TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, November 16, 2018

Weekly SSRN Tax Article Review And Roundup: Speck Reviews Shaheen's Income Tax Treaty Aspects Of Nonincome Taxes

This week, Sloan Speck (Colorado) reviews a new work by Fadi Shaheen (Rutgers), Income Tax Treaty Aspects of Nonincome Taxes: The Importance of Residence, 71 Tax L. Rev. 583 (2018).

Speck (2017)In Income Tax Treaty Aspects of Nonincome Taxes: The Importance of Residence, Fadi Shaheen argues that, in any transition from an income tax to a nonincome tax, a critical gating consideration is how that nonincome tax interplays with the concept of residence in bilateral tax treaties based on the U.S. and OECD models. In defining the scope of nonincome taxes, Shaheen lists the usual suspects—consumption and cash flow taxes such as VATs, the flat tax, and the DBCFT—as well as newer varieties, such as equalization and turnover taxes on digital transactions. One of Shaheen’s important insights is that a person’s tax residence, a primary criterion to claim treaty benefits, depends on the taxes to which that person is subject. For a newly introduced nonincome tax, the problem is larger than just whether the treaty applies to the tax instrument. Instead, the issue is that the nonincome tax may preclude persons in the relevant contracting state from claiming any treaty benefits at all. In this sense, nonincome taxes may trigger tax treaty Armageddon, rather than some milder form of dislocation that is cabined to the nonincome tax’s direct reach.

Shaheen’s focus on residence highlights two problems with nonincome taxes under the current tax treaty framework. For this purpose, imagine that the United States, say, replaces the corporate income tax with a DBCFT. First, if the DBCFT isn’t a “covered” tax (that is, a tax to which existing U.S. tax treaties apply), then domestic corporations arguably lose all treaty benefits, since they no longer are liable to pay a covered tax in the United States—and thus nonresidents under the treaty. Others contend that a U.S. DBCFT would stymie inbound investment by jeopardizing foreign companies’ ability to claim credits in their home countries for U.S. taxes paid. Shaheen radically expands the stakes by showing that a DBCFT also could cause U.S. companies to lose all of the exemptions and preferred rates that flow from bilateral tax treaties. Second, if the DBCFT is a covered tax, the consequences are potentially worse, from a U.S. perspective. Foreign companies still would be able to claim benefits under the relevant treaty, but U.S. companies (again) might lose all treaty benefits. Because the DBCFT treats U.S. residents and nonresidents the same (under, more or less, a tax base of domestic consumption minus wages), U.S. residents no longer would be subject to U.S. tax by reason of their residence. Under this argument, the DBCFT creates a fundamental disparity in taxation that disadvantages U.S. companies. Shaheen further considers the use of nominal taxes to invoke treaty application (they don’t work) and the significance of residence in whether treaties “cover” nonincome tax (it is, and—unsurprisingly—it’s complicated).

In a fundamental sense, Shaheen’s article tells a legal story, rather than one focused on administration or politics or policy. His interpretations and applications of treaty text are well-supported and nuanced. But Shaheen’s position is just that, and one could imagine a countervailing narrative that resolves enough of the legal issues differently to salvage the existing tax treaty framework in the face of novel tax instruments. Indeed, savvy policymakers may hire clever lawyers to draft rules that (purport to) alleviate the issues Shaheen raises. Furthermore, Shaheen acknowledges that his problems could be avoided altogether by retaining a complementary income tax in any reform effort that added a nonincome instrument. From this perspective, Shaheen’s article is a cautionary tale, rather than a preclusive one.

The legal story also tends to marginalize other considerations that might have more practical importance in the process of implementing a new nonincome tax. For example, contracting states would need to actually assert (and defend) Shaheen’s legal arguments to deny treaty benefits to specific persons or classes of persons. While some countries might do so, others could relax their rules pending treaty renegotiation or simply ratify the new tax’s pedigree under the existing treaty. The risks identified by Shaheen depend substantially on the pattern of enforcement by other countries, and more could be said about how these political issues might unfold—especially in light of the Trump Administration’s rhetoric about nationalism, protectionism, and bilateralism in treaty negotiations, which seems likely to persist beyond the legislative gridlock that almost certainly will characterize the next two years.

Finally, Shaheen’s nods to normative concerns left me wanting more explicit connections to broader policy debates about corporate residence on the conceptual level. Shaheen presents compelling evidence that residence poses a potential roadblock to reform, but it’s less transparent whether he believes that this barrier should exist. Admittedly, this second point isn’t really germane to his article’s main thrust, but an answer could inform conversations about whether the current tax treaty network is outmoded or inadequate after roughly a century of use. At the very least, Shaheen’s work implies that some additional nimbleness is needed.

In conclusion, Shaheen’s article illuminates an unrecognized and potentially explosive issue in international tax reform. Policymakers and practitioners, as well as academics interested in both international and domestic taxation, should take note of his technical and informative arguments as they consider the effects of proposed changes in law.

Here’s the rest of this week’s SSRN Tax Roundup:

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