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Taxing Capital Gains Difficult but Possible, IMF Officials Say

Posted on Oct. 16, 2019

Despite the practical difficulties involved, taxing nonresidents’ capital gains on transfers of indirectly owned domestic property makes economic sense and offers developing countries a potentially significant revenue source, according to IMF officials.

Speaking October 15 at the annual meetings of the World Bank and IMF in Washington, Shafik Hebous of the IMF’s Fiscal Affairs Department said developing countries’ tax administrations often cite the taxation of indirect gains on domestic immovable property as one of their top enforcement challenges. Although countries have the right to decide whether to tax these gains, IMF officials believe that gains on immovable property constitute rents that can be taxed without distorting investment decisions, according to Hebous.

“It's a policy choice. A country may wish to tax or not to tax these gains,” Hebous said. “But our research, our work, [and] our experience suggests that — on balance — there are very good reasons to tax these gains, and these reasons are based on economic principles, including efficiency and revenue.”

Hebous said that bilateral tax treaties represent one of the biggest legal obstacles to effectively taxing offshore gains. Under article 13(4) of the OECD and U.N. model tax conventions, a contracting country can tax capital gain on the offshore alienation of shares or comparable interests in an entity if domestic immovable property accounts for more than half of their value at any time during the preceding year. However, only 35 percent of bilateral treaties include a parallel provision, and treaties involving one developing country do so at an even lower rate, according to Hebous.

“The good news is that the likelihood of including this provision is increasing over time,” Hebous said.

The IMF and other multilateral organizations have recognized the more effective taxation of indirect assets transfers as a policy priority for developing countries. In July 2018, the Platform for Collaboration on Tax — a joint initiative of the IMF, OECD, U.N., and World Bank — released its second draft toolkit on taxing offshore indirect transfers that recommends the taxation of offshore indirect transfers and suggests different implementation models. According to Hebous, the objective of taxing offshore gains makes sense.

“The value is very much connected to its location and to the country in which this asset is located. And in many developing countries, they don't have too many valuable assets,” Hebous said.

According to Christophe Waerzeggers of the IMF’s Legal Department, the IMF advises developing countries bound by treaties without an exception based on article 13(4) to consider the local entity that owns the asset to have realized the gains.

“In other words, the gain is now sourced with the resident entity in the location country. There's no treaty issue because we're taxing our own residents,” Waerzeggers said.

Imposing a withholding or reporting mechanism under this approach can help developing countries overcome the information challenges involved in taxing transfers that can take place in another jurisdiction between two nonresident enterprises, Waerzeggers said. Countries should also consider expanding their definition of immovable property, regardless of which entity bears the tax liability and withholding or reporting obligations, he added.

“In both cases, countries get to define what is immovable property. And this is where the toolkit provides strong arguments for location countries to use a more expansive definition of immovable property so that the legal owner, the tax result, is more closely aligned to what the policy objective would be,” Waerzeggers said.

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