In this article we will discuss about international tax law and double taxation:- 1. Definition of International Tax Law 2. Double Taxation 3. Connecting Factor Conflicts of Double Taxation 4. Dual Role of Treaties 5. Country Examples of International Tax Law 6. Is International Tax Law Enforceable 7. International Tax Principles and Tax Treaties – Comments.
- Definition of International Tax Law
- Double Taxation
- Connecting Factor Conflicts of Double Taxation
- Dual Role of Treaties
- Country Examples of International Tax Law
- Is International Tax Law Enforceable
- International Tax Principles and Tax Treaties – Comments
1. Definition of International Tax Law:
According to Article 38(1) of the Statute of the International Court of Justice, the sources of public international law are:
(a) International conventions establishing rules expressly recognised by states,
(b) International custom, as evidence of a general practice accepted as law,
(c) The general principles of law recognised by civilized nations, and
(d) Certain judicial decisions and legal teachings.
Public international law governs the relations between States, and determines their mutual rights and obligations. It is based on international agreements and general international law. It is the body of law comprising the principles and rules of conduct that States feel themselves bound to observe and therefore commonly observe in their relationships.
Although these rules primarily govern the relations of States, international organisations, and to some extent individuals may also be the subject of the rights conferred and duties imposed by public international law.
General international law comprises customary international law and the general principles of law. While customary international law refers to the international practice of States, the general principles relate to international aspects contained in their domestic laws. Customary international law is based on the common view of States on certain matters along with the belief that it is obligatory.
It tends to be more general and harder to establish given the large number of nations in the world and the difficulty of pinpointing the precise moment in time when it comes into being. Customary laws may (or may not) be codified through treaties.
International tax law refers to the principles derived from public international law that deal with tax conflicts involving cross-border transactions. These principles are based on the international tax aspects contained in the domestic tax law and the customary practices of countries, and tax treaties. With minor exceptions, tax laws are not “international”. Besides tax treaties, there are no overriding international laws of taxation that are enforceable on taxing States.
The sources of international tax law include:
1. Multilateral international agreements, e.g. the Vienna Convention on the Law of Treaties, secondary law of international communities of States, mutual agreement procedures for equitable settlement of conflict of legal systems.
2. Comprehensive bilateral double tax treaties, e.g. treaties and protocols, exchange of letters and notes, memoranda of understanding, and supplementary administrative agreements.
3. Limited bilateral double tax treaties, e.g. reciprocal declarations, specific treaties on shipping and airlines, death duties and taxes on gifts.
4. Customary international law and general principles of law, e.g. the principles of law recognised by civilized nations in their national legal systems, statute law, customary law and judicial decisions, and the practices of international organisations.
2. Double Taxation:
International tax law governs the taxing rights of sovereign nations. These rights depend on their fiscal jurisdiction. Each country has sovereign rights within its fiscal jurisdiction. Therefore, the substance of State sovereignty is jurisdiction, or the scope within which the effective and acceptable power of the State can be exercised.
It is the “right to exercise (in regard to a portion of the globe) to the exclusion of any other State the functions of a State” (Island of Palmas v USA, 1928).
The term “fiscal jurisdiction” refers to both:
(i) The right of legislation and
(ii) The right of enforcement.
A State cannot enforce what it cannot legislate. However, the reverse may be true. A State may legislate, even when it is unable to enforce. There are two schools of thought on fiscal jurisdiction based on differing perceptions of State sovereignty. The first believes that there is no restriction on the State’s right to tax, and that it may be exercised without regard to other States.
It is, therefore, not necessary to have a legal connection or link with a jurisdiction, provided there is a valid nexus with that State. The other school maintains that the sovereign right to tax is confined to a territory having a “legally relevant connection” between the State and the taxpayer.
Although the issue is still unsettled, both views accept that “connecting factors” give a State the right to tax. These connecting factors link the taxpayer personally to a particular tax jurisdiction.
They include personal links with the home State by virtue of residence, domicile or citizenship for natural persons, and the place of incorporation or location of a registered office, or management and control for legal persons. An economic activity is also connected with the host State, which exercises its taxing rights due to the territorial link.
The domestic laws in countries normally apply the following international tax principle, based on connecting factors:
1. Residence Rule:
Unlimited taxation rights are granted to the country of residence, due to the “personal attachment” of persons. The country of residence (or nationality) may impose its taxes on the worldwide income of individuals or corporations due to the protection it offers to the tax subject.
2. Source Rule:
Limited taxation rights are granted to the country of source due to the “economic attachment” of persons. The country of source reserves the right to tax the income that is derived from the economic activities within its territory.
Under the “economic attachment”, both States are entitled to tax income arising in their tax jurisdiction. The primary taxing rights remain with the country where the income is earned, i.e. the source State. No tax conflicts should normally arise if all States followed a territorial tax system and restricted their taxing rights to income arising in their own fiscal jurisdiction.
However, the residence State retains its worldwide taxing rights to tax the foreign source income of its residents under the “personal attachment”. Tax conflicts arise largely (but not only) due to this right of the residence State that subjects its residents to tax on their foreign source income.
As double taxation is generally considered undesirable, one of the objectives of international tax principles is to ensure that income is not taxed twice. There should be no need for these principles if every person or source of income were subject to tax in one State only. However, under various domestic laws the tax revenues on the same activity may be shared or the same income taxed by two countries.
The sharing of income differs from tax overlaps. The term “double taxation” implies “over-taxation” due to overlapping taxing rights. Double or multiple taxation issues arise when the connecting factors grant competing taxing powers to two or more States on the same income.
International double taxation may be economic or juridical. Economic double taxation refers to a double tax on the same income in the hands of different persons (Examples: husband and wife, partnership and partners, company and shareholder, parent and subsidiary, etc.).
The same tax object is taxed on legally different but economically similar or connected subjects in two jurisdictions (“economic identity of subject”). Juridical double taxation deals with the same tax object and the same tax subject. It is the imposition of comparable taxes by two or more States on the same taxpayer in respect of the same subject matter and for identical periods (“legal identity of subject”).
Juridical double taxation is the result of a conflict between two tax systems. It arises due to the overlapping claims of tax jurisdictions on interrelated economic activities. The competing powers of fiscal sovereignty lead to double (or multiple) taxation in two or more jurisdictions; alternatively, it can lead to double tax exemption, i.e. non-taxation. International tax law is primarily concerned with juridical (i.e. based on jurisdiction) double taxation.
Although the domestic tax systems in most countries provide for unilateral relief, juridical double taxation conflicts are largely resolved through tax treaties negotiated under the principles of international tax law accepted by sovereign States.
Through their distributive rules that avoid double taxation and relief methods when it does arise, they ensure a fair distribution of global tax revenues among nations (inter-nation equity). They also attempt to achieve global tax neutrality where tax issues do not affect the economic choices of taxpayers on international transactions.
3. Connecting Factor Conflicts of Double Taxation:
Double taxation issues arise due to tax conflicts when the connecting factors grant competing taxing powers to two or more States on the same income. For a tax liability to arise, there must be a taxable event on which a State can exercise its taxing rights, and there must be a person who is liable to pay the tax. Moreover, the two must have some connection with the taxing jurisdiction to be subject to its tax laws.
Therefore, the three key components of any taxable transaction are:
(i) Tax subject:
The identity of the taxpayer, or a person’s relationship to the taxed object that creates a tax liability;
(ii) Tax Object:
The identity of the subject matter, or the facts that cause the tax liability; and
(iii) Connecting Factor:
There must be a “reasonable connection” between the taxing powers of the State, and the taxpayer or the transaction. Without a connecting factor between either the taxpayer or the business activity and the tax jurisdiction, a State cannot levy its tax.
Each country follows its own tax practices under its own legal system, and defines the connecting factors under its own laws. As a result, different countries apply differing definitions of taxable entities and taxable events, and then use varying bases for computing the tax under their own tax accounting rules.
(a) More than one country may claim an item of income or gain as taxable within its jurisdiction. The tax residence of a company may be based on the country of incorporation or management. An individual may be resident in more than one tax jurisdiction. The tax rules in the residence country may not coincide with those applied in the source country.
(b) Different jurisdictions may characterize a taxpayer differently under their domestic law. For example, a partnership may be fiscally transparent in one State and a taxable entity in another State.
(c) The meaning of terms (such as income tax, total income, residence, domicile, immovable property, permanent establishment), and the characterisation of transactions may vary in different countries.
These varying definitions lead to connecting factor conflicts, such as:
1. Source-Source conflicts:
Two or more countries claim the same income of a taxpayer as sourced in their country.
2. Residence-Residence conflicts:
Two or more countries regard the same taxpayer as tax resident in their country.
3. Residence-Source conflicts:
The same income is taxed twice, first by the country where it is derived under its “source rules”, and then in the country where the taxpayer resides under its “residence rules”.
4. Income characterisation conflicts:
Two States characterize or classify the same income or capital differently and, therefore, apply differing tax provisions.
5. Entity conflicts:
An entity is characterised differently under the domestic laws of the two States and, therefore, it is subject to differing taxation.
6. Mismatching tax systems:
The two tax systems provide for differing rules for assessment, definition of taxable income, or computation of taxes. The most common form of juridical conflict in international taxation relates to the Residence-Source taxation. A taxpayer satisfies a tax relationship in two States simultaneously.
The unilateral tax rules under domestic law may relieve such tax conflicts, but tax treaties normally give a more favourable treatment. Other situations usually require the assistance of specific provisions under tax treaties.
4. Dual Role of Treaties:
A treaty is an agreement between sovereign nations. Negotiated treaties frequently contain additional supporting data that form an integral part of the treaty, such as protocol, exchange of letters, or memorandum of understanding.
A protocol is a treaty by itself that amends or supports the existing treaty. The exchange of letters clarifies the treaty provisions and forms part of the treaty. They differ from a memorandum of understanding, which may or may not be binding.
Under international law, tax treaties carry the obligation to ensure that they have the force of domestic law. Some countries follow the monistic principle, under which the municipal law is linked and subordinated to the international law under the “doctrine of incorporation”.
Other countries follow, the dualistic principle, which regards the international and municipal laws as separate and requires a specific domestic legislation under the “doctrine of transformation”. Each State is free to decide its approach under its own constitutional laws to comply with its international obligations.
Thus, there are two groups of countries, as follows:
(i) Direct Effect:
Treaties are self-executing and automatically become a part of the domestic law when they are ratified. The monistic principle provides that they are enforceable under domestic law without further legislation. In some countries, they require a formal or procedural executive or legislative act to incorporate them into domestic law.
(ii) Indirect Effect:
Treaty provisions must be enacted into domestic law and require special legislative steps. The Courts cannot enforce the treaty provisions until they are “transformed” into municipal law, usually by a legislative act or delegated legislation. Under this dualistic doctrine, it is usually the related statute, and not the treaty, which has the legal authority under the domestic law.
Tax treaties are binding on the tax authorities and taxpayers under domestic law, once they become part of it, either by incorporation or transformation under its law. Its provisions are then enforceable and the taxpayer has rights and obligations under the treaty. The domestic Courts in the tax jurisdictions concerned can enforce them. The Courts must also respect the national obligations of the State under an international agreement.
The treaty’s “final provisions” govern the timing. This provision allows for the required legislative and administrative action and ensures that the new tax rules apply from the beginning of an income tax year. The dates when the treaty enters into force and when it is enforceable under domestic law may differ from the effective date under the treaty itself.
There can be different dates for each country and even different dates for different taxes in each country. Generally, retrospective application of the new treaty provisions is not permitted if they would affect the taxpayer’s rights adversely.
Thus, tax treaties serve a dual purpose and have a parallel life. They are both “State to State” agreements under the international law and also part of the statutes under the domestic law.
They are binding on the Contracting States under public international law from the date of entry into force, but may be enforceable under the domestic law by the Courts only after they are incorporated in the domestic or municipal law. Each State follows its own rules for the inclusion of the treaty under its law.
5. Country Examples of International Tax Law:
Australia follows the dualistic doctrine. Each Australian treaty is incorporated by legislative action into the domestic law as a Schedule under the International Tax Agreements Act 1953.
A tax treaty is applied and enforced in the domestic Courts as Parliamentary intent, and the Parliament can, if it wishes, override the treaty by subsequent legislation. Treaties generally prevail over domestic law, except when the Australian general anti-avoidance rule is applicable.
Each treaty is incorporated into domestic law by separate parliamentary legislation that provides that the treaty prevails over domestic law in case of conflict. In principle, as Parliament is supreme it can override the treaty through specific legislation. However, such overrides are rare.
The Income Tax Conventions Interpretation Act 1985 contains provisions that specifically allow tax treaty overrides in certain circumstances. The Act provides that the terms, which either are undefined (partly or wholly) in the treaty or require the use of the domestic law, have the meaning under the domestic law at the time when the treaty is applied and not when the treaty was entered into, except to the extent that the context otherwise requires.
France follows the monistic doctrine of incorporation.
A treaty has priority over prior or subsequent domestic legislation. Article 55 of the French Constitution 1958 mentions:
“Treaties or agreements properly ratified or approved shall possess, from the moment of publication, an authority superior to that of domestic laws providing, as regards each treaty or agreement, it is applied by the other party”.
International treaties require the approval of the Federal Parliament (Bundestag) and the Council of Constituent States (Bundesrat). Under Article 59 (paragraph 2) of the Fundamental Law, this formal approval introduces the treaty into the German legal system as an Act of Parliament with no precedence over domestic statutes.
However, since Section 2 of the General Tax Code (AO) claims superiority of tax treaties over domestic tax law, subsequent law can only override treaty law if the law expressly contradicts the treaty provisions.
India follows the dualistic doctrine, and tax treaties strictly require an Act of Parliament. However, to avoid a time-consuming and cumbersome procedure, they are enacted into domestic tax law under delegated legislation powers granted by the Parliament to the executive branch of the government.
Section 90 of the Indian Income Tax Act, 1961, empowers the central government to enter into tax treaties with the government of other countries. They do not have to be laid before Parliament since no separate legislation is required to give effect to a tax treaty. The tax treaty prevails even if it is inconsistent with the provisions of the Act.
A treaty, once ratified and incorporated, prevails over statutes unless the Indian Parliament specifically legislates a treaty override. However, Article 51 of Part IV(c) of the Indian Constitution specifically mentions, “the State shall endeavour to foster respect for international law and treaty obligations in the dealings of organised peoples with one another”.
Under the Irish Constitution, the status of a tax treaty differs from that of domestic law. Its legal validity, as part of the domestic law of the State, is derived from Article 29 of the Constitution. Treaties are negotiated and concluded by the government, but subject to approval by Parliament.
A treaty becomes part of the domestic law when an Order is made under the Taxes Consolidation Act after the Parliamentary resolution. Sec. 826 TCA 1997 mentions that such agreements are to have the force of law in Ireland “notwithstanding anything in any enactment”.
Domestic tax law cannot override tax treaties in Japan under its constitution.
Under the Dutch constitutional law, a treaty is self-executing and becomes applicable under the domestic law at the time when it enters into force. The treaty has priority over subsequent domestic law under Article 94 of the Dutch Constitution. Tax treaty restricts the application of domestic tax law.
i. United Kingdom:
The United Kingdom follows the doctrine of transformation. A provision in the tax law (currently ICTA 1988 s.788) allows the treaty to take effect by an Order in Council (delegated legislation). It also confers the authority to negotiate and conclude tax treaties to the government.
When an agreement has been initialed in draft and approved by Ministers, it is signed and then published as a draft Order in Council and laid before Parliament for its approval. The legislative process is completed when the order is made by her Majesty in Council. Instruments of ratification must usually be exchanged before a treaty can come into force.
Thus, although the making of a treaty is an executive act its obligations under the domestic law must have legislative approval. The taxpayer’s rights under a treaty arise from an Act of Parliament, which confirms the treaty and gives it the force of domestic law.
Subsequent legislation by Parliament intended expressly to override a tax treaty is possible. However, unintentional treaty overrides cannot occur, as statutes may not be interpreted to result in breaches of obligations under international law.
j. United States:
The United States follows the doctrine of incorporation. A tax treaty is self-executing and requires no further legislation. It becomes part of the domestic law, if it is consistent with the US Constitution, until it is either terminated or specifically contradicted by a subsequent federal (not state) legislation.
The US tax treaties also contain a “saving” clause that preserves its right to tax its own residents under its domestic law, regardless of the treaty.
A treaty is a part of federal legislation enforceable by the US Courts, and has an equal status with other federal laws. In case of a conflict between the treaty law and the federal law, the Courts and the tax authorities are bound to apply the measure that is later in time (“lex posterior derogat legi priori”).
However, the US Courts apply their discretion to avoid treaty overrides. The US Supreme Court held in Cook v United States that the intent of Congress to override international obligations of the United States through federal legislation must be “clearly expressed”. The US Revenue also requires that such treaty waivers must be consistent.
The US Congress has rejected the view that treaties can only be brought into line with the changing tax laws by renegotiation, since it could give the foreign states an effective veto over the US domestic law changes applicable to international business. Treaty overrides have been specifically permitted in several US tax laws.
For example, Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) provided provisions for treaty override. Another example relates to the Tax Reform Act of 1984 that permitted treaty overrides in cases of “stapled” stocks issued by foreign corporations.
6. Is International Tax Law Enforceable:
Every country has the sovereign right to establish its own tax rules, which govern its domestic and international transactions. However, countries may have legislative powers, but they may not have the enforcement rights over foreign jurisdictions.
International law only permits the enforcement by a country of its tax laws within its legislative jurisdiction. It forbids executive or administrative acts and enquiries by foreign tax authorities without the consent of the host country.
For example, a State cannot send officials to gather tax evidence, examine books, value any property or interview witnesses. No legal documents may be served and no tax may be collected in another State without its consent. Generally, one State does not normally enforce the tax laws of another State, as a matter of sovereignty.
Tax authorities must follow the principles of international law when they enforce their domestic laws abroad. Since a State is unable to exercise its tax law in another State, it sometimes applies indirect pressure on nonresidents and foreigners present in its own territory. Such methods violate the principles of international law.
“The mere fact that a State’s judicial or administrative agencies are entitled to subject a person to their personal or “curial” jurisdiction does not by any means permit them to regulate by their orders such person’s conduct abroad”.
Fiscal enforcement provisions on tax issues relating to cross-border transactions available today are limited. Under a tax treaty (OECD MC Article 26), the tax authorities of the Contracting States may exchange tax information. This Article permits the sharing of tax- related information to prevent tax evasion and frauds, unless it is contrary to the treaty provisions.
The EC Directive 1977 (as amended) provides for assistance on tax matters among member countries. Similar provisions are also contained in the OECD/Council of Europe Convention on Mutual Administrative Assistance in Tax Matters (1988), which came into force in 1995. In 2003, the OECD Committee on Fiscal Affairs added a separate Article 27 on the “Assistance in the Collection of Taxes” in its Model Convention.
7. International Tax Principles and Tax Treaties – Comments:
The two prevailing key taxing concepts in international taxation are the residence and source principles. Both of them are based on the so called “benefit theory”. Under this theory, taxes are payments for services (or benefits) rendered by the State.
Each jurisdiction has the right to tax derived from services rendered or benefits provided. The State of residence retains its rights to tax its citizens or residents on their worldwide income, while the State of source taxes the income derived within its own fiscal jurisdiction.
Although the above split of taxing rights between residence and source States is commonly accepted for distribution of taxing rights, it inevitably leads to double taxation. Double or “overlapping” taxation adversely affects international trade and economic development. It is considered as harmful to the exchange of goods and services and to the movement of capital and persons.
This double taxation is then avoided through reciprocal acceptance of taxing rights and obligations under what is fair and equitable. They require the jurisdictions to agree to share the taxing rights and give relief where double taxation arises, either under their domestic laws or under a negotiated agreement or treaty.
Besides the allocation of taxing rights and eliminating double taxation, tax treaties also provide other measures, such as:
a. Prevention of tax discrimination of nationals, permanent establishments and enterprises of the other State.
b. Resolution of tax disputes due to differences in the interpretation or application of the tax treaty.
c. Authority for tax authorities to exchange information on tax matters to ensure compliance by taxpayers and to prevent tax evasion.
d. Provision for mutual assistance in tax collection.
These objectives are not directly related to the avoidance of double taxation. A negotiated treaty may still be necessary to achieve them even when double taxation is not an issue.
Some of the principles underlying international tax law and tax treaties include:
(i) Equity and Fairness:
The tax system should be equitable and fair for taxpayers, i.e. inter-individual equity. This principle requires equal taxation on taxpayers with equal income, regardless of source, based on their ability to pay (“horizontal equity”), and the levy of progressively higher taxation on higher income (“vertical equity”).
In the international context, the system should also enable each country to receive a fair share of the taxes generated by transactions involving their jurisdiction. This allocation of the worldwide tax base is achieved through a negotiated agreement or tax treaty between fiscal jurisdictions as equal partners with reciprocal appreciation of mutual taxing rights i.e. inter-nation equity.
(ii) Neutrality and Efficiency:
Whereas tax equity relates primarily to the relationship of taxpayers to each other, neutrality refers to the relationship between the taxpayer and the State. A neutral tax system that does not interfere with market forces is regarded as a more efficient distributor of factors of production.
Therefore, the concept of tax neutrality is often stated as one of the principles of international taxation. It requires that economic processes should not be affected by external influences, like taxation.
Ideally, tax systems should be neutral as between investing at home or abroad (capital export neutrality or CEN) and as between investment by domestic and foreign investors (capital import neutrality or CIN). The former is based on the policy that a country’s nationals should have the same tax choice when making a decision to invest at home or abroad.
The latter expects that the same tax burden should be imposed on both residents and nonresidents. The overall objective is to promote free movement of capital. Any distortions in investment decisions arising from tax considerations should be avoided.
Under CEN, the Residence State ensures that the total tax burden on investment abroad is the same (not more, not less) as investment at home to neither encourage nor discourage capital outflows. Foreign source income is taxed currently by the residence State without any tax deferral (similar to domestic income), and full tax credit is given for any source taxes paid.
In the case of CIN, foreign investors bear the same (not more, not less) overall tax as domestic investors in the source State.
It applies the same tax rate as residents on income derived by nonresidents and does not impose any withholding tax on outbound payments; the Residence State gives full tax exemption. Both systems have their supporters. CEN is considered as a better approach by many developed countries to achieve worldwide economic efficiency, i.e. allocation of economic resources to achieve optimal productivity.
It favours taxation in the Residence State with a grant of tax credit to relieve foreign taxes paid. CIN supports national efficiency and international competitiveness with only source taxation and full tax exemption in the Residence State.
In reality, unless there is a completely harmonized global tax system, full neutrality under both CEN and CIN is impossible to achieve. The measures required for CEN conflict with those required for CIN, and vice versa. CEN favours worldwide taxation while CIN encourages a territorial tax system.
Moreover, pure forms of CEN or CIN are rarely used. Countries follow a combination of CEN and CIN principles depending on their overall economic policy, of which tax is one of the components. In practice, policy makers typically treat capital export neutrality as at best a secondary goal.
In virtually every country of the world, capital inflows generally are considered desirable and are encouraged through tax and other economic policies.
(iii) Promotion of Mutual Economic Relations, Trade and Investment:
Many countries (particularly developing countries) regard this objective as more significant than the avoidance of double taxation. The primary purpose of tax treaties for them is to promote economic growth through foreign investment and technology.
They are prepared to bear the loss of tax revenues due to tax incentives. For example, double non-taxation (e.g. tax sparing credits), may be regarded as a justified cost to achieve non-fiscal objectives. As net capital importers, they are also more concerned with capital import neutrality.
Tax treaties only deal with direct taxes. Developing countries usually have a low direct taxpayer base and low levels of public expenditure. Direct taxes and treaty policies often play a less significant role as a revenue source and are considered more as a policy tool to achieve their non-tax (e.g. social and economic) objectives.
They rely more on indirect taxes to meet their government budgetary needs due to the relative ease in collection and its wider tax coverage.
In the above sense, the tax policies and objectives of developing countries may differ from those of developed countries. The former countries regard direct taxation less as a means for financial resource mobilisation for the government and more as a tool to achieve higher economic growth.
Tax levels may be kept low through incentives to enhance their competitiveness for capital, markets and technology. The lack of anti-avoidance measures like controlled foreign corporation and thin capitalisation may be acceptable and tax sparing as well as treaty shopping may be deemed as tax incentives. Tax competition is both widely practiced and encouraged in these countries.
(iv) Prevention of Fiscal Evasion:
One of the stated objectives of Model tax treaties is the prevention of tax evasion. They include limited anti-avoidance measures such as comprehensive taxation for residents (Article 4), restriction on tax concessions on dividend, interest and royalty income only to beneficial owners (Articles 10, 11 and 12) and provision for exchange of tax information among tax authorities (Article 26).
A recent addition in the OECD MC is the new Article on mutual assistance in the collection of taxes (Article 27). Although, it does not include tax avoidance as an objective, the Commentary Update 2003 issued by the OECD Committee on Fiscal Affairs regards it as one of its purposes. This broadening of the treaty objectives to all forms of domestic tax avoidance rules is not accepted in many countries.
Some commentators also regard double non-taxation as tax avoidance and deem it as undesirable on neutrality and fairness grounds.
Paragraph 52 of the OECD Partnership Report 1999 reads as follows:
“… the basic purposes of the Convention (is) to eliminate double taxation and to prevent double non-taxation”.
Pursuant to this Report, the OECD MC 2000 has added a new paragraph 4 in Article 23 A, and also made certain changes in the Commentary. As double non-taxation can be both intended and non-intended, presumably the objective is to prevent unintended double non-taxation resulting from the application of the treaty.
Despite this OECD view, double non-taxation is not yet widely accepted as either tax avoidance or evasion or as an objective of tax treaties. Currently, a taxpayer may rely on a tax treaty even if it results in double non-taxation.
International taxation has the concept of reciprocity as one of its key principles. This principle affects a country’s approach to designing its international tax rules. As each State has full rights to tax income sourced in its own jurisdiction, it will accept a limitation of these rights only if the other tax jurisdiction provides for an equitable allocation of bilateral tax revenues.
Fiscal reciprocity assumes that the States have comparable social and economic backgrounds and fiscal needs. Otherwise, reciprocity requires a holistic approach based on both fiscal and non-fiscal considerations to achieve a balanced allocation of taxing rights.
The reciprocity principle has raised questions on the fairness of existing Model treaties in recent years.
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. Under the Model treaties, the source State agrees to restrict many of its taxing rights over the income derived by nonresidents within its territorial jurisdiction.
The taxing rights of the Residence State are more or less unaffected. It retains its full or unlimited taxing rights on the worldwide income and capital of its residents, with an obligation to grant relief in the limited situations when juridical double taxation arises. With the exception of avoidance of double taxation and prevention of tax evasion, the other objectives of tax treaties are still not fully accepted.
Some of the other issues that may affect international tax principles and treaties are listed below:
1. Generally, there is a consensus among nations that international double taxation is detrimental to worldwide trade and investment and should be avoided under the domestic laws and through negotiated tax treaties. Some commentators also believe that the tax system should discourage tax arbitrage, i.e. tax advantages arising from differences in tax rates and tax bases.
The latter objective may be difficult to achieve in real life unless every country has the same tax system and similar fiscal policies.
2. Each country has a primary duty to advance the interests of its citizens and residents. As countries are at differing levels of social and economic growth, their fiscal needs vary widely. Although the primary purpose of taxation is to raise revenue for the government, other non-fiscal objectives affect both domestic and international taxation.
The total benefits (tax and non-tax) provided by each country should be considered to determine both equity and reciprocity.
3. Several developing countries consider that the current allocation of tax revenues between source and residence States under the Model tax treaties is inequitable. It unduly restricts the taxing rights of source States in favour of residence States. This view is expressed by several commentators.
Reciprocity and inter-nation equity is also questioned in the tax rules applied to electronic commerce applications. The present allocation rules, as well as the latest OECD interpretations on e-commerce taxation, do not favour source countries when dealing with digital goods. Unless acceptable reciprocity is agreed, developing countries may have problems in accepting the existing Model treaties.
4. Taxation is more than just a fiscal issue. It is affected by political, social and economic factors. As a result, there are significant differences among States on the relevance of taxation (and fiscal goals in general) within their national policy. Each country tries to justifies its own approach and sometimes impose it on others.
A State’s size and its place in the world economy and political order, influence these efforts. Under these circumstances, it may not be appropriate to apply a single treaty model under a “one-size-fits-all” approach to all countries.