The unintended consequences of tax treaties and the unfair allocation of treaty taxing rights from a developing country’s perspective

Abstract

Countries often enter into double tax treaties to encourage foreign direct investment by preventing double taxation of income. However, double tax treaties often result in unintended tax consequences such as: redistributing tax revenues from developing to developed countries; facilitating tax avoidance and the resultant base erosion and profit shifting (BEPS) and double non-taxation. While double tax treaties are entered into with the main objective of eliminating double taxation in order to encourage the said foreign direct investment in developing countries, double tax treaties have not been effective in addressing the unintended consequences of concluding them, impacting the tax revenues of source countries. In achieving their main objective, double tax treaties contain provisions which can ensure that income is only taxed in one country by allocating taxing rights between residence and source countries that are party to it. However, the allocation of taxing rights in double tax treaties simply redistributes taxing rights from the country where the income is derived (i.e., source country), to the residence country. The study finds that double tax treaties, mostly those drafted based on the Organisation for Economic Co-operation Development (OECD) Model Tax Convention (MTC), typically favour developed countries as they allocate taxing rights to resident countries. As a result, the study recommends that developing countries exercise extreme caution when concluding double tax treaties as the unintended consequences of entering into the double treaties result in the loss of much needed tax revenue as the allocation rules contained therein, particularly those that are drafted based on the OECD MTC favour developed countries over developing countries.