Widening the Taxation Nexus

Year: 2021

As the world slowly emerges from the COVID-19 pandemic, no country has emerged unscathed.  While much of the global agenda has focused on ensuring businesses and citizens survive, the next step will be about fiscal recovery, for which tax policy will be a critical pillar. Countries will need revenue but imposing higher domestic taxation is unpopular as it can be harmful to growth, although the need to alleviate fiscal pressure may make it an inevitable policy choice in many jurisdictions.

In response, countries that manage to extend their tax claims with regard to cross border activities (“extra-territorial taxation”) enjoy a double bonus, as countries derive increased tax revenue from a bigger share of the global tax pie without affecting domestic growth prospects. However, such a move is often challenging as two ingredients must be present.

First, a country cannot simply enforce a tax on businesses that have no connection or nexus to the local jurisdiction. Therefore, a “taxation nexus” must be created in the domestic laws. Typically, “nexus” is established through residence or by showing that a business has income sourced from the local jurisdiction (e.g. by having a fixed place of business or sale of real property/shares in a jurisdiction/ payment for royalties/licenses). For instance, in Singapore, royalty income is regarded as sourced in Singapore if it is paid by a Singapore taxpayer. More recently, this concept of nexus has been developed further as international tax discussions have been pushing ahead to establish nexus arising from digital presence in a country.

Second, even if a nexus is created­, thereby giving the country a right to tax a foreign business, effective enforcement of such rules is difficult unless the business is brought into the taxation net.

However, as the fight for a “fair” share of the global tax pie continues to evolve, countries will inevitably move to increase their nexus, so that tax revenue can be derived from cross border activities. A recent and controversial example has been sighted in Germany, where German domestic laws will be interpreted to treat payments for rights to use trademarks or patents registered in Germany or Europe as income sourced in Germany. Controversially, this will apply even where the royalties are paid between two non-resident parties.

To quote from this recent Bloomberg article:

“The German tax authorities (GTA) in 2020 expressed their intention to employ for the first time a law which has been in effect since 1925, to levy withholding taxes on royalties paid between two nonresident parties in consideration of the right to use trademarks and patents registered with the Deutsche Patent- und Markenamt (DPMA), the European Patent Office (EPO), or the European Union Intellectual Property Office (EUIPO), among others.

There is now a risk that the GTA will hold the directors of the affected companies liable to declare, remit and pay withholding taxes for all open cases. If the directors fail to disclose the relevant cases to the GTA, they would likely be deemed to have acted negligently—if not intentionally—considering the settled position of the GTA. According to German law, this suffices to commence criminal investigations for tax evasion in case of late declaration.”

Going forward, we can expect to see more of such international tax laws coupled with aggressive enforcement. It has never been more important for multinational businesses to keep an eye out not only for new international tax laws, but to look even further ahead to keep abreast of tax policy changes.

Do feel free to contact us if you need help keeping informed on international tax policy as it applies to your business.

 

Annalise Foong is the Director of Financial and Tax Advisory at the Future-Moves Group. She has extensive experience in this field, in particular with a focus on Compliance, Tax Policy and Transaction Advisory. If your organisation is grappling with a complex tax puzzle and looking for professional and practical consultancy support, do get in touch at annalisefoong@future-moves.com.