Article 9 - Capital Gains from Alienation of Shares

New Interpretation of the Capital Gain Article in the OECD Multilateral Instrument 

[This article was published in Tax Notes International on 29th Nov 2021.] ->download [new]

 

Analysis on the Application of the Capital Gain Article under the MLI to Covered Tax Agreements

The following is the second part of the Article entitled "Interpreting the MLI: Guide to Analyzing the Treaty and Its Capital Gain Article" as was published by Tax Notes International on 26^th November 2018.

 

Article 9(1) of the MLI –  "Capital Gains from Alienation of Shares or Interests of Entities Deriving their Value Principally from Immovable Property" provides that contracting jurisdictions shall (i) adopt the 365-day holding period requirement for shares from the alienation of which gains arise, and (ii) expand the scope of gains from the alienation of shares to comparable interests including that in partnership or trust.

 

The Differing MLI Positions on Article 9

 

To illustrate how article 9 works in practice, Table 1 shows the opt-out provisions (reservations) that some selected contracting jurisdictions (one signatory and eight parties) of the MLI that have adopted under Article 9 of the MLI on 9^th April 2019, as per information from the MLI database's matrix of options and reservations that the contracting jurisdictions provided for the OECD depositary.

 

Table 1 – Reservation (opt-out provision) under Article 9(1)

 

Contracting Jurisdictions	Status	9(6)(a)	9(6)(b)	9(6)(c)	9(6)(d)	9(6)(e)
		Opt-out of Article 9(1)	Opt-out of 9(1)(a) in whole	Opt-out of 9(1)(b) in whole	Opt-out of 9(1)(a) in part	Opt-out of 9(1)(b) in part
			365-day holding period shall not apply to CTA's	Interest in partnership or trust comparable to shares shall not apply to CTA's	9(1)(a) not to apply to CTA already containing compatible provision	9(1)(b) not to apply to CTA already containing compatible provision
Australia	Definitive					Y
China (PRC)	Provisional		Y
Japan	Definitive
New Zealand	Definitive
Israel	Definitive	Y
Malta	Definitive	Y
Isle of Man	Definitive	Y
Singapore	Definitive	Y
United Kingdom	Definitive	Y

 

 

Reservations (Opt-out provision) under Article 9

 

• Pursuant to Article 9(6)(a), Isle of Man, Israel, Malta, Singapore, and the U.K. all reserve the right not to apply Article 9(1) to their respective CTAs.

• Pursuant to Article 9(6)(b), China reserves its right not to apply the holding period as provided under Article 9(1)(a) to its CTAs.

• None of the selected contracting jurisdictions make reservations under Article 9(6)(c) and Article 9(6)(d).

• Pursuant to Article 9(6)(e), Australia reserves its right for Article 9(1)(b) not to apply to its CTAs that provide that Article 9(1)(b) shall not apply to the CTAs that already contain an equivalent provision.

 

Application of Article 9 of the MLI to the Relevant Provisions in the CTAs - the Australia perspective

 

Australia gave notification to the Depositary pursuant to paragraph 9(7) that paragraph 1 shall apply to all of its 42 CTAs including the covered tax agreements with China (provisional), Japan, Malta, New Zealand, Singapore, and the United Kingdom, provided that these treaty jurisdictions do not reserve the right for Article 9(1) to apply to their CTAs with Australia. Israel and Isle of Man are excluded because Australia has not signed double tax treaties with them.

 

The Exception to the Reciprocity Principle – Compatible Provision

 

It is noted that out of a total of Australia's 42 CTAs, 19 of the CTAs already contain a provision, which has addressed the same issue, that expands the scope of shares to cover comparable interest in a land-rich entity such as interest in a partnership or trust, under Article 9(1)(b) of the MLI. Pursuant to Article 9(6)(e) of the MLI, Australia reserves its right not to apply paragraph 1(b) of Article 9 to these 19 CTAs including the tax treaties with Japan, and New Zealand. These 19 CTAs, as an exception to the reciprocity principle, will not be subject to modification under Article 9(1)(b).

 

In contrast, the tax treaty with China does not contain the provision under paragraph 9(1)(b). Since the capital gain provision in the Australia-China CTA is not compatible with the relevant provision in the MLI, Article 9(1)(b) shall apply to the Australia-China CTA, in the absence of any reservation made with respect to Article 9(1).

 

Application of the capital gain Article of the MLI to Australia-UK Tax Treaty

 

Australia and the United Kingdom have different positions on Article 9(1). Australia adopts Article 9(1) in full. The United Kingdom has opted out of Article 9(1), meaning that in the absence of adopting the alternative provision in paragraph 4, the entire Article 9 shall not apply to United Kingdom's CTAs.

 

The existing Article 13(4) [Alienation of Property] of the Australia-United Kingdom CTA contains a provision that provides that the gain from the alienation of share or comparable interests in partnership or trust shall be taxed in the other jurisdiction, but the Australia-UK CTA does not contain the 365-day holding period requirement as provided under Article 9(1)(a) of the MLI. Since the UK has reserved its right not to adopt the entire Capital Gain Article of the MLI in whole, the text of existing Article 13(4) shall not be subject to modification by the compatibility clause under Article 9(1).

 

Application of the capital gain Article of the MLI to Australia-Japan Tax Treaty

 

Both Australia and Japan adopt Article 9(1) in full. Since the existing CTA already covers the shares in a company or interests in a partnership, trust or other entity, only the inclusion of the holding period as provided under Article 9(1)(a) is required.

 

The synthesized text of the MLI provision and Article 13(2) of the Australia-Japan CTA shall read:

 

Article 13 – Alienation of Property

 

2. Income, profits or gains derived by a resident of a Contracting State from the alienation of shares in a company or of interests in a partnership, trust or other entity may be taxed in the other Contracting State where the shares or the interests derive at least 50 percent of their value directly or indirectly from real property referred to in Article 6 and situated in that other Contracting State.

 

1. Paragraph 2 of Article 13 of the MLI shall apply if the relevant value threshold is met at any time during the 365 days preceding the alienation. [Article 13(2) of the MLI shall be added to the last sentence of paragraph 2.]

 

Application of the capital gain Article of the MLI to Australia-New Zealand Tax Treaty

 

Both Australia and New Zealand adopt Article 9(1) in full. Since the existing CTA already covers the shares in a company or interests in a partnership, trust or other entity, only the inclusion of the holding period as provided under Article 9(1)(a) is required.

 

The synthesized text of the MLI provision and Article 13(4) of the Australia-Japan CTA shall read:

 

4.    Income, profits or gains derived by a resident of a Contracting State from the alienation of any shares or comparable interests deriving more than 50 per cent of their value directly or indirectly from real property situated in the other Contracting State may be taxed in that other State.

 

1. Paragraph 2 of Article 13 of the MLI shall apply if the relevant value threshold is met at any time during the 365 days preceding the alienation. [Article 13(2) of the MLI shall be added to the last sentence of paragraph 4.]

 

Application of the capital gain Article of the MLI to Japan-New Zealand Tax Treaty

 

Both Japan and Zealand opts in for Article 9(4), and both of the two contracting states have made notification to the Depositary, pursuant to Article 9(8) of the MLI.

 

The synthesized text of Article 9 of the MLI and the tax treaty provision shall read:

 

Article 13 ALIENATION OF PROPERTY

 

2. Income, profits or gains derived by a resident of a Contracting State from the alienation of shares or interests in a company, partnership or trust deriving at least 50 per cent of the value of its property directly or indirectly from immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other Contracting State, unless the relevant class of the shares or the interests is traded on a recognised stock exchange specified in subparagraph (c) of paragraph 6 of Article 22 and the resident and persons related or connected to that resident own in the aggregate 5 per cent or less of that class of the shares or the interests.

 

4. For purposes of the Convention, gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property situated in that other Contracting State.

 

The texts of Article 9(4) of the MLI shall replace Article 13(2) of the CTA as the two contracting states have made a matched notification to the Depositary.

 

Application of the capital gain Article of the MLI to Australia-China Tax Treaty

 

China reserves its right for Article 9(1)(a) [the 365-day test period] not to apply to its CTAs. Therefore, only Article 9(1)(b) [gain from the alienation of shares or comparable interests] shall apply to the provision of the CTA.

 

The synthesized text of Article 9(1) of the MLI and Paragraph 4 of Article 13 of the Australia-China DTA will be read as follows:

 

Article 13 – Alienation of Property

 

4. Income or gains derived by a resident of a Contracting State from the alienation of shares or comparable interests in a company, the assets of which consist wholly or principally of real property in the other Contracting State of a kind referred to in Article 6, may be taxed in that other State.

 

4. Gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if these shares or comparable interests derived wholly or principally their value directly or indirectly from immovable property (real property) situated in that other Contracting State.

 

Alternative Provision under Article 9(4)

 

An alternative provision under Article 9(4) of the MLI has been provided for contracting jurisdictions to modify their CTAs that, concluded long time ago, do not follow the 2017 version of the OECD Model Tax Convention. A Party to the Convention can choose to apply Article 9(4) either in addition to, or to the exclusion of Article 9(1) to bring them in line with the new version of the Model Tax Convention.

 

Table 2 - Contracting jurisdictions exercising opt-in provision under Article 9(4)

 

		9(3)	9(6)(f)
Contracting Jurisdictions	Status	Opt-in for 9(4)	Opt-out of 9(4) in part
			9(4) not to apply to CTA already containing an equivalent provision
Australia	Definitive
China (PRC) *	Provisional
Japan	Definitive	Y
New Zealand	Definitive	Y
Israel	Definitive	Y
Malta	Definitive	Y
Isle of Man	Definitive
Singapore	Definitive
United Kingdom	Definitive

 

Alternative provision under Article 9(4)

 

Both Israel and Malta opt-out of Article 9(1) pursuant to Article 9(6)(a), but both opt-in for Article 9(4). Pursuant to Article 9(8), both contracting jurisdictions have notified the Depositary of the Article and paragraph number of each such provision. Since the notifications are matched, Article 9(4) shall replace the relevant provision of the Israel-Malta CTA, pursuant to Article 9(8).

 

Both Japan and New Zealand choose to apply Article 9(4) of the MLI to their CTAs, in addition to Article 9(1). Both have given notifications to the OECD Depositary pursuant to Article 9(7). Where any contracting jurisdiction opts in for an Article of, or a provision of the Article, of the MLI, it is required to notify the OECD Depositary in order to give the legal effect to the optional provision under the MLI.

 

Application of Article 9 of the MLI to the Relevant Provisions in the CTAs - the New Zealand perspective

 

In respect of New Zealand’s CTAs, it is observed that some of them contain a specified value threshold in shares or comparable interest in a land-rich entity but do not contain the 365-day testing period as required under Article 9(1)(a). Out of a total of 37 CTAs, 23 of the New Zealand CTAs do not satisfy the requirement for Article 9(1)(a), including the tax treaties with Australia, Japan, Singapore (opt-out of whole Article 9) and the United Kingdom (opt-out of whole Article 9). These 23 CTAs, where no reservations are made under Article 9(6)(a), will be subject to modification by the compatibility clause under paragraph 9(2). The provision of the 365-day testing period shall apply in the absence of such a testing period. That is, it will be added to those CTAs.

 

Some of the New Zealand CTAs do not meet the 365-day holding period requirement and a specified value threshold for the shares or comparable interest in the land-rich entity. One example is the New Zealand-Belgium CTA (provisional) ^[1]

 

Application of the capital gain Article of the MLI to Japan-New Zealand Tax Treaty

 

Both Japan and Zealand opts in for Article 9(4), and both of the two contracting states have made notification to the Depositary, pursuant to Article 9(8) of the MLI.

 

The synthesized text of Article 9 of the MLI and the tax treaty provision shall read:

 

Article 13 ALIENATION OF PROPERTY

 

2. Income, profits or gains derived by a resident of a Contracting State from the alienation of shares or interests in a company, partnership or trust deriving at least 50 percent of the value of its property directly or indirectly from immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other Contracting State, unless the relevant class of the shares or the interests is traded on a recognised stock exchange specified in subparagraph (c) of paragraph 6 of Article 22 and the resident and persons related or connected to that resident own in the aggregate 5 percent or less of that class of the shares or the interests.

 

4. For purposes of the Convention, gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property situated in that other Contracting State.

 

Pursuant to Article 9(7), the texts of Article 9(4) of the MLI shall replace Article 13(2) of the Japan-New Zealand CTA as the two contracting states have made a matched notification to the Depositary.

 

China-New Zealand tax treaties

 

New Zealand did not include China in the list of CTAs that it confirmed at the time of deposit of its Instrument of Ratification on 18 June 2018. It is noted that New Zealand recently signed a revised tax treaty with China on 1^st April 2019 that provides for both the 365-day holding period and specified value threshold in shares or comparable interest. It is anticipated that New Zealand will give notification to include China into the list of its CTA later pursuant to Article 29(5).

 

Article 13(4) of the China-New Zealand double tax treaty (signed but not yet effective) contains both the holding period and specified value threshold requirements with respect to the tax treatment of capital gains:

 

4. Gains derived by a resident of a Contracting State from the alienation of shares or comparable interests, such as interests in a partnership or trust, may be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50 per cent of their value directly or indirectly from immovable property, as defined in Article 6, situated in that other State

 

It appears that there is a clash between China’s MLI position that provides that China has reserved its right not to apply the holding period to its CTAs, and Article 13(4) of the newly concluded tax treaty. However, by signing a new China-New Zealand tax treaty, the two Parties move a step closer to the MLI, not away from it. This practice is endorsed under the monitoring system of the Inclusive Framework. In addition, one can refer to Article 30(3) of the Vienna Convention on the Law of Treaties for guidance which provides that the new tax treaty shall prevail over the earlier one. [2]

 

Concluding comment

 

The MLI is meant to be one single agreement with one uniform text concluded by a multitude of parties. Particularly this uniform MLI text includes provisions that offer the parties different alternatives to be selected in the application of the MLI provisions to the CTAs. It is important to distinguish between an opt-in provision and an alternative provision in the application of the MLI provisions including Article 9. An understanding of the legal logic in the legal texts is a pre-requisite in the interpretation and application of the relevant legal texts including Article 9 for it is the tool to guide us through the technicality of the MLI.