General features of the OECD model tax convention.

INTRODUCTION

Tax treaties play a crucial role in international taxation as they define the rules for the allocation of taxing rights between countries and prevent double taxation. The interpretation of tax treaties is a complex issue that has been the subject of much debate in the international tax community. The OECD Model Tax Convention[1] is the most widely used model for tax treaties and provides a framework for the interpretation and application of tax treaties. The OECD Model Tax Convention was first enacted in 1963 by the Organization for Economic Co-operation and Development (OECD), which is a global intergovernmental organization. The purpose of the model was to provide a standard framework for the negotiation of bilateral tax treaties between countries. At the time of its enactment, there was a growing need for a model tax treaty that could help to prevent double taxation of income and capital between countries. The proliferation of cross-border investments and the increasing complexity of international tax law had made it difficult for countries to negotiate bilateral tax treaties on their own. The OECD Model Tax Convention was designed to provide a common approach to the allocation of taxing rights between countries, and to help promote international trade and investment. The model has since been updated regularly to reflect changes in international tax law and practice, and it remains the most widely used model for tax treaties around the world.

The first member states for the OECD Model Tax Convention were the original 18 members of the OECD in 1963, which included Austria, Belgium, Canada, Denmark, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom, and the United States[2]. Today, there are 38 member countries of the OECD, including many of the world's largest economies such as Japan, Korea, Australia, and Mexico. In addition, the model has been widely adopted by non-member countries around the world as a basis for their own tax treaties. The OECD has been used by its member states in a number of ways, firstly: Negotiation of bilateral tax treaties: The OECD Model Tax Convention provides a standard framework for the negotiation of bilateral tax treaties between countries. Member states use the model as a basis for negotiating their own tax treaties with other countries, which helps to reduce double taxation and promote cross-border investment.

Second: Development of international tax standards: The OECD has developed a range of international tax standards and guidelines, including the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, the Common Reporting Standard for the Automatic Exchange of Financial Account Information, and the Base Erosion and Profit Shifting (BEPS) Project. And Third: Peer review and monitoring: The OECD conducts peer reviews and monitoring of member states' tax policies and practices to ensure that they are in line with international standards and best practices. The results of these reviews are published in the OECD's annual reports and are used by member states to improve their tax systems and practices.

This article will discuss the general features of the OECD Model Tax Convention and its interpretation, focusing on the key issues that arise in this area.

GENERAL FEATURES OF THE OECD MODEL TAX CONVENTION

The OECD Model Tax Convention is a model treaty developed by the Organization for Economic Co-operation and Development (OECD) and serves as a template for bilateral tax treaties between countries. The model is updated regularly to reflect changes in international tax law and practice. The main features of the OECD Model Tax Convention are as follows:

Resident-Based Taxation: The model provides for resident-based taxation, which means that a country has the right to tax the worldwide income of its residents. Non-residents are only taxed on income derived from sources within the country. Under Resident-Based Taxation, a country has the right to tax the worldwide income of its residents, regardless of where that income is earned. This means that a person who is considered a resident of a particular country for tax purposes is subject to tax in that country on their global income, including income earned outside of the country[3].

For-instance, suppose that John is a resident of Country A for tax purposes, and he earns income from two sources: a job in Country A and a rental property in Country B. Under Resident-Based Taxation, Country A has the right to tax John on his worldwide income, including the income from the rental property in Country B. If Country B also claims the right to tax the income from the rental property, this would result in double taxation of the same income. To prevent double taxation, the tax treaty between Country A and Country B may provide rules for allocating the taxing rights between the two countries. For example, the treaty may provide that Country A has the primary right to tax the rental income, but Country B may also tax the income subject to certain conditions or limitations. By using the principles of Resident-Based Taxation and allocating taxing rights between countries, the tax treaty helps to prevent double taxation and promote cross-border investment.

The concept of Resident-Based Taxation is important because it helps to prevent double taxation of income and ensures that individuals and companies pay taxes in the country where they have the greatest economic connection. The OECD Model Tax Convention provides a framework for allocating taxing rights between countries, which helps to reduce conflicts and promote cross-border investment. It is worth noting that not all countries follow the principle of Resident-Based Taxation. Some countries, such as the United States, use a system of Citizenship-Based Taxation, which taxes the worldwide income of its citizens regardless of where they reside.

The provisions for Resident-Based Taxation in the OECD Model Tax Convention can be found in Article 6, which is titled "Income from Immovable Property." Specifically, Article 6(1) provides that income from immovable property, such as rental income, is taxable in the country where the property is located, but that the country of residence of the taxpayer may also have the right to tax such income under its own domestic laws. This is in line with the principle of Resident-Based Taxation. It is worth noting that Resident-Based Taxation is not limited to Article 6 of the OECD Model Tax Convention, but is a general principle that applies throughout the convention.

Source-Based Taxation: Source-Based Taxation is another principle of international taxation provided for in the OECD Model Tax Convention[4]. Under Source-Based Taxation, a country has the right to tax income that arises within its borders, regardless of the residence of the taxpayer[5]. This means that a non-resident who earns income from a source within a country may be subject to tax in that country. The principles of Source-Based Taxation are reflected in several articles of the OECD Model Tax Convention, including Articles 7, 10, 11, and 12. Article 7 of the OECD Model Tax Convention deals with the taxation of business profits. It provides that the country where a business operates (the source country) has the right to tax the profits that arise from that business in its territory, regardless of the residence of the taxpayer. Article 10 of the convention deals with the taxation of dividends. It provides that the country where the dividends originate (the source country) has the right to tax the dividends at the source, but that the country of residence of the recipient may also tax the dividends subject to certain conditions. Article 11 deals with the taxation of interest, and Article 12 deals with the taxation of royalties. Both articles provide similar rules to Article 10 for the taxation of income from these sources.

In practice, the principles of Source-Based Taxation and Resident-Based Taxation are often combined in tax treaties to prevent double taxation and promote cross-border investment.

Double Taxation Relief: Is a system that aims to eliminate or reduce the tax burden on an individual or company's income that arises from being taxed twice by two or more countries on the same income. The Organization for Economic Co-operation and Development (OECD) has developed model tax conventions that provide guidelines for Double Taxation Relief. Article 23 of the OECD model tax convention covers Double Taxation Relief. It provides for two methods of relief: Tax Credit Method: Under this method, the country of residence of the taxpayer provides relief by allowing a credit for the tax paid in the other country on the same income. Exemption Method: Under this method, the country of residence exempts the income from tax, which has already been taxed in another country[6].

For instance, suppose a company is registered in Country A and operates a branch in Country B. The profits earned by the branch in Country B are taxed in that country, and the same profits are also subject to tax in Country A as they are considered income of the parent company. To avoid double taxation, the tax paid in Country B is credited against the tax payable in Country A under the Tax Credit Method, or the profits earned in Country B are exempted from tax in Country A under the Exemption Method, depending on the provisions of the tax treaty between the two countries[7].

Prevention of Tax Avoidance: Prevention of Tax Avoidance is a set of measures that aim to prevent taxpayers from using legal means to reduce or eliminate their tax liabilities beyond the intentions of tax laws. The Organization for Economic Co-operation and Development (OECD) has developed a model tax convention that includes provisions for preventing tax avoidance. Article 6 of the OECD Model Tax Convention covers Prevention of Tax Avoidance. It provides that a treaty country may tax income that is artificially diverted from its intended recipient to a person in another country if the diversion of income was made with the main purpose of avoiding taxation. It also includes provisions for the taxation of income that is derived through a person or entity in a third country with little or no tax liability.

For example, suppose a company based in Country A earns profits from selling goods to a subsidiary company in Country B. The subsidiary then sells the goods to customers in Country C at a higher price, generating additional profits. However, the subsidiary is located in a tax haven with a low tax rate and minimal economic activity. If the company uses this structure to artificially shift profits from Country A to Country C through Country B to avoid higher taxes in Country A, then Country A may invoke the Prevention of Tax Avoidance provisions of Article 6 to tax the diverted income as if it was earned directly in Country A.

INTERPRETATION OF THE OECD MODEL TAX CONVENTION

The interpretation of tax treaties is a complex issue that involves a variety of legal and policy considerations[8]. The interpretation of the OECD Model Tax Convention is based on the Vienna Convention on the Law of Treaties, which provides a set of rules for the interpretation of international treaties. The Vienna Convention establishes that the text of a treaty should be the primary source of interpretation, and that other sources, such as the preamble, the negotiating history, and the context of the treaty, can be used to interpret the text. The OECD Commentary on the Model Tax Convention is another important source of interpretation of the model. The Commentary provides guidance on the interpretation and application of the model, and is often relied upon by tax authorities and taxpayers. The Commentary is updated regularly to reflect changes in international tax law and practice.

One of the key issues in the interpretation of the OECD Model Tax Convention is the meaning of the term "beneficial owner" in the context of the withholding tax provisions. The term is not defined in the model, and its interpretation has been the subject of much debate in tax treaty cases. The OECD has issued guidance on the meaning of beneficial ownership, which provides that a person is considered the beneficial owner of income if he or she has the right to use and enjoy the income without any obligation to pass it on to another person. The guidance also provides that the mere fact that a person is a conduit entity does not preclude it from being the beneficial owner of income[9].

Another important issue in the interpretation of the OECD Model Tax Convention is the application of the treaty abuse rule. The rule is designed to prevent taxpayers from using tax treaties to avoid paying tax, and provides that a treaty benefit may be denied if obtaining the benefit would be contrary to the purpose of the relevant treaty provisions. The application of the rule is highly fact-specific and requires a careful analysis of the relevant facts and circumstances.

SCOPE OF THE TREATY

The OECD Model Tax Convention defines the scope of the treaty by specifying the taxes covered, the persons covered, and the territory to which it applies[10]. The taxes covered by the treaty typically include income taxes, corporation taxes, and capital gains taxes. The persons covered by the treaty are individuals, companies, and other legal entities resident in one or both contracting states. The territory covered by the treaty is the geographical area of the contracting states, including their territorial waters and airspaces[11]. The interpretation of the scope of the treaty is essential to determine the tax liability of taxpayers in different jurisdictions. It involves determining the applicability of the treaty to specific situations, such as whether a taxpayer is a resident of one or both contracting states or whether a particular tax is covered by the treaty. The interpretation of the scope of the treaty requires a thorough understanding of the tax laws of both contracting states and the provisions of the treaty.

DEFINITIONS

The OECD Model Tax Convention contains definitions of key terms used in the treaty, such as "resident," "permanent establishment," and "dividend." The interpretation of these definitions is crucial to determine the tax liability of taxpayers in different jurisdictions. For example, the definition of "permanent establishment" is essential to determine whether a foreign company is subject to taxation in a contracting state where it carries on business. The interpretation of definitions in the OECD Model Tax Convention requires a comprehensive analysis of the context in which they are used and their intended meaning. The interpretation should take into account the purpose of the treaty, the legislative history, and the practices of the contracting states. In cases of ambiguity, the interpretation should be consistent with the object and purpose of the treaty and avoid creating unintended tax consequences.

CONCLUSION

In conclusion, the OECD Model Tax Convention has played a vital role in promoting fair and efficient taxation practices globally. The convention provides a framework for tax treaties between countries, including provisions on the allocation of taxing rights, the prevention of double taxation, and the exchange of information between tax authorities. Its provisions are regularly updated to reflect changes in the global economy and to address emerging tax issues. The OECD Model Tax Convention serves as a valuable tool for promoting international tax cooperation and preventing harmful tax practices. It has been widely adopted by countries worldwide and has played a crucial role in reducing barriers to trade and investment, facilitating cross-border transactions, and promoting economic growth. However, there are ongoing challenges related to the interpretation and implementation of the Model Tax Convention, particularly in the areas of transfer pricing and the prevention of tax avoidance. The OECD continues to work with member countries to address these challenges and promote the effective implementation of the Model Tax Convention.

Overall, the OECD Model Tax Convention is an important tool for promoting fair and efficient taxation practices globally and for supporting economic growth and development. Its continued development and implementation are critical to ensuring a level playing field for taxpayers worldwide.

 

REFERENCE

BOOKS

Lang, M., Pistone, P., Rust, A., Schuch, J., & Staringer, C. (2019). Double Taxation Relief: A Guide to OECD Model Tax Convention. Wolters Kluwer Law & Business.

Vogel, K., & Reimer, E. (2015). Tax Treaties and Double Taxation Relief. Kluwer Law International.

JOURNAL

 Avi-Yonah, R. S. (2019). Interpretation of the OECD Model Tax Convention: An Old Problem in Need of New Solutions. Bulletin for International Taxation, 73(5), 283-292.

Rust, A. (2016). Interpretation of the OECD Model Tax Convention: the interaction between the MLI and the Commentary. European Taxation, 56(11), 502-512.

OTHER

Organisation for Economic Co-operation and Development. (2017). OECD Model Tax Convention on Income and on Capital: Condensed Version 2017. Retrieved from https://www.oecd.org/tax/treaties/oecd-model-tax-convention-condensed-version-20745459.html (Accessed April 17, 2023)

Organisation for Economic Co-operation and Development. (2021). Members and Partners. Retrieved from https://www.oecd.org/about/members-and-partners/ (Accessed April 17, 2023)

Tax Foundation. (2021). Worldwide vs. Territorial Taxation: What’s the Difference? Retrieved from https://taxfoundation.org/worldwide-vs-territorial-taxation-whats-the-difference/ (Accessed April 17, 2023)

Internal Revenue Service. (2021). Source of Income Rules. Retrieved from https://rb.gy/ioy7q (Accessed April 17, 2023)

 Tax Foundation. (2021). Worldwide vs. Territorial Taxation: What’s the Difference? Retrieved from https://rb.gy/1gu2i (Accessed April 17, 2023)

 

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[1] Organisation for Economic Co-operation and Development. (2017). OECD Model Tax Convention on Income and on Capital: Condensed Version 2017. Retrieved from https://www.oecd.org/tax/treaties/oecd-model-tax-convention-condensed-version-20745459.html (Accessed April 17, 2023)

[2] Organisation for Economic Co-operation and Development. (2021). Members and Partners. Retrieved from https://www.oecd.org/about/members-and-partners/ (Accessed April 17, 2023)

[3] Tax Foundation. (2021). Worldwide vs. Territorial Taxation: What’s the Difference? Retrieved from https://taxfoundation.org/worldwide-vs-territorial-taxation-whats-the-difference/ (Accessed April 17, 2023)

[4] Internal Revenue Service. (2021). Source of Income Rules. Retrieved from https://rb.gy/ioy7q (Accessed April 17, 2023)

[5]Tax Foundation. (2021). Worldwide vs. Territorial Taxation: What’s the Difference? Retrieved from https://rb.gy/1gu2i (Accessed April 17, 2023)

[6] Lang, M., Pistone, P., Rust, A., Schuch, J., & Staringer, C. (2019). Double Taxation Relief: A Guide to OECD Model Tax Convention. Wolters Kluwer Law & Business.

[7] Vogel, K., & Reimer, E. (2015). Tax Treaties and Double Taxation Relief. Kluwer Law International.

[8] Avi-Yonah, R. S. (2019). Interpretation of the OECD Model Tax Convention: An Old Problem in Need of New Solutions. Bulletin for International Taxation, 73(5), 283-292.

[9] Rust, A. (2016). Interpretation of the OECD Model Tax Convention: the interaction between the MLI and the Commentary. European Taxation, 56(11), 502-512.

[10] Organisation for Economic Co-operation and Development. (2021). About the OECD. https://www.oecd.org/about/ (Accessed April 17, 2023)

[11]European Commission. (2021). OECD - Organisation for Economic Co-operation and Development. https://ec.europa.eu/taxation_customs/business/international-affairs/international-organisations/oecd-organisation-economic-co-operation-development_en (Accessed April 17, 2023)