What is Double Taxation, and How to Avoid It in Your Business?

a month ago   •   5 min read

By Silverbird Content Team

What is double taxation? It's exactly what it says on the tin: being taxed twice.

International businesses often face double taxation on their corporate profits, which is an inevitable fallout of our increasingly interconnected global economy.

It’s a nightmare scenario. Residents in England, for instance, are already subject to UK income tax and capital gains tax. If you run a business, you also have a domestic tax liability and corporation tax eats away at your profits and discourages cross-border trade. If your business's foreign income is subject to foreign tax, it's even worse.

International double taxation can be a thorn in the side of exporters, in both the UK and across the world. How can businesses claim tax relief — how can you avoid being taxed twice?


This article at a glance

Double taxation refers to the imposition of taxes on the same income, assets or financial transaction at two different points in time. There are two types of double taxation — corporate and international. Only C corporations will pay taxes at the corporate level. Businesspeople can avoid it if they pay in salaries, not dividends. Retain their corporate annual earnings. And split their income. If none of these applies to you, there are double tax agreements with which you can claim tax relief.


Will your company face double taxation issues?

There are many corporate business structures that businesspeople can choose from, from sole proprietorships to LLCs.

A sole proprietorship, an LLC (Limited Liability Company) or an S corporation can eliminate double taxation from their list of fears because you will receive double tax relief. However, those running what’s classified as a C corporation will need to watch out for double taxation.

C corporations are recognised as separate tax-paying entities. This means that your business is subject to tax.

In a nutshell:

1. C corporations pay corporate income tax on profits
2. Corporations pay shareholders dividends from the after-tax income
3. Shareholders pay personal income taxes on the dividends they receive

You might wonder where double taxation occurs. It happens when you, as the owner or shareholder, take a salary from your C corporation’s corporate earnings.

Let’s say you own a C corporation and you face taxation twice – first, on the company’s corporate earnings, and second, on the dividends or salary that you earn from your business.

Example:  

 

Tom is the owner of ABC company. The company made $200,000 in profit this year.  

 

Corporate tax rate = 20%*  

 

How much will Tom need to pay as corporate taxes? 20% on $200,000 = $40,000.  

 

After-tax dividends to be split amongst shareholders and Tom: $200,000 - $40,000 = $160,000. 

 

Let’s say Tom holds 40% of the shares of ABC company, he’ll need to pay personal income taxes on the dividend or salary he receives.   


Amount Tom earns: 40% of $160,000 = $64,000.  

 

Personal income tax Tom has to pay based on a tax rate of 10%*: 10% of $64,000 = $6,400.  

 

Therefore, the total taxes Tom has to pay for both corporate and personal adds up to: $40,000 + $6,400 = $46,400.  

 

*Rates are fictional. You should refer to your country’s tax rates for all examples.  


At first glance, this might appear as a small amount in paid tax — but the tax Tom has to pay is more than 23% of his company’s total revenue for the year.

Double taxation in international trade

The second type of double taxation is when the same income is taxed by two different countries – this is called international double taxation.

Double taxation can also be legal, which means that two countries would consider a single person as a tax resident and subject to their tax laws – in both their home country and host country. Therefore, corporate income taxes are imposed by one country's tax authorities, after the same income has already been taxed by another country. However, many countries have signed treaties to prevent this form of double taxation from occurring to foreign corporations.

Getting taxed twice is frustrating. Is there a way to maximise your earnings and avoid corporate double taxation? Can you get double taxation relief?

How to avoid double taxation on the same income

C corporations are the only businesses affected by corporate double taxation. You can get double taxation relief by organising your business as a ‘pass-through’ or ‘flow-through’ business entity. Some examples of business entities that can adopt this strategy are:

  • Sole proprietorships
  • Limited liability companies (LLCs)
  • Partnerships
  • S corporations

By doing so, your profits go directly to you. You will not pay tax at the corporate level and then again at the personal level. So, you will only pay once, at the personal rate, instead of having to pay at both the corporate and personal levels. Note that this strategy can only be adopted if your business is not a C corporation. Owners of C corporations can follow the below methods instead.

1. Skip the dividends, and pay salaries instead
If your business is a C corporation, you might want to consider not giving out dividend payments to shareholders to prevent double taxation. Instead, you can offer them a higher salary to compensate for the dividends. Salaries can be taxed at the personal rate, and in turn, you can file it under a deductible expense for your corporation. This cannot be done with dividends, as they are not considered deductible expenses.

2. Retain corporate earnings
There’s another benefit to not declaring dividends too. If you do not distribute profits as dividends to shareholders, they are not taxed on them. This means that the profits of your company are only taxed at the corporate tax rate.

3. Split your income
This is a good way to prevent double taxation. As the owner of a business, you can withdraw from the corporate profit and leave the rest of the profits in the corporation. This way, you can minimise double taxation by not hitting the progressive tax brackets, and will not be liable to pay personal tax on your income.

What about international businesses?

Can international businesses claim relief? It sounds difficult, especially since doing business internationally involves two or more countries for every manufacturing and production process. Here’s how you can prevent double taxation as an international merchant.

Double Taxation Agreements (DTAs)
Governments across the world obviously wish to ensure that corporations pay their fair share of tax. Tax evasion is a continuing problem. Still, there are numerous double-tax treaties that provide double taxation relief.

Double taxation agreements (DTAs) are in place to encourage global trade by minimising tax liabilities for corporations. In effect, the countries involved put in place a double tax agreement to avoid incidents of double taxation.

DTAs are agreements signed between two countries to prevent territorial double taxation of the same income in two different countries.

The DTA establishes regulations of how income made through cross-border transactions is handled. DTAs vary with different countries, so be sure to check whether there is a DTA signed between the two countries you plan to transact between. This will exempt tax in your home country or the country where your income is generated, depending on the conditions of the DTA signed.

A simple search on Google will bring up the countries that have a double tax treaty with your home country. For example, a search for countries that have signed DTAs with Singapore brought me to this list of DTAs, Limited DTAs and EOI Arrangements.

Make your payment method simple

There’s a lot to look out for when selling overseas. Saving on taxes and knowing how to avoid double taxation can help your company retain more profits. Apart from tax savings, knowing how to stay clear of high forex exchange rates can also boost your company’s profits.

Silverbird (add a link to the multi-currency account) helps you avoid high forex rates. We enable you to hold, transfer and exchange foreign currencies online simply by using a single multi-currency account. Make and receive payments in over 30 currencies without fuss.

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Author: Silverbird Content Team
Illustration: Kate Faldina

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