Every nation has its own mechanism for taxation. As a result, the same income of the taxpayer may get taxed in both the countries (i.e. the home and the host country). Therefore, countries enter into Double Tax Avoidance Agreement (DTAA’s) to prevent such double taxation of income earned in both countries.
Consideration should be put to their international results of tax policies.
More than 3000 bilateral income tax treaties are currently in effect and the numbers seem to be increasing with time. Double taxation in tax treaties can be eliminated by:
- allocation of sharing taxing rights
- the exclusive right to tax
- provision of giving credit for taxes paid in the source state by the residence state
- for providing co-relative adjustment
Meaning of tax treaty
Treaties are international agreements between nations under Public International Law. Tax treaties are agreements between two sovereign countries primarily governing the taxation of the residents/ nationals. It takes several years from the initiation to negotiations between the respective countries to the date when a tax treaty actually comes into force.
The definition of the treaty provided in Article 2 of the Vienna Convention of Law of treaties, 1969 (‘VCLT’) reads as under:
- ‘Treaty means an international agreement concluded between states in written form and governed by international law, whether embodied in a single instrument or in two or more related instruments and whatever its particular designation’
There can be many documents that may form part of the DTAA’s – protocols, exchange of notes agreed minutes, memorandum of agreement, etc.
Types of DTAA
Tax treaties are usually of following types:
- Bilateral treaty: These are treaties that were concluded between two states. Ex. – DTAA of India with the USA
- Multilateral treaty: These are treaties concluded between a large number of states. Ex. – convention between Nordic countries including Denmark, Finland, Iceland, Norway and Sweden, multilateral instruments
- Tax Information Exchange Agreements (TIEA): These are adopted by certain high tax countries with low or no tax countries with which they would not otherwise have a tax treaty. Ex. – TIEA of India with Bahamas, Bermuda
Some of the Model Conventions
Two tax model is followed:
- the OECD Model Convention and,
- the United Nations Model Convention
Brief description of each of the model tax conventions are:
- OECD Model Convention: Emphasis on residence-based taxation. Developed countries adopted this model in case of treaties with other developed countries
- UN Model Convention: Emphasis on source-based taxation. Developing countries adopted this model in case of treaties with developing countries or between two developing nations
- US Model Convention: Used by the USA for all of their treaty negotiations. This model has an influence on the existing tax treaty of the USA with various countries.
Interpretation of DTAA
‘A word is not a crystal, transparent and unchanged, it is the skin of a living thought and may vary greatly in color and content according to the circumstances and the time in which it is used‘
The interpretation of words and expressions used in the tax treaty is of utmost importance. That the aim of the tax treaty is to avoid double taxation. It also creates legal certainty for the benefit of the contracting state as well as for the taxpayer.
As per the VCLT, ‘The treaty should be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in light of its object and purpose’
The interpretation provisions contained in the VCLT should be seen as a means to an end. In the case of ‘rules of interpretation’, one should keep in mind that language as an expression of thought involves a process of free creation. In order to reveal the objective content of the term or phrase as may be inferred from the treaty text, it is crucial to use any materials available in connection with the treaty.
Supreme Court in Ram Jethmalani v. Union of India observed ‘the words are to be given their general meaning, general to lawyer and layman alike……The meaning of the diplomat rather than the lawyer………The broad principle of interpretation, with respect to treaties, and provisions therein, would be that ordinary meaning of words to give effect to unless the context requires or otherwise.
Some of the secondary means of interpretation of treaties are:
- Commentaries: Commentary reflects the current views on existing provisions and on their application to specific situations.
- Reference to Domestic Law: Often when terms are not clear in treaties domestic law of the country is referred to in interpreting the treaties. Reference in this regard can be placed on Section 90(3) of the Income-tax Act, 1961. ‘(3) Any term used but not defined in this Act or in the agreement referred to in sub-section (1) shall, unless the context otherwise requires, and is not inconsistent with the provisions of this Act or the agreement, have the same meaning as assigned to it in the notification issued by the Central Government in the Official Gazette in this behalf’
Moreover, documents from the OECD archives serve to relieve ambiguities in the determination of the substantive scope of tax treaties modeled on the OECD texts.
Scope of DTAA In The Indian Context
Section 90(1) of the Income-tax Act, 1961 provided that the Central Government may enter into an agreement with the Government of any country outside India or specified territory outside India
- for the granting of relief in respect of:
- income on which have been paid both income-tax under this Act and income-tax in that country or specified territory, as the case may be
- income-tax chargeable under this Act and under the corresponding law in force in that country or specified territory, as the case may be, to promote mutual economic relations, trade and investment, or
- for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country or specified territory, as the case may be
- for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this Act or under the corresponding law in force in that country or specified territory, as the case may be, or investigation of cases of such evasion or avoidance
- for recovery of income-tax under this Act and under the corresponding law in force in that country or specified territory, as the case may be
DTAA only creates an obligation for the states and not the third parties. These are agreements between the two countries and not between two taxpayers and involves negotiated sharing of tax revenues by the states.
Scope of Convention (Article 1 & Article 2):
- To whom does the Treaty apply:
- Article 1 provides for the application of tax treaty to person resident of one or both the Contracting States
- It does not apply to persons who are not residents of both the Contracting State
- ‘Person’ defined in Article 3 of the Model Convention
- Taxes covered:
- Taxes on income
- Taxes on capital
- Taxes on Central Government and Political Subdivisions
Relationship between tax treaties and domestic law:
Tax treaties with the national provisions allocate taxable income to taxpayers. It is not the intent of the tax treaty to create extra liability or burden.
Section 90(2) of the Act provides the choice for a taxpayer to be either governed by a treaty or by the normal provisions is that of the taxpayer. The taxpayer can choose between the provisions of the treaty or the Act
It is important to bring the domestic law to align with what is agreed in the tax treaties for simplification of law relating to international taxation
The concept of income in international tax law depends upon the concept of income as a tax base in each respective country. However, the concept of income in tax treaties cannot be equated with domestic concepts. The primary purpose of income taxes under domestic law is to derive revenue, while bilateral tax treaties aim at preventing double tax burdens on the same income.
Where a taxable event with respect to ‘income’ gives rise to possible double tax burdens, the application of the specific income allocation provisions will lead to workable results that are in line with the object and purpose of tax treaties to prevent double taxation and tax evasion.