Lect6 Taxes PDF

Tax havens and global capital allocation Ali Lazrak Learning Objectives Understand the different type of taxes Realize the incentives of corporation and wealthy individuals to use tax heaven to delay/avoid tax payments Be aware the importance of tax heavens in the...

Tax havens and global capital allocation Ali Lazrak Learning Objectives Understand the different type of taxes Realize the incentives of corporation and wealthy individuals to use tax heaven to delay/avoid tax payments Be aware the importance of tax heavens in the global capital allocation Outline Types of Taxation National Tax Environments Organizational Structures Tax heavens share of global capital allocation All the tables and results on investment positions in tax havens are taken from the website https://www.globalcapitalallocation.com 3 Importance of Tax havens As of December 2017, IMF coordinated investment survey reported $3.9 Trillion investment position in Cayman Island Cayman Island GDP is only $5 Billion Mismatch between the investment flow and the economic activity 4 Types of Taxation Three basic types of taxation that national governments throughout the world use in generating revenue: 1. Income tax. 2. Withholding tax. 3. Value-added tax. 5 Income Tax Income tax on personal and corporate income An income tax is a direct tax, that is, one that is paid directly by the taxpayer on whom it is levied. An income tax is levied on active income, resulting from production by the firm or individual or from services that have been provided National tax rates vary from a low of 0% to 40% or more in some countries 6  Corporate Percentage Income Tax Rates across border Country Headline Corporate income tax (CIT) rate Federal CIT: 15%. Provincial and territorial CITs range from 8% to 16% and are not deductible for Canada federal CIT purposes. United Federal CIT: 21%. State CITs range from 1% to 12% (although some states impose no CIT) and are States deductible expenses for federal CIT purposes. China 25% Hong First HKD 2,000,000 of assessable profits at 8.25%; Kong Remaining assessable profits at 16.5% Netherlan 25% ds Venezuel 34% a Vietnam 20% Cayman NA Island 46% for oil corp.'s; Bahrain 0 for other corp.'s Virgin NA Island 7  Personal Percentage Income Tax Rates across border Country Personal income tax (PIT) rate (%) Federal top rate: 33%. Canada Provincial/territorial top rates range from 11.5% to 21%. United 37% States China 45% Hong Progressive rates: ranging from 2% to 17%; Kong Standard rate: 15% Netherlan 49.5% ds Venezuel 34% a Resident: Progressive rates up to 35% for employment income; Vietnam Non-resident: A flat tax rate of 20% for employment income; See Vietnam's Individual tax summary for rates for non-employment income. Cayman NA Island Bahrain NA Virgin NA 8 Island Withholding Tax Levied on passive income earned by an individual/corporation of one country within the tax jurisdiction of another country Passive income: dividends, and interest income, and income from royalties, patents, or copyrights Many countries have tax treaties with one another specifying the withholding tax rate applied to various types of passive income. Withholding tax rates imposed through tax treaties are bilateral, or negotiated between two countries. 9  Withholding tax across border Country Withholding tax (WHT) rate (%) (Dividends/Interest/Royalties) Resident: NA; Canada Non-resident: 25 / 25 / 25, may be reduced by treaty and to 0% for most interest paid to arm's-length non-residents. Resident: NA; United States Non-resident: 30 / 30 / 30 Resident: NA; China Non-resident: 10 / 10 / 10 Resident: 0 / 0 / 0; Hong Kong Non-resident: 0 / 0 / 2.475 to 4.95 Resident: 15 / 0* / 0*; Non-resident: 15 / 0* / 0* Netherlands *As of 1 January 2021, there is a conditional WHT on interest and royalties, please refer to the section on Withholding tax. Resident: 34 / 0 or 5 / 0 - see summary; Venezuela Non-resident: 34 / see summary / see summary WHT applies to certain payments made to foreign organisations and individuals undertaking business or earning income sourced from Vietnam, regardless of the residency status. Vietnam WHT rates are nil for dividends. For interest and royalties, please refer to Vietnam's Corporate tax summary. Cayman Island NA Bahrain NA 10 Virgin Island NA Value-Added Tax 1 A value-added tax (VAT) is an indirect national tax levied on the value added in the production of a good (or service) as it moves through the various stages of production Several ways to implement a VAT, but “subtraction method” is frequently followed. In many European countries (especially the EU) and Latin American countries, a VAT has become a major source of taxation on private citizens. 11 National Tax Environments International tax environment confronting a MNC or an international investor is a function of the tax jurisdictions established by the individual countries in which the MNC does business or in which the investor owns financial assets Two fundamental types of tax jurisdiction: 1. Worldwide taxation. 2. Territorial taxation. Unless prevented, double taxation would result if all nations were to follow both methods simultaneously 12 Worldwide and Territorial Taxation The worldwide or residential method of declaring a national tax jurisdiction is to tax national residents of the country on their worldwide income no matter in which country it is earned National tax authority is declaring its tax jurisdiction over people and businesses. The territorial or source method of declaring a tax jurisdiction is to tax all income earned within the country by any taxpayer—domestic or foreign National tax authority is declaring tax jurisdiction over transactions conducted within a nation’s borders. 13 Foreign Tax Credits Approaches to avoiding double taxation: A nation could choose not to tax foreign-source income of its national residents. Alternatively, a nation could grant to the parent firm foreign tax credits, a credit given to the parent firm against taxes due in the host country based on the taxes paid to foreign tax authorities on foreign- source income. Used frequently by the United States. In a given tax year, an overall limitation applies to foreign tax credits. 14 Organizational Structures: Branch and Subsidiary Income Overseas affiliate of a U.S. MNC can be organized as a branch or a subsidiary: A foreign branch is not an independently incorporated firm separate from the parent. Active or passive foreign-source income earned by the branch is consolidated with the domestic-source income of the parent for determining the U.S. tax liability. A foreign subsidiary is an affiliate organization of the MNC that is independently incorporated in the foreign country and in which the U.S. MNC owns at least 10% of the voting equity. 15 Organizational Structures: Tax Havens A tax haven country is one that has a low corporate income tax rate and low withholding tax rates on passive income Examples of tax havens are Bahrain, Bermuda, Cayman Islands, Channel Islands (Guernsey and Jersey), and the Isle of Man. Useful as locations for a MNC to establish a wholly owned “paper” foreign subsidiary, that in turn would own the operating foreign subsidiaries of the MNC Tax havens are used for setting up "paper" subsidiaries to defer taxes on dividends. 16 Tax heavens share of global capital allocation The main purpose of Petrobras' use of tax havens is financial optimization. This involves: 1. Reducing Taxes: Tax havens (like the Cayman Islands) allow Petrobras to lower the taxes they or their investors need to pay on financial transactions such as bond issuances and dividends. For example, a bond issued through the Cayman Islands avoids the 15% withholding tax that would apply if issued directly from Brazil. 2. Bypassing Restrictions: Some countries impose regulations, such as capital controls or foreign ownership restrictions, especially in strategic industries like oil and gas. Tax havens provide a workaround. 3. Attracting Global Investors: By using tax havens, Petrobras can access a wider range of international investors who might otherwise avoid investing in Brazilian securities due to tax or regulatory barriers. 17 Petrobras 18 Petrobras 19 Petrobras 20 Petrobras 21 Example: Petrobras Bond (CUSIP 71645WAR2) $2.7 Billion, coupon of 5.375%, 10-year, issued January 2011 Immediate issuer: Petrobras Int. Fin. Co., Cayman Islands 22 Why issue/purchase securities in tax havens? Reduce corporate taxes and withholding taxes Avoid capital controls Avoid regulation Access a different investor base 23  1. Reduce withholding/corporate taxes Tax inversions: relocate headquarters to a lower tax jurisdiction Medtronic: US firm with 160B market cap relocated to Ireland even if 57% of the sales are in the US Reduce withholding taxes: If a mutual fund buys directly Petrobras’s equity from Brazil, they will have to pay 15% withholding taxes By US tax laws, mutual funds are not eligible for The Treasury International Capital (TIC) reporting system collects data for the United States on cross-border portfolio investment flows and positions tax credit for foreign investments between U.S. residents (including U.S.-based branches of firms headquartered in other countries) and foreign residents (including offshore In contract, there is 0 withholding taxes if the branches of U.S. firms). Petrobras equity is issued in Cayman Island 2. Tax Havens to Avoid Capital Controls Foreign ownership of strategic industries (IT and Telecommunication) is forbidden in China Get around this using Variable Interest Entity (VIE) structure: Alibaba, Baidu, JD.com,Tencent Evergrande also Issued Bonds in Cayman Island  3. Avoid Regulation European Firms Use Tax Havens to Avoid Regulation EU introduced “Market Abuse Regulation” (MAR) in July 2016 Extended strict disclosure requirements to issues in most of EU, but not Guernsey and Jersey 4. Access a different investor base How Big A Deal? Tax Haven Share of Total Financing How Big A Deal? Tax Haven Share Cross-Border Financing Restating the portfolio position for the US investors for bonds Who Issues Equity in Tax Havens? Who Issues Bonds in Tax Havens?  Conclusion Big disparity in corporate taxes across jurisdictions Regulations and Tax represent a first order force in cross border security issuances and investment Tax Havens are economically important Political response?