Annex 3 - Glossary
In addition to an ongoing request for competent authority assistance, a taxpayer may request assistance for subsequent filed, but yet to be audited, taxation years on the same issue. The inclusion of these subsequent “ACAP” years in the MAP discussions not only prospectively resolves double taxation but also alleviates the burden of a separate audit and MAP process.
An arrangement that determines, in advance of controlled transactions, an appropriate set of criteria (e.g. method, comparables and appropriate adjustments thereto, critical assumptions as to future events) for the determination of the transfer pricing for those transactions over a fixed period of time. An advance pricing arrangement may be unilateral involving one tax administration and a taxpayer or multilateral involving the agreement of two or more tax administrations.
Domestic taxation laws that are intended to prevent taxpayers from avoiding tax or abusing tax laws for the sole purpose of obtaining a reduction, avoidance or deferral of tax.
The international standard that OECD Member countries have agreed should be used for determining transfer prices for tax purposes. It is set forth in Article 9 of the OECD Model Tax Convention as follows: where "conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly."
A range of figures that are acceptable for establishing whether the conditions of a controlled transaction are arm's length and that are derived either from applying the same transfer pricing method to multiple comparable data or from applying different transfer pricing methods.
Taxation by means of either the tax authority or the taxpayer ("self-assessment") computing tax due over a period, usually a calendar or fiscal year. In effect, the taxpayer pays tax on an income amount after the gross amount has been received, as compared to taxation by a final withholding tax where a tax amount is retained and forwarded to the tax authorities before a net amount (of dividends, for example) is paid to the taxpayer.
Two enterprises are associated enterprises with respect to each other if one of the enterprises meets the conditions of Article 9, sub-paragraphs 1a) or 1b) of the OECD Model Tax Convention with respect to the other enterprise. See Article 3 for the definition of "enterprise".
A comparison of a controlled transaction with an uncontrolled transaction or transactions. Controlled and uncontrolled transactions are comparable if none of the differences between the transactions could materially affect the factor being examined in the methodology (e.g. price or margin), or if reasonably
accurate adjustments can be made to eliminate the material effects of any such differences.
An adjustment in which the taxpayer reports a transfer price for tax purposes that is, in the taxpayer's opinion, an arm's length price for a controlled transaction, even though this price differs from the amount actually charged between the associated enterprises. This adjustment would be made before the tax return is filed.
“Competent authority” is a term used in tax conventions to identify the person who represents the State in the implementation of the treaty, as defined under Article 3 of a tax treaty. A sample clause might be:
The term “competent authority” means, in the case of Utopia, the Commissioner of Taxation or an authorised representative of the Commissioner and, in the case of Ruritania, the Minister of Finance or an authorised representative of the Minister.
The competent authority has certain specific functions under the treaty, including acting as a contact point for both taxpayers and the other competent authority in Mutual Agreement Procedures. Sometimes there are different competent authorities for different functions under the treaty.
Transactions between two enterprises that are associated enterprises with respect to each other.
A term used in the transfer pricing context. An adjustment that creates an increase or decrease in the tax imposed on one member of the group of controlled taxpayers correlating to the "primary adjustment" made in respect of another member of the same group. The adjustment may be to the income of the group member or to an allowance of relief under a foreign tax credit or exemption mechanism. This term is generally seen as interchangeable with the term "corresponding adjustment", although when speaking of a particular monetary adjustment, some prefer to refer to "correlative adjustments".
An adjustment to the tax liability of the associated enterprise in a second tax jurisdiction made by the tax administration of that jurisdiction, corresponding to a primary adjustment made by the tax administration in a first tax jurisdiction, so that the allocation of profits by the two jurisdictions is consistent.
The situation wherein a person, being either an individual or a company, is determined "resident" under the domestic tax laws of both the States having concluded a tax treaty. This would mean the possibility of juridical double taxation - both States taxing the person as their resident. The provisions of Article 4(2) and Article 4(3) of the Model Convention are designed to solve such situations by treating the person as resident - for purposes of the treaty - of only one of the States. See also: "Tie-Breaker Rules".
"Economic double taxation" is where two different legal persons are taxed on the same income or other taxable item by more than one State. This may occur, for example where two States take different views of the profits made in transactions between a subsidiary resident in one of the States in its transactions with a parent company in the other State, so that at least some part of the profits on the transaction are taxed in both States. The Model Tax Convention does not often deal with economic double taxation, but Article 9 seeks to address aspects of this sort of double taxation of related entities. As noted by the Commentary on Article 10, at paragraph 40 certain States' domestic tax laws and treaty practice seek to avoid or mitigate economic double taxation caused by the simultaneous taxation of the company's profits at the level of the company and of the dividends at the level of the shareholder. Compare "juridical double taxation".
The method of relieving double taxation under Article 23A of the OECD Model Tax Convention.
Under this method, where a resident ("R") of one of the treaty partner States receives an amount that may be taxed in the other treaty State (which we can call for these purposes the "source State") under the tax treaty, the residence State must, when taxing R, exempt that amount from residence State taxation. In other words, R will not have to pay any tax to the residence State on the amount where the source State may levy tax under the treaty, whether or not it actually does so. This is the principle under paragraph 1 of Article 23A.
Paragraph 2 provides an exception, however in that where amounts are only liable to source State taxation to a limited extent under Article 10 (Dividends) or Article 11 (Interest), the State of residence need only give a credit, rather than an exemption in respect of that amount. Paragraph 4 provides an exception to the general exemptionprovision in paragraph 1. It provides that that obligation does not apply in certain circumstances where to apply it would result in double non-taxation as a result of different approaches to the application of the treaty which are both consistent with the meaning of the treaty.
This system of tax exemption deals with avoidance of "juridical double taxation", where the person liable to the residence State taxation is the same person liable to the source State taxation.
Article 23A does not provide for a "full exemption" system, but is rather, an "exemption with progression" system (Paragraph 3). This means that although an amount which may be taxed in the source State is exempt in the residence State, the residence State is still allowed to take that amount into account when determining the amount of tax that the resident must pay on his or her other (that is, non-exempt) income. For example, the income may be taken into account as received in order to decide what marginal tax rate applies to the other income.
A credit given for foreign tax in calculating the amount of tax to be paid in a person's country of residence. In effect, a taxpayer need not pay residence country tax on the income where the source country of the income taxes that income to an equal or greater degree. Where the residence country tax is higher, the amount of foreign tax is deducted from the amount of local tax otherwise to be paid. This avoids double taxation where, as is often the case, a tax treaty allows both the source and residence country some taxing rights.
An analysis of the functions performed (taking into account assets used and risks assumed) by associated enterprises in controlled transactions and by independent enterprises in comparable uncontrolled transactions.
Two enterprises are independent enterprises with respect to each other if they are not associated enterprises with respect to each other.
"Juridical double taxation" occurs where the same legal person is taxed twice on the same income or other taxable item by more than one State. A common situation is where the source country taxes a payment as it flows to a person (by dividend or interest withholding tax, for example, which is in effect a tax on the recipient collected by a withholding agent such as the company paying the dividend) and the residence state of the recipient also taxes that person on the same item as part of his or her worldwide income. The division of taxing rights in the Model Tax Convention, when combined with the effect of Article 23 is designed to prevent such juridical double taxation as far as is possible. Compare "economic double taxation".
A group of associated companies with business establishments in two or more countries.
A company that is part of an MNE group.
A means through which competent authorities consult to resolve disputes regarding the application of double tax conventions. This procedure, which is described and authorized by Article 25 of the OECD Model Tax Convention, can be used to eliminate double taxation that could arise from a transfer pricing adjustment, but can also be relevant for other aspects of a tax treaty's operation. In the case of MAP relating to transactions between associated enterprises, see also Article 9, especially paragraph 2.
The Model Tax Convention on Income and Capital published by the OECD, as amended from time to time. The OECD Model Tax Convention includes Commentaries on the articles of the Model. The OECD Model Tax Convention serves as a model for the negotiation of bilateral tax treaties between countries. Copies are available for sale at the OECD website.
The Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations first published by the OECD in 1995, as amended from time to time. The Guidelines provide guidance on the use of the arm’s length principle to determine transfer pricing between associated enterprises.Copies are available for sale at the OECD website.
Term given definition by Article 5 of the OECD Model Tax Convention, and used to determine whether the business profits of a resident enterprise [H/L] of the treaty partner may be taxed under Article 7 in the other treaty partner. As Article 7 makes clear, the amount of business profits so taxable, is the amount attributable under that Article to the permanent establishment. The PE test is broadly a test of whether there is the minimum economic connection necessary to justify source State taxation of such business profits under the tax treaty.
There are generally two aspects required for there to be a PE, a relationship to a particular place (the geographical aspect) and a presence for a particular point of time (the temporal aspect). There are, however, special rules for some types of PEs under the OECD Model Tax Convention, such as "construction" PEs, where the temporal period required is more than 12 months, and certain PEs constituted by "dependent agent" arrangements, where no time period applies. There are also some exclusions under the OECD Model Tax Convention, presences which are specifically stated not to be PEs, such as activities related solely to storage, display or delivery of goods or mechandise or other so-called "preparatory or auxiliary activities".
Sometimes the term "permanent establishment" is used in domestic tax legislation as well, but it may not have exactly the same meaning as in the tax treaties.
An adjustment that a tax administration in a first jurisdiction makes to a company's taxable profits as a result of applying the arm's length principle to transactions involving an associated enterprise in a second tax jurisdiction.
In the transfer pricing context, this term refers to the act by which an enterprise that has been party to a controlled transaction with an associated enterprise and has been found, in accordance with a transfer pricing adjustment, to have derived as a result of that transaction an amount of income that exceeds an arm’s length amount, returns the excess funds to its associated enterprise.
The residence State is the country where a person is resident under the treaty at the relevant time. In international tax law, this is a basis for taxation of the global income of the resident. See the text of Article 4, and its explanation, for more on treaty residence.
A constructive (that is, notional) transaction that some States assert under their domestic transfer pricing legislation after having proposed a primary adjustment in order to make the actual allocation of profits consistent with the primary adjustment. Secondary transactions may take the form of constructive dividends (that is items treated as though they are dividends, even though they would not normally be regarded as such), constructive equity contributions, or constructive loans.
A simultaneous tax examination, as defined in Part A of the OECD Model Agreement for the Undertaking of Simultaneous Tax Examinations, means an "arrangement between two or more parties to examine simultaneously and independently, each on its own territory, the tax affairs of (a) taxpayer(s) in which they have a common or related interest with a view to exchanging any relevant information which they so obtain".
The State where, for the purposes of a treaty, a taxable amount is regarded as arising. As rules in domestic law about where an amount arises differ (e.g. some might look to where the profits that become a dividend are made as the source of a dividend, whereas others may look to the State from which the dividend is paid, the Model Tax Convention often provides implied or specific rules.
For example, a State A – State B tax treaty, if it was based on the OECD Model Tax Convention, would allow State B as the source State to impose a limited withholding tax on dividends paid by corporations resident in State B to residents of State A (see Article 10), but would prohibit State B from imposing a tax on dividends paid to a resident of State A by a corporation resident in State C, even if those dividends were paid out of profits earned by the corporation in State B (see Article 21).
Source States may, under general international tax law, tax income sourced in that State. The residence State may then provide an exemption or a credit for tax paid in the source State under domestic law. A tax treaty often limits or prevents source State taxation, and also generally provides that the residence State must give a credit or exemption for tax paid in the source State under Article 23. Compare "residence State".
Tax on an item of income imposed in the State wherein that income is derived, or tax on an item of capital imposed in the State wherein that capital is situated. Many Articles of the Model Convention provide for an exemption from, or a reduction of, such "source" tax on certain items of income or capital.
These rules, Article 4 of the OECD Model Tax Convention, at paragraph 2) for individuals, and paragraph 3 for companies, seek to determine a single residence for tax treaty purposes, in those cases where a person is a resident for domestic law purposes under the domestic tax laws of both treaty States. That can most obviously happen when the two States apply different tests for residency. The tie-breaker rules do not themselves affect the situation at domestic tax law generally, although domestic laws sometimes expressly provide that certain tax benefits are not available to a domestic law resident who is regarded as a resident solely of the treaty partner State under the relevant treaty's tie-breaker rules. See also: Dual Residence.
The terms and conditions applying in transactions between associated enterprises.
An adjustment to the tax liability of an enterprise when a tax jurisdiction applies the arm's length principle to transactions between associated enterprises in a transfer pricing case. See "primary adjustment" (by the initial tax jurisdiction), "corresponding adjustment" (by the jurisdiction of the other associated enterprise) and "compensating adjustment" (reported by the taxpayer based on the arm's length principle though it differs from the actual terms and conditions of the transaction). See also a "secondary adjustment" (an adjustment arising from taxing certain notional transactions).
As part of the MAP process, one competent authority provides relief from double taxation or taxation not in accordance with the treaty. This unilateral relief can be by way of one competent authority withdrawing its initial adjustment or by the other competent authority providing a correlative adjustment.
A tax imposed at source, whereby a third party, the paying agent (such as a bank paying interest or a company distributing dividends to shareholders), must "withhold" an amount from the payment and remit it to the local tax authorities. It is a common way of ensuring that tax is collected from benefits accruing to overseas taxpayers who are beyond a State's immediate legal jurisdiction. Withholding tax will be "final" if there is no later adjustment as part of assessment. Otherwise, it is regarded as "provisional", and depending on the taxpayer's final tax liability there may be a refund or (more rarely) a requirement for further payment by the taxpayer.
Articles 10 and 11 of the OECD Model Tax Convention set limits on allowable withholding tax rates on dividends and interest under the treaty. Whether the correct tax to be applied by a State is a withholding tax on gross receipts (such as under Article 11) or a tax on net amounts (such as taxation of business profits under Article 7 (Business Profits) can be a significant issue under treaties.
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