A Complete Analysis on International Double Taxation

Ankita Tiwari

05 Jun, 2024

Every country has a sovereign right to determine its domestic tax policy. A country also has the exclusive right to tax anyone and anything within its fiscal borders. However, in this age of globalization, the transactions involve two separate jurisdictions. Such cross-border transactions raise questions such as: who should be taxed, what should be taxed and in which jurisdiction should it be taxed. These questions are key considerations in the field of international taxation. Further, a country cannot impose its tax laws on another country as both are sovereign. There is but no single international tax law that governs the taxation of cross-border/ international transactions. The overlapping of laws of different jurisdictions may give rise to international double taxation which is an unintended result of a disparity in tax legislation.

International Double Taxation arises when domestic rules are applied to cross-border transactions. One of the major objectives of international tax principles is to make sure that income is not taxed twice. Double Taxation impedes international trade and investment therefore, a significant aim of international law principle is to prevent and eliminate double taxation. Prevention and elimination of double taxation are mainly done in two ways either by i) granting double taxation relief or ii) allocating taxing rights via tax treaties. Granting double taxation relief can be done either unilaterally by the domestic/resident country or bilaterally via tax treaties. The unilateral measure means incorporating provisions on preventing double taxation in domestic tax laws. The bilateral tax treaties entered into between countries for double tax avoidance are known as Double Taxation Avoidance Agreements (DTAAs).

Worldwide and domestic tax systems – International Double Taxation

Every country has a sovereign right to design its tax system. At an international level, it gives rise to a variety of systems with no two tax systems being alike. The disparity gives rise to conflicts. It is the disparity that encouraged many states to adopt a common approach to imposing tax liability. The common approach includes the following:

1. Worldwide taxation – It is imposed by the resident state on the worldwide income of a resident.
2. Territorial taxation – It is imposed by the source state on the income or capital arising in a state.

Countries using the residence or citizenship rule generally adopt the worldwide basis for taxation and levy tax on the global income of their residents regardless of the origin of income. Whereas countries using the territorial tax system, levy tax only on domestically sourced income regardless of the residential status of the recipient. In practical implementation, a mixture of both systems is adopted. Under the worldwide tax system, only the residents of the state will be taxed and non-residents will not be taxed even if the income arises in that country. However, some countries also tax non-residents on their income arising within the country. Now countries that follow the worldwide taxation system have also begun to include aspects of a territorial system in their domestic tax system. Similarly, countries following territorial tax systems may tax foreign income if it is remitted into the country or consider certain foreign income to be sourced domestically thereby not restricting the taxing rights only to domestically sourced income. Despite following a common approach, it is inevitable to avoid the incidence of double taxation and conflicts arising out of such differences. Incidence of double taxation can be of the following types:

1. Juridical Double Taxation
   Under this type of double taxation, a taxpayer is taxed twice on the same item of income or capital. The incidence of double taxation generally arises when two or more jurisdiction levy tax on the same income or capital of the same taxpayer. In International transactions, such instances take place as a result of overlapping taxing rights on the same income or capital.
   • Source-source conflict
     Where the income or the conflict is deemed to have been sourced in two or more countries and two or more countries treat the taxable income or capital as being sourced in each of their respective countries. Such a conflict is called the source-source conflict. In such situations, if there is no provision for relief then the taxpayer would be subjected to tax to the fullest extent of each country’s laws.
   • Residence-residence conflict
     Under this type of conflict, the taxpayer qualifies as a resident of two or more jurisdictions. This can be an outcome of different tests used by different jurisdictions to determine residence under domestic law. If both jurisdictions tax their residents on worldwide income, then the taxpayer will be liable to tax in both countries. The tax treaties generally provide a way out of such a deadlock but the domestic laws might as well deal with it.
   • Source-residence conflict
     Under this type of conflict, the taxing rights of different countries overlap. In this, the taxpayer is a resident of a country that follows the residence rule for taxation and he has income or capital which is sourced in another country following territorial or source-based taxation. Usually, the domestic/resident country provides relief from double taxation arising under this type of conflict. Apart from this, even treaty relief is available to resolve the conflict of double taxation.
2. Economic Double Taxation
   This type of double taxation occurs when the same income or capital is taxed in the hands of two different taxpayers. An example of such a type of double taxation is dividend payment by a company. Dividends are first paid out of taxed profits of a company and are taxed again after distribution to the company’s shareholders. Another instance of economic double taxation can be where tax authorities of a country make transfer pricing adjustments to cross-border intra-group transactions but no collateral adjustment is made or allowed by other country’s tax authorities. Usually, the resident countries provide relief for economic double taxation and apart from a few narrow exceptions, tax treaties do not provide relief for economic double taxation.

Conclusion

International businesses frequently face the issue of double taxation where their income is taxed in the country where it is treated as an income for tax purposes both in a foreign country as well as in the domestic country. International double taxation discourages international trade as it makes international business or international transactions expensive to pursue. Every country at present date wants to open its economy for foreign business and trade. So to avoid instances of international double taxation, countries enter into tax treaties known as DTAAs. These treaties are often based on models provided by the OECD. In these treaties, the signatory countries agree to limit the taxation of international business either by exempting tax or by providing relief. This measure helps facilitate trade between the countries to avoid double taxation.

Also Read:
How Does International Taxation Operate?
The Principles of International Tax Planning
Tax Treaties and their role in International Taxation