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Maliyat Journal, No. 26, Winter 1999-2000

English section

 

 

IN THE NAME OF ALLAH

 

FROM THE PRESIDENT

 

The type of relationship existing between the tax administration and taxpayers plays a significant and sensitive role, with critical effect on the efficiency and outcome of activities of the tax machinery. For improving this feature of the conduct of the tax administration, it would be of great usefulness to take benefit from the findings of some branches of human knowledge, such as sociology and social psychology. According to such findings, the individual reactions against the way of treatment and behavior of public authorities would cross the frontiers of a limited and personal feeling, when authorities’ action concerns and touches upon the multitude of people. In such cases, the individual reactions would mutually act upon each other, as if a social procession is taking place. As a result of this social process, an average and general attitude towards the relevant authorities will be formed, which will constitute the basis of behavior of people in discharging their legal duties and obligations. 

To control this social process in a sound way and direct it towards the interest of the society, one has to study the behavior and manners demonstrated in the past and probable adverse effects that they had in mind of the general public. Then a reversal move must be started in a new direction, which may remove the unwanted negative effects of respective methods and conducts. 

A movement of this kind has already been initiated, and its traces can be noticed in different rulings and circular letters issued by the tax administration and tax forums in recent months. A new general tone and spirit can be deduced from these rulings and regulatory provisions. This new atmosphere is recognizable especially for those who deal with, or refer to, the tax verdicts and decrees in a continuous manner, either because of their occupation or for performing studies in the field of taxation.

A simple way to grasp this matter is to have a look at the contents of this Maliyat Journal, especially a section of which is devoted to tax regulations and rulings. If we compare the recent issues of the journal with those published in previous years, we would certainly comprehend this difference. For instance, in the last issue of the journal several circular letters were printed, in majority of which there could be seen references to the approach of officials towards people and taxpayers. They are instructed, under these rulings, to adopt arrangements for guiding the taxpayers and providing them with the information they need for discharging their legal duties. They are also directed to accept and deal with the taxpayers in a complaisant and courteous manner. Avoidance from unjustified delay in performance of their duties and refraining from developing an environment of dissatisfaction in their relationship with taxpayers and people are also among the instructions given to tax authorities. They are in the same way ordered to make their best to settle the issues and problems through the legal means provided under the law.

Parallel to that, the attention of officials is drawn to observance of regulations and binding verdicts of competent tax forums. In fact, abidance by the law and correct behavior towards the taxpayers are two faces of the same coin, since both of them result in more efficiency for the tax administration and creation of sound basis for achieving the real aim of the law. As we pointed out earlier, it has been proven and accepted in today’s world that the best way to improve the efficiency of the tax administration, is to secure the voluntary compliance of taxpayers. Two main requirements for achieving this aim, are the integrity of the tax machinery (in the form of observance of the law) and maintaining a reasonable relationship with taxpayers. Both these requirements are embodied in the rulings and regulations referred to above.

Dr. Aliakbar Arabmazar

 

 

An Introduction to thr Iranian Tax System

 

 

By: Dr. Mohammad Tavakkol

(Part 6)

 

In the previous parts of this essay we analyzed the regulations of the Direct Taxes Act (DTA) regarding the different types of property tax. Now we will begin our study on the main part of DTA's substantial provisions, namely those pertaining to various types of income tax.

 

Income Tax

 

The title C of the Direct Taxes Act, which is wholly devoted to the provisions of income tax, is divided to seven chapters, each covering a category of taxes on income. The criteria chosen for classification and grouping of these chapters are related to both, the kinds of income and categories of taxpayers.

The tax on income from real estate, agriculture and salary, and also the tax on incidental income, may be attributed to the first category, and three other ones (business income tax, tax on income of juridical persons and tax on aggregate income) are pertaining to the income tax of corporations and individuals.

More accurately speaking, all corporate and individual incomes are subject to chapters IV, V and VII, but the income derived from real estate, agriculture, salary, and also the income earned, either by individuals or corporations, incidentally (mostly  through favoritism) are dealt with in chapters I, II, III and VI. Each of these branches of income tax will be studied according to the same order as the title C of DTA is organized.

Chapter 1. Real Estate Income Tax

Some points are to be clarified at the outset, without which confusion and ambiguity may arise, especially for those who are not familiar with the perception that people have in this country regarding the concepts related to real property. The following points are worth mentioning in this regard:

1. The heading "real estate income tax", as used in the chapter ‘I’ of the title ‘C’ of DTA, covers various types of taxes that might be considered, especially by those disciplined under the international criteria and notions in respect of tax concepts and classifications, to be inconsistent and heterogeneous.

2. The taxes referred to under the said chapter include: tax on rental income, tax on the transfer of goodwill, immovable property transfer tax, tax on the income of the business of erecting and sale of buildings, and the tax on transfer of other rights related to the immovable property.

3. What these various types of taxes have in common is that all of them are somehow related to the immovable property. As far as the element of profit is concerned, not all cases covered by the taxes in question evidence the realization of profit. For instance, the tax on transfer of the immovable property is to be collected on basis of taxable value of the property, notwithstanding the accrual of any profit as a result of such transfer.

4. Other points worth of mentioning are as follows:

a) The taxes envisaged under the said chapter ‘I’ are not classified on basis of the type of relevant taxable persons. Therefore, all the taxpayers earning the incomes referred to in this chapter, or making transactions mentioned therein, are liable to taxation, whether they are individuals or corporations, and whether related to private or public sector;

b) The real properties subject to taxation are those located in Iran. It means that the Iranian tax law has chosen the rule of situs with regard to taxes provided in the said chapter;

c) The state-owned companies, whose income is of the types mentioned above, are not subject to the rules and procedures provided under the chapter in question. Such companies' income is assessed through the normal examination of their books of accounts (Note to Article 52, DTA). Now let us touch upon each of the above-mentioned types of taxes.

Some points are to be clarified at the outset, without which confusion and ambiguity may arise, especially for those who are not familiar with the perception that people have in this country regarding the concepts related to real property. The following points are worth mentioning in this regard:

1. The heading "real estate income tax", as used in the chapter ‘I’ of the title ‘C’ of DTA, covers various types of taxes that might be considered, especially by those disciplined under the international criteria and notions in respect of tax concepts and classifications, to be inconsistent and heterogeneous.

2. The taxes referred to under the said chapter include: tax on rental income, tax on the transfer of goodwill, immovable property transfer tax, tax on the income of the business of erecting and sale of buildings, and the tax on transfer of other rights related to the immovable property.

3. What these various types of taxes have in common is that all of them are somehow related to the immovable property. As far as the element of profit is concerned, not all cases covered by the taxes in question evidence the realization of profit. For instance, the tax on transfer of the immovable property is to be collected on basis of taxable value of the property, notwithstanding the accrual of any profit as a result of such transfer.

4. Other points worth of mentioning are as follows:

a) The taxes envisaged under the said chapter ‘I’ are not classified on basis of the type of relevant taxable persons. Therefore, all the taxpayers earning the incomes referred to in this chapter, or making transactions mentioned therein, are liable to taxation, whether they are individuals or corporations, and whether related to private or public sector;

b) The real properties subject to taxation are those located in Iran. It means that the Iranian tax law has chosen the rule of situs with regard to taxes provided in the said chapter;

c) The state-owned companies, whose income is of the types mentioned above, are not subject to the rules and procedures provided under the chapter in question. Such companies' income is assessed through the normal examination of their books of accounts (Note to Article 52, DTA). Now let us touch upon each of the above-mentioned types of taxes.

Some points are to be clarified at the outset, without which confusion and ambiguity may arise, especially for those who are not familiar with the perception that people have in this country regarding the concepts related to real property. The following points are worth mentioning in this regard:

1. The heading "real estate income tax", as used in the chapter ‘I’ of the title ‘C’ of DTA, covers various types of taxes that might be considered, especially by those disciplined under the international criteria and notions in respect of tax concepts and classifications, to be inconsistent and heterogeneous.

2. The taxes referred to under the said chapter include: tax on rental income, tax on the transfer of goodwill, immovable property transfer tax, tax on the income of the business of erecting and sale of buildings, and the tax on transfer of other rights related to the immovable property.

3. What these various types of taxes have in common is that all of them are somehow related to the immovable property. As far as the element of profit is concerned, not all cases covered by the taxes in question evidence the realization of profit. For instance, the tax on transfer of the immovable property is to be collected on basis of taxable value of the property, notwithstanding the accrual of any profit as a result of such transfer.

4. Other points worth of mentioning are as follows:

a) The taxes envisaged under the said chapter ‘I’ are not classified on basis of the type of relevant taxable persons. Therefore, all the taxpayers earning the incomes referred to in this chapter, or making transactions mentioned therein, are liable to taxation, whether they are individuals or corporations, and whether related to private or public sector;

b) The real properties subject to taxation are those located in Iran. It means that the Iranian tax law has chosen the rule of situs with regard to taxes provided in the said chapter;

c) The state-owned companies, whose income is of the types mentioned above, are not subject to the rules and procedures provided under the chapter in question. Such companies' income is assessed through the normal examination of their books of accounts (Note to Article 52, DTA). Now let us touch upon each of the above-mentioned types of taxes.

 

Tax on Rental Income

As it was noted above, the first type of taxes envisaged under the heading "real estate income tax" is the tax on rental income. The most important points worth of mentioning in respect of this type of tax are as follows:

1. The tax law (DTA) states that the rental income earned from the lease of a real property is subject to taxation, but it provides no definition for the terms ‘lease’ and ‘rental’. In such cases reference is usually made to the civil law and customary meaning of the relevant terms. According to the Article 466 of the Iranian Civil Code "lease is a contract whereby the tenant becomes the owner of the profits of the rented property". By the word "profits" the right of occupancy of the rented property is meant.

2. Although no definition for the term “lease of real estate” is given by the law, there are references to certain special cases (alongside the ordinary cases of lease of real property) that are considered to be subject to the rules of lease and rental. Reference is also made to cases not considered as leasehold, and thus not being subject to taxation under review. These two types of special cases are as follows:

A. Special cases subject to tax on rental income:

(i) where an immovable property, which has been endowed or typed up, is leased to a tenant, the case shall be subject to the tax on rental income. The term typing up a property means (in Islamic Law as well as in the Iranian Civil Code) to make the substance of the property inalienable and devoting its yield to certain (usually charitable) purposes. The same process is exactly effected through endowment of a property, and thus the terms endowment (vaqf) and tying up (Habs) have in most cases the same coverage and effects.

(ii) in case of the “mortgage in possession” the mortgagor is subject to taxation envisaged for the rental income. Mortgage in possession is a contract by which the mortgagee takes the use and possession of the property during the term of the contract.

(iii) Note 10 to the Article 53, DTA refers to another special case and states:

"Where the residential units belonging to government companies are delivered to buyers according to ordinary agreements, but not yet being transferred in a final manner, and this situation is approvable by demonstrative documents and records, such properties shall not be deemed to be leaseholds as long as they are in possession of the buyers. In these cases the buyer shall be treated, for the purpose of taxation, as the owner of the property".

Ordinary agreement is an agreement that is privately concluded between the parties without being registered by a notary public. The expression "not yet being transferred in a final manner" is also referring to the same thing. It means that the transaction is not yet registered in the books of a notary public. Under the Iranian law, transactions on immovable properties are to be effected through notaries public, if they are to be accepted as conclusive and effective.

The government companies may embark on projects for construction of houses and selling them to their employees or to other applicants. The conditions of purchase and delivery are usually determined under an ordinary agreement. After the houses or apartments are completed, they are delivered to buyers, without yet a final agreement is officially concluded between the parties and registered by a notary public.

During this period and until the final and official agreement on transfer of the property is concluded and registered by the notary public, there may arise a situation where the tax officials would consider the property as not being owned by the buyer. Then the buyer would be, most probably, considered as the tenant, and a tax on the assumed rental income would be claimed. To avoid this unwanted situation, the rule of the Note 10, as described above, has been enacted.

(iv) Before examining the second category of special cases (those not considered as leasehold), we have to refer to an exceptional case, where the tenancy relationship does exist, but the rules pertaining to taxation of rental income may not apply. This specific case is envisaged under the last sentence of the Article 53, DTA, which reads as follows:

“The rule of the present Article shall not govern in respect of the employer-provided houses belonging to juridical persons, provided that their taxes are assessed on basis of statutory books of accounts”

So, the corporations that lease their houses to their employees and receive rental from them, such rental income shall not be subject to the provisions of the chapter under consideration, and it will be treated like any other item of normal income of the company when assessing its annual taxable income.

B. The following are cases where it is assumed (according to the law) that no tenancy relation subject to rental tax does exist:  

(I) and (II) Two special cases of this type are envisaged under the Note 8 of the Article 53, DTA, which states:

"If the owner sells his dwelling place, and a respite is granted to him, under the relevant transfer deed, for evacuation of the same without payment of rental, then the property shall not be deemed as a leasehold up to six months, if it is occupied by the ex-owner during such period of respite. The same rule is applicable in case of optional sale as long as the sold property remains at the disposal of the seller, unless it is proved, on account of some documents and instruments, that a rental is being paid".

The situation described by the first sentence of the Note 8 is a common scenario under the current conditions. It usually takes a considerable time to find a new dwelling. Therefore, in most cases a respite of few months is granted to the ex-owner, during which he is allowed to continue living in his previous property. But in this case the tax department may consider him as a tenant, since the property does not belong to him any more. To escape such possibility, the law has clearly ruled that during the period of respite the property shall not be considered as leasehold, and as a result no rental income tax will be claimed. It is stipulated however, that the relevant respite and non-payment of rental should have been envisaged under the transfer deed. The maximum period of application of the said rule is six months.

The second sentence of the Note 8 pertains to the contract of optional sale. This contract is defined in the Iranian Civil Code (Article 458). According to that Article, in a contract of sale the parties may make a condition that if the seller gives the price back to the purchaser, within a specified period, he may exercise an option of cancellation of the transaction. A sale transaction with such condition is called "optional sale".

The optional sale in most cases provides a legal structure for hiding the actual relationship between the parties, which is a usurious dealing in essence. The mechanism employed is as follows: ‘A’ transfers his house to ‘B’ according to an optional sale contract with the condition that if ‘A’ would give the price of the transaction back to ‘B’ within a period of time (in most cases one year), then the sale contract would be cancelled and the sold  property would be given back to ‘A’. During the same period ‘A’ retains the possession of the property and pays certain monthly amounts to ‘B’. The amounts so paid are alleged to be rental payments, but in reality they are interests paid on the borrowed money, namely the same amount as was firstly paid to the seller as the price of the property.

By viewing the text of the Note 8 of the Article 53 of DTA under the light of the above explanations, one may conclude that the Note 8 overlooks the reality of the actual relationship of the parties and considers the monthly amounts so paid as rental.

Further cases of this type (where it is assumed, according to the law, that no tenancy relation does exist, and thus no rental tax may be charged, will be considered In the next issue of the journal, then other topics related to real estate income tax ( taxable income, cases of exemption, etc.) will be examined. 

 

 

 

 

Tax News

 

Repair of Equipment and Machinery

Out of the Country

 

A drilling company sends some of its machinery and equipment to a foreign country for being repaired by another company domiciled abroad. A question arises in connection with the income of the foreign repairing company derived from Iran, as to whether it is subject to taxation in this country.

The office of the Undersecretary for Tax Revenues refers the question to the Supreme Tax Council (STC) for reviewing. The STC examines the case in it is Plenary Board and renders the following opinion:

"The receipts of foreign companies and entities from Iranian sources for repair of machinery and equipment are not examples of cases referred to in paragraph (a) of the Article 107 of the Direct Tax Act, and thus, not subject to income tax in Iran".

The Article 107 of the Direct Taxes Act (DTA) is one of the most significant provisions of DTA, as far as the income tax of foreign enterprises is concerned. The paragraph (a) of the Article enumerates several business activities that are performed by foreigners directly, and the paragraph (b) concerns the operations performed by agencies and other representatives of foreign entities.

 

Reconstructed Plant and Tax Exemption

 

Law. Chapter 1 of the title D of the Direct Taxes Act (Articles 132 to 146) covers most of the exemptions provided under the Iranian tax law. Article 132 (first article of the said chapter) envisages a tax holiday for the enterprises engaged in production and mining activities. The tax exemption applies from the date, at which the relevant enterprise begins the stage of exploitation or extraction. But the rule of Article 132 is applicable only to the enterprises for whom the exploitation license is issued by competent authorities as from the approval date of the said law, namely February 1988. Other companies, for whom the licenses were issued before that date, are not entitled to the above exemption (which has been provided as an incentive to new producing and mining entities). They may continue to enjoy the abatements granted to them under the previous regulations.

Facts. Kermanshah Daneh Company (KDC) was established in the year 1979 and enjoyed relevant tax exemption granted under the tax law effective in that time. In September 1987 the plant and building of the company were destroyed under the air raid of Iraqi aircraft.

The company's plant was reconstructed in recent years by using financial aids received from the government. Now that the factory is rebuilt, the company is after a new exemption to be granted under the new text of the Article 132, DTA. The company argues that its plant is a new enterprise constructed after the approval of the Direct Tax Act, and thus is entitled to the tax holiday provided by the Article 132.

The relevant tax authorities did not accept the claim of the company and the case was finally refereed to the Supreme Tax Council (STC) for consideration. The STC reviewed the question in its Plenary Board, which was not able to reach consensus. The Majority (all members except one) decided that the taxpayer was not entitled to the new exemption of the Article 132, since it had enjoyed the tax exemption granted to it under the previous law in a complete manner. Demolition of the company's factory and reconstruction of it could not - according to STC - provide any rational ground in favor of the claim put forward by KDC.

The Minority (one member only) was of the opinion that the exemption of the Article 132 was accordable to the taxpayer. This opinion was based on the following arguments:

1. The KDC's factory was completely destroyed in the course of air raids of Iraqi airplanes;

2. A wholly new plant was constructed afterwards, which differed in many respects from the destroyed one; and

3. A new exploitation license was also issued for new factory.

Based on the above reasoning, the Minority considered the claim of the taxpayer as relating to a new enterprise and a different situation that can not be attributed to the ruling of the previous law, and therefore the case should be viewed under the light of the Article 132 of the current law.

 

State-owned Companies and Stamp Duty

 

The Iranian Power Development Organization (IPDO), a public institution, raised a question with regard to taxation of one of its affiliated companies. The case was pertaining to the Note of the Article 48 of the Direct Taxes Act (DTA), which provides:

"The stamp duty on the shares of companies, whose capital is entirely owned by the government, shall not exceed the amount of 2,000,000 Iranian Rials, and the balance of the applicable duty shall be exempted".

Since the Capital of IPDO's affiliated company did not belong to the government directly; it was disputed that the company could not enjoy the abatement of the Note 3, Article 48 in question. The reason, according to the respective tax office, was that the phrase "Whose capital is entirely owned by the government" has been formulated in such a way that the ownership of the government must be direct, without any intermediate entity being present. This argument was disputed by the IPDO and the case was finally referred to the Supreme Tax Council (STC), which examined it in its Plenary Board and decided in favor of the taxpayer. The Board argued that the Note 3, Article 48, DTA has referred to one condition only, which is the ownership of entire capital of the company by the government, and no other conditions are stipulated and no qualification is given with regard to the manner of ownership. Therefore, no significance can be attached to the directness or indirectness of the ownership, and thus the company in question is entitled to the exemption provided under the said Note 3 of the Article 48, DTA.

 

Fines Related to Indirect Taxes

 

The tax administration ruled in a circular letter that fines accrued in case of indirect taxes may not be spared. The only provisions related to sparing of tax fines are provided under the Article 191 of the Direct Taxes Act, which states:

"The fines provided under the present Act may be spared, totally or partially, when requested by the taxpayer and agreed upon by the Ministry of Economic Affairs and Finance".

As it can be understood from the above text, the rule of the Article 191 pertains to the fines envisaged in a law, which exclusively deals with direct taxes, and since no other regulations have been enacted to provide for sparing of fines related to indirect taxes, the above ruling of the tax administration has been adopted.

 

Opinion of the Supreme Tax Council

 

The Supreme Tax Council (STC) is the highest administrative forum within the tax organization of the country. The tasks and powers of STC are included in the Article 255 of the Direct Taxes Act (DTA). One of these tasks, which is stated in the paragraph (c) of the said Article, is the following:

"Reflecting on subjects and issues, which the Minister of Economic Affairs and Finance may refer to the Supreme Tax Council for consultation and seeking opinion".

The Article 258, DTA states that in the above cases the STC shall review the subject in its Plenary Board composed of the President and heads of branches of the Council. If the opinion of the Board is given by the majority of two thirds of its members, it shall be conclusive and must be followed in similar cases by all tax officials and fora.

In practice, the tax officials confronting difficulty in understanding and interpretation of tax regulations, which may not be solved within the relevant hierarchy, appeal to the office of the Undersecretary for Tax Revenues, and through him the case is referred to the STC for consideration.

In spite of the fact that the opinion of the STC (which is given by the Plenary Board in a conclusive manner) must be taken into account by all tax authorities and forums, it happens occasionally that some tax assessment officials disregard it in one or another way.

That is why the tax administration issued recently a circular, in which reference is made to the legal requirements explained above with regard to the observance of the STC's opinion. The circular refers also to the competence of STC members as most experienced officials in the field of tax laws and regulations, and having the highest level of expertise in this regard.

The circular warns, accordingly, those tax officials who ignore the opinion of the STC, and states that such ignorance would entail administrative and legal punishment as envisaged under the law.

 

 

Abstract of Persian Articles

 

Editorial

 

The effects that the behavior of tax officials may have on taxpayers and overall performance of the tax machinery, and measures that have been recently adopted by the tax administration to improve its relationship with taxpayers are examined  in this issue’s editorial, both in Persian and English sections.      

 

LACK OF ADJUSTMENT MECHANISM IN THE TAX LAW

 

Many cases of tax exemption, income brackets, etc. that are envisaged under the tax law contain certain figures in Iranian Rial. Such monetary amounts gradually loose their real value as the inflationary trend goes on. This phenomenon is examined by the author and adoption of an appropriate mechanism for adjustment of relevant figures and amounts is recommended. 

 

Financial Crisis  AND Taxation

 

The first part of this article was printed in the previous issue of Maliyat journal, and now the second (and last) part of the same is provided in the present issue. The article was originally written by Professor Richard Krever and published in the Asia-Pacific Tax Bulletin of IBFD (Volume 4, No. 12). From the same a Persian translation has been provided by this publication.

 

Agencies of Foreign Enterprises in Iran

 

This is the second part of a survey regarding the activities of International and multinational companies in Iran and the tax-avoidance tricks adopted by them and their agencies.

 

Inheritance and gift tax treaties

 

This journal has begun a study in the field of inheritance and gift tax treaties that is a wholly new idea in this country. The model inheritance and gift tax convention of OECD is analyzed in the light of relevant Iranian tax and civil law provisions. The present  issue of the journal provides the third part of this series of articles.

 

Contradiction of Tax Treaties with the Treaty of European Union

 

In some issues of the journal we introduce one or more tax cases dealt with by international tax forums. The case selected for this issue is the verdict of the European Court of Justice delivered on the famous case of Mr. and Mrs. Gilly. Different aspects of the case are analyzed for the Iranian readership.

 

Rulings and Regulations

 

The text of new tax laws and regulations, circular letters of the tax administration, rulings of the Supreme Tax Council and verdicts of the Administrative Court of Justice are presented in the Persian section of the journal. Some of these rulings and regulations are also provided in the English section under the heading "Tax news".

 

Tax Glossary

 

Several tax terms and expressions are presented and defined in each issue of Maliyat journal.