Countries sign treaties to prevent double international taxation in which certain rules are stablished in order to acknowledge a tax payment made in the other country.
Residents of a particular EU country are obliged to declare their worldwide income and pay income tax for that in that country.
This general rule is in apparent conflict with another general rule that states that tax should be paid in the country in which the income in generated.
To solve this situations countries sign double taxation treaties.
This is easy to understand with a study case.
A national of another country with which there is a double taxation treaty resides permanently in Spain where he has his main source of incomes. Additionally, he owns a property in his home country which he rents. He also has some investments in his home country and he received dividends.
1.His country asks him to file a tax for the revenues obtained in his rental.
2.He has informed his investment’s broker that he resides in other country. Therefore he is not withhold any tax at the time of receiving his dividends.
In Spain, he will need to declare all his worldwide incomes: the incomes coming from his work in Spain, his rent revenues and the foreign dividends.
1.In virtue of the double taxation treaty, Spain will acknowledge the tax payment for the rent revenues and apply a deduction for double international taxation which in most case will cancel out the tax derived from those incomes.
2.Since nothing was withdrawn of the dividends, he will pay for this concept fully in Spain.
What about tax rates and allowances?
The applicable tax rates and allowances are, of course, those of Spain. This sometimes brings the situation in which there is a remaining tax bill in Spain.
Consider the example the rent in the only source of income. Say that if he was resident in his home country, he would have to pay any tax for that particular amount of income because the allowances assigned in that country will cover the tax bill.
However in Spain he is applied the Spanish tax rate and the Spanish tax allowance. This might result in a payment to Spain Tax Agency.