THis is the third part of the IETL Summary notes I used for the preparation to the exam (Score 9.0). It contains all relevant case laws, references to the OECD Commentaries and examples. Please also see Parts 1, 2 and 4! :)
Lecture 8 – Exit Tax
Policy behind exit taxes
- Two main objectives:
o Fiscal territoriality – protecting the integrity of the tax base of the departure
state in line with the principle with economic allegiance
§ Tax of last chance
• Two major variables:
o Comprehensive tax liability – based on residence
§ Change in residence – shift in taxing powers of
state of departure; State will lose the
connecting element (residence) upon which it
connects the unlimited / worldwide tax liability
o Capital gains taxation
§ Accrual (increases in value are taxed as they
occur) vs. realization (value increase is only
taxed when it realizes) taxation
§ Most states only taxation of unrealized CG
o Prevention of tax avoidance
§ Tax motivated transfer of assets and residence
§ Move to a receiving state that provides a ‘step-up-system’
• Step-up system
• Take value of the shareholding at the same moment as
establishing the residence there as a starting point à state of
destination does not see a capital gain à if you know dispose
the asset at the same moment there will be no CG tax
• Taxing right goes to the State where actual value was created
f.i.: T0 (R1) – shareholding = 50; T1 (R2- step up) – shareholding
= 100 -> disposal at T1 – no capital gain àtaxpayer resident of
state R1 and is a resident within a particular company à
shareholding that he has in the company is worth 50 (T0), but
while time passes the value of the shareholding doubled to 100
(T1) there is no realization is just value that accrues due to the
shareholding à if taxpayer decides at T1 to move from R1 to R2
and become resident in R2 which provides a step up system: R2
will take value of the shareholding at the moment of
establishment of residence there as a starting point à R2 will
not see a capital gain but does not see that it was 50 before
! para. 56 of Art. 1 OECD MTC & heading of the improper use
of the convention: para. 69 possibility of the departure state
to apply exit tax
- Exit tax is the charge imposed upon transfer of residence / assets
o Triggered by persons change of residence of transfer of asset outside the
jurisdiction of a particular departure state
o Reason: Taxing gains that have accrued within their jurisdiction
o Or taxing the value that has been generated in their jurisdiction
- Art. 13 (5) OECD MTC
, o Realized capital gains are taxed in the hands of the alienator (= the person
holding the assets to which the gains pertain) in the state of residence of that
person
o In absence of an exit tax: state of departure would not be able to exercise
taxing rights over such value generated within its territory; taxpayer can take
assets to country in which he has the most benefits of them being taxed
- Preventing systems where transfer of residence has an underlying tax motivation
o Departure state wants to make sure if you have assets whose value increased
while you were resident in that state
o Difficult to distinguish when something has an underlying tax motivation
- Types of exit taxes
o Immediate and trailing taxes
o immediate exit tax:
§ Taxable event: moment you change residence or transfer of assets
§ Tax adm. Will give you assessment à want to know fair market value
of the asset at this point in time and their original value thereof à
want to impose tax on the amount of the unrealized capital gain
§ You are fictitiously regarded to have disposed of the asset and are
taxed on an unrealized capital gain
• Problem with paying tax on unrealized CG: you are paying tax
on a capital gain that only exists on paper
• Liquidity and cashflow problems
§ Choose : paying taxes immediately at time of departure or paying tax
later at time of realization event
o Trailing tax:
§ Taxable event is the same
§ Applying tax later f.i. when gain is actually realized at the moment you
have already established residence at the receiving state
§ EU Law: to be compatible with freedom of establishment: requires
possibility to deferral over more years
o Taxes on unrealized income: pay tax at later point in time for shareholdings
etc.
o Recapture rules: whilst you are a resident of a particular state, that state
grants you certain tax benefits which are only granted because the state
wants to tax the accruing related type of income later; if change of residence
occurs the departure state wants to reclaim the granted benefits (f.i. claiming
benefits of pensions)
OECD MTC
- Immediate Exit tax in domestic law = Treaty override?
- Applicability of a treaty
o Subjective (Resident of departure or of destination state) and objective scope
(Art. 2 – taxes on unrealized capital, commonly accepted to be taxes on
capital)
- Distributive rule
o Immediate exit taxes:
§ No distributive rule that covers exit tax
, §Two potentially relevant provisions:
• Art. 13 (5)
o 13 (5) requires alienation; exit tax does not depend on
an alienation but the trigger point here is the transfer
of residence or asset à does this still fall under the
scope? Depends on the understanding of the concept
of Alienation:
o What is alienation? No definition à Art. 3 (2) domestic
law of state applying the treatyà ordinary meaning: a
transfer of rights à would only cover the transfer of
rights and would lead to a very narrow interpretation
and would narrow the scope of Art. 13 (5) and is against
the purpose of a residual provision that aims at having
a broad scope because these are not covered
elsewhere; under domestic law of some countries some
transfers are only treated as an alienation and would
therefore be given the same consequences of an actual
alienation
o Para.5 of Art. 13: alienation covers, in particular (…) à
illustrative list à is not exhaustive à any other
transaction can also be within this understanding
although not mentioned
o Para. 8, 10 of 13 à examples on increment taxes à
when company has assets whose value increased or
changed so much so the company revaluated it in the
accounts à taxing only the capital appreciation
although this only exists on paper being unrealized
o Immediate exit tax = treaty override?
§ Pro:
• Whenever there is a change of residence the state of
departure relinquishes taxing rights in form of favor of the
receiving state because it loses its taxing right because of the
treaty
§ Con:
• Treaty is not applicable in the first place because there is no
cross border element (dep. State enforces tax liability against
person who is still resident of its state at this point of time)
• Treaty applies but because you have an immediate exit tax that
is applied at the last moment of being a resident of the
departure state Art. 13 (5) allocates taxing rights to the
departure state (resident)
• Domestic Treaty Override = if you amend a domestic tax law
provision and create or trigger the application of a distributive
rule which was not applicable at the time the treaty was
concluded
• OECD BEPS Action 6 para. 66 : confirmed that exit taxes are
not a treaty override; as long as the state of departure only
wants to tax unrealized capital gains that have accrued there it
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