How double taxation treaties work
Contributed by BridgeWest
06 April, 2018
International or cross-border trade is very complex from a taxation point of view, which is why all countries around the world have designed mechanisms through which the levies on such activities are regulated. The most effective tax treatment appliedby the governments to enterprises and individuals with economic activities in other countriesare double taxation treaties.
Even if each country has its own legislation related to taxation, includingdouble taxation, it is not uncommon to use models or recommendations from international institutions when drafting such agreements. From this point of view, the Organization for Economic Co-operation and Development (OECD) and the United Nations have proposed several models of double taxation agreements which were adopted and, of course, tailored by states in order to create international tax rules which are easy to follow and respect.
Taxes usually covered by double taxation agreements
First of all double tax treaties, even if concluded by the same country with other states, contain specific tax avoidance or minimization rules as they must follow the legislation, therefore the particularities of both states. Secondly, in order to be as effective as possible and to bring real benefits to those making use of them, they are negotiated and, in some cases, included in the national tax legislation.
The taxes covered by double taxation treaties are usually the income tax applicable to individuals and enterprises, the taxation of capital and of employment. Dividend, royalties and interest payments are also included in most double tax treaties. These can also apply to artists, sportsmen, students and retired persons.
As mentioned above, specific clauses can be included for certain incomes or activities. One of the best examples is Switzerland, which has aunique taxation system, and which is not part of the European Union, therefore it has not concluded any agreement at regional level. Swiss double tax treaties are, therefore, signed individually with each country in the EU.
Other states in the EU, such as Italy, the Netherlands, Germany or Ireland can also benefit from other tax regulations within the union. However, they also have their own double taxation treaties. For example, the Netherlands has nearly 100 double tax agreements, one of the greatest number of double taxation treaties concluded by an EU state.
Methods used for eliminating or reducing double taxation
The most common methods used to eliminate or reduce double taxation under such agreementsare tax exemptions or tax credits.
The tax exemption method can be applied in full or progressively. In the case of the full tax exemption method, the country in which the profits or income are earned will not impose any tax, the resident country being the one levying the tax. Under the progressive or partial tax exemption method, the tax will represent the difference between the rate in the resident country and the rate applicable in the country where the income arises. The last tax exemption method is usually employed in Italy's double tax conventions.
The second method used to alleviate double taxation is the tax credit. This method applies in the resident country which must offer a credit or refund of the tax paid by an individual or company in the country where the income was made. Most countries around the world use the tax credit method. Irish double tax treaties usually contain provisions for tax credits which can be granted totally or partially to its residents.
The development of the global economy triggers new changes, however cross-border trade remains the same which is why double taxation treaties are one of the most important tools of such activities. At the moment, there are more than 3,000 double taxation treaties enforced at global level and their number is expected to grow as more and more negotiations are carried.
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