What is Double Taxation
Double taxation is a taxation principle referring to income taxes paid twice on the same source of earned income. It can occur when income is taxed at both the corporate level and personal level. Double taxation also occurs in international trade when the same income is taxed in two different countries.
BREAKING DOWN Double Taxation
Double taxation is often an unintended consequence of tax legislation. It is generally seen as a negative element of a tax system, and tax authorities attempt to avoid it whenever possible.
Double Taxation of Corporations and Shareholders
Double taxation often occurs because corporations are considered separate legal entities from their shareholders. As such, corporations pay taxes on their annual earnings, just like individuals. When corporations pay out dividends to shareholders, those dividend payments incur income-tax liabilities for the shareholders who receive them, even though the earnings that provided the cash to pay the dividends were already taxed at the corporate level.
The concept of double taxation on dividends paid to shareholders has prompted significant debate. While some argue that taxing dividends received by shareholders is an unfair double taxation of income because it was already taxed at the corporate level, others contend this tax structure is fair.
Proponents of keeping the "double taxation" on dividends point out that without taxes on dividends, wealthy individuals could enjoy a good living off the dividends they received from owning large amounts of common stock, yet pay essentially zero taxes on their personal income. As well, supporters of dividend taxation point out that dividend payments are voluntary actions by companies and, as such, companies are not required to have their income "double taxed" unless they choose to make dividend payments to shareholders.
Most tax systems attempt, through the use of varying tax rates and tax credits, to have an integrated system where income earned by a corporation and paid out as dividends and income earned directly by an individual is, in the end, taxed at the same rate.
International Double Taxation
International businesses are often faced with issues of double taxation. Income may be taxed in the country where it is earned, and then taxed again when it is repatriated in the business' home country. In some cases, the total tax rate is so high, it makes international business too expensive to pursue.
To avoid these issues, countries around the world have signed hundreds of treaties for the avoidance of double taxation, often based on models provided by the Organization for Economic Cooperation and Development (OECD). In these treaties, signatory nations agree to limit their taxation of international business in an effort to augment trade between the two countries and avoid double taxation.