As per the Income Tax act, 1961, an NRI is liable for the payment of Income-tax in India in respect of the income which has been received in India or arises or accrued in India. However, it can be possible that such income is also taxable in the country of his residence. Hence, in this case, he shall have to pay double taxation on the single income. To remove this defect, the concept of a double taxation avoidance agreement has come into effect. The objective of a Double taxation avoidance agreement is to prevent double taxation and capital.
Following are the 2 methods used for the avoidance of double taxation:
1. Bilateral Relief: Countries are entering into Double taxation avoidance agreement (DTAA) with each other. (Section 90 and 90A)
Bilateral relief can be given by any of the 2 following methods:
- Exemption Method: Under this method, a particular income is taxed in only one of the countries and not in another country.
- Tax credit Method: As per this method, the assessee shall have to pay the taxes in both countries in accordance with the tax laws of each country. However, his country of residence, allows him to take the credit of such tax charged in the country of source.
2. Unilateral Relief: When there is no agreement between the countries, the country of the residence itself provides relief. (Section 91)
In simple words, the effect of a double taxation avoidance agreement is that
- Income shall be taxed in only one country or
- If the income is being taxed in both countries, then the tax paid in one country is allowed as a deduction from the tax payable in the other country, as per the agreement.
The provisions of the income tax act,1961 shall be applied to the extent it is more beneficial to the assessee. In other words, the assessee can use the Double taxation avoidance agreement or the Income tax act, 1961 whichever is more beneficial to him. For example: if as per Double taxation avoidance agreement with a foreign country or specified territory; the royalty income is being taxed @ 35% and as per section 115A of the Income-tax act, such royalty is being taxable at the rate of 10%. Hence, the assessee can choose to comply with the income tax act instead of a Double taxation avoidance agreement.
Also, if the provisions of the Double taxation avoidance agreement are beneficial, then DTAA will apply. For example: if as per DTAA with a foreign country or specified territory, the royalty is taxed @10% then it will be more beneficial for the taxpayer to choose DTAA although under the income tax act, the rate shall remain the same i.e. 10% but here the assessee shall get the benefit of the surcharge and education cess. In other words, if the taxpayer has chosen the Double taxation avoidance agreement over the income tax act, 1961, then there will be no education charge and surcharge.
What are the benefits to have DTAA in our country:
- Lower payment of Tax
- No surcharge or education cess
- Underlying tax credits
Meaning of terms used in the agreement
It is seen in some cases that the few terms in the agreement are not defined properly hence for this, the income tax act has made the following provisions:
- If the term is defined in the agreement, the meaning is assigned to it in the agreement.
- If the term is not defined in the agreement, but it is defined in the income tax act, then the meaning shall be assigned as per the income tax act.
- If the term is neither defined in the agreement nor the income tax act, 1961, then the meaning as defined in the notification shall be applicable.
If the assessee, other than a resident, to whom the Double taxation avoidance agreement applies, he shall not be entitled to any claims under tax residency.
The charge of tax in respect of foreign company which is at the higher than the rate which is applicable for the domestic company is chargeable and shall not be a less favorable charge or levy of tax. Let me explain this paragraph with the help of an example
Cosmos Limited, a company incorporated in Mauritius has a branch office in Hyderabad that opened in the assessment year 2019-20 disclosing the income of Rs.50 Lakhs. He has paid the applicable double taxation agreement. i.e. 30% plus education cess of the basis of paragraph 2 of article 24 of the Double taxation avoidance agreement between India and Mauritius.
Under section 90(2), where the central government has entered into an agreement for the avoidance of double taxation with the government of any country outside India, as per case may be, then in relation to the assessee to whom such agreement applies, the provisions of income tax act, 1961 shall apply to the extent they are more beneficial to the assessee. Thus in view of paragraph 2 of article 24. It appears that the Indian branch of cosmos limited, incorporated in Mauritius, is liable to tax in India at the rate applicable to the domestic company (30%) or the rate which is applicable to the firing country (40%), whichever is lower.
Under the Income-tax act, there are 5 heads of income have been defined and different sources of income are taxed in these heads and under the DTAA respectively. Here we look at some of them.
- Salary – Salary is taxed under different rates in India. Although, if the person stays in India for less than 183 days, some of the treaties provide relaxation and the salary is not borne by a permanent establishment or employer in India and received outside India.
- Income from a business/profession – India tax shall be levied on the income from a business connection. However, most treaties are providing the business profits for taxation only in cases where the income has been earned from a permanent establishment or a fixed base.
- Dividends – Dividends can be taxed by the source country i.e. it shall be taxed in the country in which such dividend has been received with the condition that the tax rates must not increase the rate mentioned in the treaty/ agreement. Dividends from mutual fund investments are tax-free in India but the resident country might tax the dividend.
- Interest – Normally we have treated the interest as income earned from bank deposits and taxed at the rate of the tax slab. However, under the provision of the DTAA, the interest earned is normally taxed at a concessional rate in the resident country. NRE fixed deposit interest is tax-free in India but Commercial Deposits and debt funds have short term gains tax of 30%. In simple words, if a person is having an NRE account, then there will be no tax liability on the interest amount.
- Royalty and fee for technical services – These services are also chargeable to tax at a concessional rate under the DTAA, rather than what is prevalent in India otherwise.
- Capital Gains – Some of the treaties or agreements that India has signed exempt one from the capital gains tax, like the treaty with Mauritius which has been explained above. Based on the clause in the treaty, the resident country gives credits for the capital gains tax paid in the other country involved in the treaty. Long-term and short-term capital gains from property and gold are taxable in India, while only short term capital gains(15%) from shares, mutual funds are taxable.
Documents to be Submitted to Benefit from the DTAA
For claiming the if the person stays in India for less than 183 days, NRIs may have to first apply for the benefits under the DTAA by timely submission of the following documents to the concerned deducting intermediary (to the bank whose services you are availing):
- Tax Residency Certificate – This certificate is required to be obtained from the government of the country in which the NRI resides. There is certain information that needs to be compulsorily mentioned in the tax residency certificate. You can also consult the tax deductor to know more about this certificate.
Following are some of the things which should be included in the TRC :
Name, Status (Individual/ Company/ Firm),
Tax Identification Number Of The Person In That Country,
Tax Status And
The Period For Which The Tax Certificate Is Issued.
An NRI may have to get TRC for two consecutive years since in India, the calendar year and the financial year differ.
- Self-declaration cum Identity form
- Self-attested copy of PAN card
- Self-attested copy of passport
Taxation for an NRI residing in any of the 84 nations with whom India has signed a DTAA – Double Tax Avoidance Agreement is subject to the clauses in that particular treaty.
Hence by reading this article, we have come to know about the double taxation avoidance agreement. DTAA is something that helps the assessee to reduce your tax burden and not tax evasion. So by Use the DTAA judiciously, one can plan to save the income tax in India and country of residence – be it UK, UAE, US. Let us know if this article was useful or if you want something to be elaborated on.