International Taxation of Income from Cross-Border Services

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1 International Taxation of Income from Cross-Border Services International Taxation Conference Mumbai, India December 2, 2006 Carol A. Dunahoo Baker & McKenzie LLP, Washington, DC Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm.

2 Overview Increasing Importance Technical Issues Taxation of Company, Employees, or Both? Personal Services or Intercompany Services? PE Implications? Compliance Obligations? Trends Increased Pressure on PE Threshold? Blurring of Services and Intangibles Transactions? Implications for International Trade and Investment? 2006 Baker & McKenzie 2

3 Increasing Importance Services are significant portion of economy in many countries and increasing portion of crossborder trade Communications and travel advances are facilitating increased performance of services at a distance from customers Increased outsourcing of service functions, to both unrelated customers and related parties Increased visits by service providers to customers and by related company personnel to service affiliates Increased cross-border secondments 2006 Baker & McKenzie 3

4 Implications For businesses Customer service concerns Competitiveness concerns cost minimization pressures For governments Potential effect on tax base Political concerns re implications for local employment? 2006 Baker & McKenzie 4

5 Technical Issues 2006 Baker & McKenzie 5

6 Taxation of Company PE exposure? Attribution of profits if PE? Transfer pricing issues? Withholding taxes? Employee-related compliance obligations? 2006 Baker & McKenzie 6

7 Company PE Exposure? Does foreign company have A fixed place of business PE? A dependent agent PE? A services PE (where treaty permits)? As a result of Outsourcing of functions to unrelated party? Functions performed by local affiliate? Short-term stewardship visits by employees to local affiliate? Longer-term secondment of employees to local affiliate? 2006 Baker & McKenzie 7

8 Company Attribution of Profits? How are the profits attributable to the PE, if any, determined? Interpret treaty provisions with reference to Domestic legislation? OECD Commentary? Current OECD project on profit attribution? Position of non-oecd Members? Increase in cross-border controversies 2006 Baker & McKenzie 8

9 Company Transfer Pricing Issues? Was service provider compensated appropriately? How to determine appropriate intercompany prices? Domestic law? OECD Transfer Pricing Guidelines? Position of non-oecd Members? Increase in cross-border controversies 2006 Baker & McKenzie 9

10 Company Withholding Taxes? Gross-basis withholding taxes on service fees under domestic law? Income taxes Indirect taxes (e.g., Indian service tax ) Withholding permitted by treaty? Fee for included services under India-U.S. Treaty? 2006 Baker & McKenzie 10

11 Company Employee-Related Obligations? Is company contractually required to equalize the taxes of seconded employees? Must company withhold taxes in respect of personal income tax obligations of seconded employees? 2006 Baker & McKenzie 11

12 Taxation of Employees Treaty provisions Who is the employer? PE implications for employer? 2006 Baker & McKenzie 12

13 Employees Treaty Provisions General OECD policy: Exempt non-resident employees from local income taxation if on short-term visits (183 days or less) Exceptions for high earners (artistes, athletes, etc.) General UN policy: Same, with additional exceptions (e.g., for top management officials) But note services PE provisions (6-month threshold) 2006 Baker & McKenzie 13

14 Employees Who is Employer? Some countries respect employment contracts; others apply substance-over-form analysis Concern about loan-out arrangements Growing focus on seconded employees Under services contract, does company provide services or may its employees be considered employees of service recipient? OECD project 2006 Baker & McKenzie 14

15 Trends 2006 Baker & McKenzie 15

16 Trends Increased Pressure on PE Threshold and on Employee Taxation? Blurring of Services and Intangibles Transactions? Implications for International Trade and Investment? 2006 Baker & McKenzie 16

17 Increased Pressure on PEs, Employees Conflicting views of employee: As protected from local income taxation by treaty if short-term presence? As creating a PE for the foreign affiliate (because conducting its business)? As employee of the local entity (because conducting its business)? Can both foreign affiliate and employee be subjected to local income taxation? Can Articles 7 and 15 apply simultaneously? 2006 Baker & McKenzie 17

18 Services vs. Intangibles Increased focus on taxation of high-value services See new U.S. services regulations on transfer pricing under section 482 Can intangible assets be transferred in the guise of services? 2006 Baker & McKenzie 18

19 Trade and Investment Implications Effect on location decision of Uncertainty Excessive tax and compliance burdens 2006 Baker & McKenzie 19

ALI-ABA Course of Study Going International: Fundamentals of International Business Transactions. December 7-9, 2006 Washington, D.C.

215 ALI-ABA Course of Study Going International: December 7-9, 2006 Washington, D.C. Presentation Slides By, Esquire Baker & McKenzie LLP Chicago, Illinois 216 2 217 Fundamentals of International Business