International

Taxation
 What is International Taxation?
 a system of taxing multinational companies and individuals
that generate income from different sources in the world
subject to charge of income tax by the tax laws of different
countries
multinational company
 a corporation that has its headquarters in one country and operates
wholly or partially owned subsidiaries in other countries
individuals and individual businesses
 a system of taxing cross border transactions or international
transactions
 transactions involving in two or more countries

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Basic Issues in International Taxation

Source of income
Tax status of taxpayers
Double taxation
Transfer pricing

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 (1) Source of Income
the place where an income is considered arise under the relevant
tax system
 Income from the performance of services: where the services are
performed
 Financing income: where the user of the financing resides
 Income related to use of tangible property: where the property is
situated
 Income related to use of intangible property: where the property is
used
 Gain on sale of real property: where the property is situated

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 Source of Income in Ethiopia
(a) Domestic Source Income
 income from a source inside the country as specified in the
income tax law

(b) Foreign Source Income

 income from a source outside the country as specified in the
income tax law

(c) Worldwide Income

 the aggregate of domestic source income and foreign source
income

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 (2) Tax Status of Taxpayers
the base for income taxation resulting from
international transactions or activities

three rules used by countries

territorial status of taxation
citizenship status of taxation
residential status of taxation

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 (a) Territorial
 considers the territory of a country where an income
arises
 only local source income is taxed
Angola, Botswana, Costa Rica, Djibouti, Georgia,
Guatemala, Hong Kong, Malaysia, Namibia,
Paraguay,Venezuela, etc.

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 (b) Citizenship
 a taxpayer’s income is chargeable to income tax in the

country as long as the taxpayer is a citizen of that country

USA, Eritrea (on non-resident citizens, with residential)

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 (C) Residential
residents of a country are taxed on their worldwide
income, while non-residents are taxed only on their
domestic source income
Algeria, Argentina, Australia, Austria, Belgium,
Brazil, Bulgaria, Burundi, Cameroon, Canada,
China, Colombia, Cote-Devoir, Croatia, Denmark,
Egypt, Ethiopia, France, Germany, India, Israel,
Italy, Japan, Kenya, Nigeria, Portugal, South Africa,
Spain, Sudan, Sweden, etc.

How to determine?

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 Residential Status Determination in Ethiopia
 Individual
has a domicile in Ethiopia
is present in Ethiopia for more than 183 days in a one-year
period either continuously or intermittently
is a citizen of Ethiopia working as an Ethiopian diplomat,
consular or other similar official posts abroad

 Body
is incorporated or formed in Ethiopia
has its place of effective management in Ethiopia

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 (3) Double Taxation

 comparable taxes are imposed by two sovereign countries on

the same item of income of the same taxpayer for the same tax
period

 if an item of income is taxed by more than one country on the

same taxpayer in respect of the same subject matter for identical
periods

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(a) Adoption of Foreign Tax Credit
 applied on a unilateral basis

(b) Adoption of TaxTreaty

 applied on bilateral basis

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 (i) Foreign Tax Credit (FTC)
 allows a taxpayer to credit his foreign income tax paid against
his home country’s income tax liability on the foreign source
income
benefits a taxpayer

 Criteria?

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 Tax Rules for Foreign Tax Credit in Ethiopia
 If a resident taxpayer has foreign income taxable under
“Schedule C” in respect of which the resident has paid foreign
income tax, the taxpayer shall be allowed a foreign tax credit of
an amount equal to the lessor of:
a) the foreign income tax paid; or
b) the business income tax payable under Schedule C in respect of
the foreign income
 The business income tax payable under Schedule C in respect of
the foreign income shall be computed by applying the average
rate of business income tax applicable to the resident taxpayer
for the year against the net foreign income of the resident for
the year.
 A foreign tax credit shall be allowed if the resident taxpayer has
a receipt for the tax from the foreign tax authority
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 Example
Binda Company, an Ethiopian resident, derived Br.100,000 in
net foreign income from a foreign country in a given tax year.
Such income is chargeable to tax under ‘schedule C’ of the
Proclamation. No any other foreign income was derived by
Binda Co. during the tax year in question.
Case 1:
The income tax rate in the foreign country where the income
derived is a flat rate of 20%.
Case 2:
The income tax rate in the foreign country where the income
derived is a flat rate of 45%.

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 (ii) Tax Treaty
 an agreement entered between two or more countries to
mitigate double taxation of the same income where both
countries claim the right to tax that same income and provide
procedural rules for the resolution of tax objections and
inconsistencies
 the goals and provisions of tax treaties vary
 OECD Model Convention
 UN Model Convention
 US Model Income Tax Convention
 most tax treaties define which taxes are covered and who is
eligible for benefits

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 Tax Treaty in Ethiopia
 means an international agreement for the avoidance of
double taxation and the prevention of tax avoidance and
evasion
 the Minister of Finance and Economic Cooperation is
empowered by the tax law to enter into a tax treaty with a
foreign government or governments

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 (4) Transfer Pricing
Transfer Price
 the price set for transactions that take place between associated
entities or related parties
 the price paid for an “exchange of goods or services” between
two associated persons or related entities
 the price assigned for intercompany transfer of goods (physical
or intangible) and services
 the amount charged by one segment of an organization for a
product or service that it supplies to another segment of the
same organization
creates income for the transferring sub-unit and a purchase cost for
the transferee sub-unit of same organization

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 Transfer Pricing?
 the pricing mechanism for intercompany transactions made
between associated enterprises or related parties

 the process of setting transfer price for transactions made

between associated enterprises or related parties

 the pricing of intercompany transactions that take place

between related entities or associated enterprises

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 Motives
There are different types of motivation for establishing transfer
prices:
 to communicate data that will lead to goal congruent decisions
 to evaluate segment performance and thus motivate subunit
managers towards goal congruent decisions
 to minimize world wide profit taxes, duties, and tariffs (in the
case of multinational companies)
 to minimize transaction taxes (in the case of domestic
transactions)

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 Transfer pricing Methods
a) Market-based transfer price
b) Cost-based transfer price
c) Negotiated transfer price

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(a) Market-based transfer price
 the price charged by the transferring unit from its external
customers is also the price charged by the transferring unit from
the transferee unit
(b) Cost-based transfer price
 the cost of product or service is the price charged by the
transferring unit from the transferee unit
 the cost to be used as a transfer price may be:- variable
manufacturing costs, absorption manufacturing costs or full product cost
(c) Negotiated transfer price
 the transfer price is reached based on negotiation between the
concerned sub-units of managers
 the supplying sub-unit transfers its products to the buying sub-unit
at the price agreed upon by the two controlled entities
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 Problems
 may result in transfer pricing manipulation/abuses
 the intentional setting of a transfer price for a transaction by one
entity with an associated entity in another jurisdiction for the
purpose of reducing the aggregate tax burden…
(a)Multinational companies may use transfer prices to minimize
their worldwide income taxes burden
 by setting high transfer price, or
 by setting low transfer price
 items produced by a Division in a low-income-tax-rate country are
transferred to a Division in a high-income-tax-rate country at a high
transfer price to minimize overall income taxes

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 Example
Binda Company is a U.S Manufacturer Company and has a
subsidiary in Canada. Product ‘Q’ is manufactured in the United
States where the tax rate is assumed to be 25% and sold in
Canada where the tax rate is assumed to be 45%.
Selling price/unit by Canada division …... . $1,500
Unit variable cost of U.S division …………. $200
Unit variable cost of Canada division …….. $150
Total fixed costs of U.S division ………….. $2,000,000
Total fixed costs of Canada division ……… $1,000,000
Assume transfer price is $500/unit in the first case and
$800/unit in the second case and 10,000 units were transferred
during the tax period.

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Case I: Company’s profit tax and profit when transfer price is $500
Manufactured Sold in Company as
Items in U.S Canada a whole

Sales price (per unit) -- $1,500 $1,500

Transfer price (per unit) $500 (500) --
Variable costs (per unit) (200) (150) (350)
Contribution margin per unit $300 $850 $1,150
Number of units… ×10,000 ×10,000 ×10,000
Total contribution margin $3,000,000 $8,500,000 $11,500,000
Fixed costs (2,000,000) (1,000,000) (3,000,000)
Profit before tax $1,000,000 $7,500,000 $8,500,000
Tax rate ×0.25 ×0.45 --
Income taxes ($250,000) ($3,375,000) (3,625,000)
Profit after tax $750,000 $4,125,000 $4,875,000
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Case II: Company’s profit tax and profit when transfer price is $800
Manufactured Sold Company as a
Items in US in Canada whole

Sales price -- $1,500 $1,500

Transfer price $800 (800) --
Variable costs (200) (150) (350)
Contribution margin $600 $550 $1,150
Number of units… ×10,000 ×10,000 ×10,000
Total contribution margin $6,000,000 $5,500,000 $11,500,000
Fixed costs (2,000,000) (1,000,000) (3,000,000)
Profit before tax $4,000,000 $4,500,000 $8,500,000
Tax rate ×0.25 ×0.45 --
Income taxes ($1,000,000) ($2,025,000) (3,025,000)
Profit after tax $3,000,000 $2,475,000 $5,475,000

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(b) Associated entities or related persons may also use transfer
prices to minimize their transaction taxes burden on
domestic transactions
 by setting low transfer prices for transactions…

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 Measures to Counter
 implementation of domestic transfer pricing law, developed
based on international best practices and guidance
 every country is following its own TP model but most of the
countries are following OECD model of convention on Transfer
Pricing
 Ethiopia has introduced and is following its own model of
Transfer Pricing under the Income Tax Law
 Ethiopia is an observer of OECD Model of convention on
Transfer Pricing

Transfer Pricing Rules in Ethiopia ???

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The End