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    DTAA - No More A Stranger

    We all are in an era of globalization with increased economic development due to the strengthening of ties between countries. This has been possible due to a rise in sale / transfer of goods, services, technology, intellectual property etc., from one country to another, irrespective of the distance between the two. The markets that have stayed untapped for long have also become a part of this global village now. To ease inter-country trade and to develop connections with all the possible nations of the world, the Governments of all countries have started entering into agreements with each other. 

    What is DTAA? 

    DTAA refers to Double Taxation Avoidance Agreement. 

    In simple terms, DTAA is a bilateral agreement entered into between two countries. 

    There are two rules for any income being taxed: 

    Rules for taxation of income 

    Source Based Taxation

     

    Income is to be taxed in the country in which it originates irrespective of the residential status of  the recipient of income

     

    Residence BasedTaxation

     

    Income is to be taxed in

     

    the    place of residence

     

    (domicile or place of

     

    incorporation) of the tax

     

    payer

     

     

     

    If both rules were to apply to a business entity, the cost of operating at an international scale would turn out to be high and such cross-border businesses would become less attractive and deter the process of globalisation.

     

    What is double taxation?

     

    Where a taxpayer is a resident in one country but has some income whose source is in another country, it gives rise to possible double taxation.

     

     

    If countries would have not entered into trade ties, the process of globalization would have collapsed at its budding stage as no person / entity would want to pay tax twice on the same income. 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.

     

    To understand the basic purpose of the bilateral agreements in avoiding double taxation let us take a small example:

     

    Mr. R is a resident of India for tax purposes. He earns certain income in Country Y during one of his visits. In which country would he be liable to pay tax for the income earned from Country Y??

     

    Mr R

    (Resident of India)

     

     

     

    Income from

     

    Country Y

     

     

     

     

     

     

     

    In Country Y

     

    In India

     

     

     

     

    As per laws of Country Y

    As per Indian laws

    (Source Based Taxation)

    (Residence Based Taxation)

     

     

     

    DOUBLE TAXATION OF

     

    THE SAME INCOME!!

     

     

     

    As shown in the above diagram, the income would be taxed twice, i.e.,

     

    ØAsperthe tax laws of Country Y, Mr. R would have to pay tax in Country Y on the income earned there. ØThesame income is liable to tax in India as Mr. R is a resident in India (the global income of a resident

     

    is taxable in India).

     

    If we assume that no trade ties have been entered between the two countries, we can visualize the situation of Mr. R whose income is being taxed twice – first in the source country (i.e., Country Y) and then in the home country (i.e., India).

     

    Double taxation causes risk to cross border transactions. Elimination or mitigation of multi-level taxation is done by various entities through network of tax treaties.

     

     

    Double taxation could be;

     

    Types of Double

     

    Taxation


    ‘DTAA’!!!!! – No more a stranger!

     

    Economic

     

    Taxation in two or more

    states but in the hands of

    d i f fe r e n t t a x p ay e rs

    [e.g. business profit and

    dividend  in  different

    countries].

     

    Juridical

     

    Two or more states levy

     

    taxes on same entity on

     

    same income for identical

     

    periods

     

     

     

    Tax treaties safeguard against juridical taxation

     

    Models of Treaties for avoidance of double taxation:

     

    There are three main models of treaties based on which each country develops its own bilateral trade agreement with another country.

     

     

     

     

    OECD

     

    Model

     

     

     

     

     

     

     

     

     

    Models

     

    of

    treaties

     

     

    UN                                                                                                     US

     

    Model                                                                                           Model

     

     

    • OECD (Organization for Economic Co-operation and Development) Model

     

    The following are the main features of the OECD Model:

     

    ØItemphasizes on residency based taxation i.e., the right to tax all income rests with the home country only.

     

    ØThismodel is usually adopted by developed countries in case of treaties entered with other developed countries.

     

    ØTheOECD Model is regularly updated to amend provisions to be in line with the interest of the law making bodies and the taxpayers.

     

    2)     UN Model

     

    The following are the main features of the OECD Model:

     

    ØThismodel emphasizes on source based taxation i.e., the right to tax all income rests with the country where the income originates from / has its source from.

     

    ØThismodel is usually adopted by developed countries in case of treaties entered with developing countries or for treaties entered into between two developed countries.

     

    • US Model

     

    The following are the main features of the OECD Model:

     

    ØTheUSModel is different from OECD and UN Models in many respects

     

    ØUSModel has established its individuality through radical departure from usual treaty clauses under

     

    OECD Model and UN Model.

    ØThismodel is used by USA for all treaty negotiations.

     

    DTAA and India

     

    Section 90 of the Income-tax Act, 1961 (“Act”) empowers the Central Government to enter into tax treaties with the Government of any foreign country / specified territory. The ranking of the treaties in the legal system depends on the country’s view on international taxation / constitutional arrangements.

     

    Various treaties have developed over years between the Indian Government and the Government of other countries to promote global trade. Such treaties are known as DTAA. At present India has entered into DTAA with 88 countries out of which 85 have been in force. DTAAs are negotiated under public international law and governed by the principal laid down under the Vienna Convention on the law of treaties of 1969 (“VCLT”) (considered to be the genesis of DTAA).

     

    DTAA are bilateral conventions aimed at addressing potential tax conflicts. In essence, DTAA reflects allocation of taxing rights amongst member countries.

     

     

    In most of the countries, DTAA prevails over domestic law. In some countries, DTAA is treated at par with the domestic law (example - US).

     

    India follows rule of source based taxation for non – residents, i.e., receipt, deemed receipt, accrual or deemed accrual. As per section 90 of the Act, a non-resident taxpayer has option to be taxed as per the tax treaty or as per domestic tax laws, whichever is more beneficial.

     

    Main objectives of DTAA:

     

    The basic objectives of DTAA are:

     

    ØLimitexercise of taxing powers in cross-border situations ØAvoidance of double taxation

    ØRational / equitable allocation of income between two countries ØPromotion of cross border trade and investment

     

    ØDefinition of uniform principles, rules, procedures etc. to facilitate recovery of tax duesØExchange of information to combat tax avoidance and tax evasion

     

    Relief under the Act:

     

    Under section 90 and 91 of the Act, relief against double taxation is provided in two ways:

     

    Unilateral Relief:

     

    Under section 91 of the Act, an individual can be relieved from double taxation by Indian Government irrespective of whether there is a DTAA between India and the other country concerned. Unilateral relief to a tax payer may be offered if:

     

    ØTheperson or company has been a resident of India in the previous year ØTheincome should be taxable in India and in another country with which there is no tax treaty ØThetax has been paid by the person or company under the laws of the foreign country in question.

     

    Bilateral Relief

     

    Under Section 90, the Indian government offers protection against double taxation by entering into a DTAA with another country, based on mutually acceptable terms.

     

     

    Types of DTAA

     

    Types of DTAA

     

     

     

     

     

    Comprehensive                                                                                                      Limited


    ‘DTAA’!!!!! – No more a stranger!

     

    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.

    DTAA Comprehensive

     

    Limited DTAAs are those

    which  are  limited  to

    c e r t a i n t y p e s   o f

    incomes only, e.g. DTAA

     

    between  India  and

    Pakistan is limited to

    shipping  and  aircraft

    profits only

     

     

    Examples of Comprehensive DTAA:

     

    • Australia

     

    • Nepal
    • US
    • China
    • Bangladesh
    • Netherlands
    • Norway Canada
    • Cyprus
    • Singapore
    • France
    • Germany
    • South Africa
    • Sri Lanka
    • Spain
    • Thailand
    • Italy
    • Japan
    • UK
    • Mauritius
    • Vietnam and many more countries

     

     

    Examples of Limited DTAA:

     

    • Pakistan

     

    • Afghanistan
    • Iran
    • Bulgaria
    • Ethiopia
    • Switzerland
    • UAE
    • Yamen Arab Republic
    • Russian Federation
    • Saudi Arabia
    • Uganda
    • Oman
    • Lebanon
    • Czechoslovakia
    • Kuwait

     

    Sources for interpreting DTAA

     

    DTAA embodies general / indefinite terms which are much open to interpretation. It is very challenging in achieving coherence in interpretation of DTAA’s due to:

     

    • Difference in interpretative principles of member countries and

     

    • Absence of rigid procedure for interpretation of terms

     

    For interpreting the same, following should be used:

     

    Primary Sources (besides

    DTAA)

     

    Secondary sources

     

     

     

     

     

     

    - VCLT

     

     

    - Memorandum

    of

    - OECD M odel Convention

    understanding (‘MoU’)

     

    and Commentary

    - Protocol

     

     

     

    - UN  Model  Convention

    - Preamble

     

     

     

    and Commentary

    - Succeeding treaties

    /

     

     

     

    parallel

    treaty

    or

     

     

     

    comparative language

     

     

     

     

    - International decisions /

     

    revenue / administrative

     

    rulings, and practices in

     

    other countries

     

    - International / Indian

     

    commentaries

     

     

    Points to be noted:

     

    It is pertinent to note the following points:

     

    ØFurnishing of a valid Tax residency certificate is the foremost condition for claiming tax treaty relief.

     

    ØAlltaxtreaties are not uniform i.e., each treaty codifies respective understanding between parties.

    The conditions need not be uniform in all treaties; E.g. Limitation of benefit clause in some treaties like Singapore

     

    ØScopeof income may vary. E.g. India US tax treaty has a narrow definition of FTS;

    ØThe‘Most Favored Nation’ clause exists in some treaties, i.e., Most Favored Nation (“MFN”) clause links bilateral agreements by ensuring that the parties to one agreement are not subjected to a treatment which is less favorable than the treatment provided to other parties under similar agreements. In effect, a country that has been accorded MFN status may not be treated less advantageously than any other country with MFN status by the promising country.

     

    It is imperative to analyze conditions of respective treaty depending on country of residence of the taxpayer.

     

    With the increasing cross-border connectivity and huge complexities involved in tax planning, a detailed understanding of how such agreements work parallelly with the Act is the utmost need of the hour!!

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