Globalisation is bringing the world closer with each passing day. Many individuals are becoming global citizens, moving from one country to the other as part of their work requirements. They are also happy to explore the new opportunities as it is financially very lucrative for them. But this has raised some tax complications for them. As a general principle, taxpayers have to pay taxes in the country where they earn income; this principle is also known as source-based taxation. No country would like any person to take away the income earned in it, without the due taxes being discharged by the individual. On top of it, if he is a resident of the other country, that country may also tax his global income (i.e. the income earned outside the country of residence).
Currently, India has comprehensive Double Tax Avoidance Agreements (DTAAs) with 88 countries, out of which 85 are in force.
All this can result in serious double taxation of the same income. In such situations, the Double Tax Avoidance Agreement (DTAA) can come to the rescue of such taxpayer. Currently, India has comprehensive DTAAs with 88 countries, out of which 85 are in force.
Note that in some countries, like the USA, people are taxed based on the citizenship—implying that irrespective of the fact that the US citizen was outside the USA for the entire tax year, he may still have to pay taxes on his global income in the USA. India, on the other hand, does not have citizenship-based taxation, following a residency-based system instead. If the taxpayer qualifies as a resident as per the residency rules listed in section 6, then he will have to pay taxes on his global income. Further, if a taxpayer is becoming a resident of both countries by applying the local tax laws, then his residential status is determined by applying the tie-breaker rule in the relevant DTAA.
What is DTAA?
It is a bilateral or multilateral agreement between two or more countries to resolve the issues of taxation of income, bring transparency and to stem tax evasion. DTAA helps in:
• Allocation of taxpayers' income and related taxing rights of two countries.
• Avoiding double taxation of income.
• For smoother recovery of income tax in both the countries.
How DTAA works
The primary purpose of the DTAA is to eliminate or avoid double taxation of income. This is achieved by adopting the various methods listed below:
• Deduction method: Under this method, the country in which the taxpayer is a resident, allows him a deduction from the taxable income, on account of the taxes paid in another country on his foreign source. This method is not very common as it does not eliminate double taxation completely.
• Exemption method: Under this method, the taxpayer can claim his foreign source income as exempt from tax. This would imply that the income is not included in taxable income at all. Hence there would be no question of double taxation. India has tax treaties with many countries, some of which provide for exemption of certain incomes from double taxation. For example, as per the India-US DTAA, social security benefits and other public pensions paid by the US to a taxpayer resident in India will be taxable in the US only. Further any US government pension, paid in respect of services rendered in US and received by a US national resident in India shall be taxable only in the US.
• Credit method: Under this method, the taxpayer first includes his foreign source income in his total taxable income in the country of residence (i.e. India) and calculates the taxes as per the normal provisions of the tax laws of that country. Then he will be eligible to claim the credit for the foreign taxes (in respect of the doubly taxed income) against the respective tax liability in the country of residence. The taxpayer will be able to claim the credit at a rate lower of the taxes paid in the foreign country and the taxes payable in the home country as applicable on the doubly taxed income. This is the most commonly used method of providing relief from double taxation and finds place in almost all the tax treaties.
If India does not have a tax treaty with the country from which you are earning income, then you can still claim foreign tax credit under section 90A of the IT Act.
In simple words, if the tax rate in the resident country is higher than the foreign country, then the taxpayer will have to pay the differential (additional) taxes in the home country. If the tax rate in the resident country is lower than the foreign country, then he will be able to claim only to the extent of the rate at which the income is taxable in resident country.
Do remember that each DTAA has some or the other beneficial provision which can help in avoiding double taxation. Hence if someone has worked outside India for part of the year and qualifies as an ordinary resident of India for the respective tax year, then it is in his interest to carefully analyse whether he is eligible for any special benefits under the relevant DTAA. If not he can at least claim the credit for the taxes paid on such income in the foreign country. Remember that the tax treaty provision will apply only to the extent beneficial to the taxpayer. Therefore, if India does not have a tax treaty with the country from which you are earning income, then you can still claim foreign tax credit under section 90A of the IT Act.