Tax treaties form an important part of the global economy. A tax treaty is reached by a bilateral agreement between two nations. This agreement is meant to prevent corporations and individuals from being doubly taxed on their passive and active income. Harold Adrion, an international tax consultant, breaks down the provisions of tax treaties for both individual and corporate taxpayers, explaining some of the issues that result from these laws.
Tax Treaty Basics
A tax treaty enables people and corporations who have income in more than one country to avoid being taxed twice on the same amount. The country where the taxpayer or company resides is known as the capital-exporting country. The country where the taxpayer or company earns money is known as the capital-importing country.
There are two major models for tax treaties: the UN Model Convention and the OECD Model. The OECD (Organization for Economic Cooperation and Development) favors capital-exporting countries in its calculations. This presents a problem for countries which have a great many foreign nationals in residence. The UN Model Convention is fairer to countries where the taxpayer or corporation physically resides.
Withholding taxes are a crucial piece of the puzzle. Tax treaties help to set the withholding rate, setting the amount of money that will move between countries. These treaties set the rates equally between both countries to avoid double-taxing the corporation or individual.
Many countries, including the United States, have added provisions to reduce individuals’ and corporations’ tax liability, in some cases setting it at zero for certain foreign investments.
Details of Tax Treaties
The United States holds tax treaties with dozens of countries around the world. Most income tax treaties include a provision that a resident or citizen of the United States shall not use its provisions as a method of avoiding taxation of income that was sourced in the United States.
For example, Canada and the United States have a standard tax treaty where both countries agree to pay taxes on the income earned in one country and not the other. The income between the two companies, when properly allocated, should allow the residents of Canada and the United States to be fairly taxed.
One caveat for Canadian taxpayers, as well as other nations where income taxes are higher than those in the United States, is that they may owe more money to their home country based on the higher tax rate. Individuals are more likely to be caught in this difficulty than businesses.
Problems with Tax Treaties
Frequently, leaders and citizens of less prosperous nations demand that tax provisions are fair for companies located in their jurisdiction. These treaties are not always fairly laid out, and countries may lose a significant amount of revenue based on a problematic tax treaty. It is necessary for smaller-income countries to make sure that all of their tax treaties with different nations have similar provisions. It is easy for multinational corporations to take advantage of the weakest tax treaty held by a smaller-income country.
The OECD and IMF (International Monetary Fund) are working together to make tax provisions fairer for all countries. This requires that member countries and their associates sign on to support these multinational agreements. Since governments that raise less than 15 percent of their gross domestic product have serious difficulties providing basic services to their citizens, it is doubly important that these countries find the fairest way to set up tax treaties.
Harold Adrion encourages businesses and individuals with interests in multiple countries to explore the meaning of tax treaties and how they can work for and against them.