7.1 The issue

Legal entities are usually not fully autonomous but are part of a larger economic unit. There is often a certain connection with other legal entities, for instance if a legal entity holds all or part of the shares in another legal entity. The question arises whether the fact that a legal entity is part of a group has or should have consequences for the way in which this legal entity is taxed. In many countries, a corporation is considered to be an independent legal entity for the purpose of profit taxation. In principle, such a legal entity is therefore taxed separately from its shareholders. But various provisions of national corporate tax laws do not always consider companies to be stand-alone entities. The underlying reasoning for this is, in essence, that the mere following of legal reality would lead to double taxation and would create opportunities for tax avoidance.

The OECD MTC is based on the separate entity approach. The fact that an entity is part of a group currently has a relatively limited impact on the way in which tax treaties are applied to this entity. On several points the OECD MTC provides for a partial group approach. The arm's length principle, which is a key element of the OECD MTC, is not capable of – fully – taking into account the group relationship. The connection between group entities leads to economies of scale, economies of scope as well as shared costs. Therefore, the profits of the group as a whole are higher than the profits of the individual group members would have been had they been truly separate legal entities. Due to the synergy benefits in the case of group companies, these companies cannot be compared to independent entities. Additionally, the various provisions in the OECD MTC that do take into account that entities may be part of a group or prescribe a group approach do not show a clear trend: different explicit and implicit group definitions are used and the objectives pursued by taking the group situation into account differ.

The legal approach taken for taxation purposes does not align with economic reality and does not seem to fit in today's internationally oriented world: it leads to double taxation and offers opportunities for tax avoidance. A multitude of ad hoc rules have been implemented in trying to solve this tax issue, for instance at the level of tax treaties. But still, the single legal entity is the starting point for these amendments and so-called solutions. This approach has created a complicated and fragmented system. The aim of this research was to solve this issue. The problem statement is:

To assess whether the current treaty rules of the OECD MTC for group entities are in line with the object and purpose of tax treaties, or whether changes are required, the objectives as included in the OECD MTC have been assessed. The main objectives are to avoid double taxation, without creating opportunities for non-taxation or reduced taxation through tax avoidance. The promotion of cross-border activities is the main underlying objective of tax treaties. All in all, the OECD strives for a neutral system (i.e., economic processes should be distorted as little as possible by taxation): there should be no double taxation and no unintended double non-taxation.