Double taxation arises when businesses and individuals derive income from foreign countries and the same income is subjected to tax by both the foreign country and home country. International double taxation is exercised since individual countries have got their own legislative tax rules and right to tax. Differences in tax systems applied by countries are usually realized in areas such as; scope of taxation, income source rules, rules governing the tax residence of an individual or company as well as the various measures within a country’s domestic laws concerning taxation. These considerations have invariably increased the level of burden of tax on foreign income making international investments in technology and expertise very challenging (Inland Revenue, 1999).
Basic systems countries have adopted to ameliorate the burden of international double taxation
The first system is the signing of an agreement based on Avoidance of Double Taxation (DTA) with other countries. The DTA is entered between two countries seeking to avoid a double taxation system. The agreement provides certainty and principles concerning the manner and ways through which tax could be imposed in the country where income is generated or payment is made. The DTA agreement analyzes the taxation rights of each country considering which country should give a tax credit to eliminate double taxation. The allocation of taxation rights over income to an individual or company could be allocated in various ways which include; one of the countries under the agreement grants full rights to tax income while the other exempts the income, sharing of tax between the two countries where the source country is limited to a specified level of tax with the country of residence granting credit for tax deduction from the source country. There is also the situation where both countries exercise full rights to tax but the source country is given credit for the tax paid by the country of residence (Inland Revenue, 1999).
Elimination of Double Taxation could be done through exemption methods. Full exemption entails the process where the income is left out without deduction since the state concerned is not entitled to consider the income in the process of determining tax rates imposed on other income. Then there is what is known as exemption with progression which is applicable in case the country of residence computes its tax using graduated rates. The tax is not imposed on the income within the residential country though its impact is taken into consideration to compute preferable tax rates within the country (Inland Revenue, 1999).
The other method of double tax elimination used by countries is known as the credit method. This involves ordinary credit where the country of residence allows a tax credit based on the restrictions on the income from the source country, this infers that relief is not given by the country of residence if tax rates are higher in the source country. Then there is full credit where the amount of tax payable in the source country is accepted as credit in full. This happens where the tax in the residential country seems lower than that from country of source, in such a case the tax on other income is given up by the country of residence (Inland Revenue, 1999).
Indicate which of these is most advantageous to taxpayers and why this is so
The exemption method is suitable to taxpayers since at times individuals offer their services for a short duration of time or at times through modern technology whereby they can work from their country of residence. At the same time, ordinary credit could be appropriately used to eliminate taxation for residents. This could be done such that credit is allowed in respect of foreign tax paid against residence tax payable on the same income. The credit process is further restricted to the lower of the foreign tax and the country of residence’s payable on the same income in question.
Describe which of these systems is preferred by most countries and why this is so
Most countries prefer the use of DTA since it provides for different standards of negotiations depending on the country with which an agreement is signed. Every DTA comes as a result of a series of negotiations between countries having their set standards of policies and technical considerations. DTA allows for every country to make certain compromises for fairness (Inland Revenue, 1999).
The methods adopted for double tax elimination depend on each country’s legislative laws concerning domestic tax. The credit method can either be used or the exemption method. At times the combination of both methods is applicable depending on the tax system in operation within the subject country.
Inland Revenue. (1999). Double Taxation Relief for Companies. Web.