handbook-tb

Taxation of income from servicessubject to domestic tax. To the extent that such amounts are deductible,they reduce or erode the domestic tax base. If the payments are subjectto source country tax in the hands of the non-resident recipients of thepayment, the domestic tax base will be eroded only to the extent of thedifference, if any, between the reduction in tax as a result of the deductionand the tax imposed on the non-resident service provider. Forexample, in principle, there will be no erosion of the domestic tax baseif non-residents are subject to tax on their net income at the same ratesapplicable to resident taxpayers. 50 However, the domestic tax base maybe eroded if non-resident service providers are subject to a final grossbasiswithholding tax that is levied at a rate less than the ordinary rateapplicable to resident taxpayers. For example, if the ordinary tax rateis 35 per cent and the rate of withholding tax on services is 15 per cent,the domestic tax base will be eroded to the extent of 20 per cent of thegross amounts paid to non-residents for services. The erosion of thedomestic tax base is greatest where the amounts paid to non-residentsfor services are deductible but the non-resident service providers arenot subject to any domestic tax for some reason.In addition, the treatment of non-resident service providersin their countries of residence must be taken into account. A nonresidententerprise may perform services in another country througha branch or PE there, through a subsidiary corporation establishedin that country or directly (that is to say, not through a branch, PE orsubsidiary) to residents of that country. Ordinarily, the source countrywill impose tax on any income from services derived by a residentsubsidiary or on income earned by the non-resident through a branchor PE, but may not impose tax on other income from services derivedby a non-resident service provider. The country in which the enterpriseis resident may tax any income derived by the enterprise from services,including services provided outside the country, unless that countrytaxes on a territorial basis or is a tax haven or provides an exemptionfor foreign source business income earned through a PE. If the countryof residence taxes the income, it will usually provide a credit for any50This analysis does not take into account the amount of tax actuallypaid by the non-resident. For example, the source country’s tax base will beeroded to the extent that the non-resident’s income from services is reducedby expenses.73