Last updated: 31 Aug 2026 10:00 Posted in: Tax
Catriona Loughran (ExtraTax Training) explains how double tax agreements allocate taxing rights between countries to prevent the same income being taxed twice, examining the common pitfalls and the practical application of double tax relief.
Once a business expands beyond its home country, double taxation becomes a risk – the potential for the same income to be taxed in two jurisdictions. To reduce this risk, countries enter into bilateral double tax agreements (DTAs), allocating taxing rights between them.
While these agreements are highly beneficial to international trade, providing important reliefs, care should be taken when applying them.
With businesses and individuals increasingly operating across borders, there are a variety of situations in which a DTA may be relevant, including:
Double taxation arises when two countries seek to tax the same income or capital gain. This most commonly occurs in one of two situations.
The first is where both countries have the right under their domestic law to tax the person receiving the income or gain. For example, a company may be treated as tax resident in both the UK and another jurisdiction because of differences in the two countries’ rules on corporate residence. Both countries may therefore seek to tax the company’s profits under their domestic laws.
The second is where the country in which the income or gain is generated (known as the source state) taxes it, while the country where the recipient is resident (known as the residence state) also taxes the same income or gain. For example, a UK company makes a gain on selling an office block in Ireland. As the property is situated there, Ireland can tax the gain under its domestic rules. As the company is UK resident, it is also taxable in the UK on its worldwide income and gains under UK domestic rules.
DTAs are bilateral agreements made between countries under international law with the aim of eliminating both types of double taxation.
Each country gives effect to a DTA through its own domestic legislation and administrative procedures.
Countries typically use a framework agreement as the basis for negotiating a DTA. The two most influential Model Tax Conventions are:
Both Model Tax Conventions are accompanied by a commentary that discusses each of their articles and acts as an aid to interpreting the model treaty. These commentaries can be used to help interpret articles of bilateral DTAs based on them.
It is important to consider the wording of the relevant DTA between the two countries, as there can be differences between a Model Tax Convention and an individual DTA, reflecting the provisions agreed by the two countries during negotiations.
The taxes typically covered by a DTA include income tax, capital gains tax and corporation tax. Social security contributions or inheritance and gift taxes are not generally covered. Countries may make separate agreements for these matters, but they are less common than DTAs.
This can create practical difficulties. For instance, a DTA may mean that an employee working overseas for a period does not need to pay income tax in the overseas jurisdiction, avoiding double taxation. However, employer and employee social security contributions may still be payable in both the home and host jurisdictions unless a separate social security agreement applies.
Countries negotiating a DTA will agree how taxing rights are allocated between them for different types of income and gains.
Where there is a dispute over the residence of an individual or entity, a tie-breaker test in the DTA will usually determine where that person or entity is to be treated as resident for the purposes of the treaty.
For example, DTAs typically set out a series of tests to determine where an individual who is resident in both countries under domestic law is to be treated as treaty resident.
Where double taxation arises because a resident of one country receives income or gains from another, the allocation of taxing rights is based on the principle that:
In certain cases, the source state has full taxing rights, for example, over income or gains arising from real estate situated within its jurisdiction. In other cases, the source state’s taxing rights are limited, such as the rate of withholding tax that may be applied on dividends or interest.
In some circumstances, such as royalty income under the OECD Model Tax Convention, the source state has no taxing rights, meaning that only the state of residence may tax the income.
Article 6 of the OECD Model Tax Convention covers the taxation of income from immovable property, such as land or buildings situated in a state.
Article 6(1) gives taxing rights to the state where the property is located. This is because most countries want to ensure that they can tax income arising from land and other immovable property situated in their territory. The recipient’s state of residence also has taxing rights.
See Example: Overseas rental income.
Article 10 of the OECD Model Tax Convention provides that dividends may be taxed in both states.
The source state, where the company paying the dividend is located, may tax the dividend, usually by applying a withholding tax. The residence state, where the person receiving the dividend is resident, may also tax the dividend. The residence state is generally responsible for relieving double taxation, either by exempting the dividend income from tax or by giving credit for the foreign tax suffered.
Article 10(2) proposes limiting the rate of withholding tax chargeable by the source state to 15%, with a lower limit of 5% where the paying and receiving companies are related, as defined by the DTA. This is an example of a limited taxing right, as it restricts the amount of tax to be applied by the source state.
See Example: Reduced withholding tax on dividends for further details.
The UK does not impose withholding tax on dividends paid by UK companies. Although the UK, as the source state, generally has taxing rights under its DTAs, it has chosen not to tax dividends paid to non-residents. This illustrates how DTAs allocate taxing rights; they cannot create a tax charge where a jurisdiction does not have the domestic rules in place to impose one.
Article 10 is one of the articles most frequently adapted when countries negotiate DTAs. Therefore, while the commentary accompanying the Model Tax Conventions can help interpret the article, it is essential to review the provisions of the relevant DTA rather than relying on the Model Tax Convention alone.
Article 11, covering interest income, operates in a similar way, giving limited taxing rights to the source state. However, care must be taken when dealing with related-party lending, as the limitation on the source state’s taxing rights only applies to the arm’s length amount of the interest.
To minimise the risk of challenge by the tax authorities, the transfer pricing treatment of the loan should be fully considered and documented when it is advanced.
A common pitfall with cross-border dividend and interest payments is assuming that the reliefs available under a treaty can be applied automatically. This is often not the case.
Most countries have procedures that must be followed before reduced rates of withholding tax can be applied. Where these procedures include obtaining documentation from the tax authorities, they can take many months to complete and should therefore be initiated well in advance of the payment date.
DTAs facilitate international trade, encouraging businesses to expand beyond their own borders. However, applying them correctly requires careful consideration of both domestic tax law and the relevant treaty provisions. Professional advice can help businesses avoid costly errors and ensure that treaty relief is claimed where available.
Example: Overseas rental income
David has always been tax resident in the UK. He owns an apartment in Spain, which he lets out for short-term holiday rentals. As David is resident in the UK, he is subject to UK income tax on his worldwide income and gains, including rental profits from the apartment in Spain.
As the apartment is situated in Spain, the rental profits are also subject to Spanish tax under its domestic law.
Article 6(1) of the UK/Spain DTA gives Spain the right to tax the rental profits in full under its domestic tax rules. The UK, as the state of residence, retains its taxing rights.
To avoid David suffering double taxation on the same income, the UK gives double tax relief using the credit method. This means that David may offset the tax paid in Spain against the UK tax payable on the Spanish rental profits.
If the Spanish tax is lower than the UK tax liability, he will have to pay the difference to HMRC. However, if he has paid more tax in Spain than is payable in the UK, he will not receive a refund from HMRC.
In practice, the credit method generally means that the higher of the two countries’ effective tax rates is ultimately borne.
Example: Reduced withholding tax on dividends
Lion Ltd is resident in Olympus. It receives a dividend from its subsidiary, which is resident in Atlantis. Assume that the two countries have a bilateral DTA based on the 2017 OECD Model Tax Convention.
Under its domestic law, Atlantis applies withholding tax at 20% on dividend payments to non-residents.
Article 10 gives Atlantis, as the source state, the right to tax the dividend. However, Article 10(2) limits the withholding tax to 5% where the beneficial owner of the dividend is a company resident in Olympus, holding at least 25% of the share capital of the paying company for at least one year.
The conditions are met in this case. Therefore, Lion Ltd and its subsidiary should follow the appropriate formalities to claim a reduction of the withholding tax rate on the dividend from 20% to 5%.
Olympus, as the residence state, also has the right to tax the dividend income. However, it is obliged under the DTA to provide double tax relief, using either the exemption or credit methods.
Assume that Olympus has a dividend participation exemption for companies receiving dividends from subsidiaries. Therefore, under its domestic law, Olympus does not tax the dividend income.
This is an example of the exemption method of double tax relief.
Author bio
Catriona Loughran
Founder & Managing Director
ExtraTax Training
"DTAs facilitate international trade, encouraging businesses to expand beyond their own borders. However, applying them correctly requires careful consideration of both domestic tax law and the relevant treaty provisions."
Catriona Loughran, Founder & Managing Director, ExtraTax Training