Agreements for avoidance of double taxation (hereafter referred as tax treaty) play a very important role in attracting foreign capital and technology. To promote inflow of foreign investment from developed countries to developing countries, the prevention or elimination of double taxation is an internationally recognised phenomenon.
Imposition of similar taxes in two or more countries on the same taxpayer in respect of the same income is considered harmful for development of economic relations between two countries and acts as a discouragement for the free flow of international trade, investment and the transfer of technology. Tax treaties are therefore made between developed and developing countries so as to avoid imposition of double taxation.
India has entered into tax treaties with almost all the important countries in the world. The tax treaties invariably provide for elimination of double taxation. For this purpose, the tax treaties contain a specific clause that if the tax is paid on the same income in India as well as the other country, a credit of the tax paid in India will be allowed to the foreign entrepreneur in the country of its residence.
However, in certain specified circumstances, the benefit of tax credit is available in the other country even though no tax is paid in India. This principle is followed in respect of tax incentives granted for developmental activities. For example, setting up a new industrial undertaking in India attracts a tax holiday for the initial period of five to ten years.
There will be no tax in India on the profits made by the new industrial undertaking during the period of tax holiday. But the said profits could be liable to tax in the country of foreign entrepreneurs residence. As such, there will be no incentive to the foreign entrepreneur to engage itself in such activities in India.
Therefore, most of the tax treaties contain a provision that the term tax payable in India shall be deemed to include any amount which would have been payable as Indian tax but because of the tax concessions available in respect of such profits, no tax was actually paid.
The aforesaid principle is duly recognised both by the Organisation for Economic Co-operation and Development (OECD) Model Convention and the United Nations Model Convention for tax treaties between developing countries and developed countries.
The above benefit is passed on by making specific reference to incentive provisions in the tax treaties. It is unfortunate that a large number of tax treaties which India has made still contain references to those provisions of the Income-Tax Act which have become redundant or which have been amended and/or substituted by other provisions.
Unless the tax treaties are updated so as to contain reference to the latest provisions of the Income-Tax Act, the purpose of tax incentive will be defeated because the foreign enterprises will be liable to pay tax on the profits from such activities in their home-country.
In the above context, special attention is invited to the tax treaties with Japan, France, South Korea, Great Britain, Mauritius, Denmark, Finland, Italy, Malaysia, New Zealand, Norway, Singapore and Spain where references to the outdated sections of the Indian Income Tax Act still exist.
On the other hand, there are certain tax treaties which do not contain any provision relating to passing on the benefit of tax-incentive provisions to foreign entrepreneurs. Such tax treaties include those with Australia, Brazil, Hungary, South Africa, Turkey, and the US.
It is suggested that the tax treaties should be reviewed on the lines as suggested above by the government. It may also be mentioned that the modification of tax treaties will have no adverse financial impact on the Indian exchequer; all that will happen is that the benefit of incentive legislation will be passed on to the foreign investors for whom the benefits are designed.