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CHAPTER 21 INTERNATIONAL TAX ENVIRONMENT AND TRANSFER PRICING SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. Discuss the twin objectives of taxation. Be sure to define the key words. Answer: There are two basic objectives of taxation that are necessary to discuss to help frame our thinking about the international tax environment: tax neutrality and tax equity. Tax neutrality has its foundations in the principles of economic efficiency and equity. Tax neutrality is determined by three criteria. Capital-export neutrality is the criterion that an ideal tax should be effective in raising revenue for the government and not have any negative effects on the economic decision making process of the taxpayer. That is, a good tax is one that is efficient in raising tax revenue for the government and does not prevent economic resources from being allocated to their most appropriate use no matter where in the world the highest rate of return can be earned. A second neutrality criterion is national neutrality . That is, regardless of where in the world taxable income is earned it is taxed in the same manner by the taxpayer’s national tax authority. In theory, national tax neutrality is a commendable objective, as it is based on the principle of equality. The third neutrality criterion is capital-import neutrality . This criterion implies that the tax burden placed on the foreign subsidiary of a MNC by the host country should be the same regardless in which country the MNC is incorporated and the same as that placed on domestic firms. Tax equity is the principle that all similarly situated taxpayers should participate in the cost of operating the government according to the same rules. This means that regardless in which country an affiliate of a MNC earns taxable income, the same tax rate and tax due date apply.
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2. Compare and contrast the three basic types of taxation that governments levy within their tax jurisdiction. Answer: There are three basic types of taxation that national governments throughout the world use in generating tax revenue: income tax, withholding tax, and value-added tax. Many countries in the world obtain a significant portion of their tax revenue from imposing an income tax on personal and corporate income. An income tax is a direct tax , that is, one that is paid directly by the taxpayer on whom it is levied. The tax is levied on active income , that is, income that results from production by the firm or individual or from services that have been provided. A withholding tax is a tax levied on passive income earned by an individual or corporation of one country within the tax jurisdiction of another country. Passive income
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