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Faculty of Law

Faculty of Law. Executive Master of Advanced Studies (MAS) in International Taxation at Neuchâtel University Prof. Dr. Frank Pötgens The OECD Model Tax Convention/Art. 15, 16, 17, 18, 10 and 11 April 2012. Income from employment (Art. 15 et seq.).

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Faculty of Law

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  1. Faculty of Law Executive Master of Advanced Studies (MAS) in International Taxation at Neuchâtel University Prof. Dr. Frank Pötgens The OECD Model Tax Convention/Art. 15, 16, 17, 18, 10 and 11 April 2012

  2. Income from employment (Art. 15 et seq.) • Art. 15 (income from employment) -> general rule -> taxation right to work state • Art. 16 (directors’ fees) -> taxation right to the state where the company is resident (of which the person at issue is a director) • Art. 17 (artistes and sportsmen) -> taxation right to the performance state • Art. 18 (pensions) -> taxation right to the state where the recipient of the pension resides

  3. Art. 15 of the OECD Model • Income from employment -> closed system according to case law of the Dutch Supreme Court ( e.g. decision of 3 May 2000, BNB 2000/296 re severance payment under the former Netherlands-Switzerland Tax Treaty) and the German Federal Tax Court (e.g. 24 February 1988, BStBL II 1988, p. 819 re severance payment under the 1971 Germany-Switzerland Tax Treaty); inter alia based upon the wording of Art. 15(1) of the OECD Model (“subject to the provisions of the Articles 16, 18 and 19”). • Closed system (functional) means that the more specific employment provisions (Art. 16, 17, 18) supersede on the general provision of Art. 15 (umbrella provision) -> (i) asses whether a more specific provision is applicable, (ii) if (i) is not the case, than Art. 15 applies. • The actual other income provision (Art. 21 of the OECD Model) does not play a part within this closed system.

  4. Art. 15 of the OECD Model • Order of preference: Art. 19 (government service) Art. 18 (pensions) Art. 17 (artistes and sportsmen) Art. 16 (director’s fees) Art. 15 (income from employment) • Art. 19 > Art. 18 [wording of Art. 19(3)] • Art. 18 > Art. 16 (case law, e.g. Dutch Supreme Court, 22 July 1988, BNB 1989/2 and Antwerp Court of Appeal, 11 June 2002, Fiscoloog, 2002/864, p. 9) • Art. 18 > Art. 17 (case law, e.g. Dutch Supreme Court, 3 May 2000, BNB 2000/328)

  5. Income from employment (Art. 15 of the OECD Model) • Art. 15 OECD Model -> 3 rules • First rule (Art. 15(1), first part of first sentence) -> taxation right to employee’s resident state • Second rule (Art. 15(1), end of first sentence and second sentence) -> general rule (Art. 15/para1) -> taxation right to the work state -> allocation of the salary to employment exercised in the work state • Third rule (Art. 15(2) -> exception to the second rule -> taxation right to the employee’s resident state if three conditions are met cumulatively (Art. 15/para.4)

  6. Income from employment (Art. 15 of the OECD Model/first rule) Rule 1: Residence State “salaries, wages and other similar remuneration” • Art. 3(2) -> domestic law unless the context requires another meaning: domestic law meaning is generally decisive in determining the meaning of “salaries, wages and other similar remuneration” (e.g. various decisions of the German Federal Tax Court re tax treaty characterization of severance payments). • The context may require a meaning deviating from the domestic law only in exceptional cases, e.g. the decisions of the Dutch Supreme of 5 September 2003, BNB 2003/379 (fictitious wage concept) and of 27 September 2000, BNB 2001/29 (disability allowances).

  7. Income from employment (Art. 15 of the OECD Model/first rule) • Para. 2.1 of the Commentary to Art. 15 of the OECD Model (broad meaning) • Causality with the employment • What can typically be comprised under the expression “salaries, wages and other similar remuneration”?

  8. Income fromemployment (art. 15 of the OECD Model/first rule) Included: • Severance payments • Sign-on fees • Income from non-competition agreements • Bonus • Employee stock options • Company car • Quasi pension rights • Early retirement schemes • Disguised salary payments • Stand-by fees • Continued service bonus • Compensation for cancelled employment

  9. Income fromemployment (Art. 15 of the OECD Model/first rule) Excluded: • Strike benefits • Disability allowances • Relief for distress

  10. Income fromemployment (Art. 15 of the OECD Model/first rule) Demarcation issues Art. 15 < - > Art. 18 • Severance payments = “salaries, wages and other similar remuneration” (the Dutch Supreme Court, 11 June 2004, BNB 2004/344 and the German Federal Tax Court, 10 July 1996, BStBl. 1997 II, p. 431). • Art. 18 ↑ -> remuneration similar to a pension if the following requirements are met: • A care requirement (Dutch Supreme Court, 20 My 1987, BNB 1992/21 and the German Federal Tax Court, 19 September 1975, BStBl. II 1976, p. 65); • A reasonableness requirement (Dutch Supreme Court, 6 November 1985, BNB 1986/35); • Termination of the employment requirement (Hessen Lower Court, 15 May 1998, IStR 1999/15, p. 471). If severance payment does not meet requirements 1-3, it is intended to bridge the period until a new employment is found -> Dutch Supreme Court, 3 may 2000, BNB 2000/296.

  11. Income fromemployment (Art. 15 of the OECD Model/first rule) Demarcation issues Art. 15 < - > Art. 13 • Employee stock options * Grant: “salaries, wages and other similar remuneration”-> para. 2.1 of the Commentary to art. 15 of the OECD Model * Falls under Art. 13 as of the moment the option is “exercised, sold or otherwise alienated” (para. 12.2 – 12.5 of the Commentary to Art. 15 of the OECD Model)

  12. Income fromemployment (Art. 15 of the OECD Model/first rule) “Employment” • Past, present and future employment: • Dutch Supreme Court 16 December 1998, BNB 1999/125 (costs) and US Tax Court in Ken Linsenmanand the Tax Court of Canada in Khabibulin(sign-on fees) re future employment • German Federal Tax Court, 10 July 1997, BStBl. II 1997, p. 341 (severance payment) re past employment

  13. Income fromemployment (Art. 15 of the OECD Model/firstrule) • Interpretation of “employment” -> Art. 3(2) of the OECD Model -> domestic law -> context • The case law in various jurisdictions demonstrates that a crucial element is whether the employee works under the authority (control) of the employer (the authority element may be interpreted differently by various jurisdictions) • Consequently, the authority relationship is also relevant on a tax treaty level when interpreting “employment” (Dutch Supreme Court, 11 February 1998, BNB 1998/11 re soccer player)

  14. Art. 15 OECD Model/secondrule Second Rule: general rule, i.e. taxation in the work state “Exercise” (“the employment is exercised”) • Physical presence * para. 1 of the Commentary to Art. 15 of the OECD Model * e.g. Dutch Supreme Court, 15 October 1986, BNB 1986/72 and it stems from the domestic law, e.g. the UK, the US, Germany, France, Belgium • Tokyo-doctrine (central point at which the employment was exercised -> rejected by the Dutch Supreme Court) • In certain specific cases the criterion of physical presence is abandoned: illness (Dutch Supreme Court, 24 April 1957, BNB 1957/189), compensation for a cancelled employment (Dutch Supreme Court, 10 August 2001, BNB 2001/353) and internationally active truck drivers (Belgium Supreme Court, 28 May 2004, FJF 2004/244; exercise of the employment at place effective management employer)

  15. Art. 15 OECD Model/secondrule Exercise • FJF 2004/244 rejected by German Federal Tax Court, 29 January 1986, BStBl. II. 1986, p. 479. • Previous German case law; senior managers of corporations (Geschäftsführer) not falling under Art. 16 of the OECD Model -> the German Federal Tax Court previously determined that they exercised their employment at the company’s situs (German Federal Tax Court, 20 October 1982, BStBl. II 1983, p. 224). • Current German case law: the previously accepted fiction for senior managers is abandoned (German Federal Tax Court, 5 October 1994, BStBl. II 1995, p. 95) -> senior managers exercise their employment in the State where they are physically present (confirmed by the Dutch Supreme Court, 19 June 1996, BNB 1996/369).

  16. Art. 15 OECD Model/secondrule Deviating view may lead to situations of double taxation or double non-taxation -> solutions: • Resulting of different classifications in domestic law affecting the tax treaty classification (reference to domestic law in Art. 3(2) of the OECD Model); qualification conflict within the meaning of para. 32.3 of the Commentary to Art. 23 of the OECD Model -> residence state is compelled following the source state’s characterization. • Subject-to-tax clauses (art. 15(4) of the 2000 Austria-Germany tax treaty); the employment is only exercised in the work state if the income resulting from that employment is actually taxed in the work state. • However, Commentary on the OECD Model is clear (para.1): physical presence is sole criterion.

  17. Art. 15 of the OECD Model/second rule Allocation (“such remuneration as is derived therefrom”) • Determining which services caused the remuneration, i.e. determining whether and to what extent the remuneration is accrued in respect of the period an employee spent in the work state. • General rule: using a time-proportionate method -> appropriate if activities are performed both in residence state and the work state or the remuneration has a connection with the services rendered in the work state unless a certain part of the remuneration has to be attributed to the labour performed in the work state. • Under the time-proportionate method the remuneration is allocated to the services rendered in the work state by using a fraction.

  18. Art. 15 of the OECD Model/second rule Allocation (“such remuneration as is derived therefrom”) • Fraction: Actual number of days of employee’s presence in the work state performing services Total number of working days per year • The definition of the numerator and denominator may vary in different jurisdictions • There are income components that should be exclusively attributable to the employment exercised in the work state, e.g. a bonus that solely depends on the profits of the company on whose behalf the services are rendered in that state.

  19. Art. 15 of the OECD Model/second rule Allocation (“such remuneration as is derived therefrom”) • Example of a fraction; German Federal Tax Court, 29 January 1986, BStBl. II 1986, p. 442: Contractually agreed number of days spent in the work state x total annual remuneration Contractually agreed number of working days per year • Weekends and holidays are excluded from numerator and denominator; contractually agreed working days = calendar days in a year -/- the days on which the employee is not obliged performing activities under the employment contract, e.g. 365 calendar years -/- 30 vacation days -/- 104 Saturdays/Sundays -/- 11 public holidays = 220 contractually agreed working days

  20. Art. 15 of the OECD Model/second rule • Deferred compensations and compensations paid in advance for the exercise of an employment; same allocation principles apply to these types of compensations -> however, is paid at an earlier or later moment in time meaning that a connection has to be established with the exercise of an employment; in practice it is not always easy to establish such a connection. • Employee stock options: according to OECD-Commentaries a pre-grant allocation of stock option benefits is possible, e.g. an option is unconditionally granted (i.e. without any condition of subsequent employment on a given date) -> in other cases the options are intended to reward future services and they must be allocated to the services rendered in the period between grant and vesting (para. 12.14 of the Commentary to Art. 15 of the OECD Model).

  21. Art. 15 of the OECD Model/second rule • Bonus: often received in a later time period than the services are rendered to which it relates -> determining which services haven given rise to the bonus (German Federal Tax Court, 5 February 1992, BStBl. II 1992, p. 660). • Continued service bonus: paid in order to persuade an employee staying with the current employer during a certain period -> conditionally granted; allocating to the services rendered between grant and becoming unconditional -> unconditionally granted; allocating to the services he rendered on behalf of his employer (residence state or fixed pattern).

  22. Art. 15 of the OECD Model/second rule Income from inactivity • Illustration of difficulties in determining various elements of the second rule; inactivity = all situations in which no immediate or direct action of the employee is required as a consideration for the income he receives from the current or former employer during a certain period of time. • Three main issues: • Does the inactivity constitute the exercise of an employment; • Where is the employment exercised; and, • To which activity should the income be allocated?

  23. Art. 15 of the OECD Model/second rule Income from inactivity Compensation for cancelled employment: • Residence state (German Federal Tax Court, 12 September 2006) or • Replacement approach and fictitious place of exercise (Dutch Supreme Court, 10 August 2001, BNB 2001/295)

  24. Art. 15 of the OECD Model/second rule Income from inactivity Sickness benefits: in the Netherlands and Germany the employer is obliged to pay all or part of the employee’s salary during illness: • Dutch case law (Supreme Court, 24 April 1957, BNB 1957/189); replacement approach + fictitious place of exercise -> where would the employment normally have been exercised if the employee had not been ill • The Netherlands case law approach is not followed in Germany (Federal Tax Court, 17 October 2003, BFH/NV 2004, 161) and in Belgium (Antwerp Court of Appeal, 26 September 1994); physical presence during illness

  25. Art. 15 of the OECD Model/second rule Income from inactivity Income from non-competition agreements: the obligation that the agreement imposes on the employee to omit certain activities during a defined period of time can be regarded as the exercise of an employment -> 2 approaches: • Allocation to the place where the competitive activities would presumably have been exercised if the former employee had performed the omitted activities (German Federal Tax Court, 9 September 1970, BStBl. II 1970, p. 867 and Belgian Court of Appeal of Brussels, 20 September 2000, T.F.R. 2008, p. 496) • Allocation to the place where the former employee is physically present to honour his commitments (residence state); Belgian Court of Appeal of Brussels, 14 November 1997, A.F.T. 1998, p. 122.

  26. Art. 15 of the OECD Model/second rule Income from inactivity Severance payments: not exercising an employment • Allocation; 3 possibilities: • Allocation to the future employment, in the context of which the place of exercise is determined fictitiously (Advisory Opinion of Dutch Advocate-General; allusion on the decision re compensation for cancelled employment; BNB 2001/353); • Residence state of the recipient of the severance payment (German Federal Tax Court, 10 July 1996, BStBl. II 1997, p. 341) -> compensation for the loss of a job that could not be attributed to specific services rendered in the work state; • Work state(s) where past services were rendered; the entitlement to the severance payment accrued during the years of service.

  27. Art. 15 of the OECD Model/second rule Severance payments: allocating the severance payments to services performed in various work states -> deviating views are employed: • All years in which activities are performed on behalf op the employer that terminated the employment and that are used in calculating the final severance payment; • The year in which the payment is received or the most recent year in which services were regularly performed; • The year in which the employment was terminated; • Specified years

  28. Art. 15 of the OECD Model/second rule Severance payments: the Dutch Supreme Court, 11 June 2004, BNB 2004/344 and 345 -> fraction: The part of the regular salary taxable in the work state during the reference period Total salary during the reference period Reference period: • The part of the year between 1 January and the date on which the employment is terminated • The 4 calendar years preceding 1 January in the year in which the employee is dismissed Absolute requirement; severance payment borne by employer or PE in the work state

  29. Art. 15 of the OECD Model/second rule Income from inactivity Stand-by fee: • Being on call = exercise of an employment (Dutch Supreme Court, 22 December 2006, BNB 2007/97 and German Federal Tax Court, 9 September 1970, BStBl. II 1970 II, p. 867) • Allocation to the place where the employee is physically present while being stand-by (see aforementioned decisions)

  30. Art. 15 of the OECD Model/third rule Residence state if the 3 conditions of Art. 15(2) are cumulatively met: • presence in the work state < 183 days during a reference period • the remuneration is paid by, or on behalf of an employer who is not residing in the work state • the remuneration is not borne by a PE which the employer has in the work state • if one conditions is not fulfilled, then second rule applies -> taxation right to the work state

  31. Art. 15 of the OECD Model/ third rule Art. 15(2)(a) -> 183 days • 12 months period commencing or ending in the fiscal year concerned • Excluded: days during which the employee is a resident of the work state (OECD Commentary Art. 15/para. 5.1 and the Dutch Supreme Court, 15 September 1999, BNB 1999/420)

  32. Art. 15 of the OECD Model/third rule Art. 15(2)(a) -> 183 days • Calculation of 183 days -> physical presence method (OECD Commentary Art. 15/para. 5): - physical presence: - part of a day; - day of arrival and day of departure; - holidays, days of sickness, etc.

  33. Art. 15 of the OECD Model/third rule Art. 15(2)(b) (an employer not residing in the work state) • Paid by, or on behalf of -> individually identifiable recharge -> example 5 (Art. 15/para. 8.24 and 8.25) and case law (below) • “An” employer -> formal and De facto employer -> states employing a formal approach can include a specific provision in their treaty counterattacking abuse (Art. 15/para. 8.3) • States employing a De facto approach may derecognize the formal employer based upon (i) the nature of the services to the user and (ii) the integration into the user's business (Art. 15/para. 8.6)

  34. Art. 15 of the OECD Model/thirdrule • Art. 15/para. 8.14 gives objective criteria to determine who is De facto employer: • who has the authority to instruct the individual regarding the manner in which the work has to be performed; • who controls and has responsibility for the place at which the work is performed; • the remuneration of the individual is directly charged by the formal employer to theenterprise to which the services are provided;

  35. Art. 15 of the OECD Model/thirdrule • Objective criteria (Art. 15/para. 8.15): • who puts the tools and materials necessary for the work at the individual’s disposal; 5. who determines the number and qualifications of the individuals performing the work; 6. who has the right to select the individual who will perform the work and to terminate the contractual arrangements entered into with that individual for that purpose; 7. who has the right to impose disciplinary sanctions related to the work of that individual; 8. who determines the holidays and work schedule of that individual.

  36. Some issues asking attention Art. 15(2)(b) and (c) of the OECD Model • Interpretation of “employer” • Qualification conflicts and interpretation conflicts • “Paid by, or on behalf of” and “borne by”

  37. Interpretation • Commentary takes “ employment” as point of departure (states following “de facto approach) -> determining whether an employment relationship arises as regards the enterprise in the work state for which the employee renders services (Art.15/para.8.4) -> however, focus is (also) on the expression “employer”: (i) place in the Commentary (ii) relevance and position of “employment” (iii) analysis made in the Commentary (objective criteria and examples) (iv) introduction Discussion Draft (2004)

  38. Interpretation • Approach adopted in the Commentary -> employment -> domestic law (Art. 15/para. 8.4) -> meaning of “employer” is determined by first interpreting “employment” -> if an employment relationship exists, the person to whom the services are rendered is regarded as the “employer” (Art. 15/para. 8.7) -> domestic laws of a state lack definition of “employer” but has definition of “employment”

  39. Interpretation • Is this interpretation to be regarded as an (indirect) reference to the domestic law of the state applying the treaty or as an autonomous interpretation of “employer”? -> probably autonomous interpretation -> Commentary: employer = enterprise to which individual renders services in an employment relationship (Art. 15/para. 8.7) -> conclusion is drawn independently from domestic law of states ->

  40. Interpretation -> However, Commentary is not entirely clear -> it does not explain this interpretation method further ->Is it more appropriate to be silent on interpretation method? -> (i) States lacking definition of employer in their domestic law -> Art. 3(2) is N/A -> autonomous interpretation (e.g. Germany and the Netherlands; no definition of employer, but of employment) (ii) Art. 3(2) is to be applied by states having a definition of employer in their domestic law, not limited to withholding tax concept (e.g. Belgium, US, UK)

  41. Interpretation -> Result: no mention of interpretation (also for states following a formal approach -> suggestion in Art. 15/para. 8.3 for alternative text to counter abuse) -> only a set of criteria (Art. 15/para. 8.14) what is an employer at a tax treaty level -> maybe that is the way in which the Commentary is applied in practice

  42. Qualification and interpretation conflicts • Qualification conflicts (Art. 23/para. 32.3) -> different treaty rules apply because of differences in the domestic law of the source and residence state -> residence state must follow source state's qualification • Interpretation conflicts (Art. 23/para. 32.5) -> difference in interpretation of the facts of the tax treaty provisions (PE) -> mutual agreement procedure (Art. 25)

  43. Qualification and interpretation conflicts • Qualification conflicts -> differences in the domestic laws of the source and residence state -> presuppose that both states apply Art. 3(2) OECD MC (includes reference to domestic law) -> if the Commentary indeed follows an autonomous interpretation of “employer” or Art. 3(2) is N/A (one or both contracting states) -> different interpretations of “employer” ≠qualification conflict, but interpretation conflict

  44. Qualification and interpretation conflicts • Art. 15/para. 8.10 makes reference to para. 32.1-32.7 of Commentary to Art. 23 (qualification and interpretation conflicts) -> the source state has a taxation right (and Art. 15(2) is N/A) in case of (i) abuse or (ii) its domestic law follows a formal approach (and the employee is formally employed by a non-resident of the source state)-> residence state is compelled to follow that qualification and to grant relief for double taxation ->

  45. Qualification and interpretation conflicts -> in case (ii), way of interpretation is relevant ->e.g. autonomous interpretation -> no qualification conflict -> residence state is not obliged to follow source state's qualification -> interpretation conflict -> mutual agreement -> inconsistent?

  46. Paid by, or on behalf of + Borne by • Art. 15/para. 6.2. -> “paid by, or on behalf of”(Art. 15(2)(b) OECD MC) and “borne by”(Art. 15(2)(c) OECD MC) serve a common purpose -> nevertheless, the Commentary does not give an explicit explanation of “paid by, or on behalf of” (contrary to “borne by”) • Example 5 (Art. 15/para. 8.24 and 8.25) -> assigning company pays salary on behalf of receiving company (individually identifiable recharge) -> bearing the costs

  47. Paidby, oronbehalfof • Art. 15/para. 8.14 mentions the direct recharge of the employee's remuneration as one of the objective criteria, but it remained silent on the explanation of “paid by, or on behalf of” • Conclusion is apparently that (i) “paid by, or on behalf of” needs no separate consideration or (ii) has the meaning given to the objective criteria (direct recharge in line with at arm´s length principle)

  48. Art. 15 of the OECD Model/third rule Art. 15(2)(c) (remunerationborneby PE) • “Borne by” -> Art. 15/para. 7. (included in the Commentary in 2000) -> decisive is attribution under Art. 7 OECD MC (at arm´s length principle) -> actually claiming “deduction” is irrelevant (Art. 15/para. 7.1) • Art. 15/para. 7.2 (included in the Commentary in 2010) -> anticipated on newly drafted Art. 7 -> notional charge -> does not affect explanation of “borne by” -> no recharge required

  49. Art. 16 of the OECD Model • Taxation right to state of which company is resident (Art. 4 of the OECD Model) -> physical presence of the director is irrelevant • No definition of director -> reference to the domestic law of the states applying the treaty (Art. 3(2) of the OECD Model) -> formal approach, i.e. Member of board of directors or member of a supervisory board -> gérant of French resident SARL is not a director within the meaning of Art. 16 of the Netherlands-France tax treaty patterned on the OECD Model (Dutch Supreme Court 10 December 2004, BNB 2005/195).

  50. Art. 16 of the OECD Model • Director can be a legal person or an individual • Derived as a “member of the board of directors”, i.e. Art. 16 covers only fees and similar payments derived in the capacity of director • Excludes remuneration for other types of services, e.g. as ordinary employee, etc. -> dual role situations; a split/distinction has to be made between remuneration (i) received as an employee and (ii) in the capacity as director -> (i) falls under Art. 15 and (ii) under Art. 16 of the OECD Model (Art. 15/para.2 and Art. 16/para. 2 + Dutch Supreme Court, 1 December 2006, BNB 2007/77)

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