I. Case Overview

Company A, a South African tax resident, owns all shares of a Dutch private limited liability company, Company B. In 2013, Company B distributed dividends. Under Dutch domestic law, dividends paid by a Dutch resident company to a foreign entity are subject to a 20% withholding tax. However, according to the South Africa-Netherlands Tax Treaty, if the beneficial owner of the dividends is a resident company of the other contracting state and holds at least 10% of the capital in the dividend-paying company, the source country should not impose a withholding tax exceeding 5% on those dividends. Based on this treaty provision, Company B withheld a 5% withholding tax. Later, Company A applied for an exemption from the withholding tax under the Most-Favored-Nation (MFN) clause of the South Africa-Netherlands Tax Treaty, but this request was denied by the Dutch tax authorities. Consequently, Company A took the case to a Dutch court. The High Court ruled in favor of Company A, and the tax authorities appealed to the Supreme Court, which ultimately upheld the ruling in favor of Company A.

II. Key Point of Dispute

The main issue was the application of the MFN clause to determine whether Company A could benefit from a full exemption from withholding tax on dividends.

The South Africa-Netherlands Tax Treaty was signed on October 10, 2005, came into force on December 28, 2008, and became effective on January 1, 2009. Article 10, paragraph 10, of the treaty states that if South Africa signs a tax treaty with a third country after this treaty is signed, and that treaty offers more favorable terms for dividend taxation, such as exemption, lower rates, or a smaller tax base, these more favorable terms should automatically apply to the South Africa-Netherlands Treaty from the date the third-country treaty takes effect.

Company A referred to the protocol of the South Africa-Sweden Tax Treaty to support its claim. This treaty was signed on May 24, 1995, and its protocol was signed on July 7, 2010, becoming effective on March 18, 2012. Since this protocol was signed after the South Africa-Netherlands Treaty became effective, it meets the timing requirements of the MFN clause in the South Africa-Netherlands Treaty. Although the protocol does not directly provide for a dividend exemption, it does include an MFN clause stating that if South Africa enters into a tax treaty with a third country that provides more favorable dividend tax treatment, this treatment automatically applies to South Africa and Sweden. Notably, the MFN clause in the South Africa-Sweden Tax Treaty does not specify any timing conditions, meaning that any more favorable dividend tax treatment in a treaty that South Africa signs with a third country, regardless of whether the treaty was signed before or after the South Africa-Sweden Treaty, would automatically apply to South Africa and Sweden.

At the time when Company B paid the dividends in 2013, South Africa had treaties with Kuwait, Cyprus, and Oman that provided for tax exemptions on dividends. Since these treaties were signed before the South Africa-Netherlands Treaty, Company A could not directly use them to invoke the MFN clause in the South Africa-Netherlands Treaty. However, because the South Africa-Sweden Treaty does not impose any time restrictions, Company A could use it as a reference to “bridge” the tax exemption on dividends outlined in the treaties between South Africa and Kuwait, Cyprus, and Oman, thus bypassing the time restrictions in the MFN clause of the South Africa-Netherlands Treaty.

III.Final Ruling

In early 2019, the Dutch Supreme Court dismissed the appeal by the Dutch tax authorities and ruled that Company A is entitled to the exemption from withholding tax on dividends under the MFN clause of the South Africa-Netherlands Tax Treaty, and the tax authorities must refund the withholding tax. The court also noted that the absence of a time limitation in the MFN clause of the South Africa-Sweden Tax Treaty may have been an oversight, given that the South African tax authorities initially intended to impose a withholding tax on outbound dividend payments. This oversight could potentially lead to a “race to the bottom,” undermining the effectiveness of time restrictions in the MFN clauses of South Africa’s other tax treaties.

IV. Insights for International Businesses

（A）Pay Attention to MFN Clauses in Tax Treaties

Due to the promotion and guidance of tax authorities, awareness among businesses about using tax treaties to protect their interests has increased in recent years. However, when utilizing treaty benefits, companies often focus on clauses limiting tax rates on dividends, interest, and royalties, without giving enough attention to other provisions. Tax treaties are highly technical legal documents, and their interpretation and application must be comprehensive; otherwise, companies might miss out on opportunities to benefit from these treaties.

（B）Identify MFN Clauses

In both OECD and UN model tax treaties, the MFN clause is not a “standard” provision and does not have a dedicated article. It is usually an agreement reached during negotiations by one or both parties to protect their residents’ interests. Therefore, it does not have a fixed position in the treaty. In some treaties, it is mentioned in specific articles, such as those on dividends, interest, and royalties; in others, there is a dedicated article for MFN treatment; and in some cases, it is included in a protocol or exchange of letters. For example, the tax treaty between China and Vietnam states in an exchange of letters that if Vietnam later changes its policy regarding negotiating tax treaties, or if Vietnam raises the time threshold for permanent establishments in treaties with other countries, this higher threshold should also apply to the China-Vietnam treaty.

（C）Monitor Developments in Host Country’s Tax Treaties

From the perspective of international businesses, if a tax treaty between China and the host country includes an MFN clause, companies should closely monitor the host country’s treaty negotiations, as the MFN clause could link to relevant provisions in the host country’s treaties with third countries. In practice, some host countries may, in good faith, proactively notify treaty partners when they conclude new treaties affecting the MFN clause’s application, prompting the partner to prepare accordingly. For example, the China-Chile tax treaty was signed in Santiago on May 25, 2015, came into force on August 8, 2016, and has been effective since January 1, 2017. The protocol of this treaty includes an MFN clause stating that if, after the signing of this treaty, Chile enters into a treaty with another country that provides a lower withholding tax rate on interest, this new rate automatically applies to the China-Chile treaty. In April 2018, the Chilean tax authorities informed the Chinese tax authorities that the limitation rates on interest in the Chile-Japan and Chile-Italy treaties were lower than those in the China-Chile tax treaty. According to the MFN clause of the China-Chile tax treaty on interest, the lower limitation rates in the Chile-Japan and Chile-Italy treaties would automatically apply to the China-Chile tax treaty. The Chinese tax authorities confirmed their understanding of the MFN clause in the China-Chile tax treaty on interest and subsequently issued a notice on applying the MFN treatment to the interest clause in the China-Chile tax treaty. However, sometimes the host country may not proactively notify such developments, so businesses need to actively track relevant information and assert their rights.

（D）Track Other Treaties Signed by the Host Country

If the MFN clause in a tax treaty between China and the host country refers to other tax treaties signed by the host country, such as those related to international air or sea transport, companies should also keep an eye on these treaties. If a company finds it challenging to track these developments, it may seek assistance from professional organizations.