Indiana Law Review


Indiana Laiv Revie^i^
Volume 12 1979 Number 2

Double Taxation/Fiscal Evasion and International Tax
Treaties

Oscar M. Trelles, II*

I. Introduction

Taxation in its original concept was free from international
complications. Taxes were imposed against land, ignoring questions

of sovereign disputes of ownership, and were collected by only one

sovereign, against land under his rule or jurisdiction.

As the basis for taxation has changed and centered on the per-
son rather than the land, problems of dual tax liability as well as

fiscal evasion have increasingly become, inter alia, a troublesome

aspect of the tax administrative process. An individual or other
legal entity residing or doing business in a foreign area is subjected

to possible tax liability by both the foreign state and the home coun-
try. At the same time, the state is hindered in its attempt to collect
a tax if a person is able to leave the jurisdiction with all his assets

while intending never to return. This Article will deal with these

two problems; and, specifically, with the solutions attempted
through international agreements.

Basically, the reason for turning to international agreements in

extending the reach of a state's fiscal system is that, as Lord

Mansfield stated: "[0]ne nation does not take notice of the revenue

laws of another" (the "notice" doctrine).^ This barrier to an alien tax

authority is so well established that it is categorized as one of the

fundamental rules of international law.^ Its proponents have stressed

the analogy to criminal law, whereby any imposition is deemed an
attack on a state's sovereignty.^ It is further contended that

unilateral provisions can best handle the problem of double taxation,

and that allowing foreign jurisdiction in evasion cases may place the
court in the embarrassing position of either applying or striking

down a tax considered to be contrary to public policy.* Opponents of

*B.A., Institute de Matanzas (Cuba), 1957; Licenciado en Derecho Diplomatico,
University of Havana, 1962; M.A.L.S., University of Toledo (Ohio), 1975.

Tlanche v. Fletcher, 99 Eng. Rep. 164, 165 (K.B. 1779).
'^Leflar, Extrastate Enforcement of Penal and Governmental Claims, 46 Harv. L.

Rev. 193, 215-23 (1932).

Ud. at 219.

*Moore v. Mitchell, 30 F.2d 600, 604 (2d Cir. 1929) (Hand, J., concurring).



342 INDIANA LAW REVIEW [Vol. 12:341

this ancient doctrine have asserted that no analogy can be made be-
tween criminal and tax law because criminal laws are punitive,

whereas taxes are imposed as a social obligation.^ They argue that
unilateral solutions to double taxation are collateral and cause as

many problems as they attempt to solve/ Lastly, opponents ask
balancing of the stigma of striking down a foreign law against the
stigma of affording delinquent taxpayers sanctuary.^ Regardless of

the arguments, the question is whether the "notice" doctrine is

merely judicial tradition without substance or a meaningful and

necessary rule of international law. If it is the former, then treaty

activity would seem a necessary solution.
This Article will analyze the problem in three sections: It will

discuss the relevance and advisability of including both areas of tax

administration, ie., double taxation and tax evasion, in the same
treaty negotiations and documents, and then will examine these two
areas separately, analyzing the special microcosm of considerations

imposed by each.

II. Advisability of Coordinating Double Taxation and Fiscal
Evasion Proposals

While still in their infancy, international tax conferences created

awareness of the need to consider the two basic problems of tax

negotiations within the same basic framework. The best demonstra-
tion of the validity of this conclusion comes from the first attempt of

the League of Nations at tax negotiations in 1920 to the resulting
treaties of 1939 to 1946.«

A. Work of the League of Nations and Development
of the O.E.C.D.'

Shortly after the International Financial Conference of 1920, a

recommendation was made to the League of Nations that it consider
the question of double taxation. The International Economic Con-
ference, which had met in 1922, recommended that the League also
examine the problem of fiscal evasion. This latter task, investigating
the question of fiscal evasion, was entrusted to a group of high of-

^See Eichel, Administrative Aspects of the Prevention and Control of Inter-

national Tax Evasion, 20 U. Miami L. Rev. 25, 71-73 (1965).
"Leflar, supra note 2, at 221.

^Eichel, supra note 5, at 72-73.

"See King, Fiscal Cooperation in Tax Treaties, 26 Taxes 889 (1948).
'This discussion is based on an analysis of King, supra note 8, at 889; and of A.

Van Den Tempel, Relief from Double Taxation 7-24 (International Bureau of Fiscal
Documentation, Developments in Taxation Since World War I No. 7, 1967); as well as
reference to certain League of Nations and O.E.C.D. reports as cited below.



1979] INTERNATIONAL TAXATION 343

ficials from the fiscal administrations of seven European countries,

the Committee of Technical Experts. On the basis of resolutions sub-
mitted in 1925 to the League's Financial Committee/" the League

Committee soon submitted to the Council of the League a report
containing four model bilateral conventions." The first model con-
vention pertained to the elimination of double income taxation, the

second to the elimination of double succession duties, the third to

the exchange of information, and the fourth to reciprocal assistance

in the collection of taxes. By 1928, the models had been circulated to
the various governments, and in October 1928, the models were
discussed and revised. Pursuant to a request that a permanent com-
mittee be formed, the Council of the League named a Fiscal Commit-
tee^^ which: (1) Drafted a model convention on allocation of business

profits,^^ and (2) revised the model conventions of 1928, incorporating

the 1932 draft.^*

Until the formulation of these two model conventions, the vast
majority of taxation treaties were deficient in most areas, and
unable to be reconciled with other treaties. The promulgation of the
Mexico and London models brought some semblance of uniformity to
the bilateral conventions executed in the post-war period, but there

still were a large number of differences in the provisions of existing
treaties,^^ resulting in considerable uncertainty for taxpayers doing

business in foreign countries. This impediment to international com-

^°Report and Resolutions Submitted by the Technical Experts to the Financial

Committee of the League of Nations, L.N. Doc. No. F. 212, 10-30 (1925) [hereinafter

cited as L.N. 1925].

^^Report Presented to the Financial Committee of the League of Nations by the

Committee of Technical Experts on Double Taxation and Tax Evasion, L.N. Doc. No.

C. 216. M. 85., 5 (1927) [hereinafter cited as L.N. 1927].

^^See Resolutions Adopted by the Council at its Fifty-Third Session, L.N. Doc.

No. C. 613. M. 190. (1928).

^'The convention was drafted after an inquiry in many countries, the results of

which were published in 1932-1933. Taxation of Foreign and National Enterprises: 1,

France, Germany, Spain, the United Kingdom, and the United States of America, L.N.

Doc. No. C. 73. M. 38. (1932); Taxation of Foreign and National Enterprises: 2, Austria,

Belgium, Czechoslovakia, Free City of Danzig, Greece, Hungary, Italy, Latvia, Luxem-

burg, Netherlands, Roumania, and Switzerland, L.N. Doc. No. C. 425, M. 217. (1933);

Taxation of Foreign and National Enterprises: 3, British India, Canada, Japan, Mex-

ico, Netherlands, Indies, Union of South Africa, States of Massachusetts, New York,
and Wisconsin, L.N. Doc. No. C. 425(a). M. 217(2). (1933), discussed in Carroll, Interna-

tional Tax Law; Benefits for American Investors and Enterprises Abroad, 2 INTL

Law. 692, 703 n.20 (1967-1968).

^*The model conventions of London were published together with the models

established during the war by a group of members of the League of Nations meeting

in Mexico. These latter models came to be referred to as the Mexico City Convention

(1943) and the London Convention (1946). Carroll, supra note 13, at 707.

^^A. Van Den Tempel, supra note 9, at 13.



344 INDIANA LA W REVIEW [Vol. 12:341

mercial transactions prompted the creation of the Fiscal Committee
of the Organization for European Economic Cooperation (O.E.E.C.)

by the O.E.E.C. Council in 1956 to study fiscal questions relating to

double taxation and tax collection.^®

The committee initially took as a major objective that of draft-
ing a series of treaty articles which could be used as a model

bilateral convention with the hope that the adoption of these articles

by a large number of countries would eventually lead to the adop-
tion of a single multilateral convention.^^ When the Organization for
Economic Co-operation and Development Fiscal Committee
(O.E.C.D.) was formed with members from the O.E.E.C. countries,
plus the United States and Canada,^® the Fiscal Committee continued

and, in 1963, completed the report on the Draft Double Taxation

Convention. This report was the culmination of the study reports
issued in 1958, 1959, 1960, and 1961. It brought together in one

publication the basic materials contained in these reports and the

complete text of the Draft Double Taxation Convention.^^ The Fiscal
Committee and its successor, the Committee on Fiscal Affairs, met
regularly and issued a number of other study reports relating to the
problems of double taxation and tax enforcement.^" More significantly,
the committee has recently completed its Model Double Taxation
Convention on Income and on Capital.^^

B. Coordination of Treaty Provisions

In determining the most effective approach towards interna-

tional agreements a decision must be made as to whether the collec-

^^Organization for Economic Cooperation and Development Fiscal Committee,

Report, Draft Double Taxation Convention 7 (1963) [hereinafter cited as O.E.C.D.

Report]. The outstanding work carried out by the League of Nations against double

taxation over a 25-year period (1921-1946) was resumed in 1956 with the creation of the

Fiscal Committee of the O.E.E.C. (later O.E.C.D.). Although the League had hoped for

the Fiscal Committee of the United Nations to continue its efforts on the subject, this

Committee did not produce much at all in regard to the drafting of model conventions
during its short existence.

^'O.E.C.D. Report, supra note 16, at 10.

"A. Van Den Tempel. supra note 9, at 11.
^''O.E.C.D. Report, supra note 16, at 41-58.

^E.g., Committee on Fiscal Affairs, O.E.C.D., The Treatment of Family Units
IN O.E.C.D. Member Countries under Tax and Transfer Systems (1977); Committee
ON Fiscal Affairs, O.E.C.D., The Tax/Benefit Position of Selected Income Groups
IN O.E.C.D. Member Countries, 1972-1976 (1978); Fiscal Committee, O.E.C.D., Fiscal
Incentives for Private Investment in Developing Countries (1965); Committee on

Fiscal Affairs, O.E.C.D., The Taxation of Collective Investment Institutions
(1978).

"Committee on Fiscal Affairs. O.E.C.D., Model Double Taxation Convention
ON Income and on Capital (rev. ed. 1977) [hereinafter cited as O.E.C.D. Model
Treaty].



1979] INTERNATIONAL TAXATION 345

tion provisions should be made an integral part of a comprehensive
treaty which contains the substantive provisions concerned with the
problem of double taxation, or whether these provisions should be
considered as separate and distinct treaties. The following is a list
of the considerations, for the most part suggested by the League's
work, necessary in deciding whether to correlate and, if so, how to
correlate the problems of double taxation and collection.

1. Both problems are responsive to the concerns of the tax-

payers and governments ^r^^;oZ^;ed — Although it might first be said
that this close relationship between double taxation and fiscal eva-
sion weighs on the side of the more comprehensive treatment, the
Committee of Experts reasoned:

Taxpayers, alarmed by proposals for fiscal control do not

understand why, before or during the framing of measures

which may prove embarrassing to them. States do not come
to some agreement in order suitably to define their respec-
tive jurisdictions as regards taxation, and to avoid taxation.

On the other hand, if States, in concluding agreements to
avoid double taxation, are given to make sacrifices in the
matter of the yield from taxation, owing to the granting of

exemption, or relief, or reduction of the rates of their taxes,

etc., they may properly endeavor to find compensation for
what they thus surrender in measures against tax evasion.^^

Thus, the greater the administrative reach, the more concern
with double taxation by the taxpayer; the greater the relief from

double taxation, the greater the desire of government to extend its
administrative reach. This conflict between the two is best reconciled,
it would seem, by dealing with double taxation and fiscal evasion

together.

2. Having a thorough knowledge of the other country's tax
system is necessary in working with both problems. — Opponents of
these collection measures have complained that not enough is known
about the foreign tax system to which one government measures
part of its collection process.^^ In working out the substantive provi-

sions on double taxation, each country must, of necessity, study in

some detail the tax system of the other. Thus, collection provisions
emerging from an informative exchange between the taxing

authorities become less amenable to attack on the basis of a lack of
knowledge of the foreign taxing system.

^L.N 1925, supra note 10, at 27.
^^See Report to the Council on the Work of the Eighth Session of the Fiscal Com-

mittee, L.N. Doc. No. C. 384. m. 229., 1-2 (1938).



346 INDIANA LAW REVIEW [Vol. 12:341

3. Both problems contain equitable concerns. — The League's
Committee of Technical Experts saw the connection as mainly a
moral one.^* The League considered the goal of both types of provi-
sions to be the equitable distribution of tax burdens between tax-
payers and governments. Therefore, separate treatment, allowing

the possibility of a one-sided approach, would lessen the chances of
achieving this goal. Stated in another way, the problem could have

been viewed as achieving an equitable distribution of tax burdens

and revenues. The most complete means towards equitable results
calls for both the prevention of fiscal evasion and relief from double

taxation.

4. A causal relationship exists between the two problems.—
Notions expressed by the League as to the causal effect the two
problems might have on each other support the side of the two-

pronged, single-treaty approach.^^ There were three aspects to this
causal connection. First, the decrease in double taxation caused a

decrease in fiscal evasion:

Double taxation, which affects many undertakings and per-
sons who exercise their trade or profession in several coun-
tries, or derive their income from countries other than the

one in which they reside, imposes on such taxpayers burdens

which, in many cases, seem truly excessive, if not in-
tolerable. At the same time, any excessive taxation, by its
very burden, brings in its train tax evasion: . . . the supres-

sion of double taxation is therefore closely connected with

the measures for the systematic prevention or checking of

such evasion.^®

Second, assistance in -matters of fiscal evasion often caused an

increase in double taxation; however, this might be remedied by

dealing with both problems together. In an early report, the Com-
mittee felt that a provision aimed at controlling fiscal evasion would

increase **the mischievous consequences of double taxation on ac-

count of the conflict of laws in respect of domicile,"" but continued:

To this objection ... it may be replied that the proposed
resolutions (referring to its 1925 Resolutions on Double' Tax-

ation and Tax Evasion) form an indivisible whole, and that
their object is to prevent both double taxation and tax eva-

"Sec L.N 1925, supra note 10, at 28.
^'L.N 1927, supra note 11, at 8.

''Id. at 8-9.

"L.iV. 1925, supra note 10, at 25.



1979] INTERNATIONAL TAXATION 347

sion. The foregoing criticism will be seen to furnish fresh

proof of the close connection between the two problems.^®

The third aspect of this relationship arises in the context of double
taxation treaties which give special benefits to the signatory states

as a means of dealing with double taxation. The measures aimed at
fiscal evasion in this context have quite a narrow application

because their need is due solely to the double taxation provisions.

The League realized this development when it concluded:

On the one hand, conventions suggested for avoiding double
taxation may contain special measures against evasion,
destined to prevent any abuse arising from their application;

on the other hand, the exchange of information may perhaps
lead to duplication in the levying (or collecting) of taxes. This

is tantamount to saying that, in elaborating any practical

measure for dealing with one of these problems, account
must also be taken of the other.^^

5. Collection provisions may reimburse a government for the
loss from double taxation provisions. — Ytiiediwe measures of collec-
tion assistance are a means to reimburse countries for the loss of
revenue sustained from the double taxation provisions. Provisions

concerned with fiscal evasion might cushion the loss in revenue

caused by double taxation provisions, and, therefore, provide an in-

centive for more nations to enter such agreements.^"

6. Double taxation provisions may carry the collection provi-
sions past taxpayer disapproval — Because governments must, in
many instances, bend to the will of their taxpayers, a point of
government strategy is the ability to enhance taxpayer reception of
collection provisions. Taxpayers, mindful of the benefits received

from double taxation provisions, would be more receptive to a com-
prehensive treaty with inseparable collection provisions.^^ Coordina-

tion between the two problems may also meet the criticism that col-
lection provisions interfere with the free flow of capital inasmuch as
double taxation, which aids the flow of capital, tends to counteract
any inhibiting effects that the collection provisions may have.

7. A double taxation provision insuring equality of treatment
helps meet the taxpayer's fear of abandonment to the collection pro-

""Id.

''Id.

'^Conventions with South Africa, New Zealand, Norway, Ireland, Greece, &
Canada on Double Taxation: Hearings Before a Subcomm. of the Comm. on Foreign
Relations United States Senate, 82d Cong., 1st Sess. 66-67 (1951) [hereinafter cited as
1951 Hearings].



348 INDIANA LAW REVIEW [Vol. 12:341

visions. — Another fear on the part of taxpayers generated by these
collection provisions is the State's abandonment of its citizens who
are taxable in another country, leaving them entirely at the discre-
tion of a foreign tax administration, and, moreover, putting itself

under the obligation to carry out, at the request of such an ad-

ministration, measures that may not be in harmony with domestic
customs.^^ However, such a danger is already reduced by the article

of the 1946 Model Convention for the Prevention of Double Taxation
of Income and Property which relates to equality of treatment.^^

8. Separate treatment enables administrations to make better
use of its few international tax specialists. — It might be said that,
since few nations have a large number of people capable of putting
together sophisticated international tax agreements, treaties of the

highest quality can be had only if efforts are concentrated on either

the problem of double taxation or of tax evasion at any one time.

That is, asking the sparse number of international tax people in the
administrations of the various governments to work towards a com-
prehensive treaty may be spreading worthwhile research too thin.^^

9. Separate treatment may avoid delay of the more important
double taxation provisions. — For any number of reasons, a govern-
ment may be apprehensive of entering into a treaty containing col-
lection provisions. The need for double taxation relief, however, may
be of great importance to both countries. Thus, one country pressing

for a collection provision may delay the needed double taxation pro-
visions.^^ If it were essential that the two be treated together, this
country would have to weigh the cost of any delay against the

necessity of a collection provision which could not be considered in

the future. But if the two might profitably be considered separately,
the country desiring the collection provision need not delay.

10. Separate treatment increases the likelihood of more coun-

tries entering into these agreements. — The less people have to
agree on, the sooner they will agree, if they are to come to any

agreement at all. Therefore, if these collection provisions are at

their best when as many nations at any one time as possible agree

to them,^® reducing the treaty to collection provisions only increases

the possibility of greater acceptance. This reasoning, of course, ig-

nores the possibility that by adding double taxation measures there

^^London and Mexico Model Tax Conventions, Commentary and Text, L.N. Doc.

No. C. 88. M. 88., 46 (1946) [hereinafter cited as L.N 1H6].
^/d at 68-69.

^See Eichel, supra note 5, at 41-42.

^See L.N 1946, supra note 32, at 46.
'"See L.N 1927, supra note 11, at 4, 27.



1979] INTERNATIONAL TAXATION 349

may be increased incentive to enter into such agreements because of
the possibility of increased taxpayer approval.

On balance it would seem, as the League concluded, that the
weightier arguments favor a comprehensive treatment of the two
problems.^^ Practical considerations, however, might make this
double-barrelled analysis unprofitable and, thus, cause abandonment
of the work on collection provisions.

Ultimately, it would seem difficult to ignore these collection pro-
visions because they might prove to be a hindrance to relief from

double taxation. This is especially so when one has conceded their
importance in attempting to reach the goal of a fair and equitable

distribution of tax burdens and benefits between governments and
taxpayers.

III. The Problem of Double Taxation

Basically, double taxation treaties are designed to avoid taxation

of a single event or transaction by two or more states. The basic
problem of double taxation was recognized by the United States early
in its history of income taxation,^* when substantial relief was pro-
vided through the foreign tax credit, as well as various other

measures.^^

Unfortunately, such unilateral solutions have several limitations.

Initially, any relief granted is given by business activity, not given

^'L.N. 1946, supra note 32, at 100.

''Revenue Act of 1919, §§ 222, 238(a), 40 Stat. 1073, 1080 (1919) (current version at

LR.C. § 901).

''See LR.C. §§ 871, 881, 882, 901. The Tax Reform Act of 1976, Pub. L. No.

94-455, 90 Stat. 1520 (1976), introduced various changes in regard to the foreign tax

credit, including the denial of the foreign tax credit to a taxpayer cooperating with, or

participating in, an international boycott based on nationality, race, or religion. Pub. L.

94-455. § 1061(a), 90 Stat. 1649 (1976) (codified at LR.C. § 908) and Pub. L. 94-455, §
1064(a), 90 Stat. 1650 (1976) (codified at LR.C. § 999). In addition, the amount of

dividends received from corporations in less-developed countries is now increased by
the amount of foreign taxes deemed paid with respect to the dividends by the recip-
ient domestic corporation to the foreign corporation. Pub. L. 94-455, § 1033(a), 90 Stat.

1626 (1976) (codified at LR.C. § 902). Further, the per-country foreign tax credit limita-

tion has been repealed, requiring the use of the overall limitation to establish the

amount of foreign tax paid which can be used to reduce United States taxes. This will

have the effect of reducing overall income from sources outside the United States by

reducing the amount of foreign taxes which can be used as a credit against United
States taxes. Pub. L. 94-455, §§ 1031(a), 1032(a), 90 Stat. 1562, 1620 (1976) (codified at

LR.C. § 904). The foreign tax credit limitation was further adjusted to reflect the
lower tax rate on capital gains income received by a corporation. Pub. L. 94-455, §
1034(a), 90 Stat. 1624 (1976) (codified at LR.C. § 904(b)(2)). Further, the foreign tax

credit is now allowed for foreign taxes paid by a third-tier subsidiary. Pub. L. 94-455, §
1037(a), 90 Stat. 1633 (1976) (codified at LR.C. § 960).



350 INDIANA LAW REVIEW [Vol. 12:341

by the individual country.*" Consequently, a nation's laws are unable

to deal with specific problems. Moreover, any relief granted is often

at the expense of the country itself. Every time another country im-
poses a tax, the United States bears the burden and effectively sub-

sidizes the foreign state."*^ Beyond the benefits of these unilateral
devices, the taxpayer is then burdened by a double tax. The only
solution to this problem is a bilateral or multilateral agreement be-
tween individual sovereigns."*^

Unilateral solutions also involve another problematic area. If

two countries provide separate relief from double taxation for any
given transaction, an individual may escape the tax of both coun-
tries. This occurs if both countries have ceded jurisdiction to tax a

specific area. This is not likely to occur if the method of relief is a
tax credit, but it can easily happen if both countries grant an

outright exemption for a particular type of income. Accordingly,

bilateral or multilateral agreements are necessary to curb the

possibility of this rather different type of tax shelter and to insure

that all income is at least subject to some type of tax.
An analysis of any attempt at an international solution to these

problems of double taxation encompasses three general areas — the
basic scope of the treaties, the basis for allocation of the overall tax

base, and, for lack of a better label, the peculiar problems involved

in each type of tax base. Due to the infinite number of possible ap-
proaches to these three areas, it is necessary to choose some base,
even an arbitrary one, on which to center the discussion. Thus, this

analysis will center on the Draft Double Taxation Convention

prepared by the Organization for Economic Co-operation and
Development Fiscal Committee."43

A. Tax Treaty Scope

All United States tax treaties are entered into by the President

of the United States and subject to the consent of the United States

^''I.R.C. § 901 allows the credit for taxes of foreign countries in terms of taxes

paid "to any foreign country or to any possession of the United States." (Emphasis add-

ed).

"This is so, because the tax was paid to and collected by the foreign country, and

generally, the taxes paid to and collected in the United States are thereby reduced.

*^See Ownes, United States Income Tax Treaties, their Role in Relieving Double

Taxation, 17 Rutgers L. Rev. 428 (1963).
'The O.E.C.D. in April, 1972, published the Revised Text of Certain Articles of

the 1963 Draft Double Taxation Convention on Income and on Capital. The Revised

Articles and Commentaries reflect modifications of the O.E.C.D. Model Draft of 1963

which member countries have included in various bilateral treaties since publication of
the 1963 Draft. Carroll, United States Tax Treaties with the European Community

Member Countries: Corporate Assets, 44-3rd T.M. A-19 (1974).



1979] INTERNATIONAL TAXATION 351

Senate.** Further affirmance of the scope of these treaties is found

in the Internal Revenue Code: ''Income of any kind, to the extent re-

quired by any treaty obligation of the United States, shall not be in-

cluded in gross income and shall be exempt from taxation under this
subtitle."*^

Yet, this seeming subjugation of the Code to international

treaties is not at all binding on the interpretation of provisions in a

convention or treaty. The Supreme Court of the United States
seems to broadly interpret provisions in treaties, while still reserv-

ing the power to limit any such provision that may cut too deeply into
the intent of the Internal Revenue Code. Compare the opinion of the
Court in Hauenstein v. Lynham-^^ "Where a treaty admits of two
constructions, one restrictive as to the rights, that may be claimed
under it, and the other liberal, the latter is to be preferred"*^ with

its recent limitation in Maximov v. United States:*^ "To say that we
should give a broad and efficacious scope to a treaty does not mean
that we must sweep within the Convention what are legally and
traditionally recognized to be domestic taxpayers not clearly within

its protections . . . ."*^

Thus, the courts have a general policy of broad interpretation of

treaty provisions, while also maintaining an unpredictable strain of

judicial opinion subjugating international conventions to the Internal

Revenue Code. In certain areas in which the Code requires strict in-
terpretation,^" this can lead to very discordant results. Thus, the

first requirement of any tax convention is a very definite delineation

of the principles of interpretation.

Clearing the hurdle problems of interpretation, the convention

must set out the scope of taxes to be considered. This was discussed
in Article 2 of the O.E.C.D. Convention:

1. This Convention shall apply to taxes on income and on

capital imposed on behalf of each Contracting State or of its

political subdivisions or local authorities, irrespective of the

manner in which they are levied.
2. There shall be regarded as taxes on income and on

capital all taxes imposed on total income, on total capital, or

on elements of income or of capital, including taxes on gains

from the alienation of movable or immovable property, taxes

"U.S. Const, art. II, § 2.

"I.R.C. § 894.

"100 U.S. 483 (1880).

*'I(L at 487; accord. Factor v. Laubenheimer, 290 U.S. 276 (1933).
"373 U.S. 49 (1963).

"/d at 56.

^'See Corn Prods. Ref. Co. v. Commissioner, 350 U.S. 46 (1955).



352 INDIANA LAW REVIEW [Vol. 12:341

on the total amounts of wages or salaries paid by enter-
prises, as well as taxes on capital appreciation . . . ."51

What is required is a very specific enumeration of the exact taxes to
be included. The Article includes taxes imposed by state and local
governments and, thereby, would solve one of the more irritating
aspects of the United States tax system. If a nonresident alien

works in the United States for a period included within the exemp-
tion provisions of an international treaty, it is often financially em-

barrassing, as well as emotionally disturbing, for the individual to

find himself unexpectedly subject to state or local income taxes.

Although it has never been specifically determined whether a
United States tax treaty is controlling over a state tax law, it ap-

pears that such an interpretation would be constitutional.^^ The
United States, however, has reserved its position on this part of the

Article, probably based more on political considerations than on con-
stitutional authority .^^

A further problem arises in determining the scope of taxes due
to the difference in tax bases of foreign countries. Taxes covered in

the conventions sometimes include, in addition to income taxes,^*

capital taxes and taxes on movable property and land.^^ Because the

conventions are intended to be reciprocal, the overall foreign taxes

are generally parallel in economic effect to United States income

taxes subject to the Treaty.

An additional problem is determining what persons are subject
to a treaty. Basically, the persons affected by the conventions are

resident individuals of each contracting country as well as corpora-

tions or other entities organized under the laws of the contracting

state. The term "enterprise" is also referred to with special
significance in most of the conventions.^* The recipients of benefits
in the treaties are almost exclusively nonresidents of the country

granting a special status. This is due to a "savings clause," which is

almost always included in tax conventions. This clause provides

that, to determine the taxes of its citizens, residents, or corpora-

"O.E.C.D. Report, supra note 16, at 4.

^^Cf. Missouri v. Holland, 252 U.S. 416 (1919) (treaty for protection of wild birds

not a violation of state's reserved powers under tenth amendment, due to national

scope of interest involved and the necessity of a treaty to protect interest).

^O.E.C.D. Report, supra note 16, at 39-40.

^See, e.g., Convention Respecting Double Taxation^ Apr. 29, 1948, United States-

Netherlands, art. I, para. (1), 62 Stat. 1757, T.I.A.S. No. 1855.

^See Convention for the Avoidance of Double Taxation, Mar. 30, 1955, United

States-Italy, art. I, para. (6), 7 U.S.T. 2999, T.I.A.S. No. 3679.

^See discussion of the term "enterprise" in O.E.C.D. Report, supra note 16, at 65.



1979] INTERNATIONAL TAXATION 353

tions, a country may include all items in taxable income under its
laws regardless of treaty provisions."

With the exception of the status of a citizen falling within the
"savings clause" category, it is necessary to determine the residence

of individuals for purposes of asserting a benefit under a tax treaty.

Article 1 of the O.E.C.D. draft provides that the convention applies

to residents of one of the contracting countries.^* Article 4 defines

residency with more particularity than any other United States
treaty has done.^^ An adequate definition becomes more and more
important with problems of multiple residences and the conse-

quences of employing an inadequate definition. The draft sets forth
various criteria for determining residence. First, the individual is

treated as a resident at the location of his permanent home. In the
case of multiple permanent homes, the draft chooses the home in
which the taxpayer has the closest personal and economic interest

("centre of vital interests"). If there is no permanent home or if the
"centre of vital interests" cannot be determined, then his habitual

abode is considered his residence. Finally, in cases of multiple

habitual abodes, the draft defers to the country of which the tax-

payer is a national.®" The United States bases tax liability on the
basis of citizenship as well as residence.®^ The term "residence" has
been defined as related to, but less substantial than, the common
law concept of domicile.®^ Adoption of the draft's definition would

certainly assist in bringing about uniformity, but it would allow
wealthy United States citizens to establish their principal residence

in low tax rate countries and obtain very substantial tax savings.

Thus, the United States probably would not enter into a multilateral

treaty embodying the residence concept, as demonstrated by its
reservation of approval of Article 4. Possibly, however, the United

States could apply Article 4 to problematic definitional questions

while still retaining the "savings clause" and not derogating the

right of the United States to tax its citizens.*^

Presently, corporations entitled to benefits under the treaties
are generally corporations organized under the laws of the contract-

^'See Crerar v. Commissioner, 26 T.C. 702 (1956) for an explanation of the "sav-

ings clause" as well as a validation of the method.

^O.E.CD. Report, supra note 16, at 41.

'Ud. at 43.

•^I.R.C. § 901; Treas. Reg. § l.l-l(a). See also, B. Bittker & L. Ebb, United
States Taxation of Foreign Income and Foreign Persons 482 (1968).

"'^Treas. Reg. § 1.871-2(b) (1971).

•"Association International de Droit Financier et Fiscal, Klimowsky, Unilateral

Measures for the Avoidance of Double Taxation, 43 Cahiers de Droit Fiscal Interna-

tional 12 (1961).



354 INDIANA LAW REVIEW [Vol. 12:341

ing states. Thus, residence is generally based on origin, rather than

principal place of business. The theoretical arguments of defining a
corporation are not nearly as great as the practical necessity of ob-

taining some standard definition. The problem of conflicting defini-
tions is demonstrated by a recent United States-Canadian conven-

tion.®^ A Canadian corporation under the treaty is different from the
Canadian corporation under national law. The O.E.C.D. draft conven-
tion provides that, if a corporation is subject to taxation in both con-

tracting states, and therefore a resident of both contracting states,

it shall be deemed to be a resident of the contracting state in which
its place of effective management is situated.®^ The implementation
of this definition would free both countries to adopt broad internal

definitions without fear of subjecting a corporation to double tax

liability.

In cases of individuals, permanent residence is a tangible con-
cept. Business enterprises, however, are judged on the basis of per-

manent establishment.®*

B. Permanent Establishment

One indicator of the residence of a business enterprise is the
country in which the enterprise is organized, although it may also
have business operations in many other countries. The purpose of
the term "permanent establishment" is to determine when the
operations subject the enterprise to the taxing authority of a coun-

try.

United States treaties have universally adopted and applied the

concept of "permanent establishment" as the principal limitation im-

posed upon the treaty parties to tax income from sources within

their boundaries.®^ For example, it is generally applied to limit taxa-

tion of industrial and commercial profits, dividends, interest, and

royalties. In essence, the treaty parties agree to exempt certain
types of income from taxation, or at least to reduce their tax on

such income, if the economic penetration into the source country by

the recipient of the income does not constitute a permanent

establishment.

Under the Internal Revenue Code, a foreign taxpayer will be
subject to United States tax on income from United States sources

^*Convention Respecting Double Taxation, Mar. 4, 1942, United States-Canada, 56

Stat. 1399, T.S. No. 983, as amended, June 12, 1950, art. XII, paras. (1M2), 2 U.S.T.

2235, T.I.A.S. No. 2347.

'"'O.E.C.D. Report, supra note 16, at 41.

"A. Van Den Tempel. supra note 9, at 38.
''See id.



1979] INTERNATIONAL TAXATION 355

if he engages in a trade or business within the United States.®^ This

concept of "engaged in a trade or business" is carried into the con-

ventions and coupled with the term "permanent establishment."
Thus, the test under United States treaties is whether the foreign
resident is engaged in a trade or business through a permanent
establishment.^^ Article 5 of the O.E.C.D. draft^° contains the defini-

tion of a permanent establishment. Specifically, the convention
states:

1. For the purposes of this Convention, the term "perma-
nent establishment" means a fixed place of business in
which the business of the enterprise is wholly or partly

carried on.

2. The term "permanent establishment" shall include es-
pecially:

a) a place of management;
b) a branch;

c) an office;

d) a factory;

e) a workshop;

f) a mine, quarry or other place of extraction of nat-

ural resources;

®*I.R.C. § 882(a) (foreign corporations subject to tax).

*®Carroll, Evolution of U.S. Treaties to Avoid Double Taxation of Income, Part

II, 3 INT'L Law 169 (1968-1969). See also Johansson v. United States, 336 F.2(i 809 (5th
Cir. 1964); Samann v. Commissioner, 313 F.2d 461 (4th Cir. 1963); Donroy, Ltd. v.

United States, 301 F.2d 200 (9th Cir. 1962); Commissioner v. Consolidated Premium
Iron Ores, Ltd., 265 F.2d 320 (6th Cir. 1959); American Trust Co. v. Smyth, 247 F.2d

149 (9th Cir. 1957).

^"O.E.C.D. Report, supra note 16, at 43. United States treaty definitions of a per-

manent establishment since 1961 have been largely patterned after the O.E.C.D. draft

prototype. Notable changes in the newer treaty definitions include allowing a foreign

enterprise to engage in the five O.E.C.D. designated ancillary and preparatory ac-

tivities, such as delivery and warehousing, without being designated as a permanent

establishment. Williams, Permanent Establishments in the United States, 29 Tax
Law. 277, 303 (1976). The newer treaties based on the O.E.C.D. Draft have replaced
the older treaty view of a permanent establishment, rigidly defined by a concept of fixed

assets or specified agencies, with a more functional view toward economic profit and

regular business activity deriving from the fixed assets or specified agencies. A fixed
place of business, which is used for regular, but ancillary and preparatory activities to

the realization of economic profit, such as storage, display, scientific research, and

advertising will not be designated as a permanent establishment subject to taxation.

The O.E.C.D.-based definitions of permissible "non-permanent establishments" permit
a considerably wider scope of activities than the earlier treaties, and illustrate the

O.E.C.D.'s evident intent to tax "only those agencies and assets which are continuously

used for business activities having an essentially direct relation to the realization of

economic profit." Id. at 354.



356 INDIANA LAW REVIEW [Vol. 12:341

g) a building site or construction or assembly project

which exists for more than twelve months.
3. The term "permanent establishment" shall not be

deemed to include:
a) the use of facilities solely for the purpose of storage,

display or delivery of goods or merchandise belong-

ing to an enterprise;

b) the maintenance of a stock of goods or merchandise

belonging to the enterprise solely for the purpose

of storage, display or delivery;

c) the maintenance of a stock of goods or merchandise

belonging to the enterprise solely for the purpose

of processing by another enterprise;

d) the maintenance of a fixed place of business solely

for the purpose of purchasing goods or merchandise,

or for collecting information, for the enterprise;

e) the maintenance of a fixed place of business solely

for the purpose of advertising, for the supply of

information, for scientific research or for similar

activities which have a preparatory or auxiliary

character, for the enterprise.

4. A person acting in a Contracting State on behalf of an
enterprise of the other Contracting State — other than an
agent of an independent status to whom paragraph 5
applies — shall be deemed to be a permanent establish-
ment in the first-mentioned State if he has, and habit-
ually exercises in that State, an authority to conclude

contracts in the name of the enterprise, unless his activ-
ities are limited to the purchase of goods or merchandise

for the enterprise.

5. An enterprise of a Contracting State shall not be
deemed to have a permanent establishment in the other
Contracting State merely because it carries on business

in that other State through a broker, general commission

agent or any other agent of an independent status,

where such persons are acting in the ordinary course
of their business.

6. The fact that a company which is a resident of a Con-
tracting State controls or is controlled by a company
which is a resident of the other Contracting State, or

which carries on business in that other State (whether

through a permanent establishment or otherwise), shall
not of itself constitute for either company a permanent
establishment of the other."

''Id. at 43.

I



1979] INTERNATIONAL TAXATION 357

This draft provision specifically covers some of the areas which
have recently caused many problems. For example, subparagraph
3(e) specifies that the operation of a so-called "propaganda office" in

one of the contracting countries shall not constitute, by itself, a per-

manent establishment. The propaganda office is a comparatively re-
cent device, used particularly by large American companies, which

involves establishing an office in a foreign country to handle adver-

tising, buying, marketing or scientific research, or related activities.

Usually the corporation operates its selling and manufacturing ac-

tivities through a subsidiary, but the "propaganda office" is a direct

arm of the parent. This draft opens the door for more extensive ac-
tivities, such as the sale of research results, by using the phrase "or

for similar activities which have a preparatory or auxiliary

character for the enterprise."^^ This language is also intended to ex-

clude from the definition an office established to service a patent or

"know how" agreement.^^ It is not, however, intended to exclude an
office established principally for the sale of research results.^*

Article 5 also excludes from the area of permanent establish-
ment an independent agent or one who does not have authority to
conclude contracts in the name of the employer other than contracts
for the purchase of goods. This has been the general rule under

United States treaties, but it has been difficult to apply .^^ The big-
gest problem arises in interpreting what is "authority to conclude
contracts." This can mean anything from allowing formal approval to
defeat the tax jurisdiction to considering a situation of co-approval

as sufficient to constitute a permanent establishment.
The open draft also adopts the principles contained in most

United States treaties concerning parent and subsidiary corpora-
tions. It applies to situations in which one corporation does not

directly have a permanent establishment in a country. A corporation
will not be considered a permanent establishment of a company for
a given country on the sole ground that the second company con-
trols the first.^® Whether the parent has a permanent establishment
due to the subsidiary's activities must be established by the or-
dinary rules. Only if such a case exists is the latter taxable in the

other country.'^

"O.E.C.D. Report, supra note 16, at 74.

''Id.

''^See, e.g., Commissioner v. Consolidated Premium Iron Ores, Ltd., 265 F.2d 320,
324-26 (6th Cir. 1959).

^"A. Van Den Tempel, supra note 9, at 39.



358 INDIANA LAW REVIEW [Vol. 12:341

C. Classes of Income

Tax treaties operate by either wholly or partially exempting
certain classes of income from the taxing authority of one of the par-

ties to the treaty. With minor exceptions, income subject to treaty
relief can be grouped into three classes: (1) Business income, (2) in-

vestment income, and (3) earned income which derives from present

or past personal services.

The concept of the permanent establishment is especially critical
in properly allocating business income. Presently, if a treaty country

is engaged in business in the United States through a permanent

establishment, it is normally taxable as a domestic corporation on its

United States income. Therefore, most treaties provide that, once an

enterprise operates through a permanent establishment in the

United States, all United States source income is taxable even if not

attributable to the permanent establishment.^^ The O.E.C.D. draft
convention, however, provides that if an enterprise conducts

business through a permanent establishment, only that portion of

the profits attributable to the permanent establishment may be taxed
by the country in which the permanent establishment is located.^^

This revised definition has the advantage of discouraging the

establishment of a separate entity to carry on the activities con-

stituting a permanent establishment solely to enable other forms of
income to enjoy the benefits of the convention.^^

The O.E.C.D. draft also presents a broad-based definition of in-
come constituting business income: "Where profits include items of
income which are dealt with separately in other Articles of this Con-

vention, then the provisions of those Articles shall not be affected

by the provisions of this Article."*^ In effect, the definition rules pro-

vide that anything called income, which is not otherwise accounted

for in the convention, shall be considered business income.

In addition, the O.E.C.D. draft includes a common provision that
once an enterprise operates through a permanent establishment in

the country, there shall be attributed to such permanent establish-

ment the industrial or commercial profits which it might be ex-

pected to derive if it were an independent enterprise dealing at

arm's length with the enterprise of which it is a part.*^

Finally, the O.E.C.D. treaty solves one of the most inequitable

provisions of many tax treaties. By not containing any general

''Kragen, Double Income Taxation Treaties: The O.E.C.D. Draft, 52 Cal. L. Rev.

306, 318 (1964).

^'O.E.C.D. Report, supra note 16, at 45.

^°See generally Surrey, The United States Tax System and International Tax

Relationships, 43 Taxes 6 (1965).
*^O.E.C.D. Report, supra note 16, at 45.

^'^See Kragen, supra note 78, at 319.



1979] INTERNATIONAL TAXATION 359

source of income rules, it is possible that a contracting state may at-
tribute industrial and commercial profits from activities carried on

from outside the other contracting state to the permanent establish-

ment.®^ The O.E.C.D. draft provides: '*[I]f the enterprise carries on
business (in another Contracting State through a permanent
establishment), the profits of the enterprise may be taxed in the
other State but only so much of them as is attributable to that per-
manent establishment."®^

One particularly difficult area of business income which is con-
sidered separately in the O.E.C.D. draft is income derived from

transportation, generally from the operation of ships and aircraft.

Article 8 of the draft provides for taxing profits by the country in
which the "place of effective management" is located.®^ In the past,
the use of such terms as "homeport," ''state in which the enterprise

is situated," or "state of registry" has failed to settle the matter ef-

fectively, and litigation has ensued.®^ The employment of a new
term, "place of effective management," may eliminate any uncertain-
ty or lack of precision if a clear definition crystalizes quickly. It is

also possible, on the other hand, that a whole host of new problems
may arise from the adoption of new terminology.®^ The treaty provi-
sions dealing with investment income, as a general rule, alleviate

double taxation. They generally provide for reciprocal exemption
from or reduction of source country taxation.

Some countries tax company profits at different rates, one rate
if profits are distributed and another if profits are held by the com-

pany. This has been one of the contributing factors in creating dif-

ficulties for those who seek a uniform solution in the field of tax
treatment of international dividend payments.®® Another part of the
problem is that the internal laws of some countries tax dividends
from resident companies at the source, while nonresidents are not

taxed at all.®^ Article 10 of the O.E.C.D. draft, and now of the Model
Convention too, is an attempt to recognize and meet these dif-
ficulties.

The O.E.C.D. draft substantially adopts the principle found in
most United States conventions — that the payee's country of

*^Sec, e.g.. Convention for the Avoidance of Double Taxation, Apr. 16, 1947,

United States-United Kingdom, art. Ill, 60 Stat. 1377 (indexed at 64 Stat. B1138),

T.I.A.S. No. 1546.

**O.E.C.D. Report, supra note 16, at 45.

'"Id. at 46.

*®Kragen, supra note 68, at 321.

"'Id. at 322-23.

'^See A. Van Den Tempel. supra note 9, at 34-37.



360 INDIANA LAW REVIEW [Vol. 12:341

residence has the right to tax his dividend income received from
sources in the other contracting country ,^° with the source country
having a limited right to tax reserved.^^ The limits are basically two-
fold. Generally, the allowable tax is limited to fifteen percent of the
gross amount of the dividends.^^ A special provision is inserted,
though, to benefit parent corporations receiving dividends from
foreign subsidiaries. The foreign country is limited to a five percent
tax on dividends paid by a subsidiary if the recipient is a company
which holds at least twenty-five percent of the capital of the cor-
poration paying dividends.^^

The same basic principle invoked for dividends is implemented
in the tax treatment of interest income.^* Interest income is generally
taxable in the state of residence of the recipient. Debtor countries
are generally reluctant to grant a complete exemption. In this
regard, the O.E.C.D. draft provides for a ten percent maximum tax
rate at the source country .^^ As a practical matter, the tax is borne
by the borrower since lending institutions generally require that the
borrower shall bear any taxes imposed by the source country with
respect to interest payments.^®

'''O.E.C.D. Report, supra note 16, at 47-48. See also, B. Bittker & L. Ebb, supra
note 61, at 183, 448.

"See, e.g., Italy, supra note 55, at art. VII.

'==O.E.C.D. Report, supra note 16, at 47-48.

^^Id. This type of provision, however, opens the door to much possible tax abuse.
The O.E.C.D. draft commentary suggests that when negotiating specific conventions,
states should have the opportunity to provide methods of preventing misuse of the
convention to avoid taxes on dividends. Id. at 106.

''Id. at 48. The 1972 Revised Text of Certain Articles of the Draft Double Taxa-

tion Convention contains certain modifications of the 1963 article on interest, such as

recognizing the right of the state of the recipient's residence to tax, provided that the

resident is the "beneficial owner" of the interest; while also permitting the State

where the interest arises to levy a tax up to 10% of the interest amount. The revision
provides that the reduced rate is not to be enjoyed by a resident of the State who car-
ries on a trade or business through a permanent establishment in the taxing state. The

commentary points out that since the creditor resident in the other contracting state is

taxable both at the source of interest and at his residence, the double liability often

hampers the movement of international investments and capital. The O.E.C.D. Commit-
tee on Fiscal Affairs concluded that interest should be taxed in the state of residence

of the creditor, but left the right to impose a tax with the State of source. Carroll,

supra note 43, at A-21. The same was confirmed in the 1977 Model Convention for the

Avoidance of Double Taxation with Respect to Taxes on Income and on Capital, art.

11.

''O.E.C.D. Report, supra note 16, at 48.

'*A. Van Den Tempel, supra note 9, at 37. To lessen obstacles to international
trade, the 1972 revision has suggested that parties to a treaty might wish to add a

clause limiting taxation to the State of residence of a recipient where: (1) Interest is

paid in relation to the sale on credit of any scientific, industrial or commercial equip-

ment, or (2) interest is paid in relation to the sale on credit of any merchandise by one



1979] INTERNATIONAL TAXATION 361

The question involved with royalties is whether they should be
treated as business income or investment income. If treated as
business income, royalties would be primarily taxed at their
source.^^ If treated as investment income, they would be primarily
taxed in the country of residence of the recipient.^® Thus, the defini-

tion of royalties is crucial. Many recent agreements have contained
no definition of royalty, and the result has been a variation in the in-

terpretation of the term. This has naturally led to some unhappiness
among those involved, especially with today's greater use of
agreements to furnish "know-how." The draft convention includes in
its definition of royalty payment any "information concerning in-
dustrial, commercial or scientific experience."^^ It leaves no room for
doubt that "know-how" payments are royalties and are to be treated
as such.^°"

Rentals of real property and royalties from natural resources

are being exclusively treated as within the domain of the country in
which the property is situated. ^°^ The O.E.C.D. draft includes "im-
movable property" in this category, and extends the term to include

livestock and farming equipment.^°^ The draft is very general in
speaking of capital gains, basically taxing immovable property in the
source state, and other property in the resident country. ^°^

The problem involved with the first two areas of income, namely
that of distinguishing one type from the other, is not nearly as

prevalent in the last area of concern — earned income. All treaties
grant special exemption to foreign residents who are temporarily
present in a treaty country with respect to income derived from per-

sonal services. The general rule that income from personal services
is taxed at the source^"* remains in the O.E.C.D. draft.

The exceptions to this rule, however, are significant. Most
treaties grant an exemption to a foreign resident provided he was

enterprise to another, or (3) interest is paid on a loan of any kind granted by a bank.

Carroll, supra note 43, at A-22.

^^O.E.C.D, Report, supra note 16, at 49. See also id. at 116-21.

''Id, at 49.

^M The O.E.C.D. Commentary of 1972 cites definition of "know-how" as "all the
undivulged technical information, whether capable of being patented or not, that is

necessary for the industrial reproduction of a product or process directly and under

the same conditions," thus including experience and applicable to more than mere ex-

amination of the product or mere knowledge of the technique. Carroll, supra note 43,

at A-22.

^'^See generally Kragen, supra note 78, at 325.

'"O.E.C.D. Report, supra note 16, at 45.

'''Id.

^'Ud. at 49. See also Kragen, supra note 78, at 326-27, for a more comprehensive

analysis. The general attitude toward capital gains is very difficult to pinpoint due to

the wide variety of methods of imposing tax.

'"O.E.C.D. Report, supra note 16, at 50.



362 INDIANA LAW REVIEW [Vol. 12:341

present in the country for only a limited period (usually 180 to 183

days) and that his compensation did not exceed a given amount
(usually $10,000).^°^ Most treaties extend this exemption only if the
compensation was paid by a nonresident alien or foreign corporate
employer/"^ Several treaties additionally exempt compensation
regardless of the type of employer, provided that the foreign resi-

dent spent less than ninety days in the country and earned less than

$3,000. In any case, the treaties do not employ permanent establish-

ment as any sort of determinative in this regard/"^
The O.E.C.D. draft makes a distinction between independent and

dependent personal services. Independent services are generally

professional services such as those rendered by scientists, artists,

writers, and teachers as well as those of physicians, lawyers,

engineers, architects, dentists, and accountants.^"^ Dependent ser-
vices are those based on salaries, wages, and other similar compen-

sation.^"^ The income derived from the former is taxed in the country of
residence unless the taxpayer "has a fixed base regularly available

to him in the other Contracting State for the purpose of performing

his activities.""" In such a case, the source state may tax him to the
extent attributable to that base."^ Dependent services are not tax-
able to the source state if: (1) The employee satisfies the 183-day
rule, (2) the employer is not a resident of the source state, and (3)
the salary is not paid by a permanent establishment in the source
state."^ Thus, the O.E.C.D. draft disregards the amount of compensa-
tion as a factor and eliminates the three-month rule. It does,

however, incorporate a distinction between types of personal service
income and extend the taxing authority of the source state to all

employees of a permanent establishment."^

^°^See, e.g.. Convention for Avoidance of Double Taxation and Prevention of

Fiscal Evasion, Oct. 28, 1948, United States-Belgium, art. XI, 4 U.S.T. 1647, T.I.A.S.

No. 2833, 05 modified and supplemented Aug. 7 & Sept. 8, 9, 1957, 4 U.S.T. 1672,
T.I.A.S. No. 2833, as supplemented Aug. 22, 1957, 10 U.S.T. 1358, T.I.A.S. No. 4280.

'""See, e.g., 4 U.S.T. at 1659.

'''Id.

'"^O.E.CD. Report, supra note 16, at 50-51. See also O.E.C.D. Model Treaty,

supra note 21, at 34-35.

'''Id.

'''Id.

'"Id.

"Hd.

"^See generally O.E.C.D. Report, supra note 16, at 51-52. See also O.E.C.D.

Model Treaty, supra note 21, at 36-37. In addition to these provisions, most tax

treaties as well as the O.E.C.D. Convention adopt special rules for directors' fees,

entertainers, government employees, and students. They are disregarded here because

of their limited significance to a broad analysis of the problem of double taxation.



1979] INTERNATIONAL TAXATION 363

D. Summary

The work of the O.E.C.D. has caused a great deal of change in
the approach to the problem of double taxation. Although the draft

was subject to many reservations, it has, for the first time, compiled
the various positions of all the member countries and has developed
a common ground from which to work. The effects of the draft, even
disregarding the vast improvement in equitable allocation of taxing

authority, can be very significant. The use of common concepts will
enable taxpayers to determine their position in a broad variety of

cases without having to study special provisions inherent in in-

dependently negotiated bilateral treaties. In addition, decisions in

one state will, for the first time, be applicable authority to another

state because of this common basis. This is not to say the draft is, or
will be, a panacea. But the 1963 O.E.C.D. draft and the continuing

work of the Fiscal Committee, now Committee on Fiscal Affairs, in-
cluding most importantly the 1977 Model Convention, do strike an
important chord in harmonizing international fiscal relationships.

IV. The Problem of Fiscal Evasion

Unlike the problem of double taxation, the problem of inter-

national fiscal evasion has not received widespread concern or public

support for the attempts at a solution. In fact, often the states in-

volved do not wish to concern themselves with the problem. The
provisions concerning fiscal evasion warranted no more than brief
notice in the 1963 O.E.C.D. draft."' However, the 1977 O.E.C.D.
Model Convention is worded much more clearly and is more exten-
sive on this subject so as to avoid such problems. Outside of their

general support for an attempted solution of the tax evasion prob-

lem, the Internal Revenue Service and the Department of the
Treasury are limited in the kind of help they can provide."^

Because of this general apathy, not as much work has been put
forth to solve this problem of fiscal evasion as has been to solve the
problem of double taxation. Thus, this portion of the Article will
first discuss the original principles set forth by the League of Na-
tions, and then analyze some of the present problems involved in
reaching a solution in this significant area of taxation — international
enforcement of tax claims.

A. Work of the League of Nations

In analyzing the problem, the League developed a set of broad
principles as to basic problems involved with international fiscal

"^O.E.C.D. Report, supra note 16, at 26.

"^See Eichel, supra note 5, at 25.



364 INDIANA LAW REVIEW [Vol. 12:341

evasion/^^ It was hoped that setting forth original guidelines would
help the member countries implement provisions that would solve
the problem. Aside from the considerations inherent in both double

taxation and fiscal evasion/^^ the League noted a number of other
factors.^^^

The League initially concluded that measures for meeting the
problem of fiscal evasion would provide an important link toward an

international tax morality among taxpayers. The League's appeal to
taxpayers declared:

[T]hese measures are in the interest of all honest taxpayers.

At the present time, there is a great deal of concealment of
income and there are taxable persons who pay no taxes at
all. If the tax on all income could be brought into the

treasuries of the various States concerned, those States

would find, as compared with the present position, a very
important additional yield, which might . . . enable them . . .
to reduce the rates of their taxes."^

Thus, the League stressed an international tax morality among
taxpayers which would enhance normal economic relations and at

the same time reduce the burden on the honest taxpayer. Given the
need and desirability of such an improved tax morality, the League
was clear as to how it might be encouraged:

It is indeed the duty of revenue authorities to see that each

taxpayer should pay the taxes for which he has been assessed

according to the laws of the country under the jurisdiction of

which he comes. Failure to collect such taxes is indeed

susceptible of impairing the services which the Government
should render to the public or bringing about an increase of

the taxes borne by non-delinquent taxpayers.'120

A second problem caused by tax evasion was interference with
the free circulation of capital. The Financial Committee, in response
to the Experts 1925 Resolutions, reported to the Council of the

League that any future investigation of the problems of fiscal eva-
sion would have to consider '*the disadvantage of placing any

obstacles in the way of the international circulation of capital, which
is one of the conditions of public prosperity and world economic

reconstruction."'^'

""L.AT. 1925, supra note 10, at 22-28.

"'See Carroll, supra note 13, at 696-97.

"»M
""L.AT. 1925, supra note 10, at 28.

'^''L.N 1946, supra note 32, at 45-46.

'^'L.N 1927, supra note 11, at 5.



1979] INTERNATIONAL TAXATION 365

In the process of its investigation, the League had to determine

whether the model conventions should be multilateral or bilateral in

form. Notwithstanding the League's previous conclusions as to the

necessity of an agreement by as many nations as possible, the
League was forced to use the bilateral approach. Such a course was
dictated by the diversity of the fiscal systems represented. The use
of a collective or multilateral approach would preclude the need for

delicate negotiations between the governments due to fundamental

differences in their systems. The need to consider diverse public opin-
ions in the various countries in order to engender taxpayer con-

fidence and support further convinced the League to follow the
bilateral route.

^^^

The Committee, therefore, reasoned that it would establish stan-
dards which would both allow for the necessary bilateral negotia-

tions and introduce a certain measure of uniformity in international

fiscal law. Thus, forced to work at a higher level of abstraction than
desired, the League requested the various nations to subscribe to
basic standards and commit themselves to general patterns of
assistance. ^^^ Unfortunately, some nations believed this was the
League's sole request. But the League asked for much more, in-
cluding the promulgation of regulations and more specific provisions
suited to each country's peculiar tax system pursuant to any

bilateral negotiations:

[I]t will be necessary to draw up regulations for the ap-
plication of the Convention. In the Committee's opinion, it

would be best that these rules should not be laid down in
the Conventions themselves. They are of too special a
nature, and, moreover, the fact that they were embodied in a
convention might delay the introduction of changes which

circumstances or experience had shown to be necessary. Ac-
cordingly, the Committee proposes that the highest fiscal
authorities should be left free to agree upon the practical
measures necessary to implement the Convention.^^^

One of the more pervasive considerations with which the League
chose to deal was the notion of protecting national sovereignty.^^^
This idea reduced itself into three principles. The first was that tax
claims from another government would not be privileged debts. The
purpose was, of course, to protect the rights of both general and

governmental creditors by preserving their positions against the

'^See id. at 8-9.

'^'Id. at 8.

'''Id. at 26.

'^^L.N. 1925, supra note 10, at 27.



366 INDIANA LAW REVIEW [Vol. 12:341

taxpayer relative to the foreign tax claim. The second was that the
foreign claim had to be res judicata. This was meant to prevent the
courts of one nation from interpreting or having to interpret the tax

laws of another. The third principle was that the enforcing state
could neither be made to use methods other than those which it had
nor be forced to use methods not provided for under the laws of the
applying state. Behind this was the notion that a nation's legal pro-
cesses were to be free from employment of measures based on alien
concepts, and that the specific means of carrying out the intended
collection assistance would have to be dictated by each nation's own
internal legislation.^^®

There were three basic reasons for the requirement that all
claims possess the final character of res judicata. The first was to
preserve the sovereignty of both the applying state and the state to

which application was made. The second was to avoid the possibility
of a nation's courts being burdened with the expensive and time con-

suming task of interpreting another nation's tax laws. The third was
that '*it would hardly be desirable to invite a foreign administration

to take measures to collect a debt which was still liable to be
cancelled on appeal."^^^

The question of whether two tax systems of two negotiating
governments were compatible was of primary importance to the
League in determining the feasibility of reciprocal assistance. As a
way of testing compatibility, the League used what it stated to be a
"rule based to some extent on the highest common factor, [ie. ,] that
no means of execution should be employed unless it is included in
the laws of both States concerned."^^^ There were two principles
stated as the basis for such a rule. The first was the requirement
that the methods of execution be limited to those provided by the
state to which application is made. The second was the principle
that the state to which application is made cannot employ any
methods which might offend the system of the applying state and
need not use methods not provided by the applying state.^^®

One might then have asked where this rather confining test left
the two negotiating governments. The only method remaining seemed
to be two types of methods, one which was to be found in both
systems, and one found only in the state to which application was

made so long as it was not offensive to the laws of the applying
state. Due to the often subtle diversities of the various tax systems.

'''Id. at 27, 35.

'''L.N 1927, supra note 11, at 28.

'^^Report Presented by the General Meeting of Government Experts on Double

Taxation and Tax Evasion, L.N. Doc. No. C. 562. M. 178., 32 (1928).

''"Id. at 30, 32.



1979] INTERNATIONAL TAXATION 367

the question of whether a method was "offensive" could turn into a
major inquiry. This inquiry could turn on an examination of the

basic concepts which underlie each country's collection procedure.

There is another concept of reciprocity at which the League only

hinted: namely, when one country's collection process is far less effi-
cient than the other's, can there really be reciprocity?^^" This is

reciprocity in the sense of cooperation and is perhaps most impor-

tant when negotiations are between a developed and an under-
developed country.

Finally, the League's concern for public opinion went in two
directions. In one way, it was forced to deal with public sentiment
vis-a-vis initial agreement to accede to such collection provisions. In
the other way, the League faced the necessity of having to write into
the collection provisions certain exceptions in order to provide for

diverse public policies. As to the need for accommodating public sen-
timent towards these collection provisions, the League stated:

As regards the carrying out of the recommendations . . . for
countering tax evasion, the Experts desire to emphasize the

fact that it will only be possible to carry out these recom-

mendations in any given country if, in the first place, public

opinion in that country is sufficiently prepared, and secondly,

if the Government of the country considers that the
measures advocated are not only compatible with public opin-

ion, but also are required for collection of its own taxes. ^^^

The result of the League's work was the manifestation of its
principles into three contexts: The basic Resolutions of 1925; the
Draft Model Bilateral Conventions of 1927-1928; and the final Draft
Model Bilateral Conventions of 1940, 1943, and 1946 in Mexico City
and London.^^^

The following are the basic Resolutions of 1925 in which can be
found most of the League's principles and upon which all later work
of the League is based:

1. Each State shall recover within its territory, in accord-
ance with its own law, taxes due in another State, including
taxes due from persons not nationals of the latter State. The
State to which such an application is made may not,
however, be requested to apply any method of execution not
provided for under the law of the State making the applica-
tion.

'^'L.N. 1925, supra note 10, at 26.

"7d at 34.
'^'Carroll, supra note 13, at 701, 707.



368 INDIANA LAW REVIEW [Vol. 12:341

2. Taxes to be recovered shall not, in the State to which ap-
plication is made, be regarded as privileged debts,.

3. Prosecutions and other measures of execution shall be
carried out, without exequatur, on the production of

documents proving that the liability in question is res
judicata. If the fiscal debt may still be the subject of an ap-
peal, conservatory measures may be taken on the production
of a decision executable against the debtor.^^^

While the latter conventions' reappraisals did not introduce any

significant new thoughts, they did redefine and reinforce the old
principles. There were, however, a few points which were modified
or expanded. The first was the substitution of "definitely due" for
"res judicata," which may have caused more uncertainty than
usefulness. The League had previously attached certainty to the
term res judicata by limiting it to a claim which was no longer liable
to be cancelled on appeal. In the 1946 convention, the Committee's

Commentary to the Conventions remarked:

According to Article XIX of the Protocol in the Mexico
Draft, XVI in the London Draft, the Convention does not ap-
ply to measures of conservancy in respect to taxes that have

not yet been assessed. However, as regards taxes that have

been assessed, but are not definitely due, the tax authorities

concerned may request the corresponding authorities of the
other State to take such measures of conservance as are

authorized by the revenue laws of the State interested.^^^

Whether this meant no change from the previous requirement,
"beyond all possibility of appeal," is still questionable. There may be
steps between a mere assessment and a claim no longer amenable to
appeal, such as when only a lower court decision is rendered. To add
to the uncertainty, the convention also speaks of claims which are

"finally determined" as well as those which are "definitely due."^^^

However, if one assumes that the League intended to maintain the

same notion that it is undesirable to allow claims that are still
outstanding to be cancelled on appeal, it would be difficult to con-

clude that it intended to allow anything less stable for collection

than a claim possessing that degree of finality which had previously

been required by the term res judicata.
The second point was the League's response to what it con-

sidered to be a rather cool reception to the collection provisions.

The League had suspected during its early work why these provi-

'''L.N 1925, supra note 10, at 35.

^^*L.N 19Jf6, supra note 32, at 53 (emphasis added).

'''Id at 52.



1979] INTERNATIONAL TAXATION 369

sions met with such distrust/^* In essence, the various governments
were fearful of placing their tax facilities at the disposal of foreign
authorities and, thereby, being required "to introduce new tax prac-
tices in order to suit the requirements of foreign governments."^^^

Also of concern to the governments was the possibility of prej-
udicially affecting the free circulation of capital. Of concern to tax-

payers was the possibility of these provisions granting a foreign tax-
ing authority greater or additional powers not allowed by its

domestic legislation. To meet this lack of confidence in the provi-
sions, the new Model Conventions contained several articles which
stressed the reciprocal aspects and provided certain safeguards.

Reciprocity was provided in the sense of compatibility as well as in
the sense of cooperation. The League provided a rather bland test
to discover whether reciprocal cooperation existed: "[R]eciprocity

shall be deemed to exist when the request is accompanied by a
declaration by the competent authorities who make the application,
officially confirming that any similar request would be complied

with in accordance with the laws of the applicant state."^^^

Safeguards were directly provided for in the Article allowing
certain excuses from compliance, such as when the request relates
to a taxpayer who is a national of the state applied to or when com-
pliance with the request compromises its security or sovereign

rights.^^®

The third distinguishing factor of the Mexico and London Con-
ventions was the limiting provisions. The new collection provisions
were limited to those items of income dealt with in the Conventions
on double taxation. This made the collection provisions complementary
to the double taxation provisions, thereby carrying even further
their prior considerations of the correlation between the two. Fur-
ther limitations were set out in the accompanying Protocol, which
provided for a monetary limit below which no assistance would be
given, and for a required statement by the interested state that the
amount due was not recoverable in the applying state.^^°

B. Present Problems of Tax Evasion Treaties

This discussion begins with the most telling, if not fundamental
complaint: namely, the problem of having to connect two systems
which do not share a common background. Most arguments against

'''See id. at 44-48.

"Vd at 46.
'''Id. at 47.

'"Id. at 48.

'*'Id. at 52.



370 INDIANA LAW REVIEW [Vol. 12:341

collection provisions, if not initially founded on it, always seem to
fall back on this incompatibility. Since this problem emerges in

diverse contexts throughout the rest of this section, only a few of its

more obvious aspects, stated in extremely general terms, are herein
mentioned. Such provisions, say the critics, would "force upon the

courts of the United States the duty of interpreting foreign tax

statutes and will require a scrutiny of the relations between the
foreign state and its citizens and force the courts to pass on ques-

tions of local policy ."^*^ And what has turned out to be the most
critical aspect of all is the risk that taxpayers might be unjustly prej-

udiced in the enforcement of such assistance provisions without ade-

quate judicial safeguards.

It is next suggested that the United States treaty provisions

dealing with collection assistance are not self-executing and,

therefore, are in need of enabling legislation.^*^ Aside from the

weight which might be given to the question of whether any
revenue measures can be self-executing due to the restrictive

language of article I, section 7 of the Constitution, the critics have

concluded that the gap resulting from the language of the Internal

Revenue Code has to be filled by Congress.^*^ With the possible ex-
ception of the wording of the Internal Revenue Code, one might
counter these contentions by stating that what in fact has caused all
this uncertainty was not the lack of supposedly needed legislation,
but rather silence on the part of the Treasury.

The opponents of collection provisions, in addition, have expressed
doubts as to the constitutionality of what they deem to be needed
implanting legislation.^** Their reasoning is as follows: Article 1, sec-

tion 8 of the Constitution provides that the Congress shall have the

power "to levy and collect taxes, duties, imposts, and excises to pay
the debts and provide for the common defense and general welfare
of the United States." Therefore, "this authorization does not en-

visage the collection of taxes for a foreign government."^*^ Further-

more, they reason: "It is equally clear that the purpose behind this

Constitutional grant of authority has not been extended by the

enactment of the Sixteenth Amendment so as to include the right to
collect foreign taxes or otherwise enforce the revenue statutes of a

foreign government."^*® However one feels about this argument, the

^*^1951 Hearings, supra note 31, at 23 (statement of Mitchell B. Carroll, National

Foreign Trade Council).

"Yd at 27-28.
"»/d at 29.

"Vd at 37-38, 73.
"Yd at 36.
"Yd at 30.



1979] INTERNATIONAL TAXATION 371

fact is that many extremely important questions remain
unanswered.

The use of the terms "finally determined" and "definitely due" in
reference to claims eligible for enforcement have raised many inter-
pretative difficulties.^*^ A threshold distinction must be made as to
whether such claims are in the nature of a judgment or something

less, such as an administrative assessment. As noted before/*® the
League of Nations was quite clear that the claim must be beyond all
avenues of appeal and, therefore, a final judgment was required.
However, this intent was later blurred by its abandonment of "res
judicata" in favor of "finally determined" and "definitely due."^*^ In

the Swedish Treaty of 1939, the accompanying Protocol states that

"finally determined" is to mean "claims which are no longer ap-
pealable, or which have been determined by decisions of a compe-

tent tribunal, which decision has become final."^^° The problem with
this definition is whether "or" applies to "claims" or to "appealable."
If it applies to the former, it implies that an administrative assess-

ment is valid; if to the latter, it merely requires that all judicial and
administrative remedies have been invoked and decided.

One commentator has concluded that the United States, having
in mind the term "res judicata" to mean beyond all possibility of
appeal, chose to use "finally determined" in order "to represent a

difference not only in phraseology but also in substantive effect," in-

tending this term to mean "only that it must be based upon an
assessment by an administrative body."^^^ In light of the use of
"finally determined" by the League of Nations and the reason sug-
gested for such a change, this above conclusion is of doubtful validity.

No matter whether one chooses to take the administrative
assessment route or the judgment route, there are further questions
that must be answered. Within the realm of allowing an ad-
ministrative assessment to form the basis of a claim for collection

assistance, the most often heard complaint is that of allowing the
case to be heard on the merits in a foreign court. It seems to always
be assumed that a claim based on an administrative assessment can
be tested on the merits, thus causing a foreign court to interpret

complicated tax laws.^^^ It has been suggested that not allowing the

taxpayer to contest the claim on the merits in a foreign court would

"^See Note, International Enforcement of Tax Claims, 50 CoLUM. L. Rev. 490,

496-98 (1950).

^**See text accompanying note 125 supra.

**^See text accompanying note 133 supra.

^^Convention with Sweden on Double Taxation, Mar. 23, 1939, United States-
Sweden, art. XXII, para. 12, 54 Stat. 1759, T.S. No. 958.

'"Note, supra note 147, at 498.

^^^See Leflar, supra note 2, at 218.



372 INDIANA LAW REVIEW [Vol. 12:341

violate the due process clause of the Constitution, and thereby

relegate the claim to an administrative assessment, placing the

claim in a better position than a judgment which must at a minimum
comply with notions of competency, jurisdiction, and notice. ^^^

Furthermore, the question is raised as to whether one in a state

which applies the Act of State Doctrine will be in a position to ques-

tion the tax on the merits. However, there is considerable doubt as

to whether this doctrine, limited in any event to a very few coun-

tries, will protect the revenue laws of a foreign state. As one source
has stated:

In the language of the Sabbatino decision, it involves the

'Validity of the public acts a recognized foreign sovereign

power commit(s) within its own territory." "Act of State"
refers to "public acts" which have been completely "ex-

ecuted" within the foreign territory, as distinct from

executory court judgments or penal or revenue laws whose
enforcement is sought abroad.^^*

In support of the validity of administrative assessments is quite

simply the fact that they are easier to get than judgments. This is

so because the United States tax jurisdiction reaches further than

its adjudicatory jurisdiction. But countering this perhaps more
desirable interpretation is the notion that the requirement of a judg-

ment with its more limited reach has a constraining effect on a coun-
try's tax laws by saying the country can have all the country can

get but the country can get only what its courts can reach.
Therefore, those taxpayers who feel that the reach of the United
States taxing jurisdiction is justified will be more susceptible to
arguments in favor of the validity of administrative assessments;

those opposed to the extent of the United States tax reach will tend

to favor the more limiting requirements of a judgment.
If one concludes that judgment is to be the intended require-

ment, there exists a further range of possible interpretations. One
possible approach would accord the foreign tax judgment the same
status as that of a state or federal tax judgment. Although the

foreign tax judgment could not be challenged on the merits, it would
still be subject to a variety of defenses; ie., lack of jurisdiction, lack

of notice, or lack of competence.^^^ But, inasmuch as assistance is

often needed to reach those who are neither citizens nor domi-
ciliaries of the applying state, the defense of lack of in personam

^^1951 Hearings, supra note 31, at 20-21 (statement of Mitchell B. Carroll, Na-

tional Foreign Trade Council).

*^^H. Steiner & D. Vaghts. Transnational Legal Problems 588 (1968).
^''^Note, supra note 147, at 497.



1979] INTERNATIONAL TAXATION 373

jurisdiction would work to greatly inhibit the use of these collection
provisions. Again, one may not view this as being an overly burden-
some limitation if he feels that a taxpayer who is neither domiciled
in nor a citizen of the taxing state should not have been subject to

its taxes in the first place. An alternative to the above interpreta-
tion would be to regard the judgment as one to be enforced on the
basis of comity.^^®

At the other end of the spectrum of possible interpretations
from administrative assessment is the construction which gives the

judgment extraordinary treatment by barring all defenses to the
claim. Such a position, it is claimed, would be the only way to make
the collection provisions "fully effective."^^^ However, this inter-
pretation is subject to doubt, for such a status has been challenged

as "legally untenable, inasmuch as it might result in a violation of

the due process clause of the Constitution,"^^* as well as being an im-
practical solution by according a foreign tax judgment a more
favorable treatment than a state or federal tax judgment.

If and when the United States is asked to enforce a foreign tax
claim, the question will arise as to whether it will look to the

substance behind the claim or merely test it along the lines of pro-

cedural due process. ^^^

^^'See Eichel, supra note 5, at 67.
^^''1951 Hearings, supra note 31, at 21 (statement of Mitchell B. Carroll, National

Foreign Trade Council).

^^'The following examples show areas where the United States might want to test

a foreign claim on its merits.

The first claim to consider is that based on a discriminatory tax. There might be

two answers to this. The first is the public policy exception found in all existing

American general collection assistance agreements. The second answer is not to enter

into such assistance agreements with a state having a "discriminatory" tax system. If

one were to examine the legislative history of tax conventions, one would readily see

that a thorough scrutiny is made of the other country's tax system before an agree-
ment is signed. See, e.g., Joint Committee on Internal Revenue Taxation,
Legislative History of United States Tax Conventions (1962). If, at some later
date, a country were to engage in discriminatory practices, the United States could, if

it chose to do so, resort to the "public policy" exception and refuse to grant enforce-

ment to the tax claim. See Note, supra note 147, at 499. This defense of a

discriminatory tax system is of course more potent when made by a United States
citizen faced with a tax bill owed to another country but is enforced by the United

States.

A second consideration is whether, while enforcing a judgment or assessment
against a citizen of a third state, the United States will look behind the judgment or

assessment to see if the tax treatment applied to him is the same as that applied to

American citizens. That is to say, if France were to discriminate against Englishmen,

would the United States still enforce a claim against the Englishman for France? For-

tunately, a provision similar to that in the Swedish Treaty will remedy such a situa-

tion. United States Treaties and Other International Agreements, Mar. 23, 1939, 15



374 INDIANA LAW REVIEW [Vol. 12:341

There are several problems in attempting to discern an intended

method of collection because of the uncertainty generated by the
wording of these collection provisions. Additional problems concern

the possible unavailability of the Internal Revenue Code provisions
and the inability — or unwillingness — of the United States revenue
authorities to say exactly what procedures they intend to follow.
The problem here is not concerned with the methods to be used in
the other country, which is extremely uncertain in itself, but rather

what methods the United States must use. The methods to be used
will be determined only if the nature of the claim transmitted can be

adequately defined. The range of possible definitions can run from
looking upon these claims as strictly American,^^° to invoking what
the League of Nations suggested, or to using methods common to
both systems. ^^^ The task of determining how these claims were in-
tended to be viewed is certainly a hopeless one for the variations

among the treaties point in all directions.
The limitation along lines of nationality, which prevented the

operation of collection provisions against citizens, corporations, or

other entities of the state to which application was made, was in

response to a series of objections directed toward the unrestricted

application of these collection provisions. The most fundamental ob-
jection indicated the reluctance on the part of Americans to subject

themselves to taxation abroad if they felt the United States was
bound to place a lien or distraint on their property at the request of

a foreign government asserting the claim.^^^ Another closely related
objection concerned the possibility of an Amercian operating abroad
being subject to the added risk of levies which he justifiably felt

were arbitrary or were inconsistent with the principles of American
law. The result was that the United States, committed to collection
assistance, would be in the embarrassing position of having to

render help against its own citizen on what might be a completely
unjustified claim. ^®^ A further objection stated that the relationship
between citizens and the federal government did not contemplate
the federal government using citizens' contributions to enforce
foreign tax claims against them. Such an objection was certainly
reminiscent of a problem the League of Nations had experienced

U.S.T. 1824, T.I.A.S. No. 5656, modified and supplemented Oct. 22, 1963. However,

this limitation stops far short of the scope within which the negotiators have expressed

they would like to work.

'^See, 1951 Hearings, supra note 31, at 17 (statement of Mitchell B. Carroll, Na-

tional Foreign Trade Council).

'^'L.N. 1925, supra note 10, at 34-35.

^^^1951 Hearings, supra note 31, at 16-17.



1979] INTERNATIONAL TAXATION 375

concerning the possible distrust that might infect a domestic system

if part of the internal machinery had to respond to foreign claims

against its own citizens.^** Therefore, operation of these provisions
by the United States against its own citizens would put Americans
operating abroad at a disadvantage, inasmuch as it would remove
the limited liability protection against tax claims enjoyed by most

aliens/®^

Many questions of the interpretation and allocation of tax
burdens placed on American business abroad had been negotiated

for years with competent tax authorities of the foreign country

without any assistance from Washington. Thus, the added leverage

given a foreign tax administration by these collection provisions was
met with understandable concern by taxpayers. Because of this added
leverage, it was also assumed, due to the growing influx of
American business abroad, that these provisions were of greater in-
terest to foreign governments than to the United States, and that

Americans should therefore not be willing to so readily accede to

such provisions.

An interesting objection stated that the American policy of
political sanctuary, long afforded aliens, should be extended to their

property as well, for without such an extension, the United States

might find itself in the position of allowing political asylum to an

alien while simultaneously attacking his property on behalf of the

country from which safety was sought.^*® The objection goes further
to include the possibility that collection provisions might prevent a

taxpayer from placing property in the United States for safekeep-

ing, looking toward the day he might have to seek refuge from

adverse political developments at home.

A broader concern, perhaps including much of the above, is
possible interference with the free flow of capital caused by collec-

tion provisions. Contrary to the broad purpose of tax treaties to

eliminate trade barriers, these collection provisions could cause un-

natural shifts in capital as well as delay the more important prom-
ulgation of substantive provisions on double taxation.^®^

Finally, the most pervasive of all taxpayer concerns is the

possibility of having to defend against a United States tax claim be-

ing executed by a foreign procedure which does not meet the
American concept of due process. As this notion has permeated so
much of the discussion of other problem areas, it is noted here only
to emphasize the fear generated by taxpayer uncertainty when

'""'L.N. 1925, supra note 10, at 26.
^^^1951 Hearings, supra note 31, at 41.

'''Id. at 39-40.

'''L.N 1946, supra note 32, at 46.



376 INDIANA LA W REVIEW [Vol. 12:341

these agreements are entered into with countries whose notions of
notice, jurisdiction, and competence differ from the American notions.
Much of this fear has often been encouraged by the possibility of a
taxpayer having to face an overzealous tax collection machine which

operates outside of the foreign country's judicial process. It has

been sought to counter these doubts by again indicating the need

for a certain latitude of discretion to rest in those who would ad-
minister these provisions. But assurances by the authorities that re-

quests for assistance will only be made in rare cases and with due
consideration for maintaining the taxpayers rights have failed to

allay these apprehensions.'168

C. The 1977 Model Convention

The purpose of the 1977 Model Convention is not to question the
principles and general structure of the 1963 Draft Convention,^^® but

rather to scrutinize all the questions of a legal, theoretical, or prac-

tical nature which have arisen in the intervening years.'^" In draft-

ing the 1977 Model Convention, it has been possible in several in-
stances to broaden or alter the texts of certain articles.^^^ Conse-

quently, this work has produced a much clearer and more specific
text and official commentary.

Nevertheless, the O.E.C.D. Committee on Fiscal Affairs con-

siders that, in regard to its work in the 1977 Model Convention, the
most important results are those reflected in the Commentaries on

the Articles.^^^ These commentaries have definitely, in every way,

clarified many of the issues or doubtful points created by the 1963
draft.

Briefly stated, the following are some of the most noteworthy
improvements brought about in the 1977 Model Convention. Article

"""See 1951 Hearings, supra note 31, at 58-61. The 1972 O.E.C.D. revision, under

the Commentary of Article 25, provided for a mutual agreement procedure, whereby a

United States corporation may apply to a competent Treasury Department authority
to appeal a mere risk of incorrect taxation, but not in accordance with the convention

of a particular country. In the procedure, states can authorize competent authorities to

settle questions of double taxation who can call on the O.E.C.D. Fiscal Commission for
guidelines. Carroll, supra note 43, at A-22-23.

^*^See O.E.C.D. Model Treaty, supra note 21.
'''Id.

"'See, ie., art. 5 (Permanent Establishment), paras. 3 & 4; art. 9 (Associated
Enterprises), para. 2; art. 17 (Artists and Athletes), para. 2; art. 19 (Government Ser-

vice); art. 21 (Other Income), para. 2; art. 24 (Non-Discrimination), para. 5; art. 25

(Mutual Agreement Procedure), paras. 1 & 2.
"Hd, see, ie., the commentaries on arts. 5 (Permanent Establishment), 10

(Dividends), 19 (Government Service), 24 (Non-Discrimination), 25 (Mutual Agreement

Procedure), 26 (Exchange of Information).



1979] INTERNATIONAL TAXATION 317

7, paragraph 1 aims at the establishment of a fair tax regulatory

system for the revenue obtained through a permanent establish-
ment. Article 7, paragraph 1, parallels Article 9 on associated enter-

prises and employs the well known "arm's length clause." Under
such a clause, only profits attributable to the permanent establish-
ment can be taxed by the country or cou^^^-i^s where that establish-
ment is located. Article 9 (Associated Enterprises), 11 (Interests)
and 12 (Royalties) seek to avoid excessive tax payments and make it
possible for the parties to readjust the target base to which the

taxes are applied. Article 9 also touches upon the adjustment of
taxes by the other contracting state and makes a modest attempt to
avoid excessive double-taxation by recommending a readjustment In
both directions.^^^

Turning from the subject of tax avoidance. Article 26 (Exchange

of Information) deals with tax evasion. Although the 1963 Draft Con-

vention contained an abbreviated form of Article 26, the 1977 Model
has expanded quite significantly upon the material, introducing, in-
ter alia, the new concepts of automatic and spontaneous exchange of
information.^^^

V. Conclusion

Although most recent tax treaties include clauses aimed at
avoiding cases of economic double taxation, specifically those which

follow the Model Treaty, problems involved in establishing a
framework for agreement and dependability are a very complex
task. Beyond even the traditional problem of general apathy on the
part of the governments and taxpayers, there are still serious dif-

ficulties in reaching a common ground of agreement. In the past, ef-
forts at a model convention have either put forth such a strict model
that no one could agree to any substantial provisions while attempt-

ing to implement the model, or have adopted the overly broad prin-

ciples established by the League which, while being accurate in
what they portray, do not establish any tangible tools with which
two countries can negotiate.

Now that we have a more sophisticated and precise model con-
vention which, rather than laying down a strict path to follow, sets
out some methods of approach to the problem, the O.E.C.D. and

other international organizations ought to continue their efforts to

^^^Van Hoorn, Problems, Possibilities, and Limitations with Respect to Measures

against International Tax Avoidance and Evasion, 8 Ga. J, Int'l & Comp. L. at 768
(1978).

^^"O.E.C.D. Model Treaty, supra note 21, at Commentary, art. 26, No. 9 (b) & (c),
186.



378 INDIANA LAW REVIEW [Vol. 12:341

create more definite methods of implementation/^^ These methods
will not necessarily result in a multilateral harmonization of inter-

national tax enforcement procedures, but they will at least enable

countries to reach some workable agreement. Judging from the past
dirth of agreement in this area, such a result would be a significant

step forward.

^^^Among other activities in this respect, the United Nations Group of Experts on

Tax Treaties between Developed and Developing Countries (U.N. Group of Experts)
has held seven meetings between 1968 and 1977. To date, seven reports have been
published by the United Nations under the title. Tax Treaties Between Developed and
Developing Countries. Each report is divided into two parts, one being a summary of
the proceedings, the other including a suggestion and consideration prepared by the

Secretary General on behalf of the Expert Group. The reports bear, respectively, the
following document numbers: U.N. Doc. E/4614-ST/EC/110 (1969); U.N. Doc.
E/4936-ST/EAC/137 (1970); U.N. Doc. ST/EAC/166 (1972); U.N. Doc. ST/ECA/188 (1973);

U.N. Doc. ST/ECA/18 (1975); U.N. Doc. ST/ESA/42 (1976); U.N. Doc. ST/ESA/78 (1978).