How tax treaties can be used in tax planning

Introduction
A tax treaty is an agreement between two (or more) countries for the avoidance of double taxation. The primary purpose of such treaties is to deal with the issues arising from the overlap of different tax systems, and in particular to allocate the taxing rights on income arising within the jurisdiction of the two countries involved. The sole right to tax is conferred to on the source or residence country.

Most tax treaties are bilateral and generally follow the pattern of those published by the OECD and the United Nations.

Many people think that only multi-national corporations can effectively enjoy the benefits of double taxation treaties. In reality they are available to all investors, be they small or large.

Historical background
With the rapid increase in the world trade, trading blocs and multi-national corporations, it became imperative that some mechanism was interposed to prevent individuals and companies from being taxed twice, or at different levels, for the same or related activities. The result, particularly after the Second World War, was the development of an ever expanding number of Double Taxation Treaties. Together with organizations such as the OECD, the General Agreement on Tariffs and Trade and also with regional trading blocs, they lay down the ground rules for the members/signatories in respect to the exact terms and conditions that should appear in any given tax treaty.

For instance, a taxpayer resident in one country who wishes to invest in another country will not make a direct investment in that country, but instead will use a series of entities located in various jurisdictions to avail himself of the benefits in the tax treaties between countries concerned. Thus, the taxpayer is able to claim treaty benefits to which he would not otherwise be entitled.

Basic objectives of tax treaties
Some of the basic objectives of any treaty (based upon the O.E.C.D. Models) would include the following:

    - To define the scope and taxes covered as well as the legal entities involved and their tax treaty definitions;
    - To establish the criteria necessary to establish tax residence in the contracting state;
    - To clearly establish when a legal entity is deemed to be trading 'in' as opposite to 'with' a contracting state;
    - Define what is meant by 'immovable' property;
    - Define the taxable position of dividend payments received from investments by a legal entity from the contracting state;
    - Define interest and royalty payments;
    - Define the position of individuals earning income from a contracting state;
    - To specify the exact method by which double taxation is avoided in each member state and
    - Elucidate 'Exchange of Information' details between the contracting states.

It is obvious that no contracting parties would have the intention of creating potential tax 'loopholes'. Most modern tax treaties also have anti-evasion/avoidance provisions, with the objective of preventing third party residents from utilizing such instruments merely as a tax mitigation 'tool'.

Nevertheless, the effective employment of such provisions is almost impossible, since it is universally accepted that companies are separate legal entities fully subject to the benefits and detriments of their jurisdiction of registration. To try and impose ownership criteria or general rules on their use would entrap far too many 'innocent' traders and re-create constraints on international commerce.

In outline, the benefits derived from treaty selection originate from the diversity of national requirements and differing tax regimes. Until such divergences are significantly narrowed, an almost impossible event, even within trading blocs such as the European Union, treaty selection will remain a viable and legal 'weapon' in the tax consultant's arsenal.

Examples of how treaties are used would include the following:
    - Taking advantage of what is deemed 'movable' and 'immovable' property with the objective of taking advantage of different countries tax systems;
    - Taking advantage of 'competence deficits';
    - Maximizing tax exemptions and credits and
    - Taking advantage of treaty 'Sandwiching'.