Chapter 8 International Taxation
withholding taxes
- a country will require the payer of the dividends to withhold some amount of taxes from the dividend payment and remit that amount to that country's government - are imposed on payments made to foreign parent companies or foreign affiliated companies - dividends, interest, and royalties are subject to this tax - rates may vary across countries
base erosion anti-abuse tax (BEAT)
- a new tax intended to apply to companies that significantly reduce their US tax liability by making payment to foreign affiliates - includes payments made to a foreign affiliate, such as royalties and management fees, excludes COGS payments - only applies to US corps. that: 1. are part of a group with average revenue of at least $500m over the previous 3 years 2. have base erosion payments exceeding 3% of the company's total deductible expenses
deemed repatriation of accumulated foreign earnings
- accumulates retained earnings of foreign subs. generated from 1987-2017 deemed to be repatriated to the US at the end of 2017, when dividends from foreign subs. were still subject to US taxation - taxed at 15.5% for RE held in cash or cash equivalents and 8% for RE that had been reinvested in noncash assets (i.e. PPE)
worldwide approach
- all income of a resident of a country or a company incorporated in a country is taxed by that country regardless of where the income is earned - foreign source income is taxed by the country of residence
OECD model
- an important article in model indicates that business profits may be taxed by a treaty partner only if they are attributable to a permanent establishment in that country - one benefit is the reduction of withholding tax rates - recommends withholding rates of: 1. 5% for direct investment dividends 2. 15% for portfolio dividends 3. 10% for interest 4 0% for royalties
permanent establishment
- an office, branch, factory, construction site, mine, well or quarry - facilities used for storage, display, or the delivery and maintenance of goods solely for processing by another enterprise do not count
controlled foreign corporation (CFC)
- any foreign corporation in which US shareholder hold more than 50% of the combined voting power or fair market value of the stock - all majority owned foreign subs. of US based companies - not exempt from subpart F income
UN model
- assumes an imbalance in tax rates - recognizes that the host country should have more taxing rights when profit repatriation essentially is a one way street
investment location decision
- based on forecasts of after-tax profit and cash flows - after-tax returns from competing investment locations vary
tax treaties
- bilateral agreements between two countries regarding how companies and individuals from one country will be taxed when earning income in the other country - designed to facilitate international trade and investment by reducing tax barriers to the international flow of goods and services - reduce the possibility of double taxation through the clarification of tax jurisdiction - provide for the possibility of reduced taxes through a reduction in withholding tax rates - require the exchange of information between countries to help in enforcing their domestic tax provisions
citizenship
- citizens are taxed by their country of citizenship regardless of where they reside or the source of the income being taxed - the US taxes on this basis
changes in corporate income tax rates
- corporate income tax rates around the world have not remained constant - there has been a continuing international trend to reduce corporate tax rates - countries may reduce their tax rates to compete against one another in attracting foreign investment and /or want to make sure their companies are international competitive
capital budgeting
- done by MNCs when making foreign investment decisions - the process in which the future cash flows to be generated by the foreign investments are forecasted, discounted to their present value, and then compared with the amount to be invested to determine a NPV
participation exemption system
- enacted by the tax cuts and jobs act in 2017 (US) - a US parent company is entitled to 100% dividends received deduction for dividends it receives from any 10% or greater owned foreign corporation - income earned by a foreign branch in the US corporation to be subject to US income taxation in the year in which it is earned
Base Erosion and Profit Shifting (BEPS)
- established by OECD - tax planning by MNEs to artificially shift profits to no or low tax jurisdictions where there is little or no real economic activity - OECD developed a 15-item action plan to help nations close the gaps in tax laws that allows MNCs to artificially, but legally, reduce their taxes - more than 100 countries and jurisdictions have expressed interest in this area and their goal is to adopt this action over time
US tax treaties
- exempts interest and royalties from withholding tax and establishes 15% as the maximum withholding rate on dividends - has treaties with more than 50 countries - recommendations regarding withholding rates are always followed
global intangible low-taxed income
- income earned by CFCs exceeding a specified return on all CFCs tangible assets - US corps. may deduct 50% of the amount included in taxable income - once it has been included in the US parent's taxable income, it can be repatriated to the US parent company without incurring further US income tax - amount to be included in US taxable income based on: 1. tested income 2. a specified return
subpart F income
- income that is easily movable to a low-tax jurisdiction - 4 types: 1. income derived from insurance of US risks 2. income from countries engaged in international boycotts 3. certain illegal payments 4. foreign base company income (most important)
tax havens
- jurisdictions with abnormally low corporate income tax rates that companies and individuals have found useful in minimizing their worldwide income taxes - a company involved in international business might find it beneficial to establish an operation in these jurisdictions to avoid paying taxes in one or more countries in which the company operates - there is considerable indirect evidence that multinational companies from the US and other countries shift income to these countries
value-added tax
- levied on value added at each stage in the production or distribution of a product or service - used in lieu of a sales tax and are generally incorporated into the price of a product or service - commonly used in countries other than the EU - need to be considered in determining the total rate of taxation to be paid in a country
income taxes
- most national governments impose a direct tax on business income - the corporate income tax rate in most countries is between 15% and 35% - MNCs must be careful to consider both national and local taxes in their analysis - some countries, local governments impose a separate tax on business income in addition to the tax levied by the national government - in a few countries, income taxes can vary according to the type of activity in which a company is engaged or the nationality of the company's owners - the manner in which taxable income is calculated will greatly affect a company's tax liability
legal form of operation
- organized as a branch of the MNC or as a subsidiary, in which case the operation is incorporated in the foreign country - tax treatment for branches and subs. could result in one legal form being preferable to the other
residence
- residents of a country are taxed by the country in which they reside regardless of their citizenship or where the income is earned - US also taxes on this basis - companies created or organized in the US are considered to be US residents for tax purposes - foreign subsidiary of a US parent is not considered a US resident and income generally is not taxed in the US
overall foreign tax credit limitation
- the US will not allow a foreign tax credit greater than the amount of taxes that would have been paid in the US
double taxation
- two countries will assert the right to tax the same income - most common overlap of jurisdictions for corporations if the situation in which the home country taxes on the basis of residence and the country in which the foreign branch or sub. is located taxes on the basis of source
tax holidays
- used in an attempt to attract foreign direct investments - deferred payment of taxes
excess foreign tax credit
1. carried back 1 year 2. carried forward 10 years - can only be used if, in the previous year or in the next 10 years that additional US taxes must be paid by the company is less than the US tax rate
what are the types of taxes imposed on international companies?
1. corporate income tax 2. withholdings tax
Why are tax issues important?
1. deciding where to locate a foreign operation 2. deciding what legal form the operation should take 3. deciding how the operation will be financed
foreign tax credits
1. deduct all foreign taxes paid on the related foreign income 2. take a credit for foreign income taxes paid on the foreign income - income taxes that are creditable include withholding taxes on dividends - sales, excise, and other types of taxes not based on income are excluded
relief from double taxation
1. exempt some or all foreign source income from taxation by adopting a participation exemption or territorial approach to corporate income taxation 2. allow the parent company to deduct the taxes paid to the foreign government in calculating its taxable income 3. to provide the parent company with a credit for taxes paid to the foreign government known as a foreign tax credit
foreign tax credit baskets
1. general income 2. passive income 3. foreign branch income (introduced in TCJA 2017) - excess FTC from one basket cannot be used to reduce additional US taxes owed to other baskets - excess FTC from one basket can be carried back and forward to offset additional US taxes paid on only that basket of income
determination of the amount of CFC income currently taxable
1. if subpart F income is less than 5% of the CFC's total income then none of the CFC's income will be taxed currently 2. if subpart F income is between 5% and 70% of the CFC's total income then the percentage of the CFC's income which is subpart F income will be taxed currently 3. if subpart F income is greater than 70% of the CFC's total income then 100% of the CFC's income will be taxed currently
Factors to determine US tax treatment of foreign operation income
1. legal form of the foreign operation (branch or corp.) 2. percentage level of ownership (CFC or not) 3. effective foreign tax rate ("tax haven" or not) 4. nature of the foreign source income (subpart F income or not) (appropriate FTC basket)
objectives of the new provisions from TCJA 2017
1. make US corporations more competitive internationally 2. prevent erosion of the US tax base 3. deemed repatriation of accumulated foreign earnings 4. taxation of global intangible low-taxed income 5. imposition of a base erosion anti-abuse law
methods of financing
1. making capital contributions (equity) 2. through loans (debt) - countries could impose a special withholdings tax on dividend and interest payments made to foreigners
foreign base company income
1. passive income 2. sales income 3. service income
passive income
interest, dividends, royalties, rents and capital gains from sales of assets
territorial approach
only the income earned within the borders of the country is taxed
service income
the CFC performs services out of its country of incorporation
tested income
the aggregate amount of foreign subsidiary income across countries less certain deductions
source of income
almost all countries assert the jurisdictional authority to tax income where it is earned regardless of the residence or citizenship of the recipient
thin capitalization
an incentive for companies to finance their foreign operations with as much debt and as little equity capital as possible
treaty shopping
describes a process in which a resident of country A uses a corporation in Country B to get the benefit of Country B's tax treaty with Country C
specified return
equal to 10% of CFCs aggregate "qualified business asset investments" which generally is equal to the book value of tangible depreciable assets
calculation of foreign tax credit
equal to the lower of: 1. the actual taxes paid to the foreign government 2. the amount of taxes that would have been paid if the income had been earned in the US
3 determining jurisdictional authority for taxes
1. source 2. citizenship 3. residence
major international tax issues
1. types of taxes 2. national tax systems 3. tax income vs. accounting income 4. international interaction of tax systems 5. international tax planning strategies 6. attempts at harmonization and recent issues
sales income
CFC makes sales outside of its country of incorporation
Capital export neutrality
a tax system meets the standard if a taxpayer's decision whether to invest at home or overseas is not affected by taxation