Double Tax Avoidance Agreement (DTAA)

1. Services Provided in India

NRIs who provide professional or consultancy services in India may earn income from those services. This income is subject to Indian taxation as it is earned in India. However, if the NRI's country of residence also taxes this income, the DTAA can be invoked to avoid being taxed twice.

Example:: Suppose an NRI residing in the United States provides IT consultancy services to a company in India. The income earned from these services is taxed in India. The DTAA between India and the US allows the NRI to claim a tax credit in the US for the taxes paid in India, thereby avoiding double taxation.

1. The NRI can claim a tax credit in their resident country for taxes paid in India.

1. Alternatively, if the DTAA specifies a lower withholding tax rate, the NRI can benefit from a reduced tax rate in India.

2. Salary Received in India

An NRI employed in India and receiving a salary is subject to Indian income tax. However, if their country of residence also taxes global income, the DTAA ensures that the same salary is not taxed again or is taxed at a reduced rate.

Example: An NRI working in India for a multinational company is paid a salary in India. The salary is subject to Indian tax. If the NRI resides in a country like Canada, which taxes global income, they can use the DTAA to avoid paying taxes on the same salary in both India and Canada.

1. The NRI can claim a tax credit in their country of residence for the taxes paid in India.

1. If the DTAA specifies that salary income earned in India is only taxable in India, the NRI may be exempt from tax on that income in their resident country.

3. House Property Located in India

NRIs who own property in India and earn rental income from it are subject to tax in India. However, this income might also be taxed in their country of residence. The DTAA ensures that they are not taxed twice on the same rental income.

Example: An NRI living in the UAE owns a rental property in Mumbai. The rental income is taxed in India. The DTAA between India and the UAE allows the NRI to either claim a tax exemption in the UAE or a tax credit for the Indian taxes paid, thereby preventing double taxation.

1. The NRI can claim a tax credit in their resident country for taxes paid on rental income in India.

1. If the DTAA allows, they may be exempt from taxation on this income in their resident country.

4. Capital Gains on Transfer of Assets in India

When NRIs sell assets such as property or shares in India, they may incur capital gains. These capital gains are taxed in India. If the NRI's country of residence also taxes capital gains, the DTAA helps in avoiding double taxation.

Example: An NRI residing in the UK sells a house in India and earns capital gains. The DTAA between India and the UK allows the NRI to either reduce the tax liability in the UK by claiming credit for taxes paid in India or possibly be exempt from UK tax on these gains.

1. The NRI can claim a foreign tax credit in their country of residence for taxes paid in India on capital gains.

1. Some DTAAs provide for exclusive taxation rights to one country, meaning the gains might be taxed only in India.

5. Fixed Deposits in India

Interest income from fixed deposits held in Indian banks is subject to tax in India. If the NRI’s country of residence also taxes this interest income, the DTAA ensures that the NRI can avoid paying taxes on the same income twice.

Example: An NRI residing in Singapore earns interest from a fixed deposit in an Indian bank. The interest income is taxed in India. The DTAA between India and Singapore allows the NRI to claim a tax credit in Singapore for taxes paid in India.

1. The NRI can claim a tax credit for the taxes paid on interest income in India.

1. If the DTAA specifies a lower withholding tax rate, the NRI benefits from reduced tax liability in India.

6. Savings Bank Account in India

Interest earned on savings bank accounts in India is taxable in India. If the NRI’s country of residence also taxes this income, the DTAA ensures that the NRI does not pay tax on the same interest income twice.

Example: An NRI living in Qatar has a savings account in an Indian bank and earns interest on it. This interest income is taxed in India. The DTAA between India and Qatar allows the NRI to claim a tax credit in Qatar for the Indian taxes paid.

1. The NRI can claim a tax credit in their country of residence for taxes paid on interest income in India.

1. Some DTAAs may exempt this income from taxation in the NRI’s resident country.

How DTAA Benefits Work

To utilise the benefits of the DTAA and avoid double taxation, NRIs can apply the following methods:

1. Tax Credit Method:
   1. The NRI can claim a credit for the tax paid in India against the tax liability in their resident country. This means the NRI will only pay the difference if the tax rate in the resident country is higher, or they may get a refund if the rate in India is higher.

1. Exemption Method:
   1. In some cases, the DTAA might exempt the income earned in India from being taxed in the NRI’s country of residence. This method is commonly used for specific types of income, such as salary or pensions.

1. Lower Withholding Tax Rates:
   1. The DTAA may specify lower withholding tax rates for certain types of income (e.g., dividends, interest, royalties). This means that the tax deducted at source (TDS) in India could be lower than the standard rate, reducing the overall tax burden on the NRI.

Importance of DTAA for NRIs

1. Prevention of Double Taxation:

The primary purpose of DTAA is to ensure that NRIs do not pay tax on the same income in two different countries, thus preventing double taxation.

1. Tax Efficiency:

By utilising DTAA benefits, NRIs can optimise their tax liabilities, ensuring they pay the minimum possible tax on their income.

1. Compliance with Global Tax Laws:

NRIs can comply with tax regulations in both India and their country of residence by following the provisions of the DTAA, avoiding penalties or legal issues.

1. Enhanced Financial Planning:

Understanding DTAA provisions allows NRIs to better plan their finances and investments, knowing that they can avoid or reduce taxes on their global income.

Steps to Apply DTAA

Step 1: Identify the Type of Income

Identify what specific type of income is being earned, such as dividends, interest, royalties, or capital gains. Each category may have different tax implications and provisions under both Indian law and the DTAA. Check how this income is classified under the Indian Income Tax Act to understand its tax treatment.

Step 2: Calculate Tax Liability under Indian Income Tax Act

Compute the tax liability for the identified type of income according to the rates and provisions set out in the Indian Income Tax Act. This gives you the baseline tax liability before applying for any DTAA benefits. Keep detailed records of the tax calculations, including the tax rates applied and any deductions or exemptions considered under Indian law.

Step 3: Review Relevant DTAA Articles

 Access the specific DTAA between India and the non-resident’s country. Review the relevant articles pertaining to the type of income in question. Understand the provisions related to reduced tax rates, exemptions, or special treatments outlined in the DTAA. These provisions will guide how the tax should be adjusted.

Step 4: Determine Tax Liability under the DTAA 

Calculate the tax liability based on the rates and rules specified in the DTAA. This typically involves applying lower withholding tax rates or claiming exemptions. Adjust your initial tax calculations to reflect the benefits provided by the DTAA. Ensure that the calculations conform to the terms of the agreement.

Step 5: Compare Tax Treatments

Refer to Section 90(2) of the Indian Income Tax Act, which allows you to compare the tax liabilities computed under Indian law and the DTAA. This section enables you to choose the most beneficial tax treatment. Assess which tax treatment results in the lowest tax liability by comparing the amounts calculated under both the Indian Income Tax Act and the DTAA provisions.

Step 6: Select and Implement the Most Advantageous Treatment

Based on your comparison, select the tax treatment that provides the most favorable outcome. This ensures you benefit from the most advantageous provisions available under the DTAA. Apply the chosen tax treatment to your tax filings or payments. Ensure that you report the final tax liability accurately and comply with the tax requirements.

How to Claim DTAA Benefits

DTAA (Double Taxation Avoidance Agreement) provides mechanisms to alleviate the impact of paying taxes on the same income in multiple countries. Here’s a detailed look at the three primary methods to claim DTAA benefits:

Deduction Method: The Deduction method allows taxpayers to reduce their taxable income in their home country by the amount of tax paid to a foreign government. This effectively lowers the amount of income that is subject to domestic tax.

Steps to Apply:

1. Calculate Foreign Tax: Determine the total amount of tax paid to the foreign government.

1. Deduct Foreign Tax: Subtract this amount from your total income to find out the net income that will be subject to domestic tax.

1. Compute Domestic Tax: Calculate the tax on the reduced income.

1. Sum of Taxes Paid: Add the domestic tax and the foreign tax paid to get the total tax burden.

Example: Mr. A, a resident of Country X, earns Rs.1000 from Country Y and pays Rs.500 in taxes to Country Y. By using the Deduction method:

1. Net Domestic Income: Rs.1000 (foreign income) - Rs.500 (foreign tax) = Rs.500.

1. Domestic Tax: 30% of Rs.500 = Rs.150.

1. Total Taxes Paid: Rs.150 (domestic tax) + Rs.500 (foreign tax) = Rs.650.

Exemption Method: The Exemption method provides tax relief by exempting the foreign income from tax in the taxpayer's home country or in the foreign country. This means that the taxpayer either does not pay tax on this income in their home country or the foreign country grants an exemption.

Steps to Apply:

1. Identify Exempt Income: Determine if the foreign income is exempt from tax in the home country.

1. Apply Exemption: Exclude this exempt foreign income from domestic tax calculations.

1. Calculate Domestic Tax: Compute the tax on the remaining income or on total income excluding the exempted foreign income.

Example: If Mr. A’s foreign income of Rs.1000 is exempt in Country X:

1. Net Domestic Income: Rs.1000 (since the foreign income is exempt).

1. Domestic Tax: 30% of Rs.1000 = Rs.300.

1. Total Taxes Paid: Rs.300 (domestic tax) + Rs.500 (foreign tax) = Rs.800.

Tax Credit Method: The Tax Credit method allows taxpayers to offset the taxes paid to a foreign government against their domestic tax liability. This reduces the domestic tax by the foreign tax paid.

Steps to Apply:

1. Calculate Domestic Tax: Determine the tax liability on the total foreign income as if it were fully taxable domestically.

1. Claim Foreign Tax Credit: Subtract the foreign tax paid from this domestic tax liability.

1. Compute Total Taxes Paid: Add the foreign tax paid to the final domestic tax liability after applying the credit.

Example: For Mr. A, who has a domestic tax rate of 30% on Rs.1000 and has paid Rs.500 in foreign tax:

1. Domestic Tax: 30% of Rs.1000 = Rs.300.

1. Tax Credit: Rs.300 (credit for foreign tax paid).

1. Final Domestic Tax: Rs.300 (domestic tax) - Rs.300 (tax credit) = Rs.0.

1. Total Taxes Paid: Rs.0 (domestic tax) + Rs.500 (foreign tax) = Rs.500.

Double Tax Avoidance Agreements with different countries

India has signed Double Tax Avoidance Agreements with many countries to prevent residents from being taxed twice on the same income. These agreements determine how income is taxed when it is earned in one country by a resident of another.

The TDS rate under DTAA varies by country and the type of income (such as dividends, royalties, or fees for technical services). The rates listed above apply to common income types, typically dividends or interest income. Some countries like Mauritius have variable rates depending on the type of income or specific provisions within the treaty. Countries like Thailand have higher TDS rates under the DTAA, while others like Germany and Kenya offer lower rates.

Indian residents who earn income from these countries can benefit from these DTAAs by paying the lower of the two tax rates (as per the DTAA or the domestic tax rate) and claiming a Foreign Tax Credit in India for any taxes paid abroad. These agreements help reduce the overall tax burden on individuals and businesses involved in cross-border transactions.

Here is the table of the DTAA TDS rates of various countries: