date | theme

08. January 2021 | Double Taxation and Double Taxation Agreement

26. October 2020 | Overview of the OECD Model Agreement – OECD-MA as the basis for DTA

08. January 2021 | Overview of the most important articles of the OECD-MA (this article)

08. January 2021 | Double taxation without DTA: Business relations with countries without DTA

The OECD Model Agreement (OECD-MA) is the basis of many double taxation agreements (DTAs) worldwide. If you know the regulations from the OECD-MA in the bilateral negotiations on the avoidance of double taxation and know how to apply them, you can incorporate these regulations into the Treaty text of the DTA and then only have to concentrate on the special cases. Therefore, in this article we go into the individual, basic provisions of the OECD-MA and explain how the articles work and are structured.

If you compare the OECD-MA with other actual DTAs, it becomes clear that the DTA often has a lot in common with the model agreement. Therefore, the OECD-MA is often used for easier understanding of a DBA. In this article, the OECD-MA should also serve us to explain the most important and common articles on the avoidance of double taxation. In this regard, we will also go into some points in detail.

1.1. Emergence of double taxation

Double taxation arises when two states establish a tax liability to a person or a source of income. This can be done by a double unlimited tax liability based on two residences, or by an unlimited tax liability in the country of residence (domicile) and a limited tax liability in the country of origin (source of income).

1.2. Allocation of taxation right: State of residence vs. State of source

While Articles 1 to 5 of the OECD-MA are general definitions and clarify the residence of persons, the main taxation standards are Articles 6 to 22 of the OECD-MA. The taxation rules assign the right to tax income in the event of double taxation to one of the two Contracting States. Depending on the chosen method of avoiding double taxation, the exemption or exemption method (Article 23a) or the credit method (Article 23b) will then apply.

2. The individual articles of the OECD-MA in overview

Article 4 OECD-MA – Resident

2.1.1. Residence of natural persons

For the allocation of the taxation right, the residence of the respective taxpayer is decisive. In principle, a residence is to be assumed to be a residence. However, if the respective taxpayer has a residence in both Contracting States, the question of residence is gradually refined in order to determine a residence of the taxpayer. Such a rule is called a tie-breaker rule. The rule brings a new requirement into play in the case of a draw – here in the question of residence – and then checks again. Ultimately, the taxpayer must be resident.

Thus, if the taxpayer has a residence in both contracting states (or neither), this would extend the residency check.

2.1.1.1. Centre of vital interests

This means that if a taxpayer has a place of residence in both contracting states, the next thing to be done is to focus on the vital interests. The center of life’s interests is made up of personal and economic relationships. Here you have to check where the taxpayer has his family and where his circle of friends, hobbies or other interests are.

2.1.1.2. Ordinary residence

Although the center of life interests cannot be precisely determined here, the next step is the habitual residence of the taxpayer. Ordinary residence means that the taxpayer spends a major part of his time in one of the contracting states.

2.1.1.3. Nationality & Understanding Procedure

As the last option of the tie-breaker rule, nationality comes into play. If the taxpayer is now a national of one of the Contracting States, then he is deemed to be resident there.

If no clarification on residency is made here either, because the taxpayer has, for example, a dual nationality or is not a national of the two states, then in the end only the agreement procedure remains. The two contracting states clarify among themselves where the taxpayer should be considered as resident.

At the end of this examination, however, it remains clear that the taxpayer must have a residence in one of the contracting states. However, these remarks apply only to natural persons.

2.1.2. Residence of legal persons

Instead of the place of residence, the place of management applies to legal persons (for example GmbH, AG). You can also have a double residence, which then leads to double taxation. In practice, this often occurs through operating sites. Corporations and corporations usually set up premises or subsidiaries abroad on site. The permanent establishment would then lead to double taxation (see Article 7 OECD-MA, permanent establishment reservation).

Immovable property is usually real estate. However, agricultural and forestry holdings are also included in this article. For immovable property, the locality principle applies: the taxation of income from immovable property is assigned to the contracting state in which the property is located.

This article covers only current income such as rental or lease, but not the sale of immovable property. This is laid down in Article 13.

Article 7 OECD-MA – Corporate profits

2.3.1. Definition of corporate profits

According to the general definitions of the OECD-MA (Article 3), the term “undertaking” means the pursuit of a business activity. Corporate profits are therefore the profits from a business activity.

A business activity can take place both as a sole proprietor and on the part of a corporation or partnership. It is important to mention here that Germany treats partnerships transparently. This means that for the question of residence, the individual partners of the partnership with their respective profit shares are decisive. For this purpose, the profits of the company itself serve only for distribution to the shareholders. Furthermore, Article 4 OECD-MA applies to the question of the residence of the person concerned.

In addition to the distribution of products or goods, a business activity also exists when services or consulting are provided. Thus, this includes the advice of freelancers.

Since the partnership is transparent, the shareholders are used for the issue of residence in a partnership. However, the partnership itself constitutes a permanent establishment.

Thus, corporate profits are assigned to the contracting state in which the company or person is resident. However, an exception is made to this basic rule if a permanent establishment is located in the other contracting state.

2.3.2. Premises reservation

Through the existence of a permanent establishment in the source country, all profits from doing business in the source country are allocated to the permanent establishment and taxed by the source country instead of the residency state. In almost all cases, the permanent establishment also leads to a limited tax liability in the source state – without a limited tax liability of the source state, there would be no double taxation.

Article 10 OECD-MA - Dividends

In principle, dividends are taxed in the contracting state of the company receiving the dividend (residency state). However, the source state (i.e. where the dividend is paid) can make a tax deduction.

The tax deduction is 5% of the (gross) dividend if the receiving company has held at least 25% of the distribution company for more than 365 days. In all other cases, the tax deduction is 15% of the (gross) dividend.

Here, too, the permanent establishment reservation applies: If the participating company has a permanent establishment in the contracting state of the distributing company, the participation of the permanent establishment can be imputed, so that no tax deduction is made – in such cases Article 7 OECD-MA applies. Whether the holding (and thus the dividend) belongs to the permanent establishment is to be assessed in terms of the actual use of the holding.

Article 11 OECD-MA – Interest

Also in the case of interest, the residence state has the right to tax. However, here too a tax deduction of 10% is made by the source state.

In addition, the premises reservation as in Article 10 OECD-MA (Dividends) also applies accordingly.

Article 12 OECD-MA – License Fees

License fees are taxed where the recipient of the license fees (the licensor) is located. Unlike dividends and interest, there is no tax deduction under the OECD-MA.

Although there is no tax deduction according to OECD-MA/DBA, Germany has created its own tax deduction according to § 50a EStG in the amount of 15 %. The German legislator thus disregards the regulations of the OECD-MA. Such a regulation, with which the legislature disregards DBA law, is called Treaty Override.

Similar to dividends and interest, there is also a premises reservation here, which must be applied accordingly.

Article 13 OECD-MA – gains on sale

Article 13 clarifies a whole series of divestments. The operations specified in Article 13 include the sale of real estate, the sale of shares in corporations (including real estate corporations) and the sale of permanent establishments and assets.

The sale of real estate (within the meaning of Article 6 OECD-MA) is taxed where the property is located (occupation principle).

In the case of the sale of shares in corporations, the right of taxation lies with the seller’s country of residence (Article 13(5) OECD-MA).

A special form of corporations here are the so-called real estate corporations. These are corporations whose assets are more than 50 % immovable. If shares in a real estate corporation are sold, the location principle applies again.

Taxation from the sale of movable property which is part of a permanent establishment (operating property) is carried out in the contracting state where the permanent establishment is located (sourced state).

Article 15 OECD-MA – Wages

In the taxation law for wages, there are basically three case groups: