Navigating the world of international taxation can be a daunting task, especially when it comes to dealing with double taxation. As individuals and businesses engage in cross-border activities, they often find themselves burdened with multiple tax liabilities, hindering economic growth and stifling opportunities.

However, there is a glimmer of hope in the form of the OECD Model Tax Treaty. This comprehensive framework provides a roadmap for countries to tackle the challenges of double taxation and foster fairness, transparency, and cooperation in the realm of taxation.

In this article, we aim to explain the provisions of the OECD Model Tax Treaty, breaking down its complexities into easily understandable terms. By doing so, we strive to empower readers with the knowledge and tools they need to navigate the intricate web of international taxation.

Whether you’re an individual seeking to invest abroad, a multinational corporation expanding its operations, a student preparing for tax exam, or simply someone curious about how double tax treaties work, this article will serve as your guide. We will unravel the key concepts, explain the crucial provisions, and shed light on the benefits that these treaties offer.

OECD Model tax treaty on income and capital – summary in simple words [All articles discussed]

Article 1: Persons covered

First article talks about the taxpayers covered, individual and company. Additionally, the types of taxes covered under the treaty. It states the purpose of the treaty, which is to avoid double taxation and prevent tax evasion in relation to the taxes covered.

Article 2: Taxes covered

Article 2 states that the Convention covers taxes on income and capital, including taxes on various types of income such as gains from the sale of property, wages or salaries, and taxes on capital appreciation.

Furthermore, the Convention applies not only to existing taxes at the time of its signature but also to any identical or substantially similar taxes that may be introduced in the future. This means that if a contracting state introduces a new tax that is similar to the taxes covered by the Convention, that new tax would also fall under the scope of the Convention.

Article 3: Definitions

Article 3 talks about the definition of different terms relevant to the treaty.

Person – includes an individual, a company and any other body of persons;
Company – means any body corporate or any entity that is treated as a body corporate for tax purposes;
Enterprise – applies to the carrying on of any business;
Enterprise of a Contracting State and Enterprise of the other Contracting State – mean respectively an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of the other Contracting State;
International traffic – refers to transportation by airplane or ship, except when the transportation is done only within a contracting state and the company operating the airplane or ship is not from that contracting state.
National – in relation to a Contracting State, means:
any individual possessing the nationality or citizenship of that Contracting State; and
any legal person, partnership or association deriving its status as such from the laws in force in that Contracting State;
Business – includes the performance of professional services and of other activities of an independent character.
Recognised pension fund – of a State means an entity or arrangement established in that State that is treated as a separate person under the taxation laws of that State and:
that is established and operated exclusively or almost exclusively to administer or provide retirement benefits and ancillary or incidental benefits to individuals and that is regulated as such by that State or one of its political subdivisions or local authorities; or
that is established and operated exclusively or almost exclusively to invest funds for the benefit of entities or arrangements referred to in subdivision.

If a country uses the Convention, any term not explained in it will have the meaning it has in that country’s tax laws. The tax laws of that country will be more important than any other laws in determining the meaning of the word. However, if the context or authorities decide, they can use a different meaning.

Article 4: Resident

A “resident of a Contracting State” refers to someone subject to tax in that state based on domicile, residence, place of management, or similar criteria according to its laws. It includes the state, political subdivisions, local authorities, and recognized pension funds. Excludes those with income only from within the state, liable to tax only on that income.
- In case of dual residency, the tie-breaker test considers:
  a) Permanent home availability (excluding rented)
  b) Closest personal and economic ties (center of vital interests).
  c) Habitual abode duration in each country.
  d) Nationality.
  e) Mutual agreement procedure (MAP) by competent authorities, if not reached to any conclusion.
Dual-resident companies seek agreement on tax residency based on factors like place of effective management (POEM) and establishment location. No relief if no agreement reached unless alternate arrangement exists.

Article 5: Permanent Establishment

Fixed place PE: This is a physical location, such as an office, factory, or warehouse, that is used by a foreign company to conduct its business activities in another country.

Agency PE: This arises when a foreign company operates through a dependent agent in another country who has the authority to conclude contracts on behalf of the foreign company.

Construction site PE: This type of PE arises when a foreign company undertakes construction activities in another country for a certain duration and level of business activity.

Service PE: This type of PE arises when a foreign company provides services in another country for a certain duration and level of business activity.

For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

The term “permanent establishment” includes especially:

a place of management;
a branch, an office, a factory; a workshop, and
a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.

A building site or construction or installation project constitutes a permanent establishment only if it lasts more than twelve months.

However, there are some exceptions where certain activities will not be considered a permanent establishment. These include:

Using facilities for storing, displaying, or delivering goods that belong to the company
Maintenance of goods for storage, display, or delivery
Maintenance of goods for processing by another company
Maintenance of a fixed place of business for the purpose of purchasing goods or collecting information
Maintenance of a fixed place of business for the combination of above activities.
These exceptions only apply if the activity is considered “preparatory or auxiliary/ support” to the company’s overall operations.

These exceptions only apply if the activity is considered “preparatory or auxiliary/ support” to the company’s overall operations.

4.1 if a company or a closely related company operates in the same place or another place in the same country, Paragraph 4 won’t apply to a fixed place of business if:

a) that place is already considered a permanent establishment under this Article, or

b) the activities of the two companies together aren’t just supporting activities and the overall activities of both companies at both places are not in preparatory or support in nature.

Agency PE- If a person represents a company in a country and regularly makes or helps to make contracts that are regularly made without changing much by the company, and these contracts are:

a) in the name of the company, or

b) for selling or leasing the company’s property, or

c) for the company’s services,

then the company will be considered to have a permanent establishment in that country, as long as the person’s activities are not limited to those mentioned in paragraph 4.

Paragraph 5 won’t apply if a person representing a company in one country does business as an independent agent in another country and acts for the company in the usual way. However, if a person works exclusively or almost exclusively for one or more closely related companies, they won’t be considered an independent agent under this paragraph for those companies.
If a company from one country controls or is controlled by a company from the other country or does business in the other country, this by itself won’t make either company a permanent establishment of the other company.
This paragraph explains what it means for a person or enterprise to be “closely related” to another enterprise. Two enterprises are considered closely related if they are controlled by the same people or entities or if one of them has more than 50% of the ownership or control of the other. Control means having the power to make important decisions about the enterprise. In other words, if one person or enterprise has a lot of power over another enterprise, they are considered closely related.

Article 6: Income from immovable property

If a resident of one Contracting State earns income from immovable property situated in the other Contracting State, that other State may tax that income.

The term “immovable property” means land and buildings, and also includes things like equipment used in agriculture and forestry, mineral deposits, and natural resources. It does not include ships and aircraft.

Article 7: Business profits

Business’s profits are taxed only in the country where they are earned. However, if the business has a fixed place of business in another country, the profits related to that place may be taxed there as well.

To determine the amount of profit attributable to the fixed place of business, it is treated as a separate entity and evaluated independently from other parts of the business. Factors such as functions, assets, and risks of the fixed place of business and other parts of the business are considered.

If a country taxes the profits from a fixed place of business located in another country, the other country should adjust the tax charged to avoid double taxation. The tax authorities of both countries should communicate and consult with each other if needed.

Article 8 – International Shipping and Air Transport

When an company from a specific country operates ships or aircraft in international traffic, the profits generated from these operations are taxable only in that country. This means that the country where the enterprise is based has the right to tax those profits.

Let’s say there is a shipping company based in Country A. This company operates several ships that transport goods and passengers internationally. The profits earned from the operation of these ships, such as freight charges and ticket sales, will be taxable only in Country A.

Article 9 – Associated Enterprises

Article 9 of the tax treaty deals with associated enterprises, which are businesses connected through management, control, or investment. It has two main provisions:

Transfer Pricing: If a business in one country influences the operations of a business in another country and they make special agreements that deviate from what independent businesses would agree upon, the profits that the second business would have earned can be taxed as if they had earned them. This ensures fair taxation based on the actual economic activities between associated enterprises.

Avoiding Double Taxation: If one country taxes profits that have already been taxed in the other country due to the special agreements between associated enterprises, the country that originally taxed the profits should adjust the tax charged to avoid double taxation. The tax authorities of both countries should consult with each other to reach a mutually agreed resolution.

Article 10 – Dividends

Dividends paid by a company resident in one country to a resident of the other country may be taxed in the recipient’s country. Article 10 gives resident country preferential taxing rights.

If the beneficial owner of the dividends is a resident of the other country, the tax on the dividends in the company’s country of residence shall not exceed:

5% of the gross dividends if the beneficial owner is a company holding at least 25% of the paying company’s capital.
15% of the gross dividends in all other cases.

“Dividends” is defined as income from shares or other corporate rights that participate in profits, subject to the same taxation treatment as income from shares in the company’s country of residence.

If the recipient of dividends is a permanent establishment (PE) in the country of the payer, taxation will be determined under Article 7 (business profits), and no relief will be provided under Article 10(2).

The second country cannot tax dividends paid by a company from another country, unless the recipient is a resident of the second country or the dividends are related to a business presence in the second country. The second country also cannot tax undistributed profits of the company, even if those profits were earned in the second country.

Article 11 – Interest

This article limits the taxation rights of the source state. The resident state has unlimited taxing rights on the interest.
The source state can tax the interest maximum rate of 10% where the recipient is the beneficial owner.
The term “interest” as used in this Article means income from debt-claims of every kind. Penalty charges for late payment shall not be regarded as interest for the purpose of this Article.
If the recipient of the interest has a PE in the other state then the other state may tax that interest at the normal income/ corporate tax rates.
When the person paying interest is a resident of a country, the interest is considered to have arisen in that country. However, if the person paying interest has a PE in a country, and the debt on which the interest is being paid is related to that PE, then the interest will be considered to have arisen in the country where the PE is located. In simpler terms, if the borrower is from one country, that country gets to tax the interest. But if the borrower has a Permanent Establishment (PE) in another country and the loan is related to that branch, then the country where the PE is located gets to tax the interest.
If there is a special relationship between the person paying interest and the person receiving it, and this relationship causes the interest amount to be higher than what would have been agreed upon under normal circumstances, then the tax provisions of this Article will only apply to the originally agreed amount. The excess amount of the interest payment will be subject to taxation according to the laws of each country involved, considering the other provisions of the tax treaty.

Article 12 – Royalties

Only the country where the Beneficial Owner of the royalty resides can tax the royalties.

“Royalties” refer to payments received for using or having the right to use copyrights, patents, trademarks, designs, secret formulas, or other intellectual property. If the Beneficial Owner has a Permanent Establishment (PE) in the country where the royalty comes from, that country can tax the royalty at regular income or corporate tax rates.

Royalty payments that are excessive due to a special relationship, considering the value of the “use, right, or information” for which they were paid, will not receive the benefits of this Article (meaning they may be subject to different tax treatment).

Article 13 – Capital gains

The country where immovable property is located has the right to tax the profits made from its sale.

The country where a Permanent Establishment (PE) is located can tax the gains from the sale of immovable property associated with that PE or the sale of the PE itself. If a foreign company sells a building through its branch office in Country B, Country B can tax the gains from the sale.

Gains derived by an enterprise operating ships or aircraft in international traffic from the sale of such assets are taxable only in the country where the enterprise is resident. For instance, if an airline company sells one of its aircraft, the country where the company is based has the right to tax the gains from the sale.

Gains from the sale of shares or comparable interests can be taxed in the other country if those shares derived more than 50% of their value directly or indirectly from immovable property located in that other country. For example, if you sell shares in a company that owns a shopping mall in Country C, Country C can tax the gains if more than half of the value of those shares comes from the mall.

Gains from the sale of any property not covered in the previous points will be taxable only in the country where the seller is a resident.

[ ARTICLE 14 – INDEPENDENT PERSONAL SERVICES ]

[This article has been removed by OECD and no longer applicable]

Article 15 – Income from employment

Generally, a person is only taxed on their employment income in the state of residence. Unless work is undertaken in the other state. In this case both states can tax.

A person is tax on employment income where the employment is exercised.
In case the employment income is exercised in another state, it may be taxed by the other state if he was physically present in other state for more than 183 days in 12-month period, he is employed through a resident employer of other state, or his remuneration is borne by a PE of other state.
Employment income from performing employment in ships and aircraft operating in international traffic, such income is taxed in the resident state of employee.

Article 16 – Director’s fees

The fees of a director resident in one state may be taxed in another state if they are derived from a company resident in that other state.

Article 17 – Entertainers and Sportspersons

Entertainers and sportspersons are taxed where their activities are performed. If a musician gives a concert in Country A, the income earned from that concert will be taxed in Country A.
If someone who is an entertainer or sportsperson earns money from their personal activities, but that money goes to someone else instead of them, the country where the entertainer or sportsperson did those activities can still tax that income. If a football player’s endorsement earnings are paid to their agent instead of directly to the player, the country where the player participated in those endorsement activities can still tax the income earned from those activities.

Article 18 – Pensions

Subject to the provisions of paragraph 2 of Article 19, pensions and other similar remuneration paid to a resident of a Contracting State in consideration of past employment shall be taxable only in that State.

Article 19 – Government Services

If an individual is paid for their work by a country, they will only have to pay taxes on that money in that specific country. But if they work in another country and are a resident there, they may have to pay taxes on that income in that other country if they are a citizen there or didn’t move there just to work.
If an individual gets money from a country, like a pension, they will only have to pay taxes on that money in the country that paid it. However, if they are both a resident and a citizen of another country, they may have to pay taxes on that income in that other country.
If an individual gets money for work related to a business owned by a country, the usual tax rules apply to that income, like for salaries, wages, and pensions. For example, A person is employed by a government-owned company in Country A. The income they earn from their employment will be subject to the regular tax rules for salaries and wages in Country A.

Article 20 – Students

If a student or business apprentice is living in a different country but goes to another country solely for the purpose of education or training, any money they receive to cover their living expenses, education, or training will not be taxed in that other country as long as the money comes from a source outside that country.

Article 21 – Other income

Items of income of a resident of a Contracting State, not covered in the other article will only be taxable in the resident’s state. Article 21 is also called dustbin article.
If the income (other than from immovable property) is effectively connected to a PE resident of other state, PE will be taxed under article 15 (normal individual/ corporate tax rates)

Article 22 – Capital

Capital represented by immovable property referred to in Article 6, owned by a resident of a Contracting State and situated in the other Contracting State, may be taxed in that other State. A person from Country A owns a rental property (immovable property) in Country B. Country B can tax the capital value of that property.
Capital represented by movable property forming part of the business property of a PE which an enterprise of a Contracting State has in the other Contracting State may be taxed in that other State. Company A, based in Country A, has a branch office (PE) in Country B. The movable assets (such as machinery or equipment) used by the branch office can be taxed in Country B.
Capital of an enterprise of a Contracting State that operates ships or aircraft in international traffic represented by such ships or aircraft, and by movable property pertaining to the operation of such ships or aircraft, shall be taxable only in that State. Airline Company X, based in Country A, operates international flights with its aircraft fleet. The capital value of the aircraft and movable assets used for airline operations will be taxed only in Country A.
All other elements of capital of a resident of a Contracting State shall be taxable only in that State. An individual from Country A has investments in stocks, bonds, and bank accounts. The capital gains or income generated from those investments will be taxed only in Country A.

Article 23 A – Exemption Method

This article provides relief by exemption as being the principal method for relief under tax treaty.

Under this article, if two countries have a tax agreement, a person earning money or owning assets in one country may be subject to taxes in that country. However, the person’s home country generally exempts that income or assets from taxation as long as the rules in the agreement are followed.

In a specific scenario where a person earns taxable income in one country and can be taxed in another country, their home country allows them to deduct the taxes paid in the other country from their own tax liability. The deduction is limited to the amount of tax they would have paid on that income in their home country.

In another specific situation, if a person in one country has income or assets exempted from taxes based on the tax agreement, that country still considers the exempted income or assets when calculating taxes on the rest of the person’s income or assets. This is known as “exemption with progression.”

It’s important to note that the exemption rule mentioned in the first paragraph does not apply if the second country also exempts the person’s income or assets from taxes under the agreement or applies the deduction rule mentioned in the second paragraph to that income.

For example, Let’s say John, a resident of Country A, works in Country B, which has a tax treaty with Country A. Based on the treaty, Country B taxes John’s income. However, Country A exempts that income from taxation. Country A still takes into account John’s tax-exempt income when determining the tax rate applicable to his remaining income in Country A.

Article 23 B – Credit Method

Article 23 B – Credit Method is a provision that helps individuals who earn income or own property in one country but reside in another country to avoid double taxation. Here’s a simple explanation with examples:

Let’s say Alex lives in Country A but earns income from a business he owns in Country B. Both countries have their own tax laws, and without any agreement, Alex would be liable to pay taxes in both countries on his business income. This would result in double taxation, which is generally considered unfair.

However, if Country A and Country B have a Convention or agreement in place, Article 23 B allows Alex to take advantage of the credit method. Under this method, John can deduct the amount of tax he paid in Country B from the tax he owes in Country A.

For instance, if Alex paid $10,000 in taxes to Country B on his business income, he can subtract this amount from the tax he owes in Country A. If his tax liability in Country A is $15,000, he would only need to pay the remaining $5,000 after applying the credit for taxes paid in Country B.

SPECIAL PROVISIONS

Article 24 – Non-Discrimination

Nationals of one state should not face a tax liability or requirement more burdensome than nationals of the other state;
Stateless persons, resident in one state, should not face tax burdens any worse than nationals in each state;
A PE shall not be taxed in a less favorable manner than an enterprise based in the same state;
Payments of interest, royalties and other disbursements deductible in one contracting state when paid to residents of that state are equally deductible if paid to residents of the other contracting state;
Enterprises of one state, owned or partly owned by residents of the other state, should not face greater burdens than enterprises owned by residents of the former state;
The non-discrimination article applies to taxes of every kind and description (ie in addition to those specifically stated in the treaty).

The discriminatory treatment must relate to taxpayers both of whom are resident. The overall principle is to avoid a ‘disguised form of discrimination based on nationality’. Difficulties arise in selecting the correct comparator.

TRIANGULAR SITUATIONS

Arise where a state A company has a PE in state B earning income in state C. The B-C treaty cannot be used to deal with double taxation where state C taxes the income at source and state B taxes the income as part of the PE, as a PE cannot claim treaty benefits.

Whether treaty relief can be claimed in state B for state C withholding taxes will depend on the non-discrimination article of the A-B treaty, and the company in state A making a claim for equal treatment of its PE in state B.

Explanation

“Triangular situations” occur when a company in one country (A) has a branch in another country (B) that earns income in a third country (C), which can result in double taxation. If state C taxes the income at source and state B taxes the same income as part of the PE, a PE cannot claim treaty benefits. However, the company in state A can claim treaty relief in state B for the withholding taxes imposed by state C, depending on whether the A-B treaty has a non-discrimination provision and if the company can make a claim for equal treatment of its PE in state B.

Article 25 – Mutual Agreement Procedure

The Mutual Agreement Procedure is a way for a person to challenge unfair taxation by presenting their case to the competent authority of either country, regardless of the remedies provided by domestic laws. If the competent authority cannot resolve the case by themselves, they will try to reach an agreement with the competent authority of the other country.

If they cannot come to an agreement within three years, the case may be submitted to arbitration. If the arbitration decision is accepted, it will be binding on both countries and will be implemented regardless of time limits set by domestic laws. The competent authorities of the countries will decide how to apply this procedure.

Article 26 Exchange of Information

This article discusses how countries agree to share information with each other to make sure their tax laws are being followed. The exchanged information should be relevant to the provisions of the agreement and must be kept secret and only used for tax-related purposes. The exchange of information is not limited by certain rules.

However, a country is not obligated to supply information that goes against its laws, is impossible to obtain, or would reveal confidential information. If a country requests information, the other country should try to obtain it, even if they don’t need it themselves.

A country cannot refuse to supply information just because it involves banks, financial institutions, or other organizations.

Article 27 – Assistance in the collection of taxes

This passage explains how different countries agree to help each other collect taxes. This assistance is not limited by certain rules. The term “revenue claim” refers to any taxes, penalties, interest, or costs owed to a country or its subdivisions.

If a revenue claim is owed by someone who cannot prevent its collection, the country with the claim can request that the other country help collect it. If a revenue claim can be conserved, the country with the claim can ask the other country to help take conservation measures.

However, the other country is not obligated to carry out measures that go against its laws or policies, would be against public policy, or would create an unreasonable administrative burden.

Proceedings related to a revenue claim cannot be brought before the courts or administrative bodies of the other country. If a revenue claim is no longer enforceable, the country that made the request must notify the other country and can choose to suspend or withdraw the request.

Article 28 – Members of diplomatic missions and consular posts

Nothing in this Convention shall affect the fiscal privileges of members of diplomatic missions or consular posts under the general rules of international law or under the provisions of special agreements.

ARTICLE 29 ENTITLEMENT TO BENEFITS

This article talks about how certain benefits from the Convention on double taxation between countries will be restricted to “qualified persons.“

These qualified persons can be individuals, certain companies or organizations that meet specific criteria, and certain collective investment vehicles.

However, certain income derived from active business activities or certain ownership structures may still qualify for benefits even if the person or entity is not a qualified person. The competent authority of a Contracting State may also grant benefits in certain circumstances. The Convention also includes provisions to prevent abuse of the benefits by those who try to obtain them through arrangements or transactions that were not intended by the Convention.

Article 30 – Territorial Extension

This article states that the Convention can be extended to other States or territories with modifications if they have similar taxes. The extension will be agreed through diplomatic channels or other procedures. If one of the Contracting States terminates the Convention, the extension to other States or territories will also be terminated. The words between brackets are only relevant if part of a State is excluded from the Convention’s application.

Article 31 – Entry into Force

1. This Convention shall be ratified, and the instruments of ratification shall be exchanged at as soon as possible.

2. The Convention shall enter into force upon the exchange of instruments of ratification and its provisions shall have effect:

a) (in State A): …………………………………

b) (in State B): …………………………………

Article 32 – Termination

This Convention shall remain in force until terminated by a Contracting State. Either Contracting State may terminate the Convention, through diplomatic channels, by giving notice of termination at least six months before the end of any calendar year after the year In such event, the Convention shall cease to have effect:

a) (in State A): …………………………………..

b) (in State B): …………………………………..

Final words on OECD Model tax treaty and its implications

Understanding the provisions of the OECD Model Tax Treaty is essential in navigating the world of international taxation. By simplifying its complexities, we aim to empower individuals and businesses to make informed decisions and embrace cross-border opportunities.

The treaty’s provisions promote fairness, transparency, and cooperation among countries, ensuring that double taxation does not hinder economic growth. It establishes clear rules for tax allocation and offers mechanisms to eliminate double taxation, fostering certainty and predictability for taxpayers.

As our global economy becomes increasingly interconnected, grasping the fundamentals of double tax treaties becomes vital. By breaking down the treaty’s language and concepts, we make it accessible to all, regardless of their tax expertise.

Simplest Guide to the OECD Model Tax Treaty [32 articles discussed]