INTERNATIONAL TAXATION

DIWAKAR EDUCATION HUB

• The world has become a global village.
Integration between countries is increasing. In
such a scenario earnings of person is not
restricted to national boundaries and there are
opportunities to make money internationally.
Due to this, there are issues of international
taxation due to income earned in foreign state
and its taxation in resident state (Taxation of
global income) as well as foreign state (Source
based taxation). This is the main reason for which
a DTAA has come into existence to play its role in
avoiding the double taxation.
 Now, for understanding DTAA we first
need to understand international
taxation.
• International Taxation

• Technically speaking there is no concept such

as International taxation. But for our
convenience we say, the international aspects
of income tax laws of a particular nation as
international taxation.
• Why DTAA?

• Every country has its own international tax laws

which are divided into two broad dimensions:
• I. Taxation of Resident Individuals and
corporations on income arising in foreign
countries-Taxation of foreign Income
• II. Taxation of Non residents on income arising
domestically-Taxation of Non-Resident
• From above one can understand what taxation of foreign income is for one
country (Resident country) is the taxation of Non-resident for another
country (Source country).
• Thus, there is dual taxation, one in resident country taxing the income and
other in source country which levies taxes on same Income.
• Therefore, there is a need for agreement between the countries for
avoiding this kind of double taxation. This Agreement is known as
Agreement for Avoidance of Double Tax or Double Tax Avoidance
Agreement – “DTAA”.
• The example below illustrates the exact need for DTAA.
• Example:
• R, Resident of country A, earns 100 of Income from country B.
• Tax rate of Country B – 40%
• Tax rate of Country A – 50%
• Taxability of Assessee R, without DTAA is as under
• From Above example one can conclude that if
double taxation is not avoided then a huge
portion of income will flow from the person
carrying on economic activity to the
Governments of two countries. This will
discourage trade and commerce heavily. Hence,
avoidance of double taxation is must because if
same income is taxed twice then the income left
for the taxpayer will be too low to make any
economic activity viable to be carried on.
• What is DTAA?

• DTAA is also known as treaty and Treaty is explained in

Vienna convention on law of tax treaties 1969 as under:
• “An international Taxation Agreement concluded between
states in written form and governed by international law,
whether embodied in a single instrument and whatever its
particular designation”
• A treaty is not a taxing statue, although it is an agreement
about how taxes are to be imposed.
• It is an act between two sovereign states and terms and
conditions mentioned therein have to be strictly followed.
• Purpose of DTAA

• DTAA is an Agreement between two or more countries for

resolving the issues of taxability of income and increased
transparency to avoid tax evasion. The purpose of DTAA is
highlighted below.
• Avoidance of Double Taxation of Income.
• For recovery of Income Tax in both the countries.
• Allocate rationally, Equitable and fairly the taxing rights
over a Taxpayer’s Income between two states.
• Encourage free flow of international Trade & Investment
and Technology.
• Increased transparency.
• Nature of DTAA

• DTAA can be either comprehensive or limited.

• I. Comprehensive:

• Provides for Taxes on Income, Capital Gains, and Capital. It Ensures that taxpayer in both the states
would be treated equally in respect of taxation.

• II. Limited:

• Provides for Taxes on income from shipping and Air Transport or estate, inheritance or gift. Limited
nature DTAA are limited to certain issues of taxability of income.

• 7. Types of DTAA

• There are two types of DTAA as listed Below:

• I. Bilateral Treaties:Agreement of DTAA between Two States.

• II. Multilateral Treaties: Agreement between two or more States.

• 8. Relief Mechanism:
• Double Taxation Occurs when there:
• Global+ Source Based Taxation
• Residency in Two States
• The Double Taxation in such Case can be eliminated by various relief mechanisms. These are as under:
• I. Deduction Method:

• The resident country allows its Taxpayer to claim a deduction for taxes, including income taxes, paid to a foreign
government in respect of foreign source income.
• It is like providing DEDUCTION as EXPENSES.

• II. Exemption Method:

• The resident country provides its taxpayer with an exemption for foreign source Income. It is like EXEMPTION of
INCOME.

• III. Credit Method:

• A. Ordinary Credit :

• Resident country gives either full/Partial credit of taxes paid in foreign country. This means Tax payer will be taxed
on same source income and tax is to be determined accordingly but tax payer will pay lower amount of taxes to
the extent credit available.
• B. Underlying Credit:

• Credit for corporate tax is available when dividends are paid by resident of one state to another. This is in addition
to tax paid on dividends.
• Example:
• R, Resident of country A, earns 100 of Income
from country B.
• Tax rate of Country B – 40%
• Tax rate of Country A – 50%
• From the Above example and computation one
can conclude that
• Deduction method does not fully avoid the
double taxation. It just saves tax by the amount of
–Foreign Tax Paid x Domestic Tax rate.
• Exemption method is more favorable if tax rate in
Domestic country are higher than that of in
Source Country.
• Credit Method is preferable as the assessee gets
taxed at domestic tax rate without any double tax
and country also gets its eligible amount of Tax.
 Tax Credit

• A tax credit is an amount of money

that taxpayers can subtract from taxes owed
to their government. The value of a tax credit
depends on the nature of the credit; certain
types of tax credits are granted to individuals
or businesses in specific locations,
classifications or industries.
Unlike deductions and exemptions, which
reduce the amount of taxable income, tax
credits reduce the actual amount of tax owed.
 Foreign tax credit
• The foreign tax credit is a non-refundable tax
credit for income taxes paid to a foreign
government as a result of foreign income tax
withholdings. The foreign tax credit is
available to anyone who either works in a
foreign country or has investment income
from a foreign source.
• What is a Withholding Tax
• A withholding tax is an amount that an employer
withholds from employees' wages and pays
directly to the government. The amount withheld
is a credit against the income taxes the employee
must pay during the year. It also is a tax levied on
income (interest and dividends) from securities
owned by a non resident as well as other income
paid to non residents of a country.
• Tax Sparing:
• Sometimes as an Incentive to economic activities, there are various
tax exemptions given. There won’t be any payment of tax by the
assessee due to these incentives. For example: Deduction under
section 80IB of Income Tax Act, 1961. Now, when the assessee is
liable to taxation in his domestic country then credit will be allowed
for taxes paid in foreign country, but due to tax exemption in such
foreign state there won’t be tax payment and no credit to balance
of taxpayer. Now, in such a case if the taxpayer is taxed on credit
method basis then he will end up paying taxes on income which
was exempt in foreign state. In such a case, there won’t be any
incentive to assessee to take up such specified activities on which
exemption is granted because if foreign country is not taxing than
domestic country will collect tax.
• Hence, to avoid such situation Tax Sparing
comes to help. Under this method, the
domestic country will deem such exempt
income as tax paid and credit of such taxes
which are deemed to be paid in foreign
country will be allowed as credit in Domestic
country. Hence, the benefit of exemption is
not hindered or wiped out due to this
method.
• This type of relief mechanism is known as Tax Sparing.
• V. Unilateral Relief:
• Some countries provide relief of Taxes paid in source country without any treaty
between those two countries. This kind of relief is known as unilateral relief.
• In India, U/s 91 unilateral relief is provided. Section 91 provides for relief from
double taxation to the Indian Residents. Relief is available of lower of Indian Tax
and Foreign Tax paid on the income so doubly taxed. It is Applicable only if the said
income does not accrue or arise in India as provided in Section 9 of the Act.

• The above are all methods of providing Relief from double taxation.
• 9. Models of Tax Treaty:

• There are major two models of Tax Treaty.

• A. Organisation for Economic Co-operation and Development (OECD Model).
• B. United Nations Model (UN) Model.
• C. US Model
• The agreement between two nations may be formed
based on acceptance of these models or two
contracting states may even include certain articles and
clause not specified. These are just a model which
provides convince in daft of DTAA.
• India in its treaties with different nations have
accepted some of the items of these models, even
included new clause and articles which are not defined
in the model and are altogether different between the
contracting states. So, treaty is not compulsorily to be
made as per model. The above Specified are just
models and not treaty.
• Applicability of DTAA:

• A Tax Treaty is applicable to persons who are residents of one or both the
contracting states. Thus, for applicability of DTAA we need to understand
the concept of residence.

• – Concept of Residence:

• Concept o residence can be classified into 2 parts:

• I. For Individuals:
• An Individual is liable to tax by virtue of his domicile, residence, Place of
incorporation, Place of management etc but excludes one who is liable to
tax in respect only of income from source in that state.
• By applying above principle one can conclude a person to be resident of
one of the contracting states and provisions of treaty will apply
accordingly.
• But sometimes a person becomes resident of two or more
state. This creates confusion as to who will tax the global
income and various issues arise to its taxability.
• A person who is resident of two states by virtue of law is
known as Dual Resident. The residency of such dual
resident is known as Dual Residency.
• This dual residency needs to be broken and the individual
needs to assign residency of one of the states.
• Hence, to determine residency the Tie – Breaker test needs
to be applied. This is explained in below mentioned chart:
How to Apply DTAA?