International Tax From Braxton Group
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International Tax from Braxton 1 International taxation 1 Double taxation 10 Transfer pricing 13 Taxation in the United States 29 Taxation in the United Kingdom 43 Tax rates 51 Dividend 55 Withholding 60 Tax treaties 64 Capital gain 69 References Article Sources and Contributors 70 Image Sources, Licenses and Contributors 71 Article Licenses License 72 1
International Tax from Braxton
International taxation
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. 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, residency, 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. Many governments tax individuals and/or enterprises on income. Such systems of taxation vary widely, and there are no broad general rules. These variations create the potential for double taxation (where the same income is taxed by different countries) and no taxation (where income is not taxed by any country). Income tax systems may impose tax on local income only or on worldwide income. Generally, where worldwide income is taxed, reductions of tax or foreign credits are provided for taxes paid to other jurisdictions. Limits are almost universally imposed on such credits. Multinational corporations usually employ international tax specialists, a specialty among both lawyers and accountants, to decrease their worldwide tax liabilities. With any system of taxation, it is possible to shift or re-characterize income in a manner that reduces taxation. Jurisdictions often impose rules relating to shifting income among commonly controlled parties, often referred to as transfer pricing rules. Residency based systems are subject to taxpayer attempts to defer recognition of income through use of related parties. A few jurisdictions impose rules limiting such deferral (“anti-deferral” regimes). Deferral is also specifically authorized by some governments for particular social purposes or other grounds. Agreements among governments (treaties) often attempt to determine who should be entitled to tax what. Most tax treaties provide for at least a skeleton mechanism for resolution of disputes between the parties.
Introduction Systems of taxation vary among governments, making generalization difficult. Specifics are intended as examples, and relate to particular governments and not broadly recognized multinational rules. Taxes may be levied on varying measures of income, including but not limited to net income under local accounting concepts, gross receipts, gross margins (sales less costs of sale), or specific categories of receipts less specific categories of reductions. Unless otherwise specified, the term “income” should be read broadly. Jurisdictions often impose different income based levies on enterprises than on individuals. Entities are often taxed in a unified manner on all types of income while individuals are taxed in differing manners depending on the nature or source of the income. Many jurisdictions impose tax at both an entity level and at the owner level on one or more types of enterprises.[1] These jurisdictions often rely on the company law of that jurisdiction or other jurisdictions in determining whether an entity’s owners are to be taxed directly on the entity income. However, there are notable exceptions, including U.S. rules characterizing entities independently of legal form.[2] In order to simplify administration or for other agendas, some governments have imposed “deemed” income regimes. These regimes tax some class of taxpayers according to tax system applicable to other taxpayers but based on a deemed level of income, as if earned by the taxpayer. Disputes can arise regarding what levy is proper. Procedures for dispute resolution vary widely and enforcement issues are far more complicated in the international arena. The ultimate dispute resolution for a taxpayer is to leave the jurisdiction, taking all property that could be seized. For governments, the ultimate resolution may be confiscation of property, dissolution of the entity, or even the death International taxation 2
penalty. Other major conceptual differences can exist between tax systems. These include, but are not limited to, assessment vs. self-assessment means of determining and collecting tax; methods of imposing sanctions for violation; sanctions unique to international aspects of the system; mechanisms for enforcement and collection of tax; and reporting mechanisms.
Taxation Systems 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 one of three forms: • Territorial: taxation only of in-country income • Residency: taxation of all income of residents and/or citizens • Exclusionary: specific inclusion or exclusion of certain amounts, classes, or items of income in/from the base of taxation 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. For example, they may tax based on residency but provide a specific amount of exclusion for certain foreign income.[3] Alternatively, they may tax income sourced in the country as well as that remitted to the country.[4] Most countries tax gains on dispositions of realty within the country, regardless of residency or their system of taxation.[5]
Territorial
A few countries tax only income earned within their borders. For example, the Hong Kong Inland Revenue Ordinance imposes income tax only on income earned from a business or source within Hong Kong.[6] Such systems tend to tax residents and nonresidents alike. The key problem argued for this type of territorial system is the ability to avoid taxation on portable income Hong Kong is an example of a territorial tax system. by moving it offshore. This has led governments to enact hybrid systems to recover lost revenue.
Residency Most income tax systems impose tax on the worldwide income of residents, and impose tax on the income of nonresidents from certain sources within the country. Prime examples of such residency Taxation in the United States and Taxation in the United Kingdom. Residency based systems face the daunting tasks of defining resident and characterizing the income of nonresidents. Such definitions vary by country and type of taxpayer. Examples include: • The U.S. provides lengthy, detailed rules for individual residency covering: • Periods establishing residency (including a formulary calculation involving three years) • Start and end date of residency • Exceptions for transitory visits, medical conditions, etc.[7] • UK establishes three categories: non-resident, resident, and resident but not ordinarily resident.[8] International taxation 3
• Switzerland residency may be established by having a permit to be employed in Switzerland for an individual who is so employed.[9]
Exclusion Many systems provide for specific exclusions from taxable (chargeable) income. For example, several countries, notably Cyprus, Netherlands and Spain, have enacted holding company reigimes that exclude from income dividends from certain foreign subsidiaries of corporations. These systems generally impose tax on other sorts of income, such as interest or royalties, from the same subsidiaries. They also typically have requirements for portion and time of ownership in order to qualify for exclusion. The Netherlands offers a “participation exemption” for dividends from subsidiaries of Netherlands companies. Dividends from all Dutch subsidiaries automatically qualify. For other dividends to qualify, the Dutch shareholder or affiliates must own at least 5% and the subsidiary must be subject to a certain level of income tax locally.[10]
Hybrid Some governments have chosen, for all or only certain classes of taxpayers, to adopt systems that are a combination of territorial, residency, or exclusionary. There is no pattern to these hybrids. Following are examples: • The U.S. allows individuals earning income from their personal services outside the U.S. — an exclusion of up to US$80,000 (indexed for inflation from a key date) from compensation for such services. Compensation income in excess of this amount is fully taxable to citizens and residents.[11] • The UK imposes a charge to tax on individuals “resident but not ordinarily resident” in the UK based on income earned in or remitted to the UK.[12] • Singapore imposes income tax on resident individuals and companies on all income earned in or remitted to Singapore.[13]
Individuals vs. enterprises Many tax systems tax individuals in one manner and entities that are not considered fiscally transparent in another. The differences may be as simple as differences in tax rates,[14] and are often motivated by concerns unique to either individuals or corporations. For example, many systems allow taxable income of an individual to be reduced by a fixed amount allowance for other persons supported by the individual (dependents). Such a concept is not relevant for enterprises. Many systems allow for fiscal transparency of certain forms of enterprise. For example, most countries tax partners of a partnership, rather than the partnership itself, on income of the partnership.[15] A common feature of income taxation is imposition of a levy on certain enterprises in certain forms followed by an additional levy on owners of the enterprise upon distribution of such income. Thus, many countries tax corporations under company tax rules and tax individual shareholders upon corporate distributions. Various countries have tried (and some still maintain) attempts at partial or full “integration” of the enterprise and owner taxation. Where a two level system is present but allows for fiscal transparency of some entities, definitional issues become very important.
Source of income Determining the source of income is of critical importance in a territorial system, as source often determines whether or not the income is taxed. For example, Hong Kong does not tax residents on dividend income received from a non-Hong Kong corporation.[16] Source of income is also important in residency systems that grant credits for taxes of other jurisdictions. Such credit is often limited either by jurisdiction or to the local tax on overall income from other jurisdictions. International taxation 4
Source of income is where the income is considered to arise under the relevant tax system. The manner of determining the source of income is generally dependent on the nature of income. Income from the performance of services (e.g., wages) is generally treated as arising where the services are performed.[17] Financing income (e.g., interest, dividends) is generally treated as arising where the user of the financing resides.[18] Income related to use of tangible property (e.g., rents) is generally treated as arising where the property is situated.[19] Income related to use of intangible property (e.g., royalties) is generally treated as arising where the property is used. Gains on sale of realty are generally treated as arising where the property is situated. Gains from sale of tangible personal property are sourced differently in different jurisdictions. The U.S. treats such gains in three distinct manners: a) gain from sale of purchased inventory is sourced based on where title to the goods passes;[20] b) gain from sale of inventory produced by the person (or certain related persons) is sourced 50% based on title passage and 50% based on location of production and certain assets;[21] c) other gains are sourced based on the residence of the seller.[22] Where differing characterizations of an item of income can result in differing tax results, it is necessary to determine the characterization. Some systems have rules for resolving characterization issues, but in many cases resolution requires judicial intervention.[23] Note that some systems which allow a credit for foreign taxes source income by reference to foreign law.[24]
Definitions of income Some jurisdictions tax net income as determined under financial accounting concepts of that jurisdiction, with few, if any, modifications.[25] Other jurisdictions determine taxable income without regard to income reported in financial statements.[26] Some jurisdictions compute taxable income by reference to financial statement income with specific categories of adjustments, which can be significant.[27] A jurisdiction relying on financial statement income tends to place reliance on the judgment of local accountants for determinations of income under locally accepted accounting principles. Often such jurisdictions have a requirement that financial statements be audited by registered accountants who must opine thereon.[28] Some jurisdictions extend the audit requirements to include opining on such tax issues as transfer pricing.[29] Jurisdictions not relying on financial statement income must attempt to define principles of income and expense recognition, asset cost recovery, matching, and other concepts within the tax law. These definitional issues can become very complex. Some jurisdictions following this approach also require business taxpayers to provide a reconciliation of financial statement and taxable incomes.[30]
Deductions Systems that allow a tax deduction of expenses in computing taxable income must provide for rules for allocating such expenses between classes of income. Such classes may be taxable versus non-taxable, or may relate to computations of credits for taxes of other systems (foreign taxes). A system which does not provide such rules is subject to manipulation by potential taxpayers. The manner of allocation of expenses varies. U.S. rules provide for allocation of an expense to a class of income if the expense directly relates to such class, and apportionment of an expense related to multiple classes. Specific rules are provided for certain categories of more fungible expenses, such as interest.[31] By their nature, rules for allocation and apportionment of expenses may become complex. They may incorporate cost accounting or branch accounting principles,[31] or may define new principles. International taxation 5
Thin capitalization Most jurisdictions provide that taxable income may be reduced by amounts expended as interest on loans. By contrast, most do not provide tax relief for distributions to owners.[32] Thus, an enterprise is motivated to finance its subsidiary enterprises through loans rather than capital. Many jurisdictions have adopted "thin capitalization" rules to limit such charges. Various approaches include limiting deductibility of interest expense to a portion of cash flow,[33] disallowing interest expense on debt in excess of a certain ratio,[34] and other mechanisms.
Enterprise restructure The organization or reorganization of portions of a multinational enterprise often gives rise to events that, absent rules to the contrary, may be taxable in a particular system. Most systems contain rules preventing recognition of income or loss from certain types of such events. In the simplest form, contribution of business assets to a subsidiary enterprise may, in certain circumstances, be treated as a nontaxable event.[35] Rules on structuring and restructuring tend to be highly complex.
Credits for taxes of other jurisdictions Systems that tax income earned outside the system’s jurisdiction tend to provide for a unilateral credit or offset for taxes paid to other jurisdictions. Such other jurisdiction taxes are generally referred to within the system as “foreign” taxes. Tax treaties often require this credit. A credit for foreign taxes is subject to manipulation by planners if there are no limits, or weak limits, on such credit. Generally, the credit is at least limited to the tax within the system that the taxpayer would pay on income earned outside the jurisdiction.[36] The credit may be limited by category of income,[37] by other jurisdiction or country, based on an effective tax rate, or otherwise. Where the foreign tax credit is limited, such limitation may involve computation of taxable income from other jurisdictions. Such computations tend to rely heavily on the source of income and allocation of expense rules of the system.[38]
Withholding tax Many jurisdictions require persons paying amounts to nonresidents to collect tax due from a nonresident with respect to certain income by withholding such tax from such payments and remitting the tax to the government.[39] Such levies are generally referred to as withholding taxes. These requirements are induced because of potential difficulties in collection of the tax from nonresidents. Withholding taxes are often imposed at rates differing from the prevailing income tax rates.[40] Further, the rate of withholding may vary by type of income or type of recipient.[41] [42] Generally, withholding taxes are reduced or eliminated under income tax treaties (see below). Generally, withholding taxes are imposed on the gross amount of income, unreduced by expenses.[43] Such taxation provides for great simplicity of administration but can also reduced the taxpayer's awareness of the amount of tax being collected.[44] International taxation 6
Treaties
Tax treaties exist between many countries on a bilateral basis to prevent double taxation (taxes levied twice on the same income, profit, capital gain, inheritance or other item). In some countries they are also known as double taxation agreements, double tax treaties, or tax information exchange agreements (TIEA).
OECD members Accession candidate countries Enhanced Most developed countries have a large engagement countries number of tax treaties, while developing countries are less well represented in the worldwide tax treaty network.[45] The United Kingdom has treaties with more than 110 countries and territories. The United States has treaties with 56 countries (as of February 2007). Tax treaties tend not to exist, or to be of limited application, when either party regards the other as a tax haven. There are a number of model tax treaties published by various national and international bodies, such as the United Nations and the OECD.[46]
Treaties tend to provide reduced rates of taxation on dividends, interest, and royalties. They tend to impose limits on each treaty country in taxing business profits, permitting taxation only in the presence of a permanent establishment in the country.[47] Treaties tend to impose limits on taxation of salaries and other income for performance of services. They also tend to have “tie breaker” clauses for resolving conflicts between residency rules. Nearly all treaties have at least skeletal mechanisms for resolving disputes, generally negotiated between the “competent authority” section of each country’s taxing authority.
Anti-deferral measures Residency systems may provide that residents are not subject to tax on income outside the jurisdiction until that income is remitted to the jurisdiction.[48] Taxpayers in such systems have significant incentives to shift income offshore. Depending on the rules of the system, the shifting may occur by changing the location of activities generating income or by shifting income to separate enterprises owned by the taxpayer. Most residency systems have avoided rules which permit deferring offshore income without shifting it to a subsidiary enterprise due to the potential for manipulation of such rules. Where owners of an enterprise are taxed separately from the enterprise, portable income may be shifted from a taxpayer to a subsidiary enterprise to accomplish deferral or elimination of tax. Such systems tend to have rules to limit such deferral through controlled foreign corporations. Several different approaches have been used by countries for their anti-deferral rules.[49] In the United States, rules provides that U.S. shareholders of a Controlled Foreign Corporation (CFC) must include their shares of income or investment of E&P by the CFC in U.S. property.[50] U.S. shareholders are U.S. persons owning 10% or more (after the application of complex attribution of ownership rules) of a foreign corporation. Such persons may include individuals, corporations, partnerships, trusts, estates, and other juridical persons. A CFC is a foreign corporation more than 50% owned by U.S. shareholders. This income includes several categories of portable income, including most investment income, certain resale income, and certain services income. Certain exceptions apply, including the exclusion from Subpart F income of CFC income subject to an effective foreign tax rate of 90% or more of the top U.S. tax rate.[50] The United Kingdom provides that a UK company is taxed currently on the income of its controlled subsidiary companies managed and controlled outside the UK which are subject to “low” foreign taxes.[51] Low tax is determined as actual tax of less than three-fourths of the corresponding UK tax that would be due on the income determined under UK principles. Complexities arise in computing the corresponding UK tax. Further, there are International taxation 7
certain exceptions which may permit deferral, including a “white list” of permitted countries and a 90% earnings distribution policy of the controlled company. Further, anti-deferral does not apply where there is no tax avoidance motive.[52] Rules in Germany provide that a German individual or company shareholder of a foreign corporation may be subject to current German tax on certain passive income earned by the foreign corporation. This provision applies if the foreign corporation is taxed at less than 25% of the passive income, as defined. Japan and some other countries have followed a “black list” approach, where income of subsidiaries in countries identified as tax havens is subject to current tax to the shareholder. Sweden has adopted a “white list” of countries in which subsidiaries may be organized so that the shareholder is not subject to current tax.
Transfer pricing The setting of the amount of related party charges is commonly referred to as transfer pricing. Many jurisdictions have become sensitive to the potential for shifting profits with transfer pricing, and have adopted rules regulating setting or testing of prices or allowance of deductions or inclusion of income for related party transactions. Many jurisdictions have adopted broadly similar transfer pricing rules. The OECD has adopted (subject to specific country reservations) fairly comprehensive guidelines.[53] These guidelines have been adopted with little modification by many countries.[54] Notably, the U.S. and Canada have adopted rules which depart in some material respects from OECD guidelines, generally by providing more detailed rules. Arm's length principle: a key concept of most transfer pricing rules is that prices charged between related enterprises should be those which would be charged between unrelated parties dealing at arm’s length. Most sets of rules prescribe methods for testing whether prices charged should be considered to meet this standard. Such rules generally involve comparison of related party transactions to similar transactions of unrelated parties (comparable prices or transactions). Various surrogates for such transactions may be allowed. Most guidelines allow the following methods for testing prices: Comparable uncontrolled transaction prices, resale prices based on comparable markups, cost plus a markup, and an enterprise profitability method.
See also • Public finance • Tax rates around the world • Tax equalization • Tax treaty
References & Further reading • Thruonyi, Viktor, Comparative Tax Law, Aspen Publishers (2003) • Lymer, Andrew and Hasseldine, John, eds., The International Taxation System, Kluwer Academic Publishers (2002) • Kuntz, Joel D. and Peroni, Robert J.; U.S. International Taxation • International Bureau of Fiscal Documentation offers subscription services detailing taxation systems of most countries, as well as comprehensive tax treaties, in multiple languages. Also available and searchable by subscription through Thomson subsidiaries. • CCH offers shorter descriptions for fewer countries (at a lower fee) as well as certain computational tools. • At least six international accounting firms (BDO, Deloitte, Ernst & Young, Grant Thornton, KPMG, and PriceWaterhouseCoopers) and several law firms have individual country and multi-country guides available, often to non-clients. See the in-country web sites for each for contact information. International taxation 8
External links • Hong Kong IRD [55] • India Income Tax Department [56] • UK HM Revenue & Customs [57] (formerly Inland Revenue) • UK International Manual [58] (non-technical guidance) • U.S. law by code section [59] • U.S. regs [60] • USTC post-94 decisions [61] • USSC cases 1937-1975 [62]
References [1] E.g., the U.S. taxes corporations on their income and their shareholders on dividends distributed from the corporation. See U.S. IRC sections 11, 1, and 61.
[2] U.S. Internal Revenue Service (U.S. IRS) Reg. (hereafter 26 CFR) §§301.7701-2 and -3 (http:/ / www. access. gpo. gov/ nara/ cfr/
waisidx_08/ 26cfr301_08. html).
[3] E.g., exclusion of foreign earned income of individuals by the United States of America (USA), 26 USC 911 (http:/ / www. law. cornell. edu/
uscode/ html/ uscode26/ usc_sec_26_00000911----000-. html) (hereafter U.S. IRC section …) [4] (UK citation needed)
[5] E.g., 26 USC 897 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000897----000-. html).
[6] “ A Brief Guide to Taxes Administered by the Inland Revenue Department 2007 – 2008 (http:/ / www. ird. gov. hk/ eng/ pdf/ tax_guide_e. pdf)”, Inland Revenue Department, The Government Of The Hong Kong Special Administrative Region, page 1.
[7] See, e.g., “ Tax Information for Visitors to the United States (http:/ / www. irs. gov/ pub/ irs-pdf/ p513. pdf)”, Publication 513 (annual), Internal Revenue Service, U.S. Department of Treasury, page 2.
[8] See, e.g., “ Residents and non-residents (http:/ / www. hmrc. gov. uk/ pdfs/ ir20. pdf)”, IR20, Inland Revenue, HMRC, page 6 et seq. [9] Switzerland requires a work permit to be employed in Switzerland. A person working in Switzerland for more than 30 days may be a resident.
See http:/ / www. taxation. ch/ index. cfm/ fuseaction/ show/ temp/ default/ path/ 1-534. htm
[10] The rules have changed over the years. For a good explanation of the 2006 changes by a major UK law firm, see http:/ / www. freshfields.
com/ publications/ pdfs/ 2006/ corp-tax-reform. pdf.
[11] “ Tax Guide for U.S. Citizens and Resident Aliens Abroad (http:/ / www. irs. gov/ publications/ p54/ index. html)”, Publication 54 (annual), Internal Revenue Service, U.S. Department of Treasury
[12] See, e.g., example of mixed source salary income at http:/ / www. hmrc. gov. uk/ manuals/ senew/ SE40222. htm.
[13] “ What is Taxable Income (http:/ / www. iras. gov. sg/ irasHome/ page03. aspx?id=440)”, Internal Revenue Authority of Singapore [14] The U.S. taxes businesses generally at rates from 15% to 35%. However, the graduated rates for individuals are different than for
corporations. United States Code Title 26 sections 1 and 11, hereafter 26 USC 1 and 11 (http:/ / www. law. cornell. edu/ uscode/ html/
uscode26/ usc_sup_01_26_10_A_20_1_30_A. html)
[15] E.g., 26 USC 701 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000701----000-. html), et seq.
[16] "www.gov.hk/en/residents/taxes/salaries/salariestax/exemption/employee.htm" (http:/ / www. gov. hk/ en/ residents/ taxes/ salaries/
salariestax/ exemption/ employee. htm). .
[17] Supra. 26 USC 861(a)(3) (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000861----000-. html) [18] 26 USC 861(a)(1) and (2) and 862(a)(1) and (2), supra. (other example citations needed) [19] U.S. IRC sections 861(a)(4) and 862(a)(4), supra. (other example citations needed) [20] 26 USC 861(a)(6) and 862(a)(6), supra.)
[21] 26 USC 863(b) (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000863----000-. html).
[22] 26 USC 865(a) (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000865----000-. html). (other examples needed) [23] See, e.g., Pierre Boulez, , in which a U.S. court determined that income received by a performer relating sale of recordings of a musical performance was sourced to where such recordings were purchased by consumers.
[24] See, e.g., India’s rules (http:/ / law. incometaxindia. gov. in/ TaxmannDit/ DispCitation/ ShowCit. aspx?fn=http:/ / law. incometaxindia. gov.
in/ DitTaxmann/ IncomeTaxActs/ 2008ITAct/ section91. htm) [25] (example citations needed) [26] The U.S. and many of its states define taxable income independently of financial statement income, but require reconciliation of the two.
See, e.g., California Revenue and Taxation Code sections 17071 (http:/ / www. leginfo. ca. gov/ cgi-bin/ displaycode?section=rtc&
group=17001-18000& file=17071-17078) et seq.
[27] "www.cra-arc.gc.ca/E/pbg/tf/t2sch1/t2sch1-08e.pdf" (http:/ / www. cra-arc. gc. ca/ E/ pbg/ tf/ t2sch1/ t2sch1-08e. pdf) (PDF). .
[28] "Auditors - GBA4" (http:/ / www. companieshouse. gov. uk/ about/ gbhtml/ gba4. shtml#c1q1). . [29] (citation needed for India) International taxation 9
[30] U.S. IRS Form 1120 Schedule M-3 (http:/ / www. irs. gov/ pub/ irs-pdf/ f1120sm3. pdf); Canadian CRA Form T-2 Schedule 1 (http:/ /
www. cra-arc. gc. ca/ E/ pbg/ tf/ t2sch1/ t2sch1-08e. pdf)
[31] U.S. regulations under 26 CFR 1.861-8 (http:/ / edocket. access. gpo. gov/ cfr_2008/ aprqtr/ 26cfr1. 861-8. htm), et seq. at (hereafter U.S. regulations §) [32] Contrast to "integrated" systems providing a credit to enterprise owners for a portion of enterprise level taxation.(citation needed)
[33] 26 USC 163(j) (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000163----000-. html) and long proposed regulations thereunder [34] (UK or Germany citation needed)
[35] 26 USC 351 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000351----000-. html).
[36] E.g., Egypt limits (http:/ / www. mof. gov. eg/ NR/ rdonlyres/ 6CA93BFB-B974-497C-98C9-F57C3CD146CE/ 0/ IncomeTaxLaw. pdf) the credit to the Egyptian income tax “that may have been payable with respect to profits from works performed abroad,” but without a thorough definition of terms. Article (54).
[37] U.S. rules limit the credit by categories based on the nature of the income. 26 USC 904 (http:/ / www. law. cornell. edu/ uscode/ html/
uscode26/ usc_sec_26_00000904----000-. html). For 20 years prior to changes first effective in 2007, there were at least nine such categories. These included, e.g., financial services income, high-taxed income, other passive income, and other (operating or general) income. UK rules provide for separate limitations based on the schedule of income on which UK tax is computed. Thus, credits were separately limited for salaries versus dividends and interest. [38] E.g., under U.S. rules, the credit is limited to U.S. tax on foreign source taxable income for a particular category. The rules for determining
source for taxation of foreign persons ( sections 861-865 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/
usc_sup_01_26_10_A_20_1_30_N_40_I. html)) apply in computing such credit, and detailed rules are provided in regulations (above) for allocating and apportioning expenses to such income. [39] Materials from one major accounting firm provide a table of over sixty such countries. Such table is not comprehensive. [40] E.g., Australia imposes a 10% withholding tax rate on interest, subject to treaty reduction. [41] E.g., Thailand taxes dividends at 10% and interest at 15%. [42] E.g., Italy taxes dividends paid to nonresidents having voting rights in the company paying the dividends at 27% but taxes dividends paid to nonresidents not having such rights at 12.5%.
[43] See, e.g., 26 USC 871 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000871----000-. html), 881 (http:/ / www.
law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000881----000-. html), and .
[44] "History of the U.S. Tax System" (http:/ / www. ustreas. gov/ education/ fact-sheets/ taxes/ ustax. shtml). U.S. Department of Treasury. . Retrieved 2006-10-31.
[45] Christians, Allison (April 2005). "Tax Treaties for Investment and Aid to Sub-Saharan Africa: A Case Study" (http:/ / papers. ssrn. com/
sol3/ papers. cfm?abstract_id=705541). Northwestern Public Law Research Paper No. 05-10; Northwestern Law & Econ Research Paper No. 05-15. .
[46] "Model Tax Convention on Income and on Capital" (http:/ / www. oecd. org/ dataoecd/ 14/ 32/ 41147804. pdf). OECD. 2008-07. . Retrieved 2009-06-26. [47] Permanent establishment is defined under most treaties using language identical to the OECD model. Generally, a permanent establishment is any fixed place of business, including an office, warehouse, etc. [48] See, for example, Singapore’s provision that offshore income is not taxed until brought onshore. [49] Anti-deferral and other shifting measures have also been combatted by granting broad powers to revenue authorities under "general
anti-avoidance" provisions. See a discussion of Canadian GAAR a CTF article (http:/ / www. ctf. ca/ pdf/ 04ctjpdf/ 04ctj2-arnold. pdf).
[50] Subpart F ( sections 951-964 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sup_01_26_10_A_20_1_30_N_40_III_50_F. html)) [51] Part XVII of Chapter IV ICTA 1988
[52] http:/ / www. hmrc. gov. uk/ manuals/ intmanual/ INTM200000. htm
[53] "Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations" (http:/ / www. oecdbookshop. org/ oecd/ display.
asp?sf1=identifiers& st1=232001041P1). .
[54] E.g., UK ICTA Section 28AA and guidelines thereunder (http:/ / www. hmrc. gov. uk/ manuals/ intmanual/ INTM430000. htm)
[55] http:/ / www. ird. gov. hk/ eng/ welcome. htm
[56] http:/ / www. incometaxindia. gov. in/
[57] http:/ / www. hmrc. gov. uk/ index. htm
[58] http:/ / www. hmrc. gov. uk/ manuals/ intmanual/ Index. htm
[59] http:/ / frwebgate. access. gpo. gov/ cgi-bin/ usc. cgi?ACTION=BROWSE& TITLE=26USCSA
[60] http:/ / www. access. gpo. gov/ cgi-bin/ cfrassemble. cgi?title=200826
[61] http:/ / www. ustaxcourt. gov/ UstcInOp/ asp/ HistoricOptions. asp
[62] http:/ / www. gpoaccess. gov/ supcrt/ Double taxation 10 Double taxation
Double taxation is the imposition of two or more taxes on the same income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). It refers to two distinct situations: • taxation by two or more countries of the same income, asset or transaction, for example income paid by an entity of one country to a resident of a different country. The double liability is often mitigated by tax treaties between countries. • in the United States, the term is used by tax abolitionists as an assertion that taxes have already been paid, such as for dividend income, inheritance, and gifts.
International double taxation agreements It is not unusual for a business or individual who is resident in one country to make a taxable gain (earnings, profits) in another. This person may find that he is obliged by domestic laws to pay tax on that gain locally and pay again in the country in which the gain was made. Since this is inequitable, many nations make bilateral double taxation agreements with each other. In some cases, this requires that tax be paid in the country of residence and be exempt in the country in which it arises. In the remaining cases, the country where the gain arises deducts taxation at source ("withholding tax") and the taxpayer receives a compensating foreign tax credit in the country of residence to reflect the fact that tax has already been paid. To do this, the taxpayer must declare himself (in the foreign country) to be non-resident there. So the second aspect of the agreement is that the two taxation authorities exchange information about such declarations, and so may investigate any anomalies that might indicate tax evasion.
European Union savings taxation In the European Union, member states have concluded a multilateral agreement on information exchange.[1] This means that they will each report (to their counterparts in each other jurisdiction) a list of those savers who have claimed exemption from local taxation on grounds of not being a resident of the state where the income arises. These savers should have declared that foreign income in their own country of residence, so any difference suggests tax evasion. (For a transition period, some states have a separate arrangement.[2] They may offer each non-resident account holder the choice of taxation arrangements: either (a) disclosure of information as above, or (b) deduction of local tax on savings interest at source as is the case for residents).
Cyprus double tax treaties Cyprus has concluded 34 double tax treaties which apply to 40 countries. The main purpose of these treaties is the avoidance of double taxation on income earned in any of these countries. Under these agreements, a credit is usually allowed against the tax levied by the country in which the taxpayer resides for taxes levied in the other treaty country and as a result the tax payer pays no more than the higher of the two rates. Further, some treaties provide for tax sparing credits whereby the tax credit allowed is not only with respect to tax actually paid in the other treaty country but also from tax which would have been otherwise payable had it not been for incentive measures in that other country which result in exemption or reduction of tax.[3] Double taxation 11
German taxation avoidance If a foreign citizen is in Germany for less than a relevant 183-day period (approximately six months) and is tax resident (i.e., and paying taxes on his or her salary and benefits) elsewhere, then it may be possible to claim tax relief under a particular Double Tax Treaty. The relevant 183 day period is either 183 days in a calendar year or in any period of 12 months, depending upon the particular treaty involved. The Double Tax Treaty with the UK, for example, looks at a period of 183 days in the German tax year (which is the same as the calendar year). So, for example, a worker could work in Germany from 1 September through to the following 30 May, a total of 10 months, whilst being tax resident in Germany and could claim to be exempt from German tax under a Double Tax Treaty. This is assuming that during this period the worker was tax resident in another country and paying taxes on salary and benefits there.
Double taxation avoidance agreement signed By India India has comprehensive Double Taxation Avoidance Agreements (DTAA ) with 79 countries. This means that there are agreed rates of tax and jurisdiction on specified types of income arising in a country to a tax resident of another country. Under the Income Tax Act 1961 of India, there are two provisions, Section 90 and Section 91, which provide specific relief to taxpayers to save them from DTAA. Section 90 is for taxpayers who have paid the tax to a country with which India has signed DTAA, while Section 91 provides relief to tax payers who have paid tax to a country with which India has not signed a DTAA. Thus, India gives relief to both kind of taxpayers. A large number of foreign institutional investors who trade on the Indian stock markets operate from Mauritius. According to the tax treaty between India and Mauritius, capital gains arising from the sale of shares are taxable in the country of residence of the shareholder and not in the country of residence of the company whose shares have been sold. Therefore, a company resident in Mauritius selling shares of an Indian company will not pay tax in India. Since there is no capital gains tax in Mauritius, the gain will escape tax altogether. The Indian and Cypriot tax treaty is the only other such Indian treaty to provide for the same beneficial treatment of capital gains. It must be noted that India has and is making attempts to revise both the Mauritius and Cyprus tax treaties to eliminate this favourable treatment of capital gains tax.
U.S. citizens and resident aliens abroad The U.S. requires its citizens to file tax returns reporting their earnings wherever they reside. However, there are some measures designed to reduce the international double taxation that results from this requirement.[4] First, an individual who is a bona fide resident of a foreign country or is physically outside the United States for an extended time is entitled to an exclusion (exemption) of part or all of their earned income (i.e. personal service income, as distinguished from income from capital or investments.) That exemption is $91,400 for 2009, pro-rated.[4] (See IRS form 2555.) Second, the United States allows a foreign tax credit by which income taxes paid to foreign countries can be offset against U.S. income tax liability attributable to foreign income. This can be a complex issue that often requires the services of a tax advisor. The foreign tax credit is not allowed for taxes paid on earned income that is excluded under the rules described in the preceding paragraph (i.e. no double dipping).[4] Double taxation 12
Double taxation within the United States Double taxation can also happen within a single country. This typically happens when subnational jurisdictions have taxation powers, and jurisdictions have competing claims. In the United States a person may legally have only a single domicile. However, when a person dies different states may each claim that the person was domiciled in that state. Intangible personal property may then be taxed by each state making a claim. In the absence of specific laws prohibiting multiple taxation, and as long as the total of taxes do not exceed the 100% of the value of the tangible personal property, the courts will allow such multiple taxation.
See also • Tax equalization • Tax treaty
External links • IRS Publication 54: Tax Guide for U.S. Citizens and Resident Aliens Abroad [5] • US Tax Planning: Foreign Earned Income Exclusion [6]
References
[1] Council Directive 2003/48/EC of 3 June 2003 on taxation of savings income in the form of interest payments (http:/ / eur-lex. europa. eu/
LexUriServ/ LexUriServ. do?uri=CELEX:32003L0048:EN:HTML) [2] See (17) and (18) of above, for a "temporary" period, Austria, Belgium and Luxembourg may apply a withholding tax to non-resident accounts rather than exchange information.
[3] Osys Global Corporate Consultants Official Website (http:/ / www. osysglobal. com/ company_registration. html)
[4] IRS Publication 54: Tax Guide for U.S. Citizens and Resident Aliens Abroad (http:/ / www. irs. gov/ publications/ p54/ index. html)
[5] http:/ / www. irs. gov/ publications/ p54/ index. html
[6] http:/ / taxes. about. com/ od/ taxhelp/ a/ ForeignIncome. htm Transfer pricing 13 Transfer pricing
Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges made between related parties for good, services, or use of property (including intangible property). Transfer prices among components of an enterprise may be used to reflect allocation of resources among such components, or for other purposes. OECD Transfer Pricing Guidelines [1] state, “Transfer prices are significant for both taxpayers and tax administrations because they determine in large part the income and expenses, and therefore taxable profits, of associated enterprises in different tax jurisdictions.” Many governments have adopted transfer pricing rules that apply in determining or adjusting income taxes of domestic and multinational taxpayers. The OECD has adopted guidelines followed, in whole or in part, by many of its member countries in adopting rules. United States and Canadian rules are similar in many respects to OECD guidelines, with certain points of material difference. A few countries follow rules that are materially different overall. The rules of nearly all countries permit related parties to set prices in any manner, but permit the tax authorities to adjust those prices where the prices charged are outside an arm's length range. Rules are generally provided for determining what constitutes such arm's length prices, and how any analysis should proceed. Prices actually charged are compared to prices or measures of profitability for unrelated transactions and parties. The rules generally require that market level, functions, risks, and terms of sale of unrelated party transactions or activities be reasonably comparable to such items with respect to the related party transactions or profitability being tested. Most systems allow use of multiple methods, where appropriate and supported by reliable data, to test related party prices. Among the commonly used methods are comparable uncontrolled prices, cost plus, resale price or markup, and profitability based methods. Many systems differentiate methods of testing goods from those for services or use of property due to inherent differences in business aspects of such broad types of transactions. Some systems provide mechanisms for sharing or allocation of costs of acquiring assets (including intangible assets) among related parties in a manner designed to reduce tax controversy. Most tax treaties and many tax systems provide mechanisms for resolving disputes among taxpayers and governments in a manner designed to reduce the potential for double taxation. Many systems also permit advance agreement between taxpayers and one or more governments regarding mechanisms for setting related party prices. Many systems impose penalties where the tax authority has adjusted related party prices. Some tax systems provide that taxpayers may avoid such penalties by preparing documentation in advance regarding prices charged between the taxpayer and related parties. Some systems require that such documentation be prepared in advance in all cases. Transfer pricing 14
Economic theory
The discussion in this section explains an economic theory behind optimal transfer pricing with optimal defined as transfer pricing that maximizes overall firm profits in a non-realistic world with no taxes, no capital risk, no development risk, no externalities or any other frictions which exist in the real world. In practice a great many factors influence the transfer prices that are used by multinational corporations, including performance measurement, capabilities of accounting systems, import quotas, customs duties, VAT, taxes on profits, and (in many cases) simple lack of attention to the pricing.
From marginal price determination theory, Transfer Pricing with No External Market the optimum level of output is that where marginal cost equals marginal revenue. That is to say, a firm should expand its output as long as the marginal revenue from additional sales is greater than their marginal costs. In the diagram that follows, this intersection is represented by point A, which will yield a price of P*, given the demand at point B. When a firm is selling some of its product to itself, and only to itself (i.e. there is no external market for that particular transfer good), then the picture gets more complicated, but the outcome remains the same. The demand curve remains the same. The optimum price and quantity remain the same. But marginal cost of production can be separated from the firm's total marginal costs. Likewise, the marginal revenue associated with the production division can be separated from the marginal revenue for the total firm. This is referred to as the Net Marginal Revenue in production (NMR) and is calculated as the marginal revenue from the firm minus the marginal costs of distribution. Transfer pricing 15
It can be shown algebraically that the intersection of the firm's marginal cost curve and marginal revenue curve (point A) must occur at the same quantity as the intersection of the production division's marginal cost curve with the net marginal revenue from production (point C). If the production division is able to sell the transfer good in a competitive market (as well as internally), then again both must operate where their marginal costs equal their marginal revenue, for profit maximization. Because the external market is competitive, the firm is a price taker and must accept the transfer price determined by market forces (their marginal revenue from Transfer Pricing with a Competitive External Market transfer and demand for transfer products becomes the transfer price). If the market price is relatively high (as in Ptr1 in the next diagram), then the firm will experience an internal surplus (excess internal supply) equal to the amount Qt1 minus Qf1. The actual marginal cost curve is defined by points A,C,D. If the firm is able to sell its transfer goods in an imperfect market, then it need not be a price taker. There are two markets each with its own price (Pf and Pt in the next diagram). The aggregate market is constructed from the first two. That is, point C is a horizontal summation of points A and B (and likewise for all other points on the Net Marginal Revenue curve (NMRa)). The total optimum quantity (Q) is the sum of Qf plus Qt.
General tax principles
Commonly controlled taxpayers often determine prices charged between such taxpayers based in part on the tax effects, seeking to reduce overall taxation of the group. OECD Guidelines state, at 1.2, “When Transfer Pricing with an Imperfect External Market independent enterprises deal with each other, the conditions of their commercial and financial relations (e.g., the price of goods transferred or services provided and the conditions of the transfer or provision) ordinarily are determined by market forces. When associated enterprises deal with each other, their commercial and financial relations may not be directly affected by external market forces in the same way.” Recognizing this, most national and some sub-national income tax authorities have the legal authority to adjust prices charged between related parties. Tax rules generally permit related parties to set prices in any manner they choose, but permit adjustment where such prices or their effects are outside guidelines.[2]
Transfer pricing rules vary by country. Most countries have an appeals process whereby a taxpayer may contest such adjustments. Some jurisdictions, including Canada and the United States [3], require extensive reporting of transactions and prices, and India requires third party certification of compliance with transfer pricing rules. Transfer pricing 16
History Transfer pricing adjustments have been a feature of many tax systems since the 1930s. Both the U.S. and the Organization for Economic Cooperation and Development (OECD, of which the U.S. and most major industrial countries are members) had some guidelines by 1979. The United States led the development of detailed, comprehensive transfer pricing guidelines with a White Paper [4] in 1988 and proposals in 1990-1992, which ultimately became regulations in 1994.[5] In 1995, the OECD issued the first draft of current guidelines, which it expanded in 1996 and 1996.[6] The two sets of guidelines are broadly similar and contain certain principles followed by many countries. The OECD guidelines have been formally adopted by many European Union countries with little or no modification. The OECD[7] and U.S.[8] systems provide that prices may be set by the component members of an enterprise in any manner, but may be adjusted to conform to an arm's length standard. Each system provides for several approved methods of testing prices, and allows the government to adjust prices to the mid-point of an arm's length range. Both systems provide for standards for comparing third party transactions or other measures to tested prices, based on comparability and reliability criteria. Significant exceptions are noted below.
Government authority to adjust prices Most governments have granted authorization to their tax authorities to adjust prices charged between related parties.[9] Many such authorizations, including those of the United States, United Kingdom, Canada, and Germany, allow domestic as well as international adjustments. Some authorizations apply only internationally. Most, if not all, governments permit adjustments by the tax authority even where there is no intent to avoid or evade tax.[10] Adjustment of prices is generally made by adjusting taxable income of all involved related parties within the jurisdiction, as well as adjusting any withholding or other taxes imposed on parties outside the jurisdiction. Such adjustments generally are made after filing of tax returns. For example, if Bigco US charges Bigco Germany for a machine, either the U.S. or German tax authorities may adjust the price upon examination of the respective tax return. Following an adjustment, the taxpayer generally is allowed (at least by the adjusting government) to make payments to reflect the adjusted prices. Most rules require that the tax authorities consider actual transactions between parties, and permit adjustment only to actual transactions.[11] Multiple transactions may be aggregated or tested separately, and testing may use multiple year data. In addition, transactions whose economic substance differs materially from their form may be recharacterized under the laws of many systems to follow the economic substance.
Arm's length standard Nearly all systems require that prices be tested using an "arm's length" standard.[12] Under this approach, a price is considered appropriate if it is within a range of prices that would be charged by independent parties dealing at arm's length. This is generally defined as a price that an independent buyer would pay an independent seller for an identical item under identical terms and conditions, where neither is under any compulsion to act. There are clear practical difficulties in implementing the arm's length standard. For items other than goods, there are rarely identical items. Terms of sale may vary from transaction to transaction. Market and other conditions may vary geographically or over time. Some systems give a preference to certain transactional methods over other methods for testing prices. In addition, most systems recognize that an arm's length price may not be a particular price point but rather a range of prices. Some systems provide measures for evaluating whether a price within such range is considered arm's length, such as the interquartile range used in U.S. regulations. Significant deviation among points in the range may indicate lack of reliability of data.[13] Reliability is generally considered to be improved by use of multiple year data.[14] Transfer pricing 17
Comparability Most rules provide standards for when unrelated party prices, transactions, profitability or other items are considered sufficiently comparable in testing related party items.[15] Such standards typically require that data used in comparisons be reliable and that the means used to compare produce a reliable result. The U.S. and OECD rules require that reliable adjustments must be made for all differences (if any) between related party items and purported comparables that could materially affect the condition being examined.[16] Where such reliable adjustments cannot be made, the reliability of the comparison is in doubt. Comparability of tested prices with uncontrolled prices is generally considered enhanced by use of multiple data. Transactions not undertaken in the ordinary course of business generally are not considered to be comparable to those taken in the ordinary course of business. Among the factors that must be considered in determining comparability are:[17] • the nature of the property or services provided between the parties, • functional analysis of the transactions and parties, • comparison of contractual terms (whether written, verbal, or implied from conduct of the parties),and • comparison of significant economic conditions that could affect prices, including the effects of different market levels and geographic markets.
Nature of property or services Comparability is best achieved where identical items are compared. However, in some cases it is possible to make reliable adjustments for differences in the particular items, such as differences in features or quality.[18] For example, gold prices might be adjusted based on the weight of the actual gold (one ounce of 10 carat gold would be half the price of one ounce of 20 carat gold).
Functions and risks Buyers and sellers may perform different functions related to the exchange and undertake different risks. For example, a seller of a machine may or may not provide a warranty. The price a buyer would pay will be affected by this difference. Among the functions and risks that may impact prices are:[19] • Product development • Manufacturing and assembly • Marketing and advertising • Transportation and warehousing • Credit risk • Product obsolescence risk • Market and entrepreneurial risks • Collection risk • Financial and currency risks • Company- or industry-specific items
Terms of sale Manner and terms of sale may have a material impact on price.[20] For example, buyers will pay more if they can defer payment and buy in smaller quantities. Terms that may impact price include payment timing, warranty, volume discounts, duration of rights to use of the product, form of consideration, etc.
Market level, economic conditions and geography Goods, services, or property may be provided to different levels of buyers or users: producer to wholesaler, wholesaler to wholesaler, wholesaler to retailer, or for ultimate consumption. Market conditions, and thus prices, vary greatly at these levels. In addition, prices may vary greatly between different economies or geographies. For example, a head of cauliflower at a retail market will command a vastly different price in unelectrified rural India Transfer pricing 18
than in Tokyo. Buyers or sellers may have different market shares that allow them to achieve volume discounts or exert sufficient pressure on the other party to lower prices. Where prices are to be compared, the putative comparables must be at the same market level, within the same or similar economic and geographic environments, and under the same or similar conditions.[21]
Types of transactions Most systems provide variations of the basic rules for characteristics unique to particular types of transactions. The potentially tested transactions include: • Sale of goods. Identical or nearly identical goods may be available. Product-related differences are often covered by patents.[22] • Provision of services.[23] Identical services, other than routine services, often do not exist. • License of intangibles.[24] The basic nature precludes a claim that another product is identical. However, licenses may be granted to independent licensees for the same product in different markets. • Use of money.[25] Comparable interest rates may be readily available. Some systems provide safe haven rates based on published indices. • Use of tangible property.[26] Independent comparables may or may not exist, but reliable data may not be available.
Testing of prices Tax authorities generally examine prices actually charged between related parties to determine whether adjustments are appropriate. Such examination is by comparison (testing) of such prices to comparable prices charged among unrelated parties. Such testing may occur only on examination of tax returns by the tax authority, or taxpayers may be required to conduct such testing themselves in advance or filing tax returns. Such testing requires a determination of how the testing must be conducted, referred to as a transfer pricing method.[27]
Best method rule Some systems give preference to a specific method of testing prices. OECD and U.S. systems, however, provide that the method used to test the appropriateness of related party prices should be that method that produces the most reliable measure of arm's length results.[28] This is often known as a "best method" rule. Under this approach, the system may require that more than one testing method be considered. Factors to be considered include comparability of tested and independent items, reliability of available data and assumptions under the method, and validation of the results of the method by other methods.
Comparable uncontrolled prices (CUP) Most systems consider a third party price for identical goods, services, or property under identical conditions, called a comparable uncontrolled price (CUP), to be the most reliable indicator of an arm's length price. All systems permit testing using this method.[29] Further, it may be possible to reliably adjust CUPs where the goods, services, or property are identical but the sales terms or other limited items are different. As an example, an interest adjustment could be applied where the only difference in sales transactions is time for payment (e.g., 30 days vs. 60 days). CUPs are based on actual transactions. For commodities, actual transactions of other parties may be reported in a reliable manner. For other items, "in-house" comparables, i.e., transactions of one of the controlled parties with third parties, may be the only available reliable data. Transfer pricing 19
Other transactional methods Among other methods relying on actual transactions (generally between one tested party and third parties) and not indices, aggregates, or market surveys are: • Cost plus (C+) method: goods or services provided to unrelated parties are consistently priced at actual cost plus a fixed markup. Testing is by comparison of the markup percentages.[30] • Resale price method (RPM): goods are regularly offered by a seller or purchased by a retailer to/from unrelated parties at a standard "list" price less a fixed discount. Testing is by comparison of the discount percentages.[31] • Gross margin method: similar to resale price method, recognized in a few systems.
Profitability methods Some methods of testing prices do not rely on actual transactions. Use of these methods may be necessary due to the lack of reliable data for transactional methods. In some cases, non-transactional methods may be more reliable than transactional methods because market and economic adjustments to transactions may not be reliable. These methods may include: • Comparable profits method (CPM): profit levels of similarly situated companies in similarly industries may be compared to an appropriate tested party.[32] See U.S. rules below. • Transactional net margin method (TNMM): while called a transactional method, the testing is based on profitability of similar businesses. See OECD guidelines below.[33] • Profit split method: total enterprise profits are split in a formulary manner based on econometric analyses.[34] CPM and TNMM have a practical advantage in ease of implementation. Both methods rely on microeconomic analysis of data rather than specific transactions. These methods are discussed further with respect to the U.S. and OECD systems. Two methods are often provided for splitting profits:[35] comparable profit split[36] and residual profit split.[37] The former requires that profit split be derived from the combined operating profit of uncontrolled taxpayers whose transactions and activities are comparable to the transactions and activities being tested. The residual profit split method requires a two step process: first profits are allocated to routine operations, then the residual profit is allocated based on nonroutine contributions of the parties. The residual allocation may be based on external market benchmarks or estimation based on capitalized costs.
Tested party & profit level indicator Where testing of prices occurs on other than a purely transactional basis, such as CPM or TNMM, it may be necessary to determine which of the two related parties should be tested.[38] Testing is to be done of that party testing of which will produce the most reliable results. Generally, this means that the tested party is that party with the most easily compared functions and risks. Comparing the tested party's results to those of comparable parties may require adjustments to results of the tested party or the comparables for such items as levels of inventory or receivables. Testing requires determination of what indication of profitability should be used.[39] This may be net profit on the transaction, return on assets employed, or some other measure. Reliability is generally improved for TNMM and CPM by using a range of results and multiple year data.[40]
Intangible property issues Valuable intangible property tends to be unique. Often there are no comparable items. The value added by use of intangibles may be represented in prices of goods or services, or by payment of fees (royalties) for use of the intangible property. Licensing of intangibles thus presents difficulties in identifying comparable items for testing.[41] However, where the same property is licensed to independent parties, such license may provide comparable transactional prices. The profit split method specifically attempts to take value of intangibles into account. Transfer pricing 20
Services Enterprises may engage related or unrelated parties to provide services they need. Where the required services are available within a multinational group, there may be significant advantages to the enterprise as a whole for components of the group to perform those services. Two issues exist with respect to charges between related parties for services: whether services were actually performed which warrant payment,[42] and the price charged for such services.[43] Tax authorities in most major countries have, either formally or in practice, incorporated these queries into their examination of related party services transactions. There may be tax advantages obtained for the group if one member charges another member for services, even where the member bearing the charge derives no benefit. To combat this, the rules of most systems allow the tax authorities to challenge whether the services allegedly performed actually benefit the member charged. The inquiry may focus on whether services were indeed performed as well as who benefited from the services.[44] For this purpose, some rules differentiate stewardship services from other services. Stewardship services are generally those that an investor would incur for its own benefit in managing its investments. Charges to the investee for such services are generally inappropriate. Where services were not performed or where the related party bearing the charge derived no direct benefit, tax authorities may disallow the charge altogether. Where the services were performed and provided benefit for the related party bearing a charge for such services, tax rules also permit adjustment to the price charged.[45] Rules for testing prices of services may differ somewhat from rules for testing prices charged for goods due to the inherent differences between provision of services and sale of goods. The OECD Guidelines provide that the provisions relating to goods should be applied with minor modifications and additional considerations. In the U.S., a different set of price testing methods is provided for services. In both cases, standards of comparability and other matters apply to both goods and services. It is common for enterprises to perform services for themselves (or for their components) that support their primary business. Examples include accounting, legal, and computer services for those enterprises not engaged in the business of providing such services.[46] Transfer pricing rules recognize that it may be inappropriate for a component of an enterprise performing such services for another component to earn a profit on such services. Testing of prices charged in such case may be referred to a cost of services or services cost method.[47] Application of this method may be limited under the rules of certain countries, and is required in some countries.[48] Where services performed are of a nature performed by the enterprise (or the performing or receiving component) as a key aspect of its business, OECD and U.S. rules provide that some level of profit is appropriate to the service performing component.[49] Testing of prices in such cases generally follows one of the methods described above for goods. The cost plus method, in particular, may be favored by tax authorities and taxpayers due to ease of administration.
Cost sharing Multi-component enterprises may find significant business advantage to sharing the costs of developing or acquiring certain assets, particularly intangible assets. Detailed U.S. rules provide that members of a group may enter into a cost sharing agreement (CSA) with respect to costs and benefits from the development of intangible assets.[50] OECD Guidelines provide more generalized suggestions to tax authorities for enforcement related to cost contribution agreements (CCAs) with respect to acquisition of various types of assets.[51] Both sets of rules generally provide that costs should be allocated among members based on respective anticipated benefits. Inter-member charges should then be made so that each member bears only its share of such allocated costs. Since the allocations must inherently be made based on expectations of future events, the mechanism for allocation must provide for prospective adjustments where prior projections of events have proved incorrect. However, both sets of rules generally prohibit applying hindsight in making allocations.[52] A key requirement to limit adjustments related to costs of developing intangible assets is that there must be a written agreement in place among the members.[53] Tax rules may impose additional contractual, documentation, Transfer pricing 21
accounting, and reporting requirements on participants of a CSA or CCA, which vary by country. Generally, under a CSA or CCA, each participating member must be entitled to use of some portion rights developed pursuant to the agreement without further payments. Thus, a CCA participant should be entitled to use a process developed under the CCA without payment of royalties. Ownership of the rights need not be transferred to the participants. The division of rights is generally to be based on some observable measure, such as by geography.[54] Participants in CSAs and CCAs may contribute pre-existing assets or rights for use in the development of assets. Such contribution may be referred to as a platform contribution. Such contribution is generally considered a deemed payment by the contributing member, and is itself subject to transfer pricing rules or special CSA rules.[55] A key consideration in a CSA or CCA is what costs development or acquisition costs should be subject to the agreement. This may be specified under the agreement, but is also subject to adjustment by tax authorities.[56] In determining reasonably anticipated benefits, participants are forced to make projections of future events. Such projections are inherently uncertain. Further, there may exist uncertainty as to how such benefits should be measured. One manner of determining such anticipated benefits is to project respective sales or gross margins of participants, measured in a common currency, or sales in units.[57] Both sets of rules recognize that participants may enter or leave a CSA or CCA. Upon such events, the rules require that members make buy-in or buy-out payments. Such payments may be required to represent the market value of the existing state of development, or may be computed under cost recovery or market capitalization models.[58]
Penalties & documentation Some jurisdictions impose significant penalties relating to transfer pricing adjustments by tax authorities. These penalties may have thresholds for the basic imposition of penalty, and the penalty may be increased at other thresholds. For example, U.S. rules impose a 20% penalty where the adjustment exceeds USD 5 million, increased to 40% of the additional tax where the adjustment exceeds USD 20 million.[59] The rules of many countries require taxpayers to document that prices charged are within the prices permitted under the transfer pricing rules. Where such documentation is not timely prepared, penalties may be imposed, as above. Documentation may be required to be in place prior to filing a tax return in order to avoid these penalties.[60] Documentation by a taxpayer need not be relied upon by the tax authority in any jurisdiction permitting adjustment of prices. Some systems allow the tax authority to disregard information not timely provided by taxpayers, including such advance documentation. India requires that documentation not only be in place prior to filing a return, but also that the documentation be certified by the chartered accountant preparing a company return.
U.S. specific tax rules U.S. transfer pricing rules are lengthy,[61] They incorporate all of the principles above, using CPM (see below) instead of TNMM. U.S. rules specifically provide that a taxpayer's intent to avoid or evade tax is not a prerequisite to adjustment by the Internal Revenue Service, nor are nonrecognition provisions. The U.S. rules give no priority to any particular method of testing prices, requiring instead explicit analysis to determine the best method. U.S. comparability standards limit use of adjustments for business strategies in testing prices to clearly defined market share strategies, but permit limited consideration of location savings.
Comparable profits method The Comparable Profits method (CPM)[62] was introduced in the 1992 proposed regulations and has been a prominent feature of IRS transfer pricing practice since. Under CPM, the tested party's overall results, rather than its transactions, are compared with the overall results of similarly situated enterprises for whom reliable data is available. Comparisons are made for the profit level indicator that most reliably represents profitability for the type of business. For example, a sales company's profitability may be most reliably measured as a return on sales (pre-tax Transfer pricing 22
profit as a percent of sales). CPM inherently requires lower levels of comparability in the nature of the goods or services. Further, data used for CPM generally can be readily obtained in the U.S. and many countries through public filings of comparable enterprises. Results of the tested party or comparable enterprises may require adjustment to achieve comparability. Such adjustments may include effective interest adjustments for customer financing or debt levels, inventory adjustments, etc.
Cost plus and resale price issues U.S. rules apply resale price method and cost plus with respect to goods strictly on a transactional basis.[63] Thus, comparable transactions must be found for all tested transactions in order to apply these method. Industry averages or statistical measures are not permitted. Where a manufacturing entity provides contract manufacturing for both related and unrelated parties, it may readily have reliable data on comparable transactions. However, absent such in-house comparables, it is often difficult to obtain reliable data for applying cost plus. The rules on services expand cost plus, providing an additional option to mitigate these data problems.[64] Charges to related parties for services not in the primary business of either the tested party or the related party group are rebuttably presumed to be arm's length if priced at cost plus zero (the services cost method). Such services may include back-room operations (e.g., accounting and data processing services for groups not engaged in providing such services to clients), product testing, or a variety of such non-integral services. This method is not permitted for manufacturing, reselling, and certain other services that typically are integral to a business. U.S. rules also specifically permit shared services agreements.[65] Under such agreements, various group members may perform services which benefit more than one member. Prices charged are considered arm's length where the costs are allocated in a consistent manner among the members based on reasonably anticipated benefits. For instance, shared services costs may be allocated among members based on a formula involving expected or actual sales or a combination of factors.
Terms between parties Under U.S. rules, actual conduct of the parties is more important than contractual terms. Where the conduct of the parties differs from terms of the contract, the IRS has authority to deem the actual terms to be those needed to permit the actual conduct.[66]
Adjustments U.S. rules require that the IRS may not adjust prices found to be within the arm's length range.[67] Where prices charged are outside that range, prices may be adjusted by the IRS unilaterally to the midpoint of the range. The burden of proof that a transfer pricing adjustment by the IRS is incorrect is on the taxpayer unless the IRS adjustment is shown to be arbitrary and capricious. However, the courts have generally required that both taxpayers and the IRS to demonstrate their facts where agreement is not reached. Transfer pricing 23
Documentation and penalties If the IRS adjusts prices by more than $5 million or a percentage threshold, penalties apply. The penalty is 20% of the amount of the tax adjustment, increased to 40% at a higher threshold.[68] This penalty may be avoided only if the taxpayer maintains contemporaneous documentation meeting requirements in the regulations, and provides such documentation to the IRS within 30 days of IRS request.[69] If documentation is not provided at all, the IRS may make adjustments based on any information it has available. Contemporaneous means the documentation existed with 30 days of filing the taxpayer's tax return. Documentation requirements are quite specific, and generally require a best method analysis and detailed support for the pricing and methodology used for testing such pricing. To qualify, the documentation must reasonably support the prices used in computing tax.
Commensurate with income standard U.S. tax law requires that the foreign transferee/user of intangible property (patents, processes, trademarks, know-how, etc.) will be deemed to pay to a controlling transferor/developer a royalty commensurate with the income derived from using the intangible property.[70] This applies whether such royalty is actually paid or not. This requirement may result in withholding tax on deemed payments for use of intangible property in the U.S.
OECD specific tax rules OECD guidelines are voluntary for member nations. Some nations have adopted the guidelines almost unchanged.[71] Terminology may vary between adopting nations, and may vary from that used above. OECD guidelines give priority to transactional methods, described as the “most direct way” to establish comparability.[72] The Transactional Net Margin Method and Profit Split methods are used either as methods of last resort or where traditional transactional methods cannot be reliably applied.[73] CUP is not given priority among transactional methods in OECD guidelines. The Guidelines state, "It may be difficult to find a transaction between independent enterprises that is similar enough to a controlled transaction such that no differences have a material effect on price."[74] Thus, adjustments are often required to either tested prices or uncontrolled proces.
Comparability standards OECD rules permit consideration of business strategies in determining if results or transactions are comparable. Such strategies include market penetration, expansion of market share, cost or location savings, etc.[75]
Transactional net margin method The transactional net margin method (TNMM)[76] compares the net profitability of a transaction, or group or aggregation of transactions, to that of another transaction, group or aggregation. Under TNMM, use of actual, verifiable transactions is given strong preference. However, in practice TNMM allows making computations for company-level aggregates of transactions. Thus, TNMM may in some circumstances function like U.S. CPM. Transfer pricing 24
Terms Contractual terms and transactions between parties are to be respected under OECD rules unless both the substance of the transactions differs materially from those terms and following such terms would impede tax administration.[77]
Adjustments OECD rules generally do not permit tax authorities to make adjustments if prices charged between related parties are within the arm's length range. Where prices are outside such range, the prices may be adjusted to the most appropriate point.[78] The burden of proof of the appropriateness of an adjustment is generally on the tax authority.
Documentation OECD Guidelines do not provide specific rules on the nature of taxpayer documentation. Such matters are left to individual member nations.[79]
China specific tax rules Prior to 2009, China generally followed OECD Guidelines. New guidelines were announced by the State Administration of Taxation (SAT) in March 2008 and issued in January 2009.[80] The new rules continue to apply to domestic and international transactions. These guidelines differ materially in approach from those in other countries in two principal ways: 1) they are guidelines issued instructing field offices how to conduct transfer pricing examinations and adjustments, and 2) factors to be examined differ by transfer pricing method. The guidelines cover: • Administrative matters • Required taxpayer filings and documentation • General transfer pricing principles, including comparability • Guidelines on how to conduct examinations • Advance pricing and cost sharing agreement administration • Controlled foreign corporation examinations • Thin capitalization • General anti-avoidance
Documentation Under the Circular, taxpayers must disclose related party transactions when filing tax returns.[81] In addition, the circular provides for a three-tier set of documentation and reporting standards, based on the aggregate amount of intercompany transactions. Taxpayers affected by the rules who engaged in intercompany transactions under RMB 20 million for the year were generally exempted from reporting, documentation, and penalties. Those with transactions exceeding RMB 200 million generally were required to complete transfer pricing studies in advance of filing tax returns.[82] For taxpayers in the top tier, documentation must include a comparability analysis and justification for the transfer pricing method chosen.[83] Transfer pricing 25
General principles Chinese transfer pricing rules apply to transactions between a Chinese business and domestic and foreign related parties. A related party includes enterprises meeting one of eight different tests, including 25% equity ownership in common, overlapping boards or management, significant debt holdings, and other tests. Transactions subject to the guidelines include most sorts of dealings businesses may have with one another.[84] The Circular instructs field examiners to review taxpayer's comparability and method analyses. The method of analyzing comparability and what factors are to be considered varies slightly by type of transfer pricing analysis method. The guidelines for CUP include specific functions and risks to be analyzed for each type of transaction (goods, rentals, licensing, financing, and services). The guidelines for resale price, cost plus, transactional net margin method, and profit split are short and very general.
Cost sharing The China rules provide a general framework for cost sharing agreements.[85] This includes a basic structure for agreements, provision for buy-in and exit payments based on reasonable amounts, minimum operating period of 20 years, and mandatory notification of the SAT within 30 days of concluding the agreement.
Agreements between taxpayers and governments and dispute resolution Tax authorities of most major countries have entered into unilateral or multilateral agreements between taxpayers and other governments regarding the setting or testing of related party prices. These agreements are referred to as advance pricing agreements or advance pricing arrangements (APAs). Under an APA, the taxpayer and one or more governments agree on the methodology used to test prices. APAs are generally based on transfer pricing documentation prepared by the taxpayer and presented to the government(s). Multilateral agreements require negotiations between the governments, conducted through their designated competent authority groups. The agreements are generally for some period of years, and may have retroactive effect. Most such agreements are not subject to public disclosure rules. Rules controlling how and when a taxpayer or tax authority may commence APA proceedings vary by jurisdiction.[86]
Reading & overall reference list Canada: • Information Circular 87-2R [87] (1999) China: Major international accounting and law firms have published summaries of the guidelines. See their web sites. India: • Income Tax Department's compilation of Transfer Pricing Rules [88] OECD: • OECD guidelines ISBN 978-92-64-07534-4, free view only version [89] • OECD Transfer Pricing Country Profiles [90], a useful cross reference to guidance in each member country United Kingdom: • Transfer pricing statute: ICTA88/Sch 28AA [91] • HMRC International Manual [58] Transfer Pricing INTM430000 [92] United States: • Law: 26 USC 482 [93] (120 words) • Regulations: 26 CFR 1.482-0 through 9 [94] Transfer pricing 26
• IRS view on OECD rules: http:/ / www. irs. gov/ pub/ irs-apa/ apa_training_oecd_guidelines. pdf • APA Procedure: Rev. Proc. 2008-31 [95] • Feinschreiber, Robert: Transfer Pricing Methods, 2004, ISBN 978-0-471-57360-9 • Parker, Kenneth and Levy, Mark: Tax Director's Guide to International Transfer Pricing, 2008, ISBN 978-1-60231-001-8 • Services by Thompson RIA and Wolters Kluwer: search "transfer pricing" on their websites
External links • PDF version of the 2009 OECD Transfer Pricing Guidelines [1] • OECD transfer pricing resources [96] • US transfer pricing portal site [97] • Ernst & Young *2009 Global Transfer Pricing survey [98] • Deloitte Touche Tohmatsu's *Strategy Matrix for Global Transfer Pricing [99] • Intra Pricing Solutions' *Transfer Pricing Country Summaries [100] • Definition of the arm's length principle of transfer pricing [101] • China's new transfer pricing regulations 2009 [102] • IRS transfer pricing documentation [103] • KPMG's Pricing Guide (8th Edition) [104] • Director's Guide to International Transfer Pricing (2010 Edition) [105] • Customs vs Tax agencies in transfer pricing [106] • Pricing Litigations [107]
References
[1] http:/ / browse. oecdbookshop. org/ oecd/ pdfs/ browseit/ 2309111E. PDF [2] Note, however, that customs, anti-dumping and import restrictions may in effect impose advance restrictions on prices charged.
[3] http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=06f8771872e186490f1634187f8a1a5f& rgn=div8& view=text& node=26:13. 0.
1. 1. 1. 0. 5. 72& idno=26
[4] http:/ / www. highbeam. com/ doc/ 1G1-7322170. html [5] TD 8552, 1994-2 C.B. 93.
[6] For history of the OECD efforts, see paper presented to the United Nations (http:/ / unpan1. un. org/ intradoc/ groups/ public/ documents/ un/
unpan002475. pdf) in 2001.
[7] See OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (http:/ / browse. oecdbookshop. org/ oecd/
pdfs/ browseit/ 2309111E. PDF), hereafter OECD xx, where xx is the cited paragraph number.
[8] See 26 CFR 1.482-0 et seq (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?sid=7846970e85e8b771bd3dd1dbb4672813& c=ecfr& tpl=/
ecfrbrowse/ Title26/ 26cfrv6_02. tpl).
[9] See, e.g., law of the U.S. at 26 USC 482 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000482----000-. html), UK
at ICTA88/s770 (http:/ / www. opsi. gov. uk/ acts/ acts1988/ ukpga_19880001_en_63), Canada {cndate=July 2010. Note that OECD Guidelines leave this issue to member governments.
[10] See, e.g., 26 CFR 1.482-1(f)(1)(i). (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=7846970e85e8b771bd3dd1dbb4672813&
rgn=div8& view=text& node=26:6. 0. 1. 1. 1. 0. 8. 179& idno=26) [11] OECD 1.36-1.41. and 26 CFR 1.482-1(f)(2)(ii).
[12] See, e.g., OECD 1.1 et seq., 26 CFR 1.482-1(b) (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr&
sid=dd2c99dc46365f8beac541369b9db25c& rgn=div8& view=text& node=26:6. 0. 1. 1. 1. 0. 8. 179& idno=26). [13] OECD 1.45, 41; 26 CFR 1.482-1(e). [14] OECD 1.49-1.51; 26 CFR 1.482-1(f)(2)(iii). [15] OECD 1.15, et seq., 26 CFR 1.482-1(d). [16] OECD 1.15, 26 CFR 1.482-1(d)(2). [17] OECD 1.19-1.29; 26 CFR 1.482-1(d).
[18] OECD 1.19, 2.7, 26 CFR 1.482-3(b)(2)(ii)(A) (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr&
sid=dd2c99dc46365f8beac541369b9db25c& rgn=div8& view=text& node=26:6. 0. 1. 1. 1. 0. 8. 183& idno=26), 26 CFR 1.482-9(c)(2)(ii)(A)
(http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=dd2c99dc46365f8beac541369b9db25c& rgn=div8& view=text& node=26:6. 0.
1. 1. 1. 0. 8. 191& idno=26). Transfer pricing 27
[19] OECD 1.20-1.27, 26 CFR 1.482-1(d)(3)(i) and (iii). [20] OECD 1.28, 1.29, 26 CFR 1.482-1(d)(3)(ii). [21] OECD 1.30, 26 CFR 1.482-1(d)(3)(iv).
[22] 26 CFR 1.482-3 (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=dd2c99dc46365f8beac541369b9db25c& rgn=div8&
view=text& node=26:6. 0. 1. 1. 1. 0. 8. 183& idno=26).
[23] OECD Chapter VII; 26 CFR 1.482-9 (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr&
sid=dd2c99dc46365f8beac541369b9db25c& rgn=div8& view=text& node=26:6. 0. 1. 1. 1. 0. 8. 191& idno=26).
[24] OECD Chapter VI; 26 CFR 1.482-4 (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=dd2c99dc46365f8beac541369b9db25c&
rgn=div8& view=text& node=26:6. 0. 1. 1. 1. 0. 8. 184& idno=26).
[25] 26 CFR 1.482-2(a) (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=dd2c99dc46365f8beac541369b9db25c& rgn=div8&
view=text& node=26:6. 0. 1. 1. 1. 0. 8. 181& idno=26). [26] 26 CFR 1.482-2(c). [27] OECD 2.5, 26 CFR 1.482-.
[28] OECD 1.68-1.70, 26 CFR 1.482-1(c), 26 CFR 1.482-8 (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr&
sid=dd2c99dc46365f8beac541369b9db25c& rgn=div8& view=text& node=26:6. 0. 1. 1. 1. 0. 8. 189& idno=26). [29] OECD 2.6-2.13, 26 CFR 1.482-5. [30] OECD 2.32-48, 26 CFR 1.482-3(d), 26 CFR 1.482-9(e). [31] OECD 2.14-2.31, 26 CFR 1.482-3(c), 26 CFR 1.482-9(d). [32] 26 CFR 1.482-5. [33] OECD 3.26-3.33.
[34] OECD 3.5-3.25, 26 CFR 1.482-6 (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=dd2c99dc46365f8beac541369b9db25c&
rgn=div8& view=text& node=26:6. 0. 1. 1. 1. 0. 8. 187& idno=26). [35] OECD 3.5. [36] 26 CFR 1.482-6(c)(2). [37] 26 CFR 1.482-6(c)(3). [38] OECD 3.43, 26 CFR 1.482-5(b)(2). [39] OECD 3.41, 26 CFR 1.482-5(b)(4). [40] OECD 3.43, 3.44, 26 CFR 1.482-1(e)(2). [41] OECD Chapter VI, 26 CFR 1.482-4.
[42] For the U.S., see, e.g., Young and Rubicam, 410 F.2d 1233 (Ct.Cl., 1969) (http:/ / cases. justia. com/ us-court-of-appeals/ F2/ 410/ 1233/
154707/ ), [ PLR 8806002]. [43] OECD 7.5, 26 CFR 1.482-9. [44] OECD 7.5-7.18, Young and Rubicam and PLR 8806002, supra. [45] OECD 7.19 et seq., 26 CFR 1.482-9. [46] Such services may be referred to those not integral to the functioning of the primary business. [47] OECD 7.33, 26 CFR 1.482-9(b). [48] Canada [49] OECD 7.29 et seq., 26 CFR 1.482-9(b)(2). Note that Canada's rules do not permit such profit.
[50] OECD Chapter VIII, 26 CFR 1.482-7T (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr&
sid=dd2c99dc46365f8beac541369b9db25c& rgn=div8& view=text& node=26:6. 0. 1. 1. 1. 0. 8. 188& idno=26). [51] OECD 8.3. [52] Note that few countries besides the U.S. have formally adopted cost sharing rules, as of 2009. The OECD Guidelines do not specifically require such rules, so adoption of the Guidelines may not constitute approval of cost sharing under the laws of some countries. [53] U.S. rules permit, in some cases, actions of members consistent with the principles of a CSA to be considered to constitute a CSA. [54] OECD 8.9, 26 CFR 1.482-7T(b)(4). [55] OECD 8.16, 8.17, 26 CFR 1.482-7T(c). [56] OECD 8.13-8.18, 1.482-7T(c). [57] OECD 8.8, 8.9, 26 CFR 1.482-7T(e). [58] OECD 8.31-8.39, 26 CFR 1.482-7T(g).
[59] USC 6662 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00006662----000-. html26). A second threshold based on the relative magnitude of the adjustment may also applyl.
[60] 26 CFR 1.6662-6 (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=7846970e85e8b771bd3dd1dbb4672813& rgn=div8&
view=text& node=26:13. 0. 1. 1. 1. 0. 16. 256& idno=26).
[61] Basic rules through 2001 26 CFR 1.482-0 through -8 (http:/ / www. irs. gov/ pub/ irs-apa/ 482_regs. pdf) plus the cost sharing ( 26 CFR
1.482-7 (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=4afca51e4a345157c36af15ce48e9cb5& rgn=div8& view=text&
node=26:6. 0. 1. 1. 1. 0. 8. 188& idno=26)) and services ( 26 CFR 1.482-9 (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr&
sid=4afca51e4a345157c36af15ce48e9cb5& rgn=div8& view=text& node=26:6. 0. 1. 1. 1. 0. 8. 191& idno=26)) regulations together exceed 120,000 words. Transfer pricing 28
[62] 26 CFR 1.482-5 (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=7846970e85e8b771bd3dd1dbb4672813& rgn=div8&
view=text& node=26:6. 0. 1. 1. 1. 0. 8. 186& idno=26). [63] 26 CFR 1.482-3(c)(2) and (d)(2). [64] 26 CFR 1.482-9(c) [65] 26 CFR 1.482-9(c). [66] 26 CFR 1.482-. [67] 26 CFR 1.482-.
[68] 26 USC 6662 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00006662----000-. html).
[69] 26 CFR 1.6662-6(d)(2)(iii) (http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=7846970e85e8b771bd3dd1dbb4672813&
rgn=div8& view=text& node=26:13. 0. 1. 1. 1. 0. 16. 256& idno=26).
[70] 26 USC 367(d) (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000367----000-. html) and 26 CFR 1.367(d)-1T
(http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?c=ecfr& sid=0450562949e7eb1a81da417b0c4ac6a9& rgn=div8& view=text& node=26:4. 0.
1. 1. 1. 0. 13. 147& idno=26). [71] German law incorporates OECD guidelines by reference. Note that while Canada and the United States are OECD members, each has adopted its own comprehensive regulations that differ in some material respects from the OECD guidelines. [72] OECD 2.5. [73] OECD 3.50-3.51 [74] OECD 2.8 [75] OECD 1.31-1.35. [76] OECD 3.26 et seq. [77] OECD 1.28-29, 1.37 [78] OECD 1.45-1.48 [79] OECD 4.4. [80] Implementation Measures of Special Tax Adjustment (Trial), Guo Shui Fa (2009) No. 2 [Circular 2, as revised] issued by the State
Administration of Taxation (http:/ / www. chinatax. gov. cn/ n6669073/ index. html) of the Peoples Republic of China, in Chinese. English
translations are available from most of the major accounting firms, and vary slightly. See, e.g., KPMG (http:/ / www. kpmg. com/ CN/ en/
WhatWeDo/ Tax/ Global-Transfer-Pricing-Services/ Documents/ Circular-20090108-0002-1e. pdf)'s version of the complete circular. Hereafter referred to as the Circular or China Circular 2 Art. xx, where xx is the article number of Circular 2. [81] China Circular 2 Art. 11. [82] China Circular 2 Art. 13-20. [83] China Circular 2 Art. 14 (iv) and (v). [84] China Circular 2 Art. 9-10. [85] China Circular 2 Art. 64, et seq.
[86] See OECD 4.124 et seq.; U.S. IRS Rev. Proc. 2008-31 (http:/ / www. irs. gov/ pub/ irs-apa/ rp-08-31. pdf); China Circular 2 Art. 46 et seq.
[87] http:/ / www. cra-arc. gc. ca/ E/ pub/ tp/ ic87-2r/ ic87-2r-e. pdf
[88] http:/ / law. incometaxindia. gov. in/ DIT/ inttpcont. aspx#
[89] http:/ / www. oecdbookshop. org/ oecd/ get-it. asp?REF=2309111E. PDF& TYPE=browse
[90] http:/ / www. oecd. org/ document/ 25/ 0,3343,en_2649_33753_37837401_1_1_1_1,00. html
[91] http:/ / www. opsi. gov. uk/ acts/ acts1998/ ukpga_19980036_en_35
[92] http:/ / www. hmrc. gov. uk/ manuals/ intmanual/ INTM430000. htm
[93] http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000482----000-. html
[94] http:/ / ecfr. gpoaccess. gov/ cgi/ t/ text/ text-idx?sid=4afca51e4a345157c36af15ce48e9cb5& c=ecfr& tpl=/ ecfrbrowse/ Title26/ 26cfrv6_02. tpl
[95] http:/ / www. irs. gov/ pub/ irs-apa/ rp-08-31. pdf
[96] http:/ / www. oecd. org/ department/ 0,2688,en_2649_33753_1_1_1_1_1,00. html
[97] http:/ / www. ustransferpricing. com
[98] http:/ / www. ey. com/ GL/ en/ Services/ Tax/ 2009-Global-Transfer-Pricing-survey
[99] http:/ / www. deloitte. com/ dtt/ article/ 0%2C1002%2Ccid%25253D216636%2C00. html
[100] http:/ / www. intrapricing. com/ country-summaries. html''Global
[101] http:/ / www. ustransferpricing. com/ arms_length_principle. html
[102] http:/ / www. kpmg. com. cn/ redirect. asp?id=0326
[103] http:/ / www. irs. gov/ businesses/ international/ article/ 0,,id=120220,00. html
[104] http:/ / www. us. kpmg. com/ services/ content. asp?l1id=20& l2id=120& cid=1042''Transfer
[105] http:/ / www. ustransferpricing. com/ internationaltransferpricing/ index. html''Tax
[106] http:/ / www. oecd. org/ dataoecd/ 40/ 54/ 39265412. pdf
[107] http:/ / in. ibtimes. com/ articles/ 42597/ 20100811/
pricewaterhousecoopers-pwc-transfer-pricing-litigations-india-direct-tax-code-oecd-bna-international. htm''Transfer Taxation in the United States 29 Taxation in the United States
Taxation in the United States is a complex system which may involve payment to many different levels of government and many methods of taxation. United States taxation includes local government, possibly including one or more of municipal, township, district and county governments. It also includes regional entities such as school and utility, and transit districts as well as state and federal government.
Federal taxation
History Tariffs were the largest source of federal revenue from the 1790s to the eve of World War I, until they were surpassed by income taxes. The first federal statutes imposing the legal obligation to pay a federal income tax were adopted by Congress in 1861 and 1862 to pay for the Civil War. The 1862 law levied a 3% tax on incomes above $800, rising to 5% for incomes above $10,000. Rates were raised in 1864. This income tax was repealed in 1872, but a new income tax statute was enacted as part of the Wilson-Gorman Tariff Act in 1894.[1] The United States Constitution specified Congress could impose a direct tax only if it was apportioned among the states according to each state's census population.[2] In its 1895 decision the Supreme Court held in the case of Pollock v. Farmers' Loan & Trust Co. that a tax on income from property (a tax on interest, dividends or rent) was a direct tax under the Constitution, and so had to be apportioned. The apportionment requirement made income taxes on property practically impossible, and Congress did not want to limit the income tax solely to a tax on wages. Therefore, in 1909 Congress proposed the Sixteenth Amendment, which became part of the Constitution in 1913 when it was ratified by the required number of states. The Amendment modified the requirement for apportionment of direct taxes by exempting all income taxes—whether considered direct or indirect—from the apportionment requirement. Congress re-adopted the income tax that same year, levying a 1% tax on net personal incomes above $3,000, with a 6% surtax on incomes above $500,000. By 1918, the top rate of the income tax was increased to 77% (on income over $1,000,000) to finance World War I. The top marginal tax rate was reduced to 58% in 1922, to 25% in 1925, and finally to 24% in 1929. In 1932 the top marginal tax rate was increased to 63% during the Great Depression and steadily increased, reaching 94% (on all income over $200,000) in 1945. During World War II, Congress introduced payroll withholding and quarterly tax payments, Franklin D. Roosevelt tried to impose a 100% tax on all incomes over $25,000 to help with the war effort. Top marginal tax rates stayed near or above 90% until 1964 when the top marginal tax rate was lowered to 70% by John F. Kennedy. The top marginal tax rate was lowered to 50% in 1982 and eventually to 28% in 1988. In 1990, the top marginal rate was raised to 31% in a budget deal President George H. W. Bush made with the Congress. In 1993 the Clinton administration proposed and the Congress accepted (with no Republican support) raising the top marginal rate to 39.6%. In 2001, President George W. Bush proposed and the Congress accepted lowering the top marginal rate to 35%. However, this measure had a sunset provision and was scheduled to expire in 2011 when rates would return to those adopted during the Clinton years. At first the income tax was incrementally expanded by the Congress of the United States, and then inflation automatically raised most persons into tax brackets formerly reserved for the wealthy until income tax brackets were adjusted for inflation. Income tax now applies to almost two-thirds of the population.[3] The lowest earning workers, especially those with dependents, pay no income taxes as a group and actually get a small subsidy from the federal government because of child credits and the Earned Income Tax Credit. Taxation in the United States 30
Some lower income individuals pay a proportionately higher share of payroll taxes for Social Security and Medicare than do some higher income individuals in terms of the effective tax rate. All income earned up to a point, adjusted annually for inflation ($94,200 for the year 2006 and $97,500 for the year 2007) is taxed at 7.65% (consisting of the 6.2% Social Security tax and the 1.45% Medicare tax) on the employee with an additional 7.65% in tax incurred by the employer. The annual limitation amount is sometimes called the "Social Security tax wage base amount" or "Contribution and Benefit Base." Above the annual limit amount, only the 1.45% Medicare tax is imposed. In terms of the effective rate, this means that a worker earning $20,000 for 2006 pays at a 7.65% effective rate ($1,530) while a worker earning $200,000 pays at an effective rate of about 4.37% ($8,740). When an individual's Social Security benefit is calculated, income in excess of each year's Social Security Tax wage base amount (e.g., $97,500 for 2007) is disregarded for purposes of the calculation of future benefits. Although some lower income individuals pay a proportionately higher share of payroll taxes than do higher income individuals in terms of the "effective tax rate", the lower income individuals also receive a proportionately higher share of Social Security benefits than do some higher income individuals, since the lower income individuals will receive a much higher income replacement percentage in retirement than higher income individuals affected by the Social Security tax wage base cap. If the higher income individuals want to receive an income replacement percentage in retirement that is similar to the income replacement percentage that lower income individuals receive from Social Security, higher income individuals must achieve this through other means such as 401(k)s, IRAs, defined benefit pension plans, personal savings, etc. As a percentage of income, some higher income individuals receive less from Social Security than do lower income individuals. Self employed people pay the entire 15.3%, but are allowed to deduct one-half of this amount in computing taxable income for purposes of the Federal income tax.[4] The federal government is now financed by a mix of personal, corporate income taxes, payroll taxes, borrowing, and other taxes. Tariffs now represent only a minor portion of federal revenues. There are also non-tax fees to recompense agencies for services or to fill specific trust funds such as the fee placed upon airline tickets for airport expansion and air traffic control. Often the receipts intended to be placed in "trust" funds are used for other purposes, with the government posting an IOU ('I owe you') in the form of a federal bond or other accounting instrument, then spending the money on unrelated current expenditures. The federal government collects several specific taxes in addition to the general income tax. Social Security and Medicare are large social support programs which are funded by taxes on personal earned income. Estate taxes are levied on inheritance. Net long-term capital gains as well as certain types of qualified dividend income are taxed preferentially. Federal excise taxes are applied to specific items such as motor fuels, tires, telephone usage, tobacco products, and alcoholic beverages. Excise taxes are often, but not always, allocated to special funds related to the object or activity taxed.
Federal tax code The Federal tax law is administered primarily by the Internal Revenue Service, a bureau of the Treasury. The U.S. tax code is known as the Internal Revenue Code of 1986 (and is separately published as title 26 of the United States Code). The Code's complexity generally arises from two factors: the use of the tax code for purposes other than raising revenue, and the feedback process of amending the code. While the main intent of the law is to provide revenue for the federal government, the tax code is frequently used for public policy reasons, i.e., to achieve social, economic, and political goals. For example, to encourage home ownership, the tax law provides a deduction for mortgage interest expense on debt secured by primary residences. In addition, the law does not allow a deduction for renters for rent paid to offset the advantage of nonrecognition of exclusion of imputed owner occupied rent. An income tax system that favors neither renting nor owning homes would not allow the mortgage interest deduction and would tax the imputed rent for owners who live in their own Taxation in the United States 31
homes. Because the government uses the tax code as an instrument of social policy, the code as a whole appears to some critics to lack a coherent organizing principle. The purported lack of a coherent organizing principle arguably has become magnified over time, due to the interplay between successive legislative amendments and regulatory changes to the law and the private sector responses to those amendments and changes. For instance, suppose that Congress enacts a tax credit to encourage a particular type of activity. In response, a group of taxpayers who are not the intended beneficiaries of the credit re-order their affairs, or the superficial aspects of their affairs, to qualify for the credit. Congress responds by amending the code to add restrictions and target the credit more effectively. Certain taxpayers manage to use this change to claim additional benefits, so Congress acts again, and so on. The result is a feedback loop of enactment and response, which, over an extended period of time, produces significant complexity.
Tax withholding Federal income taxes and federal payroll taxes in the United States are primarily collected by employers on behalf of the Internal Revenue Service (IRS). The Federal income tax uses a system of direct withholding initiated to help generate revenue during World War II. In a system famed economist Milton Friedman was important in developing, employers deduct part of a taxpayer's income directly from their payroll checks.[5] Self-employed individuals make similar payments to the government. The amount of withholding is calculated based on an employee's expected annual salary and the employee's living situation (married or unmarried, number of dependents, other factors). Withholding does not perfectly calculate an individual's tax each year. The difference between the amount withheld and the actual tax is either paid to the government after the end of the year, or refunded by the government. Withholding is done on an honor system with penalties imposed on individuals who do not have enough withheld (or make enough estimated tax payments) during the year. The amounts deducted can be found in IRS Publication 15, also referred to as Circular E. For farmers, the rules are outlined in Publication 51 (Circular A). The IRS's Publication 505 can also be used to estimate the amount of tax withheld. Some individuals choose to withhold more of their estimated tax burden than necessary, using the withholding and the refund check at the end of the year as a way of "forced savings" (at zero percent interest). Conversely, other individuals withhold as little as possible, using the general rule that, for purposes of avoiding the penalty for underpayment of estimated tax (a "penalty" that is essentially analogous to an interest charge that covers the periods from each of four specified interim payment due dates[6] to the initial due date for the filing of the tax return), the total tax paid or constructively paid by April 15 of the year following the tax year in question (i.e., the initial due date for filing the return) need be no more than 100% of the previous year's tax liability. Such individuals thus pay a relatively large amount on April 15.[7] Many individuals fall somewhere in the middle.
Individual income tax Depending on individual income, the marginal tax rate for the tax year 2009 ranges from zero to 35%.[8] The income tax is considered a progressive tax because the tax rate is higher as a percentage of the income for higher-income individuals. For an example showing the tax rates imposed by Congress in 1954 on the taxable income of unmarried individuals—with rates as high as 91%—see the chart at Internal Revenue Code of 1954. Income tax is also imposed on the taxable income of most corporations and again on dividends paid to stockholders, although individuals usually pay a preferential tax rate on dividends; this is sometimes referred to as double taxation. One unique aspect of federal income tax in the United States, is that the U.S. uses citizenship in addition to residency in determining whether a person's income is subject to U.S. taxation. All U.S. citizens, including those who do not live in the United States, are subject to U.S. income tax on their worldwide income. Certain code provisions reduce the effect of double-taxation and exclude some "earned" income. Many other countries do not impose tax on their citizens who are not resident within their borders, unless they have income which is sourced in that country (and even then they only tax that specific income).[9] Taxation in the United States 32
Tax deductions/credits The U.S. government rewards certain behavior with tax deductions or tax credits. For example, amounts used to pay mortgage interest on a personal home may be deductible, if the taxpayer elects to itemize. Taxpayers who do not participate in an employer-sponsored pension plan may contribute up to $4,000 ($5,000 if age 50 or above) into an individual retirement account, and deduct that contribution from their gross income if they fall within certain income limits. The Earned Income Tax Credit benefits low- to moderate-income working families. It is also possible to receive a child and dependent care credit for amounts spent on daycare. For businesses, a corporate expense account is treated under the tax code as either "accountable" or "unaccountable". Accountable expense accounts are subject to a variety of restrictions and IRS regulations. There must be a documented business purpose for the account, and spending from the account must be documentable, typically by means of receipts. Any money entrusted to the employee from the account that is not spent for business purposes and accounted for must be returned to the employer.[10]
Methods of calculation
There are two required ways to calculate the U.S. income tax. The "regular tax" is based on the gross income minus any applicable deductions and then a marginal tax percentage is applied according to the taxpayer's income bracket. From this result, any applicable tax credits are subtracted and the result is the income tax owed. If the result is a negative number due to refundable tax credits and/or if the Federal Withholding Tax was greater than the income tax that was actually owed, the taxpayer is entitled to a tax refund. A taxpayer eligible for a refundable credit (such as the earned income tax credit) may receive a refund even without paying any federal income tax.
The second way, the "Alternative Minimum Tax" (AMT) is based on the gross income, computed without regard to certain tax preference items (such as tax-exempt interest on certain private activity bonds) and with a reduced number of exemptions and deductions. This higher income base is taxed in two rate brackets, 26% and 28%, depending on taxpayer income. The taxpayer pays Chart showing how the United States Congress spends the federal tax [11] the higher of the "regular" tax or the AMT. revenue.
In the tax year 2000, many taxpayers in Silicon Valley were caught unprepared by the AMT due to the sudden decline in technology stock prices. Under AMT rules, unrealized gains on incentive stock options are taxed at the date the options are exercised. In contrast, under the regular tax rules capital gains taxes are not paid until the actual shares of stock are sold. For example, if someone exercised a 10,000 share Nortel stock option at $7 when the stock price was at $87, the bargain element was $80 per share or $800,000. Without selling the stock, the stock price dropped to $7. Although the real gain is $0, the $800,000 bargain element still becomes an AMT adjustment, and the taxpayer owes thousands of dollars in AMT. Taxation in the United States 33
The AMT was designed to prevent people from using loopholes in the tax law to avoid tax. However, the inclusion of unrealized gain on incentive stock options imposes difficulties for people who cannot come up with cash to pay tax on gains that they have not realized yet. As a result, Congress has taken action to modify the AMT regarding incentive stock options. In 2000 and 2001, people exercised incentive stock options and held onto the shares, hoping to pay long-term capital gains taxes instead of short-term capital gains taxes.[12] Many of these people were forced to pay the AMT on this income, and by the end of the year, the stock was no longer worth the amount of AMT tax owed, forcing some individuals into bankruptcy. In the Nortel example given above, the individual would receive a credit for the AMT paid when the individual did eventually sell the Nortel shares. However, given the way AMT carryover amounts are recalculated each year, the eventual credit received is in many cases less than originally paid, another insidious artifact of AMT. Another perceived flaw in the AMT is that it hasn't been changed at the same rate as regular income taxes. The tax cut passed in 2001 lowered regular tax rates, but did not lower AMT tax rates. As a result, certain middle-class people are affected by the AMT, even though that was not the original intent of the law. People with large deductions, particularly mortgage interest and state income tax deductions, are affected the most. The AMT also has the potential to tax families with large numbers of dependents (usually children), although in recent years, Congress has acted to keep deductions for dependents, especially children, from triggering the AMT. A further criticism is that the AMT does not even affect its intended target. Congress introduced the AMT after it was discovered that 21 millionaires did not pay any US income tax in 1969 as a result of various deductions taken on their income tax return. Since the marginal rate of persons with one million dollars of income is 35% and the AMT uses a 26% rate on all income, it is unlikely that millionaires would get tripped by the AMT as their effective tax rates are already higher. Those that do get caught by the AMT are typically upper-middle class persons making approximately $200k-$500k. Statistics from the U.S. Internal Revenue Service (IRS) for 2000 show that returns showing less than $15,000 in adjusted gross income amounted to 30% of total returns filed but accounted for less than 1% of tax paid. By contrast, although they made up only 2% of all taxpayers that year, taxpayers reporting $200,000 or more in adjusted gross income paid 45% of all federal income taxes. (See: Lucky duckies)
Progressive nature In general, the U.S. income tax is progressive, at least with respect to individuals that earn wage income. "Progressivity" as it pertains to tax is usually defined as meaning that the higher a person's level of income, the higher a tax rate that person pays. In the mid-twentieth century, tax rates in the United States and United Kingdom exceeded 90%. As recently as the late 1970s, the top tax rate in the U.S. was 70%. In the words of Piketty and Saez, "... the progressivity of the U.S. federal tax system at the top of the income distribution has declined dramatically since the 1960s".[13] They continue, "... the most dramatic changes in federal tax system progressivity almost always take place within the top 1 percent of income earners, with relatively small changes occurring below the top percentile." Progressivity in the income tax is accomplished mainly by establishing tax "brackets" - branches of income that are taxed at progressively higher rates. For example, for tax year 2006 an unmarried person with no dependents will pay 10% tax on the first $7,550 of taxable income. The next $23,100 (i.e. taxable income over $7,550, up to $30,650) is taxed at 15%. The next $43,550 of income is taxed at 25%. Additional brackets of 28%, 33%, and 35% apply to higher levels of income. So, if a person has $50,000 of taxable income, his next dollar of income earned will be taxed at 25% - this is referred to as "being in the 25% tax bracket," or more formally as having a marginal rate of 25%. However, the tax on $50,000 of taxable income figures to $9,058. This being 18% of $50,000, the taxpayer is referred to as having an effective tax rate of 18%. In recent years, a reduction in the tax rates applicable to capital gains and received dividends payments, has significantly reduced the tax burden on income generated from savings and investing. An argument is often made Taxation in the United States 34
that these types of income are not generally received by low-income taxpayers, and so this sort of "tax break" is anti-progressive. Further clouding the issue of progressivity is that far more deductions and tax credits are available to higher-income taxpayers. A taxpayer with $40,000 of wage income may only have the "standard" deductions available to him, whereas a taxpayer with $200,000 of wage income might easily have $50,000 or more of "itemized" deductions. Allowable itemized deductions include payments to doctors, premiums for medical insurance, prescription drugs and insulin expenses, state taxes paid, property taxes, and charitable contributions. In those two scenarios, assuming no other income, the tax calculations would be as follows for a single taxpayer with no dependents in 2006:
Wage income $40,000 $200,000
Allowable deductions 8,450 51,430
Taxable income 31,550 148,570
Income tax 4,445 46,725
Statutory rate 14% 31%
This would appear to be highly progressive - the person with the higher taxable income pays tax at twice the rate. However, if you divide the tax by the amount of gross income (i.e., before deductions), the effective rates are 11% and 23%: the higher income person's rate is still twice as high, but his deductions drive down the effective rate to a much greater degree. In addition, most discussions of income tax progressivity do not take into account the social security tax, which has a "ceiling". This is because social security insurance benefits are directly determined by individual social security tax contributions over that individual's lifetime. Thus, since social security taxes serve as direct individual premiums for direct individual benefits, most do not include these taxes in the calculation of the progressive nature of federal taxes much as they do not include private automobile, homeowners, and life insurance policy premiums. If one were to expand the above example to include social security insurance taxes:
Social security tax $3,060 $8,740
Total tax 7,505 55,465
Rate paid on gross income 19% 28%
Progressivity, then is a complex topic which does not lend itself to simple analyses. Given the "flattening" of tax burden that occurred in the early 1980s, many commentators note that the general structure of the U.S. tax system has begun to resemble a partial consumption tax regime.[14] In 2001 the top 1% earned 14.8% of all income and paid 34.4% of federal income taxes. The next 4% earned 12.7% and paid 20.8%. The next 5% earned 10.1% and paid 12.5%. The next 10% earned 14.8% and paid 14.8%, completing the highest quintile, which in total earned 52.4% of all income and paid 82.5% of federal income taxes. The fourth quintile earned 20.7% and paid 14.3%. The third quintile earned 14.2% and paid 5.2%. The second quintile earned 9.2% and paid 0.3%. The lowest quintile earned 4.2% and received a net 2.3% from the federal government in income "credits". When including social security insurance taxes: In 2001 the top 1% earned 14.8% of all income and paid 22.7% of all federal taxes. The next 4% earned 12.7% and paid 15.8%. The next 5% earned 10.1% and paid 11.5%. The next 10% earned 14.8% and paid 15.3%, completing the highest quintile for a total of 65.3%. The fourth quintile earned 20.7% of all income and paid 18.5%. The third quintile earned 14.2% and paid 10%. The second quintile earned 9.2% and paid 4.9%. The lowest quintile earned 4.2% and paid 1% of all federal taxes.[15] Whether this breakdown is "fair" is a matter of some debate. According to Tax Foundation, when including comprehensive household income for 1991 to 2004, which consists of both market-based income and the net value of government transfer payments, the top quintile earned 41.5% and paid 48.8% of total taxes. The fourth quintile earned 21.0% and paid 22.4%. The third quintile earned 15.4% and Taxation in the United States 35
paid 14.8%. The second quintile earned 12.2% and paid 9.6%. The lowest quintile earned 9.8% and paid 4.3% of total taxes.[16]
Percentile Earnings Federal Tax Share Federal Tax Share Federal Tax Rate (2001 CBO data) (incl. Social (incl. Social Security) Security)
Top 1% 14.8% 52.4% 34.4% 82.5% 22.7% 65.3% 33.0% 26.8%
95%–98% 12.7% 20.8% 15.8% na
90%–94% 10.1% 12.5% 11.5% na
80%–89% 14.8% 14.8% 15.3% na
60–79% 20.7% 14.3% 18.5% 19.3%
40–59% 14.2% 5.2% 10.0% 15.2%
20–39% 9.2% 0.3% 4.9% 11.6%
0–19% 4.2% −2.3% 1.0% 5.4%
Percentile Income Federal Tax Share State and Local Tax Total Tax Share Total Tax Rate (1991 to 2004 Tax Foundation (incl. govt. (incl. Social Share (incl. Fed, State, (incl. Fed, State, data) transfers) Security) Local) Local)
80%–100% 41.5% 52.8% 41.4% 48.8% 34.5%
60–79% 21.0% 22.2% 22.7% 22.4% 31.3%
40–59% 15.4% 14.1% 16.3% 14.8% 28.2%
20–39% 12.2% 8.3% 12.2% 9.6% 23.2%
0–19% 9.8% 2.6% 7.5% 4.3% 13.0%
Tax distribution As of 2007, there are about 138 million taxpayers in the United States.[17] The typical marginal federal income tax rate is 15%,[18] regardless of whether median (50th percentile) or mode (plurality) is used; state income taxes may also apply. In addition, for labor income there is a federal payroll tax rate of 7.65% for each of the employee and the employer, or 15.300% for the self-employed.[19] According to the Congressional Budget Office (CBO), “the median taxpayer has a combined marginal [tax] rate of 31.6 percent” %.[20] The Treasury Department in 2006 reported, based on Internal Revenue Service (IRS) data, the share of federal income taxes paid by taxpayers of various income levels. The data shows the progressive tax structure of the U.S. federal income tax system on individuals that reduces the tax incidence of people with smaller incomes, as they shift the incidence disproportionately to those with higher incomes - the top 0.1% of taxpayers by income pay 17.4% of federal income taxes (earning 9.1% of the income), the top 1% with gross income of $328,049 or more pay 36.9% (earning 19%), the top 5% with gross income of $137,056 or more pay 57.1% (earning 33.4%), and the bottom 50% with gross income of $30,122 or less pay 3.3% (earning 13.4%).[21] [22] If the federal taxation rate is compared with the wealth distribution rate, the net wealth (not only income but also including real estate, cars, house, stocks, etc) distribution of the United States does almost coincide with the share of income tax - the top 1% pay 36.9% of federal tax (wealth 32.7%), the top 5% pay 57.1% (wealth 57.2%), top 10% pay 68% (wealth 69.8%), and the bottom 50% pay 3.3% (wealth 2.8%).[23] Other taxes in the United States have a less progressive structure or a regressive structure, and legal tax avoidance loopholes change the overall tax burden distribution. For example, the payroll tax system (FICA), a 12.4% Social Security tax on wages up to $106,800 (for 2009) and a 2.9% Medicare tax (a 15.3% total tax that is often split between employee and employer) is called a regressive tax on income with no standard deduction or personal exemptions but in effect is forced savings which return to the payer in the form of retirement benefits and health Taxation in the United States 36
care. The Center on Budget and Policy Priorities states that three-fourths of U.S. taxpayers pay more in payroll taxes than they do in income taxes.[24] The National Bureau of Economic Research has concluded that the combined federal, state, and local government average marginal tax rate for most workers to be about 40% of income.[25] [26]
Inflation and tax brackets Most tax laws are not accurately indexed to inflation. Either they ignore inflation completely, or they are indexed to the Consumer Price Index (CPI), which some argue understates real inflation.[27] In a progressive tax system, failure to index the brackets to inflation will eventually result in effective tax increases (if inflation is sustained), as inflation in wages will increase individual income and move individuals into higher tax brackets with higher percentage rate. One example is the Alternative Minimum Tax; since it is not indexed to inflation,[28] [29] an increasing number of upper-middle-income taxpayers have been finding themselves subject to this tax. From 1971 to 1977, as the CPI increased 47%, taxpayers faced 60% more taxes at the local, state and federal levels.[30]
Payroll taxes
Social Security tax The next largest tax is Social Security tax formally known as the Federal Insurance and Contributions Act (FICA). This contribution or tax is 6.2% of an employees' income paid by the employer, and 6.2% paid by the employee (12.4% total). Self-employed workers must pay both halves of the Social Security tax because they are their own employers. This tax is paid only on earned income and, as noted above, only up to a threshold income for calendar year 2009 of $106,800 called the "Social Security Wage Base" (SSWB), for an maximum individual contribution of $6,621.60 ($13,243.20 combined). The SSWB increases every year[31] according to the national index average of wages[32] which also indexes the bend points in the Primary Insurance Amount (PIA) computations. Unearned income like interest from bonds, money market and bank accounts, dividends from REITs and common stocks, rents, and royalties are not subject to the Social Security tax. Wages are defined in the United States Code 42 USC Section 409.[33] Thus, by simple arithmetic, higher earners pay a lower average tax rate than those with earned income at the upper end, making this an extremely regressive tax. Thus, earners above the SSWB pay a much lower combined marginal federal tax rate, when including Social Security and Medicare taxes, than those at the SSWB.
Medicare tax The Medicare tax funds the Medicare program, a health insurance program for the elderly and disabled. 1.45% of the employee's income is paid by the employer as Medicare tax, and 1.45% is paid by the employee. Unlike Social Security, there is no cap on the Medicare tax. For self-employed people, Medicare taxes are fixed at 2.9% on all earnings (can be offset by income tax provisions.) As in FICA, unearned income is not subject to the Medicare contribution. Together, Social Security and Medicare taxes compose the payroll tax. These taxes are based on income, but unlike the Federal income tax, they are set aside for their specific purposes. That is, there is a statutory requirement that expenditures on these programs Medicare and Social Security come out of current taxes or accumulated trust funds, so if they go broke, the Social Security Administration and Medicare would be without the authority to pay benefits. Unlike Congress, they cannot borrow on the federal government's creditworthiness to fund operations from the credit markets. Taxation in the United States 37
Other payroll taxes The U.S. has a payroll tax to support unemployment insurance. This is 1.2% of the first $7,000, but coordinated with state unemployment agencies and taxes in such a way that most employees are not double taxed in states that have unemployment insurance. The U.S. also has a tax to pay for retraining of displaced workers, but it is only 0.1% of the first $7,000 of income, and it is assessed only on employers. The government tracks tax payment by an account number and payment date. For the IRS, the account number is a Social Security Number, Individual Taxpayer Identification Number, or Employer Identification Number.
Corporate income tax In the United States, the federal corporate income rate for the year 2006 varies between 15 and 39% depending on taxable income. But since 1999, when Treasury announced the "check the box" system, many corporations can elect to be treated as a pass-through entity, thereby skipping the entity level 35% tax and having all income pass through to the shareholders. This is the tax treatment that the much discussed "S" corporations receive; but now many more types of state-law corporations or and limited liability companies may avoid double taxation by "checking the box". Certain dividends are also subject to a lower rate of income tax than other kinds of ordinary income in the United States.
Transfer taxes The transfer tax generates roughly 1.5% ($30 billion) of the federal government's annual revenue ($2 trillion). It consists of the gift tax, the estate tax and the generation-skipping transfer tax ("GSTT"). Opponents of the transfer tax label these taxes "death taxes". The term "death tax" was popularized by Frank Luntz, a Republican political consultant, but its use goes back to at least the 19th century.[34] The gift tax is a tax levied on wealth transfers during the transferor's life while the estate tax is levied on transfers made after the transferor's death. The GSTT is a tax in addition to the gift and estate tax and is levied (in rough terms) on transfers made during life or after death to individuals removed by more than one generation from the transferor, for example, from a grandmother to a grandson. Usually transfer tax liabilities are paid by the transferor or the transferor's estate. Payment of transfer taxes by the transferor when the liability is due from the recipient is also a taxable gift. As of December 2002, tax rates for gift and estate taxes begin at 18% and rise to 50% for gifts over $12,000 or taxable estates over $2.5 million under the Unified Transfer Tax Rate Schedule. The GSTT is a flat 50%. Each individual is granted a Unified Credit (currently $345,800) the effect of which exempts estates under $1 million. Each individual is also granted an annual exclusion amount the effect of which exempts total gifts to any one individual during the year up to the annual exclusion amount (As of 2009, $13,000 per person per year). If the transferor does not elect to pay the gift tax on the value of gifts totaling more than the annual exclusion amount, the individual is deemed to have used a portion of his Unified Credit. An exemption (currently $1.1 million) for transfers subject to the GSTT is also granted to each individual during his lifetime. The Unlimited Marital Deduction allows (non-foreign) spouses to transfer any amount of wealth with no transfer tax consequences. Taxation in the United States 38
Excise taxes The U.S. maintains federal excise taxes on gasoline, diesel, distilled spirits, tobacco products, and some firearms. At this time (2010), the excise rates on motor fuel are 18.4¢ per gallon (4.9¢/l) for gasoline and 24.4¢ per gallon (6.4¢/l) for diesel (for highway use). Consumers also pay a 7.5% excise tax on airfare and a 10% excise tax on tanning services.
Reform
In 2005, the President's Advisory Panel for Federal Tax Reform criticized the tax system as being extremely complex, requiring detailed record-keeping, lengthy instructions, and complicated schedules, worksheets, and forms. They stated that it penalizes work, discourages saving and investment, and hinders the competitiveness of American business. The tax code is commonly riddled with provisions that treat similarly An anti-IRS symbol, situated taxpayers differently and create perceptions of sometimes used by tax [35] reform advocates unfairness. The panel's major reform push was for the removal of the Alternative Minimum Tax, which is not indexed for inflation. Several organizations and individuals are working for tax reform in the United States including Americans for Tax Reform, Citizens for an Alternative Tax System, Americans For Fair Taxation, and Libertarian Party (United States). Various proposals have been put forth for tax simplification in Congress including the FairTax and various Flat tax plans. Proposals have also been put forth to completely abolish the Federal Income Tax for individuals.
State and local government taxation
All states are recognized as having a plenary power to assess taxes on their citizens and on activities that occur within their borders, so long as those taxes do not infringe on a power reserved for the federal government. The Supreme Court has found, in various cases, that states cannot impose taxes "'Revenue Reform' Train Stopped by 'Vested Interests,' designed to impede interstate commerce or influence 'Local Issues,' 'Trusts,' and other poles" — Political cartoon international relations. States are also prohibited from from 1880–1900 commenting on tax reform. assessing taxes in ways that discriminate on the basis of race, gender, religion, alienage, or nationality. Finally, states may not condition the right to vote on payment of taxes. The Twenty-fourth Amendment to the United States Constitution, ratified in 1964, specifically prohibits such a condition in Federal elections; the Supreme Court ruled in Harper v. Virginia Board of Elections that the Equal Protection Clause of the Fourteenth Amendment does the same in state elections.
Local government is now typically financed by value-based property taxes, mainly on real estate. Additional taxes may be in the form of fixed sales taxes and use taxes. Local government fees such as building permit fees may reflect the added capital cost and operating costs of services such as schools and parks. Local governments may also collect fines (parking and traffic tickets), income tax, gross receipts or gross payroll tax, or a portion of sales taxes (such as meal taxes) collected by the state. In California, seeds, bulbs, starter plants and trees obtained from a garden Taxation in the United States 39
center are taxed if adjudged for decorative purposes while plants for food production are untaxed, as is food in California. Almost every state imposes "sin taxes" on products frowned upon by the community, including cigarettes and liquor. Many states also impose a gas tax. The power of the state to tax encompasses the ability to empower jurisdictions within the state such as counties, cities and school districts to impose taxes on their residents. These jurisdictions may impose any of the kinds of taxes that the state may, within the boundaries established by state law.
Income, sales, and property Each state also has its own tax system. Typically there is a tax on real estate, usually called "property taxes". Real estate taxes are often imposed on the value of real estate by reason of its ownership. For example, in Texas the real estate tax is imposed on the real estate and in particular on the owner of the real estate as of January 1 of each tax year. The tax is computed by applying a tax rate to the appraised value of the real estate as of the tax date. Some states like New York also have a real estate transfer tax. There may be additional income taxes, sales taxes, and excise taxes (including use taxes). Taxable income for state purposes is usually based on federal taxable income with certain state specific adjustments. For example, some states tax municipal bond interest derived from other states that are otherwise exempt from federal income tax. Thus, this income must be added to the federal taxable income to compute the income amount for state income tax purposes. Oil and mineral producing states often impose a severance tax, similar to an excise tax in that tax is paid on the production of products, rather than on sales. Similarly, most New England states have yield taxes on timber/firewood cutting, payable as a percentage of the value cut, not the profit. Taxes on hotel rooms are common, and politically popular because the citizens will often approve such a tax while the taxpayers will come from other areas. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not levy an individual income tax. New Hampshire and Tennessee only tax interest and dividend income. Delaware, Oregon, Montana and New Hampshire have no state or local sales tax. Alaska has no state sales tax, but allows localities to collect their own sales taxes up to a state-specified maximum. Many states also levy personal property taxes, which are annual taxes on the privilege of owning or possessing items of personal property within the boundaries of the state. Automobile and boat registration fees are a subset of this tax; however, most people are unaware that practically all personal property is also subject to personal property tax. Usually, household goods are exempt; but virtually all objects of value (including art) are covered, especially when regularly used or stored outside of the taxpayer's household. States permit the creation of special assessment districts (typically for provision of water, removal of sewage, or for parks, public transit, emergency services or schools) whose boundaries may be independent of other boundaries and whose income may be from one or more of service assessments, property taxes, parcel taxes, a portion of road or bridge tolls, or an additional increment upon sales taxes in addition to the non-tax fees for services provided (such as metered water). State government is financed mainly by a mix of sales and/or income taxes and to a lesser extent by corporate registration fees, certain excise taxes, and automobile license fees. Taxation in the United States 40
City and county tax Cities and counties in the individual states may levy additional taxes, for instance to improve parks or schools, or pay for police, fire departments, local roads, and other services. As in the case of the IRS, they generally require a tax payment account number. Other local governmental agencies may also have the power to tax, notably independent school districts. Local government usually collect property taxes but may also collect sales taxes and income taxes. Some cities collect income tax on not only residents but non-residents employed in the city. This tax can even be incurred when a non-resident works temporarily in the city. For example, in 1992 the city of Philadelphia began enforcing the collection of city wage taxes on visiting baseball players who played games in Philadelphia.[36] At least some counties levy an Occupational Privilege Tax (OPT), usually for a small amount, in some cases less than $100/yr.
Tax protester arguments Various individuals and groups have questioned the legitimacy of United States federal income tax. One such group argues that the 16th Amendment to the United States Constitution was not approved by the requisite number of states[37] and therefore never came into effect. The argument that the Sixteenth Amendment was "never ratified" has been rejected by the Internal Revenue Service and by the courts and ruled to be a frivolous argument.[38] [39] [40]
VDA: voluntary disclosure agreement A voluntary disclosure agreement (VDA) is a program whereby taxpayers can receive certain benefits from proactively disclosing prior period tax liabilities in accordance with a binding agreement.[41]
List of taxes Taxes and fees imposed by federal, state or local laws.
• Alternative Minimum Tax (AMT) • Federal unemployment tax • Luxury taxes • School tax (FUTA) • U.S. capital gains tax • FICA tax (includes Social Security • Property tax • State income tax tax and related programs) • Corporate income tax • Gasoline tax • Real estate tax • State unemployment tax (SUTA) • U.S. estate tax • Generation Skipping Tax • Recreational vehicle tax • Tariffs • U.S. excise tax (includes taxes on • Gift tax • Rental car tax • Telephone federal cigarettes and alcoholic beverages) excise tax • U.S. federal income tax • IRS penalties • Resort tax (also known as • Vehicle sales tax Hotel/Motel tax, occupancy tax) • Road usage taxes (Commercial • Workers Vehicle Operators) compensation tax • Sales tax and equivalent use tax Taxation in the United States 41
See also • Federal tax revenue by state • Federal spending and taxation across states • Tax forms in the United States • Non-profit organization • Taxation • Tax avoidance and tax evasion • Tax fraud • Tax policy • Tax resistance • Tax shelter • Development Impact Tax • Wealth tax • Marriage penalty • Expense account • United States Department of Justice Tax Division • US State NonResident Withholding Tax • Payroll tax
External links • WikiCPA [42] • The Tax History Museum [43] provides a synthetic overview of the history of American taxation. • HindSite [44] provides a historical overview of state and local fiscal politics in the U.S. • Total U.S. tax revenue 2003 [45] • How are U.S. taxes spent? [46] • VoteGopher 2008 Presidential Candidates on Tax & Spending [47]
References [1] Tariff Act, Ch. 349, 28 Stat. 509 (Aug. 15, 1894). [2] Article I, Section 2, Clause 3 (as modified by Section 2 of the Fourteenth Amendment) and Article I, Section 9, Clause 4.
[3] Income tax collection (http:/ / www. irs. gov/ pub/ irs-soi/ 02inrate. pdf), Internal Revenue Service
[4] See 26 U.S.C. § 164(f) (http:/ / www. law. cornell. edu/ uscode/ 26/ 164. html#f).
[5] Doherty, Brian (June, 1995). "Best of Both Worlds" (http:/ / reason. com/ archives/ 1995/ 06/ 01/ best-of-both-worlds). Reason. . Retrieved July 28, 2010. [6] For the tax year 2008 Form 1040, for example, the interim payment due dates are April 15, 2008, June 16, 2008 (i.e., the 16th, because June 15 falls on a weekend), September 15, 2008, and January 15, 2009. The initial tax return filing deadline for the 2008 Form 1040 would be April 15, 2009. [7] See, generally, 2007 Instructions for Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, Internal Revenue Service, U.S. Department of the Treasury. [8] Instructions for 2009 Form 1040, page 89, Internal Revenue Service, U.S. Dep't of the Treasury.
[9] Income from Abroad is Taxable (http:/ / www. irs. gov/ businesses/ article/ 0,,id=180946,00. html), Internal Revenue Service
[10] Internal Revenue Service, Publication 535 (2007), Business Expenses (http:/ / www. irs. gov/ publications/ p535/ ch11. html#d0e8332), ch. 11: Reimbursement of Travel, Meals, and Entertainment
[11] Federal Budget Spending and the National Debt (http:/ / www. federalbudget. com)
[12] Stock Options (http:/ / money. cnn. com/ 2001/ 04/ 10/ living/ q_stockoptions/ ), CNN Money [13] Piketty T., Saez E. "How Progressive is the US Federal Tax System?" Journal of Economic Perspectives, Vol. 21, No. 1, Winter 2007, pp 3-24. quote from pp 22 in the conclusion.
[14] Consumption tax (http:/ / www. taxpolicycenter. org/ TaxFacts/ TFDB/ TFTemplate. cfm?Docid=294), Tax Policy Center
[15] http:/ / www. cbo. gov/ ftpdocs/ 53xx/ doc5324/ 04-02-TaxRates. htm Taxation in the United States 42
[16] Who Pays Taxes and Who Receives Government Spending? (http:/ / www. taxfoundation. org/ files/ wp1. pdf), Tax Foundation, March 2007
[17] Internal Revenue Service Data Book, 2007 (http:/ / www. irs. gov/ pub/ irs-soi/ 07databk. pdf), Internal Revenue Service
[18] "Effective Marginal Tax Rates on Labor Income, Table 2." (http:/ / www. cbo. gov/ ftpdocs/ 68xx/ doc6854/ 11-10-LaborTaxation. pdf). . Retrieved 2010-07-27.
[19] "Social Security & Medicare Tax Rates, Tax rates as a percentage of taxable earnings" (http:/ / www. ssa. gov/ OACT/ ProgData/ taxRates. html). . Retrieved 2010-07-27.
[20] "Effective Marginal Tax Rates on Labor Income, Distribution of Combined Federal and State Tax Rates, pg. 22 col. 2" (http:/ / www. cbo.
gov/ ftpdocs/ 68xx/ doc6854/ 11-10-LaborTaxation. pdf). . Retrieved 2010-07-27.
[21] Incomes and Politics (http:/ / users1. wsj. com/ lmda/ do/ checkLogin?mg=wsj-users1& url=http:/ / online. wsj. com/ article/
SB115714468338152049. html), Wall Street Journal, September 2, 2006
[22] IRS Individual Income Tax Returns (http:/ / www. irs. gov/ pub/ irs-soi/ 04in05tr. xls) (XLS), Internal Revenue Service, 1986-2004
[23] Kennickell, Arthur (2003-03). "A Rolling Tide: Changes in the Distribution of Wealth in the U.S., 1989-2001" (http:/ / www. federalreserve.
gov/ pubs/ feds/ 2003/ 200324/ 200324pap. pdf). United States Federal Reserve. . Retrieved 2007-09-19.
[24] Kamin, David; Shapiro, Isaac (2004-09-13). "Studies Shed New Light on Effects of Administration's Tax Cuts" (http:/ / www. cbpp. org/
8-25-04tax. htm). Center on Budget and Policy Priorities. . Retrieved 2006-07-23.
[25] Burns, Scott (2007-02-21). "Your real tax rate: 40%" (http:/ / articles. moneycentral. msn. com/ Taxes/ Advice/ YourRealTaxRate40. aspx). MSN Money. . Retrieved 2008-03-13. [26] Friedman, Milton; Friedman, Rose (1980). Free to choose. Harcourt. ISBN 978-0-15-633460-0.
[27] Waggoner, John (2004-11-26). "If you think inflation is on the move, time to protect portfolio" (http:/ / www. usatoday. com/ money/ perfi/
columnist/ waggon/ 2004-11-25-inflation_x. htm). USA Today. . Retrieved 2008-02-03.
[28] TPC Tax Topics Archive: The Individual Alternative Minimum Tax (AMT): 11 Key Facts and Projections (http:/ / www. taxpolicycenter.
org/ newsevents/ events_amt_facts. cfm)
[29] Weisman, Jonathan (March 7, 2004). "Falling Into Alternative Minimum Trouble" (http:/ / www. washingtonpost. com/ wp-dyn/ articles/
A36988-2004Mar6. html). The Washington Post. . Retrieved May 24, 2010. [30] Frum, David (2000). How We Got Here: The '70s. New York, New York: Basic Books. p. 324. ISBN 0465041957.
[31] Contribution and Benefit Base table (http:/ / www. ssa. gov/ OACT/ COLA/ cbb. html)
[32] National Average Wage Index (http:/ / www. ssa. gov/ OACT/ COLA/ AWI. html)
[33] US CODE: Title 42,409. “Wages” defined (http:/ / www. law. cornell. edu/ uscode/ html/ uscode42/ usc_sec_42_00000409----000-. html) [34] A Digest of the Death Duties with numerous examples illustrating their incidence, a copious index, and an appendix of the Customs and Inland Revenue acts, 1880, 1881, 1888, 1889, the Mortmain and Charitable Uses acts, 1888, 1891, and the Intestates' Estates Act Norman, A.W. London: W. Clowes, 1892.
[35] "America Needs a Better Tax System" (http:/ / www. taxreformpanel. gov/ 04132005. pdf). The President’s Advisory Panel on Federal Tax Reform. 2005-04-13. . Retrieved 2007-01-28.
[36] Professional Athletes (http:/ / vls. law. vill. edu/ orgs/ tax-law-compendium/ Student/ NONRESAT. HTM)
[37] Give Me Liberty (http:/ / www. givemeliberty. org)
[38] Frivolous Tax (http:/ / www. irs. gov/ pub/ irs-utl/ friv_tax. pdf), Internal Revenue Service [39] United States v. Thomas, 788 F.2d 1250, (7th Cir. 1986), cert. denied, 107 S.Ct. 187 (1986); United States v. Benson, 941 F.2d 598, 91-2 U.S. Tax Cas. (CCH) paragr. 50,437 (7th Cir. 1991); Knoblauch v. Commissioner, 749 F.2d 200, 85-1 U.S. Tax. Cas. (CCH) paragr. 9109 (5th Cir. 1984), cert. denied, 474 U.S. 830 (1985); Ficalora v. Commissioner, 751 F.2d 85, 85-1 U.S. Tax Cas. (CCH) paragr. 9103 (2d Cir. 1984); Sisk v. Commissioner; 791 F.2d 58, 86-1 U.S. Tax Cas. (CCH) paragr. 9433 (6th Cir. 1986); United States v. Sitka, 845 F.2d 43, 88-1 U.S. Tax Cas. (CCH) paragr. 9308 (2d Cir.), cert. denied, 488 U.S. 827 (1988); United States v. Stahl, 792 F.2d 1438, 86-2 U.S. Tax Cas. (CCH) paragr. 9518 (9th Cir. 1986), cert. denied, 107 S. Ct. 888 (1987); United States v. House, 617 F. Supp. 237, 87-2 U.S. Tax Cas. (CCH) paragr. 9562 (W.D. Mich. 1985); Ivey v. United States, 76-2 U.S. Tax Cas. (CCH) paragr. 9682 (E.D. Wisc. 1976). [40] Brown v. Commissioner; 53 T.C.M. (CCH) 94, T.C. Memo 1987-78, CCH Dec. 43,696(M) (1987); Lysiak v. Commissioner; 816 F.2d 311, 87-1 U.S. Tax Cas. (CCH) paragr. 9296 (7th Cir. 1987); and Miller v. United States, 868 F.2d 236, 89-1 U.S. Tax Cas. (CCH) paragr. 9184 (7th Cir. 1989). For background on how arguments that the tax laws are unconstitutional may help the prosecution prove willfulness in tax evasion cases, see the United States Supreme Court decision in Cheek v. United States, 498 U.S. 192 (1991) (defendant arguing about constitutionality may be evidence that the defendant was aware of the tax law, and is not a defense to a charge of willfulness).
[41] Taxes - Voluntary Disclosure (http:/ / www. michigan. gov/ taxes/ 0,1607,7-238-43549-156155--,00. html)
[42] http:/ / wikicpa. com
[43] http:/ / www. tax. org/ Museum/ default. htm
[44] http:/ / www. hist. umn. edu/ ~hindman/
[45] http:/ / www. taxpolicycenter. org/ TaxFacts/ TFDB/ TFTemplate. cfm?Docid=407& Topic2id=90
[46] http:/ / www. federalbudget. com/
[47] http:/ / votegopher. com/ Taxation in the United Kingdom 43 Taxation in the United Kingdom
Taxation in the United Kingdom may involve payments to a minimum of two different levels of government: The central government (Her Majesty's Revenue and Customs) and local government. Central government revenues come primarily from income tax, National Insurance contributions, value added tax, corporation tax and fuel duty. Local government revenues come primarily from grants from central government funds, business rates in England and Wales, Council Tax and increasingly from fees and charges such as those from on-street parking. In the fiscal year 2007-08, total government revenue was 39.2 per cent of GDP, with net taxes and National Insurance contributions standing at 36.9 per cent of GDP[1] —approximately £606,661,000,000 (using 2008 nominal GDP measured in dollars, and converting using 2009 conversion rate).
History Income tax was first implemented in Britain by William Pitt the Younger in his budget of December 1798 to pay for weapons and equipment in preparation for the Napoleonic Wars. Pitt's new graduated (progressive) income tax began at a levy of 2 old pence in the pound (1/120) on incomes over £60 (the equivalent of £48,700 in 2007) and increased up to a maximum of 2 shillings (10%) on incomes of over £200. Pitt hoped that the new income tax would raise £10 million, but actual receipts for 1799 totalled just over £6 million.[2] Income tax was levied under five schedules. Income not falling within those schedules was not taxed. The schedules were: • Schedule A (tax on income from UK land) • Schedule B (tax on commercial occupation of land) • Schedule C (tax on income from public securities) • Schedule D (tax on trading income, income from professions and vocations, interest, overseas income and casual income) • Schedule E (tax on employment income) Later a sixth Schedule, Schedule F (tax on UK dividend income) was added. Pitt's income tax was levied from 1799 to 1802, when it was abolished by Henry Addington during the Peace of Amiens. Addington had taken over as prime minister in 1801, after Pitt's resignation over Catholic Emancipation. The income tax was reintroduced by Addington in 1803 when hostilities recommenced, but it was again abolished in 1816, one year after the Battle of Waterloo. The UK income tax was reintroduced by Sir Robert Peel in the Income Tax Act 1842. Peel, as a Conservative, had opposed income tax in the 1841 general election, but a growing budget deficit required a new source of funds. The new income tax, based on Addington's model, was imposed on incomes above £150 (the equivalent of £111,800 in 2007). UK income tax has changed over the years. Originally it taxed a person's income regardless of who was beneficially entitled to that income, but now a person owes tax only on income to which he or she is beneficially entitled. Most companies were taken out of the income tax net in 1965 when corporation tax was introduced. These changes were consolidated by the Income and Corporation Taxes Act 1970. Also the schedules under which tax is levied have changed. Schedule B was abolished in 1988, Schedule C in 1996 and Schedule E in 2003. For income tax purposes, the remaining schedules were superseded by the Income Tax (Trading and Other Income) Act 2005, which also repealed Schedule F completely. The Schedular system and Schedules A and D still remain in force for corporation tax. The highest rate peaked in the Second World War at 99.25% and remained at about 95% till the late 1970s. In 1974 the top-rate of income tax increased to its highest rate since the war, 83%. This applied to incomes over £20,000, and combined with a 15% surcharge on 'un-earned' income (investments and dividends) could add to a 98% marginal rate of personal income tax. In 1974, as many as 750,000 people were liable to pay the top-rate of income tax. [3] Margaret Thatcher, who favoured indirect taxation, reduced personal income tax rates during the 1980s. [4] In Taxation in the United Kingdom 44
the first budget after her election victory in 1979, the top rate was reduced from 83% to 60% and the basic rate from 33% to 30%. [5] The basic rate was also cut for three successive budgets - to 29% in the 1986 budget, 27% in 1987 and to 25% in 1988. [6] The top rate of income tax was cut to 40% in the 1988 budget. Business rates were introduced in England and Wales in 1990, and are a modernised version of a system of rating that dates back to the Elizabethan Poor Law of 1601. As such, business rates retain many previous features from, and follow some case law of, older forms of rating. The Finance Act 2004 introduced an income tax regime known as "pre-owned asset tax" which aims to reduce the use of common methods of inheritance tax avoidance.[7]
Overview Income tax forms the bulk of revenues collected by the government. The second largest source of government revenue is National Insurance Contributions. The third largest source of government revenues is value added tax (VAT), and the fourth-largest is corporation tax.
Residence and domicile
UK source income is generally subject to UK taxation no matter the citizenship nor the place of residence of the individual nor the place of registration of the company. For individuals this means the UK income tax liability of one who is neither resident nor ordinarily resident in the UK is limited to any tax deducted at source on UK income, together with tax on income from a trade or profession carried on through a permanent establishment in the UK and tax on rental income from UK real A pie chart showing the projected constituents of UK taxation receipts for the tax year estate. 2008-2009, according to the 2008 Budget. Individuals who are both resident and domiciled in the UK are additionally liable to taxation on their worldwide income and gains. For individuals resident but not domiciled in the UK (a "non-dom"), foreign income and gains have historically been taxed on the remittance basis, that is to say, only income and gains remitted to the UK are taxed (for such people the UK is sometimes called a tax haven). However from 6 April 2008, a (long term [resident 7 of previous 9 years]) non-dom wishing to retain the remittance basis is required to pay an annual tax of £30,000.[8]
Domicile here is a term with a technical meaning. Very roughly (and this is a considerable simplification) an individual is domiciled in the UK if he or she was born in the UK or if the UK is their permanent home, and are not a UK domicile if he or she was born outside of the UK and do not intend to remain permanently. A company is resident in the UK if it is UK-incorporated or if its central management and control are in the UK (although in the former case a company could be resident in another jurisdiction in certain circumstances where a tax treaty applies). Double taxation of income and gains may be avoided by an applicable double tax treaty - the UK has one of the largest networks of treaties of any country.[9] [10] Taxation in the United Kingdom 45
Examples of non-dom status Most migrant workers (including those from within the EEA) would classify as non-doms. However, since the non-dom exemption applies only to income sourced from outside of the UK, the majority of people making use of the tax exemption are wealthy individuals with substantial income from outside of the UK (e.g. from foreign savings.) Typical such individuals include senior company executives, bankers, lawyers, business owners and international recording artists.
The tax year The tax year in the UK, which applies to income tax and other personal taxes, runs from 6 April in one year to 5 April the next (for income tax purposes). Hence the 2009-10 tax year ran from 6 April 2009 to 5 April 2010. The odd dates are due to events in the mid-18th century. The English quarter days are traditionally used as the dates for collecting rents (on, for example, agricultural properties). The tax system was also based on a tax year ending on Lady Day (25 March). When the Gregorian calendar was adopted in the UK in September 1752 in place of the Julian calendar, the two were out of step by 11 days. However, it was felt unacceptable for the tax authorities to lose out on 11 days' tax revenues, so the start of the tax year was moved, firstly to 5 April and then, in 1800, to 6 April. The tax year is sometimes also called the Fiscal Year. The Financial Year, used mainly for corporation tax purposes, runs from 1 April to 31 March. Financial Year 2010 runs from 1 April 2010 to 31 March 2011, as Financial Years are named according to the calendar year in which they start.
Personal taxes
Income tax
Income tax forms the bulk of revenues collected by the government. Each person has an income tax personal allowance, and income up to this amount in each tax year is free of tax for everyone. For 2010-11 the tax allowance for under 65s is £6,475. This reduces by £1 for every £2 of taxable income above £100,000.[11] Above this amount there are a number of tax bands — each taxed at a different rate (as of 2010-11):[11]
UK income tax and National Insurance charges (2010-11).
UK income tax and National Insurance as a percentage of taxable pay (2010-11). Taxation in the United Kingdom 46
Rate Dividend income Savings income Other income (inc employment) Band (above any personal allowance)
Lower rate N/A 10% N/A £0 - £2440 applies only if total income falls in this band
Basic rate 10% 20% 20% £0 - £37,400
Higher rate 32.5% 40% 40% over £37,400
Additional rate N/A 50% 50% over £150,000
This table reflects the removal of the 10% starting rate from April 2008, which also saw the 22% income tax rate drop to 20%. Alistair Darling announced in the 2009 budget (22 April 2009) that, from April 2010 there would be a new 50% income tax rate for those earning more than £150,000. The taxpayer's income is assessed for tax according to a prescribed order, with income from employment using up the personal allowance and being taxed first, followed by savings income (from interest or otherwise unearned) and then dividends.
Exemptions on Investment
Certain investments carry a tax favoured status including: • UK Government Bonds (Gilts) While all income is taxable, gains are exempt for income tax purposes. • National Savings and Investments Certain investments via the state owned National Savings scheme are not subject to tax including Index linked Certificates (up to £15,000 per issue) and Premium Bonds a scheme that issues monthly prizes in place of interest on individual holdings up to £30,000. UK central government expenditure projection for tax year 2009-2010, according to the 2009 • Individual Savings Accounts Pre-Budget Report.
These permit up to £10,200.[12] Maximum of £5,100 in cash funds, and the balance being allocated either to mutual funds (Units Trusts and OEICs) or individual self-selected shares. No tax is deducted, although the 10% tax withheld on UK dividends cannot be reclaimed. • Pension funds These have the same tax treatment as ISAs in terms of growth. Full tax relief is also given at the individual's marginal rate on contributions or, in the case of an employer contributions, it is treated as an expense and is not taxed on the employee as a benefit in kind. Aside from a tax free lump sum of 25% of the fund, benefits taken from pension funds are taxable. • Venture Capital Trusts These are investments in smaller companies or funds of holdings in such companies over a minimum term of five years. These are not taxable and qualify for 30% tax relief against an individual's income. • Enterprise Investment Schemes A non taxable investment into smaller company shares over three years that qualifies for 20% tax relief. The facility also allows an indiviudal to defer capital gains liabilities (these gains can be stripped out in future years using the annual CGT allowance.) • Insurance bonds Taxation in the United Kingdom 47
These include offshore and onshore investment bonds issued by insurance companies. The main difference between the two is that corporation tax onshore means that gains are treated as if basic rate tax has been paid (this cannot be reclaimed by zero or starting rate tax payers). With both versions up to 5% for each complete year of investment can be taken without an immediate tax liability (subject to a maximum total of 100% of the original investment. On this basis, investors can plan an income stream while deferring any chargeable withdrawals until they are on a lower rate of tax, are no longer a UK resident, or their death.
Exceptions Many holdings and income from them are exempt for "historical reasons". These include • Special, low tax arrangements for the monarchy, such as the arrangement used by the British Royal Family [13] to avoid inheritance taxation. • Reduced income tax for special classes of person, such a non-doms, who claim to be resident in the UK but not "domiciled"[14] . • An Act of Parliament to protect the Earl of Abingdon and his “heirs and assignees” from paying income tax on the tolls on the Swinford Toll Bridge. • The income of charities is usually exempt from UK income tax.[15]
Inheritance tax Inheritance tax is levied on "transfers of value", meaning: 1. the estates of deceased persons; 2. gifts made within seven years of death (known as Potentially Exempt Transfers or "PETs"); 3. "lifetime chargeable transfers", meaning transfers into certain types of trust. See Taxation of trusts (United Kingdom). Legislation announced in the 2006 budget but not yet enacted will extend this category to many more trusts than previously. The first slice of cumulative transfers of value (known as the "nil rate band") is free of tax. This threshold is currently set at £312,000 (tax year 2008-09)[16] and, although it is raised annually, it has recently failed to keep up with house price inflation with the result that some 6 million households currently fall within the scope of inheritance tax. Over this threshold the rate is 40% on death. Any inheritance tax must be paid by the executors or administrators of the estate (the burden falling upon the beneficiaries) before probate is granted. Transfers of value between UK-domiciled spouses are exempt from tax. Recent changes to the tax mean that nil-rate bands will be transferable between spouses to reduce this burden - something which previously could only be done by setting up complex trusts. Gifts made more than seven years prior to death are not taxed; if they are made between three and seven years before death a tapered inheritance tax rate applies. There are some important exceptions to this treatment: the most important is the "reservation of benefit rule", which says that a gift is ineffective for inheritance tax purposes if the giver benefits from the asset in any way after the gift (for example, by gifting a house but continuing to live in it).
Council Tax Council tax is the system of local taxation used in England[17] , Scotland[18] and Wales[19] to part fund the services provided by local government in each country. It was introduced in 1993 by the Local Government Finance Act 1992, as a successor to the unpopular Community Charge ("poll tax"), which had (briefly) replaced the Rates system. The basis for the tax is residential property, with discounts for single people. As of 2008, the average annual levy on a property in England was £1,146.[20] . In 2006/2007 council tax in England amounted to £22.4 billion [21] and an additional £10.8 billion in sales, fees and charges, [22] Taxation in the United Kingdom 48
Sales taxes and duties
Value added tax The third largest source of government revenues is value added tax (VAT), charged at 17.5% on supplies of goods and services. It is therefore a tax on consumer expenditure. Certain goods and services are exempt from VAT, and others are subject to VAT at a lower rate of 5% (the reduced rate, such as domestic gas supplies) or 0% ("zero-rated", such as most food and children's clothing).[23] Exemptions are intended to relieve the tax burden on essentials while placing the full tax on luxuries, but disputes based on fine distinctions arise, such as the notorious "Jaffa Cake Case" which hinged on whether Jaffa Cakes were classed as (zero-rated) cakes—as was eventually decided—or (fully-taxed) chocolate-covered biscuits. Until 2001, VAT was charged at the full rate on sanitary towels. [24] On the 22nd June 2010, Chancellor George Osborne announced that from 4th January 2011 the UK VAT standard rate will increase from 17.5% to 20%.
Excise duties Excise duties are charged on, amongst other things, motor fuel, alcohol, tobacco, betting and vehicles.
Stamp duty Stamp duty is charged on the transfer of shares and certain securities at a rate of 0.5%. Modernised versions of stamp duty, stamp duty land tax and stamp duty reserve tax, are charged respectively on the transfer of real estate and shares and securities, at rates of up to 4% and 0.5% respectively.[25]
Motoring taxation Motoring taxes include: fuel duty (which itself also attracts VAT), and vehicle excise duty. Other fees and charges include the London congestion charge, various statutory fees including that for the compulsory vehicle test and that for vehicle registration, and in some areas on-street parking (as well as associated charges for violations).
Business taxes
Business rates Business rates is the commonly used name of non-domestic rates, a United Kingdom rate or tax charged to occupiers of non-domestic property. Business rates form part of the funding for local authorities, and are collected by them, but rather than receipts being retained directly they are pooled centrally and then redistributed. In 2005/06, £19.9 billion was collected in business rates, representing 4.35% of the total UK tax income.[26] Business rates are a property tax, where each non-domestic property is assessed with a rateable value, expressed in pounds. The rateable value broadly represents the annual rent the property could have been let for on a particular valuation date according to a set of assumptions. The actual bill payable is then calculated using a multiplier set by central government, and applying any reliefs.[27] Taxation in the United Kingdom 49
Business and personal taxes Some taxes are, depending on the circumstances, paid by both individuals and companies.
National Insurance contributions The second largest source of government revenues is National Insurance contributions (NIC), payable by employees, employers and the self-employed. Unlike income tax, Class 1 (non self-employed persons) NIC is paid between lower and upper thresholds, or between £105 and £770 per week for 2008-09.[28] A zero rate of NIC applies to earnings between the lower earnings limit of £90 per week and the earnings threshold of £105 per week (in 2008-09) to protect employees' contributory benefit entitlements. National Insurance is levied at 11% (that is, 11p in the £), but can be contracted-out for persons with a qualifying pension scheme with a reduction of 1.6%. There has also been the addition of a 1% rate on income above the upper threshold in recent years. Employers pay an additional 12.8% on earnings over the lower earnings threshold (£105 per week), but without the upper threshold, so total earnings are taxed at 12.8% per employee. Employers are additionally liable to Class 1A NIC at 12.8% on most benefits-in-kind provided to employees which are subject to income tax in the hands of the employee, and to Class 1B NIC (also at 12.8%) on the value of the tax and on certain benefits paid via a "PAYE Settlement Agreement". There are also separate arrangements for self-employed persons (who are normally liable to Class 2 flat rate NIC and Class 4 earnings-related NIC), married women, and voluntary sector workers.
Capital gains tax Capital gains are subject to tax at 18-28% (for individuals) or at the applicable marginal rate of corporation tax (for companies). The basic principle is the same for individuals and companies - the tax applies only on the disposal of a capital asset, and the amount of the gain is calculated as the difference between the disposal proceeds and the "base cost", being the original purchase price plus allowable related expenditure. However, from 6 April 2008, the rate and reliefs applicable to the chargeable gain differ between individuals and companies. Companies apply "indexation relief" to the base cost, increasing it in accordance with the Retail Prices Index so that (broadly speaking) the gain is calculated on a post-inflation basis (with different rules apply for gains accrued prior to March 1982). The gain is then subject to tax at the applicable marginal rate of corporation tax. Individuals are taxed at a flat rate of 18%, with no indexation relief (but subject to a limited relief for the first £1m of gains for "entrepreneurs".[29] . After the emergency budget on 22nd June 2010, the rate of capital gains tax was increased to 28% for higher rate taxpayers.
See also UK related • HM Revenue & Customs • Chartered Institute of Taxation • Institute of Indirect Taxation • Income in the United Kingdom • Tax credit • Starting rate of UK income tax Local taxation • Business rates • Council tax • Local income tax Taxation in the United Kingdom 50
General category • Tax • Tax haven • Tax law
References • James Kessler QC, Taxation of Foreign Domiciliaries (8th edn Key Haven Publications 2009) - discusses taxation of individuals who are UK resident but not UK domiciled. • James Kessler QC and Harriet Brown, Taxation of Charities (7th edn Key Haven Publications 2009) - discusses taxation of charities and the many exemptions from tax for charities.
External links • Guide to personal taxation [30], from UK government site Directgov (Doesn't link to correct file, website redirects to index) • Yahoo tax [31], UK tax portal • TaxationWeb [32], UK tax portal • Non Domicile Tax [33], understanding the UK policy on non-dom tax • Tax Office UK [34], Business Tax, Property Tax, UK Taxes • Taxation [35], weekly news information for UK tax practitioners • VAT Calculator [36] • Taxation of Charities online [37] • Taxation of Foreign Domiciliaries online [38] • UK VAT calculator [39]
References
[1] "Public Finances Databank" (http:/ / www. hm-treasury. gov. uk/ media/ A/ 9/ pfd_210808. xls). HM Treasury. 2008-08-21. pp. C1. . Retrieved 2008-08-23.
[2] "A tax to beat Napoleon" (http:/ / www. hmrc. gov. uk/ history/ taxhis1. htm). HM Revenue & Customs. . Retrieved 2007-01-24.
[3] IFS: Long-Term trends in British Taxation and Spending (http:/ / www. ifs. org. uk/ bns/ bn25. pdf)
[4] Thatcher Economics (http:/ / www. nationalreview. com/ nrof_bartlett/ bartlett200405170929. asp)
[5] 1979 budget (http:/ / www. margaretthatcher. org/ archive/ displaydocument. asp?docid=109497)
[6] 1988 budget (http:/ / www. margaretthatcher. org/ archive/ displaydocument. asp?docid=111449)
[7] REV BN 40: Tax Treatment Of Pre-Owned Assets (http:/ / www. hmrc. gov. uk/ budget2004/ revbn40. htm)
[8] (http:/ / www. hmrc. gov. uk/ cnr/ res-dom-faqs. htm) (http:/ / www. hmrc. gov. uk/ briefs/ income-tax/ brief1709. htm)
[9] (http:/ / www. icaew. com/ index. cfm/ route/ 154613/ icaew_ga/ en/ Library/ Links/ Tax/ Double_Taxation_Treaties)
[10] See IR20 - Residents and non-residents (http:/ / www. hmrc. gov. uk/ pdfs/ ir20. htm).
[11] "Rates and Allowances - Income Tax" (http:/ / www. hmrc. gov. uk/ rates/ it. htm). HM Revenue & Customs. . Retrieved 2010-05-02.
[12] http:/ / www. moneysupermarket. com/ c/ savings/ isas/ guide#How-much-invest
[13] Kay, Richard. "Palace fear over Queen's tax bill" (http:/ / www. dailymail. co. uk/ news/ article-113128/ Palace-fear-Queens-tax-bill. html). Daily Mail (London). .
[14] Wintour, Patrick (1 December 2009). "David Cameron tells Zac Goldsmith to end 'non-dom' tax status" (http:/ / www. guardian. co. uk/
politics/ 2009/ dec/ 01/ cameron-goldsmith-non-dom-status). The Guardian (London). . Retrieved 24 May 2010. [15] Taxation of Charities, James Kessler QC and Harriet Brown, 7th edition (2009)
[16] "Rates and Allowances - Inheritance tax" (http:/ / www. hmrc. gov. uk/ rates/ inheritance. htm). HM Revenue & Customs. . Retrieved 2007-01-24.
[17] Communities and Local Government - Council Tax: The Facts (http:/ / www. communities. gov. uk/ localgovernment/
localgovernmentfinance/ counciltaxes/ counciltaxfacts/ )
[18] Council Tax in Scotland (http:/ / www. scotland. gov. uk/ library3/ localgov/ ctvb-00. asp) Scottish Government publications
[19] Council Tax a guide (http:/ / www. voa. gov. uk/ council_tax/ Counciltax-aguide. htm) Valuation Office Agency
[20] Average council tax and % change 1999-00 to 2008-09 (http:/ / www. local. communities. gov. uk/ finance/ ctax/ data/ ctax089t1. pdf) Communities and local government - figures released 27th March 2008 Taxation in the United Kingdom 51
[21] Office of the Deputy Prime Minister, Statistical Release: Levels of council tax set by local authorities in England 2006/07, 2006 cited by
(http:/ / www. audit-commission. gov. uk/ pressoffice/ pressreleases/ Pages/
councilchargesraise11billionpoundshalfasmuchascounciltaxbutattracttoolittleattention. aspx). [22] Communities and Local Government in Local Government Finance Statistics: Revenue Outturn Service Expenditure Summary 2006/07.
cited by (http:/ / www. audit-commission. gov. uk/ pressoffice/ pressreleases/ Pages/
councilchargesraise11billionpoundshalfasmuchascounciltaxbutattracttoolittleattention. aspx)
[23] "Introduction to VAT" (http:/ / www. hmrc. gov. uk/ vat/ start/ introduction. htm). HM Revenue & Customs. . Retrieved 2008-11-23.
[24] "Animals and Animal Food" (http:/ / customs. hmrc. gov. uk/ channelsPortalWebApp/ channelsPortalWebApp. portal?_nfpb=true&
_pageLabel=pageVAT_ShowContent& id=HMCE_CL_000124& propertyType=document). HM Revenue & Customs. . Retrieved 2010-07-08.
[25] "Stamp Duty Land Tax Rates From 23/03/06 including archived Budget and Finance Bill information" (http:/ / www. hmrc. gov. uk/ so/
current_sdlt_rates. htm). HM Revenue & Customs. 2006-03-23. . Retrieved 2007-01-24.
[26] Public Finances Databank (http:/ / www. hm-treasury. gov. uk. / economic_data_and_tools/ finance_spending_statistics/ pubsec_finance/
psf_statistics. cfm) (see section C4), HM Treasury, retrieved 26 March 2007. Percentage based on Net taxes & NICs conts.
[27] The rates bill - How is it calculated? (http:/ / www. mybusinessrates. gov. uk/ rates/ how_calculated/ index. html), mybusinessrates.gov.uk
[28] "Rates and Allowances - National Insurance Contributions" (http:/ / www. hmrc. gov. uk/ rates/ nic. htm). HM Revenue & Customs. . Retrieved 2007-01-24.
[29] http:/ / www. hmrc. gov. uk/ cgt/ cgt-reform-en. pdf
[30] http:/ / www. direct. gov. uk/ MoneyTaxAndBenefits/ Taxes/ fs/ en
[31] http:/ / uk. biz. yahoo. com/ tax/ home. html
[32] http:/ / www. taxationweb. co. uk
[33] http:/ / www. thebusinesslounge. co. uk/ index. php/ non-domicile-tax/
[34] http:/ / www. taxofficeuk. com
[35] http:/ / www. taxation. co. uk
[36] http:/ / www. vatcalculator. org. uk
[37] http:/ / www. taxationofcharities. co. uk,
[38] http:/ / www. foreigndomiciliaries. co. uk/ index. php/ Main_Page,
[39] http:/ / vat-calculator. org. uk
Tax rates
In a tax system and in economics, the tax rate describes the burden ratio (usually expressed as a percentage) at which a business or person is taxed. There are several methods used to present a tax rate: statutory, average, marginal, effective, effective average, and effective marginal. These rates can also be presented using different definitions applied to a tax base: inclusive and exclusive.
Statutory A statutory tax rate is the legally imposed rate. An income tax could have multiple statutory rates for different income levels, where a sales tax may have a flat statutory rate.[1]
Average An average tax rate is the ratio of the amount of taxes paid to the tax base (taxable income or spending).[1] To calculate the average tax rate on an income tax, divide total tax liability by taxable income: • Let be the average tax rate. • Let be the tax liability. • Let be the taxable income. Tax rates 52
Marginal A marginal tax rate is the tax rate that applies to the last dollar of the tax base (taxable income or spending),[1] and is often applied to the change in one's tax obligation as income rises: To calculate the marginal tax rate on an income tax: • Let be the marginal tax rate. • Let be the tax liability. • Let be the taxable income.
For an individual, it can be determined by increasing or decreasing the income earned or spent and calculating the change in taxes payable. An individual's tax bracket is the range of income for which a given marginal tax rate applies. The marginal tax rate may increase or decrease as income or consumption increases, although in most countries the tax rate is (in principle) progressive. In such cases, the average tax rate will be lower than the marginal tax rate: an individual may have a marginal tax rate of 45%, but pay average tax of half this amount. In a jurisdiction with a regressive flat tax, the every taxpayer pays the same amount, regardless of income or consumption. Some proponents of the this system propose to exempt a fixed amount of earnings (e.g., the first ten thousand dollars) from the flat tax. In a revenue neutral situation, where imposition of a "flat tax" would target neither an increase nor decrease in the total tax revenue, the net effect of the flat tax would be to shift a significant portion of the current tax burden of the wealthy to other Americans. At the time the richest man in the world, Warren Buffett famously questioned the perceived "fairness" of this approach, rhetorically asking whether a tax system could be fair that asked for the same dollar amount from him as from his receptionist. He went on to point out that even the current progressive system was skewed towards the wealthy, by noting that his effective tax rate was 17.7% while his receptionist paid 30.0%. In economics, marginal tax rates are important because they are one of the factors that determine incentives to increase income; at higher marginal tax rates, some argue, the individual has less incentive to earn more. This is the foundation of the Laffer curve, which claims taxable income decreasing as a function of marginal tax rate, and therefore tax revenue begins to decrease after a certain point. Public discussion of "high taxes" may refer to overall tax rates or marginal taxes. Marginal tax rates may be published explicitly, together with the corresponding tax brackets, but they can also be derived from published tax tables showing the tax for each income. It may be calculated noting how tax changes with changes in pre-tax income, rather than with taxable income. Marginal tax rates do not fully describe the impact of taxation. A flat rate poll tax has a marginal rate of zero, while a discontinuity in tax paid can lead to positively or negatively infinite marginal rates at particular points.
Effective An effective tax rate refers to the actual rate, i.e., the rate existing in fact.[1] Both average and marginal tax rates can be expressed as effective tax rates. The effective tax rate is the amount of tax an individual or firm pays when all other government tax offsets or payments are applied, divided by the tax base (total income or spending).[2] If certain groups have high degrees of tax offsets compared to other groups, their effective tax rate will be different, even where their official tax rates and marginal tax rates will be equal. The effective rate of tax can often be discussed in terms of the effective marginal rate of tax - namely the amount of effective tax paid as a percentage of the last dollar earned or spent. Tax rates 53
Effective average An effective average tax rate (or average effective tax rate) may differ from an average tax rate because some measure of income other than taxable income is used. For example, the Joint Committee on Taxation typically calculates the effective average tax rate as the ratio of taxes paid to a constructed measure of "economic income".[1]
Effective marginal An effective marginal tax rate (or marginal effective tax rate, marginal deduction rate) may differ from a marginal tax rate because the taxpayer may be in an income range in which she/he is subject to a phase-out of some exclusion or deduction.[1] Where social security and other benefits are related to income, the combined tax and benefit effect can also be taken into account giving a result sometimes described as the marginal effective tax rate or the marginal deduction rate. If the marginal deduction rate exceeds 100%, then an increase in gross income leads to a decrease in disposable income, discouraging attempts to increase income. When this occurs for low income individuals, it is known as the "poverty trap".
Inclusive / exclusive
Tax rates can be presented differently due to differing definitions of tax base, which can make comparisons between tax systems confusing. Some tax systems include the taxes owed in the tax base (tax-inclusive), while other tax systems do not include taxes owed as part of the base (tax-exclusive).[3] In the United States, sales taxes are quoted exclusively and income taxes are quoted inclusively. Value added tax (VAT) countries often display this tax inclusively; however, Goods and Services Tax countries do not.[4]
For direct rate comparisons between exclusive and inclusive taxes, one rate must be manipulated to look like the other. When a tax Mathematically, 25% income tax out of $100 income system imposes taxes primarily on income, the tax base is a yields the same as 33% sales tax on a $75 purchase. household's pre-tax income. The appropriate income tax rate is applied to the tax base to calculate taxes owed. Under this formula, taxes to be paid are included in the base on which the tax rate is imposed. If an individual's gross income is $100 and income tax rate is 20%, taxes owed equals $20. The income tax is taken "off the top", so the individual is left with $80 in after-tax money. Some tax laws impose taxes on a tax base equal to the pre-tax portion of a good's price. Unlike the income tax example above, these taxes do not include actual taxes owed as part of the base. A good priced at $80 with a 25% exclusive sales tax rate yields $20 in taxes owed. Since the sales tax is added "on the top", the individual pays $20 of tax on $80 of pre-tax goods for a total cost of $100. In either case, the tax base of $100 can be treated as two parts—$80 of after-tax spending money and $20 of taxes owed. A 25% exclusive tax rate approximates a 20% inclusive tax rate after adjustment.[3] By including taxes owed in the tax base, an exclusive tax rate can be directly compared to an inclusive tax rate.
Inclusive income tax rate comparison to an exclusive sales tax rate: • Let be the income tax rate. For a 20% rate, then • Let be the rate in terms of a sales tax. • Let be the price of the good (including the tax). The revenue that would go to the government: Tax rates 54
The revenue remaining for the seller of the good:
To convert the tax, divide the money going to the government by the money the company nets:
Therefore, to adjust any inclusive tax rate to that of an exclusive tax rate, divide the given rate by 1 minus that rate. • 15% inclusive = 18% exclusive • 20% inclusive = 25% exclusive • 25% inclusive = 33% exclusive • 33% inclusive = 50% exclusive • 50% inclusive = 100% exclusive
See also • Progressive tax • Proportional tax • Regressive tax • Tax incidence • Tax rates around the world • Tax rates of Europe • Tax exporting • Capital flight
References
[1] "What is the difference between statutory, average, marginal, and effective tax rates?" (http:/ / www. fairtax. org/ PDF/
WhatIsTheDifferenceBetweenTaxRates. pdf). Americans For Fair Taxation. . Retrieved 2007-04-23.
[2] "A statistical overview" (http:/ / comparativetaxation. treasury. gov. au/ content/ report/ html/ 05_Chapter_3. asp). Australian Commonwealth Government Treasury. . Retrieved 2008-03-13. [3] Bachman, Paul; Haughton, Jonathan; Kotlikoff, Laurence J.; Sanchez-Penalver, Alfonso; Tuerck, David G. (2006-11). "Taxing Sales under
the FairTax – What Rate Works?" (http:/ / www. beaconhill. org/ FairTax2006/ TaxingSalesundertheFairTaxWhatRateWorks061005. pdf). Beacon Hill Institute. Tax Analysts. . Retrieved 2007-04-24.
[4] "Consumption Tax Topics that OECD will probably address" (http:/ / www3. ietf. org/ proceedings/ 99jul/ slides/ trade-oecd-99jul/ tsld015. htm). 1999-06. . Retrieved 2007-04-23. Dividend 55 Dividend
Accountancy
Key concepts
Accountant · Bookkeeping · Cash and accrual basis · Constant Item Purchasing Power Accounting · Cost of goods sold · Debits and credits · Double-entry system · Fair value accounting · FIFO & LIFO · GAAP / International Financial Reporting Standards · General ledger · Historical cost · Matching principle · Revenue recognition · Trial balance
Fields of accounting
Cost · Financial · Forensic · Fund · Management · Tax
Financial statements
Balance sheet · Statement of cash flows · Statement of changes in equity · Statement of comprehensive income · Notes · MD&A
Auditing
Auditor's report · Financial audit · GAAS / ISA · Internal audit · Sarbanes–Oxley Act
Professional Accountants
ACCA · CA · CGA · CMA · CPA · PA
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders.[1] When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend. For a joint stock company, a dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding. For the joint stock company, paying dividends is not an expense; rather, it is the division of after tax profits among shareholders. Retained earnings (profits that have not been distributed as dividends) are shown in the shareholder equity section in the company´s balance sheet - the same as its issued share capital. Public companies usually pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from a regular one. Cooperatives, on the other hand, allocate dividends according to members' activity, so their dividends are often considered to be a pre-tax expense. Dividends are usually settled on a cash basis, store credits (common among retail consumers' cooperatives) and shares in the company (either newly created shares or existing shares bought in the market.) Further, many public companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder. Dividend 56
History The word "dividend" comes from the Latin word "dividendum" meaning "the thing which is to be divided among all".[2]
Joint stock company dividends A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a dividend in proportion to their shareholding.
Forms of payment Cash dividends (most common) are those paid out in currency, usually via electronic funds transfer or a printed paper check. Such dividends are a form of investment income and are usually taxable to the recipient in the year they are paid. This is the most common method of sharing corporate profits with the shareholders of the company. For each share owned, a declared amount of money is distributed. Thus, if a person owns 100 shares and the cash dividend is USD $0.50 per share, the holder of the stock will be paid USD $50. Stock or scrip dividends are those paid out in the form of additional stock shares of the issuing corporation, or other corporation (such as its subsidiary corporation). They are usually issued in proportion to shares owned (for example, for every 100 shares of stock owned, 5% stock dividend will yield 5 extra shares). If this payment involves the issue of new shares, this is very similar to a stock split in that it increases the total number of shares while lowering the price of each share and does not change the market capitalization or the total value of the shares held (see also Stock dilution). Property dividends or dividends in specie (Latin for "in kind") are those paid out in the form of assets from the issuing corporation or another corporation, such as a subsidiary corporation. They are relatively rare and most frequently are securities of other companies owned by the issuer, however they can take other forms, such as products and services. Other dividends can be used in structured finance. Financial assets with a known market value can be distributed as dividends; warrants are sometimes distributed in this way. For large companies with subsidiaries, dividends can take the form of shares in a subsidiary company. A common technique for "spinning off" a company from its parent is to distribute shares in the new company to the old company's shareholders. The new shares can then be traded independently.
Dates Dividends must be "declared" (approved) by a company’s Board of Directors each time they are paid. For public companies, there are four important dates to remember regarding dividends. These are discussed in detail with examples at the Securities and Exchange Commission site [3] The declaration date is the day the Board of Directors announces its intention to pay a dividend. On this day, a liability is created and the company records that liability on its books; it now owes the money to the stockholders. On the declaration date, the Board will also announce a date of record and a payment date. The in-dividend date is the last day, which is one trading day before the ex-dividend date, where the stock is said to be cum dividend ('with [including] dividend'). In other words, existing holders of the stock and anyone who buys it on this day will receive the dividend, whereas any holders selling the stock lose their right to the dividend. After this date the stock becomes ex dividend. The ex-dividend date (typically 2 trading days before the record date for U.S. securities) is the day on which all shares bought and sold no longer come attached with the right to be paid the most recently declared dividend. This is an important date for any company that has many stockholders, including those that trade on exchanges, as it makes reconciliation of who is to be paid the dividend easier. Existing holders of the stock will receive the dividend even if Dividend 57
they now sell the stock, whereas anyone who now buys the stock will not receive the dividend. It is relatively common for a stock's price to decrease on the ex-dividend date by an amount roughly equal to the dividend paid. This reflects the decrease in the company's assets resulting from the declaration of the dividend. The company does not take any explicit action to adjust its stock price; in an efficient market, buyers and sellers will automatically price this in. Whenever a company announces a dividend pay-out, it also announces a "Book closure Date" which is a date on which the company will ideally temporarily close its books for fresh transfers of stock. Read "Book Closure" for a better understanding. Shareholders who properly registered their ownership on or before the date of record, known as stockholders of record, will receive the dividend. Shareholders who are not registered as of this date will not receive the dividend. Registration in most countries is essentially automatic for shares purchased before the ex-dividend date. The payment date is the day when the dividend checks will actually be mailed to the shareholders of a company or credited to brokerage accounts.
Dividend-reinvestment plans Some companies have dividend reinvestment plans, or DRIPs. These plans allow shareholders to use dividends to systematically buy small amounts of stock, usually with no commission and sometimes at a slight discount. In some cases the shareholder might not need to pay taxes on these re-invested dividends, but in most cases they do.
Criticism Management and the board may believe that the money is best re-invested into the company: research and development, capital investment, expansion, etc. Proponents of this view (and thus critics of dividends per se) suggest that an eagerness to return profits to shareholders may indicate having run out of good ideas for the future of the company. Some studies, however, have demonstrated that companies that pay dividends have higher earnings growth, suggesting that dividend payments may be evidence of confidence in earnings growth and sufficient profitability to fund future expansion.[4] When dividends are paid, individual shareholders in many countries suffer from double taxation of those dividends: the company pays income tax to the government when it earns any income, and then when the dividend is paid, the individual shareholder pays income tax on the dividend payment; in many countries, the tax rate on dividend income is lower than for other forms of income to compensate for tax paid at the corporate level. Taxation of dividends is often used as justification for retaining earnings, or for performing a stock buyback, in which the company buys back stock, thereby increasing the value of the stock left outstanding. In contrast, corporate shareholders often do not pay tax on dividends because the tax regime is designed to tax corporate income (as opposed to individual income) only once. The shareholder will pay a tax on capital gains (which is often taxed at a lower rate than ordinary income) only when the shareholder chooses to sell the stock. If a holder of the stock chooses to not participate in the buyback, the price of the holder's shares should rise, but the tax on these gains is delayed until the actual sale of the shares. Certain types of specialized investment companies (such as a REIT in the U.S.) allow the shareholder to partially or fully avoid double taxation of dividends. Shareholders in companies which pay little or no cash dividends can reap the benefit of the company's profits when they sell their shareholding, or when a company is wound down and all assets liquidated and distributed amongst shareholders. This, in effect, delegates the dividend policy from the board to the individual shareholder. Payment of a dividend can increase the borrowing requirement, or leverage, of a company. Dividend 58
Miscellaneous specific types In Australia and New Zealand, companies also forward franking credits or imputation credits to shareholders along with dividends. These franking credits represent the tax paid by the company upon its pre-tax profits. One dollar of company tax paid generates one franking credit. Companies can forward any proportion of franking up to a maximum amount that is calculated from the prevailing company tax rate: for each dollar of dividend paid, the maximum level of franking is the company tax rate divided by (1 - company tax rate). At the current 30% rate, this works out at 0.30 of a credit per 70 cents of dividend, or 42.857 cents per dollar of dividend. The shareholders who are able to use them offset these credits against their income tax bills at a rate of a dollar per credit, thereby effectively eliminating the double taxation of company profits. This system is called dividend imputation. The UK's taxation system operates along similar lines: when a shareholder receives a dividend, the basic rate of income tax is deemed to already have been paid on that dividend. This ensures that double taxation does not take place, however this creates difficulties for some non-taxpaying entities such as certain trusts, charities and pension funds which are not allowed to reclaim the deemed tax payment and thus are in effect taxed on their income. In India, Companies declaring or distributing dividend, are required to pay a Corporate Dividend Tax in addition to the tax levied on their income. Dividend received is exempt in the hands of the shareholder's, in respect of which Corporate Dividend Tax has been paid by the company.
Reliability of dividends There are two metrics which are commonly used to gauge the sustainability of a firm's dividend policy. Payout ratio is calculated by dividing the company's dividend by the earnings per share. A payout ratio of more than 1 means the company is paying out more in dividends for the year than it earned. Dividend cover is calculated by dividing the company's cash flow from operations by the dividend. This ratio is apparently popular with analysts of income trusts in Canada.
Other corporate dividends
Cooperatives Cooperative businesses may retain their earnings, or distribute part or all of them as dividends to their members. They distribute their dividends in proportion to their members' activity, instead of the value of members' shareholding. Therefore, co-op dividends are often treated as pre-tax expenses. Consumers' cooperatives allocate dividends according to their members' trade with the co-op. For example, a credit union will pay a dividend to represent interest on a saver's deposit. A retail co-op store chain may return a percentage of a member's purchases from the co-op, in the form of cash, store credit, or equity. This type of dividend is sometimes known as a patronage dividend or patronage refund, as well as being informally named divi or divvy.[5] [6] [7] Producer cooperatives, such as worker cooperatives, allocate dividends according to their members' contribution, such as the hours they worked or their salary.[8]
Trusts In real estate investment trusts and royalty trusts, the distributions paid often will be consistently greater than the company earnings. This can be sustainable because the accounting earnings do not recognize any increasing value of real estate holdings and resource reserves. If there is no economic increase in the value of the company's assets then the excess distribution (or dividend) will be a return of capital and the book value of the company will have shrunk by an equal amount. This may result in capital gains which may be taxed differently than dividends representing distribution of earnings. Dividend 59
Mutuals The distribution of profits by other forms of mutual organization also varies from that of joint stock companies, though may not take the form of a dividend. In the case of mutual insurance, for example, in the United States, a distribution of profits to holders of participating life policies is called a dividend. These profits are generated by the investment returns of the insurer's general account, in which premiums are invested and from which claims are paid. [9] The participating dividend may be used to decrease premiums, or to increase the cash value of the policy. [10] Some life policies pay nonparticipating dividends. As a contrasting example, in the United Kingdom, the surrender value of a with-profits policy is increased by a bonus, which also serves the purpose of distributing profits. Life insurance dividends and bonuses, while typical of mutual insurance, are also paid by some joint stock insurers. Insurance dividend payments are not restricted to life policies. For example, general insurer State Farm Mutual Automobile Insurance Company can distribute dividends to its vehicle insurance policyholders.[11] Policy holders of participating insurance policies are charged a "grossed up" premium, and the dividend is actually a return of the over payment. It is for this reason that insurance policy dividends are generally not taxed. They are merely a refund of overpaid premiums.
See also • Dividend cover • Dividend tax • Dividend units • Dividend yield • Dividend reinvestment plan • Stock buyback • Special dividend • Liquidating dividend • Qualified dividend • P/E ratio • List of companies paying monthly dividends
External links • Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends [3] – U.S. Securities and Exchange Commission • Dividend policy [12] – Literature class notes from Wharton School of Business • Dividend Policy [13] from studyfinance.com at the University of Arizona • The new U.S. dividend tax cut traps [14] from Tennessee CPA Journal, Nov. 2004 • Yield Shares - an explanation of dividend investing [15] Dividend 60
References
[1] Sullivan, arthur; Steven M. Sheffrin (2003). Economics: Principles in action (http:/ / www. pearsonschool. com/ index.
cfm?locator=PSZ3R9& PMDbSiteId=2781& PMDbSolutionId=6724& PMDbCategoryId=& PMDbProgramId=12881& level=4). Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 273. ISBN 0-13-063085-3. .
[2] "dividend" (http:/ / www. etymonline. com/ index. php?search=dividend& searchmode=none). Online Etymology Dictionary. Douglas Harper. 2001. . Retrieved 2006-11-09.
[3] http:/ / www. sec. gov/ answers/ dividen. htm
[4] http:/ / papers. ssrn. com/ sol3/ papers. cfm?abstract_id=390143 Arnott and Asness, Surprise! Higher Dividends = Higher Earnings Growth, Financial Analysts Journal, January/February 2003.
[5] Ace Hardware (2001-03-22). "Annual Report, Section 1, Business, 10-K405 SEC Filing" (http:/ / sec. edgar-online. com/ 2001/ 03/ 22/
0000002024-01-000003/ Section2. asp). .
[6] "Co-op pays out £19.6m in 'divi'" (http:/ / news. bbc. co. uk/ 1/ hi/ business/ 6247926. stm). BBC News via bbc.co.uk. 2007-06-28. . Retrieved 2008-05-15.
[7] Nikola Balnave and Greg Patmore. "The History Cooperative – Conference Proceedings - ASSLH -" (http:/ / www. historycooperative. org/
proceedings/ asslh/ balnave. html). .
[8] Norris, Sue (2007-03-30). "Cooperatives pay big dividends" (http:/ / www. guardian. co. uk/ business/ 2007/ mar/ 30/ smes. technology). The Guardian. . Retrieved 2009-06-09.
[9] "What Are Dividends?" (http:/ / www. newyorklife. com/ cda/ 0,3254,10542,00. html). New York Life. . Retrieved 2008-04-29. ""In short, the portion of the premium determined not to have been necessary to provide coverage and benefits, to meet expenses, and to maintain the company's financial position, is returned to policyowners in the form of dividends.""
[10] Jones, Frank J. (2002). "24, Investment-Oriented Life Insurance" (http:/ / books. google. co. uk/ books?id=F1hk6UFlsUsC). in Fabozzi, Frank J.. Handbook of Financial Instruments. Wiley. pp. 591. ISBN 0471220922. OCLC 52323583. .
[11] "State Farm Announces $1.25 Billion Mutual Auto Policyholder Dividend" (http:/ / www. statefarm. com/ about/ media/ media_releases/
auto_dividends. asp). State Farm. 2007-03-01. .
[12] http:/ / finance. wharton. upenn. edu/ ~unal2/ notes/ Dividends. doc
[13] http:/ / www. studyfinance. com/ lessons/ dividends/ index. mv
[14] http:/ / tscpa. com/ Journal/ articles/ dividend_tax_cut_traps. pdf
[15] http:/ / www. yieldshares. com
Withholding
Withholding tax is a government requirement for the payer of an item of income to withhold or deduct tax from the payment, and pay that tax to the government. In most jurisdictions withholding tax applies to employment income. Many jurisdictions also require withholding tax on payments of interest or dividends. In most jurisdictions there are additional withholding tax obligations if the recipient of the income is resident in a different jurisdiction, and in those circumstances withholding tax sometimes applies to royalties, rent or even the sale of real estate. Governments use withholding tax as a means to combat tax evasion, and sometimes impose additional withholding tax requirements if the recipient has been delinquent in filing tax returns, or in industries where tax evasion is perceived to be common. Typically the withholding tax is treated as a payment on account of the recipient's final tax liabilty. It may be refunded if it is detemined, when a tax return is filed, that the recipient's tax liability to the government which received the withholding tax is less than the tax withheld, or additional tax may be due if it is determined that the recipient's tax liability is more than the withholding tax. In some cases the withholding tax is treated as discharging the recipient's tax liability, and no tax return or additional tax is required. The amount of withholding tax on income payments other than employment income is usually a fixed percentage. In the case of employment income the amount of withholding tax is often based on an estimate of the employee's final tax liability, determined either by the employee or by the government. Withholding 61
Basics Some governments have written laws which require taxes to be paid before the money can be spent for any other purpose. This ensures the taxes will be paid first, and will be paid on time as the government needs the funding to meet its obligations. Typically withholding is required to be done by the employer of someone else, taking the tax payment funds out of the employee or contractor's salary or wages. The withheld taxes are then paid by the employer to the government body that requires payment, and applied to the account of the employee, if applicable). The employee may also be required by the government to file a tax return self-assessing their tax and reporting their withheld payments.
Income taxes
Wage withholding Most developed countries operate a wage withholding tax system. In some countries subnational governments require wage withholding, so that both national and subnational taxes may be withheld. In the U.S.,[1] Canada,[2] and Switzerland[3] the Federal and most state, provincial or cantonal governments, as well as some local governments, require such withholding for income taxes on payments by employers to employees. Income tax for the individual for the year is generally determined upon filing a tax return after year end. The amount withheld and paid by the employer to the government is applied as a prepayment of income taxes and is refundable if it exceeds the income tax liability determined on filing the tax return. In such systems, the employee generally must make a representation to the employer regarding factors that would influence the amount withheld.[4] Generally, the tax authorities publish guidelines for employers to use in determining the amount of income tax to withhold from wages. The United Kingdom (UK)[5] and certain other jurisdictions operate a withholding tax system known as Pay as you earn (PAYE), which is more comprehensive. PAYE systems generally aim to collect all of an employee's tax liability through the withholding tax system, making an end of year tax return redundant. However, taxpayers with more complicated tax affairs must file tax returns. Australia operates a Pay as you go (PAYG) system, which is similar to PAYE. The system applies only at the federal level, as the indivdual states do not collect income taxes.[6]
Other domestic withholding Some systems require that income taxes be withheld from certain payments other than wages made to domestic persons. The UK requires withholding of 20% tax on payments of interest by banks and building societies to individuals.[7] A similar requirement is imposed in Ireland for deposit interest.[8] The U.S. requires that payers of dividends, interest, and other "reportable payments" to individuals must withhold tax on such payments in certain circumstances.[9]
International withholding Most countries require that payers of certain amounts, especially interest, dividends, and royalties, to foreign payees withhold income tax from such payment and pay it to the government.[10] Payments of rent may be subject to withholding tax or may be taxed as business income.[11] The amounts may vary by type of income. A few jurisdictions treat fees paid for technical consulting services as royalties subject to withholding of tax.[12] The U.S. also imposes a 10% withholding tax on the gross sales price of a U.S. real property interest unless advance IRS approval is obtained for a lower rate.[13] Further, income tax treaties may reduce the amount of tax for particular types of income paid from one country to residents of the other country. The European Union has issued directives prohibiting taxation by one member nation of dividends from subsidiaries,[14] interest on debt obligations, or royalties[15] received by a resident of another member nation. See Withholding 62
also European Union withholding tax. Procedures vary for obtaining reduced withholding tax under income tax treaties. Procedures for recovery of excess amounts withheld vary by jurisdiction. In some, recovery is made by filing a tax return for the year in which the income was received. Time limits for recovery vary highly. Taxes withheld may be eligible for a foreign tax credit in the payee's home country.
Social insurance taxes (social security) Many countries (and/or subdivisions thereof) have social insurance systems that require payment of taxes for retirement annuities and medical coverage for retirees. Most such systems require that employers pay a tax to cover such benefits.[16] Some systems also require that employees pay such taxes.[17] Where the employees are required to pay the tax, it is generally withheld from the payment of wages and paid by the employer to the government. Social insurance tax rates may be different for employers than for employees. Most systems provide an upper limit on the amount of wages subject to social insurance taxes.[18]
Remittance to government Most systems require that taxes withheld must be remitted within specified time limits, which time limits may vary with the total amount so held in trust. Remittance by electronic funds transfer is often required.[19] Penalties for failure to remit withheld taxes to the government can be severe.[20] Some such penalties are increased for longer periods of nonremittance.[21]
Reporting Nearly all systems imposing withholding tax requirements also require reporting of amounts withheld in a specified manner. Copies of such reporting are usually required to be provided to both the person on whom the tax is imposed and to the levying government.[22] Reporting is generally required annually for amounts withheld with respect to wages. Reporting requirements for other payments vary, with some jurisdictions requiring annual reporting and others requiring reporting within a specified period after the withholding occurs.
See also • International tax • Tax withholding in the United States
References
[1] See U.S. Internal Revenue Service (IRS) Publication 15 (http:/ / www. irs. gov/ pub/ irs-pdf/ p15. pdf), which includes withholding tables for
income tax. State requirements vary by state; for an example, see the New York state portal for withholding tax (http:/ / www. tax. state. ny.
us/ nyshome/ wtidx. htm).
[2] See Canada Revenue Agency (CRA) Publication T4001 (http:/ / www. cra-arc. gc. ca/ E/ pub/ tg/ t4001/ t4001-09e. pdf). CRA also provides
significant online guidance accessible through a web index (http:/ / www. cra-arc. gc. ca/ payroll/ index. html), including an online payroll tax
calculator (http:/ / www. cra-arc. gc. ca/ esrvc-srvce/ tx/ bsnss/ pdoc-eng. html). [3] (English language citation needed)
[4] See, e.g., IRS Form W-4 (http:/ / www. irs. gov/ pub/ irs-pdf/ fw4. pdf).
[5] See HM Revenue and Customs (HMRC) PAYE for employers: the basics (http:/ / www. hmrc. gov. uk/ paye/ intro/ basics. htm) and references therein. Note that HMRC requires employers to implement PAYE based on tax codes assigned by local HMRC offices to the employee.
[6] See the Australian Tax Office's PAYG withholding (http:/ / www. ato. gov. au/ businesses/ content. asp?doc=/ content/ 31962. htm& pc=001/
003/ 079/ 001/ 004& mnu=& mfp=& st=& cy=1) web page for details and tools.
[7] See HMRC key information on interest (http:/ / www. hmrc. gov. uk/ tdsi/ key-info. htm). The withholding may be avoided by those whose
income is below the tax free allowance by filing Form R85 (http:/ / www. hmrc. gov. uk/ forms/ R85. pdf) with the payee. Withholding 63
[8] See Irish Tax & Customs Deposit Interest Retention Tax (http:/ / www. revenue. ie/ en/ tax/ dirt/ index. html).
[9] 26 USC 3406 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00003406----000-. html), Backup Withholding. Withholding applies to individuals who have not provided the payee a tax identification number or has failed to certify that he or she is not subject to backup withholding, or with respect to whom the IRS has notified the payee that backup withholding applies. The rate of withholding tax is the fourth lowest rate of tax for individuals.
[10] See, e.g., 26 USC 1441-1446 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sup_01_26_10_A_20_3_30_A. html), IRS
Publication 515, CRA Publication T4061 (http:/ / www. cra-arc. gc. ca/ E/ pub/ tg/ t4061/ t4061-09e. pdf). [11] For example, U.S. rules provide that rentals that rise to the level of a trade or business are not subject to withholding taxes, but other rental
income may be subject to 30% withholding tax. An election may be available under 26 USC 871(d) (http:/ / www. law. cornell. edu/ uscode/
html/ uscode26/ usc_sec_26_00000871----000-. html) or an applicable tax treaty. [12] (India citation needed)
[13] 26 USC 897 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00000897----000-. html) and 26 USC 1445 (http:/ / www.
law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00001445----000-. html). The lower rate of withholding is requested by filing IRS
Form 8288-B (http:/ / www. irs. gov/ pub/ irs-pdf/ f8288b. pdf) by the sale closing date.
[14] The parent/subsidiary directive (http:/ / eur-lex. europa. eu/ LexUriServ/ LexUriServ. do?uri=CELEX:31990L0435:EN:HTML).
[15] The interest and royalties directive (http:/ / eur-lex. europa. eu/ LexUriServ/ LexUriServ. do?uri=CELEX:32003L0049:en:HTML).
[16] See, e.g., 26 USC 3111 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00003111----000-. html); ATO Publication
71038 (http:/ / www. ato. gov. au/ content/ downloads/ SPR00108513n71038. pdf), Super: What employers need to know. Note that some
systems, e.g., the Australian state New South Wales, levy a payroll tax (http:/ / www. osr. nsw. gov. au/ taxes/ payroll/ ) independently of a social insurance system.
[17] See, e.g., 26 USC 3102 (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00003102----000-. html). [18] These limits may vary by country and year. For 2009, the U.S. income limit on the retirement portion (6.2%) of social security tax was $106,800, versus $102,000 for 2008, and there was no limit on the medicare portion (1.45%) of the tax; see Publication 15, supra. Canada wages subject to CPP were limited to $46,390 of the excess over $3,500 for 2009, at a tax rate of 4.95%; see Publication T4001, supra. UK
National Insurance contributions (http:/ / www. hmrc. gov. uk/ nitables/ ca38. pdf) are due for earnings above the Earnings Threshold (£110 weekly) up to a limit that varies depending on other coverage. [19] The U.S. requires remittance electronically within no later than the following business day when the balance of unremitted amounts exceeds $100,000, and other thresholds apply; see IRS Publication 15, supra, p. 23. Canada requires remittance within three business days of the end of the quarter-monthly period in which withholding occurs for Threshold 2 remitters; see CRA Publication T-4001, supra., p. 3.
[20] Penalties of up to 100% may be assessed against a withholding agent under 26 USC 6672 (http:/ / www. law. cornell. edu/ uscode/ html/
uscode26/ usc_sec_26_00006672----000-. html) for intentional failure to withhold and remit. The penalty may be assessed against any person, including a corporate officer or employee, having custody or control of the funds. [21] See IRS and CRA publications, supra. [22] See, e.g., IRS Form W-2 and CRA Form T4 with respect to employees, and IRS Form 1042 and CRA Form NR4 with respect to payments to foreign persons. Tax treaties 64 Tax treaties
Many countries have agreed with other countries in treaties to limit taxation (tax treaties). Tax treaties may cover income taxes, inheritance taxes, value added taxes, or other taxes.[1] Countries of the European Union (EU) have also entered into a multilateral agreement with respect to value added taxes under auspices of the EU. Tax treaties tend to reduce taxes of one treaty country for residents of the other treaty country in order to reduce double taxation of the same income. The provisions and goals vary highly; very few tax treaties are alike. Most treaties: • define which taxes are covered and who is a resident and eligible for benefits, • reduce the amounts of tax withheld from interest, dividends, and royalties paid by a resident of one country to residents of the other country, • limit tax of one country on business income of a resident of the other country to that income from a permanent establishment in the first country, • define circumstances in which income of individuals resident in one country will be taxed in the other country, including salary, self employment, pension, and other income, • provide for exemption of certain types of organizations or individuals, and • provide procedural frameworks for enforcement and dispute resolution. The stated goals for entering into a treaty often include reduction of double taxation, eliminating tax evasion, and encouraging cross-border trade efficiency.[2] It is generally accepted that tax treaties improve certainty for taxpayers and tax authorities in their international dealings.[3] Several governments and organizations have proposed model treaties to use as starting points in their own negotiations. The Organization for Economic Coorperation and Development [4] (OECD, an inter-governmental organization) model treaty [5] is often used as such a starting point. The OECD members have from time to time agreed on various provisions of the model treaty, and the official commentary [6] and member comments thereon provide excellent guidance as to interpretation by each member country.
Fiscal (Tax) Residency In general, the benefits of tax treaties are available only to persons who are residents of one of the treaty countries. [7] In most cases, a resident of a country is any person that is subject to tax under the domestic laws of that country by reason of domicile, residence, place of incorporation, or similar criteria. [8] Generally, individuals are considered resident under a tax treaty and subject to taxation where they maintain their primary place of abode.[9] However, residence for treaty purposes extends well beyond the narrow scope of primary place of abode. For example, many countries also treat persons spending more than a fixed number of days in the country as residents. [10] The United States includes citizens and green card holders, wherever living, as subject to taxation, and therefore as residents for tax treaty purposes. [11] Because residence is defined so broadly, most treaties recognize that a person could meet the definition of residence in more than one jurisdiction (i.e., "dual residence") and provide a “tie breaker” clause.[12] Such clauses typically have a hierarchy of three to five tests for resolving multiple residency, typically including permanent abode as a major factor. Tax residency rarely impacts citizenship or permanent resident status, though certain residency statuses under a country's immigration law may influence tax residency.[13] Entities may be considered resident based on their country of seat of management, their country of organization, or other factors.[14] The criteria are often specified in a treaty, which may enhance or override local law. It is possible under most treaties for an entity to be resident in both countries, particularly where a treaty is between two countries that use different standards for residence under their domestic law. Some treaties provide “tie breaker” rules for entity residency,[15] some do not.[16] Residency is irrelevant in the case of some entities and/or types of income, as members of the entity rather than the entity are subject to tax.[17] Tax treaties 65
Permanent Establishment Most treaties provide that business profits (sometimes defined in the treaty) of a resident of one country are subject to tax in the other country only if the profits arise through a permanent establishment in the other country. Many treaties, however, address certain types of business profits (such as directors' fees or income from the activities of athletes and entertainers) separately. Such treaties also define what constitutes a permanent establishment (PE). Most but not all tax treaties follow the definition of PE in the OECD Model Treaty.[18] Under the OECD definition, a PE is a fixed place of business through which the business of an enterprise is carried on. [19] Certain locations are specifically enumerated as examples of PEs, including branches, offices, workshops, and others. Specific exceptions from the definition of PE are also provided, such as a site where only preliminary or ancillary activities (such as warehousing of inventory, purchasing of goods, or collection of information) are conducted. While in general tax treaties do not specify a period of time for which business activities must be conducted through a location before it gives rise to a PE, most OECD member countries do not find a PE in cases in which a place of business exists for less than six months, absent special circumstances.[20] Many treaties explicitly provide a longer threshold, commonly one year or more, for which a construction site must exist before it gives rise to a permanent establishment.[21] In addition, some treaties, most commonly those in which at least one party is a developing country, contain provisions which deem a PE to exist if certain activities (such as services) are conducted for certain periods of time, even where a PE would not otherwise exist. Even where a resident of one country does not conduct its business activities in another country through a fixed place or business, a PE may still be found to exist in that other country where the business is carried out through a person in that other country that has the authority to conclude contracts on behalf of the resident of the first country.[22] Thus, a resident of one country cannot avoid being treated as having a PE by acting through a dependent agent rather than conducting its business directly. However, carrying on business through an independent agent will generally not result in a PE.[23]
Withholding Taxes Many tax systems provide for collection of tax from nonresidents by requiring payors of certain types of income to withhold tax from the payment and remit it to the government.[24] Such income often includes interest, dividends, royalties, and payments for technical assistance. Most tax treaties reduce or eliminate the amount of tax required to be withheld with respect to residents of a treaty country.[25]
Income from Employment Most treaties provide mechanisms eliminating taxation of residents of one country by the other country where the amount or duration of performance of services is minimal but also taxing the income in the country performed where it is not minimal. Most treaties also provide special provisions for entertainers and athletes of one country having income in the other country, though such provisions vary highly. Also most treaties provide for limits to taxation of pension or other retirement income.[26] Tax treaties 66
Tax Exemptions for Persons or Entities Most treaties eliminate from taxation income of certain diplomatic personnel. Most tax treaties also provide that certain entities exempt from tax in one country are also exempt from tax in the other. Entities typically exempt include charities, pension trusts, and government owned entities. Many treaties provide for other exemptions from taxation that one or both countries as considered relevant under their governmental or economic system.[27]
Harmonization of Tax Rates Tax treaties usually specify the same maximum rate of tax that may be imposed on some types of income. As an example, a treaty may provide that interest earned by a nonresident eligible for benefits under the treaty is taxed at no more than five percent (5%). However, local law in some cases may provide a lower rate of tax irrespective of the treaty. In such cases, the lower local law rate prevails.[28]
Provisions Unique to Inheritance Taxes Generally, income taxes and inheritance taxes are addressed in separate treaties.[29] Inheritance tax treaties often cover estate and gift taxes. Generally fiscal domicile under such treaties is defined by reference to domicile as opposed to tax residence. Such treaties specify what persons and property are subject to tax by each country upon transfer of the property by inheritance or gift. Some treaties specify which party bears the burden of such tax, but often such determination relies on local law (which may differ from country to country). Most inheritance tax treaties permit each county to tax domiciliaries of the other country on real property situated in the taxing country, property forming a part of a trade or business in the taxing country, tangible movable property situated in the taxing country at the time of transfer (often excluding ships and aircraft operated internationally), and certain other items. Most treaties permit the estate or donor to claim certain deductions, exemptions, or credits in calculating the tax that might not otherwise be allowed to non-domiciliaries.[30]
Double Tax Relief Nearly all tax treaties provide a specific mechanism for eliminating double taxation still potentially present. This mechanism usually requires that each country grant a credit for the taxes of the other country to reduce the taxes of a resident of the country. The treaty may or may not provide mechanisms for limiting this credit, and may or may not limit the application of local law mechanisms to do the same.[31]
Mutual Enforcement Taxpayers may relocate themselves and their assets to avoid paying taxes. Some treaties thus require each treaty country to assist the other in collection of taxes and other enforcement of their tax rules.[32] Most tax treaties include, at a minimum, a requirement that the countries exchange of information needed to foster enforcement.[33]
Dispute Resolution Nearly all tax treaties provide some mechanism under which taxpayers and the countries can resolve disputes arising under the treaty.[34] Generally, the government agency responsible for conducting dispute resolution procedures under the treaty is referred to as the “Competent Authority” of the country. Competent Authorities generally have the power to bind their government in specific cases. The treaty mechanism often calls for the Competent Authorities to attempt to agree in resolving disputes. Tax treaties 67
Limitations of Benefits Recent treaties of certain countries have contained an article intended to prevent "treaty shopping," which is the inappropriate use of tax treaties by residents of third states. These Limitation of Benefits articles deny the benefits of the tax treaty to residents that do not meet additional tests. Limitation of Benefits articles vary widely from treaty to treaty, and are often quite complex.[35] The treaties of some countries, such as the United Kingdom and Italy, focus on subjective purpose for a particular transaction, denying benefits where the transaction was entered into in order to obtain benefits under the treaty. Other countries, such as the United States, focus on the objective characteristics of the party seeking benefits. Generally, individuals and publicly traded companies and their subsidiaries are not adversely impacted by the provisions of a typical limitation of benefits provision in a U.S. tax treaty. With respect to other entities, the provisions tend to deny benefits where an entity seeking benefits is not sufficiently owned by residents of one of the treaty countries (or, in the case of treaties with members of a unified economic bloc such as the European Union or NAFTA, by "equivalent beneficiaries" in the same group of countries). [36] Even where entities are not owned by qualified residents, however, benefits are often available for income earned from the active conduct of a trade or business. [37]
Priority of Law Treaties are considered the supreme law of many countries. In those countries, treaty provisions fully override conflicting domestic law provisions. For example, many EU countries could not enforce their group relief schemes under the EU directives. In some countries, treaties are considered of equal weight to domestic law.[38] In those countries, a conflict between domestic law and the treaty must be resolved under the dispute resolution mechanisms of either domestic law or the treaty.[39]
External links • U.S. income tax treaties [40] • List [41] of U.S. estate and gift tax treaties • Canada income tax treaties [42] • Singapore tax treaties [43] • Australian tax treaties [44]
References [1] Agreements on tariffs, while technically tax treaties, are generally called agreements on tariffs and trade.
[2] See, e.g., the speech (http:/ / faculty. law. wayne. edu/ tad/ Documents/ Teaching_Materials/ model_treaties. pdf) by Professor McIntyre
(http:/ / www. law. wayne. edu/ faculty/ bio. php?id=43007) of Michigan's Wayne State University.
[3] Comments by New Zealand Revenue Minister (http:/ / www. beehive. govt. nz/ release/ dunne+ australia-nz+ double+ tax+ agreement+ step+ closer).
[4] http:/ / www. oecd. org/ home/ 0,2987,en_2649_201185_1_1_1_1_1,00. html
[5] http:/ / www. oecd. org/ dataoecd/ 52/ 34/ 1914467. pdf
[6] http:/ / www. oecd. org/ dataoecd/ 14/ 32/ 41147804. pdf [7] See, e.g., the OECD Model Tax Convention on Income and on Capital, Article 1 ("OECD Model") [8] See, e.g., OECD Model, Article 4.
[9] See, e.g., the treaty between Canada and Belgium (http:/ / www. fin. gc. ca/ treaties-conventions/ Belgium_-eng. asp), Article 4. [10] See, e.g., 26 U.S.C. sec. 7701(b) for the U.S. "substantial presence" test for residency. [11] See 26 U.S.C. sec. 7701(a)(30) [12] See, e.g., the Canada/Belgium treaty, supra.
[13] See, e.g., the U.S. IRS explanation (http:/ / www. irs. gov/ taxtopics/ tc851. html) of residency regarding the "green card test".
[14] See, e.g., the Canada Revenue Agency discussion (http:/ / www. cra-arc. gc. ca/ tx/ nnrsdnts/ bsnss/ bs-rs-eng. html), and the Canada/Belgium treaty, supra, which defines resident by reference to local law. [15] See, e.g., the Canada/Belgium treaty, supra. Tax treaties 68
[16] See, e.g., the old treaty (http:/ / www. irs. gov/ pub/ irs-trty/ ussr. pdf) between the United States and the former Union of Soviet Socialist Republics, which is still in force between the U.S. and several of the former Soviet republics.
[17] See, e.g., the U.S. IRS explanation (http:/ / www. irs. gov/ businesses/ article/ 0,,id=186396,00. html) of taxation of foreign partners of partnerships with a U.S. trade or business.
[18] Contrast the U.S./Italy treaty (http:/ / www. treas. gov/ offices/ tax-policy/ library/ italy. pdf) using exact OECD language with the
U.S./India treaty (http:/ / www. irs. gov/ pub/ irs-trty/ india. pdf) that has numerous special provisions. [19] 2008 OECD Model, Article 5(1) [20] Commentary to 2008 OECD Model, ¶6 [21] 2008 OECD Model, Article 5(3) [22] 2008 OECD Model, Article 5(5) [23] 2008 OECD Model, Article 5(6)
[24] Examples include the U.S. (http:/ / www. law. cornell. edu/ uscode/ html/ uscode26/ usc_sec_26_00001441----000-. html) and Singapore
(http:/ / www. iras. gov. sg/ irasHome/ page04. aspx?id=562).
[25] See, e.g., the Singapore/India treaty (http:/ / iras. gov. sg/ irasHome/ uploadedFiles/ Quick_Links/
singaporeindiadtaincorporatingprotocol2005. pdf).
[26] See, e.g., the Singapore/India treaty (http:/ / iras. gov. sg/ irasHome/ uploadedFiles/ Quick_Links/
singaporeindiadtaincorporatingprotocol2005. pdf), Article 15, which has a 183 day rule and a flat 15% tax rate where services go beyond 183 days. This treaty contains all of the provisions mentioned.
[27] See, e.g., the U.S./Canada treaty (http:/ / www. irs. gov/ pub/ irs-trty/ canada. pdf) Articles XIX and XXI.
[28] See, e.g., the Ireland/U.S. treaty (http:/ / www. irs. gov/ pub/ irs-trty/ ireland. pdf), under which dividend withholding is limited to 5% or
15%, depending on ownership levels, but where Ireland tax law imposes no withholding tax on qualifying recipients (http:/ / www. revenue.
ie/ en/ tax/ dwt/ forms/ nonresv2b. pdf).
[29] See, e.g., treaties between the U.S. and France regarding income taxes (http:/ / www. irs. gov/ pub/ irs-trty/ france. pdf) and estate and gift
taxes (http:/ / ambafrance-us. org/ IMG/ pdf_french_us_estate_tax_treaty. pdf). The provisions of this treaty reflect typical patterns, and incorporate all of the features mentioned in this secton. [30] See, e.g., the U.S./France treaty, supra, containing all of these features. [31] All of the treaties cited above feature the credit mechanism.
[32] See, e.g., the Canada/U.S. 2007 Protocol (http:/ / www. treas. gov/ offices/ tax-policy/ library/ CanadaProtocol07. pdf) Article 22, amending Treaty Article XXVI A, Assistance in Collection. [33] See, e.g., the Canada/Belgium treaty, supra. [34] The OECD model, supra, Article 25 contains typical language. [35] See, e.g., the Canada/U.S. 2007 protocol, supra, Article 25, as an example of complexity. [36] See, e.g., The United States Model Tax Convention, supra, Article 22. [37] Id.
[38] See, e.g., the U.S. Constitution (http:/ / topics. law. cornell. edu/ constitution/ articlevi), Article VI. [39] For example, Switzerland had agreed with the United States to turn over certain bank records, but the agreement was held by Swiss courts to
violate Swiss law. The Swiss administration referred the matter to the Swiss Parliament for resolution. See, e.g., CNN coverage (http:/ / www.
huffingtonpost. com/ 2010/ 01/ 27/ ubsirs-deal-court-ruling-_n_439558. html).
[40] http:/ / www. irs. gov/ businesses/ international/ article/ 0,,id=96739,00. html
[41] http:/ / www. irs. gov/ businesses/ small/ article/ 0,,id=186064,00. html
[42] http:/ / www. fin. gc. ca/ treaties-conventions/ in_force--eng. asp
[43] http:/ / iras. gov. sg/ irasHome/ taxtreaties. aspx#comprehensive
[44] http:/ / www. austlii. edu. au/ au/ other/ dfat/ countries/ Capital gain 69 Capital gain
A capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor.[1] Conversely, a capital loss arises if the proceeds from the sale of a capital asset are less than the purchase price. Capital gains may refer to "investment income" that arises in relation to real assets, such as property; financial assets, such as shares/stocks or bonds; and intangible assets such as goodwill. Many countries impose a tax on capital gains of individuals or corporations, although relief may be available to exempt capital gains: in relation to holdings in certain assets such as significant common stock holdings, to provide incentives for entrepreneurship, or to compensate for the effects of inflation.
See also • Capital gains tax • Capital gains tax in the United States • Investment • Unearned income
References
[1] Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action (http:/ / www. pearsonschool. com/ index.
cfm?locator=PSZ3R9& PMDbSiteId=2781& PMDbSolutionId=6724& PMDbCategoryId=& PMDbProgramId=12881& level=4). Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 268, 508. ISBN 0-13-063085-3. . Article Sources and Contributors 70 Article Sources and Contributors
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