Double Taxation Relief and Double Taxation Avoidance

Double Taxation Relief and Double Taxation Avoidance
  • Taxation is a crucial source of revenue for the government and there is a lot to be said about it. An income can be taxed twice while one will do for others.
  • This is why this article is exploring the difference between double taxation relief and double taxation avoidance.

In taxation, it is important to note the difference between double taxation relief and double taxation avoidance as sometimes, one’s income can be taxed twice, and eased of double taxation burden due to certain tax rules.

In certain cases of international trade and commerce, income attained by a resident of one country from another country may be taxable in both countries, due to different tax rules.

Double Taxation Avoidance on the other hand has to do with designing ways to prevent getting taxed twice.

There are certain ways through which countries grant Double Taxation Relief and there are also ways for individuals and countries to avoid Double Taxation. 

What is Double Taxation?

Double taxation simply refers to the act of taxing the same income twice. It usually happens when the same income related to an individual is treated as being accrued in more than one country.

One of the many negative features of Double Taxation is that it places an unnecessary financial burden on taxpayers.

Double Taxation can happen when income is taxed at both the corporate level and personal level.

It also happens in international trade when the same income is taxed in two different countries.

How Double Taxation Works

Double taxation often happens because corporations are seen as separate legal entities from their shareholders, which usually leads to corporations paying taxes on their yearly earnings, just like individuals.

When corporations pay out dividends to shareholders, those dividend payments invite income-tax liabilities for the shareholders, even though the income that produced the cash to pay the dividends had already been taxed at the corporate level.

Categories of Double Taxation

1. Corporate Double Taxation: This is when corporate earnings are taxed through both corporate taxation and dividend taxation.

It happens when corporate earnings are taxed twice at two different levels but on the same income.

2. International Double Taxation: This has to do with taxing foreign earnings in both the country from which it was gotten and the country where the investor lives.

It mainly has to do with international companies that operate in jurisdictions other than their home country. It can also affect the profit amassed by individuals in foreign countries.

There are two ways that Double Taxation can happen:

  • Economic Double Taxation: This happens when an individual’s income is taxed twice in the same country while being held by two different people.
  • Juridical Double Taxation: This happens when the same individual is subjected to two taxes on the same earnings gotten outside of his country, one abroad and one at home.
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Double Taxation Relief  

Double Taxation Relief has to do with easing a taxpayer’s double taxation burden.

There are two ways of providing Double Taxation relief:

  1. Bilateral Relief: This has to do with providing relief in accordance with the agreement between two countries where the tax may be owed.

How this works is that governments of two nations make a pact to provide relief against Double Taxation on a mutually agreed basis.

This can be provided in two ways;

  • Exemption method: Here, a particular income is taxed in one of the two countries and exempted in the other one.
  • Tax credit method: Here, the income is taxed together with the nations mentioned in the income tax treaty, in addition to the country of residence. This will approve the tax credit or deduction for the tax charged in the country of residence.

2. Unilateral relief: This is when relief is provided by the country where the taxpayer is a resident.

It usually applies in cases where there is no double taxation avoidance agreement, between the country of source and country of residence.

When this happens, the taxpayer’s country of residence may provide tax relief under its domestic tax laws.

Double Taxation Avoidance

Double Taxation Avoidance has to do with designing ways to prevent getting taxed twice.

Measures to Avoid Double Taxation

Double Taxation can be a very heavy burden for taxpayers, so here are some measures that can be taken to avoid it:

1. Pass-through taxation: One of the ways to avoid double taxation is to structure one’s business as a sole proprietorship or a partnership. The benefit here is that there are no dividends in such structures since profits are shared between the owner(s)/partners.

2. Withholding corporate earnings: Another measure is to retain earnings in the business instead of disseminating them to shareholders as dividends. The trick here is that, if shareholders don’t collect dividends, they’re not taxed on them, so the earnings are only taxed at the corporate rate.

3. Pay salaries rather than dividends: Instead of sharing profit as dividends and making it liable to double taxation, you can share it as salaries or bonuses.

4. Split income: Another strategy is for a business owner to take from the corporate profit what they need to support their lifestyle but leave the rest of the earnings in the corporation. This can help to avoid double taxation.

Double Taxation Avoidance Agreement

Double Taxation Avoidance Agreement (DTAA) is an agreement signed between two or more countries to help taxpayers avoid paying double taxes on the same income.

It is applicable in situations where a taxpayer dwelling in one country has to earn his/her income from another country.

Categories covered by the DTAA

  • Services.
  • Salary.
  • Property.
  • Capital gains.
  • Savings/fixed deposit accounts.

Benefits of Double Taxation Avoidance Agreements

1. The countries under the DTAA are granted relief from double taxation. Relief is granted by excluding income earned abroad from tax in the resident country.

2. DTAA can become an inducement for even legal investors to route investments through low-tax regimes to side taxation.

3. DTAA can position a country as an attractive investment destination by granting relief on double taxation.

4. DTAA also provides tax assurance to the various investors and businesses of both countries through the clear allotment of taxing rights between the contracting states by Agreement.

5. In some cases, the DTAA also provides concessional rates of tax.

To summarize, Double Taxation can be a major hassle but there are ways to ensure Double Taxation Avoidance and also Double Taxation Relief.

Double Taxation Relief and Double Taxation Avoidance

The major difference between the two concepts is that Double Taxation Relief has to do with easing a taxpayer’s double taxation burden while Double Taxation Avoidance has to do with designing ways to prevent getting taxed twice.

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