1.

International tax treaties With the rapid global growth of trade, commerce and finance in the recent years, countries of the world cannot remain aloof from each other. The interdependence of the countries is so great these days that any economic imbalance in one country adversely affects the economy in another. National policies have, therefore, become international oriented, as is normally reflected in tax legislation and practice. It is a well known fact that any change in tax law of a country has the effect of influencing its trade and commerce viz-a-viz its economic relations with other countries. Each country, therefore, exercises great care and caution in the formulation of its tax law so as not to endanger its national economic interest. Pakistan has also been cautious of this fact and in recent years has formulated tax policies which are reflective of this attitude. There can be no dispute that taxation is a deterrent against free flow of trade and business expansion. As a result of favourable or unfavourable treatment by way of taxation, the flow of trade gets regulated either adversely or favourably. The tax structure can be an important independent factor in determining the growth potential of the economy. It may stimulate or restrain the inflow or outflow of investment funds from or to foreign countries. Tax laws of a country, therefore, play an important role in international business relationship. Many international tax angularities are evened out and many problems are solved or mitigated through bilateral "treaty". It means any international agreement in written form, whether embodied in a single instrument or two or more related instruments, called either treaty, convention, protocol or covenant, concluded between two or more states governed by the international law. Such treaty is an attempt to invoke the concept of comity of nations or of rules of international law in the interpretation of an agreement that derives legal sanctity from the countrys own income-tax law. Pakistan has entered into double taxation agreements with 45 countries till December 1998. The coming chapters will explain in detail the historical background of these agreements as well as their impact on Pakistan's economy. This book will provide ample information to all those who are interested to study international tax treaties with specific reference to .taxation of non-residents in' Pakistan. 2. Double taxation agreements The interaction of two taxation systems each belonging to a different country can result in double taxation. It occurs when two States exercise their right to tax the same person on the same income. This so happens for the following reasons:(i) The States levy taxes on incomes which has arisen or accrued abroad, in cases of their residents. (ii) The States do not waive or surrender their right to tax a person on the income which has arisen or accrued in their jurisdiction by virtue of the location of the source. (iii) A person is deemed simultaneously to be resident by the two States, in one by virtue of his stay and in the other by virtue of any other criterion such as the source of income, or when the source rule overlaps because two States find the same transaction to be within

their territory. (iv) Certain States tax worldwide income of their citizens, irrespective of their being residents of either States. Double taxation agreements between two countries, therefore, aim at eliminating or mitigating the instance of double taxation. Or where such treaties are not in existence, countries have been avoiding taxing the same income twice through their unilateral action. In some cases especially for resident persons, the unilateral tax relief is provided for doubly-taxed income. For developing countries such treaties have further importance as they facilitate attracting foreign investments. Thus the arrangements between the two countries to ensure that the persons are not taxed twice over, once in one country and again in another, on the same income, have normally been embodied in an agreement called Avoidance of Double Taxation Agreement. Such agreements are given statutory force in each country. They override any other enactments. Even the Parliament itself cannot alter the wording of double taxation agreements without the consent of both the parties. 2.1. Objectives - The prime object of a double taxation agreement is to provide for the tax claims of two Governments both legitimately interested in taxing a particular source of income either by assigning to one of the two the whole claim or else by prescribing the basis on which the tax claim is to be shared between them. Double taxation agreements aim at eliminating the double taxation of certain income where a resident of one country derives income from a source of another country. This helps ensure facilitating international trade and commerce, flow of investment as also equitable collection of revenue. The agreements tend to achieve the aforementioned aims by (a) clarifying where a country of source may tax a non-resident in respect of certain types of income; (b) limiting the rate of tax a country of source may apply to certain types of income; (c) providing foreign tax credits in the country of residence against taxes paid in that country on income having source in other country. The other object of the double taxation agreement is to prevent tax avoidance and fraud by exchanging information. The absence of double 'tax agreements has effect of immediately increasing the tax charge on remittances of profits out of foreign countries in the form of dividends, royalties and interest. Such. remittances may suffer a discriminatory level of withholding tax (deduction of tax at source). The remittance, if it takes the form of profit from a branch of the head office is also subjected to tax. A number of countries viz France, Canada, Australia and the United States levy a branch profit tax to place branches on an equal footing with a subsidiary which would suffer withholding tax on dividend payable. Therefore, most double taxation agreements either eliminate or reduce the risk of double taxation. Besides, they also provide for a reduction in withholding tax rate and provide protection to the overseas residents by means of non-discrimination clause.

2.2. Pattern of taxation - Double taxation agreements determine which of the two contracting States may subject the income to their taxes. Sometimes the right to tax is given to the country where the income arises, exclusively or by way of priority. In other cases the home country of the recipient of the income has the exclusive right to tax; while in some other the source and residence country may tax the income, in which case the source country limits its tax to a certain medium whereas the residence country reduces its own tax on the same income according to the period or methods specified in the relevant double tax agreement. According to the current practice there is a well-established pattern of taxation of various types of incomes. Tax agreements contain provisions to the following fact:- Income from the business is taxed:(a) only in the home country, if the business undertaking carries on no activity in the host country; (b) only in the host country, if there is a fixed place of business i.e., permanent establishment and to the extent it is attributable to other place; (c) in both the countries (depending on whether the home country exempts the foreign profit or grants a credit). - Income from immovable property arising to a non-resident is taxed primarily in the country of its location. - Income from movable property such as dividends, interest or royalty are primarily taxed in the home country, but the host country may impose a reduced tax. - Income from personal exertion such as director's fees, service fees, pensions, remunerations, is taxed according to various rules with varying solutions. Thus, the primary right of the source country to impose tax on business profit and income from immovable property has been a well-accepted principle of all tax agreements. The primacy, however, does not mean exclusivity. In respect of income from movable property (namely, interest, dividends and royalty) and income from shipping, the principle of primacy is not followed. For such income reliance is placed on the principle of granting exclusive right of taxation by the country of residence or by the source country at reduced taxation at source. As a correlative to the right of taxation at source, the treaty imposes obligation upon the source country to ensure that the rates are not so high as to discourage investment and to take into account expenses allocable to the earning of the income so that such income would be taxed on a net basis. Such obligations stem from the appropriateness of sharing the revenue with the country providing the capital. 3. Development of double taxation agreement models The problems relating to double taxation are by and large common, with few of them being

peculiar to particular tax situation in a country. To have a model for tax convention (agreement) was thought a desirable necessity so that such model could provide a frame for the drafting of a particular agreement. Model forms for the convention applicable to all countries were first prepared by the Fiscal Committee of the League of Nations in 1927. Later the said Committee conducted meetings in Mexico during 1945 and in London in 1946 and proposed minor variations. The model conventions were published in Geneva in April 1946, by the Fiscal Committee of the UN Social and Economic Council. Model drafts were prepared by the League of Nations known as Model Treaty of Mexico of 1943 and London Model Treaty of 1946. These drafts were made the starting point by Organisation for European Cooperation and Development (OEED) and its successor Organisation for Economic Cooperation and Development (OECD) (which is a group of 24 developed countries) in attempting a draft model for the avoidance of double taxation. The draft was published in 1963, which is called the Model Convention of 1963. This model was being used by the developed countries as a basis for concluding bilateral treaties. Based on practical experience, this model was revised in 1974 and 1977. The model was reflective of the standard to be followed, and in fact is still being followed in drafting bilateral agreements, to a great extent, modified only to the extent necessary to cope with the special problems arising from the differing levels of development or differing structures of tax systems of the contracting States. The OECD provided its own commentaries on the technical expressions and clauses in the model conventions. Lord Radcliffe in Ostime (Inspector of Taxes) v. Australian Mutual Provident Society has described the language as the international tax language. The other models, viz., the Andean Model (concluded by member States of the Andean Group, viz., Bolivia, Chile, Equador, Colombia and Peru), the UN Model (published by the United Nations in 1980), the US Model (published by the United States in 1981 to serve as the basis for treaty negotiations by the US with others) differ on whether the income be taxed in the country of source or of the residence of the recipient. 3.1 Andean Model and OECD Model - The Andean Model sticks to the source country principle, while the OECD Model recognises the priority of the country of residence to tax income. The basic concept of the OECD Model is opposed to the principle of source. The approach of this model is to reserve the right to tax income and gains to the country where the taxpayer is the resident, except in cases where he has immovable property or substantial business operations through permanent establishment in the other country. Since the taxability of income is dependent upon the residential status of the investor, which in the case of developed and developing countries is always in the former because of the flow of investment being undirectional, i.e., from the developed to the developing countries, and thus confining the taxing rights to the richer countries, the approach of the OECD Model is not to the liking of the developing countries. They want to share a part of tax because the income have arisen in those countries. They want to share a part of tax because the income have arisen in those countries. The Andean Model, therefore, seeks to

resolve the basic cause of international double taxation (the differing or overlapping rules for locating the source) by locating the source in one country or the other but never in both in contrast to the OECD Model which resolves it by dividing the tax 'take' between the two countries. In doing so the OECD Model recognises, and the Andean Model ignores, that other rule, known as the sauce doctrine, that what is sauce for the goose is sauce for the gander. 3.2. UN Model and OECD Model - As the Andean Model is intended to serve the purpose of Andean Group, the UN Model is intended to serve the interests of developing countries, both are alternative to the OECD Model. It was published by the United Nations in 1980. The UN Economic and Social Council had recommended in its resolution in 1953 that the principle of source constituted the primary basis of tax agreements between the developed and the developing countries. That source principle governed the field till it was disturbed by the London and the OECD Model. The UN Group re-established the principle of source. The Model gives greater tax rights to the country where income arises by providing for high rates of withholding taxes on dividends, interest, and royalties and by allowing countries to retain most of the taxing powers available under their domestic tax laws for foreign business operating in their country. The UN Model corresponds to the OECD Model; though its contents diverge in some important respects. 3.3. US Model and OECD Model - The US Model was first published in 1976, revised in 1977 and 1981, to serve as model for all treaty negotiations by the USA. This model is designed to follow the pattern of the OECD Model as also to adapt some traditional peculiarities of the US treaty practice. 3.4. Agreement between developed and developing countries - Since many countries (including Pakistan) do not have their own models, they tend to follow either the OECD Model or the UN Model tailored to the peculiar requirement of each Contracting States or their tax laws. Tax agreements between the developed and developing countries encourage to a considerable extent promotion of the flow of investment of capital or technology for the economic development of the latter and thus are drafted to provide for favourable tax treatment to such investments on the part of the countries of the origin, both by outright tax relief and by measures which would assure to them the full benefit of any tax incentive allowed by the country of investment. So far as Pakistan is concerned bilateral agreement for regulating some of the problems of double taxation began in 1947 when it entered into an agreement for avoidance of double taxation with India in the aftermath of partition of the sub-continent. Thereafter, it has entered into agreements with various countries and has today an extensive network of such agreements. The pattern employed, which for obvious reasons employs similar forms and similar language in all the agreements, is derived from a set of model clauses proposed by the Fiscal Committee of the League of Nations and by the OECD and finally by the United Nations. 3.5. Treaty models lead to development of international tax law - In view of the standard OECD and UN Models used in all double taxation avoidance agreements, a new

era of genuine 'international tax law' (international tax law is the conglomerate of tax treaties in combination with unilateral relief provisions, the study of national tax systems as to similarities and differences) is now in the process of developing. These have served the purpose as expressed by the Secretary General of the UN in the regular session of 1987 of the Economic and Social Council that bilateral tax agreements should be as uniform as possible so as to prepare the way for international tax agreements. Any person interpreting a tax agreement must now consider decisions and rulings worldwide relating to these agreements. The maintenance of uniformity in the interpretation of a rule after its international adaption is just as important as the initial removal of divergencies. Therefore, the judgments rendered by courts in other countries or rulings given by the other tax authorities would be relevant.