The issue of jurisdictional double taxation and other fiscal questions of the same technical nature led to the formation of the Organization for Economic Co-operation and Development (OECD). OECD was formerly known as the Organization for European Economic Cooperation (OEEC). Double taxation presented obstacles to international trade relations and foreign investments. Double taxation posed a degree of uncertainty both on the part of persons (both individuals and body corporates) and the government in which a business enterprise, engaging in cross-border activities, operates. Unilateral measures for the avoidance of double taxation proved incapable and inconsistent, hence the formation of the convention (Saunders, 2001). The OECD model is not a tax treaty; it merely provides a basis for negotiations of treaties between states. For example, the United Nations treaty, the US and Netherlands models used the OECD model as a basis. The OECD model is not limited to OECD members; non-OECD countries can also use the model in negotiations. The OECD convention applied to persons who were residents of one or both states on the issues of treatment of body corporates, partnerships, individuals and other non-corporate organizations.
For the OECD convention, definitions of terms such as ”person”, ”company” were necessary. Article 3 of the convention defined the term company as anybody of persons or organization that is treated as a body corporate for tax, while the term person includes any individual, a company and other body corporates. Article 4 defines a resident of a state as “any person who, under the laws of that state, is liable to tax therein because of domicile, residence and place of management” (Hoor, 2010 p.14). However, this definition left out persons liable to tax in that state in respect of returns from investments.
OECD members are free to differ from OECD observations by entering a reservation; non-members may also enter statements of positions in respect to OECD articles. For example, Denmark reserves the right to consider the selling price from shares as dividends and tax accordingly. Under the OECD commentary, for purposes of taxation with regard to partnerships, states that impose a tax on partners based on the shares of partnership profit, regard the partnership as not to be liable to tax and thus a non-resident. The partners are, in such a case, the persons liable to tax and can as such enjoy the benefits of the convention as agreed by the states of which they are residents. This will be so even if, the laws of the state of source regard a partnership as taxable (Rinaldi, 2011). In the U.S. model, a limited liability company is treated as a partnership. The treatment of a limited liability company under the model depends on the treaty and the other state’s tax laws.
Under the convention, the phrase ‘liable to tax’ does not necessarily mean that a person must pay tax in the contracting state. Persons who meet the specified requirements in the tax laws are exempted from tax. Therefore, a person does not have to pay tax to be ‘’liable to tax’’. Article 4 of the OECD convention states that the term ‘liable to tax’ should have the following meaning: a ‘full liability to tax’ or ‘comprehensive liability to tax’ Article 10 of the OECD model examines the term ‘liable to tax’. According to the article, a person’s worldwide income is to be taxed depending on the person’s residence. In article 4 of the OECD convention, a person is not a ‘resident of a contracting state if for treaty purposes he is liable to tax in that state in respect only of income from sources. Liability to tax also requires a person to be actually liable to tax on his income. In a commentary on Article 4 of the convention, a person’s comprehensive liability to tax acts as a decisive factor as to the person’s residence (Rinaldi, 2011).
On 31st July 973, the Republic of Kenya and the Government of the United Kingdom of Great Britain and Northern Ireland agreed for the avoidance of double taxation in respect to income tax and capital gain tax. The taxes involved in this treaty included: the income tax, the corporation tax and the capital gains tax in the U.K., the income tax and graduated personal tax in Kenya. In this treaty persons liable to tax which focuses on the term resident were to a great extent reviewed in both nations.
The treaty encompassed the following on the U.K. A resident of the U.K., who receives dividends from a company resident in Kenya, may be taxed in the U.K. The Kenyan government may also levy tax, not exceeding 15% of the dividends, on such dividends. This holds only if the recipient is subject to tax in the U.K. and owns less than 10% of the class of shares in respect to such dividends. Management fees received by a resident of the U.K. may be taxed in both countries. Pensions may be taxed in both countries. Students from Kenya are exempt from U.K. tax on receipts from outside the U.K. intended for their upkeep and education and on salaries from employment in the U.K. which is necessary for their upkeep for a period of less than three consecutive years. A visiting teacher in the U.K. shall be exempted from tax in respect of remuneration from teaching for a period of fewer than two years.
The treaty encompassed the following on Kenya. A Kenyan resident receiving dividends from a company that is a resident of the U.K. shall be entitled to a tax credit to the amount in which a U.K. resident would have been taxed had he received such dividends. This holds only if the recipient is subject to tax in Kenya and owns less than 10% of the class of shares in respect to such dividends. The Kenyan tax on royalties and interest shall not be more than 15% of the aggregate only if the recipient is subject to tax in the U.K. on the same income. Tax on management fees arising from Kenya is limited to 12% of the gross fees. Kenyan tax on pensions is limited to the lower of 5% of the pension or the amount taxed in the U.K. on pension (The Kenya Gazette Supplement No. 63, 1977).
Canada partners with the United States in the U.S. treaty (Canada-United States Income Tax Convention). In TD Securities Limited Liability Company (TDLLC) vs. the Queen, the Canadian tax court held that the Limited Liability Company (LLC) was a resident of the U.S. for the purposes of the convention. The interpretation of the phrase liable to tax contemplates treaty residence.
TDLLC (the U.S. solely owned entity) was a registered broker-dealer that conducted business in both countries through permanent establishments. As a non-resident taxpayer in Canada, it was subject to branch tax under the Federal Income Tax Act. The issue was its reduction claim in the branch tax rate from the act’s rate of 25% to the treaty rate of 5. The CRA’s position was that concerning its fiscal transparency for U.S tax purposes, TDLCC was not liable to tax under U.S. laws as established in the treaty. On the other hand, TDLCC’s position was that it was a resident of the U.S. for purposes of the treaty and that it was entitled to benefit from the treaty as such; on the basis that its only member was, U.S. tax purposes, taxable.
The court ruled in favour of the plaintiff, it decided that TDLLC was a resident of the United States thus entitled to the branch tax rate reduction. In regards to the OECD model revisions of 2003, where its commentaries concluded, on treaties created on basis of the OECD convention that treaty benefits should be provided to the extent that an LLC’s income is taxable on its partners under the laws of a treaty country. The court took an opposite approach describing the OECD’s approach as a diplomatic ambiguity (Sheppard, 2011).
There are numerous case laws on the term ‘liable to tax’ within the meaning of the OECD convention-based treaties. For example, the ruling by Sweden’s Supreme Administrative Court of 1996, the ruling by Finland’s Supreme Administrative Court and the rulings by the Paris Administrative Court of Appeal (Connery et al., 2010).
References
Connery, J. Poms, D. Blasdel, J. (2010). Eligibility for Treaty Benefits Under the 2009 Protocol to the France-U.S. Income Tax Treaty.
Hoor, O. R. (2010). The OECD Model Tax Convention: A Comprehensive Technical Analysis. Legitech, 17-56.
Kenya Gazette Supplement No. 63 (1977). The Income Tax Act (cap 470): Legislative Supplement No. 48.
Rinaldi, M. J. (2011). Tax Transparent Entities. San Diego, CA: Thomas Jefferson School of Law.
Saunders, R. (2001). Understanding Double Tax Treaties. London: International Fiscal Services Ltd.
Sheppard, L. A. (2011). Tax Analysis: Can Courts Resolve Treaty Ambiguities? 571-580.