Last 18 May 2018 United Nations released the long-awaited 2017 update to the Model Double Taxation Convention between Developed and Developing Countries, during a UN Economic and Social Council meeting in New York.
The new treaty and commentary update the UN’s 2011 model tax treaty, reflecting changes approved in April 2017 by the UN Committee of Experts on International Cooperation in Tax Matters. That being said, it is now feasible to make a comparison between the article 5 of the OECD Model Convention, deeply shaped by the well-known BEPS project (i.e. Base Erosion and Profit Shifting plan), and the new definition of permanent establishment (PE) outlined by UN committee of experts’ work.
First of all, it is important to highlight that under most tax treaties, business profits derived by an enterprise are taxable exclusively by the State of residence unless the enterprise carries on business in the other State (i.e., the source State) through a permanent establishment (PE) situated therein. This international tax law’s cornerstone is called the “nexus” rule (e.g., Articles 7 of the OECD and United Nations (UN) Model Tax Conventions), as it identifies the profits that are taxable by a country by reference to their relationship to a PE.
On a further level of analysis, the nexus rule underpinned by a PE presence is based on the “origin of wealth”, which is a principle enunciated by a group of economists in a 1923 report, mandated by the League of Nations. In essence, the mentioned report rejected the argument that income should generally be taxed exclusively in the State of residence, and contended that taxation should be founded on a doctrine of economic allegiance: “whose purpose was to weigh the various contributions made by different states to the production and enjoyment of income”. Therefore, the determination of the jurisdiction with taxing rights depends on a nexus rule that aims at the substance of a business activity and attributes the primary right to tax to the Country in which this income-producing activity physically takes place. Ultimately, this mechanism has specific exceptions where separate distributive rules apply (e.g., Articles 6, 10, 11, 12, 13, or 17 of the OECD and UN Model Tax Convention).
The concept of permanent establishment is found in the early model conventions including the 1928 model conventions of the League of Nations. The new UN Model, as well as OECD Model post-BEPS, reaffirms the concept but overhauls the definition for the sake of making PE status consistent with the dramatic changes of modern economy, beginning from the digitalization of traditional business model (in this regard, see the recent OECD interim report concerning Tax Challenges Arising from Digitalization).
Since the mandate of the UN subcommittee included taking into account OECD Model developments, article 5 of the United Nations Model Convention is largely based on Article 5 of the OECD Model Tax Convention, however it contains a number of significant differences, which are made more apparent by the new wording. Chiefly, it is possible to lay down at least the following hallmarks of the UN Model:
The UN Model indicates that such an agent devoting all or nearly all their time to a particular client and not dealing with the client on an arm’s length basis is not treated as having the necessary independence (paragraph 7). It is highly significant to stress the fact that the revised UN version makes clear that in order to automatically consider an agent as not being of “an independent status”, the essential criterion is the absence of the arm’s length relationship, irrespective of the effective number of enterprises the independent agent acts for. This formula is slightly different from the OECD Model Convention, where a person is deemed to be a PE if it acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related (see art. 5, par. 6 OECD Model).
In conclusion, further relevant differences between the two tax Model conventions in question, are included in the Commentary on Article 5, which represents a combination of the 2014 and 2017 OECD commentary. As a result, several aspects of the 2017 OECD commentary are not transposed in its UN “pendant”, in particular with regard to the shaping of the so-called basic rule, as per art. 5 par. 1.
In this regard, an example is the OECD Model’s provision that underlines the importance a flexible approach when it comes to evaluate if a business model constitutes a PE. On that point, the OECD commentary affirms that “the facts and arrangements applicable at one point in time may no longer be relevant after a change in the way that the business activities are carried on in a given State” (see par. 8).
Furthermore, UN Commentary lacks the discussion of whether an employee’s home office can be an Article 5(1) permanent establishment of the employer that should not lead to the automatic conclusion that that location is “at the disposal” of that enterprise simply because an individual who works for the enterprise (par. 18 of OECD Commentary) uses that location. Besides, the new “principles” for the “at the disposal” test are absent in the UN Model Convention.
In conclusion, the new version of UN Model Convention adds new differences to old ones in comparison to its OECD’s yardstick. Just like two fraternal twins that, as time goes by, exacerbate their own characteristics but keep sharing the same blood.Back to Articles Back to Lorenzo Savastano
The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.
Lorenzo Savastano is an Italian police officer belonging to Guardia di Finanza, a highly specialised military Corps committed in fighting economic and financial crimes, both on national and international level. He obtained two master’s degrees with honors, respectively in Law and in Economic and Financial Security. In addition, he attended several courses of advanced studies in International and Corporate Tax Law as well as in Tax crimes investigations. As aggressive tax planning and financial law enforcement specialist, he currently deals with corporate illicit activities and white collar crimes investigation.
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