Selected Business Tax Issues
(I) elimination (or significant reduction) of Gredit-producing investment incentives; (2) replacing generous accelerated depreciation methods with methods that more closelv relates to the useful lite ol the
depreciable assets; and (3i introducing limitations on interest deduction of debt financing, i.e., thin capitalization rules.
Most ol these changes took place during the Lite 1980s, in the wakeo; the worldwide tax reform movement1"1; however, recent surveys indicate that many countries have been introducing similar reforms as late as the late 1 WOs and even well into the 20(K)s.m In other words, modern tax legislators continue to copycat old base-broadening trends, rather than implementing now (and mavbe mote creative) broadening instruments.
VI. CORPORATE/SHAREHOLDERS TAX INTEGRATION OF DISTRIBUTED PROFITS
A. Definition of integration and general issues
An area ol corporate taxation in which trends ol convergence ha\ e been identified by many commentators is in the extent by which the taxation of corporations and their individual shareholders are integrated.
Integration ol the individual and corporate tax systems means that corporate income should be taxed onl\ once, integrating individual income tax and corporate income tax in order to eliminate double taxation ol corporate income and the connected economic distortions (most commonly referred distortion are the incentive to invest in noncorporate rather than corporate structures, the incentive to invest in debt rather than ecjuitv, and the incentive to retain corporate profits within corporations!.
There is .in overwhelming variety of practical and theoretical methods to integrate corporate/shareholdei taxation and an almost equally overwhelming abundance ol literature describing them.1*' For our purpose, il is nol necessary to provide a detailed description ot all methods but rather to understand that all ot them operate in an oasilv described spectrum.
r'? See, !\v Auerbach, Devereux StSimpson, supra note 14-1, at 5; Devereux. Griffith & Klemm. sUprii note US, at 1302-03.
'"■ Sec c..%'. OFCD Tax Pot u v < 11 in is \o hRhim "t.xx Polio Ikixos e.. Reforms ix OECD COUNTRIES, 31-126; 157-38 <2iWi.
,!M Some examples include OE( D Kl POR1 -nn.i note 130, at 85-90; DOLI i -■•
A. Kaiin & Jeffki v Si Lehman, Corporate Incomi Iaxation, 5th ed 2S- v [Fciundatkwi Press, 5th ed 2005}; Graeme Cooper 6 Richard K. Gordon Taxation of EntorprtoR mid their (>ttmen. in I ax Law Desicn ami DRArrrs v01.1, ch. :it (\ ictor Thuronyi ed., 19%). Colloquium on Corporate Uu 47 l..v\ I Rev 427-723(1992).
IU    CLOBAI PERSPECTIVES ON INCOME fAXATlON LAW
One end of the spectrum is marked by the Classical Method, under which lull tax authority is everted both on companies ami their shareholders; namely, there is no integration. L nder such .1 system, all corporate profits are taxed twice at full rates. The first instance "t taxation is at the corporate level, on corporate profits, at corporate tax rates. The second collection ot taxesishenigdone.it the shareholder level, at Individual tax rail's (assuming shareholders are individuals), when the corporate profits are being distributed.
At the other end of the spectrum, tins double taxation is completely eliminated. The most extreme way to eliminate double taxation is to treat corporations as conduits lor all tax purposes, while all ot their profits, losses and other tax attributes are allocated to their shareholders, as it is usiiallv done in the case of partnerships and their partners. Such a radical svstem ot corporate/'shareholder taxation has never been adopted, as a general rule, in any country, "? and hence, we shall embrace some more relaxed versions of integration as the other end of our spectrum
These relaxed methods of integration are also dedicated to the elimination of the double tier taxation. Such systems appear in many forms. The most obvious one is the Hull Imputation System. In cases ot full imputation, corporate taxes are being levied, but in essence, they are nothing more than a partial withholding regime on shareholders' taxation. When corporate prolits are being distributed, shareholders are taxed at their individual capacity but also receive full credit for their proportional share ot the taxes ahead) paid by the corporation. Another way to achieve a relief in double taxation is bv Dividend Exclusion/ I xcmplion. In such a system, the corporate taxes are levied, but shareholders' level taxation is eliminated by excluding distributed profits from the individual tax base.
An article bv Yariv Brauner provides us with ,1 lull account on some recent trends of corporate/shareholder integration.1 Exploring evidence from several jurisdictions,Brauner concludes that "|d]unng the second halt ot the last century, many countries gradually replaced their so-called classical corporate tax regimes, under which corporate earnings were taxed twice . . . with an integrated regime (imputation), which taxed such earnings only once."1'" However, he also asserts that "[t]his dear and gradual trend has been abruptly reversed with the turn of the century."'This reversal of trends is also supported by a 2003 I FA
k vii\ iVc Li iiman, lil. at .16. ■ Yam Brauner) Integration in and Integration World, 2 N.Y.U. I. L & Bus. 51 i2(H)5),
U .it 68-76. - U .it 51.
Selected Husiness lax |s-vii'> '4:
study arguing that a "signilicant move away rrom the imputation system" can be observed throughout the world."" Brainier argues tli.it the primary reasons tor which imputation has been abandoned are the difficulties to extend its benefits across borders/"' if a country, in which a company is resident, grants credits to foreign shareholders lor taxes paid by the resident company, the result is zero revenue for the source country (with respect to the part ot the stake held by foreign shareholders); Of course, it is technically possible to maintain imputation as a Strictly domestic policy (i.e., extend the credits onl\ to local shareholders), as was being done during tin- I'WOs,"0 but such policies creak' preferential treatment to domestic shareholders. These policies both scared investors away (to other countries which did extend the credits across borders)1'' and also contradicted international nondiscrimination rules.M
The theoretical scheme to maintain imputation at the international level requires the source country to give up any taxation of the foreign shareholders.in tad, to move from a full imputation system to a di\ -idend exemption system, ibis can be maintained in one ol two wa\s unilateral 01 Looidinated l.nder a unilateral approach, the source system would simply exempt shareholders (both foreign and domestic I from any taxation on dividend and compensate tor the revenue loss bv rising corporate tax rates. This is not a feasible solution in the prisoner-dilemma-like environment ol global taxation. Such a tactic would probably divert FD1 away to lower-rates jurisdictions,
Under a cooperath e method, the source country will not raise corporate taxes but will share information u ith the residence COuntX) in order to assure that the residence country will Only tax the difference between the corporate tax rate in the source country and the indi\ iduaJ lax rate in the residence country. 1 bus. the source country is able to collect some revenue. It requires any country that is a partner to such a scheme to completely forego withholding on dividends and trust the other country to share complete and accurate information (in order lor the former to he able to lax its own residents holding stakes in foreign corporations). Such a level of cooperation is not ea^v lo achieve. With inadequate level of international cooperation and information sharing, countries had to find middle solutions to the problem as they moved
"  Richard Vann. General Report, m KKa CAHIfrs Di Dkoii I'iscai   I i;i \t»
l\ CoMI'AM  SlIAIJI lit ii III hs I        IOV Si m.I i or Doliill Taxai io\?, 21, .V
(2003).
Bruner, ^uprn note 156, at 7. 7ss-So '"- Id. at 84, >»' M. at M «5 w hi. at 82-83. '•  hi at 8Q 82.
146    CLOBAI I'I RSPECT1VES ON INCOME TAXATION LAW
.iw.iv from the Imputation method, while trying to maintain some of its
men Is.
It we adhere toa functional approach, it is arguable that even though a set nl corporate tax reforms in the 2()U0s implemented different Integration methods throughout the world, jurisdictions have all some remarkably similar ends. In almost all jurisdictions, imputation systems have "been replaced b) the less accurate reduced dividend tax rate system, which, in a way, is a hybrid of dividend exclusion anil the classical system."1** By lowering tax rates on dividends (but still taxing them), countries were able to keep some virtues of imputation (since it is not eliminated completely); avoid being categorized as discriminators' toward foreign shareholders (by exerting the same "partial dividend taxation" to both foreign and domestic shareholders); maintain reasonable tax revenues; and at the same time, maintain their competitive standing in comparison to other jurisdictions.
Thus, even though the movement awav from imputation has been executed in different directions, eventually, all roads have led to Rome. Placing this global movement on our previously noted spectrum, many countries have moved from the imputation end to a midlevel position between imputation s\ stems and classical systems. One commentator specificallj stated that "[Tjhere can be detected a general convergence of countries' company shareholder tax svstems in an international setting. The convergence is towards dividend reliel systems that are more neutral than imputation internationally yet retain some of the domestic benefits of imputation."Il,r
6. Some specific integration methods adopted by countries
As we have seen, every country has to deal with the following basic tax issue: how (and to what extent) double dividend taxation caused bv the overlapping of personal and corporate income taxes should be avoided In other words, even country has to decide NOW to deal with integration.
Summarizing the discussion so far. four models can be identified as lax solutions to the above-mentioned tax problem:
1. the classical system (modified or unmodified I,
2. the imputation system (full or partial);
3 the reduced taxation of distributed profits (split-rate method, dividend deduction method, zero rate method): and 4. the participation exemption
1,1 at 77 7H. Scv :i/m> Vann. >upni note Inn. al KS-h'» Vann. ••upra note Ibl), at t-V.
Selected Business fax I>mk>
According to the unmodified classical system, .ill distributions are taxed as any other items of income. In other words, this system provides no or little relief ior personal income tax on dividends. I'raditionalK both the United States and Switzerland have adopted this method. The assumption ol this model is that there is no real double taxation behind taxing distributions.
The modified classical system provides shareholders with reliel ol various kinds tor personal income tax on dividends unconnected \\ ith corporate income lax paid on distributions. This is the system adopted by Italy tor individuals.
According to the partial imputation system, partial credit i-> given for shareholder personal income tax liability in respect to corporate income tax paid on distributed dividends, I his system is adopted by the L nited Kingdom and France.
A full imputation system grants partial credit to shareholder personal income lax liability in respect to corporate income tax paid on distributed dividends. In other words, tax-credit shareholders are provided full-tax credit on tax liability for the corporate tax attributable to the dividends they receive. This system has been adopted by Australia. It was also adopted by Italy before 2004.
The reduced taxation of distributed profits model can be split into three submodels; (I) the split-rate method, according to which a loner rate is applied to distributed profits than to retained prolits. it was adopted by Gerifrtany before it moved to the participation exemption model; (2) the dividend deduction method, which provides a deduction of distributed income from the corporate income tax base; and (3) the zero rate method 'or toll integration), according to which distributed profits are exempt from corporate income tax.
llie fourth model of solving the Integration problem i-. the participation exemption model, under which dividends are not subject to lax lot the receiving shareholders, Today this model is the most common one in Europe, due to the tact that F.uropean tax law prescribed this method tor cross-border LL distributions and. therefore, many countries also adopted it domestically For example, in Italy, under lliecurrent system, corporate shareholders can exclude percent of the dividend from taxable income (partnership shareholders and sole proprietorship shareholders can exclude 60 percent of the dividend trom taxable income). However, individual shareholders are subject to a reduced rate on dividends (and capital gains) of 125 percent. In other words, Italy adopts the participation exemption model for corporate and partnership shareholders, while it adopts the modified classical system for individuals. It is worth noting that Italy, before 20O4, used to adopt full imputation system, which granted a full integration. The current model provides only a partial integration.
In the United States, a dividend tax rate cut, adopted tor individual! in 2003, provided a partial integration because it reduced the extent I
U>     UOH\l I'I'USI'IC IIVTSONJ l\Li>\tl I.WAIION1 WV
double taxation of corporate income However, this system, which is currently under revision, can be criticized with many arguments:
• It does not reach .1 tull integration.
• li creates distinctions among taxation ot different forma of income.
• it could give rise, through corporate income tax avoidance (tax
shelters and loopholes) and evasion to (quasi) double nontax-at ion. and only a small part ot the benefits given by such tax avoidance activities are recaptured upon payment of dividends.
• It increases incentives lor individuals to convert (through tax avoidance) ordinary income to capital gains.
• Price adjustments could >;rant unjustified (and undeserved) benefits to people who a I read v owned stock before the reform
As tor corporate shareholders, the United States has adopted a dividend received deduction method, which can be considered an evolution ot the participation exemption model. Generally, the United States has not adopted this method lor div idends from foreign corporations.