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Tax Sparing

Related Content: Incentives and Grants

The sphere of application of a tax incentive may be extended by way of a tax sparing clause in a tax treaty between a capital importing country and a capital exporting country.

Such clauses allow residents of the capital exporting country a credit against their domestic tax for profits or gains derived in the developing country in respect of which all or specified taxes are subject to exemption or reduction in the latter country.

The result resembles an offshore tax plan designed by the taxing government itself.

The failure of a capital exporting country to provide for tax sparing or some similar arrangement leads to a distortion of competition at the international level, since investors who are taxed on foreign income in their country of residence are at a disadvantage as compared with investors who are resident in countries giving full or partial exemptions for foreign source income, and also as compared with investors resident in the developing country itself.

A tax sparing arrangement is thus a concession offered by a capital exporting or investing country to ensure that an incentive offered by a developing country is effective. Without it, the incentive offered by the developing country may be nullified because it merely results in more tax being payable in the investing country.

Investment incentive programs, together with, or in the absence of, tax incentives, may well prove decisive in the choice of location of a project. Such programs are particularly attractive where substantial grants, interest-free or low-interest loans, factory sites, etc., are available in addition to tax incentives.

There are two areas where care should be exercised:
(1) the international measures that restrict the use of preferential tax regimes and tax havens; and
(2) the question as to whether the incentive is really beneficial.


Know your Offshore Terms:


Statute of Elizabeth

The Statute of Elizabeth is an important English law dating from 1571. This statute has also been introduced into the law of a number of legal systems based on English law, and this includes many of the states in the United States as well as into the laws of many international offshore financial centers and tax havens of the world. Under such legislation, it is sometimes possible to set aside transfers into trust even if the settlor transferred the property many years before the debt arose and, at the time of making the transfer, had no indication that the particular debt would arise in the future.

Trust Residence

In many legal systems, a trust might be exposed to the risk of being held to be a resident, unless two conditions are both satisfied: (a) that all or a majority of the trustees are neither resident nor ordinarily resident in the country concerned; and (b) that the general administration of the trust is ordinarily carried on outside the country concerned. Trust residence may thus be a factor to take into account in the design of an international tax plan, particularly where a tax haven or IOFC (international offshore financial center may be involved.

Choice of Law in International Tax Planning

Choice of law is a conflict of laws (private international law) issue, and the rules are part of the domestic law of each country. Choice of law problems frequently arise with respect to entities that are not known to, or do not enjoy legal personality in, a foreign system. The determination of the applicable law for the purpose of characterising such entities varies from one legal system to another, a point to be watched in the design of an international tax plan.

Comparable Uncontrolled Price (CUP)

A method employed for transfer pricing purposes in order to determine the price that is charged by similar companies selling the same or similar products in the same or similar circumstances.
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