Meaning and Scope

Taxation of income crossing national borders

International taxation refers to the study and application of tax rules to income that flows across national boundaries. It includes the taxation of:

• Residents earning income from foreign sources
• Non-residents earning income from within a country
• Cross-border transactions such as royalties, fees, business profits, and capital gains

The primary aim is to ensure a fair and equitable allocation of taxing rights between countries, avoiding double taxation and preventing tax evasion or avoidance.

Scope of International Taxation includes:

• Determination of tax liability of foreign individuals and entities in India
• Application of Double Taxation Avoidance Agreements (DTAAs)
• Transfer Pricing and Base Erosion and Profit Shifting (BEPS)
• International tax treaties and OECD guidelines

Taxation Jurisdiction

Source Rule vs. Residence Rule

Taxation jurisdiction refers to the authority of a country to levy tax on an individual or an entity. This is primarily based on two principles:

• Source Rule: The country where the income originates (source country) has the right to tax the income, regardless of the residence of the taxpayer.
  • Example: A non-resident earning rental income from property in India is taxed in India.
• Residence Rule: The country where the taxpayer resides has the right to tax the global income of the resident, regardless of the source of income.
  • Example: An Indian resident earning dividends from shares in the US is taxed in India.

India's Approach: India follows a combination of both rules:

• Residents are taxed on their global income (Residence Rule).
• Non-residents are taxed only on the income that accrues or arises in India (Source Rule).

These principles form the foundation of international tax treaties and help in resolving disputes related to double taxation and tax residency.

Meaning and Objectives of DTAAs

Double Taxation Avoidance Agreements (DTAAs) are treaties signed between two or more countries to avoid taxing the same income twice — once in the country where the income is earned and again in the country of residence of the taxpayer.

To eliminate tax evasion

One of the core objectives of DTAAs is to prevent tax evasion through the exchange of information between contracting states. This includes provision for mutual cooperation, transparency, and data sharing.

By clearly defining how different categories of income should be taxed, DTAAs reduce opportunities for companies and individuals to exploit gaps between jurisdictions.

To promote international trade and investment

DTAAs encourage cross-border trade and investment by ensuring tax certainty and non-discrimination. Investors gain clarity on their tax liabilities and the assurance that they won’t be taxed excessively.

India has signed DTAAs with more than 90 countries including the USA, UK, UAE, Singapore, and Mauritius, thereby making foreign collaborations and investments more attractive.

Model Conventions

OECD Model Tax Convention

The OECD Model Tax Convention is widely followed by developed countries and serves as the basis for negotiating most DTAAs. It provides a comprehensive framework for:

• Allocation of taxing rights
• Definition of key terms like Permanent Establishment and Residence
• Relief methods to avoid double taxation

This model leans towards the residence-based taxation approach, granting taxing rights to the country of residence in most cases.

UN Model Tax Convention

The UN Model Tax Convention is generally followed by developing countries. It gives more taxing rights to the source country (i.e., the country where the income originates).

It differs from the OECD Model primarily by allowing the source country to retain a higher share of taxing rights, thus favoring capital-importing countries like India.

Key Provisions in DTAAs

Definitions (Permanent Establishment, Residence)

Permanent Establishment (PE): A PE is a fixed place of business through which the business of an enterprise is wholly or partly carried on. For example, a branch office in India by a foreign company constitutes a PE.

Residence: The term ‘resident’ typically refers to any person who is liable to tax by reason of domicile, residence, place of management, or any similar criterion in one of the contracting states.

Taxation of various incomes (Business Profits, Dividends, Interest, Royalties, Capital Gains)

Business Profits

Taxable in the country where the business has a PE. If no PE exists, profits are not taxed in the source country.

Dividends

May be taxed both in the source and resident country. However, DTAAs often cap the rate in the source country (e.g., 5%–15%).

Interest

Generally taxed in the source country, but subject to a reduced rate (typically 10%–15%) under the treaty.

Royalties

Like interest, royalties are taxed in the source country at a concessional rate defined in the DTAA.

Capital Gains

Taxation rights usually depend on the nature of the asset and location. For example, gains from immovable property are taxed in the country where the property is located.

Methods of Elimination of Double Taxation (Exemption, Credit)

Exemption Method

Income that has already been taxed in the source country is exempt from tax in the residence country. No further tax is payable.

Credit Method

Under this method, tax paid in the source country is given as a credit against tax payable in the resident country. However, this is limited to the amount of Indian tax payable on such income.

Formula for Tax Credit:

If Indian Tax = ₹20,000 and Foreign Tax Paid = ₹15,000, then

Credit Allowed = $\min(\text{Indian Tax}, \text{Foreign Tax}) = ₹15{,}000$

Net Indian Tax Payable = $₹20{,}000 - ₹15{,}000 = ₹5{,}000$

Section 90 and 90A of Income Tax Act, 1961

Section 90

This section empowers the Central Government to enter into DTAAs with other countries. The main objectives include:

• Granting relief in respect of income on which tax has been paid in both countries
• Preventing evasion or avoidance of income tax
• Facilitating exchange of information

Section 90A

Introduced to allow similar agreements between India and specified territories (not necessarily sovereign states), like Hong Kong or Taiwan.

This section mirrors Section 90 and applies when such specified territories enter into agreements with India.

Key Points:

• If DTAA provisions are more beneficial than the Income Tax Act, the assessee can opt for DTAA.
• The assessee must obtain a Tax Residency Certificate (TRC) from the foreign government to avail DTAA benefits.