Double taxation

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Double taxation is the levying of tax by two or more jurisdictions on the same declared income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). This double liability is often mitigated by tax treaties between countries.

The term 'double taxation' is additionally used, particularly in the USA, to refer to the fact that corporate profits are taxed and the shareholders of the corporation are (usually) subject to personal taxation when they receive dividends or distributions of those profits.

International double taxation agreements

It is not unusual for a business or individual who is resident in one country to make a taxable gain (earnings, profits) in another. This person may find that he is obliged by domestic laws to pay tax on that gain locally and pay again in the country in which the gain was made. Since this is inequitable, many nations make bilateral double taxation agreements with each other. In some cases, this requires that tax be paid in the country of residence and be exempt in the country in which it arises. In the remaining cases, the country where the gain arises deducts taxation at source ("withholding tax") and the taxpayer receives a compensating foreign tax credit in the country of residence to reflect the fact that tax has already been paid. To do this, the taxpayer must declare himself (in the foreign country) to be non-resident there. So the second aspect of the agreement is that the two taxation authorities exchange information about such declarations, and so may investigate any anomalies that might indicate tax evasion.^[1] While individuals, or natural persons can have only one residence at a time; corporate persons, owning foreign subsidiaries, can be simultaneously resident in multiple countries. Control of unreasonable tax avoidance of corporations becomes more difficult and requires investigation of transfer pricing set for transfer of goods, intellectual property rights, and services, among its subsidiaries.^[2]

European Union savings taxation

In the European Union, member states have concluded a multilateral agreement on information exchange.^[3] This means that they will each report (to their counterparts in each other jurisdiction) a list of those savers who have claimed exemption from local taxation on grounds of not being a resident of the state where the income arises. These savers should have declared that foreign income in their own country of residence, so any difference suggests tax evasion.

(For a transition period, some states have a separate arrangement.^[4] They may offer each non-resident account holder the choice of taxation arrangements: either (a) disclosure of information as above, or (b) deduction of local tax on savings interest at source as is the case for residents).

A recent study^[5] by BusinessEurope confirms that double taxation remains a problem for European MNEs and an obstacle for cross border trade and investments. In particular, the problematic areas are limitation in interest deductibility, foreign tax credits, permanent establishment issues and diverging qualifications or interpretations. Germany and Italy have been identified as the Member States in which most double taxation cases have occurred.

Cyprus double tax treaties

Cyprus has completed over 45 Double Taxation Treaties up to today and is also in negotiations with many countries for signing Treaties with them. The main purpose of these treaties is the avoidance of double taxation on income earned in any of these countries. Under these agreements, a credit is usually allowed against the tax levied by the country in which the taxpayer resides for taxes levied in the other treaty country and as a result the tax payer pays no more than the higher of the two rates. Further, some treaties provide for tax sparing credits whereby the tax credit allowed is not only with respect to tax actually paid in the other treaty country but also from tax which would have been otherwise payable had it not been for incentive measures in that other country which result in exemption or reduction of tax.

German taxation avoidance

If a foreign citizen is in Germany for less than a relevant 183-day period (approximately six months) and is tax resident (i.e., and paying taxes on his or her salary and benefits) elsewhere, then it may be possible to claim tax relief under a particular Double Tax Treaty. The relevant 183 day period is either 183 days in a calendar year or in any period of 12 months, depending upon the particular treaty involved.

So, for example, the Double Tax Treaty with the UK looks at a period of 183 days in the German tax year (which is the same as the calendar year); thus, a citizen of the UK could work in Germany from 1 September through the following 31 May (9 months) and then claim to be exempt from German tax.

India

India has comprehensive Double Taxation Avoidance Agreements (DTAA ) with 88(signed 88 DTAAs out of which 85 have entered into force)^[6] countries. This means that there are agreed rates of tax and jurisdiction on specified types of income arising in a country to a tax resident of another country. Under the Income Tax Act 1961 of India, there are two provisions, Section 90 and Section 91, which provide specific relief to taxpayers to save them from double taxation. Section 90 is for taxpayers who have paid the tax to a country with which India has signed DTAA, while Section 91 provides relief to tax payers who have paid tax to a country with which India has not signed a DTAA. Thus, India gives relief to both kinds of taxpayers.

A large number of foreign institutional investors who trade on the Indian stock markets operate from Singapore and the second being Mauritius. According to the tax treaty between India and Mauritius, capital gains arising from the sale of shares are taxable in the country of residence of the shareholder and not in the country of residence of the company whose shares have been sold. Therefore, a company resident in Mauritius selling shares of an Indian company will not pay tax in India. Since there is no capital gains tax in Mauritius, the gain will escape tax altogether.

The Indian and Cypriot tax treaty is the only other such Indian treaty to provide for the same beneficial treatment of capital gains.

Interestingly, Singapore’s investment of $5.98 billion has over taken Mauritius’s investment of $4.85 billion as the single largest investor for the year 2013-14.

Australia

The broad principle in Australia is that, if you're an Australian resident, you are taxed on all of your worldwide income. If you're a non-resident, you are taxed just on your Australian-sourced income. This presents some problems, because when other countries operate on the same principle (and most do), individuals are likely to end up getting taxed twice.

Say, for example, you're an Australian who's published a book in the US and earns royalty income in the US from the book. Australia would tax the income (it is worldwide income and you're a resident) and the US would tax it (you're a non-resident there, but it is US-sourced) as well.

To avoid this, double tax agreements (DTA) 'tax treaties' are signed, where both countries agree on which taxes will be paid to which country in such a manner as to reduce double taxation. In the example of royalties, the US/AUS DTA says the US will tax it at the rate of 5%, and Australia will tax it at normal rates (i.e., 30% for companies) but give you a credit for the 5% you have already paid. For Australian based residents, this ends up working out the same as if the money had been earned within Australia - whilst still providing a 5% credit to the US.

It is worth noting in both Australia and outside, that the DTAs are designed to eliminate double tax, rather than introduce tax. However, if an Australian resident is a U.S. citizen they may be required to pay U.S. tax. Application of the tax treaty results in the Australian paying the higher tax level for each category of income often cancelling out the best tax breaks of either country. The U.S. considers Australian superannuation accounts as “non qualified pension plans” and these attract U.S. tax as such.^[7] The U.S. has some taxes Australia does not, such as on sale of personal residence and these get added on top without foreign tax credits.

United States

U.S. citizens and resident aliens abroad

The U.S. requires its citizens to file tax returns reporting their earnings wherever they reside. However, there are some measures designed to reduce the international double taxation that results from this requirement.^[8]

First, an individual who is a bona fide resident of a foreign country or is physically outside the United States for an extended time is entitled to an exclusion (exemption) of part or all of their earned income (that is, personal service income, as distinguished from income from capital or investments). That exemption is $97,600 for 2013, pro-rated.^[8] (See IRS form 2555.)

Second, the United States allows a foreign tax credit by which income tax paid to foreign countries can be offset against U.S. income tax liability attributable to any foreign income not covered by this exclusion. This can be a complex issue that often requires the services of a tax advisor. The foreign tax credit is not allowed for tax paid on earned income that is excluded under the rules described in the preceding paragraph (i.e. no double dipping).^[8]

Double taxation within the United States

Double taxation can also happen within a single country. This typically happens when subnational jurisdictions have taxation powers, and jurisdictions have competing claims. In the United States a person may legally have only a single domicile. However, when a person dies different states may each claim that the person was domiciled in that state. Intangible personal property may then be taxed by each state making a claim. In the absence of specific laws prohibiting multiple taxation, and as long as the total of taxes does not exceed 100% of the value of the tangible personal property, the courts will allow such multiple taxation.

Also, since each state makes its own rules on who is a resident for tax purposes, someone may be subject to the claims by two states on his or her income. For example if someone's legal/permanent domicile is in state A, which considers only permanent domicile to which one returns for residency but he or she spends 7 months of the year (say April–October) in state B where anyone who is there longer than 6 months is considered a part-year resident, that person will then owe taxes to both states on money earned in state B. College or university students may also be subject to claims of more than one state, generally if they leave their original state to attend school, and the second state considers students to be residents for tax purposes. In some cases one state will give a credit for taxes paid to another state, but not always.

Taxation of corporate dividends

In the United States, the term "double taxation" is also used to describe dividend taxation on income that was previously taxed at the corporate level.^[9] After a corporation pays taxes on profits, it can distribute those post-tax profits to shareholders through dividends or distributions. The "double taxation" occurs when a shareholder who receives the dividends or distributions then pays taxes on the income that was received. Foreign shareholders are subject to a 30% tax on the dividends (the branch profits tax). The foreign corporations are subject to U.S. income tax on their effectively connected income, and are also subject to the branch profits tax on any of their profits not reinvested in the U.S.

See also

• Tax equalization

Notes