Withholding Rate Of Tax In DTA Agreement

Usually, taxation of income of an enterprise in any State is on net basis, i.e., after allowing all relatable expenses. However, in case of non-resident recipients, who have no organisation of funds in the country of source, it becomes difficult for the source country to arrive at the taxable income using normal methods. Such income usually relates to dividends, interest, royalties and fees for technical services, shipping profits and aircraft profits. In order to remove uncertainties for both sides, the usual practice now is to specify in domestic laws, the rates of tax on gross basis. This tax is to be charged on dividends, interest and royalties or fees for services, which would be deducted at source from the payments, before they are remitted out of the country. Such retention of tax is termed as 'withholding tax'.

In the present age of economic globalization, both individuals and corporates are ever anxious to find ways and means of minimizing their tax burden. One way to do so is by moving to a tax haven, i.e., a tax jurisdiction, where the tax incidence is very small, sometimes even nil. Another way of doing this is to take the benefit of the double taxation avoidance agreements, entered into by one country with one or more other countries. This amounts to treaty shopping, which is a method of using or misusing the tax treaties by taking advantage by investing in low tax countries. In effect, there may be a situation where a person, resident in a third State, seeks to obtain the benefit of a double tax treaty between two other countries. MNCs shop for DTA Agreements, signed by countries to obtain fiscal advantages. It is used by investors for the following purposes:

1. To reduce the source country taxation.
2. To pay a low or zero effective rate of tax in the payee treaty country.
3. To pay a low or zero tax rate on payments from the payee treaty country to the tax-payer.

The Organization for Economic Co-operation & Development (OECD) has laid down four determinants for a tax haven. These include the following:

1. Lack of effective exchange of information;
2. Lack of transparency;
3. Attracting business with no substantial activities.

1. Imposes a low or zero effective tax rate on the relevant income.
2. The regime is ring-fenced (that is, it does not offer its domestic tax-payers the same incentives for the same activity as are offered to foreigners).
3. Operation of the regime is non-transparent and there is no effective exchange of information with other countries.