Question

Why do you think the foreign tax credit approach is the preferred method for offsetting double taxation in an international tax context? Weigh its benefits against its administrative, compliance, and complexity costs

Answer 1

In few countries, global incomes are taxable i.e. income earned all over the world are taxable in the resident country.For example, a US resident is earning salary income in US and say he has sold his property in UK for $500000.He is liable to pay tax on gain on sale of property in UK as well as US because in US global income are taxable.In this manner, he is doubly taxed in UK and US.

In order to avoid such kind of taxation structure, many countries have entered in double taxation avoidance agreement which is also known as treaties. A particular country may have bilateral treaties or unilateral treaties with other countries.One of the method of avoiding double tax is to foreign tax credit approach where tax paid in other countries is allowed as credit in tax paid in resident country.In our example, Assessee (tax payer) can take credit of tax paid on gain on sale of propery in UK while paying tax in his resident country in US.

Foreign tax credit approach is the preferred method for offsetting double taxation in an international tax context because it acknowledge the tax authority about different tax transaction done by tax payer in all over the world.In order to take foreign tax credit, tax payer will have to provide all details with regard to sale of property in other country in income tax return and it will inform tax authority about all transaction.It helps the tax authority to check all transations of an assessee in foreign countries.Although Administrative and Compliance cost is high in foreign tax credit approach beacuse a particular tax payer will have to be aware about all legal rules and compliances of both countries and has to incurr administrative and compliance cost but at the end it creates transparency in the taxation structure.It reduce the creation of black money through tax heaven county route.