Annex A. Operation of the targeted anti-avoidance rule

1. States S and R have concluded a treaty that includes the STTR with the rule in paragraph 11. SCo (a resident of State S) enters into an arrangement with Plc (a bank, also resident in State S) under which SCo will make a payment of covered income of 100 to Plc and Plc is contractually obliged to make a payment of 99.5, on the first day of the calendar month following the day on which SCo makes the payment of 100, to RCo (a company that is connected to SCo within the meaning of paragraph 11 and a resident of State R, which applies a statutory tax rate below the agreed minimum rate to the covered income). Plc is not connected to either SCo or RCo. Plc includes the 100 in its income and is entitled to a deduction for the 99.5 in computing its taxable income in State S.

2. The condition in subparagraph a) is met because a payment of covered income arising in State S is made by a person other than an individual (SCo) to a resident of either Contracting State (Plc, a resident of State S). The payment of 100 is the “original payment” and Plc is the “intermediary”. The condition in subparagraph b) is also met because, during a 365 day period including the day the original payment is made, Plc pays an amount (99.5, the “related payments”) equal to all or substantially all of the original payment directly to (i) RCo, a person that is not an excluded person and is connected to SCo (RCo is the “connected payee”); and (ii) RCo is subject to a tax rate below 9% in respect of the related payments in State R; and (iii) Plc recognises the 100 as income but is entitled to deduct the 99.5 in computing its taxable income in State S, meeting the base-erosion test. The condition in subparagraph c) is also met because it is reasonable to conclude that under the terms of the arrangement between SCo and Plc there is the requisite causal link between the original and related payments.

3. The effect of paragraph 11 is to treat the related payments of 99.5 made by Plc to RCo, with which it is unconnected, as payments of covered income made to a connected person in State R. The tax rate for the purposes of applying the STTR is deemed to be the rate, computed in accordance with paragraph 5, to which RCo is subject in State R in respect of the related payments. The STTR now applies because the 99.5 is deemed to be a payment of covered income arising in State S and derived by a resident of State R that is subject to a tax rate below 9%. The requirements of paragraph 1 are met. The exclusion in paragraph 8 b) does not apply, because RCo is deemed to be connected to Plc for the purposes of applying the STTR.

1. The facts are the same as in example 1, except that Plc is a resident of State R and the connected payee is TCo (a company that is connected to SCo and resident in State T, a third state). Under the arrangement, Plc will make a payment of 99.5 (the “related payments”) to TCo and SCo is contractually obliged, on the first day of the third calendar month following the date of that payment, to make a payment of covered income of 100 (the “original payment”) to Plc. TCo is subject to a tax rate, computed in accordance with paragraph 5, below 9% in State T in respect of the income of 99.5 it receives from Plc. In State R, Plc is exempt from tax in respect of the income of 100. TCo is not subject to tax in State R on the payment of 99.5 paid from Plc.

2. The condition in subparagraph a) is met for the same reasons as in example 1 (as a resident of State R, Plc is a resident of either Contracting State under the S-R treaty). The opening requirement in subparagraph b) is also met for the same reasons as in example 1 (it does not matter that the related payments precede the original payment, provided they are made in a 365 day period that includes the day of the original payment). The condition in subdivision (i) of subparagraph b) is met for the same reasons as in example 1 (that condition does not stipulate where the connected payee, TCo, is resident and applies where the connected payee is resident in a third state). The condition in subdivision (ii) of subparagraph b) is met for the same reasons as in example 1. The condition in subdivision (iii) of subparagraph b) does not need to be met because it only applies if the original payment is taxable in the State of the intermediary and, in this case, the payment received by Plc is not taxable in State R. The condition in subparagraph c) is met for the same reasons as in example 1.

3. The effect of paragraph 11 is to treat the original payment of 100 made by SCo to Plc with which it is unconnected, as a payment of covered income made to a connected person in State R. The tax rate for the purposes of applying the STTR is the rate, computed in accordance with paragraph 5, to which TCo is subject in State T in respect of the related payments of 99.5. The STTR now applies because the 100 is treated as a payment of covered income arising in State S and derived by a resident of State R that is subject to a tax rate below 9%. The requirements of paragraph 1 are met. The exclusion in subparagraph b) of paragraph 8 does not apply, because SCo is treated as connected to Plc for the purposes of applying the STTR.

1. The facts are the same as example 2, except that Plc is a resident of State T and the connected payee is RCo (a resident of State R and connected to SCo). Under an arrangement having the same features of the arrangement in example 2, SCo makes an original payment of 100 to Plc, which makes related payments of 99.5 to RCo. RCo is subject to a tax rate below 9% in State R in respect of the related payments. Paragraph 11 of the STTR in the S-R treaty does not apply, because the condition in subparagraph a) is not met. Plc is not a resident of either State S or State R. Paragraph 11 of an STTR included in the S-T treaty would, however, apply for the same reasons as in example 2.

1. The facts are the same as example 2, except that Plc is replaced by RCo (a resident of State R that is connected with both SCo and TCo). Under the arrangement, RCo will make a payment of 99.5 (the “related payments”) to TCo, and SCo is contractually obliged, on the first day of the third calendar month following the date of that payment, to make a payment of covered income of 100 (the “original payment”) to RCo. TCo is subject to a tax rate, computed in accordance with paragraph 5, below 9% in State T in respect of the income of 99.5 it receives from RCo. In State R, RCo is subject to a tax rate above 9% on its net income of 100. RCo includes the original payment of 100 in its taxable income and is entitled to a deduction for the related payments of 99.5.

2. Although the original payment of 100 is made by SCo to RCo, a connected person resident in the other Contracting State, the condition in paragraph 1 is not met because RCo is not subject to a tax rate below 9%. Paragraph 11, however, addresses arrangements, such as back-to-back arrangements, designed to get around the rate test in paragraph 1 as well as arrangements designed to take advantage of the exclusion for unconnected persons. The conditions in subparagraphs a) and b) apply equally to intermediaries that are connected persons or unconnected persons and are met for the same reasons as in example 2. In particular, RCo, although resident in a high-tax State, pays away substantially all of the original payment in the form of deductible payments that meet the base-erosion test in subdivision (iii) of subparagraph b). The conditions in subdivisions (i) and (ii) of subparagraph b) are met because the connected payee, TCo, is connected to SCo (which makes the original payment) and is subject to a tax rate below 9% in State T in respect of the related payments. The condition in subparagraph c) is met for the same reasons as in example 2.

3. The effect of paragraph 11 is to treat the original payment of 100 made by SCo to RCo as a payment of covered income made to a connected person in State R and substitute the tax rate to which TCo is subject in State T in respect of the related payments of 99.5 for the purposes of the STTR. The STTR now applies because the 100 is treated as a payment of covered income arising in State S and derived by a resident of State R that is subject to a tax rate below 9%. The requirements of paragraph 1 are met.

1. The facts are the same as in example 2. However, TCo is subject to a statutory rate of tax of 10% in State R on the payment of 99.5. TCo is also subject to a tax rate, computed in accordance with paragraph 5, of 5% in State T in respect of the income of 99.5 it receives from Plc.

The condition in subparagraph a) is met for the same reasons as in example 1 (as a resident of State R, Plc is a resident of either Contracting State under the S-R treaty). The opening requirement in subparagraph b) is also met for the same reasons as in example 1 (it does not matter that the related payments precede the original payment, provided they are made in a 365 day period that includes the day of the original payment). The condition in subdivision (i) of subparagraph b) is met for the same reasons as in example 1 (that condition does not stipulate where the connected payee, TCo, is resident and applies where the connected payee is resident in a third state). The condition in subdivision (ii) of subparagraph b) is not met. That is because the connected payee is subject to a statutory rate of tax in State R of 10% (which is higher than the tax rate in State T and therefore used for the purpose of subdivision (ii)). As a result, TCo is not subject to tax rate below 9% and paragraph 11 in the S-R treaty would not apply.

1. The facts are the same as in example 5. However, TCo is subject to a statutory rate of tax of 2% in State R on the payment of 99.5. TCo is also subject to a tax rate, computed in accordance with paragraph 5, of 5% in State T in respect of the income of 99.5 it receives from Plc.

2. The condition in subparagraph a) is met for the same reasons as in example 1 (as a resident of State R, Plc is a resident of either Contracting State under the S-R treaty). The opening requirement in subparagraph b) is also met for the same reasons as in example 1 (it does not matter that the related payments precede the original payment, provided they are made in a 365 day period that includes the day of the original payment). The condition in subdivision (i) of subparagraph b) is met for the same reasons as in example 1 (that condition does not stipulate where the connected payee, TCo, is resident and applies where the connected payee is resident in a third state). The condition in subdivision (ii) of subparagraph b) is also met because the tax rate in State T is 2% and TCo is subject to tax on the related payment in State R at 5%, both of which are below 9%. As a result, paragraph 11 in the S-R treaty would apply and the tax rate for the purposes of paragraphs 1, 2 and 5 would be 5%, being the higher of the statutory rate of tax to which the connected payee is subject in State R, and the tax rate in State T.

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