Methods for avoiding double taxation - Mazars - Poland

"Methods for avoiding double taxation"
Anna Szyszka - Tax advisor in Mazars office in Kraków

19/01/2009

The Warsaw Business Journal of 19 January 2009

Nobody likes to pay taxes. Certainly nobody likes to pay taxes twice for the same thing. In order to avoid taxation of the same income in two countries, such as when a person maintains a place of residence in one state and derives income in another, methods for eliminating double taxation - specifically double-taxation avoidance agreements - come to the rescue.

There are two main methods:

• the exemption method, and

• the credit method

These methods are included in the provisions of the tax law of the given state, or constitute a part of a double-tax avoidance treaty. It should be undelined that the taxpayer cannot choose which method shall be used, but rather must follow the rules outlined in law.

Exemption method

This method occurs in two alternative variants: exception with progression and full exemption.

Full exemption means that income derived in the source state is not taken into account while settling the tax rate in the state of residence.

Exemption with progression means that the country of residence exempts income from foreign sources, but the person's income in his or her country of residence is taxed at a rate that would be adjusted to the sum of the income. Most of the double-tax treaties concluded by Poland follow the exemption with progression method.

The purpose of this method is an arrangement of tax burdens on a progressive scale. An exception with progression is legitimised in a situation when in the state of residence there are maginal rates, since then the increase of the tax base may lead to the increase of a tax burden. If in the source state there are much lower tax rates than in the state of residence, the latest state hypothetically loses some taxes in relation to the amount that could be expected if the overall taxpayer's income was taxed in the state of residence. The idea of this method is to balance the taxation.

Credit method

The tax-credit method appears in two possible versions: full and standard (proportional).

The full tax-credit method holds that income tax paid abroad is offset against tax paid in the state of residence. However, tax due in the state of residence is computed according to the sum of income, which is derived from the sources in the state of residence and abroad.

The proportional tax-credit method entails that the qualification of taxes paid abroad in aid of taxes paid in the state of residence cannot exceed the part of tax counted prior to such qualification, which proportionally corresponds with income obtained abroad. This method is used with respect to dividends, interest and royalties as well as when there is no double tax treaty between Poland and the other country. Moreover, this method is used in the case of a taxpayer subject to unlimited tax obligations in Poland obtaining income from the activity performed exclusively outside the territory of Poland or from the sources located outside the territory of Poland, which are not tax exempt on the basis of a tax treaty.

In summary

Double taxation is not unavoidable. When deriving income from sources located in at least two different states, one should remember to take into account the double-tax avoidance treaty between them, if one exists. It should be underlined that each double-tax treaty includes the relevant method applicable with respect to taxes on income. In the case there is no double-tax avoidance treaty between Poland and another state, Polish tax law imposes the use of the tax-credit method.