Usefull examples of new conflicts in international tax law in an ever-smaller world

02.2016

Until very recently, for most individuals and companies, tax law was a strictly national matter, governed entirely by domestic rules. Over the last 15 years, however, the way people work and do business has changed profoundly, and the international dimension has become central. As a result, national tax systems — and their administrations, as well as the courts — are struggling to adapt. The following examples, drawn from our firm’s professional experience, illustrate some of the most common challenges.

A Mexican entrepreneur, benefiting from the establishment freedoms under NAFTA, founded a small software company in San Francisco. The company was set up as a Limited Liability Company (LLC), a uniquely American legal structure that allows for flexible tax treatment depending on the owner’s needs. This individual recently moved to Spain with his non-Spanish spouse and child. He regularly travels to the U.S. to manage his business but also works from Barcelona.

While it is clear that the family is tax resident in Spain, the question arises: where is the business resident? Under double tax treaties, his activity may be considered a permanent establishment in Spain. Yet, the concept is among the most complex in tax law. Furthermore, how should Spain tax the profits of a U.S. LLC, when the Spanish tax authority often does not understand what an LLC legally represents, given its hybrid nature?

A German airline pilot decides to live with his partner, also employed by the same airline, in a town near Barcelona airport. He regularly flies to Frankfurt and other destinations, spending significant time in Germany and elsewhere. The question is whether this couple are tax residents in Spain or Germany.

If they are resident in Germany because their income originates there, can Spain still claim tax residence? And if so, could they benefit from Article 7(p) of the Spanish Income Tax Act, which grants an exemption of up to €60,100 for work performed abroad? The Spanish tax administration has yet to give a clear answer.

When a user clicks on a Google Adwords advertisement, the Spanish advertiser receives an invoice from an Irish company. The advertising revenue is taxed in Ireland, where corporate income tax rates are much lower than in Spain.

The Spanish tax authority, unable to tax this income without a permanent establishment, and Spanish marketing companies, which face unfair competition, are both frustrated. The U.S. tax administration is equally dissatisfied because Google’s Irish profits are not repatriated and therefore escape U.S. taxation. The root of this issue lies in the outdated notion of permanent establishment — defined as a “fixed place of business” — developed in the 1950s for industries like mining and construction, when services and intellectual property were of minor importance. Many tax authorities would like to modernise this concept, but unilateral action is impossible: all states must agree, and some will always resist, as they benefit from the status quo.

Until recently, many pensioners residing in Spain — both Spanish and foreign — failed to declare their foreign pensions, as the Spanish tax authorities had no means of knowing about them. However, under new tax information exchange agreements between European states, Spain now receives such data.

Early this year, the tax agency sent letters to pensioners informing them, politely, that it knows of their foreign pensions and reminding them of their duty to report this income in their Spanish tax returns. To ease the impact, and to avoid cases of financial hardship, Spain introduced a partial tax amnesty for these pensioners: they would pay the tax due but face no penalties. Similar information exchange rules also apply to interest and capital gains reported by EU financial institutions, although data transmission errors remain common.

In recent years, numerous cases of tax evasion and money laundering have surfaced involving funds long hidden in jurisdictions such as Andorra or Switzerland, which until recently refused to share tax data. Even Liechtenstein has now signed an agreement with Germany enabling tax information exchange. Nevertheless, prosecuting tax fraud and money laundering remains complex.

These are relatively new offences and far more difficult to prove than traditional crimes such as theft or drug trafficking. Many high-profile corruption and tax fraud cases will likely go unpunished due to procedural or evidentiary limitations. As German tax inspectors lamented in an interview with Die Zeit (7/2014): “We are the idiots. We chase criminals on bicycles.”

These are just a few examples of a world in transition. National tax systems continue to face immense challenges in keeping pace. As we often remind our clients who encounter double taxation or relocation risks: “The economy goes global, but taxes stay national.”

++ Article originally published in German in the magazine “Economía” (December 2015), issued by the German Chamber of Commerce in Spain ++