## 1.  Introduction

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---

### Relationship between Tax Treaties and Domestic Laws
- Purpose: provide introductory guidance to the tax policy department in a developing country expanding or about to expand its tax treaty network on how to design and draft a domestic law to implement a tax treaty and related issues.
- Article references: explanatory citations use articles of the OECD Model Tax Convention (OECD MTC).
- Fundamental international-law principles:
  - Art. 26 of the Vienna Convention on the Law of Treaties (VCLT): “Every treaty in force is binding upon the parties to it and must be performed by them in good faith.” (pacta sunt servanda).
  - Art. 27 of the VCLT: “A party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.”
- Domestic-law interaction and treaty override:
  - The possibility of a treaty override depends on each country’s constitution, laws, and judicial decisions.
  - United States example: the “later-in-time” rule applies; laws and treaties are of the same order of importance (Art. VI(cl.2) of the US Constitution). Sec. 7852(d)(1) of the IRC provides that neither treaty nor law shall have preferential status by reason of its being a treaty or law. Sec. 897 of the IRC (introduced as part of the Foreign Investment in Real Property Tax Act in 1980) overrode previous tax treaties.
  - Japan example: Japanese Constitution specifies that treaties prevail over domestic laws (Art. 98(2) of the Japanese Constitution).
  - New Zealand example: clarified the supremacy of treaties in its tax law (Art. BB3(2) of New Zealand Income Tax Act).
  - Recommendation: clarify in tax laws whether tax treaties prevail over domestic laws unless the Constitution explicitly provides a rule.
- Preservation clause and saving clause:
  - Preservation clause: nullifies any treaty provisions that inadvertently take away benefits otherwise permitted by domestic law; may be worth clarifying in law or guidance where a treaty lacks explicit provisions (example: Art. 1(2) of the 2003 Japan-US tax treaty).
  - Saving clause: maintains the right of a Contracting State to tax its own resident or citizen as if the treaty did not exist; some treaties explicitly state this (example: Art. 1(2)(a) of the 2003 Japan-US tax treaty).
  - Controlled foreign corporation (CFC) issue: argument exists that a CFC rule may conflict with a tax treaty; some treaties now clarify that the CFC rule does not violate tax treaties, and OECD member countries commonly understand a CFC rule is not contrary to a tax treaty (see Para. 1(1) and Art. 10(5) of the OECD MTC; Para. 23 of the Commentary on Art. 1 of the OECD MTC).

### Role of Domestic Laws to Implement a Tax Treaty
- Necessity of implementing laws:
  - If a treaty is self-explanatory, implementing laws are unnecessary.
  - Art. 3(2) of the OECD MTC provides a rule on how to interpret terms not defined in a treaty, solving most cases.
  - However, undefined terms or terms defined in non-tax laws often lead to misunderstanding or abuse; when anticipated, the tax policy department should introduce definitions in tax laws.
  - Practical procedures for treaty benefits (e.g., claiming reduced withholding tax rates or exemptions) should be set out in domestic laws, regulations, or other guidance rather than in the treaty text.
  - Tax officials at field offices require clarification and guidance; lack of understanding can make claiming treaty benefits time-consuming and costly.
- Examples of items to include in a law implementing tax treaties or related regulations:
  - definition of terms which may cause misunderstanding or lead to abuse;
  - procedures to apply for tax treaty benefits;
  - procedures for exchange of information;
  - procedures for assistance in the collection of taxes; and
  - mutual agreement procedures.

### Definition of Terms Which May Cause Misunderstanding or Lead to Abuse
- Common problematic terms: “agent of independent status” (Art. 5), “royalties” (Art. 12), “employer” (Art. 15) of the OECD MTC.
- The Commentary to the OECD MTC may be useful guidance, but courts may not grant it legal authority; consider clarifying definitions by referring to the Commentary or by stating the country’s own definitions in law.

### Procedures to Apply for Tax Treaty Benefits
- Approaches to documentation for claiming benefits:
  - self-declaration forms of eligibility;
  - certificate of residence issued by the tax authorities of the resident’s country;
  - the US qualifed intermediary (QI) program: under the QI program, a non-US financial intermediary receiving income from a US source for the account of its offshore customers can claim treaty benefits or simplified withholding and reporting by entering into a QI agreement with the IRS. Under the QI agreement, QIs accept enhanced responsibilities for providing assurance that customers are eligible for treaty benefits and exemptions such as obtaining acceptable account-opening documentation; if non-US financial institutions do not enter a QI agreement, the institution should provide required tax certifications on a case-by-case basis.
- Differentiation by extent of source-tax reduction:
  - a certificate of residence may be required for claiming exemption from source taxation, while only a self-declared form may be required for claiming a reduction of the withholding rate.
- Limitation of benefits (LOB) provisions:
  - treaties with detailed LOB provisions require comprehensible guidance by law and regulations. The US LOB approach since 1981 typically denies reduced withholding rates to a corporation established in a treaty partner country if more than a specified percent of its stock is held by residents of countries other than the US and its treaty partner country (example in paragraph 20 of the Commentary on Art. 1 of the OECD MTC).
- Hybrid entities:
  - Definition: a hybrid entity is characterized as a corporation in one jurisdiction and as a transparent entity in another.
  - Risks: existence of hybrid entities may lead to denying treaty benefits to legitimate residents or to cross-border arbitrage. Example: a partnership fiscally transparent in a country is not liable for tax within the meaning of Art. 4(1) of the OECD MTC and therefore the partnership itself cannot claim treaty benefits even if partners are eligible residents; partners should be entitled to treaty benefits with respect to their share of partnership income (Para. 5 of the Commentary on Art. 1 of the OECD MTC).
  - Cross-jurisdictional inconsistency example: State A treats a partnership as taxable, State B treats the partnership as transparent; source country may not impose taxation inconsistent with the terms of either applicable treaty with State A or State B.
  - Recommendation: include special provisions in a tax treaty to address hybrid entities; if not included, provide guidance in law or regulations. Example guidance exists in Sec. 894 of the IRC and related Treasury regulations in the US.

### Exchange of Information
- Global context:
  - Approximately ninety jurisdictions have committed to comply with the Global Forum’s Standards of Transparency and Exchange of Information for Tax Purposes (Global Forum Standards).
  - Enacting legislation necessary to implement the Global Forum Standards is increasingly important.
- Key legal issues when preparing legislation:
  - Confidentiality of received information:
    - Reciprocal exchange requires assurance that received information will be treated with proper confidence (Para. 11 of the Commentary on Art. 26 of the OECD MTC).
    - Confidentiality rules and penalties for breach should apply to treaty-obtained information in the same manner as domestically obtained information.
  - Domestic tax interest and information-gathering measures:
    - Information gathering measures (laws and administrative or judicial measures; Para. 19.7 of the Commentary on Art. 26 of the OECD MTC) usually exist for levying domestic taxes.
    - A requested authority may need to use information-gathering measures without “domestic tax interest” to respond to a treaty request (for example, to obtain information about a loss reported by a resident of the requested country that the requested authority would not audit for its own tax purposes).
    - Recommendation: include provisions explicitly allowing tax authorities to use information-gathering measures solely to provide information to treaty partners, to avoid admissibility arguments in court.
  - Criminal cases:
    - Art. 26 of the OECD MTC permits exchange of information on all tax matters including criminal tax cases (Para. 5 of the Commentary on Art. 26 of the OECD MTC).
    - Exchange for criminal matters can also rely on mutual legal assistance treaties; where mutual legal assistance has been the only instrument, consider clarifying in law that tax authorities can use information-gathering measures to provide information on criminal tax matters under a tax treaty.
  - Bank secrecy:
    - Some countries require financial institutions to protect clients’ confidentiality even from tax authorities; the Global Forum Standards do not allow the requested country to decline to provide information because of bank secrecy (Art. 26(5) of the OECD MTC and Art. 5(4) of the OECD Model Agreement).
    - All countries committed to the Global Forum Standards are required to change laws (often non-tax laws) so tax authorities can access client information held by banks and financial institutions.
- Domestic tax interest, information gathering, and confidentiality interplay underpin timely and reciprocal exchange of information.

### Assistance in the Collection of Taxes
- Art. 27 of the OECD MTC provides for mutual assistance in the collection of taxes.
- Implementation considerations:
  - Whether a country chooses comprehensive or limited collection assistance, any revenue claim requested shall be collected by the requested country in accordance with laws governing the enforcement and collection of its own taxes, as if the revenue claim were a revenue claim of the requested country.
  - It is desirable to change laws on collection of revenue claims to clarify that the same procedures apply to revenue claims requested by treaty partners.
  - More detailed rules (for example, priority order between a revenue claim of the requested country and one of the requesting country) should be provided by laws or regulations unless existing laws already provide applicable rules without ambiguity.

### Mutual Agreement Procedures (Art. 25 of the OECD MTC)
- Legal basis and practical implementation:
  - Art. 25 provides that "an agreement between competent authorities, which resolves taxation which is not in accordance with the treaty, should be implemented notwithstanding any time limits in the domestic laws."
  - Despite this explicit waiver of domestic time limits, it is desirable that tax laws or regulations:
    - provide detailed rules on how to implement the agreement, and
    - specify necessary procedures to be taken by taxpayers.
  - Statutory limitation of assessment including refund often corresponds to the period that taxpayers and tax authorities are required to keep relevant documents under domestic laws.
  - Competent authorities frequently reach agreements well after the statutory limitation of assessment in mutual agreement procedures on transfer pricing cases.
  - Practical recommendation: laws or administrative guidelines should require at least tax authorities to keep relevant documents once a taxpayer presented a case for mutual agreement procedures to competent authorities.
- Taxpayer remedies and parallel proceedings:
  - A taxpayer may present a case irrespective of the remedies provided by domestic laws (Art. 25(2) of the OECD MTC).
  - Taxpayers often lodge a case to administrative tribunals or courts in parallel with presenting a case to competent authority because laws on appeal or litigation normally provide time limits for lodging a case which are shorter than the period that mutual agreement procedures usually need to reach an agreement.
  - Parallel pursuit of administrative/court remedies and mutual agreement procedures may cause:
    - appeal tribunal decisions or court decisions that contradict or overlap with agreements between competent authorities.
    - considerable expenses for taxpayers, tax authorities, and judicial bodies.
- Policy recommendation on coordination of remedies:
  - It would be desirable that either the mutual agreement procedures or the domestic remedy process be suspended upon a taxpayer’s request until the other remedy measure produces a result, in cases where a taxpayer lodges requests for both remedy measures.
  - If a taxpayer wants both remedy measures to proceed in parallel, the taxpayer’s decision should be respected, because a taxpayer has the right to present a case irrespective of the remedies provided by domestic laws.

*Source: _tnm1101 - 1.  Introduction; _tnm1101 - 3.5  Mutual Agreement Procedures*

### 1.  Introduction

### 1.  Introduction

### Relationship between Tax Treaties and Domestic Laws
- Purpose: provide introductory guidance to the tax policy department in a developing country expanding or about to expand its tax treaty network on how to design and draft a domestic law to implement a tax treaty and related issues.
- Article references: explanatory citations use articles of the OECD Model Tax Convention (OECD MTC).
- Fundamental international-law principles:
  - Art. 26 of the Vienna Convention on the Law of Treaties (VCLT): “Every treaty in force is binding upon the parties to it and must be performed by them in good faith.” (pacta sunt servanda).
  - Art. 27 of the VCLT: “A party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.”
- Domestic-law interaction and treaty override:
  - The possibility of a treaty override depends on each country’s constitution, laws, and judicial decisions.
  - United States example: the “later-in-time” rule applies; laws and treaties are of the same order of importance (Art. VI(cl.2) of the US Constitution). Sec. 7852(d)(1) of the IRC provides that neither treaty nor law shall have preferential status by reason of its being a treaty or law. Sec. 897 of the IRC (introduced as part of the Foreign Investment in Real Property Tax Act in 1980) overrode previous tax treaties.
  - Japan example: Japanese Constitution specifies that treaties prevail over domestic laws (Art. 98(2) of the Japanese Constitution).
  - New Zealand example: clarified the supremacy of treaties in its tax law (Art. BB3(2) of New Zealand Income Tax Act).
  - Recommendation: clarify in tax laws whether tax treaties prevail over domestic laws unless the Constitution explicitly provides a rule.
- Preservation clause and saving clause:
  - Preservation clause: nullifies any treaty provisions that inadvertently take away benefits otherwise permitted by domestic law; may be worth clarifying in law or guidance where a treaty lacks explicit provisions (example: Art. 1(2) of the 2003 Japan-US tax treaty).
  - Saving clause: maintains the right of a Contracting State to tax its own resident or citizen as if the treaty did not exist; some treaties explicitly state this (example: Art. 1(2)(a) of the 2003 Japan-US tax treaty).
  - Controlled foreign corporation (CFC) issue: argument exists that a CFC rule may conflict with a tax treaty; some treaties now clarify that the CFC rule does not violate tax treaties, and OECD member countries commonly understand a CFC rule is not contrary to a tax treaty (see Para. 1(1) and Art. 10(5) of the OECD MTC; Para. 23 of the Commentary on Art. 1 of the OECD MTC).

### Role of Domestic Laws to Implement a Tax Treaty
- Necessity of implementing laws:
  - If a treaty is self-explanatory, implementing laws are unnecessary.
  - Art. 3(2) of the OECD MTC provides a rule on how to interpret terms not defined in a treaty, solving most cases.
  - However, undefined terms or terms defined in non-tax laws often lead to misunderstanding or abuse; when anticipated, the tax policy department should introduce definitions in tax laws.
  - Practical procedures for treaty benefits (e.g., claiming reduced withholding tax rates or exemptions) should be set out in domestic laws, regulations, or other guidance rather than in the treaty text.
  - Tax officials at field offices require clarification and guidance; lack of understanding can make claiming treaty benefits time-consuming and costly.
- Examples of items to include in a law implementing tax treaties or related regulations:
  - definition of terms which may cause misunderstanding or lead to abuse;
  - procedures to apply for tax treaty benefits;
  - procedures for exchange of information;
  - procedures for assistance in the collection of taxes; and
  - mutual agreement procedures.

#### 3.1 Definition of Terms Which May Cause Misunderstanding or Lead to Abuse
- Common problematic terms: “agent of independent status” (Art. 5), “royalties” (Art. 12), “employer” (Art. 15) of the OECD MTC.
- The Commentary to the OECD MTC may be useful guidance, but courts may not grant it legal authority; consider clarifying definitions by referring to the Commentary or by stating the country’s own definitions in law.

#### 3.2 Procedures to Apply for Tax Treaty Benefits
- Approaches to documentation for claiming benefits:
  - self-declaration forms of eligibility;
  - certificate of residence issued by the tax authorities of the resident’s country;
  - the US qualifed intermediary (QI) program: under the QI program, a non-US financial intermediary receiving income from a US source for the account of its offshore customers can claim treaty benefits or simplified withholding and reporting by entering into a QI agreement with the IRS. Under the QI agreement, QIs accept enhanced responsibilities for providing assurance that customers are eligible for treaty benefits and exemptions such as obtaining acceptable account-opening documentation; if non-US financial institutions do not enter a QI agreement, the institution should provide required tax certifications on a case-by-case basis.
- Differentiation by extent of source-tax reduction:
  - a certificate of residence may be required for claiming exemption from source taxation, while only a self-declared form may be required for claiming a reduction of the withholding rate.
- Limitation of benefits (LOB) provisions:
  - treaties with detailed LOB provisions require comprehensible guidance by law and regulations. The US LOB approach since 1981 typically denies reduced withholding rates to a corporation established in a treaty partner country if more than a specified percent of its stock is held by residents of countries other than the US and its treaty partner country (example in paragraph 20 of the Commentary on Art. 1 of the OECD MTC).
- Hybrid entities:
  - Definition: a hybrid entity is characterized as a corporation in one jurisdiction and as a transparent entity in another.
  - Risks: existence of hybrid entities may lead to denying treaty benefits to legitimate residents or to cross-border arbitrage. Example: a partnership fiscally transparent in a country is not liable for tax within the meaning of Art. 4(1) of the OECD MTC and therefore the partnership itself cannot claim treaty benefits even if partners are eligible residents; partners should be entitled to treaty benefits with respect to their share of partnership income (Para. 5 of the Commentary on Art. 1 of the OECD MTC).
  - Cross-jurisdictional inconsistency example: State A treats a partnership as taxable, State B treats the partnership as transparent; source country may not impose taxation inconsistent with the terms of either applicable treaty with State A or State B.
  - Recommendation: include special provisions in a tax treaty to address hybrid entities; if not included, provide guidance in law or regulations. Example guidance exists in Sec. 894 of the IRC and related Treasury regulations in the US.

#### 3.3 Exchange of Information
- Global context:
  - Approximately ninety jurisdictions have committed to comply with the Global Forum’s Standards of Transparency and Exchange of Information for Tax Purposes (Global Forum Standards).
  - Enacting legislation necessary to implement the Global Forum Standards is increasingly important.
- Key legal issues when preparing legislation:
  - Confidentiality of received information:
    - Reciprocal exchange requires assurance that received information will be treated with proper confidence (Para. 11 of the Commentary on Art. 26 of the OECD MTC).
    - Confidentiality rules and penalties for breach should apply to treaty-obtained information in the same manner as domestically obtained information.
  - Domestic tax interest and information-gathering measures:
    - Information gathering measures (laws and administrative or judicial measures; Para. 19.7 of the Commentary on Art. 26 of the OECD MTC) usually exist for levying domestic taxes.
    - A requested authority may need to use information-gathering measures without “domestic tax interest” to respond to a treaty request (for example, to obtain information about a loss reported by a resident of the requested country that the requested authority would not audit for its own tax purposes).
    - Recommendation: include provisions explicitly allowing tax authorities to use information-gathering measures solely to provide information to treaty partners, to avoid admissibility arguments in court.
  - Criminal cases:
    - Art. 26 of the OECD MTC permits exchange of information on all tax matters including criminal tax cases (Para. 5 of the Commentary on Art. 26 of the OECD MTC).
    - Exchange for criminal matters can also rely on mutual legal assistance treaties; where mutual legal assistance has been the only instrument, consider clarifying in law that tax authorities can use information-gathering measures to provide information on criminal tax matters under a tax treaty.
  - Bank secrecy:
    - Some countries require financial institutions to protect clients’ confidentiality even from tax authorities; the Global Forum Standards do not allow the requested country to decline to provide information because of bank secrecy (Art. 26(5) of the OECD MTC and Art. 5(4) of the OECD Model Agreement).
    - All countries committed to the Global Forum Standards are required to change laws (often non-tax laws) so tax authorities can access client information held by banks and financial institutions.
- Domestic tax interest, information gathering, and confidentiality interplay underpin timely and reciprocal exchange of information.

#### 3.4 Assistance in the Collection of Taxes
- Art. 27 of the OECD MTC provides for mutual assistance in the collection of taxes.
- Implementation considerations:
  - Whether a country chooses comprehensive or limited collection assistance, any revenue claim requested shall be collected by the requested country in accordance with laws governing the enforcement and collection of its own taxes, as if the revenue claim were a revenue claim of the requested country.
  - It is desirable to change laws on collection of revenue claims to clarify that the same procedures apply to revenue claims requested by treaty partners.
  - More detailed rules (for example, priority order between a revenue claim of the requested country and one of the requesting country) should be provided by laws or regulations unless existing laws already provide applicable rules without ambiguity.

*Source: _tnm1101 - 1.  Introduction*

### 3.5  Mutual Agreement Procedures

### 3.5 Mutual Agreement Procedures

### Legal basis and practical implementation
- Art. 25 of the OECD MTC provides that "an agreement between competent authorities, which resolves taxation which is not in accordance with the treaty, should be implemented notwithstanding any time limits in the domestic laws."
- Despite this explicit waiver of domestic time limits, it is desirable that tax laws or regulations:
  - provide detailed rules on how to implement the agreement, and
  - specify necessary procedures to be taken by taxpayers.
- Statutory limitation of assessment including refund often corresponds to the period that taxpayers and tax authorities are required to keep relevant documents under domestic laws.
- Competent authorities frequently reach agreements well after the statutory limitation of assessment in mutual agreement procedures on transfer pricing cases.
- Given these facts, it is practically important that laws or administrative guidelines require at least tax authorities to keep relevant documents once a taxpayer presented a case for mutual agreement procedures to competent authorities.

### Taxpayer remedies and parallel proceedings
- A taxpayer may present a case irrespective of the remedies provided by domestic laws (Art. 25(2) of the OECD MTC).
- Taxpayers often lodge a case to administrative tribunals or courts in parallel with presenting a case to competent authority because:
  - laws on appeal or litigation normally provide time limits for lodging a case which are shorter than the period that mutual agreement procedures usually need to reach an agreement.
- Parallel pursuit of administrative/court remedies and mutual agreement procedures may cause:
  - appeal tribunal decisions or court decisions that contradict or overlap with agreements between competent authorities.
  - considerable expenses for taxpayers, tax authorities, and judicial bodies.

### Policy recommendation on coordination of remedies
- It would be desirable that either the mutual agreement procedures or the domestic remedy process be suspended upon a taxpayer’s request until the other remedy measure produces a result, in cases where a taxpayer lodges requests for both remedy measures.
- If a taxpayer wants both remedy measures to proceed in parallel, the taxpayer’s decision should be respected, because a taxpayer has the right to present a case irrespective of the remedies provided by domestic laws.

*Source: _tnm1101 - 3.5  Mutual Agreement Procedures*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/tnm/2011/_tnm1101.pdf_