What is Double Taxation Avoidance Agreement : Let’s understand

27 Jan What is Double Taxation Avoidance Agreement : Let’s understand

What is Double Taxation Avoidance Agreement- Today Current Affairs

Multinational companies are operating across multiple countries/tax jurisdictions nowadays in the age of globalization. Many times they are supposed to pay taxes in two countries,  one where they are registered and another where they are operating their businesses On the same income. This is creating the incidence of double taxation, Which has also  led to the misuse of certain loopholes in the taxing laws of different countries. 

The foreign investors/shareholders  are also facing the burden of a similar  double taxation problem. 

The governments across the world have traditionally seen this as their losses in tax revenue. 

Any country has its own international taxation laws which can be broadly divided in two. 

First, when the income is earned in a foreign country by the resident individuals or domestic companies,  means in respect of India the Indian company or Indian citizen has earned  income outside the country. 

On this income India can also take tax and the country in which this income is earned,  obviously will take tax. 

Secondly when income is earned in the domestic territory by foreign companies for foreign residents, Means  in respect of India, the foreign companies for foreign residents have earned an income inside India. Here on this income along with India the foreign country where companies are registered, can also take tax. 

The implication of the taxation of foreign income (say in US) for one country (say India – resident country) is the same as the taxation (by India) of a non-resident  for another country (say US -source country). This leads to double taxation on the same income, one by the resident country  and second by the foreign country ( source country). 

This dual taxation hinders the flow of capital and demotivates the foreign investment. To avoid this the two governments enter the treaties of double taxation avoidance agreement. Under double taxation avoidance agreement, an individual (shareholder) or company will  either pay taxes to only one country ( source of income country) or will be eligible for the credit (Input tax credit to be given by the source country) on taxes paid by the resident country On the same income. 

This rationalization in the taxation system is helpful in income tax recovery in both the countries, along with a rational and equitable allocation of  taxing rights over a taxpayer’s income  between two countries. This kind of agreement potentially promotes free flow of investment, technology and International trade; and enhances the transparency. 

There are various relief mechanismTo avoid the incidence of double taxation.  

Bilateral relief: The Hindu Analysis

Section 90/90A of the Income Tax Act, 1961 contains provisions granting foreign tax credit under DTAA. When there is an agreement between two countries, relief is calculated according to mutual agreement between such countries. Bilateral relief can be granted by either of the following methods:

• • Deduction method: The domestic country allows its taxpayer to claim a deduction for taxes, including income taxes, paid to a foreign government in respect of foreign source income.
    This method does not fully avoid double taxation but just saves tax by the amount of Foreign Tax Paid x Domestic Tax Rate.
  • Exemption method: The domestic country provides its taxpayer with an exemption for foreign source income. This method is more favorable if tax rates in domestic countries are higher than those in the source country.

Credit method: The Hindu Analysis

• • Ordinary credit: Domestic country gives either full or partial credit of taxes paid in the foreign country. This means that the taxpayer will be taxed on the same sourced income and the tax is to be determined accordingly – but the taxpayer will pay a lower amount of taxes to the extent of credit available.
  • Underlying credit: In this method, the taxes paid on the profits from which the dividend is declared can be claimed as credit against the taxes payable on the dividend income.
• Tax sparing/holiday: To incentivize economic activities, various tax exemptions are given, which help the assessee limit the tax burden. For example, deduction under Section 80-IB of Income Tax Act, 1961. Whenever the assessee is liable to taxation in their domestic country, credit will be allowed for taxes paid in the foreign country, but due to tax exemption in such foreign territory there will be no tax payment and no credit to balance of the taxpayer. Under this method, the domestic country will deem such exempt income as tax paid and credit of such taxes which are deemed to be paid in the foreign country will be allowed as credit in the domestic country.

Unilateral relief for Indian residents: The Hindu Analysis

Some countries provide relief of taxes paid in the source country without any treaty between those two countries. This kind of relief is known as unilateral relief. In India, unilateral relief from double taxation is provided to Indian residents under Section 91 of the Income Tax Act.

Social Security Agreements

India has also concluded various Social Security Agreements (SSAs) to ease the social security obligations on cross-border / international workers. Under these SSAs, incentives such as detachment, exportability of pension, totalization of benefits, and withdrawal of social security benefits are available.

India has entered into SSAs with the 20 countries, like Australia, Austria, Belgium, Canada, Japan, Switzerland, Netherland, Sweden, Norway,  Germany, Hungary, France, Finland, Portugal, etc. 

Here we mention all information about What is Double Taxation Avoidance Agreement- Today Current Affairs.

Md Layeeque Azam, Economics Faculty

MD. Layeeque Azam

Plutus IAS Current Affairs Team Member