extension
Adv LLM thesis
submitted by
Elena Natalia Vizcarra Delgado
in fulfilment of the requirements of the
'Advanced Master of Laws in International Tax Law'
degree at the University of Amsterdam
supervised by
Joanna Wheeler
PERSONAL STATEMENT
Regarding the Adv LLM Thesis submitted to satisfy the requirements of the 'Advanced Master of Laws in International Tax Law' degree:
1. I hereby certify (a) that this is an original work that has been entirely prepared and written by myself
without any assistance, (b) that this thesis does not contain any materials from other sources unless these sources have been clearly identified in footnotes, and (c) that all quotations and paraphrases have been properly marked as such while full attribution has been made to the authors thereof. I accept that any violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree. I also accept that in case of such a violation professional organizations in my home country and in countries where I may work as a tax professional, are informed of this violation.
2. I hereby authorize the University of Amsterdam and IBFD to place my thesis, of which I retain the
copyright, in its library or other repository for the use of visitors to and/or staff of said library or other repository. Access shall include, but not be limited to, the hard copy of the thesis and its digital format.
3. In articles that I may publish on the basis of my Adv LLM Thesis, I will include the following statement in
a footnote to the article’s title or to the author’s name:
“This article is based on the Adv LLM thesis the author submitted in fulfilment of the requirements of the 'Advanced Master of Laws in International Tax Law' degree at the University of Amsterdam.”
4. I hereby certify that any material in this thesis which has been accepted for a degree or diploma by any
other university or institution is identified in the text. I accept that any violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree.
signature:
name: Elena Natalia Vizcarra Delgado
Table of Contents
Table of Contents ... III
List of Abbreviations used ... V
Executive Summary (max. 1 page) ... VI
Main Findings (max. 1 page) ... VII
1.
Introduction ... 1
2.
Domestic Law ... 3
2.1. States approach to the indirect alienation of shares ... 3
2.1.1. India ... 3 2.1.2. China ... 3 2.1.3. Mexico ... 4 2.1.4. Chile ... 5 2.1.5. Argentina ... 6 2.1.6. Colombia ... 6 2.1.7. Peru ... 6 2.2. Fiscal policy ... 7
2.2.1. Underlying assets covered ... 8
2.2.2. Alienated shares ... 9
2.2.3. Tax basis ... 10
2.2.4. Covered structures ... 10
2.2.5. Evaluation period ... 11
2.2.6. Exemptions ... 12
2.2.7. A source rule or an anti-avoidance provision? ... 12
2.2.8. Enforcement provisions ... 13
3.
Scope of Article 13(4) of the MTC ... 14
3.1. Evolution of Article 13(4) ... 14
3.2. The current scope of Article 13(4) ... 15
3.2.1. Gains from the alienation ... 15
3.2.2. Shares or comparable interest ... 16
3.2.3. Any time during the 365 days preceding the alienation ... 16
3.2.4. Derive more than 50 percent of their value from immovable property ... 18
3.2.5. Directly or indirectly ... 18
3.2.6. Immovable property as defined in Article 6 ... 19
3.3. Anti-avoidance character of Article 13(4) ... 19
4.
Interaction between the MTC and the Domestic Law ... 20
4.1. Underlying assets covered ... 21
4.2. Alienated shares ... 22
4.3. Tax basis ... 22
4.4. Covered structures ... 23
4.5. Evaluation period ... 23
4.6. Exemptions ... 24
4.7. Anti-avoidance character of the provision ... 25
5.
Proposal ... 25
5.2. Additional considerations ... 26
5.2.1. Amendment to Commentary 28.6 of MTC regarding public services concessions and licenses ... 26
5.2.2. Tax basis ... 27
5.3. Advantages and disadvantages of the proposal ... 28
5.3.1. Advantages ... 28
5.3.2. Disadvantages ... 28
6.
Conclusion ... 29
List of Abbreviations used
(alphabetical list of abbreviations used in the Thesis)
DTAA Double Taxation Avoidance Agreement
FMV Fair Market Value
GAAP General Accepted Accounting Principles
GAAR General Anti-Avoidance Rule
GTTC Global Tax Treaty Commentaries published by the International Bureau of Fiscal Documentation (IBFD).
IFRS International Financial Reporting Standards
MLI Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting
MTC Model Tax Convention on Income and on Capital published by the OECD
MDT Model Double Taxation Convention between Developed and Developing Countries published by the UN
OECD Organisation for Economic Co-operation and development SAAR Specific Anti Avoidance Rule
Executive Summary
Domestic law that address the indirect alienation of assets is being adopted by several developing countries, especially in the last 10 years, however the scope of Article 13(4) remain the same since its inclusion on 2003.
The differences between both approaches generate the question if it is convenient to reassess the scope of Article 13(4) and evaluate its need to an extension to reduce said differences between the States domestic law and the DTAAs to better protect the States taxing rights.
In this analysis it was found that an extension on the scope of Article 13(4) regarding the underlying assets is not possible considering the wide spectrum of assets covered by the analysed domestic provisions of the State and their different approach to the taxation of the gains derived by the indirect alienation of assets.
However, some common ground was found regarding a particular asset and the tax basis that some States have established, which have generated some suggestion for the amendment of the MTC Commentaries.
Also, as an alternative of the extension of the scope, this document propose a provision to exclude the indirect alienation of assets regime regimen from the application of the DTAA, in order to help States to keep their taxing rights over this gains.
Main Findings
This document provide an overview on the scope of Article 13(4) of the MTC and the differences that currently exist between said article and the domestic laws regarding the indirect alienation of assets that are currently in place. The enforcement of the domestic provisions could be limited or prevented by these differences, with the situs States being not entitled to tax the indirect alienation of some of the assets as a result.
Regardless, despite that the States have adopted the same regimen, the different approaches adopted by the States to deal with the indirect alienation of assets do not allow to find a common ground between the domestic provisions currently in place. The States policy shows the common goal to protect the assets that have a strong connection to the State where said assets are situated.
Therefore, in this document an alternative provision is proposed to allow the States to keep the primarily right to tax as a source, when the assets being alienated are not considered as immovable property.
1. Introduction
Every State has the right to tax without limitation according to their domestic laws, but in order to tax States usually need a connection factor or ‘nexus’ to explain why a person or transaction should be tax in that state in the first place. It is accepted by international custom that “a country has the primary right to tax income that arises in, has a source in, or is derived from that country”1 this connection is called source jurisdiction.
Regarding capital gains that connection is given by the ‘situs’ meaning the State where the assets are situated has the primary right to tax any gains derived by the alienation of said assets. A State needs to determine which assets should be tax and on which basis to be able to exercise its tax jurisdiction effectively.
For the direct alienation of assets is clear that the State where the assets are situated at the moment of the alienation may have the right to tax any gains obtained by such alienation. However, when the alienation of the assets is performed indirectly, some States would be helpless before these transactions if their domestic laws have no addressed this issue.
In recent years several so-called ‘developing countries’ have shown an increased interest in taxing the indirect alienation of assets when said alienation is performed by a non-resident. States like China, India, Peru, and Chile were among the first ones, to include provisions in their domestic laws that allow them to tax the alienation of shares when the value of the aforementioned shares derived from assets located in said countries. These provisions do not limit the indirect alienation to immovable property, instead, the States have opted for a broad scope that includes other assets such shares and comparable interest, movable property, and rights, among others.
OECD has addressed the taxation of the capital gains in Article 13 of the MTC, providing different distributive rules for gains derived from the alienation of specific property in the first four paragraphs and deliver a catch-all for other types of property in its final paragraph2.
Article 13(1) deals with the gains derived by a resident of a contracting state for the alienation of immovable property situated in the other contracting state but what about when the alienation is performed indirectly, namely through an interposed entity? If the immovable property is held by an entity and the shares issued by this entity are the ones being alienated instead of the assets? The economic effect is the same in both situations but Article 13(1) does not cover this case.
Article 13(4) of the MTC allocates the taxing rights to the State where the immovable property is situated if the alienated shares or comparable interest of a non-resident entity derived at least 50 percent of their value from said immovable property. However, this provision only covers immovable property and left out other kind of assets that can provide value to the shares.
It should be noticed that Article 13(4) of the MTC is not the only one article that allows taxation on the gains derived from the alienation of shares, the current version of Article 13(4) of the MDT also covers the same transaction, given that both provisions have the same wording this document will address the scope of Article 13(4) contained in the MTC 2017.
1 Brian J Arnold, International Tax Primer (Fourth Edition, Kluwer Law International 2019). Pp. 24.
2 Jinyan Li and Francesco Avella, ‘Article 13: Capital Gains’, Global Tax Treaty Commentaries (Richard Vann et al, IBFD 2014). Sec. 1.1.1.1.
Although Article 13 of the MTC does not have further provisions regarding the alienation of shares, the MDT also has a provision in Article 13(5) that applies to the alienation of shares or other comparable interests that derived their value from other assets situated in the State but excluding the gains derived by the alienation of immovable property.
Unlike Article 13(4), which focus on the fact that the alienated shares or comparable interests derived 50 percent or more of its value from immovable property situated in the other State, Article 13(5) focus on the alienator, who should hold a substantial interest on the capital of the entity which shares and comparable interest are being alienated.
As the GTTC has stated, this rule “views the residence of the company as the source of capital gains on the shares, thereby recognizing the company’s residence state as the source of both dividends (income from shares) and capital gains on shares3”. Unlike Article 13(4), this provision applies only to the direct alienation of the shares or comparable interests, so “it may not be as effective in the indirect transfer situations4”, therefore this provision would not be part of the analysis in this document.
On the other hand, an entity can have valuable assets that are not immovable property, such as intangible property, licenses, and concessions for the attraction of natural resources or public services, among others. Regardless, Article 13(4) does not deal with the alienation of shares or comparable interest when their value does not come from immovable property, this situation could have a negative impact on the tax collection of a State because it forces it to relinquish to its domestic taxing rights. The capital-import States are looking for ways to protect their tax base by enacting provisions that allow them taxation over transactions that 20 years ago would be considered as out of the tax jurisdiction of a State. Nonetheless, globalisation has deemed necessary for these States to widen their tax base to protect their tax base, and also, to keep the tax collection at the necessary level to attend the obligations of the Governments.
Nonetheless, the taxation of offshore indirect alienation of assets is a topic that has not been addressed in a harmoniously way, different States have opted for different methods and requirements to put in place provisions that allow them to tax the alienation of assets according to their fiscal policies and considerations.
In order to find the determine if an extension of the scope of Article 13(4) is convenient, the present thesis will address first the domestic provisions regarding the indirect alienation of assets enacted by India, China, Mexico, Chile, Argentina, Colombia, and Peru, as well as the fiscal policy motivation for the adoption of these provisions to find if there is a consensus in the analysed domestic provisions of the States.
Secondly, it will go through the evolution of Article 13(4), its current scope and, the anti-avoidance character of this provision to determine if the extension of said Article is possible. Subsequently, it will focus on the interaction between Article 13(4) and the domestic provisions of the aforementioned States to determine the differences between both and the issues that could arise because of them. Finally, it will provide some recommendations and alternative wording to include in the commentaries to help the States to protect the application of their domestic provisions and provide an analysis of the advantages and disadvantages of that proposal.
3 ibid. Sec. 1.1.2.5.
4 United Nations and Department of Economic and Social Affairs, United Nations Handbook on Selected Issues
2. Domestic Law
2.1. States approach to the indirect alienation of shares
During the last decade, most Latin American countries have adopted provisions that deals with the indirect alienation of assets, Peru, and Chile being the first ones after the scandals that follow the indirect alienation of companies that held natural resources concessions, following by Mexico, Ecuador, Argentina, and Colombia, the necessary regulations for the application of these provisions are still pending in the last two countries.
This evaluation will focus on the fiscal policy related to the indirect alienation of assets adopted by Peru, Chile, Mexico, Argentina and Colombia, including as comparables the provisions of India and China as comparables, given that said States are somehow dependent on the exploitation of their domestic resources by non-resident companies.
Currently, the provisions of the aforementioned States are the following: 2.1.1. India
According to the Indian Income Tax Act5, it is considered income accrue or arise in India, all income accruing or arising, whether directly or indirectly, through the transfer of a capital asset situate in India. This provision has an additional explanation6, put in place through the Finance Act 2012, whose intention insertion is to widen the application as it covers incomes, which are accruing or arising directly or indirectly. The section codifies the source rule of taxation wherein the state where the actual economic nexus of income is situated has a right to tax the income irrespective of the place of residence of the entity deriving the income.
In 2016, for the indirect alienation of assets, it was added through an additional explanation7 that a company’s shares should be deemed to be derived “substantially” from Indian assets if the total value of said assets, whether tangible or intangible:
1) Exceeds the amount equivalent to 10 crore Indian rupees – approximately USD 1.4 million; and
2) Represents at least 50 percent of the total value of the company’s assets8.
The law9 also provided exemptions to some entities and transactions, such as small shareholders, with no right of management or control or with no voting power, share capital or interest exceeding 5 percent of the total, and indirect transfers that resulted from overseas amalgamation and demergers. 2.1.2. China
Regarding the indirect alienation of assets, the Chinese domestic laws1011 have established a GAAR that applies only if the transaction lacks a reasonable business purpose121314, and seeks to ensure that 5 IN: Income Tax Acts, 1961. Section 9(1)(i), National Legislation Income Tax Department – Government of
India.
6 Explanation 5, Sec. 9(1)(i) ITA 1961. 7 Explanation 6, Sec. 9(1)(i) ITA 1961.
8 Laura Kurth Marques Carvalho, ‘Brazil/Australia/Chile/China/India/International/OECD - Taxation of Offshore Indirect Transfers in Brazil in Need of Reform’ (2020) Vol. 74, 3 Bulletin for International Taxation 2020 26. Pp. 9.
9 Explanation 7, Sec. 9(1)(i) ITA 1961.
10 CN: Enterprise Income Tax Law of the People’s Republic of China, 2007, Articles 3(3) and 37, National Legislation FDI.
11 CN: Regulations of the People’s Republic of China on the Implementation of the Enterprise Income Tax Law, 2007, Articles 103 and 105, National Legislation FDI.
tax cannot be avoided through the interposition of an offshore interposed entity that holds the Chinese assets, such as shares issued by Chinese companies, immovable property and assets belonging to Chinese PE of foreign companies.
This rule apply as a deemed provision where a non-resident enterprise alienated shares of an offshore intermediary enterprise that, directly or indirectly, holds an equity interest in a Chinese enterprise, immovable properties situated on China or assets belonging to a Chinese PE of a non-resident company, this transaction is, in certain circumstances, regarded as being undertaken without a reasonable business purpose with the aim to avoid Chinese income tax, and therefore, the transaction would be re-characterized as a direct transfer of asset and be subject on a net basis to a 10 percent rate WHT15 under the GAAR.
After that, another Circular16, while providing further implementation guidance and improved reporting mechanism, clarified the application of provisions regarding formal receipts for taxpayer reporting, such as determining penalty mitigation measures and establishing the reporting process for the alienated Chinese assets, along with the review an appeal GAAR procedures.
Although its application is discretionary, there is a list of factors that should be considered by the tax authorities when conducting their assessments and a list of specific circumstances in which, if present, the indirect transfer is deemed to lack a reasonable purpose17, such as:
a) More than 75 percent of the value and more than 90 percent of the income or assets of the non-resident enterprise derived directly or indirectly derived from Chinese taxable properties;
b) The non-resident entity does not undertake substantive functions and risks to evidence economic substance;
c) The foreign income tax burden on the indirect transfer is less than the Chinese tax payable in the event of a direct transfer.
2.1.3. Mexico
Mexican Income Tax Law18 provides that it is considered Mexican source income the gains derived from the alienation of shares or securities when the book value of said shares or comparable interests derives, directly or indirectly, in more than 50 percent of real estate located in Mexico.
The income tax would be determined by applying a 25 percent rate gross sale price, or at the rate of 30 percent on the net capital gain. If the income is not subject to a preferential tax regime19 and the seller is Mexican non-resident the following requirements should be complied with on a timely basis:
12 CN: Guojia shuiwu zongju (State Administration of Taxation, SAT, to 2018) Announcement [2015] No. 7. SAT Announcement [2015] No. 7 repealed.
13 CN: SAT Circular [2009] No. 698, arts. 5 and 6
14 CN: SAT Announcement [2011] No. 24, paras. 3 to 5, which originally provided for the taxation of the indirect share transfers of non-residents involving Chinese resident enterprises.
15 Announcement [2017] No. 37 provides guidance on the calculation of disposal gains, explaining how the tax basis is to be apportioned to the transferred part of equity. The guidance also observes that the base cost of equity, referred to as its ‘net value’, must be adjusted for any asset value write downs/increments previously recognized for tax purposes
16 CN; Shuizonghan [2015] Nº. 68 (Circular 68). 17 Kurth Marques Carvalho (n 8). Pp. 10.
18 MX: Ley del Impuesto sobre la Renta [ncome Tax Law], 2002, Article 161, National Legislation SAT.
19 Article 176 of the Mexican Income Tax Law has established that a tax regime should be considered as preferential when the effective tax rate levied in the country or jurisdiction in question is less than the effective tax rate levied in Mexico by the application of a legal, regulatory, administrative provision, of a resolution, authorization, evolution, accreditation or any other process. This article also provides a guidance on how to determine if the income is subject to a preferential regime.
1) The seller has appointed a Mexican tax resident as his representative who will assume the joint tax liability for future claims to be made by the Mexican tax authorities and will keep on file documentary evidence for the sale.
2) A tax opinion report issued by a certified public accountant (“CPR”) is furnished to tax authorities in connection to the capital gain computation if the transaction is made between related parties.
Also, the same provision establishes certain transactions in which a non-Mexican resident that realize an income mentioned in the preceding paragraph may subject to an exemption, lower tax rate (10 percent) or a deferral, such as:
1) The transactions are carried out through stock exchanges and the taxpayer is a resident of a country who has a DTAA in force with Mexico.
2) They represent tax-exempt transactions executed by non-resident registered pension funds. 3) The reason for the alienation is a corporate restructuring, in this case, the tax will be paid
within the last 15 days after the last alienation was made. 2.1.4. Chile
Chilean Income Tax Law20 develops the treatment regarding the direct and indirect alienation of specific assets, establishing that the taxable event is the alienation of shares and other participation rights21 in a non-resident entity if one of the following situations occurs:
1) At least 20 percent of the FMV of the total of the shares or other interest that a non-resident possesses, directly or indirectly, comes from one or more of the following underlying assets: - Shares or any other participation rights in the property, control or profits of a company, fund or
entity incorporated in Chile;
- An agency or PE of a non-resident person or entity, and
- Any type of movable or immovable property located in Chile, or the rights over them, owned by a non-resident company or entity.
2) At the date of the alienation of the shares or other comparable interest or any time during the twelve months before this alienation, the FMV of one or more of the underlying assets described in the proportion corresponding to the indirect participation that the non-resident possesses in them is equal to or greater than EUR 136.5 million22.
In both cases, the alienation should be at least 10 percent of the total shares or other participation rights in the non-resident (intermediate) entity, considering all the alienations, directly or indirectly made by the transferor and other non-resident or domiciled members of a multinational group in Chile, at the time of the alienation or in any of the twelve months before the alienation.
Nonetheless, if the shares or other participation rights being transferred are issued by a company resident in a law o nil-tax jurisdiction the transaction would be deemed as an indirect alienation of assets regardless even if the FMV value of said shares or other participation rights that derives from the underlying assets is lower than 20 percent. This provision will not apply if the alienator can prove that (i) no Chilean resident owns more than 5 percent on the capital of the company resident in a low o nil-tax jurisdiction, and (ii) the shareholders that control 50 percent (or more) of the capital of said company are not residents in a low o nil-tax jurisdiction.
20 CL: Ley sobre Impuesto a la Renta [Income Tax Law], 1974, Article 10, Paragraph 3, National Legislation SII. 21 Such as of titles or property rights with respect to any type of entity or patrimony, constituted, formed or
resident abroad.
2.1.5. Argentina
In 2017, a provision regarding the indirect alienation of assets was introduced in Argentinian Income Tax Law23 establishing that are considered as Argentinian source income the gains derived by non-residents from the sale of shares or any participation right24 representing the capital or patrimony of a legal person, fund, trust or equivalent figure, permanent establishment, capital of affectation or any other entity, that is constituted, domiciled or located abroad if they following criteria is met:
1) At least the 30 percent of the FMV of the shares or participation rights issued by the non-resident company, at the moment of the alienation or any moment in the previous twelve months, comes from one or more of the following underlying assets:
- Shares or any other participation rights in the property, control or profits of a company, fund, trust or other entity incorporated in Argentina;
- A PE of a non-resident person or entity; or
- Other assets of any nature located in Argentina or rights over them.
2) The shares or participation rights alienated – by the alienator or together with its related parties – represent at least 10 percent of the assets of the non-resident entity that directly or indirectly owns the underlying assets, at the time of the alienation or in any of the twelve months before the alienation.
Nonetheless, this provision will not be applicable when the alienator can prove that these alienation have been made within the same economic group, provided that nor income or higher value has arisen regarding the tax cost that would have corresponded to the underlying assets located in Chile if they had been directly alienated.
2.1.6. Colombia
The Colombian Income Tax Law25 provides that is considered Colombian source income any gains derived from the indirect alienation of shares of a company, any rights or assets located in Colombia through the alienation of shares or comparable interest of non-resident entities, as if the alienation of the underlying assets has been done directly, applying a look-through approach. This provision applies if the value of the shares of a company, the rights or assets represent at least 20 percent of the FMV or the book value of the non-resident entity.
This provision does not apply if (i) the alienation of shares has been made in a recognize Stock Market or when the shares have not been purchase by a beneficial owner that possesses more than 20 percent of the same company’s shares after the alienation. It will also not apply if the alienation is the result of a merger or reorganization between non-resident entities of a multinational group, as long as the assets in Colombia do not represent more than 20 percent of the value of all assets owned by the group according to the consolidated financial statements of the parent company.
2.1.7. Peru
The Peruvian Income Tax Law26 has established that are considered Peruvian source income the gains derived from the indirect alienation of shares and other comparable interest issued by a legal person domiciled in Peru if the law requirements are met. In this situation, a transaction could fall within the scope of this provision in these two situations:
23 AR: Ley de Impuesto a las Ganancias [Income Tax Law], 1997, Article 13, Second paragraph 3 (2017), National Legislation AFIP.
24 Such as quotas, social participations, titles convertible into shares or any social rights. 25 CO: Estatuto Tributario Nacional [National Tax Statute}, Article 90-3 (2018).
1) The FMV of the shares issued by the Peruvian company represents at least 50 percent of the FMV of the total shares of the non-resident entity and the alienation is at least 10 percent of the total shares or other comparable interest of the non-resident, considering all the alienations made – through one or more simultaneous or successive operations – by the alienator or its related parties, at the time of the alienation or in any of the twelve months before the alienation; or
2) The total value of Peruvian shares to be transferred by the non-resident totals or surpasses 40,000 Tax Units (approximately EUR 45.5 million27), without any further condition or requirement. Peru has a broader concept of what constitutes an indirect alienation of shares, which includes (i) the disposition of American Depositary Receipts (ADRs) and Global Depositary Receipts (GDRs), (ii) the capital increase of a non-resident entity, when the value assigned to the new shares issued is below their market value28, and (iii) if the interposed entity is resident in a low or nil-tax jurisdiction or a non-cooperative jurisdiction – even if it does not meet situations describe above – though the alienator may prove otherwise. It should be noted that Peru has not established exceptions for the application of this provision.
It should be noticed that this provision applies only to the indirect alienation of shares, so it is possible – although highly unlikely – that the indirect alienation of shares of a company incorporated in Peru could entail the indirect alienation of assets situated in other States.
2.2. Fiscal policy
Every State has the right to establish their tax provisions to tax what they deem necessary to protect its tax base, though it is easier for a State to tax their residents. The taxation of income, profits or gains derived by a non-resident “presents special problems for countries that tax such gains differently from business income29”.
Issues such as enforcement and collection can be exacerbated when cross-border transactions and non-residents are involved. A non-resident is usually no subject to the tax legal system of a State and does not have the same obligations as a resident. States usually rely on withholding taxes for the collection of non-resident taxes when the payer is a resident but when transactions are performed between non-residents Sates need to resort to more complex mechanisms, that is the reason why several States have chosen not tax non-resident on these gains.
Even so, in recent years several States consider as ‘developing countries’ have put in place provisions that allow them to tax non-residents if they alienate shares or comparable interest of entities that derived their value from assets situated in those States. These provisions can be found also in develop countries’ domestic law, such as Australia, Canada, and Japan but in a narrower context30. In general, two factors are used to determine if an alienation of shares has happened, first if an alienation that generates capital gain has occurred, and second if there is a presence of a connecting factor with the source State, such as if the underlying assets are situated in the State and its value represents a certain percentage of the value of the alienated shares and other comparable interests. The enactment of these provisions raised concern for some international investors given that they 27 According to the 2020 Peruvian Tax Unit.
28 Carolina Masihy and Gonzalo Suffiotti, ‘Chile/Colombia/Peru/Uruguay - Recent Developments in the Taxation of Indirect Share Transfers in South America: Lessons and Challenges from Chile, Colombia, Peru and Uruguay’ (2019) Vol. 73, 9 Bulletin for International Taxation 39. Pp. 6.
29 Arnold (n 1). Pp. 85.
allow the source State to tax the gains derived by non-residents from the alienation of shares issued by a non-resident entity. It does not help that the States provisions lack uniformity in their technical designs which “may give rise to distortions, multiple taxation, and uncertainty for taxpayers.31”
Although the provisions regarding the indirect alienation of assets vary from States to State, some similarities can be found among then, according to the following:
2.2.1. Underlying assets covered
As a principle for the adoption of a provision regarding the indirect alienation of assets, the gains derived by the ‘direct’ alienation of certain assets should be tax in the State where said asset is situated. Some States have opted for not tax capital gains derived by non-residents unless the underlying immovable property is involved32.
However, developing States – such as the States subject to this analysis – have a tendency to tax non-resident on income derived by the alienation relevant assets when those are situated within their countries. The assets covered by the States domestic provisions are the following:
India Mexico Peru Colombia Chile Argentina China
Underlying assets Any asset (tangible or intangible) situated in India Immovable property situated in Mexico Shares or participations on the capital of legal entities domiciled in Peru. Shares issued by a company or partnership resident of Colombia Shares or any other participation rights in the property, control or profits of a company, fund or entity incorporated in Chile Shares or any other participation rights in the property, control or profits of a company, fund, trust or other entity incorporated in Argentina Shares issued by a Chinese company ADRs o GDRs with underlying shares or participations on the capital of legal entities domiciled in Peru. Rights situated in Colombia Agency or PE of a non-resident person or entity PE of a non-resident person or entity Assets belonging to a PE of a non-resident person or entity 31 ibid. Pp. 1. 32 ibid. Pp. 3.
Assets situated in Colombia Movable or immovable property situated in Chile, or the rights over them, owned by a non-resident company or entity. Assets of any nature situated in Argentina or rights over them. Immovable property situated in China
As can be seen, there is a wide spectrum of assets cover by the analysed States provisions. Most of these assets differ from State to State but some similarities can be found, according to the following:
1) Shares issued by an entity resident in the States territory have been included in six of the analysed provisions33.
2) Immovable property has been covered by six34 of the analysed States, specifically or implicitly by most of the analysed provisions, being Mexico the only one that covers exclusively immovable property.
3) Rights, securities, and financial instruments when its alienation entails the transfer of assets situated in the source State.
4) Movable property, these assets could belong to a PE or just being situated in the source State.
It is clear that there is no consensus on the assets that the States are looking to protect, although shares and immovable property seems to be the most favoured ones, still, several States have opted for a catch-all provision to cover the indirect alienation of assets of a wider spectrum of assets that could have some significant impact on their tax collection.
It should be noticed that the indirect alienation of assets such as telecommunication licenses (Vodafone purchased Hutchison’s participation in a joint venture to operate an Indian mobile phone company) and natural resources extraction licenses (such as the third largest oil producer Peruvian company Petrotech, and the attempt of indirect alienation of Disputada Las Condes, the largest Chilean Copper mine and), sparked the enactment of the aforementioned domestic provisions.
2.2.2. Alienated shares or most of these domestic laws came as a response after a non-tax comparable interest
Regarding the alienated shares issued by a non-resident entity there is a consensus among the States that three requirements are necessary to trigger this alienation regarding the shares, according to the following:
1) Not only shares but also comparable interest should be considered for the alienation,
2) Said alienated shares or comparable interest should be issued by a company or entity that is not a resident of the mentioned States, and
3) The value of those shares must derive from assets situated in the State according to a certain threshold.
33 With the exception of Mexico that only covers immovable property situated in its territory. 34 China, India, Mexico, Chile, Argentina and Colombia.
It should be noticed that, although all the analysed States include comparable interest in their provisions, regarding the nature of the entity that issues the alienated shares only Peru has narrowed their domestic provision to include legal persons and no other kinds of entities.
Regarding the value of the shares, five35 of the mentioned States have set a material connecting factor in their domestic law, meaning that the indirect alienation of assets will be triggered if there are substantial underlying assets in the source country36. As mentioned, this factor is given by certain requirements set in the States provisions.
Overall, it is pretty clear that the analysed States were looking to cover not only the alienation of shares but also the transactions that had the same economic effect. Also, these thresholds have as purpose to “avoid excessive compliance and administrative costs for both small shareholders and tax administrations”37, that way the Tax Administrations can focus on material indirect alienation of shares instead to dedicate time to small alienation which could end up being not worth it.
However, there is no consensus on what percentage of the alienated shares should correspond to the underlying assets or whether their determination should take into account the book value or the market value.
2.2.3. Tax basis
The States that have opted for tax the gains derived from the indirect alienation of assets have special rules for the valuation and determination of the tax basis. These provisions have established certain requirements that works for the determination of the applicability of the provisions and also for the determination of the tax basis.
For instances, in order to determine the application of the provisions thresholds have been established and those are calculate according to a percentage of the FMV or book value of the non-resident shares derives from the assets situated in the State38 (India, Peru, Chile, Argentina, and Colombia), a fixed amount on the national currency of the State, or both (India and Peru). The determination of the FMV or book value it is also used to determine the tax basis of the transaction.
Also some States39 have established that the taxation on gains derived from the alienation of indirect assets will apply only over the proportion that corresponds to the indirect participation that the alienator is transferring.
Overall, there is no consensus regarding the valuation established in the analysed domestic provisions enacted by the States, however, it would be in the best interest of the States to find a common ground that could help to reduce the complexity of the valuation provisions.
2.2.4. Covered structures
States that have enacted domestic provisions that allow them to target tax structures that have as purpose circumvent the taxation of the gains derived by the indirect alienation of assets situated in the source State, through the use of interposed entities.
35 India, Chile, Argentina, Colombia and Peru. 36 Masihy and Suffiotti (n 24). Pp.1.
37 ibid. Pp. 8.
38 India, Peru, Chile, Argetina, y Colombia. 39 India, Peru, Chile, and Argentina.
These interpose entities could be situated in the State where the immovable property is situated or outside of the source State. For instance, assets such as shares have been covered by most of the analysed provisions40 and seem to have in common a desire to avoid the circumvention of the provisions regarding the direct alienation of assets.
This situation seems to be motivated by the fact that a company or entity can be interposed between the alienator and the asset and that company could be situated either a resident or a non-resident of the State where the asset is situated, the outcome in both cases would be the same, as follows:
Therefore, to tax the indirect alienation of assets when the interposed entity is a resident of the same State where the assets are situated, a provision allowing the taxation of the shares or comparable interest is needed, otherwise these transactions would be left outside of the scope of the provision. On the other hand, the use of interposed entities outside of the source State can help the ultimate owner to dilute the percentage that represents the immovable property on the total value of the alienated shares through minor alienations performs by a different member of the same multinational group. Regarding this, some States41 have included in their provisions the alienation performs by related parties to determine if the alienation entails the indirect alienation of the assets situated in the source State, according to their particular requirements.
There is a consensus in the domestic provisions regarding cover most of the transactions that lead to the indirect alienation of assets, however, most provisions focus on the chain of interposing entities situated outside of the source States. The interpose entities situated in the source State are mostly covered by the taxation of assets such as shares and comparable interest issued by an entity resident in the State where the asset is situated, nevertheless, not all States42 covers this situation.
2.2.5. Evaluation period
To determine if the value of the alienated shares or comparable interests comes from the assets situated in their territory, some States have established an evaluation period to determine if the alienated shares or compare interests, at some point, derived their value from the assets situated in the State.
The most common period found in the analysed domestic provision is the 12 months, which can be 40 With the exception of Mexico that only covers immovable property situated in its territory.
41 Such as Peru, Chile and Argentina.
42 For instance, Mexico does not cover the indirect alienation of shares. State C B Co. State B Alienator State C B Co. State B Alienator State A State A
found in Peru, Chile, and Argentina. The Mexican income tax law has established a period of 24 months but it applies only when the alienation has been made through a stock market. India uses the aforementioned period only for exemption on the application of its provision regarding the indirect alienation of assets.
Although there is no consensus regarding the evaluation period – some States such as Canada43 and United States44 have even longer periods – it can be said that there is a tendency to look back to a certain period to determine if the alienated shares or compare interests, at some point, derived their value from the assets situated in the State. Nonetheless, it should be noticed that States such as China and Colombia have not established this provision.
2.2.6. Exemptions
It can be found, in the domestic law of the analysed States, some exemptions to the application of the provisions regarding the indirect alienation of assets. For instance, some States exempt certain alienations, such as shares of companies listed on a stock market (i.e. China and Colombia), shares exchange during an international corporate reorganisation (i.e. Chile, Colombia, and India), or small shareholders, with right of management, control or voting power, share capital or interest under an established threshold (i.e. India).
The reason why the gains derived by the indirect alienation of assets is taxed is to avoid the circumvention of the tax that would apply is the asset would be alienated directly, so the core of the provision is the ‘alienation’, but in an indirect alienation the ownership belongs to the interposed entity whose shares or comparable interest are alienated and that fact does not change by the alienation. Nonetheless, if substantial participation in the capital of the interposed company is alienated, the control on the interposed entity, which signals a change of the ultimate ownership for the asset. The reason why alienation made in a stock market and small shareholder are exempt is that in those situations there is no substantial change in the ownership of the asset, is unlike – although no impossible – to obtain control of an entity through transactions perform in the stock market. For the small shareholders, they probably have not enough force to influence the decisions of the company. These exemptions work in a similar way than the threshold and they seem to have as purpose to focus the work of the Tax Administration on alienations that entails a material relevance for the State. However, these exemptions also can establish situations that the State – according to their fiscal policy – considers not to be an alienation. Overall, the mentioned exemptions have as purpose to narrow the scope of the provisions to fit the States policy but not every State has opted to include the same provisions.
2.2.7. A source rule or an anti-avoidance provision?
Five45 of the analysed States have designed their provisions as a source-income rule, meaning that they consider as a State source income the gains derived by the indirect alienation of assets but they also have established objective criteria to determine if this has happened. These provisions deemed the alienator as the taxable person but also, provide some limitations on its application such as thresholds and exemptions.
Countries such as India, Mexico, Peru, Chile, and Argentina has established that is considered as a ‘[state] source income’ the gains derived by the indirect alienation of the assets mentioned in Section 43 Sixty (60) months.
44 Five (5) years, although the domestic law provides for special rules for the evaluation. 45 India, Mexico, Chile, Argentina and Peru.
2.2.1., despite of that, some limitations – in the form of thresholds – have been placed to the application to this provision to ensure that there is enough connection between the assets covered and the alienated shares.
However, the aforementioned provisions, despite the fact that there have been drafted as source rules, lack the general nature of a source rule, instead, they come across as provisions design as a reflection of true source rules regarding the alienation of movable and immovable property, shares and other comparable interests, among other assets. These provisions have a narrow scope which purpose is to limit the application of the provisions regarding indirect alienation of assets to transactions that will be deemed relevant to the State.
On the other hand, China’s provision comes as a GAAR instead of a source rule and it seeks to ensure that tax cannot be avoided through the interposition of an offshore interposed entity that holds the Chinese equity. The subjective character of what constitutes a ‘reasonable business purpose’ creates many challenges in its application due to difficulties aligning the buyer and alienator positions. Also, Colombia has given to its provisions a clear anti-avoidance flavour by establishing a look-through approach to tackle the circumvention of the provisions regarding the direct alienation of assets by non-resident entities.
Overall, the analysed provisions do have an anti-avoidance purpose, those are not looking to tax any alienation that is under the scope of the provision but ensure to catch those that could represent, because of their value or their relevance, a risk of avoidance if the aforementioned provisions had not been enacted.
2.2.8. Enforcement provisions
It should be noticed that the aforementioned State has had some issues with the reporting and enforcement of this alienation. Being the alienator is a non-resident of the State, the Tax Administration face several issues regarding the control of these kinds of transactions given that is easier to manage the compliance when the alienator is a taxpayer on that State,
To collect the corresponding tax, States need clear rules that allow them to withhold the tax liability and request a reporting of the transaction. Some States have established the following mechanisms to ensure the collection of the tax:
1) Colombia, the non-resident alienator should file a tax return and pay the relevant taxes within the month following the transaction, though, the Colombian alienator is subject to a different treatment.
2) Chile, the non-resident alienator is obliged to file a tax return and pay the tax when an indirect alienation of shares is made, nonetheless, the buyer is also obliged to make a provisional withholding of 20 percent over the price; or withholding of 35 percent over the capital gain. Only when the alienator files the tax return and pays the corresponding tax the buyer is relieved from withholding the tax. The underlying Chilean company that is indirectly alienated may also be jointly and severally liable for the payment of the tax, in certain circumstances46. 3) Peru, the non-resident alienator is obliged to pay the tax but there is no need to submit a
report. If the buyer is a Peruvian resident, he should withhold the corresponding tax and submit a tax return. It has also been established47 that when the direct or indirect alienation of shares or other comparable interest (terminology) is carried out by a non-resident that is related to a 46 Masihy and Suffiotti (n 24). Pp. 10.
resident company or has a permanent establishment in the State, the related company, branch or permanent establishment is liable for the tax payable unless the alienation has been made through the Lima stock market.
4) Mexico, the non-resident alienator is obliged to pay the tax within 15 days after the payment but there is no need to submit a report. If the buyer is a Mexican resident or has a PE in Mexico, he should withhold the corresponding tax and submit a tax return. If the alienated shares have been issued by an Investment Fund, the tax will be withheld by the Fund.
Although withhold the tax seems to be the favoured method to collect the corresponding tax and enforce this provision through a withholding agent, regarding the indirect alienation of assets this possibility is remote, and States have resorted to applying provisions that rely on voluntary compliance. There is no consensus in the enforcement methods applied by the States, while in some cases registration is needed in some others a joint liability is granted to the buyer if the alienator does not comply with their tax duties.
Despite the State’s best efforts, the enforcement of these provisions is still difficult for most of them, although the Mutual Assistance48 set of tools could help to change this situation in the future.
3. Scope of Article 13(4) of the MTC
3.1. Evolution of Article 13(4)
The MTC, according to the OECD49, plays a crucial role in removing tax-related barriers to cross border trade and investment and should be considered as the basis for negotiation and application of bilateral tax treaties between countries, designed to assist business while helping to prevent tax evasion and avoidance. It also provides a means for settling on a uniform basis the most common problems that arise in the field of international double taxation.
The early versions of the MTC allocated in the residence State most of the taxing rights over income derived by a resident of one of the Contracting States from a source situated in the other Contracting State, with a few provisions granting the right to tax to the source state. According to Richard Klever50, for capital-importing States, “this initial allotment of taxing rights to the residence country placed significant pressure on the exceptions to the general rule found in subsequent treaty articles.”
Article 13 appeared in the 1977 version of the MTC and it allocated non-exclusive taxing right to the source state regarding the gains derived by the alienation of immovable property and business assets forming part of a permanent establishment while providing exclusive taxing rights to the State of residence concerning the gains from the alienation of ships and aircraft operated in international traffic, boats engaged in inland waterways transport or movable property pertained to the operation of such assets, and any other property.
However, MTC Commentaries51 has established that in some States capital gains were taxed as ordinary income and added to the income from other sources, especially in the case of alienation of 48 Such as joint audits, assistance in the collection and exchange of information.
49 https://www.oecd.org/tax/treaties/model-tax-convention-on-income-and-on-capital-condensed-version-20745419.htm
50 Richard Krever, ‘Tax Treaties and the Taxation of Non-Residents’ Capital Gains’, Globalization and Its Tax
Discontents: Tax Policy and International Investments (Arthur J Cockfield, University of Toronto Press 2010).
Pp. 213.
51 OECD, Model Tax Convention on Income and on Capital 2017 (Full Version) (OECD Publishing 2019). Pp. C(13)-1, 2.
assets of an enterprise but some other States treated capital gains as subject to taxes on profits from the alienation of immovable property, general capital gains or taxes on capital appreciation. So, the decision on whether the capital gains should be taxed and how this tax should apply has been left to the domestic laws of each States.
In 2003, the MTC introduced Article 13(4) which provides that gains from the alienation of shares deriving more than 50 percent of their value, directly or indirectly, from immovable property situated in a Contracting State may be taxed in a Contracting State, it acknowledges an equal tax treatment regarding the indirect and direct alienation of immovable property – which is covered by Article 13(1) – are equally taxable in the situs State.
One of the most prominent features of this provision that works as an anti-abuse rule granting the right to tax any gains derived from the offshore direct or indirect alienation of shares, when their value is derived from immovable property situated in the source State, to the Contracting State where the underlying assets are situated, addressing the difficulties that arise when the local asset is held by an interposed company or a chain of companies. In this regard “(…) Article 13(4) ignores the legal separation of the value of immovable property and the value of the shares in distributing taxing rights. It therefore functions as a look-through rule or an anti-abuse rule.52”
Regarding this, the UN Handbook on Selected Issues for Taxation of the Extractive Industries by Developing Countries acknowledges it is “a common form of tax planning for non-residents to invest through a multi-tier non-resident corporate structure so as to facilitate a possible tax-free exit from the investment. Instead of directly selling a mine, a non-resident could avoid capital gains taxation by an offshore sale several companies up the line.53”
Despite that the policy behind Article 13(4) is to counter abuse54, its application does not require a tax avoidance intent or purpose given that this provision applied to any situation where more than 50 percent of the alienated shares derive from immovable property situated in a Contracting States without further thought regarding the purpose pursued by the taxpayer at the moment of the alienation. As a result of the Recommendations on the Final Report on Action 655, regarding the transactions that circumvent the application of Article 13(4), the 2017 version of the MTC introduce some changes to stop the use of tax structures to avoid the application of the aforementioned provision, such as the use of transparent entities as the owner to the immovable property and strategies to lower the proportion of the value of shares that are derived from the immovable property by contributing assets to the company close to the date of the alienation.
3.2. The current scope of Article 13(4)
The most relevant aspects of the provision are the following: 3.2.1. Gains from the alienation
The MTC commentaries56 has established that Article 13 does not provide a specific definition of capital gains, nonetheless, it does mention that “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, 52 Li and Avella (n 2). Sec. 3.1.4.1.1.
53 United Nations and Department of Economic and Social Affairs (n 4). Pp. 63. 54 Li and Avella (n 2). Sec. 3.1.4.1.1.
55 OECD, Preventing the Granting of Treaty Benefits in Inappropriate Circumstances, Action 6 - 2015 Final
Report (OECD Publishing 2015). Pp. 71 – 72.
the capital gain exists only on paper.”, and that “[t]he right to tax a gain from the alienation of a business asset must be given to the same State without regard to the question whether such gain is a capital gain or a business profit.”
Nevertheless, according to Jacques Sasseville, ‘the fact that an item of income is characterized as a capital gain under domestic law does not necessarily mean that this item of income will be covered by Article 1357”, so attention must be paid to the kind of income that this gain represents. For instance, the gains derived by the indirect alienation of rights58, which could be covered by Article 13(2), are considered tax according to the provisions of Article 1559 when we talk about the alienation of the exercise of employee stock options.
Nevertheless, the term ‘gain” does not have a definition in the MTC, therefore according to Article 3(2), this term shall have the meaning that has at the time of the alienation under the domestic law of the Contracting State for the taxes to which the DTAA apply. So, according to the commentaries, it could be understood that gains are any income or profit that results from the appreciation in value as long as it is associated with the alienation of a capital asset.
3.2.2. Shares or comparable interest
Art. 13(4) of the MTC protect the taxing right of the State where the immovable property is situated when instead of alienating said asset, a non-resident interposed company or entity, who owns the immovable property, is the one being alienated instead. The reference to ‘comparable interest’ has as a purpose to address any possibility of tax avoidance raised by the use of entities that are not considered as companies in the Contracting States but still can own immovable property and have the ability to generate gains or profits through activities such as alienations.
Not only companies can own immovable property but also trusts and some other transparent entities but these entities are not considered persons according to the MTC, so they provide the opportunity to circumvent the application of Article 13(4). The 2014 version of the MTC recognised this and provide for an alternative provision to include entities that do not issue shares but comply to derive at least 50 percent of their value from immovable property.
The 2017 MTC Commentaries60 also bring up this by stating that “Before 2017, paragraph 4 applied only in the case of the alienation of shares but the Commentary provided that States could extend its scope to cover also gains from the alienation of interests in other entities, such as partnerships or trusts, that did not issue shares, as long as the value of these interests was similarly derived principally from immovable property. In 2017, the reference to “comparable interests” was added for that purpose.”
3.2.3. Any time during the 365 days preceding the alienation
In the previous version of the MTC, neither Article 13(4) or the commentaries provided clarity regarding when the 50 percent test must be satisfied. Despite this, it was considered that the value of the alienated shares should be represented at least 50 percent of the value of the immovable property situated in the situs State at the moment of the alienation since there was no express indication to the contrary in the MTC.
57 Jacques Sasseville, ‘Chapter 4: Definitional Issues Related to Article 13 (Capital Gains)’, Taxation of
companies on capital gains on shares under domestic law, EU law and tax treaties, vol 10 (Guglielmo Maisto,
IBFD 2013). Pp. 2.
58 Rights are considered as movable property in most of the domestic provisions. 59 OECD (n 49). C(15)-25 – C(15)-30, 12 – 12.5.
The Final Report on BEPS Action 6 proposed the introduction of an observation period of 365 days through an amendment to the current rule, according to the following “[t]here might also be cases, however, where assets are contributed to an entity shortly before the sale of the shares or other interests in that entity in order to dilute the proportion of the value of these shares or interests that is derived from immovable property situated in one Contracting State. In order to address such cases, it was agreed that Article 13(4) should be amended to refer to situations where shares or similar interest derive their value primarily from immovable property at any time during a certain period as opposed to at the time of the alienation only61”.
The purpose of the proposal was to address the situations where assets are contributed to, or immovable property is withdrawn from, an entity shortly before the sale of the shares or other interest in that entity to dilute the proportion of the value that is derived from immovable property.
Nonetheless, it remains the question of how effective that rule could be in counteracting the circumvention of Article 13(4). According to Luca Taglialatela, “such a look-back condition has the effect of neutralising avoidance opportunities whose aim is to alter the structure of a company’s assets around the time of an alienation of shares.”
On the other hand, the cure may be worse than the disease, he mentioned that “in the case of a long look-back period, the alienation of shares may fall within the scope of the immovable property company provision even if the company no longer derives value from immovable property. Moreover, capital gains may be subject to the Article 13(4) regime even if, during the entire period in which the specific investor held the shares, the company was never an immovable property company62”.
Also, indirect alienations of assets can be part of a process of corporate reorganization through which a multinational group gets rid of a whole line of business or the whole operation in a particular State or region. These processes are long and can take several years, consequently, a period of 365 days could be considered not enough to avoid the circumvention of the threshold.
One of the biggest difficulties, for both the alienator and the Tax Administration, is the monitoring of the asset-ratio for a one year period back of the alienation of interest for every day or even moment63, on the hand, of courses increases legal certainty but also leads to more uncertainties concerning the valuation of assets over a long period. It also makes it incredibly more difficult for small investors – who have neither the intention nor the means to influence the asset allocation – to ascertain where capital gains from the sale of their shares will be taxable.
Similarly to the assets that provided value to the shares or comparable interests alienated, there is no consensus regarding the evaluation. It should be considered also that an evaluation period would also need a complex set of rules for its application and likely some exceptions (for instance, alienations perform by small shareholders or perform through a stock market) to achieve its purpose.
Although a longer evaluation period seems like a good anti-abuse provision to prevent some forms of tax avoidance, at the same time, they impose the need for clear rules for the determination of the percentage for the potential that they have to establish a more burdensome determination for both the alienator and the Tax Administration.
61 OECD (n 53) 6. Pp. 71.
62 Luca Taglialatela, ‘Treaty Abuse and Passive Income: Holding Period for Intercompany Dividends and Modifications to Article 13 Para. 4 OECD MC’, Preventing treaty abuse, vol 101 (D Blum, M Seiler and M Lang, Linde 2016).
3.2.4. Derive more than 50 percent of their value from immovable property
The most relevant aspect of this provision is the requirement that the alienated shares should derive at least the 50 percent of their value from immovable property situated in the Contracting State, this is the connection factor that allows the situs State to tax the alienation of a non-resident entity, that, in any other situation should be considered as a transaction that falls outside of the tax jurisdiction scope of the State.
According to the MTC Commentaries, the determination of whether the alienated shares or comparable interests has not been subjected of detail recommendations derive more than 50 percent of their value directly or indirectly from immovable property situated in the source State “will normally be done by comparing the value of such immovable property to the value of all the property owned by the company, entity or arrangement without taking into account debts or other liabilities (whether or not secured by mortgages on the relevant immovable property).64” but the details seem to be left to the domestic provisions of the States.
According to Richard Krever “[e]ven in a bilateral world that favours residence jurisdictions, there appears to be almost universal acceptance of a source country’s primary right to fully tax gains from the alienation of immovable property located in that country. There is a clear and close nexus between the political, social, and economic infrastructure offered in a country and generation of those gains.65”, meaning that if the value of shares derived in at least 50 percent from immovable property situated in the source state, it can be said that “there is a close economic connection between the situs state and the gains66.”
The 50 percent threshold is a suggestion of the MTC, the Contracting States can agree on a higher or lower percentage, although some States consider that a lower threshold denaturalises the purpose of this provision given that it could be difficult to sustain that most of the value of the alienated shares or comparable interests come from the value of the immovable property situated.
3.2.5. Directly or indirectly
The wording of Article 13(4) allowed States to tax any offshore indirect alienation of domestic-situs assets, no matter how many interposed entities are between the assets and the entity whose shares or comparable interest are alienated, as long as the aforementioned shares derive more than 50 percent of their value from immovable property situated in the other contracting state.
64 OECD (n 49). Pp. C(13)-10, 28.4.
65 Richard Krever, ‘Discussion of Stefano Simontacchi’s Paper on Article 13 OECD Model Convention’, Source
versus Residence: Problems Arising from the Allocation of Taxing Rights in Tax Treaty Law and Possible Alternatives (M Lang, P Pistone, J Schuch, C Staringer, Kluwer Law International 2008). Pp. 176.
