Double Taxation Avoidance Agreements (DTAA)

In India and globally, taxation typically occurs based on two principles: residency and source. Consequently, if an individual is a tax resident of one country and earns income from another, they may face taxation in both countries. This scenario often results in double taxation, a common issue for Non-Resident Indians (NRIs) and Persons of Indian Origin (PIOs), who are tax residents of another country but earn income from investments or other sources in India.

To mitigate this issue, countries enter into bilateral agreements known as Double Tax Avoidance Agreements (DTAAs). The primary goal of these agreements is to prevent the same income from being taxed in both countries. In India, the key features of DTAAs are as follows:

DTAA Overrides Income Tax Act 1961: According to section 90(2) of the Indian Income Tax Act, the provisions of a DTAA take precedence over local income tax laws.

Applying DTAA Is Optional: Taxpayers can choose to apply the DTAA or follow domestic tax laws, depending on which is more beneficial. For instance, domestic provisions like basic exemption slabs and exempt incomes (such as dividends and long-term capital gains from shares/mutual funds) might be more advantageous for NRIs.

Lower Rate of TDS: When deducting Tax Deducted at Source (TDS), the payer can opt for the rates provided in the DTAA. For example, DTAAs often set the tax rate on interest payments at 15%, compared to the 30% rate under domestic law. This makes the DTAA rates more beneficial. Similar benefits apply to royalty and technical fee payments.

Taxation in One Country: DTAAs typically specify where certain types of income will be taxed. For example, income from immovable property is generally taxed in the country where the property is located, adhering to the source-based taxation principle. This ensures taxation occurs in only one country.

Tax Credit: If an individual pays tax in the source country, and the same income is taxed again in the resident country, the DTAA provides for tax credits for the taxes paid in the source country.

NRIs Should Apply DTAA for Interest Income: NRIs are advised to utilize DTAAs for interest income from NRO accounts, government securities, loans, fixed deposits with companies, and dividends. The tax rates under DTAAs for interest income are generally lower than those under Indian tax laws.

India vs. DTAA: India has comprehensive DTAAs with approximately 90 countries. However, there are still countries without such agreements, like Hong Kong. In such cases, NRIs can seek relief under section 91 of the Income Tax Act, though the benefit is limited.

DTAA – India vs. Mauritius: The DTAA between India and Mauritius is particularly well-known. Under this agreement, capital gains from the sale of shares are taxed in the country of the shareholder's residence, not in the country where the company whose shares were sold is located. Thus, a Mauritius-resident company selling shares of an Indian company is exempt from tax in India. Since Mauritius does not have a capital gains tax, the gains are not taxed at all. This treaty is a significant factor for foreign investments in India through Mauritius, with similar benefits available in treaties with Singapore, Cyprus, and others.