Part III International taxation issues

• International taxation – imposing taxes on taxable

activities abroad by a person or company subject to
taxes;
• may include sales between companies in different
countries;
• individuals travel from one country to the other for
business or any other purpose;
• generation of income in one country as a result of
investments made by individuals or corporations of
another country; or
• services rendered by residents of one country to persons
in another country etc.
•  
• Domestic taxation concerns with the various kinds of
taxes imposed on bases that a given tax law
identifies as proper bases;
• International taxation deals with the taxation of
income originated in different countries;
• Countries involved in international taxation are
source and residence countries;
• The State where the income is generated is the
source country (State);
• The state where the taxpayer resides is the residence
country (State);
• Residence rules;
• Individuals’ residence – number of days /months
supplemented by other requirements;

• France 180 days; Germany 6 months; USA 122 days;

UK 91 days, Ethiopia 183 days (and other
requirements like has a domicile within Ethiopia; etc
• Companies residency rules usually consider:
– where the headquarter is,
– where the ownership is,
– Where the effective (central) management is etc.

• Countries have specific rules pertaining to the

determination of the resident of a company;
• For example UK company residency rules:
• if it is incorporated in the UK or, if not incorporated
in the UK, if its central management and control is
exercised in the UK.
• Ethiopia company residency rules:
• Has principal office in Ethiopia;
• Effective management in Ethiopia;
• Registered in the trade register of the concerned
government office;
• who should tax foreign source income? Residence or
source country?
• both countries have the sovereign right to impose
tax;
• every country has the right to tax income accruing,
arising or received in it, on account of the activity
carried on in its territory.
• Residence and source based taxation
• Residence based taxation
• All incomes (both foreign and domestic source
incomes) are taxable in the country of residence
only;
• No tax in source countries;
• foreign source income is exempted in the country of
source;
• likely to give advantage to developed countries at
the cost of developing countries;
• Source based taxation
• Foreign source income is taxed in the country of
origin and exempted in the country of residence;
• No taxation on foreign source income in the country
of residence;
• Likely to cause distortions – excessive capital export
• Specifically, excessive capital outflow to countries
where the tax rate is low;
• Global and territorial systems of taxation
• Global system (worldwide) - the total amount of tax
payable should be roughly independent of whether
the income is earned at home or abroad;

• It taxes residents of a country on their worldwide

income no matter in which country it is earned;
• Examples of countries using WWI method:
• A resident in the UK or US is liable to tax on
worldwide income;
• A resident of Ethiopia is also subject to tax on
worldwide income;
• Territorial system – an individual (a company)
earning income abroad needs to pay tax only to the
host government;
• Territorial taxation – taxes income in the country it is
earned; does not tax foreign source income;

• any business income earned in a territory is subject

to income tax in that territory, regardless of whether
the business is owned by foreigners.
• any foreign source income earned by residents are
exempt ed.
• Example: Mr ABC a resident in the US earned income
of $10,000 from work performed in the UK (in the
year 2008). He also earned $120,000 in the US (same
year).
• Home country (country of residence)= USA
• Host country = UK
• Income generated in the home country = $120,000
• Foreign source income = $10,000
• Taxation in the UK (host country)-non-resident
taxation
• Mr ABC is liable for income tax on $10,000;
• Taxation in the US (home country) resident taxation
(WWI)
• Residents are taxed based on their worldwide
income;
• Worldwide income in the example=
• Income in home country + income host country
• =$120,000 + $10,000 = $130,000;
• The foreign source income =$10000 is taxed twice
(double taxation of the same base);
• One of the problems in taxation of foreign source
income is the existence of double taxation;
• Double taxation has effects on the cost of operations
and effectively may act as a hindrance to cross
border activities (investments);

• International taxation regime deals with how to tax

international activities and avoid unfair treatment of
taxpayers (double taxation);

• In international taxation regime, the source State

(country) is granted the prior right to tax all income
and the residence State (country) has the primary
obligation to prevent double taxation;
• Avoiding double taxation
• The principle underlying avoidance of double
taxation is to share the revenues between the
countries involved;
• Double taxation is usually avoided through a Double
Taxation Avoidance Agreement (DTAA) entered into
by two countries for the avoidance of double
taxation on the same income.

• The DTAA eliminates or mitigates the incidence of

double taxation by sharing revenues arising out of
international operations by the two contracting
states to the agreement.
• There are at least three DTAA models;

• The OECD Model Tax Convention (Treaty) (emphasis

is on residence principle);

• UN Model (combination of residence and source

principle but the emphasis is on source principle);

• US Model
• objectives of a tax treaty include:
• prevent double taxation;
• facilitate cross boarder activities (investment etc) by
removing tax impediments;
• eliminate tax avoidance;
• exchange of information; and
• determine dispute resolution mechanisms.
• Methods for preventing double taxation
• three methods of providing relief from double
taxation –
• exemption, credit and deduction methods
• Exemption method- the residence country exempts
income that has arisen in the source country;
• Foreign source income is taxed only in the country of
origin (source);
• Example Netherlands
• credit method -residence country grants credit for
taxes paid by its resident in the source country;
• The tax paid in the source country is credited against
the total tax liability in the resident country;
• Countries using this include the US, Ethiopia etc
• Deduction method – resident countries allow
residents to deduct tax paid to a foreign country in
respect of foreign income;

• Mostly the credit method is adopted in the DTAA for

providing relief from double taxation;
Illustrative data on international double tax avoidanc
e methods.doc
• Multinational enterprises (companies);
• MNE is an entity that conducts business in more than
one jurisdiction;
• Worldwide tax saving- profit maximization
• Multinational corporations are subject to tax in their
home country depending on the specific
multinational taxation system adopted by the home
country.