What are Tax Treaties? – Master of Accounting Degrees

We live in a world of nation states with permeable borders, and tax treaties have become an essential tool of economic diplomacy. These treaties impact both individuals and companies that operate in two or more countries. The United States negotiates with other nations to provide relief from excessive taxation on the incomes of people and businesses for the benefit of all. However, this seemingly simple concept holds hidden complexities. The article below explores the subtler aspects of such treaties.

A Reciprocal Agreement

As discussed by the U.S. Internal Revenue Service (IRS), the United States holds many tax treaties with other nations. This provides relief for residents in other countries, foreign nationals, and individuals with sanctioned, non-citizen status residing within the United States with relief from some forms of taxable income. Essentially, individuals or companies that live or operate within multiple countries and have American holdings from which they derive income may be eligible for reduced or waived taxation, based on the nature of the treaty between their country and the U.S.A.

Because the treaties are mutual, U.S. residents or companies residing in on foreign soil or deriving income from a treaty partner will also receive tax relief as per the diplomatic agreement. This is a relatively straightforward arrangement when studied on an individual basis. Two countries negotiate an agreement to mitigate taxation on income derived by the citizens or companies of their treaty partner within their own borders. That’s not difficult to understand. However, there are always exceptions, loopholes, and extraordinary circumstances to consider in the world of international economic diplomacy.

A System Within a System

While international economic diplomacy operates on a global level, the taxation systems and structures developed within a country remain intact, which can render a tax treaty with a foreign power somewhat complicated. For example, the IRS notes that some states also tax the income of their residents, in addition to the federal income taxation. While this inherently represents a form of double taxation, the system has remained in place and is unlikely to change.

Additionally, a complication for any foreign national or legal resident alien is that not all states recognize such treaties negotiated by the federal government. Depending on the state in which an individual resides or a company operates, they may have to pay the full rate of state income tax levied upon all residents and citizens, even if their country has negotiated terms with the United States federal government.
Due to the nature of the political structure of the U.S., this is unavoidable, and interested individuals should consult the state tax laws to be certain of the state’s position. Naturally, the same precautions should be taken by U.S. citizens residing or conducting business in countries that have a tax agreement with the United States.

When a business becomes truly international, it may have branch offices or subsidiary companies located in several countries. At this point, multiple treaties may come into effect, and the intricacies of taxation increase in complexity. Several countries may form trading blocs or groups with shared interests in order to negotiate terms with large international powers such as the U.S. or China. This renders understanding the precise language and implications of tax treaties with individual countries or trading blocs becomes essential in the world of international economic politics.