Income tax treaties begin with the recitation that they are entered into between countries for the purposes of avoiding double taxation of international income flows, and the prevention of fiscal evasion with respect to taxes on income and capital gains.
According to international law as presented in Vienna Convention on the Law of Treaties 1969 Article 2, the term treaty means an international agreement concluded between States in written form and governed by international law, whether embodied in a single instrument or in two or more related instruments and whatever its particular designation.
In addition, Article 27 provides that one may not invoke the provisions of its internal law as justification for its failure to perform a treaty.
The Kenya supreme law of land is the 2010 constitution. Under treaty ratification, Article 2 (6) of the constitution provides that any treaty or convention ratified by Kenya shall form part of the law of Kenya under this Constitution.
In 2012, Kenya enacted the treaty making and ratification act which implemented Article 2 (6) of the constitution as part of the domestic legislation. This act provides a guidance in treaty entering, ratification and enforcement process. In addition, the income tax act 2021 revised edition provides DTAA in its legislation with a schedule specifying countries that Kenya has a signed treaty with. These countries include but not limited to Zambia, Denmark, Norway, Sweden, United Kingdom, Federal Republic of Germany, Canada, India and France.
Against that background, treaty ratification and its implementation to domestic legislation doesn’t work in isolation. This is guided by international DTAAs model developed by Organization for Economic Corporation and Development (OECD) model tax convention 2017 and UN Model 2021 Model Tax Convention between Developed and Developing Countries.
This therefore begs a closer look at key provisions introduced in the two models and its implementation and application in the domestic legislation.
As an introduction, it is prudent to understand the key articles in the two models developed. They include but not limited to;
- Article 1 and 2 which capture the scope of convention, they highlight the beneficiaries of the DTA, and taxes covered.
- Article 3 to 5: Definitions on Residents Status and Permanent Establishments (PE). These articles define specific terms utilized in the DTAA.
- Article 6 to 21, provide the basis for taxation of the various income heads noted as well as allocating taxation rights to the relevant state.
- Article 22 on Taxation of Capital, provides the basis for the taxation of capital.
- Article 23 on methods for elimination of double taxation, provides the relief through which double taxation can be sought.
- Article 24 to 30 provide for special concerns addressed by the DTAA such as exchange of information and non-discrimination provisions.
- Lastly, article 31 and 32 highlight what is required in order for the DTAA to come into force as well as termination procedures.
The DTAA models therefore are intended to:
- Eliminate double taxation on income and capital without creating opportunities for non-taxation or reduced taxation through tax avoidance or evasion (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this Convention for the indirect benefit of residents of third States)
- Encourage foreign direct investments.
- Encourage international trade.
In light of the evolution and development noticed in the international taxation arena relating to DTAA as a basis to protect Base Erosion and Profit Shifting (BEPS) by different jurisdictions; it is important to understand the specific articles highlighted in the two models guiding double taxation.
Article 1 and 2 – Scope of Convention, Beneficiaries and Taxes Covered
Scope of Convention:
UN Model Tax Convention states that the scope of convention shall apply to persons who are residents of one or both of the contracting states.
OECD Model Tax Convention: This Convention shall apply to persons who are residents of one or both of the Contracting States.
Key Issues to note:
- Many older negotiated treaties used the prior model treaty title of Personal Scope for Article 1. Both model treaties recently changed the title of Article 1 to Persons Covered to more accurately convey the correct scope of a tax treaty by specifying the types of persons or taxpayers to which a tax treaty applies.
- Article 3 defines the term “person” as including an individual, company or any other body of persons.
- Article 4 defines the term “resident of a Contracting State” as meaning any person who is liable to taxation therein on the basis of domicile, residence, place of management or any other criterion of a similar nature.
Article 1 defines the outer scope of potential treaty benefits with regard to the imposition of both source and residency income taxing jurisdiction. Yet, unintended third country benefits may still potentially be derived through the use of bilateral tax treaties. In some cases, the “beneficial owner” rules are inserted in treaties to limit the improper use of treaties.
UN Model Tax Convention: This Convention shall apply to taxes on income and on capital imposed on behalf of a Contracting State or of its political subdivisions or local authorities, irrespective of the manner in which they are levied.
OECD Model Tax Convention: This Convention shall apply to taxes on income and on capital imposed on behalf of a Contracting State or of its political subdivisions or local authorities, irrespective of the manner in which they are levied.
Key Issues to note;
- The model treaties each contain 4 paragraphs, the first two of which broadly define what taxes, both income and capital, are covered by the treaty. However, most actually negotiated treaties dispense with inclusion of the first two paragraphs and move immediately to include the third paragraph of the model treaties. The third paragraph specifies exactly which taxes of each treaty partner are to be applicable to the treaty.
- The existing taxes to which the Agreement shall apply are in particular:
- in the case of Ireland:
- the income tax;
- the universal social charge;
- the corporation tax; and
- the capital gains tax;
(Hereinafter referred to as “Irish tax”);
- in the case of Kenya, the income tax chargeable in accordance with the provisions of the Income Tax Act;
(Hereinafter referred to as “Kenyan tax”).
The definition of taxes covered relates directly to which taxes are to be accorded unilateral tax relief via the credit or exemptions mechanisms pursuant to Article 23 of the model treaties, titled Methods for the Elimination of Double Taxation. Specificity in defining the taxes to be covered by the treaty is therefore critical as taxes of either country not included in the definition of taxes covered by the treaty will not qualify for foreign tax credit purposes.
Author: Eddie Opiyo