26 Sep EU harmful tax treaties with developing countries detailed in new study
GUE/NGL has commissioned a series of studies as part of its complementary work to the European Parliament’s TAX3 Special Committee, with the purpose of further analysing those aspects of tax avoidance and tax evasion that will risk not being scrutinised in depth at the TAX3 Special Committee.
In this context, GUE/NGL has released today a study written by Martin Hearson, fellow in International Political Economy in the International Relations department of the London School of Economics and Political Science. The study is entitled “The EU’s Tax Treaties with Developing Countries – Leading By Example?“, and its objective was to determine in which way the double tax treaties signed by the EU with third countries were balanced in terms of the rights left to the developing countries to collects taxes locally from companies and individuals operating both in developing countries and in the EU.
Martin Hearson analysed 172 tax treaties in force between EU Member States and developing countries. These treaties are part of a database compiled by ActionAid containing 519 tax treaties signed by developing countries (from Sub-Saharan Africa and Asia, excluding G20 members) between 1970 and 2014, and classifying each of these treaties based on 26 points, and using an index to compare the variations with treaties signed by OECD Members with developing countries, and among non-OECD members.
As rightly noted by the study, even when a lot of attention has been given to the role of double tax treaties in international tax avoidance, another aspect of tax treaties should also be observed, i.e. the distribution of ‘taxing rights’ between developed and developing countries in the tax treaty regime. Double tax treaties generally place much more emphasis on the taxing rights of the countries of residence of multinational companies (i.e. capital exporting countries, or tax havens), imposing a lot of restrictions for tax collection in the countries that are the source of those companies’ income, often developing countries.
European Union institutions, including the Parliament, have recognised that member states’ tax treaties frequently conflict with their commitment to policy coherence for development (article 208 of the EU treaty). In this respect, the PANA recommendations of December 2017 in paragraph 168 called:
… on the Member States to properly ensure the fair treatment of developing countries when negotiating tax treaties, taking into account their particular situation and ensuring a fair distribution of taxation rights between source and residence countries; calls, in this regard, for adherence to the UN model tax convention and for transparency around treaty negotiations to be ensured;
Taxation treaties are usually based on either the OECD or the UN model tax conventions. The UN model tax convention provides more taxing rights for source countries.
However, when analysing the EU treaties with developing countries, Martin Hearson noted that most of the treaties provided even less taxing rights than the treaties signed between OECD Members and developing countries. On average, they leave intact only 40% of their developing country signatories’ taxing rights.
Figure 1: how the overall balance of EU treaties compares to the rest of the world
On specific items dealt with by tax treaties that were addressed by the study:
- For withholding tax (WHT) rates: all types of treaties show a downward trend. This downward trend matches changes in some countries’ domestic laws. As noted by Martin Hearson, this is particularly the case within the EU because of the parent-subsidiary and royalties directives, which drive rates down to zero.
- On permanent establishment (PE): treaties signed by EU countries with developing countries have begun to permit slightly more expansive taxing rights; but few EU treaties offer such generous retention of taxing rights to developing countries as those allowed in treaties signed among non-OECD countries, which tend to match the definition of PE in the UN model. Another conclusion is that, even among EU members’ treaties, there continues to be a wide variation. Some treaties signed by EU countries, even recently, impose very large restrictions on their taxing rights.
- On the taxation of services: EU treaties predominantly act to prevent developing countries from taxing services provided by EU members, except in cases where they meet the physical presence test needed for a traditional permanent establishment.
- On indirect transfer of assets: There is a wide variation in the extent to which EU members allow article 13(4) of the UN and OECD model conventions, or the more source based article 13(5) of the UN model convention (allows the source country to tax the sale of shares in a local company even if that sale is by a resident of the treaty partner), to be included in their treaties with developing countries, though in general, EU treaties have less of these provisions than non-EU treaties.
When comparing different EU Member States’ treaties with developing countries, the study notes that:
- The four countries that have the most treaties with developing countries in the sample (United Kingdom, Italy, France and Germany) provide taxing rights to developing countries that are on average value below the EU average, meaning that they have the largest concentration of treaties that restrict developing countries’ ability to tax inward investment.
- Sweden and Finland appear to have many treaties that are more favourable to developing countries than the EU average.
- Austria, for example, signed the most residence-based treaty of any EU country, with Mongolia in 2003; but it also signed a treaty with Vietnam in 2008 that left an unusually large amount of its source taxing rights intact.
- Denmark’s 1987 treaty with Pakistan offers the most favourable settlement to a developing country, while its treaty with Zambia is among the most residence-based.
- Ireland allowed for zero WHT rates in its 1971 treaty with Zambia, which it has since renegotiated. And in its 2014 treaty with Ethiopia also imposes very significant restrictions on the latter’s withholding tax rates.)
- Certain countries appear at the more source-based end of the PE spectrum, while being at the more residence-based end when it comes to WHT. This applies in particular to Luxembourg and Spain. Both are jurisdictions that can be used for tax treaty shopping structures that reduce the withholding taxes paid when income is transferred from the developing country to its parent. They do so by combining the benefits of these countries’ tax treaties with the EU’s parent-subsidiary and interest and royalty directives, which eliminate WHTs within the single market. Thus, the PE provisions may be less important than the WHT provisions in these treaties.
- France includes article 13(4) of the EU and OECD Model conventions extending the source country’s taxing rights to incorporate ‘indirect transfers’ of assets in all its treaties.
- Ireland, the Netherlands and the UK have all renegotiated their treaties with Zambia. While all of these renegotiations have strengthened the source content of the treaties, the treaties with the three EU members are Zambia’s most residence-based treaties, and are even below the EU average in terms of taxing rights allowed for developing countries.
In any case, it seems clear that the benefits developing countries aim at obtaining from tax treaties with the EU can largely be disentangled from the extensive sacrifice of taxing rights that they have made.
Considering these observations, Hearson offers several recommendations:
- EU members could ‘level up’ by offering developing countries with narrower definitions the possibility of expanding them consistent with the EU members’ other treaties.
- EU countries should consider the policy coherence aspects of the WHT rates across all their treaties with developing countries
- ‘Spillover’ analyses are badly needed to rectify the inequality – something which has long been ignored by member states.
- The EU should reconsider its opposition to a stronger UN tax committee, as the Parliament has already requested in its PANA and TAX2 recommendations.
- The EU should formulate and publish an EU Model Tax Convention for Development Policy Coherence
The reason why GUE/NGL is publishing this study is that the TAX3 Special Committee is holding a hearing on the ‘Third Country Dimension in the Fight Against Tax Crimes, Tax Evasion and Tax Avoidance‘ that includes a panel discussing ‘How bilateral tax treaties can facilitate tax abuse and trade agreements facilitate illicit financial flows’. Actually, this was going to be the title of the panel, but after the right-wing EPP and the liberals in the European Parliament opposed it for being a ‘biased title’, it changed to ’How can bilateral tax treaties and trade agreements facilitate the fight against illicit financial flows and tax evasion?’ – an impossible and ridiculous title as double tax treaties have as an objective is to avoid double taxation, and trade agreements aim at increasing trade. Thus, neither of them has as an objective to tackle illicit financial flows, and on the contrary, there is quite a lot of evidence that they tend to facilitate it.