Dieter Endres

Company taxation in the Asia-Pacific region, India, and Russia

Motivation for and Structure of the Study.- Company Taxation Regimes in the Asia-Pacific Region, India, and Russia.- The Effective Tax Burden on Domestic and Cross-Border Investments in the Asia-Pacific Region.- Tax Incentives in the Asia-Pacific Region.- Tax Planning Strategies.- Corporate Taxation and Foreign Direct Investment Flows.

Ausmaß internationaler Steuerplanung – aggressiv oder moderat?

Wenn Steuersysteme nicht neutral und aufeinander abgestimmt sind, gedeiht die Steuergestaltung. Die gezielte Nutzung der internationalen Steuerarbitrage als Nebenprodukt nicht harmonisierter Steuersysteme sieht sich aber heftiger steuerpolitischer Kritik ausgesetzt.

The Effective Tax Burden on Domestic and Cross-Border Investments in the Asia-Pacific Region

The intention of the quantitative analysis is to reveal the incentives of the tax systems in the Asia-Pacific region, India, and Russia with regard to location decisions, investment strategies and financing options for subsidiaries. The commonly accepted methodology of Devereux and Griffith (See Devereux and Griffith (1999) and Schreiber et al. (2002)) can provide reliable information on this issue and is therefore relied on in this study. This approach is a so-called forward-looking approach, calculating the tax burden on a hypothetical investment project of a company. Based on the approach of Devereux and Griffith, the European Commission carried out comprehensive surveys on the comparison of effective tax burdens in the EU (See Devereux et al. (2008) and European Commission (2001)). The model applied in this study on the Asia-Pacific region, India, and Russia is the same as the one used by the European Commission.1 An important strength of this methodology is the possibility of modelling the most relevant provisions of tax regimes in a systematic way. The model of Devereux and Griffith is explicitly conceived to compute the effective tax burden not only on marginal investments (effective marginal tax rate – EMTR) but also on highly profitable investments (effective average tax rate – EATR). Since location decisions for subsidiaries of multinational investors are usually made for highly profitable investments, the EATR constitutes the relevant measure in the context of this study.2 When computing the EATR, the most important regulations of the tax regimes in the Asia-Pacific region, India, and Russia are accounted for. Besides the regulations which determine the local tax burden borne in the potential locations of the subsidiary, territory specific withholding taxes on profit repatriation and methods for avoiding international double taxation in the investor’s home territory are accounted for in the calculations. The following section briefly outlines the underlying assumptions on investment and financing strategies and the tax provisions covered by the model.

Corporate Taxation and Foreign Direct Investment Flows

The analysis in the preceding sections has focused on describing the tax burden faced by different types of foreign investment in the Asia-Pacific Region. In this section, we discuss the interaction between corporate tax burdens and actual foreign direct investment flows. In recent decades, governments across the world have become increasingly concerned about the impact of taxes on international investment flows. High tax countries fear that the tax burden on corporate investment may lead to a relocation of economic activity to countries with lower taxes. Some countries have actively pursued a low tax strategy with the objective to attract investment from other countries. In Europe, the significant decline in corporate income tax rates which occurred during the last two decades is widely seen as reflecting the forces of corporate tax competition. In East Asia, governments are at least as concerned about attracting foreign direct investment as governments in other regions. The location of foreign direct investment depends on a large number of factors. Next to taxes, these include the proximity to clients or suppliers, the availability of key inputs like qualified employees or financial services, regulations, political stability of a country and many more. But the particular importance of taxes is due to the fact that taxes can be changed relatively easily and quickly whereas other important factors like e.g. proximity to markets or the availability of qualified employees can either not be changed at all or only in the long term.

Tax Planning Strategies

The East-Asian market has become increasingly interesting in the past years for investors from Europe and the United States. Direct investment from Germany to the fifteen territories has almost increased tenfold within the last 15 years (see Deutsche Bundesbank (1989–2007)). For the United States, the numbers show a similar trend as investments are six times as high as they were as 15 years ago (see Bureau of Economic Analyses (1989–2007)). One reason certainly is the exploitation of Asian-Pacific markets which amount to one third of worldwide GDP. Since tax policies play a great role in choosing a location for investment, tax planning strategies for multinationals have to be considered for investments in the Asia-Pacific region. The main interest of a parent company is to face a low tax burden on foreign profits and on their repatriation. Instruments to achieve such objectives are for example the location decision, the decision of financing and the establishment of holding structures. The first two topics have been covered in Chap. 3 of this study and will not be examined in great detail in this chapter. Since tax planning strategies differ between countries using the exemption or the credit method in order to avoid double taxation, they have to be developed separately in the cases of Germany and the United States. Strategies for German multinationals will first be looked at, followed by strategies for US multinationals. The underlying structure for the investment is shown in Fig. 5.1.

Motivation for and Structure of the Study

The Asia-Pacific region as well as India, and Russia have gained economic power among the world’s economies and offer enormous sales opportunities for multinational companies. Hence, these territories are going to have increasing importance as a trade and investment partner. When considering a foreign direct investment in those territories, the specific taxation framework constitutes one determinant to be accounted for in the decision making process of the multinational investor. Yet, the tax systems in these territories tend to be very complex, especially when considering the incentives offered. At the same time, they are strongly connected to the fast paced development process of the territories themselves, resulting in a sequence of more or less profound tax reforms.

Tax Incentives in the Asia-Pacific Region

It can be shown that Foreign Direct Investment (FDI) has several positive effects on the economy of the host territory. Not only an increase of productivity, but also the training of employees or the transfer of technology are important consequences and can result in economic growth for the particular territory (see Hunya (2006)). As the economic differences between Asian territories are large, there is a lot of tension in the region. In particular, countries like China, India, South Korea, and Japan are among the largest economies in the world. Indonesia, the Philippines, Malaysia, Thailand, and Vietnam are succeeding in establishing long-term growth, but smaller economies can also benefit from capital inflow through foreign direct investment and stabilise their economic growth. So far, cheap labour costs have caused an inflow of manufacturing industries, leading to Asia becoming an important source of automobiles, machinery, and electronics. The statistics show that the Foreign Direct Investment inflow in the territories of this study has almost tripled since 2005 (see UNCTAD (2009)). Tax incentives have proven their worth as an attraction for inward investment (see de Mooij and Ederveen (2003)). The leading economic territories have, in the past, attracted manufacturing investments by offering tax incentives. Now they are starting to change their focus to high technology industries. Just in 2008, China has changed its tax incentives structure from supporting foreign enterprises to supporting high technology enterprises in general. It is expected that other territories will follow this approach.

Company Taxation Regimes in the Asia-Pacific Region, India, and Russia

Generally, as regards the fiscal year 2009, the tax systems in the Asia-Pacific region, India, and Russia follow international standards. In the majority of territories considered, resident corporations are taxed on their worldwide income. In Hong Kong and Malaysia, the definition of taxable income is based on the territoriality principle. In these territories, profits are only taxable if derived from domestic sources. Singapore taxes income based on the concepts of territoriality and receipt. With respect to the integration of the corporation income tax into the personal income tax of the individual shareholders, about half the territories operate a classical system. Referring to the rate structure, the applicable nominal corporation tax rates vary considerably within the Asia-Pacific region, India, and Russia. The lowest rate is levied in Hong Kong (16.5%) whereas Japan and India tax corporate profits at a rate of 30%. The corporation tax is complemented by surcharges in India, Japan, and South Korea and by local profits taxes in Japan and the Philippines. Besides the tax rates, the regulations governing the tax base, e.g. depreciation allowances granted for tax purposes, are an important determinant of the territory-specific tax systems. Some territories (especially Hong Kong) grant generous allowances for tax purposes whereas other territories are more restrictive. Turning to non-profits taxes borne by corporations the majority of territories levy either a real estate tax or a property tax on business assets.