Maliyat Journal (Iranian Tax Review)
No. 31, Spring 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.
] ] ] ] ]
An
Introduction to the
Iranian
Tax System
By:
Dr. Mohammad Tavakkol
(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.
s s s s s
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.
“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.
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. A considerable 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 priority 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 inevitably 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 quoted 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.
J J J J J
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
judgment 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