International Tax and Royalties
By Eric Longley & Harold Peterson, Prager Metis International LLC
The text of the OECD Model Tax Convention is closely followed by most international tax treaties. In doing so it provides consistency of approach removing the need for recourse to the competent authority rules where there is a dispute as to interpretation between taxpayers and domestic tax authorities. Even so there are still interpretational issues that can aid and/or trap the unwary or uninitiated.
Article 12 of the Model Convention provides, subject to some avoidance qualifications, that royalties shall only be taxed in the state where the owner of the copyright resides. Low tax territories do not generally have double tax treaties and payment of royalties to such territories generally gives rise to withholding tax in the payer territory.
The first thing to note is that most tax treaties, following the Model, give a wide definition of royalties. Article 12 of the Model convention states:
The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience
There are a number of domestic reservations to the Model such as Australia which reserves the right to include payments or credits which are treated as royalties under domestic legislation, a number of territories reserve the right to tax at source royalties from leasing of industrial commercial or scientific equipment. Rents for the use of films are treated as royalties being payments in respect of the use of a copyright although where bilaterally agreed such rents may be treated as business profits and subject to Articles 7 and 9 instead.
Royalties are income payments paid for the use of the copyright. Where consideration is paid for the transfer of the full ownership of the copyright tax, authorities may take the view that such payments do not represent a royalty and are out of line with the provision of the royalties Article. The argument is that payment for purchase of the copyright is not for the use of a copyright but to own the copyright. Where someone buys a house they can rent it out and the income is rent, payment for use of the house. The purchase/sale of the house is a capital receipt. Similarly tax authorities may take the view that trading in copyright is the trade not the exploiting of the copyright by way of collecting royalties. Additionally, purchasing the copyright may be viewed as a capital payment in order to own the right to the royalty income. Royalties are the fruit of the tree which is the ownership of the copyright. It is the difference between a capital and an income payment. Even though the company may be effectively trading in copyrights the trade is not caught by the royalties’ provisions but may fall under Articles 7 and 9. The OECD recognise that this may give rise to difficulties.
To make matters more complex, some territories have domestic legislation that affects how royalties are dealt with. For example, in the UK, payment is to the original author (note not their incorporated company or another entity). This means that the payment does not fall under the domestic legislation to be treated as a royalty. The benefit of this is that payments to the original author are not subject to any UK withholding tax or administration reporting and such payments can be made direct to the author in a low tax territory without problem.
For most musical performers there is no copyright in their performance but publication of the performance is forbidden without the performer’s consent. Payment to the performer is payment in respect of the use of a copyright, the recording of the performance, even though the performer may not own the recording. In this regard, there is a clear connection between the performer, the performance and how payment is made. Again this raises problems where jurisdictions tax performers – an individual who performs, in another territory. Examples would be musicians on tour, sports competitors and actors. Where such individuals are not resident but visit another territory solely to record an audio visual recording it may be argued that the payment is for the use of the performing right and is therefore exempt under the double tax treaty from any payment on account of performing in that territory. Tax authorities are conflicted on this point because generally the tax authority ignores Treaty protection. Tax authorities are content to receive income under the royalties provision but reluctant to concede its application to foreign visitors when this reduces their tax burden in that territory. There is grave concern that some tax authorities may be deliberately flouting and/or breaching international treaties as protected by the Vienna Convention 1969 (law of Treaties).
Quite often, in order to avoid setting a precedent, tax authorities will work towards a practical resolution of the problem.
A recurring problem is the treatment of withholding tax on royalties and accounting by collection agents to the end copyright holder. For example, a record company collects income worldwide and accounts to the recording artist who is tax resident in the same territory. There is scope for mistreatment and/or substantial under accounting of payment due to the artist where the payer makes payment on the net amount received after deduction of withholding tax. The record company has foreign income as it is collecting income worldwide but the artist has only domestic or same territory income as they are being paid by the record company in the same territory. The record company can usually benefit from domestic tax credit rules in respect of the tax withheld on any royalty payments. Depending on the contractual arrangements, the recording artist would normally be accounted to on the gross royalty received before any tax withheld on royalty payments. Careful review of the contractual position is required as far too many royalty payers do not seem to understand their own contractual obligations, or how the royalty withholding tax system works.
Where the payer is tax resident in a different territory the situation may be much more complex, but the same principles apply.
When drawing up contracts for payment of royalties it is very important to understand the domestic and international tax treatment of royalty payments. This is an area where accountants and lawyers have to work very closely together.
It may not always be advantageous to seek shelter under the royalty provisions. Payments to offshore recipients may sometimes be better structured as business profits and/or remuneration for example.
Eric LongleyPrager Metis International LLC, New York, United States
T: +1 212 972 75 55
F: +1 212 370 15 32
Eric Longley, Prager Metis London Office
An ex-Inspector of Taxes with front line experience as managing director of a record company Eric brings a unique experience to his role as Director of Taxation in London.
Harold PetersonPrager Metis International LLC, New York, United States
T: +1 212 972 75 55
F: +1 212 370 15 32
Harold Peterson, Prager Metis New York Office
Co-Chair of the Prager Metis Tax Department, Hal has expertise in a full range of tax services. He has clients in many industries including entertainment, real estate companies, manufacturers and professional practices.
Published: March 2016 l Photo: slonme - Fotolia.com