The world’s tax treaties are based on precedents found in an OECD model tax convention or a UN model tax convention. Both models divide taxing rights on cross-border investment and business activities. The OECD model shifts taxing rights to capital exporting (residence) treaty partners while the UN treaty allows capital importing countries (Source country) to retain more taxing rights.
Many African countries have nevertheless signed tax treaties with capital exporting nations, presuming other strategic or economic benefits from the treaties outweigh the immediate fiscal cost of sacrificed tax revenue.
This article defines specific terms utilized in the DTAA. The definition clause of both the model conventions is contained under Article 3. However, OECD model includes the definitions of “enterprise” and “business” which is not present in the UN model.
The reason this has been done under the OECD is because the OECD model has done away with the separate provision on Independent Personal Services which the UN model retains.
The other minor difference is that the OECD model contains the word nationality and citizenship under the definition of nationals while the UN model only uses citizenship. This was done in the OECD model as some states use either of the two words and thus the definition would unnecessarily get restricted by inclusion of only one of the terms.
The other major difference is that the OECD model includes the definition of recognized pension fund within it, while the UN model makes it optional as many states do not include such funds under tax conventions.
The treaty term “resident of a Contracting State” as defined in Article 4 of the UN model treaty (which varies slightly from the OECD model) means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of incorporation, place of management or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof. However, the term does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein. Moreover, it should again be emphasized that under Article 3 of the model treaties the term “person” includes not only individuals, but also a company or any other body of persons.
Significance to note: The concept of “resident of a Contracting State” is important in determining a treaty’s scope of application, e.g., reduction in source country withholding rates-See UN Model, Articles 10-12 dividends, interest and royalties. An objective determination of residence is also effective in solving cases where double taxation arises from double residence under the internal laws of the Contracting States. Finally, the concept is employed in treaties to solve cases where double taxation arises as a consequence of taxation in both the residence and source countries.
The provisions dealing with permanent establishment (Article 5) is where the UN model seems to be more favorable for source-based taxation jurisdictions (Developing countries).
Building sites or construction or installation projects
Both the OECD and UN model treaties deem a building site or construction or installation project to be a permanent establishment if the site or project continues for a set period.
If the site or project is deemed to be a permanent establishment, the source country retains full taxing rights over profits of the non-resident business resulting from work on the site or project.
The crucial difference between the two treaties is the length of time activities must continue for the site or project to constitute a permanent establishment. The OECD model treaty deems a site or project to be a permanent establishment where the non-resident’s work lasts for more than 12 months; the UN model treaty only requires a six-month project. As construction and assembly times have reduced with changing technology and work practices, countries adopting treaties based on the UN model are likely to retain taxing rights over income in many more circumstances.
Services permanent establishment
Under the UN model,10 a non-resident enterprise that furnishes services of any kind in the source country for one or more periods aggregating more than six months within any 12-month period is deemed to have a permanent establishment in the source country. Profits from the provision of services will be attributed to the deemed permanent establishment and thus can be taxed in the source country where the services are provided.
In contrast, the OECD model treaty has no measure that allows a source country to treat the long-term provision of services as a deemed establishment and thus bypass the rule denying source countries any right to tax business income unless the income is derived through a permanent establishment. However, this can be very damaging for countries that import a lot of high value services especially modern technological or online services as under the OECD they shall be treated in a very traditional “brick and mortar” establishment approach which might not address the concerns of many types of services trade properly and the UN model has tried to tackle this concern.
The next major difference occurs in Para 4 of Article 5 in the two models which deal with exclusions from permanent establishment. The OECD model says that any establishment dealing with storage, display and delivery only shall be excluded while the UN model includes delivery under permanent establishment.
Moving forward, the UN Model also is more stringent towards agents acting on behalf of an enterprise as it provides that an agent who doesn’t conclude any contracts on behalf of the enterprise but maintains stock and delivery for the enterprise also amounts sufficiently as taxable permanent establishment in that state. The UN model also provides for provision dealing with special conditions where income from insurance industry amounts to taxable nexus to the source country. All these additional provisions in the UN model basically mean that the UN model is quite favorable to developing and least developed countries as all these inclusions which amount to more permanent establishments in the source states. Also, many of these inclusions have been brought keeping in mind the concerns of such countries and keeping in mind the need of the hour in the wake of more modern and complex problems.
Author: Eddie Opiyo