Two countries enter into a tax treaty to allocate the taxation rights between them about cross-border income. It is applicable when a resident of one country derives income from another country. Most articles of the treaty regulate or limits the source-based taxation rights of the country. The domestic tax laws always regulate residence-based taxation. To emphasize that Article 11 reiterates that the tax treaty will not restrict a country’s right to tax its residents. Also commonly known as the ‘savings clause.’
Paragraph 1 of Article 11 – Savings Clause
Article 11 of MLI has sought to introduce a savings clause to preserve the right of a contracting state to tax its residents. It is based on the recommendation of BEPS Action Plan 6, which provides –
“This Convention shall not affect the taxation, by a Contracting State, of its residents except with respect to the benefits granted under paragraph 3 of Article 7, paragraph 2 of Article 9 and Articles 19, 20, 23 A [23 B], 24 and 25 and 28.”
The savings clause of Article 11 carves out the exception where the right of a contracting state to tax its residents would be restricted. The following benefit granting provisions of the tax treaty shall override the provision of Article 11 –
- Granting an enterprise a correlative or corresponding adjustment following the initial adjustment made by the other State following the tax treaty on the profits of PE of the enterprise or an associated enterprise;
- Taxation of its resident individual which derives income in respect of services rendered to the other Contracting State or political subdivisions or a local authority thereof;
- Taxation of its residents individual who is a student, business apprentice, or trainer or teacher, professor, lecturer, instructor, researcher or research scholar who meets the conditions of the tax treaty;
- Provision of tax credit or tax exemption to its resident for the income that the other contracting State may tax per the tax treaty (including profits are attributable to PE situated in another contracting state in accordance to tax treaty)
- Protection of its residents against certain discriminatory taxation practices (Non-discrimination clause);
- Allowance of its residents to request the competent authority of its State or other states to consider cases of taxation under a tax treaty (Mutual Agreement Procedure);
- Taxation of its resident who is a member of a diplomatic mission, government mission, or consular post of the other State;
- Provision of taxation of pension or other payments made under the social security legislation of other contracting State shall be taxable only in other contracting State;
- Provision of taxation of pension and similar payments, annuities, alimony payments, or other maintenance payments arising in other contracting State shall be taxable only in other contracting State; or
- Any other provision which expressly limits a contracting state’s rights to tax its residents or exclusively allocates taxing rights of an item of income to a contracting state.
Paragraph 2 of Article 11 – Compatibility Clause
Paragraph 2 is a compatibility clause that describes the interaction between the savings clause mentioned in paragraph 1 and provisions of Covered Tax Agreements. This paragraph clarifies that the provision in paragraph 1 replaces existing provisions of Covered Tax Agreements stating that the Covered Tax Agreements would not affect the taxation by a Contracting Jurisdiction of its residents. Article 11(2) adds the savings clause in paragraph 1 of Article 11, where such provisions do not exist in Covered Tax Agreements.
Paragraph 3 of Article 11 – Reservation Clause
Paragraph 3 of Article 11 is a reservations clause where the country is given the option to either :
- Not to apply Article 11 to its Covered Tax Agreement entirely.
- Not to apply Article 11 to its Covered Tax agreement as a similar provision already exists.