Tax Treaty Comparison Between the United States and India - Essay Example

Gopal Pottabathni 20 November, 2007 Federal Taxation And Management Decision The persons living in the other countries are likely to be covered by the laws of both the countries, of which they are residents and where such persons are earning income as non-residents. It is therefore necessary to know the way in which income earned by them will be taxed whether in the country of their residence or the country where the income is earned. Most of the countries in the world have taken to charge tax on income/ capital have adopted more or less similar pattern, i.e. Income Tax is levied on the person who has earned the income and the tax is levied at the place where the income is earned or where he resides. Due to phenomenal growth in international growth in international trade and commerce and increasing interactivity among the nations, residents of one country extend their sphere of business operations to other countries where income is earned. It is in the interest of all the countries to ensure that undue tax burden is not cast on persons earning income by taxing them twice, once in the country of residence and again in the country where the income is earned. Double taxation can be defined as the levy of taxes on income / capital in the hands of the same tax payer in more than one country in respect of the same income or capital for the same period. The problem gets complicated since taxation schemes of different countries contain divergent notions regarding definition of income as source. The position becomes anomalous in a situation where an assessee residing in one country earns income in another country, and the tax rates in both the countries are higher than 50%. If taxed at both places on the same income the assessee will be left with a negative income. This is bound to affect the economic growth. To avoid such a hardship to individuals and also with a view to seeing that national economic growth does not suffer, Double Taxation Avoidance Agreements (D.T.A.A.) are entered into with other countries. Such tax treaties, therefore, serve the purpose of providing full protection to tax payers against double taxation and thus prevent the discouragement which double taxation may provide in the free flow of international trade and international investment. Besides, such treaties generally contain provisions for mutual exchange of information and for reducing litigation. Coming to specific provisions contained in the Indian Income-tax Act, such tax treaties are made under the provisions contained in Section 90 of the Income-tax Act which enables the Central Government to enter into treaties to avoid double taxation. Govt. of India has entered into DTA agreement with several countries, some of the main countries are Australia, Bangladesh, Canada, China, Germany, Japan, Malaysia, Mauritius, Nepal, Singapore, Sri Lanka, UAE, UAR, UK, USA, USSR etc. Government of United States of America and Government of Republic of India entered into an agreement on Double Tax Avoidance Agreement, which was signed in New Delhi on 12 September 1989. The Convention would be the first tax treaty between the United States and India. In general, it follows the pattern of the United States model tax convention but differs in a number of respects to reflect India's status as a developing country. According to Article 1 of the Convention, it shall apply to persons who are residents of United States of America or India. However in Article 4 (Residence), it is clarified that the person is said to be the resident of the particular Contracting State, if that person in under law of that Contracting State and thereby liable to tax by reason of his domicile or similar other criteria, subject to certain limitations as described in Article 4. Under the Convention the income of the permanent establishment is taxable, and both the profit and loss of the other two businesses are ignored. Under the Code, all three would be taxable. The loss would be offset against the profits of the two profitable ventures. The taxpayer may not invoke the Convention to exclude the profits of the profitable trade or business and invoke the Code to claim the loss of the loss trade or business against the profit of the permanent establishment. In Article 2, U.S. and Indian taxes are referred to in the convention as "United States Tax" and "Indian Tax" respectively. In case of the United States, the taxes covered are Federal Income Taxes imposed by the Code, combined with excise tax imposed on insurance premiums paid to foreign insurers. Under Article 7 (Business Profits), the United States cannot subject the business profits of an Indian enterprise to tax (i.e., to a covered tax) if the income of the enterprise is not attributable to a permanent establishment which the enterprise has in the United States or to sales of goods or performance of activities by the Indian company which is of the same kind as the goods sold or the activities carried out through the permanent establishment. If the Indian company sells insurance through a permanent establishment in the United States, and also sells insurance in the United States directly from India, unconnected to the permanent establishment, under the Code, the income from both parts of the business would be subject to net basis taxation, and the excise tax would not apply. A typical DTA Agreement between India and another country covers only residents of India and the other contracting country that has entered into the agreement with India. A person who is not resident either of India or of the other contracting country cannot claim any benefit under the said DTA Agreement. Such agreement generally provides that the laws of the two contracting states will govern the taxation of income in respective states except when express provision to the contrary is made in the agreement. In Article 3, the definitions are given in general to all the words and their meanings with respect to the convention. The terms "India" and "United States" are defined in paragraphs 1(a) and (b), respectively in Article 3. The term "India" means the territory of India, and is further defined to include India's continental shelf. The term "United States'" is defined geographically to mean the territory of the United States, including its continental shelf. Though not specified, the term is understood not to include Puerto Rico, the Virgin Islands, Guam or any other U.S. possession or territory. A situation may arise when originally the tax provision in the other contracting state gave concessional treatment compared to India at a particular time but Indian laws were subsequently amended to bring incidence of tax to a level lower than the tax rate existing in the other contracting state. Since the tax treaties are meant to be beneficial and not intended to put tax payers of a contracting state to a disadvantage, it is provided in Sec. 90 that a beneficial provisions under the Indian Income Tax Act will not be denied to residents of contracting state merely because the corresponding provision in tax treaty is less beneficial. Some Double Taxation Avoidance agreements provide that income by way of interest, royalty or fee for technical services is charged to tax on net basis. This may result in tax deducted at source from sums paid to Non-residents, which may be more than the final tax liability. The Assessing Officer has therefore been empowered u/s 195 to determine the appropriate proportion of the amount from which tax is to be deducted at source. There are instances where as per the Income-tax Act, tax is required to be deducted at a rate prescribed in tax treaty. However this may require foreign companies to apply for refund. To obviate such difficulties Sec. 2(37A) provides that tax may be deducted at source at the rate applicable in a particular case as per section 195 on the sums payable to non-residents or in accordance with the rates specified in D.T.A. Agreements One of the important terms that occur in all the Double Taxation Avoidance Agreements is the term 'Permanent Establishment' (PE) which has not been defined in the Income- tax Act. However as per the Double Taxation Avoidance Agreements, PE includes, a vide variety of arrangements i.e. a place of management, a branch, an office, a factory, a workshop or a warehouse, a mine, a quarry, an oilfield etc. Imposition of tax on a foreign enterprise is done only if it has a PE in the contracting state. Tax is computed by treating the PE as a distinct and independent enterprise. In order to avoid double taxation it is provided that if a resident of India becomes liable to pay tax either directly or by deduction in the other country in respect of income from any source, he shall be allowed credit against the Indian tax payable in respect of such income in an amount not exceeding the tax borne by him in the other country on that portion of the income which is taxed in the said other country. The same benefit is available to the resident of the other Country, on income taxed in India. In respect of incomes on which taxes are either exempted or reduced, the country of residence will not take the exempted income into account while determining the tax to be imposed on the rest of the income. Income derived from the operation of Air transport in international traffic by an enterprise of one contracting state will not be taxed in the other contracting state. In respect of an enterprise of one contracting state, income earned in the other contracting state from the operation of ships in international traffic, will be taxed in that contracting state wherein the place of effective management of enterprise is situated. However some DTA agreement contain provisions to tax the income in the other contracting state also, although at reduced rate. These provisions do not apply to coastal traffic. In order to plug loop holes for tax evasion, a separate article in DTA agreement provides for taxing the notional income deemed to arise on account of an enterprise of one contracting state participating directly/indirectly in the management of another enterprise in the other contracting state or where some persons participate directly or indirectly in both the enterprises under conditions different from those existing between the independent enterprises. Dividend paid by a Company which is a resident of a Contracting State to a resident of the other Contracting State will be taxed in both the States. Interest paid in a Contracting State to a resident of the other Contracting State is chargeable in both the States. Regarding Royalties arising in a Contracting State and paid to a resident of the other Contracting State:- Some DTA agreements provide for taxation in the other Contracting State. Some agreements provide for taxation in the contracting State. Some agreements provide for taxation in both the States. Capital Gains will be taxed in the state where the capital asset is situated at the time of sale. Income will be taxed in the state where the person is resident. However if he has a fixed base in the other Contracting State, the income attributable to the fixed base will be taxed in the other contracting state. If there are any disputes in the interpretation/ implementation of the terms of DTA Agreements, normal remedies of appeal etc. provided in the Income-tax Act are available to the aggrieved party. The DTA Agreements also contain mutual agreement procedure. The aggrieved party may approach the Competent Authority of the contracting State wherein he is a resident, who, if he is unable to resolve the dispute by himself will approach the Competent Authority of the other Contracting State to arrive at a solution after mutual discussion. In respect of interpretation of terms contained in DTA Agreement The Indian Income-tax Act contains a special provision, which is offered to those Non- residents who would like to have advance ruling on a matter of law or fact in relation to a transaction undertaken/proposed to be undertaken by them. The facilities available in such provision can be availed of by the Non-residents in the matters regarding Double Taxation of income also. More on this matter will be discussed in a separate chapter on the subject. Apart from relief to persons of a country where India has entered in Double Taxation Avoidance Agreement, there is relief given even in cases where the Government of India has not entered into DTA agreement with any foreign country. In such cases if any resident Indian produces evidences to show that, he has paid any tax in any country with which the Government of India has not entered into a DTA agreement, tax relief on that part of his income which suffered taxation in the foreign country, to the extent of tax so paid in such foreign country, or the tax leviable in India under the Income Tax Act on such income whichever is less shall be allowed as deduction u/s.91 while calculating his tax liabilities on such income. Works Cited 1) Tax Convention With The Republic Of India 2) Treasury Department Technical Explanation Of The Convention And Protocol Between The United States Of America And The Republic Of India For The Avoidance Of Double Taxation And The Prevention Of Fiscal Evasion With Respect To Taxes On Income Signed At New Delhi On September 12, 1989 3) Welcome-NRI.com, Double Taxation Treaties, Read More