4.3.4.3 MD benefits & the OECD MTC

What lessons can be learned from the MD for the treatment of groups of companies under tax treaties? The MD aims to eliminate tax obstacles that can hinder cross-border restructurings, mainly by providing for a deferral of tax on gains.1 The OECD MTC does not provide for a reorganization clause as such.2 However, art. 13 OECD MTC allocates the right to tax the gains from immovable property to the state in which it is situated.3 Additionally, the right to tax the gains from the alienation of movable property that forms part of the business property of a permanent establishment is allocated to the state in which the permanent establishment is situated.4 Other transfers of assets are covered by the final paragraph of the capital gains article.5 This paragraph allocates the taxing right with respect to a disposal of shares to the state of residence of the alienator of the shares.6 The gain from the transfer of shares is thus solely taxable in the state of the shareholder.7 An exception to this main rule is made for immovable property companies.8 Under that rule the right to tax the gain is allocated to the state of the shareholding. The provisions seem to provide a partial solution for reorganizations in a cross-border context.

To get a better idea of the scope of art. 13 OECD MTC, the question arises how the words ‘alienation of property’ should be interpreted. As there is no treaty definition, the domestic law definition of the Contracting State that applies the treaty would be leading, unless the context of the treaty would require otherwise.9 According to the OECD Commentary the words ‘alienation of property’ are used to cover ‘in particular capital gains resulting from the sale or exchange of property and also from a partial alienation, the expropriation, the transfer to a company in exchange for stock, the sale of a right, the gift and even the passing of property on death’.10 Given this explanation, in literature it has been concluded that cases of mergers, the exchange of shares or division of enterprises, the contribution of an enterprise or part of an enterprise to a different enterprise or change of the legal form (transformation of a company to a partnership and the other way around), are also capital gains as referred to in art. 13 OECD MTC.11 This would imply that there would be no need for a reorganization provision in the OECD MTC.

There are various bilateral tax treaties that provide for more general provisions that deal with reorganizations.12 The reason for this is the fact that – even if reorganizations are fully covered by the treaty according to the domestic law of the Contracting State – corporate reorganizations can lead to various treaty issues, which are not always solved within the current treaty framework.

An example of an issue that may arise in the context of cross-border reorganizations that is currently not always solved at a tax treaty level is a timing mismatch. This can be the case if a merger takes place in the residence state, while the absorbed company owns an asset in the source state. Maisto gives the example of company A and B, resident in state R. Company A owns immovable property in state S (see figure 4.7). Company A and company B merge. If according to the residence state the merger should not lead to tax consequences, the source state may still consider the change of title to the asset that is located in its territory to be a taxable event. If that is the case, this leads to the following consequences:13

According to the OECD Commentary, even if there is such a timing mismatch, the residence state must give relief for double taxation regardless of when the tax is levied by the source state.14 It is thus up to the residence state to provide relief of double taxation via the credit or exemption method, also in cases in which the source state taxes the item of income or capital in an earlier or later year.15 However, as in practice the OECD MTC wording for art. 23 A and 23 B is not always followed,16 solving timing mismatches can require, e.g., a MAP.17

Additionally, a difference in characterization of a corporate reorganization can lead to double taxation, which is not necessarily solved via the application of tax treaties. This could for example be the case for the transfer of an asset in the source state due to a merger of two entities in the residence state, which is characterized as a capital gain in the source state, while it is seen as a dividend in the residence state.18 According to the OECD Commentary it would in such a case again be up to the residence state to grant relief from double taxation.19

Over thirty years ago, the OECD already recognised that the lack of a reorganization provision is an obstacle to international mergers and reorganizations.20 So far this has not led to a change in the OECD MTC. In my view, given the current existing framework, a reorganization provision would be a good addition to the OECD MTC with a view to comprehensively eliminate double taxation and to stimulate cross-border investments. The question then arises what this reorganization clause would have to look like, considering the major differences between the national laws in the different states. In literature it has been suggested that a generic solution that grants some degree of discretion to the tax authorities of the Contracting States may be the best that could be achieved.21

Taking it a step further, truly eliminating the tax obstacles that hinder cross-border reorganizations would require a shift in approach. Departing from the separate entity principle and applying a full group approach would mean that no reorganization clauses would be necessary for groups of companies at all. This new approach is explained in more detail in the following chapters.