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
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”
Norms of International Taxation
• There is no normative international tax regime.
• Countries accommodate each other’s 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
Some Terminology
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“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 country’s (the source
country’s) primary right to tax income, effected by a reduction in the residence country’s tax on the income
“World-Wide Taxation” – All of a taxpayer’s 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 taxpayer’s 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 taxpayer’s 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
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
The Earliest Stages
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“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 state’s
primary entitlement to tax income arising from more modest connections than would
be required under the OECD Model Tax Convention in equivalent circumstances
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
What’s 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
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
What’s Happening In the World?
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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
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)?