Tax Law Design & Drafting

987 Pages·2000·6.875 MB·English

by  Victor Thuronyi

V O L U M E 1 & 2
1
Tax Law Design and
Drafting
Editor: Victor Thuronyi
Volume 1 & Volume 2
Tax Law Design and Drafting
Editor: Victor Thuronyi
©1996 International Monetary Fund
Volume 1: 1996
Volume 2: 1998
This book considers the development of tax legislation from a
comparative law perspective. It grows out of the IMF Legal
Department's experience in assisting many developing and transition
countries with the drafting of tax legislation, and distills from this
experience practical guidelines for officials and their advisors. The
two volumes cover a wide range of topics, from the legal framework
for taxation to VAT, and include such specialized topics as inflation
adjustment. The second volume focuses on the income tax.
TABLE OF CONTENTS
VOLUME 1 ...........................................................7
1. TAX LEGISLATIVE PROCESS ................................................. 8
I. INSTITUTIONALIZING THE TAX REFORM PROCESS ..................................................................................................... 8
II. INTERDISCIPLINARY NATURE OF TAXATION .......................................................................................................... 11
III. COMMUNICATION AND COLLABORATION IN THE TAX REFORM PROCESS .................................................................. 12
IV. DRAFTING PROCESS ...................................................................................................................................... 16
V. SPECIAL CONSIDERATIONS IN USING FOREIGN LEGAL ADVISORS .............................................................................. 17
2. LEGAL FRAMEWORK FOR TAXATION ................................ 21
I. Legal Foundation; Power to Make Tax Laws ................................................................................... 22
II. General Principles and Limitations on Power to Make Tax Laws ..................................................... 25
III. Interpretation of Tax Laws ............................................................................................................... 39
IV. Distribution of Tax Law Making Power Between the Legislative and the Executive Branches of
Government ............................................................................................................................................. 61
V. Division of Tax Powers Between the Central and Local Governments ............................................. 69
3. DRAFTING TAX LEGISLATION ............................................ 77
I. INTRODUCTION............................................................................................................................................... 77
II. UNDERSTANDABILITY ...................................................................................................................................... 79
III. ORGANIZATION ............................................................................................................................................ 90
IV. EFFECTIVENESS ............................................................................................................................................. 93
V. INTEGRATION ................................................................................................................................................ 99
4. LAW OF TAX ADMINISTRATION AND PROCEDURE .......... 106
I. Structure of Tax Administration Law ............................................................................................. 107
II. Matters to Be Included in a Tax Administration Law ..................................................................... 111
III. Taxpayer Compliance and Sanctions ............................................................................................. 122
5. REGULATION OF TAX PROFESSIONALS ............................ 143
I. Basic Policy Considerations in Regulating Tax Advisors ................................................................. 144
II. Tailoring Regulation to Functions of Tax Advisors ......................................................................... 155
III. Approaches to Regulation ............................................................................................................. 157
IV. Legal Consequences of Using Advisors .......................................................................................... 163
Appendix A. Organization of Tax Profession in Different Countries ........................................................ 166
6. VALUE-ADDED TAX ......................................................... 169
I. Introduction ................................................................................................................................... 169
II. Taxable Persons ............................................................................................................................. 180
III. Supplies of Goods and Services ...................................................................................................... 188
IV. Taxable Supplies ............................................................................................................................ 200
V. Exempt Supplies ............................................................................................................................. 206
VI. Taxable Value of Supplies .............................................................................................................. 212
VII. Payment of VAT ......................................................................................................................... 216
VIII. Procedure and Administration .................................................................................................. 226
IX. Special Cases .................................................................................................................................. 233
7. VAT TREATMENT OF IMMOVABLE PROPERTY ................. 235
I. Introduction ................................................................................................................................... 235
II. Nature of the VAT .......................................................................................................................... 235
III. How Immovable Property Should be Taxed ................................................................................... 238
IV. How Immovable Property Is Taxed ................................................................................................ 241
V. Conclusion ..................................................................................................................................... 245
8. EXCISES .......................................................................... 249
I. Introduction ................................................................................................................................... 249
II. General Design Issues .................................................................................................................... 254
III. Issues in Designing Specific Taxes .................................................................................................. 260
9. TAX ON LAND AND BUILDINGS ....................................... 266
I. Introduction ................................................................................................................................... 266
II. Legal Issues in Defining the Tax Base ............................................................................................ 271
III. Property Rights and Valuation ....................................................................................................... 283
IV. Legal Issues in Setting the Tax Rate ............................................................................................... 286
V. Administrative Issues ..................................................................................................................... 288
VI. Checklist of Issues for Legislative Drafting..................................................................................... 290
10. TAXATION OF WEALTH ................................................. 293
I. Introduction ................................................................................................................................... 293
II. Issues in the Design of Periodic Net Wealth Taxes ........................................................................ 302
III. Design of Wealth Transfer Taxes ................................................................................................... 316
11. SOCIAL SECURITY TAXATION ......................................... 339
I. Introduction ................................................................................................................................... 339
II. Issues in Social Security Taxation for Employees ........................................................................... 353
III. Issues for the Self-Employed .......................................................................................................... 377
IV. International Aspects ..................................................................................................................... 380
V. Interaction of Income Tax and Social Security Schemes ................................................................ 388
VI. Conclusion ..................................................................................................................................... 396
12. PRESUMPTIVE TAXATION ............................................. 397
I. General Concepts ........................................................................................................................... 397
II. Legal Characteristics of Presumptive Methods .............................................................................. 399
III. Particular Presumptive Methods ................................................................................................... 402
Appendix A. Lesotho Provision on Outward Signs of Lifestyle ................................................................ 426
13. ADJUSTING TAXES FOR INFLATION ............................... 430
I. EFFECTS OF INFLATION ON TAX LIABILITY—IN GENERAL........................................................................................ 431
II. ADJUSTMENT OF TAXES OTHER THAN INCOME TAX ............................................................................................ 435
III. ADJUSTMENT OF INCOME TAX ....................................................................................................................... 437
IV. CONCLUSION ............................................................................................................................................. 456
VOLUME 2 ....................................................... 471
14. INDIVIDUAL INCOME TAX ............................................. 472
I. Introduction ................................................................................................................................... 472
II. General Design .............................................................................................................................. 472
III. Taxable Income .............................................................................................................................. 478
IV. Employment Income ...................................................................................................................... 485
V. Business and Investment Income ................................................................................................... 500
VI. Miscellaneous Receipts .................................................................................................................. 501
VII. Tax Relief for Personal Expenses ............................................................................................... 508
VIII. Timing Issues ............................................................................................................................. 511
IX. The Taxpayer ................................................................................................................................. 513
X. Income Tax Rate Scale ................................................................................................................... 523
XI. Tax Offsets ..................................................................................................................................... 529
XII. Administrative Aspects of Taxing Employment Income ............................................................ 532
15. THE PAY-AS-YOU-EARN TAX ON WAGES ....................... 539
I. Introduction ................................................................................................................................... 539
II. PAYE Calculation Methods ............................................................................................................. 542
III. Finality of PAYE .............................................................................................................................. 544
IV. Administrative Burden ................................................................................................................... 547
V. Social Security Contributions ......................................................................................................... 549
VI. Administrative Constraints of Developing and Transition Countries ............................................. 550
VII. Impact of Inflation on Withholding ........................................................................................... 552
VIII. Withholding Systems: Country Examples .................................................................................. 553
IX. The PAYE Recommended for Developing and Transition Countries ............................................... 553
Appendix. Description of National PAYE Systems .............................................................................. 557
16. TAXATION OF INCOME FROM BUSINESS AND
INVESTMENT ...................................................................... 569
I. Introduction ................................................................................................................................... 569
II. Business Income ............................................................................................................................ 570
III. Investment Income ........................................................................................................................ 583
IV. Issues of Tax Accounting ................................................................................................................ 588
V. Issues Relating to the Taxation of Assets ....................................................................................... 616
VI. Special Regimes ............................................................................................................................. 625
VII. Administrative Aspects of Taxing Business and Investment Income ......................................... 635
Appendix. Relation Between Tax and Financial Accounting Rules ......................................................... 642
17. DEPRECIATION, AMORTIZATION, AND DEPLETION ........ 649
I. Introduction ................................................................................................................................... 649
II. Definition of Depreciable Property ................................................................................................ 652
III. Depreciation Rates and Methods .................................................................................................. 669
18. INTERNATIONAL ASPECTS OF INCOME TAX ................... 685
I. Introduction ................................................................................................................................... 685
II. The International Dimension of Taxation ...................................................................................... 686
III. Tax Treaties ................................................................................................................................... 689
IV. Definition of Residence .................................................................................................................. 695
V. Definition of Source of Income ...................................................................................................... 700
VI. Taxation of Residents .................................................................................................................... 716
VII. Taxation of Nonresidents .......................................................................................................... 729
VIII. Tax Treaty Issues Not Covered in Domestic Law ....................................................................... 766
IX. International Tax Priorities for Developing and Transition Countries ............................................ 773
19. TAXATION OF LEGAL PERSONS AND THEIR OWNERS ..... 776
I. Introduction ................................................................................................................................... 776
II. Enterprise Income Taxation as a Withholding Tax on Investors .................................................... 782
III. Separate Taxation of Business Enterprises and of Distributions to Investors ................................ 787
IV. Problems with Retaining Double Taxation of Business Income ..................................................... 790
V. Relationship Between Enterprise Income and Investor Income ..................................................... 793
VI. Distributions .................................................................................................................................. 846
VII. Defining Which Business Enterprises Should be Subject to Separate Corporate Tax ................ 853
VIII. Concluding Remarks .................................................................................................................. 857
20. TAXATION OF CORPORATE REORGANIZATIONS ............ 860
I. Introduction ................................................................................................................................... 860
II. Forms of Corporate Reorganization .............................................................................................. 861
III. Taxable Reorganizations ............................................................................................................... 865
IV. Tax-Free Reorganizations .............................................................................................................. 872
V. Taxes Other Than Income Tax ....................................................................................................... 887
21. FISCAL TRANSPARENCY ................................................ 889
I. Introduction ................................................................................................................................... 889
II. Partnerships ................................................................................................................................... 891
III. Trusts ............................................................................................................................................. 913
IV. Other Flow-Through Entities .......................................................................................................... 932
V. Conclusion ..................................................................................................................................... 935
22. TAXATION OF INVESTMENT FUNDS .............................. 936
I. Introduction ................................................................................................................................... 936
II. Role of Investment Funds .............................................................................................................. 937
III. Taxing Investment Funds in the Context of the Basic Tax Structure .............................................. 943
IV. Different Prototypes ...................................................................................................................... 948
V. Conclusion ..................................................................................................................................... 952
23. INCOME TAX INCENTIVES FOR INVESTMENT ................. 953
I. Introduction ................................................................................................................................... 953
II. Relationship Between Taxation and Investment ........................................................................... 954
III. General Tax Incentives ................................................................................................................... 956
IV. Special Purpose Tax Incentives ...................................................................................................... 969
V. International Aspects of Tax Incentives ......................................................................................... 973
Appendix. Tax Holidays and Loss Carryforwards .................................................................................... 983
Tax Law Design and
Drafting
Editor: Victor Thuronyi
Volume 1
1. Tax Legislative Process
by Richard K. Gordon and Victor Thuronyi1

I do not have any doubt that when we proceed to shift the taxes around so that
one set of taxpayers pays a lot more taxes and somebody else pays a lot less
taxes, the people who benefit from it do not remember it very long. They tend
to feel that it should have been that way all the time, and the people who are
paying the additional taxes resent it very bitterly.
—Sen. Russell Long.

I. Institutionalizing the Tax Reform Process

A. In General
An enormous amount has been written on the ideal structure of tax laws or on
specific technical problems in their design. Far less attention has been paid, both in the
academic literature and in technical assistance, to the process of designing and drafting
tax legislation in developing and transition countries.2 In most member countries of the
Organization for Economic Cooperation and Development (OECD), the tax legislative
process has developed into a complex ritual whereby different groups compete to pass
through the legislature their vision of an appropriate tax policy. A major tax bill in a
country like the United States involves the input of thousands of professional lobbyists,
policy analysts, lawyers, accountants, economists, and even ordinary citizens. By
contrast, the tax legislative process is much simpler in most developing and transition
countries, and has not had the opportunity to become established in many of these
countries. Far fewer people are involved. This has advantages and disadvantages. A
smaller group of well-qualified people can often do a better job in shaping a relatively
coherent law. On the other hand, the lack of institutionalized experience with tax
legislation means that the process often does not move forward smoothly, does not
involve adequate consultation,3 and often does not involve people with the necessary
expertise at relevant stages of the process. Bureaucrats responsible for tax policy and

1 This 2012 revision was done by Victor Thuronyi. The changes from the original version published in 1996 are minor. The author is
grateful to Rodell Molina for research assistance.

2With some notable exceptions. See, e.g., Michael McIntyre & Oliver Oldman, Institutionalizing the Process of Tax Reform: A
Comparative Analysis (1975) and the sources cited therein; Richard Goode, Obstacles to Tax Reform in Developing Countries, in
Taxation in Developing Countries 121 (Richard Bird & Oliver Oldman eds., 4th ed. 1990).

3See infra sec. III.
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their foreign advisors often see tax policy issues as a series of fires that need to be put out
rather than an ongoing long-term effort. The thesis of this chapter is that substantial
improvements in tax legislation can result if those responsible for tax reform focus on
process as much as on substance. The process by which tax legislation is developed can
be of key importance in determining its quality, effectiveness, and acceptability.

This chapter offers recommendations for establishing a well-functioning tax
legislative process. These recommendations are in the nature of an ideal, and they will
not all be attainable in most countries. Those responsible will have to establish priorities
and tailor the details of the process to the institutions of the particular country. We would
like to make it clear, therefore, that the discussion below is not intended to propose a
model to be rigidly applied in all circumstances. The personalities of specific individuals
involved can also make an important difference, particularly when relatively few people
are involved in tax policy formulation and drafting. Generalizations are therefore
difficult to make, but some basic issues common to most countries can be identified.

Management of the tax legislative process involves both internal bureaucratic
organization and procedure and domestic politics as well as—for many countries—
relations with foreign technical assistance advisors. Given our personal experience and
ongoing role as foreign advisors, we devote particular attention in this chapter to how
foreign advisors might fit into the process.4

B. Identifying the Problems to Be Addressed by Legislation and Establishing the Pace
of Reform

Problems in existing legislation can arise from different sources: new tax policy
choices, changes in the economy, improved techniques of tax avoidance, and earlier bad
choices in policy, drafting, and administration. To ensure that the tax laws are able to
respond to each of these problems, the finance ministry should undertake a continuous
review of tax laws.5 A single review committee, drawing on a single person from each
area of substantive tax expertise, could coordinate the process.

Such a review committee should maintain close contacts with the relevant
parliamentary committees. It should be chaired by a senior member of the ministry,
perhaps a deputy minister. Once a problem area is identified as requiring more detailed
review, a working group should be formed to develop a response.

Because tax laws tend to be numerous and complicated, it would be impossible to
subject them to complete review at all times. It should be the duty of the review

4See infra sec. V.

5In most countries, the finance ministry is responsible for tax policy; this chapter is written on that assumption. Where another agency
(most frequently, the agency responsible for tax administration) has this responsibility, the reference to the finance ministry should be
changed to be to this agency. While there is no correct answer as to which agency should be responsible for tax policy, it is clear that
problems arise where (1) this responsibility is not clearly assigned or (2) it is fragmented among different agencies. See infra sec. II.
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committee to work closely with the tax administration, which is likely to be a primary
source for notification of problems, and with research staff. In addition, it is important
for the review committee to pay close attention to the private sector. Private sector
professional associations may be an excellent source of information regarding problems.

Foreign advisors can also serve an important function in identifying problems. To
the extent of their expertise in comparative law, they are often able to note difficulties
that have arisen with similar rules in other jurisdictions.

The establishment of a review process should include an effort to keep the tax
laws as stable as possible by minimizing the frequency of change. Frequent changes in
tax legislation upset the expectations of investors and make it difficult for taxpayers to
understand and comply with the laws. A careful consideration of proposed reforms can
minimize the extent of changes needed by way of technical corrections and by way of
budgetary compensation for hastily enacted, overly generous provisions.

C. Research Support

For tax policy working groups to function adequately, they need effective
research support. Three important research areas are (1) revenue estimating, (2) surveys
of current practice, and (3) comparative law.

1. Estimating Revenue

Overall estimates of revenue must of course be made as part of the budget
process, which is beyond the scope of this discussion. But revenue estimates of particular
provisions (or proposed provisions) can also be critical in the tax policy process.
Revenue estimates can be an important weapon in opposing special tax concessions. By
showing the cost of the concession, the revenue estimate brings home the extent to which
taxes on others must be raised in order to pay for the concession. Unfortunately,
estimating revenues is an extraordinarily difficult task. The data required include
macroeconomic projections, a detailed understanding of the effects of a tax rule, and data
on what private sector firms will be affected, including size and number. In many
developing and transition countries, these data may be difficult to come by, and the actual
numbers obtained may not be very accurate. Nevertheless, it may be possible to come up
with serviceable estimates in many countries. Sophisticated models for estimating
revenues are now available for a number of jurisdictions, and private accountancy firms
have designed tax calculator models for developing and transition countries.

In some countries, the data needed to make even basic revenue estimates are
lacking. Not only does this impede informed tax policy formulation, but it surely points
out inadequacies in tax administration. A well-functioning tax administration should be
based on real-time analysis of a large amount of data, and if this is missing then this
problem should be addressed by developing the relevant analytical capacity.
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