Double taxation, a concept where the same income is taxed twice, often results in a heightened overall tax liability. This taxing process can either occur on a juridical or economic basis, affecting individuals or entities in different ways. Double taxation refers to a scenario where the same income is taxed twice, leading to an increased overall tax liability.
Types of Double Taxation
1. Juridical Double Taxation
Juridical Double Taxation arises when an income is taxed twice in the hands of taxpayers, one in the country of residence and other, in the country of source. This situation often arises due to the taxation on world-wide income for residents.
Many countries having tax laws to tax the global income of its residents (taxpayer) and that results in dual taxation of income in the hands of a taxpayer.
Example:
Mr. Mittal, an Indian resident conducting business in India, generates INR 10,00,000 from his business/ profession within the country. Additionally, he earns INR 5,00,000 from providing any services/ goods outside India (e.g., USA). Despite the fact that this income of INR 5,00,000 is not being earned within India, it is considered a part of Mr. Mittal’s taxable income. As a result, as by providing services in India, still this will be including in the taxable income of Mr. Mittal and he is liable to pay tax on his global income (INR 10,00,000 + INR 5,00,000)
2. Economic Double Taxation
Economic Double Taxation arises when the same income is taxable in the hands of two different taxpayers unlike in the case of Juridical double taxation wherein the taxpayer is the same person.
Example:
Dividend is taxed both in the hands of corporate as well as in the hands of Shareholder. (However, this may not be much relevant from the Indian perspective)
How the relief can be granted out of this double taxation?
There are two types of Double Taxation Relief mechanism to mitigate the effects of double taxation:
1. Unilateral Tax Relief
Unilateral Tax Relief may be allowed in the countries when there is no double taxation avoidance agreement (DTAA) is in place between the Country of residence and Country of source.
The relevant extract of Section 91 of the Income-tax Act, 1961 is provided as under:
“… in respect of his income which accrued or arose during that previous year outside India (and which is not deemed to accrue or arise in India), he has paid in any country with which there is no agreement under Section 90 for the relief or avoidance of double taxation, income-tax, by deduction or otherwise, under the law in force in that country, he shall be entitled to the deduction from the Indian income-tax payable by him of a sum calculated on such doubly taxed income at the Indian rate of tax or the rate of tax of the said country, whichever is the lower,… “
Hence, tax deduction is computed in this case by ascertaining the amount of income which is subject to doubly taxed and then tax relief is granted by allowing deduction from the tax liability of an amount equal to lower of:
– Amount of tax calculated at the Indian rate of tax
– Amount of tax calculated at the foreign rate of tax
2. Bilateral Tax Relief
Bilateral Tax Relief comes into picture when two countries enter into a DTAA and in this case treaty provides the manner of tax relief to be granted.
Article 23 of the UN as well as OECD Model Convention contains the provisions relating to elimination of double taxation and specify two methods:
i. Exemption method:
Under this method the income earned in the country of source is exempted in the country of residence and this is relatively uncommon from India’s standpoint. It has further categorized under below variants:
– Full exemption method
– Exemption with progression method
ii. Credit method:
Under this method the taxes paid in the country of source will be eligible for credit while settling of taxes in the country of residence subject to certain conditions. The country of residence would determine the resident’s worldwide income encompassing income earned from the country of source (foreign country) and then compute tax liability.
It has further categorized under below variants:
– Full credit method
– Ordinary credit method
– Tax sparing credit method
– Underlying tax credit method
Double taxation can pose significant financial burdens on taxpayers, especially those with global income streams. However, relief mechanisms like Unilateral and Bililateral Tax Relief offer potential solutions. Understanding these concepts and effectively utilizing relief measures can be vital in optimizing tax liabilities and ensuring compliance with global taxation norms.