In: Finance
Using examples explain the worldwide and territorial approaches of national taxation. [6 marks]
The two approaches are very much easy to understand. Lets first understand what is the basis of each separately.
The worldwide approach of national taxation is based on the concept that resident individuals and entities are taxable on their worldwide income regardless of where the income is derived. A corporation headquartered in a nation that follows this taxation system pays this tax when the foreign earning is repatriated by bringing the income back to the nation. Foreign tax credit will be available to the corporation while paying taxes.
example: if a country is following the worldwide approach of taxation then the individual in that country will be taxed on the total income irrespective o the origin of the income. To be more precise if the U.S is adopting this taxation system and Mr. A, a resident of the U.S who is having restaurant chains worldwide will be taxed on the total income he receives on his business irrespective of the fact that it originated from other nation.
Suppose home country is U.S,
A corporation in 30% tax bracket repatriates $10 million of income earned abroad, it would owe $3000000 in U.S tax. But the company already paid $2000000 of income as tax in the country where the income was earned at the country with 20% tax bracket. It would owe the U.S government another 10% ($1000000) in order to bring the total tax paid on the $10 million of income to U.S 30% tax rate.
On the other hand in the pure territorial taxation system, the nation taxes only the income derived within the territories of the nation irrespective of the residence of the taxpayer. This applies to all the business that operate within the country, whether the company's headquarters is located within the country or not.
eg; U.S doesn't tax for the income derived from other nations if the country is following the territorial tax system. By taking the example above Mr. A will be taxed only for the income from operations within the boundaries of the nation.