📚 PASS Investment Adviser (Level 2) Difficulty: Intermediate ℹ️ Info   ~5 min read
📌 Chapter 7.15 — Double Tax Avoidance Agreement

Imagine you are building a discounted cash flow (DCF) model for an Indian IT firm that generates significant revenue through subsidiaries in Singapore and the United States. During your analysis of the tax line item, you notice that the effective tax rate is notably lower than India’s corporate tax rate, despite the firm reporting higher nominal tax rates in its foreign filings.

As a research analyst, your ability to reconcile this discrepancy depends on your understanding of how the Double Taxation Avoidance Agreement (DTAA) functions as a mechanism for tax credits rather than mere tax exemptions.

In practical terms, the tax credit mechanism ensures that an Indian entity is not penalized for operating in a global market. When an Indian company pays tax in a foreign jurisdiction on income also taxable in India, the DTAA allows the company to claim a credit for the tax paid abroad, up to the amount of tax payable in India on that same income.

This is essentially a subtractive process: you calculate the total tax liability at the domestic rate and subtract the credit already settled at the source. If the foreign tax rate is lower than the Indian rate, the company merely pays the difference to the Indian exchequer. If the foreign rate is higher, the credit effectively offsets the entire domestic liability on that income, leaving no additional tax to pay in India.

For valuation purposes, this directly impacts your forecast of Free Cash Flow to the Firm (FCFF). If you ignore the DTAA framework, you might overestimate the future tax burden of a multinational firm, leading to an artificially lower valuation. Conversely, failing to account for the limitations of tax credits—such as cases where the foreign tax paid exceeds the Indian tax liability—can lead to underestimating the firm’s cash outflows.

Rigorous analysts must review the notes to the financial statements to identify whether the firm is utilizing ‘Section 90’ credits, which provides clarity on whether the tax savings are structural or transient.

Consider an Indian firm earning a profit of ₹100 Lakhs in a country where the tax rate is 15%. If the firm’s applicable tax rate in India is 25%, it will pay ₹15 Lakhs to the foreign government. Under the DTAA, the firm reports the full ₹100 Lakhs in India, calculates a gross tax liability of ₹25 Lakhs, and applies the ₹15 Lakhs credit to reduce its domestic payment to exactly ₹10 Lakhs.

This harmonization ensures that the firm remains globally competitive while fulfilling its obligations to the Indian tax authorities.1

Nuance

⚠️ Nuance
A common pitfall for candidates is assuming that the DTAA allows for a direct refund if the foreign tax rate is higher than the Indian rate. In reality, the credit is limited to the tax payable on that specific foreign income in India; the Indian government does not issue a ‘refund’ for the excess tax paid to a foreign state. Analysts often mistakenly assume the firm can carry forward or blend these credits to offset tax on unrelated domestic income, which is generally not permissible under standard tax treaty interpretations.

Check Your Understanding

Practice Question 1

An Indian resident taxpayer earns rental income of ₹5,00,000 in a country that imposes a 10% tax. The applicable tax rate in India for the taxpayer is 30%. What is the impact of the DTAA credit mechanism on the total tax liability?

Practice Question 2

If an Indian company’s foreign income is taxed at 25% in the source country and the applicable rate in India is 20%, what is the net tax liability in India for that specific income?

This is a companion read for Section 7.15 — Double Tax Avoidance Agreement from PASS Investment Adviser (Level 2) by Akhilesh Gururani, available on Amazon Kindle.

Copyright © 2026 Akhilesh Gururani. All rights reserved.

  1. Under Indian income tax law, these mechanisms are typically governed by Section 90 of the Income Tax Act, which provides the legal basis for relief from double taxation through tax treaties. ↩︎