Double Taxation refers to the situation where the same income or property is taxed twice — either in two different countries or twice within the same country. Double taxation is a serious problem in international taxation and can act as a major barrier to cross-border trade, investment, and the movement of persons. India has taken several legislative and treaty-based measures to deal with the problem of double taxation, the most important being the Double Taxation Avoidance Agreements (DTAA) under Section 90 and Section 91 of the Income Tax Act, 1961.
Meaning of Double Taxation
Double taxation occurs when:
1. International Double Taxation A person is resident in one country but earns income in another country. Both countries claim the right to tax this income — the country where the income is earned (source country) taxes it because it arises there, and the country of residence (residence country) taxes it because the person is a resident there.
Example: An Indian resident earns income from business operations in the USA. The USA taxes the income because it is earned there. India also taxes the income because the person is a resident of India and ROR persons are taxed on worldwide income. The same income is taxed twice.
2. Economic Double Taxation The same income is taxed in the hands of two different persons. For example, company profits are taxed as corporate tax in the hands of the company, and then the same profits when distributed as dividends are taxed again in the hands of the shareholders.
Types of Double Taxation
1. Juridical Double Taxation The same income of the same person is taxed by two different countries. This is the classic form of international double taxation.
2. Economic Double Taxation The same income is taxed in the hands of two different persons (e.g., company and shareholders).
Methods of Relieving Double Taxation
Indian law provides the following methods to relieve double taxation:
1. Exemption Method Under this method, the income taxed in the source country is completely exempted from tax in the residence country. This eliminates double taxation entirely but may result in the income escaping tax altogether if the source country tax rate is lower.
2. Tax Credit Method Under this method, the residence country taxes the worldwide income but gives a credit for the tax paid in the source country. The net tax payable in the residence country is reduced by the amount of tax already paid abroad.
This is the most commonly used method in Indian DTAAs.
3. Deduction Method The tax paid in the source country is allowed as a deduction from the income (not from the tax). This provides some relief but does not completely eliminate double taxation.
Double Taxation Avoidance Agreements (DTAA) — Section 90
Section 90 of the Income Tax Act, 1961 empowers the Central Government to enter into agreements with foreign countries for the avoidance of double taxation and for the prevention of fiscal evasion with respect to taxes on income.
Key features of DTAAs:
- They are bilateral treaties between India and specific foreign countries
- They override the domestic tax law to the extent they are more beneficial to the taxpayer
- They determine which country has the right to tax specific types of income
- They provide tax credit or exemption mechanisms
India has entered into DTAAs with over 90 countries including the USA, UK, Germany, Singapore, Mauritius, UAE, and many others.
Unilateral Relief — Section 91
When India does not have a DTAA with a particular country, Section 91 provides unilateral relief to Indian residents who have paid tax in that country. Under Section 91:
- The Indian resident is allowed a deduction from Indian tax equal to the lower of:
- The Indian tax rate on the doubly taxed income, OR
- The foreign tax rate on the doubly taxed income
This prevents double taxation even in the absence of a formal treaty.
DTAA with Mauritius — Famous Example
The India-Mauritius DTAA is one of the most famous and controversial DTAAs in India. Under the original treaty, capital gains arising in India to a Mauritius resident were taxable only in Mauritius. Since Mauritius did not tax capital gains, foreign investors routed investments through Mauritius to avoid capital gains tax in India. This led to massive round-tripping of Indian money through Mauritius.
The treaty was amended in 2016 to allow India to tax capital gains on Indian shares acquired after 1st April, 2017, thus closing this loophole.
Important Case Laws
1. Azadi Bachao Andolan v. Union of India (2003) The Supreme Court upheld the validity of the India-Mauritius DTAA and held that treaty shopping (using a treaty to avoid tax) is not per se illegal unless there is a specific anti-avoidance provision.
2. CIT v. P.V.A.L. Kulandagan Chettiar (2004) The Supreme Court held that where a DTAA exists, the taxpayer is entitled to choose between the DTAA and the domestic law, whichever is more beneficial.
3. Vodafone International Holdings v. Union of India (2012) The Supreme Court held that the Income Tax Act must be interpreted in light of India's international tax treaty obligations and that the substance of a transaction must be examined before applying tax rules.
Conclusion
Double taxation is a significant obstacle to international trade and investment and can cause serious hardship to taxpayers who earn income in multiple jurisdictions. India has addressed this problem through a comprehensive network of Double Taxation Avoidance Agreements with over 90 countries and through the unilateral relief provision under Section 91 of the Income Tax Act, 1961. These measures ensure that Indian taxpayers are not subjected to the hardship of paying tax twice on the same income and encourage cross-border economic activity. As India's economy becomes increasingly integrated with the global economy, the law of double taxation avoidance will continue to grow in importance.
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