Countries sign treaties to prevent double international taxation, establishing specific rules to acknowledge tax payments made in the other country.
Residents of an EU country are required to declare their worldwide income and pay income tax on it in their country of residence.
This general rule can conflict with another rule stating that tax should be paid in the country where the income is generated. To resolve these conflicts, countries sign double taxation treaties.
Let’s consider a case study to illustrate this.
A national of another country with a double taxation treaty resides permanently in Spain, where he earns his main income. Additionally, he owns a property in his home country that he rents out and has investments there, receiving dividends.
1. His home country requires him to file taxes for the rental income.
2. He has informed his investment broker that he resides in Spain, so no tax is withheld from his dividends.
In Spain, he must declare all his worldwide income: his work income in Spain, rental income, and foreign dividends.
1. Under the double taxation treaty, Spain will acknowledge the tax payment for the rental income and apply a deduction for double international taxation, which in most cases will cancel out the tax owed on that income.
2. Since no tax was withheld on the dividends, he will pay the full tax on them in Spain.
What about tax rates and allowances?
The applicable tax rates and allowances are those of Spain. This can sometimes result in a remaining tax bill in Spain.
For example, if his only income is the rental income, he might not owe any tax in his home country because of allowances that cover the tax bill. However, in Spain, the Spanish tax rate and allowances apply, which might result in a payment to the Spanish Tax Agency.