From the vantage point of a tax practitioner in 2008, it is easy to forget that period just a decade ago when e-commerce was going to revolutionise the business world–and the tax world.
Source countries; residence countries; permanent establishment concepts; income attribution; we were worried that all of our existing tax concepts would be undermined by e-commerce, so that we would need to invent a whole new way of taxing international business.
What happened? E-commerce grew and grew and grew. But after hundreds of articles in the tax press, reports by tax authorities in the US and other countries, and an extensive review by the OECD’s five Technical Advisory Groups on e-commerce, a startling consensus emerged: our existing tax concepts, and the framework for international tax embodied in the OECD’s Model Income Tax Convention, worked just fine, thank you. There was no need for a radical realignment of tax principles.
And therein lies the reason we celebrate the 50th anniversary of the OECD Model Tax Convention: while the world of international business has changed and grown and changed again, the OECD Model Tax Convention has proven its value over five decades as a framework for how we think about international tax, and the treaty shows every prospect of serving that same role for five decades more.
The OECD’s model tax treaty was not the first such treaty (that honour belongs to the model tax conventions developed by the League of Nations in the 1920s), nor is it the only such model of importance today (because the United Nations model, first issued in 1980, still has persuasive authority for some countries.) But the OECD model has achieved a consensus position as the benchmark against which essentially all tax treaty negotiations take place.
I recently talked with a former tax treaty negotiator for China, who described one of the key negotiations in which she participated with a major developing country. What was the template agreement from which the two countries began their discussions? The OECD Model Tax Convention, of course, even though neither country is an OECD member.
It is easy to be cynical about the OECD Model Tax Convention. Yes, the OECD represents the developed world and the needs of its economies. Yes, the voices of the developing economies are sometimes heard only faintly, despite a vigorous outreach effort by the OECD’s Committee on Fiscal Affairs during the past ten years. Yes, reaching consensus on reports and model language can be painfully slow.
But make no mistake: the OECD is a vitally important organisation and the OECD Model Tax Convention is a tremendously important tool for smoothing the way of international business and global trade.
Examples abound; I will offer only two.
First, the writing and analysis of the OECD on principles of international taxation are the most extensive source of guidance in the field. Indeed, there is no other authoritative voice that even ranks in the same tier as the OECD.
If a practitioner–or, say, a government official in an emerging country–has only two books on international tax in their library, it is fairly easy to guess what those books would be: the OECD Model Tax Convention and its commentaries, plus the 1995 OECD Transfer Pricing Guidelines. Why is this important? Because the principles articulated in these documents, such as the distinction between a non-taxable representative office and a taxable branch or business, the concept of income attribution, and the broad principles of arm’s-length transfer pricing, are foundations in assuring a sense of fair play in international tax.
One of the great privileges of my early tax career was to sit beside Marcia Field and Mordy Feinberg, the lead US tax treaty negotiators for 20 years from the 1970s to the 1990s, and learn as they unwrapped the subtleties of various treaty articles; these sessions were often with treaty negotiators of another country, who, like me, were less knowledgeable about the implications of particular language. The OECD model treaty has captured a hundred years of experience in international tax and distilled the core principles. Many of us learned international tax by studying the model and its commentaries.
Multinational companies are rapidly establishing their own offices in emerging markets in Africa, the Middle East, South America and Asia, where previously these companies relied on locally owned distributors. These new offices are feasible only because the basic principles of taxation articulated and demonstrated by the OECD and its Model Tax Convention are generally applicable. When a multinational company first enters Kenya, or Sri Lanka, or Uruguay, there is a common language to facilitate the discussion with the local officials on taxation.
Without the OECD, we still would have “permanent establishments” and “taxation at source” and many of the other building blocks of international tax. But there would be much greater variation in how those tax concepts would be defined and applied.
Here is an analogy: imagine giving athletes in different countries a net, a ball and a field and telling them to “go play.” Everyone may enjoy the experience, but we can be sure that no two games would be alike. Similarly, imagine giving tax officials a few concepts–“jurisdiction to tax,” “royalties,” “withholding taxes”–and telling the officials to build a system to tax non-residents. The result would be chaos.
There is much more to be done. As the e-commerce experience demonstrated in the past, and as the globalisation of financial services is demonstrating today, important work is needed to apply the principles of the OECD Model Tax Convention to specific business methods. And, educating both experienced tax practitioners and new tax officials is always a challenge, because the principles of international tax are not easy to understand. But the OECD’s continued focus on new areas of interest, such as the taxation of deferred compensation and retirement income for cross-border workers, and on hearing new voices, especially from developing countries, keeps the entire international tax community moving forward to meet the new challenges.
A second example to show the importance of the OECD model is the role it serves in weighing competing positions and then reaching a decision. It may not always be the right decision (“right”, at least, in each of our own minds!), and it certainly is not the only possible decision. But it is a decision with finality. Therefore, a construction project constitutes a permanent establishment if it lasts more than 12 months–not three months, or six months or nine months. Profits from operating aircraft in international traffic will be taxed on a residence basis, not a source basis.
The League of Nations was never able to summon the courage or authority to issue a single model. So, the League eventually developed four models. The OECD is at its best when it weighs the competing positions with respect to an issue and then offers a single consensus proposal. Once the OECD position is articulated, the burden of persuasion shifts to anyone who seeks to advance a different position. As the OECD membership expands and the number of countries with substantial international business increases, arriving at that single solution in every case will be more difficult–but also ever more critical.
The challenges to expanded international trade in the 21st century are many, as the recent failure of the Doha round of negotiations for a new world trade agreement demonstrated. But international business would be substantially more difficult if tax authorities operated singly–we could even say blindly–in determining the tax rules that apply to international transactions.
As international tax practitioners, we all share in the achievements and challenges of the OECD and its work on tax treaties. We celebrate our significant progress during the past 50 years–and, armed with the Model Tax Convention and a willingness to work co-operatively, we will meet the challenges of the next 50 years as well.
This is adapted from an article originally published by Tax Analysts. See www.taxanalysts.com
©OECD Observer No 269 October 2008