Difference in Taxation between OECD Model Treaty and UN Model Treaty

二O一二年 十二月

1. Similarity and Fundamental Differences

1.1 Background

1.2 The similarity of the model

2. Differences in Taxation of Business Income

2.1 Scope of Permanent Establishment (PE)

2.2 Determining the Income Attributable to a PE

2.3 Business Income from Operation of Ships or Aircrafts

Difference in Provisions on Withholding Rates on Certain incomes

3.1 Fundamental Concepts

3.2 The Rights of Taxation

3.3 Withholding Rates

3.3.1 Dividends

3.3.2 Interests

3.3.3 Royalties

3.4 Additional Regulations

4. Difference in Taxation of Employment and Personal Services Income

4.1 Independent Personal Services

4.2 Directors’ Fees & Artistes and Sportspersons

4.3 Pensions (under Article 18)

4.4 Students (under Article 20)

Other types of income

6. Exchange of information

7. Trend forecast

Abstract

Our discussion of difference between OECD Model Treaty and UN Model Treaty is divided in seven parts. The first part briefly explains similarities and fundamental differences between these two treaties; the second part explains in details difference in taxation of business income, which is further introduced in the following three dimensions, scope of permanent establishment, determining the income attributable to a PE and business income from operation of ships or aircrafts; the third part is about difference between the two treaties in provisions of withholding rates on certain investment income, mainly including dividends, interests and royalties; the fourth part introduces difference in taxation of employment and personal services income in following four aspects, that is, independent personal services, directors’ fees, pensions and students; the fifth part is about difference in taxation of other types of income; the sixth part introduces difference of provisions of information exchange between the two treaties; the last part is a brief description of trend of relationship between these two treaties. In general, these two treaties are congruous in most provisions; this article shed some light on difference between these two treaties, thus causing attention to this topic when taxation is calculated in real life.

【Key Words】OECD Model Treaty, UN Model Treaty, taxation, difference, business income, withholding rates, personal income, information exchange

1. Similarity and Fundamental Differences

1.1 Background

As international communication becomes more and more frequent in the daily life, international tax problems are increasing. The existing tax laws are out of steps with times. If we didn’t make changes, we would face more problems. Therefore, it’s necessary for the countries to conclude agreements of international tax in order to coordinate the tax revenues. Only in this way, can these countries further develop.

Nowadays, the tax treaties represent an important aspect of the international tax rules of most countries. Over 2000 bilateral income tax treaties are currently in effect, and the number is growing. The overwhelming majority of these treaties are based in large part in the OECD Model Treaty. The UN Model Treaty is substantially similar to the OECD Model Treaty but includes some provisions that are not includes in the OECD Model Treaty.

We are going to discuss the similarities and differences between these two treaties in order to understand how these two treaties interact and intersect. It’s very useful for us to realize the basic situation and the development prospect of the international tax.

Now, we will introduce the similarities and fundamental differences.

1.2 The similarity of the model

The remarkable similarities of the two treaties are the objectives on tax treaties. The objective of tax treaties, broadly stated, is to facilitate cross-border trade and investment by eliminating the tax impediments to these cross-border flows. This broad objective is supplemented by several more specific, operational objectives. The most important operational objective of bilateral is the elimination of double taxation. Most of the substantive provisions of the typical tax treaty are directed at the achievements of this goal. For example, tax treaties contain tie-breaker rules to make a taxpayer who is otherwise residence in both countries a resident in only one of the country. They also limit or eliminate the

source country tax on certain types of income and require residence countries to provide relief for source country taxes.

The historical emphasis in the elimination of the double taxation should not obscure the fact that most tax treaties have another equally important operational objective- the prevention if fiscal evasion. This objective counterbalances the elimination of double taxation. Just as double taxation imposes an inappropriate barrier to international commerce, the tolerance of fiscal evasion offers an inappropriate incentive to such commerce.

In addition to the two principal operational objectives of tax treaties, there are several ancillary objectives. One ancillary objective is the elimination of discrimination against foreign nationals and nonresidents.

A second ancillary objective is the exchange of information between the Contracting States. The exchange if information can be an important tool in combating fiscal evasion. And also, both of the treaties can provide certainty for taxpayers.

Beyond that, the structure of the OECE and UN is the same. They all include title and preface. Chapter 1-2 of both treaties is some conceptual problems such as the definitions of some specific words. Chapter 3-6 is about concrete problem such as income tax, property tax, double taxation relief and some special regulations. Chapter 7 includes some final rules and the complimentary close.

All of the above are the similarities of the two models. In the following part, we will talk about some fundamental differences between the two models.

1.3 Fundamental differences between the two models

The chief difference between the two models is that the UN model imposes fewer restrictions on the tax jurisdictions of the source countries, while the OECD model does not.

The OECD Model Treaty favors capital exporting countries over capital importing countries. Often it eliminates or mitigates double

taxation by requiring the source countries to give up some or all of its tax on certain categories of income earned by residences of the other treaty country. Therefore the OECD Model Treaty is unfavorable for a country that id a net importer of capital. However, the importers of capital are always developing countries. The OECD Model put much emphasis on the benefits of capital exporting countries such as the United States and the United Kingdom. The reason is that those countries are developed countries. On the contrary, the UN Model considers issues in the perspective of developed countries’ interests and needs, which can be applied to the tax affairs between the developed and developing countries as well as the international investment activities. From the above analysis, we can easily conclude that the OCED model mainly focus on the residence jurisdiction, which put emphasis on the benefits of developed countries. When it comes to the UN model, it focuses on the source jurisdiction and the benefits of developing countries.

In order to correct the flaws of the OECD Model Treaty, the UN Model Treaty came into being. For example, the UN Model Treaty does not contain specific limitations on the withholding tax rate on dividends, interest, and royalties imposed by the source county; instead, the withholding rate levels are left to bilateral negotiations between the Contracting States.

2. Differences in taxation of business income

Taxation of business income in international treaties includes three parts. They are ordinary business income, business Income from operation of ships or aircrafts, business income from associated enterprise.

2.1 Scope of Permanent Establishment (PE)

Permanent establishment is a fundamental and crucial concept in international treaties and it is the basis for taxation of business income. Under Article 5 of the OECD and UN Model Treaties, a PE generally is “a fixed place of business through which the business of an enterprise is wholly or partly carried on.” this language is used in an essentially

identical form in almost all tax treaties. Source countries can only tax business income if it is derived from permanent establishment; otherwise, source country cannot tax any income no matter how much profit is generated. For this matter, the scope of permanent establishment has always been the key issue in international treaties. It can be compared to a bridge connecting source countries and resident countries. Part or all of income not taxed by source countries may be transferred to resident countries. If both sides doesn’t tax this income, then the taxpayer actually enjoys a taxation exemption. This leads to a gain to resident countries at the cost of a loss of source countries.

(1) Minimum period (page 195)

As is stated in Article 5, (3) OECD, a building site, drilling operation, or other temporary project location constitutes a PE if the project continues for at least one year, while the UN Model Treaty uses a minimum period of 6 months. And some treaties between developing country and developed country requires an even shorter period, for example, the minimum period in India-United States treaty is 4 months. This discrepancy should not be overlooked because a lot of building activities can be finished within 6 months, thus avoiding being taxed according to UN Model. This would cause a great loss of taxation to source countries (usually developing countries) on the basis of OECD Model.

(2) Activities Covered by the Former Provision (page 197 )

Article 5, (3) UN defines an assembly line and supervisory activities conducted in connection with a building or an assembly line to be PE if it continues for at least 6 months in a 12-month period, while these two activities are not included in OECD. This means that OECD treats service trade as goods trade in taxation. In most cases, service providers are developed countries, and they conduct operation business in developing countries. However, OECD excludes those activities from taxation by source countries, while is unfavorable for developing countries.

(3) Dependent Agents (page 196)

OECD Model Treaty includes certain dependent agents of an enterprise that act on behalf of the enterprise and have, and habitually exercise, an authority to conclude contracts on behalf of the enterprise of the enterprise, while UN Model Treaty defines a more broad concept, extending to dependent agents that maintain a stock of goods from which they make deliveries on behalf of their principals. Delivery is an independent activity in UN Model, which is a part of goods trade. Thus, enterprise which undertakes delivering goods constitutes a permanent establishment. This means that source countries (usually developing countries) have the right to delivery activities. However, this difference

may not matter much in real life. That is because profits from permanent establishment conducting delivery activities need to be allocated before taxation, through which taxation difference can be eliminated.

Article 5, (5), UN Model includes warehouse in permanent establishment. In this case, source countries have the right to tax activities related to warehouses which is auxiliary, not for preparation. And this activities are certainly not included in OECD Model.

(4) Personal Services ( page 197)

The UN Model Treaty recognizes a PE in a Contracting State if it performs personal services in that State through employees or other personnel for a period for a period of 6 months in any 12-month period, while this is not included in OECD Model Treaty.

2.2 Determining the Income Attributable to a PE( page 194 )

In determining the income attributable to a PE, OECD and UN Model Treaty adopt different principles.

Article 7 (1) of the UN Model Treaty employs a limited force-of-attraction principle, which states that if an enterprise has a PE in a Contracting State, it is taxable not only on the income earned through that PE but also on income derived in that state from the sale of products similar to those sold through the PE or from business activities similar to those activities conducted through the PE.

According to Article 7 (2) of the OECD Model Treaty, an enterprise is taxable only on the taxable income attributable to the PE, that is, it follows the attribution principle.

2.3 Business Income from Operation of Ships or Aircrafts (page 199)

OECD Model Treaty assigns the exclusive right to tax such income to the country where the shipping or aircraft operation is effectively managed, even if the shipping or aircraft enterprise has a PE in the source country.

In contrast, UN Model Treaty conducts two alternative plans A & B. Alternative A of Article 8 of the UN Model Treaty, as with provisions of

OECD, assigns the exclusive right to the country where the shipping or aircraft operation is effectively managed, while Alternative B of Article 8 of the UN Model Treaty permits the source country to tax income derived from shipping and aircraft activities if such activities are "more than usual".

3. Difference in Provisions on Withholding Rates on

For investment income, it can be divided into three categories:

dividends, interests, royalties. The following contents tell the differences between OECD and UN in terms of the rights and rates.

3.1Fundamental Concepts

The definitions of dividends, interests and royalties are similar

which are showed as follows.

The term "dividends" means income from shares,, mining shares, founders' shares or other rights,

not being debt-claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the laws of the State of which the company making the distribution is a resident.

The term "interest" as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purpose of this Article.

The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph

films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.

3.2 The rights of taxation

In OCED, it is regulated that “Dividends, interests paid by a

company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State”. However, when it comes to royalties, it says “Royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State”.

In UN, it is regulated that “Dividends, interests and royalties paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State”.

Therefore, we can conclude that in the UN model, both the resident and source countries have the right to tax dividends, interest and royalties. However, In the OECD model, although source countries have the right to tax dividends, interest, they have no rights to tax royalties.

3.3 Withholding Rates

In UN, the withholding rates of dividends, interests and royalties are all decided by mutual agreements between the contracting states.

In the OECD, however, it not only regulates some certain rates but also more complicated, and the related provisions are as follows：

3.3.1 Dividends

In OECD, it regulates that dividends can also be taxed in the

Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial

owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed:

(1) 5 per cent of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) which holds directly at

least 25 per cent of the capital of the company paying the dividends;

(2) 15 per cent of the gross amount of the dividends in all other cases. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of these limitations.

3.3.2 Interests

In OECD, it regulates that interest can also be taxed in the

Contracting State in which it arises and according to the laws of that State, but if the beneficial owner of the interest is a resident of the other

Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the interest. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this limitation.

3.3.3 Royalties

As we have mentioned before, the royalties cannot be taxed in the Contracting State in which it arises, therefore, the withholding tax rate is 0.

In general, we can conclude that the withholding rates of dividends have two level——5% and 15% respectively, and that of interests and royalties are 10% and 0% respectively.

3.4 Additional regulations

We must bear in mind that the above-mentioned provisions shall not apply if the beneficial owner of the dividends, interests and royalties, being a resident of a Contracting State, carries on business in the other Contracting State of which the entity paying those investment income is a resident through a permanent establishment situated therein and the

holding in respect of which the investment income are paid is effectively connected with such permanent establishment.

In addition, for dividends, it regulates that “Where a company, which is a resident of a Contracting State derives profits or income from the

other Contracting State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid is effectively connected with a permanent establishment situated in that other State, nor subject the company's

undistributed profits to a tax on the company's undistributed profits, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State”.

Also, for interests, it is regulated that “Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention”.

Thus, by comparing the differences of dividends, interests and

royalties between the OECD Model and the UN Model about taxation rights and withholding rates. It again reflects that the OCED model mainly focus on the residence jurisdiction, which put emphasis on the benefits of developed countries. When it comes to the UN model, it

focuses on the source jurisdiction and the benefits of developing countries.

4. Difference in Taxation of Employment and Personal Services Income

In terms of the differences between OCED Model and UN Treaty in Employment & Personal Services Income, there are mainly four aspects: independent personal services, directors’ fees & artistes and sportspersons, pensions and students’ proceedings. We will discuss those aspects in detail.

4.1 Independent Personal Services (under Article 14)

In UN Model Treaty, a resident of a Contracting State who performs “professional services or other activities of an independent nature” in other Contracting State is taxable if he or she has a “fixed base” in that State. In essence, professionals and other persons performing independent services generally may be taxable whether or not they have a fixed base if they are exactly present in the country for more than 183 days of the taxable year or if their compensation is deductible in the source country.

To be more precise, the term “professional services” includes the services of physicians, lawyers, engineers, architects, dentists, and accountants, as well as independent scientific, literary, artistic, educational, and teaching activities.

While after the revision in 2000, the OECD Model Treaty claims that individuals and companies engaged in the performance of independent personal service are taxable only if he or she has a PE (permanent establishment) therein and his or her income is attributable to the PE.

Obviously, we can see that UN Model Treaty which offers various alternatives and opportunities for those developing countries is really beneficial for them. I guess that is why the UN Model Treaty is so popular all over the world.

4.2 Directors’ Fees & Artistes and Sportspersons (under Article 16 & 17)

Concerning the point of directors’ fees, both of OECD Model Treaty & UN Model Treaty state that a resident of a Contracting State, who receives directors’ fees or other similar payments as the member of the board of directions in the other Contracting State, is taxable by the second-mentioned State. It is immaterial under Article 16 whether the income of the directors of top officials arises from services performed in the Contracting State. In addition to these, UN Model Treaty adds a specific item on taxation of top officials.

The UN Model Treaty obeys the principle of fairness, that is, the equality between nations--no matter it is developed country or not. In order to achieve this goal, we have to realize the characteristics of service

trade and to rectify the existence of question and difficulties. Some OECD countries suggest that there is no close link with the permanent establishment when considering the taxation of service business. In other words, we should not judge a service business by the existence of permanent establishments.

The income from employment performed in a country may be taxable in the country under Article 15 (Dependent Personal Services) of OECD Model Treaty whether or not the employee has a fixed base in the country. Such income is exempt from tax in the source country, however, if an employee is paid by a foreign employer, the salary and bonus were not deductible by the employer in the source country, and the employee is present in the source country for not more than 183 days in any 12-month period.

Also, we should pay more attention to the statement that the generous exemption from source taxation for professionals and employees generally do not apply to entertainers and athletes (and their retinues).

With the certain exceptions, individuals performing employment services on behalf of a Contracting State are taxable only by that state. Of course, some government servants who are working in a foreign country as members of their government’s diplomatic missions are exempt from tax under special agreement or under the rules of international law. A tax treaty would not affect such exemptions.

4.3 Pensions (under Article 18)

Under OECD Model Treaty, individuals receiving pensions on account of past employment generally are taxable only by the Contracting State of which they are a resident.

On the other hand, unlike OECD, the UN Model Treaty offers some scope for taxation at source countries. Government pensions generally are taxable by the Contracting State making the pension payment unless the individual receiving the pension is both a resident and a national of the other Contracting State.

4.4 Students (under Article 20)

OECD Students and certain business apprentices or trainees who visit a Contracting State for educational or training purposes are generally not taxable in that Contracting State on foreign payments they receive for maintenance, education, or training.

Based on the above-mentioned provisions, under UN Model Treaty those people also can enjoy the same tax revenue preferential policy as the resident in that country. Some tax treaties also provide reciprocal exemptions for visiting professors and teachers.

As we known, there are relatively more students and trainees in developing would like to further their study in other developed countries; therefore, we can conclude that this item in UN Model Treaty is really in developing countries’ favor.

Of course, we should also bear in mind that both of the two treaties provide effective measure in dealing with the double taxation issues. They both contribute to the balancing of tax allocation between the residence country and source country. At the same time, they protect the local business’ interest and regulations.

5. Other types of income

Many tax treaties reserve the right to tax income, other than those types of income discussed above, to the country of residence of the taxpayer deriving income. Article 13 (Capital Gains) of the OECD and UN Model Treaties generally provides the taxation of capital gains, other than gains attributable to PE or gains from the alienation of immovable property, is reserved to the residence country. The residual rule contained in Article 21 (Other Income) of the OECD Model Treaty similarly provides that that the taxation of items of income not dealt with in other articles of the treaties given exclusively to the country of residence. Article 21 (Other Income) of the UN Model Treaty reserves to the source state the right to tax unmentioned income items. Article 21 has becoming

a significant role in recent years result from many forms of income derived from new financial instruments.

6. Exchange of information

The last difference, but not the least significant one, should be given as much as attention due to the working focus of OECD is likely to respond more quickly to tax risks derive from poor exchange of information. As the OECD Model indicates:”we are focuses on helping tax authorities to respond more quickly to tax risks, to identify trends and patterns already identified and experienced by some tax administrations, and to share experiences in dealing with them”. However, on the other hand, the UN Model is proposed to make some new provisions of exchange of information but has not published yet. So for the moment, let’s put whole our heart into investigating the new articles of OECD Model.

6.1 Relatively unconditionally exchange of information

To be in accordance with internationalization of economic relations, the first comes up with us is the relatively unconditional exchange of information. We can infer it from the Article 26 of OECD Model, which states:”If information is requested by a Contracting State in accordance with this Article, the other Contracting State shall use its information gathering measures to obtain the requested information, even though that other State may not need such information for its own tax purposes.” To be simplifying, that means the Contracting Country is supposed to provide the information as much as possible to the other Contracting Country even though it has not involved in the taxation of Contracting Country, which exhaustively change the situation in which the state carried out its duty imposed on the behalf of Contracting State or of their political subdivisions or local authorities. In spite of extra cost in collecting information of the company, we are pleasure to accept the new provision since it would guide the international transactions in a more efficient way as well as reducing the taxation conflicts between two or more countries and double taxation. Nevertheless, we want get you

noticed that any information received under the Article 26 by a Contracting State shall be treated as secret in the same manner as information obtained under the domestic laws of that State and shall be disclosed only to persons or authorities for specific purposes.

6.2 Banking secrecy can’t be the excuse to refuse to exchange information

Some new provisions about banking secrecy are the second point what we would like to explain in a detail. ”In no case shall the Contracting State to decline to supply information solely because the information is held by a bank, other financial institution, nominee or person acting in an agency or a fiduciary capacity or because it relates to ownership interests in a person”, which written in the Article 26 (5) of OECD Model, claims that the banking secrecy can’t be an excuse to refuse to exchange information with other countries. With the new requirement, it would contribute to speeding up the process of international information disclosure. What matters more, the capital flight is limited and becoming harder for the non-moral man or the illicit money by means of the bank to some degree.

6.3 Expansion in applying exchange information

The last aspect about exchange of information is the expansion in applying exchange of information in recent decade. Like what we have done above, we find the original source in Article 26 (2) of OECD. ”Any information…shall be disclosed only to persons or authorities. They may disclose the information in public court proceedings or in judicial decisions. They may be used for other purposes.” We could get the idea that we are mandatory to provide the information to the related person or authorities only, before the revision. And keeping secrets for the customers is a crucial responsibility of the organizations rather than concerning more in public interest. But now, we could do more for the benefit of residence and nation for the account of crime of corruption. In this case, many organizations could play a vital role in international counter-terrorism and anti-money laundering activities.

We are prospect to see that you could understand most part of our statements about exchange of information and realize the fact that many of the changes that were then made to the Article were not intended to alter its substance, but instead were made to remove doubts as to its proper interpretation.

7. Trend forecast

Finally, we would like to end up the paper with trend forecast of UN Model and OECD Model. As the foregoing statements, it’s apparent to identify the differences between the two models would become narrower in the future in that many new provisions in UN Model are written based on the OECD Model. In a more precise word, we could say the two models are in a convergence development.