A tax treaty, also called double tax agreement (DTA) or double tax avoidance agreement (DTAA), is an agreement between two countries to avoid or mitigate double taxation. Such treaties may cover a range of taxes including income taxes, inheritance taxes, value added taxes, or other taxes.[1] Besides bilateral treaties, multilateral treaties are also in place. For example, European Union (EU) countries are parties to a multilateral agreement with respect to value added taxes under auspices of the EU, while a joint treaty on mutual administrative assistance of the Council of Europe and the Organisation for Economic Co-operation and Development (OECD) is open to all countries. Tax treaties tend to reduce taxes of one treaty country for residents of the other treaty country to reduce double taxation of the same income.
The provisions and goals vary significantly, with very few tax treaties being alike. Most treaties:
define which taxes are covered and who is a resident and eligible for benefits,
reduce the amounts of tax withheld from interest, dividends, and royalties paid by a resident of one country to residents of the other country,
limit tax of one country on business income of a resident of the other country to that income from a permanent establishment in the first country,
define circumstances in which income of individuals resident in one country will be taxed in the other country, including salary, self-employment, pension, and other income,
provide for exemption of certain types of organizations or individuals, and
provide procedural frameworks for enforcement and dispute resolution.[2]
The stated goals for entering into a treaty often include reduction of double taxation, eliminating tax evasion, and encouraging cross-border trade efficiency.[3] It is generally accepted that tax treaties improve certainty for taxpayers and tax authorities in their international dealings.[4]
Several governments and organizations use model treaties as starting points. Double taxation treaties generally follow the OECD Model Convention[5] and the official commentary[6] and member comments thereon serve as a guidance as to interpretation by each member country. Other relevant models are the UN Model Convention,[7] in the case of treaties with developing countries and the US Model Convention,[8] in the case of treaties negotiated by the United States.
In general, the benefits of tax treaties are available only to tax residents of one of the treaty countries.[9] In most cases, a tax resident of a country is any person that is subject to tax under the domestic laws of that country by reason of domicile, residence, place of incorporation, or similar criteria.[10]
Generally, individuals are considered resident under a tax treaty and subject to taxation where they maintain their primary place of abode.[11] However, residence for treaty purposes extends well beyond the narrow scope of primary place of abode. For example, many countries also treat persons spending more than a fixed number of days in the country as residents.[12] The United States includes citizens and green card holders, wherever living, as subject to taxation, and therefore as residents for tax treaty purposes.[13] Because residence is defined so broadly, most treaties recognize that a person could meet the definition of residence in more than one jurisdiction (i.e., "dual residence") and provide a “tie breaker” clause.[14] Such clauses typically have a hierarchy of three to five tests for resolving multiple residency, typically including permanent abode as a major factor. Tax residency rarely impacts citizenship or permanent resident status, though certain residency statuses under a country's immigration law may influence tax residency. This includes the '183 day rule' when the right of abode is invoked.[15]
Entities may be considered resident based on their country of seat of management, their country of organization, or other factors.[16] The criteria are often specified in a treaty, which may enhance or override local law. It is possible under most treaties for an entity to be resident in both countries, particularly where a treaty is between two countries that use different standards for residence under their domestic law. Some treaties provide “tie breaker” rules for entity residency,[14] some do not.[17] Residency is irrelevant in the case of some entities and/or types of income, as members of the entity rather than the entity are subject to tax.[18] The OECD has moved away from place of effective management to a case-by-case resolution using Mutual Agreement Procedure (MAP) for determining conflicts of dual residency.[19]
Most treaties provide that business profits (sometimes defined in the treaty) of a resident of one country are subject to tax in the other country only if the profits arise through a permanent establishment in the other country. For eg, in the US and India tax treaty, if the person is resident of both the countries then the further clause added to the argument would be if the person owns a permanent house or has an habitual abode or being a national of a state.[20] Many treaties, however, address certain types of business profits (such as directors' fees or income from the activities of athletes and entertainers) separately. Such treaties also define what constitutes a permanent establishment (PE). Most but not all tax treaties follow the definition of PE in the OECD Model Treaty.[21] Under the OECD definition, a PE is a fixed place of business through which the business of an enterprise is carried on.[22] Certain locations are specifically enumerated as examples of PEs, including branches, offices, workshops, and others. Specific exceptions from the definition of PE are also provided, such as a site where only preliminary or ancillary activities (such as warehousing of inventory, purchasing of goods, or collection of information) are conducted.
While in general tax treaties do not specify a period of time for which business activities must be conducted through a location before it gives rise to a PE, most OECD member countries do not find a PE in cases in which a place of business exists for less than six months, absent special circumstances.[23] Many treaties explicitly provide a longer threshold, commonly one year or more, for which a construction site must exist before it gives rise to a permanent establishment.[24] In addition, some treaties, most commonly those in which at least one party is a developing country, contain provisions which deem a PE to exist if certain activities (such as services) are conducted for certain periods of time, even where a PE would not otherwise exist.
Even where a resident of one country does not conduct its business activities in another country through a fixed place or business, a PE may still be found to exist in that other country where the business is carried out through a person in that other country that has the authority to conclude contracts on behalf of the resident of the first country.[25] Thus, a resident of one country cannot avoid being treated as having a PE by acting through a dependent agent rather than conducting its business directly. However, carrying on business through an independent agent will generally not result in a PE.[26]
Many tax systems provide for collection of tax from non-residents by requiring payers of certain types of income to withhold tax from the payment and remit it to the tax authorities.[27] Withholding arrangements may apply to interest, dividends, royalties, and payments for technical assistance. Most tax treaties reduce or eliminate the amount of tax required to be withheld with respect to residents of a treaty country.[28]
Income from employment
Most treaties provide mechanisms eliminating taxation of residents of one country by the other country where the amount or duration of performance of services is minimal but also taxing the income in the country performed where it is not minimal. Most treaties also provide special provisions for entertainers and athletes of one country having income in the other country, though such provisions vary highly. Also most treaties provide for limits to taxation of pension or other retirement income.[29]
Tax exemptions
Most treaties eliminate from taxation income of certain diplomatic personnel. Most tax treaties also provide that certain entities exempt from tax in one country are also exempt from tax in the other. Entities typically exempt include charities, pension trusts, and government owned entities. Many treaties provide for other exemptions from taxation that one or both countries as considered relevant under their governmental or economic system.[30]
Harmonization of tax rates
Tax treaties usually specify the same maximum rate of tax that may be imposed on some types of income. As an example, a treaty may provide that interest earned by a nonresident eligible for benefits under the treaty is taxed at no more than five percent (5%). However, local law in some cases may provide a lower rate of tax irrespective of the treaty. In such cases, the lower local law rate prevails.[31]
Provisions unique to inheritance taxes
Generally, income taxes and inheritance taxes are addressed in separate treaties.[32] Inheritance tax treaties often cover estate and gift taxes. Generally fiscal domicile under such treaties is defined by reference to domicile as opposed to tax residence. Such treaties specify what persons and property are subject to tax by each country upon transfer of the property by inheritance or gift. Some treaties specify which party bears the burden of such tax, but often such determination relies on local law (which may differ from country to country).
Most inheritance tax treaties permit each country to tax domiciliaries of the other country on real property situated in the taxing country, property forming a part of a trade or business in the taxing country, tangible movable property situated in the taxing country at the time of transfer (often excluding ships and aircraft operated internationally), and certain other items. Most treaties permit the estate or donor to claim certain deductions, exemptions, or credits in calculating the tax that might not otherwise be allowed to non-domiciliaries.[33]
Double tax relief
Nearly all tax treaties provide a specific mechanism for eliminating it, but the risk of double taxation is still potentially present. This mechanism usually requires that each country grant a credit for the taxes of the other country to reduce the taxes of a resident of the country. Seen in the US-India treaty, as per the DTAA, if interest income arises in India and the amount belongs to a US Resident, then the said amount shall be taxable in the US. However, such interest may be liable to tax in India as per the Indian Income Tax Act.[34] The treaty may or may not provide mechanisms for limiting this credit, and may or may not limit the application of local law mechanisms to do the same.[35]
Mutual enforcement
Taxpayers may relocate themselves and their assets to avoid paying taxes. Some treaties thus require each treaty country to assist the other in collection of taxes, to counter the revenue rule, and other enforcement of their tax rules.[36] Most tax treaties include, at a minimum, a requirement that the countries exchange of information needed to foster enforcement.[14]
The purpose of this agreement is to promote international co-operation in tax matters through exchange of information. It was developed by the OECD Global Forum Working Group on Effective Exchange of Information.
The agreement grew out of the work undertaken by the OECD to address harmful tax practices. The lack of effective exchange of information is one of the key criteria in determining harmful tax practices. The mandate of the working group was to develop a legal instrument that could be used to establish effective exchange of information.
The agreement represents the standard of effective exchange of information for the purposes of the OECD's initiative on harmful tax practices. This agreement, which was released in April 2002, is not a binding instrument but contains two models for bilateral agreements. A number of bilateral agreements have been based on this agreement.[37]
Dispute resolution
Nearly all tax treaties provide some mechanism under which taxpayers and the countries can resolve disputes arising under the treaty.[38] Generally, the government agency responsible for conducting dispute resolution procedures under the treaty is referred to as the “competent authority” of the country. Competent authorities generally have the power to bind their government in specific cases. The treaty mechanism often calls for the competent authorities to attempt to agree in resolving disputes.
Limitations on benefits
Recent treaties of certain countries have contained an article intended to prevent "treaty shopping," which is the inappropriate use of tax treaties by residents of third states. These limitation on benefits articles deny the benefits of the tax treaty to residents that do not meet additional tests. Limitation on Benefits articles vary widely from treaty to treaty, and are often quite complex.[39] The treaties of some countries, such as the United Kingdom and Italy, focus on subjective purpose for a particular transaction, denying benefits where the transaction was entered into in order to obtain benefits under the treaty. Other countries, such as the United States, focus on the objective characteristics of the party seeking benefits. Generally, individuals and publicly traded companies and their subsidiaries are not adversely impacted by the provisions of a typical limitation of benefits provision in a U.S. tax treaty. With respect to other entities, the provisions tend to deny benefits where an entity seeking benefits is not sufficiently owned by residents of one of the treaty countries (or, in the case of treaties with members of a unified economic bloc such as the European Union or NAFTA, by "equivalent beneficiaries" in the same group of countries).[40] Even where entities are not owned by qualified residents, however, benefits are often available for income earned from the active conduct of a trade or business.[41]
Priority of law
Treaties are considered the supreme law of many countries. In those countries, treaty provisions fully override conflicting domestic law provisions. For example, many EU countries could not enforce their group relief schemes under the EU directives. In some countries, treaties are considered of equal weight to domestic law.[42] In those countries, a conflict between domestic law and the treaty must be resolved under the dispute resolution mechanisms of either domestic law or the treaty.[43]
Notes
↑ Agreements on tariffs, while technically tax treaties, are generally called agreements on tariffs and trade.
1 2 3 See, e.g., the Canada/Belgium treaty, supra.
↑ See, e.g., the U.S. IRS explanation of residency regarding the "green card test".
↑ See, e.g., the Canada Revenue Agency discussion, and the Canada/Belgium treaty, supra, which defines resident by reference to local law.
↑ See, e.g., the old treaty between the United States and the former Union of Soviet Socialist Republics, which is still in force between the U.S. and several of the former Soviet republics.
↑ See, e.g., the U.S. IRS explanation of taxation of foreign partners of partnerships with a U.S. trade or business.
↑ Contrast the U.S./Italy treatyArchived 2010-03-02 at the Wayback Machine using exact OECD language with the U.S./India treaty that has numerous special provisions.
↑ See, e.g., the Singapore/India treaty, Article 15, which has a 183-day rule and a flat 15% tax rate where services go beyond 183 days. This treaty contains all of the provisions mentioned.
↑ See, e.g., the U.S./Canada treaty Articles XIX and XXI.
↑ See, e.g., the Ireland/U.S. treaty, under which dividend withholding is limited to 5% or 15%, depending on ownership levels, but where Ireland tax law imposes no withholding tax on qualifying recipients.
↑ See, e.g., treaties between the U.S. and France regarding income taxes and estate and gift taxesArchived 2010-06-13 at the Wayback Machine . The provisions of this treaty reflect typical patterns, and incorporate all of the features mentioned in this section.
↑ See, e.g., the U.S./France treaty, supra, containing all of these features.
↑ All of the treaties cited above feature the credit mechanism.
↑ See, e.g., the Canada/U.S. 2007 ProtocolArchived 2010-03-02 at the Wayback Machine Article 22, amending Treaty Article XXVI A, Assistance in Collection.
↑ For example, Switzerland had agreed with the United States to turn over certain bank records, but the agreement was held by Swiss courts to violate Swiss law. The Swiss administration referred the matter to the Swiss Parliament for resolution. See, e.g., CNN coverage.
Transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort taxable income, tax authorities in many countries can adjust intragroup transfer prices that differ from what would have been charged by unrelated enterprises dealing at arm’s length. The OECD and World Bank recommend intragroup pricing rules based on the arm’s-length principle, and 19 of the 20 members of the G20 have adopted similar measures through bilateral treaties and domestic legislation, regulations, or administrative practice. Countries with transfer pricing legislation generally follow the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations in most respects, although their rules can differ on some important details.
A limited liability company (LLC) is the United States-specific form of a private limited company. It is a business structure that can combine the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. An LLC is not a corporation under the laws of every state; it is a legal form of a company that provides limited liability to its owners in many jurisdictions. LLCs are well known for the flexibility that they provide to business owners; depending on the situation, an LLC may elect to use corporate tax rules instead of being treated as a partnership, and, under certain circumstances, LLCs may be organized as not-for-profit. In certain U.S. states, businesses that provide professional services requiring a state professional license, such as legal or medical services, may not be allowed to form an LLC but may be required to form a similar entity called a professional limited liability company (PLLC).
A tax deduction or benefit is an amount deducted from taxable income, usually based on expenses such as those incurred to produce additional income. Tax deductions are a form of tax incentives, along with exemptions and tax credits. The difference between deductions, exemptions, and credits is that deductions and exemptions both reduce taxable income, while credits reduce tax.
A corporate tax, also called corporation tax or company tax, is a type of direct tax levied on the income or capital of corporations and other similar legal entities. The tax is usually imposed at the national level, but it may also be imposed at state or local levels in some countries. Corporate taxes may be referred to as income tax or capital tax, depending on the nature of the tax.
Tax exemption is the reduction or removal of a liability to make a compulsory payment that would otherwise be imposed by a ruling power upon persons, property, income, or transactions. Tax-exempt status may provide complete relief from taxes, reduced rates, or tax on only a portion of items. Examples include exemption of charitable organizations from property taxes and income taxes, veterans, and certain cross-border or multi-jurisdictional scenarios.
Double taxation is the levying of tax by two or more jurisdictions on the same income, asset, or financial transaction.
Tax withholding, also known as tax retention, pay-as-you-earn tax or tax deduction at source, is income tax paid to the government by the payer of the income rather than by the recipient of the income. The tax is thus withheld or deducted from the income due to the recipient. In most jurisdictions, tax withholding applies to employment income. Many jurisdictions also require withholding taxes on payments of interest or dividends. In most jurisdictions, there are additional tax withholding obligations if the recipient of the income is resident in a different jurisdiction, and in those circumstances withholding tax sometimes applies to royalties, rent or even the sale of real estate. Governments use tax withholding as a means to combat tax evasion, and sometimes impose additional tax withholding requirements if the recipient has been delinquent in filing tax returns, or in industries where tax evasion is perceived to be common.
The United States federal government and most state governments impose an income tax. They are determined by applying a tax rate, which may increase as income increases, to taxable income, which is the total income less allowable deductions. Income is broadly defined. Individuals and corporations are directly taxable, and estates and trusts may be taxable on undistributed income. Partnerships are not taxed, but their partners are taxed on their shares of partnership income. Residents and citizens are taxed on worldwide income, while nonresidents are taxed only on income within the jurisdiction. Several types of credits reduce tax, and some types of credits may exceed tax before credits. Most business expenses are deductible. Individuals may deduct certain personal expenses, including home mortgage interest, state taxes, contributions to charity, and some other items. Some deductions are subject to limits, and an Alternative Minimum Tax (AMT) applies at the federal and some state levels.
International taxation is the study or determination of tax on a person or business subject to the tax laws of different countries, or the international aspects of an individual country's tax laws as the case may be. Governments usually limit the scope of their income taxation in some manner territorially or provide for offsets to taxation relating to extraterritorial income. The manner of limitation generally takes the form of a territorial, residence-based, or exclusionary system. Some governments have attempted to mitigate the differing limitations of each of these three broad systems by enacting a hybrid system with characteristics of two or more.
The European Union withholding tax is the common name for a withholding tax which is deducted from interest earned by European Union residents on their investments made in another member state, by the state in which the investment is held. The European Union itself has no taxation powers, so the name is strictly a misnomer. The aim of the tax is to ensure that citizens of one member state do not evade taxation by depositing funds outside the jurisdiction of residence and so distort the single market. The tax is withheld at source and passed on to the EU Country of residence. All but three member states disclose the recipient of the interest concerned. Most EU states already apply a withholding tax to savings and investment income earned by their nationals on deposits and investments in their own states. The Directive seeks to bring inter-state income into the same arrangement, under the Single Market policy.
The criteria for residence for tax purposes vary considerably from jurisdiction to jurisdiction, and "residence" can be different for other, non-tax purposes. For individuals, physical presence in a jurisdiction is the main test. Some jurisdictions also determine residency of an individual by reference to a variety of other factors, such as the ownership of a home or availability of accommodation, family, and financial interests. For companies, some jurisdictions determine the residence of a corporation based on its place of incorporation. Other jurisdictions determine the residence of a corporation by reference to its place of management. Some jurisdictions use both a place-of-incorporation test and a place-of-management test.
A permanent establishment (PE) is a fixed place of business that generally gives rise to income or value-added tax liability in a particular jurisdiction. The term is defined in many income tax treaties and in most European Union Value Added Tax systems. The tax systems in some civil-law countries impose income taxes and value-added taxes only where an enterprise maintains a PE in the country concerned. Definitions of PEs under tax law or tax treaties may contain specific inclusions or exclusions.
Corporate tax is imposed in the United States at the federal, most state, and some local levels on the income of entities treated for tax purposes as corporations. Since January 1, 2018, the nominal federal corporate tax rate in the United States of America is a flat 21% following the passage of the Tax Cuts and Jobs Act of 2017. State and local taxes and rules vary by jurisdiction, though many are based on federal concepts and definitions. Taxable income may differ from book income both as to timing of income and tax deductions and as to what is taxable. The corporate Alternative Minimum Tax was also eliminated by the 2017 reform, but some states have alternative taxes. Like individuals, corporations must file tax returns every year. They must make quarterly estimated tax payments. Groups of corporations controlled by the same owners may file a consolidated return.
A foreign tax credit (FTC) is generally offered by income tax systems that tax residents on worldwide income, to mitigate the potential for double taxation. The credit may also be granted in those systems taxing residents on income that may have been taxed in another jurisdiction. The credit generally applies only to taxes of a nature similar to the tax being reduced by the credit and is often limited to the amount of tax attributable to foreign source income. The limitation may be computed by country, class of income, overall, and/or another manner.
Taxation in the British Virgin Islands is relatively simple by comparative standards; photocopies of all of the tax laws of the British Virgin Islands (BVI) would together amount to about 200 pages of paper.
Taxes in Germany are levied at various government levels: the federal government, the 16 states (Länder), and numerous municipalities (Städte/Gemeinden). The structured tax system has evolved significantly, since the reunification of Germany in 1990 and the integration within the European Union, which has influenced tax policies. Today, income tax and Value-Added Tax (VAT) are the primary sources of tax revenue. These taxes reflect Germany's commitment to a balanced approach between direct and indirect taxation, essential for funding extensive social welfare programs and public infrastructure. The modern German tax system accentuate on fairness and efficiency, adapting to global economic trends and domestic fiscal needs.
In Slovakia, taxes are levied by the state and local governments. Tax revenue stood at 19.3% of the country's gross domestic product in 2021. The tax-to-GDP ratio in Slovakia deviates from OECD average of 34.0% by 0.8 percent and in 2022 was 34.8% which ranks Slovakia 19th in the tax-to-GDP ratio comparison among the OECD countries. The most important revenue sources for the state government are income tax, social security, value-added tax and corporate tax.
Base erosion and profit shifting (BEPS) refers to corporate tax planning strategies used by multinationals to "shift" profits from higher-tax jurisdictions to lower-tax jurisdictions or no-tax locations where there is little or no economic activity, thus "eroding" the "tax-base" of the higher-tax jurisdictions using deductible payments such as interest or royalties. For the government, the tax base is a company's income or profit. Tax is levied as a percentage on this income/profit. When that income / profit is transferred to a tax haven, the tax base is eroded and the company does not pay taxes to the country that is generating the income. As a result, tax revenues are reduced and the country is disadvantaged. The Organisation for Economic Co-operation and Development (OECD) define BEPS strategies as "exploiting gaps and mismatches in tax rules". While some of the tactics are illegal, the majority are not. Because businesses that operate across borders can utilize BEPS to obtain a competitive edge over domestic businesses, it affects the righteousness and integrity of tax systems. Furthermore, it lessens deliberate compliance, when taxpayers notice multinationals legally avoiding corporate income taxes. Because developing nations rely more heavily on corporate income tax, they are disproportionately affected by BEPS.
The organization responsible for tax policy in Ukraine is the State Fiscal Service, operating under the Ministry of Finance of Ukraine. Taxation is legally regulated by the Taxation Code of Ukraine. The calendar year serves as a fiscal year in Ukraine. The most important sources of tax revenue in Ukraine are unified social security contributions, value added tax, individual income tax. In 2017 taxes collected formed 23% of GDP at ₴969.654 billion.
A loan-out corporation, also known as a loan-out company, or personal service corporation, is a form of US business entity in which the creator is an 'employee' whose services are loaned out by the corporate body. The creator of the corporation is typically the sole shareholder, and thus the corporation is used as a means to reduce their personal liability, protect their assets and exploit taxation advantages. Loan-Out corporations are especially prominent in the entertainment and professional sports industries, as the creator's services are typically performed on individual contract bases, and receive large, irregular sums of income throughout the year.
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