Double taxation is a highly relevant issue for both entrepreneurs and established companies. In essence, it consists of paying taxes in two different countries, each with its respective rates.
It all begins when an entrepreneur, or a group of entrepreneurs, wants to start and operate a company in a country other than that of his residence, with the intention of maximizing his profit, taking advantage of lower taxation levels. However, this isn’t as simple as it seems, even with all the facilities that certain countries offer to set up companies remotely, through the Internet. In fact, if the entrepreneur doesn’t consider some key aspects, he can be sanctioned administratively, or even criminally.
In particular, the determination of the corporate residence, that is, in which country(ies) the company must declare taxes, is of vital importance.
According to article 5 of the Organization for Economic Co-operation and Development (OECD) Model Tax Convention on Income and on Capital, a permanent establishment is “a fixed place of business through which the business of an enterprise is wholly or partly carried on” and includes:
- a place of management;
- a branch;
- an office;
- a factory;
- a workshop, and
- a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
However, it doesn’t include:
- the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
- the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;
- the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
- the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information, for the enterprise;
- the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity;
- the maintenance of a fixed place of business solely for any combination of activities mentioned in subparagraphs a) to e),
provided that such activity or, in the case of subparagraph f), the overall activity of the fixed place of business, is of a preparatory or auxiliary character.
Then, to determine the existence of a permanent establishment, the following conditions must be met:
- There must be a fixed place of business;
- Such place must be permanent;
- An economic activity must be carried out in whole or in part;
- Said activity must be carried out through the fixed place of business.
With regard to the place of business, this term refers to “any premises, facilities or installations used for carrying on the business of the enterprise whether or not they are used exclusively for that purpose.” Therefore, when an activity is performed internally with a productive nature or that is useful for the generation of profit for the company, the place of business is considered to be a permanent establishment. However, if only ancillary activities that aren’t directly related to profit generation are carried out, it cannot be considered a permanent establishment.
In this regard, each country’s legislation possibly addresses this issue differently. For example, in the case of Italy, article 162, paragraph 6, of the Consolidated Income Tax Law (TUIR) establishes that:
If a subject acts in the territory of the State on behalf of a non-resident company and regularly closes contracts or operates in order to close contracts without substantial modifications by the company and said contracts are in the name of the company, or related to the transfer of ownership, or for granting the right of use, of the assets of such company or which the company has a right to use, or in connection with the provision of services by such company, such company is deemed to have a permanent establishment in the territory of the State in relation to each activity carried out by said subject on behalf of the company, unless the activities of said subject are limited to carrying out the activities mentioned in paragraph 4 which, if performed through a fixed place of business, would not allow this fixed place to be considered a permanent establishment in accordance with the provisions of the same paragraph 4.
Paragraph 7 adds:
Paragraph 6 does not apply when the subject, who operates in the territory of the State on behalf of a non-resident company, carries out his own activity as an independent agent and acts for the company as part of his ordinary activities. However, when a subject operates exclusively or almost exclusively on behalf of one or more companies with which he is closely related, said subject will not be considered an independent agent, in accordance with this paragraph, in relation to each of such companies.
As of the subject closely related to a company, it is considered such when it directly or indirectly owns more than 50% of its capital.
Article 5, paragraph 3, subparagraph d) states that:
Companies and associations that have their registered office or their administrative headquarters or main object in the territory of the State during most of the tax period are considered residents.
Paragraph 5-bis of article 73 further specifies that:
Unless proven otherwise, the administrative headquarters of companies and entities, that have controlling interests… in the subjects indicated in subparagraphs a) and b) of paragraph 1, will be considered to exist in the territory of the State, if, alternatively:
a) they are controlled, albeit indirectly… by subjects residing in the territory of the State;
b) they are managed by a board of directors, or another equivalent management body, made up predominantly of directors who reside in the territory of the State.
Therefore, the place of residence of most directors is also relevant for determining a company’s residence.
Now, what happens if a company must pay taxes in two countries? In this case, it is convenient to consult the relevant tax legislation and the double taxation agreement signed between both countries, if one exists. For example, article 165 of the TUIR establishes that:
1. If the income produced abroad contributes to the formation of the total income, the taxes paid there definitively on said income may be deducted from the net tax due up to the amount of tax corresponding to the difference between the income produced abroad and the total income net of losses from previous tax periods admitted in decrease.
3. If there is income produced in more than one foreign State, the deduction is applied separately for each State.
Finally, if an entrepreneur doesn’t know that he must declare taxes in the country where the corporate residence is determined, in the event that it is different from the residence of the administrators, he may incur a crime by omitting a tax declaration. In Italy, who commits such a crime can be punished with imprisonment from two to five years, if the unpaid tax is greater than fifty thousand euros. Additionally, the employer could be subject to administrative sanctions.
For more information feel free to get in touch and to consult the previous sources and the book Introduzione allo studio dei paradisi fiscali e della finanza offshore by Giacalone, Costabile, and Giacalone.
