DTAA: Definition, Types, Benefits And Examples Of DTAA Work?

Many individuals own the residentship of a particular country but earn their living in a different country. As per the Income Tax Act of 1961, you must pay taxes against your earnings. So, if you are generating income from a different country, you may need to pay taxes to both your residential country and the one you are earning from. 

However, paying double tax for the same income is undoubtedly unfair. To prevent double taxation, the Fiscal Committee of the League of Nations introduced DTAA in 1927. Read along to know more about it!

What is DTAA?

DTAA stands for Double Taxation Avoidance Agreement. It is a treaty signed between different nations to prevent double taxation internationally. India has signed DTAA with over 100 countries to avoid taxation on the same income twice. This treaty covers the individuals residing in one country and generating income from the other. There are three types of DTAA: Bilateral treaties, exemption methods, and tax credits.

DTAA encourages trade in goods and services, capital investment, and other economic activities between two nations. Both countries agree upon a specific tax rate for the income generated in one country and earned by the resident of a different country. DTAA income tax may cover all forms of income or some specific ones based on the business type or position held by the citizen of one country in the other country. Here are the categories of income covered by DTAA:

• Capital gains
• Property
• Salary
• Services
• Fixed deposit accounts
• Savings, etc.

How to Determine if DTAA is Applicable?

Follow these steps to determine which Double Taxation Avoidance Agreement (DTAA) applies in your case:

DTAA Rates

The DTAA rates are not the same for each country; it varies depending on the decisions of both countries. Besides, these treaties do not have any validity period; they can continue till any of the countries terminates the pact. Moreover, the rules and regulations of DTAA are also subject to changes based on the decisions of both parties.  Generally, the TDS rates on earned interests can vary between 10% and 15%. 

However, as per Section 195, dividend income is chargeable under DTAA rates when paid to foreign or non-resident firms. In this case, the relevant DTAA rates will be considered before initiating the deduction.

Example of DTAA

Neha invests in US stocks and receives dividend every year. US withholds a tax of 25% on such dividend payouts. 

Let's examine the reason why a 25% deduction occurred in the US. This is because of the India-US DTAA, which specifies that any dividend income earned in the other country (USA) will be subject to a 25% tax rate in that country (USA).
Additionally, according to the DTAA, this dividend income may also be subject to taxation in India based on the recipient's residence status.

It is important to note that the gross amount of the dividend (Rs 20 lakh) will be reported in the Income Tax Return (ITR), rather than the net amount. However, you can claim a foreign tax credit for the taxes that were deducted in US.

Let's take a quick look at how to calculate the Foreign Tax Credit (FTC). To simplify matters, we will assume that Neha is in the 30% tax bracket and that the tax rate in India is a flat 30% (excluding any cess for this example).

Interaction of DTAA with Income Tax Act

Benefits of DTAA

As an Indian resident, you can avail multiple DTAA benefits against the agreement signed by the government of our country. Here are a few to mention:

• Tax Credit

Taxpayers are entitled to claim a credit for taxes paid internationally against their domestic tax liabilities. It helps prevent the payment of the same tax two times. Thus, the Double Taxation Avoidance Agreement helps establish the business abroad and transfer the revenue in a streamlined process. With this treaty, you can avoid twice paying taxes for the same profit.

• Provide Legal Certainty

DTAA has some specific guidelines regarding the taxation of international income, which in turn promotes legal certainty. Moreover, this legal certainty encourages developing countries to initiate foreign investments. 

• Lowers DTAA TDS Rates

The DTAA agreement often results in reduced rates of withholding tax (TDS). For example, interest, dividends, loyalties paid from other country to residents in India may be taxed at a lower rate, which is beneficial for service providers and investors.

Documents Required for Claiming DTAA Benefits

Initially, you need to check the DTAA between your residential country and the concerned country where you have a business set up. Next, you must submit the required documents to claim a tax credit or exemption. 

If you are an NRI and looking forward to claiming tax benefits in India based on the tax you are paying in a foreign country, you need to submit the following documents to the tax authorities of India:

• Tax Residency Certificate
• An indemnity or self-declaration form
• Self-attested copy of PAN card 
• Self-attested visa
• PIO proof copy to validate that you are of Indian origin
• Passport xerox(self-attested)

Besides, if you want to claim tax benefits under the DTAA agreement, you must submit the Tax Residency Certificate or TRC to a deductor. Under Sections 90 and 90A of the Income Tax Act, you must apply for the Tax Residency Certificate by submitting Form 10FA. Your certificate will be issued under Form 10FB once the verification and application processing gets completed successfully. 

Final Words

So, with the DTAA agreement, you can earn from your preferred country without affecting your citizenship or paying double taxes to both countries. However, the double taxation rule may vary from one country to the other. So, a country may deduct TDS through an international tax credit document and represent it as a paid tax. So, to avail tax benefits under DTAA, you need to know the terms and TDS rates between the two countries.