Changing rules for applying foreign tax credits

12
Jul 2017 at 04:00 / NEWSPAPER SECTION: BUSINESS

>Changing rules
for applying foreign tax credits

One
of the original principles outlined in the OECD Model Tax Convention is that no
taxpayer should be taxed repeatedly on the same amount of income earned from a
cross-border transaction. This situation is referred to as "juridical
double taxation" — where income is subject to taxes under the jurisdictions
of more than one state.

Though
an increasing number of states, including Thailand, have recently started to
circumvent tax treaty principles in an attempt to collect more taxes from major
e-commerce operators that earn substantial sums without paying sufficient tax
in the source country, eliminating double taxation continues to be the main
purpose for entering into tax treaties.

Since
the law does not provide individual taxpayers with a method to eliminate
juridical double taxation, the Revenue Department often relies on mechanisms
granted under tax treaties where relevant.

Two
principles apply in dealing with taxation of an individual under Thai law. The
first is the "source rule", whereby income derived from the Thai
source will be taxed regardless of the individual's nationality or
residence(s). The second is the "resident rule", whereby a Thai tax
resident — a person who stays in Thailand for the aggregate period(s) at least
180 days — derives income from a foreign source and brings it back to Thailand
during the same calendar year.

For
example, let's look at the case of an employee of a Thai company who is
assigned to work offshore temporarily by his employer in Thailand. The Revenue
Department considers him subject to Thai tax under the "source rule"
as the Thai employer pays his salary. However, if he is also required to pay
taxes to a foreign government, he may be allowed to use the foreign tax as a
credit against Thai personal income tax by virtue of a tax treaty of one
exists.

In
applying the foreign tax credit (FTC) method, the Revenue Department has never
challenged the eligibility of the taxpayer beyond the basics: the employee must
be a Thai tax resident and the credit amount must not exceed Thai tax imposed
on such income.

The
consequence of applying the FTC to eliminate juridical double taxation is that
one state, in this case Thailand, must surrender its taxing right to the other.
Lately, however, it appears that the Revenue Department has decided to assert
itself in this regard and will not allow some states to take advantage of tax
treaties any more.

In
a recent revenue ruling, a Thai company was hired by a Singaporean customer and
sent its employee to work in Malaysia for one year, during which the employee
had to travel back and forth. As his aggregate stays in Thailand reached 180
days, the employee was considered a Thai tax resident, but it turned out that
he was also treated as a Malaysian tax resident and subject to Malaysian tax.

Salaries
were paid to the employee's bank account in Thailand by the Thai employer,
which withheld tax and filed a return to the Revenue Department. The employee
asked the department if he was entitled to claim the FTC by using the Malaysian
tax paid as a credit against Thai tax pursuant to the Thailand-Malaysia tax
treaty.

According
to tax treaty principles, the country required to grant the FTC must be the
state of residence. Since the employee in this case had double tax residence
status, the Revenue Department applied a "tie-breaker rule" under
Article 4 of the treaty to determine the employee's residency.

The
department held that the employee "must be treated as a resident of the
state in which he had a permanent home". Since his family and the bank
account to which his Thai employer made salary payments were in Thailand,
Thailand was regarded as the "permanent home". The department further
pressed its case by stating: "If the employee had permanent homes
available in both countries, Thailand must be the country where he had closer
personal and economic relations."

The
department did not stop there. For the first time in history, it investigated
the legitimacy of the Malaysian tax to be allowed as a credit by reviewing the
Malaysian government's taxing authority under Article 14 ("Personal
Services") of the treaty. Basically, it states that the Malaysian
government cannot tax the employee if all of the following conditions are
fulfilled:

The
employee stayed in Malaysia for aggregate period(s) not exceeding 183 days
during the relevant calendar year;

The
services were rendered in name of the person in Thailand; and

The
salaries were not borne by the payer's permanent establishment in Malaysia.

Since
the first condition was not fulfilled, the Malaysian tax was deemed to be
legitimate pursuant to Article 14 and could be credited against Thai tax. The
ruling concluded: "Since both Thailand and Malaysia had taxing authorities
on the salaries received by the employee, double taxation took place. Thus,
Thailand, as the country of residency had liability to eliminate such double
taxation by granting the FTC to the employee."

Of
course, the department required that the amount of tax to be
credited must not
exceed Thai tax payable under the Revenue Code.

In
fact, the way it approached the above ruling is something the Revenue
Department should have done many decades ago. From now on, individuals who are
Thai tax residents should not jump to the conclusion they will always be
allowed the FTC without proving the legitimacy of foreign tax first.

By
Rachanee Prasongprasit and Prof Piphob Veraphong. They can be reached at [email protected]