# **1. Introduction**

Double Tax Treaties (DTT) may contribute to investment and growth by avoiding double taxation and providing certainty in taxation rights, but they may also lead to considerable tax revenue losses. DTTs serve a range of purposes, including the limitation of countries’ taxing rights. They determine, for instance, how a country can or cannot tax foreign‐owned companies and payment flows. The treaty‐based allocation of taxing rights between capital receiving source countries and capital exporting residency countries has far reaching revenue implications. With more than 3,000 tax treaties in effect today, the global network is the foundation of the international tax architecture.<sup>1</sup> Presumed tax treaty benefits should include increases in trade and investment flows, increased investment certainty, tools to combat tax evasion, and strengthening of political relations between countries. These benefits come at a cost, typically reductions in applicable withholding tax rates and limitations on tax jurisdiction. In addition, recent international activities aimed at countering treaty abuse seek to address non negligible indirect costs linked to tax treaties, which are being used as part of aggressive tax planning strategies by companies and individuals.

Ukrainian treaties, as most tax treaties globally, are largely based on the OECD’s “Model Tax Convention on Income and on Capital”, which was initially published in 1963 and designed for countries with symmetric trade and investment relations. The UN has developed a similar model, first published in 1980, which aims to better capture interests of capital receiving developing (source) countries.<sup>2</sup> Both models are similar, based on the residency principle, and allocate exclusive taxation rights to residence countries for business profits, unless these are generated through a permanent establishment (PE) in the country. Regarding passive income, the models limit the primary taxing rights of source countries by introducing maximum rates.<sup>3</sup> In recent years the role of tax treaties has been re‐evaluated, most notably in the context of work led by the OECD aimed at avoiding or countering the abuse of tax treaty provisions.<sup>4</sup> For many countries, including Ukraine, a debate on tax treaty policy, however, needs to go beyond the avoidance of treaty abuse and involve a more structured analysis of what a desirable treaty network would look like. In practice, tax treaty policy has often been relatively neglected and not been subject to a proper analysis of cost and benefits. In light of a number of aggregate studies, associated costs may be substantial. UNCTAD (2015), for instance, estimates that 30 percent of global cross‐border corporate investment stocks have 1 For an introductory overview see: Owens, J. and Bennet, M., (2008) and Arnold, B. (2013).

2 UN (2011), Model Double Taxation Convention between Developed and Developing Countries. Daurer and Krever (2014) provide a more detailed discussion.

3 The UN model does not recommend specific rates. The OECD Model Convention proposes maximum withholding rates for dividends, differentiated for substantial (5%) and small ownership in in a company (15%), for interest payments at 10%, and royalties at 0%, thus effectively providing an exclusive taxing right for the resident country of the entity receiving royalty payments. The OECD suggests that the requirement for the lower dividend withholding rate applies to shareholders exceeding a 25% interest in the company paying the dividends.

4 In 2013, the BEPS plan was initiated by the OECD, with support of the G20 and international community. The acronym stands for Base Erosion and Profit Shifting and the BEPS package includes among others: model provisions to prevent treaty abuse; standardized Country‐by‐Country Reporting; a revitalized peer review process to address harmful tax practices; and an agreement on improving dispute resolution.

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