OECD Model Tax Convention: Scope, PE, and Double Taxation Relief

The OECD Model Tax Convention on Income and on Capital is the template that governments use when they negotiate bilateral tax treaties with each other. Its job is narrow but important: when two countries both have a legitimate claim to tax the same income, the model tells them how to divide those taxing rights and how to make sure the taxpayer isn’t taxed twice on the same money. More than 3,000 bilateral tax treaties around the world are built on its structure, and the OECD’s Committee on Fiscal Affairs updates the text periodically to keep it aligned with how businesses and workers actually operate. The 2017 revision folded in the anti-abuse work from the Base Erosion and Profit Shifting (BEPS) project, and the most recent revisions were released in 2025.¹

Who and What the Convention Covers

Article 1 limits treaty benefits to persons who are residents of one or both of the countries that signed the treaty.² “Persons” covers individuals, companies, and other entities. The 2017 update added a transparency rule so that income flowing through fiscally transparent entities, like certain partnerships, gets treaty treatment based on where the partners reside rather than where the entity sits.³

Article 2 covers taxes on income and on capital, no matter how the country collects them. That umbrella reaches taxes on total income, wages, capital gains, and property. If a country introduces a new tax after signing a treaty and it is substantially similar to one already covered, the treaty automatically applies to that new tax.⁴

Residency Tie-Breakers

A treaty only works if each person is treated as a resident of just one country for its purposes. Article 4 handles dual-residency cases with a sequential test for individuals. The treaty first looks at where the person has a permanent home. If there is a home in both countries or neither, it moves to the country where personal and economic ties are closest, sometimes called the centre of vital interests. If that is still unclear, the test considers habitual abode, then nationality, and finally leaves the decision to the two governments through mutual agreement.²

Companies are handled differently after 2017. Earlier versions of the model automatically assigned residency to the country of “effective management.” The 2017 update replaced that with a case-by-case determination by the two tax authorities, reflecting how hard it is to pin management to a single location in a world of remote meetings and distributed leadership.³

Permanent Establishment: The Gateway for Taxing Foreign Businesses

Article 5 defines when a country can tax a foreign business operating within its borders. A permanent establishment is a fixed place of business where the enterprise carries out its activities. Common examples include a branch office, a factory, or a workshop. A building or construction project counts only if it lasts longer than twelve months. Without a permanent establishment, a foreign business’s profits generally remain taxable only in its country of residence. That threshold is the line between a country having no claim on the profits at all and being able to tax them.

The 2017 update expanded the definition in two important ways. It closed the “commissionnaire arrangement” loophole, where a company would use a local agent to negotiate and close deals while keeping the contracts in a different legal entity’s name. Under the revised Article 5, a person who habitually plays the principal role in concluding contracts that are then routinely completed without material modification by the enterprise can create a permanent establishment, even without formal signing authority.³ The update also tightened rules around activities previously treated as preparatory or auxiliary, making it harder for large enterprises to fragment operations across related entities and keep each one below the threshold.

Business Profits and Transfer Pricing

Once a permanent establishment exists, Article 7 governs how much profit that country can tax. The rule is attribution: the country where the permanent establishment sits can only tax the profits attributable to that establishment, not the enterprise’s global income. Profits are calculated as if the permanent establishment were a separate, independent entity dealing at arm’s length with the rest of the enterprise.

Article 9 extends the arm’s length principle to transactions between associated enterprises, particularly parent companies and their subsidiaries. When two related companies in different countries deal with each other, both tax authorities can scrutinize whether the pricing reflects what unrelated parties would agree to in an open market. If it doesn’t, either country can adjust the reported profits. This is the foundation of modern transfer pricing enforcement, and it is where most of the money in international tax disputes actually sits. The arm’s length standard is what prevents companies from funneling profits into low-tax jurisdictions through inflated management fees, below-market licensing charges, or other internal pricing strategies.

Dividends, Interest, and Royalties

Passive investment income follows a shared taxing model. Both the country where the income originates (the source state) and the country where the recipient lives (the residence state) get a piece, but the source state’s share is capped.

For dividends under Article 10, the source state’s withholding rate is capped at 5% if the beneficial owner is a company holding at least 25% of the paying company’s shares, and 15% otherwise. The 2017 update added a 365-day minimum holding period for the lower rate, so short-term holders cannot time their positions to capture the reduced withholding.³ For interest under Article 11, source-state withholding is limited to 10%, and many actual treaties negotiate that down further or eliminate it entirely. Royalties are the outlier: Article 12 grants exclusive taxing rights to the residence state, and the source state collects nothing. That is one of the sharpest differences between the OECD Model and the UN Model, which does allow source-state taxation of royalties.²

The caps serve a practical purpose. Without them, high withholding at the source can effectively shut down cross-border investment, because investors cannot always recover the full amount through foreign tax credits back home.

Capital Gains

Article 13 allocates taxing rights on capital gains by asset type. The general rule gives exclusive taxing rights to the seller’s country of residence, with a few carve-outs where the country in which the asset sits can also tax the gain.

Gains from selling immovable property are taxable in the country where the property is located, regardless of where the seller lives.
Gains on movable property forming part of a permanent establishment can be taxed in the country where the establishment is located.
Under Article 13(4), if shares in a company derive more than 50% of their value from immovable property in a country, that country can tax the gain on selling those shares. The threshold is measured over the 365 days before the sale, which prevents sellers from diluting the property value just before a transaction.⁵

All other capital gains fall to the residence state alone. Gains from selling publicly traded shares in a foreign company, for example, generally cannot be taxed by the company’s home country.

Employment, Directors, Entertainers, Pensions, Government Workers, and Students

Article 15 starts with a simple premise: employment income is taxable where the work is physically performed. If you live in one country and work in another, the work country gets first claim on those earnings. The 183-day exception prevents short business trips from creating foreign tax obligations. The residence state keeps exclusive taxing rights only when three conditions are all met: the employee is present in the work country for no more than 183 days in any twelve-month period, the employer is not a resident of the work country, and the salary is not borne by a permanent establishment there.² All three have to be satisfied at once. Miss any one and the work country can tax the income.

Articles 16 and 17 give the source state broader taxing rights in two situations. Directors’ fees are taxable in the country where the paying company is resident, even if the director never sets foot there. Entertainers and athletes can be taxed in the country where they perform, no matter how brief the engagement. Private pensions run the other direction: under Article 18, pensions paid for past employment are taxable only in the country where the retiree lives.²

Article 19 creates a separate regime for government employees. Salaries paid by a country for services rendered to that government are taxable only by the paying country. If you work for Country A’s embassy in Country B, Country A taxes your salary and Country B leaves it alone. The exception: if the employee is a national and resident of Country B, the taxing right flips to Country B. Government pensions follow the same pattern. None of this applies when the services relate to a commercial business carried on by the government; those fall back to the ordinary employment rules in Articles 15 through 18.

Article 20 protects students and business apprentices studying abroad. Payments received for maintenance, education, or training are exempt from tax in the host country, so long as those payments come from sources outside that country.⁶ The exemption covers living allowances and educational costs. It does not cover employment income the student earns locally.

How Double Taxation Actually Gets Eliminated

Assigning taxing rights is only half the work. Article 23 provides two methods that the residence state can use to relieve double taxation once the source state has exercised its right.

Exemption Method

Under Article 23A, the residence state simply excludes the foreign-sourced income from the taxpayer’s taxable base. If Country B taxed your rental income from property there, Country A (where you live) does not tax it again. Country A can still factor that income in when setting your tax rate on everything else. This “exemption with progression” prevents people from artificially dropping into a lower bracket by earning income abroad.⁷

Credit Method

Under Article 23B, the residence state taxes all worldwide income but gives a credit for the tax paid abroad. The credit cannot exceed the amount of tax that would have been due on that income under domestic law. The taxpayer effectively pays whichever country’s rate is higher. If the source state charged 20% and the residence state’s rate on that income would have been 30%, the taxpayer owes the residence state the 10% difference. If the source state’s rate was higher, the credit covers the full residence-state liability on that income, but the excess foreign tax typically cannot be used to offset other domestic income.⁷

Non-Discrimination

Article 24 stops countries from using their tax systems to disadvantage foreign nationals or foreign-owned businesses. A foreign national living in a country cannot be taxed more heavily than a local national in the same circumstances. A foreign company’s branch cannot face a heavier tax burden than a comparable domestic business doing the same work. A domestic company cannot be taxed differently just because its shareholders are foreign. And interest, royalties, and similar payments to a foreign resident must be deductible on the same terms as payments to a domestic resident, so countries cannot selectively deny deductions for cross-border payments.

These protections do not require two countries to apply the same tax rates. They require equal treatment of similarly situated taxpayers. A country can still tax foreign-source income differently from domestic-source income, as long as the distinction is not based on the taxpayer’s nationality or the ownership structure of the business.

Anti-Abuse Rules

Treaty shopping, meaning routing investments through a country purely to access its treaty network, was one of the biggest problems the 2017 update was written to address. The new Article 29 added two major tools.³

The principal purpose test (PPT) is the broader tool. A treaty benefit can be denied if it is reasonable to conclude, based on all the facts, that obtaining the benefit was one of the main purposes of the arrangement. The taxpayer can still keep the benefit by showing that granting it would be consistent with the treaty’s objectives. In practice, a holding company created in a treaty jurisdiction with no real economic substance and no purpose beyond accessing reduced withholding will likely fail the PPT.

The limitation-on-benefits (LOB) clause takes a more mechanical approach. It defines categories of “qualified persons” automatically entitled to treaty benefits: individuals, governments, publicly traded companies, subsidiaries of publicly traded companies meeting specific ownership thresholds, and recognized pension funds and nonprofits. Other entities must pass an ownership-and-base-erosion test showing that at least 50% of their shares are held by qualified residents and less than 50% of their gross income is paid out as deductible payments to non-residents.⁸ Countries can adopt the PPT alone, the LOB alone, or both. The 2017 OECD Model includes both as the default.

Dispute Resolution and Information Exchange

When a taxpayer believes one or both countries are applying the treaty incorrectly, Article 25 provides the mutual agreement procedure (MAP). The taxpayer presents the case to the tax authority of the country where they reside, which then negotiates directly with its counterpart in the other country. The goal is a resolution that eliminates the double taxation, even if it requires departing from the strict wording of domestic law.⁹

Since 2017, the OECD Model includes mandatory binding arbitration in Article 25(5). If the two authorities cannot resolve a case within two years from the date both received the necessary information, the taxpayer can request that unresolved issues go to arbitration. The UN Model uses a three-year window.⁹ Not every actual treaty includes this provision; many countries still resist binding arbitration as an encroachment on sovereignty.

Article 26 allows tax authorities to share taxpayer information with each other to combat evasion and verify assessments. Information exchanged must be kept confidential and used only for tax purposes. Three modes exist: on request (one country asks another for specific data), automatic (systematic sharing of bulk data such as bank account balances), and spontaneous (one country proactively sends information it thinks the other would find relevant). Article 27 goes further and lets countries help each other collect unpaid taxes, though it is adopted less widely, since many countries are reluctant to spend their own enforcement resources chasing another government’s debts.

The MLI and What Comes Next

Renegotiating thousands of bilateral treaties one by one to incorporate the BEPS changes would have taken decades. The Multilateral Convention to Implement Tax Treaty Related Measures, commonly called the MLI, was built to avoid that. Adopted in November 2016 and signed by 107 jurisdictions as of early 2026, the MLI lets countries modify their existing bilateral treaties simultaneously by specifying which BEPS provisions they accept.¹⁰¹¹ Where both treaty partners have adopted the same MLI provision, it supersedes the corresponding clause in their bilateral treaty.

Beyond the MLI, the OECD’s two-pillar framework is the most ambitious restructuring of international taxing rights in a century. Pillar One would reallocate a portion of taxing rights to “market jurisdictions” where customers are located, targeting the largest multinationals with revenues above €20 billion and profitability above 10%. As of early 2025, the multilateral convention for Pillar One remained unsigned and the text was still under negotiation.¹² Pillar Two is further along and establishes a 15% global minimum tax on large multinationals, with dozens of jurisdictions already having enacted implementing legislation. Pillar Two does not operate through the treaty network directly, but it reshapes the incentive landscape that treaties were originally designed to manage.

OECD Model vs. UN Model

The OECD Model is not the only template in use. The United Nations Model Double Taxation Convention offers an alternative that preserves stronger taxing rights for source states, reflecting the priorities of developing countries that more often host foreign investment than export capital. Three differences show the split most clearly. On the permanent establishment threshold, the OECD Model requires construction projects to last more than twelve months; the UN Model cuts that to six and adds a “services permanent establishment” concept with no OECD equivalent. On royalties, the OECD Model exempts them from source-state tax entirely, while the UN Model allows source-state taxation at a negotiated rate. On dividends, the OECD Model caps source-state withholding at 5% or 15%, while the UN Model leaves the rate open for bilateral negotiation, often producing higher withholding.

In practice, treaties between developed countries follow the OECD Model closely. Treaties between developed and developing countries often blend elements of both, with the developing country pushing for stronger source-state rights. The choice of model shapes who gets the revenue, which is why negotiations between countries at different stages of economic development can be contentious. Figuring out which model a specific treaty is built on is usually the first step in working out what rights a taxpayer or a tax authority actually has under it.

1
OECD. The 2025 Update to the OECD Model Tax Convention
2
National Tax Service (South Korea). OECD Model Tax Convention
3
OECD. 2017 Update to the OECD Model Tax Convention
4
IBFD. Taxes Covered under Article 2 of the OECD Model
5
United Nations. OECD Model Tax Convention – Article 13 Explained
6
OECD iLibrary. Model Tax Convention on Income and on Capital 2017 (Full Version)
7
United Nations. United Nations Model Double Taxation Convention between Developed and Developing Countries 2011 Update
8
United Nations. New Article 29 (Entitlement to Benefits)
9
United Nations. Mutual Agreement Procedure (MAP) – Article 25 of the UN Model
10
OECD. BEPS Multilateral Instrument
11
OECD. BEPS MLI Signatories and Parties
12
OECD. Multilateral Convention to Implement Amount A of Pillar One