Friday, 2 March 2012

Double Taxation Avoidance Agreement

Double taxation is the imposition of two or more taxes on the same income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). It refers to taxation by two or more countries of the same income, asset or transaction, for example income paid by an entity of one country to a resident of a different country. The double liability is often mitigated by tax treaties between countries.

The Income Tax Act of India 1961 provides relief to taxpayers who have paid tax to countries, with whom India has a DTAA, and also with whom India doesn't have said agreement. The DTAA also allows for sharing of information between tax and banking authorities of party countries. [Wikipedia] 

India - Mauritius DTAA  was signed 3 decades ago and has played an important role in facilitating foreign investment into India.
- Mauritius accounted for 37% of FDI inflows between 1991-2005. 
- Presently approximately 42% of FDI and 40% of FII inflow is from Mauritius. 
India accounts for over half the investments made by companies based in Mauritius.
However the agreement has come under criticism in India because of allegations of round-tripping of investments, which is causing a loss to the exchequer. What is happening is that, in a bid to avoid taxation on capital gains, companies are routing their investments in Indian securities through Mauritius. The DTAA provides that person will be charged capital gains tax in the place where he is resident. Since Mauritius has a zero-capital gains tax, the entity escapes paying tax altogether.2 
Recently Mauritius has been facing criticism of the international community, for having lax laws that facilitate routing of black moneyTax officials suspected that Indian nationals were sending black money overseas and then getting it back into the country via Mauritius. An OECD study (2011) has also found gaps in the India-Mauritius DTAA. On its part, Mauritius has maintained that tightening of rules has made it tough for investors to undertake such transactions. 3
The DTAA review is set to begin in Aug 2011. Officials have stressed that this will not affect FDI inflows into the country, although doubts remain. Another concern is that FIIs will be impacted if capital gains tax is imposed. 4

India inks DTAA with Lithuania (Jul'11) - to prevent fiscal evasion of tax on income and capital. Now business profits will be taxable in source country, if the establishment is counted as a 'permanent establishment'.

On 5/9/11- there is pressure on India to sign a UK-style tax treaty with Switzerland, as a measure to curtail black-
money. As per this treaty Switzerland would tax the illicit funds of British citizens stored in its banks, and share a portion of the tax proceeds with UK, while not divulging the names of the account holders.  As per the accord, Switzerland will immediately pay up $5bn towards past taxes, and henceforth deduct a tax of 48% on income earned and 27% on capital gains. There are 2 benefits for India to implement the same: 1. ensures a gradually rising flow of funds into the exchequer; 2. helps distinguish between licit and illicit funds (because onus on proving the sanctity of funds is on the account holders). 

However presently CBDT has stated that such a treaty is not conducive to the present environment. 
Acc to the existing revised DTAA between India and Switzerland, India can obtain information in specific cases without going on any fishing expedition.  

It is interesting to note that the US has refused to implement such a treaty. And has decided to press charges against Swiss banks if they do not furnish names of US account holders storing black money. The US had brought  similar pressure on the UBS bank, which furnished names in order to avoid criminal charges.  


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