Definition of a DTA
A double taxation agreement (DTA) is an agreement between two countries which is primarily intended to prevent the double taxation of any taxpayer’s income if such income is relevant to the tax laws of both countries.
Before the exact details of any DTA may be discussed, the causes behind the imposing of double taxation must first be discussed. The chief reason which is the cause of double taxation is that of a difference in the tax laws of the countries involved. One area in which tax laws may differ is related to each country’s system of taxation. Certain countries use a territorial taxation system for taxation while others use a worldwide taxation system. Due to such differences, income involving one country which uses a territorial system and a second country which uses a worldwide system would be taxed twice if no DTA between the two countries involved were to exist.
Different countries’ tax laws also specify different definitions of the source of income. In certain countries, the source of income is defined as the country in which income arises. In others, the source of income is defined as the country in which income is received. Should two countries which have differing tax laws on this matter be involved in taxation of a certain amount of income and no relevant DTA exists, the income would be taxed twice.
Each country’s tax laws also specify the tax residency criteria of the country. For this reason, in certain situations, a taxpayer or company may end up being in a position which causes the taxpayer or company in question to be a tax resident of more than
one country at the same time. If the two countries which are involved in the taxation of this taxpayer’s or company’s income are not part of a DTA, the income will be subject to taxation by the tax authorities of both countries involved.
How DTAs Work
A DTA works by clarifying the rules involved in all situations in which double taxation might result due to contradictory or ambiguous tax laws of the two countries which are part of the DTA. The DTA defines the taxing rights of each country while also providing specific details related to tax exemptions, tax relief, and tax credit. In this way, double taxation will not be imposed on income arising from any economic activities conducted between any entities of the two countries. It is also possible for the mechanisms of a DTA to extend beyond its basic provisions. There are certain situations in which the application of a DTA’s provisions may cause the amount of tax which is imposed to become lower than the standard tax rate of either country involved in the DTA. Such may be the case when both countries involved are interested in promoting trade or improving the diplomatic relationship between the two countries in question. Thus, DTAs might not only be an economic tool, but a political one as well.