How Does International Taxation Operate?

Sonal Pruthi

14 Dec, 2020

International Taxation is to tax the person’s income which has been earned or accrued by that individual in the country where he does business and where he resides. This means that the income earned at one place is taxed at two different places.

• Taxed at the place of residence
• Taxed at the place of earning

Example

The person is a resident of India and he works in Dubai and comes back to India after 6 months. So the income which has been earned in Dubai will be taxed at the place of earning that is Dubai. He is a resident of India so the income earned has been accrued in India as per Section 9 of Income Tax Act 1961^[1]. This means the income has been taxed at two different countries twice. As to avoid double taxation, India has entered into Double Taxation Avoidance Agreement with multiple countries to reduce burden of taxpayer.

Basics of International Taxation From The Perspective of India

Looking at this perspective, the concept has been divided into two parts:

Indian Income Tax Act levies tax On the Income Earned in a Foreign Country by Residents and Indian Income of NRI. As per the taxation law of our country, we have been using Residential Status in order to determine the taxable income for international taxation. The charging sections aresection 4, section 5, section 6, and section 9 of the Income Tax Act, 1961. Here we are looking at the taxable income that is, income earned in India as well as foreign country.

The point of consideration is:

Section 5(1) Of Income Tax Act –

Section 9 Which is a Deeming Provision Related to International Taxation

It has the list of income which gets accrued or arises in India for NON RESIDENTS even though the income has been earned outside India:

TDS (Tax Deducted at Source) Provision

The above diagram clearly explains the situation of the income where it is expressed that taxation of non-residents is the issue of collection of tax at the time of generation of the income itself. So we have the provision of TDS where the tax is collected at the source by the payee at the source of remittance of the sum to non-resident. Sometimes, the non-residents do not even have assets or establishments situated in India. Such Income Is Considered As Non-Resident Income.

Double Taxation Avoidance Agreement

DTAA stands for Double Taxation Avoidance Agreement. The concept has been explained in the Vienna Convention on Law of Treaties 1960. It is not a taxing statute but an agreement between the countries. It is about how taxes are levied and computed at both the countries and under the treaty.

The agreement which has been signed between two countries in order to reduce burden of double taxation on the taxpayer and resolving issues of taxability of income between the concerned nations and to increase transparency and reduce tax evasion.

How DTAA Works?

In every country, domestic tax law is the law which is applied on both residents and non-residents. But section 90 is the guiding section in case of the Double Taxation Avoidance Agreement.

Section 90 Of It Act, 1961 Is As Follows:

This Section permits the Indian Government to enter into agreements with the countries or specified territories for the purpose of Double Taxation. India has entered into agreements with approximately 88 countries.

The provision of Section 90 as follow:

• The relief to the taxpayer where he has paid tax under both systems of tax laws in different countries that is, Indian Law and in corresponding foreign law.
• To avoid the double taxation imposed in Indian Law and the corresponding foreign jurisdiction.
• To prevent tax evasion in either country that is India or foreign jurisdiction.
• It helps to exchange information of tax evasions or helps in investigating agencies in the cases of tax evasion in ether of the jurisdiction.
• Helps to create recovery of income tax  under the Income tax law or foreign jurisdiction

Section 90(2) helps to bring the treaty in the enforcement.

• It helps to compute the amount of liability of tax
• The assessee on whom the DTAA applies,
• The provision of Income Tax Act Or Provision Of DTAA will be computed
• Whichever Will Be Less Beneficial to the Assessee Will be Deducted.

DTAA Application With The Domestic Law

The following steps have to be considered for DTAA:

1. Verify the Person seeking relief under the treaty is a Resident in terms of the contracting state.
2. The above step is all about knowing the Residential Status of the assessee in terms of the respective domestic laws.
3. If the person qualifies to be of Domestic law, then compute his income according to the Domestic Tax Law.
4. Then verify the corresponding provision in DTAA for the assessee where the income liability has been generated. Calculate tax with respect to the item of income given in the treaty.
5. Check whether, the tax computed for the assessee in both the law and treaty, see which is beneficial.
6. If the domestic law is beneficial, give benefit to the assessee under it.
7. It means whichever is less (computation of tax under domestic law or DTAA) will prevail.
8. For Foreign tax credit, then Rule 128 applies.

International Tax Planning and International Taxation

International Tax Planning is carried out to achieve tax effectiveness at the cross-border transactions and lawful routing of the business activities and capital flows. The international tax planning checks the relationship between two or more taxation systems, the impact of juridical and economic double taxation. It also involves tax incentives, or tax exemptions for foreign income, use of tax treaties and anti avoidance treatments.

India’s Position to Stop Tax planning are–

1. SAAR- Specific Anti Avoidance Regulations like Section 9 ,section 64 ITA,1961
2. TRANSFER PRICING
3. GAAR

Tax Planning is prevented by the government using the methods stated above. The reason is very simple even if the assessee wants to pay tax, due to prevailing provisions in double taxation agreement and information exchange systems. Also for any medium size tax payer, it is difficult to comply with the compliances of the international taxation.

Conclusion

Read our article:DTAA – What is the Double Taxation Avoidance Agreement?