All individuals or companies with tax residency in a country are subject to income tax in that country. As long as the state in which the income is earned and the state in which the taxpayer is subject to tax on the basis of his tax reisdency are identical, this system of taxation does not pose any problems either for the state levying the tax or for the citizen subject to taxation. The situation is different, however, if income is taxed in a state which has been realized by the domestic taxpayer exclusively abroad (e.g. rental of a vacation home in Florida by a German owner), and both the state of residence (Germany) and the state from which the income originates (source state – here: USA) wish to tax the same income. This is where the material scope of international tax law comes in: The tax regulation of cross-border situations.
Based on international law, a state may, by virtue of its territorial sovereignty, enforce all public law orders, such as tax assessments, within its territory. Outside its national territory, it is obliged to respect the sovereignty of the other states. Here, it can only impose regulations on the persons subject to its personal sovereignty by virtue of its personal sovereignty, but it cannot enforce them. If the two fundamental rights of the states come into conflict with each other, a solution is usually found in favor of territorial sovereignty.
If the principles of international law described above are applied to the right to levy taxes, then every state is entitled on the basis of its territorial sovereignty to use all facts realized on its territory as a reason for taxation (principle of territoriality).
Furthermore, it is derived from the principle of territorial sovereignty that a state may, in principle, also subject to taxation facts realized outside its national territory (principle of world income), as long as the connecting factor of the taxation does not develop effects outside its own national territory that affect the territorial sovereignty of another state.
In the context of income and wealth taxation, the object of taxation must be distinguished from this. Here, a state basically has two options:
Access only to the sources of income and wealth located on its territory: taxation at source (e.g. income from renting and leasing immovable property located on the territory of the state without regard to the person);
Access to persons located on its territory: Residence taxation (Ex: taxation of all persons residing in the national territory on all income, whether domestic or foreign).
While in the case of withholding tax it is generally accepted that the existence of the source of income is sufficient for subjecting the income to taxation, another characteristic must be added in the case of residence taxation: If all persons staying on the territory of the state were subject to residence taxation, persons staying there only temporarily would also be taxed (e.g. tourists, fitters for temporary assembly). However, this is not desirable, especially since there is a risk that the personnel sovereignty of the other state would be violated.
Two specific principles have been established worldwide for the taxation of income and wealth:
Residence taxation: Unlimited, all-encompassing tax liability of world income;
Source taxation: Limited tax liability with the territorial income.
Of course, each state is free to waive certain income or tax sources (e.g. Monaco waives income taxation of natural persons resident in Monaco, except French nationals) or to grant concessions.
Emergence of double taxation.
In a cross-border situation, the competition between the principle of residence taxation and that of source taxation almost inevitably results in a competition between tax claims of two states.
This taxation conflict can lead to “international double taxation” if the following conditions are met:
As a rule, in the case of individuals, international double taxation results from the coincidence of residence and source taxation. A case that occurs less frequently in practice is the coincidence of residence taxation with domicile taxation.
Avoiding double taxation
There are several ways to eliminate or mitigate double taxation. Generally, the following measures are common, possibly in addition to each other:
Unilateral measures: The respective state attempts to eliminate or mitigate double taxation that has already occurred by means of regulations in its national tax laws.
Bilateral or bilateral measures: By concluding a so-called treaty for the avoidance of double taxation (DTA), taxation between the two countries involved is regulated by allocating taxation rights; this is already intended to prevent the occurrence of double taxation. This area also includes other international treaties dealing with taxes, e.g. capital protection agreements, aviation agreements, shipping agreements, etc.
Multilateral measures: Multilateral international law treaties and intergovernmental agreements, e.g., on the establishment of international organizations (Ex: Vienna Convention on Diplomatic and Consular Relations).
Supranational measures: Tax harmonization within the European Union.