The underlying principle which governs the reverse charge mechanism is that it seeks to shift the liability to account for the VAT on specified imported services from the supplier to the customer. The general purpose is to reduce the administrative burden for the supplier to register for VAT in a jurisdiction in which it has not established business.

In countries where the Reverse Charge Mechanism exists, the purchaser will be required to account for the VAT on the value of the supplies made to him. The purchaser will treat the imported supply as a supply made to himself and therefore will account for the output VAT. Since the supply is also a supply made to him, he is allowed to treat the same VAT as input tax and will deduct it in arriving at his VAT liability/refundable for that period.

The Reverse Charge Mechanism generally applies to imported services within many of the Caribbean countries.

Below is a summary of the countries where the Reverse Charge Mechanism is applicable:-

DEFINITION

In general/lay terms, a management charge/fee is a payment made by a company in one jurisdiction to a company in another jurisdiction for the provision of certain management services provided to it by the other.

THE MULTI-NATIONAL BUSINESS CONTEXT

In the specific context of developing countries, it is not uncommon for a local subsidiary of a multi-national company, for example, to pay its parent (often located in a developed country) for the provision of certain centralized services and expertise in order to facilitate its operations in the local Caribbean territory (e.g. accounting, treasury services and information technology).

In this manner, many multinational companies operate like a singular global entity with a core strategic vision and centralized nervous system, but with subsidiaries/branches that have delegated operational oversight in the specific regions it carries on business. Simply put, it is more efficient to operate in this manner than for the multinational to replicate the Head Office’s core functions in each territory it carries on business.

Naturally, each branch/subsidiary will pay its head office/parent for the provision of these “management” or “shared services” instead of attempting to obtain these services  within the local territory  (some of which may not be cost effectively available in the local territory in any event).

From the perspective of the local Caribbean tax authorities, however, such payments represent flows of currency outside of the country. Further, in the absence of transfer pricing legislation, unregulated payments in respect of “management charges” to a non-resident head office/parent may appear to provide an opportunity for multinationals to improperly strip profits from its Caribbean branch/subsidiary and thereby erode the local tax base.

In order to deal with these potential currency and tax leakages, many Caricom countries:

(a)    Levy withholding tax on such payments made to non-residents; and

(b)    Limit the ability of the local branch/subsidiary to deduct payments made in respect of management charges paid to non-residents in computing their taxable income.

COUNTRY SPECIFIC INFORMATION

Table: Country Overview

∇ In the absence of a specific statutory definition, regional practitioners must have regard to definitions adopted in the local courts, as is consistent with the Caribbean’s common law tradition.

Ω The statutory definition for the purposes of the “restriction” may differ from the definition for the purposes of “withholding tax”.

‡ To be updated.

THE IMPORTANCE OF CARIBBEAN TAX PLANNING

From the perspective of the multinational, the combination of withholding tax on payments made to the head office/parent and the domestic restriction on the tax deductibility of expenses incurred in respect of management charges payable to non-residents makes “management charges” a major consideration when determining the viability of doing business within a Caribbean territory.

Indeed, one may posit the view that in the context of a branch/head office arrangement a combination of a domestic restriction of management fee deductibility and a withholding tax on a payment in respect of said fees to its head office is a punitive form of double taxation in the region.

Specifically:

(i)                  the local branch operation is paying more tax than its local counterpart on the basis that it cannot deduct what would otherwise be treated as a legitimate business expense for corporation tax purposes; and

(ii)                the branch’s non-resident head office (which, in law, is the same legal entity as the branch) is also incurring the withholding tax burden on the gross payment.

Key questions

In light of these issues, amongst a host of others, it is particularly important for multinationals to obtain Caribbean tax planning advice concerning:

(i) What are the relative advantages and disadvantages of operating in the locality as a branch vs. subsidiary?

(ii) What is the definition of “management charge” in the domestic tax law of the applicable Caribbean territory?Ω

(iii) What is the definition of “management charge” in the applicable Double Taxation Treaty governing the relationship between the head office/parent company and its branch/subsidiary? Does the “Management Fee” article apply on the facts?

(iv) How are chargeable profits of “permanent establishments” determined pursuant to the applicable Double Tax Treaty?

(v) What is a “payment” and where does it “arise” for the purposes of the domestic tax law of the applicable Caribbean territory?

(vi) What are the implications of the “Associated Enterprises”, “Limitation on Benefits” and “Non-Discrimination” Articles in the applicable Double Tax Treaty?

CASE LAW (Downloadable Content for Members Only)

Against the background of these issues, the following cases are particularly noteworthy:

•  Board of Inland Revenue v Young (Selwyn), (1997) 53 W.I.R. 335

•  William H Scott v The Board of Inland Revenue, No. I 80 of 1983

•  Shell Trinidad Limited v The Board of Inland Revenue, Appeal No. 1 of 2011

•  Esso Standard Oil S.A. Limited v The Board of Inland Revenue, Nos. I 114 – 125 of 1982

•  Commissioner of Inland Revenue v Hong Seng Bank Limited, Privy Council Appeal No. 36 of 1989

•  The Appeal Commissioners v The Bank of Nova Scotia, Privy Council Appeal No. 65 of 2012

CAVEAT

This blog is published by the site administrators of www.caribbean-tax.com on June 25th, 2016 for discussion purposes only. Should you require legal advice, please contact us and we shall be happy to make a referral to a local tax practitioner.

DISCUSSION FORUM

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Branch or Subsidiary?

A question frequently asked by multinational companies seeking to do business in the Caribbean is whether they should operate through a “branch” or, alternatively, whether they should operate via a locally incorporated “subsidiary company”.

Regrettably, and all too often, the advice provided is couched in the following terms:

Both structures are largely inter-changeable, but have two main distinguishing features: an incorporated entity has the benefit of limited liability (i.e. the ability to ring fence legal liability in T&T), but “branches” have the benefit of requiring less red-tape if and when the time to wind up operations arises (a potential benefit to multi-nationals with short to medium term business interests in the territory).

In the view of the author, such conclusions are superficial at best, and inaccurate at worst. Such conclusions merely scratches at the surface of matters to be considered – advice that adds real value must analyze the proposed business adventure against the myriad of legal and regulatory matters that are relevant to the idiosyncratic circumstances of that business.

Consistent with this view, we must emphasize at the outset that this note is not intended to be a substitute for legal advice, nor is it intended to constitute an exhaustive discussion of all the possible considerations that may be relevant to this question. Instead, the author raise some of the tax considerations that should be considered.

The relevance of residence

As a starting point, it is relevant to note that a branch is likely to be treated as a “non-resident company” and a locally incorporated subsidiary is more likely than not to be treated as a “resident company” for tax purposes. This classification is the first significant distinction between the two vehicles.

World Wide Income vs. Territorial Taxation

Generally, companies that are resident in a Caribbean Country are usually chargeable to tax on their worldwide income, whereas non-resident companies are only chargeable on income directly or indirectly accruing from within that territory.

Accordingly, a branch’s tax liability is territorially ring fenced.

World Wide Loss Utilization vs. Territorial Loss Utilization

A natural corollary of the being taxable on worldwide income is that a Head Office should be entitled to take into account expenses, where so ever they occur in the world. Double tax treaties and the foreign tax credit rules focus on cross-jurisdictional tax allocation where “profits” are made. They are often silent on the issue of cross-jurisdictional “loss” allocation. As such, DTT do not deal with the computation of chargeable profits at an entity level.

A legitimate question, therefore, is to what extent can a branch structure enable a head office to reduce its taxes simultaneously at home and abroad? The author notes that inadequate consideration is often given to this very important question in the Caribbean.

In no Caribbean territory is a local parent permitted to utilize the losses of its non-resident subsidiary company in order to reduce its corporation tax liability. However, may a locally incorporated parent company utilize the losses of its non-resident branches in order to reduce its corporation tax liabilities?

Deemed Branch Profits Tax

In some jurisdictions, branches are deemed to have remitted all of their profits to their head office in the form of a dividend and is made subject to withholding tax.

Companies, however, only pay withholding tax on actual dividend payments made. The withholding tax is applicable, at most, on the sum after Corporation tax is paid (i.e. profit after tax).

Withholding tax implications

As a matter of Statutory interpretation

The following Caribbean countries have specifically legislated that for the purposes of withholding tax applicability a branch and head office must be treated as separate legal personalities:

However, in the absence of specific legislation then, and in accordance with the Caribbean’s common law tradition, regard must be had to the applicable case law.

The leading case in the region is the Privy Council case of  Appeal Commissioners v Bank of Nova Scotia [2013] UKPC 40 (download here). In this appeal, their Lordships were tasked with the construction of the Grenadian Income Tax Act (s. 50(1)) to determine whether a withholding tax obligation arose in respect of a reimbursement paid by a Grenadian Branch to its Canadian Head Office.

The material provision of the GITA provided as follows:

“50(1) Where a person whether or not engaged in a business in Grenada makes payments to a non-resident person of interest… discounts, commissions, fees, management charge, rent, lease premium, license charge, royalties or other payment whether or not the payer is entitled to deduct such payment in computing chargeable income of a business, the payer shall deduct tax at the rate specified in the third schedule and pay the amount of tax so deducted to the Comptroller within seven days after the date of payment or credit to the payee.”

The Grenadian Court of Appeal, with which the Privy Council later agreed, took the view that the legislation, though not using the term “other person” as in Antiguan legislation, does nonetheless imply a duality of entities. Further, the Privy Council opined that the word “person” is clear and does not admit the inclusion of the unincorporated Head Office and that “the payer and the payee being the same person, section 50 has no application.”

Is there a “payment”?

The obligation to remit withholding tax to the applicable taxing authority is triggered when there is a payment. Consequently, expense recognition in the context of cross-border transactions operates as an exception to generally accepted accrual accounting standard – it operates on a cash basis. Specifically, the obligation to remit withholding tax is only accounted for when the transaction has been consummated in a “payment”, and the expense is only recognized for tax deductibility purposes when WHT has been accounted for. 

Interestingly, it is universally recognized that interest is taxable or expensed on a cash basis, however as a matter of practice in the Caribbean there is inconsistency in the application of payment in the context of WHT applicability.

In the T&T case of Esso case (download here).

Are inter-company transactions tax deductible?

Related to the question of whether WHT is applicable on payments between a branch and its head office is whether an inter-office (branch/head office) transaction is relevant for tax purposes. By way of context, if a transaction were to occur between a branch and its head office both domiciled within a locality, the transaction would be a nullity for tax purposes. Should it make a difference to the taxability of the transaction that territorial waters are inter-posed in between?

It is important to consider at the outset that an external company / branch on business in a territory is a “resident” of another country. In the lexicon of double tax treaties, a branch is a “permanent establishment” of a company that is a resident of the other member country to the Double Tax Treaty. A permanent establishment “means a fixed place of business through which a resident of one of the Contracting States engages in industrial or commercial activity” (US/TT Double Tax Treaty Article 9(1)). As such, one must analyze the terms of the applicable Double Tax Treaty for additional source of guidance on the tax treatment.

It is common for the “Business Profits” Article of treaties based on the OECD Model to contain the following provisions (e.g. 7(2) and (3) of the US/TT DTT):

(2)  Where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.

(3)  In determining the profits of a permanent establishment there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment , including an allocation of executive and general administrative expenses incurred for the purposes of the enterprise as a whole, whether in the State in which the permanent establishment is situated or elsewhere.

In other words, where there is a branch and head office relationship, the payments to the HO are tax deductible. The import of this section is that one can disregard the reality that the branch and head office are one and the same legal entity, but can treat them as separate entities for the purposes of profit allocation.

Needless to say, if inter-office payments are tax deductible, may not incur withholding tax and may not be subject to a management charge restriction, operating through a branch may be particularly beneficial to some multinationals vis-à-vis a subsidiary.

Interestingly, there is no similar clause to section 7(2) of the OECD model. Instead, the language of the Caricom Treaty is as follows at article 8(3) “

“3. In determining the profits from a business activity there shall be allowed as deductions expenses which are incurred for the purposes of that activity in accordance with the laws of the Member State in which such activity is undertaken”

In other words, whereas the OECD Model specifically addresses this issue and creates the legal fiction of independent enterprises – the Caricom Treaty does not. In light of this, can a Caricom enterprise treat an inter-company transaction as taxable if the domestic law is silent on the issue?

Conclusion

For multi-national companies seeking to do business in T&T, it may be worthwhile considering using a branch instead of a subsidiary. One basis is that on inter-office transactions there ought not to be withholding tax, whereas on transactions between Parent and Subsidiary WHT may be a consideration.