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The Model Treaties
History and Development
1
United States vs. Europe
The U.S. began considering the need for tax treaties in the
early 1920s.
Before then, there was no international standard for relieving
double taxation.
The U.S. was alone in providing a unilateral foreign tax credit.
By relieving U.S. residual taxation, the FTC cedes “residence-based” taxation to
“source-based” taxation.
The FTC was therefore seen as a gift of revenue to other countries.
In stark contrast, Britain imposed worldwide taxation and provided a FTC that was
extremely limited and generally preserved its residence-based taxation.
Other European nations, especially France and Italy, relied heavily on source-based
taxation and therefore vigorously defended the U.S. position of ceding residence-
based taxation to that of source. 2
International Chamber of Commerce
Formed in 1919 by 15 nations, to facilitate discussion
surrounding promotion of international trade and investment.
The most influential nations were Belgium, France, Italy, the
United Kingdom and the United States.
In 1921, the ICC adopted a resolution that tax jurisdiction
turned on the nature of the tax.
Under direction from the U.K., distinctions were made between
“super” (progressive) and “normal” (flat rate) taxes; jurisdiction over
the former was to be based on citizenship, the latter on source
The U.S. rejected this resolution and endorsed closer adherence to
the U.S. system (ceding residence in favor of source-based tax
jurisdiction)
The ICC synthesized the U.K and U.S. views in a set of
resolutions, done in Rome, in 1923 (the “Rome Resolutions”).3
The Rome Resolutions
The Rome Resolutions incorporated the concept of a
classification and assignment system for different categories
of income
e.g. income from real estate to the nation where located, and
income from business divided among source nations according to
relative contributions
It also crystallized the notion of “residence” versus “source,”
rejecting the notion of citizenship that had been promoted by
the U.K.
Finally, it proposed the allocation of business profits between
source nations by some objective mechanism.
The Rome Resolutions essentially solidified the terminology
that formed the foundation of modern tax treaties. 4
Reaction to the Rome Resolutions
The U.S. opposed the allocation of all types of income to one
jurisdiction over another, preferring adherence to its own
model of protecting source-based over residence-based
taxation in all cases, but otherwise approved of the Rome
Resolutions.
The U.K. entirely opposed the Rome Resolutions, especially
the emphasis on source-based taxation: they argued that all
taxation should be residence-based, like the British system.
The U.K. demonstrated its unyielding commitment to residence-
based taxation in a 1926 treaty with the new Irish Free State, which
exempted non-residents from taxation.
The U.K. did not complete any other new treaties until it signed one
with the U.S. in 1945—it took almost 20 years for the U.K. to
compromise its preference for residence-based taxation.
5
Why did the US favor source, the UK residence?
The U.K. was a net exporter of capital.
The U.S. was also a net exporter of capital at that time.
However, T.S. Adams as tax advisor to the Treasury Dept, writer of
the FTC, and chief international tax negotiator on behalf of the U.S.,
preferred source based taxation for several reasons.
• he wanted to avoid antagonizing debtor nations (esp France
and Italy), who comprised the bulk of ICC members;
• the international balance of payments was overwhelmingly in
the U.S.’s favor, permitting generosity in source rules to capital
importers; and
• he had already instituted a preference for source-based taxation
domestically, by getting the FTC enacted.
6
1923 Compromise
The Rome Resolutions thus failed to resolve anything
except drawing the battle lines clearly.
In 1923, the ICC endorsed the principle that in the
long run, all taxation should be residence-based, but
in the short run, nations should work toward
developing bilateral treaties implementing the
American-style FTC.
Nevertheless, the impasse continued.
7
Enter the League of Nations
The League of Nations was conceived during the first World
War, and established in 1919 under the Treaty of Versailles
“to promote international cooperation and to achieve peace
and security.”
8
League of Nations Member Countries, 1919
Romania Yugoslavia
(Croatia, Slovenia, Macedonia, and
Poland Bosnia & Herzogovenia)
Czechoslovakia
Sweden
Norway
Denmark
Netherlands
Canada UK
Belgium
France
Switzerland
Spain Italy Japan
Portugal Greece
China
Cuba
Haiti
Persia
(Iran)
Guatemala Honduras India
El Salvador Venezuela Siam
Nicaragua (Thailand)
Panama Liberia
Colombia
Peru
Brazil
Bolivia
Paraguay
Chile Uruguay South Africa
Australia
Argentina
New Zealand
9
League of Nations Member Countries
Romania Yugoslavia
(Croatia, Slovenia, Macedonia, and
Finland Poland Bosnia & Herzogovenia)
Czechoslovakia
Luxembourg
Sweden
Norway
Denmark Estonia
Netherlands Latvia
Ireland UK Lithuania
Canada Hungary
Belgium
Austria France
Switzerland
Spain Italy Japan
Portugal Greece
Bulgaria Albania
China
Cuba
Haiti
Dominican Republic Persia
Guatemala (Iran) India
Honduras
El Salvador Venezuela Siam
Nicaragua (Thailand)
Panama Liberia Ethiopia
Colombia
Peru
Brazil
Bolivia
Paraguay
Chile Uruguay South Africa
Australia
Argentina
New Zealand
By 1925
In 1919
10
League of Nations Focus on Tax Treaties
In 1920, the League of Nations held an international financial
conference in Brussels.
They determined that double taxation was a serious
impediment to international relations and world production.
The financial committee of that conference referred the
question of double taxation to four economists: M. Bruins, M.
Einaudi, M. Seligman, and Josiah Stamp, who began working
on a report.
In 1922, the financial committee decided that both double
taxation and tax evasion should be studied together, so they
put together a new group of six people who were high
officials in their home country’s fiscal administration, to
discuss the problem of double taxation.
11
1923 Report of the 4 Economists
In 1923, the four economists released their report.
It had little impact on the ICC.
12
The 1925 Report
Meanwhile, the Committee of Technical Experts had been formed.
it included six experts from LoN member coutnries.
The 6 technical experts agreed upon a series of resolutions which they
submitted to the LoN’s financial committee in 1925 (the 1925 Report).
This report distinguished taxes on global income—now called “personal
taxes”—and all other taxes—now called “impersonal taxes.” Under this
theory:
Jurisdiction over personal taxes was to be based on residence, and
Jurisdiction over impersonal taxes was to be based on source.
This was an attempt to allow both creditor nations (U.K., Netherlands,
U.S.) as well as debtor nations (France, Italy) specific jurisdiction over
different types of taxes.
The Technical experts said that the distinction was made “purely for
practical reasons.”
13
The 1925 Report
The 1925 report was more favorable to source-based
taxation than the 1923 report.
In the 1925 report, the experts also suggested
expansion of the committee in order to start working
on a model convention.
14
Technical Experts
The newly expanded committee of technical experts comprised 14
members.
13 were from LoN member countries;
the 14th was a representative from the United States (T.S. Adams).
The ICC was invited to send a delegation to the three meetings held by
the committee of experts in 1926 and 1927.
The new committee began by reviewing the 1925 report.
They focused on drawing up a standard convention, but determined
that a multilateral or “collective” convention would be impossible
because of vast differences in tax systems.
Therefore the Committee drafted what they called “standard bilateral
conventions,” which, if used by governments, would collectively
introduce a measure of uniformity in international fiscal law.
Such uniformity might lead, they thought, to a system of general conventions that
would make possible the unification and codification of the rules previously laid
down. 15
The First Model Tax Treaty
The model convention reflected the 1925 report, providing
that personal taxation would be taxed on the basis of
residence and impersonal taxation would be taxed on the
basis of source.
16
Implementation
The binary scheme of personal vs impersonal worked well
with nations like France, which had two distinct income taxes
that fit into these categories.
However, it did not work well in the context of U.S. or U.K.
tax structures.
For example, the U.S. imposed both a flat normal tax and a
graduated surtax on individuals, plus a flat normal tax on
corporations. Which were the impersonal taxes?
The U.S. therefore argued against the personal/impersonal
distinction as being too vague for implementation.
It advocated instead the use of “origin taxes” and “residence
taxes,” a tautological distinction that essentially illustrated a
desire to write the U.S. international tax system into a model
treaty. 17
Model Treaty-Second Draft
The Committee of Experts thus drafted two model
treaties, the second reflecting a combination of the
U.S. and U.K. positions.
This draft made no mention of personal/impersonal:
instead, it articulated a general preference for
residence-based taxation (the U.K. position).
However, it also permitted source-based taxation,
most notably on business income, and called for
nations to grant U.S.-style tax credits.
18
League of Nations—Subsequent Drafts
The “Mexico Model,” adopted in 1943
reflected the interests of capital-importing nations by
providing for extensive source-based taxation of most
classes of income
The “London Model,” adopted in 1946
reflected the interests of capital-exporting nations by
emphasizing residence-based taxation.
The League of Nations dissolved in 1946 (it was
succeeded by the United Nations).
19
Enter the OECD
The League of Nations Model continued to be the
blueprint for tax treaties from the 30s to the 60s, with
some treaties reflecting the concepts embodied in the
Mexico and London Models.
Meanwhile, the Organisation for European Economic
Co-operation was developed in 1948, to coordinate
the Marshall Plan.
The OEEC transformed in 1961 into the Organisation
for Economic Co-operation and Development, a
group of 30 developed countries including the U.S.
20
OECD Member Countries
Sweden
Iceland Norway
Denmark
Netherlands
UK
Canada Ireland Germany
Belgium Austria
U.S. France Luxembourg
Switzerland
Spain Italy
Portugal
Greece Turkey
21
The OECD Model
The OECD soon began to look at the matter of tax treaties,
and first issued its own Model in 1963.
As a product of the major industrialized nations that comprise its
membership, the OECD’s model emphasizes the views of capital-
exporting countries.
Primary taxing jurisdiction is given to the residence state; and
therefore
Elimination of double taxation is primarily achieved by way of
source-state exemption (with FTC as a backstop).
The OECD recommended that its member nations should
“conform to the Draft Convention…as interpreted by the
commentaries,” when concluding or revising their bilateral
treaties. 22
The OECD Model, Cont.
The OECD updated its model treaty in 1977 and
again in 1992. Since then, it updates every few years
(1995, 1997, 2000, and 2003).
Each update reflected the experience of member
countries in negotiating tax treaties, and changes in the
domestic tax systems of the member states.
The OECD Model quickly became the standard for
member as well as non-member states.
The U.S. never adopted any of the OECD Model
Treaties as its primary negotiating document.
However, these models significantly influenced all U.S.
treaties entered into after 1963.
23
Writers of 1st Model vs Writers of 2d Model
Romania Yugoslavia
(Croatia, Slovenia, Macedonia, and
Finland Poland Bosnia & Herzogovenia)
Czechoslovakia
Luxembourg
Sweden
Iceland Norway
Sweden
Denmark
Norway
Denmark Estonia
Netherlands Latvia
Netherlands UK
Canada Ireland Germany
Lithuania
Ireland UK Hungary
Canada Belgium Austria
Belgium
France
U.S. Austria France Luxembourg
Switzerland
Switzerland
Spain
Spain Italy Japan
Portugal Italy
Portugal Greece Turkey
Greece
Bulgaria Albania
China
Cuba
Haiti
Dominican Republic Persia
(Iran)
Guatemala Honduras India
El Salvador Venezuela Siam
Nicaragua (Thailand)
Panama Liberia Ethiopia
Colombia
Peru
Brazil
Bolivia
Paraguay
Chile Uruguay South Africa
Australia
Argentina
New Zealand
OECD, of Nations, 1925
League 1961
24
Enter the UN
Its predecessor organization, the League of Nations, had been
responsible for the first model treaties.
However, the UN did not pick up on this activity until 1968, when it
was determined that the OECD Models were not appropriate for
use by developing countries, which are primarily capital-importing
(and therefore reliant on source-based taxation).
In 1968 the UN formed the “Ad Hoc Group of Experts on Tax
Treaties Between Developed and Developing Countries” to
formulate guidelines.
It took them 12 years to come up with the UN Model Treaty.
The UN Model of 1980 structurally resembled the OECD Model of
1977.
However, the UN Model emphasized the primacy of source-based
taxation.
25
Members of UN Group of Experts, 1968
Sweden
Norway
UK
Germany
Netherlands
U.S. France Turkey
Switzerland
Japan
Tunisia
Israel
Pakistan Philippines
India
Ghana Sri Lanka
Sudan
Brazil
Chile
Argentina
26
OECD Model vs UN Model
Sweden
Sweden
Norway
Iceland Norway
Denmark
UK
Netherlands
UK
Canada Ireland Germany
Germany
Netherlands Austria
Belgium
U.S. France Turkey
U.S. France
Switzerland Luxembourg
Switzerland Japan
Spain Italy
Portugal Tunisia
GreeceIsrael
Turkey
Pakistan Philippines
India
Ghana Sri Lanka
Sudan
Brazil
Chile
Argentina
UN, 1961
OECD,1968
27
UN Model Development
The original UN Model was updated and released in
1999 as a draft and 2001 as a new Model.
28
Meanwhile, in the U.S. …
Since its first treaty with France (1935), U.S. tax treaty
negotiations were based on a model developed by Treasury.
The model was intended for U.S. negotiators and was not officially
released.
After WWII, a model based on the 1945 U.S.-U.K. treaty
became the unofficial model.
Again, it was intended for U.S. negotiators and was not released.
After the publication of the 1963 OECD Model, the then
unofficial US Model met with more resistance in negotiations.
In the 1970s, the U.S. finally determined that adoption of treaty
concepts accepted by most other countries would be the only way
for the U.S. to expand and modernize its existing tax treaty network.
29
Development of the US Model
In 1976, Treasury published the first official U.S. model
treaty.
This Model followed the 1963 OECD Model both in structure and
terminology.
In 1981, Treasury released another draft.
The main change was the addition of Art. 16, a limitation on
benefits (LOB) clause designed to prevent treaty shopping.
The 1981 Model was withdrawn in July, 1992.
Another model was not released until 1996.
The 1996 Model clarified terminology, reflected changes in U.S.
internal tax provisions, and tightened the LOB clause.
A new model was released in November of 2006.).
30
