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States should embrace technology to address tax treaty obstacles

Dany Teillant and Julien Metz of Deloitte Luxembourg explain the importance of digitalisation for tax authorities as they face increasing challenges in relation to the application and implementation of tax treaties.

Can technology assist with the complex issue of tax treaty application?

Taxation must keep abreast of economic developments, including states’ tax laws and tax treaties, which are subject to regular adjustments.

While the digital transformation of economies and the acceleration of dematerialised exchanges exacerbate certain difficulties in applying tax treaties, it could also create tools that facilitate exchanges between a tax treaty’s parties and administrations.

Which procedural obstacles exist in applying tax treaties and how can technology overcome them?

Tax treaties based on the OECD Model Convention include provisions for mutual agreement procedures between states to resolve procedural obstacles, such as provisions on information exchange and recovery assistance. However, these provisions hold each state’s competent authority responsible, by mutual agreement, for resolving interpretation or application issues.

In this respect, competent authorities may communicate directly with each other and exchange information without having to use diplomatic channels. However, this creates administrative burdens and a mutual agreement procedure can last up to three years, a period that no longer seems adapted to certain economic models or activity sectors.

Similarly, each state's taxation method (tax system or withholding tax) affects the application of a tax treaty.

In this context, a digital platform with secure access, with one part reserved for correspondence between competent authorities and another part for correspondence between the state and taxpayers, would speed up communication and document-sharing between the different parties. Also, digitalising and automating certain procedural aspects (via ‘block-chain’ type models) could also simplify and secure tax treaty implementation.

Could some fundamental problems of implementing tax treaties be solved digitally?

Several fundamental problems stand in the way of a simple and effective tax treaty implementation. For example, each state’s determination of who is eligible for treaty benefits, the tax residence and/or the tax liability of that person, and the definition and qualification of the income and its link with the person may all differ, complicating the tax treaty’s application.

While the digital revolution would not completely solve these fundamental problems, a database platform shared by competent authorities, which centralises the information and definitions specific to each state, would help the classification of persons (e.g. transparent or opaque, undertakings for collective investment (UCI)) and income.

How will this digitalisation impact competent authorities’ organisational structures?

The administrative organisation of each state’s competent authorities and their lack of digital maturity can slow down and obstruct a tax treaty’s implementation. Moreover, assistance between states can be costly and, according to the usual practice, ordinary expenses incurred by a state in providing assistance to the other state will not be reimbursed by the other state. This is also true for taxpayers.

However, the use of technological tools by tax treaty parties should partially resolve states’ and taxpayers’ organisational problems. Secure databases and digital platforms could reduce costs by limiting the need for specialised human resources, which are rare in times of budgetary restraint.

How willing are states to implement proper digitalisation?

Due to the development of international investments, the complexity of international investment structures, and the difficulties in applying tax treaties to this sector, the OECD drafted the Treaty Relief and Compliance Enhancement (TRACE) initiative in 2013. TRACE aims to simplify the application of treaty benefits on dividends and interest on securities held by financial intermediaries.

On February 25 2020, the OECD published the TRACE XML Schema User Guide, providing guidance on the standardised electronic format for financial institutions to report TRACE-related information to tax administrations and for tax administrations to exchange information. The OECD also published an XML Scheme and User Guide for tax authorities to provide structured feedback to senders on errors regarding tax information exchanged through the common transmission system (CTS).

However, since its launch, the TRACE initiative has not met with the support expected from governments. While states have implemented other projects relating to the automatic exchange of information, such as the OECD’s common reporting standard or the US’s Foreign Account Tax Compliance Act (FATCA), they have shown some protectionism regarding their tax procedures. In addition, states may have misunderstood the benefits of TRACE, reducing their motivation to rapidly implement the initiative.

The age of digitalisation in tax matters and, more specifically, international taxation is only in its infancy. Its rapid development should enable taxpayers to benefit from the advantages of tax treaties in a more efficient and less costly way, while preserving and increasing the control of tax authorities over a growing number of international transactions, as well as the appetite of new generations of economic and financial operators.

Dany Teillant
T: +352 45145 2246

Julien Metz
T: +352 45145 3604

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