Double Taxation - Explained
What is Double Taxation?
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Table of ContentsWhat is Double Taxation?How Does Double Taxation Work?Corporations and Shareholders in Double TaxationDouble Taxation Due to International TransactionsAcademic Research on Double Taxation
What is Double Taxation?
Double taxation is a term used to define taxing an income twice. In financial terms, double taxation refers to paying two income taxes on the same source of income. It generally occurs in a situation where the earned income is taxed at the corporate level and personal level, i.e. the gains are first taxed at the company and then the part which gets to the investor after the company pays its taxes is then taxed again. Double taxation is not just limited to corporate and personal level as an income can be taxed by two countries in the case of international trades.
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How Does Double Taxation Work?
Double Taxation is generally not accepted by members of the public or investors as it is typically a negative and unintentional result of tax legislation. This is because it seems absurd to pay tax twice on the same incomes and this is a major reason why tax agencies and authorities try to avoid any case of double taxation as much as possible.
Corporations and Shareholders in Double Taxation
Like we earlier stated, double taxation can occur at the corporate and personal level, which in this case refers to taxi the corporation or firm, and then moving on to tax the shareholder after receiving his or her part of the already taxed gain. This generally occurs because a shareholder is considered to be a different legal entity from his or her corporation or establishment under law. This results in payment of taxes by both corporations as a separate entity, and individuals as another separate entity. When a firm or establishment releases dividends and capital gains to shareholders and investors, those payments are noted as tax eligible and subject to deductions for the shareholder who receives them. Simply put, any money that goes into the shareholders account from corporate dividends would be taxed. This would happen regardless of the fact that the corporation has already paid the tax on the total income income before transferring them to shareholders in different quantities. Double taxation on capital gains and dividends has brought up a lot of queries from the public. The public however is divided on this case. While some argue in the favor of this quota, others are against it stating that it is unfair to tax investors as they've already paid for the tax at the corporate level. Those who are in support of the system are generally quick to lash out at wealthy investors and individuals, stating that they could enjoy the benefits of dividends and possibly live off them without having to pay income taxes. This can typically be done by investing in large volumes of common stocks which they wouldn't have to pay taxes on. They also argue that the fact that dividend payments to shareholders are voluntary on the part of corporations gives them the right to abstain from paying shareholders capital gains, thus eliminating the possibilities of double taxation. With all the debate going on even at federal levels, tax agencies have found a way to reduce the shortages caused by double taxations. This is generally done by placing floating tax rates and tax credits on incomes earned by a corporation and dividends transferred to individual shareholders and making sure that they're taxed totally at the same rate. For clarity, imagine that Company A has a net profit of $400million for the tax year, and they paid each investor $4 million in dividends for the year (assuming each shareholder holds the same number of stakes). Now, to avoid double taxation, the tax agency might choose to place 15% on the corporation, thus making Company A to give out approximately $60million as income tax for the year. The remaining $340million would then be shared amongst shareholders as stated by their agreement. Now if the total income tax for the nation was to be 25%, each shareholder would be required to pay approximately 10% on their earnings. So for an investor who earns $5million dollars after his corporation has been taxed, he is further required to pay taxes worth $500,000 thus totaling 25% income tax per entity. This would lead to the corporation and the shareholders paying the same 25% which every entity is required to pay in that nation, but the value of the 10% would differ based on what each investor receives.
Double Taxation Due to International Transactions
As we stated earlier, double taxation can occur on international trades as each country would want to tax any income generated or transferred into its territory. Multinational establishments generally get tangled on what to do with the issue of double taxation due to owning different international branches subject to different states taxing structure. Income are generally taxed in the country where they're earned and also in the country where there repatriated, this making the cost of tax expenses so high that most firms decide to stick to just one region when carrying business activities. In order to avoid the issue of international double taxations, a great number of countries around the world have signed several treaties to prevent cases of double taxations factored on models offered by the Organization for Economic Cooperation and Development (OECD). These treaties contain agreements where different nations have agreed to limit or eliminate taxes on international businesses in an effort to improve trade between both nations and prevent the issues of double taxation which might eventually become triple taxation in a situation where the investors are later taxed.
Academic Research on Double Taxation