The global income tax landscape is a complex and ever-changing one. As businesses and individuals increase operations across borders, the need to understand the implications of global income tax has never been greater. In this article, we'll provide an overview of worldwide income tax systems and compare them to territorial tax systems. We'll also break down the many layers of global income tax, such as the differing rules of worldwide income tax countries, tax treaties for double taxation, and countries with reduced global income tax rates. The focus on the global tax system will be centered around the current situation in the United States.

What is a worldwide tax system?

A worldwide tax system – also known as a residence-based tax system – for corporations and individuals differs from a territorial tax system, as it includes foreign-earned income as part of the domestic tax base.

The global income tax system levies a tax on individuals and businesses regardless of where they are located or conduct business. This type of taxation is typically based on the principle of territoriality, which stipulates that taxes must be levied in totality on those who reside or conduct business within the territory of the taxing authority.

To understand how global income tax works, we can look at the United Kingdom. In 2010, the fastest man alive, Usain Bolt, turned down the opportunity to run at a track meet in London as the tax levied on his worldwide income by HM Revenue and Customs (HMRC) was more than the £100,000 ($119,000) he was due to receiving for competing at the event.

This is because, at the time, HMRC used a worldwide income tax system that charged tax on all income generated worldwide by athletes and performers, from appearance fees, prize money, and sponsorships, to business activities outside their professions.

Most athletes based outside the UK spend only a few days in the year competing there, which created a paradoxical tax situation and, thus, Usain Bolt’s refusal to attend.

This global income tax system example may be on the more extreme side, but it provides a clearer view of how global income tax can affect individuals who conduct business in different countries.

Worldwide Taxation in the United States

For individuals

Although there has been significant reform in the worldwide income tax system for US companies, US citizens are still subject to paying taxes on worldwide income. However, all is not lost.

The US exercises what is known as a “hybrid” worldwide income tax system. You’re not liable to pay full taxes on income earned abroad as you would for domestic income.

For one, many US taxpayers are unaware of how much foreign-earned income is tax-free in the USA. Expats living abroad or doing business overseas are not liable to pay taxes in the US on the first $112,000 of income earned in a foreign country.

So, although a worldwide income tax system is in place, many expats who choose to move abroad to live cheaper lifestyles fall way under this income threshold.

In addition to a tax-free threshold for foreign-earned income, by completing form 1116, you can claim a foreign income tax credit for the taxes you paid to a foreign government.

There is no standard foreign income tax rate for foreign-earned income. Still, several exclusions and deductions can be made on your tax return to make up the foreign income tax credit. A US expat calculator will help make accurate tax savings estimations. You can essentially reduce your tax liability by thousands of dollars every tax year.

For corporations

The United States of America moved from the worldwide taxation system they had in place towards territorial taxation as part of the 2017 Tax Cuts and Jobs Act (TCJA).

Before the TCJA was signed into law in 2017, the United States operated a worldwide tax system. US corporations needed to pay US corporate income taxes on all their worldwide earnings, with a foreign tax credit going towards foreign corporate taxes paid.

To provide you with an example of a US corporate income tax rate under the old system, if there was a US company with a subsidiary UK company, that subsidiary would pay 19 percent corporate tax in the UK on its earned profits.

Under the US worldwide tax system, if the subsidiary company was brought back into the US, the US parent company would owe an additional 16 percent on those earnings (the difference between the UK’s 19 percent and the old 35 percent US corporate tax rate).

Enter the territorial tax system. Under this taxation system, the US parent company wouldn’t owe any additional US corporate tax on these repatriated profits. This has significantly reduced the tax burden for US corporations operating abroad, especially US corporations with foreign subsidiaries in countries with low corporate tax systems.

How Worldwide Taxation Affects Repatriation

The worldwide taxation system heavily discourages the transfer of earnings by a corporation or individual back into the country of its tax jurisdiction. This is due to the combination of foreign taxes with national taxes creating an environment of very high taxation.

The transfer of earnings back to the registered country of an entity is known in the tax world as “reparation.”

Repatriation is often avoided or prolonged because multinational businesses and entrepreneurs can reinvest or hold foreign-earned profits overseas in offshore bank accounts and other foreign financial institutions instead of losing money on repatriating them.

The non-repatriation of foreign income has substantial adverse effects on a country and its citizens, even disregarding the money earned from tax; it’s less money circulating within the country’s economy.

The New Territorial Tax System in the United States

As part of the TCJA, the new territorial tax system was implemented to encourage the repatriation of earnings from US corporations back to the US. This system, in general, excludes foreign-earned income from domestic taxation.

To get the ball rolling, a one-time transition tax at a significantly reduced rate was introduced, allowing corporations and individuals to repatriate earnings made between 1986 and 2017.

Here are the applicable rates for transition tax:

Corporations

  • 15.5 percent on earnings and profits related to cash assets.
  • Eight percent on the rest of the accumulated earnings and profits.

Individuals

  • 17.5 percent on earnings and profits related to cash assets.
  • 9.1 percent on the rest of the accumulated earnings and profits.

To facilitate tax payments for entities with large amounts of wealth overseas, during the transitional period, the US government allows subjects to pay the transition tax over a period of eight years.

Nevertheless, certain income types, such as passive and foreign-earned capital gains, are not included. As such, the territorial taxation system is only partially territorial.

International Trend Towards Territorial Taxation

Over the past 30 years, most OECD (Organization for Economic Co-operation and Development) countries have transitioned from an arbitrary worldwide taxation system towards a territorial tax system that benefits the government, corporations, and individuals.

Most countries have aimed to reduce barriers to international capital flows and boost the competitiveness of domestically headquartered multinational firms.

A territorial taxation system can have many positive trickle-down effects, with more earnings circulating in the economy. It prevents companies from borrowing in the US to fund foreign investments, essentially taking money out of the economy to stimulate another economy.

With the increase in repatriation due to a forward-thinking tax law like territorial taxation, the country can benefit from economic growth across the board, such as more jobs, new business and investment at the local level, and more money to spend on public services.

Chile, Israel, Korea, and Mexico are the only OECD countries still operating fully worldwide income tax systems for corporations.

Reducing Your Global Taxes

Citizenship-by-investment and residency-by-investment programs can be great ways to optimize your tax affairs. Countries like Portugal and Malta that offer these programs to foreigners provide massive tax-saving benefits for expats and entrepreneurs looking to relocate abroad for tax purposes.

Along with providing highly advantageous tax systems, Portugal and Malta also employ a policy of foreign-earned income exclusion, with no income tax levied on worldwide income earned. You can enjoy a low-tax life while safeguarding income earned overseas.

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Frequently Asked Questions about Global Income Tax:

Is my global income taxable in the USA?

Regarding global income taxation, if you are a US citizen or resident living outside the USA, your worldwide income is subject to US income tax, regardless of where you reside. This is also known as double taxation. There are specific exclusions on foreign-earned income that you should check to see if you are eligible.

Most countries impose rules and stipulations related to worldwide tax liabilities, so be aware of these differences between countries.

The IRS (Internal Revenue Service) is responsible for helping taxpayers understand and meet their income tax responsibilities, including enforcing the law if the taxpayer attempts to fall short of their tax duties.

Do Canadians pay global tax?

If the Canadian Revenue Agency deems you a Canadian resident, you must pay income tax on worldwide income earned. The amount of tax you need to pay will depend on your earnings.

You should be aware of the rules in place when paying taxes on foreign-earned income. You must submit your tax return to ensure you are not withholding taxable income.

How much income earned overseas is tax-free?

Citizens living abroad should be up to speed on the tax code that applies to them. Tax laws will vary from country to country and even citizen to citizen in the same tax jurisdiction. Taxable foreign income and the amount of foreign income that is tax-free or eligible for foreign income tax credit will depend on your country’s tax rules and regulations.

Many counties have double taxation agreements and income tax treaties with foreign countries to avoid double taxation, providing some tax relief on income earned abroad.

Worldwide tax liabilities will vary, so ensure you know the rules when completing your tax return. Some counties will have citizen-based taxation, while others will have residency-based taxation.

For example, there are different tax rules for what are known as “non-resident aliens” and “resident aliens” in the US. Non-resident aliens are only liable to pay taxes on income earned from business activities within the US, whereas resident aliens and citizens must pay taxes on worldwide income.

Many jurisdictions impose rules limiting the amount of tax you need to pay in certain circumstances, and some countries may have more lenient tax laws than others.

It is best to be well-versed in tax affairs. Tax havens like the Cayman Islands have very low tax rates for companies and foreign investors in certain circumstances. Speaking to international tax specialists can help you better understand the law regarding international tax.

Are Indians taxed on global income?

Concerning global income taxation for Indian citizens, any income earned in a foreign country is liable for worldwide income tax, even if the foreign income is not received or brought into India.

Simply put, the same income you generate in a foreign country outside India is liable to income tax in India.

What is the purpose of a global tax?

The purpose of global tax is to ensure that big businesses with international operations and individuals with foreign earnings do not benefit by domiciling themselves in tax havens in order to avoid paying taxes.