The Role of Tax Treaties in Preventing Double Taxation

The article titles as “The Role of Tax Treaties in Preventing Double Taxation” is written by Mercy Nkomo, 4^th year BA LLB student at Lovely Professional University.

In today’s globalised world, businesses and individuals often earn income in multiple countries. However, this can lead to double taxation, where the same income is taxed in two different countries. This not only discourages cross-border trade and investment but also creates financial strain on taxpayers.

To resolve this issue, tax treaties, also known as Double Taxation Avoidance Agreements (DTAA), are signed between countries. These agreements help prevent double taxation, promote fair taxation, and encourage economic cooperation. In this blog, we will explore in detail the concept of tax treaties, their role in preventing double taxation, and their significance in international taxation.

Understanding Double Taxation

Double taxation is when charges are levied twice on the same source of pay. It can happen when wage is burdened at the corporate and individual level. Double Taxation can too happen in worldwide exchange or venture when the same pay is saddled in two nations. This can happen in two ways, which are :

Juridical Double Taxation– When the same person or entity is taxed on the same income in two different countries.
Economic Double Taxation– When two different entities in a group (such as parent and subsidiary companies) are taxed on the same income in different jurisdictions.

For example, if an Indian citizen earns income in the USA, both India and the USA may claim the right to tax that income. Without a tax treaty, the individual might have to pay tax in both countries, reducing their net earnings

What are Tax Treaties

A Tax Treaty also known as the Double Tax Avoidance Agreement (DTAA), is an international treaty between two or more countries designed to prevent the same Income from being taxed twice. India, for instance, has such agreements with 85 countries, benefiting individuals who reside in one country but earn Income in another. The treaty includes approaches like bilateral treaties, exemption methods, and tax credits to address double taxation. This agreement mitigates the tax burden and fosters economic cooperation by encouraging cross-border trade, capital investments, and other economic exchanges. Under DTAA, participating countries agree on specific tax rates for Income earned in one nation by residents of another. The scope of DTAA can encompass various forms of Income depending on the agreement details, which might include:

Capital gains,
Income from property,
Salaries,
Earnings from professional services,
Interest from fixed deposit accounts,
Savings, and other categories.

There are two main models used for drafting tax treaties:

OECD Model Tax Convention – Favoured by developed countries, it supports residence-based taxation.
UN Model Tax Treaty—This is Preferred by developing countries as it gives more taxation rights to the source country.

Benefits of these Treaties

These offer several advantages for example Indian residents, particularly in managing international income and investments .some of the benefits include the following:

Tax Exemption: DTAA can provide exemptions from tax in certain situations, particularly beneficial for those in business and trade. For example, capital gains may be exempt under DTAA, but it’s important to understand the specific terms and conditions that apply for claiming such exemptions.
Tax Credit: This benefit allows individuals to claim a credit for taxes paid in the country where the Income was generated. It effectively prevents paying tax on the same Income twice, facilitating smoother business operations and revenue transfer internationally.
Legal Certainty: DTAA provides clear guidelines on taxing international Income, which enhances legal certainty. This certainty is particularly encouraging for developing countries looking to attract foreign investments.
Reduced TDS Rates: The agreement also reduces TDS (Tax Deducted at Source) rates on dividends received in India. This can lead to significant savings, especially for those with substantial dividend income.
Tax Refund Opportunities: In certain cases, if a company from one country pays tax on Income earned in another country, the country of origin may offer a refund or a part of the tax paid. Under the framework of DTAA, this rebate can provide financial relief to businesses operating across borders.

Real-World Examples & Case Laws

India-Mauritius DTAA – Many companies used this treaty to avoid capital gains tax in India. However, the treaty was amended to prevent abuse.
Vodafone Case – India’s tax treaty provisions played a major role in the tax dispute related to Vodafone’s acquisition of Hutchison Essar.

Objectives and Scope of Double Taxation Avoidance Agreements

The Double Taxation Avoidance Agreement (DTAA) plays a vital role in the international business and taxation landscape, with its primary objectives being:

Avoidance of Double Taxation: This is the cornerstone of any DTAA. It ensures that Income earned in one country by a resident of another is taxed in just one of the two countries, thereby preventing the same Income from being taxed twice. This is particularly important for multinational corporations and individuals who operate across borders.
Prevention of Tax Evasion: DTAA agreements often include provisions that help prevent tax evasion, ensuring taxpayers cannot exploit loopholes in international tax rules to avoid paying taxes.
Information Exchange: These agreements often facilitate the exchange of information between the countries’ tax authorities. This exchange is crucial for enforcing tax laws and preventing illegal activities like tax evasion and money laundering.
Specific vs. Comprehensive Agreements: DTAAs can be comprehensive, covering all types of Income and capital or limited to specific sectors or types of Income. Comprehensive agreements provide a broad framework covering various income sources, while sector-specific agreements focus on particular areas like Income from aviation, shipping, etc.
Types of Double Taxation Avoidance Agreements (DTAAs)Double Taxation Avoidance Agreements (DTAAs) come in different forms, each tailored to the specific needs and relationships between the countries involved. The main types of DTAAs include

Comprehensive DTAA

This o one covers all sources of income, including business profits, salaries, dividends, interest, royalties, and capital gains. Also ensures that residents of either country are taxed only once on their income. Example India-Mauritius DTAA .

Limited DTAA

This applies only to specific types of income, such as shipping air transport, or capital gains. For India-Saudi Arabia DTAA (covers-only airline and shipping companies)**

Bilateral DTAA

This is a treaty signed between two countries to eliminate double taxation. It may include provisions for tax credits, exemptions, or tax rate reductions.

Multilateral DTAA

Involves multiple countries agreeing on taxation rules to prevent double taxation.example being Multilateral Instrument (MLI) under the OECD BEPS framework, which aims to prevent tax avoidance by multinational corporations.

Exemption Method DTAA

One country agrees to exempt certain incomes from taxation if the taxpayer has already paid taxes in the other country.

Credit Method DTAA

The taxpayer pays tax in both countries but can claim a credit in their resident country for taxes paid in the source country.

These treaties help businesses and individuals avoid excessive taxation while promoting international trade and investment. Let me know if you need specific details on any DTAA.

DTAA Rates

DTAA rates vary between countries and depend on the agreements they have with each other. Here are some key points to understand:

Different Rates for Different Countries: The tax rate under DTAA is not the same for all countries. It depends on the agreement between each pair of countries.
No Set Expiry Date: These agreements don’t have a specific end date. They continue until any of the countries involved decides to end it.
Changes are Possible: The rules and tax rates under DTAA can change if both countries agree to make amendments.
TDS Rates for Interest: The tax deducted at source (TDS) for interest income usually ranges between 10% and 15%, but this can vary based on the specific agreement.
Tax on Dividend Income: For foreign firms or non residents receiving dividend income from India, the tax rate is decided based on the relevant DTAA.

India has entered Double Taxation Avoidance Agreements (DTAAs) with approximately 85 countries.

Steps to Avail DTAA Benefits

Determine Eligibility

Ensure that there is a DTAA between your country of residence and the source country (where income is earned).

– Check whether you qualify under the provisions of the agreement.

Tax Residency Certificate (TRC)

A TRCis required from the tax authority of your country of residence to prove that you are a tax resident there.

Apply for it through the income tax department of your home country.

Fill and Submit Form 10F (If Applicable)

In India, non-residents claiming DTAA benefits must file Form 10F with the Indian tax authorities.

Self-Declaration (No Permanent Establishment Clause, If Required)

Some countries may require a self-declaration stating that you do not have a permanent establishment in the source country.

Withholding Tax Certificate (If Applicable)

If tax has already been deducted at source (TDS) in the foreign country, obtain a withholding tax certificate as proof.

File Tax Returns & Claim Refund (If Over-Taxed)

If excess tax was deducted, file tax returns in the foreign country and claim a refund under the DTAA provisions.

Documents Required

Tax Residency Certificate (TRC) from your home country.
Form 10F for non-residents in India).
Self-declaration letter(stating DTAA applicability).
Passport & Visa (to establish residential status, if required).
PAN Card (for transactions in India).
Withholding tax certificate (if tax was deducted at source).
Income documents(salary slips, dividend statements, rental agreements, etc.).
Bank statements (showing foreign income transactions).

Challenges and Criticism of Tax Treaties

While tax treaties provide several benefits, they also face challenges:

Base Erosion and Profit Shifting (BEPS) – Large corporations shift profits to low-tax countries to avoid tax.
Treaty Shopping – Some companies misuse tax treaties by setting up businesses in countries with favourable tax treaties.
Taxing the Digital Economy – Traditional tax treaties struggle to tax digital companies like Google and Amazon, which operate globally without a physical presence.

Recent Developments and Future Trends

OECD’s Multilateral Instrument (MLI) – A global initiative to modify tax treaties and prevent tax avoidance.
BEPS Action Plan – Introduced by the OECD to tackle tax treaty abuse.
Global Minimum Tax (GMCT) – Many countries are considering a global minimum corporate tax to prevent profit shifting.

Conclusion

Tax treaties are essential tools for preventing double taxation and ensuring smooth cross-border economic transactions. By providing clear taxation rules, they foster international trade and investment while avoiding excessive tax burdens on individuals and businesses.

However, the effectiveness of tax treaties is constantly challenged by evolving business models, digital transactions, and tax avoidance strategies like Base Erosion and Profit Shifting (BEPS). While initiatives like the OECD’s Multilateral Instrument (MLI) and BEPS Action Plan aim to modernise tax treaties, more work is needed to ensure that international tax rules remain fair, transparent, and adaptable.

For tax treaties to continue serving their purpose, countries must focus on:

Strengthening global cooperation to combat tax evasion.
Updating tax treaties to address digital business taxation.
Ensuring fair tax distribution between developed and developing nations.

As the world becomes more interconnected, tax treaties must evolve to balance the interests of nations while promoting a just and efficient taxation system.This blog highlights a crucial but often overlooked aspect of international taxation. It simplifies a complex legal concept, making it accessible to readers who may not have a deep understanding of tax law. The inclusion of real-world examples, case laws, and current developments ensures that the blog remains relevant and insightful.