Liability to Tax and Treaty Benefits
Wheater, Jennifer, Business Law International
Eligibility for relief under a double taxation treaty depends upon a person (be they individual or entity) being a resident of one or other of the contracting states. This is a logical requirement - such treaties are entered into by the governments of the states involved for the benefit of their residents. However, the exact definition of resident can be subject to interpretation and is generally dependent upon the concept of liability to tax. The definition of resident under Article 4 of the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention reads as follows:
'For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof. This term, however, 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.'
The OECD article is commonly adopted in treaties and the related commentary discusses this definition in some detail.
As far as individuals are concerned, the commentary is relatively specific and assumes universal application. It states that the aim behind the article is to provide that individuals will be regarded as resident if the relevant domestic law provides for them to be subject to 'comprehensive taxation (full liability to tax) ' in that state. The article itself supports this by making it clear that, under the OECD definition of resident, individuals subject to tax only on items sourced within a state are not regarded as resident for treaty purposes. Examples of such individuals would include those resident but not domiciled in the UK and using the remittance basis of tax. The remittance basis means that these individuals are liable to tax on income and gains from 'overseas' sources, only to the extent that such income and gains are remitted to the UK. The OECD definition of residence would not accommodate such a person although, presumably, they would seek to retain income and profits from the other contracting state outside the UK and thus would not seek to rely on the treaty anyway. This notwithstanding, the OECD suggests that, in the case of individuals, full liability to tax is expected worldwide for treaty benefits to be available.
The remit of the term 'liability to tax' is certainly much more easily understood in the context of an individual. In most countries, individuals are subject to comprehensive tax on their income and gains. There are no instances of individuals with particular, inalienable characteristics being eligible for special tax exemptions. Obviously, individuals may not reach a threshold of income that obliges them to pay tax - thus, while being fully liable to tax, they pay none. Equally, some jurisdictions may provide tax reliefs, for example, for families with children or married couples that are not of universal application. However, the essential feature is that all individuals are generally subject to the same tax laws and such laws are applied in accordance with their circumstances.
Beyond individuals, the matter becomes more complex. This complexity arises from the fact that jurisdictions interpret the term 'liable to tax' differently within their domestic framework. The OECD commentary recognises this. It acknowledges that while many jurisdictions treat entities that may be exempted from certain taxes as being 'liable to tax', others do not.
In certain cases, the entity position is clear and a review of these cases can help emphasise the lack of clarity in other instances.
If an entity has no tax exposure in itself as distinct from its owners, then it is relatively easy to acknowledge that it is not liable to tax. A clear example of this arises with partnerships. …