In this age of globalization many organizations including individuals have got their wings spread all over the world.
In any country the tax is levied based on 1) Source Rule and 2) the Residence Rule. The source rule holds that income is to be taxed in the country in which it originates irrespective of whether the income accrues to a resident or a non-resident whereas the residence rule stipulates that the power to tax should rest with the country in which the taxpayer resides. If both rules apply simultaneously to a business entity and it were to suffer tax at both ends, the cost of operating on an international scale would become prohibitive and would deter the process of globalisation. It is from this point of view that Double Taxation Avoidance Agreements (DTAA) becomes very significant.
In India the residential status is the key point for determination of income tax. In case of Residents their global income (i.e Indian Income as well as Foreign Income) is taxable in India whereas in case of non-residents only Indian Income is taxable. So we can say that in India residence rule is applied for residents whereas source rule is applied for Non-residents. The residential status of a person is determined based on the provisions of Section 6 of Income Tax Act 1961.
Many a times, it is seen that in case of residents, the income tax has been paid in other countries on their income abroad (i.e Foreign Income) and on the same income they are also required to pay tax in India. In such cases, there are provisions of providing relief from double tax. Basically there are two sections (i.e section 90 and section 91) in Income Tax Act 1961, which provides relief from Double tax.
As can be seen from the above diagram that section 90 is applicable in cases where India has entered into a Bilateral agreement with other country and section 91 is applicable in case where there is no such bilateral agreement (i.e there is unilateral agreement)
As of now there are 192 UN member countries out of which India has entered into Bilateral agreement with 82 countries till 07.05.2012 (i.e day of Finance Budget 2012). Hence in respect of these 82 countries Section 90 will apply and in respect of remaining 110 countries section 91 will apply.
From the petroleum industry perspective Union Minister of State for Commerce and Industry Jyotiraditya Scindia has called for greater opportunities for Indian companies in Venezuela’s growing economy, especially in the petroleum sector. Mr Scindia urged the Colombian minister to expedite the ratification of the Double Taxation Avoidance Agreement (DTAA) from the Colombian side as such measures will help build the investor’s confidence on both sides. The Colombian Minister Dr. Hart stated that enhancing economic engagement with India is a priority of the Colombian Government and he expects the Colombian Parliament to ratify the DTAA by this year end.
Where there is an DTAA agreement (Section 90)
U/s 90 there are two methods of granting relief under Double Taxation Avoidance Agreement.
1) Exemption method – A particular income is taxed in one of the both countries and exempted in the other country. (For example- For the Income from Dividend, Interest, royalty and fees for technical services source rule is applicable in treaty with Greece, Libyan and United Arab Republic. So for a citizen of these 3 countries if the dividend, interest, royalty or fees for technical services is arising in India, then it will be solely taxable in India only and if for a resident if such income is arising in any of these 3 countries then the income will solely be taxed in these 3 countries and it will not be at all taxable in India).
2) Tax Credit method- The income is taxed in both the countries as per the treaty and the country of residence will allow the tax credit / reduction for the tax charged in the country of source. For example- Mr A (an Indian resident) has received salary from a US company for job in US. Since Mr A is a resident so his global Income will be taxable. In this case source country is US (since the service has been rendered in US) and resident country is India. So at the time of computation of tax liability of Mr A the tax paid in US will be allowed as set off against his total tax liability but limited to the tax payable on such foreign income at Indian tax rates.
In case where Bilateral agreement has been entered u/s 90 with a foreign country then the assessee has an option either to be taxed as per the Double Taxation Avoidance Agreement (hereinafter referred as “DTAA”) or as per the normal provisions of Income Tax Act 1961, whichever is more favourable to assessee. [CIT Vs ITC Ltd (2002)]
For example: As per DTAA between Indian and Germany, tax on Interest is specified @ 10% whereas under Income Tax Act 1961, it depends on slab rates for individuals & HUF and flat rates (generally 30%) for other kind of assessees (like firm, company etc). Hence one can follow DTAA and pay tax @ 10% only.
Where there is an NO DTAA agreement (Section 91)
In case there is no DTAA then the relief u/s 91 is available only to Resident and not to Non-resident. The resident tax payer 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.
Misuse of DTAA, Treaty shopping and amendment made by Finance Act 2012
Treaty Shopping occurs when the resident of a third country takes advantage of the provisions of DTAA between two countries.
As per the DTAA with Mauritius, Capital Gain accruing in India to a resident of Mauritius is not taxable in India subject to certain exception. Again there is no capital gain tax applicable in Mauritius. Hence it leads to tax exemption in both the countries.
FIIs (Foreign Institutional Investors) in order to take advantage of such treaty get themselves incorporated in Mauritius and becomes the resident of Mauritius. As held by the Supreme Court in the case of UOI Vs Azadi Bachao Andolan (2003) and via CBDT Circular No 789 dated 13.04.2000 it has been clarified that wherever a certificate of residence is issued by Mauritius Authority, such certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying DTAA accordingly. Hence a number of cases of treaty shopping has been observed which is very legal.
In order to curb this treaty shopping section 90 has been amended by Finance Act 2012, by which now submission of Tax Residency Certificate (TRC) will be a necessary but not sufficient condition for availing the benefit of the agreements referred to in this section. The format of TRC will be notified by board. It appears that after notification of the format of TRC it will be difficult for an intermediate country like Mauritius to issue TRC to certify that a global company has significant operation in Mauritius.
The details of DTAA can be extracted from the site www.incometaxindia.gov.in
Contributed by: CA Srikant Agarwal