Bases for asserting jurisdictions
Who to tax?
What income to tax?
Personal relationship between a taxpayer and the country
This concept also applies to corporations and other type of entities. A corporation can be considered a citizen of the country in which it is organized and a resident of the country where it has its principal place of business.
Economic relationship between the person and the country
A person will have economic relationship with a country from where he derives his income from property or business activities. U.S citizens, resident aliens and domestic corporations are taxed on the basis of personal relationship. Nonresidents and foreign corporations are taxed on the basis of source of income.
Territorial versus Credit System
If a taxpayer is resident of one country and derives income from another country, it may lead to a problem of double taxation. Host country will assert jurisdiction on the basis of its economic relationship and home country may also impose jurisdiction on the basis of its relationship with the taxpayer. In such a situation home country will usually solve double taxation problem either by territorial system or a credit system.
Under territorial system foreign income is excluded and taxpayer is only taxed on income earned in the house country. Under the credit system home country allows a credit for any taxes paid in the foreign country. This way foreign income is taxed only one time at the higher of the host country’s rate or the home country’s rate.
Example (Host country’s rate is lower than the foreign country’s rate)
Corporation xyz has foreign source taxable income = 100
Home country’s tax rate = 40%
Host country’s tax rate = 20%
Assumption 1 = No mechanism for tax reduction
Home country’s tax = 100 x 40% = 40
Host country’s tax = 100 x 20% = 20
Total tax paid by taxpayer = 60
Assumption 2 = Territorial system exists
Home country tax = 0 x 40% = 0
Foreign country’s tax = 100 x 20% = 20
Total tax paid = 20
Assumption 3 = Credit System exists
Home country tax = 100 x 40% = 40
Foreign tax credit = 100 x 20 = 20
Total Tax paid = 40 – 20 = 20
Example 2: Host country’s tax rate is higher than the home country’s tax rate.
Taxable income = 100
Home country’s tax rate = 20%
Host country’s tax rate = 40%
Assumption 1 = Territorial system exists
Home country tax = 0 x 20% = 0
Foreign country’s tax = 100 x 40% = 40
Total tax paid = 40
Assumption 2 = Credit system exists
Home country’s tax = 100 x 20 = 20
Tax paid in foreign country = 100 x 40% = 40
Home country’s tax credit = 20
Tax to be paid in home country = 0
Tax treaties
Tax treaties provide bilateral solutions to the international double taxation. Reduce double taxation through reciprocal tax exemptions and lower tax rates for income derived by residents of one treaty country from sources within the other treaty country. Tax treaties shift the claim of primary tax jurisdiction from the host country to the home country.
Disclaimer:
This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.
References:
US Taxation of International transactions 9th Edition
Robert J. Misey Jr.
Michael S. Schadewald
Publishers: Wolter Kluwer, CCH Incorporated.