world-wide income. Residency is a
very relevant item to take into account in international taxation.
● The residence conflict happens because the tax residency is determined by each country under
domestic rules.
● This problem can be solved by bilateral Double Tax Convention (Article 4 → tie breaker rule)

Tax residence conflict: Individuals

It can be the case that a person meets under the criteria of tax residency in more than one country. This would
lead to a double taxation situation due to a conflict of residency.
If the person meets the criteria under state
A or under state B it will have residence in
state A and B respectively. If it doesn’t meet
any of those, it will probably have a tax
residence in another country. The problem
comes when it meets both criterion.
At this point we have to apply the OECD
Model Tax Convention (if there is a
treatment between two countries) in order
that the countries reach an agreement in
order to avoid double taxation when there is
 a tax treaty between the countries. Those
decisions have been based on the
commentaries of the model provided by the
OECD model convention.

Commentaries of the article 4 of the OECD tax convention (from 2010) before the BEPS project appears in 2017:
● The fact of being resident in a contracting state has different functions relevant for two cases: first to
determine the conventions personal core of application, not only tax residence will determine if we
are subject to taxation in one or another country, but also to determine whether I can apply a tax
derecognition. If I don’t qualify as a tax resident in any of the two countries signing the convention I
won’t be able to apply for the conditions of the tax residency.
● Solving cases of double taxation because of double residency.
● Double taxation cases are rising because we are acting in two different countries so, on the one hand
we will be subjected to taxation on a personal obligation, but at the same time we will be subject to
taxation in the other country because we have obtained income in the that other country.

Example of application of Article 4:

In case we have a conflict of residency the greatest resolution is provided by article 4: For individuals.

Depending on the country you have permanent dwelling (permanent home) will help to solve the problem of
tax residency conflict. But if the person has no home in any of the countries or in both countries, this won’t
help us. So, we have to go to the next criterion (if the answer to having a permanent dwelling is YES for both
states, if the answers were NO, then directly go to Habitual abode): having the centre of vital interest (or
personal ties) in any of the countries. Under the OECD model, the centre of vital interest both includes the
economic and the personal field of a person like family and social relations, occupations, cultural activities…
Centre of vital interest cannot be enough to solve the conflict of residency, so we have to move to the next
criterion. Habitual abode refers to staying in a country for a temporary period. It refers to the 183 days rule,
but normally refers to it as a temporary rule. This is one of the news introduced to the new model, where they
say that considering the habitual abode of a person is only referred to the time a person spends in a specific
territory should not be enough because this cannot be by “chance” by one time to another and maybe the
addition of the days spend in this country will really go over 183 days, but can we say that this person has a
habitual abode on this country? If this criterion still does not determine the tax residence of that person we
have to move to a last criterion which is nationality. We may also find cases of double nationality, but usually it
is quite a definitive criterion. But if in the worst scenario nationality is not enough to break up the conflict of
residency there is a final commission that says that the countries will get into discussions in order to find an
agreement to determine if the person is attached to a tax residency or another by the conflict and agreement
process (mutual agreement).

● Note: the first criterion is to have a permanent home(permanent dwelling) in one of the territories.
Regarding this criterion it is important that the person has a house available to him, it is not linked to an
ownership notion but just the availability of home (having the right to use this house – not to own it, for
example having the house rented in another country). It is also linked to the notion of permanency, so
any kind of temporal arrangement is not enough to determine the residence taxation of a person. For
example, a person residing in a hotel is determined as temporary, not availability of a house. It mentions
situations of short duration of use of a house like travel for pleasure, work travel, educational travel… If
I own a house but I rent it to another person, it cannot be considered that that house is available to me.
So, the two indicators are relevant, full availability and permanency.
Tax conflict: companies

Companies may face similar conflicts. It is not that common to have a residence conflict with firms, but it can
be the case that it faces a conflict of residency or that wants to have a double residency because of tax reasons.
So, article 4 of the OECD model also provides answers in order to determine if a company is resident in a
country or not. Traditionally it was considered that a company was resident in the country where it had the
effective place of management. The new vision considers that the effective place of management is not
enough to determine the residency of a company. Now it would not apply automatically, so the two countries
would enter into discussion in order to determine where the company is going to have its tax residency. 🡪 two
countries must discuss.

● If there is DTC, then the criterion under Article 4 can be applied

● If there is no Convention, double taxation.

There are some countries that are making some observations or reservations to the new audience. In the
commentaries, apart from the general comments, you also have observations or reservations made by some
countries. Maybe they say that they consider that the appropriate consideration would be aligned to their
domestic law, and that sometimes they reserve the right to negotiate bilateral tax treaties of a part of their new
model.
Example: Hungary, in the new model, does not agree with the interpretation of habitual abode. They considered
that the main reason to take into account habitual abode is the number of days spent by a person in a country,
so they stick to the old vision of the OECD model. Also, Estonia and Latvia made a reservation which reserves
the right to include as the criterion to solve the conflict of tax residency in case of companies according to the
effective place of management.
The OECD model is a guide, a source of interpretation, but we have to consider which is the specific warning of
the bilateral treaty negotiated by the countries. And then if we have any doubt of the interpretation we can go
to the commentaries to see what the right interpretation is. But the only applicable law is the domestic law.

If a French company, being tax resident in France, gives a loan to a Portuguese company, being tax resident in
Portugal, the Portuguese company pays an interest to the French company. This French company will be taxed
in France for its world-wide income, but since it is obtaining income in Portugal, it will be taxed twice. This is a
case of international double taxation: the same income is taxed twice in two different countries. Elimination of
double taxation is one of the main concerns in international taxation, because otherwise it disincentives
investment abroad because people doing business at the domestic level will have a fairer treatment than
people doing investments abroad.

Extensions or limits to the tax residency general rules

➢ Some countries have rules implying a tax extension for taxpayers moving their tax residency to other
countries exit tax provisions

➢ Some countries provide for special tax benefits for impatriates (people moving tax residency from their
countries of origin = incomere). These benefits are usually applied over a limited period and may imply that
even though under general rules those individuals become tax residents, they are:

✓ Only taxed on source income or local assets, or

✓ Taxed on worldwide income at reduced rates

➢ Some countries may also provide for tax benefits for individuals working abroad (i.e. short-term expatriates)
DOUBLE TAXATION

There are two types of double taxation:

● Legal: Legal (juridical) double taxation refers to circumstances where a taxpayer is subject to tax on the
same income (or capital) in more than one jurisdiction. For example, a resident of Canada who is also
considered to be a resident of the United States would be potentially subject to concurrent full taxation
in both countries. Bilateral tax treaties generally tend to eliminate (or at least reduce) the possibility of
juridical double taxation. Legal double taxation may arise for the combination of personal obligation
(PO) and source obligation (SO).

o The same person is subject to the same taxation in two countries. For example, conflict of
residency, or the application of both principle: source and personal.
● Economic: Economic double taxation refers to the taxation of two different taxpayers with respect to
the same income (or capital). Economic double taxation occurs, for example, when income earned by
a corporation is taxed both to the corporation and to its shareholders when distributed as a dividend.
o The income is taxed twice on two different people. Example: the payment of dividend is taxed
twice, once over the company, and once over the shareholders.
o Example:

▪
● Ex1: Spanish company holding a Luxembourg company, and the
Luxembourg company distributes the profit iin form of dividend, the foreign
company has to pay a dividend tax, moreover, the Spanish company also is
taxed over it.
● Ex2: When the compare distributes dividends, both the company and the
individual shareholders are taxed over the same income. → Double
taxation.
● Summary

We can avoid scenarios of legal double taxation by:

● If the double taxation comes from double residency: solved by applying the double tax convention of
the OECD. → article 4.
● Mechanisms under domestic law: there are different methods applied by different countries. Each
country decides the method to apply
● Conventions to avoid double taxation.
o Double tax conventions(treaties)
❑ Main objective: to avoid double taxation. Other objectives: to prevent tax evasion /
non discrimination.
❑ Methodology used: rules that distribute the power to tax different types of income
between the two states. Precedence over domestic legislation.
❑ In addition, the agreements include mechanisms to avoid double taxation and set
up systems for administrative assistance between the two states.
o OECD Model Convention
❑ Try to provide countries with a uniform basis to solve double taxation issues.
❑ The text is recommended to countries for their bilateral taxation agreements.
❑ Comments allow the interpretation of the bilateral Conventions.
o These conventions include

▪ Criteria to avoid double residency: clarifying the aspects that determine the residency
of a person. → tie breaking rules in case of conflict.

▪ Distribution of taxation power: between the countries. Double tax treaties are
bilateral, so countries have to decide when they are going to tax a taxable income. So,
for dividends, income, royalties, real estate income… they may decide to tax that
income in favor of the source country or in favour of the resident country. 🡪 upon two
countries.

▪ Mechanism to avoid double taxation.

● The exemption&credit methods

o Methods to avoid double taxation: tax relief system provided by the residence country
▪ Exemption methods operate on the taxable base (=income), the foreign source of
income is not taken into account in the residence country. This implies that the
exemption method normally refers to positive income and it does not cover losses.
As the residence country disregards income obtained abroad, it also disregards
losses obtained abroad. With the perspective of the host country(source country), it
is favourable to have foreign investments, and for the resident country it is a way of
incentivizing international investment by its citizens.
● Full exemption: The foreign source income is not taken into account in the
country of residence. The residence country is the one subject to the
elimination of double taxation, it is responsible to decide how the double
taxation is eliminated to the resident.
Example: A resident individual in country A obtains income abroad (country
B) up to € 6,010 and € 36,061, in country A. The tax rate levied abroad by
source obligation is 20% (source country). Progressive tax table in the
country of residence:
Up to € 30,051→ 30%

From € 30,052 to € 36,061 → 40%

From €36,062 to € 48,081 → 50%

(If we do not consider any effect of income obtained abroad)

If anything done: the individual has to pay in country of residency, A, on

worldwide income.
Full exemption method: the income from abroad is disregarded.
(30,051 * 30% = 9,015) + (6,061 * 40% = 2,404) = 11,419 → Average tax
rate = 31.6% (11419/36061)

6,010 * 20% = 1,202

Total taxation (11,419 + 1,202) = 12,621

 ● Exemption with progression: The residence country does not either
consider the income obtained abroad for the subject to taxation, but it
takes it into account for determining the taxable rate. To have this method
we need to have a progressive tax method in this country. This income
obtained abroad is not taxable in the residence country, but it is taken into
account when calculating the tax rate.
o Types
❑ Exemption with progression according to average tax rate (as seen in the
example)
❑Exemption with progression according to marginal tax rate.
❑Exemption with progression according to the lowest tax rate on scale.
Example: Taxation is levied only over €36.061 but the average tax rate is
calculated over the basis of total income up to €42.070:

(30,051 * 30% = 9,015) + (6,061 * 40% = 2404) + (6,010 * 50% =

3,005)[income from abroad] = 14,424 (theoretical tax payable)
Av. Tax rate. = tax base/total income = 14,424/42,071 = 34.286%
We tax at average tax rate our local income, obtained in Residence country
(€36.061 calculated before over global income, but the total amount of tax
liability, we sum the tax pay abroad. (42.071€)
36,061 x 34.286% = 12,363.87€ Total
total tax (12,363.87 + 1,202) = 13,565.87€
*Why do we count the money obtained in the source country in the first
part??? Because I take it into account in order to know the % I have to
apply, but I just apply it to the income in the home country.

o The 1,202 is computed as 0.2 * 6010 = 1,202

▪ Credit/deduction method: operate on the tax liability (=tax to be paid). Now we take
into account the tax paid abroad. We include in the residence country the income
obtained abroad, but then the residence country provides for a credit deduction in
order to deduct the tax paid abroad.
● Full deduction: Here I am able to deduct the whole amount of the tax paid
in the other country. We declare in the taxable base of residence country
our foreign source income (gross) but the foreign tax withheld is fully
deducted from the local tax without limitation (negative?).
o Compute the tax rate on the global income taking into account the
foreign income. Then deduct the tax liability abroad from the tax
liability in the residency country.
Ex: 42,071 x av. Tax rate (34.286%) = CI 14,424
- (1,202) deduction
CL 13,222
Total taxation (13,222 + 1,202) = 14,424€

● Limited deduction: The residence country provides the possibility to deduct

either the lower of the two tax-bases (the tax paid abroad or the tax
corresponding to the same income paid in the residence country). This is
made in order to avoid discrepancies between tax rates. So, if the tax paid
abroad is lower than the one paid in the residence country we will end up
 paying the maximum tax rate of the one applying in the residence country.
But if the tax rate in the source country is higher than the one in the
residence country part of the double taxation will not be corrected,
because I will have an access of tax paying in the other country. We declare
in the taxable base of residence country our foreign income (gross) but we
deduct from the local tax the lower of the following amounts:
o Foreign tax
o Tax that would be payable in the state of residence if this income
would have been obtained there.
Example: 42,071 x (34.286%) = CI 14,424
- (1,202) deduction 1,202
tax 13,222 (6.010x34, 286%) = 2061
Total taxation (13,222 + 1,202) = 14,424€

Economic double taxation

Only arises when receiving dividends from foreign source. As seen above, it arises when two different entities are
taxed on the same income (dividend) in two different jurisdictions. Economic double taxation arises as a result of
dividends distributed by a subsidiary. The dividend is paid out from the subsidiary’s profits which have been
taxed in its residence country. Upon distribution, the parent Company integrates those dividends with its own
profits and gets taxed on the overall. Taxation arises again on the subsidiary’s distributed profit at the level of the
parent Company.

Note: Legal double taxation will also arise if dividends are subject to withholding tax upon distribution.

● Withholding tax is the part of income retained by the firm distributing dividends from the total dividend
that should be paid.

In order to avoid or at least minimize economic double taxation, the law provides for some mechanisms which
can be complementary with those available to avoid legal double taxation The dividend paid by the subsidiary is
not integrated into parent’s taxable base as long as the parent Company meets the following conditions:

– The subsidiary’s country of residence applies taxes at a tax rate equivalent to the parent’s

– Participation in the subsidiary of at least 5%

– The subsidiary performs an economic activity

The gross dividend is allocated into the parent’s taxable base and the tax paid by the subsidiary (OP) and then
practice as much deduction to avoid economic double taxation (ordinary Allocation System or integral) as the
international legal double taxation (ordinary imputation system or integral) deducting or the first of the two
following amounts or the smaller of the two following amounts respectively:

▪ the tax paid by the subsidiary on profits obtained + tax paid by the parent as non resident on dividends in the
source country.

▪ the tax that would have been payable in the country of residence on income from which dividend is paid out
should that income have been obtained in the country of residence

- The aforementioned amount is the possible deduction applied to the dividend receiver.
- Either the first option or the smallest of the two options.
- Usually, there is full exemption of dividend.

In the European Union there is the EU directive that provides that in case of dividend payments, the
residence country will consider those dividends exempt. So, the most common system applied is the limited
deduction one but, either from double tax treaty or though something multilateral like the European union,
 countries may decide to provide a more favourable method. In the case of dividends it relates two economic
levels of taxation. In case of economic double taxation, we also have the underlying tax, the tax that charges on
corporate income out of which dividends are paid, but which does not appear as a direct deduction or
withholding from the dividend itself. In this case there are two possibilities:
● Exemption method: it implies that this income is taxed only once in one country (the source). This is
very usual in the EU not only for dividends but also for royalties paid between international partners.
● Credit method: in principle there could be different possibilities
o Deduction of the withholding tax (TAX ON THE DIVIDEND): in the case of dividend payments,
taxation in the source country would be equalized. This implies double taxation.
o Deduction of the underlying tax： corporate income tax paid by the subsidiary.
Countries provide under certain circumstances the possibility to either have a treaty for the underlying tax
payment with the other country or to exempt the dividend received as a whole.
 There could also be cases in which we obtain income in more than two countries. In this case the resident
country will have to provide us what to do in order to avoid double taxation. We can find different systems:
● Overall limitation: in the limited deduction method we have a limit, so how we calculate this limit?
Countries have different systems what would be an overall limit. I can deduct taxes paid abroad but
there would be a maximum limit including all taxes paid abroad.
● Per country limitation: to have a maximum deduction but just per countries.
● Items of income: I can have a maximum limit for dividends, another for royalties, for interest, for
investments…

Even though we are under a credit method we can still benefit from the tax differences between countries. In
order to keep tax incentives provided by investment-receiving countries there are two mechanisms:
● Tax sparing credit: A provision where a country applies a tax credit against taxes owed on foreign
income that is equivalent to the tax exemption provided by the foreign country (nominal terms
speaking). Tax sparing policies are especially important to developing countries in their effort to attract
investment. Then investors are not losing the tax benefit provided by the source country. There are
not so may around the world, but there is one between Spain and Brazil.
o In other words: the source country provides a tax credit on the tax liability of the foreign
investment that will be equal to the tax deduction in the residency country.
● Credit for notional tax (=matching credit): in this case the residence country allows deduction of the
tax paid abroad at a fixed rate. This regards also the tax effectively paid but it does not consider the
nominal amount of tax rate but just a fixed amount.

Example: Company X gets total income up to 100 (60 in residence country and 40 abroad).
Tax rates at source country are:
Residence tax rates are:
● 10% if there is tax convention
● income up to 60 → 30%
● 50% if there is no tax treaty.
● income up to 100 → 40%.
 1st row of each scenario:
with tax treaty
2nd row of each scenario:
without tax treaty

Trib. F → foreign tax

Base → taxable base in the home country (%) – amount of income it is going to be subject to taxation.

Tipo (R) → tax rate - % of tax to be applied

C. Íntegra → tax liability at the residence country – real amount of tax to be paid

DDI → How we eliminate double taxation

CL → tax to be paid in the residence country (tax liability minus double tax

elimination)

Total → tax to be paid in the residence country + double taxation elimination

R/ The most beneficial method is the full exemption method. It is normally an advantage because if
you get a full exemption method you just have to play with the tax rates paid in the source country.
The exemption with progression would also be interesting depending on the tax rates applying the
residence country, you can have distortions and end up paying quite high amount of taxes. In this
example, when there is no tax treaty, we have the same effect in the limited deduction method than
in the full deduction method.
The full deduction method is also a good one because I end up deducting the full amount of taxes
paid abroad, but it depends on the level of tax rates applied in the residence country, because if they
are high I end up paying the same amount just as if I had obtained that income on a domestic basis. I
won’t have experienced double taxation, but I would have been paying the same amount. And the
limited deduction one has some disadvantages.
Normally countries provide a limited deduction method. They try to capture as much as taxation as
possible on income obtained abroad, so they provide just for a limited deduction. This is the method
provided in domestic law. In tax treaties we can find any of those.
 Example: Income obtained in country A (residence):
8.000 Income obtained in country B: 4.000
Total income: 12.000
Children allowance: 180
Tax paid in country B: 1.200 (30% of 4.000)
Progressive tax table in the country of
From 6.000-8.00 🡪 20%
residence Up to 6.000 🡪 500
From 8.000-10.000 🡪 25%
Up to 8.000 🡪 900
From 10.000 onwards 🡪 30%
Up to 10.000 🡪 1.400

TAX PAID TAXABLE TAX TAX CHILDREN DOUBLE TAX TO TOTAL TAX
SOURCE BASE RATE LIABILITY ALLOWANCE TAX RELIEF BE PAID BURDEN

FULL
1200 8000 11,25% 900 180 0 720 1920
EXEMPTION
EXEMPT WITH
1200 8000 16,66% 1333,3 180 0 1153,3 2353,3
PROGRESSION
FULL TAX
1200 12.000 16,67% 2000 180 1200 620 1820
CREDIT
LIMITED
1200 12.000 16,67% 2000 180 666,8 1153,2 2353,2
DEDUCTION

Exercise class

1. We want to sell T-shirt in home country.

What do we want to take into account?
- Legal structure or not?
- Registration as a taxpayer as a business or professional
- Find suppliers
- VAT: rate, recover period
o I pay VAT to my suppliers, and I charge VAT from the clients. It is necessary to find a
balance, and this affect the competitiveness of my products.
- Brand registration
2. Selling T-shirt abroad.
What do we have to consider?
Imagine that we are an online shop with no presence abroad.
- Tariffs
- Contingents and restrictions.
- Direct taxes
o What happens with the profit that I obtain, where do I have to pay taxes?
o We will be taxed on my residency country? But do I have to pay tax on the source
country? If the answer is yes, then do I have some exemptions?
 o General principle: No payment in the source country.
- Indirect taxes
o VAT?
▪ If there is a difference between VAT rate, we must consider the applicable tax
rate.
▪ Where do I need to pay VAT?
● At the destination country, but the regulation varies across countries. In
some countries, if the VAT is over €10,000, the company needs to
register.
- Exchange rate fluctuations.

3. My company is based in Spain, and I want to expand internationally.

What structure do I need?
- Usually, the first tactic is to work with distributors
o And the distributors send the products to the final customer.
o This corresponds to a B2B transaction
- Question
o Do I have to pay taxes in the destination country?
▪ The destination country
▪ The concept of permanent establishment: defined as having a fixed place of
business in the other country, usually the individual only needs to pay taxes in
the residency country, but when if the entity has permanent establishment, it
might result in tax duties in the source country.
● If I do not have permanent establishment: I only get taxed at the
residency country.
● If I have permanent establishment: I might get taxed in the source
country.
o Exemption: You might be share taxed between the source
country.
o Double taxation scenario, then the residency country might
provide some remedy to mitigate the taxed paid.

● NOTE: fixed place might not be a physical place, under digital era.
- Legal structure abroad
o Subsidiary (Filial): Separate legal entity. Any liability is on the level of subsidiary.
▪ Fully residence in the Foreign country.
▪ All its profit is taxable in Foreign country
▪ The parent company only will be taxed in the Foreign country if it obtains some
income there.
▪ There might be transactions (flow of funds) between the subsidiary and the
parent company
 ● Financing: internal capital market
● Transaction of materials
o We have to take into account the prices that we are going to
charge. Consider the tax rate and manage it.
o Transfer pricing regulations: the parent company is not allowed
to set any prices.
● Return to investment
o If the parent company funds the operation through capital and
the subsidiary pays dividend, then there is economic/legal
double taxation for the parent company
o If the subsidiary funds their operation through debt.
o Branch (Succursal): Not a separate legal entity. The parent company is fully liable for the
branch.
▪ It is the example of permanent establishment.
▪ Taxable at the source country.
4. The company structure is the following: The parent company is in Spain, and there is a holding
company, a financial entity, that carries out licensing activities.
a. Chile does not have a double tax convention with Spain.
i. But there is a favourable tax regime for Holding companies
1. Exemption on dividends
2. Capital gain: the profit obtained through asset transfer between
subsidiaries.
b. In the EU, dividend from subsidiaries

- Concepts: Profit sharing loans is an example of hybrid structure

o A parent company owns 100% of the subsidiary, and the parent company will lend
money to the subsidiary, through profit sharing loan
▪ If instead of profit sharing loan, the company offers normal loan, then there will
be interest that will reduce the profit of the subsidiary company.
▪ Profit sharing loan is much more flexible. → only due when profits.

●
● In terms of interest in general:
o They are tax deductible for the borrower, and taxable for the
lender. → No problem at all.
● Peculiarity of profit sharing loans:
o In some countries, profit coming from it, is treated as interest
and in other, dividend.
o If the lender’s country, treats as dividend, and the borrower’s
country, as interest. Then it might result in double taxation
situation.
▪ No taxes&no taxes in both countries.
● Extra concept: Double Irish and Dutch sandwich.
o Double Irish: A parent company sets up two companies in
Ireland, and one Irerish company is resident in a tax haven
country like Bermuda (if the management is located there). This
Irelish company will licence the intellectual property to the
second Irelish company, tax residence in Ireland, and the
second Irelish company will receive income from licensing the
intellectual property to companies outside the US, and it will
pay at 12.5% tax rate, further reduced by payments of royalties
fees to the first Irelish company. Conditionally, the second Irish
company must be a fully owned subsidiary of the first Irelish
company.
o Dutch sandwich: It takes advantage of any agreements between
Ireland and any other EU country. There is a third European
company in the middle → the transference of royalty is tax free.

▪
 BEPS PROJECT

BEPS = Base erosion and profit shifting → Artificial movement of profits to reduce taxes taking
advantage of the mismatch between legislation between countries, related with decreasing taxable
income.

Overview

Before the BEPS project, some of the manipulations were considered legal and some others were illegal
under domestic law, however, problems arose when countries realized that they were losing tax
revenues due to miscoordination between countries.

Foreign investment
International taxation rises on a field of investments in different countries. So now we will look at the different
types of income we will obtain depending on how we structure our investments in another country:
● If you want to do business in another country, the simplest way is to start by exporting my goods by
selling them to local shops or local dealers. This means that I do not have any structure in the other
country, so I do not have to do any further investment in the other country, I am just selling my
products to the other country. In this situation I have to take into account taxes like:
o value added tax (VAT)
o custom duties
This will be my main concerns because I have to take into account whether I have to pay local VAT or
VAT in the other country. With distant sales up to a certain amount I have to register and pay local VAT.
In case we are doing business with a country which is out of the European union I will have to pay
custom duties, so this is also for me to take into account. They will be extra cost that I have to consider
when calculating the profits in the other country, we have to subtract taxes from my margin. Taxes
have to be always in the equation!
I also have to take into account where I have to pay the taxes: in principle I have to pay them in the
residence country, normally when I am just selling products and I do not have a permanent
establishment, these sales are not taxable at the source country.

● If I want to open my own establishment there, I need to contract a sales force, open shops, create an
office… In this case I am creating further links with the source country, I am having a permanent
presence → fixed place of business. When my links are increasing with the foreign country this could
qualify to have a (defacto) permanent establishment.
 If I want to have a more formal shape of my business I can incorporate a branch (sucursal), it has no
legal personality because it is a part of the business (they are the same person, so the liabilities are
counted together), so branches are also included in the permanent establishment.
With permanent establishments, in terms of indirect taxes I am subject of paying:
o VAT at all our bases because I am fully in the other country doing business
o Customs duties, just my brand will assume this payment because at any point I can decide
that in order to make my business more efficient I can create a production side in order to
avoid paying customs and duties.
In terms of direct taxes, the situation is completely different, under double tax treaties, when selling
products in another country, they are not taxable unless I have a permanent establishment. Since I
now have a permanent establishment I am fully taxable of my activity in the source country.
Depending on the country the tax paid for having an establishment could be different, but in general
terms, they can be taxable as a residence company in the source country. There are differences
because the permanent establishment is not a separate legal entity from the mother company, so,
there are certain items of income that cannot be deducted at the level of the branch such as interests
or royalties. Even though I am considering different tax payers, certain types of income can be
restricted from deduction. But in general terms we can say that branches imply full taxation in the
other country.

● Another option is to incorporate a subsidiary (SL – limited liability companies, or SA – corporations),

now I have two separate entities, legally speaking and tax wise, so in terms of liabilities, any one
incurred by the subsidiary will be assumed by the subsidiary. The situation is completely different
because now the company is fully resident in the source country. In this kind of scenario double
taxation may arise. So, now the taxes I have to take into account are:
o VAT, on a local basis, because I have a local entity doing business in the same country
o From a direct taxation point of view, this is a fully resident entity, so it will be subject to
taxation in this country.
What we can see in this kind of structure is that there will be income flowing from this entity to the
parent company. Depending on how I finance my activities I will have different flows of income
between the company in the source country and the one in the residence country. If the parent
company can give a loan to the one in the other country, this one will have to pay interest to the
mother one. If it is financed by injecting equity through a capital increase from the parent company to
the one in the source country, the mother company is remunerated through dividends. The mother
company will not be receiving direct income from the business itself, but they’ll be receiving some
income by the subsidiary in the other country.
Now we have to pay attention in how dividends are taxed in both countries being each company
resident in each country, so they have to pay fully local corporate income tax. Depending on taxation
my profits will be lower or higher. Dividends are not deductible at the level of the paying company, but
in case of interests I will get a deduction as a financial expense at the level of the local subsidiary and
will be fully taxable at the level of the foreign company. In the case of interests, the taxation will be in
both levels, source and residence countries.
Thin capitalisation rules are rules provided by several restrictions to interest deductibility to basic
rules of financing. They can be structured in different ways, either as a comparison between financing
and equity – some countries may prevent companies from getting overfinanced because they prefer to
them to be financed through equity, and they include these restrictions to interest deductibility-, or by
establishing any other kind of mechanisms in order to limit interest deductibility in the level of local
subsidiaries.
Holding company
If I have many subsidiaries in many different countries, I can create a structure to reorganize my business
abroad, and at the same time obtain tax optimization. This structure is called holding company: group of
companies interposing between the parent and the subsidiaries. They usually offer some tax benefits.
Double Tax Conventions – The OECD Model

What is a Double Tax Convention or Double Tax Treaty?

“An Agreement between two countries setting up the rules under which residents of those
countries will be subject to taxation on the economic flows between them with the aim of
avoiding situations of legal double taxation”
Any country has full tax power to determine how taxation will affect any person linked to its territory, ruling on
personal links, such as nationality, familiar links, etc.), as well as operational links, such as having a permanent
presence, place of management, etc.
In DTC countries agree on which parts of the global tax power are going to give up in favour of the other country
→ It’s a way to “split the cake”, and at the same time it tries to avoid double taxation.

DTC Main Features

● Bilateral agreement (normally)
● Only concerns direct taxation (OECD Model) → Corporate and Personal Income Tax, Capital Tax, Net
Worth Tax (impuesto sobre patrimonio), Inheritance Tax, when you die... (conventions only in some
countries)
● Prevalence over domestic legislation: In most cases, international tax treaty will be applicable with
preference in case of conflict.
● It requires the involvement of two countries

Purpose of DTC
The main purpose of DTC is to promote exchanges of goods and services, by eliminating international double
taxation (income should only be taxed once). That is, reduce excessive tax burdens that would prevent
companies and individuals from engaging in economic activities. With the evolution of countries and
conventions, DTC also prevents tax avoidance and evasion (Comments to OECD Model Convention)
DTC benefits:
● For Taxpayers, by providing relief from double taxation
● For Tax administrations, as a tool to prevent fiscal avoidance and evasion.
● Conclusion: it creates a more fluid cooperation between countries.
2017 OECD Model Tax Convention prevents treaty shopping and prioritizes benefits to economic activities by
imposing clauses under which the treaties can be applied. The OECD detects loopholes in national laws and
double tax conventions, and tax avoidance and evasion are rising as the main concerns for the OECD.

Methodology used:

- Rules that distribute power to tax different income between the states. Precedence over domestic law
- Mechanisms to avoid double taxation and to establish administrative support systems between the two
states.
- Double Tax Conventions are higher legislative instruments to national laws: usually the
Conventions are directly applicable as domestic law and the DTC rules override the applicable
domestic tax rules
- According to this principle, the Conventions determine which are the tax rules that any of the
countries will apply to residents of the other country having economic relationships in their
territories.
- Applying to the residents of other countries having economic activities in your
country.
A natural person or legal entity can be taxed on a worldwide basis (PO) and also where the income is
generated (SO). Double Taxation can be eliminated by:
1. Determining that an income can only be taxed by either the residence or the source country
2. Provide mechanisms to eliminate or reduce DT effect
3 Different scenarios

1. Domestic law subjects certain income to tax but the DTC does not allow to do
that or provides for the application of a lower tax rate.
2. The DTC allows taxation on certain income, but domestic law does not do so
or levies a lower tax rate.
● DTC allows taxation, and domestic no taxes → no taxes
3. The DTC allows taxation on certain income and domestic law effectively
subjects such income to taxation.
• Full match between DTC and domestic law.
- Prevalence of DTC over domestic law.
- Summary
o If the DTC provides for taxation at the source country (allows it), we have to check what
happens at domestic law.
▪ If source country does not provide taxation, then no tax → 2 situation
o If domestic law provides taxation, but under DTC, only residency country has taxation right,
then only → No tax could be levied in the source country.
o If both provide for taxation, but DTC provides a limit, then apply the limit.

Steps
1. We will have to go to the DTC and see if the income is taxable or exempt under the DTC, or if there is a
maximum limit, or whatever.
2. If not, we will have to look at the domestic law and see the tax treatment to the income
So, in practice, even when we have a DTC, we don’t have all the answers regarding to how an income should be
taxed.

- If income is exempted according to DTA, then no tax could be imposed.

- If not, then look at domestic law.
Advantages of the double tax conventions
If we talk about investors we have:
● Legal certainty: domestic law can change faster than tax treaties, because in the tax treaty two
countries have to agree on what they accorded. That’s why, under double tax conventions investors
will have more certainty about the regime that would be applicable in a certain period of time. It also
allows to reduce the taxation that should be expected when doing business in another country.
● Avoid double taxation: one of the objectives of international taxation. It provides a warranty that I
won’t have double taxation.
● Conflict resolution method: if you are doing business in another country and you have to face a new
tax system, this can be misunderstandings on the way you plan your investments. For instance, the tax
residency conflicts are very easy to fit in the criteria in other countries. Double tax conventions
provide for a conflict resolution method. It is a long procedure and it is not a good system, but at least
is something in order to be solved in favour of the tax payer.
In the old models we can find the Mutual Agreement Procedure (MAP). Under this procedure tax
authorities engage to enter into a discussion and try to find a solution. They have to put the efforts but
do not have the obligation to solve the problem. When the tax authorities do not achieve a solution,
an arbitration clause is open, the conflict is taken into court, and they should issue a final decision.
There are also advantages for the tax authorities.
● One of the advantages they have is that by promoting the avoidance of double taxation, they are also
promoting international trade because they know that double taxation could be a bad thing for trade.
● Tax collection: If they have a double tax convention, they can control in which other countries are
paying taxes my residents, so it a way of controlling my level of tax collection.
● Elimination of tax avoidance: In a double tax convention, I have a better position to eliminate tax
avoidance because I can have my own rules but multiplying my agreements with many other countries
will make me much stronger in order to fight against it.

The procedural aspects of DTCs

Through the double tax convention countries accept to withdraw part of their power in favour of the other
country.
1. Negotiation of the DTC terms by representatives of the two countries concerned. These negotiations
can take years. These representatives can be either representatives of the tax authorities, or any other
kind of organism.
2. Initialization: formal signature of the document by the negotiation board and submission for approval
at the political level in each country.
3. Approval by Parliament.
4. Signature: Once approved, it is formally signed by the Ministers of Finance or their representatives
(i.e. ambassadors, minister of finance…)
5. Ratification and exchange of diplomatic notes. There is a process from the authority of one of the
countries to the other saying that the convention has been approved and signed by the specific
authority, and that this is the final version of the document. The other country has to do the same. It is
so relevant that normally the effectiveness of a tax treaty does not come effective as the ratification is
finished.
6. Publication in each country officially. Ex: VOE in Spain
7. Entry into force: It is sometimes linked to ratification and other times enters into force after 3 months
of the ratification.
Differences between developed and developing countries on taxation (Not done)
It would be very difficult to try to make a tax treaty with each and every single country in the world. That’s why
having this model was a good idea. There has been a tension depending on the interests. We can distinguish
between two general areas: developing and developed countries. Depending on the model we look at, we will
find that they are more focused on developed or on developing countries way of doing business. In the mid XX
century:
● In developing countries, they were not investors, they were receiving foreign investment, and in an
important degree based on the extraction of natural resources. They will try to tax the income
obtained at the source country by taxing interests. They made a reservation in article 12 to tax
royalties at source → taxation at source

● In developed countries, the residents usually were investors in other countries. Developed countries
will try to tax their residents in all the income they obtain→ taxation as residence
*Tax holidays: it is a tax benefit provided by some countries in order to attract foreign investment in which the
first years of activity the companies will have holidays on taxation.

Types of Double Tax Conventions (DTCs):

● Income / Income and Net Wealth / Inheritance
● Bilateral and multilateral
● Model Conventions: OECD / UN / USA
o United Nations model: USA started to work on a model convention as the consequence of
the pressure received from the developing countries, they were saying that they were
receiving this foreign investment and were not able to keep the tax revenues. So, they asked
the United Nations to help them in a model convention. In 1968 there was a group of experts
in tax treaties between developed and developing countries. The efforts made by the UN
were more focused on tax cooperation (as the BEPS project).
Together with the UN, there were also international organizations like the International
Monetary Fund and the International Chamber of Commerce.
During this process the UN published a manual for the negotiation for the bilateral tax
treaties. This model was following the 1977 model of the OECD. They both are organizations
that look for the global cooperation. It is really relevant because they will try to find a project
between developed and developing countries. The manual was published for bilateral
treaties negotiations and in 1980 they published the first model. This model was also
accompanied by the commentaries.
o USA model: they made their own model tax treaty because of the Monroe doctrine. It says
that when the USA is affected in some way of a specific fact no matter on which part of the
world, they have the right to participate / made an intervention. With way they try to justify
that they can have access everywhere. Since they stick to the citizenship criteria in order to
make the nationals subjected to taxation. That is also why they developed their own tax
convention, in order to keep a minimum of standards for USA citizens.
*What is the interest of having a bilateral taxation model? Because they were looking to standardization. There
were so different models, and rules, that it was difficult to understand which the agreements were reached.
History of the OECD
By the end of XIX century, after the industrial revolution, the economic situation changed a lot. International
trade started to appear, so countries were worried that cases of double taxation would danger this
international trade. They started to think about ways of solving this issue, so that at the end of the XIX century
the first trade convention (the very first DTC) appeared (1899 – First tax convention between Prusia and
Austria). Nowadays we use similar instruments than at that point. That is why the BEPS project is so important
→ is a standardized framework, because technology has nothing to do nowadays with the one in the XIX
century, so we cannot apply the same rules as before, they are not valid anymore. After the WWI Germany
started negotiating double tax conventions in order to have a better environment when trading with their
neighbours.

The League of Nations (precedent of the United Nations) started analysing the phenomenon of double taxation
(No need to go into details.):
● In 1920 they had a International Financial Conference in Brussels
o They started to analyse the problem of double taxation
● In 1923 Report on Double taxation proposed by fiscal economists which was submitted to this
economic and financial commission and resulted to be the basis of the First DTC model
● 1928 First draft MODEL of DTC. However, they thought it was not sufficiently broad in scope.
o The first double taxation treaty was between Prusia and Austria by the end of the 19th century.
● 1928 Creation of a Fiscal Committee to consider further developments of the model.

● They prepared a new draft (multilateral) in the double tax convention of the allocation of income for
industrial and commercial enterprises in 1933
● 1933 Multilateral DTC, which was revised in 1935 but it was never adopted.
● The fiscal committee continued working during the following decade in which they prepared different
regional conferences. There are two of them which are relevant. The outcome of those conferences
was a release of a draft model but they had a completely different point of view

● 1943 Mexico Model DTC was based to the source principle as primary tax jurisdiction because many
developing countries were participating.

o the jurisdiction that had the taxing right was the source country

o They were receiving investments

● 1946 London Model DTC it changed that premise in favor of the state of residency of the tax payer.
o the new draft released gave the rights to the residence country
o the residence of those countries were investing abroad so they wanted to attract those taxes
into their country
This last two are the origin of the tendencies of the positions of developed and developing countries.
These two principles were the ones used between 1946 and 1955.

● In 1945 the League of Nations disappeared because countries considered the organisation failed in
keeping its balance and then the United Nations appeared, which continued the analysis of international
taxation. They also formed the Economic and Social Council and they took over the review and
development of the League of Nations’ London Draft
● Then the role of analysis and production of the model tax convention was taken by the OEEC
(Organisation for European Economic Cooperation), which also created a fiscal committee in 1956 and
they were working on the bilateral model.
● In 1960, the OEEC was transformed into the OECD, which after that, they took the leading role in
international taxation issues (reports, recommendations, etc.)
● Since the second half of the twentieth century, the OECD (Organization for Economic
Cooperation and Development) has taken a leading role in this field.
After the IIWW the League of Nations disappears, and the United Nations appears (1945). They form an
economic and social council and they take over the review and the development of the 1946 London Draft. The
council took the fiscal commission to do that, but they do not really have a lot of progress by doing that. Now
the role is taken by the European Economic Cooperation Organization (OEEC)
● They created in 1956 the Fiscal committee which worked on a bilateral draft of the tax convention
that was intended to be assimilated by all countries with the intention of eliminating all the existing
problems. They wanted to create one single model that integrated somehow all the positions (from
developed and developing countries).
● From 1958 till 1961 this fiscal committee prepared drafts of this new model of tax convention
● In 1960 the OEEC transformed to the OECD (Organization of Economic Cooperation and
Development). Nowadays it has a very leading role with the international development of the double
tax convention.
● In 1963 comes out the First draft of the OECD model. It is very important because there are a lot of
bilateral double tax conventions that still follow the principles of this draft. Along the years the OECD
has released several models (adjustments) to that model tax convention and countries have followed
those models on the negotiation of double tax treaty. Most of the OECD members were western
industrialized countries, so the model follows the principle of the London draft. That’s why they
allocated the primary taxing rights to the state of residency.
Since this model is favoring industrialized countries, at the beginning of the 70s, further work was
necessary to develop this model (developing countries weren’t happy and there were more things to
be taken into account). The international fiscal relations are increasing, technology also appraises, and
tax systems also become more complex. So, the OECD committee of fiscal affairs starts the revision of
the model based on the experience of the negotiations of the double tax conventions.
● In 1977 they publish a new version of the OECD Model, which has become the standard for bilateral
tax convention negotiations. During the last 30 years, most of the double tax conventions follow either
the model released 1963 or the one released the 1977. They have continued working on the models,
revising and updating them. The way they were conceived didn’t prevented the elimination of tax
evasion. So, the OECD and the countries realized they were losing tax revenues and they started
focusing more on the elimination of tax avoidance.
● These models needed a process of continuous review. They adopted the process of Ambulatory
Model Convention (1992). It was not the result of a complete revision, but the revision of some of the
articles (update). To the moment there have been several updates (90s, 2000, 2003, 2007, 2010,
2014). In 2015 the BEPS project starts. The most recent one is the one of 2017, published in 2018
which is the first model that follows the principles/recommendations released by the BEPS project.
● The United Nations also released a manual for the negationation of bilateral treaties between
developing and developed countries, followed in 1980 by the United Nations first Model tax
convention. This model, to a large extent, followed the principle set up by the 1977 OECD model
convention.
These models are the basis of what we call now soft law. The models are not enforceable; however, the
commentaries are considered as a guide for the interpretation not only about the international tax principles
and the double tax convention principles, but also regarding domestic law. This concept of soft law is very
relevant because there is no an international taxation code, so they are the top source of interpretation of the
international tax treaties. The model together with the commentaries forms what is named soft law.
This has also been taken into account by the European Court of Justice. Also, the 2017 model makes a
reference on how the commentaries have to be taken into account. The models aren’t enforceable, so
whenever we have a case, we have to look at the bilateral tax convention between those two countries, that is
what is really applicable. However, we have these models that whenever we have any doubt of the
interpretation of a particular provision we can go to the model on which it was inspired. For the interpretation,
any kind of doctrine released for the OECD must be taken into account, either in favor or in contrary to our
benefit.
Apart from the OECD doctrine there are also some documents released from the European Union with the
 interpretation of the double tax basis which are also considered as soft law. It is important nowadays, from the
revision of 2017 of the OECD model, and also of the multilateral convention, specialists started talking of
dynamic interpretation of the double tax treaties/convention. This is that if a double tax convention was
negotiated taking as a basis an old model, they consider that the new principles taken in the new models
should be taken into account on the interpretation of the new principles/treaties

Key dates:

● The First trade convention: Between Russia and Austria was elaborated 1899
● The first International Model Convention to Avoid e Double Taxation was created in 1928 in the heart of
the League of Nations
○ Mexico: Giving more importance to source country
○ London: Given more importance to residence country → more industrialized countries
● 1960: Creation of OECD
○ 1963: first draft → more importance given to western industrialized countries.
○ 1977: modification of the first draft.
● Since then, there has been a lot of revisions
○ Last one, 2017 model, published in 2018, which takes into account the BEPS project.

US model treaty

Us, as the capital of an exporting country, wanted to make sure that the taxing rights are in the residence country
but also because they use the criteria of citizenship in order to determine taxation. Therefore, they released a
model convention in 2006 and this is the basis they used in the negotiation of bilateral tax treaties. This model
has a similar structure to the one released by the OECD but it contains the principles that US wouldn't like to
renounce.
OECD model Structure: Persons covered/Types of income/Methods to eliminate double taxation
The structure of the model tax convention is more or less equal all around the world.
It starts with a presentation of several items:
Article 1. Persons covered 🡪 we need to determine
who are eligible for the double tax convention.
Article 2. Taxes covered
Definitions
Article 3. General definitions 🡪 most of terms used
along the double tax convention are covered in the
definition in order to determine the scope of the
application of the double tax convention.
Article 4. Residence
Article 5. Permanent establishment
Articles 4 and 5 also include definitions but are
more consistent and have further implications in
the appliance of the double tax convention.
Taxation of income (Second part Art 6- 22)
Here there are the rules distributing taxation
power between the countries for each type of
incomes. It is organized under a specific provision
for the different types of income. Some of these
provisions the countries decide that the taxation
right are allocated to just one country, but for some
other, two countries may be able to tax a certain
amount of income.
But for certain limits to this taxation by the source
country, this is a way of reducing the impact of
double taxation. There are also provided the
methods of avoiding double taxation.
Article 6. Income from Immovable property
Article 7. Business Profits
Article 8. Shipping, inland waterways transport and
air transport
Article 9. Associated enterprises
Article 10. Dividends (First part: what
do we understand about it, and 2nd part, how to
distribute those rights)
Article 11. Interest
Article 12. Royalties
Article 13. Capital gains
Article 14. Independent personal services (deleted
as from 2000)
Article 15. Dependent personal services (Income
from employment)
Article 16. Directors’ fees
Article 17. Artists and
sportsmen Article 18. Pensions
Article 19. Government
service Article 20. Students
Article 21. Other
income Article 22.
Capital
Methods for elimination of double taxation
Since for some types of income the countries can
share the right to tax a certain amount of
income, there is also provided the methods to
eliminate double taxation.
Article 23 A. Exemption
method Article
23 B. Credit Method
Special Provisions
Article 24. Non-discrimination 🡪 We know that
the main criteria in international taxation is
residence, but nationality can also have an
impact when determining tax residency. This
article provides that under double tax treaties,
nationals cannot be attached to more rules than
the non- nationals in that country.
Article 25. Mutual Agreement Procedure 🡪
procedure under which countries may solve
any type of conflicts under the interpretation of
the tax convention
Article 26. Exchange of information
Article 27. Assistance in the collection of taxes
Article 28. Members of diplomatic missions
and consular posts
Article 29. Territorial extension
Final provisions
Article 30. Entry into force 🡪 the clarification
process is covered, and also is provided
under which day the tax convention is
enforced.
Article 31. Termination. When does the convention’s
effect end?
 Article 1: Personal covered
Subjective scope: the persons covered by the double tax convention.
Article 1: “The present Convention applies to persons who are residents of one or both of the Contracting States”.
Taxes covered:
- Income, capital
- State, federal and local.
The article 1 also includes a part indicating the proper use of the convention → no treaty shopping
● Residency: is covered by article 4. Determined by domestic law, in case of conflict, apply the break-tie
rule.
● Persons: Covered by article 3, includes an individual, a company and any other body of persons.
Legally speaking we have to clarify who will be understand as person under the tax convention. There
can be legal structures who cannot so easily be qualified as an entity. Like:
● Individuals: They are subject to personal income tax(PIT).
● Company: means any body corporate or any entity which is treated as a body corporate for tax
purposes. They are subject to corporate income tax (CIT)
○ SA
○ SL
○ SICAV: Special(Collective) investment vehicle
■ subject to very low corporate income tax.
○ Collective companies
○ Civil entities
● Business: the term “business” includes the performance of professional services and of other
activities of an independent character
● International Traffic means any transport by a ship or aircraft except when such transport is
operated solely between places in the other Contracting State.

Special cases: Tax transparency

The company itself is not taxable ( no subject to CIT), and the taxation duty is upon the partners. It is not
qualified as a company for the purpose of the convention.
o Partnerships are considered to be taxable persons. This also depends on what each country
considers a partnership, since it is not considered in the double tax convention, we have to go to
the domestic laws in order to determine if they are determined to be persons or not. There are
several types of partnerships - general partnerships, limited partnerships, and limited liability
partnerships. A general partnership is a form of business entity in which two or more co-owners
engage in business for profit. There is no limit on the number or type of partners (i.e., individuals,
other partnerships or corporations) to form a partnership. It depends on the country, if they
determine that partnerships are legal entities, they would be considered as a legal person the tax
convention will apply the tax convention to the partnership itself, otherwise we have to go to the
partners that form the partnerships, and the tax convention will apply to them.

▪ Some countries: taxable entities for CIT purposes (then it is considered to be a

company), there is asymmetry.
● In anglosaxon countries, there are more recognised.
● For countries that do not recognise it as company, but as look through,
then they need to look at the tax residency of the partners.
o Collective Investment Vehicles is a group of investors, so we also have to determine if they are
covered or not by the double tax convention. They are taking more importance in the latest years
because they have several tax advantages but also a flexible way for investments. So, it is
important for them to know if they are covered or not by the double tax convention.
[[Under the commentaries there is a reference to the improper use of the convention. What they say that tax
payers may be tempted to abuse the tax laws of a state but also the conventions in order to have tax benefits.
In the last 20-25 years it has been a very broad practice around the world about taking advantage of taking the
money in tax heavens. It is accepted to look for a better tax position but not the evasion of paying taxes. Ex:
Apple
 ● P.O. Box Company / Conduit companies is an improper use of the tax convention. This is, you want to
contract with one country which there is no tax convention, which means that the investor will be
taxed twice. And each of those countries have a tax convention with a third one. So, they decide to do
business through that other under a false address instead of doing it directly in order to take
advantage of the tax convention.
● Move the residency in another country in order not to pay taxes not being true.
Tax conventions try to cover this impropriate use of the tax convention through the anti-abuse provisions. In
the last models the confect of the Beneficial owner was included, so in case the recipient of a certain income is
not the beneficial owner of that income because there is another one behind, the convention would not apply.
This concept it was normally referred to articles 10, 11 and 12 under interests and royalties.

In taxation is very important that everything we do, the interposition between companies, has an economic
sense. If there is no economic ground under the decision we are taking, then the treaties won’t apply. It will be
considered as Treaty shopping methods. This has been one of the bases of tax planning for the last years.]]

Objective scope: determines the framework of application of a DTC, contract or international treaty. To whom
it will apply, which taxes and which territory it covers.
● Income and capital taxes: in the bilateral tax treaties is normally explained which income and capital
taxes are covered. Sometimes it is more general statement and some others it specifies more precisely
the taxes included. They both include state or federal taxes. Any type of income or capital taxes will be
covered regardless the level of the state who manages the level of taxes.
o Any tax that is not covered under the double tax treaty, then it does not benefit from the
exemptions.

Example Treaty shopping

- There is no double tax convention between France and India, so the distribution of dividend of India to
France, they go through a Dutch entity (conduit company), so in this way France benefits from reduced
tax rate. → Restricted not banned.
Article 3: General definitions
Some definitions are covered. Not to mislead the application of the convention it is important to know what we
have to understand by:
● Person: includes an individual, a company and any other body of persons.
● Company: any body-corporate or any entity which is considered as an entity for tax purposes. Enthought
from a legal point of view an entity is considered in a certain way, for tax purposes it can be considered in
a different way.
● Territorial scope: the DTC does not include any specific definition because it is different in every bilateral
tax treaty. It is important in order to decide which territory is applicable each tax treaty.

Article 4: Residence
It covers the definition of residence. It is vital to determine the taxpayer’s residence as this implies either
taxation on a worldwide basis (unlimited tax liability) or taxation in the country where income is obtained
(limited tax liability). DTCs do not provide a definition of tax residency making reference to the criteria used by
domestic law. What it determines is the application of the residency rules in case of conflict of residency.
The rules usually established by most of the States to determine individuals’ tax residency are:
● Stay for more than 183 days in the year
● Center of economic/vital interests
● Permanent home
● Nationality
● Permanent residence visas

Dual resident tie-breaker rules.

● Availability of a permanent home
● Center of vital interests
● Habitual abode
● Nationality
● Mutual agreement

The generally established rules to determine legal persons’ tax residency are:
● Incorporation under the laws of a particular country
● Having their registered office in a particular country
● Having their place of effective management in a country. Headquarters will be deemed to be located
where the direction and control of all the activities is carried out

Article 7: Business Profits → permanent establishment notion

The profits of an enterprise of a contracting State shall be taxable only in that State (residency country) unless
the enterprise carries on business in the source country through a permanent establishment (article 5) situated
therein.
In order to know what profits means, we have to look at the domestic law because in the OECD model there is
not a definition of profit. On the commentaries it says that profit has a wide meaning and includes all income
obtained on carrying on a business. It does not include any type of income included in the tax treaty.
In paragraph 2, refers to the determination of profits attributable to the permanent establishment. It will
include only activities/transactions with independent parties. Example: Branches for tax purposes it will be
determined as two different persons. What paragraph 2 refers to is the Arm’s length principle (the basis for
transfer pricing). It implies that two related enterprises have to agree on the conditions as they were separate
entities (separate entity principle). There is this dichotomy between the legal regime and the tax regime for
permanent establishment. Legally speaking they are the same legal entity but under the taxable base they are
considered two different persons.
The permanent establishment is taxable because it is considered to have a sufficient strong link with the
source country. Only income attributable to a permanent establishment will be taxable. If a company has
several activities but just one qualifies as a permanent establishment, then just this one will be taxable.
● Separate enterprise principle
● Allocation of general and administrative expenses
● No permanent establishment for purchase of goods
● Continuity methods: coherence of the methods used.
● Prevalence of income dealt separately.
Extra info: ((One of the main issues will be how to quantify the income attributable to the permanent
establishment. A part of the Arm’s length principle there are no other specific rules of this calculation. So, we
have to go to the domestic law in order to determine the final grounds for taxation. Depending on the countries
there will be these restrictions of the deductibility of certain expenses, and in sometimes it is admissible the
deductibility of general expenses, assuming the permanent establishment is not completely separately and
needs to receive some support from the parent company.
In general terms we can say that permanent establishments are very similar taxable to domestic companies.
They are subject to something similar to corporate income tax but for non-residents and even though their
taxable base is similar to any resident company they have these peculiarities.
It also indicates there should be a continuity to the methods to determine the taxable income attributable to
the permanent establishment. We have to refer to domestic law and we have to determine specific methods
and we have to keep it along the time (we cannot change continuously the method used to determine taxable
income).

Example: A French company, with base in Paris, opens a new office in Brussels. Here the permanent
establishment concept arises: there is an entity doing business in another country. According to article 7 the
taxes will be just taxed in the residence country. But if the presence in the source country is sufficient enough to
qualify as a permanent establishment, it will be treated as a different tax payer and will be taxed in the other
country. They will be qualified legally as one single entity, but both will be taxable. If the French company is
selling goods to the branch in the other country, this transaction has to be agreed at market conditions because
this company will have profits that can be taxable in Belgium but included in the balance sheet in France.))

Summary: Business profits can only be taxed at the residence country. This is an exclusive right for taxation.
However, when there is a permanent establishment this general rule changes. When there is PE the source
country can tax the profits made in their country, but the residence country has also the taxation rights. This is
an example of shared taxation: when two countries have the right to tax a certain amount of income. It may be
a case of double taxation, so then we have to look at the way of avoiding this double taxation provided by the
OECD model.

Note: Traditionally Traditional establishment implies physical presence, nowadays things have changed.

Additional information:

- In the BEPS project, some recommendations regarding amendments have been made regarding the
definition of PE. The primary objective is to avoid fragmentation of activities in order to avoid the status
of PE. → The anti-fragmentation rule proposed.
Article 5: Permanent Establishment
This article comprises 7 paragraphs..
● 1st paragraph: Provides the basic rule to determine when we have permanent establishment.
A permanent establishment is a fixed place of business to which a business of an enterprise is fully or
partly carried on. There are 3 different notions for determining it:
o Place of business: it implies some physical presence, some policies or equipment which is
used for business. This is one of the traditional criteria for having a permanent establishment.
Now, with the digital economy this has been questioned, because now we can do business
without having a physical presence. In general terms in order to have a permanent
establishment we need to have a place of business (geographical location): premises, facilities
or installations used to carry out businesses in the source country, even if it is used or not
exclusively for that purpose. It is irrelevant if this space is owned or rented by the company,
we have to legally be able to use these premises, but they do not have to be owned by the
company.
o Fixed: it must have some degree of permanency (not purely temporary nature), this implies
that there should be a link between the place of business and a specific geographical point.
The fact that it has to be fixed implies that we can start playing in how we organize our
activities (ex: activities in neighbor locations), does then mean that I have a permanent
establishment in these other activities? If I am moving my activities from my place to another
tax authorities may have difficulties in determining whether I have a fixed establishment or
not. If that’s the case, if there is a continuity or recurrent activity in a place during a certain
period of time, then it will be also considered as a permanent establishment. In the
commentaries it is also said that if it stays more than half a year in a place, it will also be
considered as fixed.
o Carry on a business activity: This implies any activity related to the business of the enterprise
(it has to be coherent). The permanent establishment will exist once the company starts
doing this business.
● 2nd paragraph: Examples of different cases/structures of permanent
establishment. Some situations in which permanent establishment would
apply.

● 3rd paragraph: Construction/building projects.

In order to determine permanent establishment in a project under construction, this has to last more
than one year (>12 months). This time period applies for every individual project, so it has to be
determined if it is a cohesive and a coherent project. Since the article provides for a length period,
what companies do is to split project in periods of less of 1 year, so that it is not considered
permanent establishment. If they cannot split the project (ex: building a building), what they do is to
split the project in different architecture agencies so that it is seen as a sum of projects that last less
than 1 year.
In order to determine whether projects are coherent there are different methods:

● The project has just one master contract (even if the project is split)
● The nature of the company is the same
● The contracts of the project were done by related parties
In taxation it is important that everything we do has an economic sense. If we split the project
artificially, probably there is no economic sense behind. If I do it as a group and I have split the project
between companies from the same group, then it does have an economic sense.
This has been detected, and the new model has included an anti-fragmentation clause. It tries to
eliminate these practices of breaking up the constructions.
How can we determine this 12 months of construction? A permanent establishment starts at the first
moment the first works (even preparatory) are developed by the company. The project will end at the
moment the construction is completed. Warranty periods are also considered within the length of the
project.
If there are temporary interruptions (ex: rainy season) this will not interrupt the computation of the
12-month period.

The constructions included are: building sides, roads, bridges, renovation of building, installation of
new equipment such as complex machinery. Any kind of project involving construction or installation
of something will be included in this paragraph
● 4th paragraph: Situations and exceptions of permanent establishment.
Cases that in principle would qualify as permanent establishment but the tax convention exempts
them from being permanent establishment. In real situations this is a very useful article, because
under domestic law we have a very similar construction of the notion of permanent establishment,
but under domestic laws there are no exemptions to this notion, while in double tax conventions there
are many situations in which there is an exception in the application of the notion of permanent
establishment.
These exceptions have a common line: activities that have a preparatory or auxiliary nature. Because
their aim is not the obstainance of profits. Ex: storage, display the delivery of goods, stock of goods
belonging to the enterprise, having merchandise that has to be processed by another enterprise,
purchasing of goods… basically having a place of business for a combination of these activities.
Under the commentaries, activities are determined preparatory or auxiliary if they do not constitute
an essential activity (part as a whole). Representative offices are also another example because the
activity carried out is preparatory. However, if through this representative office they start doing
business, then it will be requalified as permanent establishment.
The new model has slightly changed the structure of the article, and Paragraph 4.1 includes a
modification. These changes included in the new model, some of them have the intention of
clarification of the traditional concept of the article. It is relevant because the commentaries say that
the old treaties have to be interpreted with the new version of the model.
We have to keep in mind that the new model is an outcome of the BEPS project, which it’s main goal is
to avoid tax evasion. They try to close any type of holes they see, and they are mainly based on the
practice of the companies of the last years together as the difference in criteria of the countries.

● 5th paragraph: Dependent agents

When a company has a person acting on its behalf and has the capacity to negotiate and conclude
contracts in the other country and habitually does these activities in the other country, will be also a
constitution of a permanent establishment. It may be either an individual or a company, and it is not
necessary that they are resident in the source country.
This person has the authority to represent the company and to conclude contracts. This person usually
has sufficient powers to represent and legally bind the company. It is also necessary that this person
exercises this authority on a current basis. If there is no action by this person, it won’t be determined
as permanent establishment. Contracts negotiated by this person must cover operations related to the
business.
The commentary says that if a person has the sufficient authority to negotiate all the parts, even if it
is not the one signing the contract, it will also be considered permanent establishment. Another
feature is that the person needs to be dependent, this means that the person is subjected to detailed
instructions by the company or there is a comprehensive control by the company and that it has no
entrepreneurial risk, this means that the person is acting on behalf of the company. If something
goes wrong, the person will not be held liable but the company as a whole. → the agents are not
bearing the responsibility.
The new model of 2017 has made some changes. They included as the dependent agent the person
who concludes contracts or habitually plays the principal role leading to the conclusion of contracts.
 ● 6th paragraph: Independent agents
Independent agents won’t qualify as permanent establishment. This is the case as when a company
acts in another country through a broker or an agent. In the new model this has been simplified. They
should be persons acting in the ordinary cause of business (this means that the business is
representing/intermediating for other people) independently from the company (legally and
economically). In order to be independent, they should not receive detailed instructions or not be
subject to the control of the company nor taking the risk from the operations. → independent agents
do not take the risk
Traditionally it was concluded that if a person represented different companies it was determined as
independent. This has been modified, if this person has exclusivity for these companies, this person
has to be determined as dependent.

● 7th paragraph: Subsidiary companies

Under certain situations a subsidiary may be determined permanent establishment. We can have
both, the permanent establishment and the subsidiary.

The subsidiary is qualified as a permanent establishment if it is acting as a dependent agent of the

parent company or the parent company has premises in the subsidiary

- If it is independent, then it is not qualified to be a permanent establishment.

Nowadays, with digital business, there can be different situations. The commentaries are trying to address the
situation of digital business, and also the BEPS project has a report on these businesses. Countries should
modify their domestic laws, so this is a slow path. Eu is very concerned about this situation because they have
in their territory big digital businesses that do not leave a euro in taxes. So, they are developing a planning in
order that digital business has to be taxed in Europe.
When talking about e-commerce we can face different situations. The equipment in a particular location which
can qualify as permanent establishment. But is it even more difficult when talking about software/data, so how
can this be included in the traditional concept of permanent establishment?
The commentaries distinguish into 3 different situations:
● Having a website will NOT be considered as a permanent establishment. They argue that having a
website has a nature of a preparatory or auxiliary. → It is not a tangible asset.
● Having a server:
o Hosting arrangement, if a website is hosted on the servers of another internet provider. This
is considered as NOT having a place of business in that country. There are discrepancies.
o Own server, this will be considered as a permanent establishment. But, am I really doing
business through this server? It has to be analyzed case by case. If I have just an interactive
site, then it will be considered as a permanent establishment. But is we have the website for
preparatory or auxiliary activities, then they will be more difficult to defend a permanent
establishment. → fixed presence in another country.
● Internet service providers, in principle, I need to have my equipment in the other country which is
considered as a permanent establishment.
These are the first attempts to cover internet/online activities in the traditional concept of permanent
establishment.
In case of services, there will be no permanent establishment when services are rendered but some countries
have opposed and argue that there should be permanent establishment even when I am rendering services.
They provided an alternative warning in which it is considered permanent establishment when staying in a
country rending a service for more than 6 months, or if more than 50% of the profits obtained are from the
service in the other country. The idea is that countries can decide this additional paragraph in order to allow
the existence of permanent establishment when the person has a sufficient link when providing this service.
Summary article 5
1. Basic PE rules
2. Examples
3. Building sites
4. Exclusions
5. Dependent agents
6. Independent agents
7. Subsidiaries
Definition of permanent establishment: A permanent establishment means a fixed place of business through
which the business of an enterprise is wholly or partly carried on. Important word = fixed place → physical
- However, interpretation is very relevant. → look at the commentaries.
- Place of business: does not need ownership/no need of lease → if the place is available for the business
whenever the company wants, then it is a fixed place to carry out the (core) business activity.
- Fixed place → a period of time (should not be temporary), specific link between the company and the
geographical location.
- Strategy: to fragment or divide the activity

Examples of PE
- Branch
- An office
- Workshop
- Place of management
- Dependent agent
- A mine, an oil or gas well, extraction of natural resources.
- In case of a building site or construction or installation project(renovation) constitutes a permanent
establishment only if it lasts more than twelve months. The starting point of the twelve months
whenever some actions have been taken by the company for the construction.
Article 8: International Navigation → effective place of management
In the new model it has been simplified in one paragraph. It includes transportation of people and goods and
includes inland, water ways between countries and transportation by the sea. In this case, the rule applying is
that ...
When one country may claim that a company is resident in that country because it has the headquarters there,
also when determining the criteria of taxation countries can claim taxation rights because passengers are
boarding in one country or because the tickets are sold there… Navigation involves different activities in
different countries. That’s why it is a complex issue.
The companies will be taxed where the effective place of management is located. It is a case of exclusive
taxation. This has been very controversial between the countries because all want to gain the taxation rights.
That’s why there are many reservations regarding this article.
In art. 8 There are included all profits obtained directly connected to the activities of ships and aircrafts, and
those profits obtained from secondary related activities (ex: lease of containers).

Passive income (Articles 6,10, 11 and 12)

Passive income is that income made by an initial investment made by a person or entity. It will be the one
coming from dividends (equity investments), interest (debt), royalties (right to use intangible property). These 3
articles are very similar in structure. Passive income will also include the rent, income obtained from
immovable property, and capital gains, covered by transfer (covered by article 13).
Normally source countries subject passive income to tax, and taxation is usually carried out through
withholding tax – tax that ensures payment of taxes by non-residents through the obligation of the payer of
income –.

Article 6: Income from immovable property/ real estate → shared taxation

Income deriving from immovable property can be taxed in the state where the property is located. Even
though, under this provision the source country is given the authority to tax this income, this does not exclude
the rights of the residence country to tax the immovable property income. It is also a case of shared taxation.
We will be again in a case of double taxation and we will have to go to the methods in order to determine if the
double taxation can be suppressed.

- Shared taxation between the country of the lessor and the location of the real estate.
Normally this income relates to rent paid by the tenant (lease/user) to the landlord (owner/lessor). This article
covers income derived from the real property as the result of direct use or any other forms. It includes:
● Property accessory to immovable property.
● Livestock and equipment when used in agriculture and forestry
● Rights on land and usufruct
● Exploitation or granting of mineral deposits and other natural resources.
We have to go first to the domestic law in order to understand what is described as immovable property, and
then we can look at this article.
It is excluded:
● Capital Gains: this is selling a property I own, and article 6 only covers the fact of renting or leasing the
property.
● The property is located in a 3rd state: the owner is resident in one country, the lease is from another
country and the real estate is located in a third country, the double tax convention will not apply.
● Ships and aircrafts
● Debts secured by mortgage
This article includes both the situation in which the owner is an individual or a company.
Article 10: Dividends → shared taxing rights
A dividend is considered as a formal payment made by a company to their shareholders in respect of the
shareholding. It’s an income a person receives because of its condition as a shareholder.
An open definition implies that we have to make reference to domestic law. For example, profit sharing loan
provide the lender to participate in the profits of the borrower. It is a hybrid (part of debt and part of equity). It
has been qualified as interest and as share, depending on the country or the time. This implies that we cannot
give a universal definition of dividend because it depends on the country.
Dividends can be paid in cash but also in kind. When it is paid in cash, the shareholder receives money. But
when talking about payments in kind, the shareholder receives (normally) a good of the same value that the
money, it can be an asset or shares in another company... Both of them are covered by article 10.
Another situation we can face is when income is qualified. This is when one or both parties do not respect the
market price. The excess of financing will be requalified as dividend. Under thin capitalization rules, try to keep
a balance between financing through equity and financing through debt through different ratios. If these ratios
are higher than the ones of the market, this excess will be requalified as dividends (constructive dividend) so it
won’t be deductible by the company.
- Thin capitalization: A company is said to be thinly capitalised when the level of its debt is much greater
than its equity capital. And thin capitalization rules are to limit the deductibility of the interests.
Both the source and the residence country are allowed to tax this income. The source country can be allowed
to tax the income of the dividend, but it does not have to do it. This article provides for a maximum limit of tax
rates to be applied by the source country on the dividend → there is a limit on the percentage of tax that the
source country can apply.
- It is a 5% of the gross amount of the dividends if the beneficial owner is a company which holds directly
at least 25% of the capital of the company paying the dividends,
- 15% in all the other cases. → 5% is applied in the source country if the domestic law applies a higher
rate, if the tax rate is lower than 5%, then we apply the domestic tax rate.
- These limits are provided by the DTC, if the domestic law provides a lower limit, then the lower
limit will be applied, same viceversa.
In the bilateral tax treaties there are countries that also specify the requirement of a holding period. Some
countries also link the application to having the majority of the voting rights, so it is a control criterion.
Dividends are taxable on their gross amount.
NOTE: In Europe, this article is no so effective because we have the Parent Subsidiary Directive, which covers
payments of dividends within the European union. When a company in the EU pays a dividend to another
company also from the EU, the legal double taxation (no taxation at source country) and the economic double
taxation is eliminated. This is what we call Participation Exemption Regime. There are some requirements like
minimum participation, or the requirement of a holding period, etc.
When the dividends are not received by a foreign entity but by a permanent establishment held by a foreign
entity, article 10 does not apply because those dividends are considered as business profits.
In case of a permanent establishment distributing income to the parent company, under the OECD model there
is no implication. However, the US model tax convention it is considered as a dividend and is subject to the
Branch Profit Tax.
The problem article 10 faces is the fact of determining the beneficial owner. We have to know how to split the
economic ownership and the legal ownership. If we have a trust (economic owner) or a trustee (legal owner),
the trust will be the real owner and the trustee will be the fiduciary owner (even though it holds the property,
it is not entitled to receive income related to that asset).
Summary:
Regarding dividend & interest→ shared taxation, with limits imposed to the tax rate applicable for the source
country.
The common procedure for passive income is withholding tax → the company B distributing dividends for
company A, will withhold the tax directly from the dividend payment, and company B is in charge of making
the payment to tax authorities.
Example: Company B pays 100, the tax = 10%, company B will pay 90 to company A.
Within EU → Parent subsidiary directive, and there is no taxation at source country.

Article 11: Interest → shared taxation

It also has shared taxation rights. The source country is allowed but not obliged to tax the interest. Under
article 11, there is a maximum limit on interest taxation, it shall not exceed 10% of the gross amount. Also, as
for dividends, in the EU this article is not effective because it is already fully covered by the EU directive and
when interest or royalties is paid between related parties there is no withholding tax. In the directive we see
again the concept of beneficial owner (both in EU directive and OECD model). So, the recipient is entitled to
this payment as a beneficiary and not as an intermediate, agent, depositary… Constructive dividends and
interest in profit sharing loans are out of the EU directive.
The definition included in article 11 is a closed definition, this means that we have a list of incomes that are
qualified as interest, and only these types will be treated as interest regardless the definition included in
domestic law of the contracting parties. Even though it is a closed definition, bilateral tax treaties may include
different types on income under this definition (closed but not exclusive). This is because the model is just a
reference, not an obligation to apply it.
There is the same exclusion as dividends for interest by a permanent establishment. There is also a provision
concerning the payment of interest between related entities linked by the transferred price in income. In the
application of the Arm’s length principle, it that when two companies are related they must apply under the
same conditions as if they weren’t related (market prices). If these conditions are not respected will be the
requalification of interests.
Directive 2003/49/EC: In EU interest taxation at source paid between associated enterprises →
- EU directive: No payment of interest or royalty in the source country even if permanent establishment
exists
 Article 12: Royalties
Royalties are payments for the use of intangible properties (industrial property, trademarks, patents…). Unlike
articles 10 and 11, under the OECD model there is no shared taxation. It provides exclusive taxation rights to
the residence country. In practice there are a lot of countries reserving the rights to apply shared taxation.

The term royalties mean payments of any kind received by the use, or the right to use, any copyright of literary,
artistic or scientific work including cinematograph films, any patent, trade mark, trade name, designs, plan,
secret formula or process, or for information concerning industrial, commercial or scientific (know-how).
The OECD model here shows the interests of developed countries, because they are used to export their
royalties to developing countries (export of technology). Under this clear disadvantage for developing
countries, the United Nations Model has included royalties as a shared taxation scheme in order to preserve
taxation rights of the source countries. Some of the countries that have made this reservation: Argentina,
Brazil, Australia, Canada, Chile, Check Republic, Spain, South Africa, etc.
The OECD model also provides for limits on the taxation of royalties. Normally it is a fixed limited tax rate, but
in other cases there are different applicable tax rates applicable depending on the intangible property used,
depending if it is intellectual or industrial property...
In the EU, royalties are also covered by the directives for related parties, so this article is not effective.
The EU directive, also include software. In bilateral tax treaties we will see different definitions of royalties.
Some types income, software, and the payments for the use or right to use industrial, commercial or scientific
equipment. The definition of royalties included in the OECD model of 1963 also included the use of these last
ones as royalties, however it was removed because they considered it was better to include it in article 7
(business profits).
In taxation, it is always important to analyze things on a case to case bases, because the OECD is a model, so
bilateral treaties can provide different treatments than the ones included in the model.
Difference between the know-how and the technical assistance. The technical assistance is when a technician
comes to help the user to solve the problem with a machine. This technician will have the know-how, that’s
why it is difficult to determine when there is a know-how transfer or if it just an assistance service.
● Know-how: it is qualified as royalties, which are taxable at the source country. It is a secret
information on how to do something. This special knowledge remains unrevealed to the public. It’s the
information that a competitor will never obtain by copying the product. When there is a transfer of
know-how I do not warranty a satisfactory result (just the knowledge is given).
● Technical assistance: it is qualified under article 7, so there is no taxation at the residence country.
Under a technical assistance service will always warranty the result, a final satisfactory outcome.

The case of Spain:

- Reservation
- Leasing is also included
- Taxation at source
- There is a directive 2003/49/EC
- Royalties not taxed at source between associated enterprises.
- Transitory reservation for Spain.
 Article 13: Capital Gains
It makes a distinction on the type of the asset transferred.

● If it is obtained from the transfer of immovable property, the country where the real estate is located
will have the right to tax this income. So, there will be shared taxation between the source country and
the residence country.
● In case the assets transferred are assigned to a permanent establishment in the other country this last
one will have the possibility to tax it.
● In case the capital gain comes from transfers in international traffic, we will follow article 8, so it will
only be taxable on the place where the effective management is located.
● There is also the rule for companies holding at least 50% of the real estate, in these cases the transfer
of the shares will be taxable at the country where the real estate is located (new paragraph). It is an
anti-abuse rule in order to prevent the use of companies in order to transfer real estate.
● Other assets: only taxed in the Contracting State in which the transferor is a resident.
○ The person making the transfer.
● Gains from the disposal of shares representing a substantial interest (UN Model)

Article 14: Personal Independent Services

It was eliminated and included in article 7.

Article 15: Income from employment

The income from employment must only be taxed by the resident country (of the employee) unless the
employment is carried out in another country (in this case there might be shared taxation between the
residence country of the employee and the country where the employee is providing the services). The source
country will have the taxation rights if these conditions are met:
● The employee spends more than 183 days in the State of source.
● The remuneration is paid by a company resident at the source country
● The remuneration is paid by a permanent establishment located at the source country
In other words:

Article 16: Directors’ fee

Any kind of income obtained to the condition of employee/ dependent personal services. Directors
(administrador/consegero) are those people appointed by the shareholders in order to manage a company.
They form part of the corporate body of the company (Board of Directors).
When they receive any kind of remuneration as a consequence of this post they are levied to shared taxation
rights between the residence country and the country where the company is established.
Who are the directors?
- =Administrador
- The person appointed to carry out the day by day transactions of the company.
Article 17: Artists and sportsmen
It overreads articles 7 and 15, because if this type of income was included in that articles, then the source
country would never have taxation rights. In these two articles, the source country can just tax if there is a
permanent establishment or if the person stays more than 183 days in the source country. In these cases they
would never be able to tax artists and sportsmen. That’s why article 17 provides for a shared taxation power.
Also, there was a traditional practice of incorporating a company that invoices the performance of this person
in order to be provided by employment income or fees as a service provider. This is the anti-abuse clause for
article 17(Sinatra): income may also be taxed by the State where the performance is made → eventhought the
artist is not acting directly-
- In the article 7 (Business profit) and 15 (on the employees): it demands a stronger link between the
residence country and the person in order to have shared taxation rights.

Article 18: Pensions

Is the amount received by retired people. It is very common nowadays that people retire in a different country
than the one they have worked in. In case of pensions there are exclusive taxation rights in the residence
country.
- Scandinavian countries are not happy with this provision, because many retired people transfer their
residence to southern countries.
 Article 21: Other income
Any income that cannot fall under any of the previous provisions, will fall under this article. Only the residence
country will have taxation rights.

If the recipient of the income operates through a permanent establishment, then the provisions of Article 7 will
apply. → Business profit

Example: indemnity received by a company.

Article 22: Capital

Not all bilateral tax treaties cover taxation on capital.
● Same criteria as for capital gains
○ Immovable property and assets linked to Permanent Establishment → shared taxation
○ Other cases, exclusive taxation by the State of residence. → other incomes, that do not fall in
this categories.

Articles related with the administrative aspects of the applications of the articles.

Article 24: Non-discrimination

It makes reference to nationality. For tax purposes we focus on tax residency but the double tax conventions
there are processes to forbidding discrimination based on nationality. If there is any tax provision based on
nationality, then it is forbidden.
Extra info: Also, the most favored nation clause: when two countries enter into a double tax convention, if one
of them in the future enters into another tax convention with a third country, and the provisions included into
this new tax convention are more favorable than the old one, then the other country may apply for the
application of the more favorable clauses. → replace the old one for the new one.
Article 25: Mutual agreement procedure (MAP)
It is the way provided by double tax conventions in order to solve any kind of conflict regarding interpretation
or the relationship between the tax convention and the domestic law. It does not prevent claims from the
domestic laws, but there are countries in which administrative decisions cannot go against court decisions, so
there is a court of incompatibility between MAP and judicial processes at a domestic level.
The mechanism provided by the double tax conventions for transfer pricing is the opening of a discussion
between the two countries (ONLY THE TAX AUTHORITIES, tax payers do not take part) in order to try to find an
agreement as to the conflict arising or the interpretation of a specific provision of the tax treaty. The tax
authorities commit themselves to find the best solution to the problem (how to share the revenues). This
mechanism is also provided by article 4, but in general terms is by article 25.
● This mechanism is not very efficient, as the authorities only commit themselves to try to find a solution,
so the OECD is working on improving this mechanism
[[[Extra info: How does it work? Normally the tax payer can ask for the opening of the MAP within 3 years from
the day he has received a tax assessment (normally linked to the interpretation of tax convention), in order to file
the request. Not only from the day they open the assessment, but from the day the tax payer receives a sort of
communication by the tax authorities which leads them to think that there will be a tax assessment. This
depends on each country. During this 3 years period the tax authorities have to accept the request. They can ask
for further information. After the acceptance the two countries have a period of 2 years for reaching an
agreement. They must try their best effort to reach a solution, but they are not obliged to reach one. This has
been considered as a non efficient mechanism, so it was very scarcely used.
At the level of the EU there is a multilateral convention providing for a mutual agreement procedure just
specifically on transfer pricing, because this article 25 has a wider scope (it does not only cover transfer pricing
cases, but also any kind of coalification of a taxable event or residency issues, etc.). This European convention
was structured in 2 steps procedure:
● Discussion between the tax authorities
 ● If they succeed in finding a solution they must necessarily open an arbitration. This
arbitration commission will have a final word on what the two countries have
decided.
If they do not reach a solution, they have to pass the question to the arbitration
commission.
This structure has been considered the best one on a global basis, so the OECD has promoted to adapt this EU
multilateral convention structure to the mutual agreement procedure included in the double tax treaties. Within
the BEPS project, one of the measures has been to complement the MAP with an arbitration clause. At the level
of EU they have released a proposal in order to cover any other conflict issue (not just transfer pricing). ]]]

Article 26: Exchange of information

● Tax administrations of the countries entering the DTC agree to exchange information on tax matters.
● Confidentiality standards and notification obligations are provided under paragraph 2.
● Some limitations are, however, set up to restrict the scope of the obligation to Exchange information.
○ Related with privacy problems.

Extra info[[[Reasons for tax administrations to exchange information:

● Residence status
● Payments of dividends, interests or royalties
● Beneficial ownership
● Information of the tax payers profit allocation (Article 9 – transfer pricing)

The ways information can be exchanged:

● On request: One country request information from another country.
● Spontaneously: if the tax administration in one country may consider that the information may be
interesting for the tax administration on the other country and they provide the information without
being requests.
○ 人家没问
● Automatically: it implies a systematic and periodic transmission of information of a tax payer from a
source country to residence country. This intends to provide information of the tax payer
noncompliance where tax has been evaded and the tax administration has no information of this
compliance. In 2013 automatic transfer of information was determined the minimum standard of
exchange of information between the countries. → Standardized. → most common in the international
tax environment.
Simultaneous examination/ tax audit: where the tax authorities check the tax payer’s positions. The two
countries agree on having a tax audit of the same tax payer at the same time. There is a cooperation with the
aim of obtaining a global picture of that tax payer.
○ Tax examination abroad: one country starts a tax audit, and they invite another country’s tax
authorities to cooperate with them at place to do this tax examination.
 ○ Industry wide exchange of information: both countries exchange information about that
sector.

These clauses gives many power to the tax authorities, so there is are some concerns of the
● taxpayer privacy:
● Confidentiality obligations: any information obtained by the tax authorities of the taxpayer, they have to
keep it confidential.
● Notification obligations: if there is a formal exchange of information the tax authorities are obliged to
inform the tax payer, that even if he cannot oppose to it, he must be informed.
There are some limits on the share of information:
● Tax authorities cannot request information that cannot be obtained through the administrative
measures defined by the domestic law.
● They cannot exchange info if it is protected under business secrets.
In 2009 this movement started with the approval of some International Standards of Transparency of Exchange
of Information. Later they created the Global Forum of Transparency and Exchange of Information. By the end
of 2013 it already included 121- member Countries global phenomena.
They also included the Peer Reviews: all the new measures provided by the BEPS project and the Global forum of
transparency are monitored in order to check if these measures are really implemented.
In 2018, a clause will be added in order that there is also an automatic exchange of information regarding
transfer pricing issues.
The multilateral convention between the OECD and the EU council was amended in a protocol in 2010.
- FATCA, US Foreign Accounts Tax Compliance Act (2010). It is designed to take tax payers info about the
US citizens across the world. ]]]

Article 27: Assistance of the collection of taxes.

In the framework of the cooperation between the States part of the DTC, both countries commit to provide
mutual assistance for tax collection. They also agree on providing a system for the collection of taxes, because in
the absence of international conventions, the judgements by an internal court are not enforceable in another
country, so they set up this cooperation in order to make court decisions enforceable in another country.
- Example
- A French residency operating businesses in Spain, owes a certain amount of taxes to Spanish
Authorities, but his business was liquidated and he moved to France to live. As a consequence,
it was very hard for the Spanish authorities to collect those taxes, so they asked French
authorities to cooperate in the recollection process, so now the French authorities are
collecting the taxes to be sent to Spanish authorities.
Relevant issues for the application of a DTC
● Protocol: It is an attached document being also part of the DTC and providing for clarification to DTC’s
articles wording. It is essential to take this into account when applying the DTC. It is a way of briefly
updating the tax treaty or clarifying some of its provisions. It follows the same legal technicalities as if you
want to update a contract. Whenever we are analyzing a tax treaty we have to see if there is a protocol,
because then we have to complete the provisions (that can be modified) with the protocol.
● Treaty shopping: Artificial use of companies in order to benefit from DTC’s provisions. For example,
when applying to persons (individuals or companies) that are really residents, avoiding the use of shell
companies. Anti-abuse clause: Beneficial owner notion: limits DTC application to those cases in which
the recipient of the income is actually provided the service.
● Most favoured nation clause: In the event of entering of a new DTC with other countries offering
lower taxation, this more beneficial tax regime will automatically apply to previously signed DTCs →
constantly updated
● Tax sparing/matching credit: Residence country allows for a deduction of the tax that would have
been paid at source should no tax benefit have applied or a deduction of a higher tax than the one
effectively paid → como lo entiendo yo, la reducción de impuestos no debería superar el % de
effective tax rate pagado.
● In case there is no benefit provided by the DTC, the residence country allows for the deduction of
the theoretical amount of taxes that should be paid, usually it represents a larger discount.
o To encourage investment oversea.
● Extra[[[Administration of tax convention: They provide mutual cooperation between tax
administration regarding tax payer. They maybe are the most useful tools for fighting against tax
avoidance.]]]

The multilateral instruments

On 7th June 2017, 70 countries signed this instrument to implement tax treaty related measures to prevent
lateral profit shifting. The idea was to implement in the tax treaties some measures like treaty abuse (action 6)
and those related to improving dispute resolution mechanisms (action 14). They needed an implementation and
an update of the tax systems of bilateral tax treaties. They agreed that through the sign of this instrument all
the bilateral tax treaties would automatically be updated.
● The MLI entered into force on July 1st, 2018 and covers about 1,500 DTCs.
● Further amendments to the DTCs under the MLI scope will be made through bilateral negotiation.
● The scope of MLI
General summary of the taxation rights
● On capital gains:
○ Real estate: gains on sales on real estate will be shared taxed.
○ Permanent establishment: Shared taxation between residency country and where the PE is
located.
● On ships/aircrafts international navigation: Exclusive taxation, where the effective management is
located.
● For any other assets: exclusive taxation at the residency country.
○ However, due to the existence of “special” practices, some amendments have been made
to avoid those practices.
○ Example: A person owns a real estate in another country (Y)
■ So, any capital gains derived from the transfer of real estates(art 14)→ shared
taxation, which means that there exists a possibility of double taxation, depending
on the methods to avoid double taxation offered by the residency country.
■ A regular practise to avoid double taxation was just to incorporate a company in
the country (Y) and make it the owner of the real estate, and transfer the
shares(paragraph 4) to the individual.
● There might be transfer tax the transfer of substantial interest.
● Exclusive taxing rights for residence country if the % of
participation is less than 25%
● Shared taxing rights if more than 25%.
■ So in order to avoid this practise, there has been a provision in the OECD model:
when the transfer of shares of a company which more than 50% of the assets is
composed of real estate, there might also be shared taxation.
● There is also transfer tax for the transfer of real estate.
 Transfer Pricing rules

Transfer pricing arises in a framework of doing businesses in several jurisdictions and having a fixed presence
there. When talking about multinational rules we need transfer pricing because:
● Taxable profits: within groups here is the possibility to determine where we are going to establish a
profit (in different jurisdictions).
● Different conditions: Depending on the relationship with the other party of the contract you will apply
different bases. Multinational groups can set up special relationships between them.
The concern of tax authorities is that at the end each jurisdiction wants to collect the right amount of taxes. And
this is why there are specific rules on how taxable profits should be allocated in a multinational group.

Transfer pricing is one of the main issues in the multinational tax conventions. Valuation is not an exact science.
It has been used for some aggressive tax planning, but nowadays things are changing (BEPS project).
It is also an issue for tax administrations because it is easy to have access to some financial information, but in
order to properly transfer prices, it is necessary to enter the business, and understand how each group works.

One of the bases of transfer pricing is the Comparability Analysis that implies comparing the conditions
applied in the multinational group with those applied by independent parties. Apart from comparing and
determining the prices to be applied, we also have to carry out the Functional Analysis, which involves
determining where the functions, assets and the risks incurred by the parties doing the business. It is a really
complex issue for all agents, and the complexity increases because in most cases the group is acting in different
jurisdictions, so they have to comply with different tax regimes. Double taxation is also very relevant in transfer
pricing, so it is important to find a balance between both.

Basic documentation:

Transfer Pricing Guidelines for Multinationals Enterprises and Tax Administrations

a. First version: Report on Transfer Pricing and Multinational Enterprises 1979

b. Revised and published as Guidelines in 1995

c. Further updates in 2010 and 2017. This last version incorporates revisions made in 2016, revisions agreed in
2015 BEPS Reports (Actions 8-10 and 13) and the guidance on safe harbors approved in 2013.

For tax authorities, this is also a complex issue at different levels:

● Policy level: they have to reconcile the interest in collecting taxes with the interest to promote
international trade. From a practical point of view, it is not easy to determine where income and
expenses should be allocated (difficult to collect the data).
● Separate entity approach: which expenses and gains are charged to each group entity.
This is the key for transfer pricing. We have to analyze the tax position of each of
the members of an international group as if they were independent parties. This is
because we have to
compare it with market conditions. These comparisons are based on the Arm’s
Length Principle (even parties are related; there must be a distance between
them as if they were independent).

Arm’s Length Principle

We are going to determine a taxable profit reformulating the conditions applied within a multinational group as
if they were independent parties. To do so we will have to eliminate the special conditions the related parties
have agreed. → Separate entity approach
This is a principle agreed by almost all countries, set up by the OECD, in order to achieve the dual objective of
determining the appropriate taxable base in each jurisdiction and ensuring that double taxation will not
arise. Countries want to promote international trade and ensure an appropriate taxation in each jurisdiction
both at the same time. In the BEPS project it is also one of the main issues.
This principle is covered by Article 9 of the OECD.
- Scope of application:
- One company directly controls the other company
- The same persons participate in the management or control of the companies (sister companies)
- The specific applications are developed in the guidelines.
- The basis of the application of the arm’s length principle is based on the comparison of the conditions →
the independent party that you choose to be compared to the internal transaction, must be economically
comparable. And if there is some systematic differences, it must be eliminated.
 Transfer prices
● Trade
● Services
● Intangibles
● Financing

For all these inter-group transactions, arm length principle must be applied.

The key issue for determining the appropriate taxable profit to be allocated to each of the members of a
multinational group will be the conditions the group applies between its companies and the prices they apply
in the mutual transactions. These prices are called transfer prices.
Transfer prices are the prices at which an enterprise transfers physical goods, intangible property or provides
services to associated/ related enterprises.

It is not only a matter of a price itself, but also on the conditions agreed even if the price is the same. There are
two types of transactions:
● Controlled transactions: transactions done between related parties.
● Uncontrolled transactions: transactions done between NOT related parties.

The origin of the transfer pricing rules is the OECD. They developed the first report in 1979. These comments
were added in the Transfer Pricing Guidelines, the document of reference for tax authorities and for taxpayers,
with the first publication in 1995, an update in 2010, and they published a new version in 2017 where all the
works carried out in the BEPS project were included:
● Actions 8 to 10: Aligning TP (transfer pricing) outcomes with value creation. The analysis has to be
made taking into account functions, assets and risk, but also considering the value creation, so that
the taxable profit should be allocated where value is created. This creation of value is very relevant on
the vision of transfer pricing.
● Action 13: TP documentation and basically setting out the Country by Country report (CBC), a new
approach on transfer pricing documentation.

Article 9: Associated enterprises

The 1st paragraph provides for the Arm’s length principle: “The principle requires that transactions between
associated enterprises are priced as if the enterprises were independent, operating at arm’s length (market
conditions) and engaging in comparable transactions (we have to compare what I am doing within the group
with what the market does) under similar conditions and economic circumstances”. This is the Separate entity
approach.

What do we understand by associated enterprises?

● Ownership: what is controlled is the capital.
● Control: What is controlled is the management. This control can be direct or indirect. I can take
decisions because I have a majority of votes in the directors’ board or I can nominate the directors.
Domestic law determines the link/ relation between two companies by percentages.

There are also types of relationships:

● Direct relationship: there is a direct or indirect control of one enterprise.
● Collateral relationship: one company that participates directly or indirectly with the management
control or capital of two different enterprises in two different contracting states. This two “sister”
companies are also related because they have the same “mother”.
If the related parties do NOT agree on making transactions between them under market conditions, article 9
provides the tax authorities with the power to correct the profits of related companies when they have setup
transactions that have not respected the ALP. This means that they tax the amount that should be taxable, no
the amount that they decided when making the exchange. The problem with this is that if there is no bilateral
adjustment (meaning that both different jurisdictions have to make the adjustment) there will be double
taxation. This problem arises because there are different jurisdictions. This correction is not automatically
done. There is the need of making a request to the other country’s tax authorities in order to make this
bilateral adjustment.

European Joint Transfer Pricing Forum - Documentation

Documentation has become an issue because it is an extra administrative burden for groups. It is an obligation
by law to have a specific and separate documentation about the transfer prices groups apply.
They set up documentation in two levels:
● Master file: set of documents explaining the whole transfer pricing policy. It had to be set up by the
parent company. It has to include information about the group, all the companies forming the group,
the functional analysis (of all the companies within the group) – functions, assets and risks –, the
comparability analysis, the financial statements…
● Local file: it refers specifically to each of the entities separately (we are interested in just the one
entering in the transaction). It is local and have to comply not only with the general standards but with
specific legal jurisdictions there must be specific requirements.
● Country by country report (it was extended by the BEPS project): it is aligned with the value creation.
They have to provide transversal information of the group. They have to indicate the taxable profits
declared in each country together with the taxes paid. Indicators about economic activity and financial
information in order to make possible for the tax administrations to really understand how profits are
located (have a whole picture). It complements the other two documents.

Advanced Pricing Agreement (APA)

Is an agreement reached with tax authorities in order to apply a specific policy within my group companies.
Groups can ask for a tax ruling, a formal acceptance of my policy. If I apply this policy in the same way as I
presented it to tax authorities, they cannot challenge it, so it is binding for tax authorities. This eliminates
further conflicts.

🡪 Reach an agreement with the tax authorities in advance, set up the rules, and if I stick to the rules and the
conditions have not changed, the tax authorities are bound by these decisions and cannot challenge my prices,
my taxable bases nor the taxes I have paid.

Arm’s Length Principle (II)

The arm’s length principle says that the transactions between business in the same group have to make the
transactions as independent parties would do (market conditions).
Imperfections:
● It provides parity if tax treatment between multinational organizations and independent parties. It
puts them in the same level both types of transactions, the ones between associated and independent
parties. They try to avoid creating tax advantages and promote a fairer competition between the
operators in the market.
● It has proved to be efficient in the most of cases.

The difficulties in the application of the ALP:

● Sometimes it does not take into account the economies of scales crated within international groups.
This can create distortion in the market but at the same time create economies of scale. Since the ALP
 tries to balance the conditions applied by independent parties, these economies of scale are
somehow distorted.
● Multinational groups may enter into transactions where independent parties would not, this is a
difficulty because these transactions cannot be compared.
● The ALP may result in a higher administrative burden for groups and tax administrations because it
implies, in order to ensure that the ALP is really applied, an investigation has to be carried out and the
multinational group has to comply with specific requirements to demonstrate that the transaction has
been agreed upon market conditions.
● Difficult to obtain reliable information. Prices have to be compared to market, and sometimes they
are not so easy to find nor reliable (not easily comparable).
Even though it is the most reliable principle. It is based on market prices, it minimizes the potential for double
taxation, and it is an international standard.

The application of the ALP is based on the comparison of the conditions applied on controlled transactions
(agreed by associated entities) and the uncontrolled transactions (agreed by independent parties). We have to
take into account the economic relevance conditions of the transaction: not only the features of products or
services but also the functions/risks of each party involved in the transaction.
A transaction being comparable to another implies that none of the differences could materially (not such a big
difference that can heavily affect) impact the conditions being examined, and that reasonable adjustments can
eliminate the impact of such differences. The message is that we are not talking about identical situations, but
comparable.

We can apply the ALP when there is any kind of transaction agreed between associated entities:
● Trade activities: Purchases/ sales, production and supply agreements. Everything we get when we
trade with goods.
● Services: There are groups where services are very integrated. Management and administration and
other services agreements.
● Intangibles: License and royalty contracts (patents, trademarks, know-how, R&D). Sometimes they are
all owned by one of the companies in the group, this is clear that the other companies will use them,
and some other times each company within the group owns their ouns. Knowing how to evaluate
them is also a complex issue.
● Financing: Loan agreements (interests), factoring, treasury and cash management. It is very common
to have cash pooling assessment within groups, this is a contract under which the treasury of the
group tries to be optimized. Here we have to take into account that some companies within the group
are in a more credit position (excess of treasury), and some others have a deficit in treasury. So
instead of asking for external credit (bank) they have a pool of treasury concentrated in one of the
entities in the group, and this company has to compensate the deficits of the other companies. This is
a way of optimizing the treasury within a group. This creates loans between the companies and avoid
having to ask them to the banks.

Valuation methods (OECD)

 There is a classification into two different groups:
● Traditional transaction methods: it focuses on the transaction
o Comparable uncontrolled price method (CUP): it focus to the price applied to a specific product
→ most used
o Cost plus method: it takes into account the gross margin
o Resale price method: it also takes into account the gross margin → preferred method
● Transactional profit methods: it takes into account the profits resulting from this transaction
o Profit split method: it implies that the companies involved in the transaction will split the
profits from the transaction
o Transactional net margin method: it relies on the net margin
Traditionally the Traditional Transaction Method were preferable by the OECD guidelines (and had to be
applied in a specific order). This initial rule for application of the method has changed and now the taxpayer
has the possibility to choose the method that fits better in the transaction (because not all methods are
applicable to all transactions). → there is no hierarchy

Selection of the correct method

The selection process should take into account:
● The respective strengths and weaknesses of the OECD recognized methods.
● The appropriateness of each method in view of the nature of the controlled transaction determined
through a functional analysis.
● The availability of reliable information needed to apply one particular methods.
● The degree of comparability between controlled and uncontrolled transactions including the
reliability of comparability adjustments that may be needed to eliminate material differences.

The methods provided by OECD are:

Traditional transaction methods:
1. CUP method
2. Resale price method
3. Cost plus method
Transactional profit methods:
1. Transactional net margin method (TNMM)
2. Transactional profit split method.
The Comparable Uncontrolled Prices method (CUP) → only considers the price of the product. → the
preferred one

It focuses on the price applied to a specific product between dependent and independent
parties. The use of the Comparable Uncontrolled Prices method (CUP) is reliable when:
● Both independent and related entities sell the same product under similar conditions and
circumstances.
● Reasonably, minor adjustments can be made to eliminate the effect of such differences on the price.
Transactions can be comparable when none of the differences can materially affect the transaction or in case
we can apply reasonable adjustments. When it is possible to find a comparable price, it is considered by the
OECD as the most reliable method to establish comparison. It is also one of the preferred ones by the tax
authorities.

Article with example:

https://transferpricingasia.com/2017/02/10/cup-method-with-example/

The CUP Method compares the terms and conditions (including the price) of a controlled transaction to those
of a third party transaction. There are two kinds of third party transactions.

Firstly, a transaction between the taxpayer and an independent enterprise (Internal Cup).

Secondly, a transaction between two independent enterprises (External Cup).

The below example shows the difference between the two types of CUP Methods:

CUP Method Example

With this in mind, let”s look at an example of the application of the CUP method:

A manufacturing company (X) manufactures the “Buster 3.0.” This is a high-quality vacuum cleaner. It is up to
10 times stronger than the models of most competitors. The only competing manufacturer that can provide a
vacuum cleaner performing similarly is the Dust Company, with its renowned “Dragon Buster.” X and Z sell their
vacuum cleaners via both associated and third party distributors. X and Y operate completely similar.

Now say that X has received an order from distribution company Y for the supply of 1 Buster 3.0. X and Y have
the same shareholder (Z). X wonders what transfer price it should apply. This means that X should find the
terms and conditions (here: the price) of a comparable transaction. Under the CUP method, there are now 2
options:

1. X looks at the price for which it sells 1 “Buster 3.0” to a third party distributor (Internal CUP).
2. X looks at the price for which Z (the shareholder) sells 1 “Dragon Buster” to a third party distributor
(External CUP).

Obviously, option 1 is the easy option here and would be acceptable. But option 2 would also be acceptable
and provides a better defense towards tax authorities (because “X is doing what an independent enterprise
does”).
 We can find internal and external comparable:
● External comparable: similar transactions carried out by two independent parties with similar
characteristics.
o A similar company carrying out similar transactions.

● Internal comparable: a company sells a product to both companies within the group and independent
parties. This is a very strong comparison.

Major differences that may affect the price:

- Nature of supplied products
- Differences in the functions performed
- Economic circumstances
- Different business strategies
- Differences in contractual terms
Resale Price method = Resale Minus method
It starts with the price in which a product that has been produced by a related entity has been sold to an
unrelated company (A produces and sells to B (which are related), and then B sells it to C (which are unrelated)).
It takes into account the final sale price, and in order to determine if the transfer price (the one used to sell the
product between the related parties) is correct, they will deduct the gross margin from the transfer pricing.
This gross margin must be sufficient for the entity to cover the expenses and obtain a sufficient profit to carry
out its activity. What is left from the subtracting of the gross margin is considered the Arm’s Length price for
the product.
We can take into account again external and internal comparable.

The advantage of the Resale price method, it has to take into account the features of the products sold but it
does not rely directly on the product, because we are considering a margin and not necessarily the
conditions of the product, so they are not so significant. But in this case, we have to take into account the
functions carried out between the companies involved in the transaction. Ex: if we talk of a commercial
transaction we have to take into account the functions the distributor will carry out and which are the risks.
Exclusivity in the distribution of the products could also affect comparability or accounting differences.

In reality, we need to find a comparable (same characteristics of companies and products…), which is very
hard, so it is not so commonly used.
The fact that it relies on the gross margin could have impact on the comparability because the GM is basically
formed from the operating results and depending on the accounting differences could have an impact on
determining the net sales, and the difference accounting methods. It implies a more detailed functional
analysis in order to determine functional analysis.
To calculate it starting from the final price, we subtract the gross margin (arm length), and then we get the
price in which the related entities have agreed to carry out the transaction.
Example
Example in the class:
653.2 is the price that the Spanish subsidiary should have paid to the MNE Group in order to get a gross
margin of 31.58% at the end.

Cost Plus method

It takes into account the other side of the transaction: it considers the costs incurred by an entity and they
consider that the price is correct when applying a reasonable margin. The price will be determined by adding
to the production cost a markup in order to obtain a reasonable profit. It is more useful in commercial
activities (manufacturing and services specially).
In case we have an internal comparable it is easier for tax authorities to set up a comparability. Because we
have the information within the group.
- There must be consistency in the methods applied to account for costs
“The Cost Plus Method compares gross profits to the cost of sales.”
The difficulties we can find:
● It relies on applying a reasonable markup in order to cover all the costs in order to allow the company
to cover its activity.
● Challenges of the cost bases, if we apply that there is a reasonable markup applied in different cost
bases, the results would be very different. The challenge is setting up a comparability on the cost
bases in which we are going to apply the markup.
● We have also to determine what happens with extraordinary expenses.
Process:
1. Determine the cost incurred by manufacturer (supplier)
2. Determine the appropriate mark-up on the costs.
a. We can identify it by looking at the mark-up on costs applied for comparable transactions
between independent enterprises, and apply its mark-up.

The downside of the Cost Plus Method is that it requires controlled and uncontrolled transactions to be highly
comparable. To establish such level of comparability, detailed information on the transactions should be available.
Examples are the types of products manufactured, actual activities, cost structures and the use of intangible
assets. In case this information is unavailable, the Cost Plus Method cannot be applied.

Example
Profit Split method → transactional profit method
Associated enterprises sometimes engage in transactions that are very interrelated. Therefore, they cannot be
examined on a separate basis. For these types of transactions, associated enterprises normally agree to split
the profits. (Usually for highly integrated operations and two companies carrying out the same procedure)
It tries to eliminate the effect on profits made in special conditions made or imposed in a controlled transaction
by determining the division of profits that independent parties would agree in similar transactions. The idea is
that when two companies make a joint project, they have to split proportionally the profits depending on the
different contributions they made to the project.
This method would be applicable when there are vertical
integrated activities in which it is not possible to determine
clearly the separation of the functions of one entity or the
other, or when both parties make unique and valuable
contributions.
 - The transaction made by Y and X, which is owned by Z, with Joint Venture I. Let’s say that we need to
determine the transfer prices to be charged for the transactions related to Joint Venture I. For that, we
can compare the terms and conditions of the controlled transactions by determining the division of
profits of comparable uncontrolled transactions. In this example, this means that we can compare Profit
Split I with Profit Split II.

Two Kinds Of Profit Split Methods

1. Contribution profit split method:

The contribution profit split method splits profit among associated enterprises according to the
functions performed and risks assumed. In addition, the assets are analyzed which are
contributed by each entity. In particular, intangible assets.

2. Residual profit split method:

The residual profit split method requires the identification of the routine profit for an entity as a first step. Any
remaining profit is then split based on each party’s contribution to the earning of the non-routine profit, for
example the ownership of intangibles.
Transactional net margin method (TNMM) → most used → residual method → net margin
It was a residual method at the origin of the OECD guidelines, but nowadays it is one of the most commonly
applied methods. It takes into account the Net Profit/Margin. We can make the comparison from internal or
external comparable.

- The advantages is that the TNMM requires transactions to be “broadly similar” to qualify as
comparable. “Broadly similar” in this context means that the compared transactions don’t have to be
exactly like the controlled transaction. This increases the amount of situations where the TNMM can be
used
When we mention net margin we always refer to EBIT, so we eliminate the impact of tax and interests and any
other financial transaction not really linked to the product transaction.
The strengths of the TNMM are:
● Net profit indicators are less affected by transactional differences than in the case of other methods.
So, a net margin as an indicator would be more stable than a gross margin.

o It is not so related to the product itself.

● They are more tolerant to some functional differences.
● The net margin also implies that finally we have a positive or negative profit. The tax authorities can
also base their application of the ALP on the net margin because they know that if there is a positive
net margin the company has a taxable profit.

Sometimes tax authorities use a combination of other methods and the TNMM in order to check if the gross
margin applied has an economic sense or it is also used for sanity check.
Sometimes this indicator may be affected by forces in the market, penetration strategies, etc.

Some of the indicators that we can use are:

● MO = Operating margin / Sales

● ROA = Return on Assets = Operating margin / Assets
● ROCE = Return on Capital = OP / Capital
● MUTC = Mark-up on Total Cost = Operating Margin / Total Costs
The gross margin of the related transaction should have been 315.8€.

Example of application: TNMM I

1) Net Cost Plus Margin: ratio operating profit (EBIT) to total cost
● Return on total costs of a company.
● The price =total cost + net cost plus margin
2) Net Resale Minus margin =EBIT / sales
● Measures return on sales
Comparable transaction → determined by comparability analysis
- If the related transaction and the independent transaction are fully comparable, then the price
should be exactly the same.
- If the two transactions are not fully comparable, then we should think about the Margin.
- The functional differences, business model, the products...

Comparability analysis → to know whether two transactions are comparable.

We 1st have to identify the commercial nature transactions between the related entities. When we are given a
group to analyze we have to first identify the relationships. Then we will be able to make the comparison of
the relevant conditions as those appearing in the non-related parties.
This has been acquiring more importance, it is mentioned in the BEPS project has stressed the importance of
this identification of the transactions.
They do two indications to identify the transactions.
● Comprehension of the sector and the factors affecting businesses in that sector.
● General vision of the multinational group itself before going to analyze in detail specific relations. This
would include business strategy, target market, services, supply chain…
For this analysis they propose a two-step study (from macro to micro):
1. We have to consider the case in a group perspective more than a specific company or specific
transaction.
2. Identify how each entity in the group operates in this framework. Considering the commercial
relationships and the relevance economic characteristics of those transactions.

Relevant economic characteristics of the transaction = Factors Determining Comparability:

1. Contractual clauses/ conditions
Any economic relationship is normally found in written formal contracts. These parties include the
intention they have with regard to a specific transaction: price determination, risk assumptions,
obligations, etc. We have to take into account what the parties have concluded in the agreement.
Because there we can find the rules that will be followed while carrying the transaction.
We also have to check if the facts and the way the parties are acting in practice are in accordance with
what is written in the agreement. → we have to look at the contract. If there is any contradiction, the
facts/ behavior will have more importance. We will always take into account what they do in practice.

1. Always start analysing the contract, and analyse the terms in order to determine whether the
facts are respected or not.

2. Functional analysis
Take into account the functions carried out by the parties considering risks assumed and assets used
in the transaction. It is the most important one.
Identify and compare the economically significant activities and responsibilities assumed by
independent parties and related parties, paying attention to their structure and organization. Identify
the major functions performed by the object of analysis, in order to make adjustments to remove any
material difference in relation to the functions undertaken by any independent party considered
comparable.
We will analyze also if the independent transaction is also comparable in these terms. These elements
are clearly related to the remuneration market brands to analyze their economic activity.

This functions analysis is linked to the functions as risk an asset, but recently they added the concept
of value creation (which part of the company is creating value?). Ex: Design, manufacture, assembly,
research and development, services, procurement, distribution, marketing, advertising,
transportation, finance and management.

The economic relevance of these functions should be considered in terms of their frequency, nature
and value to the respective parties to the transaction.
Risks that we have to take into account: Market risk (fluctuations in the price of materials and final
products), risk of loss associated with the investment and use of property rights, buildings and
equipment, reputational risk, financial risks (interest rate and exchange rate), credit risks, etc. The
analysis of the risk is one of the most complex parts of the functional analysis.
This analysis is carried through questionnaires made to the companies in order to understand it. We
can also use checklists.

3. Features of goods and services

This factor takes into account the object of the transaction, what we are doing. Ex: if it is a
manufacturing or a commercial transaction we will take into account what we are selling. Normally
the difference in market value on goods and services is explained through the characteristics of these
goods and services. In the case of tangible goods, we will take into account the physical appearance,
 the quality, the availability and the viability. In case of services we will take into account the quality
and the scope. In the analysis we will also take into account the intangible value associated with the
good. Ex: a difference in price in jeans could be the characteristics of the environment. If they are sold
in a luxury market the price would be much higher than if they are sold in a “mercadillo”. Another
example is if the products incorporate advanced technology.
1. Any features related to the product should be taken into consideration.
4. Economic circumstance
It refers to the circumstances of the market in which the parties operate.
Prices will be affected by the market in which the company operates. The comparison must always
take into account the characteristics of the market in which the transaction is carried out: geographic
location, size of the market, level of competition, availability of substitute products, regulations, cost
of products and transportation.
We also have to pay attention to the economic circumstances of the group: the turnover, the volume
of assets, the inventories needed for the activity, etc.

5. Business strategies
It can have a very strong impact in prices and in margins. The strategy for market penetration or
increasing the market share can cause that in a certain period of time the margins are lower. In order
to analyze if the situations are comparable we have to determine in which moment each party is
acting.
- Very related to the economic situation.
Steps to take when doing the comparability analysis
1. Determination the time period to be analyzed. Normally 3-4 years are taken.
2. Thorough analysis of taxpayer's circumstances
3. Understanding of the related transaction under consideration, based on a functional analysis to
identify
a. Parts analyzed (as appropriate)
b. The most appropriate valuation method under current circumstances
c. The most adequate profitability index
d. Any critical factors affecting comparability
4. Review internal comparable, if any. Preference is given to internal comparable. It is a time saving
because if I have a comparable within the group, I won’t have to spend time looking for comparable in
the market. This is why if we have potential internal comparable and we consider that they are not
really comparable, we have to say why they are or not comparable. If it is a comparable I am obliged
to use it, if it is not I have to justify why not.
5. Determination of available sources of information on external comparable in terms of their reliability.
6. The selection of the most appropriate transfer pricing method and, depending on the method, the
determination of the relevant financial indicators (e.g. determination of net profit indicators when
applying the transactional net margin method).
7. Identification of potential comparable → through benchmark analysis.
8. Determination of comparability and making adjustments when necessary.
9. Interpretation and use of collected data, market pricing
Repeat everything until you are satisfied.

Benchmark analysis (to determine External comparable)

It is used in situations where I do not have information about the group and I have to go to the market. But the
market depends on the sector and the activity, and there are a lot of competitors, so I need to understand
which are the independent parties with whom I can make my comparison. In order to do this analysis, I can use
public information (databases), commercial information or even sometimes private information. I can also use
sectoral information.
 Some of the databases we can use is: Amadeus, Fame, Jade, Worldscope/Orbis, SEC…
The analysis will be normally performed for separate markets, identifying the country’s set of comparable.
when searching my comparable I will have to take into account losses, if they do maybe I cannot take them into
account. Also, the public data availability, because sometimes it is difficult to obtain the information for some
periods. Also, the secrets comparable, confidential information can be kept either by the taxpayer or the tax
administration.

- Used by methods that requires margins

Aspects to take into account when developing a benchmark → to choose a database:

When selecting the companies, in order to find the comparable, we have to set up a selection criterion:
● Qualitative selection process
o Company Size: in order to be comparable they need to have similar turnover sizes.
o Type of business / functions
o Structure of FFSS: structure of financial statement
o Historical data
o Geographical situation
o SIC/NACE Code: European code used for selecting businesses doing the same activity
● Interpretation of results: It is important to interpret the results correctly. The companies belonging to
the same group as the one I am studying, must be rejected. Only independent parties can be used for
comparison.
o The results will be provided as a range of quartiles.
o If the gross margin of the benchmark company is within the lower and upper quartiles →
Comply with the Arm’s Length Principle.
We will end with a set/ number of companies which can be considered comparable to mine. When I have these
companies, I have to analyze their financial information in order to determine their gross margin obtained in
different transactions. My
company will be considered
Arm’s Length, meaning that I
am within the range of
comparability if my margin is in
between the minimum and the
maximum value of the set. I can
also look for the quartiles, 25%
– 50% – 75%. If I am
outside the range, I have to
make adjustments because the
conditions I am applying are not
comparable with the ones
chosen.
The benchmark is very useful and conclusive. But sometimes this is not sufficient, so we have to complement
the information screening on the webpages, or be sure that they do not belong to a group, maybe the markets
are not so similar, etc.

If the current pricing policy is not within the range

Following steps must be taken:

If we cannot justify why we are out of the range, and even doing the adjustments I even cannot explain why I
am not within the range, then I have to modify the transfer pricing at the Group level.
Summary of how market prices can be justified.
● Delivery of goods
o Type of operations: manufacturing, distribution, sale of materials, etc.
o Selection method: CUP, Cost Plus, Resale minus.
o Comparability analysis: AMADEUS
● Services
o Type of operations: management fees, IT services, shared personnel services, know-how,
branding, etc.
o Cost sharing arrangements (cost pools): hours of dedication, turnover, employees, etc.
o Selection method: CUP, Cost Plus, Profit Split, TNMM.
o Comparability analysis can be made through AMADEUS
● Financial operations
o Type of operations: loans, guarantees, cash pooling, etc.
o Functional and risk analysis.
o Comparability analysis: current conditions of execution of the contract. DB Loan Connector.
● Property transactions
o Types of transactions: sale and purchase of immovable property or rights thereto, rentals, etc.
o Comparability analysis: current conditions of execution of the contract. Real estate portals.
● Directors’ remuneration
o Binding relationship: difficulties for valuation at market price
o Comparability analysis: Observatory on Corporate Governance of Financial Studies
Foundation and Watson & Wyatt.

Transfer Pricing documentation

Standard approach
1. Master File: regarding all members of the group, along with an overview of the group (all transactions),
and also the economic sector that the group is operating in.
a. Comparability and functional analysis have to be included.
b. Description of the business, intangible, the activities...
2. Local File: Specific file for each of the companies of the group. It includes material transactions of the
specific company with other related companies.
a. The content might be different depending on the country.
3. Country by Country report:
a. Global allocation of the Group income and taxes paid as well as information on indicators
regarding the location of the economic activity

The time frame depends on the country when all this documentation has to be given. Some countries ask for
temporary documentation, you have to produce documentation when you file your corporate income tax
return, and some others have to deliver the documentation when the tax authorities request them. So,
documentation should be ready at any time.
Regarding materiality, some countries set up a frame scope of materiality under which companies are not
subject to the obligation of documentation or have to provide a simplified documentation. Ex: if transactions
have a value under 100.000€ does not have to be documented.
There is no international standard for updating of transfer pricing documentation, so you can use it as long as it
is valid. Probably you need to have a continuous review for updating.
There is no international standard also for the language.
- Normally the local files are translated to the local languages.
Nor penalty, in most countries, the non compliance of the ALP, can derive to penalties, as the fact of not
complying with the documentation obligation (proper, accurate or not having it on time) may also imply
penalties for the tax payer. This is very relevant because in case the company has been imposed penalties, the
access of the arbitration procedure is forbidden (companies won’t have any remedy for double taxation).
Custom duties and Indirect Taxes

Custom duties
Duties (taxes, so to speak) charged upon the introduction of goods/merchandise in a specific county or in a
custom union. In the case of Custom Union (E.g. EU) the tax is applied when the product enters the border of
the union, regardless of the specific member country.
Main Organizations in international trade
● World Customs Organization
It has developed a standard classification of products, the Harmonized System which also includes any
kind of import restrictions or custom duties applicable. The classification is also used by the European
Union, not for custom duties (as they don’t exist within member countries), but for the Intrastat
compliance.
Intrastat: As in the EU borders have effectively disappeared, countries were losing information of the
goods traded among member countries. The Intrastat is a declaration that must be filed by companies
trading within the EU. This is the way countries can know information (volume, nature, etc.) of
products traded.
● World Trade Organization
It has its origins in the GATT (General Agreement on Tariffs and Trade).
It sets up the basic rules for international trade. It is a multilateral agreement to which countries adhere.

Main rules regarding international trade

1. Non discrimination (also present in DTC principles and EU principles)
● An advantage granted to one of the member countries has to be granted to any of the other
World Trade Organization member. This is similar to the Most Favored Nation Principle (when a
country enters a DTC with another more favorable than the one previously signed, the other
countries can request the application of the most favored clause)
● Imported and domestic goods must receive the same treatment, the National Treatment
Principle.
CAUTION! This only applies once the products have been introduced in the country.

2. Reduction or elimination of obstacles to trade

Custom duties, but also referring to prohibitions, contingencies, etc. There is an agreement within the
World Trade Organization that says that once an obstacle has been revoked, it will never be applied.
These rules aim to protect national economies, but these barriers should not be so hard that they
prevent the normal development of international trade.

3. Prevention of unfair trade practices

Anti-dumping measures.
Dumping: Export of a product for a price lower than cost or than the price applied in the domestic
country. It is considered an unfair practice, as it gives privilege to imported products in detriment of
domestic products.

Economic integration mechanisms

Passing from local to regional policy. Instead of protecting products in individual markets, they enter into
association of similar countries (usually, in the same geographical area) to enlarge this protection and set up
favorable trade regimes by reducing and ultimately removing any kind of obstacle. Protecting from countries
outside the region and removing barriers within the region
1. Preferential trade agreements
Provide for preferential custom regimes, such as lower tariffs or exemptions, usually applied to
developing countries.
2. Free trade agreements
Setting up a free trade zone in which there are no custom duties or reduced ones. The Custom Free
Zones are also tax-free zones, so neither custom duties nor VAT is applied.
Custom duties or taxes will only appear when leaving these areas
E.g., EEA (European Economic Area), ASEAN (Association of Southwest Asian Nations), NAFTA (North
American Free Trade Agreement).
3. Custom unions
Free trade zones applying external tariffs to third countries (i.e. European Union, Mercosur)
Value Added Tax (VAT)

Value Added Tax, broadly based consumption tax assessed on its value added to goods and services.
→ ultimately paid by consumers. It has been historically drafted on a case-by-case basis; it is
therefore very casuistic.
It is regulated by several directives in the level of European Union. The implementation of these directives in
the national laws. It is a harmonized tax, even though there is no harmonization in the level of rates (countries
still have high degree of freedom to set up rates). It is the tax with which the EU has achieved a greater degree
of harmonization, even though there are still some areas where countries have some freedom.
VAT is in the process of constant evolution (it was created some 20-30 years ago), and the first conception was
applying VAT at origin, and there was the objective to create a whole space for VAT application, but we have
not arrived yet there. VAT is (still; in the future it may change) managed and collected on a local basis
The 2016 plan was trying to reach a final implementation phase, arriving to full integration of VAT in all senses.
For the moment, we are in the Transitory System. There is progress made to achieve full integration

VAT is:
● A general tax applying to all activities involving production and distribution of goods and supply of
services
● A consumption tax, as it’s borne by the consumer, and does not represent a charge to the business
(has no impact in the exchange of trade). VAT is fully neutral to companies, as it is ultimately borne by
consumers.
● It is charged as a percentage of the price: the actual tax burden is visible at each stage in the
production and distribution chain
● It is collected fractionally via a system of partial payments:
o taxable persons deduct from the VAT they have collected the VAT they have paid to other
taxable persons. This mechanism ensures neutrality of the tax regardless of how many
transactions are involved.

How to calculate VAT?

In the case of no margins, very simple

Raw Material 🡪 Production 🡪 Reseller 🡪 Customer

Example: 50u + VAT (rate 10%) → 55 → Purchase of 50 + VAT → 55 → Purchase of 55 VAT

charged and Output VAT (IVA repercutido) = 5 🡪 customers pays all VAT

Borne VAT and input VAT (IVA soportado) = 5

In the case of margins

Raw Material 🡪 Production 🡪 Reseller 🡪 Customer

Example: 50u + VAT → 55 → Purchase of 50 + VAT → 55 → Purchase of 55

Input VAT → 5 VAT payable = 5
Production cost = 85 Margin = 15
Sale price = 100 Output VAT → 10 Example
- The input VAT is the one that the company
pays, and output VAT is the one that
company receives.
- + balance → pay to the authorities
- - balance → request refund.
The balance matters. Companies may have their VAT payable accounts positive (they have to pay to the tax
authority) or negative (the tax authority will credit the amounts in future periods or, if it proceeds, grant a
reimbursement.
● In VAT rules we can find:
o Specific rulings regarding B2B or B2C transactions
o Specific provisions regarding exemptions and how to offset input and output VAT
● Charged as a percentage of price, and the tax burden is visible at each stage in the production and
distribution chain
● Collected fractionally via a system of partial payments → Taxable persons deduct from the VAT they
have collected the VAT they have paid to other taxable persons. This mechanism ensures neutrality of
the tax regardless of how many transactions are involved
VAT is the most common taxation system over consumption and applied in almost all countries. Exceptions:
USA and Hong Kong.
It is applied and harmonized within the EU through Directives and Regulations. The EU introduced VAT
considering neutrality and that a transparent turnover was needed to achieve an efficient single market in
Europe.
Until 1992 VAT was levied by the country of origin, and it was messy as hell. Now, there is a distinction
between transactions within the EU and with third parties (outside EU countries). It has been changed to the
current Transitory Regime (the one applied nowadays) which is the Taxation at destination.
Currently countries are working on the 2016 VAT Action Plan.
● Initial idea: Change the system and apply VAT on origin, as it was initially designed
● Current trend: Keep VAT at destination (same as the current Transitory Regime) but in a different way.
The last publication made by the OECD said that it will be the supplier the one paying VAT to the tax
authorities but, in the transaction, VAT applicable on destination will be collected.
● More recent trends: Modifications and exceptions, for example to SMEs and creation of a one-stop
shop.

International transactions

Be aware! Importance to the

transportation of the good.

Exports (Outside the EU)

One of the countries is within the EU, there is a transportation to a third country. The goods exit from the
EU and are usually shipped by the exporter.
For the seller and direct exporter, there is no VAT applicable. → VAT exemption
Conditions to the exemption:
✓ Delivery of goods
✓ Shipping of goods by the seller or on its behalf outside of the UE
✓ Exit of goods is carried out subject to customs rules.
✓The taxpayer must keep documentation records justifying the transaction
during the statute of limitations period.
 Imports (From Outside EU)
Entrance of goods from a third country to the EU. For VAT purposes, an import is an entrance in the EU territory
of the following goods:
● Those coming from third countries outside the Custom Unions
● Those coming from third territories within the Customs Unions (i.e. Canary Islands)
There is no VAT when the goods are introduced in Free Zones (i.e. Zona Franca) or in Customs Warehouses.
VAT will take place when the goods are shipped outside these special VAT regimes or when the conditions to
benefit from them are not fulfilled.
→ Imports are subject to VAT which is due at the same time than Custom Duties: Tax payer will be the importer

Intra EU deliveries / acquisitions

At the same transaction we have the two events simultaneously. Remember, there has to be a transportation
of goods to be considered a delivery / acquisition.

Intra EU deliveries are fully exempt provided the following conditions are met:

● Goods should be shipped/transported from the territory of one EU country to the territory of another
EU country
● Shipping must be made by the seller, the buyer or a third party on behalf of any of the former ones→
Proof for the transportation must be provided.
● The acquirer of the goods must be registered for VAT purposes in the other country as an
entrepreneur or professional. No exemption applies when goods are sold to final consumers
○ The acquirer of the goods must be registered in the other country for VAT purposes.

Intra EU deliveries grant the taxpayer the right to fully deduct VAT. The seller is tax exempt.

- Obviously, the VAT is deductible if the transaction implies VAT.

Example:

Italian company selling goods to a French company.

The Italian company declares 0 VAT. And the recipient, the French company (self asses) declares the VAT →
REVERSE CHARGE MECHANISM IS APPLIED. → at French rate.
The intra EU delivery is exempt for the supply, so the VAT will only be payable by the acquirer.
Transitory regime defines:
● Who is the acquirer
● Who is the taxpayer
● Where is the tax paid – Local or origin?
“VAT is applied upon destination”
How does the acquirer pay VAT? Through reverse charge mechanisms.
The acquirer self-charges VAT and declares this output VAT simultaneously. The final Balance of the acquirer
will be 0, as Output VAT = Input VAT
The trend is that VAT will be changed (not yet!, 2020-2021 forecast) to a one-stop shop, in which all traders
will pay VAT at one place regardless of the country of trade

Reverse charge mechanism

✓ The taxpayer self-charges VAT and declares this output VAT

✓ The taxpayer deducts the self- charged VAT by offsetting it with output VAT

✓ This mechanism is applied in the same tax return, which makes it neutral → the company fully recovers
the VAT.

Triangular operations
A supplier, an intermediary and an acquirer, and transportation is only made once, between supplier and
acquirer. The intermediary should register for VAT purposes in the country where goods are dispatched and
declare the intra EU acquisition and then make an internal VAT subject delivery to the acquirer. Special
simplification of these rules has been enacted, in which the intra EU acquisition made by the intermediary in
the destination country will be exempt provided that the acquirer in the third is registered for VAT purposes.
- Three member states are involved, but only 1 shipping occurs.
Old Regime:
A → C: Shipping of merchandise
A → B: Sale, Intra EU delivery
B → C: “Intra EU acquisition”, as long as B is registered for VAT in C. Then, the B → C transaction is considered
a domestic sale

New regime
A → C: Shipping
A → B: Intra EU delivery (exempt)
B → C: B → Intra EU acquisition (and it is also exempt)
C → Intra EU acquisition, and subject to VAT (self-charging mechanism)

Services
The general rule is related to the location of the service: where the taxable event takes place and where VAT
should be collected.
The internal rules for the allocation of services are:
● Where the recipient of services is located, as long as the recipient is an entrepreneur or professional
qualifying as a VAT taxpayer
● Where the supplier of services is located, when the recipient is a final consumer (no VAT taxpayer).
Exceptions apply when the final consumer is established outside the EU in relation to transfer of
intangibles, advertising, advisory services, data management and insurance among others.

Specific rules apply to certain supplies of services related to:

● Real estate: Any service related to real estate will trigger VAT where the building is located.
● Transportation: where the transportation is carried out – territory. VAT will apply to the part of the
transportation that takes place in a specific territory.
● Telecommunication: there is a category with different channels: tv, radio signals, digital services…
there are rules to be enacted between 2019-2020. There are specific rules under VAT for transports of
goods and for services (separate rules), and there are rules for European trade and international trade
within the EU.
Base Erosion and Profit Shifting (BEPS) project

It refers to tax planning strategy that exploits gaps and mismatches to tax rules to artificially shift or to low no
tax locations where there is legal or no economic activity.
Even aggressive or illegal tax planning was not permitted, now even the legal one falls under the BEPS scope.
Sometimes these techniques are not necessarily illegal, but as long as they have the intention of shifting profits
in an artificial way, they will fall under this framework and will be restricted in some way. Also the concept of
aggressive tax planning has been developed and brings a new vision in how international taxation should
consider it.
BEPS project goes against tax evasion and shifting of profits.
There is no international tax scope, so BEPS tries to unify all the domestic rules together as the double tax
treaties. There is the need that all countries compromise and unify.

This artificial shifting of profits undermines the integrity and fairness of the tax system, so the BEPS also wants
to create a fair tax environment, because firms operating internationally and taking advantage of these gaps,
they are competing in an unfair position compared to the ones doing businesses in a domestic bases
(discrimination). Normally these techniques are done by international groups, so this also undermines the
individual tax payer will to pay taxes (he can consider that of the big companies avoid paying taxes, we should
also avoid them).

It is a cooperative project because they have been able to involve developing countries 🡪 Inclusive framework

BEPS package
It provides for 15 actions and they equip governments with the domestic and international instruments. This
project was started in September 2013 because the G20 leaders endorsed the action plan BEPS to the OECD. In
2013 the OECD released a report that concluded that no single tax rules enable BEPS but the interplay among
different tax issues. These issues are:
● domestic rules that are not coordinated among countries
● international tax standards have not always followed the changing global business environment
● lack of relevant information at the level of tax administration and policy makers
● the availability of harmful tax practices.
Since 2013 the G20 and the OECD countries, has been working on an equal footing not excluding anyone.
Developing countries have been engaged through different mechanisms:
● Direct participation in the committee on fiscal affairs
● Regional tax organizations (African Tax Administration Forum or Centro Iberoamericano de
Administraciones tributaries)
● Joint with other international organizations (IMF, World Bank or United Nations)
There have been public consultations to the businesses, the academics, governments, etc. for comments to
take into account. It is another way to make it cooperative and global. With these consultations they have
received more than 105.000 submissions. After two years of work the committee released 15 actions and the
respective documents to each of these actions.
It is designed to be implemented both in domestic laws and double tax treaties.
BEPS actions
1. Digital economy
There is normally an intern report with some of the actions released. In most cases they have opened
public consultation, comments received… and then we can find the final report.
The OECD created a tax on digital economy. They released this intern report in 2014.
Through digital economy they analyzed different items like permanent establishment. They are still
working on the measures. It does not only refer to direct but also indirect taxes, because they realized
that digital economy is a new environment that has scope for direct and indirect taxes.

2. Hybrids
They exploit differences on the tax treatment of an entities or instruments under the laws of two or
more jurisdictions to achieve double non-taxation including long term deferral.
Hybrid are situations/instruments where there is not a clear nature of the transaction and the
mismatch is because two different countries grant different treatments in the same situation.
This is another example of the coordination being implemented for the BEPS project.

3. Controlled Foreign Company (CFC) rules

They were created by the US in order to prevent losing tax revenues because they were kept in foreign
subsidiary. CFC are subsidiaries that are controlled by a parent company located in a specific
jurisdiction. What this action tries to prevent is that through the use of CFC I am avoiding the
remittent of the taxable profits to the parent company.

4. Interest deductions
If I finance, my activities through deb I will reduce my taxable base because I will be paying interests. It
focuses on avoiding this excessive erosion of the taxable base through interest deductions. It is based
on best practices. BEPS risk in this area may arise in 3 different scenarios:
● Groups placing higher levels of third-party debt in high tax countries.
● Group using intragroup loans to generate interest deductions in excess of the groups actual
third-party interest expenses.
● Using third party or intragroup financing to fund the generation of tax exempt income.
The approach in order to avoid the excess financing is based on a fixed ratio rule that limits entities
net deduction interest to a maximum percentage of EBITDA (between 10%-30%). This rule has also
been implemented by the Spanish law (30% maximum).

5. Harmful Tax Practices

They are focused on improving transparency in order to eliminate the classification of harmful. It
promotes the use of those regimes (beneficial regimes) in a world bases, and exchange information in
order to know who of the tax payers is benefiting from these regimes.

6. Treaty abuse
One of the main areas of concern is Treaty Shopping. The recommendations in this area were updating
the current double tax treaties by including the clause about the limitation of benefits, the beneficial
owner clause…
In order to prevent treaty shopping or treaty abuse they thought of the implementation of the
Principal Purpose Test. Under this test they try to find out the main purpose of the transaction, the
real economic interest, economic transaction or if it is just the purpose of benefiting from the tax
regime. Countries have committed to ensure a minimum level of protection – minimum standard, and
they proposed a combination of the limitation of the benefits clause with the principle purpose
transaction test or any other.
7. Permanent establishment status
They try to solve typically situations like virtual permanent establishment, but also the artificial
avoidance of permanent establishment through the fragmentation of activities. They also reinforced
the dependent agent notion, if it has been able to negotiate all the clauses, even if he is not the one
signing, it will be considered dependent agent. These changes are already implemented even though
the ones regarding digitalization are still being developed.

8. Transfer pricing – Intangibles

It is an area in need of development because tangibles are a very complex issue.

9. Transfer pricing – Risk and Capital

Risk allocation and the relevance it has I order to determine remuneration. Also referring to other net
transactional methods like profit split.

10. Transfer pricing – High Risk transactions

Like recharacterization of activities, evaluation methods, neutralizing the use of certain kinds of
payments. They are 3 actions in one.

11. BEPS data analysis

They provide for a methodology when collecting tax information. Of both tax payers and the
implementation of certain measures.

12. Disclosure of aggressive tax planning

It refers to the cooperation among different countries in order to be able to detect aggressive tax
planning practices.

13. Transfer pricing documentation

Action introducing the country by country reports. The current documentation standard comes from
this action.

14. Dispute resolution

Making dispute resolutions more effective. It refers that in the past countries were not provide for the
arbitration phase, so the clause was not effective. There are aspects in order to improve it. One of the
main areas is introducing the arbitration part in the mutual agreement procedure in order to make it
really effective.

15. Multilateral instrument

In order to make a quick implementation of some of the measures proposed regarding the DTC by the
BEPS project, the OECD considered that the best way to incorporate them would be by a multilateral
convention in which the countries could participate. The multilateral instrument is the way of
introducing the amendments to the treaties on a global basis.
It was signed June 2017 and it is foreseen to become effective in July 2018.