India’s DTAA Regime: A Brief Primer for Foreign Investors

India’s DTAA regime covers a vast network of double tax treaties, which are supported by social security agreements, to provide tax relief. Collectively, these aim to prevent double incidence of taxation of income and ease social security obligations of international workers.

A Double Taxation Avoidance Agreement (DTAA) is a treaty signed between two countries, which incentivizes and promotes the exchange of goods, services, and investment of capital between the two countries by eliminating international double taxation. It is not a regulation to impose or determine tax rates but a comprehensive treaty between two sovereign states enumerating the detailed procedure and manner of taxation, with well-defined written terms and conditions to be strictly adhered to.

A DTAA, either bilateral or multilateral, arises in cases where there is:

• Global + source-based taxation
• Residency in two countries

DTAAs with India

India has a vast network of DTAAs with other countries under Section 90 of the Income Tax Act, 1961. Currently India has established 94 comprehensive DTAAs and eight limited DTAAs. While comprehensive agreements address all source of income, the scope of limited agreements is, as indicated, limited to specific sources.

A DTAA between India and other countries is drafted on a reciprocal basis and covers only residents of India and the residents of the negotiating country. Any person or company that is not resident, either in India or in the other country that has entered into an agreement with India, cannot claim benefits under the signed DTAA.

Withholding tax rates under DTAAs

Foreign or non-resident companies operating in India are subject to tax on their income – dividend, interest, royalty, or fees for technical services, as prescribed under the Income Tax Act.

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Under the Finance Act 2020, the Indian federal government scrapped the problematic dividend distribution tax (DDT) regime and introduced withholding tax on the payment of dividend. Consequently, dividend is now taxed only in the hands of the recipient.

According to the new regime, an Indian company paying dividends is no longer liable to DDT but should instead withhold tax at source at the time of payment of the dividend since the recipient of the dividend is now subject to tax.

The abolition of the DDT requires all equity investors to treat their dividend receipts as income and pay taxes on it at their applicable slab rates, as per the system of dividend taxation that is widely prevalent globally.

This move will benefit both foreign portfolio investors and foreign companies, along with domestic stakeholders, in the following ways:

• Multinationals and foreign companies: Under the old regime, the dividend was distributed by companies to their shareholders after paying dividend distribution tax. The DDT so paid was not eligible for credit in their respective countries while paying tax. Now, under the new regime following international practice, companies while paying dividend to non-resident shareholders are required to withhold tax at source. The TDS that is deducted is eligible as credit to foreign shareholders against the tax liability on such dividend income in its home country. A non-resident can also choose to be governed by the provision of a tax treaty, if they are more beneficial.
• Foreign portfolio investors (FPIs) structured as corporate entities: They can now pay tax on dividends earned in India at either 20 percent or lower rates, specified in tax treaties signed between India and their home countries. In some cases, rates can be as low as five percent.
• Domestic investors and wealth managers: By way of reduced rates and abolition of indirect incidence of taxation, domestic stakeholders, be it investors or wealth managers, stand to benefit under the new classical regime.

Now, under the new regime, companies will be liable to deduct TDS under following sections: 

India’s federal budget 2021 (tabled as Finance Bill 2021 in parliament) has also proposed the removal of double taxation for non-resident Indians (NRIs) on income accrued through foreign retirement benefits – to prevent hardships that non-residents face on account of double taxation.

Withholding tax rates under India’s DTAAs

Below is a list of countries that have a comprehensive DTAA with India.

Following is the list of countries with which India has limited agreements:

Purpose of DTAAs

Globalization has resulted in the rapid growth of multinational companies operating across multiple jurisdictions, which have led to certain loopholes in the manner of taxing global income – creating incidence of double taxation.

Each country has its own international taxation laws, which are divided into two broad dimensions:

• Taxation of foreign income: Taxation of resident individuals and corporations on income arising in foreign countries.
• Taxation of non-residents: Taxation of non-residents on income arising domestically.

The implication is obvious that the taxation of foreign income for one country (resident country) is the same as the taxation of non-resident for another country (source country). This leads to dual taxation, the resident country taxing the income and the source country levying taxes on same income.

To avoid this scenario, and to promote foreign investment ease flow of capital, governments enter such treaties with other countries. The need for DTAAs can be summed up as follows:

• Avoidance of double taxation of income
• Income tax recovery in both the countries
• Equitable, rational, and fair allocation of taxing rights over a taxpayer’s income between two countries
• Promotion and encouragement of free flow of international trade, investment, and technology
• Increased transparency

Applicability of DTAA provisions

Tax treaties are generally relieving in nature and do not impose tax. They are comprehensive agreements based on mutual understanding between two sovereign states and are well defined. In case of ambiguity regarding provisions, the interpretation that is harmonious with the provisions of the Income Tax Act is adopted.

Tax relief mechanisms

The incidence of dual taxation can be avoided by various relief mechanisms. These are:

Bilateral relief

Section 90/90A of the Income Tax Act, 1961 contains provisions granting foreign tax credit under DTAA. When there is an agreement between two countries, relief is calculated according to mutual agreement between such countries. Bilateral relief can be granted by either of the following methods:

• Deduction method: The domestic country allows its taxpayer to claim a deduction for taxes, including income taxes, paid to a foreign government in respect of foreign source income.
  This method does not fully avoid double taxation but just saves tax by the amount of Foreign Tax Paid x Domestic Tax Rate.
• Exemption method: The domestic country provides its taxpayer with an exemption for foreign source income. This method is more favorable if tax rates in domestic countries are higher than those in source country.
• Credit method:
  • Ordinary credit: Domestic country gives either full or partial credit of taxes paid in the foreign country. This means that the taxpayer will be taxed on the same sourced income and the tax is to be determined accordingly – but the taxpayer will pay lower amount of taxes to the extent of credit available.
  • Underlying credit: In this method, the taxes paid on the profits from which the dividend is declared can be claimed as credit against the taxes payable on the dividend income.
• Tax sparing/holiday: To incentivize economic activities, various tax exemptions are given, which help the assessee limit the tax burden. For example, deduction under Section 80-IB of Income Tax Act, 1961. Whenever the assessee is liable to taxation in their domestic country, credit will be allowed for taxes paid in the foreign country, but due to tax exemption in such foreign territory there will be no tax payment and no credit to balance of taxpayer. Under this method, the domestic country will deem such exempt income as tax paid and credit of such taxes which are deemed to be paid in the foreign country will be allowed as credit in the domestic country.

Unilateral relief for Indian residents

Some countries provide relief of taxes paid in the source country without any treaty between those two countries. This kind of relief is known as unilateral relief. In India, unilateral relief from double taxation is provided to Indian residents under Section 91 of the Income Tax Act.

Social Security Agreements

India has also concluded various Social Security Agreements (SSAs) to ease the social security obligations on cross-border / international workers. Under these SSAs, incentives such as detachment, exportability of pension, totalization of benefits, and withdrawal of social security benefits are available.

India has entered into SSAs with the following 20 countries:

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