Perhaps, it stems from a fear of being left out of a rapidly evolving global economy. Maybe, it was imposed as a condition for receiving foreign direct investment. It could be that pressure is rising thanks to the Global Forum peer reviews. Whatever the reason, many developing countries are consistently concluding tax treaties with much larger counterparts. If they aren’t careful, the mismatch in the competent authorities’ resources and experiences can lead to negative consequences for the developing country.
There is no need to rush into a treaty, having more treaties neither improves a country’s diplomatic status, nor its financial capacity. The right to tax must already be present in the domestic legislation, it will not be created by a tax treaty. Sure, treaties alleviate the imposition of double taxation, and they may foster foreign investment, but to do this, they need to be negotiated in your favour. The following tips are suggested to help the tax treaty team from developing countries get the most out of their negotiations.
Tip #1 Question whether the treaty is necessary.
At its commencement, the treaty must prove to be beneficial for both of the countries involved. Research must be done to analyze aspects of the economy; trends in the business sector, key industries, exports and imports, opportunities for economic growth, and foreign investments. The pro’s and con’s of the proposed treaty must be quantified; if the treaty doesn’t present significant advantages then there is no point in continuing any further.
Unfortunately, one of the problems afflicting developing countries is the lack of reliable data. If no sources of statistics or economic indicators exist, then evaluating the impact of a treaty becomes problematic. Therefore, developing countries may want to focus more on the long-term effects the treaty will have. Keeping in mind that the initial economic advantages of a treaty may be offset by the restrictions imposed on the country’s taxable base. Thus, for achieving short-term financial objectives, it’s safer to use tax incentives, sector specific APA’s, or safe harbours.
Tip #2 Get feedback from significant players in the economy.
Prior to starting the negotiations, the competent authority could issue a press release regarding their consideration of this treaty. A forum for communication needs to be created so that professionals from different business sectors can bring forth any concerns they may have. Having the tax authority and the business sector work together will enhance cooperation and increase taxpayer compliance (this is especially important in developing countries where a small handful of taxpayers often contribute the largest revenue percentage).
It may also prove helpful to find international experts, and foreign investors with interests in the domestic economy, to provide differing viewpoints on the expected effects of this treaty. Lastly, domestic academics with extensive knowledge in the field may also provide useful feedback.
Tip #3 Do your homework!
Revise the previous treaties (and protocols) signed by the country with which you are negotiating. Check what concessions they have given to countries with similar characteristics to yours, what terms of withholding tax they have previously agreed to, what modifications were made to the treaty model, etc. Check if the country you are negotiating with has any reservations in the OECD model commentaries. Look at the diplomatic relations between the country you are negotiating with and your other treaty partners. For example, it could be that Country A will be disconcerted when you sign a treaty with Country B as they don’t recognize Country B’s sovereignty over that jurisdiction.
Most importantly, negotiators need to come prepared; knowing what they want to ask for and what compromises they can make. It is essential to know the domestic laws and economic traits of the other country to realize the impact that your demands might have on their economy. Also, negotiators should avoid unwarranted surprises by being knowledgeable about their own country’s previous treaty concessions.
Tip #4 Tailor the provisions to meet your necessities.
Whether you are negotiating with the OECD model, the UN model, or a domestic model, there may be provisions that are inconsistent with your specific needs. Negotiators need to go through every article looking for potential problems that could arise. Modifications will be necessary to tailor the treaty to the domestic circumstances. Likewise, there may be situations were it’s beneficial to stick to the model. For example, if migration statistics show that a percentage of your citizens move to a neighbouring country during their working years, but with a tendency to return home for retirement age. Then, it would be beneficial to sign a tax treaty with that neighbour, leaving Article 19 exactly as it is, with primary taxing rights on pension payments retained by the country of residence.
Tip #5 Composition of the negotiating team.
The ideal delegation consists of four roles when negotiating in your home country and three roles when in a foreign jurisdiction. First, there needs to be a senior official with the authority to make tax policy decisions (this person does most of the talking). The second person mainly listens, informs and drafts the provisions. A third person is needed to make notes and keep track of the minutes. And, if at home, the fourth person takes care of the logistics such as; arranging the hotels, organizing the catering, preparing documentation, etc. If accepted by the other country, there could be business consultants, trainees, or foreign aids present as third party consultants.
Whoever is leading the negotiations should be an expert on taxation issues, they need to have sufficient knowledge of the domestic economy to know what concessions can be made and what to be a stickler on.
Sometimes, domestic law requires there to be a political figurehead like a representative from the Ministry of Foreign Affairs or the Ministry of Finance (if given the option, always choose the latter as this person is more likely to understand the issues being discussed).
Tip #6 Keep detailed minutes.
Make sure the person keeping the minutes is paying attention to everything that is being said, and, keeping track of what concessions have been made by either side. It can be that the participants in the delegation change, causing your next meeting to be with a new person. Therefore, minutes are very important to recount what was previously agreed to instead of starting over again. The minutes should reflect the work that results from each round, although they are not to be published or used in any legal manner.
Tip #7 Maintain a patient negotiation strategy.
There are three phases in the negotiation process;
Round 1 Explore what the other party wants to achieve with this treaty and give some information regarding your desires.
Round 2 Go through the model, using technical discussions and explanations based on your previous research, try to convince the other party of your desired provisions.
Round 3 (or more) Bargaining and trading ‘quid for pro’ based on the issues that are most important to each party. This part can require many rounds depending on how long it takes to reach an agreement. The team should be prepared to go the distance as negotiations can end up being quite lengthy and arduous (for example, negotiations between the Netherlands and Germany required 53 rounds!).
As for the negotiating style, there needs to be experienced people who can clearly explain why they want what they are asking for, all the while, respectfully acknowledging the impact these demands could have. By keeping to technical issues instead of social policies, productivity will increase. Fostering good relations and efficient collaboration between the countries is an essential part to help reduce tax avoidance schemes. Social events, networking and personal contact will help to maintain regular communication and create a positive relationship between the delegates.
Tip # 8 Technical Considerations
- If your country has simplified measures or safe harbours, these need to be discussed with the other country to make sure they will be respected without causing double taxation. Keep in mind, features of domestic law will change over time, therefore, any relevant domestic law needs to be reflected in the treaty to ensure permanence.
- If you have to accept a provision that seems excessive, because the other country won’t budge, then ask for a ‘Most Favoured Nation’ clause. This way, if that country ever concedes to a better regime in the future, they must give that concession to you as well.
- If your country uses tax incentives to attract foreign investments, then ask for a tax sparing credit to maintain the benefit in the hands of the investor. The other country will recognize the tax credit amount given to the investor as if it had been the tax actually paid. You should be prepared to explain the specifics of that investment policy; its purpose, estimated time period, and the industry characteristics.
Please note that the abovementioned tips will not necessarily be suitable in all situations. It is to be expected that the strength and development of the tax regime will differ from one developing country to the next. Therefore, the tax treaty negotiators shall take the suggested recommendations with a grain of salt, adapting and modifying them as necessary.
Best of luck!