What are the factors affecting international taxation?

By Divakar Vijayasarathy

Albert Einstein said ‘the hardest thing in the world to understand is Income Tax’, though he was only 20 when the first Double Tax Avoidance Agreement (DTAA) was signed (1899 – between Austria and Prussia), nothing much actually happened until after his death, in 1956, when the OEEC (now OECD) started work on structured DTAAs.

Today we have about 4000 DTAAs globally with India herself signing over 100 DTAAs to decide “fair” distribution of taxes between Country of Residence of taxpayer (CoR) and Country of Source of income (CoS). One can only imagine what would have been Einstein’s reaction to the current International Tax scenario.

Amidst this backdrop, every person having cross border incomes is required file an annual statement a.k.a International Tax Returns (ITR) which is the starting link between a tax payer and the Revenue. The ITR is compulsorily needed to be filed in CoR while it may be optional in the CoS based on the nature and quantum of income. Various issues need to be considered while filing an ITR, where the core purpose is to disclose (facts), determine (tax liability) and avail (tax relief). Some of the prominent factors to be considered are:

A: Disclose Factors

Indian residents need to disclose these in Schedule FA and FSI, respectively. All foreign assets, including balances in foreign bank accounts for which the taxpayer is only a signatory, must be disclosed.

Foreign Tax Credit: Indian residents availing credit for tax paid on foreign-sourced income should include the relevant details in Schedule TR.

Assets and Liabilities: If an individual’s total income exceeds Rs. 50 lakhs, Schedule AL mandates disclosure of movable and immovable assets with related liabilities. Non-residents or “Not Ordinary” residents are only required to disclose assets located in India.

Non-Resident with Tax Deducted at Source: Non-residents are not required to file an Indian tax return if taxes have been deducted u/s 115A (dividends, interest, and fees for technical services).

Exempt Income: Even though certain incomes may be exempt from taxation in India (e.g.NRE interest), they must be disclosed in the tax return.

B: Determine Factors

Permanent Establishment (PE): For business income earned from a foreign country, it is essential to determine whether a PE (Article 5) exists in the source country. Taxation of business income happens only if a PE is present in the Source country.
Tax Residency: Tax residency rules vary between countries and can be influenced by factors such as the period of stay , calendar year, PE , and tie-breaker tests (Article 4 of DTAA). Dual residency situations require careful consideration to avoid double taxation.

Tax Payer Constitution: This is a tricky situation, some source countries provide for taxing fiscally transparent entities (e.g., partnerships/ trusts) while the same income could be taxed in the resident country in the hands of the beneficial owner (partner/ beneficiary). In such cases, availing credits is challenging unless presented appropriately.

Exchange Rates: Exchange rates to convert foreign currency income to Indian rupees, can impact tax liability. Rule 115 specifies the applicable rate, often the TTBR (Telegraphic Transfer Buying Rate), on the specified date.

Deemed Residency in India: An individual may be deemed (Sec 6(1)), as a resident of India subject to his quantum of total income, period of stay and tax rates in his foreign abode. Deemed residency is a recent provision and is critical while filing an international tax return.

Calendar Year vs. Financial Year: Differences in the tax year between the source country and India can exist creating challenges for apportionment / claiming relief. The situation needs to be handled with care to avoid double taxation/ cash flow challenges.

C. Avail Factors

Foreign Tax Credit: For a resident taxpayer seeking to avail credit for foreign taxes paid, filing Form 67 before the due date of filing is mandatory.

Beneficial Withholding Taxes: Non-resident taxpayers can avail beneficial withholding tax rates under the DTAA by filing Form 10FA. This form requires attaching a Tax Residency Certificate issued by the foreign tax authority.

The above list is only illustrative and there could be additional issues owing to domestic tax laws of CoS, geo political developments or even black-swan events like Covid etc.

Filing an ITR is a complex process that needs attention to detail and informed professional guidance, as penalties for non-compliance could be expensive and even criminal in certain circumstances. Most of the factors above may not have a straight answer however, the safest option for any assessee, as the adage goes, “when in doubt, disclose”.

Churchill once said, “Out of intense complexities, intense simplicities emerge”, we truly hope, international taxation evolves into a simple and predictable system making it a potent lubricant for global trade by aligning tax payer and regulator interests.

(Author is Founder and CEO, DVS Advisors. Views expressed are personal.)