Double taxation is a situation that affects C corporations when business profits are taxed at both the corporate and personal levels. The corporation must pay income tax at the corporate rate before any profits can be paid to shareholders. Then any profits that are distributed to shareholders through dividends are subject to income tax again at the individual rate. The corporate profits are subject to income taxes twice. Double taxation does not affect S corporations, which are able to “pass through” earnings directly to shareholders without the intermediate step of paying dividends. In addition, many smaller corporations are able to avoid double taxation by distributing earnings to employee/shareholders as wages. Still, double taxation has long been subject to criticism from accountants, lawyers, and economists. Critics of double taxation would prefer to integrate the corporate and personal tax systems, arguing that taxes should not affect business and investment decisions. They claim that double taxation places corporations at a disadvantage in comparison with unincorporated businesses, influences corporations to use debt financing rather than equity financing (because interest payments can be deducted and dividend payments cannot), and provides incentives for corporations to retain earnings rather than distributing them to shareholders. Furthermore, critics of the current corporate taxation system argue that integration would simplify the tax code significantly. (referenceforbusiness.com) Double taxation arises when an individual or business acquiring income in a foreign country is required to pay taxes on that income in both the foreign country as well as the country of origin. For example, an American company operating in a developing country, in the absence of a tax treaty between the two countries may have to pay a withholding tax to the government of the developing country, as well as corporation tax to the United States government (Howard, 2001, p. 259). The purpose of this paper is to examine the merit of three basic systems, which is exemption system, credit system and deduction system. These systems are dealings with the essence of tax relief from international double taxation. The case between Turkey and Germany is more on exemption and credit system focused in my paper.
Under exemption systems, a taxpayer of a country (the residence country), will not be taxed regardless of where the income is generated, instead, taxpayers are taxed based on the source of their income (the host country), that is, only the country where the income is generated has taxing authority over the income (Stephens, 1998, p.159) With exemption system, it’s encourages resident individual or companies to venture outside their domestic environment and compete with their foreign competitors. Hence it is frequently used term of capital import neutrality. In general, it can be said that a tax exemption system encourages businesses to trade outside their home country, thus accelerating the trends towards globalization and increase of global welfare. Countries that are purely on exemption system are often referred to as “tax havens” because the country does not tax any foreign source income (FSI) earned by individuals or corporations that have that country as their home country (Stephens,
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