A Sample Survey and Analysis of Corporate Tax Incentives for FDI1
Prepared for the November 8-9, 2000 Conference on
Foreign Direct Investment in South East Europe – Implementing Best Policy Practices
A) Introduction
This paper presents an overview of corporate tax incentives to encourage foreign direct investment (FDI),
introduced or in place over the period 1995-2000 in Bulgaria and Croatia. The two-country sample is
admittedly small, and can only be taken as an illustration of efforts amongst countries in the region to
attract foreign investment capital. The report also considers tax incentives in Bosnia and Herzegovina, but
only those found in current legislation. Given the interest in analysing a possible tax competition dynamic
in the region, the paper focuses on the time series data available for Bulgaria and Croatia. The information
reported was gathered through responses to a questionnaire, shown at the end of the paper in Attachment I.2
As reviewed in section B), a number of corporate income tax relief measures continue to be on offer in
Bulgaria and Croatia. While some rationalisation of programs can be observed, tax incentive relief appears
to have grown richer over the sample period. An analysis of these provisions finds considerable scope for
tax avoidance and evasion, perhaps above and beyond that intended under the tax incentive programs.
Section C) suggests the importance for officials to continue to monitor possible impediments to FDI in
their country and region, and assess whether the social benefits of tax incentives exceed the social costs,
taking into account not only program administration costs but also ‘spillovers’ of tax relief to non-targeted
sectors of the economy.
B) Recent Corporate Tax Incentive History
This section considers corporate tax incentives introduced in Bulgaria and Croatia over the period 19952000. The review focuses on statutory corporate income tax adjustments, the introduction of special
investment allowances and deductions, the introduction of tax holidays and withholding tax (financing)
incentives.
1
This paper was prepared by W. Steven Clark of the Fiscal Affairs Division, Directorate for Financial, Fiscal and
Enterprise Affairs, OECD.
2
The OECD would like to thank Ms. Ljubica Javor of the Ministry of Finance, Republic of Croatia, Mr. Emil
Zhetchev of the Foreign Investment Agency, Bulgaria, and Mr. Mekic Dragisa of the Ministry of Foreign Trade and
Economic Relations, Bosnai and Herzegovina, for their assistance in providing answers to the questionnaire.
i) Statutory corporate tax rate adjustments
Chart I begins by considering the evolution of statutory corporate income tax rates. In Bulgaria, the basic
corporate tax rate has been following a declining trend over the sample period, with the basic rate falling
from 40% in 1995 to 36% in 1996, and then to 30% in 1998. The basic rate was reduced again in 1999 to
27% and now stands at a relatively low rate of 25%. The figures exclude income tax imposed at the
municipal level. Factoring in municipal tax at 10%, deductible from the tax base for central government
tax purposes,3 the all-in basic statutory tax rate in Bulgaria in 2000 is 32.5%. As shown in Chart I, the
preferential tax rate for small business income (that is, income up to threshold amount, set at BGN 50,000
in 2000) has also been on a downward track, with a 20% rate posted in 2000.
Chart I
Comparison of Statutory Corporate
Income Tax Rates
%
50
40
30
20
10
0
1995
Croatia
1996
1997
1998
Bulgaria (basic)
1999
2000
Bulgaria (preferential)
In contrast, Croatia increased its basic statutory corporate tax rate from 25% to 35% in 1997. However,
while this adjustment suggests an increase in the corporate tax burden in that country, Croatia has
introduced a number of corporate tax incentive programs that significantly lower the effective corporate
income tax rate, with the most generous of these recently announced to take effect in the current year 2000.
Just prior to the sample period, Croatia introduced a ‘protective interest’ deduction that allows, in effect, a
deduction against the corporate profit tax base for a deemed required rate of return on equity funds. This
deduction for the opportunity cost of equity funds is calculated by applying a notional shareholder required
rate of return (equal to a fixed real rate plus a floating inflation rate) to the beginning period stock of
3
The all in tax rate is computed as (0.10+0.25(1-0.10)=0.325.
2
shareholder equity.4 For companies in ex-war zones, the protective interest deduction may be increased by
a factor of three or four. The deduction is quite generous, providing a tax deduction that is invariant to
fluctuations in profit, while permitting interest and other deductible expenses to be written of at the basic
statutory tax rate (higher than the effective corporate tax rate that takes into account the protective interest
deduction).5
In Bosnia and Herzegovina, the basic statutory corporate income tax rate in the Federation of Bosnia and
Herzegovina (FB&H) is 30%, while in the Republic of Srpska (RS) a regresssive rate schedule applies with
a low tax rate of 10% applied to taxable income in excess of 500000 KM.6
ii) Special investment allowances and deductions
In 1999 Bulgaria enriched its tax incentives by introducing an investment tax credit (a deduction from tax
otherwise payable) earned at 10% on the portion of new real investment financed by new equity injections,
in targeted regionally-depressed areas. Qualifying investment includes the acquisition, modernisation or
reconstruction of certain tangible fixed assets (mainly buildings and equipment). Regionally-depressed
areas include those with an unemployment rate that exceeds 1.5 times the average unemployment rate for
the country. Unused tax credits may be carried forward to offset future tax liabilities for up to five years.
Also, a new corporate income tax act that came into force at the beginning of 1994 introduced accelerated
depreciation and the possibility of carrying tax losses forward for five years, with interest.7
Similarly, Croatia introduced the possibility of accelerated depreciation in 1994. Depreciation allowances
were enriched in 1998 by broad-based provisions that allow capital costs expensed on a straight-line basis
to be depreciated at one-half the normal depreciable life. For example, for assets normally written off over
5 years, with 20% of the total capital cost of an asset deductible against the tax base in each year over that
period, under the accelerated provisions allow that asset to be written-off at a 40% rate over 2.5 years.
4
In particular, the protective interest tax rate equals a fixed 5% rate (a deemed required real rate of return on equity)
plus a variable inflation rate (the rate of growth of industrial producer prices, published by the National Institute for
Statistics). For the purpose of the protective interest deduction, equity is measured as the average book value of
equity over the tax period, reduced by the book value of shares held by the taxpayer in other corporations.
5
Had shareholders been provided instead with a lower basic statutory corporate income tax rate on profit, the
incentive for earnings repatriation by way of deductible interest expense would be lower.
6
Bosnia and Herzegovina’s currency is tied to the German mark. In particular, one German mark is convertible to
one unit of domestic currency (the ‘convertible mark’ or KM). Under the regressive tax rate structure, the following
bands of taxable profit [0-100000 KM], [100000-300000 KM], [300000-500000 KM] and [500000 and over] are
taxed at rates 20%, 15%, 12% and 10% respectively.
7
Depreciation of capital costs in Bulgaria may be calculated for accounting purposes using a straight-line, progressive
or declining-balance method. For tax purposes, Bulgarian companies may use the straight-line method and the
declining-balance method, in relation to specific assets.
3
While generous, these provisions replace a pre-1994 regime in Croatia that allowed immediate and full
expensing of capital costs for plant and equipment used in manufacturing. Immediate and full expensing
of capital costs, in effect, means that investors are only subject to tax on profits in excess of a normal rate
of return on qualifying assets. However, as noted above, the Croatian tax system also offers a separate
‘protective interest’ deduction in respect of a deemed required rate of return on equity funds. Thus,
immediate and full expensing of capital costs combined with the protective interest deduction provided a
double deduction in respect of a normal rate of return on equity. It may have been that for this reason
Croatia decided to replace immediate and full deduction of capital cost for manufacturing investments with
a broader based, but still generous accelerated depreciation system.
iii) Tax holidays
In July 2000, Croatia introduced a new Investment Promotion Law that provides for a 20-year corporate tax
holiday on profits derived from investments in qualifying “newly established” companies. To qualify, the
investment must be at least 60 million kuna. Also, the project must employ a minimum of 75 employees
over the tax holiday period, beginning with the first year of investment.8 In certain cases, tax holidays may
be provided at the discretion of the Government of the Republic of Croatia, to companies that were already
existing in the tourism industry (mainly hotels) prior to the introduction of this new law.
Similarly, the Federation of Bosnia and Herzegovina (FB&H) and the Republic of Srpska (RS) both offer a
5 year tax holiday for newly established companies. The exemption of tax on profits is proportionate to the
level of investment. Therefore, where an investment project is 100% foreign-owned, corporate income tax
is fully waived for a period of 5 years. Where foreign participation is less, the percentage of corporate
profits exempted under the tax holiday is proportionately reduced. This tax relief is not available where
foreign participation is less than 20%.
Clearly, waiving corporate income tax generally holds out maximum tax relief.9 However, introducing a
tax holiday regime can put significant strain on the tax system and administration, and generally will
require base protection measures to ensure that tax relief does not spillover to non-targeted sectors. By
exempting certain companies or activities from income tax, tax holidays encourage corporate groups to
shift taxable income (either within or outside the letter of the law) to qualifying companies so as to
minimise their overall host country tax liability. A number of avenues may be open for such abuse.
8
The corporate profits tax rate is reduced to 7%, for 10 years, for investments exceeding 10 million kuna where at
least 30 employees are hired. A lower 3% tax rate applies where the initial investment exceeds 20 million kuna and at
least 50 employees are hired.
4
Most obviously, where a tax holiday is targeted at ‘newly established’ companies, taxpayers are
encouraged to transfer capital from already existing businesses to qualifying firms in order to benefit from
the tax relief. This ‘churning’ of business capital for tax purposes can lead to the false impression that new
investment has taken place, when in fact the introduction of ‘new’ productive capacity merely reflects a
reduction in operating capital elsewhere in the economy. This and other tax avoidance and evasion
opportunities created by tax holidays can be demonstrated with reference to a simple example.
Consider a pre-holiday situation illustrated in Table 1 (attached at the end of this note) where a parent
company (PCo) and its subsidiary (OpCoA) both operate in a given host country with a statutory corporate
income tax rate of 50%. The parent company may be assumed to be fully or partially foreign-owned. The
parent company holds $1000 in operating assets (e.g., plant and machinery) and $1000 in financial assets
(bonds and shares) reflecting its ownership of OpCoA. The subsidiary is capitalised with $200 of debt
capital and $800 in equity capital. The market rate of interest is taken to be 10%, and the representative
firms are assumed to be price-takers in the sense that their lending and borrowing has no impact on the
‘world’ rate of interest.10 Therefore, the parent would earn 5% after-tax on bonds (with a 50% corporate
tax rate applied to corporate income), which sets in the example the minimum rate of return required by
investors on equity shares of equivalent risk. Of course, investors would be attracted to investment
projects that provide a post-tax rate of return greater than 5% and would be expected to channel investment
funds to such projects.11
In the example shown in Table 1, the subsidiary’s operating income is split between interest income and
dividends paid to its parent PCo, in accordance with OpCoA’s capital structure and the assumed market
and shareholder required rates of return. Distributed profits are taxed in the hands of the subsidiary at
50%, while interest -- deductible for tax purposes at the subsidiary level -- is taxed in the hands of the
parent at 50%. As is normal practice, dividends received by the parent from its domestic subsidiary are
received tax free (deductible from the tax base) in order to avoid double taxation of the underlying profit
amount. As the table shows, a total of $100 in corporate income tax is collected with a 5% after-tax rate of
return on the operations of the parent and its subsidiary.
9
This is not always the situation, particularly for tax holidays with a relatively short term. In these cases, the amount
of relief offered will depend critically on the commencement date (first year of production, first year of taxable profit,
or first year of net cumulative profit) and on the tax system’s depreciation and loss carryover rules.
10
This corresponds to the small open economy assumption at the macro level.
A key assumption (used in virtually all investment models) is that the existence of economic rent (profits in excess of minimum
required returns) would attract additional financing, with expansions to the productive capital stock tending to drive down the pretax rate of return under diminishing productivity of capital at the margin An equilibrium is reached where investment projects
‘break even’, yielding a pre-tax rate of return that just provides the minimum required rate of return at the margin (zero economic
rent), and no more. In the case of a 50% corporate tax rate, this break-even point is achieved at a 10% pre-tax rate of return.
11
5
Table 2 considers the introduction of a tax holiday, and illustrates the desired outcome of the tax policy. In
particular, PCo is shown to invest an additional $500 in the host country, establishing a new subsidiary
OpCoB that undertakes activities qualifying for tax holiday treatment. Targeting under the tax holiday
could be towards activities undertaken in a given geographic area in the host country (e.g., a regional tax
incentive) or in a given industry (e.g., manufacturing activities). In the example, investment in OpCoB is
shown to occur up to the point (at the capital stock level of $500) where the pre-tax rate of return is 5 per
cent, which equals the required post-tax rate of turn under tax holiday treatment.12
Table 3 takes into account two possible but unintended incentives created by the new regime. First, it may
be that the parent company, rather than expanding its operations, would attempt to recharacterise existing
capital already in production as ‘new’ capital qualifying for the tax holiday. An actual expansion may be
viewed by the parent as unprofitable, due for example to financing constraints, limited factor supply, or
limited output demand. In any event, even where some additional investment is encouraged, the incentive
would remain to recharacterise ‘old’ capital as ‘new’. This incentive illustrated in Table 3 shows the
parent reducing its own operations by $500, and diverting this capital to OpCoB. This has the effect of
reducing host country tax revenues as income generated by this capital, previously subject to tax, is now
earned tax-free.
Second, an incentive is created to structure loans to the corporate group through OpCoB qualifying for the
tax holiday. In the example, rather than loaning $200 to OpCoA directly, the parent’s tax bill can be
reduced by having this loan intermediated by OpCoB. This can be structured by recalling the loan to
OpCoA, investing an additional $200 in equity in OpCoB, which in turn on-loans the funds to OpCoA.
The $20 on interest on this loan, which continues to be a deductible expense to OpCoA, is now received
tax free in the hands of OpCoB, and converted and paid out to the parent in the form of a tax-free intercorporate dividend.
Together, these distortions have the effect of lowering host country tax revenues to $65, as compared to the
$100 figure in Table 2 (showing the desired outcome). Furthermore, the reduction in the amount of tax on
income generated by OpCoA creates an incentive to expand the amount of capital employed in the nontargeted sector. The example shows that at the existing capital stock level of $1000, OpCoA generates a
post-tax rate of return of 6%. This means that the capital stock employed in OpCoA can be increased,
while generating above-normal post-tax rates of return. Expansion in OpCoA’s capital stock would be
expected to continue up to the point where the post-tax rate of return falls back to 5 per cent. The ability to
12
The example assumes that the tax holiday period exceeds the productive life of the capital employed in OpCoB. Where it does
not, implying that income generated by the capital would eventually be subject to tax during the post-holiday period, the required
pre-tax rate of return would fall between 5 and 10 per cent.
6
earn above-normal rates of return on OpCoA operations means that the parent’s shareholders enjoy a
windfall gain, on account of the tax holiday, on assets employed outside the non-targeted sector.
In addition to encouraging the routing of interest income through the new intermediary OpCoB, an
incentive is created to charge OpCoA a non-arm’s length price on the loan. By increasing the interest raet
charged on the $200 loan above the arm’s length (market) rate of 10 per cent, the corporate group is able to
reduce its host country tax bill even further. This is illustrated in Table 4, which considers the case where
the interest rate is increased to 20 per cent. Because the interest charge is deductible, this reduces the
amount of corporate income tax paid by OpCoA from $40 to $30. As in the previous case, the interest is
paid to OpCoB where it is received tax free, which may be then paid to the parent as a tax-free intercorporate dividend. The result is a further reduction in host country revenues ($55), an increased rate of
return on OpCoA operations, and thus a further incentive to expand investment in the non-targeted sector.
Table I below summarises these illustrative effects.
Table I
Summary of Tax Planning Opportunities and Illustrative Host Country Tax Effects
(with reference to Tables 1- 4 at the end of this note)
Debt financing for OpCoA
Transfer pricing between
(non-targeted activities)
corporate groups
Intermediated
Recharacterise
‘old’ capital as
Direct
Arm’s length
firm OpCoB)
‘new’ capital
Base case (Table1)
(via tax holiday
Non-arm’s
Host CIT
length
revenues
Na
Yes
Na
Yes
No
100
Intended impact (Table2)
No
Yes
No
Yes
No
100
Tax planning I (Table3)
Yes
No
Yes
Yes
No
65
Tax planning II (Table4)
Yes
No
Yes
No
Yes
55
Tax holiday:
iv) Withholding tax incentives
Financing incentives offered by both Bulgaria and Croatia may be considered generous. In Bulgaria, the
statutory (non-treaty) non-resident withholding tax rate on dividends, interest, royalty and other crossborder payments is 15%. Statutory non-resident withholding tax rates in developed countries tend to be in
the range of 25 to 35%. The statutory rate is often reduced through bilateral tax treaties. In a number of its
7
tax treaties, Bulgaria has agreed to lower its withholding tax rate on direct dividends to 5 per cent (see
Table 5).
This policy position is not uncommon (see Table 6), and recognises that high dividend
withholding taxes may discourage FDI, particularly where additional withholding tax on distributed
earnings imposes significant double taxation (that is, where distributions are out of profits already subject
to corporate income tax). Double taxation will not be an issue where corporate income tax is eliminated
through the use of other tax incentives in the system, implying that the 5% withholding tax rate on
dividends could be the only host country tax on distributed profit in many cases.
The treaty withholding tax rate on interest is set at zero in a number of tax treaties that Bulgaria has signed.
Again this is not an uncommon international tax policy position amongst other countries (see Table 7).
However, a zero withholding tax rate is typically not provided on interest income paid to tax havens, given
the tax avoidance opportunities that this creates. The incentive to strip profits out of a host country is
encouraged where interest payments are deductible at source (against the host country corporate tax base),
no withholding tax applies on cross-border interest payments, and the interest income is received tax-free
in the hands of an offshore finance or holding company situated in a tax haven. The same is true in the
context of royalties, management fees and other tax-deductible payments subject to no taxation. It is
noteworthy that Bulgaria has signed a treaty with Cyprus that provides for a zero withholding tax rate on
dividend, interest, royalties and technical service/management cross-border payments. The tax-planning
opportunities offered by this and similar avenues are significant. Potential host country tax base erosion
would be correspondingly large.
Croatia waives entirely non-resident withholding tax on dividends, interest and royalties.13 Thus both in
treaty and non-treaty situations, no tax is withheld on deductible cross-border payments. As noted above,
profit-stripping incentives are maximised where payments to offshore finance and holding companies
situated in tax havens are deductible at source, free of non-resident withholding tax, and received tax free
by subsidiaries of foreign direct investors.
C) Assessing the efficiency of tax incentives for FDI
As argued elsewhere, where ‘market failure’ and regional or international competitiveness arguments apply
and point towards intervention in the market through the use of corporate tax incentives, it is critical that
host country investment conditions and characteristics be assessed to gauge whether market or non-tax
13
It is also interesting that interest income is not taxed in the hands of individual savers. Interest deductions at source,
with no tax withheld at source and no personal income tax on interest income, would tend to encourage the use of
debt finance.
8
policy related impediments to FDI can be overcome in a cost-efficient way through the tax system.14 Such
impediments would be expected to generally vary from one industry to another, implying the need for a
range of data to help identify the relative advantages and disadvantages of investing in the host country.
However, analysts should nevertheless attempt to assess the importance of these considerations, at least on
an approximate basis and for broad industry classifications.
Consider, for example, an illustrative cost-benefit assessment, by a given host country, of whether or not to
proceed with a reduction in its statutory corporate income tax rate (from u0 to u1) to attract FDI. Chart II
depicts the case where a reduction in the statutory corporate tax rate is expected to have the desired effect
of encouraging foreign parents to expand their capital stock employed in the host country (from K0 to K1).
Chart II
Illustration of Tax Revenue and Surplus Implications
Accompanying a Reduction in the Statutory Corporate Tax Rate
pre- and
post-CIT
rate of
return
(Fk-d)
(Fk-d)(1-u0)
(Fk-d)(1-u1)
rg0
rg1
r*
a
c
b
K0
d
e
K1
capital stock
In general, it will be in a host country’s interest to introduce a tax incentive program only if the present
value of the social benefits to its residents, denoted by PV(B), exceeds the present value of the social costs
PV(C). We can summarise this efficiency condition using the following efficiency index:
14
See for example the Executive Summary of Corporate Tax Incentives for Foreign Direct Investment, OECD Tax
Policy Study No.3.
9
E={PV(B)/PV(C)}>1
(1)
In Chart II, the reduction in the tax rate results in a new equilibrium at point e, where the demand curve for
capital, represented by (Fk-d)(1-u1), intersects the horizontal supply of funds schedule at the required aftercorporate tax rate of return of r* set on world capital markets. 15 In assessing the efficiency index shown
above, the numerator would include the additional corporate income tax collected on increased profits
resulting from the increase in the capital stock ∆K (where ∆K measures the difference between K1 and K0).
These increased tax revenues are identified by the dotted rectangle (with corners b.c.d.e.) and measured by
(u1xrg1x∆K) where rg1 is the new pre-tax rate of return. The additional after-tax profit associated with the
FDI (shown by the rectangle b.e.K0.K1) would not be factored into the host country benefits where the
returns accrue to non-residents.16 The benefits could also include increased domestic wages (measured
gross of personal tax) from additional employment associated with the increased capital stock, and
similarly, increased income from increased demand for intermediate inputs provided by host country firms
(assuming that domestic labour markets and factor input markets are demand constrained).
Of course, key to assessing these benefits is an estimate of the likely investment response to the tax rate
reduction. This exercise is made difficult by the paucity of information on the elasticity or responsiveness
of FDI with respect to host country effective corporate tax rates. It would be prudent to use lower bound
estimates (drawn either from the academic literature, or from internal estimates) where host country
impediments to FDI are more pronounced than in host countries from which sample estimates are derived.
These lower bound estimates translate to conservative estimates of additional tax base and other spillover
benefits to the host country economy.
The denominator of the efficiency index would include foregone corporate income tax revenues on income
derived from infra-marginal investment (that is, income generated by the previous capital stock K0). In the
illustration, host country tax revenues on the prior capital stock are shown to be lower, on account of the
15
The schedule (Fk-d) in Chart II shows the pre-tax rate of return (net of depreciation) corresponding to the domestic
capital stock K measured along the bottom axis. The schedule slopes downward under the assumption that the
marginal product of capital falls as the capital stock increases. The schedule schedule (Fk-d)(1-u0) shows the
corresponding after-tax rate of return (net of depreciation), where u0 denotes the initial statutory corporate income tax
rate. With a reduction in the tax rate from u0 u1, the after-tax schedule shifts out to (Fk-d)(1-u1), showing a new
equilibrium capital stock at K1.
16
The example ignores non-resident withholding tax for simplicity. Some fraction of the after-tax profit amount
measured by b.e.K1.K0 would factor into measured benefits if the host country imposes a non-resident withholding
f
f
tax at rate w on distributed profit. This amount would be measured by w r*∆K, with ∆K=K1-K0. Also note that the
producer surplus measured by the triangle a.d.c. would accrue to non-resident shareholders.
10
reduced tax rate, in the amount of the shaded rectangle (with corners a.c.rg0.rg1).17 The costs should also
factor in an estimate of the leakage of tax relief to non-targeted sectors (not illustrated in the diagram).
Finally, and equally importantly, the costs should include the administration costs to the government of the
tax change, as could arise if the tax rate reduction was targeted at income derived from a subset of business
activities. Where, for example, the rate reduction was targeted only at income derived from manufacturing
activities, then the cost would include the cost of the government employees required to handle requests for
information and auditing of tax accounts to determine if the targeting definitions where being adhered to.
Finally, the cost measure should also include an estimate of the compliance costs of taxpayers (both those
that qualify and those that do not) in understanding and complying with the tax rules and regulations.
When assessing the benefits, costs and role of tax incentives to attract FDI, a key consideration is whether
similar relief is being offered by a neighbouring jurisdiction also competing for foreign capital. This raises
questions concerning the appropriate form and scale of tax incentive relief, as well as a range of other
design issues. It also begs the question of whether foreign direct investors could earn competitive ‘hurdle’
rates of return in a given host country and in competing jurisdictions in the region in the absence of special
tax incentives. In such cases, policy makers may wish to discuss the possibility of policy co-ordination in
the area of tax incentives to avoid revenue losses and providing foreign investors with ‘windfall gains’ –
that is, tax relief above that necessary to realise competitive after-corporate tax rates of return – and also to
address possible equity and efficiency concerns linked with the use of special tax incentives.
Where officials are confident that tax incentives can offset impediments to FDI, and yield benefits tied to
increased FDI that exceed tax revenue losses and program costs, it remains prudent to consider whether
government policies should be adjusted in other areas to reduce non-tax impediments to FDI. While
certain impediments to FDI are largely outside the control of government and may present FDI obstacles
that cannot be overcome by tax incentives or other support, in other areas, government can play a key role.
Where impediments are addressed in these ways, this may in turn reduce pressures for incentives and allow
a phase out of this support over time.
17
Note that a notional measure of reduced income tax (corresponding to the rate reduction) on profit earned on new
capital acquired solely on account of the tax relief should not be factored into measured costs (as the new capital in
the amount ∆K would not be observed at the higher tax rate).
11
Table 1
Initial direct financing structure with no tax holiday
Parent company (PCo)
Subsidiary (OpCoA)
50%
50%
Corporate income tax rate
Balance sheet items
Assets
Operating:
– plant/machinery 1000
Financial:
– loans to OpCoA 200
– shares in OpCoA 800
Pre-tax rates of return
Parent operations
10%
Subsidiary operations
10%
Corporate income tax
(CIT)
Net operating income
Interest income (from OpCoA)
Dividend income (from OpCoA)
Total income
100
20
40
160
Net operating income
Interest expense (@10%)
Net taxable income
100
20
80
Corporate income tax (CIT)
40
Dividend received deduction
Net taxable income
Corporate income tax
- of which
-- CIT on PCo operating income
-- CIT on interest income (OpCoA)
40
120
60
Distributed profit
40
Parent operations
Subsidiary (OpCoA) operations
5%
5%
Post-tax rates of return
Liabilities
Equity 2000
Assets
Operating:
– plant/machinery 1000
Liabilities
Debt (PCo) 200
Equity (PCo) 800
(debt/capital) : (1/5)
50
10
TOTAL CORPORATE
100
INCOME TAX
Notes:
The parent companys’ required after-corporate tax rate of return on investments is 5% as determined by i(1-u)=(.10)(1-.5) where the market interest
rate on bonds (i) is 10% and the host country corporate income tax rate (u) is 50%. The operating surplus of the subsidiary (OpCoA) is taxed in full at the corporate level at rate u
(with interest returns taxed in the hands of the parent, and subsidiary profit taxed at the subsidiary level). The required pre-tax rate of return on subsidiary operations (Fk) that
yields the 5% required after-corporate tax rate of return is Fk=10% as determined by iβ(1-u)+(Fk-iβ)(1-u)=i(1-u) where β denotes the debt/capital ratio (0.2).
The post-tax rate of return on PCo’s operations equals (100-50)/1000, while that for OpCoA equals (100-40-10)/1000.
12
Table 2
Expanded capital stock under tax holiday (illustration of policy goal)
Parent company (PCo)
Corporate income tax rate
Balance sheet items
New Subsidiary (OpCoB)
-- qualifying for tax holiday -0%
50%
Assets
Operating:
– plant/mach. 1000
Financial:
– loans to OpCoA 200
– shares in OpCoA 800
– shares in OpCoB 500
Liabilities
Equity 2500
Assets
Operating:
– plant/mach. 500
Subsidiary (OpCoA)
50%
Liabilities
Equity (PCo) 500
Assets
Operating:
– plant/mach. 1000
Liabilities
Debt (PCo) 200
Equity (PCo) 800
(debt/capital) : (1/5)
Pre-tax rates of return
Parent operations
10%
Subsidiary operations
5%
Subsidiary operations
10%
Corporate income tax
(CIT)
Net operating income
Interest income (from OpCoA)
Dividend income (from OpCoA)
Dividend income (from OpCoB)
Total net income
100
20
40
25
185
Net operating income
Net taxable income under tax holiday
25
0
Net operating income
Interest expense (@10%)
Net taxable income
100
20
80
Corporate income tax (tax holiday)
0
Corporate income tax
40
Distributed profit
25
Distributed profit
40
Post-tax rates of return
Dividend received deduction
Net Taxable income
Corporate income tax
- of which
-- CIT on PCo operating income
-- CIT on interest income (OpCoA)
65
120
60
Parent operations
Subsidiary operations – OpCoA
Subsidiary operations – OpCoB
5%
5%
5%
50
10
TOTAL CORPORATE
100
INCOME TAX
Notes: The example shows the parent company raising an additional $500 in equity capital to invest in a new subsidiary (OpCoB) qualifying for the tax holiday.
The pre- and post-tax rate of return on OpCoB’s operation equals 25/500.
13
Table 3
Intermediated financing under tax holiday
Parent company (PCo)
Corporate income tax rate
Subsidiary (OpCoB)
-- qualifying for tax holiday -0%
50%
Assets
Operating:
– plant/mach. 500
Financial:
– loans to OpCoA 200
50%
Balance sheet items
Assets
Operating:
– plant/mach. 500
Financial:
– shares in OpCoA 800
– shares in OpCoB 700
Pre-tax rates of return
Parent operations
Subsidiary operations
10%
10%
Subsidiary operations
5%
Subsidiary operations
10%
Corporate income tax
(CIT)
Net operating income
Interest income
Dividend income (from OpCoA)
Dividend income (from OpCoB)
Total net income
50
0
40
45
135
Net operating income
Interest income (from OpCoA)
Net taxable income under tax holiday
25
20
0
Net operating income
Interest expense (@10%)
Net taxable income
100
20
80
Corporate income tax (tax holiday)
0
Corporate income tax
40
Dividend received deduction
Net taxable income
Corporate income tax
- of which
-- CIT on PCo operating income
-- CIT on interest income (OpCoA)
85
50
25
Distributed profit
45
Distributed profit
40
Parent operations
Subsidiary operations -- OpCoA
Subsidiary operations -- OpCoB
5%
6%
5%
Post-tax rates of return
Liabilities
Equity 2000
Subsidiary (OpCoA)
Liabilities
Equity (PCo) 700
Assets
Operating:
– plant/mach. 1000
Liabilities
Debt (OpCoB) 200
Equity (PCo) 800
(debt/capital) : (1/5)
25
0
TOTAL CORPORATE
65
INCOME TAX
Notes: The example shows the parent company diverting $500 of its productive capital to OpCoB to qualify for the tax holiday for ‘new’ investment.
The parent’s loan to OpCoA (which does not qualify for the tax holiday) is structured through OpCoB to minimise the tax on earnings of OpCoA (enabling the conversion of
taxable interest to exempt dividend income in the hands of the parent).
The post-tax rate of return on PCo’s operations is equal to (50-25)/500, while that for OpCoA is (100-40)/1000, and for OpCoB is 50/500.
In the example, the tax holiday generates economic rents (above-normal rates of return) on the (unchanged )physical capital stock ($1000) in OpCoA at $1000. This non-arbitrage
result creates incentives to expand the non-targeted capital stock in OpCoA.
14
Table 4
Transfer pricing incentives under tax holiday
Parent company (PCo)
Corporate income tax rate
Subsidiary (OpCoB)
-- qualifying for tax holiday -0%
50%
Assets
Operating:
– plant/mach. 500
Financial:
– loans to OpCoA 200
50%
Balance sheet items
Assets
Operating:
– plant/mach. 500
Financial:
– shares in OpCoA 800
– shares in OpCoB 700
Pre-tax rates of return
Parent operations
Subsidiary operations
10%
10%
Subsidiary operations
5%
Subsidiary operations
10%
Corporate income tax
(CIT)
Net operating income
Interest income
Dividend income (from OpCoA)
Dividend income (from OpCoB)
Total net income
50
0
30
65
145
Net operating income
Interest income (from OpCoA)
Net taxable income under tax holiday
25
40
0
Net operating income
Interest expense (@20%)
Net taxable income
100
40
60
Corporate income tax (tax holiday)
0
Corporate income tax
30
Dividend received deduction
Net taxable income
Corporate income tax
- of which
-- CIT on PCo operating income
-- CIT on interest income (OpCoA)
85
50
25
Distributed profit
65
Distributed profit
30
Parent operations
Subsidiary operations -- OpCoA
Subsidiary operations -- OpCoB
5%
7%
5%
Post-tax rates of return
Liabilities
Equity 2000
Subsidiary (OpCoA)
Liabilities
Equity (PCo) 700
Assets
Operating:
– plant/mach. 1000
Liabilities
Debt (OpCoB) 200
Equity (PCo) 800
(debt/capital) : (1/5)
25
0
TOTAL CORPORATE
55
INCOME TAX
Notes: The investment structure is the same as that shown in Table 3. The ability to convert otherwise taxable interest income from OpCoA to exempt dividend income received
from OpCoB creates a ‘transfer pricing’ incentive to increase the interest rate charged on the loan to OpCoA to an artificially high rate (i.e., a non- arm’s length rate), in the example
shown to be 20 per cent (rather than 10). The post-tax rate of return on OpCoA’s operations increases from 6% (in Table 3) to 7%`, given by (100-30)/1000. This further increases
the incentive to expand the capital stock in the non-targeted sector (OpCoA).
15
Table 5
Bulgarian Withholding tax rates on cross-border payments of dividends and interest
(1999)(a)
Country
Armenia (note (1) and (6))
Albania (note (1), (3) and (6))
Austria
Belarus (note (6))
Belgium (note (6))
China (note (2) and (6))
Croatia
Cyprus
Czech Republic
Denmark (note (3))
Finland (note (4))
France (note (5))
Georgia (note (6))
Germany
Hungary (note (6))
India (note (6))
Indonesia (note (6))
Italy
Japan (note (3) and (6))
Macedonia (note (3) and (6))
Kazakhstan (note (8))
Korea, Rep. of (note (5) and (6))
Luxembourg (note (3))
Malta
Moldova (note (3) and (6))
Morocco (note (5))
Netherlands (note (3) and (7))
Norway
Poland (note (6))
Portugal (note (3) and (6))
Romania (note (3) and (6))
Russian Federation (note (6))
Spain (note (3))
Singapore (note (6))
Sweden
Switzerland (note (3))
Turkey (note (3) and (6))
Ukraine (note (3) and (6))
United Kingdom
Vietnam (note (6))
Zimbabwe (note (3) and (6))
Dividends
5/10
5/15
0
10
10
10
5
0
10
5/15
10
5/15
10
15
10
15
15
10
10/15
5/15
10
5/10
5/15
30
5/15
7/10
5/15
15
10
10/15
10/15
15
5/15
5
10
5/15
10/15
5/15
10
15
10/20
Interest
10/0
10/0
0
10
10
10
5
0
10
0
0
0
10/0
0
10
15
10
0
10
10/0
10
10
10
0
10/0
10
0
0
10
10
15
15
0
5
0
10
10
10
0
10
10
Source: Bulgaria Business Guide, Legal, Tax and Accounting Aspects, 2000
Royalties
10
10
0
10
5
10
0
0
10
0
5
5
10
5
10
15/20
10
5
10
10
10
5
5
10
10
10
5
0
5
10
15
15
0
5
5
5
10
10
0
15
10
Explanatory Notes to Table 5
1. The lower rate applies to dividends paid to a non-resident, which is the direct owner of at least US$
40,000 forming part of the capital of the company making the payment.
2. The withholding tax rate on royalties for the use or right to use industrial, mercantile or scientific
equipment is reduced to 7%.
3. The lower rate applies to dividends paid to a foreign company, which is in direct control of at least 25
per cent of the payer company’s capital. In the specific cases of the different countries more requirements
may be in place.
4. Ther is no withholding tax on royalties for the use or right to use of scientific or cultural works.
5. The lower rate applies to dividends paid to a foreign company, which is in direct control of at least 15
per cent of the payer company’s capital.
6. There is no withholding tax on interest when paid to public bodies (Government, Central Bank or other
state-owned financial or non-financial institutions).
7. Five per cent royalties are applicable in case the Netherlands applies withholding tax.
8. The 15 per cent rate applies in specific cases pointed out in the respective treaty.
17
Table 6
Withholding tax rates on cross-border payments of dividends - direct investment (1999)(a)
From/To
Australia
Austria
Belgium
Canada
Czech
Denmark
Finland
France
Germany
Greece
Hungary
Iceland
Ireland
Italy
Japan
Australia(a)
x
15
15
15
15
15
15
15
15
NT
15
NT
15
15
15
Austria
15
x
-
15
10
-
-
-
-
-
10
NT
-
-
-
Belgium
15
-
x
15
15
-
-
-
-
-
10
NT
-
-
5
Canada
15
15
15
x
10
5
5
5
15
NT
5
5
15
15
10
Czech Rep.
5
10
15
10
x
15
5
10
5
25
5
NT
5
15
10
Denmark
0
-
-
0/10
0
x
-
-
-
-
0
-
-
-
0
Finland
15
-
-
10
-
-
x
-
-
-
5
-
-
-
10
France
15
-
-
10
10
-
-
x
-
-
5
5
-
-
0/5
Germany
15
-
-
15
5
-
-
-
x
-
5
5
-
-
15
Greece
nda
nda
nda
nda
nda
nda
nda
Nda
nda
nda
nda
nda
nda
nda
nda
Hungary(g)
15
10
10
5
5
5
5
5
5
10
x
NT
5
10
10
Iceland
NT
NT
NT
5
NT
-
-
5
5
NT
NT
x
NT
NT
NT
Ireland(h)
-
-
-
-
-
-
-
-
-
NT
-
NT
x
-
-
Italy
15
-
-
15
15
-
-
-22.89
-
-
10
NT
-
x
10
Japan
15
10
10
10
10
10
10
0/5
10
NT
10
NT
10
10
x
Korea
15
10
15
15
5
15
10
10
10
5
10
NT
10
25
10
Luxembourg
NT
-
-
5
5
-
-
-
-
-
5
NT
-
-
5
Mexico(l)
NT
NT
5
5
NT
5
0/5
0/5
5
NT
NT
NT
5
5
0/5
Netherlands(j)
15
-
-
5
-
-
-
-
-
-
5
-
-
-
5
N Zealand(m)
15
NT
15
15
NT
15
15
15
15
NT
NT
NT
15
15
15
Norway
15
5
5
15
5
-
-
0
5
20
10
-
-
15
5
Poland
15
10
10
15
5
5
5
5
5
10
NT
10
10
10
Portugal(n) (o)
NT
10
10
NT
10
NT(10)
10
10
10
NT(10)
NT
NT
10
10
NT
Spain(p)
15
-
-
15
5
-
-
-
-
NT
5
NT
-
-
10
Sweden
15
-
-
5
-
-
-
-
-
-
5
-
-
-
10
Switzerland
15
5
10
5
5
-
0
0
5
5
10
5
10
15
10
Turkey
NT
25
NT
15
15
15
15
NT
10
NT
NT
15
10
-
-
5
5
UK(q)
USA
15
5
15
NT
-6.88
-1.25
5
5
5
NT
5
Source: OECD Tax Database
(a)
See explanatory notes to the table.
18
5
30
-6.88
5
5
5
5
10
Table 6 (cont’d)
Withholding tax rates on cross-border payments of dividends - direct investment (1999)(a)
From/To:
Korea
L’bourg
Mexico
N’lands
NZealand
Norway
Poland
Portugal
Spain
Sweden
Sw’land
Turkey
UK
USA
Australia
15
NT
NT
15
15
15
15
NT
15
15
15
NT
15
15
30
Austria
10
-
NT
-
NT
15
10
-
-
-
5
25
-
5
0/25
(a)
NT
(b)
Belgium
15
-
5
-
15
5
10
-
-
-
10
5
-
5
15/25
Canada
15
10
10
5
15
15
15
NT
15
5
5
NT
10
5
25
Czech Rep.
5
5
NT
-
NT
5
5
10
5
-
5
NT
5
5
25
Denmark
0
-
-
0
-
0
NT
-
-
-
0
-
0
0
Finland
France
10
-
-
15
-
-
-
-
-
-
15
-
5
28
NT
10
-
-
-
15
-
5
-
-
-
5 or 15(e)
15
-
5
25
25(10)
-
5
-
15
5
5
-
-
-
5
15
-
5
26..37
nda
nda
nda
nda
nda
nda
Nda
nda
nda
nda
nda
nda
nda
nda
nda
5
5
NT
5
NT
10
10
15
5
5
10
10
5
5
20-35/20
Iceland
NT
NT
NT
NT
NT
-
NT
NT
NT
-
5
NT
15
5
10/20
Ireland(h)
-
-
0
-
-
-
0
-
-
-
-
NT
-
-
0/24
Italy
15
-
15
-
15
15
10
-
-
-
15
15
-
5
32.4
Japan
12
5
0/5
5
15
5
10
NT
10
10
10
10/15
10
10
20
Korea
x
10
-
10
15
15
15
10
10
10
15
15
5
10
25
25
Germany
Greece
Hungary(g)
Luxembourg
10
x
NT
-
NT
5
5
-
-
-
-
NT
-
5
Mexico(l)
0/5
NT
x
5
NT
5
NT
NT
5
0/5
5
NT
-
5
5
10
-
-
x
15
-
-
-
-
-
-
5
-
5
25
New Zealand
15
NT
NT
15
x
15
NT
NT
NT
15
15
NT
15
15
30
Norway
15
5
-
-
15
x
5
10
10
-
5
20
5
15
25
Poland
5
5
NT
-
NT
5
X
15
5
5
5
10
5
5
nda
Portugal(n) (o)
25
(j)
Netherlands
(m)
10
NT(10)
NT
NT(10)
NT
10
10
x
10
NT(10)
10
NT
-
10
Spain
10
-
5
-
NT
10
5
-
x
-
10
NT
10
10
25
Sweden
10
-
5
-
15
-
5
-
-
x
-
15
-
5
30
(p)
Switzerland
10
-
5
-
15
5
5
10
10
0
x
NT
5
5
35
Turkey
15
NT
NT
15
NT
20-25
10
NT
NT
15
NT
x
15
15
-
-6.88
-6.88
x
-6.88
5
5
5
x
UK(q)
-6.88
USA
10
5
-6.88
5
5
-1.25
15
10
5
10
Source: OECD Tax Database
(a)
See explanatory notes to the table.
19
10
15
nda
Table 7
Withholding tax rates on cross-border payments of interest - direct investment (1999)(a)
From/To:
Australia
Austria
Belgium
Canada
Czech
Denmark
Finland
France
Germany
Greece
Hungary
Iceland
Ireland
Italy
Australia (a)
x
10
10
10
10
10
10
10
10
NT
10
NT
10
10
Japan
10
Austria
10
x
15
15
-
-
-
-
-
-
-
NT
-
10
10
Belgium (b)
10
15
x
15
10
15
10
15
15
10
15
NT
15
15
10
Canada
15
15
15
x
10
10
10
10
15
NT
10
10
15
15
10
Czech Rep.
10
10
-
10
10
x
-
-
-
-
10
-
NT
-
-
Denmark
-
-
-
-
-
x
-
-
-
-
-
-
-
-
-
Finland(c)
10
-
10
10
-
-
x
10
-
10
-
-
-
15
10
France(d)
-
-
-
-
-
-
-
x
-
NT
-
-
-
-
-
Germany(e)
10
-
15(25)
15
-
-
-
-
x
10(0)
-
-
-
10 (0)
10(0)
nda
Greece
nda
nda
nda
nda
nda
8
nda
nda
nda
nda
nda
nda
nda
nda
Hungary
10
-
15(f)
10
-
-
-
-
-
10
x
NT
-
-
10
Iceland
NT
NT
NT
-
NT
-
-
-
-
NT
NT
x
NT
NT
NT
Ireland
10
-
15
24
-
-
-
-
-
NT
-
NT
x
10
10
Italy
10
10
15
15
-
15
15
10
10
10
-
NT
10
x
10
Japan
10
10
10
10
10
10
10
10
10
NT
10
NT
10
10
x
Korea
15
10
10
15
10
15
10
10
10/15
8
-
NT
-
10
12
Luxembourg
NT
-
-
-
-
-
-
-
-
-
-
NT
-
-
-
Mexico
NT
NT
15
15
NT
15
15
15
15
NT
NT
NT
10
15
10
N’lands
N Zealand
Norway(q)
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
10
NT
10
15
NT
10
10
10
10
NT
NT
NT
10
10
NT
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
Poland
10
-
10
15
10
-
-
-
-
10
10
NT
10
10
10
Portugal
NT
10
15
NT
10
NT
15
12
15
NT
NT
NT
15
15
NT
Spain(s)
10
5
15
15
-
10
10
10
10(0)
NT
-
NT
-
12
10
Sweden
-
-
-
-
-
-
-
-
-
-
-
-
-
-
Switzerland
10
5
10
15
0
-
-
10
-
10
10
-
-
12.5
10
Turkey
NT
15
15
NT
NT
15
15
15
15
NT
10
NT
NT
15
10-15
UK
10
-
15
10
-
-
-
-
-
-
-
-
-
10
10
USA
10
-
15
10
-
-
-
-
-
30
-
-
-
15
10
Source: OECD Tax Database
(a)
See explanatory notes to the table.
20
Table 7 (cont’d)
Withholding tax rates on cross-border payments of interest - direct investment (1999)
From/To:
Australia
(a)
Korea
L’bourg
Mexico
N’lands
(a)
N.Z’land
Norway
Poland
Portugal
Spain
Sweden
Sw’land
Turkey
UK
USA
NT
10
15
NT
NT
10
10
10
10
NT
10
10
10
NT
10
10
Austria
10
-
NT
-
NT
-
-
10
5
-
5
15
-
-
-
Belgium(b)
10
15
15
10
10
15
10
15
15
10
10
15
15
15
15
Canada
15
15
15
10
15
15
15
NT
15
10
10
NT
10
10
25
Czech Rep.
10
-
NT
-
NT
-
10
10
-
-
-
NT
-
-
25
Denmark
-
-
-
-
-
-
NT
-
-
-
-
-
-
-
Finland(c)
10
-
NT
-
10
-
-
15
10
-
-
15
-
-
28
-
France(d)
Germany(e)
Greece
-
-
-
-
-
-
-
-
-
-
-
-
-
-
15(10,0)
-
15(10,0)
-
10(0)
-
-
15(0/10)
10(0)
-
-
15(0)
-
-
-
nda
nda
nda
nda
nda
nda
Nda
nda
nda
nda
nda
nda
nda
nda
nda
-/18(h)
Hungary
-
-
NT
-
NT
-
10
10(g)
-
-
10
10
-
-
Iceland
NT
NT
NT
NT
NT
-
NT
NT
NT
-
-
NT
-
-
-
Ireland
-
-(l)
5/10
-
10
-
10
15
-
-
-
NT
-
-
0/24
10
10
15
10
10
15
10
15
12
15
12.5
15
10
15
12.5/27(m)
Italy
Japan
12
10
10/15
10
(n)
10
10
NT
10
10
10
10/15
10
10
15
Korea
x
10
10
10
10
15
10
15
10
10
10
10
10
12
25
Luxembourg
-
x
NT
-
NT
-
10
NT
-
-
-
NT
-
-
-
15
NT
x
-
NT
15
NT
NT
15
15
15
NT
5
4.9
15
Mexico
Netherlands(o)
N Zealand
Norway(q)
-
-
-
x
-
-
-
NT
-
-
-
-
-
-
-
10
NT
NT
10
x
10
NT
NT
NT
10
10
NT
10
10
15
-
-
-
-
-
x
-
-
-
-
-
-
-
-
-
Poland
10
10
NT
-
NT
-
X
10
-
-
10
10
-
-
nda
Portugal
15
NT
NT
NT
NT
15
10
x
15
NT
10
NT
10
10
20
Spain (s)
10
0/10
15
10
NT
10
-
15
x
15
0/10
NT
12
10
25
-
-
-
-
-
-
-
-
x
-
-
-
-
-
10
10
15
5
10
-
10
10
10
5
x
NT
-
5
35
-
Sweden
Switzerland
Turkey
10-15
NT
NT
10-15
NT
15
10
NT
NT
15
NT
x
15
15
UK
10
-
5/10/15
-
10
-
-
10
12
-
-
15
x
-
-
USA
12
-
15(t)
-
10
-
-
10
10
-
-
15
-
x
30
Source: OECD Tax Database
(a)
See explanatory notes to the table.
21
Explanatory Notes to Table 6
General note: for countries with imputation systems, negative numbers show refundable tax credits.
Australia: (a)The table provides standard withholding rates for unimputed dividends. Most dividend
payments are imputed and are exempt from withholding tax. In addition, certain foreign-source dividends
are dividends paid to tax-exempt foreign pension funds and prescribed religious or charitable institutions
are also exempt from withholding tax.
Belgium: (b) For shares issued after 1.1.1994, the withholding rate is 15% maximum, or the treaty rate if
lower.
Finland: (d) The withholding tax is levied on the grossed up amount. Where a resident of Ireland is entitled
to tax credit in respect of such a dividend tax, he/she may also be charged in Finland according to Finnish
law at a rate not exceeding 15%.
France:
(e)
15 si contrôlé par des non-résidents.
(f)
27,5 sous réserve que les dividendes et le crédit d'impôt (avoir fiscal) soient imposés dans l'Etat de
résidence de la société bénéficiaire. Dans le cas contraire, lire 15 dans les colonnes correspondantes.
Hungary: (g)In the majority of the recipient countries the applicable tax rates depend on whether a recipient
of a beneficiary owner receives the dividend.
If the residence country of the recipient is:
Canada: the 5% rate applies if the recipient has a control - either direct or indirect - over 25% of the voting
right in respect of the distributing company,
The Czech Republic, Denmark, Finland, France, Germany, Korea, Luxembourg, Netherlands, Spain,
Sweden, U.K.: the 5% rate applies if the recipient has a stake of at least 25% in the distributing company,
Ireland: the 5% rate applies if the recipient has a stake of at least 10% in the distributing company,
Turkey: the 10% rate applies if the recipient has a stake of at least 25% in the distributing company.
USA: the 5% rate applies if the recipient has a voting stock of at least 10% in the distributing company,
Portugal: the Treaty with Portugal has been concluded but its provisions cannot currently been applied,
Non-treaty countries: the tax rate is 20% if the recipient is a company, and 20 and/or 35% - cf. note to
Table 5A- in the case of individual recipients.
Ireland: (h) From 6th April 1999 withholding tax at the standard rate of income tax (24%) applies to
dividend payments and all other relevant distributions made by all companies resident in the State, except
where the shareholder receiving the dividend is:
an Irish resident company,
an Irish resident pension fund or charity,
a person other than a company resident for tax purposes in another Member State of the European Union or
in a territory with which Ireland has a tax treaty, or
a company not resident in Ireland which is ultimately controlled by shareholders in another EU Member
State or in a treaty country, or a company which is publicly traded on a recognised Stock exchange.
In the above cases the provisions of domestic law do not permit the application of withholding
tax irrespective of the treaty position.
Tax credits attaching to Irish source dividends were abolished from 6th April 1999.
22
In table 10B the zero per cent withholding tax rate between Ireland and Denmark only applies in cases
where the beneficial owner holds more than 25 per cent of the equity capital.
Mexico: (l)In 1998 the domestic law exempted dividends from a withholding tax, thus the rates established
in the treaties were not applied, all dividends received by foreign residents were free from a withholding
tax. The 1999 Tax Law stipulates a 5% withholding tax; in those cases where the treaty rate is higher the
domestic law will prevail.
Netherlands: (j)The rates correspond to the tax treaty rates or alternatively to the rate applicable according
to the parent-subsidiary directive. The effective rates may however be lower in case the rate according to
domestic law is lower than the rate which is provided for in the treaty.
N Zealand: (m)The table provides withholding rates for unimputed dividends. Withholding tax on fullyimputed dividends is 15% to all investors. Foreign investor tax credit regime provides that company
paying a fully imputed dividend will pay a supplementary dividend sufficient to offset the 15%
withholding tax.
Portugal: (n) In some treaties there are only one withholding rate of 15% - Germany, Austria, Belgium,
France, Ireland and Italy. However in most of the treaties - Korea, Spain, Finland, Norway, Poland, Czech
Republic, Switzerland and United States - there is a 15% general rate and a 10% rate which applies if the
beneficiary owner has a stake of at least 25% in the distributing company. In the case of the United
Kingdom the 10% rate applies if the recipient has a direct control of at least 25% of the voting rights in
respect of the distributing company.
(o)
Meanwhile, according to Directive Nr 90/435/EEC, of 23rd July 1990, profits made available to a parent
company (holding at least 25% of the capital for two years) that is a resident of an EU member State, shall
be subject to a rate of 15% until 31st December 1996 and a tax rate of 10% from 1st January 1997 to 31st
December 1999.
The Convention with Denmark ceased to be in force as from 1st January 1995.
Spain: (p)According to Directive 90/435/EEC of 23d July 1990, profits distributed to a parent company
(inter alia holding at least 25% of the capital) that is a resident of an European Union member State are
exempt.
(q)
The United Kingdom does not levy withholding taxes on the payment of dividends, either at
UK:
home or abroad. It does, however, apply an abatement on the payment of the imputation tax credit granted
to a non-resident made under the provisions of a double tax treaty.
Explanatory Notes to Table 7
For countries with imputation systems, negative numbers show refundable tax credits.
Australia: (a)Interest paid on non-government public issues of securities is generally exempt from
withholding tax. In addition interest paid to tax-exempt foreign pension funds and prescribed religious or
charitable organisations is also exempt from withholding tax.
Belgium: (b)15% for securities issued after 1.3.90; 25% for securities issued before 1.3.90.
Finland: (c)Non-residents are exempt from taxes on interests derived from Finnish Bonds, debentures and
other mass instruments of debt. Loans from abroad not considered as capital investment assimilated to the
debtor’s own capital, deposits in banks or other financial institutions and foreign credit accounts.
Aforesaid exemption does not apply to a non-resident carrying on business through a permanent
establishment situated in Finland for all profits attributable to that permanent establishment.
23
France: (d)Il n’ existe aucun effet des conventions fiscales sur le taux de retenue à la source applicable aux
intérêts des obligations émises à compter du 01.01.87 dans la mesure où ces produits sont exonérés par la
loi interne (application de la mesure la plus favorable).
(e)
Germany:
In brackets: exceptional tax rates.
(f)
Hungary: In the case of Belgium interest on commercial debt (bank loans, promissory notes), instalment
payments, bankers’ current accounts and deposits are exempted.
(g)
The Treaty with Portugal has been concluded but its provision cannot currently be applied.
(h)
Interest paid on credit (loan) raised by a company from private person(s) and/or interest and exchange
gain paid in the case of the private placement or private trading of securities – if the relevant income is
higher than the ceiling laid down in the legislation – can be subject to personal income tax in accordance
with the tax rate schedule. In other cases – cf. table 5A– for individual recipients the tax rate is 0%.
The tax rate is 18% if the recipient is a company.
Ireland: (l)Luxembourg. The standard rate of withholding tax, 24% applies where the recipient is a
Luxembourg holding company (Article 29 of Ireland/Luxembourg Treaty).
(m)
Par réference aux pays avec lesquels l’Italie n’ a pas signé un traité: le taux de 12.5% concerne
Italy:
les titres d’Etat et les obligations assimilées; le taux de 27% concerne les dépôts bancaires, les comptes
courants postaux et les autres obligations.
Japan:
(n)
No provision (may be taxed in both countries according to this domestic law).
Mexico: The rates in the table are the general withholding rates of the treaties. Interest payments among
related parties are treated by the domestic law as corporate benefits and therefore are taxed as dividends;
such change in characterisation implies that the withholding rate on interest payment specified in tax
treaties is not applicable. In this case interest payments are not deductible.
Distributed dividend income is subject to regular corporate income tax of 35%, plus 5%
withholding tax rate, reinvested undistributed dividends are taxed at a rate of 32%; the additional 3% is
paid when dividends are distributed. The 40% rate is either final or creditable against personal income tax
liability.
Netherlands: The rates correspond to the tax treaty rates or alternatively to the rate applicable according to
the parent-subsidiary directive. The effective rates may however be lower in case the rate according to
domestic law is lower than the rate which is provided for in the treaty.
Norway:
(q)
There is no withholding tax on interest.
Portugal: For Germany, the 10% rate applies to interest on bank loans if this is considered of national
economic and social importance.
There are several treaties in which there are exemptions on the source, namely when the debtor is
the Government of one of the two countries or one of their sub-central administrations.
Spain: (s)Interest received by European Community debt holders from Spain are exonerated. In other
OECD, non-European countries, the rate hinges upon the existence of a Double Convention treaty or not.
In the case of long-term credits and borrowing is 0%. Figures in bracket correspond to exceptional tax
rates.
Turkey: - 10% of the gross amount of the interest from a loan made for a period of more than two years.
- 15% of the gross amount of the interest in all other cases.
USA:
(t)
Effective February 1, 1994.
24
Attachment I
QUESTIONNAIRE ON TAX INCENTIVES
FOR FOREIGN DIRECT INVESTMENT
This questionnaire solicits information on fiscal incentives
to be used as background material at the conference:
FOREIGN INVESTMENT:
ITS ROLE IN THE DEVELOPMENT
OF SOUTH-EAST EUROPE
IMPLEMENTING BEST POLICY PRACTICES
Organised within the framework
of the South-East Europe Compact for Reform, Investment, Integrity and Growth
and Hosted by the Government of Austria
Background
This questionnaire solicits information on fiscal (tax) incentives to attract foreign direct investment (FDI.)
The focus is on corporate income tax incentives (incentives that are structured through the host country’s
corporate income tax system). Personal income tax incentives and customs duty incentives are also briefly
considered. Unless otherwise indicated, we focus on tax incentives in effect over the period 1995-2000
inclusive. If the space provided under each question is insufficient, please complete the answer on a
separate page. However, in no case should the answer to any question exceed 1 page.
It is tentatively scheduled that tax experts discuss brief answers to this questionnaire in Vienna on 23-24
September, 2000.
(I) Corporate Income Tax Incentives
a) Please indicate the basic corporate income tax rate (in percentage terms, e.g., 35%) in your country over
the period 1995-2000. The corporate income tax rate is the rate applied to a corporation’s taxable income
(or tax base.)
1995:
1996:
1997:
1998:
1999:
2000:
_______
_______
_______
_______
_______
_______
Is a lower corporate income tax rate applied to business income earned by corporations owned by nonresidents (compared with the basic corporate income tax rate), or does the same tax rate apply to income
earned by resident-owned and non-resident owned companies? In what years?
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
25
b) Please describe the basic system used to depreciate capital costs – that is, the system used to depreciate
or write-off (i.e., claim as a business expense) capital costs, including machinery/equipment and buildings.
Do the depreciation rates approximate true physical depreciation rates (i.e., normal rates of wear and tear),
or are they accelerated – that is, do depreciation rates for tax purposes exceed true physical depreciation
rates? Are special depreciation rates available for investments in depressed regions, or for certain industry
sectors, or investor groups? Has the treatment varied over the period 1995-2000?
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
c) Does your tax system provide any other mechanism for enriching (increasing) depreciable capital costs
that would benefit FDI?
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
d) Has your tax system offered investment tax credits over the period 1990-2000? An investment tax
credit refers to a tax deduction from final tax payable (the term ‘credit’ does not refer to bank credit).
Unlike a depreciation write-off which is a deduction from taxable income (and therefore its value depends
18
on the corporate tax rate), an investment tax credit reduces the corporate tax liability directly. If
investment tax credits have been used, have they been available to both resident-owned and non-resident
owned companies? Can all industry sectors qualify, or only certain sectors?
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
e) Are firms given a special tax deduction for costs of finance (i.e., interest on debt or dividends on
equity)? Are firms given any special deduction when they make a dividend distribution?
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
f) Has your country concluded tax treaties with other countries? Currently, with how many OECD
countries does you country have a tax treaty (or is in the process of negotiating one)?
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
18.
To illustrate, assume that the variable Y measures gross (taxable) income from sales, C measures tax
deductible expenses other than depreciation, and D measures depreciable capital costs for corporate income
tax purposes. Let ITC measure a special investment tax credit earned as a fixed percentage (say 10%) of
the total amount of investment goods (e.g., machinery) purchased in the current period (ex., if $10 of new
machinery is purchased, the company earns an investment tax credit (ITC) of (0.10)(10)=1.) Then the final
corporate income tax liability T in the host country is given by T=(0.35)(Y-C-D)-ITC where the corporate
income tax rate is assumed in this example to be 35%. Note that the value of D depends on the tax rate,
whereas the value of the ITC does not.
26
g) What are the basic withholding tax rates applied to i) dividend distributions, ii) interest, iii) royalties
paid to non-resident direct shareholders (i.e., foreign parent companies)? Do the rates depend on whether
the recipient is resident or not in a tax treaty country (i.e., a country with which your country has a tax
treaty, if applicable)? Have these rates come down in recent years (over the sample period 1995-2000)?
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
h) What other major corporate tax incentives (e.g., tax holidays) have been used in your country over the
period 1990-2000 to attract FDI? Briefly describe the targeting of these (qualifying investment).
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
(II) Personal Income Tax Incentives
Often foreign investors choose to transfer a number of executives and technicians (‘expatriates’) to the host
country to help establish operations. Without special rules, these persons would normally be treated as
residents of the host country and subject to personal income tax. Some countries offer special personal
income tax relief to such individuals to increase the attractiveness of such transfers of workers.
19
a) Does your country operate a flat or progressive personal income tax structure? .What is the top
personal income tax rate? Please show the top rate over the sample period:
1995:
1996:
1997:
1998:
1999:
2000:
_______
_______
_______
_______
_______
_______
b) Does your country provide a reduced maximum rate of personal income tax for expatriates? If so, what
has this rate been over the sample period (1995-2000)?
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
19.
A progressive tax rate structure imposes higher tax rates to higher bands of taxable income. For example, a
progressive tax structure may apply a zero tax rate to the first $100 of taxable income, impose a 15% tax
rate on taxable income over the range ($100-$1000), and impose a 20% tax rate on taxable income in
excess of $1000. Therefore, if an individual has $5,000 of taxable income, the personal tax liability is
given by the following: T=(0.15)(900)+(0.20)(4000)=935. In contrast, a flat rate structure, with a flat tax
rate of 20%, that exempts the first $500 of taxable income would impose a personal income tax burden of
T=(0.20)(4500)=900.
27
c) In some cases, do you allow expatriates to be treated as non-resident for tax purposes? In what years
over the sample period has this policy been in effect?
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
d) Has your tax system provided any additional (standard) deductions for expatriates over this period?
Does your tax system exempt fringe benefits from taxation? If your tax system imposes social security
contributions on employers or employees, do you provide an exemption or other special relief from these
charges for expatriates? How have these treatments varied over the sample period?
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
28
(III) Duty-Free Zones and Special Economic Zones
a) Has your country had special ‘customs zones’ (often referred to as (custom) ‘duty-free zones’) in place
over the period 1990-2000 to attract FDI? A duty-free zone is a geographic area (within the physical
territory of the host country) that is treated for customs duty purposes as if it were outside the country.
This means that goods entering the zone from other countries are not treated as imports and are therefore
free of customs duty.
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
b) Does your country have special economic zones that provide exemptions from corporate income tax and
possible other taxes (perhaps in addition to exemption from customs duty)? (Note that these provisions
differ from tax holidays in that they are targeted at special geographic (and typically fenced) zones.)
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
______________________________________________________________________________________
_____________________________________________________________________________________.
29