Article 24-1 of the OECD modal convention³ stipulates that: “Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, in particular with respect to residence, are or may be subjected”.
In the revised OECD model convention of 1992 it is clearly specified that the national should be “in the same circumstances, in particular with respect to residence”, to benefit from this article. The OECD convention does not prevent a taxpayer who is non-resident and a taxpayer who is resident from being taxed in a different way, because their circumstances are not comparable. This article only forbids tax discrimination based on nationality.
The residence and territoriality principles are adopted by most national laws and bilateral conventions. Under the territoriality principle, residents and non-residents are taxed according to the source of the income received. Residents are taxed on their worldwide income and non-residents are taxed only on the income based in the country concerned. Tax conventions and EC law allows harmonisation of these rules and tries to combine the legislation of the source and the country of residence in order to avoid double taxation. For example, tax treaties usually allow the elimination of double taxation either by attributing the exclusive right to tax to the source country (“the exemption method” Article 23A of the OECD model) or by attributing a tax credit to the country of residence (“the credit method” – Article 23B of the OECD model).
However, whilst one can observe that the countries of residence normally take tax equity¹ into consideration, the same cannot be said in the case of source countries. The state of residence can tax the worldwide income subject to a tax credit, or take into account exempted income to calculate the effective tax rate of other income. These systems allow a balanced and equal taxation of residents and non-resident taxpayers. Contrary to this, in the state of source, tax equity² is less respected and it is not unusual for these states to offer to non-residents favourable tax treatment compared to residents. So, national and conventional legislation based upon the residence and territoriality principle, may lead to privileged taxation of the non-resident rather than the resident taxpayer.
The issue could be raised over the compatibility of the differential tax treatment and the “non-discriminatory principle” contained in most tax conventions.
The Future of Tax Sharing Internationally – A Dream or a Reality by Robert Anthony & Cecile Villacres
This article was first published in the March 2002 issue of BNA’s journal “Tax Planning International Review”.
The purpose of International tax law is to fix the conditions of taxation of cross border transactions. A transaction made in one state by an individual or a company resident in another state should be taxable in which state? The first state would claim the right to tax this transaction under the “residence” principle and the other state would claim the right because the transaction has taken place within its territory. This simple example demonstrates the two main principles of international tax for both individual and corporate taxation: the principle of residence and the principle of territoriality. The purpose of this article is to draw attention to the fact that these principles whilst being evident are also beginning to become obsolete and need to be rethought.