History of tax treaties and the permanent establishment concept

Abstract

Introduction The current international tax treaty system still reflects the principles and structures developed in the 1920s by the League of Nations, despite the effects of globalization. These principles were developed in a world economy in which international trade was in tangible items and international communication was slow. During the inter-war period, the double taxation of cross-border income resulting from the overlap of source jurisdiction and residence jurisdiction led to calls for measures to prevent double taxation. The International Chamber of Commerce (ICC), on behalf of enterprises, articulated a pressing need for measures to prevent double taxation. In 1928, the League of Nations developed its first model tax treaty to prevent double taxation, and this was the foundation of the 2010 OECD Model, the UN Model and of modern tax treaties. The League of Nations could not foresee the longevity of the principles and structure of its 1928 model tax convention, nor that the bilateral tax treaty system would become an extensive network. Its preference was for a multilateral tax treaty system with multiple bilateral tax treaties being a compromise intermediate measure. This chapter surveys the history of the work of the League of Nations on international taxation and its dual focus of preventing double taxation and countering tax evasion. Despite the significant changes in international trade and commerce that have occurred since the 1920s, the main international tax issue is still the same – resolving the competing claims of a source country and a residence country to prevent double taxation, tax avoidance and tax evasion. The source country, where income is earned, and the residence country, where an international enterprise is based, both claim taxing rights over cross-border income. The principal aim of tax treaties is to resolve the competing and overlapping taxing rights of a source country and a residence country to prevent double taxation. But the allocation of source country and residence country taxing rights results in winners and losers. Usually developing countries prefer source country taxation as they are net importers of capital (capital-importing countries). On the other hand, developed countries prefer residence taxation as they are net exporters of capital (capital-exporting countries). The League of Nations attempted to strike a balance between these competing taxing rights. International enterprises and multinational enterprise groups, which are usually based in capital-exporting countries, and their national governments, have a common interest in preventing double taxation as it inhibits international trade and economic growth.