ABSTRACT
Double taxation is defined as the imposition of comparable taxes in at least two countries on the same taxpayer with respect to the same subject matter and for identical periods (Baker 2001). It results from an overlap of jurisdiction to tax between a residence state, where the recipient of income lives, and a source state, where the income was generated. If both states exert their power to tax to the full extent, the total burden on trans-border economic activities is prohibitively high. In order to obtain the benefits of international liberalization, governments have a common interest in avoiding double taxation. The basic conflict is: which country has the right to tax the income, and which country must restrict its tax claims (see, for example, Li 2003)? While there were some domestic provisions and a few DTTs in continental Europe prior to World War I, after the war the problem became more pressing when many countries put taxation on a broader basis, including general income taxes. In the 1920s, the International Chamber of Commerce put the issue of double taxation on the international agenda. In response to this, the League of Nations commissioned reports by experts and convened several conferences of technical experts and government officials. During the League years, the basic principles and rules were developed that have guided the avoidance of double taxation up to today. In the 1950s and 1960s, the OECD took over the position of the League of Nations (and briefly the United Nations) as the main multilateral policy forum for discussions of international tax issues (Rixen 2008: 86-99; Picciotto 1992: 14-35). Initially, the objective of these activities was to draft a multilateral tax treaty. But governments persistently rejected the idea of a binding multilateral treaty. They were nonetheless supportive of developing a model convention (MC) that
could be employed as a template for bilateral DTTs. They insisted on keeping the MC non-binding to allow the necessary flexibility to make nationally differing tax systems compatible with one another (Rixen 2008, 2010). The development of the MC was marked by a conflict over the allocation of taxing rights. Should the MC be based on the residence or the source principle? Both principles can be normatively justified. Those emphasizing the principle of ability to pay will favor residence taxation because the residence country is in a better position to assess the taxpayer’s worldwide income. Conversely, if one regards the benefit principle as the more appropriate standard, this would suggest source taxation because the source country provides infrastructure that allows the generation of income in the first place. Both of these arguments are simple and intuitive. None of the scholars who have discussed the issue of a desirable allocation of taxing rights has come out in favor of one or the other principle; rather, they have favored some solution that accords different weights to these considerations (see, for example, Musgrave 2006; Li 2003). This normative indeterminacy was further aggravated by a distributive conflict between net capital importers and net capital exporters. Exporting countries favor the residence principle, whereas importers favor source taxation. In each case, the respective principle would result in the allocation of a bigger share of the international tax base to one or the other country (see, for example, Dagan 2000; Davies 2004).4 Accordingly, it has not been possible to achieve a general consensus on either principle. Instead, the solutions embodied in the various MCs that have been developed since the 1920s (which have remained fundamentally unchanged from that time right up to today) represent a compromise. Broadly speaking, the primary (or exclusive) right to tax active business income is granted to the source country (Article 7 of the OECD MC) if there is at least a “permanent establishment” (Article 5 of the OECD MC) – that is, a fixed place of business – in that country. The residence country, by contrast, has the primary right to tax passive income – that is, income from financial investment such as interest, dividends or royalties – with the source country having the right to levy withholding taxes (Articles 10-12 of the OECD MC).5 Overall, the MC differentiates between various kinds of income and assigns each to either the source country or the residence country. In general, the OECD MC places greater emphasis on residence taxation.6 For passive investment income, the rates for royalties are different from those for dividends or income. The OECD MC is thus based on a schedular system of taxation. The residence country is obliged to provide relief from double taxation in cases of full or limited source taxation. This can be done by granting either a foreign tax credit for the tax paid at source on the tax due in the home country or a full exemption of that income from home tax. In addition, bilateral treaties contain provisions on information exchange between tax administrations (Article 26 of the MC). This is the only provision of DTTs that is not primarily concerned with the avoidance of double taxation but focuses instead on the problem of potential tax evasion and avoidance.
