Non-discrimination articles have been used in tax treaties over a number of years, they are designed to place non-discrimination requirements on the source country rather than on the residence state.
There may arise cases where a country provides favourable treatment to its nationals and discriminates against foreigners. To circumvent such cases tax treaties provide a clause which restricts contracting states from offering discriminatory treatment to foreign nationals as compared to its nationals.
The article on non-discrimination is the tool employed by tax treaties to express and achieve this very fundamental principle of taxation and to prevent unfair taxation as distinct from preventing double taxation.
As mentioned in General remarks to the Commentary to Article 24 of the OECD Model Tax Convention on Income and on Capital (2017) (the OECD MTC): This Article deals with the elimination of tax discrimination in certain precise circumstances.
Discrimination means unequal treatment in situations which are identical or similar. Article 24 of the OECD MTC deals with non-discrimination provisions; nationality non-discrimination, permanent establishment non-discrimination, and deduction and ownership non-discrimination. The article primarily aims at ensuring to nationals of another contracting state, residents of any third state and stateless persons equality of treatment with the nationals of the contracting state with regard to taxation and laws connected therewith.
Article 24 of the OECD MTC should not be unduly extended to cover so called “indirect” discrimination. Article 24 is merely a specific enunciation of the general principle of equality. This principle requires that similar situations shall not be treated differently without valid and objective justification. Article 24 has six clauses:
Article 24(1) – Nationality non discrimination (Host state discrimination). This clause establishes the principle that for purposes of taxation, discrimination on the grounds of nationality is forbidden, and that, subject to reciprocity, the nationals of a Contracting State may not be less favourably treated in the other Contracting State than nationals of the latter State in the same circumstances. There is a list of conditions when Article applies. In addition, Article revels on concepts of nationals, tax burden, circumstances which shall be analysed.
Article 24(2) – Non-discrimination for stateless person having nationality. There is a list of conditions when Article applies. If these conditions are satisfied, such stateless person cannot be subjected to a discriminatory treatment as compared to nationals of the concerned State. Stateless person is entitled to equality of treatment with nationals of a contracting state with regard to taxation or any other requirement connected therewith. Stateless persons must, therefore, be residents of one of the contracting state to benefit from the non – discrimination provision. A legal person cannot be stateless, as it derives its status from its incorporation under some system of law.
Article 24(3) – PE Non discrimination. This clause is designed to eliminate discrimination based on the actual situs of an enterprise. When the existence of the PE is established, the nationality of the person of which it is the PE is of no relevance for claiming equal rights with the domestic enterprise.
In the court case Mitsubishi Corporation India v Indian Tax Authorities (2014), the Indian Tax Tribunal considered the provisions of Article 24 with regard to disallowance of tax deductions imposed by the Indian tax authorities. The Indian subsidiary did not deduct withholding tax from the payments to its Japanese parent company. Indian tax law disallows payments to non-residents where withholding tax was not deducted. At the same time, failure to deduct withholding tax does not result in disallowance when an Indian company makes payments to an Indian resident provided that the Indian recipient is taxable on the amounts received. It was held that this was an example of discrimination which clearly fell within Art 24(3) of the India-Japan treaty.
Article 24(4) – Deduction Non discrimination. There should be no discrimination as regards deductibility of amounts paid as interest, royalties and other disbursements by an enterprise to the residents of the other contracting state. It does not apply in case of arranged transactions in case of close relationship between the enterprise and non-resident recipient, with purpose to avoid payment of taxes (can be applied Article 9(1), Article 11(6) or Article 12(6) of the OECD MTC).
Article 24(5) – Ownership Non discrimination. The clause forbids discrimination of an enterprise on the basis that its capital is owned or controlled wholly or partly, directly or indirectly, by residents of the other Contracting States. This clause cannot be extended to non-taxation activities of the non-resident enterprise such as consolidation or transfer of properties. Withholding tax obligations that are imposed on a resident company with respect to the dividend paid to a non-resident shareholder cannot be equated with dividend paid to residents shareholders.
Article 24(6) – General (taxes covered). Article 24(6) of the OECD Model Convention makes this Article applicable to taxes of every kind and description notwithstanding the provisions of Article 2 of the convention.
There are exceptions in applicability of the Non-discrimination clause in cases where the provisions of Article 9(1) on Associated Enterprises and Article 11(5) on Interest or Article 12(4) on Royalties apply. A country can apply its domestic thin capitalisation rules insofar as these are compatible with Article 9(1) or Article 11(6). Also, a country can deny deduction if the interest payment is not at arm’s length.
The OECD Commentary 2017 deals with six aspects of equal treatment namely:
- Assessment of tax (Para 40 to 47)
- Special treatment of dividend received in respect of holdings owned by PEs (Para 48 to 54)
- Structure and rate of tax (Para 55 to 61)
- Withholding tax on dividends, interest and royalties received by a PE (Para 62 to 66)
- Credit for foreign tax (Para 67 and 68)
- Extension to PEs of the benefit of the ta treaty concluded with third states.
A Most-Favoured-Nation (MFN) treatment has long been a core standard of international economic relations. It provides for equal competitive opportunities between nations in respect to the matters to which the particular MFN clause applies, including in the field of trade, investment, or any economic co-operation. In clause 2 of the General remarks to the comments, it is stated that the provisions of the Article cannot be interpreted as to require most-favoured-nation treatment.
In September 2004 The OECD Directorate for Financial and Enterprise Affaire issued a working paper on international investment Most-Favoured-Nation Treatment in International Investment Law. This work was aimed at enhancing understanding of investment protection provisions in international investment agreements. Many MFN clauses in investment treaties contain specific restrictions and exceptions, which exclude certain areas from their application.
GATT (the General Agreement on Tariffs and Trade) and GATS (The General Agreement on Trade in Services) rules support the OECD Model Treaty non-discrimination article concept. By these rules attempts are made to encourage free trade with as few quotas as possible and placing limitations on the levels of customs duties/tariffs. Among main elements of GATT there is the “reciprocal mutual advantage” principle, i.e. the “general most-favoured nation treatment” (Article 1 of the Charter. For instance, Protocol to Russia-India tax treaty provides that the taxation of a PE of an enterprise of one contracting state in the other contracting state shall not be less favourable than the tax treatment given by that other contracting state to a PE of an enterprise of any third country.
UN Model Tax Convention also provide non-discrimination clause which are generally as such, or with slight modification, adopted by member States in their tax treaties. Clauses of OECD and UN Model Tax Conventions are nearly identical, except for slight difference in clause 4. Still, some countries tend not to have non-discrimination articles in their treaties, e.g. Australia, Canada and New Zealand, for the very reason that they may well be ineffective in a number of scenarios.
Non-discrimination in light of double taxation and anti-avoidance measures is an evolving field. So, court decision on disputes shall add further clarity to the subject. The courts can attribute either a broad meaning to non-discrimination clause or contextual meaning. The core of the principle is that similar transaction shall not be treated differently, unless different treatment is objectively justified. The non-discrimination provision is a enunciation of the general principle of equality, it is vitally important for fair tax competition.