International Taxation

Double Taxation

What is double taxation?

Double taxation means taxing the same income twice, once in the home country and again in host country. It is of relevance to mention here “No rules of international law prohibit international double taxation.” So it is for the countries in the international arena to solve double taxation problems.

Double taxation of income is a great disincentive as it

• Hampers free flow of capital and

• Becomes a prohibitive burden on taxpayers leading to decline in foreign investments.

Hence, negotiation of tax treaties between different countries became inevitable and these have been entered in large numbers based on OECD and UN models with suitable alterations, where necessary, to meet the special needs of the contracting countries. These agreements are in the nature of contracts between the countries, which have entered into such agreements.

How does double taxation arise?

International double taxation may arise in two ways.

Case 1: The jurisdictional connections used by different countries may overlap with each other.

Case 2: The taxpayer or his income may have connections with more than one country.

Methods of avoiding double taxation

Countries throughout the world are following various methods of avoiding double taxation. They are as follows.

(1) Unilateral relief

(2) Bilateral relief

(3) Multilateral relief

(4) Non-tax treaties

Unilateral relief:

Under this system of taxation whether the income is subject to tax abroad or not is immaterial. In Unitary system, relief is given by way of tax credit for the taxes paid abroad. The countries, which follow this method of tax credit, are U.S, Greece, India, and Japan to name a few. For example, under section 91 of the Income tax Act, 1961, the method is “tax credit method”. A resident in India who has paid income tax in any country with which India does not have a treaty for the relief or avoidance of double taxation is entitled to credit against his Indian Income tax for an amount equal to the Indian coverage rate or the foreign rate whichever is lower applied to the double taxed income. This is done as follows.

a. Where the foreign tax is equal to Indian tax, the full amount of foreign tax will be given credit.

b. Where the foreign tax exceeds the tax payable in India, the liability to Indian tax will be nil. However, no refund in respect of the excess amount is allowed, and

c. Where the foreign tax paid is less than the Indian tax after deducting the foreign tax would be payable by the taxpayer. The principle is that the credit allowable will never exceed the amount of Indian income tax, which becomes due or payable in respect of the doubly taxed income.

Bilateral relief:

Bilateral relief may take any one of the following two forms. Firstly, the treaty may apply exempting method, the country in question refrain from exercising jurisdiction to tax a particular income. For ex, under this exemption method, the country of source in which the Permanent Establishment (PE) is located is assigned an exclusive jurisdiction to tax the profits of the establishment. In turn it may agree to refrain from exercising its jurisdiction to tax the owner on these profits. Alternatively, the treaty may provide relief from double taxation by reducing the tax ordinarily due in one or both of the contracting parties on that income which is subject to double taxation. For example, the country, which is the source of a dividend, often agrees to reduce the withholding rate normally applicable to dividends paid to non-residents and the country of residence agrees to give a tax credit or similar relief for the tax paid to the country of source. In such a case, both the countries exercise the rights to jurisdiction, while mutually agreeing for adjustments. This helps in avoiding or at least reducing the international double taxation on the income in question. Many treaties combine both the methods of relief.

Multilateral treaties:

These are similar to bilateral treaties. It is achieved through agreement between many countries e.g. European Economic Community

Non-Tax treaties:

These are not direct treaties of tax, but are treaties of friendship, cooperation, political ties, diplomacy etc. but which consequently result in tax consequences.

Abuse of Double Taxation Avoidance Agreements

The objectives of Double Taxation Avoidance/Credit agreements are only to avoid double taxation on the same income. But it assumes that a taxpayer pays at least one tax in a country. Taxpayers across the globe indulge in a number of methods to reduce the tax by intelligence and sometimes by illegality.

They use tax avoidance devices generally by trying to exploit the Double taxation avoidance treaties. This kind of tax avoidance takes place in any one of the following manner:

1. Transfer pricing

2. Treaty Shopping

3. Misuse of DTAA’s in tax havens

Transfer Pricing

One of the tax avoidance methods, frequently adopted by the MNCs are manipulation of price in intra-firm exchange. The basic objective in this method is to maximize the company’s overall after-tax profit rather than the profit of individual subsidiaries. The prices charged by the subsidiary on sale to another located in different countries is popularly known as Transfer of pricing; prices are fixed not according

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