International Taxation

International Taxation is the branch of tax law that studies the system and rules of taxation for cross-border transactions and entities. In simple terms, it's about how a country taxes the income or assets owned by its citizens abroad (global income) or how a country taxes the income or assets generated by foreign citizens within its borders (source income).

Why is International Taxation Important?

The globalization of the economy means that business transactions and investments are no longer limited to a single country. Multinational corporations, investors, and individuals often operate in multiple jurisdictions. This situation creates several key issues that International Taxation aims to address:
 

1. Tax Avoidance and Tax Evasion: Without clear rules, entities can shift their profits or assets to jurisdictions with low tax rates (tax havens) to minimize their tax liabilities.
    

2. Double Taxation: An income might be taxed by two or more countries. For example, an Indonesian citizen working in Singapore could be taxed on their salary in Singapore and also be subject to tax in Indonesia because Indonesia follows a global income tax system (taxing all income, whether from domestic or foreign sources).
    

3. Fairness and Equity: Ensuring that every entity pays a fair share of tax where they generate income.

Fundamental Concepts in International Taxation

Here are some fundamental concepts frequently used in International Taxation:

1. Basis of Taxation:

   • Residence/Citizenship Basis: A country taxes all of a taxpayer's income, both from domestic and foreign sources. This is often referred to as "worldwide income" or "global income." Examples: The United States and Indonesia.
      

   • Source Basis: A country only taxes income that originates from within its territory, regardless of the taxpayer's residence or citizenship. Example: Most countries apply this to non-residents.
      

2. Methods to Avoid Double Taxation:

   • Exemption Method: The residence country does not tax income that has already been taxed in the source country. This can be in the form of a "full exemption" or "exemption with progression."

   • Tax Credit Method: The residence country taxes all income but provides a credit (reduction) for the tax that has already been paid in the source country. This is a common method, including in Indonesia.
      

3. Double Taxation Agreements (DTA) or Tax Treaties:

   • These are bilateral agreements between two countries to avoid double taxation and prevent tax avoidance.

   • The primary functions of a DTA are:

     • To determine the taxing rights between the residence country and the source country.

     • To reduce the income tax rate on passive income such as dividends, interest, and royalties.

     • To provide a mechanism for the exchange of information between tax authorities.
        

4. Transfer Pricing:

   • This is the determination of prices for goods, services, or assets transferred between related parties (e.g., a subsidiary and its head office).

   • Issues arise when these prices do not align with a fair market value (the arm's length principle), which can be used to shift profits to jurisdictions with lower tax rates. Tax authorities have strict rules to review these transactions.
      

5. Anti-Avoidance Rules:

   • CFC (Controlled Foreign Corporation): Rules that tax the retained profits of a foreign subsidiary (usually in a low-tax country) as if those profits have been distributed to the parent company.

   • GAAR (General Anti-Avoidance Rule): A broad rule that gives tax authorities the power to disregard a transaction or scheme that was carried out solely for the purpose of tax avoidance.

Recent Developments in International Taxation

In recent years, the landscape of International Taxation has changed dramatically, driven by international initiatives such as:

• The OECD/G20 BEPS Project (Base Erosion and Profit Shifting): A global initiative to combat tax avoidance by multinational corporations that exploit loopholes in the international tax system. BEPS has resulted in 15 actions that focus on:

  • Preventing treaty shopping (the abuse of DTAs).

  • Stricter transfer pricing rules.

  • Country-by-Country Reporting.
     

• Pillar One and Pillar Two (from the OECD): Two pillars that aim to reform international tax rules:

  • Pillar One: Reallocates a portion of the taxing rights for large multinational corporations' profits to the market jurisdictions where they sell products or services, regardless of their physical presence.

  • Pillar Two: Establishes a global minimum tax rate of 15% for multinational corporations. This is intended to end the tax rate competition that benefits low-tax jurisdictions.
     

As a tax consultant, a deep understanding of these concepts and their developments is key to providing accurate advice to clients, whether they are multinational corporations aiming for global compliance or individuals with assets or income abroad.