company in one country holds shares in an operating company in another country, is therefore crucial.
Operating Company TaxationA business would normally establish a company in the country where the economic activity is being conducted. Taxation is levied on company profits and capital gains. Taxable income is arrived at by applying a combination of local taxation rules and International Accounting Standards. A proper understanding of what costs are tax-deductible and what revenue is attributable to any particular tax year is critical. The way a business is structured or the way an operation is set up can also have a substantial impact on its tax bill.
Withholding Tax (WHT) at Operating CompanyDouble Taxation Treaties (DTTs) are agreements between countries aimed at reducing or avoiding altogether the possibility of double taxation. DTTs are mainly concerned with flows of interest, royalties and dividends. Unless the two countries in question have signed a DTT, the country of origin may hold the company in the country of destination liable to tax. This happens by virtue of the fact that the country of origin is where the income-generating activity is being conducted. The latter situation results in withholding taxes being levied in the country of origin.
Holding Company TaxationRoyalty and interest payments are normally treated as tax-deductible in the country of origin and taxed in the country of destination. Dividends, on the other hand, are an appropriation of profit and comprise income that has already been subjected to taxation in the originating country. Having understood what, if any, withholding tax is charged on the payment of a dividend by the sender, it is important to establish how that income is treated for taxation purposes under the domestic rules of the receiving country.
Withholding Tax at Holding CompanyThe owners of the holding company may be resident in the same country as the holding company, or they may be resident in a third country. Normally there would be no or low withholding taxation levied on a dividend payment if the holding company and its owner/s are resident in the same country. Such a dividend payment may or may not carry with it a tax credit that the owner could deduct from his personal tax liability. Should the owner be resident in another country, we are back to the issues and matters related to DTTs.
DTTs (and the relative OECD guidelines) assume that the entity in the country of origin and the entity in the country of destination are tax resident in their respective countries. The DTTs and guidelines also provide criteria for establishing tax residence. The key, generally speaking, is beneficial entitlement to the income and a permanent establishment in the country. Tax authorities also look for substance when considering accepting tax residence in another country. The presence of an office, employees and economic activity in a country are typically what would be expected.
General Anti-Abuse Rules (GAAR)GAAR’s aim is to avoid treaty-shopping. This is the practice of setting up entities purely for the purpose of avoiding or reducing WHTs or eventual taxation on personal income. A G20 initiative has now been taken up by the OECD. As a result of this, the OECD has published an Action Plan to counter profit-Base Erosion & Profit Shifting (BEPS). BEPS will be taken up by countries to prevent tax avoidance.
ConclusionAttention needs to be given today more than ever before on how taxation impacts cross-border activity. Apart from the basic taxation points, note should be taken of the general anti-abuse provisions and the new BEPS initiative. Getting cross-border transactions wrong is increasingly becoming more punitive.
Director & CEO at Portman International Holdings Ltd
How to Keep Your International Tax Risk at Bay, Mar 24, 2015