Double Taxation Avoidance : Tax Treaty and relief under section 90/90a/91 of the Income Tax Act
In today's modern world of advanced globalisation, business is not restricted to a single geographical territory and crosses all borders of the countries. This had emerged a complex world of business along with the complex world of Accounting and Finance.
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The taxation of income can be based on two things: Source of Income basis and
Residential status basis. Therefore, the possibility of double taxation arises.
Resident:
The country has a right to tax the profit earned on its land by anyone and to tax the global income of its residents. This leads to taxation of the same income more than once in different countries. In times when economies are going global, and borders are fading, double taxation is one of the significant obstacles to the development of inter-country economic relations.
Types of Relief under Sections 90 and 91
To prevent this hardship and to avoid the double taxation of the same income, relief under section 90/90a/91 is provided to the taxpayer in the following manner.
Bilateral Relief through DTAA (Sections 90 and 90A):
Double Taxation Avoidance Agreements Harmony: Sections 90 and 90A empower the Central Government to forge DTAA with other countries, laying the foundation for harmonious tax cooperation.
Exemption Method: A particular Income is taxed in only one of the two countries.
Tax Credit Method: Income is taxable in both countries in accordance with their respective tax laws read with double taxation avoidance agreement. However, the country of residence of the taxpayer allows him credit for the tax charged thereon in the country of source.
Unilateral Relief:
When there is no agreement between the two countries, the county of the residence itself provides relief.
What are the Relief u/s Sections 90 and 90A?
Under Sections 90 and 90A, relief applies exclusively to Indian residents, provided that India has established a Double Taxation Avoidance Agreement (DTAA) with the foreign country or a specified association where the taxpayer has earned income. If a DTAA exists with the concerned country, taxpayers can seek relief under Section 90, while relief under Section 90A can be claimed if the agreement is with specified associations.
These DTAA arrangements allow the Indian government to negotiate various terms with foreign governments, encompassing:
Relief for Taxed Income: Providing relief concerning income already taxed under the Income Tax Act and the tax laws of the foreign country.
Avoidance of Double Taxation: Preventing the occurrence of double taxation on the same income under the tax laws of both India and the foreign country.
Exchange of Information: Facilitating the exchange of information and data between countries to prevent tax evasion, investigate potential tax avoidance, and aid in the recovery of income tax.
In cases where a bilateral agreement has been established, taxpayers hold the flexibility to choose the taxation method that is more beneficial to them—whether under the terms of the DTAA or the standard provisions of the Income Tax Act.
This approach ensures that Indian residents engaged in international transactions have the option to optimise their tax liabilities based on the specific terms negotiated in the DTAA, providing a level of flexibility and fairness in cross-border taxation.
Calculating foreign tax credits involves several steps and considerations, particularly when computing double taxation relief under section 90 of the Income Tax Act. Here is a breakdown of the process:
1. Separate Computation for Each Income Source:
Compute the foreign tax credit separately for each source of income.
Calculate it as the lower of the tax payable on that income under the Income Tax Act and the foreign tax paid.
2. Conversion of Foreign Currency:
Determine the foreign tax credit by converting the foreign currency at the Telegraphic Transfer Buying Rate (TTBR) on the last day of the month immediately preceding the month in which the foreign tax was paid or deducted.
3. Total Foreign Tax Credit:
The foreign tax credit is the sum of credits computed separately for each source of income arising from a particular country.
For computing double taxation relief under section 90:
1. Compute Total Income: Calculate the aggregate of Indian income and foreign income.
2. Tax Calculation on Total Income: Compute the tax on the total global income under the Income Tax Act.
3. Average Tax Rate: Determine the average tax rate by dividing the tax amount by the global income.
4. Calculate Tax on Foreign Income: Multiply the average tax rate by the foreign income to compute the amount.
5. Compute Tax Paid in a Foreign Country: This represents the relief for double taxation, taking into account the average rate of tax on global income.
What are the Relief u/s Sections 91?
Under Section 91 of the Income Tax Act in India, relief is available to Indian residents only when there is no Double Taxation Avoidance Agreement (DTAA) with the country where the income is earned. This relief is granted on a voluntary basis by India in the absence of bilateral agreements.
Conditions to claim relief under section 91
Certain conditions must be met to be eligible for relief under Section 91 of the Income Tax Act. These conditions include:
(a) The income is taxable in India, and the taxpayer is a resident in India during the previous year, with the income accruing or arising outside India.
(b) The income should accrue or arise outside India during the previous year.
(c) The income in question has already been subjected to income tax in the foreign country.
(d) The taxpayer has paid tax on the income in the foreign country.
(e) There is no existing Double Taxation Avoidance Agreement between India and the country where the income has accrued or arisen.
If an individual meets these conditions, and there is no bilateral tax agreement between India and the relevant foreign country, the taxpayer can claim relief under Section 91. In such cases, if the income is subject to taxation in both India and the foreign country, the taxpayer is entitled to deduct the lower of the following two tax amounts from the income tax payable in India for that doubly taxed income.
(i) Tax on such doubly taxed income at the rates applicable in India, which shall be computed as follows:
Tax on Total Income in India × Such doubly taxed income
一一一一一一一一一一一一一
Total Income in India
(ii) Tax on such doubly taxed income at the rates applicable in foreign countries, which shall be computed as under:
Tax paid in foreign country
一一一一一一一一一一一一一一一一一一一一 × Such doubly taxed income
Total income assessed in foreign country.
Tie-breaker rule in Double Taxation Avoidance Agreements (DTAA)
A tie breaker rule is a provision in Double Taxation Avoidance Agreements (DTAA) designed to resolve situations where an individual or entity could potentially be considered a tax resident in more than one country. The tie breaker rule helps determine the individual's or entity's residence for tax purposes, thereby avoiding dual residency and potential double taxation.
Typically, a tie breaker rule considers a series of criteria to assign tax residency when there is a conflict. Common criteria include
1. Permanent Home- The country where the individual has a permanent home is considered the country of residence.
2. Habitual Abode - If the individual has a habitual abode (regular residence) in one country, that country is considered the country of residence.
3. Center of Vital Interests - The country where the individual's personal and economic interests are predominantly located is considered the country of residence.
4. Nationality - If the individual is a national or citizen of one of the countries in question, that country may be considered the country of residence.
The tie-breaker rule aims to provide clarity and avoid conflicting claims of tax residency between two countries. It ensures that an individual is treated as a tax resident in only one country for a specific period, preventing the double taxation that might arise if both countries were to tax the same income. The specific criteria and rules can vary between different DTAA agreements, and taxpayers should refer to the specific terms outlined in the relevant agreement between the countries involved.
Critical Benefits of Relief under section 90/90a/91:
Avoidance of Double Taxation: The primary goal is to prevent the same income from being taxed in both the country of residence and the source country, ensuring fairness and promoting international economic activities.
Promotion of Economic Cooperation: By providing a clear framework for taxation, these sections encourage cross-border trade and investment, fostering economic cooperation between nations.
Dispute Resolution Mechanism: A Mutual Agreement Procedure (MAP) under DTAA allows for resolving disputes, ensuring a fair and impartial resolution in case of disagreements between tax authorities.
Prerequisite for claiming relief
The regulations governing the claiming of foreign tax credit are outlined in Rule 128 of the Income Tax Rules, with key provisions summarised as follows:
1. Eligibility and Timing:
Indian residents can claim the foreign tax credit if tax has been paid in a foreign country.
Credit can be claimed in the year when the corresponding income is assessed or offered to tax in India.
The credit can be claimed proportionally if income is assessed over multiple years.
2. Applicability of Credit:
Foreign tax credit is applicable against tax, surcharge, and cess under Indian tax laws, excluding interest, penalty, or fees.
3. Disputed Tax Credit:
The credit is not available for disputed foreign tax.
Once the dispute is settled, the taxpayer must provide evidence of settlement, payment, and a declaration within six months.
4. Required Documents for Claim:
Form No. 67 and a certificate or statement indicating income nature and tax details from a foreign tax authority or responsible deduction entity.
Statement signed by the taxpayer, accompanied by proof of payment or deduction.
5. Filing Deadline:
Documents must be submitted on or before the due date of filing the income tax return under Section 139(1) of the Income Tax Act.
How can taxpayers claim a foreign tax credit?
Rule 128 of the Income Tax Rules, 1962, provides guidelines on how taxpayers can claim a foreign tax credit for taxes paid in a country outside India. The key points covered under Rule 128 include:
Eligibility Criteria: Taxpayers are eligible to claim a foreign tax credit if they are residents of India and have paid taxes on foreign income in a country with which India has a Double Taxation Avoidance Agreement (DTAA).
Availability of Credit: The foreign tax credit is generally available for the lower of the amount of foreign tax paid or the Indian tax payable on such foreign income. The credit is allowed in the year in which the income is offered to tax in India.
Evidence and Documentation: Taxpayers must provide evidence of the foreign tax payment and furnish necessary documents to support the claim for foreign tax credit. This may include a certificate from the tax authorities of the foreign country.
Calculation of Credit: The credit is calculated based on the amount of foreign tax paid or deemed to have been paid, as per the provisions of the Income Tax Act.
Do double taxation avoidance treaties (DTAA) override the Income-tax Act 1961 in India?
The statement is partially correct. Section 90(2) of the Income tax Act stipulates that in cases where the government has entered into a DTAA, the provisions of the Income-tax Act apply to the extent they are more beneficial to the taxpayer. This means that if there is a conflict between the provisions of the DTAA and the Income-tax Act, the provisions of the DTAA will prevail over the Act, but only to the extent that they are more advantageous to the taxpayer. However, the Income Tax Act will still prevail if its provisions are more beneficial than the DTAA's.
GAAR can have an overruling effect over the DTAA, even when the DTAA is more beneficial if the intention is to avoid tax through the misuse of the treaty. This emphasises the importance of adhering to the spirit and intent of tax laws, ensuring that benefits derived from international treaties are not misused for tax avoidance.
Note: Taxpayers should be mindful that while DTAA provisions may take precedence when more favourable, adherence to ethical tax planning practices is essential. Responsible tax planning ensures that benefits provided by international treaties are utilised within the intended framework, avoiding misuse and potential conflicts with GAAR. It's crucial to seek professional advice to navigate these complexities effectively.
Concept of Double Taxation Relief and how it relates to
"Double Taxation Relief" and "Double Taxation Avoidance" are related concepts, but they refer to slightly different aspects of international taxation.
1. Double Taxation Relief: Double Taxation Relief (DTR) is a broader term encompassing any mechanism or provision to provide relief to a taxpayer who may be subject to taxation on the same income in more than one jurisdiction.
The primary goal of Double Taxation Relief is to prevent the same income from being taxed twice, ensuring that the taxpayer does not face undue hardship due to overlapping tax obligations in different countries. Relief may be provided through various methods, including tax credits, exemptions, deductions, or bilateral tax treaties.
2. Double Taxation Avoidance: Double Taxation Avoidance (DTA) specifically refers to measures taken by countries to avoid or eliminate the double taxation of the same income. It is a more specific aspect of Double Taxation Relief.
The main objective of Double Taxation Avoidance is to create a framework, often in the form of bilateral tax treaties, to allocate taxing rights between two countries and prescribe rules for preventing or alleviating double taxation. DTA is typically achieved through negotiations between countries, resulting in agreements that specify which country has the primary right to tax certain types of income. These treaties often include provisions for tax credits, exemptions, or other mechanisms to provide relief.
Consequences of non-adherence
A) Default in Payment of Tax: The penalty, determined by tax authorities, will not exceed the outstanding tax amount.
B) Under-reporting of Income:
The penalty is 50% of the tax payable for under-reported income.
Increases to 200% if underreporting is due to misreported income.
C) Penalty for Fake Documents: The Assessee may face a penalty for false or omitted entries found by tax authorities.
D) Undisclosed Income:
a. Penalty for undisclosed income is 10%.
b. Search initiated on/after 15/12/2016:
30% penalty if disclosed during the search.
60% penalty in other cases.
FAQ
Q1. What is a Double Taxation Avoidance Agreement (DTAA)?
DTAA is a treaty between two countries to prevent the same income from being taxed twice. It outlines rules to allocate taxing rights between the countries involved.
Q2. How does DTAA benefit taxpayers?
DTAA helps taxpayers avoid double taxation by providing mechanisms for relief, such as exemption or credit, ensuring they don't pay taxes on the same income in their home and source country.
Q3. What is a Foreign Tax Credit (FTC)?
FTC is a mechanism to alleviate double taxation. It allows taxpayers to offset taxes paid in a foreign country against their home country's tax liability on the same income.
Q4. How is Foreign Tax Credit calculated?
FTC is generally calculated as the lower of the tax payable under the Indian Income Tax Act and the foreign tax paid. The conversion of foreign currency is done at the Telegraphic Transfer Buying Rate.
Q5. Who can claim Foreign Tax Credit in India?
Indian residents who have paid taxes in a foreign country or specified territory outside India are eligible to claim a Foreign Tax Credit.
Q6. How is the residential status of an individual determined under the Income Tax Act?
An individual's residential status is determined based on the number of days of physical presence in India during the financial year. The criteria include the "Resident," "Non Resident," and "Not Ordinary Resident" classifications.
Q7. Can an individual be a resident in two countries simultaneously under DTAA?
No, under the tie-breaker rules in most DTAA agreements, an individual can be a resident of only one country. The determination is typically based on factors such as permanent home and habitual abode.
Q8. What happens if there is a conflict between DTAA and the Income Tax Act?
If there is a conflict, the provisions more beneficial to the taxpayer prevail. Section 90(2) of the Income Tax Act ensures that the taxpayer gets the more advantageous treatment.
Q9. What is a tie-breaker rule in Double Taxation Avoidance Agreements (DTAA)?
A tie-breaker rule is a provision in DTAA that resolves dual residency issues by determining the tax residency of an individual in cases where more than one country claims residency.
Q10. Does the tie-breaker rule apply to all individuals covered by DTAA?
Yes, the tie-breaker rule is a standard provision in most DTAA agreements and is designed to apply when there is a conflict in determining an individual's tax residency.
By assigning tax residency to a single country, the rule ensures that an individual is subject to taxation in one country, avoiding conflicting claims and potential double taxation.
