The Convention to Avoid Double Taxation between Barbados and Spain contains a rule for the taxation of interests in the creditor’s place of residence.

Thus, Article 11 provides:

"1. Interest arising in a Contracting State whose beneficial owner is resident in the other Contracting State may be taxed only in that other State.”

However, the same Convention establishes a restriction on the application of this standard in the Convention’s Memorandum. The purpose of this restriction is to prevent, through the triangulation of Conventions, that one of the two countries ends up granting an exemption that would not have been applicable if the transaction would had been carried out directly.

Thus, paragraph 1.B. (a) of the Memorandum restricts the right to the application of the Convention to Articles 10 (Dividends), 11 (Interests), 12 (Canons) and 13 (Capital Gains) to the event that: “the income obtained by a Contracting entity which is paying dividends, interests, royalties or capital gain to a resident in another Contracting State arises in a territory without an agreement to avoid double taxation with that other Contracting State”.

Let's take an example:

Imagine a Barbados company granting a loan to a Spanish company and the Spanish company uses those resources to grant a loan to a company in Costa Rica.

According to the website of the Ministry of Finance of Costa Rica there is no CDI between Costa Rica and Barbados.

Consequently, and since Costa Rica lacks a Tax Convention with Barbados, the treatment of Article 11 of the Barbados-Spain Agreement would not apply. In the event of non-application of the Agreement, Spanish legislation on the taxation of non-residents operating in Spain will apply.

In this case, article 25 (f), 2º of Non-Resident Income Tax Law applies since it establishes a withholding tax of 19% for "interest and other income obtained from the transfer of own capital to third parties”.

In this made-up story that we are using as an example, it should also be considered that the agreement between Costa Rica and Spain determines a 10% withholding on interest on loans for a period not exceeding 5 years.

Tax conventions are agreements between two or more countries to regulate the taxation of their financial transactions to avoid double taxation. Originally, it was a mechanism to facilitate commercial transactions between countries.

For the application of these agreements it is enough to be a natural or a legal person in one of the signatory States and having executed economic transactions in the other signatory state and you only have to prove your tax residency in one of those signatory states.

In some countries, like in the UK, it is difficult to obtain the tax residence certificate if the Company has no local economic activity.  

In some others, certain type of companies is not considered taxpayer and, therefore, those companies are not entitled to receive a tax residence certificate (as in the case of LLC US).

Beyond these restrictions, implementing this type of agreements for the use of a merely incorporated Company is easy.

However, the United States included the ‘Limitation of Benefits’ clause in their tax conventions. According to this term, it is essential for any foreign Company that wants to engage commercial transactions with the US and to benefit from the application of a tax convention, to prove its residence not only with a certificate but also with a full economic activity. 

In order to limit the application of tax conventions, The OECD has included that clause in its reform plans. Therefore, in a few years we will see a comprehensive re-negotiation of all tax conventions so that they include the ‘Limitation of Benefits’ clause.

It is just a matter of time!