This blog is written by Mr. Abdul Hafeez, Senior Manager Taxation and Corporate Services. Please read this blog and provide your valued comments.
Double taxation and Tax treaties
Double taxation occurs where residence country and source country impose tax on the same source. Thus double taxation is described as the imposition of income tax by two (or more) tax jurisdictions on the same taxpayer in respect of same taxable income. To curb this problem a tax treaty is signed which is a formally concluded and approved agreement between two independent nations (bilateral treaty) or more than two nations (multilateral treaty) on matters concerning taxation, normally in written form.
Purpose of tax treaty
The states goal for entering into a tax treaty often include reduction of double taxation, eliminating tax evasion, and encouraging cross-border trade efficiency. It is generally accepted that tax treaties improve certainty for tax payers and tax authorities in their International dealings. Thus the basic idea behind tax treaties is to achieve relief from double taxation, setting out taxing rights of countries and prevent tax evasion and avoidance.
Standard Clauses of Double Taxation Treaties
Double taxation treaties contain ‘articles’ divided into chapters and parts covering various areas. Residence article is the most important provision in the double taxation treaty. It determines the person who can claim the benefit of the treaty. Residence status is determined by the domestic law of the county. It is possible that a person may be resident of more than one state. Companies that have dual residence will be resident in one of them based on the effective management. Tax authorities may regard the place of effective management as being the place where day to day management of company is carried on.
Other important articles of Double taxation treaties include taxes covered, permanent establishment, business profits, associated enterprises and articles covering various heads of income covered under treaty.
Treaty Evolution procedure
When a DTA is proposed, the two countries will start off with a model convention, which is an outline containing the standard articles and clauses of a double taxation agreement. The countries start negotiations according to their list of conditions and preferences. Thus the treaty is signed after concluding rounds of negotiations, compromises and trade-offs. This is the reason why every treaty is unique and the particular treaty must be referred to whenever an issue arises pertaining to the two countries.
There are three model conventions for double taxation treaties namely the OECD (Organization for Economic Co-operation and Development) model convention; the UN (United Nations) and the US model conventions.
Application of treaty
Whenever cross-border transactions are required to be evaluated in the light of DTA, working knowledge of double taxation agreement is vital. First of all the applicable double tax treaty is determined and then relevant provisions and clauses are examined of that particular treaty.