Ten Ways Developing Countries Can Take Control of their Own Tax Destnies
Krishen Mehta & Erika Dayle Siu (2016)
Summary by Nathalie Stroobants
I. Introducton
How developing countries get a fair deal on tax justcee This chapter describes ten ways developing countries have
taken control of their own tax destniese These methods can serve as useful models for developing countries in
striking the balance between encouraging FDI and maintaining fscal sovereignty in the pursuit of developmente
1. BE VERY CAUTIOUS ABOUT SIGNING TAX TREATIES
One-third of the bilateral tax treates (e...) have been signed by developing countriese
If not properly negotated and structured, treates ooen protect MNC’s at the expense of developing countriese
Moreover, signing tax treates doesn’t always result in greater FDI, and may even result in revenue losses to
developing countriese
When a developing country negotates a tax treaty based on an internatonal model, it is expected to commit to:
o reducing or sometmes eliminatng WHT on outlows of cash in the form of payments of interest,
royaltes, dividends, and other service fees;
o restrict the scope of their tax jurisdicton primarily to actve income from a fxed place of business;
o use specifc dispute resoluton measures that ooen include mandatory arbitraton; and
o include ND clauses, which oblige them to grant the same deductons for taxpayers resident in the treaty
partner country as they do for their own residentse
ND clauses, without a LOB or other ant-abuse clause, can prevent countries from placing caps on the
deductbility of interest payments, which can be used for proft-shioing purposese
In light of these disadvantages, a number of developing countries are now choosing not to sign these bilateral
tax treates, and yet they contnue to do business with many countries across the globee
In the case of renegotaton, inclusion of a LOB clause could provide the necessary foundaton to challenge a
claim of treaty benefts in cases of abusee
Given the resource drain of negotaton and administraton, and the inherent asymmetry of bargaining power
between developed and developing economies, many countries may do beter to avoid entering into these
agreementse
Many of the aims of tax treates can be accomplished through unilateral legislaton in domestc lawe
2. DO NOT FALL INTO THE TRAP OF TAX COMPETITION AND TAX INCENTIVES
(1) Many countries have forgone tax revenues in the form of tax incentves and reduced tax rates in the
expectaton of atractng new business investmente
As globalizaton + the mobility of capital have increased, tax competton between states has resulted in
a race to the botome
Such competton impedes long-term economic development and ooen pits impoverished countries
against each other;
winners: MNCs, losers: citzens + governments of developing countriese
(2) Governments end up giving away too much is due to the imbalance of wealth + power between large MNCs
and that of the host countrye
Many developing countries, desperate to atract FDI, ooen accept unfair conditons imposed by powerful
MNCs when negotatng contracts due to fears that the companies will take their business elsewheree
In countering this imbalance, identfcaton of a country’s value-add to specifc industries is essentale
ie Locaton savings lower operatng/labor costs + potental emerging consumer demand) are
ooen only present in developing countriese
iie Concerning natural resources, there is a high claim for source country uniqueness +
enttlement to the benefts of extractone
iiie If such tax incentves are already in place, laws are needed to evaluate their effectvenesse
, ive Evaluatons are critcal in ensuring that incentves ofer long-term benefts for development
in return for forgone public revenuese
(3) Concession of fscal sovereignty in the form of tax incentves for FDI has even more long-term negatve
efectse
Such revenue giveaways create impairment to domestc innovaton + development when they
disadvantage local frmse
If the same tax incentvessconcessions are not available to domestc frms, competton on an equal
footng is impossiblee
3. IMPOSE WITHHOLDING TAXES ON PAYMENTS TO NON-RESIDENTS
Importance of WHT:
Strengthen the negotatng positon with MNCs if for no other reason than that the government holds the
cashe
Operate as an inital presumpton of minimal proft and require the resident entty making the payment to a
nonresident entty to withhold a set percentage of the payment and remit that amount to tax authoritese
Capitalize on the tme value of money: When the government share of the payment is deducted at the
payment phase instead of collected at a later tme, the value of the tax revenues is greatere
Important enforcement tools, and simple to administere
As the reach of the digital economy expands, a few countries are also assessing WHT on non-resident providers of
digital services and online advertsinge WHT on payments for royaltes, dividends, interest, and services are widely
used in developing countriese
However, as mentoned earlier, without careful planning, WHT can ooen be reduced or eliminated directly
through withholding limitatons or indirectly through tax jurisdicton restrictons in PE provisions of tax treatese
Adopton andsor reinstatement of WHT may require some treaty renegotatone
4. ADOPT SAFE HARBORS + OTHER SIMILAR MEASURES TO SIMPLIFY TAX ADMINISTRATION + COMPLIANCE
Safe harbors:
Are “tax thresholds” that can ooen broaden the tax base by simplifying the tax regime;
Can reduce administratve burdens + ofer predictability to both companies + revenue authorites + reduce
litgaton;
Can also help boost FDIe
Presumptve Tax Regimes
Presumptve tax regimes, caps on deductons, and fxed proft margins in TP regulatons provide various
thresholds for simplifying tax systemse
Presumptve taxaton uses an established measure of business actvity to establish a broad base for taxatone
o For example, a presumptie tax (presumably at a much lower rate) can be leiied on the gross
receipts of a taxpayer without subtractng for expenses, losses, or deductonss Payments to
nonresident companies located in low- or no-tax jurisdictons are deducted as expenses, and erode
the tax bases A presumptie tax on gross receipts would efectiely disallow such proft shifings
Deducton Caps
Caps on deductons for various payments to non-resident related partes provide simplicity for both the
taxpayer and the government and protect the tax base from proft shioinge
The overall principle of a deducton cap is that any charges paid for service or management fees or interest
payments must be appropriately ted to the underlying beneft received by the resident enttye
o For example, generally a management fee of 2 percent is considered acceptable and can be built in
as a safe harbor proiision in the oierall tax laws regulatng deductble expensess
Developing countries have various optons on what deductons to allow, and how much to limit those
deductonse
o For instance, China takes the positon that management fees should be considered as a shareholder
cost, and are not deductbles
Krishen Mehta & Erika Dayle Siu (2016)
Summary by Nathalie Stroobants
I. Introducton
How developing countries get a fair deal on tax justcee This chapter describes ten ways developing countries have
taken control of their own tax destniese These methods can serve as useful models for developing countries in
striking the balance between encouraging FDI and maintaining fscal sovereignty in the pursuit of developmente
1. BE VERY CAUTIOUS ABOUT SIGNING TAX TREATIES
One-third of the bilateral tax treates (e...) have been signed by developing countriese
If not properly negotated and structured, treates ooen protect MNC’s at the expense of developing countriese
Moreover, signing tax treates doesn’t always result in greater FDI, and may even result in revenue losses to
developing countriese
When a developing country negotates a tax treaty based on an internatonal model, it is expected to commit to:
o reducing or sometmes eliminatng WHT on outlows of cash in the form of payments of interest,
royaltes, dividends, and other service fees;
o restrict the scope of their tax jurisdicton primarily to actve income from a fxed place of business;
o use specifc dispute resoluton measures that ooen include mandatory arbitraton; and
o include ND clauses, which oblige them to grant the same deductons for taxpayers resident in the treaty
partner country as they do for their own residentse
ND clauses, without a LOB or other ant-abuse clause, can prevent countries from placing caps on the
deductbility of interest payments, which can be used for proft-shioing purposese
In light of these disadvantages, a number of developing countries are now choosing not to sign these bilateral
tax treates, and yet they contnue to do business with many countries across the globee
In the case of renegotaton, inclusion of a LOB clause could provide the necessary foundaton to challenge a
claim of treaty benefts in cases of abusee
Given the resource drain of negotaton and administraton, and the inherent asymmetry of bargaining power
between developed and developing economies, many countries may do beter to avoid entering into these
agreementse
Many of the aims of tax treates can be accomplished through unilateral legislaton in domestc lawe
2. DO NOT FALL INTO THE TRAP OF TAX COMPETITION AND TAX INCENTIVES
(1) Many countries have forgone tax revenues in the form of tax incentves and reduced tax rates in the
expectaton of atractng new business investmente
As globalizaton + the mobility of capital have increased, tax competton between states has resulted in
a race to the botome
Such competton impedes long-term economic development and ooen pits impoverished countries
against each other;
winners: MNCs, losers: citzens + governments of developing countriese
(2) Governments end up giving away too much is due to the imbalance of wealth + power between large MNCs
and that of the host countrye
Many developing countries, desperate to atract FDI, ooen accept unfair conditons imposed by powerful
MNCs when negotatng contracts due to fears that the companies will take their business elsewheree
In countering this imbalance, identfcaton of a country’s value-add to specifc industries is essentale
ie Locaton savings lower operatng/labor costs + potental emerging consumer demand) are
ooen only present in developing countriese
iie Concerning natural resources, there is a high claim for source country uniqueness +
enttlement to the benefts of extractone
iiie If such tax incentves are already in place, laws are needed to evaluate their effectvenesse
, ive Evaluatons are critcal in ensuring that incentves ofer long-term benefts for development
in return for forgone public revenuese
(3) Concession of fscal sovereignty in the form of tax incentves for FDI has even more long-term negatve
efectse
Such revenue giveaways create impairment to domestc innovaton + development when they
disadvantage local frmse
If the same tax incentvessconcessions are not available to domestc frms, competton on an equal
footng is impossiblee
3. IMPOSE WITHHOLDING TAXES ON PAYMENTS TO NON-RESIDENTS
Importance of WHT:
Strengthen the negotatng positon with MNCs if for no other reason than that the government holds the
cashe
Operate as an inital presumpton of minimal proft and require the resident entty making the payment to a
nonresident entty to withhold a set percentage of the payment and remit that amount to tax authoritese
Capitalize on the tme value of money: When the government share of the payment is deducted at the
payment phase instead of collected at a later tme, the value of the tax revenues is greatere
Important enforcement tools, and simple to administere
As the reach of the digital economy expands, a few countries are also assessing WHT on non-resident providers of
digital services and online advertsinge WHT on payments for royaltes, dividends, interest, and services are widely
used in developing countriese
However, as mentoned earlier, without careful planning, WHT can ooen be reduced or eliminated directly
through withholding limitatons or indirectly through tax jurisdicton restrictons in PE provisions of tax treatese
Adopton andsor reinstatement of WHT may require some treaty renegotatone
4. ADOPT SAFE HARBORS + OTHER SIMILAR MEASURES TO SIMPLIFY TAX ADMINISTRATION + COMPLIANCE
Safe harbors:
Are “tax thresholds” that can ooen broaden the tax base by simplifying the tax regime;
Can reduce administratve burdens + ofer predictability to both companies + revenue authorites + reduce
litgaton;
Can also help boost FDIe
Presumptve Tax Regimes
Presumptve tax regimes, caps on deductons, and fxed proft margins in TP regulatons provide various
thresholds for simplifying tax systemse
Presumptve taxaton uses an established measure of business actvity to establish a broad base for taxatone
o For example, a presumptie tax (presumably at a much lower rate) can be leiied on the gross
receipts of a taxpayer without subtractng for expenses, losses, or deductonss Payments to
nonresident companies located in low- or no-tax jurisdictons are deducted as expenses, and erode
the tax bases A presumptie tax on gross receipts would efectiely disallow such proft shifings
Deducton Caps
Caps on deductons for various payments to non-resident related partes provide simplicity for both the
taxpayer and the government and protect the tax base from proft shioinge
The overall principle of a deducton cap is that any charges paid for service or management fees or interest
payments must be appropriately ted to the underlying beneft received by the resident enttye
o For example, generally a management fee of 2 percent is considered acceptable and can be built in
as a safe harbor proiision in the oierall tax laws regulatng deductble expensess
Developing countries have various optons on what deductons to allow, and how much to limit those
deductonse
o For instance, China takes the positon that management fees should be considered as a shareholder
cost, and are not deductbles
