Dual Resident Companies in the Application of Tax Treaties

What are dual resident companies?  Dual resident companies are companies which are treated for tax purposes to be tax residents in two different jurisdictions. For example, Company X might be tax resident in jurisdiction A because it was registered and incorporated in jurisdiction A and the laws of this jurisdiction treat all companies registered under […]

Written By Stephen Balzan

On September 30, 2016
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What are dual resident companies? 

Dual resident companies are companies which are treated for tax purposes to be tax residents in two different jurisdictions. For example, Company X might be tax resident in jurisdiction A because it was registered and incorporated in jurisdiction A and the laws of this jurisdiction treat all companies registered under the laws of that jurisdiction as tax residents.  On the other hand, the same company registered in jurisdiction A, might have its place of effective management (POEM) situated in jurisdiction B and the laws of this jurisdiction treats all companies which have their POEM being exercised in jurisdiction B as tax residents.  Thus it is very common to have companies which according to the laws and regulations applicable in different jurisdictions are considered to be residents in more than one jurisdiction. 

The terms ‘POEM’ and ‘residence’ 

The term ‘place of effective management’ is not defined in the OECD Model Convention (OECD MC) and according to Article 3(2) of the said Convention, any term which is not defined, will for the application of the treaty by a State, have the same meaning that it has at that time under the Laws of that State. 

The term ‘residence’ in the OECD MC also makes mention of the domestic laws and is derived from the factual existence of a tax liability under the internal laws of the two contracting states, which are parties to the treaty. According to the MC, a person is a resident of a contracting state by reason of domicile, residence, place of management or any other criterion of a similar nature.  The reliance on the internal laws of the jurisdictions applying the treaty will continue to result in situations in which companies will be treated as residents in two different jurisdictions and therefore entitled to two sets of treaties which are concluded by each of the contracting states.

The POEM as a tie-breaker rule 

In view of the fact that double taxation treaties function through the use of distributive rules, this issue of dual resident companies needs to be resolved for the proper application of a double taxation treaty.  Distributive rules seek to distribute and allocate the taxing rights between the source country (i.e. the country in which the income arises) and the resident country (i.e. the country in which the beneficial owner of the income is resident).  Thus it is important to identify the country in which the beneficial owner of the income is resident. 

The OECD MC tries to resolve this conflict through the POEM test, whereby a dual resident company will be considered to be a resident in that jurisdiction in which its POEM is situated.  This does not mean that the company will be considered to be non-resident in the country of incorporation for the purposes of that country’s tax laws.  The POEM test ensures that for the proper functioning of the treaty, the dual resident company will be considered to be a resident of the jurisdiction in which the POEM is situated. 

The POEM test is a test which in the case of dual residence, seeks to exclude an artificial person from the definition of a resident, on the basis of a purely formal criterion such as registration. 

The POEM criterion is a term which as already mentioned above, is undefined in the OECD Model Convention and has been subject to various interpretations.  Furthermore, it is possible to have a company which may have more than one POEM at a given point in time, given the modern information technology and infrastructures of this day and age.  Where the POEM tests fails to resolve the conflict, the treaty cannot be applied, therefore possibly resulting in unrelieved double taxation. Although double taxation agreements have clauses (Article 25 of the OECD MC), whereby competent authorities can seek to reach an agreement through a Mutual Agreement Procedure (MAP), this is no guarantee that the matter will be resolved in view of the fact that competent authorities may still be unable to reach an agreement, unless there is a mandatory arbitration clause.  

Dual resident companies might be seen by tax authorities as being engaged in aggressive tax planning and treaty shopping by attempting to be entitled to two sets of tax treaties.  This is undesirable.  A dual resident company is however not always the result of aggressive tax planning and should not always be deterred through unrelieved double taxation, uncertainty or onerous administrative burdens. 

The POEM is currently the sole tie breaker rule which resolves cases of dual resident companies, a test which is largely efficient in a number of cases, although in some difficult cases it fails. Examples include cases in which a company is considered to have a POEM in more than one jurisdiction or cases where a company might not have a POEM in either of the jurisdictions when applying a particular treaty. 

OECD BEPS Action Plan 6 

In view of the fact that currently the POEM test is the sole method of resolving the issue of dual resident companies, the OECD in its BEPS Action Plan 6 proposes to replace this test with a more subjective one, under which competent authorities will determine which contracting state a company should be deemed to be a resident of, by taking into account the company’s POEM, place of incorporation and any other relevant factors.

How can we help?  

For further information, please contact one of the firm’s tax partners, Stephen Balzan on [email protected] or Elaine Camilleri [email protected]. ACT can help you understand the changes to the tax rules and how these can impact your business.  

Apart from its offices in St. Julian’s Malta, ACT operates from a second office in Gozo, which is situated in the capital city of Victoria.  For an appointment in our Gozo office, please call on 00356 21378672 or send us an email on [email protected]. 

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