Double Tax Convention Notes

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Principles of International Tax Law (Double Tax Conventions) Note on Double Tax Convention Notes, created by floughnane on 07/05/2014.
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Note by floughnane, updated more than 1 year ago
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  A The types of DTCs (limited, multilateral etc.) and the negotiation of DTCs 1   Bi lateral treaties are the norm however there are some cases of multi lateral treaties Nordic states have a multi lateral convention with the aim of reducing the scope for avoidance and establishing uniformity of tax treatment.  An important feature is the zero withholding tax.CARICOM (Caribbean) of 1994.  An important feature of this is the predominance of the source principle.  Tax treaties have a clauses whereby each contracting States agrees how it will treat tax residence, to limit the circumstances in which a taxpayer might become dually resident, due to the interplay of differing domestic rules.    They may also have clauses aimed at tax avoidance  Specific rules: e.g. taxation of partnershipsGeneral rules: e.g. exchange of information  Lastly, Mutual Agreement Procedures between the 2 tax authorities

  B DTCs and domestic law:   1. Incorporation of DTCs into domestic law 3   International law applies to treaties (usually the Vienna Convention on the law of treaties - 1980).  The convention lays down the rules of territorial scope, general rules of interpretation, breaching of treaties and rules for dealing with fundamental changes in the circumstances of a State.   Treaties cannot, of themselves impose tax liabilities where none exist under domestic law - they can only reduce or eliminate domestic tax liabilities. e.g.  Domestic WHT rate on dividends = 5% and treaty provides that state may tax up to 10% then only 5% can be applied.   2. Treaty override 3   Per above the general rule is that the treaty overides the domestic provisions but when the reverse happens it is known as "treaty overide".   Intentional overide such as new domestic law is frowned uponUnintentional e.g. domestic court decision fails to look at the treaty or fails to apply Vienna interpretation (this failure could also be either intentional as there is too much tax at stake, or an unintentional oversight or mistake)When it is unintentional a state will usually undo or amend the domestic provisions.   When it is intentional, more complex issues arise to determine if a treaty can be relied upon. Common Law States:  Domestic and Treaty Law have the same status so treaty override should be possible.  However some common law States build in protection for treaties in domestic law (e.g. Australia & Canada).  UK is unclear as it has a law that that provides that a double tax treaty is to be given effect "notwithstanding anything in any other enactment".  Working on the general UK constitutional principle that Parliament cannot bind its successors it would seem possible that subsequent domestic laws can override the treaty but not laws in place at the time the treaty is made effective. Civil law states: In some civil law States treaty law is accorded higher status than domestic law and so cannot be overridden   Where override happens it is open to treaty partners to terminate the treaty.  The Vienna Convention only allows this where the override relates to a provision so material that it is unlikely the other State would have entered into the treaty if the override had been anticipated.  More likely the mutual agreement procedures will be used or the other state will make a corresponding override.

  C The format and structure of a DTC: 1. The OECD Model and the Commentaries to the OECD Model – the work of the OECD Committee on Fiscal Affairs 3   1899 - Prussia & Austria-Hungary first double tax treaty 1923 - League of Nations Finance Committee report was basis for first Model Tax Convention in 1928 addressing such questions as: Which state has priority in taxing (source and residence)Should this differ depending on type of incomeThe Committee arrive at 3 important decisions Profits of a PE of a foreign taxpayer could be taxed in the host state Tax residence depended on place of central management Subsidiaries were to be treated as separate entities for tax purposes rather than as an integral part of the parent company. At this point treaties were still rare.  As international trade developed, the transfer pricing problem emerged. In 1933 the Carroll Report to the League of Nations addressed this issue which led to a 1935 Draft Convention for the Allocation of Business Income between States for the Purposes of Taxation.  This was a forerunner to today's treaties and addressed the transfer pricing problem by requiring enterprises with establishments in more than one state to attribute to each establishment the net business income which it might be expected to derive if it were independent.  Many double tax traties followed with US and NL particularly active. 1950's - OECD was founded and took over the work of developing a model and promoting trade between member nations. It published a draft Model Tax Convention on Income and Capital in 1963     2. The UN Model 1   Developed in 1980, it favours capital importing states and was developed for use between a developed and a developing state.  Based on the OECD model but more scope afforded for taxation of foreign investor by the source state.  Designed to aid developing states to tax a larger part of the overseas investor's than other models. It permits double tax relief by exemption and includes tax sparing clauses (see page 154)   3. Specific states’ models: the US Model, the Dutch Model 1   2006 US Model is based on OECD model but with important differences.  Great emphasis on limitation of benefits with respect to its treaties (page 129 and chapter 16) No tax sparing clauses Saving clauses (Article 1.4) - page 129 & 154  

  E The interpretation of DTCs:   Treaties are governed by public international law as opposed to domestic law => problems of interpretation. Treaties need to be interpreted in a number of contexts Settling the tax liability of a resident taxpayer e.g. by granting double tax relief in accordance with the treaty.  In such cases the judge may have to have recourse to domestic law principlesIn determining in which of the 2 states an amount of income or gain is primarily taxable - e.g. in determining profits attributable to a PE the tax authority in the residence state may need to consult the tax authority of the source stateIn acting in a capacity as an independent arbitrator, for instance, on a transfer pricing dispute.  1. The general approach to interpretation 3   Different states approach matters of legal interpretation in different ways.  There are 3 main approaches; The objective approach - using ordinary meanings of words (this is prone to problems of translation/culture)The subjective approach - where the intention of the parties is examinedThe teleological approach - which looks at the aims and objectives of the treaty  Each treaty must be construed individually - although it is highly likely that a state will strive for some consistency in the interpretation of its treaties.   Court cases can be useful - e.g. definition of "beneficial ownership" in the Indofood case.  The term is widely used in treaties but rarely specifically defined.   Treaties will usually define important terms such as "person", "enterprise" or "permanent establishment" and Article 3(2) of the OECD model also provides some general rules of definition.   2. The Vienna Convention on the Law of Treaties 2   Article 31 - 33 Vienna Convention (page 1737 Materials)   Art 31 - General rule of interpretation Art 32 - supplementary rules of interpretation Art 33 - interpretation of treaties authenticated in 2 languages   3. The use of external aids for interpretation – the status and use of the OECD Commentaries 2   States may not use any material prepared unilaterally to aid interpretation - only the text itself, the preamble, the annexes and any other material prepared on a bilateral basis such as protocols, memoranda of understanding etc that were agreed upon by both parties at the time the treaty was concluded.    Art 32 of the VC provides that recourse may be had to the supplementary means of interpretation ( such as the travaux preparatoires - not generally available to the public). Art 32 provides practical means of applying the Art 31 general principles.   OECD model commentary Key source of interpretation for OECD model based treatiesAlso for US and UN based models where appropriate as these are adaptions of the OECD modelModel & Commentary are work of the Committee of Fiscal Affairs (CFA) of the OECD, composed of senior government officials in OECD MS.Status as official aid is sometimes questioned (no direct reference is made in the VC Art 31 so they fall under 32 only) but there is ample evidence of its widespread acceptance (e.g. UK case Sun Life v Pearson "the views of the experts who sat on the fiscal committee …. are entitled to a very great weight"OECD itself has stated that members should follow the commentaries when interpreting their OECD based bilateral treaties (Baker - 2002) Status of subsequent OECD amendments to the commentary - static or dynamic interpretation?  IRC v Commerzbank the subsequent material was considered to have persuasive value only However OECD in 2008 stated that where the provision in question is substantially the same as the current model version, the most recent commentary should be used (best reflects the consensus of the OECD) Smallwood case - confirmed the correct version to use was the one that was contempraneous to the facts, not the commentary in effect on the date the treaty in question was signed (this is known as the ambulatory principle)   US Technical Explanations: Not acceptable as a means of interpretation (as it is unilateral) unless where the treaty partner publicly declares its recognition for that explanation.  4. The application of Art. 3(2) OECD MTC 2   Art 3(2) - undefined terms have the meaning under the domestic law of the state for the purposes of the taxes covered (unless the context demands otherwise).  If the domestic definition is altered afterwards the consensus is that the ambulatory approach should be used.   5. Resolving interpretation issues by competent authority proceedings – Art. 25(3) OECD MTC 2   The mutual agreement procedure provided for in Article 25 will often be used to agree on a common definition of a term.   Generally the rule is that the term be given the meaning which it has in the domestic tax law of the states.  What if the local tax law definition changes over time? - generally the ambulatory definition is used - i.e. the most up to date definition.

II Double Taxation Conventions (DTCs) focusing on the current version of the OECD Model Tax Convention (MTC) Candidates will be expected to understand the operation of the provisions of the OECD MTC, to show awareness of the major points in the Commentary to the relevant Article of the OECD MTC and be aware of key reports of the OECD Committee on Fiscal Affairs and major international cases on the topic A The types of DTCs (limited, multilateral etc.) and the negotiation of DTCs 1   Bi lateral treaties are the norm however there are some cases of multi lateral treaties Nordic states have a multi lateral convention with the aim of reducing the scope for avoidance and establishing uniformity of tax treatment.  An important feature is the zero withholding tax.CARICOM (Caribbean) of 1994.  An important feature of this is the predominance of the source principle.  Tax treaties have a clauses whereby each contracting States agrees how it will treat tax residence, to limit the circumstances in which a taxpayer might become dually resident, due to the interplay of differing domestic rules.    They may also have clauses aimed at tax avoidance  Specific rules: e.g. taxation of partnershipsGeneral rules: e.g. exchange of informationLastly, Mutual Agreement Procedures between the 2 tax authorities   F Provisions relating to the scope of a DTC2:   Art. 1 (Persons covered) Invariably "persons resident in one or both Contracting States" although there may also be limitations on the persons entitled to benefits in separate "limitation of benefits" clauses or in the articles dealing with vulnerable types of income (e.g. dividends, interest, royalties).   Art. 2 (Taxes covered) Taxes to be covered are listed either in general or specific terms (often both).  Usually similar taxes are also covered with a requirement for Contracting States to notify when significant changes have been made to a countries laws.  Indirect taxes are not normally covered.  Local taxes are sometimes covered but only where specifically indicated.   Art. 30 (Entry into Force)   Art. 31 (Termination)   G Key definitional provisions:   1. The meaning of “resident” and resolution of cases of dual residence – Art. 4 OECD MTC 3   Individuals tiebreaker Art 4(2) Companies tiebreaker Art 4(3) - place of effective management (US treaties, where a companies tie breaker exists it is normally the place of incorporation, or more recently " the place where it was created") If no tiebreaker exists then usually Art 25 must be used.   2. The permanent establishment concept: determining the existence of a permanent establishment – Art. 5 OECD MTC 3   Exam Questions on PE...     H DTC provisions relating to businesses: 1. Business profits (with or without a permanent establishment) – Art 7 OECD MTC 3 2. Shipping and air transport profits – Art. 8 OECD MTC (in outline) 1 3. Associated enterprises – Art. 9 OECD MTC: status of Art. 9 and link to transfer pricing legislation 3   I DTC provisions relating to individuals: 1. Employment income – Art. 15 OECD MTC 2 2. Self-employed income – Art. 14 OECD MTC (prior to its deletion) 1 3. Pensions – Art. 18 OECD MTC 1   J DTC provisions relating to investment income and gains: 1. Income from land – Art. 6 OECD MTC 1 2. Dividends – Art. 10 OECD MTC – including some consideration of the forms of dividend article used by key states (US, UK, France, Germany) 3 3. Interest – Art. 11 OECD MTC 3 4. Royalties – Art. 12 OECD MTC 3 5. Capital gains – Art. 13 OECD MTC 2 Level 10   K Relevance of the “other income” Article – Art. 21 OECD MTC 2   L Limitation of benefit provisions: 1. Approaches to the misuse of DTCs 2 2. Abuse of law doctrines and DTCs 2 3. State practice with respect to LoB provisions 2   M Methods of elimination of Double Taxation – Arts. 23A and 23B OECD MTC 3   N The impact of the non-discrimination Article – Art. 24 OECD MTC 2   O The resolution of disputes under DTCs: 1. Competent authority/mutual agreement procedures – Art. 25 OECD MTC 2 2. Alternative means of resolving international tax disputes 2   P The application of DTCs to electronic commerce: 1. The work of the OECD Taxation Advisory Group 2 2. E-commerce and permanent establishments 2

Double Tax Conventions

Types of DTC

DTCs and Domestic

History

Interpretation

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