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What are Tax Treaties?

tax treaty

Treaty is an international agreement concluded between states in written form and governed by international law whether embodied in a single instrument or two or more related instrument .

Practical Scenario:-

In the corona situation united states of America has asked india for Hydroxychloroquine medicine to fight against the corona. So the agreement which has been entered between india and America for the supply of  Hydroxychloroquine medicine is to be treated as Treaty.

What will you get?

Now we will discuss the above mentioned strategies in detail,

1. Definition of tax treaties: –

It means a treaty between a two countries regarding the prevention of double taxation of passive and active income .

Tax treaties generally determine the amount of tax that a country can apply for tax payers income, their capital estate or wealth.

2. Role of tax treaties: –

The role of tax treaties is to eliminate double taxation and try to achieve balance and equity.  Tax treaties does not always eliminate double taxation but reduces to a tolerable level.

Types of DTAA’s: –

  • Limited DTAA’s.
  • Comprehensive DTAA’s.

                   Now we will see this in detail.

  • Limited DTAA: –

   Limited DTAA are those which are limited to certain types of income only.

eg:- DTAA between India and Pakistan is limited to income from air transport only.

  • Comprehensive DTAA: –

Comprehensive DTAA are those which covers all the incomes covered by any model convention.

3. Application of tax treaties: –

Article -4 of DTAA – gateway to avail tax benefits

A person shall be entitled to tax treaty only if he is a resident of one of the contracting state or resident of both of the contracting state.

Computation of income liable to taxation: –

Generally treaty does not provide rules for taxation of income. it would depend upon the domestic tax law of the contracting state.

Distributive rule: –

Tax treaties only assign or distribute tax jurisdiction. It does not impose tax. Having assigned the jurisdiction of tax between the State of residence and state of source the domestic tax law of the respective state determining tax rules.

According to this principle, to the extent an exemption is agreed to independent of, Whether the contracting state imposing tax in the situation in which exemption applies and irrespective of the state actually levies the tax.

The point is tax leving opportunity is given to another country and it is possible that it may levy tax or it may not. The main solution is that there should not be a double taxation.

  1. Treaties are entered into for mutual benefits: –

Tax treaties also helps to resolve problems And can obtain benefits which can not be achieved unilaterally.

Treaties are negotiated and entered into at political level and have several considerations as basis. Thus treaties could be seen in the context of aiding commercial relations between treaty partners.

  • A tax treaty may have an unequal effect: –

State A may incur an tax where as state B may not incur an tax but in future state B may also incur a tax than the treaty would be deemed as an operative treaty.

4. Interpretation of tax treaty: –

Tax treaties are signed by two soverign nations by competent tax authorities under delegation power of respective goverments. Thus an international law has to be interpreted as per Vienna convention law of treaties (VCLT) .

Therefore any dispute between two nations is to be resolved by Mutual agreement procedure as per Vienna convention of law.

Basic principles of interpretation of tax treaty: –

  • Golden rule objective interpretation: –

Any word is to be interpreted by keeping it’s objective or literally meaning in mind.

However grammatical interpretation would result in an absurdity or is marked inconsistent with other with other portion of the treaty.

  • Subjective interpretation: –

Terms of the treaty are to be interpreted as per the common intention of the parties.

  • Purposive interpretation: –

Treaty is to be interpreted so as to attainment the aims and objective of the treaty. This method is also to be termed as objects and purpose method.

  • The principles of effectiveness: –

The treaty is to be interpreted in a manner to have effect rather than make it void. Treaty should be given an interpretation which on the whole will render the treaty most effective and useful.

  • Principle of contemporanea exposito: –

A term’s treaty are to be interpreted on the basis of their meaning at the time the treaty was concluded. However this is not a universal principle.

  • Liberal construction: –

Treaties are to be literally construed so as they carries out the apparent intention of the parties.

Court further says that we can not expect the same nicety or strict documentation in modern documents such as deeds or act of parliaments.

  • Treaty as a whole integrated approach: –

A treaty should be consider as a whole and effect should be given as to each word which would be construed in a same manner whenever it occurs. Any provision should not be interpreted in isolation rather than the entire treaty should be read as a whole to arrive at its objective and its purpose.

  • Reasonableness inconsistency: –

Treaties should be given an interpretation in which the reasonable meaning of words and phrases is preferred and in which a consistent meaning is given to different portions of the instruments. In accordance with the principle of consistency , treaties should be interpreted in the light of existing international law.

Extrinsic aids to interpretation of tax treaties: –

  • Provision in parallel tax treaties: –

In the language used in two tax treaties (X and Y) are same and one treaty is more elaborative and clear in its meaning can one rely on the interpretation provided in treaty X while applying provisions of treaty Y?

As per the views of the Indian judiciary this is not possible and are contradictory by Indian courts in this regard.

  • International articles Essay’s /Reports: –

International articles Essay’s /Reports means extrinsic aids for interpretation of tax treaties. High court obtains useful interpretation of tax treaties.

  • Protocol: –

It is like supplement to a treaty. There is protocol annexed to the end of the every treaty which clarifies borderline issues.

It is an integral part of a tax treaty .

Protocol of India – France treaty is considered as a Most Favoured Nation Clause.

  • Preamble: –

It could guide in an interpretation of tax treaty.

  • Mutual agreement procedures: –

It helps to interpret any ambiguous term through bilateral negotiations. It is more authentic than other aids as official of both countries are in possession of materials / documents exchanged at the time of exchange of tax treaty which could clearly indicate the object or particular provision of a particular purpose.

  • Ambulatory V/S static approach: –

Whenever a reference is made to a treaty to the provision of domestic tax laws for assigning meaning to a particular term , a question also arise as to what meaning is to be assigned to the said term ,the one which is interpreted as the date of signing a tax treaty or the one prevailing on the date of application of a tax treaty.

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Barcelona has entered into a double taxation avoidance agreement with India. In the agreement it has been specifically mentioned that interest income is taxable in India . so it’s meaning as per the treaty is interest income taxable in india. In this way treaty interpretation takes place. Long agreements of do’s and don’t’s  are specifically entered into an agreement.

Conclusion: –

Treaty interpretation is very crucial for any country because on the basis of this tax will be charged on non–residents. Sometimes different meaning can be understand by different country. Latterly that can create into a chaos in a country.

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FAQ’s: –

Q-1 What is the benefit of a tax treaty?

A-1 treaty benefits can reduces an income of an assesse and have to pay less tax on income.

Q-2 what is the benefit of double tax treaty?

A-2 the benefit of double tax treaty is to reduces the effect of double taxation of an assessee and give some advantage to an assessee.

Q-3 Can I be resident of a two tax countries?

A-3 Yes. In some cases you can also become a resident of two countries.

Q-4 Can I be taxed in 2 countries?

A-4 Yes. It is possible in some cases that you will be taxed in two countries. Fortunately many countries have a double taxation agreement than they will be not taxed twice. But if a coiu ntry does not have a double taxation avoidance agreement with other countries than there may be a possibility of a double taxation.

Q-5 Who pays double taxation ?

A-5 Any person having an income of more than one country and that country does not have a double taxation avoidance agreement with your Home country.



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