Double taxation is a situation that affects mainly multinational corporations when business profits are taxed at both the corporate and personal levels. The corporation has to pay income tax at the corporate rate before any profits are to be paid to shareholders. Profits are distributed to shareholders through dividends are subject to income tax again at the individual rate according to tax regime of the country. This way corporate profit are counted as twice income taxes. The outcome of double taxation does not affect smaller corporations, which can distribute the earnings straight to shareholders without the intermediate step of paying dividends. On the other hand, many other smaller corporations are able to avoid double taxation by distributing earnings to their employee or shareholders as wages.
There are two types of double taxation: economical and juridical (international).
- Double economical taxation is related to the taxation of two and more taxes from one tax basis. As an example can be presented the situation when the profit of the corporation first is taxed and after being distributed among the stockholders and it is taxed again as dividend tax. Also the double taxation can occur when indirect taxes are levied, for instance, when the goods are levied excise tax, and after this VAT is imposed on the price of the goods, including excise.
- International double taxation is levying on one taxpayer in one or more countries for one object in the same period of time, which results in identical tax payment, and brings to coincidence of tax object, of tax subject and the period of tax payment. Countries can levy income taxes using the principal of residence, or territorial principal.
Double taxation is possible when one country is using residence principal in levying taxes, and the other country is using territorial principal. The double taxation can also occur in the situation when both countries affirm that the taxpayer is their resident, or when each of the countries affirms that the profit was made on its territory. Double taxation restrains the economical activity of the entrepreneur, it influences the growth of prices for goods and services, it increases tax burden on juridical and physical subjects, and also it violates the principal of tax fairness.
Double Taxation Relief
1. Exemption System
Under exemption systems, a taxpayer of a country (the residence country), will not be taxed regardless of where the income is generated, on the other hand taxpayers are taxed based on the source of their income (the host country), that is, only the country where the income is generated has taxing authority over the income.
With exemption system, it encourages the residents’ individuals or companies to venture outside their domestic environment and compete with their foreign competitors. Hence it is frequently used term of capital import neutrality. The exemption system allows business to be carried outside the home country and perform the trade at some other country, thus accelerating the trends towards globalization and increase of global welfare. Exemption system fits more to our today’s world issues of globalization of opening borders and removing barriers for free trade. Basically this is the most important part of the system. Allowing competition and opening new opportunities for the enterprises to sell their goods.
Countries that are purely on exemption system are called as “tax havens”. The reason they have this name is because the given country doesn’t require taxation for any foreign source as long as the individuals and corporations make their earnings at their own country. The biggest argument for tax havens is the amount of accounts can be traced, most countries don’t have the access to suspicious accounts and it is the most common way for money laundry. The most known tax havens are Bahamas, Cayman Islands and Cyprus etc.
2. Credit System
The credit system allows tax paid in one state to be used as credit against a taxpayer’s liability in another state. The credit will be in the form of a direct credit or indirect credit. The general idea behind a tax credit system is to be able allow business to operate the same way as if they operate with the same laws and regulations as their home country. This helps the corporations to operate as smooth as possible with fewer regulations concerning tax laws. If a business ventures abroad, it must pay tax on foreign and domestic business income domestically at the same tax rate and tax basis. Foreign tax paid can be deducted against domestic tax due. This system is also referred as Capital Export Neutral system.
Elimination of the Double Taxation
The measures that are used for prevention of double taxation can be unilateral measures that are related to the norms of internal taxation legislation and multilateral measures that are implemented using the international conventions and agreements.
Unilateral measures include the taxation tools that are foreseen by the national legislation:
- Taxation set-off (credit) implies that the taxes paid abroad are set-off in internal tax obligations;
- Tax abatement, implies that the taxes paid abroad are deducted from the amount of profit to be taxed.
Multilateral measures implies signing of international conventions in order to avoid double taxation, in which is stipulated the order of levying of profits and assets. International conventions signed in order to avoid double taxation and prevention of tax evasion have as a goal to create such conditions that would exclude situation when juridical and physical subject would be double taxed. It is coordinated by the negotiating governments, directed to prevent the tax evasion and taxation discrimination in any form, and distribution of taxation rights among the negotiating countries.