## pr18297offshoreindirecttransferstoolkitver2-071618 ## Source details **Canonical URL:** [pr18297offshoreindirecttransferstoolkitver2-071618](https://www.imf.org/-/media/files/news/press-release/pr18297offshoreindirecttransferstoolkitver2-071618.pdf) ## Other formats - [Markdown version](/-/media/files/news/press-release/pr18297offshoreindirecttransferstoolkitver2-071618.pdf.md) - [Structured JSON version](/-/media/files/news/press-release/pr18297offshoreindirecttransferstoolkitver2-071618.pdf.json) --- ### Executive summary — issue, relevance, and policy choices - Issue defined: - Offshore indirect transfers (OITs) are the sale of an entity owning an asset located in one country by a resident of another country. - Policy relevance: - OITs have emerged as a significant issue in many developing countries and were identified in IMF technical assistance work and scoping by the OECD. - OITs were not covered by the G20-OECD BEPS project; work on OITs in the extractive industries is also being done at the UN. - Location-country perspective and scope: - The location country may wish to tax gains on OITs as it does for direct transfers of immovable assets. - Taxation might reasonably be extended to assets generating location specific rents (returns in excess of the minimum “normal” level of return that are uniquely associated with some specific location). Examples include telecom licenses and other rights issued by government. - The report recognizes that gains on OITs may be attributable in part to value added by owners and managers; some countries may choose not to tax gains on OITs. - Treaty and domestic law context: - OECD and UN Model treaties suggest wide acceptance that capital gains taxation of OITs of “immovable” assets can be imposed by the location country. - Relevant model Article 13(4) is found in around 35 percent of all Double Tax Treaties (DTTs). - The Multilateral Convention (MC) has increased the number of treaties that effectively include Article 13(4); further increase expected as more parties sign and amend covered treaties. - A taxing right cannot be supported without appropriate domestic law definitions of the assets intended to be taxed and a domestic law basis to assert the right. - Need for coherence: - Countries’ unilateral responses have differed widely in assets covered and legal approaches; greater coherence could enhance tax certainty. - Two main legal approaches for location-country taxation of OITs: - Model 1: Treat an OIT as a deemed disposal of the underlying asset. - Model 2: Treat the transfer as made by the actual seller offshore but source the gain within the location country to enable taxation. - The report expresses no general preference between the two models; choice depends on country circumstances and preferences. ### Analysing OITs — definitions, revenue implications, equity and efficiency - Definitions and anatomy: - Offshore Indirect Transfer: an indirect transfer where the transferor is resident in a different country from that in which the asset is located. - Indirect Interest: ownership interest with at least one intervening entity in the chain. - Indirect Transfer: disposition of an indirect ownership interest in an asset, in whole or in part. - Revenue and timing implications: - Aggregate nominal value of tax receipts in the location country, cumulated over time, is independent of whether the asset is transferred directly or indirectly; the key issue is timing of receipts. - Example numeric illustration: at six percent interest, a delay of ten years in receiving revenue of $1 billion reduces its present value by around $450 million. - Indirect transfers conducted in low tax jurisdictions may amplify tax distortions towards delayed sale of the underlying asset. - Equity and efficiency considerations: - Location-country taxation balances taxing location-specific rents (LSRs) against recognition that part of gains may reflect value added by sellers/managers resident elsewhere. - Norms supporting source-country taxing rights: - Capital gains on onshore direct transfers of tangible assets are taxable by the country in which the asset is located. - Dividends from a domestic source may be subject to withholding by the country of residence of the paying company. - Model treaties accept that gains on ‘immovable’ assets may be taxed by the country in which the asset is located. - Counterarguments stress that some gains reflect foreign managerial value and that taxing residence may avoid distortions; residence taxation relief (dividend exemptions) and administrative limits affect practical outcomes. ### Tax treaties and empirical patterns — principal findings and statistics - Model treaty content and prevalence: - OECD and UN Model treaties accept location-country taxation of capital gains on “immovable” assets. - Article 13(4) appears in about 35 percent of all DTTs analyzed. - Article 13(4) is less likely to be included when one treaty party is a low-income resource rich country. - Multilateral Convention (MC) impact: - The MC has increased effective inclusion of Article 13(4) in covered treaties; further increases expected as more parties adopt MC provisions. - Empirical Appendix highlights (Universe of DTTs as of 2015): - Total DTTs analyzed: 3,046. - About 35 percent (973) include a provision entitling the source country to tax gains from alienation of capital stock when the property consists directly or "indirectly" principally of immovable property. - About 35 percent of treaties that involve at least one resource-rich country include Article 13.4 (291 of 834 treaties). - About 38 percent of treaties involving at least one low tax jurisdiction include Article 13.4. - Regression/estimation results (selected findings from Table D2): - Resource-rich low-income dummy: negative and significant coefficients (e.g., LPM: -0.0592**; Logit marginal effects: -0.065**), indicating lower likelihood of Article 13.4 when a treaty involves a resource-rich low-income country. - Low tax dummy: negative and significant (e.g., -0.133***; logit marginal effect -0.164***). - Year (trend from 1947 to 2015): positive and significant (e.g., 0.0136***; logit marginal effects ~0.017***), indicating increasing inclusion over time. - CIT_i - CIT_j (tax rate difference) shows positive and significant association in several specifications (e.g., 0.0030***). - Observations in regressions vary by specification: 3,044; 2,971; R^2 for LPM up to 0.146. ### Implementation challenges and two model approaches — legal design, drafting, and enforcement - Two principal legal models (design summary): - Model 1 — Deemed disposal of the local resident asset-owning entity: - Concept: Treat the OIT as a deemed disposal of the underlying asset located in the country. - Trigger example: Change in control by more than 50 percent relative to previous three years where, during the preceding 365 days, more than 50 percent of the value of the shares is derived from immovable property in Country L. - Tax mechanics: entity treated as realizing all assets and liabilities at market value immediately before change; reacquisition at market value; balance sheet reset to avoid double taxation on later disposals. - Enforcement: ordinary domestic enforcement tools apply against the local entity; step-up of tax cost reduces risk of double taxation in the location country. - Advantages: greater capacity to enforce/collect because taxpayer is local; simplicity of basis adjustment. - Disadvantages: may undermine separate legal entity doctrine; minority shareholders exposed to liabilities; liquidity/collection difficulties if local entity lacks funds; treaty arguments may still arise. - Suitability: attractive for lower capacity countries given enforceability. - Model 2 — Taxing the non-resident seller with sourcing rules: - Concept: Tax the actual offshore seller by sourcing the gain to Country L when the indirect interest derives principally from local immovable property. - Critical components: source rule (Box 6), taxable asset rule (Box 7) with full or pro rata taxation, enforcement/collection measures (withholding tax Box 8; notification/agency taxation Box 9). - Enforcement mechanisms: - Notification/reporting and information exchange. - Withholding on payment of purchase price (non-final withholding common). - Resident entity acting as agent for the non-resident. - Restrictions on registration/renewal of underlying assets until tax obligations cleared. - Advantages: preserves separate legal entity distinction; foreign tax relief remains available in seller’s residence country. - Disadvantages: harder to enforce collection against non-resident; purchaser often non-resident; pro rata or stepping-up complications across multiple tiers; treaty limitations if Article 13(4) absent. - Source rule and taxable asset rule design choices (from Box 6 and Box 7): - Source rule sample: gains from alienation of immovable property and shares if, during the 365 days preceding alienation, more than 50 percent of value of shares derived (directly or indirectly) from immovable property in Country L. - Taxable asset rule sample: chargeable income includes gains where more than 20 percent (sample) of value derives from Country L immovable property; full or pro rata inclusion options: - Full inclusion when more than 50 percent derived from local immovable property. - Otherwise, inclusion by formula A × B/C where A = amount of gain, B = value derived from local immovable property, C = total value of interest. - Definitional and threshold choices: thresholds (e.g., 50 percent, 20 percent, 10 percent), de minimis nominal value (e.g., $1 million), and portfolio vs non-portfolio distinctions (10 percent) influence coverage and avoidance risk. - Withholding and other collection design (Box 8, Box 9): - Withholding designs: final vs non-final withholding; non-final withholding typical for OITs; exclusions for de minimis transactions and listed securities; clearance certificates to limit burden. - Notification/agency taxation: resident direct owner can be statutory agent for non-resident tax liability, triggered for non-portfolio changes (example threshold: 10 percent change), with duties to notify and face joint and several liability for unpaid tax. - Practical enforcement limitations: purchaser and seller often non-resident; sale proceeds may not be within Country L; withholding and agency mechanisms intended to mitigate but not eliminate enforcement gaps. - Anti-avoidance and GAARs: - GAARs can serve as last-resort tools but may be hard to apply for low capacity tax administrations. - Some jurisdictions (example: China) adopt anti-abuse rules that collapse holding structures and re-characterize indirect transfers as direct transfers when avoidance motives and low-tax conduits are present. ### Definitional challenge — “immovable” property and location specific rents - Immovable assets and policy role: - Precise definition is a matter for national law and may be modified by treaties. - Typically includes land, buildings, structures, rights related to such property, and may include leases, exploration, prospecting, development rights, and information relating to those rights (sample definition in Box 10). - Consideration to extend definition to government-issued exclusive territorial rights capable of generating location specific rents (telecom spectrum, utilities, extractive concessions). - Sample definition (Box 10) elements: - Structural improvements to land or buildings; leases of land or buildings; exploration/prospecting/development/exploitation rights for mineral, oil or gas deposits; and information relating to such rights. - Treaty interaction: - Domestic expansion of the definition should respect good faith obligations in interpreting tax treaties; consultation with treaty partners is advised. ### Country practice and illustrative cases — highlights - India — The Vodafone Case (Box 2): - Transaction: 2006 purchase by Vodafone of Hutchison’s participation in Indian mobile operator for nearly US$11 billion via a sale of a Cayman Islands subsidiary to a Dutch-resident Vodafone subsidiary. - Indian Tax Authority sought US$2.6 billion tax on Hutchison’s capital gain; attempted to collect from purchaser by withholding. - Supreme Court of India (2012) ruled in favor of taxpayer; India later changed law to tax offshore indirect sales and attempted retroactive application; legality of retroactivity submitted to arbitration under India-Netherlands Bilateral Investment Treaty. - Uganda — The Zain Case (Box 4): - Transaction: 2010 sale by Zain International BV of Zain Africa BV for US$10.7 billion, which owned Celtel Uganda Ltd. - Uganda Revenue Administration assessed US$85 million capital gains tax against Zain International BV. - Appeals Court of Uganda ruled URA has jurisdiction to assess and tax the offshore seller; taxpayer relies on Uganda-Netherlands treaty as potentially allocating exclusive taxing rights to Netherlands—dispute unresolved. - Fiscal significance: amount at stake characterized as "in the order of 5 percent of total government revenue (and, for example, nearly 50 percent of public spending on health)." - Broader observations: - High-profile OIT disputes often involve assets deriving value from government concessions (location specific rents). - Location-country unilateral legislative changes (e.g., India, Peru, Chile) have sometimes been retrospective or expansive, increasing international uncertainty. ### Design, transitional, and double-taxation considerations - Implementation caveats: - Sample provisions are simplified and do not address all complexities (corporate reorganizations, minority shareholders, listed securities, valuation difficulties, treatment of losses, joint ventures). - Either model is recommended to be implemented prospectively, not retroactively, unless strong reasons exist; transitional arrangements (e.g., deeming market value cost base as at commencement) can be considered. - Approaches to limit double taxation: - Step-up of tax cost of relevant assets when a taxable realization occurs. - Non-recognition of gain on each intermediate asset (more comprehensive but complex). - Administrative capacity and practical suitability: - Model 1 may be preferable for lower capacity countries due to enforceability against local entities. - Model 2 preserves legal separateness and preserves residence-based foreign tax relief but requires robust withholding, notification, or agency rules to be effective. - Anti-abuse rules and GAARs have roles but depend on drafting quality and administrative capacity. ### Conclusions and policy considerations — recommended country steps and trade-offs - No one-size-fits-all solution: - The report does not express a general preference between Model 1 and Model 2; choice depends on country circumstances and preferences. - Key policy steps for location countries choosing to tax OITs: - Clearly define assets intended to be taxed (including precise treatment of immovable property and assets generating location specific rents). - Choose a legal model (deemed disposal vs. sourcing the gain) and draft clear legislative language. - Consider treaty positions and whether Article 13(4) (or Article 13.4) is in applicable DTTs; assess interaction with the Multilateral Convention where relevant. - Design enforcement and collection mechanisms (withholding, notification, agency taxation) to ensure effective collection from non-resident sellers. - Trade-offs to consider: - Equity: taxing location specific rents that belong to the location country. - Efficiency and administrative practicality: avoiding overreach where gains reflect value added outside the location country and ensuring administrable rules. - Political economy: failure to tax salient national asset sales can provoke intense domestic dissatisfaction; unilateral retrospective measures increase uncertainty. *Source: pr18297offshoreindirecttransferstoolkitver2-071618 - 2017. The PCT partners wish to express their gratitude for all submissions received.* ### 2017. The PCT partners wish to express their gratitude for all submissions received. ### pr18297offshoreindirecttransferstoolkitver2-071618 - 2017. The PCT partners wish to express their gratitude for all submissions received. ### Executive Summary - Issue defined: Offshore indirect transfers (OITs) are the sale of an entity owning an asset located in one country by a resident of another country. - Policy relevance: - OITs have emerged as a significant issue in many developing countries and were identified in IMF technical assistance work and scoping by the OECD. - OITs were not covered by the G20-OECD BEPS project; work on OITs in the extractive industries is also being done at the UN. - Location country perspective: - The location country may wish to tax gains on OITs, as it currently does for direct transfers of immovable assets. - Taxation might reasonably be extended to assets generating location specific rents (returns in excess of the minimum “normal” level of return that are uniquely associated with some specific location). Examples include telecom licenses and other rights issued by government. - The report recognizes that gains on OITs may be attributable in part to value added by owners and managers; some countries may choose not to tax gains on OITs. - Treaty context: - The OECD and UN Model treaties suggest wide acceptance that capital gains taxation of OITs of “immovable” assets can be imposed by the location country. - The relevant model Article 13(4) is found only in around 35 percent of all Double Tax Treaties (DTTs), and is less likely to be found when one party is a low income resource rich country. - The Multilateral Convention (MC) has increased the number of tax treaties that effectively include Article 13(4) of the OECD MTC; this impact is expected to increase as new parties sign the MC and amend covered tax treaties to include the new language of Article 13(4). - Domestic law requirement: - A taxing right cannot be supported without appropriate definition in domestic law of the assets intended to be taxed and without a domestic law basis to assert that taxing right. - Need for coherence: - Countries’ unilateral responses have differed widely in terms of assets covered and legal approaches; greater coherence could enhance tax certainty. - Two main approaches outlined for location-country taxation of OITs: - Model 1: Treat an OIT as a deemed disposal of the underlying asset. - Model 2: Treat the transfer as being made by the actual seller offshore, but source the gain within the location country to enable taxation. - The report expresses no general preference between the two models; choice depends on country circumstances and preferences. ### Analysing Offshore Indirect Transfers — key points - Definition and scope: - Offshore Indirect Transfer: An indirect transfer in which the transferor of the indirect interest is resident in a different country from that in which the asset in question is located. - Indirect Interest: Ownership interest in an asset in which there is at least one intervening entity in the chain of ownership. - Indirect Transfer: The disposition of an indirect ownership interest in an asset, in whole or in part. - Revenue implications: - OITs can shift taxing rights away from the location country where location specific rents exist. - Box 1 in the report: Sources of Capital Gains (listed as a substantive topic in the report). - Equity and efficiency considerations: - Taxing rights allocation on OITs balances taxing location-specific rents against recognition that part of gains may reflect value added by sellers/managers resident elsewhere. - Some countries may opt not to tax OIT gains for policy or administrative reasons. ### Tax treaties and OITs — principal findings - Model treaty content: - Both the OECD and UN Model treaties accept that capital gains taxation of OITs of “immovable” assets can be imposed by the location country. - Article 13(4) (the model provision) is not universally included: found in around 35 percent of DTTs. - Empirical pattern: - Article 13.4 (alternatively referenced) is less likely to be included when one treaty party is a low income resource rich country. - The Multilateral Convention has expanded effective inclusion of Article 13(4) in covered treaties; further increases are expected as the MC is adopted by more parties. - Practical implication: - Even where treaties permit location-country taxation, domestic law must define taxed assets and provide a legal basis to assert the taxing right; treaties alone are insufficient. ### Implementation challenges and options — two model approaches (legal design and drafting) - Overview: - The report outlines two main legal approaches to taxing OITs in the location country; careful legislative drafting is required for either approach. - Model 1 — Deemed disposal of the local resident asset-owning entity: - Concept: Treat the OIT as a deemed disposal of the underlying asset located in the country. - Effect: Enables direct taxation in the location country by treating the offshore transfer as if the asset itself were sold. - Note: Includes discussion of "Change in Control" (Box 5) as relevant drafting consideration. - Model 2 — Taxing the non-resident seller with sourcing rules: - Concept: Tax the actual offshore seller by sourcing the gain to the location country. - Effect: The gain realized by the non-resident seller is treated as arising in the location country and taxable there. - Relevant drafting considerations: source rule (Box 6), taxable asset rule: full and pro rata taxation (Box 7), enforcement/collection mechanisms including withholding tax (Box 8) and notification/agency taxation of non-portfolio interests (Box 9). - Definitional challenge: - Defining “immovable” property is critical; the report provides a sample definition (Box 10 and text at D). ### Country practice and case examples (topics covered) - The report includes country examples and cases illustrating approaches and disputes: - India—The Vodafone Case (Box 2) - Peru—The Acquisition of Petrotech (Box 3) - Uganda—The Zain Case (Box 4) - Appendix C provides examples of country practices; Appendix D presents an empirical analysis of Article 13.4 in practice, including descriptive statistics and estimation results (Appendix Tables D1 and D2). ### Conclusions and policy considerations - No single one-size-fits-all solution: - The report does not express a general preference between Model 1 and Model 2; the appropriate model depends on country circumstances and preferences. - Key policy steps for location countries choosing to tax OITs: - Clearly define assets intended to be taxed (including precise treatment of immovable property and assets generating location specific rents). - Choose a legal model (deemed disposal vs. sourcing the gain) and draft clear legislative language. - Consider treaty positions and whether Article 13(4) (or Article 13.4) is in applicable DTTs; assess interaction with the Multilateral Convention where relevant. - Design enforcement and collection mechanisms (withholding, notification, agency taxation) to ensure effective collection from non-resident sellers. - Trade-offs to consider: - Equity: taxing location specific rents that rightly belong to the location country. - Efficiency and administrative practicality: avoiding overreach where gains reflect value added outside the location country and ensuring administrable rules. *Source: pr18297offshoreindirecttransferstoolkitver2-071618 - 2017. The PCT partners wish to express their gratitude for all submissions received.* ### INTRODUCTION ### INTRODUCTION ### Background and scope - This report and toolkit responds 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)—the partner members of the Platform for Collaboration on Tax—to produce “toolkits” for developing countries for appropriate implementation of responses to international tax issues under the G20/OECD Base Erosion and Profit Shifting (BEPS) project, and additional issues of particular relevance to developing countries that the project does not address. - The specific issue addressed is the capital gains tax treatment of offshore indirect transfers of assets (OITs): the sales, that is, not of underlying assets themselves but, in some other jurisdiction, of some entity owning those assets. - Developing countries have expressed significant concern that OITs might be used to avoid, inappropriately, capital gains taxation in the country where underlying assets are located; this issue was not covered in the BEPS project but was identified by developing countries as of particular significance, especially in the extractive industries. - The issue’s importance has been stressed by IMF (see IMF 2014), the OECD (see OECD 2014a and 2014b), and the UN. ### Purpose and central questions - Aim: to provide analysis of and options for the tax treatment of OITs, identifying practicable options with a particular view to the circumstances of developing countries. - The toolkit addresses these questions: - (i) What considerations arise in deciding whether or not 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? ### Approach and limitations - Draws on existing literature, IMF technical assistance work with developing countries, and responses to public comments on the first draft. - Does not set out a single, definitive approach suitable in all circumstances; instead aims to identify practicable options. - Does not provide binding rules or authoritative provisions, nor does it aim to establish an international policy standard; it represents 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. ### Structure of the report (overview) - Next section: introduction to OITs, a highly simplified stylized example to illustrate issues, and analysis of economic considerations that inform whether to tax OITs and which types and how. - Section III: recent cases highlighting concerns and variety of unilateral country rules. - Section IV: treatment of OITs under the United Nations and OECD model tax treaties and possibilities created by the OECD’s Multilateral Convention (MC). - Section V: issues of implementation raised by two existing approaches to taxation of indirect transfers. - Final section: conclusions. Appendices: further detail on empirical analysis and selected country experiences. ### Definitions and anatomy of Offshore Indirect Transfers (OITs) - Indirect ownership interest: an arrangement with at least one intervening entity between the controlling owner and the asset. - Direct interest: no intervening entities. - Transfer: a change in the direct or indirect ownership of an asset, in whole or in part, whether between independent or related parties. - Direct transfer: disposition of a direct ownership interest in an asset, in whole or in part. - Indirect transfer: disposition of an indirect ownership interest in an asset, in whole or in part (the underlying asset is being indirectly transferred). - Illustrative stylized three-tiered ownership structure (Figure 1 in source) summary: - Corporation A has a direct interest in “Asset.” - Corporation B has a direct interest in shares of Corporation A; Corporation P1 has an indirect interest in Asset via B. - Sale of B’s shares in A by B (resident in LTJ) to P2 (resident in P) is: - a direct transfer of shares in A, and - an indirect transfer of the asset held by A that is located in country L. ### Key asset classification (tax treaty relevance) - Immovable assets: - Precise definition is a matter for national law and may be modified by tax treaties. - Typically includes land, buildings, structures, and rights related to such property (which may include agricultural, forestry, and mineral rights). - Definition could also include licenses to provide specific products or services to specified geographic locations (e.g., telecommunications), although this is not common. - Movable assets: - For this report, any asset not classed as immovable, including other physical property, intangibles (such as intellectual property or goodwill), and financial assets (e.g., stocks, bonds). - Under existing arrangements, both the location of the asset and the residence of the disposing party (the ‘transferor’) influence which taxing jurisdiction(s) may claim the right to tax transfers. ### Offshore vs Onshore transfers (definitions used here) - Offshore transfers: - Transfers in which the transferor is resident for tax purposes in a different country from that in which the asset is located, and the transferor does not have a permanent establishment in the country in which the asset is located. - Onshore transfers: - All other transfers. - Note: These terms may have meanings different from those used in domestic laws of different countries. ### Stylized tax-planning example and tax consequences - Example setup (Figure 1): - Owners of P1 want to realize capital gain on increase in value of underlying asset; owners of P2 wish to gain control. - Tax rules of at least four countries come into play: country where asset is located (L), seller’s residence (LTJ), parent of seller (P), and buyer’s residence (P2’s country). - Direct asset sale by Corporation A (onshore direct transfer) generally creates tax liability in country L and basis step-up to reflect purchase price. - Tax-efficient strategy: arrange sale indirectly by an entity resident in a low-tax country (LTJ) that applies a low tax rate to capital gains (sale by B resident in LTJ to P2 resident in P). - Any tax advantage from eliminating tax in L may be offset later by taxation under the seller parent’s country P, but delay or partial neutralization can preserve tax advantage. - Purchaser consequences: - Amount paid for shares of company A becomes tax basis for future capital gains/losses on those shares. - If underlying asset expected to decline in value, locating loss in a high-tax jurisdiction maximizes deductible value; if expected to increase, locating acquirer in a low-tax jurisdiction minimizes tax on future gain. - Round-tripping risk: - Residents of country L could use the structure for round-tripping to avoid domestic capital gains tax via offshore indirect sale. - This would be negated if country L taxes its residents on capital gains realized by controlled non-resident entities—unless the gain is illegally concealed from L tax authorities. ### Revenue implications (overview) - Revenue issues are complex and case-specific. - The report aims to bring out core considerations rather than provide an encyclopedic account. - Box 1 in the source considers the general nature of capital gains and how they arise (not reproduced here). *Source: INTRODUCTION (pr18297offshoreindirecttransferstoolkitver2-071618).* ### 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. - Two important aspects: - Capital gains can sometimes be fully anticipated, but the report principally concerns gains that typically arise from unexpected changes in future net distributions (for example, a resource discovery or an increase in commodity prices), often reflecting changes in location specific rents (LSRs). - The value that holders place on an asset typically takes into account future corporate, withholding or other taxes due—including capital gains tax on any future sales. Capital gains tax thus reaches income not taxed by these other instruments; viewed one way it is a form of double taxation, but economically it captures changes in earnings that are otherwise untaxed. ### Revenue effects from the transfer itself - Two broad possibilities for realizing an accrued capital gain: - Direct transfer of the underlying asset itself, which will be subject to tax in country L. Selling now versus later affects liability timing; deferral can be advantageous to the taxpayer. - Indirect transfer: selling an entity that owns the underlying asset, with the purchaser assumed to eventually sell the underlying asset (or it will expire with zero value). - Aggregate nominal value of tax receipts in country L, cumulated over time, is independent of whether the underlying asset is transferred directly or indirectly—eventual sale yields corresponding revenue on the accrued gain. - The key issue for country L is timing of receipts: - Example: At six percent interest, a delay of ten years in receiving revenue of $1 billion reduces its present value by around $450 million. - Distortion potential from indirect transfers: - Whether indirectness increases the attractiveness of deferring sale depends on comparison between the tax rate on the gain realized on the indirect sale of an entity and the rate at which the purchaser can deduct interest (if purchase is financed by borrowing). - If the two rates are equal, direct sale today and indirect sale today (with purchaser deferring sale of the underlying asset) yield the initial owner the same amount—tax benefits of deferral are reflected in price and neutralized by capital gains tax on the share transfer. - If the tax rate on the share transaction is low relative to the rate at which interest is deducted—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 towards 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 country L’s future receipts of corporate income tax (or, for extractives, royalties or rent tax), unless the sale leads to a step up in basis and the asset is depreciable. - Post-sale withholding taxes on dividend, interest or other payments by corporation A to its new direct owner are likely unchanged in practice; different withholding rates may apply if the new direct owner is resident in a different country, but in many cases transfers take the form of sale of an intermediate company B so that B remains direct owner of A and withholding taxes payable do not change. - “Trapped equity” point: retained earnings that give value to a purchaser can only be realized via future dividends, which will be subject to withholding when paid. ### 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 if so, to which assets? - Key considerations: inter-nation equity, efficiency, political economy, and practicability (implementation issues deferred to Section 5 in source). #### Inter-nation equity: three current norms that support source-country taxing rights - Capital gains on onshore direct transfers of tangible assets are taxable by the country in which the asset is located. - Dividends received by a parent abroad may be subject to withholding by the country in which the paying company is resident. - Widely accepted (in model treaties) that gains on ‘immovable’ assets may be taxed by the country in which the asset is located (though not all countries do so). - Implications: - The first norm points to a view that the country in which an asset is located should be entitled to tax gains associated with it, except for value-enhancement provided from abroad. - The second norm suggests parity: if dividends from a domestic source can be taxed at source, so too should capital gains associated with a domestic source—counterarguments relate to prior or future taxation of earnings via corporate or rent taxes and treaty constraints. - For countries unable to effectively tax earnings of an acquired entity or dividends to a foreign parent, taxing gains on transfers may be the surest prospect of raising revenue on associated earnings. - The third norm and immovability: - Three rationalizations for importance of immovability: - Pragmatic: immovability facilitates tax collection because the asset can be seized. - Immovability may imply value reflects location-specific rents (LSRs), which are in principle ideal for taxation (can be taxed without causing relocation). - Benefit theory: taxes as payments for public services that help maintain local asset values (less compelling). - LSRs are often associated with government-created rights (extractives, telecoms); many OIT cases involve rights explicitly tied to locations. - LSRs can be difficult to define legislatively; some countries’ definitions have expanded to include the full range of licenses associated with discovery and development. #### Counterarguments to source-country emphasis - Any gain reflects underlying income the location country has chosen not to tax; the capital gains charge may simply be that country’s preferred method—or arise because earlier law or treaties did not anticipate the issue. - The increased value of the entity sold may reflect managerial or other expertise contributed by the seller; taxing where the seller resides might be argued to avoid distorting seller location choices. Counterpoints: - Many countries operate dividend exemption schemes, indicating limited appetite to tax such gains at residence. - Structuring possibilities mean the jurisdiction where the gain is realized may not be the one providing expertise or financing; substance tests risk their own distortions. #### Efficiency considerations - General principle: tax systems should avoid distorting investors’ decisions where practicable. - Taxing rents (including LSRs) is efficient; explicit rent taxes are preferable but imperfect in practice. - Auctions are another tool for rent extraction but suffer issues of asymmetric information and thin markets. - Neutrality requirement: direct and indirect asset transfers representing the same transfer of ownership should attract the same tax treatment to avoid transaction distortion. - Given current norm of source-country taxing rights on immovable assets, neutrality is most likely achieved by taxation of indirect transfers by the location country. - Alternatively, the location country could forgo taxing either direct or indirect transfers, leaving taxation to the seller’s residence country—considered unlikely and possibly undesirable. ### Assessment and policy implications - On balance, the analysis suggests it is appropriate that the location country 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. - In equity terms, this mirrors recognized rights for direct transfers. - In efficiency terms, it provides a route to taxing LSRs when preferred instruments are unavailable or weak, and fosters neutrality between direct and indirect transfers. - Important implementation points: - Clearly defining ‘immovable assets’ is vital. Considerations of equity, efficiency and practicability converge to suggest scope could include all assets with potential to generate significant LSRs and over which government can exercise sufficient control to ensure collection; countries may, however, choose narrower definitions. - Experience shows that choosing not to exercise location-country taxing rights can provoke intense domestic dissatisfaction; sums at stake can be large and assets highly visible. - Unilateral legislative actions by location countries can exacerbate tax uncertainty and harm investors, taxpayers and governments. - Noted international model differences: - Article 13(5) of the UN Model Tax Convention extends location-country taxation up one tier of ownership to gains on company shares. There is no comparable provision in the OECD MTC. ### Illustrative cases (mentioned) - Three highly publicized OITs described in the source: Vodafone’s purchase of an interest in an Indian mobile phone operator; the indirect sale of Peruvian oil company Petrotech Peruana; and Zain’s indirect sale of assets in Africa including a mobile phone operator in Uganda. These cases highlight whether multinationals can arrange indirect transfers to avoid or minimize taxation in the asset location country. *Italic: Source — Box 1: Sources of Capital Gains (extracted content unit).* ### Box 2. India—The Vodafone Case ### Box 2. India—The Vodafone Case ### Transaction structure - 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. ### Indian Tax Authority action and domestic litigation - The Indian Tax Authority (ITA) sought to collect US$2.6 billion tax on the capital gain realized by Hutchison on the sale of the Cayman holding company. - Because Hutchison no longer had assets in India after the transaction, the ITA sought to collect the tax from the purchaser, Vodafone’s Dutch subsidiary, arguing it had the obligation to withhold the tax from the price payable to the seller. - A protracted court case followed, 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. ### Legislative change, retroactivity, and arbitration - The government of India subsequently changed the law to allow taxation of offshore indirect sales and tried to apply the new provision retroactively, in a second attempt to collect the tax from Vodafone’s Dutch subsidiary. - The legality of a retroactive effect of the law was submitted to arbitration by the taxpayer under the India-Netherlands Bilateral Investment Treaty1. - (The treaty was unilaterally terminated by In dia in December 2016, but this does not affect ongoing disputes). - Several years after their appointment, arbitrators selected by the parties finally agreed on choosing a chairman of the tribunal.1 ### Current status and relevance - The relevance of this tribunal on tax matters is still a matter of dispute. *Source: pr18297offshoreindirecttransferstoolkitver2-071618 - Box 2. India—The Vodafone Case* ### Box 4. Uganda—The Zain Case ### Box 4. Uganda—The Zain Case ### Case summary - In 2010, a Dutch subsidiary of the Indian multinational Barthi Airtel International BV purchased from Zain International BV, a Dutch company, the shares of Zain Africa BV (also a Dutch company) for US$10.7 billion, which owned in turn 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 the corresponding capital gains tax, amounting to US$85 million. - Uganda’s Appeals Court ruled that the URA does have the jurisdiction to assess and tax the offshore seller of an indirect interest in local assets (overturning an earlier ruling by the High Court of Kampala). - The taxpayer interprets the tax treaty between Uganda and the Netherlands as protecting the Netherlands’ exclusive right to tax such a transaction. This is currently unresolved. ### Legal and treaty issues - Core legal contention: whether domestic anti-avoidance rules can be supplementary to, rather than overriding, an existing bilateral tax treaty that may allocate exclusive taxing rights to the treaty partner. - Treaty interpretation risk: the taxpayer’s treaty-based argument (Uganda-Netherlands) raises a potential override question—whether treaty language precludes the location country from taxing an offshore indirect transfer. - Judicial outcome: Appeals Court in Uganda found domestic jurisdiction to tax the non-resident seller of an indirect interest; however, the treaty interpretation remains disputed by the taxpayer. ### Fiscal significance - The amount at stake in the Zain case is characterized as being "in the order of 5 percent of total government revenue (and, for example, nearly 50 percent of public spending on health)." - Comparative context: in other cases cited, amounts at stake were "around 2 percent of central government revenue (and almost 8 percent of all annual income tax revenues)." ### Policy responses and risks - Location-country responses to adverse court outcomes have included sweeping domestic policy changes: - India changed its domestic law to bring OITs into tax and sought to apply this retrospectively to 1962 (the date of the current income tax act). The amendment cited 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.” - Peru and Chile amended their domestic laws to bring into tax offshore transfers related to all assets located in their countries—not just those deriving value from immovable property located there. - Risks of unilateral responses: - Such unilateral legal changes, though understandable, risk introducing "even more incoherence and uncertainty in international taxation than already exists." - The diversity of legal systems and retrospective or expansive domestic measures can increase disputes and unpredictability for cross-border investors. ### Broader observations and implications - Common features across high-profile OIT disputes: - The indirectly-transferred asset often derived value from a concession granted by the government of the location country; value was largely location-specific rents tied to government-issued licenses. - Location countries in several notable cases "lost in court—or at least has not yet clearly won," with differing legal reasons (insufficiency of domestic law, potential treaty override). - Political economy: - Public outcry can be considerable, especially where subsidiaries being indirectly sold had previously paid little or no corporate income tax (example: a congressional investigation on Petrotech in Peru). - In Peru, transaction-linked scandals led to significant political consequences, including the dismissal of the Prime Minister and Cabinet. - Enforcement and collection challenge: - An OIT often occurs entirely outside the location country (between non-resident seller and buyer), creating "significant difficulties in collecting the tax" even when a taxing right is asserted. *Italic line: Box 4. Uganda—The Zain Case (extracted content).* ### 1. Designing the tax liability rule: There are two common models in this regard: ### Designing the tax liability rule ### Models for taxing offshore indirect transfers - Two common models: - Model 1 (taxation of a deemed direct sale by a resident): seeks to tax 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). - Model 2 (taxation of the non-resident seller): seeks to tax 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 that 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 taxable asset rule may also be used (for example, a 10 percent shareholding rule) and the law can prescribe whether the entire gain is taxable or whether taxation is pro rata when the indirect interest is less than wholly derived from local immovable property. ### Sample legislative design (Model 1) — Box 5: Change in Control - (1) 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. - (2) 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. - (3) Where this subsection applies, the entity is treated as: - (a) realizing all its assets and liabilities immediately before the change; - (b) 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; - (c) reacquiring the asset and incurring expenditure of the amount referred to in paragraph (b) for the acquisition; - (d) 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 - (e) re-stating the liability for the amount referred to in paragraph (d). ### Model 1: Deemed disposal of the local resident asset-owning entity (substantive points) - Model operation and triggers: - Taxes the unrealized gain in the hands of the local asset owning entity (typically a resident of the location country). - 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 local immovable property. - Losses should be recognized where there are no accrued gains and subject to appropriate loss utilization rules (as applicable). - Tax liability is triggered by a change of control irrespective of whether the change arises from an offshore or onshore sale; a technical direct change of control due to a corporate reorganization should not trigger the tax liability. - No ownership threshold is set for triggering liability (e.g., not limited to a 10 percent threshold) to limit avoidance opportunities. - Change of control is determined by reference to direct or indirect ownership to enable tracing through intermediate holding entities. - Valuation and basis adjustment: - Local assets are treated as disposed of for market value; administrative determination can use assumptions and adjustments based on the price at which the actual shares are sold and apportionment among local assets. - The disposal is deemed (not actual); the local asset owning entity is treated as reacquiring the assets at market value so the tax cost is stepped up to market value to protect against double taxation on subsequent changes of control. - Liabilities are reset (entire balance sheet reset) to avoid complications of historic liability values. - Enforcement/collection under Model 1: - Local asset owning entity remains subject to ordinary compliance rules; no special enforcement/collection rules are required. - Tax authority may use full enforcement tools against the local asset owning entity (e.g. penalties for failure to file and pay, seizing or freezing local assets, and potentially selling them to settle outstanding tax liability). - Key advantages of Model 1: - Greater ability to enforce and collect the tax liability because the gain is realized by a local resident entity. - Double taxation in the location country should not arise on subsequent changes of control due to the step-up to market value. - The gain is a locally sourced gain realized by a local resident entity; taxing right of the location country should not be affected by a tax treaty. - Key disadvantages of Model 1: - Possible argument that tax treaty limitations remain if a tax treaty exists, on the grounds that imposition is in substance source country taxation triggered by an offshore sale; this may be countered by treaty anti-abuse provisions such as LOB and/or PPT. - Possible double taxation if the residence country of the offshore seller taxes the seller’s gains and no foreign tax relief is available because the location country’s liability arises on the local asset owning entity (not the offshore seller). - Collection difficulties where the local asset owning entity lacks liquidity to pay the tax; parties (particularly purchasers) may need to ensure the local entity has funds to discharge its tax liability. - Undermines separate legal entity distinction and may expose continuing minority shareholders to underlying tax liability triggered by a majority seller, though those minority shareholders also benefit from the step-up to market value. - Requires the local asset-holding entity to monitor changes in its own ownership. - Suitability: - Merits of Model 1—relative ease of enforcement and simplicity of basis adjustment—can be appealing for lower capacity countries. - Source rules of Country L must be drafted so the OIT that triggered a change of control is not itself held to have a source in Country L, to avoid double taxation by applying both deemed resident taxation and actual non-resident taxation in Country L. ### Model 2: Taxing the non-resident seller (summary) - Under Model 2, Country L 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. - This model is most commonly adopted where countries have resolved to tax OITs. - Source rules are critical because a non-resident is ordinarily only subject to taxation on income derived from sources in the location country. - Sample source rules (along the lines shown in Box 5) could be considered to impose a liability on a non-resident in respect of a gain realized on the sale of an indirect interest in immovable property situated in Country L. ### Enforcement and collection mechanisms (general options discussed) - 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 the 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. - A General Anti-Avoidance Rule (GAAR) could be applied as a rule of last resort to tax a gain from an OIT in appropriate circumstances, but GAARs can be difficult for countries with weak administrative capacity to apply successfully. - Some countries adopt anti-abuse rules 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) design and drafting of the anti-abuse rule and (ii) capacity of the tax authority to apply it evenhandedly and predictably; such rules reach gains only where intentional tax avoidance can be shown and are therefore limited in scope. ### Design, transitional and double taxation considerations - Sample provisions are simplified, do not address all complex issues (corporate reorganizations, minority shareholders, joint venture arrangements, valuation difficulties, treatment of losses, listed securities, and other double taxation issues). - Either model should only be implemented on a prospective (and not retroactive) basis unless strong reasons exist; transitional arrangements could be considered (e.g. deeming market value cost base as at commencement of new taxing model). - Location country’s final provisions must take into account legal tradition, political and administrative structure, and fiscal policies. - Provisions have been designed to prevent legal double taxation by the location country (preventing 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 limiting double taxation across different taxpayers through resetting (stepping-up) the tax cost of relevant assets each time a taxable realization occurs or by providing non-recognition of gain on each intermediate asset; these approaches are more comprehensive but more complex to administer. *Source: pr18297offshoreindirecttransferstoolkitver2-071618 - 1.* ### Box 6: Source rule ### Box 6: Source rule ### Source rule — scope and trigger - Amounts derived from sources in Country L include gains 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. - Where the value of an indirect interest is principally (e.g. more than 50 percent) derived from local immovable property, the location country may tax the entire gain (relying on the source rule) as reflected in Article 13(4) of the OECD and UN Model MTCs. - A taxable asset rule can complement the source rule by: - confirming that the entire gain is taxable when the indirect interest derives more than 50 percent of its value from local immovable property; or - applying on a proportionate basis (taxing only gains attributable to the local immovable property); or - applying a modified pro rata basis where a lower threshold is met (e.g., 20 percent of the gain is derived from local immovable property rather than 50 percent or more). Kenya’s extractives sector provides an example of such a modified pro rata mechanism. ### Taxable asset rule — sample legislative approach (Box 7) - Chargeable income includes gains from 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. - Amount of gain to include in chargeable income: - 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 - in any other case, the amount computed according to the formula: - A × B/C - 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. ### Definitional and threshold design choices - Policy design choices include: - imposing tax on the disposal of all interests (including interests below de minimis amounts) where the interest disposed derives more than half its value from the asset; or - imposing liability only on disposal of more significant interests (e.g. interests of 10 percent or more of the asset); and/or - applying a back-up threshold based on nominal value (e.g. apply the rule only to interests with a value of $1 million or more). - International norm for distinguishing non-portfolio and portfolio investments: a 10 percent interest threshold could be considered. - Risks and administrative considerations: - thresholds can minimize compliance costs but must be drafted to prevent staggered sell-downs that avoid the threshold. ### Exemptions and loss recognition - Countries may exempt certain capital gains from Article 13(4) of the OECD and UN MTCs, for example gains from: - shares of companies listed on a stock exchange; - shares in the course of a corporate reorganization; - shares which derive their value from immovable property where a business is carried on; - shares held by pension funds; - a small investor’s interest in a Real Estate Investment Trust (REIT). - Losses in lieu of gains can be recognized in Country L and be subject to appropriate loss utilization rules. ### Enforcement and collection — challenges and supplemental mechanisms - Non-residents taxed under this method normally must file tax returns in Country L where a taxable gain is realized; compliance is expected to be low. - Enforcement difficulties: - sale proceeds may have left or never been in Country L; - there may be no assets in Country L to meet or secure the tax liability. - Supplemental legal protections can include restricting registration, renewal or validity of underlying assets (e.g. extractive licenses) by governmental registration bodies unless notification requirements are met and/or evidence is furnished that no tax is payable, the tax has been paid, or satisfactory payment arrangements exist. ### Withholding — rationale and design (Box 8) - Withholding mechanisms used in multiple jurisdictions (including the U.S., Canada, India, China and Australia) can collect tax from a non-resident seller’s gain. - Withholding tax regime design options: - final withholding tax: represents final tax liability (common for gross payments of dividends, interest, royalties); - non-final withholding tax: collected as an estimate of the recipient’s final income tax liability; recipient generally must file a return and pay any balancing amount or claim a refund. - Typical design for OITs: a non-final withholding regime. - Exclusions to minimize compliance costs can include transactions: - below a predetermined de minimis threshold; - related to listed securities on a stock exchange; - where a clearance certificate from the tax authority confirms no withholding is required. - Issues in adoption: - purchaser is often also a non-resident, creating similar non-compliance risks; - withholding is an estimate because the purchaser usually does not know the seller’s exact gain, increasing compliance burden for purchaser and seller; - non-compliance risk may be mitigated by purchaser incentives (penalties, risk of seizure of local asset, reputational/prudential considerations). - Sample withholding provisions (Box 8): - (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 withholding agent must pay the amount to the tax administration on or before the day that the withholding agent becomes the owner and must file a statement as prescribed. - (3) A withholding agent who fails to withhold tax 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: - (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 and pays it to the tax administration is treated as having paid the amount withheld to the recipient for the purposes of any claim by the recipient. - (6) A withholding agent who fails to withhold but pays the tax that should have been withheld 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 enforcement/collection measures if no withholding regime is adopted: - a notification/reporting obligation; and - a payment obligation for an entity in the location country to act as agent for the non-resident. - Rationale: - notification assists in assessment and exploring recovery avenues (tax treaty assistance, OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters); - imposing a payment obligation on a resident agent allows the tax authority to apply domestic enforcement tools against that resident. - Sample provisions for non-portfolio interests (illustrative, shown as triggered for non-portfolio interests of 10 percent or more): - (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)(b) does not apply to 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 - Key advantages: - 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 collection; - the agency approach assumes the direct owner in Country L can always detect transactions resulting in a 10 percent or greater change in underlying ownership; - double taxation can effectively arise on subsequent sales of interests in other entities that indirectly hold the assets because shares or interests in those entities are not stepped up to market value (a general feature with multiple tiered holding structures); - taxing right of Country L could still be limited by an applicable tax treaty that does not include an article similar to Article 13(4) of the OECD or UN Model MTC. ### Defining “immovable” property - An appropriate, clear domestic definition of “immovable property” is critical for effective application of tax liability, enforcement, and collection rules. - Suggested inclusive domestic-law definition should at least cover: - 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. - The domestic law definition is important for tax treaty application because under the OECD and UN MTCs the term “immovable property” has the meaning under the domestic law of the contracting state in which the property is located. - The definition could be further extended to capture broader location-specific rents linked to national assets, for example gains from licenses to exploit public goods (electric, gas, or other utilities; telecommunications and broadcast spectrum and networks etc.). *Source: Box 6: Source rule, pr18297offshoreindirecttransferstoolkitver2-071618* ### Box 10: Sample definition of immovable property ### Box 10: Sample definition of immovable property ### Sample 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). ### Considerations for expanding the definition - Consideration could be given to extending the definition even further, 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. - Extending the definition would ensure that gains relating to any subsequent assignments derived from those underlying rights granted by or on behalf of the government of Country L would also remain within Country L’s tax base. - The concept of location specific rents is much easier to conceive of 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 the domestic definition of “immovable property” when existing tax treaties are in force. - A country may change the definition of a term used in its domestic legislation which is also used in treaty provisions but not specifically defined for the purposes of the treaty, but should ensure modifications or extensions are compatible with the context—and negotiated position—of existing tax treaties. - Treaty partners should consult with each other in this regard. ### Rationale and policy context (from report conclusions) - The report and toolkit conclude 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” (examples cited include natural resources and the rights to location specific telecom or other licenses). - This taxation can apply regardless of whether equivalent tax in regard to the transfer would be paid elsewhere; it can be a fundamental aspect of the country’s tax laws and not only an anti-avoidance device. - Pillars of the rationale: - Equity: mirrors a generally recognized right in relation to direct transfers of immovable assets. - Efficiency: provides a backstop to taxation of location specific rents where other instruments perform imperfectly, and fosters neutrality between direct and indirect transfers. - Certainty: responds to pressures from sales of salient national assets that have led to uncoordinated measures and tax uncertainty. - The report notes that location countries may choose not to tax related OITs for reasons including capacity, revenue needs, and desire to attract foreign investment. ### Treaty prevalence and developments - 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 Multilateral Convention 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 2017 OECD and UN formulations and/or sign the MC and modify covered tax treaties to include the new language of Article 13(4). ### Legislative and enforcement implications - Such a taxing right cannot be supported without: - Appropriate definition in domestic law of the assets intended to be taxed. - A domestic law basis to assert that taxing right. - Sample legislation for such rules was provided in the text. - 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 occurring offshore by the actual seller but source the gain on that transfer within the location country, permitting the country to tax it. - The report provided sample simplified legislative language for domestic law in the location country for both approaches. ### Practical guidance and implications - A more useful conceptual approach is to identify and capture within the definition those assets whose value derives in large part from location specific rents. - While taxing location specific rents directly is preferable, imperfections in design and implementation can leave a valuable backstop function for taxation of gains associated with increases in the value of such rents. - This view supports using an expansive definition of immovable assets to include a wide range of transfers related to government-bestowed rights capable of generating substantial income. - Countries have adopted diverse measures in response to OITs, differing in: - Which assets are covered (narrow or broad definitions of immovable property; other assets like telecoms; intangibles such as corporate stock held by a non-tax resident). - The legal method used to impose the tax. - A more uniform, coordinated, and coherent approach to taxation of OITs, where countries choose to tax them, can contribute to coherence in international tax arrangements and enhanced tax certainty. *Source: pr18297offshoreindirecttransferstoolkitver2-071618 - Box 10: Sample definition of immovable property* ### 1. In any of the twelve months prior to the sale, the market value of the shares ...of the resident entity ... represent ### pr18297offshoreindirecttransferstoolkitver2-071618 - 1. In any of the twelve months prior to the sale, the market value of the shares ...of the resident entity ... represent ### Offshore Indirect Transfer (OIT) Thresholds and Definitions - Condition: "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." - Alternative condition: "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." - Scope: 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. - Residency clause: "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." ### China — Anti-abuse Approach to Taxation of Capital Gains on Transfers - General rule: - "The 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." - For other cases, "the taxation right on the indirect transfer of equity investment is sourced to the location of the investing enterprise." - Example implication: "a nonresident enterprise which owns 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." - Anti-avoidance override: - If the holding company is in a jurisdiction where the effective tax burden is lower than 12.5 percent or where offshore income is not taxed, 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 other than avoiding Chinese tax. - Legal basis: "Rule originally established in Notice No. 698, December 10, 2009 and replaced by Public Notice (2015) 7." and "Article 47 EIT Law. Some exceptions apply, for example, sale of shares in the stock exchange." - Reasonable business purpose considerations 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." - Characterization: "The Chinese approach to indirect transfers of assets is relatively defensive and discretionary: it taxes OITs when it deems that they have been structured to avoid the Chinese tax, without being taxed commensurately by another jurisdiction." ### Appendix D — Article 13.4 in Practice: Empirical Analysis (Universe of DTTs as of 2015) - Coverage: - Total DTTs analyzed: 3,046. - Data sources: 2,979 from IBFD; remainder from internet search or ActionAid tax treaties dataset. - Prevalence: - "About 35 percent of these treaties (973) include a provision that entitles the source 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." - "About 35 percent of the treaties that involve at least one resource-rich country include article 13.4 as defined in this section (291 of 834 treaties)." - "About 38 percent of the treaties that involve at least one low tax jurisdiction include Article 13.4." - Dependent variable definition: - Article 13.4 dummy = 1 if a DTT includes article 13.4 and the word "indirectly" (using the UN or the OECD version or similar variants), 0 otherwise. - Key explanatory variables (selection): - Resource-rich low-income: dummy = 1 if at least one signing country is a low-income or lower middle-income resource-rich country (World Bank classification and resource revenues exceed 10 percent). - CGT_i – CGT_j: absolute difference between concluding countries' tax rates on capital gains; corporate CGT used when codes distinguish. - Low tax: dummy = 1 if jurisdiction is included in Hines and Rice (1994) list. - Low tax × Low Income Res.: interaction between Resource-rich low-income and Low tax. - Year: year of concluding the treaty (trend variable from 1947 to 2015). ### Descriptive Statistics (Table D1) - Article13.4: 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 ### Empirical Results — Likelihood of Including Article 13.4 in a DTT (Table D2) - Models estimated: Linear Probability Model (LPM) columns (1)–(3); Logit columns (4)–(6) (marginal effects reported for logit). - Coefficient highlights (selected): - Resource-rich low-income: - LPM: -0.0592**; -0.0593**; -0.0657** - Logit (marginal effects): -0.065**; -0.064**; -0.079*** - Robust standard errors in parentheses; significance: *** p<0.01, ** p<0.05, * p<0.1 - CIT_i - CIT_j (noted as CIT in table): - Positive and significant coefficients reported (e.g., 0.0030***; 0.0042***; 0.0021**; 0.0037***) - Low tax: - LPM and logit: -0.133***; -0.164*** (significant negative association) - Low tax × Resource-rich low-income: - Coefficient in some specifications: -0.162*; -0.164 (less precisely estimated) - Year: - Positive and significant: 0.0136***; 0.0135***; 0.0141***; logit marginal effects ~0.017***/0.016***/0.017*** - Constant terms large negative values reported (e.g., -26.88***; -180.5***) - Model fit and samples: - Observations: 3,044; 2,971 (varies by specification) - R^2 reported for LPM: 0.134; 0.135; 0.146 - Notes: "As estimated coefficients in non-linear models cannot be interpreted as marginal effects, columns (4) to (6) display marginal effects (except for the constant)." ### Additional Empirical Observations - There are 454 DTTs that involve jurisdictions listed by Hines and Rice (1994) as low tax jurisdictions ("almost 1/6 of the total"). - The Hines and Rice (1994) list includes 50 jurisdictions (listed in source text). *Source: pr18297offshoreindirecttransferstoolkitver2-071618 - 1. In any of the twelve months prior to the sale, the market value of the shares ...of the resident entity ... represent (PDF).* --- _Source: https://www.imf.org/-/media/files/news/press-release/pr18297offshoreindirecttransferstoolkitver2-071618.pdf_