Arbeitsgemeinschaft Internationales Tutorium zum Internationalen Steuerrecht Steuerrecht WS 2010/2011 WiSe 2017/2018 Daniel Dürrschmidt Johannes Becker

ZEILE 3 ZEILE 2 ZEILE 1

Case Spencer Speed - Solution

A. Preliminary Thoughts The problem with this case is that there are two different recipients of payments - S (an individual) and the Ltd. (a British company). This raises the question of how to structure the case. One way would be to examine the Ltd.’s income first and income derived directly by S afterwards. Another way is to proceed in chronological order. I have chosen this second way. However, both approaches are equivalent.

B. Indianapolis Honorary Award Paid to S I. Personal Scope As an individual residing in the U.K. (Art. 4(1)(1) and Art. 3(1)(a) OECD-MC), S can invoke treaty protection under Art. 1 OECD-MC.

II. Material Scope Personal (individual) income tax falls into the material scope of the DTC, according to its Art. 2.

III. Type of Income As S performs his activity independently (he is not “employed” by someone else in the sense of Art. 15 but works as a self-employed person), the starting point for finding the correct distributive rule is Art. 7(1) OECD MC. Under this rule, it is basically the state of residence (here, the U.K.) which is entitled to exclusive taxation unless S has derived the income through a PE in the U.S. (Art. 7(1)(2) OECD MC) which has to be denied in our case. However, according to Art. 7(7) OECD MC (Art. 7(4) OECD MC 2010), this distributive rule does not apply if the income can be assigned to a different distributive rule. The only other rule at issue is Art. 17 which covers the income of “artistes and sportsmen”. Art. 17(1) specifies that three types of activities fall under this rule: entertainers (such as a theatre, motion picture, radio or television artiste), musicians, and sportsmen. Even though attending or watching formula one races can be regarded as entertainment, the additional mention of sportsmen indicates that the term “entertainer” (as used in Art. 17(1) OECD MC) should cover only persons with language-related abilities. But S could be regarded as a sportsmen. The official OECD Commentary makes clear that this term is not restricted to participants in traditional athletic events (e.g. runners, jumpers, swimmers) but that it also covers for example, golfers, jockeys, footballers, cricketers and tennis players, as well as racing drivers . Similarly, the scope of Art. 17 comprises people doing billiards and snooker, chess and bridge tournaments . Consequently, the 10,000 USD “may be taxed” in the other Contracting State under the OECD Model. That means that the U.S. (being the “other Contracting State”) is assigned primary taxation, while Britain has to avoid (Art. 23A(1) OECD MC) or remove (Art. 23B(1) OECD MC) double taxation by giving up, or reducing its domestic tax claims. 1

2

1

Paragraph 5 OECD Commentary on Art. 17. Paragraph 6 OECD Commentary on Art. 17. The Commentary seems to assign these activities to the term “entertainer” rather than “sportsman”, however. 2

LUDWIG-MAXIMILIANS-UNI VERSITÄT MÜNCHEN

SEITE 2 VON 6

C. McDonald’s Advertisement Fee Paid to t201he Ltd. With regard to the advertisement fees paid by McDonalds to the Ltd., let us assume that both States involved regard the Ltd. as the recipient of the 100,000 USD payments under their domestic law. NB. This is not self-evident. One could easily imagine a domestic tax system which considers the Ltd. as transparent (like many states treat partnerships, so-called “look-through approach”) . Transparency could be a general concept or could be assumed due to particular circumstances of a case (e.g., under the CFC legislation). However, the mere fact that an individual has interposed a company and that payments are directed via this company does not, in itself, constitute an abus de droit under most legal orders. As we will see in a minute, the OECD Model (Art. 17(2)) assumes that the interposition of companies is not, or not necessarily, ignored already by virtue of domestic law. (Otherwise, Art. 17(2) OECD MC would be superfluous.) 3

Consequently, we have to apply the DTC on the Ltd. only.

I. Personal Scope Tax treaties apply to “persons”. According to Art. 3(1)(a) OECD MC, a person includes a company, i.e. any body corporate or any entity that is treated as a body corporate for tax purposes (Art. 3(1)(b) OECD MC). Speed Promotion Ltd. is a British resident company under the Art. 4(1)(1) OECD MC. Consequently, the Ltd. can invoke treaty protection under Art. 1 OECD MC.

II. Material Scope Corporate income taxes fall into the material scope of the DTC, according to its Art. 2.

III. Type of Income Again, the starting point for characterizing the income which the Ltd. derives from the advertisement agreement with McDonalds is Art. 7(1) OECD MC (business profits). And again, Art. 7(1) could be replaced by a special rule (cf. Art. 7(7) OECD MC [new: Art. 7(4) OECD MC 2010]). As the Ltd. itself does not perform any artistic, entertainment or sportive activity, Art. 17(1) OECD MC does not apply this time. But as indicated above (box at the beginning of C.), Art. 17(2) OECD MC might come into consideration. The rule reads: Art. 17(2) OECD MC “Where income in respect of personal activities exercised by an entertainer or a sportsman in his capacity as such accrues not to the entertainer or sportsman himself but to another person, that income may, notwithstanding the provisions of Articles 7 and 15, be taxed in the Contracting State in which the activities of the entertainer or sportsman are exercised.”

The words “to another person” typically refers to interposed companies. However, the original intent of the rule was to target situations where a sportsman (like, e.g., German tennis star Steffi Graf) collected the awards and premiums for the sportive activity as such through an intermediate. Our case, however, is slightly different. The money has not been paid in consideration of the sportive activity as such but in consideration of the advertising activities which have been connected with the sportive activity. The question is, therefore, whether such side-activities are covered by Art. 17 as well. The wording of Art. 17 does not bring us to an unanimous result. However, the parties to a DTC which use the OECDMC during their negotiations usually have in mind how the OECD Commentary interprets the Model. Thus, one could consider the OECD Commentary as a supplementary source of interpreting both the OECD Model and single DTCs. On the question of advertisement payments derived by artistes and sportsmen, the OECD Commentary suggests the following solution: Besides fees for their actual appearances, artists and sportsmen often receive income in the form of royalties or of sponsorship or advertising fees. In general, other Articles would apply whenever there was no direct link between the income and a public exhibition by the performer in the country concerned. Royalties for intellectual property rights will normally be covered by Article 12 rather than Article 17 (cf. paragraph 18 of the Commentary on Article 12), but in general advertising and sponsorship fees will fall outside the scope of Article 12. Article 17 will apply to advertising or sponsorship income, etc. which is related directly or indirectly to performances or appearances in 3

Cf. the remarks in Paragraph 8 of the official OECD Commentary on Art. 17.

LUDWIG-MAXIMILIANS-UNI VERSITÄT MÜNCHEN

SEITE 3 VON 6

a given State. Similar income which could not be attributed to such performances or appearances would fall under the standard rules of Article 7 or Article 15, as appropriate. Payments received in the event of the cancellation of a performance are also outside the scope of Article 17, and fall under Articles 7 or 15, as the case may be . 4

As our case makes clear that the Ltd. receives the 100,000 USD for advertisements which were shown “during the race”. Thus, they are directly related to the sportive activity and therefore fall under Art. 17(2) OECD MC. It follows that the state where the (sportive) activities have been exercised (the U.S.) “may tax” these items of income as well. The state of residence (the U.K.) has to exempt (Art. 23A(1) OECD MC) the income or grant a tax credit (Art. 23B(1) OECD MC), as the case may be.

D. Sale of Posters I. Personal Scope This activity or, more precisely, the income derived thereby, can be protected under the DTC between France and the U.K. As S is a British resident (Art. 4(1) OECD MC), the personal scope of the treaty (Art. 1 OECD MC) does not pose any problem.

II. Material Scope Likewise, personal income taxation falls into the substantive scope of the DTC (Art. 2 OECD MC).

III. Type of Income 1. Art. 17 OECD MC

Unlike the advertisement activities during the Indianapolis race (see supra C.), these payments are neither directly nor indirectly connected to a particular sportive activity of which the place of exercise can be determined. Therefore, Art. 17(1) OECD MC does not apply. 2. Art. 7(1)(1) OECD MC

Along the lines of what has been said above regarding the relationship of Art. 17 to Art. 7, we will therefore fall back to Art. 7(1) OECD MC. There is no other distributive rule which, under Art. 7(7) OECD MC (new: Art. 7(4) OECD MC 2010), may ban the application of Art. 7(1) OECD MC. According to Art. 7(1) OECD MC, it is basically only the state where the taxpayer is resident (the U.K.) which is entitled to exclusive taxation of the respective items of income. 3. Art. 7(1)(2) OECD MC

However, a most important exception has been made if the income has been derived through a permanent establishment (PE) in the other contracting State (here France). Therefore, we have to examine whether the stall constitutes a PE under Art. 5 OECD MC. As indicated in, the test proceeds in several steps. a. Art. 5(1) OECD MC First of all, one has to scrutinize whether the wooden sales booth (the stall) is a “fixed place of business through which the business of an enterprise is wholly or partly carried on”. A “place of business” is primarily a part of the earth’s surface. Even a small place (here, 5 square meters) are sufficient. The “place”, however, includes the building or installations above the ground. The word “fixed” indicates that the “place” is not merely two-dimensional but threedimensional. Thus, it is the wooden boards or shelfs which might constitute the PE. However, are they “fixed”? This word has a double meaning. First of all, it implies a certain physical attachment connection to the soil. Cars, e.g., are not “fixed”. This becomes particularly visible if you look at the French version of the OECD Model (“établissement stable”). Second, the word “fixed” has a time element. This has influenced the English term “permanent establishment”. Even though both terms are not part of the definition in Art. 5(1) OECD MC (on the contrary, they are the terms to be defined), the adjectives “stable” and “permanent” can be referred to for clarifying the actual prerequisites of Arts. 5 and 7 OECD MC. 4

Paragraph 9 of the official OECD Commentary on Art. 17.

LUDWIG-MAXIMILIANS-UNI VERSITÄT MÜNCHEN

SEITE 4 VON 6

It is particularly this second element of duration which raises substantial doubts in our case. It has been noted explicitly that the stall was removed after the event. Unlike for building sites and construction projects (Art. 5(3) OECD MC), Art. 5(1) does not define any specific period. Art. 5(3) OECD MC may be referred to as an orientation, though. As the whole promotion event lasted for one day only, the stall was not erected “permanently”. Irrespective of how it was physically fixed (screwed on the soil or simply put upon the soil loosely), it was not “fixed over the time”. Similarly, the German Federal Tax Court (Bundesfinanzhof) ruled that a stall on a Christmas market which was established at a public place during four weeks of the year in December did not form as “permanent establishment” under Germany’s domestic law . 5

For this reason, S did not have a PE in France under Art. 5(1) OECD MC. b. Art. 5(2) OECD MC In part, however, Art. 5(1) is supplemented (and not only clarified) by Art. 5(2) OECD MC. In other words, even if the basic requirements of Art. 5(1) have not been met, a PE could be constituted under Art.5(2) OECD MC. However, none of the alternatives laid down in Art. 5(2) is fulfilled here.

IV. Conclusion For all of these reasons, we remain with the Art. 7(1)(1). Consequently, the profits which S derives from the sale of his posters in Indianapolis are taxable only in the U.K., his state of residence.

E. Sale of CD Roms I. Personal Scope As a British company (Art. 3(1)(b) OECD MC), the Ltd. is a person (Art. 3(1)(a) OECD MC) resident in one contracting state (Art. 4 (1) OECD MC) and thus enjoys treaty protection (Art. 1 OECD MC) under the tax treaty between France and the U.K.

II. Material Scope Corporate income tax is covered by Art. 2(1) OECD MC.

III. Type of Income 1. Art. 7(1) OECD MC

As before (supra D.), the sale of CD ROMs by the Ltd. could be a business in the sense of Art. 7 OECD MC. If so, the same rules would apply as to the sale of posters by S. However, the crucial point here is whether or not the sale of software can be subsumed under Art. 7(1). 2. Art. 12(1) OECD MC

Given that other distributive rules precede (Art. 7(7) OECD MC [Art. 7(4) OECD MC 2010]), one could think of Art. 12 OECD MC. This provision, it is true, does not explicitly include payments made through the sale of CD ROMs into the definition of “royalties” (Art. 12(2) OECD MC). If we look at the CD ROM as such, it is an ordinary commercial good for entertainment purposes which (like a book, a board game or a set of playing cards) falls under Art. 7 OECD MC. On the other hand, rents in respect of cinematographic films fall under Art. 12 . Similarly, the value embodied in the CD ROM is not the material of the disk as such. Rather, you pay for the right to use computer software, i.e. an intangible asset (an item of intellectual property). If one could regard Art. 12 as the distributive rule for “making 6

Bundesfinanzhof, decision of 17 September 2003, I R 12/02, regarding Sec. 12 General Tax Code - Abgabenordnung, read in connection with the 1st sentence of Sec. 28(1) Local Commercial Business Tax Act - Gewerbesteuergesetz 6 Art. 12(2) OECD MC; see also Paragraph 10 OECD Commentary on Art. 12. 5

LUDWIG-MAXIMILIANS-UNI VERSITÄT MÜNCHEN

SEITE 5 VON 6

money with intangibles”, the application of Art. 12 does come into consideration. This can be made more plausible if you imagine that the software is not sold on a (tangible) CD ROM but downloaded (after due credit card payment) from the internet. The result is the same - you have a software installed on your computer, and you have acquired the right to use (but not distribute) this software. The OECD Commentary explicitly states that the way how software is sold or distributed is irrelevant . Therefore, the crucial point is the nature of the intangible asset which has been sold. Again, we may look at the official OECD Commentary to learn more about the delimitations which should apply here. Paragraph 12 of the Commentary on Art. 12 reads: 7

12. Whether payments received as consideration for computer software may be classified as royalties poses difficult problems but is a matter of considerable importance in view of the rapid development of computer technology in recent years and the extent of transfers of such technology across national borders. In 1992, the Commentary was amended to describe the principles by which such classification should be made. Paragraphs 12 to 17 [of the Commentary on Art. 12] were further amended in 2000 to refine the analysis by which business profits are distinguished from royalties in computer software transactions. In most cases, the revised analysis will not result in a different outcome.

The Commentary goes on in enumerating a variety of different criteria for categorizing software and software-related rights. With respect to our case, it is important that the Ltd. does not sell copyrights (or, at least, no rights to produce a bigger number of copies and to re-distribute them on the market). Rather, the rights sold are only the rights to use a particular copy (and maybe a right to copy the disk for the owner’s own personal purposes, e.g. producing a backup medium). For such cases, the OECD Commentary recommends a categorization under Art. 7 rather than Art. 12 OECD MC . The same applies if the customer does acquire a copyright under a “network license”, a “campus license” or a “company license” which permits him to produce a bigger number copies for the local use within his institution. Income from all of these transactions does not fall under Art. 12 OECD MC. 8

The situation changes, however, if it is not standard software but software written especially for this particular client, or for a small number of clients which is adapted to the needs of the single customer. Such special arrangements shift the income from Art. 7 to Art. 12. After all, by selling the CD ROMs the Ltd. receives business profits under Art. 7(1), just as S did by the sale of posters. Like S, the Ltd. does not have a PE in France.

IV. Conclusion Consequently, the 10,000 USD are taxable only in the State where the Ltd. is resident, i.e. in the U.K. France must refrain from taxation according to the Art. 7(1)(1).

F. Dividend Paid to S With regard to the dividend, the Ltd. effects as a corporate shelter. Once the Ltd. has received income on the corporate level, these items of income are taxed there (see supra C. and E.). The later distribution of these profits to the shareholder (S) is regarded as the distribution of anonymous money. It is a fully new story. Consequently, we only have to look upon the internal relationship between the Ltd. and its shareholder. With regard to the material scope, the payment of 80,000 USD dividend falls into the scope of Art. 10(3) OECD MC. However, Art. 10 (according to Art. 10(1)) OECD MC applies only in cross-border situations, i.e. where the company paying the dividends is resident in one contracting state and the recipient in the other contracting state. This requirement is not met here, because both S and the Ltd. are (solely) U.K. residents. It follows that Art. 10 OECD MC does not apply. This does not mean, however, that the dividends are not covered by the DTC at all. Rather, two ways are possible: If S holds the shares in the Ltd. as part of his business assets, the dividend is part of his business profits in the sense of Art. 7(1)(1) OECD MC. By contrast, if the shares are part of his private assets, the dividend is part of the “other income” derived by S. Here, Art. 21(1) OECD MA applies.

7 8

Paragraph 14.1 OECD Commentary on Art. 12. Last sentence of paragraph 14 OECD Commentary on Art. 12.

LUDWIG-MAXIMILIANS-UNI VERSITÄT MÜNCHEN

SEITE 6 VON 6

In any case, exclusive taxation is assigned to the state where the taxpayer is resident. Thus, the U.K. is entitled to tax the dividends. All other states with which the U.K. has entered into DTCs (here, France and the U.S.) are excluded from taxation under Arts. 7(1) or 21(1), respectively.

G. Summary After all, we come to the following result:  The Indianapolis honorary award (10,000 USD received by S) would have been taxable in the U.S. under the OECD MC.  The advertisements remuneration paid by Mc Donald’s to the Ltd. is taxable primarily in the U.S.  The profits from the sale of posters which S derives in France is taxable only in the U.K.  The same holds true for the income from the sale of CD ROMs by the Ltd.  Likewise, the dividend paid by the Ltd. to S is taxable only in the U.K.