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The Quiet Strengthening of the U.N. Tax Model

Posted on May 17, 2021
[Editor's Note:

This article originally appeared in the May 3, 2021, issue of Tax Notes International.

]

In 2013, on the cusp of the first OECD base erosion and profit-shifting project, the Netherlands offered to renegotiate some of its tax treaties with over two dozen developing countries. At the time, those treaties had little, if any, antiabuse provisions, and the Netherlands wanted to modernize them in the wake of growing global scrutiny. Shortly after, Ireland decided to review its own treaty policy toward developing countries and renegotiated a few to boost their source country rights.

BEPS 2.0 appears to be reawakening some of these discussions. Last year, the Netherlands re-upped its commitment to its developing country partners and said it will be more receptive to some U.N. model provisions than it has been. Ireland is planning to update its tax treaty policy and is soliciting feedback on what that should look like for developing countries. Irish government officials want to know whether the U.N.’s model double taxation convention between developed and developing countries should apply to its treaty relationships with developing countries and under what circumstances.

These projects come at an interesting time for the U.N. model convention. Over the past few years, it has undergone a series of revisions, some of them a marked shift from the OECD’s model treaty approach on taxing rights. The U.N. model has always maintained a greater emphasis on source country rights than the OECD model. But the U.N. Tax Committee has expanded — or sought to expand — gross basis taxation under several proposals that widen the gulf between the two models. These provisions are:

  • article 12A, which provides source taxation of fees for technical services;

  • a recently approved article 12B, which establishes source taxation of automated digital services on a gross or net basis; and

  • a proposal under article 12 to include computer software payments in the definition of royalties, which would subject them to withholding.

Meanwhile, some stakeholders have argued that the proposals could make residence countries less willing to agree to the U.N. model convention and could undermine adoption of the model treaty. It is not yet clear how this will play out, particularly because some countries have signaled an interest in expanding their use of the U.N. model.

Ireland’s Consultation

BEPS 2.0 is making Ireland reconsider a few things. Chief among them, its tax treaty policy. The country has a broad treaty network of 74 signed agreements — 73 of which are in effect — and at the end of the year, Ireland’s Revenue will publish a tax treaty statement outlining what future policy will look like. Ireland says it will emphasize treaties with developing countries, in light of the country’s development commitments under the U.N.’s 2030 sustainable development goals. The consultation, which closes on May 7, asks stakeholders to weigh in on the following:

  • whether areas of Ireland’s treaty policy should be modified or tailored in relation to developing countries;

  • whether there are international best practices Ireland can rely on to enhance its approach to the circumstances of developing countries;

  • whether more emphasis should be placed on the U.N. model treaty when negotiating with developing countries (Ireland asked for examples of situations in which it would be useful for developing countries); and

  • whether any specific standard positions should be adopted for treaties with developing countries, like positions on source taxation.

This review is Ireland’s latest look at the issue. In 2015 the Irish government commissioned a study into possible spillover effects from the tax system onto developing countries amid heavy criticism that the country’s treaties with developing countries were too restrictive and affecting these countries negatively. That report, conducted by IBFD, focused on comparability. It found that the Irish tax system on its own does not create significant tax revenue losses in developing countries and that Ireland’s tax treaties with developing countries were comparable to those of its competitors.

Compared with its peers, Ireland had relatively few treaties with developing countries. But according to the report, they were still comparable on several key issues, like the definition of permanent establishment, withholding taxes on dividends, interest and royalties, the definition of royalties, and the use of antiabuse provisions. IBFD also found that Ireland was comparable in its adoption of several U.N.-type provisions favorable to source countries, including service PE provisions.

The report presented a mixed picture of withholding taxes. On one hand, it concluded that the reduction of withholding taxes on dividends, interest, and royalties under Irish tax treaties generally was not significant when compared with the domestic withholding tax rates of its developing country treaty partners. Zambia and Morocco were exceptions; in Zambia’s case, an earlier treaty lacked antiabuse provisions and did not allow the country to levy withholding taxes on dividends, interest, royalties, or fees for technical services. That treaty has since been renegotiated.

On the other hand, data from the report showed that withholding tax rates on interest were often considerably reduced under Irish treaties and its competitors, in some instances leaving source states with no residual taxing rights. But Ireland’s reductions for the developing countries were steeper than the reductions those same countries had with Ireland’s competitors. In the case of Egypt, the rate was halved, and the Irish treaties with Pakistan and Zambia eliminated source state taxing rights for royalties. Ireland renegotiated some of its treaties in the wake of the findings.

The Netherlands’ Changes

Broadly, Ireland’s treaties with its developing country partners were similar to those of its competitors. The IBFD made the same conclusion about the Netherlands when it looked at the country’s developing country treaties in 2013, but there were a few key differences. IBFD flagged the lack of antiabuse rules in 23 treaties and found that the Dutch treaties generally created the largest reduction in taxation at source for five countries: Bangladesh, Ghana, the Philippines, Uganda, and Zambia.

In the years since, the Dutch government has reevaluated some of those treaties and agreed on new antiabuse language for 13. It doubled down on the issue in 2020 when it updated the country’s Memorandum on Tax Treaty Policy, saying that it wanted to help developing countries develop effective tax systems and would be “more willing to accept certain aspects of the UN Model Double Taxation Convention than it was in the past” when negotiating treaties with developing countries. In particular, the Netherlands said it is willing to accept the U.N. model’s service PE definition — and is prepared to accept higher levels of withholding taxes on dividends, interest, and royalties with developing countries, even levels higher than agreed to in tax treaties with countries like the Netherlands.

“The Netherlands will not consistently seek to negotiate withholding taxes down to the lowest possible level,” the memorandum said.

As for article 12A, the Netherlands said it expects the issue to appear in treaty negotiations but said it will only accept the article in limited instances. The Dutch position is that article 12A presents tax base concerns: Because the tax is based on gross income, while tax offsets are based on net income, any source tax that can’t be offset could be passed on to the service recipient. Dutch authorities are also concerned that article 12A could allow source states to tax fees for services even if there’s a weak link between the source state and the services provided, because the provision applies even if the technical service weren’t provided in the source state. There’s also a first-mover reluctance involved — the Netherlands noted that many of its competitors don’t include article 12A in their treaties with developing countries.

On the other hand, the Netherlands said it understands that article 12A could provide a straightforward way of generating tax revenue for developing countries with limited enforcement capacity. Based on that, it said it will recognize a source country right to tax fees for technical services for a select group of countries — the poorest developing countries, those that have few alternative tax revenue sources. But the Netherlands would allow it only in cases in which the services are provided in the source state and for a limited time period.

Peering Into the Looking Glass

This stance is a significant development for article 12A because the article’s commentary highlights just how fraught and divisive its negotiations were. The U.N. created article 12A to address BEPS concerns over cross-border technical services, but a significant minority of the U.N. Tax Committee did not agree with the policy justification and thought that taxation of fees for technical services is appropriate only when the service provider has enough nexus to the state of the payer. Double taxation risks were a concern. Gross-up clauses were a concern. The very definition of technical services was a concern.

As things stand, the measure has been adopted in only a small handful of treaties between developed and developing countries, including the Ghana-Ireland treaty and the Brazil-Switzerland treaty. Other countries that include fees for technical services in their treaties include Cambodia, Chile, Morocco, and Uruguay. Now that the Netherlands has indicated it’s open to the provision in limited instances, it remains to be seen whether its peers will follow suit.

That trajectory could provide some clarity into what to expect with article 12B or with the article 12 computer software royalty proposal, both of which have faced similar critiques. That said, there’s an added component — as the U.N. expands its withholding provisions, there are some concerns within the business community about how they will interact with each other. It is unclear how those arguments may sway government authorities.

In response to the tax committee’s software royalties proposal, the United States Council for International Business took issue with what it called the U.N.’s “disturbing trend” of broadening the article 12 family of provisions to allow for gross basis taxation of business profits, which it said could cause overlaps and disputes.

“Such an expansion brings with it the risks of excessive taxation, double taxation, the shifting of economic cost to source country customers and/or the potential cessation of software sales into the relevant market country,” the council said. “As such, the proposal directly undermines what is supposed to be a clear objective of the U.N. Model: the protection of taxpayers against double taxation with a view to improving the flow of international trade and investment and the transfer of technology.”

Conclusion

While the OECD’s BEPS 2.0 work has attracted the lion’s share of international attention, the U.N.’s steady and consistent treaty revision work is nothing to ignore, particularly as countries like the Netherlands and Ireland signal that they are more receptive to the U.N. model and are more receptive to withholding than in the past. The next withholding-related proposal that practitioners will likely want to watch will be the software payments royalties proposal, which is one of the most contested proposals to come out of the U.N. Tax Committee. In its April session, the committee indicated that the proposal was not ready for adoption and instead agreed to include in the commentary to article 12 a minority view reflecting the positions of committee members who had supported the proposal. It remains to be seen whether the next committee will revisit the issue when it starts work in July.

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