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Double Tax Treaties and Their Interpretation

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Double Tax Treaties and Their Interpretation Double Tax Treaties and Their Interpretation by Klaus Vogel I. INTRODUCTION ........................................... 4 II. DOUBLE TAXATION AND THE NEED FOR DOUBLE TAX T REATIES ................................................ 5 A. Circumstances Giving Rise to Double Taxation ......... 5 B. Double Taxation and General Rules of International Law 7 C. Avoidance of Double Taxation, Particularly Through T reaties .............................................. 9 1. Unilateral Measures to Avoid Double Taxation ...... 9 2. The Development of Tax Treaties .................. 10 3. The OECD Model, the US Model, and Other Model T reaties ........................................... 11 D. Double Tax Treaties and Private International Law ..... 13 III. LEGAL FRAMEWORK OF DOUBLE TAX TREATIES ........... 14 A. Conclusion of Double Tax Treaties and Their Implementation in Domestic Law ...................... 15 1. N egotiation ....................................... 16 2. Ratification ....................................... 19 3. Internal Implementation ........................... 20 B. Analytical Elements of Double Tax Treaties ............ 22 1. The General Nature of Double Tax Treaties ......... 22 2. The Distributive Rules ............................. 24 a. Requirements for Application ................... 25 b. Requirements of Substantive Taxation Law ...... 25 c. Double Tax Consequences ...................... 26 C. Organizational Structure of Double Tax Treaties ........ 26 1. Treaty Organization by Chapters ................... 26 2. Distributive Rule Organization ..................... 27 3. Other Documents ................................. 29 IV. INTERPRETATION OF DOUBLE TAX TREATIES ............... 29 A. Distinctions with Interpretation of Domestic Law ....... 30 B. Principles for Interpretation of International Agreements. 31 1. Interpretation in the Federal Republic of Germany .. 32 2. The Vienna Convention ............................ 33 2 INTERNATIONAL TAX & BUSINESS LAWYER [Vol. 4:1 C. The Principle of Common Interpretation, the Importance of the OECD Model Treaty and of Parallel Treaties ..... 37 1. Common Interpretation ............................ 37 2. The OECD Model Treaty and Its Commentary ...... 39 a. Tax Treaties Between OECD Countries .......... 41 b. Tax Treaties with Non-OECD Countries ......... 42 3. Parallel Treaties ................................... 42 V. TREATY SUBJECTS: "PERSONS" AND "COMPANIES" .......... 44 A. M odel Treaty Terms .................................. 44 B. Model Treaty Rules for "Person" and "Company" .. ...... 45 1. M ain Features .................................... 45 2. Requirements in Detail ............................ 46 3. Treaty Entitlement of Bodies of Persons ............. 50 a. Tax Liability in Both Contracting States ......... 50 b. Tax Liability in One Contracting State ........... 50 c. No Tax Liability in Either State ................. 53 4. Triangular Relationships ........................... 53 a. Inconsistent Tax Rules ......................... 54 b. Treaty G aps ................................... 54 C. Special Rules in the Treaties of the Federal Republic of G erm any ............................................. 55 VI. QUALIFICATION AND RELATED PROBLEMS ................. 59 A. The Concept of Qualification .......................... 59 B. Solutions to the Qualification Problem .................. 61 1. Alternative Solutions .............................. 61 2. Analysis .......................................... 63 a. Lex Fori Qualification .......................... 63 b. Source Country Qualification .................... 64 c. Residence Country Qualification ................. 65 d. Autonomous Qualification ...................... 65 3. Sum m ary ......................................... 66 C. Article 3(2) of the Treaty Models ...................... 68 1. Characteristics .................................... 68 2. Requirements of Article 3(2) ....................... 70 3. Preference for Interpretation from the Context ....... 72 D. Special Problems of Partnerships and Noncorporate Entities .............................................. 74 1. Inference from Treaty Entitlement to the Type of Incom e ........................................... 75 2. No Inference from Calculation of Profits to the Type of Incom e ......................................... 77 1986] DOUBLE TAX TREATIES 3 VII. INTERNATIONAL TAX AVOIDANCE ......................... 78 A. Avoidance by the Taxpayer ............................ 78 B. Avoidance by the Contracting States ................... 83 VIII. CONCLUSION ............................................... 84 4 INTERNATIONAL TAX & BUSINESS LAWYER (Vol. 4:1 Double Tax Treaties and Their Interpretation by Klaus Vogelt I INTRODUCTION International double taxation occurs when two or more states impose taxes on the same taxpayer for the same subject matter. Most commonly, double taxation arises because states tax not only domestic assets and transac- tions but also assets and transactions in other states which benefit resident taxpayers, resulting in the overlap of the states' tax claims. Bilateral double tax treaties address and reduce the extent of this double taxation. The effi- cacy of the treaty approach, however, depends on common and workable in- terpretations of the treaty terms. This Article explores the problems and significant issues which arise when interpreting double tax treaties. Using the various model taxation trea- ties' and in particular an official commentary published by the Organization t Professor of Law and Director of the Research Unit for Foreign and International Financial and Tax Law, University of Munich. This Article is a revised and adapted version of the introduction to Professor Vogel's commentary on the provisions of the OECD Model Treaty and the treaties of the Federal Republic of Germany concerning the avoidance of double taxation and fiscal evasion. See K. VOGEL, DOPPELBESTEUERUNGSABKOMMEN, DAS OECD-MuSTER- ABKOMMEN UND DIE DOPPELBESTEUERUNGSABKOMMEN DER BUNDESREPUBLIK DEUTSCH- LAND AUF DEM GEBIET DER STEUERN vOM EINKOMMEN UND VERM6GEN (1983). The author gratefully acknowledges the extensive assistance of Henry A. Shannon, III in adapting and trans- lating this article. 1. See Organization for Economic Cooperation and Development (OECD), Model Double Taxation Convention on Income and Capital 1977, reprinted in I TAX TREATIES (CCH) q 151 (1980), 3 RHOADES & LANGER, INCOME TAXATION OF FOREIGN RELATED BUSINESS TRANSACTIONS §§ 15.01-15.01[30] (1985) [hereinafter cited as OECD Model]; see also United Nations Model Double Taxation Convention Between Developed and Developing Countries, U.N. Sales No. E.80.XVI.3 (1980), reprinted in I TAX TREATIES (CCH) 171 (1982), 3 RHOADES & LANGER, INCOME TAXATION OF FOREIGN RELATED BUSINESS TRANSACTIONS §§ 15.06-15.06[28] (1981) [hereinafter cited as UN Model]; U.S. Department of the Treasury, Model Income Tax Treaty of June 16, 1981, reprinted in I TAX TREATIES (CCH) 158 (1982) [hereinafter cited as U.S. Model]; also see U.S. Department of the Treasury, Model Income Tax Treaty of May 17, 1977, reprinted in 1 TAX TREATIES (CCH) 153 (1978), 31 BULL. INT'L FISCAL Doc. 313 (1977). For an article by article comparison of the texts of the OECD Model treaties (1963 and 1977), the UN Model Treaty (1980), and the U.S. Model Treaty (1981), see K. VAN RAAD, MODEL INCOME TAX TREATIES (1983). Conventions for the Avoidance of Double Taxation to which Germany is a party are reprinted in English in INTERNATIONAL BUREAU OF FISCAL DOCUMENTATION, EUR. TAX'N Supplementary Service Section C-5. 1986] DOUBLE TAX TREATIES for Economic Cooperation and Development (OECD)2 as guides, the Article reviews the tax treaty regimes of the United States and European nations and discusses several particularly troublesome aspects of treaty interpretation. Following a brief outline in Part II of the circumstances giving rise to the need for tax treaties, Part III of the Article describes how tax treaties are concluded and presents a framework from which to analyze the various ele- ments of tax treaties. Part IV outlines the general principles and sources used in double tax treaty interpretation. It distinguishes such interpretation from that of domestic law and suggests the importance of the OECD Model Treaty and parallel tax treaties. Part V illustrates the problem of interpreting a term defined in a treaty by closely examining the internationally-defined term "companies" under the OECD Model Treaty and its consequences for the entitlement to treaty benefits. Part VI presents the complicated problem of qualification which arises when a treaty term is not defined or is inadequately defined in the treaty and the parties attach different interpretations to the term under their domestic laws. In addition, Part VII of the Article discusses the problem of international tax avoidance and outlines several states' solu- tions, which generally involve restricting the interpretation of a treaty term to exclude transactions or corporate forms lacking economic substance. II DOUBLE TAXATION AND THE NEED FOR 3 DOUBLE TAX TREATIES A. Circumstances Giving Rise to Double Taxation "The phenomenon of international juridical double taxation can be gen- erally defined as the imposition of comparable taxes in two (or more) States 2. See ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT, REPORT OF THE OECD COMMITTEE ON FISCAL AFFAIRS, MODEL DOUBLE TAXATION CONVENTION ON INCOME AND ON CAPITAL (1977) [hereinafter cited as 1977 Report]. 3. See generally
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