Capítulo IV. Desarrollo
4.4 Desarrollo de los determinantes de la oferta
4.4.3 Tecnología y Stakeholders
There are two different approaches to taxing entities in a country:
1. The territorial approach to taxation: each country has the right to tax income earned inside its borders.
2. The worldwide approach: a country claims the right to tax income arising outside its border if that income is received by a corporation deemed resident within the country. The worldwide approach leads to double taxation as income will usually be taxed in the country where it is earned and again in the country where the holding entity is resident. For example, an entity resident in the UK will generally be liable to UK corporate income tax on its income from all sources worldwide. It may also be liable to overseas tax to the extent that its overseas activities fall within the tax net of other countries. Double-tax relief, as its name implies, exists to reduce the heavy tax burden so arising. In essence, its effect is to ensure that the taxpayer fi nally suffers tax at no more than the higher of the two, home or overseas tax rate.
Most countries applying the worldwide approach grant some form of relief from double taxation. Double tax relief is given according to the terms of double-tax agreements that a country has entered into, for example, the UK has entered into tax treaties with most countries in the world. In this section we are going to consider the principles followed in most double taxation agreements.
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5.8.1 The OECD model tax convention
Cross-border investment would be seriously impeded if there was a danger that the returns on such investments were taxed twice. The OECD model and the worldwide network of tax treaties based upon it help to avoid that danger by providing clear consensual rules for taxing income and capital.
The OECD model tax treaty says that business profi ts of an entity of a contracting state shall be taxable only in that state unless the entity carries on a business in the other con- tracting state through a permanent establishment in that state. If the entity carries on busi- ness in the other state, its business profi ts may be taxed in the other state to the extent that they are attributable to the permanent establishment.
Provisions for defining a permanent establishment
The OECD model in Article 5 paragraphs 1–3 contains the following defi nition:
1. For the purposes of this Convention, the term ‘ permanent establishment ’ means a fi xed place of business through which the business of an entity is wholly or partly carried on.
2. The term ‘ permanent establishment ’ includes especially: (a) a place of management
(b) a branch (c) an offi ce (d) a factory (e) a workshop
(f ) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
3. A building site or construction or installation project constitutes a permanent establish- ment only if it lasts more than 12 months.
If an entity has a permanent establishment in a country, it can be taxed in that country, causing a possible problem of double taxation.
5.9 Summary
In this chapter, we have discussed the meaning of residence and permanent establishment. We have considered problems of double taxation and double taxation treaties as well as ways of mitigating double taxation.
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Revision Questions
5
Question 1
Which of the following could NOT be used to indicate an organisation is resident in a country?
(A) Place of effective management (B) Buying or selling goods in a country (C) Place of incorporation
(D) Close economic relations with a country (2 marks)
Question 2
In no more than 15 words, defi ne the meaning of a ‘ branch ’ . (2 marks)
Question 3
Which of the following would NOT normally be subject to a withholding tax? (A) Rents
(B) Dividends (C) Interest
(D) Profi ts (2 marks)
Question 4
A double taxation treaty between two countries usually allows relief of foreign tax through a number of methods. Which one of the following is NOT a method of relieving foreign tax?
(A) Refund (B) Exemption (C) Tax credits
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Question 5
The OECD model tax convention defi nes a permanent establishment to include a number of different types of establishments:
(i) A place of management (ii) A warehouse
(iii) A workshop (iv) A quarry
(v) A building site that was used for 9 months
Which of the above are included in the OECD’s list of permanent establishments? (A) (i), (ii) and (iii) only
(B) (i), (iii) and (iv) only (C) (ii), (iii) and (iv) only
(D) (iii), (iv) and (v) only (2 marks)
Question 6
CW owns 40% of the equity shares in Z, an entity resident in a foreign country.
CW receives a dividend of $45,000 from Z, the amount received is after deduction of withholding tax of 10%. Z had before tax profi ts for the year of $500,000 and paid corpo- rate income tax of $100,000.
Requirements
(i) Explain the meaning of ‘ withholding tax ’ and ‘ underlying tax. ’ (2 marks)
(ii) Calculate the amount of withholding tax paid by CW. (1 mark)
(iii) Calculate the amount of underlying tax that relates to CW’s dividend. (2 marks)
(Total 5 marks)
Question 7
The following details relate to EA:
● Incorporated in Country A.
● Carries out its main business activities in Country B.
● Its senior management operate from Country C and effective control is exercised from
Country C.
Assume countries A, B and C have all signed double tax treaties with each other, based on the OECD model tax convention.
Which country will EA be deemed to be resident in for tax purposes? (A) Country A
(B) Country B (C) Country C
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Question 8
EB has an investment of 25% of the equity shares in XY, an entity resident in a foreign country.
EB receives a dividend of $90,000 from XY, the amount being after the deduction of withholding tax of 10%.
XY had profi ts before tax for the year of $1,200,000 and paid corporate income tax of $200,000.
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Solutions to
Revision Questions
5
Solution 1
The correct answer is (B), see Section 5.3.
Solution 2
A branch of the entity is merely an extension of the entity’s business, see Section 5.7.
Solution 3
The correct answer is (D), see Section 5.5.
Solution 4
The correct answer is (A), see Section 5.8.
Solution 5
The correct answer is (B), see Section 5.8.1.1.
Solution 6
(i) Withholding tax
A withholding tax is a tax deducted from a payment at source before it is made to the recipient. Withholding tax is most frequently used when payments are being made to recipients that are not resident within the same tax jurisdiction, but can also apply to some payments made to resident individuals.
Double taxation treaties between countries aim to reduce or eliminate withholding taxes and double taxation.
Underlying tax
Underlying tax is the tax on the profi ts out of which a dividend is paid. If an entity receives a dividend from an overseas entity, relief is sometimes given for the tax already deducted from the profi ts that were used to pay the dividend. This tax is referred to as the underlying tax.
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TION (ii) CW receives $45,000 net, this represents 90% of the gross amount, as withholding
tax has been deducted. The gross amount is $50,000 ($45,000/9 10) and with-
holding tax is 5,000.
(iii) After-tax profi ts of Z are $500,000 $100,000 $400,000 Underlying tax is $50,000/$400,000 $100,000 $12,500 See Sections 5.5 and 5.6.
Solution 7
The correct answer is (B), see Section 5.4.
Solution 8
$’000
Gross dividend 90 100/90 100 After tax profi ts 1,000 Underlying tax 100/1,000 200 20