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Double Taxation Avoidance Agreement (DTAA)One of the most heavily guarded jurisdictions of a country is its fiscal jurisdiction. Therefore, even inthe age of globalization, double taxation continues to be one of the major obstacles to the developmentof international economic relations. The Fiscal Committee of OECD in the Model Double TaxationConvention on Income and Capital, 1977, defines double taxation as ‘the imposition of comparabletaxes in two or more states on the same tax payer in respect of the same subject matter and for identicalperiods’. Whereas a tax payer’s own country (referred to as home country) has a sovereign right to taxhim, the source of income may be in some other country (referred to as host country) which also claimsa right to tax the income arising in that country. Nations are often forced to discuss and settle the claimsof other nations by means of double taxation avoidance agreements, in order to bring down the barriersto international trade.Double tax treaties are settlements between two countries, which include the elimination of internationaldouble taxation, promotion of exchange of goods, persons, services and investment of capital. This isbecause, the interaction of two tax systems of two different countries can result in double taxation.Every country seeks to tax the income generated within its territory on the basis of one or moreconnecting factors such as location of the source, residence of taxable entity and so on. Double Taxationof the same income would cause severe consequences on the future of international trade.Countries of the world therefore aim at eliminating the prevalence of double taxation. Such agreementsare known as "Double Tax Avoidance Agreements" (DTAA) also termed as "Tax Treaties".Following the footsteps of most countries of the world that levy tax on income / capital, India has alsoimposed Income Tax on the "total world income" i.e. income earned anywhere in the world. The resultis that income arising to a resident out of India is subjected to tax in India as it is part of total worldincome and, also in host country which provides the source for that income.The statutory authority to enter into such agreements is vested in the Central Government by theprovisions contained in Section 90 of the Income Tax Act in terms of which India has, by the end ofMarch 2002, entered into 64 agreements of this nature which deal with different types of income whichmay be subjected to double taxation. A list of such agreements and the respective years of their cominginto force forms annexure to this book. In addition there are 12 agreements which deal with only profitof enterprises engaged in operation of aircraft and 5 which are limited to shipping profit.Classification:Depending on their scope, double taxation avoidance agreements are classified as Comprehensive andLimited. While comprehensive Double Taxation Agreements provide for taxes on income, capital gainsand capital, Limited Double Taxation Agreements refer only to income from shipping and air transport,or estates, inheritance and gifts. Comprehensive agreements ensure that the taxpayers in both thecountries would be treated equally, in respect to problems relating to double taxation.Objectives:The object of a Double Taxation Avoidance Agreement is to provide a settlement between the tax claimsof two governments, both legitimately interested in taxing a particular source of income. Firstly, theyhelp in avoiding the burden of international double taxation, by -a) laying down rules for division of revenue between two countries;b) exempting certain incomes from tax in either country ;c) reducing the applicable rates of tax on certain incomes taxable in either countriesSecondly, the tax treaties help a taxpayer of a country to know with greater certainty the potential limitsof his tax liabilities in the other country.
Pattern of taxationDouble taxation agreements allocate jurisdiction to the concerned countries, with respect to the right totax a particular kind of income. The principle underlying tax treaties is to share the revenues betweentwo countries. If each country gets a reasonable share of tax revenues and the overall tax collection alsoincreases, both countries tend to benefit. Income from business, movable and immovable propertycomes under the sphere of double tax avoidance agreement. The agreements provide of allocation oftaxing jurisdiction to different contracting parties in respect of different heads of income. In general, therules include that income from the business is taxed:• only in the resident country, if the business entity has no activity in the source state;• Only on the source state, if there is a fixed place of business, i.e. Permanent Establishment.• Income form immovable property arising to a non-resident is taxed primarily in the state of its location, i.e. the source state.• Income from movable property such as dividends, interest and royalties are usually taxed in the resident state, but the source state may also impose a reduced tax.Methods of Eliminating Double Taxation:The objective of double taxation can be obtained through tax treaties involving various methods or acombination of the following methods:(i) Exemption Method: This method is for the residence country to exclude foreign income from its taxbase and the exclusive right to tax such incomes goes to the source country. This is known as completeexemption method and is sometimes followed in respect of profits attributable to foreign permanentestablishments or income from immovable property. Indian tax treaties with Denmark, Norway andSweden are of this nature with respect to certain incomes.(ii) Credit Method: It reflects the underline concept that the resident remains liable in the country ofresidence on its global income, however as far the quantum of tax liabilities is concerned credit for taxpaid in the source country is given by the residence country against its domestic tax as if the foreign taxwere paid to the country of residence itself.(iii) Tax Sparing: One way of directing the foreign investment flows in India from foreign developedcountries, is to let the investor preserve to himself/itself benefits of tax incentives available in India forsuch investments. This is done through the Tax Sparing method, where the tax credit is allowed by thecountry of its residence, not only in respect of taxes actually paid by it in India but also in respect ofthose taxes India forgoes due to its fiscal incentive provisions under the Indian Income Tax Act (ITA).The regular tax credit is a measure of preventing double taxation, but the tax sparing credit extends therelief granted by the source country to the investor in the residence country by the way of an inducementto stimulate foreign investment flows and does not seek reciprocal arrangements by the developingcountries.Applicability of Treaty benefits:In order to get the benefit of a tax treaty, it is necessary to have an access to it. For that purpose, a personmust qualify in terms of the treaty as a:- person- resident of any of the Contracting states; and- beneficial owner of the income by the way of dividends, interest or royalties for a lower rate ofwithholding tax.
Residence of a Person:The determination of the residential status of the tax payer is of great significance as the taxability ofincome under the domestic laws depends upon it. Moreover, only the resident of a contracting state canseek relief from double taxation. The expression ‘resident of contracting state’ refers to any person who,under the laws of that state, is liable to tax therein by reason of domicile, residence, place ofmanagement or any other criterion of a similar nature.The treaty provision determines whether a person is a resident of a contracting state. It first considers aperson’s liability to tax as a resident under the respective taxation laws of the state. If a person is aresident of both the contracting states, there are provisions to assign a single state of residence to him forpurposes of the treaty through tie-breaking rules.Business Income:The business income of a non-resident is taxable in India under section 9(1)(i) of the ITA only if itarises, directly or indirectly, through or from any business connection in India, property in India, asset orsource of income in India, or through the transfer of an Indian capital asset. Explanation 2 of section9(1) (i) contain an inclusive definition of business connection; as per which a business connection is saidto exist if any person carrying on a business activity acts on behalf of a non-resident and: -- has and habitually exercises an authority to conclude contracts on behalf of the non-resident -- has no such authority, but habitually maintains in India a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the non-resident -- habitually secures orders in India, mainly or wholly for the non-resident or its affiliates.Permanent Establishment:Double taxation agreement restricts the authority of the contracting states to tax business income of aforeign enterprise only if such enterprise carries on business in India through a permanent establishment.The term “permanent establishment” as defined in Article 5 means a fixed place of business throughwhich business of an enterprise is carried on. The definition requires performance of business activitythrough a fixed place of business in another country. The expression has been defined as a fixed place ofbusiness through which the business of an enterprise is wholly or partly carried on.The first part of Article 5(1) suggests the existence of a fixed place of business, whereas the second partpostulates that the business is carried on through a fixed place. If the second part is not attracted, there isno permanent establishment.Treating shopping:Treating shopping refers to the act of a resident of a third country taking advantage of a fiscal treatybetween states. A person acts through a legal entity created in a state essentially to obtain treaty benefitsthat would not be available directly to such person. The basic feature of treaty shopping is to establishbase companies in other states solely for the purpose of enjoying the benefit of particular treaty rulesexisting between the state involved and the third state.An example of treaty shopping can be the double Taxation agreement between India and Mauritius.Various companies have been incorporated in Mauritius to take advantage of the Indo-Mauritius DTAAin which capital gains are to assessed as per the law of the resident state of the entity. However, underthe Mauritian law, tax is not levied on capital gains. This means that the capital gains made by theMauritian entity on transfer of shares in an Indian company go without assessment.However, there has been a noticeable change in the approach of the States, particularly after the widereports of extensive money laundering and the tax evasion. As a consequence, a lot of countries are
adopting a “Limitation of Benefits” clause in the tax treaties so as to restrict third parties from takingadvantage of tax treaties between two other states.Tax Haven:Tax Haven or the place, in which certain taxes are imposed either at a low rate or not at all, is the bestpossible way out for those interested in reducing their tax rates.In some countries, high tax rates can deter the tax payers and lead them to relocate to areas withcomparative lower tax rates. This gives rise to tax competition among different governments. There aremany Tax Haven specified for different types of taxes as well as for different groups of people andcompanies. It has the potentiality to transform the tax structure of any nation. As a result, there are alsosome effective tax laws regulating the protections of the Tax Haven such that there are no revolutionarychanges or misuses within the economy.There are some specific characteristics as being identified by the Organization for Economic Co-operation and Development (OECD) to decide the tax structure of any nation to be denoted as TaxHaven. These are – • Regarding the situations when there is either payment of no/only nominal taxes. In special cases, Tax Haven creates such conditions to offer themselves as shelters for the non-residents to evade high taxes in their respective residential countries. • Tax Haven generally stresses on protecting the personal financial information of the taxpayers. They have specific laws for the benefit of corporate houses and individuals that can protect them from the scrutiny and other strict laws of the foreign tax authorities.Indian Tax Regime:The Income Tax Act, 1961 governs taxation of income in India. According to section 5 of the ITA,Indian residents are taxable on their worldwide income, and nonresidents are taxed only on income thathas its source in India. Section 6 defines who may be a tax resident and contains different residencycriteria for companies, firms, and individuals. The scope of section 5 is expanded by the ‘‘legal fictioncontained in section 9, which considers certain kinds of income to be of Indian source.The ITA favors source-based taxation as compared to the OECD model conventions or treaties enteredinto by many developed countries that favor residence based taxation. Indian courts have supportedsource based taxation in several cases in the past.Indian Policy With Respect To Double Taxation Avoidance Agreements:The policy adopted by the Indian government in regard to double taxation treaties is as follows: • Foreign trade with India should be relieved of Indian taxes considerably so as to promote its economic and industrial development. • There should be co-ordination of Indian taxation with foreign tax legislation for Indian as well as foreign companies trading with India • The agreements are intended to permit the Indian authorities to co-operate with the foreign tax administration. • Tax treaties are a good compromise between taxation at source and taxation in the country of residence
India primarily follows the UN model convention and one therefore finds the tax-sparing and creditmethods for elimination of double taxation in most Indian treaties as well as more source-based taxationin respect of the articles on ‘royalties’ and ‘other income’ than in the OECD model convention.Conclusion:The regime of international taxation exists through bilateral tax treaties based upon model treaties,developed by the OECD and the UN, between the Contracting States. India has stepped into a widenetwork of tax treaties with various countries all over the world to facilitate free flow of capital into andfrom India. However, the international tax regime has to be restructured continuously so as to respond tothe current challenges and drawbacks.2,443 words.