On 1 August 2017 the Platform for Collaboration on Tax (PCT) issued a draft toolkit on the tax treatment of offshore indirect transfers. The PCT was set up by the IMF, OECD, UN and World Bank at the request of the G20 group of countries to recommend mechanisms to ensure effective implementation of technical assistance programs. The deadline for comments on the draft toolkit is 25 September 2017.

An offshore indirect transfer of an asset is essentially the sale of an entity owning an asset located in one country by a resident of another country. This issue was not specifically covered by the reports issued by the OECD on base erosion and profit shifting (BEPS) but it has emerged during discussions with developing countries as an important issue. The issue has been noted during IMF work on technical assistance and offshore indirect transfers are also being examined as part of the UN work on taxation of extractive industries.

Different countries have approached the issue in widely different ways, in terms of the assets covered by their legislation and the legal approach followed. A more coherent policy among jurisdictions could increase tax certainty and increase collection of tax.

The discussion draft considers that not only immovable assets should be covered by legislation on offshore indirect transfers but the definition of assets covered should also include more generally assets that are generating location specific rents. Location specific rents are returns that exceed the minimum required by investors and that are not available in other jurisdictions. The report therefore suggests appropriate wording for inclusion of a broad range of assets in the definition of assets for the purpose of offshore indirect transfers.

Tax treaties

The provisions of the OECD and UN Model treaties both indicate that capital gains tax on offshore indirect assets should be allocated primarily to the jurisdiction where the asset is located. The relevant provision is in Article 13 (4) of the UN Model. Article 13 (4) states that “gains derived by a resident of a contracting state from the alienation of shares deriving more than 50 per cent of their value directly or indirectly from immovable property situated in the other contracting state may be taxed in that other state”

The provision is however only currently present in around 35% of bilateral double tax treaties and is less likely to be included in a treaty where one of the contracting states is a low income resource rich country. Even where this provision is included in a bilateral tax treaty the jurisdiction still requires an appropriate definition of these assets in domestic law to assert the right to tax the assets.

Approaches to taxing offshore indirect transfers

Two main approaches are outlined in the report for taxation of offshore indirect transfers by the jurisdiction where it is located. Sample simplified language for insertion into domestic law is provided for both approaches.

One of the approaches involves treatment of the offshore indirect transfer as a deemed disposal of the underlying asset. The tax liability would be triggered by a change of control whether onshore or offshore. Change of control would be determined by considering either direct or indirect ownership. In the case of a change of control the local entity would be treated as disposing of its assets at their market value, triggering the tax charge, and then reacquiring them. As this is a deemed disposal the local entity would still be the legal owner of the assets following the deemed disposal.

The other approach considers that the gain on the transfer of the asset is made by the non-resident seller but treats the gain on the transfer as sourced within the location jurisdiction, thereby enabling that jurisdiction to tax it. This approach is more commonly used by countries taxing offshore indirect transfers. The source rules are critical for this approach because a non-resident is normally only taxed on income from sources in the location country (the “source country”). The draft suggests a source rule including a gain arising from the disposal of immovable property in the location country; or the disposal of shares or comparable interests, if at any time during the 365 days preceding the disposal more than 50% of the value of the shares or other interest is derived, directly or indirectly through one or more interposed entities, from immovable property in the location country.