Relief from international double taxation.

• Author: Beck, Allen M.

International double taxation represents the imposition of comparable income taxes by two or more sovereign countries on the same income items on the same taxpayer for the same tax period. Bilateral tax treaties often provide solutions to this problem. Most are based on one of three models--the United States Model Income Tax Convention of September 20, 1996 (the U.S. Model), the United Nations Model Double Taxation Convention Between Developed and Developing Countries (the U.N. Model) or the Organization for Economic Cooperation and Development (OECD) Model Tax Convention on Income.

Acceptable international practice grants countries a primary right to tax income with a source in that, country. Put simply, the source country's right has priority over the taxpayer's country of residence/citizenship. The taxpayer's "home" country would then provide relief if its taxing jurisdiction (based on residence or citizenship) overlaps the source jurisdiction's right. No international consensus dictates the appropriate relief method; countries commonly use three--the deduction method, the exemption method and the credit method. Countries can use one method or a combination to provide relief from international double taxation.

Deduction Method

The deduction method (such as the U.S., under Sec. 164(a)(3)) allows residents/citizens to deduct foreign taxes paid in computing their taxable worldwide income. This treats the foreign taxes paid as a current expense; it is the least effective means of providing relief. Residents paying and deducting foreign taxes on foreign-source income are taxed at a higher combined rate than on domestic-source income. The deduction method creates an obvious bias in favor of domestic investing, and is not tax neutral in allocating resources between countries.

Exemption Method

Under the exemption method, a taxpayer's home country will tax its residents/citizens only on their domestic-source income. The country of residence exempts the taxpayer's foreign-source income from domestic taxation, leaving it to be taxed by the source country.

Many countries employ variations of this method due to different tax structures worldwide. For example, the exemption on income derived by resident companies through foreign affiliates or branches located in tax-haven countries is often limited. Only if the foreign-source income is subject to a tax by the foreign country will an exemption be available.

The "exemption with progression" is another...