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International taxation of cross-border leasing income
Mehta, A.S.
Publication date
2004
Link to publication
Citation for published version (APA):
Mehta, A. S. (2004). International taxation of cross-border leasing income.
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2.1. . 2.2. . 2.2.1. . 2.2.2. . 2.2.2.1 1 Forewordd v Chapterr 1: Introduction 1
Chapterr 2: Transaction/lease characterization aspects 7
Introductionn 7 Leasee characterization in the United States 7
Truee lease: prerequisite for obtaining the tax
advantagee 7 Thee IRS view 8 Revenuee Ruling 55-540: IRS view on what
constitutess a "true lease" 8 2.2.2.2.. Revenue Procedure 75-21: Detailed Guidelines for
grantingg advance rulings 9 2.2.2.3.. Revenue Procedure 2001-28 12 2.2.3.. Judicial developments 13
2.23A.2.23A. Case law developments vis-a-vis the Guidelines
requirements:: a comparison 13 2.2.3.2.. Court decisions on transaction characterization:
leasee v. sale 14 2.3.. Lease characterization in the United Kingdom 16
2.3.1.. Definition of finance lease 17 2.3.1.1.. Relevance of Generally Accepted Accounting
Principless 17 2.3.1.2.. Definition of "finance lease" under SSAP 21 17
2.3.2.. Court decision on characterization of lease
transactionn 18 2.4.. Lease characterization in Germany 18
2.4.1.. Significance of economic ownership 18 2.4.2.. Definition of economic ownership 18 2.4.3.. German Supreme Fiscal Court decision on
transferr of economic ownership 19 2.4.4.. Tax circulars on attribution of economic ownership 19
2.5.. Lease characterization in the Netherlands 20 2.5.1.. Significance of economic ownership 20 2.5.2.. Hoge Raad decision on economic ownership 20
2.5.3.. Lease arrangement 21 2.6.. Lease characterization in Japan 23
2.6.1.. Lease v. sale 23 2.6.2.. Finance lease 25
Chapterr 3: Depreciation/capital allowances aspects 27
3.1. . 3.2. . 3.2.1. . 3.2.1.1. . 3.2.1.2. . 3.2.1.3. . 3.2.2. . 3.2.2.1. . 3.2.2.2. . 3.2.3. . 3.2.4. . 3.2.5. . 3.3. . 3.3.1. . 3.3.2. . 3.3.3. . 3.3.3.1. . 3.3.3.2. . 3.3.3.2.1. . 3.3.3.2.2. . 3.3.3.3. . 3.3.4. . 3.3.5. . 3.4. . 3.4.1. . 3.4.2. . 3.4.2.1. . 3.4.2.2. . 3.4.2.3. . 3.4.3. . 3.4.4. . 3.4.5. . Introduction n
Generall scheme of depreciation allowance Unitedd States
Generallyy applicable method of depreciation Applicablee recovery period
Applicablee convention Unitedd Kingdom General l
Capitall allowances for cars Germany y
Netherlands s Japan n
Eligibilityy for depreciation allowance (ownership criterion) )
Unitedd States Unitedd Kingdom Germany y
Economicc ownership
Circularss issued by the Federal Ministry of Finance Fulll pay-out v. non-full pay-out leasing
Attributionn of the economic ownership in the casee of full pay-out leasing
Attributionn of the economic ownership in the case of non-fulll pay-out leasing
Netherlands s Japan n
Acceleratedd depreciation/capital allowances Unitedd States
Unitedd Kingdom First-yearr allowances Capitall allowances for ships
Rolloverr relief in respect of disposal of ships Germany y Netherlands s Japan n 27 7 28 8 28 8 29 9 29 9 29 9 30 0 30 0 31 1 32 2 32 2 33 3 33 3 34 4 34 4 35 5 35 5 36 6 36 6 37 7 37 7 39 9 40 0 40 0 40 0 40 0 40 0 41 1 42 2 43 3 44 4 44 4 Vlll l
3.5. . 3.5.1. . 3.5.1.1. . 3.5.1.2. . 3.5.1.2.1. . 3.5.1.2.2. . 3.5.2. . 3.5.2.1. . 3.5.2.2. . 3.5.2.3. . 3.5.2.4. . 3.5.2.5. . 3.5.2.6. . 3.5.2.7. . 3.5.3. . 3.5.4. .
Restrictionss on depreciation/capital allowances inn case of leasing
Unitedd States
Alternativee Depreciation System (ADS) Exceptions s
Qualifiedd technological equipment (QTE) Otherr exceptions
Unitedd Kingdom
DenialDenial of the first-year allowance Restrictionn in the case of a purchase option Restrictionn on capital allowances in the year of acquisition n
Restrictionss in the case of overseas/export leasing Restrictionn in respect of free depreciation on thee ships used for overseas leasing
Restrictionss in the case of sale and finance leaseback arrangements s
Restrictionss in the case of sale and finance leasebackk on defeased terms
Germanyy and the Netherlands Japan n 45 5 45 5 45 5 46 6 46 6 48 8 48 8 48 8 49 9 49 9 50 0 51 1 52 2 52 2 53 3 53 3
Chapterr 4: Income recognition aspects 55
4.1. . 4.2. . 4.2.1. . 4.2.2. . 4.2.3. . 4.2.3.1. . 4.2.3.1.1. . 4.2.3.1.2. . 4.2.3.2. . 4.2.3.2.1. . Introduction n
Relevantt income recognition rules in the USA (IRCC Sec. 467 and Final Sec. 467 Regulations) Applicabilityy of IRC Sec. 467
Consequencess of applicability of Sec. 467: income taxationn on an accrual basis
Rentt accruals under Sec. 467
Rentt accrual in the case of agreements not perceivedd as "tax avoidance transactions" Relevantt provision in IRC Sec. 461(b)(1) Rentt computation formulae prescribed under thee Regulations
Rentt accrual in the case of perceived "tax avoidance transactions" "
Taxx treatment of rents under the perceived "tax avoidancee transactions" 55 5 56 6 56 6 57 7 57 7 57 7 57 7 58 8 59 9 59 9 IX X
4.2.3.2.2. . 4.2.4. . 4.2.5. . 4.3. . 4.3.1. . 4.3.2. . 4.3.2.1. . 4.3.2.2. . 4.3.2.3. . 4.4. . 4.5. . 4.6. .
Meaningg of the perceived "tax avoidance transactions" "
Sec.. 467 interest Safe-harbourr provisions
Relevantt income recognition rules in the Unitedd Kingdom
Taxationn of operating lease rental income Taxationn of finance lease rental income Background d
Returnn of investment in capital form Negativee depreciation
Relevantt income recognition rules in Germany Relevantt income recognition rules in the Netherlands s
Relevantt income recognition rules in Japan
60 0 61 1 61 1 62 2 62 2 62 2 62 2 62 2 64 4 65 5 66 6 66 6
Chapterr 5: Limits of tax-driven cross-border leasing transactions 69
5.1. . 5.2. . 5.2.1. . 5.2.1.1. . 5.2.1.2. . 5.2.1.3. . 5.2.1.4. . 5.2.1.5. . 5.2.1.6. . 5.2.1.7. . 5.2.2. . 5.2.2.1. . 5.2.2.2. . 5.2.2.3. . Introduction n
Relevantt anti-avoidance rules in select jurisdictions: aa brief overview
Unitedd States
Thee sham transaction doctrine Thee step transaction doctrine Thee business purpose Doctrine Thee substance-over-form doctrine
Thee economic substance or the economic sham transactionn doctrine
Thee US Supreme Court decision in the Frank
LyonLyon case
Applicationn of "two-fold test" by the lower courtss in the United States
Unitedd Kingdom
Thee Ramsay principle (W.T. Ramsay v. IRC) Thee step-transaction doctrine (Furniss v.
DawsonDawson and Craven v. White)
Tradingg transactions v. transactions with the sole objectivee of obtaining tax advantage (Overseas
ContainersContainers (Finance) Ltd, v. Stoker (Inspector) and LuptonLupton v. FA. &AB. Ltd.)
69 9 70 0 70 0 71 1 71 1 72 2 73 3 73 3 75 5 76 6 77 7 77 7 78 8 78 8 X X
5.2.2.4. . 5.2.3. . 5.3. . 5.4. . 5.4.1. . 5.4.1.1. . 5.4.1.2. . 5.4.1.3. . 5.4.1.3.1. . 5.4.1.3.2. . 5.4.1.4. . 5.4.2. . 5.4.2.1. . 5.4.2.2. . 5.4.2.2.1. . 5.4.2.2.2. . 5.4.2.2.3. . 5.4.2.2.4. . 5.4.2.2.5. . 5.4.3. . 5.4.3.1. . 5.4.3.2. . 5.4.3.3. . 5.43.4. . 5.4.4. . 5.4.4.1. . 5.4.4.2. . 5.4.4.3. . 5.4.5. . 5.4.5.1. .
Thee limits of the Ramsay principle (MacNiven
(Inspector(Inspector of Taxes) v. Westmoreland InvestmentsInvestments Ltd)
Germanyy and the Netherlands
Legall system: impact on tax-driven cross-border leasingg transactions
Tax-drivenn leasing transaction structures Salee and leaseback
Naturee of the transaction
Thee US: Court of Appeals decision in Sun Oil Co. v.
CommissionerCommissioner of Internal Revenue
Unitedd Kingdom
Restrictivee provision under the Capital Allowancess Act 2001
UKK Court of Appeals decision in BMBF case Netherlands:: "technolease" cases
Chain-leasee structure Naturee of the transaction
BMBFBMBF (No 24) v. Inland Revenue Commissioners
Relevantt facts
Relevantt statutory provisions
Relevantt issues before the High Court
Decisionn by the High Court on applicability of Sec.. 42(3) to headlease or sublease
Criticall remarks on the High Court decision Double-dipp leasing
Naturee of transaction
Typicall double-dip lease structure
Howw does double-dip leasing provide a tax advantage? ?
Cann double-dip lease, per se, be regarded as abusive? ?
Two-tierr double-dip structures Naturee of transaction
Usee of two-tier double-dip structures in Japan Cann two-tier double-dip leasing, per se, be regardedd as abusive? Leveragedd leasing Naturee of transaction 79 9 81 1 82 2 85 5 85 5 85 5 86 6 86 6 86 6 88 8 88 8 89 9 89 9 89 9 89 9 91 1 92 2 92 2 95 5 95 5 95 5 96 6 97 7 98 8 99 9 99 9 99 9 100 0 102 2 102 2 X I I
5.4.5.2.. Comparative analysis of anti-deferral provisions (too counter rear-loaded leases) under the US and
thee UK tax laws 103 5.4.5.3.. Use of non-recourse debt funding in leveraged
leases:: position in the United States and the
Unitedd Kingdom 105 5.4.5.3.1.. United States: "at risk" provisions of Sec. 465 of
thee IRC 105 5.4.5.3.2.. United Kingdom: House of Lords decision in
EnsignEnsign Tankers case 106
5.4.5.3.3.. United Kingdom: implications of Ensign Tankers decisionn on leveraged leases involving
non-recoursee debt financing 111 5.4.5.4.. German leveraged leases 114 5.4.5.5.. Modified German leveraged leases (modified
subsequentt to Sec. 2b introduction) 115
5.4.5.6.. Japanese leveraged leases 117 5.4.6.. Replacement leases 118 5.4.7.. Like-kind exchange structure 119
5.4.8.. Lease-in-lease-out (LJLO) 120 5.4.9.. Tax sparing credit (TSC) structures 121
5.4.10.. Japanese safe-harbour structures (agreement betweenn Japanese tax authorities and Japan
Leasingg Association) 122 5.4.11.. Tokumei Kumiai arrangements 123
5.4.12.. Japanese operating leasing 124 5.4.13.. Defeasance structures 126 5.4.13.1.. Nature of transaction 126 5.4.13.2.. United Kingdom Court of Appeals decision in
BarclaysBarclays Mercantile Business Finance Ltd.
v.. Maw son (Inspector of Taxes) 127
5.4.13.2.1.. Relevant facts 127 5.4.13.2.2.. Position taken by the tax authorities 129
5.4.13.2.3.. Decision by Special Commissioners 129
5.4.13.2.4.. High Court decision 130 5.4.13.2.5.. Court of Appeals decision 131
Chapterr 6: Tax treaty implications of lease income
characterizationn 133 6.1.. Introduction 133 6.2.. Tax treaty definition of "royalties" vis-a-vis
leasee rentals for ICS equipment 133
6.2.1.. The OECD position 133 6.2.2.. Definition of "royalties" in tax treaties 134
6.3.. The characterization issue: effect on treaty
distributivee rules 135 6.3.1.. Complexity of the issue 135 6.3.2.. Characterization: from which state's perspective? 135
6.4.. Characterization of the finance lease income 137 6.4.1.. Finance lease rentals vis-a-vis "royalties" in
treatyy context 137 6.4.2.. Finance lease rentals and "interest" in treaty
contextt 138 6.4.2.1.. The characterization issue 138
6.4.2.2.. OECD position 139 6.4.2.3.. Definition of interest in tax treaties 139
6.4.2.4.. Scope of definition of interest (version a): incomee from debt claims (similar to OECD
definition)) 140 6.4.2.5.. Scope of definition of interest (version b): income
assimilatedd to income from money lent 142
6.4.2.5.1.. Position in the United States 142 6.4.2.5.2.. Position in the United Kingdom 143 6.4.2.5.3.. Position in Germany and the Netherlands 146
6.5.. Characterization of operating lease income 147
Chapterr 7: Tax treaty aspects of taxation of cross-border leasing
incomee in the source state 149
7.1.. Introduction 149 7.2.. Differing provisions in bilateral tax treaties 149
7.2.1.. Differing provisions concerning royalties 149 7.2.1.1.. Right to tax royalty income and treaty definition of
"royalties"" 149 7.2.1.2.. Withholding tax: rate differences 150
7.2.2. . 7.2.2.1. . 7.2.2.2. . 7.2.3. . 7.2.4. . 7.3. . 7.3.1. . 7.3.2. . 7.3.2.1. . 7.3.2.1.1. . 7.3.2.1.2. . 7.3.2.1.3. . 7.3.2.2. . 7.3.2.3. . 7.3.2.3.1. . 7.3.2.3.2. . 7.3.2.3.3. . 7.3.2.4. . 7.4. . 7.4.1. . 7.4.1.1. . 7.4.1.2. . 7.4.1.3. . 7.4.1.4. . 7.4.1.5. . 7.4.1.6. . 7.4.1.7. . 7.4.1.8. . 7.4.2. .
Differingg provisions concerning "interest" income Taxingg right and rate differences
"Beneficiall ownership" requirement
Differingg provisions concerning taxation of capital gains s
Implicationss of differing provisions in bilateral tax treaties s
Entitlementt to treaty benefits in case of improper usee of tax treaties (by third-country residents) Relevancee of the issue in cross-border leasing transactions s
Entitlementt in case of improper use of tax treaties: contemporaryy position
Thee OECD view
Thee 1977 and 1992 OECD MC Commentaries Thee OECD Conduit Companies Report
Thee 2003 version of the OECD MC Commentary ViewsViews expressed by commentators
Courtt decisions on treaty entitlement of interposed entities s
Courtt decisions in the United States Courtt decisions in the Netherlands Courtt decisions in Germany Conclusion n
Anti-abusee tax treaty provisions relevant for cross-borderr leasing transactions
Beneficiall ownership
Thee "beneficial owner" requirement
Purposee of the "beneficial owner" requirement Definitionn of the term "beneficial owner" OECDD Commentary on the term "beneficial owner" "
Internationall tax language meaning of "beneficiall owner"
Beneficiall ownership of income rather than the income-producingg asset
Implicationss of absence of "beneficial ownership" requirementt in a tax treaty
Thee two sublease case studies vis-a-vis the "beneficiall ownership" requirement "Limitationn on benefits" article
150 0 150 0 151 1 151 1 151 1 153 3 153 3 154 4 154 4 154 4 154 4 155 5 157 7 158 8 158 8 160 0 161 1 162 2 163 3 163 3 163 3 163 3 164 4 165 5 166 6 167 7 167 7 171 1 172 2 XIV V
8.1. . 8.2. . 8.2.1. . 8.2.2. . 8.2.3. . 8.2.3.1. . 8.2.3.2. . 8.2.3.2.1. . 8.2.3.2.2. . 8.2.3.2.3. .
Chapterr 8: Relevance of the EC Treaty (cross-border leasing
betweenn the EC Member States) 175
Scopee of the chapter 175 UKK capital allowance restrictions in the case
off outbound leases 176 Thee restrictive provision 176 Conflictt with a Treaty freedom 177 Potentiall justifications for the restrictive
nationall tax law provision 178 Needd to prevent loss of revenue 178
Fiscall cohesion 180 "Fiscall cohesion" argument: seldom accepted
byy the EC J 180
BackmanBackman and Commission v. Belgium 180
Thee two prerequisites for acceptance of the "fiscal
cohesion"" argument 181 8.2.3.2.4.. The UK restriction of capital allowance on
outboundd leases: the two conditions for the
"fiscall cohesion" argument not satisfied 184
8.2.3.3.. The abuse argument 185 8.2.3.3.1.. Argument not yet accepted by the ECJ in tax cases 185
8.2.3.3.2.. Can the Treaty be relied upon to shield abusive
transactions?? 188 8.2.3.3.3.. The abuse argument vis-a-vis the UK restriction
off capital allowances in the case of outbound leases 191
8.2.3.4.. Fiscal supervision 191 8.2.3.5.. Territoriality argument 193 8.2.4.. Main conclusion on the issue 193 8.3.. Denial of group relief in respect of losses suffered
byy subsidiaries resident in other Member States 193
8.3.1.. The issue 193 8.3.2.. The Marks & Spencer case 194
8.3.3.. Conflict with a Treaty freedom (freedom of
establishment)) 198 8.3.4.. Potential justifications for the restrictive national
taxx law provision 199 8.3.4.1.. The argument relating to the need to prevent loss of
revenuee 200 8.3.4.2.. The "fiscal cohesion" argument 200
8.3.4.4.. "Fiscal supervision" argument 204 8.3.4.5.. Territoriality argument 205 8.3.5.. Main conclusion on the issue 206
8.4.. Final conclusions 206
Chapterr 9: Summary, conclusions and recommendations 207
9.1. . 9.2. . 9.2.1. . 9.2.1.1. . 9.2.1.2. . 9.2.1.3. . 9.2.2. . 9.2.2.1. . 9.2.2.2. . 9.2.2.3. . 9.2.2.4. . 9.2.3. . 9.2.3.1. . 9.2.3.2. . 9.2.4. . 9.2.4.1. . 9.2.4.2. . 9.2.4.3. . 9.2.4.4. . 9.2.4.4.1. . 9.2.4.4.2. . 9.2.4.4.3. . 9.2.4.4.4. . 9.2.4.4.5. . Background d
Summaryy and conclusions Incomee recognition aspects
Thee tax deferral advantage of rear-loaded lease rentals s
Relevantt anti-avoidance provisions in select jurisdictions s
Effectivenesss of anti-avoidance provisions in thee United States vis-a-vis the United Kingdom Depreciationn aspects
Significancee of depreciation allowance in tax-drivenn leasing transactions
Generall scheme of depreciation allowances in thee select jurisdictions
Eligibilityy criteria for depreciation allowance (legall v. economic ownership)
Incentivess and restrictions
Transactionn characterization aspects Significancee of transaction characterization Transactionn characterization in select jurisdictions Legall systems, anti-avoidance principles and aggressivelyy tax-driven transaction structures Tendenciess of taxpayers towards aggressively tax-drivenn transactions
Scopee of general anti-avoidance rules
Impactt of legal systems on tax-driven cross-border leasingg transactions
Tax-drivenn transaction structures Salee and leaseback transactions Chain-leasee transaction structure Double-dipp leasing
Two-tierr double-dip leasing Leveragedd leasing 207 7 207 7 207 7 207 7 207 7 208 8 208 8 208 8 209 9 210 0 212 2 212 2 212 2 213 3 215 5 215 5 216 6 217 7 219 9 219 9 219 9 220 0 220 0 220 0 XVI I
9.2.4.4.5.1. . 9.2.4.4.5.2. . 9.2.4.4.5.3. . 9.2.4.4.6. . 9.2.5. . 9.2.5.1. . 9.2.5.2. . 9.2.5.3. . 9.2.5.3.1. . 9.2.5.3.2. . 9.2.6. . 9.2.6.1. . 9.2.6.2. . 9.2.6.3. . 9.2.6.4. . 9.2.7. . 9.2.7.1. . 9.2.7.2. . 9.2.7.3. . 9.3. . 9.3.1. . 9.3.2. . 9.3.3. .
Leveragedd leases with uneven rents Leveragedd leases involving non-recourse financing financing
Germann leveraged and modified leveraged leases Defeasancee structures
Taxx treaty implications of transaction characterization n
Taxx treaty definition of "royalties"
Taxx treaty characterization in the case of operating lease e
Taxx treaty characterization in the case of finance lease e
Thee issue of tax treaty characterization as "royalties" "
Thee issue of tax treaty characterization as "interest" "
Differingg provisions in tax treaties and improper usee of tax treaties
Differingg provisions in tax treaties
Improperr use of tax treaties and entitlement to treaty application n
Implicationss of absence of "beneficial ownership" requirementt in tax treaties
Effectt of typical "Limitation on benefits" article on leasingg entities
Relevancee of EC Treaty in the context of cross-borderr leasing
ECC freedom to provide services: leasing constitutess a service
Overseass leasing: capital allowance restrictions Compatibilityy of group relief regimes with the ECC Treaty
Recommendations s
Amendmentss to UK tax law for taxation of financee lease rentals on an accrual basis UKK safe-harbour rules for leasing transactions Amendmentss to the Capital Allowances Act 2001 (UK)) in respect of cross-border leases with lesseess resident in the other EC Member States
220 0 220 0 221 1 221 1 221 1 221 1 221 1 222 222 222 2 222 2 223 3 223 3 224 4 225 5 225 5 226 6 226 6 226 6 226 6 227 7 227 7 228 8 229 9 xvii i
9.3.4.. Amendments to group relief regimes under the taxx laws of the United Kingdom, Germany and
thee Netherlands 229 9.3.5.. Strengthening specific anti-avoidance regime
underr the UK tax law 230 9.3.6.. United Kingdom: specific restrictive provision
concerningg interest on non-recourse finance 232 9.3.7.. Inclusion of clarifications in tax treaties:
aspectss relating to characterization of
financee lease income 232
Appendices s 235 5
Appendixx 1 US case law on lease v. conditional sale Appendixx 2 Special and accelerated depreciation in Japan Appendixx 3 List of treaties examined
Appendixx 4 ECJ cases examined for ascertaining argumentss advanced by the Member States too justify restrictive provisions under the nationall direct tax laws
235 5 249 9 253 3
255 5
Bibliography y Tablee of case law Dutchh summary
257 7 263 3 269 9
