On 3 June 2021 the OECD published comments received from interested parties in response to a public discussion draft on proposed changes to the commentary to Article 9 (associated enterprises) of the OECD Model Tax Convention. The comments will be taken into consideration in preparing a revised commentary to Article 9 that will be included in the next update of the OECD Model.
Under Article 9 of the OECD Model the profits in relation to transactions between associated enterprises may be adjusted by the tax authority if conditions are made or imposed that would not be applicable in the case of independent enterprises engaging in transactions at arms length. In the second paragraph of Article 9 there is a provision that a corresponding adjustment may be made in the other contracting state if a primary adjustment is made in the first state.
The proposed changes to the commentary would clarify the application of Article 9 in relation to domestic law on interest deductibility, following the OECD’s transfer pricing guidance on financial transactions.
Under the updated commentary, when looking at the arm’s length nature of an interest payment the tax authority should examine the terms and conditions of the loan and also consider whether, in the circumstances, the transaction should be regarded as a loan or as another kind of transaction. The tax authority could consider whether the payment may, for example, be a contribution to equity capital rather than a loan, taking into account the domestic law and the OECD Transfer Pricing Guidelines.
The revised commentary also notes that the taxation of the arm’s length profits, and the deductibility of expenses, is to be determined by the domestic law, subject to the provisions of the tax treaty. The domestic law may provide that certain entertainment expenses are not deductible and could also apply rules limiting the deductibility of interest in line with Action 4 of the OECD project on base erosion and profit shifting (BEPS).
The amended commentary would clarify that a difference in the treatment of expenses under the domestic law of the contracting states does not in itself result in economic double taxation contrary to the provisions of a tax treaty. So, for example, there is no need for a corresponding adjustment in response to the application of a limitation on the deductibility of interest in one of the states.
A proposed amendment to the commentary on Article 25 (mutual agreement procedure) would emphasise that States should provide access to the mutual agreement procedure in transfer pricing cases, as a primary transfer pricing adjustment could otherwise lead to economic double taxation contrary to the provisions of a treaty.
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