module 1 introduction to international tax

1

Introduction International Taxation

Presented by

Edward Umling, CPA, LLM

December 7, 2009

Highlights this session

Residency Fiscal Jurisdiction Foreign Currency Treaties & Treaty Shopping

How to use a treaty How not to use a treaty (Aikens Industries)

What is International Tax ?

International taxation can mean several things

The study of the interaction of different countries' tax laws, as they affect individuals and companies with income and assets in more than one country

The comparative study of different countries' tax

laws

The international aspects of an individual country's tax laws.

My Favorite Definition

Domestic law applied at the international level

International Taxation as a Discipline

The top U.S. Tax Law Programs

• Loyola Law School • Thomas Jefferson• New York University• University of Washington • The University of San Diego

Harvard Program 1952

A) 900 B) 1,800 C) 3,600 D) More than 5,000

Part 1

Basis of Taxation

Taxation is based on “Residence”

Determining the “tax residence” of corporation is critical to ascertaining the degree of fiscal liability

The method of relief available.

World-Wide v.

Territorial Taxation

Concept of “World-Wide Taxation”

Must distinguish between Domestic and Foreign entities to determine the degree of fiscal liability when considering world-wide taxation

US Co.

GmbH

How much of the income and gain is taxable in the U.S.

assuming no Subpart F?

Concept of “World-Wide Taxation”

Must distinguish between Domestic and Foreign entities to determine the degree of fiscal liability when considering world-wide taxation

US Co.

GmBH

How much of the income and gain is taxable in the U.S.

assuming no Subpart F?

Since most countries apply unlimited fiscal liability (tax on worldwide income) on resident corporations, it is necessary to distinguish between

residents nonresidents are subjected to tax only on

sources of income and gains within that country unless, that income is attributable to a permanent establishment in that country.

A Closer Look at the Concept of “Residency”

Sourced based taxation

subjected to tax only on sources of income and gains within that country unless, that income is attributable to a “permanent establishment” in that country.

Non-residents

“permanent establishment”

Basis of Taxation

Based on residency World-wide v. territorial

Residents – world-wide Non-residents – territorial (unless an office exists)

Residency is so important that each country defines “tax residency” within

their local legislation

Independent Countries per www.countrywatch.com

Total count of Independent States: 194

What are the chances of all these countries having the same definition of tax residency?

Independent Countries per www.countrywatch.com

Total count of Independent States: 194

What are the chances of all these countries having the same definition of tax residency?

a countries domestic classification of a resident corporation conflicts with another

countries domestic classification.

Conflicts between countries defining

Resident Corporations mayoverlap claims of “non-resident”

Corporations

When definitions differ…

Not so easy to distinguish

Conflicts of Law & Resolution (Individuals)

Where a country’s domestic classifications of residency conflicts with another country, generally, a

treaty with the respective countries will assign residence to one country.

This assignment is accomplished through series of tiebreaker rules under Article 4 (residency) of the OECD Model Treaty.

treaty with the respective countries will assign residence to one country.

Lets take a look at how conflicts of residency occur

Corporate Resident “Conflicts”

Incorporation Test (United States) Management & Control Test (Europe)

Landmark case – de Beers Consolidated Mines (1906)

Settled by Article 5

“Management and Control”

This European concept is derived from case law in 1906. The High Court of Justice (Kings Bench Division), established a landmark ruling in de Beers Consolidated Mines, Limited v. Howe (Surveyor of Taxes) which held

a company is taxable where its real business is carried on.

This was, according to the court, to be the place where central management and control actually abides.

In this case, a company in South African whose affairs were controlled from the UK, was held to be a tax resident in the UK, because according to the High Court, this was the location where the organization…

Management and Control Test

"keeps house and does business”

This concept of central management & control is directed at the highest level of managements control within an organization.

Management and Control Test

The highest level of management is where the all-important decisions are made as opposed to the day-to-day

decisions.

Thus, the Corporation is regarded as tax resident in the jurisdiction where that effective management and control is exercised and not where the location of the organization resides.

So… Tax residence is where… the Management and Control Test is

satisfied

Conflicts of Law & Resolution

Occasionally, individual countries that negotiate treaties have deliberately avoided incorporating provisions within Article 4, to assign residency and leave it to the competent authorities to assign tax residence to one country or the other.

The question - which is “higher law” a treaty or local legislation?

It is generally accepted that residency provisions within treaties prevail over domestic law.

However, some countries, the United States in particular, deem the most recent domestic legislation on residency prevails over treaties.

United States “lex posterior” Principle

Tax treaties and the Internal Revenue Code have equal weight. However, the Internal Revenue Services uses the last in time rule to govern conflicts in law when applying Treaty Law to a situation.

In the United States tax statutes rank equally with Treaties.

Canada -Treaty is Highest Law

By contrast, Canada’s residency provisions in domestic law do not trump treaty provisions regardless of the date of enactment.

• Taxation based on residency

• Distinguish between residents and non-

residents

• Conflicts in defining what a tax resident

was

Jurisdiction to Tax

General Rules for Taxing Jurisdiction

Taxing jurisdiction over legal entities arises under two different approaches.

One approach assigns tax liability based upon legal connections, which exist between the country and the corporation.

This legal connections could be either incorporation or entry in the commercial register.

General Rules for Taxing Jurisdiction

The other approach assigns tax liability based upon economic connections such as place of central management and control or main activity.

Less frequently, some jurisdictions assign tax residence based upon the residence of the shareholders or where the main activity of the business is carried on.

Many jurisdictions combine the first two approaches and assign tax residence if either test is met.

Jurisdiction to Tax

Legal Connection

Economic Connection

Assigning tax residency based on central management & control is not without controversy

Difference in interpretation of terms and concepts as well as, decentralization of many multi-national companies makes it

difficult to locate where central management and control

Solved by Locating day-to-day management

Moreover, with the explosion of telecommunications, many executives and company personnel can meet in a virtual office and carry out decisions, which originate from several jurisdictions around the globe thus making it difficult to determine the actual location of central management and control. Some countries solve this problem by assigning tax residence based upon location of day-to-day management and not the superior level of management.

United States uses The “Incorporation” Test

The incorporation of a company is derived from the Latin concept; to form an indistinguishable whole.

When properly incorporated, a company forms into a distinct legal personality, separate from those who own the shares of the organization. Inherent within this personality is the ability of the organization to carry on business, contract on its own behalf and to own property.

The Corporation

Thus, a corporation is legally endowed with various rights and duties including the capacity of succession.

Because of these privileges, the organization is liable to tax on its profits and gains.

The incorporation test takes a lower position in some countries

New Zealand and Australia Treaty use place of incorporation as a tiebreaker if place of effective management is ineffective in assigning residence to one country.

The Preferred Criterion is Incorporation Test for U.S. and Canada

The United States and Canada reserve their rights under their OECD model treaty to retain the use of incorporation as the preferred criterion.

The United States in particular has incorporated this within the U.S. model treaty it concludes with other countries.

“Management and Control”

This European concept is derived from case law in 1906. The High Court of Justice (Kings Bench Division), established a landmark ruling in de Beers Consolidated Mines, Limited v. Howe (Surveyor of Taxes) which held

a company is taxable where its real business is carried on.

This was, according to the court, to be the place where central management and control actually abides.

In this case, a company in South African whose affairs were controlled from the UK, was held to be a tax resident in the UK, because according to the High Court, this was the location where the organization…

Management and Control Test

"keeps house and does business”

This concept of central management & control is directed at the highest level of managements control within an organization.

Management and Control Test

The highest level of management is where the all-important decisions are made as opposed to the day-to-day

decisions.

Thus, the Corporation is regarded as tax resident in the jurisdiction where that effective management and control is exercised and not where the location of the organization resides.

So… Tax residence is where… the Management and Control Test is

satisfied

Treaty Issues Relating to Corporate Residence

Article 4(3) of the OECD Model Treaty, provides that legal entities are resident where the effective management and control is located.

By contrast, the US Model Treaty uses the place of incorporation as the preferred criterion to assign tax residence.

OECD v. US Model

Treaty Issues Relating to Corporate Residence

Individual treaties reflect precise criteria of their negotiators.

For example, the Great Britain and Denmark Treaty uses management and control to assign tax residence.

United States and Denmark Treaty uses incorporation as the preferred criterion.

Denmark

Denmark

Common Denominator

Treaty Issues Relating to Corporate Residence

There are other treaties with Germany, France and Sweden, which use the Statutory Seat as the main criterion for tax residence.

Statutory Seat

Center of (effective management) or senior business management. The

place where management is actually conducted.

Treaty Issues Relating to Corporate Residence

Japan, as another example, uses head or main office as the criterion when concluding its treaties.

With this diversity of classifications,

defining residence between and among jurisdictions can mean the difference between taxation on worldwide income and taxation only on income that has its source in that country.

Defining residence between and among jurisdictions can mean the difference between taxation on worldwide income and taxation only on income that has its source in that country.

Treaty Issues Relating to Corporate Residence

Understanding these concepts will allow the practitioner to identify and separate those tax claims of countries that overlap another countries tax claims.

Consequences of residency conflicts “dual residency” and “double taxation”

A taxpayer satisfying a single relationship in two jurisdictions simultaneously causes overlap of taxing jurisdictions.

This overlap causes international double taxation also known as juridical double taxation.

Types of Double Taxation Economic double taxation means the

inclusion, by more than one country’s tax administration, of the same income in the tax base when the income is in the hands of different taxpayers. Taxation of Dividends distributed to shareholders under the U.S. tax regime is a good example

Example

Income is taxed at the corporate level and then it is taxed again in the hands of the recipient shareholders

Summary – cause of double taxation

Satisfying a single relationship in two different jurisdictions at the same time

Debrief Basis of Taxation

Place of Incorporation Place of Incorporation or Effective Management &

Control World-wide v. Territorial

Determining Tax Residency Residents v. Non-residents

Distinguishing can be the difference between world-wide taxation and taxation from sources only in that country (sourced based taxation)

United States SystemDebrief

U.S. Taxes on Worldwide basis US Citizens Resident Aliens Domestic Corporations

United States taxes on a source bases Non-resident Aliens Foreign Corporations

United States –two methods of releif Relief from double taxation –FTC Deduction

European System

Fiscal liability assigned based upon the Location of:

Central Management & Control Seat of Management & Control Entry into the Commercial Registry Head or Main office Location

Next Module

Part B- Foreign Tax Credit

If you have any questions please contact Edward Umling

Phone (412) 391-1994 Ext 259, email: eumling@urishpopeck.com

The informal comments and the information presented in these slides should not be construed as constituting tax advice applicable to any specific taxpayer because each taxpayer’s facts are different

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice mentioned in the presentation or contained in these slides is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transactions or matters addressed herein.