## Tax Treaties: Boost or Bane for Development?

_IMF Blog, November 16, 2016_

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## Bibliographic details
- Authors: Jim Brumby, Michael Keen
- Published: November 16, 2016

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### Overview and context
- Tax treaties number "over 3,000" and are generally designed to avoid taxing the same profit twice by determining when and how a treaty country can or cannot tax foreign-owned companies.
- Developing countries have used treaties with the intention of boosting economic development; the evidence for that is weak.
- Treaties can provide important benefits, such as exchange-of-information provisions and mechanisms for resolving disputes between taxpayers and tax administrations.
- The international system of taxation is highly complex; multinational companies can exploit treaties to route income through third countries and engage in “treaty shopping,” which is difficult for tax authorities—particularly in developing countries—to counter.

### Key insights from the IMF–World Bank panel
- Tax treaties as systemic revenue drains
  - A single disadvantageous treaty can act as a drain on a country’s revenues; Professor Stephen Shay described treaties as like a bathtub where one leaky treaty is a drain.
  - Countries with multiple treaties are exposed to the "worst" treaty: if a country has "10 treaties," investors will take advantage of the treaty that allows the most tax avoidance and links to jurisdictions with very low or zero corporate income tax rates.
  - Such strategies reduce effective corporate tax rates of multinational groups.

- Domestic politics and treaty strategy
  - Treaty negotiation pressures often come from a country’s diplomatic corps rather than its finance ministry.
  - One negotiator reported a domestic target of "100 treaties," illustrating a political focus on treaty counts rather than treaty quality.
  - This political dynamic can make it hard to persuade leaders to prioritize fiscal protection and the economic sense of individual treaties.

- Withholding taxes and trade-offs
  - Withholding obligations can help keep tax resources within a country’s borders by requiring the host country to withhold a portion of income before transfer to the resident headquarters.
  - Withholding instruments can generate revenue and act as safeguards against profit shifting.
  - Withholding may have negative effects on investment and trade: an example from Colombia shows that the combination of Colombian taxing rights and a high withholding tax in Peru can deter Colombian firms from providing profitable services in Peru, reducing trade and economic development.

### Policy recommendations and options
- Best-practice preparatory steps for treaty negotiation
  - Be systematic about treaty approach and skeptical about whether the benefits outweigh costs for a bilateral income tax treaty program.
  - Consider any one treaty as “a potential treaty with the world.”
  - Develop a domestic model treaty before entering negotiations so the government has a clear idea of acceptable terms.
  - Use other instruments or a “light treaty approach” focused on: (i) information exchange; (ii) a commitment to transfer pricing principles; and (iii) a mutual agreement procedure to resolve tax disputes.

- Options for addressing damaging treaty regimes (as proposed by Professor Shay)
  - (1) Renegotiate those treaties.
  - (2) Terminate them in accordance with their terms.
  - (3) If constitutionally possible, and as a last resort, override offending provisions with domestic legislation.
  - Recommendation: start with the worst treaty first.

- Multilateral developments
  - Countries have the option of signing a OECD-constructed, multilateral legal instrument designed to allow for the large-scale amendment of existing treaties; each country will retain its own treaty priorities, making implementation complex.

### Development implications
- Governments that raise less than "15 percent" of their gross domestic product in tax revenues have trouble funding basic services; undue loss of tax income is a critical development problem.
- Addressing treaty-related revenue loss will be key to shoring up domestic revenues in the developing world.

*Source: IMF blog post “Tax Treaties: Boost or Bane for Development?” by Jim Brumby and Michael Keen, November 16, 2016.*

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_Source: https://www.imf.org/en/blogs/articles/2016/11/16/tax-treaties-boost-or-bane-for-development_