This article first appeared in the November 10, 2014 edition of Worldwide Tax Daily
Tax practitioners and observers focused on the OECD's base erosion and profit-shifting project may be ignoring the United Nations' work at their own peril. The BEPS project may just be a passing fad, but the U.N. is quietly engaged in a much more radical experimental rewrite of fundamental international tax rules with little input from stakeholders.
The U.N tax committee has few resources. Stakeholders could assist the U.N. and ensure their input into the process by offering funding and resources in support of this work.
The U.N. Agenda
At its 10th meeting, the U.N. Committee of Experts on International Cooperation in Tax Matters considered an agenda that could result in significant changes to international tax rules. Topics under consideration included changes to the U.N. model treaty, among them:
- a proposal for a new article on fees for technical services;
- new commentary on transfer pricing;
- amendments to the double taxation article;
- revisions to address payments made to fiscally transparent entities; and
- revised commentary to the articles on permanent establishment and transportation.
By far the most controversial of these was the proposed new article on furnishing of technical services. This article is intended to tilt the allocation of global taxing rights towards source, or developing countries.
What Is the Committee?
The U.N. tax experts committee is a subsidiary body of the Economic and Social Council. It lacks the status of an intergovernmental agency, its budget is skeletal, and it has only three individuals employed by the secretariat at U.N. headquarters in New York. Its 25 members are government officials nominated by their governments, but they serve in their individual capacities.
Although the committee receives little funding from the U.N., its work is perceived as having increasingly greater importance within the organization. The U.N. program for sustainable development encompasses a number of different goals, but an important one is that economic growth in developing countries should be propelled less by direct aid and more by their own efforts to generate revenue.
Unlike with OECD tax reports, decision-making in the U.N. committee is not by consensus. What that means in practice is that the committee may decide to adopt language in the U.N. model treaty even if a significant minority of the group is in opposition. The committee represents only a small group of U.N. member countries. Although it is supposed to ensure adequate consideration of developing countries, in practice it is the voices of the participating developing countries that have the most input into the process.
What Does It Do?
The committee's work is focused on the U.N. model tax treaty, which is intended to serve as an alternative to the OECD model treaty. Its provisions have historically been considered more favorable to developing countries because they provide for greater taxing rights for source countries, rather than residence countries. However, the basis for that belief has not been clearly shown.
The U.N. model treaty was last revised in 2011. The committee is working on the next revision, expected in 2017.
In 2013 the committee published the U.N. transfer pricing manual. This manual is not intended to lay out an alternative to the arm's-length principle. Instead, it is intended to provide practical guidance in applying the arm's-length standard of transfer pricing rules for developing countries. Despite the lip service paid to arm's-length transfer pricing, the manual includes appendices describing experiences in implementation from several countries, including Brazil.
The committee trains tax administrators in developing countries. In 2014 it hosted a training workshop for government tax administrators in Panama. It also hires consultants to develop practical training materials in treaties and transfer pricing. They have been translated into Spanish, but not French.
The lack of funding affects the tax committee's ability to make progress in all of these areas, including being able to translate its training materials into the primary language used in much of Africa. It also limits the members' ability to meet regularly.
The committee often welcomes the participation of non-committee members on its subcommittees, at the discretion of their coordinators.
The tax committee has proposed adding a new article to the model treaty providing for taxation at source of fees paid for the provision of technical services. The title of the article is a misnomer; the article should be understood as intended to provide for a source state tax on a wide range of services. The article is drafted very broadly and is intended to include payments not just for technical services, but also for management and consulting services. The examples in the commentary do little to narrow this definition of services.
The article would apply to any fees paid by a resident of the source country state, regardless of where the services are performed. As an example in the commentary explains, if a resident of Dubai travels to the United States and receives services encompassed by the treaty definition of services of a technical, managerial, or consultancy nature (surgery, for example), Dubai would acquire a taxing right over the fee paid to the surgeon for performing the operation and could require the patient to withhold tax on it.
That expansion of a withholding tax to payments made for services performed outside the country imposing the tax would constitute a radical change in the global tax system. The enormous complexity of a regime requiring reporting and collection on payments for transactions does not appear to have been considered; potential impact on cross-border trade also has not received attention. At the most recent meeting of the committee, some of these concerns were raised in a debate over the proposed article, but they were largely dismissed as counterproductive to the mandate for the new article, which was to provide greater taxing rights to source countries.
Seemingly ignored was that a withholding tax on services payments could be reciprocal. In today's world, many payments for services are made by developed countries to developing countries. It has not been determined whether a developing country's revenue base would suffer if a reciprocal withholding tax on services, broadly defined, were imposed. The issue is largely moot right now because most developed countries' domestic law would not impose a withholding tax on fees for services performed outside the country (for example, if a U.S. person travels to Singapore for an operation, the U.S. resident's payment to the surgeon is not subject to U.S. tax under the code). Some countries, however, have a law providing that if a specific treaty provides a taxing right, domestic law automatically incorporates such a provision regarding transactions involving that treaty partner.
Would developed countries be prepared to accept a one-sided provision of the type envisioned by protectors of taxing rights for developing countries? If the United States enacted a withholding tax on services payments made by residents, it might provide the revenue necessary to lower the corporate rate.
Despite the significant reservations among some committee members to the proposed article, the committee voted to adopt it largely as proposed. Reservations will be noted in the commentary, including in the form of proposed alternative language.
Any provision in a model treaty requires a bilateral negotiation between the two treaty partners and ratification before it is incorporated into any functioning treaty. How this proposed article may fare during those negotiations is unclear. But what emerged from the debate is that the proposed article is considered important less for its ability to bring more revenue to developing countries (because its net benefit hasn't been analyzed), but instead as a policy statement, articulating the committee's position that source country withholding rights should be dramatically expanded.
The most significant revision to the U.N. model treaty commentary on the transfer pricing article is a reference to the U.N. transfer pricing manual. As proposed to the committee, new paragraph 4 of a revised commentary to article 9 would have provided in part:
The Committee considers that [the OECD transfer pricing] guidelines contain valuable guidance relevant for the application of the arm's length principle under Article 9 of bilateral tax conventions following the two Models. The Committee also considers it to be highly important for avoiding international double taxation of corporate profits that a common understanding prevails on how the arm's length principle should be applied, and that the two Model Conventions provide a common framework for preventing and resolving transfer pricing disputes where they would occur. With that aim in mind the Committee has developed the United Nations Practical Manual on Transfer Pricing for Developing Countries which pays special attention to the experience of developing countries, reflects the realities for such countries, at their relevant stages of capacity development, and seeks broad consistency with the guidance provided by the OECD Transfer Pricing Guidelines. [Emphasis added.]
The United States Council for International Business (USCIB) criticized the commentary's apparent departure from use of the manual as a practical tool. The USCIB pointed out the lack of stakeholder input in developing the transfer pricing manual, stating that "the rationale that the Manual was only intended to provide practical guidance and not a second source of authoritative guidance was the principal reason given that it was not necessary to have an inclusive process in developing the Manual." The council opposed the proposed language in paragraph 4 referring to the U.N.'s transfer pricing manual because, it said, it sought a "broad consistency" with the OECD transfer pricing guidelines and a "broad consistency is not necessarily consistent at all."
The tax committee later agreed to delete the reference to broad consistency and simply refer to the fact that it was intended that the U.N. transfer pricing manual be consistent with the OECD guidelines. However, the larger point raised by the USCIB letter remains: The U.N. manual does not look exclusively to OECD arm's-length standard principles in describing practical application of transfer pricing rules.
A large part of the BEPS agenda is about eliminating double nontaxation, and paragraph 4 of article 23A of the OECD model treaty (methods for eliminating double taxation -- exemption method) would appear to further that goal. Article 23A generally requires a residence country to provide an exemption for income, or deduction for taxes paid, by the source country in accordance with the treaty. Paragraph 4 would permit the residence state to assess tax on an item of income whereas the source state believes the treaty requires it to exempt the item of income from tax, thereby eliminating the possibility of unintentional double nontaxation. To the extent the source country forgoes its taxing rights under the treaty, the residence country retains the right to tax the income.
Including this paragraph in the U.N. model treaty is proving controversial. Some source countries want to ensure that if they are giving up their right to tax an item of income, or otherwise providing incentives for investment, their forgoing of a potential revenue source isn't for naught. If the residence country would simply tax that income item instead, any incentive for investment provided by the source country could be lost. This position appears to be based on an overbroad interpretation of what paragraph 4 is intended to achieve, which is limited to unintentional double nontaxation and does not extend to the protection of tax incentives provided by the source country.
Those points were made explicit in the following note prepared by India's committee member on the proposed new paragraph 4. These comments highlight the importance India places on its rights to allow for double nontaxation through its treaty network, and also demonstrate discrepancies between India's position at the U.N. and its supposed full support for the BEPS project:
including paragraph 4 of Article 23A of OECD Model in the U.N. Model would not be desirable as it will result in including the avoidance of double non-taxation as a treaty objective in the U.N. Model whereas that is not the objective of the U.N. model convention. Although some countries regard double non-taxation as undesirable, very few countries consider its avoidance as a treaty objective. Double non-taxation may be intended or unintended but does not constitute tax evasion. Double non-taxation should be considered a problem only if it is abusive.
Action item 6 of the BEPS project says the OECD will propose recommendations "to clarify that tax treaties are not intended to be used to generate double non-taxation." In asserting that double nontaxation is an acceptable result of the treaty system, the note from the Indian committee member represents a marked departure from the OECD BEPS project.
What Are the Committee's Goals?
The debate over changes to the model treaty caused some members to question the purpose of the revisions, and more broadly, of the U.N. model treaty. Those questions were dismissed as irrelevant -- yet they haven't been fully thought out at the U.N. To the extent the model is supposed to serve as a balance between source rights and residence rights, the U.N. committee is clearly in favor of shifting that balance toward source taxing rights.
An open question in the debate over using provisions of a model treaty to articulate some countries' views on how the global tax system should allocate taxing rights is how the spillover effects of these policies will play out. The IMF recently questioned whether entering into tax treaties was beneficial to developing countries.
The OECD is expanding its role in global tax policy by enhancing cooperation with developing countries. Greater cooperation with developing countries has been expressly mandated by the G-20 in its recent communiqué. As the OECD involvement with developing countries grows, the U.N.'s role in global tax policy is likely to evolve over the next few years.
Outside Input Needed
As the U.N. goes about the process of radically rewriting international tax rules, other stakeholders may find it beneficial to offer their resources in support of this process. The U.N.'s informal process means that non-members are often not able to provide input on discussion drafts. Unlike the OECD working party meetings, however, U.N. committee meetings are generally open to the public and the press.
Stakeholders may wish to consider a more coordinated and engaged process of seeking to provide input into this process.