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0:02
- Good evening everyone. And welcome to New York University School of Law. I am David Rosenbloom. I am the director of the international tax program here. And this is the beginning, this telling Tillinghast Lecture marks the beginning of our 21st year in the international tax program. We're, at least I and I think all of us are quite happy with it and quite proud of our hundreds of alumni literally throughout the world.
0:34
The Tillinghast Lecture, as many of you know is named in honor of David Tillinghast. Who was for many years a preeminent international tax lawyer in New York City, and in deed in the United States. David unfortunately is not well and cannot join us this evening. I've been in touch with his family however, and he of course wishes us well. And we're very happy to have named the lecture after David.
1:02
We've had, as I've said, 20 years of past history, and I don't wanna upstage our speaker, but I do wanna spend one minute to say that we are about to produce, we thought we would have it for tonight but we do not, we are about to produce a book in honor of our 20th year. This is a, to my left, is a mock up of the cover of the book. It's got almost 600 pages in it It's got five of the last 10 Tillinghast lectures, including a transcript of Pascal Saint-Amans's lecture last year.
1:37
And it's got 11 original articles by professors, foreign professors all, who taught in the international tax program. So we will be making that public, hopefully within the next couple of weeks. It also contains some descriptions of the ITP by faculty members and it's got 16 reminiscences from our students starting with the year 1997 and ranging right up through 2015. So it's an interesting volume. We're very happy to have that out.
2:12
Let me now turn to what I'm supposedly here to do which is to introduce our speaker. Our speaker is Porus Kaka. Whom I'm proud to say is a good friend, someone I've known for quite a few years.
2:27
Porus is a leading tax barrister in India. Represents many large companies before the high court and other courts in India, and as a trusted advisor of many companies from a lot of different countries including the United States. He is also and has been for the past couple of years the president of the World Wide International Fiscal Association, the first Asian representative to serve in that capacity. And as such he has been crisscrossing the world going to various IFA events.
3:06
And tomorrow he will be leaving immediately for Madrid, for the upcoming IFA congress that starts on the 25th I believe it is in Madrid.
3:19
Porus has decided to speak to us tonight about source taxation. Asking us, challenging us with the question of what is it exactly that we are talking about. And he met with the students at lunch as we always have our Tillinghast lecture's do. And I think there was a very considerable amount of interest in what he has to say. So without further ado I am going to turn the floor over to you Porus, and we'll all be very interested to hear what you have to say. Thank you.
3:52
(clapping)
4:03
- I need to get my watch out because as lawyers we tend to overrun the time.
4:09
Of course we're normally paid for it. (laughs) Well, when I suggest the title of this subject to David, I was pretty sanguine about the fact that I would know enough to be able to prepare this speech in a very short while.
4:27
I was very wrong. After nearly eight months of research I've been carried out in multiple jurisdictions from New York to Mumbai, I feel as if I have only reached the tip of the iceberg. Then came the even more difficult task of ensuring that no part of my speech
4:49
had similar content to anything said by the current U.S. first lady, or a perspective future one. (laughs) Anyway, in the next one hour let me try and compile the mammoth amount of information that I have had into something coherent, so that at the end of this one hour, hopefully all of you leave this hall knowing something if not exactly the meaning of source taxation. I have a pretty interesting audience, from students to very senior practitioners. So I hope some of you, and some of you
5:26
who are not familiar with international tax, and I hope that all of you take something back from this address. For the students, I know that six in the evening may be a difficult time to come and hear tax subjects, but in case you fall asleep I have a small movie for you to wake up half way through. So let me begin. And since this is my first real speech as a professor, I'm going to be rarely nasty and begin directly with a test. And I'm afraid all of you are the students
6:00
so you'll have to give the examination. The exam has only one question, and unlike normal exams you will be asked this question not once but twice. So let me ask it, how many of you in this audience know the exact legal steps, all the legal principals to identify source in taxation?
6:26
Interesting. Well we will repeat this exam at the end, and hopefully some of you will have your hands up.
6:32
This title is a shortened version of the original title. And the original title had an addition thanks to my dear friend Carol Donahue. And it went like this, "Source Taxation, does anyone know what it means," with the additional words, "does anyone care." (laughs) Carol I assure you even though this is not in the title I will cover it. So for the purpose of this address let me break it up into the following sections. Firstly definitions. Secondly, I'm gonna walk you back through history.
7:10
Thirdly, domestic provisions and the interaction with Treaty Law. Fourthly, treaty principals. Fifthly, a very fascinating section on the right to tax, and right taxation, we never seem to get there. Source from a policy perspective and economic perspective of efficiency and equity. This is part of does anyone care about economics anymore. And finally, base erosion and BEPS. I will also cover the fight back of the source countries towards the end, and we will see a comparative analysis
7:45
of countries where we are. And finally I will end with my does anyone care section. So let's begin with definitions. A very simple definition of source, I went back to none else than Oxford English Dictionary, which means the chief or prime cause of something nonmaterial or an abstract character. Any country where the income in generated has a claim to tax. On the basis that it has provided the infrastructure and the economic resources for generating the income.
8:20
This is often referred to as the benefit theory of taxation. The country with which the income has the closest economic connection is commonly called the country of source. This is a definition that looks at it, qua countries. Now let's look at the definition qua income. As noted above, the basic concept of sources, the country with which the income has the closet economic connection. In the case of active income, like business income, this concept is applied by sourcing income
8:57
to the place where the activity occurs or the value add occurs. Now, value add is a wonderful word, if you find it you've touched the end of the tax rainbow. In the case of passive income, there's minimal activity of the taxpayer in earning this income. Accordingly this income is generally sourced by the place where the asset producing the income is located in the case of tangible assets like land, or the place where the person paying the income occurs in the case of intangible assets.
9:35
For in the case of interest on loan for example, to the business where the business activity of the borrower occurs or the debtor resides. Now what is the source principal of taxation? Taxation as all of you know is an exercise of sovereignty.
9:53
sovereignty is the collection of rights and competencies which make up a state. Fiscal sovereignty is two types. The first type is national sovereignty, that allows a state to apply it's taxing powers or it's jurisdictions to its residents and nonresidents, wherever they might be. Residents and citizens wherever they might be. Territorial sovereignty on the other hand is defined by reference to geographical boundaries of the state. And within those boundaries,
10:28
the state can make fiscal assertions even over nonresidents and noncitizens. Source taxation is an assertion of territorial sovereignty.
10:42
However its ramifications are way beyond this territory and hence the problem. Remember, if you are a sovereign state, there are no rules of international tax which limit the extent of your country's tax jurisdiction outside the treaty networks. Therefore, a country can theoretically tax the sun, moon and the earth. I can see the expression on some of my loyal friends in this room and they are saying that's what they do. (laughs) The only restriction that States have
11:20
is the competence to enforce those taxes. And most States deal with this competence by imposing withholding obligations, on residents or on those who have business assets within this state. Just Oscar UK phone company the cost of trying to avoid India's withholding tax. It was one expensive long distance call. Let us now go back to some of what the author say about source. Let's go to Professor Vogel. Professor Vogel for all your students is perhaps one of the foremost authors in the field
11:59
of international tax, bringing out an exceptional volume on treaties on international tax principles. He actually goes back in time to his predecessors, Professors, Richard Musgrave and Peggy Musgrave, who had examined the concept. They defined source as, the place of the income generating activity and discuss primarily the attribution of business profits, when business activities are carried out in more than one country. Now what does all this suggest? All these definitions that I went through.
12:33
That source seems to be some natural self defining concept about which there probably is not much dissension or disagreement. This is far from the truth. Source is unambiguous only in what it excludes, not in what it includes. The only positive statement that I can make is that source refers to a state that in some way or the other is connected to the production of the income in question or to the state again, which gets the value added created to the good. Now if one were to look at BEPS,
13:12
now how many of you in this audience know what BEPS is?
13:18
Well, for those who don't, I have the movie coming up. (laughs) So in case you haven't heard about BEPS and you think it sounds like a tablet for a bad stomach, you are probably right if the stomach is the current state of international tax rules and BEPS is the solution. Let's see what BEPS is in a nutshell, and I have prepared this cameo. Some of you may have seen it a little part, but I can assure you I updated consistently from time to time.
13:52
So we start out with president Obama in his campaign trail speaking about a building in the Cayman islands. - [Obama] I used to talk about the outrage of a building in the Cayman Islands that had over 12,000 businesses claim this one building as their headquarters. And I've said before, either this is the largest building in the world or the largest tax scam in the world.
14:24
- [Guest] And businesses who think that they can carry on dodging that fair share, or that they can keep on selling to the UK and setting up ever-more complex tax arrangements abroad to squeeze their tax bill right down. Well, they need to wake up and smell the coffee, because the public who buy from them have had enough. (crowd chanting) - [News Presenter] Starbucks will pay somewhere in the range of 20 million pounds in taxes over the next few years.
14:52
- Why don't we maim and shame those companies that don't pay their taxes - Or book bought in pound sterling on Amazon.co.uk related from UK warehouse by the royal mail a UK company of course is registered in Luxembourg. - We were running a single European
15:14
- I believe I am dealing with a UK company it comes to me via royal mail with UK stamps on that's what happens when did book that I ever purchase ever get to Luxembourg? (laugh)
15:32
- To the best of our knowledge Apple has become the largest corporate income tax payer in America.
15:40
Last year our US federal cash affected the tax rate was 30.5%.
15:51
- The European Commission has today adopted a decision that Apple's tax benefits in Ireland are illegal.
16:04
Apple now have to repay the benefits worth up to 13 billion euros plus interest.
16:16
(audience laughing)
16:20
- Corporate income tax of 35%, which is the case in the US and the effective tax rate of submerse companies is two three four percent, there is a gap hard to explain. There is currently $2 trillion of profits accumulate profits which are kept offshore in the US. So there is money out there the government can come and collect. So overall plenty of good reasons to say if its legal and if we don't like it, that's changed the law. This is the project of the UECP that we call base erosion
16:53
and profit shifting the best projects. - We have come up with a figure which is between 100 billion to 240 billion dollars a year which would be a better way to incorporate these base erosion and profit shifting. This is pretty significant and fall in line with the argument for estimates recognizing that developing countries are even more heat than developed countries in really if there was in CIT on GDP. - [Narrator] Over 100 news agencies all over the world
17:24
are disclosing the Panama Papers tonight at the exact same time. So be a huge hit for several large figures in World Sports, politics and economy.
17:35
(up beat music)
17:45
- Well, I hope all of you are awake now. (laughs) So BEPS is the project that rarely wants to ensure taxation, whether it's source taxation or residents' taxation. It wants to ensure that it's not left in the tax havens. Now we've always been told that the BEPS project has nothing to do with source versus residence taxation, but if I were to look at action one which was the deliverable that we're shooting in 2014. The objectives of BEPS quad, the digital economy, were as follows.
18:19
BEPS risks are being addressed in the context of the project which will align taxation with economic activities and value creation. Structures aimed at artificially shifting profits to locations where they are taxed at favorable rates or now not taxed at all will be addressed by the ongoing work. This will restore the taxing rights at the level of the market jurisdiction and the jurisdiction of the ultimate parent company. What does this mean?
18:47
It hopes to restore the taxation in the source country and the resident country. Taxation in the market Jurisdiction is action six. Prevention of the artificial avoidance of peace, status source country action seven. Ultimate residence jurisdiction Action three. Hybrid mismatch, Action two. Interest deductions Action four. Harmful tax practices, Action five And transfer pricing's actions eight to 10. For all of those who are slightly confused with these many words.
19:20
OACD has a wonderful slide called BEPS in a nutshell. I have it, I can give it to you. It's like windows for dummies. (audience laughing) So why is source important? In international tax laws source determines the right to tax by a country other than the state of residence and it also decides the right to credit for tax paid in the source country in the country of residence. Now again, a question, I'm sorry, you might get tired. How many of you like the game candy crush? Don't worry, I do.
19:55
(laughs) So throughout this speech, look out for wonderful gems along the way because if you collect enough gems, you will understand source taxation much better. Also, we will play a little bit of angry birds. Unfortunately, the only angry bird that I have is the on very nasty anti Republican ones. So some of those comments you may just ignore. Anyway, the first gem that I come to is source is about the right to taxation, hopefully getting us to right taxation.
20:32
Now I want to go into my walk back through history. The judicial source of source. The above definitions that I went through in the dictionary would be incomplete unless I take a walk back to my college days, and see some of the judgments that came out. These are the days when Britain where the colonial masters of India at least, and of course we prior was of the United States also, what I call Brexit in reverse. So in these pre-independence days,
21:08
in a full bench of the privy council in Rhodesia metals, it was preceded over by Lordship Viscount Mam Atkin, Lord Russell, Lord wright and lord portus in 1940. had to decide the meaning of source. Now under Rhodesian law, as you remember Rhodesia as the predecessor of what is South Africa and Zimbabwe. Under Rhodesian law, income from sources within the territory of Rhodesia, other than those of a capital nature, were liable to tax. Rhodesia metals was a company,
21:40
which was in the hands of the liquidator and the company's liquidation Mining rights was sold to another company partly for consideration in shares, partly in cash. Two contentions were raised before the privy council. Firstly, the payments are on capital account, We won't go into that. The second question was whether the price received was from a source in Rhodesia. So the mining rights were in Rhodesia, transactions were done in England. So what did the company contend?
22:10
The company contended that the source was the business, and the place where the business was carried on was the source of the profit made by the business. Absolutely nothing wrong with this line of argument. However, the question was, what did the company mean by the source? The company argued the head seat, the directive power of the company was situated in England. The contracts for purchase and sale were made in England and the consideration was received in England.
22:40
This is the place where business is carried on. The place is England, the source England, not in Rhodesia. The privy council negated this argument. They went back to a previous judgment of Sao Paulo versus Carter, where an English company was running a business of a railway line in Brazil and the court upheld the sums received from a company who was running that Brazilian railway line was a source in Brazil. Similarly in Rhodesia metals, the mining rights were in Rhodesia
23:13
and the lordships took the view that the source was within Rhodesia because the business was in Rhodesia. Now the second gem. Source means not a legal concept, but something which are practical man will be regarded as a real source of income. So students and friends, the first principle is discard your legal hat put on your practical hat as we go forward. So the privy council held the business was in Rhodesia, therefore the source was in Rhodesia.
23:52
Therefore, when you sell a business located in a territory, the source is the geographical Situs of that business, not the legal Situs of the location of the company headquarters or the contract to sell. So from this little brief history lesson,
24:07
in 1940 the privy council said source is something practical, not something legal. And this is where I want to pause because when I come to 2016 you have to decide, whether what was laid down in 1940 is still valid today.
24:27
Now I come to a slightly more complex source, accrual of income and arising of income. Are these also synonymous or are these different . And for this I have to go back even beyond 1940
24:43
to pre-independence Pakistan. And the division bench of the Lahore high court in (foreign language) versus CIT Punjab. Now, very briefly, the facts of that case is the person there received a pension. He was actually working in British India. He retired and received a pension in Britain and was granted a pension of 9,500 rupees. Which in today's day is a princely sum of $135
25:14
for the whole year. And again, that nasty anti-Republican bird tells me that this is about nine days minimum wages of Mrs Clinton's proposals over 900 days of Mr Trump's. (chuckles) Anyway, I guessed. So the SSE in British India drew the pension in London and the money was not brought to British India. The issue before the Lahore high court was whether this income accrues arises in Pakistan
25:42
or does it accrue arise outside or was it from a source within the territory. After construing the entire section, after looking at the words in the entire provision, the court came to the view that no, the meaning of the word source is different from the meaning of the word accrue on a rise. I won't take you through the intricacies of the section or the reasoning or the ratio, sufficient to say that because of the counter positioning in those section of these three words one after another,
26:15
the court came to the conclusion that source means one thing. Accrual being the right to receive means something else. And arise is synonymous with accrual. So source and accrual have different meanings. Therefore, in 1936 before we commence international tax law, BEPS all these one beautiful things, source means one thing and accrual and arising means something else. Now completing my history lesson, I want to travel from British India to South Africa. And I found a wonderful case
26:47
thanks to my friend Jennifer Rovelle in South Africa, which is commissioner of inland revenue versus lever brothers. Again, the facts very briefly, a holding company in England entering into an agreement with a Dutch company, Dutch company purchasing all the assets of the British company but not being the sale price. The sale price is treated as a loan payable over time. After a year, this Dutch company became substituted by a series of agreements By a South African company.
27:23
And the question was whether the loan accrued or arise or was sourced in South Africa.
27:32
In the insecurity for indebtedness, the Dutch company had lodged the shares also in an American company. Finally, you have a South African debtor and you had a debt payable in London. What did the court hold? Interestingly, Chief Justice Watermeyer, Justice Davidson, the majority hold in the judgment held, no business carried on by the British company in South Africa. No services rendered by them in South Africa. No obligation to be performed by any party in South Africa.
28:05
The source of the interest was not in South Africa. Though the debtor resided there. Chief justice Watermeyer based his reasoning's on, how the debtor debt arose, namely The preceding sale transaction.
28:23
According to him, the source of the interest was the agreement of the sale of assets by lever brothers. This was a Unilever subsidiary, which on the income rather than the existence of the debt resulting from the sale agreement. In fact, the chief justice went to source of the source. Source Was the sale price converted into a loan? Justice Shriner On the other hand, in a dissent held interest is the fruit of money. It comes from where the money is. Irrespective of the proceeding contract,
28:56
It can be only where the creditor or the debtor resides. Dissenting from the majority judgment he held, I'm inclined to think, who, not a lawyer. I'm inclined to think that a practical man will be surprised if he were informed that interest on a source of loan was the underlying separate contract and not the loan or the debt itself.
29:23
In the OACD model convention, Justice Shriner's views are taken as the sourcing rule and not the majority judgment. From South Africa, We come back to London. An interesting case of Mitchell versus Egyptian hotels, House of Lords, 1915. A British company delegated its entire business to be managed in Egypt to a local board and the lower court had found as a question of fact that all the activities were run in Egypt. The question was though the head seat and directing power was in London,
29:59
did that make the source of the business of running the Egyptian hotels UK or Egypt. Because the facts were found by the lower court that it was Egypt. The house of Lords said we will not go into the factual part. We merely confirm the decision. I end finally down under in Australia. Nathan versus federal commissioners of income tax, the high court of Australia had to consider the case of a resident of new South Wales, which is a state in Australia
30:29
who received a dividend from a company in England, but the company also had some business in New South Wales. The question was that part of the dividend, which is attributable to the business in New South Wales, Is it from a source within Australia or not? You must remember dividends were also paid to the English shareholders. The court perhaps surprisingly held that the source of dividend declared in England but attributable to the business carried out in Australia was taxable in Australia.
31:09
Now this is going to be a nightmare if one starts looking at what dividends I am receiving and where does all my companies have their branches and start taxing them in the various jurisdictions. Fortunately, the view of Nathan is overruled by article 10(5) of the model treaty, Which prohibits the right of the state, in which business is carried on from taxing dividends belonging to residents of other state with two exceptions. Nathan therefore is not accepted treaty law.
31:40
I now come to my third candy crush gem. What is the common thread running through all these judgments? The answer is, when you think of a source, the judges who decided all these cases decided them not what they thought, not what they thought sitting as judges, but what they thought a practical man thought. So they put on their practic hats before they came to this. source can be geographical including the Situs of the place where it is, but it must be combined with some activity
32:19
including especially in the context of active income. Now, when I use the word ideal, ideal is not really a reality. When I come and develop the latter part of my lecture, you will see that geographical source and activities are sometimes separated on convenient principles. Now I come to third part. What is the domestic law, statutory source of source? As in the case of most stacks principles, I think all students must know that, you take your principles from the beginning in domestic law.
32:55
You do not go to international law straight away. You go to domestic law first. The principles in domestic law can be two ways. Statutory code rules or judge made rules. Different heads of income will have different sources. The statutory definitions can expand on accepted sources or accepted judgments like in the common law countries and for the purpose of taxation rights,
33:22
not credit currently, sources is primarily relevant when you consider a territorial system of taxation as opposed to a worldwide system that the United States currently has except for US non-residents. However, it is very relevant in the US system also for credit of taxes paid in these source countries. With these initial thoughts, let's do a little tour of the domestic principles in some of the major countries of the world. I propose to take the United States, the European union,
33:51
and and EU as, examples in this.
33:56
So let's look at source rules in a treaty in relation to taxing rights. First, let's begin with the United States. Now, I'm not an expert on us law. So I'm very pleased to inform all of you distinguished folks and especially Mr. Donald Trump. That this part of the research has been outsourced from India to the United States. (laughs) No job losses in New York. And my grateful thanks to David Rosenlone FUdge Dhar and carol Oliver For all the research.
34:27
The only problem was halfway through this research, Fudge Dhar resettled somewhere North in Canada or Boston or wherever it was. And that was a problem in trying to track him down. But fortunately next year David Tillinghast speaker will not have my problem. Because I'm told again by that nasty angry bird that once Mr. Trump is elected travel in and out of the United States is going to be prohibited especially to the NAFTA countries. (audience laughing) So now come to the United States.
35:01
The United States under this domestic law has a statutory concept of source under section 867 of the US revenue code. Which defines what is US source income. The provisions apply to interest, dividends, payment of personal services, rentals and royalty for property located in the United States, The disposition of us real property interest and the sale or exchange of inventory items. The primary source rule, for the purpose of outbound taxation is nine zero four of the internal revenue code
35:35
which provides for the on the limitation on the amount of foreign tax credit that can be taken by a taxpayer under section nine zero one a of this code. The section lays down specific source rules for the purposes of the entire provisions. Under the US model treaty. Article seven of the profits of the business profits article provides the rule for taxation of business profits of an enterprise by another state in the United States. And paragraph one States the general rule
36:08
that we have for all treaties, that you will not tax another state's enterprise in the United States. Unless it's carries on business through a permanent establishment situated there in. For students, the concept of permanent establishment for those who are not familiar with tax law, it's a provision, it's a creation under international tax law which allows a state other than the resident state to tax business profits provided the other person has an establishment in that state.
36:43
There are various definitions like a fixed place of brunch and office, things like that. If you have that, then you get taxed in the other jurisdiction.
36:54
Now let's look at the rules that are developed by the United States courts, the US courts When determining source principles follow three steps. The first step is to substantively re characterize the income so as to bring it within an existing statutory rule itself. When this characterization is not possible, the court goes to the second step. What is the second step. Is to source the income by logically comparing it in similarity to another form of income, which has a source rule
37:32
and applying that rule to this characterization. This approach is famously decided in the bank of America versus the United States judgment. This case was focused on the question of certain commissions received by the bank of America. Whether they were to be characterized at having sources within the United States or outside the United States. For the purposes of the internal revenue code. The trial court up held that all the commission should be classified as income
38:04
from outside the United States. In this case, bank of America was an edge act corporation existing under the laws of US. You know, not being an American even I read that, Bank of America was an edge act corporation. I got worried, because to us in the common law countries we have a very different meaning given to the persons who are known as on the edge.
38:31
Anyway, coming back, the edge act in 1919 allowed national banks of the United States to participate in international banking. These subs through qualified subsidiaries, These subsidiaries were permitted to offer international banking services. Being an agent at corporation, the bank of America was only permitted to transact international business and therefore actively involved in the financing of international trade. Again, it's interesting to know that US things
39:02
that all those who invest abroad are on the edge. Anyway ,the financing of international trade occurs through the issuance of short term loans, confirmed letters of credit and issuance of bankers acceptances. So the court was concerned with what ? Commissions charged by the plaintiff for letters of credit banker's acceptances and negotiations in connection with the export letters of credit. Are they within the United States sources or outside the United States sources.
39:34
So go back to my step one and step two. So when determining the first two. That is acceptance commission, the court drew an analogy, What was the closest to acceptance commission? The statute to sourcing rules dealing with interest. And the court held that these are similar to interest and therefore the statutory rules for interest would apply and acceptance and confirm commissions are foreign sourced income outside the United States. However, when coming to the last one,
40:07
which was negotiation commissions, the court's analysis was different. It said negotiation as a process is similar to personal services,
40:21
personal services are sourced where the negotiations are performed. This is in the offices in the United States and therefore negotiation commission is to be treated as is income from sources within the United States. So these are the two steps of the courts and keep these steps in mind when you come to some of the questions that I come to at the end of my speech. Finally, if you cannot re characterize, if you cannot find an analogy, something similar to a existing rule.
40:53
The courts will go to a third step and that is to substantively re characterize the income or find the analogy to another kind of payment that it can see how it originated, where the transactions producing the income took place and thereby attempting to rely on first principles. What is the first principle? Going back to our practical man. so if you will see Commissioner versus Piedras Negras broadcasting, the fifth circuit court of appeal was concerned with a radio station in Mexico,
41:29
broadcasting with transmission towers in Mexico, customers only in the United States. The question was where was this business? Where was the source of the business? Where was the source of this income? So again, facts, Mexican company programs made in Mexico, transmission towers in Mexico, customers' United States. Where is the source ? and the court ultimately held? We think the language of the statute clearly demonstrates the intendment of Congress,
42:05
that the source of income is the Situs of the income producing service.
42:11
The source of income in this case is transmission respondents broadcasting facilities were situated outside the United States, services were rendered outside the United States. None of its income was from sources within the United States. Again, this is a judgment which will have limited application for only one more year because I'm told that unless radio waves can go over a rather large wall that's to be created. (audience laughing) It may not be valid for much more time.
42:45
From United States I come to the European union. Most European countries like Austria, Belgium, France, Germany Spain Norway Denmark Sweden. Follow the territorial principle of taxation. Unlike United States worldwide system of taxation. Wherein their resident corporations are taxed on a global basis, but non-residents are taxed on what is sourced in that jurisdiction. Not to be left out in this chain is Ireland. Though Ireland's view of what is sourced in the jurisdiction
43:17
is I think currently in challenged by the European commission. Again, this nasty anti multinational bird told me the new slogan for all these tax NGOs. All of you have heard this statement. An Apple a day keeps the doctor away. Now the new one for the tax NGOs is an Apple a day keeps Ireland away. (audience laughing) Well most of these countries impose withholding taxes on income source with their jurisdiction and paid to non-residents. From EU I come very briefly to India.
43:51
India, somewhat similar to the Rhodesian metals case. The question of source is not relevant for the purpose of taxing rights in India and India taxes anything from whatever sources derived as long as it accrues or arises in India, namely the right to receive, not necessarily the source of income. Of course my friends are all smiling here in the first few row and we know that the Indian revenue is not known for taxing income that arises outside India. So these are the conditions for India.
44:24
From this brief overview of domestic and treaty rules, let's go to treaty law itself. Let's consider the relevance of source in treaty law. There are two principles why it's relevant in international tax treaty law. Again granting the right to tax and granting the right to double credit relief in the case of tax paid in the source jurisdiction. Now I come to my fourth candy crush Gem. Source in a treaty contract primarily means geographical source and unlike the Lahore high court decision,
45:07
it is used synonymously with income arising in a state. The OACD model provides for general sourcing rules with respect to certain kinds of income. There are public pensions, interests, et cetera. I don't want to trouble all of you with that, but simply stated,
45:26
whatever are treaty permits taxing to be done despite it being received by a resident of the other state means that geographically the Situs of the source is identified in a treaty context. Normally of course a source must be identified in a domestic context First, you don't go to treaty law, you first go to domestic law. If the internal concept of source is very wide, a treaty can narrow it down. But if the internal source, internal definitions are narrow, a treaty can never impose a charge.
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So sometimes there is a conflict between local sourcing rules and treaty provisions. However, some countries have found a way around that. Let's look at a few of these. Japan, France and Australia are an example. Under French internal law, that means domestic code. There is a provision which says that France not withstanding anything provision in the code the general the Impo can tax all income which is allocated to France by we have a double taxation convention.
46:35
And that would be treated as income tax on natural persons by a corporation in France. Japanese internal law also creates a tax charge with reference to the treaty. It not by make the treaty charge in additional to internal law like France, but substituting the treaty rules for those in internal internal law. So in the case of Japan, what it does is the treaty sourcing rules become the domestic sourcing rules for the purpose of application of tax . Australia is in the same position of Japan
47:07
and Australian treaties normally contained provisions which apply the treaty sourcing rules for the purposes of internal law. For example, let me read you the provision of the Australia Norway treaty. Income derived by a resident of Norway, Under any of the articles So and so maybe tax in Australia and Shall for the purposes of the income tax law in Australia be deemed to be income from sources within Australia. Such a source rule entitles Australia
47:35
to impose tax in a case where the treaty moves the source into Australia and the internal law says the source is outside Australia.
47:45
So what are the lessons that we have from this world tour.
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What the Lordship's decided in 1914 the Rhodesia metals case is that when determining source, one has to be a practical man. And when I look at some of the countries, especially France, Japan, Australia. I can see that they're treating negotiators and domestic law administrators were extremely practical. To prevent any possible conflict between treaty and domestic law, All they had to do was to create an additional provision which adds treaty source rules to domestic source rules.
48:18
This is an wonderful example of the exercise of practicality. It takes me back to what one of Hollywood's leading ladies said May West once when a reporter asked her on the number of men in her life and she promptly replied back and said, "it's not the men in my life that's important. It's the life and my men that's important." So from here, we now go to examine the treaty rules for some specific characteristics of income. Let's look at business income.
48:54
The OECD commentary in paragraph two to the model convention says that the first underlying principle of taxing business is that you will not tax income of the other contracting States unless you have a permanent establishment. Remember, I'd explain to you what permanent establishment , and this has a long history and reflects the international consensus that as a general rule, until you have a PE, it should not be properly taxed. My only point is I believe this is the OACD view,
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not necessarily the international consensus view. Anyway, I would be hesitant to define now this is the part where it gets tricky. I thought about it a lot. I would be hesitant to define the concept of the permanent establishment as a Source rule.
49:49
PE are the threshold which can be time driven like in the case of construction activities or Situs driven in the case of of a fixed place or activity driven like in the case of a service beat or contractual driven like in the case of a dependent agency. However, are these sourcing rules. Remember gem number two right to tax. I'm sure all of the distinguished lawyers in this audience will agree that bead determines the right to tax and also many of them will agree that it is so unclear
50:19
It never leads to the right tax. All I can tell them is wait till action seven happens. However, under article seven what is attributable to the PE? Once you establish that can be viewed as a sourcing rule, it determines what the source state can tax once the PE comes into existence. I have written an interesting combination of attribution using extinguishment using arms length under the Indo US treaty, but that's another debate. Another way to Look at it is no, the PE is the sourcing rule
50:56
with additional criteria built in like 180 days for a service fee or 90 days for a construction activity. These are the normal rules. Again, I use the word normal in contradistinction to abnormal, which I'll be coming to later. This might be a possible view when looked in the context of Rhodesia metals. If the construction activities or the service activities are what practical man can describe as a source of income, then the PE definition cement this
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and then add for the conditions of minimum duration, etc.
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I can see that my time is running faster. Now for passive incomes like dividends, interest royalty, there are differing views between the OACD and the United nations model that the developing countries follow. But I will only want to touch on interest. Interest is taken primarily to be the residents of the bearer. Therefore, what Justice Shriner decided in his dissent has become the accepted norm in international treaty law. So finally, what is the relevance of double taxation relief
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and the relevance of source for that? Most treaties now, we are not in the taxing rights. We are now giving credit for the taxes paid. Most treaties provide for relief on taxes paid in the other jurisdiction. Since the definition of source is given in those articles, most commentators feel, you do not have to refer to it in the article, which gives credit for relief in the taxes paid. However, United States, Canada and many countries also give definitions of source in the credit articles
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in order to prevent conflict. For example, in the United States in the credit article, it reads as follows, income derived by a resident of the United States, which may be taxed in the other state, I mean Canada, China, India. In accordance with this convention other than by reason of citizen shall be deemed to arise in Canada, India, China. So United States has a provision even in the credit article, well giving credit for taxes paid in the other the country They have a sourcing rule.
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And that sourcing rule says that what is determined in the other articles for purpose of source will follow for the purposes of credit. And I think this is a good combination to prevent any mismatch. Similarly, Canada also has a similar rule for these things. Remember I had mentioned the word normal thresholds 180 days, 90 days, but there are two countries which have decided to stop all these evil tax planners. They have created what I call "the Usain Bolt permanent establishment"
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It's the one second PE.
54:04
You can create a PE by the sneezing of the employee in the other jurisdiction.
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One of those countries is India and hold your breath. The other is the United States.
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Under the associated enterprise clause for service fees, There is no time threshold.
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So you can land in the United States and create a service fee and you can create it in far less time than it took usain bolt or Michael Phelps to finish the a hundred meter dash. Now you have no idea what this does to business. Forget any tax plan, Even those who don't indulge in tax planning can can get into a nightmare on this definition. If merely landing in a country creates a permanent establishment that allows the other state to tax you,
54:54
it creates a nightmare situation for business enterprises, which has nothing to do with tax planning. This kind of exercise of the right to taxation is not what I call right taxation. So from this, this comes a beautiful segue into the right to taxation and rights taxation. I want to examine source taxation on the provisions of the economic principles of neutrality and equity.
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And I want to take you back to 1988 A wonderful series of articles were published by professor Vogel on the systems of taxation and the economic principles underlying them. And for this, we go back into the early 19th century. To Germany and George Von Zahn in his book (foreign language) published in 1892 discarded residents as the basic criterion for taxation and discarded nationality as a physical presence only because he felt that these criteria lead to tax people
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who get no benefit or at best get a partial benefit from state activities. That's a burden is imposed on them to the disadvantage of those who get the full benefit of the state's activities. And this zahn had argued would be unfair. Therefore, what does he suggest? A combination of criteria which would give some clear limitations of taxing powers. Now what he said was this principle is economic allegiance. So the fifth gem I come to, economic allegiance to a state can be based on consumption,
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can be based on business activities including investment activities. Economic allegiance does not necessarily require physical presence to sanction taxation to the extent that economic allegiance is founded on consumption Residents would say would consider the suitable criteria, but it could not be the only controlling principle. Where a person is economically bound, not only to the state of his or her residence, but also through another state,
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through business activities by way of income arising and that state. zahn deems this allegiance, do this other state the source state to be more important than the state of residence. The state of residence, he argues should get its share of tax but less than the source state, and he recommended David division of the tax bit three quarters to the state of source, one quarter to the state of residence. I can see many of my US friends, a bit alarmed of India and China get to tax
57:45
three quarters of the income from a permanent establishment and us only a quarter. But zahn's was also aware that his suggestions might be criticized for reverting to the slightly antiquated benefit principle of taxation and endangering progressive taxation. However, prose professor Vogel notes that zahn's his ideas were original and important. Now, What happened to these ideas? well in 1921, the league of nations started the first model tax treaty. They came a little bit after zahn's
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and they were four economic experts, Gisbert Bruins from Netherlands, Luigi in Roddy from Italy, Edward Seligman from the United States and Joshua stemmed from the United Kingdom. They in 1923 adopt the word economic allegiance, but their recommendations are diametrically opposite to zahns. They recommend residence taxation over source taxation
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What happened to them? They were sacked. Because this was not acceptable to the debtor nations. So the economic experts were substituted by technical experts, and we came across the first treaty, which is a complex system of classification, assignment and source principles. It marries source In some cases, it marries residents in some places and in marries both in some cases.
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So you can see what happened between the early 20th century, just between these four. The answer is where you come from sometimes tells you where you are going. The four economic experts came from the developed world. The the other technical experts came from the developing world. And that's led the answer to the different types of treaties that you had. Golden years of source taxation. 1943 to 1946 when the league of nations adopted the Mexico model. It's a wonderful gem for source taxation.
59:58
Only three years of golden years. In 1946 the London model came and changed everything. One more forgotten voice in all of this is Arthur Harding. He is in the United States and he published his book in 1933 and he also has ideas which are similar to zahn's and professor Vogel says those ideas are similar, I don't think he knew of zahn. and he certainly did not cite zahns in his theory. Harding developed a theory regarding the state's right to tax and the territorial limits of this right
1:00:33
and he said it appears that a state may tax all property goods, labor and services which have become identified with the economic structure of the state by incorporation or integration with the business mechanism so defined. Consequently, Harding also pleads for source based taxation and also gives a detailed analysis of the concept of source. Now let's look at interest. All I can say is interestingly interest has many possibilities. It has can be the residents of the debtor,
1:01:08
the place at which the loan is made, the place at which the payments are made, or the residents of the bank through which the payments are made. So my eighth gem , if one were a practical man interest has many practical possibilities. Professor Vogel does a wonderful analysis of the Latin American countries. He begins with only 11 countries and he ends up with 40 to 50 permutations and combinations of how states could tax the interest between these 11. So again, looking at all this
1:01:42
I finally come to the economic test.
1:01:48
What do economists do? According to them market is king. And anything whether its source taxation or residence taxation, if it distorts the market, it's wrong. I can go through in great detail The analysis he has made. For example, what are the types of neutrality that you require in economics, you have import neutrality, you have export neutrality, you have Intonation neutrality. And if I caught Norman Tura and Ganden voguer. Neutrality is defined to mean that taxes do not alter
1:02:22
the relative prices of goods, services, activities or inputs in a private sector. Therefore, state neutrality means neither country will use its fiscal powers to change the relative prices in the other country. Ultimately, when professor Vogel concludes his analysis and you look at zahn's, you look at Arthur Harding all favor source taxation with some exceptions and caveats.
1:02:49
What is the meaning of source? It defines by professor Vogel as the place where the enterprise or part of the enterprise
1:02:57
by direct investment is located. Direct investment requires more than just a transient activity. This will not be music to the ears of irrespective of any activity, tax in the source country brigade.
1:03:14
Carrying out sales or performing services while traveling in a foreign country does not amount to direct investment. The country in which the sales are made merely provides the market. France, India, and China won't like the spot of professor Vogel's article. It does not contribute to production at a minimum Efficiency theory requires some transfer of capital factors for a certain duration. Sales do not transfer capital loans do. Their various types of answers on different types of income.
1:03:52
I now come to the equity principle. What is equity? Now, this is something non-tax related so all of your lawyers can look at it. It belongs to both the model world and the legal world. In a famous speech, Justice kailyn in his New Jersey versus Delaware said "law at times has a Twilight existence at which it is hardly distinguishable between morality and justice." My only concern with these commences that as we know nature, Twilight is butter brief phenomenon.
1:04:25
I only hope that the connection of law with morality and justice has more duration than just Twilight. But if you look at Professor Vogel's analysis of equity, it is wonderful. It is an interpretation concerning elements of creativity. I can see many of the lawyers beaming on this point. However, it's not ambiguous equity requires constructive interpretation. The most important criteria being integrity. lawyers don't despair. I do believe that there is a lot of integrity in our work
1:05:00
with the exception of some advertisements. When I came from India to Harvard, the most disheartening thing to see as an aspiring lawyer, was on Television, a wizened old gentleman said, "had an accident call 1-800, friendly lawyer." So anyway, integrity permits us to understand the legal order of a community as being a hierarchy of legal principles, from the more abstract to the less abstract, more abstract social equity, less than abstract the ability to pay
1:05:32
even less abstract progressive tax rate. Now you need to distinguish between individual equity and intonations equity. Basically, equity principle means that a tax claim is justified if the state's claim on that income is justified By a set of legal principles and not something which is abstract. There are two theories of taxation. The benefit theory means those who get the benefit from the state's activity should pay their taxes. The second theory sacrifice that means those who all
1:06:10
who can pay more sacrifice themselves for the persons who cannot afford. Ultimately Professor Vogel concludes that source taxation is better than residents taxation from foreign direct on intonations and individual equity.
1:06:28
I now want to go directly into my last part, which is the does anyone care section?
1:06:38
I can't look at the world today, so I have decided to look at two aspects of does anyone care? Firstly, is the market a place of source and secondly, technical services. Where is the source located for technical services? Because that's a debate going on in the United nations. Lastly, I will take a small bite out of the Apple decision of the European commission. Now, if you look at the first thing is the market a source. In today's world, technology has rendered the PE definition redundant.
1:07:10
When you look at my even earlier discussion of professor Vogel merely by making a sale into a foreign country did not mean the source of income is there. No was the residence of the buyer, but it was actually a product of manufacturing in another location. When you look at the normative theory, the question arises is by making a sale Are you using the physical, legal or economic structure so as to locate the source in this state of sale. Therefore, is the market in infrastructure.
1:07:41
Most authors give a value to market and if you will see Professor Shay's article also some time back in in the David Tillinghast address. He also recommended taxing market access. Now, the problem with the PE definition is technology has rendered the fixed place redundant action plan one of the BEPS project, in my opinion abdicates a lot of the work that requires to be done. So when fixed places are becoming irrelevant today you can sell from anywhere without requiring place.
1:08:15
Can we have another threshold for determining PE jurisdiction? I may not be popular by what I say in the next few lines, but can we have a gross sales threshold? It's already being done United Kingdom, Australia and India are already taxing sales If you artificially avoid the PE on a gross sales threshold, it could become possible in the treaty is going forward. As I said even Professor Shay she mentioned that you should have a mechanism to tax income in the United States of remote sellers.
1:08:55
The question is whether the treaty should recognize this. Today you have a non fixed place of doing business. What is the relevance of the PE discussion? I don't want to get into location savings and I'll reserve it for this for the later date. But all I'm saying is that the discussion should proceed to looking at the business reality today. Next answer source taxation on technical services, United Nations is proceeding to create a principle similar to royalty,
1:09:24
wherein taxation for technical services will take place where the pier situated, not where where the services are being rendered. Question is, is this justified? All I can say is that there may be some justification for purely technical services that have a know how content
1:09:44
that have a patron content. But can you have a justification for taxing normal business income like managerial services like consultancy services, if you want to have a sourcing principle for them, the better principle is the service fee and net income rather than the technical services on a gross income. Just to explain this clearly,
1:10:09
the principle of taxing source on royalties a goes on a grace basis. So, if you receive hundred dollars you are taxed at 30 irrespective of whether you incurred a loss or a profit.
1:10:24
If you go under the head business income, you will get taxed only if you make a profit. So the source taxation rules for technical services in my opinion, if you club pure commercial services and create a source taxation, that could create a huge distortion from all the principles that are discussed earlier where the economics are otherwise, Let me tell you what Pascal centerman said on 24th July 2016. He said said that the conventional wisdom of the OECD
1:10:55
on tax that is promoted for decades that income from rents royalties, dividends, should be taxed at more likely than wages and salaries is now dead.
1:11:06
The scary part is if you move up the tax rates on these income, how do you justify on a gross basis and not on a net basis? So I think in this does anyone care section my concerns are that perhaps and again I'll I want to balance it with the concerns of the developing world also is that people don't care if there's going to be significant erosion there's people are not going to care. I come to the last part, which is the fight back of the SOS countries. I just explained them.
1:11:41
Three countries have started it UK first. They started with the diverted profits tax Australia's come India has come. This is the fight back of the source countries. Because I can see many of you have fallen off your chairs when I refer to UK and Australia source countries. But that's precisely how these countries view themselves. They want to tax income which is being artificially avoided through the definition of PE which they perhaps view as redundant.
1:12:09
So source states like UK, Australia, India are living taxes where businesses are structured so as not to create a PE and there is significant base erosion in that country. Now, for example, remember James Cameron said Wake up and smell the coffee my video from coffee Let me come to fruits. and the decision of the European Commission on Apple. Is the apple decision about illegal state aid?
1:12:38
The answer is yes and no. Illegal state aid is the consequence. Absence of taxation of profits sourced in Ireland is the Genesis. The decision of the European commission that the attribution of sales profits made across Europe, Middle East, Africa and India, to an imaginary head office exists only on paper. This enabled Apple to pay an effective corporate tax baked corporate tax of 1% in 2013, and point 000.5% in 2014. Ultimately, this decision is also about where
1:13:18
income ought to be sourced, taxed and attributed. Therefore, to conclude much of the debate and issues in the international tax world are and will always be about source. Now, let me tell you a secret actually is not a secret. I believe many large multinational American companies are not very well liked across the Atlantic.
1:13:45
Forget Margaret vestige of the European commission who you saw on my video. How many of you have heard about Christian Khan?
1:13:53
He's the current chancellor of Austria
1:13:57
and was quoted three days ago when he invoked two potent symbols of Vienna's food culture and commenting against Starbucks and Amazon. He said every Viennese cafe, every sausage stand pays more tax in Austria than a multinational corporation.
1:14:19
If chancellors are thinking about this, something will be done. I want to end now. I will read (murmurs) . So when I look at the OECD work, and I want to end with the that when you look, I said, does anyone care? The line between base erosion and source as a concept is rapidly disappearing. The practical revenue collector. Now forget the practical man. The practical tax officer is not bound by legal no nuances. As long as it pinches my country, the sources is there,
1:14:56
you must can't be too critical of the tax officers. Remember when they see their revenue allocation disappearing in today's E-commerce age, they will fight back. Therefore though market per se may not be a source, it is a relevant factor along with other thresholds. So of course today market is base erosion. And if it results in a revenue loss countries will not care for the niceties of definitions of source. And I want to caution that any reform process that ignores revenue allocation,
1:15:28
which has happened due to E-commerce will be inherently flawed and will lead to unilateral measures such as UK, Australia, and India have done.
1:15:41
So, finally, I conclude with the 11th gem. The definition of source is not necessarily a basis from which to proceed. It is a power of a problem, it is to find that tricky place of value add or value creation. It can have multiple sources in the OECD BEPS project. There is a lot of work that's carried out by the OECD. But one part of the project, which has been completely ignored, is its cover pages. ( audience laughing) Now, I want to show you these cover pages
1:16:22
in a little bit if I can find how I can enhance this slide, but anyway, I'm also not technically then, but if you will see it begins with the desert. So the small part of the small slide in the beginning is showing the desert. And it warns you that if you do not deal with base erosion, you're going to be pretty much seeing Sahara all over the place. In 2013, you can see two people striding purposely forward and this is the OECD solving the problems of the world.
1:16:56
And then the last three are the solutions.
1:17:02
Now, what do they remind you of? All I can say is the last time I saw those wonderful exploding stars was on the Big Bang Theory. (audience laughing) So I want to end I've already overshot my time. I want to thank all of you for being such a patient audience. I want to thank Professor Rosenblum and his team for not only inviting me but being such gracious hosts, in particular Gregory and Joshua. I also want to extend a personal thanks to Justice cinna, Clive, Joanna and Tara,
1:17:40
who have traveled across continents to be here. This means a lot to me and I thank each of you individually. Finally, to my dear friend students today international tax law is a laboratory principles are changing, they are being formed as I speak. It's a wonderful place to be. The last part of my address was to my friend Robert stack who could not be here, who is the treasury secretary. All I wanted was his help in filling out some forms to ensure that the source of this speech (laughs)
1:18:21
is found to be located in Mumbai and not in New York so I can, so I can receive the honorarium without withholding US tax. Thank you. (audience clapping)
1:18:43
- That was a great deal to think about. We can take just a couple of questions. If anyone has anything that they want to raise with a porous Kaka now would be the time.
1:18:57
Everybody's shy. Yes sir.
1:19:01
(murmurs)
1:19:24
- Well I think countries Are going to get
1:19:29
more and more on the bandwagon of diverted profit tax if there is no a success on action one on the digital project. I think as I said BEPS has to provide solutions and if there is significant base erosion due to the digital economy and these countries of course introduced the law on what they see is the artificial avoidance of the peace status. But it's really against the, it is clearly against the current We rules also. And I can see that if you are going to have significant base
1:20:02
erosion you are going to do this. If the international community does not change the concepts of be and allow a more balanced allocation because today you can do business in the digital. I mean, the PE definition is in the 1960s businesses in the 2040s I mean, the definitions and business realities are decades apart. It's not even going to catch up. I mean, we are basically the definitions are catching up with servers right now. They haven't even reached, reached the IClouds.
1:20:33
So you can imagine we are way behind, and countries are going to do it. I mean, diverted profit tax may be more of a political statement, rather than an economic statement. The way I look at it, but again, I can't speak for the UK, but they are going to be doing it. So it's going to grow unless you find the solution to the big issue.
1:20:52
- Okay, any further question from the floor?
1:20:57
Well, in that event I'm going to bring this to a close. Thank porous for a wonderful presentation. There's our reception at the end of the hall. (audience clapping)
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