Methods of Avoiding Double Taxation on Income Tax

International double taxation occurs when the same income is taxed in two countries — both in the country where the income originates and in the country where the recipient is a tax resident. Simply put, taxation takes place simultaneously in the source country and the recipient’s country of residence.

There are many situations in which double taxation can arise. The most common scenario in practice is when you live in one country but work in another. Another example is purchasing real estate abroad at an attractive price and renting it out periodically. For legal entities, double taxation may occur when interest income is paid to a foreign country.

The main solution to the problem of international double taxation lies in double taxation agreements (DTAs) signed between countries. Below, we provide a brief overview of the methods used to prevent double taxation.

For tax advice on doing business in the Czech Republic, feel free to contact the specialists at 360WEDO. We’ll help you find the best solution tailored to your needs.

Double Taxation Agreements

As mentioned in the introduction, the key solution to international double taxation lies in agreements specifically designed to prevent the same income from being taxed in both the source country and the recipient country. In some cases, these agreements may even eliminate taxation altogether.

Double taxation agreements (DTAs) define which country has the right to tax certain types of income — either the country where the income originates or the country where the recipient resides. Thanks to these agreements, taxpayers are usually spared from having to pay tax on the same income twice.

Elimination of International Double Taxation

Double taxation treaties generally outline three main methods for avoiding international double taxation:

• Tax credit
• Exemption of income from taxation
• Final inclusion of tax paid abroad as an expense that reduces the taxable base

The tax credit method is further divided into simple credit and full credit, while the exemption method can be either full exemption or exemption with progression.

The Income Tax Act specifies various methods for eliminating double taxation of foreign income. The method a taxpayer must apply depends on the provisions of the double taxation treaty that the Czech Republic has signed with the relevant country.

If a Czech tax resident earns income from a country that does not have a double taxation treaty with the Czech Republic, the foreign tax paid is not credited. Instead, it is treated as a tax-deductible expense — a cost incurred in generating, securing, and maintaining taxable income — thereby reducing the taxable amount of the foreign income.

Credit Method

Under this method, the taxpayer’s domestic tax liability is reduced by the amount of tax paid abroad. The credit method is divided into two types: full credit and ordinary (simple) credit.

Full Credit Method

With the full credit method, the domestic tax liability is reduced by the entire amount of foreign tax paid, regardless of the type or rate of tax applied abroad. Although this method is considered simpler, it is rarely used in practice.

Ordinary (Simple) Credit Method

The ordinary credit method allows the taxpayer to reduce their domestic tax liability by the amount of income tax paid abroad — but only up to the maximum amount of Czech income tax that would be payable on that foreign income under the Czech Income Tax Act.

This method helps ensure fair treatment for domestic taxpayers, creating a level playing field regardless of whether the income is earned domestically or from foreign sources.

Example 1

The Czech company ABC s.r.o. grants an interest-bearing loan to its Slovenian subsidiary ABC SVK. According to the double taxation treaty between the Czech Republic and Slovenia, the Slovenian company withholds 5% tax on the interest paid to the Czech parent company.

• Taxable income in the Czech Republic: CZK 600,000
• Foreign income (Slovenia): CZK 400,000
• Total taxable income: CZK 1,000,000

The applicable double taxation treaty specifies the ordinary (simple) credit method for eliminating double taxation.

Tax Calculation:

• Czech corporate income tax rate: 19%
• Total Czech tax before credit: 19% of CZK 1,000,000 = CZK 190,000
• Proportion of foreign income: 400,000 / 1,000,000 = 40%
• Tax paid abroad: 5% of CZK 400,000 = CZK 20,000
• Maximum allowable tax credit (foreign income share × Czech tax): 40% × 190,000 = CZK 76,000

Final Tax Credit and Czech Tax Payable:

The lower amount between foreign tax paid (CZK 20,000) and maximum credit (CZK 76,000) is applied.

✅ Tax credit applied: CZK 20,000
✅ Final tax payable in the Czech Republic: 190,000 – 20,000 = CZK 170,000

Exclusion Method

The exclusion method is divided into two types: total exclusion and progressive exclusion. This approach allows foreign income that has already been taxed abroad to be excluded from domestic taxation, meaning such income is not included in the domestic tax base at all.

Total Exclusion

Under the total exclusion method, all income (or profit) earned from foreign sources is fully excluded from domestic taxation.

• For corporations, this exclusion applies to the tax base or tax losses.
• For individuals, it applies to all partial tax bases minus the sum of losses, before calculating non-taxable parts of the tax base and deductible items.

Progressive Exclusion

Under the progressive exclusion method, foreign income that has already been taxed abroad is not included in the domestic tax base. However, when calculating the applicable tax rate, the excluded foreign income is added back to the domestic tax base to determine the correct (progressive) rate.

This method is mainly relevant in systems with progressive tax rates. Since the Czech Republic uses a flat tax rate, progressive exclusion is generally not applicable.

Example 2

In 2021, a Czech company reported a domestic tax base (revenue minus tax-deductible expenses) of CZK 6,000,000. Additionally, it earned CZK 1,500,000 from a foreign permanent establishment, where it paid CZK 150,000 in foreign tax. The foreign country has a double taxation treaty with the Czech Republic, which stipulates the progressive exclusion method.

However, since the Czech Republic applies a flat corporate tax rate, the amount of foreign income does not influence the tax rate. As a result, the full exclusion method is applied in this case.

Final Calculation:

• Tax base in the Czech Republic: CZK 6,000,000 (domestic income only)
• Czech corporate income tax: 19% of CZK 6,000,000 = CZK 1,140,000

The foreign income is excluded from the Czech tax base, and no further adjustments are needed.

Tax Paid Abroad as a Deductible Expense

The final method related to double taxation is the inclusion of foreign tax paid as a deductible expense. Strictly speaking, this is not a method of avoiding double taxation, but rather a way of mitigating its effects.

This approach is applied in the following situations:

• There is no double taxation agreement between the Czech Republic and the country where the income was earned;
• The taxpayer has a global tax loss or zero tax liability in the Czech Republic, making it impossible to apply a tax credit; or
• The foreign tax paid exceeds the maximum amount that could be offset against Czech tax.

In these cases, the foreign tax paid is treated as a tax-deductible expense — reducing the Czech tax base rather than directly reducing the tax liability.

Example 3

The Czech company ABC s.r.o. granted an interest-bearing loan to its foreign subsidiary ABC Ltd. According to the double taxation treaty, the foreign company withheld 50% tax on the interest income, amounting to CZK 200,000.

• Taxable income in the Czech Republic: CZK 600,000
• Foreign income: CZK 400,000
• Total taxable income: CZK 1,000,000

The applicable double taxation treaty provides for the simple credit method to eliminate double taxation.

Tax Calculation:

• Czech corporate tax rate: 19%
• Total Czech tax before credit: 19% of CZK 1,000,000 = CZK 190,000
• Foreign income share: 400,000 / 1,000,000 = 40%
• Tax paid abroad: 50% of CZK 400,000 = CZK 200,000
• Maximum allowable tax credit: 40% × 190,000 = CZK 76,000

The tax credit applied is the lower amount between foreign tax paid and maximum allowable credit.

✅ Tax credit applied: CZK 76,000
✅ Final Czech tax payable: 190,000 – 76,000 = CZK 114,000

The remaining foreign tax paid — CZK 124,000 (i.e., 200,000 – 76,000) — can be claimed as a deductible expense in the Czech Republic.

In summary, this article has outlined the main methods of avoiding double taxation. Double taxation treaties always specify the applicable method, and taxpayers cannot choose the method themselves based on convenience. The correct method depends on the specific treaty provisions.

For detailed professional advice, simply leave a request on the 360WEDO website — our team will get in touch with you.

Sources:

https://portal.gov.cz/informace/dohody-o-zamezeni-dvojiho-zdaneni-INF-297

https://www.mfcr.cz/cs/zahranici-a-eu/smlouvy-o-zamezeni-dvojiho-zdaneni/prehled-platnych-smluv