By TreatyPro Editorial
November 5, 2012
In this article, we take a look at the Organisation for Economic Cooperation and Development’s (OECD) ongoing efforts to reform certain aspects of the Model Tax Convention, particularly with respect to recent proposals on changes to the ‘beneficial ownership’ and ‘permanent establishment’ articles, and tax treaty treatment of emissions permits.
With the Model Tax Convention on Income and Capital, the OECD aims to develop a standard set of guidelines to inform the negotiation process when two countries attempt to reach a double taxation avoidance agreement. Its origins date back to 1956, when the then Fiscal Committee of the OECD started work that would establish a draft convention to resolve double taxation problems between existing member states. The Committee’s final report, entitled Draft Double Taxation Convention on Income and Capital, was adopted by the Council of the OECD in July 1963 and member countries were urged to conform to the Draft Convention when entering into new, or revising existing, tax treaties.
The economic landscape has, however, changed vastly since the earliest Convention was first adopted. Business practices have becoming increasingly sophisticated, and with the rapid growth in cross-border trade in goods and services over the last three decades, the double taxation of business income has become a major issue. As the OECD states: “International juridical double taxation –generally defined as the imposition of comparable taxes in two (or more) States on the same taxpayer in respect of the same subject matter and for identical periods – has harmful effects on the international exchange of goods and services and cross-border movements of capital, technology and persons. In recognition of the need to remove this obstacle to the development of economic relations between countries, as well as of the importance of clarifying and standardising the fiscal situation of taxpayers who are engaged in activities in other countries, the OECD Model Convention on Income and on Capital provides a means to settle on a uniform basis the most common problems that arise in the field of international juridical double taxation.”
However, frequent changes in tax laws and practices in individual countries also mean that the Convention must be updated on a regular basis, and as a consequence it is a constantly evolving animal. Since 1992, the Model has been published in a loose-leaf format to allow the incorporation of these changes, and updates were published in 1994, 1995, 1997, 2000, 2003, 2005, 2008 and 2010. Beginning with the 1997 update, the Model was presented in two volumes. Volume I includes the Introduction and the text of the Articles of the Model and their Commentaries. Volume II includes a section on the positions of non-member countries, reprints of previous reports dealing with tax conventions that the Committee on Fiscal Affairs has adopted since 1977, the list of tax conventions concluded between member countries and the text of the Council Recommendation on the Model Tax Convention.
The 2010 update includes changes that were previously released for comment in the following discussion drafts: the granting of treaty benefits with respect to the income of collective investment vehicles; revised discussion draft of a new Article 7 (business profits) of the OECD Model Tax Convention; application of tax treaties to state-owned entities, including sovereign wealth funds; tax treaty issues related to common telecommunication transactions; and revised changes to the commentary on paragraph 2 of Article 15 (income from employment).
The Model Convention, as it read on July 22, 2010, contains 31 Articles, covering issues from residence, to income from immovable property, dividends, interest, royalties, capital gains and directors’ fees, among others. The most recent proposed updates involve clarifications to Article 5 (Permanent Establishment) and revised meanings of ‘Beneficial Owner’ in Articles 10, 11 and 12. Other changes in the pipeline include clarification of the treatment of emissions credits in double tax treaties.
Consultation on Permanent Establishment
On October 19, 2012, the OECD Committee on Fiscal Affairs requested public comment on revised proposals concerning the interpretation and application of Article 5 (permanent establishment) in the Model Tax Convention, which is primarily used for the purpose of the allocation of taxing rights when an enterprise of one State derives business profits from another State. However, according to the OECD, despite the long history of the concept of permanent establishment, its practical application raises a number of issues, mainly as a result of ever-evolving business models. The Committee on Fiscal Affairs, through a subgroup of its Working Party 1 on Tax Conventions and Related Questions, has therefore examined various questions related to the interpretation and application of the definition of permanent establishment. This public discussion draft included proposals for additions and changes to the Commentary on the OECD Model Tax Convention resulting from the work of that subgroup that have recently been presented to the Working Party for discussion. However, given the practical importance of these proposals, the Committee has decided to invite public comments on the proposed changes to the Commentary before they are thoroughly discussed by the Working Party.
The consultation covers 25 areas and includes issues such as: whether a farm can be a permanent establishment; home offices as permanent establishments; the presence of a foreign enterprise’s personnel in the host country; the meaning of “place of management”; whether “goods or merchandise” covers digital products or data; and the activities of fund managers and insurance agents.
It is proposed that a number of amendments to Article 5 be included in the next revision of the OECD Model Tax Convention due to be released in 2014, with comment welcomed until January 31, 2013. Given the wide scope of the consultation, any changes brought about by it are expected to have a significant impact on the future taxation of cross-border business.
Consultation on Beneficial Ownership
Also on October 19, 2012, the Committee on Fiscal Affairs released for public comment proposals in the area of beneficial ownership as it relates to certain articles of the Model Convention. These proposals are also derived from responses to an earlier discussion draft, which in this case was released in April 2011.
The consultation seeks to clarify when an entity should be deemed to be the beneficial owner of a dividend, royalty or interest payment, as dealt with in Articles 10, 11, and 12 of the Model Convention, respectively. In many double taxation agreements concluded in line with the OECD benchmark agreement, provision is made for a lower rate of withholding tax in cases where the recipient is the 'beneficial owner' of the asset from which the income - be it royalty, dividend or interest income - is derived. Due to the lack of a universally-agreed definition of 'beneficial ownership', the area has historically presented substantial challenges for tax practitioners and tax authorities alike.
Although there is no hard-and-fast interpretation, generally beneficial ownership provisions are incorporated into double tax agreements as an anti-avoidance mechanism, to restrict the provision of lower withholding tax rates to recipients that have the right to the end use of the income, unconstrained by any contractual or legal obligation to transmit this income to a third party, particularly a connected party. The provision was introduced to prevent entities triangulating payments through other nations that have more beneficial double tax arrangements with the country in which the payee resides. The practice, commonly referred to as treaty shopping, is a contentious issue that has most notably soured international relations between Mauritius and India.
The discussion draft does not seek to amend Articles 10, 11 and 12 of the OECD Model Tax Convention but instead proposes to revise the OECD commentary used to interpret these Articles. The OECD has invited comment on the discussion draft before December 15, 2012, for review in February 2013.
In an initial response, PwC welcomed the OECD's efforts to provide clarity given the considerable uncertainty that has historically existed, but said that the updated commentary had fallen short on a number of areas. Richard Collier, tax partner at PwC, said: "The concept of beneficial ownership has been mired in confusion and controversy over recent years. The OECD has provided some clarification on how payments being passed on affect beneficial ownership of income received, but not enough. For instance the new wording refers to 'unrelated payments' without any explanation of what it means for a payment to be related or unrelated. Beneficial ownership is a big issue for many international businesses which must comply with complex international and domestic tax rules. Given the current focus on corporate tax affairs, it is more important than ever that the rules affecting the level of tax paid are clear."
In another recent consultation, the Committee on Fiscal Affairs has invited public comment on a revised discussion draft on tax treaty issues related to emissions permits/credits. This analysis addresses the application of the provisions of the OECD Model Tax Convention to the cross-border trading of emissions permits.
Again, the consultation is driven by the results of a public discussion draft entitled ‘Tax treaty issues related to the trading of emissions permits’, released in May 2011. The few comments received on the discussion draft included the suggestion that the scope of the discussion draft be expanded to cover tax treaty issues arising from the trading of CERs (Certified Emission Reduction credits) and ERUs (Emission Reduction Units) as well as tax treaty issues arising from the issuance, as opposed to the trading, of emissions permits, CERs and ERUs.
In accordance with these suggestions, the CFA, through its Working Party 1 on Tax Conventions and Related Questions, has refined the analysis included in the discussion draft to cover the trading of CERs and ERUs as well as treaty issues that would arise if a State decided to tax emissions permits, CERS and ERUs at the time of their issuance rather than upon their alienation.This consultation closes on January 15, 2013 and comments will be reviewed at the February 2013 meeting of Working Party 1.
On March 13, 2015, New Zealand's Minister of Revenue, Todd McClay, announced the Government's tax policy work program for 2015/16, which includes key international tax reforms aimed primarily at countering base erosion and profit shifting (BEPS).