The effects of double tax treaties for developing countries. A case study of Austria's double tax treaty network.

Author:Braun, Julia
Position:Case study
 
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  1. INTRODUCTION

    In the past years, there has been an increasing awareness that governments are losing substantial tax revenues due to "aggressive" tax avoidance schemes. The G20 and the OECD strongly promote the Base Erosion and Profit Shifting initiative (BEPS), which aims at undermining aggressive tax planning structures used by multinational companies. This initiative claims that 'fixing' some individual problems of current international tax rules may solve tax avoidance issues (OECD, 2013).

    At the same time, there is a different discussion coming from the perspective of developing countries, calling for a more fundamental 'rethinking' of the international tax system. The question is raised as to how the international tax system generally and Double Tax Treaties (DTTs) in particular impact developing countries. It is being discussed whether developing countries at all benefit from the signature of DTTs under current internationally accepted standards.

    These internationally accepted standards, which are embodied in the OECD Model Tax Convention on Income and on Capital (henceforth OECD Model), and to a lesser extent in the UN Model Tax Convention, have a large influence on actual tax treaty practice (Wijnen & de Goede, 2014). As both models favor the residence principle, where tax residents of a country are subject to taxation on their worldwide income, a greater portion of taxation rights are allocated to a residence country (Daurer, 2013). DTTs based on these Conventions thereby shift taxing rights from the source state (capital-importing country) to the residence state (capital-exporting country). Between two economies with largely reciprocal foreign direct investment (FDI) positions, this reallocation of taxing rights is not problematic. When, however, such a treaty is signed between two countries with an asymmetric investment position, the capital-importing country risks to forfeit tax revenues. This is not merely a theoretical discussion, but some developing countries have already renegotiated or terminated specific DTTs that they do not perceive as beneficial for themselves. (1)

    This on-going debate motivates the present study, which analyses the Austrian DTT network with developing countries. Austria's 37 DTTs signed with developing countries are based on the OECD Model. We investigate in detail how these DTTs impact developing countries. As previous results from cross-country studies regarding the effects of DTTs for developing countries are inconclusive, we add to the literature by providing a combined legal and economic review of Austria's tax treaty policy and its ramifications for developing countries.

    Austria, as a case study, presents how the OECD Model can shape a country's treaty policy and also affect its treaty partners. Given that Austria's DTTs are very similar to the OECD Model, Austria is often thought of as a good representative of OECD standards. On the other hand, Austria has been (in)famous for its rather strict bank secrecy laws and can be viewed as a special case in this respect.

    Similar case studies have been provided for the Netherlands and Switzerland, two other small and open economies with large tax treaty networks (Burgi & Mayer-Nandi, 2013; McGauran, 2013). These two studies focus more on the analytical legal part, and are more descriptive, partly basing themselves on anecdotal evidence. The combination of a qualitative legal approach, as well as conceptual and quantitative economic analysis allows us to systematically study the impact of individual tax treaty provisions on developing countries. The three case studies for Switzerland, the Netherlands and Austria highlight that developing countries incur both costs and benefits when signing DTTs. The results of our econometric analysis moreover suggest that developing countries attract additional FDI projects in the years following the signature of a DTT.

    The paper proceeds as follows. Section 2 explicates Austria's international tax treaty policy, and particularly highlights the goals of the Austrian policies. In this context, the specific provisions regarding the allocation of taxing rights in Austrian DTTs and their potential effects on developing countries are discussed. Subsequently, Section 3 more generally studies the relationship between DTTs and FDI. After an investigation as to why attracting FDI inflows is considered so important by many developing countries, the existing literature on the relationship between DTTs and FDI is presented. In Section 4, we briefly describe Austrian investment in developing economies and then analyze econometrically to what degree DTTs contribute to encourage Austrian FDI projects in these countries. Section 5 concludes and proposes policy options.

  2. AUSTRIA'S INTERNATIONAL TAX TREATY POLICY

    2.1 GOALS OF AUSTRIA'S TAX TREATY POLICY

    Austria has a large DTT network, which as of July 2014 consists of 86 DTTs, 37 of which are with developing countries. (2) Whereas formerly Austrian DTT negotiators primarily aimed at boosting tax revenues for Austria, increasing the attractiveness of Austria as a business location is now seen as the main function of DTTs (Loukota, Seitz & Toifl, 2004; Lang, 2012). In order to ensure a uniform international tax policy in its DTT network, Austria has established a DTT Model that is very close to the OECD Model. With its DTTs, Austria pursues four goals, namely to: (i) prevent international double taxation, (ii) foster bilateral economic relations, (iii) increase legal certainty, and (iv) prevent international tax avoidance and evasion (Loukota, Seitz & Toifl, 2004).

    First, from Austria's perspective, the main purpose of DTTs is to avoid international double taxation (Jirousek, 2013 a). Austria prefers to apply the exemption method as a mechanism to avoid double taxation. (3) Under the exemption method, a "residence country" (i.e., a country where a company or an individual is considered to be a tax resident) is obliged to exclude income arising abroad (the "source country") from the taxable base to determine the tax due. Austria's domestic tax law provides for double taxation relief that is fairly similar to the relief provided under its DTTs (Section 48 of the BAO). The exemption method under Austria's domestic law applies to active income, such as income derived from businesses carried out through a permanent establishment (PE) situated abroad, which is subject to tax of at least 15%. (4)

    As is standard with most exemption countries, Austria applies the credit method to passive income, i.e. dividends, interest and royalties. The credit method requires that a residence country first computes tax due on its residents' worldwide income, and subsequently this amount is reduced by taxes previously paid in a source country. However, with no obvious differences between methods to avoid double taxation under Austria's DTTs and its domestic tax law, signing a DTT seems not to be necessary for Austrian tax residents wishing to avoid international double taxation (Loukota, Seitz & Toifl, 2004).

    For Austria, a second purpose of DTTs is to foster economic relations. In order to support expansion of its domestic firms, it is crucial from Austria's perspective to negotiate DTTs that reduce source taxation on passive income as much as possible, even below the standards embodied in the OECD Model (see Section 2.2). Usually, a source country is granted the primary (albeit reduced) taxation right, except for royalties under Article 12 OECD Model, and a residence country taxes the remaining amount.

    The third goal of Austrian DTTs is to provide legal certainty. DTTs set common rules applicable in both a residence and a source country, and thus provide legal certainty for investors and tax administrations. (5) From the perspective of a residence country, legal certainty is crucial in protecting its residents investing abroad from international tax conflicts, which may give rise to unsolved double taxation. In order to provide increased certainty, Austria tries to ensure that DTT provisions are interpreted in the same way in both the residence and the source country. Austria insists on including a provision in the DTT protocol stating that DTT provisions should be interpreted according to the OECD Commentaries, which are revised periodically (Jirousek, 2013b). 15 of Austria's DTTs with developing countries include such a provision in the protocols; seven of these provisions refer to both the OECD and the UN commentaries. Austria thereby ensures that the latest version of the OECD Commentaries is legally binding and applicable for taxpayers, tax authorities, and even in the courts of signatory countries (Pistone, 2012).

    Fourth, preventing international tax avoidance and evasion is a major concern for Austria, as for many other governments. Tax avoidance is not, per se, an illegal way to reduce taxes due, this term usually refers to "unacceptable" taxpayer behavior: although complying with the letter of the law, a taxpayer deliberately acts against the sprit or the intention of the law with the aim to reduce its tax liability. To prevent international tax avoidance, some countries prefer to include anti-avoidance provisions, such as subject-to-tax clauses, in their DTTs. Austria, however, prefers to apply anti-avoidance provisions in its domestic law, and not in its DTTs. Austria's argument is that specific anti-avoidance provisions in DTTs may stimulate creative tax planners to find ways to circumvent them and, therefore, these provisions will make it more difficult for tax authorities to argue that certain applications of the DTT are abusive (Loukota, Seitz & Toifl 2004). However, if requested by the negotiating partner, Austria agrees on inserting subject-to-tax clauses in the DTT (Burgstaller & Schilcher, 2004). Also in some of the DTTs with developing countries such subject-to-tax clauses are inserted, e.g. in the DTTs with Malaysia (Art. 20(1)) and Mexico...

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