A little commented on section of the OECD Model Tax Treaty is its anti-avoidance sections. In fact, there are several pages of discussion on this issue in the commentary on Section 1 (see paragraphs 7-25). For the next few blog posts, I want to turn to a discussion of this issue as it relates specifically to the OECD Model Treaty and more generally international planning.
Let’s begin at paragraph 7, the first in the explanation’s section on “Improper Uses of the Convention.”
The principal purpose of double taxation conventions is to promote, by eliminating international double taxation, exchanges of goods and services, and the movement of capital and persons. It is also a purpose of tax conventions to prevent tax avoidance and evasion
The convention’s primary purpose is to make it easier to move goods from point A to point B by eliminating the biggest problem facing international trade: double taxation. The tax treaty does this by allowing for the taxation of goods at a jurisdictional nexus (some type or permanent establishment or formal agency in a jurisdiction where the transaction occurs) and granting those companies taxed on this transaction a credit or deduction in their home country (assuming they are taxed on their world-wide income).
For example, a US Company X sells goods through a bricks and mortar store in Germany. Because the US has a world-wide taxation system, this transaction may be subject to tax in two locations: in Germany at the point of sale and in the US on the base company’s total income "from all sources, whatever source derived." But under the tax treaty (and corresponding US law), the Company X is granted a tax credit on its US tax which in theory should eliminate the negative earnings impact of the German Tax.
In the Model Treaty, the above transaction would come under Sections 5 (Permanent Establishment) and sections 23 (Method of Eliminating Double Taxation. See also section 7 on agency.)
The treaty also encourages cross-border flows of capital. Here the biggest impediment is high taxation at the country’s border of dividend, interest or royalty payments. For example, country X imposes a 30% tax on a payment of interest or royalties moving from within to another country. To eliminate this problem, cross-border payments are typically taxed at a lower rate under tax treaties. (See general sections 10, 11 and 12).
So far, we know the tax treaties are supposed to encourage international trade in goods. Next time, I’ll start to look at how they eliminate or discourage tax avoidance and evasion. Should you have any questions, please contact me domestically at 832.330.4101 or internationally via Skype, where my name is bonddad.
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