The application of treaties to income payments in stock-lending transactions: a study with particular reference to the Netherlands-US Treaty

Author Paola Violin
Supervisor Joanna Wheeler

Table of Contents

List of Abbreviations 

Executive Summary 

Main Findings 

1.    Introduction 
1.1.    The aim and structure of the Paper

1.2.    Description of stock-lending transactions
1.3.    Characterization of income payments in stock-lending transactions
1.4.    Description of relevant provisions and characteristics of domestic tax systems of the countries selected
1.5.    Cross-border aspects and issues of income payments in stock-lending transactions
2.    The parties involved in a cross-border stock-lending transaction
2.1.    The Distributing Company (distributing dividends)
2.2.    The Borrower (receiving the dividends and paying substitute dividends)
2.3.    The Lender (receiving substitute dividends)
3.    Payment of dividends
3.1.    Tax treaty treatment applicable with reference to the OECD Model
3.2.    Tax treaty treatment applicable with reference to the Netherlands-US Treaty
4.    Payment of substitute dividends
4.1.    Characterization of substitute dividends
4.2.    Tax treaty treatment applicable with reference to the OECD Model
4.3.    Tax treaty treatment applicable with reference to the Netherlands-US Treaty
4.4.    Deductibility of substitute dividends
5.    Practical analysis of transactions involving the Netherlands-US Treaty: description, mismatches and comparison with the OECD Model
5.1.    General remarks
5.2.    Distributing Company and Borrower in the NL; Lender in the US
5.3.    Distributing Company and Lender in the NL; Borrower in the US
5.4.    Distributing Company and Borrower in the US; Lender in the NL
5.5.    Distributing Company and Lender in the US; Borrower in the NL
6.    Conclusion
Appendix: Relevant tax treaty provisions
Bibliography

Executive Summary

This Paper analyses the relevant cross-border and tax treaty aspects regarding the distribution of dividends and payment of substitute dividends in connection with a stock-lending agreement in an international scenario, based on both the OECD Model and the Netherlands-US Treaty. The aim of the analysis is to discover the extent to which domestic laws and tax treaties are capable of providing a consistent and equitable tax treatment to such transactions, which is in accordance with acceptable policy objectives. As it is useful to see what countries have actually done in their real treaties to deal with transactions of this type and whether that solves the issues and mismatches raised, the Netherlands-US Treaty has been selected as a practical example to support the analysis. The results of the investigation conducted are structured as follows.

The Paper starts by explaining the main characteristics of stock-lending transactions, the characterization of income payments in these transactions, the relevant provisions of the domestic law of the countries selected (Netherlands and US), based on the premise that treaty concepts and implications cannot be analysed regardless of domestic law, and the cross-border aspects of income payments in stock-lending transactions.

The second section provides an overview of the tax position of the parties involved in a stock-lending transaction both generally and under the domestic laws of the countries selected, indicating the corresponding tax consequences applicable to dividends and substitute dividends, as these elements are capable of indicating whether the taxation resulting from the application of tax treaties is consistent or not.

Section three elaborates on the tax treaty treatment applicable to dividends distributed during the term of a stock-lending agreement, according to both the OECD Model and the Netherlands-US Treaty. It focuses on the applicability and potential reduction of WHT to such payments, as well as the corresponding relief, based on the definition of dividends under article 10 of both documents and the beneficial ownership requirement. The section discusses the meaning of the term ‘beneficial owner’ in the OECD Model and the implications of the different approaches for the taxation of stock-lending transactions, as well as the Dutch negative definition of beneficial owner and the implications of the special provision contained in paragraph VI of the Memorandum.

Section four presents the tax treaty treatment applicable to substitute dividends, explaining their characterization under domestic law and tax treaties in general; the taxation under the OECD Model and the Netherlands-US Treaty, with special reference to the domestic law of the countries selected and paragraph VI of the Memorandum; as well as the deductibility of such payments for the Borrower.

Further, section five analyses hypothetical stock-lending transactions with different cross-border flows of income, describing the tax treatment applicable, potential problems and solutions. In order to arrive to such results, the section describes the tax provisions of domestic laws of the countries selected, the impacts of the application of the Netherlands-US Treaty, as well as draws a comparison with the outcome resulting from the application of the OECD Model to a similar hypothetical transaction.

Finally, the conclusion summarizes the results of the studies conducted, indicating that undesirable tax consequences do arise from the simultaneous application of different approaches applicable to the taxation of cross-border stock-lending transactions and that states are encouraged to deal with them in their real treaties.