Article 13(2) of the Agreement between China and Pakistan for the avoidance of double taxation - China Working Group

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Yousaf Amanat
Yousaf Amanat & Associates, Islamabad
www.yaa.com.pk
 

Various Chinese companies currently work in Pakistan. Many of these companies are involved with infrastructure and power sector projects, working on dams and road construction. These companies contract out parts of their work involving design and engineering to other companies based in China. A legal proposition arises when such companies are tasked with deducting tax from payments to Chinese resident companies under the 2001 Income Tax Ordinance. The Chinese resident companies rightfully object as they are already being unfairly taxed under both China’s and Pakistan's tax regimes.

Both China and Pakistan are signatories to the Agreement between the Peoples Republic of China and the Islamic Republic of Pakistan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Evasion of Taxes. This tax treaty ('Treaty') was signed in 1989 and deals specifically with issues of double taxation. We are however surprised to find that most Chinese companies are either unaware of this treaty or have not given it due consideration. Even if the Chinese companies refer to the Treaty for tax relief, the problem of interpreting its articles leaves them bewildered.

For the purposes of this article we have attempted to demonstrate this problem of interpretation as well as the mechanism which may be used to resolve it.

The Treaty

Article 1 of the Treaty provides that it shall apply to persons who are residents of one or both of the contracting states. Article 2(2) provides that it shall apply to income tax in Pakistan and China. Article 3 defines ‘contracting states’ as meaning China or Pakistan as context so requires. Article 4, for the purposes of the Treaty, defines the term ‘resident’ as a person who under the laws of that contracting state is liable to tax therein by reason of their domicile, residence, place of head office or effective management, or any other criteria of a similar nature.

Interpretation of Article 13(2)

Article 7 provides that the profits of a contracting state enterprise shall only be taxable in that state unless the enterprise carries out business in the other contracting state through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other state.

Article 15 provides that income being derived from a resident of a contracting state shall only be chargeable in that contracting state unless it, the beneficial owner of the fees, also has a place of establishment or base in the other contracting state.

Article 13(1) provides that fees for technical services arising in a contracting state and paid to a resident of the other contracting state may be taxed in that other contracting state. Article 13(2) provides that such fees for technical services may also be taxed in the contracting state in which they arise and according to the laws of that state, but if the recipient is the beneficial owner thereof, the tax charged shall not exceed 12.5 per cent of the gross amount of the fees. Article 13(4) provides that the provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the fees for technical services, being a resident of a contracting state, carries on business in the other contracting state in which the fees for technical services arise, through a permanent establishment situated therein, or performs in that other state independent personal services from a fixed base situated therein and the contract in respect of which the fees for technical services are paid is effectively connected with such permanent establishment or fixed base. In such cases the provisions of article 7 or article 15, as the case may be, shall apply.

Whereas articles 7, 13(1) and 15, in our opinion, are clear that taxation on the fees being paid to a resident shall only take place in the country of which the beneficial owner of the fees is resident, the problem arises from the interpretation of article 13(4).

Article 13(4) provides that the provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the fees for technical services, being a resident of a contracting state, carries on business in the other contracting state in which the fees for technical services arise, through a permanent establishment situated therein, or performs in that other state independent personal services from a fixed base situated therein and the contract in respect of which the fees for technical services are paid is effectively connected with such a permanent establishment or fixed base.

A plain reading of article 13(4) would make it clear that it nullifies the effect of article 13(1) if the resident of China also has a business establishment in Pakistan. But article 13(4) also provides that it shall nullify the effect of article 13(2) which provides that such fees for technical services may also be taxed in the contracting state in which they arise and according to the laws of that state, but if the recipient is the beneficial owner thereof, the tax charged shall not exceed 12.5 per cent of the gross amount of the fees.

The litmus test for article 13(2)

The legal proposition which arises then is that under the Treaty, will the services be taxed in China or Pakistan? Our interpretation is that the name of the Treaty provides that it has been signed specifically to avoid the issue of double taxation. Whereas articles 7, 13(1) and 15 are clear that such fees shall only be taxed in China, the question of interpretation of article 13(4) read with article 13(2) can be resolved by the litmus test of whether or not the Chinese resident company also has a place of establishment in Pakistan. If it does, it will also be taxed in Pakistan under Article 13(2); but if it doesn’t, it will be only taxed in China under articles 7, 13(1) and 15 of the Treaty.

The relief provided by the Treaty

When confronted with a problem regarding the interpretation of the Treaty’s articles, in our opinion, it is important to bear in mind the purpose for which the Treaty was signed which is the avoidance of double taxation. Since the Treaty’s main purpose was dealing with double taxation, in our opinion this is primary purpose which the Treaty attempts to achieve, followed secondly by exceptions where the Treaty in fairness will accord benefit to the revenue collection in Pakistan where the Chinese company is also operating a place of business there.