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Summary - Class notes - Taxation
1525644000 Lecture 1
TaxTax is something that you need to pay, that is imposed on you by the government. It is imposed on individuals, entities and properties (on almost everything)
What are reasons that countries levy taxes?1. Raise revenue for the government expenditures: the government provides us with public services and those public services need to be paid.
2. Redistribute income/wealth within societies
3. Steer behavior
Depending on the type of tax, you have different aims with that tax. Some taxes are there to just generate revenue while other taxes are there really to steer behavior. A tax can also pursue multiple aims.
What kind of specific things do you get in return for your taxes?Taxes are collected for the welfare of taxpayers as a whole, but the individual taxpayer’s liability is independent of any specific benefit received. --> You don’t know exactly what are your taxes spend on. It goes into the big budget. Governments need to make sure that the revenue out of taxes cover the costs they have.
What taxes exist in the Netherlands?-VAT (Value Added Tax) à Raise revenue (redistribute income)
-Individual income tax à Redistribute wealth, raise revenue
-Corporate income tax
-Tourist tax (on nights in hotels)
-Excise duties (energy products, mineral oil, tobacco, alcoholic beverages)
-Capital gains tax
-Real estate tax
-Water & waste taxes
-Shareholder level taxes
-Motor vehicle tax
Taxes are a compulsory levy because you earn, own or consume something, differentiated into direct taxes, indirect taxes and excise duties.
Direct taxesDirect taxes relate to indicators of economic performance (income, wealth)
-Taxable person and person who bears the tax burden are identical
-Example: Personable income tax, corporate income tax
Indirect taxesIndirect tantes tax economic performance via income spending or transfer of assets
-Taxable person and person who bears the tax burden are often not identical
-Examples: Value added tax, real estate taxes, tap water taxes, waste tax
-Food: you are paying for the product, which already includes the VAT. This means that you are paying the tax, but you are not giving it to the government. The shop owner pays the tax to the government (taxable person). Het needs to declare to the government how much sales he had and what was the VAT on that, and he has to pay the VAT to the government à Mismatch between who pays it (bears the tax burden) and who gives it to the government (taxable person).
Excise dutiesExcise duties are levied on the consumption of certain goods.
-Often EU harmonized
-Often indirect taxes à similar to VAT, usually it’s included in the price
-Examples: Alcoholic beverages, energy products, mineral oil, tobacco
What are the three main topics of the public debat about taxes?-Wealth redistribution problem (economic growth of different types of companies)
-Race to the bottom (tax rates) à almost every developed country reduced their corporate income tax rate in the last decade (however, often the tax base is also becoming more broad)
-Fairness (if companies will not pay their fair share, why would I pay my part?)
Where are we now in the public debate about taxes?We are in the development of more rules, that’s good because some loopholes are being fixed. It also means that the tax law becomes more complex, because there are more requirements and more documents. Transparency and documentation also becomes more important.
What kind of impression do media articles give about companies and their corporate income tax?
Media articles make the impression that corporate income tax is a huge amount of the countries income tax and that countries miss out on a lot of revenue when companies avoid tax. However, it is less than people think, usually around 5-8% of the countries tax revenue.
Tax avoidanceLegal measures to reduce tax burden
Tax evasionIllegal measures to reduce tax burden
Does revenue losses from base erosion and profit shifting endanger countries’ budgets?Corporate income tax revenue NL: 5-8%
Corporate income tax revenue USA: 5-8%
Corporate income tax revenue Germany: 5%
Corporate income tax revenue OECD: 5-8%
à The majority of a countries income is generated by VAT.
What is the reasoning behind corporate income tax?à If an individual get dividend, you can tax it because it is income of that individual. However, a corporation can decide to retain earnings and not give dividends. This way the money never gets at individual level and that is something the government wants to avoid. Therefore the government introduces corporate income taxes. à Initial reason
à Companies use infrastructure of a country, so it’s normal that a government asks them for a certain share.
Do companies face reputational consequences from avoiding taxes?The article on the slide suggests that there can be reputational consequences for companies. However, the article of Gallemore et al. finds no effect on the reputation and reputational costs, except for a dropped stock price in the month after the company is identified as a tax avoider.
State aidCountries are not allowed to provide beneficial treatments towards certain companies. The EU said that some tax constructions are not illegal according to tax rules, but they are illegal according to state aid.
Tax LawTax law focusses on the design of tax laws, and revolves around core principles of taxation such as ability to pay and benefit principle.
Benefit principleIf you get a benefit from public services, you also need to pay for it
Ability to pay principle1) Equal income should generate equal tax payment.
2) Higher income should generate higher tax payment
Should taxes influence business decisions?
In theory, you don’t want that tax influences decisions but in reality you see that people want to avoid taxes so certain decisions are influenced by taxes.
What does the graph of individual income tax looks like?The graph shows that the 10% of the taxpayer with the highest income pays 50% (Germany) and 65% (USA) of the total income taxes.
What does the Dutch tax system looks like?Three boxes with different tax rates:
-Box 1: taxable income from work and home (mortgage deduction = deduct part of the interest payment from the tax base if you own a house)
-Box 2: taxable income from substantial income from shareholdings (substantial question varies according to countries)
-Box 3: taxable income from savings and investments à assets are being taxed, you can deduct the liabilities from your assets. Everything above 30,000 euros is subject of being taxed.
What does belong in box 1?-Profit from business and professional activities: partnerships
-Income from employment à salary
-Income from other activities à relates to cases where an individual gives assets to a corporation and the corporation generates profits from those assets à individual would like to do that because corporate tax rate is lower than individual tax rate
-Income in the form of periodic payments à retirement benefits
-Notional income and deductions from owner-occupied houses: mortgage deduction, where you can deduct certain (almost all) interest payment if you own a house à subsidy scheme for home ownership.
Why is in the NL the lowest tax rate already pretty high?In the Netherlands, the lowest tax rate is already pretty high compared to other countries. This is because the level of social security contributions in the Netherlands, these are already included in the tax rate.
Subsidy for homeowners-Interest rate from mortgage is (almost fully) deductible
-‘Notional rent’ is being added in box 1 à Because otherwise you get a lot more benefits than people who rent so this is a ‘fictitious’ rent.
Average tax rateAverage tax rate: the average tax you pay à Total income taxes paid/taxable income à Investors have to compare average tax rates of different countries to decide where to invest.
When is the average tax rate relevant?When investors have to decide in which country they should invest
Marginal tax rateMarginal tax rate: how much money would you have ‘extra’, when earning one more euro ‘extra’ à change in income taxes paid/change in taxable income à The marginal tax rate is relevant when deciding on additional income
When is the marginal tax rate relevant?The marginal tax rate is relevant when deciding on additional income/investment
What's the difference between marginal and average tax rate?Differences:
Average tax rate: important information if you think about choosing a location for the first time
Marginal tax rate: important information if you think about additional income
Do people use the average tax rate and the marginal tax rate for the right decisions?People use average tax rate instead of marginal tax rate. The reason for that is that individuals prefer to make it easy for themselves. Marginal tax rate is not always easy to calculate (the example is very easy, but in reality the tax base is very difficult) and therefore use the average tax rate in a decision. This is in their eyes efficient considering the high costs of employing the rational approach.
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Direct method of profit allocation
Standard method to allocate profits to a permanent establishment. The PE is treated for tax purposes as if it were a separate and independent enterprise. The PE accounts for revenue and deducts expenses that relate to its activities.
Indirect method of profit allocation
The profit is distributed according to allocation factors such as capital, wages, and sales.
How are profits distributed between the PE and its parent company?
- Indirect method of profit allocation
- Direct method of profit allocation
- Direct method of profit allocation
Is it possible to determine TP for transactions with PEs?
It is not possible to determine TP, because it is one legal entity
Resale price method
Determines the transfer price by deducting a gross profit margin from the price the reseller charges to third parties
TP is determined based on the cost plus a margin (what an independent retailer would ask on top to make a small profit)
Comparable uncontrolled price method
This method compares prices charged in controlled transactions (between group parties) to prices charged in uncontrolled transactions (between independent enterprises)
What are method to determine TP?
- Comparable uncontrolled price method
- Cost-plus method
- Resale price method
- Cost-plus method
- Resale price method
What's the problem with TP?
Problem with TP is that it’s not always available to compare with competitive market prices. When this would always be available, we don’t have any problems with TP. But this mismatch (the fact that we don’t have the information) that allows companies to come up with transfer prices allows them to shift profits across countries. --> Multinational companies have an incentive to use this mismatch to minimize the tax burden.
International profit allocation
The profit of a multinational company is generated in different countries and every country wants to have its fair share in that profit. Countries need to think about how the profit is allocated between different countries. This is done with transfer prices between associated entities and this TP need to be compared with market prices for comparable transactions.