International tax is international aspects of the income tax laws of particular countries. It consists of two domains. First, how residents are taxed on their income arising in foreign source income. Second, how nonresidents are taxed on their domestic source income.
In designing international tax rules, some aspects needs to consider to maintain balance position. Revenue. How international tax rules of a country will have impact on its tax revenue. Fairness. The rules must promote fairness between residents and nonresidents, as well as among residents and among nonresidents. Competitiveness. Such rules must not lower business competitiveness of the country. Neutrality. Given that ideal taxation is characterised by its neutrality, a country needs to balance different three types of neutrality: capital export neutrality, capital import neutrality and capital ownership neutrality.
Capital export neutrality principle prevents international tax rules of a country from encouraging or discouraging capital outflows. This is achieved by taxing residents on worldwide income so that residents are taxed equally whether they invest domestically or abroad.
Capital import neutrality principle requires that international tax rules of a country treat taxpayers in the country equally regardless of their tax residence. This is achieved by exempting residents’ foreign source income if the income is derived through their foreign subsidiaries.
Capital ownership neutrality principle requires that international tax rules does not distort assets ownership. This is achieved by imposing tax on a worldwide or territorial basis.
Most countries have been consistent with the above principles. Under their tax rules, resident individuals are taxed on their worldwide income (promoting capital export neutrality), unless the income is derived through foreign corporations as their subsidiaries (promoting capital import neutrality).
Three types of tax planning
Three common ways of tax planning to minimise tax liability under the application of international tax rules are double-dip leases, controlled foreign corporations (CFC), and treaty shopping.
Double-dip leases involves leasing transactions which are treated incoherently by the parties. For example, ACo (resident in Country A) leases aircraft from BCo (resident in Country B). Country A treats the lease as a sale, while Country B treats it as genuine lease which is a rent transaction. The different treatments of both countries cause double benefit claim of the asset. ACo deducts both the aircraft depreciation and lease interest. Furthermore, ACo may also be permitted to claim any investment tax credits offered by country A because of the ownership of the aircraft. Meanwhile, in Country B, BCo deducts the aircraft depreciation and may be permitted to claim any investment tax credits offered by country B because of the ownership of the aircraft.
In CFC, tax planning exploits low tax rates applied in another country. For example, Country A and Country B apply tax rates of, respectively, 40% (on worldwide income) and 0%. ACo (resident in Country A) manufactures goods in Country A and sells them abroad. To avoid being subject to tax in Country A, ACo establishes BCo to purchase goods from it at arm’s length price and reselles them to ACo’s initial customers. By having this structure, profits are earned by BCo instead of ACo and subject to tax in Country B which is a zero tax rate jurisdiction.
However, the use of CFC has been limited by two measures. First, substantial approach. If BCo in the previous example does not have any employees and never takes delivery functions of the goods, then BCo may end up being disregarded by Country A. Consequently, the profits would be considered as ACo’s profits. Second, CFC rules. This measure enables a country to immediately allocate profits derived by a foreign entity to its resident shareholders. In the previous example, Country A may deem some portions of BCo’s profits as having been derived by ACo.
Treaty shopping exploits tax treaty networks of a country to minimise tax liability. For example, ACo (resident in country A) has developed valuable intangible property and intends to license the property for use by manufacturers in several countries. However, Country A does not have treaties with those countries where the potential licensees are resident. An opportunity is available in Country B, a low tax rate country which has tax treaty with Country A and all the countries where ACo’s potential licensees are resident. Moreover, those treaties provide an exemption from any withholding tax (WHT) on royalties, which means the source jurisdictions will not impose any tax on BCo’s royalty income.
For that reasons, ACo transfers its intangible property to BCo (a wholly owned subsidiary established in country B) in order to take advantage of country B’s treaty network. The outcome is obvious. First, with respect to the transfer of intangible property from ACo to BCo, Country A may have significant difficulty in taxing the appropriate amount of gain on the transfer (because of the problem of accurately establishing the fair market value of the intangible property at the time of transfer). Second, BCo’s royalty income will be subject to tax in Country B at a low tax rate. Third, the payments made by licencees to BCo are not taxed by their respective countries because of WHT exemption under treaties between Country B and those countries. Finally, ACo’s dividend income is not subject to tax (assuming Country A adopts participation exemption for dividends from foreign corporations)
The shapes of international taxation rules around the world are influenced by many international organisations, among of which are OECD, IMF, UN and World Bank Group. Some of their main works are the Platform for Collaboration on Tax and the Global Forum on Transparency and Exhange of Information for Tax Purposes.
The Platform for Collaboration on Tax was created in 2016 as the institutional structure for the IMF, OECD, UN, and World Bank to cooperate in providing assistance to developing countries in strengthening their tax system. The objective is to prepare 8 tool kits containing practical guidance for developing countries for dealing with base erosion and related issues (the work will be done separately by each of the organizations, but they must all agree on any papers published under the Platform).
The Global Forum on Transparency and Exchange of Information for Tax Purposes is a multilateral framework consisting of 160 members (including Indonesia). On the framework, the OECD and non-OECD economies has carried out work on transparency and exchange of information (EoI) for tax purposes since 2000. They have formulated standard on EoI, both EoI on Request and automatic EoI, to be implemented by members.
- Brian J. Arnold, International Tax Primer (4th ed. 2019)
Hi, this article is summarised from Brian J. Arnold’s “International Tax Primer”. If you wish to read the book, please click FREE PREVIEW from Amazon.