Illustrations of Manner of Operation of MLI
We give in the following paragraphs four illustrations of the manner in which tax treaty provisions will be interpreted, applied or implemented after MLI enforcement.
Illustration 1
Under Article 10(2)(a) of the tax treaty between Germany and Pakistan, there is a general withholding rate of 15% of the amount of dividend. However there is a special reduced rate of 10% if the recipient being the beneficial owner holds more than 20% of shares of the company paying the dividend. Or under the Canada Pakistan tax treaty under Article x(2) special rate of 10% is applicable if the Canadian resident holds 25% of the shareholding in the Pakistani if being an industrial undertaking.
These reduced rate provisions are prone to abuse. In order to apply the principles laid down in earlier paragraph MLI has provided a solution. This solution is laid down in Article 8(4) of the Convention. This states as under:
Article 8 – Dividend Transfer Transactions
Provisions of a Covered Tax Agreement that exempt dividends paid by a company which is a resident of a Contracting Jurisdiction from tax or that limit the rate at which such dividends may be taxed, provided that the beneficial owner or the recipient is a company which is a resident of the other Contracting Jurisdiction and which owns, holds or controls more than a certain amount of the capital, shares, stock, voting power, voting rights or similar ownership interests of the company paying the dividends, shall apply only if the ownership conditions described in those provisions are met throughout a 365 day period that includes the day of the payment of the dividends (for the purpose of computing that period, no account shall be taken of changes of ownership that would directly result from a corporate reorganization, such as a merger or divisive reorganization, of the company that holds the shares or that pays the dividends).
The minimum holding period provided in paragraph 1 shall apply in place of or in the absence of a minimum holding period in provisions of a Covered Tax Agreement described in paragraph 1.
A Party may reserve the right:
a) for the entirety of this Article not to apply to its Covered Tax Agreements; and
b) for the entirety of this Article not to apply to its Covered Tax Agreements to the extent that the provisions described in paragraph 1 already include:
i) a minimum holding period; ii) a minimum holding period shorter than a 365-day period; or iii) a minimum holding period longer than a 365-day period.
This example effectively explains everything that is laid down in MLI. If the following considerations are taken into account then whole concept can be easily understood.
There is no change in the bilateral treaty. Treaty rights have not been changed;
It has only be qualified or clarified that benefit will lie only where there is substantial presence for 365 days; and
Both the countries have the right to exercise various options.
If properly analyzed this is effectively the interpretation and implementation mechanism of tax treaty. An analysis of SRO 405 reveals that the jurisdictions being Pakistan, Germany and Canada have reserved the position in this respect under Article 10(2)(a) or x(2) respectively. Now it will be read, subsequent to enforcement date, in a manner that under these treaties there has to be a 365-day presence to avail the treaty benefit. We will release soon the amended position of treaties after taking into account this subject.
Illustration 2
In almost all the bilateral treaties there is a provision to deal with the cases where a person, not being an individual having dual tax residency. This provision is contained in Article 4(3) of the Model Treaty. This has been clarified in MLI as under;
Article 4 – Dual Resident Entities
Where by reason of the provisions of a Covered Tax Agreement a person other than an individual is a resident of more than one Contracting Jurisdiction, the competent authorities of the Contracting Jurisdictions shall endeavour to determine by mutual agreement the Contracting Jurisdiction of which such person shall be deemed to be a resident for the purposes of the Covered Tax Agreement, having regard to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors. In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by the Covered Tax Agreement except to the extent and in such manner as may be agreed upon by the competent authorities of the Contracting Jurisdictions.
As is apparent it is a qualification or a clarification.
Illustration 3
Determination of permanent establishment is the crux of tax treaty provisions. In case there is a PE of a non- resident in the country of source then under the treaty provisions the source country has the right to tax the attributable income at the gross rate of tax in the country of source. This is unlike dividend, interest, royalty etc where there is no right to tax the net income of the resident of the other country. The most difficult article in any treaty is Article 4(3) of the Model Treaty. It sates as under:
4(3) Notwithstanding the preceding provisions of this article, the term “permanent establishment” shall be deemed not to include:
a) the use of facilities solely for the purpose of storage or display of goods or merchandise belonging to the enterprise;
b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage or display;
c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or for collecting information, for the enterprise;
e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;
f) the maintenance of a fixed place of business solely for any combination of activities mentioned in sub-paragraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary
Under Article 13 of MLI an explanatory concept has been laid down which states as under:
Article 13 – Artificial Avoidance of Permanent Establishment Status through the Specific Activity Exemptions
A Party may choose to apply paragraph 2 (Option A) or paragraph 3 (Option B) or to apply neither Option.
Option A
a) the activities specifically listed in the Covered Tax Agreement (prior to modification by this Convention) as activities deemed not to constitute a permanent establishment, whether or not that exception from permanent establishment status is contingent on the activity being of a preparatory or auxiliary character;
b) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any activity not described in subparagraph a);
c) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) and b), provided that such activity or, in the case of subparagraph c), the overall activity of the fixed place of business, is of a preparatory or auxiliary character.
Option B
a) the activities specifically listed in the Covered Tax Agreement (prior to modification by this Convention) as activities deemed not to constitute a permanent establishment, whether or not that exception from permanent establishment status is contingent on the activity being of a preparatory or auxiliary character, except to the extent that the relevant provision of the Covered Tax Agreement provides explicitly that a specific activity shall be deemed not to constitute a permanent establishment provided that the activity is of a preparatory or auxiliary character;
b) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any activity not described in subparagraph a), provided that this activity is of a preparatory or auxiliary character;
c) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) and b), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.
Illustration 4
This is an illustration relating to operation of the treaty mechanism. For example Article 24 of the Pakistan German tax treaty states:
Mutual Agreement Procedure Where a resident of a Contracting State considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accordance with the provisions of this Agreement, he may, irrespective of the remedies provided by the national laws of those States, present his case to the competent authority of the Contracting State of which he is a resident or, if his case comes under paragraph 1 of Article 24, to that of the Contracting State of which he is a national. This case must he presented within two years from the first notification of the action giving rise to taxation not in accordance with the Agreement.
In this respect Article 16(6) of the MLI states:
a) Each Party that has not made a reservation described in subparagraph a) of paragraph 5 shall notify the Depositary of whether each of its Covered Tax Agreements contains a provision described in clause i) of subparagraph a) of paragraph 4, and if so, the article and paragraph number of each such provision. Where all Contracting Jurisdictions have made a notification with respect to a provision of a Covered Tax Agreement, that provision shall be replaced by the first sentence of paragraph 1. In other cases, the first sentence of paragraph 1 shall supersede the provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with that sentence.
b) Each Party that has not made the reservation described in subparagraph b) of paragraph 5 shall notify the Depositary of:
i) the list of its Covered Tax Agreements which contain a provision that provides that a case referred to in the first sentence of paragraph 1 must be presented within a specific time period that is shorter than three years from the first notification of the action resulting in taxation not in accordance with the provisions of the Covered Tax Agreement, as well as the article and paragraph number of each such provision; a provision of a Covered Tax Agreement shall be replaced by the second sentence of paragraph 1 where all Contracting Jurisdictions have made such a notification with respect to that provision; in other cases, subject to clause ii), the second sentence of paragraph 1 shall supersede the provisions of the Covered Tax Agreement only to the extent that those provisions are incompatible with the second sentence of paragraph 1;
ii) the list of its Covered Tax Agreements which contain a provision that provides that a case referred to in the first sentence of paragraph 1 must be presented within a specific time period that is at least three years from the first notification of the action resulting in taxation not in accordance with the provisions of the Covered Tax Agreement, as well as the article and paragraph number of each such provision; the second sentence of paragraph 1 shall not apply to a Covered Tax Agreement where any Contracting Jurisdiction has made such a notification with respect to that Covered Tax Agreement.
c) Each Party shall notify the Depositary of:
i) the list of its Covered Tax Agreements which do not contain a provision described in clause i) of subparagraph b) of paragraph 4; the first sentence of paragraph 2 shall apply 27 to a Covered Tax Agreement only where all Contracting Jurisdictions have made such a notification with respect to that Covered Tax Agreement; ii) in the case of a Party that has not made the reservation described in subparagraph c) of paragraph 5, the list of its Covered Tax Agreements which do not contain a provision described in clause
ii) of subparagraph b) of paragraph 4; the second sentence of paragraph 2 shall apply to a Covered Tax Agreement only where all Contracting Jurisdictions have made such a notification with respect to that Covered Tax Agreement.
d) Each Party shall notify the Depositary of:
i) the list of its Covered Tax Agreements which do not contain a provision described in clause i) of subparagraph c) of paragraph 4; the first sentence of paragraph 3 shall apply to a Covered Tax Agreement only where all Contracting Jurisdictions have made such a notification with respect to that Covered Tax Agreement;
ii) the list of its Covered Tax Agreements which do not contain a provision described in clause ii) of subparagraph c) of paragraph 4; the second sentence of paragraph 3 shall apply to a Covered Tax Agreement only where all Contracting Jurisdictions have made such a notification with respect to that Covered Tax Agreement.
As can be seen from this illustration that once sentence in the treaty that requires a process has been further explained. These four illustrations reveal that MLI is actually a commentary and manner of operation of tax treaty. These provisions have simplified many issues which are usually contested.
Effective date
As per SRO 405 the date of entry into effect is July 1, 2021 (Tax Year 2022).
Conclusion
SRO 405(I)/2021 is the most important piece of regulations that has been introduced in Pakistan in relation of taxation of persons who qualify for concessions or benefits under a tax treaty. In short, MLI is the reconciliation between tax authorities in various countries and businesses in a sense that generally accepted principles have been agreed upon. This reflects the concept that tax matters cannot be decided by the court of law. Though the document is long and confusing, if the same is read in conjunction with the aforesaid notes it appears that everything is very simple and straight forward. It is nothing but an extended interpretation and application of tax treaties.
(Concluded)
Copyright Business Recorder, 2021