The general view of the purpose of tax treaties is to prevent double taxation. Double taxation arises when the residence country and source country inflict tax on the same taxable income. Double taxation is considered one of the most important problems of international taxation. Double taxation arises when a similar individual is taxed twice once in the country where he is the resident and second time in the country where he is working. The world has more than 3000 treaties on income tax, and the quantity of treaties is increasing. It is significant to assure that treaty is in force and effect. Most of these treaties are based on UN model convention and OECD model These two models have a great influence on international treaty practices and have major common provisions. In times of globalization, the taxpayers have become global but tax authorities have not become global. The tax authorities have at the most become bilateral.
Dual taxation arises when a person is considered a resident of two countries. To resolve this issue of double taxation, a person is taxed in only one country under a double taxation avoidance rule. But the convention with the United States is an exception as only individuals are exempted and companies are not exempted.
In some cases of income, it is to be taxed only by the state of habitation. A common example of this is the profit made by shipping and airline companies. As in their case determination of source is difficult. Pensions are also only taxable in the country of residence under Australia's Double Taxation Agreement. In the case of business profits, taxation is only by residence country or taxation is by both countries with relief by residence country.
In some of the cases, Double Taxation Agreement requires taxation by source country alone and it requires the country of residence to reduce or eliminate taxes so that double tax is not levied. This is followed in the case of selling property. In this situation, the other nation takes tax on the sale of the property, and the resident country relieves double taxation based on the method of relieving the double taxation.
It was important to include the exchange of information under the OECD Model Tax Convention. Co-operation between the tax authorities of the two-nation is necessary. Co-operation is essential to ensure which rule is to be applied.5 Article 1 and Article 2 will not prevent the sharing of information as mentioned by Article 26. The exchange of information under Article 26 will be successful only if the participating country ensures that the information is kept confidential. The exchange of information practically is like a black box.6 Developing countries have raised an issue that this provision will be used by a developed country to get the information by pressurizing the developing country.
This article talks about the cooperation that is carried out by the countries in assisting each other in collecting taxes. In some cases, national legislation might not allow mutual assistance or may limit the mutual assistance between different countries.
All the double tax agreements are in effect are different from each other. This is because each double tax agreement is adopted by negotiation with different countries. Different words used by different double taxation agreements may mean the same thing. It may also be possible that the same words may mean different things. The definition of the permanent establishment has a wider meaning in agreement with the United States as compared to that with Japanese. Thus it can be seen that agreement with different countries can mean different things even though all these agreements are based on the same principle.
The general principle states that a tax treaty should take precedence over national legislation. But in certain legislative nations, the terms of a tax treaty may be overridden by the domestic legislation. The court may however require the legislature to explicitly state its intention to bypass a treaty before giving effect to contrary national law.
A treaty was entered between government of the United Kingdom and Australia it came into force in 2003. As per Article 2, the treaty applies in the United Kingdom on income tax, corporation tax, and capital gain tax. In the case of Australia, it applies to income tax, the resource rent tax with respect to offshore projects related to exploitation of petroleum products, and fringe benefits tax imposed under the federal law of Australia. There are 30 articles in the United Kingdom- Australia tax treaty.
If the person I resident of both the countries based on Article 4, then that individual will be resident of only that state where he has a permanent home. If a permanent home is present in both the states or in none of them then he will be a resident of a state with which his personal and economic relations are closer. If the center of vital interest cannot be determined then nationality will be taken into consideration. If the person is national of either both the country or none of them then the issue will be resolved by mutual agreement.
If in any case any word is not defined under treaty then it would be given the meaning under the domestic law. Thus first step to decide is whether the treaty provides any definition. If the treaty does not provide the meaning then what is the meaning under domestic law. The final question that needs to be answered is whether the context of the treaty needs a meaning that is different from domestic meaning.
The objective is to facilitate cross border trade. The most important objective is to avoid double taxation. If the income generated from cross-border trade is taxable by two or more countries then due to such double taxation these international cross-border trade and investment will be discouraged. The tie-breaker rule of the United Nations Model Convention states that a person would be considered a resident of only one country for the purpose of taxation.
In the beginning, the purpose of this treaty was to prevent double taxation. As multinational companies were subjected to double taxation because of the legislation on taxation. Some of the countries provided relief by unilaterally providing certain concessions to these multinational companies. It is to be taken into consideration that another important objective is to prevent tax evasion. Another object is to remove any kind of discrimination against non-residents. It is necessary that residents of other nations who are conducting business in some other country should be treated at par with the resident of the same country. Administrative cooperation between the contracting parties is another objective. It includes the sharing of information, assisting in the collection of tax and dispute resolution. Sharing of information enables the contracting party to avoid tax evasion and avoidance.
Tax treaties increase foreign investment due to the exclusion of the tax barrier. Due to the taxation treaty, multinational companies take interest in setting up a business in another country. Due to investment by a multinational company, employment opportunities are generated which leads to the prosperity of people. Generally, it is observed that after the signing of a treaty increase in foreign portfolio investment flows. This is especially in the case of a developed country to a developing country. However, it is observed that for foreign investment double taxation treaty is beneficial for middle-income countries compared to low-income countries.
The tax treaty improves certainty in tax treatment for both taxpayers and tax administration. Hence, it becomes simple for the tax authority to collect tax and become simple for residents and companies to pay tax. This helps in the minimization of litigation. It also reduces the burden and cost of appointing a tax consultant. Tax treaties also pave the way for the exchange of tax information prevailing between contracting countries in addition to avoidance of double taxation.
Due to the tax treaty, company interests are safeguarded in contacting countries. Technology rich firm/ company transfers their technology from origin country to contracting country. If such investments are taxed in both countries then cooperation in science and technology will be minimum. Skilled people are also ready to go to the contracting country due to tax treaties.
As per Article-25 of the UK-Australia tax treaty which is about non- discrimination, a national of one country shall not be taxed in another country more than the resident of another country. Similarly, taxation on the permanent establishment of a company is levied the same tax in contracting states doing similar business in the same condition. Hence due to tax treaty investment abroad are protected.
There is a view that without a tax treaty also, double taxation can be removed by relief of double taxation either by exemption or credit by the domestic state. But these reliefs or credit may not cover all cases especially when there is a large difference in the source rule of two states or if the law of these states does not allow relief of double taxation.
The profit earned by a company will be taxable in another state only if it is carrying work in another country with a permanent establishment. If the business is carried in the manner mentioned above then the profit will be taxed. But in that case, the profit taxed will be equal to profit earned from the permanent establishment. Thus this is the advantage of having a double tax treaty as the taxation will only be levied in other countries on a company's business profit if it has a permanent establishment in that country. The profit taxed will also be limited to profit earned from that permanent establishment.
In case of salary, wages and other similar benefits derived by the person of contracting state will only be taxed in that state unless he is employed in other contracting states. If the benefit is derived from the other state such benefit will be taxed in other states.12 Thus it is an important concept of the convention that protects the person working on wages in other countries from being taxed twice. Article 16 of the 2003 Australian-UK double taxation convention states the different rules for sportsperson and entertainer. Tax on other income which is beneficially owned by residents of the contracting party shall be taxable only in that state. 13
Immediately after the signing of the tax treaty, there may be some revenue losses for the contracting countries. Tax treaties may also affect or limit the operation of some of the domestic tax laws of a country. There may be a risk of treaty shopping i.e. improper use of double tax agreement and treaty abuse. Some cases need arises to change or clarify domestic laws to conform to a tax treaty.
However, there are provisions in the tax treaty to overcome difficulties/problem that arises. As per Article 26 of the UK- Australia tax treaty a person can present a case before tax authorities of contracting countries.
There are over 3000 double taxation treaties worldwide. Most of them are primarily made on the OECD Model Tax Convention which was first published in 1963 and has been changed several times. Double taxation occurs when the residence country and source country impose a tax on the same taxable income. Double tax treaties are mostly bilateral agreements between contracting states. It is important to assure that treaty is in force and effect. If in any situation any term is not defined under treaty then it would be given the meaning under the domestic law. They are designed to minimize the extent to which the taxpayer is subject to tax on the same income in two states. Provide a degree of certainty for the tax treatment of cross-border transactions and activities. Prevent tax discrimination against taxpayers of a different state.
Remove tax as a barrier to the free flow of international trade and investment. Provides for the exchange of information between tax authorities of different states. They relieve relevant taxes but they do not levy tax. They create an opportunity for avoiding tax thus OECD is proposing changes to the treaty. Australia and United Kingdom tax treaty mainly aims for relieving taxpayers with double taxation, because double taxation has undesirable and harmful effects on trade and business expansion and exchange of services, movement of people, capital, science, and technology in the two countries. Treaties also prevent tax evasion. It is necessary to have a tax treaty with wider advantages in the present globalization environment although there may be some small disadvantages.
Arnold. B.J, An introduction to tax treaties, available at https://www.un.org/esa/ffd//////wp-content/uploads/2015/10/TT_Introduction_Eng.pdf
Convention between the Government of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains, 2003, Article 4, available at http://www.austlii.edu.au/au/other/dfat/treaties/2003/22.html
Eric Neumayer, ‘Do Double Taxation Treaties Increase Foreign Direct Investment to Developing Countries?’ (2006) 43 (8) Journal of Development Studies 1501
Lennard M. The UN Model Tax Convention as Compared with the OECD Model Tax Convention – Current Points of Difference and Recent Developments, available at https://www.africataxjournal.com/wp-content/uploads/2018/04/2-5-Lennard_0902_UN_Vs_OECD.pdf
The Tillinghast D.R. Lecture--Are Tax Treaties Necessary, 53 Tax L. Rev. 1 (1999-2000), p.1, available at https://heinonline.org/HOL/LandingPage?handle=hein.journals/taxlr53&div=8&id=&page=
Australian-UK double taxation convention
OECD Model Tax Convention
Australian Tax Office, Taxation Ruling, TR 2001/13, available at https://www.ato.gov.au/law/view/document?locid=%27TXR/TR200113/NAT/ATO%27&PiT=20041222000001#P126
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