In the European Commission’s recommendation under Commissioner Semeta’s leadership on Aggressive Tax Planning there is a passage as follows
“Specifically, Member States are encouraged to include a clause in Double Tax Conventions (DTCs) concluded with other EU Member States and with third countries to resolve a specifically identified type of double non-taxation. The Commission also recommends the use of a common general anti-abuse rule. This would help to ensure coherence and effectiveness in an area where Member State practice varies considerably.”
The paper then goes on to describe a new clause for tax treaties as follows:
To give effect to point 3.1, Member States are encouraged to include an appropriate clause in their double taxation conventions. Such clause could read as follows:
‘Where this Convention provides that an item of income shall be taxable only in one of the contracting States or that it may be taxed in one of the contracting States, the other contracting State shall be precluded from taxing such item only if this item is subject to tax in the first contracting State’.
In case of multilateral conventions, the reference to the “other contracting State” should be replaced by a reference to the “other contracting States”.
It seems to me that this is one of the most important elements in the 43 point plan. A large number of the 43 measures are aimed at improving administration and coordination. This is all understandable in the current fiscal climate but there are three new initiatives (the double non tax clause, gaar and governance in third countries) of which this would appear to be the one most likely to be implemented quickly. So what will it mean in practice if it is adopted ?
Put simply it provides a taxing right to a state where the other end of the transaction is not taxed by the other state ie “the other contracting State shall be precluded from taxing such item only if this item is subject to tax in the first contracting State” . The aim is to eliminate double non taxation. Lets consider some examples :where a state provides a participation exemption on capital gains, it would presumably allow the other state to seek to tax the capital gain as it is only precluded from taxing if the item is subject to tax in the first contracting state. I have expressed the concern that it is a widely drawn clause and that taxpayers should focus on whether there are some unintended consequences of the potential width of the clause as drafted , taxpayers need to think about this urgently.
Another topical example could be, a taxpayer charges a royalty to an EU subsidiary for which a tax deduction is claimed by the EU subsidiary. Due to its tax planning, the other end of the transaction ends up in a jurisdiction which does not tax the royalty. How would this be treated under the new article? Would the EU jurisdiction seek to disallow the deduction because it is not taxable? If the royalty was subject to a de minimis level of tax it would appear that the new clause would not be effective as the item would be “subject to tax”.
While the aim of the clause is understandable – double non taxation, the question is, does it as currently drafted hit its intended targets or are there some unintended consequences?