Basic Structure Income Tax Systems and Main Concepts of Income Tax and Corporate Income Tax Flashcards
What is the most important tax worldwide in terms of revenue?
Income tax
Where and when did the income tax originate?
UK at the end of the 18th century -> spread to industrialized countries at end of 19th century -> worldwide after WW2
Which countries do not have an income tax and why?
Monaco, United Arab Emirates - government takes a direct part of the money the corporations/people get from selling oil
What is the income tax base?
The annual net income of a person (individual or unit)
What is net income?
Revenue (gross income) - deductible expenses
In the last couple of decades, have income taxation gone up or down?
Down - US had 90% before, now almost no countries have tax rates above 50%
How does a corporate income tax often look - two characteristics?
Low rate and/or targeted benefits
Flat tax rate (usually between 9-44%)
What does the marginal rate mean?
The highest rate of tax
Advantages (3) vs. disadvantages (2) of progressive tax rates
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
How can we compare progressivity?
- Size of brackets
- Income level of country and how many people fall into each bracket
What is the taxable unit most often?
Natural person (individual) or legal person (corporation, trust, foundation etc.)
What is the effect of joint taxation of couples (e.g., when the couple is the taxable unit)? (progressive vs. flat tax rate system)
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
Advantages (1) vs. disadvantages (3) of the couple as the taxable unit
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
Global definition of income
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
Schedular definition of income
No single definition of income - different types of income are defined and taxed separately
Do countries have either a pure global or schedular income definition in practice?
No; usually a mix/scale
What are some schedular elements of income?
- Final withholding for investment income - not taxed under progressive rates
- Different rules for employment income (limited deductions, withholding)
- Different treatment for capital gains
What is the most common division of income with different tax rules (in a schedular system)?
Employment, business, and investment income
What are the advantages of a schedular vs. global income system? 2 points for each
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)
What are capital gains?
Proceedings on the sale or exchange of a capital asset
How do you calculate capital gains?
The sales value - the acquisition value - other costs incurred during lifetime (to improve or maintain value of asset)
What capital assets gain value over time?
Immovable property, shares in a company, mining rights, cryptocurrencies, stocks, bonds and obligations
Why/why not tax capital gains? 2 points each
Why:
1. To maintain progressivity of the whole income tax -> capital gains disproportionately earned by the rich
- Base erosion/tax planning -> to avoid planning around income and keeping value within the stock
Why not:
1. To encourage investment
2. Tax competition
3 problems of taxing capital gains
- Dealing with inflation - increase of general price level confused with increase in value of an asset
- Administrative issues - how to tax gains by non-residents or gains incurred abroad? (solution: exchange of information or exit taxes)
- Should we tax unrealized gains? Really rich people have most of their money in unrealized capital gain to pay very little in tax
Historical concept of income: accretion
Any realized accession to wealth is income
Historical concept of income: source
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
Which countries usually have a source concept of income?
Mainly continental Europe
Historical concept of income: Trust
Basic implication for taxes: if you sell property, you cannot tax it -> you cannot tax capital gains
Explain the concept of an (actual) trust
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
Which countries usually have the trust concept of income?
UK and former UK colonies
How do each historical concept of income look at capital gains taxes?
Accretion: is taxed
Source: is taxed, but only if earned by a business
Trust: is not taxed
What is important to know about the historical concepts of income is that…
They do not determine whether a specific item is actually taxed or not in 2023!
Employment income is usually taxed by…
Withholding
3 points on expenses regarding employment income
- Itemized expenses
- Flat deductions (are they rebuttable or not?)
- Distinguishing between expenses of private nature or expenses necessary for employment -> important for deductions
What are fringe benefits and how are they taxed?
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
What is presumptive income?
Estimating income based on a more easily verifiable measure (size of land, shop etc.)
Where is presumptive income most common?
Developing countries - but is also found elsewhere. For practical reasons as it is easier for the tax administration
Which groups of taxpayers is presumptive income often applicable to?
Small traders or agriculture where cash transactions are prevalent
Advantages (2) and disadvantages (1) of presumptive income
Advantages:
1. Easy for tax administration
2. Efficient against tax evasion
Disadvantages:
1. Questions of fairness
3 different forms of presumptive income
- Rebuttable or irrebuttable presumption (can you change it?)
- 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)
- Mechanical application (following set of strict rules/formula) or at discretion of tax authority
What is the case of the Dutch Box 3?
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
