I sometimes need to do a double take when it comes to international tax. We read of double taxation, double non-taxation, double tax treaties, double tax relief. It is enough to make anyone see double. It is time to double down on our efforts to clear up any confusion.
Double taxation is where a taxpayer pays tax twice on the same income. Usually because there are two countries who both have the right to tax it. Double non-taxation is where a taxpayer does not pay tax at all on their income – typically because both countries think that the other has the right to tax it. Most of the focus in the last five years has been on eliminating double non-taxation, but double taxation remains a significant concern for many businesses.
So why might double taxation occur?
Every country has its own corporation tax rules. Most seek to identify and tax the profits (rather than the gross income) that companies make, but each is subtly different in how they do that.
Consider a US businesswoman has set up a company in the US to sell to US customers. This company will be tax resident in the US and will only pay US corporate tax on its profits. But then she wants to start selling to British customers, so employs salespeople in the UK to lead negotiations. As the business is now partly carried on in the UK, she will have to pay UK tax on the portion of profits that arise in the UK. But the US might not stop taxing those profits just because the UK also taxes them. Even if it did, the US tax authority might have a different idea about how much of that profit arose in the UK than HMRC do. So the company could end up paying tax twice on the same profits.
Our businesswoman becomes so successful selling here that she decides to spend more time in the UK. She starts holding her board meetings here rather than flying back to the US. This indicates that her company is actually being “managed and controlled” from the UK, which makes it tax resident in the UK under our laws. But US law says that if a company was incorporated in the US, it remains US tax resident. Again, this could result in tax having to be paid twice on the same profits.
With sales continuing to grow on this side of the pond, our businesswoman decides to start selling into continental Europe. A US bank lends the company some money to fund this. When the company pays interest to the US bank, UK law says that this interest is UK-sourced, and 20 per cent of it must be withheld and paid directly to HMRC. But the bank is already subject to US tax on all its profits. This means that the bank is subject to double taxation on the profits it generates from that loan. 20 per cent of the gross interest might actually be more than the profits the bank ends up earning on that loan (once it takes its business expenses and US tax into account).
Having to pay tax twice on the same profits would make anyone think twice about whether it is worth trading internationally. While most businesses want to pay their fair share to support the economies where they do business, paying tax twice makes a big difference – especially if you are trying to pump your profits back into your business so that it can grow, and your domestic competitors are only paying tax once.
So what is the solution?
Fortunately, the US and the UK recognise the investment and growth benefits of international trade, and have agreed a Double Tax Treaty to allocate taxing rights between them. For the most part, such treaties work well, and evidence shows that they increase cross border trade and investment.
But negotiating treaties is not easy. Some are concerned that they disadvantage less developed countries who want to attract investment but have less bargaining power than developed countries. The Platform for Collaboration on Tax (a group made up of the OECD, UN, World Bank and IMF) will be releasing a toolkit to assist such negotiations later this year. There have also been concerns raised that treaties could facilitate double non-taxation – where neither country taxes the profits. In response, nearly 80 countries have recently signed a Multilateral Instrument to simultaneously amend their tax treaties to introduce anti-abuse clauses. Ensuring that tax treaties are demonstrably fair to both countries, and cannot facilitate abuse, will hopefully encourage more countries to enter into them.
For the above examples, the US/UK treaty confirms that the company is tax resident in the UK (not the US), and that the portion of its profits attributable to US activities is taxable only in the US. No tax need be withheld tax on the interest payments, because the treaty allocates the rights to tax interest to the recipient country.
The most common difficulty that remains is calculating the profit attributable to the US activities. International guidelines have been agreed at the OECD which say that you must allocate what a third party would be paid to do the same things that the company is doing in the US. However, the ever growing complexity of international business’ supply chains, difficulties in finding comparables, and - increasingly – the value of intellectual property and impacts of digitalisation, make this calculation far from clear.
One thing that is clear is that if countries move away from looking to the location of companies‘ activities to identify the location of its profits (by, for example, taxing revenues instead of profits), then this will not be relieved by existing treaties, and this will take us back to square one - double taxation. While governments might initially appreciate the additional revenue from companies paying twice, the overall impact on trade and investment really would make this a double-edged sword.
Blog by David Murray. David is a member of CIOT's International Taxes Sub-committee and Director at PwC