Double Taxation: International Standards and Laws

Double taxation occurs when two different governments impose taxes on the same income, essentially forcing the taxpayer to pay his or her taxes twice. This usually happens when a citizen of one country (or a business located in one country) earns substantial income in another country. In effort to encourage trade and investment, many countries signed double taxation treaties with each other. The double taxation treaties either reduce the taxpayer's tax burden through tax credits or eliminate it altogether by establishing guidelines that ensure that the taxpayer has to pay only one country's taxes at any given time.

Understanding Double Taxation

Every national government in the world taxes the individuals that reside within its jurisdiction. This includes the native-born citizens, naturalized citizens and resident aliens (permanent or otherwise). So when a citizen of one country earns profit in another country, he or she is subject to that other country's taxes. At the same time, the citizen is obligated to pay taxes to its country of citizenship. This occurs regardless of which country the citizen actually resides in.

The situation is further complicated by the fact that different countries have different tax laws. The rates at which the citizens are taxed and the kind of taxes that they have to pay vary depending on the country. For example, some countries may have higher income taxes or use different methods to calculate income taxes, which ensures that the taxpayer will have to pay different amounts for the same income. In order to avoid legal trouble, a taxpayer must be familiar with both sets of tax laws and keep track of all the similarities and differences, which makes paying taxes even more complicated than it already is.

Double Taxation Treaties

Double taxation treaties are designed to either reduce or eliminate double taxation between the signatory countries. It is worth noting that the treaties usually apply to income taxes rather than taxes in general. Furthermore, many countries sign treaties that pertain only to specific types of income. The details tend to vary depending on the treaty, but they tend to include at least one of the following provisions:

  • Residence-based taxation--This ensures that the taxpayer has to pay only taxes levied by the country he or she resides in during that tax year. That can be either the country where the taxpayer lives most of the year or a country where the taxpayer is a permanent resident.
  • Permanent establishment taxation--This ensures that if the taxpayer gets income from another country, he or she is taxed only if the income comes from a permanent establishment in the country in question. For the purpose of tax treaties, permanent establishment is a fixed place of business where the profits are generated--for example, a construction site or an office building.
  • Mutual tax exemption--This ensures that  organizations that are tax-exempt in one country are also tax-exempt in another country.
  • Double tax relief--This requires both signatory countries to reduce the tax burden by giving tax credits for taxpayers who have to pay foreign taxes. If one country levies a tax on its citizen that lives in another country, that other country must give the taxpayer a tax credit (and vice versa).
  • Tax rate harmonization--This ensures that certain types of income are taxed at no more than a certain preset rate. If the country's taxes are already lower than that, the taxpayer is taxed at the lower rate.
  • Mutual enforcement--This is designed to prevent taxpayers from trying to avoid paying taxes by moving to another country. The treaty requires each country to help the other country to collect any taxes that their taxpayers may owe.
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