Double taxation
Encyclopedia
Double taxation is the systematic imposition of two or more tax
es on the same income (in the case of income tax
es), asset
(in the case of capital taxes
), or financial transaction
(in the case of sales taxes). It refers to taxation by two or more countries of the same income, asset or transaction, for example income paid by an entity of one country to a resident of a different country. The double liability is often mitigated by tax treaties
between countries.
The term 'double taxation' is additionally used, pariticulary in the USA, to refer to the fact that Corporation
profits are taxed and the shareholders of the corporation are (usually) subject to further personal taxation when they receive dividends or distributions of those profits.
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.
, member states have concluded a multilateral agreement on information exchange. 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. 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).
has concluded 34 double tax treaties which apply to 40 countries. 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.
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 (whilst still paying the UK tax).
has comprehensive Double Taxation Avoidance Agreements (DTAA ) with 79 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 kind of taxpayers.
A large number of foreign institutional investors who trade on the Indian stock markets operate from 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.
It must be noted that India has and is making attempts to revise both the Mauritius and Cyprus tax treaties to eliminate this favourable treatment of capital gains tax. The Indian government periodically check for its DTAA with many countries and come up with amendments.
reporting their earnings wherever they reside. However, there are some measures designed to reduce the international double taxation that results from this requirement.
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 (i.e. personal service income, as distinguished from income from capital or investments.) That exemption is $91,400 for 2009, pro-rated. (See IRS form 2555.)
Second, the United States allows a foreign tax credit
by which income tax
es paid to foreign countries can be offset against U.S. income tax liability attributable to foreign income. This can be a complex issue that often requires the services of a tax advisor
. The foreign tax credit is not allowed for taxes paid on earned income that is excluded under the rules described in the preceding paragraph (i.e. no double dipping).
. 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.
, and partnerships, and this is a significant advantage over other business forms which are subject to double taxation.
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
es on the same income (in the case of income tax
Income tax
An income tax is a tax levied on the income of individuals or businesses . Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate...
es), asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
(in the case of capital taxes
Wealth tax
A wealth tax is generally conceived of as a levy based on the aggregate value of all household holdings actually accumulated as purchasing power stock , including owner-occupied housing; cash, bank deposits, money funds, and savings in insurance and pension plans; investment in real estate and...
), or financial transaction
Financial transaction
A financial transaction is an event or condition under the contract between a buyer and a seller to exchange an asset for payment. It involves a change in the status of the finances of two or more businesses or individuals.-History:...
(in the case of sales taxes). It refers to taxation by two or more countries of the same income, asset or transaction, for example income paid by an entity of one country to a resident of a different country. The double liability is often mitigated by tax treaties
Tax treaty
Many countries have agreed with other countries in treaties to mitigate the effects of double taxation . Tax treaties may cover income taxes, inheritance taxes, value added taxes, or other taxes...
between countries.
The term 'double taxation' is additionally used, pariticulary in the USA, to refer to the fact that Corporation
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
profits are taxed and the shareholders of the corporation are (usually) subject to further 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
Withholding tax
Withholding tax, also called retention tax, is a government requirement for the payer of an item of income to withhold or deduct tax from the payment, and pay that tax to the government. In most jurisdictions, withholding tax applies to employment income. Many jurisdictions also require...
") and the taxpayer receives a compensating foreign tax credit
Foreign tax credit
Income tax systems that tax residents on worldwide income generally offer a foreign tax credit to mitigate the potential for double taxation. The credit may also be granted in those systems taxing residents on income that may have been taxed in another jurisdiction...
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.
European Union savings taxation
In the European UnionEuropean Union
The European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...
, member states have concluded a multilateral agreement on information exchange. 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
Withholding tax
Withholding tax, also called retention tax, is a government requirement for the payer of an item of income to withhold or deduct tax from the payment, and pay that tax to the government. In most jurisdictions, withholding tax applies to employment income. Many jurisdictions also require...
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
Tax evasion
Tax evasion is the general term for efforts by individuals, corporations, trusts and other entities to evade taxes by illegal means. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability,...
.
(For a transition period, some states have a separate arrangement. 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).
Cyprus double tax treaties
CyprusCyprus
Cyprus , officially the Republic of Cyprus , is a Eurasian island country, member of the European Union, in the Eastern Mediterranean, east of Greece, south of Turkey, west of Syria and north of Egypt. It is the third largest island in the Mediterranean Sea.The earliest known human activity on the...
has concluded 34 double tax treaties which apply to 40 countries. 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 (whilst still paying the UK tax).
India
IndiaIndia
India , officially the Republic of India , is a country in South Asia. It is the seventh-largest country by geographical area, the second-most populous country with over 1.2 billion people, and the most populous democracy in the world...
has comprehensive Double Taxation Avoidance Agreements (DTAA ) with 79 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 kind of taxpayers.
A large number of foreign institutional investors who trade on the Indian stock markets operate from Mauritius
Mauritius
Mauritius , officially the Republic of Mauritius is an island nation off the southeast coast of the African continent in the southwest Indian Ocean, about east of Madagascar...
. According to the tax treaty
Tax treaty
Many countries have agreed with other countries in treaties to mitigate the effects of double taxation . Tax treaties may cover income taxes, inheritance taxes, value added taxes, or other taxes...
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
Capital gains tax
A capital gains tax is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property...
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.
It must be noted that India has and is making attempts to revise both the Mauritius and Cyprus tax treaties to eliminate this favourable treatment of capital gains tax. The Indian government periodically check for its DTAA with many countries and come up with amendments.
U.S. citizens and resident aliens abroad
The U.S. requires its citizens to file tax returnsTax return (United States)
Tax returns in the United States are reports filed with the Internal Revenue Service or with the state or local tax collection agency containing information used to calculate income tax or other taxes...
reporting their earnings wherever they reside. However, there are some measures designed to reduce the international double taxation that results from this requirement.
First, an individual who is a bona fide
Bona Fide
Bona Fide is a studio album from rock band Wishbone Ash. It is the first studio album in six years and is the only studio album to feature guitarist Ben Granfelt...
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 (i.e. personal service income, as distinguished from income from capital or investments.) That exemption is $91,400 for 2009, pro-rated. (See IRS form 2555.)
Second, the United States allows a foreign tax credit
Foreign tax credit
Income tax systems that tax residents on worldwide income generally offer a foreign tax credit to mitigate the potential for double taxation. The credit may also be granted in those systems taxing residents on income that may have been taxed in another jurisdiction...
by which income tax
Income tax
An income tax is a tax levied on the income of individuals or businesses . Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate...
es paid to foreign countries can be offset against U.S. income tax liability attributable to foreign income. This can be a complex issue that often requires the services of a tax advisor
Tax advisor
A tax advisor is a financial expert specially trained in tax law. Some countries require tax advisors to verify the balance sheets of companies above a certain size...
. The foreign tax credit is not allowed for taxes paid on earned income that is excluded under the rules described in the preceding paragraph (i.e. no double dipping).
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 domicileDomicile (law)
In law, domicile is the status or attribution of being a permanent resident in a particular jurisdiction. A person can remain domiciled in a jurisdiction even after they have left it, if they have maintained sufficient links with that jurisdiction or have not displayed an intention to leave...
. However, when a person dies different states may each claim that the person was domiciled in that state. Intangible personal property
Intangible property
Intangible property, also known as incorporeal property, describes something which a person or corporation can have ownership of and can transfer ownership of to another person or corporation, but has no physical substance. It generally refers to statutory creations such as copyright, trademarks,...
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.
'Double taxation' of Corporate dividends
Some comentators assert that shareholders are often also subject to double taxation, as the Corporation they own is taxed on its profit as a legal entity and they are taxed again at the individual level when they receive distributions. The opposite of this is called pass-through taxation, where a business entity is not taxed as a legal entity; instead, its profits are taxed at the individual level after they have paid distributions. Business entities which benefit from pass-through taxation include S-Corporations, LLCsLimited liability company
A limited liability company is a flexible form of enterprise that blends elements of partnership and corporate structures. It is a legal form of company that provides limited liability to its owners in the vast majority of United States jurisdictions...
, and partnerships, and this is a significant advantage over other business forms which are subject to double taxation.
External links
- IRS Publication 54: Tax Guide for U.S. Citizens and Resident Aliens Abroad
- US Tax Planning: Foreign Earned Income Exclusion
- Countries having Double Taxation Avoidance Agreement (DTAA) with Government of the Republic of India
- Detailed information including Divided %, Interest % and Royalty % with DTAA countries