Links Between International Tax and International Trade

1
Links Between International Tax and International
Trade Source- Versus Residence- Based
Taxation

• Frans Duynstee Vans Mens Wisselink N.V.
• Drew Morier Osler, Hoskin Harcourt LLP
• Kees van Raad Loyens Loeff, and University of
  Leiden
• Rebecca Rosenberg Caplin Drysdale
• Scott Wilkie Osler, Hoskin Harcourt LLP

2
Taxation In a Changing World

• Scott Wilkie The international context
• Kees van Raad Modalities of taxation in a
  changing world, affected by developments in the
  European Community
• Rebecca Rosenberg Redefining international tax
  rules and conventions
• Drew Morier The Canadian experience in the
  direction of more territorial

3
Norms of International Taxation

• There is no normative international tax regime.
• Countries accommodate each others national
  interests and the interests of their taxpayers by
  conceding an exclusive right to tax the income of
  their tax citizens when that income and how it
  is earned, and the affected taxpayer, have
  connections to more than one jurisdiction able to
  establish a legitimate claim to tax it, generally
  in the expectation that other countries will
  offer reciprocal concessions

4
Some Terminology

• Source Generally where income is earned or
  from where it is derived
• Residence Generally, where the income earner
  the taxpayer has its primary location, its
  place of tax citizenship
• Foreign tax credit A unilateral concession by
  a country (the residence country) of another
  countrys (the source countrys) primary right
  to tax income, effected by a reduction in the
  residence countrys tax on the income
• World-Wide Taxation All of a taxpayers
  income is in the taxable income base, and
  limitations on the scope and degree of taxation
  are effected by tax deductions and credits to
  recognize other countries legitimate taxation
• Territorial Taxation -- A country limits its
  tax base by excluding income earned outside its
  own territory, by reference to the other
  territories in which it is earned (a kind of
  blind or ubiquitous foreign tax credit)
• Tax Treaty A network of generally bilateral
  income tax treaties, which in many cases have
  primacy over trade treaties that apply in the
  same circumstances, allocate tax base between
  treaty partners to reflect the nature of the
  income and how it is earned. Generally business
  income, which requires some measure of presence
  in the (source) country in which it is earned is
  first and primarily taxable by the source state,
  with the taxpayers primary (residence) state
  expected to relieve potential double taxation by
  providing foreign tax credit. On the other hand,
  passive income, that does not reflect a unique or
  necessary connection between a taxpayer and the
  state from which the income is derived, is
  primarily taxable by the taxpayers own
  jurisdiction subject to limitations on the degree
  of taxation by the source state generally
  implemented through reductions in withholding
  taxes applicable to certain revenue streams, such
  as interest, dividends, rent and royalties., Tax
  treaties are modeled on treaties developed by the
  Organisation for Economic Co-operation and
  Development, the United Nations, particular
  countries (notably the United States) and others.
  Their role is to provide a starting point for
  negotiating particular treaties which reflect
  some measure of general agreement about when
  unrelieved double taxation should not exist as a
  result of commercial and personal income earning
  activities that involve more than one country,
  and how to effect such relief in ways that also
  enjoy general recognition at least in principle

5
Origins of International Tax Rules

• Close connection between international tax and
  trade. The intersection of commercial and trading
  relationships across geographies necessarily
  caused the intersection of other forms of
  regulation including tax. In short,
  international trade forces a confrontation and
  rationalisation of international tax rules, in
  the interests of international trade but also the
  interests served by those other forms of
  regulation, in the case of tax to fund government
  expenditures on public goods and to direct forms
  of economic activity considered beneficial for a
  healthy domestic economic and social environment
• Modern international tax rules originated with
  League of Nations sponsored studies early in
  the 20th Century, directed to avoiding gratuitous
  impediments to trade cause by unrelieved multiple
  taxation of the same income / taxpayers by more
  than one country

6
The Earliest Stages

• FCN Friendship, Commerce and Navigation
  treaties predate the work of the League of
  Nations, and also modern trade and tax treaties
• In the 1920s, it was recognized that trading
  relationships between countries, which depend on
  the commercial actions of their citizens, could
  be disrupted if all countries touched by the same
  economic activity sought to tax it
• At the time, tax regimes around the world were
  quite different. European taxation reflected a
  system of activity- or property- specific taxes
  income taxation was developing in other parts of
  the world
• From this work, in the 1920s and 1930s, came the
  basic divisions of international tax based on
  relative tax jurisdiction entitlements
  established according to where taxpayers resided
  (residence) and where income earning activities
  took place (source) with a primary tax
  entitlement enjoyed by countries hosting (being
  the source of) active business income earning
  activity that depended to some measurable and
  identifiable degree on the taxpayer actually
  establishing a necessary and observable presence
  in the host or source jurisdiction
• From this work came the early model tax treaties
  that are now reflected in the OECD, UN and other
  models. These model treaties also allow for
  different stages of economic and commercial
  development by the treaty partners. For example,
  in a number of respects, the UN Model Tax
  Convention preserves a source states primary
  entitlement to tax income arising from more
  modest connections than would be required under
  the OECD Model Tax Convention in equivalent
  circumstances

7
Why Were Treaty and Like Accommodations to Trade
Possible?

• Many reasons, but in large part because the
  occurrence and characteristics of trade were
  observable, and therefore states (and their
  economic actors taxpayers) interests were
  also observable and measurable

8
Whats Changed?

• It is more difficult to identify where valuable
  economic activity takes place as significant
  inputs to economic activity become more
  intangible or are financial, having less
  specific connections to states in which their
  value is exploited commercially than formally was
  likely when international tax rules and
  practices were being developed and first applied

9
Recurring Themes

• Countries act in their own interests to concede
  or preserve tax base with their macroeconomic
  interests (to support trade and fund public
  goods) in mind
• Countries expect reciprocal treatment for their
  taxpayers that they concede in favour of
  taxpayers who are primary adherents of other
  countries
• Excessive or multiple taxation will disrupt and
  distort trade flows that otherwise should and are
  expected to take place in the interests of
  affected countries
• Conceding tax base through foreign tax credit,
  treaty tax base allocation conventions and in
  other ways assumes being able to properly measure
  and account for the territorial source of
  income, so that other distortions in the nature
  of gratuitous tax shelter of domestic income by
  foreign-based expenses does not occur

10
Whats Happening In the World?

• There is occurring an almost vestigial return to
  original tax jurisdiction. As the location
  of valuable economic activity is less obviously
  or easily discernible, countries are reverting to
  preserve their original entitlement to tax
  income of their taxpayers absent a better claim
  established by another country to tax that income
  or taxpayer. This is evident in various ways,
  including contemporary developments in transfer
  pricing and the taxation of business
  restructurings
• At the same time, some countries seem more ready,
  possibly for practical reasons, to join others in
  conceding the entitlement of other countries to
  assert exclusive tax jurisdiction on a
  territorial basis as long as where and how the
  income earning activity takes place can be known
  and reported on. Countries know to be actively
  reconsidering the scope of their international
  tax rules include Canada, the U.S., Australia,
  New Zealand, the U.K, France, Germany and others.
• Each country engaged in this seeming tax
  exercise is at the same time effectively
  measuring how important trading and economic
  relationships affecting it take place and can be
  preserved without tax getting in the way, but
  also without renouncing the necessary national
  resources to fund public expenditures on public
  goods and direct economic activity considered
  important for the development of the domestic
  economic.
• In some parts of the world tax systems are
  subjected to other limitations that are designed
  to mitigate distortions in the application of tax
  rules but also have the effect of limiting tax
  system individuality, the application of tax
  rules for the exclusive primary benefit of the
  countries enacting them and opening up new ways
  in which tax systems confront each other. The
  non-discrimination and freedom of establishment
  provisions of the EU Treaty, as interpreted by
  the European Court of Justice, affect the scope
  and application of national tax rules in an
  international setting, in ways that also have to
  be considered when addressing international tax
  rules and conventions applied to trade

11
What Next?

• Countries have choices
• Increased source taxation, in the direction of
  more territorial taxation?
• More world wide taxation with more precise or
  targeted credit for foreign tax?
• Less attention to reciprocity of taxation in
  favour of more focus on where economic activity
  takes place regardless of the degree of taxation?
• Migration of foreign activity to the residence
  state at reduced tax rates (just low enough to
  deter location changes)?