Taxation of services in defence contracts: UN tax work pushes to change the rules
Most international contracts for the sale of defence equipment include both onshore and offshore components. The tax treatment of the onshore component, which may include services such as design or customisation, is critical for the company providing these services because it has a significant impact on its profit margin. This tax treatment usually results from the application of the tax treaty between the seller’s country and the client’s country.
While the OECD model tax treaty has for decades established a general principle that services are taxed in the service provider’s country of residence on a net basis, the UN is promoting a different principle focused on taxation in the source country, meaning the country where the service is used or benefits the client. Although the main objective is to target digital services, the UN approach may also affect the defence sector.
Since the beginning of 2024, the UN has launched a new initiative on international taxation aimed at developing a framework convention and two protocols, one of which concerns the taxation of cross‑border services. Sessions were held in August and November 2025.
The approach under discussion proposes a major shift towards source‑based taxation on gross income. Physical presence would no longer be relevant. Without distinguishing between types of services, many emerging countries argue that new criteria should determine the place of taxation, such as the location where value is created, where economic activity occurs and where the service is consumed or used, even if the service provider is neither established in the country nor has a permanent establishment there. Taxation on gross revenue is presented as the simplest option given the limited administrative resources of some tax authorities.
Developed countries participating in the UN negotiations, including France and the UK, have reiterated their commitment to net‑basis taxation and expressed reluctance to adopt new criteria that are vague and create a high risk of double taxation.
If the UN project succeeds, the impact on defence companies in developed countries could be substantial when negotiating with clients in emerging economies such as India, the Middle East, Africa or Asia, where tax treaties often follow UN guidance. The result could be systematic source‑country taxation even without any material presence on the ground and a significant risk of double taxation due to gross‑income taxation. The protocol remains under negotiation, but the UN’s tax work must be closely monitored to anticipate potential additional tax costs, which should be factored into pricing for defence equipment.
