International Taxation

International taxation
International taxation is the study or determination of tax on a person or business subject to the tax laws of different countries or the international aspects of an individual country's tax laws. Governments usually limit the scope of their income taxation in some manner territorially or provide for offsets to taxation relating to extraterritorial income.
Many governments tax individuals and/or enterprises on income. Such systems of taxation vary widely, and there are no broad general rules. These variations create the potential for double taxation (where the same income is taxed by different countries) and no taxation (where income is not taxed by any country).
'DOUBLE TAXATION'
Double taxation means taxation of same income of a person in more than one country. This results due to countries following different rules for income taxation. There are two main rules of income taxation i.e. (a) Source of income rule and (b) residence rule
As per source of income rule, the income may be subject to tax in the country where the source of such income exists (i.e. where the business establishment is situated or where the asset/property is located) whether the income earner is a resident in that country or not.
On the other hand, the income earner may be taxed on the basis of his/her residential status in that country. For example, if a person is resident of a country, he may have to pay tax on any income earned outside that country as well.
Further, some countries may follow a mixture of the above two rules.
Thus problem of double taxation arise if a person is taxed in respect of any income on the basis of source of income rule in one country and on the basis of residence in other country or the basis of mixture of above two rules.
In India, the liability under the Income-tax Act arises on the basis of the Residential Status of the assessee during the previous year. In case the assessee is resident in India, he also has to pay tax on the income which accrues or arises outside India, and also received outside India. The position in many other countries being also broadly similar, it frequently happens that a person may be found to be a resident in more than one country or that the same item of his income may be treated as accruing, arising or received in more than one country with the result that the same item becomes liable to tax in more than one country. To prevent this hardship Double Taxation Relief is provided.
METHODS OF AVOIDING DOUBLE TAXATION:
Countries throughout the world are following various methods of avoiding double taxation.
They are as follows.
(1) Unilateral relief
(2) Bilateral relief
(3) Multilateral relief
(4) Non-tax treaties
Unilateral relief:
Under this system of taxation whether the income is subject to tax abroad or not is immaterial. In Unitary system, relief is given by way of tax credit for the taxes paid abroad. The countries, which follow this method of tax credit, are, U.S, Greece, India, and Japan to name a few.
For example, under section 91 of the Income tax Act,
1961,the method is “tax credit method”. A resident in India who has paid income tax in any country with which India does not have a treaty for the relief or avoidance of double taxation is entitled to credit against his Indian Income tax for an amount equal to the Indian coverage rate or the foreign rate whichever is lower applied to the double taxed income. This is done as follows.
a. Where the foreign tax is equal to Indian tax, the full amount of foreign tax will be given credit.
b. Where the foreign tax exceeds the tax payable in India, the liability to Indian tax will be nil. However, no refund in respect of the excess amount is allowed, and
c. Where the foreign tax paid is less than the Indian tax after deducting the foreign tax would be payable by the taxpayer. The principle is that the credit allowable will never exceed the amount of Indian income tax, which becomes due or payable in respect of the doubly taxed income.
Bilateral relief:
Bilateral relief may take any one of the following two forms. Firstly, the treaty may apply exempting method, the country in question refrain from exercising jurisdiction to tax a particular income. For ex, under this exemption method, the country of source in which the Permanent Establishment (PE) is located is assigned an exclusive jurisdiction to tax the profits of the establishment. In turn it may agree to refrain from exercising its jurisdiction to tax the owner on these profits. Alternatively, the treaty may provide relief from double taxation by reducing the tax ordinarily due in one or both of the contracting parties on that income which is subject to double taxation.
For example, the country, which is the source of a dividend, often agrees to reduce the withholding rate normally applicable to dividends paid to non-residents and the country of residence agrees to give a tax credit or similar relief for the tax paid to the country of source. In such a case, both the countries exercise the rights to jurisdiction, while mutually agreeing for adjustments. This helps in avoiding or at least reducing the international double taxation on the income in question. Many treaties combine both the methods of relief.
Multilateral treaties:
These are similar to bilateral treaties. It is achieved through agreement between many countries Example, European Economic Community
Non-Tax treaties:
These are not direct treaties of tax, but are treaties of friendship, cooperation, political ties, diplomacy etc. but which consequently result in tax consequences.
Position in India:
The Income tax Act, 1961 provides unilateral relief under sec: 91 of the Act. Besides, the Central Government is empowered under Sec: 90 of the I.T Act to enter into an agreement with a foreign Government, which may take any one of the above forms discussed viz, bilateral, multilateral, non-tax treaty basis.
It may be entered for any one of the following purposes.
a. Double tax relief
b. Double tax avoidance
c. Exchange of information
d. Recovery of tax
How international double taxation may arise
International double taxation arises because each country has its own sovereign right to tax income and own set of tax rules. The areas in which two countries’ tax systems could differ include. * The scope of taxation
Some countries are on the territorial system (e.g. Singapore) whereas others have adopted a worldwide taxation basis (e.g. Australia). * Source rules for income
The source rules determine whether income is sourced in the state where income arises, or in the state where the income is received. Conflict of source rules can result in an income having a source in both countries * Rules for determining the tax residence of an individual or a company * Measures provided for under a country’s domestic laws to relieve double taxation. Double taxation invariably increases the burden of tax on foreign income. This has a negative impact on cross-border movements of investment, technology and expertise.

Double Taxation Relief provisions in India
The Central Government may enter into an agreement with the Government of any country outside India to provide for the following: a. a relief in respect of income on which have been paid both income-tax under this Act and income-tax in that country, or b. the type of income which shall be chargeable to tax in either country so that there is avoidance of double taxation of income under this Act and under the corresponding law in force in that country.
In addition, the Central Government may enter into an agreement to provide:
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 investigation of cases of such evasion or avoidance or
For recovery of income-tax under this Act and under the corresponding law in force in that country.
A taxation principle referring to income taxes that are paid twice on the same source of earned income. Double taxation occurs because corporations are considered separate legal entities from their shareholders. As such, corporations pay taxes on their annual earnings, just as individuals do. When corporations pay out dividends to shareholders, those dividend payments incur income-tax liabilities for the shareholders who receive them, even though the earnings that provided the cash to pay the dividends were already taxed at the corporate level.
Example of Double Taxation Relief
a) Mr. Bansal, a resident Indian and aged 67 years, has derived the following income during the previous year 2008-09:
(i) Income from business in India 2,50,000
(ii) Commission (Gross) from a company in Hong Kong 3,00,000
(Tax paid in Hong Kong Rs.60,000)
(iii) Dividend (Gross) from a company in Hong Kong 90,000
(Tax paid in Hong Kong Rs.18,000)
(iv) Interest on fixed deposit and savings account with banks in India 2,00,000
India has no double tax avoidance agreement with Hong Kong. Compute the income and tax payable by Mr. Bansal for assessment year 2009-10.
Solution:
The provisions of the Income-tax Act, 1961 relevant for Assessment Year 2010-11 should be taken into consideration while solving the question. Accordingly, the facts given above may be taken as relating to financial year 2009 -10.
Mr. Bansal is entitled to relief under section 91, since
(i) He is a resident in India during the relevant previous year.
(ii) Income, by way of commission and dividend, accrues or arises to him outside India (in Hong Kong) during the previous year.
(iii) Such income is not deemed to accrue or arise in India during the previous year.
(iv) The income in question, namely, commission and dividend, has been subjected to income-tax in Hong Kong in the hands of Mr. Bansal and he has paid tax on such income in Hong Kong
(v) There is no agreement under section 90 for the relief or avoidance of double taxation between India and Hong Kong.
Therefore, he is entitled to the deduction under section 91, from the Indian income-tax payable by him, of a sum, calculated on such doubly taxed income at the Indian rate of tax or at the Hong Kong rate of tax, whichever is lower.
B ) Arif, a resident both in India and Malaysia in previous year 2004-05, owns immovable properties (including residential house) at Malaysia and India. He h as earned income of Rs. 50 lakhs from rubber estates in Malaysia during the financial year 2004 -05. He also sold some property in Malaysia resulting in short-term capital gain of Rs. 10 lakhs during the year. Arif has no permanent establishment of business in India. However, he has derived rental income of Rs. 6 lakhs from property let out in India and he has a house in Lucknow where he stays during his visit to India. The Article 4 of the double taxation avoidance agreement between India and Malaysia provides that where an individual is a resident of both the Contracting States, then he shall be deemed to be resident of the Contracting State in which he has permanent home available to him. If he has permanent home in both the Contracting States, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests).
You are required to state with reasons whether the business income of Arif arising in Malaysia and the capital gains in respect of sale of the property situated in Malaysia can be taxed in India.
Solution:
The provisions of the Income-tax Act, 1961 relevant for Assessment Year 2010-11 should be taken into consideration while solving the question. Accordingly, the facts given above may be taken as relating to financial year 2009 -10.
Section 90(1) of the Income -tax Act empowers the Central Government to enter into an agreement with the Government of any country outside India for avoidance of double taxation of income under the Indian law and the corresponding law of that country. Section 90(2) provides that where the Central Government has entered into an agreement with the Government of any other country for granting relief of tax or for avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of the Income-tax Act, 1961 shall apply to the extent they are more beneficial to that assessee.
Arif has a residential house both in Malaysia and India. Thus, he has a permanent home in both the countries. However, he has no permanent establishment of business in India. The Double Taxation Avoidance Agreement (DTAA) with Malaysia provides that where an individual is a resident of both the countries, he shall be deemed to be resident of that country in which he has a permanent home and if he has a permanent home in both the countries, he is deemed to be resident of that country, which is the centre of his vit al interests i.e. the country with which he has closer personal and economic relations. Arif owns rubber estates in Malaysia from which he derives business income. However, Arif has no permanent establishment of his business in India. Therefore his personal and economic relations with Malaysia are closer, since Malaysia is the place where
(a) The property is located and
(b) The permanent establishment (PE) has been set -up
Therefore, he shall be deemed to be resident of Malaysia for A.Y. 2010 -11.
The fact of the case and issues arising therefrom are similar to that of CIT vs. P.V.A.L. Kulandagan Chettiar (2004) 137 Taxman 460 , where the Supreme Court held that
(1) If an assessee is deemed to be a resident of a contracting State where his personal and economic relations are closer, then in such a case, the fact that he is a resident in India to be taxed in terms of sections 4 and 5 would become irrelevant, since the DTAA prevails over sections 4 and 5.
(2) The treaty has application as well to capital gains derived from immovable property situated at Malaysia vide Article 6 of the tax treaty.
Therefore, in this case, Arif is not liable to income tax in India for assessment year 2010-11 in respect of business income and capital gains arising in Malaysia