## EXECUTIVE SUMMARY ## Source details **Canonical URL:** [EXECUTIVE SUMMARY](https://www.imf.org/-/media/files/miscellaneous/oit.pdf) ## Other formats - [Markdown version](/-/media/files/miscellaneous/oit.pdf.md) - [Structured JSON version](/-/media/files/miscellaneous/oit.pdf.json) --- ### Scope and purpose - The tax treatment of ‘offshore indirect transfers’ (OITs)—the sale of an entity owning an asset located in one country by a resident of another—is a significant issue in many developing countries. - The report and toolkit respond to a request by the Development Working Group (DWG) of the G20 to the IMF, OECD, WBG and the UN to produce “toolkits” for developing countries on international tax issues under the G20/OECD BEPS project and on additional issues not covered by BEPS. - Aim: provide analysis and options for the capital gains tax treatment of OITs, focusing on practicable options for developing countries. ### Core questions addressed - (i) Should such transfers be taxed in the country in which the underlying asset is located? - (ii) To which types of assets should any such taxation apply? - (iii) How can such taxation, if adopted, be best designed and implemented as a practical, legal matter? ### Economic and legal considerations — key findings - Some countries wish to tax gains on OITs as for direct transfers of immovable assets; others may extend to assets generating location specific rents (LSRs) such as telecom licenses and government-issued rights. - Gains on OITs may partly reflect value added by owners/managers; some countries may choose not to tax such gains. - Neutrality: given the norm that country L can tax direct transfers of immovable assets, taxing indirect transfers promotes neutrality between direct and indirect transfers. - Timing matters for revenue: under a constant tax rate and assuming eventual sale, nominal cumulated tax receipts in Country L are independent of direct vs indirect transfer; the issue for Country L is timing. Example: “At six percent interest, for instance, a delay of ten years in receiving revenue of $1 billion reduces its present value by around $450 million.” - LSRs are conceptually ideal for taxation and taxing gains can be a useful backstop when explicit rent taxes are imperfect. - Policy trade-offs: equity and efficiency arguments support location-country taxing rights for assets embodying LSRs; counterarguments point to residence-country claims where gains reflect managerial contribution. ### International treaty context and prevalence - OECD and UN Model treaties suggest wide acceptance that capital gains taxation of OITs of “immovable” assets can be imposed by the location country. - Article 13(4) is present in around 35 percent of all Double Tax Treaties (DTTs) (973 of 3,046 DTTs analyzed). - Article 13(4) is less likely to be present when one party is a low-income resource-rich country (291 of 834 treaties involving at least one resource-rich country include Article 13(4)). - The Multilateral Instrument (MLI) has increased the number of tax treaties that effectively include Article 13(4); further increases expected as parties sign the MLI and amend covered tax treaties. - A taxing right requires appropriate domestic-law definitions of the assets intended to be taxed and a domestic law basis to assert that taxing right. ### Need for coherence and legal clarity - Unilateral responses to OITs vary widely in covered assets and legal approaches; greater coherence could enhance tax certainty. - The toolkit does not set a single definitive approach; it provides practicable guidance and sample simplified legislative language. ### Two principal legal-design approaches (models) - Model 1: Deemed disposal model — treats an OIT as a deemed disposal of the underlying asset by the local resident asset-owning entity and a deemed reacquisition at market value. - Operational features: - Taxes unrealized gain in hands of local resident asset-owning entity when change of control occurs (e.g., more than 50 percent change of ownership within a specified period). - Losses recognized where no accrued gains. - Step up in tax cost to market value on reacquisition to mitigate double taxation on subsequent changes of control. - Enforcement/collection advantages: - Full access to enforcement tools against resident taxpayer (e.g., penalties, seizure). - Avoids reliance on treaty-based assistance for collection. - Key practical considerations: - Valuation complexity; administrative guidance required. - Liquidity concerns for local entity; suggested mitigations include purchaser directing part of purchase price to local entity or short-term deferral/spread of payment (proposed 3 to 5-year period). - Pros: - Greater ability to enforce/collect. - Prevents double taxation within location country via step-up. - Taxing right framed as resident taxation of local entity (treaty impact argued to be limited). - Cons: - May undermine separate legal entity principle; minority shareholders exposed to tax liability. - Possible international double taxation if residence country taxes seller and provides no relief. - Administrative burden to monitor ownership changes and value derivation tests. - Model 2: Source-based taxation of the non-resident seller — taxes the non-resident seller by sourcing the gain in Country L when the interest’s value is principally derived from local immovable property. - Operational features: - Requires clear source rules (e.g., 365-day lookback tests where more than 50 percent of value derived from immovable property in Country L). - Taxable asset rules can be full or pro rata; thresholds like 50 percent and alternative thresholds (e.g., 20 percent or 10 percent interest tests) are available. - Enforcement/collection mechanisms: - Withholding tax on purchase price (examples: U.S., Canada, India, China, Australia). - Notification/reporting obligations and agency taxation where a local entity acts as agent for the non-resident seller. - Legal protections such as restricting registration/renewal of underlying assets until tax obligations or satisfactory arrangements are demonstrated. - Pros: - Preserves separate legal entity distinction. - Relieves some double taxation concerns by preserving foreign tax credits in residence country. - Cons: - Reduced enforceability against non-resident sellers; withholding/agency mechanisms may mitigate but not eliminate collection risk. - Complexity with multi-tiered structures and step-up gaps across tiers. ### Enforcement and collection design options (enumerated) - Notification/reporting and information exchange mechanisms. - Withholding tax mechanisms on payment of purchase price; withholding can be final or non-final and can be adjusted by de minimis or listed-securities carve-outs. - Imposing a tax payment obligation on a resident entity as agent for the non-resident seller. - Restricting registration, renewal or validity of relevant underlying assets until notification/tax payment or satisfactory arrangements are provided. - Use of General Anti-Avoidance Rule (GAAR) or specific anti-abuse rules to collapse holding structures (noting GAAR can be hard to apply in low capacity environments). - Transitional design: generally recommend prospective implementation; sample transitional arrangement is deeming market value cost base of relevant assets at commencement. ### Thresholds, formulas, and sample measures - Time and value tests: common formulation uses a 365-day lookback period to determine whether more than a specified percentage (e.g., 50 percent or 20 percent) of the value of shares or interests is derived from immovable property in Country L. - Box 7 formula for pro rata taxation: amount included = A × B/C where - A is the amount of the gain; - B is the value derived from immovable property in Country L; - C is the total value of the interest. - Options for interest thresholds: - Apply to all interests if value derives more than half from the asset. - Apply only to significant interests (e.g., 10 percent or more). - Apply backup nominal-value thresholds (e.g., apply only to interests with value of $1 million or more). - Valuation and anti-abuse time tests are critical; guidance needed on whether cash injected shortly before disposal is included. ### Case studies and country practices — selected highlights - India — Vodafone Case: - 2006 transaction: Vodafone purchased Hutchison’s participation for nearly US$11 billion. - Indian Tax Authority sought over US$2 billion tax on Hutchison’s capital gain; Supreme Court of India ruled in 2012 in favor of the taxpayer. - India enacted a clarificatory amendment with retrospective effect to tax OITs and validated the ITA’s demand; Vodafone submitted the action to arbitration under the India-Netherlands Bilateral Investment Treaty. - Uganda — Zain Case: - 2010 sale: Dutch subsidiary of Bharthi Airtel purchased shares for US$10.7 billion; URA held Zain International BV liable for US$85 million capital gains tax. - Uganda’s Appeals Court ruled URA has jurisdiction; treaty and domestic law interactions remain unresolved. - Revenue significance: the amount at stake in the Zain case is in the order of 5 percent of total government revenue in Uganda and nearly 50 percent of public spending on health. - Comparison: Vodafone case amount was around 2 percent of central government revenue and almost 8 percent of all annual income tax revenues. - Peru: - Legislative approach: Art. 10 includes indirect sales in Peruvian source income where, in any of the twelve months prior to the sale, the market value of the resident entity’s shares represent at least fifty percent of the non-resident’s shares’ market value, and at least ten percent of the parent foreign resident assets must be transferred. - Peru expanded domestic law to tax all OITs after Petrotech; domestic legislation can be overridden by double taxation treaties. - China: - General rule: gain on direct transfers of assets in China taxed at 25 percent. - Anti-abuse: if the holding company is in a jurisdiction with effective tax burden < 12.5 percent or no taxation of offshore income, Chinese tax authorities may disregard the holding company and re-characterize the transfer as direct where no reasonable commercial purpose exists. - Re-characterization tests include value deriving at least 75 percent from Chinese taxable property and lack of substantive functions in the nonresident enterprise. ### Empirical analysis of Article 13(4) in DTTs (IMF as of 2015) - Dataset coverage: 3,046 DTTs (almost the entire universe of active DTTs in 2015). - Prevalence: - About 35 percent of treaties (973 of 3,046) include a provision allowing taxation of gains from alienation of capital stock when the property consists directly or indirectly principally of immovable property in that country. - About 35 percent of treaties concluded by at least one resource-rich country include Article 13(4) (291 of 834). - About 38 percent of treaties concluded by at least one low tax jurisdiction include Article 13(4). - Regression findings (selected): - Resource-rich low-income status is negatively associated with inclusion of Article 13(4) (coefficients reported with significance: e.g., -0.0592**, -0.0657**, -0.079*** across specifications). - Differences in capital gains or corporate tax rates between treaty partners are positively associated with inclusion of Article 13(4) (coefficients e.g., 0.0030***, 0.0042***, 0.0021**). - Low tax jurisdiction status is negatively associated with inclusion (coefficients e.g., -0.133***, -0.164***). - Year trend is positive and highly significant (coefficients e.g., 0.0136***, 0.017***), indicating increasing inclusion over time. - Descriptive statistics (Table D1 examples): - Article 13(4): N 3,046; mean 0.319; SD 0.466; min 0; max 1. - Year: N 3,046; mean 1997; SD 12.51; min 1947; max 2015. - CGT_i – CGT_j: N 2,993; mean 11.05; SD 8.512; min 0; max 35. - Low tax: N 3,046; mean 0.149; SD 0.356; min 0; max 1. - Resource-rich low-income: N 3,044; mean 0.105; SD 0.306; min 0; max 1. ### Design, administrative and transitional considerations (policy guidance) - Careful legislative drafting required to: - Define “immovable property” and scope precisely (sample statutory definition provided, inclusive of leases, exploration/prospecting/development rights, and information relating to those rights). - Specify triggering tests (e.g., change of control definitions, 365-day lookback). - Address valuation methods, step-up rules, treatment of liabilities, recognition of losses, listed securities carve-outs, corporate reorganizations, and minority shareholder protections. - Enforcement options: withholding, notification/agency taxation, registration restrictions, international information exchange, and targeted anti-abuse rules. - Implementation recommendation: unless strong reasons exist, adopt new provisions prospectively with transitional arrangements (e.g., deem market value cost base at commencement date). - Consider de minimis thresholds and exemptions consistent with Article 13(4) Commentary (examples: listed shares, corporate reorganizations, shares deriving value from immovable property where a business is carried on, pension funds, REIT small investor interests). ### Key analytical and policy conclusions (from VI. CONCLUSIONS) - It is appropriate that location countries have the right to tax OITs for assets likely to embody primarily and substantially location specific economic rents, including assets traditionally classified as “immovable.” - This taxing right: - Mirrors the recognized right for direct transfers of immovable assets (equity rationale). - Provides a backstop to taxation of location specific rents where direct taxes are imperfect (efficiency rationale). - Fosters neutrality between direct and indirect transfers and responds to political pressures regarding salient national assets. - Such taxing rights require: - Appropriate domestic-law definitions of the assets intended to be taxed. - A domestic law basis to assert that taxing right. - Two main legal approaches (deemed disposal and source-based taxation of the non-resident seller) are available; sample simplified legislative language is provided for both in the report. - A more uniform, coordinated, and coherent approach among countries that choose to tax OITs can contribute substantially to international tax coherence and enhanced tax certainty. *Source: EXECUTIVE SUMMARY, INTRODUCTION, and selected boxes and sections from “oit - EXECUTIVE SUMMARY” (IMF).* ### EXECUTIVE SUMMARY __________________________________________________________________________ 7 ### EXECUTIVE SUMMARY ### Scope and purpose - The tax treatment of ‘offshore indirect transfers’ (OITs)—the sale of an entity owning an asset located in one country by a resident of another—has emerged as a significant issue in many developing countries. - The report and toolkit respond to a request by the Development Working Group (DWG) of the G20 to the International Monetary Fund (IMF), Organization for Economic Cooperation and Development (OECD), World Bank Group (WBG) and the United Nations (UN) to produce “toolkits” for developing countries on international tax issues under the G20/OECD BEPS project and on additional issues not covered by BEPS. - The aim is to provide analysis and options for the capital gains tax treatment of OITs, with a focus on the perspective and practicable options for developing countries. ### Key issues and questions addressed - The report addresses the following core questions: - (i) What considerations arise in deciding whether such transfers should be taxed in the country in which the underlying asset is located? - (ii) To which types of assets do these considerations suggest that any such taxation should apply? - (iii) How can such taxation, if adopted, best be designed and implemented as a practical, legal matter? ### Economic and legal considerations - Some countries wish to tax gains realized on OITs—as is currently the case for direct transfers of immovable assets; others may wish to apply this treatment to a wider class of assets that generate location specific rents (returns in excess of the minimum required by investors and not available in other jurisdictions), such as telecom licenses and government-issued rights. - The report recognizes that gains on OITs may be attributable in part to value added by owners and managers, and that some countries may choose not to tax gains on OITs. - The issue has been identified in IMF technical assistance work and OECD scoping, but was not covered by the G20-OECD BEPS project. In relation to extractive industries, OITs are also the subject of work at the UN. ### International treaty context - The provisions of both the OECD and the UN Model treaties suggest wide acceptance that capital gains taxation of OITs of “immovable” assets can be imposed by the location country. - Article 13(4) of the relevant model is found only in around 35 percent of all Double Tax Treaties (DTTs) and is less likely to be present when one party is a low-income resource-rich country. - The Multilateral Instrument (MLI) has increased the number of tax treaties that include Article 13(4) of the OECD MTC; this impact is expected to increase as new parties sign the MLI and amend their covered tax treaties to include the new language of Article 13(4). - Regardless of treaty language, a taxing right cannot be supported without appropriate domestic-law definitions of the assets intended to be taxed and without a domestic law basis to assert that taxing right. ### Need for coherence and legal clarity - Countries’ unilateral responses to OITs have differed widely in which assets are covered and in legal approaches taken; greater coherence could enhance tax certainty. - There is a need for a more uniform approach among countries that choose to tax OITs. ### Two main legal-design approaches (models) presented - The report identifies two main approaches for location-country taxation of OITs and provides sample simplified legislative language for both: - Model 1: Treats an OIT as a deemed disposal of the underlying asset (a deemed disposal model). - Model 2: Treats the transfer as being made by the actual seller, offshore, but sources the gain on that transfer within the location country so that the location country can tax it. - The report expresses no general preference between the two models; the appropriate choice depends on countries’ circumstances and preferences. - Provisions designed to implement either approach require careful drafting. ### Scope and limitations of the toolkit - The toolkit focuses on core economic and legal issues and provides a stock take of approaches applied in selected countries. - It does not set out a single, definitive approach suitable in all circumstances and does not deal with all technical issues (e.g., corporate reorganizations and basis adjustments), areas where further detailed guidance might be helpful. - The analysis draws on existing literature, IMF technical assistance work, and responses to public comments on prior drafts. *Source: EXECUTIVE SUMMARY and INTRODUCTION, "oit - EXECUTIVE SUMMARY" (IMF).* ### Section IV then focuses on the treatment of OITs as they are currently addressed under the two ### Section IV then focuses on the treatment of OITs as they are currently addressed under the two ### Purpose and scope - The report: - "does not provide binding rules or authoritative provisions of any kind, nor does it aim to establish any international policy standard." - "is intended to describe an international taxation issue of concern to developing countries, and to analyze the approaches applied by selected countries with a view to identifying the pros and cons of these approaches and to provide practicable guidance to them on options for how to address that issue, should they choose to do so." - "represents the analysis and conclusions of the tax staffs of the four partner organizations and does not represent the official views of the organizations’ member countries or Management." - Notes that the illustrative cases "are solely provided for the general purpose of illustrating the international taxation issue of focus in this report and the description of those cases should not be relied upon for anything other than that general purpose." - Appendices provide further detail on the empirical analysis and on selected country experiences. *I. ANALYSING OFFSHORE INDIRECT TRANSFERS (section header present in source)* ### Definitions and the anatomy of Offshore Indirect Transfers (OITs) - An indirect ownership interest: "an arrangement under which there is at least one intervening entity between the controlling owner and the asset in question." - A direct interest: "one in which there are no intervening entities." - Stylized three-tiered ownership example (used throughout the toolkit): - Corporation A owns "Asset." - Corporation B has a direct interest in the shares of Corporation A. - Corporation P1 has an indirect interest in the Asset via B/A. - Transfer: "a change in the direct or indirect ownership of an asset, in whole or in part, whether between independent or related parties." - Transfers may give rise to a taxable capital gain (or loss), but not all transfers generate taxable gains (e.g., tax-free reorganizations subject to domestic rules requiring "substantial continuity of ultimate ownership"). - Clarified transfer types: - Direct transfer: "involves the disposition66 of a direct ownership interest in an asset, in whole or in part." - Indirect transfer: "involves the disposition of an indirect ownership interest in an asset, in whole or in part. It is the underlying asset that is being indirectly transferred.7" - Footnotes present in source: 5, 6, 7 (referenced in text). ### Asset classifications under treaties and domestic law - Tax treaties typically distinguish two classes of assets: - Immovable assets: - "The definition of this term is a matter for national law, which may or may not be modified by, and for the purposes of, any tax treaties to which the country is a party." - "The basic rule under the OECD and UN MTCs is that the term 'immovable property' has the meaning under the domestic law (tax or other law) of the contracting state in which the property is located.8" - "It typically includes land, buildings, and structures as well as rights related to such property (which may include agricultural, forestry, and mineral rights).9" - The definition could also include licenses to provide specific products or services (e.g. telecommunications) to specified geographic locations, although "this is not common." - The source notes: "The definition of immovable property is set out in Article 6 of the model treaties." - Movable assets: - For the purposes of the report: "any asset not classed as immovable." - May include other physical property, intangibles (such as intellectual property or goodwill), and financial assets (e.g., stocks, bonds). ### Offshore vs onshore transfers (defined for clarity) - Offshore transfers: - "transfers in which the transferor is resident for tax purposes in a different country from that in which the asset in question is located, and the transferor does not have a permanent establishment in the country in which the asset in question is located." - Onshore transfers: - "all other transfers." - The location of the asset and the residence of the transferor both influence which taxing jurisdiction(s) may claim the right to tax transfers; provisions differ widely across countries. ### Structuring transactions and cross-border interactions - Complex ownership structures often involve more than two jurisdictions and create interactions between multiple domestic tax laws and tax treaties. - These interactions can produce a range of outcomes, including: - Double taxation for which there may be no relief under current international norms. - Double non-taxation. - Example based on Figure 1 (stylized): - Parties and jurisdictions involved: asset located in country L; seller resident in country LTJ; parent of seller (P1) resident in country P; buyer (P2) resident in country P (or another jurisdiction). - The tax rules of at least four countries can shape the tax treatment of a single transaction. - Choices to realize gains: - Direct sale by corporation A (onshore direct): generally creates a tax liability for corporation A in country L; basis of the asset typically stepped up to reflect the purchase price. - Indirect sale via an entity resident in a low- or zero-tax jurisdiction (offshore indirect): - Example: sale by corporation B, resident in low tax country LTJ, of its shares in corporation A to corporation P2. - The tax advantage from eliminating tax otherwise payable in country L "may be offset later by taxation under the tax rules of the seller’s parent’s country P," but "anything short of immediate taxation in P, may not substantially neutralize the tax advantage of selling the asset indirectly in LTJ rather than directly in country L." - Consequences for purchaser: - Amount paid for shares of company A becomes the tax basis for calculating future capital gains (or losses) on those shares. - If the underlying asset is expected to decline in value, the tax-minimizing strategy is to locate the loss in an entity located in a high tax jurisdiction (because it generates a deduction with no offsetting charge). - If the underlying asset is expected to increase in value, the tax-minimizing strategy is to locate the company which acquires company A in a low tax jurisdiction. - Additional contextual notes from source: - "We assume throughout, except where indicated, that buyer and seller are unrelated, and so set aside issues related to transfer pricing.11" - Ownership chains can be more complex with many interposed companies and title possibly passing in another (fifth) country.12 - "Modern complex ownership structures are not necessarily, or even primarily, designed for tax reduction purposes—rather, commercial considerations often underlie them.13" - Sales include installment sales and those subject to an "overriding royalty;" in both cases, a series of payments is made to the seller (transferor) after the transfer takes place.66 - A direct transfer of shares in a company owning some real asset is an indirect transfer of that underlying real asset.7 - The acquirer might prefer to acquire the asset directly, since immovable property will generally qualify for depreciation allowances.14 - Capital losses "may be usable to offset gains on other assets."15 *Italicized attribution line as provided by the source.* ### Box 1: Sources of Capital Gains ### Box 1: Sources of Capital Gains ### Nature of capital gains - Capital gains derive in large part from changes, between the initial purchase and sale, in expected future after-tax payments to the owner of the asset. /1 - Two key aspects: - While capital gains can sometimes be fully anticipated, /2 - in the cases with which this report is principally concerned they typically arise from unexpected changes in future net distributions (for example, a resource discovery or an increase in commodity prices), which are often changes in location specific rents (LSRs). - Asset values reflect expected future corporate, withholding or other taxes due—including capital gains tax on any future sales—so capital gains tax reaches income not taxed by these other instruments and can be viewed as a form of double taxation. - More precise valuation statement (preserving source wording): - “More precisely, taking the price of an asset to be the present value of expected net distributions to the owner, the capital gain on an asset purchased at time 0 and sold at time T is the amount by which net present value of distributions subsequent to T expected at time T exceeds that expected at time 0, with the latter discounted back to time 0 less (b) the net distributions that were expected at time 0 between then and time T.” - Example observations: - “The value of an asset that derives from a certain payment at a fixed date in the future, for instance, will on that account increase as that date approaches.” - Residents of the country in which the underlying asset is located may use structures for ‘round-tripping.’ - Indirect sales offshore can—under assumed circumstances—avoid capital gains tax that would be payable on a domestic sale in L, unless country L taxes residents on capital gains realized by controlled non-resident entities. ### B. Revenue implications - Two broad ways to realize accrued capital gain: - Direct transfer of the underlying asset itself, taxable in country L; selling now or in the future (deferral advantage). - Indirect transfer: selling an entity that owns the underlying asset; purchaser assumed to eventually sell the underlying asset (or it will expire with zero value). - Under a constant tax rate and assuming eventual sale of the asset, nominal cumulated tax receipts in country L are independent of whether transfer is direct or indirect; the issue for country L is timing, not directness. - Timing effect example: “At six percent interest, for instance, a delay of ten years in receiving revenue of $1 billion reduces its present value by around $450 million.” - Stylized comparative analysis: - If the tax rate on the share transaction equals the rate at which the purchaser can deduct interest, the initial owner is indifferent between direct sale today and indirect sale today with deferred disposal of the underlying asset—the tax benefits of deferral are offset by capital gains tax on the share transfer. - If the rate of tax on the share transaction is low relative to the rate at which interest is deductible—a plausible case—then the indirect route with deferred sale is tax-preferred by the initial owner. - Conclusion: indirect transfers conducted in low tax jurisdictions may amplify tax distortions toward delayed sale of the underlying asset. - Effects on other tax payments: - If Company A remains resident in country L, the transfer has no direct impact on L’s future receipts of corporate income tax (or royalties/rent tax in extractives), unless the sale leads to a step up in basis and the asset is depreciable. - Withholding taxes on dividends, interest or other payments by A to its new direct owner may change if the new owner is resident in a different country; in practice transfers often preserve the same direct owner (B) so withholding taxes remain unchanged. - Relevant taxpayer and ability-to-pay considerations: - Seller derives capital gain by disposing of an asset including related potential future economic benefits; the seller is the taxpayer deriving income in excess of their initial investment and is generally in a position to pay tax on that income. - Buyer incurs expenditure to acquire asset and may only be in position to pay tax on future income generated by the asset; seller and buyer are different taxpayers with potentially different abilities to pay at different moments. ### C. Allocation of taxing rights on OITs: equity and efficiency considerations - Threshold question: should the country in which an asset is located have primary taxing rights on its indirect transfer abroad, and to which assets should this apply? - Inter-nation equity: three current norms suggesting some consensus for location-country taxing rights: - Capital gains on onshore direct transfers of tangible assets are taxable by the country in which the asset is located (even if seller and purchaser may be non-resident). - Dividends received by a parent company abroad may be subject to tax through withholding by the country in which the paying company is resident. - It is quite widely accepted—as reflected in model treaties—that the country in which an ‘immovable’ asset is located is entitled, if it so chooses, to tax gains reflecting increases in the value of that asset—though not all countries do so. - Arguments supporting location-country rights: - The country in which an asset is located should be entitled to tax gains associated with it, at least to the extent those gains are not attributable to value-enhancement from abroad. - If a location country cannot effectively tax earnings or dividends, taxing gains on asset transfers may be its surest prospect of raising revenue on associated earnings. - Role of immovability and location specific rents (LSRs): - Immovability facilitates tax collection (asset can be seized) and may imply the asset’s value reflects its location, i.e., LSRs—receipts in excess of the minimum “normal” return uniquely associated with a particular location. - LSRs are in principle ideal for taxation (taxable up to 100 percent in principle) without causing relocation or cessation of activity; taxing gains on transfers can be a useful backstop when explicit rent taxes are imperfect. - LSRs often associated with government-created rights—e.g., in extractives and telecoms—and many indirect-transfer cases revolve around rights explicitly tied to particular locations. - Counterarguments to emphasing location-country taxation: - Any gain reflects underlying income that the location country has chosen not to tax; capital gains may simply be that country’s chosen method of taxing the income or may reflect historical treaty choices. - Increased entity value may reflect managerial or other expertise contributed by the seller; one might argue the gain be taxed where the seller resides to preserve efficiency of value-adding activity location decisions. - Many countries operating dividend exemption schemes indicate little desire to tax such gains in the residence country. - Efficiency considerations: - Good tax design seeks to avoid distorting investors’ decisions. - Taxation of LSRs is efficient in principle; taxing gains can be a useful supplementary device where other methods of taxing LSRs are imperfect. - Neutrality requirement: direct and indirect asset transfers that represent the same transfer of ownership should, all else equal, attract the same tax treatment to avoid transaction distortion. - Given the norm that country L has right to tax direct transfers of immovable assets, neutrality is most likely achieved by taxation of indirect transfers by country L. - Alternative (location country forgoing claims so residence taxes gains) is unlikely and may be undesirable if it is a less distorting revenue source for country L. - Assessment (summary conclusion): - On balance, it is appropriate that countries should have the right to tax capital gains associated with transfers of immovable assets located there, regardless of whether the transferor is resident there or has a taxable presence there. - Rationale: mirrors recognized right for direct transfers; provides a route to taxing LSRs when preferred instruments are unavailable or weak; fosters neutrality between direct and indirect transfers. - Importance of clearly defining ‘immovable assets’: scope could include all assets with potential to generate significant LSRs and over which government can exercise sufficient control to ensure collection, though a country may choose a narrower definition. - Not exercising location-country taxing rights can provoke intense domestic dissatisfaction when assets are highly visible and sums at stake are large, potentially prompting unilateral legislative actions that increase tax uncertainty. *Italicized source attribution: Box 1: Sources of Capital Gains (oit - Box 1: Sources of Capital Gains).* ### Box 2. India—The Vodafone Case ### Box 2. India—The Vodafone Case ### Transaction structure and facts - In 2006, Vodafone purchased Hutchison’s participation in a joint venture to operate a mobile phone company in India (the owner of an operating license), for nearly US$11 billion. - Hutchison, a Hong Kong-based multinational, sold a wholly owned Cayman Islands subsidiary holding its interest in the Indian operation to a wholly owned subsidiary of Vodafone incorporated, and for tax purposes resident, in the Netherlands. - The transaction took place entirely outside India, between two non-resident companies. /1 ### Indian Tax Authority action and litigation - The Indian Tax Authority (ITA) sought to collect over US$2 billion of tax on the capital gain realized by Hutchison on the sale of the Cayman holding company. - Under Indian law, the purchaser is required to deduct tax at source while making payment to the non-resident seller; accordingly, the ITA held Vodafone’s Dutch subsidiary liable for failure to withhold tax from the price paid to Hutchison. - The ITA’s position rested on the view that the capital gains realized by the seller were taxable in India and that India’s taxing jurisdiction extended to such an offshore indirect sale. - The dispute led to protracted court proceedings, with the Supreme Court of India ruling in 2012 in favor of the taxpayer. - The Supreme Court denied the ITA’s broad reading of the law to extend its taxing jurisdiction to include indirect sales abroad, though it took the view that the transaction was in fact the acquisition of property rights located in India. ### Government response and arbitration - The government of India enacted a clarificatory amendment with retroactive effect to overcome the technical difficulty arising out of the Supreme Court ruling so as to allow taxation of offshore indirect sales and to validate the tax demand raised against Vodafone's Dutch subsidiary. - Vodafone did not challenge the legality of the retroactive effect of the law in the Indian courts; instead it submitted the action of the government of India to arbitration under the India-Netherlands Bilateral Investment Treaty. *Box source: "Box 2. India—The Vodafone Case" /1* ### Box 4. Uganda—The Zain Case ### Box 4. Uganda—The Zain Case ### Case summary - In 2010, a Dutch subsidiary of the Indian multinational Bharthi Airtel International BV purchased from Zain International BV the shares of Zain Africa BV for US$10.7 billion; Zain Africa BV owned the Kampala-registered mobile phone operator Celtel Uganda Ltd. (among other investments in Africa). - The Uganda Revenue Administration (URA) held Zain International BV liable for capital gains tax amounting to US$85 million. - Uganda’s Appeals Court ruled that the URA does have jurisdiction to assess and tax the offshore seller of an indirect interest in local assets, overturning an earlier Kampala High Court ruling. - The taxpayer interprets the tax treaty between Uganda and the Netherlands as granting the Netherlands the exclusive right to tax such transactions; whether domestic anti-avoidance rules can be supplementary to—or override—the treaty is unresolved. ### Revenue significance - The amount at stake in the Zain case is in the order of 5 percent of total government revenue in Uganda. - That same amount is nearly 50 percent of public spending on health (in Uganda). - For comparison, the Vodafone case involved an amount around 2 percent of central government revenue and almost 8 percent of all annual income tax revenues. ### Legal and factual commonalities across cases - The indirectly-transferred asset in these cases was a business whose value derived from a concession granted by the government of the location country; value was thus tied to jurisdiction and largely consisted of location-specific rents from a government-issued license. - In the three highlighted cases, the country where the underlying asset was located either lost in court or has not yet clearly won; reasons differed: - India and Peru: insufficiency of domestic income tax law to reach such transfers. - Uganda: potential treaty override (treaty without provisions like Article 13(4) discussed later in the chapter). - Public outcry was considerable in several cases, especially where the indirectly sold subsidiary had previously paid little or no corporate income tax (e.g., the congressional investigation on Petrotech in Peru); political consequences included dismissal of Prime Minister and Cabinet in Peru. ### Government responses and legal reforms - Location countries have sometimes responded to adverse court outcomes by sweeping policy changes: - Peru and Chile amended domestic laws to tax offshore transfers related to all assets located in their countries—not just those deriving value from immovable property. - India made a clarificatory amendment to its domestic law, with retrospective effect from 1962, to tax OITs. The amendment reads: “any share or interest in a company or entity registered or incorporated outside India shall be deemed to be...situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.” - Such unilateral responses reflect different legal systems and policy choices across countries. ### Implications highlighted by the Zain case - Large revenue stakes from single transactions can be material to government budgets (illustrated by the 5 percent of total revenue and near-50 percent of public health spending figures). - Treaty provisions (or their absence) and domestic enabling legislation are both critical: treaty rights alone do not create domestic enforcement or collection mechanisms; domestic law must provide enabling provisions to impose and collect the tax. - Disputes over jurisdiction and treaty interpretation may leave location countries vulnerable unless domestic law and treaty practice align to preserve source-country taxing rights. *Italic: Source — Box 4. Uganda—The Zain Case, from the provided IMF content unit.* ### 1. Designing the tax liability rule: There are two common models in this regard: ### 1. Designing the tax liability rule: There are two common models in this regard: ### Overview of the two models - Model 1 (taxation of a deemed direct sale by a resident): taxes the local entity that directly owns the asset by treating that entity as disposing of, and reacquiring, its assets for their market value where a change of control occurs (e.g. because of an offshore sale of shares or comparable interests). The relevant taxpayer is the entity which actually owns the assets from which the relevant shares derive their value. Model 1 needs to be supported by a deemed disposal and reacquisition rule of the assets from which the shares actually disposed of derive their value. - Model 2 (taxation of the non-resident seller): taxes the non-resident seller of the relevant shares or comparable interests via a non-resident assessing rule. Model 2 must be supported directly or implicitly by a source of income rule that provides a gain is sourced in the location country when the value of the interest disposed of is derived, directly or indirectly, principally from immovable property located in that country. A source rule relating to gains from disposal of other assets may also be considered, including substantial shareholdings in resident companies. A taxable asset rule can further specify whether taxation applies only to disposals of substantial interests (such as a 10 percent shareholding rule), and whether the entire gain or a pro rata portion of the gain is taxable when the indirect interest is less than wholly derived from local immovable property. - The two Models are not necessarily mutually exclusive; if both are adopted an ordering rule must be clearly established to ensure they do not both apply at the same time. ### Enforcement and collection rules (design considerations) - Key mechanisms to support enforcement and collection: - Notification/reporting and information exchange mechanisms (e.g. domestic reporting requirements supplemented, where appropriate, by international information exchange arrangements); - Withholding tax mechanisms (e.g. on payment of the purchase price); - Mechanisms imposing a tax payment obligation on a relevant local entity (e.g. as agent of the non-resident seller); - Other legal protections such as restricting registration, renewal or validity of relevant underlying assets (e.g. extractive licenses) unless applicable notification requirements have been met and/or until it is demonstrated that either: no tax is payable; the relevant tax has been paid; or satisfactory arrangements have been made for the payment of that tax. - Use of General Anti-Avoidance Rule (GAAR): - GAAR could be applied as a rule of last resort to tax a gain from an OIT in appropriate circumstances. - GAAR can be difficult for countries with weak administrative capacity to apply successfully. - Some countries adopt specific anti-abuse mechanisms that effectively collapse multiple-tier holding structures and treat the ultimate non-resident seller as the seller of the local assets (example: China). Successful application depends on: (i) the design and drafting of the anti-abuse rule (often less rules-based and more discretionary); and (ii) the tax authority’s capacity to apply the rule fairly and predictably. - Such anti-abuse rules only reach the gain if intentional tax avoidance regarding the transaction can be shown and therefore do not establish a substantive principle of the location country’s right to tax in all cases. - Practical and transitional design notes: - Sample domestic legislative provisions in the chapter are simplified, do not account for all specific tax-system circumstances (e.g. corporate reorganizations, deferral of recognition of taxable gain), and do not comprehensively address issues such as minority shareholders, joint ventures, valuation difficulties, treatment of losses, listed securities, and double taxation across multiple tiers. - Unless strong reasons exist to do otherwise, either model should only be implemented on a prospective (and not retroactive) basis (e.g. to transactions taking place after the change is announced). Appropriate transitional arrangements could include deeming the market value cost base of relevant assets to be that at the time of commencement of the new taxing model. - The ultimate set of provisions should reflect the specific legal tradition and system, political and administrative structure, and fiscal policies of the location country. - Preventing legal double taxation within the location country: - The sample provisions are designed to prevent the gain on an asset transfer being taxed twice by the location country in the hands of the same taxpayer. - Consideration could be given to broader anti-double-taxation designs to prevent the same gains being taxed multiple times in the hands of different taxpayers through realizations on intermediate shareholdings. To achieve this, either: (i) the tax cost of relevant assets (e.g. each intermediate shareholding) must be reset (stepped-up) to market value each time a relevant taxable realization occurs; or (ii) the law can provide for the non-recognition of a gain on each intermediate asset. - Such more comprehensive provisions would be more complex to apply and administer and are not reflected in the sample domestic legislative provisions in this section. - For the purposes of the sample provisions, the location country is referred to as Country L. ### B. Model 1: Taxing the Local Resident Asset-Owning Entity under a Deemed Disposal Model - Core design and rationale: - Taxes the local asset owner on the basis that the asset it holds has undergone a change of control because of an offshore sale of an entity that owns the local asset owner, directly or indirectly. - The tax liability with respect to the gain realized by the non-resident seller is (unilaterally) triggered for the local resident asset-owning entity under a specific set of domestic legislative provisions, without primary reliance on international source of income or broader international taxation rules (such as tax treaty allocation rules). - This approach has been adopted in a number of source countries, such as Nepal, Ghana and Tanzania. - Operational summary and specific features: - The model operates to tax the unrealized gain in the hands of the local asset owning entity. That entity will typically be a resident of the location country, giving that country the right to tax on both a residence basis and a source basis. - The model seeks to tax the accrued gain on the entire asset when a change of control occurs from the sale of interests whose value is principally (e.g. more than 50 percent) derived from the asset—the local immovable property. - Losses should also be recognized where there are no accrued gains, and should be subject to appropriate loss utilization rules (as applicable). - Taxation of unrealized capital gains derived by tax residents is not uncommon. The most recent example cited is the EU’s exit taxation rule, which is being implemented by all 28 EU Member States. - The tax liability is triggered by a change of control, irrespective of whether that change occurs because of an offshore or onshore sale of shares or comparable interests. - A technical direct or indirect change of ownership because of a corporate reorganization should not trigger the tax liability; this should be clarified by clearly drafted provisions. *Source: excerpt from "Designing the tax liability rule" section of the provided IMF chapter.* ### Box 5: Change in Control ### Box 5: Change in Control ### Scope and triggering conditions - Subsection (3) applies when the direct or indirect ownership of an entity mentioned in subsection (2) changes by more than 50 percent as compared with that ownership at any time during the previous three years. - An entity to which subsection (1) applies is an entity in respect of which, at any time during the 365 days preceding the relevant change in underlying ownership, more than 50 percent of the value of the shares or comparable interests issued by that entity is derived, directly or indirectly, from immovable property in Country L. - Change of control is determined by reference to direct or indirect ownership, enabling tracing through intermediate holding entities and encompassing economic/beneficial or legal ownership. ### Treatment on change of control (deemed disposal model) - Where subsection (3) applies, the entity is treated as: - realizing all its assets and liabilities immediately before the change; - having parted with ownership of each asset and deriving an amount in respect of the realization equal to the market value of the asset at the time of the realization; - reacquiring the asset and incurring expenditure of the amount referred to in paragraph (b) for the acquisition; - realizing each liability and is deemed to have spent the amount equal to the market value of that liability at the time of the realization; and - re-stating the liability for the amount referred to in paragraph (d). - The deemed disposal is for tax purposes only; legal ownership of the assets remains with the local asset owning entity. - The local asset owning entity is treated as reacquiring the assets at market value, producing a step up in tax cost to market value to mitigate double taxation on subsequent changes of control. - Liabilities are also reset under this model so the entire balance sheet is reset; no gain or loss on a liability is expected in the ordinary case where market value equals face value. ### Valuation, administrative and accounting implications - The market value of local assets deemed sold could be determined administratively using assumptions and adjustments based on the price at which the actual shares are sold, with an apportionment rule to allocate the purchase price among local assets. - Valuation exercises are complex, particularly where assets derive value from commodity prices, centrally provided inputs (e.g. management and technical expertise) and other group shareholdings. - Assets should be valued as a bundle forming a business as going concern to capture value not attributable to specific assets in financial statements. - Implementing the model may require special tax accounting rules and guidance on asset revaluation treatment, including depreciation/amortization going forward. - The model requires clear and detailed administrative guidance on valuation methods and market value determination to ensure certainty for taxpayers and tax administrations. ### Enforcement and collection rules - The local asset owning entity remains subject to ordinary compliance rules applicable to resident taxpayers, enabling the tax authority to use its full enforcement toolkit (e.g. apply penalties for failure to file and pay, seize or freeze local assets, and potentially sell them to settle tax liabilities). - The model avoids reliance on treaty-based assistance in collection for transactions between non-residents. - Practical collection challenges may arise where the local entity lacks liquidity to pay the tax liability; suggested mitigations include parties ensuring the local asset-owning entity is funded (e.g. via loan) or directing a portion of the purchase price to the local asset-owning entity on settlement. - A short-term deferral or spreading of payment obligation over a 3 to 5-year period is proposed to address ability-to-pay concerns. ### Policy rationale and anti-avoidance design choices - No de minimis threshold is set for triggering the tax—tax liability is triggered irrespective of the size of the interest sold but only to the extent the sale brings about the change in control (i.e. by more than 50 percent), whether by itself or accumulated with previous sales. This is intended to limit tax avoidance opportunities such as staggered sell-downs. - Definitions of ‘ownership’ or ‘change of ownership’ could be included to prevent narrow/formalistic interpretation and to capture changes in economic or beneficial ownership. - The model treats the gain as a locally sourced gain realized by a local resident entity; therefore, taxing rights of the location country should not be affected by a tax treaty under this model. ### Pros of Model 1 - Greater ability to enforce and collect the tax liability because the taxable gain is deemed realized by the local asset owning entity (a resident), allowing full use of enforcement tools. - Double taxation in the location country should not arise when another subsequent change of control occurs due to the step up to market value. - The gain under the deemed disposal model consists of a locally sourced gain realized by a local resident entity; the taxing right of the location country should not be affected by a tax treaty. ### Cons and drawbacks of Model 1 - Potential argument that tax treaty limitations may still apply where imposition is in substance source country taxation triggered by an offshore sale of interests; however, paragraph 3 to Article 1 of OECD and UN MTCs confirms a Contracting State’s right to tax its own residents subject to listed exceptions. - Treaty anti-abuse provisions (e.g. LOB, PPT) may be relevant where indirect transfer is motivated by tax avoidance. - Possible international double taxation: the residence country of the offshore seller could tax gains realized by that seller and provide no foreign tax relief because the location country taxes the local asset owning entity, not the non-resident seller. Double taxation concerns may be mitigated where the residence country uses a territorial system or excludes such foreign gains (e.g. participation exemption). - Liquidity concerns for the local asset owning entity to pay tax when it does not receive sale proceeds; practical solutions by transaction parties are expected to mitigate this. - Undermines separate legal entity distinction and exposes continuing minority shareholders to underlying tax liability when triggered by sale by a majority shareholder; those minority shareholders also benefit from the step up to market value. - Requires local asset-holding entity to monitor changes in its own ownership. - The model is simplified and does not deal with complexities such as corporate reorganizations, minority shareholders, joint venture arrangements, valuation difficulties, listed securities, and the treatment of losses; domestic provisions will need adaptation and could include carve-outs (e.g. IPO scenarios). ### Interaction with source rules and transition to taxing the non-resident seller (Model 2) - The source rules of the location country L must be designed to avoid the OIT that triggered a change of control having a source in Country L; otherwise, double taxation could arise from both deemed resident taxation and actual non-resident taxation in Country L. - If the actual sale of the offshore interests is held to be sourced in Country L, ordering rules are needed to clarify whether the source rule or the deemed disposal rule applies to avoid simultaneous application. - Model 2 (Taxing the Non-resident Seller) seeks to impose tax on the non-resident seller on the basis that the transfer gives rise to a gain with a local source in Country L; under that model, source rules are critical because a non-resident is ordinarily only subject to taxation on income derived from sources in the location country. - Box 6 (Source rule) example: amounts derived from sources in Country L include a gain arising from the alienation of immovable property in Country L and shares or comparable interests if, at any time during the 365 days preceding the alienation, more than 50 percent of the value of the shares or other interests is derived, directly or indirectly through one or more interposed entities, from immovable property in Country L. - The source rule may be combined with a taxable asset rule (e.g. Article 13(4) of OECD and UN Model MTCs) that allows taxation of the entire gain when more than 50 percent of the value of the indirect interest is derived from local immovable property, or designed to apply proportionately or on a modified pro rata basis with lower thresholds (e.g. 20 percent) as adopted in some jurisdictions. *Source: Box 5: Change in Control (extracted content from the supplied PDF).* ### Box 7: Taxable asset rule: Full and pro rata taxation ### Box 7: Taxable asset rule: Full and pro rata taxation ### Scope and measurement of taxable gain - The chargeable income of a person includes gains from the realization of shares or comparable interests, if, at any time during the 365 days preceding the realization, more than 20 percent of the value of the shares or other interests is derived, directly or indirectly through one or more interposed entities, from immovable property in Country L. - For the purposes of subsection (1), the amount of the gain to be included in chargeable income is: - (a) if the shares or other interests derive, or derived at any time during the 365 days preceding the realization, more than 50 percent of their value, directly or indirectly, from immovable property in Country L, the full amount of the gain; or - (b) in any other case, the amount computed according to the following formula: A × B/C - where: - A is the amount of the gain; - B is the value of the shares or other interests derived, directly or indirectly, from immovable property in Country L; and - C is the total value of the interest. - Valuation considerations and anti-abuse time test: - Valuation aspects of determining the 50% threshold are critical. - Practical tax administration guidance may be needed to establish which assets are to be treated as immovable property and what valuation methods should be used. - Guidance is particularly needed regarding the extent to which cash and cash equivalents injected into a company shortly before disposal are taken into account. - A time test, as foreseen in Article 13(4) of the OECD and UN MTCs, would be appropriate to prevent abusive transactions that dilute the proportionate value of immovable property. - Interaction with tax treaties: - The taxing right over gains realized on offshore indirect transfers principally (e.g. more than 50 percent) derived from local immovable property is generally preserved in Article 13(4) of the OECD and UN MTCs. - Domestic legislative provisions should be designed and drafted to preserve the taxing right over interests which derive more than 50 percent of their value, directly or indirectly, from immovable property in the location country as permitted by the MTCs. ### Definitions and thresholds for taxable interests - Options for defining the scope of interest subject to tax: - (i) impose tax liability on disposal of all interests (including interests representing less than a de minimis interest), if the value of the interest disposed of derives more than half its value from the asset; - (ii) impose liability only on disposal of more significant interests (e.g. interests of 10 percent or more of the asset); - (iii) apply a back-up threshold based on nominal value (e.g. apply the rule only to interests with a value of $1 million or more). - Rationale and trade-offs for a percentage interest threshold: - A 10 percent threshold could be considered as it is the international norm for distinguishing between a non-portfolio and portfolio investment. - Such thresholds could help minimize compliance costs and ease administration. - Careful drafting is required to preserve policy intent and combat tax avoidance via staggered sell-downs (selling multiple parcels each comprising less than the threshold). - Exemptions consistent with Article 13(4) Commentary (examples): - Gains derived from the alienation of: - (i) shares of companies listed on a stock exchange; - (ii) shares in the course of a corporate reorganization; - (iii) shares which derive their value from immovable property where a business is carried on; - (iv) shares held by pension funds; - (v) a small investor’s interest in a Real Estate Investment Trust (REIT). - Loss recognition: - To the extent that a loss arises, that loss could also be recognized in Country L and be subject to appropriate loss utilization rules. ### Enforcement and collection mechanisms - General enforcement challenges: - Non-residents subject to tax in Country L would normally be required to file tax returns where a taxable gain is realized in relation to the OIT. - Compliance expected to be low; enforcement instruments can be difficult to apply when sale proceeds have left (or were never in) Country L and no local assets exist to meet the tax liability. - Appropriate supplemental enforcement and collection mechanisms need to be designed, drafted and implemented. - Legal protections to support enforcement: - Restricting registration, renewal or validity of relevant underlying assets (e.g. extractive licenses) by governmental registration bodies or other issuing entities unless notification requirements are met and/or sufficient evidence is furnished that: - no tax is payable; or - the relevant tax has been paid; or - satisfactory arrangements have been made for payment of that tax. ### Withholding tax regime (Box 8 summary and text) - Use and design: - Several countries use withholding to collect tax from a non-resident seller’s gain. - A specific withholding tax regime can be designed to apply to payments to a non-resident seller. - Withholding can represent all or a portion of the tax liability (or an estimate). - Regime may be final or non-final; withholding for OITs is typically designed as a non-final regime. - Withholding regimes for OITs exist in the U.S., Canada, India, China and Australia. - Design options to minimize compliance costs: - Exclude withholding for transactions below a predetermined de minimis threshold. - Exclude withholding for transactions related to listed securities on a stock exchange. - Exclude withholding where a clearance certificate is obtained from the tax authority confirming no amount is required to be withheld. - Practical issues and incentives: - If the purchaser is also a non-resident, similar non-compliance risks arise. - Withholding is an estimate because purchaser is unlikely to know the actual quantum of the seller’s gain; purchaser and seller have additional compliance obligations (return, balancing payment or refund). - A prudent third-party purchaser is likely to comply with withholding obligations to avoid penalties and potential seizure of local assets, thereby creating purchaser interest in assuring seller compliance. - Failure to withhold exposes purchaser to penalties and potential seizure and results in a possible windfall gain for the seller if purchaser cannot recover penalties. - Box 8: sample statutory withholding provisions (selected subsections transcribed) - (1) A person must withhold tax at the prescribed rate when: - (a) the person pays an amount to another person (recipient) in acquiring shares or comparable interests; and - (b) more than 50 percent of the value of the shares or comparable interests referred to in paragraph (a) is derived, directly or indirectly through one or more interposed entities, from immovable property in Country L. - (2) The person (withholding agent) must pay the amount to the tax administration on or before the day that the withholding agent becomes the owner of the shares or comparable interests and must file a statement in the manner and form prescribed. - (3) A withholding agent who fails to withhold tax in accordance with this section must nevertheless pay the tax that should have been withheld in the same manner and at the same time as tax that is withheld. - (4) Where a withholding agent fails to withhold tax from a payment as required by this section: - (a) the recipient is jointly and severally liable with the withholding agent for the payment of the tax to the tax administration; and - (b) the tax is payable by the recipient immediately after the withholding agent becomes the owner of the shares or comparable interests. - (5) A withholding agent who withholds tax under this section and pays the tax to the tax administration is treated as having paid the amount withheld to the recipient for the purposes of any claim by the recipient for payment of the amount withheld. - (6) A withholding agent who fails to withhold tax under this section but pays the tax that should have been withheld to the tax administration in accordance with subsection (3) is entitled to recover an equal amount from the recipient. - (7) The recipient is treated as having paid any tax: - (a) withheld from the payment under this section; or - (b) paid in accordance with subsections (3) or (4). - (8) A recipient is entitled to a tax credit in an amount equal to the tax treated as paid under subsection (7) for the year of assessment in which the payment is derived. ### Notification and agency taxation (Box 9) - Two alternative or supplemental enforcement/collection measures if withholding is not adopted: - (a) a notification/reporting obligation; and - (b) a payment obligation for an entity in the location country as agent for the non-resident. - Purposes and benefits: - Notification/reporting is important for raising an assessment and for exploring recovery avenues (e.g. Assistance in the Collection of Taxes under treaties or the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters). - Imposing a payment obligation on a resident as agent for the non-resident enables the tax authority to use enforcement tools against that resident. - Examples and recent adoption: - Legislative mechanisms of this kind have recently been adopted in Kenya and Fiji for the extractives sector. - Sample legislative provisions (Box 9) shown as triggered with respect to holdings of non-portfolio interests of 10 percent or more. - Box 9: sample statutory notification/agency taxation provisions (selected subsections transcribed) - (1) Subsection (3) applies when the direct or indirect ownership of an entity mentioned in subsection (2) changes by 10 per cent or more. - (2) An entity to which subsection (1) applies consists of an entity in respect of which, at any time during the 365 days preceding the relevant change in the direct or indirect ownership, more than 50 percent of the value of the shares or comparable interests issued by that entity is derived, directly or indirectly, from immovable property in Country L. - (3) Where this subsection applies, the entity: - (a) must immediately notify the tax administration, in writing, of the change; and - (b) is liable, as agent for any non-resident disposing of the interest to which the notice under paragraph (a) relates, for tax payable by the non-resident under this Act in respect of the disposal. - (3) Subsection (3)(b) does not apply to the disposal of shares quoted in any official list of a recognized stock exchange in Country L.* - (4) Any tax paid by the entity on behalf of a non-resident under subsection (3) is to be applied against the tax liability of the non-resident under this Act. ### Pros and cons of Model 2 (agency/notification approach) - Key advantages: - It more closely preserves the separate legal entity distinction between the local asset owning entity and its relevant holding entity/parent. - Relief of double taxation is preserved in the country of residence of the seller, as foreign tax relief should remain available because the offshore seller is primarily liable for the tax payable sourced in the location country on the gain realized from the sale. - Key disadvantages: - Reduced ability to enforce and collect the tax liability as the taxable gain is realized by the non-resident seller (compared to a local entity under the deemed disposal model)—although withholding/agency mechanisms can aid enforcement. - The agency approach assumes the direct owner in Country L can always make itself aware when there has been a transaction resulting in a 10 percent or greater change in underlying ownership. - Double taxation can effectively arise on a subsequent sale of interests in other entities that indirectly hold the assets because shares or interests in those entities are not stepped up to market value; this typically arises with multiple tiered holding structures. - Even with appropriate domestic legislation, the taxing right of the location Country L could (unless there was a treaty override) still be limited by an applicable tax treaty if the relevant treaty does not include an article similar to Article 13(4) of the OECD or UN Model MTC. ### Defining “immovable” property - Importance: - An appropriate definition of “immovable property” is critical for effective application of the chosen tax liability rule and associated enforcement and collection rules. - A definition with appropriate clarity is relevant for both Model 1 and Model 2. - Models can have greater reach if the definition is extended to cover a broader category of “immovable property” than traditionally the case. - Illustration: - A sample definition of “immovable property” is set out in Box 10 (not reproduced here). The sample definition has been drafted on an inclusive basis and presupposes it would cover within the ordinary meaning of “immovable property” all traditional notions of real property (e.g. land, buildings and mines etc.). *Source: Box 7, "Taxable asset rule: Full and pro rata taxation."* ### Box 10: Sample definition of immovable property ### Box 10: Sample definition of immovable property ### Sample statutory definition - “Immovable property” includes* a structural improvement to land or buildings, an interest in land or buildings or an interest in a structural improvement to land or buildings, and also includes the following– - (a) a lease of land or buildings; - (b) a lease of a structural improvement to land or buildings; - (c) an exploration, prospecting, development, or similar right relating to land or buildings, including a right to explore for mineral, oil or gas deposits, or other natural resources, and a right to mine, develop or exploit those deposits or resources, from land in, or from the territorial waters of, Country L; or - (d) information relating to a right referred to in paragraph (c). ### Minimum elements recommended for domestic definitions - Countries should consider defining immovable property in their domestic laws to include at least: - Real property (in the narrower sense); - Mineral, petroleum, and other natural resources; and - Rights (such as those embodied in licenses) to explore for, develop, and exploit natural resources, as well as information relating to those rights. ### Relevance for tax treaties and valuation - The basic rule under the OECD and UN MTCs is that the term “immovable property” has the meaning under the domestic law (tax or other law) of the contracting state in which the property is located. - Property accessory to immovable property is to be treated as immovable property for the purposes of the application of the tax treaty provisions; this is important for determining the proportionate value of the indirect transfer that is derived from the immovable property. - Rights to immovable property, including rights to economic benefits such as usufruct and payments derived from immovable property, are to be treated as immovable property; this is critical for valuation and application of the relevant provisions. - Some countries have reserved the right to modify the relevant definition of immovable property to include, for instance, shares of companies which derive their value from immovable property. ### Possible extensions and policy considerations - The definition could be extended to cover a broader category of “immovable property” that Country L might think appropriate to tax, for example: - Gains arising in relation to location specific rents clearly linked to national assets, such as from licenses to exploit public goods (e.g., electric, gas, or other utilities; telecommunications and broadcast spectrum and networks etc.). - Consideration could be given to extending the definition to cover rights to receive variable or fixed payments in relation to extractive industry rights or government issued rights with an exclusive and territorial quality, to keep subsequent assignments within Country L’s tax base. - The concept of location specific rents is easier to conceive in economic terms than to convey in legal language; further thought is needed. - Countries must comply with good faith obligations in interpreting tax treaties if they expand domestic definitions when existing tax treaties are in force; modifications or extensions should be compatible with the context—and negotiated position—of existing tax treaties. Treaty partners should consult with each other. ### Key analytical and policy conclusions (from VI. CONCLUSIONS) - It is appropriate that location countries have the right to tax OITs, at least for assets that are likely to embody, primarily and substantially, location specific economic rents, including those traditionally thought of as “immovable”. - This taxing right: - Mirrors a recognized right in relation to direct transfers of immovable assets (equity rationale). - Provides a backstop to taxation of location specific rents where direct taxes are imperfectly designed or implemented (efficiency rationale). - Fosters neutrality between direct and indirect transfers and responds to political pressures regarding salient national assets. - Location countries may nonetheless choose not to tax related OITs depending on capacity, revenue needs, and desire to attract foreign investment. - The provisions of both MTCs suggest wide acceptance that capital gains taxation of OITs of “immovable” assets be allocated primarily to the country in which they are located. - As of 2015, Article 13(4) appeared in only around 35 percent of all DTTs, and was less likely to be found when one party is a low-income resource rich country. - The MLI has had a positive impact by increasing the number of tax treaties that effectively include Article 13(4) of the OECD MTC; this impact is expected to increase as new parties negotiate or re-negotiate treaties based on the 2017 OECD and UN formulations and/or sign the MLI and modify covered tax treaties. - Such a taxing right cannot be supported without: - Appropriate definition in domestic law of the assets intended to be taxed, and - A domestic law basis to assert that taxing right. - Two main legal approaches to enforce taxation of OITs are outlined: - Treat the OIT as a deemed disposal of the underlying asset. - Treat the transfer as taking place by the actual seller offshore, but source the gain on that transfer within the location country. - Sample simplified legislative language for both approaches was provided in the report. - A more uniform, coordinated, and coherent approach to taxing OITs, where countries choose to tax them, can contribute substantially to coherence in international tax arrangements and enhanced tax certainty. *Box 10: Sample definition of immovable property.* ### 1. Direct interests in real property located in the U.S.; ### 1. Direct interests in real property located in the U.S.; ### FIRPTA and U.S. taxation of nonresident interests - FIRPTA applies to: - 1. Direct interests in real property located in the U.S.; - 2. Interests in a domestic corporation which holds substantial U.S. real property13; - 3. Interests in domestic or foreign partnerships, trusts or estates with U.S. real property. - FIRPTA overrode treaties that exempt foreign residents from a capital gains tax on their U.S. RPIs in any of those three cases. - Basic principle preserved: gains (and losses) from dispositions of directly held U.S. RPIs of non-residents are treated as income effectively connected with a U.S. business, and the foreign investor disposing of a U.S. RPI is deemed to be engaged in a U.S. business and taxed accordingly. - Important limitation: a foreign corporation can hold U.S. real property and the disposition of its stock by a foreign investor is not subject to U.S. tax; FIRPTA does not reach foreign indirect sales of U.S. property held by a foreign corporation. - Notes and references in source: - FIRPTA principal provision: IRC, S 897. - A ‘real property holding corporation’ is defined as holding majority real property, which is marked to market.13 - In the U.S. landowners also own what lies underground beneath their property.10 ### Peru — Income Tax Law on offshore indirect sales of assets (Box A.1) - Art. 10: income from Peruvian source includes: - e) Income obtained from the indirect sale of shares or participations representing capital of legal persons residing in Peru. An indirect sale occurs when shares of a non-resident legal person that, in turn, is the owner - directly or through one or more intermediaries - of shares or participations representing the capital of a legal person resident in Peru, if concurrently: - 1. In any of the twelve months prior to the sale, the market value of the shares ...of the resident entity ... represent ... at least fifty percent of the market value of all shares ... of the non-resident entity. - 2. In any period of twelve months, shares sold by the non-resident... represent at least ten percent of the capital of the non-resident entity. - An indirect sale also occurs when a non-resident entity issues new shares ... resulting from an increase in subscribed capital, new capital contributions ... or a reorganization that diminishes their value below the market benchmark. - Whenever the share sold, or the new shares issued ... belong to an entity residing in low tax jurisdiction; it will be treated as an indirect sale. - Peru’s broader approach after Petrotech: - Peru passed legislation taxing all OITs, not just those whose value arises from immovable property located in Peru. - The sale of an interest of any nonresident company whose value results at least 50 percent from shares of companies residing in Peru would be taxed in Peru. - At least 10 percent of the parent foreign resident assets must be transferred for the tax to take effect1485, thus, sales of retail investors abroad would not be affected. - Legislative timeline notes: - The first condition was introduced with the Law No. 29663, February 2001; the second condition with Law No.29757, July 2011.14 - Peru’s domestic legislation taxing OITs can be overridden by double taxation treaties. ### China — anti-abuse approach to indirect transfers - General rule: - Gain on direct transfers of assets located in China is taxed at a 25 percent rate. - Offshore indirect transfers are equally taxed when involving the sale of immovable property located in China. - In other cases, the taxation right on the indirect transfer of equity investment is sourced to the location of the investing enterprise. - Sourcing implication: - A nonresident enterprise owning another nonresident holding company which in turn invests in a Chinese company would not be taxed in China on the gain resulting from the transfer of shares of the holding company; the capital gain is sourced in the location of the holding company.15 - Anti-abuse threshold and re-characterization: - If the holding company is situated in a jurisdiction where the effective tax burden is lower than 12.5 percent or where offshore income is not taxed, the Chinese tax authority may disregard the overseas holding company and re-characterize the indirect transfer as a direct one if it determines there is no reasonable commercial purpose to the offshore transaction other than avoiding the Chinese tax.16 - Considerations for failing the reasonable business purpose test include, for example: - i) the value of the asset directly transferred derives at least 75 percent (directly or indirectly) from Chinese taxable property; - ii) the nonresident enterprise does not undertake substantive functions and risks; - iii) the tax consequence of the indirect transfer in the foreign country is less than the Chinese tax payable if the sale had been made directly.1792 - Characterization: - The Chinese approach is relatively defensive and discretionary: it taxes OITs when it deems they have been structured to avoid Chinese tax, without being taxed commensurately by another jurisdiction. - Source annotations: - Rule originally established in Notice No. 698, December 10, 2009 and replaced by Public Notice (2015) 7.15 - Article 47 EIT Law. Some exceptions apply, for example, sale of shares in the stock exchange.16 ### Appendix D — Article 13(4) in practice — empirical analysis (IMF, as of 2015) - Coverage: - Analysis covers 3,046 DTTs (almost the entire universe of active DTTs in 2015). - Of these, 2,979 were recovered from the International Bureau of Fiscal Documentation (IBFD); the rest were recovered by internet search or from the ActionAid tax treaties dataset. - Prevalence: - About 35 percent of these treaties (973) include a specific provision that entitles a country to tax gains from alienation of the capital stock of an entity the property of which consists directly or indirectly principally of immovable property located in that country. - About 35 percent of the treaties concluded by least one resource-rich country include Article 13(4) (291 of 834 treaties). - About 38 percent of the treaties concluded by at least one low tax jurisdiction include Article 13(4). - Dependent variable definition: - Article 13(4) dummy equals one if a DTT includes article 13(4) and the word “indirectly” (using the UN or the OECD version or similar variants), and zero otherwise. - Key explanatory variables used in modelling (summary provided): - Resource-rich low-income: dummy equal to one if at least one party is a low-income or lower middle-income resource-rich country (as defined by the income classification of the World Bank and if revenues from resources exceed 10 percent). - CGT_i – CGT_j: difference (in absolute value) between the concluding countries’ tax rates on capital gains. Corporate CGT used when codes distinguish; source from Ernst and Young and Deloitte. - Low tax: dummy equal to one if jurisdiction is a low tax jurisdiction in the sense of being included in the list of Hines and Rice (1994). There are 454 DTTs that involve such countries. - Low tax × Low Income Res.: interaction term between Resource-rich low-income and Low tax. - Year: year of concluding the treaty (trend variable spanning from 1947 to 2015). - Table D1: Descriptive Statistics (as presented) - Article 13(4): N 3,046; mean 0.319; SD 0.466; min 0; max 1 - Year: N 3,046; mean 1997; SD 12.51; min 1947; max 2015 - CGT_i – CGT_j: N 2,993; mean 11.05; SD 8.512; min 0; max 35 - Low tax: N 3,046; mean 0.149; SD 0.356; min 0; max 1 - Resource-rich low-income: N 3,044; mean 0.105; SD 0.306; min 0; max 1 - Low tax × Low Income Res: N 3,044; mean 0.00591; SD 0.0767; min 0; max 1 - Table D2: Estimation results — likelihood of including Article 13(4) in a DTT (selected results and interpretation) - Models: Linear Probability Model (LPM) in columns (1)-(3) and logit model in columns (4)-(6); marginal effects reported for logit columns (4)-(6). - Resource-rich low-income: - Coefficients: -0.0592**, -0.0593**, -0.0657**, -0.065**, -0.064**, -0.079*** (standard errors in parentheses reported in table). - CIT_i - CIT_j / CGT difference (reported as CIT_i - CIT_j in table): - Coefficients: 0.0030***, 0.0042***, 0.0021**, 0.0037*** (standard errors shown in table). - Low tax: - Coefficients: -0.133***, -0.164*** (in specified columns). - Low tax × Resource-rich low-income: - Coefficient: -0.162* (reported in specified column) and -0.164 (other column). - Year: - Coefficients: 0.0136***, 0.0135***, 0.0141***, 0.017***, 0.016***, 0.017***. - Constant terms and model fit: - Constant: -26.88***, -26.76***, -27.80***, -180.5***, -177.4***, -195.8***. - Observations: 3,044; 2,971; 2,971; 3,044; 2,971; 2,971. - R2 reported: 0.134, 0.135, 0.146 (for LPM columns). - Significance notation: - Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1. - Interpretation highlights from the source: - Differences in capital gains or corporate tax rates between treaty partners (CGT_i – CGT_j / CIT_i - CIT_j) are positively associated with inclusion of Article 13(4). - Resource-rich low-income status is negatively associated with inclusion of Article 13(4) in treaties. - Presence of low tax jurisdictions and interaction with resource-rich low-income status show negative associations in some specifications. - Year trend positive and highly significant, indicating increasing inclusion over time. *Prepared from IMF source content.* --- _Source: https://www.imf.org/-/media/files/miscellaneous/oit.pdf_