UNCTAD report on DTTs: Tapping On The Line

Blog post only

Last month, UNCTAD released a guide for policy makers on the tax policy questions involved in decisions to conclude and negotiate a double tax treaty (DTT). Like other UNCTAD publications, it is well written and balanced, though this one is a little more high level than some of the other deep dives (https://taxleonard.wordpress.com/2023/02/08/tax-incentives-and-the-global-minimum-corporate-tax/).

In the executive summary, the report addresses the key trade off in DTT negotiation. A DTT stimulates cross border investment, cooperation and integration by taking away or limiting the risk of double taxation. It does so by countries agreeing to limit their taxing rights. At various points, policy makers will need to decide whether they favour an approach that protects their taxing rights, but that risks undermining the benefits of having a DTT.

The UNCTAD report puts this dilemma in relatively blunt terms when discussing permanent establishments (PEs): “When deciding on the scope of the definition of permanent establishment it is important to keep in mind that the broader the criteria (i.e. the easier it is to trigger the permanent establishment threshold), the more foreign investors will be affected, including smaller ones. Hence, while the broadest possible definition may be appealing from a tax revenue perspective, it must be balanced against its investment implications. Certain types of business activities may not take place in a jurisdiction if they trigger a permanent establishment and the concomitant compliance cost outweigh the business rationale.”

I would add to that that even the risk of triggering a PE would often be enough to stop business activities from happening. We see this in remote work, which employers generally don’t allow in cross border settings for this precise reason (which is why suggestions to just always trigger a PE for remote workers may end discussion, but also may end many forms of remote work: https://www.taxnotes.com/tax-notes-international/permanent-establishment/remote-work-permanent-establishments-new-solution-new-normal/2023/07/03/7gx2f).

The same principles apply on a host of other topics, such as excluding taxes from the DTT scope, dual residency tie breakers, withholding tax on service fees, anti-abuse provisions. Every tax authority friendly provision creates risks for taxpayers, who may decide not to invest. If a country always gives into their natural tendency to protect the tax base, the logically best result is to not conclude a DTT at all. If a country always favours investment protection, it can fence itself in. So they have to continuously toe the line.

UNCTAD only touches the surface on most topics. This key point is often not brought out. At some points, it risks simply parroting familiar lines from the BEPS report and I would have preferred a more critical discussion of different views, even if it would increase the number of pages of this report. The result of DTT mechanics is that tax policy makers take different decisions on each point, which leads to an incomplete patchwork of DTTs, creating tax cliff edge effects and incentives for DTT shopping (as discussed before: https://taxleonard.wordpress.com/2023/04/29/do-tax-treaties-distort-rather-than-support-international-trade/  https://taxleonard.wordpress.com/2023/01/09/bassline/ Treaty – Leonard’s Tax Posts (wordpress.com) https://taxleonard.wordpress.com/2023/01/09/treaty/). Cross border investment would benefit best from the certainty and reliability of a consistent framework and best practice may ultimately create convergence. Model Tax Conventions – like the OECD and the UN ones –  could help bring about that convergence, but countries also want to avoid adopting a straight line. So instead, they gently tap on the line (https://open.spotify.com/track/5lgX8i6mlCOoy3lN2BKQHD?si=97eef98c25024102) and sometimes step out.

Obvious disclaimers: this is not advice. These views are my own and do not necessarily represent my employer.