In Part 1, I have discussed some of the situations in which triangular cases arise. In this part, I am focusing on the first situation i.e. PE triangular case.
In this scenario, the income is taxed in the third state (State C) which is the source of the income earned by the PE. Thereafter, the same income is taxed in the State in which PE of the State A is located i.e. State B. Finally, the income which is taxed twice is taxed a third time in the State of residence of the person i.e. State A. A PE triangular case is illustrated in the following diagram –
The question is whether tax treaties fully or partly cover the transaction at issue and whether domestic tax law applies to PEs similarly as it does in the case of a residence.
Relief by State B for taxes paid in State C-
Unilateral relief in State B shall be applicable only to the residents of State B. Further, even though there may be a treaty between State B and State C, the same may not be applicable as the scope for claiming the double tax relief under State B and State C tax treaty is limited to residents of the treaty states.
(Hence, PE being neither the resident of State B nor of State C may not be able to claim tax treaty benefits between State B and State C)
In both the aforementioned situations, a resident of State A would qualify for the benefit of unilateral or treaty double taxation relief rules of State C in respect of the income of the PE from State C, only if State B has a tax treaty with State A and such tax treaty has a PE non-discrimination clause consistent with Article 24(3) of the OECD model convention.
Further, if under State B and State C tax treaty, the double taxation relief available to non-residents is more favorable than the unilateral relief under the domestic law of State B, a resident of State A would qualify for some more favorable relief.
The relief provided by State A for taxes paid in State B and State C –
State A in a PE triangular case may have an obligation to provide relief for the tax imposed in State C under the terms of the State A and State C tax treaty and may also have an obligation to provide relief for the tax imposed in State B under the terms of the State A and State B tax treaty.
If State A uses the credit method of relief under both its tax treaty with State C and its treaty with State B, then it will generally be capable of providing sufficient relief only in cases where the combined effective tax rate in the source state and the PE state is less than its own effective tax rate.
If both such reliefs were to be granted by R state in respect of the S state income and if it is assumed that PE state also provides double taxation relief in respect of S state tax, S source income would virtually be tax-free because of the triple taxation of S-income under the domestic laws of the three states which is offset by triple relief one by PE state and twice by residence state. While this may prevent unrelieved double taxation, it arguably does not result in an equitable sharing of tax revenues between the three states involved because the residence state is reducing the tax it collects on other income. It would be more equitable for the PE state to grant relief for tax imposed in the source state and consequently, for less relief to be granted in the residence state.
Further, if State A exempts the income attributable to State B in a PE triangular case, then it is generally considered to be incapable of fully relieving double taxation unless relief is also granted in State B.
The views in all sections are personal views of the author.