global tax treaties, UN model and OECD model with the view of analyzing their consideration towards rights to capital and tax income. By throwing light on differences and similarities among the models, the fundamental logic of each of them is explained. The article explains the prospecting policies of consideration when tax treaties are to be signed. It is because there is strong need to enforce a flexible but more aggressive strategy. The Section 1 of the article discusses rights about tax earnings through immovable property. The Section 2 is about business profits. The Section 3 throws light upon income from investment channels like royalties, interests and dividends. The Section 4 describes the capital gains. The conclusion of the article is given in Section 5.
Right to tax income from immovable property
Because of well-known significant relationship between the country of source of the income and the source of income itself, there is similarity between UN model and OECD model. Article 6 in both models discusses that if a person generates some income from immovable assets existing and operating is some other country than the residence country of the individual, the tax will be paid in the country where the assets are located. This provision is recognition of source of income and gives the source country a right that the generated income from its immovable property can be used for its development purpose by levying taxes on it. This clause is different from the one that discusses immovable property with permanent establishment. The income generated from immovable property with permanent establishment is known as business profits. This article refers to permanent establishment as PE. This clause refers to immovable property which is not permanently established. These rules are basically formed by UN model and OECD model while a majority of the global treaties being completed in the current era do not see any reservation in following them[footnoteRef:2]. [2: Ronald B. Davies, 'Tax Treaties, Renegotiations, and Foreign Direct Investment' (2003) 33 Economic Analysis and Policy 251-273.]
2. The respective rights to tax business profits
2.1 The basic principles of allocating rights to tax business profits:
Both state of source and state of residence are interested in the income generated through business activities. The state of source levies tax on it while the state of residence balances the fiscal interests with the other state. There are three fundamental guidelines in this perspective. The first one is about independent enterprise which restricts the scope of right of tax which is in the advantage of state of source. The second principle is about profits attribution and the third one is about PE. It helps identify the source from where business profits generate. It also restricts the tax right to the state of source[footnoteRef:3]. [3: Tsilly Dagan, 'The Tax Treaties Myth' (2000) 32 New York University Journal of International Law and Policy 939-996.]
2.1.1 The PE principle
The PE principle is described in UN model and the OECD model in the similar terms. Both support the view that the state in which the business is established has the right to tax its profits. If the business enterprise is foreign and the origin of investment is in some other state yet it is operating in some other state through PE, even then the tax will be paid to the state in which the enterprise is located[footnoteRef:4]. [4: OECD, Attribution of Profit to a Permanent Establishment Involved in Electronic Commerce Transactions (OECD, 2001).]
There is, however, difference of definition of PE among the UN Model and OECD Model. OECD models have strict formal clauses defining PE. UN Model attaches more importance to the state which is importing capital from other countries. Generally, less developed countries import capital to develop their industry. Hence, it tries to relax the PE restrictions. In business practices related to PE, the common subjects of discussion are insurance related business, agent sales, services furnishing, projects duration and assembly related activities etc. There are many arguments and viewpoints related to these subjects in every business circle[footnoteRef:5]. [5: Ibid; Also see OECD Centre for Tax Policy and Administration, 2010 Report On The Attribution Of Profits To Permanent Establishments (OECD, 2010); Also see, United Nations, Model Tax Convention between Developed and Developing Countries (UN, 2001).]
Keeping in view the development stage of these countries and global relations in general, countries have many options available to them. They can follow the UN model on the grounds of its development pace and the largest size. They can adopt more flexible options by having negotiations with other states. They also have the option of increasing activities in other states through potential PEs. Keeping in view the laws of other states, the business terms may be different. For instance a project, whose duration is 9 months, when analyzed in the light of Qatar treaty, gives altogether a different perspective from that given by UN Model or OECD Model. On the other hand, a six months long project of any nature (construction, supervision, installation etc.) when analyzed in the light of Nigerian tax treaty, the applicability of concept of PE is completely different as well[footnoteRef:6]. [6: OECD Centre for Tax Policy and Administration, 2010 Report On The Attribution Of Profits To Permanent Establishments (OECD, 2010); Also see, United Nations, Model Tax Convention between Developed and Developing Countries (UN, 2001).]
2.1.2 The profits attribution principle
As mentioned earlier, the state of source has the right to levy taxes on the income generated from its immovable property with PE. It is important to mention here that this right is limited to the extent of the income that is generated through PE property. If some income is generated through immovable property which is not PE, the source state does not have any right to levy tax on the income. In this case, the state of residence will levy tax on the business enterprise. There are two distinguished manners in which profits can be attributed to PE. In OECD model, profits are attributed to PE in the light of economic relationship. It strictly states that only that income is taxable by the source country which is generated through PE activities. On the other hand, the UN Model gives the country of residence a leverage to levy taxes on the profits of the enterprise. It states that if the business is operated in some other state through PE, the country of state is liable to levy taxes[footnoteRef:7]. It broadens the scope of PE. To throw further light upon the UN model of profit attribution, it is mentioned that the profit generated through PE is taxable by the country of source and the profit which is generated through trade of commodities which are similar to those as in PE, is also taxable by the country of source. Yet another point is that the income which is generated through practices and activities similar to the ones carried out in PE are also taxable by the country of source[footnoteRef:8]. It is the recognition of taxable activities by the country of source that is important, even if the enterprise carries out these activities using other platforms than PE, but the activities and traded commodities are the same. Thus UN Model is based on attraction principle which attributes the similar activities and conditions to the taxable income. If the enterprise adopts different activities or practices, the income will not be taxable by the country of source[footnoteRef:9]. [7: The general force of attraction principle gives the state of source an unrestricted right to tax the source income, regardless of its economic connection with a PE. Bin Yang, A Comparative Study on the Rules and Administration of the International Taxation System (China Tax Publishing House, 2003).] [8: Paragraph 1, Article 7 of the UN model] [9: Klaus Vogel, Klaus Vogel on Double Taxation Conventions (Kluwer Law International, 1997) 421-422; Also see, OECD, Model Tax Convention on Income and on Capital (OECD, 2010).]
The principle of economic relationship with PE is a more feasible option for the countries to promote their relations with other countries. This is so because it is lenient as compared to the attraction principle; it also eases tax administration and boosts economic efficiency. There are, however, certain cases where attraction principle is deliberately introduced. It is when the enterprises try to avoid taxes by disguised separation of activities from PE. For instance, according to the tax treaty enforced between Philippines and Germany, if it is proved that the enterprise is avoiding taxes though the activities are similar to those carried out at PE, the regulation allows the country of source to levy taxes on the total income generated by the enterprise. The tax treaties enforced with Germany by many countries like Mexico, Papua New Guinea, Indonesia, Pakistan, India and Turkey etc. have the same clauses in them.
2.1.3 The independent enterprise principle and the arm's length principle
PE is part of the enterprise that is operating business in some other country. The activities and profits both belong to the…