The United Kingdom (UK) and the Great Socialist People’s Libyan Arab Jamahiriya (Libya) signed a double tax treaty in London on 17 November 2008. The treaty has not yet entered into force. This will happen when both countries have completed their legislative procedures. In the UK, the provisions were scheduled to come into force in early April 2009 but have been delayed. In Libya, they should take effect from 1 January 2010.
The UK-Libya double tax treaty is an example of how, in the past three years, Libya has carried out economic reforms as part of a broader campaign to integrate the country into the global capitalist economy. Libya also has a growing prominence among the African countries and, in February 2009, Brotherly Leader and Guide of the Revolution, Muammar Abu Minyar al-Gaddafi, was elected as chairman of the African Union.
Double tax treaties aim to reduce or eliminate the potential for double taxation of income or gains arising in or in relation to one contracting country. They do this by allocating the taxing rights of each contracting country. Double tax treaties often contain provisions to combat tax avoidance and evasion, usually by way of an information exchange between governments.
The UK has one of the largest double tax treaty networks in the world, having negotiated agreements with more than 100 countries. Apart from Libya, the UK has entered into treaties with other African countries, including Egypt, Ghana, Kenya, Morocco, Nigeria, South Africa and Sudan.
A simple example shows how double taxation can arise in an international context. Let’s suppose that a company is tax resident in country X and carries on business through a permanent establishment (such as an office) in country Y. As is typical, that company is subject to direct tax on its worldwide profits in country X and subject to direct tax on the business profits attributable to its permanent establishment in country Y. Let’s now suppose that the company’s worldwide profits are 100, with 40 of those profits being attributable to its permanent establishment in country Y. Without double tax relief in any form, 40 of the company’s profits would be subject to tax once in country Y and then again in country X.
Clearly this would act as a deterrent to the company to form a permanent establishment in country Y.
Double tax treaties (including the UK-Libya treaty) often reduce or eliminate this form of double taxation by allowing the country in which the permanent establishment carries on business to tax the profits of that permanent establishment, with the country in which the company is resident required to give credit for the foreign tax paid.
Double tax treaties also seek to reduce or eliminate domestic withholding taxes and to give credit in one country for tax that has been withheld in the other. Libya generally does not impose withholding tax on payments of dividends, interest and royalties. The UK generally imposes withholding tax on payments of interest (at the rate of 20 per cent) and on some payments of royalties. There is currently no UK withholding tax on payments of dividends but since 1 January 2008 the UK has imposed a withholding tax of 20 per cent on distributions by real estate investment trusts (or REITs).
Under the treaty (when it comes into force), there will be the complete elimination of source-country withholding taxes on dividends, interest and royalty payments, which is a first for a UK tax treaty with an African country. This is as a result of Libya being unusual among African countries (Mauritius is another) in not imposing withholding tax. The treaty provisions therefore do not change the domestic position in Libya, but somewhat alter the UK provisions with regard to interest and some royalty payments.
The UK is also in the process of signing a double tax treaty with Ethiopia. The terms of the treaty are not yet available; however, it would be a reasonable guess that there is unlikely to be a complete elimination of sourcecountry withholding taxes on dividends, interest and royalty payments as in the UK-Libya treaty. The domestic rule in Ethiopia is that withholding tax is imposed on payment of dividends (10 per cent), interest (5 per cent) and royalties (5 per cent). On the one hand, any reduction in the rates of withholding tax in the treaty could be viewed as disadvantageous to the Ethiopian Government in the short term as it will reduce its share of the cross-border tax “pie”. On the other hand, reduced withholding taxes should encourage UK investment in Ethiopia, as the cost of accessing cross-border finance in Ethiopia should reduce.
Alongside the double tax treaty network, some countries aim to reduce their residents’ exposure to double taxation through forms of “unilateral relief”. In other words, a resident of one country may be able to reduce or eliminate its exposure to the double taxation of its profits or gains in another country, even if its country of residence does not have a double tax treaty with that country. The UK is one of the countries that gives unilateral relief. A UK resident can, in principle, obtain unilateral relief even if the UK has a double tax treaty with the relevant country. However, unilateral relief is more restrictive than double tax relief: it can only give credit for foreign tax paid against the UK tax on the same income or gains. Relying on unilateral relief will be essential for UK residents in their dealings with residents of African countries with whom the UK has not concluded treaties.