What is Double Taxation Avoidance Agreement (DTAA)? How NRIs can Claim Benefits Under DTAA

DTAA is an agreement signed between India and several countries to ensure that individuals and entities are not taxed twice on the same income.

DTAA is especially relevant for a person earning income in one country while being a resident in another country without DTAA; such income could be taxed in both countries. However, when DTAA is in effect, you will only be required to pay taxes in one country, not both. Your income would be taxable in both countries. However, taxes paid in one country can be claimed as a credit in another country, avoiding double taxation per the provisions of DTAAs.

To protect Non-Resident Indians (NRIs) from double taxation, India has signed extensive DTAAs with over 100 countries, including Australia, Canada, France, Germany, Hong Kong, Portugal, Singapore, and others.

What is Double Taxation Avoidance Agreement (DTAA)?

The Double Tax Avoidance Agreement (DTAA) is a treaty signed by two countries. It is signed to make a country an attractive destination and 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.

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 a dividend or any income from these investments, then that will be subject to tax in both India and the United States. But if India and the 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. 

DTAA Rates 

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. 

How to Determine if DTAA is Applicable?

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

How to Apply DTAA?

The following are the steps to determine how to apply DTAA:

• Tax Liability as per Income Tax Act: Find out the type of income on which DTAA applies and its tax liability under the Income Tax Act.
• Tax liability under the DTAA: If the income falls under specific articles of DTAA, then the income will be taxed as per those articles.
• Finalize the tax liability: Using section 90(2), decide which is more advantageous between the IT Act and DTAA (Treaty Override).

Note: If the NR/FC has a Permanent Establishment (PE) in India, then general articles for taxation would apply.

How to Claim DTAA Benefits?

The benefit of DTAA can be claimed by three methods:

• Deduction: Taxpayers can claim the taxes paid to foreign governments as a deduction in the country of residence.
• Exemption: Tax relief under this method can be claimed in any one of the two countries.
• Tax credit: Tax relief under this method can be claimed in the country of residence.

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%

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).

Few Basic Principles of DTAA

Section 89A Introduced in Budget 2021

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 now 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.

Countries That India Has a DTAA With 

India has signed a Double Tax Avoidance Agreement with almost 100 major nations where Indians reside. Some of these countries are:

On What Type of Income DTAA is Applicable?

Under the Double Tax Avoidance Agreement, NRIs don’t have to pay tax twice on the following income earned:

• Services provided in India.
• Salary received in India.
• House property located in India.
• Capital gains on transfer of assets in India.
• Fixed deposits in India.
• Savings bank account in India.

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.