Relief from double taxation: Articles 23(A) & 23

(B)
• Article 23 (A): Exemption method
• Article 23 (B): Credit method
• No consensus on the method(s) to relief international double taxation. Most
commonly used (one or as a combination);
• Deduction: The R state allows its taxpayers to claim a deduction in computing income for taxes,
including income taxes, paid to a foreign state, in respect of foreign source income.
• Exemption: The R state exempts foreign source income derived by its residents from residence
tax.
• Credit: The R state provides its resident taxpayers with a credit for income taxes paid to a
foreign state against residence state’s taxes otherwise payable. Under the credit method,
foreign taxes are deductible in computing the tax payable to the R state but not in computing
the taxpayer’s income ( = tax base).
• Most generous vs. least generous?
Relief from double taxation
• Assume income at Source ( = B) = 100. Tax paid in B
= 40.
• Deduction method: Tax payable in R state (A)? R
Tax rate 40%
• R will have to pay tax to R on his net income 60 (100
– 40). The foreign tax of 40 paid is deductible in
computing R’s income subject to tax in A. 60 will be B
taxed at 50% = 30 tax in A + 40 tax in B = 70 TOTAL
• Credit method: R’s tax liability in A (before any
foreign tax credit) = 100 x 50% = 50. But credit A
against the tax otherwise payable in A for the Tax rate 50%
R
taxes paid in B = 40  50 – 40 = 10 tax in A.
Total tax = 40 in B + 10 in A = 50.
• Exemption method: R will pay no tax in A in
respect of foreign sourced income in B. Total
tax = 40 (the one paid in B)

2
Relief from double taxation
• Exemption: Effectively, the R state gives up its taxing right to tax foreign source
income  exclusively taxed by the source country (territoriality principle). Used
by few countries.
• Most commonly, exemption is limited to certain types of income, most
commonly business income earned in foreign countries and dividends from
foreign affiliates.
• Sometimes, to apply exemption, the foreign income must have been subject to
a minimum rate of tax at source.
• Variation: Exemption with progression = Foreign sourced income is included in
the taxpayer’s income for the purpose of determining the taxpayer’s tax base
(tax bracket), as if the foreign income were taxable. This average rate is then
used to compute the actual tax due on the taxpayer’s other (non-exempt)
income.
Relief from double taxation: Exemption & Exemption
with progression

• Assume that Country A levies tax at a rate of 20% in the first 10,000 of
income and 40% on income in excess of 10,000. T, is resident in A, has
10,000 of domestic source income (country A) and 10,000 of exempt
foreign source income.
• How much tax would T pay under a regular exemption system?
• How much tax would T pay under an exemption with progression
system?
• 10,000 + 10,000 = 20,000. (10,000 x 10% + 10,000 x 40%) / 20,000 =
effective tax rate = 30%. Tax payable in A = 10,000 (and not 20,000) x
30% = 3,000.
Participation exemption
• Applicable to cases of international double taxation with respect to
dividends from foreign corporations and capital gains from the
disposition of shares of foreign corporations.
• Method used by many countries to eliminate double taxation of
dividends from foreign corporations (many EU countries, Australia,
Japan, the UK).
Participation exemption
• 3 key elements:
- the level of share ownership to qualify for the exemption  we need
substantial ownership interest or participation (5 – 25%);
- the nature of the income earned by the foreign corporation out of
which the dividends are paid  the exemption should be available to
dividends out of the active business income earned by a foreign
corporation (not for passive).
- the amount of the foreign tax on the income of the foreign
corporation  some countries apply participation exemption to
foreign affiliates established in comparable-tax countries or countries
with DTC that provide such an exemption.