The following points highlight the top three models for avoidance of double tax. The models are: 1. OECD Model Convention on Income and Capital (OECD MC) 2. UN Model Convention (UN MC) 3. US Model Convention (US MC).
Avoidance of Double Tax: Model # 1. OECD Model Convention on Income and Capital (OECD MC):
The OECD MC consists of 30 Articles under seven chapters.
The specific subjects covered in the MC are listed below:
Personal scope (Article 1)
Taxes covered (Article 2)
General definitions (Article 3)
Resident (Article 4)
Permanent establishment (Article 5)
Business profits (Article 7)
Shipping, inland waterways transport and air transport (Article 8)
Independent personal services (Article 14) – now deleted
Income from employment (Article 15)
Directors’ fees (Article 16)
Artistes and sportsmen (Article 17)
Government service (Article 19)
Income from immovable property (Article 6)
Income from movable property (Article 7)
Dividends (Article 10)
Interest (Article 11)
Royalties (Article 12)
Capital gains (Article 13)
Pensions (Article 18)
Students (Article 20)
Other income (Article 21)
Elimination of double taxation and treaty relief (Article 23)
Exemption method (Article 23A)
Credit method (Article 23B)
Associated enterprises (Article 9)
Capital (Article 22)
Non-discrimination (Article 24)
Mutual agreement procedure (Article 25)
Exchange of information (Article 26)
Assistance in the collection of taxes (Article 27)
Members of diplomatic missions and consular posts (Article 28)
Territorial extension (Article 29)
Entry into force (Article 30) Termination (Article 31)
Other Contents of the Model Convention:
Besides the text of the Articles, the OECD MC provides:
4. Positions of non-OECD States
As from OECD MC Update 1997, the OECD Model is presented in two volumes. Volume I include the text of the Articles contained in the Model together with Commentary on each Article. Volume II includes reprints of various reports issued by the OECD’s Committee on Fiscal Affairs since 1977, together with information on the Positions of non-Member countries.
The Commentaries illustrate or interpret the provisions of the treaty, as recommended by the OECD. They are intended to guide the application and interpretation of treaties. The Commentary on each Article also contains the Observations and Reservations, where expressed by the OECD Member States.
The Reservations express a disagreement with the text (or any variations permitted by the Commentaries) of the MC by Member States, while the Observations present their disagreements with the interpretation under the Commentaries.
Unless mentioned in the Observations and Reservations, the OECD Member States are assumed to have agreed with the MC text and the interpretation given by the Commentaries. As from 1999, the MC also contains Positions on the OECD Articles and Commentaries received from several non-OECD States.
It is arguable whether they are bound by the interpretations under the Commentaries, particularly as they were not involved in their preparation. In their case, the Commentaries are considered as a strong persuasive factor, if not necessarily binding, on them.
The text of the MC and its Commentaries are periodically updated. Since 1992, they have been updated in 1994, 1995, 1997, 2000 and 2003. The next update is expected in late 2005. These updates are amendments that reflect both substantive changes in the Articles as well as clarifications and tax treatment of new developments (e.g. electronic commerce) in the Commentaries.
Clearly, changes to the text of the Articles of the MC do not affect existing treaties unless their provisions are renegotiated accordingly. As regards the Commentaries, it is debatable whether the changes that are made to it can be applied to existing treaties.
The revised Commentaries reflect the current thinking of the OECD Committee on Fiscal Affairs, which is responsible for the MC. It suggests that its latest version should be applied to existing treaties, wherever possible.
However, the OECD MC Introduction also mentions that the amendments are largely “intended to simply clarify, and not change, the meaning of the Articles or the Commentaries”, and they cannot be applied to support a contrary interpretation. Therefore, significant changes in negotiated tax treaties may be difficult to make through changes in the Commentaries.
In recent years, the Committee has attempted to make substantive changes in negotiated tax treaties through changes in the Commentaries. Some commentators believe that as the treaty amendments through renegotiation or protocols are time-consuming and difficult, changes through the Commentaries should be permitted to respond quickly to new circumstances. This view is not widely accepted. Tax treaties are “solemn obligations that should not be disregarded except in extraordinary circumstances”.
Distributive Rules under the Model Convention:
The distributive rules are contained in Articles 6 to 22 of the OECD MC. These rules classify items of income and assign the taxing rights to one or both Contracting States. Under these rules, a schedular system initially classifies the taxable income under different categories (“income classification rules”). Each category of income is then subject to specific source rules under the treaty (“treaty source rules”).
The taxing rights for each source of income are then allocated to either the source or Residence State, or to both States (“assignment rules”). In cases where both States have the right to tax, the tax credit or exemption relief is given on the doubly taxed income by the State of residence (“relief principle”).
Income classification rules:
The income classification rules are normally based on activities, assets or contractual relationships, or relate to the alienation of assets, as follows:
Agriculture and forestry (in Article 6), business activities (Article 7), independent personal services (Article 14), and dependent personal services (Article 15).
b. Assets or contractual relationships:
Immovable property (in Article 6), dividends (Article 10), interest payments (Article 11), royalties (Article 12).
c. Alienation of assets:
Capital gains (Article 13).
Associated enterprises (Article 9), students (Article 20) and other income (Article 21).
The other Articles provide special rules for specific activities under the above four general classes of income. For example, Article 8 (shipping, inland waterways transport and air transport) is a special case of Article 7 (business profits). Article 16 (directors’ fees), Article 17 (artistes and sportsmen).
Article 18 (pensions) and Article 19 (government service) are special rules for Article 14 (now included under Article 7) and Article 15 on personal services, and sometimes of Article 7 (business profits). Both Article 7 (business profits) and Article 9 (associated enterprises) provide taxing rights to the State where the profits originate economically.
Article 7 allocates the business profits of the same resident taxpayer between the residence and source States. Article 9 deals with the taxation of two separate but associated taxpayers.
Treaty source rules:
The tax treaty also specifies the basic source rules to be followed for each class of income by both the Contracting States.
These rules decide the source of the income for treaty purposes, regardless of the domestic tax rules of each State, as follows:
a. Immovable property: the place where situated or Situs.
b. Industrial or business profits and professional services: a permanent establishment or fixed base.
c. Shipping and air transport: the place of effective management.
d. Dividend and interest income and directors’ fees: the residence of the payer.
e. Employment services and artistes and sportsmen: the place of work.
f. Government salaries and pensions: the country of the payer.
g. Other income: the residence of the recipient.
The “assignment principle” applied in the OECD MC comprises:
(a) Certain income “shall be taxable only” in a particular Contracting State. This term is mandatory and precludes the other State from exercising its right to tax. Therefore, the income or capital must be exempted from tax in the other Contracting State. (Examples: Articles 8(1), 8(2), 12(1), 13(3), 13(5), 15(2), 18, 19(1), 19(2), 21(1)), 22(3), 22(4)).
(b) Certain income “shall be taxable only in the Contracting State … unless”. This term provides exclusive primary taxing rights to the first State. However, if certain conditions are met (or not met), the same income may be taxed in the second State. (Examples: Articles 7(1), 14(1), 15(1)).
(c) Certain income “may be taxed in that other State”. This term has an enabling rather than a mandatory implication. It gives a State the option or right to tax if it so wishes, without affecting the existing rights of the other Contracting State. (Examples: Articles 6(1), 13(1), 13(2), 15(3), 16, 17(1), 17(2), 22(1), 22(2)).
(d) Certain income “may be taxed in the other State” but “may also be taxed in the first State”. This term gives both States the optional right to tax, if they wish. The Article may impose limits on source taxation in certain cases. (Examples: Articles 10(2), 11(2)).
(e) In one case, the Article specifies, “Shall not be taxed”. (Article 20).
The phrases “shall be taxable” or “may be taxed” are given the ordinary meaning of the words as “exclusive” or “non-exclusive” taxing rights, respectively. Hence:
(i) The first and second cases above provide for mandatory exclusion by the other State, unless excepted in the Article. The first case specifically refers to tax allocation and not relief, with exemption granted by the other State. The relief principle is applicable in the second case, if the other State satisfies the required conditions and exercises its non-exclusive taxing rights.
(ii) The third and fourth cases are similar and provide for an enabling, but non-exclusive, provision. Both States have the option to exercise the right, with or without limitation. Since the right of the other State is not denied, it would invariably lead to tax relief for juridical double taxation. These rules either exempt an item of income in one or the other State from taxation or make it taxable, fully or partly, in both Contracting States, as follows (subject to several exceptions):
(a) Taxed in the residence State only (Article 7(1), 8(1), 8(2), 12(1), 13(3), 13(5), 15(1) first sentence, 15(2), 18, 19(1b), 19(2b), 21(1), 22(3) and 22(4)):
i. Business profits, unless they can be attributed to a permanent establishment in the source State.
ii. Income, capital, and capital gains on certain shipping or air transport income if effective management is in the Residence State.
iii. Royalty income.
iv. Capital and capital gains, other than from certain movable and immovable property.
v. Income from performance of independent personal services not attributable to a fixed base in the source State (Article 14 now included in business profits under the OECD MC).
vi. Employment income from dependent personal services, including income from services performed in a source State on stays not exceeding 183 days in any 12-month period, provided it is paid by a nonresident employer and the expense is not borne by a permanent establishment in that State.
vii. Private pensions and other similar payments.
viii. Foreign government salaries and pensions paid for services rendered in the State of residence by employed individuals, who are nationals; if non-nationals, they must be resident for reasons other than for rendering their services.
ix. Other income not specifically covered in the treaty, unless effectively connected to a permanent establishment or fixed base in the source State.
(b) Taxed in the source State only (Article 8(1), 8(2), 13(3) 19(1 a), 19(2a) and 22(3)):
i. Income, capital and capital gains on certain shipping or air transport income if effective management is in the source State.
ii. Foreign government salaries and pensions are taxable only in the source State, unless the individual is a permanent resident or national of the Residence State.
(c) Taxed in both the Contracting States without restriction (Article 6(1), 7(1), 13(1), 13(2), 13(4), 14(1), 15(1) second sentence, 15(3), 16(1), 17(1), 17(2), 22(1) and 22(2)):
i. Income, capital and capital gains from immovable property (including shares of immovable property companies).
ii. Business profits, capital and capital gains of a permanent establishment, unless dealt with separately.
iii. Independent personal services attributable to a fixed base (now included in business profits).
iv. Dependent personal services exercised in a source State, unless taxable only in the State of residence (see (a) above)
v. Directors’ fees and income of artistes and sportsmen.
(d) Taxed in both the Contracting States but with restriction in the source State (Article 10(2) and 11(2)) and without restriction in the residence State (Article 10(1) and 11(1)):
i. Dividends and interest income (subject to withholding tax limits in the source State).
(e) Income not taxed in the source State (Article 20):
i. Payments from abroad to foreign students or business apprentices for maintenance, education or training are tax-exempt in the State of study or training.
The OECD Model applies four types of rules for taxing rights. They are:
i. Rules assigning a particular class of income or capital to one State exclusively.
ii. Rules assigning a class of income or capital to both States.
iii. Rules assigning a class of income or capital to both States, but limiting the level of taxation in the source State.
iv. Rules dealing with the taxation of students and allocation of business profits between related enterprises.
The distributive rules to assign and classify income, as given in Articles 6 to 21 of the Model treaty, relate to the income i.e. the tax object or events and not to the taxpayer i.e. the tax subject.
On cross-border transactions, the source State has the first opportunity to tax the nonresident as and when the income arises in its tax jurisdiction. Unless the source country agrees to forego or limit its rights, it can exercise them.
With few exceptions, the present Model treaties restrict the taxing rights of the source State over the income derived by nonresidents from within its territorial jurisdiction. The Residence State virtually retains its full or unlimited taxing rights on the worldwide income and capital of its residents, with the obligation to grant relief in cases of juridical double taxation.
Attribution Rules under the Model Convention:
While the distributive rules under the Model treaty assign the taxing rights over tax objects under a scheduler structure, they also refer to a tax subject or taxpayer to whom the income is attributed for tax purposes.
The various distributive Articles include terms such as “derived by” (Article 6(1), 13(1), 15(1), 16(1) and 17(1)), “of” (Article 7(1) and 21), “accrued to” (Article 9(1), “paid to” (Article 10(1), 11(1), 18,19(1)), “beneficially owned” (Article 12(1)) and “receives” (Article 20).
The treaty does not contain any specific rule linking these items to a taxpayer in one of the Contracting States. Under Article 1 of the MC, the tax subject only has to be a resident of one or both Contracting States for the application of the treaty.
The OECD Commentary mentions that the scope of the Articles in the Model treaty is limited to juridical double taxation. They deal with situations where the same income or capital is taxable in respect of the same subject matter and for an identical period by more than one State in the hands of the same taxpayer. Therefore, the OECD MC is not meant to either avoid or relieve economic double taxation.
In the Partnerships Report issued in 1999, the OECD extended the scope of the MC to international economic double taxation due to attribution conflicts between partners and partnership. The MC also provides for relief of double economic taxation in cases of transfer pricing through corresponding adjustments under Article 9(2).
Avoidance of Double Tax: Model # 2. UN Model Convention (UN MC):
The UN MC (“United Nations Model Double Taxation Convention between Developed and Developing Countries”) was first issued in 1980 and revised in 2001. It essentially follows the OECD numbering, except that Article 28 on “Territorial Extension” has been excluded. Moreover, it does not contain the new Article 27 on “Assistance in Collection of Taxes”.
The UN MC has retained Article 14 on “Independent Personal Services”, which was deleted and merged with OECD MC Article 7 in 2000. As a result, the UN MC currently consists of 29 Articles under the seven chapters. The UN MC has its own Commentaries to assist in their interpretation.
Although the UN MC is largely based on the OECD MC, the differences between both Models are significant. The UN MC puts more emphasis on source-based taxation, in contrast to the largely residence-based taxation under the OECD MC. It also stresses the role of tax treaties to promote the flow of foreign investment to developing countries.
The UN MC mentions that its primary goal is to establish “fiscal guidelines for trade liberalisation and expansion with a view to releasing additional resources for sustainable growth and promoting bilateral tax co-ordination”.
Like the OECD MC, the UN MC is not enforceable and its provisions are not binding. Its aim is to facilitate the negotiation of tax treaties. However, if the negotiating parties use the treaty wording it is presumed that they would find the UN Commentaries helpful in its interpretation.
The UN Model has not been adopted formally by the United Nations and is primarily the work of an Ad Hoc Group of Experts. Its introduction therefore mentions that the MC should not be “construed as formal recommendations of the United Nations”.
The adherence to the UN MC by members of the United Nations is voluntary. Nevertheless, over the years, the UN MC has gained wide acceptance in many developing countries. It has also influenced the general tax treaty policy of several OECD members.
The United Nations Model Double Taxation Convention between Developed and Developing Countries of 1980 was revised for the first time in the 1990s. The draft text of the revised final version was finally published on January 11, 2001 (“UN MC 2001”).
The revisions in the UN MC 2001 were primarily meant to update it in line with many (but not all) of the technical changes made in the OECD MC and its Commentaries since 1980. It also took into consideration the changes in treaty policies of developing countries based on its own research.
Besides several minor changes that have been made to make certain Articles consistent with the OECD MC, the main changes in the UN MC 2001 from the 1980 version are as follows:
This Article specifically includes a place of incorporation as a criterion for tax residence in paragraph 1. Moreover, the second sentence in the OECD MC 4(1), which was omitted in the previous 1980 version, has now been added.
The paragraph 4 includes sub-paragraph (f) that refers to the exclusion of a fixed place solely for any combination of activities mentioned in subparagraphs (a) to (e), as under the OECD MC. The paragraph 7 includes independent agents acting wholly or almost wholly on behalf of the enterprise as permanent establishments unless the transactions are conducted on an arm’s length basis as independent entities.
Moreover, the Commentary clarifies that subparagraph 5 (b) does not lead to a permanent establishment unless the stock agent conducts sales-related activities besides delivery of goods.
This Article has a new paragraph 3 that denies the corresponding or correlative adjustment under Article 9 (2) in cases of fraud, gross negligence or wilful default. The paragraph does not exist in the OECD MC.
As in the OECD MC, the treaty benefits under these Articles now depend solely on the residence of the beneficial owner in the other Contracting State, regardless of the residence of any agent or other intermediary collecting the income on behalf of the beneficial owner.
Previously, the benefits were granted only if the recipient was the beneficial owner. The UN Commentary now includes the OECD conclusions on the tax classification of software payments and contains most of the OECD Commentary changes up to the Commentary Update 1997.
The paragraph 4 now extends the taxing rights of a Contracting State to gains on the alienation of interests in partnerships, trusts and estates, besides shares of companies, that directly or indirectly principally own immovable properties situated in that State.
The term “principally” is defined as such immovable property comprising more than 50% of the total assets. The paragraph does not apply to such entities if they use these properties in their business activities, unless they are an immovable property management company, partnership, trust or estate.
The paragraph 1(c) has been deleted. It provided for the taxation of independent personal services if the remuneration was paid for activities in the other Contracting State by a resident of that State or was borne by a fixed base in the other Contracting State and exceeded a specified amount. Unlike the OECD MC, the UN MC has not deleted Article 14.
The paragraph 20 (2) dealing with grants, scholarships and remuneration from employment has been omitted (as in OECD MC).
The UN MC now includes the first three paragraphs of OECD MC as part of the Model treaty. Only paragraph 4 is now subject to bilateral negotiations.
The other differences between OECD MC and UN MC have not been materially affected.
Significant Differences between the OECD and the UN MC:
As mentioned above, although the UN MC largely (but not completely) follows the OECD MC and its Commentaries, it differs from the OECD MC on treaty policy.
There are several provisions in the UN MC that are either not found in the OECD MC or are different from the OECD MC. They include both treaty policy issues as well as greater allocation of taxes to the source State.
For example, it provides
(i) A lower activity threshold under the permanent establishment rule,
(ii) A limited “force of attraction” for profits attributable to a permanent establishment,
(iii) A withholding tax on royalties, and
(iv) Non-exclusive taxing rights over other income, not specifically dealt with in the treaty, for the source country.
The UN Commentaries also reproduce much of the OECD Commentaries. Besides these extracts, they contain useful insights on treaty policy issues affecting developing countries and commentaries (somewhat limited) on Articles where the two Models differ.
For example, the UN Commentary on Article 23 advocates tax sparing as a policy matter. Tax sparing credits are given by several developed countries (excluding the United States) under their tax treaties while many major developing countries insist on them for taxes spared by them.
The Commentaries of both the UN and OECD MCs accept tax sparing credits for developing countries but the former is far less sceptical as regards such credits. Both Models provide suitable wordings for tax sparing provisions in their Commentaries to the Model treaty.
The UN MC 2001 contains several of the changes in the OECD Model and Commentaries until 1997, as well as the modifications suggested by its own study and analysis of the treaty practices and needs of developing countries.
It has not yet considered the changes made by the OECD in its MC text and Commentaries after 1997. However, there are also changes in the OECD Model and its Commentaries that have not been adopted in the UN Model or its Commentaries in keeping with its different approach on treaty policy.
Some of the significant differences in the treaty text between the two Models are:
The Article grants additional taxing rights to the source State in the following situations:
a. Construction activities that last more than six months (OECD MC: 12 months) in any individual site or project; it also includes assembly and supervisory activities.
b. Furnishing of services, including consultancy services, where the activities of that nature last for more than six months in aggregate within any 12-month period.
c. A dependent agent, who habitually maintains a stock of goods for delivery on behalf of an enterprise and delivers them regularly, even if he has no authority to conclude contracts, (“stock agent”).
d. The activities (other than reinsurance) of an insurance enterprise if it collects premiums or insures risks through a person other than an independent agent.
e. An independent agent who acts wholly or almost wholly for an enterprise, unless the transactions are on an arm’s length basis.
Moreover, the exemption under the preparatory or auxiliary services does not apply to the use of facilities or maintenance of stock for delivery if they conduct sales-related activities.
A limited “force of attraction” rule extends the profits attributable to a permanent establishment to income derived from other sales and business activities that are the same or similar to those performed by the permanent establishment.
Several expenses paid by a permanent establishment to its head office, and vice versa, are ignored in computing the attributable profits. The paragraph that excludes profits attributable to the “purchase” function performed by the permanent establishment is omitted.
The Article provides an optional provision (alternative B) that grants the source State a limited right to tax shipping profits, if the shipping activities in the source State are more than casual.
Article 9 (3) denies the corresponding or correlative adjustment under Article 9 (2) in cases of fraud, gross negligence or wilful default. This paragraph does not exist in the OECD MC.
Articles 10 and 11:
Unlike the OECD MC, the UN Model does not provide a limit on the maximum percentage rate for the withholding tax. The rate is left to bilateral negotiations.
The Article grants shared taxing rights on royalty income to the source State, on a basis similar to interest (subject to a maximum rate to be determined by bilateral negotiations). The royalty definition also includes any payments made for the use of, or the right to use,
(i) Films or tapes for radio or television broadcasting, and
(ii) Industrial, commercial or scientific equipment.
The OECD MC was amended in 2003 to include a new paragraph 4 to grant source taxing rights on gains derived from the sale of shares in companies deriving over 50% of their value from immovable property in that State. Unlike the UN MC, it does not yet include the provision for source taxation on similar gains on sale of interest in partnerships, trusts and estates or the exemption if such properties are used in their business activities.
The OECD MC also does not include a paragraph granting non-exclusive taxing rights to the source State on alienation of shares in other companies (subject to qualifying shareholding), as provided under UN MC Article 13 (5).
The Article grants two additional taxing rights to the source State on income from independent personal services. The source State may tax the income if
(i) The remuneration is paid by a resident of the source State or is borne by a fixed base in that State, or
(ii) The stay in the other Contracting State exceeds 183 days in a tax year. Unlike the OECD MC, this Article has not been deleted and merged with Article 7.
The Article includes remuneration paid to top-level managerial officials as taxable in the State where the paying company is resident.
The Article grants exclusive taxing rights on public pension schemes to the paying State. In addition, it accepts the exclusive right of the Residence State to tax private pensions. However, it also offers an optional wording (alternative B) for them to be taxed by both States if they are paid by a resident of the other State or a permanent establishment situated in that State.
The UN MC does not contain the proposed changes in OECD Update 2005 to cover “non-periodic payments” besides pensions under this Article.
The Article grants shared taxing rights to the source State on the residuary “other income” not dealt with in the other Articles of the treaty.
This Article does not include the additional paragraph 4 in Article 23A, which was introduced in OECD MC Update 2001 that denies exemption relief in certain circumstances.
The Article provides for more comprehensive implementation clauses under the mutual agreement procedures.
The Article includes the prevention of tax fraud and tax evasion as additional objectives. The competent authorities must also develop comprehensive exchange of information systems. It excludes the changes and additional paragraphs proposed under OECD MC Update 2005.
The UN Model Treaty does not include Article 27 on Assistance in the Collection of Taxes added under the OECD MC 2003.
According to a research project conducted by the International Bureau of Fiscal Documentation (The Netherlands) in the late 1990s, the UN MC is still widely used and has also influenced the OECD MC. It concluded that the impact of the UN MC on actual tax treaties was significant, especially on issues relating to permanent establishment, the royalty definition, capital gains from the alienation of shares and the other income Article.
Avoidance of Double Tax: Model # 3. US Model Convention (US MC):
A revised US MC was issued in 1996 (“United States Model Income Taxation Convention of September 20, 1996”) to replace the earlier 1981 Model that was withdrawn in 1992. Unlike the OECD and UN MCs, the US MC is primarily used in the negotiations of bilateral tax treaties with the United States. Its purpose is to align the tax treaties with US domestic laws and tax policies.
The US MC resembles the OECD MC but does not replace it. It is more detailed in its text and explanations, and incorporates several provisions of the OECD Commentaries in the treaty text itself. It also contains extensive “Technical Explanation” to provide further insight into the US treaty policy, the definition of terms and other provisions.
Although these explanations are not explicitly part of the treaty text, they provide useful interpretations and clarifications. The Technical Explanation does not have the same legal significance as the OECD Commentaries.
Significant Differences Between OECD and US MC:
Some of the significant differences from the OECD MC are summarised below:
The treaty does not restrict, in any manner, the benefits under the domestic law of, or any other agreement between, the Contracting States (Article 1(2)). The taxpayer can choose the benefits under the domestic law selectively for any class of income, if they are more favourable (“non-aggravation” or “preservation” clause).
The “saving clause” under Article 1(4) reserves the right of each Contracting State to tax its own citizens and residents, including certain former citizens and long-term residents for up to ten years, as if the treaty had not come into effect. The saving clause is subject to certain specified exceptions (Article 1(5)).
The Article excludes taxes on capital and taxes on income and capital imposed by political subdivisions and local authorities. Therefore, the US State and local taxes are not included.
This Article follows the OECD general definitions with certain variations. For example, a “person” specifically includes an estate, a trust and a partnership. An “enterprise” covers an enterprise carried on by a resident of a Contracting State through a fiscally transparent entity (e.g. a partnership or trust) in that Contracting State. The term “international traffic” excludes transport by a ship or aircraft when such transport is solely between places in either Contracting State.
The definition includes the liability to tax due to citizenship or place of incorporation as additional criteria for residence under a treaty. The income of a fiscally transparent entity under the laws of either Contracting State is deemed to be derived by a resident of a State to the extent that the income is treated as the income of a resident under the domestic tax law (“derived through entity” principle).
A dual resident company is resident at its place of incorporation under the tie-breaker provision. The tax residence of a dual resident, other than an individual or a company, is determined by the mutual agreement of the competent authorities.
An installation or drilling rig or ship used for the exploration or exploitation of natural resources is a permanent establishment if it lasts for more than twelve months. The maintenance of a fixed place of business for any combination of activities in Article 5(4) subparagraphs (a) to (e) is presumed to be of a preparatory or auxiliary character.
A resident may elect to be taxed on a net basis (similar to a permanent establishment) in the other Contracting State on the income derived from real property, even if no net basis election is available under the domestic law of the Situs State. The net basis election can be terminated only with the consent of the competent authority of the Situs State.
The income earned by an enterprise from the rentals of tangible personal property, or from the performance of personal services are business profits. Deferred business profits attributable to a permanent establishment or fixed base are taxable even after they cease to exist.
The profits derived by an enterprise from the international operations of ships or aircraft are granted exclusively to the residence State of the enterprise. The profits include rental income on full (time or voyage) or bareboat leasing (including incidental income) of ships or aircraft used in international traffic.
The profits from the use, maintenance, or rental of containers (including barges, and related equipment for the transport of containers) in international traffic are taxable only in the Residence State of the enterprise.
The Article reduces the participation requirement from 25% shareholding to an ownership of 10% direct voting shares for the lower concessional withholding rate to apply in the source State. The source State may also impose an additional branch profits tax without violating the non-discrimination provisions under Article 24. This tax is limited to the lower concessional rate specified in Article 10 (2 (a)) of the treaty.
The Residence State has exclusive taxing rights over the interest income.
The treaty exemption in the source State is denied if the interest income is contingent on:
(i) The receipts, sales, income, profits or other cash-flow of the debtor or a related person;
(ii) Any change in the value of any property of a debtor or related person; or
(iii) Any dividend, partnership distribution or similar payments made by the debtor to a related person. Such interest income may be taxed at the rate not exceeding the upper concessional rate applicable to dividends under Article 10 (2) (b) of the treaty.
As in OECD MC, the Residence State has exclusive taxing rights. The term “royalties” also includes copyrights on other work, such as computer software, audio, videotapes or disks, and other means of image or sound reproduction. In addition, it includes any gains that are contingent on the productivity, use or disposition of a property.
The US MC does not include the new paragraph 4 added in OECD MC Update 2003 to grant source taxing rights on gains derived from the sale of shares in companies deriving over 50% of their value from immovable property in that State.
Unlike the OECD MC, this Article has not been deleted and merged with Article 7. The Article applies only to individuals or to a group of individuals (e.g. a partnership). The taxing rights in the source State are limited to the income attributable to the services performed in that State.
The employee “as a member of a regular complement” on a ship or aircraft operated in international traffic is taxable only in his State of residence.
The directors’ fees and their other compensation may be taxed in the other Contracting State only to the extent that they relate to services rendered in that State.
Income derived by a sportsman or entertainer may only be taxed by the other Contracting State if it exceeds US$ 20,000 (or equivalent in the currency of the other Contracting State) in a taxable year. When paid to another person, the provision does not apply if the entertainer or performer or any person related to him does not profit from the income in any manner.
Besides private pensions, the treaty text includes annuities, social security benefits, alimony and child support payments, and tax deductions for overseas pension contributions. Social security receipts are taxable only in the payer’s State, while alimony is taxable only in the Residence State. Child support is tax-exempt in both States.
The contributions to a recognised pension plan by an individual, who performs services in the other Contracting State, “shall be” deductible in the State where the services are performed.
Besides government employees, government service includes independent contractors engaged by the government for functions of a “governmental nature.” The US MC does not contain the proposed changes in OECD Update 2005 to specifically cover “non-periodic payments” besides pensions under this Article.
The Article exempts any payments received for full-time education at an accredited institution or full-time training by a visiting student, apprentice or a business trainee from outside the State. The tax exemption is limited to the first year of stay only for an apprentice or business trainee (but not a student).
The Article on Capital (OECD MC Article 22) is excluded since there are no federal capital taxes in the United States. The US MC Article 22 deals with the “Limitation on Benefits” under the treaty. There is no similar Article under the OECD or the UN Model treaties.
The Article contains an ordering provision when a US citizen is a resident in the other Contracting State. It provides special foreign tax credit rules in the United States for relieving double taxation imposed on them.
The Article does not require the tax treatment on nationals of the other State to be the same as that imposed on its own nationals in the same circumstances, provided it is not more burdensome.
Moreover, nonresidents who are taxable as US nationals on a worldwide basis differ in circumstances from nonresident foreign nationals. It also authorizes the United States to impose a branch profits tax without violating the non-discrimination Article. The Article does not cover stateless persons.
There is no time limit for a taxpayer to present his case to the competent authorities, and he can present his case to the authority of either Contracting State. The assessment and collection procedures must, however, be suspended during the mutual agreement proceedings.
The paragraph also provides an illustrative list of tax issues that the competent authorities may take up for resolution under the mutual agreement procedure.
The competent authorities can also agree to increases in any specific dollar amounts referred to in the treaty.
The Article provides for a wider exchange of information from banks, etc. to overcome bank secrecy laws and practices. It also obliges each Contracting State to give administrative assistance within its own laws and practice to ensure that taxpayers do not enjoy unintended treaty benefits.
Finally, it obliges the competent authorities of the requested State to allow the tax authorities to interview taxpayers and to examine the books and records in the other State with the consent of the persons who are the subject of the examination. It excludes some of the changes and additional paragraphs proposed under OECD MC Update 2005.
The US Model Treaty does not include Article 27 on Assistance in the Collection of Taxes added under the OECD MC 2003.