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League of Nations Fiscal Committee: Work of the Fiscal Committee during Its Sixth Session C.450.M.266.1936.II.A.

INTRODUCTION.

The Fiscal Committee has the honour to submit to the Council the following report on its sixth session, held at Geneva from October 15th to 21st, 1936.

The following members of the Committee were present:

M. J. H. R. SINNINGHE DAMSTÉ, Chairman,

M. H. BLAU,

M. M. BORDUGE,

Mr. Mitchell B. CARROLL, accompanied by Mr. Eldon P. KING,

M. G. MANTZAVINOS,

M. R. PUTMAN,

Mr. C. H. WAKELY.

The meetings were also attended by:

M. C. JIMENEZ CORREA, corresponding member of the Committee,

M. Robert JULLIARD, representative of the International Chamber of Commerce.

I. TAX EVASION.

At its meeting on October 10th, 1936, the Assembly of the League of Nations adopted the following resolution:

“The Assembly,

“Considering that efforts to reduce the obstacle to the international circulation of capital must not have the effect of increasing fiscal fraud;

“Being of opinion that double taxation is both one of the causes of fiscal fraud and at the same time a serious obstacle to the development of international economic and financial relations;

“And holding that only concerted action based on specific agreements for international co-operation can ensure the accurate assessment and equitable allocation of taxes:

“Requests the Fiscal Committee to pursue vigorously its work for the avoidance of double taxation as far as possible, and also its work on the subject of international fiscal assistance, in order to promote practical arrangements calculated, as far as possible, to put down fiscal fraud.”




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At its present session, the Fiscal Committee at once proceeded to comply with this request. The present report contains an account of, and a commentary on, the first conclusions reached as a result of its work.

I. Previous Work of the Fiscal Committee in the Matter of Fiscal Evasion.

The fiscal experts have met periodically for more than twelve years under the League's auspices for the purpose of studying rules liable to ensure greater justice in the taxation of individuals and legal entities engaged in activities in different countries. The problem submitted to the experts was twofold: to ensure that a taxpayer should not be doubly taxed by two States on account of the same capital or the same income, and to ensure that no taxpayer should take advantage of different systems of fiscal law to evade his obligations.

Their work has been directed towards these two aims; and though, to judge from the records of the Fiscal Committee's meetings, it seems that the study of double taxation occupies the chief place, the investigation of methods of combating tax evasion has also not been neglected. The experts had to admit, however, that the practical application of their recommendations in regard to double taxation should precede the application of measures for the prevention of tax evasion, because the latter is, if not justified, at all events provoked in many cases, by double taxation. Being threatened by double taxation, the taxpayer tries to find a way of escape, and this motive too often leads him to resort to methods which, not only enable him to escape any excessive burden, but actually place him in a privileged position as compared with his fellow-taxpayers. To-day, the work of the Fiscal Committee in the field of double taxation has progressed sufficiently to enable the Committee to reconsider the problem of tax evasion. The different States are aware, thanks to the League, of the methods of preventing the unjust taxation of taxpayers; at all events, great progress has been made: while in 1923, when the League of Nations called together the first meeting of tax experts, very few conventions existed in the field of double taxation, more than a hundred and forty are now in force. Since taxpayers are now protected from unjust taxation, a higher standard of conscientiousness can be expected from them. Moreover, the States are in a position, prior to the application of measures to prevent tax evasion, to conclude conventions for the abolition of double taxation; this would make it easier for the taxpayer to bear the burden resulting from the measures set forth hereunder.

There is another and a very different consideration that justifies the fiscal experts in the circumspection they have shown regarding tax evasion. Such evasion is practised mainly in respect of income from movable, capital, and the first paragraph of the resolution adopted by the League Assembly refers to this particular form of fraud, which is constantly increasing. For experts well acquainted with these questions, the problem of international tax evasion in respect of the income from movable capital is only one of the particular aspects of a more general problem—namely, the investigation of methods of preventing the frequent frauds that occur in the taxation of income from movable capital. The most ingenious solutions have been considered, and, technically speaking, the problem can be satisfactorily solved. But all the solutions available are open to the same objection—namely, that they disturb the circulation of capital, because they inevitably drive it to take refuge where it will be least heavily taxed. Accordingly, the various countries have hesitated to establish such control, as it would seriously affect their economic situation. Internal control is, if not inoperative, at all events very inadequate; and, in such circumstances, can international control be contemplated?

In point of fact, the two problems are interrelated. States hesitate to apply stricter internal control, because they fear that more lenient neighbouring States will benefit thereby and will drain off the main flow of capital. From the technical point of view, the principal States, realising these common dangers to which they are all liable, would have to adopt simultaneously similar methods of control for both national and international transactions. Is such simultaneous action possible? The fiscal experts are not qualified to answer that question. They emphasise the difficulty of the problem here, in order to explain the reason for the concern with which they have endeavoured to study it, as well as to show how serious the difficulty is.

2. The Problem raised by the Assembly.

The Assembly resolution is worded in very general terms; yet if [?] conveys the wish that the Committee should study, in particular, measures for combating tax evasion in respect of income from movable capital. Even when thus circumscribed, the problem still remains a vast one; and the Committee, anxious to give its answer in the shortest possible time, has, for the present, confined its study to a particular kind of fraud which is very common and hence very disturbing. Subsequently, according to the manner in which its conclusions are received, the Committee will decide whether it will have to extend its work to the investigation of processes capable of eliminating other causes of tax evasion.

The following study will therefore relate to one of the best-known methods of fraud: a taxpayer, anxious, inter alia, to escape from some of the burdens to which he would be liable if he collected the income from his movable capital in the country where he resides, has recourse to a country where he knows that the tax is lower and that measures of supervision do not exist or are less severe.

Certain technical explanations are necessary. As a rule, States tax at source income from movable capital invested in national enterprises, and also, as a rule, there may be said to be no means whereby the taxpayer can escape such taxation. But, in order not to give any advantage to investments elsewhere than in national enterprises, some States impose a “compensatory”


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tax, which is often very heavy, upon income from capital invested by their nationals in foreign enterprises. The collection of this compensatory tax is an easy matter if the income is paid in the territory of the State imposing the tax. It is much more uncertain, however, if interest is paid abroad in a State which is not concerned with the tax. Hence a first kind of tax evasion—namely, that practised by holders of foreign securities, who cash the income therefrom outside the country in which they reside.

There is a second kind of evasion, in respect of the supplementary tax (general income tax, super-tax) leviable in the taxpayer's country of residence upon the whole of his income. If he collects the whole of his income in the country in which he resides, the taxation problem is an internal one, and the various legislations, more or less strict, can make their demands proportionate to their needs. But, if the taxpayer receives part of his income abroad, the State of residence is often powerless and must apply to foreign countries for help, in order to restore fiscal equality between its nationals. To find such means of assistance has been one of the tasks of the Fiscal Committee.

3. Opinion of the Fiscal Committee.

Having considered this particular aspect of tax evasion—frauds in regard to the compensatory tax on income from foreign securities and frauds in regard to the supplementary tax—the Fiscal Committee is of opinion, subject to all the reservations in this report, that agreements based on the formula set forth below would, if generally accepted, lead to the desired result.

“In each of the contracting States, rules shall be laid down that persons or companies who, in the course of their business, pay out income derived from movable capital must report every payment made to a person not resident in the State in which this payment is effected. The notice in question shall be given to this latter State, which shall transmit it to the State in which the recipient resides.

“The term ‘income derived from movable capital’ shall, for the purpose of the present provisions, be taken to mean interest, dividends, and, in general, income from bonds, stocks and shares, and loans. The rule shall apply to every kind of payment, whether in cash or by transfer, cheque, or entry in a banking account.

“For the purpose of the present provisions, persons not resident in a State shall be deemed to mean persons having their permanent home in another State.”note

4. Advantages of the Proposal.

Were the more important States to adopt the Fiscal Committee's proposal, the frauds at present current in regard to the taxes with which we are now dealing would undoubtedly be considerably reduced, if not entirely eliminated. However incomplete the exchange of information, it is clear that, if the taxpayer knew that such a system was in force, he would be more careful and therefore more honest. Tax revenue would increase, and this would not apply merely to the revenue directly derived from the compensatory tax and supplementary tax, but also to that resulting from all taxes the assessment of which presupposes knowledge of the taxpayer's income. This rise in the yield of taxes, without any corresponding rise in rates, would increase the revenues of the contracting States and enable them to reduce taxation, thus, lessening the attractions of other methods of evasion. This would meet the argument advanced in the Fiscal Committee and elsewhere that tax evasion is due to excessive rates of taxation and that its evils will continue until its attractions are lessened by a reduction in rates.

5. Disadvantages of the Proposal.

One obvious drawback has already been pointed out in the report: it would appear unreasonable for a State to request the assistance of neighbouring States in tightening up the collection of taxes on the income from movable capital while at the same time refraining, on excellent economic or financial grounds, from taking internal action to improve the yield of other taxes on the income from movable capital. To that, however, it may be replied that the convention is reciprocal, and that States are free to proceed with greater severity in regard to income derived from abroad.

A second objection immediately presents itself: while the State can enforce certain obligations upon persons or companies who openly pay, in the course of business, the income from securities, it will be relatively impotent against concealed intermediaries who lend their names or their services to foreigners and thereby escape the general regulations. It is at once clear, however, that recourse to these intermediaries is extremely dangerous to the taxpayer, who, having no title that he can produce in court, lays himself open to losses from fraud or otherwise.

A more serious objection is that of the danger resulting from the possibility that only a few States would adopt the methods recommended by the Fiscal Committee. If there are States that have not signed the convention, to which the taxpayer can resort, all those who seek to evade payment


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will rush to take refuge there. A factitious movement of capital will develop, having nothing to do with the free play of economic laws, and the existing evil will be in no degree diminished. If, therefore, the suggested action is to be effectual, it ought to be taken by a very large number of States.

In this connection, it may be observed that as long ago as 1925 the technical experts on double taxation and tax evasion pointed out that:

“Unlike double taxation, in connection with which any problems arising between two States can be settled appropriately by means of bilateral conventions, the question of tax evasion can only be solved in a satisfactory manner if the international agreements on this matter are adhered to by most of the States and if they are concluded simultaneously. Otherwise, the interests of the minority of States, which would alone have signed the conventions, might be seriously prejudiced.” (Document F.212.)

Such are the conclusions at which the Fiscal Committee has now arrived. It is not blind to their deficiencies and has, indeed, felt in duty bound to call attention to them. The importance and the difficulty of the problem would doubtless justify a more thorough examination. Before proceeding further with this question, however, the Fiscal Committee thinks that the Council may consider it advisable to ascertain the prospects of reaching, if not a general agreement, at all events one that would extend to a considerable number of States; for, if limited to a small number of countries, the agreement may prove more dangerous than effective, and, whatever be the system recommended, the same danger is to be feared.

II. EXAMINATION OF RECENTLY CONCLUDED INTERNATIONAL CONVENTIONS FOR THE AVOIDANCE OF DOUBLE TAXATION.note

1. Since the last session of the Committee (June 1935), only one Conventionnote has been concluded for the purpose of preventing double taxation in respect of all direct taxes; this is the Convention concluded on September 25th, 1935, between Germany and Finland. Apart from a few differences of detail, this Convention applies the principles laid down in the model Conventions drawn up by the meeting of Government experts in 1928.

2. Conventions for the purpose of preventing double taxation in respect of certain specified forms of income have been concluded:

  • (a) Between the United Kingdom and Finland, on February 21st, 1935;
  • (b) Between the United Kingdom and the Netherlands, on June 6th, 1935.

These two Conventions deal with three important points:

  • (i) The reciprocal exemption from taxation of profits arising through an agency, the term “agency” connoting the relation of agent and principal, and not that of servant and master.
  • (ii) The taxation of profits arising from the sale of goods from a stock in the country.
  • (iii) The purchasing of goods or material in one of the contracting countries by a person who is resident in the other country, for sale or manufacture in another country, does not involve taxation, notwithstanding that the purchase is effected through a branch or management or agency.

3. New measures are to be noted in the conclusion of conventions relating to assistance in the collection of taxes, administrative assistance, and legal safeguards in regard to taxation. On these subjects, the following Conventions have been concluded:

  • (a) Between Roumania and Czechoslovakia, on June 20th, 1934;
  • (b) Between Germany and Sweden, on May 14th, 1935;
  • (c) Between Germany and Finland, on September 21st, 1935.

These Conventions are based generally on the drafts prepared by the meeting of Government experts in 1928.

4. The two following Conventions have been concluded for the purpose of preventing double taxation in the matter of death duties:

  • (a) Between Germany and Sweden, on May 14th, 1935;
  • (b) Between Roumania and Czechoslovakia, on June 20th, 1934.

5. A fair number of Conventions have also been concluded for the reciprocal exemption of maritime and air navigation enterprises and of motor and other vehicles.




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6. In its last report, the Committee drew attention to the large number of Conventions on double taxation that have been concluded since those model Conventions were drawn up by the general meeting of Government experts in 1928. The Committee has thought it desirable to undertake a comparative study of these Conventions, in order to bring to light the tendencies of international fiscal law and facilitate the conclusion of treaties on uniform lines. It has accordingly entrusted this task to its Technical Sub-Committee.

7. The Committee also notes with satisfaction that the fundamental clause in the model Conventions of 1928 relating to the taxation of business enterprises has been used as a basis [?] for internal legal provisions. The United States, in the Revenue Act of June 22nd, 1936, has had in mind the principle that foreign enterprises are not taxable in respect of their business income except to the extent to which that income is attributable to a permanent establishment in United States territory. Consequently, foreigners and foreign companies are not taxable in the United States in respect of income arising from transactions in stocks and bonds and commodities usually dealt with on exchanges effected through a commission agent or broker resident in the United States.

8. The draft Convention for the Purpose of facilitating Commercial Propaganda, drawn up by the Government delegates assembled at Geneva on July 4th, 1935,note includes clauses concerning exemption from certain taxes. The following are exempt from Customs duties, and also from all duties and taxes which are payable at the time of, and by reason of, importation, subject to certain reservations:

  • (a) Samples of goods of all kinds;
  • (b) Catalogues, price-lists, and trade notices;
  • (c) Printed matter and posters for propaganda, the essential purpose of which is to induce the public to visit foreign countries or fairs, exhibitions, etc.

Further, in Article 7, paragraph 3, it is stipulated that there shall be exemption from all taxes, duties or charges payable to any public authority whatsoever for persons engaged in industrial or business activities in the territory of any of the contracting parties who, either in person or by representatives or travellers, purchase goods in the territory of the other contracting parties either from merchants or in places where goods are on sale, or from producers, or who take orders from merchants and producers who trade in goods of the same kind.

These exemptions, which manifestly tend to encourage trade, are not inconsistent with the principles laid down by the Fiscal Committee, especially since they are applicable only in the absence of any permanent establishment.

III. ALLOCATION OF THE PROFITS AND PROPERTY OF INTERNATIONAL ENTERPRISES.

1. When it drew up the draft Convention for the allocation of business income between States for the purposes of taxation, the Committee decided to reserve the question of the treatment applicable to insurance enterprises for further study. It has now reconsidered this question and has come to the conclusion that, as a general rule, the principles laid down in its last reportnote for the allocation of the profits of business enterprises could be applied to insurance enterprises. Where it might not be possible to tax a branch of a foreign insurance enterprise on the basis of its separate accounts, it would seem that the procedure most likely to lead to satisfactory results would be to take as a basis the proportion between the premiums paid in respect of the transactions of the branch concerned and the total amount of the premiums paid to the enterprise as a whole. With this object, the Committee proposes to add to Article III, paragraph 4, of the “Revised Text of the Draft Convention for the Allocation of Business Income”, which is embodied in its last report, the clause reproduced in Appendix I to this document.

2. The Committee has also considered the question of the allocation of the assets of enterprises having permanent establishments in several countries, for the purposes of taxes on property, capital, or increases of property. It has come to the conclusion that the principles laid down in its draft Convention for the allocation of business income could be applied in a general way to the property and capital of business enterprises. It has accordingly drafted the clauses reproduced in Appendix II to this document. Those clauses can either be incorporated, as an addition, in conventions for the allocation of business income, or be embodied in separate conventions.

3. In accordance with the procedure followed in the case of the draft Convention for the allocation of business income, contained in its last report,note the Committee proposes to the Council


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that the separate clauses it has just drawn up for the allocation of the profits of insurance enterprises, and for allocation for the purposes of taxes on property, capital, or increases of property, of the property and capital of international enterprises, should be communicated to Governments or their observations. Their attention should, at the same time, be drawn to the fact that the clauses [?] which the Fiscal Committee has just drafted can be used as a model for bilateral agreements or multilateral conventions.

IV. EVOLUTION OF FISCAL SYSTEMS.

The results of various preliminary investigations into the behaviour of fiscal systems during the depression have enabled the Committee to clearly define the problem and draw up a programme of work. The Committee proposes to make arrangements, through its members and correspondents, for reports to be drafted on the basis of a common scheme in various representative countries. This scheme has been worked out in detail by the Committee at its present session. The Committee is of opinion that the information on the manner in which fiscal systems have reacted to economic fluctuations which will thus be assembled will be of real value to fiscal and budgetary authorities.

V. TECHNICAL QUESTIONS.

1. The Committee has in the past stressed the interest attaching to the definition of certain essential terms used, with various shades of meaning, in the different fiscal legislations. The first subject taken up by the Sub-Committee entrusted with this task was that of the concept of business income, which has an important place in the Conventions for the prevention of double taxation. An enquiry into the various aspects of this question from the fiscal standpoint was carried out with the co-operation of national experts in the following thirteen countries: Austria, Belgium, the United Kingdom, Danzig, Denmark, France, Greece, Hungary, Italy, Netherlands, Sweden, Switzerland and the United States of America. On the basis of the information compiled, the Committee has already been able to clarify some aspects of the problem, but it appeared necessary to proceed further with the work undertaken before attempting to reach definite conclusions as [?] to the manner in which business income should be treated from the fiscal point of view.

2. The collection of taxes has, in recent years, been a subject of concern for all fiscal administrations. It therefore appeared advisable that the Committee should consider this question on the basis of the experience of different countries. This question was entrusted to the Technical Sub-Committee, which will report to the Committee next year. The study is intended to facilitate the drawing-up of general rules to enable rules to be laid down which, while helping the taxpayers to pay their fiscal debt, would ensure the effective collection of taxes.

3. During the present session, the attention of the Committee was also drawn to concepts of domicile and residence. It noted that divergences in these matters resulted in difficulties in course of the negotiation and the application of conventions on double taxation. The Committee therefore decided to undertake an examination of this question with a view to arriving at a definition of these concepts by a fairly early date, in respect of both individuals and legal entities.

VI. CONSTITUTION, PROCEDURE AND PRACTICE OF COMMITTEES OF THE LEAGUE OF NATIONS.

The Fiscal Committee has examined the Report on the Constitution, Procedure, and Practice of Committees of the League of Nations, which was adopted by the Council on January 24th, 1936.note It finds that the general rules for Committees, contained in the report, involve no change in the statute of the Fiscal Committee as defined in the resolution adopted by the Council on December 14th, 1928.note Moreover, the procedure hitherto followed by the Committee is in conformity with those rules. The Committee has therefore no observations to make on the subject.




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Appendix I. ALLOCATION OF INCOME OF INSURANCE ENTERPRISES.

Proposed Addition to Article III, Paragraph 4, of the Revised Draft Convention for the Allocation of Business Income between States for the Purposes of Taxation.

In the case of insurance enterprises, and in particular those conducting the business of life assurance, such determination may be made by reference to the proportion between the premium received in respect of the permanent establishment and the total premiums received by the enterprise.

Appendix II. PRELIMINARY DRAFT CONVENTION FOR THE ALLOCATION OF PROPERTY AND CAPITAL BETWEEN STATES FOR THE PURPOSES OF TAXATION.

Being desirous of preventing the double taxation of the property and capital of business enterprises which results from conflicting principles and methods of allocating taxable property and capital, the High Contracting Parties have agreed to the following provisions:

Article I.note

An enterprise having its fiscal domicile in one of the contracting States shall not be subject to taxes on property and capital in another contracting State except in respect of property situated and capital employed within its territory and, in the case of movable property and capital, allocable to a permanent establishment situated in such State.

Article II.

Contrary to the foregoing provisions, patents, trade-marks, copyrights and similar Intangible property shall be taxable only in the State where the real centre of management is situated.

Article III.

In principle, the property and capital of the permanent establishment concerned will be taxed on the basis of the separate accounts pertaining to such establishment, subject to the necessary rectifications.

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