Lecture International and European Tax Law
Lecture 1 Scope of Tax Treaties
The first step in a cross border taxation case is always: is there a tax treaty? Which tax treaty? Is the
tax treaty applicable? In which circumstances can the treaty applied? What is the consequence of this
tax treaty? One of the basic conditions is the residency.
Before you begin to answer any treaty question, you should have to take a look if the relevant person
is a resident of one or even both of the Contracting States. First you have to look if the income are
taxable under domestic law and secondly does the treaty forbid under certain circumstances that
one of the states is allowed the taxation by state of restricts the taxation to a lower rate.
The questions you have to ask before solving a case are:
1) The treatment under domestic law;
2) Entitlement (residency);
3) Distributive rules who may tax.
Scope of tax treaties
- Personal scope (Art 1 OECD)
(1) This convention shall apply {“treaty entitlement”} to persons who are residents of one or
both of the contracting states. -> You have to test if it is a person and if this person is also
a resident. Only than the treaty is applicable.
Example: are dividends taxable in state A? The first question you have to ask: are the
dividends taxable under domestic law. Second question: does the tax treaty forbid under
circumstances that this state is allowed to tax or allows the taxation of that states or
restricts the taxation to a lower rate.
(2) … {rule for hybrid entities like partnerships} -> a partnership is a group of people who
work together for business purposes, without being incorporated. In some countries it is
treated as if it was subject to the corporation tax and in some countries. But some
country treats it like it is transparent. They tax the persons behind partnership (allocate
the assets to the partners). The partners are then subject for tax, because they are
individuals. When both countries treat it differently than this is called a hybrid entity.
o Hybrid financial instruments: when in one country it is treated as dividend and in the
other country it is seen as interest. You have different treatments in different states.
It only solves bilateral situations.
(3) … {saving clause}
The resident State is not limited to the treaty and can still tax, but have to avoid double
taxation. The most of the countries do not use it.
- Territorial scope
- Material scope (Art 2 OECD)
The OECD Model is only a model which the States can take for the negotiates. This is a base for the
most tax treaties. But it is not the concrete tax treaty. In the practice you have to look at the concrete
tax treaty. The OECD Model has a lot of explanation.
Three stages
- European law: this override tax treaties and domestic law. Only then it is effective. This
means that this also applies to treaties other than tax treaties. It will be treated as if it was
domestic law.
- Treaty law: it is determined by a treaty who may tax. This allocate taxing rights.
- Domestic law: it is determined by national law who can tax. This create taxing rights.
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,Principle Purpose Test (art 1(2) UN, art 29(9) OECD)
Notwithstanding the other provision of this Convention, a benefit under this convention shall not be
granted in respect of an item of income or capital if it is reasonable to conclude, (this is an additional
condition in aspect of the personal scope of the treaty) having regard to all relevant facts and
circumstances, that obtaining that benefit was one of the principle purposes of any arrangement or
transaction that resulted directly or indirectly in that benefit, unless it is established that granting
that benefit in these circumstances would be In accordance with the object and purpose of the
relevant provisions of this Convention.
This is a general anti abuse rule. In the Netherlands is the general anti abuse rule fraus legis. This
principle will not be applied in tax treaties situations. The tax treaty do not say that it is applicable.
But some countries will say that it is always applicable (Germany). In Germany you have a lot of
specific general anti abuse rules. The treaty will not apply in abusive situations.
Person
A person is liable to tax under the law of the State.
Art 3(1)(a) OECD: individual, company any other body of persons.
Art 3(1)(b) OECD: company = body corporate or entities treated as body corporate for tax purposes
(“subject to corporation tax”). Any entity that is corporate and all other companies that are treated
that way.
Resident person
Art 4 OECD tells you whether you’re a resident of state A or state B for treaty purposes. There is no
definition of resident in Art 4(1) OECD. But the refers to the domestic law: “liable to tax” for
example: you are a resident in Spain if you are working there for more than 183 days. In Germany
you are resident if you have a permanent home. For example: if you have an apartment in Maastricht
but also in Aachen. Then the Netherlands and Germany will both say that you are a resident. It that
case you have double taxation.
If you are not a resident in both countries on the basis of domestic law, you risk double non-taxation.
The tax treaty isn’t solving the problem. It looks at domestic law of both states. Then it can happen
that you are a resident in both states. Article 4 OECD only solves the purpose of residence for treaty
purposes.
However: limitation in respect of acceptable criteria (personal attachment)
- Domicile: in English speaking countries, domicile is linked to the intention of a taxpayer to
stay, live, and return to a certain state. There can only be one domicile. If you emigrate as an
English man to French, but if you state in your testament that you will buried in England,
then you have the intention to return. This is old fashioned.
- Residence: in common law countries, residence provides a connecting factor distinct from
domicile, mostly based on physical presence. There is a difference between ordinary
residence and residence. There are three categories: domicile, resident an ordinary resident.
This is different from the civil law countries: physical presence, home, other territorial
factors.
- Place of management.
- Criterion of similar nature.
Nationality is not sufficient even it gives rise to full tax liability: only in the US they are taxing on the
basis of nationality.
2
,Art 4(1), 2nd sentence OECD and UN MC
Clarification that source taxation is not sufficient (e.g. diplomatic and consular staff (cf. Art 28 OECD).
You have to be liable to comprehensive taxation (full liability to tax as determined by domestic law
(para 8 OECD Commentary on Art 4 OECD). It is a subject to worldwide income. If you are a resident
of the Netherlands then you will be taxed on your worldwide earned income, wherever you have
earned that income.
However: rule does not apply in countries adopting a territorial principle (para 8.3 Commentary on
Art 4 OECD) this term does not include any person who is liable to tax the State in respect only of
income from sources in that State or capital situated therein. This means that a state taxes only
income from sources of this state and it doesn’t tax worldwide income (Panama). Liability to tax does
not actually mean paying tax.
Persons liable to tax in respect only of income from source in that state is not a resident of that state.
Persons are not considered residents if they are liable to tax only in respect of income from sources
in that State (non-resident taxpayers, resident diplomats).
Pension funds are in most states not a subject to tax. In the Netherlands you can deduct the pension
premium so it is not liable to tax. If you also tax the pension fund, you would have a double taxation.
Because of this most pension funds are exempt from tax. Investment funds and REITs are also
exempt from tax. There are two different approaches:
- Is the principle liable to tax but relieved from liability to tax (para 8.11 Commentary on Art 4
OECD) meaning that you can be a resident and can also be entitled to the treaty (majority
view);
- Tax exempt entities cannot be resident (para 8.12 Commentary on Art 4 OECD).
The OECD uses case by case approach. The States should clarify the issue in the tax treaties.
The income from 30% rulings in the Netherlands are also not taxable. This means if a Dutch
enterprise hires someone from abroad and this person has certain skills which are not present in the
Netherlands, the consequence will be that 30% of the salary is exempt.
The issue of incorporation
For example: the company was incorporated in the Netherlands but have the place of effective
management in Ireland. The Netherlands use the incorporation in the Corporate tax law. There is a
taxpayer who owns the shares in Belgium. The company is paying dividends to the taxpayer in
Belgium. The Netherlands are allowed to levy withholding tax if a resident company pays dividend to
a resident person abroad (Art 10 OECD). The Netherlands have to look at Art 4(1) OECD. The
company is a resident of the Netherlands because of the incorporation. You have to look of the
incorporation is covered.
Is incorporation covered by Art 4(1) OECD? No,
- Incorporation is nationality of companies and nationality is not covered. Neither for
individuals and companies.
- It is not covered by domicile and resident -> because both concepts refer to only individuals.
- It is not the place of management -> because place of management means that you are
doing business. Incorporation does not mean that you doing business. You do not have to do
business in that country. It is cheap to establish a company in England. It has nothing to do
with substance.
3
, - It is not another criterion of similar nature -> because all elements are of territorial nature,
incorporation has no territorial link, it is of purely legal nature. They look at a place.
Incorporation is no a place. It is a legal fiction.
- It is not explicitly mentioned in the OECD Model, but in the UN Model and the US Model (the
latter also mentions citizenship). Why is it not mentioned if they want it in the OECD?
Because they do not want it in the OECD Model.
Is incorporation covered by Art 4(1) OECD? Yes,
- Domicile may also cover incorporation under domestic law.
- Residence may also cover incorporation under domestic law.
- It is a criterion of similar nature (broad understanding) since it results in full tax liability.
Example: you have a company incorporated in the Netherland, but the place of effective
management is in Ireland. The shareholder is a resident in Belgium. Can the Netherlands levy
withholding tax? It depends on the interpretation of a resident. If you conclude that incorporation is
not include, then only Ireland is the resident State. But if you conclude that incorporation is include,
both of the states are the resident state. Then you have a dual residency. You have to apply the tie
breaker.
The difference consequences are:
a) The company is not a resident in the Netherlands for treaty purposes. The Netherlands are
not allowed to levy withholding tax.
b) The company is a resident in the Netherlands for treaty purposes. If there is a dual residence,
there is a dual withholding tax, unless there is a tie-breaker applied.
Object
- Make distributive rules of tax conventions workable.
- Treaty residency (a person can be a resident under national law but not under tax treaty
law).
For example: an individual lives in Maastricht (home available) but he also has a home in Aachen
where is family lives. Or a Lux investment fund (tax exempt) holds a participation in a NL company.
Object significance
- Treaty entitlement (Art 1(1) OECD):
Treaty entitlement depends on residency of a person (personal scope) in one or both
contracting states.
- Application of distributive rules:
Distributive rules can only be applied if it’s clear who is the resident for tax treaty
purposes. Only with this knowledge we are able to determine whether the ‘source state’
has a taxing right and whether the state of residence has to avoid double taxation in
accordance with Art 23 MC. This article expressly refers to a single residence state.
- Avoidance of double taxation.
Dual residency
Art 4(2) OECD: individuals
Art 4(3) OECD: other persons (companies, etc.)
Tie-Breaker rules criteria (art 4(2) OECD)
- Where is the person a resident?
- Permanent home
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