In order to understand the practical application in which this question is answered a short description of the country is herewith given:
The country being used is a small island state of the coast of Panama. Its called Barokaland. Three main economies sustain the island, namely fishing, growth and export of juniper berries ( for the making of gin) and tourism. The fishing industry is mainly made up of local residents, who make use of closed corporations and private companies to operate within. Fish is mainly exported and amounts to 30% of the country's income. Tourism is the fastest growing economy and has increased its stake in the economy of the country from 25% to 45% over the last 10 years. Most of the businesses operating in the tourism industry operate in either private or public companies. Two major international hotel groups have invested in the island, and have to in terms of their agreement with the government employ 70% of their entire workforce from the island. The export of juniper berries constitutes 20% of the countries economy. Only one company is engaged in this market segment, this publicly owned company source the berries from farming cooperatives, from where they sort, wash, grade and package the berries for the export market.
The average income for a Barokian is $10 000 per annum. The country has an 88% employment rate and a well - developed social welfare system. Personal income tax is a standard rate of 25% on all income earned, this therefore equate to horizontal equity, but not vertical equity.
Barokaland is a signatory to the OECD.
Classic taxation of companies:
In terms of the corporate tax structure in Barokaland, all companies are deemed to be legal entities, with the accompanying legal rights and obligations. All companies must be registered with the government. Partnerships are not deemed to be companies; each partner is taxed as if they are an individual.
Companies are taxed at a standard 15% on profits prior to taxes. All profits not paid out which is more than 50% of the dividend paid are in addition taxed an additional 10%.
Dividends are taxed under the shareholders personal income tax portfolio at the standard personal income tax rate. Non-residents are required to pay the tax on the dividend prior to removal of the money out of the country. See Annexure A.
Residents who earn foreign dividends are required to declare the dividends, but can claim the tax paid in that country as a credit against their total tax liability.
A classic corporate tax system ensures that no discrimination takes place against non-residents companies and persons
No vertical equity means that more wealthier individuals or companies do not carry a bigger share of the welfare burden
The additional taxation on non-paid out profits stimulate and encourage companies to pay out the dividends to shareholders ensuring that the tax on it is also collected
Double taxation on both profits and dividends can have a negative impact on investors
Horizontal equity does stimulate a sharing of the tax burden
Potentially non-compliance by non-residents on dividend taxation exists
No vertical equity exist
Dividend imputation is utilised to imputed the tax payable on the company profit to the shareholders by way of a tax credit to reduce the income tax payable on a distribution. It reduces or eliminates the tax disadvantages of operating a business in a country. In so doing it reduces double taxation.
Implementation of dividend imputation therefore can consist of the following:
Companies still pay tax on the profits, but imputes it by way of a tax credit to the shareholders on dividend distribution. The company therefore deducts the dividends payable against the tax payable on the profit, thereby reducing double taxation
Residents: Dividends is taxable in the hands of the resident as income achieved, but can utilise the tax credit to reduce the tax liability.
Non-residents: Potential non-compliance is overcome by the creation of the tax credit on dividends. Non-residents can then utilize the credit against their tax liability in their country of residence.
Companies only pay tax on profit raised within the country, any dividends accrued from companies in foreign countries remain taxable if there is no dividend imputation in that country. If there is the tax credit is utilised to reduce the tax liability of the company.
Vertical equity can also be imposed though this process by potentially amending the tax rate on profits for resident companies on a slide rule scale, where possible making it preferential for foreign companies to chance their residence status to Baroka land, which will have additional benefits for the country, i.e personal income tax collection
It is further foreseen than with the simplification though imputation a taxation cost benefit can be effected, which will effectively mean more money for the fiscus to spend.