Is there a growing unwillingness to respect double tax treaty provisions by revenue agencies and courts around the world? Or is it simply a matter of incorrect interpretation of treaty provisions that has foreign business owners becoming concerned their treaty benefits are at risk? Foreign investors need to be able to rely on double tax treaty protection and the benefits it provides.
One provision that adds to this uncertainty is the anti-discrimination provision. This provision, in brief, is meant to put domestic and foreign companies on the same footing, by prohibiting imposition of tax or denial of a treaty benefit, on a foreign company that is more burdensome than experienced by the domestic company, in the same circumstances. In 2011, in a dispute before the Tax Court of Canada looked at anti-discrimination provision in the Canada – UK Double Tax Treaty where a UK company doing business in Canada through a permanent establishment, incurred capital losses of over $7 million. Another UK company, also doing business in Canada through a permanent establishment, purchased all the outstanding shares and wound up the company. The purchaser deducted the acquired company’s losses over a three year period. The Minister of National Revenue denied the deductions, claiming that neither company was a Canadian company and were therefore not entitled to the deduction. The Canadian court, in making its determination, considered a similar case before the New Zealand Court of Appeal, and held that discrimination based on residence does not amount to discrimination.
In another case, in Russia this time, the issue was the application of thin-capitalization rules to foreign held companies. Ordinarily, thin-cap rules disallow interest under group financing or guaranteed third party borrowings unless proven to be at arm’s length. Unfortunately, thin-cap rules are now being applied regardless of proof that such debt is held at arm’s length and in contravention of the anti-discrimination provision.
In China, the State Tax Administration has been grappling with standardizing interpretation across its many local tax bureaus. It issued guidelines for determining the beneficial ownership status of an foreign entity. This qualification allows some foreign companies to reclaim a portion of the dividend tax they pay. The guidelines have given rise to additional uncertainties in terms of implementation. A safe harbor was created for listed companies, but uncertainty remains. Unlisted companies are not covered by the safe harbor, without treaty benefits foreign companies pay a ten percent dividend tax, bring the total effective tax rate to approximately 32.5%.
Saudi Arabia has recently issued guidance, Circular No. 5068/16/1434, to ease confusion regarding Saudi Arabian entities that file a claim for reduced withholding tax paid to a nonresident company. The guidance outlines the steps necessary to claim the reduced withholding tax. This is gives foreign investors the confidence that comes with certainty in application of the law.
Double tax treaties have the effect of limiting the sovereign authority of the state to tax income at the source. Where the right to tax is reserved under the double tax treaty, but not in the relevant domestic tax code, the treaty should not be applied as an expansion of the domestic tax code to provide for additional taxation on foreign held companies, nor should treaty benefits be stripped. Regrettably, double tax treaties provisions can be disregarded or misinterpreted. The key is to be prepared, understand local interpretation, maintain required formalities and keep an eye on changes in enforcement of local tax codes.