The Concept of International Taxation - Case Study Example

The concepts of International Taxation Introduction Every country operates a National Tax System with which all businessoperations within its territory could be properly taxed. But it gets more complicated when such a country has to collect taxes, whether on income or capital gains from foreign companies located in its territory. Also, the country has to contend with the process of taxing all foreign-sourced income her citizens might have earned elsewhere. These rigorous processes are termed the concept of International Taxation (Hines 50). The three friends, George, Gordon and Nicholas from OECD countries, France, UK and the United States who are planning to start a business in a tax haven would have to confront several issues that go along with international taxation, most especially the OECD proposals, an organization their countries are member States. 2. Explaining the current rules for International Taxation Despite the fact that individual country has its unique Taxation System, all countries are bound to act in conformity with generally accepted International rules for taxing multinational companies and their citizens when they earn some amount of incomes from overseas. Hence, the rules highlighted below hold true for all international transactions currently undertaken among nations across the globe. 2 (a) Jurisdiction for taxation: The very first step in international taxation is the determination of which place or locality is eligible or has the rights to lay claims to the taxes payable by a company. There are some descriptions that could fit how a company’s jurisdiction may be determined. The first description defines a jurisdiction as the place or location where a company is legally registered or incorporated. Even though a business owner lives in France or UK or the US, but registers his/her company in, say Bahamas, the company’s jurisdiction, according to the definition above, is Bahamas. However, it is sometimes confusing to determine which jurisdiction to apportion to a company that is totally floated online: for example, the ICT companies. In this circumstance, a company’s jurisdiction may be said to be where the company’s main economic activities take place. In other words, the company’s jurisdiction would be where its majority of business operations occur; like purchasing, marketing, shipping, selling and other business activities. For example, a seller on Ebay buys advertises and sells Chinese products in the United States has the US as its jurisdiction. The theory of jurisdiction then supports the fact that a multinational company or enterprise owes its taxes to all the jurisdictions where its economic activities are carried out (Schafer 33). If the company’s Head Office is in the United States but has branches or subsidiaries in South Korea, Singapore, Kenya and Russia. Then the company’s jurisdictions for taxation include all the four residences of its operations and its Head Office. 2 (b) The Double Taxation issue: Every corporate entity dislikes the idea of paying double taxes, but this happens to be the case on most occasions. The Residence Principle versus the Source Principle reveals how double taxation could occur. Traditionally, a company is expected to pay all taxes on its incomes, capital gains and corporate transactions to the jurisdiction or residence where it is legally registered. For example, a company established by a Briton but situated in Paris owes all its taxes to the French Tax System. On the contrary, Source Principle urges a resident in a country (his/her home country, perhaps) to pay taxes on all incomes from Paris. This is the major obstacle international businesses often run into, and it is always uncomfortable to experience corporate growth under such huge burden of taxes (Frenkel et al 27). Some countries have policies that attempt to soften these harsh effects by offering some concessions on how much tax their citizens who have business interests overseas could be expected to pay. Some of these incentives include offering tax credits to their citizens by reducing or totally eradicating some taxes in lieu of a lot of taxes they might have paid overseas. In some countries, what the residents but investing abroad get are tax exemptions. 2 ( c) Taxable profits’ allocation: There are two significant approaches for allocating a company’s profits that are taxable. The first approach is recognizing each company’s subsidiary or branch as an independent taxable entity. Take for example; a multinational company with subsidiaries in six different countries (jurisdictions) would be required to settle their tax liabilities to their residence of operations. The second approach is a lot easier: all subsidiaries of a company are treated like single entity; in this way, taxes for all the branches are paid as lump sum by the company. This is popularly referred to as consolidated approach; and it prevents the error of over-taxing; as all economic activities of the company and its subsidiaries are considered to be compact and a single taxable entity (Schafer 37). 3. Analyzing OECD International Taxation Proposals Organization for Economic Co-operation and Development (OECD) has its laid-down International Taxation Proposals or regulations that all its member countries are expected to adopt as they handle any tax issues related to International transactions. George, Gordon and Nicholas are citizens of OECD member countries, namely France, UK and the United States. In their bid to unanimously set up an offshore company, their actions should be seen in the light of OECD International Taxation policies. These policies are as follows: 3 (a) Definition of jurisdiction: OECD definition of jurisdiction is all encompassing: that is, it doesn’t specify clearly how a jurisdiction could be identified. The following definitions are according to OECD proposal: a company’s jurisdiction may be a fixed place of business depending on how much time required to complete the business activity; it could be a fixed place of business by geographic link; it could be a location where active and passive business operations take place; and it could be a permanent residence where the company’s management structure is set up. OECD encourages that taxes be paid in these jurisdictions described above because business transactions occur there (OECD 78-89). 3 (b) OECD and allocation of profits: The well-accepted system of profits’ allocation for a company as proposed by OECD requires that every subsidiary of a company should separately pay its taxes on the profits allocated to it. In other words, a company which has three branches situated at three different locations is expected to pay the taxes on the profits for each branch, irrespective of intra-company business transactions, like pricing transfer, assets transfer etc. This policy is globally embraced to settle all International taxation problems. 3 (c ) Does OECD support double taxation? The answer to this question may appear a little tricky: OECD proposals fail to state specifically which Principle to accept or reject in order to eradicate double taxation. That is, it doesn’t convincingly suggest that either Residence Principle or Source Principle be given a priority status in any member States. Therefore, the issue of canceling double taxation totally rests with each member State as it deems fit. No general concession on how much percentage of taxes a member State should levy on her citizens operating businesses in other countries. 4. Pieces of advice for the three friends It is very important that George, Gordon and Nicholas fully understand the benefits establishing their company in a tax haven could bring them. A tax haven is said to be any country or society that lowers its tax rates with the tricky intention of winning over companies/investors from countries with exceptionally high tax rates. Examples of tax havens are Luxembourg, Cyprus, Monaco, Switzerland, and even UK (only acts as a tax haven for non-British businesses). Some of the benefits tax havens offer includes: Low income/corporate/capital gains taxes: Tax havens offer very low regime of income taxes, corporate taxes and capital gains taxes. Investors flock to these havens in order to hide the amount of profits they make in their business transactions. Tax havens protect the selfish interests of the foreign investors in their countries by not disclosing the actual capital gains made by the investors to the home countries. This action would help reduce the amount of source principle income taxes. Tax havens provide cheap social infrastructures that could have been so expensive in their home countries. It is very true that the cost of security in Monaco will be cheaper than that in UK or France or the United States. Considering the above benefits, George, Gordon and Nicholas should go ahead with their plan to set up a business in a tax haven as the benefits surpass the disadvantages. Works cited 1. Schafer, Anne. International Company Taxation in the Era of Information and Communication Technologies Issues and Options for Reform: Issues and Options for Reform. Pittsburgh, PA: DUV, 2005. 2. Organization for Economic Co-operation and Development. 2002 Reports Related to the OECD Model Tax Convention: Issues in International Taxation. Paris: OECD Publishing, 2003. 3. Frenkel, Jacob, Razin Assaf and Sadka, Efraim. International Taxation in an Integrated World. Cambridge, MA: MIT Press, 1991. 4. Hines, James. International Taxation and Multinational Activity. Chicago: University of Chicago Press, 2001 Read More