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Oliver R. Hoor, author of 'The OECD Model Tax Convention - A Comprehensive Technical Analysis', provides a background and brief history of double tax treaties.

Introduction

Where individuals or enterprises perform cross-border activities, they are regularly subject to tax in different jurisdictions. International juridical double taxation is mainly linked to the fact that most jurisdictions levy tax on the worldwide income of their residents and certain activities that are closely connected to the territory of their state (i.e., taxation of non-residents).

Double taxation can be avoided unilaterally if one of the states involved surrenders its taxing right. In this regard, a residence state often allows a credit for the tax levied in the source state up to an amount equal to its own tax charge. In contrast, some countries avoid double taxation via exempting income deriving from foreign sources and capital situated abroad (See VOGEL, LEHNER (Double tax treaties 2008), Introduction, No. 32).

As a rule, however, unilateral measures are insufficient to avoid double taxation satisfactorily, because usually they are neither comprehensive nor mutually consistent. Since the end of the nineteenth century, individual states have therefore entered into bilateral agreements for the avoidance of double taxation (see VOGEL, LEHNER (Double tax treaties 2008), Introduction, No. 33). Double tax treaties seek to regulate conflicts which may arise between the domestic tax laws of the Contracting States. The primary purpose of tax treaties is to eliminate double taxation as an obstacle to international trade and investment; thereby, promoting the development of economic relations between countries.

Though every tax treaty is subject to negotiations between the two Contracting States, the majority of tax treaties are fairly similar. This is because the negotiations between the Contracting States are generally based on the OECD Model Convention and amendments tailored to their particular economical interests (see BAKER (Double tax Conventions 1994), p. 4; today there are more than 3,000 tax treaties in force around the world  which are based on the OECD Model Convention). Importantly, the use of the OECD Model Convention may significantly reduce the costs and accelerate the negotiation process. It should, however, be noted that the OECD Model Convention is not legally binding; rather, a point of reference typically relied upon to achieve, inter alia, the abovementioned objectives.

The fundamental principle underlying the entire OECD Model Convention is that the allocation of taxing rights stems from the substantive economic nexus of the income and capital. The OECD Model Convention attempts to specify wherever possible a single rule for each situation. However, it at times does provide leeway to Contracting States. Indeed, while Contracting States will usually incorporate the substantive principles of the Model into their treaties, a certain flexibility remains; for example, with respect to reduced rates of withholding tax and by which method double taxation is avoided. The OECD Model Convention also mentions alternative or additional provisions for some cases.

Almost all OECD Member states have made Observations to various Articles (these “Observations” furnish a useful indication of the way in which those countries will interpret and apply the provision of the Article in question). These do not constitute disagreement with the text of the Model; rather they assist in understanding how that state will apply the provisions of a given Article. Where OECD Member states do not follow recommendations to the OECD Model Convention, Reservations are made in the Commentary thereof. 

The objective of the OECD Model Convention is the harmonisation of tax treaties concluded by OECD member states (nb The Fiscal Committee of the Organisation for Economic Co-operation and Development (“OECD”) now comprises 32 members, including Australia, Austria, Belgium, Canada, Chile, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republik, Slovenia, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States) through clarification and standardisation; thereby resulting in common solutions being applied by all countries to identical cases of double taxation. Here, the commentary on the OECD Model Convention is an important source for the interpretation of tax treaties. All the more so, if the Contracting States adhere to the text of the OECD Model Convention.

Importantly, however, a good understanding of the OECD Model Convention itself will not suffice for a sound analysis of cross-border transactions. Instead, each transaction will need to be analysed in the light of the individual tax treaty and eventual protocols concluded between the Contracting States.

The History of Tax Treaties

The OECD Model Convention and the related Commentary has an established history. In fact, the work on a first model Convention was commenced in 1921 by the League of Nations and led to the drawing up in 1928 of the first model bilateral Convention and, finally, to the Model Conventions of Mexico (1943) and London (1946). The principles of these model Conventions were followed with certain variants in many of the bilateral Conventions concluded or revised during the following decade (these Model Conventions where, however, not unanimously accepted and presented considerable variations in respect of several essential questions; see Introduction Paragraph 4 of the Commentary on the OECD Model Convention; at the beginning of 1955, 70 bilateral general Conventions had been signed between countries that are today Members of the OECD).

In 1956, the Fiscal Committee began its work on a draft Convention on the basis of the work commenced between the Wars under the auspices of the League of Nations (nb the involvement of the OECD in questions of international double taxation dates back to a resolution of the Council of its predecessor organisation, the OEEC, in March 1956, establishing a Fiscal Committee for “The study of questions relating to double taxation and of other fiscal questions of a similar technical nature”; see BAKER (Double tax Conventions 1994), p. 1). The objective was to establish a draft Convention that would effectively resolve the double taxation problems existing between OECD Member states and that would be acceptable to all Member states. On 30 September 1961, the Organisation for European Economic Co-operation (“OEEC”) changed its name to the OECD on the accession of Canada and the USA (see BAKER (Double tax Conventions 1994), p. 1, 2).

The Committee on Fiscal Affairs (nb in 1971, the “OECD Fiscal Committee” was renamed the “Committee on Fiscal Affairs”)  brings together senior tax officials from all OECD Member countries who play an active role in formulating and implementing tax policies. The Committee sets the OECD’s work programme in the tax area and provides a forum for exchanging views on tax policy and administrative issues. In this respect, the Committee has established several Working Parties, of which the most important ones are

1. Working Party 1 on Tax Conventions and Related Questions,
2. Working Party 6 on the Taxation of Multinational Enterprises, and
3. Working Party 8 on how member governments can co-operate to minimize the extent of Tax Evasion and Avoidance.

Four interim Reports were prepared from 1958 to 1961 before, in 1963, a draft model double taxation agreement and a Commentary on each Article were published, with a view to forming the basis of double taxation agreements between member states (see Introduction Paragraph 6 of the Commentary on the OECD Model Convention). In the following years, the OECD Model Convention and the related Commentary were revised by the Committee on Fiscal Affairs based on practical experience. In 1977, the Committee on Fiscal Affairs approved a new report with a partially revised Model and Commentary. Following several reports and position papers of the Committee on Fiscal Affairs, a new 1992 Draft Convention was issued. Further amendments were made in 1994, 1995, 1997, 2000, 2003, 2005, 2008 and 2010. The changes of 1977 – 2010 have, however, affected less the OECD Model Convention than the related Commentary (see VOGEL, LEHNER (Double tax treaties 2008), Introduction, No. 35 - 36).

Nevertheless, the OECD Model is not a universally accepted model tax Convention. An opposing model, designed according to the special interests of developing countries was adopted in 1971 by the member states of the Andean-Group; an alliance between Bolivia, Chile, Ecuador, Colombia, Peru and since 1973 Venezuela. This Model was drafted as an alternative to the OECD Model Convention and emphasises the 'source principle' (nb in this Model, the source state’s taxing right are extended, compared to the OECD Model Convention; see VOGEL, LEHNER (Double tax treaties 2008), Introduction, No. 37).

Moreover, the United States Treasury Department published its own model treaty in 1976 to serve as a basis for US treaty negotiations; revised models were published in 1977, 1981 and  1996. Especially important is the Limitation On Benefits (LOB) Provision in the 1996 model that denies treaty benefits to companies with insufficient business and economic connections to their claimed residence state (see BORREGO (Limitation On Benefits Clauses 2006), p. 91; see THÖMMES (LOB-Klauseln 2008), p. 577; see VOGEL, LEHNER (Double tax treaties 2008), Introduction, No. 38). 

In 1979, the United Nations published a draft model agreement for use between developed and less developed countries. It is updated periodically, although not as often as the OECD model. A major difference between the OECD and the United Nations model agreements is that the latter preserves more of the taxing rights of the state in which income arises, which tends to favour less developed countries (The structure, the mechanics and the content of the UN Model is based on the OECD Model Convention; see KRABBE (UN-Musterabkommen 2000), p. 618; see VOGEL, LEHNER (Double tax treaties 2008), Introduction, No. 37).

The above is adapted from The OECD Model Tax Convention - a Comprehensive Technical Analysis by Oliver R Hoor, which is available at Tax Bookshop.com