Taxation rights slipping through the cracks: How developing countries can get a better deal on their tax treaties

Tax treaties prescribe how countries can tax cross-border activities between the treaty partners. In the overwhelming majority of cases, they are outdated and unfair. In the form that they commonly take (following the OECD model) tax treaties are bad for developing countries because they:

• give multinational corporations a legal means to avoid or dramatically reduce tax through treaty shopping;
• are inequitable – they carve up taxing rights and generally impose more limitations on the taxing rights of developing countries than on the taxing rights of developed countries. This results in reduced developing country revenue; and
• limit the ability of developing countries to collect tax by setting maximum tax rates, narrowing the scope of taxable earnings and limiting the sovereign discretion to increase taxes.

Tax treaties are squeezing the taxing rights of developing countries and impairing their ability to collect revenue urgently needed to fund essential services, infrastructure, development goals and the promotion of women’s rights.

It is often said that tax treaties will stimulate increased foreign investment and will therefore be a net positive to a nation’s economy. The available evidence suggests however that any benefits which tax treaties might bring cannot be assumed. Tax treaties always have costs and as a result should be approached with extreme caution, particularly by developing countries.

Developing country governments have the power to close the tax loopholes created by tax treaties and stop the inequity. Some countries are re-evaluating the strength of their negotiating hand; for example Uganda, Nigeria, Rwanda, South Africa and Mongolia have either cancelled or renegotiated treaties or suspended negotiation of new treaties until a clear negotiating position is developed.

This briefing calls upon states to adopt a sceptical and evidence based approach to tax treaties which considers their development impacts and their distributional (equity) impacts. Both developed and developing countries have a responsibility to make tax treaties fairer.