Treaties on the Avoidance of Double Taxation

Treaties on the Avoidance of Double Taxation

Individual states enter into treaties on the avoidance of double taxation in order to prevent double taxation of incomes coming from abroad. According to an internationally recognised principle, not only incomes from local sources but also incomes from other states must be taxed in the state of the so called tax residence. According to the income tax law, a Czech tax resident is a taxpayer with residence on the territory of the Czech Republic or usually residing here. Taxpayer usually residing on the territory of the Czech Republic must reside here for at least 183 days of the year in question either at once or in several periods. For legal persons the situation is simpler – a legal person whose company seat or the seat of its management is in the Czech Republic is a Czech taxpayer.

In taxing incomes from abroad, the applicable legislation is the international treaty on the avoidance of double taxation and law no. 586/1992 Coll., on income tax, where the issue is addressed in article § 38f. Where the domestic income tax law and the international treaty contradict one another, the content of the international treaty prevails.

At present, the Czech Republic is party to treaties on the avoidance of double taxation with some 80 countries worldwide. The treaty specifies the method of income double taxation elimination. The two most frequently used methods are exemption of incomes with progression and ordinary tax credit. The ordinary credit method is most frequently used in the Czech Republic since the 1990s. The exemption with progression method can usually be encountered in case of older treaties, most of them effected in the 1980s.

The ordinary credit method compares the income tax paid abroad with the tax the income would be subject to in the Czech Republic. If the sum settled abroad is lower, the difference is paid in tax in the Czech Republic. If the tax paid in the source state is higher, no tax is paid in the Czech Republic.

In case of the exemption with progression method, incomes from abroad are not included in the tax base. When the tax is calculated, however, a taxation rate from such tax bracket is used which corresponds to the sum of all incomes, i.e. including those from abroad. This method, however, only applies when the state in question employs progressive system of taxation, wherein tax rates are graded in accordance with the various tax brackets. Since 2008 the Czech Republic uses proportional tax rate, which is why – when the exemption with progression method is used – the same approach is adopted as in case of the full exemption method. Incomes subject to taxation abroad are thus exempt from the tax base and only incomes reached in the Czech Republic are taxed.

Where income is reached from countries with which the Czech Republic does not have a treaty on the avoidance of double taxation, the income tax law applies. Incomes reached in the other country must first be taxed in this second state according to its laws and then again in the Czech Republic. The tax paid abroad, however, is deducted from the tax base.