A special report by the Policy Advice Division of Inland Revenue
3 February 2003
2003 update to the OECD Model Tax Convention on Income and Capital
The 2003 update to the OECD Model Tax Convention on Income and Capital makes some significant changes in relation to tax avoidance issues. They clarify that provisions of tax treaties generally will not conflict with domestic anti-abuse rules, and address concerns over misuse of the treaty by persons to obtain inappropriate benefits.
The other main changes relate to recent work by the OECD in the area of electronic commerce and on the definition of "permanent establishment". A new Article on the provision of assistance in the collection of taxes has also been introduced.
Clarification of domestic anti-abuse rules
Changes to the commentaries to Articles 1 (Persons Covered) and 10 (Dividends) of the OECD model have been made to remove uncertainty or ambiguity regarding the compatibility of domestic anti-avoidance rules with the provisions of tax treaties. Key clarifications include the following:
- States do not have to grant the benefits of a tax treaty where arrangements have been entered into that constitute an abuse of the provisions of the treaty.
- "Substance-over-form", "economic substance" and general anti-abuse rules forming part of the basic domestic rules for determining which facts give rise to a tax liability are not affected by tax treaties. Thus, as a general rule, there will be no conflict between domestic anti-abuse rules and provisions of a tax treaty.
- Controlled foreign companies legislation which results in a state taxing its residents on income attributable to their participation in certain foreign entities is generally not contrary to the provisions of tax treaties.
Restricting the entitlement to treaty benefits
Further changes have been made to the commentaries to Articles 1 (Persons Covered), 10 (Dividends), 11 (Interest), 12 (Royalties) and 23 (Elimination of Double Taxation) to address concerns over misuse of the treaty by persons to obtain benefits to which they are not directly entitled.
The changes look at the use of the "place of effective management", "permanent establishment" and "beneficial ownership" concepts to resist inappropriate treaty claims, and propose some specific limitation of benefits provisions which states may consider including in their treaties. There is also some discussion on issues arising under the OECD Harmful Tax Practices project.
Clarification of the application of the permanent establishment concept in e-commerce
The 2003 update includes changes to the commentary to Article 5 of the OECD model (Permanent Establishment) that clarify how the permanent establishment concept applies in the context of e-commerce. These important changes were made public by the OECD at the beginning of 2001, and were noted on this web site on 25 January 2001. The changes include the following key points:
- A web site cannot, in itself, constitute a permanent establishment.
- A web site hosting arrangement - where the web site of a business is hosted by an Internet Service Provider (ISP) - typically does not result in a permanent establishment.
- An ISP will not typically constitute a dependent agent of another enterprise so as to constitute a permanent establishment of that enterprise.
- A business that owns or leases a server will not necessarily have a permanent establishment where the server is located.
Treaty characterisation of e-commerce payments
The update incorporates changes to the commentary to Article 12 of the OECD model (Royalties) resulting from a consideration of whether particular e-commerce payments should be characterised as payments for the sale or lease of property, for the provision of a service, or as a royalty.
Note that New Zealand has reserved its position on one finding of the report, that payments for the use of digital products (such as software) cannot be considered as payments "for the use of, or the right to use, industrial, commercial or scientific equipment". This is because Inland Revenue is currently considering issues relating to the tax treatment of software generally, in response to submissions received on a draft ruling it published last year.
Issues arising under Article 5 (Permanent Establishment)
As part of its continuing work in the area of permanent establishments, the OECD has considered a number of practical cases that relate to the application and interpretation of the current provisions of the OECD model that define the concept of permanent establishment. The changes resulting to the commentary to Article 5 of the model address the following issues:
- Problems in applying the "fixed place of business" standard under paragraphs 1 and 2 of Article 5 (geographical link requirement, time requirement, relationship between the enterprise and the fixed place of business, place of management, active v. passive activity, cables and pipelines, sub-contractors).
- Problems in the treatment of building sites and construction or installation projects under paragraph 3 of the Article (supervisory activities and the aggregation of construction contracts, computation of the construction period, scope of the reference to "installation project", multiple installation projects, renovations, coherent geographic whole, place of management of several construction sites).
- Problems in identifying preparatory and auxiliary activities under paragraph 4 of the Article (error correction in paragraph 25, clarification of the "deeming" language, storage facilities).
- Problems related to agency permanent establishments under paragraphs 5 and 6 of the Article (level of presence of the agent in the source country, agent with implied contractual authority, habitually exercising an authority to conclude contracts, commercial representations, meaning of independence, agent with only one principal, agents acting in the ordinary course of their business).
New Article on assistance in the collection of taxes
A new Article has been included in the OECD model which will enable states to agree to provide each other with assistance in the collection of taxes.