EXECUTIVE some cases, this may cause the double-taxed
EXECUTIVE SUMMARY: Double taxation occurs when a taxpayer is taxed twice for the same asset or income.
This happens when taxing jurisdictions overlap and a transaction, asset, or income amount is subject to taxation in both jurisdictions. When an individual must deal with double taxation, he or she may lose a significant portion of income. In some cases, this may cause the double-taxed individual to experience a lowered standard of living. Corporations deal with double taxation too, as a corporation pays taxes on its earnings only to have its shareholders taxed once more.Double tax treaties comprise of agreements between two countries, which, by eliminating international double taxation, promote exchange of goods, persons, services and investment of capital. These are bilateral economic agreements where the countries concerned evaluate the sacrifices and advantages which the treaty brings for each contracting state, including tax forgone and compensating economic advantages. Double Tax Avoidance Agreements & Taxation Meaning of Treaty:In layman’s language, a treaty is a formally concluded agreement between two or more independent nations.
The Oxford Companion to Law defines a treaty as “an international agreement, normally in written form, passing under various titles (treaty, convention, protocol, covenant, charter, pact, statute, act, declaration, concordat, exchange of notes, agreed minute, memorandum of agreement) concluded between two or more states, on subject of international law intended to create rights and obligations between them and governed by international law.Examples of treaty include CTBT, Vienna Convention, and Tax Treaty such as DTAA etc. The Double Tax Avoidance Agreement (DTAA) The Double Tax Avoidance Agreement (DTAA) is essentially a bilateral agreement entered into between two countries. The basic objective is to promote and foster economic trade and investment between two Countries by avoiding double taxation. Objective of double taxation treaties: 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 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.The objectives of double taxation avoidance agreements can be enumerated in the following words: First, they help in avoiding and alleviating the adverse burden of international double taxation, by a) laying down rules for division of revenue between two countries; b) exempting certain incomes from tax in either country ; c) reducing the applicable rates of tax on certain incomes taxable in either countries Secondly, and equally importantly tax treaties help a taxpayer of one country to know with greater certainty the potential limits of his tax liabilities in the other country.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. Need for DTAA The need for Agreement for Double Tax Avoidance arises because of conflicting rules in two different countries regarding chargeability of income based on receipt and accrual, residential status etc. As there is no clear definition of income and taxability thereof, which is accepted internationally, an income may become liable to tax in two countries.
In such a case, the two countries have an Agreement for Double Tax Avoidance, in which case the possibilities are: 1. The income is taxed only in one country. 2. The income is exempt in both countries. 3.
The income is taxed in both countries, but credit for tax paid in one country is given against tax payable in the other country. In India, The Central Government, acting under Section 90 of the Income Tax Act, has been authorized to enter into double tax avoidance agreements (hereinafter referred to as tax treaties) with other countries. Types of DTAA DTAA can be of two types. i. Comprehensive.
i. Limited Comprehensive DTAAs are those which cover almost all types of incomes covered by any model convention. Many a time a treaty covers wealth tax, gift tax, surtax. Etc. too.
Limited DTAAs are those which are limited to certain types of incomes only, e. g. DTAA between India and Pakistan is limited to shipping and aircraft profits only.
Acting under the authority of law, the Central Government has so far entered into agreements with countries listed below: International Taxation (DTAA Comprehensive agreements With respect to taxes on income) 1Armenia36Namibia 2 Australia37Nepal Austria38Netherlands 4Bangladesh39New Zealand 5Belarus40Norway 6Belgium41Oman 7Brazil42Philippines 8Bulgaria43Poland 9Canada44Portuguese Republic 10China45Qatar 11Cyprus46Romania 12Czech Republic47Russia 13Denmark48Saudi Arabia 14Egypt49Singapore 15Finland50Slovenia 16France51South Africa 17Germany52Spain 18Greece53Sri Lanka 19Hashemite Kingdom of Jordan54Sudan 20Hungary55Sweden 21Indonesia56Swiss Confederation 22Ireland57Syria 23Israel58Tanzania 24Italy59Thailand 25Japan60Trinidad and Tobago 26Kazakstan61Turkey 27Kenya62Turkmenistan 28Korea63UAE 29Kyrgyz Republic64UAR (Egypt) 30Libya65UGANDA 1Malaysia66UK 32Malta67Ukraine 33Mauritius68USA 34Mongolia69Uzbekistan 35Morocco70Vietnam 71Zambia International Taxation (DTAA Limited agreements – With respect to income of airlines/merchant shipping) 1Afghanistan 2Bulgaria 3Czechoslovakia 4Ethiopia 5Iran 6Kuwait 7Lebanon 8Oman 9Pakistan 10People’s Democratic Republic of Yemen 11Russian Federation 12Saudi Arabia 13Switzerland 14UAE 15Uganda 16Yemen Arab Republic Role of tax treaties in international tax planning A tax treaty plays the following role: i. Facilitates investment and trade flow, preventing discrimination between tax payers; ii.Adds fiscal certainty to cross border operations; iii. Prevents international evasion and avoidance of tax; iv. Facilitates collection of international tax; v. Contributes attainment of international development goal, and vi. Avoids double taxation of income by allocating taxing rights between the source country where income arises and the country of residence of the recipient; thereby promoting cooperation between or amongst States in carrying out their obligations and guaranteeing the stability of tax burden.
Choice of Beneficial Provisions under DTAA/Tax lawsThe Provisions of DTAA override the general provisions of taxing statute of a particular country. It is now well settled that in India the provisions of the DTAA override the provisions of the domestic statute. Moreover, with the insertion of Sec.
90 (2) in the Indian Income Tax Act, it is clear that assessee have an option of choosing to be governed either by the provisions of particular DTAA or the provisions of the Income Tax Act, whichever are more beneficial. For example under DTAA between Indian and Germany, tax on interest is specified @ 10% whereas under Income Tax Act it is 20%. Hence, one can follow DTAA and pay tax @ 10%.Further if Income tax Act itself does not levy any tax on some income then Tax Treaty has no power to levy any tax on such income. Section 90(2) of the Income Tax Act recognizes this principle. Models of DTAA There are different models developed over a period of time based on which treaties are drafted and negotiated between two nations.
These models assist in maintaining uniformity in the format of tax treaties. They also serve as checklist for ensuring exhaustiveness or provisions to the two negotiating countries. OECD Model, UN Model, the US Model and the Andean Model are few of such models.Of these the first three are the most prominent and often used models.
However, a final agreement could be combination of different models. OECD Model- Organization of Economic Co-operation and Development (OECD) Model Double Taxation Convention on Income and on Capital, issued in 1977, 1992 and 1995 OECD Model is essentially a model treaty between two developed nations. This model advocates residence principle, that is to say, it lays emphasis on the right of state of residence to tax. UN Model- United Nations Model Double Taxation Convention between Developed and Developing Countries, 1980The UN Model gives more weight to the source principle as against the residence principle of the OECD model. As a correlative to the principle of taxation at source the articles of the Model Convention are predicated on the premise of the recognition by the source country that (a) taxation of income from foreign capital would take into account expenses allocable to the earnings of the income so that such income would be taxed on a net basis, that (b) taxation would not be so high as to discourage investment and that (c) it would take into account the appropriateness of the sharing of revenue with the country providing the capital.
In addition, the United Nations Model Convention embodies the idea that it would be appropriate for the residence country to extend a measure of relief from double taxation through either foreign tax credit or exemption as in the OECD Model Convention. Most of India’s treaties are based on the UN Model. United States Model Income Tax Convention of September, 1996. The US Model is different from OECD and UN Models in many respects. US Model has established its individuality through radical departure from usual treaty clauses under OECD Model and UN Model. General Features of DTAA ) Language used by Treaties Tax Treaties employ standard International language and standard terms.
This is done in order to understand and interpret the same term in the same manner by both assessee as well as revenue. Language employed is technical and stereotyped. Some of the terms are explained below: i. Contracting State – country which enters into Treaty ii. State of Residence- Country where a person resides iii. State of Source- Country where income arises iv.
Enterprise of a Contracting State- Any taxable unit (including individuals of a Contracting State) v.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) vi. Income arising in Contracting state – Income arising in a State of a source One has to read the treaty carefully in order to understand its provisions in their proper perspective.
The best way to understand the DTAA is to compare it with an agreement of partnership between two persons. In partnership, the words used are “the party of the first part” and in the DTAA, the words used are “the other contracting state” .One can also replace the words” Contracting States” by names of the respective countries and read the DTAA again , for better understanding. 2) Composition of a comprehensive DTAA Double Tax Avoidance agreements are divided under following heads Article No. HeadingContent 1Scope of the ConventionTo whom applicable? 2Taxes coveredSpecific taxes covered 3General definitionPersons, company enterprises, international traffic, competent authority 4Resident‘Residence’ of a contracting state who can access treaty 5Permanent EstablishmentWhat constitutes P. E.
? What does not constitute P.E? 6Income from Immovable PropertyImmovable property and income there from 7Business ProfitsDetermination and taxation of profits arising from business carried on through P. E.
8Shipping, Inland waterways & Air TransportPlace of deemed accrual of profits arising from activities and mode of taxation thereon 9Associated EnterprisesEnterprises under common management and taxation of profits owing to close connection (other than transactions of arm’s length nature ) 10DividendDefinition and taxation of dividends; Concessional rate of tax in certain situations; 1InterestDefinition and taxation of interest; Concessional rate of tax in certain situations; Taxation of interest paid in excess of reasonable rate, on account of special relationship; 12RoyaltiesDefinition of Royalties- what it includes and covers, and its taxation; Treatment of excessive payment of royalties due to special relationship; Country where taxable. 13Capital GainsDefinition- Taxation aspect; Concessional rates/exemption from tax if any; Country where taxable. 14Independent Personal ServicesTypes of services covered; Country where taxable. 5Dependent Personal ServicesDefinition Country where taxable. 16Directors Fees and Remuneration for Top Level Managerial officialDefinition Mode of Country where taxable.
17Income earned by entertainer and athletesTypes of activities covered; Mode of Country where taxable. 18Pension and social security paymentsCountry where taxable. 19Remuneration and pensions in respect of government servicesTypes of remuneration and Country where taxable. 20Payment received by students and apprenticesTaxation / Exemption of payments received by student and apprentices.
1Other IncomeResidual Article to cover income not covered under other ‘Articles’, mode of taxation and country where taxable 22Capital (Tax on wealth)Definition – made – and country where taxable 23Method of eliminationExemption Method / Credit Method 24Non Discrimination(Equitable) Basis of taxing Nationals and citizens of foreign state 25Mutual Agreement ProcedureWhere taxation is not as per provisions of the convention, a ‘person’ may present his case to Competent Authorities of respective states.Procedure in such cases 26Exchange of InformationCompetent Authorities to exchange information for carrying out provisions of the convention. Methodology.
27Assistance in collection of taxes 28Diplomatic agents and Consular corps (Officers)Privileges of this category to remain unaffected 29Territorial Extension 30Entry into forceEffective date from which convention comes into force; Assessment year from which it comes into force. 31TerminationTime – Notice period – Mode. Overall Preview of the Model ConventionIn general terms, the Articles of a convention can be divided into six groups for the purpose of analyses: 1.
Scope Provisions: these include Article 1 (Personal scope), 2 (Taxes covered), 30 (Entry into force) and 31 (Termination). These provisions determine the persons, taxes and time period covered by a treaty. 2. Definition provisions: these include Article 3 (General Definitions), 4(Residence) and 5 (Permanent Establishment) as well as the definitions of terms in some of the substantive provisions (e.
g. he definition of “immovable property” in Article 6(2)). 3. Substantive Provisions: these are the Articles between article 6 and 22 which apply to particular categories of income, capital gains or capital and allocate taxing jurisdiction between the two Contracting States. 4. Provisions for elimination of double taxation: this is primarily Article 23.
Article 25(Mutual Agreement) could also be placed in this category. 5. Anti-avoidance provisions: these include Article 9 (Associated Enterprises) and 26 (Exchange of information). 6.Miscellaneous Provisions: this final category includes Articles such as 24(Non-Discrimination), 28 (Diplomats) and 29 (Territorial Extension). How to apply DTAA The process of operation of a double taxation convention can be divided into a series of steps, involving the different types of provisions. 1.
Determine if the issue is within the scope of the convention: This involves determining firstly whether the taxpayer is within the personal scope in Article 1- that is, “persons who are residents of one or both Contracting States”.This may involve confirming that the taxpayer is a “person” within in the definition of Article 3(1) (a); it will involve confirming that the taxpayer is resident of a Contracting State according to Article 4(1). 2. Check that the treaty applies to the tax in issue- is it a tax listed in Article 2 (or a tax substantially similar to such a tax). 3. Thirdly, check that the treaty is in operation for the taxable period in issue – that the treaty is in force (Article 29) and has not been terminated (Article 30).
4. Apply the relevant definitions:At this stage the relevant definition provisions (if any) can be applied. Thus, for example, if the taxpayer is a resident of both Contracting States, the tiebreakers in Article 4(2) and (3) have to be applied to determine a single residence for treaty purposes, similarly, if it is necessary to decide whether the taxpayer has a permanent establishment in a state, then Article 5 is relevant. 5. Determine which of the substantive provisions apply: The substantive provisions apply to different categories of income, capital gains or capital; it is necessary to determine which applies.
This is a process of characterization. In many cases this may be straightforward; in others the task may not be easy. For example, payments, which are referred to as “royalties”, may in fact fall under Article 7 (Business Profits), 12 (Royalties), 13 (Capital Gains) or 14 (Independent Personal Services). Assistance in characterizing the items can be gained from the Commentaries, case law and reports of the Committee on Fiscal Affairs 6. Apply the substantive article: Substantive articles generally take one of three forms (i)The state of source may tax without limitation.Examples are: income from house property situated in that state, and business profits derived from a permanent establishment there.
(ii)The state source may tax up to a maximum: here the treaty sets a ceiling to the level of taxation at source. Examples in the OECD Models are: dividends from companies resident in that state and interest derived from there. (iii)The state of source may not tax: here, the state of residence of the tax payer alone has jurisdiction to tax. Examples in the OECD Model are: business profit where there is no permanent establishment in the state of source. . Apply the provisions for the elimination of double taxation Every one of the substantive articles must be considered along with article 23 which sets out the methods for the elimination of double taxation.
Case Laws “Ishikawajma Harima Heavy Industries Limited vs. Director of Income Tax, Mumbai Dt. 04/01/2007” In this case, the company was incorporated in Japan.
It formed a consortium with four others and entered into an agreement with an Indian firm, Petronet LNG Ltd for setting up liquefied natural gas receiving and degasification facility in Gujarat.Each member of the consortium was to receive separate payments. The contract involved offshore supply, offshore services, onshore supply, onshore services, construction and erection. The price was payable for offshore supply and services in US dollars, whereas that of onshore supply as also services, construction and erection partly in dollars and partly in rupees. The dispute arose whether the amounts received by the Japanese corporation from Petronet for offshore supply of equipment and materials were liable to tax under the Indian Income Tax Act and the India-Japan double taxation avoidance treaty.The Authority for Advance Rulings (Income Tax) ruled that the Japanese firm was liable to pay direct tax, even under the treaty. Hence the firm moved the Supreme Court.
It argued that the transactions occurred outside the country. The contract was a divisible one and therefore it did not have any liability to pay tax in regard to offshore services and offshore supply. The government, on the other hand, contended that the contract was a composite one.
The supply of goods, whether offshore or onshore, and rendition of service were attributable to the turnkey project.The Supreme Court ultimately held that the tribunal was wrong and set aside its order. While the Japanese firm got relief in the case, the judgment is notable for the principles it has laid down to be followed in such cases.
Regarding offshore supply of equipment and materials, the Supreme Court laid down nine guidelines in the context of this case, but has general application. Accordingly, 1. Only such part of the income as attributable to the operations carried out in this country can be taxed here. 2.
If all parts of the transfer of goods as well as the payment are carried on outside the country, the transaction cannot be taxed in India. 3. The principle of apportionment, wherein the territorial jurisdiction of a particular state determines its capacity to tax an event, has to be followed. 4. The fact that a contract was signed in India is of no material consequence, if the activities in connection with the offshore supply were outside the country and therefore cannot be deemed to accrue or arise in this country. . The court further clarified that there was a distinction between a business connection and a permanent establishment.
The latter is for the purpose of assessment of income of a non-resident under a double taxation avoidance agreement while the former is for the application of the Income Tax Act. As far as offshore services are concerned, the court stated that sufficient territorial nexus between the rendition of services and territorial limits of India is necessary to make the income taxable.The entire contract would not be attributable to the operations in India. The test of residence, as applied in the international law also, is that of the tax payer and not that of the recipient of such services. 6. Regarding Section 9(1)(vii)(c) of the Income Tax Act, dealing with income by way of fees for technical services by a non-resident, the Supreme Court clarified that the services should not only be utilized within India but also be rendered in India or have such a “live link” with India that the entire income became taxable here.
7.Applying the principle of apportionment to composite transactions which have some operations in one territory and some in others, it is essential to determine the taxability of various operations. The location of the source of income within India would not render sufficient nexus to tax the income from that source. 8. There exists a difference between the existence of a business connection and the income accruing or arising out of such business connection.
9. For the profits to be ‘attributable directly or indirectly’, the permanent establishment must be involved in the activity giving rise to the profits.Under Section 90 and 91 of the Income Tax Act, relief against double taxation is provided in two ways: 1. Unilateral relief 2. Bilateral relief Unilateral relief: It refers to the relief scheme which can be provided to the tax payer by home country irrespective of whether it has any agreement with other countries or has otherwise provided for any relief at all in respect of double taxation. The need for such relief may arise because every country cannot be in position to arrive at double taxation avoidance agreements.
In India, Section 91 of the Income Tax Act relates to unilateral relief.Under it, if any person/company who/which is resident in India in any previous year proves that, in respect of its income which accrued or arose during that previous year outside India, he has paid in any country with which there is no agreement (under section 90) for the relief or avoidance of double taxation, income tax, by deduction or otherwise, under the law in force in that country, it shall be entitled to the deduction from the Indian income tax payable by him of a sum calculated on such doubly taxed income at the average Indian rate of tax or the average rate of tax of the said country, whichever is lower,or at the Indian rate of tax if both the rates are equal. In other words, unilateral relief will be available for the tax-payer, if the following conditions are satisfied:- ? The person or company (assessee) in question must have been resident in India in the previous year; ?Same income must have accrued or arisen to him outside India during the previous year and it should also be received outside India. Such income must not be deemed to accrue or arise in India; That income should be taxed both in India and in a foreign country and there should be no reciprocal arrangement for relief or avoidance from double taxation with the country where the income has accrued or arisen.
?In respect of that income, the person or company (assessee) must have paid by deduction or otherwise, tax under the law in force in the foreign country in question in which the income outside India has arisen. ?It is necessary that the foreign tax be levied in a country with which India has no agreement for relief against or avoidance of double taxation, but it is immaterial that tax paid in such a foreign country is in respect of income arising in another foreign country with which Indian has such an agreement.The steps involved in calculating such relief under this section are:- (a) Calculate tax on total income (including foreign income) and claim relief applicable on it (b) Add surcharge and education cess after claiming rebate under the Section 88E (c) Compute average rate of tax by dividing the tax computed in previous step with the total income (d) Calculate average rate of tax of foreign country by dividing income-tax actually paid in the said country after deduction of all relief due (e) Claim the relief from the tax payable in India at the rate computed in previous two steps on the basis of whichever is less. For example ‘A’ a resident of India derives income of Rs.One Lakh in the form of fees for technical services rendered in country ‘X’. This income is subjected tax say @ 30% and an amount of Rs. 30,000/- is paid as tax in that country.
His “total income” in India including this foreign income is Rs. 5 Lakh on which tax payable works out to say, Rs. 1,25,000/-.
The average rate of Indian tax is Rs. 1,25,000/- ? Rs. 5,00,000/- i. e. 25%.
The Indian rate being lesser, a deduction of an amount equal to 25% of the doubly taxed income of Rs. 1,00,000/- i. e. Rs. 25,000/- will be allowed as deduction out of the total tax liability of Rs. 1,25,000/-.
This takes care, to a significant extent, the problem of double taxation i. e. taxation in India as well as in country ‘X’.The domestic tax laws contain many provisions for either exempting totally or partially foreign source income, or permitting the taxpayers to deduct foreign income-tax in the same manner as other items or cost or expenses. The other provision relates to the grant of foreign tax credit.
Such measures are taken without reference to a corresponding or reciprocal agreement with the other country. For example, in Indian Law, various exemptions for foreign source of income have been provided e. g. complete exemption is provided in respect of interest payable on the money borrowed from, or the debts owned to, the sources outside India by the Government or by an industrial undertaking under an agreement approved by Government or any financial institution- (Section 10(15)(iv) of the Income Tax Act).There are provisions permitting deduction, inter alia, in respect of remuneration in the case of professors, teachers, in respect of professional income of authors, playwrights, artists, musicians, actors or sportsmen from foreign sourcing to the extent of 25 percent to 50 percent of such income.
(Sections 80RR, 80-O of the Income-tax Act). Some of these exemptions are not for providing relief against double taxation, but for encouraging such services and encouraging earning of foreign exchange. For example, under section 80-O, where an Indian company or a resident non-corporate tax payer receives any royalty, commission, fees or any similar payment from the government of a foreign State or a foreign enterprise in consideration for the use outside India of any patent, invention model etc. or information concerning industrial, commercial or scientific knowledge experience or skill available to the foreign government or for technical or professional services rendered outside India to the foreign government or to the foreign enterprise, 50% of the income brought into India in convertible foreign exchange is reduced from the total income liable to tax. There are various exemptions in respect of income earned by non-residents in India under section 10 of the Income Tax Act.
Besides this, there is a system of providing foreign tax credit. Under the foreign tax credit system, foreign income of resident is subject to India tax liability in India arising from the receipt of foreign income. It is, however, limited to the Indian income-tax payable on that income. The essential feature of foreign tax credit is that the country allowing deduction for it treats as if it were paid to itself within certain statutory limitations of its domestic laws.Example for calculating the double taxation avoidance : We can analyze as follows to know the Unilateral relief is applicable in this situation or not The tax can be calculated as follows Websites for reference: 1)http://www. oecd. org Organization of Economic Co-operation and Development (OECD) 2)United Nations Model Double Taxation Convention between Developed and Developing Countries, 1980-http://unpan1. un. org/intradoc/groups/public/documents/un/unpan004554. pdf 3)United States Model Income Tax Convention of September, 1996. http://www. ustreas. gov/offices/tax-policy/library/model996. pdf 4) National website of the Income Tax Department of India-http://www. incometaxindia. gov. in/