DOUBLE TAXATION AVOIDANCE AGREEMENT (DTAA),TREATY SHOPPING,HYBRID MISMATCH

There are number of tools used by MNC's to evade taxes. Few of them are discussed as below :

DOUBLE TAXATION AVOIDANCE AGREEMENT (DTAA):

• Double Taxation Avoidance Agreements (DTAA) is a treaty signed between two countries, which ensure that the taxpayer is not being taxed twice (in country of job and of residence) for the same income (earned in country of job).
• Double Taxation Avoidance Agreements (DTAA) applies in cases where a tax-payer resides in one country and earns income in another.
• Double Taxation Avoidance Agreements (DTAA) is intended to make a country an attractive investment destination by providing relief on dual taxation.
• Double Taxation Avoidance Agreements (DTAA) can provide reliefs in various arrangements like:

1. Exemption of income earned abroad from tax in the resident country
2. Provisioning of amount to the extent of taxes that have already been paid abroad.

TREATY SHOPPING:

“Treaty shopping” generally refers to a situation where resident of source country (A), earning  income from another country (B), is able to benefit from a tax treaty ie DTAA between the source country (A) and yet another country (C).  

Jurisdiction A --imposes a 25% withholding tax, 

Jurisdiction C --imposes a 5% withholding tax .

Jurisdiction A    0% treaty with Jurisdiction C.

Impact of Tax deduction on any company X belonging to country A :

01.Company X located in jurisdiction A ---Direct Investments in Jurisdiction B

Tax implications on Company X:25% withholding tax is imposed on incomes earned from Jurisdiction B.

02.If company X located in jurisdiction A ---Indirect Investments in Jurisdiction B via Jurisdiction CTax implications on Company X :

Effectively ,5 % withholding tax is imposed on incomes earned from Jurisdiction B. 

So, withholding tax payment is reduced by 20% , compared to paying them directly. 

In the above example, it is clear that Tax Treaty reduces the tax implication.

HYBRID MISMATCH :

• Hybrids mismatch arrangements (HMA) are arrangements which exploit differences in the tax treatment of various financial instruments
• Hybrids mismatch arrangements (HMA) may significantly reduce overall tax for taxpayers and therefore decrease tax revenues of countries.

Example :

• An Indian Company is having its subsidiary in US. Indian company gives a loan to its US subsidiary.  
• Interest taxed @ 15% in USA; and 30% in India. 
• Net tax cost will be 30%.

but Instead of loan,

• Indian company invests in Preference shares in its US subsidiary, redeemable at premium. 
• In USA, premium on redeemable preference shares is treated as interest and US will levy tax @ 15% on interest.
• In India, inflation adjusted capital gain on redemption of preference shares may be almost 0.
• So effective Tax  implication will be 15%.

So Tax implication is reduced from 30 % to 15 % by merely change in the nature of instrument.