Some fundamentals of the international tax system

Traditionally, the right to tax (or not tax) subjects has been the sole preserve of the sovereign and its parliament. This worked while most capital and citizens were static although freeports have existed since ancient times.

As an example, Jebel Ali was a free port long before Dubai became a modern tourism and finance centre. It was possible to form a Jebel Ali Freezone company (FZE) subject to a minimum capital requirement. A trader of commodities between Europe and Asia, for example, could buy widgets for $10.00 in Asia, sell them to their Jebel Ali FZE for $20, then deliver them to an agent in Rotterdam for $30. Only half of the sale price was exposed to tax for the contract performed at the port of delivery.

These days, the freedom of states to set their own tax rates has been restricted by pressure from international organizations. The Financial Action Task Force (FATF) was set up in 1989 to counter money laundering. Low or nil tax rates and inadequate supervision were seen as harmful practices akin to attracting the proceeds of crime. The FATF became politicized with perceived rates of wealth inequality increasing.

The rise of international dotcom business, able to trade from anywhere, gave rise to multilateral Base Erosion and Profit Shifting (BEPS) agreements permitting states to tax some transactions that would otherwise escape their domestic tax net. BEPS was known as the Amazon tax because many domestic taxes and double tax agreement rules only applied international transactions when the agreement was made in the state, there was a “dependent” agent in the state or the taxpayer had a physical presence in the state. Amazon and other dot com vendors were often outside the scope of such tax rules. The rule for the place and time of formation of a contract, was where the acceptance of an offer was posted.

The BEPS rules were in the process of being implemented when further multi-lateral agreements entered into by 130 states were entered into in 2021 known as Pillars 1 and 2. Pillar 1 allocates some taxing rights over very large and profitable multinations’, to states where they do business without a physical presence having to be established. Pillar 2 sets a minimum 15% rate of corporation tax.

In the case of individuals, capital became more mobile when exchange controls were lifted in the late 1970s. Individuals found ways to use the special attributes of individual states and territories. Some British Crown dependencies legislated for international business companies (required to trade outside their place of incorporation), with zero corporation tax rates.

Until around the 1990s, the UK had a policy of wishing to attract foreign banking and finance experts to the City and exempted them from UK tax on the income and gains of their assets retained outside the UK. This was the non-Dom rule. In general, before 2017, a individual born outside the UK would not be deemed to be UK domiciled until they had been resident for 17 of the last 20 UK tax years. Residence was assessed according to the number of days spent in the UK in a tax year. In one year, if more than half (183 days) or over 90 days on average over four years, then the UK would claim residence. Also, until 2019, a non-resident was able to buy and sell some UK assets without the gains being subject to UK Capital Gains Tax.

Employment and other active income from the UK and income from a fixed base was taxable in the UK even if it belonged to non-UK resident so, for most people, whether they are resident or not wasn’t, from a tax point of view, very important but; for wealthy mobile people, with passive income such as interest, royalties and dividends, it matters.

Generally, once a person or company is resident in a state, they may be taxable on their worldwide income. The UK exempts foreign passive income of non-doms subject to the ‘remittance basis’ rules. New Zealand and Aus don’t generally offer this exemption but they have a temporary transitional residence status, during which, passive from income is exempt.

Some international business centres such as Singapore and Hong Kong exempt the foreign income of their residents.

The UK updated its residence test in 2013. Tax rules are complex. This newsletter is not intended to be legal or tax advice. Please consult a tax adviser before selling an asset.

G7 Agree on Global Corporation Tax

On 5th June, 2021, the G7 announced an historic agreement on the reform of cross-border taxation of corporate profits.

All tax “law” is domestic law made by the governments, parliaments and sovereigns of particular states. Most cross-border corporate tax rules of individual states are however subject to the international tax treaties entered into by them.

International “law” principles generally require that the domestic tax laws of an individual state are subject to the international treaties or agreements (DTAs) that state enters into with other states. In New Zealand, the UK and other commonwealth states, treaties are embodied in domestic law by regulations made under the Income Tax Act. In New Zealand’s case, this treaty override principle is enforceable under its domestic law because the Income Tax Act 2007 s BH1(4) provides that a DTA has effect “despite anything in this Act”. See Also CIR v ER Squibb & Sons (NZ) Ltd (1992) 6 PRNZ 601 (CA) at 607.

Many DTAs are based on the OECD Model. According to the OECD Model, a company or person “carrying on” business in another state is not enough to trigger a “source” of taxable income in the other state or the other state’s right to tax the “profits” of that business.

DTA’s generally only allow a state to tax an overseas business if the overseas business has a Permanent Establishment (PE) or fixed base in that state.

Article 8(1) of the UK-NZ DTA, for example, includes:

“The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein.

If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment”.

The term Permanent Establishment has a meaning specific to DTAs. The requirement for a fixed base arose from the practice of cross border business in the post World War I era. This “compromise” (requiring a PE in the source state) before the source state has a right to tax the profits of the enterprise, has been the basis of the international tax treaty network since the 1920s.

Craig Elliffe stated in his 2018 International and Cross Border Taxation in New Zealand at 17.3.4,

“A vendor of goods and services can deal with a New Zealand purchaser without any need to perform any of the actions which could give rise to business being carried on in New Zealand”.


Since around the time of the 2009 Global Financial Crash and the rise and dominance of the giant digital businesses such Amazon, Google and Facebook, the OECD has pursued the project concerned with Base Erosion and Profit Shifting as a multilateral Action Plan “designed to deal with aggressive tax planning and tax avoidance” including to prevent “treaty abuse” by permitting a deemed PE to exist and other anti tax avoidance measures.

And “This area of e-commerce and the source rules is likely to be an area of considerable tax tension and change in the next decade”.

Place of Residence

Under principles of international law, companies are considered to be resident (and resident for local tax purposes) in their place of incorporation. Some states, such as the UK, also allow place of management to determine place of residence. When directors on a company permanently live in countries other than the place of incorporation, the place of management is determined according to where the key management decisions are made. See De Beers Consolidated Mines Ltd v Howe, 5 TC 213.

‘A company resides … where its real business is carried on … and the real business is carried on where the central management and control actually abides’.

The De Beers company was incorporated in South African and its main trading operations were there. The controlling board of directors exercised its powers in the UK. The company was held to be resident in the UK.

Many states ignore place of management and tax companies based on their place of incorporation only.


With residence established, if a company earns income in another country it may be subject to tax on part or all of its income twice: by the state in which it is “resident” and possibly by the “source” jurisdiction (the state where the income is earned).

Professor Craig Elliffe’s article, Justifying Source Taxation in the Digital Age (see link below) includes:

Most theories for the justification of tax fall loosely into two major categories. These are the benefit theory and the ability to pay theory. Convention views the benefit theory as supporting source taxation, whilst the ability to pay theory supports residence taxation.

The ability to pay has been linked to the place of residence because generally a company will have one main physical presence similar to its place of incorporation.

Prof Elliffe states regarding ability to pay and residence basis taxation that: The advantage of the ability to pay theory is that it simplifies the relationship to one of compulsion which then enables the state to determine how payments can be made to allocate expenditure, distribute and secure price-level stability and full employment. Furthermore, it positively reinforces the principles of progressive taxation. This principle suggests that taxpayers suffer a burden in proportion to their income which is why it is also sometimes described as the sacrifice theory.

The benefit theory relates to other territories whether the corporation does business where under “a concept of mutual benefit or relationship”, an individual returns “to the community a portion of the economic progress they have derived from the community”.

The benefit theory became “embedded in the current international tax framework”. The so-called 1920s compromise of allocating taxing rights between source and residence countries is an integral part of the rules which form the basis of the modern international tax system and the OECD double tax model.

“Taxing rights are available to the source state only provided that the non-resident enterprise maintained a PE (usually a fixed place of business) in that state through which the enterprise’s business was carried out”.

However, “one of the most significant tax issues of the 21st century has been the ability of highly digitalised businesses to carry out economic activity in the source state without establishing a physical presence or a PE”.

G7 Agreement

The 5th June 2021 G7 announcement stated that the agreement “on global tax reform”..”will mean that the largest multinational tech giants will pay their fair share of tax in countries in which they operate”.

The agreement contains two “pillars”.

Pillar One

The largest and most profitable multinationals will be required to pay tax on their profits of doing business in the countries where they operate. In other words, establishing a PE will not be required.

Conditions applicable to Pillar One are that the firm must

  • be global and very large.
  • have at least a 10% profit margin on its turnover.

Under Pillar One, 20% of the business’s profit on operations in a particular country over 10% would be “reallocated” from the residence to the source state and be taxable in the source state.

This would require amendments to the existing DTA network.

Pillar Two

The G7 agreed that globally and country by country, corporation tax should be at least 15%.

The intention of Pillar Two is for states to cooperate on aligning their corporation tax rates rather than competing with one another to attract tax payers to relocate from one to the other. Competition of this sort has the effect of pushing tax rates down and increasing inequality within individual states.