Associated Enterprises Taxed Under DTA Agreements

In order to plug loop holes for tax evasion, there is generally a separate article in DTA agreement, which provides for taxing the notional income, deemed to arise on account of an enterprise of one contracting state, participating directly/indirectly in the management of another enterprise in the other contracting state or, where some persons participate directly or indirectly in both the enterprises, under conditions different from those existing between the independent enterprises.

Dividend paid out by a company in country A to a resident of country B could e taxed in both countries. Prior to 1st June 1997, a dividend, received by a shareholder from an Indian company was taxable in India. However, the DTAAs provide for a concessional rate of tax, e.g. 5% or 10%, as against the normal rate of tax of 25% under section 115A of the Income-tax Act. A resident of another contracting State, entitled to the receipts of a DTAA, was therefore entitled to opt for the lower rate of tax to be applied to him in the paying country. In India, with effect from 1st June 1997 to 31st March 2002 a tax on distribution of dividends is to be paid by the Company on distributing the dividends. No tax is levied by India on the recipient of the dividend. However, by virtue of the Finance Act 2002, dividend is again taxable in the hands of the recipient with effect from AY: 2003-2004 and therefore the taxability of dividend under the DTAA assumes significance.

• If the payee is the Government or the Central Bank of the Government or a Government agency, the interest would usually be exempt from tax in the country in which the payment is made.
• Penalty charges for late payment e.g. for defaults in clearance of dues for purchases will not constitute interest nor will any item be treated as dividend, though styled as dividend by the taxpayer or the person with whom he has the relevant transaction.
• There will be no deduction of tax at source if the payee has a permanent establishment in the country from which the payment is made, or if he is engaged in professional services there. In this case, the income will be covered by his assessment to tax in that country in the ordinary course.
• Interest will be deemed to arise in that State in which the payer resides.

Royalties are defined as a share of the proceeds from a patent, book, song, etc. paid to the owner, author, composer, etc. Royalty is defined in the majority of the agreements to cover payments of any kind, received as consideration for the use of or the right to use any copyright of literary, artistic or scientific work, including motion pictures, films, tele-video tapes for use in connection with radio or television, any patent, trademark, design or model plan or secret formula or process for the use of or, the right to use industrial, commercial or scientific experience.