6.3.6 Reorganization clauses

Tax treaties based on the OECD MTC do not, in principle, offer a solution for the tax aspects of international group reorganizations.1 Still, some bilateral tax treaties do contain reorganization provisions. The main problems that are not always solved in the current framework are timing mismatches and differences in characterization.2 A proper interpretation can be left to the national courts of the Contracting States. However, even though timing mismatches are generally not solved in tax treaties, adding a reorganization provision to the OECD MTC seems advisable to comprehensively eliminate double taxation and to stimulate cross-border investments by providing legal certainty. Such a provision should eliminate double taxation, without providing tax avoidance opportunities. Therefore, it should contribute to a more neutral tax system.

There are large differences in domestic law with respect to the domestic taxation of reorganizations, making it difficult to provide a general solution. The restructuring provision in the bilateral tax treaty between Canada and the United States is recommended by Jiménez-Valladolid de l’Hotellerie-Fallois. The provision reads as follows:3

A positive aspect of this provision is the fact that it includes all kinds of reorganization options. It gives the Contracting States the option to provide for deferral of taxation under certain circumstances. Application of the rule requires a case-by-case approach. Jiménez-Valladolid de l’Hotellerie-Fallois views the provision as a flexible solution to overcome the difficulties that follow from the discretion given to the tax authorities when applying the clause.4 However, Ault and Sasseville indicate that the scope of the provision is rather limited, as it is specifically aimed at solving a certain timing mismatch. The provision only applies if the initial alienation of the property is potentially taxable in both Contracting States, while only one of the states provides for deferral of taxation on the basis of its domestic law. Additionally, it does not provide legal certainty to taxpayers, as the provision provides some degree of discretion to the tax authorities. Therefore, it would only contribute to a limited extent to achieving the objectives of the OECD MTC.5 All in all, even though the flexibility of the provision is a clear advantage, the provision does not seem a desirable addition to the OECD MTC due to its limited scope of application as well as its uncertain character.

Li and Avella discuss a second common type of treaty provisions that deal with corporate reorganizations: rules that do no allocate taxing rights to the source state, so the alienation is solely covered by the residence state. It would then depend on the domestic law of the residence state whether or not the reorganization would lead to taxation. Attributing the taxing rights to the jurisdiction of the alienator (the residence state) seems logical, as the deferred claim on the underlying assets (the increase in value of those assets has led to the increase in the value of the shares) remains available after the share transfer. However, the question is whether the source state would agree to this, as it would mean their direct taxing rights would be taken away. Additionally, to make sure there is no double taxation with respect to the alienation of shares, the source state should allow ‘a bump-up in the cost basis of the share in computing the amount of taxable gains.’6 A provision that seems to meet this objective, is the provision that is included in the Protocol to the tax treaty between Mexico and the Netherlands:7

The provision applies to a specific range of reorganizations, is self-executing and requires an adjustment of the cost basis without a MAP.8 The provision aims to eliminate double taxation, without providing possibilities for tax avoidance. Therefore, it stimulates cross-border activities and leads to a more neutral system. Another advantage of such a provision in comparison to the provision in the treaty between Canada and the United States is that it provides legal certainty as no mutual agreement between the Contracting States would be required. By providing legal certainty, cross-border activities would be stimulated. All in all, this provision is my view clearly preferable over the provision in the treaty between Canada and the United States.

Apart from the aforementioned, it should be noted that some countries include a specific provision in their reorganization clause to prevent taking abuse of the beneficial treatment of reorganizations.9 For an OECD compliant tax treaty this seems not necessary, as abuse would already be in scope of the PPT.

The proposal by Maisto might be of interest for countries that would not be in favour of a full reorganization provision in tax treaties. In an intra-EU parent-subsidiary context, the author proposes to fully exempt capital gains on disposals of shares: both in the state of residence of the parent company and in the state of residence of the subsidiary company.10 This would eliminate economic double taxation in group situations. The reasoning behind such an approach is that the higher value of shares is attributable to the undistributed profits of the company. Therefore, the capital gain can be seen as economically equivalent to a profit distribution. The introduction of such a provision could contribute to achieving the OECD MTC objectives. It would, however, be more limited in scope than the aforementioned two options and thus also contribute to achieving the OECD MTC objectives to a lesser extent.

The exact wording of a reorganization provision to be used would depend on the domestic law and the tax treaty policy of the Contracting States. It would be important to provide for tax relief with respect to intra-group reorganizations via tax treaties. In designing such a tax treaty provision, it should be kept in mind that a provision that fully restricts the source state from taxation might be a desirable solution (if the source state agrees with this approach). In my view, the provision as included in the tax treaty between Mexico and the Netherlands could be a starting point. As indicated, it would eliminate double taxation without providing tax avoidance possibilities. An important advantage of this ‘easy’ approach is the legal certainty in comparison with a provision that requires a mutual agreement between the relevant states. Additionally, it is a more comprehensive solution than the partial solution suggested by Maisto. Therefore, an intra-group reorganization provision that fully restricts the source state from taxation seems to provide the best match with the objectives of the OECD MTC.