Avoidance of double taxation

Definition

Avoidance of double taxation refers to the legal strategy or arrangements put in place to ensure that income is not taxed twice by different jurisdictions. This is particularly relevant for entities such as real estate investment trusts (REITs), which often distribute income to shareholders and can be subject to taxation at both the corporate and individual levels. By using specific tax structures or treaties, the goal is to mitigate the financial burden on investors and promote investment in real estate.

5 Must Know Facts For Your Next Test

1. REITs must distribute at least 90% of their taxable income to shareholders to qualify for special tax treatment, which helps in avoiding double taxation at the corporate level.
2. Tax treaties can provide reductions in withholding tax rates on dividends paid to foreign investors, further enhancing the avoidance of double taxation.
3. Double taxation occurs when the same income is taxed in more than one jurisdiction, which can happen when a REIT earns income in different states or countries.
4. Investors in REITs often receive Form 1099-DIV reporting the distributions, which helps them report their income accurately and avoid double taxation.
5. Proper structuring of investments and understanding of local tax laws are essential for minimizing the risk of double taxation for REIT investors.

Review Questions

• How does the distribution requirement of REITs contribute to the avoidance of double taxation?
  • The distribution requirement mandates that REITs distribute at least 90% of their taxable income to shareholders. This allows REITs to avoid being taxed at the corporate level, as they do not retain significant earnings within the company. By passing most of the income directly to shareholders, it helps ensure that only individual investors pay taxes on their share of the income, thereby effectively avoiding double taxation.
• Discuss how tax treaties can assist investors in minimizing double taxation when investing in REITs.
  • Tax treaties between countries can significantly aid investors by reducing withholding tax rates on dividends paid from REITs. This means that when a foreign investor receives dividends from a U.S. REIT, for example, the amount taxed may be lower due to treaty provisions. By establishing lower rates or exemptions through these agreements, investors can maximize their returns and reduce their overall tax liability, facilitating better cross-border investment flows.
• Evaluate the implications of avoiding double taxation for global investors in real estate markets, particularly through REITs.
  • Avoiding double taxation has profound implications for global investors in real estate markets. It encourages international capital flows by making investments in REITs more attractive due to potential higher returns after taxes. When investors know they won’t be taxed multiple times on their income from real estate investments, they are more likely to invest across borders. This promotes diversification and can lead to greater liquidity in global real estate markets while fostering economic growth through increased investment activity.

Related terms

Real Estate Investment Trust (REIT): A REIT is a company that owns, operates, or finances income-producing real estate, allowing individual investors to earn a share of the income without having to buy, manage, or finance any properties.

Tax Treaties: Tax treaties are agreements between two or more countries that determine how income earned in one country by a resident of another country will be taxed, aiming to prevent double taxation and tax evasion.

Pass-Through Entity: A pass-through entity is a business structure that passes its income directly to its owners or investors, avoiding corporate taxation and thus reducing the risk of double taxation.