BASIC INTERNATIONAL TAX
INTRODUCTION TO INTERNATIONAL TAX
International tax refers to the tax relationship of a person or business subject to the tax laws of different countries or the internationals aspects of an individual’s country tax laws depending on the scenario. It basically is the relationship between a country’s tax laws and how it affects the tax laws of others countries in order to ensure a fair and responsible tax system internationally without dispute. These relationships are usually evidenced in International tax treaties such as a Double Taxation Treaty.
The globalized nature of the world has led to the creation of Multi-National Companies that operate in two or more countries at the same time. This could lead to double taxation by the different countries creating a strain on the profits of these companies. This necessitates the creation of a double taxation treaty between countries that clearly defines the percentage of tax each country is entitled to from these companies. It also creates lucrative employments for International Tax Specialists to help to navigate these liabilities.
A very common tactic used by the Multi-National Corporations (MNCs) is to shift their income between two or more countries in order to reduce their tax liability using a technique called Transfer Pricing. This is a process whereby a company uses its subsidiary in another country to reduce tax paid by shifting its profits to countries with a low tax rate or countries that are tax havens. However, a lot of countries, with the United States and Canada leading the way have found a way to deal with this technique by imposing strict detailed rules that makes it impossible to perform; the Arm’s length principle being one of the most effective.
MODEL TAX CONVENTIONS
These are intended to provide a starting point for tax treaty negotiations between nations. There are three major model conventions that one needs to be familiar with: Organisation for Economic Cooperation and Development (OECD) Model Tax Convention, United States Model Tax Convention and The United Nations Model Tax Convention. These three models are not binding, but are designed to make tax treaty negotiations easier and to avoid any complications for nations whose laws require ratification.
OECD Model Tax Convention on Income and on Capital
The OECD began in 1961 replacing the Organisation for European Economic Co-operation (OECC) created in 1948. The organization today includes 33 nations (mostly developed European nations and the United States). This convention contains commentaries along with reservations from member nations and opposing positions taken from nonmember nations. The OECD model provides the basis for tax treaty negotiations for most developed nations, who either use the model convention as their starting point or adapt most or all of the provisions for their own model tax convention. The OECD recently updated the model tax convention in July 2014.
U.S. Model Income Tax Convention (U.S. Model Income Technical Explanation)
The U.S Income Tax Convention provides the starting point for the United States in negotiating tax treaties and was originally published in 1981, with revisions made in 1996 and 2006. It contains accompanying technical explanations and is used to ensure that any issues that could potentially complicate the ratification process in the Senate are disposed of during bilateral negotiations. The U.S. model is similar to the OECD model in most respects, but differs regarding anti-discrimination provisions related to foreign taxpayers and it also targets the use of tax havens more aggressively.
U.N. Model Double Taxation Convention between Developed and Developing Countries
The United Nations model published in 1980 was designed to assist developing nations with respect to tax treaty negotiations. The U.N. model is similar to the OECD Model and contains some of the same provisions but there are some notable differences such as provisions with blank percentages facilitating greater flexibility in tax treaty negotiations and more of a focus on source based taxation as opposed to residence based taxation. The U.N. Model is substantially different from the U.S. Model because of less rigorous nondiscrimination policies as well as less emphasis on tax fraud and fiscal evasion.
Tax treaties are the most authoritative source of international tax law but that authority is contingent upon how an individual nation views the terms of the treaty in relation to its domestic laws. In Nigeria, Section 12 of the 1999 Constitution allows for the President to negotiate tax treaties although these treaties do not have the force of law unless it has been enacted into law by the National Assembly. This was emphasized in Section 38(1) of PITA. Some countries view the treaties as automatically binding whereas other countries require special legislative procedures beyond simple ratification before the treaty’s provisions effectively become law. The United States in particular views tax treaties as “the supreme law of the land.” However, if there is a conflicting statute such authority depends on whether the treaty was passed later than that statute. Treaties that are passed later in time are more authoritative than those entered into beforehand. Self-executing treaties (those with provisions that stipulate enforcement) have more force in most jurisdictions than non-self-executing treaties.
PURPOSE OF TAX TREATIES
Tax treaties exist for the most part to avoid double taxation and prevent tax fraud or fiscal evasion. Double taxation takes place when the taxpayer is taxed by the foreign nation of residence and the home country at the same time. For example, if a U.S. citizen were living abroad in Argentina, that person would not only be subject to taxation in that country but also the United States, regardless of residence. Double taxation is problematic because it can stifle commerce, discourage international trade, and can be particularly devastating to nations whose economies rely heavily on tourism. While double taxation can be crippling to all nations, tax evasion is a greater concern for developed nations than it is for developing nations because they are more likely to lose revenue. The expatriation of citizens and corporations to nations known as “tax havens” that boast little or no tax burden has been a problem in recent years. Tax treaties may also deal with other issues such as nondiscrimination against foreign nationals and the reduction of withholding rates.
ALTERNATIVES TO TAX TREATIES
Customary International Law
For those matters not covered by tax treaties, customary international law can help by looking at the “relatively uniform and consistent state practice regarding a particular matter” to determine whether such action was taken based on the obligation or belief that it was legal based on international law. Customary international law will review past actions taken by nations with respect to tax related issues and evidence of such can be found through sources of state practice, digests, and yearbooks.
General Principles of Law
For matters that cannot be determined by treaties or customary international law, general principles of law can provide guidance to attorneys who are handling issues with little or no legal precedence. These are basic legal concepts that are imperative to all nations and involve matters not readily dealt with by treaties. The authority of general principles of law has been given credibility by the Statute of the International Court of Justice requiring the court to consider, after consulting treaties and customary international law, “the general principles of law recognized by civilized nations” in determining the outcome of cases. General principles of law can be established by looking at case law and scholarly works.
GENERAL BASIS OF INTERNATIONAL TAX (RESIDENCY AND INCOME)
It is a common misconception that either a company or an individual can only be tax resident in one jurisdiction at any one time. Most countries will tax an individual who spends six months within their borders. As a simple example, an individual who spends six months in the UK and the other six months in the USA may be considered tax resident in both the US and the UK and therefore subject to tax on his worldwide income in both countries.
A similar position can arise in respect of companies. Most countries consider any company that is incorporated within their jurisdiction to be tax resident there. Most countries also consider any company that is managed and controlled within their jurisdiction to be locally tax resident, even if it is incorporated abroad. A company is generally considered to be “managed and controlled” wherever its directors habitually meet and reside. Thus a company incorporated in the US that has a board of directors who meet and reside in the UK, could be deemed subject to both US and UK tax on its worldwide income. This “management and control” test means that it will rarely be the case that an individual residing onshore can safely act as the director of an offshore company without making that company liable to tax in his home jurisdiction.
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, residence-based, or exclusionary system.
Section 3 and 10 of PITA provides the basis of chargeable tax for individuals in Nigeria. Section 10(a) of PITA provides that the gain or profit from an employment shall be deemed from Nigeria if the duties of the employment are wholly or partly performed in Nigeria, unless the duties are performed on behalf of an employer who is in a country other than Nigeria and the remuneration of the employee is not borne by a fixed base of the employer in Nigeria, the employee is not in Nigeria for a period or periods amounting to an aggregate of 183 days (inclusive annual leave or temporary period of absence) or more in any 12 month period and unless the remuneration of the employee is liable to tax in that other country under the provisions of the avoidance of double taxation treaty with that other country.
Thus, if a person is employed by a company resident or based in Nigeria, that individual is subject to tax unless the remuneration is not borne by an employer resident in Nigeria or the individual does not remain in Nigeria for more than 183 days in a 12-month period or the individual has already paid tax to another country under a double taxation treaty.
Section 3 of PITA talks about income subject to tax which includes income from inside and outside Nigeria for whatever period of time, gain and profit from any trade, business, profession or vocation, salary, wage, fee, allowance, compensation, bonuses, premiums, benefits and other perquisites allowed, given or granted to any temporary or permanent employee, gain or profit including premiums arising from a right granted to any other person for the use or occupation of any property, dividend, interest or discount, charge and annuity and any profit or gain or other payment not falling in any of the above.
Section 14 of PITA also provides that the income from any interest on money lent by an individual, or an executor, or a trustee, outside Nigeria to a person in Nigeria: including a person who is resident or present in Nigeria at the time of the loan: shall be deemed to be derived from Nigeria if there is liability to payment in Nigeria of the interest regardless of what form the payment takes and wherever the payment is made OR the interest accrues in Nigeria to a foreign company or person regardless of what form the payment takes and wherever the payment is made.
Section 9 of CITA states that charge of company’s tax shall, for each year of assessment, be payable at the rate specified in subsection (1) of section 40 of this Act upon the profits of company accruing in, derived from, brought into, or received in, Nigeria. Section 9(2) states that interest shall be deemed to be derived from Nigeria if there is a liability to payment of the interest by a Nigeria company or a in Nigeria regardless of where or in what form the payment is made or the interest accrues to a foreign company or person from a Nigerian company or a company in Nigeria regardless of whichever way the interest may have accrued.
Section 13 of CITA provides a comprehensive basis of tax for both Nigerian and foreign companies. Section 13(1) provides that the profits of a Nigerian company shall be deemed to accrue in Nigeria wherever they have arisen and whether or not they have been brought into or received in Nigeria. This mean that the profits of a Nigerian company is taxable no matter where the profits where made or if they have been brought into the country. On the other hand, Section 13(2) states that the profits of a foreign company from any trade or business shall be deemed to be derived from Nigeria if that company has a fixed base in Nigeria to the extent that the profit is attributable to the fixed base OR if it does not have a fixed base in Nigeria but habitually operate a trade or business through a person in Nigeria authorized to conclude contracts on its behalf or on behalf of some other companies controlled by it or which have controlling interest in it or habitually maintains a stock of goods or merchandise in Nigeria from which deliveries are regularly made by a person on behalf of the company to the extent that the profit is attributable to business or trade or activities carried on through that person OR if that trade or business or activities involve a single contract for surveys, deliveries, installations or construction; the profit from that contract OR where the trade or business or activities is between the company and another person controlled by it or which has a controlling interest in it and conditions are made or imposed between that company and such persons in their commercial or financial relations which in the opinion of the board is deemed to be artificial or fictitious, so much of the profits adjusted by the board to reflect arm s length transaction.
The act in Section 13(3) then goes on to exclude “storage or display of goods or merchandise” and “facilities used solely for the collection of information define” from the definition of “Fixed Base”.
The act also provides for rules guiding specific companies like Companies engaged in shipping or air transport in Section 14, Companies engaged in Cable undertakings in Section 15 and Insurance companies in Section 16.
International Tax or foreign tax is clearly very essential to the development of any country. The relationship between international tax and Foreign Direct Investment (FDI) cannot be denied as countries with lesser foreign tax rates usually get more. Countries have adjusted their foreign tax policy in line with their country’s needs. For example, a country in need of FDI can make policies that make them tax havens for foreign companies. Nigeria must do the same and adopt an autochthonous foreign tax policy that best serves our needs.
This article was written by Olakanye Oluwatobi, A 500 level student of the Univeristy of Lagos and an avid member of the Tax Club University of Lagos.