UN Model vs OECD Model Treaty: Key Differences in Taxation for Developing Countries

QUESTION POSTED BY: Student
PROGRAMME: Postgraduate Diploma in International Taxation
TOPIC: Introduction to International TaxationFOR MORE INSIGHT ON INTERNATIONAL TAXATION, PLEASE READ THIS ARTICLE: Introduction to International Taxation: Key Concepts & Guidelines International Taxation encompasses the framework of laws, principles, and treaties that govern the tax obligations of individuals and entities engaged in economic activities that span multiple jurisdictions. This field addresses how income, profits, and gains are taxed when operations or investments extend... (WEEKS 1 & 2)
LECTURER: Dr Daniel N Erasmus

FULL QUESTION

The UN Model Treaty was developed with the developing countries’ intentions and benefits more in mind compared to the OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model Treaty. In terms of their contents, what are the specific differences?

ADDITIONAL WRITTEN ANSWER

The key distinction between the UN Model Convention and the OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model Convention lies in the approach to taxation, which stems from the differing interests of developed and developing nations. The OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model primarily favors residence-based taxation, reflecting the priorities of developed countries, which often have significant multinational enterprisesWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include... (MNEsWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include...) and seek to tax income where the enterprise is resident. In contrast, the UN Model focuses on source-based taxation, aligning more with the needs of developing countries, which want to tax income generated within their borders by foreign enterprises. This focus allows these countries to benefit from the activities of non-resident companies operating locally.

Here are specific differences between the two models:

1. Permanent Establishment (PE) Definition and Threshold:

UN Model: Expands the definition of a permanent establishment (PE), lowering the threshold for foreign enterprises to be considered as having a taxable presence in the source country. This allows source countries greater opportunities to tax the profits of foreign companies. For example, the UN Model includes a “service PE” clause that allows the source country to tax services performed within its territory, even if no fixed place of business exists.
OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model: The PE definition is more restrictive, focusing on activities carried out through a fixed place of business. It limits taxing rightsFiscal Sovereignty is the inherent authority of a state to independently manage its financial and economic policies, especially the power to levy and collect taxes within its jurisdiction. Central to national autonomy, fiscal sovereignty enables governments to shape economic policies that reflect their priorities, ranging from welfare programs to defence and infrastructure investment. It also underpins each country’s approach to... in the source country, favoring the residence country of the multinational.

2. Taxation of Business Profits:

UN Model: Grants source countries greater taxing rightsFiscal Sovereignty is the inherent authority of a state to independently manage its financial and economic policies, especially the power to levy and collect taxes within its jurisdiction. Central to national autonomy, fiscal sovereignty enables governments to shape economic policies that reflect their priorities, ranging from welfare programs to defence and infrastructure investment. It also underpins each country’s approach to... over business profits, even when the activities of the non-resident enterprise are not substantial. For example, it allows the taxation of profits that arise from a PE in the source country, with broader definitions of what constitutes a PE.
OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model: Provides a more limited ability for source countries to tax business profits, especially if the enterprise does not meet the stricter PE definition. This tends to benefit the residence country, where the enterprise is headquartered.

3. Taxation of Dividends, Interest, and Royalties:

UN Model: Source countries are given the right to impose higher withholding taxes on dividends, interest, and royalties. This ensures that developing countries can tax payments made to foreign investors, such as royalties for the use of intellectual propertyIntellectual Property (IP) refers to creations of the mind, including inventions, literary and artistic works, symbols, names, images, and designs used in commerce. It grants creators exclusive legal rights to use and exploit their work, ensuring protection against unauthorised use or reproduction. These rights are critical in fostering innovation and creativity while providing economic value to individuals and organisations. IP....
OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model: Restricts the source country’s ability to impose withholding taxes on dividends, interest, and royalties. Lower or zero withholding tax rates are often encouraged, benefiting the residence countries, which are usually the home of the investor or patent holder.

4. Capital GainsCapital gains refer to the profit earned when an asset, such as real estate, stocks, bonds, or even a collectible, is sold or exchanged for a price that exceeds its original purchase cost. These gains are a critical component of personal and corporate finance, as they influence investment strategies and tax obligations. Capital gains are realised when an asset is...:

UN Model: Provides broader taxing rightsFiscal Sovereignty is the inherent authority of a state to independently manage its financial and economic policies, especially the power to levy and collect taxes within its jurisdiction. Central to national autonomy, fiscal sovereignty enables governments to shape economic policies that reflect their priorities, ranging from welfare programs to defence and infrastructure investment. It also underpins each country’s approach to... to the source country, especially regarding gains from the sale of shares or interests in local businesses, real property, or other significant investments.
OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model: Typically limits the taxing rightsFiscal Sovereignty is the inherent authority of a state to independently manage its financial and economic policies, especially the power to levy and collect taxes within its jurisdiction. Central to national autonomy, fiscal sovereignty enables governments to shape economic policies that reflect their priorities, ranging from welfare programs to defence and infrastructure investment. It also underpins each country’s approach to... of the source country to gains arising from real property or local PEs, benefiting the residence country of the investor.

5. Fees for Technical Services:

UN Model: Includes a specific article that allows the source country to tax fees paid for technical services, management, or consultancy fees rendered within its territory. This is particularly relevant for developing countries that import these services from more advanced economies.
OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model: Does not have a similar provision. This limits the ability of the source country to tax such fees, as they are often considered to be taxed only in the residence country.

6. Dispute Resolution (Mutual Agreement Procedure – MAP):

UN Model: Lacks a mandatory arbitration clause for resolving disputes between contracting states, which might result in unresolved issues between developed and developing nations. Many developing countries prefer flexibility and control in tax disputesTax Disputes arise when there is a disagreement between taxpayers and tax authorities regarding the interpretation or application of tax laws. These disputes may concern various issues such as the accuracy of a tax return, the eligibility for tax deductions or credits, the correct amount of tax liability, or transfer pricing adjustments. Tax disputes can lead to lengthy legal proceedings....
OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model: Includes a mandatory arbitration clause, ensuring that disputes, if unresolved by negotiation, will be arbitrated by a third party. This is more in line with the interests of developed countries seeking certainty and efficiency in dispute resolution.

7. Transfer PricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... and Anti-Avoidance MeasuresAnti-abuse provisions are legislative measures implemented by tax authorities to prevent taxpayers from exploiting legal loopholes or engaging in artificial arrangements solely to reduce their tax liabilities. These provisions are essential tools for revenue authorities to maintain fairness in the tax system, ensuring that the intent of tax laws is respected and that tax bases are protected against erosion due...:

UN Model: Developing countries under the UN Model may adopt stricter transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... provisions and anti-avoidance rules to protect their tax baseThe tax base is a fundamental concept in taxation, representing the total amount of economic activity or assets upon which a tax is levied. It is the foundation upon which governments calculate the amount of tax owed, based on factors like income, property value, sales, or corporate profits. Understanding the tax base is essential for tax professionals, businesses, and policymakers,... from profit shiftingProfit Shifting is a strategic practice employed by multinational enterprises (MNEs) to reduce their global tax liability by shifting profits from high-tax jurisdictions to low- or no-tax jurisdictions. The primary method involves transferring income-generating activities, intangible assets, or other high-value components within the group to countries with favourable tax regimes. Profit Shifting is a critical concern for tax authorities and... by MNEsWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include....
OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Model: While OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... countries follow the OECD Transfer Pricing GuidelinesThe OECD Transfer Pricing Guidelines serve as a critical framework for multinational enterprises (MNEs) and tax administrations worldwide. They provide detailed principles for the pricing of intra-group transactions to ensure that profits are allocated fairly across jurisdictions, based on the arm’s length principle. In essence, these Guidelines are instrumental in preventing tax base erosion and profit shifting by MNEs. The..., which aim for a balanced approach, they are generally more aligned with residence-based principles that sometimes limit the source country’s taxing power.

Adoption of the UN Model in Africa: EXAMPLES

Most developing countries, particularly in Africa, prefer the UN Model due to its source-based taxation, which provides more control over taxing foreign enterprises. Some African countries that have adopted or use the UN Model Convention include:

Kenya: Actively uses the UN Model to maintain taxing rightsFiscal Sovereignty is the inherent authority of a state to independently manage its financial and economic policies, especially the power to levy and collect taxes within its jurisdiction. Central to national autonomy, fiscal sovereignty enables governments to shape economic policies that reflect their priorities, ranging from welfare programs to defence and infrastructure investment. It also underpins each country’s approach to... over foreign companies, especially those involved in natural resource extraction.
Botswana: Uses the UN Model to preserve its right to tax foreign enterprises engaged in the mining sector and other industries that are critical to its economy.
Zambia: The UN Model allows Zambia to levy withholding taxes on cross-border payments like interest and royalties, ensuring that foreign investors contribute to local tax revenues.
Namibia: Adopts the UN Model to secure taxing rightsFiscal Sovereignty is the inherent authority of a state to independently manage its financial and economic policies, especially the power to levy and collect taxes within its jurisdiction. Central to national autonomy, fiscal sovereignty enables governments to shape economic policies that reflect their priorities, ranging from welfare programs to defence and infrastructure investment. It also underpins each country’s approach to... over foreign companies, particularly in its growing sectors like manufacturing and services.