What Is Double Taxation?
Double taxation is a situation that affects C corporations when business profits are taxed at both the corporate and personal levels. The corporation has to pay income tax at the corporate rate before any profits are to be paid to shareholders. Profits are distributed to shareholders through dividends are subject to income tax again at the individual rate according to tax regime of the country. This way corporate profit are counted as twice income taxes. The outcome of double taxation does not affect S corporations, which can distribute the earnings straight to shareholders without the intermediate step of paying dividends. On the other hand, many other smaller corporations are able to avoid double taxation by distributing earnings to their employee or shareholders as wages.
Critics of double taxation would prefer to integrate the corporate and personal tax systems, it states the taxes should not have an effect on business and investment decisions. It is stresses that double taxation places, corporations are in a disadvantage in contrast with unincorporated businesses, this has an influence in such a way the corporations start using the debt for financing matters instead of equity financing so that the corporations retain their earnings instead of disturbing to its shareholders. (referenceforbusiness.com)
2.1. Exemption system
Under exemption systems, a taxpayer of a country (the residence country), will not be taxed regardless of where the income is generated, on the other hand taxpayers are taxed based on the source of their income (the host country), that is, only the country where the income is generated has taxing authority over the income (Stephens, 1998, p.159).
This is more related with our subject especially regarding the core problem occurred during double taxation agreement between Turkey and Germany.
With exemption system, it encourages the residents’ individuals or companies to venture outside their domestic environment and compete with their foreign competitors. Hence it is frequently used term of capital import neutrality. The exemption system allows business to be carried outside the home country and perform the trade at some other country, thus accelerating the trends towards globalization and increase of global welfare. Exemption system fits more to our today’s world issues of globalization of opening borders and removing barriers for free trade. Basically this is the most important part of the system. Allowing competition and opening new opportunities for the enterprises to sell their goods.
Countries that are purely on exemption system are called as “tax havens". The reason they have this name is because the given country doesn’t require taxation for any foreign source as long as the individuals and corporations make their earnings at their own country. The biggest argument for tax havens is the amount of accounts can be traced, most countries don’t have the access to suspicious accounts and it is the most common way for money laundry. The most known tax havens are Bahamas, Cayman Islands and Cyprus etc… (Stephens, 1998).
2.2. Credit system
The credit system allows tax paid in one state to be used as credit against a taxpayer's liability in another state. The credit will be in the form of a direct credit or indirect credit (August, 2004, p 732)
The general idea behind a tax credit system is to be able allow business to operate the same way as if they operate with the same laws and regulations as their home country. This helps the corporations to operate as smooth as possible with fewer regulations concerning tax laws. If a business ventures abroad, it must pay tax on foreign and domestic business income domestically at the same tax rate and tax basis. Foreign tax paid can be deducted against domestic tax due. This system is also referred as Capital Export Neutral system.
Tax-credit systems have been implemented in the United States, OECD countries, and newly industrialized economies.
3. Double taxation agreement between Turkey and Germany
3.1. Avoiding double taxation
There are several ways for corporations to avoid double taxation. For small corporations, all of the major shareholders are also employees of the firm. These corporations are able to avoid double taxation by distributing earnings and profits to employees as wages and fringe benefits. The income tax should be paid individually by every employee. Companies are usually able to deduct wages and services as expense from the amount of tax they shall pay. This helps corporations to pay less tax on each tax period. For many small businesses, distributions to employee/owners account for all of the corporation’s income, and there is nothing left over that is subject to corporate taxes. In cases where income is left in the business, it is usually retained in order to finance future growth for later investment opportunities.
Larger corporations—which are more likely to have shareholders so they are treated in a different way so in this case they cannot have corporate profits distributed to them in the form of salaries and fringe benefits—are often able to avoid double taxation as well. Of course, the shareholder/consultant must pay taxes on his or her compensation. It is also possible to add shareholders to the payroll as members of the board of directors. Finally, tax-exempt investors such as pension funds and charities are often significant shareholders in large corporations. (referenceforbusiness.com)
3.2. Background of double taxation agreement between Turkey and Germany
Avoidance of double taxation between Turkey and Germany has a long story. It goes back to end of 1960’s. For this purpose between the two countries began talks in 1968. After long negotiations and interviews both parties prepared a draft agreement on 19.10.1968.
This text is signed by two authorized representatives of the Government; the finalized draft is ratified by the parliaments of both countries and after that a long time period had to pass in order to put this agreement into action. Unfortunately from 1968 until 1985 the agreement couldn’t come up to reality. The final agreement was signed in Bonn (Former capital of West Germany) on 16.14.1985. Unfortunately no real explanation was given for the delay to finalize the agreement from any of the parties.
3.3. Legal formality
The agreement between Turkey and Germany is the avoidance of double taxation taxes on income and wealth. This has become the fourth agreement Turkey has ever done with another country. As It is mentioned the final agreement was reached in 1985 but the ratifications took around four years for the parliaments to agree. January 1.st 1990 is the milestone of this agreement where it came to exercise.
As mentioned on the last paragraph of the agreement, the texts were written in Turkish, German and in English languages to avoid misunderstandings by the translation between Turkish and German. If the disagreement cannot be solved than English version shall prevail.
3.4. Taxes covered subject of the agreement
According to OECD model tax treaties the agreement of avoidance of double taxation between Turkey and Germany includes the following taxes.
3.5. Some other topics covered under the tax agreement
Bilateral agreements to prevent double taxation is not only about to prevent double taxation issues. Such as the OECD’s Model, in such agreements, exchange of information, Nondiscrimination, Mutual agreement procedure, administrative support also helps to prevent tax evasion.
When we take a look at the agreement of avoidance of double taxation between Turkey and Germany we can see some parts regarding to tax evasion;
Article: 24- Equal treatment
Article :25- Mutual agreement
Article: 26- Exchange of information
Article: 27- Diplomatic and consular privilege
3.6. Terminologies used in the agreement
To understand what actually the agreement is about and how the subjects are determined we need to follow some terminologies in order to understand where we can put the stones.
The term Person: Means any individual and any corporation. "Company “ refers to all kinds of legal entity for tax purposes as a legal entity or person means any traded.
Legal head: This statement of the Turkish Commercial Law, or Law of the German financial means within the context of legal settlement.
Competent authority: Means the Minister of Finance of Republic of Turkey and the Federal Republic of Germany.
Fiscal domicile: The concept in general, under the laws of the contracting states of one or the other, place of residence (settlement), home, legal center, business center, the tax liability due to any other criterion of a similar nature refers to places that can be established.
Permanent establishment: Some examples of places within the coverage, place of management, branch, office, factory, workshop, mine, oil or natural gas wells in excess of six months as a listed building site, but the remaining places are also out of order.
3.7. Model used for the agreement
Tax treaties, prepared by international organizations according to specific models of prevention of double taxation agreement. The aim of preparing this kind of models, for income and wealth helps the states to come to an agreement by which determines the general rules of taxation.
3.8. Nowadays there are two official models
OECD agreement model: This model is the principle of domicile based. The control of Taxation of a resident taxpayer is owned by the state of the taxpayer.
The taxation authority, receives the taxes from the immovable property of the taxpayer in this state. In summary the OECD model, the actual residence is the primary taxation, and the income coming to that state let’s say from abroad is the secondary taxation.
United Nations Model Convention: The OECD Model Agreement, the agreements signed between developed and developing countries due to insufficient way to protect the interests of developing countries. The United Nations Model Treaty has been developed for the protection purposes. This model, put emphasis on the taxation of natural resources of the country.
3.9. Taxation agreement with the relevant provisions
Since the agreement is very long and explaining each of them will require a lot of explanation and many pages I will try to mention some points of the agreement which are relevant to my topic. Below I will give the name and the articles of some part of the agreement and write them what article includes which element. The parts including the articles about the taxation are found between the articles 6-21.
Article 6: Matter of real estate income.
Article 7: Matter of commercial profits.
Article 8: Navigation, air and land transport.
Articles 9&10: Substance-dependent enterprises dividends matter.
Article 11: Material interest.
Article 12: Article grid operating charges royalties.
Article 13: Material increase in value of capital gains.
Article 14: Item self-employment activities.
Article 15: Substance-dependent activities.
Article 16: Managers payments.
Article 17: Artists and athletes.
Article 18: Substance pensions.
Article 19: Matter of public servants.
Article 20: Teachers and students with substance.
Article 21: Provisions of the taxation of other income is divided into substance.
Article 22: Taxation of wealth.
The most important of all is the article 23. This articles tales the basis of OECD model of agreement and removes the basis of double taxation between two countries. This article shows the tow model to remove double taxation. These methods are 23/A the ‘Exemption method’ and 23/B ‘Credit method’. These two methods are closely related to each other.
“At the first stage, each country chooses between the exemption and the credit method (as prescribed by the OECD model treaty) and at the second stage, each country sets nationally optimal non-discriminatory capital tax rates. It is shown that in the subgame perfect equilibrium both countries choose the exemption method. Mutual application of the exemption method is also shown to yield the highest welfare for each country. While the tax export effect generally induces both countries to choose inefficiently high tax rates, this effect is weakest when both countries exempt foreign earned profits from domestic taxation." (Exemption vs. credit in international double taxation treaties)
4. Major problems faced with Germany during double taxation
For the Turkish citizens been living in Germany for many years the German government was questioning the source of their incomes that they have in Turkey.
German citizens have residency in Turkey and get their pensions from Germany had a problem. Turkey had the right to tax them but because of internal issues the Turkish domestic laws leave the income tax to be written as a income. The German side was asking to write them as tax. But the problem could not be solved.
Germany is a big fair and exhibition country. Turkish companies apply to many of those during the years. To keep the business alive the federal government was giving participants the right to tax non-refundable. For EU members this procedure still continues but for the Turkish companies this refund option is not available anymore.
The German tax authorities wanted to access the bank accounts in Turkey of Turkish citizens living in Germany. The branch of Turkish national bank in Germany was ridden with police force and all documents were seized by the federal forces. This action was not welcomed in the Turkish side.
Germany is the strongest business partner of Turkey. Around 55% of Turkey’s exports are to European Union countries. Germany itself is more 30% of this export figures. When we look at the population of Turks living in Germany is about 3 million people. During my research about the double taxation rule between Turkey and Germany I found out it is about to finish starting from January 1.st 2011. The reasons I mentioned above are most probably the main reasons why it won’t be valid anymore. I personally couldn’t find any relevant or an official statement from any part about what exactly the main problem was? Or rumors about there are still negotiations about it. No real confirmation can be found about the topic.
I believe the income taxes shall be registered in Turkey for the German citizens receiving pensions in Turkey. For the German point of view I believe they try to minimize tax evasion is one of the most important issues. Avoiding double taxation can boost the trade between two countries and allow the firms to invest and employ more labor for their future growth plans.
Social, economic and cultural relations between two nations are very closely related especially starting from the beginning of 1960’s. a reasonable and a working tax agreement shall be obtained and sustained. Regarding the problem both governments must really bring solutions to the problems.
Another appearing problem is when the Turkish citizens come back to Turkey after retiring from Germany will have a 25% cut from their wages. Apart from this the taxpayers of both countries will pay the full tax and face higher tax loads. As for the final conclusion double taxation is beneficial for the corporations and also for the individuals. It helps the countries to control and monitor the every single transaction in the book. Increases trade potentials as well as increasing the cultural integrity between countries. t importance of double taxation is very crucial especially for Turkey. It has a lot of benefits for the countries that have bases either in Germany or in Turkey. When we look at the bilateral trade figures of 2008 Turkey’s export to Germany is $13billion worth and Import to Turkey is $18 billion respectively. Also 3700 German companies are established in Turkey and 70000 Turkish enterprises exist in Germany. This figure itself shows the importance of trade and double taxation necessity. We shall not forget the fact Turkish immigrants are the biggest minority in Germany and German companies are on the top of the foreign investors list in Turkey.
From January 1.st 2011 the current agreement is going to be terminated. we can see the changes on trade figures in the next quarter data for each country.