The purpose of this article is to review double tax treaties with a view to gaining an understanding of what they are and how the operate, how they are interpreted and concentrate on the rationale behind them. In order to meet these objectives it has been necessary to review in detail the standard treaty format found in the OECD Model Convention and this has been done by breaking the Convention into separate and distinct parts which have functions of their own. In addition treaty shopping and limitation of benefits provisions together with a review of some recent cases involving the interpretation of double tax treaties has been included.
1. The purpose of double tax treaties
Double tax treaties are viewed as beneficial by most states because they allow business to transact with a degree of certainty both on the part of the individuals, partnerships or corporate entities and the government of that state in which that business entity operates. The perceived benefits of double tax treaties can be identified as:
i. Clarification of taxing rights of each State Double tax treaties allow elucidation of taxation rights between states. The taxing rights under the treaty only apply to residents of a particular country (and some e.g. partnerships may not be covered), and only in respect of taxes stated within the treaty. There may also be some items of income or capital which are not covered by the treaty in which case, without a general article, one falls back again to local law. Once the taxpayer is satisfied that the treaty covers them and the taxes for which clarification is sought, then the particular article is referred to in order to ascertain tax exemption or applicable reductions or exemptions.
ii. Avoidance of double international juridical taxation International juridical double taxation is where the same profits are taxed in two or more States on the same person (corporate or individual); this compares with economic double taxation where the same State may tax the same profits to two or more persons (eg dividends representing taxed corporate profits are taxed again in the individual’s hands, ie the classical system of taxation as compared to the imputation system).
iii. Prevention of fiscal evasion with anti-avoidance provision The exchange of information provision (see Article 26 below) should enable countries to obtain information in order to ensure its taxing rights are preserved, although the effectiveness of such provisions for tax avoidance as opposed to tax fraud may be limited at present. The various articles then individually legislate wherever possible to prevent tax avoidance in clarifying what would be considered business profits, acceptable interest deductions, etc., and the views of each State may differ significantly in practice on such subjective issues. The Mutual Agreement article attempts to provide for such eventualities, but the willingness of the competent authorities to agree these issues are currently left to discussion as opposed to specifically legislated for.
iv. Countries which are parties to double tax treaties High tax countries have no reason to enter into double tax treaties with tax havens such as Bermuda, British Virgin Islands, Anguilla etc., which do not levy tax on profits. Indeed certain countries such as Hong Kong, with a source system of taxation may equally have no reason to worry about international juridical double taxation since non-local source profits are exempt from tax in any event. However, where their residents are actively engaged in business abroad, e.g. South Africa, it would wish to conclude treaties to clarify taxing rights and prevent fiscal evasion. Low tax countries which are often referred to as tax havens because they offer certain concessions, for example, the Channel Islands, Liechtenstein, Malta and Cyprus may have double tax treaties but either they are very few in number (for example the Channel Islands with UK only, Liechtenstein with Austria only), or the countries with whom they negotiate treaties may wish to impose limitations within the treaties (exclusion of offshore companies). Cyprus is one of the few countries which have generally been able to negotiate a wide range of treaties without such limitations, although they do exist in certain treaties (treaties with the UK and the US for example). High tax countries need the widest range of double tax treaties to limit international juridical double taxation; their residents require clarification of what profits will be taxed where, and countries will often permit certain activities to be either exempt from tax or suffer a reduced rate of local tax in an effort to stimulate their international trade. Equally, such countries will desire the anti-avoidance provisions to enable them to secure their tax revenue.