TAX treaties are usually signed between two countries to principally facilitate international trade and commerce to achieve tax neutrality without taxation becoming an impediment. Until recently, the major objectives of tax treaties were avoidance of double taxation on the same income in different countries, allocation of taxing rights to each of the respective countries, exchange of information between countries, assisting in the fight against fraud and tax evasion, and facilitating investment.

Domestic tax laws of the countries in which international businesses operate can create conflicts in the taxation on income or capital. Whenever such conflicts occur, the tax treaties are extremely useful to provide businesses guidance on resolving these disputes.

In the event the specific treaty provisions cannot resolve the problems, there is an overriding provision in most treaties that allows the relevant countries to invoke dispute resolution measures such as Mutual Agreement Procedures where the government authorities of the countries in dispute will meet with one-another to negotiate a settlement. In the case of the European Union, if a dispute cannot be resolved between the countries involved, the parties concerned have to resort to arbitration.

What is the Current Scene?

Originally, tax treaties were intended to avoid double taxation for businesses operating across borders. However, many big multinationals have taken advantage of the treaties to avoid paying taxes as part of a larger scheme of things. The most common example would be treaty shopping, whereby companies would form shell companies in intermediate countries where they do not have any substance or presence but using the intermediate country as a conduit to merely flow through transactions to leverage off the treaty benefits such as lower withholding taxes, exemption from income, or lower tax rates.

Big multinationals have large resources to plan their taxes such that they avoid paying taxes anywhere in the world or pay extremely minimal taxes in relation to their large revenues. This is called “double non-taxation”.

Large companies would be trading internationally but would argue that they have either no presence or insignificant presence in the countries they operate, and they would legally park their income in tax havens, in countries where the taxation regime is lax, or in countries where the tax rates are very low.

What is the Counteroffensive?

In 2015, the Organisation for Economic Cooperation and Development member countries came up with 15 action points to minimise tax avoidance. These measures were intended as a counteroffensive to preventing double non-taxation. To implement many of these action points, the tax treaties had to be bilaterally amended. This was too troublesome and time consuming because hundreds of treaties across the world needed to be amended to implement these 15 action points quickly.

To solve this problem, 102 countries in January 2024 agreed to come on board to sign a single instrument called the Multilateral Instrument (MLI) which automatically supplements their tax treaties among themselves, subject to certain reservations expressed by each of the parties.

What to Watch Out For

When any taxpayer is looking for guidance for avoidance of double taxation or double non-taxation, you need to look at the MLI that Malaysia has signed on together with the tax treaty. It is important to read the protocols and annexures to ensure that you are using the tax treaty properly.

Only tax residents of the respective countries can use the tax treaties. When there are conflicts between the domestic legislation and the tax treaty, the provisions under the tax treaty will override the domestic legislation.

This article is contributed by Thannees Tax Consulting Services Sdn Bhd managing director SM Thanneermalai (www.thannees.com).

The article was first published here.

Photo by Nataliya Vaitkevich.