RELIEF FROM DOUBLE TAXATION

Relief from double taxation generally follows one of three
• the deduction method;
• the credit method; or
• the exemption method.
The least applied of the three is the deduction method.
THE DEDUCTION METHOD,
 It  is normally applied by the country of residence, the foreign tax is treated as a deductible expense
so that the income is taxed net of foreign tax. This method is generally the least favourable to the taxpayer. It is usually used as a unilateral tool in the absence of a tax treaty. International tax arrangements,whether bilateral or multilateral, normally prevent double taxation through the credit method or the exemption method.
THE CREDIT METHOD
Under the credit method, the country of residence taxes the foreign income of its residents but allows the foreign tax as a credit against its own tax. Generally, it does not refund excess foreign tax over its own tax. The ultimate tax liability of the taxpayer is, therefore, the higher of the domestic or foreign tax .
A variation of the credit method is the “tax sparing” or “matching credit” method, under which the country of residence in effect grants a credit for a tax that is higher than the tax actually levied
in the source country. The matching credit issue has been considered important by many developing countries .The credit method attempts to achieve full “horizontal equity”more effectively than the deduction or exemption method. Under the horizontal equity theory, resident taxpayers pay the same amount of tax regardless of whether they derive domestic-source or foreign source income. However, the credit method is complex from both a compliance and an enforcement perspective, as the foreign income needs to be recomputed according to domestic rules. It may also discourage investments abroad or encourage the deferral (i.e. non repatriation) of types of foreign income, such as dividends, which are normally not assessed for tax in the country of residence until
actually received. Since the taxpayer’s ultimate tax liability is the higher of the country of residence and source country tax, the source country can manipulate the credit method to its advantage
by increasing its own tax up to the amount of the country of residence tax without, on balance, aggravating the ultimate tax position of the investor.
THE EXEMPTION METHOD
Under the exemption method, the country of residence disregards the foreign-source income of its residents. The foreign tax is, therefore, the only tax burden borne by that income. This method is most favourable to the taxpayer if the source country tax is lower than the country of residence tax. It is also easily enforceable, fosters capital-import neutrality and, in principle, does not encourage deferral of income. However, it is more prone to abuse and can cause discrimination between residents, depending on whether they realize domestic or foreign income. Normally, the exemption method is applied by the country of residence. For certain types of income, however, tax arrangements may require the source country to exempt the income. This is
generally the case for passive income, including royalties and capital gains.