Double Tax Treaties
Zarb, Bert J., The CPA Journal
The Basics and Benefits
The realities of globalization have brought the subject of international double taxation out of the background and into the limelight. The popularity of multinational companies, the exponential growth in the transfer of resources across boundaries, together with the recent explosion in electronic commerce, have all contributed to an increased awareness by all those concerned with or involved in transborder trade and commerce.
Over many years, tax specialists, scholars, administrators, and practitioners have come to terms with the serious problems that can arise from the imposition of tax belonging to the same person on the same income and for the same period of time. The origins of these efforts can be traced back to shortly after World War I, when the League of Nations was asked to do something to alleviate the problems of double taxation. Between 1923 and 1946, a number of studies and draft conventions were produced. It was not until 1963, however, that the first serious effort addressing the onerous effects of double taxation was addressed. The Organization for Economic Co-operation and Development (OECD) achieved this milestone when it submitted its final report, "Draft Double Taxation Convention on Income and Capital."
The OECD' s model treaty, which has gone through several revisions over the years, still stands as the model upon which most of the current existing double tax agreements are based. Even though the United States did not adopt the OECD model as its primary negotiating document, it significantly influenced U.S. treaties entered into after 1963.
As these efforts, spearheaded by the OECD, were going on, the United Nations (UN) quickly realized that the OECD model was inadequate for primarily capital-importing developing countries. Thus, in 1968, the UN formed the "Ad hoc Group of Experts on Tax Treaties between Developed and Developing Countries" in order to formulate guidelines. In 1980, the UN published its version of a tax treaty model specifically addressing the special circumstances of developing nations. This model was updated as a draft in 1999 and as a final model in 2001.
The development of the model U.S. treaty took a different path. The United States signed its first income tax treaty with France in 1935; the negotiations were based on a model developed by the U.S. Treasury. Although this model was intended to be used for U.S. negotiations, it was not the official U.S. model yet. The double tax treaty that the United States signed with the United Kingdom in 1945 became the unofficial model for future treaties. With the subsequent publication of the OECD model in 1963, the unofficial U.S. model encountered resistance during negotiations. It was not long before the United States realized that the only way to modernize its existing network of tax treaties was to use the treaty concepts already in use by the international community.
The first official U.S. model tax treaty, issued in 1976, resembled the OECD model both in structure and in terminology. On June 16, 1981, the U.S. Treasury Department published a draft Model Income Tax Convention specifically limiting the potential hazards of "treaty shopping" (discussed below). This 1981 model was withdrawn as an official U.S. model on July 17, 1992. The Treasury Department issued a new version of the U.S. Model Income Tax Convention and Model Technical Explanations on November 15, 2006. The new version of these two documents takes into account recent changes in U.S. domestic law and tax treaty policies since the last update in September 1996.
All tax treaty models provide detailed explanations of each of their articles. Tax treaty interpretation is also covered by international law. This is addressed by article 31(1) of the Vienna Convention on Law of Treaties, which states: "A treaty should be interpreted in good faith and in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in light of its object and purpose. …