Double Taxation Avoidance Agreements (DTAAs) are treaties between two countries to prevent people or companies from being taxed twice on the same income. These treaties ensure that taxes are paid in only one country, avoiding the issue of paying taxes on the same income in both places.
By identifying which country has the exclusive right to tax such income, DTAAs reduce the problem of taxation in the same country and encourage international business and investment.
Read on to learn how knowledge of DTAAs may affect your income tax, save you some money, and help you comply with international taxation laws.
What is Double Taxation?
When two or more taxes are levied on a given income, the implementing jurisdictions refer to this as double taxation. This usually occurs when a person or a company has some revenue source in another country and is liable to taxes in their country of residency and source.
For instance, when an individual is employed in another country or is an expatriate, he or she can be required to remit income tax to both the foreign country he or she is working in and the home country.
Understanding Double Taxation Avoidance Agreement (DTAA)
DTAA, or the Double Taxation Avoidance Agreement, is a tax treaty between any two countries in the world. It is aimed at conditions when a person or company may become a taxpayer on the same income in the two countries.
Structure and Scope
DTAAs are comprehensive documents that cover various types of income, including but not limited to:
- Employment income
- Business profits
- Dividends, interest, and royalties
- Capital gains
- Other emoluments, such as pensions and other retirement benefits
Key Components
- Residency Rules: DTAAs prescribe how to assess whether an individual or a company is a tax resident.
- Taxing Rights: They determine which contracting states are entitled to tax various kinds of income.
- Tax Rates: Most DTAAs cap the tax that may be levied on different categories of income.
- Dispute Resolution: These agreements contain provisions related to settling disputes between the tax authorities.
Objective of DTAA
DTAA Duration and Rates
Most Double Taxation Avoidance Agreements (DTAAs) are drafted for long-term use. These agreements don’t have a specific expiration date but will continue until formally withdrawn with the consent of the involved parties.
The rates and regulations included in DTAAs differ from country to country due to special agreements between the parties. For instance, the Tax Deducted at Source (TDS) rates on interest earned generally range from 7.50% to 15%, with most countries settling at 10% or 15%.
How to Determine If DTAA is Applicable?
The table below shows the steps for determining if DTAA is applicable:
| Steps | Details |
| Identify the Countries | Find out the country of residence and the country in which income is received.
Check if there is a DTAA between these two countries. |
| Establish Residency Status | Check your tax residency in the two countries.
DTAAs are usually made concerning residents of one or both contracting states. |
| Categorise the Income | Determine the nature of income received, such as wages, business income, interest, or dividends.
Some income types may receive different treatment under DTAAs. |
| Review DTAA Provisions | Review the DTAA document and analyse articles relevant to your income type.
Pay attention to definitions, scope, and limitations |
| Understand Relief Methods | Find out if the DTAA uses an exemption or credit method for tax relief.
Learn how the relief applies in both countries. |
| Ensure Compliance | Ensure compliance with the paperwork requirements of both tax departments.
Submit the necessary documents to prove eligibility for DTAA benefits. |
Read Also: TDS on Sale of Property in 2024 – Complete Guide
Benefits of DTAA
It is important to note that Double Taxation Avoidance Agreements (DTAAs) provide more benefits than simply avoiding double taxation.
- These bilateral treaties are vital in promoting international economic relations, improving the flow of cross-border investments, and ensuring the effectiveness of taxation.
- DTAAs have a positive impact by improving the understanding and certainty of taxes and assisting individuals, businesses, and governments.
- They act as measures against the evasion of taxes and ensure international fiscal cooperation between different nations.
Example of DTAA and Its Impact on Income Tax
To illustrate, imagine an Indian software engineer, Priya, landing a 10-month contract job in the US. An employee of the Lansing-based corporation, Priya has an income of $100,000 in the US.
1. Without DTAA:
Priya pays 25% tax, which is $25,000 in the US. If she returns to India, she must pay 30% of the tax on her total annual income. In India, she would pay an additional $30,000 in taxes, making the total tax payable $55000.
2. With India-US DTAA:
According to the treaty, the United States has the primary right to tax income earned there.
India, the country of residence, also has the right to tax global income.
3. Tax Calculation:
- Priya spent $25,000 as tax in the United States.
- For her, the tax liability in India is $30,000.
- She can still assert a credit for the $25,000 that was paid to the U.S.
- To sum up, the additional amount which is needed to be paid by Priya is only $ 5000 in India.
4. Outcome:
- Total tax paid: $30,000 ($25,000 in the US + $5,000 in India)
- Tax saved due to DTAA: $25,000.
Read Also: What are the Tax Benefits on Under Construction Properties?
Basic Principles of DTAA
- Residence Principle: DTAAs provide specific guidelines on ascertaining whether a person or an organisation is a tax resident. This principle assists in determining which country has the primary right to tax the taxpayer’s global income.
- Source Principle: This principle enables the country where the income was earned or the source country to assess that income, irrespective of the taxpayer’s domicile.
- Elimination of Double Taxation: DTAAs contain techniques of how to prevent or at least reduce the problem of double taxation, which is typically done through:
- Exemption Method: Under this technique, dividends received from a foreign country are taxed solely in the taxpayer’s home country, not in the country where the dividends were obtained.
- Credit Method: Where the tax has been paid in one country, it is set off against tax payable in another country.
- Exchange of Information: Treaties help exchange information between revenue bodies to curb tax evasion and ensure that the agreement’s provisions are properly applied.
Double Taxation Avoidance Agreements (DTAAs) are essential for those involved in international cross-border activities in the contemporary economy. To improve their international tax situation, taxpayers should consider the principles and benefits of DTAAs.
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FAQs
1. What is a Double Taxation Avoidance Agreement (DTAA)?
The Double Tax Avoidance Agreement (DTAA) is a tax treaty between two contracting states. It is signed to make a country more desirable for foreign investors and to give NRIs relief from being taxed twice.
2. Why is DTAA important for global investors and expatriates?
DTAA assists in avoiding over-taxation or large cash outflows for NRIs/Persons of Indian Origin (PIO)/Overseas Citizens of India (OCI), as the same income is considered taxable in two or more countries.
3. What are the benefits of a DTAA for foreign companies operating in India?
A DTAA benefits foreign companies in India because it eliminates the possibility of them being taxed twice on the same amount of revenue, once in their home country and another in India.
4. How do I apply for benefits under a DTAA in India?
The following are the steps one must follow when intending to claim benefits under a DTAA in India:
- The applicant should also secure a Tax Residency Certificate (TRC) from the tax authorities of his/her home country.
- Form 10F must be filed in India with details such as address, country of residence, and TRC information if required.
- Form 10F and TRC must be filed with income tax returns or when taxes are being withheld in India.
- Follow the Indian tax laws and the provisions of the DTAA to avoid any discrepancies in the correct implementation of the treaty benefits.
5. What documentation is required to claim benefits under a DTAA in India?
Below are the documents needed while claiming DTAA benefits in India
- Tax Residency Certificate.
- An indemnity or self-declaration form.
- Photocopy of the PAN card the candidate has filled in herself/ himself.
- Self-attested visa.
- Original valid PIO proof copy to substantiate that the applicant is of Indian origin.
- Passport Xerox (self-attested).
