Methods for elimination of double taxation

Question 1

What are the main reasons for international juridical double taxation?

Answer 1

1. Concurrent full tax liability
   
   • 2 states claim taxpayer as a resident = both tax on worldwide income
   • Solution: art. 4 OECD MC = tie breaker rules
2. Concurrent limited and full tax liability
   
   • Occurs the most = source state claims unlimited taxing rights on taxpayer and residence state claims full unlimited taxing rights
   • Allocation of the right to tax: art. 23A and 23B

Question 2

What are the main reasons for economic juridical double taxation?

Answer 2

1. Transfer pricing adjustments
   
   • Art. 9(2) + art. 25 OECD MC
2. Intra-group dividends
   
   • Special clauses in bilateral tax treaties or Parent/Subsidiary Directive

Question 3

What are the methods for elimination of juridical double (non) taxation?

Answer 3

1. Exemption method: art. 23A
   
   • Full exemption
   • Exemption with progression
2. Credit method: art. 23B
   
   • Full credit
   • Ordinary credit

Question 4

What are the 3 possibilities when taxing rights hve been divided?

Answer 4

1. Resident state = exclusive taxing rights = no double taxation: eg. royalties/income airline companies = effective management of company
2. Source state = exclusive taxing rights -> double taxation possible: solution = art. 23
3. Shared taxing rights betweens tates: dividend/income interest: limited taxing right source + unlimited taxing rights resident state

Question 5

What is the exemption method?

Answer 5

• Art. 23A: most countries use this: Belgium as well
• Income that may be taxed in source state is not taxed again in residence state = exemption of foreign source income that may be taxed in other State
• 2 systems:
  
  • Full exemption
  • Exemption with progression
• Mechanism: residence State takes into account foreign source income that is exempt in residence state to determine tax rate applicable to income that is taxable in residence State.

Question 6

What are the conclusions on the exemption method?

Answer 6

• Amount of tax in S does not affect the amount of tax relief given in R
  
  • Whether 20% or 40%: this does not affect amount of exception
• Underlying rationale: Capital Import Neutrality (CIN): CIN-States guarantee their residents that they compete on foreign market at foreign market conditions. Equal treatment on the foreign market of local investors & foreign (inbound) investors.
  
  • Stimulate investments abroad because of exemptions no matter the rate abroad

Question 7

What is the credit method?

Answer 7

• Article 23B
• Foreign source income irrespective of whether it has been taxed in source State is taxed again in residence State but with credit for the foreign tax paid (if any).
• Tax credit = deduction of foreign (source) State tax from residence State tax

Question 8

What are the steps for the credit method?

Answer 8

1. UK resident should declare all his foreign source income in resident state
2. He will be taxed again on that foreign source income = juridicial international double taxation
3. Credit = deduct source state tax from residence tax = credit for taxes paid abroad

• Full credit: Residence State allows reduction of RS-tax on income taxable in RS equal to total tax due in Source State

Question 9

What is the conclusion on credit method?

Answer 9

• When S-tax is higher than R-tax attributable to S-income, it reduces tax effectively levied in R on R-income → loss of tax revenues in R –> full creidt not applied in practice because states lose revenues

Question 10

What is ordinary credit?

Answer 10

• Ordinary credit: jargon: same way but with a twist in 3rd step
• Credit for S-tax limited to R-tax attributable to S-income
• Result: double taxation is not fully removed! = credit is capped: residence state tax that pertains to foreign source income

Question 11

What are the conclusions credit method?

Answer 11

• RS never apply full credit in practice because of risk of loss of tax revenues if SS tax rate is higher than RS tax rates
• Underlying rationale: Capital Export Neutrality (CEN): taxation of foreign income in residence State should be such that investor is not encouraged nor discouraged from investing abroad. Equal treatment of home investor & foreign investor in home market … At least if R-tax rate is equal or higher than S-tax rate. If S-rate exceeds R-rate neutrality is abandoned and full credit is swapped for ordinary credit which is not neutral (see ex. above).
• Tax credit States “tax away” the advantage of operating in other States where tax rates are lower than in Residence State.
  
  • Is Credit Method compatible with the Internal EU market? Yes according to ECJ: as long as there’s equal treatment taxpayers only operating in 1 market & crossborder
• Equal treatment home state investor/ foreign state investor = tax away the advantage

Question 12

Does the exemption method lead to double non taxation?

Answer 12

• State of residence must exempt regardless whether or not effective taxation in source state (“may be taxed in other State”) à if no effective tax in source State; result = double non-taxation
• BUT exceptions if States bilaterally agree to include “subject to tax”- clause in Art. 23 A (1) OECD MC (see e.g. supra capital gains, private pensions)
• Exemption with progression for individuals. Full exemption for companies (Art. 23 A (3) OECD MC)
• Which income ? All income that may be taxed in the source State (except dividends and interest)

Question 13

What is important for declaring income?

Answer 13

• If you do not report your income, if you do not file a tax return -> Belgium should not exempt income.
  
  • State should not give opportunity to commit fraud
• Even if Belgian resident declares: that state might still decide not to tax: domestic laws or tax free bracket
• What should states do to avoid double non-taxation?
  
  • Include “subject to tax” clauses = resident state will only exempt if income has been effectively taxed abroad = no more double non-taxation

Question 14

What is the special rule for dividends and interest wrt exemption method?

Answer 14

• Special rule for dividends and interest (+ royalties, if contrary to Art. 12 OECD MC they have been taxed in Source State)
  
  • Ratio : juridical double taxation resulting from shared taxing rights between RS and SS under Art. 10-11 (or 12) OECD MC/UN Model
  • Credit method: ordinary credit (Art. 23 A (2) OECD MC)
• OECD recommends credit systems for critical areas: the Netherlands have switched

Question 15

Is there a risk for double non-taxation with the credit method?

Answer 15

• Ordinary credit method
• State of residence must allow a credit
• But credit depends on whether tax is actually levied in Source state à no risk for double non-taxation
• That’s why OECD recommends Exemption States to switch over in “critical sectors” from exemption to credit (see supra Art.17 artistes & sportsmen)

Question 16

What is the relief for economic double taxation on intra-group dividends?

Answer 16

• No rule in OECD MC (but often provided for in bilateral treaties)
• In EU: Parent/Subsidiary Directive (two rules)
  
  • * No withholding tax in source State (= relief for juridical double taxation) (Art. 5) (see supra dividends)
  • * Relief for economic double taxation à MS of residence of parent (Art. 4)
• Two options for relief of economic double taxation in MS of parent
  • (i) Exemption of dividends from subsidiary
  • (ii)Tax dividends of subsidiary but allow parent to deduct from its corporate tax, the tax paid by subsidiary in its MS on profits out of which dividend is paid (“indirect tax” or “credit for underlying tax”)
• Conditions:
  
  1. Parent and Sub are taxable companies resident in EU
  2. At least 10 % shareholding (MS have option to add a 2-year uninterrupted holding requirement to prevent abuses)
• In Belgium = DBI regime