In this blog post, Sayandeep Pahari, a student pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes how reliefs are calculated under DTAA.
In this era of globalization, an international or cross-border transaction has become an indispensable component of our economy. Taxation policies are modified, subject to the tax regimes of other countries. The domestic tax policies of one country affect its transaction with other countries, which has led to the reviewing of taxation system periodically in order to suit the contemporary needs. There are two principles, which govern the fiscal jurisdiction of taxation between two sovereign states. One is called the source rule and the other residence rule. Source rule holds that income should be taxed in the place of origin irrespective of the residential status of an individual whereas; the residence rule assesses an individual based on their residence. Therefore, a business based on two countries; will fall under the conflict of these two separate rules and suffer taxes at both ends. If States decide to tax income on such unilateral basis, without any agreement with the other State, it will create an obstruction to trade and hinder globalization. In India, liability under Income Tax Act arises on the basis of the residential status of the assessee during the previous year.
Double taxation means taxing the same income twice, which happens when the same item of an individual’s income is treated as accruing, arising or received in more than one country. DTAA or Double Taxation Avoidance Agreement is a treaty, which helps to overcome such perplexity by enacting rules of taxation between Source and Residential country. It is a universally accepted principle that no income should be taxed twice. Income Tax Act, 1961 serves to such principle by providing relief against double taxation under section 90 and section 91.
Types of Relief
There are two ways by which relief can be provided:
- Bilateral relief – When the Governments of two countries enter into an agreement to provide relief against double taxation by jointly working out the system to grant it. In India, bilateral relief is provided under Section 90 and 90A of the Income-tax Act, 1961.
Agreements in this kind of relief can be of two types:
When two countries agree that income arising from specified sources, which are taxable in both the countries, should either be taxed in only one of them or that each of the two countries should tax only a particular specified portion of the income so that there is no overlapping.
Tax Credit Method
In this kind of agreement, single taxability is not provided but some relief is provided. The assessee is given a deduction though he is liable to have his income taxed in both the countries.
Section 90 Of Income-Tax Act, 1961 states:
(1) The Central Government may enter into an agreement with the Government of any country outside India—
(a) for the granting of relief in respect of—
(I) income on which have been paid both income-tax under this Act and income-tax in that country; or
(ii) income-tax chargeable under this Act and under the corresponding law in force in that country to promote mutual economic relations, trade and investment, or]
(b) for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country, or
(c) for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this Act or under the corresponding law in force in that country, or investigation of cases of such evasion or avoidance, or
(d) for recovery of income-tax under this Act and under the corresponding law in force in that country, and may, by notification in the Official Gazette, make such provisions as may be necessary for implementing the agreement.
(2) Where the Central Government has entered into an agreement with the Government of any country outside India under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.]
(3) Any term used but not defined in this Act or in the agreement referred to in subsection (1) shall, unless the context otherwise requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning as assigned to it in the notification issued by the Central Government in the Official Gazette in this behalf.
Section 90A Of Income –Tax, 1961 Act states, Adoption by Central Government of agreement between specified associations for double taxation relief.
- Unilateral relief – The relief provided by home country irrespective of any agreement with the country concerned. This kind of relief exists because bilateral agreements might not be sufficient to meet all the cases. In India, Section 91 of the Income Tax Act, 1961 provides such relief. In other words, where Section 90 does not apply for relief under Section 91 will be available. Unilateral relief is only available in respect to doubly taxed income that is part of income which is included in assessee’s total income.
Section 91 of Income Tax Act ,1961 states:
(1) If any person who is resident in India in any previous year proves that, in respect of his income which accrued or arose during that previous year outside India (and which is not deemed to accrue or arise in 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, he 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 Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal.
(2) If any person who is resident in India in any previous year proves that in respect of his income which accrued or arose to him during that previous year in Pakistan he has paid in that country, by deduction or otherwise, tax payable to the Government under any law for the time being in force in that country relating to taxation of agricultural income, he shall be entitled to a deduction from the Indian income-tax payable by him—
(a) Of the amount of the tax paid in Pakistan under any law aforesaid on such income which is liable to tax under this Act also; or
(b) Of a sum calculated on that income at the Indian rate of tax;
Whichever is less.
(3) If any non-resident person is assessed on his share in the income of a registered firm assessed as resident in India in any previous year and such share includes any income accruing or arising outside India during that previous year (and which is not deemed to accrue or arise in India) in a country with which there is no agreement under section 90 for the relief or avoidance of double taxation and he proves that he has paid income-tax by deduction or otherwise under the law in force in that country in respect of the income so included he shall be entitled to a deduction from the Indian income-tax payable by him of a sum calculated on such doubly taxed income so included at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal.
Calculation of Relief from Double Taxation
The process which is generally adopted by the authorities in order to grant bilateral relief under Section 90 and 90A is:
Step 1 – Compute the total income of person liable to tax in India in accordance with the provision of the Income-tax Act.
Step 2– Allow relief as per the terms of the tax treaty entered into with the other contracting country or specified territory , as the case may be , where the income has suffered double taxation.
Under Section 91 of Income Tax Act, 1961 the steps for calculating relief are:
Step 1 – Calculate tax on total income inclusive of the foreign income on which relief is available. Claim any relief allowable under the provision of this act including rebates available under section 88E but before relief due under sections 90, 90A and 91.
Step 2 – Add surcharge if applicable + education cess + SHEC after claiming the rebate.
Step 3– Calculate the average rate of tax by dividing the tax computed under Step 2 with the total income (inclusive of such foreign income).
Step 4-Calculate the average rate of tax of the foreign country by dividing income tax actually paid in the said country after deducting all relief due. This should be done before deduction of any relief due in the said country in respect of double taxation by the whole amount of the income as assessed in the said country.
Step 5– Claim the relief from the tax payable in India at the rate calculated at Step 3 or Step 4, whichever is less.
The double taxation system is propitious for enhancing the business environment in a country. A treaty of double taxation provides against non-discrimination of foreign taxpayers as well as benefits the taxpayer of a country to know about his liabilities with a greater certainty. One of the recent highlights includes the bilateral agreement between India and Mauritius. Previously, only Mauritius had the right to tax on capital gains by companies investing in India. Tax on capital gains was nearly zero in Mauritius which made the country a sweet spot for individuals investing in Indian companies. After the amendment to the treaty, India gets the right to tax on capital gains from transfer of shares of Indian resident companies.
Double taxation is the levying of tax by two or more jurisdictions on the same declared income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). Double liability is mitigated in a number of ways, for example:
- the main taxing jurisdiction may exempt foreign-source income from tax,
- the main taxing jurisdiction may exempt foreign-source income from tax if tax had been paid on it in another jurisdiction, or above some benchmark to not include tax haven jurisdictions,
- the main taxing jurisdiction may tax the foreign-source income but give a credit for foreign jurisdiction taxes paid.
Another approach is for the jurisdictions affected to enter into a tax treaty which sets out rules to avoid double taxation.
The term "double taxation" can also refer to the double taxation of some income or activity. For example, in some jurisdictions, corporate profits are taxed twice, once when earned by the corporation and again when the profits are distributed to shareholders as a dividend or other distribution.
The Types of Double Taxation
There are two types of double taxation: economical and juridical (international).
International double taxation agreements
Main article: Tax treaty
It is not unusual for a business or individual who is resident in one country to make a taxable gain (earnings, profits) in another. This person may find that he is obliged by domestic laws to pay tax on that gain locally and pay again in the country in which the gain was made. Since this is inequitable, many nations make bilateral double taxation agreements with each other. In some cases, this requires that tax be paid in the country of residence and be exempt in the country in which it arises. In the remaining cases, the country where the gain arises deducts taxation at source ("withholding tax") and the taxpayer receives a compensating foreign tax credit in the country of residence to reflect the fact that tax has already been paid. To do this, the taxpayer must declare himself (in the foreign country) to be non-resident there. So the second aspect of the agreement is that the two taxation authorities exchange information about such declarations, and so may investigate any anomalies that might indicate tax evasion. While individuals, or natural persons can have only one residence at a time; corporate persons, owning foreign subsidiaries, can be simultaneously resident in multiple countries. Control of unreasonable tax avoidance of corporations becomes more difficult and requires investigation of transfer pricing set for transfer of goods, intellectual property rights, and services, among its subsidiaries.
European Union savings taxation
Main article: European Union withholding tax
See also: Tax residence
In the European Union, member states have concluded a multilateral agreement on information exchange. This means that they will each report (to their counterparts in each other jurisdiction) a list of those savers who have claimed exemption from local taxation on grounds of not being a resident of the state where the income arises. These savers should have declared that foreign income in their own country of residence, so any difference suggests tax evasion.
(For a transition period, some states have a separate arrangement. They may offer each non-resident account holder the choice of taxation arrangements: either (a) disclosure of information as above, or (b) deduction of local tax on savings interest at source as is the case for residents).
A recent study by BusinessEurope confirms that double taxation remains a problem for European MNEs and an obstacle for cross border trade and investments. In particular, the problematic areas are limitation in interest deductibility, foreign tax credits, permanent establishment issues and diverging qualifications or interpretations. Germany and Italy have been identified as the Member States in which most double taxation cases have occurred.
Cyprus double tax treaties
Cyprus has completed over 45 Double Taxation Treaties up to today and is also in negotiations with many countries for signing Treaties with them. The main purpose of these treaties is the avoidance of double taxation on income earned in any of these countries. Under these agreements, a credit is usually allowed against the tax levied by the country in which the taxpayer resides for taxes levied in the other treaty country and as a result the tax payer pays no more than the higher of the two rates. Further, some treaties provide for tax sparing credits whereby the tax credit allowed is not only with respect to tax actually paid in the other treaty country but also from tax which would have been otherwise payable had it not been for incentive measures in that other country which result in exemption or reduction of tax.
German taxation avoidance
If a foreign citizen is in Germany for less than a relevant 183-day period (approximately six months) and is tax resident (i.e., and paying taxes on his or her salary and benefits) elsewhere, then it may be possible to claim tax relief under a particular Double Tax Treaty. The relevant 183 day period is either 183 days in a calendar year or in any period of 12 months, depending upon the particular treaty involved.
So, for example, the Double Tax Treaty with the UK looks at a period of 183 days in the German tax year (which is the same as the calendar year); thus, a citizen of the UK could work in Germany from 1 September through the following 31 May (9 months) and then claim to be exempt from German tax.
India has comprehensive DTAAs with 88 countries, out of which 85 have entered into force. This means that there are agreed rates of tax and jurisdiction on specified types of income arising in a country to a tax resident of another country. Under the Income Tax Act 1961 of India, there are two provisions, Section 90 and Section 91, which provide specific relief to taxpayers to save them from double taxation. Section 90 is for taxpayers who have paid the tax to a country with which India has signed DTAA, while Section 91 provides relief to tax payers who have paid tax to a country with which India has not signed a DTAA. Thus, India gives relief to both kinds of taxpayers.
A large number of foreign institutional investors who trade on the Indian stock markets operate from Singapore and the second being Mauritius. According to the tax treaty between India and Mauritius, capital gains arising from the sale of shares are taxable in the country of residence of the shareholder and not in the country of residence of the company whose shares have been sold. Therefore, a company resident in Mauritius selling shares of an Indian company will not pay tax in India. Since there is no capital gains tax in Mauritius, the gain will escape tax altogether. The Protocol for amendment of the India-Mauritius Convention signed on 10 May 2016, provides for source-based taxation of capital gains arising from alienation of shares acquired from 1 April 2017 in a company resident in India. Simultaneously, investments made before 1 April 2017 have been grandfathered and will not be subject to capital gains taxation in India. Where such capital gains arise during the transition period from 1 April 2017 to 31 March 2019, the tax rate will be limited to 50% of the domestic tax rate of India. However, the benefit of 50% reduction in tax rate during the transition period shall be subject to the Limitation of Benefits Article. Taxation in India at full domestic tax rate will take place from financial year 2019-20 onwards.
The revised DTAA between India and Cyprus signed on 18 November 2016, provides for source based taxation of capital gains arising from alienation of shares, instead of residence based taxation provided under the DTAA signed in 1994. However, a grandfathering clause has been provided for investments made prior to 1 April 2017, in respect of which capital gains would continue to be taxed in the country of which taxpayer is a resident. It also provides for assistance between the two countries for collection of taxes and updates the provisions related to Exchange of Information to accepted international standards.
The India-Singapore DTAA at present provides for residence based taxation of capital gains of shares in a company. The Third Protocol amends the DTAA with effect from 1 April 2017 to provide for source based taxation of capital gains arising on transfer of shares in a company. This will curb revenue loss, prevent double non-taxation and streamline the flow of investments. In order to provide certainty to investors, investments in shares made before 1 April 2017 have been grandfathered subject to fulfillment of conditions in Limitation of Benefits clause as per 2005 Protocol. Further, a two-year transition period from 1 April 2017 to 31 March 2019 has been provided during which capital gains on shares will be taxed in source country at half of normal tax rate, subject to fulfillment of conditions in Limitation of Benefits clause.
The Third Protocol also inserts provisions to facilitate relieving of economic double taxation in transfer pricing cases. This is a taxpayer friendly measure and is in line with India’s commitments under Base Erosion and Profit Shifting (BEPS) Action Plan to meet the minimum standard of providing Mutual Agreement Procedure (MAP) access in transfer pricing cases. The Third Protocol also enables application of domestic law and measures concerning prevention of tax avoidance or tax evasion. Interestingly, Singapore’s investment of $5.98 billion has over taken Mauritius’s investment of $4.85 billion as the single largest investor for the year 2013-14.
In principle, an Australian resident is taxed on all worldwide income, while a non-resident is taxed only on Australian-sourced income. Both legs of the principle offer an opportunity for taxation in more than one jurisdiction. To avoid double taxation of income by different jurisdictions, Australia has entered into double taxation avoidance agreements (DTAs) with a number of other countries, under which both countries agree on which taxes will be paid to which country. For example, in the case of royalties, the DTA with the United States says that the US will tax Australian residents at the rate of 5%, and Australia will tax it at normal rates (i.e., 30% for companies) but give a credit for the 5% already paid. For Australian residents, this ends up working out the same as if the money had been earned within Australia - whilst still providing a 5% credit to the US.
U.S. citizens and resident aliens abroad
The U.S. requires its citizens to file tax returns reporting their earnings wherever they reside. However, there are some measures designed to reduce the international double taxation that results from this requirement.
First, an individual who is a bona fide resident of a foreign country or is physically outside the United States for an extended time is entitled to an exclusion (exemption) of part or all of their earned income (that is, personal service income, as distinguished from income from capital or investments). That exemption is $100,800 for 2015, pro-rated. (See IRS form 2555.)
Second, the United States allows a foreign tax credit by which income tax paid to foreign countries can be offset against U.S. income tax liability attributable to any foreign income not covered by this exclusion. This can be a complex issue that often requires the services of a tax advisor. The foreign tax credit is not allowed for tax paid on earned income that is excluded under the rules described in the preceding paragraph (i.e. no double dipping).
Double taxation within the United States
Double taxation can also happen within a single country. This typically happens when subnational jurisdictions have taxation powers, and jurisdictions have competing claims. In the United States a person may legally have only a single domicile. However, when a person dies different states may each claim that the person was domiciled in that state. Intangible personal property may then be taxed by each state making a claim. In the absence of specific laws prohibiting multiple taxation, and as long as the total of taxes does not exceed 100% of the value of the tangible personal property, the courts will allow such multiple taxation.
Also, since each state makes its own rules on who is a resident for tax purposes, someone may be subject to the claims by two states on his or her income. For example, if someone's legal/permanent domicile is in state A, which considers only permanent domicile to which one returns for residency but he or she spends 7 months of the year (say April–October) in state B where anyone who is there longer than 6 months is considered a part-year resident, that person will then owe taxes to both states on money earned in state B. College or university students may also be subject to claims of more than one state, generally if they leave their original state to attend school, and the second state considers students to be residents for tax purposes. In some cases one state will give a credit for taxes paid to another state, but not always.
Taxation of corporate dividends
Main article: Dividend tax
In the United States, the term "double taxation" is also used to refer to dividend taxation. It refers to the taxation of dividend income when received by a shareholder that had been previously taxed at the corporate level.
Foreign shareholders are subject to a 30% tax on the dividends, called the branch profits tax. Foreign corporations are subject to United States income tax on their "effectively connected income", and are also subject to the branch profits tax on any of their profits not reinvested in the U.S.
In recent years, the development of overseas investment of Chinese enterprises is growing rapidly and becomes rather influential. Thus, dealing with cross-border taxation matters turns into one of the significant financial and trade projects of China, and the problems of cross-border taxation is still increasing. In order to solve the problems, the multilateral tax treaties between countries, which can provide legal support to help enterprises from both sides with double taxation avoidance and tax issues solutions, are established. To fulfill the "going global" strategy of China and support the domestic enterprises to adapt to the globalization situation, China has been making efforts on promoting and signing multilateral tax treaties with other countries to achieve mutual interests. By the end of November 2016, China has officially signed 102 double taxation avoidance agreements. Out of which 98 agreements have already entered into force. In addition, China signed double taxation avoidance arrangement with Hong Kong and Macau Special Administrative Region. China also signed double taxation avoidance agreement with Taiwan in August 2015, which has not entered into force yet. According to the Chinese State Administration of Taxation, the first double taxation avoidance agreement was signed with Japan in September 1983. The latest agreement was signed with Cambodia in October 2016. As for the situation of state disruption, China would continue the signed agreement after the disruption. For example, China first signed double taxation avoidance agreement with Czechoslovakia Socialist Republic in June 1987. In 1990, Czechoslovakia divided into two countries, Czech Republic and Slovakia Republic, and the initial agreement signed with Czechoslovakia Socialist Republic was continually used in two new countries. In August 2009, China signed the new agreement with Czech Republic. And when it comes to the special case of Germany, China continued using the agreement with The Federal Republic of Germany after two Germanys reunited. China have signed double taxation avoidance agreement with many countries. Among them, there are not only countries which have made large investment in China, but also countries which as well-relationship recipient of Chinese investment. As for the agreement quantity, China is now next only to United Kingdom. For those countries which have not signed the double taxation avoidance agreements with China, some of them signed information exchange agreements with China.
There are mainly four effects of signing Double Taxation Avoidance agreement.
1. Eliminate the double taxation, decrease the tax cost of "going global" enterprises.
2. Increase the certainty of taxation, decrease the risk of cross-border taxation
3. Decrease the tax burden of "going global" enterprises in the host country, improve the competitiveness of those enterprises.
4. When taxation disputes occur, the agreements can provide bidirectional consultation mechanism, solve the existed disputed problems.
Under general conditions, the tax rate under tax treaty is often lower than the domestic tax rate under the law of host country. Take Russia as an example, in Russia, the standard withholding tax rate of interest and royalty under domestic law is both 20%. According to the newest tax treaty China signed with Russia, the withholding tax rate of interest is 0 and the withholding tax rate of royalty is 6%. This can obviously reduce the tax cost of enterprises, increase the willing of "going global" and the competitiveness of domestic enterprises, and bring the goodness.
Though signing double taxation avoidance agreement is a way to solve the tax problems, there still can be other problems led out, or we can call it "side effect".
The intention of tax treaties is to avoid or eliminate double taxation. The term double taxation which existed in the tax treaties is mostly juridical double taxation, which "refers to circumstances where a taxpayer is subject to tax on the same income (or capital) in more than one jurisdiction". By contrast, the economic double taxation "is related to the taxation of two and more taxes from one tax basis". Solving economic double taxation mostly is not the main aim of the agreements, but this type of double taxation is not totally ignored.
The initial aim of tax treaties is to avoid double taxation between two countries. Later, with closer the transnational economic relationships are, and the development of transnational enterprises, the governments realized it was necessary to enhance the cooperation through more well-established law together to face the tax evasion of transnational enterprises. Thus, some terms were added into the initial treaties, especially the information exchange terms and tax collection assistance terms. In this way, the second aim, to avoid tax evasion was appear in the theme.
The impact and the aim of the tax treaties are integrated, they are both to avoid double taxation in order to improve economic exchanges and relationships, to enhance the government cooperation in order to avoid tax evasion. However, the side effect gradually appeared. The tax provides possibilities of avoiding tax in a legal way to transnational taxpayers. In order to avoid double taxation, the agreement divided the jurisdiction of taxation, including shared and excluded jurisdiction of taxation. It also established the limited tax rate in the origin countries. These all can be called the preferential treatments of the taxation agreement. The transnational enterprises, in order to get maximized profit, can use the terms of domestic law and taxation agreement, to avoid both taxation from origin country and residence country legally and achieve double taxation free. This can be a severe undermine to the international order, and a challenge to the domestic governments.
- ^Darren Rykers (2009): A Critical Analysis of how Double Tax Agreements can facilitate Fiscal Avoidance and Evasion; The Taxpayer and the Lotus, 17 Nov.2009.
- ^Gio Wiederhold (2013): Valuing Intellectual Capital, Multinationals and Taxhavens; Springer Verlag, 2013, Chap.4.
- ^"Announcement: server inaccessibility - European Commission". Retrieved 31 May 2016.
- ^See (17) and (18) of above, for a "temporary" period, Austria, Belgium and Luxembourg may apply a withholding tax to non-resident accounts rather than exchange information.
- ^Double Taxation Cases Outside the Transfer Pricing Area, December 2013
- ^"Double Taxation Avoidance agreement (DTAA) with South Korea". Press Information Bureau. Retrieved 31 May 2016.
- ^ abc"Publication 54 (2015), Tax Guide for U.S. Citizens and Resident Aliens Abroad". Retrieved 31 May 2016.
- ^Robert Carroll (2010) "Archived copy". Archived from the original on 2011-07-05. Retrieved 2012-02-19.
- ^"国家税务总局". www.chinatax.gov.cn.
- ^"避免双重征税 中国已签订99个税收协定中华人民共和国商务部网站". www.mofcom.gov.cn.
- ^Krishna, Vern (2012). Income tax law (2nd ed.). Toronto: Irwin Law. ISBN 978-1-55221-235-6.
- ^"Concept of Double Taxation". MBA Knowledge Base. 15 January 2011.