Double Taxation Agreements

Profits earned in a high tax country can sometimes be extracted to tax havens as interest, royalties or management charges. In all these cases the country of source is likely to have rules limiting the effectiveness of the technique. The object here is to arrange for payments to be made which are an allowable deduction against taxable profits in the country of origin, thus reducing the taxable profits there. There may be withholding taxes in the country of origin, and taxes in the country of receipt. Provided that these total less than the tax that would have been levied on the profits against which the payments are charged, there is a net advantage.

Double Taxation Agreements ("DTA") affect the ways in which dividends, interest and royalties extracted from third countries are taxed. For example, if a British company pays dividends to American or Swiss shareholders, withholding tax is limited to 15 per cent. If dividends are paid to a shareholder resident in a country which imposes no tax and is not a party to any double taxation agreement, withholding tax will be at the full standard rate. If a US company pays dividends to a UK shareholder, withholding tax is limited to 15 per cent and there is no withholding tax on interest and royalties.

Payments to a tax haven country suffer 30% in the above cases. Thus an important group of tax haven operations rests on the proper exploitation of double taxation agreements, and more sophisticated operations involve countries which levy some tax but which are parties to double taxation agreements.

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