DOUBLE TAXATION AVOIDANCE AGREEMENT

By :SUKHDEEP SINGH

Double taxation traditionally occurs when a taxpayer is taxed twice on the same income by two jurisdictions (source jurisdiction & residence jurisdiction). Relief is usually made on a unilateral basis (domestic laws) or a bilateral basis (DTAs)..

The term 'double taxation' is additionally used, particularly in the USA, to refer to the fact that corporate profits are taxed and the shareholders of the corporation are (usually) subject to personal taxation when they receive dividends or distributions of those profits

DTAA

Objectives of DTAA

Avoiding and alleviating the adverse burden of international double taxation, by -1.laying down rules for division of revenue between two countries;2.exempting certain incomes from tax in either country;3.reducing the applicable rates of tax on certain incomes taxable in either countries.

Tax treaties help a taxpayer of one country to know with greater certainty the potential limits of his tax liabilities in the other country.

Another benefit from the tax-payers point of view is that, to a substantial extent, a tax treaty provides against non-discrimination of foreign tax payers or the permanent establishments in the source countries vis-à-vis domestic taxpayers.

Functions of DTAA

•DTAAs ensure that countries adopt common definitions for factors that determine taxing rights and taxable events. Crucial among these is the definition of a permanent establishment.

•Most treaties also specify a Mutual Agreement Procedure (MAP) which is invoked when interpretation of treaty provisions is disputed.

•To prevent abuse of treaty concessions, treaties increasingly incorporate restrictions and rules, such as a general anti-avoidance rule (GAAR), that allow tax authorities to determine if a transaction is only undertaken for tax avoidance or not.

•Benefit limitation tests and controlled foreign corporation (CFC) rules also place limits on claims of residence in countries eligible for treaty concessions.

PROVISIONS OF DTAA

Section 90 - Agreement with foreign countries or specified territories

Since the tax treaties are meant to be beneficial and not intended to put tax payers of a

contracting state to a disadvantage, it is provided in Sec. 90 that a beneficial provision under

the Indian Income Tax Act will not be denied to residents of contracting state merely because

the corresponding provision in tax treaty is less beneficial.

Section 90A -Double taxation relief to be extended to agreements adopted by the Central

Government

Section 91 -Countries with which no agreement exists-Unilateral Agreements

Some Double Taxation Avoidance agreements provide that income by way of interest, royalty

or fee for technical services is charged to tax on net basis.

TYPES OF RELEIFS

Bilateral reliefUnder this method, the Governments of two countries can enter into an agreement to provide relief against double taxation by mutually working out the basis on which relief is to be granted.

Bilateral relief may be granted in either one of the following methods: a. Exemption method, by which a particular income is taxed in only one of the two countriesb. Tax relief methods under which, an income is taxable in both countries in accordance with the respective tax laws read with the Double Taxation Avoidance Agreements. However, the country of residence of the taxpayer allows him credit for the tax charged there in the country of source.

Unilateral reliefThis method provides for relief of some kind by the home country where no mutual agreement has been entered into between the countries

METHODS OF ELIMINATING DOUBLE TAXATION

1.EXEMPTION METHOD

2.CREDIT METHOD

3.TAX SPARING

There are Two major types of DTAA Model

1.OECD MODEL

OECD Models are generally adopted by developed nations and their emphasis is on the residency based taxation.

2.UN MODEL UN Model emphasis is on the source based taxation and generally adopted by the developing nations.

COMPONENTS OF TAX TREATY

1.The date on which it come into effect.

2. Applicability–Applies to a person who is resident of one or both the countries There may be cases, when it has been found that the assesseeis resident in both the countries then tie-breaker rule has to apply to determine the residential status.

3.General Definitions – Article 3 of DTAA generally covers general definition of Person, Company, contracting state, Enterprise of a contracting state, Competent Authority, national etc, which all are applicable to the respective DTAA.

4.The Tax which it covers –What kind of tax the treaty covers should be known as there are different form of tax in different countries & the DTAA will provide the relief on the specified tax as mentioned in the DTAA.

CONTD….

•Permanent Establishment and its parameters

•The definition of concepts like immovable property, dividend, business profits, royalty, technical fees, salaries etc.

•.Different ways of tax-sharing depending upon the residential statute, permanent establishment, fixed base or tax sharing with both countries giving agreed part of relief.

•Stipulation as to the method of relief either by way of exempting income or where it is taxable, taxing it at stipulated rate, which may be lower than the domestic rate, or by unilaterally giving credit for tax paid in the other country.

•Exchange of information with special reference to the concept of associated enterprises primarily to tackle diversion of income to avail treaty benefit or evasion of tax in one or the other country

DTAA a Reality check

(a)DTAAs with countries from which India receives inward factor flows are unlikely to be beneficial to India.

(b) On the other hand, DTAAs with destinations for Indian outward factor flows may be beneficial to India.

(c) With two way factor flows between treaty partners, outward factor flows from India will largely determine if the DTAA benefits India or not.

In fact, the data available leaves little doubt that India's DTAAs, whatever their impact on factor flows, cause great loss of fiscal revenue due to FDI being routed through low tax countries .

Evidence of this is can be seen by comparing Tables

Direction of India’s Outward FDI

Trade data

Case Study : Vodafone Tax Dispute

One of the most controversial areas in taxation under the Indian Income Tax Act, 1961 in recent days has been the Vodafone tax controversy.

Several important questions of law in the area of taxation of non-residents – pertaining to both chargeability and machinery provisions – are at issue in the Vodafone controversy.

The case provides a useful backdrop for anchoring the theoretical arguments on the taxation of non-residents.

Vodafone Controversy: An Introduction The Supreme Court decided the long awaited tax

controversy between Vodafone International Holdings B.V (VIH) and Tax Authorities in India.

The Judgment led VIH benefited with Rs. 12,000 Cr. The Judgment is a landmark judgment and has laid the guidelines for deciding the taxability of income under some of the controversial provisions of the Income Tax Act, 1961 such as interpretation of Section 9 in the Indian Tax legislations.

However, the facts and circumstances play a decisive role. In this case, the motley assortment of the facts and

circumstances are jumbled to the extent that it was really hard to decide whether the income is taxable under the Act or not.

2010 January;- Vodafone replies to I.T notice saying I.T department doesn't have jurisdiction April;- Vodafone reaches 100 m customer in India May;- Price war in India cause Vodafone group plc to written down value of Vodafone

Essar by $2.3 Billion (Rs.15157 cr.) Vodafone pays 11618cr for 3g spectrum in 9 circles. June;- Vodafone files petition in Bombay h c challenging I.T department’s order that

claims jurisdiction September;- High court says Vodafone must pay capital gains tax on the deal. Vodafone

appeals to S C. Sc ask I.T department to qualify tax liability. November;- S C ask Vodafone to deposit Rs. 2500 Cr. and provide bank Aurantees of Rs.

8500cr pending final verdict.

2011 : March;- Vodafone recieves tax notice from I.T department asking it

to explain why it should not be Laible for penalties of up to 100% of tax found due.

May;- Vodafone makes 1st ever profit in India of 15 m Euros in

2010-11 April;-

S C stays I.T department from enforcing any liability until October of final hearing

August;- S C begins hearing the case.Vodafone sells 5.5% of India business to Piramal

healthcare for $640 million(around Rs. 2890 cr.) to comply with FDI rules

2012 January;- Vodafone appoints investment bank N M Rothschild

to manage initial public offering(IPO)

Jan 20 Vodafone wins tax case in S C

Stated by SC the government cannot tax a deal between two foreign entities, even if the transaction includes an Indian asset

Amendment was done in the Income Tax Act with retrospective effect from 1962 so that all persons, whether residents or non-residents, having business connection in India, will have to deduct tax at source and pay it to the government even if the deal is executed on a foreign soil!.

Impact of this case

ConclusionDTAAs are possibly a suboptimal fiscal policy tool, particularly with respect to countries from which India receives FDI and other factor flows. They may be of some use for countries serving as destinations of Indian factor flows if these partner countries are naïve enough to tolerate fiscal losses or if intangible FDI benefits are felt by them to be significant.

Suggestions:a. Revision of withholding tax rates to stop treaty shopping. b. In particular, ensuring that there is provision allowing for purely residence taxation of a source of income: source withholding taxes to protect revenue to some extent should invariably be present. c. Introduction of articles or sub-articles relating to beneficial ownership and effective control as preconditions for an entity being entitled to treaty benefits d. Strengthen information sharing either via additional DTAA provisions or by becoming signatories of the OECD initiated "Agreement on Exchange of Information on Tax Matters" discussed earlier