An Introduction to Double taxation Avoidance Agreement.

Introduction

With the exponential growth of trade and commerce in the globalised era, the spectrum of taxes associated with it has also expanded with it. However, the question remains, which country will be the recipient of taxes paid by the corporation- the origin country or the source country? As a solution to this, the treaty of Double Tax Avoidance Agreement or DTAA came into being. DTAA entailed a treaty or an agreement between two sovereign states ensuring that a corporation has to pay all the associated taxes to the trade and commercial practice only once and to the one country as per the agreement. In essence and as noted in the case of Laxmipat Singhania v. CIT[1], the principle governing the law of taxation dictates that the one income can’t be taxed twice, establishing the DTAA as a statute under the Income Tax Act.

Double Tax[Image Source:Istock]

Illustration

A company XYZ originating from country A has invested in trade in the source country B. The debate arises which country is liable for collecting the tax, or are both the countries which are liable?

So according to the DTAA, to ensure there is no tax evasion or the company is paying double tax for single operation, the company will only pay tax to one country as per the agreement formed between them.

Thus in essence we can say that, in order to prevent the hassle occurred due to improper taxation methods across the globe, DTAA ensured that the agreement covered all the bullet points related to the operation and tax regime[2]. In this blog, I will be focusing on the impact of DTAA in the taxation regime from the perspective of International laws. I will be talking about and analysing the need and interpretation of DTAA.

The OECD Model

The extensive network of tax treaties that has grown since the work of the League of Nations in the 1920s is the foundation of the tax treaty system. Following the League of Nations’ demise and replacement by the United Nations, OECD assumed the lead in developing the tax treaty system. The OECD Model and Commentary, as well as publications on specific topics, are the primary means through which the OECD guides tax treaty system norms[3]. The OECD Model serves as the framework for tax treaties between OECD countries. The inclusion of the OECD in the tax treaties of both OECD and non-OECD nations is a notable success as governments vigorously preserve their sovereignty and tax jurisdiction[4].

Objective

The goals of OECD were to “clarify, standardize and confirm the fiscal situation of taxpayers who are engaged in commercial, industrial, financial, or any other activities in other countries through the application by all countries of common solutions to identical cases of double taxation[5].” Moreover, the OECD Model seek to implement a uniform form to support economic development and collaboration, as well as combating poverty via the promotion of economic stability.

  1. It also assures that the environmental impact of economic and social development is constantly taken into account.
  2. Over the years, the OECD has helped to enhance living standards in a number of nations.
  3. It has also aided in the rise of global trade.

Double Taxation Avoidance Agreement

If we put it simply, the Double Taxation Avoidance Agreement is a bilateral treaty between two sovereign states[6] whose aim is to promote and foster trade and commerce while preventing double taxation on the same. However, it is relevant to note that, there are no specified uniform provisions regulating double taxation, making it a burden upon the players in the international arena to regulate and implement the concept for the sake of global trade and commerce[7]. Thus, integrating certain provisions produced by the League of Nations in their first Model Bilateral Convention[8] and domestic laws, the current form of DTAA is being implemented in the country.

The need

It could be argued that the genesis of the concept of double taxation is an outcome of the basic international agreements which used to be formulated between the friendly states containing provisions for non-aggression, trade, and exchange of information. Evolving on the same principle, the agreement of double taxation tried to regulate international trade and economics in the globalized era and amongst friendly or unfriendly states[9].

However, the theme remains that the need for the double taxation avoidance system is because:

  1. To incorporate drastic but significant changes occurring in the global economic system.
  2. To have a comprehensive but standardized agreement ensuring that there will be no violation of the rights of the taxpayers irrespective of their nationality and income brackets.
  3. Last but not the least, to avoid and alleviate the negative burden of international double taxation.

Advantages of DTAA

The advantages of DTAA go beyond the main reasoning of prevention of double taxation[10], under this agreement the following benefits also could be reaped:

  1. Tax Exemption: if the source country exempt tax on investments coming from the origin, then it will be known as tax exemption. For example, Country X imposes a 10% tax on capital gains. Now, tax exemption occurs when the government of country X (source country) declares that it will not collect tax on investment from country Y (origin country) and exempts country Y from tax on capital gains on investment.
  2. Lower Tax Rate: Similar to above situation, but here the source country instead of exempting the whole amount just simply lowers the tax rate. Thus, instead of a 10% rate, country X would only impose a 5% tax rate on capital gains from Country Y.
  3. Refund: Assume that company X from country A (origin country) invests in country B (source country) and pays INR 100/-  as tax on income earned in country B. (source country). Nation A (the origin country) may return the entire or a portion of the tax to firm X. In the notion of Double Tax Avoidance Agreement, this is known as a rebate (DTAA).

Important Clauses

  1. Types of relief methods: Section 90 and 91 of the Income tax act, 1961 deals with relief granted under DTAA, these two types of relief methods are:
  2. Bilateral Relief: Under this, the governments of two or more countries may enter into an agreement to provide relief by jointly determining how the relief is to be awarded by granting either tax exemption or relief.
  3. Unilateral Relief: Even if there is no mutual agreement between the two nations, the nation of origin provides this relief for tax paid by the business of origin.
  4. Types of Agreement: it is important to determine whether the agreement entered is a comprehensive or specific agreement. A comprehensive agreement would include all sorts of revenue from investment between the origin and source countries. Whereas, a specific agreement indicates that the agreement only applies to the money earned by the investment for which the two nations made the agreement.
  5. Tax on Dividend, Interest, Royalty and fees from technical services: Dividend, interest, royalties, and fees from technical services will be taxed where the recipient of the dividend, interest, or royalty lives. However, the question is whether such tax treaties would supersede the Income Tax Act. In the Vodafone South Ltd. case, the Karnataka High Court ruled that tax treaties take precedence over the Income Tax Act.
  6. Provision of Limits of Benefits (LOB) clause: To avoid abuse of the double taxation agreement, the nation’s include a section known as the Limitation of Benefits (LOB clause) in their agreement, which assesses which investments are done only to profit from the DTAA and which are legal investments[11].
  7. Concept of residence: as per the condition of the DTAA, the concept of residency has to be clarified for both individual and legal entities aka a corporation. As the former is liable to pay tax by having his domicile, place of incorporation, residence, and so on in that state, but excludes those who are only required to pay tax on income from other sources in that state. Following this technique, one may establish that a person is a resident of one of the signing states, and the treaty’s provisions will apply accordingly.

Whereas in the case of a corporation, the test is to determine the place of incorporation or effective management.

Conclusion

The Double Taxation Avoidance Agreement was basically brought upon to answer the age-old dilemma: which country will be the recipient of taxes paid by the corporation- the origin country or the source country? With NRI Tax payers comprising as prominent feature of globalisation, the DTAA indeed helped in eradicating ambiguity of the tax payers. The Agreement ensured that the exchange of mutual information is protected from getting misused as treaty shopping by the tax payers.

Author: Vaishali Prasad, Symbiosis Law School, Pune, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.

[1] (1969) 72 ITR 291 (SC)

[2] R. Santhanam, Handbook on Double Taxation Avoidance Agreements & Tax Planning for Collaborations, (5th Edn. 2001)

[3] Michael Kobetsky, The role of the OECD Model Tax Treaty and Commentary, in International Taxation of Permanent Establishments: Principles and Policy 152–178 (2011).

[4] Parth Upadhyay, 2021. UN MODEL TAX CONVENTION VS. OECD MODEL TAX CONVENTION: SIGNIFICANCE OF DISTINCTION.

[5] 2010 OECD Model, p. 7, para. 2

[6] Vinod Singhania & Monica Singhania, ‘Corporate Tax Planning and business Tax Procedure’ 205 (Taxmann, 1th Edn 2010)

[7] Chhavi Agarwal, Double Taxation Avoidance Agreement and Non-Discrimiantion Rule.

[8] The OECD Model Convention is often taken into consideration for interpreting the Agreements between the countries who are not the members of OECD though it is primarily meant for OECD member countries.

[9] See Reuven Avi-Yonah, Michael McIntyre and Victor Thuronyi, International Aspects of Income Tax, Chapter 18, International Aspects of Income Tax, Tax Law Design and Drafting, volume 2; International Monetary Fund: 1998.

[10] Thanvi, Irfan. (2022). THE DOUBLE TAXATION AVOIDANCE AGREEMENT (DTA) BETWEEN INDIA AND SINGAPORE-A CAUSAL ANALYSIS FOR NON-RESIDENT INDIANS (NRIS’s).

[11] P. Kanthi Visalakshi, LIMITATION OF BENEFITS CLAUSE EXPLAINED.

 

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