D T A A

Introduction of double taxation

In the current era of cross -border transactions across the world, due to unique growth in international trade and commerce and increasing interaction among the nations, residents of one country extend their sphere of business operations to other countries where income is earned. One of the most significant results of globalization is the noticeable impact of one country’s domestic tax policies on the economy of another country. This has led to the need for incessantly assessing the tax regimes of various countries and bringing about indispensable reforms. Therefore, the consequence of taxation is one of the important considerations for any trade and investment decision in any other countries.

Before considering the basic principles of international double taxation ,you need to make sure we know

what a tax is ?

“A compulsory levy made by public authority for which nothing is received directly in return”

This definition suggest that the nature of tax is that it is a payment made(a cost incurred ) without the usual associated receipt ,

Other transactions, of any consideration in return.

The interaction of two tax systems each belonging to different country, can result in double taxation. Double Taxation of the same income in the hands of same entity would give rise to harsh consequences and impair economic development. Concept of Double taxation

Meaning of double taxation

Double taxation means taxing the same income twice, once in the home country and again in host country. It is of relevance to mention here “No rules of international law prohibit international double taxation.” So it is for the countries in the international arena to solve double taxation problems. Where a taxpayer is resident in one country but has a source of income situated in another country, it gives rise to possible double taxation.

Double taxation of income is a great disincentive as it Hampers free flow of capital and

Becomes a prohibitive burden on taxpayers leading to decline in foreign investments.

If both rules apply simultaneously to a business entity and it were to suffer tax at both ends, the cost of operating in an international scale would become prohibitive and deter the process of globalization. It is from this point of view that Double taxation avoidance Agreements (DTAA) become very significant.

Double Taxation of the same income would cause severe consequences on the future of international trade. Countries of the world therefore aim at eliminating the prevalence of double taxation. Such agreements are known as "Double Tax Avoidance Agreements" (DTAA) also termed as "Tax Treaties”.

In India, the Central Government, acting under Section 90 of the Income Tax Act, has been authorized to enter into double tax avoidance agreements with other countries.

Rules due to which double taxation arises

Source Rule – Under which the income of a person is subjected to taxation in the country where the source of such income exists i.e. where the business establishment is situated or where the assets/property is located irrespective of whether the income earner is a resident in that country or not; and

  Residence Rule – Under which the income earner is, taxed on the basis of his/her residential status in that country. Hence, if a person is resident of a country, he/she may have to pay tax on any income earned outside that country as well.

HOW TO CALCULATE RELIEF UNDER SECTION 90, WHAT TREATY USE FOR THIS CALCULATION?

First include the income earned and taxed in the foreign country along with the income earned in India.

Then calculate tax on the Total income Above.

Now calculate average rate of tax.

Then multiply such rate with the income earned from foreign country.

Deduct tax paid in the foreign country from the tax calculated in step. 4 above, .

Such amount is relief u/ s 90.

Example

In case of Resident individual. Income earned in India = Rs500000 Income earned from foreign = 200000 (tax paid there = Rs. 50,000)

1) Total income is = 500000 + 200000 = 700000

2) Tax calculated on 7,00,000/- is Rs. 118450/-

3) average rate of tax is (118450 / 700000) = 16.92%

4) Calculate average tax on foreign income i.e. 200000 x 16.92% = Rs. 33840/-

5) Tax paid in foreign country is Rs. 50,000.

6) Hence relief u/s 90 is lower of 33840 and 50000, i.e 33.840/-

Therefore tax statement is,

Tax on total income = 118450

Less: relief u/s 90 = 33840

Tax payable 84610/-

Reliefs for double taxation

The relief against such double taxation in India has been provided under Section 90and Section 91 of the Income Tax Act. They contain two ways of double taxation relief

Unilateral relief

Bilateral Relief

Unilateral relief:

Under this system of taxation whether the income is subject to tax abroad or not is immaterial. In Unitary system, relief is given by way of tax credit for the taxes paid abroad. The countries, which follow this method of tax credit, are, U.S, Greece, India, and Japan to name a few.

For example, under section 91 of the Income tax Act,1961,the method is “tax credit method”. A resident in India who has paid income tax in any country with which India does not have a treaty for the relief or avoidance of double taxation is entitled to credit against his Indian Income tax for an amount equal to the Indian coverage rate or the foreign rate whichever is lower applied to the double taxed income. This is done as follows.

Unilateral relief will be available for the tax-payer, if the following conditions are satisfied:-

The person or company (assesses) in question must have been resident in India in the previous year;

Same income must have accrued or arisen to him outside India during the previous year and it should also be received outside India. Such income must not be deemed to accrue or arise in India;

That income should be taxed both in India and in a foreign country and there should be no reciprocal arrangement for relief or avoidance from double taxation with the country where the income has accrued or arisen.

In respect of that income, the person or company (assessee) must have paid by deduction or otherwise, tax under the law in force in the foreign country in question in which the income outside India has arisen.

It is necessary that the foreign tax be levied in a country with which India has no agreement for relief against or avoidance of double taxation, but it is immaterial that tax paid in such a foreign country is in respect of income arising in another foreign country with which Indian has such an agreement

Bilateral Relief

Under Section 90, Indian government provides protection against double taxation by entering into a mutually agreed tax treaty (DTAA) with another country. Under bilateral relief, protection against double taxation is provided either by completely avoidance of overlapping tax or waiving a certain amount of the tax payable in India.

Bilateral relief is provided in section 90 and 90A of the Indian Income Tax Act.

Bilateral relief is provided through following methods:

Exemption Method

One method of avoiding double taxation is for the residence country to altogether exclude foreign income from its tax base. The country of source is then given exclusive right to tax such incomes. This is known as complete exemption method and is sometimes followed in respect of profits attributable to foreign permanent establishments or income from immovable property. Indian tax treaties with Denmark, Norway and Sweden embody with respect to certain incomes.

Credit Method

This method reflects the underline concept that the resident remains liable in the country of residence on its global income, however as far the quantum of tax liabilities is concerned credit for tax paid in the source country is given by the residence country against its domestic tax as if the foreign tax were paid to the country of residence itself.

Tax Sparing

One of the aims of the Indian Double Taxation Avoidance Agreements is to stimulate foreign investment flows in India from foreign developed countries. One way to achieve this aim is to let the investor to preserve to himself/itself benefits of tax incentives available in India for such investments. This is done through “Tax Sparing”. Here the tax credit is allowed by the country of its residence, not only in respect of taxes actually paid by it in India but also in respect of those taxes India forgoes due to its fiscal incentive provisions under the Indian Income Tax Act.

Objectives OF DTAA

Avoiding and alleviating the adverse burden of international double taxation, by –

1. Laying down rules for division of revenue between two countries;

2. Exempting certain incomes from tax in either country;

3. Reducing the applicable rates of tax on certain incomes taxable in either countries.

4. Tax treaties help a taxpayer of one country to know with greater certainty the potential limits of his tax liabilities in the other country.

5. Another benefit from the tax-payers point of view is that, to a substantial extent, a tax treaty provides against non-discrimination of foreign tax payers or the permanent establishments in the source countries vis-à-vis domestic tax payers.

DTAA Models :

There are Two major types of DTAA Model

1. OECD MODEL : OECD Models are generally adopted by developed nations and their emphasis is on the residency based taxation.

2. UN MODEL : UN Model emphasis is on the source based taxation and generally adopted by the developing nations.

There are also US model Convention & Indian Model Convention too.

Components of Tax Treaty

An analysis of any tax treaty would have the following components:

1. Date : The date on which it come into effect.

2. Applicability –Applies to a person who is resident of one or both the countries. “Resident” is defined under domestic law of different counties differently. Article 4 expects that it should based upon domicile, physical residence, place of management or such other criteria but makes it clear that where a person is a resident in both the countries, it is the location of the permanent home or where vital interests are located or where he is citizen, in that order, will decide the residential status. There may be cases, when it has been found that the assessee is resident in both the countries then tie-breaker rule has to apply to determine the residential status.

3. General Definitions –Article 3 of DTAA generally covers general definition of Person, Company, contracting state, Enterprise of a contracting state, Competent Authority, national etc, which all are applicable to the respective DTAA.

4. The Tax which it covers –What kind of tax the treaty covers should be known as there are different form of tax in different countries & the DTAA will provide the relief on the specified tax as mentioned in the DTAA.

5. Permanent Establishment and its parameters –

a. PE means a fixed place from where the business of the enterprise is carried on.

b. PE includes place of management, branch, office, factory, workshop, mine , quarry, an oil or gas well, a construction site for long duration, a service location for a long duration and a dependent agency with power to conclude contracts

6. Definitions : The definition of concepts like immovable property, dividend, business profits, royalty, technical fees, salaries etc.

7. Method of Relief : Stipulation as to the method of relief either by way of exempting income or where it is taxable, taxing it at stipulated rate, which may be lower than the domestic rate, or by unilaterally giving credit for tax paid in the other country.

8. Exchange of information with special reference to the concept of associated enterprises primarily to tackle diversion of income to avail treaty benefit or evasion of tax in one or the other country.

9. Provision for elimination of double taxation.

10. Other clauses to suit the requirement of the participating countries

Conclusion

Apart from relief to persons of a country where India has entered in Double Taxation Avoidance Agreement, there is relief given even in cases where the Government of India has not entered into DTA agreement with any foreign country. In such cases if any resident Indian produces evidences to show that, he has paid any tax in any country with which the Government of India has not entered into a DTA agreement, tax relief on that part of his income which suffered taxation in the foreign country, to the extent of tax so paid in such foreign country, or the tax leviable in India under the Income Tax Act on such income whichever is less shall be allowed as deduction u/s 91 while calculating his tax liabilities on such income.