Double taxation

Double taxation refers to the imposition of two or more taxes on the same income, asset, or financial transaction by different jurisdictions or within the same jurisdiction.
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Updated on Jun 11, 2024
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In this guide

3 key takeaways:

  • Double taxation can occur at both international and domestic levels, affecting individuals and businesses.
  • It typically arises from the overlapping tax jurisdictions of multiple countries or within a country (e.g., federal and state taxes).
  • Measures such as tax treaties and tax credits are used to mitigate the effects of double taxation.

What is double taxation?

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Double taxation occurs when the same income, asset, or financial transaction is taxed by two or more taxing authorities. This can happen in two main contexts: international and domestic. International double taxation arises when the same income is taxed by two different countries, often due to differences in tax residency rules or source-based taxation. Domestic double taxation occurs within a single country when the same income is subject to multiple layers of taxation, such as federal and state taxes.

Types of double taxation:

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  1. International Double Taxation: This type arises when an individual or business earns income in one country but is a resident of another country, leading both countries to tax the same income. For example, a person living in Country A but earning income in Country B may face taxes from both Country A (residence-based taxation) and Country B (source-based taxation).
  2. Corporate Double Taxation: This occurs when corporate profits are taxed at the company level and then again at the shareholder level when profits are distributed as dividends. For example, a corporation pays corporate income tax on its earnings, and shareholders pay personal income tax on dividends received from these earnings.

How is double taxation mitigated?

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Countries and tax authorities implement various measures to reduce the burden of double taxation:

  • Double Taxation Agreements (DTAs): Bilateral or multilateral treaties between countries that outline how income will be taxed by the respective countries to avoid double taxation. These agreements typically provide methods such as tax credits or exemptions.
  • Tax Credits: Allow taxpayers to offset the tax paid to one jurisdiction against the tax liability in another jurisdiction. For instance, if a taxpayer pays taxes on foreign income, they can claim a credit for those taxes against their domestic tax liability.
  • Tax Exemptions: Some countries exempt certain types of income from taxation to avoid double taxation. For example, some countries may exempt foreign-earned income from domestic taxation.
  • Domestic Legislation: National laws and regulations may provide relief mechanisms, such as the United States’ foreign tax credit or the UK’s double taxation relief.

Examples of double taxation:

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  • Dividends: Corporate profits are taxed at the corporate level, and shareholders also pay taxes on the dividends they receive.
  • Cross-Border Employment: An individual works in one country but resides in another, leading to both countries taxing the same income.
  • Property Transactions: Buying and selling real estate may involve taxes at multiple levels (e.g., municipal, state, and federal) within the same country.
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  • Tax Residency: Rules determining a person’s or entity’s tax residency status and how it impacts taxation.
  • Corporate Taxation: Understanding how corporate profits are taxed and the implications for shareholders.
  • International Taxation: Overview of taxation issues that arise in cross-border transactions and income.
  • Tax Treaties: Detailed examination of bilateral and multilateral agreements designed to prevent double taxation.

Summary

Double taxation can create significant financial burdens for individuals and businesses, but various mechanisms, such as double taxation agreements, tax credits, and exemptions, help mitigate its effects. Understanding these measures is crucial for navigating the complexities of both domestic and international tax systems. For further insights, explore related topics like tax residency, corporate taxation, international taxation, and tax treaties.


Sources & references

Arti

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