Double Taxation Avoidance Agreement

Double Taxation Avoidance Agreement
20 June 2020

Double Taxation Avoidance Agreement

The double taxation avoidance agreement is an agreement which aids the taxpayer to get relief from double taxation on the same income. If India has signed any double taxation agreement with any foreign country; it means that the taxpayer of those countries does not have to pay the tax on the same income in both the countries. Therefore, double taxation avoidance agreement is a useful tool that helps the taxpayer to avoid “double taxation”.

In the case of claiming relief under double taxation avoidance agreement two essential things are needed to find out. These are:

  1. The country of residence.
  2. The source country.

The source country 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 country of residence rule specifies that the power to tax should rest with the country in which the taxpayer resides. If both rules apply concurrently to a business entity and it was to suffer tax at both ends, the cost of operating on an international scale would deter the process of globalization and would become prohibitive. It is from this point of view that Double Taxation Avoidance Agreements (DTAA) becomes very crucial.

The key purpose of the double taxation avoidance agreement is to give relief to the taxpayer from double taxation. A country entered into a double taxation avoidance agreement with a foreign state so that; by this agreement it can prevent double taxation of the same income in different countries. In India, section 90 and section 91 of the income tax act deals with the double taxation avoidance agreement.

Section 90 (2) of the Income Tax Act, 1961 explains that if India has double taxation avoidance agreement with any other foreign country then it is the assessee who will decide that which provision is more helpful for them and that provision will apply appropriately

To avoid paying tax on the same income twice, one can use the provisions of the Double Taxation Avoidance Agreement, a tax treaty that India has signed with many countries.

Every individual who is a legal resident of India is liable to pay taxes in India on her or his global income. However, non-residents have to pay tax only on the income earned in India or from an activity or a source carried out in India.

A resident of India is defined as a person who has been in India for a period of 182 days or more in the financial year or who has been in India for 60 days or more in a financial year and 365 days or more in the 4 years before that financial year.

Non-Resident’s definition under the Income Tax Act, 1961 is tied to the number of days of an individual’s stay in India during a particular financial year. A person is Non-Resident under IT Act if his stay in India does not exceed 181 days in a financial year (1st April to 31st March of next year).

The mechanism of double tax avoidance can be effected in either of the following two ways:

  1. Exemption Method: The Resident country exempts income earned in a foreign country.
  2. Tax Credit Method: It grants credits for the tax paid in another country.
Methods for Tax Benefits under DTAA 
  1. Exemption method: Under this method, income is taxed in only one of the two countries. According to the terms of the treaty with countries like Libya, Greece, and the United Arab Republic, income from Interest, Dividend, royalty, and fees for technical services are applicable. So for a citizen of these three countries, any income accruing in the form of, interest, dividend, royalty or fees for technical services arising in India, will be completely taxable in India and if for a resident if such income is arising in any of these three countries then the income will completely be taxed in these three countries and it will not be at taxed in India.
  2. Deduction method: Under this method, tax paid in the country of source is deducted from the Global income and then on residual amount income tax is paid.
  3. Credit method: Under this method, the country of residence includes income from the country of the source (India) in the total taxable income of the taxpayer and tax on the basis of such taxpayer’s total income (including income from the country where income was earned) is then computed. A deduction is permitted from its own taxes for taxes paid in the country where income was earned. There are some variations of the Credit method which are as follows :
    1. Ordinary credit method
    2. Underlying Tax Credit method
    3. Tax Sparing credit
Income Types under double Tax Avoidance Agreement 

Under the Double Tax Avoidance Agreement, NRIs don’t have to pay tax twice on the following income earned from :

  1. Services provided in India.
  2. Salary received in India.
  3. House property located in India.
  4. Capital gains on transfer of assets in India.
  5. Fixed deposits in India.
  6. Savings bank account in India.
Procedure for Claiming Relief from Double Taxation

The procedures which are needed to be followed for claiming relief from double taxation are as follows :

  1. Firstly it is necessary to find out “the country of residence” then the next step is to find out which provisions are there in the DTAA between the two countries.
  2. Then it is required to check that the person who claims “tax exemption” and tax credit” whether he paid tax in “the source country”. For this he has to submit the following documents to the tax-authorities as evidence. These are as follows :
    1. Tax Residency Certificate
    2. Self-attested Xerox of Pan Card.
  3. Self-attested Xerox of passport & visa.
  4. Self-declaration & identity form.