Double Taxation Avoidance Agreements with India

Prepared By: Nishidh Patel

nishidh41@gmail.com

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Introduction

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.

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Double Taxation

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.

This arises from two basic rules that enable the country of residence as well as the country where the source of income exists to impose tax, namely,

Source 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 nonresident

Residence rule The residence rule stipulates that the power to tax should rest with the

country in which the taxpayer resides.

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.

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Double Taxation Avoidance Agreements or “DTAA”

International double taxation has adverse effects on the trade and services and on movement of capital and people. Taxation of the same income by two or more countries would constitute a prohibitive burden on the tax-payer.

The domestic laws of most countries, including India, mitigate this difficulty by affording unilateral relief in respect of such doubly taxed income (Section 91 of the Income Tax Act).

But as this is not a satisfactory solution in view of the divergence in the rules for determining sources of income in various countries, the tax treaties try to remove tax obstacles that inhibit trade and services and movement of capital and persons between the countries concerned. It helps in improving the general investment climate.

The double tax treaties (also called Double Taxation Avoidance Agreements or “DTAA”) are negotiated under public international law and governed by the principles laid down under the Vienna Convention on the Law of Treaties.

It is in the interest of all countries to ensure that undue tax burden is not cast on persons earning income by taxing them twice, once in the country of residence and again in the country where the income is derived. At the same time sufficient precautions are also needed to guard against tax evasion and to facilitate tax recoveries.

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Double Taxation

The Fiscal Committee of OECD in the Model Double Taxation Convention on Income and Capital, 1977,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’.

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.

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Necessity of Double Taxation Avoidance Agreements

The need and purpose of tax treaties has been summarized by the OECD in the ‘Model Tax Convention on Income and on Capital’ in the following words:

‘It is desirable to clarify, standardize, and confirm the fiscal situation of taxpayers who are engaged, industrial, financial, or any other activities in other countries through the application by all countries of common solutions to identical cases of double taxation’.

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Objectives of Double Taxation Avoidance Agreements

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.

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

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 taxpayers.

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Functions of DTAAs

DTAAs ensure that countries adopt common definitions for factors that determine taxing rights and taxable events. Crucial among these is the definition of a permanent establishment.

Most treaties also specify a Mutual Agreement Procedure (MAP) which is invoked when interpretation of treaty provisions is disputed.

To prevent abuse of treaty concessions, treaties increasingly incorporate restrictions and rules, such as a general anti-avoidance rule (GAAR), that allow tax authorities to determine if a transaction is only undertaken for tax avoidance or not.

Benefit limitation tests and controlled foreign corporation (CFC) rules also place limits on claims of residence in countries eligible for treaty concessions.

Exchange of tax information on either a routine basis or in response to a special request is provided for in most treaties to assist countries counter tax evasion.

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Salient Features of Double Taxation Avoidance Agreements (DTAAs) agreements between India &other countries

As of now there exists 84 Double Taxation Avoidance Agreements (DTAAs) between India & other countries.

These treaties are usually between countries with substantial trade or other economic relations. Most treaties are between pairs of developed countries while, of the balance, most are between developed and developing countries.

DTAAs

Provide reciprocal concessions to mitigate double taxation,

Assign taxation rights roughly in accordance with that “existing consensus” and

Largely though not rigidly follow the OECD Model Tax Convention or, for developing countries, the UN Tax Convention.

Recent treaties contain new clauses following the OECD Model Tax Conventions of 2005 to 2010 which extend areas of cooperation to administrative and information issues.

A typical DTA Agreement 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 express provision to the contrary is made in the agreement.

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DTAAs & relevant provisions of Income-Tax Act, 1961

Section 90 - Agreement with foreign countries or specified territories –Bilateral Relief Since the tax treaties are meant to be beneficial and not intended to put tax payers of a

contracting state to a disadvantage, it is provided in Sec. 90 that a beneficial provision under the Indian Income Tax Act will not be denied to residents of contracting state merely because the corresponding provision in tax treaty is less beneficial.

Section 90A - Double taxation relief to be extended to agreements (between specified Associations) adopted by the Central Government

Section 91 - Countries with which no agreement exists-Unilateral Agreements

Some Double Taxation Avoidance agreements provide that income by way of interest, royalty or fee for technical services is charged to tax on net basis.

This may result in tax deducted at source from sums paid to Non-residents which may be more than the final tax liability. The Assessing Officer has therefore been empowered under section 195 to determine the appropriate proportion of the amount from which tax is to be deducted at source.

There are instances where as per the Income-tax Act, tax is required to be deducted at a rate prescribed in tax treaty. However this may require foreign companies to apply for refund.

To prevent such difficulties Sec. 2(37A) provides that tax may be deducted at source at the rate applicable in a particular case as per section 195 on the sums payable to non-residents or in accordance with the rates specified in D.T.A. Agreements.

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Types of relief

1. Bilateral relief Under this method, the Governments of two countries can enter

into an agreement to provide relief against double taxation by mutually working out the basis on which relief is to be granted. India has entered into 84 agreements for relief against or avoidance of double taxation.

Bilateral relief may be granted in either one of the following methods:

a. Exemption method, by which a particular income is taxed in only one of the two countries; and

b. Tax relief methods under which, an income is taxable in both countries in accordance with the respective tax laws read with the Double Taxation Avoidance Agreements. However, the country of residence of the taxpayer allows him credit for the tax charged thereon in the country of source.

2. Unilateral relief This method provides for relief of some kind by the home country

where no mutual agreement has been entered into between the countries.

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Methods of Eliminating Double Taxation

1. 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.

2. 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.

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Methods of Eliminating Double Taxation

3. 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.

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.

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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.

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Components of Tax Treaty

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

1. 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 there is fixed abode 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.

a. In the case of individual his personal & economic ties determine his residential status.

b. In the case of others, it is the place of effective management.

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. The definition which will be applicable in both countries irrespective of domestic law, as for example on such vital issues as residence, which may be different from the residential statute in local law with greater stress on nexus between source & income, definition of certain categories’ like technical services etc.

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Components of Tax Treaty

6. 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.

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

8. Different ways of tax-sharing depending upon the residential statute, permanent establishment, fixed base or tax sharing with both countries giving agreed part of relief.

9. 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.

10. 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.

11. Provision for elimination of double taxation.

12. Provision for non- discrimination etc.

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

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Case Laws

UOI v. Azadi Bachao Andolan (Mauritius) Validity of CBDT Circular No. 786, providing that Mauritian tax residency certificate was

sufficient proof to avail benefits under Indo-Mauritius DTAA, upheld: Supreme Court

Aditya Birla Nuvo Limited v ADIT (Italy) Payment made by assessee to an Italian Company (GTA) for Deputing Certain

Technicians to India for Supervising erection of Machinery would not be chargeable to tax in India because person who rendered services were not present in India for required number of days as envisaged by article 5(j) of DTAA.

Microsoft Corporation vs. ADIT (USA) ITAT Delhi in the case of Microsoft Corporation held that payment made for grant of licence in respect

of Copy right by end user is taxable as royalty as per s.9(1)(vi),domestic tax legislation to override treaty provisions in case of irreconcilable conflict.

ADIT v. Chiron Behring Gmbh & Co KG (Germany) Royalty income earned by a resident of Germany from India has to be assessed to tax at

the rate of 10% as provided in Article 12 of DTAA.

Praxair Pacific Ltd In RE (Mauritius , 42 DTR (AAR) 177) Shares held by the applicant as investment in the books of accounts are treated as

capital asset. Applicant is not liable to be taxed in India on the proposed transfer of said shares to its wholly –owned subsidiary company in India in view of section 47 (iv) or under art 13 of India Mauritius treaties.

Hindustan Petroleum Corporation Ltd. vs. ADIT [(2010) 130 TTJ 518 (Mum.)] It is not necessary that unless a person be taxed in the UAE that person cannot claim the

benefits of Indo- UAE tax treaty in India, what is really relevant to see is whether or not the recipient was resident of the UAE.

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DTAAs in Recent News

India, Sweden sign protocol for amending double taxation avoidance pact

No progress in tax avoidance treaty revision with Mauritius: FM

India, Sri Lanka sign pacts on anti-terror, double taxation avoidance

Proposal to amend double taxation avoidance deal between Bangladesh and India cleared

Budget 2013: USIBC for a fair transparent tax environment

Registered FIIs take P-note route to avoid tax tangles

FinMin to make it easier for foreigners to prove tax residency

Govt postpones GAAR implementation by 2 years to 2016

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