S. 247“Star Companies” in International Tax Law

Martin Jau

S. 249I. Introduction

1.1 Overview

The use of an enterprise such as a service company personally owned by the artiste or sportsman (a “Star” company; sometimes also called a “Rent-A-Star company”) is a well-known phenomenon with regard to the aim to lower the tax burden of, in particular, artistes and sportsmen who are active internationally. Ever since such companies have been being used for tax planning schemes, their abusive intention has been obvious. However, not all structures are to be characterized as tax evasion; some of them having objective business reasons that could be regarded as legal tax avoidance.

The latest judgment by the England and Wales House of Lords (judgment re Andre Agassi v Robinson) applied the British “look through” approach and decided: “The British tax liability has never been exclusively limited to British subjects and foreigners resident within the jurisdiction, according to Lord Scott of Foscote. (All) Payments made to Agassi Enterprises Inc., a non British (“ = Rent-A-Star”) service company, shall therefore be characterized as if such payments S. 250shall be made to the individual Agassi, performing in the UK”. No reference to the OECD MC Art. 17 para. 1 was made in this judgment.

This judgment does not take into account the generally accepted principles of the OECD MC. By failing to respect the existing DTC UK – US, the House of Lords created a British “island” approach which will have to be scrutinized in future day-to-day application, especially considering the DTC’s allocation rights.

1.2 Reasons for interposing an enterprise

According to the OECD’s 1987 report, it is the rich and famous artistes and sportsmen in particular who try to escape normal taxation via avoidance schemes and slave arrangements. Pursuant to the OECD, artistes and sportsmen try to reduce their tax burden, to defer the tax to be paid on earned income by interposing a legal entity with a seat in a no or low tax jurisdiction and routing their income through such an entity and finally to realize tax optimal passing-through of sheltered income to either a domestic holding company or to the company’s “tax haven” residence state.

The use of such companies with regard to structures available under civil law results in a first tax advantage (shifting and sheltering the respective income by tax deferral), using low or no tax countries as their state of incorporation/state of statutory seat. The advantage of saving the income in the interposed company without distribution (tax-free sheltering) ends up in tax deferral.

The privileged taxation of dividend income, most likely paid out at a later time, in the residence state of the artiste/sportsman is a further advantage of such a strategy. This is because the performance income is converted into dividend income, which may be taxed more favorably (e.g. in countries with a dual income taxation system)

The artiste/sportsman may largely or entirely escape host-country tax by receiving only a small salary from his/her performance in the year the services are performed since Art. 17 (1) only applies to salaries paid to the artiste/sportsman. The artiste/sportsman may arrange to receive further payments in a later year,S. 251 when he is not subject to host-country tax, perhaps as deferred salary payments, dividends or liquidation distributions. The benefits may also include deductible accident and medical insurance programs, group-term life insurance and qualified retirement plans, paid by the interposed entity on behalf of the artiste/sportsman. Sometimes (or even often) the interposed company fulfills an economic role for the artiste/sportsman. The interposed company acts e.g. as an organizer of concerts, festivals and other entertaining events, being responsible for all arrangements other than strictly local ones, i.e. employment of staff, organizing traveling arrangements and accommodation, taking care of stage arrangements, and a diversification of risks. When all business relations are concluded on an arm’s length basis, no abuse occurs and therefore no “look-through” approach should be taken. Also, the acceptance of such a construction should not depend on where the interposed entity is located and should rather be determined on the basis of the criteria mentioned earlier, i.e. the “business reason or substance over form doctrine”.

1.3 Rent-A-Star structures found in practice

A basic case illustrating the tax planning and tax avoidance possibilities is the following:

The artiste/sportsman sets up a corporation in a low-tax country. The artiste/sportsman enters into an employment contract with the corporation. The agreements with the promoters are concluded by the corporation rather than theS. 252 artiste/sportsman. Whereas artistes/sportsmen are, in principle, subject to limited tax liability in the country in which they perform their activities, a corporation residing in a DTC country may be taxed in the source country only if it maintains a PE in the state of performance.

The developed states (especially OECD member countries) have mechanisms in their national laws that are designed to counteract such strategies. Many states provide for a look-through approach for taxing the income of the entity as income of the artiste or sportsman. Even without specific anti-abuse rules, general income attribution rules enable states to treat the income as being accrued to the artiste sportsman himself if the interposed entity turns out to be merely artificial. If there is no treaty, the state of performance is free to look through or to tax the Star Company according to its domestic tax rules of limited tax liability. A very broad survey of such domestic allocation rules is given in section II of the present contribution.

However, if a tax treaty is applicable, it restricts the taxing rights of the contracting states. Depending on whether the treaty contains only an Art. 17 (1) or also an Art. 17 (2), the range of the taxation rights in the state of performance for payments made to the interposed company in connection with sportive or artistic events is different. This will be illustrated in section III of the present contribution.

If we look for court cases, a number of cases have been decided so far.S. 253 Interestingly enough, some of the Court decisions seem to be quite arbitrary, especially when it comes to the reasoning.

However, most of the decisions are based on domestic law and do not deal with treaty rules. Therefore, the intentions in the OECD MC were not considered in the decisions. Quite surprisingly, none of the Court cases dealt with a hybrid structure, which is quite usual when it comes to international tax planning and structuring (e.g. IP and merchandising structures). Of course, such structures have been implemented, otherwise famous tennis players or formula 1 drivers would spend a lot of their income in paying taxes.

Since Star Companies offer a wide array of avoidance possibilities, they are not favored by the tax authorities. It is also understood that e.g. the US majorS. 254 sports leagues approach Rent-A-Star Companies with reluctance. It is reported, for example, that their use by players in major league baseball, the National Football League, and the National Hockey League has not been widespread, and that the National Basketball Association does not permit its clubs to contract with loan-out companies.

II. Domestic income allocation – the example of Switzerland

2.1 Non-resident artistes and sportsmen subject to the Wage Withholding Tax Procedure (WWTP)

Non-resident artistes/sportsmen exercising their personal activity in Switzerland are subject to limited (Federal and Cantonal) income taxation and the tax is levied at source.

2.1.1 Income directly paid to artistes/sportsmen

Since the WWTP applies irrespective of the nationality of the taxpayer, Swiss artistes/sportsmen resident abroad are also taxed at the source if they derive employment/business income from sources in Switzerland.

For purposes of Art. 92 DFTL, it is irrelevant whether the performance-related income qualifies as employment income, as self-employed service income, or even as business income. Any income that is attributable to the artiste’s/sportsman’s person rather than to the artiste’s/sportsman’s performance is not subject to tax.

S. 2552.1.2 Income paid to third parties (indirectly paid to artistes/sportsmen)

The same rules are applicable with respect to remunerations paid to a third party. Unless either the artiste/sportsman or an affiliated person benefits directly or indirectly from the third person’s profit, the WWTP applies only to the part of the remuneration that is forwarded to the artiste/sportsman.

The taxation of the third person’s remaining profit depends on the third person’s residence. If the third person is resident in Switzerland or abroad, in a non-DTC state, “domestic” tax law prevails: In the former case, the profit element of the third person will ordinarily be taxed (unlimited tax liability of the third person in Switzerland). According to Art. 5 (2) DFTL in the latter case, only the part of the income that is attributable to an artiste’s/sportsman’s performance in Switzerland is subject to tax (performance-related income), regardless of whether this third party is an individual or a legal entity.

These rules regarding the taxation of income paid to a third party are currently being challenged by the UEFA. In this case the UEFA paid remunerations to the national football federations involved. From the UEFA’s point of view, remunerations should not to be taxable in Switzerland but only in the state of residence of the football players. The UEFA pointed out that it does not pay income related to the performance of the football player, but a “premium” to the participating football clubs. According to the DTC CH-UK the remunerations related to a performance are subject to tax where the artiste/sportsman performs. Performance-related income is taxed even if it is paid to a third party.

S. 2562.2 Allocation rules according to DTC concluded by Switzerland

2.2.1 Income directly paid to artistes/sportsmen

Most of the Swiss treaties contain articles similar to Art. 17 of the OECD MC. None of the DTCs concluded by Switzerland have adopted Art. 23 (B) OECD MC (credit method); however, they tend to follow the pattern of Art. 23 (A) OECD MC (exemption method).

Swiss-source performance income paid to an artiste/sportsman will be taxed at source if:

• the artiste/sportsman is resident of a state with which Switzerland did not conclude a DTC;

• the artiste/sportsman is resident in a double tax contracting state. The corresponding DTC allocates the right to tax to Switzerland (state of performance) under Art. 17 (1). This is typical of most of the DTC concluded by Switzerland. However, there are reservations on this in two DTCs. This will be discussed in the following.

Since income from the activities of artiste/sportsman does not regularly accrue to the artiste/sportsman but instead to third persons, such as a management company, an association (e.g. football team) or a Star Company, Switzerland made a reservation to Art. 17 (2) of the OECD MC to the effect that Switzerland only wants to apply Art. 17 (2) to abusive schemes. Most of Swiss DTCs contain a provision similar to Art. 17 (2) OECD, with the exception of six.

Moreover, the majority of the Swiss DTC provide expressly that where there are doubts performance-related income paid to a third party is taxed only in the state of performance even if there is not sufficient proof that either the artiste/sportsmanS. 257 or an affiliated person benefits directly or indirectly from the third person’s profit.

2.2.2 Special cases

With regard to the DTC CH-NL there is a peculiarity to be considered. Although this DTC does mention artistes and sportsmen in the respective article, the DTC allocates the right to tax to Switzerland only for artistes. Hence, sportsmen may only be taxed in the state of the performance under this treaty if they have a PE in the state of performance. With regard to the DTC CH-NL, an actual case was decided on 19 January 2007: The UEFA made payments to the national football federations involved. From the UEFA’s point of view, the remuneration was not taxable in Switzerland but only in the football players’ state of residence. The UEFA pointed out that it does not pay income related to the performance of the football player, but a “premium” to the participating football clubs.

The Tax Administration of the Canton Berne approved the appeal of the European Football Association (UEFA) against the source tax assessment with regard to the Champions League football game FC Thun-Ajax Amsterdam FC. In the decision it was pointed out that the DTC CH-NL does not allocate to Switzerland the right to tax the remunerations in connection with a sportive performance in Switzerland. The DTC CH-NL does not contain a special provision with regard to the taxation of sportsmen, but only for artistes. Therefore, for sportsmen the general rules of the treaty apply. Consequently, one has to distinguish between sole traders and employees. Dutch sole traders are only taxable in Switzerland if they carry on business through a PE in Switzerland, which will hardly ever be the case. Dutch employees, on the other hand, will be taxed in Switzerland under Art. 15, unless the 183-day rule is applied.

The latter could apply to payments made by the UEFA to football players employed by the foreign club. By contrast, payments not directly paid for the performance of the players (such as performance-related premiums paid to the club) may not be taxed in the state of performance under Art. 15 of the treaty. Therefore, the corresponding DTC did not allocate any right to tax to Switzerland at all. Interestingly, there are no other legal arguments presented in this case.

III. The international allocation rules – an overview

3.1 A review of Art. 17 OECD Model Convention

A review of the history of Art. 17 of the current OECD MC reveals that it was inserted in the MC because it was believed that artistes and sportsmen would have a tendency not to report income earned in the source country to their country ofS. 258 residence. The 1963 draft of the OECD MC provided in Art. 17 that the right to tax the income of a performance of artistes and sportsmen is allocated to the country of performance, but not exclusively, setting aside the normal allocation rules of Arts. 7, 14 and 15.

Art. 17 was extended in 1977 by adding a second paragraph, which provided that where another person (not the artiste or sportsman himself) receives the remuneration for the performance, the source country still holds the right to tax the income. Top artistes and sportsmen had started to use “loan-out companies”, most often owned by themselves, which contract for the performances of the artistes and sportsmen. Para. 4 of the 1977 Commentary indicates that the OECD did not intend to attack normal employer-employee relations in Art. 17 (2) OECD MC. The text of the 1977 MC made it clear: rather, the purpose was to counteract the tax avoidance schemes of self-employed top artistes/sportsmen. However, the wording was much broader than necessary for this object and purpose in the 1977 Commentary.

In 1987, the OECD Committee on Fiscal Affairs published a report, that referred to a study based on 19 country submissions. Some countries had reported to the OECD that top artistes and sportsmen were loaned out by companies, which gave the artistes and sportsmen a small salary and received the main part of the performance income as a company profit. These considerations were mentioned as if Art. 17 (2) OECD MC had not been introduced 10 years earlier.

The mistrust and suspicion that rich and famous artistes/sportsmen in particular were trying to escape from normal taxation became more marked. The main purpose of the 1987 report was “to help Member countries to establish a system by which the income of the artiste/sportsman could effectively be taxed in the country of performance”. Six major elements from the 1987 Report have been transferred to the 1992 Commentary on Art. 17 of the OECD MC. WithS. 259 regard to the topic here, the most interesting point of these six amendments is obviously the reversal from the limited to the unlimited approach in the Commentary of Art. 17 (2) OECD MC. The unlimited approach was laid out in Para. 11 of the Commentary that was changed in 2000: Not only Rent-A-Star Companies but also incorporated teams, troupes etc. fall within the scope of Art. 17 (2) OECD MC. This meant that, in addition to the artistes’ and sportsmen’s salaries for their personal performance, the profits of the (separate) legal entity were also taxable in the country of performance. Thus, even without having a PE in the country of performance, a separate legal entity could be taxed, although it was not an artiste/sportsman itself.

3.2 Interpretation in the Commentary

Although the text of Art. 17 OECD of the Model Convention itself remained unchanged in this context, the OECD Commentary’s 1992 version, para. 8 provided for changes. According to Art. 17 (1), the state of performance’s primary right to tax is limited to cases were income accrues “in the entity for the individuals benefit”. Therefore, the state of performance is not entitled under the lookthrough approach of Art. 17 (1) OECD MC to tax the profit element accruing to the beneficial ownership of the third person. Unfortunately, the term “income” has not yet been defined.

Under Art. 17 (2), by contrast, it is not the person of the artiste or sportsman himself, but a third person receiving the income of an artiste or sportsman that can be taxed in the source state, regardless of the question whether the artiste or sportsman himself receives any payments. Para. 11 of the Commentary takes the position that Art. 17 (2) OECD MC does not limit the application of Para. (2) to devices of tax evasion and lists three main cases for an application:

• The management company that receives income for the appearance of e.g. a group of artistes/sportsmen,

• The team, troupe, orchestra, etc. that is constituted as a legal entity and

• The “artiste-company”, a tax avoidance device, where the performance income of an artiste/sportsman is paid to another person, the artiste company and not to the artiste/sportsman.

The first two cases were a new interpretation with regard to the 1977 Commentary. The last case corresponds to Para. 4 of the 1977 Commentary. AsS. 260 pointed out before, the object of Para. (2) is not to allocate to the state of performance the taxation of business profits, but to obtain a right to tax income derived by artistes/sportsmen from their personal performance-related services as such that accrues not to the artiste/sportsman himself but to another person, in other words to anyone other than the artiste/sportsman.

IV. The scope of Art. 17 (1) OECD MC

4.1 Interposition of a legal entity

Diagram 1

Facts:

State R and State P have concluded a DTC along the lines of the OECD MC. The artiste/sportsman is resident in State R. He signed a contract (e.g. an employment contract or a service contract) with his Star Company, set up in a low-tax country Y (e.g. Switzerland). The Star Co. concluded an arrangement with the Organizer of the event in state P and “loaned out” the artiste/sportsman to the event organizer for the performance. According to the contract with the organizer, Star Co. receives 100 and pays a salary of 20 to the artiste/sportsman, which is related to the specific performance given in state P.

S. 261Solution:

According to Art. 17 (1) DTC R-P, the right to tax the remuneration (20) paid to the artiste/sportsman is allocated to state P, because the remuneration is derived from an activity performed in state P. Art. 17 (1) is applicable regardless of the fact that the income of the artiste or sportsman is paid to him by a third person (in this case his star company). If the artiste/sportsman “receives performance-related income” from his Star Co, state P has the same taxation rights as if the compensation had been paid directly to the individual performer.

However, under Art. 17(1) state P has no taxing right for the “business profit” portion (80). The profit element, however, accruing from a performance to the interposed legal entity would be liable to tax under Para. (2). This interpretation suggested by the OECD Commentary, which is followed by the Swiss tax authorities, is, however, not undisputed in the literature.

According to Swiss domestic tax law: if the artiste/sportsman or an affiliated individual benefits directly or indirectly from the interposed entity’s profit, the remaining business profit must be taxed at source accordingly. In this case a tax treaty (not containing an Art. 17 [2]) would restrict Swiss national law, as under tax treaties only containing Art. 17 (1) Switzerland could not levy a tax on income derived by third persons, as far as the profit element is concerned.

S. 262Diagram 2

Facts:

The basic facts are similar to those in diagram 1, but in this scenario, the Star Co. does not pay any remuneration in the current tax year to the artiste/sportsman. Instead, the Star Co. might most likely distribute a dividend or forward the money at a later time in the form of wages or service fees.

Solution:

Art. 17 (1) DTC R-P allocates the taxation rights with regard to “income derived by … as an entertainer … or as a sportsman … from his personal activities as such exercised in the other contracting state, may be taxed in that other state”. The artiste/sportsman might argue that no remuneration has been derived by him and, therefore, according to Art. 17 (1) state P does not have any taxation rights. If the remunerations will be paid to the artiste/sportsman at a later time, Art. 17 (1) should be applicable, as income is derived by the artiste in connection with an activity (previously) performed in state P. Hence, basically the taxation rights kick in, as soon as the income from the (former) performance accrues to the artiste or sportsman.

However, there will be practical difficulties, as potential withholding taxes levied in year 1, when the payments are made by the organizer to the star company, will have to be refunded on the request of the star company, as soon as theS. 263 latter proves that no income accrued to the artiste or sportsman. When in later years such payments are made to the artiste or sportsman and the taxation rights under Art. 17 (1) kick in, there are no more possibilities for state P to get hold of tax.

With regard to the profits sheltered in the Rent-A-Star Co., the question arises whether or not dividend payments might also fall under Art. 17 (1). The answer to this question is negative, since Art. 17 allocates only performance-related income derived by an artiste/sportsman and does not prevail over Art. 10 OECD MC. It follows that income transformed into dividends avoids the artiste’s/sportsman’s taxation in the state of performance under Art. 17 (1).

This shows that – from the states’ perspective – good arguments speak in favor of introducing an Art. 17 (2) in their tax treaties, in order to solve legal and factual problems with the collection of taxes in the case of tax schemes with companies wholly owned by artists and sportsmen. Art. 17 (2) – undisputedly – grants a taxing right to the state of the performance regardless of the question whether income accrues to the artiste or sportsman himself.

4.2 Interposition of partnership

4.2.1 Transparent partnership

If the partnership qualifies as a transparent partnership according to the state of performance’s domestic law, the state of performance looks through the partnership and each (artiste/sportsman) partner is taxed accordingly on the remuneration received for the performance in state P (Art. 17 [1] DTC PR).

S. 2644.2.2 Non-transparent partnership/hybrid structure

Diagram 3: Hybrid structure/Conflict of characterization

As pointed out in 3.2, Art. 17 (1) DTC R-P also covers remunerations according to personal performance paid to third parties. If the state of performance characterizes partnerships as transparent, it will look through this third person and treat the performance income as derived by the artiste/sportsman himself.

On the other hand, if the state of performance treats the partnership as transparent (like a legal entity) it can only tax the company income, but not according to Art. 17 (1).

However, if the state of performance treats a partnership as transparent, and the low-tax state (state of incorporation of the partnership) on the other hand considers a partnership as non-transparent, a conflict of characterization arises. In this situation, the state of performance will impose its tax based on Art. 17 (1) OECD MC. The low-tax state, being the state of residence of the partnership,S. 265 will also tax the company’s revenue accrued to the performance in state of performance. According to Vogel, the state of residence should take the state of performance’s characterization for granted.

Scenario a)

If state P characterizes the partnership as transparent, but the low-tax state as non-transparent, Art. 17 (1) of the DTC R-P is to be applied, since Art. 1 in conjunction with Art. 4 (persons covered) characterizes the artiste/sportsman as a “person covered” according to the respective DTC. Therefore, the DTC R-P allocates to state P the right to tax the remuneration (related to the personal performance) paid to the partnership as if it had been paid directly to the artiste/sportsman. In conclusion, this structure does not lead to any tax benefit since sheltering does not take place at all. Therefore, it is not recommended from a tax planning perspective.

Scenario b)

If state P characterizes the partnership as non-transparent, Art. 17 (1) of the DTC R-P does not allow state P to tax the income derived by the partnership (see 4.1/Diagram 1, solution). In this situation, the partnership is not liable to tax in the low-tax country (transparent) and is therefore not a resident of that state for purposes of the DTC low-tax country-P.

According to the author, the low-tax state will have to grant double taxation relief only insofar as the company’s income may be taxed by state P under the DTC P-low-tax state. The state of performance, however, only taxes the income attributable to the personal performance of the artiste/sportsman. Therefore, one might argue whether the third state has to grant relief since the conditions of Art. 23 A/B of the DTC are not met. Finally, the author doubts that third state will be obliged to grant relief for tax imposed in the state of performance.

V. Conclusion

It has been shown that states have a wide range of instruments in their national tax laws in order to counter tax avoidance schemes in connection with companies wholly or primarily owned by artistes or sportsmen (“star companies”, also called “rent-a-star-companies”). Such basic domestic tax rules, like the look-through approach and general income attribution rules, were introduced in section 1.3 and examined more closely in section II. by using the example of Swiss domestic law.

S. 266In section III. the effect of tax treaties on such national rules was examined on the basis of Art. 17 (1) and Art. 17 (2) OECD Model. It appears that Art. 17 (1) enables taxation of the artiste or sportsman, even if the income is paid to third persons. However, Art. 17 (1) requires for taxation in the state of performance that income be derived by the artiste or sportsman himself/herself. Based on this conclusion, various scenarios were identified in section 4.1 and 4.2, where source taxation in the country of performance fails because the star company does not pay the artiste or sportsman, makes deferred payments or transforms the income into dividends. In all these cases withholding taxes (if levied in the state of performance) have to be refunded on the request of the star company.

At the same time, it is clear that factual and legal problems of source taxation in connection with interposed entities can be avoided by the states, if they introduce Art 17 (2) in their tax treaties. This provision also allows source taxation of income of artistes and sportsmen in cases where no income accrues to the artiste or sportsman himself/herself.

S. 267VI. Appendix 1: Rates of Swiss (Federal & Cantonal) Wage Withholding Tax Rates for artistes and sportsmen