Transcript Elimination of Double Taxation –Tax Credits

Presented By
CA Swatantra Singh,
B.Com , FCA, MBA
Email ID: [email protected]
New Delhi , 9811322785
,
www.caindelhiindia.com,
www.carajput.com
RESIDENTIAL STATUS UNDER THE DOUBLE TAXATION
AVOIDANCE AGREEMENTS
Importance of Article 4
Application of the DTAA
 Avoidance of double taxation due to dual
residence


Resolves cases of double taxation between the
State of Residence and State of Source
Allocates residential jurisdiction to one of the
Contracting States
 This Article needs to be traversed before
proceeding to avail any treaty benefits

3
Residence under treaty v/s under Domestic Tax Laws

Treaty does not lay down conditions for defining
residents under DTL

Residence must primarily be determined as per the
rules of the DTL

Provides a mechanism when the respective DTL of a
CS results in double residence

4
Once residence is determined under the treaty,
residence under the DTL becomes irrelevant SC in CIT v P.V.A.L. Kulandagan Chettiar ,267
ITR 654
Structure of Article 4
Article 4(1)

Definition of a resident
Article 4(2)

Tie-breaker rule for individuals
Article 4(3)

5
Tie-breaker rule for persons other than individuals
Article 4(1)
“Resident of a CS” means:

Any person

who under the laws of the State

is liable to tax therein

by the reason of his domicile, residence, place of
management (place of incorporation also in UN MC)

or any other criteria of similar nature
and also includes that State, any Political sub-division
or local authority thereof

6
Article 4(1)
 The
term does not include any person who
is liable to tax in that State in respect only
of income from sources in that State or
capital situated therein
7
Article 4(2)
Tie-breaker Rule

Availability of a Permanent Home

Closeness of personal and economic relations with a
State (centre of vital interests)

Habitual Abode

Nationality

Mutual Agreement Procedure
Should exist for the period for which taxation is an
issue
8
Article 4(3)
Triangular treaty situation
US-UK DTAA
USA
Indo-US DTAA
India
UK
Interest
income
Indo – UK DTAA
Article 4(2) also determines which of the two CS will
tax income from sources in a third State
Article 4(3)
Tie-breaker for persons other than individuals
If a person other than an individual is resident
on
both the States under Article 4(1), then it shall
be
deemed to be a resident only of the State in
which
its place of effective management is situated
10
Article 4(3)

Activated only when the company is a
resident of both the Contacting States
under Article 4(1)

Does not alter status under domestic tax
laws

11
Place of incorporation not relevant but
place of effective management
Article 4 – Some issues






12
Meaning of ‘liable to tax’?
Any other criteria of similar nature?
Meaning of ‘Permanent home’?
Meaning of ‘Centre of Vital Interests’?
Meaning of ‘Habitual Abode’?
Meaning of ‘Place of effective
management’?
Liable to tax




Four situations possible :
Source of income not taxable in SoR
Entity is exempt from tax in SoR
Entity does not pay any tax in SoR due to
losses, deductions, etc.
Entity itself is not covered by the tax law in
SoR
When can the person said to be ‘liable to tax’
in the above situations ?
13
Liable to tax

Mohsinally Alimohammed Rafik’s case, 213
ITR 317 (AAR)

Cyril Eugene Pereira’s case , 239 ITR 650(AAR)

SC decision in the case of Azadi Bachao
Andolan, 263 ITR 706

Abdul Razak’ case ,276 ITR 306 (AAR)

Asst. DIT v. Green Emirate Shipping & Travels
,286 ITR (AT) 60 (Mum.)
14
Liable to tax
Principle laid down in Rafik’s case

Does not mean the person should be factually
charged to tax

Means a person who is liable to be subjected
to tax

Otherwise DTAA would have used different
words

15
Liberal interpretation of DTAA favoured to give
full effect to the other words and provisions
Liable to tax
Contrary Ruling in the case of Pereira’s case

DTAA meant only for the tax payers who are liable to
pay tax twice on same income

Objective of the DTAA was to avoid only actual double
taxation

Fiscal residence of a person is to be decided on the
basis of his actual liability to pay taxes

Rejected the “potential” double taxation theory as tax
is an actual levy
16
Liable to tax

DTAA covers only existing taxes and any
future taxes will have to be notified by the
Competent Authorities

Section 90 does not mandate the Government
to enter into a DTAA when there is no tax
payable

Rafik’s case did not consider the scope of
section 90

DTAA has covered all eventualities to cover
individuals also as it is expected to be in
operation indefinitely
17
Liable to tax
SC in Azadi Bachao Andolan:

‘Liable to tax’ is not the same as ‘pays tax’

‘liability to tax’ is a legal situation and
‘payment of tax’ is a fiscal fact

Section 90(1)(a)
distinguished

“Residence” is a term of limitation
18
and
90(1)(b)
to
be
Liable to tax
SC in Azadi Bachao Andolan:

Liability for taxation not to be decided on
the basis of exemption granted for a source
of income

Did not agree with the Cyril Pereira AAR

Accepted the “potential double taxation”
theory
19
Liable to tax
AAR, in Abdul Razak’s case held that:

Individuals
were
excluded
from
the
definition of ‘person’ under the UAE decree
and therefore not liable for tax

Expression meant that even though a
person did not pay tax, he should be a tax
subject

Article 4(1) postulated existence of tax
20
liability in praesenti
Liable to tax
AAR, in Abdul Razak’s case held that:

Tax treaty should be liberally interpreted but
only to iron out creases

Proposed that a person need not pay tax but
should be subject to tax
Relied on SC decision and yet a different
conclusion was reached
21
Liable to tax
Mumbai ITAT, in Green Emirate Shipping, held:




Expression should be read with words immediately
following it – “ by reason of”
Fiscal domicile required for liability to tax i.e. State
should have right to tax – then it is immaterial whether
the tax was actually levied
Covered “potential” double taxation also
Obiter passed for clarification
Relied on SC decision and yet a different conclusion from
Abdul Razak was reached
22
Liable to tax
The position can be summed up:

Exempt Income
- SC approved in UOI v. Azadi Bachao Andolan

Exempt entity
- SC approved in UOI v. Azadi Bachao Andolan
- AAR in Abdul Razak
- OECD MC Comm (Pension funds, etc)
23
Liable to tax

Non-taxpaying entity
- SC approved in UOI v. Azadi Bachao Andolan

Excluded entity - Individuals
- AAR disapproved in Abdul Razak’s case
ITAT in Green Emirate held that noncorporate
entity eligible for DTAA
- Amendment in Indo – UAE DTAA
Excluded entity – partnerships & companies
24
- AAR rulings have not addressed in detail

Liable to tax
Validity of a Tax Residency Certificate (‘TRC’)

TRC for residence under Indo – Mauritius DTAA
recognized – Circular No. 789 dt 13-04-2000– upheld by
SC

25
Whether TRC for other DTAAs permissible?
Any other criteria of a similar nature

Should it be construed analogously to the
preceding words?

AAR in Rafik’s case:
- Cannot be given a very narrow meaning
- Denote nexus of taxability with a Contracting
State
- Nexus for taxability could be the situs on
income

Nationality / place of incorporation excluded ?
26
Tie-breaker – Permanent Home

Permanent use of a house as opposed to short
duration of stay

To be understood in an objective sense as an
opposite of “ for a limited period” – AAR in Dr.
Rajnikant Bhat’s case -222 ITR 562

Uncertain stay in a CS does not make that stay
less permanent

27
Continuous availability
Permanent Home
No set formula. To be inferred from various
circumstances:
 Long residence
 Purchase / lease of land
 Marriage with a native
 Presence of spouse / children
 Existence of a business
 Education of children
 Membership of religious / charitable
organisations
28
Tie-breaker – Centre of Vital Interests




To be applied when Permanent Home available
is available in both the States
Involves determination of personal and
economic ties
Personal conduct of an individual is
paramount
Circumstances listed under Permanent Home
criteria are also relevant


29
Whether any preference of domestic ties over
economic ties or vice-versa intended?
Overall circumstances should be evaluated
Tie-breaker - Habitual Abode

Applicable when a permanent home is
available but the centre of vital interest cannot
be determined

Also applicable when no permanent home is
available

Regard should be had to stay in a CS whether
at the permanent home or any other place
within that State

Comparison must cover sufficient length of
time
30
Place of Effective Management – Judicial Views

AARP. No. 9 of 1995 (1996) 220 ITR 377
- From where, factually and effectively, the
day to
day affairs of the company was
carried on
and not
the place in which may
reside the ultimate control
of the company
- Article 4(3) contemplates not the location
generally but as between two Contracting
States

Affirmed in:
- P. No.10 of 1996 [1997] 224 ITR 473
- DLJMB Mauritius Investment Co , 228 ITR 268
31
Variations in DTAAs
Article 4
Indo-US DTAA
Article 4(1)

Additionally includes citizenship and place of
incorporation

Additional clause for partnerships, etc.
determining the residence of the partners/
beneficiaries to be the State of residence

Excludes a person who is liable to tax only in
respect of income from sources within that
State
33
Indo-US DTAA
Article 4(3)
 Dual residency
denied except:
- Article 10(2) –
- Article 26 –
- Article 27 –
- Article 28 –
- Article 30 –

34
of companies – DTAA benefits
Dividends
Non-discrimination
Mutual Agreement Procedure
Exchange of information
Entry into Force
Dual residency of persons
companies
and
individuals
Agreement Procedure
other than
–
Mutual
Variations in other DTAAs
Indo – Australian DTAA
Article 4(1)
 Defines resident to be a person resident for the
purposes of its tax.
 Contains only availability of permanent home
and centre of vital interests in the tie breaker
rules.
 Citizenship and habitual abode are factors
determining the degree of personal and
economic relations
35
Variations in other DTAAs
Indo Bulgaria DTAA
Article 4(1)
 Contains different definitions for determination
of a resident of Bulgaria and a resident of
India.
 Residence of Bulgaria is based on nationality
and residence of India is based on the usual
criteria
Article 4(2)
 Contains only the Centre of Vital Interest and
the Mutual Agreement Procedure criteria
36
Variations in other DTAAs
Indo Kuwait DTAA and Indo Saudi Arabia DTAA
Article 4(1)
 Residence in Kuwait / SA is based on a stay
of 183 days in a fiscal year and residence of
India is based on the usual criteria
In the amended Indo – UAE DTAA, the period
of
stay of 183 days is in a Calendar year
37
Other Variations
No tie-breaker clause
 Indo – Greece
 Indo – Libya
Head Office Criteria rather than POM
 Indo – Japan
 Indo – China
Tie-breaker clause resorts to MAP rather than PEM
 Indo – Japan
 Indo – Canada
 Indo – Indonesia
 Indo – Thailand
38
Elimination of Double
Taxation –Tax Credits
Effect of Double Taxation
Resident
Income in UK
India
1,000,000
1,000,000
1,000,000
Tax Rate in India
30%
40%
50%
UK Tax rate
40%
50%
60%
Tax in UK
400,000
500,000
600,000
Tax in india
300,000
400,000
500,000
Total Tax
700,000
900,000
1,100,000
Effective tax rate
70%
90%
110%
40
Purpose of DTAA

Title in most Model Conventions:
 “Convention
between [State A] and [State B]
for the avoidance of double taxation and
prevention of fiscal evasion”.
41
Purpose of DTAA
• One of the primary objectives of
International tax principles is avoidance
of double taxation


Tax payers
engaged in cross
border
transactions are
taxed twice on
same income
Double taxation
implies ‘over –
taxation’ due to
overlapping
taxing rights.
• DTAA provides for the tax claims of two
States both legitimately interested in
taxing a particular source of income
either by assigning to one of the two the
whole claim or else by prescribing the
basis on which the tax is to be shared
between them
• The scope of the Articles on elimination
of double taxation is to deal with the
“juridical double taxation” where the
same income or capital is taxable in the
hands of the same person by more than
one State
42
Objectives of DTAAs as defined
under Indian Laws
Avoidance
Relief
For granting relief in respect of
• Income on which taxes have been paid both
in India as well as the other State with which
India has entered into a treaty (doubly taxed
income) – Section 90(1)(a)(i)
• Income tax chargeable under the Act and in
the other State to promote mutual economic
relations, trade and investment – Section
90(1)(a)(ii).
For avoidance of double taxation – Section
90(1)(b).
Section 90
of the
Income-tax
Act
Recovery
For recovery of income-tax – Section 90(1)(d).
Information
For exchange of information for the prevention
of evasion or avoidance of income-tax in either
Country – Section 90(1)(c).
43
43
Elimination of double taxation




Countries often provide their residents with
relief from double taxation through their
domestic tax laws
DTAAs contain articles for the elimination of
double taxation.
Relief via DTAAs may be more generous than
the domestic tax laws
Relief entrenched in the DTAA also restricts a
county’s ability to amend unilaterally the double
tax relief provisions in its domestic law to the
detriment of tax payers.
44
Elimination of Double Taxation
Residence State will provide the relief –
Residence as per Article 4
 Allocation of Right to Tax
-Renunciation of Right to tax by either
state (Dependant services)
- sharing of rights ( R will provide Relief )
 Exclusive right given to Country R – Term
“shall be taxable only”

45
Methods to Eliminate Double Taxation
Deduction Method
 Exemption Method
 Foreign Tax Credit Method
 Tax Sparing Method
 Reduced Tax Rate Method

Most jurisdictions use a mixture of deduction, exemption ,
foreign tax credit and tax sparing methods. The reduced
rate method is generally not used
46
Deduction Method
Deduction of foreign taxes (FT) from the
taxable income in Country R
 Limits relief only to the extent of FT * tax
rate in Country R
 Does not completely eliminate ResidenceSource conflict
 Less Desirable Method
 Good in Tax Loss situation

47
Example – Deduction Method
Particulars
Amount
Foreign source income (Country S)
50
Domestic income (Country R)
50
World wide income
100
Foreign tax payable on foreign source income (40% x
50)
20
World wide income
100
Less: Foreign tax paid
(20)
Taxable income in country R
80
Domestic tax payable in country R (35% X 80)
28
Total tax payable by the tax payer (20+28)
48
State S tax rate is assumed at 40%, State R tax 35%
Foreign Tax paid is 20, benefit received is 35% of 20 i.e 7
48
Exemption Method
Country R does not include in its taxable
income computation of income which may
be taxed only in Country S or E
 Full Exemption method-completely ignores
Foreign Income
 Exemption with Progression – Considers
foreign income for rate purpose-applicable
only if Country R has progressive tax
system – imposes higher tax on Domestic
Income

49
Example-Full exemption Vs progressive
exemption
Particulars
Full
exemption
Exemption
with
progressio
n
Foreign source income (Country S)
50
50
Domestic income (Country R)
50
50
World wide income
100
100
Foreign tax payable on foreign source
income (40% x 50)
20
20
17.5
22.5
(50 x 35%)
(50 x 45%)
37.5
42.5
Country R -35% upto 50 and 45% after 50
Domestic tax payable on domestic source
income only
Total tax payable by the tax payer on world
wide income of 100
Group Dynamics
50
Exemption method -concerns
Reduces the tax share of Country R
 PE losses can not be used for set off
 Encourages use of low tax countries as
Source state
 May result in Double Non Taxation where
source country exempts such income

51
Foreign Tax Credit Method
State R allows a deduction (credit) from tax
payable in Sate R for tax paid in State S

Steps:
The State R calculates tax including income
taxable in State S or E (except where an exclusive
right to tax is with State S)
 State R allows a deduction from its own tax for tax
paid in State S / E

Two Methods : Full Credit and Ordinary
Credit
52
Full Credit Method
Total Tax paid in State S / E deducted
from Tax payable in State R
 Tax payer liable to pay R only the
difference in tax between S & R
 Effective Tax Rate is the Rate of Country
R
 Full Tax Credit is rarely used (US)

53
Example -Full Credit
Particulars Sate S : 40% , R : 35%
Full Credit
Foreign source income (Country S)
50
Domestic income (Country R)
50
World wide income
100
State S tax payable on State S source
income (40% x 50)
20
State R tax payable on world wide income
(35% x 100)
35
Less: Tax credit for foreign tax paid on
foreign source income
(20)
Tax payable in country R
15
Total tax payable by the tax payer
35
(20+15)
54
Ordinary Credit




Limits the tax credit to the tax on the doubly taxed
income, as computed under the domestic law, as if it
were earned at home in the same accounting
period.
If Home Country Tax exceeds the tax payable on
such income in Source country, Tax payer pays in
Country R
Excess Tax is not refunded if Source country tax is
more
Most Commonly used method
55
Example –Ordinary Credit
Particulars Sate S : 40% , R : 35%
Ordinary
Credit
Foreign source income (Country S)
50
Domestic income (Country R)
50
World wide income
100
State S tax payable on State S source
income (40% x 50)
20
State R tax payable on world wide income
(35% x 100)
35
Less: Tax credit for foreign tax paid on
foreign source income
(17.5)
(35% x 50)
Tax payable in country R
17.5
Total tax payable by the tax payer
37.5
(20+17.5)
56
Tax rate in R is more than rate in S
Country R
40%
Country S
35%
Ordinary
Credit
Full Credit
Foreign source (Country S)
50
50
Domestic Income (Country R)
50
50
World Wide Income
100
100
Foreign Tax payable on Foreign Source Income ( 35% and
50)
17.5
17.5
Domestic tax payable on World Wide income (40% of 100)
40
40
Less: Full Credit
17.5
Less: Ordinary Credit (see note)
17.50
Tax payable in country R
Total Tax payable in both country
Ordinary credit
20.00
Group Dynamics
22.5
22.50
40
40.00
57
Tax Credit Vs Investment Decision
Tax rate in Country R
35%
Tax rate
30%
Country S1
Pre-tax return
Country S2
1000
Tax paid in Country S1
10%
900
300
Tax paid in Country S2
90
Country R's tax
350
315
Less: FTC ordinary
300
90
50
225
650
585
700
810
58
Tax payable in R
Return to Investor
Return to Country R
Group Dynamics
Credit in case of loss
Foreign Source Income (Country S)
1,000
Domestic Income (Country R)
-
5,000
World Wide Income (loss)
-
4,000
FT payable on Foreign Source (20% 1000)
200
Domestic Tax Payable on Worldwide income
0
Less: FTC
0
Tax payble in R
0
Total tax paid in both country
200
59
Gross vs Net
Country R Borrows Rs1,000 @ 10%
Lends to Country S @ 12%
Tax rate in Country S - 10% on gross
Tax rate in country R-15% on net
Gross Interest income(1000*12%)
120
Less: Interest expense (1000*10%)
100
Net Income
20
FT payable in S
12
Domestic Tax payable on worldwide Income
3
Less: ordinary credit
3
Net tax payable in R
0
Total Tax payable
12
Effective tax rate
60%
60
Foreign Tax Credit methodconcerns
Excess Foreign tax Credit unusable if
Carry forward or Carry back not allowed
 Effectively Tax payer pays higher of
Foreign tax or the Home tax which ever is
higher
 Eliminates the tax incentives and relief
given in source state – 54EC, 54EF etc.

61
Tax Sparing Method



Source country offers tax incentives to investors with NIL
or reduced tax rate which result in reduced or no tax
payable in the source country.
A notional tax credit is granted in the resident country for
the tax not paid under special incentive
schemes/allowances in the source country.
Treaty prescribes exact nature of such tax free income;


e.g. India-US- Sec 10A income
Absence of tax sparing clause in the Treaties would
result in the transfer of tax revenues from Source to
Resident state with no ultimate benefit to the tax payer.
62
Underlying Tax Credit ( UTC)




In case of US companies holding at least 10% stake in an
Indian Company and from which the US company receives
dividends, the US company would be able to claim a credit
even in respect of the taxes paid by the Indian company on
the profits out of which it has paid dividends against its US
taxes
Individuals and non – corporate assessees not covered
Only relevant for USA under the Treaty – India does not
allow underlying tax credit
India provides underlying tax credit in respect of the Mauritius
tax payable by the company in respect of the profits out of
which such dividend is paid by a company resident in
Mauritius to an Indian company ( ownership stake of 10%
required)
63
Example -UTC
Income before taxation of the Mauritius Co
100,000
Tax @ 40%
40,000
Income after Tax
60,000
Dividend Distributed by the Mauritius Co
30,000
Profit carried forward
30,000
50% of the equity of Mauritius Co. is held by Indian Co
Dividend paid to Indian Company
15,000
UTC (15,000 X 40,000 / 60,000)
10,000
64
Elimination as per DTAA

OECD Model Convention –Article 23



Article 23 deals with the Treaty relief from double taxation where the
same income or capital is taxed by more than one state under the
Treaty
As the prior taxing rights remain with the source state, the relief
provisions apply to the residence state only.
Residence state to elect from the following methods:




Exemption method (Article 23A) which considers ‘income’
Credit Method (Article 23B) which considers ‘tax’
A contracting state may also use a combination of the two methods.
UN Model Convention – Article 23



UN Model also specifies ‘Exemption Method’ (Article 23A) and
‘Credit Method’ (Article 23B) to be adopted by residence state.
The UN Committee provides for investment incentives through tax
sparing credits.
Countries, remain free to adopt these investment incentives
65
Documentation Required for FTC

Overseas Tax Returns

Overseas Tax withholding certificates

Certificate of Residency

Certificate from Foreign Tax authorities

Third party certification

Fiscal year mismatch – part year return, part year withholding
certificate?
66
Limitations on FTC
-
-
Per-Country Limitation
World wide Limitation
Per-category Limitation
Excess of Foreign Tax Credit-Carry back
or Carry forward
67
Optimal Credit Method for FTC
Country S1 Country S2 Country S3
100,000
100,000 100,000
30%
42%
20%
30,000
42,000
20,000
300,000
92,000
Country R Worldwide
100,000
400,000
30%
120,000
Income
Rate of taxation
Tax amount
Total Foreign Sourced Income
Total Foreign Taxes Paid
Foreign Tax Credit
A - Country by Country Method
30,000
30,000
20,000
B - Full Credit Method
C - Aggregation or Overall Method (with limitation)
FTC = Resident Income Tax X Foreign Source Income / Worldwide taxable income
120,000 X 300,000 / 400,000
Carry forward / carry back ward
80,000
92,000
90,000
2,000
68
Practical Issues in FTC







Only Taxes covered in scope-State taxes not
covered
Dividend Distribution Tax – no credit if there is
no underlying tax credit
Different Assessment Period
Timing of Tax Filings in both countries
Different method of income computation
Conversion of Forex
Shifting of Residence and Timing Difference
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Presented By
CA Swatantra Singh, B.Com , FCA, MBA
Email ID: [email protected]
New Delhi , 9811322785,
www.caindelhiindia.com,
www.carajput.com
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