In the era of technological globalization, it is commonplace for an individual or business to earn income in a country other than the country of residence. Such an instance, where you are resident in one country but have source of income in another, may give rise to possible double taxation.
In light of such cross-border transactions, the effect of taxation is an important consideration to avoid being subjected to tax twice. Here are a few facts about Double Taxation that you (probably) did not know.
Double Taxation Avoidance Agreement (DTAA)
Double taxation means taxation of the same income of a person in more than one country. This results due to countries following different rules for taxation, namely,
# Source rule: Source rule holds that income is to be taxed in the country in which it originates irrespective of whether you are a resident or non-resident.
# Residence rule: Residence rule stipulates that the power to tax should rest on the country in which you reside.
The governments of two countries enter into a DTAA which lays down the rules for taxation by the source country and residence country. Each category of income such as dividend, interest, capital gains, fees for technical services, royalty etc. is defined by a rule for granting relief to the taxpayer.
DTAA in India
India follows the residence rule of taxation, which means that you will be taxed on the basis of your residential status. The Income Tax Act provides for double taxation relief by way of Bilateral and Unilateral Relief.
Bilateral Relief [Section 90]-
India has signed Double Taxation Avoidance Agreements with more than 80 countries such as the USA, the UK, China, France, Germany, Canada etc.
There are two ways in which such relief is granted:
# Exemption method: Income is taxed in only one of the countries or each of the two countries tax only a particular specified portion
# Tax credit method: Income is taxable in both the countries as per their respective laws, and you are allowed a deduction from the tax payable in the country of residence of a part of the tax paid in the source country
Taxability – Such income shall be included in your total income chargeable to tax in India and relief shall be granted in accordance with the method for avoidance of double taxation provided in such agreement. You can claim relief by applying the provisions of either the treaty or the domestic law, whichever is beneficial.
It is important to note that a specific provision of the DTAA will prevail over the general provision of the Income Tax Act. However, if there is no specific provision in the treaty, then the Income Tax Act shall apply.
For example, Simran earns foreign income for technical services in a country with which India has a DTAA.
Fee for technical services is to be taxed @15%, whereas it is taxable under section 115A of the Income Tax Act @10%, then it will be beneficial to apply section 115A. On the other hand, if as per provisions of DTAA, it is either not taxable or taxable at a rate less than 10%, then it will be better to apply DTAA instead of section 115A of the Income Tax Act.
Unilateral Relief [Section 91]-
Such a relief is granted where no mutual agreement exists with the source country. Relief under section 91 will be granted if all the following conditions are fulfilled:
# You are resident in India during the year in which such income in taxable
# Income accrues or arises outside India
# Income is not deemed to accrue or arise in India during the year
# Income has been subject to tax in the foreign country and tax has been paid thereon
Taxability – Deduction from the Indian income tax would be the amount calculated on such doubly taxed income at
1. the average Indian rate of tax or the average rate of the tax of the said country, whichever is lower, or
2. at the Indian tax rate if both the tax rates are equal
Average rate of tax means the tax payable on total income, after deduction of any relief due under the provisions of the Act but before deduction of any relief due under this Chapter, divided by the total income
For example, Raj earned foreign income of Rs 4 lakh from a country with which India does not have a DTAA and Rs 15,000 was deducted at source. As per the Income Tax Act, his total income is Rs 6 lakh and tax payable thereon is Rs 33,475. Relief under section 91 will be the lower of
Hence, relief available shall be @5.58% or 3.75% of foreign income whichever is less.
Relief = 4,00,000 x 3.75% = Rs 15,000
(By Tanvi Chopra, Founder & CEO, Insta C.A.)