INTERNATIONAL TAX TREATIES, POST-COLONIAL COUNTRIES, AND THE CONTINUING POWER IMBALANCE
“the use of tax treaty networks to reduce tax payments…is a major issue for many developing countries, which would be well advised to sign treaties only with considerable caution.”
Nyasaland was under the governorship of Geoffrey Francis Taylor Colby, the Queen appointed representative, when it signed a tax treaty with the UK in 1955. Under this treaty Nyasaland was to not charge any withholding taxes, i.e., taxes on money leaving a country. British companies could therefore move money out of Nyasa through any medium freely without paying any tax. 65 years since the signing of the treaty and 54 years since Nyasaland’s independence to become the Republic of Malawi, the treaty continues to exist. With all different strategies of tax avoidance not only the companies based out of the UK, but other European countries like the Netherlands continue to “unduly” benefit from this tax treaty which otherwise they would have been subject to Malawi’s 15% withholding tax rate. The UK remains Malawi’s third largest source of foreign funds flow and in such a situation renegotiating the treaty can have a significant impact on Malawi’s whatsoever small source of income. From an objective perspective, the only question remaining is “has the sun ever set on the empire?”
The objective of this piece is to briefly understand the existing tax treaties in the light of power imbalance caused by sustaining colonial shadow and how the development in international taxation law has failed to curb the same. The bird eye view is that the once colonial countries still struggle to be amongst developed nations and multinational countries gain advantages, strategically and non-strategically, from such negotiations imbalance leading to failure of treaty based regimes.
INTERNATIONAL TAX TREATIES vis-a-vis DEVELOPMENT: NEO-COLONIALISM?
The initial and sole purpose of Tax treaties under OECD mechanism was to augment economic activities by preventing double taxation on capital and income. But somehow they have become a new tool of colonialism where the developing countries give away their resources with insufficient returns and all this due to either archaic tax treaties which poses difficulty in renegotiation or strategic negotiations to have a willful tax treaty by a developed country.
The developing erstwhile colonial countries provide for rich natural resources. In civil society parlance, they are called Resourceland with large reserves of natural resources, especially oil but they for scientific or monetary reasons lack the technology to utilize these resources optimally. Though such assistance in helping developing countries with foreign funds and new economic opportunities in return for resources is not an issue in itself, but the unfair advantage gained in paying due monetary payments via the concept of “Treaty Shopping” has caused Resourceland’s major loss of deserved funds. For instance, the DTAA between the Netherlands and Uganda is clearly in favor of the former as the dividends paid from Uganda to an investor owning more than 50% of the shares will not be taxed. So hypothetically in the situation of Netherlands-Uganda if an Oil company based in some third country opens up a subsidiary or as they are called “letterbox companies’’ in the Netherlands and then through this route starts business in Uganda, it will still gain those benefits. In reality, 95% of Dutch investments in Uganda originates from a third country.
Now this creates a chicken-egg situation because the developing countries do not want to lose foreign investment and for that ends up providing benefits to multinationals from developed countries who taking advantage of this ends up gaining huge leverage. So it eventually results in a vicious cycle of balancing whatever the money may flow and letting go of deserved funds due to the undeserving financial imbalance. For instance, Bangladesh has lost USD $85 million per annum because of its DTAA which does not allow it to levy withholding taxes.
Such treaties continue to exist(s) with some dating back to colonial roots:
The advent of technology has further augmented such avoidance treaties. The system of digital companies is complex in the potential that their incorporation, physical presence, servers, service provider and use may all be present in different countries. It makes it difficult to trace their permanent establishment and much more difficult if we add layers of subsidiaries and letterbox companies. Companies like Google, Facebook and Apple have already been exposed to their avoidance strategies like the double Irish with a Dutch sandwich.
LACUNA IN TREATY REGIME
However, for all the measures adopted, it has not reduced the disadvantages of the treaty based model of taxation. Though they are named “double taxation avoidance treaties”, they have rather become a source of credit input or gaining subsidies. Martin Hearson in his book “Studies in the History of Tax Law” writes:
“Critics argue that, by concluding tax treaties, capital-importing developing countries have therefore been subsidising capital-exporting countries’ international tax systems.”
Further citing an Irish adviser to the government of Zambia, he adds:
“The practical effect of the present network of double taxation agreements between developed and developing countries is to shift substantial amounts of income tax revenues to which developing countries have a strong legitimate and equitable claim from their treasuries to those of developed countries…..In other words, the present system of tax agreements creates the anomaly of aid in reverse — from poor to rich countries.”
Then there is the personal and professional motivation of negotiators. Hypothetically an Indian negotiator may be inclined to give more leverage to a foreign investor if the government back home has a time bound “Make in India” target to achieve. There can be historical and political motivation for signing a tax treaty too. For instance, the Netherlands model of Tax treaty still relies on their historical tax treaty template with Germany pre-World War II. This treaty was signed in the background of a number of personal (double tax complaints by one Count William Bentinck und Waldeck Limpurg to Dutch Minister of Finance), political (world war, geo-political presence) and compromises (Germany formed a new draft in the anticipation of getting it signed early).
Similar is true for tax treaty negotiations between UK and erstwhile colonial countries like Kenya, Zambia, Egypt, Thailand, Tanzania and Brazil. The UK’s aim naturally was to ensure that its investors are not at disadvantage with local competitors of capital import countries. The UK itself provided enough domestic credits to its investors and relying on an agreement would have caused more disadvantage to them considering developing countries are more likely to have discriminatory provisions. So they started to rely on so called “international standard” or the OECD model to ensure equity for their investors when firstly, there were enough protection to their investors within their country; secondly, there was no equal playground for developing countries from the beginning; and thirdly, developing countries had relatively inexperienced negotiators. For instance, during the UK-Tanzania negotiation of 1977, the then head of the UK team in his confidential memo to his government mentioned how the Tanzania negotiator was a “pleasant man” but “knew very little about the implications of international tax agreements”.
Moving to more technical issues with tax treaties there is wrongful assumption of reciprocity in model tax treaties. The tax policy behind the model treaty seems to presume that both the countries are going to benefit from reversal in “source” and “residence” status with reciprocal flow of capital and services. But when it comes to Colonial-developed countries and colonized-developing countries there is rarely any comparative reciprocity of trade and thus, income.
The tax treaties are limited to income only and other taxes on trade are dealt in by trade agreement(s). Further these treaties are naturally in the form of bi-lateral treaty. India has a separate DTAA with 160 countries and this in multiplication of trade agreements. According to one estimate, there would have to be over 32,000 bilateral tax treaties to comprehend all nation states mutual agreements on tax.
Considering this the treaty method is neither uniform nor comprehensive.
An econometric study with colonialism as variable suggests that “if a developing country has ever been a colony of an industrialized country, the probability of these two countries signing a DTAA is higher.” Further there is no established link or research to show that the DTAA has led to an increase in FDI or tax revenues.
Though the OECD model remains the churning inspiration for developed countries, the UN Model Tax Treaty is considered to be comparatively in favor of source countries i.e., developing countries. There are a few instances where the developing countries have relied on the UN Model. In a scenario of no progress from model reforms of OECD or UN for that matter, the countries are themselves trying to re-negotiate their treaties; sometimes unilaterally. For instance, India has last year only re-negotiated its treaty with Mauritius which earlier exempted capital gains tax for companies based out of the latter. Official data states that in the last decade the highest foriegn investment to India has come from Mauritius. In 2019, India has also ratified OECD’s the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS) to ensure on checking tax evasion. Similarly, the government of Senegal canceled its tax treaty with Mauritius in 2020 claiming the treaty was causing them a loss of USD 257 million over 17 years. In 2015, both South Africa and Rwanda began talks to renegotiate their tax treaties with Mauritius.
Are there ways to improve the treaty based international taxation regime or is there an alternative to the tax treaty model? Exploring the former, the first essential is to break the history or precedents from affecting the negotiation process. The tax treaty shall be a sui generis model in itself. This probably can be done by mechanism of an institution as third party monitored negotiation. As long as the two sovereign but economically unequal powers negotiate unmonitored OECD model’s will remain for namesake. There are strong differences in real treaties signed and the Model treaty. Secondly, there is direct conflict between competitive tax regimes and hypothetical goals of Tax treaties to increase investments. As long as options are available, MNCs will opt for such avoid method(s). This again calls for a monitored method of treaty regime or atleast shift in goals of DTAA. It is apparent that DTAA has become more than what they were supposed to be and in such a scenario recalibrating not only theirs but OECD Model Treaty’s goal to “equitable and transparent taxation within cooperative regime” can help reduce abuse. It has to be understood that the OECD or UN system of tax law does not exist in a vacuum. The Declaration on the Granting of Independence to Colonial Countries and Peoples (General Assembly resolution 1514 (XV)), 1960 and “Declaration on Principles of International law concerning Friendly Relations and Cooperation among States in accordance with the Charter of the United Nations’’, 1970 are very part of the same system. When such declaration(s) recognizes the inherent political and social rights of erstwhile colonial countries, their non-extension to the economic sphere will leave the Treaty regime as mere facade.
Also there lies an anomaly in the treaty regime and reform. There are so many treaties that it is practically impossible to change each one of them. One practical reform could be to have a multilateral treaty on at least certain aspects of the OECD or UN Model Treaty. For instance countries could scale back provisions which allocate tax jurisdiction and offer a new multilateral instrument as a possible means to do so.
Lastly, not going into details of how there shall be limits on exemptions or better laws to identify genuine beneficiaries of tax treaties, the developing countries can at least make their own system(s) more accountable in the form of ratification from parliament or clean deals. As one would say international tax treaties were never the issue, greed was.
This piece was first published on the Indian Journal of International Economics Law’s Blog on June 30, 2021. The relevant link is above. I am thankful to the team of IJIEL for their kind review.