3.1 International taxation

Question 1

Opportunities offered by the digital economy to trade internationally brings new tax issues

Answer 1

• In which country should a company pay tax on profits earned
• What happens when a company is taxed in multiple countries
• Tax regulators now have to consider new ways of ensuring tax is charged appropriately on income earned by companies in the digital economy

Question 2

Corporate residence

Answer 2

A company normally pays tax on it’s worldwide income in the country where it is resident

Question 3

A company can be resident for tax purposes in either

Answer 3

• the country of incorporation
• the country of control / central management
• the country where the head office is located or board meetings held

Question 4

If a company has dual resident status

Answer 4

• ie. incorporated in one country but is centrally managed in another
• it will generally be agreed by countries concerned that the company be treated as resident in the country of central management

Question 5

OECD model tax convention suggests

Answer 5

• that an entity is resident in the country of it’s effective management
• even so there is still a possibility that income will be taxed on same income in more than one country
• this happens when an entity has a permanent establishment in a country that is different to it’s residence

Question 6

The OECD model states the business profits can be

Answer 6

taxed in a country where they have a permanent establishment in that country, such as:
- A factory
- A workshop
- An office
- An branch
- A place of management
- A mine, oil, gas well, extraction of natural resources
- A construction / building site lasting more than 12 months
(excludes facilities used only for display, storage or delivery)

Question 7

Double taxation

Answer 7

Some or all of the profits of a company may end up being taxed in more than one country
- ie, income taxed in country where it was earned and in the country it is resident
- double taxation relief will be available if there is a double tax treaty between countries

Question 8

Double taxation relief - three main ways:

Answer 8

• Exemption - countries agree on certain types of income which will be exempt or partially exempt from tax in one country or the other
• Tax credit - the tax paid in one country may be deducted as a credit from the tax due in the other country (normally restricted to lower of two)
• Deduction - the foreign tax is deducted from foreign income so only the net amount will be subject to tax in country of residence

Question 9

Types of overseas operations

Answer 9

A company that trades internationally
- may do so from it’s country of residence without any form of physical operation or presence in other countries
- or they may set up an overseas operation which can be run as a:
* branch
* subsidiary (entity resident in a foreign country whose share capital is owned by an entity resident in another country)

Question 10

The features of operating an overseas operation as a subsidiary:

Answer 10

• The overseas subsidiary is a separate entity for tax purposes
  The parent only pays tax on income received from subsidiary (dividends, interest, royalties) and not on it’s profits
  Subsidiary will pay tax on profits in it’s country of residence
• Loss relief may not be available for the group because the overseas subsidiary will be paying tax under a different tax regime
• The parent company is not usually subject to capital tax on gains made by the overseas subsidiary
• Assets transferred to the parent may result in a capital gains tax liability

Question 11

The features of operating as an overseas branch are:

Answer 11

• The overseas branch is treated as an extension of the existing company’s activities
  All profits made by branch will be subject to tax in country where it is situated and also subject to tax as part of company’s profit in country of residence (double taxation)
  Money transferred from the overseas branch to existing company is not usually treated as a dividend
• Losses made by overseas branch are usually available for group relief
• The existing company is usually subject to capital tax on gains made by the overseas branch
• Assets can be transferred between them with no capital gain/loss

Question 12

Types of foreign tax:

Answer 12

• Withholding tax
• Underlying tax

Both may be relieved by various methods of double tax relief

Question 13

Withholding tax

Answer 13

Some countries will deduct tax at source on payment of items such as interest, royalties, rent, dividends and capital gains
The net income (gross payment less tax) is then received by recipient in foreign country

Question 14

Underlying tax

Answer 14

When a company pays a dividend it is out of post tax profits
The tax on profit used to pay the dividend is called underlying tax
If a company receives a dividend from an overseas subsidiary, it will be taxed once in the overseas country as part of normal tax on profits, and then again in country of receipt as income on dividends

Question 15

Underlying tax calculation

Answer 15

Tax on profits
/ Profit after tax X Gross dividend

Question 16

Transfer pricing

Answer 16

• Applies to a group situation where either goods are sold between companies at a favorable price or loans are made on favorable terms
• This results in transactions not taking place at arms length and profits of the companies within group are distorted
• This may be an attempt to avoid tax if profits are moved to a country with a lower tax rate
• This could damage public perception and they may be criticized for not paying their fair share of tax

Question 17

The rules for transfer pricing are intended to counter such avoidance:

Answer 17

• Goods and services - an adjustment will be made in the corporate tax calculation for the entity gaining the tax advantage to reflect the profit that would have been made if transaction was at arms length
• Provision of loan finance - if it is not at normal commercial terms (an amount a third party would be willing to provide) this is thin capitalization. Any interest charged on the excess is not allowable for tax purposes