Navigating International Taxation: Best Practices for Global Compliance
Navigating the International Taxation landscape can be difficult for businesses that operate across borders. Firms need to stay updated on tax obligations, tax treaties, and compliance standards so that they can avoid mistakes and comply with regulations. International taxation involves many aspects, such as foreign tax requirements, transfer pricing, and the effects of double taxation agreements.
As businesses grow internationally, recognizing these complexities becomes critical for successful financial management and risk avoidance. This blog seeks to provide best practices for handling international tax, enabling firms to maximize their tax strategies, reduce liabilities, and comply with a variety of rules. Organizations that take a proactive approach can improve operational efficiency and support long-term growth in the global economy.
What is International Taxation
In basic language, international taxation means taxation around the world. International taxation is the study or determination of tax on a person or business subject to the law of different countries
Under International Taxation:
- FOREIGN TAX CREDIT
- DOUBLE TAXATION AVOIDANCE AGREEMENT
- TRANSFER PRICING
FOREIGN TAX CREDIT
When a resident taxpayer receives income from a foreign state after deduction of tax by a foreign state, a resident taxpayer also has to pay the tax in India on global income, this amounts to double taxation in the hand of the resident taxpayer. Resident taxpayers can claim the benefit of that foreign tax against the tax payable in a domestic country.
In India Sections 90 and 91 deal with the concept of foreign tax credit. Taxes paid outside India can be claimed as a deduction from tax payable in India.
- Section 90 deals with claims of foreign tax credit in cases where India has entered into a double taxation avoidance agreement.
- Section 91 deals with cases where India has not entered into a double taxation avoidance agreement.
- The credit of foreign tax is available only against the income tax in India not against interest and penalty etc.
- The foreign tax credit shall be lower than the tax payable under the Income Tax Act and tax paid outside India.
- For claiming the benefit of the foreign tax credit, form 67 is required to be filed in India before the due date of filing of the Income Tax return.
- In Form 67, proof of foreign tax paid outside India needs to be furnished.
DOUBLE TAXATION AVOIDANCE AGREEMENT
To avoid double taxation, for transactions between two different countries, this double taxation avoidance agreement tells us which country has the right to hold the tax and how much tax is required to be charged. Typically, the country where the income is generated retains the primary right to levy the taxes. Also, countries of residency may impose a lower tax rate.
To apply the Double Taxation Avoidance Agreement (DTAA), compare the tax liabilities under the Income Tax Act and the DTAA. The final tax liability will be determined based on which option offers the greater benefit, whether it be under the Income Tax Act or the provisions of the DTAA.
Few Principles of DTAA
| DTAA | Income Tax Act | Comment |
| A treaty does not address a particular issue | Income Tax contains the relevant provision for that issue | Refer to the Income Tax Act |
| The treaty contains certain provisions for the issue | Income Tax law is silent on that issue | Refer DTAA |
| If the treaty has a provision on the issue | Income Tax law has also provisions on the same issue | Follow whatever is more beneficial for the taxpayer |
| If the treaty has provisions | Law has contradictory provisions | Treaty will prevail |
Example of Double Taxation Avoidance Agreement
India with Mauritius – DTAA Example
India and Mauritius have comprehensive DTAA to govern the taxation of income. The agreement applies to income tax including any surcharge and surtax imposed under the Companies (Profits) Surtax Act, 1964, and in the case of Mauritius, the income tax.
This DTAA has become one of the controversial DTAAs that India has entered into. Before 2017 the DTAA stated that the capital gains arising from the sale of shares would be taxable in the state in which the shareholder is a resident, not in the state where the company whose shares have been sold is a residence. Thus a company that was incorporated in Mauritius and was selling shares of the company resident in India was not paying any capital gains in India. Because of no capital gains tax in Mauritius, the entire capital gain that arose remained untaxed. This led to FII routing their investment in India through Mauritius-based shell companies, in turn leading to loss of tax revenue. In 2017 the government of India amended the treaty and removed this exemption.
India with Netherlands – DTAA Example
India entered into a double taxation agreement with the Netherlands in 1989. This DTAA is applicable on income tax, wages tax, dividend tax, and capital tax when it comes to the Netherlands. Concerning India, the treaty would apply to income tax including surcharge, surtax, and wealth tax.
After the amendments to the India- Mauritius, India – Singapore, and India – Cyprus treaty to prevent the routing of investment through these nations, the Netherlands has become the next favorable nation as it provides exemption to a Dutch shareholder from Indian capital gains tax provided they meet requirements under the treaty.
Various Article under Double Taxation Avoidance Agreement
ARTICLE 1: PERSONAL SCOPE
It tells us who can avail the benefit of this DTAA.
ARTICLE 2: TAXES COVERED
What are the taxes covered under the double taxation avoidance agreement
ARTICLE 3: GENERAL DEFINITION
It tells us a definition of a term used in DTAA
ARTICLE 4: RESIDENT
When a person is said to be a resident of one state and when a person is said to be a resident of both states.
ARTICLE 5: PERMANENT ESTABLISHMENT
Business profits derived by residents of a contracting state are taxable in the state of source, only when such a person has a permanent establishment in the state of source.
ARTICLE 6: INCOME FROM IMMOVABLE PROPERTY
ARTICLE 7: BUSINESS PROFIT
A mechanism to compute the business profit has been prescribed in Article 7.
ARTICLE 9: ASSOCIATED ENTERPRISES
When two enterprises are said to be associated enterprises in which country profits of associated enterprises would be taxable.
ARTICLE 10: DIVIDEND
In which country a dividend paid by one country to another country would be taxable?
ARTICLE 11: INTEREST
In which country and at what rate interest arising in one country and paid to another country would be taxable?
ARTICLE 12: ROYALTIES AND FEES FOR TECHNICAL SERVICES
ARTICLE 13: CAPITAL GAINS
ARTICLE 14: INDEPENDENT PERSONAL SERVICES
ARTICLE 15: DEPENDENT PERSONAL SERVICES
ARTICLE 16: DIRECTORS’ FEES
ARTICLE 17: ARTISTES AND ATHLETES
ARTICLE 18: PENSIONS AND ANNUITIES
ARTICLE 19: GOVERNMENT SERVICE
ARTICLE 20: PROFESSORS, TEACHERS AND RESEARCH SCHOLARS
ARTICLE 21: STUDENTS AND APPRENTICES
ARTICLE 24: NON-DISCRIMINATION
It describes that tax treatment of non-resident persons shall not be less favorable than that of residents of that particular country.
ARTICLE 25: MUTUAL AGREEMENT PROCEDURE
The competent authority of one state shall endeavor to resolve any case arising out of mutual agreement by mutual agreement with another contracting state.
ARTICLE 26: EXCHANGE OF INFORMATION
The competent authority of one state can exchange the information with another state insofar as taxation thereunder is not in contravention of convention.
The above information received by another contracting state shall be treated in the same manner as information obtained under the domestic law of that state only.
ARTICLE 30: TERMINATION
Either of the contracting states can terminate the DTAA by giving the notice as per the prescribed timeline. This article prescribes the procedure for termination of the Agreement.
TRANSFER PRICING
Transfer Pricing was introduced vide Sections 92 to 92F of the Indian Income Tax Act, 1961 (the Act) which covers intragroup cross-border transactions. The sections became applicable from 1st April 2001 for cross-border transactions and from 1st April 2012 for specified domestic transactions. After the introduction of these sections, transfer pricing has become the most significant international tax issue affecting multinational enterprises operating in India. The regulations are broadly based on the Organisation for Economic Co-operation and Development (OECD) Guidelines. It describes the various transfer pricing methods, imposes far-reaching annual transfer pricing documentation requirements, and contains severe penal provisions for non-compliance with the rules and regulations.
Statutory rules and regulations :
Income arising from cross-border transactions or specified domestic transactions between associated enterprises should be computed having regard to the arm’s-length price.
The arm’s-length principle and pricing methodologies
The term ‘arm’s-length price’ is defined by Section 92F of the Act to mean a price that is applied or is proposed to be applied to transactions between persons other than AEs in uncontrolled conditions. The following methods are prescribed by Section 92C of the Act for determination of arm’s-length price:
- Comparable uncontrolled price (CUP) method.
- Resale price method (RPM).
- Cost plus method (CPM).
- Profit split method (PSM).
- Transactional net margin method (TNMM).
- Such other methods as may be prescribed
Conclusion
In conclusion, understanding International Taxation is essential for businesses operating across borders to ensure compliance with complex global tax laws. Key components like foreign tax credit, double taxation avoidance agreements, and transfer pricing play a crucial role in managing international tax liabilities. By implementing best practices, companies can minimize tax risks, optimize their tax strategies, and remain compliant with international tax regulations. Partnering with experienced consultants can further help in navigating these complexities and ensuring long-term financial success in the global market.
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