Fairness in allocating taxation rights between source and residence states

165 Pages·2014·2.17 MB·English

Fairness in allocating taxation right
between source and residence
states

The Dutch perspective, comparative research and a
rethinking of models

Name: Luuk Bosch
ANR: s405438
Study: Fiscal Economics
Submission Date: 12-6-2014
Supervisor: Mr. dr. D.S. Smit
Exam Committee: Prof. dr. P.H.J. Essers
Prof. dr. E.C.C.M. Kemmeren
Fairness in allocating taxation rights between source and residence states

Jeroen Pauw:

“The point is that at the place of the production, the place where people
work, no actual tax is paid and at the place where no work is done,
but that does have a low tax rate, there this low tax rate is paid and
this is the thing that is unfair.”1

1 Translation of a debate in a Dutch current affairs program (‘Pauw en Witteman’, 27-03-2013) regarding tax
avoidance. Original conversation: Jeroen Pauw: “Het punt is dus, op de plek waar het geproduceerd wordt,
waar mensen werken, wordt eigenlijk geen belasting betaald en op de plek waar niet gewerkt wordt en een
laag belastingtarief is, daar wordt dat lage belastingtarief betaald en dat is het oneerlijke eraan.” Jesse Klaver:
“Dat is het oneerlijke eraan.”

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Fairness in allocating taxation rights between source and residence states

Preface
This master thesis is written in the context of my study Fiscal Economics at Tilburg University. In the
beginning of this year I was offered the opportunity to participate in the EUCOTAX Wintercourse; a
great chance to expand my borders, both literally as figuratively. This thesis is the outcome of lot of
early mornings and late nights in the library of the university, but in my perspective the result is
rewarding. However, I could not have made it the way it is right now without the help of some
inspirational people. Therefore, I wish to take the occasion to briefly pay my gratitude to them.
Firstly, I want to thank professor Essers, professor Kemmeren, drs. Peters and Mark Vitullo for their
feedback and support during the pre-Wintercourse meetings. Besides this, I had to pleasure of the
company of professor Essers, professor Kemmeren and Femke Poort during the Wintercourse in
Paris. The professor student dinner was a night to remember. During this evening I found out that
they are as pleasant as a company as they are acknowledged with respect to the field of international
tax law. In specific I want to thank, my supervisor, Daniël Smit. I enjoyed the discussions we had
regarding international tax law during our meetings. He encouraged me to follow my own ideas,
even though we did not always agree on the topic.
I also especially want to thank my EUCOTAX group mates from the other participating universities
and my fellow Tilburg University participants, Keven Gielissen, Naomi Misseyer, Isabella Fluitsma,
Betul Gumus and Ralf Stoks. Without their support and warm personalities the Wintercourse would
not have been the same. I still get a smile on my face when thinking about the miraculous stories
that happened during that week in Paris with them.
Finally, I want to thank my parents, brother, girlfriend and close friends. During the last few months I
haven’t reserved the time for them they deserve, but still they supported my throughout the entire
process of writing my thesis.

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Fairness in allocating taxation rights between source and residence states

Contents
Preface ........................................................................................................................................ 2
Contents ...................................................................................................................................... 3
List of abbreviations ..................................................................................................................... 7
1 Introduction in international tax law ..................................................................................... 8
1.1 Double taxation ............................................................................................................. 8
1.1.1 Legal and economic double taxation ............................................................................... 8
1.1.2 Why should double taxation be prevented? ................................................................... 9
1.1.3 What is the connection between the European Union and taxation treaties? ............ 10
1.2 Justifications in international taxation.......................................................................... 11
1.2.1 Residency ....................................................................................................................... 12
1.2.2 Nationality ..................................................................................................................... 12
1.2.3 Source ............................................................................................................................ 13
1.2.4 Principle of origin .......................................................................................................... 14
1.3 Principle of neutrality .................................................................................................. 14
1.3.1 Capital export neutrality (CEN) ...................................................................................... 15
1.3.2 Capital import neutrality ............................................................................................... 17
1.3.3 Is one theory superior to the other? ............................................................................. 17
1.4 Dutch system to prevent double taxation ..................................................................... 19
1.4.1 Dutch unilateral provision ............................................................................................. 19
1.4.2 Dutch tax treaty policy .................................................................................................. 21
2 Fairness in international taxation law .................................................................................. 24
2.1 Important principles regarding fairness ........................................................................ 24
2.1.1 Equality .......................................................................................................................... 24
2.1.2 Ability to pay .................................................................................................................. 25
2.1.3 Benefit principle ............................................................................................................ 25
2.1.3.1 Composite income tax system .................................................................................. 33

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Fairness in allocating taxation rights between source and residence states

2.1.3.2 Examples .................................................................................................................... 38
2.1.3.3 Composite income tax system and neutrality ........................................................... 41
2.1.4 Importance of fairness in taxation ................................................................................ 41
2.1.4.1 Action Plan on Base Erosion and Profit Shifting ........................................................ 42
2.2 Conclusion ................................................................................................................... 44
3 Different types of income .................................................................................................... 45
3.1 Business profit and other independent activities .......................................................... 45
3.1.1 The permanent establishment ...................................................................................... 46
3.1.1.1 Dutch domestic law and unilateral provision ............................................................ 46
3.1.1.1.1 Residents – Natural persons................................................................................ 46
3.1.1.1.2 Residents – Entities ............................................................................................. 47
3.1.1.1.3 Non-residents ...................................................................................................... 48
3.1.1.2 The OECD MTC and Dutch treaty policy .................................................................... 49
3.1.2 Allocating profits to the permanent establishment ...................................................... 53
3.1.3 Literature ....................................................................................................................... 55
3.1.4 Principle of origin .......................................................................................................... 57
3.1.5 BEPS – Action 6 – preventing treaty abuse ................................................................... 59
3.1.5.1 Other approach to prevent treaty abuse .................................................................. 60
3.1.6 EUCOTAX comparative law ............................................................................................ 62
3.1.6.1 Table .......................................................................................................................... 62
3.1.6.2 Analysis ...................................................................................................................... 66
3.1.7 Conclusion ..................................................................................................................... 68
3.2 Income from employment ........................................................................................... 69
3.2.1 Income from employment............................................................................................. 70
3.2.1.1 Dutch unilateral provision ......................................................................................... 70
3.2.1.2 OECD MTC & Dutch treaty policy .............................................................................. 71
3.2.1.3 Literature ................................................................................................................... 73

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3.2.1.4 Principle of origin ...................................................................................................... 74
3.2.2 Government service ...................................................................................................... 74
3.2.2.1 Unilateral provision ................................................................................................... 75
3.2.2.2 OECD MTC & Dutch treaty policy .............................................................................. 75
3.2.2.3 Literature ................................................................................................................... 76
3.2.2.4 Principle of origin ...................................................................................................... 77
3.2.3 Pensions ......................................................................................................................... 77
3.2.3.1 OECD MTC & Dutch treaty Policy .............................................................................. 77
3.2.3.2 Unilateral provision ................................................................................................... 78
3.2.3.3 Literature ................................................................................................................... 79
3.2.3.4 Principle of origin ...................................................................................................... 80
3.2.4 Directors’ fees................................................................................................................ 81
3.2.5 Artistes and sportsmen ................................................................................................. 83
3.2.5.1 Principle of origin ...................................................................................................... 85
3.2.5.2 Literature ................................................................................................................... 86
3.2.6 Professors ...................................................................................................................... 87
3.2.7 EUCOTAX comparative law ............................................................................................ 88
3.2.7.1 Table .......................................................................................................................... 88
3.2.7.2 Analysis ...................................................................................................................... 92
3.3 Passive income ............................................................................................................ 93
3.3.1 Dividends ....................................................................................................................... 94
3.3.1.1 Domestic & EU law .................................................................................................... 94
3.3.1.2 Unilateral provision ................................................................................................... 95
3.3.1.3 OECD MTC and Dutch treaty policy ........................................................................... 95
3.3.1.4 Principle of origin ...................................................................................................... 97
3.3.1.5 Literature ................................................................................................................... 98
3.3.2 Interest ........................................................................................................................ 102

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3.3.2.1 Domestic & EU law & unilateral provision .............................................................. 102
3.3.2.2 OECD MTC en Dutch treaty policy ........................................................................... 103
3.3.2.3 Principle of origin .................................................................................................... 105
3.3.2.4 Different treatment of dividend and interest payments ........................................ 106
3.3.2.5 Conclusion ............................................................................................................... 109
3.3.3 Royalties ...................................................................................................................... 110
3.3.3.1 Domestic & EU law & unilateral provision .............................................................. 110
3.3.3.2 OECD MTC en Dutch treaty policy ........................................................................... 112
3.3.3.3 Principle of origin .................................................................................................... 114
3.3.3.4 Literature ................................................................................................................. 115
3.3.4 EUCOTAX comparative law .......................................................................................... 117
3.3.4.1 Table ........................................................................................................................ 117
3.3.4.2 Analysis .................................................................................................................... 122
3.4 Immovable property ................................................................................................... 124
3.4.1 Unilateral provision ..................................................................................................... 124
3.4.2 OECD MTC & Dutch treat policy .................................................................................. 124
3.4.3 Principle of origin ........................................................................................................ 126
3.4.4 EUCOTAX Comparative law ......................................................................................... 127
3.4.4.1 Table ........................................................................................................................ 127
3.4.4.2 Analysis .................................................................................................................... 130
4 Conclusion and summary ................................................................................................... 132
Bibliography .............................................................................................................................. 139
Annex: Comparative Law: Country overview .............................................................................. 145

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List of abbreviations

BNB Beslissing Nederlandse Belastingrechtspraak
CCCTB Common Consolidated Corporate Tax Base
CEN Capital export neutrality
CIN Capital import neutrality
CJEU Court of Justice of the European Union
DTA Dividendbelasting (Dutch Tax Act 1965)
DTC Double tax convention
DTCs Double tax conventions
EU European Union
EUCOTAX European University Cooperating on Taxation
IB / PITA Wet Inkomstenbelasting 2001 (Personal Income Tax Act 2001)
IW / TRA Invorderingswet 1990 (Tax Recovery Act 1990)
PRTA Wet Loonbelasting 1964 (Pay Roll Tax Act 1964)
MTC Model tax convention
NL Netherlands
OECD Organisation for Economic Co-operation and Development
PE Permanent establishment
PEs Permanent establishments
PRTA Wet Loonbelasting 1964 (Pay Roll Tax Act 1964)
STLA Algemene wet rijksbelastingen 1959 (State Tax Law Act)
Vpb / CITA Wet Vennootschapsbelasting 1969 (Corporate Income Tax Act 1969)
UK United Kingdom
UN United Nations
US United States

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Fairness in allocating taxation rights between source and residence states

1 Introduction in international tax law
1.1 Double taxation
In 1872, Great Britain and Switzerland reached an agreement regarding the prevention of double
taxation.2 The British government was worried over the inheritance taxation that Switzerland levied
on the income of British citizens who owned property in Switzerland. The climate in Switzerland is
more favorable and the cost of living was less than in London and this made Switzerland and
especially the area near the lake of Geneva a popular location to own immovable property.
Switzerland levied a succession tax on all property – and thus not only on the immovable property
located in Switzerland - of some of these British citizens. In these cases, the Swiss law considered the
British deceased as a domicile of Switzerland. Great Britain also levied an inheritance tax on its
citizens. The result was double taxation, due to the reason that the taxpayer is considered a resident
of both states or because of a mismatch between the nationality/citizen principle, the residence
principle and/ or the source principle. To prevent this, the governments concerned decided to start
negotiations about a treaty over how to allocate the taxation rights. Taxpayers were only considered
a resident in the other countries if a certain list of requirements was fulfilled. If the deceased was not
a resident of the other state, that state would only be allowed to tax the property located in that
state. This is an important moment in international taxation, because it was the first treaty regarding
the prevention of double taxation between still existing nations.3
1.1.1 Legal and economic double taxation
The definition of the OECD for double taxation is as follows:
‘The imposition of comparable taxes in two (or more) States on the same taxpayer in respect of the
same subject matter and for identical periods.’4
This may occur if two different states use different principles. For example, if one state claims taxing
authority based on the nationality of the taxpayer and the other state claims taxing authority based
on the place of residence of the taxpayer. Double taxation could also occur if two (or more) states
consider the taxpayer as their citizen, resident or if they consider the source/ origin of the income to
be located in their territory.5 A combination of both happened in the situation as described above in

2 See Jogaranjan, S. (2012). The Conclusion and Termination of the 'First' Double Taxation Treaty. British Tax
Review, Vol 3, 2012.
3 In 1869 Prussia and Saxony signed a tax treaty during the process of the German unification.
4 See OECD. (2010). Model Tax Convention on Income and on Capital. OECD Publishing.
5 See Doernberg, R. (2004). International taxation in a Nutshell. St. Paul: Thomson West.

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Fairness in allocating taxation rights between source and residence states

the 19th century. This is an example of legal double taxation. Legal double taxation occurs when the
same income at the same subject (taxpayer) is taxed by multiple states.
Another cause of double taxation is economic double taxation. This occurs when the same income is
taxed twice at different legal entities. For example; firstly, the income of the subsidiary is taxed by a
corporate income tax. The income is taxed for the second time with an income tax at the level of the
shareholder after the subsidiary distributes the income to the shareholder. Many states prevent this
type of double taxation with the use of a participation exemption. The Netherlands is one of those
states.6
The use of a different method when determining the transfer price can also be the cause of
economic double taxation.7 For example, if state A sets a value of 100 euro as appropriate for the
produced intermediate goods in the factory plant located in state A. As the source state of the
income it taxes a revenue of 100 euro. If state B – in which the company owns the production plant
which is the next chain in the production line - sets a value of 80 euro for the same goods it will only
allow an expense of 80 euro. The result is that 100 euro is taxed in state A but only a deductible
expense of 80 is allowed in country B. There could be double taxation over 20 euros.
In general, taxation treaties often focus on the prevention of legal double taxation.
1.1.2 Why should double taxation be prevented?
In the situation described above the inheritance tax would be levied twice by two different states. Of
course, this imposes an inconvenient burden on the taxpayer, but how problematic is double
taxation for the economy as a whole?
According to the free market ideology, an optimal allocation of production factors will be reached in
a free market. What Adam Smith describes as the invisible hand would ensure that if everyone acts in
their own interest, it would benefit all.8 Governmental interference might influence the functioning
of the market mechanism. That is why it is believed that taxation should not – or at least as less as
possible – affect the decision making process.9 The best way to get a clear understanding of the

6 See article 13 Dutch CITA 1969
7 See Lang, M. (2002). Eindfuhrung in das recht der dopelbesteuerung. Vienna: Linde Verlag.
8 See Smith, A. (1776). An Inquiry into the nature and causes of the wealth of nations Book V. Chap II London:
Methuen & Co Ltd.
9 See Smith, A. (1776). Wealth of Nations, Book V. London: Methuen & Co. Ltd.

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