International Taxation Basics

Transcription

1 International Taxation Basics

2 Dilbert about int l taxation 2

3 Agenda I. Fundamental questions of int l taxation II. Avoiding double taxation, double tax treaties, the OECD modell convention III. EU directives IV. A few practical examples V. Hungary in the int l taxation 3

4 Fundamental questions of int l taxation 4

5 Fundamental questions of int l taxation Assessing tax is each states sovereign right: each state can independently decide: - How it formulates its internal and external taxation rules; - How it demarcates its tax claim from other state s claims. Existence or absence of tax liability! Different methods can lead to juridical multiple or under taxation. 5

6 Fundamental Questions of Int l Taxation Demarcation of Tax Claims In the case of direct and property taxes, for tax payers - Principle of residency - Principle of territory (source principle) Tax subjects - Principle of universality - Principle of territory In the case of indirect taxes - Principle of destination country - Principle of country of source 6

7 Fundamental Questions of Int l Taxation Principle of Residency Based on personal bond. Results in unlimited tax liability, tax payer is taxed on its world income, not taking into consideration the source of the income. Definition of personal bond: Entities - Place of incorporation - real seat a. place of central management and control (Anglo-Saxon countries) b. place of management (Continental countries) Individuals - Permanent residence - Habitual place of abode - Center of vital interest - Citizenship 7

8 Fundamental Questions of Int l Taxation source principle Based on economic bond. Results in limited tax liability, the tax payer is taxed only on its income derived from and assets located in the given country. Usually no distinction is made between individuals and companies for defying the source of income. Typical withholding tax incomes: - dividend; - interest; - royalty; - capital gains; etc. 8

9 Fundamental Questions of Int l Taxation Double Taxation Issue: different countries use different taxation principles and methods. - Conflict of taxation principles (residency vs. source) - Different definitions of residency (residency vs. residency) - Different definition, understanding of source (source vs. source) Double taxation (juridical and/or economical)! 9

10 Fundamental Questions of Int l Taxation Residency vs. source X state residency Seat 19% Income: HUF 100 Y state source Factory 25% tax: HUF 44 No int l activity, tax: HUF 25 or 19 10

11 Fundamental Questions of Int l Taxation Double Taxation Solution: self-confinement, distribution of taxing rights. 3 possible methods: - Unilateral, based on internal rules (e.g. corp. tax, PIT) - Bilateral, based on bilateral conventions a. OECD Model convention b. USA Model convention c. UN Model convention - Multilateral a. Multilateral int l conventions b. EU directives Techniques of avoiding double taxation. 11

12 Agenda I. Fundamental questions of int l taxation II. Avoiding double taxation, double tax treaties, the OECD model convention III. EU directives IV. A few practical examples V. Hungary in the int l taxation 12

13 Forms and tax consequences of foreign activities Basically there are two ways an enterprise can expand its activities abroad (individual?): - Sets up a branch office (premises, same person, PE): branch income is taxed in the country of residency, since this is the part of the world wide income (same person); and the source country based on the principle of source. - Establishes a subsidiary (separate person): in the country of the subsidiary taxed based on residency, country of the parent company taxes the dividend that is distributed. A country: 30% CIT Company Residency Residency Parent company Dividend B country: 20% CIT PE Source Residency Subsidiary 13

14 Forms and tax consequences of foreign activities A country: 30% CIT Company Residency Residency Parent company Dividend B country: 20% CIT PE Source Residency Subsidiary PE Subsidiary B country income: B CIT (20%): tax level B profit after tax: Distribution of dividend: - JDT EDT 80 A CIT (30%): tax level Net income

15 Forms and tax consequences of foreign activities A country: 30% CIT Company Residency Residency Parent company Dividend B country : 20% CIT PE Source Residency /Source Subsidiary PE B country income: Subsidiary B CIT (20%): tax level B profit after tax: Distribution of dividend - 80 B withholding tax (eg. 15%) - JDT EDT tax level Net distr. dividend: - JDT 68 A CIT (30%): tax level Net income:

16 Methods of Avoiding Double Taxation It is the duty of the state of residence to eliminate double taxation (if it arises or may arise). Methods: - Credit - Exemption - Deduction - Tax sparing Income exemption Tax exemption 16

17 Methods of Avoiding Double Taxation - Example Credit Exemption A country subsidiary (PBT): A country CIT rate: 16% 16% 16% 16% CIT: PAT (dividend): Dividend rate: 5% 20% 5% 20% Dividend withholding tax: B country, parent co. (PBT): B country CIT rate: 14% 14% 14% 14% Calculated CIT: Taxes paid abroad: Credited tax Taxes payable in B country: Total tax liability:

18 Income vs Tax Exemption Income exemption: foreign income (loss) is not taken into consideration (disregarded). Tax exemption: tax is calculated based on world wide income, then the part attributable to the foreign income is exempted (on a pro rata basis). Income exempt. Tax exempt. World wide income Foreign income Taxable income in residence Calculated tax (40% CIT) Tax calc. on foreign income - (100/300)x120=40 Payable tax = 80 Different results: - Progressive tax rate - Foreign loss 18

19 Income vs Tax Exemption (foreign loss) Tax exempt. Income exempt. A: 40% CIT B: 30% CIT Ww income.: 80 Residency tax: 32 Tax exempt. - Tax :Ww income -20 :Foreign income 100 :Tax base 40 :Tax 19

20 Tax Exemption Timing (foreign loss) Without Recapture 1. year 2. year A: 40% CIT B: 30% CIT = (170x0,4) Ww income: Residency tax: Tax exempt. - (50/120)x48=20 Tax = 20

21 Tax Exemption Timing (foreign loss) Recapture 1. year 2. year A: 40% CIT B: 30% CIT = (170x0,4) Ww income: Residency tax: Tax exemption: - [(50-20)/120]x48=12 Tax = 21

22 Tax Exemption Timing (domestic loss) Foreign income cannot be carried forward 1. year 2. year A: 40% CIT B: 30% CIT = 4 (10x0,4) 70 Ww income: Residency tax: Tax exempt. (50/50)x20=20 (70/100)x40=28 Tax = 20 unit foreign income is lost, because the country of residence will not provide tax reimburssement (quotient cannot be > 1) 22

23 Tax Exemption Timing (domestic loss) Foreign income can be carried forward 1. year 2. year A: 40% CIT B: 30% CIT = 4 (10x0,4) 70 Ww income: Residency tax: Tax exempt. (50/50)x20=20 [(70+20)/100]x40=36 Tax = 20 unit of foreign inc. is carried forward 23

24 Country vs. Aggregated Exemption Distinction by source country. Countries often differentiate by income types as well. Tax rate Income Residency state ( R state) 40% 100 S1 state 30% 60 S2 state 25% -40 Ww income Calc. Tax R state 48 - Exempt. by country (Not on S2, because it s negative) 48-(60/120)x48=24 - Aggregated exempt. 48-[(60-40)/120]x48=40 24

25 Credit Credit: the tax (same type) paid in the source state can be deducted from the tax payable in the country of residence. Limits: - Max. in the amount of tax calculated on the given income based on domestic rules - Max. in the amount of foreign paid tax. If the activity in the source state is loss making, it makes the same result as tax exemption. Problem: if the foreign tax exceeds the local Excess Foreign Tax Credit (EFTC) 25

26 Credit - Example A: 40% CIT B: 30% CIT Ww income: 300 Residency tax: 120 Credit (min): Source tax: 30 A tax on foreign income: 100/300x120=40 30 Tax payable: 90 26

27 Credit - EFTC 1. year 2. year A: 40% CIT B: 30% CIT Ww income: Residency tax: Credit (min): Source tax: A tax on foreign income: 60/60x24=24 100/160x64=40 EFTC: 6 1. year EFTC=6 + Credited tax: Payable tax:

28 Credit vs. Exemption Credit vs. tax exemption - If loss is arising in the source country, the result will be the same. - If profit is generated in the source country and the local tax rate < foreign tax rate, the result will be the same. - If profit is generated in the source country, tax exemption is more favourable in the case of local tax rate > foreign tax rate. Credit vs. income exemption - If loss is generated in the source country, credit is more favourable. - If profit is generated in the source country and the local tax rate < foreign tax rate, the result will be the same. - If profit is generated in the source country, income exemption will be more favourable in the case of local tax rate > foreign tax rate. 28

29 Agenda I. Fundamental questions of int l taxation II. Avoiding double taxation, double tax treaties, the OECD model convention III. EU directives IV. A few practical examples V. Hungary in the int l taxation 29

30 Tax treaties the OECD Model Convention Aim of tax treaties: - Support international trade exempt from tax obstacles (avoidance of double or multiple taxation) - Mainly to avoid juridical double taxation. - Resolve conflicts of residency- and source principles. - Resolve conflict of residency- and residency principles. - Distribute taxation right between the contracting parties. - Prevent international tax evasion, under taxation. 30

31 Tax treaties the OECD Model Convention Benefits for the contracting parties: - Treaties limit the gross based withholding taxation. - Harmonize the source taxation and the method for avoiding double taxation in the residence state (i.e. distribution of taxing rights) - Define the methods for avoiding double taxation - Enhance exchange of information, provide support in the collection of taxes (battle on offshore locations). Treaties override the domestic law. 31

32 The OECD Model Convention 1. Persons covered 2. Taxes covered 3. General definitions 4. Resident 5. Permanent establishment 6. Income from immovable property 7. Business profit 8. Shipping, inland waterways transport and air transport 9. Associated enterprises 10. Dividend 11. Interest 12. Royalties 13.Capital gain 14.[Deleted] 15. Income from employment 16. Directors fee 17. Artistes and sportsmen 18. Pensions 19. Government service 20. Students 21. Other income 22. Capital 23. Avoidance of double taxation 24. Non-discrimination 25. MAP 26. Exchange of information 27. Assistance in the collection of taxes 28. Diplomatic bodies, consulates 29. Territorial extension 30. Entry into force 31. Termination March

33 Application of tax treaties 6 step approach 33

34 Tax treaties How to interpret them? They are concluded between countries and therefore, due consideration is to be given to the Vienna Convention (Vienna Convention on the Law of Treaties 1969). Do not create additional tax liability, only distribute the taxing right between the contracting states. Commentary to the OECD Model Treaty: - Can a 2012 amendment to the Commentary be applied when interpreting an OECD Model based tax treaty that was concluded in 1996? - Specification vs. novelty. Applicable article: more than one article may apply to a given income it has to be investigated which one prevails over the other(s)! Definitions: - Who is the state applying the treaty? - Which definition is to be applied? - OECD solution? 34

35 The OECD Model Convention personal scope Personal scope: the convetion applies to persons (natural, legal or other) who are residents of on or both of the contracting states - Has to be person: question of partnerships (can execute rights, assume liabilities, may sue or be sued). - Must have unlimited tax liability in at least one of the contracting states. Personal scope decides which treaties is applicable (triangular cases). 35

36 The OECD Model Convention personal scope What is the applicable wht? US 5% A Interest B 10% HU 10% CH 36

37 The OECD Model Convention personal scope What is the applicable wht? W L e/m Inc. 10% 5% S 37

38 The OECD Model Convention residency Resolving conflicts - Residency vs. source - Residency vs. residency In the application of the convention: any person who under the laws of a contracting state is liable to tax therein based on its worldwide income due to any criterion. The conracting state, any political subdivision of local authority thereof is per definition resident (usually they are tax exempt) Does not inlcude persons who are only subject to tax based on income sourced or property located in the given state. 38

39 The OECD Model Convention residency India UAE Disposition of the sub after migration Subsidiary 20% capital gain tax 0% captal gain tax 39

40 The OECD Model Convention residency What does worldwide tax liability mean? - Loss in a given tax year? - Exempt income? - Exempt persons (REITs)? - What does tax liability mean (tax payment liability)? Tie-breaker rule for dual residence cases: Entities - Place of effective management - HU: strategic and day-to-day senior decision making - MAP Individuals - Permanent home - Centre of vital interests - Habitual abode - Nationality - MAP 40

41 The OECD Model Convention residency Application of the tie-breaker rule: - What is a permanent home? - When assessing the centre of vital interests economic or personal ties are more important? - Pavarotti case Habitual abode: a period that is sufficiently long considering the circumstances of the given case - 6 months - interruptions? 41

42 The OECD Model Convention subject Applies only to income and property taxes. - In Hungary to personal- and corporate income taxes (in the past it applied to special profit tax as well); - Does not apply to indirect taxes (i.e. VAT) - Local business tax? - Innovation contribution? - Austerity taxes? Exhaustive list, taxes of a similar nature introduced later on. Contracting parties have to notify each other about the introduction of any new, for the purposes of the convention, relevant taxes. 42

43 The OECD Model Convention territorial scope Most treaties do not contain specific provisions in this respect. The territory of contracting parties: applies to persons that are resident in either or both of the contracting states Kosovo, Channel Islands, Gibraltar, French Guyana, etc? Can be extended to: - Any other state or territory whose international affairs are handled by one of the contracting states, and - That levies taxes that are in substance the same as the taxes covered by the convention. 43

44 The OECD Model Convention entry into force Both contracting states ratification is necessary for the treaty to enter into force. Process of ratification is subject to domestic law. Only enters into force after the contracting states have notified each other about the fact of ratification. Special provisions may apply to the effective date of certain articles. 44

45 The OECD Model Convention Allocation of Taxation Right 1. Taxable without limitation in the state of source. (e.g.): - Income of permanent establishment; - Income from immovable property; - etc. 2. Limited taxation in the state of source. - dividend; - Interest; - Royalty? 3. Taxed only in the state of residence. (e.g.) - Business profits; - Capital gain; - Other income; March etc. 45

46 The OECD Model Convention methods for avoiding double taxation It is the state of residency s obligation to avoid double taxation, if it may arise. Treaty methods: - Credit - Exemption The exact calculation method is not defined in detail, it is left to domestic law (especially in the case of exemption). Problem: domestic method may result in additional tax liability in an international situation compared to a pure domestic one it may be in conflict with the general purpose of the treaty! 46

47 The OECD Model Convention business profits Taxable only in the state of residence. Does not solely apply to legal entities or other persons (i.e. it applies to private entrepreneurs as well). No other method is necessary to avoid juridical double taxation (no exemption or credit is needed). Exception: PE income! 47

48 The OECD Model Convention PE Definition: Fixed place of business through which the business of an enterprise is wholly or partially carried on. Extremely important in int l taxation. Unlimited taxation right to the source country. May be created easily and in certain cases its not straightforward whether it exists or not! Has to be investigated on a case-by-case basis. UN Model deviation: Force of attraction 48

49 The OECD Model Convention PE Definition: Fixed place of business through which the business of an enterprise is wholly or partially carried on. What does it really mean: - Existence of a place of business, i.e. a facility such as premises or in certain cases machinery or equipment. - Must be fixed, i.e. it must be established at a distinct place with a certain degree of permanence rule of thumb: 6 months - The carrying on of the business of the enterprise through this fixed place of business. This means usually that persons who in one way or the other are dependent on the enterprise (personnel) conduct the business of the enterprise in the State in which the fixed place is situated. 49

50 The OECD Model Convention PE PE especially: - place of management; - branch; - office; - factory; - workshop; - a mine, an oil and or gas well, a quarry or any other place of extraction of natural resources. Purpose? Conclusion: the detailed list of examples can and should be disregarded. 50

51 The OECD Model Convention PE Special rule: Project PE - Building site > 12 months - Construction or installation project PE retroactively What about interruptions: 1 May 1 November, 1 January 1 June Main contractor and subcontractors? 51

52 The OECD Model Convention PE Do not qualify as PE: - Warehouse, exhibition gallery, freight equipment; - Stored goods, exhibited and conveyed resources; - Resources manufactured by other enterprises; - Business place for gathering information and purchasing goods; - preparatory, auxiliary character activities; - Combination of the above. Should be investigated on a case-by-case basis what qualifies as e.g. auxiliary! 52

53 The OECD Model Convention PE Independent (broker) and dependent agent. Subsidiary. Substance over form! Definition of the income of the permanent establishment: arm s lenght principle. AOA! Technique of the avoidance of double taxation: exemption. 53

54 The OECD Model Convention Dividend Sharing of taxation right. Most countries tax them at source Hungary? Method of avoiding double taxation: credit Dividend: - Max. 5%, if the beneficial owners has min. 25% direct interest. - Max. 15% in other cases. - Capital interest is what matters, not voting right. Defines dividend overrides domestic law (see USA)! Method of collecting tax. Has a bilateral reach: it only applies to dividend paid by resident of one contracting state to a resident of the other contracting state triangular cases and their problems! 54

55 The OECD Model Convention Dividend Aim of the beneficial ownership clause is to prevent abuse of the treaty (treaty shopping). C C Wht:0% dividend B A Wht:30% A Wht:0% Not paid to beneficial owner: full wht applies (30%) B C convention s applicability? 55

56 The OECD Model Convention Dividend Bilateral reach: Parent Parent PE Dividend Dividend HU Sub Sub CH Bank account CH HU No CH wht No CH wht 56

57 The OECD Model Convention Dividend Triangular cases: DE Parent HU CH Parent PE Dividend Dividend Sub Sub PE CH HU CH is not limited to wht Only CH wht, no HU wht 57

58 The OECD Model Convention Dividend domestic law Income shrinks ATP: 29! CIT: 25% D 38 dividend CIT: 28% C 53 dividend ETR: 71% CIT: 35% B CIT: 19% 100 income A 81 dividend 58

59 The OECD Model Convention Dividend domestic law Participation exemption ATP: 81 CIT: 25% Exempt income D 81 dividend CIT: 28% Exempt income C 81 dividend ETR: 19% CIT: 35% Exempt income B CIT: 19% 100 income A 81 dividend 59

60 The OECD Model Convention Dividend domestic law Dividend is not tax exempt: - At the level of the individual owner. - If the sub is a controlled foreign corporation. CFCs are typically created to allocate income to low tax jurisdictions. If distributed dividend is tax exempt income, the domestic tax liability would be avoided. If the CFC does not distribute the income, the domestic tax liability is deferred. Taxation of deemed distributions 60

61 The OECD Model Convention Dividend CFC regulations are typically aimed at passive income. Why? Typical CFC regulations: - Controlled and foreign resident entity in most cases. - Targets low tax countries (HU) or has a global view (US, CA). - The previous compares the domestic tax level to the foreign (nominal rates, average effective rates or amount of tax actually paid). - The latter is justified by the fact that many tax systems provide for benefits to passive income. Thus, only passive income is allocated to the owner level as tainted income. - Safe harbour regulations: real economic presence; de minimis exemption; distribution exemption; listing on stock exchange. 61

62 The OECD Model Convention Dividend Cirumventing the CFC regulations of Parent country. Maltese DTTs apply to the royalty income. HU Parent 35 refund 65 dividend CIT: 35% 0% wht 100 royalty MT Sub 35 CIT Tax Authority 62

63 The OECD Model Convention Interest Sharing of taxation right between state of source and residence. Most countries levy wht on it Hungary? Method of avoiding double taxation: credit. Very similar to the article regulating dividends. Interest: - Max. 10% wht, if paid to beneficial owner (see dividend). - New definitions: arises and arm s length Defines interest overrides domestic law! Method of collecting tax: withholding Has a bilateral reach triangular issues! 63

64 The OECD Model Convention Related parties Deals with economic double taxation. Applicable: - There is a special relationship between the contracting parties that enables one to influence the other, and - The transaction is not at arm s length. Contracting states may adjust the tax bases. Adjustment has to be simultaneous. 64

65 The OECD Model Convention Royalties Only taxable in the state of residence. Most countries still levy wht deviation from the OECD Model ENSZ Model. Hungary? Method of avoiding double taxation: taxing right is allocated solely to the state of residence (in practice: credit). Defines royalty overrides domestic law Works like the articles applicable to dividends/interests. 65

66 The OECD Model Convention Real estate Income derived from utilizing/disposing real estate may be taxed unlimitedly in the state of source. State of residence may also tax! Overrides other articles (e.g. Art. 7) it does not need to be a PE for the source state to be able to tax! Method of avoiding double taxation: generally exemption Has a limited scope just like the articles applicable to dividends or interests. Defines real estate. 66

67 The OECD Model Convention Real estate Limited scope: the place of residence of the person earning the income and the place where the real estate is located are the factors that count. NL PT IT Lease fee PT-NL: NL may tax, PT may tax, but shall give relief for double taxation. PT-IT: PT may tax, IT may not tax real estate is not located there! 67

68 The OECD Model Convention Real estate Farm Market Sale 68

69 The OECD Model Convention Capital gain Only taxable in the state of residence, except - Real estate - PE property - Ships, aircrafts, etc (see later). - Real estate holding companies (not in all treaties, it is a SAAR). Method of avoiding double taxation? 69

70 The OECD Model Convention Capital gain Sale of shares in real estate companies A Co. Sales price Offshore Co. Sales price Offshore Co. Sales price A Co. 70

71 Agenda I. Fundamental questions of int l taxation II. Avoiding double taxation, double tax treaties, the OECD model convention III. EU directives IV. A few practical examples V. Hungary in the int l taxation 71

72 EU Directives Multilateral. Only within the EU. Mandatory for all the member states. Pursuit of aims, implementation is free. Double tax treaties vs. directives. Most important from the direct taxation point of view: - Parent-subsidiary directive - Merger directive - Interest-royalty directive - Code of Conduct. 72

73 EU Directives Parent-Subsidiary Directive Aim: exemption of dividend taxation from withholding tax and corp. income tax. Methods of exemption: - Exempt from tax base, or - Full credit method in respect of tax payable after dividend (withholding tax and CIT payed by subsidiary too). Conditions of implementation: - Persons covered (companies) - Minimum 10% of the shares - Possiblity of 2 years holding provision. Newest developments. 73

74 EU Directives Merger Directive Aim: int l mergers, asset deals, tax exemption of share exchanges. Types: - Merger ( upstream and downstream ) - De-merger (spin off) - Preferential transfer of assets (business unit, max 10% cash) - Share exchange (max 10% cash). Pursuit of tax exemption: deferring of tax liability - Base of the depreciation remains unchanged - No significant cash movement - Does not aim to avoid taxation 74

75 EU Directives Interest + Royalty Directive Aim: withholding tax exemption of interest and royalty payments between related parties. Conditions: - Holding of 25% of shares directly - Arm s length interest - Actual beneficiary - Taxable at the beneficiary. 75

76 Thank you for the attention!