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Basics of tax in the International Regime

AREAS TO BE COVERED

1. Need for international taxation

2. Provisions of IT Act applicable

3. Basics of DTAAs

4. Anti-Avoidance rules
RELEVANT PROVISIONS

Section 5 defines total income for the purpose of taxation


Section 5(1) effectuates residence based principle:
Income of resident
(i) received or deemed to be received in India.
(ii) accrues/arises or is deemed to accrue/arise in India.
(iii) accrues/arises to him outside India. (not for RNOR as per
proviso)
Section 5(2) effectuates source based principle:
Income of non resident
(i) received or deemed to have been received in India
(ii) accrues or arises or deemed to accrue or arise in India
Resident and Resident but
Ordinary not an ordinary Non Resident
Resident resident
Accrues or
arises (or T T T
deemed) in India
Received (or
T T T
deemed) in India

Accrues or Only PGBP from


arises outside T estab. in India - NT
India T
Received
T NT NT
outside India
INCOME DEEDED TO ARISE OR ACCRUE IN
INDIA

Section 9 includes:
Income accruing or arising directly or indirectly through or from any
business connection in India, or property or asset or source of income in
India or transfer of capital assets situated in India.

Business connection means a person acting on behalf of the


non resident to carry out daily business.
Income is taxable to the extent attributable to the business
connection. Ex- Service by a non resident enterprise through
some employees.
Transfer with underlying Indian assets is taxable as per Section
9.
Vodafone Case: Effect on Indirect transfers
INDIRECT TRANSFER
DOUBLE TAXATION AVOIDANCE
AGREEMENTS

Simultaneous application of residence based taxation and


source based taxation leads to double taxation.
Ex- If X a resident of A earns income abroad in B there would be
double taxation.
Double Taxation Avoidance Agreements (DTAAs) are treaties
that countries sign to prevent overlap of taxation. (of the same
income of the same person)
Section 90 empowers the Central Government to enter into
agreements with other countries to prevent double taxation and
to prevent tax avoidance
In case of a conflict between DTAA and IT Act, the more
beneficial shall prevail.
IMPORTANT ASPECTS OF DTAAs

Applies to residents of one or both contracting states

Resident is a person who is a resident liable to be taxed as per the


law of the country (on the basis of domicile, management etc.)

Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706(SC),


the Supreme Court held that:

Liability to taxation is a legal situation; payment of tax is a fiscal


fact. For the purpose of application of Article 4 of the DTAC, what is
relevant is the legal situation, namely, liability to taxation, and not
the fiscal fact of actual payment of tax. If this were not so, the DTAC
would not have used the words liable to taxation, but would have
used some appropriate words like pays tax.

Ex- If person exempt from tax may become taxable in future and
therefore liable to be taxed as there he may be potentially taxed.
IMPORTANT ASPECTS OF DTAAs

Applies to residents of one or both contracting states

Resident is a person who is a resident liable to be taxed as per the


law of the country (on the basis of domicile, management etc.)

Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706(SC),


the Supreme Court held that:

Liability to taxation is a legal situation; payment of tax is a fiscal


fact. For the purpose of application of Article 4 of the DTAC, what is
relevant is the legal situation, namely, liability to taxation, and not
the fiscal fact of actual payment of tax. If this were not so, the DTAC
would not have used the words liable to taxation, but would have
used some appropriate words like pays tax.

Ex- If person exempt from tax may become taxable in future and
therefore liable to be taxed as there he may be potentially taxed.
Permanent Establishment test for taxing NRs

Does NR have presence in India by fixed place of business or


agency PE?
If NR enterprise has an establishment (PE) as per the relevant
DTAA, then the business income attributable to the PE can be taxed
in the source country.
This is taxation of source based income for Non Resident.
PE a fixed place of business through which the business of
enterprise is wholly or partly carried on.
Intimate and real relationship between the fixed place and the
business.
Direct Nexus,
It should be actively carrying on the business through a fixed
place of business.
ASPECTS Of DTAAs

Distributive rights of both contracting parties to the business profits


earned in one contracting state. In case of PE- income attributable
to that PE is taxable.
Dividends and Royalties taxable in Resident State. Other State
may charge royalty in certain circumstances upto 15-20% if the
beneficial owner (payee) is a resident of the other state.
Meaning of beneficial ownership
FOREIGN TAX CREDIT

There are two methods of tax credit provided for in DTAAs:


Tax Credit method (Article 23A)
Tax exemption method.
Deduction method
In the exemption method the right to tax is left solely to the
Source State as per its own tax laws.
In the credit system, the Residence country provides credits to
the extent of the tax paid in the source country.
In the deduction method, the tax paid is deducted form the
income as expenses.
ANTI-AVOIDANCE RULE

There are three kind of Anti-Avoidance Rule. These rules are as


follows:
General Anti-Avoidance Rule (GAAR)
Specific Anti-Avoidance Rule (SAAR)
Judicial Anti-Avoidance Measures (JAAM)
GENERAL ANTI AVOIDANCE RULE

The object of this rule is to avoid giving benefit to transaction that


lack commercial substance and their only aim is to take tax
benefit.
It is an Impermissible Avoidance Agreement if:
The whole arrangement has been entered with an objective
of obtaining tax benefits and
The arrangement creates rights and obligation not normally
created in arms length transaction
If it results in a direct or indirect misuse or abuse of the
provisions of the code or lack commercial substance in whole
or part, or is not bonafide.
SPECIFIC ANTI AVOIDANCE RULE

Transfer Pricing: Applies to any International Transaction


(involving at least one non-resident) between associated
enterprises. Such transaction must be done at the same price as
it would have been between two unrelated parties (Arms' Length
Price).

Thin Capitalisation: Thin capitalization is another Specific Anti


Avoidance rule which prevents the borrowed capital to be made
up of a greater proportion of debt than equity.
This is usually done to avoid tax payment since tax relief can be
obtained for debt instruments in terms of interest (expenditure)
payable.
JUDICIAL ANTI AVOIDANCE RULE

The guiding principles are:


Business Purpose Rule (motive test)
Substance over Form Rule (artificiality test)

Business purpose rule implies that there must be a commercial


purpose behind the transaction and it must not merely be for tax
avoidance.

The substance versus form rule: there should be prevalence of


economic or social reality over the literal wording of legal
provisions.
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