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Commentary

I. Commentary on the Model Bilateral Convention on the Prevention of the Double Taxation of Income and Property

INTRODUCTION

The cases of international double taxation that may arise in connection with taxes on income and property fall into three classes. The first and most important category includes the cases due to the co-existence of personal and impersonal tax liability. Tax liability is said to be personal when it is based on the personal status of the taxpayer himself—e.g., his nationality, domicile, residence. Impersonal tax liability exists when a country taxes income earned or received within its territory regardless of the personal status of the recipient. Any person who is taxable in one country on account of his personal status and who receives income from another country or holds property therein is exposed to such double taxation. This result can be avoided only if one or both of the jurisdictions concerned limit their fiscal claims or allow a credit against their tax on account of the foreign tax.

Under a second category come the cases of double taxation due to the fact that countries apply different criteria as regards personal tax liability, or define differently the bases of such liability. Taxpayers whose personal allegiance is divided between two or more countries or is doubtful may be subject to double taxation of this kind, as, for instance; nationals of one country having their domicile or residence in another, persons with a domicile or residence in two different countries, persons simultaneously regarded by two tax jurisdictions as domiciled or resident in their respective territories.

A third kind of international double taxation of income and property includes the cases where two or more countries regard a given kind of income or property as taxable in their respective territories because they apply different tests of impersonal tax liability. Double taxation of this kind may


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occur, for instance, when the assets or activities that produce a given income are located or carried out in more than one country, or when the income is collected elsewhere than in the country where it is earned or from which it is due.

According to the proposals embodied in the Mexico and London Model Conventions, double taxation of income and property is prevented by two sets of clauses which are mutually complementary. In the first place, a definition is given of the conditions under which each kind of income as characterised by the type of property or activity from which it is derived may be taxed in a country according to the criterion of impersonal tax liability. In the second place, it is provided that taxes so paid are to be deducted from, or credited against, the tax due by the taxpayer in the country where he has his residence or “fiscal domicile”.

Both in the Mexico and London drafts, Article I of the Model Convention on income and property taxes defines the general object and scope of the instruments. Articles II to XII indicate the conditions under which the various kinds of income, as defined by their economic source, may be taxed in a country when the beneficiary has his residence or “fiscal domicile” in the other country. In the Mexico draft, these articles follow the principle that income may be taxed in a country when it has its source therein: i.e., when it results from property or activities located in that country. This principle is also admitted in the London draft, but it is modified as regards interest, dividends, royalties, annuities and private pensions.

In both drafts, Articles XIII and XIV refer to taxation in the country of permanent residence or fiscal domicile. In the London draft, a new Article XV has been inserted to cover taxes on property, capital and wealth. Discriminatory taxation is dealt with in Article XV of the Mexico draft and Article XVI of the London draft, which have the same wording. Protection of taxpayers' rights is the special subject of Article XVI of the Mexico draft and Articles XVII and XVIII of the London draft. Finally, the last two articles of both drafts refer to the implementation and duration of the convention.

In both drafts, the Model Convention is followed by a Protocol containing definitions of such phrases as “fiscal


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domicile”, “permanent establishment” and rules of procedure on such matters as the allocation of business profits. The articles of the Protocol will be considered in the commentary which follows together with the articles of the Model Convention to which they respectively refer. Henceforth, separate reference to the Mexico or London drafts will be made only when they differ. Moreover, when an article is referred to, it should be taken as an article of the Model Convention and when reference is made to an article of the Protocol, it will be explicitly stated.

Ad Article I.—Object and Scope of the Model Convention

According to Article I, the Convention is to apply to all natural and juridical persons who have their “fiscal domicile” in one of the contracting States and, at the same time, derive income which is taxable in the territory of the other State. Further, Article XV of the London draft extends the application of the Convention to “taxes on property, capital or increment of wealth”.

The question of defining and determining “fiscal domicile” is dealt with in Article II of the Protocol. This seemed desirable because national tax laws and practices differ in those respects.

According to Article II of the Protocol, the phrase “fiscal domicile” signifies, in the case of individuals, the place where a person has his normal residence or permanent home. This definition is that used in the earlier model conventions drafted by the Fiscal Committee. It is, however, added that, in case the taxpayer has several residences, his fiscal domicile will be his main residence, which will be determined in the light of the duration, regularity, frequency of his stays, the place where the family of the taxpayer is usually present, the proximity to the place where the party concerned carries on his occupation. Accordingly, in determining the “fiscal domicile” of an individual, reference would have to be made not only to the mere possession or availability of a dwelling but also the family, social and economic connections binding a person to a given place.

The wording of paragraph 4 of Article II of the Protocol differs in the Mexico and London drafts. According to the Mexico formula, the fiscal domicile of a partnership, company


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or other similar entity would be situated in the country under the laws of which it was organised. According to the London formula, the fiscal domicile of such entities would be the country in which their real centre of management is situated. In favour of the Mexico definition, it was stated that it agreed better with American legal systems. For its part, the London definition is that contained in the earlier work of the Fiscal Committee and it appears in most tax treaties concluded between European countries.

The Convention is intended to apply to all taxpayers in the contracting States, whether nationals or foreigners, provided they have their “fiscal domicile” in one of the two contracting States. Indeed, since foreigners with their fiscal domicile in a country are generally subject therein to a general tax liability on their total income from domestic and foreign sources, it is legitimate that they should enjoy the double-taxation relief provided by the Convention.

Nationals of the contracting States who have their “fiscal domicile” in a third State do not come under the provisions of the Convention, since most countries do not tax their nationals having their fiscal domicile abroad, except, of course, on the income they derive from their country. The status of such persons would have to be considered by tax treaty negotiators when one or both of the States concerned bases personal liability to income tax on nationality as well as on “fiscal domicile”.

The Convention is intended to apply to all ordinary and special taxes on individual and corporate income, whatever may be their denomination and method of assessment. In the London draft, its provisions extend also to taxes on property, capital and wealth to which a reference is made in Article XV of that draft. The structure of Article I is such as to enable tax negotiators to indicate, through an enumeration, the taxes to which the Convention should apply. Such an enumeration might include, in addition to national taxes levied by the central or federal Government, taxes levied by political subdivisions and local authorities such as the States of a federation, provinces and municipalities.

Paragraph 2 of Article I of the Convention contains a provision which is intended to assure the automatic adaptation


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of the Convention to changes in the taxes of the contracting States. It does so by providing for the extension of the provisions of the Convention to taxes or increases of taxes introduced after the signature of the instrument, provided such new levies rest upon substantially the same bases as the taxes enumerated in the convention. It is moreover specified in Article XIX of the London draft that “… in the event of substantial changes of tax laws of either of the contracting States, the competent authorities of the two contracting States shall confer together and take the measures required in accordance with the spirit of the Convention”.

Ad Article II.—Income from Real Property

In both the Mexico and London versions, the Model Convention follows the generally accepted principle that income from real property is taxable in the country where the real property is situated. In this context, income from real property means the income that results directly from the ownership or possession of real property, as such income and property are defined in the country where the latter is situated, according to Article III of the Protocol. The income in question is mainly represented by the rent received from a tenant and also the rental value of the property when it is occupied by the owner or possessor personally, in case this rental value is subject to income tax or to a substitute form of taxation under the laws of the country concerned.

It may be noted that “royalties from immovable property or in respect of the operation of a mine, a quarry or other natural resource” are mentioned separately in Article X. That article, however, follows the same principle as is contained in Article II, and states that such royalties are taxable in the country where the property in respect of which they are due is situated.

Profits resulting from the sale and exchange of real property are governed by Article XII, but this article applies the same principle as in Article II and provides for the taxation of such profits in the country where the property concerned is situated.

Income derived from the exploitation of lands, buildings, and sub-soil as a part of a business, including mining, forestry and agriculture, does not come within the purview of Article II, but of Article IV, concerning business income.




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Ad Article III.—Income from Mortgages

The effect of Article III, paragraph 1, is to make the rule governing the income from real property apply also to taxation of income from mortgages on such property. This rule would, however, not apply to those so-called mortgage bonds which are not guaranteed by any specific real property and which are issued by credit institutions in order to finance the loans they grant on mortgages drawn up in their names. Such bonds would come rather under the provisions of Article IX, which applies to income from movable capital in general, in the Mexico draft, and to interest on debts in the London draft.

By analogy with the above-mentioned rule on income from mortgages on real property, the second paragraph of Article III provides that income from mortgages on sea and air vessels is taxable in the country of registry, since such vessels are generally regarded as being legally situated in that country.

Ad Article IV.—Income from Business

Both in the London and Mexico drafts, “income from any industrial, commercial or agricultural enterprise and from any other gainful occupation” is governed by Article IV of the Model Convention and Articles IV to VIII of the Protocol. Such income is mainly represented by business profits and this phrase shall be used for brevity's sake.

The first question which arises in international tax practice concerning business profits is the following: What are the facts which render an enterprise liable to taxation on its profits in a foreign country? This question is dealt with in paragraphs 1 and 2 of Article IV in both drafts. According to the Mexico version, an enterprise will be liable to tax on its profits in a foreign country if it has carried out its business or activities in that country provided such activities did not merely take the form of isolated or occasional transactions. On the other hand, the London draft requires that an enterprise should have a “permanent establishment” in a country to become subject to the income-tax laws of that country.

It was argued in favour of the criterion contained in the Mexico draft that, if an enterprise were to be taxable on its profits in a foreign country only if it had a permanent establishment


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in that country, some countries would lose revenue. Moreover, certain forms of fiscal evasion might be encouraged. Indeed, some enterprises might seek to avoid taxation in a country by carrying out their business in that country without maintaining a permanent establishment therein or by concealing the existence of such an establishment.

However, when the Fiscal Committee considered in London the Mexico draft, it referred to the fact that the criterion of the “permanent establishment” more or less as defined by the Committee in its earlier worknote, was contained in nearly all double-taxation treaties relating to business income. On that occasion, it was stated that the use of this criterion was not in itself apt to facilitate fiscal evasion since, in virtue of Article XIII of the Model Tax Convention, the total tax liability of an enterprise remains, as a rule, the same, no matter in what proportion its income is divided between its own country and the foreign country where it may do business. Further, it was recalled that the detection of enterprises concealing their business from the tax authorities was essentially a matter for internal tax administration. Finally, past experience was said to show that it is extremely difficult to tax foreign enterprises efficiently and equitably when they do not possess a permanent establishment in a country.

The phrase “permanent establishment” is defined in Article V, paragraph 1, of the Protocol. Two conditions are required in order for an enterprise to be considered as possessing a “permanent establishment” in a country: it must have some “fixed place” of business in the country; and that place of business must have a productive character—i.e., contribute to business earnings.

There are establishments which fulfil only the first condition. These should therefore not give rise to income-tax liability in the country where they are situated. This class includes establishments which do not directly contribute to business earnings, such as research laboratories, experimental plants, information bureaux, storehouses, purchasing offices, advertising displays and showrooms where no goods are sold. To


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apply income tax on an assumed profit in the case of such establishments would easily lead to arbitrary or extra-territorial taxation.

The case of purchasing offices deserves special mention and various tax treaties contain specific provisions in their connection. From a general point of view, it is sometimes argued that, when goods are bought in a country, the profits should be divided between the two functions of purchase and sale just as they are divided between manufacture and sale. It is added that to exempt purchasing establishments of foreign enterprises would constitute a discrimination against domestic exporters. On the other hand, it has been pointed out that the act of purchasing in itself yields no profits. Indeed, unlike producing, converting, processing, manufacturing, sorting, preserving, assembling, packing and transporting, a purchase adds no value to the thing bought. Consequently, it seems that the taxation of a so-called purchasing profit by the country where the purchasing establishment is situated, except perhaps when income is attributed to a purchasing establishment on a commission basis—i.e., as if that establishment were an independent agent working for a foreign firm—would give an extra-territorial scope to its income tax.

Though the Mexico and London drafts do not contain any explicit rule about the income-tax treatment of such establishments, it may be mentioned that an earlier unpublished draft stipulated that the “mere purchase of goods by an establishment in one country for the supply of selling or processing establishments in the other country” could not be regarded as a basis for income-tax liability in the country where the purchase was made. It seemed understood that this rule would apply only if the purchasing establishment which the enterprise concerned maintained in that country confined its activities to purchasing only, and rendered no other services such as sorting, grading, or packing goods to the enterprise to which it belonged.

The Mexico and London Model Conventions have taken over from the earlier work of the Fiscal Committee the provisions which allow a distinction to be made between dealings through an autonomous agent and dealings through a permanent establishment or branch. According to Article V,


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paragraph 3, of the Protocol, a foreign enterprise is not, in principle, liable to income tax in a country if its operations in that country are exclusively carried out through a broker, commission agent, or other agent of a genuinely independent status in that country. An agent, however, will not be considered as independent, according to Article V, paragraph 4, of the Protocol, and the enterprise for which he acts will be liable to income tax in the country where he is established in cases such as the following: the agent habitually acts in the name of the enterprise concerned as a duly accredited agent and enters into contracts on its behalf; the agent is a salaried employee of the enterprise and habitually transacts business on its account; the agent habitually holds, for the purpose of sale, a stock of goods that belong to the enterprise.

Article V, paragraph 5, of the Protocol adds that, when the office and business expenses of the agent—in particular, the rent of the premises used by him when working for the enterprise concerned—are paid by that enterprise, this fact will be regarded as proof of a contract of employment, indicating that the enterprise possesses an establishment in the country.

According to the above-mentioned provisions, there seem to be consequently four distinct criteria according to which a foreign enterprise may be deemed to have an establishment in the country where it deals through an agent:

  • (a) Power of the local agent to bind the enterprise;
  • (b) Existence of a contract of employment with a local agent;
  • (c) Maintenance in the country of a stock of goods under the control of an agent for sales in that country;
  • (d) Payment of the rent of the premises used by the agent and of his office expenses.

Any of these four conditions is sufficient to render an enterprise liable to income tax in its own name in the country where an agent operates, provided that the condition which is fulfilled corresponds to a permanent state of things or an habitual practice.

On the other hand, paragraphs 6 and 7 of Article V of the Protocol stipulate that foreign enterprises doing business in a


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country through brokers and commissioned agents of a genuinely independent status, or through commercial travellers visiting customers or suppliers in a country, should not be liable to income tax in that country.

Paragraph 8 of Article V of the Protocol refers to subsidiary companies. It states that a subsidiary cannot be regarded as a permanent establishment of the parent enterprise. This provision has two main effects. In the first place, the country where the subsidiary is situated is not entitled to tax the parent company except, of course, on the dividends which the parent company may receive from its subsidiary, in accordance with the provisions of Article IX of the Mexico draft and Article VIII, paragraph 2, of the London Model Convention, to which reference is made on page 25. Secondly, in taxing the parent company, the authorities of the country in which such company is situated may not take into account the actual profits made by the subsidiary company in the other country, but only the dividends and other income paid by the subsidiary to the parent company. These rules follow the principle that a subsidiary constitutes a distinct legal entity and should therefore be taxed separately. At the same time, Article VII of the Protocol indicates the criteria according to which the correctness of the mutual relations between parent and subsidiary companies can be checked so as to avoid abuses resulting in the diversion of profits or losses from one company to the other.

While paragraphs 1 and 2 of Article IV of the Model Convention and the complementary provisions in Article V of the Protocol, which have been considered above, define the conditions under which an enterprise may be subject to income tax in a foreign country, paragraphs 3 and 4 of Article IV of the Model Convention and Article VI of the Protocol refer to the method of determining the share of its total profits on which an enterprise may be taxed in a foreign country when it possesses an establishment in that country.

The main principle regarding allocation of profits is that the profits on which a branch or permanent establishment of a foreign enterprise may be taxed in the country where such establishment is situated cannot exceed the earnings that are


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the direct result of the activities of the establishment concerned or the yield of the assets pertaining to it. Concerning the method of application of this principle, section A of paragraph 1 of Article VI of the Protocol states that “there shall be attributed to each permanent establishment the net business income which it might be expected to derive if it were an independent enterprise engaged in the same or similar activities, under the same or similar conditions”. This method of determining or allocating the profits attributable to a permanent establishment is known as the method of separate accounting. Its intended result is that each establishment or branch is taxed as if it constituted a distinct independent enterprise and the profits of the establishment are assessed independently of the results of the business done elsewhere by the enterprise to which it belongs. This method implies as a rule that records and accounts are kept for each establishment on the same basis as in the case of an independent enterprise engaged under similar conditions in the same line of business. The purpose of these accounts is to express dealings made with other establishments of the enterprise as if those dealings were with other firms unconnected with the establishment and were conducted in accordance with the market conditions relevant to such dealings.

The use of the method of separate accounting as the fundamental procedure for the determination of the profits attributable to each country in which an enterprise has an establishment is intended to serve four purposes: first, by treating a branch establishment not as part of an enterprise but as a self-contained unit and thus generally avoiding reference to results or data outside the country concerned, it gives the taxation of branch establishments a strictly territorial scope not extending beyond the boundaries of the countries concerned; secondly, the method helps to enforce the principle of equality of treatment of foreigners by placing, in principle, branches of foreign enterprises on the same footing as similar establishments of domestic enterprises as regards the computation of receipts and expenses, which, once they have been allocated or apportioned by separate accounting, are to be treated in accordance with the tax laws of the country to which they have been attributed; thirdly, the use of separate


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accounting as a basis for the assessment of income tax conforms to the usual practice among concerns engaged in international business of keeping separate accounts for each of their establishments; finally, separate accounting serves the revenue interests of the country concerned, since, when it is properly applied and supervised, it prevents the concealment of profits or their diversion from one country to another. In this connection, Article VI, paragraph 1, section B, of the Protocol specifically foresees the possibility of a rectification by the fiscal authorities concerned of the “accounts produced, especially in order to correct errors or omissions, or to re-establish the prices or remunerations entered in the books at the value which would prevail between independent persons dealing at arm's length”. A rectification made in the accounts of an establishment situated in one country should not, however, result in double taxation of the enterprise concerned. A rectification made in one country may therefore call for a corresponding adjustment in the accounts of the establishment in the other country with which the dealings to which the rectification referred have been effected. This matter is dealt with in the second sentence of the above-mentioned section B of paragraph 1 of Article VI of the Protocol.

The assessment of the profits of a permanent establishment according to the method of separate accounting implies that, when required, the necessary data are made available by the enterprise concerned to the tax authorities, and that the records of the establishment conform to certain standards of completeness and accuracy. When such conditions are not fulfilled, the assessment must be made on a presumptive basis. It is to this question that Article VI, paragraph 1, section C, of the Protocol refers. There it is provided that, if the establishment does not produce an accounting, or the accounting produced is deficient and the deficiencies cannot be remedied, or if the tax authorities and the taxpayer agree, the profits of the establishment involved may be determined by applying a certain percentage to its gross receipts. The object of the procedure remains, however, to treat the establishment of the foreign enterprise according to the same standards as a similar domestic concern engaged in the same line of business. It is therefore suggested that the percentage should be fixed by comparison with the


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conditions and the results of similar enterprises operating in the country. Moreover, it is specified that, when the activities of a permanent establishment resemble those of a commission agent or broker, the income may be determined on the basis of the customary commission received for such services. It may be noted that this “commission basis” may, when appropriate, be used by establishments keeping regular accounts and entitled to be assessed according to the method of separate accounting.

Section D of paragraph 1 of Article VI of the Protocol deals with the cases where neither the method of separate accounting nor the method of a percentage of gross receipts is applicable. Such a situation arises when a comparison between the nature of the activities and the conditions of operation of the establishment of the foreign enterprise cannot be made with those of full-fledged domestic enterprises. It is provided that, in this case, the method of fractional apportionment may be applied. Under this method, the earnings of each establishment are computed as a proportion of the entire profits of the enterprise to which the establishment belongs, on the basis of the general balance-sheet and profit-and-loss account of the enterprise. Such fractional apportionment may be unlimited or limited. In the first case, it takes as its starting-point the total income derived by the enterprise as a whole from all sources. In the second case, reference is made only to that part of the total profits of the enterprise which is derived from transactions in which a part has been taken by the establishment whose share in the total profits is to be determined. It is to this second form of fractional apportionment that recourse may be had according to the Protocol. The share of the total profits from joint transactions that is attributable to the establishment concerned is to be determined by dividing these profits according to the ratio that exists between certain factors pertaining to the establishment concerned and the total of the same factors for the entire enterprise. Examples of the factors that may enter into the apportionment formulæ are plant and equipment, circulating capital, payrolls, cost of operation, physical output, turnover. It is understood that the selection and the weighting of the different factors that it may appear appropriate to use will


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differ according to the type of enterprise. It is, however, provided that the formulæ of apportionment should be “so selected as to ensure results approaching, as closely as possible, those which would be reflected by a separate accounting”.

Though the method of fractional apportionment is mentioned by the Model Convention only in the third place, after the methods of separate accounting and percentage of turnover, this does not mean that the partial use of fractional apportionment is excluded when, as is generally desirable, branch establishments are taxed according to the method of separate accounting. There are, indeed, in most enterprises with two or more establishments certain items of expenses that must necessarily be apportioned in order to achieve the object of separate accounting, which is to place branches of foreign enterprises on the same footing as domestic concerns. An application of this idea is found in paragraph 2 of Article VI of the Protocol, which provides that, in the determination of the net income of a permanent establishment according to separate accounting, a share of the general expenses of the head office of the enterprise may be charged to the establishment.

The object of paragraph 3 of Article VI of the Protocol is to state explicitly certain corollaries of the method of separate accounting as applied to banking and financial enterprises. Thus it says that the interest on the permanent capital allotted to a branch cannot be deducted from the income of that branch in the country where it is situated even if the capital takes the form of an advance, loan, overdraft or deposit. On the other hand, when such items do not represent the permanent capital of the establishment concerned, the corresponding interest may be deducted from the gross income of the debtor establishment and treated as a receipt of the ereditor establishment.

In view of their special conditions of operation, insurance companies represent one of the forms of enterprise which call for particular rules in the allocation of their profits between their various establishments. It has seemed desirable, therefore, to specify in Article VI, paragraph 4, of the Protocol that, where required, the taxable income of the branch of an


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insurance company may be determined either by the method of percentage on gross receipts or by fractional apportionment. In the first case, coefficients established by reference to corresponding national enterprises in the country concerned would be applied to the gross premiums resulting from the activity of the branch concerned. In the second case, the income of the branch in question would be determined by applying, either to the total net income of the concern as a whole, or merely to that part of the total operating and investment income of the enterprise as a whole which corresponds to the kind of activities in which the branch in question is engaged, the ratio existing between the gross premiums received by the establishment and the total gross premiums received by the enterprise in connection with the same kind of business.

Ad Article V. — Income from International Navigation

The effect of Article V is to make income from international maritime and air transport taxable only in the country where the vessel is registered provided the owner or operator has his fiscal domicile in that country. The difference in wording of that article in the Mexico and London drafts is due to the fact that an attempt has been made to state this rule more precisely in the latter draft. The rule in question is contained in numerous special and general tax treaties. It is intended to facilitate the operation of international transport enterprises. It also avoids the numerous difficulties which experience has shown to be involved in the taxation of profits from international navigation outside the home-country of the operating enterprise.

For its part, inland water transport is not affected by Article V and remains, like rail and road transport, subject to the provisions of Article IV, which applies to business income in general. The provisions of that article remain applicable also to the income that a maritime or air transport enterprise might derive from services other than actual maritime or air transport—e.g., warehousing charges, insurance commissions and travel agency fees.




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Ad Article VI.—Remuneration from Personal Services and Private Employment

Article VI of the London draft reproduces Article VII of the Mexico draftnote and it is intended to cover the earnings from all private employments and professions. It does not apply, however, to private pensions, which are dealt with separately in Article XI, or to other forms of earned income which are mentioned in other articles such as Articles IV, V, VI and VIII.

The first paragraph of Article VI lays down the general principle that remuneration for labour and personal services, as understood in this context, is taxable only in the country where the services are rendered. According to paragraphs 2 and 3 of that article, however, a person having his fiscal domicile in one of the contracting States will be considered as having rendered services in the other contracting State only if the period or periods during which he has stayed in the other country exceed 183 days. This modification of the rule of taxing the remuneration for personal services in the country where the corresponding services are rendered is intended to facilitate the operations of enterprises engaged in international trade and the movement of workers across national borders.

Paragraphs 4 and 5 deal specifically with independent professions and embody rules similar to those of paragraphs 2 and 3 of Article IV relating to the taxation of business income according to the criterion of permanent establishment. According to paragraph 4, the country where the earnings from professional services are to be taxed is determined not by the actual place where the services are rendered but by the place where the taxpayer concerned has a permanent establishment in which or from which he renders his services. Paragraph 5 relates to the person who has offices in both contracting States. In this case, the taxpayer will be taxable in each State only


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to the extent that the income he receives results from services rendered in or from the office situated in that State.

Ad Article VII. — Civil Service Salaries and Pensions

The provisions contained in Article VI of the Mexico draft concerning civil service salaries and pensions have been reworded in Article VII of the London draft so as to be at once more comprehensive and precise. The effect of the article as it now stands is to exempt from income tax in a country remuneration from personal services rendered in that country when the following conditions are fulfilled:

  • (a) The paying authority must be the Government, a political subdivision or a governmental agency of one of the contracting States;
  • (b) The payee must be a national of the above-mentioned State;
  • (c) The payment must be in respect of the performance of diplomatic, consular or other governmental functions;
  • (d) Such functions must fall within the normal field of governmental duties and must not be connected with the carrying-on of a trade or a business on behalf of the paying authority.

Contracting States may find it convenient to specify the officials or functions that are to be covered by this rule, which is not intended to restrict any tax immunity or privilege granted to diplomatic or consular agents under international usage or treaties.

Ad Article VIII.— Dividends

In the Mexico draft, dividends and interest were covered together under the phrase “income from movable capital” in Article IX of the Convention, which was completed by a definition in Article IX of the Protocol.

In the London draft, Articles VIII and IX, which deal separately with dividends and interest, have taken the place


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of Article IX of the Mexico draft. According to this article, dividends were to be taxed in the country where the capital from which they were derived was invested—i.e., put into productive use. The result was that in most cases dividends would have been taxable in the same country as the business profits from which they were paid out.

According to Article VIII, paragraph 1, of the London draft, dividends are taxable in the country where the distributing entity has its fiscal domicile or, according to the provisions of Article II, paragraph 4, of the Protocol, its “real centre of management”. Therefore, in the case of a company having a branch establishment in a foreign country, the profits earned by the company will be taxable, in whole or in part, in that country according to the provisions of Article IV, which applies to business profits as such. But the dividends, or the profits the company itself distributes, will be taxable exclusively in the country of its fiscal domicile, subject, of course, to the provisions of Article XIII which apply to the taxation of the income as a whole of the person receiving the dividends.

The principle laid down in paragraph 1 of the present article is reasserted in paragraph 3 of that article, which refers also to “undistributed profits”. This reference is justified by the fact that, when distribution of dividends falls below a certain limit, the legislation of certain countries provides for a special tax on “undistributed profits”. It remains permissible, however, for countries which tax the earnings made by companies and similar entities through profits or corporation taxes, to apply such taxes under the rules of Articles IV and XIII.

Paragraph 2 of the present article is intended to avoid the special cases of double or multiple taxation which may occur when the income distributed by a company is derived from dividends received from subsidiaries or related companies, etc. It was thought that an equitable and convenient manner of avoiding such double taxation was to exempt inter-company dividend distributions when the recipient company had a dominant participation in the management or capital of the paying company, so that the dividends tax is collected once only on the final distribution of dividends.




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Ad Article IX.—Interest on Debts

According to the provisions of the London draft, interest on all kinds of indebtedness is to be taxed, in principle, exclusively in the State where the creditor has his fiscal domicile. This is the opposite of the rule contained in Article IX of the Mexico draft. Indeed, it was considered that, especially as regards interest, the country from which capital originated had a prior right to tax such interest wherever the capital was invested. Nevertheless, it was conceded that the State of the debtor could tax such interest in the same way as if it were paid to nationals or residents by means of deduction or withholding at source. At the same time, it was thought that this withholding tax should not exceed a certain percentage to be fixed by agreement.

Both as regards dividends and interest, it should be noted that the treatment of income from movable capital is one of the most complex questions that arise in connection with the prevention of international double taxation. In this matter, there is an opposition of interests between capital-exporting countries and capital-importing countries. The revenue interests of the former are best served by taxation of income from capital at the home of the creditor or beneficiary; those of the latter countries by taxation at the home of the debtor or, rather, the place where the investment is used.

The practical solution of the problem depends, in most cases, on the extent to which each of the contracting States is willing to limit its right of taxation in order to facilitate international investment. In this connection, it is advisable that regard should be had not only to the incidence of a tax on the income from imported capital, and the immediate effects of such measures on public revenue, but also to the consequences, economic and fiscal, entailed by the economic development, trade and increase of income which in both countries may follow the capital movements in question.

Ad Article X.—Royalties from Real Estate, Patents and Copyrights

In the same way as other income from real property, which is governed by Article II of the Model Convention, royalties


  ― 27[4347] ―
received by a person, as owner or possessor of real property in consideration of the right to use or exploit natural deposits and resources situated on the surface or in the subsoil of his property, such as mines, quarries, wells, springs, waterfalls, forests, are taxable in the country where the property is situated. In so far as a distinction between income governed by Article II and Article X respectively is required, for instance, in connection with computation of taxable income or application of tax rates, reference should be made to the provisions of Article III of the Protocol.

The second paragraph of Article X refers to royalties from scientific, industrial and commercial property, such as patents, secret processes and formulæ, trade-marks and trade-names. The Mexico Convention, applying the principle of immediate economic origin, placed them under a single rule according to which the royalties are taxable in the country where the patent or other similar right to which they correspond is exploited. As a result, the returns of patents and similar rights always remained taxable in the country where the rights were used, whether the proprietor exploited them himself or through a lessee.

Following a similar line of reasoning to that which inspired the new wording of Articles VIII and IX of the London draft, royalties from patents and similar rights are made taxable in the new version of paragraph 2 of the article under consideration exclusively in the country to which the grantor belongs. A restriction to that principle is, however, made by the new paragraph 3 in case the concession has taken place between inter-related enterprises. In that case, the royalties become taxable in the country where the rights are exploited subject to deduction of “all expenses and charges including depreciation relative to such rights”.

The fourth paragraph of Article X in the London draft is identical with the third paragraph of the Mexico version. Copyright royalties from artistic and scientific productions, wherever earned, remain exclusively taxable in the country where the recipient has his fiscal domicile or permanent establishment. The specific purpose of this rule is to facilitate cultural exchanges.




  ― 28[4348] ―

Ad Article XI.—Private Pensions and Life Annuities

The Mexico draft made private pensions and life annuities taxable according to the principle of taxation by origin in the country where the debtor has his fiscal domicile. This was in line with the rule adopted in Article IX of that draft as regards income from movable capital. In the London draft, private pensions and life annuities are made taxable in the country of fiscal domicile of the creditor, as in the case of interest from debts. In both drafts, Article X of the Protocol contains a special provision relating to the taxation of allowances of students and apprentices from one country who are staying in the other for their studies or training. These remittances are made exempt from taxation in the country where the beneficiaries are studying.

Ad Article XII.—Capital Gains

The first paragraph of Article XII in the London draft reproduces the provisions already contained in the Mexico draft. It stipulates that gains derived from the sale or exchange of real property are taxable only in the State in which the property is situated. As in the case of taxation of income from real property covered by Article II of the Model Convention, the clauses of Articles II and III of the Protocol would apply as regards matters of definition.

The second paragraph of Article XII in its London wording extends the provisions of Articles IV and V as regards the taxation of the gains derived from the sale or exchange of assets other than real property appertaining to a business enterprise. In other words, such gains would be taxable in the country where the income of the property which has been disposed of would itself be taxable.

The third paragraph states that gains derived from any other capital assets not covered in the preceding paragraphs should be taxed in the country of the fiscal domicile of the recipient. It is, of course, understood that the clauses referred to above apply only to the extent that the internal tax legislation of a country provides for the taxation of such capital gains.




  ― 29[4349] ―

Ad Article XIII.—Taxation Rights of the Country of “Fiscal Domicile”

Except for a slight change in wording which affects only the last section of the English text, the provisions of Article XIII are the same in the London and Mexico drafts. This article reserves to the country where the taxpayer has his fiscal domicile the right to tax the taxpayer's entire income even when it is taxable, in part or as a whole, in the other country. From the tax due in the country of “fiscal domicile” a deduction has to be made, however, on account of the taxes paid in the other country in accordance with the preceding articles of the Model Convention. The simplest manner of determining this deduction would be to take the actual amount of tax paid in the other country. Regard is to be had, however, not only to the interests of the taxpayer but also to those of the State in which he has his fiscal domicile. Article XIII admits, therefore, that, from the tax due in the country of “fiscal domicile”, the taxes due in the other country should be deducted only to the extent that they do not exceed that proportion of the tax effectively due in the country of domicile which corresponds to the proportion of the income taxable in the other country in relation to the entire income of the taxpayer.

It may be noted that the above-mentioned limit of deduction will operate in the country of “fiscal domicile” only when the tax schedule in the other country is so high that the effective percentage of tax in respect of the part of income taxable in its territory exceeds the tax percentage which in the country of “fiscal domicile” corresponds to the total income of the taxpayer.

In bilateral treaties, it may be found advantageous to combine with the clauses of Article XIII provisions fixing or limiting the rate of tax applicable to the income derived from a country by a taxpayer having his “fiscal domicile” in the other country. Such fixed or ceiling tax rates might, in particular, be contemplated in connection with income from capital and this is provided for in paragraph 3 of Article IX of the London draft.

A special question arises in connection with dividends paid to a person by a company in the country other than that


  ― 30[4350] ―
in which he has his “fiscal domicile”. Depending on the system followed by that country in respect of the taxation of corporate income, the tax borne by such dividends may take different forms—e.g., the form of a tax paid by the distributing company in its own name or that of a tax on corporate earnings. Therefore, to enable the taxpayer in receipt of dividends so taxed in the country of their origin to obtain, in connection with such dividends, the deduction provided by Article XIII, it may be desirable to stipulate that taxes which a company is required to withhold from dividends it distributes or to pay on such dividends shall be considered as having been paid by the shareholder for the purpose of this article.

Taxable years and tax collection dates differ from country to country. This should be considered when determining, in tax treaties, the taxes which may be deducted or offset against one another according to Article XIII.

Ad Article XIV.—Fiscal Domicile in Two Countries

Article XIVnote relates to the case of taxpayers who, as the result of the construction given to the articles of the Convention by the national tax administration or of the internal legislation of the contracting parties, might be regarded as having a “fiscal domicile” in each of the two countries concerned. It also applies to taxpayers who move from one country to another in the course of a taxable year.

In its present wording, the article implies that income tax is collected in the year following that in which the income was earned. It provides that the tax pertaining to the country of “fiscal domicile” under Article XIII shall be divided between the contracting States in proportion to the period of stay during the taxable year, or according to some other proportion to be agreed upon by the competent authorities. In connection with this article, there arises the same question as was mentioned in the final paragraph of the commentary to Article XIII concerning differences in taxable years.




  ― 31[4351] ―

Ad Article XV.—Taxes on Property and Wealth

This article, which was not included in the Mexico version, was drafted at the London meeting in order to take care of the cases of double taxation which may arise in connection with the taxes on property, capital and increment of wealth which a number of European countries apply as a complement to income taxes or have introduced as special war or post-war measures. The principle laid down in this article is that property, capital and increment of wealth may be taxed in a country only if that country would have the right to tax, according to the preceding provisions of the Model Convention, the income originating from the assets in question.

Ad Article XVI.—Equality of Treatment

The purpose of Article XVI is to prevent discriminatory treatment in one country of taxpayers having their “fiscal domicile” in the other country whether or not they are nationals of that country. It specifically debars either of the contracting States from subjecting taxpayers having their fiscal domicile in the other State to higher or other taxes than those applicable in respect of the same income to taxpayers who have their fiscal domicile in the former State or are nationals of that State. There is no doubt that these provisions are also intended to apply, [?]mulatis mutandis, to the taxes on property, capital or increment of wealth mentioned in Article XV, though this is not specifically stated in the Model Convention.

Ad Article XVII.—Taxpayers' Rights of Appeal

The special procedures of appeal provided for in Article XVII are intended not to replace but to supplement the procedures of tax appeal established by the tax legislation of the contracting States. The taxpayer who, in spite of the provisions of the Convention, has suffered double taxation has the option of filing his appeal with the tax authorities of the country of which he is a national or of the country where he has his fiscal domicile; for it seems legitimate that he should be able to obtain the protection in tax matters of one or the other


  ― 32[4352] ―
State according to the circumstances. It should, moreover, be noted that the procedure contemplated is not a judicial procedure, but a direct consultation between the tax administrations involved.

Ad Article XVIII.—General Preservation of Taxpayers' Rights

It may happen that the internal legislation of a country party to a double-taxation treaty grants certain benefits to taxpayers in the form of exemptions, deductions, credits, allowances, rights of appeal, etc., which are more advantageous or more convenient to the parties concerned than the provisions of the Model Convention. It is the object of the new Article XVIII of the London draft to specify that such benefits are not impaired by the provisions of the Convention.

Ad Article XIX.—Relations between Tax Administrations

The object of Article XIX of the London draft, which, except for an additional clause, follows the wording of Article XVII of the Mexico draft, is to entitle the tax administrations of the contracting States to correspond directly with one another and to co-operate in the application of the Convention, without necessarily having to resort to diplomatic channels. It also enables them to agree on administrative provisions which, while not expressly provided for in the Convention, are in accordance with its spirit and may be required to give it full effect.

The addition to which reference has just been made is intended to permit tax administrations to adapt the provisions of the Convention in the event of “substantial changes in the tax laws” without having resort to the formal conclusion of a new convention.

Ad Article XX.—Ratification and Duration of the Convention

The final article of the Convention deals with the procedure of ratification. It refers also to the entry into force of the


  ― 33[4353] ―
Convention and to its duration. In this connection, an initial period of three years is suggested, as such a period seems to be generally desirable in order to give sufficient trial to the system of preventing double taxation which is embodied in the Model Convention. A question which tax negotiators may have to consider in fixing the dates of entry into force of the Convention is that of the possible differences in fiscal years. In many conventions that have been concluded in the past, their date of entry into force has been fixed independently of the actual date of ratification. Quite a few of them have been made retroactively applicable to tax claims relative to previous tax years that are outstanding at the time of the signature of the convention and which would not have arisen if the facts motivating such claims had taken place after the entry into force of the convention.




  ― 34[4354] ―

II. Commentary on the Model Bilateral Convention for the Prevention of the Double Taxation of Estates and Successions

GENERAL STRUCTURE OF THE MODEL CONVENTION

There is an analogy between the forms of double taxation that may occur through duties on estates and successions and through taxes on income and property.

As in the case of income tax, liability to estate and succession duties may indeed have a personal or an impersonal basis. In other words, an estate may be held liable to duty in a country on account of the nationality or domicile of the deceased and, at the same time, be taxed in another country on account of the situation of property belonging to the estate.

Double taxation of an estate may also occur because it is taxable in one country on account of the nationality of the deceased and in another country on account of his domicile. In this connection, there may be, furthermore, differences as to the determination of the nationality or the domicile of the deceased.

An estate will also be exposed to double taxation when two or more countries regard a given property as subject to duty in their respective territories because they employ different criteria regarding impersonal tax liability. One country may, for instance, take into account the physical location of the property, while the other refers to the legal situs of such property, and there may be divergencies as to the determination of such situs.

Consequently, there is a noticeable parallelism between the Model Convention on estates and succession duties and the Model Convention concerning income and property taxes, both in the Mexico and London drafts.




  ― 35[4355] ―

The field of application of the Model Convention on estates and successions is defined in Article I. Articles II to IV refer to the taxation of estates according to situs. Article II deals especially with real property and its appurtenances, Article III with personal property related to a business enterprise and Article IV with other kinds of personal property. Article V regulates the allocation of debts between the two countries concerned in order to determine the net value of the estate taxable in each country. Taxation in the country of domicile of the deceased is governed by Article VI, which, in a manner analogous to Article XIII of the Model Convention on income and property taxes, provides that the country of domicile of a deceased person, while entitled to tax the entire value of the estate involved no matter where the property is situated, should grant a deduction from its taxes on account of the taxes paid in the country where a part of the estate is taxable in accordance with any of the provisions of Articles II to V. In the London draft, however, real property is excluded from taxation in the country of domicile. Article VII refers to the continuous co-operation which should be maintained between tax administrations for the purposes of the application of the Convention, and Article VIII refers to the entry into force, duration and termination of the Convention.

The Convention is followed by a Protocol containing rules intended to facilitate the settlement of questions arising in connection with the determination of domicile of a deceased person and the taxable situs of the various kinds of property. In this respect the London draft is more complete than the Mexico draft and contains specific indications as to the determination of the situs of personal property for the purposes of estate duties. According to the method followed in the commentary on the Model Bilateral Convention for the Prevention of Double Taxation of Income and Property, the provisions of the Protocol to the present Model Convention will be dealt with in conjunction with the articles of the main Convention to which they refer.




  ― 36[4356] ―

Ad Article I. Object and Scope of the Model Convention

The wording of Article I in the London draft is simpler and briefer than in the Mexico draft. But it is clear in both drafts that the provisions of the Model Conventions are to apply to the estates of persons domiciled at the time of their death in either one of the contracting States, whether or not they were nationals of that State or of the other State. The estate of a foreigner is indeed generally subject in that country to the same tax liability as the estate of a national. It seems therefore appropriate that relief from international double taxation of an estate should be granted, irrespective of the nationality of the deceased, when he was domiciled at the time of his death in either one of the contracting States.

In the present Model Convention, “domicile” is defined somewhat differently from what it is in the Model Convention for the Prevention of the Double Taxation of Income and Property. In that text, it may be recalled, the “fiscal domicile” of the individual is “the place where the individual has his normal residence, the term ‘residence’ being understood to mean permanent home”.note According to Article I of the Protocol of the Model Convention on estate and succession duties, “the domicile of a person at the time of his death is the place where he then had his permanent residence with the manifest intention of retaining it”. Although the wording of this definition of “domicile” differs slightly from that of the definition given by the General Meeting of Government Experts on Double Taxation in their model bilateral convention on succession duties, their comments on the matter still apply to the new definition. They stated that:

“It is clear that the conception of domicile appropriate to a duty which is levied once and for all on the occasion of death must imply a greater degree of permanence than the conception on which an annual tax such as the income tax is based. It is unlikely that any State would claim the right to levy a death duty on the whole property of a deceased person on the ground that at the time of his death he was temporarily resident within its borders if his permanent


  ― 37[4357] ―
home and true economic allegiance lay elsewhere. But when it is sought to define the precise character and degree of permanence of the residence which should exist in order to justify a claim to tax on the ground of domicile, wide divergencies of view are found to exist in the different legal systems of the various countries of the world. In these circumstances, it has not been found possible to do more than frame a definition which seems to command the greatest common measure of agreement in the various codes of law”.note

The second paragraph of Article I of the Protocol covers the case of deceased persons who at the time of their death had no domicile as defined above and were nationals of both contracting States. In such cases, it shall be presumed that the deceased “had his domicile in the country in which his family, social and economic interests were centred”. Though there is no provision in the present text concerning deceased persons who had no “domicile” as defined above but were nationals of only one of the contracting States, it may be presumed that it was intended that in such cases the deceased would be considered as having his domicile in the country of which he is a national, in accordance with the rule contained in the model convention of 1928.note

The taxes to which the Model Convention should apply include duties based on the total value of the estate of a deceased person irrespective of the manner in which such estate is divided and distributed among heirs or legatees, and duties assessed on the value of the share accruing to each heir or legatee and computed with reference not only to the value of that share but also to the degree of relationship between the deceased and the successor concerned.

Article I of the Model Convention is drawn up in such a way as to enable the negotiators using the Model Convention to enumerate the duties to which they desire that the Convention should apply. In this connection, it would have to be determined in the case of each bilateral treaty whether it should or should not apply also to gifts inter vivos, as such gifts are taken into account in certain countries in the computation of death duties, subject to certain conditions relating to


  ― 38[4358] ―
their amount and to their proximity in time to the decease of the donor. A similar question may arise with respect to the judicial and administrative fees collected in connection with the distribution of an estate.

The Protocol contains a clause—Article VIII in the Mexico draft and VII in the London draft—which in varying forms is found in a number of conventions concerning death duties. It safeguards the tax immunities that are granted or may be granted to diplomats and similar public officials, and protects the right of the country of which the above-mentioned officials are nationals to tax upon their decease the property which they leave in the other contracting State, subject to the general rules of international law and of internal law of the two countries concerned.

Ad Article II.—Real Property

Article II of the Model Convention merely conforms to the rule contained in all national legislation and bilateral agreements according to which real property, personal property accessory thereto, and rights relating to, or secured by, real property are subject to the estate and succession duties and similar taxes in the country where the property is situated, irrespective of the domicile or nationality of the deceased.

Article II of the Protocol, which states that it is the law of the State in which the property is situated that should determine whether it is real or personal, also follows a generally accepted practice.

Ad Article III.—Business Establishments

The provisions of Article III have been drawn up in the light of the bilateral conventions concluded during the inter-war period. Most, if not all, of these conventions stipulate that commercial, mining and agricultural establishments are subject to estate and succession duties in the country where they are situated. This rule applies not only to the tangible property which materially represents the business establishment but also to all assets which pertain to the business carried on in such establishment, since such business property


  ― 39[4359] ―
constitutes an accounting unit which should be taxed as a whole.

In conformity with these principles, Article III contains two rules which relate respectively to the case where an enterprise which is part of a taxable estate has a permanent establishment in one country only and the case where it has one or more establishments in each of the contracting States. In the first case, the entire property pertaining to the permanent establishment is taxable in the country where the establishment is situated. In the second case, each country is entitled to tax the property of the enterprise to the extent to which such property belongs or relates to the establishment or establishments situated in that country. The problem of allocation which this procedure entails is to be solved according to Article IV of the Protocol, by means of the criteria and accounting rules contained in Articles IV, V and VI of the Protocol of the Model Convention for the Prevention of the Double Taxation of Income and Property which define, among other things, the phrase “permanent establishment”, and indicate the accounting rules to be followed in the allocation of the assets and liabilities of such establishments.

Ad Article IV.—Personal Property

Article IV of the Convention, relative to personal property not covered by Articles II and III, has to be read in conjunction with Article V of the Protocol. This article of the Convention entitles the country where property is situated at the time of death of the deceased to apply its estate and succession duties to such property. In the Mexico draft, the article in question included certain clauses which were, in fact, a duplication of the more detailed provisions of Article VI relative to the taxing right of the country of domicile. Moreover, the Mexico draft gave no specific indications as to the criteria according to which situation of property was to be determined for estate and succession duty purposes. This gap is now filled by the detailed provisions of Article V of the Protocol of the London draft. It should be noted that the rules suggested in Mexico and in London concerning personal property constitute a departure from the general trend of the treaties concerning


  ― 40[4360] ―
death duties which were concluded up to the war recently ended. In this connection, it was proposed at the Mexico Conference that the present article of the Model Convention should be worded as follows:

“All other property to which Articles II and III do not apply shall be exclusively taxed in the country of the fiscal domicile of the deceased.”

It was argued in support of that suggestion that it was by no means generally admitted in private international law that, for purposes of successions, the law of situation of the property should apply in so far as personal property is concerned; in this respect, many jurisdictions refer to the law of domicile. It was observed that none of the bilateral conventions that had been concluded for the prevention of double taxation concerning death duties provided for the taxation of property other than real estate and business enterprises and their appurtenances in the country of situation. Attention was also drawn to the fact that exclusive taxation of property other than that covered by Articles II and III in the country of domicile of the deceased might prove more convenient both for the heirs and for the tax administrations concerned.

Ad Article V.— Deduction of Debts

Since death duties are generally assessed on the net value of the taxable estate, it is desirable therefore to indicate in what manner and proportion debts should be deducted from the property taxable in each of the contracting States. Such is the purpose of Article V of the Model Convention.

Two main kinds of debt may be distinguished for this purpose:

  • (a) Special debts which are secured by or relate to specific property, such as debts guaranteed by a mortgage or a lien;
  • (b) General debts which are not especially guaranteed by, and are not otherwise manifestly connected with, any particular asset of the deceased.



  ― 41[4361] ―

As regards the first kind of debt, the conventions concluded during the 'twenties and 'thirties have stipulated that they were deductible from the real estate or the industrial and commercial establishments to which they were related. The fairness of such provisions is obvious. Section A of the article under consideration is worded to that effect.

It may happen that such special debts exceed the value of the property from which they should be primarily deducted. Section B prescribes that the amount of such excess should be deducted from the value of the other property which the deceased may have held in the same country at the time of his death. In the normal course of events it may, indeed, be presumed that the debt has a greater degree of connection with the property situated in the same country as the original guarantee than with property situated elsewhere.

Only when the amount of the special debt involved exceeds the value of all the property left by the deceased in the country where the original guarantee is situated, may the debt be deducted from property situated in the other country, according to Section C.

As regards general debts, it seems logical, as suggested in Section D, that they should be deducted proportionately to the value—net or gross according to the terms of the agreement which would have to be reached in that connection—of the property left by the deceased in each country, in view of the present wording of Articles II, III and IV.

If Article IV had been drafted in such a way as to give to the State of domicile the exclusive right of taxing property not covered by Articles II and III, then the rule as regards the deduction of general debts might have been the following:

“A general debt without specific guarantee shall be deducted from the property taxable in the country of domicile of the deceased in accordance with Article IV. If such a debt exceeds the value of the property taxable in the country of the domicile of the deceased, the excess shall be deducted from the value of the property in the other country.”

Article V of the Model Convention is completed by Articles VI and VII of the Protocol in the London draft. The


  ― 42[4362] ―
effect of these provisions is that, once the debts of an estate have been allocated between the two contracting States according to the provisions of Article V of the Convention, the question of whether a debt so allocated is to be deducted from the property in the country concerned will depend on the general provisions which the legislation of that country contains as to the conditions under which a debt may be deducted from the value of an estate for tax purposes.

In the Mexico draft, there was a special rule embodied in Article VII of the Protocol concerning the deduction of debts from inalienable property. This rule, which had been taken from certain relatively old treaties between Central European countries, was left out in the London draft because it had little practical significance.

Ad Article VI.—Domicile Taxation

Article VI in the Mexico draft stipulates that, while the country of domicile is entitled to impose its duties on the entire estate of the deceased, it should deduct from the tax so assessed the amount of tax due in the other country, under Articles II, III and IV, provided that the amount of this tax does not exceed a certain proportion of its own tax. This proportion is determined by computing the ratio which the tax of the country of domicile that corresponds to the property taxable in the country of situation according to Articles II to IV bears to the total tax which would have been due if the entire estate had been taxable in the country of domicile of the deceased. This method of preventing double taxation through death duties corresponds to that provided in Article XIII of the Model Convention for the Prevention of the Double Taxation of Income and Property.

The general principle and the wording of this article are the same in the London draft as in the Mexico draft except that the country of domicile is no longer entitled to take into account real property taxable in the country of situation according to Article II in determining its tax on the total estate. It seems to follow that the country of domicile is not expected to grant a deduction from, or credit against, its tax on the total estate on account of the taxes paid in the country


  ― 43[4363] ―
of situation under Article II. In other words, according to the London draft, the application of estate and succession duties on real property is made quite independent of the taxation of the entire estate in the country of fiscal domicile of the deceased.

Ad Article VII.—Inter-Administrative Co-Operation

As in the matter of income taxes, the prevention of double taxation through death duties cannot be assured merely through provisions which each administration would apply separately and interpret independently. Article VII of the present Model Convention reproduces, therefore, the provisions of Article XVII of the Model Convention on income and property taxes which relate to inter-administrative consultation and co-operation.

Ad Article VIII.—Ratification and Duration of the Convention

The wording of Article VIII of this Model Convention is the same as that of Article XVIII of the Model Convention on income and property taxes and the same considerations apply in both cases.




  ― 44[4364] ―

III. Commentary on the Model Bilateral Convention for the Establishment of Reciprocal Administrative Assistance for the Assessment and Collection of Taxes on Income, Property, Estates and Successions

Introduction

Following the precedents of the General Meeting of Government Experts on Double Taxation and Fiscal Evasion of 1928, it appeared desirable at the Mexico and London meetings to complement the model conventions on the prevention of double taxation with a Model Convention on Reciprocal Administrative Assistance in tax matters.

Nevertheless, while the Government Experts drafted two separate model conventions dealing respectively with assessment of taxes and with collection of taxes, both subjects are now treated in a single instrument. Indeed, the kind of co-operation which is required for reciprocal assistance between administrations for the assessment and for the collection of taxes is substantially the same in both fields. Consequently, many formal provisions are valid in both cases. At the same time, if tax negotiators desire to restrict administrative co-operation to matters of assessment, as is not infrequently done in bilateral agreements, it is simple to eliminate from the Model Convention the provisions which find an application only as regards the collection of taxes.

The object of the Model Convention is indicated in its Article I, which provides that co-operation between tax administrations for the assessment and collection of taxes should be limited to taxes in connection with which double taxation has been or is being avoided and this article makes the provisions of the Convention subject to reciprocity. Article II lays down the bases upon which tax administrations would be entitled to correspond in connection with exchange of information. Article III relates to certain kinds of easily available data for which the procedure of exchange of information


  ― 45[4365] ―
is simplified in the Mexico draft and made automatic in the London draft. Collection of taxes is dealt with in Article IV. Article V indicates certain cases where a request for information or for assistance in tax collection may be rejected at the discretion of the authorities receiving the request. The rules as to the secrecy to be maintained by the officials of one administration in connection with information received from the administration of the other country are contained in Article VI. Article VII deals with the measures which the tax administrations of the contracting States may take in consultation to carry out and interpret the Convention, and Article VIII refers to the entry into force, duration and termination of the agreement.

A detailed Protocol contains provisions concerning the following matters: designation of the authorities entitled to correspond with one another for the application of the Convention; manner in which the existence of reciprocity will be ascertained in the case of the various types of requests; form in which requests may be made and the documents that should accompany them; action to be taken by an administration receiving a request for assistance; form which should govern legal and judicial acts performed in compliance with the Convention; rules applying to collection, handling, transfer of funds, and settlement of accounts between the two administrations.

Ad Article I.—Object and Scope of the Model Convention

According to the initial clauses of Article I, the object of the Model Convention on Reciprocal Administrative Assistance is that “of assuring, in the interest of Governments and taxpayers, an effective and fair application of the taxes to which apply the Conventions for the Prevention of the Double Taxation of Income, Property, Estates and Successions”. It is indeed the duty of revenue authorities to see that each taxpayer should pay the taxes for which he has been assessed according to the laws of the country under the jurisdiction of which he comes. Failure to collect such taxes is indeed susceptible of impairing the services which the Government


  ― 46[4366] ―
should render to the public or bringing about an increase of the taxes borne by non-delinquent taxpayers.

Bilateral arrangements between tax administrations for the prevention of fiscal evasion have, on various occasions, met with suspicion. Various reasons may explain this distrust. There may have been a certain background of opposition to direct taxation, or at least to certain of its forms, and to an increase of the investigating powers of revenue authorities. Another factor was an unwillingness to place the facilities of the national tax administration at the disposal of foreign authorities and still more to introduce new tax practices in order to suit the requirements of foreign Governments. In certain instances, there was a fear that the existence of too close a system of tax supervision and control would induce capital to prefer countries where its tax treatment was less strict or less burdensome. Moreover, the feeling was sometimes manifested that the proposals which ostensibly related to the prevention of fiscal evasion constituted in reality an attempt to interfere with the freedom of capital movements.

These objections have not, however, prevented some thirty-odd bilateral conventions on reciprocal assistance between tax administrations from being concluded by some fifteen countries, mostly European, during the inter-war period, and it is clear that, in so far as they exist, the dangers mentioned above may be avoided through appropriate provisions.

It is but legitimate that reciprocal assistance between tax administrations should exist only as regards taxes concerning which double taxation is avoided, or at least mitigated, between the two countries. This is clearly stipulated in Article I, which makes the Convention on reciprocal administrative assistance a complement to the Conventions on the prevention of double taxation through income taxes and death duties.

It is also stated in Article I that assistance must be reciprocal. To exist, such reciprocity requires that the tax legislation and organisation of each of the contracting States are such that the powers of the respective national administrations to obtain information and to enforce revenue claims are substantially the same, except for mere formal differences


  ― 47[4367] ―
in procedure. Article II of the Protocol indicates the manner in which the existence of reciprocity should be ascertained in each case.

Reciprocity means also that the State that receives a request for assistance from the other State should in principle exert the same diligence in carrying out such request as if it were acting on its own behalf. The provisions of Article I of the Model Convention are completed in this respect by those of Article VII of the Protocol in the Mexico draft, V in the London draft, concerning the duties of the tax authorities of a country with regard to requests for assistance from the corresponding authorities of the other country.

The fact that there is an arrangement for tax assistance with another country should not give to any national tax administration greater powers of investigation and tax enforcement against its own taxpayers than those which are conferred upon it by its own domestic legislation. Such extension might, indeed, indirectly violate the guarantees granted to the taxpayers by that legislation. At the same time, an agreement for reciprocal tax assistance should not imply for any administration the obligation to take any measure that is repugnant to its national legislation or its established practices. It is therefore stipulated in Article I, in addition to the general requirement of reciprocity, that the information that may be furnished under the Convention will be. “such information in matters of taxation as the competent authorities of each State have at their disposal or are in a position to obtain under their own laws.…”

Mention may also be made, in this connection, of Article V of the Model Convention, which stipulates, among other things, that requests for information may be denied if they involve the obligation to obtain or supply information which is not procurable under the legislation of the State applied to or under that of the applying State, or if they imply administrative or judicial action incompatible with the legislation and practices of either contracting State.

Reference should also be made, however, to Article X of the Protocol, which admits as an exception to or modification of the principles which have just been outlined that “any special forms of assistance not being incompatible with the


  ― 48[4368] ―
laws of the State applied to may be adopted at the request of the applying State”.

In order to complete the enumeration of the general conditions under which reciprocal assistance may be granted in tax matters, it may be well to mention at this juncture certain other provisions contained in Article V of the Convention, which is in effect a complement of Article I.

In addition to the requirements which Article I imposes, as mentioned above, regarding reciprocity and compatibility of the requests for assistance, and the action taken thereon, with the legislation and practice of both contracting States, in Article V it is provided that administrative assistance should never entail for either administration the necessity for taking measures that might imply the violation of a professional, industrial or trade secret. This matter of administrative secrecy is also dealt with in Article VI of the Model Convention.

It may not be thought desirable that an agreement for reciprocal administrative tax assistance should result in a State's abandoning its citizens who are taxable in another country entirely to the discretion of a foreign tax administration and, moreover, putting itself under the obligation to carry out at the request of such an administration measures that may not be in harmony with domestic customs. Such a danger is already reduced by the article of the Model Convention for the Prevention of the Double Taxation of Income and Property which relates to equality of treatment (Mexico draft, Article XV; London draft, Article XVI). Moreover, Article V gives the authorities of the State applied to the right in various cases to refuse at their discretion to give effect to a request for tax assistance when it relates to one of its nationals.

The safeguarding of the rights of domestic creditors in the State which receives a request for assistance as regards collection of taxes may also have to be taken into account. It is for this reason that the Protocol (Article XI, Mexico draft, Article IX, London draft) provides that “revenue claims for collection shall not receive preference over either public or private claims in the State applied to” whatever may be the priority given to such revenue claims in the country by which the request for assistance in collection is made.




  ― 49[4369] ―

Ad Article II.—Information to be Supplied on Request

The object of Article II is to enable the competent authorities of the contracting States to correspond directly as regards the information they may need from one another in connection with the taxes to which the Convention applies, as such taxes are defined in Article I of the present Model Convention and by the initial articles of the Model Conventions on the prevention of double taxation through income taxes and death duties.

The compliance with such requests is of course subject to the general conditions which have been reviewed above in the comment on Article I.

As to the rules that apply specifically to the subject-matter of Article II, it may be noted that, according to Article I of the Protocol, the competent authorities that are entitled to correspond in this connection are “the highest tax authorities of each of the contracting States or the duly authorised representatives of such authorities”.

Such requests should be formulated in the official language of the applicant State. They should specify the authority making the request, the name and address and nationality of the person to whom the request relates, the taxation in respect of which it is made, according to the Protocol (paragraph 1 of Article IV, Mexico draft; Article III, London draft). They should be accompanied by a declaration by the competent authorities who make the application, officially confirming that any similar request would be complied with in accordance with the laws of the applicant State, according to Article II of the Protocol, unless the information falls within the scope of Article III of the Convention, in which case reciprocity will be presumed to exist without any specific declaration to that effect.

The information that may be applied for under this article may be in the hands of the administration to which the request is directed or it may have to be secured from an outside source. This source may be the party concerned himself or persons who, as a result of their relations with the taxpayer, can give information about his affairs, or resort may have to be made to experts or witnesses. In all such cases, the authorities


  ― 50[4370] ―
receiving a request, provided that the request is allowable under Articles I and V of the Model Convention, must exert diligence in complying with the request (Article XIII of the Protocol in the Mexico draft, XI in the London draft), must advise the applicant authority as to the action taken on the request (Article XIII of the Protocol in the Mexico draft, XI in the London draft) and, if the request cannot be complied with, must state the reasons why, transmitting all the relevant information that is in their possession and that they may communicate (Article XIV of the Protocol in the Mexico draft). This latter provision was eliminated as redundant in the London draft.

If compliance with a request requires a formal procedure such as legal service of documents, the provisions of Article IV, paragraph 2, of the Protocol apply. Accordingly, the authority making a request has to indicate “the address of the recipient and the nature and purpose of the document for service”. The form of service is itself governed by Articles VI and VII of the Protocol in the Mexico draft, IV and V in the London draft, which provide that the authorities receiving a request for the service of a document “may limit their action in connection with the service of the document to merely handing it to the recipient, if the latter is willing to receive it” and that, “if the competent authorities of the applicant State so desire, the document may be served in the form prescribed in similar cases by the internal law of the State applied to”. It may also be noted that Article X of the Protocol in the Mexico draft, VIII in the London draft, stipulates that “assistance procedure shall be in the form for which the laws of the State applied to provide.… Any special forms of assistance not being incompatible with the laws of the State applied to may be adopted at the request of the applying State”.

As regards the expenses which may be involved by requests for assistance, reference should be made to Article XVIII of the Protocol in the Mexico draft, XV in the London draft, which provides that, in principle, assistance is to be gratuitous, except with regard “to emoluments paid to witnesses, experts, agents of execution and to legal and judicial fees incurred in connection with the service of a document or the enforcement


  ― 51[4371] ―
of a revenue claim. The revenue authorities shall notify one another as required of the probable amount of such costs, fees or charges”.

Ad Article III.—Exchange of Readily Available Information

An increasing number of tax agreements provides for the automatic exchange between national revenue authorities at the end of each year of information on payments of rents, dividends, interest, royalties, annuities, salaries, pensions, on bank accounts and deposits, and on inventories of estates. These data are indeed frequently collected by tax administrations in the ordinary course of their business and they can conveniently transmit them to the authorities of another country when they concern a foreign taxpayer. It is the object of Article III of the London draft to provide for such exchange of information.

Though the formula now embodied in the London draft was submitted to the Mexico meeting, it appeared at that time that an automatic exchange of information between tax authorities would work satisfactorily only in the case of countries having a very-well-established tax system and administration. It was therefore not deemed desirable to provide for such a procedure in the Model Convention as prepared in Mexico. Nevertheless, even in the Mexico draft there remains a distinction between the information generally included under Article II and the four kinds of data specifically mentioned in Article III. Indeed, a request for information under Article II may be rejected by the administration receiving such a request on any of the grounds mentioned in Article V. On the other hand, these limitations do not apply to the information specifically mentioned in Article III, since the reservations and safeguards contained in Article V do not seem to be called for in the case of such information. Moreover, reciprocity is presumed to exist as regards information covered by Article III, without any special declaration to that effect in the case of each individual request.




  ― 52[4372] ―

Ad Article IV.—Assistance in Tax Collection

The main rules governing the assistance which the tax administration of one State may render to that of the other State as regards tax collection are contained in Article IV. The provisions of this article are of course subject to the reciprocity requirements of Article I of the Convention and Article II of the Protocol and to the general safeguards of Article V (in particular, Sections B and D) of the Model Convention.

Assistance as regards collection may, in principle, be asked only as regards revenue claims which are definitely due, though paragraph 4 of Article IV contemplates the possibility of measures of conservancy in connection with revenue claims not definitely due.

Under the general rule requests for collection assistance “shall be accompanied by such documents as are required by the laws of the applying State to establish that the taxes are definitely due” (paragraph 3 of Article IV of the Model Convention) and that requirement will be satisfied “by a copy or official extract of the final decision or order by the competent authorities concerning the revenue claim in question and by a statement from the competent authorities to the effect that the revenue claim is final” (Article VIII of the Protocol in the Mexico draft, VI in the London draft). The claims for which collection assistance may be requested include in addition to the principal of the tax, the “interest, costs, additions to taxes, and fines not being of a penal character, according to the laws of the State applied to” (Article IV of the Convention, paragraph 1). Nevertheless, requests for assistance should only be made when the amount involved justifies such procedure and when the State concerned cannot collect it by its own means (Article IX of the Protocol in the Mexico draft, VII in the London draft).

The provisions mentioned in the last two paragraphs of the comment to Article II, as regards the form of service of documents, rules of procedure (including forms of representation) and the refund of expenses, apply when requests for collection assistance involve legal action or judicial proceedings. In such cases, however, requests for the service of documents should


  ― 53[4373] ―
indicate, in addition to the information required for collection purposes: “the amount of principal due and interest due and the date from which such interest begins to run; in the case of fiscal penalties, the nature and amount of such penalties; and any other information of a nature to facilitate or accelerate collection” (Article IV of the Protocol, paragraph 3).

To safeguard the interests of domestic creditors in the State applied to, Article XI of the Protocol in the Mexico draft, IX in the London draft, provides that “revenue claims for collection shall not receive preference over either public or private claims in the State applied to”.

According to Article XVI of the Protocol in the Mexico draft, XIII in the London draft, “collection shall always take place in the currency of the State applied to”. To that effect, the amount for collection will be converted by the authorities of the State applied to into their own currency at the last exchange rate quoted on the appropriate market. These provisions presuppose, of course, a certain stability of exchange rates, and special arrangements might have to be considered in the case where either or both of the countries concerned have a highly fluctuating currency. Article XV of the Protocol in the Mexico draft, XII in the London draft, provides that “the State applied to shall be responsible to the applying State for the sums collected on the latter's behalf …” and Article XVII of the Protocol in the Mexico draft, XIV in the London draft, stipulates that the amount so collected shall be paid over to the account of the central bank of the applying State with the central bank of the State applied to after deduction of the costs that may be due as indicated in the last paragraph of the comment to Article II.

According to Article XIX of the Protocol in the Mexico draft, XVI in the London draft, the Convention does not apply to measures of conservancy in respect to taxes that have not yet been assessed. However, as regards taxes that have been assessed, but are not definitely due, the tax authorities concerned may request the corresponding authorities of the other State “to take such measures of conservancy as are authorised by the revenue laws of the State interested”, subject, of course, to the general requirements of reciprocity contained in Article I of the Convention, Articles II and XII


  ― 54[4374] ―
(last sentence) of the Protocol in the Mexico draft, II and X in the London draft, and the safeguards contained in Article V of the Convention.

Ad Article V.—General Safeguards

Reference has been made in connection with all the preceding articles of the Model Convention to Article V, since its clauses are key provisions which delimit the practical scope of the system of reciprocal administrative assistance contemplated in the Model Convention. According to this article, any request for information or for assistance with regard to collection is allowable only if it entails action that is compatible with the legislation of both contracting States. It safeguards also professional, industrial and trade secrecy, and it gives the authorities receiving a request for information or for assistance the right to decline to comply with such a request when [?]it relates to a taxpayer who is one of their nationals or when compliance may endanger the security or sovereign rights of the State applied to. It should, however, be noted that the reservations of Article V do not apply to the information mentioned under Article III of the Convention, as in ordinary practice such information is readily available and does not involve probing into the intimate affairs of a person or into governmental secrets.

Ad Article VI.—Safeguards of Administrative Secrecy

Reciprocal assistance between tax administrations is possible only if each administration is assured that the other administration will treat with proper confidence the information which may have to be communicated to it in the course of their co-operation. At the same time, the respect of such secrecy by the officials of a country is a matter of national jurisdiction. It is therefore provided in Article VI that information communicated under the provisions of the Convention shall be kept secret by the authorities receiving it “in the same way and to the same extent as is done in the State that


  ― 55[4375] ―
supplies it”. Sanctions for the violation of such secrecy by an official of the State that has received information shall, however, be governed by the administrative and penal laws of that State.

Ad Article VII.—Application of the Convention

The object of Article VII is intended to furnish the basis for continuous co-operation between the tax authorities concerned as regards the interpretation and application of the Convention and the adoption of special measures in order to enforce the Convention, or to complete it with respect to doubtful cases or matters not expressly provided for. It may be of interest to note that the second sentence of this article enables the contracting States, when signing a convention for reciprocal administrative assistance in tax matters, to agree formally only on the essential provisions of the agreement and to dispense as they see fit with the detailed provisions contained in the Protocol and those of the Model Convention which appear secondary or superfluous in view of the kind of relations that are likely to develop between the tax authorities in the contracting States. Indeed, the second sentence of that article stipulates that, “with respect to the provisions of this Convention relating to exchange of information, service of documents and mutual assistance in the collection of taxes, … such authorities may, by common agreement, prescribe rules concerning matters of procedure, forms of application and reply, conversion of currency, disposition of amounts collected, minimum amounts subject to collection and related matters”. Article XX of the Protocol in the Mexico draft was left out in the London draft because it appeared to go beyond the general scope of the Convention.

Ad Article VIII.—Ratification and Duration of the Convention

The provisions of Article VIII of the Model Convention are identical with those of the final articles of the Model Conventions on double taxation through income taxes and death


  ― 56[4376] ―
duties. It is, of course, clear that the entry into force and duration of the Convention on reciprocal assistance between tax administrations should coincide with that of the Convention or Conventions for the prevention of double taxation in respect of the taxes to which the Convention on administrative assistance applies.

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