European and International Taxation

Transcription

1 European and International Taxation Fundamentals of international corporate taxation Jean Monnet Module: Managing the EU: Taxation, Governance and Economics The content does not represent the view of the Erasmus+ project nor the European Commission but only of the author Cluj-Napoca Jean Monnet Module: Managing the EU: Taxation, Economics and Governance

2 Taxation basic principles Tax Base X Tax Rate = Tax Revenue Tax Base: - an item, occurrence, transaction, or activity with respect to which a tax is levied Tax Rate: - a percentage multiplied times the tax base to determine tax revenue Tax Revenue: - total tax collected by the government and available for public use

3 Definition: Ø Statutory tax rates Ø Effective tax rates Ø Effective marginal tax rate (EMTR) Ø Effective average tax rate (EATR)

4 Corporate income tax rate Year Central government Corporate income tax rate Country Australia Austria Belgium Canada Chile Czech Republic Denmark Estonia Finland France Germany Greece Hungary Iceland Ireland Israel Italy Japan Korea Latvia Luxembourg Mexico Netherlands New Zealand Norway Poland Portugal Slovak Republic Slovenia Spain Sweden Switzerland Turkey United Kingdom United States 34,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 34,00 34,00 34,00 34,00 34,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 39,00 39,00 39,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 29,12 28,12 26,12 24,12 22,12 22,12 22,12 22,12 19,50 19,50 18,00 16,50 15,00 15,00 15,00 15,00 15,00 15,00 15,00 16,00 16,50 17,00 17,00 17,00 17,00 17,00 17,00 17,00 20,00 20,00 20,00 21,00 22,50 24,00 31,00 31,00 31,00 31,00 28,00 26,00 24,00 24,00 21,00 20,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 32,00 30,00 30,00 30,00 30,00 28,00 28,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 24,50 23,50 22,00 26,00 26,00 26,00 26,00 26,00 24,00 23,00 22,00 21,00 21,00 21,00 21,00 21,00 21,00 21,00 20,00 20,00 29,00 29,00 29,00 29,00 29,00 26,00 26,00 26,00 26,00 26,00 26,00 26,00 24,50 24,50 20,00 20,00 20,00 37,76 36,43 35,43 35,43 35,43 34,93 34,43 34,43 34,43 34,43 34,43 36,10 36,10 38,00 38,00 38,00 34,43 42,20 26,38 26,38 27,96 26,38 26,38 26,38 26,38 15,83 15,83 15,83 15,83 15,83 15,83 15,83 15,83 15,83 40,00 37,50 35,00 35,00 35,00 32,00 29,00 25,00 25,00 25,00 24,00 20,00 20,00 26,00 26,00 26,00 29,00 18,00 18,00 18,00 18,00 16,00 16,00 17,33 20,00 20,00 20,00 19,00 19,00 19,00 19,00 19,00 19,00 19, ,00 20,00 20,00 20,00 20,00 30,00 30,00 18,00 18,00 18,00 18,00 18,00 18,00 15,00 15,00 18,00 20, ,00 20,00 16,00 12,50 12,50 12,50 12,50 12,50 12,50 12,50 12,50 12,50 12,50 12,50 12,50 12,50 12,50 36,00 36,00 36,00 36,00 35,00 34,00 31,00 29,00 27,00 26,00 25,00 24,00 25,00 25,00 26,50 26,50 25,00 37,00 36,00 36,00 34,00 33,00 33,00 33,00 33,00 27,50 27,50 27,50 27,50 27,50 27,50 27,50 27,50 27,50 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 28,05 28,05 23,90 23,40 28,00 28,00 27,00 27,00 27,00 25,00 25,00 25,00 25,00 22,00 22,00 22,00 22,00 22,00 22,00 22,00 22, ,00 15,00 15,00 15,00 15,00 15,00 15,00 25,00 25,00 22,00 19,00 15,00 15,00 15,00 15,00 15,00 15, ,20 31,20 22,88 22,88 22,88 22,88 22,88 22,88 22,88 21,84 21,84 22,05 22,05 22,47 22,47 22,47 22,47 35,00 35,00 35,00 34,00 33,00 30,00 29,00 28,00 28,00 28,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 35,00 35,00 34,50 34,50 34,50 31,50 29,60 25,50 25,50 25,50 25,50 25,00 25,00 25,00 25,00 25,00 25,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 33,00 30,00 30,00 30,00 28,00 28,00 28,00 28,00 28,00 28,00 28,00 28,00 28,00 28,00 28,00 23,75 28,00 28,00 28,00 28,00 28,00 28,00 28,00 28,00 27,00 27,00 25,00 30,00 28,00 28,00 27,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 32,00 32,00 30,00 30,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 27,00 30,00 30,00 30,00 28,00 28,00 29,00 29,00 25,00 25, ,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 19,00 23,00 22,00 22,00 22,00 25,00 25,00 25,00 25,00 25,00 25,00 25,00 23,00 22,00 21,00 20,00 20,00 18,00 17,00 17,00 17,00 17,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 32,50 30,00 30,00 30,00 30,00 30,00 30,00 30,00 28,00 25,00 28,00 28,00 28,00 28,00 28,00 28,00 28,00 28,00 28,00 26,30 26,30 26,30 26,30 22,00 22,00 22,00 22,00 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 8,50 33,00 33,00 33,00 30,00 33,00 30,00 20,00 20,00 20,00 20,00 20,00 20,00 20,00 20,00 20,00 20,00 20,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 30,00 28,00 28,00 28,00 26,00 24,00 23,00 21,00 20,00 20,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00 35,00

5 Corporate Income Tax Rates ( ) European and International Taxation

6 Relationship between CIT Tax and Tax Revenue for the States European and International Taxation

7 Transaction or activity based tax Transaction (event) based taxes - VAT, sales tax, excise tax - estate tax, gift tax Activity based tax => Income tax - Individuals - Legal Entities

8 The Relationship between taxes and Race to the bottom theory Empirical evidence? FDI Ø Assignment: Choose a region and test if there is any connection between the FDI inflows / outflows and tax system?

9 European and International Taxation Basic principles of international taxation Jean Monnet Module: Managing the EU: Taxation, Governance and Economics The content does not represent the view of the Erasmus+ project nor the European Commission but only of the author Cluj-Napoca Jean Monnet Module: Managing the EU: Taxation, Economics and Governance

10 Taxes and international business decisions ü Taxation playes a very important role for companies => Difference in tax rate => any examples? => See recent book: Products/Trends-and-Players-Tax-Policy ü MNC are the one typ of companies which are affected the most by the variable taxation => Where to locate foreign operations? What legal form of operations should it take? How the operation should be financed

11 The impact of taxes on international business decisions: Ø The location of international investments is affected by relative tax rates in the alternative countries Ø The decision about the legal form of the foreign operation, branch or a corporation, is dependent on differential tax treatments. Ø Method of financing, debt or equity, is affected by the rules governing taxation of interest and dividends in the host country.

12 Apple Case Study: Introduction Graphic:

13 Google Case Study: Introduction Graphic: Ella Rubeli

14 Double Irish and Dutch Sandwich Graphic: economicsonline.co.uk

15 International Tax? Ø What is international tax? Ø Has this changed with the formation of the European Union? How do we measure international tax?

16 Objectives of international tax regulations Ø National wealth maximization Ø Tax equity of fairness Ø Economic efficiency Compatibility of tax systems

17 Taxation of inward investments capital import neutrality v The principle that all investments within a country should face the same tax burden, regardless of whether they are owned by a domestic or a foreign investor v Importance of investors Case Study the Polish Stock Exchange vs. Romanian Stock Exchange FDI in CEE Countries. Assignment: Literature review on studies that focus on FDI. Gathering data on the topic. Ø capital import neutrality? Ø Tax holiday for investors (China)

18 Taxation of outward investments capital export neutrality Ø The principle that investors should pay equivalent taxes on capital income, regardless of the country in which the income is earned Ø two competing theories of tax neutrality: 1. Territoriality 2. capital export neutrality ü Importance of own investors ü Tax neutrality for investors

19 International Taxation ü Just a term, not a new tax ü used to refer to underlying principles that govern the situations and transactions when 2 or more taxing jurisdictions ü Clash applied to a business situation or transaction

20 Sources: Domestic Law provisions: Defining the concept of tax obligations Eliminating double taxation International Tax Treaties: Eliminating the possible double taxation Eliminating tax evasion Providing for legal framework for cooperation between tax administrations

21 Definition of tax liability Taxpayers Basic principles: Persons resident in the country Persons resident in other Jurisdiction Scope (Tax Base) Income from the whole world Unlimited (worldwide) tax liability Income from the sources in the country Concept Limited tax liability Residence Source

22 ü Domestic law The function of residence Personal or economic attachment to a jurisdiction Connecting factor to worldwide tax liability ü Tax Treaties Determining the applicable tax treaty Determining the entitlement to treaty benefits Determining the entitlement to double tax relief Presenting the case for a mutual agreement procedure

23 Residence of individuals (Domestic Law 1. Factors: Physical presence Availability of dwelling Art. 7 par. 23 Fiscal Code) Centre of vital interests (economic, social or family) Permanent or principal residence Habitual, usual or customary place of abode 2 Intention to reside permanently, but no minimal threshold is normally required (e.g. Brazil) 3 Romanian State employees working abroad 4 Relevance of the duration of the stay (183-days basis)

24 Residence of Companies (Domestic Law) Formal connecting factors: Place of incorporation (US, Romania) Statutory seat or head office (Germany) General meeting of shareholders Place where books and records are kept Substantive connecting factors: Central management and control (UK) Place of effective management (France) Place of main activity (Israel before 2003) or main business purpose (Italy)

25 Normally income derived: Income from sources: ü From business/economic activities ü Return from investments ü Other payments/ or income in kind

26 Sources of income: Income from selling goods/services Income from managerial, financial, consultancies, auditing, legal services, and software maintaining services Income from immovable property Individual employment income Remuneration of managers Income in the form of chargefree transfer of capital Capital gains Fines, penalties Dividends Interest Royalty Lease payment Pensions Winnings Other

27 Dividends, Interest Withholding Tax: Insurance premiums paid on risk insurance agreements Insurance premiums paid on risk re-insurance agreements International transportation services Other income from selling goods/services, managerial/financial consultancies, capital gains, royalty, etc.

28 European and International Taxation Double Tax Conventions Jean Monnet Module: Managing the EU: Taxation, Governance and Economics The content does not represent the view of the Erasmus+ project nor the European Commission but only of the author Cluj-Napoca Jean Monnet Module: Managing the EU: Taxation, Economics and Governance

29 Tax treaties ütotal tax treaties in the world üby end 2004: o 2,559 double tax treaties o 1,718 bilateral investment treaties o 215 preferential trade and investment agreements o and since then?

30 Purpose and objectives Ø Removal of tax barriers to cross-border trade and investment o Elimination of double taxation o Certainty of tax treatment o Reduce tax rates o Lower compliance costs o Prevention of fiscal evasion o Prevention of tax discrimination o Resolution of tax disputes

31 Place of treaties in the legal system Treaty: a formal agreement between two or more States Phases: negotiation, signature, ratification, entry into force Place of treaties in the legal system depends on the country s view on international law Most countries: treaty prevails over domestic law Some countries (e.g. US): treaty equals domestic law Object of tax treaties: limit exercise of national taxing powers on cross-border situations

32 Model Conventions Why do we need a Model Tax Convention? What is a Model Tax Convention? What is the legal value of a Model Convention? Model Conventions League of Nations Models OECD Model 1963, 1977, 1992, 2014 UN Model 1980 and 2001 CIAT Model ASEAN Model National models (e.g. USA, Netherlands)

33 Model conventions and bilateral treaties v The OECD Model Tax Convention and its Commentary v The OECD Model and bilateral treaties among OECD countries v Provisions based on the Model v Reservations v Observations v Provisions not based on the Model v Bilateral treaties with non-oecd countries v Bilateral treaties between non-oecd countries

34 Effects of the tax treaties Elimination of Double Taxation Allocation of exclusive taxing rights Providing for methods of credit/exemption Mutual Agreement procedure Elimination of Tax Evasion Exchange of Information Cooperation between tax administrations

35 Tax treaty structure Scope of the treaty (Articles 1, 2 and 29) Definitions (Articles 3 to 5) Distributive rules (Articles 6 to 22) Exclusive allocation of taxing rights Shared allocation of taxing rights Elimination of double taxation (Article 23) Exemption (Article 23A); Credit (Article 23B) Special provisions (Articles 24 to 28) Procedural rules (Articles 25, 26 and 27) Principles (Articles 24 and 28) Final provisions (Articles 30 and 31)

36 Allocating Taxing Rights under the Treaty Exclusive allocation Income..shall be taxable only State of residence (Arts. 7; 8; 12; 13(3),(5); 15; 18; 21) State of source (Art. 19) Consequence: No double taxation Shared allocation Income..may be taxed (Arts. 6; 7; 10; 11; 13(1), (2), (4); 15; 16; 17; 19) Both States tax: double taxation Primary allocation: State of source Secondary allocation: State of residence may tax and give relief

37 European and International Taxation Double Taxation Cluj-Napoca Jean Monnet Module: Managing the EU: Taxation, Economics and Governance

38 Impact of Double Taxation Tax in general is a transaction cost Double taxation means double the cost Reduces after tax profit Activities can result in loss Obstacle to business and investment

39 Elimination of Double Taxation Based on Domestic law Unilateral relief Based on International Agreements Double Tax Treaties

40 Sources of Double Taxation: ü Source and residence tax jurisdiction ü source jurisdiction ü residence jurisdiction ü Juridical double taxation ü source source conflict ü residence residence conflict ü source residence conflict Methods of relief from juridical double taxation ü Exemption method ü Full exemption ü Exemption with progression

41 Source and residence: Examples: (1) Jack is the resident of U.S. and he also gets service income in China in Then both US and China will tax on his service income. (2) T Co. is incorporated in France but has its effective management in Singapore. Then both France and Singapore will tax on the income of T Co. (3) P Co. is the parent company in Japan and Q Co. is the subsidiary company in China. Q will pay the dividend to P. Obviously the dividend is from the profit after tax in China. Then the dividend of P will be taxed by Japanese government too. => What should we tax? Who should tax?

42 Source and jurisdiction: The source jurisdiction of taxation means that a country (Country A) taxes non-resident individuals and corporations income arising to them domestically (from country A) This system of taxation captures income derived by the non-resident from the sale or use of goods, services, capital or other resources to customers in country A. Import of goods/services etc. Country A Country B Payment to foreigners = Income of foreigner derived from country A Country A is the source

43 Residence jurisdiction The residence jurisdiction of taxation involves the taxation of country A s resident individuals and corporations on income arising in foreign countries (and of course domestically) => worldwide income This system of taxation captures income derived by the non-resident from the sale or use of goods, services, capital or other resources to customers in country A. Export of goods/services etc. Country Country A B Income from resident derived from foreign country

44 Juridical double taxation üsource and residence taxa jurisdictional approaches work well when they are applied by and in respect of only one country. However, the mischief arises when taxpayers engage in crossborder income earning activities where both the taxpayer s country of residence and the country that is the source of the income apply either or both of the source and residence doctrines => person is taxed twice => juridical double taxation!

45 Juridical double taxation Can be generally defined as the imposition o comparable taxes in two (or more) States on the same taxpayer in respect of the same subject matter and for identical periods. Its harmful effects on the exchange of goods and services and movements of capital, technology and persons are so well known that is is scarcely necessary to stress the importance of removing the obstacle that double taxation presents to the development of economic relations between countries (OECD Committee on Fiscal Affairs) => conflicts Source source conflict Resident resident conflict Source resident conflict

46 Relief mechanisms => avoidance of d.t. There are three methods in common use for granting relief from international double taxation. Deduction method (Not included in DTT) Exemption method Credit method (most difficult)

47 Deduction method 1. Definition: Foreign taxes paid by a resident of a country are deducted as current expenses in computing the resident s taxable income in the resident country. A deduction is a reduction in the gross (total) amount that must be included in the taxable base.

48 Deduction method: 2. Valuation: The deduction method is the least generous method of granting relief from international double taxation, so it is not sanctioned by the OECD Model Treaty and UN Model Treaty. But several countries that have adopted the credit method have retained the deduction method as an optional form of relief.

49 Deduction method => example Country A Country B income Tax rate 40% 30%

50 Example 1 (1) without relief of double taxation: Foreign tax: 30*30%=9 Domestic tax: 100*40%=40 Total tax: 9+40=49

51 Example 1 (2) Deduction method Foreign tax: 30*30%=9 Foreign income taxable: 30-9=21 Total domestic income taxable: 70+21=91 Total domestic tax: 91*40%=36.4 Total tax: = 45.4

52 Deduction method 4. Conclusion: The effect of the deduction method is that residents earning foreign-source income and paying foreign income taxes on that income are taxable at a higher combined tax rate than the rate applied to domestic-source income. So the deduction method creates a bias in favor of domestic investment over foreign investment. From the viewpoint of national self-interest, deduction method may be justified. But from the perspective of the total tax burden on a taxpayer s worldwide income, deduction method does not achieve equal treatment of residents.

53 Exemption method 1. Definition: The country of residence taxes its residents on their domestic-source income and exempts them from domestic tax on their foreign-source income. 2. Application: (1) Very few countries Hong Kong is a prominent example have adopted the exemption method with respect to all foreign source income earned by their residents. (It is in fact the source jurisdiction.) Q: Where does the system encourage taxpayer to invest?

54 Exemption method (2) For most countries using the exemption method, however, the exemption of foreign source income is limited to certain types of income, most commonly business income and dividends from foreign affiliates. Further, the exemption method is often restricted to income that has been subject to tax or subject to a minimum rate of tax by the foreign country. 3. Two methods in countries whose tax rates are progressive: (1) Full exemption (2) Exemption with progression An exemption method under which certain foreign-source income is exempted from tax but is taken into account in determining the rate of tax applicable to other income.

55 Exemption method example 2 Example: T Co. is the resident of country A, which adopts full progressive tax rate. Country A Country B Income Tax rate <80, 35% >80, 40% 30%

56 Example 2 (1) Full exemption The income 30 of country B is free of tax. Country A only levy tax on the domestic income 70. Tax: 70*35%=24.5 (2) Exemption with progression Suppose all the income is domestic, then the tax rate would be 40%. Tax: 70*40%=28

57 Exemption method 4. advantage and disadvantage: Advantage: The exemption method is relatively simple for the tax authorities to administer and is effective in eliminating international double taxation. For the partial exemption system to work effectively, a country must be able to ensure that the exemption is limited to foreign source income that is subjective to foreign tax comparable to domestic tax.

58 Exemption method Disadvantage: (1) The exemption with progression system is more complex. (2) It offends against the tax policy objectives of fairness and economic efficiency. Therefore, a full exemption method of relieving double taxation is difficult to justify and is used by few countries. (3) One weakness of an exemption system is its likely impact on the shifting of tax burdens from the earner to the income payer.

59 Credit method 1. Definition: Foreign taxes paid by a resident of a country are credited against the residence country s tax on the resident s foreign-source income. The credit method completely eliminates international double taxation of the residencesource type.

60 Credit method- example 3 For example, T Co. is the resident of country A and has a branch in country B. Country A Country B income tax rate (1) 30% 30% (2) 30% 20% (3) 30% 40%

61 Example 3 domestic tax before credit *30%=3 000 (1) (2) (3) Foreign tax 2000*30%= *20%= *40%=800 Foreign tax credit Final domestic tax = = =2400

62 Example 3 Under the credit method, foreign-source income is subject to domestic tax whenever the foreign tax rate is less than the domestic tax rate. Credit countries invariably do not pay tax refunds when their taxpayers pay a foreign income tax at an effective rate that is higher than the domestic effective tax rate. Nor do they allow the excess foreign tax to offset taxes imposed on domestic income. In other words, the credit for foreign taxes paid is usually limited to the amount of the domestic tax payable on the foreign-source income

63 Credit method types of limitations Countries use a variety of types of limitations. 1. overall or worldwide limitation: ----The credit is limited to the lesser of the aggregate of foreign taxes paid and the domestic tax payable on the total amount of the taxpayer's foreign source income. This method permits the averaging of high foreign taxes paid to some countries with low foreign taxes paid to other countries. 2. country-by-country limitation ----the credit is limited to the lesser if the taxes paid to each foreign country and the domestic tax payable on the taxpayer's income from each country. This method prevents the averaging of high and low foreign taxes paid to various countries, but it permits the averaging of high and low rates of foreign tax paid to a particular country on different types of income.

64 Exemption method 3. item-by-item limitation ----the credit is limited to the lesser of the foreign tax paid on each particular item of income and the domestic tax payable on that item of income. This method prevents averaging and is probably the best method from a theoretical perspective, although few countries use it in practice.

65 Example 4: Example:Compute the limitation on credit and the tax payable of R Co. to country A using the overall and country-by-country limitation methods respectively. Country company Income payable Tax rate A Controlling, R % Foreign tax B Branch, S % 60 C Branch, T % 40

66 (1) overall limitation: Total tax before credit =( )*50%=600 (1) overall limitation: Limitation on credit: ( )*50%=100 Foreign tax: 60+40=100 Country A tax after credit: =500

67 (2) country-by-country limitation: Country B limitation: 100*50%=50 Country C limitation: 100*50%=50 Country B tax: 60 Country C tax: 40 Country A tax after credit: =510

68 Q: Suppose the income taxable of T Co. is -50. Total tax before credit =( )*50%=525 (1) overall limitation: Limitation on credit: (100-50)*50=25 Foreign tax: 60 Country A tax after credit: =500 (2) country-by-country limitation: Country B limitation: 100*50%=50 Country C limitation: 0 Country B tax: 60 Country C tax: 0 Country A tax after credit: =475

69 In conclusion: when the foreign branches make a profit, overall limitation method can decrease the tax burden of the taxpayer. When some foreign branches make a loss, country-by-country limitation method can decrease the tax burden of the taxpayer.

70 Dragos PĂUN Faculty of Business Module Leader Tel:

71 European and International Taxation Double Tax Conventions provisions Jean Monnet Module: Managing the EU: Taxation, Governance and Economics The content does not represent the view of the Erasmus+ project nor the European Commission but only of the author Cluj-Napoca Jean Monnet Module: Managing the EU: Taxation, Economics and Governance

72 Defining Permanent Establishment Introduction - Definition of Permanent Establishment => crucial to the taxation of business profits - PE term comes from 1920s.. Threshold level of presence to be reached before source taxation rights are triggered - Usually PE -> a foreign branch (exemptions = computer server) - Difference between PE and subsidiary => PE is not a legal entity distinct from the parent / taxed under sourced. Subsidiary is independent legal entity / taxed under residence. - Organization perspective: PE seen as a part of the corporate entity - PE: transfer pricing issues (art. 5 OECD Model Tax Convention)

73 Defining Permanent Establishment The concept of a permanent establishment - PE: as a taxing right problem source / residence - If a PE exists -> allocation rights of taxation to the country where the profits are obtained (SOURCE state) Which definition of PE is to be applied? a) If no DTC between domestic country and foreign country -> domestic law definition of PE b) If DTC is in force => DTC definition of PE

74 The concept of permanent establishment

75 Defining Permanent Establishment The concept of permanent establishment Definition of PE according to article 5(1) of the OECD model treaty: PE: a fixed place of business through which the business of an enterprise is wholly or partly carried out According to article 5(2) of the OECD model treaty - PE includes: - A place of management - A branch - An office - A factory - A workshop - A mine, an oil or gas well, a quarry or ay other place of extraction of natural resources According to article 5(3) of OECD model treaty PE includes: A building site or construction or installation project constitutes a PE only if it lasts more than 12 month

76 Physical PE fixed place of business According to the definition, a physical presence appears to be required, which must be fixed Situation different in respect of various e-commerce situations According to OECD Commentary fixed means: established at a distinct place with a certain degree of permanence In practice, fixed place of business (commercial aspect) could be: a) A stand in marketplace b) A part of premises of another enterprise NO requirements for this place to be owned => OECD considers that a fixed place of business (geographical aspect) should be a specific geographical point

77 Physical PE fixed place of business PE: a fixed place of business through which the business of an enterprise is wholly or partly carried out It is clear PE = for dependent agents or employees It is unclear if PE or other personnel (example below) German company based in Germany specialized in block-booking hotel rooms in Paris for German tour operators. It had no premises in France, nor any persons capable of binding it in contract there. An unconnected travel agency in Paris made office space available to the German company from time to time which was used by a manager of the German firm when he visited. It was hardly ever used as a correspondence address. The German manager owned a couple of flats in Paris and stayed in these during his visits. Is this construction triggering a PE risk? Response: 1.The lack of formal accommodation at the disposal of the German company and the lack of evidence that any business of the company was conducted from any Parisian address led the Court to decide that there was no PE in France 2.The German company had no legal interest in any premises in Paris, nor could it be proved that the company s business was being carried on in Paris in premises owned by anyone else. CONCLUSION: NO PE risk

78 Construction PE Usually refers to building site or construction or installation project Period to trigger a PE: mainly 12 month

79 Agency PE The override to the fixed place of business requirement: A key test as to whether an enterprise is carrying out business in a country: Art. 5 para. 5. of the OECD Model Tax Convention Notwithstanding the provisions of paragraphs 1 and 2, where a person other than an agent of an independent status to whom paragraph 6 applies is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.

80 Agency PE A person acting on behalf of the enterprise Other than an agent of independent status An authority to concluded contracts in the name of the enterprise This authority must e habitually exercised

81 Agency PE The use of agents dependent agents Companies usually use agents to secure sales at the beginning of activities Personnel defined in OECD Commentary as all those who receive instructions from the company, not merely its employees Depending on person, it may be created a PE without being a fixed place of business by a dependent agent Dependent agent: may or not be an employee of the company must have authority to bind the enterprise in contract in the State concerned Substance over form principle when assessing the nature of the agent

82 i) UN Model Convention Services PE the furnishing of services [ ] through employees or other personell [ ], but only if activities of that nature continue for a period or periods aggregating more than 6 months within any 12-monthsperiod. OECD Model Convention/ Commentaries No fixed place of business is necessary! Services performed outside the source state are not taxable therein Tax should be levied on a net amount (e.g. profit) Source state taxation allowed only when a certain threshold is reached Addition to the definition of PE: a)through an individual who is present in that other State for a period or periods exceeding in the aggregate 183 days in any twelve month period, and more than 50 per cent of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other State through that individual, or b) for a period or periods exceeding in the aggregate of 183 days in any 12 month period, and these services are performed for the same projects through one or more individuals who are present and performing such services in that other State.

83 EXEMPTIONS FROM PE: 1. The exception for activities which are preparatory or auxiliary Art. 5 para 4 OECD Model Tax Convention: Notwithstanding the preceding provisions of this Article, the term "permanent establishment" shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise; e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; f) the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

84 Exemption from PE: the exemption for activities which are preparatory or auxiliary Examples of activities which are categorized as preparatory or auxiliary : Advertising services for the whole company, not for other third parties Supply of information for scientific research

85 Independent agent not give rise to a PE: Exemptions to PE: An agent bearing a commercial degree of entrepreneurial risk; An agent being both legally and commercially independent of the enterprise; An agent not being required to comply with detailed instructions from the enterprise; An agent not being subject to comprehensive control by the enterprise; The agent having skill and knowledge on which the enterprise relies, e.g. a network of contacts, local market knowledge, expertise in local government rules and regulations; The agent working for a number of different clients. Independent agent acting on the ordinary course of the business Group companies are not necessarily dependent agents whether such companies are acting on concluding contracts on behalf of the parent company

86 European and International Taxation Double Tax Conventions Jean Monnet Module: Managing the EU: Taxation, Governance and Economics The content does not represent the view of the Erasmus+ project nor the European Commission but only of the author Cluj-Napoca Jean Monnet Module: Managing the EU: Taxation, Economics and Governance

87 Overall Structure of a DTC Article 1 & 2 Article 3, 4, 5 Article 6 to 21 Article 22 Article 23A and 23B Article 24 and 29 Article 30, 31 Scope of the convention General Definitions, Residency, Permanent Establishment, Taxation of various incomes Taxation of capital Methods for elimination of double taxation Special provisions Non discrimination, MAP, etc. Entry into force, Termination

88 Dividends Preliminary remarks DTC and Dividends Objective of dividends article: to limit the amount of tax that the source state can charge on a payment of a dividend from a company resident in that state. Dividends - distribution of profits to the shareholders by companies limited by shares, limited partnerships with share capital, limited liability companies or other joint stock companies (legal entities with a separate juridical personality distinct from all their shareholders) Profits of partnerships - the profits of a business carried on by a partnership are the partners profits derived from their own exertions - for them they are business profits. => the partner is ordinarily taxed personally on his share of the partnership capital and partnership profits.

89 Dividends vs. business profits of partner The position is different from the shareholder He is no a trader and the company s profits are not his He is personally taxable only on those profits which are distribute by the company (apart from the provisions in certain countries laws relating to the taxation of undistributed profits in special cases) From the shareholders standpoint, dividends are income from the capital which they have made available to the company as its shareholders

90 Dividends - refers to the tax of the source state not exceeding: European and International Taxation 5% of the gross amount of the dividends where the beneficial owner is a company (other than a partnership) and holds at least 25% of the capital paying the dividend, and not exceeding 15% of the gross amount of the dividends in all other cases (Article 10(2) OECD Model Treaty).

91 In practice: the tax rate % (commonly referred to as the withholding tax ) and the beneficial owner threshold % vary (in this respect reference is often made to voting shares)! These percentages may in fact have little impact in the context of some domestic laws, such as in the UK, where there is no withholding tax on dividends.

92 Beneficial Owner a key concept => enables a tax authority to deny treaty benefits where in substance a person is not the true beneficial owner, but it is not entirely clear what it means it certainly does not include a nominee or an agent it broadly refers to the person who has the main or principle ownership rights

93 The purposes of the other paragraphs to the dividends article are: 1. to specify that the residence state of the recipient of dividends may tax the dividends without limit (Article 10(1)); 2. to define what a dividend means. Essentially this term covers income arising from shares in a company, including from jouissance rights or shares, founders shares, or other rights that are not debt-claims but entitle the recipient to a participation in the profits of a company (Article 10(3)); 3. to deal with the situation where shares are owned through a PE (Article 10(4)); and 4. to prohibit the extra-territorial taxation of dividends (Article 10(5)).

94 Dividends and Permanent Establishments Article 10(4) covers the situation where the beneficial owner of the shares in a company has a PE in the other state through which the shares are owned. The state of the PE then has the right to tax any dividends at the normal income or corporate tax rates, rather than the rates set out in Article 10(2). Extra-territoriality applies when a state tries to tax a dividend on the basis that the source of its profits, or part of the source of its profits, arises in that state even though the dividend does not emanate from a company resident in that state. This is strictly prohibited under the terms of a treaty. A state may, however, tax dividends from shares of companies, wherever resident, if the shares are effectively connected with a PE there.

95 The secondary withholding tax Country A Country B Company X -PE- Dividends Company X -resident- Dividends Shareholders of company X State A is allowed to tax the profits of company X (not resident in state A) in state A only if there is a permanent establishment in state A. State A cannot tax profits arising in state A when company X distributes them to shareholders in State B.!This is sometimes referred to as secondary withholding tax.

96 The Parent-Subsidiary Directive 90/435/EEC 2003/123/EC 2015/121/EU Ensure the establishment and effective functioning of the common EU market; No WHT on dividends in the Source state Cross-border payments only Minimum holding of 10% / period of 2 years

97 Royalties Background Royalties arising in a Contracting State (Source State) and beneficially owned by a resident of the other Contracting State (Residence State) shall be taxable only in that other State (Residence State). How does it work?... Relief or exemption in respect of an item of income is granted by the State of source to a resident of the other Contracting State to avoid in whole/in part the double taxation that would otherwise arise from the current taxation of that income in the State of residence. What does the term beneficial owner mean?... The term beneficial owner is not used in a narrow technical sense, rather, it should be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance.

98 Royalties - definition The term royalties as used in Article 12 of the OECD Model Treaty includes three main areas of intangible rights in relation to payments of any kind received as consideration of, or the right to use such rights. These are: any copyright of literary, artistic or scientific work including cinematograph films ; any patent, trade mark, design or model, plan, secret formula or process ; information concerning any industrial, commercial or scientific experience.

99 Royalties some brief examples: 1. Will the payments made by a telecommunications network operator to another network operator under a typical roaming agreement constitute royalties? Since these payments are not made in consideration for the use of, or right to use, property, or for information, referred to in the definition, they will not constitute royalties. 2. What about rents in respect of cinematograph films, whether such films are exhibited in cinemas or in television? These payments may represent royalties. It may, however, be agreed through bilateral negotiations that rents in respect of cinematograph films shall be treated as business profits.

100 Royalties some brief examples: 3. A distributor of clothes resident in one Contracting State pays a certain sum of money to a manufacturer of branded shirts, who is a resident of the other Contracting State, as consideration for the exclusive right to sell in the first State the branded shirts manufactured abroad by that manufacturer. Could this type of payment trigger a royalty? In this example, the resident distributor does not pay for the right to use the trade name or trade mark under which the shirts are sold; given the fact that he obtains the exclusive right to sell in his State of residence shirts that he will buy from the manufacturer, we cannot consider these types of payments as royalties.

101 Royalties and the concept of know-how Know how: payments received as consideration for information - concerning industrial, commercial or scientific experience What about know-how? transfer of certain information that has not been patented and does not generally fall within other categories of intellectual property rights it is related to un-divulged information of an industrial, commercial or scientific nature arising from previous experience, in the know-how contract, one of the parties - can use the know-how for his own account, his special knowledge and experience which remain unrevealed to the public. there is the need to distinguish between two types of payments: payments for the supply of know-how and payments for the provision of services.

102 Royalties and the concept of know-how!computer programming - know-how only where it is made to acquire information constituting ideas and principles underlying the program, such as logic, algorithms or programming language or techniques, where this information is provided under the condition that the customer not disclose it without authorization and where it is subject to any available trade secret protection.!computer software know-how only when the user is able to exploit the rights for commercial gains!copyright - royalty where the consideration is for granting of rights to use the program in a manner that would, without license, constitute an infringement of copyright

103 Situation 1: Royalties computer software: Consider the case for transactions that permit the customer (which may be an enterprise) to electronically download digital products (such as software, images, sound or text) for that customer s own use or enjoyment. Could this payment represent a royalty? Generally, no. Where the consideration is essentially for something other than for the use of, or right to use, rights in the copyright (such as to acquire other types of contractual rights, data or services), and the use of copyright is limited to such rights as are required to enable downloading, storage, performance or display device, such use of copyright should not affect the analysis of the character of the payment for purposes of applying the definition of royalties.

104 Situation 2 Royalties computer software: Imagine a book publisher who would pay to acquire the right to reproduce a copyrighted picture that it would electronically download for the purpose of including it on the cover of a book that it is producing. Clue: In this transaction, the essential consideration for the payment is the acquisition of rights to use the copyright in the digital product, i.e. the right to reproduce and distribute the picture, and not merely for the acquisition of the digital content. Could this type of payment trigger a royalty? Yes. Transaction where the essential consideration for the payment is the granting of the right to use a copyright in a digital product that is electronically downloaded for that purpose will give rise to royalties.

105 Royalties paragraph 3 where the beneficial owner of the royalty has a PE in the other Contracting State through which the royalties arise => the PE state may tax such royalties at the normal income/corporate tax rates (this is similar to the dividend and interest articles).

106 Royalties paragraph 4 The purpose of this paragraph => to restrict the operation of the provisions concerning the taxation of royalties in cases where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of royalties exceeds the amount which would have been agreed upon by the payer and the beneficial owner had they stipulated at arm s length. With regard to the taxation treatment to be applied to the excess part of the royalty, the exact nature of such excess will need to be ascertained according to the circumstances of each case, in order to determine the category of income in which it should be classified for the purpose of applying the provisions of the tax laws of the States and the provisions of the Convention. Should the principles and rules of their respective laws oblige the two Contracting States to apply different Articles of the Convention for the purpose of taxing the excess, it will be necessary to resort to the mutual agreement procedure provided by the Convention in order to resolve the difficulty.

107 DTC and Other income (Art 21 OECD Model Treaty) It is the article that sweeps up any income that is not covered in any other specific article. The essence => only taxing the income in the state of the resident owner The article has two paragraphs: 1. Article21(1) OECD Model Treaty provides that items of income of a resident not otherwise addressed covered in the other articles of the treaty will only be taxable in the resident s state. This includes income from other sources and income from other classes. 2. Article 21(2) then goes on to say that if the income (other than from immovable property) is effectively connected to a PE which the resident has in the other contracting state then it will be taxed under the provisions of the business profits article, i.e. it will be taxed in the PE state.

108 Other income (art. 21 OECD Model Treaty) examples Social securities payments Liquidation proceeds (if not classified as dividends or capital gains)

109 DTC and Business Profits sets out the limits of the source state s taxing rights in relation to business profits if an enterprise resident in a contracting state has a PE in the other state through which it carries on business => taxable in that other state, as well as the state of residence (subject to double taxation relief). The tax is limited in the source state to no more than the profits attributable to the PE. if, however, an enterprise does not have a PE in the other state => taxed in the state of residence (Article 7(1) OECD Model Treaty).

110 Business Profits paragraph 2 does not specifically deal with the issue of whether expenses are deductible when computing the taxable income of the enterprise in either State PEs must be accorded the same right as resident enterprises to deduct the trading expenses paragraph 3 of the updated Article 7 => reciprocal adjustments to the profits calculated in respect of the PE paragraph 3 allows corresponding adjustments to avoid double taxation, on consultation of the two States involved

111 Business Profits Article 7(4) => cedes priority to another specific income article of a treaty, if an item of income (forming a part of the profits of an enterprise) is dealt with under that article. This is the same as the previous Art 7(7).

112 DTC and Interest limit the tax imposed by the source state where the interest arises and counters the treaty benefits available where there is an excessive payment of interest arising from a special relationship : 1.The resident state has unlimited taxing rights on the interest (Article 11(1)). 2.There is a limit on the withholding tax that may be imposed by the source state on the interest (maximum 10%). However, the recipient must be the beneficial owner 3.Definition of interest - exhaustive definition covering income from debt claims of every kind, whether or not secured by a mortgage and whether or not carrying a right to participate in the debtor s profits. Income from government securities and income from bonds or debentures are included. Penalty charges for late payment of interest are not to be regarded as interest (Article 11(3)).

113 DTC and Interest 4. If the recipient of the interest has a PE in the other state then the other state may tax that interest at the normal income/corporate tax rates (Article 11(4)). 5. The circumstances when interest arises in a state. This includes where the payer is resident in a state, or where interest is borne by a PE in that state (whether paid by the PE itself or elsewhere) (Article 11 (5)). 6.Excessive interest payments arising under a special relationship, having regard to the debt claim on which the interest is paid, will not attract the interest article benefits, e.g. limiting withholding taxes.! It should be noted that a number of treaties do not allow withholding taxes to be imposed on interest and that, within the EU, the Interest and Royalties Directive (Directive 2003/49/EC) may apply to avoid withholding taxes on interest.

114 DTC and capital gains (Art. 13 OECD Model Treaty) This article has five paragraphs covering the following: 1. A source state has the right to tax gains (not defined in the Treaty and therefore domestic interpretation should be applied) from the alienation (again not defined, but certainly relates to actual sales but it is questionable whether it can relate to deemed disposals under domestic tax laws) of immovable property (defined in Article 6 OECD Model Treaty). 2. A source state can tax gains on the sale of immovable property associated with a PE or on the sale of the PE itself (Article 13(2)). 3. In the case of alienation of ships and aircraft only the state of effective management has the taxing rights (Article 13(3)). 4. A source state can tax the gains on the sale of shares in a company owning land situated in the source state where the land forms more than 50% of the value of the company (Article 13(4)) (shares are, however, generally regarded as movable property, falling within the ambit of Article 13(3) or 13(5)). 5. In cases not covered by Articles 13(1), 13(2), 13(3) or 13(4), the state of the seller is only able to tax the gain (Article 13(5)).

115 European and International Taxation Transfer Pricing and thin capitalization Jean Monnet Module: Managing the EU: Taxation, Governance and Economics The content does not represent the view of the Erasmus+ project nor the European Commission but only of the author Cluj-Napoca Jean Monnet Module: Managing the EU: Taxation, Economics and Governance

116 Agenda of the lecture 1. Introduction to transfer pricing 2. Main features of transfer pricing legislation 3. OECD Model Article 9: associated enterprises 4. Advance pricing agreements ( APAs ) 5. The OECD transfer pricing guidelines

117 Introduction transfer - transactions between related parties, both domestic and cross-border pricing - commercial relationships/terms of trade between related parties Transfer pricing regulations - a major consideration in trading relationships between related companies because of tax consequences OECD guidelines followed by authorities when judging transfer pricing transactions across borders between enterprises in different countries

118 Introduction: Arm s length principle ü price that might have been expected if the parties to a commercial understanding or transaction had been independent persons dealing at arm s length with each other in a normal commercial manner unaffected by any special relationship between them Why? unrelated parties involved - maximize their revenues or minimize their costs related parties involved - profit attribution between them, profit shiftingat free will

119 Introduction to transfer pricing Overview v arm s length approach - identify the terms of trade that would be obtained on the same transactional relationships between unrelated parties in the same commercial circumstances. v OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD TP Guidelines ) v incorporation of the arm s length concept within domestic tax legislation v short history of the OECD TP Guidelines: issued in 1979 updated in 1995 Updated July published in September 2010

120 The WIND GROUP is the parent company of a wind turbine manufacturer. The company has two subsidiaries: Dutch Parts - manufactures circuit boards for the turbines in the Netherlands and Turbines UK - produces and assembles the turbines. SHIFTING PROFITS FROM UK TO NL: YEAR 1: 100 EUR per board YEAR 2: 150 EUR per board

121 Transfer Pricing dispute: GSK vs. IRS US tax authority European and International Taxation For 14 years, GlaxoSmithKline (GSK) and its predecessor companies had disagreed with the IRS about the transfer prices the U.S. subsidiary of GSK paid its U.K. parent for several different drugs. The dispute primarily involved the appropriate pricing method for GSK s Zantac, a product designed to treat stomach ailments and ulcers. The primary issue in the GSK case was the transfer price at which the U.K. parent, GlaxoSmithKline PLC, sold drugs (primarily Zantac) to its U.S. subsidiary. In a parentsubsidiary transaction such as this, the transfer price does not affect the overall profit of the group, but it does affect the overall taxes paid by the group. Resolution: GSK and the IRS agreed to a $3.4 billion settlement, the largest in IRS history.

122 Introduction totransfer pricing Unitary taxation / global formulary apportionment qalternative approach to arm s length principle qformula to allocate profits between countries by considering different factors qnot an approved method of the OECD qusa application of the unitary taxation because of the state tax rates qcommon consolidated corporate tax base (CCCTB) initiatives project in EU formulary apportionment to fight against profitsshifting in theeu qin practice: consolidated profits of the group are allocated/apportioned to a state based on sales, payroll, property, etc Disadvantages: Not a valid concept for many countries Not an accepted method for computing profits Impact on different accounting implications from country to country

123 Arm s length principle qmain objective of transfer pricing documentation identify third party comparables => benchmark price Comparables are: qinternal - those experienced by one of the related parties in its dealings with third parties, or qexternal - those transactions or commercial relations betweenthird parties which are in the public domain and can be pointed to as a direct comparison. Any resulting independent prices obtained by this method are referred to as a comparable uncontrolled prices ( CUPs ) => ideal way of benchmarking.

124 In order to identify appropriate comparable data, the initial groundwork needs to be undertaken. This involves understanding: 1. the functions that the business performs in relation to the commercial relationship under consideration functional analysis e.g. distribution, manufacturing, R&D 2. the nature of the asset (tangible or intangible) or service, including quality, quantity, reliability and name recognition; 3. the risks attaching to the functions and activities e.g. FX currency risk 4. the contractual terms of any arrangement, whether in writing or by inference to the actions of the parties e.g. payment terms, delivery terms, guarantee terms 5. business policies, projections, forecasts and strategies; and 6. economic background, including geographic location, market performance and competition.

125 Transfer pricing of Permanent establishments üprofits attributable to a permanent establishment which it might be expected to make if it were a separate and independent enterprise engaged in the same or similar activities under the same or similar conditions üimportant to establish the functions, the key entrepreneurial risks of the PE and its underlying assets

126 Main features of TP legislation 1. Methods to analyze TP q CUP, resale method and cost plus wide spread around the world 2. Documentation and compliance issues q Some countries specific tax returns in respect of TP (e.g. USA, Australia) q generally tax audit procedures q Widespread documentation requirement to demonstrate that prices are at arm s length 3. Tax audit and penalties All countries have imposed penalties and adjustment of profits Some differences from country to country

127 Main features of TP legislation 4. Thin capitalisation - Issue of excessive debt from related parties -Methods to avoid such cases 5. APAs -unilateral or bilateral agreements -based on MAP ofthe OECD -validate price cross-border arrangements

128 OECD MODEL ARTICLE 9: ASSOCIATED ENTERPRISES Double tax treaties and transfer pricing! 4 main areas where tax treaties follow the OECD Model related to transfer pricing: 1. The associated enterprises article (Article 9 OECD Model) - TP adjustments 2. Article 11 OECD Model - denies treaty benefits when the amount of the interest exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship 3. Royalty article (Article 12(4) OECD Model) - similar in effect to that of the interest article 4. The mutual agreement procedure ( MAP ) (Article 25 OECD Model) - enables transfer pricing disputes to be resolved

129 OECD MODEL ARTICLE 9: ASSOCIATED ENTERPRISES Article 9 Associated Enterprises (OECD Model Treaty) qpermits a country to make an upward adjustment to the profits of a local enterprise qpermits the other state to make a corresponding/compensating adjustment qmap procedures to be used Associated enterprises are defined in two ways: i. either one enterprise participates directly or indirectly in the management, control or capital of another enterprise in the other state, or ii. both enterprises have the same persons participating in the management, control or capital.

130 ADVANCE PRICING AGREEMENTS ( APAs ) the advantage => enable local companies to enter into APAs where there is a need to overcome complex transfer pricing issues with overseas related parties. -2 APA methods: 1. Bilateral APAs 2 countries/tax authorities involved based ona MAP ofa treaty multilateral APA in theory, possible to be obtained as an extension of a bilateral APA - In practice, very difficult to be achieved

131 2. Unilateral APAs ADVANCE PRICING AGREEMENTS ( APAs ) -which are those agreed with local tax authorities without reference to another authority Important: -domestic legislation in place in order to initiate APA -country without specific APA legislation - MAY bea party to a bilateral APA as a result of another country s APA regulations and the existence of a tax treaty with a MAP! IN ROMANIA 2 UNILATERAL APAs What is in practice an APA? -written agreement between tax paying company and local revenue authority -enjoys overseas tax authority and related overseas company

132 OECD Guidelines content THE OECD TRANSFER PRICING GUIDELINES 1. Thearm s length principle (Chapter I of the Guidelines); 2. Transfer pricing methods; traditional transaction methods (Chapter II): CUP, resale price, cost plus, profit split, transaction net margin methods; 3. Comparability analysis (Chapter III); 4. Administrative approaches to avoiding and resolving transfer pricing disputes (Chapter IV); 5. Documentation (Chapter V); 6. Intangible property (Chapter VI); 7. Intra-group services (Chapter VII); and 8. Costcontribution arrangements (Chapter VIII).

133 Methodologies and their application 1. Comparable Uncontrolled Price ( CUP ) -the most objective method European and International Taxation -price = the one which would be charged in a similar transaction with an unconnected party -types of CUPs: 1. the CUP between two unconnected parties THE OECD TRANSFER PRICING GUIDELINES 2. the CUP that the enterprise would charge when dealing with an unconnected third party An uncontrolled transaction can be said to be comparable to a controlled transaction if: there are no differences between the transactions being compared or between the enterprises entering into the transactions which could materially affect the price charged in the open market where there are differences, reasonably accurate adjustments could be made to eliminate their effect.

134 THE OECD TRANSFER PRICING GUIDELINES Example of CUP A manufacturer sells heaters to a number of companies in different countries, who distribute the goods to the end user. In country X, the climate is unusually mild all year round and therefore the associated distributor has to incur a lot of marketing cost to shift any units. In country Y, the climate is cold all year round; the heaters sell as soon as the independent distributor can stock them. No marketing is required.

135 Implications on illustration: q the first distributor has a much lower margin than the second. q country X distributor might negotiate a lower price with the manufacturer, related to its additional marketing costs q impact on arm s length differences in the markets might affect the price paid for the same goods, at the same number and at the same time

136 2. Resale price q specific for marketing or distribution operations, manufacturing operations q involves the enterprise constructing the arm s length price. q it uses known resale price margins either from the company s own transactions with third parties or from transactions between unconnected parties q the transfer price is constructed

137 Example of the resale price method the case of goods coming into the UK from a connected party, the transfer price would be constructed as follows: UK selling price Transport costs Advertising Other costs Resale price Margin* Known (X) (X) (X) (X) Arm s length price X

138 3. Cost plus method (C+) -used for contract manufacturing and provision of services -how? It takes the costs incurred - direct and indirect - and adds an agreed mark up. 4.Profit split method transactionalmethod -used to resolve the more complex transfer pricing exercise -related to highly integrated activities -how? It looks at the overall profit made on the transaction and seeks to split it between the different parts of the enterprise on the same basis as it would be split between unconnected parties 5. Transaction net profit margin (TNMM) transactional method -commonly used in the US and may be used where other methods prove difficult -how? Computation of the profit net margin derived by an entity as a result of its transactions with related parties compared with an estimation of this margin at the level that entity would have obtained in transactions with non-related entities or with profit net margin derived from independent party transactions

139 Intra-group services -many group services that may be subject to transfer pricing - for example marketing, IT, finance or human resources. How to analyze these types of services 1. Have the services been supplied? 2. An independent enterprise would have been prepared to pay for such services? 3. An independent enterprise would have needed to perform them in house? If all answers are yes => a service has been provided such services should be recharged at an arm s length price

140 European and International Taxation EU Tax Harmonization - VAT Cluj-Napoca Jean Monnet Module: Managing the EU: Taxation, Economics and Governance

141 European VAT General Principles Introduction Territory Taxable Person Taxable Transaction Place of Taxable Transaction Chargeable event Taxable Amount Tax Rates Exemptions Deductions Persons liable for payment of tax

142 Introduction 1967: First Directive (introduce by 1970) 1973: Nine different systems 1977: Sixth Directive on Harmonization 1991: Intra-community borders abolished 1999: Labour-intensive services 2000: Tax representation made optional 2002: Imports of radio, TV and electronic services taxed at place of consumption

143 The main features of the EU VAT system Taxation in the "Member State of consumption". taxation of supplies of goods and services, taxation of imports and exemption of exports exemption of intra-community supplies and taxation of intra-community acquisitions.

144 Import VAT procedure Clear distinction between: the place where the import takes place (MS of arrival of the goods) and the place of consumption (MS of destination of the goods). European and International Taxation Art 60 of the VAT Directive (2006/112/EC) : "The place of importation shall be the Member State within whose territory the goods are located when they enter the Community."

145 Import VAT procedures Different possible scenarios: Final destination is the MS where the import takes place : VAT declared together with customs duties, possible deferred payment. Final destination is another MS : VAT exemption of import (art 143.d of VAT Directive) and subsequent intracommunity supply, taxation of intracommunity acquisition in the MS of destination.

146 Import VAT procedures Obligations in cases goods are supplied or transferred to another MS: Conditions for the exemption are set by the MS (art 131 of VAT directive), Different obligations, control mechanisms in place, - VAT declaration, - VAT identification / possible tax representative, - Recapitulative statement (VIES)

147 The concept of centralised clearance Art. 106 of the modernised Customs Code Possibility for importers to declare and pay all their import duties in their MS of establishment, wherever the goods are supplied / transferred.

148 The concept of centralised clearance European and International Taxation By 2013 Centralised clearance would apply to: goods that stay in the MS of physical importation, Goods that are supplied / transferred to MS of establishment, Goods that are supplied or transferred to a third MS. Customs formalities complied with and customs duties paid in MS of establishment.

149 VAT aspect of centralised European and International Taxation clearance Need to comply with current VAT obligations in the MS of physical importation (even if customs obligations are complied with in the MS of establishment). This is both valid in cases: Where goods stay in the MS of importation (declaration, payment, possibly deferred ) Where goods leave the MS of importation (declaration, exemption, intracommunity statement ).

150 VAT aspects of centralised clearance Clear that the real benefit of centralised clearance for economic operators (importers) will only arise if the VAT dimension is fully taken into account Council statement stressed that "centralised clearance might need adjustments in the area of VAT.

151 All of EU Excluded Canary Islands French DOMs Included Monaco in France Isle of Man in UK Territory

152 Taxable Persons A person who engages in Economic Activity Independently Even occasionally Exemptions Illegal Free Public bodies (except for commercial activities) Private consumers Inclusions Any person buying new means of transport from another member-state Imports : taxable person includes consumers

153 Taxable Transactions Supply of Goods Transfer of economic ownership Deemed supply of goods (for self, employees) Supply of Services Imports Any transaction which is not a supply of goods Intra-Community Acquisitions

154 General rule European and International Taxation Place of Taxable Transactions Where transport begins Where Supplier has fixed establishment Exemption Many services (real estate, entertainment) Works contracts (registration number) Imports (country of import) Intra-community acquisitions (destination generally)

155 Supplier OSP - Customer Member State 1 Supplier A Goods bought and processed in one Member State and sent to principal in another State Member State 2 G o o d s C Principal Processor B Member State 1 A and B invoice directly to C (HT). C includes this in his intercommunity acquisitions

156 Principal- OSP1-OSP2-Principal Goods sent for processing in two different States before being returned to principal Member state 1 Member state 2 B Processor 1 Principal A Partly processed goods C Processor 2 Member state 3 B and C invoice A only to the extent of value of processing work. Acquisition is made in State 1 (Transfer of goods are not deemed to be acquisitions for VAT)

157 Intra-Community Acquisitions General Rule: Supplies exempt, Purchases Taxed, In Destination country Taxable Persons:» Intra-community acquisitions added to sales» But also deducted from purchases Conditional exemption: Country of origin: Small farmers, consumers buying < Mail orders, etc shipping < 100,000 (or 35,000) Exemption Transport, Ancillary services to transport, Intermediaries in transport Inclusion: Consumer buying transport

158 Intra-Community Transactions European and International Taxation Place of Taxable Transaction in Intra-Community Transactions Shipment to Customer with VAT number Shipment in country of origin to Customer without VAT number Shipment to country of destination to customer without VAT number Shipment to Customer with installation Sales to country below its threshold (100,000 or 35,000) Sales to country beyond its threshold Invoice without VAT Invoice with VAT of origin State Invoice with VAT of destination State Invoice with VAT of country of installation

159 Triangular Sales Goods dispatched directly European and International Taxation Triangulation (3 parties - A,B,C, 3 States 1,2,3) A in 1 sells to B in 2 who sells to C in 3. Goods despatched from A directly to C Member State 1 Goods Member State 3 A C Invoice Invoice B Member State 2

160 EXAMPLE B is French (VAT 19.6%). He purchases goods worth 50,000 from A, an English company (VAT 17.5%), and directs that send goods directly to C in Italy (VAT 20%). The English company, bills B for the transport of 5000 also. B bills his Italian customer, C, for 75,000. The diagram in the above box therefore describes the situation. The taxation would depend on where B is registered.

161 REGISTERATION and VAT If French company had identification number - in UK and France Treatment of transaction for VAT The English company makes a local sale to B in UK and charges VAT of 17.5% of = B s sale to C is exemp t. He has still to get a refund of C s acquisition is taxable in Ireland at 20% of = "- in Italy and France A s supply to B is exempt. B, the French comp any, receives goods in Italy. It has to pay VAT on intra Community acquisitions in Italy 20% of = He then makes local sale to C, charges and collects VAT of 20% on = from C. - in France only C, the Italain comp any declares intra-community acquisition of and p ay s VAT of 20% or 15,000. A is exempt because he supplied. B is exempt for the A to B acquisition transaction because of triangular sale disp osition. B is exemp t for the B to C transaction because it is a supp ly.

162 Example 2: In the above triangular sale case, if the English company wants to charge the French company 5,000 for transporting goods directly to Ireland, what would be the tax on the transport. If French company had identification number - in UK and France Transport (if VAT registration number given) VAT of UK on transport (since both parties are registered in UK). 17.5% of 5000 = in Italy and France VAT of Italy on transport 20% of 5000 = in France only VAT of France on transport 19.6% * 5000 = 980 Note: If no VAT registration number is provided to transporter, UK s VAT would apply (country of departure): 17.5% on 5000 = 875.

163 Chargeability General rule Chargeable event Delivery of goods Performance of service Tax becomes chargeable When authority entitled to it» On delivery of goods» On payment by customers for services» On importing (crossing customs barrier) Exemptions to general rule Repeated payments (for services & construction work) At time of billing: last installment On-account payment Each payment European and International Taxation

164 Tax liability Goods/services Imports Earlier of invoice or delivery / performance Time of importing or included in tax return Intra-community transactions Later of chargeable event or Invoice but before 15th of month after acquisition

165 Tax Rates Vary from one country to another Minimum 15% One or two lower rates, at least 5% No refunds should result No new Zero tax rates

166 Exemptions Within the country Public Interest Others (insurance, credit, real estate) No deductions allowed Option to be taxed for some of these International transactions Exports Deductibility allowed Import of items which are exempt from domestic VAT Temporary imports, VAT warehouses

167 Deductions Deduction of input VAT by taxable persons Not by final customers Not by holding companies As soon as invoice received If taxable and non-taxable business, proportional deductibility allowed

168 Example: A buys inputs of 500 and sells for 1000 to B. B makes a local sale for VAT Return of A VAT return of B Case I: A and B are from Luxembourg VAT Collected 15% of 1000 = % of 2000=300 VAT deductible 15% of 500 = 75 15% of 1000=150 VAT paid = = 150 Case II: A is Danish, B is Luxembourgois A. Hypothetical (doesn t happen) VAT collected Exempt Intra-community % of 2000=300 = 0 VAT deductible 25% of 500 = 125 Exempt of 1000= 0 VAT paid (refund) = (125) = 300 Case II B: Actual (what is done) VAT collected Exempt Intra-community 1000 = 0 15% of 2000= 300 VAT collected : Intracommunity 15% of 1000 = 150 acquisitions VAT deductible (on purchases) 25% of 500 = % of 1000 = 150 VAT paid (refund) = (125) = 300

169 Persons liable for payment European and International Taxation Taxable person If reverse charge is applied, the receiver If identification number issued, the registered person For imports, the importer Taxable representative optional

170 Calculate VAT due ABC Ltd, a French comapny April Turnover in France (VAT 19,6%) Exports to USA 9000 Intra-community sales (Denmark 25%) 8000 Intra-Community Sales (Germany 15%) 7000 Transfers to VAT registered warehouse in Portugal (VAT17%) 6000 Transfers to VAT non-registered warehouse in Sweden (VAT 25%) 5000 Total Raw Materials bought in France Imports from India 5000 Purchases from Spain (VAT16%) 4000 Fixed Assets bought in France 3000 Fixed Assets bought from Sweden 2000 Total 29000

171 Calculation of VAT due - Solution European and International Taxation Return Filed by ABC Tax Collected Sales in France Transfers to non-registered warehouse in Sweden 5000 Purchases from Spain: Intracommunity acquisitions 4000 Purchases from Sweden : Intracommunity acquisitions ,60% 4116 Exempt Exports to USA 9000 Intra-community sales (Denmark and Germany) Transfers to registered VAT warehouse Deductible Raw Material bought in France Imports from India 5000 Purchases from Spain 4000 Fixed assets bought from France 3000 Fixed Assets bought from Sweden ,60% 5684 Tax to be paid / (Refund due) -1568

172 European and International Taxation EU Tax Harmonization VAT in Member States The case of Romania Cluj-Napoca Jean Monnet Module: Managing the EU: Taxation, Economics and Governance

173 Is VAT payable in Romania? 5 Essential questions: 1. Taxable person 2. Operation is taxable 3. Place of the operation 4. Exemption 5. Person that has to pay the VAT

174 Romania? YES Exemption? NO NO YES LIABLE PERSSON NO VAT IN ROMANIA NO VAT DUE IN ROMANIA VAT SUPPLYER VAT CLIENT VAT IMPORTER VAT fiscal reprezentative

175 Taxable person => art. 269 Fiscal Code ü any person that undergoes üin an independent matter üno matter the place üeconomic activities as forseen in art. 269(2) of the fiscal code üwhatever the purpose and the outcome of this activity.

176 Taxable operations ü Supply of goods or services in cash ü Place of supply => Romania ü Undertaken by a taxable person ü Has to be generated from an economic activity European and International Taxation

177 Place of the operation ² Supply of goods with transportation => Place where the goods are located at the beginning includes intra-community acquisitions ² Supply of goods without transportation: the place where the goods are available to the client ² Supply of goods with installation / assembly => the place where these are installed ² Intra-community purchases => Place => the member state where the transport ends! ² Import of goods => Place => where the goods enter the community

178 Import VAT procedures Obligations in cases goods are supplied or transferred to another MS: Conditions for the exemption are set by the MS (art 131 of VAT directive), Different obligations, control mechanisms in place, - VAT declaration, - VAT identification / possible tax representative, - Recapitulative statement (VIES)

179 Servicii legate de bunurile imobile Servicii de restaurant si catering B2B Locul undebeneficiarul isi are stabilit sediulactivitatii economice, exceptand: Art. 271 CF Activitati culturale, artistice, sportive, stiintifice, educationale, de divertisment precum sialte activitati similare Servicii de intermediere B2C Locul unde prestatorul isi are stabilit Inchiriere de mijloace de transport pe termen scurt (Rent a car) Servicii intangibile Reguli speciale - Use and enjoyment sediul activitatii sau un sediu fix de la care suntprestate serviciile exceptand: Activitati auxiliare serviciilor detransport precum si lucrarile asupra bunurilor mobile corporale : Servicii de transport intra-comunitar

180 Supply of services B2B Where the beneficiary has its HQ or a PE B2C Where the supplier has his HQ or a PE from where the activities are carried out

181 Supply of services - exemptions B2B / B2C In case of services related to imovable goods Services related to cultural/sports/education/scie ntific activities Local transport of people Restaurant and catering Rent a car (short term lease of vehicles) Beneficiary is outside the EU: Services related to transport, evaluations and works on movable goods => taxable in Ro if these are done in Ro B2C Mediation services Intra-community transport Beneficiary is outside the EU: Leasing / renting transport vehicles

182 Case studies: Case studies: European and International Taxation Hungary Romania Supplier in HUN Romanian client is a taxable person Raw materials Processed goods Processed return to Romania