Question

In what ways can a country provide relief from double taxation? Under what circumstances is it advantageous to take a deduction rather than a credit for taxes paid in a foreign country?

Answer 1

Answer

In this age of globalization many organizations including individuals have got their wings spread all over the world. In any country the tax is levied based on 1) Source Rule and 2) the Residence Rule. The source rule holds that income is to be taxed in the country in which it originates irrespective of whether the income accrues to a resident or a non-resident whereas the residence rule stipulates that the power to tax should rest with the country in which the taxpayer resides. If both rules apply simultaneously to a business entity and it were to suffer tax at both ends, the cost of operating on an international scale would become prohibitive and would deter the process of globalisation. It is from

In this age of globalization many organizations including individuals have got their wings spread all over the world.

In any country the tax is levied based on 1) Source Rule and 2) the Residence Rule. The source rule holds that income is to be taxed in the country in which it originates irrespective of whether the income accrues to a resident or a non-resident whereas the residence rule stipulates that the power to tax should rest with the country in which the taxpayer resides. If both rules apply simultaneously to a business entity and it were to suffer tax at both ends, the cost of operating on an international scale would become prohibitive and would deter the process of globalisation. It is from this point of view that Double Taxation Avoidance Agreements (DTAA) becomes very significant.

There are limited circumstances, however, in which foreign source income earned by a foreign taxpayer is subject to U.S. taxation. A foreign taxpayer engaged in a trade or business in the United States is taxed by the United States on all income that is "effectively connected" with that trade or business. 60 Although effectively-connected income is generally sourced within the United States,6 ' this income includes certain foreign source income if the taxpayer maintains an office or fixed place of business within the United States to which the foreign source income is attributable. 62 Since the United States is not the host country as to this income, it is appropriate for the United States to grant a foreign tax credit for taxes paid to the country in which the income is sourced. 63