The famous quote by Benjamin Franklin, "In this world nothing can be said to be certain, except death and taxes," still rings true today. Even though taxes are not easily noticeable in the United Arab Emirates (UAE), oil companies and foreign banks are subject to corporate tax as part of the tax regime. With the introduction of value-added tax (VAT), this quote is even more relevant. Despite these taxes, UAE remains an appealing destination for foreign investors.
The DTAA (Double Taxation Avoidance Agreement) between India and UAE (United Arab Emirates) was signed on April 11, 1993, and came into effect on November 22, 1994. The main objective of this agreement is to avoid double taxation of income earned by individuals and companies in both countries.
OVERVIEW
A Double Tax Treaty (DTT) is an agreement between two countries that aims to eliminate double taxation of income earned by a resident of one country in another. The UAE has signed DTAAs with many countries to provide clarity on taxation of various types of income, such as business income, dividends, and royalties. DTTs determine taxation based on each country's tax laws, promoting trade and investment by reducing tax barriers and avoiding disputes between tax authorities. The DTT in the UAE is crucial for avoiding double taxation, promoting cross-border investment and trade.
Article 5 of the India-UAE DTAA defines "Permanent Establishment" (PE): it is a fixed place of business where an enterprise conducts its business, which can be a management place, branch, office, factory, workshop, mine, oil or gas well, or any place for natural resource extraction. The term also includes construction or installation projects lasting over six months. The article provides guidelines for determining a PE in India or the UAE, with exceptions for certain activities such as storage or delivery of goods. Its objective is to avoid double taxation of income from enterprise activities in both countries.
Here are some significant characteristics of the DTAA between India and UAE:
1. Taxation of Business Income: Under the agreement, Article 7 provides about the business income earned by a company in one country is only taxable in that country, unless it has a permanent establishment (PE) in the other country. If it has a PE in the other country, the income earned through that PE is taxable in that country.
An Indian company, ABC Pvt. Ltd., has a branch in UAE and earns AED 500,000 as business income in UAE. Under the DTAA, the business income earned by ABC Pvt. Ltd. in UAE will be taxed in both countries. ABC Pvt. Ltd. will pay 30% tax in UAE (AED 150,000) and can claim this amount as a credit against the tax payable in India. Assuming the tax rate in India is 25%, the final tax payable by ABC Pvt. Ltd. in India will be INR 0, since the tax paid in UAE is higher than the tax payable in India. This allows ABC Pvt. Ltd. to avoid double taxation and ensures that the company only pays tax on its income once.
2. Taxation of Royalties and Fees for Technical Services: Article 12 of DTAA provides Royalties and fees for technical services earned by a resident of one country are taxable only in that country, unless the recipient has a PE in the other country.
Let's say an Indian company, XYZ Pvt. Ltd., provides technical services to a company in UAE and earns royalty income of AED 1,000,000 for the use of its patented technology. Under the DTAA, the royalties earned by XYZ Pvt. Ltd. in UAE will be taxed in both countries. Tax rate in UAE for royalties is taxed at 12.5%. Here, the company can claim the tax paid in UAE as a credit against the tax payable in India (15% for royalties). Hence, the final tax payable by XYZ Pvt. Ltd. in India will be INR 3,75,000.
3. Taxation of Capital Gains: Article 13 of DTAA provides for the taxation of capital gains arising from the sale of shares of a Company. Gains from the sale of shares in a company resident in one country are taxable only in that country, unless the shares derive their value mainly from immovable property located in the other country.
An Indian resident individual, Mr. A, sells shares of a UAE company with a capital gain of AED 1,000,000. Under the DTAA, capital gains arising from the sale of shares in a company resident in one country are taxable only in that country, unless the shares derive their value mainly from immovable property located in the other country.
In this case, since the shares derive their value mainly from immovable property located in UAE, the capital gains will be taxable in both India and UAE. Assuming the tax rate in UAE is 20%, Mr. A will pay AED 200,000 as tax in UAE. In India, assuming Mr. A held the shares for more than 24 months, the tax rate would be 20%. The tax payable in India will be INR 30,00,000.
However, since Mr. A has already paid AED 200,000 (equivalent to INR 30,00,000) as tax in UAE, he can claim this amount as a credit against the tax payable in India. Therefore, the final tax payable by Mr. A in India will be INR 0. The DTAA ensures that Mr. A only pays tax on the capital gains once and avoids double taxation.
4. Taxation of Dividends: Article 10 provides about Dividends that paid by a company resident in one country to a resident of the other country are taxable in the country of residence of the recipient.
A resident individual of UAE, Ms. B, holds shares in an Indian company that pays dividends of INR 1,00,000. Dividends paid by a company resident in one country to a resident of the other country are taxable in the country of residence of the recipient. Assuming the tax rate in UAE for dividends is 5%, Ms. B will pay AED 5,000 (equivalent to INR 1,00,000) as tax in UAE. In India, Ms. B's taxable dividend income will be INR 1,00,000 and she can claim the tax paid in UAE as a credit against the tax payable in India, thereby avoiding double taxation.
5. Taxation of Individuals: The agreement provides for the taxation of income earned by individuals. Income from employment in one country is taxable only in that country, unless the individual is a resident of the other country and performs services in the first country for more than 183 days in a year.
Mr. C, a UAE resident, works 200 days for an Indian company earning INR 10,00,000. DTAA mandates income from employment is taxable only in that country, unless the resident works over 183 days in the other country. Tax rates in India and UAE are 30% and 20%, respectively. After claiming a tax credit, Mr. C owes AED 32,500 in UAE. DTAA prevents double taxation.
6. Elimination of Double Taxation: Article 25 of The agreement provides for the elimination of double taxation by allowing a tax credit for the tax paid in the other country against the tax payable in the country of residence.
Illustration: Let's say a company registered in the UAE has a branch in India that generates a profit of INR 1,00,000. As per the DTAA, the profit of the branch will be taxable in India as well as in the UAE. Resulting in tax the rate of tax in the UAE for corporate profits is 12.5%liabilities of AED 12,500 as per UAE and the tax rate for corporate profits is 30%, resulting in a tax liability of INR 30,000 for the branchin India. However, the DTAA allows the UAE company to claim a tax credit for the tax paid in India, resulting in a final tax liability of AED 12,200 in the UAE.
CASE LAWS
1. In the case law Abu Dhabi Commercial Bank, Mumbai v. Department of Income Tax pertains to the tax treatment of fees earned by a foreign bank in India. The case was heard in the Income Tax Appellate Tribunal (ITAT) and the decision was delivered in 2017.The dispute was regarding whether the fees earned by the Abu Dhabi Commercial Bank (ADCB) from its Indian operations were taxable in India under the DTAA . The Income Tax Department argued that the fees earned by the bank were taxable in India as the bank had a permanent establishment (PE) in India. However, the ITAT ruled in favour of ADCB, stating that the bank did not have a PE in India as per the provisions of the India-UAE DTAA. The ITAT held that the services provided by the bank did not constitute a PE as they were preparatory or auxiliary in nature, and did not contribute to the bank's income. With pertinent to this case, The ITAT also referred to a previous ruling in the case of Morgan Stanley v. DCIT, where it was held that "preparatory or auxiliary" activities could not be considered as constituting a PE under the India-USA DTAA. Hence, the Abu Dhabi Commercial Bank case law provides guidance on the tax treatment of fees earned by foreign banks in India, and emphasizes the importance of analyzing the provisions of the relevant DTAA to determine tax liability.
2. In the case of Dr. Rajinikant Bhatt v. Assessee pertains to the interpretation of Article 12 of the DTAA deals with "Royalties and Fees for Technical Services." According to this article, royalties and fees for technical services that are paid to a resident of one country (in this case, the UAE) by a resident of the other country (India) may be taxed in both countries, subject to certain conditions. The case arose when Dr. Rajinikant Bhatt, a resident of the UAE, provided technical services to an Indian company and received payments for the same. The Indian tax authorities argued that the payments made to Dr. Bhatt were subject to tax in India, as per the provisions of the DTAA. Dr. Bhatt, on the other hand, argued that the payments were not taxable in India, as he did not have a permanent establishment (PE) in India. He further contended that the technical services provided by him did not constitute "royalties" or "fees for technical services" as per the definition of these terms under the DTAA.
The case was heard by the Income Tax Appellate Tribunal (ITAT), which upheld the contentions of Dr. Bhatt. The ITAT held that the services provided by Dr. Bhatt did not fall under the definition of "fees for technical services" as per the DTAA, as they did not involve the use of any specialized knowledge or skill. The ITAT also held that Dr. Bhatt did not have a PE in India, as he did not have any fixed place of business in India, and his services were provided from the UAE. Therefore, the payments made to him were not taxable in India.
The decision of the ITAT in this case is significant as it clarifies the scope of taxation of "fees for technical services" under the India-UAE DTAA. It emphasizes the need for a careful examination of the facts and circumstances of each case to determine the taxability of such payments