Residence and source based taxation offer two
rationales by which a nation can impose income tax upon a person or
corporation. Each principle establishes a tax claim over a taxpayer by
virtue of the connection between that taxpayer (and his/her activities)
and the nation in question. It is the form and quality of this
connection which determines the mode of taxation applied and the
justifications advanced to support it:
- Residence-based taxation is applied to persons
who are citizens of, live in or treat a jurisdiction as their home. It
entitles taxation of both the domestic and worldwide income of those
persons.
- Alternatively, source-based taxation is applied
to income made within the borders of the home nation; regardless of who
made it. A source-based claim only entitles the home nation to tax
domestic income, not foreign income.
Rationales – The root
rationale for residence taxation is the ‘ability to pay' (Smith, Kant).
Taxes, as Holmes argued, are the "price of a civilised society". Rawls
posits the risk-adverse bargain: at the ‘original position', knowing
not whether we would be ‘winners' or ‘losers' in society, we would all
bargain for certain basic standards. Having made the bargain and
received societal benefits, we must come good if we can. Elementary
justice requires contributions according to what we have (our ‘ability
to pay'). (Smith). If one benefits from society, one should bear the
burdens as well. This burden is typically only applied to those with a
sufficient connection to the home society (cf: US citizenship tax). If
there is no connection, (presumably) no opportunity to access many
societal benefits arises. On that basis most countries do not apply
residence taxation to citizens who are far removed from their country.
By contrast, source taxation is primarily
justified against a ‘benefits' rationale (Shay et al). Those who make
income from a country will inevitably use, rely on and derive benefits
from the "physical, legal and/or economic infrastructure" (Shay et al)
of the host country. The retort might be what benefits and to what
value? Businesspeople will argue the tax paid far exceeds the value of
specific benefits provided. However, it is submitted this "constrained
view" is inappropriate (Shay). Benefits are not limited to "basic
services" (Ibid, 89) like the road outside and weekly garbage
collection. They include everything which makes up a safe and
productive society (Ibid); like a healthy and educated workforce (Shay).
Alternatively, source taxes are a ‘market charge'
to be paid in consideration for market access. This analysis does not
require a justification of the particular level of tax; although if it
is too high no-one would pay and foreign investment would dwindle (the
level is set by what foreigners are willing to pay). Snidely, however,
some say that non-voting foreigners are convenient tax targets (Shay,
89). Finally a point of doctrinal distinction: at least conventionally,
the ability to pay cannot form a rationale for source taxation (Shay,
94). This is because a source country cannot accurately judge the
ability to pay of foreigner. It does not know and cannot enquire of
worldwide income so at to compute a ‘fair' portion of source tax.
However is this necessarily true? Perhaps ability might be measured on
income the source country knows about? (Shay, 95).
Geography & Conflict – Resident
taxation is worldwide taxation; it is aimed at resident taxpayers in
the home country. By norm source taxation is geographically limited
taxation (Shay) targeted at foreigners trading within the borders. A
potential for conflict exists as residence claims will inevitably cover
source claims over income. Where is occurs, the problem of double
taxation is evident: for example, say A is a resident of country X.
Assume A earns 40 in X and 20 from investments in country Y. X will tax
A under the residence principle on his worldwide income (40 + 20 = 60).
However, Y is likely to impose source tax on the 20. In effect both X
and Y will purport to tax the same income. This shows that
residence-based taxation will often overlap with the territorially
specific claims of source tax.
Enforcement – Enforcement
methods differ vis-à-vis residence and source taxation. In the example,
A would be required to lodge a tax return in X disclosing his domestic
and foreign income. He would then pay any excess tax liability at the
end of the financial year. As a resident of X (and physically present),
his records can be inspected, lifestyle investigations made and seizure
of property and assets is readily achievable. Further domestic criminal
sanctions are easily applied. However Y faces a problem with respect to
source tax A owes. Y cannot require A to lodge a tax return as it
cannot enforce the requirement, particularly if A has never entered Y.
Even if enforcement options are available they are likely to be costly.
The solution is to apply ‘pre-paid' taxation. Assuming purely
investment income, Y will impose a gross-basis withholding
tax on A's 20 income from interest or dividends. This will
be taxed when income is paid out of Y to A. Note however that this
approach is not suitable under the residence principle as a withholding
tax is a blunt, fixed rate impost that does not vary with the ability
to pay. If source tax were to adopt an ability rationale, it might
allow a system under which withholding tax could be (fully or
partially) claimed back by the taxpayer given low ability evidenced by
an optional return.
To conclude, source and residence taxation form
distinct taxation types under differing rationales. The type of
taxation will determine who pays, where they pay, how much they pay and
what happens if they do not pay. It is in the interest of all taxpayers
to know these things.
Article Source:
http://www.articlesbase.com/taxes-articles/the-distinction-between-
residence-and-source-based-taxation-2523862.html
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