Double Tax Treaty Definition

Double Tax Treaty Definition (DTT) is a bilateral agreement between two countries with two primary objectives:

1) to eliminate the double taxation of the same income for the same taxpayer, and

2) to prevent tax evasion and avoidance through cooperation.

It allocates taxing rights between the Source State (where income arises) and the Residence State (where the taxpayer is resident), while reducing withholding taxes on cross-border flows like dividends, interest, and royalties. DTTs are largely based on model conventions (OECD, UN).

Key Mechanisms to Eliminate Double Taxation
The Residence State typically applies one of two main methods:

• Exemption Method : The foreign income is excluded from the tax base in the Residence State (often with progression for rate purposes).
• Tax Credit Method : The foreign income is taxed, but a credit is granted for taxes paid in the Source State (ordinary credit is limited to the domestic tax due on that income).

Practical Application: Dividends
A common DTT provision caps the Source State’s withholding tax on dividends at 5% for substantial shareholdings (e.g., ≥10-25%) and at 15% for portfolio dividends, down from higher domestic rates (often 20-30%). The Residence State then applies its relief method (e.g., Tax Credit), ensuring the income is taxed only once overall.

This framework promotes cross-border investment and economic cooperation while providing legal certainty to taxpayers.

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