 Hello and welcome to this session. This is Professor Farhad and this session would look at tax treaties Which is a topic covered in international accounting and or taxation course as always I would like to remind you to connect with me on LinkedIn if you haven't done so YouTube as you would need you would need to subscribe I have 1,500 plus accounting auditing tax and finance lectures also I have my website on my website. I have additional resources such as PowerPoint slides notes multiple choice questions 2000 plus CPA CPA questions if you are looking to study with another individual I suggest use you check out study pal.co. They are available in 85 countries and 2800 cities. It's an artificial intelligence driven by the study body platform that match you with a CPA or a CFA or whatever Exam you are studying for Tax treaty first. Let's start up talk about what is a tax treaty? Well tax treaty is basically a bilateral agreement between two countries Regarding how companies and individual from one country will be taxed when they earn income in their other country simply put It's how are we gonna tax each other? How are you how are you gonna tax my citizen or my residents and how am I gonna tax your Citizens and resident and what I mean by citizen including corporation. So what is the purpose of a tax treaty? Well, it's to facilitate to make it easier for Countries and individuals and companies to participate in international trade and investment And one way to do so is reduce the tax barrier makes the tax barrier easier for companies and individual So the goods will flow from one country into the other because as we saw in the prior session One major problem of international trade and investment is the double taxation and double taxation Basically, you get taxed twice on the same income either in your home country or in the host country or in both at the same time Okay, and both at the same time or sometimes through a third party Also, what tax treaties provide is the possibility of reducing withholding taxes And we talked about withholding rates in the prior chapter if you if you reduce my withholding great I'm more likely to invest in your in your country because I can get money more than if you have a higher withholding Okay, but you have to keep in mind treaties require the exchange of information between countries to help in enforcing their domestic tax provision So simply put if you are two countries are going into a treaty with each other They should be in a sense friendly and open because the enforcement mechanism has to be there for the treaty to work So there's a lot of political Political consideration Factored into the tax treaty now there are many tax treaties around the world one model. We call it the organization for economic cooperation and development OECD model and most Most income taxes treaties signed by the major industrial countries, which is the right here the OECD countries They follow this model. They follow this OECD model an important aspect of this model an important article is A treat indicate an important article in this model Treaty indicate that a business profit may be taxed by a treaty partner country only if they are attributable to a permanent Establishment so simply put they say I'm only going to tax you if you have a permanent establishment in my country That's that's how I'm going to be taxing you now. Now. Let's talk about what do they mean by permanent establishment? That could include an office a branch a factory construction site mine well or quarry It does not include Facilities for storage display delivery and maintenance of goods already for processing by another enterprise does not constitute permanent establishment So basically they define what do they mean by permanent establishment? So I'm going to tax you if you have what's considered permanent establishment and those are the most industrial countries now again not everyone follow this OECD to To to the letter but that's what they use when they start the negotiation Okay, if there is no permanent establishment Then the income is not taxed in that country simply put if you don't have a permanent establishment Generally speaking, I am not going to tax you. Okay more about the OECD model One of the most important Aspect of this model is the reduction in withholding rate, which is good So I'm going to give you a list of the reduction, which is you don't have to know it just fyi For example, the model is 5 for direct investment in dividend Paid by subsidiaries to the parent withholding 15 for portfolio dividend paid to individual 10 interest on interest and zero percent on royalties So notice the OECD model may be a starting point for negotiation It doesn't have to be now generally speaking you would assume that countries with more outbound investment than inbound So if a country invests more in other countries, so their corporation is like they have a lot of multinational corporation They will always try to reduce the host countries write the tax. Okay simply put You know Seek and zero withholding on interest basically They don't want you to to withhold anything because when they want to get their money out because they are investing They want to get all of their money 100 percent. So this is the OECD model. Some countries follow it. We have also the UN model The OEC model assumed that countries are economic economically equal because they're all developed countries the UN model treat The country is differently. We have the develop and the developing countries basically the develop are Part of the OECD because they're well established and develop and they have a strong economy But the UN assumes there is an imbalance between the develop and the developing countries So the UN model recognize that the host country often a developing country where You are running your business should have more tax and write when profit Repatriation when profit is repatriated to the mother country or to the parent company simply put They try to give more power to the developing countries. So this way they can collect more taxes this way they can develop themselves That's the whole that's the whole Assumption behind this now the u.s. We also have our own model We have our own model when we negotiated tax Tax agreement bilateral tax agreement the u.s. Model exempt interest and royalties from withholding And establishes a 15 maximum for withholding on dividend Now it doesn't have to be this is the max for some countries We may have more but generally speaking and the u.s. Has treaties with more than 50 countries Of course the eu, australia, new zealand, ukraine, russia, egypt and israel, mexico, canada india so on and so forth and this is a list Of the different rate for example, if you notice here for the philippine You know the paid dividend paid on withholding is 20% now if there is no treaty It is the no treaty So if you have no treaty with a particular country, we would help 30% for example notice with canada zero paid Interest paid on interest paid to parent royalty paid to parent zero and only 5% on dividend basically canada is very close to us Germany same deal. So those are good deals. Those are good deals just to give you an idea What what you know what different treaties what different treaties are now Also as far as south america is of 2018 except for brazil. So brazil That's the only country that we don't have a tax treaty with All the other countries including believe it or not venzuela. It's which is misspelled We have a treaty with venzuela as well Now now one explanation why the us doesn't have treaty in brazil is there is little brazilian investment in the us So the the brazilian government they have no incentive to have a treaty because they don't invest in the us If anything the us invest in brazil and they want to have money Less money flown out of brazil. So it's the opposite So the reduction the reduction in withholding taxes with the result from a tax treaty would mostly benefit the us individual and companies who receive interest and dividend from the brazilian investment Therefore the brazilian has a little incentive. Okay, so the brazilian government is not interested because They don't they're gonna get the same benefit now Haven't said so if we compare brazil to poland poland don't have a lot of business investment in the us But poland we do have a tax treaty with poland because they have a different motive Okay, so there's also a very little polish investment in the us However, poland differ from brazil. Is there interested in attracting us investments? They want the us investments. Therefore, they want to make it as easy as possible Okay, so the us poland tax treaty allows poland to better compete and other countries in that region by attracting us investments okay, and Understanding the potential of to be derived from a tax treaty is very important. So it's very important You have a tax treaty why for example, let's assume $100 in dividend paid by a subsidiary in japan Okay, 95 would be received by the us parent company after the japanese would hold five percent So if you invest in japan, if you're gonna take $100 send it to the parent company The parent company would receive 95. We have a tax treaty. Let's assume the same thing with Taiwan we have in taiwan if you're gonna send $100 The parent company in the us would receive $80 simply put everything else is equal You know we the us company will prefer to open in japan and that's why that's why haven't tax treaty gives you an advantage in a sense Now let's talk about something called Treaty shopping, which is not as common as before but let's just cover it in case you run through the you're at it somewhere Or it's required. So what is treaty shopping treaty shopping describe a process in which a resident of country a Uses a corporation in country b to get the benefit of country b's treaty with country c Simple example, let's go back to the brazilian assume that a brazilian taxpayer has an investment in the us us dollar It is because the us has no treaty with brazil dividend payment to the brazilian investor Are taxed or the us government would have 30 percent So simply put if they pay you $100 the brazilian investor would receive $30 So the brazilian invests in the us They would receive $100 of dividend the government takes 30 the brazilian investor get $70 Now what is a tax treaty? Here's how the tax treaty work So here's what the brazilian investor would do and this was very common up until the late 80s until 1988 well Between the us and an island called the netherland entails the n a it's It's right in the caribbean sea right here in the caribbean sea You know of the events well inshore, okay? So what happened? So what what what investors used to do especially brazilian investors? They will the brazilian taxpayer would use this treaty to their advantage and what they would do They will open they will establish a subsidiary in The northern entail they will establish a subsidiary and the subsidiary will buy the stocks on their behalf now When When let's assume they bought IBM stocks or apple and apple or IBM paid dividend Well, the US government since they have a treaty with the With the netherland entails they will the the the holy subsidiary the brazilian holy subsidiary would receive 90 percent Now what happened is now this money is then transferred to the brazilian investor So basically this is what the treaty shopping is, okay? So and especially if there is if there's a treaty between the netherland entails and the brazil which is they'll get the remaining 80 percent so this way They will This way the brazilian investment would be able to keep an additional 20 percent because remember no treaty The brazilian would receive 70 dollars if they go through the entails They're going to only get 10 dollars or 10 percent off. They will get 90 dollars Which is 20 percent more so simply put it would look something like this The brazilian investor set a holding set a holding company in that island In the debt company now invest in the us the company in the us paid a hundred dollar We only deduct 10 dollars and 90 dollars goes to the To the to the holding company then the holding company will pay the 90 dollars There's no in-contact withholding between brazil and the netherland entails now. I'm assuming you know what happened now Well, there we go It's it's not about president trump But obviously president trump is trying to crack down on treaties like this But the point is Since the late 1980s the us government has been trying to limit the benefit for these provisions because they're aware of them They're aware of them now most most of the time when the us negotiate They want to make sure that That certain treaty benefit are not available 50 percent or more of the corporation is held by a third party Unless those stocks are publicly traded simply put if we have an agreement with country be Well, guess what country be benefit if if someone if another individual or another corporation owned 50 percent more by Someone other than country be then they don't benefit. Okay, the insertion of such limitation Would preclude the brazilian investors from enjoying the reduce what holding great paid by us companies Okay, in addition to entering new treaties the us has attempted to renegotiate its existing treaties with tax haven countries We talked about the tax haven countries to include the limitation on these Benefit provisions. Okay, and in some cases when the us failed to renegotiate They simply can't solve the agreement just this is true about the nether and anthills island, which is you know what we're not interested Okay, so the united states no longer have double taxation treaty with with this island now Keep in mind. This is tax treaties are ongoing process follow the news and with president trump in office I don't know for the next at least another year year and a half and who knows maybe four years after I can predict the future this topic will be very very interested But at least now you have an idea the purpose of the tax treaty. Why do we have a tax treaty? What are the benefit for the host country for the parent company? And if you have any questions email me if you need additional Lectures about related topics, please visit my website where you can download the power point as well as multiple choice questions Notes and CPA questions and consider subscribing. It's an investment in your career