This is a chapter from the book: "Taxes Crossing Borders (and Tax Professors Too) - Liber Amicorum Prof Dr R.G. Prokisch".
Kees van Raad
One of the obvious advantages of email communication is that records not only are easily saved but also remain easily accessible. I obtained my first email account (with CompuServe) in 1991, through my colleague and friend Richard Doernberg who taught international tax law at Emory University in Atlanta, Georgia. With the luring perspective that I would be able to communicate online with people from all over the world, I signed on. For a number of months Richard was my only online contact. To obtain a message from him I needed to employ a dial-in modem (at that time: a sizeable metal box) to get online from time to time to check whether any message had arrived. In order to eliminate the awkward need to repeatedly make modem calls, we later on agreed to notify one another of an email message having been dispatched, by sending a fax message advising that an online message had been forwarded and could be downloaded. Times have changed – fortunately.
One important aspect of email I did not realize at that time is that – provided one had been careful enough to consistently make backups, as commonly occurring computer crashes often resulted in a loss of email correspondence – a complete record of one’s incoming and outgoing email messages provides a perfect archive of communications. This advantage over traditional communication through letters became obvious when I recently tried – in vain – to locate in my extensive paper archive my early correspondence with Rainer Prokisch. My search provided convincing evidence that if files are not meticulously archived they have little, if any, value for reconstructing the past.
In the absence of any email messages between Rainer and me before the early 1990s, I can only guess when we first met. I assume it was in the late 1980s when he worked at the Ludwig-Maximilians-Universität in Munich as one of the assistants of prof. Klaus Vogel with whom I got in contact shortly after he had published the first German edition of this Doppelbesteuerungsabkommen in 1983. Starting with the 2d edition of that book Rainer was the main author of the chapter on Art. 15 OECD Model. For that reason I was very happy that after his appointment at Maastricht University he was willing in the early years of ITC Leiden’s Adv LLM in International Tax Law Program to come to Leiden and teach Art. 15 in the comprehensive Tax Treaties course of that program. In view of the important contribution he made to the ITC’s Adv LLM Program, I would like to devote my contribution to this Festschrift honoring Rainer Prokisch to a brief review of some of the issues involving Art. 15 that stem from its text and structure.
In the section that follows, I will first discuss a simplification of the text of the provisions of Art. 15, which could make the life a little easier for tax treaty teachers that need to explain to novice students of that article a set of rules that seems to have been designed to guarantee that tax treaty science remains reserved for those willing to continuously immerge themselves in one of the unnecessarily complex OECD Model provisions. Below, I will first deal with a simplification of text and structure of Art. 15 and, next, turn my attention to amending some of its rules.
Art. 15 of the OECD Model (along with Art. 7, Art. 8 and Art. 18) belongs to the small group of articles with a distributive rule that fundamentally differs from the rules laid down in the other articles of Chapter III of the OECD Model. It covers a particular category of income without regard to the nexus that the income concerned may have with the source state (in OECD Model terminology: the ‘other state’, hereinafter also referred to as ‘OS’). In this respect these articles differ from, e.g., Art. 6 which covers immovable property income only if the income has a specific nexus with the OS: the immovable property from which the income is derived must be situated in the OS. If the property is located elsewhere, Art. 6 is not applicable. Art. 15 (along with Art.s 7, 8 and 18), on the contrary, covers the pertinent type of income that the OS may want to tax regardless of the nexus a given income item may have with that OS.
Of the articles with which Art. 15 shares this all-nexus feature, Art. 7 (Business profits) stands out as it – similar to Art. 15 but different from the other articles in this small group – provides for an exception to the main rule that the pertinent group of income items may not be taxed in the OS. The exception applies if and to the extent the given income has a particular nexus with the OS. In the case of Art. 15 this nexus is ‘exercising employment in the [OS]’ while Art. 7 provides for a similar nexus: ‘carrying on business activities in the [OS]’.
The two articles provide for distributive rules that are quite similar: they restrict the OS-nexus (‘exercising employment’, ‘carrying on business’) by imposing further conditions. Under Art. 7 for the OS to tax the profits from the business carried on in that state, it is needed that the business is conducted in the other state through a permanent establishment. And Art. 15 requires that the employee who exercises his employment activities in the OS, either spends in that state over 183 days within any 12 months period, or has an employer that is a resident of the OS, or receives a salary that is borne by an OS-located permanent establishment of his employer.
The two-step exception provided for in Art. 7 for OS taxation is drafted in a simple manner and is laid down in the second part of the first sentence of para. 1 of Art. 7:
1. ‘unless the enterprise carries on business in the OS’;
2. ‘through a permanent establishment situated therein’.
If we compare this to Art. 15, it strikes that the text of the additional conditions for this article (in Art. 7: ‘through a permanent establishment situated therein’) is quite comprehensive: rather than being laid down in just an additional part of a sentence, the Art. 15 conditions for OS taxation comprise an entire paragraph (para. 2 of Art. 15):
[1. ‘unless the employment is exercised in the OS’]
2. ‘Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:
a. the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned, and
b. the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State, and
c. the remuneration is not borne by a permanent establishment which the employer has in the other State’.
These Art. 15 conditions for OS taxation are difficult to read as they include a double negative: the OS may not tax if ‘a. … not … and b. … not … and c. not’. The rules in effect state:
[1. unless the employment is exercised in the OS]
2. and all of the following three (negative) conditions are not met:
– the recipient is present in the OS for not more than 183 days in any 12 month period;
– the remuneration is not paid or borne by an employer who is a resident of the OS;
– the remuneration is not borne by an employer’s PE in the OS.
If we would assume that the exception to the Art. 15 main rule were subject only to the first of the three (negative) conditions (i.e., 183 days presence), the text of exception and additional condition could be simplified by replacing in the text of that condition the double negative (the condition that the recipient is present in the OS for not more than 183 days in any 12 month period, is not met) by a single positive:
1. unless the employment is exercised in the OS;
2. and the recipient is present in the OS for more than 183 days in any 12 month period.
Now, as the actual Art. 15 has three (negative) conditions, the other two could similarly be added in a reversed positive phrase as follows (in simplified wording):
2. and the recipient is present in the OS for more than 183 days in any 12 month period or his employer is a resident of that state or carries on business in that state through a PE that bears the remuneration.
In this manner – and returning to the original text of the conditions regarding presence duration and employer’s residence – the contents of the current paragraphs 1 and 2 of Art. 15 can be rephrased as follows (the text is broken up in order to highlight its structure):
‘… salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State, unless the employment is exercised in the other Contracting State and
– the recipient is present in the other State for more than 183 days in any 12 month period commencing or ending in the fiscal year concerned, or
– the remuneration is paid by, or on behalf of, an employer who is a resident of the other State, or
– the remuneration is borne by a permanent establishment which the employer has in the other State’.
In this positive phrasing the meaning and operation of the provision are easier to understand. Still, the text gives rise to various issues. Two of them will be explained and analyzed in the next section.
The adjustment of the structure of Art. 15 as suggested in the preceding paragraph does not deal with issues that are raised by the text of the first two conditions which are laid down in subpara. a (183 days) and subpara. b (employer).
The first of the three alternative conditions reads: ‘The recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in any 12 month period commencing or ending in the fiscal year concerned’.1
The policy reason for introducing a time threshold for the work state (‘WS’) to tax the employment income earned in that state is perfectly understandable. What is incomprehensible is that the requirement refers to the time that the employee is physically present in the WS irrespective whether during that time the employee is engaged in work in the WS or is perhaps spending time there for other reasons. Why would employment income earned during e.g. two months of work in the WS be taxable in that state if the employee happens to have spent in that period e.g. five additional months in the WS for unrelated reasons, whereas the employment income earned in the WS by a similarly situated fellow worker who did not spent such additional five months in that state, is not be taxable there? History does not shed much light on this issue.2 The condition was introduced in the League of Nations model conventions not until the 1943 Mexico and 1946 London Drafts. The model texts refer to the employee being ‘temporarily present within the latter State for a period or periods not exceeding a total of one hundred and eighty three days’. As some of the drafting of League of Nations Model texts is not very precise, it may well be that this phrase was intended to refer to the time spent in the other state for employment. In the absence, however, of any explanation or discussion of the issue in the official documents, this remains mere speculation3. Occasionally, in an actual treaty the employment income provision may expressly require presence in the WS for reasons of employment; see e.g. Art. 14, para. 2(a) of the 2006 treaty between the Republic of Austria and the Czech Republic:4
‘(a) the recipient is employed in the other State for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned’.
It is unclear why it generally would be easier to apply a test employing days of presence rather than days of employment as has occasionally been suggested, since the issues stemming from whether parts of days, days of sickness spent in the WS, etc., should be taken into account, appear to be similar in both approaches. In the absence of substantive arguments that the test should also take into account the work-unrelated days of presence rather than only the days on which employment activities are exercised, it is proposed to amend the condition by restricting the time requirement to days spent in the WS for reasons related to the employment as is done in the treaty provision quoted above. It is therefore suggested to replace the current text of subpara. a by the text quoted above from the Austrian-Czech treaty.
The policy reason for granting a taxing right to the WS in instances where the employer is a resident of the WS is obvious. In such case the salary will typically be borne by that employer, thereby reducing the employer’s taxable profits, for which compensation is offered by the taxation of the salary received by the employee. This ‘compensation’ argument also applies to the third condition (subpara. c: ‘the remuneration is not borne by a permanent establishment which the employer has in the other State’). With regard to that condition, it is noted in sec. 7 of the OECD Commentary on Art. 15 that the WS may tax ‘the remuneration that could give rise to a deduction, having regard to the principles of Article 7 …, in computing the profits of a permanent establishment situated in the State in which the employment is exercised’. While a similar consideration appears to be applicable to the case of a resident employer, the Commentary on para. 2(b) of Art. 15 is silent in this respect. In a 2000 publication by Luc de Broe, et al., on the interpretation of this para. 2(b)5 comprehensive evidence is provided, however, of the same rationale underlying this subparagraph, including a reference to par. 90 of the 1999 OECD Partnership Report.6 On the basis of the foregoing it appears appropriate to replace the current awkward requirement that the remuneration be ‘paid by, or on behalf of’ the employer, by ‘borne by’ the employer.
With regard to the rationale underlying the conditions laid down in para. 2(b) and 2(c) it must be recognized that with respect to the employee’s remuneration the connection between deduction under Art. 7 and taxability under Art. 15 remains imperfect. For deducting under Art. 7 a salary in computing the profits attributable to the PE it suffices that the salary expense is incurred for purposes of the PE (as established under the rules laid down in the Art. 7 Commentary and the 2010 OECD Report on the attribution of profits to permanent establishments), no matter whether the employee performs the pertinent work in the WS or elsewhere. For WS taxation, however, of the pertinent salary to the employee under Art. 15 it is additionally required that the employee has exercised his employment activities in the WS. If the employee has not exercised the pertinent activities in that state, his salary cannot, despite the deduction from the profits in that state under Art. 7, be taxed in that state. An example of a case in which this issue arises involves an employee who is a resident of one treaty state (‘RS’) and works for an employer who as a resident of the other treaty state (WS) carries on business through a PE in a third state (or in the employee’s RS). If the employee is engaged in activities for that PE, the employee’s remuneration expense will be attributed to the PE. In that instance, through the double taxation relief that the employer’s RS will provide in respect of the foreign PE profits, the employee’s salary is borne effectively not by the RS of the employer (i.e. the WS) but by the PE state (the third state, or the employee’s RS). At first sight, this appears to be a correct outcome in a case where it is not the employer’s RS that may tax the salary (as it is not effective borne in that state) but the PE state (as the salary is attributable to the PE). Along this line, as the salary is legally borne by the employer (as an expense incurred by the general enterprise) but not effectively borne, it would appear appropriate to provide for an exception to the rule of para. 2(b): no taxing right for the WS if the salary is not ‘effectively’ borne in that WS. At closer examination, however, it is clear that the PE state, while bearing the salary expense, will not be able to tax the salary under the rules of Art. 15 of its treaty with the employee’s residence state (RS) since the nexus requirement of para. 1 that the employment is exercised in the OS is not met. As the PE state (while bearing the salary expense) cannot tax the salary, the employer’s residence state WS (while not effectively bearing the expense of the salary) should not be barred from taxing it. These considerations lead me to suggesting not to follow the proposal made by Luc de Broe, et al., to replace in para. 2(b) the words ’paid by, or on behalf of,’ by ‘borne by’.7 Instead, I would propose to remove the reference to the remuneration and require only that the employer is a resident of the WS.
Based on the foregoing it is proposed to replace the text of para.s 2(b) and 2(c) of Art. 15 by the following combined text:
‘the employer is a resident of the other State or carries on business in the other State through a permanent establishment that bears the remuneration’.
If this text is combined with the other parts of the existing text of Art. 15, the overall text proposed to replace the current text of para.s 1 and 2 of Art. 15 will read:
‘Subject to …, … remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State and the recipient is present in the other State for more than 183 days in any twelve month period commencing or ending in the fiscal year concerned, or the employer is a resident of the other State or carries on business in the other State through a permanent establishment that bears the remuneration. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in the other State.’
A few years ago I wrote in a Festschrift: ‘An author interested in issues that involve the structure, contents and operation of the OECD Model should not write on those issues with the aim – or hope – to have the OECD’s Committee of Fiscal Affairs study the suggestions made, approve them and incorporate them in an update of the Model and Commentary. Although it happens (see, e.g., John F. Avery Jones et al., Credit and Exemption under Tax Treaties in cases of Differing Income Categorisation, 36 European Taxation 118;  BTR 212, suggesting the `better´ interpretation of Art. 23A, para. 1, to be subscribed to by the OECD), it does not happen often. An author should write on such issues because it satisfies his desire to see whether existing rules can be made less complex without affecting their efficiency. It is a bit like mathematics: finding a clean, clever and compact solution to a problem that was not solved earlier or only in a complicated manner, gives intellectual joy, similar to esthetic and sensual joys, which may enrich an individual’s life. And that may be one reason why the practice of contributing to a Festschrift continues in this day and age where people seem to have less and less time’.8
Having said that, I trust that the adoption by the OECD of the changes that I propose for Art. 15 text will provide Rainer with an ample opportunity to update his Art. 15 commentary in the Vogel/Lehner book and thereby smoothen the transition from an active professorship to a well-earned Ruhestand.