The next tax treaty battle: Who gets to tax cross-border services?

How the UN Framework Convention on International Tax Cooperation could reshape international taxation

For decades, international taxation relied on a relatively simple principle: a country generally needed a sufficient physical connection to a foreign business before it could tax its profits. Permanent establishment mattered. Offices mattered. Where people worked mattered. But the global economy has changed faster than the rules designed to tax it.

Today, a consulting firm can advise a client thousands of kilometres away. Technology, management, financial, and professional services can cross borders instantly, while the provider may have no office, employees, or traditional permanent establishment in the country where the economic benefit is received.

That raises a deceptively simple question: Who should have the right to tax that income? The answer may be starting to change.

The proposed UN Framework Convention on International Tax Cooperation, and particularly its protocol addressing cross-border services, could become an important step in reconsidering how taxing rights are divided between residence and source countries.

From physical presence to economic connection

Under traditional treaty architecture, business profits are generally taxable in the residence country unless the enterprise operates in the other jurisdiction through a permanent establishment. That principle worked reasonably well in an economy built around factories, offices, and employees. It becomes more difficult in an economy built around knowledge and remote delivery.

Consider a consulting firm in Country A advising a multinational in Country B. The work is performed remotely. There is no office or permanent establishment in Country B. Yet the advice is used there and may create substantial economic value there.

Increasingly, source countries are asking: If the income is economically connected to our market, why should physical presence remain the decisive factor? 

And this is not simply about Big Tech. Management fees, consulting, engineering, technology, professional services, and intra-group arrangements could all become increasingly relevant.

The question for multinational groups may therefore evolve from whether they have a permanent establishment to: where is the service economically connected, and which jurisdiction has the right to tax it?

The practical problem

Expanding source taxation is easier in theory than in practice. Withholding tax on gross payments may be administratively simple, but gross revenue is not profit. A professional services firm receiving USD 1 million may incur substantial salaries, technology costs, travel, and subcontractor expenses to generate that revenue. At the same time, if the source country taxes the payment while the residence country taxes the provider’s profits, double taxation becomes a real concern.

Rates, thresholds, sourcing rules, foreign tax credits, and coordination with thousands of existing bilateral treaties will therefore determine whether new rules create greater fairness or simply greater complexity.

Why Mexico should pay attention

Mexico sits on both sides of this equation: it imports substantial services from foreign providers while Mexican professional, technology, and other service businesses increasingly operate internationally. Changes in sourcing principles could therefore affect inbound payments, withholding taxes, treaty positions, transfer pricing, foreign tax credits, and the profitability of outbound engagements.

Businesses should not wait for a final convention to start asking the right questions.

For more than a century, international taxation has tried to determine where income is earned. Physical presence once provided much of the answer. Services are changing that equation. The next major tax treaty battle may not be about where a company has an office – it may be about where its services leave an economic footprint.

For multinational groups, this shift is a reminder that cross-border service arrangements can no longer be reviewed in isolation. Tax treaties, withholding obligations, transfer pricing, and the commercial terms of an engagement increasingly need to be considered together. The businesses that anticipate these changes will be better positioned not only to manage tax exposure, but to structure international growth with greater certainty.

---

Prof Sergio Guerrero Rosas, Managing Director at Guerrero y Santana, has over 25 years’ experience advising companies from SMEs to multinationals, as well as individuals, on tax and estate planning. He is also Global Vice Chair of the GGI Trust & Estate Planning (TEP) Practice Group.