Leiden Law Blog

Source state taxation in model tax treaties

Source state taxation in model tax treaties UN Photo/Sophia Paris

During the Seventh Meeting of the United Nations Committee of Experts on International Cooperation in Tax Matters in October 2011 in Geneva, the 2011 update of the UN Model Double Taxation Convention between Developed and Developing Countries (UN Model) has been approved. This UN Model, together with the UN Manual for the Negotiation of Bilateral Tax Treaties between Developed and Developing Countries and the currently prepared UN Transfer Pricing Manual for Developing Countries, form the basic documents for developing countries to assist in their needs when negotiating and concluding tax treaties with other countries.

The OECD Member States also have agreed on a model tax treaty. However, since the OECD Model is drafted by industrialised countries, this OECD Model is not considered to be the relevant model tax treaty for developing countries.

The main difference between the UN Model and the OECD Model is a variance in the applicability of the principle of source state taxation. As the OECD is an international organisation of industrialised countries, so is the OECD Model a model tax treaty between these industrialised countries which have more or less the same (high) economic standards. In contrast, the UN Model is explicitly meant, reference is made to its full title, to provide guidance to developing countries. The fiscal knowledge of the governments of developing countries cannot be compared to the (academic) knowledge and level of education in the industrialised countries.  

In general, in the OECD Model the source state may tax the business profits derived from activities within the source state. The state in which the company is tax resident is, by means of the specific tax treaty, not allowed to tax those profits, although this resident state would tax the profits based on its domestic legislation. By means of the tax treaty, double taxation is avoided.

The UN Model provides for a larger portion of source state taxation. This means that more profits derived from activities in the source state can be taxed by that source state. In a tax treaty which is based on the UN Model the source state is in principle the developing country. Consequently, the developing country can tax a larger portion of the profits and thus earns a relatively large portion for its national budget.

I believe that the conceptual difference in applying the principle of source state taxation between the UN Model and OECD Model is necessary. As long as economical differences exist between developed and developing countries, this should be expressed in tax treaties. Periodical reviews and further development of the application of the source state taxation principle in tax treaties should improve the interpretation, application and implementation in tax treaties by developing countries. Both from an academic as well as a practical perspective.

2 Comments

Lodewijk Wisse
Posted by Lodewijk Wisse on June 4, 2012 at 10:33

Dear Robert,

Thank you for your question.

The UN Model has been and is still used commonly as basis for developing countries in their tax treaty policy (if applicable) and the corresponding negotiations. If you want to read more about the impact of the UN and OECD Models on specific tax treaties, I can recommend the following book, which is just recently published:

M. Lang, et al., The Impact of the OECD and UN Model Conventions on Bilateral Tax Treaties, Cambridge University Press: Cambridge 2012.

This book includes national reports of 37 countries from five continents, including both developed and developing countries.

Best regards,

Lodewijk

Robert van Asten
Posted by Robert van Asten on June 1, 2012 at 12:07

Dear Lodewijk,

Interesting article. Do you know whether this treaty has already been used to serve as model for a tax treaty between a developed and undeveloped country?

KR.

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