Tax treaties exist between many countries on a bilateral basis to prevent double taxation (taxes levied twice on the same income, profit, capital gain, inheritance or other item). In some countries they are also known as double taxation agreements, double tax treaties, or tax information exchange agreements (TIEA). In fact these are Double Taxation Avoidance Treaties i.e. treaties to avoid tax being levied twice.
Most developed countries have a large number of tax treaties, while developing countries are less well represented in the worldwide tax treaty network. The United Kingdom has treaties with more than 110 countries and territories. The United States has treaties with 56 countries (as of February 2007). Tax treaties tend not to exist, or to be of limited application, when either party regards the other as a tax haven. There are a number of model tax treaties published by various national and international bodies, such as the United Nations and the OECD.
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International double taxation, narrowly defined, occurs when two different states impose a comparable tax on the same potential taxpayer on the same taxable item. The concept has been defined more broadly, but with less precision, as the result of overlapping tax claims of two or more states. For example, someone who is resident for tax purposes in France and who makes an interest-bearing deposit with a bank in the UK is potentially exposed to income tax on the interest in the UK and in France.
The concept of international double taxation that bilateral tax treaties seek to remove is broader than the narrow definition. It includes some types of economic double taxation—that is, taxation of something already taxed under another country's laws whether or not it is formally subject to multiple levels of taxation. For example, many tax treaties operate to provide tax relief to a corporate group when a state has imposed a corporate income tax on profits earned by a subsidiary corporation and another state otherwise would impose a corporate income tax on its parent corporation when those profits are distributed as a dividend.
In general, tax treaties attempt to eliminate most forms of international double taxation, narrowly defined, and various other forms of international double taxation when a failure to do so would have a demonstrably harmful impact on international trade and investment.
A major goal of bilateral tax treaties is to remove impediments to international trade and investment by abating the risk of double taxation that can occur when both contracting states impose tax on the same income. This goal is advanced in five distinct ways.
- First, a bilateral tax treaty generally increases the extent to which exporters residing in one contracting state can engage in trading activity in the other contracting state without attracting tax liability in that latter.
- The second state can usually only impose tax on the business profits of a person who is resident in the other state if they operate in the second state through a permanent establishment there.