Capital Gains | Article 13 | OECD Model Tax Convention

Capital Gains as per Article 13 of the OECD Model Tax Convention

Comparison of taxation practices prevalent in the OECD Member countries shows the varied taxation practices adopted by states with respect to capital gains taxation.

Some countries have adopted No-taxation policy on the Capital gains, whereas some would tax only the enterprises for the capital gains; some countries tax all types of capital gains, some countries might be selective about it.

Article 13 of the OECD model tax convention is powerless against the domestic law of the contracting states. Moreover, Article 13 does not specify the list of taxes that is to be applied for capital gains as the Article will apply to all kinds of taxes levied by the Contracting States on capital gains.

Article 13 has created five scenarios when capital gains arise: movable property, immovable property, ships and aircraft, shares, and others.

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Capital Gains as per Article 13 of the OECD Model Tax Convention

Taxation of the capital gains on the immovable property?

Paragraph 1 of Article 13 provides the taxation rights on the alienation of immovable property (Mentioned under Article 6) to the State where the immovable property is present. The rights are not exclusive. The State of Residence may also tax the gain but has to provide credit for the taxes paid in the State of the source.

Paragraph 1 of Article 13 is applicable when:

  1. The person is a resident of one State
  2. And the immovable property is situated in another State.
  3. There is an alienation of the said immovable property


Paragraph 1 of Article 13 is supplemented by those of Paragraph 4, which applies to gains from the alienation of shares or comparable interests that derive more than 50%  of their value from immovable property.

The term ‘alienation of immovable property’  covers the capital gains resulting from the sale, exchange of property, partial alienation, the expropriation, the transfer to a company in exchange for stocks and shares, the gift, and inheritance. It includes the gain accrued in the long term or the short term (i.e., speculative).

Some countries may choose to tax or not to tax the capital gains arising from the exchange of property or on capital appreciation and revaluation of assets not involving alienation.

Explain taxation of capital appreciation of the assets briefly.

Paragraph 2 of Article 2 of the OECD Model tax convention, has briefly touched upon the taxes mentioned in this convention will also include taxes levied on capital appreciation. Hence, when the countries agreeing have adopted the policy to tax the capital gains on the capital appreciation of the asset and the asset has not been alienated, the State of the source will have the right to impose a tax on that gain if domestic law empowers it to do so.

How to compute the capital gain for Article 13?

Article 13 is silent on the methodology of computing the capital gain; domestic tax laws will be the guiding force here. The general practice is to derive capital gains by reducing the cost from the selling price. All expenses incidental to the purchases, and all expenditure for improvements form part of the cost.

If the accounting rules are different among the Contracting state, there will be a difference in capital gains computed. Let us explain the fundamental difference that would be faced:


  1. Major Inc of State A has acquired the corporate office building in State B at 10000$ in the year 2018.
  2. In the books of Major Inc, the office now stands at value 8000$ after the depreciation allowance of 2000$.
  3. Major Inc is facing a significant scandal in State B and hence chose to sell the property to Helper Inc at 12000$ in the year 2020.

Assuming State A and State B have adopted OECD model tax convention, how will State A and State B compute the capital gains?

State A:State B:
Sale value:                                                                 12000$Sale value:                                     12000$
Cost after depreciation allowance:                        8000$Cost :                                               10000$
Capital Gains                                                             4000$Capital Gains                                   2000$

State B cannot consider the depreciation allowance as the books of accounts are maintained in State A and not in State B.

State A will tax the entire gain, but provide the relief for the taxes paid in the State of the source.

Such scenarios of differences will arise due to domestic laws and the rate of exchange too.

Note: Article 13 does not apply to prizes in a lottery or premiums and bonuses attaching to bonds or debentures.

Process of capital gain taxation for property owned by a Permanent establishment

When international taxation involves the scenarios of cross border investments through the mode of the permanent establishment, the gain from the alienation of movable properties of the permanent establishment will be taxable in the State of the source.

So the next obvious question, what is movable property?

The movable property would be any property other than the immovable property mentioned under Article 6. So all the intangible, know-how, and movable property of the Permanent Establishment will attract Article 13(2).

Note: Paragraph 2 of Article 13 has a broader interpretation; hence when the permanent establishment is alienated (alone or the whole enterprise), the gain will be taxable under the State of the source.

Note: Paragraph 2 of Article 13 does not follow the concept of  ‘force of attraction of the permanent establishment.’ The Paragraph merely suggests that gains arising from the alienation of the movable property forming part of the business property of the permanent establishment are taxable in the State where permanent establishment exists. The gains from other movable property will be taxable only in the State of residence of the alienator, as provided by Article 13(5).

How to identify whether the property is part of the business property of the Permanent Establishment?

If ‘Economic ownership’ of the property is with the permanent establishment, then the property is said to be forming part of the business property. The economic ownership of the property means the equivalent of ownership for income tax purposes by a separate enterprise with the tax benefits and burdens. Accounting the property in the books will not be sufficient to connect the property to the permanent establishment effectively.

Taxation of the capital gains on the ships and aircraft?

Enterprises operating ships and aircraft in international traffic follow the principles of Article 8, and Paragraph 3 of Article 22 for capital gains taxation of movable property.

Paragraph 3 of Article 13 is applicable when:

The enterprise operating ships and aircraft alienates the movable property,

Note: Paragraph 3 applies to enterprise operating ships and aircraft in international traffic, whether for transportation activities or when leasing the vessel or aircraft on charter fully equipped, crewed, and supplied. But will not apply if the enterprise does not operate them.

Taxation of the capital gains on the shares and securities?

Taxation of the capital gains on the shares and securities are in the State where the immovable property exists when :

  1. Any time during the 365 days preceding the separation
  2. the shares or comparable interests derived
  3. more than 50%  of its value
  4. directly or indirectly from immovable property situated in a Contracting State

How to identify the value of the shares or comparable interests?

For finding the value of shares or the comparable interests, compare the value of the particular immovable property to the amount of all the property owned by the company, entity or arrangement without taking into account of debts or liabilities. (it is irrespective of whether the immovable property was on loan).

Note: The term comparable interests pull the non-corporate entities like partnerships, trusts, and others into Article 13(4).


Mr. Richguy, the resident of State R, incorporated a wholly-owned company Rich Inc on January 1, 2019. The capital of the company is 200 shares of 100$ each. He invests 15000$ to procure a commercial space in State S on the same day, and balance is available as cash balance for future opportunities. 

Mr. Richguy sold 100 shares of Rich Inc to Mr.Newguy on September 2, 2019, for 500$ each. Assuming State R and State S have adopted the OECD Model Tax Convention, which State will tax the capital gains?

According to Paragraph 4 of Article 13, State S has the right to tax the capital gains on the sale of shares from Mr.Richguy to Mr.Newguy.

What is the general rule of taxation of capital gains in case of unspecified property?

Paragraph 5 of Article 13 acts as a rule for the capital gains tax for scenarios not specified under Paragraph 1 to 4 of Article 13.

On the alienation of any property, not specified in Paragraph 1 to 4 of Article 13, the taxation rights on capital gains tax are with the State of which alienator is resident. This rule is in line with Article 22.

Are the sale of shares on liquidation of the company covered under Article 13(5)?

When the shareholder alienates the shares for:

  1. liquidation of the company,
  2. redemption of shares,
  3. reduction of capital

the difference between proceeds obtained by the shareholder and the par value of the shares is, in general, a distribution of accumulated profits, not capital gains. The difference is taxable under Article 10 as dividends, mentioned in Article 10(3).

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