UN Approaches for Taxing Cross-Border Services Raise Concerns

A two-pronged effort winding its way through the United Nations approval process may usher in a radical new approach to taxing cross-border services in many countries.

Developing countries in Africa, Asia, and Latin America—frustrated with what they see as unfairness in the two-pillar solution for international tax from the Organization for Economic Cooperation and Development—have turned to the UN to create an alternative international tax policy process that they could control through majority voting.

This new process took a leap forward on Aug. 16, when a UN ad-hoc committee adopted terms of reference for a framework on international tax cooperation that listed cross-border services as the first of two protocols to be developed over the next three years. More than 100 nations voted in favor of sending the proposal to the UN General Assembly for approval later this year, over the objections of the US and several allies.

At the same time, a UN committee of experts will meet in October to discuss a proposal called Article xx, which would be added to the UN model treaty to change the rules on withholding taxes on cross-border payments for services. It would radically expand the taxing rights of jurisdictions that import services from abroad.

For example, a design firm in one country may be hired and paid by a company in another country to produce a certain type of design. The design firm may do all the work at its home office and do nothing in the customer’s country. Article xx would permit the customer’s country to impose withholding tax on the payment to the design firm.

If the withholding tax were payable on the gross amount of the cross-border payment, the design firm most likely would suffer double taxation and might decide not to sell its services to customers in the taxing country in the future. This type of distortion of business decision-making is what good tax policy is meant to avoid.

Adopting Article xx in the UN model treaty would send an undesirable signal to governments around the world that it’s acceptable to impose withholding taxes on outbound service fees of all types. If withholding of tax from gross payments was permitted, the resulting overtaxation of international business would inhibit economic growth in both source countries and residence countries.

This two-pronged UN process could therefore result in a significant and detrimental change in taxation of cross-border services income. How it will play out is unclear. One possibility is that the committee of experts will approve, by majority vote, the addition of an Article xx to the model treaty that allows gross-basis taxation via withholding, and the negotiators of the framework and its early protocols will simply rubber-stamp that approach.

Alternatively, the committee of experts might end up approving a more moderate version of Article xx that allows only withholding on a net amount of income from services, in which case the negotiators of the framework might take a divergent approach.

Multinational service providers and their advisers should start thinking about the potential consequences of new withholding taxes on service fees. If a particular market is important, the company might wish to avoid the risk of gross-basis withholding by establishing a permanent establishment in the country, thereby ensuring that income from local customers would be taxed on a net basis.

At a minimum, multinationals should be monitoring UN developments and taking advantage of any opportunities to provide input into the policymaking process. Notably, the committee of experts’ meeting in mid-October, which will be held in the UN’s complex in Geneva, is open to all interested parties, and observers are allowed to speak during the meeting.

A concerted effort to make the committee members aware of the policy concerns about Article xx might mitigate the harmful effects of adopting the proposal as it currently stands.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jefferson VanderWolk, partner at Squire Patton Boggs, was head of the tax treaty, transfer pricing, and financial transactions division at the OECD Center for Tax Policy and Administration.

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