Introduction to international business taxation Flashcards
Direct taxation
The taxpayer bears the burden of the tax, is liable to pay the tax and cannot pass on the incidence of the tax
Indirect taxation
The incidence of the tax is shifted (the tax is passed on the consumer)
Consumption taxes
Taxing the consumer on his or her spending on goods and services
Personal income tax
Salaries, wages, rent received from leasing property and proceeds of business operations
Capital gain
Profit resulting from the increase in value of assets that are not part of the inventory (stock)
Double taxation
Corporate income tax and personal income tax are taxed seperately –> Double taxation
Full Integration system
Company is owned by shareholders
Company is a mere conduit and company income is taxed in the hands of the shareholder
CIT is a prepayment of individual income tax (all profit allocated to the shareholders)
Good system to tax profit according to “ability to pay” principle of the shareholders
Partial integration
Grant relief either at the level of company or at the level of the shareholder
SEVERAL OPTIONS:
Dividend deduction – company deduct dividend distribution
Plit-rate system - different rate to distributed/retained profit
Exemption method (the dividends are expempted in the hands of shareholders
Dividend imputation (gross-up = the amount dividend received + the company tax attributable to that dividend) + tax credit
Juridical double taxation
The same income (dividends) is taxable in the hands of the same taxpayer (ACo) by more than one state (state a and b)
Goals of DTC
1) foster commercial relationship between two countries
2) prevention juridical double taxation + economic double taxation
Tax neutrality
Taxation should not, or at least as possible, influence an efficient allocation of production factors
Capital import neutrality (relief double taxation)
Neutrality in the source of investment (all firms of all nations pay the same rate of tax)
No discrimination foreign investors and domestic investors
Determining tax residence of individuals (Factors)
1) Time spent in a particular country
2) Connection with a particular country
3) Other rules, such as citizenship (US)
–> Combination of different rules to determine tax residence
Resident state
Where you are a tax resident and pays tax to the state
Tax residents worldwide income (income from resident state and foreign state; worldwide tax system) eg. US
Source state
Where you are not a tax resident (non-resident) but generates income from the states territory and pays tax to the state
Tax non-residents income derived from its territory; territorial tax system
E.g. most EU countries
Mismatch of tax law
Different countries have different rules to determine their own tax residence
Double tax convention
Model developed convention for bilateral tax treaties
Main effect: allocating taxes rights
Priority of DTC over domestic law
Tie breaker rule
Determine one state to tax
Place of effective management
Where key management and commercial decisions that are necessary for the conduct of the business as a whole are in substance made
Mutual agreement procedure
Taxpayer: Corporation
Dual residence: double taxation
Apply for MAP from its tax authority
Tax authorities of two states of the DTC
Make an agreement on the residence of the corporation
Exemption method (methods for mitigating double taxation)
Resident state does not tax the foreign income of its tax residents
Foreign income is exempt
Effect on tax base (foreign income is excluded from tax base
Reduce tax base
Credit method (methods for mitigating double taxation)
Resident state gives a credit for the foreign tax paid at source state
Taxpayer still pays total tax at resident state
No effect on tax base
Corporation
Independent legal person
Shareholders are separate/independent from the corporation
Legal personality
Own assets and income
Can directly enter into legal relations
Partnership
No independent legal personality
Partners share ownership and are responsible for all the debts and legal responsibilities
Non-transparent entity vs Transparent entity
non-transparent entity:
Tax corporation: The corporation is non-transparent for tax purposes
Transparent entity:
Partnership; Tax partners: The entity is considered as transparent for tax purpose No tax at partnership level
Hybrid entities
Entities that are treated as transparent for tax purposes in one state and non-transparent in another state
Permanent establishment
Tax concept – doing economic activities at source with sufficient presence that entitle the source country to leva a tax + no legal personality
Types of PEs in the OECD MC allowing taxation at source state
Physical base PE
Construction PE
Agency PE
service PE
Dependent agent
A permanent establishment without the need to a fixed place of business
Independent PE (Definition
No independent agent: Person who acts exclusively or almost exclusively on behalf of one or more closely related enterprises
Not required to comply with detailed instructions from the enterprise
No control of enterprise
Anti fragmentation rule
Enterprises cannot fragment a cohesive operational activity into several small operations in order to argue that each is merely of a preparatory or auxiliary character
Relevant business activity
Use of a formula to split between head office and PE
Relevant business activity
Use of a formula to split between head office and PE
functionally separate entity
PE - is a separate and independent enterprise (functions, assets and risks)
Profit allocation steps
Step 1: Functions, assets and risks
A functional analysis has to be carried out before transactions within various parts of a single enterprise have to be priced at arms length giving rise to a profit element
Step 2: The arms length method
Determination of the PE remuneration by reference to the functions performed, assets used and risk assumed by the enterprise
Interests vs Dividends
Interests: Income for lender from money that is offered to the borrower
Interest should be paid even if there is no profit
Must be paid
Fixed rate
Dividends:
Income offered to the shareholders of a company
dividends can only be paid when there are profits made by the company
Can be optional. The company can decide when to pay
Depends on companys plan to calculate
Debt vs equity financing
Debt:
Money raised by a company from borrowed capital
Loan and bonds
Obligation
Comparatively short term
Less risk
Return in interest
Fixed return
Equity:
Money raised by a company issuing shares
Shares and stock
Ownership
Long term
HIgh risk
Return on dividend
Variable return
Tax treatment of debt vs equity
Debt – Interest – Payments:
For borrower: tax deductible, not taxed
for lender: taxed
Equity – dividend – payments
For company: Not tax deductible
Taxed
For shareholder: exempt (usually)
Interest arising in source state and paid to a resident of resident state may be taxed in resident stae
Source stat ecan also tax the same interest with limitations; Interest may also be taxed in source state but if the beneficial owner of the interest is a resident of resident state, the tax so charged shall not exceed 10% of the gross amount of the interest
Royalty (definition)
Any payment of any kind received as consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinema tographic films, patents, trademarks, designs, or models, plans, secret formulas or processes, or the information concerning industrial, commercial or scientific
Royalty - import source of revenue for developing countries versus residence countries
Exclusive taxing rights for the residence state OECD MC
Article 12 UN MC:
Shared taxing rights
Limited taxing rights for source state (example 10% + double taxation relief at the residence state (credit)
Broad concept also royalty (leasing industrial, commercial or scientific equipment) - they were eliminated from the OECD MC within the definition of royalty
In the case of software; is the licensee entitled to commercial exploitation of the product? can the purchaser introduce modifications in the software (substantive rights) limited period of time/geographic zone?
–> no royalty, thus article 7 OECD MC
Distribution agreements of a product
Distribution agreements, commercialization of a product does not entail the right of use of the trademark
Exclusive distribution right of a product is not a royalty (exclusive right to sell branded t-shirts - no right to use the trademark)
BUT if the distributor purchases raw materials that are subject to transformation and sold by the distributor under, for instance, the trademark of the foreign company
Crucial distinction: Business profits and technical services
Specific provision
Sometimes within the definition of royalty
withholding tax
a tax deducted at source, especially one levied by some countries on interest or dividends paid to a person resident outside that country.
Technical services
Usually the same WHT (withholding tax) for royalty
The term fees for technical services means any payment in consideration for any service of a managerial, technical or consultancy nature (broad meaning). Difficult to determine in many cases
Be aware: you need domestic law to tax (DTCs only allocate taxing rights)
Mixed contracts (royalty, service, sale)
CDI canada-peru (article 12 does not cover technical services)
Break down the contract
But if one part (principal purpose and the other parts are ancillary - the tax treatment of the principal should generally applied to the whole amount
Difficulties in aggregation/disaggregation
Transfer of ownership (different su-allocation rule)
Gains from the alienation of any property, other than that referred to in paragraphs 1,2,3,4 shall be taxable only in the contracting state of which the alienator is a resident
Transfer of shares - company resident in canada sell the shares of its subsidiary in colombia / only canada can tax the capital gain
Alienation of shares:
Sale of house: capital gain (taxation at source)
Sale of shares - capital gain (taxation at residence)
Indirect transfer of shares:
Mauritius company sell shares of a US company.
Can india tax the capital gain?
Capital gain taxable in india if mauritius company sales shares in indian company NOT THE CASE
No covered indirect transfer of shares
No tax in india
new business model - main features
Technology and hyper-connectivity
Heavy reliance on data (data mining) and users
would be difficult, if not impossible, to ring-fence the digital economy from the rest of the economy. Attempting to isolate the digital economy as a separate sector would inevitably require arbitrary lines to be drawn between what is digital and what is not
No physical presence is required to obtain profits - source countries do not perceive getting a fair share
General Anti-avoidance rules (GAARs)
A GAAR is a provision of last resort that is capable of being invoked by a tax authority to strike down unacceptable tax avoidance practices that would otherwise comply with the terms and statutory interpretation of the ordinary tax law.
Indicators for an inappropriate legal structure:
If a third party, on considering the economic facts and effects of the structure, would not have chosen the same legal structure without the generated tax benefit;
The interposition of relatives or other closely related persons or companies soley for tax purposes; or
The transfer or shifting of income or capital assets to other legal entities solely for tax purposes
