Personal Tax Planning and Income Tax

Income tax planning can make a significant difference to the tax you pay. By
planning for income tax, you should be able to take advantage of any
opportunities to minimize your tax bill
● The individual income tax (or personal income tax) is a tax levied (imposed,
charged) on the wages, salaries, dividends, interest, and other income a person
earns throughout the year.
● Ang buwis sa indibidwal na kita (o buwis sa personal na kita) ay isang
buwis na ipinapataw sa mga sahod, suweldo, dibidendo, interes, at iba
pang kita na kinikita ng isang tao sa buong taon.
● Taxation rates may vary by type or characteristics of the taxpayer
and the type of income.
● High earning individuals or high income earners and where do you
earn, locally or internationally. Or if you are a business owner or
not.
○ The tax rate is the percentage of an income or an amount of money
that has to be paid as tax.
Tax computation in the Philippines changed this January 2018 in the form
of the Tax Reform Bill of the Duterte Administration. The current tax table is
relatively simpler, and allows employees to take home more money than
before.Annual Income Tax Return
The main objectives of tax planning
The main objective of tax planning is to reduce one’s tax liability. Authorities, like the
BIR, implement legal measures and regulations to ensure citizens pay the required tax
amount.

Effective tax planning helps individuals and businesses save more money while
adhering to legal and regulatory requirements.

Tax planning is the foundation of effective financial planning.

● The most important initial element in financial planning is Budgeting

It ensures that savings from taxes are generated according to the legal obligations
required by the government. Business owners ensure that finances saved from
taxable sources are redirected towards income-generating plans. Tax planning
also ensures that businesses take appropriate precautions to avoid future
litigation or audits.
Ang pangunahing layunin ng pagpaplano ng buwis ay bawasan ang pananagutan
sa buwis ng isang tao. Sa PILIPINAS, ang mga awtoridad, tulad ng BIR, ay
nagpapatupad ng mga legal measures at regulasyon upang matiyak na
nagbabayad ang mga mamamayan na subject sa annual income tax return na
kinakailangang halaga ng buwis.

Ang epektibong pagpaplano ng buwis ay nakakatulong sa mga indibidwal at mga

negosyo o negosyante na makapag-ipon ng mas maraming pera habang
sumusunod sa mga legal and regulatory requirements.

Tinitiyak nito na nakapag-ipon ka na nakasunod ka pa sa legal na obligasyon na

required ng gobyerno. Tax planning also ensures that businesses take appropriate
precautions to avoid future litigation or audits.

Annual Income Tax Return For Individuals

Earning Purely Compensation Income
(Including Non-Business/Non-Profession
Related Income)
This return shall be filed by every resident citizen deriving compensation income from all sources, or resident alien
and non-resident citizen with respect to compensation income from within the Philippines, except the following:

1. An individual whose taxable income does not exceed P 250,000.00; derived from sources within the Philippines

For Purely Self-Employed Individuals and/or Professionals Whose Gross Sales/Receipts and
Other Non-Operating Income Do Not Exceed the VAT Threshold of P3,000,000, the tax shall be, at
the taxpayer’s option:

1. 8% Income Tax on Gross Sales or Gross Receipts in Excess of P250,000 in Lieu of the
Graduated Income Tax Rates and the Percentage Tax;
For Individuals Earning Both Compensation Income and Income from Business and/or Practice of
Profession, their income taxes shall be:

1. If the total Gross Sales/Receipts Do Not Exceed VAT Threshold of P3,000,000, the
Individual Taxpayer May Opt to Avail

Who pays capital gains tax?

● If you're self-employed or in a business partnership you pay capital gains tax.
Limited companies and most unincorporated associations pay corporation tax on
capital gains not capital gains tax.
● Effective tax planning can take advantage of tax allowances and reliefs on capital
gains to create a lower overall tax liability.
● Rules can be complicated, so take professional advice from your accountant.
A professional advisor who fully understands your objectives and personal
circumstances can help you develop an IHT plan tailored to your particular needs.

This outline provides a brief introduction to personal income tax planning and other
personal tax planning issues. If you are in business, this should be part of a broader
look at your overall business taxes.

o Tax Planning - Earnings

Income tax planning can offer significant savings in two areas.
Basic income tax planning should include keeping adequate records and preparing for
income tax returns. The self-employed, company directors, high earning employees and
anyone with complex tax affairs must complete a self-assessment tax return.
The most basic way to reduce taxes is to lessen income. Of course, it doesn’t
mean that you should quit your high paying job and take one that pays less. The
point is if you apply the strategies on tax planning , you seem to have a lesser
salary because your gross income is adjusted (lessened).
Your employer may offer various employee benefits, some of which - such as various
employee incentive schemes - offer tax advantages. Your income tax planning should
include assessing the value of these benefits to you and their tax effects.

● Avoid taxing the non-taxable income. Check the proper treatment of

the items of income in your gross sales or gross receipts to avoid paying
 taxes on non-taxable items like unrealized foreign exchange gains and
others.
Most forms of income from wages are taxable, but some income types are
usually tax-free, such as life insurance benefits and inheritances. Other types of
nontaxable income might include public assistance or welfare grants, alimony
and child support, death benefits, and gifts.
● There is no inheritance tax in the Philippines. However, an estate tax of 6% is
imposed on the assets of the decedent taxpayer. Gross estate includes
essentially all substantially valuable property owned by the person at
death, including real estate, cash, stocks, life insurance, jewelry, furniture,
and owed debts.
● The Philippine law states that married couples are legally obliged to
support members of the family, including the spouse and not just the kids.
However, the offending spouse is not entitled to support.
● As long as the legal wife and spouse are still married, the wife has
the right to ask for spousal support (also known as alimony).
○ Nontaxable income is income that is not subject to taxes.

○ Inheritances, gifts and bequests.

○ Cash rebates on items you purchase from a retailer, manufacturer or
dealer.
○ Alimony payments (for divorce decrees finalized after 2018)
○ Child support payments.
○ Most healthcare benefits.
○ Money that is reimbursed from qualifying adoptions.
○ Welfare payments.

● Monitor unappropriated retained earnings in relation to your paid-

up capitalization to avoid penalties. Unappropriated retained
earnings are not allowed to exceed paid-up capital. The Tax Code
imposes a 10% penalty tax on improper accumulations.

○ Appropriated retained earnings are set aside by the board and are
assigned to a specific purpose, such as factory construction,
hiring new labor, buying new equipment, or marketing. They will
not be distributed to shareholders as dividend payments.
Unappropriated retained earnings can be passed on to
shareholders in the form of dividend payments.
○ Paid-up capital is the amount of money a company has received from
shareholders in exchange for shares of stock. Paid-up capital is
 created when a company sells its shares on the primary market directly to
investors, usually through an initial public offering (IPO).

● Double Declining Depreciation

For business owners, as you already know to arrive at the tax liability, you first
have to determine the gross income. Then you deduct that with the allowable
deductions then multiply it by the tax rate. With basic mathematical operation,
you can determine that by increasing the deductions, you reduce your tax
liability. This is where depreciation comes in.

The double declining method is a depreciation method wherein your depreciation

expense is higher in the earlier life of an asset. In turn, your deductions from
gross income are higher at the early life of an asset hence lesser tax liability.

● The most basic type of depreciation is the straight line

depreciation method. You use it to write off the same depreciation
expense every year. So, if an asset costs P10,000, you might
write off P1000 every year for 10 years. Your annual depreciation
amount never changes.
● On the other hand, with the double declining balance depreciation
method, you write off a large depreciation expense in the early
years, right after you’ve purchased an asset, and less each year
after that. So the amount of depreciation you write off each year
will be different.

This may not be applicable for all but it certainly is one way for you to lower your
tax. For businesses or corporations, the double declining is very useful especially
if a business is starting out or has just been established because its tax liability
becomes less burdensome in you first years of operation.

Maaaring hindi ito naaangkop para sa lahat ngunit tiyak na isa itong paraan para
mapababa mo ang iyong buwis. Para sa mga negosyo o korporasyon, ang double
declining ay lubhang kapaki-pakinabang lalo na kung ang isang negosyo ay
nagsisimula o kakatatag pa lang dahil ang tax liability nito ay nagiging mas
pabigat sa iyong mga unang taon ng operasyon.
 ● Track All Itemized Deductions

As obvious as it may seem, it is very important to keep track of all your

deductions for you to include everything in your yearly tax form and avoid paying
beyond your correct tax liability. It is important to point out that it’s not the
government’s fault if you don’t know that an item is to be included or if you forgot
to include an item that should be part of your itemized deductions.

In that regard, the items that should be included in the itemized deductions are
Expenses, Interest, Taxes, Losses, Bad Debts, Depreciation, Depletion of
Oil, Gas Wells or Mines, Charitable & Other Contributions, Research &
Development, Pension Trusts, Additional Requirements for Deductibility of
Certain Payments, Optional Standard Deduction, and Premium Payments
on Health and/or Hospitalization Insurance.

Maximize allowable deductions. Deductible expenses must be

supported with documents such as official receipts and sales
invoices. For example, some deductible expenses require specific
documentation like a board resolution for bad debts and a BIR
notification for casualty losses. In addition, the correct tax must be
withheld if an expense is subject to withholding tax, otherwise
such expense may be disallowed as a tax deduction.

Important Tax-related Documents You Need to Keep

If you want to lower your taxes, make sure to keep these documents.

Invoices and receipts

You will need receipts and invoices to support your expenses when you file your income
tax returns for the year.
Cash register tape receipts

Your cash register tape receipts contain information about your business’ daily
transactions. Make sure not to lose this.

Credit card receipts and statements

Keeping credit card receipts and statements will help you properly report any business
and personal-related expenses.

Proof of payment documents

If you are filing income tax returns, remember to keep all of your proof of payment
documents. This includes receipts, invoices, and money pay-in slips.

Account statements

These are the official business and personal accounts that you have with financial
institutions. It includes bank account statements, and credit card statements, among
many others.

o Tax Planning - Savings

Income tax planning should take into account the income tax treatment of
savings. Simple income tax planning steps can include using ISAs or transferring
savings to your spouse to eliminate or reduce income tax (and capital gains tax).
● Generally, donations made to strangers are subject to 30% donor’s tax based on
the net gift. For this purpose, the Tax Code defines a “stranger” as a person who
is not a brother, sister, spouse, ancestor and lineal descendant, or a relative by
consanguinity in the collateral line within the fourth degree of relationship.
● On the other hand, donations to relatives exceeding P100,000 are subject to
graduated tax rates ranging from 2% to 15%, while those below P100,000 are
exempt.

People are constantly looking for ways to reduce their income tax obligations.
And there are several ways to do so. If you want to expand your knowledge about
tax-saving instruments you should consider the following ways to save income
tax.

How to save tax?

● Save for Retirement

One of the most straightforward ways to reduce taxable income is to maximize
retirement savings. Even if there are already mandatory government plans for
retirement, it is wise to avail of another one or Premium Payments on Health
Insurance to reduce your taxes (i.e. from work).
If you avail of another retirement plan, on paper, you seem to have a lesser
salary because your gross income is adjusted (lessened) due to your
contribution.
From this, there is a down side – you receive less every pay day. But to think of
it, it’s not half bad because you will receive a whole lot more when you retire.
● PHILHEALTH, SSS, GSIS (exclusive to government employees)

Apart from benefits on retirement, pension schemes can provide benefits

to dependents on death in service or death after retirement. Pension
benefits are also portable and need not be 'frozen' when your
employment status changes.
Mula dito, mayroong isang down side – mas mababa ang natatanggap mo
bawat sweldo. But to think of it, it’s not half bad dahil mas marami ka pang
matatanggap kapag nagretiro ka. Hindi habang buhay kikita ka ng pera
mula sa pagt-trabaho not unless may sarili kang negosyo at malagong-
malago na ito.

● SAVING IS DIFFERENT FROM INVESTING

Saving is putting money away to keep and use later. Investing you
are putting money in, hoping that it will increase in the future.

Long-term investments tax exempt

The Bureau of Internal Revenue reiterated that interest earnings from long-term
deposits or investments are exempted from income tax as long as these have a maturity
period of not less than five years.
The long term deposits or investments covered by this rule are time deposits or
investments in the form of savings, common or individual trust funds, deposit substitutes
and investment management accounts.

The long-term deposits or investments must be issued by banks only and not by other
entities or individuals. These must also be issued by banks in denominations of
P10,000.

The income tax exemption can only be enjoyed by depositors that are individual
citizens or aliens engaged in trade or business in the Philippines.

Moreover, these deposits should not be terminated before end of the fifth year
otherwise they shall be subjected to the graduated withholding tax rates based on the
age of the deposit – five percent (four years to less than five years), 12 percent (three
years to less than four years) and 20 percent (less than three years).

Investment income is taxed differently from wage income, and that

may be especially evident in the way that capital gains are treated.
The BIR taxes long-term capital gains at 15 percent, 20 percent —
and 0 percent. Yes, 0 percent. But you have to follow the rules very
carefully.
INCOME TAX EXEMPTION OF INTEREST INCOME EARNINGS
FROM LONG TERM DEPOSITS OR INVESTMENT CERTIFICATES
UNDER SEC 24(B)(1) & 25(A)(2) OF THE NATIONAL INTERNAL
REVENUE CODE OF 1997, AS AMENDED

● Open a flexible spending account (FSA).

This is a great way to “pre-save” for expenses you know you’ll have, such as
childcare, elder care, medical expenses, or prescriptions. If an FSA is available
through your employer, every dollar you put in lowers your taxable income. The
money comes out of your paycheck on a pre-tax basis. Then you submit
qualifying expenses for reimbursement as they occur.
o Tax Planning - Property Taxes
Owning your own property is relatively lightly taxed, though you are likely to pay stamp
duty when you purchase a property as well as being liable to council tax. Unlike most
other investments, your main home is exempt from capital gains tax.
However, you may be liable to capital gains tax if you own a second home, investment
properties, land, business premises or use your home to generate income by renting it
out, for example. Planning for income tax on property is vital, as the tax treatment can
be complex and you will also need to consider your exposure to capital gains tax.

Tax Planning and Tax Management:

Comparison

Key Differences Between Tax Planning and Tax Management

Tax planning and tax management might

sound like the same thing, but there’s a big
difference. Tax planning is all about making sure you take advantage of
every legal deduction and credit to minimize your tax bill. Tax management, on
the other hand, is about reducing the taxes you owe each year. It’s more proactive
than reactive, you work to keep your taxable income as low as possible, so you owe
less. Both are important, but they require different skill sets and knowledge. If
you’re looking to get a handle on your taxes, it’s important to understand the
difference between tax planning and tax management.

Tax Planning:

The purpose of tax planning is to determine a person’s financial affairs in a way that
maximizes all the deductions, exemptions, allowances, and rebates that are allowable
legitimately so that his or her tax liability is low.
Tax Management:

The term tax management refers to the process of complying with income tax laws and
regulations. Penalties, prosecutions, appeals, tax revisions, and settlements of tax
cases fall under tax management. Tax management aims at ensuring compliance with
tax laws at a specified time and manner as well as minimizing tax costs.

The Differences

Tax Planning Tax Management

Tax planning is all about minimizing A focus is placed on ensuring compliance

your tax burden. By taking advantage of with legal formalities in order to minimize
tax breaks and deductions, you can taxes.
lower your overall tax liability

It can help you make better decisions. Assists in meeting the conditions for
effective decision-making.

Prior to selecting the best alternative, The process consists of maintaining

various alternatives are compared. accounts in prescribed forms, filing returns,
and paying taxes.

Future benefits are taken into account in In tax management, the past, present, and
tax planning. future are taken into account.

Various tax benefits can be claimed The use of tax management contributes to
through tax planning. the adherence to the conditions for
effective decision-making.
Managing your taxes is an important part of financial planning, and it’s something that
should be done throughout the year, not just during tax season. By taking a proactive
approach to tax management, you can save yourself time and money. Our advisors are
here to help you every step of the way, so don’t hesitate to get in touch if you have any
questions.

The difference between tax planning and tax management are presented in the points
below:

1. Tax planning can be defined as the systematic planning of assessee’s

financial and business affairs by adhering to the taxation provisions, in a
way that complete benefit can be availed of all the applicable deductions,
exemptions, allowances and rebate. On the contrary, tax management
implies the practice to avoid defaults and penalties and adhere to the legal
provisions of the Income-tax Act.
a. Planning is a process for getting ideas into action. If you are
systematic about it, then the process and hence the action can be
made easier and more effective.
● Sistematikong PAGPAPLANO, SHORT TERM sa paraan maaaring
makuha ng kumpletong benepisyo ng lahat ng naaangkop na
pagbabawas, exemption, allowance at rebate. samantalahin ang bawat
legal na bawas at kredito upang mabawasan ang iyong bayarin sa
buwis
● PAGSASANAY. LONG TERM maiwasan ang mga default at parusa at
sumunod sa mga legal na probisyon ng Income-tax Act
2. Tax Planning is all about planning of taxable income and planning of
investments of the assessee. As against, Tax Management deals with the
proper maintenance of financial records, audit of accounts, timely filing of
the return, payment of taxes and appearing before the appellate authority,
whenever required.
● PAGPAPLANO. Not just in earnings and savings, they have to
consider other major sources of income.
● TAMANG PAGPAPANATILI ng financial records, audit of accounts,
timely filing of the return, payment of taxes. KEEPING YOUR RECORDS
APPROPRIATELY. helps you manage compliance.
3. Tax Planning aims at reducing the tax burden of the assessee to a
minimum by utilizing all the permissible tax deductions, exemptions, and
allowances. Conversely, the main purpose of tax management is to comply
with the provisions of the relevant tax statute and allied rules.
 ● naglalayong bawasan ang pasanin sa buwis
● utilizing.make practical and effective use of. to use
something in an effective way
● Naglalayong sumunod sa mga probisyon ng may-katuturang batas sa
buwis at mga kaalyadong tuntunin
● COMPLY.is to conform, submit as required. to act according to
an order, set of rules
4. While tax planning is not a compulsory activity, tax management is
compulsory for all the assessee.
● Hindi sapilitan, not mandatory
● Sapilitan, mandatory

Tax Evasion and Tax Avoidance: Differences

Key Differences Between Tax Avoidance and Tax Evasion

The following are the major differences between Tax Avoidance and Tax Evasion:

1. A planning made to reduce the tax burden without infringement of the

legislature is known as Tax Avoidance. An unlawful act, done to avoid tax
payment is known as Tax Evasion.
● An infringement is a violation, a breach, or an unauthorized act.
Infringement occurs in various situations. A harm to one's right is an
infringement. A violation of a statute is also an infringement.
● not according to or acceptable to the law. a serious offence.
2. Tax avoidance refers to hedging of tax, but tax evasion implies the
suppression of tax.
● hedging lowers expected tax liabilities. indicated that hedging
increases a firm’s value by reducing expected taxes and expected
costs of financial distress.
● Suppression is the act of keeping something from happening such as
an activity or publication.
3. Tax Avoidance involves taking benefit of the loopholes in the law.
Conversely, Tax Evasion includes the deliberate concealment of material
facts.
● A loophole is an absence or something vague in a rule or law that
allows a person to avoid something
 ● the action of hiding something or preventing it from
being known. If you are hiding something you are
considered as subject to suspicion.
4. The arrangement for tax avoidance is made prior to the occurrence of tax liability.
Unlike Tax Evasion, where the arrangements for it, are made after the
occurrence of the tax liability.
5. Tax avoidance is completely legal however Tax Evasion is a criminal
activity.
6. The result of tax avoidance is the postponement of the tax, whereas the
consequence of tax evasion if the assessee is found guilty of doing so, is either
imprisonment or penalty or both.

Double Taxation: Defined and Explained

What is Double Taxation?

Double taxation is a situation associated with how corporate and individual income is
taxed and is, therefore, susceptible to being taxed twice.

Summary

● Double taxation is mainly found in two forms – corporate double taxation, which
is taxation on corporate profits through corporate tax and dividend tax levied on
dividend pay-outs, and international double taxation, which involves the taxation
of foreign income in the country where the income is derived, as well as the
country where an investor is a resident.

● There are various ways to mitigate corporate double taxation, such as legislation,
structuring an organization into a sole proprietorship, parentship, or LLC,
avoiding the payment of dividends, and shareholders becoming employees of the
businesses they own.
● International double taxation can be mitigated by formulating trade treaties, such
as double taxation agreements (DTAs), with countries they trade with and using
relief methods such as the exemption and foreign tax credit methods.

Categories of Double Taxation

1. Corporate Double Taxation

It is a situation in which corporate earnings are taxed twice at two different levels but
include the same income. A corporate organization’s net income is taxed as corporate
tax, and when the same income is distributed to shareholders as a dividend, it is again
taxed by way of a dividend tax. Corporate double taxation is common not only in the
United States but in several countries around the world.

● Double taxation is a tax principle referring to income taxes paid twice on the
same source of income. It can occur when income is taxed at both the
corporate level and personal level.

Arguments against corporate double taxation indicate that as shareholders are the
owners of a corporation in which corporate tax is levied on profits attributable to the
owners, income distributed to them as dividends and taxed with dividend tax at a
personal level represents the same income stream being taxed twice.

● For example, corporate profits may be taxed first when earned by the corporation
(corporation tax) and again when the profits are distributed to shareholders as a
dividend or other distribution (dividend tax).

However, arguments for the maintenance of the double taxation regime contend that
since a corporation in the form of a company is a separate legal entity divorced from the
company’s individual owners, taxation on both corporate earnings and dividends is
justified.

2. International Double Taxation

International double taxation mainly concerns multinational entities that operate in
jurisdictions other than their home country, but it can also affect foreign income earned
by individuals in foreign countries. There are instances where foreign income is taxed in
the country where the income is derived and the country where an investor resides.

● Double taxation occurs in international trade or investment when the same

income is taxed in two different countries.
● For example, Ash Company, a resident of a country, Philippines, may earn
income in Australia from extensive activities therein. The Philippines would tax
Ash Company on its worldwide income, which would include the income earned
in Australia. Australia would tax the income arising from the activities conducted
within its territorial boundaries.

Hence, double taxation induces a hardship on taxpayers through an increased tax

burden on the investor and can result in the increase of the price of goods and services,
discourages cross border investment through curtailing capital movement, and violates
the tax fairness principle.
 ● Again, this sort of double taxation doesn’t have to happen. Many countries have
signed mutual treaties and instituted tax credits to limit this sort of double taxation
in the interest of stimulating international investment and trade.

Conclusion

If you own a business, the last thing you want is to get taxed on your income
more than once. The obvious reason that people debate double taxation is that
the same money is being earned once but taxed twice.

Measures to Avoid Double Corporate Taxation

1. Legislation
Legislation must be enacted to remove elements of double taxation, which is inefficient
and discourages investment. If investors are able to receive their dividends tax-free,
they will be inclined to invest more rather than retain profit, especially for mature
companies that do not need much capital.

2. Pass-through taxation
It involves structuring the business as a sole proprietorship, a partnership, or an LLC
adopt pass-through taxation features. There are no dividends in such structures, as
profits are shared between the owner(s)/partners. However, the strategy is only
applicable to small organizations.

3. Absence of dividend payments

Avoiding payment of dividends and retaining profits in the business to generate growth.
The strategy works for start-ups and organizations in the growth phase of the business
life cycle. It is critical to growing product scope and market share. Shareholders of
mature companies with stable cash flows and very little cash appetite expect dividend
compensation.

4. Personal income tax status

Shareholders can add themselves as employees in smaller companies or as executive
directors in larger companies and get paid a salary; however, they would still be taxed
on their salary through a personal tax rate. It would not qualify as double taxation.

Managing International Double Taxation

The best way to manage the challenge of international double taxation is to come up
with tax treaties between countries and legal jurisdictions. The treaties involve
collaboration between jurisdictions and the exchange of information. They are
established to reduce or eliminate illegal taxation practices, promote trade efficiency
between nations, prevent tax evasion, and ensure tax certainty.
Double Taxation Agreements (DTA)
A double taxation agreement (DTA) refers to an agreement signed between two
countries to prevent or minimize territorial double taxation of the same income by the
two countries. DTAs are put in place to ensure they alleviate double taxation, which
undoubtedly discourages international trade. Given the global village the world has
become, double taxation is counterproductive and discourages investment flows.

DTAs encourage cross-border trade and investment between countries. When trade
between two countries is growing, and both countries anticipate further growth, they
usually facilitate the signing of a DTA to eliminate double taxation and improve trade
between them. The DTA establishes rules and regulations of how income earned
through cross-border transactions is treated and ensures that the income is not
compromised through double taxation.

A DTA can require that tax is charged in the investor’s home country and is exempt in
the country where the income is generated. Alternatively, an investor may be levied tax
where the income arises, and the investor will receive a foreign tax credit in the home
country.

Double Taxation Relief

1. Exemption method
Under the exemption method, a taxpayer is exempt from tax in their resident country or
jurisdiction regardless of where the income is generated. However, taxpayers are liable
to pay tax in the host country where income is generated. The exemption method
encourages cross-border investments by investors in their resident countries and
removes barriers to free trade, thereby increasing trade and the globalization of
business.

Countries that solely use the exemption method are termed tax havens, as they do not
tax –or apply low tax rates to – foreign earned income by resident corporations and
individuals. Most tax havens attract wealthy individuals, multinational corporations, and
financial institutions that seek to minimize tax liabilities.

However, tax havens are being criticized for helping protect the financial transactions of
criminals and shady businesses and facilitate money laundering. Examples of tax
havens include The Cayman Islands, Bermuda, The Bahamas, and Cyprus.

2. Foreign tax credit (FTC)

The foreign tax credit method taxes the income of residents regardless of where it
arises. The FTC method requires the home country to allow a credit against domestic
tax liability where a resident pays tax in a country where the revenue arises.
The tax paid in one country is used to offset the tax liability in another country. This
method helps businesses to operate normally within existing tax regulations. FTC can
also be termed the Capital Export Neutral System.