Double Taxation Avoidance Agreement
Also written DTAA · Double Taxation Avoidance Agreement (DTAA) · Tax treaty · Double tax treaty
A treaty between two or more countries that prevents the same income being fully taxed twice, either by allocating the taxing right or by the residence country giving credit for tax paid at source.
In plain language
A resident of India pays Indian tax on worldwide income. The country where that income arises usually taxes it too, because it is the source. Left alone, the same rupee is taxed twice.
A DTAA is the agreement between the two countries that stops this. It works in one of two ways: by allocating the taxing right to one country, or — far more commonly — by the residence country giving credit for the tax already paid in the source country.
For a non-resident earning in India, it does something else as well: it offers a rate. Where a DTAA applies, the non-resident is taxed at the rate in the treaty or the rate in the Income Tax Act, whichever is more beneficial to him.
How it works
Two situations, and the exam asks about both.
Indian resident, foreign income. The income is taxable in India because a resident is taxed on global income. The source country taxes it too. India, as the residence country, allows credit for the foreign tax when computing the total Indian liability. The workbook's illustration is an Indian student earning in France and a returning NRI holding UK bonds — both pay French or UK tax and both get credit in India.
Non-resident, Indian income. Here the treaty supplies a ceiling rate, and the assessee picks whichever of the two rates is lower. The comparison is done income head by income head — the same person can take the treaty rate on one stream and the Act rate on another.
The paperwork is not optional. To claim any DTAA relief the non-resident must obtain a Tax Residency Certificate from the country of residence, and additionally furnish Form 10F, a self-declaration giving prescribed details.
A worked example
Mr A is a tax resident of the USA and a non-resident in India. In the year he earns, from India:
- Interest on debentures: Rs 10,00,000
- Dividend on Indian shares: Rs 2,20,000
| Income | Income Tax Act | India-USA DTAA | Rate applied | Tax |
|---|---|---|---|---|
| Interest Rs 10,00,000 | slab rates | 15% (Article 11) | 15% | Rs 1,50,000 |
| Dividend Rs 2,20,000 | 20% | 25% | 20% | Rs 44,000 |
Notice that the answer goes one way on interest and the other way on dividend. The treaty is better on interest; the Act is better on dividend. Picking "the DTAA rate" across the board would cost him Rs 11,000 on the dividend alone.
Change one fact. Suppose Mr A is a tax resident of the UK instead. The India-UK DTAA gives a dividend rate of 10%:
Dividend tax = 2,20,000 x 10% = Rs 22,000
Same investor, same shares, same Indian company — Rs 22,000 more tax for being resident in one country rather than another. And in either case he must produce a TRC plus Form 10F, or he is taxed under the Act with no relief at all.
Why NISM asks about it
Chapter 7 (Concepts in Taxation) introduces DTAA at section 7.15 after establishing residential status, and Chapter 10 (Taxation of Debt Products) applies it to interest and dividend income of non-residents, with the worked USA-versus-UK comparison above. Chapter 11 returns to it for dividends on equity. The examinable rule is always the same: treaty rate or Act rate, whichever is more beneficial, claimed only on production of a TRC and Form 10F.
Common exam traps
- The DTAA rate is a ceiling, not a mandate. If the Income Tax Act rate is lower, the assessee takes the Act rate.
- The comparison is per income stream. One assessee can be on the treaty rate for interest and the Act rate for dividend in the same return.
- Relief needs a TRC and Form 10F. A question that describes a non-resident with no TRC is testing this, not the rate.
- Credit is given by the residence country, not the source country. India gives credit for foreign tax to its residents; it does not refund Indian tax to a foreigner.
- A DTAA does not make income exempt. It caps the rate or grants a credit — the income is still reported.
- Non-resident Indian citizens and persons of Indian origin have a separate route in Chapter XII-A of the Act; the workbook treats it as an alternative to, not part of, the treaty.
Where this is taught
Free preparation for NISM Series XIX-ARelated terms
- Non-ResidentAn assessee who fails every residency test in section 6 — taxable in India only on income received, accruing or deemed to accrue in India, and on nothing that arises abroad.
- Resident but Not Ordinarily ResidentA middle residential status for income tax: the person is a resident of India, yet foreign income unconnected with an Indian business or profession stays outside the Indian tax net.
- Residential statusThe classification — resident (ordinarily or not ordinarily), deemed resident or non-resident — that decides which income is taxable in India. Citizenship alone is not the test.
- Tax Residency CertificateThe certificate a non-resident investor obtains from its home tax authority to claim benefits under a Double Taxation Avoidance Agreement — without it, Indian domestic rates apply.
- Liberalised Remittance SchemeThe RBI facility letting a resident individual remit up to USD 250,000 per financial year abroad for any permissible current or capital account transaction, including investment in offshore funds.
- Offshore Fund StructureA structure used when there is no intent to pool capital in India: the pooling vehicle is domiciled abroad, such as in Mauritius or Singapore, takes offshore investors' money and invests directly into Indian companies.
- Regulatory RiskThe risk that laws and regulations change unfavourably — raising costs or altering competition — and hurt investment returns. The workbook treats it as a part of legal risk.
- Limitation of Benefit (LOB) clauseA tax treaty provision denying treaty relief to an entity without genuine economic substance in the treaty country — the workbook notes GAAR is not invoked where an LOB clause already addresses the avoidance.
- Place of Effective ManagementThe tax-residency test that can treat an offshore fund as an Indian tax resident if its real decision-making is found to happen in India — a risk offshore AIF structures manage through their local advisory offices.
- Withholding taxTax deducted from income at the point it is paid or credited — for an AIF, 10% on income distributed to a resident investor and 20% where a non-resident is paid dividend.
- BEPSThe OECD's Base Erosion and Profit Shifting project — 15 action plans against global tax avoidance, whose Action Plan 15 produced the Multilateral Instrument that rewrites India's tax treaties.
- Person resident in IndiaFEMA's definition of residence under section 2(v) — broadly a person normally residing in India for more than 182 days in the preceding financial year, plus Indian-registered bodies and certain offices.
- Alternate Minimum TaxA floor tax on non-corporate assessees — 18.5% of adjusted total income, 15% for a co-operative society — payable when it exceeds their normal tax, with the excess carried forward as credit for 15 years.
- GAAR testThe two-part test for an impermissible avoidance arrangement: the main purpose must be to obtain a tax benefit, and the arrangement must carry at least one of four tainted elements.
- Tax treaty shoppingArrangements aimed at obtaining the reliefs of a double taxation avoidance agreement for the indirect benefit of residents of some other country — which India's treaties must not create opportunities for.
- General Anti-Avoidance RulesChapter X-A provisions of the Income-tax Act, applying to income arising on or after 1 April 2017, letting the tax authorities deny the benefit of an arrangement that lacks commercial substance and exists mainly for tax.
- Resident and Ordinarily ResidentThe residential status under which an individual's worldwide income is taxable in India — reached by being resident and failing both of the not-ordinarily-resident tests.
- FVCI RouteThe route for SEBI-registered off-shore funds to make venture capital investments in eligible unlisted Indian companies — in stipulated priority sectors, or start-ups in any sector — at freely agreed prices.
- Multilateral InstrumentAn OECD-framework multilateral treaty that lets countries swiftly modify their bilateral tax treaties to curb treaty shopping and tax avoidance; it supplements, supersedes or modifies how a DTAA applies.
- TDS on IDCWTax deducted at source at 10 percent on an IDCW from a mutual fund scheme above Rs 5,000 — applicable even to resident investors, unlike redemption proceeds, which carry no TDS for residents.
- Non-Resident IndianAn Indian citizen or person of Indian origin who does not meet the resident conditions. NRIs may invest in PMS through NRE or NRO accounts and are taxed only on Indian income.
- Hybrid pass-through entityREITs are taxed as a hybrid pass-through entity — rental, interest and SPV dividend income is exempt at the REIT and taxed only when distributed to unit-holders, but not every category of REIT income gets this treatment.
- Income from foreign sourcesIncome accruing or arising outside India, other than income from a business controlled in or a profession set up in India, and not deemed to accrue or arise in India.
- Maintaining a foreign life policyA person who becomes resident in India need not buy fresh life cover here and may keep an existing overseas policy alive, paying the premiums from foreign income or remitting them from India.
- Special Purpose VehicleA separate entity, usually a company, floated to hold and develop real estate, in which a REIT or InvIT holds a controlling interest — the indirect route through which a trust owns its assets.
- Specified accountA retirement account held in a notified country - the USA, Canada or the UK - whose income Section 89A lets an Indian resident be taxed on at withdrawal rather than as it accrues.