Tax treaties are becoming more important, especially in today’s global economy where income is earned across borders.
A tax treaty is an official agreement between two countries that sets the rules for how income is taxed when it crosses borders. Without these treaties, a person or business could be taxed twice on the same income, once by the country where the money is earned and again by the country where they live.
Two major global organizations have shaped how these treaties work: the United Nations (UN) and the Organisation for Economic Cooperation and Development (OECD). The UN focuses on helping developing countries maintain more tax rights, while the OECD supports rules that benefit countries where taxpayers live, usually in developed nations.
In this article, we’ll explain everything you need to know about tax treaties, what they are, how they work, the different types, and more. Here is what to expect.
What are tax treaties?
Tax treaties are agreements between two countries that help prevent people and businesses from paying tax twice on the same income. They also aim to reduce tax evasion. These agreements explain which country can tax certain types of income, like wages, interest, or business profits. For people and companies earning money in more than one country, tax treaties make it clear where taxes should be paid and often provide tax relief or exemptions.
Common scenarios where someone would need to know about tax treaties include working abroad, owning foreign investments, getting dual citizenship, retiring in another country, or holding a Golden Visa that grants residency by investment.
How do tax treaties work?
Tax treaties are legally binding agreements between two countries, usually signed and ratified according to each country’s laws. Once in force, they become part of international law and often take priority over national tax laws when there is a conflict. This means that if a country’s domestic tax law says one thing, but a treaty says another, the treaty rules usually apply provided it has been properly ratified.
However, not all tax treaties are the same, but most are international agreements between two countries. These are called bilateral tax treaties. They create rules that both countries must follow, but they don’t automatically give rights to individual people or businesses, which are called third parties. Still, the purpose of these treaties is to help taxpayers in both countries.
Whether a taxpayer gets the benefits of a treaty depends on the laws in each country. In some countries, the treaty takes effect right away after it’s signed and this is called “self-executing.” In other words, the government must first pass a law or take another step to make the treaty work for its residents.
Types of Tax Treaties
There are two main types of tax treaties, based on what they aim to cover:
Income Tax Treaties (Double Tax Agreement)
Double Taxation Agreements are the most common type and are made between two countries to prevent the same income from being taxed twice. They cover taxes on income such as salaries, business profits, interest, dividends, pensions, and royalties. They also include rules for tax residency and often offer methods like tax credits or exemptions to avoid double taxation.
Estate, Inheritance, and Gift Tax Treaties
These treaties deal with taxes on the transfer of wealth through inheritance or gifts. They help prevent double taxation when someone leaves assets in another country or gives gifts across borders.
Some countries also have Tax Information Exchange Agreements (TIEAs), which are not full tax treaties but still help in sharing tax data. These agreements are especially useful for fighting tax evasion. TIEAs are often made between high-tax countries and low- or no-tax countries where a regular tax treaty might not exist. They require the low- or no-tax countries to share tax information. This exchange of information helps countries keep track of income and ensure taxes are being paid fairly, to reduce the chance of tax evasion.
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United nations vs OECD Tax Treaty Model
The United Nations (UN) Model Tax Treaty and the OECD Tax Treaty Model are both guides used by countries to make tax agreements. These agreements help countries decide how to share taxing rights and avoid taxing the same income twice. However, they differ in how they handle particular issues, especially when it comes to supporting developing countries.
Key Differences between UN VS OECD Tax Treaty Model
UN Tax Treaty Model: The UN Tax Treaty Model is made to help developing countries. It gives them more power to tax income that is earned within their borders. This helps them keep more tax money from international businesses or people who make money in their country. The UN model allows developing countries tax different types of income like royalties, dividends, and capital gains more easily which helps support their economies.
OECD Model Tax Convention: The OECD Model Tax Treaty is mainly used by developed countries. It gives more taxing rights to the country where the person or business lives, also called the residence country, not where the income was earned. This model helps large international businesses by reducing the taxes they pay in foreign countries. It also helps make global trade and investment easier by limiting extra tax costs for foreign companies or individuals.
Feature | UN Model Tax Treaty | OECD Model Tax Treaty |
Target Audience | Primarily aimed at developing countries. | Mainly for developed countries. |
Allocation of Taxing Rights | Favors the country where income is earned (source country). | Favors the country of residence of the taxpayer. |
Taxation on Royalties | Allows source country to tax royalties more heavily. | Limits source country taxation on royalties. |
Capital Gains | Allows source country to tax capital gains more easily. | Gives more taxing rights to the country of residence. |
Permanent Establishment (PE) | Broader definition of what constitutes a PE, giving source countries more taxing rights. | More limited definition of PE, giving residence country more rights. |
Dividends | Allows source countries to tax dividends at a higher rate. | Reduces source country tax on dividends. |
How do withholding tax policies relate to tax treaties?
Withholding tax policies are directly related to tax treaties because tax treaties often reduce or eliminate the amount of withholding tax that one country can charge on specific kinds of income paid to the other country’s residents.
To add more context, a withholding tax policy is a rule that requires a certain percentage of income paid to a person or business, especially one based in another country, to be taken out (withheld) by the payer and sent directly to the government as tax. This usually applies to income like dividends, interest, royalties, or service payments.
Do tax havens sign tax treaties?
Yes, some tax haven countries sign tax treaties, but not very often. A tax haven is a country or place with very low or no income taxes. Instead of full tax treaties, many of them sign Tax Information Exchange Agreements (TIEAs).
Some tax havens also sign limited treaties with specific countries to attract business or follow international rules. However, these treaties usually do not offer the same tax benefits as those between bigger or richer countries.
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What is a saving clause in a tax treaty?
A saving clause in a tax treaty is a rule that allows a country to keep the right to tax its own residents as if the treaty did not exist. This means that even if the treaty gives tax benefits, the country can still apply its normal tax laws to its residents.
What is a reciprocal tax treaty?
A reciprocal tax treaty means both countries in the agreement give each other the same or similar tax benefits. It’s a two-way deal where each country agrees to reduce or avoid taxing special kinds of income like pensions, salaries, or business profits for residents of the other country.
Tax treaty countries
Many countries around the world have built strong tax treaty networks to support international trade, investment, and mobility. The table below lists countries that have signed a large number of bilateral tax treaties and those with active treaty networks.
Countries that have signed many bilateral tax treaties | Countries that maintain active tax treaty networks |
United States | Ireland |
United Kingdom | Poland |
Canada | Portugal |
Germany | Czech Republic |
France | Hungary |
Italy | Singapore |
Netherlands | Malaysia |
Switzerland | Thailand |
Japan | Brazil |
Australia | South Africa |
Spain | New Zealand |
India | United Arab Emirates (UAE) |
South Korea | Norway |
China | Sweden |
Mexico | Denmark |
Countries with Tax Treaties with the U.S
Note that the tax treaties with Hungary and Russia have been suspended. More up-to-date information on U.S. tax treaties can be found on the IRS official website.
Country | ||
Armenia | India | Portugal |
Australia | Indonesia | Romania |
Austria | Ireland | Russia* |
Azerbaijan | Israel | Slovak Republic |
Bangladesh | Italy | Slovenia |
Barbados | Jamaica | South Africa |
Belarus* | Japan | Spain |
Belgium | Kazakhstan | Sri Lanka |
Bulgaria | Korea (South) | Sweden |
Canada | Kyrgyzstan | Switzerland |
Chile | Latvia | Tajikistan |
China | Lithuania | Thailand |
Cyprus | Luxembourg | Trinidad and Tobago |
Czech Republic | Malta | Tunisia |
Denmark | Mexico | Turkey |
Egypt | Moldova | Turkmenistan |
Estonia | Morocco | Ukraine |
Finland | Netherlands | United Kingdom |
France | New Zealand | Uzbekistan |
Georgia | Norway | Venezuela |
Germany | Pakistan | |
Greece | Philippines | |
Iceland | Poland | |
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Frequently Asked Questions about Tax Treaties
What is a tax treaty?
A tax treaty is an agreement between two countries that sets rules on how income is taxed when earned across borders. It helps avoid double taxation and clarifies which country gets the right to tax certain types of income.
Why do countries sign tax treaties?
Countries sign tax treaties to encourage trade, investment, and cooperation. These treaties protect taxpayers from being taxed twice and create clear rules for handling cross-border income.
Do tax treaties apply to individuals and businesses?
Yes, tax treaties apply to both individuals and businesses. They outline how income like salaries, dividends, royalties, and profits should be taxed between two countries.
What is double taxation?
Double taxation happens when the same income is taxed by two different countries. Tax treaties help prevent this by dividing taxing rights or allowing tax credits or exemptions.
Do tax treaties override domestic law?
In many countries, tax treaties override domestic tax laws when there is a conflict. However, this depends on how each country incorporates treaties into its legal system.
What are TIEAs and how are they different from tax treaties?
Tax Information Exchange Agreements (TIEAs) are not full tax treaties. They only allow countries to share tax information to fight tax evasion, especially with low-tax jurisdictions.
How do I know if my country has a tax treaty with another country?
Most countries publish a list of tax treaties on their tax authority’s website. You can check there to see if a treaty exists and what it covers.
What are the UN and OECD models in tax treaties?
The UN Model gives more taxing rights to the source country, helping developing nations. The OECD Model favors the country where the taxpayer lives, usually benefiting developed countries.
