Why Do the United States Conclude Tax Treaties?

Why Does the United States Conclude Tax Treaties? Yariv Brauner University of Florida

Introduction • • • • • • •

Legal status of tax treaties Background – the negotiation process Basic Policy Concise history The decision to negotiate / conclude a treaty The contents of tax treaties Policy conclusions

Legal Status • (Tax) treaties and statutes are both “the law of the land” – i.e., no superior status to tax treaties – Treaty override possible and used in practice – The courts soften the conflict - possibly eliminating inexplicit/unintended override

• Treaty override controversial, yet little consequence in reality – Justified as mostly targeting domestic abuse – Other countries join the United States in practice

Background • Long (several years) and non-standard process • Secret and uncontrolled – Senate’s advice and consent being the sole effective control

• Doubts about the existence of clear treaty policy and a serious tax policy discourse generally within the Treasury department (executive branch) – General discomfort of Congress with tax treaties • that are difficult to amend, while domestic law changes at least on an annual basis • That depend on incomplete information about the treaty partner and lack of political control over the process

– Experts: No serious and open discussion between Congress and the Treasury about the goals: what is “good” for the American people? – No evidence on coordination of statutory and treaty tax policy

Basic Policy • Acceptance of the rules of the game, with some U.S. accents • Negotiating team follows the published “U.S. Model, accompanied by a technical explanation • Resembles the OECD Model – Saving clause – Effective management does not dominate the corporate residence rules – Limitation on benefits – More extensive exchange of information – No tax sparing

Concise History • Active in the League of Nations’ work (1920s) • First tax treaty concluded with France (1935) – Followed by Canada (1937) and Sweden (1939)

• Post WWII – first Northern Europe (and NZ) – – – –

Then – more Europe, Australia, S. Africa, others.. End 1950s – Africa and Caribbean nations 1960-1974 – only Luxemburg + terminations End 1970s – More Europe + Korea

• 1980s-present – slow pace of additions / Africa and Caribbean terminations • Very few in Latin America and Africa, otherwise almost complete coverage of important trade partners

The Decision to Negotiate / Conclude • Foreign policy – Politics – Defense

• Economic policy – Major trade partners • Relevance of actual trade relationship

– Impact of lobbying / particular interest groups • Investors prefer a “treaty in place”

– Position • The U.S. is now a net capital importer • The U.S. is a less dominant capital exporter / price maker

The Content • Rosenbloom: policy designed in the 1960s – Based on the choice of residence based taxation, compatible with the position of the U.S. as a large net capital exporter • Maximal reduction of withholding tax rates • Each treaty a separate, independent contract – no consistency or comprehensiveness concerns • Focus on U.S. taxpayers – unwillingness to grant significant advantages via treaties [and primary worry from abuse of treaties by them – less worried about foreigners taking advantage of U.S. treaties – Y.B.]

• Recent policy

Clear, Coherent and Transparent Policy? • Instinctively, we are attracted to it – especially academics - yet, maybe practically it is not desirable? • Transparency dismissed as bad for negotiation – Yet, the U.S. Model is public – And, changes in policy may be referred from other treaties that are public

• Standardization

Conclusion • Decision to negotiate • Process standardized yet not studied • Separate from decision to conclude – The Model – The international tax regime

• Senate oversight – Other political constraints

• • • •

Maintenance Personal aspects Resources Unclear goals

Brazil – United States Tax Treaty • History – Mutual suspicion – Tax sparing

• But, nowadays, Brazil is left essentially alone among our most serious trade partners without a treaty • Why? • Traditional reasons to conclude – – – –

Foreign policy Politics MNEs interests Economic policies

Brazil – United States Tax Treaty (cont.) • Other reasons – Association of productive countries – Eliminate disincentives that we do not believe in anyway

• So, why not? – Insistence on tax sparing – Trust, cooperation • Exchange of information • Bank secrecy

– Brazil’s independence from OECD hegemony

Tax Sparing and Matching Credits • Goal: support tax incentives of a developing treaty partner • Consistent U.S. policy • Reasons – Tax treaties should not affect U.S. taxation of U.S. citizens and residents – Tax treaties inappropriate mechanism for economic assistance – Incompatible with CEN based FTC • FTC as an extraordinary benefit

• Difficult to operate in compatibility to domestic tax law and third party treaties

Tax Sparing (cont.) • Critique of the support of tax incentives – Theoretically weak story – Generally granted, cannot be fine-tuned – Opaque and unstudied policies – Device of tax competition – But, this critique may be viewed as paternalistic • Indeed, opposition by international institution ineffective

Tax Sparing (cont.) • Critique of the practice of tax sparing – Dependent on treaties with no reason – No coherent policy as for who gets it and who does not (arbitrary), but no “give and take” – No thought of realistic “triangular cases” – No reliable and honest data on effect • No attempt to seriously study efficacy

• Similarly to the corollary of tax incentives, no mechanism of control, duration, etc.. • Also, tax planning that achieves the same result is available – This goes against the important U.S. principle of anti treaty shopping despite LOB – May help the wrong taxpayers (e.g. MNEs with excess credits..)

• May be beneficial to developing countries (i.e. counterproductive..)

Tax Sparing (cont.) • Realistically, the claim in support of tax sparing is a call for a reform of our international tax regime • I am sympathetic to the desire to control a divided, agreed upon part of the relevant tax base – This is the heart of the formulary apportionment reform I support

• Considered radical, yet not legally impossible even in the particular context of one treaty only – Although this may be “too much” politically – I am not sure that the “exemption” solution is easier to implement politically • And, is inferior from third treaties perspective

The downside of not having a treaty • It is not so difficult to treaty shop – few pay full tax price – Wasteful – Goes against a principle that may be more important than not allowing tax sparing – the elimination of tax avoidance and treaty shopping

Conclusion • Grim picture of stubborn conservatism – Demonstration of the harm of standardization and the model based approach

• In the current frame work Brazil’s insistence on tax sparing is misguided • Brazil is in a unique situation to lead the developing world in negotiation of a treaty – Exemption solution • Current appeal: calling the bluff

– Exploring a margin for negotiations