taxation of capital gains in an international context...introduction what is capital gain? •no...

8 November 2017

Taxation of Capital Gains in an International Context

Law Department

Copenhagen Business School

http://europa.eu/!td94Dn

Peter Koerver Schmidt

Jesper Anker Howes

February 10th 2017

November 8 2017


- Taxation of capital gains – Main challenges and trends

Agenda Introduction Assets Taxation of Capital gain in International Context

Vessels

Real Estate

Shares

Agenda

Introduction

Trends

Introduction What is capital gain?

• No exact definition

• In this presentation:

• With focus on companies and CIV

• Gains resulting from the sale or exchange of property:

1. Shares

2. Real estate

3. Vessels.

• Not covering mark-to-market taxation nor intangibles.

page 6

Capital gain taxation - Initial considerations - Seller

• Who are the tax payers involved?

Corporations, individuals, industrial or institutional investor, collective investment vehicle (private equity funds)

• What are the assets transferred?

Shares, real estates, intangibles or vessels?

• Where are seller, buyer and asset?

Same jurisdiction or multiple jurisdictions?

• When did the transfer take place?

Last income year, this year or a future transaction

• Was there an actual gain?

Positive difference between sale and acquisition price.

• Who will tax?

Seller’s jurisdiction, buyer’s jurisdiction or target jurisdiction

• What kind of taxation?

Profit or gross taxation.

page 7

Capital gain taxation - Initial considerations – Buyer – going forward

Industrial Buyer:

Purpose?

Synergy effect or investment with intention of sale?

Contemplated Restructure?

Watch out if activities and functions are transferred

Any restrictions on future restructure of group?

Local taxation if transfer of ownership, bottleneck for dividends etc.

• Institutional Buyer/investor

• Direct investment or via CIV (private equity)?

• Repatriation strategy?

• What about future recaps?

• Generally for all:

• Indirect taxes: VAT, GST stamp duties!

page 8

Shares

BPM-D reconciliation to Nimbus page 9

Base case: Sale of company(shares) (1/5)

• Buyer, Seller and Target company are all residents of State A.

• Taxation is (obviously) only a question of legislation in State A- No cross border element -> No risk of double taxation.

• Tax consequences were (hopefully) foreseeable.

page 10

Seller Co

Buyer Co

Target Co

Shares

Remuneration

A

Base case: Sale of company (shares) (2/5)

• Seller Co, Buyer Co and Target Co are all residents of different jurisdictions?

• What if State A,B and C all of them impose taxes?

• Any tax treaty?

page 11

Seller Co

Buyer Co

Target Co

Shares

Remuneration A B

C

OECD article 13

• Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other State.

2) Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State, including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise), may be taxed in that other State

3) (…)

4) Gains derived by a resident of a Contracting State from the alienation of shares deriving more than 50 per cent of their value directly or indirectly from immovable property situated in the other Contracting State may be taxed in that other State

5) Gains from the alienation of any property, other than that referred to in paragraphs 1, 2, 3 and 4, shall be taxable only in the Contracting State of which the alienator is a resident.

page 12


• Provided there is a tax treaty in place with a wording equal to OECD Article 13 (5) only State A should tax a potential gain

• How to claim treaty benefits?

• At filing?

• Upfront approval?

• Reclaim procedure?

• Depending on jurisdiction and procedure a reclaim may be risky

page 13

Seller Co

Buyer Co

Target Co

Shares

Remuneration

A

C

B

Base case: Sale of company (shares)(4/5)

• Provided no DTA with wording as article 13(5):

• What if more than one Target jurisdiction and both impose tax on gains?

• Need to a purchase price allocation?

• What if tax authorities in State C and D disagrees with PPA?

• Access to claim DTT between C and D?

• Risk of double taxation?

• Becomes even more complicated with sale of entire groups.

page 14

Seller Co

Buyer Co

Target Co I

Shares

Remuneration

Target Co II

A B

C D


• Assuming no DDT protection at the level of Target Co

• What if sale takes place at the level of a HoldCo (in another jurisdiction)

• No (direct) change in ownership of Target Co

• Taxation of indirect capital gain?

page 15

Seller Co

Buyer Co

Hold Co

Shares

Remuneration

Target Co

A B

C

D

Vodafone – case

page 16

Hutchinson Tele. Holdings

(Cayman)

HTI Holdings Ltd

(BVI)

CGP Investments (Cayman)

Various Mauritius entities

Hutch Essar Ltd. (India)

Vodafone plc (UK)

Vodafone NL (Netherlands)

Remuneration

Indian withholding tax?

Indian Tax Man: Yes

Vodafone: No

Indian courts: No

Indian lawmaker: Yes.

SAAR example Denmark (1/2)

• Local Special Anti-avoidance Regimes should be kept in mind.

• In Denmark a reclassification regime applies for gains on intragroup sale => Taxed as dividends

• Especially relevant for PE funds.

• In the scenario to the left Danish withholding tax could very well apply on distributions of dividends made from Hold Co.

page 17

Hold Co (DK)

Target Co (DK)

PE Fund

Investors

Dividends

No DK taxation

Dividends

+ DK WHT

SAAR example Denmark (2/2)

• In order not to trigger Danish WHT someone came up with the idea of doing internal sale of shares instead of distributing dividends as Denmark does not levy taxation/withholding tax on gains.

• NewCo would then acquire HoldCo on a note (debt to PE). Any gain would not be subject to DK taxation and going forward instalments would neither be subject to Danish taxation.

• SAAR implies that such gain should be treated as dividends and not gain.

• Also have impact on recaps

• What about tax treaty?

page 18

Hold Co (DK)

Shares

Target Co (DK)

PE Fund

Investors

Dividends

No DK taxation

Instalments/repayment

No DK Taxation

New Hold Co (DK) Dividends

No DK taxation

Real Estate


Base case: Sale of real estate (1/3)

• Buyer, Seller and Real Estate are all residents of State A.

• Taxation is (obviously) only a question of legislation in State A- No cross border element -> No risk of double taxatoion.


page 20

Seller Co

Buyer Co

Property

Remuneration

Real Estate

A


• Seller Co, Buyer Co and Real Estate are all residents of different jurisdictions?


• Any tax treaty?

page 21

Seller Co

Buyer Co

Property

Remuneration

Real Estate

A B

C

OECD article 6

• Income derived by a resident of a Contracting State from immovable property (including income from agriculture or forestry) situated in the other Contracting State may be taxed in that other State.

2) The term "immovable property" shall have the meaning which it has under the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources; ships, boats and aircraft shall not be regarded as immovable property

• (…)

page 22


• If sale of Real Estate trigger local taxation what if shares in PropCo are sold instead?

• Generally to consider if Sale of shares vs. Real Estate:

• Tax exempted?

• Deferred taxes?

• Step up in depreciations?

• Stamp duty?

• Other indirect taxes?

• Tax liability?

page 23

Seller Co

Buyer Co

shares

Remuneration

Real Estate

Prop Co

A B

C

OECD article 13

• Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 and situated in the other Contracting State may be taxed in that other State.

• (…)

4) Gains derived by a resident of a Contracting State from the alienation of shares deriving more than 50 per cent of their value directly or indirectly from immovable property situated in the other Contracting State may be taxed in that other State

5) (…)

page 24

Vessels


Sale of vessel (1/2)

• Buyer and Seller and Ship are all residents/located of/in State A.

• Taxation is (obviously) only a question of legislation in State A- No cross border element -> No risk of double taxation.


page 26

Seller Co

Buyer Co

Ownership

Remuneration

Ship

A

Sale of Vessels (2/2)

• Seller Co, Buyer Co and ship are all residents/located of/in different jurisdictions?


• Any tax treaty?

page 27

Seller Co

Buyer Co

shares

Remuneration

Ship

A B

C

OECD Article 13 (3)

• Gains from the alienation of ships or aircraft operated in international traffic, boats engaged in inland waterways transport or movable property pertaining to the operation of such ships, aircraft or boats, shall be taxable only in the Contracting State in which the place of effective management of the enterprise is situated.

page 28

Trends


Trends : Fight against aggressive tax planning (or re-emerge of the robber barons?)

page 30

Examples of jurisdictions with variations of taxation of non-residents with regards to capital gain taxation

• India

• China

• Brazil

• Indonesia

• Australia

• Canada

• France

• Spain

• Czech Republic

• Japan

• Etc.

page 31

Katja Dyppel Weber

2017 CORIT

Granting, vesting, sale etc. Timing of a taxable event?

Katja Dyppel Weber

2017 CORIT

Timing of taxable events

Why is the timing of taxable events relevant?

• Timing of taxation (upon realization)

• Timing of valuation

• Exit/entry – right to levy tax

The claim of legal title/time of sale

• Signing of the agreement

• Granting

• Vesting

• Delivery of the shares/options/warrants

2017 CORIT


Illustrate how timing of realization can be shifted

• What can be considered taxable events for Danish tax purposes

Example 1: Conditional agreements

Example 2: Amended terms &

conditions

Example 3: Mutual binding options

2017 CORIT

Example 1

Conditional Agreements (share based salary) • Relevant tax treatment of employee

• Taxable value and timing of taxation

Granting Vesting Exercise/Sale

LL § 28 and § 7P Claim of legal title, depends on the conditions in the agreement

2017 CORIT

Example 1 - continued

Conditional agreements (general considerations)

• Taxable event: When claim of legal title is obtained

Conditional agreements

• May shift the time of claim of legal title

• Retrospective (the assets should be returned upon non-payment)

• Suspensive (the transfer of the asset is contingent on payment)

• Suspensive conditions? Relevant factors

• Can the taxpayer control the outcome, i.e. whether the condition(s) will be meet

• Does a real uncertainty exits

2017 CORIT


Conditional Agreements (share based salary)

• Main rule: claim of legal title is obtained upon granting

• Shares: When the agreement is entered into

• Options/warrants: When decision is made on a general meeting

• Usual conditions in employee programs

• Vesting contingent on reaching economic goals

• Vesting contingent on the employee being alive at the time of delivery/exercise

• Vesting contingent on employment at a certain time

– Covered by the “Stock option Act” or not

– Sufficient uncertainty of whether the shares etc. will be vested

2017 CORIT

Example 2

Amended terms and conditions (forwards and options) • Relevant tax treatment

• Taxable value and timing of taxation of shares (vs. derivatives)

Sale of shares (on forward/option) Exercise

Realization

Significant amendments of terms and conditions may trigger realization

Realization postponed

Amended terms

2017 CORIT


Amended terms and conditions (general considerations) • Significant amendments of terms and conditions are

considered disposal/sale for tax purposes • The remuneration is represented by the amended agreement • Amended terms – incl. waived rights – on non-acquired

shares, options etc. has no tax consequences

Forwards and options – significant amendments?

• Amendments of key terms • Exercise price • Exercise period/time

Employee programs - significant amendment? • Amendments based on restructurings • New shares due to conversion of the company for civil law

purposes • IPO • Smaller amendments in regard to warrants accepted

2017 CORIT

Example 3

Mutual binding options • Relevant tax treatment

• Taxable value and timing of taxation of shares vs. derivatives

General considerations • When two or more options are entered into resulting in a

situation similar to sale

• Not to be confused with a straddle transaction

Stock option Exercise/Sale of option

Mutual binding options may trigger realization

Realization postponed

Mutual binding options

2017 CORIT


Mutual binding options (TfS 1996, 469 H) • In 1979 a taxpayer acquired a firm • Entered into a lease of the building, that terminated 31/10 1986. The

lease could not be terminated earlier

Decision • Sufficient degree of uncertainty about outcome of the agreements • 7 years until (latest) exercise -> it was uncertain whether he 1) was

still owner of the firm and 2) whether he was able to fulfill the terms of the purchase agreement

• Call option (no fixed exercise time)

1986 (exercise)

1984 Exercised call option

• Obligation to buy (same terms and price)

1979

1985 sold building

2017 CORIT


Mutual binding options (TfS 1999, 214 H - dissent) • In 1983 a director resigned and sold some of his shares in the company

Decision (3 out of 5)

• Unlikely that the call option would not be exercised • The shares were in reality already paid for in 1983 • The seller could obtain tax exempt gain on shares • The buyer was essentially in the same position as if the shares were

sold in 1983

1989 (exercise/termination)

• Issued a call option • Loan (principal equal to exercise price) • Shareholders agreement, limiting distributed dividends

1983

Realization was triggered

2017 CORIT


Mutual binding options (TfS 2005, 933 H) • 75 % of the shares in a company were sold in May 1999

Decision • Based on a probability assessment, it must have been clear to

the parties that a transfer would be made

• Significant difference in exercise price

• Call option on the additional shares (Exercise price app. 92 M DKK)

1/8-01– 30/4-02 (exercise)

• Put option on the addition shares (Exercise price app. 121 M DKK)

May 1999 Exercise


2017 CORIT


Mutual binding options (SKM2011.533.H) • Medio 2000 two existing shareholders (H2 and G1) entered into a put and

a call on the shares in the jointly owned company (G1 DK).

Decision

• Purpose of the agreement: G1 wanted the company to be a 100 % owned subsidiary

• It was highly unlikely that none of the parties would exercise the options, as the exercise prices were almost identical

• It makes no difference that the call price was higher than the put

• G1 was granted a call option

22/12-01– 22/1-02 (exercise)

• H2 was granted a put option (exercise price 2.5 % lower than under call)

Medio 2000 23/1-02 + 30 days (exercise)


2017 CORIT


Conclusions?

• Concrete assessment

• Uncertainty

• Shift in economic balance/value

• Control

• Tax motivation?

2017 CORIT

KATJA DYPPEL WEBER ASSOCIATE PARTNER, M.SC., PH.D.

CORIT ADVISORY P/S LYNGBY HOVEDGADE 17, 2. SAL 2800 KONGENS LYNGBY DENMARK

P: +45 40 42 22 95 E: [email protected]

WWW.CORIT-ADVISORY.COM

2017 CORIT

Matti Kukkonen

by Matti Kukkonen,

Head of Department of Accounting and Commercial Law

Professor of Tax Law

Hanken School of Economics, Helsinki


Wednesday 8 November 2017, CBS Solbjerg Plads Campus

The definition of income: whether value increase of a capital asset belongs to the taxable income?

- older restrictive concept of taxable income vs. the current broad (comprehensive) concept of taxable income Spreading of taxation of changes in value: whether

changes in value are taxed based on accrual or only with realization?

Taxation method of inflation component of change in value: whether taxation is applied to nominal or real change in value?

Tax systems of changes in value: independent taxation, proportional taxation or partial or complete progression?

The effect of ownership time to the tax rate? Tax neutrality of tax treatment of different types of

capital income and taxation of changes in value of different taxpayers (individuals/corporate bodies)

Deductibility of capital losses: deduction forward or backwards, limitations.

The role of the seller type and/or the object of the sale

The international tax perspective (groups of companies): where (in which country or tax system) capital gain or tax-deductible tax loss is shown or realized?

Many possibilities (individual or investor tax view):

- normal marginal tax on capital income (or at least some part of the total capital income),

- a flat universal tax on all capital income (Nordic style),

- specific tax rates on specific types of capital income or use of wealth tax; also taxes on securities and/or real property

If positive capital income is taxed, negative outcome (capital losses) should be tax-deductable

Taxation rules, outcomes and concepts may differ between personal taxation and corporate (business) taxation

The sale of a SME can be considered to create taxable personal income (earned income, labour income), not capital gain (CI) when the seller is an individual owner or a familyowned firm

Intercorporate capital gains ( corporation, a company sells) are many times considered tax-exempt (participation exemption rules) by the corporate tax rules: dividends and capital gains are treated similarly in this concept

Tax exemption for intercorporate capital gains is an anomaly considering the current comprehensive concept of taxing all corporate (business) income

Tax exemptions create interpretational problems, borderline issues and incentives for active tax evasion/avoidance

Accrual capital gains tax? Is it really feasible as a basic tax rule?

In some corporate income tax systems company’scapital gains may be taxed before the actual income realization event (based on accounting rules and syste ms, mostly financial assets)

Wealth tax, real estate tax (property tax) and securities tax are all specific forms of accrual taxes (taxing the value of capital assets); they may be used both in corporate and individual taxation

BUT: the main rule in the European corporate (and individual) income tax systems is taxation based on realization (and participation exemption which mostly excludes intercorporate gains to be taxed)

The realization principle creates lock-in problems when the tax payment can be ”avoided” by not selling the asset

The current main rule in the (European) corporate (and individual) income tax systems is capital gains taxation based on realization event (and within the corporate taxation the use of a participation exemption which mostly excludes intercorporate gains)

BUT: The realization principle creates lock-in problems when the tax payment can be ”avoided” by not selling the asset

Lock-in effect can have various forms: eternal, permanent, transitory

Realization-based system allows active tax planning and postponement of the tax payments

The magnitude of the economic consequeces varies with different owner and asset types

Participation exemption means that there is no tax incentive regarding intercorporate capital gains = no lock-in

Accrual capital gains tax includes problems regarding payment of taxes without any actual income (money)

Obviously ”low” level accrual tax (wealth value tax or some other) means smaller problems with tax payments

Some tax systems use both: capital gains tax + wealth tax or property tax (or securities tax, sales tax etc.); also inheritance tax should not be forgotten here

The wealth tax was abolished in Finland some years ago but we do have a (up-going..) real estate tax. This accrual-type capital tax is based on the value of land and buildings (agricultural land and forests are not taxed)

Applying realization principle is normally a practical compulsion due to issues related to valuation of property and liquidity. is considered uncertain.

The concept of realization of investment instrument or other property item can be reviewed from the viewpoint of liquidity, exclusion of risk, and measurability.

In a conventional alienation situation the realization meets all three requirements. Those transactions, which do not meet all these three requirements, are problematic.

The Anti-tax-avoidance directive (ATAD 2016) covers all taxpayers that are subject to corporate tax in member states, including subsidiaries of companies based in third countries. It lays down anti-tax-avoidance rules for situations that may arise in five specific fields:

Interest limitation rules.

Exit taxation rules, to prevent tax base erosion in the state of origin. Corporate taxpayers may try to reduce their tax bills by moving their tax residence and/or assets, merely for aggressive tax planning purposes.

General anti-abuse rule

Controlled foreign company (CFC) rules

Rules on hybrid mismatches

The taxable base is formed by the difference between market value and value for tax purposes at the time of exit of the assets concerned. This means in effect an accrual tax on capital appreciation

If assets are transferred to another Member State, those Member States are obliged to allow taxpayers to value the assets at market value. In such cases taxpayers also have the right to defer tax claims arising from exit taxation by paying in installments for five years.

This means that there is a postponement possibility for the actual payment of capital gains tax. If a taxpayer chooses to defer a tax claim, interest may be charged and, if there is an actual risk of non-recovery, securities may be demanded by the Member State involved.

EU member States should apply this provision by January 1, 2020

The major idea of our article (NTJ, Torkkeli-Kukkonen) is to focus on the capital gains tax viewpoint of a seller in a group structure. The possible corporate capital gains tax of intercorporate alienations of shares is analyzed from the seller company’s viewpoint (=tax subject).

The concept ”participation exemption” is widely used to refer to the partial or total tax exemption of intercorporate capital gains within a larger structure of groups of companies.

The term intercorporate refers to the share alienations with a larger corporate structure (a group of companies). The basic alienation case sonsiders the tax ation of mother company selling the shares of a daughter company: can the seller company ”use” participation exemption or not?

These alienations are sometimes also described as intracorporate sales.

PURPOSE: to ease the use of corporate restructurings; the system is used widely in the European corporate tax systems - enables flexible ownership changes without the assets beeing locked-in

The exemption differs from the comprehensive (broad) definition of the taxable income concept

Participation exemption allows effective transfers of profits to the parent company. From the parent company the profits can then be distributed as dividends to shareholders or reinvested to subsidiaries.

The current exemption does not apply to the disposals of real estates and disposals of the shares of the real estate companies.

This exemption encourages to the incorporation and realization of share ownerships instead of a substance sale.

The system means non-neutrality between direct and indirect ownership (smaller companies, only a few individual owners).

If the owner entrepreneur sells her/his direct ownership, the disposal could be taxable capital income . But, if the shares are owned by the parent company in a group of companies (under the Business Income Tax Act), the disposal is normally tax-exempt.

There are many requirements for a tax-exempt disposal at seven different levels (Business Income Tax Act 6 b §).

The first four and the last item of the criteria can be considered as general criteria and the rest of the items can be considered as special criteria:

The form of the company of the seller (the subject). The tax exemption only applies to corporate bodies as the seller.

The tax law applied to the seller. The tax exemption is only applicable to the corporate bodies under the Business Income Tax Act. The tax exemption is not applied to private equity firms.

The income source. The tax exemption is only applied in the income source of the Business Income Tax Act.

The asset class. The tax exemption is only applied to fixed asset shares.

The target of the sale. The tax exemption is applicable to other fixed shares than the shares of a real estate company or housing company.

The ownership share and time. The tax exemption applies to the shares owned for one year as a minimum and the sold shares should represent at least 10 percent of the total shares.

The sale of shares is part of a major restructuring. There cannot exist a purpose for tax avoidance as defined in the Business Income Tax Act 52 h § and Tax Procedure Act 28 §.

Business Income Tax Act 6 b §

The Supreme Administrative Court Decision (KHO in Finnish) 2012:73 (for an opposite interpretation see KHO 2012:74) indicates that the transferof assets so that the business relationship remains between the parent company (the old business company) and the new company continuing the business means that the Tax Procedure Act 28 § cannot be applied and the Business income Tax Act 6 b is applied even though the mother company (seller) is effectively “only” a holding company.

Here we have a very thin line between tax avoidance and the “normal use” of tax exemption

The biggest interpretation problems arise within family-owned SMEs with two-level ownership structures

A Oy had been involved in establishing B Oy in 1998, after which A Oy sold its business to B Oy. A Oy had gained based on the participation agreement done in the connection of the establishment of B Oy royalty income up to 236 000 euro until the year 2006. B Oy had operated within premises which A Oy had acquired and renewed for that purpose and rented to B Oy. A Oy had rented apartments to the employees of B Oy and in 2003–2006 cars to the use of B Oy. B Oy had started the business on August 1 1998 partly with the machinery and equipment of A Oy. A Oy had alienated its production machinery and equipment to the use of B Oy without a consideration for the first three years. In December 2001 B Oy was committed to pay to A Oy on the production machinery and equipment a total compensation of 410 000 Finnish markka. A Oy had granted loans to B Oy and guaranteed loans of B Oy. The only shareholder and member of the board of A Oy had been working as a chief executive officer and member of B Oy during the time period between the establishment of B Oy and the alienation of shares in 2006.

When the above-stated items were taken into account as a whole, A Oy was considered to be a company carrying out business and the shares of B Oy belonged to the fixed assets of A Oy based on the operational and administrative relationship described above.

CHALLENGE: The various identification requirements complicate the interpretation of the exemption rules.

For example, the key differences within the various Nordic corporate capital gains tax models can be identified from the particular regulations created against tax avoidance and the requirements (see the Finnish list earlier) created to identify a share ownership with relevant business relationship

FUTURE?: Neither the total harmonization or the total abolition of corporate tax can probably be a dictating force in the short term at least.(CBIT, ACE…)

One somewhat limited tax harmonization option is to renew, as a start, the corporate tax systems and taxation of corporate gains through the harmonization of tax rates and tax exemptions between the European or at least the Nordic (dual income tax) countries

DREAM?: Nordic countries could lead the way to building cross-border corporate capital gains tax development bodies and eventually harmonising the treatment of capital gains...

A functional and realistic corporate capital gains tax system for intercorporate capital gains could be created by combining the ”best” features of the Danish, Dutch and UK corporate capital gains taxation system (see the picture)

Denmark and United Kingdom have clear object company requirements with ownership share and substantial shareholding that could be used in a new future corporate capital gains taxation system.

Netherlands have developed tests,withwhich companies can test, whether the ownership share in an object company are business-related.

By combining the provisions for the object company applied in Denmark, Netherlands and United Kingdom, it would be possible to decide, whether the shareholding in an object company is substantial and business-related

Separation of the direct investment shares and portfolio shares create the baseline in the future development as well as identification of substantial shareholdings and business relationship. Subject (selling company) requirements could be simplified so that the subject company is a legal person.

Object (the target company to be sold) requirement could include at least two options:

- As the first option, the requirement could be that the object company is a subsidiary company, which means that the owner company owns the certain percentage of the equity and the equity is divided into shares (based on the Dutch feature).

-As the second option, the ownership share should be 10 percent or more, which ensures that the object of the alienation is business-related (based on the Danish feature).

Less than 50 percent of the total assets of the object company should be passive, which ensures that the object of the alienation is business-related. The meaning of the passive assets could be defined more accurately than in the Netherlands to avoid interpretation issues. In addition to these requirements, the future corporate capital gains taxation model should refer to the definition of business income.

The big picture has importance: the possible corporate (and individual?) tax harmonization of income tax systems at the European/Nordic level?

Shall we still only patch some details in the different systems of EU member countries or what happens?

The current framework has clear interpretation problems, tax avoidance issues and functional difficulties

Boundaries between/within: personal income (labour income), corporate (business) income

Is it realistic and reasonable ( as an alternative) to tax market value changes (some type of accrual tax or wealt tax)?; the role of real income against nominal income?’

The newest proposals: Common Corporate Tax Base (CCTB) and a Common Consolidated Corporate Tax Base (CCCTB)?

The CCTB proposal (2016-17) provides for the determination of a single set of rules for the calculation of the corporate tax base. Companies operating across borders in the EU would therefore no longer have to deal with 28 different set of national rules when calculating their taxable profits. This system would be mandatory for groups of companies beyond a certain size.

NOTE: The CCTB proposal includes tax exemption for corporate dividends and also for capital gains (with minimum of twelwe months of ownership time and 10 % investment level).

This proposal concerns the corporate tax base and it is not meant to harmonize the various national corporate tax rates.

DREAM ON...

THE ESTONIAN CORPORATE TAX SYSTEM = NO TAX BEFORE ”REALIZATION”

No corporate tax on retained earnings

- 20/80 tax on distributed profit

Tax payment can be postponed; would abolish or diminish the interpretation problems of participation exemption

Total focus shift from the company (firm) level tax to the owner-investor level tax

Has been considered to be non-realistic for Finland

Matti Kukkonen, Dr. Iur (Tax Law, 1996), Doctor of Economics (2000), Professor, Dean (Head of Department of Commercial Law and Accounting), Hanken School of Economics, Helsinki. Email: [email protected]

Anu Torkkeli, Doctor of Economics (2016), Post-doc researcher, Hanken School of Economics, Helsinki. Email: [email protected]. Dissertation: Structuring Corporate Capital Gains Tax System in the European Union. A Comparative Finnish Perspective. Ekonomi och samhälle, Nr 296, Publications of the Hanken School of Economics (Helsinki 2016).

mailto:[email protected]

2017 CORIT

Mark Gergen

A Securities Tax and the Problems of Taxing Global Capital

Prof. Mark P. Gergen University of California, Berkeley

School of Law


Copenhagen Business School

8th Nov. 2017

Most nations, including the U.S., rely on several over-lapping or alternative tax instruments to tax business capital (around half of the world’s wealth).

• Individual income tax on interest, dividends, and capital gains.

• Corporate income tax.

• Pass-through taxation of business income not subject to corporate income tax.

78

This approach to taxing capital creates distortions and gaming opportunities:

• Form of business alters tax burden (corporation v. partnership)

• Form of interest in business alters tax burden (debt v. equity)

• How owners reap business income alters tax burden (interest v. dividends v. retention and share appreciation)

Plus inherent problems of measuring capital income:

• Devising rules on capitalization and cost recovery to distill income from cash flows.

• The realization requirement and attendant problems.

“Financialization”—the growing intermediation of capital through securities markets and sophisticated financial intermediaries—creates additional problems:

• Securities markets organize around tax clienteles to minimize tax burden.

• Financial derivatives (e.g., options, forward contracts, swaps) create new gaming opportunities within old systems.

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There is a growing consensus among U.S. tax scholars that the existing system for taxing capital is busted beyond repair. But what to do?

One school of thought is not to tax capital. Replace the income tax with a wage tax, a cash-flow consumption tax, or a value-added tax.

The original Republican House Bill (Spring 2017) would have replaced the corporate income tax with a border-adjusted destination-based cash flow tax (DBCFT): a value-added tax with a deduction for wages, which would be taxed at the individual level through a wage/income tax.

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Another school of thought is to reform how we tax capital. The leading proposals redefine the corporate tax base to eliminate (or reduce) the distinction between debt and equity.

Comprehensive Business Income Tax (“CBIT”), U.S. Treasury 1992 Tax capital income, both normal returns and supra normal returns, once at the entity level by eliminating interest deduction and not taxing dividends and interest at the individual level. Continue to tax capital gains at individual level unless gain is attributable to retained earnings taxed at corporate level.

Allowance for Corporate Equity (“ACE”) Equalize debt and equity by allowing corporation to deduct notional (imputed) return on the book value of equity as well as interest. Only supra normal returns are taxed at entity level. Mirrlees Review proposes to extend policy of not taxing normal returns to individual level by not taxing interest and providing a rate of return allowance (RRA) on risky assets.

Cash flow corporate tax Expense corporate investment. Like ACE in that only supra normal returns are taxed at entity level.

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Toder & Viard (2014 to present) Replace corporate income tax with shareholder level accrual based tax on dividends + changes in market value of publicly traded corporate equity.

Kleinbard, Dual BEIT (2007 to present) Entity level tax on supra normal returns achieved by Cost of Capital Allowance (COCA) deduction, which is derived by applying COCA rate to sum of adjusted tax basis of company’s assets. No interest deduction. Individual (investor) level tax on imputed normal return, which is determined by applying COCA rate to investor’s basis in company’s debt and equity. Basis is increased by this amount and decreased by cash distributions (e.g., interest or dividends paid).

Recent proposals by U.S. scholars

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What I propose Securities tax Flat annual tax remitted by securities issuer on market value of publicly traded security, debt and equity. Securities issuer gets a credit based on the market value of publicly traded securities it holds.

Existing investor level exemptions from capital income taxes for savings in tax-deferred accounts and nonprofits are replaced by a partial rebate of the tax. An alternative is to bifurcate the tax, collecting part at the entity level and part at the individual level.

An entity-level wealth tax using the normal return rule to estimate value of illiquid assets. Could also be described as an imputed income tax.

Complementary tax Flat annual tax on estimated value of assets other than publicly traded securities held by individuals and nonprofits. Asset value is estimated assuming investment yields a normal return and subtracting cash distributions. Entity remits tax on interest (debt and equity) held by person subject to the tax. Revaluation rule.

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Problems of taxing global capital:

• Base erosion and profit shifting (BEPS) activities by multinational corporations (MNCs)—the ephemeral source of MNC income.

• Tax competition between nations for capital and financial service income.

• Tax havens and hidden wealth.

Existing international tax system is based on national tax systems that tax capital through a combination of a corporate income tax and an individual income tax on interest, dividends, and capital gain.

• “Source-based” taxation of corporate income (direct investment)

• “Destination-based” taxation of individual income (portfolio investment)

Existing U.S. system taxes global income of U.S. corporations (on repatriation and with a credit for foreign taxes paid). This has led U.S. MNCs to move their tax home abroad (inversion) and to keep $2+ trillion “abroad” in foreign subsidiaries.

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What would be the global effects if U.S. replaced corporate income tax with securities tax?

Absence of U.S. corporate income tax would induce U.S. and foreign MNCs to engage in BEPS activities to shift reported income to U.S., decreasing global tax revenue.

In long run, corporate investment would shift to U.S. because of absence of corporate income tax.

Other nations would retaliate (e.g., apply CFC rules to U.S. source income of foreign MNC).

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Solution: give U.S. MNC partial* credit against securities tax for foreign taxes paid on foreign source income and retain corporate income tax for U.S. source income of foreign MNC.

* Credit is only partial to replace burden of individual U.S. capital income taxes on foreign investment by U.S. MNC.

Todar & Viard (2016) revise proposal to retain U.S. corporate income tax at 15% rate along with shareholder level accrual based tax on dividends plus changes in market value of corporate equity. This alleviates these concerns.

Reforms that retain a U.S. corporate income tax and alter the tax base (CBIT, ACE, cash flow) do not as directly implicate these concerns. See Mooij and Devereux, An Applied Analysis of ACE and CBIT Reforms in the EU, 18 Int’l Tax and Public Finance 93 (2011), for an analysis of the effects of CBIT and ACE on BEPS activities and location of MNC fixed investment.

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What would be the global effects if U.S. replaced individual income tax on interest, dividends, and capital gains with securities tax?

Increase in U.S. tax burden on foreign portfolio investment in U.S. should decrease flow of foreign portfolio investment to U.S. and increase cost of capital in U.S.

Solution: rebate part of the securities tax to foreign persons who hold U.S. securities. (An alternative is to bifurcate the tax, collecting part at the entity level and part at the individual level.)

In the absence of a rebate, foreign persons who hold U.S. securities could engage in tax credit arbitrage transactions with U.S. entities that pay the securities tax or the complementary tax.

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CBIT also eliminates individual income tax on interest and dividends and collects capital tax at entity level.

U.S. Treasury 1992 study punts on this issue, saying it would be worked out in tax treaty negotiations during transition phase.

Mooij and Devereux (2011) predict a small positive effect on national welfare of nations with large multi-national sector and high corporate tax rates. An increase in the tax burden on foreign investment increases the cost of capital, but this is mitigated by a reduction in the corporate tax rate and an increase in fixed capital investment by MNCs.

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Reforms that reduce or eliminate entity-level tax on capital—ACE, cash-flow corporate tax, Todar & Viard, and Kleinbard—would have the opposite effect. They would decrease the U.S. tax burden on foreign portfolio investment in the U.S., which should increase its flow and reduce the cost of capital.

Mooij and Devereux (2011) predict ACE would expand investment though, if the tax rate is set to produce the same revenue as the existing corporate income tax, then the increase in the tax rate necessitated by the smaller base has an offsetting effect in reduced fixed capital investment by MNCs.

Todar & Viard (2016) modify proposal to retain corporate income tax to preserve some U.S. tax burden on foreign portfolio investment in corporate equity.

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Corporate choice of tax home

What would be the effect if the U.S. replaced the corporate income tax with a securities tax, gave a U.S. MNC a credit for foreign taxes paid on foreign source income, retained the corporate tax for U.S. source income of a foreign MNC, and gave foreign investors a partial rebate of the securities tax?

A MNC with substantial U.S. source income and substantial U.S. ownership would have a strong incentive to select a U.S. tax home so that investment by U.S. wealth owners would bear only the burden of the securities tax.

It is not clear this would cause a foreign MNC to switch to a U.S. tax home. The switch generally should increase a MNC’s U.S. tax expense. The tax benefit is reaped by U.S. owners of its debt and equity, who are relieved of the burden to pay the securities tax. This benefit will reduce a MNC’s capital cost of only if U.S. investors are the marginal, price-setting clientele for its securities.

If this is thought to be a problem, then it can be addressed by allowing a foreign MNC to issue U.S. securities subject to the securities tax with a credit against the U.S. corporate income tax.

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Tax havens and hidden wealth

Collecting capital taxes at the entity level, rather than the individual level, makes it impossible for individuals to avoid capital taxes by investing through tax havens.

U.S. is a holdout from CRS. U.S. financial institutions are only required to report interest paid to foreign account holders. They are not required to report when a foreign individual is a beneficial owner of an account, the balance in an account, non-interest income, or foreign source income.

Securities tax and complementary tax provide a mechanism to deter foreign wealth owners from using U.S. as a tax haven without the U.S. having to join CRS.

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taxation of capital gains in an international context...introduction what is capital gain? •no...

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