Computation of Personal Income Tax in Nigeria by qcr21630

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									                       Lecture 13

           TAXATION

Topics covered:
   • Income Taxes
   • Double Taxation
   • Tax Treaties
   • Tax Incentives
   • Tax Avoidance and Evasion




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                    A. INCOME TAXES

1.        Most Widely Used Basic Tax
2.        Governments Use One of Two “Models” to
          Collect Income Taxes
     a.      Schedular model: Imposes taxes at flat rates on
            different sources of income.
     b.      Global model: Imposes uniform rates on all
            sources of income.




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             A. INCOME TAXES
b.    Global model (continued)
     1) Progressive rates are commonly
        imposed.
       a) Defined: Rates that increase as
          income increases.
     2) Advantages of global model:
       a) Not regressive.
       b) Not anti-entrepreneurial.




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     B. BASES OF INCOME TAXATION

1.   Nationality Principle: States tax their
     citizens, nationals, and domestic companies on
     their worldwide income no matter where they
     may reside




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 JUDGE JUDY READY TO RULE--




Case: Cook v. Tait, US Collector of Internal Revenue for Dist. Maryland:
+Court               +Facts                  +Legal Significance
+Parties             +Rational
+Issue               +Result
     B. BASES OF INCOME TAXATION

2.        Residency Principle: States tax the worldwide
          income of persons legally residing within their
          territories
     a.         Determining residence
           1)     Natural persons — determined by one or more of three
                  tests:
                 a)   Objective test: The length of time a person resides within a
                      state’s borders.
                 b)   Subjective test: The intent of the individual to make a place
                      his or her permanent domicile or household.
                 c)   Declarative test: The individual meets the admission criteria
                      for entering the country as a resident.

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B. BASES OF INCOME TAXATION

a.    Determining residence (continued)
     2) Companies — determined by two tests:
        1) Where the company was incorporated.
           1) The rule common to common law countries.
        2) b) Where the company is managed.
           1) The rule common to civil law countries.




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 JUDGE JUDY READY TO RULE--




Case: Crown Forest Industries v. Canada:
+Court              +Facts                 +Legal Significance
+Parties            +Rational
+Issue              +Result
   B. BASES OF INCOME TAXATION

3. Source Principle: States tax a taxpayer’s
   income only from sources within their territorial
   jurisdiction
   a.    Income accrued or derived from local sources
         commonly includes:
        1) Income derived from property located within the
           country.
        2) Income derived from any trade or profession
           carried on through any agency or branch within
           the country.
        3) Income derived from local employment.


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     B. BASES OF INCOME TAXATION

4.        Interrelationship of Taxation Bases
     a.      These three bases for imposing taxation may
             be used in conjunction with each other.
     b.      Priority:
           1) Source principle is usually regarded as the
              normal or default rule.
           2) Nationality and residency are usually treated as
              supplemental and subordinate rules.



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     B. BASES OF INCOME TAXATION

1.        Persons Immune from Taxation
     a.     The following persons are commonly immune
            from taxation:
          1) Foreign governments.
          2) Foreign diplomats.
          3) International organizations and their personnel.
             a) Depending on exemptions granted by the host
                state.




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                      C. INCOME

1.        Income Categories
     a.     Personal or business income: The earnings or
            profits made by individuals and businesses.
     b.     Capital gains income: The increases in value
            of the underlying capital owned or invested by
            individuals and businesses.
          1) In most countries: All income (including capital
             gains) is taxed at the same rates.
          2) Some countries: Capital gains are taxed at a
             different rate than personal or business income.

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              C. INCOME

a.    Capital gains income (continued)
     3) Other countries: Capital gains
        are given allowed tax breaks
        depending on:
       a) How long the assets are held, or
       b) To what purpose the proceeds are
          put.




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                       C. INCOME

2.        Computation of Income
     a.     Income of employed persons: Salaries and
            wages.
     b.     Income for self-employed persons and
            companies.
          1) Calculated by one of two methods —
             a) Profit and loss statement method: Gross business
                income is offset by allowable losses and
                deductions.
             b) Balance sheet method: Income is calculated as
                the difference between net worth at the beginning
                and the end of the accounting period.
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              C. INCOME

b.    Income for self-employed persons
      and
      companies (continued)
     1) Adjustments are made to reflect
        local definitions of income —
       a) Personal exemptions.
       b) Deductions for expenses.
       c) Credits for double taxation.




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                      C. INCOME

1.        Integration of Company and Personal
          Income Taxes
     a.     Problem: How to allocate (or integrate) the tax
            burden between companies and their dividend
            receiving shareholders.
     b.     Approaches:
          1) Classical system: Impose a tax on company
             earnings and on company dividends when they
             are distributed.


                                                     16 of 37
                  C. INCOME

3.   Integration of Company and Personal
     Income Taxes (continued)
     2) Shareholder imputation system:
        a) Impose a tax on company earnings and on
           company dividends when they are distributed.
        b) Give shareholders a credit for the taxes paid by
           the company on distributed dividends to offset
           their personal income tax obligation.




                                                       17 of 37
                 C. INCOME

3.   Integration of Company and Personal
     Income Taxes (continued)
     3) Company deduction system:
        a) Companies deduct distributed dividends as an
           operating expense before determining their
           company income.
        b) Shareholders pay ordinary income taxes on the
           dividends they receive.




                                                   18 of 37
                  C. INCOME

3.   Integration of Company and Personal
     Income Taxes (continued)
     4) Company two-rate system — applies two
        rates of company taxes:
        a) Higher rate for undistributed profits.
           b) Lower rate for distributed profits.




                                                    19 of 37
 JUDGE JUDY READY TO RULE--




Case: Johansson v. U.S.:
+Court               +Facts      +Legal Significance
+Parties             +Rational
+Issue               +Result
                 C. INCOME

3.   Integration of Company and Personal
     Income Taxes (continued)
     4) Shareholder two-rate system: Imposes a lower
        personal tax rate for income received as
        dividends.
     5) Shareholder exempt system: No taxes are
        imposed on dividend income received by
        shareholders.



                                                21 of 37
                  C. INCOME

3.   Integration of Company and Personal
     Income Taxes (continued)
     7) Full-integration system:
        a) No company taxes are collected.
        b) All company profits (whether they are distributed
           or not) are deemed to be distributed to
           shareholders.
        c) Shareholders pay personal income taxes on
           distributed, and deemed to be distributed,
           dividends.

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 JUDGE JUDY READY TO RULE--




Case: Reiss & Company (Nigeria) v. Federal Bd. Of Inland Revenue:
+Court             +Facts                 +Legal Significance
+Parties           +Rational
+Issue             +Result
               D. DOUBLE TAXATION

1.        Defined: Taxation of the same income in two
          countries
2.        Systems for Relief from Double Taxation
     a.      Exemption system:
           1) Income is taxed in one state (commonly a host
              state).
           2) Income is exempt from tax in a second state
              (commonly the home state).



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              D. DOUBLE TAXATION

1.        Systems for Relief from Double Taxation
          (continued)
     b.     Credit system: Tax paid in one state is used as
            a credit against a taxpayer’s liability in another
            state.
     c.     Deduction system: A taxpayer deducts the tax
            paid to one state from the profits liable to
            taxation in the second state.



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                 E. TAX TREATIES

1.        Purpose: To ameliorate the problem of double
          taxation and other matters, including tax
          incentives, tax avoidance, and tax evasion
2.        Model Treaties — these are widely used
     a.     Organization for Economic Cooperation and
            Development (OECD) Model Treaty.
     b.     United Nations (UN) Model Treaty.




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                 E. TAX TREATIES

3.        Coverage of Tax Treaties
     a.     Taxes covered by most treaties:
          1) 1) Income taxes.
          2) Capital gains taxes.
          3) Taxes on net wealth.
     b.     Persons covered by most treaties:
          1) Natural persons.
          2) Companies.



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                 E. TAX TREATIES

4.        Double Taxation Provisions
     a.     Significant factors: Residency, personality,
            and source of income.
     b.     General rule: States may only tax residents.




                                                     28 of 37
        E. TAX TREATIES

1) Exceptions — relate to the taxpayer’s:
   a) Personality.
      i. Non-resident person providing independent or
           professional services may be taxed by a tax treaty
           state if the person maintains a fixed base within
           that state.
      ii. Non-resident employee may be taxed in a tax
           treaty state to the extent of the earnings the
           employee receives in that state.
      iii. Non-resident companies may be taxed by a tax
           treaty state if they maintain a permanent
           establishment within that state.


                                                       29 of 37
          E. TAX TREATIES

1) Exceptions (continued) —
  b) Sources of income:
     i.  Immovable property is taxable only
         in the state where the property is
         located.
     ii. Dividends remitted by a subsidiary
         are subject to limited withholding
         taxes by the host (or source) state.




                                         30 of 37
         E. TAX TREATIES

1) Exceptions (continued) —
   b)   Sources of income:
        i. Dividends received by a parent company are
            subject to the ordinary income taxes of the home
            state.
        ii. Capital gains relating to immovable and movable
            business property may be taxed in both states.
             a] Other capital gains may only be taxed in the
                 state of residency.




                                                      31 of 37
                 F. TAX INCENTIVES

1.        Purpose: A tax scheme used primarily by host
          states to encourage international trade
2.        Examples of Tax Incentives
     a.     Income tax holidays for foreign investors.
     b.     Capital allowances (e.g., accelerated depreciation).
     c.     Carrying forward of allowances for income tax
            deductions.
     d.     Waivers and deductions of import duties.
     e.     Export subsidies.
     f.     Deferment of corporation registration fees and duties.
     g.     Tax exemptions for expatriate employees.

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     G. TAX AVOIDANCE AND EVASION

1.        Tax Avoidance
     a.     Defined: Efforts by individuals and companies
            to —
          1) Take advantage of loopholes in the tax laws, or
          2) Where some doubt exists as to the interpretation
             of a tax law, to benefit from that doubt.




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     G. TAX AVOIDANCE AND EVASION

1.        Tax Avoidance (continued)
     b.        Common examples:
          1)    Tax havens.
          2)    Transfer pricing.
          3)    Treaty shopping.
          4)    Thin capitalization.




                                       34 of 37
G. TAX AVOIDANCE AND EVASION

  1) Tax havens.
    a)  Defined: States that provide a refuge from taxes for —
       i. Taxpayers themselves.
       ii. The taxpayers’ income.
       iii. The taxpayers’ capital and other assets.
    b) Methods for countering:
       i. Many states tax income earned in tax havens.
       ii. Some states try to structure their own tax laws to limit
            the usefulness of tax havens to local residents.
       iii. Other states impose special taxes on certain types of
            income and transactions that commonly involve the use
            of tax havens.


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G. TAX AVOIDANCE AND EVASION

  2) Transfer pricing.
     a)    Defined: The practice of charging arbitrary
           prices for goods or services provided by one
           affiliate company to another affiliated company
           so as to lower the tax burden of the overall
           enterprise.
          i.   Purpose: Allows small profits to be made on the
               books of affiliates in countries with high taxes and
               large profits are assigned to affiliates in countries
               with low taxes.




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G. TAX AVOIDANCE AND EVASION

  2) Transfer pricing (continued)
     b)    Methods for countering:
          i.   Many states require affiliates to deal with each
               other at arm’s length.
               a] An affiliated establishment is attributed those
                  profits which it would earn if it were a
                  completely independent entity dealing with
                  another similar enterprise under ordinary
                  market conditions.
          i.   Some US states use the so-called “unitary business
               rule.”
               a] Defined: Multinational enterprises are taxed on a
                  percentage of their worldwide income, regardless
                  of where it was earned or by whom.
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G. TAX AVOIDANCE AND EVASION

  3) Treaty shopping.
     a)   Defined: “Shopping” for countries with
          beneficial tax treaty provisions, and then setting
          up subsidiary enterprises in those countries to
          take advantage of their treaties.
          i. The subsidiaries are commonly known as “conduit
             companies.”
     b)   Methods for countering.
          i. General rule: Suspend treaty benefits for non-
             residents who seek to abuse the tax treaties.



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G. TAX AVOIDANCE AND EVASION

  4) Thin capitalization.
     a)   Defined: A company is purposely financed by
          loans rather than by equity capital, so that it may
          deduct interest paid on its loans as a business
          expense.
          i. This arrangement results in lower tax payments for
             the company in most states.
     b)    Method of countering on the domestic level:
          Disallowing the interest deduction when the debt
          to equity ratio exceeds a particular norm.



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     G. TAX AVOIDANCE AND EVASION

2.        Tax Evasion
     a.     Defined: The willful and conscious
            misrepresentation or concealment of one’s tax
            obligations, or the flight of a taxpayer to
            another country.
     b.     All States View Tax Evasion as Illegal
     c.     States Cooperate in Varying Degrees in
            Prosecuting International Tax Evaders



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 G. TAX AVOIDANCE AND EVASION

2. Tax Evasion (continued)
   1) Tax cooperation treaties.
     a) Council of Europe / OECD 1988
        draft Convention on Mutual
        Administrative Assistance in Tax
        Matters provides for information
        exchanges.
   2) Tax amnesty: Allows delinquent
      taxpayers to pay all or part of
      their overdue taxes and thereby
      avoid possible prosecution.
                                    41 of 37
 JUDGE JUDY READY TO RULE--




Case: Kalo v. Commissioner of Internal Revenue :
+Court             +Facts                 +Legal Significance
+Parties           +Rational
+Issue             +Result
Time of Acceptance Clause

								
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