Double tax treaties – isn’t it obvious?

Double tax treaties (DTTs) sound like trouble. Double tax? In reality, DTTs are a taxpayer’s friend. Also known as double tax agreements (DTAs), DTTs are designed to prevent double taxation - on rare occasions they can even create a ‘double no tax’ outcome.

DTTs are binding agreements normally adopted into domestic law that determine which country has taxing rights over income, gains, and sometimes other taxes, where the laws of two countries both apply. 

The number of DTTs has proliferated in recent years. Unsurprising, given the world comprises of approximately 200 sovereign states and the explosion in world trade and global mobility over the past few decades.

Thankfully, there are several model conventions, so many bilateral agreements share several similarities. Most DTTs are based on Organisation for Economic Co-operation and Development (OECD), or United Nations principles. A notable exception is the US, which has created its own models for treaties it strikes with other countries.

Location, location, location

Treaties often start with key definitions, and the scope of the agreement identifying exactly who (companies and individuals) and which taxes are covered. Where one lives in another country from one’s income, gains, or wealth, DTTs determine if tax arises where the individual or their income, gains or wealth are situated.

Tie-break anyone?

Because the tax residency rules of two different countries are rarely identical, clauses known as tie-breakers are used to determine where an individual resides for tax purposes in those cases where they are deemed to be tax resident in both countries by the respective domestic laws.

For an example of when a tie-break might be required, take an individual who left the UK and moved to France towards the end of the UK tax year (and where the split year does not apply). The individual may be considered UK tax resident, but because it is their intention to remain in France with a French home, they would also be considered a French tax resident under one of the four tests that apply there. A tie-break may therefore be required.

How do tie-breaker rules work?

Keeping with the UK/France convention of 2009 and broadly in keeping with the OECD model, for individuals, rather than companies, this works as follows as per Article 4.2 and is self-explanatory.

“Where … an individual is a resident of both Contracting States, then his status shall be determined in accordance with the following rules:

1. he shall be deemed to be a resident only of the Contracting State in which he has a permanent home available to him; if he has a permanent home available to him in both States, he shall be deemed to be a resident only of the State with which his personal and economic relations are closer (centre of vital interests);
2. if the Contracting State in which he has his centre of vital interests cannot be determined, or if he does not have a permanent home available to him in either State, he shall be deemed to be a resident only of the State in which he has an habitual abode;
3. if he has an habitual abode in both Contracting States or in neither of them, he shall be deemed to be a resident only of the State of which he is a national;
4. if he is a national of both Contracting States or of neither of them, the competent authorities of the States shall settle the question by mutual agreement.”

The latter, in reality, is very rarely required to come into play, and to avoid doubt, the OECD strictly defines expressions such as permanent home and vital interests.

Special provisions often apply for students, teachers, and those undertaking government service, amongst others, and exchange of information commitments are also normally included to help prevent abuse.

A UK perspective

The UK has a well-developed network of DTTs with over 130 countries. Most are under the OECD model, and a summary can be found here - Digest of Double Taxation Treaties April 2018 (publishing.service.gov.uk).

However, conspicuous by its absence is any reference to inheritance taxes (IHT). This is because IHT and death duties are often covered by entirely separate treaties. The UK has surprisingly few, at just ten. Treaties with France, Italy, India and Pakistan were in place before 1975 during the Estate Duty era and have different rules to eliminate double taxation than those with Ireland, South Africa, the US, the Netherlands, Switzerland and Sweden (who no longer have IHT of their own).

It’s possible that where taxes are broadly similar, in the UK and elsewhere, and both can apply, ‘unilateral relief’ from the UK might be available. Inheritance Tax: Double Taxation Relief - GOV.UK (www.gov.uk)

Practicalities

Form P85 should be used by a UK tax resident in anticipation of moving abroad. It asks questions about income, tax, and residency status so that one’s tax record can be updated. It can be submitted online using the Government Gateway or by post. Form DT-Individual can be used by someone living overseas who has UK income, to apply for the relief at source and claim a repayment of UK Income Tax. Proof of one’s status overseas is required as part of the process.

Paying the right amount of tax isn’t easy, especially where the UK is concerned. But it can be done.

This material is not tax, legal or accounting advice and should not be relied on for tax, legal or accounting purposes. Quilter Cheviot Limited does not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting adviser(s) before engaging in any transaction.