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Double Taxation: Understanding Its Impact and Relief Measures

Double taxation is a situation where an income is subject to tax twice which can happen in many ways. This can occur in one of two ways - economic or juridical. Economic double taxation occurs if an income or a part of it is taxed twice in the same country, in the hands of two individuals. Alternatively, juridical double taxation occurs if income earned outside India is taxed two times in the hands of the same individual, once abroad and once in their home country. This unique situation puts an undue burden on the taxpayer when their income is taxed twice1
  • Double taxation occurs when income is taxed at both the corporate level and personal level, as in the case of stock dividends.
  • Double taxation also refers to the same income being taxed by two different countries.
  • While critics argue that dividend double taxation is unfair, advocates say that without it, wealthy stockholders could virtually avoid paying any income tax.

Types of Double Taxation
There are mainly two types of double taxation:
  1. Corporate Double Taxation:
    This refers to the taxation on corporate profits through corporate taxation and dividend taxation (imposed on dividend pay-outs).
  2. International Double Taxation:
    This refers to the taxation of foreign income in both the country where the income is derived and the country where the investor resides Income Earned Outside of India . 1 Anderson, S. (2007). The Economics of Dowry and Bride Price. Journal of Economic Perspectives, 21(4): 151- 174. 2 Anderson, S. (2003). Why Dowry Payments Declined with Modernization in Europe but are Rising in India. Journal of Political Economy, 111(2): 269-310. What is DTAA (Double Taxation Avoidance Agreement.) Many times, if you live abroad and have an income source in India, you will be taxed in both your country and the place you reside. Thus, India has implemented the DTAA (Double Tax Avoidance Agreement) policy.

    It is a tax treaty that India signs with another country in order to avoid double taxation. Using this treaty, an individual can avoid being taxed twice. DTAAs can either be comprehensive agreements, which cover all types of income, or specific agreements, which target only certain types of income.
  3. For instance, there is a DTTA (Double Taxation Avoidance Agreement) between India and Singapore under which income is taxed based on the residential status of the individual. This streamlines the flow of taxation and ensures that the individual is not taxed twice for the income earned outside India. Currently, India has DTAAs in place with more than 80 countries.

    Many people believe that the DTAA will allow them to avoid paying taxes altogether, but that is not true. Since the DTAA allows for a rebate, not a total deduction, NRIs can decrease their tax implications when they earn income in India. How is Relief Against Double Taxation Provided under the Income Tax Act? There are many cases in which residents have paid income tax to another country on their foreign income but are also required to pay tax in India on that same income.

    Relief from double tax is available in such cases. The Income Tax Act 1961 contains two Sections (Section 90 and Section 91) that provide relief from double taxation. Most tax systems attempt, through the use of varying tax rates and tax credits, to have an integrated system where income earned by a corporation and paid out as dividends and income earned directly by an individual is, in the end, taxed at the same rate. For example, in the U.S. dividends meeting certain criteria can be classified as "qualified" and as such, subject to advantaged tax treatment: a tax rate of 0%, 15% or 20%, depending on the individual's tax bracket.2 The corporate tax rate is 21%, as of 2022 4 How to avoid juridical double taxation? 3 University Press.
  4. Wealth and the Property Rights of Women in South Asia. In Jack, G. and Stanley, J. T. (Eds.) The Double Tax Avoidance Agreement (DTAA) helps you avoid paying taxes in both your home country and the country you reside. The tax treaty is signed by India and another country to avoid double taxation. Some DTAAs are comprehensive agreements comprising all income types, while others are specific agreements focusing on a few income types.

Many people are under the impression that by using a DTAA, they can avoid paying taxes altogether. However, that is not true. The Data allows for a rebate, not a total deduction, which means when NRIs earn income in India, they can reduce their tax implications. H The following diagram illustrates the application of Sections 90 and 91:
Most tax systems attempt, through the use of varying tax rates and tax credits, to have an integrated system where income earned by a corporation and paid out as dividends and income earned directly by an individual is, in the end, taxed at the same rate. For example, in the U.S. dividends meeting certain criteria can be classified as "qualified" and as such, subject to advantaged tax treatment: a tax rate of 0%, 15% or 20%, depending on the individual's tax bracket.2 The corporate tax rate is 21%, as of 2022

  1. Bilateral Relief Covered Under Section 90:

    Double Taxation Avoidance Agreements grant relief in two ways under Bilateral relief covered under Section 90. The relief is offered in two ways.

    1. Exemption Method:

      The exemption method ensures that you will not be taxed twice. That is, if an income earned outside India has been taxed in the relevant foreign country, it is not subject to tax in India.

    2. Tax Credit Method:

      According to this method, the individual or the corporation can claim a tax credit (deduction) for the taxes paid outside India. This tax credit can be utilized to set-off the tax payable in India, thereby reducing the assessee's overall tax liability.

    Double Taxation Relief Example - Tax Credit Method:

    According to the DTAA between India and Germany, interest is taxed at 10%, whereas under Income Tax Act 1961, it is based on slab rates for individuals and HUFs, and flat rates (generally 30%) for other assessees (firms, companies, etc). In this case, one can follow DTAA and pay tax at 10% only.

    Despite the fact that there are few things an individual taxpayer can do to avoid double taxation, the Income Tax Act itself contains provisions for individuals whose income is likely to be taxed twice. Double Taxation Avoidance Agreements (DTAAs) are the basis for this relief measure.

  2. Double Taxation Relief: Unilateral relief Covered Under Section 91

    Section 91 of the Income Tax Act, 1961 provides for unilateral relief against double taxation. According to the provisions of this section, an individual can be relieved of being taxed twice by the government, irrespective of whether there is a DTAA between India and the foreign country in question or not. However, there are certain conditions that have to be satisfied in order for an individual to be eligible for unilateral relief.

These conditions are:
  • The individual or corporation should have been a resident of India in the previous year.
  • The income should have been accrued to the taxpayer and received by them outside India in the previous year.
  • The income should have been taxed both in India and in the country with which there is no DTAA.
  • The individual or corporation should have paid tax in that foreign country.

Thus, by utilising the provisions of DTAAs and the relief measures offered under the Income Tax Act, individuals earning income from other countries can minimise their tax liabilities and avoid the burden of double taxation.

Incomes on Which DTAA Allows Tax Rebate NRIs can take advantage of the Double Tax Avoidance Agreement or DTAA to deduct double taxes paid on income earned from the following sources:
  • The salary received in India
  • Fixed deposits in India
  • Capital gains earned on asset transfers in India
  • House property situated in India
  • Services offered in India
  • Indian savings bank account

In the event that income from these sources is taxed in the country you currently reside in, then you can take advantage of the DTAA benefits to avoid paying taxes in India.

Benefits available under DTAAs
There are lots of benefits associated with DTAA for taxpayers. The basic benefit includes not having to pay double taxes on the same income. Apart from this, � According to these treaties, each country determines its own resident status in accordance with its domestic laws. When a person qualifies for tax residency in both countries, the treaty may provide a tiebreaker. As an example, a PIO could qualify as an Indian tax resident if his/her stay in India exceeds a specific threshold. Additionally, they may be considered US tax residents by virtue of their citizenship. In this case, the tiebreak rule under the India-USA DTAA comes into play, and it may occur that the person qualifies as a tax resident of the United States.

Those who are tax residents of countries with which India has DTAAs can claim tax exemptions under these agreements and their tax liability in India will be limited to the extent of taxing rights permitted by the DTAAs. Even if the scope of taxation under the Indian income tax law is wider, such individuals may benefit from the treaty by virtue of section 90 of the Indian Income-tax Act, 1961, subject to certain procedural requirements, such as submission of Tax Residency Certificates (TRC) of the other country.

However, if a person qualifies as a tax resident of India both under the Indian law and the relevant treaty, then India will have residual powers of taxation, subject to the limited rights granted to the other country under the treaty.

Foreign Tax Credit (FTC) in India:
Once an NRI or PIO qualifies as an Indian tax resident, he/she will be eligible to claim credit of taxes paid in other foreign countries in his/her income tax return filed in India, subject to certain conditions and procedural compliances prescribed in rule 128 of the Income Tax Rules. FTC is allowed in the year when the corresponding income is taxed in India. Form 67 along with documents supporting payment or deduction of tax in other countries will be required to be submitted by the individual.

What Is An Example Of Double Taxation
Let's use a corporation that makes $1 million in earnings as an example. It keeps $500,000 in earnings and distributes $500,000 in dividends to its shareholders. As a shareholder, Joe gets dividends of $10,000. Joe must also pay tax on the $10,000 in income at his personal tax rate in addition to the 21% corporate tax that the corporation paid on the $1 million.

Impact of double taxation
When you start a business, it is vital to decide the product or service you will sell. Another crucial decision is the organisation's structure and associated tax liabilities.

A partnership firm or private limited company must pay business taxes as a separate legal identity. A dividend tax is also levied if they declare dividends. But, the dividend received by the shareholder of the company is exempt from income tax.

A Corporation is taxed at the corporate level on profits, and the owners of the company are taxed on the dividends paid from the corporation. Thus, the corporation pays corporate income tax, and the shareholders and owners pay personal income tax on the dividends. Additionally, if a company owner or shareholder draws a salary from Corporation's earnings, they will pay personal income taxes. So, if you are the owner of a Corporation, you have to pay taxes twice on your earnings, once on the corporate profits and once on the salaries you earn from the business.

The concept of double taxation on dividends has prompted significant debate. While some argue that taxing shareholders on their dividends is unfair, because these funds were already taxed at the corporate level, others contend this tax structure is just.

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