DOUBLE TAX AVOIDANCE AGREEMENT

Double Taxation Avoidance Agreement

FOREIGN INCOME of a person generally becomes liable to tax in two countries – the country in which income is earned and the country in which the person is resident. Double taxation of such income is avoided by means of double taxation avoidance agreements entered into by the government of india with the government of other countries under section 90. Where the income accrues or arises in a country with which no agreement exists , unilateral tax relief is provided on the doubly taxed income under the provisions of section 91.

Where a taxpayer is resident in one country but has a source of income situated in another country it gives rise to possible double taxation. This arises from the two basic rules that enables the country of residence as well as the country where the source of income exists to impose tax namely,

(i)                  the source rule and

(ii)                 The residence rule.

The source rule holds that income is to be taxed in the country in which it originates irrespective of whether the income accrues to a resident or a non-resident whereas the residence rule stipulates that the power to tax should rest with the country in which the taxpayer resides. If both rules apply simultaneously to a business entity and it were to suffer tax at both ends, the cost of operating on an international scale would become prohibitive and would deter the process of globalisation. It is from this point of view that Double Taxation Avoidance Agreements (DTAA) become very significant.

Double taxation means taxing the same income twice in the hands of an assessee. In India, a person is taxed on the basis of his residential status. Likewise, it may so happen that he is taxed on this basis or some other basis in another country on the same income. However, it is a universally accepted principle that the same income should not be subjected to tax twice. In order to take care of such situations, the Income-tax Act, 1961 has provided for double taxation relief.

The government of india has entered into comprehensive agreements for avoidance of double taxation with 57 countries .

TYPES OF RELIEF

Relief from double taxation can be provided in mainly two ways:

(i) Bilateral Relief ; and

(ii) Unilateral relief

Bilateral Relief : Under this method, the Governments of two countries can enter into an agreement to provide relief against double taxation by mutually working out the basis on which the relief is to be granted. India has entered into agreements for relief against or avoidance of double taxation with more than 50 countries which include Sri Lanka, Switzerland, Sweden, Denmark, Japan, Federal Republic of Germany, Greece, etc..

Bilateral Relief may be granted in either one of the following methods:

(a) Exemption method, by which a particular income is taxed in only one of the two

countries; and

(b) Tax relief method, under which, an income is taxable in both countries in accordance with their respective tax laws read with the double taxation avoidance agreement. However, the country of residence of the tax payer allows him credit for the tax charged thereon in the country of source.

In India, double taxation relief is provided by a combination of the two methods.

Unilateral Relief : This method provides for relief of some kind by the home country even where no mutual agreement has been entered into be the two countries.

DOUBLE TAXATION RELIEF PROVISIONS UNDER THE ACT

Sections 90 and 91 of the Income tax Act, 1961 provide for double taxation relief in India.

Agreement with foreign countries or specified territories - Bilateral relief

[Section 90]

Section 90 (1) provides that the Central Government may enter into an agreement with the Government of any country outside India or specified territory outside India,—

(a) for the granting of relief in respect of—

(i) income on which income-tax has been paid both in India and in that country or

specified territory; or

(ii) income-tax chargeable under this Act and under the corresponding law in force

in that country or specified territory to promote mutual economic relations, trade and investment; or

(b) for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country or specified territory; or

Accordingly, the Central Government has notified that where such an agreement provides that any income of a resident of India may be taxed in the other country then, such income shall be included in his total income chargeable to tax in India in accordance with the provisions of the Income-tax Act, 1961, and relief shall be granted in accordance with the method for elimination or avoidance of double taxation provided in such agreement.

(c) for exchange of information for the prevention of evasion or avoidance of income tax chargeable under this Act or under the corresponding law in force in that country or specified territory or investigation of cases of such evasion or avoidance; or

(d) for recovery of income-tax under this Act and under the corresponding law in force in that country or specified territory.

The Central Government may, by notification in the Official Gazette, make such provisions as may be necessary for implementing the agreement.

(ii) Where the Central Government has entered into such an agreement with the Government of any country outside India or specified territory outside India for granting relief of tax, or for avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.

(iii) Any term used but not defined in this Act or in the agreement referred to above shall have the same meaning as assigned to it in the notification issued by the Central Government in the Official Gazette in this behalf, unless the context otherwise requires, provided the same is not inconsistent with the provisions of this Act or the agreement.

(iv) The charge of tax in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable, shall not be regarded as less favourable charge or levy of tax in respect of such foreign company.

The position of law is that the double taxation avoidance treaties entered into by the Government of India override the domestic law. This has been clarified by the CBDT vide circular no.333 dated April 2, 1982, which provides that a specific provision of the DTAA will prevail over the general provisions of the Income-tax Act. Therefore, where a DTAA provides for a particular mode of computation of income, this mode will take precedence over the Income-tax Act.

However, where there is no specific provision in the treaty, then the Income tax Act will apply.

Models of Treaties

Tax treaties are generally based on certain models. The most common ones are :

(i) OECD model (Organisation of Economic Co-operation and Development) - Most of India’s treaties are based on this model.

(ii) U.N. models Double Taxation Convention, 1980 between developed and developing countries.

Double taxation relief to be extended to agreements (between specified associations) adopted by the Central Government [Section 90A]

(i) Section 90A provides that any specified association in India may enter into an agreement with any specified association in the specified territory outside India and the Central Government may, by notification in the Official Gazette, make the necessary provisions for adopting and implementing such agreement for -

(1) grant of double taxation relief,

(2) avoidance of double taxation of income,

(3) exchange of information for the prevention of evasion or avoidance of income- tax,

or

(4) recovery of income-tax.

Section 90A(1) provides that an agreement may be entered into by any specified association in India with any specified association in the specified territory outside India which may be adopted by the Central Government by way of notification in the Official Gazette, for granting relief of tax or, as the case may be, for avoidance of double taxation.

The Central Government has, vide Notification No.90/2008 dated 28.8.2008, notified that where such an agreement provides that any income of a resident of India may be taxed in the other country then, such income shall be included in his total income chargeable to tax in India in accordance with the provisions of the Income-tax Act, 1961, and relief shall be granted in accordance with the method for elimination or avoidance of double taxation provided in such agreement.

(ii) In relation to any assessee to whom the said agreement applies, the provisions of the Income-tax Act shall apply to the extent they are more beneficial to that assessee.

(iii) Any term used but not defined in the Income tax Act or in the said agreement shall have the same meaning as assigned to it in the said notification, unless the context requires otherwise, and it is not inconsistent with the provisions of the Income tax Act or the said agreement.

(iv) The charge of tax at a higher rate for a company incorporated in the specified territory outside India as compared to a domestic company would not be considered as less favourable charge or levy of tax in respect of such company.

(v) For the purpose of this section, the ‘specified association’ means any institution,

association or body, whether incorporated or not, functioning under any law for the time being in force in India or the laws of the specified territory outside India and which may be notified as such by the Central Government and ‘specified territory’ means any area outside India which may be notified by the Central Government.

CASE ANALYSIS:

Question1: X Ltd is an Indian company . For the previous year 2012-13. The following incomes are noted from the books of  accounts of the tax payer –

Income from the business in India                                                      Rs 380,000

Income from a business in a foreign country with which india has an ADT Rs 216,000.

According to the ADT agreement Rs 216,000 is taxable in india. However it can also be taxable in the foreign country @17.5%. this foreign tax can be set off against the Indian tax.

Answer:

Computations of income tax of X Limited:

	Indian tax	Foreign tax
Income from the business in India	380,000	-
Income from a business in a foreign country	216,000	216,000
Net income	596,000	216,000
Tax in india @30.9%	184,164	-
Tax in the foreign country@17.5%	-	37,800
Less: Tax paid in the foreign country	37,800	-
Tax payable in india	146,364	-

Question 2: X is 28 years old and is resident in india . His income is Rs 896,000 from a business in india and Rs 192,000 from a business in a foreign country with whom india has an ADT agreement. According to the ADT agreement , income is taxable in the coutry in which it is earned and not in the other country. However such income would be included for calculation purpose of tax rate.

Countries with which no agreement exists - Unilateral Agreements [Section 91] :

In the case of income arising to an assessee in countries with which India does not have any double taxation agreement, relief would be granted under Section 91 provided all the following conditions are fulfilled:

(a) The assessee is a resident in India during the previous year in respect of which the income is taxable.

(b) The income accrues or arises to him outside India.

(c) The income is not deemed to accrue or arise in India during the previous year.

(d) The income in question has been subjected to income-tax in the foreign country in the hands of the assessee.

(e) The assessee has paid tax on the income in the foreign country.

(f) There is no agreement for relief from double taxation between India and the other country where the income has accrued or arisen.

In such a case, the assessee shall be entitled to a deduction from the Indian income-tax payable by him. The deduction would be a sum calculated on such doubly taxed income at the Indian rate of tax or the rate of tax in the said country, whichever is lower, or at the Indian rate of tax if both the rates are equal.

Conditions

The assessee shall be allowed relief in respect of such income under section 91 provided all the following conditions are fulfilled :-

(a) The assessee is a resident in India during the relevant previous year.

(b) The income accrues or arises to him outside India during that previous year.

(c) Such income is not deemed to accrue or arise in India during the previous year.

(d) The income in question has been subjected to income-tax in the foreign country in the hands of the assessee and the assessee has paid tax on such income in the foreign country.

(e) There is no agreement under section 90 for the relief or avoidance of double taxation between India and the other country where the income has accrued or arisen.

TREATY OVERRIDES DOMESTIC LAW:

The specific provisions of the Agreement for Avoidance of Double Taxation should override the general provisions of the Income Tax Act 1961 clarified by circular of CBDT No 333 and Sec 90(2) of Income Tax Act 1961