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Worldwide and Territorial Tax Systems |
(Excerpt from The Joint Committee on Taxation, JCX-68-03)
Worldwide tax system
In a pure worldwide tax system, resident individuals and entities are taxable on their worldwide income, regardless of where the income is derived. Double taxation of foreign income is mitigated through the allowance of a foreign tax credit. However, the credit is generally limited to ensure that the residence country preserves its right to tax income derived within the residence country. Since corporations are generally respected as separate entities, foreign-source income earned by a resident through a foreign corporation generally is not subject to tax until repatriated. In the United States, several complex anti-deferral regimes apply as exceptions to this general rule and tax U.S. shareholders currently on certain mobile or passive income derived through certain foreign corporations.
Territorial tax system
In a pure territorial tax system, the country taxes only income derived within its borders, irrespective of the residence of the taxpayer. Thus, unlike in a worldwide tax system, foreignsource income earned by a resident is exempt from tax. There is no need for a foreign tax credit, because exemption generally eliminates the possibility of double taxation of foreign income. There also is no need for complicated anti-deferral rules, because foreign-source income is exempt from tax in the first place. As a practical matter, however, countries that have adopted territorial-type tax systems generally have included exceptions to the territorial principle for certain cases deemed to be abusive, using regimes similar to the U.S. anti-deferral rules and foreign tax credit.
Mixed systems
No country uses a pure worldwide or territorial system. Systems may be accurately characterized as predominantly worldwide or territorial, but all systems share at least some features of both worldwide and territorial approaches.
