What is double taxation, and how to avoid it?

What is double taxation, and how to avoid it?

09 May, 2023

Taxation is a crucial source of revenue for the government. But, in some cases, the profit or income can be taxed twice. Double taxation refers to a situation in which your tax burden increases significantly because of levying taxes at different levels, even when the source of income is one. Let’s understand the meaning and types of double taxation and how you can avoid it.

What is double taxation?

Double taxation, as the name suggests, occurs when an income is subjected to taxes twice. It is classified into two categories - economic and juridical. Economic double taxation refers to a situation wherein an income or part of it is taxed twice within the same country in the hands of two individuals.

Juridical double taxation occurs when an individual earns an income outside India and pays taxes on it twice, once in the home country and once abroad.

Impact of double taxation

When you start a business, it is vital to decide the product or service you will sell. Another crucial decision is the organisation’s structure and associated tax liabilities.

A partnership firm or private limited company must pay business taxes as a separate legal identity. A dividend tax is also levied if they declare dividends. But, the dividend received by the shareholder of the company is exempt from income tax.

A Corporation is taxed at the corporate level on profits, and the owners of the company are taxed on the dividends paid from the corporation. Thus, the corporation pays corporate income tax, and the shareholders and owners pay personal income tax on the dividends.

Additionally, if a company owner or shareholder draws a salary from Corporation’s earnings, they will pay personal income taxes. So, if you are the owner of a Corporation, you have to pay taxes twice on your earnings, once on the corporate profits and once on the salaries you earn from the business.

How to avoid economic double taxation?

Double taxation exerts undue financial stress on taxpayers. If you don’t want to pay business and personal taxes on the same earnings, there are ways to reduce or eliminate these issues.

1. Retain corporate earnings

It is possible to avoid double taxation by retaining profits in the business instead of distributing it to shareholders as dividends. When shareholders don’t receive dividends, they do not have to pay taxes on them. As a result, the profit is taxed at the corporate rate only.

In some companies, the shareholders depend on company profit for income. Here, keeping profits in the business isn’t a solution. However, if you have the bandwidth to reinvest the cash, you can utilise it for business growth.

2. Pay salaries and not dividends

Another way to avoid double taxation is to distribute salaries or bonuses as profits rather than dividends. Salaries or bonuses are taxable for employees but are deductible expenses for the business.

3. Income splitting

Splitting the income is another strategy to save on taxes. The business owner withdraws a specific amount from the business profits to support their lifestyle but leaves the remaining profits in the corporation. Income splitting can minimise double taxation as progressive tax brackets affect Corporations and individuals. When you take a tax-deductible salary and leave the rest of the profit for reinvestment, your business’s taxable income and your personal gross income reduce.

Corporation owners may feel that double taxation is a penalty, but by incorporating these strategies, they can reduce the burden of double taxation.

How to avoid juridical double taxation?

The Double Tax Avoidance Agreement (DTAA) helps you avoid paying taxes in both your home country and the country you reside. The tax treaty is signed by India and another country to avoid double taxation. Some DTAAs are comprehensive agreements comprising all income types, while others are specific agreements focusing on a few income types.

Many people are under the impression that by using a DTAA, they can avoid paying taxes altogether. However, that is not true. The Data allows for a rebate, not a total deduction, which means when NRIs earn income in India, they can reduce their tax implications. HDFC Bank provides an online DTAA Annexure you can use to avail of tax rate deductions.

Understanding the rules of double taxation and how it is calculated and levied can help you lower your tax liabilities and plan finances better. Moreover, HDFC Bank makes paying taxes easy with a few clicks online. You can pay all types of taxes - income or service, direct or indirect, central or state. You can pay from home or the office, even after banking hours, using your HDFC Bank NetBanking Account

More ways to reduce your taxable income as a self employed individual.

​​​​​​​*Terms and conditions apply. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. You are recommended to obtain specific professional advice from before you take any/refrain from any action. Tax benefits are subject to changes in tax laws. Please contact your tax consultant for an exact calculation of your tax liabilities.

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