The Applicability of Double Tax Treaties to Individuals Benefiting
from Preferential Tax Regimes (e.g. art. 24-bis TUIR)
Adv LLM thesis
submitted by
Ludovico Carpanetto
in fulfilment of the requirements of the
'Advanced Master of Laws in International Tax Law'
degree at the University of Amsterdam
supervised by
Joanna Wheeler
co-supervised by
Alessandro Bavila
PERSONAL STATEMENT
Regarding the Adv LLM Thesis submitted to satisfy the requirements of the 'Advanced Master of Laws in International Tax Law' degree:
1. I hereby certify (a) that this is an original work that has been entirely prepared and written by
myself without any assistance, (b) that this thesis does not contain any materials from other sources unless these sources have been clearly identified in footnotes, and (c) that all quotations and paraphrases have been properly marked as such while full attribution has been made to the authors thereof. I accept that any violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree. I also accept that in case of such a violation professional organizations in my home country and in countries where I may work as a tax professional, are informed of this violation.
2. I hereby authorize the University of Amsterdam and IBFD to place my thesis, of which I retain
the copyright, in its library or other repository for the use of visitors to and/or staff of said library or other repository. Access shall include, but not be limited to, the hard copy of the thesis and its digital format.
3. In articles that I may publish on the basis of my Adv LLM Thesis, I will include the following
statement in a footnote to the article’s title or to the author’s name:
“This article is based on the Adv LLM thesis the author submitted in fulfilment of the requirements of the 'Advanced Master of Laws in International Tax Law' degree at the University of Amsterdam.”
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signature:
name: Ludovico Carpanetto
Table of Contents
Table of Contents
... 3
List of abbreviations used
... 5
Executive Summary
... 6
Main Findings
... 7
Introduction
... 9
Chapter I
... 11
The concept of liable to tax under art. 4 (1) of the OECD Model
... 11
1.
The function of art. 4 (1) in the framework of double tax treaties 1 ... 11
2.
The History of art. 4 (summary) 2 ... 12
2.1
The reports of 1923 and 1925 2.1 ... 12
2.2
From the reports of the League of Nations to the OECD Model Convention of 1963
2.2
12
3.
The meaning of liable to tax 3 ... 14
3.1
The second sentence 3.1 ... 15
3.2
Potential vs actual taxation 3.2
... 17
4.
Double-non-taxation and subject-to-tax clauses 4 ... 19
Chapter II
... 23
Art. 24-bis TUIR and the concept of liable to tax under art. 4 (1)
... 23
1.
Introduction 1 ... 23
2.
Art. 24-bis and territorial systems 2 ... 24
2.1
What is meant by territorial systems 2.1
... 24
2.2
Treaty entitlement for source-based territorial systems 2.2 ... 25
2.3
Art. 24-bis as a residence-based territorial system 2.3... 26
2.3.1
Art. 24-bis as a residence-based system 2.3.1
... 26
2. 3. 2 Art. 24-bis as a territorial system... 28
2.4
Conclusions 2.4... 29
3.
Other preferential regimes for individuals 3. ... 30
3.1
The remittance basis 3.1 ... 30
3.1.1
Remittance basis and double tax treaties 3.1.1 ... 30
3.1.2
Case law on the application of tax treaties to individuals taxed on a remittance
basis 3.1.2
... 32
3.3
Comparison with Italian tax treaty practice 3.3
... 34
Conclusion
... 36
Appendix – Description of the Italian new-residents regime (art. 24-bis) ... 37
List of abbreviations used
Art., Arts. Article, Articles Boll. Trib. Bollettino Tributario Brit. Tax Rev. British Tax Review
Bull. Int. Tax. Bulletin of International Tax Cass. Corte di Cassazione Corr. Trib. Corriere Tributario
CTC Commissione Tributaria Centrale CTR Commissione Tributaria Regionale D. Lgs. Decreto Legislativo
EU European Union Eu. Tax. European Taxation
OECD Organisation for Economic Cooperation and Development Op. cit. Opere Citato
Ord. Ordinanza Par. Paragraph Sec. Section Sent. Sentenza
TUIR Testo Unico delle Imposte sui Redditi UK United Kingdom
UN United Nations
Executive Summary
The purpose of my research was to establish whether double tax treaties apply to individuals benefiting from preferential tax regimes, such as the one recently introduced in Italy in art. 24-bis of the Italian Income Tax Act (hereinafter: “TUIR”). Indeed, the second sentence of art. 4 (1) of the OECD Model excludes from the definition of “resident of a Contracting State”, relevant for determining treaty entitlement under art. 1, persons who are liable to tax in the residence State only on income from sources in the State. Therefore, since preferential regimes for individuals usually provide for favourable tax treatment on foreign income of new residents, the issue arises of determining whether such taxpayers may fall under the scope of this provision.
The first step was to focus on the core of the matter, which derives from a clash between the rationale governing double tax treaties and the typical features of tax competition in the field of taxation of individuals. Whereas double tax treaties originate from the assumption, relevant for defining treaty entitlement, that States tax their residents on their worldwide income, tax competition is bringing about a deviation from this assumption, with the introduction of special regimes which reduce the tax liability of residents, especially on their foreign income.
The issue has an important outcome in practice, since, considering that a foreign tax credit is not granted for taxes on foreign income falling under the scope of the Italian regime for new residents, the beneficial character of the scheme is highly dependent on the solution to the problem of the applicability of double tax treaties.
I decided to deal with the matter, firstly, by trying to clarify the meaning of the provision of art. 4 (1), which is not clear-cut. For this purpose, I analysed the context in which it was developed, by reading the first reports of the Financial Committee of the League of Nations, which was tasked with designing the framework of double tax treaties starting with an examination of the main features of domestic tax systems that determined the problem of double taxation, as well as the documents of the Working Parties established by the OECD, with the purpose of taking on the work previously carried out by the League of Nations and coming up with a new Model convention. I also examined the case law of domestic courts, in order to appreciate whether a common interpretation is provided to the provision of art. 4 (1), which can amount to a general rule applicable in all circumstances. In the last part of the first chapter, I also investigated the concept of “subject-to-tax”, included in some treaties in clauses which render the granting of treaty benefits by one of the Contracting States dependent on effective taxation of the relevant item of income in the other Contracting State. The purpose of this investigation was to understand the differences between the concept of liable to tax and that of subject to tax, and whether subject to tax clauses may trigger an issue in relation to preferential regimes for individuals.
The second part of my research was devoted to the main issue of the applicability of double tax treaties to individuals opting for the Italian preferential regime. Since no judgments or official documents of foreign tax authorities have yet been released with regard to this new scheme, I decided to deal with the matter on a comparative basis, relying on two benchmarks. Therefore, I first compared the Italian regime with the concept of a territorial system, since the OECD Commentary expressly excludes from the scope of the second sentence of art. 4 (1) persons that are residents of territorial systems which tax only domestically sourced income. I then analysed the solutions provided in treaty practice as well as by the courts of source States with regard to other preferential regimes for individuals in force in other European tax systems, focusing in particular on the remittance basis taxation of the UK and the lump-sum regime of Switzerland. Therefore, for this second part of my research, I carried out an extensive survey on the tax treaties concluded by Hong Kong and Singapore, which I used as examples of territorial systems, as well as by the UK and Switzerland.
Main Findings
The research I have carried out led me to conclusions regarding both the meaning of the provision of art. 4 (1) and the compatibility of beneficial tax regimes for individuals with the requirements of such provision. As far as the first matter is concerned, I have reached the conclusion that, considering the context in which it was developed, the only condition that the first sentence of art. 4 (1) imposes is that, to give rise to treaty entitlement, a domestic tax liability must be grounded in an attachment criterion of a personal nature, meaning that it must be related to the person of the taxpayer and not the income, by identifying an effective connection between the taxpayer and the jurisdiction of the Contracting State. This interpretation stems from the consideration that the only form of tax liability which the drafters of the first models of the League of Nations, whose work was then inherited by the OECD, wanted to exclude from the application of tax treaties was source liability, that represented originally the relevant rule for the allocation of taxing rights over impersonal taxes. Instead, a tax liability based on a personal element, such as residence or domicile, which originally represented the relevant rule for the allocation of taxing rights over personal taxes, was also the one chosen for determining treaty entitlement, once the distinction between personal and impersonal taxes was abandoned in the OECD Model of 1963. Indeed, only a tax liability grounded in criteria referring to the person of the taxpayer can, at least potentially, bring about taxation on the worldwide income, which is the main cause of double taxation.
Therefore, since it was impossible to reach an agreement among States over a single definition of resident for treaty purposes during the preparatory work to the OECD Model of 1963, it was decided to include a provision which simply refers to the tax liability provided by the domestic law of States on the basis of many possible criteria, which are all of a personal nature. However, whether this tax liability must determine an effective imposition of taxes in the residence State on the worldwide income is a matter on which the interpretation of national courts differ, although potential taxation is usually considered enough to trigger treaty entitlement under art. 4 (1).
Moreover, the second sentence of art. 4 (1) has a highly limited scope, related to situations in which taxation only on income from sources in the State is the outcome of the application of another international agreement. This point is extensively argued in Sec. 3.1 of the first chapter, based on the reason why the provision was included in the Model, the examples of application of the rule provided by the Commentary and the replacement of the expression “law” with “laws” in the first sentence.
In relation to subject-to-tax clauses too, in the same way as for the liable to tax concept, it is not possible to establish a single meaning applicable to all situations. Therefore, ultimately the only difference between the two concepts is this: whereas “liable to tax” relates to the person of the taxpayer, “subject to tax” refers to the relevant item of income.
Bearing in mind the conclusions reached in the first chapter, the second one analyses, firstly, the issue of treaty entitlement with regard to territorial system, based on the distinction between source-based and residence-source-based territorial systems. As far as the former are concerned, treaty entitlement seems to be precluded by the very fact that they employ an attachment criterion of an impersonal nature as a basis for taxation, which, as explained in the first chapter, is the only one excluded from the scope of art. 4 (1). As far as the latter are concerned, treaty entitlement under the first sentence is granted by the circumstance that the residence of the taxpayer is the basis of taxation, but it might be precluded by the second sentence in the case when foreign income is not taxed at all. However, art. 24-bis can be regarded as a residence-based territorial system only from a material point of view, since foreign-sourced income is not fully exempt, but only subject to a favourable treatment.
Then, the last part of the second chapter demonstrates how entitlement to treaties following the OECD did not constitute an issue in relation to other preferential regimes for individuals, such as the remittance basis of the UK and the lump-sum applied in Switzerland. Indeed, the denial of treaty benefits is usually not carried out relying on specific clauses related to the single item of income.
In conclusion, the issue of treaty entitlement in relation to preferential tax regimes proves the existence of a flaw in the framework of double tax treaties, namely that the relevant factor for determining treaty entitlement, a general liability to tax on a resident taxpayer, is no longer the one always giving rise to the main issue of double taxation, which tax conventions address. For this reason, double non-taxation can arise from the application of double tax treaties, and individuals opting for art. 24-bis cannot be ruled out from treaty entitlement simply because they are subject to favourable tax treatment on their foreign income in the residence State.
Introduction
“When international tax law was created in the 1920’s and 1930’s the sole purpose of the international tax regime was to mitigate double taxation so that governments could benefit from economic liberalisation”1. From the point of view of political economy, the avoidance of double taxation
was a concern collectively shared by governments for the purpose of maximising national welfare, by assuring parity of treatment between domestic and international investment. However, after this goal had been achieved with the conclusion of double tax conventions, then the problem of under-taxation became relevant. This second issue is a direct consequence of the way the first one was solved, since it is only worthwhile for individuals and companies to engage in cross-border investment if a double tax treaty is in force. Indeed, if double tax treaties were not in force, then domestic tax advantages, provided either by the source or the residence State, would be nullified by the denial of treaty benefits, either in the form of exemption or reduction of withholding taxes by the source State, or in the form of credit or exemption for taxes paid abroad by the residence State.
Therefore, the legal framework of international tax law not only is unfit for solving the problem of under-taxation, but it also constitutes its basis. Indeed, only once double taxation is avoided and “international investment is free to move across borders”2, can States then benefit individually in
attracting foreign capital in their countries, by providing for a favourable tax system. As far as taxation of individuals is concerned, a favourable tax system is being granted by more and more States, with the implementation of special schemes for taxpayers transferring their residence to the country. Art. 24-bis of the Italian Income Tax Act (hereinafter: “TUIR”), recently introduced with the Budget Law of 2016, is a clear example of such a trend towards tax competition, being aimed at attracting wealthy foreign individuals, by replacing ordinary taxation on foreign income with a lump-sum substitute tax of 100,000 euros.
Hence, the issue arises of establishing whether individuals can sum to the benefits granted by the Italian tax system with art. 24-bis, tax relief provided by double tax treaties. The matter is of extreme relevance for individuals opting for this scheme. Indeed, on the one hand, if double tax treaties did not apply, then the beneficial character of this rule would be largely outweighed by the denial of exemptions or reduction in withholding taxes on foreign income in the Source State, especially considering that art. 24-bis excludes the application of foreign tax credit. On the other hand, if double tax treaties did apply, then the regime would be highly beneficial for individuals producing large amounts of income abroad, that would be subject to limited taxation in Italy, as residence State, and fully exempt or subject to a reduced withholding tax in the source State in the application of the relevant treaty.
Within the legal framework of double tax treaties, as mirrored in the OECD Model, although not originally designed to deal with the issue of double non-taxation, a rule can be traced that might appear suitable to be applied to the issue at stake. The second sentence of art. 4 (1) rules out from the definition of resident a Contracting State, relevant for determining treaty entitlement under art. 1, “any person who is liable to tax therein in respect only on income from sources in that State or capital situated therein”. Therefore, the issue of the applicability of double tax treaties to individuals entitled to preferential tax regimes is to be investigated in light of the requirements for treaty entitlement set forth by art. 4 (1), by examining whether those taxpayers, whose foreign source income is subject to a special tax treatment in the residence State, can be ruled out from the application of the relevant treaty, because liable to tax in Italy “only on income from sources in that State”.
In this regard, the Italian Tax Authority issued a Circular shortly after the adoption of the regime in the legislation, with the purpose of clarifying its modes of application, stating that “taxpayers that exercise the option under art. 24-bis are to be considered residents for treaty purposes, since their
1 RIXEN T., “From Double Tax Avoidance to Tax Competition: Explaining the Institutional Trajectory of
International Tax Governance”, Review of International Political Economy, 2011, 2: 197
worldwide income is still taxed in Italy, except when the single treaties provide for requirements different from the ones of art. 4 (1) of the OECD Model”3.
Therefore, the purpose of this essay is to analyse whether it is possible to share the conclusion of the Italian Tax Authority, in order to determine if source States will have to apply the relevant tax convention to individuals opting for the regime. In the first chapter, the analysis is carried out through a clarification of the meaning of the provision of art. 4 (1), considering the historical context in which it was developed and the interpretation given by the OECD Commentary, as well as by prominent authors, such as Pijl, Avery Jones and Vogel. Then, the second chapter deals with the specific aspects of the issue of treaty entitlement for individuals opting for art. 24-bis by relying on two comparative benchmarks. Hence, the matter is examined, firstly, in the light of the solutions adopted for domestic systems taxing only income sourced in their territory, on the basis of the distinction between source-based and residence-based territorial systems elaborated by Hwa See, and, secondly, in the light of the solutions adopted for other preferential regimes for individuals, such as the remittance basis taxation, in force in the UK, and the lump-sum scheme, applied in Switzerland.
Chapter I
The concept of liable to tax under art. 4 (1) of the OECD Model
1. The function of art. 4 (1) in the framework of double tax treaties 1
Every legislative text requires rules establishing its scope, namely the circumstances under which its prescriptions become applicable, that can be defined through subjective, objective, geographical or temporal elements. As far as double tax treaties are concerned, the scope is primarily determined through a subjective requirement. Indeed, the opening provision of both the OECD and the UN Model prescribes that “The Convention shall apply to persons who are residents of one or both of the Contracting States”.
The term resident is defined in art. 4 (1) as “any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature”. Therefore, this rule, by referring to “the laws of that State”, requires the assistance of domestic law, in order to derive its substance. Indeed, art. 4 (1) is one of those provisions which reflects the division of functions and competence between tax treaties and domestic law. On the one hand, tax treaties, since concluded by States primarily to overcome the issue of double taxation, being the outcome of the parallel exercise of their tax jurisdiction, “achieve no more (and no less) than disentangling the transnational tax base and assigning it to different jurisdictions”4. On the other hand,
the identification of the nexus between this base and a country is left to domestic law of States5, which
generally employ criteria, such as residence and domicile, to trigger a form of tax liability that, by extending to economic activities exercised beyond their national boundaries, clashes with the tax jurisdiction claims of the so-called “source State”.
Indeed, as expressed in the OECD Commentary to art. 4, “generally the domestic laws of the various States impose a comprehensive liability to tax – full tax liability – based on the taxpayer’s personal attachment to the State concerned (the “State of residence”)”6. A personal attachment of this
kind is identified in varying legal concepts in the national laws of States, such as domicile, residence and place of management, that, if giving rise to full tax liability for a person in a Contracting State, render such person resident for treaty purposes. However, despite the concept of resident for treaty purposes relying entirely on a person being subject to full liability to tax in a Contracting State, the Model “does not lay down standards, which the provisions of the domestic laws on <residence> have to fulfil in order that claims for full tax liability can be accepted between the Contracting States”7.
It is precisely in this discrepancy that the core issue of the compatibility of preferential regimes with the liable-to-tax requirement resides. Indeed, whereas tax liability is conceived by the Model as a binary concept (either limited or full), States’ domestic laws provide for a wide range of tax obligations. The problem then arises of determining when a tax liability can be considered as meeting the threshold required by art. 4 (1) for granting the status of resident for treaty purposes.
However, before delving into this matter, it is first relevant to summarily analyse the various stages in the history of art. 4 (1). Only in this way is it possible to interpret the provision in accordance with how it was perceived by its drafters in the OECD.
4 RIXEN T., “From Double Tax Avoidance to Tax Competition: Explaining the Institutional Trajectory of
International Tax Governance”, Review of International Political Economy, 2011, 2: 206
5 OECD COMMENTARY to art. 4 (1), par. 4: “Conventions for the avoidance of double taxation do not normally
concern themselves with the domestic laws of the Contracting States laying down the conditions under which a person is to be treated fiscally as <resident> and, consequently, is fully liable to tax”
6 OECD C
OMMENTARY to art. 4, par. 3
2. The History of art. 4 (summary) 2
Determining the conditions giving rise to treaty entitlement is a key issue in the design of double tax treaties. Indeed, it is essential to identify the features of the domestic laws of States which, since they constitute the premise for double taxation, need to be taken into account as a starting point for the granting of treaty benefits. This is why the matter has been subject to thorough scrutiny in the series of reports and model conventions issued, first by the League of Nations, and then by the OECD. However, for the purpose of this dissertation, it is sufficient to highlight some specific considerations elaborated in these documents, which are relevant for the interpretation of art. 4 (1) with regards to the question of the compatibility of preferential regimes with the treaty concept of “liable to tax”.
2.1 The reports of 1923 and 1925 2.1
The four economists8 who were asked in 1921 by the Financial Committee of the League of
Nations to prepare a report on double taxation, in their attempt to identify “common principles” that could be employed in the drafting of treaties aimed at solving this issue, sought in the domestic laws of States criteria constituting “the basis for taxation”, namely those legal categories which, by identifying a form of allegiance of individuals to a State, represent one of the two premises for levying tax, together with the situs or location of wealth.
In the report, delivered in 1923, they pointed out how taxation based on political allegiance or nationality does not constitute the best solution, since, as the mobility of individuals has broken the strong connection between political duties and political rights, “the political ties of a non-resident to the mother country may often be merely nominal”9. On the other hand, domicile or habitual residence
seemed criteria constituting a more defensible basis, as “those who are permanently or habitually resident in a place ought undoubtedly to contribute to its expenses”10. The term domicile was then used
“in the sense of permanent or habitual residence”11.
In the following report of 1925 on the topic of double taxation and tax evasion, the notion of “fiscal domicile” was chosen as the premise for the application of resolutions on double taxation. It refers to a condition which, despite being labelled with a different terminology in the internal laws of countries, indicates in all of them a form of economic allegiance of individuals to the jurisdiction of a State, determined by their presence in its territory. The principle of domicile was also employed in the report as the main rule for the allocation of taxing rights between Contracting States as far as personal taxes are concerned.
2.2 From the reports of the League of Nations to the OECD Model Convention of 1963 2.2
Two main considerations can be derived from these reports. Firstly, it is relevant to point out how the principles elaborated by the experts of the League of Nations stem from the distinction between personal and impersonal taxes (or impôts réels), which characterised tax systems in the early 1920’s.
8 Prof. Bruins (Commercial University, Rotterdam), Prof. Senator Einaudi (Turin University), Prof. Seligman
(Columbia University, New York) and Sir Josiah Stamp, K.B.E. (London University)
9 League of Nations, Report on Double Taxation, 5 April 1923: 18 10 Ibidem: 19
As defined by the American economist Young in 1915, although “all taxes, of course, are personal in the sense that in their final incidence they are paid out of personal incomes”, it is still possible to distinguish between the two categories, since for impersonal taxes “taxation is framed and imposed so as to fall evenly upon a given class of things […] without primary reference to the taxpayer, to his relation as resident or non-resident to the government imposing tax, or to his ability to pay”. Instead, income taxes, being “progressive and proportional, and falling alike on different classes of income receivers, are considered personal taxes” 12. Hence, the jurisdictional claim of States for the former
category of taxes is based on the source of income or wealth, whereas for the latter it relies on the prolonged presence of a person in their territory, referred to as domicile or residence. While most Continental European States had only impersonal taxes and the UK and the US had only personal income taxes, Italy and France had a mixture of both, with income tax usually applying only to individuals with higher income.
Therefore, tax treaties at that time were divided into two sections, one for each tax category. As far as impôts réels were concerned, the country of origin, being the country in which the source of income in question is located, was granted the primary right to tax, although purely impersonal taxes cannot give rise to many double taxation issues. For personal taxes, the principle of domicile was the main rule, subject to few exceptions (ex. immovable property) for which the origin rule applied. In the draft conventions released by the Fiscal Committee of the League of Nations in 1928, draft 1a maintained this separation, but draft 1c provided for a single set of provisions applying both to personal and impersonal taxes.
This second text became the basis for future treaties and for the Model designed by the OECD in 1963, in which the two principles of origin and domicile or residence apply for allocating taxing rights between the two Contracting States depending on the item of income concerned. In addition, taxation on the basis of domicile or residence in one State determines treaty entitlement, since it is linked with a form of tax liability that, being grounded on a personal attachment criterion, can extend beyond the territory of a State and thus raise the issue of double taxation. Instead, what is undoubtedly excluded by the definition of resident for treaty purposes is a form of tax liability based purely on the source of income, disregarding any personal element of the taxpayer, which had originated as a criterion for the allocation of taxing rights in the matter of impersonal taxes.
Secondly, it is important to underline how the process undertaken by the League of Nations and by the OECD of developing common principles of taxation in the international sphere, was hampered by inconsistency both in national and international regulations regarding the various criteria at the basis of personal taxation and their interpretation. Indeed, in their analysis of fiscal theories, domestic laws, and international agreements, the experts of the League of Nations were “struck by the variety of terms used – domicile, residence, mere stay, abode, nationality, seat or locality of the main establishment”13.
As pointed out above, fiscal domicile was the one initially selected by the Financial Committee. However, even this term assumes different meanings across different countries, in particular between common law and civil law traditions. Without delving into details in the definition of domicile in common law, it can be summarily defined as the “place where an individual has a true, fixed permanent home and principal establishment, and to which place, whenever absent the individual has the intention of returning”14. Therefore, it is similar to the concept of residence, but it also requires the subjective element
of intending to stay in one place or returning after leaving. On the other hand, in civil law countries, it identifies a much weaker connection to a territory, being the place where a person has established its principle centre of affairs and business. Hence, in order to avoid the concurrent taxation of a person in more than one State determined by mismatches in the definition of domicile, the experts called for a
12 YOUNG A.A., “Personal or impersonal taxation?”, Proceedings of the Annual Conference on Taxation under
the Auspices of the National Tax Association, 1915, 9: 337
13 League of Nations, “Report on Double Taxation and Tax Evasion”, 7 February 1925: 20 14 S
ONNIER B.M.,COLON R., “A Primer on Domicile and Statutory Residence for State Income Tax Purposes”, Journal of State Taxation, 2015, 3: 24
uniform interpretation among States of “domicile” and “habitual residence” or even for “a modification of their conceptions of private, administrative and fiscal law”15.
Nonetheless, such a request could not but fell on deaf ears, due to the utmost importance covered by such a categorisation in the exercise of State sovereignty and the difference in the legal traditions they originate from. Indeed, the issue of mismatches in the personal attachment criteria between the national laws of States emerged again once the OECD (at that time still “OECC”) set up a Fiscal Committee with the purpose of taking over the role previously played by the League of Nations in the field of double taxation, by proceeding with the drafting of a new Model Convention. When the Fiscal Committee established “Working Party 2” in 1956, in charge of studying the concept of fiscal domicile, one of the main problems pointed out in the second report issued by this group of experts regarded precisely “the overwhelmingly different definitions of fiscal domicile and hence the urgent need for standardization”16. For this reason, the Working Party decided to leave aside the notion of fiscal domicile,
which thus lost its role as a leading concept in determining the personal scope of the conventions in the work of the OECD. In the subsequent report, the Working Party proposed to replace the notion of “fiscal domicile” with the expression “fully liable to tax”. However, this proposal was opposed by the Swiss delegation, which argued that “fiscal domicile is not to be taken to mean merely domicile under civil law, but to include all circumstances creating an unlimited liability to taxation”17. The outcome of this
negotiation was then an alternative provision allocating taxing rights to “the State where the person is subject to full taxation under the criteria set out by the Swiss delegation”18. Finally, the last step in the
process of shaping of the current version art. 4 (1), was to bring the notion of “residence” into the discussion and use that instead of domicile as the relevant concept with regard to treaty entitlement. Indeed, “the concept of domicile had been so strained by domestic definitions that it no longer seemed appropriate, whereas residence, which was used by the US and the UK, and had been adopted by France in its treaty with the UK, appeared “a more appropriate shorthand reference”19.
This is, in short, how the version of art. 4 (1), contained in the OECD Model of 1963, came into existence. It was the result of the impossibility of reconciling States on the definition of a common personal nexus identifying a “resident of a Contracting State”, due to the difference in the domestic law concepts and the respective forms of tax liabilities they bring with them. Apart from the inclusion of the second sentence in 1977, which will be subject to thorough scrutiny in the following section, and some changes in the Commentary, the wording of art. 4 (1) has remained unchanged since then.
3. The meaning of liable to tax 3
Bearing in mind the considerations formulated regarding the function and history of art. 4 (1), it is possible to proceed with an analysis of the meaning of the expression “liable to tax”. As noted above, the OECD defined the concept by reference to the rules of domestic laws setting out personal attachment criteria, on the assumption that those criteria give rise to a “full/comprehensive tax liability” in at least one of the Contracting States. Nevertheless, since neither the text of the provision nor that of the Commentary provides a definition of “liable to tax”, the issue of determining requirements for a tax liability to be considered “full or comprehensive” arises.
However, little guidance is given by the OECD documents in this respect. The Commentary even excludes the possibility that such a question is to be resolved by reference to the framework of
15 League of Nations, “Report on Double Taxation and Tax Evasion”, 7 February 1925: 20
16 O
BUOFORIBO B.R., “Article 4 : Resident - Global Tax Treaty Commentaries", 2019, IBFD Online Portal: sec.
1.2.2.2
17 Ibidem: sec. 1.2.2.3 18 Ibidem
19 V
ANN R., “<Liable to Tax> and Tax Residence Under Tax Treaties”, G. Maisto (ed.), Residence of Companies under Tax Treaties and EC Law, IBFD, Amsterdam 2009: 15
double tax treaties, since “they do not lay down standards which the provisions of the domestic laws on <residence> have to fulfil in order that claims for full tax liability can be accepted between the Contracting States”20, but remits the matter entirely to the domestic laws of the Contracting States. Nevertheless, as
pointed out by Wheeler in her essay on tax treaty entitlement, “it is submitted that this statement is manifestly wrong”, firstly because “art. 4 does set a standard by defining residence by reference to a liability to tax that is imposed according to a person’s <domicile, residence, place of management or any other criterion of a similar nature>”21 and secondly because a limit needs to be set in order to safeguard
a source State from having to grant tax treaty benefits in cases of absurd residence claims from the other State22. Despite this remark, it must be accepted as a matter of fact that, although appearing to
be wrong, this is the conceptual framework employed by the OECD. As explained above, this approach was determined by the impossibility of reaching agreement over a complete definition of resident for treaty purposes, due to the irreconcilable differences in the national laws of countries. The only condition which seems to be required is the attachment criterion employed by States, in order to give rise to treaty entitlement, must identify an effective connection between the person of the taxpayer and the jurisdiction of a Contracting State.
This method can also be found in other documents, such as the Partnership Report, that, despite dealing with a different issue, namely mismatches regarding the qualification of a taxable unit and its attribution of income in the domestic laws of States, can still be referred to by analogy. It is then possible to outline how, even for this report, the starting point is the acceptance as compatible with tax treaties of any qualification provided for by the domestic laws of States, which are the only ones competent for establishing the necessary features giving rise to tax liability.
3.1 The second sentence 3.1
Little clarification on the meaning of the expression can be derived from the second sentence of art. 4 (1) and the relative paragraphs in the Commentary either. The rule excludes from the meaning of “liable to tax” and therefore from entitlement to treaty benefits, those persons that, despite meeting the requirements of the first sentence, are liable to tax only “in respect of income from sources in that State (the residence State) or capital situated therein”. Nevertheless, in the present section it will be argued, again by reference to the context in which the rule was developed, how its scope proves to be extremely limited and it is therefore of little help for the purpose of solving the main issue addressed by this essay.
Although the second sentence was only included in the Model in 1977, a similar statement was present in the Commentary to the Draft Convention of 1963. Therefore, the origin of the provision is to be sought in the work of the OECD Fiscal Committee which resulted in the approval of the Draft of 1963. In particular, the need to include a similar rule emerged in Working Party 14, which was included at the request of the Swiss delegation to draft articles on different general topics, such as definitions, the mutual agreement procedure and taxation of diplomats.
As regards the latter topic, the issue arose of the possible double-non-taxation caused by the concurrent application of double tax treaties and other international conventions. Indeed, the Vienna Convention on Diplomatic Relations, which came into force in 1961, after nearly ten years of negotiations, in art. 34 exempts diplomats in the receiving State from income or capital taxes not having their source in that State. The problem of double-non-taxation then arises. Since experience indicates that generally diplomats establish homes in the receiving country, with their spouses and children and thus become part of the community, except when their stay is of a short duration, they qualify as residents in the
20 OECDC
OMMENTARY to art. 4, par. 4
21 WHEELER J., “The Missing Keystone of Income Tax Treaties”, World Tax Journal, 2011, 6: 283
22 The Author gives the example of a State that would adopt legislation envisaging that everyone whose
receiving State for domestic law purposes. The receiving State is also likely to be the winning State under the tie-breaker rule of art. 4 (2). However, if they were granted the benefits of both double tax treaties and the Vienna Convention part of their income would escape taxation. Therefore, Working Party 14 proposed to solve the question by including in the Model a provision such as the current art. 28, which safeguards “fiscal privileges of members of diplomatic missions or consular posts under the general rule of international laws or under the provisions of special agreements”, but at the same time ruling out diplomats from the scope of application of double tax treaties.
Once transposed in the Commentary to the Model of 1963, the direct reference to diplomats was replaced by a broader exception for any individual. Then, when the second sentence of art. 4 was introduced in 1977, the reference was inserted in the Commentary as an example of cases of application of the provision, and the exception in the Model became even broader, by referring to “any person”23.
However, it is possible to share the conclusion of Pijl who, in his essay on the other example of excluded persons that was later added to the Commentary in 2008 regarding dual residents (par. 8.2), points out how “the new par. 8.2 merely embroiders on previously (1963) existing material in the Commentary, which had already accepted the exclusion of comparable persons if, as a consequence of any other international law, a person was merely liable to taxation therein in respect of income of domestic sources”.24 What Pijl argues is that, although it is not clear in the OECD documents why the exception
from diplomats devolved into a general exception for individuals, it is evident that the scope of the second sentence remains mostly limited to cases in which taxation only of income from sources in the residence State occurs as a consequence of the application of other international agreements.
Although not expressly mentioned in the Commentary, this argument appears to comply with the prescription of par. 8.3 to interpret the second sentence “in line with the object and purpose of the provision”. Two main reasons support this position. The first can be derived from the Commentary itself, which, in the version of 2008 provides as another example of persons falling under the scope of the second sentence and therefore excluded from treaty benefits, the case of persons that, for the purposes of a double tax treaty, are subject to taxation only from sources of a State as a consequence of the application of the tie-breaker rules in a treaty with a third State, in which such third State resulted the winning State. Therefore, in this case too the limitation on a residence-based liability to sources in that State alone is an outcome of the application of another treaty. On the other hand, the Commentary points out that the rule must not be interpreted as excluding “from the scope of application of the Convention all residents of countries adopting a territorial principle in their taxation”. Indeed, in this situation it is a State’s internal law which, in the exercise of its sovereign prerogatives, which are not restricted by art. 4, establishes a form of tax liability for its residents limited to income from sources in its territory.
The second argument comes from the expression “under the laws of that State” in the first sentence of art. 4, as it was modified in 1977 replacing the previous expression “under the law of that State”. In the same year, the second sentence was added to the Model. As pointed out by Pijl, these modifications imply a different approach in the liable-to-tax test. In the first version, the term “law” (“droit” in the French version) suggests a “holistic one-step approach”, in which domestic legislation and international law are considered together for the purpose of deciding whether or not a person is fully liable to tax. Instead, “1977’s article 4(1) analysis as to whether or not there is comprehensive taxation is divided in two steps”25. Considering, the term “laws” (“legislation” in the French version) to refer to
“material rules of law promulgated by a local legislator”26, then the first sentence determines whether a
person is liable to tax according to such domestic rules, whereas the second one excludes those
23 OECDC
OMMENTARY to art. 4, par. 8.1 second sentence: “that situation exists in some States in relation to
individuals, e.g. in the case of foreign diplomatic and consular staff serving in their territory”
24 P
IJL H., “The Excluded Resident and the Term ‘ Law ’/‘ Laws ’ in Article 4 of the OECD Draft ( 1963 ) and
OECD Model ( 1977 / 2010 )”, Bull. Int. Tax, 2012, 1: 4
25 P
IJL, op. cit.: 10
persons who are not subject to a comprehensive tax liability but only as a consequence of the application of international law.
In conclusion, the second sentence of art. 4 (1) does not shed light on the issue of compatibility of preferential regimes with the liable-to-tax test either, but confirms the approach of the OECD explained in the previous paragraph of remitting to the domestic law of States the question of defining rules regarding tax liability. Therefore, to sum up what has been observed above, what is definitely excluded by the OECD from the definition of resident for treaty purposes is only a tax liability purely based on source of income and a tax liability which, although defined domestically on a personal ground, results in taxation on source due to the application of international rules.
3.2 Potential vs actual taxation 3.2
The last attempt in this quest for a rule prescribing clear requirements for the interpretation of the expression “full tax liability” is, then, to examine the domestic law of States, in order to verify whether common principles are applied, which could, if not amounting to a unwritten rule of international law, at least provide some guidance. Nonetheless, as noted by the Commentary, the countries’ approach in this matter is not uniform. The main issue on which they differ is whether the liable to tax test is met by persons who are only “considered liable to comprehensive taxation even if the Contracting State does not in fact impose tax”27. This situation may arise in many different instances ranging from subjective
exemptions (related to the taxpayer), complete objective exemptions (the person’s only income is of a type which is specifically exempt), tax holidays in the form of a nil rate, cases where the tax due is waived or refunded, income is completely offset by the tax sparing credit, taxable income is below the tax threshold, the legal person is in a loss position, or an individuals is in a credit position since its deductions for personal allowances fully offset the positive taxable income28. In relation to art. 4 (1),
being a rule establishing the scope of the conventions by reference to the subjective requirement of being a resident taxpayer, the issue is mainly related to cases of subjective exemptions, such as for partnerships, charities and pension funds, which are also the ones addressed by the Commentary29.
However, given the vagueness of the concept of liable to tax, the same issue could be in principle raised also in the other circumstances. The matter can regard preferential regimes for individuals as well, such as the one of art. 24-bis, that, although they generally do not fully exempt individuals, they still move away from the traditional worldwide taxation principle. Although the specific implications of the issue in relation to such regimes will be subject to an extensive analysis in the next chapter, it is relevant at this point of the dissertation to outline its general aspect in relation to the distinction between actual and potential taxation.
Two different interpretation of the liable-to-tax test are usually employed. For States adopting a “formal approach”, persons who are within the framework of their tax jurisdiction but do not actually pay any tax there qualify for treaty entitlement, whereas for States adopting a “material approach”, actual taxation is required. Such a different interpretation of the concept of liability to tax is deeply intertwined with the question of defining the purpose of tax treaties, which is also characterised by two different points of views. On the one hand, those authors who, like Van Weeghel, believe that double tax treaties are mainly concluded for the purpose of avoiding double taxation and thus that “the residence
27 OECDCOMMENTARY to art. 4, par. 8.11 28 See O
LIVER J.D.B., “International Tax Problems of Charities and Other Private Institutions with Similar
Tax Treatment”, Report of the IFA Congress of 1985, Kluwer Law and Taxation: 65-66
29 For recognised pension funds, the issue has been solved in the last OECD Model of 2017 through their
requirement does serve to limit the application to situations in which there is double taxation”30, will tend
to support a material interpretation of the liable-to-tax test. One the other hand, those who, like Couzin, consider that “tax treaties seek to avoid double taxation, but they also allocate taxing jurisdiction and such allocation often occurs in a context where double taxation is in no way involved”31 will also consider
that “the purpose of the residency article is to refer a person to a country that imposes unlimited taxation, not to require such person be subject to unlimited taxation if the domestic law relieves some or all of that tax liability”32.
As recognised by the Commentary, the latter is the interpretation adopted by most countries in their case law or official documents of their tax authorities33. In order to exemplify this kind of approach
it is possible to illustrate three leading cases, in which tax liability was considered by the court to be integrated even if the taxpayer was exempt from income tax in the residence State. In the Union of India
v Azadi Bachao Andolan case34, the Indian Supreme Court in recognising the status of resident for the
purposes of the India-Mauritius tax treaty to a holding company established in the Mauritius argued how “liability to tax is a legal situation; payment of tax is a fiscal fact. In applying Article 4 it is the legal situation that is relevant, not the fiscal fact of actual payment of tax”. In the SICAV 35case the Belgian
Court of Appeal adopted the same approach of the High Court of Mumbai recognising the status of resident for treaty purposes to a Luxembourg Investment Company which was exempt from taxes in Luxembourg. Moreover, a similar approach is followed by the US Treasury too with regards to charitable entities. As expressed in the Internal Revenue Bulletin of 2000 “the phrase liable to tax as used in the above article (art. 4 of the US Model of 1981, which is the same as the current art. 4 of the OECD Model) does not require actual taxation. Thus, the fact that a person is only nominally taxable does not preclude that person from meeting the applicable <liable to tax> standard of this article”36.
In Italy too, both the Tax Authority and the Supreme Court adopt a formal interpretation of the concept of liable to tax. The former stated in a circular of 1996 that the concept of residence for treaty purposes “implies the requirement of being liable to tax based on a personal connection of the taxpayer with the residence State”37 regardless of whether tax is actually levied in Italy. This approach is also the
one consistently adopted by the Italian Supreme Court in its case law, which has confirmed this interpretation in two recent judgments38. In these pronunciations, the Court recognised the status of
resident for treaty purposes in one case for a German company, which was exempted under German law from taxation on capital gains from the alienation of shares, and in the other for a Swiss association, whose profits were totally exempt under Swiss law because the association pursues a public utility goal. According to the Supreme Court, “the sufficiency of the sole factor of the existence of a potential tax liability in the other State must be considered consistent with the function of double tax treaties of eliminating the overlap of national tax systems, in order to avoid that taxpayers are subject to a higher tax burden on foreign income and to support international trade”39. This approach is regarded by Italian
authors in line with the main principles of international tax law, as the principle of single taxation. Indeed, as Sartori points out, “by granting double-non-taxation in this case, the Court did not violate the principle of single taxation, but gave it a strict and correct application, articulating it in terms of neutrality […].
30 Hoge Raad, 4 December 2009, No. 07/10383, BNB 2010/177 (with conclusion by Advocate-General
Niessen and comment by S. Van Weeghel): 24
31 C
OUZIN R., “Corporate Residence and International Taxation", IBFD, Amsterdam, 2002: sec. 3.1.1 32 DIRKIS M., "The Expression ‘Liable to Tax by Reason of His Domicile, Residence’ Under Art . 4 ( 1 ) of the
OECD Model Convention", G. Maisto (ed.), Tax Residence of Individuals under the OECD Model
Convention, IBFD, Amsterdam, 2009: sec: 6.3.2
33 OECDC
OMMENTARY to art. 4 (1), par. 8. 11
34 Supreme Court of India, Union of India And Anr vs Azadi Bachao Andolan And Anr, 7 October 2003 /08 35 Court of Appeal of Brussels, 29 Nov. 2018, 2012/AR/906
36 Revenue Ruling 2000-59, Internal Revenue Bulletin: 594
37 Circular of the Italian Minister of Finance of the 23/12/1996, n. 306 (Translated by the Author) 38 Cass., sent. 11/10/2018, n. 25219; Cass., ord. 17/4/2019, n. 10706)
Indeed, it would be paradoxical if the principle of single taxation would lead to a taxation of the transnational income higher than it would have occurred at a purely domestic level”40.
On the other hand, in court decisions of other States it is possible to identify a material approach to the interpretation of the liable-to-tax test. In 2009 the Supreme Court of the Netherlands41, in applying
the treaty between the Netherlands and the US, which has the same wording of art. 4 (1), but with the addition that exempt pension funds and organisations as defined in art. 35 and 36 of the relative treaty are also considered resident, ruled that associations established in the Netherlands, which are generally not taxed in so far as they do not perform business activities and which are not organisations falling under art. 36 of the relevant treaty, cannot be regarded as resident for treaty purposes.
To sum up, although art. 4 (1) is usually subject to a formal interpretation in the case law of States, which consider potential taxation enough to qualify for resident for treaty purposes, it is not possible to draw that such interpretation constitute a general rule applicable in all circumstances. Nonetheless, the interpretation of the liable-to-tax test as not requiring a person to be subject to tax on all of his income appears to be not only the majority position, but also the one more coherent with the general principles of international taxation. Indeed, treaties being auxiliary to domestic law, it seems more appropriate to consider them limited to an assessment of the substantial connection with a Contracting State, regardless of whether actual taxation in that State occurs or not. Indeed, unlike the case of diplomats for which double-non-taxation descends from a mismatch in the concurrent application of two treaties, in the case of exempt entities or individuals entitled to preferential regime, total or partial double non taxation is an outcome of a sovereign choice of States in the design of their tax systems, to which, as explained in the previous sections, double tax treaties do not intend to impose boundaries. Therefore, the principle of single taxation cannot go so far as to deny entitlement to treaty benefits in cases where a State decides to exercise its tax jurisdiction by providing for limited or excluded tax obligations for its residents, since such choice falls within a competence of States which treaties only recognise as a starting point for their application. In this regard, “non-taxation should be understood as another way to exercise sovereignty on a unilateral or bilateral basis […]. Tax sovereignty is not only relevant with respect to what a State can (and does) actively demand of taxpayers but also with respect to what a state (intentionally) does not demand of them according to the very design of the tax system”42.
Thus, the only condition art. 4 (1) seems to require is that the personal attachment criterion, employed by the internal law of States, which grants the status of resident for treaty purposes, must identify a material connection with its jurisdiction which can, at least potentially, bring about worldwide taxation.
4. Double-non-taxation and subject-to-tax clauses 4
One of the consequences which can be drawn from the previous section, at least if a formal approach in the interpretation of the liable-to-tax test is applied, is that the rules establishing the personal scope of double-tax treaties do not exclude double non-taxation, namely when one and the same income is not subject to tax either in the resident State or in the source State. Indeed, since worldwide taxation of residents is then only an assumption double tax treaties originate from, but does not constitute a binding legal requirement for their application, it might occur that an item of foreign-sourced income, attributable to a resident person, and to which the convention allocates exclusive taxing rights to the residence State, is not taxed in this State, due to any of the reasons mentioned above, thus escaping
40 S
ARTORI N., “Doppia Non Imposizione e Convenzioni Internazionali. Nota a margine di una recente e ineccepibile decisione della Cassazione”, Riv. dir. trib., 2/10/19, online version: sec. 5 (Translated by the Author)
41 Hoge Raad, 4 December 2009, No. 07/10383, BNB 2010/177 42 LAGUNA, op. cit., 194
taxation in both States. Double-non-taxation is also conceivable in the inverse perspective, less relevant for the purpose of this essay, namely when the source State does not tax an item of income to which it was attributed exclusive taxing rights.
Indeed, despite the introduction of a preamble in the OECD Model of 2017 following BEPS Action 6, which refers to the purpose of “eliminating double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion and avoidance”, and its inclusion in many existing treaties through art. 6 of the Multilateral Instrument, it is possible to share the conclusion of Peng and Schuch that “its usefulness remains limited to the interpretation of substantive treaty provisions since it is not of itself able to enforce any obligations”43, in accordance with art. 31 (1) of the Vienna Convention
on the Law of Treaties.
The very elimination of double taxation, which is historically one of the expressed purposes of tax treaties, does not always effectively occur through tax treaties. Firstly, tax conventions are limited in their material scope to taxes on income and capital which are listed by Contracting States in art. 2. Therefore, they do not limit taxing rights over taxes which are revenue based, such as the equalisation levy applied in India, or which have not been inserted in art. 2. Secondly, also in cases of the so-called “conflicts of qualification”, meaning when different distributive rules are applied by the tax authorities of the two States, since art. 3 (2) gives priority to the national law of the State applying the Convention, such differences of interpretation may well not be solved and, as a consequence, double taxation may remain44.
If the elimination of double taxation, despite being mentioned in the preamble of double-tax treaties and constituting the very reason why the subject of international tax law came into existence, is not always ensured by treaties, a fortiori, the avoidance of double-non-taxation, constituting a much more recent concern, that found its way into the preamble of the conventions mainly thanks to its introduction as a minimum standard of the MLI, cannot amount to a general binding rule of double tax treaties. The indication of the preamble, which merely represents a generic intention of the Contracting States, is therefore limited to an interpretative tool in the hands of judges, useful in cases when double-non-taxation proves to be an outcome of the application of the treaty, such as in cases of differences in treaty application to facts or in interpretation of treaty rules45. In such situations, the preamble might be
helpful in solving the conflict through an interpretation which prevents double taxation or double non-taxation. However, where double-non-taxation occurs because of exemptions provided for by the domestic law of the Contracting States, then the preamble is of no help, since it certainly does not have the legal power to repeal national legislation.
Therefore, considering as a starting point that the framework of the OECD Model does not shut the door on double-non-taxation, then it is up to States in the negotiations of the single tax treaties to decide whether to include either provisions that expressly allow for double-non-taxation, such as tax sparing credits, or other ones that are aimed at avoiding it, such as subject-to-tax clauses, namely “rules which make the granting of treaty benefits dependent on actual taxation, usually of a specific type of income”46. Therefore, such clauses go beyond the only allocation of taxing rights usually provided for by
distributive provisions, requiring those taxing rights to be exercised by either the residence or the source State.
The OECD contemplated this kind of provision for the first time in the report of 1987 “Double taxation convention and the use of conduit companies” as a possible approach in solving the issue of the source State having to grant treaty benefits to persons different from those that will economically enjoy those benefits. Nevertheless, in the same report it acknowledged that for these clauses “it is difficult to give a strict definition of the excluded situation” and they would result in ruling out persons
43 PENG C.,SCHUCH J., “The Relevance of the Preamble for Treaty Entitlement”, M. Lang et al. (eds.), Tax
Treaty Entitlement, IBFD, Amsterdam 2015: 3
44 See OECD COMMENTARY to art. 23, par. 32.1 and subs. 45 See OECD C
OMMENTARY to art. 23, par. 32. 5
that do not constitute conduit companies, such as “charitable organisations, pension funds or similar institutions”47.
Indeed, the main issue related to subject-to-tax clauses is that it is not possible to establish a single threshold above which the subject-to-tax test is deemed to be met applicable for all these clauses. Firstly, the very expression “subject-to-tax” is open to many different interpretations. Secondly, the wide range of articles of the convention in which these clauses are included, together with significant variances in the wording employed, make it impossible to determine a single meaning applicable to all subject-to-tax clauses. Hence, their meaning will ultimately vary according to the text of the single provision, the purpose of their inclusion and the approach adopted by the court that is to be apply them in the specific case.
The IFA Report of 2004 on Double non-taxation showed that, depending on the object and purpose of the provision in which they are included, at least three different approaches in the definition of the concept of “subject-to-tax” are adopted by States. Some countries, like the Netherlands, Spain and the UK, require that the item of income should not be exempt by the Contracting State that has taxing rights under a double-tax convention, but consider the subject-to-tax test met in the case when no taxes are levied due to the taxpayer’s personal circumstances, such as loss carry-forward or deductions fully offsetting taxable income. Other States, such as Belgium, consider an item of income subject to tax if it is attributed to a person liable to tax even if the income itself is usually exempt. Other ones require an effective amount of tax in connection with the income to be effectively levied or a certain rate to be applied. However, this latter approach, in order to safeguard legal certainty, needs to be founded on legislative parameters which determine when an item of income can be considered as effectively taxed. In this regard, the OECD, with the addition to the Commentary to art. 1 of 2017, suggests States which do not intend to grant treaty benefits with respect to income that is subject to certain features of another domestic system, especially in relation to passive income, to include special provisions linking the granting of treaty benefits on specific thresholds related to the determination of the taxable base or of the rate of taxation in the residence State.
Another issue related to subject-to-tax clauses concerns changes in the domestic law of the Contracting States. Since these clauses are drafted to tackle specific features of internal law which were in force at the time of the negotiation, they may not be suited to dealing with new rules or modification of existing rules, enacted after the conclusion of a treaty and which cause double-non-taxation.
In conclusion, although subject-to-tax clauses may constitute an effective tool for avoiding specific cases of double non-taxation, just as it is not possible to identify specific requirements defining the “liable to tax”, so too does the “subject to tax” test lend itself to specular differences of interpretation. Actual taxation, which is usually deemed to be necessary for subject-to-tax clauses, is a concept which lacks any exhaustive meaning and, therefore, requires further conditions to acquire full normative reach. Consequently, also considering how both in English and in French (assujettie à l’impôt and soumis à
l’impôt) the two terms can be used interchangeably, it is possible to share the conclusion that the only
difference between the two concepts lies in the fact that the former “is applied to persons” and is used to decide whether the person is or is not taxable as resident without “considering separate sources of income” and the latter “is applied to income” and is used to consider “whether the particular item of income is taxable or not”48. However, in both cases, in the absence of clarification, the issue of
determining when a person is liable to tax or when an item of income is subject to tax remains. Nonetheless, the need for States to include subject-to-tax clauses in their treaties proves a point which is highly relevant for the purpose of this dissertation, namely that the second sentence of art. 4 (1) alone is not sufficient to solve the issue of the source State having to grant relief for income that is untaxed in the residence State and that its function is limited to excluding from treaty entitlement diplomats and other persons taxed only on income from sources in the State as a consequence of the
47 OECD, “Double Tax Conventions and the Use of Conduit Companies”, 1987: 98
48 AVERY JONES J.F., “Weiser v HMRC: Why Do We Need <Liable to Tax> and <Subject to Tax> Clauses?”,
application of another international agreement. Indeed, subject-to-tax clauses in provisions allocating exclusive taxing rights to the residence State over foreign sourced income would have not been necessary if taxpayers, taxed only on income from sources in the State, had already been excluded from treaty entitlement. Therefore, as observed again by Avery Jones, “it is inherent in the OECD definition of resident for treaty purposes that not all income might be taxable on a residence basis”, and that, whereas the second sentence “was added in 1977 to deal with one major problem, particularly affecting diplomats, […] subject tax clauses were instead necessary to deal with the rest of the problem of the source state giving relief for income that was untaxed in the residence state”49.
