In the present era of cross-border transactions across the world, the impact of taxation is one amongst the most important as well as necessary considerations for any trade and investment decision in other countries. One of the most significant results of globalization is the visible impact of a country's domestic tax policies on the economy of another country.

This has led to the requirement for incessantly assessing the tax regimes of various countries and bringing about necessary reforms. In various instances it was observed that the same income of an individual is taxed twice by two different states (countries), which led to the emergence of Double Taxation Avoidance Agreements.

What is Double Taxation?

Double taxation refers to a situation where taxes are paid twice on the same income. The nature of international taxation is the discussion as to whether or not a state has the right to tax an individual or a company and if yes, then to what extent. In other words it can be said that what is the jurisdiction of a country or a state to tax the individuals or companies.[i]Where a taxpayer is a resident of one state but has a source of income situated in another state it gives rise to the possibility of double taxation. This gives rise to two basic rules that enable the state of residence and also the state where the source of income exists to impose the tax, namely:

1. When the income is to be taxed in the country or state in which it originates, regardless of whether the income accrued is of a resident or a non-resident is known as the Source Rule, and
2. On the other hand where the taxing power should be with the country or the state in which the taxpayer resides is known as Residence Rule.

If both of these rules were to apply simultaneously to a business entity, it would suffer taxation at both ends. As a consequence, the cost of operating on an international scale would become prohibitive for the business entity and would deter it from conducting its business, thereby hindering the process of globalization.[ii]

Double taxation is possible at both, international as well as domestic level. At the domestic level, the most common example is in case of corporate dividends. When a business generates profits and distributes it to shareholders in form of dividends, it pays tax on the dividend which is known as Dividend Distribution Tax (DTT).

Alongside DTT, the income received by shareholders is also taxed at an individual level. The existing tax provisions provide that the income from dividends is tax free in the hands of the investor up to Rs 10,00,000 and beyond that tax is levied @10%. Further it is stated that the dividends from domestic companies are tax-exempt, but dividends from foreign companies are taxable in the hands of investors.

Even under the GST Law it has been specified that the importers are required to discharge IGST at 5% on ocean freight charges under the reverse charge mechanism. Whereas, at the same time, customs duty levied on the CIF value (including the freight components) of the goods imported into India is also required to be paid by the importer. As a consequence, it leads to double taxation on the ocean freight under GST law and thereby increased the cost of imports.

Recently, in the case of Mohit Minerals Pvt. Ltd. & Ors. Vs. Union of India & Ors. [TS-29-HC-2020(GUJ)-NT], the Gujarat High Court has passed a landmark and judgement and has held that no tax shall be leviable on the ocean freight for services rendered by a person who is located in non-taxable territory by way of transportation of goods by a vessel from a place outside India up to the customs station of clearance in India.

What is DTAA?

Double Taxation Avoidance Agreement is a bilateral agreement between two states to avoid double taxation of the same income [iii]. Double Tax Avoidance Agreements or Double Tax Treaties or simply Tax Treaties are instruments in international tax laws, mostly governed by the Vienna Convention on the Law of Treaties, and the structure is generally based on the UN Model Tax Convention or the OECD Model Tax Convention.

Double Tax treaties provide a consistent, common and logical basis by which pairs of states can divide up between themselves, the taxing rights over persons who have a tax connection with both states, whether by reason of tax residence or because of the existence of a source of income. [iv]

The DTAA along with the domestic law of the states provides for the structure of taxation to be followed, but in case of collusion of provisions, the provisions of the treaty tend to override the provisions of the domestic law of the states[v]. The main aim of the DTAAs is to provide a uniform basis for taxation between the states, prevent evasion and avoidance of taxes, protect taxpayers from double taxation, promote international trade and protect the taxpayers against discrimination.

Concept of Permanent Establishment

Permanent Establishment, has been used by countries to define and prove the presence of foreign taxable business in its jurisdiction[vi]. If a company has a taxable presence outside the company's state of residence then it is called as Permanent Establishment (PE). If a company having an establishment in a foreign land and its decisions for its operations are taken in the same foreign land then such establishment is considered a company/firm of the foreign country, thereby all the laws applicable to a local company will be applicable to such company.

In CIT Vs. Vishakhapatnam Port Trust[vii], Permanent Establishment has been defined as the foreign enterprise having a permanent or permanent substantive element in another country, which can be attributed to a fixed place of business in that country. It should have such a nature that it is equivalent to a virtual projection of a foreign enterprise in one country on the soil of another country.

Situation of DTAA in Indian Law

The main aim of DTAA is to avoid the dual taxation or double taxation of the same income in different countries who have agreed to such an arrangement. Under Indian Laws, a person is taxed on the basis of his residential status. Similarly, there exists a possibility that the person may either be taxed on this basis or some other basis in another country on the very same income. However, it is a universally accepted and a applied principle that the same income should not be subjected to be taxed twice. In order to take care of such situations, the Income-tax Act, 1961 has provided for double taxation relief under Section 90 and 91 of the Income Tax Act deals with the same.

It is important to assess as to which of the provisions shall prevail in case of dispute between the Income Tax Act and DTAA. For that section 90, of the Income Tax Act, invests in the assessee the power to choose as to which of the provision is more favourable to him and thus that provision shall prevail. [viii]

In case of Union of India v. Azadi Bachao Andolan [ix], the question arose before the apex court was whether the assessee as per the powers given to him under Section 90(2), Income Tax Act,1961, has the power to choose Income Tax Act for particular forms of income and DTAA for other?
To which the Apex Court held that:
as per the language of the provision it allows and grants the power to assessee to tax his particular income under the Act and other under DTAA, thus favouring and benefitting the assessee.

As per section 90(2), when the Government of India enters into an agreement with the Government of any other country for granting relief of tax or for the purpose of avoidance of double taxation, then in relation to the assessee to whom such agreement applies, the provisions of both, the 1961 Act as well as the provisions of DTAA shall apply and if the provisions of DTAA are more beneficial to the assessee, they shall override the provisions of Income-tax Act (SNC Lavalin/Acres Inc. vs. Assistant Commissioner of Income Tax, Palampur). [x]

Thereby Double Taxation Avoidance Agreement supersedes the general domestic tax law provisions of the state. In India the 1961 Act thereby allows the assessee the choice to be governed either by the relevant DTAA or the 1961 tax Act.

Thus Double taxation is the levy of tax by two or more countries on the same income, asset or financial transaction. This double liability is mitigated in many ways, one of them being a tax treaty between the two states. Thereby where a tax treaty exists between two countries to avoid taxing the same income is known as DTAA. India's situation in relation to double taxation is very firm as, being a hub for international investment and also forming a large number of emigrants, which has paved the way for India in understanding the importance of DTAAs and thereby have actively pursued this matter.

For instance, our country has 85 active agreements of this kind. Apart from these separate international agreements with different states, the Income Tax Act in itself provides relief from double taxation, which is covered under Sections 90 and 91 of the aforementioned Act.

If any issue or conflict arises, then the provisions of DTAA will be binding. For instance, the DTAA between India and Singapore provides that capital gains of shares in a company are to be taxed based on residence. Which in turn helps in curbing revenue loss, avoiding double taxation and streamline the flow of investments. It must be noted DTAA is not mandatory for any assessee.

Benefits of DTAA

One of the essential advantage of DTAA is that countries having DTAAs tend to become lucrative investment hubs. This helps in attracting foreign investment into a country and its subsequent development. Major benefits of DTAA are enjoyed by the NRI's, as, if they are generating income in both the countries i.e. in India and their country of residence, and there is a DTAA in place between both the states then NRIs can either avoid paying tax twice or pay a lower rate of tax, which if not for DTAA they would have had to pay taxes in both the countries. Another lucrative benefit of this is that it helps in creating a trust, both formal and informal, between the states, which helps in boosting the relationship and also keeping a cordial diplomatic relation between the states. In addition to these it neutralises the effect of hybrid mismatch arrangement.

End-Notes:

1. Principles of International Taxation, Sixth Edition, Lynne Oats, Angharad Miller and Emer Mulligan Pg. 20
2. https://resource.cdn.icai.org/57023bos46229mod4cp3.pdf
3. Investopedia – Double Taxation - https://www.investopedia.com/terms/d/double_taxation.asp
4. Principles of International Taxation, Sixth Edition, Lynne Oats, Angharad Miller and Emer Mulligan Pg. 143
5. What if I am liable to tax in two countries on the same income? https://www.litrg.org.uk/tax-guides/migrants/residence-and-domicile/what-double-taxation-agreement
6. The ultimate guide to permanent establishment https://shieldgeo.com/ultimate-guide-permanent-establishment
7. (1983), 144-ITR-146 (AP).
8. Section 90, Income Tax Act, 1961
9. 263 ITR 706
10. SNC Lavalin/Acres Inc. vs. Assistant Commissioner of Income Tax, Palampur (ITAT Delhi) : MANU/ID/5236/2007