Double taxation
exists when the same source of income is subject to tax in two or more States,
known for tax purposes as the Source State and the Resident State.
The
difference between the Source and Resident State is analyzed below:
Source State is the State in which the income was generated. Source State claims taxing right because the income was generated in its territory.
Resident State is the State in which the tax payer is tax resident. In the majority of the States, the domestic tax law provides for taxing rights of the Resident State on the income generated by the tax payer on a worldwide basis.
Conflicts may
arise on income generated outside of the Resident State because the Source
State may claim taxing rights as well as the Resident State therefore the
income is subject to double taxation i.e. to both Source State and Resident
State. This is known as Juridical Double Taxation which is defined as the tax
payer is taxed on the same source of income by two States, the Source and the
Resident. The double taxation relief basically resolves this juridical double
taxation either with relief by credit
or relief by exemption.
Relief by credit
The tax imposed
on the source state on the particular source of income is deducted from the tax
imposed in the resident state. The relief by credit can be either ordinary
credit or full credit. Ordinary credit means that the tax imposed in the source
state is restricted to the tax imposed on the resident state which is imposed
to the income taxed in the source state. Full credit means that the resident
state allows for deduction of the total amount of tax paid in the source state.
The relief by
credit mainly applies to withholding tax imposed to the source state. This
withholding tax is deducted from the tax imposed on the resident state. The tax
authorities of the resident state will request for documents proving the
imposition of withholding tax in the source state like tax certificate issued
by the tax authorities of the source state or tax receipt.
Relief by exemption
Under the
principle of relief by exemption, the income generated in the source state and
thus subject to tax in the source state exempts from the tax imposed in the
Resident state. In substance this income is treated as tax free income in the
tax computation of the tax payer in the resident state.
The relief by
exemption mainly applies to profits generated through a Permanent Establishment
in the source state. The source state claims taxing rights on the profits of
the permanent establishment and the resident state exempts it from taxation.
Difference between credit and exemption method
Fundamentally,
the difference between the two methods is that the exemption method looks at
the income while the credit method looks at the tax.
Double Taxation Relief
The double taxation relief is granted in two ways:
Bilateral double
taxation relief: This depends on the terms of the double taxation treaty
concluded between the two States. The majority of the double taxation treaties
are based on the OECD Model Tax Treaty which provides for relief by credit and
relief by exemption depending on the particular source of income.
Bilateral double
taxation relief: This depends on the terms of the double taxation treaty
concluded between the two States. The majority of the double taxation treaties
are based on the OECD Model Tax Treaty which provides for relief by credit and
relief by exemption depending on the particular source of income.
Unilateral
double taxation relief: This depends on whether the domestic tax law of the
resident state provides for unilateral double taxation relief i.e. irrespective
of the existence of double taxation treaty the resident state provides relief
on the tax imposed on the source state. Cyprus tax law provides for unilateral
tax relief.
Conclusion:
The double taxation
is becoming nowadays a very challenging issue for the taxpayers and the tax
professionals who should be aware of the methods of its elimination and present
to the tax authorities the required documents so as to avoid being taxed twice
on the same source of income.
Please do not
hesitate to contact our office should you need any additional clarifications.
Author
Antonis
Chrysanthou FCCA
Managing
Director
CPV Audit
Services Limited