handbook-tb

Preventing tax treaty abusesubparagraph a) shall be considered to be satisfied with respectto such item only if the trade or business activity carried on bythe resident in the first-mentioned Contracting State is substantialin relation to the trade or business activity carried on bythe resident or associated enterprise in the other ContractingState. Whether a trade or business activity is substantial for thepurposes of this paragraph will be determined based on all thefacts and circumstances.In applying this test, the payer and the recipient are allowed (andrequired) to aggregate any “activities conducted by persons connectedto a person.” This aggregation occurs for any entity that shares 50 percent common ownership or more and may have significant effects indeciding whether activities conducted in the recipient State are substantialwhen compared with those conducted in the source State.The active income test does not contain a restriction or qualificationwhere base-eroding payments are made. Therefore, a companythat conducts active business operations in the residence State facesno denial of treaty benefits even though most of its income leaks fromthe residence State to a third country. This creates a curious outcome.A privately held company might not satisfy the tests to be a “qualifiedperson” under subparagraph 2 e) because a substantial portion of itsincome is eroded by deductible payments made to third countries. If,however, that same company conducts an active business, the ultimatedestination of its income becomes irrelevant.2.3.1.3 Equivalent benefitsThe OECD Action 6 — 2014 Deliverable also includes in paragraph 4a third method for qualifying for treaty benefits. This option woulddeal with structures that appear to involve shopping between treaties(rather than into treaties). For example, a structure might exist whichwould not satisfy the objective LOB tests for a particular treaty, but theparticipants in that structure would all be entitled to similar benefitsunder other treaties. The obvious question is: should the source countrysimply apply the original treaty anyway, given that it would affordsimilar benefits if it applied the other relevant treaties instead?In the example below, Company B may not be entitled to treatybenefits under the A-B treaty where its shares are not traded on a local307