OECD Model Tax Convention

Why it works

©OECD

Can the OECD Model Tax Convention, which is 50 years old this year, continue to fulfill its role of helping to make international taxation fairer and more manageable? Probably yes, though there are challenges.

Half a century ago, the Fiscal Committee of the Organisation for European Economic Co-operation (OEEC), which later became the OECD, published a first draft installment of how a model treaty on international taxation might look. The global economy was starting to become more integrated in the 1950s and the intention was to assist businesses and governments by helping to avoid double taxation and to prevent tax evasion. The question to resolve was straightforward enough: how might governments claim their rightful taxation from growing international businesses, while not leaving corporations worried about being unfairly taxed across the different jurisdictions in which they operate?

The OECD Model Tax Convention was born. It was an interesting baby. The so-called London and Mexico models of the League of Nations are clearly in the family tree, but the direct parents were those senior tax officials from European countries who, in 1956, began a collective project aimed at the development of uniform tax treaty provisions under the umbrella of the OEEC. Like all parents, they did not know what their baby would grow up to be.

Back in those days the pace of life was more sedate. Delegates would come to Paris a few times a year for week-long drafting sessions. By mid-week exhaustion would set in, so each Wednesday a trip to the countryside was arranged. Refreshed, the delegates would then return to their labours.

By 1963 a full draft was ready though it was not until 1977 that the model Double Taxation Convention was published. The 1963 draft was essentially the consolidation of four earlier drafts, the first one of which was published in 1958. This is why we consider that the birth of the OECD model was 1 July 1958.

At the outset, there were fewer than 15 countries involved in drafting the first text; by 1963 the OECD had expanded to 20 countries. It was primarily OECD member countries that contributed to the model, but since 1996 we have opened up the process to non-OECD countries and to business and each year in September, the OECD hosts a global forum of government officials from around the world who work on tax treaties. We have also put in place a global network of tax centres for officials from non-OECD countries to learn the skills of negotiating treaties and applying them: over 1,000 tax officials from across the globe have completed these courses.

Today there are more than 3,000 tax treaties in force around the world based on the OECD model. Some 30 non-OECD countries have set out their positions on the model. We do not always agree with each other, but at least we know where we disagree.

Quite simply, the OECD model has established itself as the means of settling the most common problems that arise in the field of international taxation. By enabling a certain harmonisation of double tax treaties, it guides bilateral negotiations and helps settle disputes on a uniform basis. Consider the issue of double taxation. If a US company sells its products in the US and derives income from this activity, it will pay taxes in the US. If the same company sells its products also in France, it may well have to pay tax on the same income both in France and in the US. But how much tax should the company pay and to which tax authority? The detrimental effects of getting this double taxation wrong on international trade, investment and confidence are self-evident. Clearly, neither business nor government wants to be out of pocket or feel discouraged or discriminated against. Double tax treaties help resolve these conundrums by providing agreed rules for allocating taxing rights on cross-border income between the two countries, so that the US company is free from double taxation on its income.

The OECD Model Tax Convention helps resolve such problems, though it is not binding by law. Rather, the OECD issues a Recommendation based on the common position of its members, who in turn commit to follow the model and its commentaries, while taking on board its reservations, when concluding or revising bilateral tax treaties. The extensive and regularly updated commentaries that accompany the model provide guidance on the accepted interpretations of the main text and have come to serve as a very useful reference to taxpayers, tax administrations and the courts, whether in OECD member countries or elsewhere around the world.

For this “soft law” approach to work, adaptability and transparency are needed. Changes to the model are always published in draft form in advance, and member countries have time to discuss and decide whether or not further changes are required. On-going dialogue with business and nonmembers is key in setting proper international tax rules and the model has always drawn strength from the input by tax authorities and the changing experience of business over the years.

Since 1991, the Committee on Fiscal Affairs has provided periodic and more timely updates and amendments, without waiting for a complete revision. To date, there have been updates in 1992, 1994, 1995, 1997, 2000, 2003, 2005 and 2008.

Take the 2008 update, which has just been approved with a number of interesting changes based on reports issued by the OECD over the past couple of years. For instance, it introduces a mandatory, binding arbitration provision to resolve difficult unsolved issues through what we call the mutual agreement procedure, with expanded and clarified commentaries on how the mutual agreement procedure itself should operate.

We have clarified the methodology for determining the profits attributable to a permanent establishment (e.g. a branch) through which a resident of one country carries on business in the other country–an issue of particularly keen interest to businesses operating in the financial sector.

And we have also made clarifications with respect to the thorny concept of “place of effective management”, which is the tiebreaker test to solve cases where corporations have dual residency for tax purposes, and have provided an alternative provision that moves away from the “place of effective management” test and refers the case to the “mutual agreement procedure”.

So what of the next 50?

The OECD Model Tax Convention has a conundrum of its own to resolve: how to remain firm while adapting to new circumstances with ever greater speed. True, we have met new challenges before–we answered how e-commerce should be taxed across borders, for instance–but new challenges continue to emerge, such as sovereign wealth funds, amid heightened expectations on the part of governments, international business and the public.

Can the OECD Model Tax Convention continue to meet such challenges? We believe it can, but here is a wish list of ten items which could really make a positive difference for the next 50 years.

1. Make arbitration provisions the norm in treaties. It would probably be rarely used, which would indicate that the procedure was working as intended because the parties had reached agreement without the need for binding arbitration.

2. Ensure a more consistent application of tax treaties.

3. Start work on a multilateral instrument on value-added tax (VAT). It is remarkable that 141 countries around the world have a VAT, but there is no agreement on many important issues, such as the place of consumption.

4. Find a way to speed up the process of updating treaties based on the model.

5. Give greater recognition to the fact that treaties are also about eliminating tax evasion and not just about eliminating double taxation.

6. Encourage a greater involvement of senior policymakers in treaties. Treaties are too important to be left to (more junior) negotiators.

7. Provide a greater co-ordination among OECD member countries vis-à-vis the new countries that are entering the treaty work for the first time (e.g. Hong Kong, China).

8. Review the nature of the reservations and observations in the Model, and how these relate to setting out minority views in the Commentaries.

9. Increase the involvement of non-OECD member countries and work harder at giving them a seat at the table.

10. Finally, none of this will happen unless governments put more resources into national departments responsible for international issues.

* Raffaele Russo from the CTPA also contributed to this article.

 

References

OECD (2008), Model Tax Convention on Income and on Capital, seventh edition of the condensed version, Paris, August 2008.

For more on tax treaties, see www.oecd.org/ctp/tt

See also www.oecd.org/ctp

Special note on transfer pricing:

A draft on the Transfer Pricing Aspects of Business Restructurings is now online for discussion at www.oecd.org/ctp/tp/br. Please submit comments by 19 February 2009.

©OECD Observer No 269 October 2008




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