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Thin Capitalisation

Thin Capitalisation. What is Thin Capitalisation. Main forms of profit reduction. OECD model convention. China DTA network. An example Domestic law design issues. Thin Capitalisation. Main forms of profit manipulation Transfer pricing : Serious risk to source country,

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Thin Capitalisation

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  1. Thin Capitalisation What is Thin Capitalisation. Main forms of profit reduction. OECD model convention. China DTA network. An example Domestic law design issues.

  2. Thin Capitalisation • Main forms of profit manipulation • Transfer pricing: Serious risk to source country, • Thin Capitalisation: Serious risk to source country, • Leasing: Serious risk to source country • Capital allowances: serious risk to source country.

  3. Thin Capitalisation • OECD Model Convention • No specific article • No specific prohibitions in domestic law • Article 9 Model Convention • Associated Enterprises • Article 24 Model Convention • Non Discrimination

  4. Thin Capitalisation • China DTA network • Russia • No article 9 • Hong Kong • Article 25: Nothing in this Arrangement shall prejudice the right of One Side to apply its domestic laws and measures concerning tax aviodance….[which ] includes any laws and measures for preventing prohibiting avoiding or resisting the effect of any transaction, arrangement or practice which has the purpose or effect of conferring a tax benefit on any person.

  5. Thin Capitalisation • China DTA network • Singapore • Article 26: Nothing in this Arrangement shall prejudice the right of each contracting state to apply its domestic laws and measures concerning the prevention of tax avoidance whether or not described as such in so far as they do not give rise to taxation contrary to this agreement. • Netherlands, Switzerland, Luxembourg • Article 9 and nothing else.

  6. mine Source country Operating Co. Source Country Parent Co. Foreign Shareholders dividends Australian Holding Co. dividends AUSTRALIAN PUBLIC COMPANY dividends Australian Shareholders Thin Capitalisation

  7. Thin Capitalisation mine Labour Technical Assistance Finance Essential inputs exploration Capital activities Research and equipment development Source country Operating Co. Source country Parent Co. PROFIT TRAP TAX HAVEN: Hong Kong. Australian group

  8. Thin Capitalisation

  9. Thin Capitalisation • Financing interest withholding tax DTA 5%-10% - Debt: lower tax: deduction/NRWT - Equity: higher tax; company tax/NRWT - Debt/Equity ratios: thin capitalisation • Intellectual Property DTA 0% - 5% - royalties: lower tax; deduction/NRWT - management fees: deduction/NRWT - Expert employees: deduction no NRWT

  10. Thin Capitalisation Cross boarder leasing • domestic law- finance leases • DTA • PE substantial equipment • interest article • royalty article • RESULT • possible to avoid source country tax on lease payments to parent co.

  11. 16. THIN CAPITALISATION

  12. Source Sub Third Party Parent Difference Revenue 100 100 - Interest Expense (10) (50) 40 NPBT 90 50 40 Tax 50% 45 25 (20) Thin Capitalisation Source Resources Source Sub 100% debt MNC 50% interest 100% debt 10% interest Third Party Source

  13. Source Sub ThirdParty Parent Difference Revenue 100 100 - Interest Expense (10) (50) 40 NPBT 90 50 40 Tax 50% 45 25 (20) Thin Capitalisation SourceResources Source Sub MNC 100% debt 100% debt 50% interest 50% interest Third Party Source ThirdParty Parent 50%

  14. Thin Capitalisation • The problem • interest is an expense but dividends are not, • source country taxation of interest paid to MNC LOWER THAN deduction to MNC SOURCE country subsidary • Design features to reduce this practice • non resident lenders, • domestic entities; • debt : equity ratio • debt : asset ratio • excessive interest 110% • back to back loans

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