Article 2 of the OECD Model Tax treaty is about the taxes covered under the treaty entered into by the Contracting States.
- What is the purpose of Article 2 of the OECD Model Tax Treaty?
- Extract of Article 2 of the OECD Model Tax Treaty.
- What are the taxes covered in the treaty?
- Does Article 2 cover the penalties, interest, and other charges applied to taxes?
- Declaration on taxes covered
- Impact on the treaty when Contracting states declare new taxes after signing the treaty?
- Observations of countries on the OECD Model Tax Treaty Commentary
- Reservation expressed by the Countries
What is the purpose of Article 2 of the OECD Model Tax Treaty?
In every tax treaty defining the taxes covered by it is essential for limiting the jurisdiction of the countries while exercising the taxation. This Article intends to make the terminology of the taxes covered by the Convention crystal clear so that no ambiguity would cause difficulty for impacting nation and persons. Paragraph 1 has, therefore, stated the taxes on income and capital rather than the vague terminology of “direct taxes.”
Extract of Article 2 of the OECD Model Tax Treaty.
1. This Convention shall apply to taxes on income and on capital imposed on behalf
of a Contracting State or of its political subdivisions or local authorities, irrespective of the manner in which they are levied.
2. There shall be regarded as taxes on income and on capital all taxes imposed on
total income, on total capital, or on elements of income or of capital, including taxes
on gains from the alienation of movable or immovable property, taxes on the total
amounts of wages or salaries paid by enterprises, as well as taxes on capital
3. The existing taxes to which the Convention shall apply are in particular:
a) (in State A): ……………………………………
b) (in State B): ……………………………………
4. The Convention shall apply also to any identical or substantially similar taxes
that are imposed after the date of signature of the Convention in addition to, or in place of, the existing taxes. The competent authorities of the Contracting States shall notify each other of any significant changes that have been made in their taxation laws.
What are the taxes covered in the treaty?
According to Paragraph 1 of Article 1 of the OECD Model Tax treaty, the Convention applies to all the taxes on income and capital imposed by the Contracting country. It is immaterial in which authority applies such taxes in the contracting state ( for instance, State, province, regions, municipalities, etc.) and in which manner it is used.
According to Paragraph 2 of Article 1 of the OECD Model Tax treaty, the following broad types of taxes would be treated as a tax on income and capital under the treaty:
- The tax imposed on total income
- The tax imposed on total capital
- The tax imposed on different elements of income or capital
- Tax on the alienation of movable or immovable property
- Tax on the total amount of wages or salaries paid by enterprises (such as “payroll tax”; “Lohnsummensteuer” in Germany; “Taxe sur les salaires” in France). Social security charges, or any other fees paid where there is a direct connection between the tax and the individual benefits to be received, shall not be regarded as “taxes on the total amount of wages.”
- Tax on capital appreciation
Does Article 2 cover the penalties, interest, and other charges applied to taxes?
Article 2 of the OECD Model Tax treaty does not state anything on the accessory charges which would be levied by the countries on the taxes of income and capital. The Model Tax Convention (OECD), in its commentaries, states that the country which has a right to tax an item of income or capital under their law also has the right to tax the duties or charges accessory to them: increases, costs, penalties, interest, etc. It has not been considered necessary to specify these, as it is evident as these are covered. However, some countries would object to this interpretation, and they may include clarification on these in their treaty.
Note: Portugal has disagreed with the interpretation mentioned above and choose not to consider penalties, interest, and other charges on income and capital as the taxes covered under Article 2.
Declaration on taxes covered
Paragraph 3 of the OECD Model Tax Treaty lists down the names of taxes that are imposed by the contracting states on the income and capital as on the date of entering into the treaty. Some countries would prefer not to include Paragraph 1 and 2 of Article 2 of the OECD Model Tax Treaty in their bilateral treaty. They will choose to exhaustively list the taxes that would be covered by their bilateral tax treaty.
Impact on the treaty when Contracting states declare new taxes after signing the treaty?
Paragraph 4 of the OECD Model Tax Treaty states that the Convention would apply to all the identical or substantially similar taxes that are levied by the Contracting State after signing the bilateral tax treaty. Each participating state should notify the counterparty country about the significant changes made in the taxation laws.
Observations of countries on the OECD Model Tax Treaty Commentary
Portugal holds the view that interest and penalties are not taxes covered by the Convention.
Reservation expressed by the Countries
Canada, Chile, and the United States of America reserve their position on Paragraph 1, where it states the Convention should apply to taxes of political subdivisions or local authorities.
Australia, Japan, and Korea reserve their position on Paragraph 1 which states that Convention shall apply to taxes on capital
Greece and Latvia hold the view that “taxes on the wages and salaries paid by enterprises” should not be considered as taxes on income and hence will not be covered under the treaty.