Solving your query regarding: What is Double Taxation Avoidance Agreement?

In a globalized world where businesses and individuals engage in cross-border transactions and investments, the issue of double taxation can be a significant concern. Double taxation occurs when a taxpayer is liable to pay taxes on the same income in more than one country. To mitigate this issue and encourage international trade and investment, countries often enter into Double Taxation Avoidance Agreements (DTAA), also known as tax treaties. These agreements provide a framework for resolving conflicts arising from overlapping tax jurisdictions and ensure that income is not taxed twice. In this article we will delve in to the concept of Double Taxation Avoidance Agreement.

Understanding Double Taxation

Double taxation can arise in two main forms: economic double taxation and juridical double taxation. Economic double taxation occurs when the same income is subject to tax in multiple jurisdictions due to the residence of the taxpayer in one country and the source of income in another. 

On the other hand, juridical double taxation takes place when two countries claim the right to tax the same income based on their respective domestic laws. These situations can lead to a significant tax burden on taxpayers, reducing the attractiveness of cross-border transactions and investments.

What is Double Taxation Avoidance Agreement?

A Double Taxation Avoidance Agreement (DTAA) is a bilateral agreement between two countries that outlines the rules for allocating taxing rights on various types of income generated by individuals and businesses that have connections to both countries. 

The primary objective of a DTAA Agreement is to prevent double taxation and provide clarity on the taxation of cross-border income. These agreements help facilitate international trade, investment, and economic cooperation by eliminating uncertainties related to tax liabilities.

The Role of Double Taxation Avoidance Agreements (DTAA)

DTAAs are bilateral agreements between two countries that aim to eliminate or reduce the incidence of double taxation. These agreements establish clear rules for the allocation of taxing rights between the contracting states and often include provisions to prevent tax evasion and promote cooperation between tax authorities.

India, recognizing the importance of facilitating international trade and investment, has entered into DTAAs with various countries. These agreements provide a framework for determining which country has the primary right to tax specific types of income. For instance, DTAAs typically allocate the right to tax business profits, dividends, interest, royalties, and capital gains arising from the alienation of property to either the residence country or the source country, depending on the nature of the income and the provisions of the agreement.

Key Features of Indian Double Taxation Avoidance Agreements (DTAA)

Indian DTAAs generally incorporate the following key features:

• Residence vs. Source Taxation: DTAAs specify the criteria for determining an individual or entity’s tax residency. The agreement ensures that the taxpayer is not subject to taxation on the same income in both the country of residence and the country where the income originates (source country).
• Reduction or Elimination of Withholding Tax: Withholding taxes often imposed on cross-border payments such as dividends, interest, and royalties, are typically reduced or eliminated under DTAAs. This reduction helps to encourage international trade and investment by ensuring that excessive taxes are not deducted at the source.
• Mutual Agreement Procedure (MAP): DTAAs establish a mechanism for resolving disputes between the contracting states regarding the interpretation and application of the agreement. The MAP allows the competent authorities of both countries to discuss and resolve these issues through consultation.
• Exchange of Information: DTAAs also promote transparency and cooperation between tax authorities by including provisions for the exchange of information. This assists in preventing tax evasion and promoting fair taxation practices.
• Savings Clause: Many DTAAs include a savings clause that allows a country to tax its residents based on its domestic laws, even if the income is not explicitly covered by the agreement. This clause helps protect the country’s right to tax certain income streams.

Rates under the Double Taxation Avoidance Agreement

The DTAA, which India has signed with other nations, specifies the rate at which tax must be deducted on income received to residents of that country. This means that when NRIs make income in India, the TDS Rates on DTAA’s applicable will be calculated using the rates specified in the Double Taxation Avoidance Agreement with that country. 

Double Taxation Avoidance Agreement: Section 89A of Finance Act, 2021

The Finance Act, 2021 added a new Section 89A to alleviate NRI burden caused by double taxation on money collected in overseas retirement accounts maintained with designated nations.

This section applies to “specified persons” – individuals who are Indian residents, opened an account in a notified nation while a non-resident of India, and are now residents of that country. 

A “notified account” is an account established for retirement benefits by a specific individual in the notified country, and income from such an account is not taxed on an accrual basis, but is taxable by that country on a receipt basis.

According to the new clause, such income shall be taxed in the way and year specified.

Determination of Applicability of Double Taxation Avoidance Agreement

To establish which Double Taxation Avoidance Agreement (DTAA) applies to your particular case, follow these steps:

• The DTAA only applies when a transaction is taxable in both India and another country. A non-resident (NR) or a Foreign Company (FC) should also be involved in the transaction.
• Determine the non-resident party’s residential status. 
• The DTAA Agreement between India and that country will apply.

Note: Click here to check the Countries that have a Double Taxation Avoidance Agreement with India.

Procedure to apply for Double Taxation Avoidance Agreement

The steps for determining how to apply DTAA are as follows:

• Tax responsibility under the Income Tax Act, 1961: Determine the type of income that is subject to the DTAA and its tax responsibility under the Income Tax Act, 1961.
• Tax responsibility under the DTAA: If the income falls under certain articles of the DTAA, it will be taxed in accordance with such articles.
• Finalise the Tax Liability: Using section 90(2), of the Income Tax Act, 1961 which determines the DTAA (Treaty Override) is more favourable.

Note: If the NR/FC has a Permanent Establishment (PE) in India, general taxation provisions apply.

Documents required for receiving DTAA Benefits

To benefit from the requirements of the DTAA, an NRI individual must provide the following documentation to the relevant deductor in a timely manner.

• Format for self-declaration and indemnity
• PAN Card copy that has been self-attested
• Copy of self-attested visa and passport
• (If applicable) PIO proof copy
• TRC (Tax Residency Certificate)

The Finance Act, 2021 states that unless a person gives a Tax Residency Certificate to the deductor, they are not eligible to claim any benefits of relief under a Double Taxation Avoidance Agreement. Application for Certificate of Residence for Purposes of an Agreement Under Sections 90 and 90A of the Income-Tax Act, 1961 (Form 10FA) must be made to the income tax authorities in order to get a Tax Residency Certificate. The certificate will be issued in Form 10FB once the application has been handled properly.

Conclusion

Double Taxation Avoidance Agreements play a crucial role in promoting international trade, investment, and economic cooperation by avoidance of double taxation. India’s extensive network of DTAAs reflects its commitment to fostering a business-friendly environment and attracting foreign investment. These agreements provide clear guidelines for the taxation of various types of income, prevent tax evasion, and establish mechanisms for resolving disputes. As the global economy continues to evolve, DTAAs remain a vital tool for ensuring fair and efficient taxation in a cross-border context.

Connect with our Tax Consultant at Legal Window; they will guide you through the entire technicalities of Taxation related to NRI and DTAA’s.