Tax Law - Diritto Tributario (Prof. Parada)

(-) COSTS OF GOODS SOLD

(-) EXPENSES

Operating expenses (utilities, wages, rent)

Non-operating expenses (R&D, marketing, other investments)

= TAXABLE INCOME

(-) CORPORATE INCOME TAX*

= NET PROFITS

*NB the corporate income tax is calculated multiplying taxable income times tax rates.

EXAMPLE:

Tot. revenues = 100.000

Cost of goods sold = (20.000)

Operating expenses:

Salaries = 20.000

Rent = 10.000

Utilities = 5.000

Depreciation = 5.000

TAXABLE INCOME = 40.000

CIT 30% = (12.000)

NET PROFIT = 28.000

When Net Profit is negative, we have a loss; it is not necessarily something bad for the economy, it can be

something very good. We have various treatment of losses:

• Loss “carry back” = accounting practice that consist in using NOLs (net operating losses) against

previous years NOPs (net operating profits)

• Loss “carry forward = accounting practice that consists in using NOLs against future years’ NOPs

Payment of Dividends and Double Taxation: it is one of the negative facts about a Corporation. But what

companies do in order to avoid double taxation? In some countries, the government guarantee some

credits at the shareholder level according to the amount of taxes paid at the level of the corporation:

“imputation System”.

Tax credit and/ or exemption are usual in cross-border situations.

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So, a corporation is paying a tax on the profit (CIT), then if net profit is positive it will distribute dividend to

shareholders. A shareholder has different incomes plus dividends, but dividends arrive with a credit of the

amount to which dividends are taxed, that must be subtracted after computing its personal income tax.

This system, the imputation System, concerns only some companies. If there is not this system, you will pay

all the PIT (personal income taxes) plus the tax on dividends (which are taxed because of the CIT).

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CASE STUDY:

TIAF is a company incorporated in country X which sells cars. On 31 Dec 2017, the company showed the

following economic results derived from its activities:

Total Revenues = 2.000.000 EUR

Interest income = 100.000 EUR

Cost of goods Sales = 100.000 EUR

Operational expenses = 400.000 EUR

Non-operational expenses = 100.000

CIT rate = 35%

What is the taxable income of TIAF for purposes of the CIT in country X? explain the results.

➢ Taxable income is 1.500.000 (rev. + int. - cost of goods - operate. Exp.-non-op. Exp.)

What is the amount of CIT to be paid in 2017?

➢ It is 1.500.000 times 0,35 = 525.000

What is the effective tax rate paid by TIAF?

➢ I think it is 0,25 because it is the amount of CIT (525.000) paid divided by the overall revenues

(2.100.000); so, it is 25%

Would your result change if TIAF would have a NOL of 1.500.000 in 2018 to carry back to 2017? How?

➢ The result would change because if you take back a loss of 1.500.000 to the year in which you earn

1.500.000 then you wouldn’t have a profit, so you wouldn’t pay taxes.

CASE STUDY:

A company has 1.000.000 EUR losses in 2017. The company has the chance of either using those losses up

to one year back or up to three years in the future. In 2016 the company registered net profits after taxes

of 500.000 EUR. The total revenues of the company in 2016 were 2.000.000 EUR and the totals

expenses/costs were 1.000.000 EUR. The same expenses/costs re expected for 2018, although the

revenues estimated are 3.000.000 EUR.

How much CIT did the company paid in the 2016? (without considering the use of NOL). What is the

effective CIT rate in 2016?

➢ The CIT is 50% because the taxable Income is 1.000.000 and net profit is 500.000.

How much CIT is the company expected to pay in 2018 (without NOL)? Please assume that effective tax rate

equals the statutory tax rate.

➢ Since revenues are 3.000.000 and cost 1.000.000, we have 2.000.000 of taxable income so net

profit is 1.000.000 (because CIT 50%) and so effective CIT paid is always 1.000.000.

Would you recommend to “carry back” or “carry forward” the amount of NOL of 2017? Why?

➢ I think it’s better to carry forward because in this way you delete completely the loss, while if you

carry back to 2016 (when the profit was 500.000) you get 500.000 euros losses in any case.

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CASE STUDY:

A company has 1.000.000 EUR losses in 2017. The company has the chance of either using those losses up

to one year back or up to three years in the future. In 2016 the company registered a profit after taxes of

500000 EUR. The total revenues of the company in 2016 were 2.000.000 EUR and the totals expenses

were 1.000.000 EUR. The same expenses are expected for 2018 although the estimated revenues are

3.000.000 EUR.

How much CIT did the company paid in 2016? (without considering the use of NOL’S). what is the effective

CIT rate in 2016?

➢ It is 500.000 EUR, so 50% of the profit (2.000.000 – 1.000.000 = EBT – taxes 500.000 so 500.000

which is the half).

How much CIT is the company expecting to pay in 2018 (without considering the use of NOL’s)? Please

assume that the CIT rate from 2016 is still the same in 2018.

➢ It will pay 1.000.000 EUR because it is 3.000.000 – 1.000.000 = 2.000.000 EBT and the half goes to

taxes, so it is 1.000.000 EUR.

Would you recommend carrying back or carry forward the amount of NOL’s of 2017? Why?

➢ I would recommend carrying back so in 2016 I wouldn’t pay taxes; however, it could take long, so

maybe it is better to carry forward to 2018 so you will pay taxes as 2016 and you will have an

advantage to predict the future in a better way.

**losses are used to reduce taxable income, they are considered as expenses when you carry back or

forward them. 12

Lecture Four:

Personal Income Tax (PIT)

it is affected by the residence of the individuals of course:

• Factual test of residence = more than 83 days in a calendar year

• Domicile (deal with the intention to remain in a specific place

But how do we calculate the Personal income tax?

(+) GROSS INCOME

Wages

Pensions

Capital gain

Interests (etc.)

(-) EXPENSES (standard amount or itemized) *

(-) PERSONAL EXEMPTIONS

If you have children

If you have a disable

= TAXABLE INCOME

(-) PERSONAL INCOME TAX (progressive)

NET INCOME

*Countries generally have a long list of itemized deduction based on what you performed or based on the

cost you have. On the other hand, you can have a fixed amount to pay independently by what you have or

spend. Sometimes you can choose between the two methods.

Personal exemptions are not a general rule; it works for instance in the United States.

The difference between CIT and PIT is that personal income tax is progressive:

(this is an example of U.S. tax rates for singles)

Tax rate 2017 taxable income

10% 0 to 9325

15% 9326 to 37.950

25% 37.951 to 91.900

28% 91.901 to 191.650

33% 191.651 to 416.700

35% 416.701 to 418.400

39,6% 418.401 or more 13

Payment of Dividends and Double Taxation:

Some countries to avoid double taxation as we’ve said use an Imputation system, so they give a credit to

the shareholder of the same amount of the Corporate Income Taxes.

Here we have how an imputation system works

Corporation X Shareholder

Taxable income 100 Dividends 70

CIT (30%) 30 Gross-up 30

Net Profits 70 Taxable income 100

Personal income 40

tax (40%)

Tax credit 30

Personal income 10

taxpaid

As you can see 30 of CIT are then subtracted from the PIT as a credit of the same amount. You add the

gross up in order to simulate 100 gained by the corporation, because otherwise you would have an excess

of credit.

Remember that here this company has just one shareholder that is the one taxed on the right.

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CASE STUDY:

Pietro is a 38 years old divorced man who lives in “Smile town” (Palm Country) and provided marketing

services as a freelancer. In 2017 he earned 35.000 EUR from his services. In addition, he has a

participation in a company incorporated in Palm country from where he received 15.000EUR dividend in

2017. Accordingly, Pietro’s expenses in 2017 included:

Mortgage interest paid: 2000 EUR

Interest paid on a loan used to buy his family car: 1000 EUR

Alimony: 2000 EUR

Let us assume that by law, Pietro is entitled to a standard deduction of expenses of 3600 EUR for 2017,

which he can only use instead of itemized deductions. He also is entitled to a “child tax credit” of 1000

EUR per each child under 18 years old living with him. He has three children: Maria 19, Manuel 6 and

Marta 11. Maria is the only one living with him so far.

What is Pietro’s gross income in 2017?

➢ His gross income is 35.000 + 15.000 = 50.000 EUR

What is Pietro’s taxable amount in 2017?

➢ His taxable amount is 50.000 – 3.600 = 46.400 EUR (standardized). The amount of itemized

deduction is 4000 EUR (because the loan for personal car is not deductible) so 50.000 – 4000 =

46.000.

Assuming the given tax rates (below), what is the total taxes that Pietro must pay in 2017?

10% 0-10,000

25% 10,001 to 30,000

33% 30,001 to 100,000

35% 100,001 and more

➢ He is going to pay 33% because has a taxable income between 30.000 and 100.000, so he will pay

46.400 times 0,33 = 15.312 EUR

Would you recommend Pietro to do something in order to reduce his tax burden in future years?

➢ I recommend him to take back two sons who were under 18 years old in order to gain deductions

on taxable income.

In November 2017, a Hurricane affected the whole Smile town. Pietro lost his house valued in 50,000 EUR.

Would your calculation change considering this new fact? How?

➢ It depends, if the country is allowing some deductions for causalities, he will have an amount (a

part of 50.000) to deduct, otherwise fuck off.

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CASE STUDY:

The only shareholder of a closed stock corporation received a dividend distribution in 2017 for the

amount of 70,000 EUR. The profit of the company pre-CIT were 100,000 EUR and the CIT paid was 30,000

EUR. If the shareholder also has income from interest of 10,000 and wages from 200,000 EUR and the

standard deduction for taxpayer is 10,000.

Please calculate the personal income tax of him considering:

1) An imputation tax system.

2) A non-imputation tax system.

Use the following tax brackets to apply the tax rates:

0% 0-10,000

25% 10,001 to 30,000

35% 30,001 to 290,000

40% 290,001 and more

➢ So, for an imputation system we have:

Here we have the Gross up, so the personal income tax is 120.000 (40% of 300.000)

Corporation Shareholder

Pre-CIT profit 100.000 Dividends 70.000

CIT 30.000 Gross-up 30.000

Dividends 70.000 Wage 200.000

Interest 10.000

Gross Income 310.000

Standard deduction 10.000

Taxable Income 300.000

Personal Income Tax (40%) 120.000

Tax credit 30.000

Profit 150.000

➢ In a non-imputation system, we