Capital 6 III

Question 1

How does the dividend exemption system system ensure neutrality towards the legal form of a company?

Answer 1

Neutrality is achieved when the personal income tax rate and corporate income tax rate are the same.

Question 2

What happens under the dividend exemption system if tax rates differ?

Answer 2

• PIT rate > CIT rate: Corporations are favored
• PIT rate < CIT rate: Sole proprietors are favored

Question 3

How does the classical system or partial imputation system affect sole proprietors and partnerships?

Answer 3

If profits are distributed, corporations are discrimated against sole proprietors

Question 4

What is the main challenges of the shareholder relief system regarding discrimination of the legal form?

Answer 4

• There is no clear answer whether corporations are discriminated against partnerships or sole proprietors

The tax burden depends on:
- Corporate income tax rate (CIT)
- Personal income tax rate (PIT) on dividend income

Question 5

Is there a neutrlity towards the lego form of company in losses and contractual relations?

Answer 5

It is not achieved in other cases:

• Losses: Sole proprietorships can compensate losses against other taxable income while corporations cannot
• Contractual: Assets and payments from contractual relations are assigned to business for sole proprietorship, while for corporations it are different sources

Question 6

Why should intercompany dividends not be taxed?

Answer 6

• taxation of dividends/capital gains at the corporate shareholder level would result in multiple taxation
• Subsidiary (corporate level I): CIT
• Parent (Corporate level II): CIT
• Shareholder level (individual person): PIT

Question 7

What are the mechanism to avoid triple/multiple taxation of intercompany dividends?

Answer 7

• Exemption method (dividends and capital gains are empt either full or 95%
• Tax credit (only dividends)

Question 8

How are intercompany dividends generally treated for tax purposes

Answer 8

Dividends are considered tax-exempt income.

Question 9

What types of costs can occur at the corporate level for exempt dividend income?

Answer 9

Costs include refinancing, acquiring a subsidiary, and monitoring.

Related concepts:
Net principle
Non-deductible business expense
No violation of the net principle if using a tax credit method.

Question 10

What is the tax solution for intercompany dividends in countries like France, Germany, and Italy?

Answer 10

• Dividends are not 100% exempt.
• 5% of dividends are treated as a non-deductible business expense (deemed income).
• Companies can deduct all costs related to exempt dividend income.
• Effectively, only 95% of intercompany dividends are tax-exempt.

Question 11

How is the taxation of a corporation at the corporate level?

Answer 11

• has own legal capacity
• Corporation can conclude contracts with its shareholders as well as with third parties, e.g. regarding financing, management, know-how, rental agreements
• Payments are deductible from the tax base when accrued and reduce the taxable income of the corporation, e.g., intereest, salaries, royalties, rents

Question 12

How is the taxation of a corporation at the shareholder level?

Answer 12

• Payments are included in the taxbale income of shareholders
• Classification into different categories of income, e.g. capital income, employment income, income from immovable property,
• Category of income determines, date of taxation, amount of taxes, if different income categories are subject top different tax rates

Question 13

How do contracts influence the overall tax burden at the corporation and shareholder level?

Answer 13

1.Reduction of profits:
- Corporation: Saves corporation tax (payments reduce tax base).
- Shareholder: Saves income tax on dividends (capital gains) as they are reduced

2.Increase in personal income: Payments from contracts increase shareholder income

Question 14

Under what conditions do contractual relations reduce the overall tax burden?

Answer 14

Contractual relations reduce the tax burden if:

The additional personal income tax on additional income is lower than:
- Foregone corporation tax on profits.
- Individual income tax on dividends (capital gains).

Question 15

Why do substantial shareholders have an incentive to reduce corporate profits?

Answer 15

They aim to:

• Reduce corporate profits.
• Increase personal income by concluding or adjusting payments for contracts.

Question 16

How can profits be shifted to optimize tax planning?

Answer 16

Profits can be shifted:

• From the corporate level
• To the shareholder level

Question 17

Under what conditions is shifting profits advantageous?

Answer 17

• Corporate profits are taxed twice (CIT and PIT on dividends)
• Individual income is subject to a lower income tax burden.

Question 18

What is required for contracts to comply with the arm’s length principle?

Answer 18

Approval by the arm’s length principle means:

• Contracts with shareholders follow the same conditions as those with third parties
• Contracts must be fair and comparable to third-party agreements

Question 19

What are examples for the arm´s length principle regarding loans and compensation?

Answer 19

• Shareholder loans: market interest rate
• Compensation for management: comparable to managers excersing similar functions

Question 20

When is approval of contractual relations denied under the arm’s length principle?

Answer 20

Approval is denied if payments to shareholders are higher than those that would occur between third parties

Question 21

What are the qualifications for profits shifted to shareholders?

Answer 21

Profits shifted above the arm’s length price (e.g., interest above market rates) are either:
- Hidden distribution of profits (deemed dividends).
- Non-deductible business expenses.

Question 22

What are the four main factors incentivizing profit shifting from the corporate to the shareholder level?

Answer 22

• Substantial shareholding: Substantial shareholders influence contracts for their own benefit, violating the arm’s length principle.
• Corporation tax system: Classical tax systems emphasize hidden profit distributions and debt-equity restrictions.
• Different tax rates: Lower tax rates on other income sources compared to dividends increase incentives to shift profits
• Additional taxes on corporate profits: E.g., trade tax on business income in Germany raises the corporate tax burden.

Question 23

What do thin capitalization rules restrict?

Answer 23

Thin capitalization rules restrict debt financing to prevent excessive interest payments for tax deductions

• These rules are applied in the EU and other non-EU countries.

Question 24

Thin capitalization rules
Under what conditions are interest payments not deductible as business expenses?

Answer 24

If the proportional total debt of a shareholder exceeds the:

• Debt-to-equity ratio (safe haven).
• Amount of net assets.
• Percentage of EBITDA.

Question 25

How are interest payments on excessive debt treate under the thin capitalization rules?

Answer 25

1.Interest payments exceeding limits are not deductible as business expenses.
2.They are reclassified as:
- Hidden profit distributions, or
- Non-deductible business expenses.