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How tax treaty works to avoid double tax – Indian Tax Prospective

In our previous paper, we have discussed the tax ability of Non-Residents under Indian Income Tax Act. In this paper, we are discussing how tax treaties assist avoiding double tax on the same income; one, at source Country and another at resident Country.

In the resident Country, tax is an obligation, while in source Country, tax is a cost. Tax treaties assist the tax payers to avoid the hardship to pay tax twice on the same income. Therefore, tax treaties are the agreement between two Countries that covers tax aspects on cross border transaction between them and thereby provides mechanism to avoid double tax on such transactions.

As treaties are entered into to promote international trade based on the negotiations and bargains to seek concessions by each Country primarily for avoidance of double taxation. Therefore, the non-resident tax payers are given the legal right to choose between Indian Tax provisions and treaty provisions; obviously he will choose whichever is beneficial to him.

Though the treaty making is done through bilateral negotiations, but for the sake of standardization of treaty draft, it is based on Model Conventions enumerated by international organisations.

Beyond any doubt, a bilateral tax treaty shall always benefits the tax payers who are the residents of these two Countries. Broadly, treaty benefits are of two type; one, division of taxing rights between them based on the nature of income or giving taxing rights to both, lower rate of tax in source Country and normal rate of tax in resident Country with tax credit of taxes paid in source Country.

It is extremely simple to apply tax treaty if we follow these simple steps:

  1. Apply provisions of Indian Income tax Act to the transaction in hand, we have to move on the tax treaty ONLY if income from that transaction is taxable in the hands of Non-resident in India.
  2. Calculate the tax impact on income from that transaction as per Indian Income Tax Act.
  3. Ensure that the non-resident who is subject matter of transaction in hand is tax Resident of the Country of which we are applying tax treaty based on tax residency Certificate (TRC).
  4. Based on the characterization of Income from the transaction in hand, calculate the tax impact as per the provision of tax treaty on income from that transaction.
  5. Compare the tax impact under both the provision of Indian Income tax act and provision of relevant treaty.
  6. Choose whichever is beneficial to non-resident taxpayers.

Notwithstanding of the above, the interpretation of tax laws and tax treaties turn the simplicity into complexity. So, in forthcoming papers, we shall address all the complexities one by one.

(Disclaimer: This content is meant for our clients or professional friends only for stimulating discussion on the subject matter not to frame any commercial opinion. All efforts are made to compile correctly with no guarantee of extreme accuracy)

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