Countries have their own tax laws and if you are resident in one jurisdiction and have income from another, you may be obliged to pay tax on the same income in both locations.
This is known as ‘double taxation’. In this series of blogs, we will explore the concept of Double Taxation Agreements and how these can be utilised to avoid being taxed twice.
Clients with international lifestyles frequently ask us questions on income tax laws. Examples include:
- If I live in Country A and have income from Country B, am I taxed twice on this income?
- If I live in Country A, but have a holiday home in Country B, a pension from Country C and a Buy to Let in Country D, where on earth am I taxed?
The starting point to answering these and similar questions is to check the DTAs between the country of residence and the country where the asset is situated or where the income arises. So, let’s take a whistle stop tour of DTAs.
A DTA is an agreement between two countries (known in DTA terminology as ‘contracting states’) drawn up in such a way as to avoid the same income, gain or asset being taxed twice. Most states’ DTAs are based on an Organisation for Economic Co-operation and Development (‘OECD’) model treaty. As a result, most DTAs have similar structures and there are generally many similarities between most DTAs.
The structure of a typical DTA includes the following ‘articles’:
- Taxes covered, e.g. income tax, capital gains tax, corporation tax, petroleum tax, etc.
- Residence – how the prime residence is determined when an individual or company appears to be resident in both states.
- Numerous articles dealing with how and where various types of income are taxed, e.g. rent, business profits, dividends, employment income, state and private pension receipts, etc.
- How and where capital gains are taxed.
- Relief from double taxation.
- Exchange of information.
...and many more.
In numerous cases, both states may have taxing rights on certain income (rents are a typical example). Where the DTA permits both states to tax, the DTA will give guidance as to which state gets the first taxing rights. The second state can then tax the same income but must give a credit for the tax suffered in the first state. This credit however is limited to the tax payable in the second state. So, a taxpayer cannot claim a tax refund in either state if the tax in the second state is less than the tax in the first state. If it is more, the taxpayer pays the difference in the second state. Therefore, where both states tax, the total tax suffered will be the higher of the two states’ rates.
It is worth a short consideration of a typical residence article. Taking the UK/USA DTA as an example, the article firstly defines what and who is included as a ‘resident’. Aside from an individual and a company/corporation, a resident includes a pension scheme, employee benefit trust, charity and other less obvious entities and organisations. The DTA then goes on to cover situations where an individual is a resident of both states. This is effectively a tie-breaker clause which determines which state has the first taxing rights, or in which country an individual or company is ‘more resident’. The order of how this is determined is by reference to:
- Where the individual has their permanent home, or if in both states;
- Where his/her centre of vital interests is, this being where his personal or economic relations are closer, or if this is inconclusive;
- Where he/she has a habitual abode, or if this is inconclusive;
- Of which state he/she is a national, or if this is inconclusive;
- Then the ‘competent authorities’ of the two states (in the case of the UK/USA DTA, this would be HMRC and the IRS) “shall endeavour to settle the question by mutual consent”. Heaven help the individual if that arises, which, in reality, it seldom does!
In part two of this blog series, we will look at a few other articles of a typical DTA, particularly the concept and workings of a Permanent Establishment.Back to top