How can double taxation can be avoided

Broadly the tax treaties are meant to avoid double taxation. Double Taxation is avoided by allocating or apportioning taxing rights of the Contracting States. The methods adopted are: -

1.    Assigning exclusive jurisdiction to one of the States. In such case, the jurisdiction of the other contracting State is avoided. E.g. the article dealing with "shipping and air transport" profit in the model treaty provides that the profit derived by an enterprise of a contracting State shall be taxable only in that State. The source country does not in such cases have taxing jurisdiction. Another example is in respect of income from immovable property which, in a large number of treaties, is made taxable only in the contracting State in which such property is situated. Capital Gain from alienation of shipping or aircraft operated in international traffic is also made taxable only in the contracting State of which the alienator is a resident. This method is known as " Exemption Method" as it exempts the income in the other state and thereby avoid double taxation.

2.    Sometimes whereas the exclusive right is provided to one State the other State, instead of granting total exemption in respect of that income, grants exemption with progression. This means that the income is included in the total income for arriving at the average rate of tax only but no tax is charged thereon. It is only the other income which is subjected to tax at the average rate so worked out. Under this system double taxation is substantially avoided not wholly.

3.    By apportioning the tax liability.  In respect of certain income, the primary jurisdiction is vested in the home country i.e. State of residence. However, the source country is also allowed to levy tax in respect of such income at the rate lower than the normal domestic rate of taxation as may be agreed upon between the contracting States. Examples of such apportionments are taxation of dividend, interests, royalty, fees for technical services which are primarily taxable in the country of residence but the source country has also been given right to tax such income at the rate of tax not exceeding the rate specified in the treaty. Thus, while the country of residence levies tax at the normal domestic rate, the source country can tax it only at the rate not exceeding the rate prescribed in the treaty.

1. The Double Taxation as a result of the source country also levying tax is avoided by providing for credit to be given by the home country in respect of the tax paid in the source country. Thus whatever tax is paid in the State of source is reduced from the tax payable in the State of residence. If, therefore, the rates in two countries are equal, the total of taxes paid in the two countries will be broadly equal to the tax payable in the country of residence.

2. In respect of business income also, the taxing right is primarily with the home country. However, if an establishment is carrying on business activities in the other country through a permanent establishment situated in that country, the income attributable to such activities is subjected to tax in the other country also. Double Taxation so resulting is taken care of by the system of credit to be given by the country of residence.