Tax treaties and residence
11 July 2012
Posted by: SAIT Technical
By Anna Steward (Moneywebtax)
Why is it so important?
With new statutory residence rules due to come into force in the UK from 6 April 2013, it is increasingly important to understand the impact and application of double taxation treaties and in particular the ‘tie-breaker' clauses for residence.
For individuals moving to the UK with the intention of becoming permanently resident there, or for those who have been resident in the UK for some time and only travel abroad occasionally, local UK residence rules should be the key focus. However, increasingly individuals and families live more fluid lives between different countries and it is essential that they consider, where applicable, the impact a double taxation treaty may have on the manner in which they pay income and capital gains taxes and in which country.
How does the tie-breaker rule work?
Individuals who live between two or more countries may find that, under the domestic laws of those countries, they are resident in both countries. Modern tax treaties contain tie-breaker rules for determining residence in these circumstances. This ‘rule' is effectively a test which will enable the taxpayer to determine which country he or she should consider him or herself resident for the purposes of assessing which country will have premier taxing rights in relation to certain sources of income. The rules vary from treaty to treaty but broadly, these tests are as follows:
1. Where is the individual's permanent home?
Individuals will be resident in the country in which they have a permanent home available to them (this may include a rental property).
2. Centre of vital interests
If it can be determined in which country individuals have closer personal and economic relations then they will be resident in that country. However, this test can be difficult to determine - what if an individual has family in one country but works in another? It is important when trying to answer this question that an individual's social, domestic, financial, political and cultural links are all considered.
3. Habitual abode
Broadly speaking this is the country in which individuals spend most of their time.
If the individual has dual nationalities then a treaty will usually provide a mechanism by which the two countries will negotiate and agree an individual's residence for the purpose of the treaty.
Why is it so important?
Take the following example:
David and his wife Samantha, both resident but not domiciled in the UK, leave the UK for Switzerland with their children where David has a new job.
They let out their house in London and rent a house near Geneva. Their children are enrolled in a local school and they transfer the majority of their funds held by them in the UK to their new Swiss accounts to cover their initial living expenses, leaving a small amount of funds in the UK.
David returns to the UK regularly for meetings with work colleagues and Samantha often joins him to visit her parents who live just outside London.
Under the new statutory residence rules, depending on the number of days David and Samantha spend in the UK, they risk being treated as resident in the UK which would mean that David's employment income could be taxable in the UK under domestic rules as could any other foreign income or gains which they remit to the UK.
By applying the tie-breaker tests in the UK/Swiss double tax treaty, the fact that David and Samantha have a permanent home available to them only in Geneva should result in their being treated as Swiss resident under the treaty. Even if the UK tax authorities try to argue that they have a permanent home available to them with Samantha's parents, it is quite clear that their centre of vital interests has been transferred to Switzerland and that Switzerland is their ‘habitual abode' and that, under the terms of the double tax treaty, they are resident in Switzerland. The result of this is that David's employment income should be taxed only in Switzerland and income from other offshore accounts spent in the UK should not be treated as a taxable remittance.
Practical planning points
Individuals and families with interests in more than one country should not rely on the domestic rules of each of those countries in establishing where and how they will be taxed. They should seek specialist advice in relation to international planning which will cover the application of the relevant tax treaties