Double Taxation Avoidance Agreements (DTAA) are the tax treaties or agreements entered into between countries to avoid taxing the same income twice and preventing double taxation of income earned in both the countries. DTAA are entered into between two or more countries to ensure that there is no tax evasion and double payment of tax.
India has Double Taxation Avoidance Agreements (DTAA) with 88 countries out of which 86 are in force. In most countries, tax is levied based on the Source Rule and the Residence Rule. The source rule holds that income is to be taxed in the country in which it originates, irrespective of whether the income accrues to a resident or a non-resident, whereas the residence rule stipulates that the power to tax should rest with the country in which the taxpayer resides. From plain reading, it can be understood that both rules cannot be applicable simultaneously, because business entities would suffer from taxation at multiple ends and it would be detrimental to do business on a global scale. In such scenarios, the Double Taxation Avoidance Agreements (DTAA) hold significant importance. Sections 90 and 91 of the Income Tax Act provide relief from paying double tax. Section 90 is applicable when India has entered into a bilateral agreement with another country and Section 91 becomes applicable in cases where this is no bilateral agreement i.e., unilateral agreement.
India-Mauritius treaty was signed between the two countries in 1982 and one of the most important features of the treaty is applicability of Article 13 which provided for capital gains exemption to Mauritius resident on transfer of Indian shares and securities. After 33 years, the treaty was subsequently amended in 2016 and capital gains on investments made in India through companies in Mauritius became fully taxable.
The revised treaty holds that investors from Mauritius shall be taxable at domestic rates of India from April 1, 2019, which has been limited to 50% of domestic rate from the period of April 1st, 2017 till March 31st, 2019 subject to the Limitation of Benefits (LOB) article. The amendment covers the loophole through which tax avoiders were successfully able to avoid tax, thereby increasing the tax inflow towards India. Similarly, the India – Singapore treaty also went through a significant amendment removing the capital gains exemption which was available earlier. Despite the amendments, there is still much to look forward to as Mauritius as a destination offers much more than any other country. Some of the comparative advantages being the headline rate of tax which is taxable at 3% and the withholding tax which is at 7.5%, which makes it an attractive option when compared to other countries.
Historically speaking, the DTAA between Singapore and India came into effect in 1994. The provisions of this agreement were modified by a protocol signed on June 29, 2005 and the second protocol was signed on June 24, 2011. The DTAA between Indian and Singapore was amended on December 30th, 2016 by the signing of a Third Protocol. It can be said to be closely aligned to the decision of amendment of India Mauritius treaty, construed as collateral and with an implied justification that a revision/amendment was unavoidable. Construing the importance of Article 13 in the DTAA, the Limitation of Benefits clause was introduced in the protocol signed between the countries in 2005.
Article 13 specifies the State in which capital gains are subject to tax and the amendment provides that any capital gains that arise on the sale of property or shares are taxable only in the country where the investor resides. This amendment proves beneficial to Singapore since it does not levy any tax on capital gains. To avoid exploitation of the proviso, the Limitation of Benefits clause was inserted into the DTAA wherein a company incorporated in Singapore shall not be entitled to exemption of capital gains if it was solely formed for such purpose. In addition to this, the companies that have little to no business in Singapore with no continuity cannot avail the benefit. The amendment states that the existing provisions will continue to apply to capital gains from the sale of shares acquired before April 1, 2017. The capital gains from the sale of shares acquired in a company from April 1, 2017 up to March 31, 2019 will be taxed in the country where the company is a tax-resident at a rate of 50% of the capital gains tax rate applicable in that country and the capital gains arising from the sale of shares acquired in a company on or after April 1, 2019 will be taxed in the country where the company is a tax-resident.
The initial treaty between Indian and Cyrus from June, 1994 was replaced with the Double Taxation Avoidance Agreement signed between both the countries on November 18th, 2016. One of the most important changes brought forward was the effective implementation of Article 26 of the OCED Model tax convention which provides for exchange of information and symbiotic assistance in collection of taxes. The revised treaty is set forward to bring in more Foreign Direct Investment (FDI) from Cyprus and is expected to boost trade relations between the countries. Similar to the Agreements between Mauritius and Singapore, Cyprus was also used an exit as the country did not tax capital gains and was used by many foreign investors to make investments in India. Observingly, one of the interesting points to ponder upon is that while the India Mauritius DTAA provides for a window wherein capital gains taxes will apply at 50% of the domestic tax rates during the transition period of 2 years, on the other hand the treaty between India and Cyprus there is no such relief because capital gains arising from the sale of shares shall be liable for tax at the domestic rates.
Notification No. 86/2013 issued by the Central Board of Direct Taxes, classified Cyprus as a non-cooperative jurisdiction for failing to provide information under the provisions for exchange of information as per the agreement. The Amended treaty provided for the rescindment of Cyprus from India's blocked list of non-cooperative countries, to which Cyprus had been added through the notification dated 01.11.2013. The revised treaty has also amended the scope of ‘Permanent Establishment’ to increase its scope to include Service PE within the definition and also indulged in grandfathering of investments prior to April 1, 2017 with respect to the capital gains taxes. Importantly, there was revision of the treaty to source based taxation arising from the alienation of shares from the earlier concept of resident based taxation. The fact that Cyprus has been removed from India's list of non-cooperative countries provides for a strong appeal to the investors for contributing to the increasing FDI to India.
Among one of the benefits which Double Taxation Avoidance Agreements offers, it is the ample opportunity for countries to attract investment in the form of FDI. Advantageously, in DTAA’s between countries there are the benefits regarding tax exemption, as was initially seen in agreements with Mauritius and Singapore. Similarly, there are certain disadvantages as well. Even though DTAA’s are entered into between countries with the objective of removing double taxation and promotion of investment in their respective countries, sometimes they can be taken advantage of by shell companies to evade taxes thereby leading to losing of revenue by the countries. Consequently, to prevent misuse of the DTAA’s, a Limitation of Benefits article is usually inserted by countries in the DTAA’s entered by them which determine the investments made just in order to get benefit of the treaties in place. In the future, many more changes may be inserted by the countries, to avail certain benefits and in order to make the DTAA’s foolproof in effectively dealing with the aspect of double taxation.