This chapter provides the necessary context. This will help you in interpreting the article within its context.

COMMENTARY ON ARTICLE 1


CONCERNING THE PERSONS COVERED BY THE CONVENTION

1. Whereas many conventions concluded in the first part of the 20th century
were applicable to “citizens” of the Contracting States, conventions concluded
afterwards almost always apply to “residents” of one or both of the Contracting
States irrespective of nationality. That approach is reflected in paragraph 1. The
term “resident” is defined in Article 4. The fact that a person is a resident of a
Contracting State does not mean, however, that the person is automatically
entitled to the benefits of the Convention since some or all of these benefits may be
denied under various provisions of the Convention, including those of Article 29.

2. This paragraph addresses the situation of the income of entities or
arrangements that one or both Contracting States treat as wholly or partly fiscally
transparent for tax purposes. The provisions of the paragraph ensure that income
of such entities or arrangements is treated, for the purposes of the Convention, in
accordance with the principles reflected in the 1999 report of the Committee on
Fiscal Affairs entitled “The Application of the OECD Model Tax Convention to
Partnerships”. 1 That report therefore provides guidance and examples on how the
provision should be interpreted and applied in various situations.


3. The report, however, dealt exclusively with partnerships and whilst the
Committee recognised that many of the principles included in the report could also
apply with respect to other non-corporate entities, it expressed the intention to
examine the application of the Model Tax Convention to these other entities at a
later stage. As indicated in paragraph 37 of the report, the Committee was
particularly concerned with “cases where domestic tax laws create intermediary
situations where a partnership is partly treated as a taxable unit and partly
disregarded for tax purposes.” According to the report
Whilst this may create practical difficulties with respect to a very limited
number of partnerships, it is a more important problem in the case of other
entities such as trusts. For this reason, the Committee decided to deal with this
issue in the context of follow-up work to this report.


4. Paragraph 2 addresses this particular situation by referring to entities that are
“wholly or partly” treated as fiscally transparent. Thus, the paragraph not only
serves to confirm the conclusions of the Partnership Report but also extends the
application of these conclusions to situations that were not directly covered by the
1 Reproduced in Volume II of the full version of the OECD Model Tax Convention at
page R(15)-1.
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56 MODEL TAX CONVENTION (CONDENSED VERSION) © OECD 2017
report (subject to the application of specific provisions dealing with collective
investment vehicles, see paragraphs 22 to 48 below).


5. The paragraph not only ensures that the benefits of the Convention are granted
in appropriate cases but also ensures that these benefits are not granted where neither Contracting State treats, under its domestic law, the income of an entity or
arrangement as the income of one of its residents. The paragraph therefore confirms
the conclusions of the report in such a case (see, for example, example 3 of the report). Also, as recognised in the report, States should not be expected to grant the benefits of a bilateral tax convention in cases where they cannot verify whether a person is truly entitled to these benefits. Thus, if an entity is established in a jurisdiction from which a Contracting State cannot obtain tax information, that State would need to be provided with all the necessary information in order to be able to grant the benefits of the Convention. In such a case, the Contracting State might well decide to use the refund mechanism for the purposes of applying the benefits of the Convention even though it normally applies these benefits at the time of the payment of the relevant income. In most cases, however, it will be possible to obtain the relevant information and to apply the benefits of the Convention at the time the income is taxed (see for example paragraphs 43 to 45 below which discuss a similar issue in the context of collective investment vehicles).


6. The following example illustrates the application of the paragraph:
Example: State A and State B have concluded a treaty identical to the Model Tax
Convention. State A considers that an entity established in State B is a company and
taxes that entity on interest that it receives from a debtor resident in State A. Under
the domestic law of State B, however, the entity is treated as a partnership and the
two members in that entity, who share equally all its income, are each taxed on half
of the interest. One of the members is a resident of State B and the other one is a
resident of a country with which States A and B do not have a treaty. The paragraph
provides that in such case, half of the interest shall be considered, for the purposes
of Article 11, to be income of a resident of State B.


7. The reference to “income derived by or through an entity or arrangement” has a
broad meaning and covers any income that is earned by or through an entity or
arrangement, regardless of the view taken by each Contracting State as to who derives that income for domestic tax purposes and regardless of whether or not that entity or arrangement has legal personality or constitutes a person as defined in
subparagraph a) of paragraph 1 of Article 3. It would cover, for example, income of any partnership or trust that one or both of the Contracting States treats as wholly or partly fiscally transparent. Also, as illustrated in example 2 of the report, it does not matter where the entity or arrangement is established: the paragraph applies to an entity established in a third State to the extent that, under the domestic tax law of one of the Contracting States, the entity is treated as wholly or partly fiscally transparent and income of that entity is attributed to a resident of that State.


8. The word “income” must be given the wide meaning that it has for the purposes
of the Convention and therefore applies to the various items of income that are
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57MODEL TAX CONVENTION (CONDENSED VERSION) © OECD 2017
covered by Chapter III of the Convention (Taxation of Income), including, for example, profits of an enterprise and capital gains.


9. The concept of “fiscally transparent” used in the paragraph refers to situations
where, under the domestic law of a Contracting State, the income (or part thereof) of
the entity or arrangement is not taxed at the level of the entity or the arrangement but at the level of the persons who have an interest in that entity or arrangement. This will normally be the case where the amount of tax payable on a share of the income of an entity or arrangement is determined separately in relation to the personal characteristics of the person who is entitled to that share so that the tax will depend on whether that person is taxable or not, on the other income that the person has, on the personal allowances to which the person is entitled and on the tax rate applicable to that person; also, the character and source, as well as the timing of the realisation, of the income for tax purposes will not be affected by the fact that it has been earned through the entity or arrangement. The fact that the income is computed at the level of the entity or arrangement before the share is allocated to the person will not affect that result.1 States wishing to clarify the definition of “fiscally transparent” in their bilateral conventions are free to include a definition of that term based on the above explanations.


10. In the case of an entity or arrangement which is treated as partly fiscally
transparent under the domestic law of one of the Contracting States, only part of the
income of the entity or arrangement might be taxed at the level of the persons who
have an interest in that entity or arrangement as described in the preceding paragraph whilst the rest would remain taxable at the level of the entity or arrangement. This, for example, is how some trusts and limited liability partnerships are treated in some countries (i.e. in some countries, the part of the income derived through a trust that is distributed to beneficiaries is taxed in the hands of these beneficiaries whilst the part of that income that is accumulated is taxed in the hands of the trust or trustees; similarly, in some countries, income derived through a limited partnership is taxed in the hands of the general partner as regards that partner’s share of that income but is considered to be the income of the limited partnership as regards the limited partners’ share of the income). To the extent that the entity or arrangement qualifies as a resident of a Contracting State, the paragraph will ensure that the benefits of the treaty also apply to the share of the income that is attributed to the entity or arrangement under the domestic law of that State (subject to any anti-abuse provision such as a limitation-on-benefits rule).