INTERNATIONAL TAX
ENVIRONMENT
Submitted by:
Avirup Dutta (15BSP0285)
Arjun Basak (15BSP0239)
Ankur Vyas (15BSP0209)
Abhilash Gudipati (15BSP0025)
Asish Bhatta (15BSP0270)
Dinesh Bisth (15BSP0392)
Devang Sharma (15BSP0370)
INTERNATIONAL TAX
ENVIRONMENT
DEFINITION
International taxation is the study of tax on a person or business subject to the tax laws of
different countries or the international aspects of an individual country's tax laws. International
taxation is the study or determination of tax on a person or business subject to the tax laws of
different countries or the international aspects of an individual country's tax laws as the case may
be. Governments usually limit the scope of their income taxation in some manner territorially or
provide for offsets to taxation relating to extraterritorial income. The manner of limitation
generally takes the form of a territorial, residential, or exclusionary system. Some governments
have attempted to mitigate the differing limitations of each of these three broad systems by
enacting a hybrid system with characteristics of two or more.
OBJECTIVES
The twin objectives of taxation are:
1. Tax Neutrality
2. Tax Equity
TAX NEUTRALITY
A tax scheme is tax neutral if it meets three criteria:
Capital Export Neutrality: Capital-export neutrality is the criterion that an ideal tax
should be effective in raising revenue for the government and not have any negative
effects on the economic decision making process of the taxpayer. That is, a good tax is
one that is efficient in raising tax revenue for the government and does not prevent
economic resources from being allocated to their most appropriate use no matter where in
the world the highest rate of return can be earned. The tax scheme does not incentivize
citizens move their money abroad.
National Neutrality: A second neutrality criterion is national neutrality.
That is,
regardless of where in the world taxable income is earned it is taxed in the same manner
by the taxpayers national tax authority.
In theory, national tax neutrality is a
commendable objective, as it is based on the principle of equality. Taxable income is
taxed in the same manner by the taxpayers national tax authorities regardless of where in
the world it is earned.
Capital Import Neutrality: The third neutrality criterion is capital-import neutrality.
This criterion implies that the tax burden placed on the foreign subsidiary of a MNC by
the host country should be the same regardless in which country the MNC is incorporated
and the same as that placed on domestic firms. The tax burden on a MNC subsidiary
should be the same regardless of where in the world the MNC in incorporated.
TAX EQUITY
Tax equity is the principle that all similarly situated taxpayers should participate in the
cost of operating the government according to the same rules. This means that regardless
in which country an affiliate of a MNC earns taxable income, the same tax rate and tax
due date apply. Regardless of the country in which an affiliate of a MNC earns taxable
income, the same tax rate and tax due date should apply. The principal of tax equity is
difficult to apply; the organizational form of the MNC can affect the timing of the tax
liability.
TYPES OF TAXATION
There are three basic types of taxation that national governments throughout the world
use in generating tax revenue:
Income Tax
Withholding Tax
Value-added Tax
Income Tax
o An income tax is a tax on personal and corporate income.
o Many countries in the world obtain a significant portion of their tax revenue from
income taxes.
o An income tax is a direct tax that is one that is paid directly by the taxpayer upon
whom it is levied.
Withholding Tax
Withholding taxes are withheld from the payments a corporation makes to the taxpayer.
The taxes are levied on passive income earned by an individual or corporation of one
country within the tax jurisdiction of another country.
Passive income includes dividends and interest income, income from royalties, patents, or
copyrights.
A withholding tax is an indirect tax.
Value-Added Tax
An income tax has the incentive effect of discouraging work.
A VAT has the incentive effect of discouraging consumption (thereby encouraging saving).
VATs are easier to administer as well. While taxpayers have an incentive to hide their
income,
Producers have an incentive to make sure that their upstream suppliers in the production
process
Declare the value added (and pay the tax!).
Other Types Of Taxation
A wealth tax is a tax levied not on income but on the wealth of a taxpayer. Property taxes
are an example.
A poll tax is a tax on your existence. It is so called because it was collected from those
who wished to vote.
THE NATIONAL TAX ENVIRONMENTS
Worldwide Taxation
Territorial Taxation
Foreign Tax Credits
Worldwide Taxation
Tax national residents of the country on their worldwide income no matter in which country it
was earned. The U.S. has a worldwide tax system. A corporation headquartered in the U.S. must
pay the corporate income tax on all its income, regardless of whether it is earned in the U.S. or
overseas. The corporation pays this tax when the foreign earnings are repatriated by bringing
the income back to the U.S. This is known as deferral, because the income tax owed can be
deferred until a later date when the income is repatriated.
When a corporation chooses to repatriate earnings and pay the U.S. corporate income tax, the
law allows a foreign tax credit to offset a portion of the amount of U.S. tax that the corporation
would otherwise have to pay.
Example: A corporation in the 35 percent tax bracket repatriates $1 million of income earned
abroad; it would owe $350,000 in U.S. tax. But it has already paid $200,000 in tax to the country
where the income was earned at that country's 20 percent rate. It would owe the U.S. government
another 15 percent ($150,000) in order to bring the total tax paid on the $1 million of income to
the U.S. 35 percent tax rate.
The U.S. waits to tax most foreign earnings when they are repatriated, but it does tax some
foreign earnings immediately. This is known as passive income and includes many types of
investment income. For example, interest earned on a bond held by a foreign subsidiary could be
immediately taxable in the U.S.
Territorial Taxation
Territorial taxation tax residents based upon where the taxable event occurred. Under a territorial tax
system, the U.S. would tax only the U.S. income of a corporation and would exempt most or all foreign
income. By doing this, a territorial system would allow U.S. corporations to compete with foreign
corporations on a level playing field. In order to prevent erosion of the tax base, a territorial system could
still cover income from financial assets held by a foreign subsidiary that could easily be held by the U.S.
Company. Most countries have a territorial system. Among G-7 countries, only the U.S. has a worldwide
tax system. Among OECD nations, 26 have territorial systems including Australia, Canada, France,
Germany, Japan, Spain, and the United Kingdom. Eight OECD nations have worldwide systems,
including the U.S., Greece, Ireland, South Korea, and Mexico. The other OECD nations with worldwide
tax systems have top tax rates far below the top U.S. corporate tax rate.
Foreign Tax Credit
A foreign tax credit (FTC) is generally offered by income tax systems that tax residents on
worldwide income, to mitigate the potential for double taxation. The credit may also be granted
in those systems taxing residents on income that may have been taxed in another jurisdiction.
The credit generally applies only to taxes of a nature similar to the tax being reduced by the
credit (taxes based on income) and is often limited to the amount of tax attributable to foreign
source income. The limitation may be computed by country, class of income, overall, and/or
another manner.
Most income tax systems therefore contain rules defining source of income (domestic, foreign,
or by country) and timing of recognition of income, deductions, and taxes, as well as rules for
associating deductions with income. For systems that separately tax business entities and their
members, a deemed paid credit may be offered to entities receiving income (such as dividends)
from other entities, with respect to taxes paid by the pay or entities with respect to the income
underlying the income recognized by the member. Systems with controlled foreign corporation
rules may provide deemed paid credits with respect to deemed income inclusions under such
rules. Some variations on the credit provide for a credit for hypothetical tax to encourage foreign
investment (sometimes known as tax sparing).
QUALIFYING FOREIGN TAXES
You can claim a credit only for foreign taxes that are imposed on you by a foreign country or
U.S. possession. Generally, only income, war profits and excess profits taxes qualify for the
credit. See What Foreign Taxes Qualify For The Foreign Tax Credit? for more information.
Taken as a deduction, foreign income taxes reduce your U.S. taxable income. Deduct foreign
taxes on Schedule A (Form 1040), Itemized Deductions
Taken as a credit, foreign income taxes reduce your U.S. tax liability. In most cases, it is to your
advantage to take foreign income taxes as a tax credit.
If you choose to exclude either foreign earned income or foreign housing costs, you cannot take
a foreign tax credit for taxes on income you can exclude. If you do take the credit, one or both of
the choices may be considered revoked.
How to Claim the Foreign Tax Credit
File Form 1116, Foreign Tax Credit, to claim the foreign tax credit if you are an individual, estate
or trust, and you paid or accrued certain foreign taxes to a foreign country or U.S. possession.
Corporations file Form 1118, Foreign Tax CreditCorporations, to claim a foreign tax credit.
Compliance Issues
The foreign tax credit laws are complex. Refer to Foreign Tax Credit Compliance Tips for help
in understanding some of the more complex areas of the law. Below are some of the compliance
issues:
Foreign sourced qualified dividends and/or capital gains (including long-term capital
gains, collectible gains, unrecaptured section 1250 gains, and section 1231 gains) that are
taxed in the United States at a reduced tax rate must be adjusted in determining foreign source
income on Form 1116, Foreign Tax Credit, line 1a.
Interest expense must be apportioned between U.S. and foreign source income.
Charitable contributions are usually not apportioned against foreign source income;
however, contributions to charities organized in Mexico, Canada, and Israel must be
apportioned against foreign source income.
The amount of foreign tax that qualifies as a foreign tax credit is not necessarily the
amount of tax withheld by the foreign country. If you are entitled to a reduced rate of foreign
tax based on an income tax treaty between the United States and a foreign country, only that
reduced tax qualifies for the credit. It is up to you whether you want to ask for a refund from
the foreign country of the difference (excess) for which a foreign tax credit is not allowed.
If a foreign tax redetermination occurs, a redetermination of your US tax liability is
required in most situations. You must file a Form 1040X or Form 1120X. Failure to notify the
IRS of a foreign tax redetermination can result in a failure to notify penalty.
A foreign tax credit may not be claimed for taxes on income that you exclude from U.S.
gross income.
ORGANIZATIONAL STRUCTURES FOR
REDUCING TAX LIABILITIES
Branch & Subsidiary Income
Payments to and from Foreign Affiliates
Tax Havens
Controlled Foreign Corporation
Foreign Sales Corporation
Branch & Subsidiary Income
An overseas affiliate of a U.S. MNC can be organized as a branch or a subsidiary.
A foreign branch is not an independently incorporated firm separate from the parent. n
Branch income passes directly through to the parents income statements.
A foreign subsidiary is an affiliate organization of the MNC that is independently
incorporated. Income may not be taxed in the U.S. until it is repatriated, under certain
circumstances.
Payments to and from Foreign Affiliates
Having foreign affiliates offers transfer price tax arbitrage strategies.
The transfer price is the accounting value assigned to a good or service as it is
transferred from one affiliate to another.
If one country has high taxes, dont recognize income therehave those affiliates pay
high transfer prices. If one country has low taxes, recognize income therehave those
affiliates pay low transfer prices.
Tax Havens
Tax havens are countries with low corporate income tax rates and low withholding tax
rates on passive income.
Tax havens were once useful as locations for a MNC to establish a shell company.
The Tax Reform Act of 1986 greatly diminished the need for and ability of U.S.
corporations to profit from the use of tax havens.
Controlled Foreign Corporation
The Tax Reform Act of 1986 created a new type of foreign subsidiary: the controlled
foreign corporation.
A controlled foreign corporations a foreign subsidiary that has over half of its voting
stock held by U.S. shareholderseven if these shareholders are unaffiliated.
Foreign Sales corporation
The undistributed income of a minority foreign subsidiary of a U.S. MNC is tax deferred
until it is remitted via a dividend.
This is not the case with a controlled foreign corporationthe tax treatment is much less
favorable.
The result is that foreign tax credits are unlikely to be completely used.
BIBLIOGRAPHY
1) EUN/RESNICK. (2007). INTERNATIONAL FIANACIAL MANAGEMENT. THE MCGRAW
HILL.
1) Tax History: Why U.S. Pursues Citizens Overseas, Wall Street Journal, May 18, 2012.
2) Canadian banks to be compelled to share clients' info with U.S., CBC News, November 25,
2013.
3) Income Tax Act 1989, Pacific Islands Legal Information Institute.
4) "What is taxable income", Inland Revenue Authority of Singapore.
