International tax planning necessary to reduce incidence of taxation-II

Roy Rohatgi

This is the second and concluding part of the series on international tax planning. The first part discussed that international tax planning is the art of structuring the proper combination of transactions and ownership of entities lawfully to ensure tax effective routing of business activities and capital flows on cross-border transactions. The need for and opportunities in international tax planning were also covered in the first part.

C. What can be achieved by international tax planning?
The overall tax planning should minimise global taxes and achieve the maximum after-tax income for the ultimate recipient of the income. The general objective should be to increase the overall result after tax (not just reduce taxes) on the repatriated funds earned abroad.
These incomes may arise from active sources, such as business or commercial profits and personal services, or passive income as dividends, interest, royalties, etc. The tax planning must be holistic, i.e. it should cover the entire transaction from its source to the ultimate destination of the net-of-tax income, that is, follow the flow of funds. It must include any intermediary jurisdiction, if used. This front-end tax planning for the entire transaction from host-to-home requires a careful review of all relevant domestic tax systems and tax treaties.

The three levels of tax impact on cross-border transactions are:

(i) in the source or host country: taxes payable on profits earned through subsidiaries or branches, and on repatriation of profits or capital from operating locations;

(ii) in the intermediary country/ies (if used): corporate or income taxes and withholding taxes on outward payments made to home country; and

(iii) in the residence or home country: taxes on profits and capital received, and sometimes even if not received, from entities in the other countries.

Tax planning can be achieved at each level. For example:
(i) The taxation in the source country can be reduced through:
(a) local tax planning to optimise the use of available tax deductions, incentives, tax losses and special tax concessions under domestic law and tax treaties;
(b) tax exemption under domestic law or tax treaties through the break or “fracture” of the connecting tax factors affecting tax residence, the source of income or gain, the nature and place of transaction, or the legal form of the entity;
(c) the application of various measures to ensure that substantial profits arise outside the country through profit extraction or diversion techniques; such techniques can help to shift profits from high tax to low tax locations (and vice verse for expenses), or move taxable profits from profitable to loss-making jurisdictions;
(d) the use of tax treaties to achieve either a reduction in withholding taxes, or tax exemption if the business presence does not lead to a permanent establishment or fixed base; and
(e) the selection of the appropriate legal entity (e.g. branch or subsidiary) and the form of financing (debt or equity) from a tax viewpoint.

(ii) Intermediate country taxation on remitted income flows can be reduced through:

(a) the use of tax treaties to reduce withholding taxes in the Host country;
(b) the proper selection of tax havens to minimise or avoid the corporate tax, and the withholding taxes, which is due on outgoing payments made by the intermediate entity;
(c) tax arbitrage through a change in the nature or character of the transaction or income paid to the Home country;
(d) the use of various tax concessions, such as the participation exemption, European Union’s Parent-Subsidiary Directive for holding companies, special provisions for trade blocks, headquarters or service companies, etc.; and
(e) the funds can be retained offshore to achieve tax deferral on remittances to Home country, if the Home tax rate is higher; alternatively, they can be accumulated for reinvestment abroad or paid as an upstream loan to the parent company.
(iii) The taxation on profits repatriated to the home country can be reduced through:
(a) the use of global corporate structures that avoid, reduce or defer the tax liability; and
(b) the optimal use of available foreign tax credits and exemptions to reduce domestic tax payments.

International tax planning examines the routing of money flows in cross-border transactions, as they pass from host country, where they arise, to the home country, where they eventually end. It requires a detailed understanding of host, home and intermediary tax laws and systems, and tax treaties, having regard to the anti-avoidance rules in various countries. Unlike domestic tax planning, effective international tax planning depends on the knowledge of domestic laws and tax treaties in more than one country. It is more flexible, but also more complex.

Tax planning is an art. It relies on the knowledge and skills of the tax planner. There is no ideal or risk-free solution. The tax planner should review the level of risk. The review should include the objectives, approach and conclusions of the tax planning.

They should check the applicability of tax treaties, and the validity of the legal entities in the jurisdictions involved. They should monitor future changes in law and tax practices in the host and home countries (including intermediary country, if used). The plan must also meet the business objectives at an acceptable level of tax and administrative costs.

Tax planning involves tax mitigation through the use of tax treaties and the lawful use of tax concessions given by various countries.
It does not imply or encourage tax evasion or tax avoidance. It is based on legal and acceptable use of tax laws and treaties to minimise worldwide tax liability. It accepts that tax payments are a legitimate cost of doing business in any country.International tax planning must be done lawfully, that is within the law of each country where the business is transacted. It should not rely on tax loopholes since the litigation costs can be high.

Above all, it should rely on legitimate tax mitigation and not unacceptable tax avoidance schemes.

The author is ex-managing partner, Arthur Andersen, India. The views expressed here are his own.