Issues Regarding International Taxation - Essay Example

International Taxation Issues Question: An Australian individual wants to commence manufacturing operations of prefabricated birdcages that come in kit assembly form, from overseas in Iberica. Australia does not have a tax treaty with Iberica. The following information is relevant: 1) Manufactured birdcages are constructed from materials purchased in Iberica on arms' length terms by the Iberican branch or subsidiary (the investment vehicle). The income in relation to Iberican operation is only from the sale of the manufactured goods. 2) Iberica has a company tax rate of 27%. 3) Financing of the Iberican operations will be by equity. 4) Withholding tax on company dividends is imposed in Iberica. Required: 1) Advise of the taxation implications for an Australian individual investor establishing operations in Iberica as a branch or as a subsidiary. 2) If it was decided to establish an Australian company, to be the investor of the Iberican operations, advise how the taxation implications change if either an Iberican branch or subsidiary was established. 3) Advise what taxation consideration need to be given if the purchase from the Iberican operations by an Australian company were not for arms' length prices. Explain the reason and the rational of this concept requiring to be addressed for Australian Taxation purposes. Introduction: An Overview of Taxation in Australia In Australia, companies and individuals can be taxable persons. They are tax on income derived inside Australia and/or from outside sources and the tax treatment depends whether or not they are residents or non-residents of Australia. A resident individual is taxable on its assessable income derived from any source, whereas a non-resident individual is taxable only on the assessable income derived in Australia. Taxes imposed may come from business income, or in the payment of interests, dividends, royalties, rent, or capital gains. Taxes can be further classified as withholding tax or taxes on the sale of goods or render of service. A company is resident in Australia for tax purposes if: 1) It is incorporated in Australia (irrespective of where central management and control is exercised). Once a company has been incorporated in Australia it can never lose its Australian residence for tax purposes; 2) Central management and control is exercised in Australia (irrespective of which country the company was incorporated in); and, 3) The company is neither incorporated in Australia nor is its central management and control exercised there but carries on business in Australia and its voting control is in the hands of resident Australian shareholders.1 A company which is a resident in Australia is liable to Australian income tax to all its assessable income which is not specifically exempt, less allowable deductions with a credit for qualifying foreign taxes paid. Assessable income includes the income calculated by the normal accounting concepts, with specified adjustments, and certain capital gains. Normally, tax losses can be carried forward indefinitely or transferred amongst group companies, for offset against future profits. A non-resident company is liable to income tax only on assessable income derived from sources in Australia.2 Double Taxation If a resident company or individual in Australia is doing business outside Australia, the taxes applicable to that country can also be available to it, and vice-versa, even if it already paid the same tax in the country of origin. That is what we call double taxation. Double taxation of foreign income for resident Australian companies has traditionally avoided by entering into a tax treaty with other countries. At present, Australia has entered into tax treaty with more than 40 countries. They prevent double taxation and fiscal evasion and foster cooperation between Australia and other international authorities by enforcing their respective tax laws.3 Income from subsidiaries resident in "unlisted" jurisdictions is taxed a second time in Australia but a tax credit is given for any tax already paid in the foreign jurisdiction whether it be corporate income tax, capital gains tax or withholding taxes. An "unlisted" jurisdiction is a jurisdiction which does not have a similar tax system to Australia (e.g. low tax offshore jurisdictions). For this rule to apply to a subsidiary the resident parent corporation must control at least 10% of its share capital.4 If you conduct a business alone, without a partner, then you are classified as a Sole Trader. This definition applies whether or not you have employees working for you. It is an inexpensive business to establish and maintain, with the least reporting to Government. The sole trader is personally liable for all business debts, which means all assets may be at risk.5 A sole trader is a company for the purpose of tax payment. Answers: Based on the aforementioned, the Australian individual investor establishing operations in Iberica maybe taxed on his income only (income tax) based on the following consideration: 1) if he resides in Australia during the conduct of the business, he can be taxed on his/income only derived from the sale of the manufactured goods in Iberica. This is because he is not conducting a business as a company but as a distributor of the Iberican company. Therefore, no other taxes could be paid by him since he is only acting in his personal business. The parent company is liable for the payment of other taxes to the Australian and Iberican governments in the entry of their products in Australia like the materials used in manufacturing the birdcages which the Australian individual sold; and, 2) If the Australian individual is not a resident of Australia at the time of the sale, he/she cannot be taxed on his/her income since the source of the income is outside Australia. Under the Australian taxation law, only the income derived from sources within Australia are taxable on the part of non-resident individual. In the absence of tax treaty between Iberica and Australia, the Australian investor can also be taxed by the Iberican government on his income derived from Iberica. However if the Australian individual decided to establish an Australian company as a subsidiary or branch of the Iberican company, he/she will be taxed as a company and the kind of tax it is liable is the withholding or final tax. A company is liable to pay the following final taxes on its international operation: 1) business income; 2) payment of interests; 3) payment of dividends; 4) royalties; 5) capital gains; 6) and others. In case of subsidiaries or branches, the mother company is liable in paying the said taxes if the operation of the company is in international. In this case, the mother company based in Iberica will be the one liable to pay the taxes (or as the payee) and the subsidiary company in Australia is the payor, or in charge of paying the tax in Australia in behalf of the Iberican company. The method is paying the tax in this case is the pay-as-you go system (PAYG) since the payee is non-resident. Under the PAYG, non-residents are liable for Australian tax on all assessable income earned in Australia. This includes the interest, dividend, and royalty income.6 And since no tax treaty was entered into between Australia and the Iberican government, the mother company can be taxed fully in Australia. The interest, dividend or royalty does not need to be actually paid to the non-resident to be subject to the tax. If the income is re-invested, accumulated, capitalized or otherwise dealt with on behalf of the non-resident, or as the non-resident directs, it is deemed to be paid.7 Taxes paid under the PAYG system is a final tax. This means that before the subsidiary or branch of the company remits all the income derived from those sources of taxes as mentioned to the mother company, the subsidiary or branch as the payor should immediately remove the taxes from the said income and pay it to the Australian government in the form of final tax. Australian resident entity acting on behalf of a non-resident must also withhold interest, dividends, or royalties received by it, if the non-resident is so entitled when the Australian resident entity receives the payment, or the non-resident becomes so entitled after the Australian resident entity receives the payment.8 When two companies that are affiliated by a connection through a parent company, the type of business they transact is often referred to as an arm's length transaction. The price per unit that is extended for the items bought and sold is referred to as an arm's length price. The basic premise behind the extension of an arm's length price is to ensure that even though both the buyer and seller companies are affiliated through a parent company, the rates or prices extended will still reflect fair market value. This means that while the subsidiary may be able to enjoy the same volume discounts that may be extended to any customer with a similar pattern of volume purchasing, there will be no special in-house discounts extended. In effect, the arm's length price is another way of stating that the sister company cannot expect any discounts or price breaks above those that would be extended to any customer.9 Extending an arm's length price essentially accomplishes two things. First, this form of pricing structure is good for the seller. Pressure to supply goods at cost to a sister company would easily drive down profits, and could place the company in a precarious financial position. Second, extending an arm's length price helps to prevent such matters as questions about taxes from becoming a problem.10 In the absence of the arms' length prices in the Iberican operations by the Australian company, there is the absence definite taxes to be charged on the subsidiary company. The Australian branch or company may be compelled to pay a higher or lower tax than its other subsidiaries since there is no way of determining the fair market value of its products in Australia. As a result, the income of the subsidiary and or the mother company may become precarious or unstable. References "ATO ID 2005/13." Retrieved on March 27, 2009 from "Australia: The Ralph Corporate Tax Reform". Retrieved on March 26, 2009 from "Company Formation and Tax Rates". Retrieved on March 25, 2009 from "Corporate Multinational Taxation". Retrieved on March 25, 2009 from "Doing Business in Australia". Retrieved on March 25, 2009 from "Income Tax Assessment Act 1936 - SECT 447". Retrieved on March 27, 2009 from "PAYG withholding from interests, dividends and royalties to non-residents." Retrieved on March 31, 2009 from "What is arm's length Price". Retrieved on March 31, 2009 from Read More