UNIT 7: TAXATION OF CROSS 7 BORDER ACTIVITIES
Key unit competencies: Compute taxation of cross border activities.
Scenario 1
Mr. Robert has a manufacturing and selling company which produces
2 products, product A and Product B. Product A is mainly consumed in
Rwanda, this means that Mr. Robert does not export product A. Product
B is mainly consumed outside of Rwanda, this means that Mr. Robert do
export of product B in different countries including East Africa Community
(EAC) countries. Due to an increase of customers in Uganda and Kenya,
Mr. Robert has opened a branch there and to make sure that the branches
is earning more profit, he has started to purchase the local products and
do a retailing there. In the recent period Mr. Robert has discovered that
the price of raw materials in Uganda are cheaper than in Rwanda and
has started to purchase the raw materials in Uganda and transfer them inRwanda without charging any additional cost to Rwandan company.
Scenario 2
Joe is a citizen of and lives in Rwanda. He has a home here, and lives here
with his wife and family. Thus, in the normal scheme of things, Joe would
be taxed on his income in Rwanda, in common with all other residents
and citizens who live here, and who use the roads, sanitation systems and
other public services here. However, Joe is slightly unusual, Every Tuesday
morning Joe flies to Tanzania, works there until Thursday afternoon andthen flies home again. He gets paid in Tanzania.
Question on scenario 1
As far as taxation is concerned, which types of trading Mr. Robert is doing?
How can you relate the two businesses of Mr. Robert?
Question on Scenario 2
In which country does the tax liability of Joe will fall? How that is will be
decided? What will happen if Joe taxed on Income Received in Rwanda
and income received in Tanzania? What do you think Rwanda should do toprotect Joe for being taxed in Tanzania?
7.1. Distinction between trading in and trading with a country
Learning Activity 7.1
From the photo above, describe the activity that person is doing?
This refers to the trading made within the territory of the country i.e., bothbuyer and seller are in the same country.
7.1.2. Trading with a country.
This refers to the trading with other territories i.e., the seller is in one country,
and the buyer is in another “international” trade. Trade with a country
accommodates the cross-border activities because under this, the buyer
or seller transfers the property, goods and services between individuals orbusiness entities who reside in different Jurisdictions/Countries.
Application activity 7.1
With clear example, differentiate trading in a country and cross borderactivities
7.2. Double taxation agreement
Learning Activity 7.2
What are you seeing on the above photo?
7.2.1. Double taxation
As we have seen in the introductory activity, if an individual or a company
is resident in Rwanda, they will be charged Rwandan income tax on their
Rwandan and overseas taxable income sources. Foreign source income may
have already suffered taxation overseas, according to the tax rules of theoverseas jurisdiction.
Income that is chargeable to income tax in Rwanda is the gross amount of
foreign income received. If the income also suffered tax in the foreign country,
there is ‘double taxation’. Hence, double taxation, refer to when a taxpayer
taxed both on income received where in his/her mother country taxed on gross
income received from local and foreign and the foreign country taxed him/heras he/she generated the income from its territory.
7.2.2. Double taxation agreement
International Taxation involves taxation which is cross border. It can arise
from an individual having taxable income or assets in two countries, or a
business operating in two (or more) countries. Due to increased globalization,
the growing level of businesses trading internationally around the globe, and
increased personal mobility, international taxation is becoming more and
more prevalent. Travel restrictions are less onerous, and it is no longer difficult
for people to move from one state to another to carry out businesses or to
seek employment opportunities. Capital is more mobile and with advances
in e-commerce and e-banking it moves more swiftly than ever before. Suchactivities are all likely to attract tax liabilities.
The Organization for Economic Co-operation and Development (OECD) has
developed a Model Tax Convention which may be used to determine how
double taxation is avoided. Countries may refer to the Model Tax Convention
when making their own double taxation agreements.
The main principles of the Model Convention are as follows:a) Total exemption from tax is given in the country where incomeDouble taxation arrangements may take the form of:
arises in the hands of certain persons such as visiting diplomats and
teachers on exchange programmes.
b) Preferential rates of withholding tax are applied to payments of
investment income whereby the usual rate would be replaced by a
lower rate.
c) Double taxation relief is given to taxpayers in their country of
residence by way of a credit for tax suffered in the country where
income arises. This may be in the form of relief for withholding tax
only or for underlying tax on profits out of which a dividend is paid
as well.
d) There is exchange of information so that tax evaders can be pursued
internationally.
e) There are rules to determine a person’s residence and to prevent dual
residency.
f) There are rules which render certain profits taxable in only one
country of the two contracting countries.
g) There is a non-discrimination clause so that a country does not taxforeigners more heavily than its own nationals
a) Bilateral conventions or agreements relief;
b) Unilateral relief;
Bilateral conventions or agreements relief: These are bilateral agreements
for relief from double taxation. This involves countries affected negotiating anagreement with a view to minimize or eradicate effects of double taxation.
Unilateral relief: Due to the difficulty involving double taxation negotiations,
it is possible for an individual country to remove the burden of double taxation
from international trade by opting to give relief for foreign taxation on a unilateral
basis i.e. without regard to whether the other taxing country extended relief or
not. This may be triggered by a representation by the business community.
A unilateral approach is usually a last resort where negotiations have proveddifficult due to political and other reasons.
Rwanda has double taxation agreements in place with Barbados, Belgium,
Jersey, Mauritius, Morocco, Singapore, South Africa, People’s Republic of China,
Democratic Republic of Congo, Luxembourg, Qatar, Turkey and United Arab
Emirates. These generally impose lower rates of withholding tax on payments
such as dividends, interest, management fees and royalties being paid from
Rwandan enterprises to entities located in these overseas countries. For
example, payments to South Africa have 10% withholding tax imposed insteadof the usual 15%.
7.2.3. Foreign tax credit
Foreign tax credit is also known as Double Taxation Relief. Actually, a foreign
tax credit or double taxation relief is given to eliminate the effects of double
taxation where income that has suffered tax in one country is also subjected to
tax in another country. The relief is given by way of a credit for the foreign tax
paid. And remember a foreign tax relief is granted to individual or company
where there is double taxation agreement in those countries. Thus, in the context
of Rwanda, a foreign tax credit arises when a tax payer who is a resident of
Rwanda is taxed on the income received both in Rwanda and outside Rwanda.
However, that tax liability is reduced by the amount of tax paid outside.
Note: According to article 7 of Law Nº 027/2022 of 20/10/2022 Establishing
Taxes on Income; If during a tax period, a resident in Rwanda generates
income derived from taxable activities performed abroad, in accordance with
Articles 4 and 6 of this Law, the income tax payable by that resident in respect
of that income is reduced by the amount of foreign tax payable on such income.
The amount of foreign tax payable shall be substantiated by appropriate
evidence such as tax declaration, a withholding tax certificate or other similar
acceptable document. However, the reduction of the income tax provided for
under Paragraph one of this Article shall not exceed the tax payable in Rwandaon income from abroad.
Steps in computing double taxation relief1. Calculate the total income received in resident and foreign countryApplication activity 7.2
2. Compute the tax liability of the total income earned from resident and
foreign country
3. Compute the tax liability of the income earned from resident country
4. Compute the tax liability that should have been paid in resident country
(Tax liability of the total income- Tax liability of the income earned from
resident country
5. Computation of the double taxation relief/ Foreign tax credit; This
should be equal to the lower between the tax liability computed in step4 and the actual tax paid in foreign country
Hellen is resident of Rwanda, during the month of December 2022 she
received the following employment income. From Rwanda; she received a
salary of FRW 720,000. From Kenya; she received Kenyan Shillings (KES)
5,400 net of tax of KES 780. Assume that Rwanda has a double taxation
agreement with Kenya and 1KES = FRW 100.
Required:
Compute the double taxation relief due to Hellen for the month of December
2022
7.3. East African Customs UnionLearning Activity 7.3
Describe your observation on the above photo
7.3.1. Meaning of East African Customs Union
The Customs Union is the first Regional Integration milestone and critical
foundation of the East African Community (EAC), which has been in force since
2005. It means that the EAC Partner States have agreed to establish free trade
(or zero duty imposed) on goods and services amongst themselves and agreed
on a common external tariff (CET), whereby imports from countries outside
the EAC zone are subjected to the same tariff when sold to any EAC PartnerState. East African customs union is also referred as Customs Union.
7.3.2. Features of a Customs Union
The main features of a Customs Union include the following:
i. A common set of import duty rates applied on goods from third countriesSuch main features of the EAC Customs Union are embodied in the Customs
(Common External Tariff, CET);
ii. Duty-free and quota-free movement of tradable goods among its
constituent customs territories;
iii. Common safety measures for regulating the importation of goods from
third parties such as phyto-sanitary requirements and food standards.
iv. A common set of customs rules and procedures including documentation;
v. A common coding and description of tradable goods (common tariff
nomenclature, CTN);
vi. A common valuation method for tradable goods for tax (duty) purposes
(common valuation system);
vii. A structure for collective administration of the Customs Union.
viii. A common trade policy that guides the trading relationships with
third countries/trading blocs outside the Customs Union i.e., guidelines
for entering into preferential trading arrangements such as Free Trade
Area’s etc. with third parties.
Union Protocol and its annexures, Common Customs Law (and regulations)
and the Treaty. (Reference for students and Teachers).7.3.3. Objectives of the Customs Union
The objectives of the East African Community are broader and cover almost
all spheres of life, the main objective of the Customs Union is formation of a
single customs territory. Therefore, trade is at the core of the Customs Union.
It is within this context that internal tariffs and non-tariff barriers that could
hinder trade between the Partner States have to be eliminated, in order tofacilitate formation of one large single market and investment area.
Objectives of the Customs Union
The objectives of the Customs Union include:
a) Further liberalize intra-regional trade in goods on the basis of mutually
beneficial trade arrangements among the Partner States;
b) Promote efficiency in production within the Community;
c) Enhance domestic, cross border and foreign investment in the
Community; and
d) Promote economic development and diversification in industrialization
in the Community
Application activity 7.3With a clear example, outline the objectives of customs union.
7.4. Transfer pricing
Learning Activity 7.4
Describe your observation on the photo above?7.4.1. Transfer pricing principles
Multinational groups of companies will typically trade with each other in
goods and services. The prices at which such transactions occur is called
the transfer price. While the trading of goods between Rwanda and other
countries is governed by Article VII of GATT (the General Agreement on
Tariffs and Trade), and must not take place at an artificial or contrived value,
this rule does not apply to the transfer price for services. An overseas parent
company could therefore charge management fees, and manipulate the
transfer price so that profits arise in a country where the rates of taxation are
lower so that the overall tax liability of the group is minimized. The transfer
pricing rules mean that the purchase price of goods and services paid for by
Rwandan businesses to related parties should not exceed the amount thatwould have been paid to an independent third party.
7.4.2. Definition of related person
Article 3 of Law No 027/2022 of 20/10/ 2022 defines related persons as ‘any
person who acts, or is likely to act, in accordance with the directives, opinion
or wishes of another person when such directives, opinion or wishes are
communicated or not communicated to them’. The following are specifically
deemed related persons:a) An individual and his or her spouse and their direct lineal ascendantsA common example of related persons is a company and its shareholders and
or direct lineal descendants and their relatives in the collateral
lineage until at least the 3rd degree.
b) A person who participates directly or indirectly in the management,
control or capital of another person.
c) Third person who participates directly or indirectly in the
management, control or capital or both control and capital of
another person;
d) Such persons referred to under sub items a., b. and c. who participate
directly or indirectly in the management, control or capital of an
enterprise.
e) A person who is under direct or indirect common control with
another person
directors; the shareholders meet the definition in (b) above as persons who
participate in the capital of the company (which is a legal person in its own
right), and the directors participate in management.
7.4.3. Impact of transfer pricing rules
Related persons must retain documents that justify that the prices charged on
transactions between themselves were carried out on an arm’s-length basis. If
a taxpayer fails to retain such documentation, the tax administration has the
power to adjust taxable profits accordingly. For example, if the price paid for
a management service by a Rwandan business to its overseas parent company
was above an arm’s-length price, the tax administration would increase taxable
income by the difference between the actual price and the arm’s-length price.
7.4.4. Thin capitalization
Internationally, most tax jurisdictions (including Rwanda) provide that taxable
income may be reduced by amounts paid as interest on loans to related parties.
By contrast, most do not provide tax relief for distributions to owners made
to shareholders by way of dividends. As a result, multinational enterprises are
motivated to finance their foreign subsidiary companies through loans rather
than share capital. When the subsidiary is financed heavily by debt finance, its
taxable profits would be substantially reduced by interest payments.
To prevent huge reductions of taxable profits by way of interest deductions, thin
capitalization rules apply. These rules limit the amount of interest that would
be allowed as a deduction when computing taxable business profits. This is
done by not allowing as an expense the amount of interest paid on related party
loans when the company’s debt to equity ratio exceeds a certain limit.
In Rwanda, this limit is a ratio of four to one: where debt is more than four
times equity (share capital on the balance sheet), a company is said to be ‘thinly
capitalized’ and interest payable on loans to related persons will not be giventax relief (and must therefore be added back).
Application activity 7.4
A Plc is a registered commercial bank in Rwanda. The bank pays its French
parent company a management services charge of FRW 50,000,000 per
year. This figure is 25% higher than what other banks in Rwanda pay for the
same services to their parents’ companies. In addition, this is higher than
the other group subsidiaries’ pay despite the fact that the services provided
by the parent to all of its subsidiaries in Africa are similar in scope.
Required:
Compute the transfer pricing adjustment if any.
7.5. Computation of tax for cross border activitiesLearning Activity 7.5
Describe your observation on the above photo?
7.5.1. Compute the tax relating to cross border activities for
an individual
The tax liability should be equal to Gross tax liability computed as per tax
rate for individual in Rwanda minus the double taxation relief.
Steps for computing tax liability1. Calculate the Double taxation relief7.5.2. Compute the tax relating to cross border activities for a
2. Compute the tax liability, the tax liability or tax payable is equal to
Gross tax liability minus double taxation relief.
company
The tax liability should be equal to gross tax liability computed as per tax
rate for companies in Rwanda minus the double taxation relief.
Recall: The income tax shall not exceed the tax payable in Rwanda on income
from abroad. This means that the rate of tax for foreign income should not
exceed the tax rate charged in Rwanda.
Steps for computing tax liability
1. Calculate the Double taxation relief
2. Compute the tax liability, the tax liability or tax payable is equal to Gross
tax liability minus double taxation relief. Remember: CIT rate in Rwandais 30%
Application activity 7.5
1. Daniel, a resident of Rwanda earned income from Rwanda and
United Kingdom (UK) as he has a part time job there. During the
month of December 2022, Daniel received an Income from Rwanda
of FRW 1,765,000 and Income from United Kingdom (UK), he
received UK£ 480 net of tax deducted amounting to UK£ 96. The
average exchange rate during that time 1 UK £ was FRW 1400.
Rwanda has signed a double taxation agreement with UK.
Required:
Compute the tax liability due to Daniel for the month of December 2022.
2. Maurice Enterprise Ltd is company operating in Rwanda since
2015, because Rwanda and Mauritius signed a double taxation
agreement, Maurice enterprise Ltd has expanded its business to
Mauritius to exploit the benefit of that agreement.
During the year ended 31st December 2021, Maurice Enterprise Ltd had
made a profit before tax (PBT) of FRW 4,500,000 in Rwanda’s business
activities and Net equivalent of FRW 17,000,000 in Mauritius. The
corporate income tax rate at Mauritius was 15%.
Required:
Compute the tax liability due to Maurice Enterprise Ltd for the year ended
31st December 2021.
Skills Lab Activity 7
Through the field visit of one of the companies that do business crossing
out of Rwanda’s territory, student will be required to prepare a report on
the following questions:1. How that company do declaration of an income received fromEnd of unit assessment 7
outside of Rwanda?
2. How much of tax paid in the foreign country that company operating
in?
3. What are the challenges of trading with other countries faced by
that company?
4. What was the facilitation of Rwanda in the business process of thatcompany?
Questions1. List the features of customs unionRequired:
2. Describe thin capitalization.
3. Differentiate bilateral and unilateral agreement relief as form of
double taxation agreement.
4. Mr. Alex Mugabe works partially in Rwanda and partially in Canada.
His family is based in Rwanda. During the month of January 2023,
Mr. Mugabe earned an equivalent of Rwanda francs 3,600,000 gross
from his employment in Canada. He paid an equivalent of Rwandan
francs 1,100,000 as tax on the income. He also earned income from
his employment income in Rwanda of FRW 1,200,000. Assume that
Rwanda has a double taxation agreement with Canada.
Tax liability for Mr. Alex Mugabe for the month of January 2023.
5. Bugesera Company Ltd (CL Ltd) is a company operating in Rwanda
and South Africa. For the year ended 31st December 2022, CL Ltd
generated a gross profit of FRW 15,000,000 in Rwanda and SouthAfrican Rand (ZAR) 600,000 in South Africa.
Additional information:
i. CL Ltd incurred expenses of FRW 8,400,000 to generate income in
Rwanda
ii. 1 ZAR= FRW5
iii.No expenses incurred in south Africa.
iv. Rwanda and south Africa signed a double taxation agreement.
v. CL Ltd paid tax of ZAR 210,000 in South Africa.
Required:
Calculate the tax liability to be paid by CL Ltd for the year ended 31stDecember 2022.