International Double Taxation: Update of OECD Documents

With the aim of stimulating transnational trade and investment, since the early 1900s countries have been working through tax treaties to mitigate double taxation issues. The starting point of a tax treaty is the dilemma which arises where the same income or capital is subject to tax in the taxpayer’s state of residence and also in the state from which the income derives. Thus, tax treaties generally restrict the application of the internal tax law of a treaty state both when this state acts as the source state and in its function as residence state. Countries general agree to reduce source-based taxation to the extent the other country will do the same for its nationals or residents.

Most tax treaties worldwide are based on the Organisation for Economic Co-operation and Development’s Model Convention, which is generally used by both OECD member countries and non-member countries as the basis for the negotiation, application and interpretation of their bilateral tax treaties.

This Model Convention has been subject to several updates. To date, there have been updates in 1992, 1994, 1995, 1997, 2000, 2003, 2005, 2008 and, most recently, in 2010.

This year, the Organisation for Economic Co-operation and Development’s Council also approved the 2010 versions of its Transfer Pricing Guidelines and its Report on the Attribution of Profits to Permanent Establishments.

The most important changes of the 2010 update of the Model Convention include:

(i) the substitution of Article 7 (“Business Profits”) and its commentary, for a revised approach of attribution of profits to a permanent establishment;
(ii) new text relating to the granting of the benefits of tax treaties with respect to the income of collective investment vehicles;
(iii) the application of tax treaties to state-owned entities (including sovereign wealth funds);
(iv) tax treaty issues related to common telecommunication transactions;
(v) the application of Article 15 (“Income from Employment”) to employees who work for a short period in a foreign country.

The update also includes changes made by a number of members and non-members to their observations, reservations or positions on the Model Convention.

The 2010 revision to the Transfer Pricing Guidelines is the first major revision to this document since the Guidelines were first released in 1995. It includes:

(i) more detailed guidance on how to perform comparability analyses in practice in order to compare the conditions of transactions between associated enterprises with those transactions between independent enterprises:
(ii) new guidance on how to select the most appropriate transfer pricing method to the circumstances of the case and on how to apply in practice two of the OECD-approved transfer pricing methods, referred to as “transactional profit methods”, namely the transactional net margin method and the transactional profit split method;
(iii) a new chapter providing detailed guidance on the transfer pricing aspects of business restructurings.

Finally, the updated version of the Report on the Attribution of Profits to Permanent Establishments does not change the conclusions of the previous version, but simply deletes obsolete cross-references and aligns the Report’s wording with the text of the new Article 7 of the Model Convention and the revised Transfer Pricing Guidelines.