Source, residence and duplicity in the OECD's approach
One form of tax evasion that is common in developing countries is for wealthy individuals to invest in bank deposits or other passive investments (or even active investments) in OECD financial centers or other financial centers. The income on such investments, often protected by secrecy/confidentiality laws in those financial centers, is frequently not declared by the investor to the tax authorities in the country of residence of the investor. That wealthy investor may also engage in “round-tripping” – the wealthy local investor exports capital to a secrecy jurisdiction, where the capital is disguised through offshore secrecy mechanisms, then returned to his or home country in the developing world, where it may benefit from tax holidays or other special privileges that are frequently offered to supposedly “foreign” capital.
Now this has an important role to play on the question of “source country” taxation versus “residence” country taxation. (In short, imagine an investment by a US-based multinational in Ethiopia, which earns income there. The “source” country is Ethiopia, which is the source of income; the “residence” country is the U.S., where the multinational corporation is resident.) This raises the significant question of who gets to tax the income: the source country (Ethiopia) or the residence country (the United States.) Residence-country taxation, of course, tends to favour rich nations where the multinationals tend to be based; source-country taxation would favour developing nations where much of the multinationals’ income is earned.
As TJN has noted several times in the past, the OECD has unsurprisingly pushed energetically for the primacy of residence-country taxation (which favours rich nations) and the OECD model income tax treaty reflects that. Developing countries have pushed for source-country taxation and they have tried to have the UN Model Income Tax Treaty, an alternative to the OECD's model, reflect that. As TJN members can attest at first hand, however, the OECD has, step by step, tried to undermine the UN Tax Committee on that question.
In this context, a TJN correspondent has sent us this, which contains a twist to the normal source vs. residence classification.
“On the major tax issue of cross border illicit funds flows from the South to the North, with the income thereon theoretically “returning” to the South, the OECD policy of exchange of information “upon request” undermines residence country taxation (in this case, the residence country is the country in the South where the investor/tax evader resides).
That is, by requiring the source country (basically onshore and offshore financial centers, where the investor/tax evader invests his/her/its money) only to exchange information “upon request” rather than via automatic exchange of information, the OECD in effect permits the source country (a rich country) to prevent the residence country (a poor country) from taxing that income. The result: regarding the major tax issue of capital flight from the South to the North, the OECD undermines developing countries’ ability to tax their citizens’ income, because it is to the advantage of OECD financial centers and offshore financial centers, to a large degree controlled or influenced by the OECD, to do so.
But with regard to industrial/manufacturing/intellectual property income flowing from the South to the North, the OECD insists on residence-based rather source country taxation -- because it is to the advantage of the OECD to do so. Real duplicity!
What is needed is a study about how source country taxation is essential (in tax treaties and otherwise) for developing countries. The study of the impact of income tax treaties on developing countries is a part of this more comprehensive topic of residence country versus source country taxation."
Read more about source-based and residence-based taxation here. Read more about information exchange standards here.