Tax Treaties

When a business from one jurisdiction invests in another, the question then arises as to which jurisdiction gets to tax which bits of the income that the investment generates. So countries sign Double Tax Treaties or Double Tax Agreements (DTAs) with each other that sort out these and other questions. A key aim is to prevent the same income getting taxed twice: so-called ‘double taxation’.

Three main concerns stand out here from a tax justice perspective.

First, underlying the system of international tax treaties has been an overriding focus on preventing ‘double taxation’ – but this has, in practice, led to a world of widespread double non-taxation – that is, where income effectively gets taxed nowhere.

Second, should it be the jurisdiction that is the source of that income (i.e. the one that hosts the inward investment) which taxes the income, or the jurisdiction where the investor is resident: the capital-exporting country? (See our briefing paper on this, and see more below.)

DTAs generally tend to follow two models. The first, dominant model is overseen by the OECD, a club of rich countries. This model is generally more favourable to rich countries, where most multinationals are resident. The second is the UN model, which gives somewhat greater taxing rights to “source” countries, typically developing countries receiving inward investment, but only up to a point: the UN has unfortunately been pressured by OECD countries to modify its model in their favour.

A third is question is: how does enough information get exchanged under the agreements to allow tax authorities to get the information they need? DTAs contain protocols for information exchange, but there is another class of tax treaties too: Tax Information Exchange Agreements (TIEAs). These are narrower in scope and concern only information exchange. Generally, countries ought only to sign TIEAs, not DTAs with tax havens, unless they want to see their tax dollars leak offshore through treaty abuses.

Key problems

Tax treaties restrict the right of states to tax foreign investors and foreign-owned companies. The idea is to encourage international investment between the countries concerned, but since developing countries are generally only importers of capital, the relationship is unequal.

In many cases, treaties also do not provide an adequate basis for a adequate tax information exchange between developing and developed countries, and in particular with secrecy jurisdictions. Some, such as Switzerland, have forced developing countries into making large tax concessions in their treaties, in exchange for (often minimal) information exchange.

In addition, multinationals usually channel investments through intermediary companies formed in convenient jurisdictions so they can take advantage of treaty-shopping’, which helps them structure low-tax (or zero-tax) pathways through the international tax system. Some countries deliberately facilitate these pathways by setting themselves up asconduit’ countries. They do this principally by signing many treaties favourable to multinationals, and also passing laws that encourage the formation of ‘holding companies’ or ‘international business corporations’. Common conduit countries include Luxembourg, the Netherlands, Switzerland, and Mauritius.

OECD nations have inserted various anti-abuse clauses into their treaties with such countries, but developing countries generally have not: however some are now beginning to challenge OECD model treaties, partly due to pressure from tax justice activists.

The OECD has also produced a report with recommendations on anti-abuse measures, under its so-called “Base Erosion and Profit Shifting (BEPS)” programme, its flagship global project to tackle multinational tax abuses. There has been some progress, but far too little, in our view. We believe developing countries should suspend any new tax treaty negotiations until the current reforms ensure that multinationals can be taxed `where economic activities take place and value is created’ as called for by the G20 world leaders in the St Petersburg Tax Declaration of 2013.

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