In the current era of cross-border transactions and constant growth of international trade and commerce, more and more residents of a country are extending their sphere of business operations into other countries. This has led to the need for assessing the tax regimes of various countries and bringing about essential reforms. International double taxation has adverse effects on trade, services, and on the movement of capital and people. Taxation of the same income by two or more countries would constitute a prohibitive burden on the tax-payer.
Therefore, to avoid such hardship to individuals and also with a view to ensuring that national economic growth does not suffer, the Central government under Section 90 of the Income Tax Act has entered into Double Tax Avoidance Agreements with other countries. The double tax treaties (also called Double Taxation Avoidance Agreements or “DTAA”) are negotiated under the public international law and governed by the principles laid down under the Vienna Convention on the Law of Treaties.
Objectives of DTAA:
- Protection against double taxation
- Prevention of discrimination in an international context
- Mutual exchange of information
- Legal and fiscal certainty
What is Double Taxation?
The Fiscal Committee of OECD defines double taxation as ‘the imposition of comparable taxes in two or more states on the same tax payer in respect of the same subject matter and for identical periods’.
It is a fundamental rule of law of taxation that unless otherwise expressly provided, income cannot be taxed twice. The possibility of double taxation occurs when the taxpayer is resident in one country but has a source of income situated in another country. Two basic rules come into play in such situations, the source rule, and the residence rule. The source rule holds that income is to be taxed in the country in which it originates irrespective of whether the income accrues to a resident or a non-resident, whereas the residence rule stipulates that the power to tax should rest with the country in which the taxpayer resides. If both rules were to apply simultaneously to a business and it was to suffer tax at both ends, the cost of operating on an international scale would become exorbitant.
International double taxation arises when various sovereign countries exercise their sovereign power to subject the same person to taxes of substantially similar character on the same income. There are three distinct classes of cases in which international double taxation may arise:
- The first and most important class includes those cases where double taxation is ‘due to co-existence of personal and impersonal tax liability’. Personal tax liability is based on the personal status of taxpayer i.e. his nationality, domicile, and residence whereas impersonal tax liability arises when a state claims tax on income earned or received within its territory without having regard to the personal status of the recipient. A person may be subjected to tax on the same income in one country on account of his personal status and in another because the source of his income is situated within the territory. Property may be taxed in the country where it is situated and also by the country where its owner resides.
- The second class includes cases of simultaneous personal liability of a person in various countries. This may arise when different countries apply different criteria to personal liability to tax or where the conditions of the same criteria are differently defined in different countries. One country may claim personal tax on account of nationality, and the other because of domicile or residence of the person concerned within its borders. A person who has his domicile in one and a residence in another may be liable to tax in the country of his domicile and that of his residence as well. He may reside in various countries and be liable to personal tax in each of them. Also, the same person may be claimed as domiciled or residents by different countries in each of which he fulfills the legal conditions of such personal status.
- The third class of double taxation arises when various countries apply different tests of impersonal liability. Double taxation of this kind may occur, for instance when the assets or activities, that produce a given income are situated elsewhere than in the country where the income is earned or from which it is due. Business transactions may be subjected to tax both in the country of their origin and of their completion. Tax on salaries and other remuneration for professional activities or employment may be demanded by the country where the act is performed, or where it is paid for, or where the employee or professional man resides or belong by nationality.
METHODS OF ELIMINATING DOUBLE TAXATION:
- 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 the 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 underlying 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 DTAA is to stimulate foreign investment flows in India from foreign developed countries. One way to achieve this aim is to let the investor avail 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 residents, 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. Thus, tax sparing credit is an extension of the normal and regular tax credit to taxes that are spared by the source country i.e. forgiven or reduced due to rebates with the intention of providing incentives for investments.
MODES OF RELIEF:
The solution to the problem of double taxation is to establish a method in which the individual’s whole income is taxed, but is taxed only once, and the liability is divided amongst the taxing territories according to relative interests of the taxpayer in each territory. This is brought about by treaties between the governments of two territories, i.e., bilateral relief. When relief is provided to one’s own national irrespective of reciprocity by the Government of the other authority, it is called unilateral relief.
- Unilateral relief:
Under this system of taxation, relief is given by way of a tax credit for the taxes paid abroad. The countries, which follow this method of the tax credit, are U.S, Greece, India, and Japan to name a few.
For example – 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:
- Where the foreign tax is equal to Indian tax, the full amount of foreign tax will be given credit.
- Where the foreign tax exceeds the tax payable in India, the liability to Indian tax will be nil. However, no refund in respect of the excess amount is allowed, and
- Where the foreign tax paid is less than the Indian tax after deducting the foreign tax would be payable by the taxpayer. The principle is that the credit allowable will never exceed the amount of Indian income tax, which becomes due or payable in respect of the doubly taxed income.
- Bilateral relief:
Bilateral relief is provided when the governments of two States enter into tax treaties which may take any one of the following two forms:
- The treaty may apply the exempting method, wherein the country in question refrains from exercising jurisdiction to tax a particular income.
- Alternatively, the treaty may provide relief from double taxation by reducing the tax ordinarily due to one or both of the contracting parties on that income which is subject to double taxation.
India has entered into a wide network of tax treaties with various countries all over the world to facilitate the free flow of capital into and from India. India has comprehensive DTAAs with 88 countries. Under the Income Tax Act 1961 of India, there are two provisions, Section 90 and Section 91, which provide specific relief to taxpayers to save them from double taxation. Section 90 is for taxpayers who have paid the tax to a country with which India has signed DTAA, while Section 91 provides relief to taxpayers who have paid tax to a country with which India has not signed a DTAA. Thus, India gives relief to both kinds of taxpayers. One can find the tax-sparing and credit methods for elimination of double taxation in most Indian treaties. A typical DTAA between India and another country covers only residents of India and the other contracting country who has entered into the agreement with India. A person who is not resident either of India or of the other contracting country cannot claim any benefit under the said DTA Agreement. Such agreement generally provides that the laws of the two contracting states will govern the taxation of income in respective states except when an express provision to the contrary is made in the agreement.
In India, Chapter IX of Income Tax Act, 1961 contains a provision relating to double taxation relief. Section 90 empowers the Central government to enter into an agreement (DTAA) with the Government of another country outside India for the specified objects. When such agreement does not exist relief is provided in Section 91.