International Tax Law (basics)
It is human nature to look for benefits. Children, for example, know what is forbidden by the mother and allowed by the father, they go to the grandmother for additional pocket money and they ask the worker on the street to buy them a beer in the shop.
Businessmen look which countries offer good business conditions, they transfer functions and use advantages from tax treaties, they check alternatives if there are too many regulations and taxes and they invest where the authorities are less strict.
If country A offers a variety of benefits but charges high taxes and country B offers less benefits for less tax, it makes sense to receive benefits in country A and to pay tax in country B. However, high taxes do not automatically mean high benefits, many countries need money to pay old debt, and other countries pay large parts of the budgets for social transfers to people who are able but not willing to work while the economy has to employ migrants to meet the demand.
Regarding tax laws, there is a hierarchy:
- National tax law that takes into account taxation of international activities.
- Double taxation treaties (DTT) are bilateral agreements that limit the taxing rights of the contracting states. This limitation depends, if the DTT is applicable, how this agreement defines residence and permanent establishment (tie breaker rule: stronger than the national definition) and how the countries are regulating the taxation rights for different categories of income. Almost all DTT can be found in the Internet.
- Multilateral agreements usually cover a few topics for a group of participating countries. Examples are EU directives (merger directive, parent-subsidiary directive and the interest and royalty directive).
Most double tax treaties follow the pattern of the text of one version of the OECD Model, which covers specific subjects. Examples are the definition of residence (art. 4) and permanent establishment (art. 5) as well as various income sources (e.g. art. 7 business income, art. 10 dividends, art 11 interest, art. 12 royalties) and application rules (art.23 tax credit or exemption method).
Usually, active income is taxable in the source state (employment income, business profits, etc.), while income from short time employment and passive income like dividends, interests or royalties is taxed by the residence state but there might be a withholding tax in the other state, too.
Tax planning involves steps to maximize total net income, this includes not only the tax rates, but also regulations, switching costs, structure costs and the tax basis:
- Definition of existing business processes and relevant tax subjects (who has to pay tax), tax objects (for what tax has to be paid), tax basis and tax rates.
- Possible scenarios including transfer of functions
- To benefit from liberal business regulations
- To benefit from lower salary levels
- To benefit from lowering the tax base (allowable deductions and exemptions)
- To benefit from lower tax rates
- Similar to the concept of “total costs of ownership” in IT, there should be an integrated approach when changes are planned.
- Check of alternatives:
- Non- tax topics:
- switching costs and structure costs
- audit and publication requirements
- labor law and work permits
- legal enforcement of contractual agreements
- asset protection
- marketing aspects (near to customers, language)
- costs and availability of personnel
- differences in legal structures and their cross border qualification: hybrid instruments can be used to create deductible expenses in one country that result in tax free profits in another country.
- Taxation and social charges:
- tax on business profits
- tax on dividends
- withholding tax
- social charges on employment and self-employment income
- tax on capital gains
- inheritance tax
- real estate tax
- attitude of tax authorities (degree of “form over substance” attitude)
- reliable publications by tax authorities and possibilities for a ruling
- degree of centralization and service of tax authorities
- Non- tax topics: