International Taxation & DTAA Basics

International Taxation is concerned with taxation of cross border transaction in goods, services, transfer of technology and capital. It defines the right and obligations of non-residents in the host country.

Most countries follow residence-based system of taxation. A residence-based system taxes the worldwide income of the residents of that country. When a resident of that country (residence country) ventures out to another country (source country) and earns income in source country, the source country would charge tax on the income earned within its jurisdiction. The residence country would again tax the income taxed in source country since a person who is resident within residence country’s jurisdiction has earned that income. This gives rise to what is commonly known as ‘doubly taxed income’.

Double taxation is harmful for movement of capital, technology and people. Principle of avoidance of Double Taxation is to share the revenues between two countries. Each country gets its share of tax revenues and the bilateral and multilateral trade grows. Trade flourishes when there is free flow of goods and services. Overall tax collection increases and both countries tend to benefit. Prosperity comes not by levy of tax; it comes by trade, commerce and cross border investments.

Methods of eliminating Double Taxation:

1. Exemption Method

The income arising in the source country is exempted by the country of residence. As a result, the income arising in the source country is taxed only in the source country. Such Income is thus taxed only once.

2. Credit Method

The home country gives credit for the tax paid in the host country (source country) on the income arising in the host country. Credit is given at the rate of tax prevailing in the home country (country of residence) or the rate of tax paid in the host country, whichever is lower.

What are DTAA?

A Double Taxation Avoidance Agreement (DTAA) is an agreement entered into between two countries for avoidance of double taxation on the same income in the hands of the same person. Double Taxation Avoidance Agreements (D.T.A.A) are entered into after protracted negotiations. Methods are evolved to ensure that double taxation is mitigated by exempting the income already taxed or by giving credit for the tax paid by the business entity in the host country. As a result, the business entity effectively pays tax only once.

Objectives of DTAA

To allocate fiscal jurisdictions so as to eliminate double taxation.

To provide certainty to the taxpayer.

To prevent tax evasion through exchange of information.

To promote trade, business and investment between the two countries

To eliminate discrimination in taxation between the subjects of the two countries.

To share the tax revenue.

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