Wednesday, February 1, 2012

The OECD Model Treaty; Residence, Part II

Last week, I looked at the residence provisions of the OECD Model Tax Treaty for individuals.  This week, I'll take a look at the provisions for non-individuals.

Before moving forward, however, it's important to briefly diverge into an area of academic discussion: partnerships, and how the OECD treaty deals with these business entities.  Under Article 1, the treaty applies to "persons who are residents of one or both of the contracting states."  This leads to the question of, "how does the treaty deal with a pass-through entity?"  Is the entity actually a separate company or is the entity a collection of its partners?  If the latter, how do we deal with that?  While this might seem like an academic debate, in reality it's not, as some jurisdictions treat these business entities in a very different manner.  The debate went so far as to have the OECD issue a paper on this topic, titled, "Double Taxation Conventions and the Use of Conduit Companies."  I would highly recommend reading the paper, as it offers some fascinating insights into partnerships the world over and how they are used in complicated business transactions.

All that being said, the word "person" (which is used in the above referenced Article 1 of the treaty) is defined in Article 3, which states, "the term person includes an individual, a company and any other body of persons."  The accompanying commentary adds this:
The definition of the term "person" given in subparagraph a) is not exhaustive and should be read as indicating that the term "person" is used in a very wide sense (cf. especially Articles 1 and 4). The definition explicitly mentions individuals, companies and other bodies of persons. From the meaning assigned to the term "company" by the definition contained in subparagraph b) it follows that, in addition, the term "person" includes any entity that, although not incorporated, is treated as a body corporate for tax purposes. Thus, e.g. a foundation (fondation, Stiftung) may fall within the meaning of the term "person". Partnerships will also be considered to be "persons" either because they fall within the definition of "company" or, where this is not the case, because they constitute other bodies of persons.
In short, after a long debate about partnerships and how to deal with them, we see they are covered by the convention.

That leads us to the question of residence of a non-person, which the treaty deals with thusly (Article 4(3)):
Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, then it shall be deemed to be a resident only of the State in which its place of effective management is situated.
The commentary adds this clarification:
As a result of these considerations, the "place of effective management" has been adopted as the preference criterion for persons other than individuals. The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entitys business are in substance made. The place of effective management will ordinarily be the place where the most senior person or group of persons (for example a board of directors) makes its decisions, the place where the actions to be taken by the entity as a whole are determined; however, no definitive rule can be given and all relevant facts and circumstances must be examined to determine the place of effective management. An entity may have more than one place of management, but it can have only one place of effective management at any one time.
There are two possible ways to deal with a business entity: either the entity is a resident of the country where it is incorporated or it's a resident based on its place of effective management.  As the commentary points out, the primary reason the treaty settled on the place of effective management test was some companies with extensive international transportation operations (shipping and air transport companies) would be placed at an extremely advantageous tactical advantage using the place of incorporation test.   As such, the place of management test was adopted.

Finally, residence is usually a non-issue.  The rules are written in such a way as to provide clear guidance and procedures to determine residence with little difficulty.  

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