Every nation has sovereign right to tax its residents on their worldwide incomes. This may result in double taxation both in country of residence and country of source.
If there is a conflict between domestic law and treaty, treaty prevails as it’s an agreement between two sovereign nations. `Treaty override` is a case where a state takes a decision to reverse and give priority to domestic law; however, this is quite rare.
DTAA can only relieve tax, can never impose tax.
Rules for reliefs from UK tax are found in Taxation (International and Other Provisions) Act 2010 (TIOPA 2010). This Act complements the Income Tax Act 2007 for matters involving international taxation.
Treaty Models
OECD – sample treaty between two developed nations. Emphasis is on right of `state of residence` to tax.
UN Model – sample treaty between developed and developing nations, to encourage flow of investments from developed to developing nations. A compromise between source principle and residence principle. More weight to source principle. India’s most treaties are based on UN model.
US Model – different clauses from both UN and OECD model.
How it works?
In order to make use of the treaty the tax payer should be, usually, resident of one of contracting states.
Resident could be different from tax resident as per domestic law, it is defined as `fiscal residence` in the treaty.
Interpretation of Tax Treaties
We can refer to following sources:
- OECD commentary
- UN Model commentary
- Internal Revenue Service (IRS) United States provides useful treaty and explanations, for example for US and UK treaty [click here]
Comments on some issues we faced:
- “shall be taxable only” or “may be taxed”
“shall be taxable only” means taxable only in one state.
Example: UK India DTAA Article 19.2 states “Any pension paid by the Government of a Contracting State to any individual in respect of services rendered to that Government shall be taxable only in that Contracting State “i.e. Pension payable by Government of India (GOI) to an individual for services rendered to GOI, this pension income will be taxable only in India, even though individual getting the pension is resident in UK.
“may be taxed” means can be taxable in both countries; unless restricted by other Articles of the DTAA.
Example: UK India DTAA Article 6.1 states “Income from immovable property may be taxed in the Contracting State in which such property is situated” i.e. rental income from a property situated in India can be taxable in India and also taxed in UK.2
Methods of Elimination of Double Taxation
This is the main reason for DTAA.
There are two methods of elimination:
- Exemption
- Credit Method
1. Exemption Method
1.1 Full Exemption: Income earned in one state is fully exempt in other.
1.2 Exemption with Progression: foreign income is considered only for the tax rate purpose.
2. Credit Method
2.1 Full credit: Total foreign tax paid is allowed as a credit against tax payable.
2.2 Ordinary Credit: Credit allowed only to that part of income tax which is attributable to the income taxable in the state of residence. Usual method in UK treaties.
2.3 Tax sparing: Credit allowed for foreign tax deemed paid. Read our blog UK India DTAA NRE interest income.
Helpful numerical examples given in Tax and Treaty Guide by NK Bhat, Yogesh Thar and Mayur Nayak of Bombay Chartered Accountants’ Society
Another helpful book with examples – Interpretation and application of Tax treaties by Ned Shelton [Tolley International Series].
Notes
- US UK treaty Article 11 Interest states – Interest arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State. Explanation note states Paragraph 1 generally grants to the State of residence the exclusive right to tax interest beneficially owned by its residents and arising in the other Contracting State.
- See similar provision in US UK treaty Article 6 and explanation notes state – This Article does not grant an exclusive taxing right to the situs State; the situs State is merely given the primary right to tax.
Further sources:
Bonus:
UK India has a separate treaty for IHT ; link here.
Useful Links provided by HMRC
OECD – Model Tax Convention on Income and Capital
Gov.UK Links
Residency, Domicile and Remittance Basis Manual
Details of MAP process and who to contact to request MAP assistance
SA Help-sheet Links
HS304 – Non-Residents – Relief under Double Taxation Agreements
Roy Accountants 