Double taxation is the levying of tax by two or more jurisdictions on the same declared income, asset or financial transaction. It may occur where a business or individual who is resident in one country makes a taxable gain in another country. Most countries, including the US and Australia, tax their residents on their worldwide income.
Double taxing income, apart from being inequitable, would discourage international trade and hurt economic growth. To avoid these negative consequences most countries enter into tax treaties which sets out rules to avoid double taxation.
Generally, these double taxation agreements require either:
- That tax be paid in the country of residence, and be exempt in the country in which it arises, or
- Taxable in the country where the gain arises and the taxpayer receives a compensating foreign tax credit in the country of residence (to reflect the tax paid).
Double tax treaty manipulation involves structuring entities and transactions between different countries to minimise or eliminate tax. For example, a large number of foreign institutional investors who trade on the Indian stock markets operate from Mauritius. The tax treaty between India and Mauritius states capital gains arising from the sale of shares are taxable in the country of residence of the shareholder only (and not in the country of residence of the company whose shares have been sold). Therefore, a company resident in Mauritius selling shares in an Indian company will not pay tax in India. As there is no capital gains tax in Mauritius, the gain will escape tax altogether.