Double taxation agreements and treaty shopping
The taxation of a person is based on two principles: Source and Residence. A person for tax purposes includes an individual, trust, company, partnership and any form of business arrangement one chooses to take on.
It should be noted that with globalisation, there is a constant mix of these two principles of source and residence.
Consequently, one may face taxation twice, hence the coining of the term “Double Taxation.” It is to this end that the Tax Authorities have seen it wise to have Double Taxation Agreements/Treaties (“DTAs”) in order to reduce on the phenomena of double taxation.
A tax treaty is a formally concluded and ratified agreement between two independent nations (bilateral treaty) or more than two nations (multilateral treaty) on matters concerning taxation. Tax treaties sometimes have reduced rates of tax and/or exemptions.
For example, one may face a lower or reduced tax rate because he is a resident of one state and sourcing income from another pursuant to a double taxation treaty between the two states. Uganda has various double taxation treaties with Mauritius, Italy, Netherlands, South Africa, UK, India, Denmark and Norway.
However, the aspects of double tax treaties has created a situation where taxpayers look for States with double tax agreements so that they can benefit from the various tax exemptions or reduced tax rates. The element where parties look out for the favourable tax treaties so that they take advantage of the rates is called “treaty shopping.”
Technically, treaty shopping is the practice of structuring a multinational business to take advantage of more favorable tax treaties available in certain jurisdictions. A business that resides in a home country that doesn’t have a tax treaty with the source country from which it receives income can establish an operation in a second source country that does have a favorable tax treaty in order to minimize its tax liability with the home country. Treaty shopping is commonly accomplished through what are known as ‘conduit’ entities or special purpose vehicles.
The conduit company takes advantage of the treaty provisions under its own name in Country S; economically, however, the treaty benefit goes to persons not entitled to use that treaty. The conduit company is usually able to enjoy reduced withholding tax rates or exemption from capital gains tax in the source country.
The aspect of treaty shopping is disadvantageous to the Tax Authorities as they lose revenue. The taxpayer also suffers as he/she faces higher tax rates on personal and corporate income in order to cover up this deficit in the budget.
It is for this reason that most countries have established a mechanism to control or reduce this treaty shopping. One of the many ways to control treaty shopping is the enacting of anti-treaty shopping laws in their domestic legislation.
Like many other developing countries, the Government of Uganda are in recent years taking bold steps towards ensuring that Uganda receives all due taxes. It has stated that it is developing a policy framework to guide treaty negotiations ahead.
Nevertheless, under the Income Tax Act, In order to benefit from a double Tax agreement in Uganda, one needs to show that they own 50% of the company and are residents in that State. Section 88 (5) of the income Tax Act provides that a double tax agreement shall only apply where the person claiming relief from double taxation has 50% or more ownership of the company and is resident of the other contracting state.
In my view, this provision in our laws only solves the problem half way. Currently many multinational companies today have cushioned their operations to try and water down the effect of such laws and regulations. Tracing the underlying ownership of some of the present day multinationals is difficult. For example, a subsidiary in Uganda may have its parent in Mauritius.
This Parent company may have also be controlled by three companies who are all Mauritian companies. Further, these companies controlling the parent may have other companies controlling them that are from Cayman Island and Mauritius. The icing on the cake may be that these companies owning stake in the Parent may also have other companies controlling them from the United States and UK.
The question therein would be who then has the underlying ownership of such a company and can the Uganda Revenue Authority trace such a string of cushioned ownership?
The writer is tax, legal and corporate services specialist with KPMG-Uganda