Applicability of bilateral treaties in Triangular cases (Part 4)

In Part 3, I have discussed Reverse PE triangular case. In this part, i am focusing on third situation i.e. Dual resident triangular cases.

Dual resident triangular cases usually arises where a person who is resident in two states (State A and State B) for tax purposes receives income from sources in a third state (State C). This is illustrated in the following diagram:

This above situation possibly arises because of the fact that domestic tax systems of different states use different criteria (say incorporation under the laws of that state or
effective management test or management and control test) for determining the residential status.

In illustration above, if the Dual resident company receives interest income from State C, then two tax treaty shall be applicable (State A and State C tax treaty and State B and State C tax treaty). If the withholding tax rates in two treaties are different, it then become important to analyse which tax treaty should apply. Possible view in such situations are –

  • Situation 1 – Tax treaty that contains lower tax rate should be applied. This premise is based on the presumption that the taxpayer (the dual resident company) may elect which tax treaty should be applied or that international law requires the application of the most favourable tax treaty.
  • Situation 2 – This is based on the text of the second sentence of Article 4(1) of the OECD Model Tax Convention. This sentence stipulates that a person for the purposes of the tax treaty is not treated as a resident of a contracting state if that person is liable to tax in that state only in respect of income from sources within that state although the person is a resident of that state according to the domestic legislation of that state. Now, if there is a tax treaty applicable between States A and State B and tax treaty contains the tiebreaker rule of Article 4(3) of the tax treaty, the dual resident company will for the purposes of that treaty be considered a resident of the state in which the place of effective management is situated (State B in our case). Hence, company shall be taxable on worldwide income in State B. In the other state (i.e. State A) due to the impact of the State A and State B tax treaty, the company is only liable to tax in respect of income from sources within that state. Therefore, due to the second sentence of Article 4(1) of the tax treaty, the company does not qualify as a resident of State A under the State A and State C tax treaty. However, for Situation 2 to be applicable, relevant tax treaty should contain second sentence in its Article 4(1) similar to that of OECD Model convention. Pertinent to mention that since the 2008 update, the Commentary to the OECD Model Tax Convention also indicates that Situation 2 should be followed.

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