In the present situation of globalization, Tax regimes plays a vital role in investment and trading decisions in other countries. The visible impact of globalization depends upon one country's tax policies on the other country. Double taxation is acting as one of the hurdle for globalization. In order to relieve from the hurdle government has decided to provide the relief from double taxation in two forms.
Meaning of Double Taxation:
Double taxation means taxing the same income twice in the hands of the same assessee.
Case of arising Double Taxation:
Where a Tax payer is resident in one country but has the source of income from another country, it gives rise to possible double taxation. This arises from two basic rules that enables the country of residence as well as the country of source of income to impose tax namely i) Source Rule and ii) Residence Rule.
The source rule states the income should be taxed in the country where it accrues irrespective of the receiver whether is a resident or non-resident whereas the resident rule states that the power to tax rests with the country in which the tax payer resides. If the situation leads to apply both the rules, in two different corners from the different countries, tax should be payable .in both the countries which leads to increase in operating cost for the company which pulls down the goal of opting globalization, In order to avoid this type of double taxation, Double taxation avoidance agreements came into existence.
Types of relief of Double Taxation:
i) Bilateral Relief
ii) Unilateral Relief
Bilateral relief (Section 90): In this type of relief both the governments mutually comes to an understanding to provide a relief either by way of tax credit method and the tax exemption method. At present, India has Double taxation agreements with approximately with 90Countries and our country follows both the methods with different countries. The country in which the tax payer resides is cslled the 'Home state' and the country from which the income originates is called 'Host State'.
Tax Credit Method: In this type of relief, both the governments levies tax but the government of one country gives credit to the extent of tax paid in the other country. Here the question arises which country should tax first and which country should give the tax credit to the extent of the tax paid on such income in the other country.
Whenever this question arises source rule comes into the picture first i.e the country from which the income originates or accrues should charge the tax first and residence rule comes next i.e the country in which the tax payer resides should give the credit of tax paid regarding such income in the other country.
Tax Exemption Method: In this type of relief, the income is taxed only in one country and the other country gives exemption for payment of tax.. The question here is whether the 'home state' or the 'host state' is obliged to give exemption. In the case of Corporate assessee the country in which the tax payer has the "Permanent Establishment" can levy tax on such income and the other country should grant exemption for such income.
If the tax payer has the 'permanent Establishments' in both the countries then the country where the head office is located can collect tax and the other country should grant exemption in respect of such income.
In the case, If the tax payer is a non-corporate assessee , the country in which the tax payer has 'permanent home' shall collect tax and the other country should grant exemption. However, in the exceptional cases if the assessee has 'permanent home' in both the countries then the 'personal relationship' or 'economic relationship' closer to the country then that can collect tax and the other country shall grant exemption.
Here, the word 'personal relationship' means the country where is has most of the relatives and friends and the word 'economic relationship' means the country in which his business transactions are more than the other can collect tax and the other country shall grant exemption.
Tax treaties are generally of two types:
i) OECD Model
ii) UN Model
In general, Our country follows both of the methods.
Unilateral Relief (Section 91): In this type of relief, the involvement of both the governments is absent. Only one government i.e our government will give relief to the tax payer.
For more detailed understanding, check out a problem on double tax after reading this. You will come to complete understanding.
Tags :Income Tax