Maliyat Journal (Iranian Tax Review)
No. 30, Winter 2000-2001
English Section
IN THE NAME OF ALLAH
FROM THE PRESIDENT
The increasing expansion and complexity of economic, political, technological and legal relations of today’s world have resulted in proliferation and development of cross-border transactions among different countries and involvement of transnational corporations in the economy and trade of developing countries. These enterprises try to shift the profits of their subsidiaries from one jurisdiction to another by exploiting the differences in tax, customs and currency policies of various countries, in order to minimize their global tax liabilities. The unavoidable result of such a course of action is the deprivation of some nations - especially those of the developing countries - from a considerable part of their revenue. The main device employed by those companies for achieving the above goal is the use of transfer pricing tricks, utilized in transactions among the members of these groups.
Such
transactions and transferring include sales of raw materials, semi-finished and
finished goods, machinery and equipment, intangible assets (like technical
know-how, patents, trade marks, etc.) and different types of technical, legal,
accounting and other services.
The extent of
these intra-group transferring is increasingly rising, so that the aggregate
effect of the tricks referred to above may deprive many countries from a large
share of their tax revenue. Of course the consequences of unsound and
artificial transfer pricing are not confined to taxation domain. The profit
shifting through transfer pricing manipulation is also detrimental to a
country’s economic development and interests the consequences of this process
may hamper and harm the business competition as well. The false pricing methods
can increase the profits of a group and place them in an advantageous position
in comparison with their competitors.
A number of
developing countries have not yet approached the issue seriously. This may be
the result of either the unawareness of the true nature of the multinationals’
measures and maneuvers, or due to fear of discouraging foreign investment. Lack
of adequate administrative infrastructure has also some bearing on reluctance
of such countries to confront the matter seriously.
The situation,
however, is wholly different in most jurisdictions, including a considerable
number of developing countries. Tax authorities have, in general, become much
more aggressive in the transfer-pricing arena, and special regulations are
adopted in the tax code or other laws of the majority of nations in this
regard. Comments and rulings are also systematically issued to supplement the
law. The verdicts rendered by administrative and judicial appeal for a have
also certain impacts on development of law in respect of transfer pricing
issues.
Studies,
analyses, initiatives and reactions in this field have led to a situation where
not only the governments and tax authorities, but also the academic and
research institutions have become interested in the subject of transfer
pricing. A considerable number of courses, seminars, etc. are set up each year
to provide education and training with regard to this issue, and many books,
brochures and periodicals about this subject around the world.
A keen interest
in the topic has been taken by certain international organizations such as the
Organization for Economic Co-operation and Development (OECD) sand the United
Nations Conference on Trade and Development (UNKTAD). These organizations, as
well as the famous accounting and auditing institutes allocate substantial
resources to studies in this respect, the outcome of which is presented to the
world as reports, books, etc.
In 1997, the
UNCTAD organized an intergovernmental working group of experts for studying the
subject of transfer pricing. In the final report of the group we find the
following statement:
“Developing
countries and countries in transition are increasingly at risk until they adopt
regulations which insure the equitable pricing of transferred goods and
services. The economic consequences, most notably loss of tax revenue, of
profit-shifting via transfer pricing manipulations are detrimental to a
country’s continuing development”.
Under these
conditions, which is properly described by the UN economic affiliate, and where
the problem of transfer pricing has become the issue of majority of states, the
excuses such as the attraction of foreign investment can not hinder the
effective and serious measures of governments for challenging the tax-avoidance
tricks referred to above.
The Maliyat journal considers itself bound by the duty to study and analyze the subject of transfer pricing and ways and means for eliminating the harmful effects of this process for the economy of the country. We have done so in the past, and will do our best in the future with the aim of familiarizing our readership with this issue of global significance.
Dr. Aliakbar
Arabmazar
An Introduction to the
Iranian Tax System
(Part 9)
In previous issues we studied
the tax on properties first, then touched upon the income taxation, by
examining the tax on real estate income. In this connection, the rental income
taxation and the tax on transfer of real properties and good will were reviewed
and it was stated that this latter kind of income tax is usually determined on
basis of what is termed the “transactional value”. Now the concept of
transactional value and the manner of its determination will be considered.
As it was pointed out earlier, the term “transactional value” in
the context of the Iranian tax law means in effect the “taxable value” and has
nothing to do with the actual prices of the relevant transactions. The factors
and elements that must be taken into consideration for determining the taxable
(transactional) values are as follows:
1. As regards the
goodwill, the type of business carried out in the relevant property and other
factors effective on the value thereof (Note 1 to the Article 79, DTA);
2. In respect of urban
lands, the specifications and particulars stated below:
- geographical position
(landscape, type of soil, underground facilities, climate and altitude of the
area),
- legal conditions
(whether the property concerned has a single owner or is owned jointly by two
or more persons, the ownership is based on an official title deed or not, the
ownership thereof is based on an official deed or not, the property is leased
out or there are no tenants, etc.),
- urban services
(water, electricity, telephone, gas, hygienic and sanitary conditions,
education, urban transportation and similar facilities),
- surface extent, and
density of population and buildings,
the type of application
of the land,
- accessibility of
verdant area and shopping centers, and
the type of roads in
terms of transportation and traffic (paragraph (a) of the Article 64, DTA);
3. In case of
agricultural and rural lands, the taxable (transactional) value is determined
by due regard not only to the considerations stated in the paragraph 2 above,
but also to the following particulars:
- distance of the
property to the town,
- type of the produce
and its price,
- quality of the soil,
- quantity of available
water,
capability for
mechanical cultivation,
- natural conditions of
the land,
existence of roads,
their type and distance to the main road, and
whether the land,
building or trees of a garden belong to different persons or not (paragraph (b)
of the Article 64, DTA); and
4. The taxable value of
buildings is determined by due regard to:
- the type of materials
used (steel, or reinforced concrete structure, steel beam roof, etc.),
the age and density of
buildings,
- the purposes for
which they are allocated (residence, business, - professions, etc.), and
the kind of ownership
of the land of the building and superstructure over it.
A body called The Real
Estates Valuation Committee (REVC) consisting of 6 members is in charge of
determining the taxable value of real properties. It comprises the
representatives of The Finance Ministry and some other ministries and
organizations referred to under the Article 64 of The Direct Taxes Act (DTA).
Some local credible experts are also introduced by the councils of cities and
towns to take part in the committee.
The taxable values
appraised by the REVC remain valid until new values are determined. In cases
where no taxable (transactional) value is determined for a property, the
taxable value of the nearest similar location shall apply (Article 61, DTA).
The transactional
values so determined, are usually published by the General Directorate of Tax
Information and Services (Ministry of Finance), and those interested can refer
to it for more information.
Some individuals and
corporations engage in the business of erection and sale of buildings. As far
as the taxation is concerned, this is a twofold or two-sided activity. In first
place, it involves the transfer of real properties and thus is subject to the
tax of transfer of real property as described above. Besides that, those
engaged in such activity carry out a business and have to pay the tax on their
profits. So, they become subject to the provisions of the Chapter IV, Title C,
regarding the tax on business income, if they are individuals, and subject to
corporate tax (Chapter V, Title C) in case they are companies. The regulations
concerning business and corporate income tax will be studied later, Few words,
however, must be stated about the relationship of these two types of taxes at
this stage. A property constructed by the persons in question comprises land
and building. The taxable value is usually calculated for the land as well as
for the building separately. The business of erection and sale concerns, in
principle, the building and, therefore, the transfer tax related to the
building is in essence a tax on the business of the seller. So, when
calculating such persons’ business tax (under the provisions of the relevant
chapter of the law), the transfer tax paid in respect of the building must be
subtracted from the business tax of the same persons.
If no taxes are
applicable in the case of erection and sale business, or if the applicable tax
is below the transfer tax pertaining to the building, then the payment of the
transfer tax will suffice (Article 77, DTA).
The Note of the Article
77 envisages a special case, where an individual whose ordinary business is not
the construction and sale of real properties, sells during a single tax year,
more than one residential unit or two business units that are built by himself.
Such person shall be considered, for tax purposes, as being engaged in the
erection and sale business.
Where a taxpayer transfers
several properties during a single year, he shall be liable to taxation with
respect to the aggregate of such transactions at the rates set forth in the
Article 59, DTA (as mentioned earlier).
These taxpayers are
required to draw up, with regard to the aggregate of their annual transactions,
a tax return and file the same with the relevant tax office not later than the
end of the month Ordibehesht (21st May) of the next year. The
balance of the tax arising from the total transaction should also be paid at
the same time.
In all other cases, the
relevant taxpayers are required to file their tax returns and to pay the
applicable taxes according to the procedure, and within the time limits,
provided under the Article 80, DTA.
Our study with regard
to the tax on real estate income (Chapter I, Title C) comes to an end at this
point. The tax on income from agriculture and the tax on salary income will be
examined in coming issues.
The Supreme Tax Council (STC) is
the highest forum inside the tax organization for reviewing final decisions of
administrative appeal for a, in cases where the complaints submitted are based
on, and related to the questions of law. The verdicts of the STC, when rendered
by the Plenary Board, may not be cancelled or changed, unless by legislation or
by a new verdict of the same Board.
In this issue we
review an award of the Plenary of the STC regarding the taxation of the
representative offices of foreign banks.
As it is understood from the
introduction of the award, the representative offices in question are licensed
by the Iranian Central Bank and can not engage in banking business (borrowing
and lending money, opening bank accounts, etc.).
It has also been
stated in the same part of the award, that there exist two different opinions
in this regard.
Some officials are
of the opinion that the said representative offices are not subject to
taxation, since they engage in no banking activities, as stated above.
According to the second view, however, such offices are to be taxed, because
the relevant foreign banks earn income via their activities.
The award of the
SCT’s Plenary Board reads as follows:
“The foreign banks
are clear examples of foreign juridical persons. Therefore, if it is
ascertained, on basis of evidence and documents, that they have earned income
in Iran by setting up representative offices, they shall certainly become
subject to taxation in respect of such income”.
In rendering the
above opinion, the SCT relied on the following grounds and arguments:
1. Under the paragraph (c) of the Article1 of the Direct Taxes Act
(DTA), non-Iranian persons (whether real or juridical) are subject to taxation
with regard to their income derived in Iran, as well as in respect of their
income from Iranian sources “for the granting of licenses and other rights, or
for the provision of training and technical assistance, and also for the
transfer of cinematographic films”.
According to the
SCT, the said paragraph provides a common and general rule with regard to
taxability of the income of non-Iranian persons derived in Iran, and also in
respect of certain kinds of income earned from Iranian sources. This argument
means that the taxability of these types of income of foreign persons and
enterprises is a common (and not restricted) rule, and thus is extendable to
foreign banks as well.
The paragraph (c)
of the Article 105, DTA states
that the foreign juridical persons and entities residing abroad are taxable in
respect of their “aggregate taxable income derived from the operation of their
investment in Iran or from the activities performed by them, directly or
through the agencies like branches, representatives, agents and the like, in
Iran, and also with regard to their income from Iran for granting of licenses
and other rights, or for provision of training and technical assistance”. The
said paragraph determines then the tax rates applicable to the income of such
entities.
By referring to
the above paragraph, the SCT aims again at presenting legal reasoning in
connection with the taxability of income of foreign enterprises derived in
Iran, and also from Iran in certain cases.
Paragraph (a) and (b) of the Article 107, DTA provide for the
manner of assessment of the taxable income of the same taxpayers (foreign
juridical persons and enterprises residing abroad), respectively for the income
earned “from” Iran and the income derived “in Iran”.
These paragraphs
too evidence, according to the STC, the liability of foreign entities to
Iranian taxation, in cases where certain incomes are attributable to them.
Comment
“In
Iran” and “From Iran”
Some points are worth noting in this regard:
To make the income of an enterprise residing in a country subject
to taxation of another country, from which the income is derived, is contrary
to recognized principles and, therefore must be restricted to exceptional and
clearly defined cases. According to common practice, trading “with” a country
should not be taxed in that country, otherwise, the aggregate between nations
will become subject to taxation, a result which would harm the international
commerce and development. Based on these considerations, the Iranian tax law
has viewed the taxation of foreign entities derived from Iran as an exception
treatment and therefore enumerated such cases one by one. They include the
income derived for the granting of licenses and similar rights, provision of
training any technical assistance, and transfer of cinematographic films. This
enumeration is given in all provisions relied upon by the SCT, as referred to
above.
The cases related to the income derived “from Iran”, however, are
not pertaining to the subject under our review, namely the status of
representative offices of foreign banks, So, we have to focus on the income
derived “in Iran”, in case of which reference has also been made (in both
articles 105 and 107, DTA) to the activity of the “representative” as well.
1.
Representative
office of foreign banks
Now let us see what
in fact constitutes a representative office of foreign banks, and to what
extent the attribution of income to such offices is accurate and measurable.
The following definition (or description) is given in this regard by an author:
“A representative
office located abroad is a foreign office of a bank employing one or more
persons. A representative office does not lend or borrow funds independently,
for its “own account”. The representative office serves as a contact point for
the non-resident bank it represents, it gathers information for the head office
and other offices and sometimes brings in new clients. A representative office
may, moreover, maintain contacts with correspondent banks in the host country
or in countries surrounding that country.
In view of the
fact that the representative office dos not engage in the activities reserved
for credit institutions, the presence of such an office in no way affects the
existing (friendly) relations with the local banks. The representative office
may also serve to explore the local market of the host country.
A disadvantage of
the representative office is that it is prohibited from active banking
activities in the host county. Also, any market research carried out by a
representative office generally will not have the scope or depth of a study
performed by a larger branch with more personnel and a deeper affinity with the
local market because of its effective participation therein”.
As to the
activities of a creature like the one described above, it might become quite
difficult to attribute a clear and definite income, unless the representative
office goes beyond its legal status and involves in operations more susceptible
of earning some discernible and measurable income. Probably the SCT had the
same consideration in view, when used a conditional tone in its award and
stated:
“… if it is
ascertained, on basis of evidence and documents, that they [foreign banks] have
earned income by setting up representative offices, they shall certainly become
subject to taxation in respect of such income”.
Tax
treaties
The point the SCT remained
silent about was the ruling of the Iranian double taxation treaties with regard
to the issue of representative offices’ taxation. Aconsiderable number of tax
treaties are concluded, especially in recent years, between Iran and other
countries. As far as the international tax relations of the country are
concerned, the provisions of these agreements are to be taken into account in
the first place. In other words, in case of contradiction between the tax
agreements and domestic law, the proiority should be given to tax treaties
(which at the same time have become a part of the national law, after being
approved by the parliament). So, we will also touch upon these treaties,
without dealing with which our study will remain incomplete.
Iranian double taxation
treaties are, like those of many other states, drawn on basis of the OECD Model
Convention. The issue under our consideration is dealt with in that part of tax
treaties, which pertains to the concept of permanent establishment. The article
7 of the OECD Model Convention, as well as that of the Iranian tax treaties,
present a basic rule in this respect. As an example we quote this principle
from the text of the Iran-France tax treaty:
“The profits of an enterprise
of a Contracting State shall only be taxable in that State unless the
enterprise carries on business in the other Contracting State through a
permanent establishment situated therein. If the enterprise carries on business
as aforesaid, the profits of the enterprise may be taxed in the other State but
only so much of them as is attributable to that permanent establishment”.
The first question coming to
mind is whether the representative office of foreign banks is a permanent establishment
or not. At first glance, the answer might seem to be positive, since not only
the text of the Article 7 can be construed in this way, but also the paragraph
2 of the Article 5 states that the term permanent establishment shall include
certain places, one of them being “an office”.
Meanwhile, according to the
definition given under the paragraph 1 of the Article 5, the basic
characteristics of the permanent establishment are as follows:
-
the existence of a place of business, such as premises, etc;
-
this place must be established (fixed) at a distinct place with a
certain degree of permanence; and
-
the carrying out of the business of the enterprise through this
fixed place of business.
At least, the first and second
conditions are true in respect of the representative office of foreign banks.
In spite of that, we have to
take into account the content of the paragraph 3 of the same article as well.
This paragraph lists a number of business activities which are treated as
exceptions to the general definition laid down in paragraph 1 and which are not
permanent establishments, even if the activity is carried on through a fixed
place of business. The subparagraph “d” of that paragraph includes the fixed
places of business maintained solely for collecting information for the
principal enterprise. One of the main tasks of representative offices is also
the collection of information for their principals, namely the relevant foreign
banks.
Another exception is referred
to under the sub-paragraph “e” of the said paragraph, which provides that a
fixed place of business, through which the enterprise exercises solely an
activity which has for the enterprise a “preparatory or auxiliary character” is
deemed not to be a permanent establishment. Such a place of business may
somehow contribute to the productivity of the principal enterprise, but the
services it performs are so remote from the actual realization of profits that
it is difficult, and in some degrees illogical, to allocate any profit to the
fixed place of business in question.
The activities of
representative offices of foreign banks were described earlier. Majority of
these activities have preparatory and auxiliary character in relation to the
business of the foreign banks situated abroad.
That being the case, one can
conclude that such representative offices may not be considered permanent
establishments, under the provisions of double taxation treaties.
However, the above conclusion
is conditioned on the assumption that the representative offices in question
would not overstep the bounds determined for them by the law, contract, or by
the very nature of their profession. Neglecting this requirement and engaging
in other profit-producing activities would in evitably entail tax liability for
them.
Case law
With regard to the preparatory
and auxiliary nature of activities of representative offices, the view of the
Swiss Supreme Court rendered on September 17, 1976 is of special interest. The
following text with respect to the said opinion is quoter from a book
concerning the international tax law of Switzerland:
“… the Swiss Supreme Court had
the occasion to confirm the application of Article 5, paragraph 3 (e) of the
Switzerland-Spain tax treaty. A Spanish bank had set up a representation office
in Geneva. Its mission was to explain to banks and Swiss businesses the
services that the Spanish bank can render, to establish contacts with Swiss
businessmen in view of Spanish business, and to provide the Spanish head office
with information concerning the Swiss economy. The representation office had
not negotiated or signed any contracts on behalf of the Spanish bank. The
question had been raised as to whether the Geneva operations constituted a
permanent establishment. The Swiss Supreme Court concluded that the mere fact
of having an office in Switzerland was not sufficient to constitute a permanent
establishment. It was moreover necessary to analyze the activity in
Switzerland. Based on the above mentioned facts, the Swiss Supreme Court
concluded that the bank did not conduct any of its banking business through the
Swiss office and that the activities of the Swiss office could only be
characterized as being of a preparatory or auxiliary nature. It was therefore
not considered as a permanent establishment.
Conclusion
Under the provisions of double
taxation treaties, the representative offices of foreign banks may not be
considered as permanent establishments, and thus, are not subject to taxation
in host countries. No contradiction seems to exist in this regard under the
provisions of Articles 105 and 107 of the Direct Taxes Act.
However, the conduct of
representative office is important in this connection. If they involve in
operations beyond the limitations described above, then they may become subject
to taxation in accordance with legal provisions.
Abstracts of Persian Articles
Editorial
The transfer pricing tricks of multinational and international
groups and the negative effects of this process on tax revenue of developing
countries is addressed in the editorial of this issue of Maliyat journal.
Tax Capitulation!
Tax officials in all countries are obligated to discharge their
duties with regard to all taxpayers in equal manner and without
discrimination. This obvious and
natural principle is sometimes challenged by certain people and agencies in a
special way. They argue that the
foreign persons and enterprises engaged in economic activities inside the
country should be treated differently in comparison with the citizens, and in
particular they should be trusted much more, as far as their tax statements and
declarations are concerned. The
reason, according to advocates of this thesis, is the need of the country for
attraction of foreign investment and technology. This subject is analyzed and criticized by the author.
Pursuing Greater Compliance and Less Burden
This is a Persian translation of an article written by Dr. Marsha
Blumenthal concerning the compliance burden in the United States (printed in
the IBFD Bulletin, volume 54, No. 7). Since the article is relatively long, it
will be introduced in two parts,
respectively in the present and next issue.
Iranian International Tax Regulations
The author comments on a verdict delivered by the Supreme Tax
Council (STC) on exemption of foreign embassies and consulates acting in Iran
form certain indirect taxes levied as a percentage of the price of
communication services. The STC based its opinion on Vienna Conventions of 1961
and 1963 (regarding the diplomatic and consular relations). This opinion is
examined by the author. A similar article is presented in the English section
of the journal.
Court of Administrative Justice and Supreme Tax Council
The author maintains that the Court of Administrative
Justice (CAJ) is not competent for
annulling the verdicts of the Plenary Session of the Supreme Tax Council (STC).
A recent judgement of the CAJ, by which a verdict of the said Plenary Session
has been annulled, is criticized in this article not only for that reason, but
also for the defects of legal argument as described by the author.
Inheritance and Gift Tax Treaties
The 7th part of this series of articles is provided in the
present issue. The regulations of the OECD Model regarding non-discrimination
(Article 10) and a part of the Article 11 concerning the mutual agreement
procedure are examined.
Transfer Pricing
This is also a continuation of the study undertaken in the field
of transfer pricing. The sixth part of the study concerning “Fourth Methods”
(like CUP, profit-split method, rate of return method, etc.) is provided in
this issue.
Tax Penalties around the World
A new study is undertaken by this journal in respect of penalties
applicable to tax offences in different countries. In this issue the
regulations of France concerning administrative and criminal tax offences and
penalties are reviewed.
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.
The End