What is a Bilateral Tax Agreement?

A bilateral tax agreement is an agreement between two tax jurisdictions such as municipalities, states, or countries to address the problem of double taxation. When two tax jurisdictions agree to reduce conflicts arising from duplication of taxes especially when it affects citizens or organizations that reduce in more than one country, a bilateral tax agreement is reached. Otherwise called a tax treaty, this agreement fosters relations between two jurisdictions and fosters foreign trade and investment. 

Back to: Accounting & Taxation

How Does a Bilateral Tax Agreement Work?

A bilateral tax agreement is a key way to eliminate the double taxes that individuals and corporations who reside in more than one jurisdiction or country face. Double taxation has disadvantages, the major one being it causes tax evasion. It also discourages foreign trade and investment between the two countries. The Organization for Economic Cooperation and Development (OECD) has certain guidelines for bilateral agreements. When a tax treaty exists between two jurisdictions, it enhances cooperation in tax collection between the two jurisdictions.

BilateralTax Agreements and Residency

Individuals who are domiciled in the two countries are said to have residency in both. Given the tax rules of the countries, such individuals might be subjected to double taxation. In a bilateral tax agreement, tax jurisdictions seek to eliminate the problem of double taxation that individuals and corporations are exposed to. Hence, under this agreement, only one country is regarded as a domicile for tax purposes. There are certain conditions that must be met before a country is considered domicile, the most important one is the number of days an individual spends in such a country. For instance, individuals who spend more than 183 days in European countries are considered to be domiciled there and are thereby subject to tax laws of the country.

The United States Is Different

The tax condition in the United States is quite different from other nations. Holders of green card and US citizens are mandated to pay federal income tax in the United States regardless of whether they are domiciled in another European country. Despite this existing tax rule, the US government provided a means to eliminate double taxation by allowing citizens who live outside America to enjoy the Foreign Earned Income Exclusion (FEIE). As of 2018, Americans who are domicile abroad can deduct up to $104,100 from their tax return, this is a form of tax relief.