International Tax Policy And Double Tax Treaties PDF

2.1. Introduction Some countries tax their citizens or residents on their worldwide income. Others tax income sour state only. Most countries adopt a combination of these approaches. As a result, it is quite possibl fact, it is rather common) that taxpayers that engage in cross-border transaction...

2.1. Introduction Some countries tax their citizens or residents on their worldwide income. Others tax income sour state only. Most countries adopt a combination of these approaches. As a result, it is quite possibl fact, it is rather common) that taxpayers that engage in cross-border transactions are taxed more t (usually twice) on the same amount of income. This phenomenon is known as “double taxation”. taxation can take different forms, but regardless of the form it inhibits economic activity. Therefo international tax policymakers have designed ways to try to ensure that income derived by a taxp ultimately taxed only once. In this chapter we will see how this is achieved. In doing so, we shall – discuss the concepts of “source taxation” and “residence taxation”; – consider the types of jurisdictional conflicts that cause double taxation; – explain and illustrate the methods of elimination and reduction of juridical double taxation, and d the advantages and disadvantages of each method; and – examine the concept of “economic double taxation”, and analyse tax policy measures that circum in an international context. 2.2. Source and residence tax jurisdictions In the context of taxation of cross-border economic activity, a government is broadly concerned a things: (I) the activities in its country of residents of other countries, and (ii) the activities of its re foreign countries. These two aspects give rise to the two fundamental platforms of a country’s int tax law, commonly known as (I) the and (ii) the source jurisdiction of taxation residence jurisdiction of. taxation 2.2.1. Source jurisdiction The source jurisdiction of taxation means that a country (let us assume that it is your country) tax non-resident individuals and corporations on income arising to them domestically, i.e. from your principle, this system of taxation captures income derived by the non-residents from the sale (or u goods, services, capital or other resources to (by) customers in your country. This idea can be illustrated as 11 follows: Put simply, the policy reason for taxing income that has a source in your country stems from the b Copyright 2014. IBFD. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. EBSCO Publishing : eBook Academic Collection (EBSCOhost) - printed on 12/13/2021 6:53 AM via UNIVERSITEIT VAN AMSTERDAM AN: 1553348 ; Holmes, Kevin J..; International Tax Policy and Double Tax Treaties : An Introduction to Principles and Application Account: uamster.main.ehost 31 theory of taxation. Your country taxes income of which it is the source because of a nexus betwee that produce the income, i.e. there is an identifiable and tangible connection between your country activities and the income earning activity. In other words, your country will tax income arising or having a within its jurisdiction if it has provided public goods (e.g. roading and other infrastructure, police force protection, the form and administration of the legal system, etc.) for the benefit of the non-r taxpayer to enable the taxpayer to undertake its economic activity, which generated the income. In the tax imposed can be regarded as a contribution towards the cost of those public goods. The benefit theory rationale behind the source basis of taxation therefore implies that the non-resi taxpayer needs to have some sort of presence in your country or otherwise undertakes some activ makes an investment in your country), in order to be able to take advantage of the public goods o government. As we shall see in , this logic explains why, in principle, DTAs require a non-resident chapter 9 business taxpayer to have a “permanent establishment” in your country before it may impose tax non-resident’s business income sourced in your country. It therefore follows that a non-resident th exports goods or services from overseas to your country is not liable to pay tax there on income f export sales (notwithstanding that the income is nevertheless derived from your country) because exporting of goods or services by a non-resident to your country does not involve any presence or involvement there of the non-resident exporter. Thus, as no benefit of your country’s public good by the foreign exporter, no contribution to the cost of its public goods is warranted. The same conclusion can be reached by reference to the so-called “doctrine of economic allegian postulates, in an international tax context, that tax should be paid in a country the taxpayer’s according to in the country. An element of the doctrine of allegiance then is to look to where the economic interest 12 income or wealth is produced, in a physical or economic sense, i.e. to ascertain the of the income or origin wealth produced. 2.2.2. Residence jurisdiction The residence jurisdiction involves the taxation of your country’s resident individuals and corpora income arising in foreign countries (and also in your country itself), i.e. on the taxpayer’s worldw This encompasses income derived by the resident from the sale (or use) of goods, services, capita resources to (or in) other countries. This general concept can also be demonstrated diagrammatica Again, applying the benefit theory of taxation, income is taxed because of a nexus between your c not the activity this time but, the that earns the income. The net is now cast wider. The resident person taxpayer is taxed on its worldwide income because (I) the taxpayer draws the benefit of the gover public goods to facilitate the economic activity that produces its income from all sources (i.e. from within and outside your country), and (ii) the resident taxpayer typically obtains a greater level of goods from the government than a non-resident taxpayer, e.g. public education and social welfare Over a longer term, (at least some of) those public goods have put the resident (natural person) ta position to earn her worldwide income, and therefore warrant a greater contribution towards the government’s costs vis-à-vis a non-resident taxpayer. Furthermore, under the doctrine of economic allegiance, a taxpayer’s economic interest which ari place of domicile, residence or nationality justifies taxation of the taxpayer’s income in his countr residence. 2.3. Juridical double taxation The source and residence tax jurisdictional approaches work well together when they are applied respect of only one country (or where a taxpayer does not engage in cross-border income earning in which case a taxpayer is taxed on a residence basis on its domestic source income). However, t arises when taxpayers (either resident or non-resident) engage in cross-border income earning act where both the taxpayer’s country of residence and the country that is the source of the income ap or both of the source and residence doctrines of taxation in their domestic law. In these cases, the person can be taxed twice on the same income in more than one country. This result is known as juridical. The focus here is on the taxable subject being taxed twice. double taxation 13 Simply put, comparable taxes could be, and are being, imposed by two or more countries on the s taxpayer in respect of the same income in the same period, resulting in double taxation. The OEC Committee on Fiscal Affairs states in its introduction to the OECD model DTA: International juridical double taxation can be generally defined as the imposition of comparable t two (or more) States on the same taxpayer in respect of the same subject matter and for identical periods. Its harmful effects on the exchange of goods and services and movements of capital, tech and persons are so well known that it is scarcely necessary to stress the importance of removing t obstacles that double taxation presents to the development of economic relations between countri Juridical double taxation can arise from three conflicts: (1) a source–source conflict; (2) a residence–residence conflict; and (3) a source–residence conflict. 2.3.1. Source–source conflict Here, two countries each assert, in terms of their respective domestic tax laws, that it is the source taxpayer’s income. Each country contends that it is entitled to impose tax on the taxpayer’s incom from the source. Consequently, the taxpayer suffers tax twice on the same income: once in the fir that asserts that it is the source of the income and again in the other country that is also claiming t source of the income. For example, the domestic law of Country A may state that income from sh operations is sourced in Country A if the ship that produces the income sails through its territoria while the domestic law of Country B may state that income from shipping operations is sourced i if the cargo or passengers that produce that income embark in Country B. 2.3.2. Residence–residence conflict Here, two countries each assert, in terms of their respective domestic tax laws, that it is the countr residence of the taxpayer. In these circumstances, the taxpayer is described as a “dual resident”. F Hungary may consider a company resident of Hungary for tax purposes because the company wa incorporated in Hungary, while Poland may consider the same company a resident of Poland for t because the company has its management office in Warsaw. Each country contends that it is entitl impose tax on the taxpayer’s worldwide income. Consequently, the taxpayer suffers tax twice on worldwide income: once in the first country that asserts that it is the taxpayer’s country of residen again in the other country that is also claiming to be the taxpayer’s country of residence. 2.3.3. Source–residence conflict The source-residence conflict is by far the most common conflict in international taxation. In this EBSCOhost - printed on 12/13/2021 6:53 AM via UNIVERSITEIT VAN AMSTERDAM. country asserts the right to tax a taxpayer’s income as the taxpayer’s country of residence and the country asserts its right to tax taxpayer’s income as the country of source. For example, Country R its right under its domestic law to tax the worldwide income of a banking corporation, being a com resident in Country R, while Country S will legitimately assert its right under its domestic law to profits of the bank’s branch, which is located in Country S. Thus, the profits of the bank’s branch twice: once in Country S as income sourced in Country S and again in Country R as part of the ba corporation’s worldwide income. 2.4. Methods of relief from juridical double taxation Juridical double taxation is potentially enervating for a taxpayer. To illustrate, assume that Black resident company of the United Kingdom, undertakes oil processing business activities in Venezu UK resident, Black Gold faces a UK tax rate of 23% on its worldwide income (which includes its derived from Venezuela). Venezuela imposes a rate of tax of 34% on the profits of foreign compa Black Gold derives profits from Venezuela of GBP 1 million, it will pay GBP 340,000 to the Ven Revenue, being tax imposed on income derived from Venezuela, and GBP 230,000 to the UK Rev respect of the portion of its worldwide income derived from Venezuela), the effective tax rate bein (assuming the absence of any double tax relief). If the respective tax rates were 50%, the taxpaye left with nothing, and if the total of the tax rates exceeded 100%, the taxpayer would have insuffi income to fund the tax liabilities, let alone having any residual for itself. Clearly, in the absence o for the double impost of taxation on the same income, rational taxpayers would simply not enter i international business arrangements that produced such results, the upshot being that the effect of double taxation is to thwart cross-border international activity, which might otherwise lead to an o allocation of resources and greater national welfare for the two countries concerned. It is therefore necessary that some mechanism(s) should be in place to eliminate (or, at least, to al effect of juridical double taxation if cross-border commerce is to be facilitated to produce the opti allocation of resources internationally. There are three methods by which a taxpayer may obtain relief from juridical double taxation: (1) the exemption method; (2) the tax credit method; and (3) the deduction method. In each case, the relief is based on the international custom (and the practical reality) whereby the which income has its source has the primary right to tax that income such that the country of resid generally expected to provide the relief from double taxation. The first two methods offer a taxpa relief from juridical double taxation. The third method fails to do so: it gives only partial relief. 2.4.1. Exemption method Under the exemption method, or territorial tax system, residents of a country (Country R) are taxe on only domestic income, i.e. income derived from Country R. Country R does tax foreign source income. not Although this method of double tax relief completely eliminates the source–residence conflict, it comply with the common international tax policy objective of capital export neutrality, i.e. a resid Country R being taxed on its income in the same way in Country R, regardless of the source of th domestic or foreign – so that Country R’s tax system is a neutral factor in the taxpayer’s investme (cf. ). The absence of capital export neutrality creates a bias towards a resident deriving foreign section 2.4.2. source income, which is free of tax in Country R. Consequently, the exemption method is not the relief method of choice for most countries. 2.4.1.1. Full exemption The so-called “full exemption” method excludes foreign source income from Country R’s tax bas calculations altogether, such that Country R’s standard tax rate scale simply applies to the taxpaye domestic source income in Country R. There is a total separation between a taxpayer’s foreign so and domestic source income for the purposes of taxation, as illustrated below: Example 2.1. Suppose that a resident of Country R derives income of 50 from Country R and income of 50 from country (Country S). The tax rate in Country R is 35% and the tax rate in Country S is 40%. Coun its residents a tax exemption for foreign source income. The taxpayer obtains full relief from dou She is effectively taxed in Country R, at its rate of tax, only on income sourced in Country R and S, at its rate of tax, only on her income sourced from Country S, as follows: By way of example, the full exemption method is employed in Australia in relation to gains or loa certain foreign venture capital investments. 2.4.1.2. Exemption with progression Exemption with progression qualifies the full exemption method by allowing Country R to take th of exempted income into account when determining the tax to be imposed on the non-exempt inc reference to “progression” in “exemption with progression” means progression in the rate of tax ( levels increase); thus, exemption with progression produces a different result from full exemption Country R has a progressive tax rate scale. Exemption with progression does not dilute relief from taxation; it simply imposes tax at a higher rate on domestic source income. Example 2.2. EBSCOhost - Now assume in Example 2.1. that the tax rate in Country R is 35% for income up to 50 and 45% from 50 to 100. When Country R takes into account the exempt income of 50 to calculate the tax its resident, it aggregates domestic and foreign source income (50 + 50) to determine the taxpayer income (assessable and exempt) at 100, an amount to which the 45% rate applies. Under the exem progression method of eliminating double taxation, this rate is applied to the non-exempt portion taxpayer’s total income. Therefore, 15 The increase in total tax payable, cf. the full exemption method, of 5 (from 37.5 to 42.5) is attribu increase in domestic tax payable of 5 (from 17.5 to 22.5), which is in turn brought about by the 10 in the tax rate applicable to the domestic source income of 50, i.e. [45% – 35%] × 50. The Netherlands applies the exemption with progression method as a general rule in its domestic method is also adopted in Australia in relation to foreign source income derived by tax residents o under certain circumstances, e.g. the earnings of individuals who work overseas on approved proj more than 90 days and the earnings of individuals who are employed overseas in foreign service. exemption method (either full or with progression) is the most administratively efficient method o taxation relief since it obviates the need for Country R to ascertain its resident taxpayer’s tax posi Country S. It is also regarded as more sympathetic to developing countries and, partly for that rea adopted by altruistically oriented countries such as the Netherlands. However, the exemption met inappropriate method if a taxpayer’s gross income is used for purposes other than assessment of i e.g. to determine the taxpayer’s eligibility for social welfare benefits and has a revenue cost to Co compared with the foreign tax credit method (see ), when Country S’ tax rate is lower than that section 2.4.2. of Country R. 2.4.2. Foreign tax credit method Under the foreign tax credit method, Country R taxes foreign source income (as well as domestic income), but allows domestic taxes payable in Country R on worldwide income to be reduced by taxes paid to Country S by the resident on its foreign source income. This method also completely the source–residence conflict. In addition, this approach preserves capital export neutrality becau Country R to tax its residents’ worldwide income, irrespective of the source of the income, before relief from double taxation. 2.4.2.1. Full credit Country R may allow its resident to claim a full credit for the whole amount of the taxes paid to C the resident’s foreign source income. Example 2.3. Taking the same income facts as in Example 2.1. above: EBSCOhost - printed on 12/13/2021 6:53 AM via UNIVERSITEIT VAN AMSTERDAM. All use subject to https://www.ebsco.com/terms-of-use 36 Here, the effective tax rate on all of the taxpayer’s worldwide income is 35%, i.e. Country R’s tax (because Country R allows a credit for all of Country S’ tax even though it is imposed at a higher 40%). 2.4.2.2. Ordinary credit Normally a country of residence would not allow a full credit of tax paid to a country of source w latter country’s tax rate is higher than that in the country of residence. In Example 2.3., logically C entitled to collect tax of 17.5 on domestic source income (which has nothing to do with Country S × 50 (domestic source income). As we saw, Country R’s levy on the taxpayer’s foreign source inc 17.5, i.e. 35% × 50 (foreign source income). But by allowing the taxpayer a tax credit for all of th in Country S (i.e. 20, being 40% × 50 (foreign source income)), Country R in effect cedes part of collectable on the domestic source income. It is not rational for Country R to allow a tax credit fo on foreign source income that results in Country R giving up tax to which it is otherwise entitled source income, and is unrelated to Country S. Consequently, to protect its tax revenue collectable domestic source income, Country R should limit the amount of the foreign tax credit which it allo amount of tax that Country R would otherwise have collected on the foreign source income. Such foreign tax credit is known as an “ordinary tax credit”. The ordinary tax credit is normally calculated by way of allocating a proportionate share of the ta total income tax liability in Country R on its worldwide income (before allowing for the foreign t its foreign source income. This means pro-rating the total income tax liability in Country R betwe source and domestic source income in the respective ratios of: (1) foreign source income as a proportion of total income; and (2) domestic source income as a proportion of total income. The foreign tax credit limitation imposed by the ordinary tax credit method is then determined by the ratio calculated under (1) above to the taxpayer’s total income tax liability in Country R on its income (before allowing for the foreign tax credit) Double Tax Treaties 3.1. Introduction A significant role of a double tax agreement (DTA) between two or more countries is to remove t taxation (discussed in ), which is an impediment to cross-border trade in goods and services, and the chapter 2 movement of capital and people between countries. Many countries have now entered into scores comprehensive DTAs with other countries to assist in the avoidance of double taxation. The second purpose of a DTA is the prevention of fiscal evasion, which can reduce a country’s ta where a taxpayer has economic connections with more than one country. In this general context, it is particularly important to know how DTAs come about and how they a the benefit of taxpayers, which embark upon transactions or economic events that have internatio ramifications, and for the benefit of tax administrations in different countries, which are charged w responsibility of protecting their state’s tax base. This chapter provides you with an understanding of the conceptual basis, and operation, of a DTA – explain what DTAs are and why we need them; – look at the history of the development of DTAs; – examine the role of model DTAs; and – distinguish between bilateral and multilateral DTAs. You will need to refer to the OECD and UN model DTAs from this chapter onwards. You can acc models at: OECD model DTA: http://www.keepeek.com/Digital-Asset-Management/oecd/taxation/model-tax-convention-on-inc -capital-2010_9789264175181-en#page1. UN model DTA: http://www.un.org/esa/ffd/documents/UN_Model_2011_Update.pdf. 3.2. What is a double tax treaty? A DTA is often referred to as a “double tax agreement”, a “double tax treaty”, a “double tax conv simply a “tax treaty”. “Tax treaty” is defined in the as a “Term generally used International Tax Glossary 19 to denote an agreement between two (or more) countries for the avoidance of double taxation.” T goes on to say that: In fact there are various types of tax treaty of which the most common are treaties for the avoidan double taxation of income and capital (usually known as a comprehensive income tax treaty). Suc treaties are also commonly expressed to be aimed at the prevention of fiscal evasion. In avoiding taxation, such treaties also provide for the distribution between the treaty partners of the rights to which may either be exclusive or shared between the treaty partners. (...) 3.3. Purpose of double tax treaties From their inception the raison d’être of DTAs has been the avoidance of double taxation. The so that problem necessarily involves taxing income only once and that leads to consideration of whic will have the taxing right. More recently, DTAs have also developed into instruments to prevent t in a cross-border context 8.1. Introduction This chapter examines the concept of residence and its pivotal application to DTAs. It focuses on personal scope test of residence of individuals and companies for DTA purposes. In doing so it ad difficulties of applying the tests to taxpayers that are resident in more than one contracting state, i the domestic laws of those states, and of applying the corporate residence test in the increasing gl world economy. In this chapter we shall: – discuss the residence tests for individuals and companies for the purpose of a country’s domestic and for DTA purposes; – consider the meanings and applications of the terms “permanent home”, “centre of vital interests” “habitual abode” and “national”; – describe the difficulties of applying the residence tests; – explain the meaning of a dual resident and the need for the “tie-breaker” rule; and – discuss the relevance of the place of effective management test in the context of global telecommunications. 8.2. Domestic law residence tests The test of a person’s residence depends firstly on the nature of the person with which we are con is the person an individual or a legal entity, such as a company? 8.2.1. Individuals The definition of “residence” of an individual in the domestic tax law of most countries is underp requirement of a link between the individual and the state. We discussed in the tax policy reason chapter 2 behind this link. Many countries use a combination of objective and subjective tests of a person’s residence in thei law. The is typically based on a minimum fixed period of time in which a person is physically objective test present in a country, e.g. a person is a resident of a country for tax purposes (as distinct from imm citizenship purposes) if she is present in the country for more than (say) 183 days in a calendar ye a 12-month period. This “bright-line” test (i.e. you are either within the rule or outside of it) is an and objective test of residence, provided that the country implementing it has adequate border con records readily accessible by the tax administration of people’s movements into and out of its cou measure the total days of a person’s presence in the country. While this is relatively easily done in states like Japan and Mauritius (and other non-island states with tight border controls e.g. the Uni it is a largely impractical test to apply in political blocs where there is freedom of movement betw countries comprising the bloc; for example, Member States of the European Union. Other objective bright-line tests of residence include: – the person’s visa and immigration status; for example, holding of a residence permit of a country, you hold a residence permit under the country’s immigration laws, you are automatically a reside the country for tax purposes; – nationality, i.e. if you are a national of a country under the country’s immigration laws, you are automatically a resident of the country for tax purposes; – citizenship, i.e. if you are a citizen of a country, you are automatically a resident of the country fo purposes. This rule applies, for example, in the United States. In that case, the rule is also enshrin the “savings clause” in the US model DTA, which provides in article 1(4) that, except where exceptions in article 1(5) apply, the DTA “shall not affect the taxation by [the United States] of it residents (as determined under Article 4 (Resident)), and its citizens. Notwithstanding other provi of this Convention, a former citizen or former long-term resident of [the United States] may, for t period of ten years following the loss of such status, be taxed in accordance with the laws of [the United States].” Nationality and citizenship are not the same thing. Nationality is a legal relationship involving all an individual to a country and protection of that individual by that state. Nationality determines th rights of a person, natural or artificial, under international law. Citizenship, on the other hand, is c with an individual’s status and civil rights under municipal law. Therefore, all citizens are nationa particular country, but all nationals may not necessarily be citizens of the country: State Trading Corporation (1963) 2 SCJ 605 (India). v. Commercial Tax Officer The alternative determinant of residence is a , which is one of a question of the degree to which subjective test an individual has established her allegiance to a country by joining to a sufficiently significant de economic and social life. It is a “facts-and-circumstances” test, which is applied in the domestic l countries in addition to the objective days-of-presence test and by other countries because, for the given above, they are unable to apply the days-of-presence test effectively in practice. The facts-and-circumstances test looks to the following sorts of factors as indicia of residence in – Whether the person has a permanent home or habitual place of abode in the country. – Whether the person’s place of economic and social interests is in the country, i.e. by examining m such as the location of the person’s income producing activities, investments, professional associa family, personal interests, etc. 8.2.2. Companies The tests of residence of companies also fall into objective and subjective categories. The objectiv bright-line test is simply to determine a company’s residence on the basis of its place of incorpora “legal seat”, i.e. generally its registered office. The shortcoming of this test is that if a company w avoid being a resident of Country R it could incorporate (or reincorporate) in another country, notwithstanding that its real physical and economic presence is in Country R. Therefore, many countries also include in their definitions of corporate residents subjective factor to the place of the real operation of the company. To determine whether a company is a resident o particular country, we then ask: – Where is the company’s place of management? (Applied, for example, in Germany) – Where is the company’s place of day-to-day management? (Applied, for example, in Denmark.) – Where is the company’s head office? (Applied, for example, in Brazil, Japan and Slovenia.) – Where does the board of directors meet? – Where is the central management and control of the company located? (Applied, for example, in Australia, Canada, Cyprus, Israel and the United Kingdom.) – Where is the place of effective management of the company? (Applied, for example, in Austria, EBSCOhost - printed on 12/13/2021 6:54 AM via UNIVERSITEIT VAN AMSTERDAM. All use subject to https://www.ebsco.com/terms-of-use 107 Belgium, China, Croatia, the Czech Republic, Italy, the Netherlands, Norway (where “effective management” refers to the non-executive board), Portugal, South Africa, Spain, Switzerland and Turkey (where “effective management” refers to the top management of the company).) – Where is the company’s centre of administrative management? (Formerly applied in New Zealan – Where is the company’s management office? (Applied, for example, in Poland.) – Where is the company’s main activity? (Applied, for example, in France.) – Where is the company’s main business purpose carried out? (Applied, for example, in Italy.) – Where is the shareholder voting control exercised? (Applied, for example, in Guernsey. 9.1. Introduction When an entity (Company R), which is resident in Country R, wishes to undertake business trans Country S through a presence in Country S, Company R typically does so through a subsidiary co (Company S) located in Country S. The profits derived by Company S are taxable in Country S. I those profits, interest and royalty payments may be made by Company S to its parent, Company R Country R. Such payments may be subject to withholding tax at source at the time that they are m after-tax profits will usually be distributed by Company S by way of dividend payments to Comp dividend payments are also likely to be subject to withholding tax at source in Country S. The important point to note first of all, from an international tax perspective, is that, in this parent scenario, there are two separate legal entities: (i) Company R, being a company resident in Count (ii) Company S, a separate (although not unrelated) company resident in Country S. This distincti illustrated as follows: An alternative structure by which Company R may undertake its business in Country S is for Com open a branch in Country S. In this case, the branch is a separate legal entity, but merely an extension of not Company R. Here, the profits derived by the branch from Country S will be taxable in Country S source in Country S. Legally, Company R, which is resident in Country R, is the taxpayer in Coun respect of those profits derived by it from Country S. Under this scenario, assuming that Country residents on a worldwide income basis, Company R is also taxable in Country R on the profits tha from Country S. This is because the profits derived by the branch from Country S are derived not separate legal entity in Country S, but by Company R. In this case, the branch is known as a permanent of Company R located in Country S. This alternative structure can be illustrated as follows: establishment 4 119 The domestic law of most countries contains provisions that describe circumstances under which derived, and therefore taxable, in the jurisdiction. These domestic rules may be lists of all circum may make reference to business concepts or establishments within the jurisdiction. For example, of Greece include a non-exhaustive positive list of all situations that give rise to income having a Greece. We saw in that Tanzania takes a similar approach. German and Austrian domestic tax section 1.4.2. law contain references to PEs and permanent representatives; UK domestic tax law refers to a “tr on in the United Kingdom; US domestic tax law similarly refers to a “trade or business” concept; Zealand domestic tax law refers to a “fixed establishment”; and Australian domestic tax law refer As we have already seen, where a DTA exists between two countries and a non-resident is deeme domestic law of one of those countries to derive taxable profits therefrom, the provisions of the D override the domestic law, thereby narrowing down the application of the domestic law. This chapter examines the DTA concept of a PE and the means by which its profits are taxed in th of source, and the country of residence of the entity of which the PE forms a part. On completion of this chapter, you should be able to: – understand, where a DTA operates, the need for existence of a PE in a source state before that sta may tax a non-resident’s business profits; – explain the meaning of a PE and distinguish between a basic-rule PE, a construction PE and an ag PE; – determine whether or not a non-resident’s business activities in a country amount to a PE; – distinguish between dependent and independent agents, and subsidiary companies in the determin of a PE; – discuss the application of the traditional notion of a PE to e-commerce; and – understand how the notion of a PE can be extended to tax income from services. 9.2. Application of domestic law As for all income that arises from cross-border transactions, the taxation of business profits in eac prima facie determined by applying the domestic law of the state. Once that is done, the provision relevant DTA are overlaid upon the outcome of application of the domestic law (i.e. a tax impost profits in the country concerned) to determine whether the taxpayer can obtain any relief under th 9.3. Business profits EBSCOhost - printed on 12/13/2021 6:54 AM via UNIVERSITEIT VAN AMSTERDAM. All use subject to https://www.ebsco.com/terms-of-use 120 The basic concept of the OECD model DTA (and most actual DTAs) is that an enterprise should n for tax on profits earned in a country that is not the country of residence of the enterprise, unless t enterprise has a real and significant or substantial economic nexus with the country in which the p A business enterprise will only have such a real and significant or substantial nexus if it carries on the other country through a in that country. PE Article 7(1) of the OECD model DTA provides that business profits are taxable in the residence state only the taxpayer has a PE in the source state the income is attributable to that PE. Where this proviso unless and is met, the income of the PE is also taxable in the source state. The operation of article 7(1) is therefore dependent upon the existence of a PE in the source state apply article 7(1) we must ascertain the meaning of “permanent establishment”. The logic of the a be illustrated as follows: 9.4. Meaning of “permanent establishment” Article 5 essentially comprises seven elements: (1) the basic-rule PE; (2) examples of PEs (positive definitions); (3) construction projects; (4) exceptions to PEs (negative definitions); (5) dependent agents; (6) independent agents; and (7) subsidiary companies. We shall analyse each of these elements in turn. 9.4.1. Basic-rule permanent establishment Article 5(1) of the OECD model DTA states that: For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on. This basic-rule PE definition stipulates three criteria: EBSCOhost - printed on 12/13/2021 6:54 AM via UNIVERSITEIT VAN AMSTERDAM. All use subject to https://www.ebsco.com/terms-of-use 121 9.4.1.1. Place of business This requirement necessitates some physical presence, e.g. some premises or equipment, which a the business. 9.4.1.2. A fixed place The place of business must be in the sense that it is a place, which exhibits some degree of fixed distinct. Paras. 4.1 and 4.2 of the OECD commentary on article 5 speak in terms of the availability in the permanence source state of space to an enterprise: “... the mere fact that an enterprise has a certain amount of disposal which is used for business activities is sufficient to constitute a place of business. No for right to use that place is therefore required.” Therefore, an enterprise that is a resident of one state this test, have a fixed place of business in another state where it occupies premises in the latter sta any formal leasing arrangement. However, the mere presence of an enterprise at a particular locat necessarily mean that that location is at the disposal of the enterprise. A PE can exist if the place of business has a certain degree of permanence, i.e. if it is not of a pur temporary nature. However, that does not mean that a PE cannot exist for a very short period of ti be that the nature of the business in question is such that it will only be carried on briefly. 9.4.1.3. Carry on business It is necessary that the enterprise not only has a fixed place of business but also wholly or partly c business through that fixed place. The concepts “permanent establishment” and “carrying on busi inextricably bound together. The carrying on of a business involves the carrying on in a country o any activity related to the business of the enterprise. Subject to article 5(4), it would seem, therefo employees of the enterprise are to be found at a fixed place conducting part of the business of the the enterprise will have a PE in the state in which the fixed place is located. The powers of the em dealing with third parties are irrelevant. Whether or not the employee can conclude contracts, a fi will be a PE if the employee works there. (Contrast this with the position under article 5(5) of the model DTA concerning dependent agents, discussed in ) section 9.4.5. Under company legislation, a business cannot usually be considered to be carried on unless contr being concluded. In the context of DTAs, this interpretation of carrying on business appears to be narrow. It is submitted that any activity related to the business of the enterprise would be sufficien constitute the “carrying on of business” of the enterprise. This assertion is based on the premise th on of a business is usually regarded as being a whole series of activities, the concluding of contra only one such activity. 9.4.2. Examples of permanent establishments Article 5(2) proffers some examples of PEs. The list in article 5(2) is not intended to be exhaustiv of article 5(2) states that the term “permanent establishment” the following types of includes especially presence: (a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources (but not exploration). EBSCOhost - printed on 12/13/2021 6:54 AM via UNIVERSITEIT VAN AMSTERDAM. All use subject to https://www.ebsco.com/terms-of-use 122 In all cases the business of the enterprise must be carried on in whole or in part through the releva place before it constitutes a PE of an enterprise; that is, the requirements of article 5(1) must be m any of the listed places could be a PE. 57 The definition of a PE is markedly different in the CARICOM Agreement. This is because the CA Agreement is entirely premised upon source based taxation. Consequently, article 8(2) of that Ag states that: A business enterprise shall be regarded as undertaking activities in the territory of [Country S] wh it has in [Country S] any of, but not limited to, the following: a. an office, or place of business management; b. a factory, plant, industrial workshop or assembly shop; c. a construction project in progress; d. a place or facility where natural resources are extracted or exploited, such as a mine, well, quarry, plantation or fishing boat; e. an agency, or premises, for the purchase or sale of goods; f. a depository, storage facility, warehouse or any similar establishment used for receiving, storing or delivering goods; g. any other premises, offices or facilities, the purposes of which are preparatory or auxiliary to the business activities of the enterprise; h. an agent or representative. Again, this provision is open-ended, i.e. it is an inclusive definition and therefore does not purpor exhaustive. For instance, on-site equipment, such as a pump, which is not mentioned in the above may be an example of a PE. Here, virtually any presence in the source state will constitute a PE. Except for a specific referenc branch”, the items listed in article 5(2) of the OECD model DTA are encompassed within Paras. ( (d) of the above definition. Nevertheless, a branch will be caught within the definition, because (i manifestation of a business undertaking activities and (ii) the definition states that it is not limited matters listed in Paras. (a) to (h)