Double taxation treaties are used to remove the barriers that would arise if these treaties did not exist. What do I mean? We distinguish between limited and unlimited tax liability. A taxpayer who is resident in a given country is subject to an unlimited tax liability in that country, i.e. taxation on his total, global and worldwide income. However, there is also a limited tax liability. If you are not a resident of a particular country, but you earn income within its territory, that country is also entitled to levy taxes under its limited tax liability. And now you see, if in the regulations of many different countries there is both unlimited and limited tax liability, it results in the fact that if someone is a resident of one country and gets income from another country, then for this foreign income the tax authorities of 2 countries extend their hands and say, pay us taxes. But it is not at all an intention to limit the international transactions. That is why conventions have been created historically to avoid double taxation, that is, precisely to attribute to a certain country the tax competence to tax a certain cross-border event, to try to eliminate this double taxation or, at least, mitigate it.
Therefore, such agreements are concluded to avoid double taxation, which are usually bilateral agreements, in the case of Poland these are always bilateral agreements, for either Poland and Germany, Poland and France, Poland and Russia, etc. On the other hand, there are multilateral agreements between various parties in the world. But this is not a Polish practice of treaties. The information is that there are several basic templates of this type to create double taxation treaties. The most popular template is the OECD Organization template. We as Poland are a member of the OECD and for this reason we mainly use this template. There are also other templates from individual countries, for example, the United States also has its own template and is such a strong economy that it is able to impose agreements on other countries, based on its own template. The agreements in terms of their structure are usually very similar, but in terms of content they can differ significantly. And you should always search in this particular treaty and not rely on your knowledge. Poland has more than 90 agreements. As you can see, we don’t have an agreement with every country in the world.
The taxpayer must be a tax resident of one of these 2 contracting states. Double taxation treaties refer to income taxes, for example, they do not apply to VAT, they do not apply to inheritance and gift tax. The term company is usually understood as a legal person or an entity treated as a legal person. Only those companies that are treated as a legal entity for tax purposes.
The fourth article defines how to determine residence. It is a place of residence or registered office. The conflict of laws rule will allow us to resolve cases of dual residence. The fifth article defines the forms of occurrence of the so-called permanent establishments, that is, those legally independent parts of the company that are located abroad outside the country of registered office. There are various forms of establishments, in the form of an office, in the form of a construction or assembly, or in the form of a dependent agent, but sometimes in unusual treaties, for example, in the treaty with the Czech Republic, there is also a fourth type of an establishment in the form of a continuous provision of services without having a permanent installation. Reading further the double taxation treaties, the following articles deal with different types of income.
However, of course, we must remember that double taxation treaties were concluded at very different moments and the model of the OECD, this model convention looked different in the 1970s than today.
We come to the most important part of the agreement: the methods to avoid double taxation. If the article of the agreement relating to a specific type of income shows that both countries still retain the tax competence to tax this income, then these methods are supposed to mitigate the double taxation. The country of residence uses the tax credit method (reducing the tax to the extent that the taxable income has been taxed in another State) or the progression-based exemption method (ceasing to tax certain income). Now, which method to use? It does not depend on the will of the taxpayer. This is always written in contracts.
There is salso another interesting article. It refers to an arbitration procedure, i.e. a mutually agreed procedure that can be initiated by the taxpayers if they see that their case is treated differently by the 2 countries concerned.
Protocol to a Double taxation treaty
After some time it may turn out that countries may want to terminate the old treaty and sign a completely new one. And that’s how it’s often done. However they can also say: let’s leave this old treaty, but let’s conclude an additional protocol, that will change certain provisions, certain rules. Subsequently, protocols are concluded for some treaties. Therefore you always have to check: were there no additional protocols later? These protocols can change the wording of the double taxation treaties.
MLI – Multilateral convention to implement treaty-related measures to prevent base erosion and profit shifting
The Multilateral convention to implement treaty-related measures to prevent base erosion and profit shifting, of 24 November 2016, is known as “MLI”. The MLI Convention does not function as a protocol for a treaty. It does not change the wording of the legal text of double taxation treaties. It is a completely different legal act, a different international treaty. That Convention MLI applies to specific treaties, the wording of these treaties does not change. It works alongside.
Practical example: double taxation of the same income in two countries
I’d like to explain it with the use of an example for which several Polish companies have already paid a lot. I’d also like to make you aware of the fact that it is better not to delegate abroad people who are employed in Poland under civil law contracts. I will explain why. Let’s assume there is one person employed in Poland and is sent to work abroad. Supposedly, he is still a Polish resident. He will work abroad and now the question arises: under what item does this type of income belong? Well, if it were an employment contract there would be no doubt, right? In the double tax treaties there is an article 15: Dependent personal services. However, there is also an article on the independent personal services. Poland will believe that this person’s work is an activity carried out personally and independently, a mandate contract. In the national regulations, mandate contracts, unless they are part of the business activity of the person accepting the mandate, are treated as income from the activity of personal fulfilment. Poland assumes, that in relation to the double taxation treaties, also the article should apply which regards the professions and activities carried out personally or independently. That’s the Polish position. What happens sometimes, and I didn’t invent this case out of thin air, only a few Polish companies have already stumbled upon this, is that there’s a tax control in the other country, and the tax inspectors discover that person sent to work in that country and they start investigating the situation, and they see that the person is employed under a mandate contract, but they have a different approach. They say: wait a minute, this person works like under the employment contract. Due to the content of an agreement, they will summarize it up to Article 15 Dependent personal services. A problem arises, which results from a different classification of the same income by 2 countries to different sources of income. Poland will persist: for activity carried out personally, basically, this income is only taxable in the country of residence. Unless, of course, the one who performs independent work in this other country has a fixed base through which he performs this activity. Well, such a delegated contractor won’t have that fixed base as a rule, and he will not have anyone with whom he does this activity. Therefore, Poland will insist that this is taxed only in Poland. On the other hand, that country will say, wait a minute, salaried work is completely different and usually allows this income to be taxed in the country where the work is done and where this person is located. There’s an exception called a delegation clause. This is a provision of Article 15, which says that there are 3 conditions that must be met together, and even if this person is working abroad, in the latter country, however, is only taxable in the country of residence, which is a special exception, but normally Article 15 says that the country of work is the actual stay during the performance of the work.
And here you probably already know what I’m aiming for. None of the countries wants to deviate from their analysis and all that remains is to pay taxes here and here, or a procedure of mutual agreement must be initiated, but we don’t know when it will end. This is what I wanted to tell you: be careful not to delegate people abroad with mandate contracts.
