International Finance _ Taxation & legal framework aspects

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406 FIN – International Finance
Unit No. 4
TAXATION SYSTEMS AND LEGAL ASPECTS
Presented By:
Dr. K. Meenakshi
1
Sanjivani College of Engineering, Kopargaon
Department of MBA
www.sanjivanimba.org.in

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International double taxation
• International double taxation refers to the situation where two or more countries impose
taxes on the same income or assets of an individual or a company. This can occur when a
taxpayer is a resident of one country but earns income or holds assets in another country.
• Double taxation can have significant financial implications and create a burden on
taxpayers.
• To alleviate the negative effects of double taxation, countries often enter into double tax
treaties or agreements with each other. These treaties aim to prevent or mitigate double
taxation by allocating taxing rights between the countries involved and providing
mechanisms for relieving double taxation.
• The specific provisions of these treaties can vary, but they typically include methods such as
tax credits, exemptions, or deductions.

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Types of Double Taxation
• Double taxation of income: This occurs when a taxpayer is required to pay taxes on the
same income in both the country of residence and the country where the income is earned.
The taxpayer may be subject to tax on the income in their country of residence based on
worldwide income, while the country where the income is earned may also tax the income
based on the source principle.
• Double taxation of dividends: This type of double taxation occurs when a company pays
dividends to its shareholders, and both the company and the shareholders are taxed on the
same income. The company may be subject to corporate tax on its profits, and the
shareholders may also be subject to tax on the dividends they receive.

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• Double taxation of capital gains: Capital gains tax is levied on the profit earned from the
sale of certain assets, such as stocks, real estate, or businesses. Double taxation of capital
gains can occur if the taxpayer is subject to tax on the capital gains in both the country where
the asset is located and the country of residence.
Double tax treaties aim to resolve these issues by providing relief mechanisms. For
example, a tax treaty may allow for the elimination of double taxation by exempting certain
types of income or providing a tax credit for taxes paid in the other country.

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Key Ways - International Double Taxation - Regulation
• Double Taxation Treaties (DTTs): Countries often enter into DTTs to address issues of
double taxation. These treaties determine which country has the primary right to tax specific
types of income or assets. They typically allocate taxing rights based on the residence of the
taxpayer or the source of income. DTTs also provide mechanisms for relieving double
taxation through methods such as tax credits, exemptions, or deductions.
• Tax Credit: One common method for relieving double taxation is the tax credit mechanism.
If a taxpayer is subject to tax on the same income in two countries, the tax paid in one
country can be credited against the tax liability in the other country. This ensures that the
taxpayer is not taxed twice on the same income. Tax credits can be provided as a full or
partial relief, depending on the provisions of the DTT.

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• Exemption: Some DTTs provide for the exemption of certain types of income from taxation
in one country if they are already taxed in the other country. This eliminates double taxation
by exempting income from taxation in the country of residence if it has already been taxed in
the source country. The exemption method is commonly used for dividends, interest, and
capital gains.
• Tax Deduction: Another relief method is the tax deduction, where the taxpayer is allowed to
deduct the tax paid in one country from the taxable income in the other country. This
reduces the overall tax liability, although it may not fully eliminate double taxation.

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• Mutual Agreement Procedure (MAP): DTTs often include a mutual agreement procedure,
which allows taxpayers to seek resolution when they believe they are being subjected to
double taxation that is not in accordance with the treaty. The MAP provides a mechanism
for the tax authorities of the countries involved to resolve disputes and reach an agreement
on the allocation of taxing rights and the relief of double taxation.
• Exchange of Information: To ensure effective enforcement of tax laws and prevent tax
evasion, DTTs often include provisions for the exchange of information between the tax
authorities of the treaty countries. This facilitates the sharing of relevant tax-related
information to ensure compliance and enforcement.

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Tax Evasion
Tax evasion refers to the illegal act of intentionally avoiding paying taxes owed to the
government by using fraudulent or deceptive means. It involves the deliberate
misrepresentation or concealment of income, assets, transactions, or other financial information
to reduce tax liabilities or evade tax obligations altogether.
Tax evasion is considered a criminal offense in most jurisdictions and is subject to
penalties, fines, and even imprisonment.

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Methods or Practices Used in Tax Evasion
• Underreporting Income: Taxpayers may intentionally fail to report their full income or
manipulate accounting records to show lower income than actually earned, thereby
reducing their tax liability.
• Offshore Tax Evasion: Individuals or businesses may use offshore accounts, entities, or
jurisdictions to hide income or assets, thereby evading taxation in their home country.
• Shell Companies and Complex Business Structures: Creating complex business structures
involving multiple entities, including shell companies or offshore entities, can be used to
hide the true ownership of assets or income and evade taxes.

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• False Deductions and Expenses: Taxpayers may fraudulently claim fictitious or inflated
deductions, expenses, or tax credits to reduce their taxable income and lower their tax
liability.
• Cash Transactions and Unreported Income: Engaging in cash transactions or accepting
payments "under the table" without reporting the income is a common method of tax
evasion. This includes unreported tips, rental income, or cash-based businesses.
• Transfer Pricing Manipulation: Multinational corporations may manipulate transfer prices
between related entities in different jurisdictions to shift profits to low-tax jurisdictions and
avoid higher taxes in countries with higher tax rates.
• Failure to File Tax Returns: Some individuals or businesses may simply fail to file tax
returns altogether, effectively evading taxes by avoiding any reporting of income or financial
information.

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Measures to Detect and Combat Tax Evasion
• Tax Audits: Tax authorities conduct audits to review taxpayers' financial records,
transactions, and compliance with tax laws to identify discrepancies or signs of potential tax
evasion.
• Information Exchange: Governments cooperate internationally by exchanging financial and
tax-related information through agreements, such as tax information exchange agreements
(TIEAs) or the automatic exchange of financial account information under initiatives like the
Common Reporting Standard (CRS).
• Whistleblower Programs: Some countries have established programs to encourage
individuals to report tax evasion by offering rewards or protections for whistleblowers who
provide credible information.

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• Strengthening Legal Frameworks and Penalties: Governments may enact stricter laws,
increase penalties, and establish specialized agencies or units dedicated to combating tax
evasion.
• Technology and Data Analysis: Tax authorities use advanced data analysis techniques and
technology to identify patterns, anomalies, or inconsistencies in taxpayer data that may
indicate potential tax evasion.

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Money Laundering
Money laundering refers to the process of making illegally obtained funds appear legal
or "clean" by concealing their true origin, ownership, or destination. It involves a series of
complex transactions and activities designed to disguise the illicit nature of proceeds derived
from criminal activities.
The term "money laundering" originates from the idea of making "dirty" or illicit
money appear as if it came from legitimate sources.

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Money laundering is a serious criminal offense with severe legal consequences. It
undermines the integrity of the financial system, facilitates the financing of terrorism and
organized crime, and distorts economic activities.
To combat money laundering, governments and financial institutions have
implemented stringent anti-money laundering (AML) measures, including customer due
diligence, transaction monitoring, reporting of suspicious activities, and international
cooperation to detect and prevent money laundering activities.

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Money Laundering - Stages
• Placement: This is the initial stage where illicit funds are introduced into the legitimate financial
system. It involves converting cash proceeds into other forms, such as bank deposits, money orders, or
investments. The purpose is to place the illegal funds into the financial system without raising
suspicion.
• Layering: In this stage, the launderer engages in a series of transactions and movements of funds to
create layers of complexity and confusion, making it difficult to trace the original source of the funds.
This may involve multiple bank transfers, currency exchanges, or purchases of assets to obscure the
money trail.
• Integration: This final stage involves merging the laundered funds back into the legitimate economy,
making them indistinguishable from legitimately earned funds. The launderer may invest the funds in
legal businesses or assets, such as real estate, businesses, or luxury goods, to legitimize their origin.

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Money Laundering - Methods & Techniques
• Smurfing or Structuring: Breaking down large amounts of cash into smaller, less conspicuous
transactions to avoid suspicion and reporting requirements.
• Shell Companies: Creating fictitious companies or using existing ones to make the illegal funds
appear as legitimate business income.
• Offshore Accounts and Tax Havens: Utilizing offshore financial institutions and jurisdictions with lax
regulations to hide the true ownership of funds and avoid detection.
• Trade-Based Money Laundering: Manipulating international trade transactions, such as over- or
under-invoicing goods or services, to move funds across borders and obscure the source of the illicit
funds.
• Digital Currencies: Exploiting cryptocurrencies or digital payment systems to convert illicit funds into
a form that is difficult to trace.

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Money Laundering: Legal Framework
The establishment of a robust legal framework is crucial in combating money
laundering. A comprehensive legal framework consists of laws, regulations, and enforcement
mechanisms that provide a strong basis for preventing, detecting, investigating, and
prosecuting money laundering activities.

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• Criminalization of Money Laundering: Countries should enact laws that explicitly
criminalize money laundering as a standalone offense. These laws should define money
laundering, establish elements of the offense, and prescribe penalties commensurate with
the seriousness of the crime.
• Predicate Offenses: Money laundering is typically linked to underlying criminal activities,
known as predicate offenses. Legal frameworks should identify a comprehensive list of
predicate offenses, such as drug trafficking, corruption, fraud, organized crime, and
terrorism financing. By criminalizing these underlying offenses, countries can effectively
target the proceeds derived from them.

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• Customer Due Diligence (CDD) and Know Your Customer (KYC) Requirements: Financial
institutions and designated non-financial businesses and professions (DNFBPs) should be
subject to robust CDD and KYC obligations. These requirements mandate the identification
and verification of customer identities, monitoring of customer transactions, and reporting
of suspicious activities to relevant authorities.
• Reporting Obligations: Countries should establish mechanisms for financial institutions
and DNFBPs to report suspicious transactions to the appropriate authorities. This includes
requirements for filing suspicious transaction reports (STRs) or suspicious activity reports
(SARs) when there are reasonable grounds to suspect money laundering or terrorist
financing.

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• Financial Intelligence Units (FIUs): FIUs serve as central agencies responsible for receiving,
analyzing, and disseminating financial intelligence to combat money laundering. Legal
frameworks should provide for the establishment and operation of FIUs, empowering them
with the necessary authority and resources to perform their functions effectively.
• Record Keeping Requirements: Financial institutions and DNFBPs should be mandated to
maintain appropriate records of customer transactions and related information. Record
keeping requirements aid in investigations and provide a trail of financial activities for law
enforcement agencies.

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• International Cooperation: Legal frameworks should incorporate provisions for
international cooperation in the fight against money laundering. This includes mechanisms
for mutual legal assistance, extradition, asset recovery, and sharing of information and
intelligence with foreign jurisdictions.
• Supervision and Regulation: Effective supervision and regulation of financial institutions
and DNFBPs are essential to ensure compliance with anti-money laundering (AML)
measures. Regulators should have powers to inspect, assess, and enforce compliance with
AML requirements, impose sanctions for non-compliance, and provide guidance and
support to entities covered by the regulations.

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• Penalties and Enforcement: Legal frameworks should establish appropriate penalties and
sanctions for money laundering offenses, including fines, imprisonment, and confiscation of
assets. Adequate resources, training, and cooperation among law enforcement agencies and
judicial bodies are essential for the effective enforcement of AML laws.
• International Standards and Best Practices: Countries should align their legal frameworks
with international standards and best practices, such as those developed by the Financial
Action Task Force (FATF) and other regional or international bodies. Adhering to these
standards enhances international cooperation, strengthens the global AML regime, and
helps countries assess their own AML systems.

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Functions & Activity - FATF
• The Financial Action Task Force (FATF) is an intergovernmental body established in 1989 to
combat money laundering, terrorist financing, and other threats to the integrity of the
international financial system.
• The FATF sets global standards, develops recommendations, and promotes the
implementation of effective measures to prevent and combat these illicit activities.
• The FATF operates through a network of member countries and regional-style bodies,
known as FATF-Style Regional Bodies (FSRBs), which help promote the implementation of
AML/CFT measures at the regional level. The FATF's work has had a significant impact on
strengthening global AML/CFT efforts and enhancing the integrity of the international
financial system.

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• Setting International Standards: The FATF develops and promotes international standards
and recommendations for combating money laundering, terrorist financing, and
proliferation financing. The FATF's flagship document is the "FATF Recommendations,"
which provide a comprehensive framework of measures to be implemented by countries to
address these risks.
• Mutual Evaluations: The FATF conducts mutual evaluations to assess countries' compliance
with the FATF Recommendations and the effectiveness of their anti-money laundering and
counter-terrorist financing (AML/CFT) systems. The evaluations analyze the legal and
institutional frameworks, regulatory measures, and implementation efforts of member and
non-member countries. The results of these evaluations help identify areas for improvement
and provide guidance to countries to strengthen their AML/CFT regimes.

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• Identifying High-Risk Jurisdictions: The FATF identifies jurisdictions with strategic
deficiencies in their AML/CFT systems through a process known as the "FATF Public
Statement." These jurisdictions, commonly referred to as "high-risk" or "non-cooperative"
jurisdictions, are subject to increased monitoring and countermeasures by the international
community to address the identified deficiencies.
• Typologies Research: The FATF conducts research and analysis on emerging trends,
techniques, and methods used in money laundering, terrorist financing, and proliferation
financing. This research helps identify new risks, vulnerabilities, and typologies, enabling
countries and the private sector to better understand and mitigate these threats.

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• Guidance and Best Practices: The FATF provides guidance and best practices to assist
countries in implementing effective AML/CFT measures. This includes issuing guidance on
specific topics, such as risk-based approaches, virtual assets and cryptocurrencies, beneficial
ownership, and combating terrorist financing.
• International Cooperation and Outreach: The FATF fosters international cooperation
among member countries and other stakeholders, including regional bodies, international
organizations, and the private sector. It promotes information sharing, capacity building,
and technical assistance to support the implementation of AML/CFT measures globally.

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• Risk Assessments and Strategic Initiatives: The FATF conducts risk assessments and
strategic initiatives to address evolving risks and challenges in the field of money
laundering, terrorist financing, and proliferation financing. These initiatives aim to improve
the effectiveness of AML/CFT efforts and address emerging threats, such as the use of new
technologies and the financing of proliferation activities.
• Compliance Monitoring: The FATF monitors the progress and compliance of member
countries with its standards and recommendations. It assesses the implementation of
AML/CFT measures by member countries through regular follow-up evaluations and
maintains a process to track their progress in addressing deficiencies.

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Thank You