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Trade between two or more countries attracts international tax. In the current scenario, it is impossible for a country to not have any international transactions. The business structures have evolved and the transactions have become intensely intermingled. It becomes very important for the tax laws of one country to cope with that of the other country. However, it is an unrealistic scenario for countries to always have similar laws. The laws within a country might as well not be similar. Due to this tax evasion whether deliberate or not, has also risen. This makes tax planning very important especially while making international transactions. Tax planning is a method to mitigate tax liability by undertaking measures within the four corners of the law. Once these measures step out of the four corners of the law, it becomes tax evasion. Tax evasion is illegal as it is the commission of an act prohibited by law. In international transactions, tax planning becomes even more important due to the difference in laws among countries and the various international tax treaties which come into the picture. Tax planning is a combination of a financial and a business decision to minimize tax liability and avail maximum benefit.
Table of Contents
The Principles that have to be followed while international tax planning is:
Double taxation and double non-taxation are the main reason for the emergence of international tax planning. Double Taxation means tax is levied by both countries on one transaction. On the other hand, double non-taxation means that a transaction goes un-taxed in both contracting states. The purpose of tax planning is to remove the instances of double taxation and double non-taxation and promote international trade. This has led to the adoption of unilateral and bilateral reliefs. The unilateral reliefs apply when there is no mutual agreement between two contracting states and the home country provides certain reliefs to its residents. On the other hand, Bilateral reliefs are those reliefs in which two contracting states negotiate and decide on how and where to tax a particular income. These bilateral agreements are called DTAAs. DTAAs is a major source in tax planning.
The types of relief provided by DTAAs can be broadly categorized into four methods:
The connecting factors help determine the jurisdiction where tax shall be levied. Tax planning helps identify whether the tax shall be levied on an individual or an entity. Further tax planning also helps identify under which rule an individual or an entity is to be taxed.
Two connecting factors determine the tax jurisdiction for individuals are:
The former depends upon the relation taxpayer has with the country, such as residence, domicile, or nationality. The latter depends on the place from where income generates. Most nations adopt a mixture of both wherein they tax residents on their global income and non-residents on income generated in their nation.
It depends upon factors like place of incorporation or place of registered office and place of effective management of business (POEM). When a jurisdiction’s residency determining factors are the place of incorporation or registered office, the company incorporated or registered in this jurisdiction shall be its resident. The state in which a company is legally incorporated or registered in its residence state. On the other hand, residence based on POEM means the place where key strategic and managerial decisions are taken shall be the resident state. Key strategic and managerial decisions signify the final decision-making power or superior control. It is a subjective concept and is ultimately based on the facts and circumstances of the case.
The presence of P.E. in a country primarily enables a country to tax the income generated in that country. It also means that in the presence of a P.E., the source country’s right to tax dominates that of the resident country. It means a fixed place of business through which a business of an enterprise is wholly or partly carried on. The term P.E. includes a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; and f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.
The mutual agreement rule implies that the conflict arising between the Contracting States, due to differences in law, must be resolved by mutual agreement.
A treaty is an international agreement between States in written form and are governed by international law. Treaties dealing in matters related to tax are known as Tax Treaties. It generally applies to a person who is a resident of at least one of the contracting states between whom the tax treaty is concluded. There are two types of tax treaties i.e., either bilateral or multilateral. Bilateral tax treaties are treaties on tax matters concluded between two nations. Multilateral tax treaties are those that are concluded between more than two nations. As the main objectives of a tax treaty are: i) prevention of tax evasion and ii) avoidance of double taxation. Bilateral tax treaties become the most common form of tax treaties. While conducting tax planning understanding tax treaties is very important as avoidance of double taxation is a major purpose for entering into a tax treaty. For eg; In India, when a tax treaty conflicts with domestic law, the domestic law shall prevail. Proper tax planning helps the foreign entity transacting in India to understand the tax system of a country.
Taxing corporate structures has become a difficult task since they have evolved with time. Having a complex business as well as tax structure raises confusion as to which state should tax the income. Further, the wiping up of territorial borders and opening up of the economy to boost business has made it easy to dodge tax. Taxpayers take the advantage of the differences in tax laws so suppose an income is taxable in one country and is exempt from tax in another, then the income is shifted to the country which exempts it from tax. Tax planning is done to resolve the rising instances of tax evasion and to minimize the instances of exploitation by building a bridge between the gaps in tax laws. The OECD with the cooperation of states came up with BEPS Action Plans. BEPS stands for Base Erosion and Profit Shifting. BEPS Action Plans cater to the rising instances of BEPS. The Action Plans include various instruments which deal with advanced issues of tax. These instruments are:
The Principles laid down in the tax treaties or any instrument formulated by the OECD are the basis on which every country formulates its tax laws. Understanding these basic principles will help in understanding the local tax laws of a country and will ease the tax planning process. Based on these principles, a person or an entity can decide which country to transact with and under which method will they be able to minimize tax liability most. Tax planning has become an important aspect in deciding a strategy for international transactions. Tax planning enhances the productivity of investments by utilizing the resources fully. Therefore, tax planning also contributes to the economic development of the taxpayer as well as the country.
Read our Article: A Discourse on Tax Planning Strategies
Ankita is an Advocate and has joined Enterslice as a Legal Researcher. Her work focuses on General Civil and Commercial laws, Corporate Taxation Laws, Labour and Employment Laws and Dispute Resolution. She is a law graduate from School of Law, University of Petroleum and Energy Studies. Prior to joining Enterslice, Ankita has the experience of practicing law in Delhi and Odisha.
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