Double Tax Agreement

What is double taxation?

Double taxation is a situation in which a taxpayer is subjected to similar tax obligations by two different countries for the same income, during the same timeframe, and related to the same subject matter.

This problem arises from the fact that each nation has the authority to impose taxes within its territorial boundaries, and its legal system enforces these tax laws without considering their impact on individuals or entities outside its jurisdiction.

International law does not impose any obligation on countries to account for the tax laws of other nations when establishing their tax rates, nor does it require them to limit their taxation in any particular manner.

Consequently, the same income can be taxed by more than one nation, resulting in double taxation.

Double taxation typically occurs in two main scenarios:

1. Residence vs. Source Taxation: In this scenario, one country taxes income based on the recipient’s place of residence, while another taxes it based on the source of income.
2. Dual Residency or Citizenship: Double taxation can also arise when an individual or entity is a resident of one state and a citizen of another, and both countries levy taxes on the same income.

Double taxation can be further complicated by the following factors:

• Even among nations imposing tax based on the recipient’s personal attributes, one jurisdiction may tax based on residency, while another may use nationality or domicile as the basis, leading to potential multiple taxations of the same income.
• Conflicts and inconsistencies can occur when multiple jurisdictions have differing interpretations of the criteria for tax liability. For example, a taxpayer may be considered a resident of two different countries under each country’s laws, or the same income may be deemed sourced in multiple countries.

To mitigate the issue of double taxation, double tax agreements are employed. These agreements work to limit the domestic tax laws of one or more participating countries in the following ways:

Overriding Domestic Provisions: DTAs can supersede the domestic tax laws of the countries involved, ensuring that the same income is not taxed twice.
Tax Credit Mechanism: These agreements obligate one or both countries to grant a credit against their domestic taxes for taxes already paid in the other country, thereby reducing the risk of double taxation.

Capital gains tax

Capital gains are the profits made from selling valuable assets, such as stocks, real estate, or businesses. When you make money from these sales, it’s subject to taxation. In Australia, this tax is known as Capital Gains Tax (CGT).

The complexity arises when the assets are international, and the question of which country gets to tax the gain comes into play.

For Australian residents, if you sell assets like property or shares, you’re generally required to pay CGT. For non-residents, you’ll usually only be taxed on capital gains from selling property in Australia, but this applies to property bought after a specific date, September 20, 1985.

This means if you’re a non-resident selling Australian property, you’re subject to CGT.

DTAs and capital gains taxation

Residency Matters: DTAs take into account your tax residency. If you’re a resident of one country but earn capital gains from selling assets in another country (for instance, a non-resident making gains in Australia), the DTA helps decide which country has the right to tax that gain.

Location of the Asset: For CGT, the location of the valuable item you sold plays a crucial role. The general rule is that the country where the property or asset is located has the right to tax the capital gain.

Avoiding Double Taxation: If your case involves a DTA between your home country and the foreign country where the gain was made, the DTA will often allow you to claim a credit for any tax you paid in the foreign country.

This ensures you don’t end up paying tax on the same gain in both your home country and the foreign country.

Business profits and permanent establishment

When it comes to taxing business profits in the context of international taxation, a crucial consideration is the concept of a ‘permanent establishment.’ This term refers to a fixed location or place of business where a taxpayer conducts some or all of their business activities.

Under the business profits article found in many tax treaties, the profits generated by a business in one country can be subject to taxation in another country, but only in two specific situations:

Presence of a PE: The first condition is that the business must actually operate within the second country through a permanent establishment. This means the business has a physical, fixed place of business in that country, like an office, branch, or factory.

Attribution of Profits: The second condition involves the determination of which portion of the business’s profits can be attributed to the activities conducted through the permanent establishment. In other words, only the profits related to the business operations occurring at the permanent establishment can be subject to taxation in the second country.

Legal effect of double tax agreements