International juridical double taxation, generally defined as the imposition of taxes in two (or more) States on the same taxpayer of the same income, has harmful effects on the international exchange of goods and services, as well as cross-border movements of capital, technology and persons. In recognition of the need to remove this obstacle for the development of economic relations between countries, as well as for the importance of clarifying and standardising the fiscal situation of taxpayers who are engaged in activities in other countries, the DTAA was introduced.

Double Taxation Avoidance Agreement

DTAA is an agreement between two countries. DTAA agreements specify the jurisdiction of taxation in respect of any income (more notably in the nature of business profits, interest, dividend, capital gains, royalty and fees for technical services). Generally the country of residence of the person earning income is given the right to levy tax on any income arising out of the above categories from another jurisdiction. However, the source country from where the income is earned is also given the power to levy tax on certain incomes, with certain caveats and conditions. Generally the caveats are limitations in rates of tax and certain additional conditionality prescribed. The rate of taxation is on gross receipts without deduction of expenses.

Standard Treaties

DTAA is more or less standardised formats and have been reviewed and updated from time to time. Two international bodies play a pivotal role in development of DTAA:

1. Organisation for Economic Co-operation and Development (OECD): OECD Model treaty is essentially a treaty between two developed nations. This model advocates residence principle, in other words, it lays emphasis on the right of country of residence of person to tax.

2. United Nation: UN model Treaties are entered into between developed and developing nations.

Source Rule vs Residence Rule of Taxation

Most countries adopt residential status as the basis of taxation, but at times the source or territoriality principal is also adopted so as to tax the income in the country where it arises. The UN model has a slant on source principal and it is generally believed that it is more lenient towards developing countries than the OECD model. However OECD model is most widely used, as the developing countries who are also exporters of capital to the developing nations, like to tax global income of their tax residence. However, lot of negotiations are done before finalising tax treaties between two countries and everyone ensures fair share of income for their own country.

Type of Treaties In general, treaties can be categorised as, Compressive and Limited. Comprehensive DTAA covers almost all types of income as covered by any model convention such as Wealth Tax, Gift Tax, Estate or Inheritance Tax, Surtax etc. Whereas, Limited treaties cover only certain specific types of income like, profit from shipping and aircraft operations only.

Content of Tax Treaties Tax treaties comprise of various articles and can be comprised into various sections

(1) Section I: Persons covered, Taxes covered

(2) Section II: General definition, determining Resident status or Permanent Establishment

(3) Section III: Taxation of Income (Immovable property, Business profit, Shipping, Dividends, Interest, royalties Capital Gains, other income etc.)

(4) Section IV: Method of elimination of Double Taxation (Exemption Method - This ensures complete avoidance of tax overlapping. TAX Credit Method - This provides relief by giving the tax payer a deduction from the tax payable in India)

(5) Chapter V: Special provision (Mutual agreement procedure, Exchange of information)

Reading of Tax Treaties and Making Sense of It All

(1) When entering into any international transaction, it is best to first find out whether the two counties have signed a Compressive or Limited DTAA between them

(2) Most of the tax treaties have to be read in conjunction with local laws of the country with which they are dealing. When deciding the tax impact, you need to check both domestic laws and DTAA and apply whichever is beneficial

(3) DTAA is generally favourable as compared to local laws

(4) Steps for application of tax treaty:

(a) First Check if there is DTAA between India and the country with which you are contracting

(b) Whether the relief from tax you sought, is covered in DTAA

(c) Determine residential status as per treaty

(d) Go to the specific article which covers the income in question

(e) Apply the article and determine tax impact

(f) Check if the local law is more lenient as compared to DTAA

(g) Apply most beneficial provision

Treaty Mechanism or Actual Operation

 (1) When the resident of a country (say, India) has income taxable in another country – COS, say (UK), DTA will be invoked. The Indian resident understands that UK Income-tax department - HMRC (Her Majesty’s Revenue & Customs department), cannot levy full income-tax on his British income. Considering the category of his income, he will file appropriate income-tax returns and claim the relief. If his return is found to be correct, HMRC will accept his claim of DTA relief.

(2) The Indian Resident will also file his Income-tax return in India. He has to disclose his global income in his Indian return. This will include his UK income. From the Indian tax payable in India, he will claim credit for the taxes paid or payable in UK. If the Indian AO finds his claim to be correct, he will grant credit for the taxes paid or payable in UK.

(3) Normally, the assessee will end up paying tax at the higher, of the COS or COR rate. In other words, if the UK tax rate is higher, the Indian tax will be reduced to zero. If the UK tax is lower, balance will be paid in India.

 

Umesh Tela

Umesh Tela is Senior Manager with Finance & Accounts team, IL&FS Financial Services ( IFIN ), based at Mumbai
IFIN is a subsidiary of Infrastructure Leasing & Financial Services Limited ( IL&FS ), India




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