IMPACT OF DOUBLE TAXATIONS AVOIDANCE AGREEMENT (DTAA’S)

A. Mahalakshmi, Student, Sathyabama Institute Of Science And Technology

1. Abstract: 

DTAA is the bilateral agreement that two independent states sign on the same income in respect of double taxation arising out of this income. Majorly, its objective is to permit the facilitation and encouragement of trade and investments globally free of the burden of double taxation. Double tax occurs when income sourced from a taxpayer’s home country is taxed in both that home country and another foreign country from which the income is derived. International law does not prohibit double taxation. Therefore, it is upon individual countries to address and solve such issues through mutual agreements. Otherwise, double taxation might deter the free movement of capital, create over-financing burdens on the taxpayers and discourage foreign investment. In most cases, double taxation occurs because tax-payers may have nexus to multiple jurisdictions, causing their tax laws to overlap with one another. It means that an individual or entity may be forced to pay taxes both in the country where they reside and in the country where the income originates. To solve this problem, the DTAAs contain various provisions like reduced tax rates or total exemptions for specific types of income. For example, while a tax payer from a particular country is subject to tax upon the dividend interest and royalty earned by its entities within the other country. This avoids double taxation of any income under the DTAA and results in an economically cooperative agreement and avoidance of financial shock.

KEYWORDS:  Double Taxation – Tax Avoidance – Tax Treaty – Bilateral Agreement – Tax Residency Certificate (TRC) – Treaty Override – Domestic Tax Law – Tax Neutrality – Treaty Override

2. Introduction:

               A Double Tax Avoidance Agreement is the treaty between two nations so that a country becomes more attractive to investments and offers relief to Non-Resident Indians from being taxed multiple times on the same income. Though DTAA does not completely exempt NRIs from taxation, it ensures them from paying high taxes in both countries. The agreements also reduce the chances of tax evasion. The DTAA treaties cover all sorts of income, including employment, profits of business, dividends, interest, royalties, and capital gains. Such conventions clearly define which country enjoys the taxing rights for which forms of income.Generally, the country of source is regarded as the primary source for taxation rights. However, the country of resident taxpayer has the right to tax income; usually, exemption in the source country is only to the extent applicable over there. 

3. Elimination of Double Taxation: 

         The essence of a DTAA is to avoid the evil of double taxation. It imposes a burden upon the taxpayer. In its absence, a person or businesses conducting cross-border transaction is levied with taxation by both the source and the residence country.

Methods for Eradication of Double Taxation:

  • Method of Exemption :Income accrued in one state does not come under taxation by another state. Income which the Indian resident will garner in the DTAA country, would not bring within its ambit of Indian income-tax.
  • Tax Credit Method: The tax liability of the resident country is offset by the amount paid as tax in the source country. For instance, in case an Indian citizen has paid tax on his income in the United States, that amount will reduce the tax liability in India.

Advantage: It lowers the tax incidence upon people and businesses and hence it does not restrict the trade or economic activity due to taxation.

4. Promotion of Foreign Direct Investment (FDI): 

              DTAAs make a country-friendly tax environment to attract the investment and collaboration of foreign economies and businesses. They ease the risk of double tax liability and hence make any kind of cross-border investments feasible.

  • India as an example: Double taxation agreements between India and countries like Singapore, Mauritius and the United Arab Emirates provide preferential tax treatment on capital gains, dividends and royalties, thereby attracting foreign direct investment over time. 
  • Tax rates: Double taxation agreements generally provide reduced tax rates on dividends, interest, royalties and technical service charges, making investment more attractive.

5. Strengthening Economic Relations:

DTAAs help build economic and trade ties among countries. They ease out tax barriers and enable both countries to create a cordial environment for the same. Countries entering DTAAs establish trust, developing diplomatic relations, further helpful in economic cooperation between two nations.

  • For example, India’s DTAA with Japan and South Korea has not only reduced their tax burden but also collaborated with them in the fields of infrastructure, technology and trade sectors.

6. Taxation Certainty and Clarity

DTAAs provide both the individual taxpayer as well as business enterprises which engage in international trade clarity and certainty of their liabilities in taxes. They define taxing rights between a source country and a country of residence, thus clearing up uncertainty about which one has the primary right to tax particular incomes. Given the predictability of their tax liabilities, businesses are better able to plan long-term strategies. The inclusion of EOI(exchange of information) provisions ensures the transparency, thus preventing tax avoidance and evasion.

7. protection Against Tax Evasion and Avoidance

                   DTAAs of today are also equipped with provisions that will prevent and curb tax evasion and avoidance among multinational corporations and individuals. 

  • Exchange of Information (EOI): All countries share information regarding any tax evasion activities.
  • LOB Clause: This provision disallows “treaty shopping,” which is investing through countries that have liberal DTAAs for them to avoid taxes.
  • BEPS Action Plans: In line with OECD’s Base Erosion and Profit Shifting (BEPS) initiative, DTAAs are amended to address artificial profit shifting to low-tax jurisdictions.

8. Relief for Non-Residents:

             Non-residents, expatriates, foreign companies, and freelancers also enjoy relief under DTAA, for income of this nature is taxable at a reduced tax rate or completely exempt.

Some examples are as follows:

  • Dividends, Royalties, Interest, Fees for technical services are taxed at a concessional rate.
  • The foreign employees in India employed under the provision of DTAA are saved from the problem of double taxation since they can obtain exemption and credit.
  • Benefit: That relief would make it cheaper for individuals and businesses operating across borders to avoid onerous tax burdens.

9. Boost to the Digital Economy

                 The digital economy has made businesses offer services across countries without a physical presence, creating complexities regarding taxation. DTAAs help address

Some of these issues:

  • Mutually agreed provisions can solve taxation issues on digital services, e-commerce, software exports, and online platforms.
  • The emerging concepts like “Significant Economic Presence (SEP)” ensure that digital businesses pay taxes in countries where they generate economic value.

10. Reducing Litigation and Disputes:

DTAs provide ways of resolving conflicts, usually regarding double taxation or the tax treaties’ misinterpretation.

  • Mutual Agreement Procedure(MAP): The tax departments of the two countries meet each other to amicably settle the disputes. One can rely on these provisions to avoid protracted and uncertain litigation.
  • Benefit: The mechanisms to settle disputes improve investor confidence and fair treatment of taxpayers.

11.Problems with DTAAs: 

  • Treaty Shopping: Corporates exploit the DTAAs by bringing investments through third countries, which have favorable tax treaties. Example: The use of India-Mauritius DTAA.
  • BEPS (Base Erosion and Profit Shifting): Corporates shift the profit to low-tax locations in order to minimize overall tax liabilities.
  • Digital Economy Issues: Most of the DTAAs were developed prior to the digital economy and therefore do not provide any issues relating to the taxation of digital transactions.
  • Compliancy Burden: Running DTAAs can prove difficult, especially for organizations operating in more than one jurisdiction.

12.CASE STUDY: 

  1. DIT v. Morgan Stanley & Co.

               The Supreme Court has held that the Indian branch of Morgan Stanley does not constitute a permanent establishment (PE) within the meaning of the India-US Customs Tariff Convention because it was properly remunerated for the services rendered. According to the Court, the India-US tariff convention does not entitle a PE to additional profits unless it is properly compensated for the service rendered.

  1. Sanofi Pasteur Holding SA v. Department of Revenue

                The Andhra Pradesh High Court held that the India-France DTAA exempted capital gains arising in an Indian entity from transfers of shares by a French company. The provisions of the treaty, inter alia, took the precedence of domestic tax legislations and ensured that Sanofi Pasteur was not subjected to the burden of double taxation.

  1. Engineering Analysis Centre of Excellence Pvt. Ltd. V. CIT

                 Supreme court in this case held that, it had previously declared payments for use of software do not qualify as ”royalties” within multiple DTAAs that come with India-USA and India-Singapore. For such, software use money earned and applied are not considered subject to taxation in India, rendering a landmark judgment.”.

13. CONCLUSION: 

                  Double taxation agreements (DTAs) are at the heart of international taxation. They are tools that help to stimulate economic growth and reduce tax burdens by promoting international cooperation. By avoiding double taxation of income, they provide a propitious climate for cross-border trade and investment, and international economic integration. But DTAAs do not come without problems. The main issues that affect their effectiveness include treaty abuse, where entities exploit loopholes to avoid taxes, and procedural complexities in implementation. Additionally, the digital economy complicates taxation since businesses can generate significant revenue in a country without any physical presence. India has adopted a balanced approach towards DTAAs. It aims to attract foreign investments while protecting its tax base. It renegotiated treaties with Mauritius and Singapore to curb abuse and prevent revenue losses. Internationally, the country has adopted reforms such as the OECD BEPS initiative and the Multilateral Instrument (MI) to modernize tax treaties and respond to new challenges. At the domestic level, measures such as the General Anti-Tax Avoidance Rules (GAATRs) are also strengthening its efforts to ensure fair taxation. Indeed, despite the changes, the future of indirect tax treaties remains very promising. Evolution in global tax norms should thus make it even more central in reorienting international trade and investment policies. It means adjusting the new standards being advocated globally while looking into emerging concerns.

REFERENCE 

Books and Journals

  • “International Taxation: Principles and Practices” by T.P. Ghosh.
  • “Global Taxation After BEPS” by Yariv Brauner.

Websites and Online Sources

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