Nov 21, 2020

International Tax and Double Taxation

Are you a non-British citizen with business or investment interests in the UK? If you are, then, whether you live in the UK or not, you might be subject to Double Taxation arising from International Tax laws and treaties. This article is for you. Read it. It might save you a lot of money.

What is Double Taxation?

You’ll have read it in the news. So many international companies plan aggressively to avoid Double Taxation – paying tax in their host country as well as in the country where there they generate their income.
In this article, we’ll explore the different kinds of Double Taxation, which arise in cross-border transactions.

Double Taxation most commonly arises when countries levy tax on the worldwide income of their tax residents, as well as on income generated by activities located on their territory. This, of course, means that companies and individuals who trade across borders are liable to different taxes in different countries – a scenario that can be complex and expensive to manage.

So as to avoid double Taxation, countries apply tax treaties. These are designed to determine the country that is entitled to levy tax. These treaties are largely based on the OECD model convention

The principle of sovereignty

Countries levy tax according to the principle of sovereignty, to which there are two aspects.

  1. National sovereignty – this applies to citizens and residents of a country. The country will levy tax on its citizens and residents wherever they might be.
  2. Territorial sovereignty – relating to a country’s geographical borders. This entitles countries to tax non-resident individuals or entities on their income sourced in their territories.

Primary and Residual Taxing rights
The general rule is that the source country has a primary taxing right while the residence country has a residual taxing right.

The residence country can levy tax on an individual’s worldwide income on the basis of his residence (principle of residence). So - if the source country doesn’t have an exclusive taxing right according to the relevant tax treaty, the residence country retains a residual taxing right. The residence country also has an obligation not to apply double Taxation.

The source country can tax any income generated within its territory (principle of source). However, some countries might decide against this approach. Instead, the income is transferred to the residence country without suffering any withholding taxes.

What forms can Double Taxation take?

  1. Juridical Double Taxation. This includes comparable taxes by more than one country on the same taxpayer in respect of the same income or capital during the same period. The juridical double Taxation mainly arises due to the fact that Countries levy taxes on financial transactions.
  2. Economic Double Taxation. This is levied when the same income or capital is subject to comparable taxes by more than one country in the same period but in the hand of different taxpayers.

Reasons for double Taxation

1.    Double Taxation may arise when an individual or entity


-          is a tax resident in one country

-          derives income from another

-          and both Countries levy taxes on that income.

As an example, Company A, resident in Country A, generates income from immovable property located in Country B. The Sovereignty Principle means that Company A becomes subject to taxes in Country A regarding this income. However, again because of the territorial sovereignty principle, Country B will also levy taxes on the income.


2.      Double Taxation may also arise when a person is considered as a resident by two different Countries. Each country considers that the person is a tax resident of its country. This person (individual or entity) then pays taxes in both Countries on his worldwide incomes …

 

3.      Two or more Countries subject the same person to tax on income derived from their territories. Company A, resident in Country A, grants a loan to Company C, a company established in Country C. In this case, Country C may levy taxes on interest payments between Company C and the permanent establishment in Country B. Country B may also levy taxes on distributed income from Company A’s permanent establishment located in Country B to Company A.

 

4.      The same circumstances can work differently in two different Countries. This happens with hybrid companies and financing instruments. For example, Company A, established in Country A, grants funds to its subsidiary, Company B, located in Country B by using a hybrid financing instrument. Country B will consider that this instrument is equity. This means that Country B will tax the remuneration to Company A as dividends (non-tax deductible in Country B). Country A will consider this as debt and will then tax the remuneration as interest income (fully taxable in Country A). This is not a good approach. However, the opposite approach is ideal, as it will lead to double non-taxation.

Tax treaties are created in order to avoid issues created by double Taxation. However, an aggressive use of tax treaties can create double non-taxation cases.

Seek advice

We’re International Tax experts. Do you own a company (or are you, as an individual) in a country different from that of which you’re a citizen? You’ll need advice on how best and legally to avoid Double Taxation. We have unrivalled expertise in this sector. Get in touch. We’re always here to help.

 

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