Transcript Profit Determination

Comparative Corporate Income Taxes
in Europe
Prof. Dr. Geerten M.M. Michielse
Technical Assistance Advisor IMF, Washington
Georgetown University Law Center
What will be discussed?

Corporate Income Tax Systems

Measurement of Business Income

Thin Capitalization

Inter-company Dividends (EU Parent-Subsidiary)

Corporate Reorganizations (EU Merger)

Liquidations
May 2003
Corporate Income Tax Systems
Corporate
Income
Tax
Systems
No integration
Classical System
Integration of
Distributed Profits
Corporate Level
Dividend
Deduction
System
May 2003
Split Rate
System
Full
Integration
Shareholder Level
Advanced
Profit Tax
System
Dividend
Exemption
System
Final
Withholding
System
Imputation
System
Current EU Systems
Country:
System:
Rate (%):
AUT
Final Withholding
34
BEL
Final Withholding
33.99
DEU
Dividend Exemption
39.58
DNK
Classical
30
ESP
Imputation
35
FIN
Imputation
29
FRA
Imputation
34.33
GBR
Imputation
30
GRC
Dividend Exemption
35
IRL
Classical
12.5
ITA
Imputation
38.25
LUX
Dividend Exemption
30.38
NLD
Classical
34.5
PRT
Imputation
33
SWE
Classical
28
Central & East European Systems
Country:
System:
Rate (%):
BGR
Final Withholding
23.5
CZE
Advanced Profit Tax
31
EST
)1
HUN
Final Withholding
18
LTU
Advanced Profit Tax
24
LVA
Dividend Exemption
25
POL
Final Withholding
27
ROM
Final Withholding
25
SVK
Final Withholding
25
SVN
Dividend Exemption
25
May 2003
Preliminary Conclusions

Only CZE has integration on corporate level (APTS);

GRC has moved from corporate level (DDS) to
shareholder’s level (DES);

DEU, IRL and LTU have moved away from
integration of tax liability (APTS/IMPS);

FRA is gradually moving out of IMPS (by reducing
imputation-%);

Most countries favor FWHT.
May 2003
Dividend Deduction and
Split Rate Systems
(international aspects)

Non-Resident Shareholders
– exclusion from DDS/SRS  discrimination?
– high withholding tax
distribution quota
 tax treaty protection


Permanent Establishment
– moment of distribution parent company
– allocation issues
May 2003
Lithuanian Profit Tax
(before 2003)
Pre-tax profits
Profit tax (24%)
Dividend distribution
Withholding tax (29% of 760)
Profit tax
Less: WHT credit
MPT
At shareholder’s level: dividends taxable in full
May 2003
1,000
240
760
220
240
220
20
Czech Corporate Income Tax
Pre-tax profits
Income tax (31%)
Dividend distribution
Withholding tax (15% of 690)
Income tax
Less: 50% WHT credit
MCIT
At shareholder’s level: final withholding
May 2003
1,000
310
690
104
310
52
258
Advanced Profit Tax Systems
(European aspects)




No withholding tax on dividends
paid to qualifying EU parent company;
No credit for withholding tax available;
Higher tax rate on companies owned
by qualifying EU parent companies;
Non-discrimination issue.
May 2003
Solution: Advanced Profit Tax
Pre-tax profits
Profit tax (20%)
Dividend distribution
Advanced profit tax (25% of 800)
1,000
200
800
200
Profit tax
Less: Advanced profit tax
Main profit tax
At shareholder’s level: dividends taxable in full
May 2003
200
200
0
Finnish Imputation System
Pre-tax profits
Corporate income tax (29%)
Available for distribution
Imputation credit (CIT)
Grossed-up dividends
Personal income tax (38%)
Imputation credit
Net tax due
May 2003
1,000
290
710
290
1,000
380
290
90
French Imputation System
Pre-tax profits
Corporate income tax (34.33%)
Available for distribution
Imputation credit (10% of 657)
Grossed-up dividends
Personal income tax (49.58%)
Imputation credit
Net tax due
May 2003
1,000
343
657
66
723
358
66
292
Imputation Systems
(international aspects)

Distribution of foreign source profit to
domestic shareholders


Distribution of domestic source profit to
foreign shareholders


Equalization tax?
Tax credit?
Distribution of foreign source profit to
foreign shareholders

May 2003
Equalization tax exemption?
Cash Flow Tax Systems

Croatia (1994-2000):
– Investment income is tax exempt;
– ‘Protective Interest’ deduction (normal rate of
return on equity);
– Economic rent taxable (35%).

Estonia (2000-…?):
– Retained earnings are tax exempt;
– Distribution of profit establishes profit tax
(26/74th);
– Final withholding tax (26%).
May 2003
Croatian Corporate Tax System
Commercial profit
PI deduction (5% of equity)
Taxable profit
1,000
500
500
Corporate income tax (35%)
Available for distribution
At shareholder’s level: dividends exempt
May 2003
175
825
Estonian Corporate Tax System
Commercial profit
1,000
Dividend distribution
Corporate income tax (26/74th)
Available for distribution
Withholding tax (26%)
Net dividend received
At shareholder’s level: final withholding
May 2003
1,000
351
649
169
480
Cash Flow Tax Systems
(international/european issues)

Croatian variant:
– Characterization as income tax?
– FTC countries wipe out PI deduction
– Harmful tax competition?

Estonian variant:
– Characterization as withholding tax?
– Harmful tax competition?
May 2003
Harmful Tax Competition


Open only to non-residents or to transactions to nonresidents;
Ring-fenced from the domestic market;
(i.e. they do not have an impact on the national tax base)



Granted without any real economic activity and
substantial economic presence;
Profit determination departs from internationally
accepted (OECD) standards (??);
Lack of transparency.
May 2003
Epson case (C-375/98)
Portuguese Inheritance and Gift Tax

Arguments by ECJ:
– Chargeable event = payment of dividends
– Taxable amount = income from the shares
– Taxable person = holder of the shares

Decision by ECJ:
– WHT: any tax of whatever nature or however described,
which takes the form of WHT on dividends.
May 2003
Athinaika Case (C-294/99)
Greek dividend withholding tax under DDS

Arguments by ECJ:
–
–
–
–

Chargeable event = distribution of profit
Tax directly related to size of distribution
No absorption of loss carry forward
DTA provision indicates withholding tax
Decision by ECJ:
– WHT if tax-exempt income re-incorporated in tax basis upon
distribution, whereas otherwise exempt.
May 2003
Profit / Corporation Tax

Profit Tax
– Distinction between Business Income and Other Income
– Profit vs. Income Tax

Corporate Income Tax
– Distinction between Legal Entities and Individuals
– Corporate Income vs. Personal Income Tax
May 2003
Common Law Systems
(Characteristics)
Fear for strong Administration resulted in:

Extensive Legislative Texts
(due to implementation of case law)

Extensive Set of Definitions
(textual interpretation)

Separate Set of Tax Provisions
(due to confiscatory character)

Separate Capital Gains Tax
(capital gains vs. ordinary income)
May 2003
What will be discussed?

Corporate Income Tax Systems

Measurement of Business Income

Thin Capitalization

Inter-company Dividends (EU Parent-Subsidiary)

Corporate Reorganizations (EU Merger)

Liquidations
May 2003
Measuring Business Income



How are tax laws related to accounting
practice?
What are the main issues that need to
be determined in measuring the
income of a business in its accounts?
In what areas do the principal
problems arise in practice?
May 2003
Balance Sheet

Commercial Balance Sheet
– information instrument
e.g. to shareholders / debtors
– management tool
 tendency to overvalue

Fiscal Balance Sheet
– state revenue instrument
 tendency to undervalue
May 2003
Fiscal Accounts
(current EU Member States)

‘Autonomy of Fiscal Accounts’ Concept
 Separate legal provisions
 FIN, GBR and IRL
 Jurisprudence (‘sound business practice’)
 NLD

‘Unity of Law’ Concept (i.e. business
accounts)
 AUT, BEL, DEU, DNK, ESP, FRA, GRC, ITA, LUX, PRT and
SWE
May 2003
‘Unity of Law’ Concept
(arguments pro)

Sound Business Practice &
General Accepted Accounting Principles

No decisive reason to deviate

Measurement of ‘distributable’ profit

Juridical process can be streamlined

More in line with continental view
May 2003
‘Unity of Law’ Concept
(arguments contra)


End of traditional freedom to choose a
fiscal system and to revoke that choice
Treasury becomes a direct interested
party in the application of GAAP

Linkage is not unquestioned

Different objectives / purposes
May 2003
‘Sound Business Practice’
(Netherlands)

Starting Point:
– Principles of Business Economics

Exceptions, when conflicting with:
– any Regulation in Tax Law;
– a General Intention; or
– Principle of the Relevant Tax Law.
May 2003
Commercial Code
(Germany and Austria)
‘Maßgelichkeit’ Principle:

Assets and Liabilities
– Materielle Maßgeblichkeit (DEU)

Commercial Valuation
– Formelle Maßgeblichkeit (AUT)
May 2003
General Accounting Plan
(France)

Accounting Boards (‘tableaux comptables’)
used in Tax Declaration must be established
in accordance with accounting rules
and

If no contrary tax law or regulation provides
a different solution, accounting rules are
applied
May 2003
Profit-and-Loss Account Method
(Latvia)
Article 4(1):
“The taxable income … shall be the amount
of annual profit (loss) as stated in the profit
and loss statement … calculated in
accordance with [the provisions] of the law
On Annual Reports of Enterprises, … .
Taxable income shall be adjusted … in
accordance with this Law.”
May 2003
Measuring Business Income

Balance Sheet
– measuring of income by comparison of
two financial statements

Profit-and-Loss Account
– measuring of income for a period of time
May 2003
Profit-and-Loss Account

General Rule: Financial Statements

Tax Provisions:
Increased by e.g.:
Non-deductible expenses
 Provisions and reserves

Decreased by e.g.:
Exempt dividends
 Deferred capital gains

May 2003
Balance Sheet
Net Equity Balance Sheet Ending 2002
Net Equity Balance Sheet Beginning 2002 -/-
Net Equity Accretion during 2002
Profit Distributions / Private Expenses +
Taxable Business Income
May 2003
Measuring Business Income



How are tax laws related to accounting
practice?
What are the main issues that need to
be determined in measuring the
income of a business in its accounts?
In what areas do the principal
problems arise in practice?
May 2003
Fiscal / Commercial Profit
(typical areas of deviation)








Non-deductible Expenses
Depreciation
Provisions and Reserves
Bad Debts
Losses
Inflation
Capital Gains and Losses
Tax Incentives
May 2003
Non-Deductible Expenses

General rule excludes private expenses

Technical (legislative)


Private Elements


representation, entertainment
Avoidance


dividend distributions, recoverable VAT
thin capitalization
Political unwanted

May 2003
bribes, penalties
Provisions / Reserves
(EU Member States)

Risks and Future Expenses


Bad Debts



General: DNK (limited), ESP (only for SME’s), GRC, ITA and
NLD
Specific: all other Member States, including those above
Pensions


AUT, BEL, DEU, ESP, FRA, GBR, IRL, LUX, NLD and PRT
AUT, BEL, DEU, GRC, ITA, LUX, NLD and SWE
Repairs

May 2003
FIN, DEU (substantial maintenance), ESP (if plan approved),
FRA, IRL, ITA, NLD and SWE
Risks and Future Expenses
(AUT, BEL, DEU, ESP, FRA, GBR, IRL, LUX, NLD and PRT)

Common conditionalities:
–
–
–
–
–
–

Taxpayer’s estimation (e.g. in AUT and ESP)
Objective facts and circumstances (e.g. in AUT and ESP)
Business experience (e.g. in AUT)
Cause in current tax year (e.g. in BEL, DEU and GBR)
Mandatory under commercial code (e.g. in DEU)
Claim lodged or very possible (e.g. in BEL and DEU)
Some countries (e.g. DNK and SWE) allow only a
provision for guarantees
May 2003
Bad Debts
(all EU Member States)

General Provision
(allowed in DNK, ESP, GRC, ITA and NLD)
– Typically limited, e.g. max. 5% of trade
receivables (GRC and ITA) or only available for
SME’s (ESP)

Specific Provision
(allowed in AUT, BEL, DEU, DNK, ESP, FIN,
FRA, GBR, IRL, LUX, NLD, PRT and SWE)
– Based on loan-by-loan approach
May 2003
Pensions
(AUT, BEL, DEU, GRC, ITA, LUX, NLD and SWE)
Main Characteristics:





Obligation to pay future pensions
Legally ‘qualified’ pension scheme
Actuarial computation
Mandatory inclusion in commercial balance
sheet (BEL)
Discount rate (AUT: 20%, DEU: 6%)
May 2003
Repairs
(FIN, DEU, ESP, FRA, IRL, ITA, NLD and SWE)

Replacement Reserve (FIN, NLD and SWE)
max. 2 years (FIN)
 max. 3 years (SWE)
 max. 4 years (NLD)


Substantial maintenance and repair (DEU)

Approved Repair Plan (ESP)

Limited to 5% of book value (ITA)
May 2003
Ordinary Losses
(EU Member States)

Carry Forward
– Unlimited:
AUT, BEL, DEU, DNK, GBR, IRL, ITA (only for start-up
losses), LUX, NLD and SWE
– Limited:




5 years: FRA, GRC and ITA
6 years: PRT
10 years: ESP and FIN
Carry Back
DEU (1 year + max), FRA (3 years), GBR (1 year), IRL
(1 year) and NLD (3 years)
May 2003
What will be discussed?

Corporate Income Tax Systems

Measurement of Business Income

Thin Capitalization

Inter-company Dividends (EU Parent-Subsidiary)

Corporate Reorganizations (EU Merger)

Liquidations
May 2003
Treatment of Interest Expenses

Limitation of Interest related to Exempt Income

Obligation to Pay Subscribed Capital in Full

Limitation of Interest Rate

Debt-to-Equity Ratio

Tax Haven Creditors

General Anti-Avoidance Rules
May 2003
Thin Capitalization Rules
(EU Member States)
Loans Affected
Ratio
Result
BEL
Directors and
Shareholders
1:1
Re-characterization
DEU
Substantial shareholders
(>25%)
1.5:1
Re-characterization
DNK
Controlling shareholders
(>50%)
4:1
Non-deductibility
ESP
Non-resident related
companies
3:1
Re-characterization
FRA
Controlling shareholders
(>50%)
1.5:1
Non-deductibility
GBR
75% non-resident parent
companies
1:1
Re-characterization
IRL
75% non-resident parent
companies
n/a
Re-characterization
LUX
Shareholders
undisclosed Re-characterization
PRT
Related parties (>25%)
2:1
Non-deductibility
Thin Capitalization Rules
(Central & East European Countries)
Loans Affected Ratio
Result
BGR
All
1:1
Non-deductibility
CZE
Non-resident
related parties
4:1
Non-deductibility
HUN
Related parties 3:1
Non-deductibility
LVA
All
2:1
Non-deductibility
POL
Substantial
shareholders
3:1
Non-deductibility
ROM
All
1:1
Limited deductibility (50% of
profits)
SVK
Related parties 4:1
Non-deductibility
SVN
Substantial
shareholders
Non-deductibility
May 2003
3:1
Thin Capitalization
(technical issues)

Equity definition
– Revaluation reserve
– Negative equity position

Back-to-back loans / Guaranteed loans

Non-deductibility vs. Re-characterization

Non-discrimination
May 2003
Equity Definition
(Germany)
Para. 8a, Abs. 2 Kist:
“Anteiliges Eigenkapital des Anteilseigners ist der Teil des Eigenkapitals der
Kapitalgesellschaft zum Schluß des vorangegangenen Wirtschaftsjahrs, der dem
Anteil des Anteilseigners am gezeichneten Kapital entspricht. Eigenkapital ist das
gezeichnete Kapital abzüglich der ausstehenden Einlagen, zuzüglich der
Kapitalrücklage, der Gewinnrücklagen, eines Gewinnvortrags und eines
Jahresüberschusses sowie abzüglich eines Verlustvortrags und eines
Jahresfehlbetrags (§ 266 Abs. 3 Abschnitt A, § 272 des Handelsgesetzbuches) in der
Handelsbilanz zum Schluß des vorangegangenen Wirtschaftsjahrs; Sonderposten mit
Rücklageanteil (§ 273 des Handelsgesetzbuches) sind zur Hälfte hinzuzurechnen. Eine
vorübergehende Minderung des Eigenkapitals durch einen Jahresfehlbetrag ist
unbeachtlich, wenn bis zum Ablauf des dritten auf das Wirtschaftsjahr des Verlustes
folgenden Wirtschaftsjahrs das ursprüngliche Eigenkapital durch Gewinnrücklagen
oder Einlagen wieder hergestellt wird.”
May 2003
Back-to-Back Loans
Parent
Company
bank deposit
or guarantee
Commercial
Bank
loan
Subsidiary
Company
Example provision:
“If a loan is received from a third party and an associated person of the recipient
gives a guarantee on this loan, para. … shall be applicable as if the associated
person made the loan directly.”
May 2003
Re-characterization vs. Non-deductibility

Re-characterization
interest re-characterized as dividend
 debt re-characterized as equity

 profit allocation

Non-deductibility
 profit determination
May 2003
International Withholding Tax

Re-characterization


Art. 10(3) OECD refers to domestic definition of source state
Art. 23 OECD requires relief for dividend w/h
 no double taxation

Non-deductibility


Art. 11(2) OECD
Art. 23 OECD requires relief for interest w/h
 no double taxation
May 2003
International Economic Double
Taxation

Recharacterization




OECD-Commentary: Art. 9 applicable
IFA-Resolution: arm’s length approach preferred
Michielse: nonsense, Art. 9 cannot apply
Art. 9(2) OECD: no obligation for corresponding
adjustment
 danger of double taxation

Non-deductibility

profit determination is not profit allocation
 double taxation
May 2003
Non-discrimination

Article 24(4) OECD
interest payments to non-residents shall be
treated under the same conditions for tax
purposes as interest payments to residents
(except for Art. 9(1) and Art. 11(6) OECD)

Article 24(5) OECD
resident companies shall be treated under the
same conditions for tax purposes irrespective
whether its shareholders are residents or nonresidents
May 2003
What will be discussed?

Corporate Income Tax Systems

Measurement of Business Income

Thin Capitalization

Inter-company Dividends (EU Parent-Subsidiary)

Corporate Reorganizations (EU Merger)

Liquidations
May 2003
Intercompany Dividends
(parent company)

Domestic subsidiary

Qualifying EU subsidiary
– At least 25% shareholding
– Minimum holding period of (maximum) 2 years

Other subsidiary
May 2003
Intercompany Dividends Received
(EU Member States)

Exemption Method
– Full exemption
AUT, DEU(r), DNK, FIN(nr), GBR(r), GRC(r), IRL(r),
LUX, NLD and SWE
– 95% exemption
BEL, DEU(nr), FRA, ITA(nr) and PRT

Credit Method
ESP, FIN(r), GBR(nr), GRC(nr), IRL(nr) and ITA(r)
May 2003
Intercompany Dividends Received
(Central & East European Countries)

Domestic subsidiaries
– Exemption method
BGR, HUN, LTU, LVA and SVN
– ‘Separate tax base’ method
CZE, PLN, ROM(fwh) and SVK(fwh)

Foreign subsidiaries
– Exemption method
HUN, LTU and LVA
– ‘Separate tax base’ method
CZE
May 2003
Intercompany Dividends Paid
(EU Member States)

Domestic Parent Company
Exemption (except ESP: 25%)

Qualifying EU Parent Company
Exemption, if:
-

At least 25% shareholding; and
Minimum holding period (BEL, DEU, DNK, ESP, ITA and NLD: 1
year – AUT,FRA and PRT: 2 years)
Other Foreign Parent Company
 Exemption (DNK and SWE)
 25% (IRL 24%, ITA 27%, FIN 29%)
May 2003
Intercompany Dividends Paid
(Central & East European Countries)

Domestic Parent Company
– Exemption (BGR, EST, HUN, LVA and SVN)
– General WHT (CZE, POL, ROM and SVK)

Foreign Parent Company
– WHT rates (10-20%) apply
May 2003
What will be discussed?

Corporate Income Tax Systems

Measurement of Business Income

Thin Capitalization

Intercompany Dividends (EU Parent-Subsidiary)

Corporate Reorganizations (EU Merger)

Liquidations
May 2003
Capital Gains on Shares

Common Law
– Separate Capital Gains Tax (basis and
rate)

Civil Law
– Shares are business assets
– Substantial shareholding
– Speculative transactions
May 2003
Common Law Regime
(assets / liabilities)



Distinction between income and capital
gains
Capital allowances for depreciation
Only capital gains on assets (!)
At disposal of assets:
 Recapture of capital allowances in Income
Tax
 Capital Gains Tax on difference between
market value and acquisition price
May 2003
Civil Law Regime
(assets / liabilities)



Capital gains are treated as ordinary income
Depreciation (business expense)
Capital gains on both assets and liabilities
At disposal of assets:
 Capital gain / loss taxable at normal rate on
difference between market value and book
value
May 2003
Mergers & Reorganizations

Capital Gains / Losses
– Depreciation Basis
– Transfer of Provisions / Reserves

Transfer of Loss Carry Forward

Liquidation Proceeds
May 2003
Reorganizations
(covered by EU Merger Directive)

Transfers of Assets

Exchanges of Shares

Mergers

Division
May 2003
Transfer of Assets
Sh T
Transferring
entity
Sh R
Receiving
entity
Sh T
Transferring
entity
Receiving
entity
May 2003
Before
After
Sh R
Exchange of Shares
Sh AD
Sh AG
Sh AD
Sh AG
Acquiring
entity
Acquired
entity
Acquiring
entity
Acquired
entity
May 2003
Before
After
Mergers

into an existing company

into a newly established company

into the parent company
May 2003
Merger
Sh T
Sh R
Transferring
entity
Receiving
entity
May 2003
Before
Sh T
Sh R
Receiving
entity
After
Division
Sh T
Sh T
Transferring
entity
May 2003
Before
Receiving
entity
After
Receiving
entity
EU Merger Directive



Introduction of cross-border mergers
within EU Member States
Loss carry-over facility extended – if
available – to cross-border mergers
Roll-over-relief for capital gains
realized
May 2003
EU Merger Directive
(problem areas)


Issuance of new shares /
Transfer of existing shares
Omission of certain valuation rules
– Shares received as consideration (both States)
– Shares / Assets received in State of residence

Interpretation issues
– 10% cash payment
– Anti-avoidance rule
May 2003
Transfer of Assets
(valuation issues)
Transferring
company
D
C
Receiving
company
A
PE
May 2003
B
Exchange of Shares
(valuation issues)
Sh AD
E
F
Acquiring
Company
H
Acquired
Company
May 2003
G
Merger
(valuation issues)
Sh T
E
Transferring
company
Sh R
F
E
Receiving
company
A
PE
May 2003
B
Omission of Valuation Rules

Shares received in consideration [company
T or shareholder AD]
(a) in State of residence [D]
(b) in State of source [C] or [F][H]
– Nonresidents (corporate entities) exempt
– Tax treaty protection

Shares / assets received in State of
residence [company R or AG] [B] or [G]
– (Participation) exemption
May 2003
France

Prior approval of MoE&F in several cases

Reporting requirements

Revaluation gain [company R]

Business purpose test / 5 years holding
period
May 2003
Germany

“Buchwertverknüpfung”
i.e. double tax claim on both assets
transferred and shares received

PE merger questionable
Condition for merger = German unlimited
tax liability
May 2003
The Netherlands

Motivated by valid commercial reasons
– Restructuring
– Rationalization of business activities

Same tax regime requirement

3-years holding period
May 2003
United Kingdom


No implementation of Merger / Division
Special EU provisions:
(a) Transfers of Assets
– ‘ownership’ test (Sec. 343 ICTA)
– ‘bona fide commercial transaction’ requirement
(b) Exchanges of Shares
– Limited to Secs. 126-138 TCGA
– ‘business purpose’ test (Sec. 139-5 TCGA)
May 2003
What will be discussed?

Corporate Income Tax Systems

Measurement of Business Income

Thin Capitalization

Intercompany Dividends (EU Parent-Subsidiary)

Corporate Reorganizations (EU Merger)

Liquidations
May 2003
Corporate Liquidations


Last opportunity to tax shareholders on
undistributed profits
Dividend distribution
Occasion to tax shareholder on appreciation in
value of his investment
Capital Gain on shares
May 2003
Corporate Liquidations
(dividend distribution)
Liquidation payments
Less: nominal value of shares
(or – if higher)
acquisition price of shares
Dividend distribution
Difference between acquisition price and nominal
value of shares might be treated as Capital Loss
May 2003