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A Guide to the Concept of Double Taxation

What is Composite Supply? A Complete Overview

The term "double taxation" describes the imposition of taxes on the same income in two distinct nations or by two distinct individuals. Income tax is levied twice when there is double taxation. One country may impose residence-based taxation at the source level while another country imposes a levy at the investor or payor levels. When two nations are involved—the one where you live and the other where you earned the return—taxation of returns becomes problematic. The question of "Which country's laws would be followed while taxing the returns?" becomes evident as a result. Would you pay two taxes? To address these queries and settle the tax consequences associated with money generated abroad, the Double Tax Avoidance Agreement was executed. Let us explain the concept of double taxation and its avoidance in detail.

 

Table of Contents

 

What is Double Taxation?

When income is taxed twice, it is referred to as double taxation. Either a juridical or an economic event may cause this. When income, or a portion of it, is taxed twice in the same nation to two different people, it is referred to as economic double taxation. On the other hand, legal double taxation happens when a person who earns money outside of India is taxed twice—once overseas and once in their nation of residence. Due to this particular circumstance, the taxpayer bears an excessive burden of double taxation on their income. Two primary forms of double taxation exist: 

  • Corporate double taxation is the term used to describe the taxation of corporate profits by both corporation and dividend taxes (paid on dividend distributions).

  • International double taxation is the practice of taxing foreign income in both the nation of residence for the investor and the nation from which the money is sourced.

Tax law frequently has an unintended consequence of double taxation. Due to the common perception that it is an undesirable aspect of the tax system, tax authorities attempt to avoid it wherever possible.


Implications of Corporate Double Taxation

Double taxation is a prevalent problem in the corporate sector, especially when profits are subject to corporation taxation. After being paid to shareholders, the dividends are subject to another round of taxation at the relevant rate. It basically means that the same earnings are subject to two different taxes, which can affect both small and large firms. Furthermore, the owners incur a double tax burden when they are also stockholders in the business. 

In addition to paying taxes on the dividends they get from the business's profits, they also have to pay extra income tax depending on their tax bracket. This hypothetical situation highlights the unexpected effects of tax rules on companies and their owners. Legislation, forming a corporation as a partnership, LLC, or sole proprietorship, skipping dividend payments, and having shareholders labour for the companies they control are just a few strategies to lessen corporate double taxation.


Strategies to Avoid Double Taxation

While the thought of paying your taxes twice is daunting, the good thing is that the situation is avoidable in most cases. Here are a few strategies that can help you prevent double taxation. 

  • Legislation: Laws Double taxation must be abolished by law since it is ineffective and discourages investment. If dividends are tax-free, investors are more likely to make larger investments, particularly in well-established companies with modest capital needs. Move-Through Taxation: Setting up the business as an LLC, partnership, or sole proprietorship and putting pass-through taxation elements in place are required. Because the owners or partners divide the profits, these kinds of arrangements don't pay dividends. However, the strategy is limited to small enterprises.

  • No Dividend Disbursements: maintaining earnings inside the business to support expansion rather than paying dividends. Start-ups and companies in the growth stage of their business life cycles can benefit from this strategy. It is necessary to increase product scope and market share. Investors expect dividend payments from established companies with steady cash flows and no need for new funding. 

  • Personal Income Tax Status of Each Individual: Shareholders are nonetheless liable for personal income tax on their compensation even if they are paid as employees in smaller companies or as executive directors in larger companies and get a salary. Double taxes would not apply in this situation.


Double Taxation Relief in the Income Tax Act

Residents have frequently paid income tax to another nation on their foreign income, but they are also obligated to pay tax in India on the same income. In these circumstances, there is double tax relief available. Two provisions (Sections 90 and 91) of the Income Tax Act of 1961  shield taxpayers against double taxation. Let us explain these in detail.


Bilateral Relief under Section 90

Avoidance of Double Taxation agreements assists in two ways under Section 90. The two elements of the bilateral relief include:

  • Method of Exemption: There will be no double taxation thanks to the exemption technique. In other words, income generated outside of India is not taxable in India if it has already been taxed in the relevant foreign nation. 

  • Utilising Tax Credits: Using this procedure, a tax credit (deduction) for taxes paid outside of India can be claimed by an individual or a corporation. The assessee's total tax obligation might be decreased by using this tax credit to offset the tax owed in India.


Unilateral Relief under Section 91

A person may receive unilateral relief from double taxation under Section 91 of the Income Tax Act of 1961. This section's provisions can exempt an individual from paying taxes to the government twice, regardless of the existence of a double taxation agreement (DTAA) between India and the foreign nation in question. Nonetheless, for someone to be qualified for unilateral relief, certain requirements must be met. These prerequisites are: 

  • The person or business must have resided in India during the preceding year.

  • The previous year's revenue ought to have accrued to the taxpayer and been received by them outside of India.

  • Both India and the nation with which there is no DTAA should have taxed the revenue.

  • The foreign nation required the person or business to pay taxes.


Understanding Double Taxation Avoidance Agreement

If you are a foreign resident with an income source in India, you will frequently be subject to taxes in both your home country and your country of residence. India has therefore put the Double Tax Avoidance Agreement (DTAA) policy into effect. India and another nation have signed a tax treaty to prevent double taxation. By invoking this treaty, an individual can avoid having to pay taxes twice. DTAAs can be specific agreements that only target certain types of income or they can be all-inclusive agreements that cover all types of income.

For example, income is taxed according to an individual's residence status under a Double Taxation Avoidance Agreement (DTTA) between Singapore and India. This guarantees that the person is not taxed twice for money generated outside of India and simplifies the tax process. At the moment, India has DTAAs with over 80 nations.


Conclusion

Double taxation is typically the result of legislation that affects different income levels at separate rates. While some revenues, like dividends, are taxed twice, others, like other types of income, are taxed only after they are expensed in the payor's books. Because of the frequent modifications to income tax regulations and the unique needs of every business, navigating the world of double taxation in the corporate sector can be difficult. Seek guidance from licenced tax attorneys and public accountants to understand the intricacies and determine the best course of action for your circumstances.


Frequently Asked Questions

Q1. What is the concept of double taxation?

When taxes are applied twice to one source of income, this is known as double taxation. This happens when dividends are subject to taxation. Just like people, businesses must pay taxes on their yearly income. Shareholders may be required to pay income tax on dividends that these firms subsequently distribute to them.



Q2. What is an example of double taxation?

Dividend income taxation is a common instance of double taxation at the corporate and investor levels. First, the dividend-paying corporation taxes its whole earnings. Dividends to the company's shareholders represent a fraction of the earnings after taxes.



Q3. Is double taxation legal?

Indeed, there is such a thing as double taxation and it is possible under certain conditions. Nonetheless, several nations have put in place tax treaties to stop or lessen double taxation of their citizens.



Q4. Can a taxpayer claim a tax deduction for double taxation?

If you pay taxes on the same income or assets in two different countries, you can be eligible for a tax deduction for double taxation. Seek advice from a tax expert for further details.



Q5. How can I avoid double taxation in India?

By utilising foreign tax incentives, tax treaties between nations, or tax-minimizing corporate structures, you may be able to prevent double taxation. To cease paying taxes twice on your income, you can also petition for relief under Sections 90, 90A, and 91 of the Income Tax Act. You can ask to be released from both foreign and domestic double taxes.



Q6. What are the problems with double taxation?

Double taxation is a prevalent concern for international enterprises. Both the nation in which the income is made and the nation in which the business is headquartered may impose taxes on it. There are instances when the total tax rate is so high that doing business internationally becomes unaffordable.



Q7. Are there any benefits to double taxation?

Even while double taxation is perceived as onerous for both individuals and corporations, it benefits the two taxing nations by bringing in money. The provision of infrastructure and public services can then be funded by this money.



Q8. With how many countries has India signed Double Taxation Avoidance Agreements?

India has double taxation avoidance agreements (DTAAs) with more than 90 nations; certain tax treaties provide reduced withholding tax (WHT) rates.



Q9. How can double taxation be avoided in international business?

Double taxation can be avoided through tax treaties, foreign tax credits, and tax exemption methods. Businesses often use these tools to ensure they are not taxed twice on the same income.



Q10. What is the difference between economic and juridical double taxation?

Economic double taxation refers to the same income being taxed twice in the hands of different taxpayers (e.g., a corporation and its shareholders). Juridical double taxation occurs when the same income is taxed twice in the hands of the same taxpayer by two different jurisdictions.



Q11. How do tax treaties help prevent double taxation?

Tax treaties between countries allocate taxing rights and provide relief mechanisms like tax credits or exemptions to avoid double taxation. They help in determining which country has the primary right to tax specific types of income.



Q12. What are foreign tax credits and how do they work?

Foreign tax credits allow taxpayers to reduce their domestic tax liability by the amount of tax paid to a foreign government. This mechanism helps prevent double taxation by ensuring that taxpayers are not taxed twice on the same income.



Q13. How does double taxation impact multinational corporations?

Double taxation can increase the tax burden on multinational corporations, affecting their profitability and cash flow. It may also influence their decisions on where to invest and how to structure their operations.



Q14. What role does the OECD play in addressing double taxation?

The OECD develops guidelines and models for tax treaties that help countries prevent double taxation and resolve disputes. The OECD's Model Tax Convention is widely used as a basis for negotiating tax treaties.



Q15. How do Controlled Foreign Corporation (CFC) rules relate to double taxation?

CFC rules are designed to prevent tax avoidance by taxing the income of foreign subsidiaries in the parent company's home country. These rules can sometimes lead to double taxation if the same income is taxed in both jurisdictions.



Q16. What is the impact of BEPS (Base Erosion and Profit Shifting) on double taxation?

The BEPS project aims to prevent tax avoidance by multinational companies. While it targets tax base erosion, it also addresses double taxation issues by promoting more consistent international tax rules.



Q17. Can pensions be subject to double taxation?

Yes, pensions can be subject to double taxation if the pension income is taxed in both the country of residence and the country where the pension was earned. Tax treaties often provide specific provisions to avoid this.



Q18. What is the 'relief by credit' method?

The relief by credit method allows taxpayers to offset the amount of tax paid to a foreign country against their domestic tax liability, thus preventing double taxation on the same income.



Q19. How does double taxation affect estate and inheritance taxes?

Double taxation can occur in estate and inheritance taxes if both the country of the deceased's domicile and the country where the assets are located claim taxing rights. Tax treaties and domestic laws often provide mechanisms to mitigate this.



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