Governments levy taxes to provide public goods, distribute resources, and stabilise their economy.
Every tax has three essential elements: a base, a rate, and a taxpayer.
Types of taxes: consumption taxes, wealth taxes, personal income tax, capital gains tax, and corporation tax.
Compliance and administrative costs of taxation.
Tax avoidance.
Tax expenditure.
Mills, Erikson and Maydew (1998) estimate that large corporations save on average $4 for every $1 spent on tax planning activities.
Planning technique include the use of tax havens, the use of specially targeted tax regimes by countries which are not obviously tax havens, and the manipulation of international transfer prices to transfer profits into low tax jurisdictions away from higher tax ones.
OECD Model Convention on Double Taxation 'tie breaker' guidelines:
Approaches to determining the tax residence of individuals:
Approaches to determining tax residence for companies:
The international standard most commonly used is the 'place of effective management' or 'central management and control':
There are two types of double taxation: economic and juridical.
Economic double taxation is a broad term that covers any situation where an amount of income is taxed twice.
Juridical double taxation occurs where more than one country attempts to tax the same income.
There are three main methods by which countries of residence may give relief for double taxation:
More precise description:
For the domestic regulator, choosing between methods of double tax relief is a tradeoff between capital export neutrality and domestic tax base protection.
Types of foreign tax which may qualify for double tax relief ('creditable taxes'):
In connection with foreign dividends:
Turnover taxes such as sales taxes or indirect taxes generally do not entitle to double tax relief. But the General Agreement on Tariffs and Trade (GATT) permits the indirect taxes on exports to be rebated where these can be ascertained with accuracy (e.g. VAT with EU to non-EU)
'Portfolio investment' vs. 'foreign direct investment':
Where there is foreign direct investment, most countries will allow the foreign corporation taxes ('underlying tax') suffered on the foreign profits out of which the dividend has been paid to be set against the domestic tax liability in addition to any withholding tax.
Pooling allowed of foreign income in the home country tax computation ('onshore pooling').
Pooling allowed of foreign income within a foreign intermediate company ('offshore pooling').
Tier limitations on indirect credits from foreign subsidiaries.
Potential limitations on pooling: tax havens and credit capping.
Treaties cannot, of themselves, impose tax liabilities where none exist under domestic law. They can only reduce or eliminate domestic tax liabilities.
Double tax treaties are instruments of international law, and most are governed by the Vienna Convention on the Law of Treaties whilst their text is usually based on the Model Convention provided by the OECD. The provisions of treaties normally override any conflicting provisions in a country's domestic law.
The OECD Model Convention awards priority in taxing rights to the country of source.
There is a general principle that countries will not enforce the tax claims of other countries. E.g. 'English courts have no jurisdiction to entertain an action [...] for the enforcement, either directly or indirectly, of a penal, revenue or other public law of a foreign State.' (Dicey and Morris, The Conflict of Laws).
Interpretation of Tax Treaties: States may not use any material prepared unilaterally to aid interpretation, but only the materials which were agreed upon by both parties at the time the treaty was concluded. All interpretative materials must be contemporaneous with the signing of the treaty unless concluded with the other contracting state subsequently by mutual agreement.
The OECD Commentary and reports of the OECD Committee on Fiscal Affairs may be used to help interpret treaties, and are sometimes expressly referred to within tax treaties.
Bilateral treaties remain the norm compared to multilateral treaties.
The term 'permanent establishment' (PE) most commonly refers to a foreign branch. A PE is part and parcel of the same corporate entity as the head office.
The State where the PE is located may tax the profits of the entity which are attributable to the PE using the source principle; those profits must be arrived at by employing the fiction that it is a separate legal entity.
Requirement of a 'fixed place of business'. OECD commentary: fixed means established at a distinct place with a certain degree of permanence. Mechanical equipment does not have to be fixed to the soil. At least six month is usually necessary for permanence to arise.
The override to the 'fixed place of business' requirement: concluding contracts in the other State.
The exception for activities which are 'preparatory or auxiliary': stock used for storage, display, or delivery; purchasing goods or gathering information; always for the company's own benefit only.
The use of agents: independent agents do not count; dependant ones do. Dependence exists if and only if the agent can bind the enterprise in contract in the State concerned; employment status is irrelevant. There also has to be frequency and customer-facing.
Independence of an agent will be demonstrated by a combination of the following factors:
Some difficulties with the agency rules: the concept of agency is understood differently in different countries, depending on whether the country has a common law or civil law system.
The attribution of profits to a PE.
The 'working hypothesis': 'the profits to be attributed to a PE are the profits that the PE would have earned at arm's length as if it were a separate enterprise performing the same functions under the same or similar conditions'.
PE - An outdated concept?
There is an ever-increasing non-correlation between the location of tangible assets and that of intangible assets.
A commonly adopted strategy is to commence with a foreign branch so as to utilise any foreign losses in the early years, but then convert the branch to a subsidiary, so that only profits remitted to the UK are taxed in the UK.
Tax position of UK residents working abroad.
Tax allowances.
Tax position of individuals coming to the UK to work.
Tax treatment of employees resident but not ordinarily resident in the UK.
Tax treatment of employees who have a foreign domicile and work for a non-resident employer.
Travelling expenses.
National insurance contributions for employees going to work abroad.
The taxation of share options for internationally mobile employees.
Tax equalisation arrangements.
Personal tax planning for employees posted abroad.
Debt financing is usually more tax efficient than equity financing because interest is tax deductible whereas dividends are not.
The effect of withholding taxes.
International treasury management within multinational groups of companies.
Maximising the value of the tax deduction for interest: basic strategies.
Financing investment in countries with high inflation.
Cross-border tax arbitrage:
Offshore financial centers are jurisdictions in which transactions with non-residents far outweigh transactions related to the domestic economy.
The types of tax havens (Kudrle (2003)):
The growth of the offshore financial sector.
The Eurobond Market: Eurobonds are negotiable, fixed term and bearer.
Transaction -based methods of determing ‘arm’s length’ price.
The OECD recommends the use of three methods:
The US insists on a statistical approach, whereby only values within the inter-quartile range (excluding the lowest 25% and the highest 25% of results) are considered acceptable. The IRS also favours the median point as the most appropriate point in the range for a comparable.
Transactional-profit-based methods of determining ‘arm’s-length’ price.
These are identified by the OECD as methods of last resort but are increasingly being used, particularly in the US:
Cost sharing arrangements: the current regulations merely require that the actual percentage of expected benefit should not deviate from the percentage used to determine cost sharing payments by more than 20%.
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