1. Introduction:
- Double Tax Avoidance Agreements (DTAAs) serve as crucial treaties between two nations aimed at preventing the double taxation of income. By delineating the taxation rights of each country, these agreements offer relief to non-resident individuals (NRIs) from the burden of being taxed multiple times on the same income.
- The DTAA between India and the United States of America (USA) stands as a cornerstone in facilitating economic relations between these two powerhouse nations. Initiated with the primary objective of preventing double taxation and fiscal evasion, this bilateral agreement serves as a pivotal tool for promoting cross-border trade, investment, and economic co-operation between India and USA.
- In today’s interconnected global economy, businesses frequently span international borders, leading to a critical issue of double taxation. This occurs when the same income is taxed in both the resident and source countries, burdening taxpayers with excessive liabilities and discouraging foreign investment and trade. Acknowledging this challenge, India and USA collaboratively established the DTAA which came into force on 18 December 1990.
- The primary aim of this agreement is to offer clarity, certainty, and relief to taxpayers concerning their tax obligations in both jurisdictions. By instituting transparent rules for the allocation of taxation rights, the DTAA effectively mitigates the adverse effects of double taxation, thus creating an environment conducive to cross-border transactions.
- In this article we will discuss the framework of the agreement entered between India and USA.
2. Applicability of DTAA:
- The India – USA treaty aimed at preventing double taxation of income earned by residents of both countries. This agreement extends its application to persons who are residents of either India or USA, as well as those who are residents of both countries simultaneously. These persons may include:
> Individual
> Company
> Partnership Firm
> Trust
> Any other entity having income in both countries
- The DTAA does not override or negate the domestic tax laws of either country but rather provides guidelines and mechanisms to prevent double taxation and resolve tax disputes between the two nations, and therefore each Contracting State, whether it’s India or USA, maintains the right to impose taxes on person who are considered residents according to the criteria outlined in Article 4 of DTAA. This authority exists independently to India and USA under the DTAA.
- The taxes which are covered under this agreement are:
In the United States:
a) Federal income tax/ United States tax as imposed by the Internal Revenue Code (IRC), excluding the below-mentioned:
i) Accumulated earnings tax, which is levied to prevent a corporation from accumulating its earnings and profits beyond the reasonable needs of the business for the purpose of avoiding income taxes on its stockholders.
ii) Personal holdings tax, which is designed to discourage wealthy individuals from using corporations as a way to shield their passive income from higher personal income tax rates.
iii) Social security taxes, which is a payroll tax collected to fund the social security program and provide benefits to qualifying beneficiaries, including retirees, disabled individuals, and survivors of deceased workers
b) Exercise taxes on insurance premiums paid to foreign insurers are applicable only if the risks covered by such premiums are not reinsured with an entity ineligible for tax exemption under this or any other relevant convention In India:
a) Income tax including the surcharge but excluding the income tax on undistributed income of companies, and
b) Surtax as per Indian laws
3. Definition of Resident of Contracting State as per DTAA:
- As per Article 4 of the India-USA DTAA, a “resident” of a Contracting State refers to any person or entity subject to taxation in that State based on factors like their domicile, residence, citizenship, business operations, or incorporation. However, there are exceptions to this definition:
a) This term excludes individuals or entities solely taxed on income generated within their own country.
b) In case the income derived from partnerships, estates, or trusts, residency applies only if that income is taxed in the same State as either the resident’s income or the income of the partnership, estate, or trust’s beneficiaries.
- Moreover, in situations where an individual is deemed a resident of both Contracting States, the determination of residency hinges on specific factors:
|
Scenario |
Determination of Residential Status |
| If the individual has a permanent home in one State: | He shall be considered as a resident of that State. |
| If the individual has a permanent home in both States: | He shall be considered as a resident of the State where their personal and economic ties are stronger (center of vital interests). |
| If he/she does not have a permanent home available to him in either State: | He shall be considered as a resident of the State where they have a habitual abode (regular residence). |
| If he/she has an habitual abode in both or neither States: | He shall be considered as a resident of the State of which they are a national (citizen). |
| If he/she is a national of both or neither States: | The competent authorities of contracting States will determine their residency through mutual agreement. |
4. Taxation of incomes as per DTAA
A. Income from immovable property – Article 6 of DTAA
- As per Article 6 of DTAA, income derived from immovable property is to be taxed in the country in which it is situated. Following is considered as income from the immovable property:
> Income from agriculture or forestry
> Income derived from the direct use, letting etc.
> Income from immovable property of an enterprise
B. Dividend – Article 10 of DTAA
- As per Article 10 of DTAA, dividends paid by a Company resident in one Contracting State to a resident of the other Contracting State may be taxed in the recipient’s country. However, the country where the company paying the dividends is based also has the right to tax them according to its laws. For example, if a Company in India pays dividends to a shareholder residing in USA, USA may tax those dividends as well as per the local laws. Similarly, the dividend may also be taxed in India. This is where the DTAA comes in to avoid double taxation. The DTAA will provide the benefit of avoidance or relief from double taxation under Article 25 of the DTAA.
As per DTAA, the tax so charged shall not exceed:
|
If recipient is a Company that owns at least 10% of the voting stock of the paying company |
15% of the gross amount of dividend |
| Other cases | 25% of the gross amount of dividend |
- The term dividends in this context refers to earnings from owning shares or similar rights in a company, excluding debts.
C. Interest Income – Article 11 of DTAA
- As per Article 11 of DTAA, Interest earned by a person resident of one Contracting State from the other Contracting State may be taxed in the recipient’s country. However, the Country where the interest arises also has the right to tax it according to its laws.
For example, if a person resident in India earns interest from investments in USA, India may also have the right to tax that income. Similarly, USA may also tax the interest income as per local laws. This is where the DTAA comes into play, ensuring that the person is not required to pay tax on the same income twice.
As per DTAA, the tax so charged shall not exceed:
|
Interest paid on a bank loan or a similar financial institution (including an insurance company) |
10% of the gross amount of interest |
| Other cases | 25% of the gross amount of dividend |
- The term interest mean income from debt-claims of every kind, whether or not secured mortgage, income from government bonds or corporate debentures, etc.
D. Royalty and Fees for included Services – Article 12 of DTAA
- As per Article 12 of DTAA, royalties and fees for included services arising in a contracting state and paid to a resident in other Contracting State may be taxed in the recipient’s Country. However, the Country where the Company paying royalties and fees is based also has the right to tax them according to its laws.
- If the beneficial owner of the royalties or fees for included services is a resident of the other Contracting State, the tax so charged shall not exceed:
|
In case of payments for using or owning rights to copyrights, patents, trademarks, or industrial equipment, including any gains from selling those rights or property |
15% of the gross amount of royalties or fees for included services |
| In case of payments for utilizing equipment used in industries, commerce, or scientific equipment, but excludes payments related to renting ships, aircraft, or containers directly involved in transportation activities | 10 % of the gross amount of royalties or fees for included services |
- For the purpose of India – USA DTAA, fees for included services, include the following:
a) Services that are directly related to the use or enjoyment of certain rights, properties, or information.
b) Services that provide technical knowledge, experience, skills, knowhow, or processes or involve the development and transfer of technical plans or designs.
It is clear that for a service to qualify as fees for included services, there should be made available technical knowledge, experience, skill, know-how or processes to the service recipient.
The receiver of this service can be said to acquire the relevant skills used by the service provider only if he acquires those skills so that he can himself use them independently without getting any assistance or being dependent on the service provider in the future.
For example, if the consulting firm shares its expertise in software architecture and design principles with the Indian company’s development team, the payments made for this service would qualify as fees for included services.
E. Capital gains – Article 13 of DTAA
In this case, the capital gains are subject to tax based on the country’s domestic laws.
For example, if a US Resident, say, Miss Meena, sells her Indian property in the Indian market, then the property is liable to be taxed as per the Indian domestic laws.
F. Independent Personal Services – Article 15 of DTAA
A resident of one state deriving income from professional services from the performance in the other state will be taxable only in the residing state except if:
> if such person has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities; in that case, only so much of the income as is attributable to that fixed base may be taxed in that other State; or
> if the person’s stay in the other Contracting State is for a period or periods amounting to or exceeding in the aggregate 90 days in the relevant taxable year.
G. Income received by Professors, Teachers and Research Scholars – Article 22 of DTAA
The income of a professor, teacher or research scholar who moves to another country is exempt from tax if they fulfill the following conditions:
> The engagement is for a period not exceeding two years, and
> Before the visit, the individual should be resident of the first country
H. Relief from double taxation – Article 25 of DTAA
In the United States, residents are entitled to credit against their US Tax for:
> Income Tax paid to India by the resident or on their behalf.
> If a US company owns at least 10% of the voting stock of an Indian-resident company and receives dividends, the income tax paid to the Indian Government by the Indian company on the profits from which dividends are paid shall be eligible for credit.
In India, if an Indian resident earns income that is taxed in the United States, India will allow a deduction equal to the income tax paid in the United States. However, this deduction cannot exceed the Indian tax paid on the foreign income earned.
5. Conditions to avail benefits of DTAA:
- As per sub-section (4) of section 90 of the Income Tax Act, 1961 (the Act), a non-resident will not be entitled to claim any relief under such agreement unless a tax residency certificate of the person being a non-resident of other country is provided. Further, if the tax residency certificate does not contain all the details as required under Rule 21AB(2) of the Income Tax Rules, 1961 (the Rules), Form 10F will have to be electronically furnished under Rule 21AB(1) of the Rules.
Conclusion: The India-USA Tax Treaty stands as a vital instrument in promoting economic cooperation and preventing double taxation. Understanding its provisions empowers taxpayers to navigate cross-border transactions with clarity and confidence, fostering a conducive environment for international trade and investment.
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The contributors to the Article are Sumit Mahajan, AccuWiz Consulting LLP along with inputs from CA Sonakshi Sood.
Disclaimer: The content/information is only for general information of the user and shall not be construed as legal advice. The facts stated are based on information available in public domain. Views expressed above are personal.
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