Double Tax Avoidance Agreement (DTAA)

Summary: The Double Taxation Avoidance Agreement (DTAA) is a bilateral agreement between countries designed to prevent taxpayers from being taxed twice on the same income in both their resident and source countries. This mechanism is crucial in today’s globalized world where individuals and businesses earn income from multiple countries. DTAA primarily benefits Non-Resident Indians (NRIs) and Persons of Indian Origin (PIOs), who might otherwise face dual taxation. The agreement offers relief by allowing taxpayers to choose the most beneficial tax regime, whether under the DTAA provisions or the domestic tax laws. DTAA also ensures lower tax rates for specific transactions, like dividends, and provides mechanisms such as Foreign Tax Credit to reclaim excess tax paid abroad. India has signed DTAAs with 94 countries, fostering international trade and investment by minimizing tax evasion and encouraging economic cooperation. Various models, such as the OECD, UN, US, and ANDEAN, provide different frameworks for these agreements, balancing the taxation rights between the resident and source countries. Additionally, the agreement includes specific forms for claiming benefits, ensuring transparency and compliance. Methods like the Full Exemption and Foreign Tax Credit are employed to eliminate double taxation, thereby enhancing cross-border economic activities.

DTAA (Double Taxation Avoidance Agreement)

Due to world becoming more globalised and foreign marketplaces becoming easier day by day to access with the modern technology advancements the revenue generation of a taxpayer from various sources is guaranteed.

Thus, in case of income arising from any international transaction and to avoid such income being double taxed in the home country (being the resident of the country) and as well as Host country or Source Country (being the country where the income is generated) mechanism of DTAA was brought into effect.

Generally, the taxation arises on either resident basis or source basis. To a person who is tax resident in one country and earning income from India or vice versa, taxability of income arises from two countries. This situation is mostly faced by NRIs/PIOs.

What does DTAA mean?

DTAA is a financial or bilateral agreement between Government of countries to avoid the double taxation of any income earned by the taxpayer.

Objectives of DTAA: –

• To provide relief to taxpayers to mitigate double taxation.
• To encourage international trade and investment.
• To promote development of economic relations between countries.

Need of DTAA: –

• To minimise the tax evasion by the taxpayers
  • Example: – In countries such as New Zealand, Hong Kong, Singapore, Switzerland capital gains is exempted from taxation while in India as per Income Tax Act, 1961 earnings via capital gains is taxable at different slab rates depending upon the nature of transaction. Now, assuming an individual who is a resident of India has capital gains in one of the countries where the taxation is exempted, the same shall be taxable as per the IT Provisions.

• To ensure that there prevail no opportunities for non-taxation of income.

Features of DTAA:

• As per Section 90(2) of Income tax Act, 1961, the DTAA override the provisions of Income tax Act,1961.
• The option to either be taxed via DTAA provisions or IT Provisions is at the disposal of the assessee. Thus, if the domestic taxation proves to be much more beneficial to the taxpayer, then they are eligible to claim the benefit.
• The DTAA provides lower rate of TDS in few transactions.
  • For Example: – As per DTAA the dividend income is taxes at 15%/25% but as per Section 195 of Income Tax Act,1961 the same is liable to be taxed at 20%.
• In case where the assessee is double taxed or has remitted excess tax, the excess amount can be reclaimed by the assessee in the form of Foreign Tax Credit as per Rule 128 of Income tax Rules, 1962 through Form No. 67.
• Currently, India has signed DTAA with 94 various countries. With the remaining countries where there exists no such agreement the assessees can claim restricted benefit through Section 91 of Income Tax Act, 1961.

Models of DTAA:

Different models have been developed over time to ensure uniformity and exhaustiveness in tax treaties between two nations. The most prominent ones are OECD Model, UN Model, US Model, ANDEAN Model.

• OECD Model: –
  • The draft was prepared by Organisation for Economic Co-operation and Development of UN, with developed countries as its members.
  • This model is generally adopted by developed countries.
  • This model greatly favours the residence principle i.e., the right of the country of residence to impose tax.

• UN Model: –

• • United Nations Model Double Taxation Convention between Developed and Developing Countries, 1980.
  • The UN Model is generally adopted by the developed and developing countries to form a treaty.
  • This model provides more weightage on the “Source” principle rather than “residence” principle of OECD Model.
  • The UN Model epitomizes the idea of double taxation relief either through foreign tax credit or exemption as in the OECD Model.
  • The UN Model promotes flow of investments between the countries and also requires sharing of tax revenue with the country that provides the capital.
  • It is to be noted that most of India’s treaties are based on UN Model.

• US Model: –

• • United States Model Income Tax Convention of September 1996
  • The US Model greatly differs from the OECD and UN models.

• ANDEAN Model: –

• • The ANDEAN Model favours taxation in source country.
  • This model is generally adopted by the underdeveloped countries such as, Bolivia, Columbia etc.

Forms under DTAA:

1. FORM NO. 10FA– An application for certificate for resident for the purposes of Section 90 and 90A of Income Tax Act, 1961.

2. FORM NO. 10F– The details such as, status of the assessee, PAN, Nationality etc to be provided.

3. FORM NO. 10FB– This is the certificate of residence which will be issued by the Government post submission of FORM NO. 10FA by the taxpayer.

4. FORM NO. 67– This is a statement of income earned from a country outside India and Foreign Tax Credit.

Methods of Eliminating Double Taxation: –

• Full Exemption Method-

• • Under the Exemption method, the foreign income is completely disregarded while calculating the income of the resident country.
  • This method implies that the residents of a country will only be taxed in that country based on their domestic income.

• Exemption with Progression-

• • Under this method even though the foreign income is exempted, the resident country shall include the foreign income for the purpose of determining the tax rate applicable to the taxpayer.
  • This will result in applicability of higher tax rate when the taxpayer has high foreign sourced income.
  • This method will ensure that a portion of the foreign income is taxed and prevent the taxpayer from enjoying the benefits of lower tax rate.

• Foreign Tax Credit (Rule 128 of Income Tax Rules, 1962): –

An assessee can claim credit of tax paid in the source country by way of deduction in the year in which such tax was paid by him known as Foreign Tax Credit.

Conditions of Foreign Tax Credit: –

• • Foreign Tax Credit can be availed as per Section 90 and 90A of Income Tax Act, 1961 when India has entered into agreements with other countries. (Double Tax Avoidance).
• • Where there exists no DTAA between countries in such cases the foreign tax credit can be availed as per Section 91 of Income Tax Act,1961. (Double Tax Relief).

Section 91 states that the assessee shall be entitled to the deduction from the Income tax payable on doubly taxed income at the rate of Income tax or rate of tax of foreign country, whichever is lower.

• • Further, aforementioned tax credit be availed only to the extent of tax liability discharged in the foreign country on foreign income against Indian tax liability. However, it is pertinent to mention that in case there is any excess payment in the source country, the taxpayer will not be entitled to avail any refund benefit on such excess tax remitted.
• • The credit shall be allowed only for the tax, surcharge and cess payable and not for any interest, penalty or fee.
• • In case if the assessee’s tax is disputed the credit cannot be availed in such cases.