I’m on my way to the UN tax committee’s annual session in Geneva. This year’s agenda contains quite a few interesting topics. I can’t write about them all, but I thought I might pick out three that seem particularly interesting. Since they are all discussions about the model treaty and its commentary, the common question that they pose is, “what is the purpose of a model tax treaty?” I think you can take three (not mutually exclusive) views about this:
- It tells countries what works technically. It combines the wisdom of some of the most experienced tax officials in the world to produce a technically sophisticated template that negotiators can rely on.
- It tells countries what is politically palatable. If a provision is included in the UN model, for example, a group of experts from developed and developing countries have all been willing to agree to its inclusion, so neither side is going to consider it too outrageous.
- It tells countries what is acceptable behaviour. The models sketch out the concepts and principles that committee members think should underpin a country’s international tax system. It conveys an expectation that a country’s tax rules should be compatible with these concepts and principles.
From an international relations side, we might say that the first two purposes are about reducing transaction costs for negotiations, by providing countries with information ahead of time. The last one, on the other hand, would suggest that treaties act as instruments through which norms about acceptable behaviour are established and diffused within an international community.
The status of the OECD transfer pricing guidelines
When the 2010 update to the UN model treaty was being finalised, there was some controversy around article 9, which deals with transfer pricing and the arm’s length principle. The commentary to the previous version of the UN model stated that the OECD’s transfer pricing guidelines were “internationally accepted guidelines” and recommended that countries should follow them. A minority of committee members didn’t accept this view, and so rather than resolve the conflict, the commentary now records that [pdf] “The views expressed by the former Group of Experts have not yet been considered fully by the Committee of Experts, as indicated in the Records of its annual sessions.” Unusually, the record of the discussion identifies the dissenters as the Chinese, Brazilian and Indian members of the committee. It is worth noting that none of these three individuals are still members of the committee.
The new committee is going to discuss a proposed wording to resolve those differences. This wording states only that the OECD guidelines “contain valuable guidance” and adds that
the Committee has developed the United Nations Practical Manual on Transfer Pricing for Developing Countries which pays special attention to the experience of developing countries, reflects the realities for such countries, at their relevant stages of capacity development, and seeks broad consistency with the guidance provided by the OECD Transfer Pricing Guidelines.
There is a furious letter [pdf] from the US Council for International Business, which seems to be targeted directly at India, China and Brazil:
It seems inconsistent for G20 countries and other non-OECD countries that are now advocating for their views to be reflected in the OECD Transfer Pricing Guidelines to accept concessions from others participating in the development of those Guidelines and then undercut the very outcome of those negotiations by arguing elsewhere for positions that were rejected in that forum. If any notion of “fairness” has relevance in international tax, surely it should include the concept that acceptance of an invitation to bargain on an equal footing over a set of rules carries with it the good faith obligation to live by those same rules.
The letter argues that the UN Manual was not produced with enough participation from businesses, that the OECD guidelines are now formulated with input from “a broad spectrum of countries”, and that the proposed UN aim of “broad consistency” will permit “multiple, inconsistent applications of that principle, will lead to multiplied disputes, increased double taxation, and ultimately to serious damage to the cross-border trade and investment that fuels economic growth and development.”
This might be an argument based on purpose 1, 2 or 3 above. On 1, USCIB is arguing that the changes will create technical problems. On 2, it is arguing that the political signalling effects of the OECD and UN models undermine each other when countries agree to one thing at the OECD and push a different position at the UN. Finally, on 3, it is clearly concerned about diluting the clear message sent by the treaty commentaries at present, which is that the OECD guidelines are the only internationally accepted authority when it comes to transfer pricing.
Both as a discussion in its own right [pdf], and through a paper for the Extractive Industries subcommittee [pdf], there’s a lot of discussion of “indirect transfers”, where a capital asset in a developing country is sold, but the transaction takes place through the sale of a holding company located in another country. I have written about an example of this recently, and it was highlighted in the recent IMF spillovers report. As I observed, it doesn’t look like the G-20/OECD processes are going to look at this problem in any depth, so this is an instance where the UN committee is examining an issue of clear concern and interest among developing countries.
The discussion focuses on article 13(4) which covers the sale of a company whose value consists principally of immovable property. This may include a mine, or a capital-intensive business such as a mobile phone network. The UN papers highlight a range of administrative issues: how a developing country can know if a sale taking place abroad falls within the scope of this article, how to value the gain, how to define “immovable property” since the model treaties are not as clear as they could be on this matter.
What interests me most is the question of how to actually collect the tax, when the payment is made outside the country, and when by definition the company making the gain may no longer have any assets in the country. As the extractives paper observes:
While both the UN and OECD Models now contain optional Assistance in the Collection of Tax Debt Articles for countries wanting to provide for this in bilateral tax treaties, and there is a multilateral OECD/ Council of Europe Convention on Mutual Administrative Assistance in Tax Matters on the subject, this is not yet something most developing countries have provision for in their bilateral or multilateral relationships.
This is something tax authority officials from developing countries are definitely seeking from renegotiations. In the meantime, the extractives paper describes alternatives, which include asking the purchaser (who by definition will have assets in the country) to withhold the capital gains tax when paying for the transaction, and refusing to grant export licenses until the capital gains tax has been collected.
I don’t know how controversial this is going to be, but insofar as it is about providing advice to developing countries, I think that makes it a matter of purpose 1.
The committee is going to discuss a draft article [pdf] that would allow developing countries to tax technical services. This is a provision that exists in some form in many tax treaties already, and has been introduced into models such as the East African Community’s new model treaty. But neither the UN nor OECD model treaties include it. From a technical point of view (purpose 1), this new addition should be a good thing: since these provisions are fairly popular among developing countries’ tax treaties already, having an international Committee of Experts formulate a model provision built on their collective wisdom is surely a good thing.
That’s not the view taken by the International Chamber of Commerce in a letter [pdf] that outlines the main arguments likely to be raised against a withholding tax on management fees. The ICC is opposed to such a tax per se, but it emphasises that it is even more concerned about the double taxation that might result if countries impose such a tax it unilaterally. Here is what it says:
Given that it is the unanimous view of OECD Member States that the source basis taxation is not appropriate for services performed by a nonresident outside that State, it is unlikely that the country where services are performed will give up its right to tax and therefore such a provision is unlikely to serve as an effective model for bilateral agreements. While the UN Model reflects different interests than the OECD Model and different rules are therefore appropriate in some cases, it should be considered if deviating from a rule in the OECD Model that reflects unanimous agreement among OECD member countries will inevitably lead to conflicts in treaty negotiations. Doing so will likely encourage countries to take aggressive unilateral positions (in the absence of a treaty). The adoption of this rule on a unilateral basis will increase double taxation, reduce cross-border trade and increase costs for local consumers.
This is an argument that really goes to the heart of what the UN model is for. I think the ICC’s concern is that including an article sanctioning withholding taxes on technical fees in the model treaty will embolden developing countries to insist on the right to levy such taxes, and that this will make it harder for them to reach agreement with developed countries. That’s purpose 3.
An opposite argument, of course, would be that the UN committee, with members from OECD and non-OECD countries, should be in a good position to formulate an article that reconciles the concerns of OECD members and non-members. That’s purpose 2.
Following the ICC’s argument cited above, the model treaty’s job is not to provide a template that is to be used where countries do agree to include a particular provision. It is about circumscribing a definition of what is considered reasonable behaviour by a developing country. Keep it out of the model, they are saying, to discourage developing countries from doing it altogether.