Table of Authorities
International Instruments
- OECD Model Tax Convention on Income and on Capital 2017
- United Nations Model Double Taxation Convention between Developed and Developing Countries 2017
Page Contents
Introduction
As the world moves increasingly towards economic integration and globalization there is a lot of cross border trade, investment and business which will only increase as more and more developing and least developed countries open up their borders for more business with the international community. In such a competitive and trade driven atmosphere every country wants to attract the best businesses and investment into their economies. This has resulted in these countries vying to create a consistent and facilitative business atmosphere. One of the most important topics in this regard has come to be the framework for taxation especially of multinational entities and cross-border transactions and money flows. A comprehensive framework for cooperation in taxation between countries and checking the shifting of tax base for saving profits from taxation are the most popular issues for academic and legal discourse in the field of international taxation today. Many organizations thus come up with their own model laws in this regard which can be used by countries to base their tax treaties with each other. The two most popular ones are the OECD and the UN model tax conventions which have been used by many countries to design treaties amongst themselves.
Quite naturally different countries have different objectives to achieve for different purposes from their tax treaties. For example least developed countries (LDCs) and developing countries that open their borders and resources up for foreign businesses want to get higher taxation returns from them in order for development and common good and thus would prefer a system which would allow taxation at the source state where the income or profit is derived. On the other hand, the developed nations would want a more residence based taxation system as they are mostly capital exporting countries. Added to this is the pressure of having good ease of doing business and investor friendly environment has led to certain less developed countries to relent taxation rights in order to be more attractive business destinations. However, this is a double edged sword.
Keeping all this in mind, this paper is aimed at doing a comparative analysis between the two main model tax instruments i.e. the OECD and the UN models and which are one is more suited towards LDCs and developing countries and which is not due to being more beneficial towards already developed countries.
Negotiating Bilateral Tax Treaties: Reasons and Considerations
Before we can discuss which model tax convention is better for which kind of countries and why, we must first look at what is the basic premise behind choosing tax treaties and what kind of considerations different countries have in mind while negotiating these treaties with each other.
The basic premise behind having tax treatise is to choose the extent to which one country is ready to forego some of its taxing rights in order to address concerns of double taxation, tax evasion and for promoting investment and business. There are two main ways in which income or profits from international transactions are taxed by countries. First, by asserting the right to tax the source of the income by the country where it originates and the second is by asserting the right to tax the resident whom the income accrues to by the country where the resident is situated.[1] There exists a third assertion which is mostly used only by the USA and originates in its own Model Tax Treaty by the US Treasury Department is the assertion on the basis of Citizenship.[2] However, this is not a very widely accepted position apart from the USA which also applies it with various qualifications in practice. Therefore, we will only consider the two main principles stated earlier. In the absence of any tax treaty, the first problem is that both countries might end up taxing the income due to conflicting assertions. The second possibility is that the source country where the income is generating will always be successful in taxing the income first before it can be repatriated thus the resident country will always be at a loss if it wants to continue to promote cross border trade and expansion of business.[3] Added to it a country like USA which also taxes based on citizenship, although rare, could complicate matters further. Another, problem that arises sometimes is the way different countries define residency of an entity for the purpose of taxation. This is especially of significance where multinational corporations are involved which are sometimes incorporated in one jurisdiction while they are organized in another or carry on their effective management form another jurisdiction.[4] This is one of the main issues that various model tax treaties have tried to address in the Permanent Establishment topic. Due to all the above reasons a good bilateral tax framework is necessary for avoiding any confusion as to conflicting definitions by states. Thus it is very necessary to have a good tax treaty for coordination.
Once establishing the necessity for a tax treaty as the first consideration the logical next consideration is which country needs to relent its rights to what extent as to not be very adversely affected by foregoing taxation rights at the expense of promoting business. This is the core of treaty negotiations and choice of a model tax convention as the correct basis for negotiations.
Negotiating for the correct rights under a tax treaty is an easier venture when two developed countries are involved. This is so because developed countries have a much healthier two-way when it comes to capital exporting activities.[5] Thus whatever taxing rights a country gives up in income sourced in its territory in favor of the other country which has residency over the earner will be offset by the other country giving up its rights on the residents of the first country.[6] Thus the treaty negotiations between such countries are relatively easier as they give mutual benefits to each other based on their advantages in whichever sectors they export business to each other.
This is not so easy when it comes to developing or least developed countries. Firstly, they do not have the same level of overseas trade and investment as their developed counterparts and thus if they give up a lot of rights in favor of resident countries they will not be able to offset these from the gains they may make from exporting capital to the developed countries.[7] Secondly, most LDCs and developing countries require more revenue in order to support their developing industries and also for various systemic and social issues that they face and therefore cannot afford to lose immediate tangible tax income for future strategic or economic gains which may or may not flow for other factors.[8] Even so many developing nations have done this due to pressures of ensuring a place in the international trade arena. Finally, where two LDCs or developing countries are involved who do not have any clear cut comparative advantage over each other, the tax negotiations can become very difficult and at times even acrimonious.
Thus these are the main considerations that various countries have based on their economies and their place in the development spectrum. Based on these, most countries draw inspiration from different model tax treaties to formulate their own tax treaties with different countries. The two main models in these regard i.e. the UN model and the OECD model are discussed in the next chapter in detail as to which is better which kind of country.
Comparative Analysis of the OECD and The UN Model Tax Conventions
Background
Thus far we have seen that tax treaties not only solve problems such as double taxation, tax avoidance etc but they also are relevant to the conditions of the taxing jurisdictions and the kind of economic benefits they want to derive from their relationship with the other contracting state. Quite naturally then the two main treaties formed by the OECD and the UN serve such considerations over and above the basic concerns of double taxation, tax avoidance etc.
It is widely observed that the OECD model is more favorable towards capital exporting countries than the UN which is more equitable towards capital importing countries.[9] To understand this point the historical underpinnings of the two models need to be understood. The OECD which is an organization of mostly economically stronger nations came out with its tax model first for cooperation between its members but more and more countries started attaching themselves to it so that they can be on good economic and strategic terms with the OECD.[10] Therefore the OECD model still has a more pro capital exporting countries orientation as it was made to cater countries which export business to other countries which become the source of income for their resident entities. Due to this form of the OECD it was realized by the UN mostly at the behest of LDCs and developing countries that a new model is required with a framework which is more sympathetic towards capital importing countries that rely on being investment destinations for economic development.[11] Keeping this in mind, an in depth analysis of the provisions of the two models and how it affects LDCs and Developing countries is given below.
The UN Model vis-à-vis The OECD Model
At the very outset the very name of the UN model tries to reflect the difference between the two models. While the full name of the UN model is the Model Double Tax Convention between Developed and Developing Countries, the OECD model is named the Model Tax Convention of Income and on Capital. Further the official Introduction of the UN Model very clearly and outright states that it favors a “Source Country” taxing right approach or the “host of investment” which is mostly done for the sake of developing countries but some developed countries also support it today.[12] On the other hand, the OECD model talks about concepts of clarification, standardization and confirmation of taxpayer’s rights and liabilities and also talks about co-operation by nations in the field of tax administration.[13] The UN model goes on to say that although it favors source taxation more but it represents a compromise between the two approaches and seeks to balance them by various means.[14] The OECD model purports that the UN model significantly takes from the OECD model while differing from OECD model in some respects which the OECD has also tried to take into account following some countries’ representations.[15]
Thus even though it is true that a large portion of the two models is quite similar in form and effects, the major differences in the more substantial provisions of the models give them their respective characteristics that differentiate them. These major differences are discussed below by comparing the concerned provisions in detail.
Definitions Clause: The definition clause of both the model conventions is contained under Article 3. There are very few significant differences between the two models regarding this. The most important ones are that the OECD model includes the definitions of “enterprise” and “business” which is not present in the UN model at all.[16] The reason this has been done under the OECD is because the OECD model has done away with the separate provision on Independent Personal Services which the UN model retains. Therefore these two definitions cover such services in order to bring them under the provisions for permanent establishments and business profits. This was done because it was observed that there was no tangible difference intended by contracting states between permanent establishment and fixed base which was earlier used for the provision on independent personal services and that there was no solid differentia between activities falling between business profits and professional services.[17] The UN model thought that there might be situations where these two concepts could differ and also because having a separate provision gives a stronger basis for negotiations and bargaining power to states who are concerned about such services in their areas.[18] Therefore, the UN model retains the provision although it makes space for an OECD like format if states wish so.
The other minor difference is that the OECD model contains the word nationality and citizenship under the definition of nationals while the UN model only uses citizenship. This was done in the OECD model as some states use either of the two words and thus the definition would unnecessarily get restricted by inclusion of only one of the terms.[19] The other major difference is that the OECD model includes the definition of recognized pension fund within it while the UN model makes it optional as many states do not include such funds under tax conventions.[20]
Permanent Establishment: The provisions dealing with permanent establishment (Article 5) is where the UN model seems to be more favorable for source based taxation and thus better of LDCs and developing countries.
The very first difference is the threshold for building sites which is 12 years in case of the OECD while it is six months in case of the UN model. The immediate effect of this is that construction and infrastructure industries get a larger leeway in taxation in host states in terms of the OECD model. However, the major reservation against this has been leveled as technological advancement and modern building methods which create a taxable footprint much before a timeline like 12 months.[21] Thus a timeline like 12 months could be too rigid a one in which time the whole project itself is finished given that such larger taxable projects of this sort are mostly carried on by larger infrastructural firms from advance countries.
The next difference is that the UN model contains a provision for when providing services falls under permanent establishment.[22] Such a provision is completely missing from the OECD model which propounds that there should be no difference between provision of goods or services.[23] However, this can be very damaging for countries that import a lot of high value services especially modern technological or online services as under the OECD they shall be treated in a very traditional “brick and mortar” establishment approach which might not address the concerns of many types of services trade properly and the UN model has tried to tackle this concern.
The next major difference occurs in Para 4 of Article 5 in the two models which deal with exclusions from permanent establishment. The OECD model says that any establishment dealing with storage, display and delivery only shall be excluded while the UN model includes delivery under permanent establishment.
Moving forward, the UN Model also is more stringent towards agents acting on behalf of an enterprise as it provides that an agent who doesn’t conclude any contracts on behalf of the enterprise but maintains stock and delivery for the enterprise also amounts sufficiently as taxable permanent establishment in that state.[24] The UN model also provides for provision dealing with special conditions where income from insurance industry amounts to taxable nexus to the source country.
All these additional provisions in the UN model basically mean that the UN model is quite favorable to developing and least developed countries as all these inclusions which amount to more permanent establishments in the source states. Also many of these inclusions have been brought keeping in mind the concerns of such countries and keeping in mind the need of the hour in the wake of more modern and complex problems.
Business Profits: The rule on business profits is contained in Article 7 of the two models. The main difference between the two models is that the UN model provides taxation of such profits of an enterprise which are not directly attributable to a permanent establishment of an enterprise but pertain to same or similar kind of goods sale or same or similar kinds of business activity as the permanent establishment of the enterprise. This is also known as the “limited force of attraction rule” and has been criticized by more developed countries as it provides for taxation of income which is not directly attributable to the permanent establishment which might disincentivize business and burden taxpayers.[25] However, such a rule has implications of developing countries as it brings other business income under taxation while also providing certainty in attribution of such profits which in the absence of such a provision would be left to the negotiations between contracting states where the developed country could dominate ad arm twist the other country.
Transport and Shipping: Article 8 of the UN model provides two alternatives; the first one is the same as the OECD model which means the residence state has taxing rights on enterprise running the international traffic. The second approach is that when the activity has a “more than casual” attachment to the source state then it may also enjoy taxation rights. This arrangement of more than casual involvement was included for the betterment of LDCs and developing nations as they often do not have well developed shipping and international transport facility thus depend heavily on enterprises based in developed jurisdictions.[26]
Dividends, Interests and Royalties: As far as dividend under Article 10 in the two models is concerned, the UN model leaves it to personal negotiations between state parties to decide the maximum rate of tax charged on foreign direct investment and foreign portfolio investment by source countries. The OECD provides 5% and 15% respectively for FDI and FPI. The UN model does this because the relative conditions of parties might differ if they are developed, developing or LDCs and providing a blanket rate might go against that.[27] Even many OECD countries have higher rates than those suggested by the OECD model and thus the purpose of those rates becomes even more questionable. [28] Article 11 on interest arising from various kinds of claims is also left for bilateral negotiations in the UN model as opposed to the OECD model for the same reason.
Article 12 deals with royalties. The UN model provides for source country taxation for royalties while the OECD model does not. Despite the OECD model not providing for it more than half the countries follow the UN approach for the reason that ideally royalties from intellectual property should be taxed where the intellectual property is being used and creates value there.[29]
Capital Gains: Capital gains are discussed under article 13 of the two models and are mostly similar in both the treaties. However, the UN model provides for a catch-all provision that says that any other sort of capital gain arising from sources other than immovable property can also be taxed in the source country based on bilateral negotiations for the same.[30]
Other Income (Article 21): The other income provision is a residuary provision dealing with any sort of income not dealt with in any other provision of the convention. This is generally as a matter of practice left to resident country taxation. However, the UN model gives leeway for source taxation of such income in cases where it arises in source country and it has a domestic provision dealing with it. In such cases there can be a division of taxation rights between the two countries.[31]
Conclusion
The paper firstly discussed why a good tax convention is necessary for countries today. Thereafter we looked at the various considerations that go into tax treaty negotiations between countries and the basic differences between developed countries and developing countries and their corresponding concerns regarding tax treaties. In the backdrop of this the paper then went on to a detailed comparison of the United Nations Model and the OECD model. Keeping all this in mind it is not difficult to conclude that the OECD model is very westward/ developed countries favoring model even though it purports that it has addressed the concerns of other countries as well. The UN model clearly gives a lot more rights of source country taxation which is objectively good for LDCs and developing countries and also provides a good base for negotiating tax treaties at the very least. Furthermore, the UN model also takes into account and tries to address more current trends and issues relating to building sites, treatment of services, delivery services and royalties on intellectual property. Thus it has a more modern approach so to say. Lastly, the UN model borrows a lot of its basic framework from the OECD model itself and makes additions and modifications to it in order to make it more equitable and more suitable for a larger amount of member nations. Thus it can be considered to bring together the best of both worlds i.e. all the salient features of the OECD model along with the more equitable approach developed through the UN mechanism taking into account the consideration of a larger number of countries. In light of all this, it can easily be concluded that the UN model is much better suited to the needs of Least Developed Countries and Developing Countries including India.
Bibliography
Articles
- R. Whittaker, ‘An Examination of the O.E.C.D. and U.N. Model Tax Treaties: History, Provisions and Application to U.S. Foreign Policy’ 8 N.C. J. Int’l L. & Com. Reg. 39 (2016) <https://core.ac.uk/download/pdf/151515676.pdf>
- Michael Lennard, ‘The UN Model Tax Convention as Compared with the OECD Model Tax Convention – Current Points of Difference and Recent Developments’ Asia Pacific Tax Bulletin (2009) <https://www.taxjustice.net/cms/upload/pdf/Lennard_0902_UN_Vs_OECD.pdf>
- PWC, ‘OECD and UN updated income and capital Model Tax Conventions provide guidance on BEPS and other issues’ Tax Policy Bulletin (2018) <https://www.pwc.com/gx/en/tax/newsletters/tax-policy-bulletin/assets/pwc-oecd-un-updated-income-capital-model-tax-conventions.pdf>
- Veronika Daurer and Richard Krever, ‘Choosing between the UN and OECD Tax Policy Models: an African Case Study’ EUI Working Papers RSCAS 2012/60 <https://cadmus.eui.eu/bitstream/handle/1814/24517/RSCAS_2012_60rev.pdf?sequence=3>
Other Sources
- Commentaries on the Articles of the OECD Model Tax Convention < https://read.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version
- -2017_mtc_cond-2017-en#page9>
- Commentaries on the Articles of the United Nations Model Double Taxation Convention < https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf>
[1] PWC, ‘OECD and UN updated income and capital Model Tax Conventions provide guidance on BEPS and other issues’ Tax Policy Bulletin (2018) <https://www.pwc.com/gx/en/tax/newsletters/tax-policy-bulletin/assets/pwc-oecd-un-updated-income-capital-model-tax-conventions.pdf>.
[2] Donald. R. Whittaker, ‘An Examination of the O.E.C.D. and U.N. Model Tax Treaties: History, Provisions and Application to U.S. Foreign Policy’ 8 N.C. J. Int’l L. & Com. Reg. 39 (2016) <https://core.ac.uk/download/pdf/151515676.pdf>.
[3] Veronika Daurer and Richard Krever, ‘Choosing between the UN and OECD Tax Policy Models: an African Case Study’ EUI Working Papers RSCAS 2012/60 <https://cadmus.eui.eu/bitstream/handle/1814/24517/RSCAS_2012_60rev.pdf?sequence=3>.
[4] Donald. R. Whittaker (n 2).
[5] Veronika Daurer and Richard Krever (n 3).
[6] Veronika Daurer and Richard Krever (n 3).
[7] Veronika Daurer and Richard Krever (n 3).
[8] Veronika Daurer and Richard Krever (n 3).
[9] PWC (n 1).
[10] Donald. R. Whittaker (n 2).
[11] Donald. R. Whittaker (n 2).
[12] United Nations Model Double Taxation Convention between Developed and Developing Countries 2017, Introduction Para 3.
[13] The OECD Model Tax Convention on Income and on Capital 2017, Introduction Para 2.
[14] United Nations Model Double Taxation Convention between Developed and Developing Countries 2017, Introduction Para 12, 13.
[15] The OECD Model Tax Convention on Income and on Capital 2017, Introduction Para 14.
[16] The OECD Model Tax Convention on Income and on Capital 2017, Art. 3(1) (c), (h).
[17] OECD Commentary on Article 14 <https://read.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2017_mtc_cond-2017-en#page9>.
[18] UN Commentary on Article 14 <https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf>.
[19] OECD Commentary on Article 3 <https://read.oecd-ilibrary.org/taxation/model-tax-convention-on-income-and-on-capital-condensed-version-2017_mtc_cond-2017-en#page9>.
[20] UN Commentary on Article 29 Para 14 <https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf>.
[21] Michael Lennard, ‘The UN Model Tax Convention as Compared with the OECD Model Tax Convention – Current Points of Difference and Recent Developments’ Asia Pacific Tax Bulletin (2009) <https://www.taxjustice.net/cms/upload/pdf/Lennard_0902_UN_Vs_OECD.pdf>.
[22] United Nations Model Double Taxation Convention between Developed and Developing Countries 2017, Article 5(3)(b).
[23] Michael Lennard (n 21).
[24] United Nations Model Double Taxation Convention between Developed and Developing Countries 2017, Article 5(5)(b).
[25] Michael Lennard (n 21).
[26] UN Commentary on Article 8 <https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf>.
[27] UN Commentry on Article 10 <https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf>.
[28] Michael Lennard (n 21).
[29] Michael Lennard (n 21).
[30] UN Commentary on Article 13 Para 5 <https://www.un.org/esa/ffd/wp-content/uploads/2018/05/MDT_2017.pdf>
[31] United Nations Model Double Taxation Convention between Developed and Developing Countries 2017 Article 21(3).
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