How to avoid double taxation

Two case studies on how one can use the exemption method or the credit route

Imagine this. You are an Indian working for one of the IT majors and have been recently transferred to the UK.

Six months into the job, you are gripped with a niggling doubt: Will my income be taxed in the UK or India, or will I be asked to pay taxes in both the countries?

With the increasing movement of employees across countries in the past few years, it’s a pertinent question. Employees are required to abide by laws of both the countries — their home country being the resident country and source country where the income arises.

This would result in the same income being taxed in two countries. To avoid this double taxation, Double Tax Avoidance Agreements (‘DTAA’) have been entered into by various countries to avoid a person being doubly taxed in the source country and the country of residence.

India, at present, has entered into DTAAs with various countries. Relief of double taxation is generally available under two methods:

A. Exemption method - Under this method, either of the state has an exclusive right to tax the income arising in the source state.

B. Tax credit method - Under this method, foreign tax credit is given in the resident state in respect of tax paid in the source state on the doubly taxed income.

In India, taxability depends on the residential status and the source of income. In India while a Non- Resident (‘NR’)/Not Ordinarily Resident (‘NOR’) is taxed on the Indian sourced income, a Resident and Ordinarily Resident (ROR’) is taxed on worldwide income. In the example given below, we look at two scenarios of double taxation and how the same can be avoided.

A UK employee working in India qualifying to be a ROR during FY 2014-2015 returns to his home country on July 31, 2014.

In the present case, since the employee qualifies to be an ROR in India, his worldwide income would be subject to tax in India. Hence, the salary income earned by him in the UK during the period August 1, 2014 to March 31, 2015 would be subject to tax in India. Further, under the UK laws, assuming he also qualifies to be a resident of the UK from August 1, 2014, UK would also tax his salary income from August 1, 2014.

However, a DTAA exists between India and the UK and the employee can avail of the benefits of the DTAA to the extent it is more beneficial to him. Typically, under the DTAA, where an individual is a resident of both countries, the tie-breaker test would have to be applied to ascertain the country of residence according to DTAA.

Under the tie-breaker clause, conditions such as existence of permanent home, closeness of economic and social ties and the like are factors in determining the residency and the same has to be examined. In the present case, the individual is deputed from the UK. Assuming his residency tie- breaks to the UK, under the India-UK DTAA, he will be exempt from tax in India on salary earned during the period August 1, 2014 to March 31, 2015 under Article 16 of the India UK DTAA.

However,according to the provisions of the India tax law, a Tax Residency Certificate (TRC) would be required to be obtained from the UK authorities to claim the exemption along with Form 10F under the Income-tax Act, 1961 (Act).

In this scenario, double tax is avoided by an exemption method.

An Indian employee deputed outside India and providing services outside India qualifying to be an ROR in India in the year of deputation (assuming he is deputed to the UK with effect from January 1, 2015).

Where an employee is deputed to the UK and qualifies to be an ROR in the year of deputation (i.e. FY2014-2015), he would be taxable on global income in India including salary for the period January 1, 2015 to March 31, 2015. Assuming he qualifies as resident of the UK with effect from January 1, 2015, he would also be taxable in UK on salary income earned in the UK for the period January 1, 2015 to March 31, 2015.

Now assuming his residency tie-breaks to India, then under the India-UK DTAA he would be eligible to claim credit in India of taxes paid in the UK on such doubly taxed income in accordance with the India-UK DTAA.

In this case, double tax is avoided by the credit method.

As it is evident from above, where your income is derived in one state and you are resident of another state, double tax can be avoided by applying the DTAA. However, where double tax is avoided by exemption method, it is relevant to obtain TRC from the resident country. Where double tax is avoided by claiming foreign tax credit, it is imperative that the proof of taxes paid (such as tax return, tax receipts, tax certificates) in the other country is maintained as evidence. Further, one should be mindful to examine each Article of the respective country DTAA to claim an exemption or take credit.

It would be relevant to note that even in the absence of a DTAA entered with that country, a resident of India can claim foreign tax credit under the domestic tax laws in accordance with section 91 of the Act subject to evidence being maintained.

Homi Mistry is partner with Deloitte Haskins & Sells LLP