handbook-tb

Graeme S. CooperA more complicated question arises for companies that do morethan engage in “active trade or business” — for example, a single companywhich is both a manufacturer and which licenses intellectualproperty to related entities. The drafting of the clause suggests thatsuch a company would satisfy this part of the test as long as its manufacturingoperations were more than merely cosmetic.The second part of the active business income test requires that:the income derived from the other Contracting State isderived in connection with, or is incidental to, that tradeor business.In other words, a company which satisfies the active incometest based on its status as a manufacturer cannot rely on that status toenjoy treaty benefits for all items of income it earns from the sourcecountry — merely for income which is earned in connection with itsmanufacturing operations. Where a single company is both a manufacturerand licenses intellectual property to related entities, it may beargued that the royalties derived from the intellectual property thatit licenses is income that is “in connection with, or is incidental to,that [manufacturing] trade or business.” On the other hand, royaltiesderived from unrelated intellectual property are presumably excludedfrom enjoying treaty benefits.The third part of the active income test (subparagraph b) is anadditional requirement which must be met if the resident is earningactive business income through its offshore branch or from an associatedenterprise in the source country. That is to say:if a resident of a Contracting State derives an item of incomefrom a trade or business activity conducted by that resident inthe other Contracting State, or derives an item of income arisingin the other Contracting State from an associated enterprise…Where either situation exists, the added requirement is thatthe business operations of the recipient are regarded as “substantial”when compared with the business operations conducted by the payer.In other words, income will not enjoy treaty benefits if it is being paidto an entity that is largely packaging some modest business activities.Subparagraph 3 b) further states that:306