Double Taxation Avoidance Scheme – An Outline
For an individual who is a Non-Resident Indian (NRI) working in a country outside India, DTAA or Double Taxation Avoidance Agreement would help in avoiding the payment of double tax on the income earned by him in both the country of residence and India. India has signed DTAA with around 80 countries or more around the world which makes it easy for the citizens and NRIs to earn income anywhere in the world and avoid paying double tax on the same which otherwise would add-up to the cost of the individual on the income earned.
Understanding Double Taxation Avoidance Agreement
DTAA is nothing but a treaty which is entered into, between India and another country or may be more than 2 countries such that the taxpayers can avoid the payment of double taxes on income earned by them from source country and the country of residence. And the need for such an agreement or treaty has arisen due to the imbalance that is existing with respect to the tax collection on the global income.
Say, a person who is holding shares or share of profit from a business in USA, but is residing in India. As he is a resident in India, the global income of such assessee shall be taxed in India as per the provisions of the Income Tax Act. And the same shall also be taxable in the country of source which here is USA. Hence, the assessee will have to pay double tax on such income earned i.e., with rest to country of residence and the country of source of such income. But DTAA will help in avoiding this double taxation and payment of double tax on such income.
DTAAs with India
India has formed a good network of DTAAs with various countries in accordance with section 90 of the Income Tax Act. At present they have formed 94 comprehensive DTAAs and 8 limited DTAAs. Comprehensive Agreements address all sources of income, while the scope of limited agreement is limited to certain specific sources of incomes like:
- Income from Operation of Aircrafts and Ships,
- Inheritance, and
The income sources of comprehensive agreement would include the following:
- Services provided in India,
- Salary received in India,
- House Property located in India,
- Capital gains on the transfer of assets in India,
- Fixed Deposits in India.
It should be noted that DTAA between India and such other country is drafted on reciprocal basis and would cover only the residents of India and the person of the negotiating country. So, any country or a person who is not a resident in either India or the negotiating country cannot claim the benefits under the signed DTAA.
Purpose of DTAA
With globalization there was a rapid increase in the number of the multinational companies which are operating across countries. This have led to various loopholes in the manner in which global income is taxed. Every country is having its own International Taxation Laws and this will be divided into two broad dimensions:
- Taxation of foreign income: It is which is taxation of resident individuals and corporations on income which is arising in foreign countries.
- Taxation of non-residents: It is on the incomes which are arising domestically.
As stipulated before, the taxation of the income arising from one country is taxable in another country on the basis of source and resident country. And this leads to double or dual taxation on the income. For avoiding this, and promoting the foreign investment, governments enter into DTAA with other countries. The major purposes of DTAA have been given below:
- It will avoid double taxation of income,
- The Income Tax recovery in both the countries,
- Equitable, rational and fair allocation of taxing rights with regard to the income earned by an assessee with respect to the source country and the country of residence,
- There will be an increased transparency with respect to earnings,
- There will also be a promotion of investment, technology advancement and international trade flow.
Tax Relief Mechanisms
The dual or double taxation can be avoided through various relief mechanisms, which are discussed below:
This is coming under section 90 or 90A of the Income Tax Act and it grants foreign tax credit under DTAA. Here with the mutual agreement or DTAA, the tax calculation shall also be done in accordance to mutual agreements between such countries. Following are the methods which can be used for the same:
- Deduction Method, allows the assessee to claim deductions for taxes like income taxes which are paid by the assessee to the foreign government with respect to the foreign sourced income earned by them. Though this method does not avoid double taxation, it will help the assessee save tax based on the amount of tax paid by the assessee in the foreign country.
- Exemption Method, is the one which provides, the tax payer or the assessee with an exemption for foreign source of income and would become beneficial for the assessee if the tax rates in the domestic country are high when compared to the foreign country or the source country.
- Credit Method, includes the ordinary credit and underlying credit. Under the ordinary credit, either full or partial credit for taxes paid in the foreign country will be provided by the domestic country. The assessee will be taxed twice on the income earned but will pay only lower amount of taxes as the credit available shall be deducted from the same.
While in the underlying credit, the taxes paid on profits from which dividend is declared shall be claimed as credit against the taxes which are payable on the dividend income earned by the assessee.
- Tax Sparing/Holiday, is the tax exemptions of various kinds which are given to the assessee for limiting the tax burden. Section 80-IB deduction of Income Tax Act can be taken as an example. When an assessee is liable to pay tax on the income earned in the domestic country, the same tax will be allowed as credits for taxes paid in foreign country. But in certain circumstances there will be tax exemptions provided in the foreign territory, there won’t be any tax payment or credit balance provided to the tax payer. So, the domestic country will deem such exempt income as paid and the credit for the same shall be allowed in the domestic country as they are deemed to be paid in the foreign territory or the foreign country.
Unilateral Relief for the Indian Residents
This includes the relief which are provided by certain source countries with respect to the taxes paid in the source country despite of not having a treaty between the two countries. This relief is known as unilateral relief and India provides the same to the Indian Residents by virtue of section 91 of the Income Tax Act.
There are also various SSAs or Social Security Agreements which are entered into by India for easing the social security obligations on cross boarder or international workers. The incentives include:
- Exportability of pension,
- Totalization of benefits,
- Withdrawal of social security benefits.
DTAAs are entered into by countries for making it beneficial for the tax payers, which are also done with an intention to not cause any loss to the government as well. So, every tax payer should utilize such arrangements and abide by the same for a mutually beneficial tax payments.