A tax treaty, also called double tax agreement (DTA) or double tax avoidance agreement (DTAA), is an agreement between two countries to avoid or mitigate double taxation. Such treaties may cover a range of taxes including income taxes, inheritance taxes, value added taxes, or other taxes.Agreements on tariffs, while technically tax treaties, are generally called agreements on tariffs and trade. Besides bilateral treaties, multilateral treaties are also in place. For example, European Union (EU) countries are parties to a multilateral agreement with respect to value added taxes under auspices of the EU, while a joint treaty on mutual administrative assistance of the Council of Europe and the Organisation for Economic Co-operation and Development (OECD) is open to all countries. Tax treaties tend to reduce taxes of one treaty country for residents of the other treaty country to reduce double taxation of the same income.
The provisions and goals vary significantly, with very few tax treaties being alike. Most treaties: define which taxes are covered and who is a resident and eligible for benefits, reduce the amounts of tax withheld from interest, dividends, and royalties paid by a resident of one country to residents of the other country, limit tax of one country on business income of a resident of the other country to that income from a permanent establishment in the first country, define circumstances in which income of individuals resident in one country will be taxed in the other country, including salary, self-employment, pension, and other income, provide for exemption of certain types of organizations or individuals, and 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.See, e.g., the speech by Professor McIntyre of Michigan's Wayne State University. It is generally accepted that tax treaties improve certainty for taxpayers and tax authorities in their international dealings.
Several governments and organizations use model treaties as starting points. Double taxation treaties generally follow the OECD Model Convention and member comments thereon serve as a guidance as to interpretation by each member country. Other relevant models are the UN Model Convention,UN Model Convention (2011 version) in the case of treaties with developing countries and the US Model Convention,US Model Convention (2016 version) in the case of treaties negotiated by the United States.
Tax residency
In general, the benefits of tax treaties are available only to tax residents of one of the treaty countries.See, e.g., the OECD Model Tax Convention on Income and on Capital, Article 1 ("OECD Model") In most cases, a tax resident of a country is any person that is subject to tax under the domestic laws of that country by reason of domicile, residence, place of incorporation, or similar criteria.See, e.g., OECD Model, Article 4.
Generally, individuals are considered resident under a tax treaty and subject to taxation where they maintain their primary place of abode.See, e.g., the treaty between Canada and Belgium , Article 4. However, residence for treaty purposes extends well beyond the narrow scope of primary place of abode. For example, many countries also treat persons spending more than a fixed number of days in the country as residents.See, e.g., 26 U.S.C. sec. 7701(b) for the U.S. Substantial Presence Test for residency. The United States includes citizens and green card holders, wherever living, as subject to taxation, and therefore as residents for tax treaty purposes.See 26 U.S.C. sec. 7701(a)(30) Because residence is defined so broadly, most treaties recognize that a person could meet the definition of residence in more than one jurisdiction (i.e., "dual residence") and provide a “tie breaker” clause.See, e.g., the Canada/Belgium treaty, supra. Such clauses typically have a hierarchy of three to five tests for resolving multiple residency, typically including permanent abode as a major factor. Tax residency rarely impacts citizenship or permanent resident status, though certain residency statuses under a country's immigration law may influence tax residency. This includes the '183 day rule' when the right of abode is invoked.See, e.g., the U.S. IRS explanation of residency regarding the "green card test".
Entities may be considered resident based on their country seat of management, their country of organization, or other factors.See, e.g., the Canada Revenue Agency discussion, and the Canada/Belgium treaty, supra, which defines resident by reference to local law. The criteria are often specified in a treaty, which may enhance or override local law. It is possible under most treaties for an entity to be resident in both countries, particularly where a treaty is between two countries that use different standards for residence under their domestic law. Some treaties provide “tie breaker” rules for entity residency, some do not.See, e.g., the old treaty between the United States and the former Union of Soviet Socialist Republics, which is still in force between the U.S. and several of the former Soviet republics. Residency is irrelevant in the case of some entities and/or types of income, as members of the entity rather than the entity are subject to tax.See, e.g., the U.S. IRS explanation of taxation of foreign partners of partnerships with a U.S. trade or business. The OECD has moved away from place of effective management to a case-by-case resolution using Mutual Agreement Procedure (MAP) for determining conflicts of dual residency.
Permanent establishment
Most treaties provide that business profits (sometimes defined in the treaty) of a resident of one country are subject to tax in the other country only if the profits arise through a permanent establishment in the other country. E.g., in the treaty between US and India, if the person is a resident of both countries then further clause added to the argument would be if the person owns a permanent house or has an habitual abode or being a national of a state.“Income Tax Department” 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 (PE). Most but not all tax treaties follow the definition of PE in the OECD Model Treaty.Contrast the U.S./Italy treaty using exact OECD language with the U.S./India treaty that has numerous special provisions. Under the OECD definition, a PE is a fixed place of business through which the business of an enterprise is carried on.2008 OECD Model, Article 5(1) Certain locations are specifically enumerated as examples of PEs, including branches, offices, workshops, and others. Specific exceptions from the definition of PE are also provided, such as a site where only preliminary or ancillary activities (such as warehousing of inventory, purchasing of goods, or collection of information) are conducted.
While in general tax treaties do not specify a period of time for which business activities must be conducted through a location before it gives rise to a PE, most OECD member countries do not find a PE in cases in which a place of business exists for less than six months, absent special circumstances.Commentary to 2008 OECD Model, ¶6 Many treaties explicitly provide a longer threshold, commonly one year or more, for which a construction site must exist before it gives rise to a permanent establishment.2008 OECD Model, Article 5(3) In addition, some treaties, most commonly those in which at least one party is a developing country, contain provisions which deem a PE to exist if certain activities (such as services) are conducted for certain periods of time, even where a PE would not otherwise exist.
Even where a resident of one country does not conduct its business activities in another country through a fixed place or business, a PE may still be found to exist in that other country where the business is carried out through a person in that other country that has the authority to conclude contracts on behalf of the resident of the first country.2008 OECD Model, Article 5(5) Thus, a resident of one country cannot avoid being treated as having a PE by acting through a dependent agent rather than conducting its business directly. However, carrying on business through an independent agent will generally not result in a PE.2008 OECD Model, Article 5(6)
Withholding taxes
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 tax authorities.Examples include the U.S. and Singapore. Withholding arrangements may apply to 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.See, e.g., the Singapore/India treaty.
Income from employment 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.See, e.g., the Singapore/India treaty, Article 15, which has a 183-day rule and a flat 15% tax rate where services go beyond 183 days. This treaty contains all of the provisions mentioned.
Tax exemptions Most treaties eliminate from taxation income of certain diplomatic personnel. Most tax treaties also provide that certain entities exempt from tax in one country are also exempt from tax in the other. Entities typically exempt include charities, pension trusts, and government owned entities. Many treaties provide for other exemptions from taxation that one or both countries as considered relevant under their governmental or economic system.See, e.g., the U.S./Canada treaty Articles XIX and XXI.
Harmonization of tax rates Tax treaties usually specify the same maximum rate of tax that may be imposed on some types of income. As an example, a treaty may provide that interest earned by a nonresident 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 law rate prevails.See, e.g., the Ireland/U.S. treaty, under which dividend withholding is limited to 5% or 15%, depending on ownership levels, but where Ireland tax law imposes no withholding tax on qualifying recipients.
Provisions unique to inheritance taxes Generally, income taxes and inheritance taxes are addressed in separate treaties.See, e.g., treaties between the U.S. and France regarding income taxes and estate and gift taxes . The provisions of this treaty reflect typical patterns, and incorporate all of the features mentioned in this section. Inheritance tax treaties often cover estate and gift taxes. Generally fiscal domicile under such treaties is defined by reference to domicile as opposed to tax residence. Such treaties specify what persons and property are subject to tax by each country upon transfer of the property by inheritance or gift. Some treaties specify which party bears the burden of such tax, but often such determination relies on local law (which may differ from country to country).