3.3.3.8 Art. 12 OECD MTC: Royalties

Art. 12 OECD MTC regulates the allocation of the taxing rights in respect of royalties. The state of residence of the beneficial owner of the royalties is allocated the full taxing right.1 Royalties, like interest, are usually deductible from the tax base. Due to the exclusive taxing rights for the state of residence, there is, in principle, no double taxation. The article thus contributes to the objectives pursued by the OECD. Like art. 10 and art. 11 OECD MTC, the article has a bilateral scope of application. The provision does not impose a subject-to-tax requirement.2

There are exceptions to the main rule of exclusive taxing right of the state of residence. For example, the source state may tax royalties if the beneficial owner of the royalties has a permanent establishment in the source state and the item of property or right giving rise to the royalties is effectively connected with the permanent establishment.3

Art. 12, par. 4, OECD MTC includes an anti-abuse provision in accordance with art. 11, par. 6, OECD MTC. The provision is intended to prevent excessive royalties from being paid because of a special relationship between the payer and the beneficial owner. This anti-abuse provision is the only form of a group approach included in art. 12 OECD MTC. Art. 12 OECD MTC provides that the source state is not obliged to refrain from withholding tax on such excessive royalties. For the excess part, other provisions like art. 7 or art. 21 OECD MTC may apply, which could still limit the source state’s ability to deduct withholding tax. If the excessive part is reclassified as a dividend, this would be in scope of art. 10 OECD MTC. It would thus depend on how the excess part would be qualified, whether or not art. 12, par. 4, OECD MTC would prevent tax avoidance in line with the objectives of the OECD MTC.

Because of the great similarity between art. 10 and art. 12 OECD MTC, I refer to the comments included in the section on art. 10 OECD MTC for the comments on the beneficial owner requirement and income recharacterization.