Double Taxation

Double taxation is the systematic imposition of two or more taxes on the same income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). It refers to taxation by two or more countries of the same income, asset or transaction, for example income paid by an entity of one country to a resident of a different country. The double liability is often mitigated by tax treaties between countries.

Corporations are often also subject to double taxation, as they are taxed on their income as a legal entity and then again at the individual level when they pay distributions to their shareholders. The opposite of this is called pass-through taxation, where a business entity is not taxed as a legal entity; instead, its profits are taxed at the individual level after they have paid distributions.

Business entities which benefit from pass-through taxation include S-Corporations, LLCs, and partnerships, and this is a significant advantage over other business forms which are subject to double taxation. It is not unusual for a business or individual who is resident in one country to make a taxable gain (earnings, profits) in another. This person may find that he is obliged by domestic laws to pay tax on that gain locally and pay again in the country in which the gain was made. Since this is inequitable, many nations make bilateral double taxation agreements with each other.

In some cases, this requires that tax be paid in the country of residence and be exempt in the country in which it arises. In the remaining cases, the country where the gain arises deducts taxation at source ("withholding tax") and the taxpayer receives a compensating foreign tax credit in the country of residence to reflect the fact that tax has already been paid. To do this, the taxpayer must declare himself (in the foreign country) to be non-resident there.

So the second aspect of the agreement is that the two taxation authorities exchange information about such declarations, and so may investigate any anomalies that might indicate tax evasion.

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