Double taxation is the imposition of two or more taxes on the same income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). It refers to two distinct situations:
• Taxation of divided income without relief or credit for taxes paid by the company paying the dividend on the income from which the dividend is paid.
• Taxation by two or more countries of the same income, asset or transaction, for example income paid by an entity of one country to a resident of a different country. The double liability is often mitigated by tax treaties between countries.
INTERNATIONAL DOUBLE TAXATION AGREEMENT
It is not unusual for a business or individual who is a resident in one country to make a taxable gain 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 countries make bilateral agreements with each other. In some cases, this requires that tax be paid in the country of residence and be exempt in the country of gain arises deducts tax at source and the tax payer 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 tax payer must declare himself to be a 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.
INDIA MAURITIUS TAX TREATY
A large number of Foreign Institutional Investors who trade on the Indian stock markets operate from Mauritius. According to the tax treaty, capital gains arising from the sale of shares are taxable 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.
DOUBLE TAXATION WITHIN THE UNITED STATES
Double taxation can also happen within a single country when sub national jurisdictions have taxation powers and have competing claims. However when a person dies different states, may each claim that the person was domiciled in that state. Intangible property may then be taxed by each state making a claim.
India has adopted the system under which Income Tax on residents is imposed on the “total world income” i.e. income earned anywhere in the world. Whereas a tax payer’s own country has a sovereign right to tax him, the source of income may be in some other country which country also claims a right to tax the income arising in that country.
In case of non-resident, however, it is not the “total world income” but only that income is subjected to tax in India which is earned in this country. Since a resident is taxed in respect of foreign income in his own country as well as in the country where it is earned, he is subjected to tax in both the countries in respect of the same income the purpose of double tax avoidance agreement is to avoid such double taxation to the extent agreed upon.
Growth in international trade and commerce results in cross-country flow of capital, services and technology and globalization of economy. Residents of one country extend their business operations to other countries. The effort is, therefore, to ensure that heavy tax burden is not cast as a result of double or multiple taxation. The object is to achieved by governments entering into agreements with the other countries whereby the respective jurisdiction is so identified that a particular income is taxed in one country only or, in case it is taxed in both the countries, suitable relief is provided in one country to mitigate the hardship caused by taxation in another jurisdiction.
Such agreements are known as “Double Tax Avoidance Agreements” (DTAA) also termed as “Tax Treaties”. The statutory authority to enter into such agreements is vested in the Central Government by the provisions contained in Section 90 of the Income Tax Act in terms of which India has, by the end of March 2002, entered into 64 agreements of this nature which are comprehensive in the sense that they deal with different types of income which may be subjected to double taxation. In addition there are 12 agreements which deal with only profit of enterprises engaged in operation of aircraft and 5 which are limited to shipping profit.
SALIENT FEATURES OF THE DOUBLE TAXATION AVOIDANCE AGREEMENT
A typical DTA agreement between India and another country covers only resident of India and the other contracting country who has entered into the agreement with India. A person who is not resident either of India or of the other contracting country cannot claim any benefit under the said DTA agreement. Such agreement generally provides that the laws of the two contracting states will govern the taxation of income in respective states except when express provision to the contrary is made in the agreement. Since the tax treaties are meant to be beneficial and not intended to put tax payers of a contracting state to a disadvantage. Some Double Taxation Agreements provide that income by way of interest, royalty or fee for technical services is charged to tax on net basis.
There are instances where as per the Income Tax Act; tax is required to be deducted at a rate prescribed in tax treaty. However this may require foreign companies to apply for refund. To obviate such difficulties Section 2(37A) provides that tax may be deducted at source at the rate applicable in a particular case as per Section 195 on the sums payable to non-residents or in accordance with the rates specified in DTA Agreements.
In order to avoid double taxation it is provided that if a resident of India becomes liable to pay tax either directly or by deduction in the other country in respect of income from any source, he shall be allowed credit against the Indian tax payable in respect of such income in an amount not exceeding the tax borne by him in the other country on that portion of the income which is taxed in the said other country. The same benefit is available to the resident of the other country, on income taxed in India.
TAXATION OF INCOME FROM AIR AND SHIPPING TRANSPORT UNDER DTA AGREEMENT
Income derived from the operation of Air transport in International traffic by an enterprise of one contracting state will not be taxed in the other contracting state. In respect of an enterprise of one contracting state, income earned in the other contracting state from the operation of ships in international traffic, will be taxed in that contracting state wherein the place of effective management of enterprise is situated. These provisions do not apply to coastal traffic.
TAXATION OF INCOME FROM ASSOCIATED ENTERPRISES UNDER DTA AGREEMENTS
A separate article in DTA agreement provides for taxing the notional income deemed to arise on account of an enterprise of one contracting state participating directly/indirectly in the management of another enterprise in the other contracting state or where some persons participate directly or indirectly in both the enterprises under conditions different from those existing between the independent enterprises.
TAXATION OF DIVIDEND INCOME UNDER DTA AGREEMENT
Dividend paid by a Company which is a resident of a Contracting State to a resident of the other Contracting State will be taxed in both the States.
TAXATION OF INTEREST INCOME UNDER DTA AGREEMENT
Interest paid in a Contracting State to a resident of the other Contracting State is chargeable in both the States.
TAXATION OF INCOME FROM ROYALTIES UNDER DTA AGREEMENT
Regarding Royalties arising in a Contracting State and paid to a resident of the other Contracting State:-
i. Some DTA agreements provide for taxation in the other for taxation in the other Contracting State.
ii. Some agreements provide for taxation in both the Contracting State.
iii. Some agreements provide for taxation in both the States
TAXATION OF INCOME FROM CAPITAL GAINS UNDER DTA AGREEMENT
Capital gains will be taxed in the state where the capital asset is situating at the time of sale.
TAXATION OF INCOME FROM PROFESSIONAL SERVICES UNDER DTA AGREEMENT
Income will be taxed in the state where the person is resident. However if he has a fixed in the other Contracting State, the income attributable to the fixed base will be taxed in the other Contracting State.
Prepared by
Harshavardhan Bhandari
KPIT Cummins Infosystems LTD
