INTM630260 - Royalty Withholding: Anti Treaty Shopping Rules: Examples

Conduit arrangement

An intellectual property payment royalty is made from the payer in the UK to a payee who is resident of a Country A. The payer and payee are connected parties. The DTA between the UK and Country A assigns exclusive taxing rights over royalties to the state where the beneficial owner was a resident – Country A.

The payee in Country A (even though the beneficial owner) pays the royalty on, perhaps through a licence/ sub-licence agreement, directly or indirectly, to an affiliate in Country B.

The result of the above arrangement is that no tax arises in the UK as a result of the DTA between the UK and Country A. The royalty payment between Country A and Country B is also not liable to tax, perhaps because Country A does not tax such payments. If Country B is a low/ no tax jurisdiction, then the royalty payment suffers minimal taxation. If the UK does not have a DTA with Country B, then taxing rights would have remained in the UK and there would be a duty to withholding income tax in the UK.

If one of the main purposes of the arrangement was to obtain a tax advantage by virtue of a provision of the DTA between the UK and Country A, S917A would apply.

A range of factors will be considered in determining whether one of the main purposes of the arrangement was made under DTA tax avoidance arrangements. Clearly, there would need to be a tax advantage, as defined in the legislation, for this to be considered a tax avoidance arrangement. The substance of the activity in Country A may also be persuasive. For example, whether there sufficient staff in that jurisdiction with the necessary skills and expertise to develop, enhance, maintain, protect and exploit that intellectual property. The factors considered in moving the intellectual property to that jurisdiction are also likely to be important, for example consideration of the infrastructure and local legal system. As noted in INTM630240, objective consideration of the context and circumstances will be required. The conclusions from Action Point 6 of the OECD BEPS project, and the consequent 2017 update to the Commentary to the OECD Model Convention relating to the Principal Purpose Test, will assist in determining whether S917A applies to an arrangement.

Assigning IP to an affiliate

A multinational group assigns intellectual property to an affiliate in Country A.

The UK has a treaty with Country A providing for sole residence state taxation of royalties.

The affiliate has a substantive operation and a large R&D function.

S917A will apply if one of the main purposes of the transfer of the intellectual property was to obtain a tax advantage by virtue of a provision of the DTA. There would be a tax advantage if, for example, the UK’s DTA with the original holder of the IP provided for source state taxation. The treaty with Country A would remove the UK tax liability.

A range of factors will need to be taken into account in determining whether the transfer is part of DTA tax avoidance arrangements where intellectual property is assigned. These might include whether there has been a separation of ownership from the functions needed to properly manage the asset and any cost synergies as a result of using a centralisation model (but not those based on the original centralisation being tax-driven).

Third state permanent establishment

Royalty payments are made from the UK to Country A. The UK-Country A DTA provides for sole residence state taxation.

The non-UK resident in Country A in turn assigns the royalties to a permanent establishment in Country B.

The domestic provisions in Country A exempt branch income from tax in Country A.

Country B is a low/ no tax jurisdiction and so the royalty income is not taxed.

There is no DTA between the UK and Country B. If the royalty had been paid from the UK-Country B direct the UK would have taxing rights.

S917A will apply if the main, or one of the main, purposes of holding intellectual property in Country A was to take advantage of the DTA between the UK and Country A. Such an example is considered in the Action Point 6 Report from the OECD BEPS project, as incorporated into the Commentary to the OECD Model Convention following the 2017 update.

No tax advantage

A multinational group develops and holds intellectual property in Country A. The UK DTA with Country A provides for the taxation of royalties only in the residence state.

The group decides to consolidate its intellectual property in a regional hub and chooses Country B, whose DTA with the UK also provides for taxation only in the residence state, in preference to Country C, whose treaty with the UK allows a source state taxing right.

Even though one of the reasons for transferring the IP to Country B rather than Country C might have been to obtain the benefits of the DTA between Country B and the UK, S917A would not apply to deny those treaty benefits as there was no tax advantage as a result of the transfer of intellectual property from Country A.

Establishing a subsidiary

A multinational group wants to establish a research and development centre through a subsidiary in Europe.

This subsidiary will develop intellectual property in its country of residence through staff engaged for that purpose which it is then expected to licence either to other group companies or third parties.

In deciding to establish its subsidiary in Country A, the group considers a number of factors, including the availability of staff with the appropriate skills, infrastructure, reliable legal system, the local tax regime and the comprehensive DTA network of Country A, including its DTA with the UK.

Merely reviewing the effect of the DTA between Country A and the UK on future payments of royalties does not enable a conclusion to be drawn about the purposes of the group in establishing the Country A subsidiary. The subsidiary will conduct substantive economic activity in Country A using real assets. The economically significant risks will be controlled there. The activity will be conducted through the groups own staff located in Country A. As a result, the granting of a treaty benefit in these circumstances would be likely to be in accordance with the object and purpose of the DTA. S917A would not apply to deny treaty benefits in respect of future royalty payments unless the Country A subsidiary enters into other specific transactions to which section 917A would apply.