when income is taxed twice, either in two different countries or once as a personal unit and another time as a corporate unit.
Double Taxation Details
When you work or sell products in one country but are a resident of another country, your income may become subject to taxation in both countries. We commonly think of multinational corporations that operate in multiple countries as the ones that are the most affected by double taxation. Very often, this dissuades companies from investing globally or causes an increase in the price of the items that they sell.
In the United States, an organization's net income is taxed once at 21%. The dividends from the net income received by the shareholders (the corporation owners) are taxed again at 37%. Supporters of double taxation claim that a corporation is a separate legal entity, and so, it should be taxed on both revenue and dividends.
When globalization started to rise, many countries began focusing on incorporating laws to remove double taxation. Across the world, various states have entered tax treaties, like double taxation agreements (DTAs). DTAs require that when the investor's home country charges a tax, the tax in the country where they earn the money must be levied. Recent news reported the newly signed double taxation agreements between the USA and Cyprus, and Jamaica and the United Arab Emirates.
Real-World Example of Double Taxation
In 2021, the European Court of Justice reviewed the operations South Korean company providing mobile phone services to customers temporarily living in Austria. The court decided that the service should be taxed twice–in the country where it originates and in the country where people use it.
Democracy Builders Fund, an S corporation that has owned the campus of Marlboro College since last July, has received almost $1 million in federal COVID relief funds to support 270 jobs. According to the Internal Revenue Service, shareholders of S corporations submit their personal income tax returns and have their taxes calculated at their individual tax rates. As opposed to C corporations, this allows S corporations to avoid double taxation on the corporate income.
Double Taxation vs. Exemption Method
As described above, there are several ways a company can avoid double taxation: enact legislation, establish the corporation as a partnership, halt the dividend payout, add the shareholders to the list of employees and pay them salaries instead of dividends, treaties, double taxation agreements, and last but not least, the exemption method.
The exemption method clears the corporations from the responsibility to pay taxes in their resident countries. Countries using the exemption method have been named tax-havens. Critics condemn these countries for protecting criminal activities like money laundering.
History of Double Taxation
When discussing double taxation, it's important to mention the Tax Cuts and Jobs Act (TCJA) introduced in 2017. It decreased the tax rate from 35% to 21% and permitted the deduction of the cost of new investments for the year they were made. Before the TCJA, the USA imposed a tax on all income, disregarding the location of the source. In addition, TCJA spared from taxation the dividends that domestic corporations get from foreign corporations.