Partnerships involving three states
According to the OECD Model Tax Convention on Income and on Capital, partnership cases that involve three states "pose difficult problems with respect to the determination of entitlement to benefits under conventions”. Where a partner is a resident of one state, "the partnership is established in another state and the partner shares in partnership income arising in a third state then the partner may claim the benefits of the convention between his state of residence and the state of the source of the income to the extent that the partnership’s income is allocated to him for the purposes of taxation in his state of residence”.
Furthermore, if the partnership is also taxed as a resident of the state in which the partnership is established "the partnership may itself claim the benefits of the convention between the state in which it is established and the state of source”. In cases such as this or a case of ‘double benefits’, the state of source "... may not impose taxation which is inconsistent with the terms of either applicable convention, therefore, where different rates are provided for in the two conventions, the lower will be applied”.
It is stated by the OECD that contracting states "may wish to consider special provisions to deal with the administration of benefits under conventions in situations such as these, so that the partnership may claim benefits, but that partners could not present concurrent claims” (OECD, 2000). These provisions would ensure the "appropriate and simplified administration of the giving of benefits”.
The OECD states that no benefits will be available under the convention between the state "in which the partnership is established and the state of source if the partnership is regarded as transparent for tax purposes by the state in which it was established” because the partnership is not a resident for purposes of the convention (unless a special provision to the contrary exists).
If for tax purposes the partnership is regarded as transparent by the state in which the partnership is established and if the income of the partnership "is not allocated to the partner under the taxation law of the state of residence of the partner, the state of source may tax partnership income allocable to the partner without restriction”.
The application of the fiscally transparent approach creates difficulties in applying tax conventions.In the situation where a partnership is not a resident of a contracting state since the partnership is not liable for tax, and the partners are liable for tax in their state of residence on their share of the income of the partnership, expectations are that the state will apply the provisions of the convention "as if the partners had earned the income directly so that the classification of the income for purpose of the allocative rules of Articles 6 to 21 will not be modified by the fact that the income flows-through the partnership”.
Types of transparency
There are stated in the work of Baker (2002) to be four types of transparency: (1) complete transparency; (2) transparency with reporting obligations; (3) optional transparency; and (4) partial transparency. Baker states that in the case of complete transparency and optional transparency that it is likely that there would not be a liability for taxation of the entity.However, when partial transparency is elected these entities would be liable to tax "on the income on which the entity is liable to tax”.
Baker reports that the United States is one of the countries, of which there are only a few, that has adopted a provision "in its model tax treaty and domestic legislation dealing with the application of double tax conventions to hybrid entities” in what is broadly the adoption of a ‘flow-through’ approach and which is stated in Article 4(1)(d) of the US Model (1996) as follows: "An item of income, profit or gain derived through an entity that is fiscally transparent under the laws of either contracting state shall be considered to be derived by a resident of a state to the extent that the item is treated for the purposes of the taxation law of such contracting state as the income, profit or gain of a resident.”
This work has reviewed the international tax treatment of partnerships under international conventions
where the partnership is either regarded as being transparent or an entity for tax purposes.
Source: By Daniel N. Erasmus (TaxTALK)