Basic Structure Income Tax Systems and Main Concepts of Income Tax and Corporate Income Tax

Question 1

What is the most important tax worldwide in terms of revenue?

Answer 1

Income tax

Question 2

Where and when did the income tax originate?

Answer 2

UK at the end of the 18th century -> spread to industrialized countries at end of 19th century -> worldwide after WW2

Question 3

Which countries do not have an income tax and why?

Answer 3

Monaco, United Arab Emirates - government takes a direct part of the money the corporations/people get from selling oil

Question 4

What is the income tax base?

Answer 4

The annual net income of a person (individual or unit)

Question 5

What is net income?

Answer 5

Revenue (gross income) - deductible expenses

Question 6

In the last couple of decades, have income taxation gone up or down?

Answer 6

Down - US had 90% before, now almost no countries have tax rates above 50%

Question 7

How does a corporate income tax often look - two characteristics?

Answer 7

Low rate and/or targeted benefits

Flat tax rate (usually between 9-44%)

Question 8

What does the marginal rate mean?

Answer 8

The highest rate of tax

Question 9

Advantages (3) vs. disadvantages (2) of progressive tax rates

Answer 9

Disadvantages:
1. Inefficient
2. Dis-incentivizing people to work more

Advantages:
1. Incentivizing people to start working
2. Redistribution based on ability-to-pay
3. Fairness

Question 10

How can we compare progressivity?

Answer 10

1. Size of brackets
2. Income level of country and how many people fall into each bracket

Question 11

What is the taxable unit most often?

Answer 11

Natural person (individual) or legal person (corporation, trust, foundation etc.)

Question 12

What is the effect of joint taxation of couples (e.g., when the couple is the taxable unit)? (progressive vs. flat tax rate system)

Answer 12

In a progressive tax system: Income can be transferred to your spouse for the purpose of filing taxes which can effectively lower your joint tax burden (preventing one from falling into higher tax bracket)

In a flat tax system: no effect

Question 13

Advantages (1) vs. disadvantages (3) of the couple as the taxable unit

Answer 13

Advantages:
1. Encourages marriage -> good if you hold strong traditional values

Disadvantages:
1. Goes against equality
2. Married couples already have favorable conditions
3. Works against the principle of progressivity

Question 14

Global definition of income

Answer 14

Unitary definition of income which is subject to a single progressive rate schedule - all types of income fall into one category with all sources of income taxed in the same way

Question 15

Schedular definition of income

Answer 15

No single definition of income - different types of income are defined and taxed separately

Question 16

Do countries have either a pure global or schedular income definition in practice?

Answer 16

No; usually a mix/scale

Question 17

What are some schedular elements of income?

Answer 17

1. Final withholding for investment income - not taxed under progressive rates
2. Different rules for employment income (limited deductions, withholding)
3. Different treatment for capital gains

Question 18

What is the most common division of income with different tax rules (in a schedular system)?

Answer 18

Employment, business, and investment income

Question 19

What are the advantages of a schedular vs. global income system? 2 points for each

Answer 19

Global:
1. Simple
2. Not a lot of incentives for planning around your income

Schedular:
1. Prevents taxpayers from using losses in one area against gains in another to pay loss taxes
2. Easier to tax certain things with a flat rate than progressive because you can create a different category (e.g., interest income)

Question 20

What are capital gains?

Answer 20

Proceedings on the sale or exchange of a capital asset

Question 21

How do you calculate capital gains?

Answer 21

The sales value - the acquisition value - other costs incurred during lifetime (to improve or maintain value of asset)

Question 22

What capital assets gain value over time?

Answer 22

Immovable property, shares in a company, mining rights, cryptocurrencies, stocks, bonds and obligations

Question 23

Why/why not tax capital gains? 2 points each

Answer 23

Why:
1. To maintain progressivity of the whole income tax -> capital gains disproportionately earned by the rich

2. Base erosion/tax planning -> to avoid planning around income and keeping value within the stock

Why not:
1. To encourage investment
2. Tax competition

Question 24

3 problems of taxing capital gains

Answer 24

1. Dealing with inflation - increase of general price level confused with increase in value of an asset
2. Administrative issues - how to tax gains by non-residents or gains incurred abroad? (solution: exchange of information or exit taxes)
3. Should we tax unrealized gains? Really rich people have most of their money in unrealized capital gain to pay very little in tax

Question 25

Historical concept of income: accretion

Answer 25

Any realized accession to wealth is income

Question 26

Historical concept of income: source

Answer 26

An item is only income if it flows from a (more or less continuous) source. This excludes as income: lottery-winnings, gifts, private capital gains, payments received after end of employment

Question 27

Which countries usually have a source concept of income?

Answer 27

Mainly continental Europe

Question 28

Historical concept of income: Trust

Answer 28

Basic implication for taxes: if you sell property, you cannot tax it -> you cannot tax capital gains

Question 29

Explain the concept of an (actual) trust

Answer 29

Settlor who owns something (e.g., property) who wants to give it to the beneficiary, but doesn’t give it direct but manage it through a trustee. This is to avoid the beneficiaries splitting up and selling the property -> they can only use proceeds from the property itselt, not sell it

Question 30

Which countries usually have the trust concept of income?

Answer 30

UK and former UK colonies

Question 31

How do each historical concept of income look at capital gains taxes?

Answer 31

Accretion: is taxed

Source: is taxed, but only if earned by a business

Trust: is not taxed

Question 32

What is important to know about the historical concepts of income is that…

Answer 32

They do not determine whether a specific item is actually taxed or not in 2023!

Question 33

Employment income is usually taxed by…

Answer 33

Withholding

Question 34

3 points on expenses regarding employment income

Answer 34

1. Itemized expenses
2. Flat deductions (are they rebuttable or not?)
3. Distinguishing between expenses of private nature or expenses necessary for employment -> important for deductions

Question 35

What are fringe benefits and how are they taxed?

Answer 35

Benefits you get from your job that is not income -> company car, apartment, meals etc. paid by your employer

Difficult to tax - a company car that you use privately can be taxed for the private purposes but this can in practice be difficult

Question 36

What is presumptive income?

Answer 36

Estimating income based on a more easily verifiable measure (size of land, shop etc.)

Question 37

Where is presumptive income most common?

Answer 37

Developing countries - but is also found elsewhere. For practical reasons as it is easier for the tax administration

Question 38

Which groups of taxpayers is presumptive income often applicable to?

Answer 38

Small traders or agriculture where cash transactions are prevalent

Question 39

Advantages (2) and disadvantages (1) of presumptive income

Answer 39

Advantages:
1. Easy for tax administration
2. Efficient against tax evasion

Disadvantages:
1. Questions of fairness

Question 40

3 different forms of presumptive income

Answer 40

1. Rebuttable or irrebuttable presumption (can you change it?)
2. Presumptive tax exclusive or a minimum tax (minimum tax meaning that you either pay the presumptive tax or the actual tax you own, whichever is highest)
3. Mechanical application (following set of strict rules/formula) or at discretion of tax authority

Question 41

What is the case of the Dutch Box 3?

Answer 41

A presumptive income tax on investment income - assuming everyone makes a profit of 4% per year on wealth they possessed at the beginning of the year

Amendment of system is in progress as the “Hoge Raad” found it to be against the European Convention on Human Rights and ruled that no presumptive tax can be levied