Navigating economic diplomacy-II

Some scholars argue that investment treaties were signed by developing countries not because they expected any substantial benefits or were somehow pressured into signing them by the developed countries, but because the state leaders and their bureaucracies due to their lack of capacity failed to comprehend what the agreements entailed and just thought that it would project them as modern, liberal, and law-abiding actors in a post-Cold War world characterized by the rise of neoliberalism. It is also interesting that unlike some other forms of treaties, they were typically signed entirely away from the scrutiny of public glare and received little attention by parliaments, the press, or the public at large.

BITs, and Pakistan’s BITs are no exception, were rarely the result of developing countries securing their optimum national interests, contrary to what should be assumed from rational actors. Rather than conducting an unbiased search and assessment of information, and then engaging their counterparts from the developed countries by meaningful economic diplomacy to promote the state’s economic interests, they often based their expectations about the economic benefits of the treaties on wishful thinking.

Thus, reinforcing the criticism in modern literature that policymakers, especially in countries like Pakistan, are subject to intellectual limitations and are often prone to make mistakes. Their careers and job progression do not require engaging in cumbersome cost-benefit calculations when evaluating the implications of different policies and no systemic safeguards exist to ensure that their decision making is not swayed by systematic information processing biases.

Navigating economic diplomacy–I

Next, we come to the second and the more important network of bilateral treaties, known as the Avoidance of Double Taxation Agreements (DTAs). A global network of over three thousand bilateral tax treaties protects multinational companies from millions of dollars of tax payments on their foreign commercial activities. The first tax treaty that dealt with the avoidance of double taxation dates back to 1899 and was concluded between the Austro- Hungarian Empire and Prussia.

If the resident of one state, be it a natural person or a corporation, derives income from activities in another state, then the place where the income is generated is called the source country and the place where the individual or company resides is the resident country.

Both these countries have sovereign right to tax the income from the particular cross-border transactions, and if they do so international double taxation occurs, meaning that the same income is taxed twice, albeit by different countries. To prevent the double taxation, both the countries enter into bilateral DTAs.

The DTAs allocate and often limit taxing rights and impose obligations on both the contracting states. The DTAs are based on either the UN model that is widely believed to provide a fairer template for negotiations between lower-income and higher-income countries, and the more influential equivalent published by the Organization for Economic Co-operation and Development (OECD) that leans heavily in the favour of the higher-income countries.

Introduction to the UN Model treaty describes the role of DTAs in the words, “Broadly, the general objectives of bilateral tax treaties therefore include the protection of taxpayers against double taxation with a view to improving the flow of international trade and investment and the transfer of technology.”

DTAs are enforceable through domestic courts and tax treaties take precedence over domestic law in most countries. By agreeing to surrender their inherent taxing rights the contracting countries are effectively sacrificing their sovereignty.

Study after study by legal scholars has found that the rules governments have negotiated to divide the tax base among themselves, having been written by a club of higher-income countries, deny lower-income countries a fair share in the taxes paid by multinationals and others deriving income from their home countries.

Independent scholars contend that the real effect of tax treaties is often not to remove double taxation but to transfer most of the cost of doing so from the capital-exporting country to the capital importer. Research has found that capital exporting states have a greater motivation to relieve double taxation unilaterally, but they use treaties, drafted over decades by tax experts from higher-income countries to transfer most of the cost of double taxation relief to the capital-importing state.

This is achieved primarily by limiting taxation in capital-importing states. Many legal scholars doubt the benefits, if any, of DTAs in creating a fair global taxation system. Tsilly Daganin, “The Tax Treaties Myth”, argues that the main effect of these tax treaties is “regressive redistribution” or “aid in reverse - from poor to rich countries,” to benefit the developed countries at the expense of the developing ones.

Others believe that the success of the high-income states in negotiating ever more treaties has come at the expense of the tax revenue bases of low-income countries. Critics argue that tax treaties place too much of the burden of relieving double taxation on lower-income countries, rather than relieving double taxation, tax treaties between higher-income and lower-income countries merely shift the burden of doing so from the former to the latter.

The global tax system is said to be slanted in favour of paying taxes in the headquarters countries of transnational companies, rather than in the countries where raw materials are produced or the products are sold, thus depriving the poorer countries of precious revenues. Tax treaties have been pursued by developed countries as a way to protect their own business interests and to globally enforce the tax standards they have developed for themselves.

Copyright Business Recorder, 2024