Introduction To The Law of Double Tax Conventions S8
Introduction To The Law of Double Tax Conventions S8
Introduction To The Law of Double Tax Conventions S8
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2"d edition
Content
Preface ............................................................................................................................................................. . 5
Preface .............................................................................................................................................................. 7
List of abbreviations .............................................................................................................................. 15
Literature cited in the text .................................................................................................................. 19
List of court cases .................................................................................................................................... 23
1. The problem of double taxation ..................................................................................... 27
1.1. Basics of intemationallaw ........................................................................................ 27
1.2. Circumstances giving rise to double taxation ............................................. 27
1.2.1. Taxation ofworldwide income (full tax liability)
in two states ........................................................................................................ 27
1.2.2. Full tax liability and limited tax liability ..................................... 28
1.2.3. Limited tax liability in two states ...................................................... 29
1.2.4. Economic double taxation ....................................................................... 29
1.3. Elimination of double taxation ............................................................................... 30
1.3.1. Double taxation conventions ................................................................. 30
1.3.2. Unilateral measures ...................................................................................... 30
2. State practice in the conclusion of DTCs ................................................................ 32
2.1. Conventions in intemationallaw .......................................................................... 32
2.2. The importance of model conventions ............................................................. 32
2.3. The importance ofthe OECD Model................................................................ 33
2.4. Bilateral peculiarities ..................................................................................................... 34
3. The effects ofDTCs ................................................................................................................... 35
3.1. The allocation oftaxing rights ................................................................................ 35
3.2. The limiting effects of DTCs ................................................................................... 36
3.3. The relationship to domestic law .......................................................................... 36
3.3.1. Implementation ofDTCs into domestic law ............................. 36
3.3.2. Priority ofDTC law ..................................................................................... 36
3.3.3. Priority of domestic law ............................................................................ 38
3.3.4. What to consider first in practice: DTC or
domestic law? ................................................................................................... 38
4. The interpretation of double taxation conventions ....................................... 41
4.1. Principles of interpretation in intemationallaw ........................................ 41
4.2. The use of principles of interpretation stemming from
intemationallaw with respect to DTCs ........................................................... 44
4.2.1. Autonomy ofDTC law .............................................................................. 44
4.2.2. The importance of domestic law ........................................................ 45
4.2.3. The importance ofthe OECD Model and its
Commentary ....................................................................................................... 48
tax liability. However, ifthe connection is weak or consists only of objective fac-
tors, only the income eamed in that state is taxed (principle ofterritoriality). This
is called limited tax liability.
5 A taxable person can have elose personal connections with two or more states.
Under the tax laws ofvarious states, for example, the person's domicile is a con-
necting factor. In others, residence and citizenship are connecting factors. De-
pending on the applicable laws, each ofthese criteria can lead to full tax liability.
Therefore, it is not rare in practice, for the same person to be subject to full tax
Iiability in two or more states. This can lead to the levying of taxes on world-
wide income in two or more states.
6 This might lead to severe tax consequences as a very recent case shows: Ac-
cording to reports in the media, one of the founders of Facebook "officially de-
friended the United States [... ], giving up his American citizenship for the more
tax-friendly residency status of Singapore." The reason for this move might have
been the IPO ofFacebook in May 2012. His stake ofabout 4% was worth approx-
imately USD 4 billion and would have triggered a substantial capital gains tax in
the United States. It should be noted, however, that it is not possible to escape all
US taxes. US citizens who give up their citizenship owe what is effectively an exit
tax on the capital gains from their stock holdings, even if they do not seIl the
shares. Therefore, the founder in the end can still expect a large tax bill. The advan-
tage, however, is that this tax bill is based only on an appraisal. His Facebook stake
could have been valued at less than it was worth once the shares were traded pub-
liely. It could be argued that the value ofhis stake should be discounted because of
the potential difficulty of selling the shares while the company remains private.
7 Example
An individual who lives in Spain and whose centre oJeconomic interests is in
France is subjecI 10 Juli lax liability in both states. If there were no DTC be-
tween France and Spain, both countries would tax the person 's entire world-
wide income.
into transactions with each other.Each residence state determines the taxable base
for corporate income tax under its domestic corporate tax law. Ifthe two compa-
nies enter into transactions with each other, the tax authorities of the two states
could assign different values to those transactions (for a detailed description of
transfer pricing issues, cf. m.no. 472 et seq.). Economic double taxation may then
arise.
15 Example
A multinational group 01 companies has subsidiaries in China and Brazi/.
The Chinese company seils products to the Brazilian company lor CNY
100.000. The Chinese tax authorities consider that the CNY 100.000 price is
appropriate. whereas the Brazilian tax authorities are olthe opinion that the
appropriate price would be CNY 80, 000. This may lead 10 economic double
taxation.
Example 28
The OECD Model provides that royalties are taxed exclusively in the state of
the recipient's residence, to the exclusion ofthe source slate (Art. 12 OECD
Model, cf m.no. 305 et seq.). According to the UN Model, royalties mayaiso
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 es-
tablished in bilateral negotiations. The UN Model 's principle regarding
source taxation for royallies considers the situation of the developing coun-
tries: know-how is providedprimarily by entrepreneurs ofdeveloped countries
to enterprises in developing countries. Only rarely does the opposite occur.
Thus, developing countries want 10 relain the righl to tax remuneration paid
in return for know-how.
cia) rules in relation to domestic tax rules. The priority ofDTe law is based on its
lex specialis character.
Example 51
A eonstruetion eompany resident in Bangladesh is hired to build an office in
India and requires 4 months for the construetion. Under the Bangladesh-India
DTC, the ineome from this project eannot be taxed by India; Art. 7 of the DTC
provides that income of a eompany resident in Bangladesh ean only be taxed
in Bangladesh. An exception exists ifthe Bangladesh company carries on busi-
ness in India through a PE (Art. 7(1) ofthe Bangladesh-India DTC). Under
Art. 5(2), however, a eonstruction site constitutes a PE only if it lasts for more
than 183 days. Therefore, there is no PE in India under the DTC. Aecording
to Indian domestie law, ineome reeeived in India or arising in India is taxable
under Sec. 4 ofthe Indian ITA. Sinee the DTC is the more specijic law, India
will apply the DTC and not the domestie rules. The imposition oftax by India
would eonstitute an infringement of internationallaw.
The characterization of DTe rules as special rules makes it necessary that DTe 52
rules refer not only to the same requirements to which domestic tax rules refer but
also to at least one supplementary requirement. Accordingly, DTe rules are as a
rule only important if all the requirements for the application of a certain domestic
tax provision are met and the DTe rules lead to different legal consequences. In
other words, there are two groups of requirements in connection with DTe
rules: One group consists ofthe requirements which lead to taxation under domes-
tic law and the other group consists of the supplementary requirements that are
found in DTe rules.
Example 53
A scientist is resident in Switzerland and is subjeet to worldwide taxation
therein. He per/orms independent personal services in Italy. Under Italian
law, the scientist would be subjeet to tax on the income earnedfrom these ac-
tivities. Under Art. 14 of the Italy-Switzerland DTC (Art. 14 of the former
OECD Model), however, as long as the scientist does not have a fixed base
regularly available to hirn in Italy, Italy may not tax the income. The law in It-
aly (irnposition oftax) is in eonflict with the DTC (no imposition oftax). The
eonfliet is to be resolved infavour ofthe DTC rule.
In addition to the lex specialis rule, the lex posterior rule can playa role in the 54
interpretation ofDTes. It is doubtful whether a domestic tax rule can prevail over
an existing DTe. In these cases it is questionable whether the treaty prevails as lex
specialis or whether a later domestic law prevails as lex posterior. This question
cannot be decided by examining the provisions alone. In the scope of the interpre-
tation, all the interpretation materials must be taken into ac count. If the interpre-
tat ion leads to the result that the domestic law prevails, this constitutes an in-
fringement of intemationallaw.
certain parts. Whether the stencil or the pattern is examined first, the same conclu-
sion results, so the order of application can be decided pragmatically from case to
case." (cf. m.no.45). The order is therefore not a matter of interpretation and does
not have any impact on the content of individual treaty articles. Anyone applying
the treaty must consider this issue in every particular case exclusively under prac-
tical criteria.
Example 59
In IN, ITAT 30 Jun. 2008. Epcos AG v. Assistant Commissioner of Income
Tax. a German company earned incomefrom the provision oftechnical ser-
vices to an Indian subsidiary. The German company paid taxes in India at a
rate of 10%, relying on the applicability of Art. 12 of the Germany-India
DTC (HRoyalties and fees for technical services "). The Indian Tax Officers
assessed the German company arguing that Art. 7 rather than Art. 120fthis
treaty was applicable. The Indian Tax Officers argued that the German com-
pany had a PE in India and therefore the income in question should be taxed
in India in accordance with Art. 7 ofthe Germany-India DTC. They therefore
assessed tax at 20% instead of 10%. The Indian Tax Officers gave an inter-
pretation of Indian domestic law by which the onus ofproving the non-exist-
ence of a PE in India was upon the German company. supporting their
argument by stating that domestic law is to be appliedfirst and tax treaty law
is to be applied thereafter. The ITAT stated that there is no Hconceptual sup-
port or other material whatsoever for 'domestic law first' approach. though,
in all fairness, there is literature to support the proposition that the debate
regarding whether one should see the treaty first or domestic law first is a
non-starter. Whichever path we follow, we reach the same destination any-
way; whether or not cross- border income is taxable in the source state in the
light ofthe domestic tax laws read with the applicable tax treaty, it would not
make any difference, in the ultimate analysis. whether one examines the case
on the touchs tone of the scheme of the treaty first and domestic law later, or
vice versa. "
What has proven to be useful is the practice of first consulting domestic law to 60
determine whether any liability for tax exists and then consulting the DTC to de-
termine whether it provides any relief from this liability. If there is no liability
for tax under domestic law, there is no need to consult the DTC since the DTC in
practice does not create a liability to tax (cf. m.no. 46). The mere allocation of
taxing rights to a contracting state does not create an independent basis for taxa-
tion. On the other hand, it can occasionally be useful to consult the DTC first to
determine whether a contracting state has the right to tax at all, and, as a second
step, to determine the manner in wh ich the contracting state exercises this right.
If, under the treaty, there is no right to tax, there is no need to consult domestic
law.
61 Example
A resident of Canada wins a lottery in Aus/ria. One begins with the domeslic
right to tax. Since Canadian domestic law does not tax lotfery winnings, the
winnings are not taxable in Canada. From the point of view of Canadian ta-c
law, an examination ofthe DTC between Austria and Canada is therefore un-
necessary. This is not altered by thefacI that under Art. 21(/) ofthe DTC be-
tween Canada and Auslria, Canada has the right to tax this income.
Furthermore, the lottery winnings are not taxable in Austria either becallse
they are not regarded as taxable income. Th is is not altered by the fact that un-
der Art. 21 (2) Austria-Canada DTC, Austria also has a righl 10 lax this in-
come. The DTC does not provide an independent legal basis for taxing this
income.