International taxation Introduction

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of Tax System
Typical taxes are:
Customs
Indirect taxes
Consumption taxes
Taxes on mineral oil, cigarettes, coffee, alcohol, beer, energy
Value Added Tax (VAT)/Sales Tax
Direct taxes
Income Tax (for individuals)
Corporate Income Tax (CIT – for corporations)
Surcharges (in Germany: Solidarity surcharge)
Net value tax (not in Germany)
Municipal Taxes (in Germany – trade tax)
Other Taxes

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of Tax System
Basic distinction between
Taxation of individuals
applicable taxes: income tax, trade tax, solidarity surcharge
Taxation of partnerships
applicable taxes: trade tax, but not income tax (if treated as transparent)
In Russia: treated as corporations
Taxation of corporations
Applicable taxes: corporate income tax, trade tax, solidarity surcharge

Master of International Business
21 -23 October, 2014 St Petersburg
Basic of Tax System
Partnerships
Partnerships treated as transparent
In Russia: intransparent
Therefore not subject to income tax
Income of partnerships is allocated to participants
Participants are taxed with part of partnership income allocated to them
income stream: business profits
Interests, rents, remuneration of services paid to participants are not deducted from income of partnership, but treated as part of partnership income (“Special remunerations”)

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of Tax System
Corporations
Treated as intransparent
Only one income stream (business income)
Interests only partly deductible (30 % of EBIDTA), but carry forward
No tax free zone
Germany: Flat tax rate of 15 % (plus solidarity surcharge)
Dividend taxed as income of shareholder; withholding tax 25 %
Therefore double taxation of distributed profits, but normally relieved
Different relief systems:
Germany: Dividends tax free if shareholder is a corporation (same in Russia); Dividends taxed with 60 % if shareholder is an individual
Reduced CIT rate for distributed profits
Tax credit systems

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Scope of income tax/CIT:
Most countries operate a system of “worldwide income” for their residents
Some countries operate a “territorial regime”: Only income from sources of the own state are taxed
Some countries in Middle/South America
Some countries do not impose direct taxes on income
Kuwait, Qatar, Saudi Arabia, United Arab Emirates, Tax havens
Some countries operate a “remittance system”: Foreign-based income from individuals not having their domicile in the country is only taxed if remitted in the country
UK, Ireland, Singapore

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Scope of income tax/CIT:
Individuals are subject to unlimited taxation in state of residence/substantial presence (taxation of worldwide income) ? residence rule;
Otherwise individuals and corporations are subject to limited taxation with source income only ? source rule
Therefore basic distinction: State of residence – state of source
Residence/physical presence of an individual means:
Living home in a country, or
physical presence during a certain period of time (Germany: more than 6 month; Russia: 183 days or more)
Citizenship (USA)
Domicile (UK)

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Example: USA
Unlimited taxation rule is applied if taxpayer
Has the nationality of the US (irrespective where he is resident)
Holds a Green Card
Meets the physical presence test
Physical presence if tax payer on a weighted average of the last 3 years was more than 183 days present in the US
weighted average:
days present of the running year plus 1/3 of previous year plus 1/6 of year before previous year

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Unlimited taxation of Corporations
Place of central (effective) management
Place of registered office
Established in accordance with national law
Place where general meeting of shareholders is held
Place where books and records are maintained

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Limited taxation:
Genuine links: Country can tax income of non-residents if
from sites situated in that country
from permanent establishments located in that country
from employment carried out in that country
from capital, if debtor/payer is resident in that country
from sales of shares if the corporation whose shares are sold has its registered office or place on management in Germany (if shareholder is resident in that country: unlimited taxation)
Benefits covering basic needs of individuals not granted
System of withholding taxes largely used

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Withholding tax system:
Taxes in case of limited taxation in the source state is raised by withholding taxes normally for the following income streams:
Employment (PAYE)
Dividends (German withholding tax rate: 25 %)
Interests (Germany: not subject to limited taxation)
Royalties (German withholding tax rate: 15 %)
Payments to sportsmen, artists etc (German withholding tax rate: 15 %)
No withholding tax on (depending on national tax laws):
Permanent establishments
Professional services
Agriculture
Rent from sites

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Withholding tax system:
Withholding tax is levied on gross income
Therefore no deduction of expenses, no refund
Withholding tax covers full tax liability
No additional tax assessment
Example: Dividend Royalty
Gross amount 100 100
Tax of payer 15 0
Net amount 85 100
Withholding tax 20 % 17 20
Costs of payee 1 75
Net amount 67 5
Taxable (Div: 60 % of 84) 50,4 25
Tax of payee 40 % 20,2 10
Tax credit 17 20
Net amount after tax 63,8 5

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Avoidance of double Taxation
Unilateral method: tax credit
Method in Double Taxation Agreements (DTA):
Exemption method
Tax credit method
Fictious tax credit/economic development zones
Effects:
Tax credit method: Neutrality of capital export (Income of investments is taxed with the tax rate of state of residence of investor: no difference if he invests in his own or in a foreign state)
Exemption method: Neutrality of capital import (Income of investments is taxed with the tax rate of the state of investment: no difference if the invested funds come from the state of investment or from abroad)

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Aim: Neutrality of tax systems
Tax system is “neutral” if it has no effect on costs of investments/costs of financing
Complete neutrality of tax systems cannot be achieved; politicians have to make a choice taking into account the political preferences
System of neutrality of capital exports (tax credit method) achieves tax neutrality in the state of residence, but not in the state of investment
System of neutrality of capital import (exemption method) achieves tax neutrality in the state of investment, but not in the state of residence
Exemption method is therefore preferred by states where investment in foreign states has priority (eg Germany; West European States)
Tax credit method is preferred by states who concentrate more on domestic markets (eg US, UK, Russia)

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Exemption method
Only in DTA, not unilaterally
Advantages:
Tax benefits of source state remain effective
Administratively not complex
Does not involve two tax authorities
Eliminates actual and potential double taxation
Disadvantages:
No tax revenue for state of residence
Losses may be disallowed by state of residence
Encourages use of tax havens
Calculation of effects on progression may be difficult

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Tax Credit Method
Direct tax credit: Taxes paid by the taxpayer in another country on foreign based income are credited
What is “foreign based income”? Conflict of Qualifications
Advantages:
Deduction of foreign losses in country of residence
Discourages use of tax havens
Disadvantages
Possibility of excess foreign tax credit, tax bill therefore higher
Eliminates tax relief given in source state
Eliminates only actual double taxation
Can be complicated

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Tax Credit Method
Excess tax credit can result from
Limitation of tax credit to domestic tax liability, if source tax is higher
Tax credit system
Per country limitation
overall limitation
per-category-limitation
Germany: per country limitation
Russia: unclear
Domestic losses
Difference in calculation of tax base
Timing differences
Excess tax credit: carry-forward, carry-back or deduction as expense

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Special forms of tax credit method:
Indirect tax credit (credit of underlying taxes):
Credit of taxes not paid by the tax payer (but by the company he has invested in)
How deep can the company chain be?
Not granted in Russia (in Germany not applicable since dividend is tax-free)
Fictitious tax credit (Tax sparing credit)
Credit of taxes which have not been paid
In case of less developed countries only
Has mostly the effect of an exemption

Master of International Business
21 -23 October, 2014 St Petersburg
Basics of International Taxation
Tax Credit Method
Effects of per country limitation
Income from state X: 10.000 €, withholding tax 25 %
Income from state Y: 10.000 €, withholding tax 15 %
Tax rate in state of residence: 20 %.
State X Y Sum
Income 10.000 10.000 20.000
Tax 2.000 2.000 4.000
Tax credit -2.500 -1.500 - 4.000
Remaining tax 0 500
Germany and Russia: No carry-forward of unused tax credit;
therefore problem of timing/tax base differences