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What is Double Taxation?
Double taxation refers to situations wherein there is income, an asset, or some financial transaction that falls within two or more taxing jurisdictions. This mostly happens with respect to international business, whereby a company or individual is faced with an income liability in their home country and the country in which income has been earned. Specifically, regarding corporate tax, double taxation mostly affects businesses dealing with this issue, more so for multinationals.
Double Taxation and Corporate Tax
The corporate tax refers to the tax on the profit gained by a company with varying rates charged by different countries. Double taxation in the context of a corporation typically arises in the following two situations:
International Double Taxation:
When a company generates income in another country, such income is usually subjected to tax by the country in which the income is generated and also the country where the company has its domicile.
Economic Double Taxation:
It refers to tax incidence on the same income stream twice. For example, a corporation whose earnings are subject to corporate tax, and then the dividend distributed to shareholders from those earnings is taxed again in the hands of shareholders.
Types of Double Taxation
There are two major types of double taxation:
Juridical Double Taxation:
This is the situation whereby two or more tax jurisdictions impose tax on the same entity for the same income. An example would be whereby a corporation is taxed on its worldwide income in its home country and also is taxed on that very same income in a foreign country where it operates.
Economic Double Taxation:
This type occurs when the same income is subjected to tax in the hands of different taxpayers. As an example, the profit of a company is taxed at the corporate level, and then again, at the individual level, the dividends distributed to shareholders get taxed.
The Two Methods of Taxation
Worldwide Taxation:
In this approach, residents and domestic corporations are taxed on their worldwide income, irrespective of where it is generated. For instance, the United States employs worldwide taxation, meaning that American citizens and companies are required to report income both at home and abroad and pay taxes on it. In return, though, to avoid double taxation, the U.S. permits foreign tax credits.
Territorial Taxation:
In territorial taxation, only the income made within the borders of a country is subjected to tax. This system is employed by most European countries. Basically, under this system, foreign income by its residents or domestic corporations is not taxed by the home country. This would avoid double taxation without the need for tax treaties or foreign tax credits.
Conclusion
More importantly, this process of double taxation at the corporate level may have significant implications for international business operations and investment decisions. The kinds of double taxation and the methods for its application are very important to be known by any corporation in order to face the challenges of the global tax environment. Enterprises can reduce the effects of double taxation by using tax treaties, credits, and exemptions to ensure a better tax outcome and improve their competitiveness in the global marketplace.
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