Methods for avoiding double taxation – how to apply these?

Each Double Tax Treaty (DTT) defines the techniques for avoiding double taxation and the income types which they relate to. The model of the Organization for Economic Cooperation and Development – OECD determines that the techniques are to be explained in Chapter V – “Methods for avoidance of double taxation” in each DTT. Thus, regardless how we name these techniques below, the way of application should be sought in the respective DTT.

The methods are applied when the annual tax return under the Personal Income Tax Act (PITA) and the Corporate Income Tax Act (CITA) is submitted for incomes paid abroad.

Applicable methods for double taxation avoidance include:

  • Full tax credit
  • Regular tax credit
  • Exemption with progression

For the purposes of the below examples, we will assume that the rate in Bulgaria is 10% and the foreign tax rate is 18%.

Full tax credit

               The full amount of the tax paid abroad for the relevant income is deducted.

Example:

  • Annual income, source from Bulgaria: 2000
    • Bulgarian tax: 200 (according to Bulgarian tax rate applied to a tax basis of 2000)
  • Annual income, source from abroad: 1000
    •  Bulgarian tax: 100 (according to the Bulgarian tax rate applied to a tax basis of 1000)
    •  Foreign Tax: 180 (according to foreign tax rate applied to a tax basis of 1000)
  • Total annual income: 2000+1000=3000
  • Total annual tax debt in Bulgaria: 120, calculated as follows:
    • Bulgarian income tax, source from Bulgaria: 200
    • Bulgarian income tax, sources from abroad: 100
    • Full tax credit: -180
  • Final total annual tax: 300, calculated as follows:
    • Total annual tax debt in Bulgaria: 120
    • Foreign tax: 180
  • Total annual income after taxes : 2700 

Ordinary tax credit

The lesser sum of tax amount paid abroad and the tax amount, which would have been paid for the same income in Bulgaria, is deducted. I.e. the deduction is limited to the tax amount on the foreign income which would have been paid in Bulgaria.

Example 1:

  • Annual income, source from Bulgaria: 2000
    • Bulgarian tax: 200 (according to Bulgarian tax rate applied to a tax basis of 2000)
  • Annual income, source from abroad: 1000
    • Bulgarian tax: 100 (according to Bulgarian tax rate applied to a tax basis of 1000)
    • Foreign Tax: 180 (according to foreign tax rate applied to a tax basis of 1000)
  • Total annual income: 2000+1000=3000
  • Total annual tax debt in Bulgaria: 200, calculated as follows:
    • Bulgarian income tax, source from Bulgaria: 200
    • Bulgarian income tax, sources from abroad: 100
    • Full tax credit: -100 (100<180)
  • Final total annual tax: 380, calculated as follows:
    • Bulgarian income tax, source from Bulgaria: 200
    • Foreign tax: 180
  •  Total annual income after taxes: 2620

Example 2:

  • Annual income, source from Bulgaria: 2000
    • Bulgarian tax: 200 (according to Bulgarian tax rate applied to a tax basis of 2000)
  • Annual income, source from abroad: 1000
    • Bulgarian tax: 100 (according to Bulgarian tax rate applied to a tax basis of 1000)
  • Foreign Tax: 72 (according to foreign tax rate applied to a tax basis of 400)
  • Total annual income: 2000+1000=3000
  • Total annual tax debt in Bulgaria: 228, calculated as follows:
    • Bulgarian income tax, source from Bulgaria: 200
    • Bulgarian income tax, source from abroad: 100
    • Full tax credit: -72 (72<100)
  • Final total annual tax: 300, calculated as follows:
    • Bulgarian income tax, source Bulgaria: 228
    • Foreign tax: 72
  •  Total annual income after taxes: 2700

Exemption with progression

The foreign income is deducted from income subject to taxation in Bulgaria, but it is “artificially“ included in determining the tax basis in Bulgaria for the purposes of determining the higher tax rate, when the taxation is under a progressive scale.

I.e. Foreign income is added, so that the possibly higher tax rate is determined, following which the foreign income is deducted, but the higher tax rate remains applicable for the remaining income.

Since the tax rate in Bulgaria is a flat no-scale rate, the so-called “artificially” addition of the foreign income does not make sense, so in practice this method leads to full tax exemption in Bulgaria for the respective foreign income.

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