Double Taxation Avoidance Agreements

A Double Taxation Avoidance Agreement (DTAA) is a treaty signed between two countries, which incentivizes and promotes the exchange of goods, services, and investment of capital by eliminating international double taxation. It is not a regulation to impose or determine tax rates but a comprehensive treaty between two sovereign states enumerating the detailed procedure and manner of taxation, with well-defined written terms and conditions to be strictly adhered to.

India’s DTAA regime covers a vast network of double tax treaties, which are supported by social security agreements, to provide tax relief. Collectively, these aim to prevent double incidence of taxation of income and ease social security obligations of international workers.

A DTAA, either bilateral or multilateral, arises in cases where there is:

• Global and source-based taxation
• Residency in two countries

Purpose of DTAAs

Globalization has resulted in the rapid growth of multinational companies operating across multiple jurisdictions, which have led to certain loopholes in the manner of taxing global income – creating incidence of double taxation.
Each country has its own international taxation laws, divided into two broad dimensions:

• Taxation of foreign income: Taxation of resident individuals and corporations on income arising in foreign countries.
• Taxation of non-residents: Taxation of non-residents on income arising domestically.

The implication is obvious that the taxation of foreign income for one country (resident country) is the same as the taxation of non-resident for another country (source country). This leads to dual taxation, the resident country taxing the income and the source country levying taxes on the same income.
To avoid this scenario, and to promote foreign investment ease flow of capital, governments enter such treaties with other countries. The need for DTAAs is as follows:

• Avoidance of double taxation of income
• Income tax recovery in both the countries
• Equitable, rational, and fair allocation of taxing rights over a taxpayer’s income between two countries
• Promotion and encouragement of free flow of international trade, investment, and technology
• Increased transparency

Supposing that there is one taxpayer (resident of Country X) operating in three countries i.e. Country X, Y & Z and each country has its own tax system and rights over the taxpayers.
Two types of Double Taxations arise:

• Economic Double Taxation: The same income is taxed in two countries in the same period in the hands of different taxpayers.
• Juridical Double Taxation: The same income is taxed in two countries in the same period in the hands of the same taxpayer.

To eliminate the effects of double taxation, double taxation avoidance agreements are in effect.

Canada and India - DTAA Agreement

The Government of Republic of India has comprehensive DTAA with the Government of Canada. This Agreement shall apply to persons who are residents of one or both of the Contracting States i.e. Canada or India. The Agreement contains 30 Articles that explain the different rules relating to Residence, Permanent Establishment and taxability of various sources of income.

DTAAs with India

A DTAA between India and other countries is drafted on a mutual basis and covers only residents of India and the residents of the negotiating country. Any person or company that is not a resident, either in India or in the other country that has entered into an agreement with India, cannot claim benefits under the signed DTAA.
From an investor’s perspective, confusion about international taxation can arise when investors are subject to two different and potentially conflicting tax systems. For example, Hong Kong and Singapore adopt a “territorial source” principle of taxation, which means that only profits sourced locally are taxable. Meanwhile, other countries, such as India and the United States are on the worldwide tax system, and resident enterprises can be required to pay tax on income sourced both inside and outside of the country. DTAAs not only provide certainty to investors regarding their potential tax liabilities, but also act as a tool to create tax efficient international investments.

Sources of Income considered under comprehensive Agreement and Limited Agreement

India has a vast network of DTAAs with other countries under Section 90 of the Income Tax Act, 1961. Currently India has established 94 comprehensive DTAAs (applicable to income sources arising from Services provided in India, Salary received in India, House property located in India, Capital gains on transfer of assets and Fixed deposits in India) and eight limited DTAAs (applicable to income sources arising from Operation of Aircrafts & ships, Estates, Inheritance & Gifts).

Applicability of DTAA provisions

Tax treaties are generally relieving in nature and do not impose tax. They are comprehensive agreements based on mutual understanding between two sovereign states and are well defined. In the case of ambiguity regarding provisions, the interpretation that is harmonious with the provisions of the Income Tax Act is adopted.

• When a treaty does not mention dispute and domestic law contains provisions regarding the same issue then provisions of domestic law will be considered.
• When a treaty contains certain provisions regarding a matter and domestic law does not the treaty will be what is in effect.
• When a treaty explains a particular provision and domestic law also contains the provisions regarding the same element then the Law which is beneficial for the assesse is to be considered.
• When a treaty contains the provisions and domestic law contains contradictory provisions regarding the same element then the treaty’s provisions will prevail over domestic law.

Tax relief mechanisms

The incidence of dual taxation can be avoided by various relief mechanisms. These are:

1. Bilateral relief

Section 90/90A of the Income Tax Act, 1961 contains provisions granting foreign tax credit under DTAA. When there is an agreement between two countries, relief is calculated according to mutual agreement between such countries. Either of the following methods can grant bilateral relief:

• Deduction method: The domestic country allows its taxpayer to claim a deduction for taxes, including income taxes, paid to a foreign government in respect of foreign source income. This method does not fully avoid double taxation but just saves tax by the amount equals to Foreign Tax Paid x Domestic Tax Rate.
• Exemption method: The domestic country provides its taxpayer with an exemption for foreign source income. This method is more favorable if tax rates in domestic countries are higher than the source country.
• Credit method:
  1. Ordinary credit: Domestic country gives either full or partial credit of taxes paid in the foreign country. This means that the taxpayer are taxed on the same sourced income and the tax is to be determined accordingly – but the taxpayer will pay lower amount of taxes to the extent of credit available.
  2. Underlying credit: In this method, the taxes paid on the profits from which the dividend is declared can be claimed as credit against the taxes payable on the dividend income.
• Tax sparing/holiday: To incentivize economic activities, various tax exemptions are given, which help the assesse limit its tax burden. For example, deduction under Section 80-IB of Income Tax Act, 1961 indicates that whenever the assesse is liable to taxation in their domestic country, a credit will be allowed for taxes paid in the foreign country. Due to tax exemption in such foreign territory, there will be no tax payment and no credit to the balance of taxpayer. Under this method, the domestic country will deem such exempt income as tax paid. Credit of this taxes paid in the foreign country will be allowed as credit in the domestic country.

2. Unilateral relief for Indian residents

Some countries provide relief of taxes paid in the source country without any treaty between those two countries. This kind of relief is unilateral relief. In India, unilateral relief from double taxation is provided to Indian residents under Section 91 of the Income Tax Act.

How can Non-resident Indians (NRI) claim benefit of DTAA?

Non-resident Indians residing in any of the DTAA countries can avail of tax benefits provided under DTAA by timely submission of the following documents every financial year within the due dates:

• Tax Residency Certificate (TRC): You need to submit TRC to claim benefits under DTAA. To obtain a TRC, you can approach the tax/government authorities of your current residence country, where you would get TRC certified, upon downloading form 10F.
• Form 10F: You need to submit form 10F to avail benefits under DTAA.
• Permanent Account Number (PAN): You also need to submit your PAN along with the above documents to get tax benefits.

How to apply for DTAA?

The process of application of DTAA involves a series of steps, involving the different types of provisions.

• Determine whether the issue is within the scope of the convention.
• Check that the treaty applies to the tax in issue – is it a tax listed in Article 2 (or a tax substantially similar to such a tax).
• Check that the treaty is in force for the taxable period in issue.

How is Double Taxation Avoidance Agreement relief calculated?

In case there is DTAA with the country, then Tax Relief can be claimed under Section 90.
Steps to compute Double Taxation relief:

• Step 1: Calculate Global Income i.e. aggregate of Indian income and foreign income
• Step 2: Compute tax on such global income as per the slab of tax rates applicable in India
• Step 3: Calculate the average rate of tax (i.e. Global income divided by the amount of tax)
• Step 4: Compute an amount by multiplying foreign income with such average rate of tax
• Step 5: Compute Tax paid in the foreign country

In case there is no DTAA, then Tax Relief can be claimed Under Section 91.
Steps to follow:

• Step 1: Compute tax payable in India
• Step 2: Compute lower of Indian rate of tax and rate of tax in foreign country
• Step 3: Multiply the rate obtained in Step 2 by the doubly taxed income.