TAX SPARING A reconsideration of the reconsideration Prof. Dr. Luís Eduardo Schoueri.

TAX SPARING

A reconsideration of the reconsideration

Prof. Dr. Luís Eduardo Schoueri

International Tax Regime

Territoriality x Worldwide taxation

A never-ending debate

Capital Export Neutrality (CEN) The final taxation is determined by the

Residence State Neutrality to the investor

interests

A Corp

B Corp

C Corp

loan

interests

State A State B

10% WHT

Tax rate on WW income: 30%

10% credit from WHT (State B)

loan

Capital Export Neutrality (CEN) CEN is NOT definitive

Neutrality?

If Source’s rate is higher, there is no reimbursement for the over-taxation

Under the same level of taxation, investors prefer to invest in a developing country’s infrastructural environment

Taxation at source

Capital import neutrality (CIN)

Capital Import Neutrality (CIN) The State of the investment determine

the final taxation of income sourced in its territory Neutrality under Source State perspective

$$

10% WHT

B Corp

C Corp

A Corp

State A

K

$$

$$

10% CIT

10% WHT

State B

State C

Territoriality x WW Taxation

CIN: exemption

CIN x CEN

CIN

Exemption method

Source State decides whether or not to tax

CEN

Credit method

Neutralizes any taxation decision of the Source State

The MORE the Source taxes, the LESS will be tax due at Residence;

The LESS the Source taxes, the MORE will be the tax due at Residence.

Tax sparing

Tax sparing aim at (i) assuring that treaty benefits will be maintained or (ii) at maintaining unilateral tax exemptions25%

15%

25%

Internal tax rate

Treaty tax rate

Tax credit

25%

15%

15%

10%

Internal tax rate (general)

Treaty tax rate

Tax credit

Internal tax rate (tax incentive)

(i) Matching credit

(ii) Tax sparing s.s.

Brazilian tax treaty policy

1960 Decade:

Brazilian perspective: territoriality

The Source State must have the exclusive right to tax

Taxation at source: 25%

Double taxation: illegitimate intrusion of the Residence State

Brazilian tax treaty policy

1960: first Brazilian treaties

Military government, foreign investments and development

Treaties as tools of economic policy

The decrease of the taxation at source must be in favor of the investor

Matching credit and tax sparing provisions

Matching Credit and/or Tax Sparing

Austria Belgium (expired) Denmark Spain Finland France Netherlands

Hungary Italy Luxembourg Norway The Czech and

Slovak Republics Sweden Germany (revoked)

Available on the Double Tax Treaties concluded between Brazil and the following European countries:

THE 1998 OECD REPORT

The OECD Report

Report “Tax Sparing: a Reconsideration”, 1998

Main concerns the potential for abuse offered by tax sparing the effectiveness of tax sparing as an instrument of foreign

aid to promote economic development of the source country general concerns with the way in which tax sparing may

encourage States to use tax incentives

“(…) tax sparing should be considered only in regard to States the economic level of which is considerably below that of OECD member States.”

RECONSIDERING OECD’s RECONSIDERATION

Reconsidering the OECD Report OECD Report: tax sparing would be in

disuse

Reconsidering…

Thuronyi: tax sparing clauses may be found in 1/3 of tax treaties signed from 2000 to 2003

Half of them involving OECD Members

Reconsidering the OECD Report OECD Report: there is no evidence that

tax sparing would affect the level of FDI

Reconsidering…

What is the effect of DTTs on FDI at all? Inconclusive researches

Brazil-Germany tax treaty Post-revocation: increase on German investments

Reconsidering the OECD Report OECD Report: lower taxation at source

as a condition for granting tax sparing (“high price”)

Reconsidering…

OECD itself advocates lower taxation at source

One should not generalize the idea that treaty negotiators would not be capable of deciding what to concede

Reconsidering the OECD Report OECD Report: increase in the standards

of living in developing countries

Reconsidering…

The OECD Report does not rely on any specific data on this issue

UN’s 2000 Millennium Development Goals Report “Ever-increasing inequality between countries”

Reconsidering the OECD Report OECD Report: the potential for abuse

derived from tax sparing clauses

Reconsidering…

If potential for abuse was to be considered, sooner or later no single article would survive

More consistent approach: treaty shopping and anti-abuse clauses (e.g. LOB)

Reconsidering the OECD Report OECD Report: tax sparing would

encourage an excessive repatriation of profits

Reconsidering…

Only valid for time conditioned clauses

Provided benefits are the same, investors’ decisions to repatriate profits should not be dependent on tax sparing provisions

Reconsidering the OECD Report OECD Report: tax sparing as a subsidy to

developing countries

Reconsidering…

Tax sparing is a mechanism for the recognition of the limits of States’ tax jurisdiction

Tax sparing confirms that Residence has no taxing right on an item of income granted to the Source State

Reconsidering the OECD Report

State BState A

Tax treaty

Exemption by the Residence What about if Residence State exempts

an item of income which would be taxable in Source State?

No limit should be applicable to the taxation of the Source State, since there would be no risk of double taxation

“Residual” tax power of the Source State

Tax sparing reconsideration

It is time to reconsider tax sparing…

… but NOT in the sense of OECD’s reconsideration!

THANK YOU!

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