By Doug Connolly & Julie Martin, MNE Tax
The OECD on March 29 proposed changes to its model tax convention commentary that would alter language regarding the arm’s length treatment of interest payments between associated enterprises located in different countries and clarify a state’s obligation to make corresponding adjustments in cases involving related-party loans.
The proposed changes to the OECD Model Tax Convention on Income and on Capital are designed to clarify the application of Article 9 as it relates to domestic laws on interest deductibility, including laws aimed at preventing tax avoidance described in Action 4 of the OECD’s base erosion and profit shifting (BEPS) project. The discussion draft includes several clarifying revisions to the commentary under Article 9 and related articles.
Article 9 of the OECD model treaty deals with the allocation of profits in transactions between associated enterprises. The proposed amendments would replace paragraph 3 of the Article 9 commentary, which addresses thin capitalization rules, with new language regarding the determination of arm’s length interest payments.
The new language specifies that, in assessing whether an interest payment reflects the arm’s length amount, states will generally consider the loan terms and conditions, such as the rate of interest.
The proposed language adds that states may also consider, based on the facts and circumstances, whether a purported loan should be regarded as a contribution to equity or another kind of transaction. In making this determination, the proposed commentary says that countries should take into account the factors described in domestic laws and judicial doctrines or the OECD transfer pricing guidelines.
The proposed changes under Article 9 further clarify that once the profits of the associated enterprises have been allocated in accordance with the arm’s length principle, domestic law determines whether and how those profits are taxed (to the extent consistent with other articles of the treaty). Article 9 does not address the deductibility of expenses or computation of taxable income under domestic law, only allocation of profits.
As such, the new commentary clarifies that any mismatch arising from the subsequent computation of tax under domestic laws would not yield double taxation for purposes of the treaty. States, therefore, have no obligation to make a corresponding adjustment to an affiliated company when mismatches due to domestic law differences occur, the proposed new commentary to Article 9 states.
The OECD proposes an additional clarification regarding the availability of the mutual agreement procedure for transfer pricing cases in proposed new paragraph 12.1 to the commentary on Article 25 as follows:
More generally, the economic double taxation that may result from a primary adjustment consisting of the inclusion of profits of associated enterprises in an amount not justified by reference to the arm’s length standard would result in taxation not in accordance with one of the objects and purposes of the Convention to eliminate double taxation. A denial of access to the mutual agreement procedure in these circumstances, with a view to eliminating the economic double taxation that could follow from such an adjustment, would likely frustrate an objective of the Convention. States should therefore provide access to the mutual agreement procedure in transfer pricing cases.
The OECD said this provision aims to confirm OECD member state practices and reinforce the BEPS Action 14 final report’s conclusions.
Finally, a proposed change to the commentary to Article 24 (nondiscrimination) makes it clear that states can impose additional information requirements with respect to payments made to non-residents, including reversing the burden of proof, as such measures are intended to ensure similar levels of compliance and verification in the case of payments to residents and non-residents.
The OECD issued the proposed changes in a public discussion draft and expects to include them in the next update to the OECD model tax convention. Comments on the discussion draft are due before May 28.
Doug Connolly
Doug Connolly is Editor-in-Chief of MNE Tax. He has more than 10 years of experience covering tax legal developments, previously working with both a Big Four firm and a leading legal publisher. He holds a law degree from American University Washington College of Law.
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Julie Martin
Julie Martin is the founder of MNE Tax. She edits the publication and regularly contributes articles on new developments in cross-border business taxation.
Julie has worked as a tax journalist and editor for more than 13 years. Prior to that, she worked as an in-house tax attorney in New York. She also holds an LLM in taxation from New York University School of Law.
Julie can be reached at [email protected].
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