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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 Yathish B.Com, LLB, FCA PARTNER M/S. SHEKAR & YATHISH PASSIVE INCOMES

Dividend, Interest and Capital Gains – Basic Concepts · but if the beneficial owner of the interest is a resident of the other Contracting State (A foreign Country), the tax so

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Page 1: Dividend, Interest and Capital Gains – Basic Concepts · but if the beneficial owner of the interest is a resident of the other Contracting State (A foreign Country), the tax so

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

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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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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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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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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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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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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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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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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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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.

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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

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THANK YOU

[email protected]