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International Taxation - Some concepts

International Taxation - Some concepts

The developed nations have tried to protect their tax base by enacting various anti-avoidance provisions. The three most common anti – avoidance measures adopted by the taxing authorities of these countries is Controlled Foreign Companies regime, transfer pricing and thin capitalization. OECD has recognized these measures and has adopted them in the model stating that they do not contravene the basic International Tax principles.

1) Transfer Pricing
Today the role of multinational enterprises in the world trade has increased over last 20 years and this growth presents complex taxation issues for both tax administration and the MNEs themselves since separate country rules for the taxation of MNEs cannot be viewed in isolation but must be addressed in a broad international context. The need to comply with laws and administrative requirements that may differ from country to country creates additional problems.

Transfer prices are the prices at which an enterprise transfers physical good and intangible property or provides services to associated enterprises. Article 9 of OECD deals with associated enterprises and it deals with transfer pricing at arm length’s principle. There are various methods given to use transfer pricing and the concerned state is ready to use any of them.

2) Thin Capitalisation
Financing an overseas investment is complex as it can be financed by equity, intra group debt or external debt when a group guarantee may be required by the lender. This is important as interest is deductible and dividends are not. Thin capitalization rules really relate to excessive loans to help tax authorities to protect their tax base in relation to inbound investment by regulating the proportion of debt on which interest is deductible. Thin capitalization is a mechanism wherein funds are infused into a company in the form of loan rather than equity to avail tax benefits to ensure that the capital of the company is very small or thin. A higher debt component in the capital structure reflects by an extraordinary high debt-equity ratio enables companies to save on taxes since interest on loans is normally deductible for calculating taxable profits. This is in contrast to dividends which are not deductible. If the company’s debt or equity ratios exceeds a certain norm then some or all of the interest is to be disallowed as an expense or depending on the terms of the relevant country’s domestic legislation more generally treated as dividends. The most obvious thin capitalisation arises in the context of associated enterprises, Article 9 of OECD Model which allows the profits of associated enterprises to be adjusted to the arm’s length profit should be considered first.

3) Controlled Foreign Company (CFC)
The general rule of international tax is that the profits of a subsidiary are not taxed in the country of the parent unless and until distributed by dividends to the parent. Controlled Foreign Company rules help tax authorities to protect their tax base in relation to outbound investment by providing an alternative means of taxation at the level of parent company. CFC rules operates in an environment where all group transaction take place at arm’s length.
The general feature of CFC
1) Bring forward the time of taxation at the level of parent
2) Tax system which might otherwise not be taxed
3) Focus on investment income
4) Can focus on and therefore tax business profits