The Case for Residency-Based Taxation of Financial Transactions in Developing Countries

Abstract

The globalization process does not permit a country that wishes to be involved in this process to take an independent stand in choosing its tax system, especially with respect to financial transactions. Choosing tax rules that are unacceptable in the world’s leading countries could adversely affect an economy’s competitiveness in the world’s capital markets. The growth in international capital movements is a contributory factor in this respect.
In 1923, a committee comprised of four economists submitted a report to the League of Nations that set forth the basic principles underlying international tax principles, most of which still prevail today. Upon the issuance of the League of Nations Report in 1923, two generally recognized regimes for international tax have emerged – residency (or global) and source (or territorial). In a residency-based tax regime, residents are taxed on their worldwide income. In a territorial regime, by contrast, residents are not taxed on foreign source income, and foreign taxpayers are taxed on income generated in the source country. Over the years, there has been a significant degree of convergence among countries; as of today, most tax jurisdictions, whether developed or developing, use both source and residence taxation to some extent. According to Professor Reuven Avi Yonah, most countries follow an “international tax regime” in both their internal laws and tax treaties.