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1/23/2010
1
DIVIDEND, INTEREST & CAPITAL
GAINS – BASIC CONCEPTS
Workshop on
Basics of International Taxation
Institute of Chartered Accountants of India
CA Kusuma YathishB.Com, LLB, FCA
PARTNER
M/S. SHEKAR & YATHISH
PASSIVE INCOMES
1/23/2010
2
OBJECTIVE
Jurisdictional Taxing Rights
Investment Incomes
– Dividend
– Interest
Capital Gains
UN Model Convention
PRINCIPLES OF INTERNATIONAL
TAXATION
Jurisdiction Exclusivity
Resident Country Taxation
Source Country Taxation
Domestic law
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3
DIVIDEND
DIVIDENDS
Meaning of Dividend under International
Tax;
Taxation thereof;
Participatory and Portfolio Dividends;
Dividend and PE;
Beneficial Ownership;
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DEFINITION OF DIVIDEND -DTAA
The term Dividends as used in this article means
income from share.
“Jouissance” shares or :Jouissance” rights
Mining shares,
Founders Shares, or
Other rights, not being debt-claim, participating in profits,
Income from other corporate rights which is subjected to
the same taxation treatment as income from shares by the
law of [ Country S].
DIVIDENDS – MEANING
Distribution of profits or shareholders
funds
Cash or kind
Deemed Dividends / Constructive
Dividends
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TAXATION
Domestic Tax Laws
– Gross Dividend / Net Dividend
– Withholding tax
DTAA
– Resident State
– Source State
DIVIDENDS – ARTICLE 10(1) & 10(2)
Right is to the Resident State
Source State may also Tax
This implies that if Domestic Law of Country R taxes
foreign dividends derived by its resident share
holders, the DTA between Country R and Country S
is not going to stop Country R from doing so.
OECD Vs. UN model DTAA‟s
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Participation Dividends
Portfolio Dividends
a. 5% of the gross amount of dividends if the beneficial
owner is a company (other than a partnership) which
holds directly at least 25% of the capital of the
company paying dividends.
b. 15% of the gross amount of Dividends in all other
cases.
DIVIDENDS AND PERMANENT
ESTABLISHMENTS
- Art.10(4) of the OECD model DTA provides for special
treatment of Dividend received by a permanent establishment
of a non resident in the source state.
- It provides that the provisions of paragraph 1 and 2 shall not
apply if the „beneficial owner‟ of the Dividends, being a
resident of [Country R], carries on business in [Country S]
through a permanent establishment situated [in Country S]
and the holding in respect of which the dividends are paid is
„effectively connected‟ with such permanent establishment. In
such case the provisions of Article 7 shall apply.
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DIVIDENDS AND PE – CONTD.,
o The UN Model DTA extends this provision beyond only
permanent establishment to the fixed bases in Country S of
taxpayers who provides independent personal services. In which
case the Dividends that arise from shareholding that are effectively
connected with such fixed bases are taxed in accordance with
Art.14 (Independent Personal Services) of the UN model DTA.
o Dividends are taxed as business profits of the permanent
establishment (Income of the independent personal service
provider) on a net income basis (i.e. after allowance for deductible
expenditure incurred in producing that income) under Art.7 (or
Art.14 of the UN model DTA whichever is applicable)
Dividend derived by a PE can give rise to 4 scenarios based on the location of the PE, viz.:
SCENARIO - 1SCENARIO 2 SCENARIO 3 SCENARIO 4
PE receiving dividend from
Company S in Country S is in
Country R which is the residence
of its Parent Co. too
PE of Company R,
PE receiving
dividend from
Company S in
Country S is located
in Country
PE of Company R, PE
receiving dividend
from Company S in
Country S is located in
Country T
PE of Company
R, PE receiving
dividend from
Company T in
Country T is
located in
Country S
TAX IMPLICATION UNDER DTAA
Art.10(1)&(2) would apply. 10(4)
would not apply as PE is not in
Country S
Art.10(4)would
apply as PE is in
Country S
Art. 10(4) would not
apply as the PE is in
Country T. Art.
10(1)&(2) would apply
going by the concept of
beneficial ownership.
Provided it is known to
Co. S that Co. is the
beneficial owner of the
PE
DTA between
Countries R & S
not applicable as
dividend is not
paid to the PE
by a Co. Which
is resident of
Country S. The
applicable DTA
would be the
one between
Country R &
Country T
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Head
Office
PE
Company S
Country R
Country S
Company R
Dividend
SCENARIO - 1
Dividend derived by a PE can give rise to 4 scenarios based on the location of the PE, viz.:
SCENARIO 1SCENARIO - 2
SCENARIO 3 SCENARIO 4
PE receiving
dividend from
Company S in
Country S is in
Country R
which is the
residence of its
Parent Co. too
PE of Company R, PE receiving
dividend from Company S in
Country S is located in Country.
PE of Company R, PE
receiving dividend
from Company S in
Country S is located in
Country T
PE of Company
R, PE receiving
dividend from
Company T in
Country T is
located in
Country S
TAX IMPLICATION UNDER DTAAArt.10(1)&(2)
would apply.
10(4) would not
apply as PE is
not in Country
S
Art.10(4)would apply as PE is in
Country S
Art. 10(4) would not
apply as the PE is in
Country T. Art.
10(1)&(2) would
apply going by the
concept of beneficial
ownership. Provided
it is known to Co. S
that Co. is the
beneficial owner of
the PE
DTA between
Countries R & S
not applicable as
dividend is not paid
to the PE by a Co.
Which is resident
of Country S. The
applicable DTA
would be the one
between Country R
& Country T
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9
Head
Office
PE
Company S
Country R
Country S
Company R
Dividend
SCENARIO - 2
Dividend derived by a PE can give rise to 4 scenarios based on the location of the PE, viz.:
SCENARI
O 1
SCENARIO 2SCENARIO - 3
SCENARIO 4
PE
receiving
dividend
from
Company S
in Country
S is in
Country R
which is the
residence
of its Parent
Co. too
PE of Company
R, PE receiving
dividend from
Company S in
Country S is
located in
Country
PE of Company R, PE
receiving dividend from
Company S in Country S is
located in Country T.
PE of Company R, PE
receiving dividend from
Company T in Country
T is located in Country S
TAX IMPLICATION UNDER DTAAArt.10(1)&(
2) would
apply. 10(4)
would not
apply as PE
is not in
Country S
Art.10(4)would
apply as PE is in
Country S
Art. 10(4) would not apply as the PE
is in Country T. Art. 10(1)&(2) would
apply going by the concept of
beneficial ownership. Provided it is
known to Co. S that Co. is the
beneficial owner of the PE
DTA between
Countries R & S not
applicable as dividend
is not paid to the PE by
a Co. Which is
resident of Country S.
The applicable DTA
would be the one
between Country R &
Country T
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10
Head
Office
PE
Company S
Country R
Country S
Company R
Dividend
Country T
SCENARIO - 3
Dividend derived by a PE can give rise to 4 scenarios based on the location of the PE, viz.:SCENARIO 1 SCENARIO 2 SCENARIO 3
SCENARIO - 4PE receiving
dividend from
Company S in
Country S is in
Country R which
is the residence
of its Parent Co.
too
PE of Company R, PE
receiving dividend from
Company S in Country
S is located in Country
PE of Company R, PE
receiving dividend from
Company S in Country
S is located in Country T
PE of Company R, PE
receiving dividend from
Company T in Country T
is located in Country S
TAX IMPLICATION UNDER DTAAArt.10(1)&(2)
would apply.
10(4) would not
apply as PE is
not in Country S
Art.10(4)would apply as
PE is in Country S
Art. 10(4) would not
apply as the PE is in
Country T. Art.
10(1)&(2) would apply
going by the concept of
beneficial ownership.
Provided it is known to
Co. S that Co. is the
beneficial owner of the
PE
DTA between Countries R &
S not applicable as dividend
is not paid to the PE by a Co.
Which is resident of Country
S. The applicable DTA
would be the one between
Country R & Country T
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11
Head
Office
PE
Company TCountry T
Country S
Company R
Dividend
Country R
SCENARIO - 4
Beneficial Owner
Anti-avoidance measure – to avoid treaty abuse
This concept has its origin in local laws with theintention to distinguish between the rights held on thesame property by different persons, viz, the legalowner and beneficial owner.
Beneficial owner is regarded as the one with thegreatest ownership rights, while the legal ownergenerally has a fiduciary obligation to the beneficialowner and not derive any direct benefit out ofownership of the property.
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12
Company D Company C
Country S
Dividend
WHT 20%
Country R
Illustration – Beneficial Owner
Company D Company C
Country RCountry S
Intermediary T
No
Dividend
WHTCountry T
Dividend
WHT 0%
Illustration – Beneficial Owner –Contd.,
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13
Extra Territorial Taxation
Article 10(5) – prohibits the Country S from taxing the
dividends paid by Company R situated in Country R
merely because Company R derives its income from
its activities in Country S.
Further, it also prohibits Country S from taxing the
undistributed profits of Company R even if incomes of
the Company R consists wholly or partly income
arising in Country S.
INTEREST
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INTEREST
Meaning of Interest - International Tax
Interest Payments - PE
Interest Arising
Interest Payments – Associated Parties
Source state Taxation
ARTICLE 11
11(1) – Taxing right to Resident State
11(2) – Limited Taxing right to Source State
11(3) – Definition of Interest
11(4) – Interest and PE
11(5) – Interest Arise
11(6) – Interest and Associated Parties
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TAXING RIGHTS UNDER DTAA –ARTICLE 11(1) AND 11(2)
1. Interest arising in a Contracting State (India) and paid to a resident of
the other Contracting State (A foreign Country) may be taxed in that
other State (A foreign Country).
2. However, such interest may also be taxed in the Contracting State
(India) in which it arises and according to the laws of that State (India),
but if the beneficial owner of the interest is a resident of the other
Contracting State (A foreign Country), the tax so charged shall not
exceed per cent of the gross amount of the interest. The
competent authorities of the Contracting States shall by mutual
agreement settle the mode of application of this limitation.
MEANING OF INTEREST –ARTICLE 11(3)
The term “interest” as used in this article means
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 government securities and income from
bonds or debentures, including premiums and prizes
attaching to such securities, bonds or debentures.
Penalty charges for late payment shall not be regarded
as interest for the purpose of this article.
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INTEREST AND PERMANENT ESTABLISHMENTS
The provisions of paragraphs 1 and 2 shall not apply
if the beneficial owner of the interest, being a resident of a Contracting
State, carries on business in the other Contracting State in which the
interest arises, through a permanent establishment situated therein, or
performs in that other State independent personal services from a fixed
base situated therein, and the debt claim in respect of which the interest
is paid is effectively connected with (a) such permanent establishment
or fixed base, or with (b) business activities referred to in (c) of
paragraph 1 of article 7.
In such cases the provisions of article 7 or article 14, as the case may
be, shall apply.
Head
Office
PE
Company S
Country R
Country S
Company R
Interest
SCENARIO - 1
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17
Head
Office
PE
Company S
Country R
Country S
Company R
Interest
SCENARIO - 2
Head
Office
PE
Company S
Country R
Country S
Company R
Interest
Country T
SCENARIO - 3
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INTEREST ARISE
Interest shall be deemed to arise in a Contracting State when
the payer is a resident of that State. Where, however, the
person paying the interest, whether he is a resident of a
Contracting State or not, has in a Contracting State a
permanent establishment or a fixed base in connection with
which the indebtedness on which the interest is paid was
incurred, and such interest is borne by such permanent
establishment or fixed base, then such interest shall be
deemed to arise in the State in which the permanent
establishment or fixed base is situated.
INTEREST PAYMENT –
ASSOCIATED ENTERPRISES
Article 11(6) - Where, by reason of a special relationship
- between the payer and the beneficial owner or
- between both of them and some other person,
- the amount of the interest, having regard to the debt claim for which
it is paid, exceeds the amount which would have been agreed upon
by the payer and the beneficial owner in the absence of such
relationship (arms length interest),
- the provisions of this article shall apply only to the last-mentioned
amount.
- In such case, the excess part of the payments shall remain taxable
according to the laws of each Contracting State, due regard being had
to the other provisions of this Convention.
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19
IMPACT OF INTEREST PAYMENT TO ASSOCIATED ENTERPRISES
Annual Interest (5% of USD 1,000,000) 50,000
Country S Tax on interest income derived by
M/s. Parent co (10% of USD 50,000)
Art.11(2) – (A)
5,000
Tax Benefit to M/s. Sub co of deduction of
interest paid to M/s. Parent co
(30% of USD 50,000) - (B)
(15,000)
Net Tax Benefit to Group – (A) – (B) (10,000)
USD
IMPACT OF INTEREST PAYMENT TO ASSOCIATED ENTERPRISES
Annual Interest (15% of USD 1,000,000) 150,000
Country S Tax on interest income derived by
M/s. Parent co (10% of USD 150,000)
Art.11(2) – (A)
15,000
Tax Benefit to M/s. Sub co of deduction of
interest paid to M/s. Parent co
(30% of USD 150,000) - (B)
(45,000)
Net Tax Benefit to Group – (A) – (B) (30,000)
USD
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ASSOCIATED ENTERPRISES
Anti-avoidance measure
Excess interest – how treated?
CAPITAL GAINS
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CAPITAL GAINS
Alienation of Property
– Movable
– Immovable
– Ships and Aircraft
– Shares
– Other Gains
Capital Gains and PE
Article 13 (1) to 13(5)
ALIENATION OF PROPERTY
Gains from
– partial / full alienation of property
– Expropriation of property
– Transfer of property in exchange for shares
– Sale of right
– Gift of property
– Transmission
Property includes Liabilities as well as Assets
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ALIENATION OF IMMOVABLE PROPERTY
Situs Test
Resident Country has right to Tax
Source Country „may‟ tax
Treaties
Treaties with US and UK provide that the capital
gains should be taxed in accordance with the
domestic law of the respective countries – which
countries domestic law to be applied – Source
Country or Residence Country?
Treaties with Japan and Russia state that transfer of
shares not covered by the immovable property
criterion or the prescribed share holding criterion
will be taxed in the Source Country.
1/23/2010
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CAPITAL GAINS SUMMATION
Source of gain from alienation
Taxing Right
Residence stateSource
state
State of place
of effective
management
Immovable property Shares:
>50% value = immovable
property
P
P
P
P
Movable property
- permanent establishment
- ships, aircraft, boats
P
X
P
X P
Other property (movable or
immovable) P X
REFERENCE MATERIAL
Basic International Taxation – Roy Rohatgi
International Tax Policy and Double Tax Treaties – Kevin Holmes