Global Tax Insights

Q3, 2012(Issue 1)

CONTENTSCOuNTry FOCuS

Germany ..............................................2

India .....................................................3

Singapore ............................................4

Romania ..............................................5

South Africa ........................................6

TEChNICal updaTES

News from OECD................................7

INTErNaTIONal Tax CaSES

Thoughtbuzz (P) Ltd ...................... 10

International Business Machines Corporation v. Commissioner Of Taxation ........................................... 12

Velcro Canada Inc. v. Her Majesty The Queen ....................................... 13

Tradehold Ltd v. The Commissioner For The South African Revenue Service ............................................. 15

EdITOrIal

“Taxes grow without rain” Jewish Proverb

With geographical boundaries shrinking and innovative structures for doing cross-border business being the order of the day, tax administrators across the world must adapt to constant change. Successive budgets make changes to tax laws, sometimes even retrospective to tax transactions that are settled through due process of law. This makes it imperative for the owners of businesses to keep abreast of the latest developments in tax laws across the world.

With this in mind, and moving a step further in achieving Morison International’s (MI) mission of providing members and their clients with access to high-quality professional accountancy, auditing, taxation, business advisory, consultancy and legal services in all major locations around the world, we are pleased to share with you the first issue of Global Tax Insights. The newsletter will be a quarterly publication and will cover latest developments in taxation across the globe.

The newsletter is divided into three technical sections, designed to reflect the most relevant information from a global tax perspective:

Country Focus compiles the latest developments in direct tax from various countries.

Technical updates provides an update on the Organisation for Economic Co-operation and Development’s (OECD) draft report on transfer pricing on intangibles.

International Tax Cases presents three recent cases from India, Australia and Canada, examining how courts across the globe are interpreting the term ‘royalty’ in terms of the tax treaties; whether a payment for right to use a licence in an Intellectual Property Right (IPR) constitutes a ‘royalty’ has always been subject to debate. The fourth case law deals with interpretation of the term ‘resident’ in the treaty between South Africa and Luxembourg.

Member firms of MI have contributed to each of these sections, without which this newsletter would not have been possible. All these firms deserve special thanks for their help and support.

We would be happy to receive your feedback and suggestions on this initiative and on the contents of this newsletter. You may email your suggestions to sachin@scvasudeva.com.

Happy reading!

Sachin VasudevaSenior Partner, S.C. Vasudeva, India

Country Focus

2

GErmaNy Contributed by Bettina Ohlwein, MIRA Audit AG, Germany

draft new rules regarding dividends and capital gains for minority shareholders

Under current German legislation, dividends and capital gains from the sale of shares received by corporations are tax free. However, an amount equivalent to 5% of the dividend income is treated as a non-deductable business expense, making the effective tax rate on dividends and these types of capital gains <2%. The actual expenses (e.g. financing of the investment) is, however, allowed as a deduction.

Withholding tax has to be deducted by the company paying the dividends, but it can be claimed back in certain situations:

� If the corporation receiving the dividend is a German company

� If the tax rate according to the applicable double tax treaty is lower than the tax withheld

� If the EU Parent-Subsidiary Directive can be applied.

In July 2012, the Bundesrat (Upper House of the German parliament) asked the Bundestag (Lower House) to include a provision in the annual tax bill 2013 to abolish the rule for minority shareholders not having >10% of the shares in the corporation. This would lead to the full taxation on dividends and capital gains of these shares. The tax rate will be about 30% if shares are held by a German corporation, and 16% for any other corporations (the difference is due to trade tax liability).

According to the draft rules, the loss from the sale of shares and any business expenses related to the shares (e.g. the financing cost) can only be offset against gains from the same investment. If there are no gains, then the losses and expenditure can be carried forward.

If these new rules come into effect, this will have a major impact on the minority shareholdings of <10% and might make it necessary to rethink existing structuring for such shareholders.

Country Focus

3

INdIa Contributed by Ms Aditi Gupta, S. C. Vasudeva & Co., India

Changes brought in by Budget 2012

The Indian taxation system has advanced aggressively with globalisation, making it the most important source of revenue in the Indian economy. However, tax planning through well-planned structures, and selling valuable properties indirectly by entering into a maze of framework agreements, has become very common today. Seeking to minimise the loss of revenue due to such practices, certain changes have been brought to Section 9 of the Indian Income Tax Act, 1961 (‘the Act’) by the Finance Act, 2012 dealing with the deeming fiction of income. These amendments are outlined briefly below.

a. Transfer of capital asset situated in India

Prior to the amendment in Section 9(1)(i) of the Act, the said Section provided that all income accruing or arising, whether directly or indirectly, (a) through or from any business connection in India, or (b) through or from any property in India, or (c) through or from any asset or source of income in India, or (d) through the transfer of a capital asset situated in India shall be deemed to accrue or arise in India.

Based on the aforesaid provisions of Section 9 of the Act, there was a tax dispute between the Indian Tax Authorities and Vodafone International Holdings B.V. The amount in dispute was US$ 11.2 billion, making it one of the biggest controversies in Indian multijurisdictional history. The tax dispute was settled in January 2012 by the Supreme Court of India in favour of Vodafone, the Court holding that on the transfer of shares of a foreign company to a non-resident offshore, there was no income that was deemed to have accrued or arisen in India even though the concerned foreign company held shares of an Indian company.

Certain changes have been brought in Section 9 of the Act, thereby overruling the Vodafone judgment. The amendment (made retrospectively from 1 April 1962) clarifies the intent of legislation that if a transfer of a share or other interest in a company or entity has taken place outside India, but the value of the share or unit is derived substantially from the assets in India, then income arising from sale of such share or unit shall be deemed to accrue or arise in India.

The amendment, as a result, nullifies the effect of the Supreme Court ruling in the case of Vodafone, wherein the Apex Court had held that transfer of shares of a company outside India does not result in any income accruing in India.

b. royalty

To resolve the contentious issue of taxation of royalties applicable to the software, media and entertainment industries, Section 9(1)(vi) of the Act has been amended to provide that:

� Transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence), irrespective of the medium through which such right is transferred.

In view of this amendment, the transaction giving any right to use of computer software, for instance, would be classified as royalty and taxable on a gross basis under the Act. However, the tax treaties on the other hand provide that payments of any kind received as consideration for use of, or the right to use, any copyright of a literary, etc. are considered as royalty income.

The definition under the tax treaties is different from the one introduced in the Act and may thus lead to litigation.

c. advance pricing agreements (apa)

The Indian government has introduced the concept of advance pricing agreement (APA), effective from 1 July 2012, by inserting two new Sections – 92CC and 92CD – in the Income Tax Act, 1961.

The introduction of APA under transfer pricing regulations is a positive step to reduce the litigation, as it will be based on bilateral understanding between two countries. This amendment would allow the Central Board of Direct Taxes (CBDT) of the Indian Revenue Service to enter into APAs with taxpayers, for a a period of up to 5 years, binding both the taxing authority and taxpayer with regard to the transactions covered by the agreement.

Country Focus

4

SINGapOrE Contributed by Esther Mok, Paul Wan & Co., Singapore

a. Simplified annual tax filing for small companies: Form C-S

To simplify annual tax filing for small companies, Inland Revenue Authority of Singapore (IRAS) has designed a new three-page Form C-S from Year of Assessment (YA) 2012. Companies that meet qualifying conditions may e-file their Form C-S via my Tax portal or submit Paper Form C-S, and so do not need to submit financial statements and tax computations together with the form. Companies are still required to maintain proper accounting records and prepare annual financial statements and tax computations, but now only need to submit these upon request by IRAS. The due date for filing Form C-S is 15 December annually.

b. Singapore withholding tax made easier

Businesses may now file their company’s withholding tax return via S.45 e-Services instead of by paper form filing with IRAS office. The deduction will be made on the 25th day of the month after the due date for payment.

c. Waiver of Estimated Chargeable Income (ECI) filing for companies with turnover not exceeding uS$ 1 million

Currently, all companies (with or without taxable profits) have to file their ECI within 3 months after the end of their financial year ended. Effective from YA 2013, companies with financial year ending October 2012 or after, need not file ECI with IRAS if annual revenue does not exceed US$1 million and ECI is nil.

Country Focus

5

rOmaNIa Contributed by Ramona Burduja, Boscolo & Partners, Romania

provisions regarding individuals tax residence in romania

The Minister of Public Finance has issued Order no. 74/2012 relating to individuals’ tax residence in Romania. The key points are outlined below.

a. residence criteria

The Order transposes from the OECD Model Tax Convention on Income and on Capital the tax residence criteria in respect of an individual arriving in Romania. The residence criteria shall be based on the following parameters:

� Availability of a permanent home

� Location of the individual’s usual abode

� Location of centre of vital interests

� Nationality of the individual.

An individual considered as a tax resident in a state that has a double taxation avoidance treaty concluded with Romania may be subject to income tax in Romania for the income sourced in Romania, subject to the provisions of the double taxation avoidance treaty.

b. Taxation on worldwide income

An individual who is considered as a resident of Romania is liable to tax on their income worldwide.

c. Obligations on arriving in romania

Non-resident individuals arriving in Romania for a period of >183 days within any period of 12 consecutive months are obliged to file with the tax authorities the form ‘Set of questions for determining the fiscal residence of the individual on arriving in Romania’, along with other documents mentioned in the Order, no later than 30 days after the end of the 183-day period. Based on this form, the competent tax authority will notify the non-resident individual within 30 days whether s/he is subject to income tax only for the income sourced in Romania, or for the worldwide income.

d. Obligations upon leaving romania

In order to keep track, the Romanian tax authorities require that non-resident individuals who submitted the above-mentioned form upon arriving in Romania are obliged to file the form ‘Set of questions for determining the fiscal residence of an individual upon leaving Romania’ no later than 30 days before leaving the country. Based on this form and on the individual’s situation, the competent tax authority will notify the individual within 15 days whether s/he continues to have tax liabilities in Romania or will be removed from the Romanian tax authority’s records.

e. Obligations for non-resident individuals present in romania

Non-resident individuals who arrived in Romania after 1 January 2009 and continue to be present after 1 January 2012 are obliged to file the form ‘Set of questions for determining the fiscal residence of the individual on arriving in Romania’ during 2012. Individuals who arrived in Romania before 1 January 2009 and who request a tax residence certificate from the Romanian tax authorities are also obliged to file the questionnaire for establishing their tax residential status and to confirm payment of tax both for income earned in Romania and for income obtained abroad.

Country Focus

6

SOuTh aFrICa Contributed by Zweli Mabhoza, SizweNtsalubaGobodo, South Africa

An interesting amendment to the tax legislation is the introduction of Section 9H in the Income Tax Act, no. 58 of 1962 (‘the Act’). The effective date of this section is 8 May 2012. Although the changes in the Act have not yet been promulgated, the proposed section has an impact on the judgement of the Supreme Court of Appeal in the case of Tradehold ltd (‘Tradehold’) versus the Commissioner for the South african revenue Service (‘SarS’).

Section 9h

The National Treasury proposes to levy an exit charge in respect of deemed disposal of assets before a person ceases to be resident which would not be eligible for treaty protection. Based on this proposed change, a person’s year of assessment will be deemed to have ended the day before that person becomes a resident of another country. In addition, a company will be deemed to have liquidated all its assets and distributed proportionately to its shareholders.

The introduction of Section 9H has a number of implications for companies who cease to be residents

of South Africa. Firstly, that company will need to file a tax return on the basis that its year end finishes the day before that company becomes resident of another country. Although not a requirement, company tax returns are normally supported by signed annual financial statements (AFS). It is not clear whether the application of Section 9H will require a company to prepare audited AFS.

Even if the company is not required to prepare audited AFS, tax authorities could ask questions if the audited AFS are reflecting major differences to the amounts used in preparing the tax return in terms of Section 9H. If the company is deemed to have distributed its assets to its shareholders, this means that the shareholders could be liable for dividend tax and other indirect taxes such as transfer duties.

It remains to be seen whether Section 9H will be promulgated in its current form.

7

Technical Updates

NEWS FrOm ThE OECd Contributed by the Editorial Team

The OECD has come out with a Discussion Draft on the Revision of the Special Considerations for Intangible in Chapter VI of the OECD Transfer Pricing Guidelines and related Provisions (draft guidelines). As per the draft guidelines, the comparability and functional analysis to determine arm’s-length conditions for the use or transfer of intangibles should include the following considerations:

� Identify specific intangibles

� Determine which parties should be entitled to retain the return derived from the use of the transfer of the intangibles

� Consider the nature of the controlled transactions and whether they involve the use of intangibles and/or lead to transfer of intangible between the parties

� Assess the remuneration that would be paid between independent parties for the use or transfer of such intangibles.

Identifying intangibles

For the purposes of transfer pricing, the draft guidelines recommend that the word ‘intangible’ is intended to mean something that is not a physical or financial asset, and which is capable of being owned or controlled for use in commercial activities. Thus the draft guidelines propose to reject the accounting and/or legal definition of ‘intangible’, proposing instead that the guiding principle in identification of intangibles should be the determination of the conditions that would be agreed upon between independent parties for a comparable transaction – in other words, whether an asset (not a physical or financial asset) constitutes an intangible would be tested by determining whether, in a transaction between independent parties, a compensation would be provided for the asset.

The draft guidelines state that this unique definition is specifically only for transfer pricing purposes and has no impact on the definition of intangible for local law or treaty purposes.

The draft guidelines provide an illustration of items that would be considered as intangibles – patents, know-how and trade secrets, trademarks, trade names, brands and licences, and similar limited rights in intangibles. The draft guidelines also provide that ‘goodwill and

ongoing concern value’ are also intangibles, though the guidelines stop short of providing any precise definition of ‘goodwill and ongoing concern’ value for transfer pricing purposes.

‘Group synergies’ and ‘market-specific characteristics’ are not intangibles, according to these draft guidelines. However, there was no consensus among the members on whether ‘assembled workforce’ would constitute an intangible or not.

Identification of parties entitled to intangible-related returns

The second aspect in transfer pricing analysis dealing with the use or transfer of intangibles involves the identification of the member or members of a multinational enterprise (MNE) group who are entitled to intangible-related returns in arm’s-length transactions. The intangible-related return attributable to a particular intangible is an economic return from business operations involving use of that intangible after deducting:

� The costs and expenses relating to the business operations

� Returns to business functions

� Assets other than the particular intangible in question

� Risks, taking into account appropriate comparability alignments.

The draft guidelines provide guidance in order to determine which member of the MNE group is entitled to intangible-related returns. The guidelines provide that the following factors should be considered for this purpose:

� The terms and conditions of legal arrangements, including relevant registrations, licence agreements and other relevant contracts

� Whether the functions performed, the assets used, the risks assumed and the costs incurred by members of the MNE group in developing, enhancing, maintaining and protecting intangibles are in alignment with the allocation of entitlement to intangible-related returns in the relevant registrations and contracts

8

Technical Updates

� Whether services rendered in connection with the developing, enhancing, maintaining and protecting intangibles by other members of the MNE group to the member or members of the MNE group entitled to intangible-related returns under the relevant registrations and contracts are compensated on an arm’s-length basis under the relevant circumstances.

The draft guidelines further provide that generally where the relevant registrations and contractual arrangements are in alignment with the conduct of the parties, the entity entitled to use the intangible and to exclude others from using the intangible, under applicable law and under relevant contacts is the entity entitled to intangible-related returns with respect to that intangible for transfer pricing purposes. Where the conduct of the parties is not aligned with the terms of legal registrations and contracts, it may be appropriate to allocate all or part of the intangible-related returns to the entity or entities that, as a matter of substance, perform the functions, bear the risks, and bear the costs that relate to development, enhancement, maintenance and protection of the intangibles. The guidelines further suggest that the parties’ conduct should generally be taken as the best evidence concerning the true allocation of entitlement to intangible-related returns.

Transactions involving the use or transfer of intangibles

The next step in the analysis of controlled transactions involving intangibles, is the identification and characterisation of those transactions. The draft guidelines provide that they are two general types of transaction where the identification and examination of intangibles are relevant for transfer pricing purposes:

� Transactions involving the use of intangibles in connection with the sale of goods and services

� Transactions involving transfer of intangibles.

The draft guidelines recommend that when intangibles are used to create a product or render a service, the intangible should be identified and taken into account in the comparability analysis, in the selection and application of the most appropriate transfer pricing method for that transaction, and in the choice of the tested party.

In the case of transfer of intangibles, the draft guidelines provide that such a transfer may encompass all rights in the intangible in question or only limited

rights. It is therefore crucial to identify with specificity the nature of the intangible and rights in intangible for the transfer between associated enterprises.

determining arm’s-length conditions

The draft guidelines provide that in order to determine the arm’s-length price, the transfer pricing analysis must take into account the options realistically available to each of the parties to the transaction. In considering these options, the perspectives of each of the parties to the transaction must be taken into account. A one-sided comparability analysis does not provide sufficient basis for evaluating a transaction involving the use of transfer of intangibles.

The draft guidelines further provide that in transactions involving the use or transfer of intangibles or rights in intangibles, the comparability of the intangibles themselves must be considered. Particularly when the Comparable Uncontrolled Price CUP method is considered to be the most appropriate transfer pricing method, the comparability of the transferred intangible to intangibles transferred in potentially comparable uncontrolled transactions must be evaluated. In conducting a comparability analysis, the following factors must be considered:

� Exclusivity

� Extent and duration of legal projection

� Geographic scope

� Useful life

� Stage of development

� Rights to enhancements, revision and updates

� Expectation of future benefits

If there are differences in comparability factors, the draft guidelines provide that in cases where these differences can have significant economic consequences that may be difficult to adjust for in a reliable manner, then assessment by some method other than CUP may be more reliable.

The draft guidelines also suggest the use of valuation techniques, such as the income-based valuation techniques that are premised on the calculation of discounted value of projected future cash flows.

The draft guidelines also suggest the use of the transactional profit split methods where reliable

9

Technical Updates

uncontrolled transactions cannot be identified – such as where both parties to the transaction make unique and valuable contributions to the transactions. The draft guidelines, however, provide a caution that care should be taken to identify the intangibles in question, to evaluate the manner in which those intangibles contribute to the creation of value and to evaluate other income-producing functions, risks and assets.

The guidelines also provide that valuation of intangibles on the basis of mark-ups over development cost is unlikely to provide an accurate measure of value and should generally be discouraged. Though the guidelines tilt in favour of using the CUP method and the transactional profit split methods, it does not reject the use of valuation techniques that can be useful in some circumstances.

CONCluSION

The draft guidelines contain a number of new provisions to deal with the complex issue of transfer pricing analysis in respect of intangibles. Once the guidelines are finalised, it is hoped that the issues involving transfer pricing of intangibles would be addressed by various countries by taking recourse to these guidelines.

10

International Tax Cases

Contributed by member firms and compiled by the Editorial Team

ThOuGhTBuZZ (p) ltd, IN RE, AAR No. 1036 of 2010 (71 DTR 105) (2012) The Authority for Advance Ruling (AAR) in India has given a ruling in the case of THOUGHTBUZZ (P) Ltd, IN RE, AAR No. 1036 of 2010 (71 DTR 105) (2012) wherein it has held that payment for subscription fees towards social media monitoring services constitutes royalty under the India Singapore Tax Treaty.

Facts

� The applicant, a tax resident of Singapore, was engaged in the business of providing social media monitoring services for companies, brands and products. It also mapped blogs, forums, Facebook posts and Twitter users country-wide to provide social media analytics for different markets. Further, it provided a platform to users to hear and engage with their customers, brand ambassadors etc. through the internet.

� The system operated by the applicant-generated reports with analysis with reference to inputs provided by clients.

� The applicant charged a subscription fee for these services.

� The applicant sought an advance ruling by the Authority on the following issue:

Issue

Whether the amount received by offering subscription-based-service is taxable in India?

applicant’s contention:

� Subscription fees received from its customers in India for providing social media monitoring services were not taxable as royalty under Section 9(1)(vi) of the Act or under Article 12 of the treaty with Singapore.

� No exclusive right or copyright was given to the customers. What is passed on to the customer did not amount to information in the nature of its own knowledge, experience or skill in commercial and financial matters. The applicant was only providing information over the internet, and had

no intellectual property right over it. The applicant’s role was only to collate information and provide this to its subscribers.

� The applicant also claimed that subscription fees were not equipment royalty as per clause (iv)(a) of Explanation 2 to Section 9(1)(vi) of the Act. The customer did not operate or control the equipment in any manner. The subscribers have no possessory rights in relation to equipment and merely took them as a facility or as use of sophisticated equipment installed by the applicant, outside India.

� Since the applicant has no permanent establishment in India, the income was only taxable in Singapore in terms of Article 7 of tax treaty.

revenue’s contention

� The subscription fees enabled the client to access data through the sophisticated system and help in tracking internet messages and feedback through a computer program ‘crawler’ owned by the appellant.

� The subscription fees paid to the applicant by the subscriber cannot be disassociated from the user of the computer system.

� The subscription fees were paid not only for the use of equipment but also for imparting of information concerning technical, industrial, commercial or scientific knowledge, experience or skill. The payment received was therefore royalty as defined in the Act or the tax treaty.

ruling of aar

� The AAR observed that the appellant is in the business of gathering, collating and making available or imparting information concerning industrial and commercial knowledge, experience and skill. Consequently the payment received from the subscriber would be royalty in terms of clause (iv) of the Explanation 2 to Section 9(1)(vi) of the Act and liable to be taxed as such under the Act.

� The AAR also held that the services rendered by the applicant would qualify as royalty under paragraph

11

International Tax Cases

2 of Article 12 of the tax treaty since it is the grant of the use for consideration, the process or information concerning industrial, commercial or scientific experience.

EdITOrIal COmmENT

The ruling of the AAR is not binding upon other cases, but has a persuasive value and therefore before structuring any such transaction companies should take into account the view expressed by the AAR in the aforesaid case.

12

International Tax Cases

INTErNaTIONal BuSINESS maChINES COrpOraTION v. COmmISSIONEr OF TaxaTION [Federal Court of Australia] [2011] 10 Taxmann.com 145

The Federal Court of Australia had an opportunity to adjudicate upon the provisions of Article 12 of the US-Australia Treaty and held that payment made for right to use the IP licences and right to market and distribute the IP licences was in the nature of royalty.

Facts

International Business Machines Corporation Australia (IBMA) was an indirect wholly owned subsidiary of IBM, a US company, and acted as IBM’s Australian distributor of computer software protected by intellectual property (IP) owned by IBM pursuant to Software Licence Agreement (SLA). Under the SLA, IBM and World Trade, two US companies granted to IBMA such intellectual property (IP) rights as were necessary for distribution of relevant products of IBM. As per the SLA, IBMA had two distinct rights, i.e. right to use IP licences and the right to market and distribute the IP licences. There was no dispute that, to the extent IP licences were the subject-matter of the SLA and to the extent that the payments were for those licences, they would properly be characterised as royalties. IBM contended that the payment with regard to distribution right would not fall under the definition of ‘royalty’ as per Article 12 of the treaty between Australia and the USA.

Issue

Whether payments made by IBMA to IBM and World Trade for such right to distribute IP licences were ‘royalties’ as defined in Article 12(4) of the Treaty between Australia and the USA.

decision

The court observed that the term ‘royalties’ as defined in in Article 12(4) of the Treaty includes payment of any kind, to the extent to which the payment is consideration for the use of or the right to use any specified IP right ‘or other like property or right’. Clearly, all rights that can be characterised as IP rights are thereby included.

Taking the whole of the SLA into account, it was clear that the SLA granted to IBMA such IP rights as were necessary for distribution of the relevant products by IBMA. It was not a distribution agreement that conferred distribution rights independent of the grant of IP rights.

In the language of Article 12(4) of the Treaty, the payments were either ‘consideration for […] the right to use any copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right’ within the meaning of Article 12(4)(a)(i) or, to the extent the payments did not fall within Article 12(4)(a)(i), the payments were for either ‘technical […] or commercial knowledge or information’ supplied by IBM Article 12(4)(b)(i) or for ‘the supply of any assistance of an ancillary and subsidiary nature’ to enable the application of the rights referred to in Article 12(4)(a)(i) or the knowledge/information referred to in Article 12(4)(b)(i)/(Article 12(4)(b)(ii)).

The rights/contents granted by the SLA were, in each case, rights/contents of a kind contemplated by Article 12(4). The definition of ‘royalties’ applies to payments both for the use of IP – that is, the exercise of the right granted, and also for the grant of the right to use the IP. This is consistent with the proposition that the use of an IP right involves the use of subject-matter which, if no right to use had been granted, would infringe the IP right.

Thus, the court held that the full amount of the payments was ‘royalties’ as defined in Article 12(4) of the Treaty.

EdITOrIal COmmENT

Ordinarily, income arising from distribution of products would be characterised as business income, however, the court observed in the instant case that the relevant agreement was a composite agreement and distribution of the products was not separate from the main SLA and therefore the entire payment was characterised as royalty.

13

International Tax Cases

VElCrO CaNada INC. v. hEr maJESTy ThE QuEEN [Tax Court of Canada] [2012] 20 Taxmann.com 126

In the aforesaid case, admittedly the payments made were ‘royalties’ but the issue was which company was the beneficial owner of the royalty and whether the treaty benefits between Canada and the Netherlands would be available to the parties concerned.

Facts

Velcro Canada Inc. (VCI) was in business of manufacturing and selling Velcro fasteners. VCI paid royalties under Licence Agreement to Velcro Industries BV (VIBV), previously resident of the Netherlands, for use of Velcro Brands Technology. In 1995, VIBV became a resident of the Netherlands Antilles and in October 1995 assigned Licence Agreement to Velcro Holdings BV (VHBV), a subsidiary of VIBV, which was a resident of the Netherlands. As per the agreement, VHBV was to pay consideration to VIBV for assignment of licence agreement.

As a result of assignment of licence by VIBV to VHBV, VCI started paying royalties to VHBV between 1996 and 2004. In turn, VHBV paid around 90% of that amount over to VIBV. Since there existed no tax treaty between Canada and the Netherlands Antilles, any royalties paid by VCI to VIBV would have been subject to withholding tax of 25%. However, in terms of the tax treaty between Canada and the Netherlands, VCI continued to withhold tax from royalties payable to VHBV at rate of 10% pursuant to the treaty, as VHBV was tax resident of the Netherlands. Subsequently, the rate of royalty was changed from 10% to zero in December 1998, which resulted in VCI ceasing to withhold any tax from royalties.

The tax authorities took the view that VIBV was the beneficial owner of royalties from VCI between 1996 and 2004, and therefore VHBV was not entitled to get the benefit of the reduced rate of withholding under the treaty. It was alleged that VCI failed to withhold and remit withholding tax of 25% of royalties paid to VHBV under Section 12 of Canadian Income Tax Act, since VHBV was not the beneficial owner of royalties paid to it by VCI.

Issue

Whether VBHV is the beneficial owner of royalty and thus payment by VCI to VHBV is subject to withholding tax in accordance with the treaty between Canada and the Netherlands, or VIBV will be considered as the beneficial owner of royalties and since there is no treaty between Canada and the Netherlands Antilles, the withholding tax rate will be 25%.

decision

The court held that beneficial ownership of royalties rested in VHBV and not in VIBV, and therefore VCI was correct in deducting the taxes as per the tax treaty between Canada and the Netherlands. The court observed the following factors in arriving at the decision that VHBV is the beneficial owner of the royalties:

� For VHBV to be considered a conduit, the question to consider is: Where did right to use and enjoyment and assumption of risk and control of the payments lie?

� VHBV assumed currency risk in relation to royalties, since monies were received by VHBV in Canadian funds, converted eventually to US funds or Dutch funds and nothing in any of agreements referred to shifting any currency risk to anyone else from VHBV

� Royalties did not just flow through VHBV but, at the discretion of VHBV, royalty payments were co-mingled with other funds of VHBV and were subject to risk of creditors, as for its other assets

� Since VHBV reported royalty funds as assets on their financial statements, they were at risk of seizure or availability to creditors, with no priority given to VIBV as a creditor

� Funds paid to VIBV by VHBV were not necessarily the same funds as royalty payments received, because the original payments were co-mingled with other assets of VHBV

� There was no predetermined flow of funds; rather, it was a contractual obligation by VHBV to pay to VIBV a certain amount of monies within a specified time frame

14

International Tax Cases

� VHBV was not collecting the royalty as an agent of VIBV and there was nothing in the agreements to suggest that VHBV was a mere channel to collect royalty on behalf of VIBV

� To rule that VHBV was a conduit, there would have to have been no discretion with respect to funds. It is only when there is ‘absolutely no discretion’ regarding use and application of funds that the Court takes the draconian step of piercing corporate veil.

EdITOrIal COmmENT

The Hon’ble Court has laid down important steps for determining whether the company to which the payment is being made can be considered as a conduit of another company or not. In the instant case, the Court rightly observed that VHBV was entitled to receive the royalties in its own right and not as an agent of VIBV.

15

International Tax Cases

TradEhOld lTd v. the COmmISSIONEr FOr ThE SOuTh aFrICaN rEVENuE SErVICE [Supreme Court of Appeal, South Africa (132/11) [2012] ZASCA 61]

This case relates to interpretation of Article 4 of the Treaty between South Africa and Luxembourg.

Facts

Tradehold, a South African company, indirectly held 100% of Tradego Ltd, a company incorporated in Guernsey. On 2 July 2002, at a meeting of Tradehold’s board of directors in Luxembourg, it was resolved that all further board meetings would be held in that country. This had the effect that, as from 2 July 2002, Tradehold became effectively managed in Luxembourg. It nevertheless remained a ‘resident’ in the Republic, notwithstanding the relocation of the seat of its effective management to Luxembourg by reason of the definition, at that time, of the term ‘resident’ in Section 2 of the Act. This status changed with effect from 26 February 2003, when the definition was amended and Tradehold ceased to be a resident of South Africa. The amendment on 26 February 2003 excluded from the definition of a resident any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between governments of the Republic and that other country for the avoidance of double taxation.

Contention of the tax authorities

South African Revenue Service (SARS) contended that when Tradehold relocated its seat of effective management to Luxembourg on 2 July 2002, or when it ceased to be a resident of the Republic on 26 February 2003, there was a deemed disposal of its only relevant asset, resulting in a capital gain being realised in the 2003 year of assessment of an amount of R 405,039,083 (exit tax). SARS was relying on paragraph 12 of the Eighth Schedule to the Act. According to this paragraph,

a. where a person who ceases to be a resident, or a resident who is as a result of the application of any agreement entered into by the Republic for the avoidance of double taxation treated as not being a resident, in respect of all assets of that person other than assets in the Republic listed in paragraph 2(1)(b)(i) and (ii),

b. that person must be treated for the purposes of this Schedule as having disposed of those assets for proceeds equal to the market value of those assets at the time of the event referred to in (a) and to have immediately reacquired those assets at an expenditure equal to that market value, which expenditure must be treated as an amount of expenditure actually incurred and paid for the purposes of paragraph 20(1)(a).

Contention of the tax payer

Tradehold contended that if there was a deemed disposal of the investment by Tradehold during the 2003 year of assessment, the capital gain that resulted from that disposal was not taxable in South Africa but in Luxembourg in terms of terms of Article 4(3) of the Double Tax Agreement (DTA) entered into between South Africa and the Government of Luxembourg. In terms of Article 4(3), the deemed place of residence of a company is the place where its effective management is situated.

decision

The Supreme Court of Appeal held that:

� Double tax agreements effectively allocate taxing rights between the contracting states where broadly similar taxes are involved in both countries. A double tax agreement thus modifies the domestic law and will apply in preference to the domestic law to the extent that there is any conflict. The Court said that the first step therefore is to determine into which Article of the DTA the particular tax falls

� Article 2 of the DTA specifies the taxes to which it applies. With regard to South Africa, it is said to apply to ‘the normal tax’, which includes tax on capital gains

� The term ‘alienation’ must be given a meaning that is congruent with the language of the DTA having regard to its object and purpose. In this regard, the Court concluded that the term ‘alienation’ as it is used in the DTA is not restricted to actual alienation. It is a neutral term having a broader meaning, including both actual and deemed disposals of assets giving rise to taxable capital gains

16

International Tax Cases

� From 2 July 2002, when Tradehold relocated its seat of effective management to Luxembourg, the provisions of the DTA became applicable and that country had exclusive taxing rights in respect of all of Tradehold’s capital gains.

The views expressed in this newsletter are not those of Morison International and are not a substitute for professional advice. Before taking any decision based on the content of this newsletter readers are advised to consult their tax advisor. Whilst every endeavour has been made to ensure the accuracy of the information contained in this booklet, no responsibility is accepted for its accuracy and completeness.

EdITOrIal COmmENT

The Hon’ble Supreme Court rightly held that the treaty would prevail over the domestic law and therefore allowed the taxpayer to claim treaty benefits in the instant case. However, as reported in the Country Focus for South Africa, the Revenue Authorities have introduced a Section 9H to the Act to overrule the aforesaid judgement. This raises an important issue concerning international tax law as to whether a country can unilaterally amend its domestic law to deny treaty benefit to the taxpayer.