The Working Group on Tax Conventions and Related Questions (the “Working Group”) of the Organisation for Economic Co-operation and Development (the “OECD”), the subsidiary body of the OECD Committee on Fiscal Affairs in charge of the Model Tax Convention, has recently undertaken work to amend the Commentary on Article 9. The changes put forward in the consultation are expected to be included in the next update to the OECD Model Tax Convention.
The proposed changes to the OECD Model Tax Convention are designed to provide guidance on the application of Article 9 as it relates to domestic laws on interest deductibility, including laws aimed at preventing tax avoidance described in Action 4 of the OECD’s base erosion and profit shifting (BEPS) project. The discussion draft includes several revisions to the commentary under Article 9 and related articles.
The Working Group invited interested parties to send their comments on this discussion draft before 28 May 2021. On 3 June 2021, the Working Group confirmed it will consider these comments as it finalizes its work in this area with the expectation that revised commentaries will be included in the next update of the OECD Model Tax Convention.
To put it in a nutshell, the proposed changes to the commentary on Article 9 of the OECD Model aim at replacing paragraph 3 of the Article 9 commentary, with new wording regarding the determination of arm’s length interest payments. Accordingly, in assessing whether an interest payment can be regarded as an arm’s length amount, a jurisdiction should typically examine the terms and conditions of the loan agreement such as the rate of interest. It may also need to examine, based on the facts and circumstances, whether a loan should be regarded as a loan or as another kind of transaction, such as a contribution to equity capital. In this context, while making a determination as to the extent to which a loan is regarded as a loan, a jurisdiction should take into account factors discussed in its domestic laws (including judicial doctrine), or in the OECD Transfer Pricing Guidelines.
Moreover, the proposed changes further clarify that Article 9 does not deal with the issue of whether expenses are deductible when computing the taxable income. The conditions for the deductibility of expenses are a matter to be determined by domestic law, subject to the provisions of the Convention and, in particular, paragraph 4 of Article 24. Henceforth, when domestic law limits the deductibility of otherwise arm’s-length payments, this would not lead to economic double taxation for purposes of paragraph 2 of Article 9 of the OECD Model Tax Convention and therefore a corresponding adjustment would not have to be made.