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Introduction to International Taxation

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  1. Introduction to International Taxation Prof. Dr. von Wuntsch

  2. Avoidance of International Double Taxation DTCs

  3. Total revenue+ 21,000,000 • Expenses before depreciation- 14,000,000 • Depreciation - 2,000,000 • = Earnings before tax = 5,000,000 • - Host government tax (20 %)- 1,000,000 • = Earnings after tax= 4,000,000 • + Depreciation (noncash expense) + 2,000,000 • = Gross Cash Flow = 6,000,000 • Fund remitted by subsidiary (100%)6,000,000 • Withholding tax on dividends (5%)- 300,000 • = Remitted funds after withholding tax= 5,700,000 • Exchange rate ( 0.50 ) • = CF to parent2,850,000 • Frage: Wie wird die Dividende bei der MutterG steuerlich erfasst ? Foreign subsidiary and double taxation:

  4. Methods for avoiding international double taxation Non DTC countries DTC countries According to respective national provisions - → Unilateral relief: U.K.: • ICTA 1988, ss 788-816 USA: • § 901 IRC Germany: • § 34c Income Tax • § 8b (1), 26 (1) Corp. Tax According to DTCs → Bilateral relief: • see OECD-Model • see several DTCs Methoden Übersicht

  5. Structure of a DTC (OECD-Model) • Structure of the OECD-Model: • Definition of „Personal Scope“ and „Tax Covered“ (see Art. 1 und 2 OECD-Model) • General Definitions (see Art. 3 bis 5 OECD-Model): • - „Company“ • - „Residence“ • - „Permanent Establishment“

  6. Structure of a DTC (OECD-Model) • For the „Relief from Double Taxation“ • see Art. 23A OECD-Model: • 2 Methods: • Credit method • (b) Exemption method

  7. Structure of a DTC (OECD-Model) Taxes on Income: - Income from Immovable (Real) Property (Art. 6) - Business Profits (Art. 7) - Shipping and Air Transport (Art. 8) - Associated Enterprises (Art. 9) - Dividends (Art. 10) - Interest (Art. 11) - Royalties (Art. 12) - Gains (Art. 13) - Independent Personal Services (Art. 14) - Dependent Personal Services (Art. 15) - Directors`Fees (Art. 16) - Artistes and Athletes (Art. 17) - Pensions, Anuuities, Alimony, and Child Support (Art. 18) - Government Service; Social Security (Art. 19) - Visiting Professors and teachers; Students and Trainees (Art. 20) - Other Income (Art. 21)

  8. DTC (OECD-Model): Participation  Individual country A Comp. country B  Dividends • Dividends shall be taxed • in dividend-receiving country • Art. 10 (1) OECD-Model • Withholding tax = 15 % • Art. 10 (2)OECD • Credit method • Art. 23 A (2) OECD-Model 2. Corp. tax

  9. Head-Office country A Permanent Establishment country B DTC (OECD-Model): • Principle of Permanent Establishment • Art. 7 i.V.m. Art. 5 OECD Exempted from taxation 2. Problem: Calculation of PE-profits Art. 7 (2), (3) OECD

  10. Participation  Comp. 1 country A Comp. 2 country B  Dividends DTC (OECD-Model): • Dividend shall be taxed in dividend-receiving country • Withholding tax •  5 or 15 % • Art. 10 (2) OECD • Credit method • Art. 23 A (2) OECD 2. Corporation tax

  11. Participation  Comp. 1 Country A Comp. 2 country B Special case: Intercompany dividends Normal regulation in German DTC (see DTC: Germ./USA):  Dividends 1. Withholding tax  5 or 15 % Art. 10 (2) DTC: USA 1. Exempted from Corporation tax: (a) see Art. 23 (2) DTC: USA  for at least 10%holding of shares (Activity-Clause possible !) (b) see § 8b (1) German CT 2. Corporation tax 2. Add 5 % of exempted dividend: § 8b (5) German CT

  12. European Parent/Subsidiary Directive • 1. Goal of the Directive: • Intercompany-dividends shall be exempted from • Withholding Tax. • That means that the parent company can receive dividends • from the subsidiary amounting to 100 %. • 2. Conditions for applying the Directive: • 1. ) Parent- and subsidiary company are limited companies • 2. ) Residence of both companies in the European Union • 3. ) Both companies are liable to Corporation Tax

  13. European Parent/Subsidiary Directive • Status of parent company: • The parent company holds at least 25 % of subsidiary- • shares • (Germany applied the Directive fixing a lowest participation • of 10 %.) • (2) Holding period of shares: at least 2 years • (Germany applied the Directive fixing a one year period.)

  14. Provisions on double taxation: I. Imputation / Credit method → Foreign taxes are offset against domestic taxes on foreign source income → The foreign tax credits are limited to the amount of tax that would have been paid domestically

  15. Conditions of applying the credit method: • The person applying the imputation method has to be identical with the foreign tax payer • A certain amount of income is double taxed • The foreign country has to impose taxes similar to German Income Tax

  16. Credit method (in Germany): → Imputation / Credit method: • Sect. 34c (1) EStG = German Income Tax Law • Sect. 26 (1) KStG = German Corporation Tax Law Example: Foreign tax rate: 50 % German tax rate: 38 % (1) German Income Tax on worldwide income: Foreign profits 100 Domestic profits 200 300 Income Tax: 114

  17. (2) Credit limit to the amount of tax that would have been paid domestically: 114 * 100/300 = 38 (3) Tax credit: Income Tax 114 Tax credit - 38 payable 76 Total tax load: 76 + 50 = 126

  18. Provisions on double taxation: II. Exemption method: → If a German limited company holds shares in another (domestic or foreign) limited companythe dividends distributed to it are exempted from taxation in Germany • see German DTCs and • Sect. 8b (1) KStG = German Corporation Tax Law This provision is not relevant for the exam !

  19. § 8b para. 5 KStG Not relevant for exam ! → 5 % of the exempted dividends distributed by foreign corporations to German corporations must be added to the taxable profits, if foreign dividends are exempted from taxation in Germany Background of this regulation: For the purpose of taxation expenses that are connected with tax-free-income are not considered to be deducted from net profits. This also applies to tax-exempt-dividends in the case of inter-company participation. According to German law it is assumed that 5% of these tax-free-dividends are related with special expenses, such as financial and administrative costs. This means that the total profit has to be increased by this amount.)

  20. Objectiv to set up neutral tax rules that don’t distort the allocation of capital Not relevant for exam Two principles of neutrality: Capital import neutrality (CIN): Goal: The marginal effective tax rate on suppliers of capital in any country should be the same. Effect: Foreign and domestic income from investment are taxed differently. Capital export neutrality (CEN): Goal: Investors pay the same taxes no matter where their investments are located. Effect: Decisions of business are not affected by tax policy

  21. Methods that achieve CIN or CEN:Not relevant for exam ! → CIN Exemption method: Income from investment abroad is exempt from taxation in the capital exporting country Effect: Capital mobility will equalize after-tax returns on investments → CEN Credit method: Foreign taxes are (partially or completely) offset against domestic taxes on foreign source income Effect: Capital mobility will equalize pre-tax rates of return on investment

  22. European Taxation General Statements

  23. Taxation in the European Union Art. 5 EC-Treaty: →Principle of Subsidiarity The Community shall take action only if the objectives of the common market cannot be sufficiently achieved by the Member States. Art. 93 EC-Treaty: The Council shall adopt provisions for the harmonisation of legislation concerning turnover taxes.

  24. Taxation in the European Union Art. 96 EC-Treaty: Differences amoung Member States shall not distort the conditions of competition in the common market. The Council can issue the necessary directives if consultation does not lead to the elimination of distortions.

  25. Goal • EU commission wants to initiate a single tax base for all EU taxes • jungle of tax systems hinders competitiveness of EU industries through • compliance costs • double taxation • protectionist regulations • harmonized tax system should improve fairness, efficiency, simplicity and transparency

  26. Current Situation Tax policy in general is a basic of national sovereignty Corporate taxes can be seen as benefit taxes corporations pay for the public services they use (e.g. infrastructure) EU member states’ total tax revenues as a percentage of GDP at around 40% (Corporation tax only) National corporation tax law has to be in alignment with the various “freedoms” of the EC Treaty

  27. Current Situation All member states in the EU tax company profits Tax rates vary enormously Differences in the way taxable profits are calculated and the level of corporation taxation

  28. Country • 1997 • 1998 • 1999 • 2001 • BE • 41 • 40 • 39 • 39 • DK • 34 • 34 • 32 • 30 • De • 45/30 • 45/30 • 40 • 25 • It • 53.2 • 41.2 • 37 • 36 • Fr • 36.6 • 36.6 • 33.33 • 33.33 Corporation Tax Rates

  29. Corporation Tax Systems Classical System (without tax relief for shareholder) Classical System (with tax relief for shareholder) Exemption system: Tax exemption for shareholder Partial Imputation system: partial tax credit Imputation system: full tax credit Countries Switzerland USA Irland Belgium Germany (from 01) Denmark Luxemburg Netherlands Austria Sweden Greece Finland Norway France Japan Canada(Ontario) Portugal Spain UK Italy Germany (till 2000) Tax rates (%) 17 – 30 40,8 (2000) 12.5 34 26.4 (38.6 %) 30 22 31.5 25 28 25/32 26 28 (2000) 33.3 35,17 (2000) 43,62 (2000) 25 35 30 33 42,2 Relief Corporation Tax and Income Tax without any relief Parts of the dividend are not liable to income tax Shareholder is not liable to income tax on dividends A part of CT is imputed to the shareholder as a tax credit All of the CT is imputed to the shareholder as a tax credit

  30. → Tax havens in Europe: Switzerland Holding- and domicile companies: 0.4 – 3.5 % Capital Tax Luxembourg Holding companies: 0.2 – 1 % of the value of the shares (tax d`abonnement) Coordination Centers: Taxable base = 5 % of the calculated cost-price (without cost of personnel and financial cost)

  31. Netherlands Financial Companies: Only 20 % of the profits arising from financial activities are allowed to be taxed with the normal rate of 35 % CT. Ireland CT rate = 12.5 % CT rate in Center for international financial services in Dublin: = 10 % (till year 2005) → tax avoidance and anti-abuse rules (CFC Legislation and Transfer Pricing Guidelines)

  32. Effects of tax competition States compete among themselves to attract economic activity Tax competition could lead to a “race to the bottom” in tax rates or revenues Many economists tend to regard tax competition as beneficial

  33. Do differences in taxation cause major distortions in the internal market of the European Union ? Conclusions and recommendations of the RUDING Committee (1992): → Elimination of withholding tax levied by source on dividends paid by subsidiaries to parent companies ( “Parent / Subsidiary Directive” ) → uniform withholding tax of 30 % for other dividends → rules concerning transfer-pricing adjustments ( Arbitration Convention )

  34. → Prescription of a minimum and maximum corporation tax rate ( 30 - 40 % ) → Harmonization of the corporation tax systems → considerations of fairness and transparency among the Member States Question: How would you explain the theoretical concept of the committee concerning an efficient tax policy and allocation of capital

  35. Taxation in the European Union Question: Should the European policy lead to the harmonization of taxation in the Member States ?

  36. Benefits from globalization → Important benefits: • better allocation of resources • greater access to foreign goods and services • greater range of choice • decreasing costs of travel and transport • decreasing costs of information

  37. Negative aspects from globalization(see: Vito Tanzi): Crossborder effects of national policies: • “Spillover-effects” in an integrating world economy • Political competition derives from economical competition. This process has an impact on: → increasing tax competition among countries → tax incentives in order to attract foreign investments → Risk of reduction in tax revenue (“tax degradation”) → market distortions

  38. EXAMPLES: • Multinational companies establish integrated production processes with an incentive to lower world-wide tax liabilities • Transfer pricing and the risk of tax migration • Portfolio-investors and the problem of under- reporting interest flows → risk of capital flight

  39. The future of tax systems Competition • can reduce the ability of governments financing the welfare state • might reduce the rates of the VAT´s as the mobility of population raises • is likely to induce countries to reduce their effectiv tax rates on corporate income to attract capital inflows • is likely to change the general concept of income tax → from the concept of global income tax to a schedular approach to taxation → Progressive and low tax rates on capital incomes, wages / salaries and rentals according to their degree of mobility→ “Dual Tax System”

  40. Transfer Pricing OECD Guidelines not relevant for exam !

  41. Methods to determine reasonable / arm`s length prices (see OECD Transfer Prices Guidelines for multinational enterprises): • Comparable Uncontrolled Price Method (deriving prices directly from comparable other transactions) •Resale Price Method (going back to the original price on the basis of further sellings of comparable goods or services) • Cost Plus Method(cost price + normal profit rate) • other methods:Profit Split Method (not recognized by all countries)

  42. Advantages for Holdings • Complexity of the decision making process can be reduced by splitting up a big company into several independent companies • Concentration on the core business • Settlement of subsidiaries near the regional markets • Reduction of Hierarchy and increase in flexibility • Strategic Alliances between subsidiaries and foreign companies • Transfer of profits to countries with favorable tax rates

  43. Transfer Pricing amoung MNCs → Foreign subsidiaries can be used to generate profits in the country with a lower tax load → Tax administrations try to correct manipulated transfer prices → Tax administrations have the power to substitute undervalued prices; they can establish reasonable market prices = arm`s length prices (principle of dealing-at-arm`s-length)