Updated on: Apr 28th, 2023
10 min read
As the world becomes more connected and globalised, it has become increasingly common for individuals and companies to conduct business across borders or work remotely. This also means they may have to pay taxes in multiple countries from where they earn their income. This can lead to double taxation. This is where Double Taxation Avoidance Agreements (DTAAs) come in.
Let's understand how DTAA works with the help of an example. Let's say you are a resident of India who has invested in a company located in the United States (US stocks). When you receive dividend or any income from these investments, then that will be subject to tax in both India and United States. But if India and US have a DTAA agreement, you will not have to pay double taxes. This income earned by you from the US will be taxed in either India or the US, depending on the terms of the agreement.
The Double Tax Avoidance Agreement is a treaty signed by two countries. The agreement is signed to make a country an attractive destination as well as to enable NRIs to get relief from having to pay taxes multiple times. DTAA does not mean that the NRI can completely avoid taxes, but it does mean that the NRI can avoid paying higher taxes in both countries. DTAA also reduces the instances of tax evasion.
The DTAA agreements cover a range of income such as income from employment, business profits, dividends, interest, royalties, capital gains, among others. These agreements specify guidelines as to which country holds the right to impose taxes on particular types of income. Typically, the country where the income is generated retains the primary right to levy taxes on it, whereas the country of residency may also impose taxes, at a lower rate.
DTAA, signed by India with different countries, fixes a specific rate at which tax has to be deducted on income paid to residents of that country. This means that when NRIs earn an income in India, the TDS applicable would be according to the rates set in the Double Tax Avoidance Agreement with that country.
Follow these steps to determine which Double Taxation Avoidance Agreement (DTAA) applies in your case:
|Step 1||Is DTAA applicable?||DTAA applies only when the transaction is taxable both in India and in an another country. Also, one party involved in the transaction should be a non-resident (NR) or a foreign company (FC).|
|Step 2||Which DTAA is applicable?||Identify the residential status of the non-resident party. |
DTAA between India and that country will be applicable
The following are the steps to determine how to apply DTAA:
Note: If the NR/FC has a Permanent Establishment (PE) in India, then general articles for taxation would apply.
The benefit of DTAA can be claimed by three methods:
Example: A who is a resident of country X, earns Rs 100 from country Y.
Tax rate of Country X – 30%
Tax rate of Country Y – 50%
|Particulars||Deduction Method||Exemption Method||Tax Credit Method|
|Foreign Income Tax (30%)||30||30||30|
|Net Domestic Income||70||Nil||100|
|Final Domestic tax||35||Nil||20|
|Total Domestic and Foreign Taxes||65||30||50|
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.
|Withholding Tax (25%)||5,00,000|
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).
|Withholding Tax (25%)||(A)||5,00,000|
|Tax in India||(B)||3,00,000|
|Foreign Tax Credit||(C) = Lower of (A) or (B)||3,00,000|
|Tax Payable in India||(B) - (C)||0|
|DTAA||Income Tax Act||Remarks|
|If the treaty does not address a particular dispute||But the Income Tax law contains relevant provisions,||Refer to the Income Tax Act for guidance on the matter.|
|If a treaty includes certain provisions||But law is silent on dispute resolution mechanism||Refer treaty|
|If the treaty has a provision||Income tax law also has the same provision||Follow whatever is more beneficial for the taxpayer|
|If treaty has some provisions||Law has contradictory provisions||treaty will prevail|
Finance Act 2021 introduced a new Section 89A for removing hardship for NRI due to double taxation on money accrued in foreign retirement accounts maintained with notified countries.
This provision is applicable to "specified persons" - individuals who are residents of India, opened an account in a notified country while being a non-resident of India, and a resident of that particular country.
A "notified account" refers to an account established by a specified person in the notified country for retirement benefits, and income from such an account is not taxable on an accrual basis, but is taxable by that country on a receipt basis.
The new provision states that such income will be taxed in such manner and in the year as may be prescribed.
India has signed a Double Tax Avoidance Agreement with most major nations where Indians reside. Some of these countries are:
|Country||DTAA TDS rate|
|United States of America||15%|
|Mauritius||7.5% to 10%|
Under the Double Tax Avoidance Agreement, NRIs don’t have to pay tax twice on the following income earned from:
If income from these sources is taxable in the NRI’s country of residence, they can prevent double taxation by utilizing the benefits of the DTAA.
The income on which a NRI can claim tax exemption/credit will be mentioned in the DTTA with the resident country. The provisions of DTAA are not the same for all countries.