Thursday, November 03, 2005

Has the issue of “Tax Treaty Override” been exaggerated?

In its report “Tax Treaty Override”, adopted by the OECD Council on 2 October 1989, the OECD clearly stated that “the tendency in certain States for domestic legislation to be passed or proposed which may override provisions of tax treaties” implies a loosening of the principle “pacta sunt servanda”, in other words, that treaty override is a breach of international law. “Under international law treaties have to be observed by the parties as long as they are valid, and unless they have been formally denounced. Domestic legislation (whether subsequent to signature or otherwise) or other reasons in no way affect the continuing existence of that international obligation.”

As suggestions for action the OECD strongly urged Member countries to avoid any legislation, which would constitute a treaty override. Accordingly, the motive for enacting legislation that overrides treaties can be less strong if all countries agree that they will promptly undertake bilateral or multilateral consultations to address problems connected with treaty provisions, whether arising in their own country or raised by countries with which they have tax treaties. OECD Working Party No. I of the Committee on Fiscal Affairs is an appropriate forum for facilitating such consultation. In that context, in 1989 the OECD Committee stated that it intended to follow developments closely in domestic legislation of Member countries and publicly and forcefully to condemn any action which would constitute a breach of international obligations, including bringing such situations to the attention of the OECD Council (did it?).

This small introduction helps to frame the most recent paper by the distinguished US scholar R. Avi-Yonah on "Tax Treaty Overrides: A Qualified Defense of US Practice"

According to Prof. Avi-Yonah, “the ability of some countries to unilaterally change, or "override," their tax treaties through domestic legislation has frequently been identified as a serious threat to the bilateral tax treaty network. In most countries, treaties (including tax treaties) have a status superior to that of ordinary domestic laws. However, in some countries (primarily the U.S., but also to some extent the U.K. and Australia) treaties can be changed unilaterally by subsequent domestic legislation. This result clearly violates international law. However, since in the same countries courts are likely to follow domestic law even if it violates international law, both taxpayers and the other treaty partner have little practical recourse in the case of a treaty override beyond terminating the treaty, which is an extreme and rarely taken step. Therefore, the OECD in 1989 issued a report urging member countries to refrain from treaty overrides.

The paper of Prof. Avi-Yonah argues that the seriousness of the treaty override issue has been exaggerated. Accordingly, "in practice, most countries, including the U.S. (which was clearly the target of the OECD Report) rarely override treaties, and when they do, in most cases the override can be justified as consistent with the underlying purposes of the relevant treaty. Moreover, treaty overrides can sometimes be an important tool in combating tax treaty abuse. Thus, I believe that if used correctly, treaty overrides can be a helpful feature of the international tax regime, albeit one that should be used sparingly and with caution."


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