Double Taxation – How does it occur?

What Is Double Taxation?

Double taxation is a tax principle referring to income taxes paid twice on the same source of income. It can occur when income is taxed at both the corporate level and personal level. Double taxation also occurs in international trade or investment when the same income is taxed in two different countries. It can happen with 401k loans.

What is the Process of Double Taxation?

Since corporations and their stockholders are regarded independent legal entities, double taxation is common. As a result, corporations, like people, pay taxes on their annual earnings. Even if the earnings that supplied the funds to pay the dividends were previously taxed at the corporate level, when businesses pay dividends to shareholders, the dividend payments result in income-tax liabilities for the shareholders who receive them.

Tax policy frequently has unforeseen consequences, such as double taxation. It is widely regarded as a bad aspect of the tax system, and tax officials try to prevent it as much as possible.

Most tax systems attempt, through the use of varying tax rates and tax credits, to have an integrated system where income earned by a corporation and paid out as dividends and income earned directly by an individual is, in the end, taxed at the same rate. For example, in the U.S. dividends meeting certain criteria can be classified as “qualified” and as such, subject to advantaged tax treatment: a tax rate of 0%, 15% or 20%, depending on the individual’s tax bracket. The corporate tax rate is 21%, as of 2022.

International Double taxation

Double taxation is a problem that many international firms encounter. Income may be taxed in the nation where it is earned, and then again when it is repatriated to the company’s home country. In certain circumstances, the total tax rate is so high that conducting foreign business is prohibitively expensive.

To prevent these problems, governments all over the world have signed hundreds of double taxation treaties, many of which are based on models developed by the Organization for Economic Cooperation and Development (OECD) (OECD). Signatory governments agree to limit their taxes of foreign commerce under these treaties in order to increase trade between the two countries while avoiding double taxation.