Liechtenstein as a member of the European Economic Area (EEA) but not of the European Union, is obliged to implement the EU Directives and has implemented nearly all of them into its own law. Liechtenstein like Switzerland, Austria and Luxembourg takes pride in its privacy laws which have existed since the beginning of last century. The new law on due diligence enacted on 1 January 2001 has already included the provisions of the EU Directive on money laundering to become effective as at 15 June 2003.

Since 1st January 1995 Liechtenstein and Switzerland have had a treaty for the avoidance of double taxation in relation to interest from loans secured by mortgage, income from employment, and annuities and pensions. Prior to this double tax treaty special agreements existed with certain Swiss Cantons regarding taxation of succession and donations. Even without such agreements the hitherto applied rules will continue to be respected.

Another tax treaty which covers a broader tax field was concluded with Austria. However this tax treaty does not apply to the so-called tax-privileged (domiciliary and holding) companies if the shareholders are domiciled outside of Liechtenstein.

The Liechtenstein tax law does not provide extensive rules for the avoidance of double taxation and there are many situations under which double taxation may occur for which the law does not provide remedies, especially for legal entities. However, the tax administration is often willing to grant relief from Liechtenstein taxes in cases where its residents are subject to tax both in the country of source of the income and in Liechtenstein in a manner which it considers unfair. Besides this, the local taxes have sought to take into account the Liechtenstein competition in the international financial environment.

The Liechtenstein domiciliary and holding companies which are not taxed on their profit, which is normally derived from proceeds outside of Liechtenstein, do not suffer any double taxation as the tax already paid abroad is not further taxed in Liechtenstein.

As with other small countries which offer a special favourable tax regime Liechtenstein experiences the pressure from "high tax" countries and organisations under their control. Various countries like Gibraltar, Isle of Man, Cyprus, have adjusted or are adjusting their tax laws in order to meet the criteria set by the OECD.1 Other countries like Ireland are reducing their income tax to a favourable and attractive rate, however have to cope with defensive measures by their neighbours which raise higher taxes.

The UK government for example has proposed the removal of Ireland from the list of countries in which Controlled Foreign Companies enjoy automatic exemption from the UK's CFC rules. The decision announced on 23 July 2002, followed recent amendments to lower the corporation tax rate in the Republic of Ireland to 12.5 %.

Most high tax countries have a number of measures to avoid treaty shopping or the transfer of the taxable profit to low tax countries, e.g. through the CFC (Controlled Foreign Companies) legislation (or Subpart F legislation in the US or "Aussensteuergesetzgebung" in Germany).

High tax countries not satisfied with the existing net of measures to stop or reduce tax avoidance or evasion favour and try to force the implementation of a worldwide system of EXCHANGE OF INFORMATION using their membership of the OECD to achieve their objectives.

Cyprus for example has announced in the second half of 2002 the amendment of its tax laws in order to comply with the OECD and EU practice. It has further announced that once Cyprus will enter the EU (in 2005) the tax authorities will have to disclose information to other EU members under the EU directive 70/799 (Mutual Assistance). Disclosure will also follow with the respective treaty partners once the OECD draft for an agreement on exchange of information is introduced into international treaty practice. This amendment seems to be important to Cyprus so that it will no longer be considered as a supporter of international tax avoidance as evidenced by lack of effective exchange of information provisions.

Cyprus has an extensive network of double tax treaties. The companies falling within the range of the new tax law are supposed to benefit from the extensive treaty network.

This short article seeks to address whether on the basis of the OECD model tax convention on income and on capital a tiny country like Liechtenstein can hold on their existing clients living abroad if they start exchanging information with foreign tax authorities.

Discussion on the model tax convention on income and on capital of the OECD

The OECD model tax convention pursues – in the author's own words - the purpose of avoiding double taxation between two parties having any relationship through which there is a transfer of income or capital from one party to another.

The convention has introduced various measures to combat tax avoidance which could easily happen if a company has its domicile in a low tax country and all capital and profit is transferred to that company. One of such forms was the introduction of the concept of the "beneficial owner" or to look at the place of effective management and control of a company (substance test). The use of "Base Companies" or "Conduit Companies" has led an increasing number of OECD member countries to implement treaty provisions to counter abuse and to preserve anti-avoidance legislation in their domestic law. Quite often such legislation can be found in the double tax treaties and in the domestic laws. More and more treaty provisions have been or are being designed to cover these and other forms of abuse.

The OECD mentions for example in its draft contents of the 2002 update to the model tax convention from 2 October 2001 on page 5 to conduit company cases (commentary on the model tax convention2): Many countries have attempted to deal with the issue of conduit companies and various approaches have been designed for that purpose. One solution would be to disallow treaty benefits to a company not owned, directly or indirectly, by residents of the State of which the company is a resident. For example, such a "look-through" provision might have the following wording: "A company that is a resident of a Contracting State shall not be entitled to relief from taxation under this Convention with respect to any item of income, gains or profits if it is owned or controlled directly or through one or more companies, whereever resident, by persons who are not residents of a contracting state." Contracting states wishing to adopt such a provision may also want, in their bilateral negotiations, to determine the criteria according to which a company would be considered as owned or controlled by non-residents. The "look-through approach" underlying the above provision seems an adequate basis for treaties with countries that have no or very low taxation and where little substantive business activities would normally be carried on. Even in these cases it might be necessary to alter the provision or to substitute for it another one to safeguard bona fide business activities.

Germany for example extensively applies the "look through" approach and there are numerous cases where companies having their statutory domicile in Delaware, England, Cyprus or Liechtenstein were simply considered as transparent and the income was attributed to the German ultimate beneficiary even though management and control was in the countries of statutory domicile (or at least not in Germany (for Delaware)). Quite often the company's existence was also disregarded.

Article 10 of the OECD model tax convention points out that (1) dividends paid by a company which is a resident of a contracting state to a resident of the other contracting state may be taxed in that other state; (2) however such dividends may also be taxed in the contracting state of which the company paying the dividends is a resident and according to the laws of that state, but if the beneficial owner of the dividends is a resident of the other contracting state, the tax so charged shall not exceed 5 or 15 per cent (remark: depending upon the conditions as stated in the article).

The clause "beneficial owner" makes it clear that the state of source does not have to give up its taxing rights over dividend income merely because that income was immediately received by a resident of a state with which the state of source had concluded a convention. The term "beneficial owner" may be used in a very broad sense to avoid double taxation and prevent fiscal evasion and avoidance. "The report from the Committee on Fiscal Affairs entitled "Double Taxation Conventions and the Use of Conduit Companies" concludes that a conduit company cannot normally be regarded as the beneficial owner, if though the formal owner, it has, as a practical matter, very narrow powers which render it, in relation to the income concerned, a mere fiduciary or administrator acting on account of the interested parties." (see draft contents of the 2002 update to the model tax convention dd. 2 October 2001 by the OECD, page 22, commentary on article 10, point 12.1)

The OECD's commentary on dividends (Art. 10 of the model tax convention) sets forth that the limitation of tax in the state of source remains available when an intermediary, such as an agent or nominee located in a contracting state or in a third state, is interposed between the beneficiary and the payer but the beneficial owner is a resident of the other contracting state.

In the light of the above discussion it would be interesting to analize how many double tax treaties signed with low tax countries will be effective as long as the ultimate beneficiaries are domiciled in the source (high tax) country of the income. It is a fact that companies in low tax countries have quite often a low infrastructure and are not extensively staffed because there is simply no need for performing the trading and holding activities. The usual attitude of high tax countries will be to treat such companies as "conduit companies" and generally apply CFC rules.

It is also noteworthy that many directors of the corporate taxpayers concerned, located in states which have signed double tax treaties, do not know the ultimate beneficiary in the sense of the commentary. Nevertheless the double tax treaties are applied as the companies show sufficient substance and the management and control principle is applied, or simply because such taxpayers (companies) are located in high tax countries and act as nominees. Compared to earlier versions the OECD model tax convention seems to be more and more the instrument to combat low tax countries without consideration of a level playing field.

The interpretation and application of the model tax convention differ highly between the OECD member countries and others.


It would not be wise to give a prognosis as to where small countries will be in ten years. They will need to adapt and offer niche products. The abolition of existing favourable tax systems or the full exchange of information with high tax countries might cause the same or more damages as not taking the pressure in earnest and taking measures to deal with the OECD. In principle, high tax countries have already sufficient measures to avoid tax evasion and even counter legitimate avoidance. There remains also the bitter taste that any possible future double tax treaties with Liechtenstein would transfer the tax profit outside of Liechtenstein as long as the so-called ultimate beneficiary cannot move to the tiny country. It is hardly imaginable that Liechtenstein could sign double tax treaties obliging the contracting parties to give up any CFC practice with respect of Liechtenstein companies.

If however there were to be a level playing field in which the rights and needs of small countries are respected, there could be a platform to discuss the conclusion of double tax treaties where both countries or its resident persons (physical and juridical) benefit through sharing of profit. An exchange of information without adequate accompanying measures and concessions by the high tax countries cannot be considered as a "level playing field".

1 The OECD (Organization for Economic Cooperation and Development) has its seat in Paris and was founded in 1961. There are around 29 industrialized member states. Its purpose is the coordination of the policy on economic matters and development.

2 This commentary – like the model tax convention – is a recommendation to OECD members to use this convention for drafting a double tax treaty and/or to use the documentation for their application. Tax administrations, tax payers and courts will use more and more the convention and the commentary for any kind of tax matters. The commentary itself is not considered to be an interpretation of the convention, although there is a strong tendency to do so (in its own favour).

The article does not replace any legal consultancy, it is intended simply to provide general information. The Allgemeines Treuunternehmen offers a comprehensive range of services relating to the formation of companies, the provision of advice on legal and tax matters such as "family office". Supported by around 90 members of staff, our team of professionals ensures that clients receive individual attention. For more information please contact Roger Frick, Allgemeines Treuunternehmen, FL-9490 Vaduz.