Understanding Double Taxation and Double Taxation Avoidance Agreements (DTAAs)
Nikita Tejwani,
CA Nikita Tejwani, the founder of TaxForNri, hails from Gandhidham, Gujarat. A Chartered Accountant with a Diploma in International Financial Reporting Standards (IFRS) earned in December 2023, she brings a wealth of expertise and passion to the field. Driven by a mission to simplify financial and compliance challenges, Nikita is dedicated to empowering NRIs with tailored solutions that help them achieve their financial goals and maintain strong connections with their roots.
In today’s globalized world, individuals and businesses earn income in multiple countries. While this opens up numerous opportunities, it also brings tax complexities, including double taxation. This article explores the concept of double taxation, how it is addressed through Double Taxation Avoidance Agreements (DTAA), and the provisions under the Indian Income Tax Act, particularly Sections 90, 90A, and 91.
What is Double Taxation?
Double Taxation occurs when the same income is taxed twice in two jurisdictions. This typically arises when:
- Source Rule: Taxation of income earned within a country’s borders.
- Residency Rule: Taxation of a country’s residents on their global income.
For instance, if an Indian resident earns income in the USA, it may be taxed in both countries, leading to double taxation.
What is a Double Taxation Avoidance Agreement (DTAA)?
A DTAA is a bilateral treaty between two countries that prevents or mitigates double taxation. Its primary objectives include:
- Eliminating double taxation on the same income.
- Promoting cross-border trade and investment.
- Preventing tax evasion by fcailitating the exchange of information.
DTAAs achieve this by defining which country has the right to tax specific types of income and by offering tax relief through exemption or credit methods.
Types of Agreements to Avoid Double Taxation
1. Bilateral Agreements
- These agreements between the two countries are meant to avoid double taxation.
- Bilateral agreements typically allocate taxing rights and provide relief mechanisms to taxpayers.
2. Unilateral Relief (Section 91)
- If no DTAA exists between the two countries, India provides relief through unilateral measures.
- Section 91 of the Income Tax Act allows an Indian resident to claim a tax credit for taxes paid in a foreign country, even in the absence of a bilateral treaty.
Tax Relief Mechanisms Under DTAAs
1. Exemption Method
- The income is taxed in only one country and exempted in the other.
- Example: If a DTAA specifies that rental income is taxable only in the country of source, the resident country exempts this income from tax.
2. Credit Method - The income is taxed in both countries, but the resident country provides a tax credit for the tax paid in the source country.
- Example: If a resident of India earns income in the USA and pays taxes there, India allows a credit for the tax paid in the USA while taxing the remaining amount.
Relevant Provisions Under the Indian Income Tax Act
Section 90
- Governs agreements between India and foreign countries to grant relief in cases of double taxation.
- It ensures that taxpayers can benefit from the terms of the DTAA.
- Example: If a DTAA exists, taxpayers can opt for the provisions of the DTAA or domestic law, whichever is more beneficial.
Section 90A
- Covers agreements between India and specified associations of foreign countries (e.g., regional groupings such as SAARC).
- Provides relief similar to Section 90 but applies to agreements with associations rather than individual countries.
Section 91
- Provides unilateral relief in cases where no DTAA exists.
- It allows Indian residents to claim a tax credit for taxes paid in a foreign country, limited to the Indian tax liability on the same income.
Example of Tax Relief Under DTAA
Imagine an Indian resident earns $10,000 in the USA and pays 15% tax there. If India’s tax rate is 30%, the tax treatment would be as follows:
- Exemption Method: Income is taxed only in the USA, and India exempts it completely.
- Credit Method: India taxes the $10,000 at 30% (i.e., $3,000) but allows a credit of $1,500 for the tax paid in the USA. The net tax payable in India is $1,500.
Benefits of DTAAs
- Tax Savings: Reduces the overall tax burden on taxpayers.
- Clarity: Provides clear guidelines on the taxation of various types of income.
- Promotes Investment: Encourages cross-border trade and investment by eliminating tax uncertainties.
- Prevention of Tax Evasion: Facilitates exchange of information between countries.
Conclusion
Double taxation can be a significant challenge for global taxpayers, but mechanisms like DTAAs and unilateral relief ensure fair taxation. Understanding provisions like Sections 90, 90A, and 91 of the Indian Income Tax Act can help individuals and businesses optimize their tax obligations and avoid unnecessary financial strain.
If you’re earning income from multiple countries, consult a tax expert to navigate DTAAs effectively and maximize your tax benefits.
Disclaimer by Author
The contents are only a high-level commentary on tax and related regulations in India. This is neither an opinion nor a piece of advice. Also, these may not be subject to conditions that must be considered for decision-making purposes. It is recommended that advise is taken from experts or academicians if any business decision or practical implications are to be addressed. The write-up may broadly reflect the law as it stands on a date, however, there may be an inadvertent inaccuracy. Readers’ discretion is advised.
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