1. CHAPTER 15 International taxation

2. Contents  Introduction – Main types of taxation  Corporate income tax and dividends  Deferred taxation  International taxation  Transfer pricing  Tax havens

3. Main types of taxation  Taxation as costs  Social security charges  Local/regional taxes  National corporate income taxes  Taxation on behalf of a third party  Value added tax

4. Value added tax  Imposed on customers at each stage of a product’s value-added chain, based on the value added at that point  Gross amount of VAT on sales and on purchases is netted in the accounting system and net amount is paid periodically to the tax authorities  Not part of revenue or expenses, but included in receivables and payables (cash flow effect)

5. Corporate income tax  Income tax payable = Taxable profit * Tax rate (f.i. 30%)  Taxable profit is not equal to accounting profit  Differences? Some expenses are not allowed tax-wise (entertaining, fines, excess depreciation, excess provisions, etc.) Special tax allowances (for capital investment, environmental protection, etc.) Income that is non-taxable  Deferred taxes arise from these differences

6. Taxable profit Reconciliation statement: Accounting profit before tax Add back: disallowed expenses Deduct: special tax allowances and non- taxable income = Taxable profit

7. Taxation of dividends  Problem of potential double taxation of dividends due to concurrent corporate and personal taxation  Solutions:  Profits paid to shareholders are taxed at a lower rate than those retained in the company, or  Tax credit on the dividend for shareholders

8. Deferred taxation  Deferred taxes  Income statement perspective on deferred taxes  Balance sheet perspective on deferred taxes  Presentation of deferred taxes in the financial statements

9. Deferred taxes  Differences between objectives of measuring (accounting) profit for financial reporting purposes and basic tax raising motives of measuring taxable profit  Accounting rules regarding income taxes:  Tax effects of transactions are recognised in the financial statements in the same period as the related business transactions themselves  Current income tax cost (taxable profit * nominal tax rate) is only part of these tax effects

10. Deferred taxes (cont.)  Income statement: deferred tax cost (or benefit) complements current tax cost  Balance sheet: deferred tax assets and deferred tax liabilities reflect future tax consequences of transactions that were not treated identically for taxation and financial reporting purposes

11. Income statement perspective on deferred taxes  Cfr. Reconciliation statement - two types of differences:  Permanent differences  Timing differences  Timing differences arise because the timing of income and expenses in the income statement occurs in different period from taxable profit  Timing differences arise in one period and reverse in one or more subsequent periods

12. Illustration – Tax deductible accelerated depreciation  Purchase of a fixed asset (€10,000) with tax incentive (accelerated depreciation) in 20X1  Useful life = 2 years and no residual value  Depreciation  Financial statements: 5,000 in 20X1 and in 20X2  Tax calculation: 10,000 in 20X1 and 0 in 20X2  Pre-tax profit of 20,000 in 20X1 and 20X2 and tax rate of 50 per cent

13. Illustration – Income tax calculation 20X120X2 Pre-tax profit (includes depreciation expense) 20,000 Timing difference (accelerated depreciation) - 5,000+ 5,000 Taxable profit15,00025,000 Tax due at 50%7,50012,500

14. Illustration – Income statement effect without deferred taxes 20X120X2 Pre-tax profit20,000 Corporate income taxes due - 7,500- 12,500 Net profit after tax12,5007,500

15. Illustration – Income statement effect including deferred taxes 20X120X2 Pre-tax profit20,000 Total tax expense: °Taxes due °Deferred tax expense °Deferred tax income - 7,500 - 2,500 - 12,500 +2,500 Net profit after tax10,000

16. Illustration – Deferred taxes on the balance sheet  Deferred tax expense => Deferred tax liability  Indicates that profit in the financial statements has in the past been higher than for tax purposes  Liability: reflects future taxation on the difference – postponement of tax payments to future periods  At reversal of timing difference:  Deferred tax income in income statement  Settlement of deferred tax liability

17. Alternative illustration – Provision not accepted for tax purposes  Deferred tax income => Deferred tax asset  Indicates that profit in the financial statements has in the past been lower than for tax purposes  Asset: reflects future tax savings on the difference – taxes paid, but recoverable in future periods  At reversal of timing difference:  Deferred tax expense in income statement  Use of deferred tax asset

18. Balance sheet perspective on deferred taxes  Deferred taxation based on balance sheet values  ‘Temporary differences’: differences between balance sheet values and tax values of assets and liabilities  Tax value (tax base) = the amount at which the asset or liability is recognised for tax purposes  Temporary differences are broader than timing differences

19. IAS 12 Income taxes  Two types of temporary differences:  Taxable differences that result in deferred tax liabilities – taxable amounts in determining taxable profit of future periods  Deductible differences that result in deferred tax assets – amounts that are deductible in determining taxable profit in future periods  Deferred tax asset / liability is measured as the temporary difference multiplied by the tax rate (applicable when asset is realised or liability is settled)

20. Illustration - Tax deductible accelerated depreciation (repeat) 20X120X2 (a) Accounting balances Asset carrying amount 1 January Additions Accounting depreciation Asset carrying amount 31 December 0 10,000 -5,000 5,000 0 -5,000 0 (b) Tax values Asset tax base 1 January Additions Tax depreciation Asset tax base 31 December 0 10,000 -10,000 0 00000000 (c) Temporary differences5,0000

21. Illustration - Tax deductible accelerated depreciation  Temporary difference of 5,000 in 20X1  Taxable or Deductible ? Tax base of asset < Book value of asset Future accounting depreciation will be higher than tax depreciation Future taxes due will be higher than expected on accounting profit => Taxable temporary difference Deferred tax liability of 2,500 (50 per cent tax rate) Deferred tax expense of 2,500  Reversal in 20X2  Settlement of deferred tax liability  Deferred tax income of 2,500

22. Presentation of deferred taxes in financial statements  Separate presentation of deferred tax assets (liabilities) in balance sheet  Classified as non-current balance sheet items  Tax expense (income) related to ordinary activities presented on the face of the income statement  Additional disclosures in the notes:  Details on major components of tax expense  Numerical explanation of relationship between tax expense and accounting profit  Details on temporary differences and related deferred tax assets and liabilities

23. International taxation  Taxation is administered on a company-by- company basis and calculated on individual subsidiaries’ accounts  International taxation presents both threats and opportunities  Structuring of international transactions in the most tax efficient way  Avoiding double taxation (double tax treaties)

24. Transfer pricing  Transfer prices are the prices at which goods and services change hands between subsidiaries of a group  Artificially fixing transfer prices is a way of determining where profits are taxed  Double tax treaties usually state that transfer prices must be “at arms’ length” or at market rates  Intra-group charges (like royalties for use of intellectual property and interest charges) are also usually structured according to a tax treaty

25. Tax havens  Tax havens typically offer low tax or flat rate tax for companies which are resident but whose activities are external to the haven (‘off-shore’)  Frequently used by a MNC to provide international services (like finance, insurance) to the group  Do not generally benefit from tax treaties with other countries  Costs are not negligible and substantial throughout is needed to create tax savings

26. Offshore financial centres  Near relatives of a tax haven, but benefit from double tax treaties with major trading countries  The corporate tax they levy is sufficiently high for developed countries not to treat them as a tax haven, but sufficiently low so as still to be attractive to companies