Foreign Direct Investments (FDI)
Countries have the fundamental choice to impose tax on a worldwide or a territorial basis. Most countries chose to tax their residents on their worldwide income. The taxation on a worldwide income basis implies capital export neutrality and taxation on a territorial basis implies capital import neutrality. The provisions in tax treaties to avoid double taxation are the Credit and Exemption Method.
The general idea of Capital Export Neutrality (CEN) and Capital Import Neutrality (CIN) is that economic decisions made by acting entrepreneurs should not be influenced by taxation. According to the definition, "export neutrality means that the investor should pay the same total (domestic plus foreign) tax whether he receives a given investment income from foreign or from domestic sources, and "import neutrality means that capital funds originating in various countries should compete at equal terms in the capital market of any country.
The basis and the application of the Credit Method and the Exemption Method in Tax Treaties can be found in Model Conventions. The concept of capital import neutrality and capital export neutrality get the hang of tax treaties by means of two methods to avoid double taxation. The tax exemption method (capital import neutral system) and the tax credit method (capital export neutral system) are commonly used in bilateral and multinational tax treaties.
An important feature of the OECD and UN models is the protection from manipulation of declared profits by multinational enterprises because of the use of manipulated transfer prices and thin capitalization as the two main forms. On the other hand, many national tax regulations provide tax relief to small firms and to firms that invest in research and development but this relieves are much harder to remove than to introduce.
The EC Treaty takes precedence over bilateral tax treaties negotiated between member states. The fundamental economic freedoms of the EC Treaty, especially free movement of persons, of goods, of services, of capital and of payments and freedom of establishment in connection with intra-Community investments affect bilateral tax treaties. To achieve this, taxation of income within the EC must be neutral in the sense of non-discrimination and non-restriction clauses.