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Nature and purposes of double taxation agreements and the issues of interpretation to which they may give rise

Nature and purposes of double taxation agreements and the issues of interpretation to which they may give rise

Double Taxation Agreements (DTAs) are predominantly bilateral in nature. They are concluded on international level under international public law and thus on international level guarantee that they will become a part of domestic law of contracting states after their ratification.

There are two ways how contracting states incorporate DTAs into their domestic legislation:

Direct effect incorporation does not require any additional legal procedures, and DTA automatically becomes a part of domestic legislation right after its ratification (the USA, France, Switzerland, Luxemburg). In some jurisdictions a legislative act is required (Austria).

Indirect effect incorporation needs special legislation for incorporation of DTA into its domestic law system (the UK, India).

DTAs override domestic legislation, they prevail over internal laws and regulations. There are three main models of DTAs:

  1. The US Model Treaty (updated in 2016) is used by the USA in negotiations with other states, with inclusion of citizenship and focus on limitation of benefits.
  2. The UN Model Treaty (updated in 2017) is used by developing countries, allocates more taxing rights for source countries.
  3. The OECD Model Treaty (updated in December 2017) was initially developed by the League of Nations; most often is referred to in treaty negotiations. The OECD Model places limits in source countries on withholding taxes rates and sets out the limits of the source state’s taxing rights in relation to business profits.

There are also other models such as Dutch Model, Nordic Model, Intra-Asian Model.

A number of legislative documents and international agreements may influence DTAs. For example, FATCA that have been accepted by many states and the US; the Competent Authority Agreement signed by more than 90 states by mid-2017, which implements the Common Reporting Standard for Automatic Information Exchange; OECD/Council of Europe Convention on Mutual Administrative Assistance in Tax Matters.

The central purpose of DTAs is to lessen or eliminate double taxation. This purpose flows from the aim to promote international trade. It is believed that double taxation of cross-border transaction is the main obstacle of international economic activities. Thus, DTAs encourage free movement of goods, services and capital from country to country.

This purpose is usually achieved by either exemption method (Article 23A of OECD Model Treaty), or by credit method (Article 23B of OECD Model Treaty). DTAs are actively used by contracting states to eliminate judicial double taxation when the same income, from the same activities, same source, gained in the same period, in the hands of the same taxpayer is taxed by several states.

DTAs also contribute to combatting fiscal evasion. The contracting states cooperate through mutual assistance and agreed administrative procedures. The main areas are exchange of information, assistance in collecting taxes, dispute resolution.

Another purpose of DTAs is provision of certainty to taxpayers, by giving understanding on tax system and determination of basic concepts such as “permanent establishment”, so that enterprises have clear vision of tax issues of their business.

In addition, rather consequence than purpose, DTAs promote tax non-discrimination. Entering into DTA, both contracting states have guarantees that their residents carrying out business in the territory of another contracting state, will have the same treatment as residents of that state.

There is no one global standard of interpretation of DTAs, it is a task of domestic courts to develop this approach.

The Vienna Convention on Law of Treaty, as of May 1969 (Vienna Convention) is used as an overall public international law guidance for interpretation of DTAs.

Article 31 of the Vienna Convention has general rules of treaty interpretation, according to it they have to be interpreted in good faith. The contracting states are required to include preamble with explanations and annexes, such as agreements and procedures agreed by contractors. Contracting states shall consider practices and international rules. If the contracting parties have agreed on some definition, it shall prevail.

Article 32 sets forth supplementary means of interpretation. It states, that additional external aids and subsequent agreements shall be taken into account when interpreting treaties. Thus, the recourse may be had to preparatory work of the treaty, its initial purpose.

The comments to the Model Treat are not legally binding, though OECD in fact casts duty on its members to observe them (“soft obligation”). In addition, the courts usually apply those comments for interpretation of treaties.

Professionals maybe asked to provide their expert interpretation; they can be tax experts, legal advisors, professors, members of treaty negotiating team.

The main difficulties arise when there is a difference in interpretation of treaty in international and domestic legislation. The most typical issues are as follows:

The DTAs can be composed in three languages that makes it difficult to coordinate terminology. If there is no direct definition in DTAs, then the domestic notion can be used, the question is which approach to use – static or ambulatory.

Another problem is lack of notions and definitions, credible data.

Some scholars point other that due to long negotiation process, DTAs maybe composed in “looser” terms.

The court cases of interest as for issue of treaty interpretation are Indofood v JP Morgan (2006) and Bayfin HMRC (2011).

In spite of all the issues and difficulties, DTAs became an inseparable instrument of international legislation and are being enhanced and updated constantly for further facilitation of legal and efficient cross-border activates, which, hopefully, will be beneficial for both states and businesses.

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