MDT 2017

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1 United Nations Model Double Taxation Convention between Developed and Developing Countries 2017

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3 ST/ESA/PAD/SER.E/213 Department of Economic & Social Affairs United Nations Model Double Taxation Convention between Developed and Developing Countries 2017 Update asdf United Nations New York, 2017

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5 INTRODUCTION A. ORIGIN OF THE UNITED NATIONS MODEL CONVENTION 1. The United Nations Model Double Taxation Convention between Developed and Developing Countries (the United Nations Model Convention) forms part of the continuing international efforts aimed at eliminating double taxation. These efforts were begun by the League of Nations and pursued in the Organisation for European Economic Co-operation (OEEC) (now known as the Organisation for Economic Co-operation and Development (OECD)) and in regional forums, as well as in the United Nations, and have in general found concrete expression in a series of model or draft model bilateral tax conventions. 2. These Models, particularly the United Nations Model Convention and the OECD Model Tax Convention on Income and on Capital (the OECD Model Convention) have had a profound influence on interna - tional treaty practice, and have significant common provisions. The similarities between these two leading Models reflect the importance of achieving consistency where possible. On the other hand, the important areas of divergence exemplify, and allow a close focus upon, some key differences in approach or emphasis as exemplified in country practice. Such differences relate, in particular, to the issue of how far one country or the other should forego, under a bilateral tax treaty, taxing rights which would be available to it under domestic law, with a view to avoid - ing double taxation and encouraging investment. 3. The United Nations Model Convention generally favours reten - tion of greater so called “source country” taxing rights under a tax treaty — the taxation rights of the host country of investment— as compared to those of the “residence country” of the investor. This has long been regarded as an issue of special significance to developing countries, although it is a position that some developed countries also seek in their bilateral treaties. 4. The desirability of promoting greater inflows of foreign invest - ment to developing countries on conditions which are politically acceptable as well as economically and socially beneficial has been frequently affirmed in resolutions of the General Assembly and the iii

6 Introduction Economic and Social Council of the United Nations and the United Nations Conference on Trade and Development. The 2002 Monterrey 1 Consensus on Financing for Development and the follow up Doha 2 together rec Declaration on Financing for Development of 2008 - ognize the special importance of international tax cooperation in encouraging investment for development and maximizing domestic resource mobilisation, including by combating tax evasion. They also recognize the importance of supporting national efforts in these areas by strengthening technical assistance (in which this Model will play a vital part) and enhancing international cooperation and participation in addressing international tax matters (of which the United Nations Model Convention is one of the fruits). 5. The growth of investment flows between countries depends to a large extent on the prevailing investment climate. The prevention or elimination of international double taxation in respect of the same income — the effects of which are harmful to the exchange of goods and services and to the movement of capital and persons, constitutes a significant component of such a climate. 6. Broadly, the general objectives of bilateral tax treaties there - fore include the protection of taxpayers against double taxation with a view to improving the flow of international trade and investment and the transfer of technology. They also aim to prevent certain types of discrimination as between foreign investors and local taxpayers, and to provide a reasonable element of legal and fiscal certainty as a framework within which international operations can confidently be carried on. With this background, tax treaties should contribute to the furtherance of the development aims of developing countries. In addition, the treaties seek to improve cooperation between taxing authorities in carrying out their functions, including by the exchange of information with a view to preventing avoidance or evasion of taxes and by assistance in the collection of taxes. 6.1 Finally, it has become clear as a result of international focus on base erosion and profit shifting that treaties are not intended to facili - tate treaty shopping and other treaty abuses. 1 United Nations 2002, A/CONF.198/11. 2 A/CONF.212/L.1/Rev.1. United Nations 2008, iv

7 Introduction 7. The desirability of encouraging the conclusion of bilateral tax treaties between developed and developing countries was recognized by the Economic and Social Council (ECOSOC) of the United Nations, in its resolution 1273 (XLIII) adopted on 4 August 1967. This led to the Secretary-General setting up in 1968 the Ad Hoc Group of Experts on Tax Treaties between Developed and Developing Countries. The Group was composed of tax officials and experts from both developing and developed countries, appointed in their personal capacity. 8. In 1980, the United Nations published, as a result of the Ad Hoc Group of Experts’ deliberations, the United Nations Model Double Taxation Convention between Developed and Developing Countries, which was preceded in 1979 by the Manual for the Negotiation of Bilateral Tax Treaties between Developed and Developing Countries (the Manual). By its resolution 1980/13 of 28 April 1980, the Economic and Social Council renamed the Group of Experts as the “Ad Hoc Group of Experts on International Cooperation in Tax Matters” (the Ad Hoc Group of Experts) recognizing the importance of non tax treaty-related international tax cooperation issues. 9. In the 1990s, the Ad Hoc Group of Experts recognized that significant changes had taken place in the international economic, financial and fiscal environment. In addition, there was increasing focus on tax impacts of new financial instruments, transfer pricing, the growth of tax havens and globalization affecting international economic relations. The increasingly frequent updates to the OECD Model Convention contributed to the need for an ongoing review of process of greater reflection on international tax cooperation issues. Consequently, the Ad Hoc Group of Experts proceeded with the revision and update of the United Nations Model Convention and the Manual. This led to a new version of the United Nations Model 3 - ) and a new ver Convention (revised in 1999 and published in 2001 4 sion of the Manual (published electronically in 2003 ). 10. In 2005 the Ad Hoc Group of Experts was upgraded by con - version into a Committee structure, which remains its current form. 3 United Nations 2001, E.01. XVI.2. Available at: http://www.un.org/ esa/ffd/tax/index.htm. 4 http://www.un.org/esa/ffd/tax/manual.htm. v

8 Introduction The 25 members of the Committee of Experts on International Cooperation in Tax Matters are nominated by countries and chosen by the Secretary-General of the United Nations to act in their personal capacities for a period of 4 years. The Committee now directly reports to the ECOSOC. 11. In 2013, 25 new members were appointed to the Committee of Experts. At the time of completion of this updated version of the United Nations Model Convention, the members of the Committee 5 were as follows: Armando Lara Yaffar (Mexico) Chairperson of the Committee; Henry John Louie (United States of America) First vice Chairperson; Mohammed Amine Baina (Morocco) Second Vice Chairperson; Liselott Kana (Chile) Third Vice Chairperson; Pragya S. Saksena (India) Fourth Vice Chairperson; Nasser Mohammed Al Khalifa (Qatar); Bernadette May Evelyn Butler (Bahamas); Andrew Dawson (United Kingdom of Great Britain and Northern Ireland); Johan Cornelius de la Rey (South Africa); El Hadji Ibrahima Diop (Senegal); Noor Azian Abdul Hamid (Malaysia); Kim Jacinto-Henares (Philippines); Toshiyuki Kemmochi (Japan); Cezary Krysiak (Poland); Wolfgang Karl Lasars (Germany); Enrico Martino (Italy); Eric Nii Yarboi Mensah (Ghana); Ignatius Kawaza Mvula (Zambia); Carmel Peters (New Zealand); Jorge Antonio Deher Rachid (Brazil); Christoph Schelling (Switzerland); Stig B. Sollund (Norway); Xiaoyue Wang (China); Ingela Willfors (Sweden); and Ulvi Yusifov (Azerbaijan). B. SPECIAL CHARACTERISTICS OF THE UNITED NATIONS MODEL CONVENTION 12. The United Nations Model Convention represents a compromise between the source principle and the residence principle, although as noted above, it gives more weight to the source principle than does the OECD Model Convention. The United Nations Model Convention is not intended to be prescriptive, but to equip decision-makers in coun - tries with the information they need to understand the consequences 5 The countries nominating the members are listed for information only, because as noted above, members of the Committee act in their personal capacity, rather than as representatives of those countries. vi

9 Introduction of these differing approaches for their country’s specific situation. As noted in the Introduction to the previous version of the United Nations Model Convention, the provisions of the Model Convention are not themselves enforceable. Its provisions are not binding and should not be construed as formal recommendations of the United Nations. Rather, the United Nations Model Convention is intended to facilitate the negotiation, interpretation and practical application of bilateral tax treaties based upon its provisions. 13. The United Nations Model Convention seeks to be balanced in its approach. As a corollary to the principle of taxation at source the Articles of the Convention are based on a recognition by the source a ) taxation of income from foreign capital should take country that ( into account expenses allocable to the earnings of the income so that such income is taxed on a net basis, that ( b ) taxation should not be so high as to discourage investment and that ( c ) it should take into account the appropriateness of the sharing of revenue with the coun - try providing the capital. In addition, the United Nations Model Convention embodies the idea that it would be appropriate for the residence country to extend a measure of relief from double taxation through either a foreign tax credit or an exemption, as is also the case with the OECD Model Convention. 14. In drawing upon the United Nations Model Convention for guidance, a country should bear in mind the important relationship between treaties and domestic law, the nature of which may vary from country to country. In general, the provisions of tax treaties prevail over the provisions of domestic law in the event of a conflict between those provisions. More specifically, tax treaties establish which Contracting State shall have jurisdiction to tax a given item of income or capital and under what conditions and subject to which limitations it may do so. Consequently, countries wishing to enter into bilateral tax treaty negotiations should analyse carefully the applicable provi - sions of their domestic tax laws in order to assess the implications of applying the treaty. They should also discuss the relevant domestic laws of potential treaty partners, as part of the preparation for and negotiation of a treaty. 15. Domestic tax laws in their turn exert a substantial influence on the content of bilateral tax treaties. They are an important reason for vii

10 Introduction many of the differences between treaties, as countries seek to preserve domestic taxing rights in their treaty networks. Such domestic laws, and the treaty practice reflecting them, form the basis for the policy positions found in the various Models. Conversely, if countries do not exert certain taxing rights in domestic law, and see no likelihood of that charging, they generally do not seek to retain the ability to exert that taxing right under their treaties. Should their policy change, the domestic law may later be introduced to exert the domestic taxing right, but it would only operate to the extent that it was consistent with the treaty relationships. 16. This current revision of the United Nations Model Convention continues an ongoing process of review, which the Committee hopes will result in more frequent updates of particular Articles and Commentaries to keep up with developments, including in country practice, new ways of doing business, and new challenges. It will therefore operate as a process of continuous improvement. This means that some articles have not yet been substantively reviewed by the Committee. 17. The main objectives of this revision of the United Nations Model Convention have been to take account of developments in the area of international tax policies relevant for developing and developed countries. The Committee identified a number of issues that require further work. In particular it mandated one Subcommittee to address the issue of the taxation treatment of services in general and in a broad way including all related aspects and issues but the issue of taxation of fees for technical services should also be addressed in particular. The Subcommittee therefore focused its work on the drafting of the new article with its commentary which is now included in the 2017 update of the Model. It was recognized, however, that this was the initiation of extensive work. In the future, if the Committee so decides, any poten - tial conclusions that could be useful may be presented as a Committee Report which may shape the next revision of the United Nations Model Convention. The work programme of the Committee, including that on services, will be made available as it develops on the Committee’s 6 website. 6 http://www.un.org/esa/ffd/ffd-follow-up/tax-committee.html. viii

11 Introduction 17.1 In addition, the Committee has undertaken work on base ero - sion and profit shifting issues. Initially, the Committee focused on its own experiences and engaged with other relevant bodies, with a view to monitoring developments on base erosion and profit shifting issues and communicating on such issues with officials in developing coun - tries (especially the less developed) directly and through regional and inter-regional organisations. This communication was done with a view to help inform developing countries on such issues, help facilitate - the input of developing country experiences and views into the ongo ing United Nations work and help facilitate the input of developing country experiences and views into the OECD/G20 Action Plan on Base Erosion and Profit Shifting. In 2014 the Committee commenced work on changes to the United Nations Model Tax Convention to address base erosion and profit shifting issues either arising out of the work of the G20 and OECD or relating specifically to issues that arose in respect of the Convention. This update incorporates the results of work done on those issues. C. TAX POLICY CONSIDERATIONS THAT ARE RELEVANT TO THE DECISION OF WHETHER TO ENTER INTO A TAX TREATY OR AMEND AN EXISTING TREATY In 2005 the Committee established a Subcommittee on 17.2 Negotiation of Tax Treaties – Practical Issues. This Subcommittee pre - pared an update to the United Nations Manual for the Negotiation of Bilateral Tax Treaties between Developed and Developing Countries 7 which was adopted by the Committee in 2015 and published in 2016. The aim of the Manual is to provide a guide to all aspects of treaty negotiation, including a brief description of the Articles of the United Nations Model Convention, to negotiators of tax treaties. While every country should form its own policy considerations and define its objectives in relation to tax treaties, the Manual seeks to provide practical guidance on all aspects of treaty negotiations, including on how to prepare for and conduct negotiations. It examined in depth the most common reasons why a country would enter into a tax treaty with another, for example, the facilitation of inbound and outbound investment by removing or reducing double taxation or excessive 7 New York: United Nations, 2016. ix

12 Introduction source country taxation, the reduction of cross-border tax avoidance - and evasion through the exchange of information and mutual assis tance in collection of taxes, or for political reasons. Treaty negotiators in developing countries are encouraged to use this Manual in prepar - ing for tax treaty negotiations, in the light of their countries policy framework and the intended outcomes they wish to achieve. 17.3 In particular, the Committee noted that the Manual provides the following useful checklist of the benefits and costs commonly associated with tax treaties: Benefits: — Increased foreign investment as a result of removal or reduction of tax barriers — Greater access to foreign technology and skills — - Flow-on benefits to the local economy from increased for eign investment — Increased certainty for both taxpayers and tax administrations — Improved consistency for tax treatment — Protection for investment abroad — Avoidance of fiscal evasion Costs: — Immediate revenue costs — Affect or limit on the operation of certain domestic tax laws — Risk of treaty shopping and treaty abuse — Risk of double non-taxation Need for changes and/or clarifications to domestic law to — conform with tax treaties — Challenges to tax administration capacity to negotiate and administer tax treaties, including obligations under the mutual agreement procedure, exchange of information and, in some treaties, assistance in the collection of taxes 17.4 Following the work by the OECD and G20 on Action 6 (Pre - venting the Granting of Treaty Benefits in Inappropriate Circumstances), x

13 Introduction the OECD inserted a section into the Introduction to the OECD Model Convention on the tax policy considerations that are relevant to the decision of whether to enter into a tax treaty, amend an existing tax treaty, or, as a last resort, terminate a tax treaty. The Committee took note of the considerations identified by the OECD and suggests to consider them additionally beside the United Nations Manual for the Negotiation of Bilateral Tax Treaties between Developed and Developing Countries. The relevant section of the Commentary to the OECD Model Convention is as follows: 15.1 In 1997, the OECD Council adopted a recommendation that the Governments of member countries pursue their efforts - to conclude bilateral tax treaties with those member coun tries, and where appropriate with non-member countries, with which they had not yet entered into such conventions. Whilst the question of whether or not to enter into a tax treaty with another country is for each State to decide on the basis of differ - ent factors, which include both tax and non-tax considerations, tax policy considerations will generally play a key role in that decision. The following paragraphs describe some of these tax policy considerations, which are relevant not only to the ques - tion of whether a treaty should be concluded with a State but also to the question of whether a State should seek to modify or replace an existing treaty or even, as a last resort, terminate a treaty (taking into account the fact that termination of a treaty often has a negative impact on large number of taxpayers who are not concerned by the situations that result in the termina - tion of the treaty). 15.2 Since a main objective of tax treaties is the avoidance of double taxation in order to reduce tax obstacles to cross-border services, trade and investment, the existence of risks of double taxation resulting from the interaction of the tax systems of the two States involved will be the primary tax policy concern. Such risks of double taxation will generally be more important where there is a significant level of existing or projected cross-border trade and investment between two States. Most of the provi - sions of tax treaties seek to alleviate double taxation by allocat - ing taxing rights between the two States and it is assumed that where a State accepts treaty provisions that restrict its right to xi

14 Introduction tax elements of income, it generally does so on the understand - ing that these elements of income are taxable in the other State. Where a State levies no or low income taxes, other States should consider whether there are risks of double taxation that would justify, by themselves, a tax treaty. States should also consider whether there are elements of another State’s tax system that could increase the risk of non-taxation, which may include tax advantages that are ring-fenced from the domestic economy. 15.3 Accordingly, two States that consider entering into a tax - treaty should evaluate the extent to which the risk of double tax ation actually exists in cross-border situations involving their residents. A large number of cases of residence-source juridical double taxation can be eliminated through domestic provi - sions for the relief of double taxation (ordinarily in the form of either the exemption or credit method) which operate without the need for tax treaties. Whilst these domestic provisions will likely address most forms of residence-source juridical double taxation, they will not cover all cases of double taxation, espe - cially if there are significant differences in the source rules of the two States or if the domestic law of these States does not allow for unilateral relief of economic double taxation (e.g. in the case of a transfer pricing adjustment made in another State). 15.4 Another tax policy consideration that is relevant to the conclusion of a tax treaty is the risk of excessive taxation that may result from high withholding taxes in the source State. - Whilst mechanisms for the relief of double taxation will nor mally ensure that such high withholding taxes do not result in double taxation, to the extent that such taxes levied in the State of source exceed the amount of tax normally levied on profits in the State of residence, they may have a detrimental effect on cross-border trade and investment. Further tax considerations that should be taken into 15.5 account when considering entering into a tax treaty include the various features of tax treaties that encourage and foster eco - nomic ties between countries, such as the protection from dis - criminatory tax treatment of foreign investment that is offered by the non-discrimination rules of Article 24, the greater cer - tainty of tax treatment for taxpayers who are entitled to benefit xii

15 Introduction from the treaty and the fact that tax treaties provide, through the mutual agreement procedure, together with the possibility for Contracting States of moving to arbitration, a mechanism for the resolution of cross-border tax disputes. - 15.6 An important objective of tax treaties being the preven tion of tax avoidance and evasion, States should also consider whether their prospective treaty partners are willing and able to implement effectively the provisions of tax treaties concern - ing administrative assistance, such as the ability to exchange tax information, this being a key aspect that should be taken into account when deciding whether or not to enter into a tax treaty. The ability and willingness of a State to provide assis - tance in the collection of taxes would also be a relevant factor to take into account. It should be noted, however, that in the absence of any actual risk of double taxation, these adminis - trative provisions would not, by themselves, provide a sufficient tax policy basis for the existence of a tax treaty because such administrative assistance could be secured through more tar - geted alternative agreements, such as the conclusion of a tax information exchange agreement or the participation in the multilateral Convention on Mutual Administrative Assistance 8 in Tax Matters. D. MAIN FEATURES OF THIS REVISION OF THE UNITED NATIONS MODEL CONVENTION 18. The main differences between the Articles of this version of the United Nations Model Convention and the previous version published in 2012 are as follows: — A modified title of the Convention and a new preamble of the Convention emphasizing that treaties should not create opportunities for tax avoidance or evasion, including through treaty shopping; — A new version of Article 1 that includes a fiscally transpar - ent entity clause, and a saving clause which clarifies that residence taxation is generally preserved under tax treaties; 8 [Footnote to paragraph 15.6:] Available at http://www.oecd.org/ctp/ exchange-of-tax-information/ENG-Amended-Convention.pdf. xiii

16 Introduction A modified version of Article 4 that includes a new “tie — breaker” rule for determining the treaty residence of dual-resident persons other than individuals; A modified version of Article 5 to prevent the avoidance of — permanent establishment status; A modified Article 10 to change the circumstances in which — a lower rate applies for dividends on direct ownership of shares above a 25% threshold; — A new Article 12A to provide for source taxation of fees for technical services; — A new version of Article 13, paragraph 4 to modify the scope of the land-rich company rule; — A modified version of Article 13, paragraph 5 for consist - ency with Article 13, paragraph 4; — Changes to Articles 23A and 23B to clarify that there is no obligation to provide relief for tax imposed on a solely res - idence basis; A new Article 29 that contains provisions relating to entitle - — - ment to treaty benefits. These include a limitation on ben efits rule, a third state permanent establishment rule and a general anti-abuse rule. 19. There have been changes to the Commentaries on the Articles to reflect the changes referred to above. E. THE COMMENTARIES 20. The Commentaries on the Articles are regarded as part of the United Nations Model Convention, along with the Articles themselves. The United Nations Model Double Taxation Convention between Developed and Developing Countries is referred to in the Commentaries on the Articles as “the United Nations Model Convention”. The OECD Model Tax Convention on Income and on Capital is referred to in the Commentaries on the Articles as “the OECD Model Convention”, and ref - erences are to the 2014 version of that Model unless otherwise indicated. Sometimes wording from a different version of the OECD Commentary is quoted as being more relevant than the 2014 version to interpreting United Nations Model Convention, and this is noted in such cases. xiv

17 Introduction 21. In quoting the Commentaries on the Articles of the OECD - Model Convention, sometimes parts of a paragraph or entire para graphs have been omitted as not being applicable, for whatever reason, to the interpretation of the United Nations Model Convention. In such cases, the omission is indicated by ellipsis [...]. It cannot necessarily be assumed that non-inclusion, of itself, represents any disagreement with the content of the deleted provisions, and the context of the omis - sion should be considered in determining whether the omitted words were seen as irrelevant to interpretation of the United Nations Model Convention, on the one hand, or were instead left for future consider - ation. In some cases, the OECD Model Convention wording is quoted, but with minor amendments included in square brackets ([ ]) to reflect a relevant difference in the United Nations Model Convention, such as the retention of the “fixed base” concept. Where quoted OECD Model convention passages include footnotes, the footnotes have been given new numbering, rather than retaining the original OECD numbering. 22. In quoting the Articles and Commentaries of the OECD Model Convention it is noted that various OECD Member States have expressed “reservations” on certain Articles and have made “obser - vations” on particular aspects of the Commentaries and that some non-OECD Member States have expressed “positions” in relation to certain Articles and Commentaries. Such formal expressions of dif - ferences of view to those taken in the OECD Model Convention are contained in the text of the OECD Model Convention, as revised from time to time. The Committee has recognized in preparing this update to the United Nations Model Convention that such expressions of country views are a useful aspect of the OECD Model Convention in terms of understanding how it is interpreted and applied by the specific countries expressing those views, even though they have not been repeated in the text of the United Nations Model Convention for practical reasons. 23. This updated version of the United Nations Model Convention often reflects views upon which a consensus could not be reached, with, for example, other views held by one or more members also being noted. This has allowed a broader expression of views and approaches that the Committee considers may assist in the interpreta - tion and application of bilateral tax treaties. It follows, however, that it xv

18 Introduction should not be assumed that any individual member of the Committee took a particular view in respect of any particular issue addressed in this Convention. Additionally, in some cases, the views reflected in the Commentaries relate to discussions held by the former Group of Experts, or held by the Committee before or after particular individu - als were members. 24. The role of the Financing for Development Office Secretariat, including Michael Lennard, Secretary of the Committee, in complet - ing this update is acknowledged, as is the technical assistance given by Brian Arnold, Claire McLellan, Bob Michel and Jacques Sasseville. The editorial assistance of Mary Lee Kortes and Janaina Muller is also recognized. xvi

19 Contents INTRODUCTION ... iii ... Origin of the United Nations Model Convention A. iii B. Special characteristics of the United Nations Model Convention vi C. Tax policy considerations that are relevant to the decision of ix whether to enter into a tax treaty or amend an existing treaty .. Main features of this revision of the United Nations Model D. xiii Convention ... ... The commentaries E. xiv Part One Articles of the United Nations Model Double Taxation Convention between Developed and Developing Countries SUMMARY OF THE CONVENTION ... 3 ... 5 TITLE OF THE CONVENTION PREAMBLE OF THE CONVENTION ... 5 I SCOPE OF THE CONVENTION ( Article 1 and 2 ) ... 7 II DEFINITIONS ( Articles 3 to 5 ) ... 9 III TAXATION OF INCOME ( Articles 7 to 21 ) ... 15 IV Article 22 ) ... 32 TAXATION OF CAPITAL ( V METHODS FOR THE ELIMINATION OF DOUBLE Article 23 ) ... 33 TA X ATION ( VI SPECIAL PROVISIONS ( Articles 24 to 29 ) ... 35 VII FINAL PROVISIONS ( Articles 30 to 31 ) ... 56 Pa r t Tw o Commentaries on the Articles of the United Nations Model Double Taxation Convention between Developed and Developing Countries Commentary on chapter I: SCOPE OF THE CONVENTION ... 59 59 1: P ersons covered ... Article 122 Article 2: T axes covered ... xvii

20 Contents Commentary on chapter II: 127 DEFINITIONS ... eneral definitions 127 G Article 3: ... Article 4 : Resident ... 132 Permanent establishment ... 143 Article 5 : TAXATION OF INCOME ... 209 Commentary on chapter III: Income from immovable property 209 Article 6: ... Business profits ... 212 Article 7 : International shipping and air transport ... 238 Article 8: Article Associated enterprises ... 251 9: Dividends ... 257 Ar ticle 10: 11 : Interest ... 277 Article : Royalties ... 295 12 Article : Fees for technical services ... 318 Article 12A : ... Capital gains Article 13 362 A r t icle 14 : ... 378 Independent personal services : ... 382 Article 15 Dependent personal services Article 16 : Directors’ fees and remuneration of top-level ... 410 managerial officials : Ar ticle 17 ... 412 Artistes and sportspersons Article : Pensions and social security payments ... 419 18 Article 19 : Government service ... 442 Article 20 : ... 448 Students : Article 21 ... 454 Other income Commentary on chapter IV: TA X ATION ON CAPITAL ... 461 Article 22: Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 461 Commentary on chapter V: METHODS FOR THE ELIMINATION OF DOUBLE TAXATION ... 465 Article 23: Methods for the elimination of double taxation ... 465 Commentary on chapter VI: SPECIAL PROVISIONS ... 515 515 Article 24: Non-discrimination ... xviii

21 Contents utual agreement procedure ... 547 M Article 25: 26: E xchange of information ... 634 Article 27: A ssistance in the collection of taxes ... Article 684 Article 28: M embers of diplomatic missions and consular posts 696 ... Article 29: E ntitlement to benefits 698 Commentary on chapter VII: FINAL PROVISIONS ... 803 803 Articles 30 and 31: E ntry into force and termination ... xix

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23 Part One ARTICLES OF THE UNITED NATIONS MODEL DOUBLE TAXATION CONVENTION BETWEEN DEVELOPED AND DEVELOPING COUNTRIES

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25 SUMMARY OF THE CONVENTION Title and Preamble Chapter I Scope of the Convention Persons covered Article 1 Taxes covered Article 2 Chapter II Definitions Article 3 General definitions Article 4 Resident Article 5 Permanent establishment Chapter III Taxation of income Article 6 Income from immovable property Business profits Article 7 Article 8 International shipping and air transport (alterna - tive A and B) Article 9 Associated enterprises Article 10 Dividends Article 11 Interest Article 12 Royalties Article 12A Fees for technical services Article 13 Capital gains Article 14 Independent personal services Article 15 Dependent personal services Article 16 Directors’ fees and remuneration of top-level manage - rial officials Article 17 Artistes and sportspersons Article 18 Pensions and social security payments (alterna - tive A and B) 3

26 Article 19 Government service Article 20 Students Article 21 Other income Chapter IV Taxation of capital Capital Article 22 Chapter V Methods for elimination of double taxation Article 23 A Exemption method Article 23 B Credit method Chapter VI Special provisions Article 24 Non-discrimination Article 25 Mutual agreement procedure (alternative A and B) Article 26 Exchange of information Article 27 Assistance in the collection of taxes Article 28 Members of diplomatic missions and consular posts Article 29 Entitlement to benefits Chapter VII Final provisions Article 30 Entry into force Termination Article 31 4

27 TITLE OF THE CONVENTION Convention between (State A) and (State B) for the elimination of double taxation with respect to taxes on income and capital and the prevention of tax avoidance and evasion 9 PREAMBLE OF THE CONVENTION (State A) and (State B), Desiring to further develop their economic relationship and to enhance their cooperation in tax matters, Intending to conclude a Convention for the elimination of double tax - ation with respect to taxes on income and on capital without creat - ing opportunities for non-taxation or reduced taxation through tax avoidance or evasion (including through treaty-shopping arrange - ments aimed at obtaining reliefs provided in this Convention for the indirect benefit of residents of third States) Have agreed as follows: 9 The Preamble of the Convention shall be drafted in accordance with the constitutional procedures of the Contracting States. 5

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29 Articles 1 and 2 Chapter I SCOPE OF THE CONVENTION Article 1 PERSONS COVERED 1. This Convention shall apply to persons who are residents of one or both of the Contracting States. 2. For the purposes of this Convention, income derived by or through an entity or arrangement that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State shall be considered to be income of a resident of a Contracting State but only to the extent that the income is treated, for purposes of taxation by that State, as the income of a resident of that State. 3. This Convention shall not affect the taxation, by a Contracting State, of its residents except with respect to the benefits granted under [paragraph 3 of Article 7], paragraph 2 of Article 9 and Articles 19, 20, 23 A [23 B], 24 and 25 A [25 B] and 28. Article 2 TA X ES COVER ED 1. This Convention shall apply to taxes on income and on capital imposed on behalf of a Contracting State or of its political subdivi - sions or local authorities, irrespective of the manner in which they are levied. 2. There shall be regarded as taxes on income and on capital all taxes imposed on total income, on total capital, or on elements of income or of capital, including taxes on gains from the alienation of movable or immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation. 7

30 Article 2 The existing taxes to which the Convention shall apply are in 3. particular: ( a ) (in State A): ... ( b ) (in State B): ... 4. The Convention shall apply also to any identical or substan - tially similar taxes which are imposed after the date of signature of the Convention in addition to, or in place of, the existing taxes. The competent authorities of the Contracting States shall notify each other of significant changes made to their tax law. 8

31 Article 3 Chapter II DEFINITIONS Article 3 GENERAL DEFINITIONS For the purposes of this Convention, unless the context other - 1. wise requires: a ) The term “person” includes an individual, a company and any ( other body of persons; b ( ) The term “company” means any body corporate or any entity that is treated as a body corporate for tax purposes; ( c The terms “enterprise of a Contracting State” and “enterprise ) of the other Contracting State” mean respectively an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of the other Contracting State; ( d ) The term “international traffic” means any transport by a ship or aircraft, except when the ship or aircraft is operated solely between places in a Contracting State and the enterprise that operates the ship or aircraft is not an enterprise of that State; ( e ) The term “competent authority” means: (i) (In State A): ... (ii) (In State B): ... ( f ) The term “national” means: any individual possessing the nationality of a (i) Contracting State (ii) any legal person, partnership or association deriving its status as such from the laws in force in a Contracting State. 2. As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that 9

32 Articles 3 and 4 State prevailing over a meaning given to the term under other laws of that State. Article 4 RESIDENT For the purposes of this Convention, the term “resident of a 1. Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of - incorporation, place of management or any other criterion of a sim ilar nature, and also includes that State and any political subdivision or local authority thereof. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein. 2. Where by reason of the provisions of paragraph 1 an individual - is a resident of both Contracting States, then his status shall be deter mined as follows: a ) He shall be deemed to be a resident only of the State in which he ( has a permanent home available to him; if he has a permanent home available to him in both States, he shall be deemed to be a resident only of the State with which his personal and economic relations are closer (centre of vital interests); b ) If the State in which he has his centre of vital interests cannot ( be determined, or if he has not a permanent home available to him in either State, he shall be deemed to be a resident only of the State in which he has an habitual abode; ( c ) If he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident only of the State of which he is a national; d ) If he is a national of both States or of neither of them, the com - ( petent authorities of the Contracting States shall settle the ques - tion by mutual agreement. 3. Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, the compe - tent authorities of the Contracting States shall endeavour to determine 10

33 Articles 4 and 5 by mutual agreement the Contracting State of which such person shall be deemed to be a resident for the purposes of the Convention, having regard to its place of effective management, the place where it is incor - porated or otherwise constituted and any other relevant factors. In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by this Convention except to the extent and in such manner as may be agreed upon by the competent authorities of the Contracting States. Article 5 PERMANENT ESTABLISHMENT For the purposes of this Convention, the term “permanent 1. establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on. The term “permanent establishment” includes especially: 2. ( a A place of management; ) ( b ) A branch; ( c ) An office; ( d ) A factory; e ) A workshop; ( ( ) A mine, an oil or gas well, a quarry or any other place of extrac - f tion of natural resources. 3. The term “permanent establishment” also encompasses: ( a ) A building site, a construction, assembly or installation project or supervisory activities in connection therewith, but only if such site, project or activities last more than six months; ( b ) The furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue within a Contracting State for a period or peri - ods aggregating more than 183 days in any 12-month period commencing or ending in the fiscal year concerned. 11

34 Article 5 4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: ( The use of facilities solely for the purpose of storage or display a ) of goods or merchandise belonging to the enterprise; b ) The maintenance of a stock of goods or merchandise belonging ( to the enterprise solely for the purpose of storage or display; ( c ) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; ( ) The maintenance of a fixed place of business solely for the pur - d - pose of purchasing goods or merchandise or of collecting infor mation, for the enterprise; e ) The maintenance of a fixed place of business solely for the pur - ( pose of carrying on, for the enterprise, any other activity; ( f ) The maintenance of a fixed place of business solely for any com - bination of activities mentioned in subparagraphs ( a e ), ) to ( (f) , the provided that such activity or, in the case of subparagraph overall activity of the fixed place of business, is of a preparatory or auxiliary character. 4.1 Paragraph 4 shall not apply to a fixed place of business that is used or maintained by an enterprise if the same enterprise or a closely related enterprise carries on business activities at the same place or at another place in the same Contracting State and: (a) that place or other place constitutes a permanent establishment for the enterprise or the closely related enterprise under the provisions of this Article, or (b) the overall activity resulting from the combination of the activ - ities carried on by the two enterprises at the same place, or by the same enterprise or closely related enterprises at the two places, is not of a preparatory or auxiliary character, provided that the business activities carried on by the two enterprises at the same place, or by the same enterprise or closely related enter - prises at the two places, constitute complementary functions that are part of a cohesive business operation. 12

35 Article 5 5. Notwithstanding the provisions of paragraphs 1 and 2 but subject to the provisions of paragraph 7, where a person is acting in a Contracting State on behalf of an enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, if such a person: ( a habitually concludes contracts, or habitually plays the princi - ) pal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise, and these contracts are (i) in the name of the enterprise, or (ii) for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or (iii) for the provision of services by that enterprise, unless the activities of such person are limited to those men - tioned in paragraph 4 which, if exercised through a fixed place of business (other than a fixed place of business to which par - agraph 4.1 would apply), would not make this fixed place of business a permanent establishment under the provisions of that paragraph; or ( ) the person does not habitually conclude contracts nor plays the b principal role leading to the conclusion of such contracts, but habitually maintains in that State a stock of goods or merchan - dise from which that person regularly delivers goods or mer - chandise on behalf of the enterprise. Notwithstanding the preceding provisions of this Article but 6. subject to the provisions of paragraph 7, an insurance enterprise of a Contracting State shall, except in regard to re-insurance, be deemed to have a permanent establishment in the other Contracting State if it collects premiums in the territory of that other State or insures risks situated therein through a person. 7. Paragraphs 5 and 6 shall not apply where the person acting in a Contracting State on behalf of an enterprise of the other Contracting State carries on business in the first-mentioned State as an independ - ent agent and acts for the enterprise in the ordinary course of that 13

36 Article 5 business. Where, however, a person acts exclusively or almost exclu - sively on behalf of one or more enterprises to which it is closely related, that person shall not be considered to be an independent agent within the meaning of this paragraph with respect to any such enterprise. 8. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other. 9. For the purposes of this Article, a person or enterprise is closely related to an enterprise if, based on all the relevant facts and circum - stances, one has control of the other or both are under the control of the same persons or enterprises. In any case, a person or enterprise shall be considered to be closely related to an enterprise if one pos - sesses directly or indirectly more than 50 per cent of the beneficial interest in the other (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) or if another person or enterprise possesses directly or indirectly more than 50 per cent of the beneficial interest (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the bene - ficial equity interest in the company) in the person and the enterprise or in the two enterprises. 14

37 Articles 6 and 7 Chapter III TAXATION OF INCOME Article 6 INCOME FROM IMMOVABLE PROPERTY 1. Income derived by a resident of a Contracting State from immovable property (including income from agriculture or forestry) situated in the other Contracting State may be taxed in that other State. The term “immovable property” shall have the meaning which 2. it has under the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable prop - erty and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources; ships and aircraft shall not be regarded as immova - ble property. The provisions of paragraph 1 shall also apply to income 3. derived from the direct use, letting or use in any other form of immov - able property. 4. The provisions of paragraphs 1 and 3 shall also apply to the income from immovable property of an enterprise and to income from immovable property used for the performance of independent per - sonal services. Article 7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State shall be tax - able only in that State unless the enterprise carries on business in the 15

38 Article 7 other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of a ) that permanent establishment; ( b ) sales in them as is attributable to ( that other State of goods or merchandise of the same or similar kind as c ) other business those sold through that permanent establishment; or ( activities carried on in that other State of the same or similar kind as those effected through that permanent establishment. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment. 3. In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the business of the permanent establishment including executive and general administrative expenses so incurred, whether in the State in which the permanent establishment is situated or elsewhere. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar pay - ments in return for the use of patents or other rights, or by way of com - mission, for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the permanent establishment. Likewise, no account shall be taken, in the determination of the profits of a permanent establishment, for amounts charged (otherwise than towards reimbursement of actual expenses), by the permanent establishment to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents or other rights, or by way of commission for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices. 16

39 Articles 7 and 8 4. In so far as it has been customary in a Contracting State to determine the profits to be attributed to a permanent establishment on the basis of an apportionment of the total profits of the enterprise to its various parts, nothing in paragraph 2 shall preclude that Contracting State from determining the profits to be taxed by such an apportion - ment as may be customary; the method of apportionment adopted shall, however, be such that the result shall be in accordance with the principles contained in this Article. 5. For the purposes of the preceding paragraphs, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to t he cont ra r y. 6. Where profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article. (NOTE: The question of whether profits should be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods and merchandise for the enterprise was not resolved. It should therefore be settled in bilateral negotiations.) Article 8 INTERNATIONAL SHIPPING AND AIR TRANSPORT Article 8 (alternative A) 1. Profits of an enterprise of a Contracting State from the opera - tion of ships or aircraft in international traffic shall be taxable only in that State. 2. The provisions of paragraph 1 shall also apply to profits from the participation in a pool, a joint business or an international operat - ing agency. 17

40 Articles 8 and 9 Article 8 (alternative B) Profits of an enterprise of a Contracting State from the opera 1. - tion of aircraft in international traffic shall be taxable only in that State. 2. Profits of an enterprise of a Contracting State from the opera - tion of ships in international traffic shall be taxable only in that State unless the shipping activities arising from such operation in the other Contracting State are more than casual. If such activities are more than casual, such profits may be taxed in that other State. The profits to be taxed in that other State shall be determined on the basis of an appropriate allocation of the overall net profits derived by the enter - prise from its shipping operations. The tax computed in accordance with such allocation shall then be reduced by ___ per cent. (The per - centage is to be established through bilateral negotiations.) 3. The provisions of paragraphs 1 and 2 shall also apply to profits from the participation in a pool, a joint business or an international operating agency. Article 9 ASSOCIATED ENTERPRISES 1. Where: ( a an enterprise of a Contracting State participates directly or ) indirectly in the management, control or capital of an enter - prise of the other Contracting State, or ( b ) the same persons participate directly or indirectly in the man - agement, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State, and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. 18

41 Articles 9 and 10 2. Where a Contracting State includes in the profits of an enterprise of that State — and taxes accordingly — profits on which an enterprise of the other Contracting State has been charged to tax in that other State and the profits so included are profits which would have accrued to the enterprise of the first-mentioned State if the conditions made between the two enterprises had been those which would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be had to the other provisions of the Convention and the competent authorities of the Contracting States shall, if necessary, consult each other. The provisions of paragraph 2 shall not apply where judicial, 3. administrative or other legal proceedings have resulted in a final ruling that by actions giving rise to an adjustment of profits under paragraph 1, one of the enterprises concerned is liable to penalty with respect to fraud, gross negligence or wilful default. Article 10 DIVIDENDS 1. Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State. 2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed: ( a ) ___ per cent (the percentage is to be established through bilat - eral negotiations) of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) which holds directly at least 25 per cent of the capital of the company paying the dividends throughout a 365 day period that includes the day of the payment of the dividend (for the purpose of computing that period, no account shall be taken of changes 19

42 Article 10 of ownership that would directly result from a corporate reor - ganisation, such as a merger or divisive reorganisation, of the company that holds the shares or that pays the dividend); b ) ___ per cent (the percentage is to be established through bilat - ( eral negotiations) of the gross amount of the dividends in all other cases. The competent authorities of the Contracting States shall by mutual - agreement settle the mode of application of these limitations. This par agraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid. The term “dividends” as used in this Article means income 3. from shares, “jouissance” shares or “jouissance” rights, mining shares, founders’ shares or other rights, not being debt claims, participating - in profits, as well as income from other corporate rights which is sub jected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident. 4. The provisions of paragraphs 1 and 2 shall not apply if the ben - eficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the com - - pany paying the dividends is a resident, through a permanent estab lishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such case the provi - sions of Article 7 or Article 14, as the case may be, shall apply. 5. Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except in so far as such dividends are paid to a resident of that other State or in so far as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State, nor subject the company’s undistrib - uted profits to a tax on the company’s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State. 20

43 Article 11 Article 11 INTEREST 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State, but if the ben - eficial owner of the interest is a resident of the other Contracting State, the tax so charged shall not exceed ___ per cent (the percentage is to be established through bilateral negotiations) of the gross amount of the interest. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this limitation. The term “interest” as used in this Article means income from 3. debt claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor’s profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late pay - ment shall not be regarded as interest for the purpose of this Article. 4. The provisions of paragraphs 1 and 2 shall not apply if the ben - eficial owner of the interest, being a resident of a Contracting State, carries on business in the other Contracting State in which the interest - arises, through a permanent establishment situated therein, or per forms in that other State independent personal services from a fixed base situated therein, and the debt claim in respect of which the inter - est is paid is effectively connected with ( a ) such permanent establish - ment or fixed base, or with ( b ) business activities referred to in ( c ) of paragraph 1 of Article 7. In such cases the provisions of Article 7 or Article 14, as the case may be, shall apply. 5. Interest shall be deemed to arise in a Contracting State when the payer is a resident of that State. Where, however, the person paying the interest, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in con - nection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment 21

44 Articles 11 and 12 or fixed base, then such interest shall be deemed to arise in the State in which the permanent establishment or fixed base is situated. 6. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention. Article 12 ROYA LT I E S 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed ___ per cent (the percentage is to be established through bilateral negotiations) of the gross amount of the royalties. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this limitation. 3. The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cin - ematograph films, or films or tapes used for radio or television broad - casting, any patent, trademark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment or for information concerning industrial, com - mercial or scientific experience. 4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the 22

45 Articles 12 and 12A royalties arise, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right or property in respect of which a ) such permanent the royalties are paid is effectively connected with ( establishment or fixed base, or with ( b ) business activities referred to c ) of paragraph 1 of Article 7. In such cases the provisions of Article in ( 7 or Article 14, as the case may be, shall apply. 5. Royalties shall be deemed to arise in a Contracting State when the payer is a resident of that State. Where, however, the person paying the royalties, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the liability to pay the royalties was incurred, and such royalties are borne by such permanent establishment or fixed base, then such royalties shall be deemed to arise in the State in which the permanent establishment or fixed base is situated. 6. Where by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, - the amount of the royalties, having regard to the use, right or infor mation for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the pay - ments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention. Article 12A FEES FOR TECHNICAL SERVICES Fees for technical services arising in a Contracting State and 1. paid to a resident of the other Contracting State may be taxed in that other State. 2. However, notwithstanding the provisions of Article 14 and sub - ject to the provisions of Articles 8, 16 and 17, fees for technical services arising in a Contracting State may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if 23

46 Article 12A the beneficial owner of the fees is a resident of the other Contracting State, the tax so charged shall not exceed ___ percent of the gross amount of the fees [the percentage to be established through bilateral negotiations]. 3. The term “fees for technical services” as used in this Article means any payment in consideration for any service of a managerial, technical or consultancy nature, unless the payment is made: (a) to an employee of the person making the payment; (b) for teaching in an educational institution or for teaching by an educational institution; or (c) by an individual for services for the personal use of an individual. 4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of fees for technical services, being a resident of a Contracting State, carries on business in the other Contracting State in which the fees for technical services arise through a permanent establishment situated in that other State, or performs in the other Contracting State independent personal services from a fixed base sit - uated in that other State, and the fees for technical services are effec - tively connected with: (a) such permanent establishment or fixed base, or (b) business activities referred to in (c) of paragraph 1 of Article 7. In such cases the provisions of Article 7 or Article 14, as the case may be, shall apply. 5. For the purposes of this Article, subject to paragraph 6, fees for technical services shall be deemed to arise in a Contracting State if the payer is a resident of that State or if the person paying the fees, whether that person is a resident of a Contracting State or not, has in a Contracting State a permanent establishment or a fixed base in connection with which the obligation to pay the fees was incurred, and such fees are borne by the permanent establishment or fixed base. 6. For the purposes of this Article, fees for technical services shall be deemed not to arise in a Contracting State if the payer is a resident of that State and carries on business in the other Contracting State through a permanent establishment situated in that other State or per - forms independent personal services through a fixed base situated in 24

47 Articles 12A and 13 that other State and such fees are borne by that permanent establish - ment or fixed base. 7. Where, by reason of a special relationship between the payer and the beneficial owner of the fees for technical services or between both of them and some other person, the amount of the fees, having regard to the services for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the fees shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention. Article 13 CAPITAL GAINS 1. Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other State. 2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enter - prise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or of such fixed base, may be taxed in that other State. 3. Gains that an enterprise of a Contracting State that operates ships or aircraft in international traffic derives from the alienation of such ships or aircraft, or of movable property pertaining to the opera - tion of such ships or aircraft, shall be taxable only in that State. 4. Gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value 25

48 Articles 13 and 14 directly or indirectly from immovable property, as defined in Article 6, situated in that other State. 5. Gains, other than those to which paragraph 4 applies, derived by a resident of a Contracting State from the alienation of shares of a company, or comparable interests, such as interests in a partnership or trust, which is a resident of the other Contracting State, may be taxed in that other State if the alienator, at any time during the 365 days preceding such alienation, held directly or indirectly at least ___ per cent (the percentage is to be established through bilateral negotiations) of the capital of that company or entity. 6. Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3, 4 and 5 shall be taxable only in the Contracting State of which the alienator is a resident. Article 14 INDEPENDENT PERSONAL SERVICES 1. Income derived by a resident of a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that State except in the following circumstances, when such income may also be taxed in the other Contracting State: ( a If he has a fixed base regularly available to him in the other ) Contracting State for the purpose of performing his activities; in that case, only so much of the income as is attributable to that fixed base may be taxed in that other Contracting State; or ( b ) If his stay in the other Contracting State is for a period or peri - ods amounting to or exceeding in the aggregate 183 days in any twelve-month period commencing or ending in the fiscal year concerned; in that case, only so much of the income as is derived from his activities performed in that other State may be taxed in that other State. 2. The term “professional services” includes especially independ - ent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, archi - tects, dentists and accountants. 26

49 Articles 15 and 16 Article 15 DEPENDENT PERSONAL SERVICES 1. Subject to the provisions of Articles 16, 18 and 19, salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived there - from may be taxed in that other State. Notwithstanding the provisions of paragraph 1, remuneration 2. - derived by a resident of a Contracting State in respect of an employ ment exercised in the other Contracting State shall be taxable only in the first-mentioned State if: ( a ) The recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in any twelve-month period commencing or ending in the fiscal year concerned; and ( b ) The remuneration is paid by, or on behalf of, an employer who is not a resident of the other State; and ( ) The remuneration is not borne by a permanent establishment or c a fixed base which the employer has in the other State. Notwithstanding the preceding provisions of this Article, remu - 3. neration derived by a resident of a Contracting State in respect of an employment, as a member of the regular complement of a ship or aircraft, that is exercised aboard a ship or aircraft operated in international traffic, other than aboard a ship or aircraft operated solely within the other Contracting State, shall be taxable only in the first-mentioned State. Article 16 DIRECTORS’ FEES AND REMUNERATION OF TOP-LEVEL MANAGERIAL OFFICIALS 1. Directors’ fees and other similar payments derived by a resident of a Contracting State in his capacity as a member of the Board of Directors of a company which is a resident of the other Contracting State may be taxed in that other State. 27

50 Articles 16, 17 and 18 2. - Salaries, wages and other similar remuneration derived by a res ident of a Contracting State in his capacity as an official in a top-level managerial position of a company which is a resident of the other Contracting State may be taxed in that other State. Article 17 ARTISTES AND SPORTSPERSONS Notwithstanding the provisions of Articles 14 and 15, income 1. derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio or television artiste, or a musician, or as a sportsperson, from his personal activities as such exercised in the other Contracting State, may be taxed in that other State. 2. Where income in respect of personal activities exercised by an entertainer or a sportsperson in his capacity as such accrues not to the entertainer or sportsperson himself but to another person, that income may, notwithstanding the provisions of Articles 7, 14 and 15, be taxed in the Contracting State in which the activities of the enter - tainer or sportsperson are exercised. Article 18 PENSIONS AND SOCIAL SECURITY PAYMENTS Article 18 (alternative A) 1. Subject to the provisions of paragraph 2 of Article 19, pensions and other similar remuneration paid to a resident of a Contracting State in consideration of past employment shall be taxable only in that State. 2. Notwithstanding the provisions of paragraph 1, pensions paid and other payments made under a public scheme which is part of the social security system of a Contracting State or a political subdivision or a local authority thereof shall be taxable only in that State. 28

51 Articles 18 and 19 Article 18 (alternative B) Subject to the provisions of paragraph 2 of Article 19, pensions 1. and other similar remuneration paid to a resident of a Contracting State in consideration of past employment may be taxed in that State. However, such pensions and other similar remuneration may 2. also be taxed in the other Contracting State if the payment is made by a resident of that other State or a permanent establishment situ - ated therein. 3. Notwithstanding the provisions of paragraphs 1 and 2, pensions paid and other payments made under a public scheme which is part of - the social security system of a Contracting State or a political subdivi sion or a local authority thereof shall be taxable only in that State. Article 19 GOVERNMENT SERVICE a ) Salaries, wages and other similar remuneration paid by a 1. ( Contracting State or a political subdivision or a local author - ity thereof to an individual in respect of services rendered to that State or subdivision or authority shall be taxable only in that State. b ) However, such salaries, wages and other similar remuneration ( shall be taxable only in the other Contracting State if the ser - vices are rendered in that other State and the individual is a resident of that State who: (i) is a national of that State; or (ii) did not become a resident of that State solely for the pur - pose of rendering the services. 2. ( a ) Notwithstanding the provisions of paragraph 1, pensions and other similar remuneration paid by, or out of funds created by, a Contracting State or a political subdivision or a local author - ity thereof to an individual in respect of services rendered to that State or subdivision or authority shall be taxable only in that State. 29

52 Articles 19, 20 and 21 ( ) However, such pensions and other similar remuneration shall b be taxable only in the other Contracting State if the individual is a resident of, and a national of, that other State. The provisions of Articles 15, 16, 17 and 18 shall apply to salaries, 3. wages, pensions, and other similar remuneration in respect of services rendered in connection with a business carried on by a Contracting State or a political subdivision or a local authority thereof. Article 20 STUDENTS Payments which a student or business trainee or apprentice who is or was immediately before visiting a Contracting State a resident of the other Contracting State and who is present in the first-mentioned State solely for the purpose of his education or training receives for the pur - pose of his maintenance, education or training shall not be taxed in that State, provided that such payments arise from sources outside that State. 21 Article OTHER INCOME 1. Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State. 2. The provisions of paragraph 1 shall not apply to income, other than income from immovable property as defined in paragraph 2 of Article 6, if the recipient of such income, being a resident of a Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situ - ated therein, and the right or property in respect of which the income is paid is effectively connected with such permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply. 30

53 Article 21 3. Notwithstanding the provisions of paragraphs 1 and 2, items of income of a resident of a Contracting State not dealt with in the fore - going Articles of this Convention and arising in the other Contracting State may also be taxed in that other State. 31

54 Article 22 Chapter IV TA X ATION OF CAPITA L Article 22 CAPITAL 1. Capital represented by immovable property referred to in Article 6, owned by a resident of a Contracting State and situated in the other Contracting State, may be taxed in that other State. Capital represented by movable property forming part of the 2. business property of a permanent establishment which an enter - prise of a Contracting State has in the other Contracting State or by movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services may be taxed in that other State. 3. Capital of an enterprise of a Contracting State that operates ships or aircraft in international traffic represented by such ships or aircraft, and by movable property pertaining to the operation of such ships or aircraft, shall be taxable only in that State. [4. All other elements of capital of a resident of a Contracting State shall be taxable only in that State.] (The question of the taxation of all other elements of capital of a resi - dent of a Contracting State is left to bilateral negotiations. Should the negotiating parties decide to include in the Convention an article on the taxation of capital, they will have to determine whether to use the wording of paragraph 4 as shown or wording that leaves taxation to the State in which the capital is located.) 32

55 Article 23A Chapter V METHODS FOR THE ELIMINATION OF DOU BLE TA X ATION 23 A Article EXEMPTION METHOD 1. Where a resident of a Contracting State derives income or owns capital which may be taxed in the other Contracting State, in accordance with the provisions of this Convention (except to the extent that these provisions allow taxation by that other State solely because the income is also income derived by a resident of that State or because the capital is also capital owned by a resident of that State), the first-mentioned State shall, subject to the provisions of paragraphs 2 and 3, exempt such income or capital from tax. 2. Where a resident of a Contracting State derives items of income which, in accordance with the provisions of Articles 10, 11, 12, and 12A may be taxed in the other Contracting State, the first-mentioned State shall allow as a deduction from the tax on the income of that resident an amount equal to the tax paid in that other State. Such deduction shall not, however, exceed that part of the tax, as computed before the deduction is given, which is attributable to such items of income which may be taxed in that other State. 3. Where in accordance with any provision of this Convention income derived or capital owned by a resident of a Contracting State is exempt from tax in that State, such State may nevertheless, in calcu - lating the amount of tax on the remaining income or capital of such resident, take into account the exempted income or capital. 4. The provisions of paragraph 1 shall not apply to income derived or capital owned by a resident of a Contracting State where the other Contracting State applies the provisions of this Convention to exempt such income or capital from tax or applies the provisions of paragraph 2 of Article 10, 11, 12 or 12A to such income; in the latter case, the 33

56 Articles 23A and 23B first-mentioned State shall allow the deduction of tax provided for by paragraph 2. Article 23 B CREDIT METHOD 1. Where a resident of a Contracting State derives income or owns capital which may be taxed in the other Contracting State, in accordance with the provisions of this Convention (except to the extent that these provisions allow taxation by that other State solely because the income is also income derived by a resident of that State or because the capital is also capital owned by a resident of that State), the first-mentioned State shall allow: (a) as a deduction from the tax on the income of that resident an amount equal to the income tax paid in that other State; as a deduction from the tax on the capital of that resident, an (b) amount equal to the capital tax paid in that other State. Such deduction in either case shall not, however, exceed that part of the income tax or capital tax, as computed before the deduction is given, which is attributable, as the case may be, to the income or the capital which may be taxed in that other State. 2. Where, in accordance with any provision of this Convention, income derived or capital owned by a resident of a Contracting State is exempt from tax in that State, such State may nevertheless, in calcu - lating the amount of tax on the remaining income or capital of such resident, take into account the exempted income or capital. 34

57 Article 24 Chapter VI SPECIAL PROVISIONS Article 24 NON-DISCRIMINATION 1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, in particular with respect to residence, are or may be subjected. This provision shall, notwithstanding the provisions of Article 1, also apply to persons who are not residents of one or both of the Contracting States. 2. Stateless persons who are residents of a Contracting State shall not be subjected in either Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of the State concerned in the same circumstances, in particular with respect to residence, are or may be subjected. 3. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities. This provision shall not be construed as obliging a Contracting State to grant to residents of the other Contracting State any personal allow - ances, reliefs and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents. 4. Except where the provisions of paragraph 1 of Article 9, par - agraph 6 of Article 11, paragraph 6 of Article 12, or paragraph 6 of Article 12A apply, interest, royalties, fees for technical services, and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible 35

58 Articles 24 and 25 under the same conditions as if they had been paid to a resident of the first-mentioned State. Similarly, any debts of an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable capital of such enterprise, be deductible under the same conditions as if they had been contracted to a resident of the first-mentioned State. 5. Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned State are or may be subjected. 6. The provisions of this Article shall, notwithstanding the provi - sions of Article 2, apply to taxes of every kind and description. Article 25 MUTUAL AGREEMENT PROCEDURE Article 25 (alternative A) 1. Where a person considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accord - ance with the provisions of this Convention, he may, irrespective of the remedies provided by the domestic law of those States, present his case to the competent authority of the Contracting State of which he is a res - ident or, if his case comes under paragraph 1 of Article 24, to that of the Contracting State of which he is a national. The case must be presented within three years from the first notification of the action resulting in taxation not in accordance with the provisions of the Convention. 2. The competent authority shall endeavour, if the objection appears to it to be justified and if it is not itself able to arrive at a sat - isfactory solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State, with a view to the avoidance of taxation which is not in accordance with this Convention. 36

59 Article 25 Any agreement reached shall be implemented notwithstanding any time limits in the domestic law of the Contracting States. 3. The competent authorities of the Contracting States shall endeavour to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention. They may also consult together for the elimination of double taxation in cases not provided for in the Convention. 4. The competent authorities of the Contracting States may com - municate with each other directly, including through a joint commis - sion consisting of themselves or their representatives, for the purpose of reaching an agreement in the sense of the preceding paragraphs. The competent authorities, through consultations, may develop appro - priate bilateral procedures, conditions, methods and techniques for the implementation of the mutual agreement procedure provided for in this Article. Article 25 (alternative B) 1. Where a person considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accord - ance with the provisions of this Convention, he may, irrespective of the remedies provided by the domestic law of those States, present his case to the competent authority of the Contracting State of which he is a res - ident or, if his case comes under paragraph 1 of Article 24, to that of the Contracting State of which he is a national. The case must be presented within three years from the first notification of the action resulting in taxation not in accordance with the provisions of the Convention. 2. The competent authority shall endeavour, if the objection appears to it to be justified and if it is not itself able to arrive at a sat - isfactory solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State, with a view to the avoidance of taxation which is not in accordance with this Convention. Any agreement reached shall be implemented notwithstanding any time limits in the domestic law of the Contracting States. 3. The competent authorities of the Contracting States shall endeavour to resolve by mutual agreement any difficulties or doubts 37

60 Article 25 arising as to the interpretation or application of the Convention. They may also consult together for the elimination of double taxation in cases not provided for in the Convention. The competent authorities of the Contracting States may com - 4. municate with each other directly, including through a joint commis - sion consisting of themselves or their representatives, for the purpose of reaching an agreement in the sense of the preceding paragraphs. - The competent authorities, through consultations, may develop appro priate bilateral procedures, conditions, methods and techniques for the implementation of the mutual agreement procedure provided for in this Article. 5. Where, ( a ) under paragraph 1, a person has presented a case to the compe - tent authority of a Contracting State on the basis that the actions of one or both of the Contracting States have resulted for that person in taxation not in accordance with the provisions of this Convention, and b ) the competent authorities are unable to reach an agreement to ( resolve that case pursuant to paragraph 2 within three years from the presentation of the case to the competent authority of the other Contracting State, any unresolved issues arising from the case shall be submitted to arbi - tration if either competent authority so requests. The person who has presented the case shall be notified of the request. These unresolved issues shall not, however, be submitted to arbitration if a decision on these issues has already been rendered by a court or administrative tribunal of either State. The arbitration decision shall be binding on both States and shall be implemented notwithstanding any time limits in the domestic laws of these States unless both competent authorities agree on a different solution within six months after the decision has been communicated to them or unless a person directly affected by the case does not accept the mutual agreement that implements the arbitration decision. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this paragraph. 38

61 Article 26 Article 26 EXCHANGE OF INFORMATION 1. The competent authorities of the Contracting States shall exchange such information as is foreseeably relevant for carrying out - the provisions of this Convention or to the administration or enforce ment of the domestic laws of the Contracting States concerning taxes of every kind and description imposed on behalf of the Contracting States, or of their political subdivisions or local authorities, inso - far as the taxation thereunder is not contrary to the Convention. In particular, information shall be exchanged that would be helpful to a Contracting State in preventing avoidance or evasion of such taxes. The exchange of information is not restricted by Articles 1 and 2. Any information received under paragraph 1 by a Contracting 2. State shall be treated as secret in the same manner as information obtained under the domestic laws of that State and it shall be disclosed only to persons or authorities (including courts and administrative bodies) concerned with the assessment or collection of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes referred to in paragraph 1, or the oversight of the above. Such persons or authorities shall use the information only for such purposes. They may disclose the information in public court proceedings or in judi - cial decisions. Notwithstanding the foregoing, information received by a - Contracting State may be used for other purposes when such informa tion may be used for such other purposes under the laws of both States and the competent authority of the supplying State authorizes such use. 3. In no case shall the provisions of paragraphs 1 and 2 be con - strued so as to impose on a Contracting State the obligation: ( a ) To carry out administrative measures at variance with the laws and administrative practice of that or of the other Contracting State; ( b ) To supply information which is not obtainable under the laws or in the normal course of the administration of that or of the other Contracting State; ( c ) To supply information which would disclose any trade, business, industrial, commercial or professional secret or trade process, 39

62 Artilces 26 and 27 or information, the disclosure of which would be contrary to ordre public public policy ( ). 4. If information is requested by a Contracting State in accordance with this Article, the other Contracting State shall use its information gathering measures to obtain the requested information, even though that other State may not need such information for its own tax pur - poses. The obligation contained in the preceding sentence is subject to the limitations of paragraph 3 but in no case shall such limitations be - construed to permit a Contracting State to decline to supply informa tion solely because it has no domestic interest in such information. 5. In no case shall the provisions of paragraph 3 be construed to permit a Contracting State to decline to supply information solely because the information is held by a bank, other financial institu - tion, nominee or person acting in an agency or a fiduciary capacity or because it relates to ownership interests in a person. 6. The competent authorities shall, through consultation, develop appropriate methods and techniques concerning the matters in respect of which exchanges of information under paragraph 1 shall be made. 27 Article 10 ASSISTANCE IN THE COLLECTION OF TAXES The Contracting States shall lend assistance to each other in 1. the collection of revenue claims. This assistance is not restricted by Articles 1 and 2. The competent authorities of the Contracting States may by mutual agreement settle the mode of application of this Article. 10 In some countries, national law, policy or administrative consider - ations may not allow or justify the type of assistance envisaged under this Article or may require that this type of assistance be restricted, e.g. to coun - tries that have similar tax systems or tax administrations or as to the taxes covered. For that reason, the Article should only be included in the Con - vention where each State concludes that, based on the factors described in paragraph 1 of the Commentary on the Article, they can agree to provide assistance in the collection of taxes levied by the other State. 40

63 Article 27 2. The term “revenue claim” as used in this Article means an amount owed in respect of taxes of every kind and description imposed on behalf of the Contracting States, or of their political subdivisions or local authorities, insofar as the taxation thereunder is not contrary to this Convention or any other instrument to which the Contracting States are parties, as well as interest, administrative penalties and costs of collection or conservancy related to such amount. 3. When a revenue claim of a Contracting State is enforceable under the laws of that State and is owed by a person who, at that time, cannot, under the laws of that State, prevent its collection, that revenue claim shall, at the request of the competent authority of that State, be accepted for purposes of collection by the competent authority of the other Contracting State. That revenue claim shall be collected by that other State in accordance with the provisions of its laws applicable to the enforcement and collection of its own taxes as if the revenue claim were a revenue claim of that other State. 4. When a revenue claim of a Contracting State is a claim in respect of which that State may, under its law, take measures of con - servancy with a view to ensure its collection, that revenue claim shall, at the request of the competent authority of that State, be accepted for purposes of taking measures of conservancy by the competent authority of the other Contracting State. That other State shall take measures of conservancy in respect of that revenue claim in accordance with the provisions of its laws as if the revenue claim were a revenue claim of that other State even if, at the time when such measures are applied, the revenue claim is not enforceable in the first-mentioned State or is owed by a person who has a right to prevent its collection. 5. Notwithstanding the provisions of paragraphs 3 and 4, a reve - nue claim accepted by a Contracting State for purposes of paragraph 3 or 4 shall not, in that State, be subject to the time limits or accorded any priority applicable to a revenue claim under the laws of that State by reason of its nature as such. In addition, a revenue claim accepted by a Contracting State for the purposes of paragraph 3 or 4 shall not, in that State, have any priority applicable to that revenue claim under the laws of the other Contracting State. 41

64 Article 27 6. Proceedings with respect to the existence, validity or the amount of a revenue claim of a Contracting State shall not be brought before the courts or administrative bodies of the other Contracting State. Where, at any time after a request has been made by a Con - 7. tracting State under paragraph 3 or 4 and before the other Contracting State has collected and remitted the relevant revenue claim to the first-mentioned State, the relevant revenue claim ceases to be a ) in the case of a request under paragraph 3, a revenue claim of ( the first-mentioned State that is enforceable under the laws of that State and is owed by a person who, at that time, cannot, under the laws of that State, prevent its collection, or ( b ) in the case of a request under paragraph 4, a revenue claim of the first-mentioned State in respect of which that State may, under its laws, take measures of conservancy with a view to ensure its collection the competent authority of the first-mentioned State shall promptly notify the competent authority of the other State of that fact and, at the option of the other State, the first-mentioned State shall either suspend or withdraw its request. 8. In no case shall the provisions of this Article be construed so as to impose on a Contracting State the obligation: ( a ) to carry out administrative measures at variance with the laws and administrative practice of that or of the other Contracting State; ( b ) to carry out measures which would be contrary to public policy ( ordre public ); ( ) to provide assistance if the other Contracting State has not pur - c sued all reasonable measures of collection or conservancy, as the case may be, available under its laws or administrative practice; ( d ) to provide assistance in those cases where the administrative burden for that State is clearly disproportionate to the benefit to be derived by the other Contracting State. 42

65 Articles 28 and 29 Article 28 MEMBERS OF DIPLOMATIC MISSIONS AND CONSULAR POSTS Nothing in this Convention shall affect the fiscal privileges of mem - bers of diplomatic missions or consular posts under the general rules of international law or under the provisions of special agreements. Article 29 11 ENTITLEMENT TO BENEFITS 1. Except as otherwise provided in this Article, a resident of a - Contracting State shall not be entitled to a benefit that would other wise be accorded by this Convention (other than a benefit under para - graph 3 of Article 4, paragraph 2 of Article 9 or Article 25) unless such resident is a “qualified person”, as defined in paragraph 2, at the time that the benefit would be accorded. 2. A resident of a Contracting State shall be a qualified person at a time when a benefit would otherwise be accorded by the Convention if, at that time, the resident is: (a) an individual; that Contracting State, or a political subdivision or local author - (b) ity thereof, or an agency or instrumentality of that State, politi - cal subdivision or local authority; (c) a company or other entity, if, throughout the taxable period that includes that time, the principal class of its shares (and any dis - proportionate class of shares) is regularly traded on one or more recognised stock exchanges, and either: 11 The drafting of this Article will depend on how the Contracting States decide to implement their common intention, reflected in the pream - ble of the Convention and incorporated in the minimum standard agreed to as part of the OECD-G20 Base Erosion and Profit Shifting project by particu - lar countries, to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, includ - ing through treaty shopping arrangements. 43

66 Article 29 (i) its principal class of shares is primarily traded on one or more recognised stock exchanges located in the Contracting State of which the company or entity is a resident; or (ii) the company’s or entity’s primary place of management and control is in the Contracting State of which it is a resident; (d) a company, if: throughout the taxable period that includes that time, at (i) least 50 per cent of the aggregate vote and value of the shares (and at least 50 per cent of the aggregate vote and value of any disproportionate class of shares) in the company is owned directly or indirectly by five or fewer companies or entities entitled to benefits under subpar - agraph c) of this paragraph, provided that, in the case of indirect ownership, each intermediate owner is a resident of the Contracting State from which a benefit under this Convention is being sought or is a qualifying intermediate owner; and (ii) with respect to benefits under this Convention other than under Article 10, less than 50 per cent of the company’s gross income, and less than 50 per cent of the tested group’s gross income, for the taxable period that includes that time, is paid or accrued, directly or indirectly, in the form of payments that are deductible in that taxable period for purposes of the taxes covered by this Convention in the company’s Contracting State of residence (but not includ - ing arm’s length payments in the ordinary course of busi - ness for services or tangible property, and in the case of a tested group, not including intra-group transactions) to persons that are not residents of either Contracting State entitled to the benefits of this Convention under subpara - graph a), b), c) or e); (e) a person, other than an individual, that (i) is a [agreed description of the relevant non-profit organi - sations found in each Contracting State], 44

67 Article 29 12 (ii) to which subdivision (i) of is a recognised pension fund the definition of recognised pension fund in paragraph 1 of Article 3 applies, provided that more than 50 per cent of - the beneficial interests in that person are owned by indi viduals resident of either Contracting State, or more than [__ per cent] of the beneficial interests in that person are owned by individuals resident of either Contracting State or of any other State with respect to which the following conditions are met individuals who are residents of that other State are (A) - entitled to the benefits of a comprehensive conven tion for the avoidance of double taxation between that other State and the State from which the benefits of this Convention are claimed, and (B) with respect to income referred to in Articles 10 and 11 of this Convention, if the person were a resident of that other State entitled to all the benefits of that other convention, the person would be entitled, under such convention, to a rate of tax with respect to the par - ticular class of income for which benefits are being claimed under this Convention that is at least as low as the rate applicable under this Convention; or is a recognised pension fund to which subdivision (ii) of (iii) the definition of recognised pension fund in paragraph 1 of Article 3 applies, provided that it is established and operated exclusively or almost exclusively to invest funds for the benefit of entities or arrangements referred to in the preceding subdivision; (f) a person other than an individual, if (i) at that time and on at least half the days of a twelve-month period that includes that time, persons who are residents of that Contracting State and that are entitled to the benefits of this Convention under subparagraph a), b), c) or e) own, directly or indirectly, shares representing at least 50 per cent of the aggregate vote and value (and at least 50 per 12 As to incorporation of such a definition, see paragraph 14 of the Commentary on Article 29. 45

68 Article 29 cent of the aggregate vote and value of any disproportion - ate class of shares) of the shares in the person, provided that, in the case of indirect ownership, each intermediate owner is a qualifying intermediate owner, and (ii) less than 50 per cent of the person’s gross income, and less than 50 per cent of the tested group’s gross income, for the taxable period that includes that time, is paid or accrued, directly or indirectly, in the form of payments that are deductible for purposes of the taxes covered by this Convention in the person’s Contracting State of residence (but not including arm’s length payments in the ordinary course of business for services or tangible property, and in the case of a tested group, not including intra-group transactions), to persons that are not resi - dents of either Contracting State entitled to the benefits of this Convention under subparagraph a), b), c) or e) of this paragraph; or (g) [possible provision on collective investment vehicles]; (a) A resident of a Contracting State shall be entitled to bene 3. - fits under this Convention with respect to an item of income derived from the other Contracting State, regardless of whether the resident is a qualified person, if the resident is engaged in the active conduct of a business in the first-mentioned State (other than the business of making or managing investments for the resident’s own account, unless these activities are bank - ing, insurance or securities activities carried on by a bank or [list financial institutions similar to banks that the Contracting States agree to treat as such], insurance enterprise or registered securities dealer respectively), and the income derived from the other State emanates from, or is incidental to, that business. For purposes of this Article, the term “active conduct of a busi - ness” shall not include the following activities or any combina - tion thereof: (i) operating as a holding company; (ii) providing overall supervision or administration of a group of companies; providing group financing (including cash pooling); or (iii) 46

69 Article 29 (iv) making or managing investments, unless these activities are carried on by a bank [list financial institutions similar to banks that the Contracting States agree to treat as such], insurance enterprise or registered securities dealer in the ordinary course of its business as such. (b) If a resident of a Contracting State derives an item of income from a business activity conducted by that resident in the other Contracting State, or derives an item of income arising in the other State from a connected person, the conditions described in subparagraph a) shall be considered to be satisfied with respect to such item only if the business activity carried on by the resident in the first-mentioned State to which the item is related is substantial in relation to the same or complementary business activity carried on by the resident or such connected person in the other Contracting State. Whether a business activity is substantial for the purposes of this paragraph shall be determined based on all the facts and circumstances. (c) For purposes of applying this paragraph, activities conducted by connected persons with respect to a resident of a Contracting State shall be deemed to be conducted by such resident. 4. [A rule providing so-called derivative benefits. The question of how the derivative benefits paragraph should be drafted in a conven - tion that follows the detailed version is discussed in the Commentary.] 5. A company that is a resident of a Contracting State that func - tions as a headquarters company for a multinational corporate group consisting of such company and its direct and indirect subsidiaries shall be entitled to benefits under this Convention with respect to dividends and interest paid by members of its multinational corpo - rate group, regardless of whether the resident is a qualified person. A - company shall be considered a headquarters company for this pur pose only if: (a) such company’s primary place of management and control is in the Contracting State of which it is a resident; (b) the multinational corporate group consists of companies resi - dent of, and engaged in the active conduct of a business in, at least four States, and the businesses carried on in each of the 47

70 Article 29 four States (or four groupings of States) generate at least 10 per cent of the gross income of the group; (c) the businesses of the multinational corporate group that are carried on in any one State other than the Contracting State of residence of such company generate less than 50 per cent of the gross income of the group; (d) no more than 25 per cent of such company’s gross income is derived from the other Contracting State; (e) such company is subject to the same income taxation rules in its Contracting State of residence as persons described in para - graph 3 of this Article; and (f) less than 50 per cent of such company’s gross income, and less than 50 per cent of the tested group’s gross income, is paid or accrued, directly or indirectly, in the form of payments that are deductible for purposes of the taxes covered by this Convention in the company’s Contracting State of residence (but not includ - ing arm’s length payments in the ordinary course of business for services or tangible property or payments in respect of finan - cial obligations to a bank that is not a connected person with respect to such company, and in the case of a tested group, not including intra-group transactions) to persons that are not res - idents of either Contracting State entitled to the benefits of this Convention under subparagraph a), b), c) or e) of paragraph 2. If the requirements of subparagraph b), c) or d) of this paragraph are not fulfilled for the relevant taxable period, they shall be deemed to be fulfilled if the required ratios are met when averaging the gross income of the preceding four taxable periods. 6. If a resident of a Contracting State is neither a qualified person pursuant to the provisions of paragraph 2 of this Article, nor entitled to benefits under paragraph 3, 4 or 5, the competent authority of the Contracting State in which benefits are denied under the previous provisions of this Article may, nevertheless, grant the benefits of this Convention, or benefits with respect to a specific item of income or capital, taking into account the object and purpose of this Convention, but only if such resident demonstrates to the satisfaction of such com - petent authority that neither its establishment, acquisition or main - tenance, nor the conduct of its operations, had as one of its principal 48

71 Article 29 purposes the obtaining of benefits under this Convention. The com - petent authority of the Contracting State to which a request has been made, under this paragraph, by a resident of the other State, shall consult with the competent authority of that other State before either granting or denying the request. 7. For the purposes of this and the previous paragraphs of this Article: (a) the term “recognised stock exchange” means: [list of stock exchanges agreed to at the time of sig - (i) nature]; and (ii) any other stock exchange agreed upon by the competent authorities of the Contracting States; (b) with respect to entities that are not companies, the term “shares” means interests that are comparable to shares; (c) the term “principal class of shares” means the ordinary or common shares of the company or entity, provided that such class of shares represents the majority of the aggregate vote and value of the company or entity. If no single class of ordinary or common shares represents the majority of the aggregate vote and value of the company or entity, the “principal class of shares” are those classes that in the aggregate represent a major - ity of the aggregate vote and value; (d) two persons shall be “connected persons” if one owns, directly or indirectly, at least 50 per cent of the beneficial interest in the other (or, in the case of a company, at least 50 per cent of the aggregate vote and value of the company’s shares) or another person owns, directly or indirectly, at least 50 per cent of the beneficial interest (or, in the case of a company, at least 50 per cent of the aggregate vote and value of the company’s shares) in each person. In any case, a person shall be connected to another if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same person or persons. (e) the term “equivalent beneficiary” means: (i) a resident of any State, provided that: (A) the resident is entitled to all the benefits of a com - prehensive convention for the avoidance of double 49

72 Article 29 taxation between that State and the Contracting State from which the benefits of this Convention are sought, under provisions substantially similar to subparagraph a), b), c) or e) of paragraph 2 or, when the benefit being sought is with respect to interest or dividends paid by a member of the resident’s mul - tinational corporate group, the resident is entitled to benefits under provisions substantially similar to paragraph 5 of this Article in such convention, provided that, if such convention does not contain - a detailed limitation on benefits article, such con vention shall be applied as if the provisions of sub - paragraphs a), b), c) and e) of paragraph 2 (including the definitions relevant to the application of the tests in such subparagraphs) were contained in such con - vention; and (B) (1) with respect to income referred to in Article 10, 11, 12 or 12A if the resident had received such income directly, the resident would be entitled under such - Convention, a provision of domestic law or any inter national agreement, to a rate of tax with respect to such income for which benefits are being sought under this Convention that is less than or equal to the rate applicable under this Convention. Regarding a company seeking, under paragraph 4, the benefits of Article 10 with respect to dividends, for purposes of this subclause: (I) if the resident is an individual, and the company is engaged in the active conduct of a business in its Contracting State of residence that is substantial in relation, and similar or complementary, to the business that generated the earnings from which the dividend is paid, such individual shall be treated as if he or she were a company. Activities conducted by a person that is a connected person with respect to the company seeking benefits shall be deemed to be conducted by such company. Whether a business activity is substantial shall 50

73 Article 29 be determined based on all the facts and circum - stances; and (II) - if the resident is a company (including an individ ual treated as a company), to determine whether the resident is entitled to a rate of tax that is less than or equal to the rate applicable under this Convention, the resident’s indirect holding of the capital of the company paying the dividends shall be treated as a direct holding; or (2) with respect to an item of income referred to in Article 7, 13 or 21 of this Convention, the resident is entitled to benefits under such Convention that are at least as favourable as the benefits that are being sought under this Convention; and (C) notwithstanding that a resident may satisfy the requirements of clauses A) and B) of this subdi - vision, where the item of income has been derived through an entity that is treated as fiscally transpar - - ent under the laws of the Contracting State of resi dence of the company seeking benefits, if the item of income would not be treated as the income of the resident under a provision analogous to paragraph 2 of Article 1 had the resident, and not the company seeking benefits under paragraph 4 of this Article, itself owned the entity through which the income was derived by the company, such resident shall not be considered an equivalent beneficiary with respect to the item of income; a resident of the same Contracting State as the company (ii) seeking benefits under paragraph 4 of this Article that is entitled to all the benefits of this Convention by reason of subparagraph a), b), c) or e) of paragraph 2 or, when the benefit being sought is with respect to interest or dividends paid by a member of the resident’s multina - tional corporate group, the resident is entitled to benefits under paragraph 5, provided that, in the case of a resident described in paragraph 5, if the resident had received such 51

74 Article 29 interest or dividends directly, the resident would be enti - tled to a rate of tax with respect to such income that is less than or equal to the rate applicable under this Convention to the company seeking benefits under paragraph 4; or (iii) a resident of the Contracting State from which the bene - fits of this Convention are sought that is entitled to all the benefits of this Convention by reason of subparagraph a), b), c) or e) of paragraph 2, provided that all such residents’ ownership of the aggregate vote and value of the shares (and any disproportionate class of shares) of the company seeking benefits under paragraph 4 does not exceed 25 per - cent of the total vote and value of the shares (and any dis proportionate class of shares) of the company; (f) the term “disproportionate class of shares” means any class of shares of a company or entity resident in one of the Contracting States that entitles the shareholder to disproportionately higher participation, through dividends, redemption payments or oth - erwise, in the earnings generated in the other Contracting State by particular assets or activities of the company; (g) - a company’s or entity’s “primary place of management and con trol” is in the Contracting State of which it is a resident only if: (i) the executive officers and senior management employees - of the company or entity exercise day-to-day responsi bility for more of the strategic, financial and operational policy decision making for the company or entity and its direct and indirect subsidiaries, and the staff of such persons conduct more of the day-to-day activities neces - sary for preparing and making those decisions, in that Contracting State than in any other State; and (ii) such executive officers and senior management employees exercise day-to-day responsibility for more of the strategic, financial and operational policy decision-making for the company or entity and its direct and indirect subsidiaries, and the staff of such persons conduct more of the day-to- day activities necessary for preparing and making those decisions, than the officers or employees of any other com - pany or entity; 52

75 Article 29 (h) - the term “qualifying intermediate owner” means an intermedi ate owner that is either: (i) a resident of a State that has in effect with the Contracting State from which a benefit under this Convention is being sought a comprehensive convention for the avoidance of double taxation; or (ii) a resident of the same Contracting State as the company - applying the test under subparagraph d) or f) of para graph 2 or paragraph 4 to determine whether it is eligible for benefits under the Convention; the term “tested group” means the resident of a Contracting (i) State that is applying the test under subparagraph d) or f) of paragraph 2 or under paragraph 4 or 5 to determine whether - it is eligible for benefits under the Convention (the “tested resi dent”), and any company or permanent establishment that: (i) participates as a member with the tested resident in a tax consolidation, fiscal unity or similar regime that requires members of the group to share profits or losses; or (ii) shares losses with the tested resident pursuant to a group relief or other loss sharing regime in the relevant taxable period; [and] (j) the term “gross income” means gross receipts as determined in the person’s Contracting State of residence for the taxable period that includes the time when the benefit would be accorded, except that where a person is engaged in a business that includes the manufacture, production or sale of goods, “gross income” means such gross receipts reduced by the cost of goods sold, and where a person is engaged in a business of providing non-financial ser - vices, “gross income” means such gross receipts reduced by the direct costs of generating such receipts, provided that: (i) except when relevant for determining benefits under Article 10 of this Convention, gross income shall not include the portion of any dividends that are effectively exempt from tax in the person’s Contracting State of resi - dence, whether through deductions or otherwise; and (ii) except with respect to the portion of any dividend that is taxable, a tested group’s gross income shall not take 53

76 Article 29 into account transactions between companies within the tested group; [and] 8. (a) Where an enterprise of a Contracting State derives income from (i) the other Contracting State and the first-mentioned State treats such income as attributable to a permanent establishment of the enterprise situated in a third juris - diction, and (ii) the profits attributable to that permanent establishment are exempt from tax in the first-mentioned State, the benefits of this Convention shall not apply to any item of income on which the tax in the third jurisdiction is less than the lower of [rate to be determined bilaterally] of the amount of that item of income and 60 per cent of the tax that would be imposed in the first-mentioned State on that item of income if that per - manent establishment were situated in the first-mentioned State. In such a case any income to which the provisions of this paragraph apply shall remain taxable according to the domestic law of the other State, notwithstanding any other provisions of the Convention. The preceding provisions of this paragraph shall not apply if the (b) income derived from the other State emanates from, or is inci - dental to, the active conduct of a business carried on through the permanent establishment (other than the business of making, managing or simply holding investments for the enterprise’s own account, unless these activities are banking, insurance or securities activities carried on by a bank, insurance enterprise or registered securities dealer, respectively). (c) If benefits under this Convention are denied pursuant to the preceding provisions of this paragraph with respect to an item of income derived by a resident of a Contracting State, the com - petent authority of the other Contracting State may, neverthe - less, grant these benefits with respect to that item of income if, in response to a request by such resident, such competent authority determines that granting such benefits is justified in light of the reasons such resident did not satisfy the require - ments of this paragraph (such as the existence of losses). The 54

77 Article 29 competent authority of the Contracting State to which a request has been made under the preceding sentence shall consult with the competent authority of the other Contracting State before either granting or denying the request. 9. Notwithstanding the other provisions of this Convention, a benefit under this Convention shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accord - ance with the object and purpose of the relevant provisions of this Convention. 55

78 Articles 30 and 31 Chapter VII FINA L PROVISIONS Article 30 ENTRY INTO FORCE 1. This Convention shall be ratified and the instruments of rati - fication shall be exchanged at ______________________ as soon as possible. 2. The Convention shall enter into force upon the exchange of instruments of ratification and its provisions shall have effect: ( a ) (In State A): ... ( b ) (In State B): ... Article 31 TER MINATION This Convention shall remain in force until terminated by a Contracting State. Either Contracting State may terminate the Convention, through diplomatic channels, by giving notice of termination at least six months before the end of any calendar year after the year ____. In such event, the Convention shall cease to have effect: ( a ) (In State A): ... ( b ) (In State B): ... TERMINAL CLAUSE NOTE: The provisions relating to the entry into force and termina - tion and the terminal clause concerning the signing of the Convention shall be drafted in accordance with the constitutional procedure of both Contracting States. 56

79 P a r t Tw o COMMENTARIES ON THE ARTICLES OF THE UNITED NATIONS MODEL DOUBLE TAXATION CONVENTION BETWEEN DEVELOPED AND DEVELOPING COUNTRIES

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81 Article 1 Commentary Commentary on chapter I SCOPE OF THE CONVENTION Article 1 PERSONS COVERED A. General considerations 1. Article 1 of the United Nations Model Convention reproduces Article 1 of the OECD Model Convention. The title of Article 1 was changed in 1999 from “Personal scope” 2. to “Persons covered”. The first article of the Convention should specify the types of persons or taxpayers to whom the Convention applies. The title “Personal scope” did not convey the scope of application of the Convention. Hence, the title of Article 1 was appropriately changed to “Persons covered” to convey the correct scope of the Convention. B. Commentary on the paragraphs of article 1 Paragraph 1 Like the OECD Model Convention, the United Nations Model 3. Convention applies to persons who are “residents of one or both of the Contracting States”. The personal scope of most of the earliest con - ventions was more restrictive, in that it encompassed “citizens” of the Contracting States. However, in some early conventions that scope was wider, covering “taxpayers” of the Contracting States, that is persons who, although not residing in either State, are nevertheless liable to tax on part of their income or capital in each of them. In some articles there are exceptions to this rule, for example in Articles 24, paragraph 1, 25, paragraph 1, and 26, paragraph 1. Paragraph 2 4. Paragraph 2 addresses special issues presented by payments to entities that are either wholly or partly fiscally transparent, such 59

82 Article 1 Commentary as partnerships and trusts. The OECD Committee on Fiscal Affairs adopted in 1999 the report entitled “The application of the OECD Model Tax Convention to partnerships”. The report deals with the application of the provisions of the OECD Model Tax Convention, and indirectly of bilateral tax conventions based on that Model, to partnerships. The Committee on Fiscal Affairs recognizes, however, that many of the prin - ciples discussed in that report may also apply, mutatis mutandis, to other non-corporate entities. In that report, references to “partnerships” cover entities which qualify as such under civil or commercial law as opposed - to tax law. The wide differences in the views of the OECD member coun tries stem from the fact that their domestic laws treat partnerships in different ways. In some OECD countries, partnerships are treated as taxable units and sometimes even as companies, while other OECD countries do not tax the partnership as such and only tax individual partners on their shares of partnership income. Similar differences in the tax treatment of partnerships exist in the developing countries. The intent of paragraph 2 is to realize the principles set forth in the report. 5. An important question is whether a partnership should itself be allowed the benefits of the Convention. If, under the laws of a Contracting State, partnerships are taxable entities, a partnership may qualify as a resident of that Contracting State under paragraph 1 of Article 4 and therefore be entitled to benefits of the Convention. However, if a partnership is treated as fiscally transparent under the laws of the residence State, and accordingly, the partners are taxed on the partnership’s income, paragraph 2 provides that the provisions of the Convention should be applied at the level of the partners. 6. As the first step in applying the benefits of the Convention, par - agraph 2 identifies the resident of a Contracting State that derives an item of income for which treaty benefits are sought. In order to be entitled to such benefits, such resident must also satisfy any additional requirements that are set forth in the applicable treaty, such as ben - eficially owning the item of income under the tax principles of the source State, any applicable requisite ownership thresholds (such as those found in subparagraph 2(a) of Article 10 (Dividends)), and either a principle purpose test or a limitation on benefits provision. 7. These general principles are expanded upon in paragraphs 2 through 16 of the Commentary on Article 1 of the 2017 OECD Model Convention: 60

83 Article 1 Commentary 2. This paragraph addresses the situation of the income of entities or arrangements that one or both Contracting States treat as wholly or partly fiscally transparent for tax purposes. The provisions of the paragraph ensure that income of such entities or arrangements is treated, for the purposes of the Convention, in accordance with the principles reflected in the 1999 report of the Committee on Fiscal Affairs entitled “The Application of the 13 OECD Model Tax Convention to Partnerships”. That Report therefore, provides guidance and examples on how the provi - sion should be interpreted and applied in various situations. 3. The Report, however, dealt exclusively with partnerships and while the Committee recognized that many of the prin - ciples included in the Report could also apply with respect to other non-corporate entities, it expressed the intention to examine the application of the Model Tax Convention to these other entities at a later stage. As indicated in paragraph 37 of the report, the Committee was particularly concerned with “cases where domestic tax laws create intermediary situations where a partnership is partly treated as a taxable unit and partly disregarded for tax purposes.” According to the Report: Whilst this may create practical difficulties with respect to a very limited number of partnerships, it is a more important problem in the case of other entities such as trusts. For this reason, the Committee decided to deal with this issue in the context of follow-up work to this report. 4. Paragraph 2 addresses this particular situation by refer - ring to entities that are “wholly or partly” treated as fiscally transparent. Thus, the paragraph not only serves to confirm the conclusions of the Partnership Report but also extends the application of these conclusions to situations that were not directly covered by the Report [...]. 5. The paragraph not only ensures that the benefits of the Convention are granted in appropriate cases but also ensures that these benefits are not granted where neither Contracting State treats, under its domestic law, the income of an entity or 13 Reproduced in Volume II of the full-length version of the OECD Model Tax Convention at page R(15)-1. 61

84 Article 1 Commentary arrangement as the income of one of its residents. The para - graph therefore confirms the conclusions of the Report in such a case (see, e.g., example 3 of the Report). Also, as recognised in the Report, States should not be expected to grant the benefits of a bilateral tax convention in cases where they cannot verify whether a person is truly entitled to these benefits. Thus, if an entity is established in a jurisdiction from which a Contracting State cannot obtain tax information, that State would need to be provided with all the necessary information in order to be able to grant the benefits of the Convention. In such a case, the - Contracting State might well decide to use the refund mecha nism for the purposes of applying the benefits of the Convention even though it normally applies these benefits at the time of the payment of the relevant income. In most cases, however, it will be possible to obtain the relevant information and to apply the benefits of the Convention at the time the income is taxed (see for example paragraphs 43 to 45 below which discuss a similar issue in the context of collective investment vehicles). 6. The following example illustrates the application of the paragraph: Example: State A and State B have concluded a treaty iden - tical to the Model Tax Convention. State A considers that an entity established in State B is a company, and taxes that entity on interest that it receives from a debtor resident in State A. Under the domestic law of State B, however, the entity is treated as a partnership, and the two members in that entity, who share equally all its income, are each taxed on half of the interest. One of the members is a resident of State B and the other one is a resident of a country with which States A and B do not have a treaty. The paragraph provides that in such case, half of the interest shall be con - sidered, for the purposes of Article 11, to be income of a res - ident of State B. 7. The reference to “income derived by or through an entity or arrangement” has a broad meaning and covers any income that is earned by or through an entity or arrangement regard - less of the view taken by each Contracting State as to who derives that income for domestic tax purposes and regardless 62

85 Article 1 Commentary of whether or not that entity or arrangement has legal person - ality or constitutes a person as defined in subparagraph (a) of paragraph 1 of Article 3. It would cover, for example, income of any partnership or trust that one or both of the Contracting States treats as wholly or partly fiscally transparent. Also, as illustrated in example 2 of the Report, it does not matter where the entity or arrangement is established: the paragraph applies to an entity established in a third State to the extent that, under the domestic tax law of one of the Contracting States, the entity is treated as wholly or partly fiscally transparent and income of that entity is attributed to a resident of that State. 8. The word “income” must be given the wide meaning that it has for the purposes of the Convention and therefore applies to the various items of income that are covered by Chapter III of the Convention (Taxation of Income), including, for example, profits of an enterprise and capital gains. 9. The concept of “fiscally transparent” used in the para - graph refers to situations where, under the domestic law of a Contracting State, the income (or part thereof) of the entity or arrangement is not taxed at the level of the entity or the arrangement but at the level of the persons who have an interest in that entity or arrangement. This will normally be the case where the amount of tax payable on a share of the income of an entity or arrangement is determined separately in relation to the personal characteristics of the person who is entitled to that share, so that the tax will depend on whether that person is taxable or not, on the other income that the person has, on the personal allowances to which the person is entitled and on the tax rate applicable to that person; also, the character and source, as well as the timing of the realization, of the income for tax purposes will not be affected by the fact that it has been earned through the entity or arrangement. The fact that the income is computed at the level of the entity or arrangement before 14 the share is allocated to the person will not affect that result. States wishing to clarify the definition of “fiscally transparent” in their bilateral conventions are free to include a definition of that term based on the above explanations. 14 See paragraph 37-40 of the Partnership Report. 63

86 Article 1 Commentary 10. In the case of an entity or arrangement which is treated as partly fiscally transparent under the domestic law of one of the Contracting States, only part of the income of the entity or arrangement might be taxed at the level of the persons who have an interest in that entity or arrangement as described in the preceding paragraph, while the rest would remain taxable at the level of the entity or arrangement. This, for example, is how some trusts and limited liability partnerships are treated in some countries (i.e. in some countries, the part of the income derived through a trust that is distributed to beneficiaries is taxed in the hands of these beneficiaries while the part of that income that is accumulated is taxed in the hands of the trust or trustees; similarly, in some countries, income derived through a limited partnership is taxed in the hands of the general partner as regards that partner’s share of that income but is considered to be the income of the limited partnership as regards the lim - ited partners’ share of the income). To the extent that the entity or arrangement qualifies as a resident of a Contracting State, the paragraph will ensure that the benefits of the treaty also apply to the share of the income that is attributed to the entity or arrangement under the domestic law of that State (subject to any anti-abuse provisions such as a limitation-on-benefits rule). 11. As with other provisions of the Convention, the provi - sion applies separately to each item of income of the entity or arrangement. Assume, for example, that the document that establishes a trust provides that all dividends received by the trust must be distributed to a beneficiary during the lifetime of that beneficiary, but must be accumulated afterwards. If one of the Contracting States considers that, in such a case, the ben - eficiary is taxable on the dividends distributed to that benefi - ciary, but that the trustees are taxable on the dividends that will be accumulated, the paragraph will apply differently to these two categories of dividends, even if both types of dividends are received within the same month. 12. By providing that the income to which it applies will be considered to be income of a resident of a Contracting State for the purposes of the Convention, the paragraph ensures that the relevant income is attributed to that resident for the purposes of 64

87 Article 1 Commentary the application of the various allocative rules of the Convention. Depending on the nature of the income, this will, therefore, allow the income to be considered, for example, as “income derived by” for the purposes of Articles 6, 13 and 17, “profits of an enterprise” for the purposes of Articles 7, 8 and 9 (see also paragraph 4 of the Commentary on Article 3) or dividends or interest “paid to” for the purposes of Articles 10 and 11. The fact that the income is considered to be derived by a resident of a Contracting State for the purposes of the Convention also means that, where the income constitutes a share of the income of an enterprise in which that resident holds a participation, - such income shall be considered to be the income of an enter prise carried on by that resident (e.g., for the purposes of the definition of enterprise of a Contracting State in Article 3 and paragraph 2 of Article 21). 13. Whilst the paragraph ensures that the various allocative rules of the Convention are applied to the extent that income of fiscally transparent entities is treated, under domestic law, as income of a resident of a Contracting State, the paragraph does not prejudge the issue of whether the recipient is the beneficial owner of the relevant income. Where, for example, a fiscally transparent partnership receives dividends as an agent or nom - inee for a person who is not a partner, the fact that the dividend may be considered as income of a resident of a Contracting State under the domestic law of that State will not preclude the State of source from considering that neither the partnership nor the partners are the beneficial owners of the dividend. 14. The paragraph only applies for the purposes of the Convention and does not, therefore, require a Contracting State to change the way in which it attributes income or character - izes entities for the purposes of its domestic law. In the example in paragraph 6 above, whilst paragraph 2 provides that half of the interest shall be considered, for the purposes of Article 11, to be income of a resident of State B, this will only affect the maximum amount of tax that State A will be able to collect on the interest and will not change the fact that State A’s tax will be payable by the entity. Thus, assuming that the domestic law of State A provides for a 30 per cent withholding tax on the 65

88 Article 1 Commentary interest, the effect of paragraph 2 will simply be to reduce the amount of tax that State A will collect on the interest (so that half of the interest would be taxed at 30 per cent and half at 10 per cent under the treaty between States A and B) and will not change the fact that the entity is the relevant taxpayer for the purposes of State A’s domestic law (such as a provision confirm - ing that a trust may qualify as a resident of a Contracting State despite the fact that, under the trust law of many countries. A trust does not constitute a “person”). The last sentence of the paragraph clarifies that the para 15. - graph is not intended to restrict in any way a State’s right to tax its own residents. This conclusion is consistent with the way in which tax treaties have been interpreted with respect to part - nerships (see paragraph 6.1 of this Commentary as it read after 2000 and before the inclusion of paragraph 3 in 2017). 16. Paragraphs 2 and 3 do not, however, restrict the obligation to provide relief of double taxation under Articles 23 A and 23 B where income of a resident of that State may be taxed by the other State in accordance with the Convention. There may be cases however, where the same income is taxed by each Contracting State as income of one of its residents and where relief of double taxation will be necessary with respect to tax paid by a differ - ent person. Where, for example, one of the Contracting States taxes the worldwide income of an entity that is a resident of that State whereas the other State views that entity as fiscally transparent and taxes and members of that entity who are resi - dents of that other State on their respective share of the income, relief of double taxation will need to take into account the tax that is paid by different taxpayers in the two States. In such a case, however, it will be important to determine, under Articles 23 A and 23 B, to what extent the income of a resident of one Contracting State “may be taxed in the other Contracting State in accordance with the provisions of this Convention (except to the extent that these provisions allow taxation by that other State solely because the income is also income derived by a res - ident of that State [...]”. In general, this requirement will result in one State having to provide relief of double taxation only to the extent that the provisions of the Convention authorise the 66

89 Article 1 Commentary other State to tax the relevant income as the State of source or as a State where there is a permanent establishment to which that income is attributable (see paragraphs 11.1 and 11.2 of the Commentary on Articles 23 A and 23 B). While as a general matter, the Committee is in agreement with par - agraphs 2 to 16 of the Commentary to Article 1 of the OECD Model quoted above, some Committee members have expressed concerns regarding the application of the paragraph when income is derived by or through an entity or arrangement resident in a third state and that has interest holders resident in a Contracting State under whose tax laws the entity is treated as fiscally transparent with respect to the income. In such case, the tax treaties of both the country of residence of the entity or arrangement and the country of residence of the inter - est holders could be applicable, creating the risk of duplicative claims of benefits under different tax treaties on a single item of income. However, such risks are mitigated by the fact that while in such case, more than one person may be viewed as deriving an item of income, the fact remains that only one payment is being made from the country of source, affording that country only one opportunity to grant benefits with respect to the item of income. Moreover, the issue of duplicative claims of treaty benefits have not been problematic in the practice of countries that include provisions similar to paragraph 2. In the expe - rience of those countries, the entity and its interest holders typically consult and provide to the withholding agent a single claim for treaty benefits on the payment. Additionally, the requirement that a person deriving an item of income under paragraph 2 must also satisfy all applicable requirements set forth in the treaty should reduce instances of duplicative claims of benefits. If a Contracting State is confronted with a situation of duplicative claims for benefits, it may engage in the mutual agreement procedure to obtain additional information as necessary to make the proper determination of which claim for treaty benefits to honor. 7.1 Contracting States wishing to provide clarity for both their treaty partners and for taxpayers are free to enter into and publish competent authority agreements of general applicability pursuant to paragraph 3 of Article 25 (Mutual Agreement Procedure) regarding the application of paragraph 2. 67

90 Article 1 Commentary Paragraph 3 In the 2017 update, the Committee decided to introduce a 8. so-called “saving clause” as paragraph 3 to Article 1. This follows the new provision included in the OECD Model Convention follow - ing the recommendations of the OECD/G20 in the Final Report on Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances), which is based on a similar provision included in the US model. The intent of the saving clause is to put at rest the argument that some provisions aimed at the taxation of non-residents could be - interpreted as limiting a Contracting State’s right to tax its own resi dents. While such interpretations have been rejected, the Committee considers that a saving clause in the United Nations Model Convention puts the matter beyond doubt that a Contracting state is able to tax its own residents notwithstanding any other provisions of the relevant bilateral treaty. 9. The 2017 OECD Commentary on the issue reads as follows: 17. Whilst some provisions of the Convention (e.g. Articles 23 A and 23 B) are clearly intended to affect how a Contracting State taxes its own residents, the object of the majority of the pro - visions of the Convention is to restrict the right of a Contracting State to tax the residents of the other Contracting State. In some limited cases, however, it has been argued that some provisions could be interpreted as limiting a Contracting State’s right to tax its own residents in cases where this was not intended (see, for example, paragraph 81 below, which addresses the case of controlled foreign companies provisions). 18. Paragraph 3 confirms the general principle that the Convention does not restrict a Contracting State’s right to tax its own residents except where this is intended and lists the pro - visions with respect to which that principle is not applicable. 19. The exceptions so listed are intended to cover all cases where it is envisaged in the Convention that a Contracting State may have to provide treaty benefits to its own residents (whether or not these or similar benefits are provided under the domestic law of that State). These provisions are: — [Paragraph 3 of Article 7, which requires a Contracting State to grant to an enterprise of that State a correlative 68

91 Article 1 Commentary adjustment following an initial adjustment made by the other Contracting State, in accordance with paragraph 2 of Article 7, to the amount of tax charged on the profits of a permanent establishment of the enterprise.] Paragraph 2 of Article 9, which requires a Contracting — State to grant to an enterprise of that State a correspond - ing adjustment following an initial adjustment made by the other Contracting State, in accordance with para - graph 1 of Article 9, to the amount of tax charged on the profits of an associated enterprise. — Article 19, which may affect how a Contracting State taxes an individual who is resident of that State if that individual derives income in respect of services rendered to the other Contracting State or a political subdivision or local authority thereof. — Article 20, which may affect how a Contracting State taxes an individual who is resident of that State if that individual is also a student who meets the conditions of that Article. — Articles 23 A and 23 B, which require a Contracting State to provide relief of double taxation to its residents with respect to the income that the other State may tax in accordance with the Convention (including profits that are attributable to a permanent establishment situated - in the other Contracting State in accordance with para graph 2 of Article 7). — Article 24, which protects residents of a Contracting State against certain discriminatory taxation practices by that State (such as rules that discriminate between two persons based on their nationality). — Article 25 which allows residents of a Contracting State to request that the competent authority of that State consider cases of taxation not in accordance with the Convention. — Article 28, which may affect how a Contracting State taxes an individual who is resident of that State when that individual is a member of the diplomatic mission or consular post of the other Contracting State. 69

92 Article 1 Commentary 20. The list of exceptions included in paragraph 3 should include any other provision that the Contracting States may agree to include in their bilateral convention where it is intended that this provision should affect the taxation, by a Contracting State, of its own residents. For instance, if the Contracting States agree, in accordance with paragraph 27 of the Commentary on Article 18, to include in their bilateral convention a provision according to which pensions and other payments made under the social security legislation of a Contracting State shall be taxable only in that State, they should include a reference to that provision in the list of exceptions included in paragraph 3. Other examples include the alternative provisions in paragraphs 23, 30, 37 and 68 of the Commentary on Article 18 because these provisions provide benefits that are typically intended to be granted to an individual who participated in a foreign pension scheme before becoming a resident of a Contracting State. 21. The term “resident”, as used in paragraph 3 and through - out the Convention, is defined in Article 4. Where, under par - agraph 1 of Article 4, a person is considered to be a resident of both Contracting States based on the domestic laws of these States, paragraphs 2 and 3 of that Article determine a single State of residence for the purposes of the Convention. Thus, paragraph 3 does not apply to an individual or legal person who is a resident of one of the Contracting States under the laws of that State but who, for the purposes of the Convention, is deemed to be a resident only of the other Contracting State. Improper use of tax treaties 10. The principal purpose of double taxation conventions is to promote, by eliminating international double taxation, exchanges of goods and services, and the movement of capital and persons. However, the provisions of tax treaties are drafted in general terms and taxpayers may be tempted to enter into arrangements so as to obtain benefits in circumstances where the Contracting States did not intend that these benefits be provided. Such improper uses of tax treaties are a source of concern to all countries but particularly for countries that have limited experience in dealing with sophisticated tax-avoidance strategies. 70

93 Article 1 Commentary 11. The Committee considered that it would therefore be helpful to examine the various approaches through which those strategies may be dealt with and to provide specific examples of the application of these approaches. In examining this issue, the Committee recognized that for tax treaties to achieve their role, it is important to maintain a balance between the need for tax administrations to protect their tax revenues from the misuse of tax treaty provisions and the need to provide legal certainty and to protect the legitimate expectations of taxpayers. In the 2017 update the Committee made several changes to 12. the United Nations Model Convention to prevent taxpayers from using the provisions of bilateral tax conventions based on the United Nations Model Convention improperly to obtain treaty benefits. First, the title of the Convention has been amended to refer expressly to “the prevention of tax avoidance and evasion.” Second, a new preamble has been added which clarifies that tax conventions are not intended to create opportunities for tax avoidance or evasion including tax avoid - ance through treaty-shopping arrangements. Third, a new general anti-abuse rule has been included in Article 29, paragraph 9 of the United Nations Model Convention. This general anti-abuse rule and the specific anti-abuse rules included in tax treaties are intended to - deny treaty benefits with respect to certain transactions and arrange ments where granting such benefits would be contrary to the object and purpose of the Convention. These additions to the United Nations Model Convention will 13. make the provisions of the Convention more effective in preventing treaty abuse. However, many countries may have existing bilateral tax conventions that do not contain these new provisions, in particular the general anti-abuse rule in Article 29, paragraph 9. This part of the Commentary describing the various approaches that countries may adopt to combat tax avoidance through the improper use of tax trea - ties, is especially important where their treaties do not include Article 29, paragraph 9. 14. Paragraphs 15 to 55 below are based on the 2017 OECD Commentary on Article 1 with appropriate modifications. In general, the basic approaches to controlling treaty abuse described below are intended to be consistent with the relevant Commentary on Article 1 of the OECD Model Convention. 71

94 Article 1 Commentary 15. There are a number of different approaches used by countries to prevent and address the improper use of tax treaties. In general, these approaches involve the interpretation and application of the provi - sions of a treaty or the interpretation and application of domestic law. Dealing with tax avoidance through domestic law involves the possi - ble application of: a. specific anti-abuse rules in domestic law general anti-abuse rules in domestic law and b. judicial doctrines and principles of interpretation that are part c. of domestic law. These domestic-law approaches are discussed generally in paragraphs 16 and 17 below and separately in more detail in paragraphs 31 to 47. Dealing with tax avoidance through tax conventions involves the pos - sible application of: a. specific anti-abuse rules in tax treaties b. general anti-abuse rules in tax treaties and c. the interpretation of tax treaty provisions. These treaty-based approaches are discussed generally in paragraphs 18 to 30 below and separately in more detail in paragraphs 48 to 56. 1. Approaches to prevent the improper use of tax treaties Addressing tax avoidance through domestic anti-abuse rules and judicial doctrines 16. Domestic anti-abuse rules and judicial doctrines may be used to address transactions and arrangements entered into for the purpose of obtaining treaty benefits in inappropriate circumstances. These rules and doctrines may also address situations where transactions or arrangements are entered into for the purpose of abusing both domes - tic laws and tax conventions. 17. For these reasons, domestic anti-abuse rules and judicial doc - trines play an important role in preventing treaty benefits from being granted in inappropriate circumstances. The application of such domestic anti-abuse rules and doctrines, however, raises the issue of possible conflicts with treaty provisions, in particular where treaty 72

95 Article 1 Commentary provisions are relied upon in order to facilitate the abuse of domestic law provisions (e.g. where it is claimed that treaty provisions protect the taxpayer from the application of certain domestic anti-abuse rules). This issue is discussed below in relation to specific legislative anti-abuse rules, general legislative anti-abuse rules and judicial doctrines. Addressing tax avoidance through tax conventions 18. Article 29, paragraph 9 and the specific treaty anti-abuse rules included in tax conventions are aimed at transactions and arrange - ments entered into for the purpose of obtaining treaty benefits in inap - propriate circumstances. Where, however, a tax convention does not include such rules, the question may arise whether the benefits of the tax convention should be granted when transactions that constitute an abuse of the provisions of that convention are entered into. 19. Many States address that question by taking account of the fact that taxes are ultimately imposed through the provisions of domestic law, as restricted (and in some rare cases, broadened) by the provi - sions of tax conventions. Thus, any abuse of the provisions of a tax convention could also be characterised as an abuse of the provisions of domestic law under which tax is levied. For these States, the issue becomes whether the provisions of tax conventions may prevent the application of the anti-abuse provisions of domestic law, which is the question addressed in paragraphs 35 to 44 below. As explained in these paragraphs, as a general rule, there will be no conflict between such rules and the provisions of tax conventions. 20. Other States prefer to view some arrangements as abuses of the convention itself, as opposed to abuses of domestic law. These States, however, consider that a proper construction of tax conventions allows them to disregard abusive transactions and arrangements, such as those entered into with the view to obtaining unintended benefits under the provisions of these conventions. This interpretation results from the object and purpose of tax conventions as well as the obli - gation to interpret them in good faith (see Article 31 of the Vienna Convention on the Law of Treaties). 21. Under both approaches, therefore, it is agreed that States do not have to grant the benefits of a double taxation convention where 73

96 Article 1 Commentary arrangements that constitute an abuse of the provisions of the conven - tion have been entered into. 22. It is important to note, however, that it should not be lightly assumed that a taxpayer is entering into the type of abusive transactions referred to above. A guiding principle is that the benefits of a double taxation convention should not be available where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions. That principle applies independently from the provisions of Article 29, paragraph 9, which merely confirm it. 23. The guiding principle in paragraph 22 above has been endorsed by the OECD in paragraph 61 of the 2017 Commentary on Article 1 of the OECD Model Convention (paragraph 9.5 of the Commentary on Article 1 of the 2014 OECD Model Convention). The members of the Committee endorsed that principle in the 2011 update of the United Nations Model Convention and they continue to endorse it. They consider that such guidance as to what constitutes an abuse of treaty provisions serves an important purpose as it attempts to bal - ance the need to prevent treaty abuses with the need to ensure that countries respect their treaty obligations and provide legal certainty to taxpayers. Clearly, countries should not be able to escape their treaty obligations simply by arguing that legitimate transactions are abusive and domestic tax rules that affect these transactions in ways that are contrary to treaty provisions constitute anti-abuse rules. 24. Under the guiding principle presented above, two elements must therefore be present for certain transactions or arrangements to be found to constitute an abuse of the provisions of a tax treaty: — a main purpose for entering into these transactions or arrangements was to secure a more favourable tax position, and — obtaining that more favourable treatment would be con - trary to the object and purpose of the relevant provisions. 25. These two elements will also often be found, explicitly or implicitly, in general anti- avoidance rules and doctrines developed in various countries. 74

97 Article 1 Commentary 26. In order to minimize the uncertainty that may result from the application of that approach, it is important that this guiding principle be applied on the basis of objective findings of facts, not solely the alleged intention of the parties. Thus, the determination of whether a main purpose for entering into transactions or arrangements is to obtain tax advantages should be based on an objective determination, based on all the relevant facts and circumstances, of whether, without these tax advantages, a reasonable taxpayer would have entered into the same transactions or arrangements. 27. The potential application of these principles or of Article 29, paragraph 9 does not mean that the inclusion, in tax conventions, of - specific provisions aimed at preventing particular forms of tax avoid ance is unnecessary. Where specific avoidance techniques have been identified or the use of such techniques is especially problematic, it will often be useful to add to the Convention provisions that focus directly on the relevant avoidance strategy. Also, this will be necessary where a State which adopts the view described in paragraph 20 above believes that its domestic law lacks the anti-avoidance rules or princi - ples necessary to properly address such a strategy. 28. For instance, some forms of tax avoidance have already been expressly dealt with in the Convention, e.g. by the introduction of the concept of “beneficial owner” (in Articles 10, 11, 12, and 12A) and of special provisions such as paragraph 2 of Article 17 deal - ing with so-called artiste-companies. Such problems are also men - tioned in the Commentaries on Article 10 (paragraph 13 quoting paragraphs 17 and 22 of the Commentary on Article 10 of the 2014 OECD Model Convention) and Article 11 (paragraph 18 quoting paragraph 12 of the Commentary on Article 11 of the 2014 OECD Model Convention). 29. Also, in some cases, claims to treaty benefits by subsidiary com - panies, in particular companies established in tax havens or benefit - ing from harmful preferential regimes, may be refused where careful consideration of the facts and circumstances of a case shows that the place of effective management of a subsidiary does not lie in its alleged state of residence but, rather, lies in the state of residence of the parent company so as to make it a resident of that latter state for domestic law purposes (this will be relevant where the domestic law of a state uses 75

98 Article 1 Commentary the place of management of a legal person, or a similar criterion, to determine its residence). 30. Careful consideration of the facts and circumstances of a case may also show that a subsidiary is managed in the state of residence of its parent in such a way that the subsidiary had a permanent establish - ment (e.g. by having a place of management) in that state to which all or a substantial part of its profits are properly attributable. Specific legislative anti-abuse rules found in domestic law 31. Tax authorities seeking to address the improper use of a tax treaty may first consider the application of specific anti-abuse rules included in their domestic tax law. 32. Many specific anti-abuse rules found in domestic law may be relevant for that purpose. For instance, controlled foreign corporation (CFC) rules may apply to prevent certain arrangements involving the use, by residents, of base or conduit companies that are residents of treaty countries; thin capitalization rules or earnings stripping rules may apply to restrict the deduction of base-eroding interest pay - ments to residents of treaty countries; transfer pricing rules (even if not designed primarily as anti-abuse rules) may prevent the artificial shifting of income from a resident enterprise to an enterprise that is resident of a treaty country; exit or departure taxes rules may prevent the avoidance of capital gains tax through a change of residence before the realization of a treaty-exempt capital gain and dividend stripping rules may prevent the avoidance of domestic dividend withholding taxes through transactions designed to transform dividends into treaty-exempt capital gains; and anti-conduit rules may prevent cer - tain avoidance transactions involving the use of conduit arrangements. 33. A common problem that arises from the application of many of these and other specific anti-abuse rules to arrangements involv - ing the use of tax treaties is possible conflicts with the provisions of tax treaties. Where two Contracting States take different views as to whether a specific anti-abuse rule found in the domestic law of one of these States conflicts with the provisions of their tax treaty, the issue may be addressed through the mutual agreement procedure having regard to the following principles. 76

99 Article 1 Commentary 34. Generally, where the application of provisions of domestic law - and the provisions of tax treaties produces conflicting results, the pro - visions of tax treaties are intended to prevail. This is a logical conse quence of the principle of “pacta sunt servanda” which is incorporated in Article 26 of the Vienna Convention on the Law of Treaties. Thus, if the application of specific anti-abuse rules found in domestic law were to result in a tax treatment that is not in accordance with the provisions of a tax treaty, this would conflict with the provisions of that treaty and the provisions of the treaty should prevail under public international law. 35. As explained below, however, such conflicts will often be avoided and each case must be analysed based on its own circumstances. 36. First, a treaty may specifically allow the application of certain types of specific domestic anti-abuse rules. For example, Article 9 of the Convention specifically authorizes the application of domestic transfer pricing rules in the circumstances defined by that Article. Also, many treaties include specific provisions clarifying that there is no conflict or, even if there is a conflict, allowing the application of the domestic rules. This would be the case, for example, for a treaty provision that expressly allows the application of thin capitalization rules, CFC rules or departure tax rules or, more generally, rules aimed at preventing the avoidance of tax found in the domestic law of one or both of the Contracting States. Second, many tax treaty provisions depend on the application 37. of domestic law. This is the case, for instance, for the determination of the residence of a person, the determination of what is immovable property and the determination of when income from corporate rights might be treated as a dividend. More generally, paragraph 2 of Article 3 makes domestic rules relevant for the purposes of determining the meaning of terms that are not defined in the treaty. In many cases, therefore, the application of domestic anti-abuse rules will impact how the treaty provisions are applied rather than produce conflict - ing results. For example, if a domestic law provision treats the profits realised by a shareholder when a company redeems some of its shares as dividends, such a redemption could be considered to constitute an alienation for the purposes of paragraph 5 of Article 13. However, par - agraph 14 of the Commentary on Article 10 (quoting paragraph 14 of 77

100 Article 1 Commentary the Commentary on Article 10 of the 2014 OECD Model Convention) recognises that such profits will constitute dividends for the purposes of Article 10 if the profits are treated as dividends under domestic law. Third, the application of tax treaty provisions in a case that 38. involves an abuse of these provisions may be denied under the general anti-abuse rule in Article 29, paragraph 9, or in the case of a treaty that does not include that Article, under a proper interpretation of the treaty in accordance with the principles in paragraphs 54 to 56 below. In such a case, there will be no conflict with the treaty provi - sions if the benefits of the treaty are denied under both the interpreta - tion of the treaty and the application of domestic specific anti-abuse rules. Domestic specific anti-abuse rules, however, are often drafted by reference to objective facts, such as the existence of a certain level of shareholding or a certain debt-equity ratio. While this greatly facil - itates their application and provides greater certainty, it may some - times result in the application of these rules to transactions that do not constitute abuses. In such cases, the Convention will not allow the application of the domestic rule to the extent of the conflict. For exam - ple, assume that State A has adopted a domestic rule to prevent tempo - rary changes of residence for tax purposes under which an individual who is a resident of State B is taxable in State A on gains from the alienation of property situated in a third State if that individual was a resident of State A when the property was acquired and was a resident of State A for at least seven of the 10 years preceding the alienation. In such a case, to the extent that paragraph 6 of Article 13 would prevent the taxation of that individual by State A upon the alienation of the property, the Convention would prevent the application of State A’s domestic rule unless the benefits of paragraph 6 of Article 13 could be denied, in that specific case, under Article 29, paragraph 9 or the principles in paragraphs 54 to 56 below. 39. Fourth, the application of tax treaty provisions may be denied under judicial doctrines or principles applicable to the interpretation of the treaty (see paragraphs 43 to 47 and 54 to 56 below). In such a case, there will be no conflict with the treaty provisions if the benefits of the treaty are denied under both a proper interpretation of the treaty and as result of the application of domestic specific anti-abuse rules. Assume, for example, that the domestic law of State A provides for the taxation of gains derived from the alienation of shares of a domestic company 78

101 Article 1 Commentary in which the alienator holds more than 25 per cent of the capital if that alienator was a resident of State A for at least seven of the 10 years preceding the alienation. In year 2, an individual who was a resident of State A for the previous 10 years becomes a resident of State B. Shortly after becoming a resident of State B, the individual sells all the shares of a small company that he previously established in State A. The facts reveal, however, that all the elements of the sale were finalised in year 1, that an interest-free “loan” corresponding to the sale price was made by the purchaser to the seller at that time, that the purchaser cancelled the loan when the shares were sold to the purchaser in year 2 and that the pur - chaser exercised de facto control of the company from year 1. Although - the gain from the sale of the shares might otherwise fall under para graph 6 of Article 13 of the State A-State B treaty, the circumstances of the transfer of the shares are such that the alienation in year 2 constitutes a sham within the meaning given to that term by the courts of State A. In that case, to the extent that the sham transaction doctrine developed by the courts of State A does not conflict with the rules of interpretation of treaties, it would be possible to apply that doctrine when interpreting paragraph 6 of Article 13 of the State A-State B treaty, which would allow State A to tax the relevant gain under its domestic law rule. 40. A similar analysis applies in the case of controlled foreign corpo - ration (CFC) rules. A significant number of countries have adopted CFC provisions to address issues related to the use of foreign base companies. Whilst the design of this type of legislation varies considerably among countries, a common feature of these rules, which are now internation - ally recognised as a legitimate instrument to protect the domestic tax base, is that they result in a Contracting State taxing its residents on income attributable to their participation in certain foreign entities. It has sometimes been argued, based on a certain interpretation of provi - sions of the Convention such as paragraph 1 of Article 7 and paragraph 5 of Article 10, that this common feature of CFC legislation conflicted with these provisions. Since CFC legislation results in a State taxing its own residents, the new saving provision added to the United Nations Model Convention in the 2017 update as [paragraph 3 of Article 1] confirms that it does not conflict with tax conventions. The same conclusion must be reached in the case of conventions that do not include a provision similar to [paragraph 3 of Article 1]. For the reasons explained in para - graphs 8 of the Commentary on Article 7 and 16 of the Commentary on 79

102 Article 1 Commentary Article 10, the interpretation according to which these Articles would prevent the application of CFC provisions does not accord with the text of paragraph 1 of Article 7 and paragraph 5 of Article 10. It is also not valid when these provisions are read in their context. Thus, whilst some countries have felt it useful to expressly clarify, in their conventions, that their CFC legislation did not conflict with the Convention, such clarifi - cation is not necessary. It is recognised that CFC legislation structured in this way is not contrary to the provisions of the Convention. General legislative anti-abuse rules found in domestic law 41. Many countries have included in their domestic law a legislative anti-abuse rule of general application, which is intended to prevent abusive arrangements that are not adequately dealt with through spe - cific anti-abuse rules or judicial doctrines. 42. The application of such general anti-abuse rules also raises the question of a possible conflict with the provisions of a tax treaty. In the vast majority of cases, however, no such conflict will arise. Conflicts will first be avoided for reasons similar to those presented in para - graphs 39 and 40 above. In addition, where the main aspects of these domestic general anti-abuse rules are in conformity with the guiding principle in paragraph 22 above and are therefore similar to the main aspects of Article 29, paragraph 9, which incorporates this guiding principle, it is clear that no conflict will be possible since the relevant domestic general anti-abuse rule will apply in the same circumstances in which the benefits of the Convention would be denied under Article 29, paragraph 9, or, in the case of a treaty that does not include that Article, under the guiding principle in paragraph 22 above. This is the same general conclusion of the OECD, which is reflected in paragraph 77 of the Commentary on Article 1 of the OECD Model Convention. Judicial doctrines and principles of interpretation that are part of domestic law 43. In the process of determining how domestic tax law applies to tax avoidance transactions, the courts of many countries have devel - oped different judicial doctrines or principles of interpretation that may have the effect of preventing domestic law abuses. These include 80

103 Article 1 Commentary the sham, business purpose, substance over form, economic substance, - step transaction, abuse of law and fraus legis approaches. These judi cial doctrines and principles of interpretation vary from country to country and evolve over time based on refinements or changes result - ing from subsequent court decisions. 44. These doctrines are essentially views expressed by courts as to how tax legislation should be interpreted and typically become part of the domestic tax law. 45. While the interpretation of tax treaties is governed by gen - eral rules that have been codified in Articles 31 to 33 of the Vienna Convention on the Law of Treaties, nothing prevents the application of similar judicial approaches to the interpretation of the particular provi - sions of tax treaties. If, for example, the courts of one country have deter - mined that, as a matter of legal interpretation, domestic tax provisions should apply on the basis of the economic substance of certain transac - tions, there is nothing that prevents a similar approach to be adopted with respect to the application of the provisions of a tax treaty to similar transactions. This is illustrated by the example in paragraph 40 above. 46. As a general rule and having regard to paragraph 22, therefore, the preceding analysis leads to the conclusion that there will be no conflict between tax conventions and judicial anti- abuse doctrines or general domestic anti-abuse rules. For example, to the extent that the application of a general domestic anti-abuse rule or a judicial doc - trine such as “substance over form” or “economic substance” results in a recharacterisation of income or in a redetermination of the tax - payer who is considered to derive such income, the provisions of the Convention will be applied taking into account these changes. 47. Whilst these rules do not conflict with tax conventions, there is agreement that member countries should carefully observe the spe - cific obligations enshrined in tax treaties to relieve double taxation as long as there is no clear evidence that the treaties are being abused. Specific anti-abuse rules found in tax treaties 48. Some forms of treaty abuse can be addressed through specific treaty provisions. A number of such rules are already included in the 81

104 Article 1 Commentary United Nations Model Convention; these include, in particular, the - reference to an agent who maintains a stock of goods for delivery pur poses (subparagraph (5) (b) of Article 5), the concept of “beneficial owner” (in Articles 10, 11, 12, and 12A), the “special relationship” rule applicable to interest, royalties, and fees for technical services (para - graph 6 of Article 11, paragraph 6 of Article 12, and paragraph 7 of Article 12A), the rule on alienation of shares of immovable property companies (paragraph 4 of Article 13) and the rule on “star-companies” (paragraph 2 of Article 17). Another example is the modified version of the limited force-of-attraction rule of paragraph 1 of Article 7 that is found in some tax treaties and that applies only to avoidance cases. 49. Clearly, such specific treaty anti-abuse rules provide more cer - tainty to taxpayers than broad general anti-abuse rules or doctrines. This is acknowledged in paragraph 22 above and in paragraph 62 (par - agraph 9.6 of the 2014 Commentary on Article 1) of the 2017 OECD Commentary on Article 1, which explains that such rules can usefully supplement general anti- avoidance rules or judicial approaches. 50. One should not, however, underestimate the risks of relying extensively on specific treaty anti-abuse rules to deal with tax treaty avoidance strategies. First, specific anti-abuse rules are often drafted once a particular avoidance strategy has been identified. Second, the inclusion of a specific anti-abuse provision in a treaty can weaken the case as regards the application of general anti-abuse rules or doctrines to other forms of treaty abuses. Adding specific anti-abuse rules to a tax treaty could be wrongly interpreted as suggesting that an unac - ceptable avoidance strategy that is similar to, but slightly different from, one dealt with by a specific anti-abuse rule included in the treaty is allowed and cannot be challenged under general anti-abuse rules. Third, in order to specifically address complex avoidance strate - gies, complex rules may be required. This is especially the case where these rules seek to address the issue through the application of crite - ria that leave little room for interpretation rather than through more flexible criteria such as the purposes of a transaction or arrangement. For these reasons, whilst the inclusion of specific anti-abuse rules in tax treaties is the most appropriate approach to deal with certain situations, it cannot, by itself, provide a comprehensive solution to treaty abuses. 82

105 Article 1 Commentary General anti-abuse rules found in tax treaties In the 2017 update of the United Nations Model Convention, a 51. general anti-abuse rule was added to the Convention as paragraph 9 of Article 29. Article 29, paragraph 9 is intended to prevent the improper use of tax treaties by denying the benefits of a treaty where a main purpose of a transaction or arrangement is to obtain those benefits and granting those benefits would contrary to the object and purpose of the relevant provisions of the treaty. As explained in paragraph 22 above, Article 29, paragraph 9 52. is consistent with and confirms the guiding principle for granting treaty benefits. Thus, many countries are able to deny treaty benefits in abusive cases without the need for a general anti-abuse rule, such as Article 29, paragraph 9, in their treaties. For this purpose, these coun - tries can apply a general anti-abuse rule found in domestic law, judicial doctrines or principles of interpretation found in domestic law or they can interpret the provisions of their tax treaties in order to deny the benefits of a treaty in abusive cases. 53. Some countries may not feel confident that their domestic law and approach to the interpretation of tax treaties would allow them to adequately address improper uses of their tax treaties. These countries could consider including a general anti-abuse rule in their treaties, such as paragraph 9 of Article 29. A country that wishes to include a general anti-abuse rule in its treaties may need to adapt the wording to its own circumstances, particularly as regards the approach that its courts have adopted with respect to tax avoidance. In particular, a country that has a general anti-abuse rule in its domestic law should avoid, as far as possible, any inconsistency between that domestic rule and the general anti-abuse rule included in its treaties. The interpretation of tax treaty provisions 54. Another approach that has been used to counter improper uses of treaties has been to consider that there can be abuses of the treaty itself and to disregard abusive transactions under a proper interpreta - tion of the relevant treaty provisions that takes account of their con - text, the object and purpose of the treaty as well as the obligation to interpret these provisions in good faith in accordance with Article 31 83

106 Article 1 Commentary of the Vienna Convention on the Law of Treaties. As noted in para - graph 20 above, a number of countries have long used a process of legal interpretation to counteract abuses of their domestic tax laws and it seems entirely appropriate to similarly interpret tax treaty provisions to counteract tax treaty abuses. The guiding principle in paragraph 22 above is equally applicable for the purpose of interpreting the provi - sions of a treaty to prevent the abuse of the treaty as it is for purposes of determining whether the provisions of a treaty prevent the application of specific or general anti-abuse rules found in domestic law. 55. Paragraphs 22 to 24 above provide guidance as to what should be considered to be a tax treaty abuse. That guidance would obviously be relevant for the purposes of the application of this approach. 56. As part of the 2017 update, the title of the United Nations Model Convention was amended to include an express reference to the pre - vention of tax avoidance and evasion as a purpose of the Convention. In addition, a new preamble to the Convention was added to clar - ify that the Contracting States do not intend the provisions of the Convention to create opportunities for non-taxation or reduced taxation through tax avoidance or evasion including through treaty-shopping. Treaty-shopping is only one example of the improper use of tax treaties; other examples can be found in paragraphs 58 to 117 below. Since the title and preamble form part of the context of the United Nations Model Convention, they should play an important role in the interpretation of the provisions of the Convention to prevent treaty abuse. 2. Examples of improper uses of tax treaties 57. The following paragraphs illustrate the application of the approaches described above in various cases involving the improper use of tax treaty provisions (these examples, however, are not intended to prejudge the legal treatment of these transactions in domestic law or under specific treaties). Dual residence and transfer of residence 58. There have been cases where taxpayers have changed their tax residence primarily for the purposes of getting tax treaty benefits. The following examples illustrate some of these cases: 84

107 Article 1 Commentary Example 1 : Mr. X is a resident of State A who has accumu - — lated significant pension rights in that country. Under the treaty between State A and State B, pensions and other simi - lar payments are only taxable in the State of residence of the recipient. Just before his retirement, Mr. X moves to State B for two years and becomes resident thereof under the domestic tax law of that country. Mr. X is careful to use the rules of paragraph 2 of Article 4 to ensure that he is resident of that country for the purposes of the treaty. During that period, his accrued pension rights are paid to him in the form of a lump-sum payment, which is not taxable under the domestic law of State B. Mr. X then returns to State A. — Example 2 - : Company X, a resident of State A, is contemplat ing the sale of shares of companies that are also residents of State A. Such a sale would trigger a capital gain that would be taxable under the domestic law of State A. Prior to the sale, company X arranges for meetings of its board of direc - tors to take place in State B, a country that does not tax capital gains on shares of companies and in which the place where a company’s directors meet is usually determinative of that company’s residence for tax purposes. Company X - claims that it has become a resident of State B for the pur poses of the tax treaty between States A and B pursuant to paragraph 3 of Article 4 of that treaty, which is identical to the United Nations Model Convention. It then sells the shares and claims that the capital gain may not be taxed in State A pursuant to paragraph 6 of Article 13 of the treaty (paragraph 5 of that Article would not apply as Company X does not own substantial participations in the relevant compa nies). Example 3 : Ms. X, a resident of State A, owns all the shares — of a company that is also a resident of State A. The value of these shares has increased significantly over the years. Both States A and B tax capital gains on shares; however, the domestic law of State B provides that residents who are not domiciled in that State are only taxed on income derived from sources outside the State to the extent that this income is effectively repatriated, or remitted, thereto. In contem - plation of the sale of these shares, Ms. X moves to State B for 85

108 Article 1 Commentary two years and becomes resident, but not domiciled, in that State. She then sells the shares and claims that the capital gain may not be taxed in State A pursuant to paragraph 6 of Article 13 of the treaty (the relevant treaty does not include a provision similar to paragraph 5 of the United Nations Model Convention). 59. Depending on the facts of a particular case, it might be possible to argue that a change of residence that is primarily intended to access treaty benefits constitutes an abuse of a tax treaty. In cases similar to these three examples, however, it would typically be very difficult to find facts that would show that the change of residence has been done primarily to obtain treaty benefits, especially where the taxpayer has a permanent home or is present in another State for extended periods of time. Many countries have therefore found that specific rules were the best approach to deal with such cases. 60. One approach used by some of these countries has been to include in their tax treaties provisions allowing a State of which a taxpayer was previously resident to tax certain types of income, e.g. capital gains on significant participations in companies or lump-sum payments of pension rights, realized during a certain period following the change of residence. An example of such a provision is found in par - agraph 5 of Article 13 of the treaty signed in 2002 by the Netherlands and Poland, which reads as follows: The provisions of paragraph 4 shall not affect the right of each of the Contracting States to levy according to its own law a tax on gains from the alienation of shares or “jouissance” rights in a company, the capital of which is wholly or partly divided into shares and which under the laws of that State is a resident of that State, derived by an individual who is a resident of the other Contracting State and has been a resident of the first-mentioned State in the course of the last ten years preceding the alienation of the shares or “jouissance” rights. 61. Countries have also dealt with such cases through the use of so-called “departure tax” or exit charge” provisions, under which the change of residence triggers the realization of certain types of income, e.g. capital gains and pensions. To the extent that the liability to such 86

109 Article 1 Commentary a tax arises when a person is still a resident of the State that applies the tax and does not extend to income accruing after the cessation of residence, nothing in the Convention, and in particular in Articles 13 and 18, prevents the application of that form of taxation. Thus, tax treaties do not prevent the application of domestic tax rules according to which a person is considered to have realised pension income, or to have alienated property for capital gain tax purposes, immediately before ceasing to be a resident. 62. A proper interpretation of the provisions of paragraphs 2 and 3 of Article 4 may also be useful in dealing with cases similar to these exam - ples. Concepts such as “centre of vital interests” and “place of effective management”, which was the tie-breaker rule for legal entities before the 2017 update of the Convention, require a strong relationship between a taxpayer and a country. The fact that a taxpayer has a home availa - ble to him in a country where he sojourns frequently is not enough to claim that that country is his centre of vital interests; likewise, the mere fact that meetings of a board of directors of a company take place in a country is not sufficient to conclude that this is where the company is effectively managed. However, because many cases with respect to the dual residence of legal entities involve abusive arrangements, the 2017 update replaced paragraph 3 of Article 4, which deals with cases of dual residence of legal persons on the basis of their place of effective manage - ment, by a rule that leaves such cases of dual residence to be decided on a case- by-case under the mutual agreement procedure. 63. Example 3 raises the potential for tax avoidance arising from remittance-based taxation. This issue is dealt with in paragraph 118 below quoting paragraph 108 of the Commentary on Article 1 of the 2017 OECD Model Convention. Treaty shopping 64. “Treaty shopping” is a form of improper use of tax treaties that refers to arrangements through which persons who are not entitled to the benefits of a tax treaty use other persons who are entitled to such benefits in order to indirectly access these benefits. For example, a com - pany that is a resident of a treaty country would act as a conduit for chan - neling income that would economically accrue to a person that is not a 87

110 Article 1 Commentary resident of that country so as to improperly access the benefits provided by a tax treaty. The conduit entity is usually a company, but may also be a partnership, trust or similar entity that is entitled to treaty benefits. Granting treaty benefits in these circumstances would be detrimental to the State of source since the benefits of the treaty would be extended to persons who were not intended to obtain such benefits. 65. A treaty shopping arrangement may take the form of a “direct 15 conduit” or that of a “stepping stone conduit”, as illustrated below. Company X, a resident of State A, receives dividends, interest 66. or royalties from Company Y, a resident of State B. Company X claims that, under the tax treaty between States A and B, it is entitled to full or partial exemption from the domestic withholding taxes provided for under the tax legislation of State B. Company X is wholly-owned by a resident of third State C who is not entitled to the benefits of the treaty between States A and B. Company X was created for the purpose of obtaining the benefits of the treaty between States A and B and it is for that purpose that the assets and rights giving rise to the dividends, interest or royalties have been transferred to it. The income is exempt from tax in State A, e.g. in the case of dividends, by virtue of a partic - ipation exemption provided for under the domestic laws of State A or under the treaty between States A and B. In that case, Company X con - stitutes a direct conduit of its shareholder who is a resident of State C. 67. The basic structure of a stepping stone conduit is similar. In that case, however, the income of Company X is fully taxable in State A and, in order to eliminate the tax that would be payable in that country, Company X pays high interest, commissions, service fees or similar deductible expenses to a second related conduit company, Company Z, a resident of State D. These payments, which are deductible in State A, are tax-exempt in State D by virtue of a special tax regime available in 16 that State. The shareholder who is a resident of State C is therefore seeking to access the benefits of the tax treaty between States A and B by using Company X as a stepping stone. 15 See page R(6)-4, paragraph 4 of the OECD Report: Double Taxation Conventions and the use of Conduit Companies . Reproduced in Volume II of the full-length version of the OECD Model Convention at page R(6)-1. 16 Id. 88

111 Article 1 Commentary 68. In order to deal with such situations, tax authorities have relied on the various approaches described in the previous sections. 69. For instance, specific anti-abuse rules have been included in the domestic law of some countries to deal with such arrangements. One example is that of the United States regulations dealing with financing arrangements. For the purposes of these regulations, a financing arrange - ment is a series of transactions by which the financing entity advances money or other property to the financed entity, provided that the money or other property flows through one or more intermediary entities. An intermediary entity will be considered a “conduit”, and its participation in the financing arrangements will be disregarded by the tax authorities if (i) tax is reduced due to the existence of an intermediary, (ii) there is a tax avoidance plan, and (iii) it is established that the intermediary would not have participated in the transaction but for the fact that the intermediary is a related party of the financing entity. In such cases, the related income shall be recharacterized according to its substance. 70. Other countries have dealt with the issue of treaty shopping through the interpretation of tax treaty provisions. According to a 1962 decree of the Swiss Federal Council, which is applicable to Swiss treaties - with countries that, under the relevant treaties, grant relief from with holding tax that would otherwise be collected by these countries, a claim for such relief is considered abusive if, through such claim, a substantial part of the tax relief would benefit persons not entitled to the relevant tax treaty. The granting of tax relief shall be deemed improper (a) if the requirements specified in the tax treaty (such as residence, beneficial ownership, tax liability, etc.) are not fulfilled and (b) if it constitutes an abuse. The measures which the Swiss tax authorities may take if they determine that a tax relief has been claimed improperly include (a) refusal to certify a claim form, (b) refusal to transmit the claim form, (c) revoking a certification already given, (d) recovering the withholding tax, on behalf of the State of source, to the extent that the tax relief has been claimed improperly, and (e) informing the tax authorities of the State of source that a tax relief has been claimed improperly. 71. Other countries have relied on their domestic legislative gen - eral anti-abuse rules or judicial doctrines to address treaty shopping cases. As already noted, however, legislative general anti-abuse rules and judicial doctrines tend to be most effective when it is clear that 89

112 Article 1 Commentary transactions are intended to circumvent the object and purpose of tax treaty provisions. 72. Treaty shopping can also, to some extent, be addressed through anti-abuse rules already found in most tax treaties, such as the concept of “beneficial ownership”. 73. Some countries, however, consider that the most effective approach to deal with treaty shopping is to include in their tax trea - ties specific anti-abuse rules dealing with that issue, such as the rules in paragraphs 1 to 7 of Article 29 which were added to the United Nations Model Convention in 2017. 74. When considering the various approaches for dealing with treaty shopping, countries should take account of their ability to administer those approaches. For many developing countries, it may be difficult to apply very detailed rules that require access to substantial information about foreign entities. These countries might consider that a more lim - ited approach which has the effect of denying the benefits of specific Articles of the Convention where transactions have been entered into for a main purpose of obtaining those benefits, might be more adapted to their own circumstances. The Articles concerned are 10, 11, 12 and 21; the provision should be slightly modified as indicated below to deal with the specific type of income covered by each of these Articles: The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the [Article 10: “shares or other rights”; Article 11: “debt-claim”; Articles 12 and 21: “rights”] in respect of which the [Article 10: “dividend”; Article 11: “interest”; Articles 12 “royalties” and Article 21: “income”] is paid to take advantage of this Article by means of that creation or assignment. 75. In the 2017 update, a new preamble was added to the Convention, which expressly states that the Convention is not intended to create opportunities for tax avoidance including through treaty-shopping arrangements. In addition, the title of the Convention was amended to provide that the purposes of the Convention include the prevention of tax avoidance and evasion. These changes should play an important role in ensuring that the provisions of the Convention are interpreted and applied to prevent abusive treaty shopping arrangements. 90

113 Article 1 Commentary 76. The general anti-abuse rule in paragraph 9 of Article 29, which was added to the Convention in the 2017 update, may also be effective in preventing abusive treaty shopping arrangements. Triangular Cases 77. With respect to tax treaties, the phrase “triangular cases” refers to the application of tax treaties in situations where three States are involved. A typical triangular case that may constitute an improper use of a tax treaty is one in which: — dividends, interest, royalties or fees for technical services are derived from State S by a resident of State R, which is an exemption country. — that income is attributable to a permanent establishment established in State P, a low tax jurisdiction where that 17 income will not be taxed. 78. Under the State R - State S tax treaty, State S has to apply the benefits of the treaty to such income because it is derived by a resident of State R, even though the income is not taxed in that State by reason of the exemption system applied by that State. 79. In the 2017 update, paragraph 8 of Article 29 was added to the Convention to deal with triangular cases. Under that provision, the benefits of the Convention are denied if the tax imposed on the income by the State in which the permanent establishment is located is less than 60 percent of the tax that would have been imposed by the residence State if the income had been derived by a resident of that State and was not attributable to a permanent establishment in a third state. See paragraph 35 of the Commentary on Article 29 (quoting par - agraphs 161 to 168 of the 2017 OECD Commentary on Article 29) with respect to paragraph 8 of Article 29. 80. If similar provisions are not systematically included in the trea - ties that have been concluded by the State of source of such dividends, interest, royalties or fees for technical services with countries that have an exemption system, there is a risk that the relevant assets will be 17 “Triangular Cases”, in volume II of the full-length version of the OECD Model Tax Convention, OECD, R(11)-3, at paragraph 53. 91

114 Article 1 Commentary transferred to or the relevant services will be provided by associated enterprises that are residents of countries that do not have that type of provision in their treaty with the State of source. Attributing Profits or Income to a Specific Person or Entity A taxpayer may enter into transactions or arrangements in 81. order that income that would normally accrue to that taxpayer accrues to a related person or entity so as to obtain treaty benefits that would not otherwise be available. Some of the ways in which this may be done (e.g. treaty shopping and the use of permanent establishments - in low-tax countries) have already been discussed. The following dis cusses other income shifting scenarios. Non arm’s length transfer prices i) It has long been recognized that profits can be shifted between 82. associated enterprises through the use of non arm’s length prices and the tax legislation of most countries now includes transfer pricing rules that address such cases. These rules are specifically authorized by Article 9 of the United Nations and OECD Model Conventions. This, however, is a complex area, as shown by the extensive guidance produced by the 18 19 OECD and the Committee as to how these rules should operate. ii) Thin capitalization In almost all countries, interest is a deductible expense whereas 83. dividends, being a distribution of profits, are not deductible. A for - - eign company that wants to provide financing to a wholly-owned sub sidiary may therefore find it beneficial, for tax purposes, to provide that financing through debt rather than share capital, depending on the overall tax on the interest paid. A subsidiary may therefore have almost all of its financing provided in the form of debt rather than share capital, a practice known as “thin capitalization,” or it may claim 18 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations , 1995 (as updated). 19 United Nations Practical Manual on Transfer Pricing for Developing , United Nations, New York, 2013 (as updated). Countries 92

115 Article 1 Commentary excessive interest deductions relative to its earnings, a practice known as “earnings stripping.” 20 84. , coun - According to the OECD report on “Thin Capitalisation” tries have developed different approaches to deal with this issue. These approaches may be broadly divided between those that are based on the application of general anti-abuse rules or the arm’s length principle and those that involve the use of fixed debt-equity or interest-earnings ratios. The former category refers to rules that require an examina - 85. - tion of the facts and circumstances of each case in order to deter mine whether the real nature of the financing is that of debt or equity. This may be implemented through specific legislative rules, general - anti-abuse rules, judicial doctrines or the application of transfer pric ing legislation based on the arm’s length principle. 86. - The fixed ratio approach is typically implemented through spe cific legislative anti- abuse rules; under this approach, if the total debt/ equity or interest/earnings ratio of a particular company exceeds a predetermined ratio, the interest on the excessive debt or the interest in excess of the specified percentage of earnings may be disallowed, deferred or treated as a dividend. 87. To the extent that a country’s thin capitalization or earnings stripping rule applies to payments of interest to non-residents but not to similar payments that would be made to residents, it could be in vio - lation of paragraph 4 of Article 24, which provides that “interest, roy - alties and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first- mentioned State”. There is a specific exception to that rule, how - ever, where paragraph 1 of Article 9, which deals with transfer pricing adjustments, applies. For that reason, as indicated in paragraph 74 of 21 the OECD Commentary on Article 24: 20 Thin Capitalisation . Reproduced in volume II of the full-length ver - sion of the OECD Model Convention at page R(4)-1. Available at www.oecd. org/dataoecd/ 42/20/42649592.pdf. 21 Paragraph 74 of the OECD Commentary on Article 24 is reproduced in the Commentary on Article 24 of this Model. 93

116 Article 1 Commentary Paragraph 4 does not prohibit the country of the borrower from applying its domestic rules on thin capitalisation insofar as these are compatible with paragraph 1 of Article 9 or para - graph 6 of Article 11. However, if such treatment results from rules which are not compatible with the said Articles and which only apply to non-resident creditors (to the exclusion of resident creditors), then such treatment is prohibited by paragraph 4. 88. Paragraph 3 of the OECD Commentary on Article 9, which is - reproduced under paragraph 5 of the Commentary on the same pro vision of this Model, clarifies that paragraph 1 of Article 9 allows the application of domestic rules on thin capitalization insofar as their effect is to assimilate the profits of the borrower to an amount corre - sponding to the profits which would have accrued in an arm’s length situation. While this would typically be the case of thin capitaliza - tion rules that are based on the arm’s length principle, a country that has adopted thin capitalization rules based on a fixed ratio approach would, however, typically find it difficult to establish that its thin capi - talization rules, which do not refer to what independent parties would have done, satisfy that requirement. For that reason, countries that have adopted thin capitalization 89. or earnings stripping rules based on a fixed ratio approach often con - sider that they need to include in their treaties provisions that expressly allow the application of these rules. For example, Article 13 of the Protocol to the treaty between France and Estonia provides as follows: The provisions of the Convention shall in no case restrict France from applying the provisions of Article 212 of its tax code (code général des impôts) relating to thin capitalization or any sub - stantially similar provisions which may amend or replace the provisions of that Article. iii) The use of base companies 90. Base companies situated in low-tax jurisdictions may be used for the purposes of diverting income to a country where that income will be subjected to taxes that are substantially lower than those that would have been payable if the income had been derived directly by the shareholders of that company. 94

117 Article 1 Commentary 91. - Various approaches have been used to deal with such arrange - ments. For example, a company that is a mere shell with no employ ees and no substantial economic activity could, in some countries, be disregarded for tax purposes pursuant to general anti-abuse rules or judicial doctrines. It could also be possible to consider that a base com - pany that is effectively managed by shareholders who are residents of another State has its residence or a permanent establishment in that State. The first approach is described in paragraph 41 to 47 above. The second approach is described in paragraphs 29 and 30 above. These approaches, however, might not be successful in dealing 92. with arrangements involving companies that have substantial man - agement and economic activities in the countries where they have been established. One of the most effective approaches to dealing with such cases is the inclusion, in domestic legislation, of controlled foreign corporation (CFC) legislation. While the view has sometimes been expressed that such legislation could violate certain provisions of tax treaties, the Committee considers that this would not be the case of typical CFC rules, as indicated in paragraph 40 above. Directors’ fees and remuneration of top-level managers iv) 93. According to Article 16 (Directors’ fees and Remuneration of Top-Level Managerial Officials), directors’ fees and the remuneration of officials in a top-level managerial position of a company may be taxed in the State of residence of the company regardless of where the services of these directors and top-level managers are performed. A “salary split” arrangement could be used in order to reduce the taxes that would be payable in that State pursuant to that Article. Assume, for example, that Company A, a resident of State A, has two subsidi - aries, Company B and Company C, which are residents of State X and State Y respectively. Mr. D, a resident of State X, is a director and an official in a top-level managerial position of Company B. State X levies an income tax at progressive rates of up to 50 per cent. State Y has a similar income tax system but with a very low tax rate. Countries X and Y have a tax treaty which provides that State X applies the exemption method to income that may be taxed in State Y. For the purpose of reducing the tax burden of Mr. D, Company A may appoint him as a director and an official in a top-level managerial position of 95

118 Article 1 Commentary Company C and arrange for most of his remuneration to be attributed to these functions. 94. Paragraph 1 of Article 16 applies to directors’ fees that a person receives “in his capacity” as a director of a company and paragraph 2 applies to salaries, wages and other similar remuneration that a person receives “in his capacity” as an official in top-level managerial position of a company. Thus, apart from the fact that such an arrangement could probably be successfully challenged under general anti-abuse rules or judicial doctrines, it could also be attacked through a proper analysis of the services rendered by Mr. D to each company from which he receives his income, as well as an analysis of the fees and remuneration paid to other directors and top-level managers of Company C, in order to determine the extent to which director’s fees and remuneration received from that company by Mr. D can reasonably be considered to be derived from activities performed as a director or top-level manager of that company. v) Attribution of interest to a tax-exempt or government entity According to paragraph 12 of the Commentary on Article 11, 95. countries may agree during bilateral negotiations to include in their 22 treaties an exemption for interest of the following categories: — Interest paid to Governments or government agencies; — - Interest guaranteed by Governments or govern ment agencies; Interest paid to central banks; — — Interest paid to banks or other financial institutions; — Interest on long-term loans; Interest on loans to finance special equipment or — public works; or — Interest on other government-approved types of invest - ments (e.g. export finance). 22 Many treaties additionally exempt from source taxation interest paid to financial institutions and interest on sales on credit (see paragraphs 12 and 13 of the Commentary on Article 11). 96

119 Article 1 Commentary 96. Where a tax treaty includes one or more of these provisions, it may be possible for a party that is entitled to such an exemption to engage in back-to-back arrangements with other parties that are not - entitled to that exemption or, where a contract provides for the pay ment of interest and other types of income that would not be exempt (e.g. royalties), to attribute a greater share of the overall considera - tion to the payment of interest. Such arrangements would constitute improper uses of these exemptions. 97. While it could be argued that an easy solution would be to avoid including such exemptions in a tax treaty, it is important to note that these are included for valid policy purposes, taking into account that source taxation on gross payments of interest will frequently act as a tariff and be borne by the borrower. Also, as long as a country has agreed to include such exemptions in one of its treaties, it becomes dif - ficult to refrain from granting these in treaty negotiations with other similar countries. 98. Many of the approaches referred to above in the case of treaty shopping may be relevant to deal with back-to-back arrangements aimed at accessing the benefits of these exemptions. Also, cases where the consideration provided for in a mixed contract has been improp - erly attributed to interest payments can be challenged using specific domestic anti- abuse rules applicable to such cases, general domestic anti-abuse rules or doctrines or a proper interpretation of the treaty provisions. Where the overall consideration is divided among related parties, paragraph 6 of Article 11 and paragraph 1 of Article 9 may also be relevant to ensure that the benefit of the treaty exemption only applies to the proper amount of interest. Finally, some countries have included specific anti-abuse rules in their treaties to deal with such back-to-back arrangements. An example of such a rule is found in par - agraph b) of Article 7 of the Protocol to the treaty signed in 2002 by Australia and Mexico, which reads as follows: The provisions of [...] paragraph [2 of Article 11] shall not apply to interest derived from back-to-back loans. In such case, the interest shall be taxable in accordance with the domestic law of the State in which it arises. 97

120 Article 1 Commentary Hiring-out of Labour The Commentary on Article 15 reproduces the part of the 99. Commentary on the OECD Model Convention that deals inter alia with arrangements known as “international hiring- out of labour”. This refers to cases where a local enterprise that wishes to hire a foreign employee for a short period of time enters into an arrangement with a non-resident intermediary who will act as the formal employer. The employee thus appears to fulfil the three conditions of paragraph 2 of Article 15 so as to qualify for the tax exemption in the State where the employment will be exercised. The Commentary on Article 15 includes - guidance on how this issue can be dealt with, recognizing that domes tic anti-abuse rules and judicial doctrines, as well as a proper con - struction of the treaty, offer ways of challenging such arrangements. Artistes and sportspersons 100. A number of older tax treaties do not include paragraph 2 of Article 17 (Artistes and Sportspersons), which deals with the use of so-called “star-companies”. In order to avoid the possible application - of provisions based on paragraph 1 of that Article, residents of coun tries that have concluded such treaties may be tempted to arrange for the income derived from their activities as artistes or sportspersons, or part thereof, to be paid to a company set up for that purpose. 101. As indicated in the Commentary on Article 17, which repro - duces paragraph 11 of the OECD Commentary on that Article, such arrangements may be dealt with under domestic law provisions that would attribute such income to the artistes or sportspersons: [...] The third situation involves certain tax avoidance devices in cases where remuneration for the performance of an artiste or sportsman is not paid to the artiste or sportsman himself but to another person, e.g. a so-called artiste company, in such a way that the income is taxed in the State where the activity is performed neither as personal service income to the artiste or sportsman nor as profits of the enterprise, in the absence of a permanent establishment. Some countries “look through” such arrangements under their domestic law and deem the income 98

121 Article 1 Commentary to be derived by the artiste or sportsman; where this is so, para - graph 1 enables them to tax income resulting from activities in their territory [...]. Paragraph 11.2 of the OECD Commentary, which was added in 102. 2003, clarifies that a country could also rely on its general anti-avoidance rules or judicial doctrines to deal with abusive arrangements involving star-companies: As a general rule it should be noted, however, that, regard - 11.2 less of Article 17, the Convention would not prevent the applica - tion of general anti-avoidance rules of the domestic law of the State of source which would allow that State to tax either the entertainer/sportsman or the star-company in abusive cases, as is recognised in paragraph 24 of the Commentary on Article 1. 103. Finally, as regards the anti-abuse rule found in paragraph 2 of Article 17, tax administrations should note that the rule applies regard - less of whether or not the star- company is a resident of the same coun - try as the country in which the artiste or sportsperson is resident. This clarification was also added to the OECD Commentary in 2003: 11.1 The application of paragraph 2 is not restricted to situ - ations where both the entertainer or sportsman and the other person to whom the income accrues, e.g. a star- company, are residents of the same Contracting State. The paragraph allows the State in which the activities of an entertainer or sportsman are exercised to tax the income derived from these activities and accruing to another person regardless of other provisions of the Convention that may otherwise be applicable. Thus, not - withstanding the provisions of Article 7, the paragraph allows that State to tax the income derived by a star-company resident of the other Contracting State even where the entertainer or sportsman is not a resident of that other State. Conversely, where the income of an entertainer resident in one of the Contracting States accrues to a person, e.g. a star- company, who is a resident of a third State with which the State of source does not have a tax convention, nothing will prevent the Contracting State from taxing that person in accordance with its domestic laws. 99

122 Article 1 Commentary Transactions that modify the treaty classification of income Articles 6 to 21 allocate taxing rights differently depending 104. on the nature of the income. The classification of a particular item of income for the purposes of these rules is based on a combination of treaty definitions and domestic law. Since taxpayers determine the contents of the contracts on which classification for the purposes of domestic law and treaty provisions is typically based, they may, in some cases, try to influence that classification so as to obtain unin - tended treaty benefits. The following paragraphs provide a few examples of arrange - 105. ments that seek to change the treaty classification of income. Depending on the circumstances, such arrangements may be addressed through specific domestic or treaty anti-abuse rules or under general anti-abuse rules or judicial doctrines. A practical issue, however, will often be that, in some of these cases, it will be difficult to discover and establish the connection between various transactions that will be entered into for the purpose of altering the treaty classification. Conversion of dividends into interest (i) 106. Converting dividends into interest will be advantageous under a treaty that provides for source taxation of dividends but not of inter - est payments. Assume that X, a resident of State R, owns all the shares of Company A, which is a resident of State S. In contemplation of the payment of an important dividend, X arranges for the creation of holding Company B, which will also be a resident of State S; X is the only shareholder of Company B. X then sells the shares of Company A to Company B in return for interest-bearing notes (State R and State S allow that transfer to be carried out free of tax). The payment of interest by Company B to X will be made possible by the payment of dividends by Company A to Company B, which will escape tax in State S under a participation exemption or similar regime or because of the deduction of interest payments on the notes issued to X; X will thus indirectly receive the dividend paid by Company A in the form of interest payments on the notes issued by Company B and will avoid source taxation in State S. 100

123 Article 1 Commentary (ii) Allocation of price under a mixed contract A mixed contract covers different considerations, such as the 107. - provision of goods, services, know-how and the licensing of intangi bles. These generate different types of income for treaty purposes. In many cases, the acquirer will be indifferent to the allocation of the price between the various considerations and the provider may there - fore wish, in the relevant contract, to allocate a disproportionate part of the price to items of income that will be exempt in the State of source. For instance, a franchising contract may involve the transfer of goods to be sold, the provision of various services, the provision of know-how and royalties for the use of intellectual property (e.g. trade - marks and trade names). To the extent that the non-resident franchisor does not have a permanent establishment in the State of residence of the franchisee, Article 7 would not allow that State to tax the business profits attributable to the provision of inventory goods and services but Article 12 would allow the taxation of the royalties and the pay - ments related to know-how. Since all of these payments would nor - mally be deductible for the franchisee, it may not care about how the overall price is allocated. The contract may therefore be drafted so as to increase the price for the provision of the goods and services and reduce the royalties and the price for the provision of know-how. 108. Since the parties to the contract are independent, domestic transfer pricing legislation and Article 9 of the Convention would typically not apply to such transactions. Developing countries may be particularly vulnerable to such transactions since custom duties, which would typically have made it less attractive to allocate the price to the transfer of goods, are gradually being reduced and the determi - nation of the proper consideration for intangible property is often a difficult matter, even for sophisticated tax administrations. (iii) Conversion of royalties into capital gains 109. A non-resident who owns the copyrights in a literary work wishes to grant to a resident of State S the right to translate and repro - duce that work in that State in consideration for royalty payments based on the sales of the translated work. Instead of granting a license to the resident, the non-resident enters into a “sale” agreement whereby 101

124 Article 1 Commentary all rights related to the translated version of that work in State S are disposed of by the non- resident and acquired by the resident. The consideration for that “sale” is a percentage of the total sales of the translated work. The contract further provides that the non-resident will have the option to reacquire these rights after a period of five years. 110. Some countries have modified the definition of royalties to expressly address such cases. For example, subparagraph a) of para - graph 3 of Article 12 of the treaty between the United States and India provides that The term “royalties” as used in this Article means: a) payments of any kind received as a consideration for the use of, or the right to use, any copyright [...] including gains derived from the alienation of any such right or property which are con - tingent on the productivity, use, or disposition thereof [...]. (iv) Use of derivative transactions 111. Derivative transactions can allow taxpayers to obtain the eco - nomic effects of certain financial transactions under a different legal form. For instance, depending on the treaty provisions and domestic law of each country, a taxpayer may obtain treaty benefits such as no or reduced source taxation when it is in fact in the same economic position as a foreign investor in shares of a local company. Assume, for instance, that Company X, a resident of State A, wants to make a large portfolio investment in the shares of a company resident in State B, while Company Y, a resident in State B, wants to acquire bonds issued by the government of State A. In order to avoid the cross-border payments of dividends and interest, which would attract withholding taxes, Company X may instead acquire the bonds issued in its country and Company Y may acquire the shares of the company resident in its country that Company X wanted to acquire. Companies X and Y would then enter into a swap arrangement under which they would agree to make swap payments to each other based on the difference between the dividends and interest flows that they receive each year; they would also enter into futures contracts to buy from each other the shares and bonds at some future time. Through these transactions, the taxpayers would have mirrored the economic position of cross-border investments in the shares and bonds without incurring the liability to 102

125 Article 1 Commentary source withholding taxes (except to the extent that the swap payments, - which would only represent the difference between the flows of divi dends and interest, would be subject to such taxes under Article 21 and the domestic law of each country). Transactions that seek to circumvent thresholds found in treaty provisions 112. Tax treaty provisions sometimes use thresholds to determine a country’s taxing rights. One example is that of the lower limit of source tax on dividends found in subparagraph (a) of paragraph 2 of Article 10, which only applies if the beneficial owner of the dividends is a company which holds directly at least 25 per cent of the capital of the company paying the dividends. 113. Taxpayers may enter into arrangements in order to obtain the benefits of such provisions in unintended circumstances. For instance, a non-resident shareholder could, in contemplation of the payment of a dividend, arrange for shares to be temporarily trans - ferred to a resident company or non-resident company in the hands of which the dividends would be exempt or taxed at a lower rate. Such a transfer could be structured in such a way that the value of the expected dividend would be transformed into a capital gain exempt from tax in the source State. Although paragraph 2 of Article 10 was amended in the 2017 update to add a 365-day holding period require - ment, as long as the company to which the shares are transferred owns more than 25 per cent of the company paying the dividends for 365 days or more, the benefit of the lower rate in paragraph 2 of Article 10 would apply. As noted in the Commentary on Article 10, which reproduces paragraph 17 of the OECD Commentary as it read in 2014 on that Article: The reduction envisaged in subparagraph a) of paragraph 2 should not be granted in cases of abuse of this provision, for example, where a company with a holding of less than 25 per cent has, shortly before the dividends become payable, increased its holding primarily for the purpose of securing the benefits of the above-mentioned provision, or otherwise, where the qual - ifying holding was arranged primarily in order to obtain the 103

126 Article 1 Commentary reduction. To counteract such manoeuvres Contracting States may find it appropriate to add to subparagraph a) a provision along the following lines: provided that this holding was not acquired primarily for the purpose of taking advantage of this provision. The following are other examples of arrangements intended to circum - vent various thresholds found in the Convention. Time limit for certain permanent establishments Article 5, paragraph 3 of the Convention includes a rule accord 114. - ing to which, in certain circumstances, the furnishing of services by a foreign enterprise in a State for more than 183 days will constitute a permanent establishment. Taxpayers may be tempted to circumvent the application of that provision by splitting a single project between associated enterprises so that none of the enterprises furnishes ser - vices in the State for more than 183 days. Paragraphs 11 and 12 of the Commentary on Article 5 deal with such arrangements. Thresholds for the source taxation of capital gains on shares Paragraph 4 of Article 13 allows a State to tax capital gains on 115. shares of a company (and on interests in certain other entities) if the shares derive more than 50 per cent of their value, directly or indirectly, from immovable property situated in that State at any time in the 365 days preceding the alienation of the shares. This 365-day period for testing whether more than 50 per cent of the value of the shares of a company or other entity are derived from immovable property was added to paragraph 4 of Article 13 of the United Nations Model Convention as part of the 2017 update of the Convention. 116. Before the addition of the 365-day testing period to paragraph 4 of Article 13, one could attempt to circumvent that provision by dilut - ing the percentage of the value of an entity that derives from immova - ble property situated in a given State in contemplation of the alienation of shares or interests in that entity. In the case of a company, that could be done by injecting a substantial amount of cash in the company in exchange for bonds or preferred shares the conditions of which would 104

127 Article 1 Commentary provide that such bonds or shares would be redeemed shortly after the alienation of the shares or interests. 117. If a treaty does not contain a testing period such as the 365-day period in paragraph 4 of Article 13 of the United Nations Model Convention and the facts establish that assets have been transferred to an entity for the purpose of avoiding the application of paragraph 4 of Article 13 to a prospective alienation of shares or interests in that entity, a country’s general anti-abuse rules or judicial doctrines or a general anti-abuse rule in the treaty may well be applicable. Some countries, however, may wish to provide expressly in their treaties that paragraph 4 will apply in these circumstances. This could be done by adding to Article 13 a provision along the following lines: For the purposes of paragraph 4, in determining the aggregate value of all assets owned by a company, partnership, trust or estate, the assets that have been transferred to that entity pri - marily to avoid the application of the paragraph shall not be taken into account. Restricting treaty benefits with respect to income that is subject to certain features of another State’s tax system 118. As indicated in paragraph 17.2 of the Introduction (quoting par - agraph 15.2 of the Introduction to the 2017 OECD Model Convention): ... it is assumed that where a State accepts treaty provisions that restrict its right to tax elements of income, it generally does so on the understanding that these elements of income are taxable in the other State. Where a State levies no or low income taxes, other States should consider whether there are risks of double taxation that would justify, by themselves, a tax treaty. States should also consider whether there are elements of another State’s tax system that could increase the risk of non-taxation, which may include tax advantages that are ring-fenced from the domestic economy. Accordingly, the Committee decided that the following provisions of the Commentary on Article 1 of the OECD Model Convention, which were added as part of the 2017 update of that Convention, are also relevant for purposes of the United Nations Model Convention: 105

128 Article 1 Commentary 83. A State may conclude that certain features of the tax - system of another State are not sufficient to prevent the conclu sion of a tax treaty but may want to prevent the application of that treaty to income that is subject to no or low tax because of these features. Where the relevant features of the tax system of the other State are known at the time the treaty is being nego - tiated, it is possible to draft provisions that specifically deny treaty benefits with respect to income that benefits from these features (see, for example, paragraph 108 below). Such features might, however, be introduced in the tax 84. system of a treaty partner only after the conclusion of a tax treaty or might be discovered only after the treaty has entered into force. When concluding a tax treaty, a Contracting State may therefore be concerned about features of the tax system of a treaty partner of which it is not aware at that time or that may subsequently become part of the tax system of that treaty partner. Controlled foreign company provisions (see paragraph [32] above) and other approaches discussed in the above section on “Improper use of the Convention” may assist in dealing with some of these features but since the difficulties created by these features arise from the design of the tax laws of treaty partners rather than from tax avoidance strategies designed by taxpay - ers or their advisers, Contracting States may wish to address these difficulties though specific treaty provisions. The follow - ing include examples of provisions that might be adopted for that purpose. Provision on special tax regimes 85. Provisions could be included in a tax treaty in order to deny the application of specific treaty provisions with respect to income benefiting from regimes that satisfy the criteria of a general definition of “special tax regimes”. For instance, the benefits of the provisions of Articles 11 and 12 could be denied with respect to interest and royalties that would be derived from a connected person if such interest and royalties benefited, in the State of residence of their beneficial owner, from such a special tax regime; this would be done by adding to Articles 11 and 12 a provision drafted along the following lines (which 106

129 Article 1 Commentary could be amended to fit the circumstances of the Contracting States or for inclusion in other Articles of the Convention): Notwithstanding the provisions of [(in the case of Article - 11): paragraphs 1 and 2 but subject to the provisions of par agraph 4] [(in the case of Article 12): paragraph 1 but sub - ject to the provisions paragraph 3] of this Article, [interest] [royalties] arising in a Contracting State and beneficially owned by a resident of the other Contracting State that is connected to the payer may be taxed in the first-mentioned Contracting State in accordance with domestic law if such resident benefits from a special tax regime with respect to the [interest] [royalties] in the State of which it is resident. For the purposes of the above provision, the reference to a res - ident that is “connected” to the payer should be interpreted in accordance with the definition of “connected person” which is found in the Commentary on paragraph 7 of Article 29. As indicated in paragraph 127 of that Commentary, if the above provision is included in the Convention, it would seem appropri - ate to include that definition in paragraph 1 of Article 3, which includes the definitions that apply throughout the Convention. - Some States, however, may prefer to replace the reference to a res ident that is “connected” to the payer by a reference to a resident that is “closely related” to the payer, the main difference being that, unlike the definition of “connected” person, the definition of “closely related” person found in paragraph 8 of Article 5 does not apply where a person possesses directly or indirectly exactly 50 per cent of the aggregate vote and value of another person (if the definition of “closely related” person is used for the purposes of the above provision, that definition would be more appropri - ately included in paragraph 1 of Article 3). 86. Also, the above provision would require a definition of “special tax regime”, which could be drafted as follows and added to the list of general definitions included in paragraph 1 of Article 3: the term “special tax regime” means any statute, regula - tion or administrative practice in a Contracting State with respect to a tax described in Article 2 (Taxes Covered) that meets all of the following conditions: 107

130 Article 1 Commentary results in one or more of the following: (i) a preferential rate of taxation for interest, royal A) - ties or any combination thereof as compared to income from sales of goods or services; B) a permanent reduction in the tax base with respect to interest, royalties or any combination thereof without a comparable reduction for income from sales of goods or services, by allowing: an exclusion from gross receipts; 1) a deduction without regard to any corre 2) - sponding payment or obligation to make a payment; 3) a deduction for dividends paid or accrued; or 4) taxation that is inconsistent with the prin - ciples of Article 7 or Article 9; or C) a preferential rate of taxation or a permanent re - duction in the tax base of the type described in parts 1), 2), 3) or 4) of clause B) of this subdivision - with respect to substantially all of a company’s in come or substantially all of a company’s foreign source income, for companies that do not engage in the active conduct of a business in that Con - tracting State; (ii) in the case of any preferential rate of taxation or per - manent reduction in the tax base for royalties, does not condition such benefits on A) the extent of research and development activities that take place in the Contracting State; or B) expenditures (excluding any expenditures which relate to subcontracting to a related party or any acquisition costs), which the person enjoying the benefits incurs for the purpose of actual research and development activities; (iii) is generally expected to result in a rate of taxation that is less than the lesser of either: [rate to be determined bilaterally]; or A) 108

131 Article 1 Commentary B) - 60 per cent of the general statutory rate of com pany tax applicable in the other Contracting State; does not apply principally to: (iv) A) recognised pension funds; B) organisations that are established and maintained exclusively for religious, charitable, scientific, ar - tistic, cultural or educational purposes; C) persons the taxation of which achieves a single lev - el of taxation either in the hands of the person or the person’s shareholders (with at most one year of deferral), that hold a diversified portfolio of secu - rities, that are subject to investor-protection regu - lation in the Contracting State and the interests in which are marketed primarily to retail investors; or D) persons the taxation of which achieves a single level of taxation either in the hands of the person or the person’s shareholders (with at most one - year of deferral) and that hold predominantly im movable property; and (v) after consultation with the first-mentioned Contracting State, has been identified by the other Contracting State through diplomatic channels to the first-mentioned Contracting State as satisfying subdivisions (i) through (iv) of this subparagraph. No statute, regulation or administrative practice shall be treated as a special tax regime until 30 days after the date when the other Contracting State issues a written public notification identifying the regime as satisfying subdivisions (i) through (iv) of this subparagraph. 87. The above definition of the term “special tax regime” applies to any legislation, regulation or administrative practice (including a ruling practice) that exists before or comes into effect after the treaty is signed and that meets all of the follow - ing five conditions. 88. Under the first condition, described in subdivision (i) of the definition, the regime must result in one or more of the following: 109

132 Article 1 Commentary A. - a preferential rate of taxation for interest, royal ties or any combination thereof as compared to income from sales of goods or services; certain permanent reductions in the tax base with B. respect to interest, royalties or any combination thereof without a comparable reduction for sales or services income; or a preferential rate of taxation or certain perma - C. nent reductions in the tax base with respect to substantially all income or substantially all foreign source income for companies that do not engage in the active conduct of a business in that Con - tracting State. This part of the definition is intend - ed to identify regimes that, in general, tax mobile income more favourably than non-mobile income. 89. As provided in clause A), subdivision (i) shall be met if a regime provides a preferential rate of taxation for interest, royal - ties or a combination of the two as compared to sales or services income. For example, a regime that provides a preferential rate of taxation on royalty income earned by resident companies, but does not provide such preferential rate to income from sales or services, would meet this condition. Furthermore, a regime that provides a preferential rate of taxation for all classes of income, but such preferential rate is in effect available primarily for interest, royalties or a combination of the two, would satisfy subdivision (i) despite the fact that the beneficial treatment is not explicitly limited to those classes of income. For example, a tax authority’s administrative practice of issuing routine rulings that provide a preferential rate of taxation for companies that represent that they earn primarily interest income (such as group financing compa - nies) would satisfy subdivision (i) even if such rulings as a techni - cal matter provide that preferential rate to all forms of income. 90. Similarly, as provided in clause B), subdivision (i) shall be met if a regime provides for a permanent reduction in the tax base with respect to interest, royalties or a combination thereof as compared to sales or services income, in one or more of the following ways: an exclusion from gross receipts (such as an automatic fixed reduction in the amount of royalties included 110

133 Article 1 Commentary in income, whereas such reduction is not also available for - income from the sale of goods or services); a deduction with - out any corresponding payment or obligation to make a pay ment; a deduction for dividends paid or accrued; or taxation that is inconsistent with the principles of Articles 7 or 9 of the Convention. An example of a tax regime that results in taxa - tion that is inconsistent with the principles of Article 9 is that of a regime under which no interest income would be imputed on an interest-free note that is held by a company resident of a Contracting State and is issued by an associated enterprise that is a resident of the other Contracting State. 91. A permanent reduction in a State’s tax base does not arise merely from timing differences. For example, the fact that a particular country does not tax interest until it is actually paid, rather than when it economically accrues, is not regarded as a regime that provides a permanent reduction in the tax base, because such a rule represents an ordinary timing difference. However, a regime that results in excessive deferral over a period of many years shall be regarded as providing for a permanent reduction in the tax base, because such a rule in substance con - stitutes a permanent difference in the base of the taxing country. 92. Alternatively, as provided in clause C), subdivision (i) shall be satisfied if a regime provides a preferential rate of taxation or a permanent reduction in the tax base (of the type described above), with respect to substantially all income or substantially all foreign source income, for companies that do not engage in the active conduct of a business in the Contracting State. For example, regimes that provide preferential rates of taxation only to income of group financing companies or holding companies would generally satisfy subdivision (i). 93. A regime that provides for beneficial tax treatment that is generally applicable to all income (in particular to income from sales and services) and across all industries should not satisfy subdivision (i). Examples of generally applicable provisions that would not satisfy subdivision (i) include regimes permitting standard deductions, accelerated depreciation, corporate tax consolidation, dividends received deductions, loss carryovers and foreign tax credits. 111

134 Article 1 Commentary 94. The second condition, described in subdivision (ii) of the definition, applies only with respect to royalties and is met if a regime does not condition benefits either on the extent of research and development activities that take place in the Contracting State or on expenditures (excluding any expendi - tures which relate to subcontracting to a related party or any acquisition costs), which the person enjoying the benefits incurs for the purpose of actual research and development activities. Subdivision (ii) is intended to ensure that royalties benefiting from patent box or innovation box regimes are eligi - ble for treaty benefits only if such regimes satisfy one of these two requirements. Some States, however, would prefer that the requirements of subdivision (ii) be restricted so as to only be met if a regime conditions benefits on the extent of research and development activities that take place in the Contracting State. States that share that view may prefer to use the following alternative version of subdivision (ii): (ii) in the case of any preferential rate of taxation or per - manent reduction in the tax base for royalties, does not condition such benefits on the extent of research and development activities that take place in the Contracting State; Under either version of subdivision (ii), royalty regimes that have been considered by the OECD’s Forum on Harmful Tax Practices and were not determined to be “actually harmful” generally would not meet subdivision (ii) and, if so, would not be treated as special tax regimes. 95. The third condition, described in subdivision (iii) of the definition, requires that a regime be generally expected to result in a rate of taxation that is less than the lesser of a rate that would be agreed bilaterally between the Contracting States and - 60 per cent of the general statutory rate of company tax appli cable in the Contracting State that considers the regime of the other State as a potential “special tax regime”. 96. States may consider it useful to clarify the reference to “rate of taxation” for the purposes of subdivision (iii) by includ - ing the following in an instrument reflecting the agreed inter - pretation of the treaty: 112

135 Article 1 Commentary Except as provided below, the rate of taxation shall be deter - mined based on the income tax principles of the Contracting State that has implemented the regime in question. Therefore, in the case of a regime that provides only for a preferential rate of taxation, the generally expected rate of taxation under the regime shall equal such preferential rate. In the case of a regime that provides only for a permanent reduction in the tax base, the rate of taxation shall equal the statutory rate of company tax generally applicable in the Contracting State to companies subject to the regime in question less the product of such rate and the percentage reduction in the tax base (with the baseline tax base determined under the principles - of the Contracting State, but without regard to any perma nent reductions in the tax base described in clause B) of sub - division (i)) that the regime is generally expected to provide. For example, a regime that generally provides for a 20 per cent permanent reduction in a company’s tax base would have a rate of taxation equal to the applicable statutory rate of company tax reduced by 20 per cent of such statutory rate. In the case of a regime that provides for both a preferential rate of taxation and a permanent reduction in the tax base, the rate of taxation would be based on the preferential rate - of taxation reduced by the product of such rate and the per centage reduction in the tax base. 97. The preceding would clarify that the rate of taxation should be determined based on the income tax principles of the Contracting State that has implemented the regime in question. Therefore, in the case of a regime that provides only for a pref - erential rate of taxation, the generally expected rate of taxation under the regime will equal such preferential rate. In the case of a regime that provides only for a permanent reduction in the tax base, the rate of taxation will equal the statutory rate of company tax in the Contracting State that is generally applicable to com - panies subject to the regime in question less the product of such rate and the percentage reduction in the tax base (with the base - line tax base determined under the principles of the Contracting State, but without regard to any permanent reductions in the tax base described in clause B) of subdivision (i) of the definition) that the regime is generally expected to provide. For example, 113

136 Article 1 Commentary a regime that generally provides for a 20 per cent permanent reduction in a company’s tax base would have a rate of taxation equal to the applicable statutory rate of company tax reduced by - 20 percent of such statutory rate. Therefore, if the applicable stat utory rate of company tax in force in a Contracting State were 25 per cent, the rate of taxation resulting from such a regime would be 20 percent (25 – (25 x 0.20)). In the case of a regime that provides for both a preferential rate of taxation and a permanent reduction in the tax base, the rate of taxation would be based on the preferential rate of taxation reduced by the product of such rate and the percentage reduction in the tax base. The fourth condition, described in subdivision (iv) of the 98. definition, provides that a regime shall not be regarded as a special tax regime if it applies principally to pension funds or organisations that are established and maintained exclusively for religious, charitable, scientific, artistic, cultural or educa - tional purposes. Under subdivision (iv), a regime shall also not be regarded as a special tax regime if it applies principally to persons the taxation of which achieves a single level of taxa - tion, either in the hands of the person or its shareholders (with at most one year of deferral), that hold a diversified portfolio of securities, that are subject to investor-protection regulation in the residence State, and interests in which are marketed pri - marily to retail investors. This would generally correspond to the collective investment vehicles referred to in paragraph 22 above. Another exception provided in subdivision (iv) applies to regimes that apply principally to persons the taxation of which achieves a single level of taxation, either in the hands of the person or its shareholders (with at most one year of deferral), and such persons hold predominantly immovable property. 99. The fifth condition, described in subdivision (v) of the definition, provides that the Contracting State that wishes to treat a regime of the other State as a “special tax regime” must first consult the other Contracting State and notify that State through diplomatic channels that it has determined that the regime meets the other conditions of the definition. 100. The final part of the definition requires that the Contracting State that wishes to treat a regime of the other State 114

137 Article 1 Commentary as a “special tax regime” must issue a written public notification stating that the regime satisfies the definition. For the purposes of the Convention, a special tax regime shall be treated as such 30 days after the date of such written public notification. Provision on subsequent changes to domestic law 101. Whilst the above suggested provision on special tax regimes would address the issue of targeted tax regimes, it would not deal with changes of a more general nature which could be introduced into the domestic law of a treaty partner after the conclusion of a tax treaty and which might have prevented the conclusion of the treaty if they had existed at that time. For instance, some Contracting States might be concerned if the overall tax rate that another State levies on corporate income falls below what they consider to be acceptable for the purposes of the conclusion of a tax treaty. Some States might also be concerned if a State that taxed most types of foreign income at the time of the conclusion of a tax treaty decided subsequently to exempt such income from tax when it is derived by a resident company. The following is an example of a provision that would address these concerns, it being understood that the features of that provision would need to be restricted or extended in order to deal adequately with the specific areas of concern of each State: If at any time after the signing of this Convention, a 1. Contracting State a) reduces the general statutory rate of company tax that applies with respect to substantially all of the income of resident companies with the result that such rate falls below the lesser of either (i) [rate to be determined bilaterally] or (ii) 60 per cent of the general statutory rate of com - pany tax applicable in the other Contracting State, or b) the first-mentioned Contracting State provides an exemption from taxation to resident companies for substantially all foreign source income (including interest and royalties), 115

138 Article 1 Commentary the Contracting States shall consult with a view to amending this Convention to restore an appropriate allocation of taxing rights between the Contracting States. If such consultations do not progress, the other Contracting State may notify the first-mentioned Contracting State through diplomatic channels that it shall cease to apply the provisions of Articles 10, 11, 12, [12A] and 21. In such case, the provisions of such Articles shall cease to have effect in both Contracting States with respect to payments to resident companies six months after the date that the other Contracting State issues a written public notification stating that it shall cease to apply the provisions of these Articles. 2. For the purposes of determining the general statutory rate of company tax: a) the allowance of generally available deductions based on a percentage of what otherwise would be taxable income, and other similar mechanisms to achieve a reduction in the overall rate of tax, shall be taken into account; and b) the following shall not be taken into account: (i) a tax that applies to a company only upon a dis - tribution by such company, or that applies to shareholders; and (ii) the amount of a tax that is refundable upon the distribution by a company of a dividend. 102. This suggested provision provides that if, at any time after the signing of the Convention, either Contracting State enacts certain changes to domestic law, the provisions of Articles 10, 11, 12, [12A] and 21 may cease to have effect with respect to payments to companies if, after consultation, the Contracting States fail to agree on amendments to the Convention to restore an appropriate allocation of taxing rights between the Contracting States. 103. Paragraph 1 of the suggested provision addresses two types of subsequent changes that could be made by a State, after the signature of a tax treaty, to the tax rules applicable to companies resident of that State. The first type is when that State reduces the general statutory rate of company tax that applies with respect 116

139 Article 1 Commentary to substantially all of the income of its resident companies, with the result that such rate falls below the lesser of a minimum rate that would need to be determined bilaterally or 60 per cent of the general rate of company tax applicable in the other State. 104. For the purposes of paragraph 1, the “general statutory rate of company tax” refers to the general rate of company tax provided by legislation; if rates of company taxes are graduated, it refers to the highest marginal rate, provided that such rate applies to a significantly large portion of corporate taxpayers and was not established merely to circumvent the application of this Article. A general statutory rate of company tax that is applicable to business profits generally or to so-called “trading income” (broadly defined to include income from manufac - turing, services or dealing in goods or commodities) shall be treated as applying to substantially all of the income of resi - dent companies, even if narrow categories of income (including income from portfolio investments or other passive activities) are excluded. A reduced rate of tax that applies only with respect to capital gains would not fall within the scope of this Article; the distinction between business profits and capital gains shall be made according to the domestic laws of the residence State. Paragraph 2 addresses specific issues that may arise in deter - mining what is a State’s general statutory rate of company tax. Subparagraph a) of paragraph 2 provides that paragraph 1 applies equally to reductions to the general statutory company tax rate, as well as to other changes in domestic law that would have the same effect using a different mechanism. For example, if the statutory company tax rate in a Contracting State was 20 per cent, but, after the signing of the Convention, compa - nies resident in the Contracting State are permitted to claim deductions representing 50 per cent of what otherwise would be their taxable income, the general statutory rate of company tax would be 10 per cent (20 – (20 x 0.50)). Similarly, if the statutory company tax rate in a Contracting State was 20 per cent, but after the signing of the Convention, companies resident in the Contracting State are allowed to deduct an amount equal to a percentage of their equity up to 50 per cent of what otherwise would be their taxable income, and in general, most compa - nies are able to utilize the maximum available deduction, the 117

140 Article 1 Commentary general rate of company tax would be 10 per cent. Subparagraph b) of paragraph 2 sets forth taxes that shall not be taken into account for purposes of determining the general statutory rate - of company tax. First, as provided in subdivision (i) of subpar agraph b), taxes imposed at either the company or shareholder level when the company distributes earnings shall not be taken into account when determining the general rate of company tax (e.g. if resident companies are not subject to any taxation at the company level until a distribution is made, the tax levied upon distribution would not be considered part of the general rate of company tax). Second, as provided in subdivision (ii) of subpar - agraph b), any amounts of corporate tax that under a country’s domestic law would be refundable upon a company’s distribu - tion of earnings shall not be taken into account for purposes of determining the general statutory rate of company tax. 105. The second type of subsequent change in domestic tax law covered by paragraph 1 is when a State provides an exemption from taxation to companies resident of that State with respect to substantially all foreign source income (including interest and royalties) derived by these companies. The reference to an exemption for substantially all foreign source income earned by a resident company is intended to describe a taxation system under which income (including income from interest and roy - alties) from sources outside a State is exempt from tax solely by - reason of its source being outside that State (so-called “territo rial” systems). The reference does not include taxation systems under which only foreign source dividends or business profits from foreign permanent establishments are exempt from tax by the residence State (so-called “dividend exemption” systems). 106. When either type of subsequent domestic law change occurs, the Contracting States shall first consult with a view to concluding amendments to the Convention to restore an appro - priate allocation of taxing rights between the two Contracting States. In the event that such amendments are agreed, or that the Contracting States agree, after such consultation, that the allocation of taxing rights in the Convention is not disrupted by the relevant change made to the domestic law of one of the States, paragraph 1 has no further application. If, however, after a reasonable period of time, such consultations do not progress, 118

141 Article 1 Commentary the other State may notify the State whose domestic law has changed, through diplomatic channels, that it shall cease to apply the provisions of Articles 10, 11, 12, 12A and 21. Once - such diplomatic notification has been made, in order for par agraph 1 to apply, the source State must announce by public notice that it shall cease to apply the provisions of these Articles. Six months after the date of such written public notification, the provisions of these Articles shall cease to have effect in both Contracting States with respect to payments to companies that are residents of either State. Provision on notional deductions for equity One example of a tax regime with respect to which treaty 107. benefits might be specifically restricted relates to domestic law provisions that provide for a notional deduction with respect to equity. Contracting States which agree to prevent the appli - cation of the provisions of Article 11 to interest that is paid to connected persons who benefit from such notional deductions may do so by adding the following provision to Article 11: 2. Notwithstanding the provisions of paragraph 1 of this Article, interest arising in a Contracting State and bene - ficially owned by a resident of the other Contracting State that is connected to the payer (as defined in paragraph 8 of Article 5) may be taxed in the first-mentioned Contracting State in accordance with domestic law if such resident benefits, at any time during the taxable year in which the interest is paid, from notional deductions with respect to amounts that the Contracting State of which the beneficial owner is a resident treats as equity. The explanations in paragraph 85 above concerning the refer - ence to a resident that is “connected” to the payer apply equally to the above provision. Provision on remittance based taxation 108. Another example of a tax regime with respect to which treaty benefits might be specifically restricted is that of remit - tance based taxation. Under the domestic law of some States, persons who qualify as residents but who do not have what is 119

142 Article 1 Commentary considered to be a permanent link with the State (sometimes referred to as domicile) are only taxed on income derived from sources outside the State to the extent that this income is effec - tively repatriated, or remitted, thereto. Such persons are not, therefore, subject to potential double taxation to the extent that foreign income is not remitted to their State of residence and it may be considered inappropriate to give them the benefit of the provisions of the Convention on such income. Contracting States which agree to restrict the application of the provisions of the Convention to income that is effectively taxed in the hands of these persons may do so by adding the following provision to the Convention: Where under any provision of this Convention income arising in a Contracting State is relieved in whole or in part from tax in that State and under the law in force in the other Contracting State a person, in respect of the said income, is subject to tax by reference to the amount thereof which is remitted to or received in that other State and not by refer - ence to the full amount thereof, then any relief provided by the provisions of this Convention shall apply only to so much of the income as is taxed in the other Contracting State. In some States, the application of that provision could create administrative difficulties if a substantial amount of time elapsed between the time the income arose in a Contracting State and the time it were taxed by the other Contracting State in the hands of a resident of that other State. States concerned by these difficulties could subject the rule in the last part of the above provision, i.e. that the income in question will be entitled to benefits in the first-mentioned State only when taxed in the other State, to the condition that the income must be so taxed in that other State within a specified period of time from the time the income arises in the first-mentioned State. 3. The importance of proper mechanisms for the application and interpretation of tax treaties 119. The Committee recognizes the role that proper administrative procedures can play in minimizing risks of improper uses of tax trea - ties. Many substantive provisions in tax treaties need to be supported 120

143 Article 1 Commentary by proper administrative procedures that are in line with the proce - dural aspects of domestic tax legislation. Developing countries may consider developing their own procedural provisions regarding treaty application by learning from countries that have successful experience of treaty application. 120. The Committee also recognizes the importance of proper mech - anisms for tax treaty interpretation. In many countries, there is a long history of independent judicial interpretations of tax treaties, which provide guidance to tax administrations. Countries that have a weaker judicial system or where there is little judicial expertise in tax treaty interpretation may consider alternative mechanisms to ensure correct, responsive and responsible treaty interpretations. 121. Whilst anti-abuse rules are important for preventing the improper use of treaties, the application of certain anti-abuse rules may be challenging for tax administrations, especially in developing coun - tries. For instance, whilst an effective application of domestic transfer pricing rules may help countries to deal with certain improper uses of treaty provisions, countries that have limited expertise in the area of transfer pricing may be at a disadvantage. In addition, countries that have inadequate experience of combating improper uses of treaties may feel uncertain about how to apply general anti-abuse rules, especially where a purpose test is involved. This increases the need for appropriate mechanisms to ensure a proper interpretation of tax treaties. Developing countries may also be hesitant to adopt or apply gen - 122. eral anti-abuse rules if they believe that these rules would introduce an unacceptable level of uncertainty that could hinder foreign investment in their territory. Whilst a ruling system that would allow taxpayers to quickly know whether anti-abuse rules would be applied to prospective transactions could help reduce that concern, it is important that such a system safeguards the confidentiality of transactions and, at the same time, avoids discretionary interpretations (which, in some countries, could carry risks of corruption). Clearly, a strong independent judicial system will help to provide taxpayers with the assurance that anti-abuse rules are applied objectively. Similarly, an effective application of the mutual agreement procedure will ensure that disputes concerning the application of anti-abuse rules will be resolved according to internation - ally accepted principles so as to maintain the integrity of tax treaties. 121

144 Article 2 Commentary Article 2 TA X ES COVER ED A. General considerations Article 2 of the United Nations Model Convention reproduces 1. Article 2 of the OECD Model Convention. 2. This Article is designed to clarify the terminology and nomen - clature concerning the taxes to be covered by the Convention. In this connection, it may be observed that the same income or capital may be subject in the same country to various taxes — either taxes which differ in nature or taxes of the same nature levied by different polit - ical subdivisions or local authorities. Hence double taxation cannot be wholly avoided unless the methods for the relief of double taxation applied in each Contracting State take into account all the taxes to which such income or capital is subject. Consequently, the terminol - ogy and nomenclature relating to the taxes covered by a treaty must be clear, precise and as comprehensive as possible. As noted in the Commentary on Article 2 of the OECD Model Convention, this is necessary: 1. [...] to ensure identification of the Contracting States’ taxes covered by the Convention, to widen as much as possi - ble the field of application of the Convention by including, as far as possible, and in harmony with the domestic laws of the Contracting States, the taxes imposed by their political subdi - visions or local authorities, to avoid the necessity of concluding a new convention whenever the Contracting States’ domestic laws are modified, and to ensure for each Contracting State notification of significant changes in the taxation laws of the other State. B. Commentary on the paragraphs of article 2 Paragraph 1 3. This paragraph states that the Convention applies to taxes on income and on capital, irrespective of the authority on behalf of which 122

145 Article 2 Commentary such taxes are imposed (e.g. the State itself or its political subdivisions or local authorities) and irrespective of the method by which the taxes are levied (e.g. by direct assessment or by deduction at the source, in the form of surtaxes or surcharges or as additional taxes). Paragraph 2 4. This paragraph defines taxes on income and on capital, as taxes on total income, on total capital or on elements of income or of capital, including taxes on gains from the alienation of movable or immov - able property, taxes on capital appreciation and taxes on the total amounts of wages or salaries paid by enterprises. Practices regarding the coverage of taxes on the total amount of wages and salaries paid by enterprises vary from country to country and this matter should be taken into account in bilateral negotiations. According to paragraph 3 of the Commentary on Article 2 of the 2017 OECD Model Convention, taxes on the total amount of wages do not include “[s]ocial security charges, or any other charges paid where there is a direct connec - tion between the levy and the individual benefits to be received”. The OECD Commentary further observes: 4. Clearly a State possessing the right to tax an item of income or capital under the Convention may levy the taxes imposed by its legislation together with any duties or charges accessory to them: increases, costs, interest, penalties etc. It has not been con - sidered necessary to specify this in the Article, as it is obvious that a Contracting State that has the right to levy a tax may also levy the accessory duties or charges related to the principal duty. Most States, however, do not consider that interest and penalties acces - sory to taxes covered by Article 2 are themselves included within the scope of Article 2 and, accordingly, would generally not treat such interest and penalties as payments to which all the provisions concerning the rights to tax of the State of source (or situs) or of the State of residence are applicable, including the limitations of the taxation by the State of source and the obligation for the State of residence to eliminate double taxation. Nevertheless, where taxation is withdrawn or reduced in accordance with a mutual agreement under Article 25, interest and administrative penalties accessory to such taxation should be withdrawn or reduced to the extent that they are directly connected to the taxation (i.e. a 123

146 Article 2 Commentary tax liability) that is relieved under the mutual agreement. This would be the case, for example, where the additional charge is computed with reference to the amount of the underlying tax liability and the competent authorities agree that all or part of the underlying taxation is not in accordance with the provisions of the Convention. This would also be the case, for example, where administrative penalties are imposed by reason of a transfer pric - ing adjustment and that adjustment is withdrawn because it is considered not in accordance with paragraph 1 of Article 9. 5. The Article does not mention “ordinary taxes” or “extraordinary taxes”. Normally, it might be considered justifi - able to include extraordinary taxes in a Model Convention, but experience has shown that such taxes are generally imposed in very special circumstances. In addition, it would be difficult to define them. They may be extraordinary for various reasons; their imposition, the manner in which they are levied, their rates, their objects, etc. This being so, it seems preferable not to include extraordinary taxes in the Article. But, as it is not intended to exclude extraordinary taxes from all conventions, ordinary taxes have not been mentioned either. The Contracting States are thus free to restrict the convention’s field of applica - tion to ordinary taxes, to extend it to extraordinary taxes, or even to establish special provisions. Paragraph 3 5. This paragraph provides the Contracting States an opportunity to enumerate the taxes to which the Convention is to apply. According to the Commentary on Article 2, paragraph 3, of the OECD Model Convention, the list “is not exhaustive”, for “it serves to illustrate the preceding paragraphs of the Article”. In principle, however, it is expected to be “a complete list of taxes imposed in each State at the time of signature and covered by the Convention”. Paragraph 4 6. The Commentary on Article 2, paragraph 4 of the OECD Model Convention is applicable: 124

147 Article 2 Commentary 7. - This paragraph provides, since the list of taxes in par agraph 3 is purely declaratory, that the Convention is also to apply to all identical or substantially similar taxes that are imposed in a Contracting State after the date of signature of the Convention in addition to, or in place of, the existing taxes in that State. 8. Each State undertakes to notify the other of any signifi - cant changes made to its taxation laws by communicating to it, for example, details of new or substituted taxes. Member coun - tries are encouraged to communicate other significant devel - opments as well, such as new regulations or judicial decisions; many countries already follow this practice. Contracting States are also free to extend the notification requirement to cover any significant changes in other laws that have an impact on their obligations under the convention. Contracting states wishing to do so may replace the last sentence of the paragraph by the following: The competent authorities of the Contracting States shall notify each other of any significant changes that have been made in their taxation laws or other laws affecting their obli - gations under the Convention. 125

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149 Article 3 Commentary Commentary on chapter II DEFINITIONS Article 3 GENERAL DEFINITIONS A. General considerations 1. Article 3 of the United Nations Model Convention is the same as Article 3 of the OECD Model Convention, except that Article 3 of the OECD Model Convention defines the terms “enterprise” and “business” c) and h) of paragraph 1 while Article 3 of the United in subparagraphs Nations Model Convention does not. This is because the OECD Model Convention has deleted Article 14 (Independent Personal Services) while the United Nations Model Convention still maintains it. 2. Several general definitions are normally necessary for the understanding and application of a bilateral tax convention, although terms relating to more specialized concepts are usually defined or interpreted in special provisions. On the other hand, there are terms whose definitions are not included in the Convention but are left to bilateral negotiations. 3. Article 3 of the United Nations Model Convention, like Article 3 of the OECD Model Convention, sets forth a number of general definitions required for the interpretation of the terms used in the Convention. These terms are “person”, “company”, “enterprise of a Contracting State”, “international traffic”, “competent authority” and “national”. Article 3 leaves space for the designation of the “competent authority” of each Contracting State. The terms “resident” and “per - manent establishment” are defined in Articles 4 and 5 respectively, while the interpretation of certain terms used in the articles on special categories of income (e.g. immovable property, dividends) is clarified in the articles concerned. The parties to a convention are left free to agree bilaterally on a definition of the terms “a Contracting State” and “the other Contracting State”. They also may include in the definition of a Contracting State a reference to continental shelves. 127

150 Article 3 Commentary B. Commentary on the paragraphs of article 3 Paragraph 1 ( The term “person” a ) The term “person”, which is defined in subparagraph ( ) as 4. a including an individual, a company and any other body of persons, should be interpreted very broadly. According to paragraph 2 of the Commentary on Article 3 of the OECD Model Convention, the term also includes “any entity that, although not incorporated, is treated as a body corporate for tax purposes. Thus, a foundation ( fon - e.g. ) may fall within the meaning of the term “person”. dation, Stiftung Partnerships will also be considered to be “persons” either because they fall within the definition of “company” or, where this is not the case, because they constitute other bodies of persons.” ( b ) The term “company” 5. The definition of the term “company”, like the corresponding definition in the OECD Model Convention, is formulated with special reference to Article 10 on dividends. The definition is relevant to that Article and to Article 5, paragraphs 8 and 9, Article 16 and Article 29 corresponding respectively to Article 5, paragraphs 7 and 8, Article 16 and Article 29 of the OECD Model Convention. (c) The term “enterprise of a Contracting State” 6. Subparagraph ( c ) defines the terms “enterprise of a Contracting State” and “enterprise of the other Contracting State”. It does not define the term “enterprise” per se, because, as noted in the Commentary on the OECD Model Convention, “[t]he question whether an activity is performed within an enterprise or is deemed to constitute in itself an enterprise has always been interpreted according to the provisions of the domestic laws of the Contracting States”. ( d ) The term “international traffic” 7. The definition of the “international traffic” is based on the prin - ciple that the right to tax profits of an enterprise of a Contracting State 128

151 Article 3 Commentary arising from the operation of ships or aircraft in international traffic - resides only in that State. This principle is set forth in Article 8 (alter native A), paragraph 1 (corresponding to Article 8, paragraph 1, of the OECD Model Convention), and in Article 8 (alternative B), paragraph 1, and the first sentence of paragraph 2 (provided in the latter case that the shipping activities concerned are not more than casual). However, the Contracting States may agree on a bilateral basis to substitute a reference to the State in which the place of effective management of d ) if appropriate to con - the enterprise is situated in subparagraph ( form to the general tenor of the other articles relating to international traffic. In such cases, as noted in the 2017 version of the Commentary on Article 3 the OECD Model Convention, the definition should read: “the term ‘international traffic’ means any transport by a ship or air - craft except when the ship or aircraft is operated solely between places in a Contracting State in which the enterprise that operates the ship or aircraft does not have its place of effective management.” 8. As also noted in the same OECD Commentary, “[t]he definition of the term “international traffic” is broader than is normally under - stood. The broader definition is intended to preserve for the State of the enterprise the right to tax purely domestic traffic as well as interna - tional traffic between third States, and to allow the other Contracting State to tax traffic solely within its borders”. A ship or aircraft is oper - ated solely between places in the other Contracting State in relation to a particular voyage if the place of departure and the place of arrival of the ship are both in that other Contracting State. Thus, for example, a cruise beginning and ending in that other Contracting State without a stop in a foreign port does not constitute a transport of passengers in international traffic. Conversely, a cruise beginning and ending in that other Contracting State with a stop in a foreign port constitutes a transport of passengers in international traffic and for this purpose a “stop” has taken place if passengers are permitted to go ashore, even temporarily, but only at a scheduled intermediate destination. 8.1 The 2017 version of the OECD Commentary also explains that “[t]he definition was amended in 2017 to ensure that it also applied to a transport by a ship or aircraft operated by an enterprise of a third State. Whilst this change does not affect the application of Article 8, which only deals with profits of an enterprise of a Contracting State, 129

152 Article 3 Commentary it allows the application of paragraph 3 of Article 15 to a resident of a Contracting State who derives remuneration from employment exercised aboard a ship or aircraft operated by an enterprise of a t hird State.” ) The term “competent authority” ( e 9. As in the OECD Model Convention, the definition of the term “competent authority” is left to the Contracting States, which are free to designate one or more authorities as being competent for the pur - pose of applying the Convention. This approach is necessary because in some countries the implementation of double taxation conventions may not lie solely within the jurisdiction of the highest tax authorities in so far as some matters may be reserved to, or may fall within the competence of, other authorities. ( ) The term “national” f 10. - Initially, the definition of the term “national” occurred in par agraph 2 of Article 24 relating to “Non-discrimination”. As a result, the definition of the term “national” would have restricted applica - tion only for the purposes of Article 24. Since the term “national” has been referred to in other articles of the Convention as well, namely, Article 4, paragraph 2, subparagraphs ( ) and ( d ), Article 19, Article c 24 and Article 25, it was decided in 1999 to shift the definition of the f ) term “national” from paragraph 2 of Article 24 to subparagraph ( of paragraph 1 of Article 3. For natural persons, the definition merely states that the term applies to any individual possessing the nationality of a Contracting State. It has not been found necessary to introduce into the text of the Convention any considerations on the significa - tion of the concept of nationality, any more than it seemed appropriate to make any special comment on the meaning and application of the word. In determining what is meant by “the nationals of a Contracting State” in relation to individuals, reference must be made to the sense in which the term is usually employed and each State’s rules on the acquisition or loss of nationality. 11. Subparagraph ( f ) is more specific as to legal persons, partner - ships and associations. By declaring that any legal person, partnership or association deriving its status as such from the laws in force in a 130

153 Article 3 Commentary Contracting State is considered to be a national, the provision disposes of a difficulty which often arises in determining the nationality of companies. In defining the nationality of companies, some States have regard less to the law which governs the company than to the origin of the capital with which the company was formed or the nationality of the individuals or legal persons controlling it. 12. Moreover, in view of the legal relationship created between the company and the State under whose laws it is constituted, which resembles the relationship of nationality for individuals, it seems appropriate not to deal with legal persons, partnerships and associ - ations in a special provision, but to assimilate them with individuals under the term “national”. Paragraph 2 13. Like Article 3, paragraph 2, of the OECD Model Convention, this paragraph contains a general rule concerning the meaning of terms used but not defined in the Convention. According to the OECD Commentary, paragraph 2 was amended in 1995 in order: 13.1 [...] to conform its text more closely to the general and consistent understanding of member states. For purposes of paragraph 2, the meaning of any term not defined in the Convention may be ascertained by reference to the meaning it has for the purpose of any relevant provision of the domestic law of a Contracting State, whether or not a tax law. However, where a term is defined differently for the purposes of dif - ferent laws of a Contracting State, the meaning given to that term for purposes of the laws imposing the taxes to which the Convention applies shall prevail over all others, including those given for the purposes of other tax laws. States that are able to enter into mutual agreements (under the provisions of Article 25 and, in particular, paragraph 3 thereof) that establish the meanings of terms not defined in the Convention should take those agreements into account in interpreting those terms. When a conflict arises between the law in force when the Convention was signed and that in force when the Convention is applied, the latter law prevails. 131

154 Articles 3 and 4 Commentary 14. The OECD Commentary states: However, paragraph 2 specifies that this applies only if 12. the context does not require an alternative interpretation. The context is determined in particular by the intention of the Contracting States when signing the Convention as well as the meaning given to the term in question in the legislation of the other Contracting State (an implicit reference to the principle of reciprocity on which the Convention is based). The word - ing of the Article therefore allows the competent authorities some leeway. Consequently, the wording of paragraph 2 provides a sat - 13. isfactory balance between, on the one hand, the need to ensure the permanency of commitments entered into by States when signing a convention (since a State should not be allowed to make a convention partially inoperative by amending after - wards in its domestic law the scope of terms not defined in the Convention) and, on the other hand, the need to be able to apply the Convention in a convenient and practical way over time (the need to refer to outdated concepts should be avoided). Article 4 RESIDENT A. General considerations 1. Article 4 of the United Nations Model Convention reproduces Article 4 of the OECD Model Convention with one adjustment, namely, the addition in 1999 of the criterion “place of incorporation” to the list of criteria in paragraph 1 for taxation as a resident. According to the Commentary on Article 4 of the OECD Model Convention: 1. The concept of “resident of a Contracting State” has vari - ous functions and is of importance in three cases: a ) in determining a convention’s personal scope of application; b ) in solving cases where double taxation arises in con - sequence of double residence; 132

155 Article 4 Commentary c in solving cases where double taxation arises as a ) consequence of taxation in the State of residence and in the State of source or situs. Like Article 4 of the OECD Model Convention, Article 4 of the 2. United Nations Model Convention defines the expression “resident of a Contracting State” and establishes rules for resolving cases of double residence. In the two typical cases of conflict between two residences situs , the conflict arises because, and between residence and source or under their domestic laws, one or both Contracting States claim that the person concerned is resident in their territory. In this connection the OECD Commentary provides the following clarification: 3. Generally the domestic laws of the various States impose a comprehensive liability to tax—“full tax liability”—based on the taxpayers’ personal attachment to the State concerned (the “State of residence”). This liability to tax is not imposed only on persons who are “domiciled” in a State in the sense in which “domicile” is usually taken in the legislations (private law). The cases of full liability to tax are extended to comprise also, for instance, persons who stay continually, or maybe only for a certain period, in the territory of the State. Some legislations impose full liability to tax on individuals who perform services on board ships which have their home harbour in the State. 4. Conventions for the avoidance of double taxation do not normally concern themselves with the domestic laws of the Contracting States laying down the conditions under which a person is to be treated fiscally as “resident” and, consequently, is fully liable to tax in that State. They do not lay down standards which the provisions of the domestic laws on “residence” have to fulfil in order that claims for full tax liability can be accepted between the Contracting States. In this respect the States take their stand entirely on the domestic laws. 5. This manifests itself quite clearly in the cases where there is no conflict at all between two residences, but where the con - flict exists only between residence and source or situs. But the same view applies in conflicts between two residences. The special point in these cases is only that no solution of the con - flict can be arrived at by reference to the concept of residence 133

156 Article 4 Commentary adopted in the domestic laws of the States concerned. In these cases special provisions must be established in the Convention to determine which of the two concepts of residence is to be given preference. B. Commentary on the paragraphs of article 4 Paragraph 1 3. The former Group of Experts decided to adopt as paragraph 1 of Article 4, the paragraph 1 of Article 4 of the OECD Model Convention, and had initially decided not to adopt the second sentence which reads: “This term [resident of a Contracting State], however, does not include any person who is liable to tax in that State in respect only of income - from sources in that State or capital situated therein”. The second sen tence, which was included in the OECD Model Convention to deal, for example, with the special situation of foreign diplomats and consular staffs serving in a country which taxed residents on the basis of their worldwide income, who might be considered (under the domestic law of the country in which they are serving) as residents but, because of their special status, might nevertheless be taxable only on income from sources in that State, was incorporated in 1999 in paragraph 1 of Article 4 of the United Nations Model Convention as well. 4. The OECD Commentary observes: In accordance with the provisions of the second sentence 8.1 of paragraph 1, however, a person is not to be considered a “res - ident of a Contracting State” in the sense of the Convention if, although not domiciled in that State, he is considered to be a resident according to the domestic laws but is subject only to a taxation limited to the income from sources in that State or to capital situated in that State. That situation exists in some States in relation to individuals, e.g. in the case of foreign diplomatic and consular staff serving in their territory. 8.2 According to its wording and spirit the second sentence also excludes from the definition of a resident of a Contracting State foreign held companies exempted from tax on their for - eign income by privileges tailored to attract conduit compa - nies. It also excludes companies and other persons who are not 134

157 Article 4 Commentary subject to comprehensive liability to tax in a Contracting State because these persons, whilst being residents of that State under that State’s tax law, are considered to be residents of another State pursuant to a treaty between these two States. The exclu - sion of certain companies or other persons from the definition - would not of course prevent Contracting States from exchang ing information about their activities (see paragraph 2 of the Commentary on Article 26). Indeed States may feel it appro - priate to develop spontaneous exchanges of information about persons who seek to obtain unintended treaty benefits. Paragraph 1, similar to the corresponding provision of the 5. OECD Model Convention, refers to the concept of residence contained in the domestic laws of the Contracting States and lists the criteria for taxation as a resident: domicile, residence, place of management (to which the United Nations Model Convention adds “place of incorpo - ration”) or any other criterion of a similar nature. Thus formulated, the definition of the term “resident of a Contracting State” is, according to the OECD Commentary, aimed at covering, as far as individuals are concerned, “[...] the various forms of personal attachment to a State which, in the domestic taxation laws, form the basis of a comprehen - 23 sive taxation (full liability to tax)”. 6. The OECD Commentary observes: 8.4 It has been the general understanding of most member countries that the government of each State, as well as any polit - ical subdivision or local authority thereof, is a resident of that State for purposes of the Convention. Before 1995, the Model did not explicitly state this; in 1995, Article 4 was amended to conform the text of the Model to this understanding. (It may be mentioned that in 1999, the United Nations Model Convention also adopted the same amendment.) 8.6 Paragraph 1 refers to persons who are “liable to tax” in a Contracting State under its laws by reason of various criteria. In many States, a person is considered liable to comprehensive tax - ation even if the Contracting State does not in fact impose tax. For example, pension funds, charities and other organisations 23 Paragraph 8 of the OECD Commentary on Article 4. 135

158 Article 4 Commentary may be exempted from tax, but they are exempt only if they meet all of the requirements for exemption specified in the tax laws. They are, thus, subject to the tax laws of a Contracting State. Furthermore, if they do not meet the standards specified, they are also required to pay tax. Most States would view such enti - ties as residents for purposes of the Convention (see, for exam - ple, paragraph 1 of Article 10 and paragraph 5 of Article 11). 8.7 In some States, however, these entities are not considered liable to tax if they are exempt from tax under domestic tax laws. These States may not regard such entities as residents for purposes of a convention unless these entities are expressly cov - ered by the convention. Contracting States taking this view are free to address the issue in their bilateral negotiations. 8.8 Where a State disregards a partnership for tax purposes and treats it as fiscally transparent, taxing the partners on their share of the partnership income, the partnership itself is not liable to tax and may not, therefore, be considered to be a resident of that State. In such a case, since the income of the partnership “flows through” to the partners under the domestic law of that State, the partners are the persons who are liable to tax on that income and are thus the appropriate persons to claim the benefits of the conventions concluded by the States of which they are residents. This latter result will be achieved even if, under the domestic law of the State of source, the income is attributed to a partnership which is treated as a separate taxable entity. For States which could not agree with this interpretation of the Article, it would be possible to provide for this result in a special provision which would avoid the resulting potential double taxation where the income of the partnership is differ - ently allocated by the two States. Some members of the Committee of Experts disagree with the prop - osition in paragraph 8.8 of the 2014 OECD Commentary extracted above that the partners of fiscally transparent partnerships can claim the benefits of the Convention. They are of the view that a special rule is required in a Convention to provide such a result. This is achieved, for instance, by adopting the new paragraph 2 of Article 1 that is now included in the Convention. Paragraph 2 of Article 1 clarifies that the Convention will apply to the partnership’s income to the extent that 136

159 Article 4 Commentary the income is treated, for purposes of taxation by that State, as the income of a partner who is a resident of that State. The same treatment will apply to income of other entities or arrangements that are treated as fiscally transparent under the tax law of a Contracting State. 6.1 Some countries wish to clarify that recognized pension funds will be treated under Article 4 as residents of the Contracting State in which they are established. These countries could amend paragraph 1 of Article 4 by adding reference to recognized pension funds. Paragraph 2 7. This paragraph, which reproduces Article 4, paragraph 2, of the OECD Model Convention, lists in decreasing order of relevance a number of subsidiary criteria to be applied when an individual is a res - ident of both Contracting States and the preceding criteria do not pro - vide a clear-cut determination of his status as regards residence. It may be noted that in 1999, the word “only” was inserted in subparagraphs ( a ), ( b ) and ( c ) of paragraph 2, following the changes previously made to the OECD Model Convention. The OECD Commentary states: 9. This paragraph relates to the case where, under the provisions of paragraph 1, an individual is a resident of both Contracting States. 10. To solve this conflict special rules must be established which give the attachment to one State a preference over the attachment to the other State. As far as possible, the preference criterion must be of such a nature that there can be no question but that the person concerned will satisfy it in one State only, and at the same time it must reflect such an attachment that it is felt to be natural that the right to tax devolves upon that particular State. The facts to which the special rules will apply are those existing during the period when the residence of the taxpayer affects tax liability, which may be less than an entire taxable period. For example, in one calendar year an individual is a resident of State A under that State’s tax laws from 1 January to 31 March, then moves to State B. Because the individual resides in State B for more than 183 days, the individual is treated by the tax laws of State B as a State B resident for the entire year. Applying the spe - cial rules to the period 1 January to 31 March, the individual was 137

160 Article 4 Commentary a resident of State A. Therefore, both State A and State B should treat the individual as a State A resident for that period, and as a State B resident from 1 April to 31 December. 11. The Article gives preference to the Contracting State in which the individual has a permanent home available to him. - This criterion will frequently be sufficient to solve the con e.g. where the individual has a permanent home in one flict, Contracting State and has only made a stay of some length in the other Contracting State. Subparagraph 12. means, therefore, that in the application a) of the Convention (that is, where there is a conflict between the laws of the two States) it is considered that the residence is that place where the individual owns or possesses a home; this home must be permanent, that is to say, the individual must have arranged and retained it for his permanent use as opposed to staying at a particular place under such conditions that it is evident that the stay is intended to be of short duration. 13. As regards the concept of home, it should be observed that any form of home may be taken into account (house or apartment belonging to or rented by the individual, rented fur - nished room). But the permanence of the home is essential; this means that the individual has arranged to have the dwelling available to him at all times continuously, and not occasionally for the purpose of a stay which, owing to the reasons for it, is necessarily of short duration (travel for pleasure, business travel, educational travel, attending a course at a school, etc.). 14. If the individual has a permanent home in both Contracting States, paragraph 2 gives preference to the State with which the personal and economic relations of the individ - ual are closer, this being understood as the centre of vital inter - ests. In the cases where the residence cannot be determined by reference to this rule, paragraph 2 provides as subsidiary crite - ria, first, habitual abode, and then nationality. If the individual is a national of both States or of neither of them, the question shall be solved by mutual agreement between the States con - cerned according to the procedure laid down in Article 25. 15. If the individual has a permanent home in both Contracting States, it is necessary to look at the facts in order 138

161 Article 4 Commentary to ascertain with which of the two States his personal and eco - nomic relations are closer. Thus, regard will be had to his family and social relations, his occupations, his political, cultural or other activities, his place of business, the place from which he administers his property, etc. The circumstances must be examined as a whole, but it is nevertheless obvious that con - siderations based on the personal acts of the individual must receive special attention. If a person who has a home in one State sets up a second in the other State while retaining the first, the fact that he retains the first in the environment where he has always lived, where he has worked, and where he has his family and possessions, can, together with other elements, go to demonstrate that he has retained his centre of vital interests in the first State. 16. Subparagraph b) establishes a secondary criterion for two quite distinct and different situations: a ) the case where the individual has a permanent home available to him in both Contracting States and it is not possible to determine in which one he has his centre of vital interests; ) the case where the individual has a permanent home b available to him in neither Contracting State. Preference is given to the Contracting State where the individ - ual has an habitual abode. 17. In the first situation, the case where the individual has a permanent home available to him in both States, the fact of having an habitual abode in one State rather than in the other appears therefore as the circumstance which, in case of doubt as to where the individual has his centre of vital interests, tips the balance towards the State where he stays more frequently. For this purpose regard must be had to stays made by the individual not only at the permanent home in the State in question but also at any other place in the same State. 18. The second situation is the case of an individual who has a permanent home available to him in neither Contracting State, as for example, a person going from one hotel to another. In this case also all stays made in a State must be considered without it being necessary to ascertain the reasons for them. 139

162 Article 4 Commentary 19. - In stipulating that in the two situations which it contem plates preference is given to the Contracting State where the individual has a habitual abode, subparagraph does not spec - b) ify over what length of time the comparison must be made. The comparison must cover a sufficient length of time for it to be possible to determine whether the residence in each of the two States is habitual and to determine also the intervals at which the stays take place. Where, in the two situations referred to in subparagraph 20. b) the individual has a habitual abode in both Contracting States or in neither, preference is given to the State of which he is a national. If, in these cases still, the individual is a national of both Contracting States or of neither of them, subparagraph d) assigns to the competent authorities the duty of resolving the difficulty by mutual agreement according to the procedure established in Article 25. Paragraph 3 Paragraph 3, which reproduces Article 4, paragraph 3, of the 8. OECD Model Convention, deals with companies and other bodies of persons, irrespective of whether they are legal persons. The 2017 OECD Commentary indicates in paragraph 21 that “It may be rare in practice for a company, etc. to be subject to tax as a resident in more than one State, but it is, of course, possible if, for instance, one State attaches importance to the registration and the other State to the place of effective management. So, in the case of companies, etc. also, special rules as to the preference must be established. According to paragraph 22 of the same OECD Commentary, “When paragraph 3 was first drafted, it was considered that it would not be an adequate solution to attach importance to a purely formal criterion like registration and preference was given to a rule based on the place of effective manage - ment, which was intended to be based on the place where the company, etc. was actually managed”. 9. However, the OECD/G20 recommendation in the Final Report on Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances) resulted in changes to sole reliance on place of effective management to resolve cases of dual residence. In 2017 140

163 Article 4 Commentary the Committee decided that the changes to the OECD Commentary should also be adopted as follows: 23. - In 2017, however, the Committee on Fiscal Affairs rec ognised that although situations of double residence of entities other than individuals were relatively rare, there had been a number of tax avoidance cases involving dual resident compa - nies. It therefore concluded that a better solution to the issue of dual residence of entities other than individuals was to deal with such situations on a case-by-case basis. As a result of these considerations, the current version 24. of paragraph 3 provides that the competent authorities of the Contracting States shall endeavour to resolve by mutual agreement cases of dual residence of a person other than an individual. 24.1 Competent authorities having to apply paragraph 3 would be expected to take account of various factors, such as where the meetings of the person’s board of directors or equiva - lent body are usually held, where the chief executive officer and other senior executives usually carry on their activities, where the senior day-to-day management of the person is carried on, where the person’s headquarters are located, which country’s laws govern the legal status of the person, where its accounting records are kept, whether determining that the legal person is a resident of one of the Contracting States but not of the other for the purpose of the Convention would carry the risk of an improper use of the provisions of the Convention etc. Countries that consider that the competent authorities should not be given the discretion to solve such cases of dual residence without an indication of the factors to be used for that purpose may want to supplement the provision to refer to these or other factors that they consider relevant. 24.2 A determination under paragraph 3 will normally be requested by the person concerned through the mechanism pro - vided for under paragraph 1 of Article 25. Such a request may be made as soon as it is probable that the person will be con - sidered a resident of each Contracting State under paragraph 1. Due to the notification requirement in paragraph 1 of Article 25, it should in any event be made within three years from the first 141

164 Article 4 Commentary notification to that person of taxation measures taken by one or both States that indicate that reliefs or exemptions have been denied to that person because of its dual-residence status with - out the competent authorities having previously endeavoured to determine a single State of residence under paragraph 3. The competent authorities to which a request for determination of residence is made under paragraph 3 should deal with it expedi - tiously and should communicate their response to the taxpayer as soon as possible. 24.3 Since the facts on which a decision will be based may change over time, the competent authorities that reach a deci - sion under that provision should clarify which period of time is covered by that decision. 24.4 The last sentence of paragraph 3 provides that in the absence of a determination by the competent authorities, the dual-resident person shall not be entitled to any relief or exemp - tion under the Convention except to the extent and in such manner as may be agreed upon by the competent authorities. This will not, however, prevent the taxpayer from being con - sidered a resident of each Contracting State for purposes other than granting treaty reliefs or exemptions to that person. This will mean, for example, that the condition in subparagraph b) of paragraph 2 of Article 15 will not be met with respect to an employee of that person who is a resident of either Contracting State exercising employment activities in the other State. Similarly, if the person is a company, it will be considered to be a resident of each State for the purposes of the application of Article 10 to dividends that it will pay. 10. While the place of effective management test was removed from Article 4, paragraph 3 in the 2017 UN Model update, some States may consider it to be preferable to deal with cases of dual residence of enti - ties using such a test. These States may consider that this rule can be interpreted in such a way to prevent it from being abused and may wish to include the following version of paragraph 3, which appeared in the United Nations Model Convention prior to the 2017 update: 3. Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, 142

165 Articles 4 and 5 Commentary then it shall be deemed to be a resident only of the State in which its place of effective management is situated. Article 5 PERMANENT ESTABLISHMENT A. General considerations 1. Article 5 of the United Nations Model Convention is based on - Article 5 of the OECD Model Convention but contains several signif icant differences. In essence these are that under the United Nations Model Convention: there is a six-month test for a building or construction site — constituting a permanent establishment, rather than the twelve-month test under the OECD Model Convention, and it expressly extends to assembly projects, as well as supervisory activities in connection with building sites and construction, assembly or installation projects (para - graph 3 ( a )); — the furnishing of services by an enterprise through employ - ees or other personnel results in a permanent establishment where such activities continue for a total of more than 183 days in any twelve-month period commencing or ending in the fiscal year concerned (paragraph 3 ( b )); — Article 14 (Independent personal services) has been retained, whereas in the OECD Model Convention, Article 14 has been deleted, and Article 5 addresses cases that were previously considered under the “fixed base” test of that Article. As noted below (in paragraph 15.1 and thereafter), while the United Nations Model Convention has retained Article 14, the present Commentary provides guidance for those countries not wishing to have such an article in their bilateral tax agreements; — in the list of what is deemed not to constitute a permanent establishment in paragraph 4 (often referred to as the list of “preparatory and auxiliary activities”) “delivery” is not 143

166 Article 5 Commentary mentioned in the United Nations Model Convention, but is mentioned in the OECD Model Convention. Therefore a delivery activity might result in a permanent establish - ment under the United Nations Model Convention, without doing so under the OECD Model Convention; — the actions of a “dependent agent” may constitute a per - manent establishment, even without having and habitually exercising the authority to conclude contracts in the name of the enterprise, where that person habitually maintains a stock of goods or merchandise and regularly makes deliver - ies from the stock (paragraph 5 ( b )); — there is a special provision specifying when a permanent establishment is created in the case of an insurance busi - ness; consequently a permanent establishment is more likely to exist under the United Nations Model Convention approach (paragraph 6); and These differences are considered in more detail below. 2. The concept of “permanent establishment” is used in bilateral tax treaties to determine the right of a State to tax the profits of an enterprise of the other State. Specifically, the profits of an enterprise of one State are taxable in the other State only if the enterprise main - tains a permanent establishment in the latter State and only to the extent that the profits are attributable to the permanent establishment. The concept of permanent establishment is found in the early model conventions including the 1928 model conventions of the League of Nations. The United Nations Model Convention reaffirms the concept. B. Commentary on the paragraphs of article 5 Paragraph 1 3. This paragraph, which reproduces Article 5, paragraph 1 of the OECD Model Convention, defines the term “permanent establish - ment”, emphasizing its essential nature as a “fixed place of business” with a specific “situs”. According to paragraph 2 of the OECD Model Commentary, this definition contains the following conditions: 144

167 Article 5 Commentary the existence of a “place of business”, i.e. a facility such as — premises or, in certain instances, machinery or equipment; this place of business must be “fixed”, i.e. , it must be — established at a distinct place with a certain degree of permanence; — the carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who, in one way or another, are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated. The OECD Model Commentary goes on to observe: 3. It could perhaps be argued that in the general definition some mention should also be made of the other characteristic of a permanent establishment to which some importance has sometimes been attached in the past, namely that the establish - ment must have a productive character, i.e. contribute to the profits of the enterprise. In the present definition this course has not been taken. Within the framework of a well-run busi - ness organisation it is surely axiomatic to assume that each part contributes to the productivity of the whole. It does not, of course, follow in every case that because in the wider context of the whole organisation a particular establishment has a “pro - ductive character” it is consequently a permanent establishment to which profits can properly be attributed for the purpose of tax in a particular territory (see Commentary on paragraph 4). 4. The term “place of business” covers any premises, facil - ities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that pur - pose. A place of business may also exist where no premises are available or required for carrying on the business of the enter - prise and it simply has a certain amount of space at its disposal. It is immaterial whether the premises, facilities or installations are owned or rented by or are otherwise at the disposal of the enterprise. A place of business may thus be constituted by a pitch in a market place, or by a certain permanently used area in a customs depot ( e.g. for the storage of dutiable goods). Again the place of business may be situated in the business facilities of 145

168 Article 5 Commentary another enterprise. This may be the case for instance where the foreign enterprise has at its constant disposal certain premises or a part thereof owned by the other enterprise. 4.1 As noted above, the mere fact that an enterprise has a - certain amount of space at its disposal which is used for busi ness activities is sufficient to constitute a place of business. No formal legal right to use that place is therefore required. Thus, for instance, a permanent establishment could exist where an enterprise illegally occupied a certain location where it carried on its business. 4.2 Whilst no formal legal right to use a particular place is required for that place to constitute a permanent establishment, the mere presence of an enterprise at a particular location does not necessarily mean that that location is at the disposal of that enterprise. These principles are illustrated by the following examples where representatives of one enterprise are present on the premises of another enterprise. A first example is that of a salesman who regularly visits a major customer to take orders and meets the purchasing director in his office to do so. In that case, the customer’s premises are not at the disposal of the enterprise for which the salesman is working and therefore do not constitute a fixed place of business through which the busi - ness of that enterprise is carried on (depending on the circum - stances, however, paragraph 5 could apply to deem a permanent establishment to exist). 4.3 A second example is that of an employee of a company who, for a long period of time, is allowed to use an office in the headquarters of another company ( e.g. a newly acquired subsid - iary) in order to ensure that the latter company complies with - its obligations under contracts concluded with the former com pany. In that case, the employee is carrying on activities related to the business of the former company and the office that is at his disposal at the headquarters of the other company will constitute a permanent establishment of his employer, provided that the office is at his disposal for a sufficiently long period of time so as to constitute a “fixed place of business” (see para - graphs 6 to 6.3) and that the activities that are performed there go beyond the activities referred to in paragraph 4 of the Article. 146

169 Article 5 Commentary 4.4 - A third example is that of a road transportation enter prise which would use a delivery dock at a customer’s warehouse every day for a number of years for the purpose of delivering goods purchased by that customer. In that case, the presence of the road transportation enterprise at the delivery dock would be so limited that that enterprise could not consider that place as being at its disposal so as to constitute a permanent establish - ment of that enterprise. A fourth example is that of a painter who, for two years, 4.5 spends three days a week in the large office building of its main client. In that case, the presence of the painter in that office building where he is performing the most important functions of his business ( i.e . painting) constitute a permanent establish - ment of that painter. 4.6 The words “through which” must be given a wide mean - ing so as to apply to any situation where business activities are carried on at a particular location that is at the disposal of the enterprise for that purpose. Thus, for instance, an enterprise engaged in paving a road will be considered to be carrying on its business “through” the location where this activity takes place. 5. According to the definition, the place of business has to be a “fixed” one. Thus in the normal way there has to be a link between the place of business and a specific geographical point. It is immaterial how long an enterprise of a Contracting State operates in the other Contracting State if it does not do so at a distinct place, but this does not mean that the equipment con - stituting the place of business has to be actually fixed to the soil on which it stands. It is enough that the equipment remains on a particular site (but see paragraph 20 below). 5.1 Where the nature of the business activities carried on by an enterprise is such that these activities are often moved between neighbouring locations, there may be difficulties in determining whether there is a single “place of business” (if two places of business are occupied and the other requirements of Article 5 are met, the enterprise will, of course, have two per - manent establishments). As recognised in paragraphs 18 and 20 below a single place of business will generally be considered to exist where, in light of the nature of the business, a particular 147

170 Article 5 Commentary location within which the activities are moved may be identified - as constituting a coherent whole commercially and geographi cally with respect to that business. 5.2 This principle may be illustrated by examples. A mine clearly constitutes a single place of business even though busi - ness activities may move from one location to another in what may be a very large mine as it constitutes a single geograph - ical and commercial unit as concerns the mining business. Similarly, an “office hotel” in which a consulting firm regularly rents different offices may be considered to be a single place of business of that firm since, in that case, the building constitutes a whole geographically and the hotel is a single place of business for the consulting firm. For the same reason, a pedestrian street, outdoor market or fair in different parts of which a trader reg - ularly sets up his stand represents a single place of business for that trader. The OECD Commentary then examines some examples relating to the provision of services. In quoting the following two paragraphs, the Committee notes that Article 5, paragraph 3, subparagraph ( b ) of the United Nations Model Convention provides a specific provision in - relation to furnishing of services by an enterprise through employ ees or personnel engaged for that purpose. In practice, therefore, the points made in paragraphs 5.3 and 5.4 of the OECD Commentary (as with other parts of the OECD Commentary to Article 5, paragraph 1) may have less significance for the United Nations Model Convention than in their original context. 5.3 By contrast, where there is no commercial coherence, the fact that activities may be carried on within a limited geo - graphic area should not result in that area being considered as a single place of business. For example, where a painter works successively under a series of unrelated contracts for a number of unrelated clients in a large office building so that it cannot be said that there is one single project for repainting the build - ing, the building should not be regarded as a single place of business for the purpose of that work. However, in the different example of a painter who, under a single contract, undertakes work throughout a building for a single client, this constitutes a single project for that painter and the building as a whole can 148

171 Article 5 Commentary then be regarded as a single place of business for the purpose of - that work as it would then constitute a coherent whole commer cially and geographically. 5.4 Conversely, an area where activities are carried on as part of a single project which constitutes a coherent commer - cial whole may lack the necessary geographic coherence to be considered as a single place of business. For example, where a consultant works at different branches in separate locations pursuant to a single project for training the employees of a bank, each branch should be considered separately. However if the consultant moves from one office to another within the same branch location, he should be considered to remain in the same place of business. The single branch location possesses geographical coherence which is absent where the consultant moves between branches in different locations. The OECD Commentary then continues: 6. Since the place of business must be fixed, it also follows that a permanent establishment can be deemed to exist only if the place of business has a certain degree of permanency, i.e. if it is not of a purely temporary nature. A place of business may, however, constitute a permanent establishment even though it exists, in practice, only for a very short period of time because the nature of the business is such that it will only be carried on for that short period of time. It is sometimes difficult to deter - mine whether this is the case. Whilst the practices followed by member countries have not been consistent in so far as time requirements are concerned, experience has shown that perma - nent establishments normally have not been considered to exist in situations where a business had been carried on in a country through a place of business that was maintained for less than six months (conversely, practice shows that there were many cases where a permanent establishment has been considered to exist where the place of business was maintained for a period longer than six months). One exception has been where the activities were of a recurrent nature; in such cases, each period of time during which the place is used needs to be considered in combination with the number of times during which that place is used (which may extend over a number of years). Another 149

172 Article 5 Commentary exception has been made where activities constituted a business - that was carried on exclusively in that country; in this situa tion, the business may have short duration because of its nature but since it is wholly carried on in that country, its connection - with that country is stronger. For ease of administration, coun tries may want to consider these practices when they address disagreements as to whether a particular place of business that exists only for a short period of time constitutes a permanent establishment. The Committee agrees with the approach taken in paragraph 6 of the OECD Commentary, while recognizing that such exceptional situa - tions will not often arise in practice, and that special care should there - fore be taken when relying on paragraph 6 as applicable in an actual case. The OECD Commentary continues: 6.1 As mentioned in paragraphs 11 and 19, temporary inter - ruptions of activities do not cause a permanent establishment to cease to exist. Similarly, as discussed in paragraph 6, where a particular place of business is used for only very short periods of time but such usage takes place regularly over long periods of time, the place of business should not be considered to be of a purely temporary nature. 6.2 Also, there may be cases where a particular place of busi - ness would be used for very short periods of time by a number of similar businesses carried on by the same or related persons in an attempt to avoid that the place be considered to have been used for more than purely temporary purposes by each par - ticular business. The remarks of paragraph 18 on arrangements intended to abuse the [six] month period provided for in para - graph 3 would equally apply to such cases. 6.3 Where a place of business which was, at the outset, designed to be used for such a short period of time that it would not have constituted a permanent establishment but is in fact maintained for such a period that it can no longer be considered as a temporary one, it becomes a fixed place of business and thus — retrospectively — a permanent establishment. A place of business can also constitute a permanent establishment from its inception even though it existed, in practice, for a very short 150

173 Article 5 Commentary period of time, if as a consequence of special circumstances ( e.g. death of the taxpayer, investment failure), it was prematurely liquidated. For a place of business to constitute a permanent estab - 7. lishment the enterprise using it must carry on its business wholly or partly through it. As stated in paragraph 3 above, the activity need not be of a productive character. Furthermore, the activity need not be permanent in the sense that there is no interruption of operation, but operations must be carried out on a regular basis. Where tangible property such as facilities, industrial, 8. commercial or scientific (ICS) equipment, buildings, or intan - gible property such as patents, procedures and similar prop - erty, are let or leased to third parties through a fixed place of business maintained by an enterprise of a Contracting State in the other State, this activity will, in general, render the place of business a permanent establishment. The same applies if capital is made available through a fixed place of business. If an enterprise of a State lets or leases facilities, ICS equipment, buildings or intangible property to an enterprise of the other State without maintaining for such letting or leasing activity a fixed place of business in the other State, the leased facility, ICS equipment, building or intangible property, as such, will not constitute a permanent establishment of the lessor provided the contract is limited to the mere leasing of the ICS equipment etc. This remains the case even when, for example, the lessor supplies personnel after installation to operate the equipment provided that their responsibility is limited solely to the opera - tion or maintenance of the ICS equipment under the direction, responsibility and control of the lessee. If the personnel have wider responsibilities, for example participation in the deci - sions regarding the work for which the equipment is used, or if they operate, service, inspect and maintain the equipment under the responsibility and control of the lessor, the activity of the lessor may go beyond the mere leasing of ICS equipment and may constitute an entrepreneurial activity. In such a case a permanent establishment could be deemed to exist if the cri - terion of permanency is met. When such activity is connected 151

174 Article 5 Commentary with, or is similar in character to, those mentioned in paragraph 3, the time limit of [six] months applies. Other cases have to be determined according to the circumstances. The business of an enterprise is carried on mainly by 10. the entrepreneur or persons who are in a paid-employment relationship with the enterprise (personnel). These personnel include employees and other persons receiving instructions from the enterprise ( e.g. dependent agents). The powers of such personnel in its relationship with third parties are irrelevant. It makes no difference whether or not the dependent agent is authorised to conclude contracts if he works at the fixed place of business [...]. But a permanent establishment may neverthe - less exist if the business of the enterprise is carried on mainly through automatic equipment, the activities of the personnel being restricted to setting up, operating, controlling and main - taining such equipment. Whether or not gaming and vending machines and the like set up by an enterprise of a State in the other State constitute a permanent establishment thus depends on whether or not the enterprise carries on a business activ - ity besides the initial setting up of the machines. A permanent establishment does not exist if the enterprise merely sets up the machines and then leases the machines to other enterprises. A permanent establishment may exist, however, if the enterprise which sets up the machines also operates and maintains them for its own account. This also applies if the machines are oper - ated and maintained by an agent dependent on the enterprise. 11. A permanent establishment begins to exist as soon as the enterprise commences to carry on its business through a - fixed place of business. This is the case once the enterprise pre pares, at the place of business, the activity for which the place of business is to serve permanently. The period of time during which the fixed place of business itself is being set up by the enterprise should not be counted, provided that this activity differs substantially from the activity for which the place of business is to serve permanently. The permanent establishment ceases to exist with the disposal of the fixed place of business or with the cessation of any activity through it, that is when all acts and measures connected with the former activities of 152

175 Article 5 Commentary the permanent establishment are terminated (winding up cur - rent business transactions, maintenance and repair of facilities). A temporary interruption of operations, however, cannot be regarded as a closure. If the fixed place of business is leased to another enterprise, it will normally only serve the activities of that enterprise instead of the lessors; in general, the lessors per - manent establishment ceases to exist, except where he contin - ues carrying on a business activity of his own through the fixed place of business. In 2017, a number of changes were made to Article 5 and, con - 3.1 sequently, to this Commentary. Changes related to the addition of paragraph 4.1 and the modification of paragraphs 4, 5 and 6 of the Article that were made as a result of the adoption of the Report on Action 7 of the OECD/G20 Base Erosion and Profit Shifting Project are prospective only and, as such, do not affect the interpretation of the former provisions of the United Nations Model Tax Convention and of treaties in which these provisions are included, in particular as regards the interpretation of paragraphs 4 and 5 of the Article as they read before these changes. Paragraph 2 4. Paragraph 2, which reproduces Article 5, paragraph 2 of the OECD Model Convention, lists examples of places that will often constitute a permanent establishment. However, the provision is not self-standing. While paragraph 2 notes that offices, factories, etc., are common types of permanent establishments, when one is looking at the operations of a particular enterprise, the requirements of para - graph 1 must also be met. Paragraph 2 therefore simply provides an indication that a permanent establishment may well exist; it does not provide that one necessarily does exist. This is also the stance of the OECD Model Commentary, where it is assumed that States interpret the terms listed “in such a way that such places of business constitute permanent establishments only if they meet the requirements of para - graph 1”. Developing countries often wish to broaden the scope of the term “permanent establishment” and some believe that a warehouse should be included among the specific examples. However, the deletion of “delivery” from the excluded activities described in subparagraphs 153

176 Article 5 Commentary ( ) and ( b ) of paragraph 4 means that a “warehouse” used for any pur - a - pose is (subject to the conditions in paragraph 1 being fulfilled) a per manent establishment under the general principles of the Article. The OECD Commentary points out in paragraph 13 that the term “place of management” is mentioned separately because it is not necessarily an “office” and that “where the laws of the two Contracting States do not contain the concept of a ‘place of management’ as distinct from an ‘office’, there will be no need to refer to the former term in their bilateral convention”. In discussing subparagraph ( f 5. ), which provides that the term “permanent establishment” includes mines, oil or gas wells, quar - ries or any other place of extraction of natural resources, the OECD Commentary states that “the term ‘any other place of extraction of natural resources’ should be interpreted broadly” to include, for exam - ple, all places of extraction of hydrocarbons whether on or offshore. Because subparagraph ( f ) does not mention exploration for natural resources, whether on or offshore, paragraph 1 governs whether explo - ration activities are carried on through a permanent establishment. The OECD Commentary states: [...] Since, however, it has not been possible to arrive at a 15. - common view on the basic questions of the attribution of tax - ation rights and of the qualification of the income from explo ration activities, the Contracting States may agree upon the insertion of specific provisions. They may agree, for instance, that an enterprise of a Contracting State, as regards its activities of exploration of natural resources in a place or area in the other Contracting State: a ) shall be deemed not to have a permanent establish - ment in that other State; or ) shall be deemed to carry on such activities through a b permanent establishment in that other State; or c ) shall be deemed to carry on such activities through a permanent establishment in that other State if such activities last longer than a specified period of time. The Contracting States may moreover agree to submit the income from such activities to any other rule. 154

177 Article 5 Commentary 6. f ) the expression “any As mentioned above, in subparagraph ( other place of extraction of natural resources” should be interpreted broadly. Some have argued that, for this purpose, a fishing vessel could be treated as a place of extraction or exploitation of natural resources since “fish” constitute a natural resource. In their analysis, although it is true that all places or apparatus designated as “permanent establish - a ) to ( e ) in paragraph 2 have a certain degree ments” in subparagraphs ( of permanence or constitute “immovable property”, fishing vessels can be considered as a place used for extraction of natural resources, which may not necessarily mean only minerals embedded in the earth. In this view, fishing vessels can be compared to the movable drilling platform that is used in offshore drilling operations for gaining access to oil or gas. Where such fishing vessels are used in the territorial waters or the exclu - sive economic zone of the coastal State, their activities would constitute a permanent establishment, situated in that State. However, others are of the view that such an interpretation was open to objection in that it constituted too broad a reading of the term “permanent establishment” and of the natural language of the subparagraph. Accordingly, in their opinion, any treaty partner countries which sought to advance such a proposition in respect of fishing activities, should make that explicit by adopting it as a new and separate category in the list contained in this Article. Consequently, the interpretation on the nature of this activity has been left to negotiations between Contracting States so that, for - example, countries which believe that a fishing vessel can be a perma nent establishment might choose to make that explicit in this Article, such as by the approach outlined in paragraph 13 of this Commentary. The interpretation as to the nature of this activity would, therefore, be left to negotiations between Contracting States. Paragraph 3 7. This paragraph covers a broader range of activities than Article 5, paragraph 3 of the OECD Model Convention, which states, “A building - site or construction or installation project constitutes a permanent estab lishment only if it lasts more than twelve months”. In addition to the term “installation project” used in the OECD Model Convention, sub - paragraph ( a ) of paragraph 3 of the United Nations Model Convention includes an “assembly project” as well as “supervisory activities” in con - nection with “a building site, a construction, assembly or installation 155

178 Article 5 Commentary project”. Another difference is that while the OECD Model Convention uses a time limit of 12 months, the United Nations Model Convention reduces the minimum duration to six months. In special cases, this six-month period could be reduced in bilateral negotiations to not less than three months. The Committee notes that there are differing views a ) of paragraph 3 is a “self-standing” pro - about whether subparagraph ( - vision (so that no resort to paragraph 1 is required) or whether (in con trast) only building sites and the like that meet the criteria of paragraph 1 would constitute permanent establishments, subject to there being a specific six-month test. However, the Committee considers that where a building site exists for six months, it will in practice almost invariably also meet the requirements of paragraph 1. In fact, an enterprise having a building site, etc., at its disposal, through which its activities are wholly or partly carried on will also meet the criteria of paragraph 1. 8. Some countries support a more elaborate version of subpara - graph ( a ) of paragraph 3, which would extend the provision to encom - pass a situation “where such project or activity, being incidental to the sale of machinery or equipment, continues for a period not exceeding six months and the charges payable for the project or activities exceed 10 per cent of the sale price of the machinery or equipment”. Other countries believe that such a provision would not be appropriate, par - ticularly if the machinery were installed by an enterprise other than the one doing the construction work. 9. b ) deals with the furnishing Article 5, paragraph 3, subparagraph ( of services, including consultancy services, the performance of which does not, of itself, create a permanent establishment in the OECD Model Convention. Many developing countries believe that management and consultancy services should be covered because the provision of those services in developing countries by enterprises of industrialized countries can generate large profits. In the 2011 revision of the United Nations Model Convention, the Committee agreed to a slight change in the wording of subparagraph ( b ) of paragraph 3, which was amended to read: “but only if activities of that nature continue (for the same or a connected project) within a Contracting State for a period or periods aggregating more than 183 days in any twelve-month period commenc - ing or ending in the fiscal year concerned”, rather than, “but only if activities of that nature continue (for the same or a connected project) 156

179 Article 5 Commentary within a Contracting State for a period or periods aggregating more than six months within any twelve-month period”, as it formerly read. This was seen as providing greater consistency with the approach taken ). In the 2017 revision the in Article 14, paragraph 1, subparagraph ( b Committee made a further change to subparagraph (b) to remove the words in parenthesis “(for the same or a connected project)” altogether. This change is discussed in more detail in paragraph 12 below. 10. A few developing countries oppose the six-month (or 183 days) thresholds in subparagraphs ( ) and ( b ) of paragraph 3 altogether. They a have two main reasons: first, they maintain that construction, assembly and similar activities could, as a result of modern technology, be of very short duration and still result in a substantial profit for the enterprise; second, and more fundamentally, they simply believe that the period during which foreign personnel remain in the source country is irrel - evant to their right to tax the income (as it is in the case of artistes and sportspersons under Article 17). Other developing countries oppose a time limit because it could be used by foreign enterprises to set up artificial arrangements to avoid taxation in their territory. However, the - purpose of bilateral treaties is to promote international trade, invest ment, and development, and the reason for the time limit (indeed for the permanent establishment threshold more generally) is to encourage businesses to undertake preparatory or ancillary operations in another State that will facilitate a more permanent and substantial commitment later on, without becoming immediately subject to tax in that State. 11. In this connection, the 2017 OECD Model Commentary observes, with changes in parentheses to take account of the different time periods in the two Models: 51. The [six] month test applies to each individual site or project. In determining how long the site or project has existed, no account should be taken of the time previously spent by the contractor concerned on other sites or projects which are totally unconnected with it. A building site should be regarded as a single unit, even if it is based on several contracts, provided that it forms a coherent whole commercially and geographically. Subject to this proviso, a building site forms a single unit even if the orders have been placed by several persons ( e.g. for a row of houses). 157

180 Article 5 Commentary 52. The [six] month threshold has given rise to abuses; it has sometimes been found that enterprises (mainly contractors or subcontractors working on the continental shelf or engaged in activities connected with the exploration and exploitation of the continental shelf) divided their contracts up into several parts, each covering a period less than [six] months and attributed to a different company, which was, however, owned by the same group. Apart from the fact that such abuses may, depending on the cir - cumstances, fall under the application of legislative or judicial antiavoidance rules, these abuses could also be addressed through the application of the anti-abuse rule of paragraph 9 of Article 29, as shown by example J [and example N] in paragraph [182] of the Commentary on Article 29. Some States may nevertheless wish to deal expressly with such abuses. Moreover, States that do not include paragraph 9 of Article 29 in their treaties should include an additional provision to address contract splitting. Such a pro - vision could, for example, be drafted along the following lines: For the sole purpose of determining whether the [six] month period referred to in paragraph 3 has been exceeded, a) where an enterprise of a Contracting State carries on activities in the other Contracting State at a place that constitutes a building site or construction[, assem - bly] or installation project [or supervisory activities - in connection therewith] and these activities are car ried on during one or more periods of time that, in the aggregate, exceed 30 days without exceeding [six] months, and b) connected activities are carried on at the same build - ing site, or construction[, assembly] or installation project [or supervisory activities in connection therewith,] during different periods of time, each exceeding 30 days, by one or more enterprises closely related to the first-mentioned enterprise, these different periods of time shall be added to the period of time during which the first-mentioned enterprise has carried on activities at that building site or construction[, assembly] or installation project [or supervisory activities in connection therewith]. 158

181 Article 5 Commentary The concept of “closely related enterprises” that is used in the above provision is defined in paragraph [9] of the Article (see paragraphs 119 to 121 below). For the purposes of the alternative provision found in 53. paragraph 52, the determination of whether activities are con - nected will depend on the facts and circumstances of each case. Factors that may especially be relevant for that purpose include: — whether the contracts covering the different activities were concluded with the same person or related persons; — whether the conclusion of additional contracts with a person is a logical consequence of a previous contract concluded with that person or related persons; — whether the activities would have been covered by a single contract absent tax planning considerations; — whether the nature of the work involved under the differ - ent contracts is the same or similar; whether the same employees are performing the activi - — ties under the different contracts The Committee points out that measures to counteract abuses would apply equally in cases under Article 5, paragraph 3, subparagraph ( b ). The anti-contract splitting rule provided in paragraph 52 of the OECD Commentary can be amended to also counteract abuses under subparagraph (b). A further possibility is to include the following text immediately after subparagraph (b), which is based on a similar provision found in the 2016 treaty between Chile and Japan, but uti - lizes the closely related enterprise wording contained in the OECD provision: The duration of activities under subparagraphs (a) and (b) shall be determined by aggregating the periods during which activities are carried on in a Contracting State by closely related enterprises, provided that the activities of such a closely related enterprise in that Contracting State are connected with the activities carried on in that Contracting State by its closely related enterprises. The period during which two or more closely related enterprise are carrying on concurrent activities shall be counted only once for the purpose of determining the duration of activities. 159

182 Article 5 Commentary The Commentary of the 2014 OECD Model Convention contains the following relevant passages: 19. A site exists from the date on which the contractor begins his work, including any preparatory work, in the country where the construction is to be established, e.g. if he installs a planning office for the construction. In general, it continues to exist until the work is completed or permanently abandoned. A site should not be regarded as ceasing to exist when work is temporarily dis - continued. Seasonal or other temporary interruptions should be included in determining the life of a site. Seasonal interruptions - include interruptions due to bad weather. Temporary interrup tion could be caused, for example, by shortage of material or labour difficulties. Thus, for example, if a contractor started work on a road on 1st May, stopped on 1st [August] because of bad weather conditions or a lack of materials but resumed work on 1st [October], completing the road on 1st [January the following year], his construction project should be regarded as a permanent establishment because [eight] months elapsed between the date he first commenced work (1st May) and the date he finally finished (1st [January] of the following year). If an enterprise (general contractor) which has undertaken the performance of a comprehensive project subcontracts parts of such a project to other enterprises (subcontractors), the period spent by a subcontractor working on the building site must be considered as being time spent by the general contractor on the building project. The subcontractor himself has a permanent establishment at the site if his activities there last more than [si x] mont hs. The Committee considers that the reference in the penultimate sentence of this paragraph of the OECD Commentary to “parts” of such a pro - ject should not be taken to imply that an enterprise subcontracting all parts of the project could never have a permanent establishment in the host State. The Commentary of the 2014 OECD Model Convention continues as follows: 19.1 In the case of fiscally transparent partnerships, the [six]- month test is applied at the level of the partnership as concerns its 160

183 Article 5 Commentary own activities. If the period of time spent on the site by the part - ners and the employees of the partnership exceeds [six] months, the enterprise carried on by the partnership will therefore be considered to have a permanent establishment. Each partner will thus be considered to have a permanent establishment for pur - poses of the taxation of his share of the business profits derived by the partnership regardless of the time spent by himself on the site. 20. The very nature of a construction or installation project may be such that the contractor’s activity has to be relocated - continuously or at least from time to time, as the project pro gresses. This would be the case for instance where roads or canals were being constructed, waterways dredged, or pipelines laid. Similarly, where parts of a substantial structure such as an offshore platform are assembled at various locations within a country and moved to another location within the country for final assembly, this is part of a single project. In such cases the fact that the work force is not present for [six] months in one particular location is immaterial. The activities performed at each particular spot are part of a single project, and that project must be regarded as a permanent establishment if, as a whole, it lasts for more than [six] months. 12. Until the 2017 update the UN Model contained the words “(for the same or a connected project)” in subparagraph (b). This wording was removed as the “project” limitation was easy to manipulate and created difficult interpretive issues and factual determinations for tax authorities, which in particular for developing countries is an unde - sired administrative burden. Moreover, from a policy perspective, if a non-resident provides services in a country for more than 183 days, the non-resident’s involvement in the commercial life of that country clearly justifies the country taxing the income from those services whether the services are provided for one project or multiple projects. The degree of the non-resident’s involvement in the source country’s economy is the same, regardless of the number of projects involved. It has been argued that taxpayers can more easily monitor the location of the activities of their employees and independent contractors on a project-by-pro - ject basis. Requiring enterprises, even large enterprises with multiple projects, to keep records with regard to the countries in which their employees and independent contractors are working does not appear to 161

184 Article 5 Commentary be unduly onerous or unreasonable—especially in light of technological - advances. However, for countries that are concerned about the uncer - tainty involved in adding together unrelated projects and the undesir able distinction it creates between an enterprise with, for example, one project of 95 days duration and another enterprise with two unrelated projects, each of 95 days duration, one following the other, may add the words “(for the same or a connected project)” in paragraph 3 subpar - agraph (b). 12.1 The Committee observed in general terms that broadening the scope of subparagraph 3(b) means that the revised provision will apply in certain circumstances instead of the new Article 12A in relation to technical service fees. 13. If States wish to treat fishing vessels in their territorial waters as constituting a permanent establishment (see paragraph 6 above), they could add a suitable provision to paragraph 3, which, for example, might apply only to catches over a specified level, or by reference to some other criterion. 14. If a permanent establishment is considered to exist under par - agraph 3, only profits attributable to the activities carried on through that permanent establishment are taxable in the source country. The following passages of the 2010 OECD Model Commentary 15. are relevant to Article 5, paragraph 3, subparagraph ( a ) of the United Nations Model Convention, although the reference to an “assembly project” in the United Nations Model Convention and not in the OECD Model Convention, and the six-month period in the United Nations Model Convention should, in particular, be borne in mind: 16. This paragraph provides expressly that a building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months. Any of those items which do not meet this condition does not of itself constitute a permanent establishment, even if there is within it an installation, for instance an office or a workshop within the meaning of paragraph 2, associated with the construction activity. Where, however, such an office or workshop is used for a number of construction projects and the activities per - formed therein go beyond those mentioned in paragraph 4, it 162

185 Article 5 Commentary will be considered a permanent establishment if the conditions of the Article are otherwise met even if none of the projects involve a building site or construction or installation project that lasts more than twelve months. In that case, the situation of the workshop or office will therefore be different from that of these sites or projects, none of which will constitute a perma - nent establishment, and it will be important to ensure that only the profits properly attributable to the functions performed and risks assumed through that office or workshop are attributed to the permanent establishment. This could include profits attrib - utable to functions performed and risks assumed in relation to the various construction sites but only to the extent that these functions and risks are properly attributable to the office. 17. The term “building site or construction or installation project” includes not only the construction of buildings but also the construction of roads, bridges or canals, the renovation (involving more than mere maintenance or redecoration) of buildings, roads, bridges or canals, the laying of pipe-lines and excavating and dredging. Additionally, the term “installation - project” is not restricted to an installation related to a construc tion project; it also includes the installation of new equipment, such as a complex machine, in an existing building or outdoors. On-site planning and supervision of the erection of a building are covered by paragraph 3. States wishing to modify the text of the paragraph to provide expressly for that result are free to do so in their bilateral conventions. Alternative text for countries wishing to delete Article 14 15.1 Some countries have taken the view that Article 14 should be deleted and its coverage introduced into Articles 5 and 7. Countries taking such a view often do so because they perceive that the “fixed base” concept in Article 14 has widely acknowledged uncertainties and that the “permanent establishment” concept can accommodate the taxing rights covered by Article 14. This approach is expressed by the Commentary on Article 5 of the 2017 OECD Model Convention as follows: 2. Before 2000, income from professional services and other activities of an independent character was dealt with under a 163

186 Article 5 Commentary separate Article, Article 14. The provisions of that Article i.e. were similar to those applicable to business profits but it used the concept of fixed base rather than that of permanent estab - lishment since it had originally been thought that the latter concept should be reserved to commercial and industrial activ - ities. The elimination of Article 14 in 2000 reflected the fact that there were no intended differences between the concepts of per - manent establishment, as used in Article 7, and fixed base, as used in Article 14, or between how profits were computed and tax was calculated according to which of Article 7 or 14 applied. The elimination of Article 14 therefore meant that the definition - of permanent establishment became applicable to what previ ously constituted a fixed base. 15.2 Many countries disagree with these views and do not believe they are sufficient to warrant deletion of Article 14. Further some countries consider that differences in meaning exist between the “fixed base” (Article 14) and “permanent establishment” (Article 5) concepts. In view of these differences, the removal of Article 14 and reliance on Articles 5 and 7 will, or at least may, in practice lead to a reduction of source State taxing rights. Considering the differences of views in this area, differences which could not be bridged by a single provision, the Committee considers that Article 14 should be retained in the United Nations Model Convention but that guidance in the form of an alter - native provision would be provided in this Commentary for countries wishing to delete Article 14. This alternative differs from that provided for under the 15.3 OECD Model Convention, which reflected in its changes the con - 24 That clusions of an OECD report on Article 14 released in 2000. report suggested certain changes to Articles of the OECD Model Convention (and bilateral treaties) as well as consequential changes to the Commentaries. Since most countries deleting Article 14 will be doing so for the reasons outlined in the OECD report, and are likely to follow the recommendations in the OECD Model Convention, the changes to the Articles proposed in that report, as they now appear in 24 Issues Related to Article 14 of the OECD Model Tax Convention. Reproduced in Volume II of the full-length version of the OECD Model Con - vention at page R(16)-1. 164

187 Article 5 Commentary the OECD Model Convention, are addressed in the paragraphs below regarding the possible deletion of Article 14. The differences between that approach and the alternative wording provided below, result from relevant differences between Article 14 of the United Nations Model Convention and Article 14 as it previously appeared in the OECD Model Convention. 15.4 Since the deletion of Article 14 is merely presented as an option that some countries may prefer to follow, the entire discussion on the consequential implications of such an approach is addressed in this Commentary on Article 5, including identifying the possibility, and in most cases the need, to make certain consequential changes reflecting - the deletion of Article 14, the need to remove references to “independ ent personal services” and “fixed base” and the possibility of removing references to “dependent personal services” for the sake of clarity. Changes to Articles 14 and 5 15.5 Article 14 would be deleted. Subparagraph ( b ) of paragraph 3 of Article 5 would read as follows: ( b ) the furnishing of services , including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue within a Contracting State for a period or periods aggregating more than 183 days within any twelve-month period commencing or ending in the fiscal year concerned; The changes to the version of this subparagraph in the 1999 15.6 United Nations Model Convention are minor, comprising (i) the dele - tion of the words “including consultancy services”, after the words “the furnishing of services”, on the basis that the wording was unnec - essary and confusing, such services being clearly covered; (ii) the replacement of the six-month test with the 183 days test, as noted in paragraph 9 above; and (iii) the use of a semicolon rather than a period at the end of the subparagraph, with the introduction of subparagraph ( c ). In 2017, the Committee removed the words in parenthesis, “(for the same or connected project)” from subparagraph (b). Countries that are concerned about the uncertainty this might create may continue to include this text. 165

188 Article 5 Commentary 15.7 c ) of paragraph 3 would also be inserted, A new subparagraph ( as follows: ( for an individual, the performing of services in a c ) - Contracting State by that individual, but only if the indi - vidual’s stay in that State is for a period or periods aggre gating more than 183 days within any twelve-month period commencing or ending in the fiscal year concerned. Subparagraph ( 15.8 ) is intended to ensure that any situation pre - c viously covered by Article 14 would now be addressed by Articles 5 and 7. The wording reflects the fact that deletion of Article 14 of the United Nations Model Convention would involve deletion of the “days of physical presence” test found in subparagraph ( b ) of paragraph 1 of Article 14 of that Model, which had no counterpart in the OECD Model Convention when the deletion of Article 14 was agreed for that Model. 15.9 It should be noted that subparagraph ( c ), in attempting to reflect the operation of the current Article 14, paragraph 1, subparagraph ( b ), - more explicitly indicates that the subparagraph only applies to indi viduals. In this respect, it follows and makes clearer the interpretation found in paragraph 9 of the Commentary on Article 14, to the effect that Article 14 deals only with individuals. The Committee notes that some countries do not accept that view and should seek to clarify the issue when negotiating Article 14. 15.10 It should also be noted that the last part of Article 14, paragraph 1, subparagraph ( b ) has not been transposed into Article 5: (“... in that case, only so much of the income as is derived from his activities per - formed in that other State may be taxed in that other State”). The reason for this is that Article 7 provides its own attribution rules, which, in most cases, means that only the profits of an enterprise attributable to that permanent establishment (that is, the “physical presence” in subparagraph ( c ) of paragraph 3) may be taxed by the State where the permanent establishment exists. Where a “limited force of attraction” rule as provided in Article 7 has been adopted in bilateral treaties, other business activities of a same or similar kind as those effected through the physical presence permanent establishment may be taxed by the State where the permanent establishment exists, which can be justified as treating various forms of permanent establishment in the same way. 166

189 Article 5 Commentary In the event of States agreeing to a limited force of attraction rule in Article 7 and also to deletion of Article 14, but not wishing to apply the limited force of attraction rule to cases formerly dealt with by Article ), it could explicitly be provided that 14, paragraph 1, subparagraph ( b ) of paragraph 3 cases. c such a rule did not apply to subparagraph ( Consequential changes to other Articles In paragraph 1 of Article 3, existing subparagraphs ( c ) to ( f ) 15.11 should be renumbered as subparagraphs ( ) to ( g ) and the following d new subparagraphs ( ) and ( h ) added: c c ) the term “enterprise” applies to the carrying on of ( any business; ( h ) the term “business” includes the performance of profes - sional services and of other activities of an independent character. The reasoning for this change is reflected in paragraphs 4 and 15.12 10.2 of the OECD Commentary on Article 3 as follows: 4. The question whether an activity is performed within an enterprise or is deemed to constitute in itself an enterprise has always been interpreted according to the provisions of the domestic laws of the Contracting States. No exhaustive defini - tion of the term “enterprise” has therefore been attempted in this Article. However, it is provided that the term “enterprise” applies to the carrying on of any business. Since the term “business” is expressly defined to include the performance of professional services and of other activities of an independent character, this clarifies that the performance of professional services or other activities of an independent character must be - considered to constitute an enterprise, regardless of the mean ing of that term under domestic law. States which consider that such clarification is unnecessary are free to omit the definition of the term “enterprise” from their bilateral conventions. 10.2 The Convention does not contain an exhaustive defini - tion of the term “business”, which, under paragraph 2, should generally have the meaning which it has under the domestic law of the State that applies the Convention. Subparagraph h ), how - ever, provides expressly that the term includes the performance 167

190 Article 5 Commentary of professional services and of other activities of an independent character. This provision was added in 2000 at the same time as Article 14, which dealt with Independent Personal Services, was deleted from the Convention. This addition, which ensures that the term “business” includes the performance of the activities which were previously covered by Article 14, was intended to prevent that the term “business” be interpreted in a restricted way so as to exclude the performance of professional services, or other activities of an independent character, in States where the domestic law does not consider that the performance of such services or activities can constitute a business. Contracting States for which this is not the case are free to agree bilaterally to omit the definition. Paragraph 4 of Article 6 should be amended by removing the 15.13 reference to independent personal services as follows: 4. The provisions of paragraphs 1 and 3 shall also apply to the income from immovable property of an enterprise and to income from immovable property used for the performance of independent personal services . 15.14 Paragraph 4 of Article 10 should be amended as follows: 4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State of which the company paying the dividends is a resident or per - through a permanent establishment situated therein forms in that other State independent personal services from a fixed base situated therein and the holding in respect of which the dividends are paid is effectively connected with such per - manent establishment or fixed base . In such case the provisions of Article 7 or Article 14, as the case may be, shall apply. 15.15 Paragraph 5 of Article 10 should be amended as follows: 5. Where a company which is a resident of a Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of 168

191 Article 5 Commentary which the dividends are paid is effectively connected with a per - or a fixed base situated in that other State, manent establishment nor subject the company’s undistributed profits to a tax on the company’s undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State. 15.16 Paragraph 4 of Article 11 should be amended as follows: 4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the interest, being a resident of a Contracting State, carries on business in the other Contracting State in which the interest arises, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the debt claim in respect of which the interest is paid is effectively connected with ( ) such permanent establishment or fixed base , a b ) business activities referred to in ( c ) of paragraph 1 of or with ( Article 7. In such cases the provisions of Article 7 or Article 14, as the case may be, shall apply. Paragraph 5 of Article 11 should be amended as follows: 15.17 Interest shall be deemed to arise in a Contracting State 5. when the payer is a resident of that State. Where, however, the person paying the interest, whether he is a resident of a - Contracting State or not, has in a Contracting State a perma or a fixed base in connection with which nent establishment the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment or a fixed base , then such interest shall be deemed to arise in the State in which the permanent establishment or a fixed base is situated. 15.18 Paragraph 4 of Article 12 should be amended as follows: 4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise, through a permanent estab - lishment situated therein, or performs in that other State inde - pendent personal services from a fixed base situated therein, 169

192 Article 5 Commentary and the right or property in respect of which the royalties are a ) such permanent establish paid is effectively connected with ( - or with ( ) business activities referred to or a fixed base, b ment, in ( c ) of paragraph 1 of Article 7. In such cases the provisions of or Article 14, as the case may be, shall apply. Article 7 15.19 Paragraph 5 of Article 12 should be amended as follows: 5. Royalties shall be deemed to arise in a Contracting State when the payer is a resident of that State. Where, however, the person paying the royalties, whether he is a resident of a - Contracting State or not, has in a Contracting State a perma or a fixed base in connection with which the nent establishment liability to pay the royalties was incurred, and such royalties are borne by such permanent establishment or fixed base , then such royalties shall be deemed to arise in the State in which the permanent establishment or fixed base is situated. 15.20 Paragraph 2 of Article 13 should be amended as follows: Gains from the alienation of movable property forming 2. part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services , including such gains from the alienation of such a permanent establishment (alone or with the whole enter - pr ise) or of such fixed base , may be taxed in that other State. 15.21 If Article 14 is deleted, it would depend on agreement between the countries as to whether the following Articles are renumbered, but the usual practice is to renumber those Articles, or to rename an addi - tional article as Article 14. 15.22 Countries may wish to replace the title of Article 15 as fol - lows: “INCOME FROM EMPLOYMENT DEPENDENT PERSONAL SERVICES ”, as provided for in the 2000 and subsequent OECD Model Conventions. The basis for this change is that where Article 14 is removed it will usually represent a conscious decision to move away from the concepts of independent and dependent personal services, and an acceptance that Article 15 deals only with employment services, 170

193 Article 5 Commentary any other provision of services, being dealt with under Article 7 or by specific articles such as Articles 16 or 17. 15.23 ), paragraph 2 of Article 15 should be amended Subparagraph ( c by removing references to the fixed base concept, as follows: c ) ( - the remuneration is not borne by a permanent estab lishment or a fixed base which the employer has in the other State. The following amendments should be made to Article 17 so as 15.24 - to remove references to the deleted Article 14 and so as to add refer ences to Article 7: ( ) Modify paragraph 1 of Article 17 to read as follows: a Notwithstanding the provisions of Articles 1. 7 and 15, 14 income derived by a resident of a Contracting State as an enter - tainer, such as a theatre, motion picture, radio or television artiste, or a musician, or as a sportsperson, from his personal activities as such exercised in the other Contracting State, may be taxed in that other State. ( ) Modify paragraph 2 of Article 17 to read as follows: b Where income in respect of personal activities exercised by 2. an entertainer or a sportsperson in his capacity as such accrues not to the entertainer or sportsman himself but to another person, that income may, notwithstanding the provisions of Articles 7 and 15, be taxed in the Contracting State in which 14 the activities of the entertainer or sportsperson are exercised. 15.25 Paragraph 2 of Article 21 should be amended as follows: 2. The provisions of paragraph 1 shall not apply to income, other than income from immovable property as defined in par - agraph 2 of Article 6, if the recipient of such income, being a resident of a Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right or property in respect of which the income is paid is effectively connected with such permanent establishment or fixed base . In such case, the provisions of Article 7 or Article 14, as the case shall apply. may be, 171

194 Article 5 Commentary 15.26 Paragraph 2 of Article 22 should be amended as follows: Capital represented by movable property forming part of 2. the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting or by movable property pertaining to a fixed base available State to a resident of a Contracting State in the other Contracting - State for the purpose of performing independent personal ser vices , may be taxed in that other State. Paragraph 4 In 2017, the Committee agreed to include in the update to 16. the United Nations Model Convention, an amended paragraph 4 of Article 5. The changes made were based on the recommendations of the OECD/G20 Final Report on Action 7 (Preventing the Artificial Avoidance of Permanent Establishment Status). Paragraph 4 was mod - ified so that all of the activities covered by paragraph 4 are subject to the condition that they are preparatory or auxiliary. 17. The new paragraph 4 of Article 5 in the United Nations Model Tax Convention still omits the reference to “delivery” in subpar - agraphs ( a b ). The deletion of the word “delivery” reflects the ) and ( - majority view of the Committee that a “warehouse” used for that pur - pose should, if the requirements of paragraph 1 are met, be a perma nent establishment. 17.1 In view of the similarities to the recommended text and the general relevance of its Commentary, the general principles of Article 5, paragraph 4 under both Models are first noted below and then the practical relevance of the deletion of references to “delivery” in the United Nations Model Convention is considered. 18. Following the changes to the OECD Commentary to reflect the changes to paragraph 4 of Article 5 of the OECD Model Convention, the 2017 OECD Model Commentary now reads as follows: 58. This paragraph lists a number of business activities which are treated as exceptions to the general definition laid down in paragraph 1 and which, when carried on through fixed places of business, are not sufficient for these places to constitute 172

195 Article 5 Commentary permanent establishments. The final part of the paragraph provides that these exceptions only apply if the listed activities have a preparatory or auxiliary character. Since subparagraph - e) applies to any activity that is not otherwise listed in the par agraph (as long as that activity has a preparatory or auxiliary character), the provisions of the paragraph actually amount to a general restriction of the scope of the definition of perma - nent establishment contained in paragraph 1 and, when read with that paragraph, provide a more selective test, by which to determine what constitutes a permanent establishment. To a considerable degree, these provisions limit the definition in paragraph 1 and exclude from its rather wide scope a number of fixed places of business which, because the business activities exercised through these places are merely preparatory or aux - iliary, should not be treated as permanent establishments. It is recognised that such a place of business may well contribute to the productivity of the enterprise, but the services it performs are so remote from the actual realisation of profits that it is dif - ficult to allocate any profit to the fixed place of business in ques - tion. Moreover subparagraph f ) provides that combinations of activities mentioned in subparagraphs a) to e) in the same fixed place of business shall be deemed not to be a permanent establishment, subject to the condition, expressed in the final part of the paragraph, that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character. Thus the provisions of paragraph 4 are designed to prevent an enterprise of one State from being taxed in the other State if it only carries on activities of a purely pre - paratory or auxiliary character in that State. The provisions of paragraph 4.1 (see below) complement that principle by ensur - ing that the preparatory or auxiliary character of activities car - ried on at a fixed place of business must be viewed in the light of other activities that constitute complementary functions that are part of a cohesive business and which the same enterprise or closely related enterprises carry on in the same State. 59. It is often difficult to distinguish between activities which have a preparatory or auxiliary character and those which have not. The decisive criterion is whether or not the activity of the fixed place of business in itself forms an essential and significant 173

196 Article 5 Commentary part of the activity of the enterprise as a whole. Each individual case will have to be examined on its own merits. In any case, a fixed place of business whose general purpose is one which is identical to the general purpose of the whole enterprise, does not exercise a preparatory or auxiliary activity. As a general rule, an activity that has a preparatory charac - 60. ter is one that is carried on in contemplation of the carrying on of what constitutes the essential and significant part of the activity of the enterprise as a whole. Since a preparatory activity precedes another activity, it will often be carried on during a relatively short period, the duration of that period being determined by the nature of the core activities of the enterprise. This, however, will not always be the case as it is possible to carry on an activity at a given place for a substantial period of time in preparation for activities that take place somewhere else. Where, for example, a construction enterprise trains its employees at one place before these employees are sent to work at remote work sites located in other countries, the training that takes place at the first location constitutes a preparatory activity for that enterprise. An activ - ity that has an auxiliary character, on the other hand, generally corresponds to an activity that is carried on to support, without being part of, the essential and significant part of the activity of the enterprise as a whole. It is unlikely that an activity that requires a significant proportion of the assets or employees of the enterprise could be considered as having an auxiliary character. 61. Subparagraphs a) to e) refer to activities that are carried on for the enterprise itself. A permanent establishment would therefore exist if such activities were performed on behalf of other enterprises at the same fixed place of business. If, for instance, an enterprise that maintained an office for the adver - tising of its own products or services were also to engage in advertising on behalf of other enterprises at that location, that office would be regarded as a permanent establishment of the enterprise by which it is maintained. 62. Subparagraph a ) relates to a fixed place of business con - stituted by facilities used by an enterprise for storing, display - ing or delivering its own goods or merchandise. Whether the activity carried on at such a place of business has a preparatory 174

197 Article 5 Commentary or auxiliary character will have to be determined in the light of - factors that include the overall business activity of the enter prise. Where, for example, an enterprise of State R maintains in State S a very large warehouse in which a significant number - of employees work for the main purpose of storing and deliv ering goods owned by the enterprise that the enterprise sells online to customers in State S, paragraph 4 will not apply to that warehouse since the storage and delivery activities that are per - formed through that warehouse, which represents an important asset and requires a number of employees, constitute an essen - tial part of the enterprise’s sale/distribution business and do not have, therefore, a preparatory or auxiliary character. 63. Subparagraph a) would cover, for instance, a bonded ware - house with special gas facilities that an exporter of fruit from one State maintains in another State for the sole purpose of storing fruit in a controlled environment during the custom clearance process in that other State. It would also cover a fixed place of business that an enterprise maintained solely for the delivery of spare parts to customers for machinery sold to those custom - ers. Paragraph 4 would not apply, however, where an enterprise maintained a fixed place of business for the delivery of spare parts to customers for machinery supplied to those customers and, in addition, for the maintenance or repair of such machinery, as this would go beyond the pure delivery mentioned in subparagraph a) and would not constitute preparatory or auxiliary activities since these after-sale activities constitute an essential and significant part of the services of an enterprise vis-à-vis its customers. 64. Issues may arise concerning the application of the defini - tion of permanent establishment to facilities such as cables or pipelines that cross the territory of a country. Apart from the fact that income derived by the owner or operator of such facilities from their use by other enterprises is covered by Article 6 where these facilities constitute immovable property under paragraph 2 of Article 6, the question may arise as to whether subparagraph a) applies to them. Where these facilities are used to transport property belonging to other enterprises, subparagraph a), which is restricted to delivery of goods or merchandise belonging to the enterprise that uses the facility, will not be applicable as 175

198 Article 5 Commentary concerns the owner or operator of these facilities. Subparagraph e) also will not be applicable as concerns that enterprise since the cable or pipeline is not used solely for the enterprise and its use is not of preparatory or auxiliary character given the nature of the business of that enterprise. The situation is different, however, where an enterprise owns and operates a cable or pipeline that crosses the territory of a country solely for purposes of trans - porting its own property and such transport is merely incidental to the business of that enterprise, as in the case of an enterprise that is in the business of refining oil and that owns and oper - ates a pipeline that crosses the territory of a country solely to transport its own oil to its refinery located in another country. In such case, subparagraph a) would be applicable. A separate - question is whether the cable or pipeline could constitute a per manent establishment for the customer of the operator of the cable or pipeline, i.e. the enterprise whose data, power or prop - erty is transmitted or transported from one place to another. In such a case, the enterprise is merely obtaining transmission or transportation services provided by the operator of the cable or pipeline and does not have the cable or pipeline at its disposal. As a consequence, the cable or pipeline cannot be considered to be a permanent establishment of that enterprise. 65. Subparagraph b) relates to the maintenance of a stock of - goods or merchandise belonging to the enterprise. This subpar agraph is irrelevant in cases where a stock of goods or merchan - dise belonging to an enterprise is maintained by another person in facilities operated by that other person and the enterprise does not have the facilities at its disposal as the place where the stock is maintained cannot therefore be a permanent establish - ment of that enterprise. Where, for example, an logistics com - pany operates a warehouse in State S and continuously stores - in that warehouse goods or merchandise belonging to an enter prise of State R to which the logistics company is not closely related, the warehouse does not constitute a fixed place of busi - ness at the disposal of the enterprise of State R and subpara - graph b) is therefore irrelevant. Where, however, that enterprise is allowed unlimited access to a separate part of the warehouse for the purpose of inspecting and maintaining the goods or merchandise stored therein, subparagraph b) is applicable and 176

199 Article 5 Commentary the question of whether a permanent establishment exists will depend on whether these activities constitute a preparatory or auxiliary activity. a ) 66. For the purposes of the application of subparagraphs b and ), it does not matter whether the storage or delivery takes place before or after the goods or merchandise have been sold, provided that the goods or merchandise belong to the enter - prise whilst they are at the relevant location (e.g. the subpara - graphs could apply regardless of the fact that some of the goods that are stored at a location have already been sold as long as the property title to these goods only passes to the customer upon or after delivery). Subparagraphs a) and b ) also cover situations where a facility is used, or a stock of goods or merchandise is maintained, for any combination of storage, display and deliv - ery since facilities used for the delivery of goods will almost always be also used for the storage of these goods, at least for a short period. For the purposes of subparagraphs a) to d ), the words “goods” and “merchandise” refer to tangible property and would not cover, for example, immovable property and - data (although the subparagraphs would apply to tangible prod ucts that include data such as CDs and DVDs). 67. Subparagraph c) covers the situation where a stock of goods or merchandise belonging to one enterprise is processed by a second enterprise on behalf of, or for the account of, the first-mentioned enterprise. As explained in the preceding par - agraph, the mere presence of goods or merchandise belonging to an enterprise does not mean that the fixed place of business where these goods or merchandise are stored is at the dis - posal of that enterprise. Where, for example, a stock of goods belonging to RCO, an enterprise of State R, is maintained by a toll-manufacturer located in State S for the purposes of process - ing by that toll-manufacturer, no fixed place of business is at the disposal of RCO and the place where the stock is maintained cannot therefore be a permanent establishment of RCO. If, how - ever, RCO is allowed unlimited access to a separate part of the facilities of the toll-manufacturer for the purpose of inspect - ing and maintaining the goods stored therein, subparagraph c) will apply and it will be necessary to determine whether the 177

200 Article 5 Commentary maintenance of that stock of goods by RCO constitutes a pre - paratory or auxiliary activity. This will be the case if RCO is merely a distributor of products manufactured by other enter - prises as in that case the mere maintenance of a stock of goods for the purposes of processing by another enterprise would not form an essential and significant part of RCO’s overall activity. In such a case, unless paragraph 4.1 applies, paragraph 4 will deem a permanent establishment not to exist in relation to such a fixed place of business that is at the disposal of the enterprise of State R for the purposes of maintaining its own goods to be processed by the toll-manufacturer. 68. The first part of subparagraph d) relates to the case where premises are used solely for the purpose of purchasing goods or merchandise for the enterprise. Since this exception only applies if that activity has a preparatory or auxiliary character, it will typically not apply in the case of a fixed place of busi - ness used for the purchase of goods or merchandise where the overall activity of the enterprise consists in selling these goods and where purchasing is a core function in the business of the enterprise. The following examples illustrate the application of paragraph 4 in the case of fixed places of business where pur - chasing activities are performed: Example 1 : RCO is a company resident of State R that is a — large buyer of a particular agricultural product produced - in State S, which RCO sells from State R to distributors sit uated in different countries. RCO maintains a purchasing office in State S. The employees who work at that office are experienced buyers who have special knowledge of this type of product and who visit producers in State S, determine the type/quality of the products according to international standards (which is a difficult process requiring special skills and knowledge) and enter into different types of con - tracts (spot or forward) for the acquisition of the products by RCO. In this example, although the only activity performed through the office is the purchasing of products for RCO, which is an activity covered by subparagraph d), paragraph 4 does not apply and the office therefore constitutes a perma - nent establishment because that purchasing function forms an essential and significant part of RCO’s overall activity. 178

201 Article 5 Commentary Example 2 : RCO, a company resident of State R which oper - — ates a number of large discount stores, maintains an office in State S during a two-year period for the purposes of researching the local market and lobbying the government for changes that would allow RCO to establish stores in State S. During that period, employees of RCO occasionally pur - chase supplies for their office. In this example, paragraph 4 applies because subparagraph f ) applies to the activities performed through the office (since subparagraphs d) and e) would apply to the purchasing, researching and lobbying activities if each of these was the only activity performed - at the office) and the overall activity of the office has a pre paratory character. 69. The second part of subparagraph d) relates to a fixed place of business that is used solely to collect information for the enterprise. An enterprise will frequently need to collect infor - mation before deciding whether and how to carry on its core business activities in a State. If the enterprise does so without maintaining a fixed place of business in that State, subpara - graph d) will obviously be irrelevant. If, however, a fixed place of business is maintained solely for that purpose, subparagraph d) will be relevant and it will be necessary to determine whether the collection of information goes beyond the preparatory or auxiliary threshold. Where, for example, an investment fund sets up an office in a State solely to collect information on pos - sible investment opportunities in that State, the collecting of information through that office will be a preparatory activity. The same conclusion would be reached in the case of an insur - ance enterprise that sets up an office solely for the collection of information, such as statistics, on risks in a particular market and in the case of a newspaper bureau set up in a State solely to collect information on possible news stories without engag - ing in any advertising activities: in both cases, the collecting of information will be a preparatory activity. 70. Subparagraph e ) applies to a fixed place of business main - tained solely for the purpose of carrying on, for the enterprise, any activity that is not expressly listed in subparagraphs a) to d); as long as that activity has a preparatory or auxiliary char - acter, that place of business is deemed not to be a permanent 179

202 Article 5 Commentary establishment. The wording of this subparagraph makes it unnecessary to produce an exhaustive list of the activities to which the paragraph may apply, the examples listed in subpara - graphs a) to d) being merely common examples of activities that - are covered by the paragraph because they often have a prepara tory or auxiliary character. Examples of places of business covered by subparagraph 71. e) are fixed places of business used solely for the purpose of advertising or for the supply of information or for scientific research or for the servicing of a patent or a know-how con - tract, if such activities have a preparatory or auxiliary charac - ter. Paragraph 4 would not apply, however, if a fixed place of business used for the supply of information would not only give information but would also furnish plans etc. specially devel - oped for the purposes of the individual customer. Nor would it apply if a research establishment were to concern itself with manufacture. Similarly, where the servicing of patents and know-how is the purpose of an enterprise, a fixed place of busi - ness of such enterprise exercising such an activity cannot get the benefits of paragraph 4. A fixed place of business which has the function of managing an enterprise or even only a part of an enterprise or of a group of the concern cannot be regarded as doing a preparatory or auxiliary activity, for such a managerial activity exceeds this level. If an enterprise with international ramifications establishes a so-called “management office” in a State in which it maintains subsidiaries, permanent establish - ments, agents or licensees, such office having supervisory and co-ordinating functions for all departments of the enterprise located within the region concerned, subparagraph e) will not apply to that “management office” because the function of man - aging an enterprise, even if it only covers a certain area of the operations of the concern, constitutes an essential part of the business operations of the enterprise and therefore can in no way be regarded as an activity which has a preparatory or aux - iliary character within the meaning of paragraph 4. 72. Also, where an enterprise that sells goods worldwide establishes an office in a State and the employees working at that office take an active part in the negotiation of important 180

203 Article 5 Commentary parts of contracts for the sale of goods to buyers in that State - without habitually concluding contracts or playing the princi pal role leading to the conclusion of contracts (e.g. by partic - ipating in decisions related to the type, quality or quantity of products covered by these contracts), such activities will usually constitute an essential part of the business operations of the enterprise and should not be regarded as having a preparatory or auxiliary character within the meaning of subparagraph e) of paragraph 4. If the conditions of paragraph 1 are met, such an office will therefore constitute a permanent establishment. 73. As already mentioned in paragraph 58 above, paragraph 4 is designed to provide exceptions to the general definition of paragraph 1 in respect of fixed places of business which are engaged in activities having a preparatory or auxiliary character. f Therefore, according to subparagraph ), the fact that one fixed place of business combines any of the activities mentioned in a the subparagraphs e ) does not mean of itself that a perma - ) to nent establishment exists. As long as the combined activity of such a fixed place of business is merely preparatory or auxiliary a permanent establishment should be deemed not to exist. Such combinations should not be viewed on rigid lines, but should be considered in the light of the particular circumstances. 74. Unless the anti-fragmentation provisions of paragraph 4.1 are applicable (see below), subparagraph f ) is of no relevance in a case where an enterprise maintains several fixed places of a ) to e ) apply as in such a case business to which subparagraphs each place of business has to be viewed separately and in isola - tion for deciding whether a permanent establishment exists. The fixed places of business to which paragraph 4 applies 75. do not constitute permanent establishments so long as the busi - ness activities performed through those fixed places of business are restricted to the activities referred to in that paragraph. This will be the case even if the contracts necessary for establishing and carrying on the business are concluded by those in charge of the places of business themselves. The conclusion of such contracts by these employees will not constitute a permanent establishment of the enterprise under paragraph 5 as long as the conclusion of these contracts satisfies the conditions of 181

204 Article 5 Commentary paragraph 4 (see paragraph 33 below). An example would be where the manager of a place of business where preparatory or auxiliary research activities are conducted concludes the con - tracts necessary for establishing and maintaining that place of business as part of the activities carried on at that location. 76. If, under paragraph 4, a fixed place of business is deemed not to be a permanent establishment, this exception applies likewise to the disposal of movable property forming part of the business property of the place of business at the termination of the enterprise’s activity at that place (see paragraph 11 above and paragraph 2 of Article 13). Where, for example, the display of merchandise during a trade fair or convention is excepted under subparagraphs a ) and b ), the sale of that merchandise at the termination of the trade fair or convention is covered by subparagraph e) as such sale is merely an auxiliary activity. The exception does not, of course, apply to sales of merchandise not actually displayed at the trade fair or convention. 77. Where paragraph 4 does not apply because a fixed place of business used by an enterprise for activities that paragraph 4 is also used for other activities that go beyond what is preparatory - or auxiliary, that place of business constitutes a single perma nent establishment of the enterprise and the profits attributable to the permanent establishment with respect to both types of - activities may be taxed in the State where that permanent estab lishment is situated. 19. The Committee took note that some members thought that the scope of paragraph 4 is too wide and poses challenges (see above par - agraph 18 quoting paragraph 21.1 of the OECD Commentary) which may be particularly difficult for developing countries to handle due to the lack of administrative capacity. Countries that have those concerns may consider eliminating the paragraph entirely. Another option that may also be considered for those that want to limit the scope of the paragraph is to eliminate subparagraphs which may be regarded as too extensive in scope, in particular members mentioned subparagraphs e) and f). However, negotiators of an agreement should make sure that the application of the remaining paragraph is limited by the pre - paratory or auxiliary requirement in order for the paragraph to only eliminate from the permanent establishment concept in paragraph 1, 182

205 Article 5 Commentary work being of no or very little significance in view of the other work performed by the enterprise. 19.1 It was also noted that some States may consider that the activi - ties in paragraph 4 are intrinsically preparatory or auxiliary in nature - and take the view that these activities should not be subject to the pre - paratory or auxiliary condition since any concern about the inappro priate use of these exceptions are addressed through the provisions of paragraph 4.1. States that share this view are free to amend paragraph 4 as follows (and may also agree to delete some of the activities listed in subparagraphs a) to d) below if they consider that these activities should be subject to the preparatory or auxiliary condition in subpar - a g r aph e)): 4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: (a) The use of facilities solely for the purpose of storage or display of goods or merchandise belonging to the enterprise; (b) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage or display; (c) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; (d) The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; (e) The maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; or (f) The maintenance of a fixed place of business solely for any combination of activities mentioned in subpara - graphs (a) to (e), provided that the overall activity of the fixed place of business resulting from this combi - nation is of a preparatory or auxiliary character. 183

206 Article 5 Commentary 20. - As noted above, the United Nations Model Convention, in con trast to the OECD Model Convention, does not refer to “delivery” in subparagraphs ( ) or ( b ). The question whether the use of facilities for a the “delivery of goods” should give rise to a permanent establishment has been debated extensively. A 1997 study revealed that almost 75 included the “deliv - per cent of the tax treaties of developing countries a ) and ( b ) of ery of goods” in the list of exceptions in subparagraphs ( paragraph 4. Nevertheless, some countries regard the omission of the expression in the United Nations Model Convention as an important point of departure from the OECD Model Convention, believing that a stock of goods for prompt delivery facilitates sales of the product and thereby the earning of profit in the host country. 21. In reviewing the United Nations Model Convention, the Committee retains the existing distinction between the two Models, but it notes that even if the delivery of goods is treated as giving rise to a permanent establishment, it may be that little income could properly be attributed to this activity. Tax authorities might be led into attribut - ing too much income to this activity if they do not give the issue close - consideration, which would lead to prolonged litigation and incon sistent application of tax treaties. Therefore, although the reference to “delivery” is absent from the United Nations Model Convention, countries may wish to consider both points of view when entering into bilateral tax treaties, for the purpose of determining the practical results of utilizing either approach. Paragraph 4.1 21.1 In 2017 the Committee decided to adopt a new paragraph 4.1 in Article 5. The new paragraph 4.1 is an anti-fragmentation rule that was recommended for the OECD Model Tax Convention in the OECD/ G20 Final Report on Action 7 (Preventing the Artificial Avoidance of Permanent Establishment Status). The purpose of this new paragraph is to prevent an enterprise from fragmenting its activities — either within the enterprise or between closely related enterprises — in order to qualify for the specific activity exemptions in paragraph 4 of Article 5. The Final Report also includes new Commentary to provide guid - ance on the application of paragraph 4.1 to situations where an enter - prise or a group of closely related enterprises attempt to circumvent 184

207 Article 5 Commentary the preparatory or auxiliary activity rule in paragraph 4 by fragment - ing a cohesive business operation into several small operations. The new 2017 OECD Commentary states: [...] Under paragraph 4.1, the exceptions provided for by 79. paragraph 4 do not apply to a place of business that would oth - erwise constitute a permanent establishment where the activ - ities carried on at that place and other activities of the same enterprise or of closely related enterprises exercised at that place or at another place in the same State constitute complementary functions that are part of a cohesive business operation. For paragraph 4.1 to apply, however, at least one of the places where - these activities are exercised must constitute a permanent estab lishment or, if that is not the case, the overall activity resulting from the combination of the relevant activities must go beyond what is merely preparatory or auxiliary. 80. The provisions of paragraph [9] are applicable in order to determine whether an enterprise is a closely related enterprise with respect to another one (see paragraphs 119 to 121 below). 81. The following examples illustrate the application of par - agraph 4.1: Example A : RCO, a bank resident of State R, has a number — of branches in State S which constitute permanent estab - lishments. It also has a separate office in State S where a few employees verify information provided by clients that have made loan applications at these different branches. The results of the verifications done by the employees are forwarded to the headquarters of RCO in State R where other employees analyse the information included in the loan applications and provide reports to the branches where the decisions to grant the loans are made. In that case, the exceptions of paragraph 4 will not apply to the office because another place (i.e. any of the other branches where the loan applications are made) constitutes a per - manent establishment of RCO in State S and the business activities carried on by RCO at the office and at the relevant branch constitute complementary functions that are part of a cohesive business operation (i.e. providing loans to clients in State S). 185

208 Article 5 Commentary Example B : RCO, a company resident of State R, manufac - — tures and sells appliances. SCO, a resident of State S that is a wholly-owned subsidiary of RCO, owns a store where it sells appliances that it acquires from RCO. RCO also owns a small warehouse in State S where it stores a few large items that are identical to some of those displayed in the store owned by SCO. When a customer buys such a large item from SCO, SCO employees go to the warehouse where they take possession of the item before delivering it to the customer; the ownership of the item is only acquired by SCO from RCO when the item leaves the warehouse. In this case, paragraph 4.1 prevents the application of the exceptions of paragraph 4 to the warehouse and it will not be necessary, therefore, to determine whether paragraph 4, and in particular subparagraph 4 a) thereof, applies to the warehouse. The conditions for the application of paragraph 4.1 are met because — SCO and RCO are closely related enterprises; — SCO’s store constitutes a permanent establishment of SCO (the definition of permanent establishment is not limited to situations where a resident of one Contracting State uses or maintains a fixed place of business in the other State; it applies equally where an enterprise of one State uses or maintains a fixed place of business in that same State); and — The business activities carried on by RCO at its ware - house and by SCO at its store constitute complementary functions that are part of a cohesive business operation (i.e. storing goods in one place for the purpose of deliv - ering these goods as part of the obligations resulting from the sale of these goods through another place in the same State). Paragraph 5 22. In 2017 the Committee decided to modify paragraphs 5 and 7 of Article 5. The new paragraphs address the artificial avoidance of PE status through commissionaire arrangements and similar strategies. These changes to the United Nations Model Convention and relevant 186

209 Article 5 Commentary Commentary are in line with recommendations for the OECD Model Convention in the OECD/G20 Final Report on Action 7, (Preventing the Artificial Avoidance of Permanent Establishment Status). 22.1 It is generally accepted that, if a person acts in a State for an - enterprise in such a way as to closely tie up the activity of the enter prise with the economic life of that State, the enterprise should be treated as having a permanent establishment in that State — even if it does not have a fixed place of business in that State under paragraph 1. Paragraph 5 achieves this by deeming a permanent establishment to exist if the person is a so-called dependent agent who carries out on a ) or ( b behalf of the enterprise an activity specified in subparagraph ( ). 22.2 a ) follows the substance of the OECD Model Subparagraph ( - Convention and proceeds on the basis that if a person habitually con - clude contracts in the name of the enterprise, for the transfer of owner ship or the granting of the right to use the enterprise’s property, or for the provision of services by that enterprise creates for that enterprise a sufficiently close association with a State (or if they are habitually playing the principal role leading to the conclusion of such contracts), then it is appropriate to deem that such an enterprise has a permanent establishment there. The condition in subparagraph ( b ), relating to the maintenance of a stock of goods, is discussed below. 23. In relation to subparagraph ( a ), a dependent agent causes a “permanent establishment” to be deemed to exist only if that person repeatedly concludes contracts or plays the principal role leading to the conclusion of contracts and not merely in isolated cases. The 2017 OECD Model Commentary states further: 84. For paragraph 5 to apply, all the following conditions must be met: a person acts in a Contracting State on behalf of an — enterprise; — in doing so, that person habitually concludes contracts, or habitually plays the principal role leading to the con - clusion of contracts that are routinely concluded without material modification by the enterprise, and — these contracts are either in the name of the enterprise or for the transfer of the ownership of, or for the granting 187

210 Article 5 Commentary of the right to use, property owned by that enterprise or - that the enterprise has the right to use, or for the provi sion of services by that enterprise. 85. Even if these conditions are met, however, paragraph 5 will not apply if the activities performed by the person on behalf of the enterprise are covered by the independent agent exception of paragraph 6 or are limited to activities mentioned in paragraph 4 which, if exercised through a fixed place of busi - ness, would be deemed not to create a permanent establishment. This last exception is explained by the fact that since, by virtue of paragraph 4, the maintenance of a fixed place of business solely for the purposes of preparatory or auxiliary activities is deemed not to constitute a permanent establishment, a person whose activities are restricted to such purposes should not create a permanent establishment either. Where, for example, a person acts solely as a buying agent for an enterprise and, in doing so, habitually concludes purchase contracts in the name of that enterprise, paragraph 5 will not apply even if that person is not independent of the enterprise as long as such activities are preparatory or auxiliary (see paragraph 68 above). 86. A person is acting in a Contracting State on behalf of an - enterprise when that person involves the enterprise to a par ticular extent in business activities in the State concerned. This will be the case, for example, where an agent acts for a principal, where a partner acts for a partnership, where a director acts for a company or where an employee acts for an employer. A person cannot be said to be acting on behalf of an enterprise if the enterprise is not directly or indirectly affected by the action performed by that person. As indicated in paragraph 83, the person acting on behalf of an enterprise can be a company; in that case, the actions of the employees and directors of that company are considered together for the purpose of determin - ing whether and to what extent that company acts on behalf of the enterprise. 87. The phrase “concludes contracts” focuses on situations where, under the relevant law governing contracts, a contract is considered to have been concluded by a person. A contract may be concluded without any active negotiation of the terms 188

211 Article 5 Commentary of that contract; this would be the case, for example, where the relevant law provides that a contract is concluded by reason of a person accepting, on behalf of an enterprise, the offer made by a third party to enter into a standard contract with that enterprise. Also, a contract may, under the relevant law, be concluded in a State even if that contract is signed outside that State; where, for example, the conclusion of a contract results from the acceptance, by a person acting on behalf of an enter - prise, of an offer to enter into a contract made by a third party, it does not matter that the contract is signed outside that State. In addition, a person who negotiates in a State all elements and details of a contract in a way binding on the enterprise can be said to conclude the contract in that State even if that contract is signed by another person outside that State. 88. The phrase “or habitually plays the principal role lead - ing to the conclusion of contracts that are routinely concluded without material modification by the enterprise” is aimed at sit - uations where the conclusion of a contract directly results from the actions that the person performs in a Contracting State on behalf of the enterprise even though, under the relevant law, the contract is not concluded by that person in that State. Whilst the phrase “concludes contracts” provides a relatively well-known test based on contract law, it was found necessary to supplement that test with a test focusing on substantive activities taking - place in one State in order to address cases where the conclu sion of contracts is clearly the direct result of these activities although the relevant rules of contract law provide that the con - clusion of the contract takes place outside that State. The phrase must be interpreted in the light of the object and purpose of paragraph 5, which is to cover cases where the activities that a person exercises in a State are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, i.e. where that person acts as the sales force of the enterprise. The principal role leading to the conclusion of the contract will therefore typically be associated with the actions of the person who convinced the third party to enter into a contract with the enterprise. The words “contracts that are routinely concluded without material modification by the enterprise” clarify that where such principal role is performed in that State, the actions 189

212 Article 5 Commentary of that person will fall within the scope of paragraph 5 even if - the contracts are not formally concluded in the State, for exam ple, where the contracts are routinely subject, outside that State, to review and approval without such review resulting in a mod - ification of the key aspects of these contracts. 89. The phrase “habitually plays the principal role leading to the conclusion of contracts that are routinely concluded with - out material modification by the enterprise” therefore applies where, for example, a person solicits and receives (but does not formally finalise) orders which are sent directly to a warehouse from which goods belonging to the enterprise are delivered and where the enterprise routinely approves these transactions. It does not apply, however, where a person merely promotes and markets goods or services of an enterprise in a way that does not directly result in the conclusion of contracts. Where, for example, representatives of a pharmaceutical enterprise actively promote drugs produced by that enterprise by contacting doc - tors that subsequently prescribe these drugs, that marketing activity does not directly result in the conclusion of contracts between the doctors and the enterprise so that the paragraph does not apply even though the sales of these drugs may signif - icantly increase as a result of that marketing activity. 90. The following is another example that illustrates the application of paragraph 5. RCO, a company resident of State R, distributes various products and services worldwide through its websites. SCO, a company resident of State S, is a wholly-owned subsidiary of RCO. SCO’s employees send emails, make tele - phone calls to, or visit large organisations in order to convince them to buy RCO’s products and services and are therefore responsible for large accounts in State S; SCO’s employees, whose remuneration is partially based on the revenues derived by RCO from the holders of these accounts, use their rela - tionship building skills to try to anticipate the needs of these account holders and to convince them to acquire the products and services offered by RCO. When one of these account hold - ers is persuaded by an employee of SCO to purchase a given quantity of goods or services, the employee indicates the price that will be payable for that quantity, indicates that a contract 190

213 Article 5 Commentary must be concluded online with RCO before the goods or ser - vices can be provided by RCO and explains the standard terms of RCO’s contracts, including the fixed price structure used by RCO, which the employee is not authorised to modify. The account holder subsequently concludes that contract online for the quantity discussed with SCO’s employee and in accordance with the price structure presented by that employee. In this example, SCO’s employees play the principal role leading to the conclusion of the contract between the account holder and RCO and such contracts are routinely concluded without material modification by the enterprise. The fact that SCO’s employees cannot vary the terms of the contracts does not mean that the - conclusion of the contracts is not the direct result of the activ ities that they perform on behalf of the enterprise, convincing the account holder to accept these standard terms being the cru - cial element leading to the conclusion of the contracts between the account holder and RCO. 91. The wording of subparagraphs a), b) and c) ensures that paragraph 5 applies not only to contracts that create rights and obligations that are legally enforceable between the enterprise on behalf of which the person is acting and the third parties - with which these contracts are concluded but also to con tracts that create obligations that will effectively be performed by such enterprise rather than by the person contractually obliged to do so. 92. A typical case covered by these subparagraphs is where contracts are concluded with clients by an agent, a partner or an employee of an enterprise so as to create legally enforceable rights and obligations between the enterprise and these clients. These subparagraphs also cover cases where the contracts con - cluded by a person who acts on behalf of an enterprise do not legally bind that enterprise to the third parties with which these contracts are concluded but are contracts for the transfer of the ownership of, or for the granting of the right to use, property owned by that enterprise or that the enterprise has the right to use, or for the provision of services by that enterprise. A typ - ical example would be the contracts that a “commissionnaire” would conclude with third parties under a commissionnaire 191

214 Article 5 Commentary arrangement with a foreign enterprise pursuant to which that commissionnaire would act on behalf of the enterprise but in doing so, would conclude in its own name contracts that do not create rights and obligations that are legally enforceable between the foreign enterprise and the third parties even though the results of the arrangement between the commissionnaire and the foreign enterprise would be such that the foreign enterprise would directly transfer to these third parties the ownership or use of property that it owns or has the right to use. 93. The reference to contracts “in the name of ” in subpara - graph a) does not restrict the application of the subparagraph to contracts that are literally in the name of the enterprise; it may apply, for example, to certain situations where the name of the enterprise is undisclosed in a written contract. 94. The crucial condition for the application of subpara - graphs b) and c) is that the person who habitually concludes the contracts, or habitually plays the principal role leading to the conclusion of the contracts that are routinely concluded with - out material modification by the enterprise, is acting on behalf of an enterprise in such a way that the parts of the contracts that relate to the transfer of the ownership or use of property, or the provision of services, will be performed by the enterprise as opposed to the person that acts on the enterprise’s behalf. 95. For the purposes of subparagraph b), it does not matter whether or not the relevant property existed or was owned by the enterprise at the time of the conclusion of the contracts between the person who acts for the enterprise and the third parties. For example, a person acting on behalf of an enterprise might well sell property that the enterprise will subsequently produce before delivering it directly to the customers. Also, the reference to “property” covers any type of tangible or intangible property. 96. The cases to which paragraph 5 applies must be distin - guished from situations where a person concludes contracts on its own behalf and, in order to perform the obligations deriv - ing from these contracts, obtains goods or services from other enterprises or arranges for other enterprises to deliver such goods or services. In these cases, the person is not acting “on behalf ” of these other enterprises and the contracts concluded 192

215 Article 5 Commentary by the person are neither in the name of these enterprises nor - for the transfer to third parties of the ownership or use of prop erty that these enterprises own or have the right to use or for the provision of services by these other enterprises. Where, for - example, a company acts as a distributor of products in a par ticular market and, in doing so, sells to customers products that it buys from an enterprise (including an associated enterprise), it is neither acting on behalf of that enterprise nor selling prop - erty that is owned by that enterprise since the property that is sold to the customers is owned by the distributor. This would still be the case if that distributor acted as a so-called “low-risk distributor” (and not, for example, as an agent) but only if the - transfer of the title to property sold by that “low-risk” distrib utor passed from the enterprise to the distributor and from the distributor to the customer (regardless of how long the distrib - utor would hold title in the product sold) so that the distributor would derive a profit from the sale as opposed to a remunera - tion in the form, for example, of a commission. 97. The contracts referred to in paragraph 5 cover contracts relating to operations which constitute the business proper of the enterprise. It would be irrelevant, for instance, if the person - had authority to conclude employment contracts for the enter prise to assist that person’s activity for the enterprise or if the person concluded, in the name of the enterprise, similar con - tracts relating to internal operations only. Moreover, whether or not a person habitually concludes contracts or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise should be determined on the basis of the com - mercial realities of the situation. The mere fact that a person has attended or even participated in negotiations in a State between an enterprise and a client will not be sufficient, by itself, to conclude that the person has concluded contracts or played the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise. The fact that a person has attended or even partici - pated in such negotiations could, however, be a relevant factor in determining the exact functions performed by that person on behalf of the enterprise. 193

216 Article 5 Commentary 98. - The requirement that an agent must “habitually” con - clude contracts or play the principal role leading to the con clusion of contracts that are routinely concluded without material modification by the enterprise reflects the underlying principle in Article 5 that the presence which an enterprise maintains in a Contracting State should be more than merely transitory if the enterprise is to be regarded as maintaining a permanent establishment, and thus a taxable presence, in that State. The extent and frequency of activity necessary to conclude that the agent is “habitually concluding contracts or - playing the principal role leading to the conclusion of con tracts that are routinely concluded without material modi - fication by the enterprise” will depend on the nature of the contracts and the business of the principal. It is not possible to lay down a precise frequency test. Nonetheless, the same sorts of factors considered in paragraph 6 would be relevant in making that determination. 24. The Committee discussed the significance of the reference to contracts “that are routinely concluded without material modification by the enterprise.” The Committee noted that, even if the enterprise makes material modifications to some contracts (and even to the majority of contracts resulting from the activities of the local sales force) before the contracts are approved, as long as there is a person who habitually plays a principal role leading to the conclusion of other contracts that the enterprise concludes without any material modifi - cation, a dependent agent PE will still arise as a result of the activi - ties of that person. Some Committee members still preferred to omit that phrase because they favoured a broader formulation. They also thought it would encourage enterprises to claim that the condition was not met and to artificially avoid having a PE. Countries that share this concern are free to omit the words “that are routinely concluded without material modification by the enterprise”. 25. With the addition of paragraph 5, subparagraph ( b ), relating to the maintenance of a stock of goods, this paragraph is broader in scope than paragraph 5 of the OECD Model Convention. Some coun - tries believe that a narrow formula might encourage an agent who was in fact dependent to represent himself as acting on his own behalf. 194

217 Article 5 Commentary 26. - The former Group of Experts understood that paragraph 5, sub b - paragraph ( ) was to be interpreted such that if all the sales-related activ ities take place outside the host State and only delivery, by an agent, takes place there, such a situation would not lead to a permanent establish - 25 ment. The former Group of Experts noted, however, that if sales-related activities (for example, advertising or promotion) are also conducted in that State on behalf of the resident (whether or not by the enterprise itself or by its dependent agents) and have contributed to the sale of such 26 goods or merchandise, a permanent establishment may exist. Paragraph 6 This paragraph of the United Nations Model Convention does 27. not correspond to any provision in Article 5 of the OECD Model Convention and is included to deal with certain aspects of the insur - ance business. The Commentary of the OECD Model Convention nev - ertheless discusses the possibility of such a provision in bilateral tax treaties in the following terms: According to the definition of the term “permanent 39. establishment” an insurance company of one State may be taxed in the other State on its insurance business, if it has a fixed place of business within the meaning of paragraph 1 or if it carries on business through a person within the meaning of paragraph 5. Since agencies of foreign insurance companies sometimes do not meet either of the above requirements, it is conceivable that these companies do large-scale business in a State without being taxed in that State on their profits arising from such business. In order to obviate this possibility, various conventions concluded by OECD member countries include a provision which stipulates that insurance companies of a State are deemed to have a permanent establishment in the other State if they collect premiums in that other State through an agent established there — other than an agent who already constitutes a permanent establishment by virtue of paragraph 5 — or insure risks situated in that territory through such an 25 See paragraph 25 of the Commentary on Article 5 of the 1999 version of the United Nations Model Convention. 26 Ibid. 195

218 Article 5 Commentary agent. The decision as to whether or not a provision along these lines should be included in a convention will depend on the factual and legal situation prevailing in the Contracting States concerned. Frequently, therefore, such a provision will not be contemplated. In view of this fact, it did not seem advisable to insert a provision along these lines in the Model Convention. 28. Paragraph 6 of the United Nations Model Convention, which achieves the aim quoted above, is necessary because insurance agents generally have no authority to conclude contracts; thus, the conditions of paragraph 5, subparagraph ( ) would not be fulfilled. If an insurance a agent is independent, however, the profits of the insurance company attributable to his activities are not taxable in the source State because the provisions of Article 5 paragraph 7 would be fulfilled and the enterprise would not be deemed to have a permanent establishment. 29. Some countries, however, favour extending the provision to allow taxation even where there is representation by such an inde - pendent agent. They take this approach because of the nature of the - insurance business, the fact that the risks are situated within the coun try claiming tax jurisdiction, and the ease with which persons could, on a part-time basis, represent insurance companies on the basis of an “independent status”, making it difficult to distinguish between dependent and independent insurance agents. Other countries see no reason why the insurance business should be treated differently from activities such as the sale of tangible commodities. They also point to the difficulty of ascertaining the total amount of business done when the insurance is handled by several independent agents within the same country. In view of this difference in approach, the question how to treat independent agents is left to bilateral negotiations, which could take account of the methods used to sell insurance and other features of the insurance business in the countries concerned. Paragraph 7 30. The first sentence of this paragraph reproduces Article 5, par - agraph 6 of the OECD Model Convention, with a few minor drafting changes. The relevant portions of the Commentary on the 2017 OECD Model are as follows: 196

219 Article 5 Commentary 102. Where an enterprise of a Contracting State carries on business dealings through an independent agent carrying on business as such, it cannot be taxed in the other Contracting State in respect of those dealings if the agent is acting in the ordinary course of that business [...]. The activities of such an agent, represents a separate and independent enterprise should not result in the finding of a permanent establishment of the foreign enterprise. 103. The exception of paragraph 6 only applies where a person acts on behalf of an enterprise in the course of carry - ing on a business as an independent agent. It would therefore not apply where a person acts on behalf of an enterprise in a different capacity, such as where an employee acts on behalf of her employer or a partner acts on behalf of a partnership. As explained in paragraph 8.1 of the Commentary on Article 15, it is sometimes difficult to determine whether the services rendered by an individual constitute employment services or services rendered by a separate enterprise and the guidance in paragraphs 8.2 to 8.28 of the Commentary on Article 15 will be relevant for that purpose. Where an individual acts on behalf of an enterprise in the course of carrying on his own business and not as an employee, however, the application of paragraph 6 will still require that the individual do so as an independent agent; as explained in paragraph 111 below, this independent status is less likely if the activities of that individual are performed exclusively or almost exclusively on behalf of one enterprise or closely related enterprises. 104. Whether a person acting as an agent is independent of the enterprise represented depends on the extent of the obli - gations which this person has vis-à-vis the enterprise. Where the person’s commercial activities for the enterprise are subject to detailed instructions or to comprehensive control by it, such person cannot be regarded as independent of the enterprise. Another important criterion will be whether the entrepreneur - ial risk has to be borne by the person or by the enterprise the person represents. In any event, the last sentence of paragraph 6 provides that in certain circumstances a person shall not be considered to be an independent agent (see paragraphs 119 to 197

220 Article 5 Commentary 121 below). The following considerations should be borne in mind when determining whether an agent to whom that last sentence does not apply may be considered to be independent. - 105. It should be noted that, where the last sentence of para - graph 6 does not apply because a subsidiary does not act exclu sively or almost exclusively for closely related enterprises, the control which a parent company exercises over its subsidiary in its capacity as shareholder is not relevant in a consideration of the dependence or otherwise of the subsidiary in its capacity as an agent for the parent. This is consistent with the rule in paragraph 7 of Article 5 (see also paragraph 113 below). 106. An independent agent will typically be responsible to his principal for the results of his work but not subject to signifi - cant control with respect to the manner in which that work is carried out. He will not be subject to detailed instructions from the principal as to the conduct of the work. The fact that the principal is relying on the special skill and knowledge of the agent is an indication of independence. 107. Limitations on the scale of business which may be con - ducted by the agent clearly affect the scope of the agent’s authority. However such limitations are not relevant to dependency which is - determined by consideration of the extent to which the agent exer cises freedom in the conduct of business on behalf of the principal within the scope of the authority conferred by the agreement. 108. It may be a feature of the operation of an agreement that an agent will provide substantial information to a principal in connection with the business conducted under the agreement. This is not in itself a sufficient criterion for determination that the agent is dependent unless the information is provided in the course of seeking approval from the principal for the manner in which the business is to be conducted. The provision of infor - mation which is simply intended to ensure the smooth running of the agreement and continued good relations with the princi - pal is not a sign of dependence. 109. Another factor to be considered in determining inde - pendent status is the number of principals represented by the agent. As indicated in paragraph 111, independent status is less likely if the activities of the agent are performed wholly or 198

221 Article 5 Commentary almost wholly on behalf of only one enterprise over the lifetime of the business or a long period of time. However, this fact is not by itself determinative. All the facts and circumstances must - be taken into account to determine whether the agent’s activ ities constitute an autonomous business conducted by him in which he bears risk and receives reward through the use of his entrepreneurial skills and knowledge. Where an agent acts for a number of principals in the ordinary course of his business and none of these is predominant in terms of the business carried on by the agent, dependence may exist if the principals act in concert to control the acts of the agent in the course of his busi - ness on their behalf. 110. An independent agent cannot be said to act in the ordi - nary course of its business as agent when it performs activities that are unrelated to that agency business. Where, for example, a company that acts on its own account as a distributor for a number of companies also acts as an agent for another enter - prise, the activities that the company undertakes as a distrib - utor will not be considered to be part of the activities that the company carries on in the ordinary course of its business as an agent for the purposes of the application of paragraph 6). Activities that are part of the ordinary course of a business that an enterprise carries on as an agent will, however, include inter - mediation activities which, in line with the common practice in a particular business sector, are performed sometimes as agent and sometimes on the enterprise’s own account, provided that these intermediation activities are, in substance, indistinguish - able from each other. Where, for example, a broker-dealer in the financial sector performs a variety of market intermedia - tion activities in the same way but, informed by the needs of the clients, does it sometimes as an agent for another enterprise and sometimes on its own account, the broker-dealer will be considered to be acting in the ordinary course of its business as an agent when it performs these various market intermediation activities. 111. The last sentence of paragraph 6 provides that a person is not considered to be an independent agent where the person acts exclusively or almost exclusively for one or more enterprises 199

222 Article 5 Commentary to which it is closely related. That last sentence does not mean, however, that paragraph 6 will apply automatically where a person acts for one or more enterprises to which that person is not closely related. Paragraph 6 requires that the person must be carrying on a business as an independent agent and be acting in the ordinary course of that business. Independent status is less likely if the activities of the person are performed wholly or almost wholly on behalf of only one enterprise (or a group of enterprises that are closely related to each other) over the lifetime of that person’s business or over a long period of time. Where, however, a person is acting exclusively for one enterprise, to which it is not closely related, for a short period - of time (e.g. at the beginning of that person’s business opera tions), it is possible that paragraph 6 could apply. As indicated in paragraph 109 above, all the facts and circumstances would need to be taken into account to determine whether the per - son’s activities constitute the carrying on of a business as an independent agent. 112. The last sentence of paragraph 6 applies only where the person acts “exclusively or almost exclusively” on behalf of closely related enterprises, as defined in paragraph [9]. This means that where the person’s activities on behalf of enterprises to which it is not closely related do not represent a significant part of that person’s business, that person will not qualify as an independent agent. Where, for example, the sales that an agent concludes for enterprises to which it is not closely related repre - sent less than 10 per cent of all the sales that it concludes as an agent acting for other enterprises, that agent should be viewed as acting “exclusively or almost exclusively” on behalf of closely related enterprises. 113. The rule in the last sentence of paragraph 6 and the fact that the definition of “closely related” in paragraph 8 covers sit - uations where one company controls or is controlled by another company do not restrict in any way the scope of paragraph 8 of Article 5. As explained in paragraph 117 below, it is possible that a subsidiary will act on behalf of its parent company in such a way that the parent will be deemed to have a perma - nent establishment under paragraph 5; if that is the case, a subsidiary acting exclusively or almost exclusively for its parent 200

223 Article 5 Commentary will be unable to benefit from the “independent agent” excep - tion of paragraph 6. This, however, does not imply that the parent-subsidiary relationship eliminates the requirements of paragraph 5 and that such a relationship could be sufficient in itself to conclude that any of these requirements are met. 31. In the 1999 revision of the Model, the wording was amended to clarify that the essential criterion for treating an agent as not being of “an independent status” was the absence of an arm’s length relationship. In the 2017 update, the Committee decided that the lack of an 32. - arm’s length relationship should not be a deciding factor in determin ing that an agent does not qualify as an agent of independent status and removed this requirement from the independent agent rule. In making its decision it was noted that removal of the arm’s length condition was made because prior to the 2017 update, it was easier to qualify as “an independent agent” under the United Nations Model Convention than under the OECD Model Convention. Paragraph 8 33. The present paragraph reproduces Article 5, paragraph 7 of the 2017 OECD Model Convention. The Commentary on the OECD text is as follows: 115. It is generally accepted that the existence of a subsidiary company does not, of itself, constitute that subsidiary company a permanent establishment of its parent company. This follows from the principle that, for the purpose of taxation, such a sub - sidiary company constitutes an independent legal entity. Even the fact that the trade or business carried on by the subsidiary company is managed by the parent company does not consti - tute the subsidiary company a permanent establishment of the parent company. 116. A parent company may, however, be found, under the rules of paragraphs 1 or 5 of the Article, to have a permanent establishment in a State where a subsidiary has a place of busi - ness. Thus, any space or premises belonging to the subsidiary that is at the disposal of the parent company [...] and that consti - tutes a fixed place of business through which the parent carries 201

224 Article 5 Commentary on its own business will constitute a permanent establishment of the parent under paragraph 1, subject to paragraphs 3 and 4 of the Article (see for instance, the example in paragraph 15 above). Also, under paragraph 5, a parent will be deemed to have a permanent establishment in a State in respect of any activities that its subsidiary undertakes for it if the conditions of that paragraph are met (see paragraphs 82-99 above) , unless these activities are limited to those referred to in paragraph 4 of the Article or unless paragraph 6 of the Article applies. 117. The same principles apply to any company forming part of a multinational group so that such a company may be found to have a permanent establishment in a State where it has at its disposal [...] and uses premises belonging to another com - pany of the group, or if the former company is deemed to have a permanent establishment under paragraph 5 of the Article [...]. The determination of the existence of a permanent establish - ment under the rules of paragraphs 1 or 5 of the Article must, however, be done separately for each company of the group. Thus, the existence in one State of a permanent establishment of one company of the group will not have any relevance as to whether another company of the group has itself a permanent establishment in that State. The Committee notes that determining whether or not a per - 34. manent establishment exists on a separate entity basis may entail vul - nerability to abusive arrangements. Depending on the domestic law of States, safeguards against purely artificial structures may be found through application of a rule according to which substance overrides form. The Commentary of the 2017 OECD Model Convention also states the following: 118. Whilst premises belonging to a company that is a member of a multinational group can be put at the disposal of another company of the group and may, subject to the other conditions of Article 5, constitute a permanent establishment of that other company if the business of that other company is carried on through that place, it is important to distinguish that case from the frequent situation where a company that is a member of a multinational group provides services ( e.g. management services) to another company of the group as part of its own 202

225 Article 5 Commentary business carried on in premises that are not those of that other company and using its own personnel. In that case, the place where those services are provided is not at the disposal of the latter company and it is not the business of that company that is carried on through that place. That place cannot, therefore, be considered to be a permanent establishment of the company to which the services are provided. Indeed, the fact that a compa - ny’s own activities at a given location may provide an economic benefit to the business of another company does not mean that - the latter company carries on its business through that loca tion: clearly, a company that merely purchases parts produced or services supplied by another company in a different coun - try would not have a permanent establishment because of that, even though it may benefit from the manufacturing of these parts or the supplying of these services. Paragraph 9 35. This paragraph reproduces Article 5, paragraph 8 of the 2017 OECD Model Convention; the relevant portions of the Commentary on the OECD text are as follows: Paragraph [9] explains the meaning of the concept of a 119. “person closely related to an enterprise” for the purposes of the Article and, in particular, of paragraphs 4.1 and 6. That concept is to be distinguished from the concept of “associated enter - prises” which is used for the purposes of Article 9; although the two concepts overlap to a certain extent, they are not intended to be equivalent. 120. The first part of paragraph [9] includes the general defi - nition of “a person closely related to an enterprise”. It provides that a person is closely related to an enterprise if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same persons or enterprises. This general rule would cover, for example, situations where a person or enterprise controls an enterprise by virtue of a special arrangement that allows that person to exercise rights that are similar to those that it would hold if it possessed directly or indirectly more than 50 per cent of the beneficial interests in 203

226 Article 5 Commentary the enterprise. As in most cases where the plural form is used, the reference to the “same persons or enterprises” at the end of the first sentence of paragraph [9] covers cases where there is only one such person or enterprise. 121. The second part of paragraph [9] provides that the defi - nition of “person closely related to an enterprise” is automati - cally satisfied in certain circumstances. Under that second part, a person is considered to be closely related to an enterprise if either one possesses directly or indirectly more than 50 per cent of the beneficial interests in the other or if a third person possesses directly or indirectly more than 50 per cent of the beneficial interests in both the person and the enterprise. In the case of a company, this condition is satisfied where a person holds directly or indirectly more than 50 per cent of the aggre - gate vote and value of the company’s shares or of the beneficial equity interest in the company. Electronic commerce The Commentary of the 2017 OECD Model Convention includes 36. the following section on “electronic commerce”: Electronic commerce 122. There has been some discussion as to whether the mere use in electronic commerce operations of computer equipment in a country could constitute a permanent establishment. That question raises a number of issues in relation to the provisions of the Article. 123. Whilst a location where automated equipment is operated by an enterprise may constitute a permanent establishment in the country where it is situated (see below), a distinction needs to be made between computer equipment, which may be set up at a location so as to constitute a permanent establishment under certain circumstances, and the data and software which is used by, or stored on, that equipment. For instance, an Internet web site, which is a combination of software and electronic data, does not in itself constitute tangible property. It therefore does 204

227 Article 5 Commentary not have a location that can constitute a “place of business” as there is no “facility such as premises or, in certain instances, machinery or equipment” (see paragraph 6 above) as far as the software and data constituting that web site is concerned. On the other hand, the server on which the web site is stored and through which it is accessible is a piece of equipment having a physical location and such location may thus constitute a “fixed place of business” of the enterprise that operates that server. 124. The distinction between a web site and the server on which the web site is stored and used is important since the enterprise that operates the server may be different from the enterprise that carries on business through the web site. For example, it is common for the web site through which an enterprise carries on its business to be hosted on the server of an Internet Service Provider (ISP). Although the fees paid to the ISP under such arrangements may be based on the amount of disk space used to store the software and data required by the web site, these contracts typically do not result in the server and its location being at the disposal of the enterprise (see paragraph 10 to 19 above), even if the enterprise has been able to determine that its web site should be hosted on a particular server at a par - ticular location. In such a case, the enterprise does not even have a physical presence at that location since the web site is not tangible. In these cases, the enterprise cannot be considered to have acquired a place of business by virtue of that hosting arrangement. However, if the enterprise carrying on business through a web site has the server at its own disposal, for exam - ple it owns (or leases) and operates the server on which the web site is stored and used, the place where that server is located could constitute a permanent establishment of the enterprise if the other requirements of the Article are met. 125. Computer equipment at a given location may only con - stitute a permanent establishment if it meets the requirement of being fixed. In the case of a server, what is relevant is not the possibility of the server being moved, but whether it is in fact moved. In order to constitute a fixed place of business, a server will need to be located at a certain place for a sufficient period of time so as to become fixed within the meaning of paragraph 1. 205

228 Article 5 Commentary 126. Another issue is whether the business of an enterprise may be said to be wholly or partly carried on at a location where the - enterprise has equipment such as a server at its disposal. The ques tion of whether the business of an enterprise is wholly or partly carried on through such equipment needs to be examined on a case-by-case basis, having regard to whether it can be said that, because of such equipment, the enterprise has facilities at its dis - posal where business functions of the enterprise are performed. Where an enterprise operates computer equipment at a 127. particular location, a permanent establishment may exist even - though no personnel of that enterprise is required at that loca - tion for the operation of the equipment. The presence of per sonnel is not necessary to consider that an enterprise wholly or partly carries on its business at a location when no person - nel are in fact required to carry on business activities at that location. This conclusion applies to electronic commerce to the same extent that it applies with respect to other activities in e.g. automatic pump - which equipment operates automatically, ing equipment used in the exploitation of natural resources. 128. Another issue relates to the fact that no permanent estab - lishment may be considered to exist where the electronic com - merce operations carried on through computer equipment at a given location in a country are restricted to the preparatory or auxiliary activities covered by paragraph 4. The question of whether particular activities performed at such a location fall within paragraph 4 needs to be examined on a case-by-case basis having regard to the various functions performed by the enterprise through that equipment. Examples of activities which would generally be regarded as preparatory or auxil - iary include: — providing a communications link— much like a tele - phone line — between suppliers and customers; — advertising of goods or services; — relaying information through a mirror server for secu - rity and efficiency purposes; — gathering market data for the enterprise; supplying information. — 206

229 Article 5 Commentary 129. Where, however, such functions form in themselves an essential and significant part of the business activity of the enterprise as a whole, or where other core functions of the enterprise are carried on through the computer equipment, these would go beyond the activities covered by paragraph 4 and if the equipment constituted a fixed place of business of the enterprise (as discussed in paragraphs 123 to 127 above), there would be a permanent establishment. What constitutes core functions for a particular enter - 130. prise clearly depends on the nature of the business carried on by that enterprise. For instance, some ISPs are in the business of operating their own servers for the purpose of hosting web sites or other applications for other enterprises. For these ISPs, the operation of their servers in order to provide services to custom - ers is an essential part of their commercial activity and cannot be considered preparatory or auxiliary. A different example is that of an enterprise (sometimes referred to as an “e-tailer”) that carries on the business of selling products through the Internet. In that case, the enterprise is not in the business of operating servers and the mere fact that it may do so at a given location is not enough to conclude that activities performed at that loca - tion are more than preparatory and auxiliary. What needs to be done in such a case is to examine the nature of the activities performed at that location in light of the business carried on by the enterprise. If these activities are merely preparatory or auxiliary to the business of selling products on the Internet (for example, the location is used to operate a server that hosts a web site which, as is often the case, is used exclusively for advertising, displaying a catalogue of products or providing information to potential customers), paragraph 4 will apply and the location will not constitute a permanent establishment. If, however, the typical functions related to a sale are performed at that location (for example, the conclusion of the contract with the customer, the processing of the payment and the delivery of the products are performed automatically through the equipment located there), these activities cannot be considered to be merely pre - paratory or auxiliary. 131. A last issue is whether paragraph 5 may apply to deem an ISP to constitute a permanent establishment. As already noted, 207

230 Article 5 Commentary it is common for ISPs to provide the service of hosting the web sites of other enterprises on their own servers. The issue may then arise as to whether paragraph 5 may apply to deem such ISPs to constitute permanent establishments of the enterprises that carry on electronic commerce through web sites operated through the servers owned and operated by these ISPs. Whilst this could be the case in very unusual circumstances, paragraph 5 will generally not be applicable because the ISPs will not con - stitute an agent of the enterprises to which the web sites belong, because they will not conclude contracts or play the principal role leading to the conclusion of contracts in the name of these enterprises, or for the transfer of property belonging to these enterprises or the provision of services by these enterprises, or because they will act in the ordinary course of a business as independent agent, as evidenced by the fact that they host the web sites of many different enterprises. It is also clear that since the web site through which an enterprise carries on its busi - ness is not itself a “person” as defined in Article 3, paragraph 5 cannot apply to deem a permanent establishment to exist by virtue of the web site being an agent of the enterprise for pur - poses of that paragraph. 37. The Committee of Experts notes that the OECD Commentary, in paragraph 124, draws a distinction between a contract with an Internet Service Provider and one with a place of business at the dis - posal of the enterprise. In this regard, the Committee recognizes that some businesses could seek to avoid creating a permanent establish - ment by managing the contractual terms in cases where the circum - stances would justify the conclusion that a permanent establishment exists. Such abuses may fall under the application of legislative or judi - cial anti-avoidance rules. 208

231 Article 6 Commentary Commentary on chapter III TAXATION OF INCOME Article 6 INCOME FROM IMMOVABLE PROPERTY A. General considerations 1. Article 6 of the United Nations Model Convention reproduces Article 6 of the OECD Model Convention with the exception of the phrase “and to income from immovable property used for the perfor - mance of independent personal services” which appears at the end of paragraph 4 of the United Nations Model Convention. This phrase is included in the United Nations Model Convention as a result of the retention of Article 14 dealing with Independent Personal Services. 2. In taxing income from immovable property, the object should be the taxation of profits rather than of gross income; the expenses incurred in earning income from immovable [real] property or from agriculture or forestry should therefore be taken into account. This objective should not, however, preclude the use of a withholding tax on rents from immovable [real] property, based on gross income; in such cases the rate should take into account the fact that expenses have been incurred. On the other hand, if a withholding tax on gross rents is used, it will be just as satisfactory if the owner of the immovable [real] property can elect to have the income from the property taxed on a net basis under the regular income tax. Article 6 is not intended to prevent a country which taxes income from agriculture or other immovable property on an estimated or similar basis from continuing to use that method. 3. Some members of the former Group of Experts were of the view that the distribution of dividends by a company referred to in Article 13, paragraph 4, should be treated as income from immovable property and, therefore, as covered by Article 6. However, this view was not shared by most other members. 209

232 Article 6 Commentary 4. It was noted that in some countries, a person may receive income (typically rental income) from immovable property in circum - stances where that person instead of directly owning the immovable property owns shares of a company owning that property and that the ownership of those shares entitles that person to the use or enjoyment of the property. Contracting States are free to expand the scope of the Article to cover the deemed income from that use or enjoyment. They may also expand the scope of Article 22 to allow source taxation of shares of such companies. B. Commentary on the paragraphs of article 6 Paragraph 1 5. This paragraph grants the right to tax income from immovable property (including income from agriculture or forestry) to the State of source, that is, the State where the property in question is situated. In the words of the Commentary on the OECD Model Convention, this provision is based on “the fact that there is always a very close economic 27 connection between the source of this income and the State of source”. 6. The OECD Commentary observes: 1. [...] Although income from agriculture or forestry is included in Article 6, Contracting States are free to agree in their bilateral conventions to treat such income under Article 7. Article 6 deals only with income which a resident of a Contracting State derives from immovable property situated in the other Contracting State. It does not, therefore, apply to income from immovable property situated in the Contracting State of which the recipient is a resident within the meaning of Article 4 or situated in a third State; the provisions of paragraph 1 of Article 21 shall apply to such income. Paragraph 2 7. This paragraph, which gives the term “immovable property” the meaning that it has under the law of the Contracting State in which 27 Paragraph 1 of the OECD Commentary on Article 6. 210

233 Article 6 Commentary the property is situated, is intended to alleviate difficulties of inter - pretation with regard to whether an asset or a right is to be regarded as immovable property. In addition the paragraph lists a number of assets and rights which are in any case to be regarded as covered by the term. On the other hand, the paragraph provides that ships and air - craft shall not be regarded as immovable property. Interest from debt secured by immovable property is not covered by Article 6, but is a matter which is instead dealt with under Article 11 relating to interest. Paragraph 3 8. - This paragraph provides that the general rule set forth in para graph 1 shall apply regardless of the form in which immovable prop - erty is used. Paragraph 4 9. This paragraph stipulates that the provisions of paragraphs 1 and 3 apply also to income from immovable property, of industrial, commercial and other enterprises and to income from immovable property used for the performance of independent personal services. The OECD Commentary also observes that: 4. [...] the right to tax of the State of source has priority over the right to tax of the other State and applies also where in the case of an enterprise income is only indirectly derived from immovable property. This does not prevent income from immov - able property, when derived through a permanent establishment, from being treated as income of an enterprise, but secures that income from immovable property will be taxed in the State in which the property is situated also in the case where such prop - erty is not part of a permanent establishment situated in that State. It should further be noted that the provisions of the Article do not prejudge the application of domestic law as regards the manner in which income from immovable property is to be taxed. These observations apply equally in the case of non-industrial and non-commercial activities by reason of the inclusion in paragraph 4 of the United Nations Model Convention on income from immovable property used for the performance of independent personal services. 211

234 Article 7 Commentary Article 7 BUSINESS PROFITS A. General considerations Article 7 of the United Nations Model Convention consists of 1. several provisions of Article 7 of the 2008 OECD Model Convention, either unchanged or substantially amended, and some new provi - sions. The Committee of Experts decided at its 2009 annual session not to adopt the OECD approach to Article 7 arising from the OECD’s 28 2008 report Attribution of Profits to Permanent Establishments (the 2008 Permanent Establishments Report). The 2008 Permanent Establishments Report envisions taking into account dealings between different parts of an enterprise such as a permanent establishment and its head office to a greater extent than is recognized by the United Nations Model Convention. That approach by the OECD is now reflected in the new Article 7 in the 2010 OECD Model Convention and the Commentary on that Article. The Committee of Experts decided not to adopt this OECD approach because it was in direct conflict with paragraph 3 of Article 7 of the United Nations Model Convention which generally disallows deductions for amounts “paid” (other than toward reimbursement of actual expenses) by a permanent establishment to its head office. That rule is seen as continuing to be appropriate in the context of the United Nations Model Convention, whatever changes have been made to the OECD Model Convention and Commentaries. It should therefore be noted that all subsequent references to Article 7 of the OECD Model Convention and its Commentary relate to the 2008 OECD Model Convention. Article 7 in the United Nations Model Convention and the 2008 OECD Model Convention are largely con - sistent (except for the specific United Nations additions). Aspects of the 2008 OECD Commentary in places reflect views contained in the 2008 Permanent Establishments Report. Where the 2008 OECD Commentary reflects the approach of that Report, reference is instead made to the 2005 OECD Model Convention which is not affected in this way. 28 Report on the Attribution of Profits to Permanent Establishments, 2008. Available at http://www.oecd.org/dataoecd/20/36/41031455.pdf. 212

235 Article 7 Commentary 2. - There is general acceptance of the arm’s length principle embod - ied in the OECD Model Convention, under which the profits attributa ble to a permanent establishment are those which would be earned by the establishment if it were a wholly independent entity dealing with its head office as if it were a distinct and separate enterprise operating under conditions and selling at prices prevailing in the regular market. The profits so attributable are normally the profits shown on the books - of the establishment. Nevertheless, this principle permits the authori ties of the country in which the permanent establishment is located to rectify the accounts of the enterprise, so as to reflect properly income which the establishment would have earned if it were an independent enterprise dealing with its head office at arm’s length. The application of the arm’s length principle to the allocation of profits between the home office and its permanent establishment presupposes for most countries that the domestic legislation authorizes a determination on the basis of the arm’s length principle. 3. The application of the arm’s length principle is particularly important in connection with the difficult and complex problem of deductions to be allowed to the permanent establishment. It is also generally accepted that in calculating the profits of a permanent estab - lishment, allowance should be made for expenses, wherever incurred, for the purpose of the business of the permanent establishment, including executive and general administrative expenses. Apart from what may be regarded as ordinary expenses, there are some classes of expenditure that give rise to special problems. These include inter - est and royalties etc. paid by the permanent establishment to its head office in return for money lent or patent rights licensed by the latter to the permanent establishment. They further include commission fees (except for reimbursement of actual expenses) for specific services or for the exercise of management services by the enterprise for the benefit of the establishment. In this case, it is considered that the pay - ments should not be allowed as deductions in computing the profits of the permanent establishment. Conversely, such payments made to a permanent establishment by the head office should be excluded from the profits of the permanent establishment. On the other hand, an allocable share of such payments, e.g., interest and royalties, paid by the enterprise to third parties should be allowed. As noted in para - graph 1 above, this approach is consistent with the approach adopted 213

236 Article 7 Commentary in interpreting Article 7 in the 2008 OECD Model Convention but it varies from the approach adopted by the OECD in its 2008 Permanent Establishments Report. Under the OECD Model Convention, only profits attributable 4. to the permanent establishment may be taxed in the source country. The United Nations Model Convention amplifies this attribution prin - ciple by a limited force of attraction rule, which permits the enterprise, once it carries out business through a permanent establishment in the source country, to be taxed on some business profits in that country arising from transactions by the enterprise in the source country, but not through the permanent establishment. Where, owing to the force of attraction principle, the profits of an enterprise other than those attributable directly to the permanent establishment may be taxed in the State where the permanent establishment is situated, such prof - its should be determined in the same way as if they were attributable directly to the permanent establishment. 5. The United Nations Model Convention does not contain para - 29 graph 5 of Article 7 of the 2008 OECD Model Convention, which states, “No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise”. When drafting the 1980 United Nations Model Convention the former Group of Experts could not reach a con - - sensus on whether profits should be attributed to a permanent estab lishment by reason of the mere purchase of goods and therefore decided to include in Article 7 a note stating that this question should be settled in bilateral negotiations. When this issue was considered by the former Group of Experts, several members from developing countries believed that this provision could be included if it were amended to include a - statement that in the case of a permanent establishment engaged in pur chasing and other activities, profits derived from purchasing activities should be attributed to the permanent establishment. Other members from developing countries felt that the provision should be omitted because, even where purchasing is the sole activity of an enterprise in the source country, a permanent establishment could exist in that coun - try, the purchasing activity may contribute to the overall profit of the 29 Paragraph 5 of Article 7 of the OECD Model Convention was deleted as part of the 2010 update of the OECD Model Convention. 214

237 Article 7 Commentary enterprise, and some portion of that profit thus may appropriately be - taxed by that country. The members from developed countries gener ally favoured inclusion of paragraph 5 of Article 7 of the OECD Model 30 Convention, without amendment. B. Commentary on the paragraphs of article 7 Paragraph 1 6. This paragraph reproduces Article 7, paragraph 1, of the 2008 b ) and ( OECD Model Convention, with the addition of clauses ( ). c In the discussion preceding the adoption by the former Group of Experts of this paragraph, several members from developing coun - tries expressed support for the force of attraction rule, although they would limit its application. Clauses ( b ) and ( c ) mean that the United Nations Model Convention amplifies the corresponding Article in the OECD Model Convention by including a limited force of attraction rule. This allows the country in which the permanent establishment is located to tax not only the profits attributable to that permanent establishment but other profits of the enterprise derived in that coun - try to the extent allowed under the Article. It is noted that the force of attraction rule is limited to business profits covered by Article 7 and - does not extend to income from capital (dividends, interest and royal ties) covered by other treaty provisions. Those in favour of such a rule argue that neither sales through independent commission agents nor purchasing activities would become taxable to the principal under that rule. Some members from developed countries pointed out that the force of attraction rule had been found unsatisfactory and abandoned in recent tax treaties concluded by them because of the undesirability of taxing income from an activity that was totally unrelated to the establishment and that was in itself not extensive enough to constitute a permanent establishment. They also stressed the uncertainty that such an approach would create for taxpayers. Members from develop - ing countries pointed out that the force of attraction approach avoids some administrative problems because, under that approach, it is not necessary to determine whether particular activities are related to 30 The wording favoured by those members was identical to that found in paragraph 5 of the 2008 OECD Model Convention. 215

238 Article 7 Commentary the permanent establishment or the income involved attributable to it. That was the case especially with respect to transactions conducted directly by the home office within the country that are similar in nature to those conducted by the permanent establishment. However, after discussion, it was proposed that the “force of attraction” rule in Article 7 should be limited to that last situation so that it would apply to sales of goods or merchandise and other business activities in the following manner: If an enterprise has a permanent establishment in the other Contracting State for the purpose of selling goods or mer - chandise, sales of the same or a similar kind may be taxed in that State even if they are not conducted through the permanent establishment; a similar rule applies if the permanent establishment is used for other business activities and the same or similar activities are performed without any connection with the permanent establishment. 7. When the United Nations Model Convention was revised in 1999, however some members considered that this limited force of attraction rule should not apply where an enterprise is able to demon - strate that the sales or business activities were carried out for reasons other than obtaining treaty benefits. This recognizes that an enterprise may have legitimate business reasons for choosing not to carry out sales or business activities through its permanent establishment. The Committee considers that the following part of the 8. Commentary on paragraph 1 of Article 7 of the 2008 OECD Model Convention is applicable to the corresponding paragraph of Article 7: When referring to the part of the profits of an enterprise 11. that is attributable to a permanent establishment, the second sentence of paragraph 1 refers directly to paragraph 2, which provides the directive for determining what profits should be attributed to a permanent establishment. As paragraph 2 is part of the context in which the sentence must be read, that sen - tence should not be interpreted in a way that could contradict paragraph 2, e.g. by interpreting it as restricting the amount of profits that can be attributed to a permanent establishment to the amount of profits of the enterprise as a whole. Thus, whilst paragraph 1 provides that a Contracting State may only tax the profits of an enterprise of the other Contracting State to the extent that they are attributable to a permanent establishment 216

239 Article 7 Commentary situated in the first State, it is paragraph 2 that determines the meaning of the phrase “profits attributable to a permanent establishment”. In other words, the directive of paragraph 2 - may result in profits being attributed to a permanent establish ment even though the enterprise as a whole has never made profits: conversely, that directive may result in no profits being attributed to a permanent establishment even though the enter - prise as a whole has made profits. Clearly however, the Contracting State of the enterprise 12. has an interest in the directive of paragraph 2 being correctly applied by the State where the permanent establishment is located. Since that directive applies to both Contracting States, the State of the enterprise must, in accordance with Article 23, eliminate double taxation on the profits properly attributable to the permanent establishment. In other words, if the State where the permanent establishment is located attempts to tax profits that are not attributable to the permanent establishment under Article 7, this may result in double taxation of profits that should properly be taxed only in the State of the enterprise. 13. The purpose of paragraph 1 is to provide limits to the right of one Contracting State to tax the business profits of enterprises [that are residents] of the other Contracting State. The paragraph does not limit the right of a Contracting State to tax its own residents under controlled foreign companies provi - sions found in its domestic law even though such tax imposed on these residents may be computed by reference to the part of the profits of an enterprise that is resident of the other Contracting State that is attributable to these residents’ participation in that enterprise. Tax so levied by a State on its own residents does not reduce the profits of the enterprise of the other State and may not, therefore, be said to have been levied on such profits (see also paragraph 23 of the Commentary on Article 1 and para - graphs 37 to 39 of the Commentary on Article 10). Some countries disagree with the approach taken in the second sen - tence of paragraph 13 of the OECD Commentary which states that paragraph 1 of Article 7 does not limit the right of a Contracting State to tax its own residents under controlled foreign companies provisions found in its domestic law. 217

240 Article 7 Commentary Paragraph 2 This paragraph reproduces Article 7, paragraph 2, of the OECD 9. Model Convention. When last considered by the former Group of Experts a member from a developed country pointed out that his country was having some problems with inconsistent determination of the profits properly attributable to a permanent establishment, espe - cially with regard to “turnkey” contracts. Under a turnkey contract a contractor agrees to construct a factory or similar facility and make it ready for operation; when the facility is ready for operation, it is handed over to the purchaser, who can then begin operations. The international tax problems occur when the facility is to be constructed in one country by a contractor resident in another country. The actual construction activities carried on in one country clearly constitute a permanent establishment within that country if of sufficiently long duration. Turnkey contracts, however, often involve components other than normal construction activities, including the purchase of capi - tal goods, the performance of architectural and engineering services and the provision of technical assistance. Those latter items, it was explained, are sometimes completed before construction activities actually start (and hence, before the creation of a permanent establish - ment at the construction site) and often outside the country in which the construction site/permanent establishment is situated. 10. The question thus arose how much of the total profits of the turnkey contract is properly attributable to the permanent establish - ment and taxable in the country in which it is situated. A member from a developed country said that he knew of instances in which countries had sought to attribute the entire profits of the contract to the per - manent establishment. It was his view, however, that only the profits attributable to activities carried on by the permanent establishment should be taxed in the country in which the permanent establishment was situated, unless the profits included items of income dealt with separately in other articles of the Convention and were taxable in that country accordingly. 11. The Group recognized that the problem was a complex and potentially controversial one involving many interrelated issues, such as source of income rules and the definition of permanent establishment and the concept of profits of an enterprise. The Group 218

241 Article 7 Commentary acknowledged that the problem might be considered in the course of bilateral negotiations, but it agreed upon no amendment to address it. 12. When the United Nations Model Convention was revised in 1999, some members of the former Group of Experts were of the view that the last part of paragraph 2 was too narrow, as they considered that it refers only to transactions between the permanent establish - ment and the home office, and does not take into account transac - tions between the permanent establishment and, for example, other permanent establishments of the same enterprise. For this purpose, Contracting States may consider the alternative clarification: There shall in each Contracting State be attributed to that per - manent establishment the profits that it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions. 13. Although the point in controversy relating to the allocation of profits between different permanent establishments as opposed to allocation between a permanent establishment and its head office was not in doubt, it was generally accepted that the concern of the former Group of Experts should be clearly noted. 14. As observed in paragraph 14 of the Commentary on Article 7 of the 2008 OECD Model Convention, paragraph 2 as presently worded: “contains the central directive on which the allocation of profits to a permanent establishment is intended to be based.” As stated in the Article, this is of course subject to the provisions of para - graph 3 of the Article. Paragraph 14 of the OECD Commentary continues: The paragraph incorporates the view that was generally con - tained in bilateral conventions, that the profits to be attributed to a permanent establishment are those which that permanent establishment would have made if, instead of dealing with the rest of the enterprise, it had been dealing with an entirely sepa - rate enterprise under conditions and at prices prevailing in the ordinary market. This corresponds to the “arm’s length” prin - ciple discussed in the Commentary on Article 9. Normally, the profits so determined would be the same profits that one would 219

242 Article 7 Commentary expect to be determined by the ordinary processes of business accou nta nc y. Since the arm’s length principle also extends to the attribution of prof - its which the permanent establishment may derive from transactions with other permanent establishments of the enterprise, the existing paragraph 2 should be construed to make it applicable to such situa - tions. Therefore, where an enterprise of a Contracting State carries on its business activities in the other Contracting State through a perma - nent establishment situated therein, it would be necessary to attribute to such permanent establishment the profits which it could be in a position to make if it were a distinct enterprise engaged in the same or similar activities under the same or similar conditions and operating at arm’s length, and dealing wholly independently with the enterprise of which it is a permanent establishment or the other permanent estab - lishments of that enterprise. 15. The determination of the profits attributable to a specific permanent establishment is an instance where the Commentary in the 2008 OECD Model Convention refers to the 2008 Permanent Establishments Report. Given the comments in paragraph 1 above the Committee considers that the following part of the Commentary on paragraph 2 of Article 7 of the 2005 OECD Model Convention is applicable to paragraph 2 of Article 7 of the United Nations Model Convention: 12. In the great majority of cases, trading accounts of the per - manent establishment— which are commonly available if only because a well-run business organisation is normally concerned to know what is the profitability of its various branches — will be used by the taxation authorities concerned to ascertain the profit properly attributable to that establishment. Exceptionally there may be no separate accounts [...]. But where there are such accounts they will naturally form the starting point for any pro - cesses of adjustment in case adjustment is required to produce the amount of properly attributable profits. It should perhaps be emphasized that the directive contained in paragraph 2 is no jus - tification for tax administrations to construct hypothetical profit figures in vacuo; it is always necessary to start with the real facts of the situation as they appear from the business records of the 220

243 Article 7 Commentary permanent establishment and to adjust as may be shown to be necessary the profit figures which those facts produce. 12.1 This raises the question as to what extent such accounts should be relied upon when they are based on agreements between the head office and its permanent establishments (or between the permanent establishments themselves). Clearly, such internal agreements cannot qualify as legally binding contracts. However, to the extent that the trading accounts of the head office - and the permanent establishments are both prepared symmetri cally on the basis of such agreements and that those agreements reflect the functions performed by the different parts of the enter - prise, these trading accounts could be accepted by tax authori - ties. In that respect, accounts could not be regarded as prepared symmetrically unless the values of transactions or the methods of attributing profits or expenses in the books of the permanent establishment corresponded exactly to the values or methods of attribution in the books of the head office in terms of the national currency or functional currency in which the enterprise recorded its transactions. However, where trading accounts are based on internal agreements that reflect purely artificial arrangements instead of the real economic functions of the different parts of the enterprise, these agreements should simply be ignored and the accounts corrected accordingly. This would be the case if, for example, a permanent establishment involved in sales were, under such an internal agreement, given the role of principal (accepting all the risks and entitled to all the profits from the sales) when in fact the permanent establishment concerned was nothing more than an intermediary or agent (incurring limited risks and entitled to receive only a limited share of the resulting income) or, conversely, were given the role of intermediary or agent when in reality it was a principal. 12.2 In this respect, it should also be noted that the principle set out in paragraph 2 is subject to the provisions contained in paragraph 3, especially as regards the treatment of payments which, under the name of interest, royalties, etc. are made by a permanent establishment to its head office in return for money loaned, or patent rights conceded by the latter to the permanent e s t a bl i s h me nt [...]. 221

244 Article 7 Commentary 13. Even where a permanent establishment is able to produce detailed accounts which purport to show the profits arising from its activities, it may still be necessary for the taxation authorities of the country concerned to rectify those accounts in accordance with the arm’s length principle [...]. Adjustment of this kind may be necessary, for example, because goods have been invoiced from the head office to the permanent establish - ment at prices which are not consistent with this principle, and - profits have thus been diverted from the permanent establish ment to the head office, or vice versa. 14. In such cases, it will usually be appropriate to substitute for the prices used ordinary market prices for the same or simi - lar goods supplied on the same or similar conditions. Clearly the price at which goods can be bought on open market terms varies with the quantity required and the period over which they will be supplied; such factors would have to be taken into account in deciding the open market price to be used. It is perhaps only necessary to mention at this point that there may sometimes be perfectly good commercial reasons for an enterprise invoicing its goods at prices less than those prevailing in the ordinary market; this may, for example, be a perfectly normal commercial method of establishing a competitive position in a new market and should not then be taken as evidence of an attempt to divert profits from one country to another. Difficulties may also occur in the case of proprietary goods produced by an enterprise, all of which are sold through its permanent establishments; if in such circumstances there is no open market price, and it is thought that the figures in the accounts are unsatisfactory, it may be necessary to calculate the permanent establishment’s profits by other methods, for example, by applying an average ratio of gross profit to the turnover of the permanent establishment and then deducting from the figure so obtained the proper amount of expenses incurred. Clearly many special problems of this kind may arise in individual cases but the general rule should always be that the profits attributed to a permanent establish - ment should be based on that establishment’s accounts insofar as accounts are available which represent the real facts of the situation. If available accounts do not represent the real facts then new accounts will have to be constructed, or the original 222

245 Article 7 Commentary ones rewritten, and for this purpose the figures to be used will be those prevailing in the open market. 15. Many States consider that there is a realisation of a taxa - ble profit when an asset, whether or not trading stock, forming - part of the business property of a permanent establishment sit - uated within their territory is transferred to a permanent estab lishment or the head office of the same enterprise situated in another State. Article 7 allows such States to tax profits deemed to arise in connection with such a transfer. Such profits may be determined as indicated below. In cases where such transfer takes place, whether or not it is a permanent one, the question arises as to when taxable profits are realised. In practice, where such property has a substantial market value and is likely to appear on the balance sheet of the importing permanent estab - lishment or other part of the enterprise after the taxation year during that in which the transfer occurred, the realisation of the taxable profits will not, so far as the enterprise as a whole is concerned, necessarily take place in the taxation year of the transfer under consideration. However, the mere fact that the property leaves the purview of a tax jurisdiction may trigger the taxation of the accrued gains attributable to that property as the concept of realisation depends on each country’s domestic law. 15.1 Where the countries in which the permanent establish - - ments operate levy tax on the profits accruing from an inter nal transfer as soon as it is made, even when these profits are not actually realised until a subsequent commercial year, there will be inevitably a time lag between the moment when tax is paid abroad and the moment it can be taken into account in the country where the enterprise’s head office is located. A serious - problem is inherent in the time lag, especially when a perma nent establishment transfers fixed assets or — in the event that it is wound up — its entire operating equipment stock, to some other part of the enterprise of which it forms part. In such cases, it is up to the head office country to seek, on a case by case basis, a bilateral solution with the outward country where there is serious risk of overtaxation. 15.2 Another significant problem concerning the transfer of assets, such as bad loans, arises in relation to international 223

246 Article 7 Commentary banking. Debts may be transferred, for supervisory and financ - ing purposes, from branch to head office or from branch to branch within a single bank. Such transfers should not be recognised where it cannot be reasonably considered that they take place for valid commercial reasons or that they would have taken place between independent enterprises, for instance where they are undertaken solely for tax purposes with the aim of maximising the tax relief available to the bank. In such cases, the transfers would not have been expected to take place between wholly independent enterprises and therefore would - not have affected the amount of profits which such an inde - pendent enterprise might have been expected to make in inde pendent dealing with the enterprise of which it is a permanent establishment. 15.3 However, there may exist a commercial market for the transfer of such loans from one bank to another and the cir - cumstances of an internal transfer may be similar to those which might have been expected to have taken place between independent banks. An instance of such a transfer might be a case where a bank closed down a particular foreign branch and had therefore to transfer the debts concerned either back to its head office or to another branch. Another example might be the opening of a new branch in a given country and the subsequent transfer to it, solely for commercial reasons, of all loans pre - viously granted to residents of that country by the head office or other branches. Any such transfer should be treated (to the extent that it is recognised for tax purposes at all) as taking place at the open market value of the debt at the date of the transfer. Some relief has to be taken into account in comput - ing the profits of the permanent establishment since, between separate entities, the value of the debt at the date of transfer would have been taken into account in deciding on the price to be charged and principles of sound accounting require that the book value of the asset should be varied to take into account market values. 15.4 Where loans which have gone bad are transferred, in order that full, but not excessive, relief for such a loss be granted, it is important that the two jurisdictions concerned reach an 224

247 Article 7 Commentary agreement for a mutually consistent basis for granting relief. In such cases, account should be taken of whether the transfer value, at the date of the internal transfer, was the result of mis - taken judgment as to the debtor’s solvency or whether the value at that date reflected an appropriate judgment of the debtor’s position at that time. In the former case, it might be appropriate for the country of the transferring branch to limit relief to the actual loss suffered by the bank as a whole and for the receiv - ing country not to tax the subsequent apparent gain. Where, however, the loan was transferred for commercial reasons from one part of the bank to another and did, after a certain time, improve in value, then the transferring branch should normally be given relief on the basis of the actual value at the time of the transfer. The position is somewhat different where the receiving entity is the head office of a bank in a credit country because normally the credit country will tax the bank on its worldwide profits and will therefore give relief by reference to the total loss suffered in respect of the loan between the time the loan was made and the time it was finally disposed of. In such a case, the transferring branch should receive relief for the period during which the loan was in the hands of that branch by reference to the principles above. The country of the head office will then give relief from double taxation by granting a credit for the tax borne by the branch in the host country. Paragraph 3 16. The first sentence of paragraph 3 of Article 7 reproduces with minor drafting differences the entire text of Article 7, paragraph 3, of the 2008 OECD Model Convention. The rest of the paragraph consists of additional provisions formulated by the former Group of Experts in 1980. These provisions stem from a proposal by members from devel - oping countries, who felt that it would be helpful to include all the necessary definitions and clarifications in the text, with a view, in par - ticular, to assisting developing countries not represented in the Group. Some of those members also felt that provisions prohibiting the deduc - tion of certain expenses should be included in the text of a bilateral tax treaty to make it clear that taxpayers were fully informed about their fiscal obligations. In the course of the discussion it was pointed 225

248 Article 7 Commentary out that the additions to the OECD text would ensure that the per - manent establishment would be able to deduct interest, royalties and other expenses incurred by the head office on behalf of the establish - ment. The Group agreed that if billings by the head office included the full costs, both direct and indirect, then there should not be a further allocation of the executive and administrative expenses of the head office, since that would produce a duplication of such charges on the transfer between the head office and the permanent establishment. It was pointed out that it was important to determine how the price was fixed and what elements of cost it included. Where an international wholesale price was used, it would normally include indirect costs. There was general agreement within the Group that any duplication of costs and expenses should be prevented. 17. The business profits of an enterprise of a Contracting State are exigible to tax in that State alone unless the enterprise carries on busi - ness in the other Contracting State through a permanent establishment situated therein. The profits and gains of the business would be worked out by deducting all expenses related to the business activity, other than capital expenditures which are currently not deductible or expenses of a personal or non-business nature which cannot be attributed to the business of the enterprise. Normally, many countries while consider - ing the question of deductibility of business expenses apply the criteria of such expenditure being wholly, exclusively and necessarily for the purposes of the business. The basic objective in this regard is to ensure that the expenditure claimed as a deduction in determining the taxable profits is relevant, referable and necessary for carrying out the business operations. There has to exist a nexus between the expenditure and the business activity so that the expenditure incurred is justified by business expediency, necessity or efficiency. After it has been determined that an item is deductible under the foregoing criteria, then it should be consid - ered whether there are specific legislative provisions placing a monetary or other ceiling on the deduction of business expenditure, otherwise a claim for deductibility of expenditure will have to be considered in its entirety, without considering the reasonableness of the amount or its impact on the profitability of business operations. 18. The Committee considers that the following part of the Commentary on paragraph 3 of Article 7 of the 2008 OECD Model 226

249 Article 7 Commentary Convention is applicable to the first part of the corresponding para - graph of Article 7 of the United Nations Model Convention: 27. This paragraph clarifies, in relation to the expenses of a permanent establishment, the general directive laid down in - paragraph 2. The paragraph specifically recognises that in cal culating the profits of a permanent establishment allowance is to be made for expenses, wherever incurred, that were in curred for the purposes of the permanent establishment. Clearly in some cases it will be necessary to estimate or to calculate by conventional means the amount of expenses to be taken into account. In the case, for example, of general administrative expenses incurred at the head office of the enterprise, it may be appropriate to take into account a proportionate part based on the ratio that the permanent establishment’s turnover (or perhaps gross profits) bears to that of the enterprise as a whole. Subject to this, it is considered that the amount of expenses to be taken into account as incurred for the purposes of the per - manent establishment should be the actual amount so incurred. The deduction allowable to the permanent establishment for any of the expenses of the enterprise attributed to it does not depend upon the actual reimbursement of such expenses by the permanent establishment. It has sometimes been suggested that the need to reconcile 28. paragraphs 2 and 3 created practical difficulties as paragraph 2 required that prices between the permanent establishment and the head office be normally charged on an arm’s length basis, giving to the transferring entity the type of profit which it might have been expected to make were it deal ing with an independent enterprise, whilst the wording of paragraph 3 suggested that the deduction for expenses in curred for the purposes of permanent establishments should be the actual cost of those expenses, normally without adding any profit element. 29. In fact, whilst the application of paragraph 3 may raise some practical difficulties, especially in relation to the separate enterprise and arm’s length principles underlying paragraph 2, there is no difference of principle between the two paragraphs. Paragraph 3 indicates that in determining the profits of a per - allowed as manent establishment, certain expenses must be 227

250 Article 7 Commentary deductions whilst paragraph 2 provides that the - profits deter paragraph 3 mined in accordance with the rule contained in relating to the deduction of expenses must be those that a separate and distinct enterprise engaged in the same or simi - lar activities under the same or similar conditions would have made. Thus, whilst paragraph 3 provides a rule applicable for the determination of the profits of the permanent establishment, paragraph 2 requires that the profits so determined correspond to the profits that a separate and independent enterprise would have made. Also, paragraph 3 only determines which expenses 30. should be attributed to the permanent establishment for pur - poses of determining the profits attributable to that permanent establishment. It does not deal with the issue of whether those expenses, once attributed, are deductible when computing the taxable income of the permanent establishment since the conditions for the deductibility of expenses are a matter to be determined by domestic law, subject to the rules of Article 24 on Non-discrimination (in particular, paragraphs 3 and 4 of that Article). Despite the above comments, the Committee of Experts notes that some countries may wish to point out in the treaty text that they allow only those deductions that are permitted by their domestic laws. 31. In applying these principles to the practical determina - tion of the profits of a permanent establishment, the question may arise as to whether a particular cost incurred by an enter - prise can truly be considered as an expense incurred for the purposes of the permanent establishment, keeping in mind the separate and independent enterprise principles of paragraph 2. Whilst in general independent enterprises in their dealings with each other will seek to realise a profit and, when transfer - ring property or providing services to each other, will charge such prices as the open market would bear, nevertheless, there are also circumstances where it cannot be considered that a particular property or service would have been obtainable from an independent enterprise or when independent enter - prises may agree to share between them the costs of some activ - ity which is pursued in common for their mutual benefit. In 228

251 Article 7 Commentary these particular circumstances, it may be appropriate to treat any relevant costs incurred by the enterprise as an expense incurred for the permanent establishment. The difficulty arises in making a distinction between these circumstances and the cases where a cost incurred by an enterprise should not be considered as an expense of the permanent establishment and the relevant property or service should be considered, on the basis of the separate and independent enterprises principle, to - have been transferred between the head office and the perma nent establishment at a price including an element of profit. The question must be whether the internal transfer of property and services, be it temporary or final, is of the same kind as those which the enterprise, in the normal course of its business, would have charged to a third party at an arm’s length price, i.e. normally including in the sale price an appropriate profit. by 32. On the one hand, the answer to that question will be in the affirmative if the expense is initially incurred in performing a function the direct purpose of which is to make sales of a spe - cific good or service and to realise a profit through a permanent establishment. On the other hand, the answer will be in the the negative if, on the basis of the facts and circumstances of specific case, it appears that the expense is initially in curred in performing a function the essential purpose of which is to rationalise the overall costs of the enterprise or to increase in a general way its sales. 33. Where goods are supplied for resale whether in a finished state or as raw materials or semi-finished goods, it will normally be appropriate for the provisions of paragraph 2 to apply and for the supplying part of the enterprise to be allocated a profit, measured by reference to arm’s length principles. But there may be exceptions even here. One example might be where goods are not supplied for resale but for temporary use in the trade so that it may be appropriate for the parts of the enterprise which share the use of the material to bear only their share of the cost of such material e.g. in the case of machinery, the depreciation costs that relate to its use by each of these parts. It should of course be remembered that the mere purchase of goods does not constitute a permanent establishment (subparagraph 4 d) of 229

252 Article 7 Commentary Article 5) so that no question of attribution of profits arises in such circumstances. 34. In the case of intangible rights, the rules concerning the payment relations between enterprises of the same group ( e.g. of royalties or cost sharing arrangements) cannot be applied in respect of the relations between parts of the same enterprise. Indeed, it may be extremely difficult to allocate “ownership” of the intangible right solely to one part of the enterprise and to argue that this part of the enterprise should receive royalties from the other parts as if it were an independent enterprise. Since there is only one legal entity it is not possible to allocate legal ownership to any particular part of the enterprise and in practical terms it will often be difficult to allocate the costs of creation exclusively to one part of the enterprise. It may there - fore be preferable for the costs of creation of intangible rights to be regarded as attributable to all parts of the enterprise which will make use of them and as incurred on behalf of the various parts of the enterprise to which they are relevant accordingly. In such circumstances it would be appropriate to allocate between the various parts of the enterprise the actual costs of the crea - tion or acquisition of such intangible rights as well as the costs subsequently incurred with respect to these intangible rights, without any mark-up for profit or royalty. In so doing, tax authorities must be aware of the fact that the possible adverse consequences deriving from any research and development activity ( the responsibility related to the products and dam - e.g. ages to the environment) shall also be allocated to the various parts of the enterprise, therefore giving rise, where appropriate, to a compensatory charge. 35. The area of services is the one in which difficulties may arise in determining whether in a particular case a service should be charged between the various parts of a single enter - prise at its actual cost or at that cost plus a mark-up to represent a profit to the part of the enterprise providing the service. The trade of the enterprise, or part of it, may consist of the provision of such services and there may be a standard charge for their provision. In such a case it will usually be appropriate to charge a service at the same rate as is charged to the outside customer. 230

253 Article 7 Commentary 36. Where the main activity of a permanent establishment to provide specific services to the enterprise is to which it longs and where these services provide a real advantage to be the enterprise and their costs represent a significant part of the expenses of the enterprise, the host country may require that a profit margin be included in the amount of the costs. As far as possible, the host country should then try to avoid schematic solutions and rely on the value of these services in the given circumstances of each case. 37. However , more commonly the provision of services is merely part of the general management activity of the company taken as a whole as where, for example, the enterprise conducts a common system of training and employees of each part of the enterprise benefit from it. In such a case it would usually be appropriate to treat the cost of providing the service as being part of the general administrative expenses of the enterprise as a whole which should be allocated on an actual cost basis to the various parts of the enterprise to the extent that the costs are incurred for the purposes of that part of the enter prise, without any mark-up to represent profit to another part of the enterprise. 38. The treatment of services performed in the course of the general management of an enterprise raises the question whether any part of the total profits of an enterprise should be deemed to arise from the exercise of good manage ment. Consider the case of a company that has its head office in one country but carries on all its business through a permanent establishment situated in another country. In the extreme case it might well be that only the directors’ meetings were held at the head office and that all other activities of the company apart from purely formal legal activities, were carried on in the per - manent estab lishment. In such a case there is something to be said for the view that at least part of the profits of the whole enterprise arose from the skillful management and business acumen of the directors and that part of the profits of the enter - prise ought, therefore, to be attributed to the country in which the head office was situated. If the company had been managed by a managing agency, then that agency would doubtless have charged a fee for its services and the fee might well have been a 231

254 Article 7 Commentary simple percentage participation in the profits of the enterprise. But whatever the theoretical merits of such a course, practical consider ations weigh heavily against it. In the kind of case quoted the expenses of management would, of course, be set lishment in accord against the profits of the permanent estab - ance with the provisions of paragraph 3, but when the matter is looked at as a whole, it is thought that it would not be right to go further by deducting and taking into account some notional agement”. In cases identical to the figure for “profits of man extreme case mentioned above, no account should therefore be taken in determining taxable profits of the permanent estab - lishment of any notional figure such as profits of management. 39. It may be, of course, that countries where it has been customary to allocate some proportion of the total profits of an enterprise to the head office of the enterprise to represent the profits of good management will wish to continue to make such an allocation. Nothing in the Article is designed to pre - vent this. Nevertheless , it follows from what is said in paragraph 38 above that a country in which a permanent establishment is situated is in no way required to deduct when calculating the profits attributable to that permanent establishment an amount intended to represent a proportionate part of the profits of man - agement attributable to the head office. 40. It might well be that if the country in which the head office of an enterprise is situated allocates to the head office some percentage of the profits of the enterprise only in respect of good management, while the country in which the perma - nent establishment is situated does not, the resulting total of the amounts charged to tax in the two countries would be greater than it should be. In any such case the country in which the head office of the enterprise is situated should take the initiative in arranging for such adjustments to be made in computing the taxation liability in that country as may be necessary to ensure that any double taxation is eliminated. 41. The treatment of interest charges raises particular issues. First, there might be amounts which, under the name of interest, are charged by a head office to its permanent establishment with respect to internal “loans” by the former to the latter. Except for 232

255 Article 7 Commentary financial enterprises such as banks, it is generally agreed that such internal “interest” need not be recognised. This is because: — From the legal standpoint, the transfer of capital against payment of interest and an undertaking to repay in full at the due date is really a formal act incompatible with the true legal nature of a permanent establishment. From the economic standpoint, internal debts and receiv - — ables may prove to be non existent, since if an enterprise is solely or predominantly equity funded it ought not to - be allowed to deduct interest charges that it has man ifestly not had to pay. Whilst, admittedly, symmetrical charges and returns will not distort the enterprise’s over - all profits, partial results may well be arbitrarily changed. 42. For these reasons, the ban on deductions for internal debts and receivables should continue to apply generally, sub - ject to the special situation of banks, as mentioned below. A different issue, however, is that of the deduction of inter - 43. est on debts actually incurred by the enterprise. Such debts may relate in whole or in part to the activities of the permanent estab - lishment; indeed, loans contracted by an enterprise will serve either the head office, the permanent establishment or both. The question that arises in relation to these debts is how to determine the part of the interest that should be deducted in computing the profits attributable to the permanent establishment. The approach 44. [...] before 1994, namely the suggested direct and indirect apportionment of actual debt charges, did not prove to be a practical solution, notably since it was unlikely to be applied in a uniform manner. Also, it is well known that the indirect apportionment of total interest payment charges, or of the part of interest that remains after certain direct allo - cations, comes up against practical difficulties. It is also well known that direct apportionment of total interest expense may not accurately reflect the cost of financing the permanent estab - lishment because the taxpayer may be able to control where loans are booked and adjustment may need to be made to reflect economic reality, in particular the fact that an independent enterprise would normally be expected to have a certain level of “free” capital. 233

256 Article 7 Commentary Consequently, the Committee of Experts considers it preferable to look - for a practical solution. This would take into account a capital struc ture appropriate to both the organization and the functions performed taking into account the need to recognize that a distinct, separate and independent enterprise should be expected to have adequate funding. Paragraph 4 19. This paragraph reproduces Article 7, paragraph 4, of the 2008 OECD Model Convention. The Committee considers that the follow - ing part of the Commentary on paragraph 4 of Article 7 of the 2008 - OECD Model Convention is applicable to the corresponding para graph of Article 7 of the United Nations Model Convention: 52. It has in some cases been the practice to determine the profits to be attributed to a permanent establishment not on the basis of separate accounts or by making an estimate of arm’s length profit, but simply by apportioning the total profits of the enterprise by reference to various formulae. Such a method dif - fers from those envisaged in paragraph 2, since it contemplates not an attribution of profits on a separate enterprise footing, but an apportionment of total profits; and indeed it might produce a result in figures which would differ from that which would be arrived at by a computation based on separate accounts. Paragraph 4 makes it clear that such a method may continue to be employed by a Contracting State if it has been custom - ary in that State to adopt it, even though the figure arrived at may at times differ to some extent from that which would be obtained from separate accounts, provided that the result can fairly be said to be in accordance with the principles contained in the Article. It is emphasized, however, that in general the profits to be attributed to a permanent establishment should be determined by reference to the establishment’s accounts if these reflect the real facts. It is considered that a method of allo - cation which is based on apportioning total profits is generally not as appropriate as a method which has regard only to the activities of the permanent establishment and should be used only where, exceptionally, it has as a matter of history been cus - tomary in the past and is accepted in the country concerned both by the taxation authorities and taxpayers generally there 234

257 Article 7 Commentary as being satisfactory. It is understood that paragraph 4 may be - deleted where neither State uses such a method. Where, how ever, Contracting States wish to be able to use a method which has not been customary in the past the paragraph should be amended during the bilateral negotiations to make this clear. 54. The essential character of a method [for apportioning] total profits is that a proportionate part of the profits of the whole enterprise is allocated to a part thereof, all parts of the enterprise being assumed to have contributed on the basis of the criterion or criteria adopted to the profitability of the whole. The difference between one such method and another arises for the most part from the varying criteria used to determine what is the correct proportion of the total profits [...]. [T]he criteria commonly used can be grouped into three main categories, namely those which are based on the receipts of the enterprise, its expenses or its cap - ital structure. The first category covers allocation methods based on turnover or on commission, the second on wages and the third on the proportion of the total working capital of the enterprise allocated to each branch or part. It is not, of course, possible to say in vacuo that any of these methods is intrinsically more accurate than the others; the appropriateness of any particular method will depend on the circumstances to which it is applied. - In some enterprises, such as those providing services or produc ing proprietary articles with a high profit margin, net profits will depend very much on turnover. For insurance enterprises it may - be appropriate to make an apportionment of total profits by ref erence to premiums received from policy holders in each of the countries concerned. In the case of an enterprise manufacturing goods with a high-cost raw material or labour content, profits may be found to be related more closely to expenses. In the case of banking and financial concerns the proportion of total work - ing capital may be the most relevant criterion. [...] [T]he general aim of any method [for apportioning] total profits ought to be to produce figures of taxable profit that approximate as closely as possible to the figures that would have been produced on a sepa - rate accounts basis, and that it would not be desirable to attempt in this connection to lay down any specific directive other than that it should be the responsibility of the taxation authority, in consultation with the authorities of other countries concerned, 235

258 Article 7 Commentary to use the method which in the light of all the known facts seems most likely to produce that result. 55. The use of any method which allocates to a part of an enterprise a proportion of the total profits of the whole does, of course, raise the question of the method to be used in comput - ing the total profits of the enterprise. This may well be a matter which will be treated differently under the laws of different countries. This is not a problem which it would seem practica - to attempt to resolve by laying down any rigid rule. It is ble its scarcely to be expected that it would be accepted that the prof puted to be apportioned should be the profits as they are com under the laws of one particular country; each country con - cerned would have to be given the right to compute the profits according to the provisions of its own laws. Paragraph 5 20. This paragraph reproduces Article 7, paragraph 6, of the 2008 OECD Model Convention. The Committee considers that the follow - ing part of the Commentary on paragraph 6 of Article 7 of the 2008 OECD Model Convention is applicable to the corresponding para - graph of Article 7 of the United Nations Model Convention: 58. This paragraph is intended to lay down clearly that a method of allocation once used should not be changed merely because in a particular year some other method produces more favourable results. One of the purposes of a double taxation convention is to give an enterprise of a Contracting State some degree of certainty about the tax treatment that will be accorded to its permanent establishment in the other Contracting State as well as to the part of it in its home State which is dealing with the permanent establishment; for this reason, paragraph 6 gives an assurance of continuous and consistent tax treatment. Paragraph 6 21. This paragraph reproduces Article 7, paragraph 7, of the 2008 OECD Model Convention. The Committee considers that the follow - ing part of the Commentary on paragraph 7 of Article 7 of the 2008 236

259 Article 7 Commentary OECD Model Convention is applicable to the corresponding para - graph of Article 7 of the United Nations Model Convention: 59. Although it has not been found necessary in the Convention to define the term “profits”, it should nevertheless be understood that the term when used in this Article and elsewhere in the Convention has a broad meaning including all income derived in carrying on an enterprise. Such a broad meaning corresponds to the use of the term made in the tax laws of most OECD member countries. This interpretation of the term “profits”, however, may give 60. rise to some uncertainty as to the application of the Convention. If the profits of an enterprise include categories of income which are treated separately in other Articles of the Convention, e.g. dividends, it may be asked whether the taxation of those profits is governed by the special Article on dividends etc., or by the provisions of this Article. 61. To the extent that an application of this Article and the special Article concerned would result in the same tax treat - ment, there is little practical significance to this question. Further, it should be noted that some of the special Articles contain specific provisions giving priority to a specific Article (cf. paragraph 4 of Article 6, paragraph 4 of Articles 10 and 11, paragraph [4] of Article 12 and paragraph 2 of Article 21). 62. It has seemed desirable, however, to lay down a rule of interpretation in order to clarify the field of application of this Article in relation to the other Articles dealing with a specific category of income. In conformity with the practice generally adhered to in existing bilateral conventions, paragraph 7 gives first preference to the special Articles on dividends, interest etc. It follows from the rule that this Article will be applicable to business profits which do not belong to categories of income covered by the special Articles, and, in addition, to dividends, interest etc. which under paragraph 4 of Articles 10 and 11, par - agraph [4] of Article 12 and paragraph 2 of Article 21, fall within this Article [...]. It is understood that the items of income cov - ered by the special Articles may, subject to the provisions of the Convention, be taxed either separately, or as business profits, in conformity with the tax laws of the Contracting States. 237

260 Articles 7 and 8 Commentary 63. It is open to Contracting States to agree bilaterally upon special explanations or definitions concerning the term “profits” with a view to clarifying the distinction between this term and e.g. the concept of dividends. It may in particular be found appropri - ate to do so where in a convention under negotiation a deviation - has been made from the definitions in the special Articles on div idends, interest and royalties. It may also be deemed desirable if the Contracting States wish to place on notice, that, in agreement with the domestic tax laws of one or both of the States, the term “profits” includes special classes of receipts such as income from the alienation or the letting of a business or of movable property used in a business. In this connection it may have to be consid - ered whether it would be useful to include also additional rules for the allocation of such special profits. 22. It is important to note that in the United Nations Model Convention, payments “for the use of, or the right to use, industrial, commercial or scientific equipment” are treated differently than under the OECD Model Convention. They remain within the definition of “royalties” in paragraph 3 of Article 12 and accordingly by reason of paragraph 6 of Article 7 continue to fall under the provisions of Article 12, rather than those of Article 7. Article 8 INTERNATIONAL SHIPPING AND AIR TRANSPORT A. General considerations 1. Two alternative versions are given for Article 8 of the United Nations Model Convention, namely Article 8 (alternative A) and Article 8 (alternative B). Article 8 (alternative A) reproduces Article 8 of the OECD Model Convention. Article 8 (alternative B) introduces substantive changes to Article 8 (alternative A), dealing separately with profits from the operation of aircraft and profits from the operation of ships in paragraphs 1 and 2, respectively. Paragraph 3 reproduces par - agraph 2 of the 2017 OECD Model, with minor adjustment to reflect the additional paragraph added in alternative B. 238

261 Article 8 Commentary 2. With regard to the taxation of profits from the operation of ships in international traffic, many countries support the position taken in Article 8 (alternative A). In their view, shipping enterprises should not be exposed to the tax laws of the numerous countries to which their operations extend. They argued that if every country taxed a portion of the profits of a shipping line, computed according to its own rules, the sum of those portions might well exceed the total income of the enterprise. Consequently, that would constitute a seri - ous problem, especially because taxes in developing countries could be excessively high, and the total profits of shipping enterprises were frequently quite modest. Other countries asserted that they were not in a position to 3. forgo even the limited revenue to be derived from taxing foreign ship - ping enterprises as long as their own shipping industries were not more fully developed. They recognized, however, that considerable difficulties were involved in determining a taxable profit in such a sit - uation and allocating the profit to the various countries concerned in the course of the operation of ships in international traffic. 4. Since no consensus could be reached on a provision concerning the taxation of shipping profits, the use of two alternatives in the Model Convention is proposed and the question of such taxation should be left to bilateral negotiations. 5. Until 2017, the texts of Article 8 (alternatives A and B) both refer to the “place of effective management of the enterprise”. Taking into account the practice of most countries, the Committee of Experts then decided to follow the wording of other Articles and to refer instead to an “enterprise of a Contracting State” and the Article (alter - natives A and B) was changed accordingly. Some countries may, how - ever, prefer to continue to use the previous formulation and to refer to the “State in which the place of effective management of the enterprise i s sit u ate d ”. 6. Although there was a consensus to recommend Articles 8 (alter - natives A and B) as alternatives, some countries who could not agree to Article 8 (alternative A) also could not agree to Article 8 (alternative B) because of the phrase “more than casual”. They argued that some countries might wish to tax either all shipping profits or all airline 239

262 Article 8 Commentary profits, and acceptance of Article 8 (alternative B) might thus lead to a revenue loss, considering the limited number of shipping companies or airlines that are enterprises of those States. Again, in such cases taxation should be left to bilateral negotiations. 7. Depending on the frequency or volume of cross-border traffic, countries may, during bilateral negotiations, wish to extend the pro - visions of Article 8 to cover rail or road transport. As explained in paragraph 15 below, they may also want to cover inland waterways transport. 8. [Renumbered] B. Commentary on the paragraphs of article 8 (alternatives A and B) Paragraph 1 of Article 8 (alternative A) 9. This paragraph, which reproduces Article 8, paragraph 1, of the 2017 OECD Model Convention, has the objective of ensuring that prof - its from the operation of ships or aircraft in international traffic will be taxed in one State alone. The paragraph’s effect is that these profits are wholly exempt from tax at source and are taxed exclusively in the Contracting State of the enterprise engaged in international traffic. It provides an independent operative rule for these activities and is not qualified by Articles 5 and 7 relating to business profits governed by the permanent establishment rule. The exemption from tax in the source country is predicated largely on the premise that the income of these shipping enterprises is earned on the high seas, that exposure to the tax laws of numerous countries is likely to result in double taxa - tion or at best in difficult allocation problems, and that exemption in places other than the home country ensures that the enterprises will not be taxed in foreign countries if their overall operations turn out to be unprofitable. Considerations relating to international air traffic are similar. Since a number of countries with water boundaries do not have resident shipping companies but do have ports used to a signifi - cant extent by ships from other countries, they have traditionally dis - agreed with the principle of such an exemption of shipping profits and would argue in favour of alternative B. 240

263 Article 8 Commentary 10. The Commentary on the 2017 OECD Model Convention notes that while paragraph 1 is based on the principle that the taxing right shall be left to the Contracting State of the enterprise, some countries may wish to refer instead to the place of effective management of the enterprise and draft the paragraph along the following lines: Profits from the operation of ships or aircraft in international traffic shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated. Countries wishing to refer to the “place of effective manage - 10.1 ment of the enterprise” in paragraph 1 may also want to deal with the particular case where the place of effective management of the enter - prise is aboard a ship, which could be done by adding the following provision: If the place of effective management of a shipping enterprise is aboard a ship, then it shall be deemed to be situated in the Contracting State in which the home harbour of the ship is sit - uated, or, if there is no such home harbour, in the Contracting State of which the operator of the ship is a resident. 10.2 - Referring to the meaning of the term “profits from the opera tion of ships or aircraft in international traffic”, the Commentary on the 2017 OECD Model Convention sets down two categories of profits which should fall within the scope of paragraph 1 of Article 8. The first relates to profits directly obtained by the enterprise from the car - riage of passengers or cargo in international traffic, and the second to profits from activities to permit, facilitate or support international traffic operations. Within the second category the Commentary dis - tinguishes two different types of activities: those directly connected with such operations and those not directly connected but “ancillary” to such operations. The Commentary notes as follows: 4. The profits covered consist in the first place of the profits directly obtained by the enterprise from the transportation of passengers or cargo by ships or aircraft (whether owned, leased or otherwise at the disposal of the enterprise) that it operates in international traffic. However, as international transport has evolved, shipping and air transport enterprises invariably carry on a large variety of activities to permit, facilitate or support 241

264 Article 8 Commentary their international traffic operations. The paragraph also covers profits from activities directly connected with such operations as well as profits from activities which are not directly con - nected with the operation of the enterprise’s ships or aircraft in international traffic as long as they are ancillary to such operation. 4.1 Any activity carried on primarily in connection with the transportation, by the enterprise, of passengers or cargo by ships or aircraft that it operates in international traffic should be considered to be directly connected with such transportation. Activities that the enterprise does not need to carry on for 4.2 the purposes of its own operation of ships or aircraft in inter - national traffic but which make a minor contribution relative to such operation and are so closely related to such operation that they should not be regarded as a separate business or source of income of the enterprise should be considered to be ancillary to the operation of ships and aircraft in international traffic. 11. Applying the principles set out above, the Commentary on the 2017 OECD Model Convention deals with a number of activities in relation to the extivered in the country of destination by any mode of inland transportation operated by other enterprises. In such a case, any profits derived by the first enterprise from arranging such transportation by other enterprises are covered by the paragraph even though the profits derived by the other enterprises that provide such inland transportation would not be. 5. Profits obtained by leasing a ship or aircraft on charter fully equipped, crewed and supplied must be treated like the profits from the carriage of passengers or cargo. Otherwise, a great deal of business of shipping or air transport would not come within the scope of the provision. However, Article [12], and not Article 8, applies to profits from leasing a ship or air - craft on a bare boat charter basis except when it is an ancillary activity of an enterprise engaged in the international operation of ships or aircraft. 6. Profits derived by an enterprise from the transportation of passengers or cargo otherwise than by ships or aircraft that it operates in international traffic are covered by the paragraph 242

265 Article 8 Commentary to the extent that such transportation is directly connected with - the operation, by that enterprise, of ships or aircraft in inter national traffic or is an ancillary activity. One example would be that of an enterprise engaged in international transport that - would have some of its passengers or cargo transported inter nationally by ships or aircraft operated by other enterprises, e.g. under code-sharing or slotchartering arrangements or to take advantage of an earlier sailing. Another example would be that of an airline company that operates a bus service connecting a town with its airport primarily to provide access to and from that airport to the passengers of its international flights. A further example would be that of an enterprise that 7. transports passengers or cargo by ships or aircraft operated in international traffic which undertakes to have those passengers or that cargo picked up in the country where the transport orig - inates or transported or delivered in the country of destination by any mode of inland transportation operated by other enter - prises. In such a case, any profits derived by the first enterprise from arranging such transportation by other enterprises are covered by the paragraph even though the profits derived by the other enterprises that provide such inland transportation would not be. An enterprise will frequently sell tickets on behalf of 8. other transport enterprises at a location that it maintains pri - marily for purposes of selling tickets for transportation on ships or aircraft that it operates in international traffic. Such sales of tickets on behalf of other enterprises will either be directly con - nected with voyages aboard ships or aircraft that the enterprise operates (e.g. sale of a ticket issued by another enterprise for the domestic leg of an international voyage offered by the enter - prise) or will be ancillary to its own sales. Profits derived by the first enterprise from selling such tickets are therefore covered by the paragraph. 8.1 Advertising that the enterprise may do for other enter - prises in magazines offered aboard ships or aircraft that it oper - ates or at its business locations (e.g. ticket offices) is ancillary to its operation of these ships or aircraft and profits generated by such advertising fall within the paragraph. 243

266 Article 8 Commentary 9. - Containers are used extensively in international trans - port. Such containers frequently are also used in inland trans port. Profits derived by an enterprise engaged in international transport from the lease of containers which are usually either directly connected or ancillary to its operation of ships or air - craft in international traffic and in such cases fall within the scope of the paragraph. The same conclusion would apply with respect to profits derived by such an enterprise from the short-term storage of such containers (e.g. where the enterprise - charges a customer for keeping a loaded container in a ware house pending delivery) or from detention charges for the late return of containers. 10. An enterprise that has assets or personnel in a foreign country for purposes of operating its ships or aircraft in interna - tional traffic may derive income from providing goods or services in that country to other transport enterprises. This would include (for example) the provision of goods and services by engineers, ground and equipment maintenance staff, cargo handlers, cater - ing staff and customer services personnel. Where the enterprise provides such goods to, or performs services for, other enterprises and such activities are directly connected or ancillary to the enterprise’s operation of ships or aircraft in international traffic, the profits from the provision of such goods or services to other enterprises will fall under the paragraph. 10.1 - For example, enterprises engaged in international trans port may enter into pooling arrangements for the purposes of reducing the costs of maintaining facilities needed for the oper - ation of their ships or aircraft in other countries. For instance, where an airline enterprise agrees, under an International Airlines Technical Pool agreement, to provide spare parts or maintenance services to other airlines landing at a particular location (which allows it to benefit from these services at other locations), activities carried on pursuant to that agreement will be ancillary to the operation of aircraft in international traffic. 11. [Deleted] 12. The paragraph does not apply to a shipbuilding yard operated in one country by a shipping enterprise having its place of effective management in another country. 244

267 Article 8 Commentary 13. [Renumbered] 14. Investment income of shipping, inland waterways or air transport enterprises (e.g. income from stocks, bonds, shares or loans) is to be subjected to the treatment ordinarily applied to this class of income, except where the investment that generates the income is made as an integral part of the carrying on of the busi - ness of operating the ships or aircraft in international traffic in the Contracting State so that the investment may be considered to be directly connected with such operation. Thus, the paragraph would apply to interest income generated, for example, by the cash required in a Contracting State for the carrying on of that business or by bonds posted as security where this is required by law in order to carry on the business: in such cases, the invest - ment is needed to allow the operation of the ships or aircraft at that location. The paragraph would not apply, however, to inter - est income derived in the course of the handling of cash-flow or other treasury activities for permanent establishments of the enterprise to which the income is not attributable or for associ - ated enterprises, regardless of whether these are located within or outside that Contracting State, or for the head office (central - isation of treasury and investment activities), nor would it apply to interest income generated by the short-term investment of the profits generated by the local operation of the business where the funds invested are not required for that operation. 14.1 Enterprises engaged in the operation of ships or aircraft in international traffic may be required to acquire and use emissions permits and credits for that purpose (the nature of these permits and credits is explained in paragraph 75.1 of the Commentary on Article 7). Paragraph 1 applies to income derived by such enterprises with respect to such permits and credits where such income is an integral part of carrying on the business of operating ships or aircraft in international traffic, e.g. where permits are acquired for the purpose of operating ships or aircraft or where permits acquired for that purpose are subsequently traded when it is realised that they will not be needed. 11.1 Some members do not fully agree with the interpretation of “profits from the operation of ships or aircraft in international traffic” 245

268 Article 8 Commentary in paragraphs 10.2 and 11 of this Commentary. Some of those mem - bers consider that activities of an ancillary nature are not covered by the text of Article 8 as such activities are not mentioned in the text - of that article of the United Nations Model Convention. Others con sider that only some of the examples given in the OECD Commentary quoted above will not fall within the definition of “profits from the operation of ships or aircraft in international traffic”. Paragraph 1 of Article 8 (alternative B) This paragraph reproduces Article 8, paragraph 1, of the OECD 12. Model Convention, with the deletion of the words “ships or”. Thus the paragraph does not apply to the taxation of profits from the operation of ships in international traffic but does apply to the taxation of prof - its from the operation of aircraft in international traffic. Hence the Commentary on paragraph 1 of Article 8 (alternative A) is relevant in so far as aircraft are concerned. Paragraph 2 of Article 8 (alternative B) 13. This paragraph allows profits from the operation of ships in inter - national traffic to be taxed in the source country if operations in that - country are “more than casual”. It also provides an independent opera tive rule for the shipping business and is not qualified by Articles 5 and 7 relating to business profits governed by the permanent establishment rule. It covers both regular or frequent shipping visits and irregular or isolated visits, provided the latter were planned and not merely fortui - tous. The phrase “more than casual” means a scheduled or planned visit of a ship to a particular country to pick up freight or passengers. 14. The overall net profits should, in general, be determined by the authorities of the State of the enterprise (or the State in which the place of effective management of the enterprise is situated). The final condi - tions of the determination might be decided in bilateral negotiations. In the course of such negotiations, it might be specified, for exam - ple, whether the net profits are to be determined before the deduction of special allowances or incentives which could not be assimilated to depreciation allowances but could be considered rather as subsi - dies to the enterprise. It might also be specified in the course of the 246

269 Article 8 Commentary bilateral negotiations that direct subsidies paid to the enterprise by a - Government should be included in net profits. The method for the rec ognition of any losses incurred during prior years, for the purpose of the determination of net profits, might also be worked out in the nego - tiations. In order to implement that approach, the country of residence would furnish a certificate indicating the net shipping profits of the enterprise and the amounts of any special items, including prior-year losses, which in accordance with the decisions reached in the negoti - ations were to be included in, or excluded from, the determination of the net profits to be apportioned or otherwise specially treated in that determination. The allocation of profits to be taxed might be based on some proportional factor specified in the bilateral negotiations, pref - erably the factor of outgoing freight receipts (determined on a uniform basis with or without the deduction of commissions). The percentage reduction in the tax computed on the basis of the allocated profits is intended to achieve a sharing of revenues that would reflect the mana - gerial and capital inputs originating in the country of residence. Operation of boats engaged in inland waterways transport 15. Profits of an enterprise of a Contracting State derived from inland waterways transport fall within the scope of paragraph 1 of Article 8 (Alternative A) or paragraph 2 of Article 8 (Alternative B) only to the extent that such transport constitutes international traffic pursuant to the definition of that term in Article 3. Some countries (e.g. countries where foreign enterprises are allowed to carry on cabo - tage operations on a river that flows through them) may wish, how - ever, to extend the treatment provided for in paragraph 1 of Article 8 (Alternative A) to the profits derived from any transport on rivers, canals and lakes; these countries may do so by including the following provision in their bilateral treaties: Profits of an enterprise of a Contracting State from the oper - ation of boats engaged in inland waterways transport shall be taxable only in that State. Where such a provision is included, the title of Article 8 should logi - cally be amended to read “Shipping, inland waterways transport and air transport”. 247

270 Article 8 Commentary 15.1 Other countries, however, consider that inland waterways transport that does not constitute international traffic should not be treated differently from other business activities taking place within their borders. These countries consider that although it is possible that inland waterways transport that does not constitute international traf - fic could give rise to problems of double taxation, such problems can be addressed through the rules of Articles 7 and 23 A or 23 B in the cases where foreign enterprises are allowed to carry on such transpor - tation activities. 16. The rules set out in paragraphs 9 to 11.1 above relating to taxing rights and profits covered apply equally to the alternative provision set forth in paragraph 15 above. The 2017 Commentary on the OECD Model Convention also notes as follows: 16. The above provision would apply not only to inland water - ways transport between two or more countries (in which case it would overlap with paragraph 1), but also to inland waterways transport carried on by an enterprise of one State between two points in another State. The alternative formulation set forth in paragraph 2 above according to which the taxing right would be granted to the State in which the place of effective management of the enterprise is situated also applies to the above provision. If this alternative provision is used, it would be appropriate to add a reference to “boats engaged in inland waterways trans - port” in paragraph 3 of Articles 13 and 22 in order to ensure that such boats are treated in the same way as ships and aircraft operated in international traffic (see also paragraph 9.3 of the Commentary on Article 15). Also, the principles and examples included in paragraphs 4 and 14 above would be applicable, with the necessary adaptations, for purposes of determining which profits may be considered to be derived from the oper - ation of boats engaged in inland waterways transport. Specific tax problems which may arise in connection with inland water - ways transport, in particular between adjacent countries, could also be settled specially by bilateral agreement. 17. Whilst the above alternative provision uses the word “boat” with respect to inland waterways transport, this reflects a traditional distinction that should not be interpreted to restrict in any way the meaning of the word “ship” used throughout the 248

271 Article 8 Commentary Convention, which is intended to be given a wide meaning that covers any vessel used for water navigation. 18. - It may also be agreed bilaterally that profits from the oper ation of vessels engaged in fishing, dredging or hauling activities on the high seas be treated as income falling under this Article. Enterprises not exclusively engaged in shipping or air transport. With regard to enterprises not exclusively engaged in shipping 17. or air transport, the Commentary on Article 8 of the 2017 OECD Model Convention observes: 19. - It follows from the wording of paragraph 1 that enter prises not exclusively engaged in shipping or air transport nevertheless come within the provisions of this paragraph as regards profits arising to them from the operation of ships or aircraft belonging to them. 20. If such an enterprise has in a foreign country permanent establishments exclusively concerned with the operation of its ships or aircraft, there is no reason to treat such establishments differently from the permanent establishments of enterprises engaged exclusively in shipping or air transport. 21. Nor does any difficulty arise in applying the provisions of paragraph 1 if the enterprise has in another State a permanent establishment which is not exclusively engaged in shipping or goods are carried in its own ships to a per air transport. If its - manent establish ment belonging to it in a foreign country, it is right to say that none of the profit obtained by the enterprise properly be taxed in the through acting as its own carrier can State where the permanent establishment is situated. The same must be true even if the permanent establishment maintains installations for operating the ships or aircraft ( e.g. consign - ment wharves) or incurs other costs in connection with the carriage of the enterprise’s goods ( e.g. staff costs). In this case, even though certain functions related to the operation of ships and aircraft in international traffic may be performed by the permanent establishment, the profits attributable to these func - tions are taxable exclusively in the State to which the enterprise belongs. Any expenses, or part thereof, incurred in performing 249

272 Article 8 Commentary such functions must be deducted in computing that part of the - profit that is not taxable in the State where the permanent estab lishment is located and will not, therefore, reduce the part of the profits attributable to the permanent establishment which may be taxed in that State pursuant to Article 7. 22. Where ships or aircraft are operated in international traf - fic, the application of the alternative formulation in paragraph [10] above to the profits arising from such operation will not be affected by the fact that the ships or aircraft are operated by a permanent establishment which is not the place of effective management of the whole enterprise; thus, even if such prof - its could be attributed to the permanent establishment under Article 7, they will only be taxable in the State in which the place of effective management of the enterprise is situated [...]. 18. [Deleted] Paragraph 2 of Article 8 (alternative A) and paragraph 3 of Article 8 (alternative B) Paragraph 2 of Article 8 (alternative A) reproduces Article 8, 19. paragraph2, of the OECD Model Convention. Paragraph 3 of Article 8 (alternative B) also reproduces the latter paragraph, with one adjust - ment, namely, the replacement of the phrase “paragraph 1” by the words “paragraphs 1 and 2”. As the Commentary on the OECD Model Convention observes: 23. Various forms of international co-operation exist in ship - ping or air transport. In this field international co-operation is secured through pooling agreements or other conventions of a similar kind which lay down certain rules for apportioning the receipts (or profits) from the joint business. 24. In order to clarify the taxation position of the participant in a pool, joint business or in an international operating agency and to cope with any difficulties which may arise the Contracting States may bilaterally add the following, if they find it necessary: ... but only to so much of the profits so derived as is attrib - utable to the participant in proportion to its share in the joint operation. 250

273 Article 9 Commentary Article 9 ASSOCIATED ENTERPRISES A. General considerations Article 9 of the United Nations Model Convention reproduces 1. Article 9 of the OECD Model Convention, except for paragraph 3. Both Models embody the arm’s length principle that forms the basis for allocating profits resulting from transactions between associated enterprises. Article 9 should be considered in conjunction with Article 25 on mutual agreement procedure and Article 26 on exchange of information. The application of the arm’s length principle for the allocation 2. of profits between the associated enterprises presupposes for most countries that the domestic legislation authorizes a determination on the basis of the arm’s length principle. 3. It is noted that the Commentary of the OECD Model Convention includes the following general statement on the Article: 1. This Article deals with adjustments to profits that may be made for tax purposes where transactions have been entered into between associated enterprises (parent and subsidiary companies and companies under common control) on other than arm’s length terms. The Committee has spent considerable time and effort (and continues to do so) examining the condi - tions for the application of this Article, its consequences and the various methodologies which may be applied to adjust profits where transactions have been entered into on other than arm’s length terms. Its conclusions are set out in the report entitled Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations , which is periodically updated to reflect the progress of the work of the Committee in this area. 4. The OECD Commentary continues by stating that the Tra n s f e r Pricing Guidelines for Multinational Enterprises and Tax Administrations “represen[t] internationally agreed principles and provid[e]s guidelines for the application of the arm’s length principle of which th[e]is Article is the authoritative statement.” The Committee considers that those 251

274 Article 9 Commentary guidelines contain valuable guidance relevant for the application of the - arm’s length principle under Article 9 of bilateral tax conventions fol lowing the two Models. The Committee also considers it to be highly important for avoiding international double taxation of corporate profits that a common understanding prevails on how the arm’s length prin - ciple should be applied, and that the two Model Conventions provide a common framework for preventing and resolving transfer pricing dis - putes where they would occur. With that aim in mind the Committee has developed the United Nations Practical Manual on Transfer Pricing for Developing Countries which pays special attention to the experience of developing countries, reflects the realities for such countries, at their relevant stages of capacity development, and seeks consistency with the guidance provided by the OECD Transfer Pricing Guidelines. B. Commentary on the paragraphs of article 9 Paragraph 1 5. Paragraph 1 provides that in cases involving associated enter - prises, the tax authorities of Contracting States may for the purpose of calculating tax liabilities rewrite the accounts of the enterprises if as a result of the special relationship between the enterprises the accounts do not show the true taxable profits arising in those States. It is evidently appropriate that an adjustment should be sanctioned in such circum - stances. The provision applies only if special conditions have been made or imposed between the two enterprises. Clearly no re-writing of the accounts with a consequential adjustment should be made if the trans - actions between the associated enterprises have taken place on a normal open market commercial basis, in other words, at arm’s length. 6. In the OECD Committee on Fiscal Affairs’ Report on “Thin 31 Capitalisation”, it is stated that there is an interplay between tax treaties and domestic rules on thin capitalization which is relevant to the scope of the Article. As noted in paragraph 3 of the OECD Commentary on Article 9: 31 Adopted by the Council of the OECD on 26 November 1986 and reproduced in volume II of the full-length version of the OECD Model Tax Convention at page R(4)-1. 252

275 Article 9 Commentary a) The Article does not prevent the application of national rules on thin capitalisation insofar as their effect is to assimilate the profits of the borrower to an amount cor - responding to the profits which would have accrued in an arm’s length situation; b) The Article is relevant not only in determining whether the rate of interest provided for in a loan contract is an arm’s prima facie loan can be length rate, but also whether a regarded as a loan or should be regarded as some other kind of payment, in particular a contribution to equity capital; The application of rules designed to deal with thin capitali - c) sation should normally not have the effect of increasing the taxable profits of the relevant domestic enterprise to more than the arm’s length profit, and that this principle should be followed in applying existing tax treaties. The OECD Commentary continues: 4. The question arises as to whether special procedural rules which some countries have adopted for dealing with transactions between related parties are consistent with the Convention. For instance, it may be asked whether the reversal of the burden of proof or presumptions of any kind which are sometimes found in domestic laws are consistent with the arm’s length principle. A number of countries interpret the Article in such a way that it by no means bars the adjustment of profits under national law under conditions that differ from those of the Ar ticle and that it has the function of raising the arm’s length principle at treaty level. Also, almost all member coun - tries consider that additional information requirements which would be more stringent than the normal requirements, or even a reversal of the burden of proof, would not constitute discrimination within the meaning of Article 24. However, in some cases the application of the national law of some coun - tries may result in adjustments to profits at variance with the principles of the Article. Contracting States are enabled by the Article to deal with such situations by means of correspond - ing adjustments (see below) and under mutual agreement procedures. 253

276 Article 9 Commentary Paragraph 2 In the words of the OECD Commentary, “The re-writing of 7. transactions between associated enterprises in the situation envisaged in paragraph 1 may give rise to economic double taxation (taxation of the same income in the hands of different persons), insofar as an enter - prise of State A whose profits are revised upwards will be liable to tax on an amount of profit which has already been taxed in the hands of its associated enterprise in State B.” The OECD Commentary observes that “[p]aragraph 2 provides that in these circumstances, State B shall 32 make an appropriate adjustment so as to relieve the double taxation”. However, according to the OECD Commentary, 6. [...] an adjustment is not automatically to be made in State B simply because the profits in State A have been increased; the adjustment is due only if State B considers that the figure of adjusted profits correctly reflects what the profits would have been if the transactions had been at arm’s length. In other words, the paragraph may not be invoked and should not be applied where the profits of one associated enterprise are increased to a level which exceeds what they would have been if they had been correctly computed on an arm’s length basis. State B is therefore committed to make an adjustment of the profits of the affiliated company only if it considers that the adjustment made in State A is justified both in principle and as regards the amount. 7. The paragraph does not specify the method by which an adjustment is to be made. OECD member countries use differ - ent methods to provide relief in these circumstances and it is therefore left open for Contracting States to agree bilaterally on any specific rules which they wish to add to the Article. Some States, for example, would prefer the system under which, where the profits of enterprise X in State A are increased to what they would have been on an arm’s length basis, the adjustment would be made by re-opening the assessment on the associated enter - prise Y in State B containing the doubly taxed profits in order to reduce the taxable profit by an appropriate amount. Some other States, on the other hand, would prefer to provide that, for 32 Paragraph 5 of the OECD Commentary on Article 9. 254

277 Article 9 Commentary the purposes of Article 23, the doubly taxed profits should be treated in the hands of enterprise Y of State B as if they may be taxed in State A; accordingly, the enterprise of State B is entitled to relief in State B, under Article 23, in respect of tax paid by its associate enterprise in State A. It is not the purpose of the paragraph to deal with what 8. might be called “secondary adjustments”. Suppose that an upward revision of taxable profits of enterprise X in State A has been made in accordance with the principle laid down in paragraph 1 and suppose also that an adjustment is made to the profits of enterprise Y in State B in accordance with the principle laid down in paragraph 2. The position has still not been restored exactly to what it would have been had the transactions taken place at arm’s length prices because, as a matter of fact, the money representing the profits which are the subject of the adjustment is found in the hands of enterprise Y instead of in those of enterprise X. It can be argued that if arm’s length pricing had operated and enterprise X had subsequently wished to transfer these profits to enterprise Y, it would have done so in the form of, for example, a dividend or a royalty (if enterprise Y were the parent of enterprise X) or in the form of, for example, a loan (if enterprise X were the parent of enterprise Y) and that in those circumstances there could have been other tax consequences ( e.g. the operation of a withholding tax) depending upon the type of income concerned and the pro - visions of the Article dealing with such income. 9. These secondary adjustments, which would be required to establish the situation exactly as it would have been if transac - tions had been at arm’s length, depend on the facts of the in di - vidual case. It should be noted that nothing in paragraph 2 prevents such secondary adjustments from being made where they are permitted under the domestic laws of Contracting States. The paragraph also leaves open the question whether 10. there should be a period of time after the expiration of which State B would not be obliged to make an appropriate adjust - ment to the profits of enterprise Y following an upward revision of the profits of enterprise X in State A. Some States consider that State B’s commitment should be open-ended — in other words, that however many years State A goes back to revise 255

278 Article 9 Commentary assessments, enterprise Y should in equity be assured of an appropriate adjustment in State B. Other States consider that an open-ended commitment of this sort is unreasonable as a matter of practical administration. In the circumstances, therefore, this problem has not been dealt with in the text of the Article; but Contracting States are left free in bilateral con - ventions to include, if they wish, provisions dealing with the length of time during which State B is to be under obligation to make an appropriate adjustment [...]. 11. If there is a dispute between the parties concerned over the amount and character of the appropriate adjustment, the mutual agreement procedure provided for under Article 25 should be implemented; the Commentary on that Article con - tains a number of considerations applicable to adjustments of the profits of associated enterprises carried out on the basis of the present Article (following, in particular, adjustment of transfer prices) and to the corresponding adjustments which must then be made in pursuance of paragraph 2 thereof [...]. 8. The view has been expressed that a correlative adjustment under paragraph 2 could be very costly to a developing country which may consider not including paragraph 2 in its treaties. However, paragraph 2 is an essential aspect of Article 9 and failure to provide a correl - ative adjustment will result in double taxation, which is contrary to the purpose of the Convention. A country should closely examine the primary adjustment under paragraph 1 before deciding what correla - tive adjustment is appropriate to reflect the primary adjustment. Some countries take the view that it may be desirable to eliminate the obli - gation that a State may have to make a correlative adjustment when the other Contracting State has previously adjusted the transfer prices. This approach can be achieved by changing the word “shall” to “may”. Contracting States may, during bilateral negotiations, use the word that is convenient. However, there is no consensus on this point and the language of paragraph 2 remains unchanged. Paragraph 3 9. The United Nations Model Convention was amended in 1999 by the insertion of paragraph 3. Paragraph 2 of Article 9 requires a 256

279 Articles 9 and 10 Commentary country to make an “appropriate adjustment” (a correlative adjust - ment) to reflect a change in the transfer price made by a country under Article 9, paragraph 1. Paragraph 3 provides that the provisions of paragraph 2 shall not apply where the judicial, administrative or other legal proceedings have resulted in a final ruling that, by actions giving rise to an adjustment of profits under paragraph 1, one of the enter - prises is liable to penalty with respect to fraud, gross negligence or wilful default. In other words, in case a final order has been passed in a judicial, administrative or other legal proceeding pointing out that in relation to the adjustment of profits under paragraph 1 one of the enterprises is subject to a penalty for fraud, gross negligence or wilful default, there would be no obligation to make the correlative adjustment under paragraph 2. This approach means that a taxpayer may be subject to non-tax and tax penalties. Some countries may con - sider such double penalties as too harsh, but it should be borne in mind that cases involving the levy of such penalties are likely to be exceptional and there would be no application of this provision in a routine manner. 10 Article DIVIDENDS A. General considerations 1. Article 10 of the United Nations Model Convention reproduces the provisions of Article 10 of the OECD Model Convention with the exception of paragraph 2, which contains substantive differences and paragraphs 4 and 5 which refer to independent personal services from a fixed base. Article 10 deals with the taxation of dividends received by a resident of a Contracting State from sources in the other Contracting State. Paragraph 1 provides that dividends may be taxed in the country of residence, and paragraph 2 provides that dividends may be taxed in the country of source, but at a limited tax rate. The term “dividends” is defined in paragraph 3 as generally including distributions of cor - porate profits to shareholders. As the OECD Commentary observes in paragraph 3: “From the shareholders’ standpoint, dividends are income from the capital which they have made available to the company as its 257

280 Article 10 Commentary shareholders.” Paragraph 4 provides that paragraphs 1 and 2 do not apply to dividends that are attributable to a permanent establishment of the recipient in the source country, and paragraph 5 generally pre - cludes a Contracting State from taxing dividends paid by a company resident in the other State unless the shareholder is a resident of the taxing State or the dividends are attributable to a permanent establish - ment of the recipient in that State. B. Commentary on the paragraphs of article 10 Paragraph 1 2. This paragraph, which reproduces Article 10, paragraph 1, of the OECD Model Convention, provides that dividends may be taxed in the State of the beneficiary’s residence. It does not, however, provide that dividends may be taxed exclusively in that State and therefore leaves open the possibility of taxation by the State of which the company paying the dividends is a resident, that is, the State in which the dividends orig - inate (source country). When the United Nations Model Convention was first considered, many members of the former Group of Experts from developing countries felt that as a matter of principle dividends should be taxed only by the source country. According to them, if both the country of residence and the source country were given the right to tax, the country of residence should grant a full tax credit regardless of the amount of foreign tax to be absorbed and, in appropriate cases, a tax-sparing credit. One of those members emphasized that there was no necessity for a developing country to waive or reduce its withholding tax on dividends, especially if it offered tax incentives and other concessions. However, the former Group of Experts reached a consensus that divi - dends may be taxed by the State of the beneficiary’s residence. Current practice in developing/developed country treaties generally reflects this consensus. Double taxation is eliminated or reduced through a combi - nation of exemption or tax credit in the residence country and reduced withholding rates in the source country. 3. According to the Commentary on Article 10, paragraph 1, of the OECD Model Convention, 7. [...] The term “paid” has a very wide meaning, since the concept of payment means the fulfilment of the obligation to 258

281 Article 10 Commentary put funds at the disposal of the shareholder in the manner required by contract or by custom. 8. The Article deals only with dividends paid by a company which is a resident of a Contracting State to a resident of the - other Contracting State. It does not, therefore, apply to divi dends paid by a company which is a resident of a third State or to dividends paid by a company which is a resident of a - Contracting State which are attributable to a permanent estab lish ment which an enterprise of that State has in the other Contracting State . [...] Paragraph 2 4. This paragraph reproduces Article 10, paragraph 2, of the OECD Model Convention with certain changes which will be explained hereunder. 5. The OECD Model Convention restricts the tax in the source country to 5 per cent in subparagraph a) for direct investment div - idends and 15 per cent in subparagraph b) for portfolio investment - dividends, but the United Nations Model Convention leaves these per centages to be established through bilateral negotiations. 6. Prior to the 2017 update, the minimum ownership necessary for direct investment dividends was reduced in subparagraph ( a ) from 25 per cent to 10 per cent. However, the 10 per cent threshold which determines the level of shareholding qualifying as a direct investment was intended to be illustrative only. The former Group of Experts decided to replace “25 per cent” by “10 per cent” in subparagraph ( ) a as the minimum capital required for direct investment dividend status because in some developing countries non-residents are limited to a 50 per cent share ownership, and 10 per cent is a significant portion of such permitted ownership. However, as part of the 2017 update, the current Committee of Experts considered that 25 per cent is a more appropriate threshold for direct investment, in line with the OECD Model Convention. 6.1 Also, in line with the changes to the recommendations in the OECD/G20 Final Report on Action 6 (Preventing the Granting 259

282 Article 10 Commentary of Treaty Benefits in Inappropriate Circumstances), the Committee considered that in order to prevent abuse of the lower withholding rate for direct investment dividends, a 365 day holding period should be inserted into subparagraph (a). This 365 day holding requirement may be met either at the time of payment of the dividend or after the time the dividend is paid. The Commentary to the 2017 OECD Model Convention contains the following passage: 16. Before 2017, paragraph 17 of the Commentary on the Article provided that “[t]he reduction envisaged in subpara - graph a) of paragraph 2 should not be granted in cases of abuse of this provision, for example, where a company with a holding of less than 25 per cent has, shortly before the dividends become payable, increased its holding primarily for the purpose of securing the benefits of the above-mentioned provision, or oth - erwise, where the qualifying holding was arranged primarily in order to obtain the reduction.” Such abuses were addressed by the final report on Action 6 of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project. As a result of that report, sub - paragraph a) was modified in order to restrict its application to situations where the company that receives the dividend holds directly at least 25 per cent of the capital of the company paying the dividends throughout a 365 day period that includes the day of the payment of the dividend. The subparagraph also provides, however, that in computing that period, changes of ownership that would directly result from a corporate reorganisation, such as a merger or divisive reorganisation, should not be taken into account. Also, the addition of Article 29 will address other abusive arrangements aimed at obtaining the benefits of sub - paragraph a). 7. The former Group of Experts was unable to reach a consen - sus on the maximum tax rates to be permitted in the source country. Members from the developing countries, who basically preferred the principle of the taxation of dividends exclusively in the source country, considered that the rates prescribed by the OECD Model Convention would entail too large a loss of revenue for the source country. Also, although they accepted the principle of taxation in the beneficiary’s country of residence, they believed that any reduction in withhold - ing taxes in the source country should benefit the foreign investor 260

283 Article 10 Commentary rather than the treasury of the beneficiary’s country of residence, as may happen under the traditional tax-credit method if the reduction lowers the cumulative tax rate of the source country below the rate of the beneficiary’s country of residence. 8. The former Group of Experts suggested some considerations that might guide countries in negotiations on the rates for source country taxation of direct investment dividends. If the developed (residence) country uses a credit system, treaty negotiations could appropriately seek a withholding tax rate at source that would, in combination with the basic corporate tax rate of the source country, produce a combined effective rate not exceeding the tax rate in the residence country. The parties’ negotiating positions may also be affected by whether the res - idence country allows credit for taxes spared by the source country under tax incentive programmes. If the developed country uses an exemption system for double taxation relief, it could, in bilateral nego - tiations, seek a limitation on withholding rates on the grounds that ( a ) the exemption itself stresses the concept of not taxing inter-corporate dividends, and a limitation of the withholding rate at source would be in keeping with that concept, and ( b ) the exemption and resulting departure from tax neutrality with domestic investment are of benefit to the international investor, and a limitation of the withholding rate at source, which would also benefit the investor, would be in keeping with this aspect of the exemption. 9. Both the source country and the country of residence should be able to tax dividends on portfolio investment shares, although the relatively small amount of portfolio investment and its distinctly lesser importance compared with direct investment might make the issues concerning its tax treatment less intense in some cases. The former Group of Experts decided not to recommend a maximum rate because source countries may have varying views on the importance of portfo - lio investment and on the figures to be inserted. 10. In 1999, it was noted that recent developed/developing country treaty practice indicates a range of direct investment and portfolio investment withholding tax rates. Traditionally, dividend withholding rates in the developed/developing country treaties have been higher than those in treaties between developed countries. Thus, while the OECD direct and portfolio investment rates are 5 per cent and 15 per cent, 261

284 Article 10 Commentary developed/developing country treaty rates have traditionally ranged between 5 per cent and 15 per cent for direct investment dividends and 15 per cent and 25 per cent for portfolio dividends. Some develop - ing countries have taken the position that short-term loss of revenue - occasioned by low withholding rates is justified by the increased for eign investment in the medium and long terms. Thus, several modern developed/developing country treaties contain the OECD Model rates for direct investment, and a few treaties provide for even lower rates. 11. Also, several special features in developed/developing country a ) the tax rates may not be the same for both treaties have appeared: ( countries, with higher rates allowed to the developing country; ( ) tax b rates may not be limited at all; ( ) reduced rates may apply only to c d ) the lowest rates or exemption may income from new investment; ( - apply only to preferred types of investments (e.g. “industrial under takings” or “pioneer investments”); and ( e ) dividends may qualify for reduced rates only if the shares have been held for a specified period. In treaties of countries that have adopted an imputation system of corpo - ration taxation (i.e. integration of company tax into the shareholder’s company tax or individual income tax) instead of the classical system - of taxation (i.e. separate taxation of shareholder and corporation), spe cific provisions may ensure that the advanced credits and exemptions granted to domestic shareholders are extended to shareholders resi - dent in the other Contracting State. Although the rates are fixed either partly or wholly for reasons 12. connected with the general balance of the particular bilateral tax treaty, the following technical factors are often considered in fixing the rate: ( a ) the corporate tax system of the country of source (e.g. the extent to which the country follows an integrated or classi - cal system) and the total burden of tax on distributed cor - porate profits resulting from the system; ( b ) the extent to which the country of residence can credit the tax on the dividends and the underlying profits against its own tax and the total tax burden imposed on the taxpayer, after relief in both countries; ( c ) the extent to which matching credit is given in the country of residence for tax spared in the country of source; 262

285 Article 10 Commentary ( ) the achievement from the source country’s point of view of d - a satisfactory balance between raising revenue and attract ing foreign investment. 13. The Commentary on the 2010 OECD Model Convention con - tains the following passages: If a partnership is treated as a body corporate under the 11. domestic laws applying to it, the two Contracting States may agree to modify subparagraph of paragraph 2 in a way to give a) the benefits of the reduced rate provided for parent companies also to such partnership. The requirement of beneficial ownership was introduced 12. in paragraph 2 of Article 10 to clarify the meaning of the words “paid ... to a resident” as they are used in paragraph 1 of the Article. It makes plain that the State of source is not obliged to give up taxing rights over dividend income merely because that income was immediately received by a resident of a State with which the State of source had concluded a convention. The term “beneficial owner” is not used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance. 12.1 Where an item of income is received by a resident of a Contracting State acting in the capacity of agent or nominee it would be inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption merely on account of the status of the immediate recipient of the income as a resident of the other Contracting State. The imme - diate recipient of the income in this situation qualifies as a res - ident but no potential double taxation arises as a consequence of that status since the recipient is not treated as the owner of the income for tax purposes in the State of residence. It would be equally inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption where a resident of a Contracting State, otherwise than through an agency or nominee relationship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. For these reasons, the report from the Committee 263

286 Article 10 Commentary on Fiscal Affairs entitled “Double Taxation Conventions and 33 concludes that a conduit the Use of Conduit Companies” company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income con - cerned, a mere fiduciary or administrator acting on account of the interested parties Subject to other conditions imposed by the Article, the 12.2 limitation of tax in the State of source remains available when an intermediary, such as an agent or nominee located in a Contracting State or in a third State, is interposed between the beneficiary and the payer but the beneficial owner is a resident of the other Contracting State. 13. The tax rates fixed by the Article for the tax in the State of source are maximum rates. The States may agree, in bilateral negotiations, on lower rates or even on taxation exclusively in the State of the beneficiary’s residence. The reduction of rates provided for in paragraph 2 refers solely to the taxation of div - idends and not to the taxation of the profits of the company paying the dividends. Under the domestic laws of many States, pension funds 13.1 and similar entities are generally exempt from tax on their investment income. In order to achieve neutrality of treatment as regards domestic and foreign investments by these entities, - some States provide bilaterally that income, including div idends, derived by such an entity resident of the other State shall be exempt from source taxation. States wishing to do so may agree bilaterally on a provision drafted along the lines of the provision found in paragraph 69 of the Commentary on Ar ticle 18. Similarly, some States refrain from levying tax on divi - 13.2 dends paid to other States and some of their wholly-owned entities, at least to the extent that such dividends are derived from activities of a governmental nature. Some States are able to grant such an exemption under their interpretation of the 33 Reproduced in Volume II of the full-length version of the OECD Model Tax Convention at page R(6)-1. 264

287 Article 10 Commentary sovereign immunity principle (see paragraphs 6.38 and 6.39 of the Commentary on Article 1); others may do it pursuant to provisions of their domestic law. States wishing to do so may confirm or clarify, in their bilateral conventions, the scope of these exemptions or grant such an exemption in cases where it would not otherwise be available. This may be done by adding to the Article an additional paragraph drafted along the fol - lowing lines: Notwithstanding the provisions of paragraph 2, dividends referred to in paragraph 1 shall be taxable only in the Contracting State of which the recipient is a resident if the beneficial owner of the dividends is that State or a political subdivision or local authority thereof. The two Contracting States may also, during bilateral 14. negotiations, agree to [lower the holding percentage required for direct investment dividends]. A lower percentage is, for instance, justified in cases where the state of residence of the parent company, in accordance with its domestic law, grants exemption to such a company for dividends derived from a holding of less than 25 per cent in a non-resident subsidiary. 15. In subparagraph a) of paragraph 2, the term “capital” is used in [...] [defining the minimum ownership required for direct investment dividends]. The use of this term in this context implies that, for the purposes of subparagraph , it a) should be used in the sense in which it is used for the purposes of distri bution to the shareholder (in the particular case, the company). parent a) As a general rule, therefore, the term “capital” in subparagraph a) should be understood as it is under - stood in company law. Other elements, in particular the reserves, are not to be taken into account. b) Capital, as understood in company law, should be indicated in terms of par value of all shares which in the majority of cases will be shown as capital in the company’s balance sheet. c) No account need be taken of differences due to the different classes of shares issued (ordinary shares, 265

288 Article 10 Commentary preference shares, plural voting shares, non-voting shares, bearer shares, registered shares etc.), as such differences relate more to the nature of the share - holder’s right than to the extent of his ownership of the capital. d) When a loan or other contribution to the company does not, strictly speaking, come as capital under company law but when on the basis of internal law or practice (“thin capitalisation”, or assimilation of a loan to share capital), the income derived in respect thereof is treated as dividend under Article 10, the value of such loan or contribution is also to be taken as “capital” within the meaning of subparagraph . a) e) In the case of bodies which do not have capital within the meaning of company law, capital for the purpose subparagraph a) is to be taken as meaning the of total of all contributions to the body which are taken into account for the purpose of distributing profits. In bilateral negotiations, Contracting States may depart from the criterion of “capital” used in subparagraph of paragraph a) 2 and use instead the criterion of “voting power”. 13.1 Treaties entered into prior to the 2017 update will not include the new time threshold until they are renegotiated bilaterally or amended Multilateral Convention to Implement Tax Treaty Related through the Measures to Prevent Base Erosion and Profit Shifting . Accordingly, for some, the following passages of the 2010 OECD Model Commentary remain relevant: 16. Subparagraph a) of paragraph 2 does not require that the company receiving the dividends must have owned at least [25] per cent of the capital for a relatively long time before the date of the distribution. This means that all that counts regarding the holding is the situation prevailing at the time material for the coming into existence of the liability to the tax to which para - graph 2 applies, i.e. in most cases the situation existing at the time when the dividends become legally available to the share - holders. The primary reason for this resides in the desire to have a provision which is applicable as broadly as possible. To require 266

289 Article 10 Commentary the parent company to have possessed the minimum holding for a certain time before the distribution of the profits could involve extensive inquiries. Internal laws of certain OECD member coun - tries provide for a minimum period during which the recipient company must have held the shares to qualify for exemption or relief in respect of dividends received. In view of this, Contracting States may include a similar condition in their conventions. The reduction envisaged in subparagraph a) of paragraph 17. 2 should not be granted in cases of abuse of this provision, for example, where a company with a holding of less than [25] per cent has, shortly before the dividends become payable, increased its holding primarily for the purpose of securing the benefits of the above-mentioned provision, or otherwise, where the qual - ifying holding was arranged primarily in order to obtain the reduction. To counteract such manoeuvres Contracting States may find it appropriate to add to subparagraph a) a provision along the following lines: provided that this holding was not acquired primarily for the purpose of taking advantage of this provision. 13.2. The 2010 OECD Commentary, that is relevant to treaties entered into before and after the 2017 update, continues as follows: 18. Paragraph 2 lays down nothing about the mode of taxa - tion in the State of source. It therefore leaves that State free to apply its own laws and, in particular, to levy the tax either by deduction at source or by individual assessment. 19. The paragraph does not settle procedural questions. Each State should be able to use the procedure provided in its own laws. It can either forthwith limit its tax to the rates given in the Article or tax in full and make a refund [...]. Specific questions arise with triangular cases (see paragraph 71 of the Commen tary on Article 24). 20. It does not specify whether or not the relief in the State of source should be conditional upon the dividends being subject to tax in the State of residence. This question can be settled by bilateral negotiations. 21. The Article contains no provisions as to how the State of the beneficiary’s residence should make allowance for the 267

290 Article 10 Commentary taxation in the State of source of the dividends. This question is dealt with in Articles 23 A and 23 B. 22. Attention is drawn generally to the following case: the beneficial owner of the dividends arising in a Contracting State is a company resident of the other Contracting State; all or part of its capital is held by shareholders resident outside that other State; its practice is not to distribute its profits in the form of dividends; and it enjoys preferential taxation treatment (private investment company, base company). The question may arise whether in the case of such a company it is justifiable to allow in the State of source of the dividends the limitation of tax which - is provided in paragraph 2. It may be appropriate, when bilat eral negotiations are being conducted, to agree upon special exceptions to the taxing rule laid down in this Article, in order to define the treatment applicable to such companies. Paragraph 3 14. This paragraph reproduces Article 10, paragraph 3, of the OECD Model Convention. The relevant part of the Commentary on the 2010 OECD Model Convention reads as follows: 23. In view of the great differences between the laws of OECD m ember countries , it is impossible to define “divi dends” fully and exhaustively. Consequently, the definition merely mentions examples which are to be found in the majority of the member countries’ laws and which, in any case, are not treated differently in them. The enumeration is followed up by a general formula. In the course of the revision of the 1963 Draft Convention, a thorough study has been undertaken to find a solution that does not refer to domestic laws. This study has led - to the conclusion that, in view of the still remaining dissimilar ities between member countries in the field of company law and taxation law, it did not appear to be possible to work out a defi - nition of the concept of dividends that would be independent of domestic laws. It is open to the Contracting States, through bilateral negotiations, to make allowance for peculiarities of their laws and to agree to bring under the definition of “divi - dends” other payments by companies falling under the Article. 268

291 Article 10 Commentary 24. The notion of dividends basically concerns distributions b) of para by companies within the meaning of subparagraph - graph 1 of Article 3. Therefore the definition relates, in the first - instance, to distributions of profits the title to which is consti tuted by shares that is holdings in a company limited by shares (joint stock company). The definition assimilates to shares all securities issued by companies which carry a right to participate in the companies’ profits without being debt claims; such are, - for example, “jouissance” shares or “jouissance” rights, found ers’ shares or other rights participating in profits. In bilateral conventions, of course, this enumeration may be adapted to the legal situation in the Contracting States concerned. This may be necessary, in particular, as regards income from “jouissance” shares and founders’ shares. On the other hand, debt-claims participating in profits do not come into this category [...]; like - wise interest on convertible debentures is not a dividend. 25. Article 10 deals not only with dividends as such but also with interest on loans in so far as the lender effectively shares the risks run by the company, i.e. when repayment depends largely on the success or otherwise of the enterprise’s business. Articles 10 and 11 do not therefore prevent the treatment of this type of interest as dividends under the national rules on thin capitalisation applied in the borrower’s country. The question whether the contributor of the loan shares the risks run by the enterprise must be determined in each individual case in the light of all the circumstances, as for example the following: the loan very heavily outweighs any other contribution — to the enterprise’s capital (or was taken out to replace a substantial portion of capital which has been lost) and is substantially unmatched by redeemable assets; — the creditor will share in any profits of the company; the repayment of the loan is subordinated to claims of — other creditors or to the payment of dividends; — the level or payment of interest would depend on the profits of the company; — the loan contract contains no fixed provisions for repay - ment by a definite date. 269

292 Article 10 Commentary 26. The laws of many of the States put participations in a société à responsabilité limitée (limited liability company) on the same footing as shares. Likewise, distributions of profits by cooperative societies are generally regarded as dividends. 27. Distributions of profits by partnerships are not dividends within the meaning of the definition, unless the partnerships are subject, in the State where their place of effective manage - ment is situated, to a fiscal treatment substantially similar to that applied to companies limited by shares (for instance, in - Belgium, Portugal and Spain, also in France as regards distribu commanditaires tions to sociétés en commandite simple ). in the On the other hand, clarification in bilateral conventions may be necessary in cases where the taxation law of a Contracting State gives the owner of holdings in a company a right to opt, under certain conditions, for being taxed as a partner of a partnership, or, vice versa, gives the partner of a partnership the right to opt for taxation as the owner of holdings in a company. 28. Payments regarded as dividends may include not only distributions of profits decided by annual general meetings of shareholders, but also other benefits in money or money’s worth, such as bonus shares, bonuses, profits on a liquidation and disguised distributions of profits. The reliefs provided in the Article apply so long as the State of which the paying company is a resident taxes such benefits as dividends. It is immaterial whether any such benefits are paid out of current profits made by the company or are derived, for example, from reserves, i.e. profits of previous financial years. Normally, distributions by a company which have the effect of reducing the membership rights, for instance, payments constituting a reimbursement of capital in any form whatever, are not regarded as dividends. 29. The benefits to which a holding in a company confer entitlement are, as a general rule, available solely to the share - holders themselves. Should, however, certain of such benefits be made available to persons who are not shareholders within the meaning of company law, they may constitute dividends if: — the legal relations between such persons and the com - pany are assimilated to a holding in a company (“con - cealed holdings”) and 270

293 Article 10 Commentary the persons receiving such benefits are closely con - — nected with a shareholder; this is the case, for example, where the recipient is a relative of the shareholder or is a company belonging to the same group as the company owning the shares. 30. When the shareholder and the person receiving such ben - efits are residents of two different States with which the State of source has concluded conventions, differences of views may arise as to which of these conventions is applicable. A similar problem may arise when the State of source has concluded a convention with one of the States but not with the other. This, however, is a conflict which may affect other types of income and the solution to it can be found only through an arrange - ment under the mutual agreement procedure. 4 Paragraph 15. This paragraph, which makes paragraphs 1 and 2 inapplicable to dividends on shares that are effectively connected with a perma - nent establishment or fixed base of the recipient in the source country, reproduces Article 10, paragraph 4, of the OECD Model Convention - except the United Nations Model Convention refers to a company per forming independent personal services from a fixed base. The 2010 OECD Commentary also notes that paragraph 4 does not adopt a force of attraction rule, allowing dividends to be taxed as business profits if the recipient has a permanent establishment or fixed base in the source country, regardless of whether the shareholding is connected with the permanent establishment. Rather, the paragraph only permits divi - dends to be taxed as business profits “[...] if they are paid in respect of holdings forming part of the assets of the permanent establishment or 34 otherwise effectively connected with that establishment [...]”. The OECD Commentary also notes: 32. It has been suggested that the paragraph could give rise to abuses through the transfer of shares to permanent establish - ments set up solely for that purpose in countries that offer pref - erential treatment to dividend income. Apart from the fact that 34 Paragraph 31 of the OECD Commentary on Article 10. 271

294 Article 10 Commentary such abusive transactions might trigger the application of domes - - tic anti-abuse rules, it must be recognised that a particular loca tion can only constitute a permanent establishment if a business is carried on therein and, also, that the requirement that a share - holding be “effectively connected” to such a location requires that the shareholding be genuinely connected to that business. Paragraph 5 This paragraph, which bars a Contracting State from taxing div 16. - idends paid by a company resident in the other State merely because the company derives income or profits in the taxing State, reproduces Article 10, paragraph 5, of the OECD Model Convention except for the reference in the United Nations Model Convention to “fixed base”. The OECD Commentary reads as follows: The Article deals only with dividends paid by a company 33. which is a resident of a Contracting State to a resident of the other State. Certain States, however, tax not only dividends paid by companies resident therein but even distributions by non-resident companies of profits arising within their territory. Each State, of course, is entitled to tax profits arising in its ter - ritory which are made by non-resident companies, to the extent provided in the Convention (in particular in Article 7). The shareholders of such companies should not be taxed as well at any rate, unless they are residents of the State and so naturally subject to its fiscal sovereignty. 34. Paragraph 5 rules out the extraterritorial taxation of dividends, i.e. the practice by which States tax dividends dis - tributed by a non-resident company solely because the corpo - rate profits from which the distributions are made originated in their territory (for example, realised through a permanent establishment situated therein). There is, of course, no question of extraterritorial taxation when the country of source of the corporate profits taxes the dividends because they are paid to a shareholder who is a resident of that State or to a permanent establishment [or fixed base] situated in that State. 35. Moreover, it can be argued that such a provision does not aim at, or cannot result in, preventing a State from subjecting 272

295 Article 10 Commentary the dividends to a withholding tax when distributed by foreign companies if they are cashed in its territory. Indeed, in such a case, the criterion for tax liability is the fact of the payment of - the dividends, and not the origin of the corporate profits allot ted for distribution. But if the person cashing the dividends in a Contracting State is a resident of the other Contracting State (of which the distributing company is a resident), he may under Article 21 obtain exemption from, or refund of, the withholding tax of the first-mentioned State. Similarly, if the beneficiary of the dividends is a resident of a third State which had concluded a double taxation convention with the State where the divi - dends are cashed, he may, under Article 21 of that convention, obtain exemption from, or refund of, the withholding tax of the last-mentioned State. 36. Paragraph 5 further provides that non-resident com - panies are not to be subjected to special taxes on undistrib - uted profits. 37. It might be argued that where the taxpayer’s country of residence, pursuant to its controlled foreign companies legisla - tion or other rules with similar effect seeks to tax profits which have not been distributed, it is acting contrary to the provisions of paragraph 5. However, it should be noted that the paragraph is confined to taxation at source and, thus, has no bearing on the taxation at residence under such legislation or rules. In addition, the paragraph concerns only the taxation of the company and not that of the shareholder. 38. The application of such legislation or rules may, how - ever, complicate the application of Article 23. If the income were attributed to the taxpayer then each item of the income would have to be treated under the relevant provisions of the Convention (business profits, interest, royalties). If the amount is treated as a deemed dividend then it is clearly derived from the base company thus constituting income from that com - pany’s country. Even then, it is by no means clear whether the taxable amount is to be regarded as a dividend within the meaning of Article 10 or as “other income” within the mean - ing of Article 21. Under some of these legislation or rules the taxable amount is treated as a dividend with the result that an 273

296 Article 10 Commentary exemption provided for by a tax convention, an affiliation e.g. exemption is also extended to it. It is doubtful whether the Convention requires this to be done. If the country of residence considers that this is not the case it may face the allegation that it is obstructing the normal operation of the affiliation exemp - tion by taxing the dividend (in the form of “deemed dividend”) in advance. 39. Where dividends are actually distributed by the base - company, the provisions of a bilateral convention regard ing dividends have to be applied in the normal way because there is dividend income within the meaning of the conven - tion. Thus, the country of the base company may subject the dividend to a withholding tax. The country of residence of the shareholder will apply the normal methods for the elimination of double taxation ( i.e. tax credit or tax exemption is granted). This implies that the withholding tax on the dividend should be credited in the shareholder’s country of residence, even if the distributed profit (the dividend) has been taxed years before under controlled foreign companies legislation or other rules with similar effect. However, the obligation to give credit in that case remains doubtful. Generally the dividend as such is exempted from tax (as it was already taxed under the relevant legislation or rules and one might argue that there is no basis for a tax credit. On the other hand, the purpose of the treaty would be frustrated if the crediting of taxes could be avoided by simply anticipating the dividend taxation under counteracting legis - lation. The general principle set out above would suggest that the credit should be granted, though the details may depend on the technicalities of the relevant legislation or rules and the system for crediting foreign taxes against domestic tax, as well e.g. time lapsed since the as on the particularities of the case ( taxation of the “deemed dividend”). However, taxpayers who have recourse to artificial arrangements are taking risks against which they cannot fully be safeguarded by tax authorities. 17. It may be relevant to point out that certain countries’ laws seek to avoid or mitigate economic double taxation, that is, the simultane - ous taxation of the company’s profits at the level of the company and of dividends at the level of the shareholder. For a detailed consideration 274

297 Article 10 Commentary of this matter, it may be instructive to refer to paragraphs 40 to 67 in the Commentary on Article 10 of the OECD Model Convention. Branch profits taxes The inclusion of a branch profits tax provision in a revised United 18. Nations Model Convention was discussed at the 1987 and 1991 meet - ings of the former Group of Experts. The issue was further discussed in the 1997 meeting (Eighth Meeting) of the former Group of Experts and it was considered that because only a few countries had a branch tax, the paragraph might be better placed in the commentaries and not in the main text. It would be left to the Contracting States, if they so desire, during the course of bilateral negotiations to incorporate the provisions relating to the branch profits tax in their bilateral tax trea - ties. Developing countries were generally not opposed to the principle of branch profits taxation, even if they did not impose a branch profits tax. 19. Some members, while citing the justification of branch profits taxation as a means of achieving rough parity in source country tax - ation whether business in that country is conducted through a sub - sidiary corporation or a branch, maintained that the principle should be followed logically throughout the Convention. Thus, in this view, contrary to paragraph 3 of Article 7 of the United Nations Model Convention, all expenses of the permanent establishment must be deductible as if the permanent establishment were a distinct and sep - arate enterprise dealing wholly independently with the head office. 20. Another member from a developed country noted that his country imposed the tax in two separate parts: (i) a tax analogous to a dividend withholding tax was imposed on the “dividend equivalent amount” of a branch that was approximately the amount that would likely have been distributed as dividends if the branch were a subsid - iary; and (ii) a second tax, analogous to a withholding tax on interest paid by a subsidiary resident in that country to its foreign parent, was imposed on the excess of the amount of interest deducted by the branch in computing its taxable income over the amount of interest actually paid by the branch. The principal purpose of that system was to mini - mize the effect of tax considerations on the foreign investor’s decision whether to operate in the country in branch or subsidiary form. 275

298 Article 10 Commentary 21. - If one or both of the Contracting States impose branch prof its taxes, they may include in the Convention a provision such as the following: Notwithstanding any other provision of this Convention, where a company which is a resident of a Contracting State has a permanent establishment in the other Contracting State, the profits taxable under Article 7, paragraph 1, may be subject to an additional tax in that other State, in accordance with its laws, but the additional charge shall not exceed ___ per cent of the amount of those profits. 22. The suggested provision does not recommend a maximum branch profits rate. The most common practice is to use the direct investment dividend rate (e.g. the tax rate in paragraph 2( a )). At the 1991 meeting of the former Group of Experts there was agreement among the supporters of branch profits taxation that, in view of the principles enunciated in support of the system, the rate of tax on branch profits should be the same as that on dividends from direct investments. However, in several treaties the branch profits tax rate was the rate for portfolio investment dividends (typically a higher rate) and in some treaties the branch tax rate was lower than the direct investment dividend rate. Although a branch profits tax is on business profits, the provision may be included in Article 10, rather than in Article 7, because the tax is intended to be analogous to a tax on dividends. 23. The provision allows the branch profits tax to be imposed only on profits taxable under Article 7, paragraph 1, on account of the permanent establishment. Many treaties further limit the tax base to such profits “after deducting therefrom income tax and other taxes on income imposed thereon in that other State”. Other treaties do not contain this clause because the concept is included under domestic law. 24. At the former Group of Experts 1991 meeting, attention was drawn to the fact that a branch profits tax provision could potentially conflict with a treaty’s non-discrimination clause. Since a branch prof - its tax is usually a second level of tax on profits of foreign corporations that is not imposed on domestic corporations carrying on the same activities, it could be viewed, as a technical matter, as prohibited by Article 24 (Non-discrimination). However, countries imposing the 276

299 Articles 10 and 11 Commentary tax do so as an analogue to the dividend withholding tax paid on dividends from a subsidiary to its foreign parent, and they therefore consider it appropriate to include in the non-discrimination Article an explicit exception allowing imposition of the branch tax. The non-discrimination Article in several treaties with branch profits tax provisions contains the following paragraph: Nothing in this Article shall be construed as preventing either Contracting State from imposing a tax as described in paragraph ___ [branch profits tax provision] of Article 10 (Dividends). However, the branch profits tax provision suggested above makes this provision unnecessary because it applies “notwithstanding any other provision of this Convention” and thus takes precedence over other treaty provisions, including Article 24 (Non-discrimination). 25. Some members of the former Group of Experts pointed out that there are many artificial devices entered into by persons to take advantage of the provisions of Article 10 through, inter alia, creation or assignment of shares or other rights in respect of which a dividend is paid. While substance over form rules, abuse of rights principle or any similar doctrine could be used to counter such arrangements, Contracting States, which may want to specifically address the issue, may include a clause on the following lines in their bilateral tax trea - ties during negotiations, namely: The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the shares or other rights in respect of which the dividend is paid to take advantage of this Article by means of that creation or assignment. Article 11 INTEREST A. General considerations 1. Article 11 of the United Nations Model Convention reproduces the provisions of Article 11 of the OECD Model Convention with the 277

300 Article 11 Commentary exception of paragraphs 2 and 4, in which substantive changes have - been made and with respect to paragraphs 4 and 5 which refer to inde pendent personal services from a fixed base. 2. Interest, which, like dividends, constitutes income from movable capital may be paid to individual savers who have deposits with banks or hold savings certificates, to individual investors who have purchased bonds, to individual suppliers or trading companies selling on a deferred payment basis, to financial institutions which have granted loans or to institutional investors which hold bonds or debentures. Interest may also be paid on loans between associated enterprises. 3. At the domestic level, interest is usually deductible in calcu - lating profits. Any tax on interest is paid by the beneficiary unless a special contract provides that it should be paid by the payer of the interest. Contrary to what occurs in the case of dividends, interest is not liable to taxation in the hands of both the beneficiary and the payer. If the latter is obliged to withhold a certain portion of the interest as a tax, the amount withheld represents an advance on the tax to which the beneficiary will be liable on his aggregate income or profits for the fiscal year, and the beneficiary can deduct this amount from the tax due from him and obtain reimbursement of any sum by which the amount withheld exceeds the tax finally payable. This mechanism pre - vents the beneficiary from being taxed twice on the same interest. At the international level, when the beneficiary of the inter - 4. est is a resident of one State and the payer of the interest is a resident of another, the interest is subject to taxation in both countries. This double taxation may considerably reduce the net amount of interest received by the beneficiary or, if the payer has agreed to bear the cost of the tax deductible at the source, increase the financial burden on the payer. 5. The Commentary on the OECD Model Convention notes that, although this double taxation could be eliminated by barring the source country or the residence country from taxing the interest, 3. A formula reserving the exclusive taxation of interest to one State, whether the State of the beneficiary’s residence or the State of source, could not be sure of receiving general approval. 278

301 Article 11 Commentary Therefore a compromise solution was adopted. It provides that interest may be taxed in the State of residence, but leaves to the State of source the right to impose a tax if its laws so provide, it being implicit in this right that the State of source is free to give up all taxation on interest paid to non-residents. Its exer - cise of this right will however be limited by a ceiling which its tax cannot exceed [...]. The sacrifice that the latter would accept in such conditions will be matched by a relief to be given by the State of residence, in order to take into account the tax levied in the State of source (see Article 23 A or 23 B). Certain countries do not allow interest paid to be deducted 4. for the purposes of the payer’s tax unless the recipient also resides in the same State or is taxable in that State. Otherwise they forbid the deduction. The question whether the deduction should also be allowed in cases where the interest is paid by a resident of a Contracting State to a resident of the other State is dealt with in paragraph 4 of Article 24. B. Commentary on the paragraphs of article 11 Paragraph 1 6. This paragraph reproduces Article 11, paragraph 1, of the OECD Model Convention, the Commentary on which reads as follows: 5. Paragraph 1 lays down the principle that interest aris - ing in a Contracting State and paid to a resident of the other Contracting State may be taxed in the latter. In doing so, it does not stipulate an exclusive right to tax in favour of the State of resi dence. The term “paid” has a very wide meaning, since the concept of payment means the fulfilment of the obligation to put funds at the disposal of the creditor in the manner required by contract or by custom. 6. The Article deals only with interest arising in a Contracting State and paid to a resident of the other Contracting State. It does not, therefore, apply to interest arising in a third State or to interest arising in a Contracting State which is attributable to a permanent establishment which an enterprise of that State has in the other Contracting State [...]. 279

302 Article 11 Commentary Paragraph 2 This paragraph reproduces Article 11, paragraph 2, of the OECD 7. Model Convention with one substantive change. The OECD Model Convention provides that the tax in the country of source “shall not exceed 10 per cent of the gross amount of the interest”, but the United Nations Model Convention leaves this percentage to be established through bilateral negotiations. 8. When this Article was considered by the former Group of Experts, members from developing countries took the view that the source coun - try should have the exclusive, or at least the primary, right to tax inter - est. According to that view, it is incumbent on the residence country to prevent double taxation of that income through exemption, credit or other relief measures. These members reasoned that interest should be taxed where it was earned, that is, where the capital was put to use. Some members from developed countries felt that the home country of the investor should have the exclusive right to tax interest, since in their view that would promote the mobility of capital and give the right to tax to the country that is best equipped to consider the characteristics of the taxpayer. They also pointed out that an exemption of foreign interest from the tax of the investor’s home country might not be in the best interests of the developing countries because it could induce investors to place their capital in the developing country with the lowest tax rate. 9. The members from developing countries agreed to the solution of taxation by both the country of residence and the source country embodied in Article 11, paragraphs 1 and 2, of the OECD Model Convention but found the ceiling of 10 per cent of the gross amount of the interest mentioned in paragraph 2 unacceptable. Since the former Group of Experts was unable to reach a consensus on an alternative ceiling, the matter was left to bilateral negotiations. 10. The decision not to recommend a maximum withholding rate can be justified under current treaty practice. The withholding rates for interest adopted in developed/developing country tax treaties range more widely than those for dividends — between complete exemption and 25 per cent. However, some developing countries have reduced the interest withholding rate to attract foreign investment; several of them have adopted rates at or below the OECD rate of 10 per cent. 280

303 Article 11 Commentary 11. A precise level of withholding tax for a source country should take into account several factors, including the following: the fact that the capital originated in the residence country; the possibility that a high source rate might cause lenders to pass the cost of the tax on to the borrowers, which would mean that the source country would increase its revenue at the expense of its own residents rather than the foreign lenders; the possibility that a tax rate higher than the foreign tax credit limit in the residence country might deter investment; the fact that a lowering of the withholding rate has revenue and foreign exchange consequences for the source country; and the main direction of interest flows (e.g. from developing to developed countries). 12. In negotiations on bilateral treaties with a general positive rate - for interest withholding, a lower ceiling or even exemption has some times been agreed upon for interest in one or more of the following categories: a Interest paid to Governments or government agencies; ( ) b ( ) Interest guaranteed by Governments or government agencies; ( c ) Interest paid to central banks; ( d ) Interest paid to banks or other financial institutions; ( e Interest on long-term loans; ) f ) Interest on loans to finance special equipment or ( works; or public ( g ) Interest on other government-approved types of invest - ment (e.g. export finance). With respect to bank loans and loans from financial institutions, a major justification for the reduced rate is the high costs associated with these loans, particularly the lender’s cost of funds. The withhold - ing tax, because it is a gross basis tax, has a high effective tax rate. If the effective rate is higher than the general tax rate in the lend - er’s country of residence, the borrower is often required to bear the tax through a gross-up feature in the loan agreement. In that case, the withholding tax amounts to an additional tax on residents of the source State. One way to deal with this is to allow the lender to elect to treat such income as business profits under Article 7, but this approach raises computation and administrative issues for banks and tax administrators. 281

304 Article 11 Commentary 13. A similar justification exists for reduced rates on interest from credit sales. The supplier in such cases often merely passes on to the customer, without additional charge, the price he has had to pay to a bank or export finance agency to finance the credit. For a person selling equipment on credit, the interest is more an element of the sales price than income from invested capital. 14. In addition, long-term credits correspond to investments that should be profitable enough to be repaid in instalments over a period. In the latter case, interest must be paid out of earnings at the same time as instalments of credit are repaid out of capital. Consequently, any excessive fiscal burden on such interest must be passed on to the book value of the capital goods purchased on credit, with the result that the fiscal charge levied on the interest might, in the last analysis, diminish the amount of tax payable on the profits made by the user of the capital goods. 15. At the former Group of Experts 1991 meeting, some members argued that interest income received by government agencies should be exempted from source country taxation because exemption would facilitate the financing of development projects, especially in devel - oping countries, by eliminating tax considerations from negotiations over interest rates. Some members from developing countries asserted that the financing of such projects would be enhanced even further if the interest income was also exempt from tax in the lender’s country of residence. 16. The predominant treaty practice is to exempt governmental interest from source country tax, but there is a wide range of practice on the details. In some instances interest income is exempted if paid by a government or paid to a government; in other instances only interest paid to a government is exempt. Also, the definition of “government” varies to include, e.g. local authorities, agencies, instrumentalities, central banks, and financial institutions owned by the government. 17. The former Group of Experts observed that long-term credits often call for special guarantees because of the difficulty of long-term political, economic and monetary forecasting. Moreover, most devel - oped countries, in order to ensure full employment in their capital goods industries or public works enterprises, have adopted various measures to 282

305 Article 11 Commentary encourage long-term credits, including credit insurance or interest-rate reductions by government agencies. These measures may take the form of direct loans by government agencies tied to loans by private banks or private credit facilities or interest terms more favourable than those obtainable on the money market. These measures are not likely to persist if the preferences are effectively cancelled out or reduced by excessive taxation in the debtor’s country. Thus, not only should interest on loans made by a government be exempted, but an argument exists for exempt - ing interest on long-term loans made by private banks where such loans are guaranteed or refinanced by a government or a government agency. 18. - The Commentary on the 2010 OECD Model Convention con tains the following passages: 9. The requirement of beneficial ownership was introduced in paragraph 2 of Article 11 to clarify the meaning of the words “paid to a resident” as they are used in paragraph 1 of the Article. It makes plain that the State of source is not obliged to give up taxing rights over interest income merely because that income was immediately received by a resident of a State with which the State of source had concluded a convention. The term “ben - eficial owner” is not used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance. Relief or exemption in respect of an item of income 10. is granted by the State of source to a resident of the other Contracting State to avoid in whole or in part the double taxa - tion that would otherwise arise from the concurrent taxation of that income by the State of residence. Where an item of income is received by a resident of a Contracting State acting in the capacity of agent or nominee it would be inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption merely on account of the status of the immediate recipient of the income as a resident of the other Contracting State. The immediate recipient of the income in this situation qualifies as a resident but no potential double taxation arises as a consequence of that status since the recipient is not treated as the owner of the income for tax purposes in the State of residence. It would be equally inconsistent with the object 283

306 Article 11 Commentary and purpose of the Convention for the State of source to grant - relief or exemption where a resident of a Contracting State, oth erwise than through an agency or nominee relationship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. For these reasons, the report from the Committee on Fiscal Affairs entitled “Double Taxation 35 Conventions and the Use of Conduit Companies” concludes that a conduit company cannot normally be regarded as the - beneficial owner if, though the formal owner, it has, as a prac tical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties. 11. Subject to other conditions imposed by the Article, the limitation of tax in the State of source remains available when an intermediary, such as an agent or nominee located in a Contracting State or in a third State, is interposed between the beneficiary and the payer but the beneficial owner is a resident of the other Contracting State (the text of the Model was amended in 1995 to clarify this point, which has been the consistent posi - tion of all member countries). States which wish to make this more explicit are free to do so during bilateral negotiations. 12. The paragraph lays down nothing about the mode of tax - ation in the State of source. It therefore leaves that State free to apply its own laws and, in particular, to levy the tax either by deduction at source or by individual assessment. Procedural questions are not dealt with in this Article. Each State should be able to apply the procedure provided in its own law [...]. 13. It does not specify whether or not the relief in the State of source should be conditional upon the interest being subject to tax in the State of residence. This question can be settled by bilateral negotiations. 14. The Article contains no provisions as to how the State of the beneficiary’s residence should make allowance for the taxa - tion in the State of source of the interest. This question is dealt with in Articles 23 A and 23 B. 35 Reproduced in Volume II of the full-length version of the OECD Model Tax Convention at page R(6)-1. 284

307 Article 11 Commentary Paragraph 3 This paragraph reproduces Article 11, paragraph 3, of the OECD 19. Model Convention. The relevant part of the Commentary on the 2010 OECD Model Convention reads as follows: 18. Paragraph 3 specifies the meaning to be attached to the term “interest” for the application of the taxation treatment defined by the Article. The term designates, in general, income from debt mortgage and claims of every kind, whether or not secured by whether or not carrying a right to participate in profits. The term “debt claims of every kind” obviously embraces cash deposits and security in the form of money, as well as government securities, and bonds and debentures, although the three latter are specially mentioned because of their importance and of certain peculiari - ties that they may present. It is recognised, on the one hand, that mortgage interest comes within the category of income from movable capital ( revenus de capitaux mobiliers ), even though cer - tain countries assimilate it to income from immovable property. On the other hand, debt claims, and bonds and debentures in carry a right to participate in the debtor’s prof particular, which - its are nonetheless regarded as loans if the contract by its general character clearly evidences a loan at interest. 19. Interest on participating bonds should not normally be considered as a dividend, and neither should interest on con - vertible bonds until such time as the bonds are actually con - verted into shares. However, the interest on such bonds should be considered as a dividend if the loan effectively shares the risks run by the debtor company [...]. In situations of presumed thin capitalisation, it is sometimes difficult to distinguish between dividends and interest and in order to avoid any pos - sibility of overlap between the categories of income dealt with under Article 10 and Article 11 respectively, it should be noted that the term “interest” as used in Article 11 does not include items of income which are dealt with in Article 10. 20. As regards, more particularly, government securities, and bonds and debentures, the text specifies that premiums or prizes attaching thereto constitute interest. Generally speaking, what constitutes interest yielded by a loan security, and may 285

308 Article 11 Commentary properly be taxed as such in the State of source, is all that the institution issuing the loan pays over and above the amount paid by the subscriber, that is to say, the interest accruing plus any premium paid at redemption or at issue. It follows that when a bond or debenture has been issued at a premium, the excess of the amount paid by the subscriber over that repaid to him may ducted from constitute negative interest which should be de the interest that is taxable. On the other hand, any profit or loss which a holder of such a security realises by the sale thereof to another person does not enter into the concept of interest. Such profit or loss may, depending on the case, constitute either a - business profit or a loss, a capital gain or a loss, or income fall ing under Article 21. 21. Moreover, the definition of interest in the first sentence of paragraph 3 is, in principle, exhaustive. It has seemed prefera - ble not to include a subsidiary reference to domestic laws in the text; this is justified by the following considerations: a) the definition covers practically all the kinds of income which are regarded as interest in the various domestic laws; the formula employed offers greater security from b) the legal point of view and ensures that conventions would be unaffected by future changes in any coun - try’s domestic laws; c) in the Model Convention references to domestic laws should as far as possible be avoided. It nevertheless remains understood that in a bilateral convention two Contracting States may widen the formula employed so as to include in it any income which is taxed as interest under either of their domestic laws but which is not covered by the definition and in these circumstances may find it preferable to make reference to their domestic laws. 21.1 The definition of interest in the first sentence of paragraph 3 does not normally apply to payments made under certain kinds of non-traditional financial instruments where there is no underlying debt (for example, interest rate swaps). However, the definition will apply to the extent that a loan is considered 286

309 Article 11 Commentary to exist under a “substance over form” rule, an “abuse of rights” principle, or any similar doctrine. Furthermore, in a number of countries, certain non-traditional 19.1 financial arrangements are assimilated to debt relations under domestic tax law, although their legal form is not a loan. The defini - tion of interest in paragraph 3 applies to payments made under such arrangements. - The definition applies, for instance, to Islamic financial instru 19.2 ments where the economic reality of the contract underlying the instrument is a loan (even if the legal form thereof is not). This may murabaha, istisna’a , certain forms of be the case, for example, of and (i.e., profit-sharing deposits and diminish - musharaka mudaraba musharaka ) and ijara (where assimilated to finance lease), as well ing 36 sukuk based on such instruments. as 19.3 Countries that do not deal specifically in their domestic law with the above-mentioned instruments and generally follow an economic-substance-based approach for tax purposes may, neverthe - less, apply the definition of interest to payments made under those instruments. Alternatively, such countries, as well as those following a purely legal approach for tax purposes, may wish to refer expressly to such instruments in the definition of interest in the treaty. This may be done by inserting the following after the first sentence: The term also includes income from arrangements such as Islamic financial instruments where the substance of the under - lying contract can be assimilated to a loan. 19.4 It is clear that the definition does not apply to Islamic financial instruments the economic substance of which cannot be considered as a loan. 19.5 The OECD Commentary then continues: 22. The second sentence of paragraph 3 excludes from the definition of interest penalty charges for late payment but 36 The Committee has decided to include more details regarding these instruments in the next version of the United Nations Manual for the Negoti - ation of Bilateral Tax Treaties between Developed and Developing Countries. 287

310 Article 11 Commentary Contracting States are free to omit this sentence and treat pen - alty charges as interest in their bilateral conventions. Penalty charges, which may be payable under the contract, or by cus - toms or by virtue of a judgement, consist either of payments calculated or else of fixed sums; in certain cases they may com - bine both forms of payment. Even if they are determined pro rata temporis they constitute not so much income from capital as a special form of compensation for the loss suffered by the creditor through the debtor’s delay in meeting his obligations. Moreover, considerations of legal security and practical con - venience make it advisable to place all penalty charges of this kind, in whatever form they be paid, on the same footing for the purposes of their taxation treatment. On the other hand, two Contracting States may exclude from the application of Article 11 any kinds of interest which they intend to be treated as dividends. 23. Finally, the question arises whether annuities ought to be assimilated to interest; it is considered that they ought not to be. On the one hand, annuities granted in consideration of past employment are referred to in Article 18 and are subject to the rules governing pensions. On the other hand, although it is true that instalments of purchased annuities include an interest element on the purchase capital as well as return of capital, such instalments thus constituting “ fruits civils” which accrue from day to day, it would be difficult for many countries to make a distinction between the element representing income from cap - ital and the element representing a return of capital in order merely to tax the income element under the same category as income from movable capital. Taxation laws often contain spe - cial provisions classifying annuities in the category of salaries, wages and pensions, and taxing them accordingly. Paragraph 4 20. This paragraph, which provides that paragraphs 1 and 2 do not apply to some interest if the recipient has a permanent establishment or fixed base in the source country, reproduces Article 11, paragraph 4, of the OECD Model Convention, with two modifications. First, the 288

311 Article 11 Commentary United Nations Model Convention refers to a fixed base as well as a permanent establishment. Secondly, the OECD version only applies if the obligation on which the interest is paid is effectively connected with the permanent establishment or fixed base. Since the United Nations Model Convention, unlike the OECD Model Convention, adopts a limited force of attraction rule in Article 7, defining the income that may be taxed as business profits, a conforming change is made in Article 11, paragraph 4, of the United Nations Model Convention. This modification makes paragraphs 1 and 2 of Article 11 inapplicable if - the debt claim is effectively connected with the permanent establish ment or fixed base or with business activities in the source country of the same or similar kind as those effected through the permanent establishment. Paragraph 5 21. This paragraph reproduces Article 11, paragraph 5, of the OECD Model Convention, which specifies that interest is from sources in the residence country of the payer, except that the United Nations version refers to a fixed base as well as a permanent establishment. The first sentence of paragraph 5 was amended in 1999 in line with the OECD Model Convention. However, in the course of discussion, the former Group of Experts agreed that countries might substitute a rule that would identify the source of interest as the State in which the loan giving rise to the interest was used. Where, in bilateral negotia - tions, the two parties differ on the appropriate rule, a possible solution would be a rule which, in general, would accept the place of residence of the payer as the source of interest; but where the loan was used in the State having a “place of use” rule, the interest would be deemed to arise in that State. The OECD Commentary on Article 11, paragraph 5, reads as follows: 26. This paragraph lays down the principle that the State of source of the interest is the State of which the payer of the inter - est is a resident. It provides, however, for an exception to this rule in the case of interest-bearing loans which have an obvious economic link with a permanent establishment owned in the other Contracting State by the payer of the interest. If the loan was contracted for the requirements of that establishment and 289

312 Article 11 Commentary the interest is borne by the latter, the paragraph determines that the source of the interest is in the Contracting State in which the permanent establishment is situated, leaving aside the place of residence of the owner of the permanent establishment, even when he resides in a third State. 27. In the absence of an economic link between the loan on which the interest arises and the permanent establishment, the State where the latter is situated cannot on that account be regarded as the State where the interest arises; it is not entitled to tax such interest, not even within the limits of a “taxable - quota” proportional to the importance of the permanent estab lishment. Such a practice would be incompatible with para - graph 5. Moreover, any departure from the rule fixed in the first sentence of paragraph 5 is justified only where the economic link between the loan and the permanent establishment is suffi - ciently clear-cut. In this connection, a number of possible cases may be distinguished: The management of the permanent establishment a) has contracted a loan which it uses for the specific requirements of the permanent establishment; it shows it among its liabilities and pays the interest thereon directly to the creditor. The head office of the enterprise has contracted a b) loan the proceeds of which are used solely for the purposes of a permanent establishment situated in another country. The interest is serviced by the head office but is ultimately borne by the permanent establishment. c) The loan is contracted by the head office of the enter - prise and its proceeds are used for several permanent establishments situated in different countries. In cases a) and b) the conditions laid down in the second sen - tence of paragraph 5 are fulfilled, and the State where the - per manent establishment is situated is to be regarded as the State where the interest arises. Case c), however, falls outside the provisions of paragraph 5, the text of which precludes the attri - bution of more than one source to the same loan. Such a solu - trative tion, moreover, would give rise to considerable adminis 290

313 Article 11 Commentary complications and make it impossible for lenders to calculate in advance the taxation that interest would attract. It is, however, open to two Contracting States to restrict the application of the a) or to extend it to case c). final provision in paragraph 5 to case 28. Paragraph 5 provides no solution for the case, which it excludes from its provisions, where both the beneficiary and the payer are indeed residents of the Contracting States, but the loan was borrowed for the requirements of a permanent establishment owned by the payer in a third State and the interest is borne by that establishment. As paragraph 5 now stands, therefore, only its first sentence will apply in such a case. The interest will be deemed to arise in the Contracting State of which the payer is a resident and not in the third State in whose territory is situated the permanent establishment for the account of which the loan was effected and by which the interest is payable. Thus the interest will be taxed both in the Contracting State of which the payer is a resident and in the Contracting State of which the beneficiary is a resident. But, although double taxation will be avoided between these two States by the arrangements provided in the Article, it will not be avoided between them and the third State if the latter taxes the interest on the loan at the source when it is borne by the permanent establishment in its territory. It has been decided not to deal with that case in the 29. Convention. The Contracting State of the payer’s residence does not, therefore, have to relinquish its tax at the source in favour of the third State in which is situated the permanent establishment for the account of which the loan was effected and by which the interest is borne. If this were not the case and the third State did not subject the interest borne by the permanent establishment to source taxation, there could be attempts to avoid source tax - ation in the Contracting State through the use of a permanent establishment situated in such a third State. States for which this is not a concern and that wish to address the issue described in the paragraph above may do so by agreeing to use, in their bilateral convention, the alternative formulation of paragraph 5 suggested in paragraph 30 below. The risk of double taxation just referred to could also be avoided through a multilateral 291

314 Article 11 Commentary convention. Also, if in the case described in paragraph 28, the State of the payer’s residence and the third State in which is situated the permanent establishment for the account of which the loan is effected and by which the interest is borne, together claim the right to tax the interest at the source, there would be nothing to prevent those two States together with, where appro - priate, the State of the beneficiary’s residence, from concerting measures to avoid the double taxation that would result from such claims using, where necessary, the mutual agreement pro - cedure (as envisaged in paragraph 3 of Article 25). As mentioned in paragraph 29, any such double taxation 30. could be avoided either through a multilateral convention or if the State of the beneficiary’s residence and the State of the pay - er’s residence agreed to word the second sentence of paragraph 5 in the following way, which would have the effect of ensuring that paragraphs 1 and 2 of the Article did not apply to the inter - est, which would then typically fall under Article 7 or 21: Where, however, the person paying the interest, whether he is a resident of a Contracting State or not, has in a State other than that of which he is a resident a permanent estab - lishment [or a fixed base] in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by such permanent establishment or fixed base, then such interest shall be deemed to arise in the State in which the permanent establishment [or fixed base] is situated. 31. If two Contracting States agree in bilateral negotiations to reserve to the State where the beneficiary of the income resides the exclusive right to tax such income, then ipso facto there is no value in inserting in the convention which fixes their relations that provision in paragraph 5 which defines the State of source of such income. But it is equally obvious that double taxation would not be fully avoided in such a case if the payer of the interest owned, in a third State which charged its tax at the source on the interest, a permanent establishment for the account of which the loan had been borrowed and which bore the interest payable on it. The case would then be just the same as is contemplated [...] above. 292

315 Article 11 Commentary Paragraph 6 This paragraph reproduces Article 11, paragraph 6, of the OECD 22. Model Convention, the Commentary on which reads as follows: 32. The purpose of this paragraph is to restrict the oper - ation of the provisions concerning the taxation of interest in cases where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest paid exceeds the amount which would have been agreed upon by the payer and the beneficial owner had they stipulated at arm’s length. It provides that in such a case the provisions of the Article apply only to that last-mentioned amount and that the excess part of the interest shall remain taxable according to the laws of the two Contracting States, due regard being had to the other pro - visions of the Convention. 33. It is clear from the text that for this clause to apply the interest held excessive must be due to a special relationship between the payer and the beneficial owner or between both of them and some other person. There may be cited as examples cases where interest is paid to an individual or legal person who directly or indirectly controls the payer, or who is directly or indirectly controlled by him or is subordinate to a group having common interest with him. These examples, moreover, are sim - ilar or analogous to the cases contemplated by Article 9. 34. On the other hand, the concept of special relationship also covers relationship by blood or marriage and, in general, any community of interests as distinct from the legal relation - ship giving rise to the payment of the interest. 35. With regard to the taxation treatment to be applied to the excess part of the interest, the exact nature of such excess will need to be ascertained according to the circumstances of each case, in order to determine the category of income in which it should be classified for the purposes of applying the provisions of the tax laws of the States concerned and the provisions of the Convention. This paragraph permits only the adjustment of the rate at which interest is charged and not the reclassification of the loan in such a way as to give it 293

316 Article 11 Commentary the character of a contribution to equity capital. For such an adjustment to be possible under paragraph 6 of Article 11 it would be necessary to as a minimum to remove the limiting phrase “having regard to the debt-claim for which it is paid”. If greater clarity of intent is felt appropriate, a phrase such as “for whatever reason” might be added after “exceeds”. Either of these alternative versions would apply where some or all of an interest payment is excessive because the amount of the loan or the terms relating to it (including the rate of interest) are not what would have been agreed upon in the absence of the special relationship. Nevertheless, this paragraph can affect - not only the recipient but also the payer of excessive inter est and if the law of the State of source permits, the excess amount can be disallowed as a deduction, due regard being had to other applicable provisions of the Convention. If two Contracting States should have difficulty in determining the other provisions of the Convention applicable, as cases require, to the excess part of the interest, there would be nothing to prevent them from introducing additional clarifications in the last sentence of paragraph 6, as long as they do not alter its general purport. 36. Should the principles and rules of their respective laws oblige the two Contracting States to apply different Articles of the Convention for the purpose of taxing the excess, it will be necessary to resort to the mutual agreement procedure pro - vided by the Convention in order to resolve the difficulty. 23. When this issue was last considered, some members of the former Group of Experts pointed out that there are many artificial devices entered into by persons to take advantage of the provisions of Article 11 through, inter alia, creation or assignment of debt claims in respect of which interest is charged. While substance over form rules, abuse of rights principle or any similar doctrine could be used to counter such arrangements, Contracting States which may want to specifically address the issue may include a clause on the following lines in their bilateral tax treaties during negotiations, namely: The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned 294

317 Articles 11 and 12 Commentary with the creation or assignment of the debt claim in respect of which the interest is paid to take advantage of this Article by means of that creation or assignment. 12 Article ROYA LT I E S A. General considerations Article 12 of the United Nations Model Convention repro - 1. duces Article 12 of the OECD Model Convention, with the following exceptions: first, substantive differences appear in paragraphs 1 and 3; second, paragraphs 2 and 5 do not appear in the OECD Model Convention with the result that the paragraph numbers in the United Nations Model Convention differ from those in the OECD Model Convention; and third, a drafting adjustment is made in paragraph 4. 2. When the user of a patent or similar property is resident in one country and pays royalties to the owner of the property who is resident in another country, the amount paid by the user is generally subject to withholding tax in his country, the source country. The source country tax is imposed on the gross payments, with no allowance for any related expenses incurred by the owner. Without recognition of expenses, the owner’s after-tax profit may in some cases be only a small percentage of gross royalties. Consequently, the owner may take the withholding tax in the source country into account in fixing the amount of the royalty, so that the user and the source country will pay more for the use of the patent or similar property than they would if the withholding tax levied by the source country were lower and took into account the expenses incurred by the owner. A manufac - turing enterprise or an inventor may have spent substantial sums on the development of the property generating the royalties, because the work of research and testing involves considerable capital outlays and does not always yield successful results. The problem of determining the appropriate tax rate to be applied by the source country to gross royalty payments is therefore complex, especially since the user may make a lump sum payment for the use of the patent or similar property, in addition to regular royalty payments. 295

318 Article 12 Commentary 3. The Commentary on Article 12 of the OECD Model Convention includes the following preliminary remarks: 1. In principle, royalties in respect of licences to use patents and similar property and similar payments are income to the recipient from a letting. The letting may be granted in connec - tion with an enterprise ( e.g. the use of literary copyright granted by a publisher or the use of a patent granted by the inventor) or e.g. quite independently of any activity of the grantor ( use of a patent granted by the inventor’s heirs). 2. Certain countries do not allow royalties paid to be de ducted for the purposes of the payer’s tax unless the recip - ient also resides in the same State or is taxable in that State. Otherwise they forbid the deduction. The question whether the deduction should also be allowed in cases where the royalties are paid by a resident of a Contracting State to a resident of the other State is dealt with in paragraph 4 of Article 24. B. Commentary on the paragraphs of article 12 1 and 2 Paragraphs 4. Paragraph 1 omits the word “only” found in the corresponding provision of the OECD Model Convention, which provides that “royal - ties arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State”. Paragraph 2 is an addition flowing logically from the premise under - lying paragraph 1, which is that royalties may be taxable in the source country as well as the residence country. By providing for taxing rights in respect of royalties to be shared between the State of residence and the State of source, the United Nations Model Convention departs from the principle of exclusive residence State’s right to tax provided in the OECD Model Convention. In this context, it should be noted that several member States of OECD have recorded reservations to the exclusive residence State taxation of royalties provided by Article 12 of the OECD Model Convention. 5. The Commentary on the 2010 OECD Model Convention con - tains the following relevant passages: 296

319 Article 12 Commentary 4. The requirement of beneficial ownership was introduced in paragraph 1 of Article 12 to clarify how the Article applies in relation to payments made to intermediaries. It makes plain that the State of source is not obliged to give up taxing rights over royalty income merely because that income was immediately received by a resident of a State with which the State of source had concluded a convention. The term “beneficial owner” is not used in a narrow technical sense, rather, it should be under - stood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance. Relief or exemption in respect of an item of income 4.1 is granted by the State of source to a resident of the other Contracting State to avoid in whole or in part the double tax - ation that would otherwise arise from the concurrent taxation of that income by the State of residence. Where an item of income is received by a resident of a Contracting State acting in the capacity of agent or nominee it would be inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption merely on account of the status of the immediate recipient of the income as a resi - dent of the other Contracting State. The immediate recipient of the income in this situation qualifies as a resident but no potential double taxation arises as a consequence of that status since the recipient is not treated as the owner of the income for tax purposes in the State of residence. It would be equally inconsistent with the object and purpose of the Convention for the State of source to grant relief or exemption where a resident of a Contracting State, otherwise than through an agency or nominee relationship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. For these reasons, the report from the Committee on Fiscal Affairs entitled “Double Taxation Conventions and 37 the Use of Conduit Companies” concludes that a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has, as a practical matter, very 37 Reproduced in Volume II of the full-length version of the OECD Model Tax Convention, at page R(6)-1. 297

320 Article 12 Commentary narrow powers which render it, in relation to the income con - cerned, a mere fiduciary or administrator acting on account of the interested parties. Subject to other conditions imposed by the Article, the 4.2 limitation of tax in the State of source remains available when an intermediary, such as an agent or nominee, is interposed between the beneficiary and the payer, in those cases where the beneficial owner is a resident of the other Contracting State (the text of the Model was amended in 1995 to clarify this point, which has been the consistent position of all member countries). States which wish to make this more explicit are free to do so during bilateral negotiations. 6. During discussion by the former Group of Experts in 1999, members from developing countries argued that, in order to facilitate the conclusion of tax treaties between those countries and developed countries, the primary right to tax royalties should be given to the country where the income arose, that is, the source country. Patents and processes might be licensed to developing countries after they had been fully exploited elsewhere and, according to these members, after the expenses incurred in connection with their development had already been largely recouped. 7. Members from developed countries responded that it would be unrealistic to assume that enterprises selected the oldest patents for licensing to developing countries. Normally, an enterprise would license its patents to foreign subsidiaries and therefore select the most up-to-date inventions, in the hope of expanding existing markets or opening up new ones. Patents are not merchandise but instruments for promoting industrial production. Several members from developed countries held as a matter of principle that the country of residence of the owner of a patent or similar property should have the exclusive or primary right to tax royalties paid thereon. 8. Since the former Group of Experts reached no consensus on a particular rate for the withholding tax to be charged on royalties on a gross basis, the rate should be established through bilateral negoti - ations. The following considerations might be taken into account in negotiations: 298

321 Article 12 Commentary First, the country of source should recognize both current — expenses allocable to the royalty and expenditure incurred in the development of the property whose use gave rise to - the royalty. It should be considered that the costs of devel oping the property are also allocable to profits derived from other royalties or activities, past or fu ture, associated with these expenditures and that expenditure not directly - incurred in the development of that property might never theless have contributed significantly to that development. Second, if an expense ratio is agreed upon in fixing a gross — rate in the source country, the country of the recipient, if following a credit method, should also use that expense ratio in applying its credit, whenever feasible. Therefore, that matter should be considered under Article 23 A or 23 B. 9. Other factors might influence the determination of the with - holding tax on gross royalties, including the developing countries’ need to earn revenue and conserve foreign exchange; the fact that royalty payments flow almost entirely from developing countries to developed countries; the extent of assistance that developed countries should, for a variety of reasons, extend to developing countries; and the spe - cial importance of providing such assistance in the context of royalty payments; the desirability of preventing a shift of the tax burden to the licensees in the licensing arrangement; the ability that taxation at source confers on a developing country to make selective judgements by which, through reduced taxation or exemption, it could encourage those licens - ing arrangements if they were considered desirable for its development; the lessening of the risks of tax evasion resulting from taxation at the source; the fact that the country of the licensor supplies the facilities and activities necessary for the development of the patent and thus under - takes the risks associated with the patent; the desirability of obtaining and encouraging a flow of technology to developing countries; the desir - ability of expanding the field of activity of the licensor in the utilization of the research; the benefits that developed countries obtain from world development in general; the relative importance of revenue sacrifice; the relation of the royalty decision to other decisions in the negotiations. 10. Income from film rentals should not be treated as industrial and commercial profits but should be dealt with in the context of royalties. 299

322 Article 12 Commentary The tax would thus be levied on a gross basis but expenses would be taken into account in fixing the withholding rate. With regard to expenses, there are factors that could be regarded as peculiarly relevant to film rentals. As a general rule, the expenses of film producers might be much higher and the profits lower than in the case of industrial royalties. On the other hand, because a considerable part of film expenses represents high salaries paid to actors and other participants who may be taxed solely by the country of residence, and not by the source country, these expenses might not justify any great reduction of the withholding tax - at source. However, it could be said that the amounts involved are nev ertheless real costs for the producer and should be taken into account, while at the same time all countries involved should join in efforts to make sure that such income does not escape tax. Further, while the write-off of expenses in the country of residence does not mean that the expenses should not be taken into account at source, at some point old films could present a different expense situation. 11. Some members of the former Group of Experts expressed the view that because copyright royalties represent cultural efforts, they should be exempted from taxation by the source country. Other mem - bers, however, argued that tax would be levied by the residence coun - try, and the reduction at source would not benefit the author. Other members favoured exempting copyright royalties at the source, not necessarily for cultural reasons, but because the country of residence is in a better position to evaluate the expenses and personal circum - stances of the creator of the royalties, including the period over which the books or other copyrighted items had been created; a reduction of the source country tax could be supported in some cases by the fact that the tax was too high to be absorbed by the tax credit of the residence country. However, source countries might not be willing to accept that approach to the problem. Furthermore, if the person deal - ing with the source country might be the publisher and not the author, arguments supporting the exemption of the author’s income because of his personal situation obviously do not apply to the publisher. Paragraph 3 12. This paragraph reproduces Article 12, paragraph 2, of the OECD Model Convention, but does not incorporate the 1992 300

323 Article 12 Commentary amendment thereto which eliminates equipment rental from this Article. Also, paragraph 3 of Article 12 includes payments for tapes and royalties which are not included in the corresponding provision of the OECD Model Convention. The following portions of the OECD Commentary are relevant (the bracketed paragraphs being portions of the Commentary that highlight differences between the United Nations Model Convention and the OECD Model Convention): 8. Paragraph 2 contains a definition of the term “royalties”. These relate, in general, to rights or property constituting the different forms of literary and artistic property, the elements of intellectual property specified in the text and information concerning industrial, commercial or scientific experience. The definition applies to payments for the use of, or the entitlement to use, rights of the kind mentioned, whether or not they have been, or are required to be, registered in a public register. The definition covers both payments made under a licence and com - pensation which a person would be obliged to pay for fraudu - lently copying or infringing the right. 8.4 As a guide, certain explanations are given below in order to define the scope of Article 12 in relation to that of other Articles of the Convention, as regards, in particular, [equipment renting and] the provision of information. 10. Rents in respect of cinematograph films are also treated as royalties, whether such films are exhibited in cinemas or on the television. It may, however, be agreed through bilateral negotiations that rents in respect of cinematograph films shall profits and, in consequence, subjected to be treated as business the provisions of Articles 7 and 9. 11. In classifying as royalties payments received as consid - eration for information concerning industrial, commercial or scientific experience, paragraph 2 is referring to the concept of “know-how”. Various specialist bodies and authors have formulated definitions of know-how. The words “payments ... for information concerning industrial, commercial or scientific experience” are used in the context of the transfer of certain information that has not been patented and does not gener - ally fall within other categories of intellectual property rights. It generally corresponds to undivulged information of an 301

324 Article 12 Commentary industrial, commercial or scientific nature arising from previ - ous experience, which has practical application in the operation of an enterprise and from the disclosure of which an economic benefit can be derived. Since the definition relates to informa - tion concerning previous experience, the Article does not apply - to payments for new information obtained as a result of per forming services at the request of the payer. Some members of the Committee of Experts are of the view that there is no ground to limit the scope of information of an industrial, com - mercial or scientific nature to that arising from previous experience. The OECD Commentary then continues: In the know-how contract, one of the parties agrees to 11.1 impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public. It is recognised that the grantor is not required to play any part himself in the application of the formulae granted to the licensee and that he does not guarantee the result thereof. This type of contract thus differs from contracts for the 11.2 provision of services, in which one of the parties undertakes to use the customary skills of his calling to execute work him - self for the other party. Payments made under the latter con - tracts generally fall under Article 7 [or in the case of the United Nations Model Convention Article 14.] The need to distinguish these two types of payments, i.e. 11.3 - payments for the supply of know-how and payments for the pro vision of services, sometimes gives rise to practical difficulties. The following criteria are relevant for the purpose of making that distinction: — Contracts for the supply of know-how concern informa - tion of the kind described in paragraph 11 that already - exists or concern the supply of that type of informa tion after its development or creation and include spe - cific provisions concerning the confidentiality of that information. — In the case of contracts for the provision of services, the supplier undertakes to perform services which may require the use, by that supplier, of special knowledge, 302

325 Article 12 Commentary skill and expertise but not the transfer of such special knowledge, skill or expertise to the other party. — In most cases involving the supply of know-how, there would generally be very little more which needs to be done by the supplier under the contract other than to supply existing information or reproduce existing mate - rial. On the other hand, a contract for the performance of services would, in the majority of cases, involve a very much greater level of expenditure by the supplier in order to perform his contractual obligations. For instance, the supplier, depending on the nature of the services to be rendered, may have to incur salaries and wages for employees engaged in researching, designing, testing, drawing and other associated activities or payments to sub-contractors for the performance of similar services. 11.4 Examples of payments which should therefore not be considered to be received as consideration for the provision of know-how but, rather, for the provision of services, include: — payments obtained as consideration for after-sales service, — payments for services rendered by a seller to the pur - chaser under a warranty, payments for pure technical assistance, — — payments for a list of potential customers, when such a list is developed specifically for the payer out of generally available information (a payment for the confidential list of customers to which the payee has provided a particu - lar product or service would, however, constitute a pay - ment for know-how as it would relate to the commercial experience of the payee in dealing with these customers), payments for an opinion given by an engineer, an advo - — cate or an accountant, and — payments for advice provided electronically, for elec - tronic communications with technicians or for accessing, through computer networks, a trouble-shooting database such as a database that provides users of software with non-confidential information in response to frequently asked questions or common problems that arise frequently. 303

326 Article 12 Commentary 11.5 In the particular case of a contract involving the provision, - by the supplier, of information concerning computer program ming, as a general rule the payment will only be considered to be made in consideration for the provision of such information so as to constitute know-how where it is made to acquire information constituting ideas and principles underlying the program, such as logic, algorithms or programming languages or techniques, where this information is provided under the condition that the customer not disclose it without authorisation and where it is subject to any available trade secret protection. 11.6 In business practice, contracts are encountered which cover both know-how and the provision of technical assistance. One example, amongst others, of contracts of this kind is that of franchising, where the franchisor imparts his knowledge and experience to the franchisee and, in addition, provides him with varied technical assistance, which, in certain cases, is backed up with financial assistance and the supply of goods. The appro - priate course to take with a mixed contract is, in principle, to break down, on the basis of the information contained in the contract or by means of a reasonable apportionment, the whole amount of the stipulated consideration according to the various parts of what is being provided under the contract, and then to apply to each part of it so determined the taxation treatment proper thereto. If, however, one part of what is being provided constitutes by far the principal purpose of the contract and the other parts stipulated therein are only of an ancillary and largely unimportant character, then the treatment applicable to the principal part should generally be applied to the whole amount of the consideration. 12. Whether payments received as consideration for com - puter software may be classified as royalties poses difficult problems but is a matter of considerable importance in view of the rapid development of computer technology in recent years and the extent of transfers of such technology across national borders. In 1992, the Commentary was amended to describe the principles by which such classification should be made. Paragraphs 12 to 17 were further amended in 2000 to refine the analysis by which business profits are distinguished from 304

327 Article 12 Commentary royalties in computer software transactions. In most cases, the revised analysis will not result in a different outcome. 12.1 - Software may be described as a program, or series of pro grams, containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software). It can be transferred through a variety of media, for example in writing or electronically, on a magnetic tape or disk, or on a laser disk or CD-Rom. It may be standardised with a wide range of applications or be tailor-made for single users. It can be transferred as an integral part of computer hardware or in an independent form available for use on a variety of hardware. 12.2 The character of payments received in transactions involving the transfer of computer software depends on the nature of the rights that the transferee acquires under the par - ticular arrangement regarding the use and exploitation of the program. The rights in computer programs are a form of intel - lectual property. Research into the practices of OECD member countries has established that all but one protects rights in com - puter programs either explicitly or implicitly under copyright law. Although the term “computer software” is commonly used to describe both the program — in which the intellectual prop - erty rights (copyright) subsist— and the medium on which it is embodied, the copyright law of most OECD member countries recognises a distinction between the copyright in the program and software which incorporates a copy of the copyrighted pro - gram. Transfers of rights in relation to software occur in many different ways ranging from the alienation of the entire rights in the copyright in a program to the sale of a product which is subject to restrictions on the use to which it is put. The consid - eration paid can also take numerous forms. These factors may make it difficult to determine where the boundary lies between software payments that are properly to be regarded as royalties and other types of payment. The difficulty of determination is compounded by the ease of reproduction of computer software, and by the fact that acquisition of software frequently entails the making of a copy by the acquirer in order to make possible the operation of the software. 305

328 Article 12 Commentary 13. - The transferee’s rights will in most cases consist of par tial rights or complete rights in the underlying copyright (see paragraphs 13.1 and 15 below), or they may be (or be equiva - lent to) partial or complete rights in a copy of the program (the “program copy”), whether or not such copy is embodied in a material medium or provided electronically (see paragraphs 14 to 14.2 below). In unusual cases, the transaction may represent a transfer of “know-how” or secret formula (paragraph 14.3). Payments made for the acquisition of partial rights in the 13.1 copyright (without the transferor fully alienating the copyright rights) will represent a royalty where the consideration is for granting of rights to use the program in a manner that would, without such license, constitute an infringement of copyright. Examples of such arrangements include licenses to reproduce and distribute to the public software incorporating the cop - yrighted program, or to modify and publicly display the pro - gram. In these circumstances, the payments are for the right to use the copyright in the program ( i.e. to exploit the rights that would otherwise be the sole prerogative of the copyright holder). It should be noted that where a software payment is properly to be regarded as a royalty there may be difficulties in applying the copyright provisions of the Article to software payments since paragraph 2 requires that software be classified as a literary, artistic or scientific work. None of these catego - ries seems entirely apt. The copyright laws of many countries deal with this problem by specifically classifying software as a literary or scientific work. For other countries treatment as a scientific work might be the most realistic approach. Countries for which it is not possible to attach software to any of those categories might be justified in adopting in their bilateral trea - ties an amended version of paragraph 2 which either omits all references to the nature of the copyrights or refers specifically to software. 14. In other types of transactions, the rights acquired in rela - tion to the copyright are limited to those necessary to enable the user to operate the program, for example, where the transferee is granted limited rights to reproduce the program. This would be the common situation in transactions for the acquisition of a program copy. The rights transferred in these cases are specific 306

329 Article 12 Commentary to the nature of computer programs. They allow the user to copy the program, for example onto the user’s computer hard drive or for archival purposes. In this context, it is important - to note that the protection afforded in relation to computer pro grams under copyright law may differ from country to country. In some countries the act of copying the program onto the hard drive or random access memory of a computer would, without a license, constitute a breach of copyright. However, the copy - right laws of many countries automatically grant this right to the owner of software which incorporates a computer program. Regardless of whether this right is granted under law or under a license agreement with the copyright holder, copying the pro - gram onto the computer’s hard drive or random access memory or making an archival copy is an essential step in utilising the program. Therefore, rights in relation to these acts of copying, where they do no more than enable the effective operation of the program by the user, should be disregarded in analysing the character of the transaction for tax purposes. Payments in these types of transactions would be dealt with as commercial income in accordance with Article 7. 14.1 The method of transferring the computer program to the transferee is not relevant. For example, it does not matter whether the transferee acquires a computer disk containing a copy of the program or directly receives a copy on the hard disk of her computer via a modem connection. It is also of no rel - evance that there may be restrictions on the use to which the transferee can put the software. 14.2 The ease of reproducing computer programs has resulted in distribution arrangements in which the transferee obtains rights to make multiple copies of the program for operation only within its own business. Such arrangements are commonly referred to as “site licences”, “enterprise licenses”, or “network licences”. Although these arrangements permit the making of multiple copies of the program, such rights are generally lim - ited to those necessary for the purpose of enabling the opera - tion of the program on the licensee’s computers or network, and reproduction for any other purpose is not permitted under the license. Payments under such arrangements will in most cases be dealt with as business profits in accordance with Article 7. 307

330 Article 12 Commentary 14.3 Another type of transaction involving the transfer of computer software is the more unusual case where a software house or computer programmer agrees to supply information about the ideas and principles underlying the program, such as logic, algorithms or programming languages or techniques. In these cases, the payments may be characterised as royalties to the extent that they represent consideration for the use of, or the right to use, secret formulas or for information concerning industrial, commercial or scientific experience which cannot be separately copyrighted. This contrasts with the ordinary case in which a program copy is acquired for operation by the end user. 14.4 Arrangements between a software copyright holder and a distribution intermediary frequently will grant to the distribu - tion intermediary the right to distribute copies of the program without the right to reproduce that program. In these transac - tions, the rights acquired in relation to the copyright are limited to those necessary for the commercial intermediary to distribute copies of the software program. In such transactions, distribu - tors are paying only for the acquisition of the software copies and not to exploit any right in the software copyrights. Thus, in a transaction where a distributor makes payments to acquire and distribute software copies (without the right to reproduce the software), the rights in relation to these acts of distribution should be disregarded in analysing the character of the transac - tion for tax purposes. Payments in these types of transactions Article would be dealt with as business profits in accordance with 7. This would be the case regardless of whether the copies being distributed are delivered on tangible media or are distributed electronically (without the distributor having the right to repro - duce the software), or whether the software is subject to minor customisation for the purposes of its installation. 15. Where consideration is paid for the transfer of the full ownership of the rights in the copyright, the payment cannot represent a royalty and the provisions of the Article are not applicable. Difficulties can arise where there is a transfer of rights involving: — exclusive right of use of the copyright during a specific period or in a limited geographical area; 308

331 Article 12 Commentary additional consideration related to usage; — — consideration in the form of a substantial lump sum payment. 16. Each case will depend on its particular facts but in general if the payment is in consideration for the transfer of rights that constitute a distinct and specific property (which is more likely in the case of geographically-limited than time-limited rights), such payments are likely to be business profits within Article 7 (or 14 in the case of the United Nations Model Convention) or a capital gain within Article 13 rather than royalties within Article 12. That follows from the fact that where the ownership of rights has been alienated, the consideration cannot be for the use of the rights. The essential character of the transaction as an alienation cannot be altered by the form of the consideration, the payment of the consideration in instalments or, in the view of most countries, by the fact that the payments are related to a contingency. 17. Software payments may be made under mixed contracts. Examples of such contracts include sales of computer hardware with built-in software and concessions of the right to use soft - ware combined with the provision of services. The methods set out in paragraph 11 above for dealing with similar problems in relation to patent royalties and know-how are equally applicable to computer software. Where necessary the total amount of the consideration payable under a contract should be broken down on the basis of the information contained in the contract or by means of a reasonable apportionment with the appropriate tax treatment being applied to each apportioned part. 17.1 The principles expressed above as regards software pay - ments are also applicable as regards transactions concern - ing other types of digital products such as images, sounds or text. The development of electronic commerce has multiplied the number of such transactions. In deciding whether or not payments arising in these transactions constitute royalties, the main question to be addressed is the identification of that for which the payment is essentially made. 17.2 Under the relevant legislation of some countries, trans - actions which permit the customer to electronically download 309

332 Article 12 Commentary digital products may give rise to use of copyright by the cus - e.g. because a right to make one or more copies of the tomer, digital content is granted under the contract. Where the con - sideration is essentially for something other than for the use of, or right to use, rights in the copyright (such as to acquire other types of contractual rights, data or services), and the use of copyright is limited to such rights as are required to enable downloading, storage and operation on the customer’s com - puter, network or other storage, performance or display device, - such use of copyright should not affect the analysis of the char acter of the payment for purposes of applying the definition of “royalties”. 17.3 This is the case for transactions that permit the customer - (which may be an enterprise) to electronically download digi tal products (such as software, images, sounds or text) for that customer’s own use or enjoyment. In these transactions, the payment is essentially for the acquisition of data transmitted in the form of a digital signal and therefore does not consti - tute royalties but falls within Article 7 or Article 13, as the case may be. To the extent that the act of copying the digital signal onto the customer’s hard disk or other non-temporary media involves the use of a copyright by the customer under the relevant law and contractual arrangements, such copying is merely the means by which the digital signal is captured and stored. This use of copyright is not important for classification purposes because it does not correspond to what the payment is essentially in consideration for ( i.e. to acquire data transmitted in the form of a digital signal), which is the determining factor for the purposes of the definition of royalties. There also would be no basis to classify such transactions as “royalties” if, under the relevant law and contractual arrangements, the creation of a copy is regarded as a use of copyright by the provider rather than by the customer. 17.4 By contrast, transactions where the essential considera - tion for the payment is the granting of the right to use a copy - right in a digital product that is electronically downloaded for that purpose will give rise to royalties. This would be the case, for example, of a book publisher who would pay to acquire the right to reproduce a copyrighted picture that it would electronically 310

333 Article 12 Commentary download for the purposes of including it on the cover of a book - that it is producing. In this transaction, the essential consid eration for the payment is the acquisition of rights to use the copyright in the digital product, i.e. the right to reproduce and distribute the picture, and not merely for the acquisition of the digital content. Some members of the Committee of Experts are of the view that the payments referred to in paragraphs 14, 14.1, 14.2, 14.4, 15, 16, 17.2 and - 17.3 of the OECD Commentary extracted above may constitute royal ties. The OECD Commentary then continues: 18. The suggestions made above regarding mixed contracts could also be applied in regard to certain performances by artists and, in particular, in regard to an orchestral concert given by a conductor or a recital given by a musician. The fee for the musical performance, together with that paid for any simultaneous radio broadcasting thereof, seems to fall to be treated under Article 17. Where, whether under the same contract or under a separate one, the musical performance is recorded and the artist has stipulated that he be paid royalties on the sale or public playing of the records, then so much of the payment received by him as consists of such royalties falls to be treated under Article 12 where, however, the copyright in a sound recording, because of either the relevant copyright law or the terms of contract, belongs to a person with whom the artist has contractually agreed to provide his services ( i.e. a musical performance during the recording), or to a third party, the payments made under such a contract fall under Articles 7 [or Article 14 of the United Nations Model Convention] ( e.g. if the performance takes place outside the State of source of the payment) or 17 rather than under this Article, even if these pay - ments are contingent on the sale of the recordings. 19. It is further pointed out that variable or fixed payments for the working of mineral deposits, sources or other natural resources are governed by Article 6 and do not, therefore, fall within the present Article. 13. Paragraph 2 of Article 12 of the OECD Model Convention (cor - responding to paragraph 3 of Article 12 of the United Nations Model Convention) was amended by deleting the words “or the use of, or the 311

334 Article 12 Commentary right to use, industrial, commercial or scientific equipment” by the Report entitled “The Revision of the Model Convention” adopted by the Council of the OECD on 23 July 1992. However, a number of OECD member countries have entered reservations on this point. 13.1 The reference in Article 12(3) to “industrial, commercial or scientific equipment” addresses circumstances in which the owner of the equipment earns profits from letting another person use that equipment, without having the owner establish any presence in the state where it is used, or where the user resides, which would satisfy the requirements of Article 5 for the existence of a permanent estab - lishment. For this kind of business the equipment itself, when used by another person, is treated in the United Nations Model Convention as having significance similar to that of a permanent establishment. 13.2 The term “equipment” is not defined in this Model. Accordingly, the provisions of paragraph 2 of Article 3 apply, which means that the term may have different meanings in different States. However, a feature that is always present is that the equipment will be used in the perfor - mance of a task. It is a tool used by a business in the sense that it is not enjoyed for its own sake. Thus, for example, a car rented by a tourist will not be considered to be “equipment.” Neither can equipment include intellectual property, immovable property covered by Article 6, or prop - erty covered by Article 8. Industrial, commercial or scientific equipment is clearly a subset of equipment and may, outside of a consumer context, include (not an exhaustive list) ships, aircraft, cars and other vehicles, cranes, containers, satellites, pipelines and cables etc. 13.3 A clear distinction must be made between royalties paid for the use of equipment, which fall under Article 12, and payments consti - tuting consideration for the sale of equipment, some or all of which may, depending on the case, fall under Articles 7, 11, 13, 14 or 21. Some contracts combine the lease element and the sale element, so that it sometimes proves difficult to determine their nature and economic substance. In the case of credit sale agreements, hire purchase agree - ments and other forms of finance leases, it seems clear that the sale element is paramount, because the parties have from the outset agreed that the ownership of the property in question shall be transferred from one to the other, although they have made this dependent upon the payment of the last instalment. Consequently, the instalments paid 312

335 Article 12 Commentary by the purchaser / hirer do not, in principle, constitute royalties. In the case, however, of an operating lease, the sole, or at least the principal, purpose of the contract is normally that of lease, even if the lessee has the right thereunder to opt during its term to purchase the equipment in question outright. Article 12 therefore applies in the normal case to the rentals paid by the lessee, including all rentals paid up to the date the lessee exercises any right to purchase. Indications for a finance lease rather than an operating lease might include, for example: — the lease is long term and non-cancellable; — the term of the lease is likely to cover a substantial part (or all) of the equipment’s useful life; there is no other likely user of the equipment, or it is not — feasible for the equipment to be leased to another lessee; — the lessee of the equipment behaves as owner; — the lessee carries positive and / or negative residual value risk or utility in respect of the equipment; — the lease payments to use the equipment are high particu - larly at the beginning such that they constitute an inordi - nately large proportion of the amount needed to secure the acquisition; — the lease payments materially exceed the current fair rental value and thus compensate for more than just the use of property; and — some portion of the lease payments is specifically desig - nated as interest or is otherwise readily recognizable as the equivalent of interest. 13.4 With regard to satellite operators and their customers, the char - acterization of a payment by the customer to the satellite operator as a royalty will depend to a large extent on the specific contractual arrange - ments. If the owner of the satellite leases it to another person and that person operates it, the payment for the lease would be a royalty payment for the use of industrial, commercial or scientific equipment. However, in many cases the customer does not acquire the possession or control of the satellite, but makes use of part or all of its transmission capac - ity. The satellite would continue to be operated by the lessor. In such cases, members are of the opinion that the payments made would be 313

336 Article 12 Commentary in the nature of transmission services to which Article 7 or Article 12A applies. Other members are of the opinion that a payment for the use of the transmission capacity (or transport or transmission capacity in the case of pipelines or cables) could be regarded as payments made for the leasing of industrial, commercial or scientific equipment. 14. When the former Group of Experts considered this issue, it addressed the problems of distinguishing royalties from types of income properly subject to other articles of the Convention. A member from a developed country asserted that the problem was that the “roy - alties” definition makes an imperfect distinction between revenues that constituted royalties in the strict sense and payments received for brain-work and technical services, such as surveys of any kind (engineering, geological research etc.). The member also mentioned the problem of distinguishing between royalties akin to income from capital and payments received for services. Given the broad definition of “information concerning industrial, commercial or scientific expe - rience”, some countries tend to regard the provision of brain-work and technical services as the provision of “information concerning indus - trial, commercial or scientific experience” and to regard payment for such information as royalties. 15. In order to avoid those difficulties, this member proposed that the definition of royalties be restricted by excluding payments received for “information concerning industrial, commercial or scientific experience”. The member also suggested that a protocol should be annexed to the treaty making it clear that such payments should be deemed to be prof - its of an enterprise to which Article 7 would apply and that payments received for studies or surveys of a scientific or technical nature, such as geological surveys, or for consultant or supervisory services, should also be deemed to be business profits subject to Article 7. The effect of these provisions would be that the source country could not tax such payments unless the enterprise had a permanent establishment in that country and that taxes should only be imposed on the net income ele - ment of such payments attributable to that permanent establishment. 16. Some members from developing countries interpreted the phrase “information concerning industrial, commercial or scientific experience” to mean specialized knowledge, having intrinsic prop - erty value relating to industrial, commercial, or managerial processes, 314

337 Article 12 Commentary conveyed in the form of instructions, advice, teaching or formulas, - plans or models, permitting the use or application of experience gath ered on a particular subject. They also pointed out that the definition of the term royalties could be broadened through bilateral negotiations to include gains derived from the alienation of any such right or property that were contingent on the productivity, use or disposition thereof. The former Group of Experts agreed that literary copyrights could be interpreted to include copyrights relating to international news. Paragraph 4 This paragraph reproduces with modifications Article 12, para 17. - graph 3, of the OECD Model Convention, which states that paragraph 1 does not apply to royalties beneficially owned by a person having a 38 permanent establishment in the source country if the right or prop - erty from which the royalties derive is effectively connected with the 39 permanent establishment. The former Group of Experts decided to modify paragraph 3 of the OECD Model Convention by introducing a limited force of attraction principle. In addition to royalties excluded from the application of paragraph 1 by paragraph 3 of the OECD Article, paragraph 4 of the United Nations Model Convention excludes royalties which are received in connection with business activities described in subparagraph ( c ) of paragraph 1 of Article 7 (business - activities of the same or similar kind as those of a permanent estab lishment in the source country), even if the business activities are not carried on through a permanent establishment or a fixed base. The United Nations Model Convention also modifies the paragraph to refer to paragraph 2 as well as paragraph 1. Paragraph 5 18. This paragraph, which provides that royalties are considered income from sources in the residence country of the payer of the roy - alties, is an innovation of the United Nations Model Convention, not found in Article 12 of the OECD Model Convention. 38 Or a fixed base; see Article 14 of the United Nations Model Convention. 39 See footnote above. 315

338 Article 12 Commentary 19. As in the case of interest, some members suggested that some countries may wish to substitute a rule that would identify the source of a royalty as the State in which the property or right giving rise to the royalty (the patent etc.) is used. Where, in bilateral negotiations, the two parties differ on the appropriate rule, a possible solution would be a rule which, in general, would accept the payer’s place of residence as the source of royalty; but where the right or property for which the royalty was paid was used in the State having a place of use rule, the royalty would be deemed to arise in that State. 6 Paragraph This paragraph reproduces Article 12, paragraph 4, of the OECD 20. Model Convention, the Commentary on which reads as follows: 22. The purpose of this paragraph is to restrict the opera - tion of the provisions concerning the taxation of royalties in cases where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the royalties paid exceeds the amount which would have been agreed upon by the payer and the beneficial owner had they stipulated at arm’s length. It pro vides that in such a case the provisions of the Article apply only to that last-mentioned amount and that the excess part of the royalty shall remain taxable according to the laws of the two Contracting States due regard being had to the other provisions of the Convention. The paragraph permits only the adjustment of the amount of royalties and not the reclassification of the royalties in such a way as to give it a different character, e.g. a contribution to equity capital. For such an adjustment to be possible under paragraph 4 of Article 12 it would be necessary as a minimum to remove the limiting phrase “having regard to the use, right or information for which they are paid”. If greater clarity of intent is felt appropriate, a phrase such as “for what - ever reason” might be added after “exceeds”. 23. It is clear from the text that for this clause to apply the payment held excessive must be due to a special relationship between the payer and the beneficial owner or between both of them and some other person. There may be cited as examples 316

339 Article 12 Commentary cases where royalties are paid to an individual or legal person who directly or indirectly controls the payer, or who is directly or indirectly controlled by him or is subordinate to a group having common interest with him. These examples, moreover, are similar or analogous to the cases contemplated by Arti cle 9. 24. On the other hand, the concept of special relationship also covers relationship by blood or marriage and, in general, any community of interests as distinct from the legal relation - ship giving rise to the payment of the royalty. With regard to the taxation treatment to be applied to the 25. excess part of the royalty, the exact nature of such excess will need to be ascertained according to the circumstances of each case, in order to determine the category of income in which it should be classified for the purpose of applying the provisions of the tax laws of the States concerned and the provisions of the Convention. If two Contracting States should have difficulty in determining the other provisions of the Convention applicable, as cases required, to the excess part of the royalties there would be nothing to prevent them from introducing additional clari - fications in the last sentence of paragraph 4, as long as they do not alter its general purport. 26. Should the principles and rules of their respective laws oblige the two Contracting States to apply different Articles of the Convention for the purpose of taxing the excess, it will be necessary to resort to the mutual agreement procedure pro - vided by the Convention in order to resolve the difficulty. 21. When this issue was last considered by the former Group of Experts, some members pointed out that there are artificial devices entered into by persons to take advantage of the provisions of Article 12 through, inter alia, creation or assignment of agreements for the use, right or information with respect to intangible assets for which royalties are charged. While substance over form rules, abuse of rights principles or any similar doctrine could be used to counter such arrangements, Contracting States which may want to specifically address the issue may include a clause on the following lines in their bilateral tax treaties: The provisions of this Article shall not apply if it was the main purpose, or one of the main purposes, of any persons concerned 317

340 Articles 12 and 12A Commentary with the creation or the assignment of the rights in respect of which the royalties are paid to take advantage of this Article by means of that creation or assignment. 12A Article FEES FOR TECHNICAL SERVICES A. General considerations 1. Article 12A was added to the United Nations Model Convention in 2017 to allow a Contracting State to tax fees for certain technical services paid to a resident of the other Contracting State on a gross basis at a rate to be negotiated by the Contracting States. Under this Article, a Contracting State is entitled to tax fees for technical services if the fees are paid by a resident of that State or by a non-resident with a permanent establishment or fixed base in that State and the fees are borne by the permanent establishment or fixed base; it is not necessary for the technical services to be provided in that State. Fees for techni - cal services are defined to mean payments for services of a managerial, technical or consultancy nature. 2. Until the addition of Article 12A, income from services derived by an enterprise of a Contracting State was taxable exclusively by the State in which the enterprise was resident unless the enterprise carried on business through a permanent establishment in the other State (the source State) or provided professional or independent personal ser - vices through a fixed base in the source State. With the rapid changes in modern economies, particularly with respect to cross-border ser - vices, it is now possible for an enterprise resident in one State to be sub - stantially involved in another State’s economy without a permanent establishment or fixed base in that State and without any substantial physical presence in that State. In particular, with the advancements in means of communication and information technology, an enterprise of one Contracting State can provide substantial services to custom - ers in the other Contracting State and therefore maintain a signifi - cant economic presence in that State without having any fixed place of business in that State and without being present in that State for any substantial period. The OECD/G20 Base Erosion and Profit Shifting 318

341 Article 12A Commentary Project, Action 1: Final Report “Addressing the Tax Challenges of the Digital Economy” (2015) illustrates the difficulties faced by tax policy makers and tax administrations in dealing with the new digital busi - ness models made available through the digital economy. The Report did not recommend, for the time being, a withholding tax on digital transactions (which include digital cross border services); nor did it recommend a new nexus for taxation in the form of a significant eco - nomic presence test. However, it was recognized that countries were free to include such provisions in their tax treaties, among other addi - tional safeguards against BEPS. Before the introduction of Article 12A, countries were faced 3. with more restrictive rules of application when technical services were provided cross border. In general, the rules under Article 7, together with Article 5, and Article 14 of the United Nations Model Convention give limited scope for taxing income from such services, in particular without a fixed base or permanent establishment in the State of source. As noted in these Commentaries, countries have different interpre - tations of those rules, which can make their application difficult for all parties. 4. Furthermore, under Article 12 of the United Nations Model Convention, fees for technical services paid by a resident of one Contracting State to a resident of the other Contracting State cannot generally be taxed as royalties by the State in which the payer is res - ident. However, some countries take the view that the expression “information concerning industrial, commercial or scientific expe - rience” includes certain technical services, as noted in paragraph 5 below. Article 12 permits a Contracting State in which royalties arise to tax the gross amount of the royalty payments at a rate to be negoti - ated between the Contracting States. Royalties are defined in Article 12, paragraph 3 to mean payments for the use of, or the right to use, any copyright, patent, trademark, design, plan, secret formula or process, any industrial, commercial or scientific equipment, or information concerning industrial, commercial or scientific experience. In other words, royalties are payments for the use of, or the right to use, intel - lectual property, equipment or know-how (information concerning industrial, commercial or scientific experience). Thus, royalties involve the transfer of the use of, or the right to use, property or know-how. In contrast, when an enterprise provides services to a customer, it does not 319

342 Article 12A Commentary typically transfer its property or know-how or experience to the cus - tomer; instead, the enterprise simply performs work for the customer. Under a so-called “mixed contract,” an enterprise may provide both services and the right to use property or know-how to a customer. In such situations, in accordance with paragraph 12 of the Commentary on Article 12 (quoting paragraph 11.6 of the Commentary on Article 12 of the OECD Model Convention), the payments under the contract must be disaggregated into separate elements of payments for services and royalties unless one element is only ancillary and largely unim - portant. The negotiation of a rate of tax for fees for technical services under Article 12A that is the same as the rate for royalties in Article 12 may help to alleviate difficulties with mixed contracts, may be useful for developing countries with scarce administrative resources and may also reduce potential conflicts in applying the article. 5. In addition, countries have different interpretations of the meaning of the expression “information concerning industrial, com - mercial or scientific experience” in Article 12, paragraph 3 of the United Nations Model Convention (the same wording is contained in Article 12, paragraph 2 of the OECD Model Convention). Some coun - tries take the position that the provision of brain-work and technical services is covered by this phrase, and therefore payments for such services are in general taxable under Article 12. (See paragraphs 14 and 16 of the Commentary on Article 12.) 6. The uncertainty concerning the treatment of fees for technical and other similar services under the provisions of the United Nations Model Convention as it read before 2017 was undesirable for both tax - payers and tax authorities. It may also have resulted in difficult disputes, both for taxpayers and administrations, consuming scarce resources, as well as causing unrelieved double taxation or double non-taxation. 7. Fees for technical services may also result in the erosion of the tax base of countries that are prevented from taxing such fees by the provisions of the United Nations Model Convention. Fees for techni - cal services are usually deductible against a country’s tax base if the payer is a resident of the country or a non-resident with a permanent establishment or fixed base in the country. The reduction or erosion of a country’s tax base by deductible fees for technical services is not generally objectionable. If the payer is an enterprise, the payments are 320

343 Article 12A Commentary legitimate expenses incurred by the payer for the purpose of earn - ing income and should be deductible (assuming, of course, that the amount of the payments is reasonable). If the country is entitled to tax the non-resident service provider on the fees earned for the technical services, the reduction of the country’s tax base by the deductible pay - ments is offset by the country’s tax on those fees. 8. Where technical services are provided by an enterprise of one Contracting State to an associated enterprise in the other Contracting State, there is the possibility that the payments may be more or less than the arm’s length price of the services. Within a multinational group, fees for technical services may sometimes be used to shift profits from a profitable group company resident and operating in one coun - try to another group company resident in a low-tax country. Assume, for example, that Company B, an enterprise resident in Country B, a low-tax country, provides managerial, technical or consultancy ser - vices to Company A, an associated enterprise resident in Country A, a high-tax country. Assuming that the tax treaty between Country A and Country B contains provisions following those of the United Nations Model Convention, Company B can avoid having a perma - nent establishment in Country A by not establishing a fixed place of business in Country A and by not furnishing services in Country A for more than 183 days in any 12-month period. Thus, before the adoption of Article 12A, even if Company B was subject to tax on its income from services provided to Company A under the domestic tax law of Country A, the income would not have been taxable by Country A as a result of the tax treaty between Country A and Country B. If, for what - ever reason, Company B is not taxable by Country B on that income, or is subject to a low rate of tax on such income, the multinational enterprise will have effectively shifted profits from a relatively high-tax country (Country A) to a relatively low-tax country (Country B). 9. In addition, ordinarily the fees paid by Company A to Company B for the services would be deductible by Company A in computing its income subject to tax by Country A. This deduction reduces the tax base of Country A and, before the adoption of Article 12A, Country A would not have been able to impose tax on the payments by Company A to Company B, as discussed in paragraph 8, to offset the effect of the deduction. However, under Article 12A, if the fees for technical 321

344 Article 12A Commentary services were paid by a resident of Country A or a non-resident of Country A with a permanent establishment or fixed base in Country A, Country A would be entitled to tax those fees. The base erosion and profit shifting illustrated in the example 10. above raise serious concerns for both developed and developing coun - tries. However, the problem is especially serious from the perspective of developing countries, because they are disproportionately import - - ers of technical services and often lack the administrative capac ity to control or limit such base erosion and profit shifting through anti-avoidance rules in their domestic law and tax treaties. 11. The inability of countries to tax fees for technical services pro - vided by non-resident service providers under the provisions of the United Nations Model Convention before the addition of Article 12A may have given non-resident service providers, in certain circum - stances, a tax advantage over domestic service providers. Fees for technical services provided by domestic service providers are subject to domestic tax at the ordinary rate applicable to business profits. In contrast, as indicated above, non-resident service providers would not have been subject to any domestic tax if they did not have a permanent establishment or fixed base in that country, and they might have been subject only to low taxes (or no tax at all) on the fees earned in their country of residence. As a result of these considerations, the United Nations 12. Committee of Experts identified fees for technical services as a matter of priority to be dealt with as part of its larger project on the taxation of income from services under the United Nations Model Convention. After considerable study and debate, having due regard to all the argu - ments for and against the expansion of taxing rights with regards to services, the Committee decided to add a new article to the United Nations Model Convention expanding the taxing rights for States from which fees for technical services are paid. 13. The majority of the Committee of Experts rejected the position that a State should be entitled to tax income from services derived by a resident of the other Contracting State only if the services are provided in the first State. In particular, the majority rejected the argument that the residence of a payer of fees for technical services in a Contracting 322

345 Article 12A Commentary State and the deduction of those fees against that State ́s tax base do not provide sufficient nexus to that State to justify that State taxing those fees. In the view of those members of the Committee, base erosion is a sufficient justification for the taxation of income from employment under Article 15 and directors’ fees and remuneration of top-level managerial officials under Article 16. Although taxation of employ - ment income under Article 15 is limited to employment exercised in a country, Article 16 allows a Contracting State to tax an individual res - ident in the other Contracting State on fees derived by the individual as a director or remuneration derived as a top-level managerial official of a company resident in the first State, irrespective of whether the services are rendered inside or outside the first State. Moreover, under Articles 7 and 14, a country is entitled to tax income derived outside the country as long as the income is attributable to a permanent estab - lishment or fixed base in that country. 14. Article 12A may result in some non-resident service providers grossing up the cost of technical services provided to residents of a Contracting State. Countries should be aware of this possibility in the same way that they should be aware of the possibility of similar grossing up with respect to interest and royalties under Articles 11 and 12 respectively. The possibility that fees for technical services may be grossed up is a factor to be taken into account in this regard, along with many other factors. It is also a factor to be taken into account in establishing the maximum rate of tax imposed by a Contracting State on fees for technical services under Article 12A, paragraph 2. 15. The taxation of fees for technical services on a gross basis under Article 12A may result in excessive or double taxation. However, the possibility that fees for technical services may be subject to excessive or double taxation is reduced or eliminated under Article 23 (Methods for the Elimination of Double Taxation). In addition, the possibility of excessive or double taxation can be taken into account in establish - ing the maximum rate of tax imposed by a Contracting State on fees for technical services under Article 12A, paragraph 2, and depending on the negotiated rate, the risk of an excessive tax may be completely eliminated. 16. Despite the inclusion of Article 12A in the United Nations Model Convention, a significant minority of the members of the Committee 323

346 Article 12A Commentary did not agree with the policy justifications set forth above for the - Article. Fundamentally, these members did not agree with the justi fication set forth in paragraph 2 above that rapid changes in modern economies, particularly with respect to cross-border services, enable non-resident service providers to be substantially involved in another State’s economy without a physical presence. Rather, these members were of the view that in cases of payments for technical services that are not provided in the payer’s State, there is no nexus to that State that warrants taxation by that State on the payment. In the view of these members of the Committee, as a policy 17. matter, taxation of fees for technical services is warranted only when the service provider has a sufficient nexus to the payer’s State, which typically is in the form of a permanent establishment or fixed base. In other words, to justify taxation of technical services in a State, the services should be provided in that State with the degree of nexus required by Articles 5 (Permanent Establishment), 7 (Business Profits) and 14 (Independent Personal Services). 18. The other argument advanced for the inclusion of Article 12A is that payments for services are deductible and hence erode the tax base of the payer’s State. However, in the view of the members opposed to Article 12A, mere deductibility of a commercially justified payment - cannot be equated to harmful base erosion, and is therefore not a suf ficient reason for taxing that payment in the same State. 19. Those members of the Committee that did not agree with the inclusion of Article 12A in bilateral tax treaties were also concerned that the term “technical services” as used in the Article is not ade - quately defined. These members were therefore concerned that the application of the Article would result in increased uncertainty, incon - sistent treatment, and lengthy disputes between taxpayers and tax authorities. 20. In the view of those members of the Committee that did not agree with the inclusion of Article 12A, a further problem with tax - ation of fees for technical services on a gross basis is that it can lead to double taxation. The imposition of a tax on a gross basis denies the taxpayer the ability to take into account expenses that were incurred in connection with the provision of the services, which would be 324

347 Article 12A Commentary deductible if tax were imposed on a net basis. Thus, it is possible that the residence State’s remedies for relieving double taxation may not be adequate to fully relieve the gross-basis taxation imposed by the other State. 21. As a matter of broader economic policy, those members that opposed the inclusion of Article 12A were concerned that, as a result of the Article, consumers of technical services in the source State may encounter higher prices for those services, because foreign service pro - viders could pass added tax costs on to the consumer through means such as so-called “gross-up” clauses in contracts. Typically, a gross-up - clause will specify a net amount that the provider will receive, effec tively passing the burden of any withholding tax on to the consumer of the services. The use of gross-up clauses could result in the tax being shifted to the consumer and make it more expensive to purchase the services. This can put a foreign service provider at a competitive dis - advantage, effectively foreclosing access to a market that imposes such a withholding tax and restricting the consumer’s legitimate choice of suppliers. 22. These members were also concerned that the inclusion of Article 12A would lead to trade distortions as the taxation of goods and services would operate on a different basis. The reason for this is that the profits of an exporter of goods are taxable only in its State of residence, whereas, under Article 12A, what is in effect an import tariff would be applied to technical services. 23. In summary, these members did not accept the analysis in par - agraphs 2 to 15 above, and regarded any expanded taxing jurisdiction on fees for technical services as an unjustified shift of the balance of taxation from the place where services are provided to the place where services are consumed. Countries sharing these concerns may wish not to include Article 12A in their bilateral tax treaties. 24. Alternatively, countries, which wish to obtain additional taxing rights on fees for technical services, but are concerned with the broad scope of Article 12A, may consider agreeing to amend Article 12 (Royalties) to permit taxation of certain “fees for included services,” an approach that is found in a number of bilateral tax treaties between developing and developed countries. The underlying policy rationale 325

348 Article 12A Commentary for this narrower approach is that, in order to justify taxation by the - State from which the payment is made even in cases where the ser vices are not performed in that State, fees for services must be directly related to the enjoyment of property for which a royalty as otherwise defined in Article 12 is paid. Wording for this narrower alternative approach is set forth in paragraphs 25 and 26 of the Commentary on Article 12. 25. However, a majority of the members of the Committee of Experts was of the view that the alternative referred to in paragraph 24 is not an acceptable alternative to Article 12A for developing coun - tries because, in essence, those members considered that there is no principled justification for restricting the taxation of fees for technical services to services directly related to property producing royalties. Moreover, those members took the view that the alternative supported by a minority of the members of the Committee contains many vague terms of uncertain meaning, which may lead to frequent disputes about the interpretation of that provision. 26. Instead, countries concerned about the scope of Article 12A and the uncertainty associated with the definition of “fees for tech - nical services” in Article 12A, paragraph 3 might consider an alterna - tive version of Article 12A under which Article 12A would potentially apply to all fees for services (technical and other services) provided in a Contracting State, and also to fees for services provided outside that State by closely related persons, other than payments expressly excluded under paragraphs 3(a), (b), and (c). Under this alternative provision, paragraphs 1, 2, 4, and 7 of Article 12A would remain unchanged except that the term “fees for technical services” in those paragraphs would be replaced by the term “fees for services.” However, paragraphs 3, 5 and 6 would be replaced by the following paragraphs: 3. The term “fees for services” as used in this Article means any payment in consideration for any service, unless the pay - ment is made: (a) to an employee of the person making the payment; (b) for teaching in an educational institution or for teaching by an educational institution; or (c) by an individual for services for the personal use of an individual. 326

349 Article 12A Commentary 5. For the purposes of this Article, fees for services shall be deemed to arise in a Contracting State if: (a) the services are performed in that State; or (b) the payer is a resident of that State and the fees are paid to a closely related enterprise or person unless the payer carries on business in the other Contracting State or a third State through a permanent establishment situated in that State, or performs independent personal services through a fixed base situated in the other Contracting State or a third State and such fees are borne by that permanent establishment or fixed base; or (c) the payer has in that State a permanent establishment or a fixed base in connection with which the obligation to pay the fees for services was incurred, and such fees are borne by such permanent establishment or fixed base, and are paid to a closely related enterprise or person. 6. For the purposes of this Article, a person is closely related to an enterprise if, based on all the relevant facts and circum - stances, one has control of the other or both are under the con - trol of the same persons or enterprises. In any case, a person shall be considered to be closely related to an enterprise if one possesses directly or indirectly more than 50 per cent of the beneficial interest in the other (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the com - pany) or if another person possesses directly or indirectly more than 50 per cent of the beneficial interest (or, in the case of a company, more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in the company) in the person and the enterprise. For the purposes of this Article, an individual shall be a closely related person with respect to another individual if the individual is related to that other individual by blood relationship, marriage or adoption. 27. Under this alternative, a country would be entitled to impose tax under Article 12A, paragraph 2 up to the maximum agreed rate on fees for services paid by a resident of that country or by a non-resident with a permanent establishment or fixed base in that country to a 327

350 Article 12A Commentary resident of the other Contracting State if the fees for services arise in - the first country. Fees for services would be deemed to arise in a coun try in accordance with paragraph 5 if: 1. the services are provided in that country or 2. the services are provided outside that country by a person who is closely related to the payer of the fees. Thus, this alternative provision would eliminate any disputes about whether the relevant services are within the definition of “fees for technical services” in Article 12A, paragraph 3 because it applies to all fees for services except those payments excluded by paragraphs 3 (a) to (c). Under this alternative provision, a Contracting State would not be entitled to tax fees for services paid to service providers resident in the other Contracting State that are not closely related to the payer for services performed outside the first State. In contrast, under Article 12A, fees for technical services paid to non-closely related service pro - viders resident in the other Contracting State for services provided outside the first State would be taxable by the first State. However, under the alternative provision, a Contracting State would be entitled to tax fees for services provided outside that State if the services are provided by persons closely related to the payer. In many cases, such closely-related party services present the most serious risk of eroding a country’s tax base. 28. For purposes of the alternative provision, paragraph 6 provides - rules for determining whether a person is closely related to an enter prise and whether an individual is closely related to another individ - ual. The concept of a closely related person is to be distinguished from the concept of “associated enterprises” which is used for the purposes of Article 9; although the two concepts overlap to a certain extent, they are not intended to be equivalent. 29. A person is closely related to an enterprise if, based on all the relevant facts and circumstances, one has control of the other or both are under the control of the same persons or enterprises. This general rule would cover, for example, situations where a person or enterprise controls an enterprise by virtue of a special arrangement that allows that person to exercise rights that are similar to those that it would hold if it possessed directly or indirectly more than 50 per cent of the beneficial interests in the enterprise. As in most cases where the plural 328

351 Article 12A Commentary form is used, the reference to the “same persons or enterprises” at the end of the first sentence of paragraph 6 covers cases where there is only one such person or enterprise. - 30. The second sentence of paragraph 6 provides that the defini - tion of “person closely related to an enterprise” is automatically sat isfied in certain circumstances. A person is considered to be closely related to an enterprise if either one possesses directly or indirectly more than 50 per cent of the beneficial interests in the other or if a third person possesses directly or indirectly more than 50 per cent of the beneficial interests in both the person and the enterprise. In the case of a company, this condition is satisfied where a person holds directly or indirectly more than 50 per cent of the aggregate vote and value of the company’s shares or of the beneficial equity interest in t he compa ny. 31. The final sentence of paragraph 6 provides that individuals are closely related if they are related by blood relationship, marriage or adoption. This rule is necessary for situations where an individ - ual pays for services (other then services for the personal use of an individual) provided by another individual who is not carrying on an enterprise. For this purpose, the terms “blood relationship,” “mar - riage” and “adoption” take their meaning from the domestic law of the country applying the treaty in accordance with paragraph 2 of Article 3. 32. Article 12A allows fees for technical services to be taxed by a Contracting State on a gross basis. Many developing countries have limited administrative capacity and need a simple, reliable and effi - cient method to enforce tax imposed on income from services derived by non-residents. A withholding tax imposed on the gross amount of payments made by residents of a country, or non-residents with a per - manent establishment or fixed base in the country, is well established as an effective method of collecting tax imposed on non-residents. Such a method of taxation may also simplify compliance for enter - prises providing services in another State since they would not be required to compute their net profits or file tax returns. 33. Article 12A does not require any threshold, such as a perma - nent establishment, fixed base or minimum period of presence in a 329

352 Article 12A Commentary Contracting State as a condition for the taxation of fees for techni - cal services. In this regard, Article 12A is significantly different from Article 7 and Article 14. However, in the case of technical services, modern methods for the delivery of services allow non-residents to perform substantial services for customers in the other country with little or no presence in that country. This ability to derive income from a country with little or no presence there, combined with concerns about the base-erosion and profit-shifting aspects of technical services, is considered by a majority of the members of the Committee to justify the absence of any threshold requirement as a condition for a country to tax fees for technical services. Where fees for technical services are dealt with in both Article 34. 12A and Article 7, paragraph 6 of Article 7 provides that the provisions of Article 12A prevail. However, this priority for Article 12A does not apply if the beneficial owner of the fees for technical services carries on business through a permanent establishment in the Contracting State in which the fees for technical services arise, and those services are effectively connected with the permanent establishment or business activities referred to in (c) of paragraph 1 of Article 7. In this situation, paragraph 4 of Article 12A provides that the provisions of Article 7 apply instead of Article 12A. Similarly, where fees for technical services are dealt with in 35. both Article 12A and Article 14, Article 12A, paragraph 2 indicates expressly that Article 12A applies notwithstanding the application of Article 14. However, this priority for Article 12A over Article 14 does not apply if the beneficial owner of the fees performs independ - ent personal services in the Contracting State in which the fees for technical services arise through a fixed base situated in that State and the technical services are effectively connected with the fixed base. In this situation, Article 12A, paragraph 4 provides that the provisions of Article 14 apply instead of Article 12A. 36. There is no overlap between Article 12A and Articles 15, 18 and 19 dealing with income from employment, pensions and govern - ment services respectively because the definition of “fees for technical services” in Article 12A, paragraph 3 expressly excludes payments, including pension payments, to employees. Thus, for example, pay - ments received by an employee from an employer resident in a country 330

353 Article 12A Commentary for employment services exercised outside that country would not be taxable by that country under Article 12A, paragraph 2 even if the payments are fees for technical services. Since paragraph 2 of Article 12A is subject to the provisions of 37. Articles 8 (International Shipping and Air Transport), 16 (Directors’ Fees and Remuneration of Top-Level Managerial Officials) and 17 (Artistes and Sportspersons), Article 12A does not apply to fees for technical services to which the provisions of those Articles apply. In general, the taxing rights of a country under Article 8, 17 or 18 are unlimited, whereas the taxing rights under Article 12A, paragraph 2 are limited to the maximum percentage of the gross fees for technical services agreed to in that provision. The relationship between Article 12A, paragraph 2 and Articles 8, 17 and 18 is discussed further in the Commentary on paragraph 2. B. Commentary on the paragraphs of article 12A Paragraph 1 38. This paragraph establishes that fees for technical services arising in one Contracting State and paid to a resident of the other Contracting State may be taxed in the other Contracting State. It does not, however, provide that such fees are taxable exclusively by the State of residence. 39. In most cases, the person who provides technical services will receive fees for those services. If the person who receives the fees for technical services is not the person who provides those services, it is a matter of domestic law as to who is the proper taxpayer with respect to those fees. If fees for technical services are paid to a person, other than the person who provides the services, Article 12A applies to the fees as long as the recipient is a resident of the other Contracting State. 40. The expression “fees for technical services” is defined in para - graph 3 to mean any “payment” for managerial, technical or consulting services. The term “payment” has a broad meaning consistent with the meaning of the related term “paid” in Articles 10 and 11. As indicated in paragraph 3 of the Commentary on Article 10 (quoting paragraph 7 of the Commentary on Article 10 of the OECD Model Convention) 331

354 Article 12A Commentary and paragraph 6 of the Commentary on Article 11 (quoting paragraph 5 of the Commentary on Article 11 of the OECD Model Convention), the concept of payment means the fulfilment of the obligation to put funds at the disposal of the service provider in the manner required by contract or custom. 41. Article 12A deals only with fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State. It does not, therefore, apply to fees for technical services arising in a - third State. Paragraph 5 and paragraph 6 specify when fees for techni cal services are deemed to arise in a Contracting State and deemed not to arise in a Contracting State, respectively. However, unlike Articles 10 and 11, which do not apply to dividends paid by a company resident in a third State or interest arising in a third State, Article 12A applies to fees for technical services paid by a resident of a Contracting State or a third State that are borne by a permanent establishment or fixed base that the resident has in the other Contracting State. Paragraph 2 42. This paragraph lays down the principle that the Contracting State in which fees for technical services arise may tax those payments in accordance with the provisions of its domestic law. However, if the beneficial owner of the fees is a resident of the other Contracting State, the amount of tax imposed by the State in which the fees for technical services arise may not exceed a maximum percentage, to be established through bilateral negotiations, of the gross amount of the payments. 43. When considered in conjunction with Article 23 (Methods for the Elimination of Double Taxation), paragraph 2 establishes the pri - mary right of the country in which fees for technical services arise to tax those payments in accordance with its domestic law (subject to the limitation on the maximum rate of tax if the beneficial owner of the fees is a resident of the other Contracting State). Accordingly, the country in which the recipient of the fees is resident is obligated to prevent double taxation of those fees. Under Article 23 A or 23 B, the residence country is required to provide relief from double taxation through the exemption from tax of the fees for technical services or the granting of a credit against tax payable to the residence country on the fees for technical services for any tax imposed on those fees by the 332

355 Article 12A Commentary other Contracting State in accordance with Article 12A. In this regard, where a country applies the exemption method under Article 23 A, it is entitled to apply the credit method under Article 23 A, paragraph (2) with respect to items of income taxable under Article 10, 11, 12 or 12A. The decision not to recommend a maximum rate of tax on fees for 44. technical services is consistent with Articles 10, 11 and 12 of the United Nations Model Convention dealing with dividends, interest and royalties, respectively. This decision can be justified under current treaty practice. The withholding rates on fees for technical services adopted in bilateral tax treaties between developed and developing countries vary widely. Thus, the maximum rate of tax on fees for technical services is to be established through the bilateral negotiations of the Contracting States. A precise level of withholding tax on fees for technical services 45. should take into account several factors, including the following: — the possibility that a high rate of withholding tax imposed by a country might cause non-resident service providers to pass on the cost of the tax to customers in the country, which would mean that the country would increase its revenue at the expense of its own residents rather than the non-resident service providers. — the possibility that a tax rate higher than the foreign tax credit limit in the residence country might deter investment. the possibility that some non-resident service providers — may incur high costs in providing technical services, so that a high rate of withholding tax on the gross fees may result in an excessive effective tax rate on the net income derived from the services. — the potential benefit of applying the same rate of with - holding tax to both royalties under Article 12 and fees for technical services under Article 12A. See Example 6, para - graphs 97 and 98. — the fact that a reduction of the withholding rate has revenue and foreign-exchange consequences for the country impos - ing withholding tax, and — the relative flows of fees for technical services (e.g., from developing to developed countries). 333

356 Article 12A Commentary 46. Paragraph 2 applies notwithstanding the provisions of Article 14. Under Article 14, income from the performance of professional or other independent personal services by a person who is a resident of a Contracting State is taxable by the other Contracting State only if the services are performed through a fixed base in the other Contracting State that is regularly available to the person or if the person stays in that State for 183 days or more in any twelve-month period commenc - ing or ending in the relevant fiscal period. Under paragraph 4, if a resident of one Contracting State per 47. - forms independent personal services (that are technical services) in the other Contracting State through a fixed base that is regularly available to the resident and receives fees for technical services within the meaning of Article 12A, paragraph 3, Article 14 will apply to those payments in priority to Article 12A. However, if a resident of one Contracting State provides independent personal services (that are technical services) that arise in the other Contracting State, but those services are not provided through a fixed base in that other State, the fees for those services are taxable by that other State under Article 12A paragraph (2). 48. Paragraph 2 applies in priority to Article 7 as a result of Article 7, paragraph 6. Thus, the conditions for the taxation of the business profits of an enterprise under Article 7 do not apply to fees for tech - nical services covered by paragraph 2. Fees for technical services are taxable by a Contracting State under paragraph 2 if the fees arise in that State irrespective of whether the enterprise providing the services has a permanent establishment in that State, provides services that are similar to those effected through the permanent establishment or provides the technical services in that State. However, by virtue of par - agraph 4, if an enterprise of one Contracting State provides technical services through a permanent establishment in the other Contracting State and receives fees for those technical services within the meaning of paragraph 3, Article 7 will apply to those payments in priority to Article 12A, paragraph 2. 49. The application of paragraph 2 is expressly subject to the provi - sions of Article 8. Certain payments for international shipping, air trans - portation or inland waterways transport under Article 8 could be within the definition of “fees for technical services” in paragraph 3. This might be the case with respect to auxiliary activities that are closely connected 334

357 Article 12A Commentary to the direct operation of ships and aircraft, as discussed in paragraph 11 of the Commentary on Article 8. To eliminate any uncertainty in this regard, paragraph 2 explicitly provides that in any situation in which both Article 12A and Article 8 apply to the same services, the provisions of Article 8 prevail. Thus, any fees for technical services that result from the operation of ships or aircraft in international traffic, or the operation of boats in inland waterways, in accordance with the terms of Article 8 are taxable exclusively in accordance with that Article. 50. Similarly, paragraph 2 is subject to the provisions of Article 16 - dealing with directors’ fees and the remuneration of top-level manage - rial officials. Therefore, under Article 16 where directors’ fees or remu neration of top-level managerial officials are taxable by the Contracting State in which the company paying the fees or remuneration is resident, Article 12A cannot apply to the fees or remuneration because para - graph 2 is expressly subject to the provisions of Article 16. The taxing rights of a Contracting State under Article 16 are unlimited, whereas the taxing rights under Article 12A are limited to the maximum rate of tax agreed to in paragraph 2. If, however, the payments are outside the scope of Article 16 (because, for example, the payments are made with respect to services provided by the individual in a capacity, other than that of a director or top-level managerial official of the company, such as an independent contractor), the other State is entitled to tax the payments in accordance with paragraph 2. 51. Similarly, paragraph 2 is expressly subject to the provisions of Article 17 dealing with entertainment or sports activities. Although it may be unlikely that such activities would be within the defini - tion of “fees for technical services” in paragraph 3, it is important to provide certainty in this regard. Therefore, if an overlap between the provisions of paragraph 2 and Article 17 does occur, Article 17 takes precedence over Article 12A. If, however, an artiste or sportsperson resident in one Contracting State receives fees for technical services from a person resident in the other Contracting State and those fees are outside the scope of Article 17 (because, for example, although the fees are in consideration for personal activities as an artiste or sports - person, those activities take place outside the country in which the payer is resident), the first Contracting State is entitled to tax the fees under paragraph 2. 335

358 Article 12A Commentary 52. The requirement of beneficial owner is included in paragraph 2 to clarify the meaning of the words “paid to a resident” as they are used in paragraph 1 of the Article. It clarifies that a Contracting State is not obliged to give up taxing rights over fees for technical services merely because those fees were paid directly to a resident of another State with which the first State had concluded a convention. 53. Since the term “beneficial owner” is included in paragraph 2 to address potential difficulties arising from the use of the words “paid to a resident” in paragraph 1, it is intended to be interpreted in this context and not to refer to any technical meaning that it could have had under the domestic law of a specific country. The term “beneficial owner” is therefore not used in a narrow technical sense (such as the meaning 40 that it has under the trust law of many common law countries ), rat her, it should be understood in its context, in particular in relation to the words “paid to a resident”, and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance. 54. Relief or exemption in respect of an item of income is granted by a State to a resident of the other Contracting State to avoid in whole or in part the double taxation that would otherwise arise from the concurrent taxation of that income by the State of residence. Where an item of income is paid to a resident of a Contracting State acting in the capacity of agent or nominee it would be inconsistent with the object and purpose of the Convention for a State to grant relief or exemption merely on account of the status of the direct recipient of the income as a resident of the other Contracting State. The direct recipient of the income qualifies as a resident but no potential double taxation arises as a consequence of that status, since the recipient is not treated as the owner of the income for tax purposes in the State of residence. 55. It would be equally inconsistent with the object and purpose of the Convention for a State to grant relief or exemption where a resident of 40 For example, where the trustees of a discretionary trust do not dis - tribute fees for technical services earned during a given period, these trustees, acting in their capacity as such (or the trust, if recognised as a separate taxpay - er) could constitute the beneficial owners of such fees for the purposes of Arti - cle 12A even if they are not the beneficial owners under the relevant trust law. 336

359 Article 12A Commentary a Contracting State, otherwise than through an agency or nominee rela - tionship, simply acts as a conduit for another person who in fact receives the benefit of the income concerned. For these reasons, the report from the OECD’s Committee on Fiscal Affairs entitled “Double Taxation 41 Conventions and the Use of Conduit Companies” concludes that a conduit company cannot normally be regarded as the beneficial owner if, though the formal owner, it has as a practical matter very narrow powers which render it in relation to the income concerned a mere fiduciary or administrator acting on account of the interested parties. 56. In these various examples (agent, nominee, conduit company acting as a fiduciary or administrator), the direct recipient of the fees for technical services is not the “beneficial owner” because that recip - ient’s right to use and enjoy the fees is constrained by a contractual or legal obligation to pass on the fees received to another person. Such an obligation will normally derive from relevant legal documents but may also be found to exist on the basis of facts and circumstances showing that, in substance, the recipient clearly does not have the right to use and enjoy the fees unconstrained by a contractual or legal obligation to pass on the fees received to another person. This type of obliga - tion would not include contractual or legal obligations that are not dependent on the receipt of the fees by the direct recipient such as an obligation that is not dependent on the receipt of the fees and which the direct recipient has as a debtor or as a party to financial transac - tions. Where the recipient of fees for technical services does have the right to use and enjoy the fees unconstrained by a contractual or legal obligation to pass on the fees received to another person, the recipient is the “beneficial owner” of those fees. 57. The fact that the recipient of fees for technical services is consid - ered to be the beneficial owner of those fees does not mean, however, - that the limitation of tax provided for by paragraph 2 must automati cally be granted. This limitation of tax should not be granted in cases of abuse of this provision. As explained in the section on “Improper use of the Convention” in the Commentary on Article 1, there are many ways of addressing conduit company structures and, more generally, treaty shopping situations. These include specific anti-abuse provisions 41 Reproduced at page R(6)-1 of Volume II of the full-length version of the OECD Model Tax Convention. 337

360 Article 12A Commentary in domestic law and treaties, general anti-abuse rules in domestic law and tax treaties, judicial doctrines, such as substance-over-form or economic substance approaches, and the interpretation of tax treaty provisions. Whilst the concept of “beneficial owner” deals with some forms of tax avoidance (i.e. those involving the interposition of a recip - ient who is obliged to pass on fees for technical services to someone else), it does not deal with other cases of treaty shopping and must not, therefore, be considered as restricting in any way the application of other approaches to addressing such cases. 58. The above explanations concerning the meaning of “beneficial owner” make it clear that the meaning given to this term in the context of the Article must be distinguished from the different meaning that 42 that has been given to that term in the context of other instruments concern the determination of the persons (typically the individuals) that exercise ultimate control over entities or assets. That different meaning of “beneficial owner” cannot be applied in the context of the Convention. Indeed, that meaning, which refers to natural persons (i.e., individuals), cannot be reconciled with the express wording of Article 10, subparagraph 2(a), which refers to the situation where a company is the beneficial owner of a dividend. In the context of Articles 10, 11, 12 42 See, for example, Financial Action Task Force, International Stand - ards on Combating Money Laundering and the Financing of Terrorism & Proliferation—The FATF Recommendations (OECD-FATF, Paris, 2012), which sets forth in detail the international anti-money laundering standard and which includes the following definition of beneficial owner (at page 109): “the natural person(s) who ultimately owns or controls a customer and/or the person on whose behalf a transaction is being conducted. It also incorporates those persons who exercise ultimate effective control over a legal person or arrangement.” Similarly, the 2001 report of the OECD Steering Group on Corporate Governance, “Behind the Corporate Veil: Using Corporate Enti - ties for Illicit Purposes” (OECD, Paris, 2001), defines beneficial ownership as follows (at page 14): In this Report, “beneficial ownership” refers to ulti - mate beneficial ownership or interest by a natural person. In some situations, uncovering the beneficial owner may involve piercing through various inter - mediary entities and/or individuals until the true owner who is a natural per - son is found. With respect to corporations, ownership is held by shareholders or members. In partnerships, interests are held by general and limited part - ners. In trusts and foundations, beneficial ownership refers to beneficiaries, which may also include the settlor or founder. 338

361 Article 12A Commentary and 12A, the term “beneficial owner” is intended to address difficulties arising from the use of the words “paid to” in relation to dividends, interest, royalties and fees for technical services rather than difficul - ties related to the ownership of the underlying property or rights in respect of which the amounts are paid. For that reason, it would be inappropriate, in the context of these articles, to consider a meaning developed in order to refer to the individuals who exercise “ultimate 43 effective control over a legal person or arrangement”. 59. - Subject to other conditions imposed by the Article, the limita tion of tax in a State remains applicable when an intermediary, such as an agent or nominee located in the other Contracting State or in a third State, is interposed between the beneficiary and the payer but the beneficial owner is a resident of the other Contracting State. The text of the United Nations Model Convention was amended in 2001 and 2017 (following amendments to the OECD Model Convention in 1995 and 2014) to clarify this point. Paragraph 3 60. The paragraph lays down nothing about the mode of taxation in the State in which fees for technical services arise. Therefore, it leaves that State free to apply its own laws and, in particular, to levy the tax either by deduction at source or individual assessment. As with other provisions of the United Nations Model Convention, procedural ques - tions are not dealt with in the Article. Each State is able to apply the procedure provided in domestic law. 61. This paragraph specifies the meaning of the phrase “fees for technical services” for purposes of Article 12A. The definition of “fees for technical services” in paragraph 3 is exhaustive. “Fees for technical services” are limited to the payments described in paragraph 3; other payments for services are not included in the definition and are not dealt with in Article 12A. See the examples in paragraphs 87 to 103 below. 62. Article 12A applies only to fees for technical services, and not to all payments for services. Paragraph 3 defines “fees for technical 43 See the Financial Action Task Force’s definition quoted in the previ - ous note. 339

362 Article 12A Commentary services” as payments for managerial, technical or consultancy ser - - vices. Given the ordinary meanings of the terms “managerial,” “tech nical” and “consultancy,” the fundamental concept underlying the definition of fees for technical services is that the services must involve the application by the service provider of specialized knowledge, skill or expertise on behalf of a client or the transfer of knowledge, skill or expertise to the client, other than a transfer of information covered by the definition of “royalties” in Article 12, paragraph 3. Services of a routine nature that do not involve the application of such specialized knowledge, skill or expertise are not within the scope of Article 12A. 63. The ordinary meaning of the term “management” involves the application of knowledge, skill or expertise in the control or admin - istration of the conduct of a commercial enterprise or organization. Thus, if the management of all or a significant part of an enterprise is contracted out to persons other than the directors, officers or employ - ees of the enterprise, payments made by the enterprise for those management services would be fees for technical services within the meaning of paragraph 3. Similarly, payments made to a consultant for advice related to the management of an enterprise (or of the business of an enterprise) would be fees for technical services. 64. The ordinary meaning of the term “technical” involves the application of specialized knowledge, skill or expertise with respect to a particular art, science, profession or occupation. Therefore, fees received for services provided by regulated professions such as law, accounting, architecture, medicine, engineering and dentistry would be fees for technical services within the meaning of paragraph 3. Thus, if an individual receives payments for professional services referred to in Article 14, paragraph 2 from a resident of a Contracting State, those payments would be fees for technical services. If the payments arise in that Contracting State because they are made by a resident of that State or borne by a permanent establishment or fixed base in that State, the payments would be subject to tax by that State in accordance with paragraph 2 irrespective of the fact that the services are not performed in that State through a fixed base in that State. 65. Technical services are not limited to the professional services referred to in Article 14, paragraph 2. Services performed by other 340

363 Article 12A Commentary professionals, such as pharmacists, and other occupations, such as scien - - tists, academics, etc., may also constitute technical services if those ser vices involve the provision of specialized knowledge, skill and expertise. 66. The ordinary meaning of “consultancy” involves the provision of advice or services of a specialized nature. Professionals usually pro - vide advice or services that fit within the general meaning of consul - tancy services although, as noted in paragraphs 63 and 64, they may also constitute management or technical services. The terms “management,” “technical” and “consultancy” do not 67. have precise meanings and may overlap. Thus, for example, services of a technical nature may also be services of a consultancy nature and management services may also be considered to be services of a con - sultancy nature. 68. The definition of “fees for technical services” does not include a reference to the domestic law of a Contracting State. The lack of any reference to domestic law is justified because: (a) the definition generally covers most types of services that are regarded as technical services under the domestic law of the countries that tax such services; (b) such a reference would introduce a large element of uncertainty; (c) future changes in a country’s domestic law with respect to the taxation of fees for technical services could otherwise have an effect on the Convention; and (e) in the United Nations Model Convention, reference to domestic laws should be avoided as far as possible. - It would be inconsistent with the definition of “fees for technical ser vices” for the meaning of terms used in the definition, especially the terms “management,” “technical” and “consultancy,” to be determined in accordance with the domestic law of the country applying the treaty under Article 3, paragraph 2. 69. As expressly provided in subparagraph 3(a), fees for technical services for purposes of Article 12A do not include payments of salary, wages or other remuneration to an employee of the payer. Where such payments are made by an employer resident in one Contracting State to 341

364 Article 12A Commentary an employee resident in the other Contracting State, they are covered by Article 15 or Article 19 (Government Service) of the Convention. In addition, since pensions arise in respect of prior employment, they are excluded from Article 12A and are dealt with by Article 18 (Pensions and Social Security Payments) even if the employment involved the provision of technical services to the employer. 70. As expressly provided in paragraph 3, the definition of fees for technical services does not include payments for teaching in an edu - cational institution or teaching by an educational institution. Thus, if an educational institution established in one Contracting State pays for teaching services provided by an individual or an enterprise resident in the other Contracting State that are otherwise considered to be fees for technical services, the payments made by the educational institu - tion for those teaching services are excluded from the definition of “fees for technical services” by subparagraph 3(b). Further, if an educational institution established in one Contracting State receives payments from an enterprise resident in the other Contracting State for teaching ser - vices provided by that institution to some of the enterprise’s employees, the payments received by the educational institution for those teaching services (to the extent that they would otherwise be considered to be fees for technical services) would not be fees for technical services subject to Article 16 because of the specific exclusion in subparagraph 3(b). There is no definition of the term “educational institution” for purposes of sub - paragraph 3(b). Consequently, in accordance with Article 3, paragraph 2 of the Convention, the term would have its meaning under the law of the State applying the Convention. The meaning of the term would gener - ally include universities, colleges and other post-secondary educational institutions. Countries in which the term “educational institution” has a very broad or unusual meaning may wish to clarify the meaning of the term in their treaties. Some countries may be concerned that the exclusion in sub - 71. paragraph 3(b) is excessively broad and uncertain and may be subject to abuse. These countries may wish to omit the exclusion in subpar - agraph 3(b) entirely or limit that exclusion to teaching services that are provided as part of a degree program offered by an educational institution. These countries are free to do so by adding the words “as part of a degree granting program” or similar words to subparagraph 3(b). In this case, payments received by an educational institution for 342

365 Article 12A Commentary teaching services of a managerial, technical or consultancy nature that are not part of a degree program would be fees for technical services within the meaning of paragraph 3. As expressly provided in subparagraph 3(c), the definition of 72. “fees for technical services” does not include payments by individuals for services for personal use. Such payments would not normally be deductible by those individuals for tax purposes, and therefore the payments would not cause any erosion of the tax base of the State in which the fees for technical services arise. Moreover, the imposition of withholding tax obligations on such payments by individuals under domestic law would be difficult to enforce and might cause serious - compliance problems for individuals utilizing technical services sup plied remotely by non-residents. 73. The definition of “fees for technical services” in paragraph 3 does not exclude profits from international shipping, inland water - ways transport and international air transport, income from enter - tainment and sports activities, and pensions and social security payments. However, such income (even if it is within the definition of “fees for technical services”) is not subject to tax by a country under paragraph 2 if it is taxable under Article 8 (International Shipping and Air Transport), 17 (Artistes and Sportspersons), or 18 (Pensions and Social Security Payments) as the case might be, because paragraph 2 is expressly subject to the provisions of Article 8, 17 and 18. 74. The treatment of reimbursements of expenses for purposes of the definition of “fees for technical services” in paragraph 3 poses special difficulties. As an initial matter, it is important to distin - guish between an allowance for expenses and the reimbursement of expenses. An allowance is an amount usually established in advance for which the recipient of the allowance is not obligated to account; a per diem allowance for meals and accommodation is an example of a typical allowance. Since the recipient of an allowance does not have to account for the actual expenses incurred, any allowance received by a person for technical services is included within the meaning of “fees for technical services” under paragraph 3. 75. The reimbursement of expenses is different from an allowance because the person must account for the actual expenses incurred, 343

366 Article 12A Commentary and only those actual expenses qualify for reimbursement. The issue is whether payments received in reimbursement of actual expenses incurred in connection with the provision of technical services should be included in the definition of “fees for technical services”. 76. First, a person may be reimbursed for expenses incurred in con - nection with providing technical services, but may not receive any fee for those services. For example, an individual resident in one Contracting State might be invited to speak at a conference or participate in a meet - ing in the other Contracting State and might be reimbursed for his or her travel expenses, but not receive any fee. In these circumstances, it seems difficult to justify the application of withholding tax to the reim - bursement. However, unless reimbursements are explicitly excluded from the definition of “fees for technical services”, paragraph 2 would permit the State in which the fees arise to impose withholding tax on the reimbursement at the rate specified in the treaty. 77. Second, a non-resident service provider may be paid a fee and separately reimbursed for all the expenses incurred in providing the services. In these circumstances, if reimbursements are excluded from the definition of fees for technical services, the tax imposed by the State in which the fees arise would be limited to the amount of the fee. On these facts, the fee represents the non-resident’s entire net profit from the performance of the technical services. However, the maximum limit on the tax imposed under paragraph 2 is based on the gross amount of the payments, and the rate of withholding tax specified in Article 12A may have been established on the assumption that the fees represent the non-resident’s gross revenue. As a result, if reimbursements are excluded from the definition of fees for technical services, the rate of withhold - ing agreed to by the Contracting States may be too low. Moreover, the exclusion of reimbursements from the definition of fees for technical services might lead to abuses. For example, in order to reduce the source country’s withholding tax, non-resident service providers might receive payments labeled as reimbursements that are actually fees, or might be reimbursed for expenses for which they would not ordinarily be reim - bursed. Preventing these types of abuses would impose a significant administrative burden on the tax authorities. 78. Third, a non-resident service provider might not be reimbursed for any of the expenses incurred in providing the services. In this 344

367 Article 12A Commentary case, the amount of the payment received by the non-resident service provider will be greater than the amount of the service provider’s net profit. The maximum rate of withholding tax in paragraph 2 may have been agreed to on the assumption that some of a non-resident’s expenses would be reimbursed. On this assumption, the maximum rate of withholding tax may be established at a higher rate than it otherwise would be in order to approximate tax on the net profit. Therefore, if reimbursements are excluded from the definition of “fees for technical services”, the rate established in the treaty might be too - high for a non-resident service provider that receives no reimburse ment for expenses. 79. The issues discussed in paragraphs 77 and 78 are illustrated in the example in paragraph 80, which shows that the effect of a gross-based withholding tax on fees for technical services depends, in part, on whether payments in reimbursement of expenses are subject to the withholding tax and the extent to which service providers are reimbursed for their expenses. 80. Example: X, a resident of Country A, is a management consult - ant, who provides advice to companies concerning best practices for corporate governance. X enters into a contract to provide services to B Co, a public company resident in Country B, for a period of 60 days for fees of 5,000 per day plus the reimbursement of reasonable expenses incurred in providing the services. X receives fees of 300,000 from B Co and a payment of 250,000 in reimbursement for expenses. Thus, in this situation, X’s net profit from the services provided to B Co is 300,000. Assume that Country A and Country B have entered into a tax treaty with a provision identical to Article 12A of the United Nations Model Convention which allows the imposition of withhold - ing tax on fees for technical services at a maximum rate of 5 percent. On these facts, assuming that the payment in reimbursement for X’s expenses is not considered to be fees for technical services, Country B would be entitled to impose tax of 15,000 of the fees received by X, which represents a relatively low tax rate of 5 percent on X’s net profit. Alternatively, assuming that the payment in reimbursement of X’s expenses is subject to withholding tax under Article 12A, Country B would be entitled to impose tax of 27,500, which represents a tax rate of over 9 percent on X’s net profit. If X did not receive any reimbursement 345

368 Article 12A Commentary for his expenses, Country B’s tax would be 15,000 representing a tax rate of 30 percent on X’s net profit irrespective of whether payments in reimbursement of expenses are subject to withholding tax under Article 12A as fees for technical services. 81. It appears to be extremely difficult to predict to what extent, on average, non-resident service providers are reimbursed for their expenses. As a result, any single rule for the treatment of reimburse - ments will operate improperly in some situations. On the one hand, if reimbursements are excluded from the definition of “fees for technical services”, the rate agreed to in the treaty might be too low where most or all of a non-resident’s expenses are reimbursed, but too high where none of the expenses are reimbursed. Also, taxpayers might try to dis - guise part of their fees as reimbursements of expenses and it might be difficult for the tax authorities to detect such abuses. On the other hand, if reimbursements are not excluded, the rate agreed to in the treaty might be too high where a non-resident’s expenses are reim - bursed, but too low where they are not reimbursed. 82. As a result of the difficulties described in the foregoing para - graphs, the solution that has been adopted is to omit any reference to the reimbursement of expenses in the definition of “fees for technical - services” in Article 12A, paragraph 3. However, countries are encour aged to deal with the problem in their domestic laws and to take the issue into account in establishing the maximum rate of tax under Article 12A, paragraph 2. 83. Although paragraph 3 defines the phrase “fees for techni - cal services,” it does not provide a definition of the term “services.” Similarly, other articles of the United Nations Model Convention dealing with various types of services do not contain any definition of the term “services.” Neither Article 14, which deals with profes - sional and other independent personal services, nor Article 19, which deals with services rendered to the government of a Contracting State, provides a definition of the term “services.” Similarly, the General Agreement on Trade in Services does not contain any definition of the term “services.” 84. Although the term “services” in the phrase “fees for technical services” is undefined in the context of Article 12A, the term “services” 346

369 Article 12A Commentary should be understood to have a broad meaning in accordance with ordinary usage to generally include activities carried on by one person for the benefit of another person in consideration for a fee. Such activ - ities can be carried out in a wide variety of ways and the manner in which such services are provided does not alter their character for the purpose of Article 12A, to the extent that such services fall within the definition of “fees for technical services” in paragraph 3. 85. It is often necessary to distinguish between fees for services, - including fees for technical services, and royalties in order to deter mine whether Article 12 or another Article of the Convention (Article 12A in the case of “fees for technical services”) is applicable. The dis - tinction between fees for services and royalties is clear in principle. Under Article 12, paragraph 3, royalties are payments for the use, or the right to use, certain types of property or information concerning industrial, commercial or scientific experience (so-called know-how). In contrast, the performance of services does not involve any transfer of the use of, or the right to use, property. However, in practice it is often difficult to distinguish between royalties and fees for services, including technical services, especially with respect to so-called mixed contracts. Guidance with respect to the distinction between fees for services and royalties is provided in paragraph 12 of the Commentary on Article 12 of the United Nations Model Convention, which repro - duces paragraphs 11.2 –11.6 of the Commentary on Article 12 of the OECD Model Convention. See also paragraphs 100 to 103 below. 86. The following examples illustrate the application of the defini - tion of “fees for technical services” in paragraph 3. 87. Example 1: X is a resident of State R and a heart surgeon. X’s practice is carried on primarily in State R, although X occasionally travels to other countries to provide heart surgery. X provide surgery in State R on an individual resident in State S. The tax treaty between State R and State S contains a provision identical to Article 12A of the United Nations Model Convention. Although the payments made by the patient, a resident of State S, to X would be considered to be fees for technical services that arise in State S, they are explicitly excluded from the definition by subparagraph (c) of paragraph 3. As a result, the payments would not be taxable by State S in accordance with Article 12A, paragraph 2. 347

370 Article 12A Commentary 88. The result in Example 1 would be the same if X travelled to State S and provided the surgery in State S unless X provided the services through a fixed base regularly available to X in State S, in which case Article 14 would apply. 89. Example 2: X is a resident of State R and a heart surgeon. X’s practice is carried on primarily in State R, although X occasionally travels to other countries to provide heart surgery. X enters into a con - tract with a health services corporation resident in State S under which X agrees to provide heart surgery on patients referred to him by the health services corporation. X is not an employee of the health services corporation. The surgeries are provided both in State S and in State R. The tax treaty between State R and State S contains a provision iden - tical to Article 12A of the United Nations Model Convention. Under Article 12A, paragraph 3, the payments made by the health services corporation, a resident of State S, to X would be considered to be fees for technical services that arise in State S, irrespective of whether the surgery is provided in State S, State R or a third State. As a result, the payments would be taxable by State S in accordance with paragraph 2. If X were an employee of the health services corporation, the payments to X would be excluded from the definition of “fees for technical ser - vices” by subparagraph 3(a). 90. Example 3: R Company is a resident of State R. R Company’s business is the collection, organization and maintenance of various databases. R Company sells access to these databases to its clients. One of R Company’s clients is Company S, a resident of State S. State R and State S have entered into a tax treaty that contains a provision identical to Article 12A of the United Nations Model Convention. The payments that R Company receives from S Company for access to its databases would not be fees for technical services within the mean - ing of paragraph 3. Although R Company used its knowledge, skill and expertise in creating the database, the services that R Company provides to S Company — access to the database — are routine services that do not involve the application of R Company’s knowledge, skill and expertise for the benefit of S Company. Accordingly, Article 12A would not apply to the payments. 91. If, however, S Company entered into a contract with R Company under which R Company created a specialized database customized 348

371 Article 12A Commentary for S Company’s use from information supplied by S Company or collected by R Company, the payments by S Company to R Company would be “fees for technical services” under paragraph 3. In this situ - ation, R Company would be applying its knowledge, skill and exper - tise for the benefit of S Company. As a result, the payments would be taxable by State S in accordance with paragraph 2. It would not matter whether R Company performed all or any part of the services of creat - ing the database in State S. 92. Example 4: R Company, a resident of State R, is engaged in the insurance business in both State R and State S. R Company provides insurance against a wide variety of risks through standard form insur - ance contracts. State R and State S have a tax treaty that is the same as the United Nations Model Convention, including Articles 5, 7 and 12A. Article 12A would not apply because the insurance premiums received by R Company cannot be considered to be fees for technical services within the meaning of paragraph 3. Although R Company uses its knowledge, skill and expertise to develop its various insurance products that are sold to its clients, R Company is not applying its knowledge, skill and expertise directly for the benefit of each particu - lar client. 93. In Example 4, if R Company writes customized insurance con - - tracts dealing with special risks for some clients in State S, the insur ance premiums derived by R Company may be considered to be fees for technical services within the meaning of paragraph 3. However, R Company would be deemed to have a permanent establishment in State S under Article 5, paragraph 6 to the extent that it collects premiums or insures risks in State S other than through an agent of independent status. Therefore, by virtue of paragraph 4, the income derived from R Company’s insurance activities in State S would be taxable by State S in accordance with Article 7, and Article 12A would not apply. 94. Example 5: R Company is a financial institution resident in State R. R Company provides a wide variety of financial services to its customers, including acceptance of deposits, extension of credit, credit and debit cards, payment and transmission services, bankers drafts, guarantees, foreign exchange, negotiable instruments, derivative products, investment research and advisory services. R Company’s business is conducted primarily in State R, but it also has clients in 349

372 Article 12A Commentary other countries, including State S. State R and State S have a tax treaty that is identical to the United Nations Model Convention, including Article 12A. Whether the payments received for services provided by a 95. financial institution constitute fees for technical services within the meaning of paragraph 3 depends on the nature of the particular ser - vices. Many services provided by financial institutions do not involve the application of any specialized knowledge, skill and expertise on behalf of a particular client. Instead, the financial institution uses its knowledge, skill and expertise to develop general products, services - or practices that are made available to its clients routinely in consid eration for fees. This would be the case, for example, with respect to payment and transmission services, banker’s drafts, foreign exchange, debt and credit card services and negotiable instruments. 96. However, where a financial institution uses its knowledge, skill and expertise to provide research, analysis or advice to a specific client related to that client’s particular circumstances, the payments received by the financial institution for those services could be fees for technical services within the meaning of paragraph 3. This would be the case, for example, if, in Example 5, R Company provides advice to S Company, resident in State S, with respect to a potential merger or acquisition involving S Company. As a result, the payments for such advice would be fees for technical services taxable by State S in accordance with paragraph 2. If, however, R Company provides the services through a permanent establishment located in State S, the fees received for those services would be taxable by State S in accordance with Article 7 rather than Article 12A by virtue of paragraph 4 (see paragraph 93). 97. Example 6: S Company, an enterprise resident in State S, enters into a contractual arrangement with R Company, an enterprise resi - dent in State R, for the right to use a patented chemical formula owned by R Company for the production of an industrial substance. The con - tract also requires R Company to use its specialized knowledge and expertise to assist S Company to produce the industrial substance in accordance with specifications set out in the contract. In particular, R Company will provide the following services for S Company: — provide the production procedures and assist S Company in carrying out those procedures and 350

373 Article 12A Commentary provide specifications concerning the necessary materials, — tools, and containers used in the production process. R Company also agrees to use its best efforts to ensure that S Company is able to produce the industrial substance in the quantities and with the characteristics that S Company expects. State S and State R have entered into a tax treaty with provisions identical to those of the United Nations Model Convention, including Article 12A. In Example 6, the payments by S Company to R Company for 98. the right to use the patented formula would be royalties within the meaning of Article 12, paragraph 3. However, the payments for the services provided by R Company to S Company would not be royalties because R Company is not transferring its specialized knowledge, skill or experience to S Company. On the facts of Example 6, R Company is using its specialized knowledge, skill and experience on behalf of S Company and guaranteeing the result of S Company’s use of the patented chemical formula. Consequently, the payments made by S Company to R Company for the services are fees for technical services within the meaning of paragraph 3 and State S would be entitled to impose tax on those fees under paragraph 2. As noted in paragraphs 4 and 5 above, under the United 99. Nations Model Convention as it read before 2017, it was difficult, but important, to determine if certain payments were royalties or fees for services. If the payments were royalties, they would have been taxa - ble by the Contracting State in which they arose in accordance with Article 12 subject to the limitation on the rate of tax in paragraph 2 of Article 12. On the other hand, if the payments were fees for ser - vices, they would have been taxable by a Contracting State only if the service provider had a permanent establishment or fixed base in that State and the payments were attributable to that permanent establishment or fixed base in accordance with Article 7 or Article 14. Thus, the tax consequences varied significantly depending on whether payments were characterised as royalties or fees for services. The determination of the nature of payments as royalties or fees for services was especially difficult with respect to mixed contracts involving the transfer of the use of or the right to use information concerning industrial, commercial or scientific experience and the performance of services. 351

374 Article 12A Commentary 100. The addition of Article 12A to the United Nations Model - Convention in 2017 has had the potential effect of reducing the sig nificance of the distinction between royalties and fees for technical services if the limits on the rate of tax in paragraph 2 of Article 12 and paragraph 2 of Article 12A are the same. If these rates of tax are the same, it will not matter whether payments under mixed contracts are considered to be royalties for the transfer of know-how or fees for technical services. However, if the maximum rates of tax in the two articles are different, it will be important to determine if a particular payment is a royalty taxable in accordance with Article 12, fees for technical services under Article 12A, or some other type of payment. The following example illustrates the distinction between pay - 101. ments for the transfer of know-how and fees for technical services. The considerations to be taken into account in making this distinction are discussed in paragraph 12 of the Commentary on Article 12. 102. Example 7: S Company, an enterprise resident in Country S, enters into a contractual arrangement with R Company, an enterprise resident in Country R, to acquire the use of a secret formula or pro - cess developed by R Company. The contract requires R Company to provide the information to S Company subject to strict confidentiality conditions and to use its specialized knowledge and expertise to train employees of S Company with respect to the use of the secret formula or process. State R and State S have entered into a tax treaty with pro - visions identical to those of the United Nations Model Convention, including Articles 12And 12A. 103. In Example 7 the payments made by S Company to R Company for the right to use the secret formula or process would be payments for “information concerning industrial, commercial or scientific expe - rience” within the meaning of the definition of “royalty” in paragraph - 3 of Article 12. This would be the case even if the information repre sents know-how that is not patented or otherwise protected by intel - lectual property laws. Similarly, the payments made by S Company to R Company for the training of S Company’s employees would also be payments for “information concerning industrial, commercial or scientific experience” within the meaning of the definition of “royalty” in paragraph 3 of Article 12 since the training is necessary to trans - fer R Company’s know-how to S Company. Therefore, irrespective 352

375 Article 12A Commentary of whether the payments for the training are provided for separately from the payments for the secret formula or process or whether the contract provides for a single payment for both, the payments for the training would be considered royalties under Article 12 rather than fees for technical services under Article 12A. However, if the train - ing provided by R Company was not necessary to transfer the secret formula or process to S Company and S Company could obtain such training from other sources, the training would not be considered to be a transfer of know-how and the payments for the services would be considered fees for technical services assuming that they fit within the definition of “fees for technical services” in paragraph 3 of Article 12A. 4 Paragraph 104. This paragraph provides that paragraphs 1 and 2 do not apply to fees for technical services if the person who provides the services has a permanent establishment or fixed base in the State in which the fees arise and the fees are effectively connected with that permanent estab - lishment or fixed base. In this regard, paragraph 4 is similar to Article 10, paragraph 4, Article 11, paragraph 4 and Article 12, paragraph 4. Thus, if a resident of one Contracting State provides technical services through a permanent establishment or fixed base located in the other Contracting State, the fees received for those services will be taxable by the State in which the permanent establishment or fixed base is located in accordance with Article 7 or Article 14, rather than in accordance with Article 12A. 105. Since Article 7 of the United Nations Model Convention adopts a limited force-of-attraction rule, which expands the range of income that may be taxed as business profits, paragraph 4 also makes para - graphs 1 and 2 inapplicable if the fees for technical services are effec - tively connected with business activities in the State in which the fees arise that are of the same or similar kind as those effected through the permanent establishment. 106. The paragraph does not define the meaning of the expression “effectively connected.” As a result, whether fees for technical services are effectively connected with a permanent establishment, fixed base or business activities similar to those carried on through a permanent establishment must be determined on the basis of all the relevant facts 353

376 Article 12A Commentary and circumstances of each case. In general, fees for technical services would be considered to be effectively connected with a permanent establishment or fixed base if the technical services are closely related to or connected with the permanent establishment or fixed base or if the business activities are similar to those carried out through the per - manent establishment. This will be the case where the remuneration paid to the person providing the services is borne by the permanent establishment or fixed base in the State in which the fees arise. Where paragraph 4 applies, fees for technical services are taxa 107. - ble by the State in which the fees arise as part of the profits attributable to the permanent establishment in accordance with Article 7 or the income attributable to the fixed base in accordance with Article 14. Thus, paragraph 4 relieves the State in which the fees for technical ser - vices arise from the limitations on its taxing rights imposed by Article 12A. Where Article 7 applies as a result of the application of paragraph 4, most countries consider that the State in which the permanent establishment is located is allowed to tax only the net profits from the technical services attributable to the permanent establishment. Article - 7 does not preclude taxation of business profits attributable to a per manent establishment on a gross basis, but a Contracting State must not discriminate against residents of the other State in violation of par - agraph 3 of Article 24 (Nondiscrimination). Similarly, where Article 14 applies, most countries consider that the State in which the fixed base is located is allowed to tax only the net income derived from the technical services. However, it may be useful for countries to clarify these issues during the negotiation of the treaty (see paragraphs 9 and 10 of the Commentary on Article 14). Paragraphs 5 and 6 108. Paragraph 5 lays down the principle that the State in which fees for technical services arise for purposes of Article 12A is the State of which the payer of the fees is a resident or the State in which the payer has a permanent establishment or fixed base if the fees for technical services are borne by the permanent establishment or fixed base. It is not necessary for the services to be provided in the Contracting State in which the payer is resident or has a permanent establishment or fixed base. Whether a person is a resident of a Contracting State for 354

377 Article 12A Commentary purposes of Article 12A is determined in accordance with the provi - sions of Article 4 of the Convention. 109. - Where there is an obvious economic link between technical ser vices being provided and the permanent establishment or fixed base of the payer to which the services are provided, the fees for technical services are considered to arise in the State in which the permanent establishment or fixed base is situated. This result applies irrespective of the residence of the owner of the permanent establishment or fixed base, even where the owner resides in a third State. Where there is no economic link between the technical services 110. and the permanent establishment or fixed base, the payments for tech - nical services are considered to arise in the Contracting State in which the payer is resident. If the payer of fees for technical services is not a resident of a Contracting State, Article 12A does not apply to the fees for technical services unless the payer has a permanent establishment or fixed base in the Contracting State and there is a clear economic link between the technical services and the permanent establishment or fixed base. Otherwise there would be, in effect, a force-of-attraction principle for fees for technical services, which would be inconsistent with other provisions of the United Nations Model Convention. 111. Paragraph 5 is subject to paragraph 6, which provides an exception to the source rule in paragraph 5. Paragraph 6 deems fees for technical services made by a resident of a Contracting State not to arise in that State where that resident (the payer) carries on business through a permanent establishment in the other Contracting State or performs independent personal services through a fixed base in the other Contracting State or in a third State and the fees for technical services are borne by that permanent establishment or fixed base. As a result, in these circumstances, the Contracting State in which the payer is resident is not allowed to tax the payments for technical ser - vices under paragraph 2. 112. The phrase “borne by” must be interpreted in the light of the underlying purpose of paragraphs 5 and 6, which is to provide source rules for fees for technical services. A Contracting State is entitled to tax fees for technical services under paragraph 2 only if the fees arise in that State. The basic source rule in paragraph 5 is that fees for 355

378 Article 12A Commentary technical services arise in a Contracting State if the payer is a resident of that State or the payer has a permanent establishment or fixed base in a Contracting State and the fees for technical services are borne by that permanent establishment or fixed base. However, the basic rule is limited by the deeming rule in paragraph 6 where the payer is a resi - dent of a Contracting State but the fees for technical services are borne by a permanent establishment or fixed base that the payer has in the other Contracting State. Where fees for technical services are incurred for the purpose 113. of a business carried on through a permanent establishment or for the purpose of independent personal services performed through a fixed base, those fees will usually qualify for deduction in computing the prof - its attributable to the permanent establishment under Article 7 or the income attributable to the fixed base under Article 14. The deductibility of the fees for technical services provides an objective standard for deter - mining that the payments have a close economic connection to the State in which the permanent establishment or fixed base is situated. 114. The fact that the payer has, or has not, actually claimed a deduc - tion for the fees for technical services in computing the profits of the per - manent establishment or the income of the fixed base is not necessarily conclusive, since the proper test is whether any deduction available for those fees should be taken into account in determining the profits attrib - utable to the permanent establishment or the income attributable to the fixed base. For example, that test would be met even if no amount were actually deducted as a result of the permanent establishment or fixed base being exempt from tax or as a result of the payer simply deciding not to claim a deduction to which it was entitled. The test would also be met where the fees for technical services are not deductible for some reason other than the fact that the fees for technical services should not be allocated to the permanent establishment or fixed base. 115. The application of paragraphs 5 and 6 can be illustrated by the following examples. 116. Example 8: R Enterprise is carried on by a resident of State R. R Enterprise provides technical services to S Company, a resident of State S. The tax treaty between State R and State S is identical to the United Nations Model Convention, including Article 12A. S Company carries 356

379 Article 12A Commentary on business in State S and in State R (or a third State) through a per - manent establishment situated there. However, the technical services provided by R Enterprise to S Company are related to S Company’s business carried on in State S, not to the business carried on through the permanent establishment in State R (or a third State). 117. In Example 8, since the payments are made by S Company, a res - ident of State S, and are not borne by a permanent establishment of S Company in State R, the fees for technical services would be considered to arise in State S in accordance with paragraph 5. Therefore, State S would be entitled to tax the fees for technical services under paragraph 2. 118. Example 9: The facts are the same as in Example 8, except that the fees for technical services are borne by S Company’s permanent establishment in State R. 119. In Example 9, since the fees for technical services are borne by a permanent establishment of S Company situated in State R, paragraph 6 applies to deem the fees for technical services not to arise in State S. Consequently, the fees for technical services are not taxable by State S under paragraph 2 but are taxable exclusively by State R under para - graph 1 of Article 12A. 120. In Example 9, Article 12A of the Convention denies State S the right to tax the fees for technical services despite the fact that the fees are paid by a resident of State S. This result is justified because the fees relate to a business carried on by a resident of State S in State R. In such a situation, where fees for technical services are deductible in comput - ing the profits of a business attributable to a permanent establishment situated in the other Contracting State or in computing the income from independent personal services furnished through a fixed base situated in the other Contracting State, those payments have a closer economic connection to the activities carried on in that other State than to State S. 121. Example 10: T Enterprise is carried on by a resident of State T. T Enterprise carries on business through a permanent establishment situated in State S or provides independent personal services through a fixed base situated in State S. T Enterprise pays R Company, a res - ident of State R, for technical services provided by R Company for T 357

380 Article 12A Commentary Enterprise in connection with its income-earning activities carried on in State S. The payments made by T Enterprise to R Company for the technical services are deductible in computing the profits attributa - ble to the permanent establishment of T Enterprise in State S or the income attributable to the fixed base of T Enterprise in State S. The tax treaty between State S and State T is identical to the United Nations Model Convention including Article 12A. In Example 10, although the fees for technical services are 122. not paid by a resident of State S, the fees are borne by the permanent establishment or fixed base that T Enterprise has in State S. In these circumstances, the fees for technical services have a close economic connection to the income-earning activities of T Enterprise carried on in State S. Thus, the fees are deemed to arise in State S in accordance with paragraph 5 and State S is entitled to tax the payments in accord - ance with paragraph 2. 123. In the case of interest and royalties, paragraph 21 of the Commentary on Article 11 and paragraph 19 of the Commentary on Article 12 of the United Nations Model Convention indicate that coun - tries might substitute a rule that would identify the source of interest or royalties as the State in which the loan giving rise to the interest or the property or right giving rise to the royalties was used. A similar source rule might be substituted for purposes of Article 12A. Similarly, as suggested in the Commentary on Articles 11 and 12, where, in bilat - eral negotiations, the parties differ on the appropriate rule, a possible solution would be a rule that, in general, would accept the payer’s place of residence as the source of fees for technical services, but where the technical services are used or consumed in a State having a place-of- use rule, the payment would be deemed to arise in that State. 124. Various other alternative source rules for fees for technical ser - vices are possible. Such alternatives include the following: — The Contracting States might decide not to include para - graph 6. If paragraph 6 were omitted from Article 12A, fees for technical services would be considered to arise in the State in which the payer is resident, even where those fees are incurred for purposes of a permanent establishment or fixed base of the payer situated outside the payer’s State of residence. 358

381 Article 12A Commentary The Contracting States might decide not to include para - — graph 6 and to revise paragraph 5 so that fees for technical services could be considered to arise in a Contracting State only if the payer is a resident of that State and the technical services are used or consumed by the payer in that State; or if the payer is not a resident of a Contracting State, the payer has a permanent establishment or fixed base situated in a Contracting State and the fees for technical services are borne by that permanent establishment or fixed base. - In this case, technical services used or consumed by a resi dent of a Contracting State outside that State would not be considered to arise in that State, and that State would not be entitled to tax fees for such services under Article 12A. Paragraph 6 would be unnecessary because technical ser - vices used or consumed outside a Contracting State would include any technical services incurred for the purposes of a resident’s permanent establishment or fixed base situated outside that State. — Fees for technical services could be considered to arise in a Contracting State only if the payer is a resident of that State and the technical services are provided in that State or if the payer, not being a resident of a Contracting State, has a permanent establishment or fixed base situated in a Contracting State and the fees for technical services are borne by that permanent establishment or fixed base. In this case, a Contracting State would be entitled to tax fees for technical services paid by its residents to residents of the other Contracting State if the technical services are pro - vided in the State. In this situation, paragraph 6 would be unnecessary. 125. - Paragraph 6 provides no solution for the case where the bene ficiary and the payer are residents of the Contracting States, but the fees for technical services were incurred for the benefit of a perma - nent establishment or fixed base owned by the payer in a third State and the fees for technical services are borne by that permanent estab - lishment or fixed base. In such a case, the fees for technical services are deemed to arise in the Contracting State of which the payer is a resident under paragraph 5 and not in the third State in which the 359

382 Article 12A Commentary permanent establishment or fixed base is situated. Thus, the fees for technical services will be taxed both in the Contracting State of which the payer is a resident and in the Contracting State of which the bene - ficiary is a resident. Although double taxation will be avoided between these two States, it will not be avoided between them and the third State if the third State taxes the fees for technical services because they are borne by the permanent establishment or fixed base in its territory. Paragraph 6 is consistent in this regard with paragraph 5 of Article 11 and paragraph 5 of Article 12. 126. As explained in paragraph 21 of the Commentary on Article 11 (quoting paragraphs 29 and 30 of the Commentary on Article 11 of the OECD Model Convention), if the third State did not subject the fees for technical services to tax, there could be attempts to avoid taxation in the Contracting State of which the payer is a resident through the use of a permanent establishment or fixed base situated in such a third State. States for which this is not a concern and that wish to address the issue described in paragraph — above may do so by agreeing, in their bilateral convention, to the alternative formulation of paragraph 6 suggested in paragraph 127 below. 127. - As mentioned in paragraph 126, the State of which the bene ficiary is a resident and the State of which the payer of fees for tech - nical services is a resident may avoid the double taxation described in paragraph 125 above by agreeing to the following wording of paragraph 6: 6. For the purposes of this Article, fees for technical ser - vices shall be deemed not to arise in a Contracting State if the payer is a resident of that State and carries on business in the other Contracting State or a third State through a permanent establishment situated in that other State or the third State, or performs independent personal services through a fixed base situated in that other State or the third State and such fees are borne by that permanent establishment or fixed base. This wording would have the effect of ensuring that paragraphs 1 and 2 would not apply to the fees for technical services because they would not arise in a Contracting State. As a result, such fees for technical services would typically fall under Article 7 or 14. 360

383 Article 12A Commentary Paragraph 7 The purpose of paragraph 7 is to restrict the operation of the 128. provisions concerning the taxation of fees for technical services in cases where, by reason of a special relationship between the payer and the beneficial owner of the fees or between both of them and some other person, the amount of the fees paid exceeds the amount that would have been agreed upon by the payer and the beneficial owner if they had stipulated at arm’s length. Paragraph 7 provides that in such a case the provisions of the Article apply only to the - last-mentioned amount and the excess part of the fees for techni cal services would remain taxable according to the laws of the two Contracting States, due regard being had to the other provisions of the Convention. 129. It is clear from the text that in order for this paragraph to apply the fees for technical services held to be excessive must be due to a spe - cial relationship between the payer and the beneficial owner of the fees or between both of them and some other person. There may be cited as examples of such a special relationship cases where fees for technical services are paid to an individual or legal person who directly or indi - rectly controls the payer, or who is directly or indirectly controlled by the individual or is subordinate to a group having common interest with the individual. These examples, moreover, are similar or analo - gous to the cases contemplated by Article 9. 130. On the other hand, the concept of special relationship also covers relationship by blood or marriage and, in general, any commu - nity of interests as distinct from the legal relationships giving rise to the fees for technical services. 131. With regard to the taxation treatment to be applied to the excess part of the fees for technical services, the exact nature of such excess will need to be ascertained according to the circumstances of each case, in order to determine the category of income into which it should be classified for the purposes of applying the provisions of the tax laws of the States concerned and the provisions of the Convention. Unlike Article 11, paragraph 6, which, because of the limiting phrase “having regard to the debt-claim for which it is paid,” permits only the adjust - ment of the rate at which interest is charged, paragraph 7 permits the 361

384 Articles 12A and 13 Commentary reclassification of the fees for technical services in such a way as to give them a different character. This paragraph can affect not only the recipient of the fees, but also the payer of excessive fees for technical - services; if the law of the State where the payer is resident or has a per manent establishment or a fixed base permits, the excess amount can be disallowed as a deduction, due regard being had to other applicable provisions of the Convention. If two Contracting States have difficulty in determining the other provisions of the Convention applicable, as cases require, to the excess part of the fees for technical services, there would be nothing to prevent them from introducing additional clarifi - cations in the last sentence of paragraph 7, as long as they do not alter its general purport. 132. Where the principles and rules of their respective laws oblige the two Contracting States to apply different Articles of the Convention for the purpose of taxing the excess part of fees for technical services, it will be necessary to resort to the mutual agreement procedure pro - vided by the Convention in order to resolve the difficulty. Article 13 CAPITAL GAINS A. General considerations 1. Article 13 of the United Nations Model Convention consists of the first four paragraphs of Article 13 of the OECD Model Convention. Paragraph 5 is a distinct provision in the United Nations Model Convention. Paragraph 6 is the same as paragraph 5 of the OECD Model Convention but adjusted to take into account the insertion of the additional paragraph. 2. The text of this Article resulted from a compromise which the former Group of Experts felt would be most acceptable to both devel - oped and developing countries. Some members from developed coun - tries advocated the use of Article 13 of the OECD Model Convention, which (1) allows the source country to tax capital gains from the alien - ation of immovable property and from movable property that is a part of a permanent establishment or pertains to a fixed base for performing 362

385 Article 13 Commentary independent personal services, (2) permits gains from the alienation of ships and aircraft in international traffic to be taxed only in the State of the relevant enterprise, and (3) reserves to the residence country the right to tax gains on the alienation of other types of property. Most members from developing countries advocated the right of the source country to levy a tax in situations in which the OECD reserves that right to the country of residence. 3. Concerning the taxation of capital gains in both developed and developing countries, the following remarks from the preliminary remarks in the Commentary on Article 13 of the 2010 OECD Model Convention are pertinent: A comparison of the tax laws of the OECD member coun - 1. tries shows that the taxation of capital gains varies considerably from country to country: — in some countries capital gains are not deemed to be tax - able income; — in other countries capital gains accrued to an enterprise are taxed, but capital gains made by an individual out - side the course of his trade or business are not taxed; — even where capital gains made by an individual outside - the course of his trade or business are taxed, such tax ation often applies only in specified cases, e.g. profits from the sale of immovable property or speculative gains (where an asset was bought to be resold). 2. Moreover, the taxes on capital gains vary from country to country. In some OECD member countries, capital gains are taxed as ordinary income and therefore added to the income from other sources. This applies especially to the capital gains made by the alienation of assets of an enterprise. In a number of OECD member countries, however, capital gains are subjected to special taxes, such as taxes on profits from the alienation of immovable property, or general capital gains taxes, or taxes on capital appreciation (increment taxes). Such taxes are levied on each capital gain or on the sum of the capital gains accrued during a year, mostly at special rates, which do not take into account the other income (or losses) of the taxpayer. It does not seem necessary to describe all those taxes. 363

386 Article 13 Commentary 3. The Article does not deal with the above-mentioned ques - tions. It is left to the domestic law of each Contracting State to decide whether capital gains should be taxed and, if they are taxable, how they are to be taxed. The Article can in no way be construed as giving a State the right to tax capital gains if such right is not provided for in its domestic law. The Article does not specify to what kind of tax it applies. It is understood that the Article must apply to all kinds of taxes levied by a Contracting State on capital gains. The wording of Article 2 is large enough to achieve this aim and to include also special taxes on capital gains. The OECD Commentary on Article 13 contains the following 4. general remarks: 4. It is normal to give the right to tax capital gains on a prop - erty of a given kind to the State which under the Convention is entitled to tax both the property and the income derived therefrom. The right to tax a gain from the alienation of a busi - ness asset must be given to the same State without regard to the question whether such gain is a capital gain or a business profit. Accordingly, no distinction between capital gains and commercial profits is made nor is it necessary to have special provisions as to whether the Article on capital gains or Article 7 on the taxation of business profits should apply. It is however left to the domestic law of the taxing State to decide whether a tax on capital gains or on ordinary income must be levied. The Convention does not prejudge this question. The Article does not give a detailed definition of capital 5. gains. This is not necessary for the reasons mentioned above. The words “alienation of property” are used to cover in particu - lar capital gains resulting from the sale or exchange of property and also from a partial alienation, the expropriation, the trans - fer to a company in exchange for stock, the sale of a right, the gift and even the passing of property on death. 6. Most States taxing capital gains do so when an alienation of capital assets takes place. Some of them, however, tax only so-called realised capital gains. Under certain circumstances, though there is an alienation no realised capital gain is recog - when the alienation proceeds are nised for tax purposes ( e.g. 364

387 Article 13 Commentary used for acquiring new assets). Whether or not there is a realisa - tion has to be determined according to the applicable domestic tax law. No particular problems arise when the State which has the right to tax does not exercise it at the time the alienation takes place. 7. As a rule, appreciation in value not associated with the alienation of a capital asset is not taxed, since, as long as the owner still holds the asset in question, the capital gain exists only on paper. There are, however, tax laws under which capital appreciation and revaluation of business assets are taxed even if there is no alienation. Special circumstances may lead to the taxation of the 8. capital appreciation of an asset that has not been alienated. This may be the case if the value of a capital asset has in creased in such a manner that the owner proceeds to the revaluation of this asset in his books. Such revaluation of assets in the books may also occur in the case of a depreciation of the national currency. A number of States levy special taxes on such book profits, amounts put into reserve, an increase in the paid-up capital and other revaluations resulting from the adjustment of the book-value to the intrinsic value of a capital asset. These taxes on capital appreciation (increment taxes) are covered by the Convention according to Article 2. 9. Where capital appreciation and revaluation of business in assets are taxed, the same principle should, as a rule, apply as the case of the alienation of such assets. It has not been found necessary to mention such cases expressly in the Article or to lay down special rules. The provisions of the Article as well as those of Articles 6, 7 and 21, seem to be sufficient. As a rule, the right to tax is conferred by the above-mentioned provisions on the State of which the alienator is a resident, except that in the cases of immovable property or of movable property forming part of the business property of a permanent establishment [or pertaining to a fixed base], the prior right to tax belongs to the State where such property is situated. Special attention must be drawn, however, to the cases dealt with in paragraphs 13 to 17 below. 10. In some States the transfer of an asset from a perma - nent establishment situated in the territory of such State to a 365

388 Article 13 Commentary permanent establishment or the head office of the same enter - prise situated in another State is assimilated to an alienation of property. The Article does not prevent these States from taxing profits or gains deemed to arise in connection with such a transfer, provided, however, that such taxation is in accordance with Article 7. 11. The Article does not distinguish as to the origin of the capital gain. Therefore all capital gains, those accruing over a long term, parallel to a steady improvement in economic con - - ditions, as well as those accruing in a very short period (spec ulative gains) are covered. Also capital gains which are due to depreciation of the national currency are covered. It is, of course, left to each State to decide whether or not such gains should be taxed. 12. The Article does not specify how to compute a capital gain, this being left to the domestic law applicable. As a rule, - capital gains are calculated by deducting the cost from the sell ing price. To arrive at cost all expenses incidental to the pur - chase and all expenditure for improvements are added to the purchase price. In some cases the cost after deduction of the depreciation allowances already given is taken into account. Some tax laws prescribe another base instead of cost, the e.g. value previously reported by the alienator of the asset for capital tax purposes. 13. tion Special problems may arise when the basis for the taxa of capital gains is not uniform in the two Contracting States. The capital gain from the alienation of an asset computed in one State according to the rules mentioned in paragraph 12 above, may not necessarily coincide with the capital gain computed in the other State under the accounting rules used there. This may capital gains because occur when one State has the right to tax it is the State of situs while the other State has the right to tax because the enterprise is a resident of that other State. 14. The following example may illustrate this problem: an enterprise of State A bought immovable property situated in State B. The enterprise may have entered depreciation allow - ances in the books kept in State A. If such immovable prop - erty is sold at a price which is above cost, a capital gain may be 366

389 Article 13 Commentary realised and, in addition, the depreciation allowances granted - earlier may be recovered. State B, in which the immovable prop erty is situated and where no books are kept, does not have to take into account, when taxing the income from the immov - able property, the depreciation allowances booked in State A. Neither can State B substitute the value of the immovable prop - erty shown in the books kept in State A for the cost at the time of the alienation. State B cannot, therefore, tax the depreciation allowances realised in addition to the capital gain as mentioned in paragraph 12 above. On the other hand, State A of which the alienator is a res 15. - ident, cannot be obliged in all cases to exempt such book profits fully from its taxes under paragraph 1 of the Article and Article 23 A (there will be hardly any problems for States applying the tax credit method). To the extent that such book profits are due to the realisation of the depreciation allowances previously claimed in State A and which had reduced the income or profits taxable in such State A, that State cannot be prevented from taxing such book profits [...]. 16. Further problems may arise in connection with profits due to changes of the rate of exchange between the currencies of State A and State B. After the devaluation of the currency of State A, enterprises of such State A may, or may have to, increase the book value of the assets situated outside the territory of State A. Apart from any devaluation of the currency of a State, the usual fluctuations of the rate of exchange may give rise to - so-called currency gains or losses. Take for example an enter prise of State A having bought and sold immovable property sit - uated in State B. If the cost and the selling price, both expressed in the currency of State B, are equal, there will be no capital gain in State B. When the value of the currency of State B has risen between the purchase and the sale of the asset in relation to the currency of State A, in the currency of that State a profit will accrue to such enterprise. If the value of the cur rency of State B has fallen in the meantime, the alienator will sustain a loss which will not be recognised in State B. Such currency gains or losses may also arise in connection with claims and debts contracted in a foreign currency. If the balance sheet of 367

390 Article 13 Commentary a permanent establishment situated in State B of an enterprise of State A shows claims and debts expressed in the currency of State B, the books of the permanent establishment do not show any gain or loss when repayments are made. Changes of the rate of exchange may be reflected, however, in the accounts of the head office. If the value of the currency of State B has risen (fallen) between the time the claim has originated and its repayment, the enterprise, as a whole will realise a gain (sustain a loss). This is true also with respect to debts if between the time they have originated and their repayment, the currency of State B has fallen (risen) in value. The provisions of the Article do not settle all questions 17. regarding the taxation of such currency gains. Such gains are in most cases not connected with an alienation of the asset; they may often not even be determined in the State on which the right to tax capital gains is conferred by the Article. Accordingly, the question, as a rule, is not whether the State in which a perma - nent establishment is situated has a right to tax, but whether the State of which the taxpayer is a resident must, if applying the exemption method, refrain from taxing such currency gains which, in many cases, cannot be shown but in the books kept in the head office. The answer to that latter question depends not only on the Article but also on Article 7 and on Article 23 A. If in a given case differing opinions of two States should result in an actual double taxation, the case should be settled under the mutual agreement procedure provided for by Article 25. 18. Moreover the question arises which Article should apply when there is paid for property sold an annuity during the lifetime of the alienator and not a fixed price. Are such annu - ity payments, as far as they exceed costs, to be dealt with as a gain from the alienation of the property or as “income not dealt with” according to Article 21? Both opinions may be supported by arguments of equivalent weight, and it seems difficult to give one rule on the matter. In addition such problems are rare in practice, so it therefore seems unnecessary to establish a rule for insertion in the Convention. It may be left to Contracting States who may be involved in such a question to adopt a solution in the mutual agreement procedure provided for by Article 25. 368

391 Article 13 Commentary 19. The Article is not intended to apply to prizes in a lottery or to premiums and prizes attaching to bonds or debentures. 20. The Article deals first with the gains which may be taxed in the State where the alienated property is situated. For all other capital gains, paragraph [6] gives the right to tax to the State of which the alienator is a resident. 21. As capital gains are not taxed by all States, it may be considered reasonable to avoid only actual double taxation of capital gains. Therefore, Contracting States are free to supple - ment their bilateral convention in such a way that a State has to forego its right to tax conferred on it by the domestic laws only if the other State on which the right to tax is conferred by the Convention makes use thereof. In such a case, para - graph [6] of the Article should be supplemented accordingly. Besides, a modification of Article 23 A as suggested in [...] the Commentary on Article 23 A is needed. B. Commentary on the paragraphs of article 13 Paragraph 1 5. This paragraph reproduces Article 13, paragraph 1, of the OECD Model Convention, the Commentary on which is as follows: 22. Paragraph 1 states that gains from the alienation of immovable property may be taxed in the State in which it is situated. This rule corresponds to the provisions of Article 6 and of paragraph 1 of Article 22. It applies also to immovable property forming part of the assets of an enterprise [or used for performing independent personal services]. For the defi - nition of immovable property paragraph 1 refers to Article 6. Paragraph 1 of Article 13 deals only with gains which a resident of a Contracting State derives from the alienation of immov - able property situated in the other Contracting State. It does not, therefore, apply to gains derived from the alienation of im movable property situated in the Contracting State of which the alienator is a resident in the meaning of Article 4 or situated in a third State; the provisions of paragraph 5 [paragraph 6 of the United Nations text] shall apply to such gains (and not, as 369

392 Article 13 Commentary was mentioned in this Commentary before 2002, those of para - graph 1 of Article 21). 23. The rules of paragraph 1 are supplemented by those of paragraph 4, which applies to gains from the alienation of all or part of the shares in a company holding immovable pr op e r t y [...]. Paragraph 2 6. This paragraph reproduces Article 13, paragraph 2, of the OECD Model Convention. The relevant part of the Commentary on the 2010 OECD Model Convention reads as follows: 24. Paragraph 2 deals with movable property forming part of the business property of a permanent establishment of an enterprise [or pertaining to a fixed base used for performing independent personal services]. The term “ movable property” means all property other than immovable property which is dealt with in paragraph 1. It includes also incorporeal property, such as goodwill, licences, etc. Gains from the alienation of such assets may be taxed in the State in which the perma nent establishment [or fixed base] is situated, which corre sponds to the rules for business profits [and for income from independ - ent personal services] (Article[s] 7 [and 14]). 25. The paragraph makes clear that its rules apply when mov - able property of a permanent establishment [or fixed base] is alienated as well as when the permanent establishment as such (alone or with the whole enterprise) [or the fixed base as such] is alienated. If the whole enterprise is alienated, then the rule applies to such gains which are deemed to result from the alien - ation of movable property forming part of the business property of the permanent establishment. The rules of Article 7 should then apply mutatis mutandis without express reference thereto. For the transfer of an asset from a permanent establishment in one State to a permanent establishment (or the head office) in another State, see paragraph 10 above. 26. On the other hand, paragraph 2 may not always be appli - cable to capital gains from the alienation of a participation in an was enterprise. The provision applies only to property which 370

393 Article 13 Commentary owned by the alienator, either wholly or jointly with another person. Under the laws of some countries, capital assets of a partnership are considered to be owned by the partners. Under some other laws, however, partnerships and other associations are treated as body corporate for tax purposes, distinct from their partners (members), which means that participations in such entities are dealt with in the same way as shares in a company. Capital gains from the alienation of such partici - pations, like capital gains from the alienation of shares, are fore taxable only in the State of residence of the alien there - ator. Contracting States may agree bilaterally on special rules gov erning the taxation of capital gains from the alienation of a participation in a partnership. 27. Certain States consider that all capital gains arising from sources in their territory should be subject to their taxes according to their domestic laws, if the alienator has a perma - nent establishment within their territory. Paragraph 2 is not based on such a conception which is sometimes referred to as “the force of attraction of the permanent establishment”. The paragraph merely provides that gains from the alienation of movable property forming part of the business property of a permanent establishment [or of movable property pertaining to a fixed base used for performing independent personal services] may be taxed in the State where the permanent establishment [or the fixed base] is situated. The gains from the alienation of all other movable property are taxable only in the State of res - idence of the alienator as provided in paragraph [6]. The fore - going explanations accord with those in the Commentary on A r t i c l e 7. Paragraph 3 7. This paragraph reproduces Article 13, paragraph 3, of the 2017 OECD Model Convention, the Commentary on which is as follows: 28. An exception from the rule of paragraph 2 is provided for ships and aircraft operated in international traffic and movable property pertaining to the operation of such ships and aircraft. Normally, gains from the alienation of such assets are taxable 371

394 Article 13 Commentary only in the State of the enterprise operating such ships and air - craft . This rule corresponds to the provisions of Article 8 and of paragraph 3 of Article 22. Contracting States which would prefer to confer the exclusive taxing right on the State in which the place of effective management of the enterprise is situated are free, in bilateral conventions, to substitute for paragraph 3 a provision corresponding to that proposed in paragraph 2 of the Commentary on Article 8 [paragraph 10 of the Commentary on Article 8 in the UN Model]. Paragraph 4 8. This paragraph corresponds with paragraph 4 of the OECD Model Convention. Until the 2017 update, paragraph 4 of the United Nations Model Convention read as follows: 4. Gains from the alienation of shares of the capital stock of a company, or of an interest in a partnership, trust or estate, the property of which consists directly or indirectly principally of immovable property situated in a Contracting State may be taxed in that State. In particular: (a) Nothing contained in this paragraph shall apply to a company, partnership, trust or estate, other than a company, partnership, trust or estate engaged in the business of management of immovable properties, the property of which consists directly or indirectly principally of immovable property used by such company, partnership, trust or estate in its business activities. (b) For the purposes of this paragraph, “principally” in relation to ownership of immovable property means the value of such immovable property exceeding 50 per cent of the aggregate value of all assets owned by the company, partnership, trust or estate. Both formulations are designed to prevent the avoidance of taxes on the gains from the sale of immovable property. Since it is often rel - atively easy to avoid taxes on such gains through the incorporation of a company to hold such property, it is necessary to tax the sale of shares in such a company. This is especially so where ownership of the 372

395 Article 13 Commentary shares carries the right to occupy the property. In order to achieve its objective, paragraph 4 would have to apply regardless of whether the company is a resident of the Contracting State in which the immov - able property is situated or a resident of another State. In 1999, the former Group of Experts decided to amend paragraph 4 to expand its scope to include interests in partnerships, trusts and estates which own immovable property. In 2017, the Committee decided to adopt the updated provision from the OECD Model Convention, as the concept of a “comparable interest” is broadly equivalent to what was previously covered by paragraph 4 of the United Nations Model Convention. 8.1 In addition to introducing the concept of a “comparable interest”, paragraph 4 was expanded to cover situations where assets are contrib - uted to an entity shortly before the sale of the shares (or comparable interests) in that entity in order to dilute the proportion of the value of these shares (or comparable interests) that is derived from immov - able property situated in that other Contracting State. It achieves this by looking at whether the shares (or comparable interests) derived their value primarily from immovable property at any time during the 365 days preceding the alienation, as opposed to the time of alienation only. 8.2 - By providing that gains from the alienation of shares or com parable interests which, at any time during the 365 days preceding the alienation, deriving more than 50 per cent of their value directly or indirectly from immovable property situated in a Contracting State may be taxed in that State, paragraph 4 provides that gains from the alienation of such shares or comparable interests and gains from the alienation of the underlying immovable property, which are covered by paragraph 1, are equally taxable in that State. 8.3 Paragraph 4 allows the taxation of the entire gain attributable to the shares or comparable interests to which it applies even where part of - the value of these shares or comparable interests is derived from prop erty other than immovable property located in the source State. The determination of whether shares of a company or comparable interests derive, at any time during the 365 days preceding the alienation, more than 50 per cent of their value directly or indirectly from immovable property situated in a Contracting State will normally be done by com - paring the value of such immovable property to the value of all the prop - erty owned by the company, entity or arrangement without taking into 373

396 Article 13 Commentary account debts or other liabilities of the company (whether or not secured by mortgages on the relevant immovable property). 8.4 In adopting the updated wording from the OECD Model Convention in 2017, the Committee decided to omit paragraph 4(a) from the United Nations Model Convention as it did not reflect common practice. It was found that the provision was very rarely used and was difficult to apply. However, countries may agree during bilateral negotiations to include the words from subparagraph (a) as it appeared prior to the 2017 update, at the end of paragraph 4, as follows: 4. Gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the aliena - tion, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property, as defined in Article 6, situated in that other State. Nothing contained in this paragraph shall apply to a company, partnership, trust or estate, other than a company, partner - ship, trust or estate engaged in the business of management of immovable properties, the property of which consists directly or indirectly principally of immovable property used by such company, partnership, trust or estate in its business activities. Paragraph 5 9. Some countries hold the view that a Contracting State should be able to tax a gain on the alienation of shares of a company resident in that State, whether the alienation occurs within or outside that State. However, it is recognized that for administrative reasons the right to tax should be limited to the alienation of shares of a company in the capital of which the alienator at any time during the 365 days preceding the alienation, held, directly or indirectly, a substantial participation. The determina - tion of what is a substantial participation is left to bilateral negotiations, in the course of which an agreed percentage can be determined. 9.1 In 2017, the Committee decided to include the reference to “comparable interests” in paragraph 5 in order to mirror that similar changes made to paragraph 4. 374

397 Article 13 Commentary 10. This paragraph provides for taxation of a gain on the alienation of shares and comparable interests as contemplated in the paragraph above but excludes gains from the alienation of shares to which par - agraph 4 of Article 13 of the Convention applies. The wording clearly stipulates that a gain on the alienation of any number of shares may be taxed in the State in which the company is a resident as long as the shareholding is substantial at any time during the 12-month period preceding the alienation. A substantial shareholding is determined - according to the percentage shareholding decided in the relevant bilat eral negotiations. Consequently, even if a substantial shareholding is alienated through a number of transfers of smaller shareholdings, the taxing right granted by the paragraph will still apply if the shares transferred were alienated at any time during the 12-month period. 11. It will be up to the law of the State imposing the tax to determine which transactions give rise to a gain on the alienation of shares and how to determine the level of holdings of the alienator, in particular, how to determine an interest held indirectly. An indirect holding in this context may include ownership by related persons that is imputed to the alienator. Anti-avoidance rules of the law of the State imposing the tax may also be relevant in determining the level of the alienator’s direct or indirect holdings. The treaty text itself or associated docu - ments could alternatively expand on the meaning of these concepts. 12. - The question of laying down a concessionary rate of tax (com pared with the normal domestic rate) on gains arising on alienation of shares, other than the shares referred to in paragraph 4, that is, not being shares of companies principally owning immovable property, has also been considered. Since the gains arising on alienation of shares being taxed in a concessionary manner is likely to encourage investment in shares, promote foreign direct investment and portfolio investment, and thereby give impetus to the industrialization of the country, countries may consider discussing this matter during bilateral negotiations and making necessary provision in the bilateral tax treaties. 13. It is costly to tax gains from the alienation of quoted shares. In addition, developing countries may find it economically rewarding to boost their capital markets by not taxing gains from the alienation of quoted shares. Countries that wish to do so may include in their bilat - eral tax treaties the following: 375

398 Article 13 Commentary Gains, other than those to which paragraph 4 applies, derived by a resident of a Contracting State from the alienation of shares of a company, or comparable interests, such as interests in a part - nership or a trust, which is a resident of the other Contracting State, excluding shares in which there is substantial and reg - ular trading on a recognized stock exchange, may be taxed in that other State if the alienator, at any time during the 365 days preceding such alienation, held directly or indirectly at least ___ per cent (the percentage is to be established through bilateral negotiations) of the capital of that company. The treaty text itself or associated documents could expand on the meaning of the phrases “substantial and regular trading” and “recog - nized stock exchange”. 14. Some countries might consider that the Contracting State in which a company is resident should be allowed to tax the alienation of its shares only if a substantial portion of the company’s assets are sit - uated in that State and in bilateral negotiations might seek to include such a limitation. Other countries engaged in bilateral negotiations might seek 15. to have paragraph 5 omitted entirely, where they take the view that taxation in the source State of capital gains in these situations may create economic double taxation in the corporate chain, thus ham - pering foreign direct investment. This consideration is, in particular, relevant for countries that apply a participation exemption not only to dividends received from a substantial shareholding, but also to capital gains made on shares in relation to such substantial holdings. 16. If countries choose not to tax the gains derived in the course of corporate reorganizations, they are of course also free to do so. Paragraph 6 17. This paragraph reproduces Article 13, paragraph 5, of the OECD Model Convention with a drafting adjustment replacing the words “in paragraphs 1, 2, 3 and 4” with “in paragraphs 1, 2, 3, 4 and 5”. The Commentary on Article 13, paragraph 5, of the 2010 OECD Model Convention is therefore relevant, mutatis mutandis, to paragraph 6. That Commentary reads as follows: 376

399 Article 13 Commentary 29. As regards gains from the alienation of any property - other than that referred to in paragraphs 1, 2, 3, 4 and [5], par agraph [6] provides that they are taxable only in the State of which the alienator is a resident [...]. The Article does not contain special rules for gains from 30. the alienation of shares in a company (other than shares of a company dealt with in paragraph[s] 4 [and 5]) or of securities, bonds, debentures and the like. Such gains are, therefore, taxa - ble only in the State of which the alienator is a resident. 31. If shares are sold by a shareholder to the issuing company in connection with the liquidation of such company or the reduc - tion of its paid-up capital, the difference between the selling price and the par value of the shares may be treated in the State of which the company is a resident as a distribution of accumulated profits and not as a capital gain. The Article does not prevent the State of residence of the company from taxing such distri - butions at the rates provided for in Article 10: such taxation is permitted because such difference is covered by the definition of the term “dividends” contained in paragraph 3 of Article 10 and interpreted in paragraph 28 of the Commentary relating thereto. debentures are The same interpretation may apply if bonds or higher than the par redeemed by the debtor at a price which is value or the value at which the bonds or debentures have been issued; in such a case, the difference may represent interest and, therefore, be subjected to a limited tax in the State of source of the interest in accordance with Article 11 (see also paragraphs 20 and 21 of the Commentary on Article 11). 32. There is a need to distinguish the capital gain that may be derived from the alienation of shares acquired upon the exercise of a stock-option granted to an employee or member of a board of directors from the benefit derived from the stock-option that is covered by Articles 15 or 16. The principles on which that distinction is based are discussed in paragraphs 12.2 to 12.5 of the Commentary on Article 15 and paragraph 3.1 of the Commentary on Article 16 [of the OECD Model Convention]. 18. However, as indicated in paragraph 2 above, most members from developing countries suggested the following alternative to Article 13, paragraph 5, of the OECD Model Convention: 377

400 Articles 13 and 14 Commentary 5. Gains from the alienation of any property other than those gains mentioned in paragraphs 1, 2, 3 and 4 may be taxed in the Contracting State in which they arise according to the law of that State. This alternative is equivalent to saying that either or both States may tax according to their own laws and that the State of residence will eliminate double taxation under Article 23. Countries choosing this alternative may wish through bilateral negotiations to clarify which particular source rules will apply to establish where a gain shall be considered to arise. Article 14 INDEPENDENT PERSONAL SERVICES 1. Article 14 of the United Nations Model Convention reproduces in paragraph 1, subparagraph ( a ) and paragraph 2 the essential pro - visions of Article 14 of the OECD Model Convention (1997 version). The whole of Article 14 and the Commentary thereon were deleted from the OECD Model Convention on 29 April 2000. Paragraph 1, subparagraph ( ), allows the country of source to tax in one situation b in addition to the one contained in Article 14, paragraph 1, of the 1997 OECD Model Convention. More completely, while the former OECD Model Convention allowed the source country to tax income from independent personal services only if the income was attributable to a fixed base of the taxpayer, the United Nations Model Convention also allows taxation at source if the taxpayer is present in that country for more than 183 days in any twelve-month period commencing or ending in the fiscal year concerned. 2. In the discussion of Article 14, some members from develop - ing countries expressed the view that taxation by the source country should not be restricted by the criteria of existence of a fixed base and length of stay and that the source of income should be the only crite - rion. Some members from developed countries, on the other hand, felt that the exportation of skills, like the exportation of tangible goods, should not give rise to taxation in the country of destination unless the person concerned has a fixed base in that country comparable to a 378

401 Article 14 Commentary permanent establishment. They therefore supported the fixed base cri - - terion, although they also accepted that taxation in the source coun try is justified by continued presence in that country of the person rendering the service. Some members from developing countries also expressed support for the fixed base criterion. Other members from developing countries expressed preference for the criterion based on length of stay. 3. - In developing the 1980 Model, several members from develop ing countries had proposed a third criterion, namely, the amount of remuneration. Under that criterion, remuneration for independent personal services could be taxed by the source country if it exceeded a specified amount, regardless of the existence of a fixed base or the length of stay in that country. 4. As a compromise, the 1980 Model included three alternative a )–( c criteria found in subparagraphs ( - ) of paragraph 1, the satisfac tion of any one of which would give the source country the right to tax the income derived from the performance of personal activities by an individual who is a resident of the other State. However, in 1999, the former Group of Experts decided to omit the third criterion, namely, the amount of remuneration, specified in subparagraph ( c ), retaining subparagraphs ( a b ). ) and ( Subparagraph ( 5. ), which reproduces the sole criterion in the a OECD Model Convention, provides that the income may be taxed if the individual has a fixed base regularly available to him for perform - ing his activities. Though the presence of a fixed base gives the right to tax, the amount of income that is subject to tax is limited to that which is attributable to the fixed base. Subparagraph ( b ) as amended in 1999, extends the source coun - 6. try’s right to tax by providing that the source country may tax if the individual is present in the country for a period or periods aggregating at least 183 days in any twelve-month period commencing or ending in the fiscal year concerned, even if there is no fixed base. Only income derived from activities exercised in that country, however, may be taxed. Prior to the amendment, the requirement of minimum stay in the Contracting State was a “period or periods amounting to or exceeding in the aggregate 183 days in the fiscal year concerned”. A member from 379

402 Article 14 Commentary a developed country, however, expressed a preference for retaining the previous wording for technical reasons. By virtue of the amendment, the provisions of Article 14, paragraph 1, subparagraph ( b ), have been ), a brought on a par with those of Article 15, paragraph 2, subparagraph ( relating to the minimum period of stay in the other Contracting State. 7. c ) provided a further cri - Prior to its deletion, subparagraph ( terion for source country tax when neither of the two conditions specified in subparagraphs ( ) and ( b ) is met. It was provided that if a the remuneration for the services performed in the source country exceeds a certain amount (to be determined in bilateral negotiations), the source country may tax, but only if the remuneration is received from a resident of the source country or from a permanent establish - ment or fixed base of a resident of any other country which is situated in that country. 8. It was observed that any monetary ceiling limit fixed in this behalf becomes meaningless over a period of time due to inflation and would only have the effect of limiting the amount of potentially val - uable services that the country will be able to import. Moreover, the provision to this effect appeared only in 6 per cent of the existing bilat - eral tax treaties finalized between 1980 and 1997. It was, accordingly, c ) of paragraph 1 of Article 14. decided to delete subparagraph ( The former Group of experts discussed the relationship between 9. Article 14 and subparagraph 3( b ) of Article 5. It was generally agreed that remuneration paid directly to an individual for the performance of activity in an independent capacity was subject to the provisions of Article 14. Payments to an enterprise in respect of the furnishing by that enterprise of the activities of employees or other personnel are subject to Articles 5 and 7. The remuneration paid by the enterprise to the individual who performed the activities is subject either to Article 14 (if he is an independent contractor engaged by the enterprise to perform the activities) or Article 15 (if he is an employee of the enter - prise). If the parties believe that further clarification of the relation - ship between Article 14 and Articles 5 and 7 is needed, they may make such clarification in the course of negotiations. 10. Since Article 14 of the United Nations Model Convention con - tains all the essential provisions of Article 14 of the 1997 OECD Model 380

403 Article 14 Commentary Convention, the former OECD Commentary on that Article is rele - vant. That Commentary reads as follows: 1. The Article is concerned with what are commonly known as professional services and with other activities of an inde - pendent character. This excludes industrial and commercial activities and also professional services performed in employ - ment, e.g. a physician serving as a medical officer in a factory. It A should, however, be observed that the rticle does not concern independent activities of artistes and sportsmen, these being covered by Article 17. 2. The meaning of the term “professional services” is illus - trated by some examples of typical liberal professions. The enumeration has an explanatory character only and is not exhaustive. Difficulties of interpretation which might arise in special cases may be solved by mutual agreement between the competent authorities of the Contracting States concerned. 3. The provisions of the Article are similar to those for business profits and rest in fact on the same principles as those of Article 7. The provisions of Article 7 and the Commentary - thereon could therefore be used as guidance for interpret ing and applying Article 14. Thus the principles laid down in Article 7 for instance as regards allocation of profits between head office and permanent establishment could be applied also in apportioning income between the State of residence of a person performing independent personal services and the State where such services are performed from a fixed base. Equally, expenses incurred for the purposes of a fixed base, including executive and general expenses, should be allowed as deduc - tions in determining the income attributable to a fixed base in the same way as such expenses incurred for the purposes of a permanent establishment [...]. Also in other respects Article 7 and the Commentary thereon could be of assistance for the interpretation of Article 14, e.g. in determining whether com - puter software payments should be classified as commercial income within Article 7 or 14 or as royalties within Article 12. 4. Even if Articles 7 and 14 are based on the same principles, it was thought that the concept of permanent establishment should be reserved for commercial and industrial activities. 381

404 Articles 14 and 15 Commentary The term “fixed base” has therefore been used. It has not been thought appropriate to try to define it, but it would cover, for instance, a physician’s consulting room or the office of an archi - tect or a lawyer. A person performing independent personal services would probably not as a rule have premises of this kind in any other State than of his residence. But if there is in another State a centre of activity of a fixed or a permanent character, then that State should be entitled to tax the person’s activities. Some countries interpret Article 14 differently from the inter - 11. pretation delineated in paragraphs 9 and 10 above. These countries may, therefore, wish to clarify their positions and agree on these aspects bilaterally, if not already dealt with. Article 15 DEPENDENT PERSONAL SERVICES 1. Article 15 of the United Nations Model Convention reproduces Article 15 of the OECD Model Convention. The only differences are that the heading of the OECD Article now reads “INCOME FROM EMPLOYMENT” and the reference to “fixed base” in paragraph 2, sub - paragraph c - ) has been taken out. These changes stem from the elimi nation of Article 14 from the OECD Model Convention in 2000. The Commentary on Article 15 of the 2010 OECD Model Convention reads as follows: Paragraph 1 establishes the general rule as to the taxa - 1. tion of income from employment (other than pensions), namely, that such income is taxable in the State where the employment is actually exercised. The issue of whether or not services are provided in the exercise of an employment may sometimes give rise to difficulties which are discussed in paragraphs 8.1 ff . Employment is exercised in the place where the employee is physically present when performing the activities for which the employment income is paid. One consequence of this would be that a resident of a Contracting State who derived remunera - tion, in respect of an employment, from sources in the other State could not be taxed in that other State in respect of that 382

405 Article 15 Commentary remuneration merely because the results of this work were exploited in that other State. 2. The general rule is subject to exception only in the case of pensions (Article 18) and of remuneration and pensions in respect of government service (Article 19). Non-employment remuneration of members of boards of directors of companies is the subject of Article 16. 2.1 Member countries have generally understood the term “salaries, wages and other similar remuneration” to include benefits in kind received in respect of an employment ( e.g. stock-options, the use of a residence or automobile, health or life insurance coverage and club memberships). 2.2 The condition provided by the Article for taxation by the State of source is that the salaries, wages or other similar remuneration be derived from the exercise of employment in that State. This applies regardless of when that income may be paid to, credited to or otherwise definitively acquired by the employee. 3. Paragraph 2 contains, however, a general exception to the rule in paragraph 1. This exception covers all individuals rendering [dependent personal] services in the course of an - employment (sales representatives, construction workers, engi neers, etc.), to the extent that their remuneration does not fall under the provisions of other Articles, such as those applying to government services or artistes and sportsmen. 4. The three conditions prescribed in this paragraph must be satisfied for the remuneration to qualify for the exemption. The first condition is that the exemption is limited to the 183 day period. It is further stipulated that this time period may not be exceeded “in any twelve month period commencing or ending in the fiscal year concerned”. This contrasts with the 1963 Draft Convention and the 1977 Model Convention which provided 44 that the 183 day period should not be exceeded “in the fiscal year concerned”, a formulation that created difficulties [in cases] where the fiscal years of the Contracting States did not 44 The same change was made in 1999 in the United Nations Model Convention. 383

406 Article 15 Commentary coincide and which opened up opportunities in the sense that operations were sometimes organised in such a way that, for example, workers stayed in the State concerned for the last 5 1/2 months of one year and the first 5 1/2 months of the following year. The present wording of subparagraph 2 a) does away with such opportunities for tax avoidance. In applying that wording, all possible periods of twelve consecutive months must be con - sidered, even periods which overlap others to a certain extent. For instance, if an employee is present in a State during 150 days between 1 April 01 and 31 March 02 but is present there during 210 days between 1 August 01 and 31 July 02, the employee will have been present for a period exceeding 183 days during the second 12 month period identified above even though he did not meet the minimum presence test during the first period considered and that first period partly overlaps the second. 5. Although various formulas have been used by member countries to calculate the 183 day period, there is only one way which is consistent with the wording of this paragraph: the “days of physical presence” method. The application of this method is straightforward as the individual is either present in a country or he is not. The presence could also relatively easily be documented by the taxpayer when evidence is required by the tax authorities. Under this method the following days are included in the calculation: part of a day, day of arrival, day of departure and all other days spent inside the State of activ - ity such as Saturdays and Sundays, national holidays, holidays before, during and after the activity, short breaks (training, strikes, lock-out, delays in supplies), days of sickness (unless they prevent the individual from leaving and he would have otherwise qualified for the exemption) and death or sickness in the family. However, days spent in the State of activity in transit in the course of a trip between two points outside the State of activity should be excluded from the computation. It follows from these principles that any entire day spent outside the State of activity, whether for holidays, business trips, or any other reason, should not be taken into account. A day during any part of which, however brief, the taxpayer is present in a State counts as a day of presence in that State for purposes of computing the 183 day period. 384

407 Article 15 Commentary 5.1 Days during which the taxpayer is a resident of the source - State should not, however, be taken into account in the calcu a) has to be read in the context of the first lation. Subparagraph part of paragraph 2, which refers to “remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State”, which does not apply to a person who resides and works in the same State. The words a) , refer to the “the recipient is present”, found in subparagraph recipient of such remuneration and, during a period of residence in the source State, a person cannot be said to be the recipient of remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State. The following examples illustrate this conclusion: — Example 1: From January 01 to December 01, X lives in, and is a resident of, State S. On 1 January 02, X is hired by an employer who is a resident of State R and moves to State R where he becomes a resident. X is subsequently sent to State S by his employer from 15 to 31 March 02. In that case, X is present in State S for 292 days between 1 April 01 and 31 March 02 but since he is a resident of State S between 1 April 01 and 31 December 01, this first - period is not taken into account for purposes of the cal a) . culation of the periods referred to in subparagraph Example 2: From 15 to 31 October 01, Y, a resident of State — R, is present in State S to prepare the expansion in that country of the business of ACO, also a resident of State R. On 1 May 02, Y moves to State S where she becomes a resident and works as the manager of a newly created subsidiary of ACO resident of State S. In that case, Y is present in State S for 184 days between 15 October 01 and 14 October 02 but since she is a resident of State S between 1 May and 14 October 02, this last period is not taken into account for purposes of the calculation of the periods referred to in subparagraph a) . 6. The second condition is that the employer paying the remuneration must not be a resident of the State in which the employment is exercised. Some member countries may, how - ever, consider that it is inappropriate to extend the exception of 385

408 Article 15 Commentary paragraph 2 to cases where the employer is not a resident of the - State of residence of the employee, as there might then be admin istrative difficulties in determining the employment income of the employee or in enforcing withholding obligations on the employer. Contracting States that share this view are free to adopt bilaterally the following alternative wording of subparagraph 2 b ): the remuneration is paid by, or on behalf of, an b) employer who is a resident of the first-mentioned State, and 6.1 The application of the second condition in the case of fiscally transparent partnerships presents difficulties since such partnerships cannot qualify as a resident of a Contracting State under Article 4 (see paragraph 8.2 of the Commentary on Article 4). While it is clear that such a partnership could qualify as an “employer” (especially under the domestic law definitions of the term in some countries, where an employer is defined e.g. as a person liable for a wage tax), the application of the condi - tion at the level of the partnership regardless of the situation of the partners would therefore render the condition totally meaningless. 6.2 b) and c) of The object and purpose of subparagraphs paragraph 2 are to avoid the source taxation of short-term employments to the extent that the employment income is not allowed as a deductible expense in the State of source because the employer is not taxable in that State as he neither is a resident nor has a permanent establishment therein. These subparagraphs can also be justified by the fact that imposing source deduction requirements with respect to short-term employments in a given State may be considered to constitute an excessive administrative burden where the employer neither resides nor has a permanent establishment in that State. In order to achieve a meaningful interpretation of subparagraph b) that would accord with its context and its object, it should therefore be considered that, in the case of fiscally transparent partnerships, that subparagraph applies at the level of the part - ners. Thus, the concepts of “employer” and “resident”, as found in subparagraph b) , are applied at the level of the partners rather than at the level of a fiscally transparent partnership. This 386

409 Article 15 Commentary approach is consistent with that under which other provisions of tax conventions must be applied at the partners’ rather than at the partnership’s level. While this interpretation could create difficulties where the partners reside in different States, such difficulties could be addressed through the mutual agreement procedure by determining, for example, the State in which the partners who own the majority of the interests in the partner - ship reside ( the State in which the greatest part of the deduc - i.e. tion will be claimed). Some members of the Committee of Experts disagree with the prop - osition in paragraph 6.2 of the OECD Commentary extracted above b ) are that the concepts of “employer” and “resident” in subparagraph ( applied at the level of partners. They dispute the stated rationale for this - approach, i.e. that in cases of fiscally transparent partnerships, provi sions of tax conventions must be applied at the partners’ level. They are of the view that a special rule is required in a convention to provide such a result. The OECD Model Commentary continues as follows: 7. Under the third condition, if the employer has a permanent establishment [or a fixed base if he performs professional services or other activities of an independent character] in the State in which the employment is exercised, the exemption is given on condition that the remuneration is not borne by that permanent establishment [or a fixed base which he has in that State]. The phrase “borne by” must be interpreted in the light of the under - c) of the Article, which is to ensure lying purpose of subparagraph that the exception provided for in paragraph 2 does not apply to remuneration that could give rise to a deduction, having regard to the principles of Article 7 and the nature of the remuneration, in computing the profits of a permanent establishment situated in the State in which the employment is exercised. 7.1 The fact that the employer has, or has not, actually claimed a deduction for the remuneration in computing the profits attributable to the permanent establishment is not neces - sarily conclusive since the proper test is whether any deduction otherwise available with respect to that remuneration should be taken into account in determining the profits attributable to the permanent establishment. That test would be met, for instance, even if no amount were actually deducted as a result 387

410 Article 15 Commentary of the permanent establishment being exempt from tax in the source country or of the employer simply deciding not to claim a deduction to which he was entitled. The test would also be met where the remuneration is not deductible merely because of its where the State takes the view that the issuing of nature ( e.g. shares pursuant to an employee stock-option does not give rise to a deduction) rather than because it should not be allocated to the permanent establishment. 8. There is a direct relationship between the principles underlying the exception of paragraph 2 and Article 7. Article 7 is based on the principle that an enterprise of a Contracting State should not be subjected to tax in the other State unless its business presence in that other State has reached a level suffi - cient to constitute a permanent establishment. The exception of paragraph 2 of Article 15 extends that principle to the taxa - tion of the employees of such an enterprise where the activities of these employees are carried on in the other State for a rela - tively short period. Subparagraphs b ) and c ) make it clear that the exception is not intended to apply where the employment services are rendered to an enterprise the profits of which are - subjected to tax in a State either because it is carried on by a res ident of that State or because it has a permanent establishment therein to which the services are attributable. 8.1 It may be difficult, in certain cases, to determine whether the services rendered in a State by an individual resident of another State, and provided to an enterprise of the first State (or that has a permanent establishment in that State), constitute employment services, to which Article 15 applies, or services ren - dered by a separate enterprise, to which Article 7 applies or, more generally, whether the exception applies. While the Commentary previously dealt with cases where arrangements were structured for the main purpose of obtaining the benefits of the exception of paragraph 2 of Article 15, it was found that similar issues could arise in many other cases that did not involve tax-motivated transactions and the Commentary was amended to provide a more comprehensive discussion of these questions. 8.2 In some States, a formal contractual relationship would not be questioned for tax purposes unless there were some 388

411 Article 15 Commentary evidence of manipulation and these States, as a matter of domestic law, would consider that employment services are only rendered where there is a formal employment relationship. If States where this is the case are concerned that such 8.3 approach could result in granting the benefits of the exception provided for in paragraph 2 in unintended situations ( e.g. in so-called “hiring-out of labour” cases), they are free to adopt bilaterally a provision drafted along the following lines: Paragraph 2 of this Article shall not apply to remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State and paid by, or on behalf of, an employer who is not a resident of that other State if: a) the recipient renders services in the course of that employment to a person other than the employer and that person, directly or indirectly, supervises, directs or controls the manner in which those services are performed; and b) those services constitute an integral part of the busi - ness activities carried on by that person. 8.4 - In many States, however, various legislative or jurispru e.g. substance over form rules) have dential rules and criteria ( been developed for the purpose of distinguishing cases where services rendered by an individual to an enterprise should be considered to be rendered in an employment relationship (contract of service) from cases where such services should be considered to be rendered under a contract for the provision of services between two separate enterprises (contract for ser - vices). That distinction keeps its importance when applying the provisions of Article 15, in particular those of subparagraphs 2 b) and c). Subject to the limit described in paragraph 8.11 and unless the context of a particular convention requires otherwise, it is a matter of domestic law of the State of source to determine whether services rendered by an individual in that State are provided in an employment relationship and that determina - tion will govern how that State applies the Convention. 8.5 In some cases, services rendered by an individual to an enterprise may be considered to be employment services for 389

412 Article 15 Commentary purposes of domestic tax law even though these services are provided under a formal contract for services between, on the one hand, the enterprise that acquires the services, and, on the other hand, either the individual himself or another enterprise by which the individual is formally employed or with which the individual has concluded another formal contract for services. 8.6 In such cases, the relevant domestic law may ignore the - way in which the services are characterised in the formal con tracts. It may prefer to focus primarily on the nature of the ser - vices rendered by the individual and their integration into the business carried on by the enterprise that acquires the services to conclude that there is an employment relationship between the individual and that enterprise. 8.7 Since the concept of employment to which Article 15 refers is to be determined according to the domestic law of the State that applies the Convention (subject to the limit described in paragraph 8.11 and unless the context of a particular conven - tion requires otherwise), it follows that a State which considers such services to be employment services will apply Article 15 accordingly. It will, therefore, logically conclude that the enter - prise to which the services are rendered is in an employment relationship with the individual so as to constitute his employer b ) and c for purposes of subparagraph 2 ). That conclusion is consistent with the object and purpose of paragraph 2 of Article 15 since, in that case, the employment services may be said to be rendered to a resident of the State where the services are performed. 8.8 As mentioned in paragraph 8.2, even where the domes - tic law of the State that applies the Convention does not offer the possibility of questioning a formal contractual relationship and therefore does not allow the State to consider that services rendered to a local enterprise by an individual who is formally employed by a non-resident are rendered in an employment relationship (contract of service) with that local enterprise, it is possible for that State to deny the application of the exception of paragraph 2 in abusive cases. 8.9 The various approaches that are available to States that want to deal with such abusive cases are discussed in the 390

413 Article 15 Commentary section “Improper use of the Convention” in the Commentary on Article 1. As explained in paragraph 9.4 of that Commentary, it is agreed that States do not have to grant the benefits of a tax convention where arrangements that constitute an abuse of the Convention have been entered into. As noted in paragraphs 9.5 of that Commentary, however, it should not be lightly assumed that this is the case (see also paragraph 22.2 of that Commentar y). 8.10 The approach described in the previous paragraphs therefore allows the State in which the activities are exercised to reject the application of paragraph 2 in abusive cases and in - cases where, under that State’s domestic law concept of employ ment, services rendered to a local enterprise by an individual who is formally employed by a non-resident are rendered in an employment relationship (contract of service) with that local enterprise. This approach ensures that relief of double taxation will be provided in the State of residence of the individual even if that State does not, under its own domestic law, consider that there is an employment relationship between the individual and the enterprise to which the services are provided. Indeed, as long as the State of residence acknowledges that the concept of employment in the domestic tax law of the State of source or the existence of arrangements that constitute an abuse of the Convention allows that State to tax the employment income of an individual in accordance with the Convention, it must grant relief for double taxation pursuant to the obligations incorpo - rated in Articles 23 A and 23 B (see paragraphs 32.1 to 32.7 of the Commentary on these articles). The mutual agreement pro - cedure provided by paragraph 1 of Article 25 will be available to address cases where the State of residence does not agree that the other State has correctly applied the approach described above and, therefore, does not consider that the other State has taxed the relevant income in accordance with the Convention. 8.11 The conclusion that, under domestic law, a formal con - tractual relationship should be disregarded must, however, be arrived at on the basis of objective criteria. For instance, a State could not argue that services are deemed, under its domestic law, to constitute employment services where, under the relevant facts and circumstances, it clearly appears that these services 391

414 Article 15 Commentary are rendered under a contract for the provision of services con - cluded between two separate enterprises. The relief provided under paragraph 2 of Article 15 would be rendered meaningless - if States were allowed to deem services to constitute employ ment services in cases where there is clearly no employment relationship or to deny the quality of employer to an enterprise carried on by a non-resident where it is clear that that enterprise provides services, through its own personnel, to an enterprise carried on by a resident. Conversely, where services rendered by an individual may properly be regarded by a State as rendered in an employment relationship rather than as under a contract for services concluded between two enterprises, that State should logically also consider that the individual is not carrying on the business of the enterprise that constitutes that individual’s formal employer; this could be relevant, for example, for pur - poses of determining whether that enterprise has a permanent establishment at the place where the individual performs his activities. 8.12 It will not always be clear, however, whether services ren - dered by an individual may properly be regarded by a State as rendered in an employment relationship rather than as under a contract for services concluded between two enterprises. Any disagreement between States as to whether this is the case should be solved having regard to the following principles and examples (using, where appropriate, the mutual agreement procedu re). 8.13 The nature of the services rendered by the individual will be an important factor since it is logical to assume that an employee provides services which are an integral part of the business activities carried on by his employer. It will therefore be important to determine whether the services rendered by the individual constitute an integral part of the business of the enterprise to which these services are provided. For that purpose, a key consideration will be which enterprise bears the responsibility or risk for the results produced by the indi - vidual’s work. Clearly, however, this analysis will only be rel - evant if the services of an individual are rendered directly to an enterprise. Where, for example, an individual provides ser - vices to a contract manufacturer or to an enterprise to which 392

415 Article 15 Commentary business is outsourced, the services of that individual are not - rendered to enterprises that will obtain the products or ser vices in question. - 8.14 Where a comparison of the nature of the services ren dered by the individual with the business activities carried on by his formal employer and by the enterprise to which the ser - vices are provided points to an employment relationship that - is different from the formal contractual relationship, the fol lowing additional factors may be relevant to determine whether this is really the case: who has the authority to instruct the individual regard - — ing the manner in which the work has to be performed; — who controls and has responsibility for the place at which the work is performed; the remuneration of the individual is directly charged by — the formal employer to the enterprise to which the ser - vices are provided (see paragraph 8.15 below); — who puts the tools and materials necessary for the work at the individual’s disposal; who determines the number and qualifications of the — individuals performing the work; — - who has the right to select the individual who will per form the work and to terminate the contractual arrange - ments entered into with that individual for that purpose; — who has the right to impose disciplinary sanctions related to the work of that individual; — who determines the holidays and work schedule of that individual. 8.15 Where an individual who is formally an employee of one enterprise provides services to another enterprise, the financial arrangements made between the two enterprises will clearly be relevant, although not necessarily conclusive, for the purposes of determining whether the remuneration of the individual is directly charged by the formal employer to the enterprise to which the services are provided. For instance, if the fees charged by the enterprise that formally employs the individual represent the remuneration, employment benefits and other employment 393

416 Article 15 Commentary costs of that individual for the services that he provided to the other enterprise, with no profit element or with a profit element that is computed as a percentage of that remuneration, benefits and other employment costs, this would be indicative that the remuneration of the individual is directly charged by the formal employer to the enterprise to which the services are provided. That should not be considered to be the case, however, if the fee charged for the services bears no relationship to the remunera - tion of the individual or if that remuneration is only one of many factors taken into account in the fee charged for what is really a contract for services ( where a consulting firm charges a e.g. client on the basis of an hourly fee for the time spent by one of its employee to perform a particular contract and that fee takes account of the various costs of the enterprise), provided that this is in conformity with the arm’s length principle if the two enter - prises are associated. It is important to note, however, that the question of whether the remuneration of the individual is directly charged by the formal employer to the enterprise to which the services are provided is only one of the subsidiary factors that are relevant in determining whether services rendered by that individual may properly be regarded by a State as rendered in an employment relationship rather than as under a contract for services concluded between two enterprises. 8.16 Example 1: Aco, a company resident of State A, concludes - a contract with Bco, a company resident of State B, for the pro vision of training services. Aco is specialised in training people in the use of various computer software and Bco wishes to train its personnel to use recently acquired software. X, an employee of Aco who is a resident of State A, is sent to Bco’s offices in State B to provide training courses as part of the contract. In that case, State B could not argue that X is in an employ - 8.17 ment relationship with Bco or that Aco is not the employer of X for purposes of the convention between States A and B. X is formally an employee of Aco whose own services, when viewed in light of the factors in paragraphs 8.13 and 8.14, form an integral part of the business activities of Aco. The services that he renders to Bco are rendered on behalf of Aco under the contract concluded between the two enterprises. Thus, provided that X is not present in State B for more than 183 days during any relevant twelve month period 394

417 Article 15 Commentary and that Aco does not have in State B a permanent establishment - which bears the cost of X’s remuneration, the exception of para graph 2 of Article 15 will apply to X’s remuneration. 8.18 Example 2: Cco, a company resident of State C, is the parent company of a group of companies that includes Dco, a company resident of State D. Cco has developed a new world - wide marketing strategy for the products of the group. In order to ensure that the strategy is well understood and followed by Dco, which sells the group’s products, Cco sends X, one of its - employees who has worked on the development of the strat egy, to work in Dco’s headquarters for four months in order to advise Dco with respect to its marketing and to ensure that Dco’s communications department understands and complies with the worldwide marketing strategy. 8.19 In that case, Cco’s business includes the management of the worldwide marketing activities of the group and X’s own services are an integral part of that business activity. While it could be argued that an employee could have been easily hired by Dco to perform the function of advising the company with respect to its marketing, it is clear that such function is frequently performed by a consultant, especially where spe - cialised knowledge is required for a relatively short period of time. Also, the function of monitoring the compliance with the group’s worldwide marketing strategy belongs to the business of Cco rather than to that of Dco. The exception of paragraph 2 of Article 15 should therefore apply provided that the other conditions for that exception are satisfied. 8.20 Example 3: A multinational owns and operates hotels worldwide through a number of subsidiaries. Eco, one of these subsidiaries, is a resident of State E where it owns and operates a hotel. X is an employee of Eco who works in this hotel. Fco, another subsidiary of the group, owns and operates a hotel in State F where there is a shortage of employees with foreign lan - guage skills. For that reason, X is sent to work for five months at the reception desk of Fco’s hotel. Fco pays the travel expenses of X, who remains formally employed and paid by Eco, and pays Eco a management fee based on X’s remuneration, social contri - butions and other employment benefits for the relevant period. 395

418 Article 15 Commentary 8.21 In that case, working at the reception desk of the hotel in State F, when examined in light of the factors in paragraphs 8.13 and 8.14, may be viewed as forming an integral part of Fco’s business of operating that hotel rather than of Eco’s business. Under the approach described above, if, under the domestic law of State F, the services of X are considered to have been ren - dered to Fco in an employment relationship, State F could then logically consider that Fco is the employer of X and the excep - tion of paragraph 2 of Article 15 would not apply. 8.22 Example 4: Gco is a company resident of State G. It carries on the business of filling temporary business needs for highly specialised personnel. Hco is a company resident of State H which provides engineering services on building sites. In order to complete one of its contracts in State H, Hco needs an engi - neer for a period of five months. It contacts Gco for that purpose. Gco recruits X, an engineer resident of State X, and hires him under a five month employment contract. Under a separate con - tract between Gco and Hco, Gco agrees to provide the services of X to Hco during that period. Under these contracts, Gco will pay X’s remuneration, social contributions, travel expenses and other employment benefits and charges. 8.23 In that case, X provides engineering services while Gco is in the business of filling short-term business needs. By their nature the services rendered by X are not an integral part of the business activities of his formal employer. These services are, however, an integral part of the business activities of Hco, an engineering firm. In light of the factors in paragraphs 8.13 and 8.14, State H could therefore consider that, under the approach described above, the exception of paragraph 2 of Article 15 - would not apply with respect to the remuneration for the ser vices of the engineer that will be rendered in that State. 8.24 Example 5: Ico is a company resident of State I special - ised in providing engineering services. Ico employs a number of engineers on a full time basis. Jco, a smaller engineering firm resident of State J, needs the temporary services of an engineer to complete a contract on a construction site in State J. Ico agrees with Jco that one of Ico’s engineers, who is a resident of State I momentarily not assigned to any contract concluded by 396

419 Article 15 Commentary Ico, will work for four months on Jco’s contract under the direct supervision and control of one of Jco’s senior engineers. Jco will pay Ico an amount equal to the remuneration, social con - tributions, travel expenses and other employment benefits of that engineer for the relevant period, together with a 5 per cent commission. Jco also agrees to indemnify Ico for any eventual claims related to the engineer’s work during that period of time. 8.25 In that case, even if Ico is in the business of providing engineering services, it is clear that the work performed by the engineer on the construction site in State J is performed on behalf of Jco rather than Ico. The direct supervision and control exercised by Jco over the work of the engineer, the fact that Jco takes over the responsibility for that work and that it bears the cost of the remuneration of the engineer for the relevant period are factors that could support the conclusion that the engineer is in an employment relationship with Jco. Under the approach described above, State J could therefore consider that the excep - tion of paragraph 2 of Article 15 would not apply with respect to the remuneration for the services of the engineer that will be rendered in that State. 8.26 Example 6: Kco, a company resident of State K, and Lco, a company resident of State L, are part of the same multinational group of companies. A large part of the activities of that group are structured along function lines, which requires employees of different companies of the group to work together under the supervision of managers who are located in different States and employed by other companies of the group. X is a resident of State K employed by Kco; she is a senior manager in charge of supervising human resources functions within the multina - tional group. Since X is employed by Kco, Kco acts as a cost centre for the human resource costs of the group; periodically, these costs are charged out to each of the companies of the group on the basis of a formula that takes account of various factors such as the number of employees of each company. X is required to travel frequently to other States where other compa - nies of the group have their offices. During the last year, X spent three months in State L in order to deal with human resources issues at Lco. 397

420 Article 15 Commentary 8.27 - In that case, the work performed by X is part of the activ - ities that Kco performs for its multinational group. These activ ities, like other activities such as corporate communication, strategy, finance and tax, treasury, information management and legal support, are often centralised within a large group of companies. The work that X performs is thus an integral part of the business of Kco. The exception of paragraph 2 of Article 15 should therefore apply to the remuneration derived by X for her work in State L provided that the other conditions for that exception are satisfied. 8.28 Where, in accordance with the above principles and - examples, a State properly considers that the services ren dered on its territory by an individual have been rendered in an employment relationship rather than under a contract for services concluded between two enterprises, there will be a risk that the enterprises would be required to withhold tax at source in two jurisdictions on the remuneration of that individual even though double taxation should ultimately be avoided (see paragraph 8.10 above). This compliance difficulty may be partly reduced by tax administrations making sure that their domes - tic rules and practices applicable to employment are clear and well understood by employers and are easily accessible. Also, the problem can be alleviated if the State of residence allows enterprises to quickly adjust the amount of tax to be withheld to take account of any relief for double taxation that will likely be available to the employee. 2. Paragraph 3 of Article 15 repro duces paragraph 3 of Article 15 of the OECD Model Convention as was modified in 2017. The relevant part of the Commentary on the 2017 OECD Model Convention reads as follows: 9. Paragraph 3 applies to the remuneration of crews of ships or aircraft operated in international traffic and provides that such remuneration shall be taxable only in the State of residence of the employee. The principle of exclusive taxation in the State of residence of the employee was incorporated in the paragraph through a change made in 2017. The purpose of that amend - ment was to provide a clearer and administratively simpler rule concerning the taxation of the remuneration of these crews. 398

421 Article 15 Commentary 9.1 At the same time, the definition of international traffic was modified to ensure that it also applied to a transport by a ship or aircraft operated by an enterprise of a third State. As explained in paragraph 6.1 [paragraph 8.1 of the UN Commentary] of the Commentary on Article 3, this last change allows the application of paragraph 3 of Article 15 to a resident of a Contracting State who derives remuneration from employment exercised aboard a ship or aircraft operated by an enterprise of a third State. Where, however, the employment is exercised by a resi 9.2 - dent of a Contracting State aboard a ship or aircraft operated solely within the other State, it would clearly be inappropriate to grant an exclusive right to tax to the State of residence of the employee. The phrase “other than aboard a ship or aircraft operated solely within the other Contracting State” ensures that the paragraph does not apply to such an employee, which means that the taxation of the remuneration of that employee is covered by the provisions of paragraphs 1 and 2 of the Article. 9.3 As indicated in paragraph 9 above, paragraph 3 applies to the crews of ships or aircraft. This is made clear by the reference to employment exercised “as a member of the regular comple - ment of a ship or aircraft”. These words are broad enough to cover any employment activities performed in the course of the usual operation of the ship or aircraft, including, for example, the activities of employees of restaurants aboard a cruise ship or the activities of a flight attendant who would only work on a single flight before leaving his employment; they would not cover, however, employment activities that may be performed aboard a ship or aircraft but are unrelated to its operation (e.g. an employee of an insurance company that sells home and auto insurance to the passengers of a cruise ship). As explained in paragraph 15 of the Commentary on 9.4 Article 8, States wishing to apply the same treatment to trans - port on rivers, canals and lakes as to shipping and air transport in international traffic may extend the scope of Article 8 to cover profits from the operation of boats engaged in inland waterways transport. These States could then wish to apply paragraph 3 of Article 15 to the remuneration of employees working on these boats. In the case of the remuneration derived by an employee 399

422 Article 15 Commentary working aboard a boat engaged in inland waterways transport, however, paragraph 3 should only apply to the extent that the boat is operated by an enterprise of the State of residence of the employee. It would indeed be inappropriate for one Contracting State to be required to exempt remuneration derived by an employee who is a resident of the other State but is employed by an enterprise of the first-mentioned State (or of a third State with which the first-mentioned State did not agree to exempt profits derived from the operation of boats engaged in inland - waterways transport) where that remuneration relates to activ ities exercised solely in that first-mentioned State. Contracting States wishing to address this issue could do so by including in their bilateral treaty a separate provision dealing with crews of boats engaged in inland waterways transport that would be drafted as follows: Notwithstanding the preceding provisions of this Article and of Article 1, remuneration derived by an individual, whether a resident of a Contracting State or not, in respect of an employment, as a member of the regular complement of a boat, that is exercised aboard a boat engaged in inland waterways transport in a Contracting State and operated by an enterprise of the other State shall be taxable only in that other State. However, such remuneration may also be taxed in the first-mentioned State if it is derived by a resident of that State. 9.5 As indicated in paragraph 2 [paragraph 10 of the UN Commentary] of the Commentary on Article 8, some States may prefer to attribute the exclusive right to tax profits from shipping and air transport to the State in which the place of effective management of the enterprise is situated rather than the State of residence. Where the Contracting States follow that approach, a similar change should be made to the alternative provisions included in paragraphs 9.4 above and 9.6 below if these provisions are used. 9.6 Some States prefer to allow taxation of the remuneration of an employee who works aboard a ship or aircraft operated in international traffic both by the State of the enterprise that operates such ship or aircraft and the State of residence of the 400

423 Article 15 Commentary employee. States wishing to do so may draft paragraph 3 along the following lines: 3. Notwithstanding the preceding provisions of this Article and Article 1, remuneration derived by an individual, whether a resident of a Contracting State or not, in respect of an employment, as a member of the regular complement of a ship or aircraft, that is exercised aboard a ship or air - craft operated in international traffic by an enterprise of a Contracting State shall be taxable only in that Contracting State. Where, however, such remuneration is derived by a resident of the other Contracting State, it may also be taxed in that other State. 9.7 Some States wishing to apply that approach may also wish to restrict the application of paragraph 3 to employees who are residents of one of the Contracting States, which could be done by using the following wording: 3. Notwithstanding the preceding provisions of this Article, remuneration derived by a resident of a Contracting State in respect of an employment, as a member of the regular complement of a ship or aircraft, that is exercised aboard a ship or aircraft operated in international traffic shall be tax - able only in that State. Where, however, the ship or aircraft is operated by an enterprise of the other Contracting State, such remuneration may also be taxed in the other State. 9.8 According to the alternative provision in paragraph 9.6 above, the Contracting State of the enterprise has the primary right to tax the remuneration of the employee. Where the employee is a resident of the other Contracting State, the remu - neration may also be taxed in that other State, subject to the obligation of that State to provide relief of double taxation under the provisions of Article 23 A or 23 B. 9.9 Since that alternative provision allows taxation in the State of the enterprise that operates the ship or aircraft, it may help to address the situation of employees who work exten - sively aboard ships or aircraft operated in international traffic and who may find it advantageous to establish their residence in States that levy no or little tax on the employment income derived from such work performed outside their territory. The 401

424 Article 15 Commentary provision assumes, however, that the Contracting States have - the possibility, under their domestic law, to tax the remunera tion of employees working aboard ships or aircraft operated in international traffic solely because the enterprises that operate these ships or aircraft are enterprises of these States. Where this is not the case, the use of that provision in combination with the exemption method for the elimination of double taxation would create a risk of non-taxation. Assume, for instance, that the above provision has been included in a treaty between States R and S, that State R follows the exemption method and that an employee who is a resident of State R works on flights between - State R and third States operated by an airline that is an enter prise of State S. In that case, if the domestic law of State S does not allow State S to tax the remuneration of employees of the airline who are not residents of, and do not work in, State S, State S will be unable to exercise the taxing right that has been allocated to it but State R will be required to exempt such remu - neration because, under the provisions of the Convention, State S has the right to tax that remuneration. 9.10 As explained in paragraph 3.1 [paragraph 10.1 of the UN Commentary] of the Commentary on Article 8, it may be provided that the reference to the “place of effective manage - ment” in the alternative provision in paragraph 2 [10] of that Commentary is applicable if the place of effective management of a shipping enterprise is aboard a ship. According to the domes - tic laws of some member countries, tax is levied on remunera - tion received by non-resident members of the crew in respect of employment aboard ships only if the ship has the nationality of such a State. For that reason conventions concluded between these States provide that the right to tax such remuneration is given to the State of the nationality of the ship. On the other hand many States cannot make use of such a taxation right and the provision could in such cases lead to a non-taxation situa - tion similar to the one described in the preceding paragraph. However, States having that taxation principle in their domestic laws may agree bilaterally to confer the right to tax remunera - tion in respect of employment aboard ships on the State of the nationality of the ship. 402

425 Article 15 Commentary 10. - It should be noted that no special rules regarding the tax ation of income of frontier workers or of employees working on trucks and trains travelling between States are included as it - would be more suitable for the problems created by local condi tions to be solved directly between the States concerned. 11. No special provision has been made regarding remuner - ation derived by visiting professors or students employed with view to their acquiring practical experience. Many conven - a tions contain rules of some kind or other concerning such cases, the main purpose of which is to facilitate cultural rela - tions by providing for a limited tax exemption. Sometimes, tax exemption is already provided under domestic taxation laws. The absence of specific rules should not be interpreted as con - stituting an obstacle to the inclusion of such rules in bilateral conventions whenever this is felt desirable. The treatment of employee stock-options 12. The different country rules for taxing employee stock-options create particular problems which are discussed below. While many of these problems arise with respect to other forms of employee remuneration, particularly those that are based on the value of shares of the employer or a related com - pany, they are particularly acute in the case of stock-options. This is largely due to the fact that stock-options are often taxed e.g. when the option is exercised or the shares sold) at a time ( that is different from the time when the employment services that are remunerated through these options are rendered. 12.1 As noted in paragraph 2.2, the Article allows the State of source to tax the part of the stock-option benefit that consti - tutes remuneration derived from employment exercised in that State even if the tax is levied at a later time when the employee is no longer employed in that State. 12.2 While the Article applies to the employment benefit derived from a stock-option granted to an employee regardless of when that benefit is taxed, there is a need to distinguish that employment benefit from the capital gain that may be derived from the alienation of shares acquired upon the exercise of the 403

426 Article 15 Commentary option. This Article, and not Article 13, will apply to any ben - efit derived from the option itself until it has been exercised, sold or otherwise alienated ( - e.g. upon cancellation or acquisi tion by the employer or issuer). Once the option is exercised or alienated, however, the employment benefit has been real - ised and any subsequent gain on the acquired shares ( i.e. the value of the shares that accrues after exercise) will be derived by the employee in his capacity of investor-shareholder and will be covered by Article 13. Indeed, it is at the time of exercise that the option, which is what the employee obtained from his employment, disappears and the recipient obtains the status of shareholder (and usually invests money in order to do so). Where, however, the option that has been exercised entitles the employee to acquire shares that will not irrevocably vest until the end of a period of required employment, it will be appropri - ate to apply this Article to the increase in value, if any, until the end of the required period of employment that is subsequent to the exercise of the option. 12.3 The fact that the Article does not apply to a benefit derived after the exercise or alienation of the option does not imply in any way that taxation of the employment income under domes - tic law must occur at the time of that exercise or alienation. As already noted, the Article does not impose any restriction as to when the relevant income may be taxed by the State of source. Thus, the State of source could tax the relevant income at the time the option is granted, at the time the option is exercised (or alienated), at the time the share is sold or at any other time. The State of source, however, may only tax the benefits attrib - utable to the option itself and not what is attributable to the subsequent holding of shares acquired upon the exercise of that option (except in the circumstances described in the last sen - tence of the preceding paragraph). 12.4 Since paragraph 1 must be interpreted to apply to any benefit derived from the option until it has been exercised, sold or otherwise alienated, it does not matter how such benefit, or any part thereof, is characterised for domestic tax purposes. As a result, whilst the Article will be interpreted to allow the State of source to tax the benefits accruing up to the time when the 404

427 Article 15 Commentary option has been exercised, sold or otherwise alienated, it will e.g. as be left to that State to decide how to tax such benefits, either employment income or capital gain. If the State of source the option decides, for example, to impose a capital gains tax on when the employee ceases to be a resident of that country, that tax will be allowed under the Article. The same will be true in the State of residence. For example, while that State will have sole taxation right on the increase of value of the share obtained after exercise since this will be considered to fall under Article 13 of the Convention, it may well decide to tax such increase as employment income rather than as a capital gain under its domestic law. 12.5 The benefits resulting from a stock-option granted to an employee will not, as a general rule, fall under either Article 21, which does not apply to income covered by other Articles, or Article 18, which only applies to pension and other similar remuneration, even if the option is exercised after termination of the employment or retirement. 12.6 Paragraph 1 allows the State of source to tax salaries, wages and other similar remuneration derived from employ - ment exercised in that State. The determination of whether and to what extent an employee stock-option is derived from employment exercised in a particular State must be done in each case on the basis of all the relevant facts and circum - stances, including the contractual conditions associated with that option ( e.g. the conditions under which the option granted may be exercised or disposed of). The following general princi - ples should be followed for that purpose. The first principle is that, as a general rule, an employee 12.7 stock-option should not be considered to relate to any services rendered after the period of employment that is required as a condition for the employee to acquire the right to exercise that option. Thus, where a stock-option is granted to an employee on the condition that he provides employment services to the same employer (or an associated enterprise) for a period of three years, the employment benefit derived from that option should generally not be attributed to services performed after that three year period. 405

428 Article 15 Commentary 12.8 In applying the above principle, however, it is important to distinguish between a period of employment that is required to obtain the right to exercise an employee stock-option and a period of time that is merely a delay before such option may be exercised (a blocking period). Thus, for example, an option that is granted to an employee on the condition that he remains employed by the same employer (or an associated enterprise) during a period of three years can be considered to be derived from the services performed during these three years while an option that is granted, without any condition of subsequent employment, to an employee on a given date but which, under its terms and conditions, can only be exercised after a delay of - three years, should not be considered to relate to the employ ment performed during these years as the benefit of such an option would accrue to its recipient even if he were to leave his employment immediately after receiving it and waited the required three years before exercising it. 12.9 It is also important to distinguish between a situation where a period of employment is required as a condition for the acquisition of the right to exercise an option, i.e. the vesting of the option, and a situation where an option that has already vested may be forfeited if it is not exercised before employment is terminated (or within a short period after). In the latter sit - uation, the benefit of the option should not be considered to relate to services rendered after vesting since the employee has already obtained the benefit and could in fact realise it at any time. A condition under which the vested option may be for - feited if employment is terminated is not a condition for the acquisition of the benefit but, rather, one under which the ben - efit already acquired may subsequently be lost. The following examples illustrate this distinction: — Example 1: On 1 January of year 1, a stock-option is granted to an employee. The acquisition of the option is conditional on the employee continuing to be employed by the same employer until 1 January of year 3. The option, once this condition is met, will be exercisable from 1 January of year 3 until 1 January of year 10 (a 406

429 Article 15 Commentary 45 so-called “American” option ). It is further provided, however, that any option not previously exercised will be lost upon cessation of employment. In that example, the right to exercise that option has been acquired on 1 January of year 3 ( the date of vesting) since no further i.e. period of employment is then required for the employee to obtain the right to exercise the option. — Example 2: On 1 January of year 1, a stock-option is granted to an employee. The option is exercisable on 1 January of year 5 (a so-called “European” option). The option has been granted subject to the condition that it can only be exercised on 1 January of year 5 if employ - - ment is not terminated before that date. In that exam ple, the right to exercise that option is not acquired until 1 January of year 5,which is the date of exercise, since employment until that date is required to acquire the right to exercise the option ( i.e. for the option to vest). 12.10 There are cases where that first principle might not apply. - One such case could be where the stock-option is granted with out any condition to an employee at the time he either takes up an employment, is transferred to a new country or is given significant new responsibilities and, in each case, the option clearly relates to the new functions to be performed by the employee during a specific future period. In that case, it may be appropriate to consider that the option relates to these new functions even if the right to exercise the option is acquired before these are performed. There are also cases where an option vested technically but where that option entitles the employee to acquire shares which will not vest until the end of a period of required employment. In such cases, it may be appropriate to consider that the benefit of the option relates to the services rendered in the whole period between the grant of the option and the vesting of the shares. 45 Under an “American” stock-option, the right to acquire a share may be exercised during a certain period (typically a number of years) whilst under a European stock-option, that right may only be exercised at a given on a particular date). moment ( i.e. 407

430 Article 15 Commentary 12.11 The second principle is that an employee stock-option should only be considered to relate to services rendered before the time when it is granted to the extent that such grant is - intended to reward the provision of such services by the recip ient for a specific period. This would be the case, for example, where the remuneration is demonstrably based on the employ - ee’s past performance during a certain period or is based on the employer’s past financial results and is conditional on the - employee having been employed by the employer or an associ ated enterprise during a certain period to which these financial results relate. Also, in some cases, there may be objective evi - dence demonstrating that during a period of past employment, there was a well-founded expectation among participants to an employee stock-option plan that part of their remuneration for that period would be provided through the plan by having stock-options granted at a later date. This evidence might include, for example, the consistent practice of an employer that has granted similar levels of stock-options over a number of years, as long as there was no indication that this practice might be discontinued. Depending on other factors, such evi - dence may be highly relevant for purposes of determining if and to what extent the stock-option relates to such a period of past employment. 12.12 Where a period of employment is required to obtain the - right to exercise an employee’s stock-option but such require ment is not applied in certain circumstances, e.g. where the employment is terminated by the employer or where the employee reaches retirement age, the stock-option benefit should be considered to relate only to the period of services actually performed when these circumstances have in fact occurred. 12.13 Finally, there may be situations in which some factors may suggest that an employee stock-option is rewarding past services but other factors seem to indicate that it relates to future services. In cases of doubt, it should be recognised that employee stock-options are generally provided as an incentive to future performance or as a way to retain valuable employees. Thus, employee stock-options are primarily related to future services. However, all relevant facts and circumstances will 408

431 Article 15 Commentary need to be taken into account before such a determination can be made and there may be cases where it can be shown that a stock-option is related to combined specific periods of previous options are granted on the basis of the and future services ( e.g. employee having achieved specific performance targets for the previous year, but they become exercisable only if the employee remains employed for another three years). 12 .14 Where, based on the preceding principles, a stock-option is considered to be derived from employment exercised in more than one State, it will be necessary to determine which part of the stock-option benefit is derived from employment exercised in each State for purposes of the application of the Article and of Articles 23 A and 23 B. In such a case, the employment ben - efit attributable to the stock-option should be considered to be derived from a particular country in proportion of the number of days during which employment has been exercised in that country to the total number of days during which the employ - ment services from which the stock-option is derived has been exercised. For that purpose, the only days of employment that should be taken into account are those that are relevant for the e.g. those during which services are rendered stock-option plan, to the same employer or to other employers the employment by whom would be taken into account to satisfy a period of employment required to acquire the right to exercise the option. 12.15 It is possible for member countries to depart from the case-by-case application of the above principles (in paragraphs 12.7 to 12.14) by agreeing to a specific approach in a bilateral con - text. For example, two countries that tax predominantly at exer - cise of an option may agree, as a general principle, to attribute the income from an option that relates primarily to future services to the services performed by an employee in the two States between date of grant and date of exercise. Thus, in the case of options that do not become exercisable until the employee has performed services for the employer for a specific period of time, two States could agree to an approach that attributes the income from the option to each State based on the number of days worked in each State by the employee for the employer in the period between date of grant and date of exercise. Another example would be 409

432 Articles 15 and 16 Commentary for two countries that have similar rules for the tax treatment of employee stock-options to adopt provisions that would give to one of the Contracting States exclusive taxation rights on the - employment benefit even if a minor part of the employment ser vices to which the option relates have been rendered in the other State. Of course, member countries should be careful in adopting such approaches because they may result in double taxation or double non-taxation if part of the employment is exercised in a third State that does not apply a similar approach. Although Articles 14, 15, 19 and 23 may generally be adequate 3. to prevent double taxation of visiting teachers, some countries may wish to include a visiting teachers article in their treaties. Reference is made to paragraphs 10 to 12 of the Commentary on Article 20 for a comprehensive treatment of this subject. Article 16 DIRECTORS’ FEES AND REMUNERATION OF TOP-LEVEL MANAGERIAL OFFICIALS 1. Article 16, paragraph 1, of the United Nations Model Convention reproduces Article 16 of the OECD Model Convention. 2. Since Article 16, paragraph 1, of the United Nations Model Convention reproduces the whole of Article 16 of the OECD Model - Convention, the Commentary on the latter Article, which reads as fol lows, is relevant: 1. This Article relates to remuneration received by a resident of a Contracting State, whether an individual or a legal person, in the capacity of a member of a board of directors of a com - pany which is a resident of the other Contracting State. Since it might sometimes be difficult to ascertain where the services are performed, the provision treats the services as performed in the State of residence of the company. 1.1 Member countries have generally understood the term “ fees and other similar payments” to include benefits in kind received by a person in that person’s capacity as a member of 410

433 Article 16 Commentary the board of directors of a company ( stock-options the use e.g. or automobile, health or life insurance cover of a residence - age and club memberships). 2. A member of the board of directors of a company often also has other functions with the company, e.g. as ordinary employee, adviser, consultant, etc. It is clear that the Article does not apply to remuneration paid to such a person on account of such other functions. [This position does not apply under the United Nations Model Convention to the extent that paragraph 2 of Article 16 applies.] 3. In some countries organs of companies exist which are similar in function to the board of directors. Contracting States are free to include in bilateral conventions such organs of com - panies under a provision corresponding to Article 16. 3.1 Many of the issues discussed under paragraphs 12 to 12.15 of the Commentary on Article 15 in relation to stock-options granted to employees will also arise in the case of stock-options granted to members of the board of directors of companies. To the extent that stock-options are granted to a resident of a Contracting State in that person’s capacity as a member of the board of directors of a company which is a resident of the other State, that other State will have the right to tax the part of the stock-option benefit that constitutes director’s fees or a similar payment (see paragraph 1.1 above) even if the tax is levied at a later time when the person is no longer a member of that board. While the Article applies to the benefit derived from a stock-option granted to a member of the board of directors regardless of when that benefit is taxed, there is a need to distinguish that benefit from the capital gain that may be derived from the alienation of shares acquired upon the exercise of the option. This Article, and not Article 13, will apply to any benefit derived from the option itself until it has been exercised, sold or otherwise alienated ( e.g. upon cancellation or acquisition by the company or issuer). Once the option is exercised or alienated, however, the benefit taxable under this Article has been realised and any subsequent gain on the acquired shares ( i.e. the value of the shares that accrues after exercise) will be derived by the member of the board of direc - tors in his capacity of investor-shareholder and will be covered 411

434 Articles 16 and 17 Commentary by Article 13. Indeed, it is at the time of exercise that the option, - which is what the director obtained in his capacity as such, dis appears and the recipient obtains the status of shareholder (and usually invests money in order to do so). 3. Article 16 of the United Nations Model Convention also includes a second paragraph not in the OECD Model Convention, dealing with remuneration received by top-level managerial officials. The former Group of Experts decided that where a top-level man - 4. agerial position of a company resident in a Contracting State is occupied by a resident of the other Contracting State, the remuneration paid to that official should be subject to the same principle as directors’ fees. 5. The term “top-level managerial position” refers to a limited group of positions that involve primary responsibility for the general direction of the affairs of the company, apart from the activities of the directors. The term covers a person acting as both a director and a top-level manager. Article 17 ARTISTES AND SPORTSPERSONS Article 17 of the United Nations Model Convention reproduces 1. Article 17 of the OECD Model Convention. Unlike the term “enter - tainer”, the term “sportspersons” is not followed in paragraph 1 by illustrative examples but is nevertheless likewise to be construed in a broad manner consistent with the spirit and purpose of the Article. 2. The Commentary on Article 17 of the 2010 OECD Model Convention is as follows: 1. Paragraph 1 provides that artistes and sportsmen who are residents of a Contracting State may be taxed in the other Contracting State in which their personal activities as such are performed, whether these are of [an independent or of a depend - ent] nature. This provision is an exception to the rules in Article [14] and to that in paragraph 2 of Article 15, respectively. This provision makes it possible to avoid the practical 2. 412

435 Article 17 Commentary difficulties which often arise in taxing artistes and sportsmen performing abroad. Moreover, too strict provisions might in certain cases impede cultural exchanges. In order to overcome this disadvantage, the States concerned may, by common agree - ment, limit the application of paragraph 1 to [independent] activities. To achieve this it would be sufficient to amend the text of the Article so that an exception is made only to the pro - visions of Article [14]. In such a case, artistes and sportsmen performing in the course of an employment would automati - - cally come within Article 15 and thus be entitled to the exemp tions provided for in paragraph 2 of that Article. 3. Paragraph 1 refers to artistes and sportsmen. It is not possible to give a precise definition of “artiste”, but paragraph 1 includes examples of persons who would be regarded as such. These examples should not be considered as exhaustive. On - the one hand, the term “artiste” clearly includes the stage per former, film actor, actor (including for instance a former sports - man) in a television commercial. The Article may also apply to income received from activities which involve a political, social, religious or charitable nature, if an entertainment character is present. On the other hand, it does not extend to a visiting con - e.g. cam ference speaker or to administrative or support staff ( - eramen for a film, producers, film directors, choreographers, technical staff, road crew for a pop group etc.). In between there is a grey area where it is necessary to review the overall balance of the activities of the person concerned. 4. An individual may both direct a show and act in it, or may direct and produce a television programme or film and take a role in it. In such cases it is necessary to look at what the individual actually does in the State where the performance takes place. If his activities in that State are predominantly of a performing nature, the Article will apply to all the resulting income he derives in that State. If, however, the performing element is a negligible part of what he does in that State, the whole of the income will fall outside the Article. In other cases an apportionment should be necessary. 5. Whilst no precise definition is given of the term “sports - men”, it is not restricted to participants in traditional athletic 413

436 Article 17 Commentary events ( runners, jumpers, swimmers). It also covers, for e.g. example, golfers, jockeys, footballers, cricketers and tennis players, as well as racing drivers. The Article also applies to income from other activities 6. which are usually regarded as of an entertainment character, such as those deriving from billiards and snooker, chess and bridge tournaments. 7. Income received by impresarios, etc. for arranging the appearance of an artiste or sportsman is outside the scope of the Article, but any income they receive on behalf of the artiste or sportsman is of course covered by it. 8. Paragraph 1 applies to income derived directly and indi - rectly by an individual artiste or sportsman. In some cases the income will not be paid directly to the individual or his impre - sario or agent. For instance, a member of an orchestra may be paid a salary rather than receive payment for each separate performance: a Contracting State where a performance takes place is entitled, under paragraph 1, to tax the proportion of the musician’s salary which corresponds to such a performance. e.g. a Similarly, where an artiste or sportsman is employed by one person company, the State where the performance takes place may tax an appropriate proportion of any remuneration paid to the individual. In addition, where its domestic laws “look through” such entities and treat the income as accruing directly to the individual, paragraph 1 enables that State to tax income derived from appearances in its territory and accruing in the entity for the individual’s benefit, even if the income is not actually paid as remuneration to the individual. 9. Besides fees for their actual appearances, artistes and sportsmen often receive income in the form of royalties or of sponsorship or advertising fees. In general, other Articles would apply whenever there was no direct link between the income and a public exhibition by the performer in the country con - cerned. Royalties for intellectual property rights will normally be covered by Article 12 rather than Article 17 (see paragraph 18 of the Commentary on Article 12), but in general advertising and sponsorship fees will fall outside the scope of Article 12. Article 17 will apply to advertising or sponsorship income, 414

437 Article 17 Commentary etc. which is related directly or indirectly to performances or appearances in a given State. Similar income which could not be attributed to such performances or appearances would fall - under the standard rules of Article [14] or Article 15, as appro priate. Payments received in the event of the cancellation of a performance are also outside the scope of Article 17, and fall under Articles 7, [14] or 15, as the case may be. 10. The Article says nothing about how the income in ques - tion is to be computed. It is for a Contracting State’s domestic law to determine the extent of any deductions for expenses. Domestic laws differ in this area, and some provide for taxa - tion at source, at a low rate based on the gross amount paid to artistes and sportsmen. Such rules may also apply to income paid to groups or incorporated teams, troupes, etc. Some States, however, may consider that the taxation of the gross amount may be inappropriate in some circumstances even if the applicable rate is low. These States may want to give the option to the taxpayer to be taxed on a net basis. This could be done through the inclusion of a paragraph drafted along the following lines: Where a resident of a Contracting States derives income referred to in paragraph 1 or 2 and such income is taxable in the other Contracting State on a gross basis, that person may, within [period to be determined by the Contracting States] request the other State in writing that the income be taxable on a net basis in that other State. Such request shall be allowed by that other State. In determining the taxable income of such resident in the other State, there shall be allowed as deduc - tions those expenses deductible under the domestic laws of the other State which are incurred for the purposes of the activities exercised in the other State and which are available to a resident of the other State exercising the same or similar activities under the same or similar conditions. 11. Paragraph 1 of the Article deals with income derived by individual artistes and sportsmen from their personal activi - ties. Paragraph 2 deals with situations where income from their activities accrues to other persons. If the income of an enter - tainer or sportsman accrues to another person, and the State 415

438 Article 17 Commentary of source does not have the statutory right to look through the person receiving the income to tax it as income of the performer, paragraph 2 provides that the portion of the income which cannot be taxed in the hands of the performer may be taxed in the hands of the person receiving the remuneration. If the person receiving the income carries on business activities, tax may be applied by the source country even if the income is not attributable to a permanent establishment there. [If the person receiving the income is an individual, the income may be taxed even in the absence of a fixed base.] But it will not always be so. There are three main situations of this kind: The first is the management company which receives a) , e.g. income for the appearance of - a group of sports men (which is not itself constituted as a legal entity). b) The second is the team, troupe, orchestra, etc. which is constituted as a legal entity. Income for perfor - mances may be paid to the entity. Individual members of the team, orchestra, etc. will be liable to tax under paragraph 1, in the State in which a performance is given, on any remuneration (or income accruing for their benefit) as a counterpart to the performance; however, if the members are paid a fixed periodic remuneration and it would be difficult to allocate a portion of that income to particular performances, - member countries may decide, unilaterally or bilat erally, not to tax it. The profit element accruing from a performance to the legal entity would be liable to tax under paragraph 2. c) The third situation involves certain tax avoidance devices in cases where remuneration for the perfor - mance of an artiste or sportsman is not paid to the artiste or sportsman himself but to another person, e.g. a so-called artiste company, in such a way that the income is taxed in the State where the activity is performed neither as personal service income to the artiste or sportsman nor as profits of the enter - prise, in the absence of a permanent establishment. Some countries “look through” such arrangements 416

439 Article 17 Commentary under their domestic law and deem the income to be derived by the artiste or sportsman; where this is so, paragraph 1 enables them to tax income result - ing from activities in their territory. Other countries cannot do this. Where a performance takes place in such a country, paragraph 2 permits it to impose a tax on the profits diverted from the income of the artiste or sportsman to the enterprise. It may be, however, that the domestic laws of some States do not enable them to apply such a provision. Such States are free to agree to other solutions or to leave paragraph 2 out of their bilateral conventions. 11.1 - The application of paragraph 2 is not restricted to situ ations where both the entertainer or sportsman and the other person to whom the income accrues, a star-company, are e.g. residents of the same Contracting State. The paragraph allows the State in which the activities of an entertainer or sportsman are exercised to tax the income derived from these activities and accruing to another person regardless of other provisions of the Convention that may otherwise be applicable. Thus, not - withstanding the provisions of Article 7, the paragraph allows that State to tax the income derived by a star-company resident of the other Contracting State even where the entertainer or sportsman is not a resident of that other State. Conversely, where the income of an entertainer resident in one of the Contracting e.g. a star-company, who is a resident States accrues to a person, of a third State with which the State of source does not have a tax convention, nothing will prevent the Contracting State from taxing that person in accordance with its domestic laws. 11.2 - As a general rule it should be noted, however, that, regard less of Article 17, the Convention would not prevent the applica - tion of general anti-avoidance rules of the domestic law of the State of source which would allow that State to tax either the entertainer/sportsman or the star-company in abusive cases, as is recognised in paragraph 24 of the Commentary on Article 1. 12. Where, in the cases dealt with in paragraphs 1 and 2, the exemption method for relieving double taxation is used by the State of residence of the person receiving the income, that State 417

440 Article 17 Commentary would be precluded from taxing such income even if the State where the activities were performed could not make use of its right to tax. It is therefore understood that the credit method should be used in such cases. The same result could be achieved by stipulating a subsidiary right to tax for the State of residence of the person receiving the income, if the State where the activ - ities are performed cannot make use of the right conferred on it by paragraphs 1 and 2. Contracting States are free to choose any of these methods in order to ensure that the income does not escape taxation. 13. Article 17 will ordinarily apply when the artiste or sports - man is employed by a Government and derives income from that Government [...]. Certain conventions contain provisions exclud - ing artistes and sportsmen employed in organisations which are subsidised out of public funds from the application of Article 17. 14. Some countries may consider it appropriate to exclude from the scope of the Article events supported from public funds. Such countries are free to include a provision to achieve this but the exemptions should be based on clearly definable and objective criteria to ensure that they are given only where intended. Such a provision might read as follows: The provisions of paragraphs 1 and 2 shall not apply to income derived from activities performed in a Contracting State by artistes or sportsmen if the visit to that State is wholly or mainly supported by public funds of one or both of the Contracting States or political subdivisions or local authorities thereof. In such a case, the income is taxable only in the Contracting State in which the artiste or the sports - man is a resident. 3. When this issue was considered by the former Group of Experts, some members indicated that the examples given in the Commentary on Article 17, paragraph 2, of the OECD Model Convention should not be understood as limiting the field of application of taxation to the incomes mentioned in that Commentary. In fact, the wording of the Commentary would allow taxation of the enterprise in the other Contracting State, with the same limitations as those imposed for artistes or sportspersons resident in a Contracting State and carrying out activities in the other State. 418

441 Articles 17 and 18 Commentary 4. On the other hand, members expressed the view that some countries might wish paragraph 2 to have a narrower scope. Article 18 PENSIONS AND SOCIAL SECURITY PAYMENTS A. General considerations 1. Two alternative versions are given for Article 18 of the United Nations Model Convention, Article 18 A and Article 18 B. 2. Article 18 A, like Article 18 of the OECD Model Convention, provides that the State of residence has an exclusive right to tax pen - sions and other similar remuneration. It departs, however, from the OECD Article by granting to the State of source an exclusive right to tax the payments made within the framework of a public scheme which is part of the social security system of that State or a political subdivision or a local authority thereof. 3. Under Article 18 B the State of source may tax pensions and other similar remuneration and the provisions of Article 23 A or 23 B will determine whether the State of residence shall exempt such income or shall allow, as a deduction from its own tax on such income, the tax paid in the State of source. Article 18 B allows, however, exclu - sive source taxation when the payments are made within the frame - work of a public scheme which is part of the social security system of a State or a political subdivision or a local authority thereof. B. Commentary on the two alternative versions of article 18 Commentary on the paragraphs of Article 18 A Paragraph 1 4. According to this paragraph, pensions, and other similar remu - neration, paid in respect of private employment are taxable only in the State of residence of the recipient. Since this paragraph reproduces the 419

442 Article 18 Commentary text of Article 18 of the OECD Model Convention, the Committee con - siders that the following part of the OECD Commentary is applicable: 1. - According to this Article, pensions paid in respect of pri vate employment are taxable only in the State of residence of the recipient. Various policy and administrative considerations support the principle that the taxing right with respect to this type of pension, and other similar remuneration, should be left to the State of residence. For instance, the State of residence of the recipient of a pension is in a better position than any other State to take into account the recipient’s overall ability to pay tax, which mostly depends on worldwide income and personal circumstances such as family responsibilities. This solution also avoids imposing on the recipient of this type of pension the administrative burden of having to comply with tax obligations in States other than that recipient’s State of residence. Scope of the Article 3. The types of payment that are covered by the Article include not only pensions directly paid to former employees but also to other beneficiaries ( e.g. surviving spouses, companions or children of the employees) and other similar payments, such as annuities, paid in respect of past employment. The Article also applies to pensions in respect of services rendered to a State or a political subdivision or local authority thereof which are not covered by the provisions of paragraph 2 of Article 19. The Article only applies, however, to payments that are in consid - eration of past employment; it would therefore not apply, for example, to an annuity acquired directly by the annuitant from capital that has not been funded from an employment pension scheme. The Article applies regardless of the tax treatment of the scheme under which the relevant payments are made; thus, a payment made under a pension plan that is not eligible for tax relief could nevertheless constitute a “pension or other similar remuneration” (the tax mismatch that could arise in such a sit - uation is discussed below). 4. Various payments may be made to an employee following cessation of employment. Whether or not such payments fall 420

443 Article 18 Commentary under the Article will be determined by the nature of the pay - ments, having regard to the facts and circumstances in which they are made, as explained in the following two paragraphs [...]. While the word “pension”, under the ordinary meaning 5. of the word, covers only periodic payments, the words “other similar remuneration” are broad enough to cover non-periodic payments. For instance, a lump-sum payment in lieu of peri - odic pension payments that is made on or after cessation of employment may fall within the Article. Whether a particular payment is to be considered as other 6. remuneration similar to a pension or as final remuneration for work performed falling under Article 15 is a question of fact. For example, if it is shown that the consideration for the payment is the commutation of the pension or the compensation for a reduced pension then the payment may be characterised as “other similar remuneration” falling under the Article. This would be the case where a person was entitled to elect upon retirement between the payment of a pension or a lump-sum computed either by ref - erence to the total amount of the contributions or to the amount of pension to which that person would otherwise be entitled under the rules in force for the pension scheme. The source of the payment is an important factor; payments made from a pension scheme would normally be covered by the Article. Other factors which could assist in determining whether a payment or series of payments fall under the Article include: whether a payment is made on or after the cessation of the employment giving rise to the payment, whether the recipient continues working, whether the recipient has reached the normal age of retirement with respect to that particular type of employment, the status of other recipients who qualify for the same type of lump-sum payment and whether the recipient is simultaneously eligible for other pension benefits. Reimbursement of pension contributions ( e.g. after temporary employment) does not constitute “other similar remuneration” under Article 18. Where cases of difficulty arise in the taxation of such payments, the Contracting States should solve the matter by recourse to the provisions of Article 25. 7. Since the Article applies only to pensions and other similar remuneration that are paid in consideration for past 421

444 Article 18 Commentary employment, it does not cover other pensions such as those that are paid with respect to previous independent personal services. Some States, however, extend the scope of the Article to cover all types of pensions, including Government pensions; States wishing to do so are free to agree bilaterally to include provi - sions to that effect. Cross-border issues related to pensions 8. The globalisation of the economy and the development of international communications and transportation have consid - erably increased the international mobility of individuals, both for work-related and personal reasons. This has significantly increased the importance of cross-border issues arising from the interaction of the different pension arrangements which exist in various States and which were primarily designed on the basis of purely domestic policy considerations. As these issues often affect large numbers of individuals, it is desirable to address them in tax conventions so as to remove obstacles to the international movement of persons, and employees in particular. Many such issues relate to mismatches resulting from 9. differences in the general tax policy that States adopt with respect to retirement savings. In many States, tax incentives are provided for pension contributions. Such incentives frequently take the form of a tax deferral so that the part of the income of an individual that is contributed to a pension arrangement as well as the income earned in the scheme or any pension rights that accrue to the individual are exempt from tax. Conversely, the pension benefits from these arrangements are taxable upon receipt. Other States, however, treat pension contributions like other forms of savings and neither exempt these contributions nor the return thereon; logically, therefore, they do not tax pen - sion benefits. Between these two approaches exist a variety of systems where contributions, the return thereon, the accrual of pension rights or pension benefits are partially taxed or exempt. 10. Other issues arise from the existence of very differ - ent arrangements to provide retirement benefits. These 422

445 Article 18 Commentary arrangements are often classified under the following three broad categories: — statutory social security schemes; occupational pension schemes; — — individual retirement schemes. The interaction between these three categories of arrangements presents particular difficulties. These difficulties are com - pounded by the fact that each State may have different tax rules for the arrangements falling in each of these categories as well as by the fact that there are considerable differences in the extent to which States rely on each of these categories to ensure retire - e.g. some States provide retirement ment benefits to individuals ( benefits almost exclusively through their social security system while others rely primarily on occupational pension schemes or individual retirement schemes). 11. The issues arising from all these differences need to be - fully considered in the course of bilateral negotiations, in par ticular to avoid double taxation or non-taxation, and, where appropriate, addressed through specific provisions [...]. Many countries have adopted the approach under which, subject 5. to specific conditions, tax on contributions to, and earnings in, pen - sion schemes or on the accrual of pension rights is totally or partially deferred and is recovered when pension benefits are paid. Other coun - tries, however, treat pension contributions, or some kind of them, like other forms of savings and neither exempt those contributions nor the return thereon. Those countries generally do not tax the corresponding pension benefits. Where an individual has been granted tax relief in a country that has adopted the first approach and, before the payment of all or part of the pension benefits, that individual becomes a resident of a country having adopted the second approach, the mismatch in the approaches adopted by the two countries will result in a situation where no tax will ever be payable on the relevant income. In order to avoid such unintended result, countries could include in paragraph 1 an additional sentence along the following lines: However such pensions and other similar remuneration may also be taxed in the other Contracting State if the payment is 423

446 Article 18 Commentary made by or on behalf of a pension fund established in that other State or borne by a permanent establishment situated therein and the payment is not subject to tax in the first-mentioned State under the ordinary rules of its tax law. 6. The Committee considers that the following part of the OECD Com mentary which deals with exempt pensions is also applicable to paragraph 1: [S]ome States do not tax pension payments generally or 22. otherwise exempt particular categories or parts of pension payments. In these cases, the provisions of the Article, which provides for taxation of pensions in the State of residence, may result in taxation by that State of pensions which were designed not to be taxed and the amount of which may well have been determined having regard to that exemption. This may result in undue financial hardship for the recipient of the pension. 23. To avoid the problems resulting from this type of mis - match, some States include in their treaties provisions to pre - serve the exempt treatment of pensions when the recipient is a resident of the other Contracting State. These provisions may be restricted to specific categories of pensions or may address the issue in a more comprehensive way. An example of that latter approach would be a provision drafted along the fol - lowing lines: Notwithstanding any provision of this Convention, any pension or other similar remuneration paid to a resident of a Contracting State in respect of past employment exercised in the other Contracting State shall be exempt from tax in the first-mentioned State if that pension or other remunera - tion would be exempt from tax in the other State if the recip - ient were a resident of that other State. Paragraph 2 7. Under this paragraph the State of source has an exclu - sive right to tax pensions paid and other payments made within the framework of a public scheme which is part of the social security system of that State or a political subdivision or a 424

447 Article 18 Commentary local authority thereof. Countries using the credit method as - the general method for relieving double taxation in their con ventions are thus, as an exception to that method, obliged to exempt from tax such payments to their residents as are dealt with under paragraph 2. The exclusive right of the State of source to tax pensions paid and other payments made under scheme which is part of the social security system is a public predicated on the rationale that the payments involved are nanced out of the tax revenues of the State of wholly or largely fi source. This is the case when there are no contributions by the prospective beneficiaries of the payments or when the contrac - tual savings contributed under the social security scheme have to be supplemented by the tax revenues of the . State of source Such may not always be the case however when the social secu - rity system functions on the basis of the capital ization principle rather than that of the distribution principle. 8. No consensus emerged within the OECD Committee on Fiscal Affairs on the inclusion in the text of Article 18 of the OECD Model of a provision allowing the State of source to tax payments made under its social security system. However, the OECD Commentary proposes an alternative paragraph provid - ing for such right. The Committee considers that the following part of the OECD Commentary is applicable to paragraph 2: 28. Although the above draft provision refers to the social security [system] of each Contracting State, there are limits to what it covers. “Social security” generally refers to a system of mandatory protection that a State puts in place in order to provide its population with a minimum level of income or retirement benefits or to mitigate the financial impact of events such as unemployment, employment-related inju - ries, sickness or death. A common feature of social secu - rity systems is that the level of benefits is determined by the State. Payments that may be covered by the provision include retirement pensions available to the general public under a public pension scheme, old age pension payments as well as unemployment, disability, maternity, survivorship, sickness, social assistance, and family protection payments that are made by the State or by public entities constituted 425

448 Article 18 Commentary to administer the funds to be distributed. As there may be substantial differences in the social security systems of the Contracting States, it is important for the States that intend - to use the draft provision to verify, during the course of bilat eral negotiations, that they have a common understanding of what will be covered by the provision. 9. Some countries using the credit method as the general method for the elimination of double taxation of income derived by their res - idents may consider that the State of source should not have an exclu - sive right to tax social security payments. Those countries should then substitute the words “may be taxed” for the words “shall be taxable only” in paragraph 2 of their treaties. 10. The countries that wish to deal with the consequences of the privatisation of their social security system may propose to amend the provisions of paragraph 2 along the following lines in order to cover their privatised system: Notwithstanding the provisions of paragraph 1, pensions paid and other payments made under a public scheme or a manda - tory private scheme which is part of the social security system of a Contracting State or a political subdivision or a local author - ity thereof shall be taxable only in that State. Commentary on the paragraphs of Article 18 B 11. Several countries consider that pensions paid in consideration of past employment should not be taxed exclusively in the benefi - ciary’s State of residence. Various policy considerations support this rule. Since pensions are in substance a form of deferred compensation for services performed in the State of source, they should be taxed at source as normal employment income would be. When tax relief is granted for pension contributions, the tax on part of the employment income is deferred until retirement and the tax so deferred should be recovered even if the individual has ceased to be a resident before all or part of the pension benefits is paid. Pension flows between some developed and developing countries may not be reciprocal and in some cases represent a relatively substantial net outflow for the devel - oping country. 426

449 Article 18 Commentary 12. If the State of source does not grant any personal allowances - to non-residents, the source taxation of pensions may result in exces sive taxation. This issue should be discussed during negotiations. The Contracting States may agree in those cases that the State of source shall grant to a resident of the other State any personal allowances, reliefs and reductions for taxation purposes granted to its own residents in the proportion which the pensions and other similar remunerations bear to world income of the resident of the other State. A sentence drafted along the following lines may be added in paragraph 2: The other State shall grant to a resident of the first-mentioned State any personal allowances, reliefs and reductions for tax - ation purposes which it grants to its own residents. Those allowances, reliefs and reductions shall be granted in the pro - portion which the pensions and other similar remunerations taxable in that State bear to the world income taxable in the first-mentioned State. 13. The State of source might be considered to be the State in which the fund is established, the State where the relevant work has been performed or the State where deductions have been claimed. It is fairly common for employees of transnational corporations to perform ser - - vices consecutively in several different countries. In such case, tax ation in the State where those services were performed or in which - relief was granted would raise uncertainty and administrative diffi culties for both taxpayers and tax authorities because it would create the possibility of different parts of the same pension being taxable in different States of source. It is generally agreed, therefore, that taxation of pension at source should be construed to mean taxation at the place in which the pension payments originate, not the place in which the services were performed or in which tax relief was granted. Paragraph 1 14. This paragraph, although it recognizes the right of the State of residence of the recipient to tax pensions and other similar remuner - ation, leaves open the possibility that the State of source may also be given the right to tax in certain conditions which are defined in para - graph 2. Paragraph 4 of the Commentary on paragraph 1 of Article 18 427

450 Article 18 Commentary A is applicable in order to determine the scope of Article 18 B and to consider the cross-border issues related to pensions. Paragraph 2 As indicated above, the State of source may tax pensions and 15. other similar remuneration paid in consideration of past employment if the payments involved are made by a resident of that State or a per - manent establishment situated therein. Some countries could, however, consider that the State which 16. has given tax relief with regard to contributions to the pension scheme or to the accrual of pension rights should have the right to tax the resultant pension. This could be the case where countries grant also tax relief with respect to contributions to or pension rights within for - eign pension funds. The following provision is an example of such a provision: However such pensions and other similar remuneration may also be taxed in the other Contracting State to the extent that they arise from contributions that have qualified for tax relief in that other State. As already explained in paragraph 13, this approach would raise administrative difficulties, especially in the case of individuals who have worked in more than one country during their career. Such dif - ficulties should be addressed in order to avoid situations, for example, where two countries would claim to have source taxation rights on the same pension. Paragraph 3 17. Since paragraph 3 of Article 18 B is identical to paragraph 2 of Article 18 A, the Commentary on the latter paragraph (see above) is fully applicable to the former. 18. The OECD Model Convention in the Commentary on Article 18 under paragraphs 31 to 69 has dealt with the question of tax treat - ment of contributions to foreign pension schemes, the question of tax obstacles to the portability of pension rights and the question of the 428

451 Article 18 Commentary tax exempt treatment of investment income derived by pension funds established in the other Contracting State. Incorporation of these paragraphs in the Commentary on Article 18 in the United Nations Model Convention would send a strong positive signal to potential inward investors. Allowing recognition of cross-border pension con - tributions and facilitating cross-border transfer of pension rights from a pension scheme to another will also stimulate movement of person - nel to foreign countries. The Committee considers that the following part of the OECD Commentary is therefore relevant to Article 18 A and Article 18 B: The tax treatment of contributions to foreign pension schemes [made by or for employees and individuals providing independent services] A. General comments 31. It is characteristic of multinational enterprises that their staff are expected to be willing to work outside their home country from time to time. The terms of service under which staff are sent to work in other countries are of keen interest and importance to both the employer and the employee. One con - sideration is the pension arrangements that are made for the employee in question. Similarly, individuals who move to other countries to provide independent services are often confronted with cross-border tax issues related to the pension arrange - ments that they have established in their home country. 32. Individuals working abroad will often wish to continue contributing to a pension scheme (including a social security scheme that provides pension benefits) in their home country during their absence abroad. This is both because switching schemes can lead to a loss of rights and benefits, and because many practical difficulties can arise from having pension arrangements in a number of countries. 33. The tax treatment accorded to pension contributions made by or for individuals working outside their home coun - try varies both from country to country and depending on the circumstances of the individual case. Before taking up an overseas assignment or contract, pension contributions made 429

452 Article 18 Commentary by or for these individuals commonly qualify for tax relief in con the home country. When the individual works abroad, the - tributions in some cases continue to qualify for relief. Where the individual, for example, remains resident and fully taxable in the home country, pension contributions made to a pension scheme established in the home country will generally con - quently, contributions tinue to qualify for relief there. But fre paid in the home country by an individual working abroad do not qualify for relief under the domestic laws of either the home country or the host country. Where this is the case it can become expensive, if not prohibitive, to maintain membership of a pen - sion scheme in the home country during a foreign assignment or contract. Paragraph 37 below suggests a provision which Member countries can, if they wish, include in bilateral treaties to provide reliefs for the pension contributions made by or for individuals working outside their home country. 34. However, some member countries may not consider that the solution to the problem lies in a treaty provision, prefer - ring, for example, the pension scheme to be amended to secure deductibility of contributions in the host State. Other countries may be opposed to including the provision below in treaties where domestic legislation allows relief only with respect to contributions paid to residents. In such cases it may be inappro - priate to include the suggested provision in a bilateral treaty. 35. The suggested provision covers contributions made to all forms of pension schemes, including individual retirement schemes as well as social security schemes. Many Member countries have entered into bilateral social security totalisa - tion agreements which may help to partially avoid the problem with respect to contributions to social security schemes; these agreements, however, usually do not deal with the tax treatment of cross-border contributions. In the case of an occupational scheme to which both the employer and the employees contrib - ute, the provision covers both these contributions. Also, the provision is not restricted to the issue of the deductibility of the contributions as it deals with all aspects of the tax treatment of the contributions as regards the individual who derive benefits from a pension scheme. Thus the provision deals with issues 430

453 Article 18 Commentary such as whether or not the employee should be taxed on the employment benefit that an employer’s contribution constitutes and whether or not the investment income derived from the contributions should be taxed in the hands of the individual. It does not, however, deal with the taxation of the pension fund on its income (this issue is dealt with in paragraph 69 below). Contracting States wishing to modify the scope of the provision with respect to any of these issues may do so in their bilateral negotiations. B. Aim of the provision 36. The aim of the provision is to ensure that, as far as possible, individuals are not discouraged from taking up overseas work by the tax treatment of their contributions to a home country pension scheme. The provision seeks, first, to determine the general equivalence of pension plans in the two countries and then to establish limits to the contributions to which the tax relief applies based on the limits in the laws of both countries. C. Suggested provision 37. The following is the suggested text of the provision that could be included in bilateral conventions to deal with the problem identified above: 1. Contributions to a pension scheme established in and recognised for tax purposes in a Contracting State that are made by or on behalf of an individual who renders services in the other Contracting State shall, for the purposes of determining the individual’s tax payable and the profits of an enterprise which may be taxed in that State, be treated in that State in the same way and subject to the same con - ditions and limitations as contributions made to a pension scheme that is recognised for tax purposes in that State, pro - vided that: a) the individual was not a resident of that State, and was participating in the pension scheme, immedi - ately before beginning to provide services in that State, and 431

454 Article 18 Commentary b) the pension scheme is accepted by the competent authority of that State as generally corresponding to a pension scheme recognised as such for tax pur - poses by that State. For the purposes of paragraph 1: 2. a) the term “a pension scheme” means an arrangement in which the individual participates in order to secure retire ment benefits payable in respect of the services referred to in paragraph 1; and b) a pension scheme is recognised for tax purposes in a - State if the contributions to the scheme would qual ify for tax relief in that State. The above provision is restricted to pension schemes estab 38. - lished in one of the two Contracting States. As it is not unusual for individuals to work in a number of different countries in succession, some States may wish to extend the scope of the pro - vision to cover situations where an individual moves from one Contracting State to another while continuing to make contri - butions to a pension scheme established in a third State. Such an extension may, however, create administrative difficulties if the - host State cannot have access to information concerning the pen e.g. through the exchange of information provisions sion scheme ( of a tax convention concluded with the third State); it may also create a situation where relief would be given on a non-reciprocal basis because the third State would not grant similar relief to an individual contributing to a pension scheme established in the host State. States which, notwithstanding these difficulties, want to extend the suggested provision to funds established in third States can do so by adopting an alternative version of the sug - gested provision drafted along the following lines: Contributions made by or on behalf of an individual who 1. renders services in a Contracting State to a pension scheme a) recognised for tax purposes in the other Contracting State, b) in which the individual participated immedi - ately before beginning to provide services in the first-mentioned State, 432

455 Article 18 Commentary c) in which the individual participated at a time when that individual was providing services in, or was a resident of, the other State, and d) that is accepted by the competent authority of the first-mentioned State as generally corresponding to a pension scheme recognised as such for tax purposes by that State, shall, for the purposes of e) determining the individual’s tax payable in the first-mentioned State, and determining the profits of an enterprise which may f) be taxed in the first-mentioned State, be treated in that State in the same way and subject to the same conditions and limitations as contributions made to a pension scheme that is recognised for tax purposes in that first-mentioned State. For the purposes of paragraph 1: 2. a) the term “a pension scheme” means an arrangement in which the individual participates in order to secure retirement benefits payable in respect of the services referred to in paragraph 1; and b) a pension scheme is recognised for tax purposes in a State if the contributions to the scheme would qual - ify for tax relief in that State. Characteristics of the suggested provision D. 39. The following paragraphs discuss the main characteris - tics of the suggested provision found in paragraph 37 above. 40. Paragraph 1 of the suggested provision lays down the char - acteristics of both the individual and the contributions in respect of which the provision applies. It also provides the principle that contributions made by or on behalf of an individual rendering services in one Contracting State (the host State) to a defined pen - sion scheme in the other Contracting State (the home State) are to be treated for tax purposes in the host State, in the same way and subject to the same conditions and limitations as contributions schemes of the host State. to domestic pension 433

456 Article 18 Commentary 41. relief with respect to contributions to the home Ta x scheme under the conditions outlined can be country pension given by either the home country, being the country where the pension scheme is situated or by the host country, where the eco - nomic activities giving rise to the contributions are carried out. 42. A solution in which relief would be given by the home country might not be effective, since the individual might have no or little taxable income in that country. Practical considera - tions therefore suggest that it would be preferable for relief to be given by the host country and this is the solution adopted in the suggested provision. 43. individual , par - In looking at the characteristics of the agraph 1 makes it clear that, in order to get the relief from taxation in the host State, the individual must not have been resident in the host State immediately prior to working there. 44. Paragraph 1 does not, however, limit the applica tion of the provision to individuals who become resident in their host State. In many cases individuals working abroad who remain resident in their home State will continue to qualify for relief there, but this will not be so in all cases. The suggested provision therefore applies to non-residents working in the host State as well as to who attain residence status there. In some individuals member countries the domestic legislation may restrict deduct - ibility to contributions borne by residents, and these member countries may wish to restrict the suggested provision to cater for this. Also, States with a special regime for non-residents ( e.g. taxation at a special low rate) may, in bilateral negotiations, wish to agree on a provision restricted to residents. 45. In the case where individuals temporarily cease to be res - ident in the host country in order to join a pension scheme in a country with more relaxed rules, individual States may want a provision which would prevent the possibility of abuse. One form such a provision could take would be a nationality test which could exclude from the suggested provision individuals who are nationals of the host State. 46. As already noted, it is not unusual for individuals to work in a number of different countries in succession; for that reason the suggested provision is not limited to individuals who are 434

457 Article 18 Commentary residents of the home State immediately prior to providing ser - vices in the host State. The provision covers an individual coming to the host State from a third country as it is only limited to indi - viduals who were not resident in the host country before start - ing to work there. However, Article 1 restricts the scope of the Convention to residents of one or both Contracting States. An individual who is neither a resident of the host State nor of the home State where the pension scheme is established is therefore outside the scope of the Convention between the two States. The suggested provision places no limits on the length of 47. time for which an individual can work in a host State. It could be argued that, if an individual works in the host State for long enough, it in effect becomes his home country and the provision should no longer apply. Indeed, some host countries already restrict relief for contributions to foreign pension schemes to cases where the individuals are present on a temporary basis. 48. In addition, the inclusion of a time limit may be helpful in preventing the possibility of abuse outlined in paragraph 45 above. In bilateral negotiations, individual countries may find it appropriate to include a limit on the length of time for which an individual may provide services in the host State after which reliefs granted by the suggested provision would no longer apply. In looking at the characteristics of the contributions, par - 49. agraph 1 provides a number of tests. It makes it clear that the provision applies only to contributions made by or on behalf of an individual to a pension scheme established in and recognised for tax purposes in the home State. The phrase “recognised for tax purposes” is further defined in subparagraph 2 b) of the suggested provision. The phrase “made by or on behalf of ” is intended to apply to contributions that are made directly by the individual as well as to those that are made for that individual’s benefit by an employer or another party ( e.g. a spouse). While paragraph 4 of Article 24 ensures that the employer’s contribu - tions to a pension fund resident of the other Contracting State are deductible under the same conditions as contributions to a resident pension fund, that provision may not be sufficient to ensure the similar treatment of employer’s contributions to domestic and foreign pension funds. This will be the case, for 435

458 Article 18 Commentary example, where the employer’s contributions to the foreign fund are treated as a taxable benefit in the hands of the employee or where the deduction of the employer’s contributions is not dependent on the fund being a resident but, rather, on other conditions ( e.g. registration with tax authorities or the presence of offices) which have the effect of generally excluding foreign pension funds. For these reasons, employer’s contributions are covered by the suggested provision even though paragraph 4 of Article 24 may already ensure a similar relief in some cases. The second test applied to the characteristics of the con 50. - tributions is that the contributions should be made to a home State scheme recognised by the competent authority of the host State as generally corresponding to a scheme recognised as such for tax purposes by the host State. This operates on the premise that only contributions to recognised schemes qualify for relief in member countries. This limitation does not, of course, nec - essarily secure equivalent tax treatment of contributions paid where an individual was working abroad and of contributions while working in the home country. If the host State’s rules for recognising pension schemes were narrower than those of the home State, the individual could find that contributions to his home country pension scheme were less favourably treated when he was working in the host country than when working in the home country. 51. However, it would not be in accordance with the stated aim of securing, as far as possible, equivalent tax treatment of contributions to foreign schemes to give relief for contributions which do not— at least broadly — correspond to domestically rec - ognised schemes. To do so would mean that the amount of relief in the host State would become dependent on legislation in the home State. In addition, it could be hard to defend treating indi - viduals working side by side differently depending on whether their pension scheme was at home or abroad (and if abroad, whether it was one country rather than another). By limiting the suggested provision to schemes which generally correspond to those in the host country such difficulties are avoided. 52. The suggested provision makes it clear that it is for the competent authority of the host State to determine whether the 436

459 Article 18 Commentary scheme in the home State generally corresponds to recognised - schemes in the host State. Individual States may wish, in bilat eral negotiations, to specify expressly to which existing schemes the provision will apply or to establish what interpretation the - competent authority places on the term “generally correspond ing”; for example how widely it is interpreted and what tests are imposed. The contributions covered by the provision are limited 53. in payments to schemes to which the individual was partici - pating before beginning to provide services in the host State. This means that contributions to new pension schemes which an individual joins while in the host State are excluded from the suggested provision. It is, however, recognised that special rules may be 54. needed to cover cases where new pension schemes are substi - tuted for previous ones. For instance, in some member coun - tries the common practice may be that, if a company employer is taken over by another company, the existing company pen - sion scheme for its employees may be ended and a new scheme opened by the new employer. In bilateral negotiations, there - fore, individual States may wish to supplement the provision to cover such substitution schemes; this could be done by adding the following sub-paragraph to paragraph 2 of the suggested provision: a pension scheme that is substituted for, but is sub - c) stantially similar to, a pension scheme accepted by the competent authority of a Contracting State under subparagraph b) of paragraph 1 shall be deemed to be the pension scheme that was so accepted. 55. Paragraph 1 also sets out the relief to be given by the host State if the characteristics of the individual and the con - tributions fall within the terms of the provision. In brief, con - tributions must be treated for tax purposes in a way which corresponds to the manner in which they would be treated if these contributions were to a scheme established in the host State. Thus, the contributions will qualify for the same tax relief ( e.g. be deductible), for both the individual and the employer (where the individual is employed and contributions are made 437

460 Article 18 Commentary by the employer) as if these contributions had been made to a scheme in the host State. Also, the same treatment has to be given as regards the taxation of an employee on the employ - ment benefit derived from an employer’s contribution to either a foreign or a local scheme (see paragraph 58 below). 56. This measure of relief does not, of course, necessarily secure equivalent tax treatment given to contributions paid when an individual is working abroad and contributions paid when he is working in the home country. Similar considerations apply here to those discussed in paragraphs 50 and 51 above. The measure does, however, ensure equivalent treatment of the - contributions of co-workers. The following example is consid ered. The home country allows relief for pension contributions subject to a limit of 18 per cent of income. The host country allows relief subject to a limit of 20 per cent. The suggested pro - vision in paragraph 37 would require the host country to allow relief up to its domestic limit of 20 per cent. Countries wishing to adopt the limit in the home country would need to amend the wording of the provision appropriately. 57. The amount and method of giving the relief would depend upon the domestic tax treatment of pension contri - butions by the host State. This would settle such questions as whether contributions qualify for relief in full, or only in part, and whether relief should be given as a deduction in computing taxable income (and if so, which income, e.g. in the case of an individual, only employment, [independent personal services] or business income or all income) or as a tax credit. 58. For an individual who participates in an occupational pension scheme, being assigned to work abroad may not only mean that this employee’s contributions to a pension scheme in his home country cease to qualify for tax relief. It may also mean that contributions to the pension scheme by the employer are regarded as the employee’s income for tax purposes. In some member countries employees are taxed on employer’s contributions to domestic schemes whilst working in the home country whereas in others these contributions remain exempt. Since it applies to both employees’ and employers’ contribution, the suggested provision ensures that employers’ contributions 438

461 Article 18 Commentary in the context of the employees’ tax liability are accorded the same treatment that such contributions to domestic schemes would receive. a) defines a pension scheme for the pur - 59. Subparagraph 2 poses of paragraph 1. It makes it clear that, for these purposes, a pension scheme is an arrangement in which the individual who makes the payments participates in order to secure retirement benefits. These benefits must be payable in respect of services provided in the host State. All the above conditions must apply to the pension scheme before it can qualify for relief under the suggested provision. Subparagraph 2 60. refers to the participation of the indi - a) - vidual in the pension scheme in order to secure retirement ben efits. This definition is intended to ensure that the proportion of contributions made to secure benefits other than periodic pension payments on retirement, e.g. a lump sum on retirement, will also qualify for relief under the provision. 61. The initial definition of a pension scheme is “an arrange - ment”. This is a widely drawn term, the use of which is in tended to encompass the various forms which pension schemes (whether social security, occupational or individual retirement schemes) may take in different member countries. Subparagraph 2 a) sets out that participation in this 62. scheme has to be by the individual who provides services referred to in paragraph 1 there is no reference to the identity of the recipient of the retirement benefits secured by participation in the scheme. This is to ensure that any proportion of contri - butions intended to generate pension for other beneficiaries ( e.g. surviving spouses, companions or children of employees) may be eligible for relief under the suggested provision. 63. The definition of a pension scheme makes no distinction between pensions paid from State-run occupational pension schemes and similar privately-run schemes. Both are covered by the scope of the provision. Social security schemes are there - fore covered by the provision to the extent that contributions to such schemes can be considered to be with respect to the services provided in the host State by an individual, whether as an employee or in an independent capacity. 439

462 Article 18 Commentary 64. b) further defines the phrase “recognised Subparagraph 2 - for tax purposes”. As the aim of the provision is, so far as pos sible, to ensure that contributions are neither more nor less favourably treated for tax purposes than they would be if the individual were resident in his home State, it is right to limit the scope of the provision to contributions which would have qualified for relief if the individual had remained in the home State. The provision seeks to achieve this aim by limiting its scope to contributions made to a scheme only if contributions to this scheme would qualify for tax relief in that State. This method of attempting to achieve parity of treatment 65. assumes that in all member countries only contributions to rec - ognised pension schemes qualify for relief. The tax treatment of contributions to pension schemes under member countries’ tax systems may differ from this assumption. It is recognised that, in bilateral negotiations, individual countries may wish to further define the qualifying pension schemes in terms that match the respective domestic laws of the treaty partners. They may also wish to define other terms used in the provision, such as “renders services” and “provides services”. Tax obstacles to the portability to pension rights 66. Another issue, which also relates to international labour mobility, is that of the tax consequences that may arise from the transfer of pension rights from a pension scheme estab