TAX SPARING A reconsideration of the reconsideration Prof. Dr. Luís Eduardo Schoueri

International Tax Regime Territoriality x Worldwide taxation A never-ending debate

Capital Export Neutrality (CEN) The final taxation is determined by the Residence State Neutrality to the investor interests A Corp B Corp C Corp loan State A State B 10% WHT Tax rate on WW income: 30% 10% credit from WHT (State B)

Capital Export Neutrality (CEN) CEN is NOT definitive Neutrality? If Source’s rate is higher, there is no reimbursement for the over- taxation Under the same level of taxation, investors prefer to invest in a developing country’s infrastructural environment Taxation at source Capital import neutrality (CIN)

Capital Import Neutrality (CIN) The State of the investment determine the final taxation of income sourced in its territory Neutrality under Source State perspective $$ 10% WHT B Corp C Corp A Corp State A K 10% CIT State B State C

Territoriality x WW Taxation CEN: foreign tax credit system CIN: exemption

CIN x CEN CIN Exemption method Source State decides whether or not to tax CEN Credit method Neutralizes any taxation decision of the Source State The MORE the Source taxes, the LESS will be tax due at Residence; The LESS the Source taxes, the MORE will be the tax due at Residence.

Tax sparing Tax sparing aim at (i) assuring that treaty benefits will be maintained or (ii) at maintaining unilateral tax exemptions 25% 15% Internal tax rate Treaty tax rate Tax credit (i) Matching credit 25% 15% 10% Internal tax rate (general) Treaty tax rate Tax credit Internal tax rate (tax incentive) (ii) Tax sparing s.s.

Brazilian tax treaty policy 1960 Decade: Brazilian perspective: territoriality The Source State must have the exclusive right to tax Taxation at source: 25% Double taxation: illegitimate intrusion of the Residence State

Brazilian tax treaty policy 1960: first Brazilian treaties Military government, foreign investments and development Treaties as tools of economic policy The decrease of the taxation at source must be in favor of the investor Matching credit and tax sparing provisions

Matching Credit and/or Tax Sparing Available on the Double Tax Treaties concluded between Brazil and the following European countries: Austria Belgium (expired) Denmark Spain Finland France Netherlands Hungary Italy Luxembourg Norway The Czech and Slovak Republics Sweden Germany (revoked)

THE 1998 OECD REPORT

The OECD Report Report “Tax Sparing: a Reconsideration”, 1998 Main concerns the potential for abuse offered by tax sparing the effectiveness of tax sparing as an instrument of foreign aid to promote economic development of the source country general concerns with the way in which tax sparing may encourage States to use tax incentives “(…) tax sparing should be considered only in regard to States the economic level of which is considerably below that of OECD member States.”

RECONSIDERING OECD’s RECONSIDERATION

Reconsidering the OECD Report OECD Report: tax sparing would be in disuse Reconsidering… Thuronyi: tax sparing clauses may be found in 1/3 of tax treaties signed from 2000 to 2003 Half of them involving OECD Members

Reconsidering the OECD Report OECD Report: there is no evidence that tax sparing would affect the level of FDI Reconsidering… What is the effect of DTTs on FDI at all? Inconclusive researches Brazil-Germany tax treaty Post-revocation: increase on German investments

Reconsidering the OECD Report OECD Report: lower taxation at source as a condition for granting tax sparing (“high price”) Reconsidering… OECD itself advocates lower taxation at source One should not generalize the idea that treaty negotiators would not be capable of deciding what to concede

Reconsidering the OECD Report OECD Report: increase in the standards of living in developing countries Reconsidering… The OECD Report does not rely on any specific data on this issue UN’s 2000 Millennium Development Goals Report “Ever-increasing inequality between countries”

Reconsidering the OECD Report OECD Report: the potential for abuse derived from tax sparing clauses Reconsidering… If potential for abuse was to be considered, sooner or later no single article would survive More consistent approach: treaty shopping and anti- abuse clauses (e.g. LOB)

Reconsidering the OECD Report OECD Report: tax sparing would encourage an excessive repatriation of profits Reconsidering… Only valid for time conditioned clauses Provided benefits are the same, investors’ decisions to repatriate profits should not be dependent on tax sparing provisions

Reconsidering the OECD Report OECD Report: tax sparing as a subsidy to developing countries Reconsidering… Tax sparing is a mechanism for the recognition of the limits of States’ tax jurisdiction Tax sparing confirms that Residence has no taxing right on an item of income granted to the Source State

Reconsidering the OECD Report State A State B Tax treaty

Exemption by the Residence What about if Residence State exempts an item of income which would be taxable in Source State? No limit should be applicable to the taxation of the Source State, since there would be no risk of double taxation “Residual” tax power of the Source State

Tax sparing reconsideration It is time to reconsider tax sparing… … but NOT in the sense of OECD’s reconsideration!

THANK YOU! schoueri@lacazmartins.com.br