Double Taxation Convention, or DTA for short, regulates the taxation of natural and legal persons who are resident in several Contracting States. The aim is to avoid double taxation of income, since both countries regularly have an unlimited tax liability. An important principle here is the locality principle, which for taxation is linked to the locality (the “location”) of a source of income.
The location principle is based on the principle that assets located in a state “X” also use the infrastructure and possible state services there. The right to tax the ‘fruits’ of these activities should therefore also be exercised by the State providing infrastructure and other services. As a result, the DBA regulations thus follow a certain fairness idea.
Example: A taxpayer living in Germany leases several holiday properties in Croatia. Now he decides to sell to a Croatian citizen. There is a profit of EUR 1,500,000.
Solution (without DTA): The profit is, unless there is a case of § 23 EStG, fully taxable in Germany.
Problem: According to a healthy moral understanding, the tax is due to the country Croatia. Because the property occupied there may have caused damage to the environment, led to a sealing of the ground and made a repair of the road necessary by numerous vehicles. In addition, Croatian workers were used for the ongoing maintenance of the property.
Solution (with DBA): In order to replace at least parts of the costs incurred by the country Croatia – directly or indirectly – the profit is also subject to Croatian income tax. Because the location principle of the DBA-Croatia depends on the location of the property.
Now, however, the taxpayer is taxable in both states. The result may be a tax burden of more than 80%. Here, too, the DTA comes into play, because this finally regulates which of the two contracting states now waives a part of the tax (actually) due to it.
The OECD Model Agreement, on which most DTAs are based, contains various forms of the localization principle. For example, it can be found in the following articles:
This article does not replace tax or legal advice in an individual case. Facts, current law, jurisdiction, documentation and implementation remain decisive.