DTAABy – Akhilesh shuklaCA Final

SYNOPSIS IntroductionConcept of Double TaxationDTAASec 90 & 91 of IT Act 1961,WHY DTAATreaty OverrideComposition of DTAAMethods of elimination of Double TaxationDouble Non TaxationAsseesse’s Approach to DTAASome Practical issue’s

Double TaxationThose who are migrating to other countries to earn a living have to pay taxes in their country of residence as per prevalent taxes laws of the country. However, it is quite likely that these people have certain investments in their home country, India, and they are liable to pay taxes on gains made from such investments in India. So far this is fine and surely acceptable to all concerned.

The problem arises when they are told that as per the globally accepted norms, if a taxpayer is resident in one country buthas a source of income situated in another country, there is a situation at hand where his income is taxed in both countries, or Double Taxation occurs

CONCEPT OF DOUBLE TAXATION JURISDICTIONAL DOUBLE TAXATION - One

and the same person is taxed on the same income in more than one state. This may happen for one of the following reasons:

Residence in one state and source in another state

Triangular taxation ECONOMIC DOUBLE TAXATION - Two

separate persons are taxed on the same income in more than one state

Foreign income taxed in the hand of overseas company distributing dividend and dividend taxed in the hands of shareholder

Taxation in source country in the hands of a partnership entity whereas in the residence county, partners of such partnership are taxable

Hence need for elimination of Double taxation!

DOUBLE TAXATION AVOIDANCE AGREEMENT

Definition - It is a formally concluded & ratified agreement between two independent (Bilateral treaty) or more than two independent (Multilateral treaty) nations on matter concerning taxation.

These treaties are based on the general principles laid down in the model draft of the Organisation for Economic Cooperation and Development (OECD) with suitable modifications as agreed to by the other contracting countries.

KINDS OF DTAA

There are different models for DTAA are available but agreement are categorised on the basis of scope

Comprehensive agreement : Scope addressed to all sources of income

Illustratively : USA,UK

Limited agreement : Scope only cover : Illustratively : Lebanon , Pakistan

Income from operation of aircrafts & Ships

Estates Inheritance Gifts

Sec - 90  (1) The central govt. may enter into an agreement with the govt. of any country outside India,-For the granting of relief orFor the avoidance of double taxation of income for the prevention of evasion or avoidance of income-taxfor recovery of income-tax (2) Where the Central Government has entered into an agreement, under sub-section (1) for granting relief of tax then the provisions of this Act shall apply to the extent they are more beneficial to that assesse.

DTAA PROVIDES BILATERAL RELIEF TO THE ASSESSE UNDER SECTION – 90 OF INCOME TAX

ACT, 1961

WHAT IF THERE IS NO DTAA BETWEEN TWO COUNTRIES ?

THEN ASSESSE CAN GET UNILATERAL RELIEF UNDER SECTION – 91 OF

INCOME TAX ACT, 1961Requirements : There is no DTAA with that country Income has accrued or arisen outside India and is

doubly taxed Taxes have been paid in the source country Items of Income not covered under DTAA eligible

for credit

Reliefs : Deduction from the Indian income-tax payable by

him of a sum calculated on such doubly taxed income at the Indian rate

of tax, OR

the rate of tax of the said country,

Whichever is the lower, OR The Indian rate of tax if both the rates are equal

Particulars Case I Case II

Assumptions (INR) (INR)

Income in India 150,000 150,000

Income in foreign country 100,000 100,000

Global income 250,000 250,000

Tax rate in India 30% 30%

Tax rate in foreign state 25% 35%

Workings

Income tax on global income (A)

75,000

75,000

Indian tax on foreign income (B) 30,000 30,000

Foreign tax on foreign income (C) 25,000 35,000

Unilateral tax relief as per the Act – Lower of (B) or (C) (D) 25,000 30,000

Tax payable in India (A) – (D) (E) 50,000 45,000

Total tax outflow (B) + (E) 75,000 80,000

Effective global tax rate 30% 32%

UNILATERAL RELIEF – ILLUSTRATION

WHY DTAA ?Free flow of international trade and investment.Protection against double taxationPrevent discrimination between tax payersMutual exchange of informationLegal and fiscal certaintyAcceptable basis to share tax revenue between

statesEncourage transfer of technologyEncourage settlement of international disputes

by arbitration

TREATY OVERRIDE

The DTAA override the provisions of the domestic statute. Moreover, with the insertion of

Sec.90 (2) in the Indian Income Tax Act,

Assessee can avail benefit of bilateral agreements between contracting state;

ORAssessee can choose to be governed by Indian tax laws

Whichever is more beneficial to tax-payer !!

IMPORTANT TERMS FOR TREATY

Contracting State - country which enters into Treaty

State of Residence- Country where a person resides

State of Source- Country where income arises

Enterprise of a Contracting State- Any taxable unit (including individuals of a Contracting State)

Permanent Establishment - A fixed base of an enterprise in the state of

Source (usually a branch of a foreign company and in some cases wholly – owned subsidiaries as well)

Income arising in Contracting state - Income arising in a State of a source

COMPOSITION OF DTAA/TREATY

Article No

Heading Content

1. Scope of the Convention

To whom applicable?

2. Taxes covered Specific taxes covered3. General definition Persons, company enterprises,

international traffic, competent authority

4. Resident ‘Residence’ of a contracting state who can access treaty

5. Permanent Establishment

What constitutes P.E.?What does not constitute P.E?

6. Income from Immovable Property

Immovable property and income there from

7. Business Profits Determination and taxation of profits arising from business carried on through P.E.

Article No

Heading Content

8. Shipping, Inland waterways & Air Transport

Place of deemed accrual of profits arising from activities and mode of taxation thereon

9. Associated Enterprises

Enterprises under common management and taxation of profits owing to close connection (other than transactions of arm’s length nature )

10. Dividend Definition and taxation of dividends;Concessional rate of tax in certain situations;

11. Interest Definition and taxation of interest;Concessional rate of tax in certain situations;Taxation of interest paid in excess of reasonable rate, on account of specialrelationship;

12. Royalties Definition of Royalties- what it includes and covers, and its taxation;Treatment of excessive payment of royalties due to special relationship;Country where taxable.

Article No

Heading Content

13. Capital Gains Definition- Taxation aspect;Concessional rates/exemption from tax if any;Country where taxable.

14. Independent Personal Services

Types of services covered;Country where taxable.

15. Dependent Personal Services

DefinitionCountry where taxable.

16. Directors Fees and Remuneration for Top Level Managerial official

DefinitionMode of Country where taxable.

17. Income earned by entertainer and athletes

Types of activities covered;Mode of Country where taxable.

18. Pension and social security payments

Country where taxable.

19. Remuneration and pensions in respect of government services

Types of remuneration and Country where taxable.

Article No

Heading Content

20. Payment received by students andapprentices

Taxation / Exemption of payments received by student and apprentices.

21. Other Income Residual Article to cover income not covered under other ‘Articles’, mode oftaxation and country where taxable

22. Capital (Tax on wealth)

Definition – made – and country where taxable

23. Method of elimination

Exemption Method / Credit Method

24. Non Discrimination (Equitable) Basis of taxing Nationals and citizens of foreign state

25. Mutual Agreement Procedure

Where taxation is not as per provisions of the convention, a ‘person’ maypresent his case to Competent Authorities of respective states.Procedure in such cases

26. Exchange of Information

Competent Authorities to exchange information for carrying out provisionsof the convention.Methodology.

Article No

Heading Content

27. Assistance in collection of taxes

28. Diplomatic agents and Consular corps (Officers)

Privileges of this category to remain unaffected

29. Territorial Extension

30. Entry into force Effective date from which convention comes into force;Assessment year from which it comes into force.

31. Termination Time – Notice period – Mode.

ELIMINATION DOUBLE TAXATION AS PER DTAA

OECD Model Convention –Article 23 Article 23 deals with the Treaty relief from double taxation

where the same income or capital is taxed by more than one state under the Treaty

As the prior taxing rights remain with the source state, the relief provisions apply to the residence state only.

Residence state to elect from the following methods: Exemption method (Article 23A) which considers

‘income’ Credit Method (Article 23B) which considers ‘tax’ A contracting state may also use a combination of the

two methods.

UN Model Convention – Article 23 UN Model also specifies ‘Exemption Method’ (Article 23A)

and ‘Credit Method’ (Article 23B) to be adopted by residence state.

The UN Committee provides for investment incentives through tax sparing credits.

Countries, remain free to adopt these investment incentives

BILATERAL RELIEF – METHODS

Methods

Exemption

Exemption with progression

Credit

Full credit Tax sparingOrdinary Credit

Underlying tax credit

Full exemption

EXEMPTION METHOD UNDER THIS METHOD, THE RESIDENCE COUNTRY

EXEMPTS THE INCOME ARISING IN THE SOURCE COUNTRY

INCOME WOULD BE CHARGEABLE TO TAX ONLY IN THE SOURCE COUNTRY

GENERALLY PREFERRED IN DTAAS BETWEEN A DEVELOPED COUNTRY AND DEVELOPING COUNTRY, AS THE DEVELOPED COUNTRY WOULD GENERALLY BE EXPORTING CAPITAL AND TECHNOLOGY TO DEVELOPING COUNTRY

TWO VARIANTS –

FULL EXEMPTION – THE RESIDENCE COUNTRY FULLY EXEMPTS THE

INCOME EARNED BY ITS RESIDENT IN THE SOURCE COUNTRY. ACCORDINGLY THE CAPITAL / TECHNOLOGY EXPORTER WOULD NOT BE REQUIRED TO PAY TAX ON SUCH INCOME WHICH WOULD MAKE IT ATTRACTIVE FOR THE EXPORTER TO EXPORT CAPITAL/ TECHNOLOGY TO THE SOURCE COUNTRY (EG ARTICLE XVII OF INDIA – GREECE DTAA)

EXEMPTION WITH PROGRESSION – THE RESIDENCE COUNTRY

EXEMPTS THE SOURCE COUNTRY INCOME BUT THE EXEMPT INCOME IS CONSIDERED FOR DETERMINING THE TAX ON THE NON-EXEMPT INCOME (EG ARTICLE 23 OF INDIA – AUSTRIA DTAA)

EXEMPTION METHOD - CONCERNS

REDUCES THE TAX SHARE OF RESIDENT STATE

ENCOURAGES USE OF LOW-TAX COUNTRIES AS SOURCE STATE

MAY RESULT IN DOUBLE NON-TAXATION (EXPLAINED LATER) WHERE SOURCE COUNTRY EXEMPTS SUCH INCOME

UNDER THIS METHOD, THE RESIDENCE COUNTRY EXEMPTS THE TAXES PAID IN THE SOURCE COUNTRY

FOR THE RESIDENCE COUNTRY, THE LOSS OF REVENUE IS GENERALLY LOWER IN CREDIT METHOD, THEREFORE GENERALLY MOST DTAAS RELIEVE DOUBLE TAXATION ONLY THROUGH CREDIT METHOD

NON-REFUNDABLE TAX CREDIT – IN CASE THE TAX PAYABLE IN RESIDENT STATE IS LESS THAN THE CREDIT AVAILABLE OR THE RELEVANT INCOME IS EXEMPT IN RESIDENT STATE, THE RESIDENT WOULD NEVER GET REFUND OF THE EXCESS CREDIT FOR THE TAXES PAID IN SOURCE STATE

CREDIT METHOD

Four variants Full credit – Resident state grants credit for the

taxes paid in the Source State without any restriction

Ordinary credit – Tax credit is restricted to lower of the taxes to be paid in the Resident state or the actual taxes discharged in the Source state

Tax sparing – Income exempt in the Source state. However such income is taxable in the Resident state for which the resident state provides for deemed tax exemption or deemed tax credit

Underlying tax credit – Mechanism to eliminate a form of ‘economic double taxation’

TAX SPARING METHOD SOURCE COUNTRY OFFERS TAX INCENTIVES TO INVESTORS WITH NIL OR REDUCED TAX RATE WHICH RESULT IN REDUCED OR NO TAX PAYABLE IN THE SOURCE COUNTRY.

A NOTIONAL TAX CREDIT IS GRANTED IN THE RESIDENT COUNTRY FOR THE TAX NOT PAID UNDER SPECIAL INCENTIVE SCHEMES/ALLOWANCES IN THE SOURCE COUNTRY.

GENERALLY ATTACHED TO INCOME LIKE DIVIDEND, INTEREST, ROYALTIES, FOREIGN BRANCH / PERMANENT ESTABLISHMENT INCOME

TREATY PRESCRIBES EXACT NATURE OF SUCH TAX FREE INCOME; • E.G. INDIA-US- SEC 10A INCOME

ABSENCE OF TAX SPARING CLAUSE IN THE TREATIES WOULD RESULT IN THE TRANSFER OF TAX REVENUES FROM SOURCE TO RESIDENT STATE WITH NO ULTIMATE BENEFIT TO THE TAX PAYER.

UNDERLYING TAX CREDIT (UTC) CONCEPT: A FORM OF RELIEF FROM ‘ECONOMICAL DOUBLE TAXATION’.

COMPUTATION METHODOLOGY CO-RELATION OF DIVIDENDS TO POST TAX PROFITS OF

SUBSIDIARY EFFECT OF EXCHANGE RATES

REQUIREMENT OF SUBSTANTIAL SHAREHOLDING ALSO APPLIED UNDER CFC REGULATIONS INDIA’S TAX TREATY WITH SINGAPORE AND MAURITIUS PROVIDE

FOR UNDERLYING TAX CREDIT. SOME COUNTRIES SPECIFY UP TO HOW MANY LAYERS, UTC CAN

BE CLAIMED UTC UNDER NATIONAL TAX LAW – EG. SINGAPORE, UK,

MAURITIUS ETC.

DOUBLE NON-TAXATIONDOUBLE NON-TAXATION IS A SITUATION WHERE ON

ACCOUNT OF BENEFITS AVAILABLE UNDER DTAA, A TAX PAYER IS NOT LIABLE TO TAX IN BOTH THE RESIDENT STATE AS WELL AS SOURCE STATE

CAPITAL GAINS TAXABILITY UNDER THE INDIA – MAURITIUS TAX TREATY IS A CLASSIC EXAMPLE OF THE SAME Company

X(Mauritius resident)

Mauritius

Capital Gains exempt in India for a Mauritius resident as per DTAA between India and Mauritius

Capital Gains exempt in Mauritius as per Mauritius tax laws

India

Indian Co

Shares held

Mr X

Sale of shares of Indian Co

As visible from the diagram, the above arrangement discharges Company X from tax liability from both the Resident state (Mauritius) as well as Source state (India)

Some companies take undue advantage of the above arrangement by merely incorporating subsidiaries in low-tax jurisdictions and by shifting the profits through legal planning into these subsidiaries

ASSEESSE’S APPROACH TO DTAA

CHECK IF THE TREATY IS IN EFFECT! ENTRY INTO FORCE – CHECK FOR EACH OF THE COUNTRIES, THE DATE OF ENTRY INTO FORCE OF THE CONVENTION THE DATE OF EFFECT OF THE CONVENTION

ENSURE THAT THE TREATY HAS NOT TERMINATED!TREATY REMAINS INTO FORCE TILL TERMINATEDSOME TREATIES PROVIDE FOR A PERIOD DURING WHICH

TREATY CAN’T BE TERMINATEDTERMINATION REQUIRES NOTICE THROUGH DIPLOMATIC

CHANNELSSOME TREATIES PROVIDE FOR PERIOD OF NOTICE & SOME

DO NOTCHECK IF THE TREATY IS IN FORCE BEFORE APPLYING IT!

SOME PRACTICAL ISSUE’S

Dividend Distribution Tax – no credit if there is no underlying tax credit

Different Assessment Period Timing of Tax Filings in both countries Different method of income computation Conversion of Forex Shifting of Residence and Timing Difference Undue advantage merely incorporating subsidiaries

in low-tax jurisdictions and by shifting the profits through legal planning into these subsidiaries

Thank you