INTERNATIONAL TAXATION ISSUES

The tax authorities to prepare a new defense for gaps, corporations adjust with the
strategy and try to open up new loopholes or exploit which has existed. For multinational
corporations (MNE), each authority taxation around the world has a set of differences that
must be adjusted.
The challenge is significant, and the tax accountant's office should work together with
experts from the tax law in every country where it operates, as well as the technical advisor in
exchange controls and the possibility of cash flow. Although the tax system in the world is
different, it is generally accepted that each country has the right to tax income earned within
that limit. Opinions differ as to the notion of income tax, which determined how much it
costs, and what kind of taxes should be used (such as direct or indirect). In addition, there are
differences in tax law compliance based on cultural differences and attitudes towards law
enforcement.
16.1. DIRECT TAXES
1. Corporate Income Tax
Two approaches corporate income tax is a classic approach and integrated systems.
Classic system used in the United States, Belgium, the Netherlands, and Luxembourg,
for example, income tax when it is received by each entity. With that, the corporate
income tax is two times - when corporations get and when received by shareholders as
dividends. While the Integrated System try to take a good tax system for corporations
and shareholders into consideration to eliminate double taxation. In most cases, there
is only partial rather than full integration, so that double taxation is not completely
eliminated. There are two ways to integrate systems, namely:
a. Through the split (cleavage) value as in Germany
b. The second and dominant approach to integrate is the imputation involving the
same income tax as dividends assessed whether abolished or not, but that allows
some or all of the tax credit for shareholders. This is the approach followed by
most of the rest of the countries of the European Union (EU), the majority of
European countries, and other countries such as the United Kingdom, Italy, and
France.
2. What Income is Taxable?
In a country, which is taxable income different kind. Revenues from exports of
goods and services as well as from a foreign branch or a foreign company. Foreign
source income worldwide of exports of goods and services acquired when taxed. Tax
incentives, such as sales of foreign companies in the United States, can be used to

boost exports, but this incentive has implications for foreign source income tax in a
different way from domestic revenues.
Income taxes abroad and branches of foreign companies are more complex.
Two different approaches to the taxation of foreign source income is that a territorial
approach and the approach of the world. Territorial approach as used in Hong Kong,
for example, asserts that only income earned in Hong Kong should be subject to the
charge that is a source of foreign income tax to be in the country where it is produced,
not in Hong Kong.
The worldwide approach, such as those used in the United States, whether
domestic or tax foreign source income. This can lead to double taxation because it
allows income tax in two different countries. Two main ways to minimize the double
taxation of foreign source income on which the tax through a tax credit (allowing
companies to direct credit, domestic tax for income taxes already paid).
3. Determination of Expenses
Another factor that causes the difference in the amount of taxes paid is to treat
the expenditure of certain countries for tax purposes. Spending is usually a matter of
time. Opinions also differ from country to country that is useful for the survival of an
asset. If the government allows the company to write off an asset in 5 years, while in
other countries the same has assets of 10 years, with the tax burden in both countries
will be very different. In addition, there may be a big difference between the effective
tax high with liberal tax laws which could result in the determination of the cost is
relatively low so that the effective income tax and lower taxes, and is assessed from
the attention of investors.
4. Withholding Tax
Income earned by foreign subsidiaries or affiliates of multinationals are taxed
abroad and the taxes imposed on foreign corporations, not to the parent company.
However, the actual cash return to the parent company in the form of dividends,
royalties (payments made by foreign companies to the parent for the use of patents,
trademarks, processes, and so on), and intra-company debt interest to tax the parent
company. This tax varies in size from one country to another and depends on whether
the country has a tax treaty with another country.
16.2. INDIRECT TAXES
1. Value-Added or Goods and Services Taxes

In some countries, like the United States, the direct taxation of individuals is
the most important source of revenue for the government. In other country, such as
France, direct taxes are very important.
a. Value-Added Tax
In Europe, VAT, sometimes referred to as TVA, is one of the many sources of
government revenue and is also a major revenue source for funding the operation
of the European Union. The basic concept of VAT is a tax that is applied at each
stage of the production process for the value added by the company to purchase
goods from the outside, which should be subjected to VAT. Business tax imposed
by their sales in value, but tax ultimately falls on the consumer because a
company pays VAT on the costs themselves can reclaim tax already paid. The
main method for computing VAT and are necessary in the EU is a subtractive
16.3.

method.
THE AVOIDANCE OF DOUBLE TAXATION OF FOREIGN SOURCE

INCOME
1. Credits and Deductions
2. Tax Treaties
16.4. U.S. TAXATION OF FOREIGN SOURCE INCOME
1. The Tax Haven Concept
2. The Controlled Foreign Corporation
3. Subpart F Income
a. Insurance of U.S. Risks
b. Foreign-based Company Personal Holding Company Income
c. Foreign-based Company Sales Income
d. Foreign-based Company Services Income
Foreign- based company services income arises from contracts utilizing
technical, managerial, engineering, or other skills.
e. Foreign-based Company Shipping Income
Foreign- based company shipping income arises from using aircraft or
ships for transportation outside the country where the CFC is incorporated.
f. Foreign-based Oil-Related Company Income
Foreign- based oil-related company income arises from large oil or natural
gas producers in a country outside the country where the CFC is incorporated.
g. Boycott-related Income and Foreign Bribes
The inclusion of bribes and boycotts as Subpart F income resulted from the
TRA of 1976. To penalize companies that supported the Arab boycott of Israel,
congress decided to classify income from operations resulting from countries
involved in certain inte4rnational boycotts as subpart F income.
Subpart F income has several implications. For foreign corporation that are
not CFCs, income is not taxable to the U.S. shareholder (the parent corporation)
until a dividend is declared. For CFCs active income is also deferred, but passive

or Subpart F income must be recognizes by the parent when earned, regardless of

when a dividend is declared. The United States, like most individualized
countries, use the worldwide approach, which means that the IRS taxes U.S.
16.5.

residents on their worldwide income.

TAX EFFECTS OF FOREIGN EXCHANGE GAINS AND LOSSES
Transaction gains and losses are recognized in income when the rate changes, not

when the transaction finally settled. In the case of financial statements, gains and losses that
arise under the current rate method are taken directly to a separate component of
stockbrokers equity, whereas gains and losses that arise under the temporal method are taken
directly to income.
The treatment of these gains and losses for tax purposes is not consistent with the
requirements of Statement No. 52. Generally, gains and losses from foreign currency
transactions are treated as ordinary income on loss and are recognized only when realized;
gains and losses cannot be recognized while foreign currency balances are being held.
1. Foreign Currency Transactions
The IRS treats foreign currency transactions from the two-transactions
perspective just as statement No. 52 does. However, it does not recognize gains and
losses until the financial obligation has actually been settled. For tax purposes,
however, the firm would wait until January 31 when it settles the financial obligation
to determine the gains and losses.
2. Branch Earnings
U.S. tax law has introduced the concept of a qualified business unit (QBU),
which is a trade or business for which separate books are kept. For tax purposes, the
earnings of a QBU can be divided into two parts: earnings that have been distributed
back to the home office and earnings that are retained in the foreign location. In the
case of a branch , both types are taxable to the home office. The amount of earnings
distributed to the home office is translated at the exchange rate in effect on the date of
the transfer, and branch profits are translated at the average exchange rate.
This translation approach is called the profit-and-loss approach by IRS, which
requires that the profit-and-loss statement of the branch be translated into dollars at
the average exchange rate for the year. A difference between the average exchange
rate and the exchange rate when the distribution is made can give rise to a gain or
loss, as illustrated in Exhibit 16.4.
UNTUK GAMBAR
3. Taxable Earnings from Foreign Corporations

The recognition of earnings of a foreign corporation depends on whether the

corporation is a CFC. When the foreign corporation is not a CFC, income is not
recognized by the U.S. parent until a dividend is distributed. In such a case, the tax
credit formula, as we discussed earlier, is as shown in Exhibit 16.5.
Untuk gambar
The dividends are translated at the rate in effect when they are paid, and
incomes taxes, for purposes of computing the deemed direct tax, are translated at the
rate when they were paid. Because the foreign subsidiary is not taxed until a dividend
is declared, the parent company does not have to translate the financial statements into
dollars for tax purposes.
4. Controlled Foreign Corporation
A CFC has two type of income: non-Subpart F income and Sub-part F income.
The non-Subpart F income is not taxed to the parent company until a dividend has
been distributed, so the same rules as described earlier apply for the non CFC
situation. In case of Subpart F income, the IRS assumes that a constructive dividend
has been declared at the end of the year, so it is necessary to translate the financial
statements of the firm into dollars. The profit-and loss statement is translated into
16.6.

dollars at the average exchange rate for the year, as for branch earnings.
TAX INCENTIVES
Tax incentives are of two major types: incentives by countries to attract foreign

investors and incentives by countries to encourage export of goods a services. Tax incentives
to invest usually involve tax holidays of one form or another. Another popular form of
incentive involves exports.
Within the United States and United Kingdom, many local authorities can and do
offer reductions in or the elimination of local property taxes. U.S. cities and states can often
be persuaded to waive state and city income taxes for a major investment.
1. Foreign Sales Corporation
The Foreign Sales Corporation Act of 1984 was signed into law on July 18,
1984, as a part of the TRA of 1984, and the new law was designed to replace the
Domestic International Sales Corporation (DISC) legislation that had been in
existence in the United States since 1972.
The DISC was established in the 1970s to encourage exports by U.S. firms.
The DISC was just a paper shell rather than an operating company, so it violated
subsidy rules established by the General Agreement on Tariffs and Trade (GATT),
now known as the World Trade Organization (WTO).

In 1999, EU challenged the FSC at the WTO as a violation of the Subsidies

and Countervailing Measures (SCM) portion of the Uruguay Round Code. The WTO
did not rule on the EU claim that FSC violates the SCM because export are taxed
16.7.

more favourably than production for the home U.S. market

TAX DIMENSION OF EXPATRIATES
Most countries tax the earnings of their residents. A survey by Business International

revealed that of eight major Western countries, the United States is the only one that taxes its
expatriates on worldwide income. The United States does, however, provide some relief for
citizens who have been residents outside the United States for an uninterrupted period that
includes zan entire year
16.8.

INTRACORPORATE TRANSFER PRICING

Transfer pricing is the pricing of goods and services between all combinations of parents and

subsidiaries. As such internal transfers include raw materials, semi finished and finished goods,
allocation of fixed costs, loans, fees, royalties for use of trademarks, copyrights, and other factors. In
theory, such prices should be based on production costs. Transfer pricing is also a management control
tool, and tax minimization may clash with the objective of motivating management control tool and
tax minimization may clash with the objective of motivating management to enhance profitability

1. Transfer Pricing and Tax Havens

Transfer pricing is often used to take advantage of tax havens. Factors influencing
transfer-pricing decisions (Tang survey, 1992) such as corporate profitability, differential tax
rates, restrictions on repatriation of profits or dividends, competitive position of foreign
subsidiaries. The consistently most important factors besides corporate profitability were
differential tax rates, restriction on repatriation of profits or dividends, and the competitive
position of foreign subsidiaries.

2. Tax Considerations in Transfer Pricing Decisions

Newsweek magazine gave an overly simplistic, hypothetical example of a U.S.
company that manufactured goods through its German subsidiary and sold them to its Irish
subsidiary, which in turn sold the goods back to the U.S. parent company. The goods were
manufactured at a cost of $80 by the German subsidiary and sold for the same amount to the
Irish subsidiary. Even though the tax rate in Germany is 45 percent, there is no tax on the
transaction. The Irish subsidiary then sells the goods to the U.S. parent for $150, earning a
profit of $70. Because the tax rate in Ireland is only 4 percent for that transaction, the Irish
subsidiary pays only $2.80 in tax. The U.S. parent then sells the goods for $150, earning no
profit and paying no tax, even though the U.S. tax rate is 35 percent. Thus, the U.S. company
ends up paying only $2.80 in income taxes, and this amount is paid in Ireland.
Transfer pricing has become increasingly important with the increase in MNEs. Ernst
and Young Transfer Pricing 2003 Global Survey Results, which is 86% of MNE parent

companies and 93% of subsidiaries, identified transfer pricing as the most important
international tax issue they deal with. If companies must make an adjustment, 1 in 3 with be
threatened with a penalty and 1 in 7 will pay a penalty40% of adjustments result in double
taxation. Sales of goods are the most audited, while audits of services and intangibles are
increasing.

a. U.S. Rules
In the United States, section 482 of IRS code governs transfer pricing. IRS may
reallocate income, deductions, credits, and allowances if it feels tax evasion is occurring.
Transactions must be at arms length. IRS is concerned with five areas: loans and
advances, performance of services, use of tangible property, use of intangible property,
sale of tangible property.

b. Methods for Determining Arms Length Prices

In making the allocations, the key for the IRS is to try to establish what an arm`s
length price should be. For tangible property there are six methods. Comparable
uncontrollable price method, which is market price, determines transfer price. Resale
price method, which is used if comparable uncontrollable price method cannot be used.
Comparable profits method, which is less common. Cost-plus method, which is costs of
manufacturing plus a normal profit margin. Profits split method is less common. Other
methods are less common.

16.9. TAX PLANNING IN THE INTERNATIONAL ENVIRONMENT

1. Choice of Methods of Servicing Foreign Markets
There are variety of ways in which a firm can choose to service its foreign markets.
a. Export
The firm should decide whether to service products for the parent country or
abroad. A U.S. firm needs consider the benefits of a sales office abroad. If licensing
technology, be aware of withholding taxes and relevant tax treaties.
b. Foreign Branches
Good to open a branch office at first to offset home country income with foreign
losses. The home office could use branch losses to offset home office income for tax
purposes. Branch remittances are not usually subject to withholding taxes.
c. Foreign Subsidiaries
Income is sheltered from taxation in home country until a dividend is remitted
(except for passive income of a CFC). The major problem with operating through a
subsidiary is that any losses sustained cannot be recognized by the parent company. Thus,
the subsidiary form of organization is much more valuable after the start-up years.
d. Location of Foreign Operations
The location of foreign operations is influenced by three major tax factors: tax
incentives, tax rates, and tax treaties. Tax incentive can reduce cash outflow of an
investment project. The determination of revenues and expenses for tax purpose is a
function of tax law in most countries. Tax treaties have critical impact on the cash flows
related to withholding taxes on dividends, interest, and royalties. Strict attention to tax

treaties can help investors choose the location of their legal operation wisely. For example
Withholding tax between U.S. and U.K. is 15%, but both countries have 5% withholding
agreement with the Netherlands. An arrangement could be made to send dividends from
the U.K. to Holland, then to the U.S., and the 15% tax would be partially avoided.

2. Transfer Pricing
Transfer pricing is a method of equalizing taxes globally. This ability is limited by the
increasing vigilance of tax authorities. Tax planning decisions should not crowd out
management control and other essential issues