Objectives of International Taxation

The main objectives of International Taxation are the Neutrality and Equity.

Tax Neutrality

A neutral tax is one that would not influence any aspect of the investment decision such as the location of the investment or the nationality or the investor. The basis justification for tax neutrality is economy efficiency. World welfare will be increase if capital is free to move from countries were the rate of return is low to those where it is high. Therefore, if the tax system distorts the after-tax profitability between two investments or between two investor leading to a different set of investments being undertaken, then gross world product will be reduced. Tax neutrality can be separated into domestic and foreign neutrality. Domestic neutrality is an compasses the equal treatment of any citizen investing at home and citizen investing abroad. The key issues to consider here are whether the marginal tax burden is equalized between home and host countries and whether such equalization is desirable.

Foreign neutrality: The theory behind Foreign neutrality in international taxation is that the tax burden placed on the foreign subsidiaries of domestic companies should equal that imposed on foreign-owned competitor operating in the same country.

Tax Equity

The basis of tax equity is the criterion that all tax payers in a similar situation be subject to the same rules. All Companies should be taxed on income, regardless of where it is earned. This, the income of a foreign branch should be taxed in the same manner that the income of a domestic branch is taxed.… Read the rest

Double Taxation Relief

One of the major risk in the International Business is the payment of taxes in both the countries i.e. the country in which the business is actually effected and in the country where the MNC is having its head office. This type of double taxation will definitely impede the growth and development of the MNCs in multiple ways. So the provisions are made to avoid the double taxation (Double Taxation Relief) between the two countries through two types of relief namely Bilateral Relief and Unilateral Relief.

Bilateral Relief

Under this scheme, relief against the burden of double taxation is worked out on the basis of mutual agreement between two countries. There are two types of agreements. In one type, the two concerned countries agree that certain incomes which are likely to be taxed in both countries shall be taxed only in of them or that each of the two countries should tax only a specified portion of the income. In the other type, the income subject to tax in both the countries but the assessee is given a deduction from the tax payable by him in the other country, usually the lower of the two taxes paid. This is called bilateral relief.

Unilateral Relief

There is no agreement under this scheme. Under unilateral relief, if any MNC who is resident in India in any previous year proves that, in respect of its come which accrued or arose during that previous year outside India, it has paid in country with which there is no agreement for the relief or avoidance of double taxation, income tax by deduction or otherwise, under the law in force in that country, it shall be entitled to the deduction from the Indian Income Tax payable by him of a sum calculated on such double taxed income at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal.… Read the rest

Direct and Indirect Taxes

Taxes are classified as direct tax and indirect tax. But the meaning of these two types of taxes is not clear. For a long time economists interpreted these two types in different ways. For instance, one group of economists considered taxes on production as direct taxes and those on consumption as indirect taxes. J.S. Mill distinguished these two types of taxes in terms of the ability to shift the tax. Any person on whom the tax is imposed, if he himself pays the tax, it is called direct tax and if he is able to shift the tax to somebody who ultimately pays it then it is called indirect tax. For example, income tax is paid by a person as it is levied on the income earned by him, so it is a direct tax. On the other hand the sales tax imposed on the seller is shifted to the buyer. Now-a-days the distinction between direct and indirect taxes is explained with reference to the basis of assessments and not on the point of assessment. Hence, taxes assessed on the basis of income are called direct taxes and those assessed on the basis of expenditure are called indirect taxes. However, even this classification is not free from difficulties. For instance, when one man’s income is treated as another man’s expenditure, tax on one man’s income may become the tax on another man’s expenditure. Hence, till date there has been no satisfactory distinction between direct and indirect taxes. However, in practice this distinction is retained more for the purpose of grouping the different taxes.… Read the rest

Principles of a Sound Tax System

According to Mrs. Hicks, a sound tax system should have the following characteristics:

  1. It should facilitate financing of public services.
  2. Tax, should be levied according to the ability of the people, the index of ability being income and family circumstances and
  3. Similarly placed persons should pay similar taxes to avoid any discrimination.

From the discussion above, we may lay down the following four broad characteristics as the principles of a sound tax system.

  1. Equality in Tax Burdens: This principle suggests that when the taxes are levied they ensure equality in tax burdens. In other words, through taxes the government can ensure that the tax burden is spread in such a way that persons who are placed in similar positions are made to bear the same burden of taxes. This implies that people who are better-off should bear more tax burden than those who are worse-off. Though this principle is universal, yet in the implementation of this principle problem like indicators of equality, effectiveness in practice, the method of achieving this equality, etc., will all be faced.
  2. Productivity: With the ever increasing responsibility of modern welfare state, the need for financial resources is always felt. As the modern governments spend huge amounts of money on public projects to maintain high level of public welfare, they have to raise enormous funds through taxation. Unless taxes are productive, the governments will find it difficult to implement public projects. Especially in a developing country, taxes are to be highly productive so that country can achieve growth with stability.
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Adam Smith’s Canons of Taxation

Canons of taxation are sets of criteria by which to judge taxes. These canons are still widely accepted as providing a good basis by which to judge taxes. Adam Smith laid down four canons of taxation. They are:

  1. Canon of Ability: According to this principle of taxation, the people in a country should contribute towards the government expenditure. Their contribution should be according to the ability to pay of each individual. A rich man should contribute more and the poor either should contribute less  or can be exempted. This principle of taxation will ensure that the cost of public expenditure is shared by the people in accordance with their individual ability.
  2. Canon of Certainty: Adam Smith insisted that the government should know in advance the amount of revenue that it could raise and the time when it could mobilize the revenue. On the part of individual tax payers, they must know clearly the amount of tax that they have to pay, the time when they should pay and the method of paying the tax. Adam smith felt that it is necessary that the people should be certain about their tax commitment, so that there cannot be any exploitation of the tax payers either by the government or by the tax collectors.  This implies, once the people are clear about the amount of lax, they will plan their expenditure accordingly so that tax payment will not be felt a penalty.
  3. Canon of Convenience: According to this canon, the tax should be such that it is levied at the time when it is convenient for the people to pay.
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International Taxation

For the worldwide/global operation of firms, taxation plays a vital role. International taxation has become the core of various financing decisions which includes international investment decisions, international working capital decisions, fund raising decisions and the decisions related to dividend and other payments. The tax decision is also relevant in domestic firms also.

The managing of taxation is an extremely difficult issue for the international corporations. The various reasons are given as follows:

  • The firms are supposed to work in several tax jurisdiction or authorities where the tax rates are diverse and also the administration of the tax system is not uniform.
  • The ultimate load of tax in the framework of international firms is determined by means of a more complex interaction of varying descriptions of the tax base.
  • The difference in tax treatment in different nations will direct to distortions in worldwide trade and investment. The companies which are situated in the low-tax country can have a periphery over other firms in worldwide market. There are possibilities to divert the investment to those countries that have low cost rates.
  • The overlapping takes place between the international firms with different tax jurisdictions, utilize the arbitrage opportunities and retain an edge over the domestic firms.

The bases of international tax system are:

  • Tax neutrality – The neutrality of international tax system is important because it must not affect the economic efficiency. If the tax is neutral then it will not influence the locality of the investment or nationality of the investor. The capital can shift from a nation with lesser return to a nation with higher return.
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