OECD Model Tax Convention - Coursework Example

? The definition of Permanent Establishment Article 5 of the OECD Model Tax Convention Introduction Personal and Corporate Income Tax and the tax on Goods and Services are the largest sources of revenue for governments around the world. For the fiscal year 2012-13, the total tax revenues for the UK are forecast at ? 568.8 billion, representing around 36% of the GDP. Personal income taxes make up 26.2% of the tax revenues and national insurance contributions 17.9%. VAT accounts for another 17.2%. Corporate income taxes account for only 7.4 % of UK’s tax revenues 1. The proportion of corporate taxes in the total taxes for all OECD countries is similar to that for the UK. Raising personal income taxes or the goods and services tax any further would be extremely unpopular with the people. There is widespread anger in the UK and in other OECD countries about the tax avoidance practices of large multinational corporations. In the UK, the Public Accounts Committee of Parliament questioned senior executives of Starbucks, Amazon and Google on their tax avoidance practices which were held to be against the spirit if not the letter of the law 2. Multinational Corporations (MNC) accounted for over $33 trillion in global sales in 2010 with a value addition of over $16 trillion, representing one-quarter of the world GDP. Many of the MNC from the Fortune 100 list have bigger revenues than several of the emerging economy countries around the world and most of these MNC are headquartered in the OECD countries 3. 1 Browne, J. and Roantree, B., “A Survey of the UK Tax System”, IFS Briefing Note BN09, October 2012. accessed 20 March 2013. 2 Knight, L., “Corporate tax avoidance: How do companies do it?” BBC News, 4 Dec 2012. < http://www.bbc.co.uk > accessed on 20 March 2013. 3 UNCTAD Report, “World Investment Report 2011”, United Nations Conference on Trade and Development < http://www.imf.org > accessed on 20 March 2013. There is, therefore, increased focus on finding ways to get the MNC to pay a higher share of taxes than they do at present. The right to tax is considered a sovereign right and is fiercely defended by all countries. Diane Ring of the Boston Law Scholl has written that while sovereignty has no exclusive definition, a sovereign state is made up of three core elements “people, territory and a government” and the government of a territory has the sovereign right to tax people living in that territory 4. A Multinational Corporation, by definition, operates in multiple countries and there is the perennial challenge of determining which government has taxation rights over the MNC and for what part of its income. 2. The Evolution of the OECD Model Tax Convention The Organization for European Economic Cooperation which later became the OECD first published a draft double taxation avoidance agreement in 1958 with the objective of preventing individuals or companies being taxed in both the country of residence (Country R) and the country of source for the income (Country S) and for the prevention of tax evasion. This document has served as the basis for over 3000 bilateral tax treaties in force around the world 5. The Model Convention has been periodically updated by the OECD and a draft 2012 revision is currently in circulation. Many developing countries around the world felt that the OECD model convention was unduly favourable to the advanced economies and lobbied the United Nations to evolve an alternative Model Double Taxation convention which was first issued in 1977. 4 Ring, D.M., “Democracy, Sovereignty and Tax Competition: The Role of Tax Sovereignty in shaping Tax Cooperation”, Boston College Law School, 28 Jan 2009. < http:// www.lawdigitalcommons. bc.edu > accessed on 20 March 2013. 5 Bennett, M., “The 50th Anniversary of the OECD Model Tax Convention”, 2008. < http:// www.worldcommercereview.com > accessed on 20 March 2013. This model has also been periodically updated. The UN model gives the source country greater rights to tax income than the country of residence when compared with the OECD model 6. It is important to recognise that both are only models to be used as the basis for bi-lateral Double Taxation Avoidance Agreements (DTAA). The actual DTAA is the governing document in respect of taxation of cross-border incomes. Each country modifies the DTAA to suit what it perceives as its own interests in relation to the other country to the agreement. The chart below shows the broad structure of double taxation avoidance that applies to DTAA treaties. 6 Lennard, M., “The UN Model Tax Convention as compared with the OECD Model Tax Convention – Current Points of difference and recent developments”, Asia Pacific Tax Bulletin, Jan/Feb 2009. < http:// www.taxjustice.net > accessed on 20 March 2013. It is interesting to note that China which was a developing economy when it signed its first DTAA agreements is now a developed economy and is seeking changes to suit its new status. For example, in the 2011 treaty with UK which replaced the 1984 treaty, China has sought reciprocal reduction of withholding taxes on investors reflecting the new factor of Chinese investing in the UK 7. 3. “Permanent Establishment” - definition in the OECD 2010 model convention 3.1 The OECD model states upfront in Article 1 that the DTAA shall apply to persons who are residents of one or both the contracting states. The term “person” is defined to include an individual, a company or any other body of persons. A “resident” is defined as any person who, by the laws of that state, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of similar nature. The intention of this article, clearly, is that a MNC must first be determined to be a resident of the country in which it is subject to tax. A corporate body is classified as a resident of a country if it its conducts business from a “permanent establishment” (PE). 3.2 Article 5 of the OECD model convention defines a permanent establishment as a fixed place of business through which the business of the enterprise is carried on 8. This apparently simple statement is, in itself, subject to various interpretations. The term “fixed” is used to differentiate from transient places of business (such as a hotel room) but does not connote any requirement of the business operating from a specific location or building. 7 Out-law.com, “UK and China update double taxation agreement before it comes into force”, Out-law.com, 7 March 2013. < http:// www.out-law.com > accessed on 20 March 2013 8 Miller, A and Oates, L, “Principles of International Taxation”, ISBN-10: 1847663214, 2009, Chapter 8 pp 179-182. In case law, it has been established that a ship or an oil rig can be deemed a permanent establishment (subject to certain minimum time periods of use). It could also be various project sites. The premises of an agent who acts on behalf of a foreign company can also be deemed to be the permanent establishment of an overseas company subject to certain safeguards. Some commentators have termed the OECD model tax convention as being made up of three distinct types of permanent establishments, the Physical PE, the Project PE and the Agency PE (Castro, 2012). 3.3 The OECD Model Convention also draws a distinction between the main business activities of the overseas company and a set of activities defined as preparatory or auxiliary activities. A place used for storage or display of merchandise to customers or to other companies for processing is not a permanent establishment. An office maintained for purchasing materials or for advertising or scientific research does not become a permanent establishment. The 2012 draft revision seeks to address several questions that have arisen in the interpretation of the definition of PE 9. 3.4 The OECD model also points that the branch of an overseas company does not constitute a PE. The tax authority needs to determine if the income on which tax is sought actually arose out of the activities of the branch. Many developing countries, based on the UN model tax convention, seek to apply what is termed “the force of attraction” criterion. These countries take the position that all business that an overseas company secures is, in some manner, is due to the company’s 9 Miller, A and Oates, L, “Principles of International Taxation”, ISBN-10: 1847663214, 2009, Chapter 8 pp 209-211. presence in the country through the branch. They therefore seek to tax the profits from all business that the overseas company secured from the source country. 3.5 The previous OECD model was primarily focused on cross-border trade of goods. Cross border trade in services now accounts for over 70% of GDP for the developed countries and around 40% for the developing economies. The OECD model defines various kinds of cross-border services and suggests the country of taxation for each type of services. The GATS mode 1 services are rendered entirely from overseas by post or as is more common today, electronically. These are only taxed in the country of residence. Modes 2 and 3 where services are rendered through an agent or PE in which case, taxation is in the customer state. The major problems relate to the Mode 4 services such as consultancy or provision of on-site people such as for project management. Many of these taxation issues are in litigation around the world. A additional problem is that under the UN model, many developing countries impose a withholding tax on payments for these services and these are often disallowed by the country of residence for set-off against taxes payable to them 10. 3.6 4. One example of the complexities of an MNC contract for taxation As an example, the organization chart shown below is that of a Norwegian offshore oil exploration company that had contracted for oil exploration work in Australia a few years ago. Different elements of the total oil exploration contract were carried out by different parts of the company, each of which is resident in a different country. The major issues for the Australian tax authority is to first determine if each of these legally separate entities has a permanent establishment in Australia. 10 Miller, A and Oates, L, “Principles of International Taxation”, ISBN-10: 1847663214, 2009, Chapter 9 pp 226- 229 Thereafter, it is necessary to determine if the value of the sub-contracts awarded by the parent company are fair and then to determine if profits were made on each such contract to determine what taxes are payable in Australia. This complex organization structure has not been created by the Norwegian company specifically for tax avoidance but has been the result of a series of acquisitions over time to build up its expertise in various technologies needed for the off shore oil industry. Such complex transaction structures are becoming the norm rather than the exception for large value or complex cross-border projects. (Image www.deepoceangroup.com) 1. The challenge of tax avoidance practices by Multinational Companies The UK Revenue and Customs authority HMRC estimates that the “tax gap” which is the shortfall between estimated tax due to the Government and what is actually collected in the UK is ? 35 billion. This is 8% of the total tax collections. 14% of this ? 35 billion is through tax avoidance, most of which is by corporate tax payers. The European Commission estimates that tax fraud costs the European Union countries over € 1 trillion. The EC recognises that this is a cross border problem that requires various countries to co-operate to find a solution 11. Tax laws in all countries are elaborate and the governments have attempted to modify legislation when individual avoidance schemes come to light. These modifications add further to the complexity of the law and new schemes are devised to circumvent the law. This has become a game of wits between the revenue authorities on one hand and the taxpayers and their accountants on the other 12. The NAO has reported that between 2004 and 2011, 2300 tax avoidance schemes have been disclosed to the tax authorities and on average 100 new schemes emerge each year. The HMRC has succeeded in challenging only 40 schemes in two years 13. The outrage about tax avoidance schemes is that these schemes provide an unfair competitive advantage to certain companies over many others who comply fully with the law both in its requirements and intent. 11 EC Taxation, “Fight against tax fraud and tax evasion”, 2012. < http:// www.bbc.co.uk > accessed on 20 March 2013. 12 Seeley, A.,” Tax Avoidance: a General Anti-avoidance Rule”, 3 Oct 2012. accessed on 20 March 2013. 13 BBC News, “Tax avoidance schemes cost UK billions in lost revenue”, 21 Nov 2012. < http:// www.bbc.co.uk > accessed on 20 March 2013. 2. Will a change in Article 5 of the OECD Model help? The magnitudes of tax avoidance reported in the UK and in the European Union and the fact that some of the most respected companies have been shown involved in it suggests that no modification to the OECD model tax convention will be adequate. What will be needed instead is social pressure on companies to pay their fair share of taxes. The UK volunteer group Uncut led a boycott of Starbucks Coffee outlets across the UK on reports of tax avoidance by paying a 6% royalty to an associate company in the Netherlands. The company quickly agreed to pay additional taxes of ? 20 million over the next two years 14. It may appear that Starbucks as a beverage outlet company was susceptible to such a boycott and the tactic is not possible with other industrial or financial services companies. Perhaps the pressure has to be exerted by large institutional investors such as pension funds and insurance companies. Tax compliance disclosures should also be made part of the corporate governance requirements. Just as large corporations are now proud to disclose their social responsibility projects and green initiatives relating to the environment, public sentiment should compel these companies to become proud of their tax compliance records as well. * * * * 14 McVeigh, T., Stewart, H., & Bowers, S., “UK Uncut protestors shut down Starbucks shops”, The Observer, 9 Dec 2012. < http:// wwww.guardian.co.uk > accessed on 20 March 2013. References: BBC News,” Tax avoidance schemes cost UK billions in lost revenue”, 21 Nov 2012, < http:// www.bbc.co.uk > accessed on 20 March 2013. Bennett, M., “The 50th Anniversary of the OECD Model Tax Convention”, 2008. < http:// www.worldcommercereview.com > accessed on 20 March 2013. Browne, J. and Roantree, B., “A Survey of the UK Tax System”, IFS Briefing Note BN09, October 2012. < http:// www.ifs.org.uk > accessed on 20 March 2013. Castro, L. F. M., “Problems Involving Permanent Establishments: Overview of Relevant Issues in Today’s International Economy”, The Global Business Law Review, Vol.2:125 (2012) < http:// www.globalbusinesslawreview.org > accessed on 20 March 2013. EC Taxation, “Fight against tax fraud and tax evasion”, 2012. < http:// www.bbc.co.uk > accessed on 20 March 2013. Knight, L., “Corporate tax avoidance: How do companies do it?” BBC News, 4 Dec 2012. < http:// www.bbc.co.uk > accessed on 20 March 2013. Lennard, M., “The UN Model Tax Convention as compared with the OECD Model Tax Convention – Current Points of difference and recent developments”, Asia Pacific Tax Bulletin, Jan/Feb 2009. < http:// www.taxjustice.net > accessed on 20 March 2013. Miller, A and Oates, L, “Principles of International Taxation”, ISBN-10: 1847663214, 2009 McVeigh, T., Stewart, H., & Bowers, S., “UK Uncut protestors shut down Starbucks shops”. The Observer, 9 Dec 2012. < http:// wwww.guardian.co.uk > accessed on 20 March 2013. Out-law.com, “UK and China update double taxation agreement before it comes into force”, 7 March 2013. < http:// www.out-law.com> accessed on 20 March 2013. Seeley, A., “Tax Avoidance: a General Anti-avoidance Rule”, 3 Oct 2012. < http:// wwww.ccls.qmul.ac.uk > accessed on 20 March 2013. Ring, D.M., “Democracy, Sovereignty and Tax Competition: The Role of Tax Sovereignty in shaping Tax Cooperation”, Boston College Law School, 28 Jan 2009. < http:// www.lawdigitalcommons. bc.edu > accessed on 20 March 2013. UNCTAD Report, “World Investment Report 2011”, published by the United Nations Conference on Trade and Development (UNCTAD). < http:// www.imf.org > accessed on 20 March 2013. Read More