Many countries have agreed with other countries in treaties to mitigate the
effects of double taxation. Tax treaties may cover income taxes, inheritance
taxes, value added taxes, or other taxes. Besides bilateral treaties, also
multilateral treaties are in place: Countries of the European Union have
also entered into a multilateral agreement with respect to value added
taxes under auspices of the EU, while a joint treaty on mutual administrative
assistance of the Council of Europe and the OECD exists open to all nations. Tax
treaties tend to reduce taxes of one treaty country for residents of the
other treaty country in order to reduce double taxation of the same income. The
provisions and goals vary highly; very few tax treaties are alike. Most
treaties: define which taxes are covered and who
is a resident and eligible for benefits, reduce the amounts of tax withheld from
interest, dividends, and royalties paid by a resident of one country to
residents of the other country, limit tax of one country on business
income of a resident of the other country to that income from a permanent
establishment in the first country, define circumstances in which income of
individuals resident in one country will be taxed in the other country, including
salary, self-employment, pension, and other income,
provide for exemption of certain types of organizations or individuals, and
provide procedural frameworks for enforcement and dispute resolution.
The stated goals for entering into a treaty often include reduction of double
taxation, eliminating tax evasion, and encouraging cross-border trade
efficiency. It is generally accepted that tax treaties improve certainty for
taxpayers and tax authorities in their international dealings.
Several governments and organizations have proposed model treaties to use as
starting points in their own negotiations. The Organisation for
Economic Co-operation and Development model treaty is often used as such a
starting point. The OECD members have from time to time agreed on various
provisions of the model treaty, and the official commentary and member comments
thereon serve as a guidance as to interpretation by each member country.
Tax residency In general, the benefits of tax treaties
are available only to persons who are residents of one of the treaty
countries. In most cases, a resident of a country is any person that is subject
to tax under the domestic laws of that country by reason of domicile,
residence, place of incorporation, or similar criteria.
Generally, individuals are considered resident under a tax treaty and subject
to taxation where they maintain their primary place of abode. However,
residence for treaty purposes extends well beyond the narrow scope of primary
place of abode. For example, many countries also treat persons spending
more than a fixed number of days in the country as residents. The United States
includes citizens and green card holders, wherever living, as subject to
taxation, and therefore as residents for tax treaty purposes. Because residence
is defined so broadly, most treaties recognize that a person could meet the
definition of residence in more than one jurisdiction and provide a “tie breaker”
clause. Such clauses typically have a hierarchy of three to five tests for
resolving multiple residency, typically including permanent abode as a major
factor. Tax residency rarely impacts citizenship or permanent resident
status, though certain residency statuses under a country's immigration
law may influence tax residency. Entities may be considered resident
based on their country of seat of management, their country of
organization, or other factors. The criteria are often specified in a
treaty, which may enhance or override local law. It is possible under most
treaties for an entity to be resident in both countries, particularly where a
treaty is between two countries that use different standards for residence under
their domestic law. Some treaties provide “tie breaker” rules for entity
residency, some do not. Residency is irrelevant in the case of some entities
and/or types of income, as members of the entity rather than the entity are
subject to tax. Permanent establishment
Most treaties provide that business profits of a resident of one country are
subject to tax in the other country only if the profits arise through a permanent
establishment in the other country. Many treaties, however, address certain types
of business profits separately. Such treaties also define what constitutes a
permanent establishment. Most but not all tax treaties follow the definition
of PE in the OECD Model Treaty. Under the OECD definition, a PE is a fixed
place of business through which the business of an enterprise is carried on.
Certain locations are specifically enumerated as examples of PEs, including
branches, offices, workshops, and others. Specific exceptions from the
definition of PE are also provided, such as a site where only preliminary or
ancillary activities are conducted. While in general tax treaties do not
specify a period of time for which business activities must be conducted
through a location before it gives rise to a PE, most OECD member countries do
not find a PE in cases in which a place of business exists for less than six
months, absent special circumstances. Many treaties explicitly provide a
longer threshold, commonly one year or more, for which a construction site must
exist before it gives rise to a permanent establishment. In addition,
some treaties, most commonly those in which at least one party is a developing
country, contain provisions which deem a PE to exist if certain activities are
conducted for certain periods of time, even where a PE would not otherwise
exist. Even where a resident of one country
does not conduct its business activities in another country through a fixed place
or business, a PE may still be found to exist in that other country where the
business is carried out through a person in that other country that has the
authority to conclude contracts on behalf of the resident of the first
country. Thus, a resident of one country cannot avoid being treated as having a
PE by acting through a dependent agent rather than conducting its business
directly. However, carrying on business through an independent agent will
generally not result in a PE. Withholding taxes
Many tax systems provide for collection of tax from nonresidents by requiring
payors of certain types of income to withhold tax from the payment and remit
it to the government. Such income often includes interest, dividends, royalties,
and payments for technical assistance. Most tax treaties reduce or eliminate
the amount of tax required to be withheld with respect to residents of a
treaty country. Income from employment
Most treaties provide mechanisms eliminating taxation of residents of one
country by the other country where the amount or duration of performance of
services is minimal but also taxing the income in the country performed where it
is not minimal. Most treaties also provide special provisions for
entertainers and athletes of one country having income in the other country,
though such provisions vary highly. Also most treaties provide for limits to
taxation of pension or other retirement income.
Tax exemptions Most treaties eliminate from taxation
income of certain diplomatic personnel. Most tax treaties also provide that
certain entities exempt from tax in one country are also exempt from tax in the
other. Entities typically exempt include charities, pension trusts, and
government owned entities. Many treaties provide for other exemptions from
taxation that one or both countries as considered relevant under their
governmental or economic system. Harmonization of tax rates
Tax treaties usually specify the same maximum rate of tax that may be imposed
on some types of income. As an example, a treaty may provide that interest
earned by a nonresident eligible for benefits under the treaty is taxed at no
more than five percent. However, local law in some cases may provide a lower
rate of tax irrespective of the treaty. In such cases, the lower local law rate
prevails. Provisions unique to inheritance taxes
Generally, income taxes and inheritance taxes are addressed in separate
treaties. Inheritance tax treaties often cover estate and gift taxes. Generally
fiscal domicile under such treaties is defined by reference to domicile as
opposed to tax residence. Such treaties specify what persons and property are
subject to tax by each country upon transfer of the property by inheritance
or gift. Some treaties specify which party bears the burden of such tax, but
often such determination relies on local law.
Most inheritance tax treaties permit each country to tax domiciliaries of the
other country on real property situated in the taxing country, property forming
a part of a trade or business in the taxing country, tangible movable
property situated in the taxing country at the time of transfer, and certain
other items. Most treaties permit the estate or donor to claim certain
deductions, exemptions, or credits in calculating the tax that might not
otherwise be allowed to non-domiciliaries.
Double tax relief Nearly all tax treaties provide a
specific mechanism for eliminating it, but the risk of double taxation is still
potentially present. This mechanism usually requires that each country grant
a credit for the taxes of the other country to reduce the taxes of a
resident of the country. The treaty may or may not provide mechanisms for
limiting this credit, and may or may not limit the application of local law
mechanisms to do the same. Mutual enforcement
Taxpayers may relocate themselves and their assets to avoid paying taxes. Some
treaties thus require each treaty country to assist the other in
collection of taxes and other enforcement of their tax rules. Most tax
treaties include, at a minimum, a requirement that the countries exchange
of information needed to foster enforcement.
Tax information exchange agreement The purpose of this agreement is to
promote international co-operation in tax matters through exchange of
information. It was developed by the OECD Global Forum Working Group on
Effective Exchange of Information. The working group consisted of
representatives from OECD Member countries as well as delegates from
Aruba, Bermuda, Bahrain, Cayman Islands, Cyprus, Isle of Man, Malta, Mauritius,
the Netherlands Antilles, the Seychelles and San Marino.
The agreement grew out of the work undertaken by the OECD to address
harmful tax practices. The lack of effective exchange of information is one
of the key criteria in determining harmful tax practices. The mandate of
the working group was to develop a legal instrument that could be used to
establish effective exchange of information.
The agreement represents the standard of effective exchange of information for
the purposes of the OECD’s initiative on harmful tax practices. This agreement,
which was released in April 2002, is not a binding instrument but contains two
models for bilateral agreements. A number of bilateral agreements have been
based on this agreement. Dispute resolution
Nearly all tax treaties provide some mechanism under which taxpayers and the
countries can resolve disputes arising under the treaty. Generally, the
government agency responsible for conducting dispute resolution procedures
under the treaty is referred to as the “competent authority” of the country.
Competent authorities generally have the power to bind their government in
specific cases. The treaty mechanism often calls for the competent
authorities to attempt to agree in resolving disputes.
Limitations on benefits Recent treaties of certain countries
have contained an article intended to prevent "treaty shopping," which is the
inappropriate use of tax treaties by residents of third states. These
limitation on benefits articles deny the benefits of the tax treaty to residents
that do not meet additional tests. Limitation on Benefits articles vary
widely from treaty to treaty, and are often quite complex. The treaties of
some countries, such as the United Kingdom and Italy, focus on subjective
purpose for a particular transaction, denying benefits where the transaction
was entered into in order to obtain benefits under the treaty. Other
countries, such as the United States, focus on the objective characteristics
of the party seeking benefits. Generally, individuals and publicly
traded companies and their subsidiaries are not adversely impacted by the
provisions of a typical limitation of benefits provision in a U.S. tax treaty.
With respect to other entities, the provisions tend to deny benefits where
an entity seeking benefits is not sufficiently owned by residents of one
of the treaty countries. Even where entities are not owned by qualified
residents, however, benefits are often available for income earned from the
active conduct of a trade or business. Priority of law
Treaties are considered the supreme law of many countries. In those countries,
treaty provisions fully override conflicting domestic law provisions. For
example, many EU countries could not enforce their group relief schemes under
the EU directives. In some countries, treaties are considered of equal weight
to domestic law. In those countries, a conflict between domestic law and the
treaty must be resolved under the dispute resolution mechanisms of either
domestic law or the treaty. External links
Pension tax relief Australian tax treaties
Barbados tax treaties Canada income tax treaties
Dutch tax treaties Mauritius tax treaties
Singapore tax treaties United Kingdom tax treaties
U.S. income tax treaties List of U.S. estate and gift tax
treaties The Exchange of Tax Information Portal
Notes