4.3.3.3 IRD benefits & the OECD MTC

To what extent are the IRD group benefits similar to the benefits already provided under the OECD MTC with respect to interest and royalties? The first question that arises in this respect is whether the terms interest and royalties are defined in a similar manner in the IRD and the OECD MTC. The IRD defines interest as income from debt claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. A penalty charge for late payment will not be regarded as interest.1 The definition of interest as included in the IRD is almost exactly the same as the definition that is included in the OECD MTC.2 From the explanatory memorandum accompanying a draft proposal for the IRD, it follows that the definition is based on the one used in the OECD MTC.3

In the IRD the term royalties means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematograph films and software, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience. Additionally, payments for the use of, or the right to use, industrial, commercial or scientific equipment are to be regarded as royalties.4 For this definition the EC also made use of the definition as included in the OECD MTC.5 However, for application of the OECD MTC the ‘payments for the use of, or the right to use, industrial, commercial or scientific equipment’ are governed by the business profits articles.6 Furthermore, the IRD definition explicitly includes payments relating to software. Therefore, the OECD definition of royalties is narrower than the IRD definition. The derogations from the OECD definition probably relate to the difference in purpose of the two instruments: the goal of the Directive is to eliminate source taxation of intra-EU cross-border transactions within groups of companies, while tax treaties more in general aim to allocate the taxing powers regarding interest and royalty income of any kind.7 There are thus no differences between both definitions that should be taken into account in determining whether IRD-like benefits would be desirable for groups of companies in a tax treaty context.

Art. 11 OECD MTC gives the source country the opportunity to withhold a limited withholding tax of 10%. It is then up to the residence state to provide relief for double taxation. No minimum holding percentage is required for application of the article. For interest the IRD is – given that the strict application requirements are met – more beneficial for taxpayers, as it provides for a full elimination of withholding taxes. For the withholding tax on interest, an OECD MTC compliant tax treaty will provide for the prevention of juridical double taxation at the level of the recipient via the application of art. 23 A or 23 B OECD MTC. However, usually the juridical double taxation is not fully eliminated, as withholding tax is levied as a percentage of the gross amount, whereas for determining the credit for taxes paid abroad the net amount is taken into account.8

Art. 12 OECD MTC gives the state of the beneficial owner the exclusive right to tax the royalties.9 Art. 12 OECD MTC thus has in essence the same effect as the application of the IRD, noting that the scope of application of the provision is broader, as the OECD MTC provision does not prescribe any shareholding requirement.

If there is a special relationship between the payer and the beneficial owner of the interest or royalties, or between one of them and some other person, benefits are only partially granted both under the IRD10 and the OECD MTC.11 In that situation, the benefits are restricted to the amount which would have been agreed by the payer and the beneficial owner had no such special relationship existed.

The IRD provides for specific rules regarding the treatment of permanent establishments of qualifying companies. As explained in par. 4.3.2.3, the involvement of permanent establishments in a structure can lead to double taxation as well as tax avoidance opportunities for the application of tax treaties which cannot easily be solved within the current tax treaty framework.

The question arises whether, assessed from the scope and objectives of the OECD MTC, on a tax treaty level benefits similar to the IRD should be available in group situations. As described, the IRD aims to prevent juridical double taxation of interest and royalty payments under specific circumstances. In essence, the IRD provides a group approach with the aim to prevent juridical double taxation. The OECD MTC also aims to eliminate juridical double taxation. Due to the concurrence between the goals of the IRD and the OECD MTC, a similar approach with respect to interest and royalty payments in group situations seems conceptually desirable.

The IRD applies a more beneficial treatment of interest payments compared with the OECD MTC, while the treatment for royalties is similar. For the OECD MTC it could be considered to fully prevent juridical double taxation in group situations for interest payments as well. Such a more extensive group approach would better take into account the group situation of a multinational company. As for interest payments a holding in the capital of the company is not required, it would have to be determined under which requirements such a group approach would have to be applied (i.e., how should the concept of group be defined). To fully eliminate juridical double taxation with respect to interest payments in group situations on a treaty level – using the current framework – it seems most logical to amend the distributive rule (similar to the article on royalties) to allocate taxing jurisdiction on an exclusive basis to the residence state.

A downside of eliminating withholding taxes on interest in intra-group situations is that it could provide additional tax avoidance opportunities, as interest payments are deductible. Moreover, in essence, the aforementioned is solely aimed at eliminating one of the problems that is the result of the separate entity principle that is at the heart of the international tax domain. Truly solving this problem, rather than countering one of the consequences, would require a comprehensive shift in approach. If a group approach would be applied, there would be no intra-group interest and royalty payments whatsoever. This shift in approach is elaborated upon in the following chapters.