Presentation-CA Jimit Devani - Credit Mechanism - 16 October 2013

Credit Mechanism- CTC International Tax Study circle

16 October 2013

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Whether Article 23 would deal with it?

Where each Contracting State subjects the same person to tax on his worldwide income or capital (concurrent full liability to tax)

X may be tax resident of State R1 and State R2;

State R1 and State R2 will seek to tax his global income

Conflict resolved by Article 4 (Resident) tie breaker test

Scenario 1 | Resident of two states


Where a person is a resident of Contracting State (State R) and derives income from, or owns capital in, the other Contracting State (State S or E) and both States impose tax on that income or capital

Conflict resolved by renunciation / sharing of the right Article 6 to 23

Scenario 2 | Resident of one state and source in other state

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Can both types of double taxation be dealt through a tax treaty?

Types of double taxation

Where the same income or capital is taxable in the hands of the same person by more than one state

Juridical double

taxationTwo different persons are taxable in respect of the same income or capital

Economic double

taxation

Methods of Elimination of Double Taxation

Draft for Discussion

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Types of double taxation relief

Elimination of double taxation

Non-treaty countries

Unilateral credit for residents

Section 91

Treaty countries

Bilateral credit Section 90 +

Article 23 of DTAA

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Treaty relief

Covers cases of juridical double taxation

Does not cover all cases of Economic double taxation

Article 23 of Model Convention - Methods of Elimination of Double Taxation.



Methods of credit

Methods of granting

credit

Exemption method

Article 23A

Full exemption

Exemption with

progression

Credit method

Article 23B

Full credit Ordinary credit


Exemption vs. Credit

Exemption method

Income exclusion i.e. State R does not tax the income

which may be taxed in State S

No overlapping of taxing rights

Credit method

Income inclusion However, State R gets only a

subsidiary right to tax

Credit available of tax paid in State S i.e. only additional amount of tax payable in

State R

Exemption method


Concept

Full exemption

Completely exempt in State R irrespective of rate of tax in State S

Most beneficial method for taxpayer

Exemption with progression

Exempt in State R Included for determining tax rate

on rest of income in State R Normally followed method


Source: OECD Commentary

Illustration | Facts

Total income 1,00,000Derived from State R 80,000Derived from State S 20,000Rate of tax in State R Income of 100,000 35%

Income of 80,000 30%Rate of tax in State S Case (i) 20% - tax on 20,000 4,000

Case (ii) 40% - tax on 20,000 8,000

Tax in State R (if no Convention) 35,000


Here, State R shall exempt 20,000 and tax only 80,000

Particulars Case (i) Case (ii)

Tax in State R @ 30% on 80000 (A) 24,000 24,000

Tax in State S @20% on 20000 (B) 4,000 8,000

Total taxes if DTAA (C) = (A) + (B) 28,000 32,000Tax in State R (Assuming no DTAA) (D) 35,000 35,000Total taxes if no DTAA (E) = (D) + (B) 39,000 43,000

Relief given in State R = (E) (C) 11,000 11,000

Illustration | Full exemption method



State R imposes tax on 80,000 at the rate of tax applicable to total income wherever it arises (1,00,000) i.e. @ 35%

Particulars Case (i) Case (ii)

Tax in State R @ 35% on 80000 (A) 28,000 28,000

Tax in State S @20% on 20000 (B) 4,000 8,000

Total taxes if DTAA (C) = (A) + (B) 32,000 36,000Tax in State R (Assuming no DTAA) (D) 35,000 35,000Total taxes if no DTAA (E) = (D) + (B) 39,000 43,000

Relief given in State R = (E) (C) 7,000 7,000

Illustration | Exemption with Progression


Credit method


Concept

Full credit

Credit in State R for entire amount No restrictions on credit

Ordinary credit

Proportionate tax credit Cannot exceed tax liability in State

R Normally followed method


Illustration | Facts

Total income 1,00,000Derived from State R 80,000Derived from State S 20,000Rate of tax in State R 35%Rate of tax in State S Case (i) 20% - tax on 20,000 4,000

Case (ii) 40% - tax on 20,000 8,000Tax in State R (if no Convention) 35,000Total Tax Case (i) 39,000

Case (ii) 43,000Source: OECD Commentary


Here, State R shall give credit of entire tax paid in State S irrespective of tax paid on the same income in State R

Particulars Case (i) Case (ii)Tax in State R @ 35% on 1,00,000 (A) 35,000 35,000Less: Tax in State S @ 20%/40% on 20,000 (B) 4,000 8,000Tax due (C) = (A)-(B) (if DTAA) 31,000 27,000Total taxes in State R (D) (Assuming no DTAA) 35,000 35,000Relief given in State R (D) (C) (under DTAA) 4,000 8,000

Illustration | Full credit method



State R allows deduction of tax in State S on the income from S, but in no case allows more than the portion of tax in State R attributable to the income from S (maximum deduction). The maximum deduction would be 35% of 20,000 = 7,000

Particulars Case (i) Case (ii)Tax in State R @ 35% on 1,00,000 (A) 35,000 35,000Less: Tax in State S @ 20% on 20,000 in case(i) and as above in Case (ii) (and not 40% of 20,000) (B)

4,000 7,000

Tax due if DTAA (C) = (A) (B) 31,000 28,000Total taxes 35,000 36,000Relief given in State R 4,000 7,000

Illustration | Ordinary credit method


Special Types of Tax Credit


Not found in model

convention but found in some

treaties

Credit is given for taxes that would have

been payable in State S

during the tax holiday period

Protects fiscal incentives

provided by a country

Usually, State R would

provide for deemed tax

exemption or deemed tax

credit

Tax sparing | Concept


Tax sparing | Illustration (1/2)

Total income 1,00,000Derived from State R 80,000Derived from State S 20,000Tax free income (incentives provided by State S) 5,000

Rate of tax in State R Income of 1,00,000 - 35%

Rate of tax in State S 20% - tax on 15,000 3,000

Facts:


Particulars Amount AmountTax in State R @ 35% on 1,00,000 35,000Less: Tax credit availableTax paid in State S (15,000 @20%) 3,000Tax Spared = 5,000 @ 20%, 1,000

4,000Tax due 31,000Total taxes 34,000Relief given in State R 4,000

Tax sparing | Illustration (2/2)


Underlying tax credit (UTC) | Concept

Available to company resident in State R

which receives dividend from company resident

in State S

Considers tax paid by company in State S

A form of relief from economic double

taxation

Computation methodology - Co-

relation of dividends to post tax profits of

subsidiary

Requirement of substantial shareholding


Company in State S Amount

PBT 3,00,000

Tax @ 30% 90,000

PAT 2,10,000

Dividend distribution 2,10,000

Company in State R holds 80% stake in Company in State S and receives dividend of 1,68,000 (210000@80%) from Company in State S

Tax deducted at source by State S 33,600 (168,000@20%); Net dividend received by Company in State R 1,34,400

Tax rate in State R 35% Assumption: Dividend Income is the only income of Company in State R and it has no deductible

expenses

UTC | Illustration (1/2)


Particulars AmountNet Dividend Income received in State R 1,34,400Add: Taxes withheld 33,600Gross Dividend Income 168,000Underlying tax credit = Gross Dividend / Distributable profits * Actual tax paid on those profits (1,68,000 / 2,10,000 * 90,000)

72,000

UTC | Illustration (2/2)



Indian Treaties usually follow the ordinary credit method of

granting tax credit

The only treaty where full credit is available Namibia

Treaties containing all the three methods of elimination of double taxation, viz. exemption, credit and tax sparing for different types of incomes Bulgaria Czechoslovakia Poland

Various treaties which provide for UTC in respect of dividend income

Indian tax treaties



Whether credit is available even if income is not subject to tax in State S?

Whether tax credit can be claimed in the year of payment in foreign country or in

the year in which income is offered for tax in the resident country ?

Whether relief u/s 91 can be taken in respect of incomes not covered within the

purview of DTAAs?

Whether tax credit available on interest or penal sums paid in foreign country?

Credit for Dividend Distribution Tax and Fringe Benefit Tax paid?

Certain Issues (1/2)



Whether credit can claimed against MAT paid in India?

Whether reliance can be placed upon the certificate issued by the revenue

authorities of State S?

How to claim credit in State R when there are profits / losses from one or more

foreign jurisdictions?

Certain Issues (2/2)

Whether credit can be claimed in case of different treatment given by State S?

Characterisation of income



Thank You

Jimit DevaniSenior Manager [email protected]+91 98207 51951

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Credit Mechanism- CTC International Tax Study circle16 October 2013Slide Number 2Slide Number 3Types of double taxationMethods of Elimination of Double TaxationTypes of double taxation reliefTreaty reliefMethods of creditExemption vs. Credit Exemption methodConceptIllustration | FactsSlide Number 13Slide Number 14Credit methodConceptIllustration | FactsSlide Number 18Slide Number 19Special Types of Tax CreditSlide Number 21Slide Number 22Slide Number 23Slide Number 24Slide Number 25Slide Number 26Slide Number 27Certain Issues (1/2)Certain Issues (2/2)Slide Number 30

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Presentation-CA Jimit Devani - Credit Mechanism - 16 October 2013