International Tax: Taxation of Nonresidents (Gross Basis and Net Basis)

ITP

  • TAXING NONRESIDENTS
    • International consensus: countries are entitled to tax any income arising or having its source in their territory
    • Tax policy considerations: countries will tax nonresidents to the point that there is some good reason not to tax more
      • Nonresidents should not be treated better than residents in similar situation
        • Nonresidents do derive benefits such as infrastructure, legal system and market from the source country
      • However, nonresidents should not be treated less favorably than residents in similar situation
        • Rationale:
          1. Discrimination will trigger other countries to do the same towards the country’s residents at a disadvantage
          2. Discrimination discourages foreign investments
        • Nondiscrimination principle: Art 24 of the OECD and UN Model Treaties
          • The OECD Model Treaty:
            • Art 24(1): individual nonresidents (nationals of another country) and individual residents should be treated equally
              • Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances, in particular with respect to residence, are or may be subjected. This provision shall, notwithstanding the provisions of Article 1, also apply to persons who are not residents of one or both of the Contracting States.

            • Art 24(2): individual nonresidents (stateless persons) and individual residents should be treated equally
              • Stateless persons who are residents of a Contracting State shall not be subjected in either Contracting State to any taxation or any requirement connected therewith, which is other or more burdensome than the taxation and connected requirements to which nationals of the State concerned in the same circumstances, in particular with respect to residence, are or may be subjected.

            • Art 24(3): PEs and resident enterprises should be treated equally
              • The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities. This provision shall not be construed as obliging a Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs and reductions for taxation purposes on account of civil status or family  responsibilities which it grants to its own residents.

            • Art 24(4): payments to nonresidents and payments to resident should be treated equally
              • Except where the provisions of paragraph 1 of Article 9, paragraph 6 of Article 11, or paragraph 4 of Article 12, apply, interest, royalties and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State. Similarly, any debts of an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable capital of such enterprise, be deductible under the same conditions as if they had been contracted to a resident of the first-mentioned State.

            • Art 24(5): Subsidiaries of nonresidents and resident enterprises should be treated equally
              • Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned State are or may be subjected.

            • Art 24(6)
              • The provisions of this Article shall, notwithstanding the provisions of Article 2, apply to taxes of every kind and description.

          • In addition, non-discrimination principle does not prevent a country to treat nonresidents more favorably than residents (e.g., provides tax incentives for nonresidents to attract foreign investments)
      • Considerations on enforcement capabilities.
  •  NEXUS
    • a country must determine The nexus between a nonresident and the country (activities, property ownership, physical presence, income receipt, etc) in order to tax them
  • THRESHOLD REQUIREMENT
    • Reasons for the establishment of a threshold requirement:
      • A threshold requirement provides certainty for nonresidents as to when they become subject to tax by a country
      • Without any threshold, all domestic source income of nonresidents are taxable.
        • This will discourage cross-border trade and investments or result in nonresidents ignoring  their tax obligations
        • High burden on tax authorities (identifying all nonresidents earning income from the country, and getting information about that income, and collecting the tax of nonresidents that do not have substantial and continuing presence in the country)
    • Threshold: various types of income of nonresidents
      1. Business profits, the thresholds may be:
        1. Permanent establishment
          • Nonresidents are taxed by a country on their business income only if the income is attributable to a PE in the country
          • Art 7 of the OECD and UN Model Treaties
        2. 183-day test (business profits from services; the UN Model Treaty)
      2. Income from immovable property, threshold = the property is located in the country
      3. Employment income, threshold = the physical presence of the employee in the country and the performance of the duties of employment in the country
        • However, under tax treaties where the employee and the employer are nonresident, a country can tax the employment income if:
          1. there is a PE in the country; or
          2. the employee is physically present in the country for more than 183 days
      4. Investment income, there is no threshold.
        • The requirement is only
          1. a payment made by a resident of the source country; or
          2. a nonresident carries on a business in the source country
  • SOURCE RULES
    • Is: what amounts derived by nonresidents that are subject to tax
    • The more expansive a country’s source rules are, the more likely it is that its source claims will overlap with other countries’ source claim (double taxation)
  • COMPUTATION RULES
    • Is: what amounts are included in income, allowable deductions, timing of income and deductions
    • The rules:
      • In general, the rules are the same as the rules applicable to residents.
        • Non-discrimination article of treaties: the source country is required to allow nonresidents to deduct expenses in computing the profits (business profits -> net basis) attributable to a PE on the same basis as residents engaged in similar activities
          • Exception: for income of a nonresident that is subject to a final wihttholding tax (investment income), the tax is on a gross basis (or on a basis of a fixed percentage of the gross payment, as applied by some South American countries, to give ‘formulary deductions’)
      • But, there are some differences with the rules applicable to residents
        • TP rules (applicable only to transaction between a resident and a nonresident), thin capitalization rules (only resident-nonresident), CFC rules (only a nonresident company controlled by a resident)
  • TAXATION OF VARIOUS TYPES OF INCOME OF NONRESIDENTS
    1. Business income
      • Once a nonresident has met the minimum threshold requirement (usually a PE), domestic tax rules apply, either:
        • on all business income, or
        • on all income, i.e. business income of the PE, other business income that has a correlation with the PE, and investment income (force-of-attraction principle)
          • The OECD Model Treaty does not recognize the force-of-attraction principle. Taxable income only consists of (business) income attributable to a PE.
          • The UN Model Treaty recognize the force-of-attraction principle on a limited basis, i.e. taxable income consists of business income in the source country derived by the PE and other business income the source country that is not derived by the PE but has the same/similar type with that is derived by that PE.
    2. Income from immovable property
      • The existence of immovable property serves as tax justification, threshold requirement, and source rule.
      • The OECD and UN Model Treaties:
        • give taxing right to source country
          • Arts 6 and 13(1): a source country right is entitled to tax the income (derived from the immovable property) and gains (from the disposal of the immovable property)
        • treat income immovable property and business income differently
          • Art 6 (Income from Immovable Property): there is no requirement for income from immovable property to be taxed on a net basis; while Art 7 (Business Profits): business income is taxed on a net basis
    3. Income from employment
      • Requirements:
        • the employment activities are performed in the country; or
        • the income is derived from the country; or
        • the benefits from the employment activities are used or consumed in the country
      • Threshold
        • Most countries: no minimum threshold
          • However, some countries apply thresholds
            • the US, providing exemptions if:
              • the employment income is paid by a nonresident employer
              • the amounts of income are not more than USD 3,000, and
              • the employee is present in the US for not more than 90 days
            • Rationale: difficult in enforcement if the payor is a nonresident and the employee is present only for a short period.
        • The OECD and UN Model Treaties
          • taxable by the source country only if the employee is present in the country to perform the employment services
          • exempt if:
            1. the employee is present in the source country for less than 183 days, and
            2. paid by a nonresident employer, and
            3. the remuneration is not deductible for purposes of computing the income of a PE that the nonresident employer has in the source country
    4. Investment income
      • The definition of taxable investment income
        • if a country impose tax on certain investment income, it is important to distinguish 1) between investment income and business income; 2) among the types of investment income that are taxable
      • Threshold: usually no threshold
      • Source rule
        • In general: the source country is the country in which the payer is resident (just like the OECD and UN Model Treaties)
        • However, several countries have special rules. For example: with respect to interest and royalties, the source country is the country in which the funds or property are used.
    5. Capital gains
      • The following gains may be taxable in the source country:
        1. gains from the disposal of immovable property situated in a country
          • including indirect transfers: the disposal of shares of a company that own, directly or indirectly, land or other types of asset (such as licenses) located in a country
            • the purpose of indirect transer tax is to prevent avoidance from tax on gains from the disposal of immovable property
          • Consistent with the OECD and UN Model Treaties (Art 13)
        2. gains from the disposal of property of a business carried on in a country (often through a PE)
          • Consistent with the OECD and UN Model Treaties (Art 13)
        3. substantial participations in resident companies, partnership, and other legal entities
          • Consistent with the UN Model Treaty (Art 13)
          • The OECD Model Treaty: nontaxable in the source country
      • Enforcement
        1. With respect to gains from the disposal of immovable property situated in a country
          • there are 3 types of enforcement:
            1. the purchaser withholds an amount on account of the seller’s tax from the purchase price, or
            2. the seller prepays the tax (excessive prepayment may be claimed to get refund), or
            3. the seller provides security for the payment of the tax
          • if the purchaser is nonresident, registration of the property is not allowed unless the tax has been paid
        2. With respect to indirect transfers, enforcement:
          • the purchaser withholds tax from the purchase price (although this method is not as effective as the enforcement on the disposal of immovable property in which the tax can be a requirement for property registration)
          • if the underlying asset is a license, the enforcement:
            • the direct owner of the license pays the tax as the agent of the actual nonresident seller, or
            • the purchaser withholds tax from the purchase price
        3. With respect to gains from the disposal of property of a business carried on in a country, enforcement:
          • uses the same enforcement mechanisme on income from business (by including gains into tax calculation of the PE)
  • COLLECTION RULES
    • Two major problems in taxing nonresidents: obtaining information dan collecting the tax
      1. Problem #1: Obtaining the necessary information
        • Types of information:
          1. Basic information to identify nonresidents: name address, taxpayer identification number (if any)
          2. Information to determine whether the nonresidents are carrying business in the source country, have PEs there, or are earning investment income there
          3. Information to determine/verify the computation of a nonresident’s domestic source income (revenue and expenses)
          4. Information concerning transactions with related party (especially if the related party is resident)
          5. Information to verify the nonresident’s claim (if any) of a reduction/exemption from the source country tax under an applicable tax treaty
        • How to get information: reporting requirements
          • obtained from the nonresidents themselves
          • obtained from a third party
          • exchange of information
            • under tax treaty (the OECD and UN Model Treaties: Art 26), or
            • under Tax Information Exchange Agreements (TIEAs)
        • Penalty for not satisfying reporting requirements
          • the taxpayer may be precluded, in any subsequent legal proceedings, from introducing foreign-based information that is not disclosed when requested by the tax authority
      2. Problem #2: Collecting the tax
        • Two methods of collection:
          1. Assessment (for net basis with the requirement of filing a tax return)
          2. Withholding (for passive income, gross basis)
        • Enforcement to unpaid tax:
          • If the nonresident has assets in the source country is physically present in the source country, collection action can be taken by the source country directly against the nonresident
          • Otherwise, special measures to collect the tax:
            • obtaining a court judgment for the unpaid tax from the country’s courts and then seeking enforcement of that judgment by the courts in the nonresident’s country of residence (however, many countries will not enforce other countries’ criminal and tax judgments)
            • requesting assistance in the collection of the unpaid tax from the country of residence pursuant to tax treaty between the two countries. (Art 27 (Assistance in Collection) of the OECD (since 2002) and UN (since 2011) Model Treaties)
            • requesting the residence country to collect the source country’s tax as if it were tax owing to the residence country pursuant to Mutual Administrative Assistance in Tax Matters section 5.9.2 (exchange of information) entered into both countries

Source:

  1. Brian J. Arnold, International Tax Primer (4th ed. 2019)
  2. The OECD Model Tax Convention

 

1. Foto_AGUS DWI PUTRA

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.

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