Tax Treaties: A Curse or a Blessing? Presentation made at the ICTD Annual Centre Meeting Arusha, 2014

1. Tax
Trea'es
A
curse
or
a
blessing?
Research
on
Developing
Countries
JUDr.
Tomas
Balco,
LL.M.,
ACCA
Ministry
of
Finance
of
Slovakia
ICTD

2. Introduc'on
• Chartered
Cer'fied
Accountant
–
ACCA
(FCCA)
• 3
law
degrees
– Doctor
in
Law
(Interna'onal
Law)
– Magister
in
Law
– Postgraduate
LL.M.
in
Interna'onal
Tax
Law
(Vienna)
• Work
Experience
– Slovakia
(MoF),
Kazakhstan
(KIMEP
University
&
CATRC,
PwC),
Netherlands
(IBFD),
Czech
Republic
(MoF,
DeloiWe),Chile
(MoF),
Belgium
(European
Commission)
• Other
– Since
2008
–
Member
of
SubcommiWees
-­‐
UN
CommiWee
of
Experts
– Projects
(World
Bank,
IFC,
USAID,
EU)
• Focus
of
Research
and
Tax
Policy
Work
–
Interna'onal
Taxa'on,
Extrac've
Industry,
Financial
Sector
• Proud
to
teach
– ITC
Leiden
University
(Netherlands),
KIMEP
University
(Kazakhstan),
IBDT
Brazil,
African
Ins'tute
–
University
of
Pretoria
(SA),
University
of
Lausanne
(CH)

3. Rela'onship
with
ICTD
• Introduced
to
Mick
Moore
by
Sol
PiccioWo
in
Spring
2014
• Draa
Working
Papers
– Introduc'on
to
Extrac've
Industry
Taxa'on
– Tax
Treaty
Issues
in
Extrac've
Industry
• hWp://www.un.org/esa/ffd/tax/tenthsession/
CRP3_AWachmentE_TreatyIssues.pdf
• New
Tax
and
Development
Short
course
at
IDS,
in
partnership
with
ICTD
and
ATAF
– Interna'onal
Taxa'on
and
Extrac've
Industry
• Monday
26th
–
Thursday
29th
January
2015,
IDS
(Brighton,
UK)
• hWp://www.ids.ac.uk/tax-­‐course
• REDE
Project
proposals
– Protec'ng
the
Source
Tax
Base
(Pilot
Project
–
3
months)
– Extrac've
Industry
Taxa'on

4. Tax
Trea'es
and
Domes'c
Law
• Tax
Trea'es
– Bilateral
and
in
some
cases
Mul'lateral
Instruments
– Concluded
with
2
main
objec'ves
• Elimina'on
of
Double
Taxa'on
• Elimina'on
of
Tax
Evasion
– Rela'on
to
domes'c
law
• Prevail
over
the
domes'c
law
– Take
away
the
taxing
rights
of
the
country
– Reduce
tax
trea'es
– In
theory
reciprocity
– Reality
• Economic
differences
lead
to
lack
of
factual
reciprocity
• Trea'es
are
abused
and
as
result
facilitate
the
base
erosion
and
profit
shiaing
-­‐>
Risk
to
domes'c
revenue
mobiliza'on

5. Domes'c
Law
–
Source
Taxa'on
• Can
a
good
tax
treaty
solve
the
problem?
– No
–
it
starts
by
domes'c
law
• Where
domes'c
law
comes
short
–
treaty
does
not
remedy
• Taxa'on
of
income
having
a
source
in
the
country
• Payments
made
from
country
• Ac'vi'es
carried
in
the
country
• Deduc'ons
made
in
the
country
• Other
nexus
to
the
jurisdic'on
(e.g.
Capital
Gains
from
Indirect
transfer
of
shares)
• Cri'cal
factors
– Defini'on
of
income
having
source
in
country
• Absence
of
defini'on
–
no
tax
liability
– Tax
Collec'on
and
enforcement
mechanism
• Absence
of
collec'on
mechanism
=
non-­‐compliance
– An'-­‐abuse
provisions
• An'-­‐base
erosion
and
profit
shiaing
rules

6. Domes'c
Law
&
DTT
Overlap
Domes'c
Law
–
Source
Taxa'on
Collec'on
mechanism
Tax
Treaty

7. Tax
Trea'es
• Benefits
of
Tax
Trea'es
• Poten'al
Loss
of
Revenue
• Examples
of
Treaty
Abuse
• How
to
stop
the
Abuse?
• Tax
Treaty
Applica'on
– Issues
Arising
– Refund
and
Automa'c
Applica'on
• Tax
Policy
and
Administra'on
Considera'ons

8. Benefits
of
Tax
Trea'es
(Elimina(on
of
Double
Taxa(on)
– Exclusive
Taxing
Rights
(Usually
state
of
residence)
• But…Country
of
Source
(Usually
the
Developing
Country)
is
loosing
the
right
to
tax
– In
theory
reciprocity…
but
in
reality….
Flow
of
investment
vs.
oumlow
of
resources,
profits
and
tax
base…
– Credit
and
Exemp'on
• But…
can
be
achieved
by
domes'c
law
the
Country
of
Residence
(Country
of
investor)
– Mutual
Agreement
Procedure
• But…
countries
may
oaen
have
different
perspec'ves
and
agreement
may
not
be
reached

9. Benefits
of
Tax
Trea'es
(Comba(ng
tax
evasion)
• Exchange
of
Informa'on
– Yes,
but
oaen
'mes
limited
ability
to
determine
what
informa'on
is
needed
• And
limits
on
what
informa'on
may
be
provided
– Can
be
achieved
by
special
agreements
on
Exchange
of
Informa'on
• Assistance
in
Collec'on
of
Tax
Claims
– Yes,
but
s'll
rarely
used
by
developing
countries
• Can
be
also
achieved
by
specialized
administra've
agreements

10. Poten'al
Implica'ons
of
DTT
(for
source
country)
• Ar'cle
7
–
Taxa'on
of
Business
Profits
– Loss
of
Taxing
rights
on
provision
of
services
or
commercial
ac'vi'es
below
the
Permanent
Establishment
threshold
• Ques'on?
Where/how
high
is
the
threshold?
• Ar'cle
8
–
Profits
of
companies
carrying
out
interna'onal
transporta'on
– These
companies
may
take
advantage
of
special
tonnage
or
other
regimes
and
pay
very
low
tax
• Ar'cle
10,
11,
12
–
Reduced
Tax
Rates
on
income
in
form
of
dividend,
interest,
royalty
– Can
also
lead
to
Zero
rates
if
trea'es
nego'ated
wrongly

11. Poten'al
Implica'ons
of
DTT
(for
source
country)
• Ar'cle
13
–
Taxa'on
of
Capital
Gains
– Sale
of
Shares
–
Exclusive
Taxing
Rights
to
the
Country
of
Residence
(Holding
Company)
– Indirect
Transfer
of
Shares
• Tax
Treaty
provisions
may
significantly
limit
the
ability
of
taxing
rights
in
specula've
holding
arrangements
– See
Approach
of
India
(Vodafone
Case)
– See
Approach
of
China
(Challenging
the
Substance
of
such
companies)
– See
Approach
of
Kazakhstan
(Special
mechanism
devised)
• Ar'cles
14,
15
–
Taxa'on
of
Independent
Personal
Services,
Employment
Income
– Loss
of
revenue
unless
Fixed
Base
or
threshold
met

12. Issues
• Does
country
need
the
tax
treaty
network?
• If
yes,
what
will
be
the
tax
treaty
policy?
• If
treaty
is
concluded,
what
will
be
the
administra've
aspects
of
tax
treaty
applica'on?
– Objec've
to
mi'gate
abuse
• Mode
of
Treaty
applica'on
• Administra've
requirements
• Will
country
have
domes'c
an'-­‐treaty
shopping
rules?

13. What
can
go
wrong
in
Tax
Treaty
Policy
and
Nego'a'on?
• Nego'ate
a
wrong
type
of
treaty
– OECD
Model
instead
of
UN
Model
• See
examples
on
next
slides
– Lack
of
specific
country
tailoring
• Special
rules
may
be
required
– Extrac've
Industry
specifics
» Jurisdic'on
(off-­‐shore),
Types
of
taxes
covered
» Source
taxa'on
–
Permanent
Establishment
specifics
» Source
taxa'on
-­‐
PE,
Technical
Services
– Financial
Services
taxa'on
» Insurance
taxa'on
» Deriva've
taxa'on
– E-­‐commerce

14. Example
–
Mongolia
Outcome
of
2011
ADB
Seminar
-­‐
Tokyo

15. Example
of
Fatal
Error
-­‐
Dividends
(Mongolia
–
Netherland s
DTT)
15
Paragraph 3 effectively reverses – paragraph 2
Paragraph 2 – looks like very good deal for developing country
Paragraph 3 – takes it down to Zero – most likely only one
country will benefit from this provision

16. Example
of
Fatal
Error
-­‐
Royal'es
(Mongolia
–
Netherland s
DTT)
Protocol
Provision
–
reverses
the
posi'on
to
the
OECD
With
reference
to
paragraph
2
of
Ar'cle
12
it
is
understood
that,
as
long
as
Country
A
(OECD
country)
does
not,
according
to
its
internal
law,
levy
a
tax
at
source
on
royal'es
paid
to
non-­‐
residents,
the
provision
of
paragraph
2
of
Ar'cle
12
shall
not
apply
and
royal'es
shall
be
taxable
only
in
the
Contrac'ng
State
of
which
the
beneficial
owner
of
the
royal'es
is
a
resident.
16

17. What
to
do?
• Why
did
developed
country
put
developing
country
in
such
a
posi'ons
–
is
it
dealing
with
equals?
Ethics?
• Op'ons?
– Renego'ate
the
tax
treaty
– Terminate
the
treaty
– Teach
them
a
lesson
• Offer
route
to
the
global
tax
community
to
access
the
tax
free
distribu'on
of
dividend
from
this
country,
which
so
fairly
treated
the
developing
country
– May
speed
up
the
renego'a'on…
17

18. Mongolia
Terminated
4
Trea'es
2012
18

19. How
was
it
solved?
Termina'on
of
4
Tax
Trea'es
by
Mongolia
• Mongolia
has
recently
(28.11.2012)
adopted
a
law
to
terminate
4
tax
trea'es:
– Netherlands
(effec've
1.1.2014)
– Luxemburg
(effec've
1.1.2014)
– Kuwait
(effec've
1.1.2015)
– UAE
(effec've
1.1.2015)
19

20. Reasons?
Netherlands
– Art
10
(2)
–
15%
WHT
/
However
(10/3)
0%
if
BO
of
the
dividends
is
a
company
the
capital
of
which
is
wholly
or
partly
divided
into
shares
…(?)
– Art
12
(2)
–
5%
WHT
/
However
(Protocol)
as
long
as
under
internal
law
NL
does
not
levy
WHT
on
royalty
–
Exclusive
taxing
to
country
of
residence
– Ar'cle
13
–
Sale
of
shares
–
Exclusive
Taxing
right
to
State
of
Residence
20

21. Reasons?
Luxemburg
– Art
10
(2)
–
5%
/
15%
WHT
/
However
(10/3)
0%
if
BO
holds
>
25%
of
shares
for
longer
than
12
months
– Art
11
(2)
–
10%
WHT
/
However
(11/3)
0%
for
any
bank
loans,
commercial
debt
and
bank
deposits
– Ar'cle
13
–
Sale
of
shares
–
Exclusive
Taxing
right
to
State
of
Residence
21

22. Reasons?
Kuwait
and
UAE
Kuwait
UAE
Dividend
5%
(Gov
exemp'on)
0%
Interest
5%
(Gov
exemp'on)
0%
Royalty
10%
10%
Capital
Gains
Exclusive
-­‐
Residence
Exclusive
-­‐
Residence
22

23. Examples
of
Treaty
Abuse
• Holding
Structures
– Dividends,
Capital
Gains
• Reduced
Rates
and
Exemp'ons
• Financing
Structures
– Interest
• Reduced
Rates
and
Deduc'bility
(Tax
Base
Erosion)
• Trading
Structures
– Business
Profits
(Sale
of
Goods
or
Services)
• Transfer
Pricing

24. Holding
structures
§ Profits
derived
from
shareholdings
(dividends
and
capital
gains)
are
fully
tax
exempt
in
the
some
jurisdic'ons
(Netherlands,
Luxemburg,
Cyprus,
Austria,
UK,
etc
under
the
par'cipa'on
exemp'on
§ Low
or
now
dividend
withholding
taxes
under
double
tax
trea'es
§ Many
favorable
tax
trea'es
§ Investments
protected
by
BITs
(Bilateral
Investment
Treaty)
§ Exit
structures
available
to
secure
tax
efficient
repatria'on
of
profits
Shareholders
HoldCo
Developing
Country
Exit
vehicle

25. Example
1
–
Direct
Sale
of
Shares
• Company
A
sells
shares
in
C
to
company
B
• DTT
13
(4)
missing
• DTT
between
A
–
C
takes
away
taxing
right
from
Country
C
-­‐>
no
taxa'on
in
country
C,
Country
A
exempts
Capital
Gains
from
tax
under
domes'c
rules
-­‐>
double
non-­‐
taxa'on
C
B
A

26. Example
2
–
Indirect
Transfer
of
Shares
• Indirect
transfer
of
shares
in
C
via
sale
of
shares
of
company
D
– Country
C
may
loose
the
taxing
right,
since
the
shares
that
are
sold
are
not
shares
of
C,
but
that
of
D
–
outside
of
the
jurisdic'on
– Extra-­‐territorial
Capital
Gain
• India
(Vodafone
Cas)
• China
approach
• Kazakhstan
rules
– OECD
vs
UN
DTT
Model
rules
– Cri'cal
aspects:
• Tax
Treaty
provisions
– UN
vs.
OECD
• Domes'c
Law
– Broader
Source
Defini'on
– Immovable
property
defini'on
A
D
C
B

27. Financing,
Royalty,
Services
structures
§
Interest,
Royalty,
Services
deduc'ble
in
the
country
of
source
§ Intermediary
company
in
Tax
Treaty
jurisdic'on
–
using
the
tax
treaty,
the
country
of
source
either
losses
the
taxing
right
(services)
or
the
WHT
may
be
limited
(also
down
to
Zero).
Cri'cal
factor
for
success
–
the
intermediary
jurisdic'on
does
not
levy
WHT
on
these
payments
(either
based
on
domes'c
law
or
DTT)
§ Mi'ga'on?
§ Consistent
tax
treaty
network,
limita'on
to
deduc'bility
Loan or Hybrid
Instrument
Loan or Equity
Intermediatry
Company
Off-­‐shhore
Opera'ng
Companies
Source – Atlas Tax Lawyers

28. Trading
structure
§ Company
in
the
Treaty
jurisdic'on
acquires
goods
from
source
country
company
and
sells
to
customers
§ Intermediary
company
is
ac'ng
as
agent
/
nominee
/
invoicing
en'ty
§ Shares
in
Intermediary
company
held
by
Founda'on
or
independent
party,
therefore
no
related
party
transac'ons
(deac'vate
TP
rules)
§ Principal
is
located
in
a
low
taxed
jurisdic'on
(bearing
all
risk)
§ Intermediary
company
is
usually
seen
as
a
reliable
trading
partner
§ Intermediary
company
receives
cost
plus
remunera'on
or
commission
fee
§ Low
taxed
en'ty
realizes
excess
income
Investors
Source
Country
Invoice
Invoice
Low
tax
jurisdic'on
(principal)
Intermediary
Company
(agent)
Goods
Customers
Owned by
Foundation or
independent
party
Profits

29. Tanzanian
Tax
Treaty
Network
(9+
DTT s)
Dividends Interest Royalties
Individuals,
companies
Qualifying
companies
(%) (%) (%) (%)
Canada 25 20 15 20
Denmark 15 15 12.5 20
Finland 20 20 15 20
India 10 5 10 10
Italy 10 10 15 15
Norway 20 20 15 20
South Africa 20 10 10 10
Sweden 25 15 15 20
Zambia 0 0 0 0

30. Zambian
Tax
Treaty
Network
(21+
DTT)
Dividends Interest Royalties
Individuals,
companies
Qualifying
companies
(%) (%) (%) (%)
France – – – –
Ireland 0 0 0 0
Japan 0 0 10 10
Kenya – – – –
Mauritius 15 5 10 5
Seychelles 10 5 5 10
South Africa – – – –
Switzerland – – – –
Tanzania – – – –
Uganda – – – –

31. South
African
Tax
Treaty
Network
(73
DTT)
Dividends Interest Royalties
Individuals,
companies
Qualifying
companies
Cyprus 0 0 0 0
Grenada – – – –
Hungary 15 5 0 0
Ireland 10 5 0 0
Kuwait 0 0 0 10
Luxembourg 15 5 0 0
Malawi – – – 0
Mauritius 15 5 0 0
Netherlands 10 5 0 0
Norway 15 5 0 0
Seychelles 10 5 0 0
Sierra Leone – – – –
Zambia – – 0 –
Zimbabwe – – – –

32. How
to
limit
the
abuse?
• Domes'c
An'-­‐Abuse
Provisions
• General
An'-­‐avoidance
Rule
• Many
Developing
Countries
do
not
have
them
• Special
rules
• Domes'c
law
based
An'-­‐treaty
shopping
• Transfer
Pricing,
• Thin-­‐Cap
and
other
deduc'on
limita'on
rules
• WHT
on
payments
to
Tax
Havens
-­‐
Black
list
• Tax
Treaty
Based
An'-­‐Avoidance
Rules
• Limita'on
of
Benefits
Clause
• Ac'on
6
BEPS
-­‐
recommenda'on
• Beneficial
Ownership
requirement
• Only
limited
to
Ar'cles
10,
11,
12

33. Refund
vs.
Automa'c
Applica'on
• Issue
• Inappropriate
applica'on
of
DTT
• Lack
of
en'tlement
• Transparent
en'ty?
• Exempt
en'ty
• En'ty
in
Special
Economic
Zone
• En'ty
ac'ng
as
agent/intermediary
• SoluEon
• Special
procedures
for
applica'on
of
DTT
• Refund
mechanism
(Subject
to
administra've
review)
• Approval
process
• Automa'c
applica'on
(subject
to
requirements)
• Automa'c
applica'on
(no-­‐requirements)
• Minimum
requirements
– Requirement
of
Cer'ficate
of
Residence
– Extreme
–
always
with
Apos'l
or
Legaliza'on
– Affidavit
on
Beneficial
Ownership

34. Tax
Treaty
Applica'on
• 3
Approaches
– Detailed
regula'ons
and
procedures
• Most
aspect
of
Treaty
Applica'on
regulated
in
detail
– Some
degree
of
guidance
and
regula'on
• Providing
some
sporadic
guidance
–
Refund
vs.
Automa'c
Treaty
Applica'on
– Hardly
any
guidance
• Minimum
–
level
–
establishing
the
role
of
trea'es
in
rela'on
to
Tax
Code
• No
proper
guidance,
no
proper
forms

35. Tax
Policy
and
Tax
Administra'on
Considera'ons
• Different
levels
of
aWen'on
to
DTT
• Level
of
Capacity
– To
Legislate
and
Nego'ate
Tax
Trea'es
• Limited
knowledge
of
the
concepts
and
principles
– To
Administer
and
Audit
• Lack
of
qualified
staff
• Limited
systems
(sources
of
informa'on)
– To
resolve
disputes
• Limited
competencies
to
nego'ate
MAP
• Mostly
absence
of
Arbitra'on
provisions
– Where
they
exist
–
they
are
not
ac'vated
as
required
– Challenge
in
form
of
harmful
tax
compe''on
– Conflic'ng
interest
of
different
countries

36. Focus
of
Source
Tax
Base
Protec'on
Project
• Stage
1
– Country
specific
research
-­‐
Throw
a
net
and
collect
a
sample
of
issues
– Country
specific
problems
in
domes'c
law
–
shortcomings
in
defini'ons,
collec'on
mechanism,
lack
of
an'-­‐abuse
provisions
– Country
Specific
Good
or
Genius
prac'ces
–
developing
countries
some'mes
tend
to
come
up
with
some
original
ideas
on
how
to
deal
with
challenges
(Tax
Collec'on
mechanism,
Defini'ons,
Limita'ons
to
deduc'bility)
• Stage
2
– Analyze,
Summarize
and
Generalize
• What
are
the
common
issues
and
problems?
• What
are
the
areas
requiring
further
study/research
–
is
something
missing
in
OECD
BEPS
project?
• Stage
3
– Recommenda'ons
• Country
Specific
and
also
General
Recommenda'ons
• Stage
4
– Findings
dissemina'on
• Policy
Maker
mee'ngs,
delivery
of
recommenda'on,
contribu'on
to
regional
discussion

37. Thank
you…
Tombalco@yahoo.com
Tomas.balco@mfsr.sk