Chapter 15 - International Taxation Flashcards
What is the concept of “international taxation”?
The combined effect of more than one country having the ability to tax the same income.
What is double taxation?
When the same income is taxed in multiple countries. An example would be foreign rental income where both countries want to tax the rental income. If there is no agreement between the countries, a 20% tax rate (in both) could quickly become 40% between the two.
How do countries reduce double taxation?
- Exempting foreign-source income from home country taxation
- Giving credit for foreign taxes paid to reduce home country taxation
- Making agreements with other countries as to how to share the right to tax specific income types
What is the simplest method for a country to avoid double taxation?
Exempt foreign-source income from taxation. While simple, this is not a popular choice as countries would prefer to tax income to add to their national revenue.
Hong Kong and Singapore exempt foreign-source income earned by resident companies.
How does the US take a hybrid approach to taxing foreign-source income?
Exempts foreign source income earned by US companies as long as it remains outside of the country. When repatriated back to the US, it is subject to tax. Many US companies leave their foreign-source income offshore as a result.
How can holding companies be used to defer foreign-source income tax?
When used judiciously, investors can ‘park’ profits earned in foreign countries and defer/avoid taxation in their home country. This largely depends on the home country and the country where the income is earned. Must be carefully planned and well-implemented.
What is the purpose of income tax treaties?
Agreements between countries on how specific income types are taxed.
What are the 3 main sources of tax law for a taxpayer earning foreign-source income?
- Domestic tax law in the country in which the income is generated
- Domestic tax law in the country in which the recipient is resident
- Any income tax treaties
What grants the government(s) to authority to levy taxes in Canada?
The Constitution Act of 1867.
In the US, it is the Constitution.
Who developed the model tax treaty that most international tax treaties follow?
The Organisation for Economic Co-operation and Development (OECD) in the 1960s
What does it mean by international tax treaties being almost exclusively bilateral in nature?
Not effective when 3 or more countries are involved.
What is the downside for a country having multiple international tax treaties?
Limits the country’s ability to change domestic tax legislation in a way that could be inconsistent with the treaties they’ve negotiated. Also costly and difficult to terminate a treaty.
Under what laws are treaties governed?
By international, rather than domestic, tax law
What is Canada’s 183-day rule.?
Individuals who stay in the country for 183 days or more are deemed residents of Canada for tax purposes for the entire year.
How can nationality impact taxation?
A good example is the US, where anyone who is a US national automatically becomes a US taxpayer. While treaties largely resolve cases of double taxation, where the US tax is higher than that of the country in which the citizen is living, a US tax balance will be owed.
How do many countries stop companies from simply choosing to incorporate under the law of low-tax countries?
Apply an alternative test for tax residence that is based on where the company’s business is actually conducted.
Which country will have the primary right of taxation in the absence of a tax treaty?
The source country in which the income is derived.
How is income from immovable property taxed under the OECD model tax treaties?
May be taxed in the country in which the property is located. The source country has the full right to tax and not merely a more limited right to levy a withholding tax, like it does with other investment income.
How are dividends defined under many of Canada’s income tax treaties?
Income from shares and are payments that represent participation in a paying entity’s profits.
Which country under the OECD model tax treaty has the primary taxation rights related to dividends?
Primary rights belong to the country of residence. Though the source country has a more limited right to tax the dividends, so long as the recipient of the dividend income is also its beneficial owner.
How is interest income treated under the OECD model tax treaty?
May be taxed in both the source country and residence country. Withholding tax at source is generally limited to 10% if the recipient is the beneficial owner (may be up to 15%).
How are royalties treated under the OECD model tax treaty?
Exclusive taxation rights are granted to the residence country of the royalties’ beneficial owner, though many tax treaties do not follow this and allow the source country to charge withholding taxes. (Like in Canada and the US, withholding tax on royalties is limited to 10%).
How does the US tax capital gains?
Short-term gains (less than 1 year) are taxed as income, long-term gains are taxed at special lower rates.
How does the OECD model tax treaty deal with the varying domestic tax approaches to capital gains?
In most situations (excluding the sale of portfolio investments) capital gains are taxable exclusively in the recipient’s resident country. Often an exception for real estate where it’s common for both countries to have taxation rates.
How does a country have a right to tax gains on the disposition of property for a non-resident where the property is also not residing in that country?
Special income tax treaty right (specifically in US and Canada) which permits the country from which the taxpayer ceases to be a resident to tax gains on the disposition of property if the disposition happens in the first 10 years of the change in residence.
How much tax would someone owe if they received $1,000 in foreign dividends with a 15% withholding rate and they are in a 45% marginal tax bracket in their residence country (Canada)?
$150 would be withheld by the foreign country. $450 total would be owing in Canadian income taxes, but $150 would be credited. This person would then only owe $300 in taxes to Canada. Total taxes paid are $450 with $150 going to the foreign source country and $300 going to the resident country.
How does the US have a “basket” approach to taxing foreign income and how does this differ from Canada?
Foreign withholding taxes on all passive income can be accumulated in one basket for all countries. Higher and lower tax rates can be averaged out to potentially claim a larger foreign tax credit. In Canada, foreign tax credits are calculated on a per-country basis. Canada uses a basket approach to a smaller extent by separating foreign business income from other income, ensuring taxes paid on business income cannot be used to reduce overall taxes and vice versa.
Does Canada allow tax relief by deduction?
If withholding tax a foreign country takes in excess of 15%, the excess can be used as a tax deduction against a taxpayer’s income.
What is the US “saving clause”?
The US reserves the right to charge full US taxes on its residents and on individuals who are, or have been, US citizens. A US citizen living in a foreign country may find they are subject to full residence-based taxation in both countries. Foreign countries will often credit an individual for their US taxes owing, but only to an extent. The “saving clause” provides an additional tax credit on their US tax return for the amount of tax they pay to the foreign country in which they are resident.
