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Let’s Talk Taxes – Tax Treaties

Asha Dixit

“Tax treaties may allow residents of foreign countries to be taxed at a reduced rate, or to be exempt from U.S income taxes on certain items of income they receive from sources within the United States.”
www.irs.gov, Tax Treaties   

A tax treaty is a bilateral agreement between two countries enabling the smooth conduct of business across international borders. The intent of these international treaties is to eliminate or mitigate double taxation affecting individuals, partnerships and corporate entities. They lay out in detail the taxing rights of each of the countries involved in the treaty.

US has entered into tax treaties with many countries. All treaties have standard provisions related to scope, definitions, taxation of income and capital, elimination of double taxation, and prevention of tax avoidance and evasion. Typically treaty provisions are reciprocal.  Foreign countries with whom US has tax treaties will have tax treaties which may provide reciprocal provisions for elimination or mitigation of double taxation affecting US citizens or residents.

S is a US citizen. S has interest income of $60,000 from India. Since US has a tax treaty with India, S should consult with her tax consultant in India and find out if there are any double tax avoidance treaty provisions that may help reduce the taxes payable to India.

Many US taxpayers wrongly assume that even if higher taxes are paid to foreign states, they will be able to obtain a credit for the entire amount on their US tax return.  Unfortunately though the US allows for a foreign tax credit, the amount of the credit allowed for taxes paid to foreign jurisdictions is never more than the amount of US income tax attributable to the foreign income.

X pays $20,000 of taxes to a foreign jurisdiction during 2012. X files his 2012 tax return; the amount of tax attributable to the foreign income was only $10,000. Unfortunately for 2012, even though X paid $20,000 in foreign taxes he will only be allowed a foreign tax credit of $10,000.

As discussed, tax treaties are important to individuals and entities helping them eliminate or mitigate the double taxation when income is subject to taxation by multiple countries.

Disclaimer: Every individual’s tax situation is different and tax situations change over time. This article is intended to give general information to enable the reader to discuss their situation with a tax adviser.  It is not intended to be tax or legal advice and should not be construed as such.

(Asha Dixit, CPA, MBA, MS is a partner with Shah, Dixit & Associates P.C. in Burlington, MA. For further information, contact Ms. Dixit at asha@shahdixit.com. )

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