INTRODUCTION
International trade has existed since the birth of nations, but there has been an accelerating growth not only in trade but also in finance and investment since the end of World War II. This growth has far outstripped the general growth in the world economy. One important cause has been the gradual removal of barriers to international trade through the various negotiating rounds of the General Agreement on Tariffs and Trade (the GATT, which as of 1995 is administered by the World Trade Organization, or WTO). For finance, the removal of exchange controls in most industrial countries, commencing from the floating of exchange rates in the early 1970s, has been a notable factor leading to the globalization of world capital and financial markets. The international organizations most involved here have been the IMF and the Bank for International Settlements.
There are two main categories of case that international tax rules have to deal with. First, there is the taxation of persons from outside a country who work, enter into transactions, or have property or income in the country. Second, there is taxation of persons who belong to a country and work, enter into transactions, or have property or income abroad. The usual term used in international taxation to denote the concept of a person’s belonging to a country is “residence” (“resident” and “nonresident” being used to indicate whether a particular person belongs to a country or not); similarly the usual term for income arising in a particular place is “source” (“domestic” and “foreign” being used to indicate whether particular income is sourced inside or outside a country).
DOUBLE TAXATION AVOIDANCE AGREEMENT (DTAA)
The Double Tax Avoidance Agreement (DTAA) is a tax treaty signed between two or more countries to help taxpayers avoid paying double taxes on the same income. A DTAA becomes applicable in cases where an individual is a resident of one nation, but earns income in another.
DTAAs can be either be comprehensive, encapsulating all income sources, or limited to certain areas, which means taxing of income from shipping, inheritance, air transport, etc. India presently has DTAA with 80+ countries, with plans to sign such treaties with more countries in the years to come. Some of the countries with which it has comprehensive agreements include Australia, Canada, the United Arab Emirates,Germany, Mauritius, Singapore, the United Kingdom and the United States of America.
TAX TREATIES
Tax treaties (also often referred to as double taxation conventions or double tax agreements) are international agreements entered into by countries and hence subject to general international law on treaties as codified in the Vienna Convention on the Law of Treaties. Most tax treaties are bilateral, that is, involve two countries only, and cover income and capital taxes, though there are some examples of multilateral tax treaties. There are well in excess of 1,000 tax treaties and the number is growing rapidly.
STRUCTURE OF TAX TREATIES
The history of tax treaties can be traced to the League of Nations, which was pressed to deal with the problem of double taxation after income taxes became important during the First World War and which developed a number of models for use in negotiation of bilateral 9 tax treaties. The major modern successor to these models is the OECD Model Tax Convention on Income and on Capital (the OECD Model), which itself has 10 various versions. Of especial interest to developing and transition countries is the 1980 UN gone through Model Double Taxation Convention (the UN Model), which was based on the 1977 OECD Model but designed to take into account the special interests of developing countries.
PURPOSE OF TAX TREATIES
The purpose of bilateral tax treaties is typically expressed in their preamble to be “the avoidance of double taxation and the prevention of fiscal evasion.” As most countries 14 contain within their domestic law provisions to prevent double taxation of their residents in the most common case (where another country taxes the same income on a source basis), the main operation of tax treaties in this respect is for other types of double taxation that can arise as elaborated below. The prevention of fiscal evasion primarily refers to cases where taxpayers fraudulently conceal income in an international setting and rely on the inability of tax administrations to obtain information from abroad. The exchange of information article in tax treaties is the major provision dealing with this problem. Because of the capital flight experienced by many developing and transition countries, exchange of information is important, but in practice there are some considerable hurdles to successful exchange for reasons developed below.
From the perspective of developing and transition countries, there are a number of other purposes of tax treaties that are usually unstated but in many cases are more important. First, there is the division of tax revenues to be derived from income involving the two countries that are parties to the treaty. Where flows of income from business and investment are balanced between two countries, or even among a group of countries, it often does not make a large difference if each country agrees to significantly curtail its source jurisdiction to tax, as its residence taxation of income sourced in the other country is correspondingly increased. Where the flows are substantially unbalanced, the conclusion of a treaty under which each country gives up some of its source jurisdiction to tax generally has the effect of transferring revenue from one country to the other. Typically, developing and transition countries (and many smaller industrial countries) will be in the position vis-à-vis industrial countries of substantial net capital importers and hence will want to preserve source country tax rights.
RELATIONSHIP OF TAX TREATIES AND DOMESTIC LAW
This attitude was most noticeable among Latin American countries, while by contrast many Asian countries have extensive tax treaty networks; nowadays Latin American countries, including Chile, are embarking on active treaty negotiation programs. See Richard Vann, Tax Treaty Policy of Dynamic Non-Member Economies, in Tax Treaties: Linkages between OECD Member Countries and Dynamic Non-Member Economies (Vann ed., 1996). To the extent that countries did encourage foreign investment, tax treaties were necessary for tax sparing in relation to tax incentives.
The greater openness in the past of some Asian countries to foreign investment may explain the previous difference in treaty policy between Asia and Latin America. Tax relations among the transition countries used to be handled by the COMECON treaties, (involving Bulgaria, Czechoslovakia, East Germany, Hungary, Mongolia, Poland, Romania, and the Soviet Union) Council for Mutual Economic Assistance Agreement on the Avoidance of Double Taxation on the Income and Property of Bodies Corporate (1979) and Agreement on the Avoidance of Double Taxation on Personal Income and Property (1979). Both of these tax treaties adhere even more strongly to the residence principle than the OECD Model.
It is not necessary to incorporate into domestic law the contents of treaties that operate only between states and do not directly affect private persons. A tax treaty, however, is intended to confer enforceable rights on taxpayers against the countries that are parties to the treaty. How this occurs is a matter for the constitutional law of each state, but in many cases it is necessary for each country to carry out some formal law-making process, such as approval of the tax treaty by parliament.
Further, the provisions of tax treaties are intended to have precedence over any inconsistent provisions of domestic tax law. Again, how this is effected is a matter for the constitutional law of the countries concerned. A common practice is to insert such a provision either into the law giving effect to the treaty or into the domestic tax law itself.The usual result of such a provision under the law of most countries is that, apart from the administrative treaty provisions on the mutual agreement procedure and the exchange of information, a treaty sets limits on the operation of domestic law but does not expand its operation.
Thus, if a country taxes business profits arising from sales to residents of the country by a resident of another country without reference to a permanent establishment concept, the business profits article of a tax treaty will usually prohibit such taxation, unless those profits are attributable to a permanent establishment in the country. The outcome is the same if the domestic law uses a permanent establishment concept, but the concept is wider than that used in a relevant treaty. Similarly, if the tax applied under domestic law to dividends and interest paid to a resident of the other treaty country exceeds the maximum rates permitted in the treaty, the source state is obliged to reduce its taxation accordingly.
CONCLUSION
The consequence of this relationship between tax treaties and domestic law suggests an important guideline for drafting the domestic tax rules themselves. If the domestic rules by and large follow the rules typically found in tax treaties, this will simplify the question of the relationship between tax treaties and domestic law and provide transparency to foreign investors as well as indicating (even in the absence of an extensive tax treaty network) the intention of the country to adopt internationally accepted standards.
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