Introduction to the Law of Double Taxation Conventions
3. Aufl. 2021
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S. 52. State practice in the conclusion of DTCs
2.1. Conventions in international law
20
At the conclusion of a DTC, the two parties to the convention accept an international law obligation. They commit themselves to relinquishing, completely or partially, the imposition of taxes in specific situations. The convention is subject to the rules of public international law.
21
The contracting states are free to decide the manner in which they will give up taxing rights. For example, they may change domestic law so that only the transactions set out in the DTC regarding the imposition of taxes remain. Often, however, the conventions are directly applicable as domestic law. In this case, the DTC rules override the otherwise applicable domestic tax rules.
2.2. The importance of model conventions
22
Every DTC is negotiated separately. Nevertheless, many of the existing DTCs throughout the world resemble each other. This can be traced to the model tax conventions developed by international organizations. These model tax conventions are usually the starting point for bilateral negotiations. The parties to the convention only need to negotiate those points upon which they wish to deviate from the model tax convention.
23
The work of the League of Nations contributed to the development of standardized model tax conventions. In the years between World Wars I and II the League of Nations produced several model tax conventions which gained importance in the negotiations of bilateral tax conventions between states and left their mark on the later work of other international organizations.
24
The OEEC, and later the OECD, continued the work of the League of Nations. In 1963, 1977 and 1992, the OECD published model tax conventions in the area of taxes on income and on capital (cf. m.no. 29 et seq.). These agreements were further developed in 1994, 1995, 1997, 2000, 2002, 2005, 2008, 2010, 2014 and 2017. In 1966 and in 1982, model tax conventions in the area of inheritance taxes were published (cf. m.no. 533 et seq.).
25
The United Nations published an independent UN Model in 1980; revised and updated versions were subsequently published in 2001, 2011 and 2017.
26
In most respects, the UN Model follows the OECD Model and deviations exist only with respect to certain issues. Major differences can be found in Art. 5 (permanent establishment), Art. 7 (business profits), Art. 9 (associated enterprises), Art. 10 (dividends), Art. 11 (interest), Art. 12 (royalties), Art. 13 (capital gains) and Art. 21 (other income). Since the UN Model is based on the interests of developing countries, these differences mostly try to ensure that the source country retains certain taxing rights.
S. 6
27
Example
The OECD Model provides that royalties are taxed exclusively in the state of the recipient’s residence, to the exclusion of the source state (Art. 12 OECD Model, cf. m.no. 298 et seq.). According to the UN Model, royalties may also be taxed in the state in which they arise. The UN Model does not establish a tax rate for the source state but leaves this question open. The rate is to be established in bilateral negotiations. The UN Model’s principle regarding source taxation for royalties considers the situation of the developing countries: know-how is provided primarily by entrepreneurs of developed countries to enterprises in developing countries. Only rarely does the opposite occur. Thus, developing countries want to retain the right to tax remuneration paid in return for know-how.
2.3. The importance of the OECD Model
28
The OECD Models have had considerable influence in international tax law. They influenced other model tax conventions and many states use the OECD Model as a basis for their DTC negotiations.
29
In the area of taxes on income and on capital, the first OECD Model Tax Convention was published, along with a Commentary, in 1963. Over the years the Commentary has become more and more detailed. It explains the rules extensively and provides numerous examples to better understand the provisions of the OECD Model. Both documents were developed by the OECD Committee on Fiscal Affairs. The OECD Council recommended to the Member countries to make use of the Model and the Commentary: The Council thereby recommended that Member countries should continue with their efforts to enter into bilateral tax conventions, that they should adopt the OECD Model as a basis for their negotiations and that they should continue to notify the Committee on Fiscal Affairs of their reservations on articles and observations on the Commentary. Non-Member countries are invited to express their divergent views in the positions to the OECD Model (cf. m.no. 33).
30
In 1977, a revised OECD Model was published by the OECD Committee on Fiscal Affairs. This revision took practical experience with negotiating DTCs into account. In particular, the Commentary was considerably amended and expanded. Since then, the OECD often changes the Commentary even if the relevant provision of the OECD Model was not changed. The OECD revises its positions, sometimes they even deviate from a position they took before.
31
In 1992, the OECD Model was again revised. The speed increased: between 1994 and 2014 there were ten amendments. Some of these were only of minor relevance. Most of the changes concerned the Commentary to the OECD Model.
32
The 2017 Update of the OECD Model was again of major relevance. It primarily comprises changes to the OECD Model that were developed through the OECD/G20 BEPS (Base Erosion and Profit Shifting) Project. The OECD tried to reduce tax planning opportunities at all levels. Tax treaties should not create opportunities S. 7for non-taxation or reduced taxation through tax evasion or avoidance. Some of the changes were very general, such as mentioning that goal already in the preamble, others were very technical. The 2017 Update also included certain other changes to the OECD Model that had been discussed for some years and were not developed as part of the work on the treaty-related BEPS measures. Again, the Commentary was amended significantly.
2.4. Bilateral peculiarities
33
States that use the OECD Model as a basis for negotiations usually deviate from the model on some points. This is because most states cannot agree with all the rules of the OECD Model. Many OECD Member countries have entered reservations on specific rules of the OECD Model. The contracting states furthermore try to take into consideration their own economic interests as well as the peculiarities of their law and social systems.
34
Example
In the OECD Model, the PE concept is used to determine the right of a contracting state to tax the profits of an enterprise of the other contracting state. Sometimes, however, it is questionable whether certain activities constitute a PE in a contracting state. Therefore, considering the special problems in applying Art. 5 OECD Model to certain activities, Denmark reserved the right to insert in a special article relating to offshore hydrocarbon exploration and exploitation and related activities: The DTC between Denmark and Slovenia (concluded in 2001), for example, constitutes that such activities are deemed to be a PE.
35
Numerous states also use the OECD Model as a basis for their own model tax conventions and incorporate their own deviations. They use these deviating models during their bilateral negotiations.
36
Example
The United States is concerned about the improper use of a DTC. In order to prevent abuse, the United States attaches great importance to restrictions on the entitlement to the benefits of the DTC. Given this concern as well as other issues, the United States published its own Model Tax Convention in 1996 and issued, after an update in 2006, a new version of this model in 2016. The United States uses this model in its bilateral negotiations. Thus, many DTCs concluded by the United States contain many similarities (cf. Avi-Yonah/Tittle, BFIT 2007, 224).
37
Model tax conventions are also published by countries that generally agree with the OECD Model standards but want to make clear the policy principles followed by their own treaty negotiators. For example, in 2007, Belgium published its own Draft Standard Model Convention and related Protocol although, at that time, it had made only seven reservations on the OECD Model and two observations on the Commentary. The Belgian Model (further updated in 2010) officially sets forth the policy principles that the Belgian negotiators will follow in negotiating tax treaties and is presented as such to countries that want to enter into treaty S. 8negotiations with Belgium (cf. De Broe, BFIT 2008, 322 et seq.; the 2010 version no longer totally reflects Belgium's current tax treaty policy).
2.5. Bringing the Tax Treaties in Line with the OECD Model
38
Countries revise their bilateral tax treaties from time to time. Often, they take the opportunity to adapt their treaty to changes of the OECD Model. However, most governments have limited resources to negotiate new and renegotiate existing DTCs. It therefore often takes many years until updates of the OECD Model find their way in the bilateral DTCs. It is not rare that existing tax treaties reflect old versions of the OECD Model.
39
Since the OECD saw an urgency to implement the new and modified provisions developed under the BEPS Project in the DTCs, the “Multilateral Instrument” (MLI) was developed under the auspices of the OECD. The MLI is a multilateral convention, which swiftly modifies the application of existing bilateral tax treaties without the need to renegotiate each such treaty individually. It does not replace the existing tax treaties, but rather changes their content (cf. Lang, SWI 2017, 625).
40
In principle, the provisions of the MLI are optional. If a country wishes not to apply a certain provision, it can simply opt out of its application. However, the negotiating parties (a group of more than 100 jurisdictions) agreed to set a number of mandatory rules, the so-called minimum standards, which each country wishing to use the MLI has to implement. Part of these minimum standards are measures primarily to counter treaty abuse and to a lesser extent also to improve dispute resolution mechanisms while providing flexibility to accommodate specific tax treaty policies.
41
In order for a tax treaty to be modified by the MLI, it is necessary for both signatory states to a certain tax treaty to have signed the MLI and listed the relevant treaty in its MLI position under Art. 2. Only when both signatory states have notified the same treaty, their notifications match and the MLI will be able to modify the underlying bilateral tax treaty.
42
Besides the minimum standards representing the mandatory part of the MLI, all other provisions are optional. States may choose from the provisions and apply only those they wish to modify their treaties with. Through this flexible mechanism, states are able to consider their individual tax policy approaches and only choose the provisions that make sense for their treaty network. As mentioned above, if a state wishes not to apply a certain provision, it is required to formulate a reservation and thereby opt out of the relevant provision. An exception of this general mechanism can be found in Part VI of the MLI: in order to apply the part about the arbitration provisions, a state must choose to specifically opt in.
43
The MLI was finalized in November 2016 and a first signing ceremony was held in Paris on 6 June 2017. A total of 76 jurisdictions signed the MLI in this first ceremony. In the meantime, the MLI covers almost 100 jurisdictions.