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Double Taxation Avoidance Agreement

Double Taxation Avoidance Agreement



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Published by: abhaypandit on Jul 30, 2009
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Double taxation avoidance agreement
 Double taxation may arise when the jurisdictional connections, used by different countries, overlap or it may arise when thetaxpayer has connections with more than one country. A person earning any income has to pay tax in the country in which theincome is earned (as source Country) as well as in the country in which the person is resident. As such, the said income isliable to tax in both the countries. To avoid this hardship of double taxation, Government of India has entered into DoubleTaxation Avoidance Agreements (DTAA’s) with various countries. DTAA’s provide for the following reduced rates of tax ondividend, interest, royalties, technical service fees, etc., received by residents of one country from those in the other.
India has a well-developed tax structure with a three-tier federal structure, comprisingthe Union Government, the State Governments and the Urban/Rural Local Bodies. Thepower to levy taxes and duties is distributed among the three tiers of Governments, inaccordance with the provisions of the Indian Constitution. Since 1991 tax system inIndia has under gone a radical change, in line with liberal economic policy and WTOcommitments of the country like reduction in custom and excise duties, loweringcorporate tax, widening of the tax base and toning up the tax administration. Thephenomenal growth in international trade and commerce and increasing interactionamong nations, citizens, residents and businesses of one country has extended theirsphere of activity and business operations to other countries. To avoid hardship toindividuals and also with a view to ensure that national economic growth does notsuffer,
the Central government under Section 90 of the Income Tax Act has enteredinto Double Tax Avoidance Agreements with other countries.
(1)Protection against double taxation:
 These Tax Treaties serve the purpose of providing protection to tax-payers against double taxation and thus preventing anydiscouragement which the double taxation may otherwise promote in the free flow of international trade, international investment and international transfer of technology;
(2)Prevention of discrimination at international context:
 These treaties aimat preventing discrimination between the taxpayers in the international field andproviding a reasonable element of legal and fiscal certainty within a legal framework;
(3)Mutual exchange of information:
In addition, such treaties containprovisions for mutual exchange of information and for reducing litigation by providingfor mutual assistance procedure; and
(4)Legal and fiscal certainty:
 They provide a reasonable element of legal andfiscal certainty within a legal framework.
Double taxation can be defined as the levy of taxes on income or capital in the handsof the same tax payer in more than one country, in respect of the same income orcapital for the same period.
[2]Double taxation may arise when the jurisdictionalconnections, used by different countries, overlap or it may arise when the taxpayer
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has connections with more than one country. For e.g. An NRI will have to pay tax onthe income earned in India on source basis i.e. where income accrues or arises. On thesame income, tax will have to be paid in the country of residence on residence basis.As such, an NRI will end up paying Income-tax twice on the same income. Tax Treatiesprovide protection to tax payers against such double taxation.
A person earning any income has to pay tax in the country in which the income isearned (as Source Country) as well as in the country in which the person is resident.As such, the said income is liable to tax in both the countries. To avoid this hardship of double taxation, Government of India has entered into Double Taxation AvoidanceAgreements (DTAAs) with various countries. DTAAs provide for the following reducedrates of tax on dividend, interest, royalties, technical service fees, etc., received byresidents of one country from those in the other.
[3]Where total exemption is notgranted in the DTAAs and the income is taxed in both countries, the country in whichthe person is resident and is paying taxed, the credit for the tax paid by that person inthe other country is allowed.Where tax relief has been given by one country, the country of residence generallyallows credit for the tax so spared, to avoid nullifying the relief. If the rate prescribedin the Indian Income-tax Act, 1961 is higher than the rate prescribed in the Tax Treatythen the rate prescribed in the Tax Treaty has to be applied. In other words, provisionsof DTAA or Indian Income-tax Act, whichever are more favourable to an individualwould apply.
[4]Thus In order to avail the benefits of DTAA, an NRI should be residentof one country and be paying taxes in that country of residence. India has entered intoDTAA with around 65 countries. These treaties are based on the general principles laiddown in the model draft of the Organisation for Economic Cooperation andDevelopment (OECD) with suitable modifications as agreed to by the other contractingcountries. Thus in case there is a DTAA between India and United States of America, an NRIshould be a resident of USA and paying taxes there. In case of income earned in Indiaby NRI, tax paid in India is allowed as credit against tax paid in USA.
A typical DTA Agreement between India and another country usually covers persons,who are residents of India or the other contracting country, which has entered into theagreement with India. A person, who is not resident either of India or of the othercontracting country, would not be entitled to benefits under DTA Agreements.
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One of the most important clauses of double taxation avoidance treaty betweendifferent nations is the clause of non-discrimination.
[5]Non-discrimination in simplewords means that neither of the contracting countries gives any preferentialtreatment in taxing its own residents or citizens vis-Ã -vis foreign persons i.e. thereis no discrimination between the local assesses and foreign assesses as far astaxation is concerned. There must be a level playing field for assesses, locals as wellas the foreigners. Most international tax treaties provide that there will not be anydiscrimination in taxation between locals and foreigners. In fact, if there is anydiscrimination, it will be a positive one. This may be for several reasons such asincentive for foreign investment in the country, globalization etc.
 The correct legal position is that where a specific provision is made in the doubletaxation avoidance agreement, that provision will prevail over the general provisionscontained in the Income-tax Act, 1961. In fact, the Double Taxation AvoidanceAgreements, which have been entered into by the Central Government under section90 of the Income-tax Act, 1961, also provide that the laws in force in either countrywill continue to govern the assessment and taxation of income in the respectivecountry except where provisions to the contrary have been made in the agreement. Thus, where a Double Taxation Avoidance Agreement provides for a particular mode of computation of income, the same should be followed, irrespective of the provisions inthe Income-tax Act. Where there is no specific provision in the agreement, it is thebasic law, i.e. the Income-tax Act that will govern the taxation of income.
 The four clauses of sub-section (1) lay down the scope of power of the CentralGovernment to enter into an agreement with another country. Clause (a)contemplates situations where tax has already been paid on the scope in bothcountries and it empowers the central government to grant relief in respect of suchdouble taxation. Clause (b), which is wider than the clause (a),
[6]provides that anagreement may be made for the avoidance of double taxation of income under thisAct and under the corresponding law in that country. This clause cannot be extendedto make provisions in agreements for situations not relating to double taxation.However, it is not necessary that a situation regarding avoidance of double taxationcan arise only when tax is actually paid in one of the contracting countries.
[7]Moreover, as long as the objectives in these clauses are sought to be effectuated byany agreement, the power of the central government cannot be said to have beenused in an ultra vires manner.
[8]Clause (c) and (d) essentially deal with agreementsmade for exchange of information, investigation of cases and recovery of Income Tax.
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