The Double Tax Avoidance Agreement (DTAA) is a treaty that is signed by two countries. The agreement is signed to make a country an attractive destination as well as to enable NRIs to take relief from having to pay taxes multiple times.
DTAA does not mean that the NRI can completely avoid taxes, but it means that the NRI can avoid paying higher taxes in both countries. DTAA allows an NRI to cut down on their tax implications on the income earned in India. DTAA also reduces the instances of tax evasion.
Mr X, a resident of India works in the United States. In turn, for the work done, Mr X is given some remuneration in the United States. Now, the US Government levies the Federal Income Tax on the income earned in the US.
However, there is a possibility that the Indian Government also charges income tax on the same sum, i.e. the remuneration earned abroad as Mr X is a resident of India.
To save innocent taxpayers like Mr X from the harmful effects of double taxation, the Governments of two or more countries may enter into an agreement known as the Double Taxation Avoidance Agreement (DTAA). Thus, Governments enter into a Double Taxation Avoidance Agreements with the intent of providing relief to the tax-payers:
The DTAA applies to the residents of the contracting states i.e. India and USA, subject to certain exceptions.
The DTAA applies to the following taxes:
Resident: A Resident refers to a person who as per the relevant laws of the Contracting States, i.e. India and the US are liable to pay tax by reason of domicile, residence, citizenship, place of management, place of incorporation, etc.
If a person is a resident of both contracting states, then residence will be determined as follows:
General Rule: Individual is deemed to be a resident of the state where his permanent home is available
|Situation||Deemed to be a resident of the country in which:|
|A permanent home in both states||Personal and economic relations are closer.|
|If the above rule is not determinable or no permanent home in either state is there||Habitual abode is present|
|Habitual abode in both states||He is a National|
|National of both states or neither of them||Competent Authorities shall determine the residential status by mutual agreement.|
General Rule: Income derived by a resident from immovable property is to be taxed in the state where the immovable property is situated. Eg: If a US Resident derives rental income from immovable property situated in India, then the rental income will be liable to tax in India. Applicability as per the agreement: For instance, the following points will be considered as income from the immovable property:
General Rule: Dividend paid by a resident company of a contracting state to a resident of the other contracting state, may be taxed in that other state.
Eg: If a US Company pays a dividend to an Indian Resident shareholder, then the dividend income will be liable to tax in India. Further, USA (Company paying the dividend) also has a right to tax the said dividend in their state. However, if the beneficial shareholder is a resident of India i.e. a resident of the other contracting state, then the tax so charged shall not exceed:
|(a)||The beneficial owner is a company which owns at least 10% of the voting stock of the company paying the dividend||15% of the gross amount of dividend|
|(b)||Other Cases||25% of the gross amount of dividend|
General Rule: Interest arising in a contracting state and paid to a resident of the other contracting state may be taxed in that other State.
As per the DTAA, if interest income arises in India and the amount belongs to a US Resident, then the said amount shall be taxable in the US. However, such interest may be liable to tax in India as per the Indian Income Tax Act (ie the contracting state where the interest has arisen).
Exception : If the beneficial owner of the interest is a resident of the USA (resident of the other contracting state), then the tax charged in India shall not exceed:
|(a)||Interest paid on a bank loan (involved in bonafide banking business) or a similar financial institution (including an insurance company)||10% of the gross amount of interest|
|(b)||In other cases||15% of the gross amount|
Every contracting state may tax capital gains as per the applicable domestic law with an exception to shipping and air transport companies. In other words, generally, capital gains are subject to tax based on the domestic laws of the country. For eg: If a US Resident, say, Miss J, sells an Indian Property, then the property is liable to tax as per the Indian Domestic Laws.
Eg: If Miss K, an Indian Resident moves to the US to serve either as a teacher or as a research scholar at any University or College or Recognised Educational Institution, then Miss K may be exempted from tax on the fulfilment of the following conditions:
Note: This exemption shall be available for a maximum period of two years from the date he/she first visits that state for the aforementioned purpose. Additional Condition for Research: This exception shall be applicable only if such research is undertaken by the individual in the public interest and not primarily for the benefit of some private party.
In USA: USA shall allow its residents’ credit against the US Tax with respect to:
In India: If an Indian Resident derives income and the same is taxed in the United States, then India shall allow the amount equal to the income tax paid in the United States, as a deduction. However, such deduction shall not exceed the Indian tax paid on the foreign income earned. As per the agreement, income shall be deemed to arise as follows:
|1||Income derived by a resident of one contracting state (Eg USA)||Taxed in another contracting state (Eg: India)|
|2||Income derived by a resident of one contracting state (USA)||Income not taxed in the other contracting state|
However, for the purpose of ascertainment of the source of income, the domestic laws of the contracting states shall also apply.