Individual foreign tax relief and tax treaties play an important role in international tax agreements. With individuals and companies forming cross-border affiliations, the problem of double taxation is created, which must be resolved. This article’s focus revolves around individual foreign tax relief and tax treaties which are used to obtain double taxation relief.
What is Foreign Tax Relief?
Foreign tax relief refers to relief given by a country in respect of tax levied and charged in another country on income earned by citizens or residents of the former in the other country. When citizens derive income in another country, the income is liable to be taxed both in the country of residence as well as the country of source. In order to eliminate this form of double taxation, most countries offer either a credit or an exemption form of Foreign Tax Relief.
Table: Comparison of Foreign Tax Relief Methods:
| Reliefs | Credit Method | Exemption Method |
|---|---|---|
| Double Taxation Relief | Credits foreign tax against home country tax on same income | Fully or partially exempts foreign income from home country tax |
| Applicable Limits | Foreign tax credit limited to home country tax on foreign income | No limits, provides more generous relief |
| Unused Credits | Excess credits cannot offset home tax on other incomes | Not applicable as exemption from home tax is provided |
| Record Keeping | Requires maintaining foreign tax payment records | Simpler as no credit to carry forward or back |
| Cash Flow Impact | Delays home tax payment if credit offsets tax liability | More immediate home tax relief as income exempted |
How do Tax Treaties work?
Tax treaties, or double taxation agreements (DTAs), refer to bilateral arrangements entered into by two nations in order to avail double taxation relief on income while providing clear information. Key features of tax treaties include:
- Definition of resident - who is considered a resident of a contracting state for treaty purposes
- Taxing rights – determination of which country has the exclusive right to tax various forms of income such as business profits, dividends, interests etc., using conditions such as a permanent establishment
- Various deportation methods of double taxation – methods through which the tax on the same income would be escaped or eliminated
- Non-discrimination clauses – residents should not be treated worse than the domestic residents
- Sharing of data - the signatories were expected to exchange tax data in order to fight evasion and avoidance.
If an individual receives income arising from a DTA country, then the provisions of the tax treaty override the domestic legislation. The provisions concern the level of source country taxation and the level of relief in the country of residence of the amounts through correlation of their tax systems.
Benefits of Tax Treaties
Tax treaties benefit individuals, businesses and the governments in the following ways:
- Double taxation relief - Through restricting source country taxation and availing relief measures, the treaty aim at ensuring that the income is taxed only once.
- Certainty and reduced compliance costs - The clear definitions and levels of foreign taxes foster certainty concerning tax claims and the costs of foreign tax compliance.
- More cross-border flow – The centralization or the reduction of tax liabilities brings about more cross border flow which is essential for investment and trading among nations.
- Dispute prevention and resolution - Such procedures assist in preventing and solving disputes and avoiding circumstances such as double taxation without involving the legal process.
- Exchange of information – Effective measures to counter evasion through mutual sharing of tax information between treaty nations.
- Non-discrimination provisions – Individuals from treaty countries are given national treatment and are taxed in accordance with the domestic source country residents.
Read more: Guide: Tax Law for Foreign Banks in Dubai
Foreign Tax Relief for Expat Individuals
People who are employed in another country as they uphold residence in their native country are referred to as expatriates or expats. Reliefs available to expats include:
- Foreign tax credit: Permits allowance of foreign income taxes from home country tax on the same income as provided under the conditions of the treaty.
- Income tax exemption: Part or the whole of the income earned through employment or pension in another country continues to be exempt from taxation at source.
- Deduction of foreign taxes: In countries where credit method is not applicable, it is acceptable to offset foreign taxes from the taxable income.
- Personal allowance: Some companies provide special privileges or exceptions based on overwork for foreign employees working overseas.
- Tax reimbursement: This is because some employers provide monetary compensation or “gross up” part of the foreign tax paid to ensure that the employees’ disposable income remains the same.
FAQs
Q1. How does the foreign tax credit differ from a tax deduction?
A1. A credit directly decreases the home country tax amount which is payable on foreign income while the deduction only decreases the overall income upon which the tax is calculated. Hence a credit offers more aggregate relief to tax.
Q2. If a company pays higher taxes abroad, can the excess be used to offset domestic taxes?
A2. No, the credit method of claiming the foreign tax credit is limited to the amount of domestic tax payable on the foreign income. Any excess therein cannot be utilized in a manner of reducing or counterbalancing other income generating streams in its home country.
Q3. Can a country tax its citizens' foreign income without a tax treaty?
A3. Yes, the taxation rights of a country are first and foremost defined by national laws. But a tax treaty serves as an assurance that taxation is done in a moderated manner and double taxation is alleviated in a more favorable manner by the provisions under the tax treaty.
Conclusion:
In conclusion, foreign tax relief and tax treaties is very important in reducing cases of double taxation as a result of international operations. Through well-coordinated tax systems, they also enable and encourage more trade, investment and labour mobility across national borders through clear demarcation of relief measures. Appropriate knowledge of treaty and domestic law provisions allows individuals and businesses to benefit from international taxation mechanisms.
Read more: Expansion of UAE Double Tax Treaty to Strengthen its Global Position
Seek the Expert Services of Tax Consultants in UAE
UAE double taxation treaties are significant for individuals seeking foreign tax relief. These treaties not only eliminate the burden of double taxation but also provide various other benefits, including reduced withholding tax rates and tax credits. To fully avail of the benefits of these treaties, Taxable Persons are advised to seek expert assistance from Tax Consultants in UAE. Thus, contact us today and we shall be glad to assist you.