Issues related to Double taxation

Double taxation is a situation associated with how corporate and individual income is taxed and is, therefore, susceptible to being taxed twice.

Categories of Double Taxation

1. Corporate Double Taxation

It is a situation in which corporate earnings are taxed twice at two different levels but include the same income. A corporate organization’s net income is taxed as corporate tax, and when the same income is distributed to shareholders as a dividend, it is again taxed by way of a dividend tax. Corporate double taxation is common not only in the United States but in several countries around the world.

Arguments against corporate double taxation indicate that as shareholders are the owners of a corporation in which corporate tax is levied on profits attributable to the owners, income distributed to them as dividends and taxed with dividend tax at a personal level represents the same income stream being taxed twice.

However, arguments for the maintenance of the double taxation regime contend that since a corporation in the form of a company is a separate legal entity divorced from the company’s individual owners, taxation on both corporate earnings and dividends is justified.

2. International Double Taxation

International double taxation mainly concerns multinational entities that operate in jurisdictions other than their home country, but it can also affect foreign income earned by individuals in foreign countries. There are instances where foreign income is taxed in the country where the income is derived and the country where an investor resides.

Hence, double taxation induces a hardship on taxpayers through an increased tax burden on the investor and can result in the increase of the price of goods and services, discourages cross border investment through curtailing capital movement, and violates the tax fairness principle.

Measures to Avoid Double Corporate Taxation

1. Legislation

Legislation must be enacted to remove elements of double taxation, which is inefficient and discourages investment. If investors are able to receive their dividends tax-free, they will be inclined to invest more rather than retain profit, especially for mature companies that do not need much capital.

2. Pass-through taxation

It involves structuring the business as a sole proprietorship, a partnership, or an LLC adopt pass-through taxation features. There are no dividends in such structures, as profits are shared between the owner(s)/partners. However, the strategy is only applicable to small organizations.

3. Absence of dividend payments

Avoiding payment of dividends and retaining profits in the business to generate growth. The strategy works for start-ups and organizations in the growth phase of the business life cycle. It is critical to growing product scope and market share. Shareholders of mature companies with stable cash flows and very little cash appetite expect dividend compensation.

4. Personal income tax status

Shareholders can add themselves as employees in smaller companies or as executive directors in larger companies and get paid a salary; however, they would still be taxed on their salary through a personal tax rate. It would not qualify as double taxation.

Managing International Double Taxation

The best way to manage the challenge of international double taxation is to come up with tax treaties between countries and legal jurisdictions. The treaties involve collaboration between jurisdictions and the exchange of information. They are established to reduce or eliminate illegal taxation practices, promote trade efficiency between nations, prevent tax evasion, and ensure tax certainty.

Double Taxation Agreements (DTA)

A double taxation agreement (DTA) refers to an agreement signed between two countries to prevent or minimize territorial double taxation of the same income by the two countries. DTAs are put in place to ensure they alleviate double taxation, which undoubtedly discourages international trade. Given the global village the world has become, double taxation is counterproductive and discourages investment flows.

DTAs encourage cross-border trade and investment between countries. When trade between two countries is growing, and both countries anticipate further growth, they usually facilitate the signing of a DTA to eliminate double taxation and improve trade between them. The DTA establishes rules and regulations of how income earned through cross-border transactions is treated and ensures that the income is not compromised through double taxation.

A DTA can require that tax is charged in the investor’s home country and is exempt in the country where the income is generated. Alternatively, an investor may be levied tax where the income arises, and the investor will receive a foreign tax credit in the home country.

Double Taxation Relief

1. Exemption method

Under the exemption method, a taxpayer is exempt from tax in their resident country or jurisdiction regardless of where the income is generated. However, taxpayers are liable to pay tax in the host country where income is generated. The exemption method encourages cross-border investments by investors in their resident countries and removes barriers to free trade, thereby increasing trade and the globalization of business.

Countries that solely use the exemption method are termed tax havens, as they do not tax –or apply low tax rates to foreign earned income by resident corporations and individuals.  Most tax havens attract wealthy individuals, multinational corporations, and financial institutions that seek to minimize tax liabilities.

However, tax havens are being criticized for helping protect the financial transactions of criminals and shady businesses and facilitate money laundering. Examples of tax havens include The Cayman Islands, Bermuda, The Bahamas, and Cyprus.

2. Foreign tax credit (FTC)

The foreign tax credit method taxes the income of residents regardless of where it arises. The FTC method requires the home country to allow a credit against domestic tax liability where a resident pays tax in a country where the revenue arises.

The tax paid in one country is used to offset the tax liability in another country. This method helps businesses to operate normally within existing tax regulations. FTC can also be termed the Capital Export Neutral System.

Tax Residency Certificate

The Government of India has made it mandatory for assessor’s to obtain Tax Residency Certificate (TRC) from the country of residence to avail the benefits of the Double Taxation Treaty in India.

DTAA Agreement with Mauritius

India has a comprehensive DTAA agreement with Mauritius wherein the capital gains arising from the sale of shares are taxable in the country of residence of the shareholder and not in the country of residence of the company whose shares have been sold. Therefore, a Company incorporated in Mauritius selling shares of an Indian Company will not pay capital gains tax in India. Further, since there is no capital gains tax in Mauritius, the entire gain on capital gains arising from the sale of shares will not be taxed. Hence, this unique feature of the DTAA agreement between India and Mauritius is used by many Foreign Institutional Investors to trade in the Indian stock markets and avoid capital gains tax in India and Mauritius.

India has DTAA agreements that are similar to the India; Mauritius DTAA Agreement with Singapore and Cypriot. Hence, many Indian Companies and Foreign Investors invest through these foreign companies in foreign countries into India.

List of Countries having Double Taxation Treaty with India

The following are the list of countries having the Double Taxation Treaty with India:

• Armenia
• Australia
• Austria
• Bangladesh
• Belarus
• Belgium
• Botswana
• Brazil
• Bulgaria
• Canada
• China
• Cyprus
• Czech Republic
• Denmark
• Egypt
• Estonia
• Ethiopia
• Finland
• France
• Georgia
• Germany
• Greece
• Hashemite Kingdom of Jordan
• Hungary
• Iceland
• Indonesia
• Ireland
• Israel
• Italy
• Japan
• Kazakastan
• Kenya
• Korea
• Kuwait
• Kyrgyz Republic
• Libya
• Lithuania
• Luxembourg
• Malaysia
• Malta
• Mauritius
• Mongolia
• Montenegro
• Morocco
• Mozambique
• Myanmar
• Namibia
• Nepal
• Netherlands
• New Zealand
• Norway
• Oman
• Philippines
• Poland
• Portuguese Republic
• Qatar
• Romania
• Russia
• Saudi Arabia
• Serbia
• Singapore
• Slovenia
• South Africa
• Spain
• Sri Lanka
• Sudan
• Sweden
• Swiss Confederation
• Syrian Arab Republic
• Tajikistan
• Tanzania
• Thailand
• Trinidad and Tobago
• Turkey
• Turkemistan
• UAE
• UAR (Egypt)
• UGANDA
• United Kingdom
• Ukraine
• United Mexican States
• United States of America
• Uzbekistan
• Vietnam
• Zambia