ATAF Technical Review of the Platform for Collaboration on Tax Discussion Draft
The Taxation of Offshore Indirect Transfers — A Toolkit
1. Background
This report is one of a number of toolkits being produced by the IMF, OECD, World Bank Group and United Nations, the partner members of the Platform for Collaboration on Tax in response to a request by the Development Working Group (DWG) of the G20. The toolkits’ stated aim is to assist developing countries in the appropriate implementation of responses to international tax issues under the G20/OECD Base Erosion and Profit Shifting (BEPS) project as well as additional issues of particular relevance to developing countries that the BEPS project does not address.
The Discussion Draft report provides analysis, options and recommendations for the tax treatment of what is often referred to as offshore indirect transfers. This is an important tax issue for African and other developing countries as shown by the Zain case in Uganda where the tax at stake was USD85 million which is reported to be approximately 5% of total government revenue. The report is therefore very relevant to ATAF members.
This technical review by ATAF provides an overview of the key issues covered in the Discussion Draft and ATAF’s views on those key issues.
2. The issue
The illustrative example in figure 1 on page 12 of the Discussion Draft provides a very clear description of an indirect transfer and is replicated below for ease of reference:
In this transaction Corporation B, resident in LTJ, sells it shares in Corporation A to Corporation P2, resident in P. This is a direct transfer of the shares in Corporation A, and an indirect transfer of the asset held by Corporation A that is located in country L.
In its technical assistance work with its members ATAF have often seen anonymised cases where Corporation A above is located in an African country and has a very valuable asset such as a telecoms licence or a mining licence. Such a licence may be extremely valuable and a transfer of ownership in such an asset may give rise to a very significant taxable gain or loss and the issue is which taxing jurisdiction or jurisdictions may claim the right to tax the transfers.
Assuming that P1 and P2 are unrelated so there are no transfer pricing issues here and that Corp P1 wants to realise a capital gain reflecting an increase in the value of the underlying asset and that P2 wishes to gain control of that asset the tax rules of (at least) four countries will come into play in determining the tax treatment of this transaction (along with any applicable tax treaties).
These are:
- The country in which the underlying asset is located = Country L
- The country where the seller (Corp. B) is resident = Country LTJ
- The country in which the parent (Corp P1) of the seller is resident = Country P
- The country in which the buyer (Corp P2) is resident
As shown in the example the P1 group may arrange for the sale to be made indirectly by an entity in a country (LTJ) that applies a low tax rate to capital gains.
3. How should taxing rights on the offshore indirect transfer be allocated?
The Discussion Draft looks at this as a question of principle i.e. whether as a question of principle the country in which the asset is located should have primary taxing rights on its indirect transfer abroad and if so, to precisely which asset this should apply
The Discussion Draft comes to the conclusion that there are arguments both in favour and not in favour of that country having primary taxing rights but on balance it favours allocating taxing rights with respect to capital gains associated with transfers of immovable assets to the country in which the assets are located, regardless of whether the transferor is resident there or has a taxable presence there.
This conclusion will assist many African countries as these are often the countries where the asset is located and reflects the approach ATAF has taken in its Model Tax Convention as discussed in more detail in Section 5 below.
4. Domestic tax legislation
As noted in the Discussion Draft where there is an offshore indirect transfer of an asset the country in which the asset is located must have a domestic tax framework in place that contains an indirect transfer taxing rule if it is to have a legal right to tax the transfer. It will also need appropriate domestic enforcement rules to collect the resulting tax liability.
This is needed in addition to ensuring the appropriate tax treaty provisions are in place (see section 5 below) as a tax treaty cannot create taxing rights or enforcement mechanisms if they do not exist in domestic law.
i. Tax Liability Rule
The Discussion Draft sets out two common models for designing the tax liability rule. The first model seeks to tax the local entity that directly owns the asset in question 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 model seeks to tax 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 either directly or indirectly.
The second model seeks to tax the non-resident seller of the relevant shares or comparable interest via a non-resident assessing rule.
The Discussion Draft favours the first Model as it is easier to enforce and simpler. The second model is often adopted by countries seeking to tax offshore indirect transfers but the report notes it can give rise to greater enforcement challenges and has more complex design options than Model 1.
It is ATAF’s view that adopting Model 1 would be a preferable option for members due to its greater enforceability and simplicity which makes it clearer for taxpayers to comply with and tax administrations to enforce.
ii. Enforcement/collection rules
Ii is also vital that countries enact enforcement/collection rules to ensure the tax administration can enforce collection of the assessed tax. There are various elements that might be included in such rules and countries will need to review these and decide which ones meet the country’s own policy objectives.
The Discussion Draft provides sample domestic legislative provisions which are general in nature and have been designed and drafted to prevent legal double taxation by the location country.
ATAF has considerable experience in assisting its members draft new domestic tax legislation and members may request assistance from ATAF’s technical assistance team in drafting legislation on indirect transfer of assets for their country.
5. Tax Treaty implications
The development and application of any domestic legislative provisions will need to take into account any existing tax treaty obligations.
The taxing rights on gains realised on offshore indirect transfers which are principally (e.g. more than 50%) derived from local immovable property is generally preserved in Article 14 (4) in the ATAF Model Tax Convention and Article 13(4) of both the OECD and UN Model Tax Conventions. All of the Models permit the location country to capture gains from the sale of relevant interposed holdings at different tier levels.
It is important that the issue of the definition of the scope of the interest which is subject to tax is properly defined and not too narrow. It is critical to have an appropriate definition of “immovable property” for both the tax liability rule and the associated enforcement and collection rules. The report provides a sample minimal definition. That definition is considered to be a minimum domestic law definition. Article 14(4) of the ATAF Model has the broader definition recommended in the BEPS Action 6 report which includes not only gains from shares but also gains from the alienation of interests in other entities, such as partnerships or trusts.
A robust and sufficiently broad definition of immovable property will also be important in the context of the application of a tax treaty. This is because as stated in Article 6(2) of the ATAF, OECD and UN Models the term “immovable property” shall have the meaning which it has under the law of the Contracting State in which the property in question is situated.
However the minimum definition could be further extended to cover a broader category of immovable property that it would be appropriate for the location country to seek to tax. In particular consideration should be given by ATAF members to extending the definition as done in Article 6(2) of the ATAF, OECD and UN Models to cover rights to receive variable or fixed payments in relation to extractive industry rights or government issued rights with an exclusive quality.
ATAF has considerable experience in the drafting and negotiation of Tax Treaties and members may request assistance from ATAF’s technical assistance team in drafting their Tax Treaties.
6. Conclusion
The report supports the approach taken in the ATAF Model Tax Convention that the country in which the asset is located should have primary taxing rights on an indirect transfer of its ownership that take place outside the location country. The provisions of both the OECD and UN Model also supports the ATAF Model’s approach and this indicates quite wide international acceptance of the principle that capital gains taxation of offshore indirect transfers of “immovable property” should be primarily allocated to the location/source country.
It is therefore very important that ATAF members review their Tax Treaties and ensure that the equivalent of Article 14(4) and Article 6(2) of the ATAF model are included in all of their Tax Treaties.
In addition as a Tax Treaty cannot create a taxing charge members need to ensure that their domestic legislation creates a taxing right for such offshore indirect transfers and has appropriate rules for enforcement and collection of the tax created by that taxing right.
ATAF are able to provide assistance to members on both reviewing and revising their existing tax treaties and on drafting appropriate domestic legislation to ensure its members have the legal framework in place to address the potentially significant tax loss for such offshore indirect transfers.
Members requiring such assistance from ATAF should contact:
- Mary Baine at mbaine@ataftax.org
- Thulani Shongwe at tshongwe@ataftax.org
- Tracey Brooks at tbrooks@ataftax.org
- Lee Corrick at lcorrick@ataftax.org
