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Chapter 4

Tax law

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17 views8 pages

Chapter 4

Tax law

Uploaded by

Deniz Onal
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Chapter 4 ‘Tax Treaties and Their Role in International Taxation 4.1, What are tax treaties? A treaty can be defined as “an international agreement concluded be- ‘ween States in writen form and governed by international law, whether embodied in a single instrument or in two or more related instruments and whatever its particular designation’! Tax treaties, which are one of ‘many categories of treaties, are those that deal with matters related 10 taxation ‘There are various types of tax treaties and various approaches to catego ricing them. ‘The main types are presented in part 2 of this book. They include () tax treaties concluded on a bilateral basis, Le. treaties between two parties, which are the most widespread form of tax treaties and (i) ‘multilateral treaties, Le. treaties concluded by more than two partes. The ‘models for bilateral treaties are discussed further in chapter 5, and mult Iateral treaties are discussed in chapter 6, “Tax treaties can differ depending on the type of taxes they cover. By a large majority, the most prevalent are treaties that cover taxes on income ‘and taxes on capital. These treaties are generally based on various versions of the OECD Mode! and many include elements from the UN Model (see ‘chapter 5). Income and capital tax treaties are also commonly referred to as “comprehensive tax treaties", due o the fact that they include provisions forall or most types of income, e.g. business income, passive income and ‘employment income. In contrast, some tax treaties govern only issues re lated to the taxation of a specific type of income, such as income derived from international shipping and air transportation. Inheritance and gift treaties cover taxes on estates, inheritance and gifts” Additionally, there are treaties that regulate cross-border matters related to social security levies, and several countries have developed Vienna Convention om he Law of Treaties at. 2(1(2) (23 May 1969), Treaties ID therenafter Vienna Convention. 2. See alo OECD Estate, Ineriice and Gift Model Convention (3 June 1982), Hodes IBFD. 45 ‘Chapter 4 -Tax Treaties and Their Role in International Taxation ‘an extensive network of such treaties." Administrative assistance agree- ments are another category of tax treaties, which include, among others, lax information exchange agreements. These treaties are discussed in chapter 7 4.2, Tax treaties and the domestic legal framework ‘Tax treaties, together with domestic legislation, create a legal framework for countries’ tax systems. From the moment a treaty becomes part of domestic law, itis binding on taxpayers and on the tax authorities of the ‘contracting states. Furthermore, from that moment on, a treaty becomes enforceable by the judiciary system. The manner in which tax treaties are introduced into the domestic system, as well as the interaction between ‘domestic legislation and tax treaties, are discussed in chapter 24 though part of the domestic legal framework, tax treaties operate der ently ftom the provision of domestic a. The main difference is that tax treaties generally* do not create tax liability for taxpayers: among other things, they determine which of the weaty parters has the right to tax and to what extent this right can be exercised. Accordingly, when a tax realy provides, for example, that income “may be taxed in a Contracting State {according tothe laws ofthat State" such right ean be exercised bythe ‘nractng state only ifthe domestic lw of that state allows i o tax that particular ype of income. For that reason, atax treaty is relieving in nature by limiting the right wo tax of contracting stats. Even though tax treaties c certain interpretations, nevertheless deteriorate the postion of a taxpayer. This was the case in a decision of the Supreme Court of the Netherlands in 1980," in which, asthe result of the application ofthe treaty’s residency ot ereate a tax liability, they may, subject to 3. Foe example, the Netherlands has conciuded 24 socal security agreements ‘with counties outside the European Economic Area (EU Memb Sats pls Iceland, icchtensicin and Norway). The EEA countries and Switzerland are covered by the [rovsioos of EU Regulation No, 883/2004 onthe coordination of socal security s8- 4. In some counties, however, views have been expresed that a ax treaty thats futlyadoped inthe domestic ax system may be interpreted as creating ata ibiiy, regardless ofthe provisions ofthe domestic law. As an example see ‘Austalisn Tax Office: AU: TR2O0I3 Income Tax: Interpreting Aust ‘Tax Treaties, 2001 (consolidated 2016) Such views, however, are marginal. 5. NL: HR, 12 Mar. 1980, 19180, No disclosed ». De inpecter, Tax Treaty Case Law IBFD, 46 “The roe of tax teatit rules, a taxpayer was denied an income tax deduction that otherwise would hhave been available, Nevertheless, this decision has not seta consistent line of interpretation by Dutch jurisprudence, and such a position seems to be ‘an aberration rather than the norm, 4.3. The role of tax treaties ‘Traditionally, tax treaties are concluded fortwo main purposes: (i) forthe avoidance of double taxation, in particular when double taxation arises as ‘result of source and residence taxation; and (i) forthe prevention of fs- cal evasion, ‘The OBCD confirms that the accomplishment of these two purposes is the ‘main objective of the OECD Model. The introductory text to the OECD. ‘Model reads as follows: 2. Ithas long been recognized [..] that itis desirable to clarity, standaeise, and confirm the fiscal situation of taxpayers who are engaged in commercial, ‘or any other activities in other counties through the p= plication by all euntres af common solutions to identical cases of double {axation, These countries have also long recognised the need to improve ad- ministrative co-operation in tax matters, notably through exchange af itor: ‘mation and assistance clletion of axes, forthe purpose of preventing tax evasion and avoidance, 3. These ae the main purposes af the OECD Made! Tox Convention on In- ‘ome and on Capital. “These two main purposes are reaffirmed by the titles of many tax treaties, ‘Which are often worded as “Agreement Between (State A] and [State B] for the Avoidance of Double Taxation and the Prevention of Fiscal Eva- sion with Respect to Taxes on Income and on Capital” or other similar language. Sections 4.3.1-4.3.3 present the treaty mechanisms for the avoidance of double taxation and the prevention of tax evasion and avoidance, as well as discuss other important roles of tax treaties. 6 OECD Model Tax Convention on Income and on Capita introduction, paras. 2 and 321 Nov. 2017), Models IPD (hereinafter OCD Model (2017) ” ‘Chapter 4 Tax Treaties and Their Role in International Taxation 43.1. Avoidance of double taxation ‘The avoidance of double taxation is by far the most important purpose of tax treaties, This is primarily achieved through the limitation ofthe taxing rights of one or both ofthe contracting states and through the application ‘of a double tax relief method ‘The limitation of taxing right is achieved through the application of so- called distributive rules (or allocation rules), The purpose of these rules is to indicate which of the contracting states has the right to tax and to ‘what extent tis right can be exercise’ Ideally, such rules would provide for no overlap ofthe taxing rights of both contracting states. In situations \where such overlap exists, ie. when both states are allowed to tax the same income (ether fully ort limited extent, the state of residence must pro- vide relief from double taxation. ‘The distributive rules are included in a tax treaty’ substantive articles that apply to particular types of income and capital, while relief from double taxation is regulated in a separate article. Both the substantive provisions 1s well as the rules for the relief of double taxation are discussed in depth in part 3 ofthis book, ‘Most tax treaties contain the main distributive rules, similar to those in the OECD Model. Under these rules, the state of residence is generally (al- though by no means always) allowed to taxa particular item of income or capital, while the extent of taxing rights of the source state differs depend- ing on the treaty provision Inthe first type of distributive rule, the source state is not allowed to tax at all, giving exclusive taxing rights tothe residence state. Typically, such provisions include the phrase "shall be taxable ony in [..". For example, under article 12 of the OECD Model, royalties may be taxed only in the state of residence. Provisions on pensions under article 18 of the OECD ‘Model in most cases also give exclusive taxing rights co the state of resi- dence. Since the income is taxed in only one state (ie, the residence state), double taxation is eliminated entirely. 7 Although commonly used, the terms “allocation rules" and “isributive ules” ae not eately correct. Infact, more pevise tem is “Limitation rules”. This is be suse tx teas generally dono crate ax ibility for taxpayers; thera ist imi the extent which domestic ule canbe applied, See further se. 82. 48 ‘The rol oftax treaties In the second type of distributive rule, the source state also has a right to tax, but this right is limited to a specified maximum. For example, arti- cle I1 of the OBCD Model allows the source state to tax interest payments, but such tax may not exceed 10% ofthe gross amount. The usual wording of such provision is: “[..] may also be taxed in (...] but (..] the tax so charged shall not exceed [...]". Under this type of distributive rule, double taxation is not avoided entirely, and therefore, the state of residence has to provide relief from double taxation. Inthe thid type of distributive rule, the source state has unlimited taxing rights. The typial wording in this case uses the phase “may be taxed in {..1": For example, income from immovable property may be taxed in the source state under article 6 ofthe OBCD Model. Similar othe second type of distributive rule, double taxation isnot eliminated under this rule, and the residence state is required to provide rei. In adsition to these three main distributive rules, which are the most com- ‘mon in tax treaties, there are also some relatively rare provisions that grant an exclusive taxing right to the source state. Under the OECD Model, an example of such provisions is the taxation of certain remuneration for government services under article 19, Such income is taxable only by the souree state, and consequently, double taxation is avoided entirely. In the early stages of the development of the international tax treaty net- ‘work, when the first tax treaties were being signed, domestic laws did not provide sufficient solutions for juridical double taxation. Comprehensive solutions were thus being introduced by bilateral income tax treaties and \were later adopted in the first model conventions. Today, double taxation ccan, to a great extent, be resolved through domestic measures, including ‘measures limiting domestic source taxation, reduced withholding tax rates and domestic methods for relieving double taxation. Thus, one may argue that the practical role of tax treaties in resolving double taxation may have reduced in relative significance. However, the importance of tax treaties is derived from the fact that their provisions cannot be easily modified unilaterally, and therefore create a stable legal framework (see also section 43.3), 4.3.2. Prevention of tax evasion and avoidance Another important role of tax treaties is the prevention of tax evasion and tax avoidance. This could be achieved, for example, through measures on ” Chapter 4- Tax Treaties and Ther Role in International Taxation ‘exchange of information and on assistance inthe collection of taxes, which ‘ean be found in articles 26 and 27 of the OECD Model. This is also con- firmed in the introduction to the OECD Model, although itis acknow- edged there that, in the absence of the risk of double taxation, these admin- istrative measures do not by themselves justify the need forthe conclusion of a tax treaty.” In such cases, it is more appropriate to address tax evasion and tax avoidance through other more targeted instruments, such a a tax information exchange agreement. ‘The significance of tax treaties in the prevention of tax avoidance has been stressed in particular within the framework of the OECD/G20 project to tackle base erosion and profit shifting (the BEPS Project)” In this con- text, it has been expressly recognized’ that tax treaty provisions are not intended to create opportunities for non-taxation or reduced taxation. Ac cordingly itis the role of tax treaties to prevent such arrangements. AS & result of the BEPS Project, a number of provisions were introduced into the OECD Model, including a revised preamble to the Model, which ex presses the intention ofthe contracting states to “conclude a Convention for the elimination of double taxation (..] without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance” (see section 5.2), Administrative measures directed atthe prevention of tax evasion and tax avoidance are discussed in part 3 of this book. Other measures that deal ex- plicitly with anti-avoidance are within the scope of Volume 2 ofthis book. 4.3.3. Other objectives of tax treaties Besides the main role of relieving double taxation and preventing tax eva- sion and tax avoidance, tax treaties also fulil other important roles. ‘One such role is the prohibition of discriminatory tax treatment on var ‘ous grounds, including discrimination on the ground of nationality. Conse- quently, domestic law may be impacted by the non-diserimination clauses in areas other than those generally covered by tax treaties. For example, the application of non-

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