Tax treaties tend to avoid, for residents of one treaty country, double taxation of income coming from the other treaty country. The majority of tax treaties are bilateral because they are signed between two countries.
Apart from bilateral treaties, some multilateral treaties have also been signed. For example, the E.U. member states have agreed to a multilateral agreement with respect to the value added tax.
The typical content of tax treaties
• lay down the rules defining what country a person is a fiscal resident in,
• define which taxes are covered and who is eligible for benefits according to the treaty,
• reduce the amounts of tax withheld from interest, dividends and royalties paid by a resident of one country to a resident of the other country,
• limit taxation of business income in one country attributable to a resident of the other country to the same amount of tax that applies to a permanent resident in the country where the income is realised,
• define circumstances under which income of individuals residing in one country will be taxed in the other country, including salary, pension and other income,
• provide procedural frameworks for enforcement and dispute resolution.
The stated goals for entering into a treaty often include reduction of double taxation, eliminating tax evasion and encouraging cross-border trade efficiency. It’s generally accepted that tax treaties increase the level of confidence for taxpayers and tax authorities in their international dealings.
According to Wikipedia, the OCDE model of treaty is based on the following items:
Generally, an individual is considered resident under a tax treaty and subject to taxation where they maintain their primary residence. For companies, residence is determined based on their place-of-management, place-of-incorporation or other elements.
Most treaties provide that business profits of a resident of one country are subject to taxation in the other country only if the profits arise through a permanent establishment in the other country. Many treaties, however, address certain types of business profits (such as directors’ fees or income from the activities of athletes and entertainers) separately. Such treaties also define what constitutes a permanent establishment. Most but not all tax treaties follow the definition of PE in the OECD Model Treaty. Under the OECD definition, a PE is a fixed place of business through which the business of an enterprise is carried out.
Many tax systems provide for collection of tax from non-residents by requiring payers of certain types of income to withhold tax from the payment and remit it to the government. Such income often includes interest, dividends, royalties, and payments for technical assistance. Most tax treaties reduce or eliminate the amount of tax required to be withheld with respect to residents of a treaty country.
Most treaties provide mechanisms eliminating taxation of residents of one country by the other country where the amount or duration of performance of services is minimal, but also taxing the income in the country performed where it is not minimal. Most treaties also provide special provisions for entertainers and athletes of one country having income in the other country, though such provisions vary highly. Also, most treaties provide for limits to taxation of pension or other retirement income.
Tax Exemptions for Persons or Entities
Most treaties make certain diplomatic personnel exempt from taxation income. Most tax treaties also provide that certain entities exempt from tax in one country are also exempt from tax in the other. Entities typically benefitting from tax exemptions include charities, pension trusts and government owned entities. Many treaties provide for other exemptions from taxation that one or both countries consider relevant under their governmental or economic system.
Harmonization of Tax Rates
Tax treaties usually specify the same maximum tax rate that may be imposed on some types of income. As an example, a treaty may provide that interest earned by a non-resident eligible for benefits under the treaty is taxed at no more than five percent (5%). However, local law in some cases may provide a lower rate of tax irrespective of the treaty. In such cases, the lower local rate prevails.
Provisions Unique to Inheritance Taxes
Generally, income taxes and inheritance taxes are addressed in separate treaties. Since only a few countries have signed treaties related to inheritance taxes, quite often double taxation applies.
Double Tax Relief
Nearly all tax treaties provide a specific mechanism for eliminating it, but the risk of double taxation is still potentially present. This mechanism usually requires that each country grant a credit for the taxes of the other country to reduce the taxes of a resident of the country. The treaty may or may not provide mechanisms for limiting this credit, and may or may not limit the application of local law mechanisms to do the same.
Tax Information Exchange Agreement
The purpose of this Agreement is to promote international co-operation on tax matters through exchange of information. It was developed by the OECD Global Forum Working Group on Effective Exchange of Information.
The Agreement represents the standard of effective exchange of information for the purposes of the OECD’s initiative on harmful tax practices. This Agreement, which was released in April 2002, is not a binding instrument but contains two models for bilateral agreements. A number of bilateral agreements have been based on this Agreement.
Nearly all tax treaties provide some mechanisms under which taxpayers and the countries can resolve disputes arising under the treaty. The treaty mechanism often calls for the Competent Authorities to attempt to agree in resolving disputes.
Limitations of Benefits
Recent treaties of certain countries have contained an article intended to prevent “treaty shopping”, which is inappropriate use of tax treaties by residents of third states. These Limitation of Benefits articles deny the benefits of the tax treaty to residents who don’t meet additional requirements. Limitation of Benefits articles vary widely from treaty to treaty and are often quite complex.
Priority of Law
Treaties are considered to be the supreme law of many countries. In those countries, treaty provisions fully override conflicting domestic law provisions.
Find Tax Treaties
There are many bilateral Tax treaties and each week new ones are signed or amended.
To be up to date in this dynamic environment, visit: www.tax-treaties.com
Which taxes to consider?
The taxes to consider are principally related to the type(s) of business a client plans to run.
For information, please find below the main taxes and relevant elements to consider:
Taxes on corporate income and gains
- Corporate income tax rate
- Capital gain tax rate
- Branch tax rate
- Withholding tax rate
- Taxes on the dividends
- Taxes on the interest
- Taxes on royalties
- Branch remittance tax
- Net operating losses (carryback, carryforward)
- Special optional tax rates
- Conversion of debt into equities
- Participation exemption
- Foreign tax relief
- Determination of trading income
- Transfer pricing
- Investment tax credit
- Group of companies’ tax system
- Foreign-exchange controls
- Debt-to-equity rules
- Anti-avoidance legislation
- Tax treaties signed and tax rates agreed
- Offshore companies
- Mergers and liquidations
- Transfer of company seat
When it comes to VAT, this indirect tax doesn’t apply to pure holding companies whose activities are limited to holding, controlling and managing their stakes.
On the other hand, mixed holding companies that, on top of being stake holders, carry out commercial, industrial or service activities are subject, as any ordinary company, to the existing VAT regulations in their country of residence.