International Taxation Concepts, Part I
The first part of our concept roundup series related to international taxation and compliance.
With our background in international tax case law and successful cross-border tax compliance, we wanted to shortlist some concepts to make the space seem a little less daunting for readers. Below are some basic but important concepts that often come up in our advisory. Be sure to check out the other parts of this series too.
Double Tax Treaties
Over 3,000 bilateral tax treaties govern a wide range of cross-border taxation issues, while existing principally to avoid double taxation as well as double non-taxation. The bilateral treaties are based on the OECD Model or the UN Model. They want to incentivize cross-border economic activity in ways that are fair, and these treaties regularly bring MNCs, small companies, and individuals to tax courts in jurisdictions around the world. We leverage these treaties as much as possible to design mobility policies and apply treaty benefits in home-host country pairs. The treaties enjoy a wide range of acronyms, i.e. DTA (agreement), DTT (treaty), DTC (convention). Check out of our individual posts on recent DTA cases that we find illuminating.
Permanent Establishment
"Permanent Establishment" (PE) is a comprehensive international taxation topic. Overall, it is the vehicle by which countries lay rights to taxation on non-resident entities and individuals engaged in economic activity in their borders. More succinctly, it is the threshold for source-country taxation. The nature of PE, types of PE, and elaborations on PE-avoidance arrangements have been expanded in tax treaties over the decades but especially since the 2017 OECD Model updates driven by the BEPS project. While registering and managing a PE is sometimes the easier thing to do, triggering a PE is often a concern for many MNCs, smaller companies, and individuals engaged in cross-border activity who wish to avoid triggering taxation in a jurisdiction. The case law clarifies that there are no hard-fast rules for triggering or not triggering PE outside of assessing the actual nature of the activity, e.g. a number-of-days test, location of contracts, fixed location, technical form, etc. are not decisive factors. Instead, courts have given themselves a lot of maneuvering room in declaring a PE for a given company or individual, and for tax planning purposes one always has to start from the substance and beneficiaries of the cross-border activity.
OECD Model
The OECD Model Tax Convention forms the basis of the large majority of tax treaties entered into by developed nations, primarily to avoid the double taxation of income and capital but also to counter general anti-avoidance of taxes. It is a collection of 32 articles as well as expansive article commentary. The actual bilateral DTAs sometimes exclude or modify provisions of the OECD articles and commentary. However the OECD model and the expansive tax treaty case law in tax courts around the globe cover pretty much all aspects of cross-border taxation between developed nations. Overall the spirit of the OECD Model is to incentivize cross-border economic activity in a way that is fair for all countries. The 2017 edition contains major anti-avoidance updates related to the OECD BEPS project.
UN Model
The United Nations Model Convention is an analog of the OECD Model for treaties between developed and developing nations. However it also submits globally impactful proposals for changes to tax conventions, in particular related to updating tax conventions for the digital age.
Vienna Convention
The Vienna Convention on the Law of Treaties (VCLT) is the “treaty about treaties”. It’s often invoked in tax treaty case law to determine how domestic laws should be applied against a bilateral treaty or vice versa. Its “good faith” provision encourages interpretion of cases with respect to the sprit of the particular treaty, taking into account all context, objects, and the treaty’s purpose, leading to dynamic rulings in cross-border taxation disputes.
BEPS
The "Base Erosion and Profit Shifting Project" from the G20 and OECD is a comprehensive set of proposals to prevent tax avoidance in cross-border activity and delineate the artificial arrangements that facilitate the avoidance. The stated goal of BEPS is to realign the location of profits with the location of activity. "Base erosion" refers to lowering the tax base, and "profit shifting" refers to the artifical shifting of profits to another tax jurisdiction. It is estimated up to $300 Billion in tax is avoided each year through exploiting gaps and weaknesses in international tax law.
MLI
The OECD's Multilateral Instrument is the means by which thousands of tax treaties globally have adopted the BEPS provisions, and in short time horizons as it does not require a re-negotiation of tax treaties, just a signing of the MLI. The treaty updates have come into effect or will soon in over 100 jurisdictions starting January 2019.
Residency
Residency is an important concept for tax purposes, as there is often substantial difference in the taxation regimes of residents, non-residents, or third residency categories such as domiciliary status, temporary residents, non-permanent residents, resident aliens, etc. Primarily, residency status impacts income tax rates, contribution obligations, and taxation of global income or income remittance. Determination of residency varies per country, though in practice many use a 183-day rule. It’s not uncommon in global mobility to have two tax residencies, with the bilateral tax treaty containing a “tie-breaker test” to determine tax year residency; the tie-breaker usually comes down to where employment activity actually occurs.
Domicile
Domicile is a residency-like concept in certain tax codes that also affords flexibility in tax claims. For example one can be a tax resident of the UK but non-domiciled in the UK, in which case they can favorably elect to have their global income taxed on a remittance basis when/if income enters the UK. Typically you only have one domicile (by default the country of your father's/mother's domicile), and you can only change domicile if you have permanently moved to a different country.
Totalization Treaties
Many countries have bilateral totalization treaties, designed to avoid double contributions to statutory social funds as well as to recognize the social fund contributions made by foreign employees in their country. “Substantially similar” taxes to the standard social fund contributions are typically recognized as well. The “totalization” refers to the totaling of contribution credits made between the two countries, so that mobile employees aren’t at a disadvantage for social fund benefits.
Foreign Tax Credits
FTCs and foreign tax deductions on tax returns are the main procedures for seeking relief from double taxation under bilateral tax treaties. Policies vary, and they are usually "non refundable" in nature, meaning they do not allow one to pay less tax overall than the amount the taxpayer is subject to in their home country. There are also rules that specify when you can claim credits as well as when particular taxes, income exemptions, or deductions of the other country will not qualify for relief.
Flat Non-Resident Rates
This concept refers to the tax codes of a number of countries where a flat employment income tax rate is offered for non-residents, usually at a considerable advantage over the income tax rates for residents. Generally such countries use a 183-day rule to qualify individuals for non-resident rates, sometimes with exceptions such as long-term work visa holders. These rates might inform a split-year tax return strategy for short-term assignments or first year of long-term assignments, where allowed.
Substantially-All Test
As a converse to “Flat non-resident rates”, there are of course tax advantages related to having the status of resident over non-resident, especially as relates to income exemptions, deductions, and tax credits. A “substantially-all” provision usually means for non-residents if 90% or more of worldwide income for the year is derived from the non-resident country, then they are eligible for certain tax advantages of residents.
Assignee Tax Breaks
In order to attract talented expat assignees within their borders, some countries allow special tax benefits for assignees and intra-company transferees. These can be deductions for relocation costs, tax-free fringe benefits for housing, cars, and education, and in a few countries, advantageous flat income tax rates for assignees, usually limited to less than 5 years.
This concludes part I of our concepts in international taxation. Keep learning more in International Taxation Part II
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