INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

RELIEF FROM DOUBLE TAXATION

Presentation by: T.P.OSTWAL

26/07/2013 (c) T.P.Ostwal & Associates 1

SYNOPSIS

Causes of double taxation

What is ‘double taxation relief’ (‘DTR’)

Unilateral relief

Treaty relief

Credit method

Exemption method

Tax sparing

Underlying tax credit

Other methods for relieving double taxation

Some issues


CAUSES OF DOUBLE TAXATION… Rules of taxation

Article 265 of Constitution (Indian context)

[No tax shall be levied or collected except by authority of law.]

Sufficient nexus between subject and state. Residence rules

Source based rules

[Supreme Court Ruling- Ishikawajma-Harima Heavy Industries Ltd. vs. DIT (288 ITR 408)]

Taxation systems:

worldwide taxation system [eg. USA, UK, India, etc]

territorial taxation system [eg. HK]

modified territorial taxation system [eg. Singapore]26/07/2013 (c) T.P.Ostwal & Associates 3

… CAUSE OF DOUBLE TAXATION

Same income taxed twice

Residence in two states

Residence in state A and source in state B

Concept of:

Juridical double taxation

Economic double taxation

DTR:

Unilateral; or

Bilateral


UNILATERAL TAXATION RELIEF-INDIA S.91 OF ITA Resident in India only eligible for UTR

Income accrued outside India (say, in state ‘X’)

and

That income NOT deemed to accrue in India

No DTAA with state ‘X’ [providing for (a) relief or, (b) avoidance of, double taxation]

What about notified territories with which only exchange of information or assistance in tax collection treaty signed? Will they be out of section 91?

What about the countries with whom limited treaty exist [eg. India-Ethiopia] and subject income is not covered in treaty? Whether s.91 will rescue the case?

Tax paid in state ‘X’-federal, state or municipal

By deduction or otherwise

Relief from Indian income tax available

Relief only on “doubly taxed income”


Foreign source income

…UNILATERAL TAXATION RELIEF- INDIA Relief at

Indian rate of tax. or Rate of tax in state ‘X’


Whichever is lower

S. 91 Foreign Source Income ??


SBT BANK LtdIndia

SBT HK Branch

ABC LtdHK

Indian Customer

Indian Project Office

Loan for Indian project

Interest

HK income tax on interest income

Power project set up contract-Whether tax credit for HK corporate tax available?- Whether tax credit for Indian TDS, if any, available?

ILLUSTRATION…

CASE 1 CASE 2 Income in foreign state ‘A’ 100 100 Indian income 150 150 Global income 250 250 Tax rate in foreign state ‘A’ 25% 35% Tax rate in India 30% 30% Indian tax on global Income 75 75 Foreign tax on foreign income 25 35 Indian tax on foreign income 30 30


…ILLUSTRATION

CASE 1 CASE 2

DTR in India 25 30 Effective tax out go

In State ‘A’ 25 35 In India 50

45 Total income tax paid 75

80


Effective global tax rate 30% 32%

TREATY RELIEF

Article 23 of MC- “ Methods of Elimination of Double Taxation”.

Article 23A : Exemption Method

Article 23B : Credit Method

Credit subject to the restriction and limitation of the domestic tax laws

Covers cases of “juridical double taxation”

[same income taxed in the hands of same person by more than one state]

Does not cover all cases of “Economic double taxation”

[same income taxed in the hands of different persons by different states]

MAP is remedy for economic double taxation ??26/07/2013 (c) T.P.Ostwal & Associates 10

INTERNATIONAL JURIDICAL DOUBLE TAXATION

Concurrent full liability to tax ( e.g. residence in both states)

Residence of state R taxed in state R on residence rules and taxed in state S on source rules

PE situations-NR in both states.

(Concurrent limited tax liability)


TREATY PROVISIONS

“Shall be taxable only”(normally) in state R

No DTR required

“May be taxed” ( in state S)

DTR required to be given by state R

Article 23 provides rules for DTR by state R and not by state S.


EXEMPTION METHOD

‘R’ does not tax income which “may be taxed” in S.

‘R’ does not tax income which “shall be taxable only” in S

Two Methods:

Income taxed in S not taken into account at all by R

(full exemption method)

Income taxed in S not taxed by R, but R takes into consideration the income for tax rate purposes (exemption with progression)

Effective only where progressive rates of taxes exist, mostly in case of individuals


CREDIT METHOD…

State ‘R’ includes the income earned in State S for computing total tax liability in State R

Out of the total tax liability in state ‘R’, credit is given for tax paid in S


…CREDIT METHOD…

Two approaches:

‘R’ allows deduction of total amount of tax paid in ‘S’

(Full Credit Method)

‘R’ allows deduction restricted to that part of tax payable in ‘R’ which is appropriate to the income earned in ‘S’

(Ordinary Credit Method)


…CREDIT METHOD

Exemption Method = income exclusion V/s.

Credit Method = tax credit .


ILLUSTRATIONS Income from ‘R’ 80,000

Income from ‘S’ 20,000

Total Income 1,00,000

Rate of Tax in R :

On 80,000 30%

On 1,00,000 35%


…ILLUSTRATIONS…

Rate of Tax in S :

Case I : 20%

Case II : 40%

Assume no DTAA relief /no Unilateral relief.

Total Tax Liability:

Case I : (R)35,000 + (S) 4,000=39,000

Case II: (R)35,000 + (S) 8,000= 43,000


FULL EXEMPTION METHOD

CASE I CASE II

Tax in R (30% of Rs 80,000) 24,000 24,000

Tax in S (20 or 40% of 20K) 4,000 8,000

Total global tax 28,000 32,000

(Notional) DTA relief 11,000 11,000

39,000 43,000


In full exemption method, rate of tax in foreign jurisdiction does matter

EXEMPTION WITH PROGRESSION

CASE I CASE II

Tax in R(35% of Rs 80,000) 28,000 28,000

Tax in S 4,000 8,000

Total tax 32,000 36,000

(notional) tax relief 7,000 7,000

39,000 43,000


In ‘exemption with progression’, level of foreign source income matters in addition to foreign tax rate.

CREDIT METHOD (FULL CREDIT METHOD)

CASE I CASE II

Tax due in R(35% of 1,00,000) 35,000 35,000

Tax due in S 4,000 8,000

Tax credit:

Total tax payable in State R 35,000 35,000

Foreign tax credit by R (full) 4,000 8,0008,000

Final tax payable in R 31,000 27,000


In ‘full tax credit’, total amount of foreign taxes is credited to the extent does not exceed overall state R taxes.

CREDIT METHOD (ORDINARY CREDIT-simplistic illustration) CASE I CASE II

Tax in R(35% of 1,00,000) 35,000 35,000

Tax in S 4,000 8,000

Tax credit:

Total tax payable in state R 35,000 35,000

State R tax on foreign source income 7000 70007000

Qualifying tax credit 4000 7000

Final tax payment in state R 31000 28000


In ‘ordinary tax credit’, tax credit is restricted to state R tax or foreign tax on foreign income whichever is lower. Excess FTC?

ORDINARY CREDIT METHOD LIMITATIONS:

Usual restrictions:

item or source basis

per category basis

averaging of foreign taxes on income falling in same category

per country basis

averaging of foreign taxes on incomes arising in single country

worldwide or overall limitations averaging of foreign taxes on all foreign source income


…Ordinary Credit Method:Limitations: Effect of Country R ‘Source Rules’.

Effect of Country R ‘tax computation rules’

Effect of Country R ‘expense allocation rules’


UNDERLYING TAX CREDIT

Concept:

A form of relief from ‘Economical Double Taxation’.

Computation Methodology

Co-relation of dividends to post tax profits of subsidiary

Effect of exchange rates

Requirement of substantial shareholding

Also applied under CFC regulations

India’s tax treaty with Singapore and Mauritius provide for underlying tax credit.

Some countries specify upto how many layers, UTC can be claimed

UTC under national tax law – eg. Singapore, UK, Mauritius etc.


TAX SPARING …

Not found in MC -but found in some treaties.

Generally, national tax laws of countries not provide for Tax Sparing; only treaty may provide for same.

Exception: national tax credit rules of Mauritius.

Income exempt in ‘S’ for some reasons

(like economic development etc)

Income taxable in ‘R’

‘R’ provides for deemed tax exemption or deemed tax credit.


…TAX SPARING

Generally attached to income like:

Dividend

Royalty

Foreign branch / PE income

Interest

May provide for more or less than the Country S tax waived(e.g. India-Cyprus on interest @ 10%, Cyprus=> India: dividend @10%)

Source country taxes spared are not grossed up (No Phantom Grossing up)


Other Methods

Expense deduction for foreign tax

Carry forward / backward of excess tax credit

Countries have exhaustive foreign tax credit rules.


Microsoft Office Word 97 - 2003 Document

26/07/2013 (c) T.P.Ostwal & Associates| 29

Some issues

Date: 18th May 2007 (c) T.P. Ostwal

Some issues

Qualifying foreign taxes?

Same or similar taxes

Taxes on income

What if foreign taxes are paid on presumptive basis?

Whether foreign taxes to be grossed up in case of underlying tax credit?...tax sparing?

Whether foreign taxes can be claimed as tax deductible expense?

Issues concerning source of income?

Section 91

Tax treaty26/07/2013 (c) T.P.Ostwal & Associates 30

..some issues

Amount of maximum tax credit?

How to quantify residence country tax on foreign source income?

What if tax exemptions or deductions exist on foreign source income?

Average rate to be applied?

Issues related to allocation of expenses to foreign source income?

Issues connected with underlying tax credits:

Upto how many layers?

How to compute?

Level of shareholding?

Proof of foreign taxes?26/07/2013 (c) T.P.Ostwal & Associates 31

..some issues

Whether accrued foreign tax but not paid, can be claimed as foreign tax credit?

What if there is change in foreign tax liability subsequently?

Additional liability

Refund of foreign taxes

What exchange rate to be applied for conversion of foreign taxes into Indian rupees?

Carry back or carry forward of foreign tax credit?

Whether excess foreign tax credit can be claimed as expenses?

Whether tax credit can be claimed for interest and / or penalty or fine paid in foreign country?


…some issues

ESOPs Perquisites in state ‘A’ in year of exercise Capital Gains in state ‘B’ in year of sale



[Agreement with foreign countries or specified territories.1490. (1) The Central Government may enter into an agreement with the Government of any country outside India or specified territory outside India,— (a) for the granting of relief in respect of— (i) income on which have been paid both income-tax under this Act and income-tax in that country or specified territory, as the case may be, or (ii) income-tax chargeable under this Act and under the corresponding law in force in that country or specified territory, as the case may be, to promote mutual economic relations, trade and investment, or (b) for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country or specified territory, as the case may be, or (c) for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this Act or under the corresponding law in force in that country or specified territory, as the case may be, or investigation of cases of such evasion or avoidance, or (d) for recovery of income-tax under this Act and under the corresponding law in force in that country or specified territory, as the case may be,and may, by notification in the Official Gazette, make such provisions as may be necessary for implementing the agreement.(2) Where the Central Government has entered into an agreement with the Government of any country outside India or specified territory outside India, as the case may be, under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.(3) Any term used but not defined in this Act or in the agreement referred to in sub-section (1) shall, unless the context otherwise requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning as assigned to it in the notification issued by the Central Government in the Official Gazette in this behalf.Explanation 1.—For the removal of doubts, it is hereby declared that the charge of tax in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable, shall not be regarded as less favourable charge or levy of tax in respect of such foreign company.Explanation 2.—For the purposes of this section, “specified territory” means any area outside India which may be notified14a as such by the Central Government.]

Sec. 90 of ITA

Sec. 91 of ITA Countries with which no agreement exists. 1791. (1) If any person who is resident in India in any previous year proves that, in respect of his income which accrued or arose during

that previous year outside India (and which is not deemed to accrue or arise in India), he has paid in any country with which there is no agreement under section 90 for the relief or avoidance of double taxation, income-tax, by deduction or otherwise, under the law in force in that country, he shall be entitled to the deduction from the Indian income-tax payable by him of a sum calculated on such doubly taxed income18 at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal.

(2) If any person who is resident in India in any previous year proves that in respect of his income which accrued or arose to him during that previous year in Pakistan he has paid in that country, by deduction or otherwise, tax payable to the Government under any law for the time being in force in that country relating to taxation of agricultural income, he shall be entitled to a deduction from the Indian income-tax payable by him—

(a) of the amount of the tax paid in Pakistan under any law aforesaid on such income which is liable to tax under this Act also; or (b) of a sum calculated on that income at the Indian rate of tax; whichever is less. (3) If any non-resident person is assessed on his share in the income of a registered firm assessed as resident in India in any previous

year and such share includes any income accruing or arising outside India during that previous year (and which is not deemed to accrue or arise in India) in a country with which there is no agreement under section 90 for the relief or avoidance of double taxation and he proves that he has paid income-tax by deduction or otherwise under the law in force in that country in respect of the income so included he shall be entitled to a deduction from the Indian income-tax payable by him of a sum calculated on such doubly taxed income so included at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal.

Explanation.—In this section,— (i) the expression “Indian income-tax” means income-tax 19[***] charged in accordance with the provisions of this Act; (ii) the expression “Indian rate of tax” means the rate determined by dividing the amount of Indian income-tax after deduction of

any relief due under the provisions of this Act but before deduction of any relief due under this 20[Chapter], by the total income; (iii) the expression “rate of tax of the said country” means income-tax and super-tax actually paid in the said country in accordance

with the corresponding laws in force in the said country after deduction of all relief due, but before deduction of any relief due in the said country in respect of double taxation, divided by the whole amount of the income as assessed in the said country;

(iv) the expression “income-tax” in relation to any country includes any excess profits tax or business profits tax charged on the profits by the Government of any part of that country or a local authority in that country.26/07/2013 (c) T.P.Ostwal & Associates 35

THANK YOU


T.POSTWAL

[email protected]+919004660107

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INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA