Tie-breaker rules for situations of dual tax residency
Tie-breaker rules are included in tax-treaties to help determine which country has the right to tax an individual as the country of residence in case the individual qualifies as a resident (for tax purposes) under the domestic laws of both countries.
How can you become a resident in more than one country at the same time?
There are many cases in which an individual can be considered as a resident under the domestic income tax laws of multiple countries, especially in the year of immigration/emigration. This is also a common occurrence for individuals who habitually reside in more than one country and for those who reside in one country and work (just across the border) in another country.
Some exceptional cases of dual-residence occur because the domestic laws of countries define “resident” (for tax purposes) in different ways. For instance, tax residency in the Netherlands depends on the particular facts and circumstances of the individual, such as the availability of a permanent home, where his/her family resides and other such personal and economic connections. On the other hand, many other countries, including India, US, UK and Spain, determine tax residency based on the number of days an individual is physically present there (in the current year and sometimes in the current and previous tax years). It is also not uncommon that countries use more than one concept of tax residency for income tax residence. A good example is the US who continues to tax its nationals even if they have moved abroad and not or hardly are present in the US anymore. Hence, it is easy to see how someone could qualify as a resident (for income tax purposes) in both these countries in the same tax-year because of the use of differences in concepts.
Further, tax years may overlap – since some countries follow the calendar (January to December) and others follow the financial year (April to March) as the tax year – also, leading to situations of dual residency if countries do not apply concepts of split year residency but only tax residency for the whole tax year or not.
What are the consequences of qualifying as a resident of a country (for tax purposes)?
Most countries tax “residents” on their worldwide income (while allowing for exemptions/credits for taxes paid on income sourced in other countries). So, qualifying as a resident in two countries could mean that you are taxable in both countries on your entire income. In such cases, tie-breaker rules (included in tax treaties) may come to your rescue.
How can tie-breaker rules help?
Tie-breaker rules, as the name suggests, serve to determine which of two countries should tax an individual as his/her country of residence, in case there is a “tie” on the matter between two countries. The country of residence (determined according to the tie-breaker rules) taxes the induvial (usually) on worldwide income (while allowing for exemptions of income or credits for taxes paid on income sourced in the other country) and the other country taxes the individual only on income sourced in that country. Hence, double taxation of the same income is avoided.
How do tie-breaker rules work?
Tie-breaker rules (found in tax-treaties) are based on facts and circumstances, rather than number of days. They provide a step-by-step course for analysing an individual’s particular circumstances and thereby determining which of two countries is to be seen as the country of residence for the puroises of applying the tax treaty only.
1. The first criteria is access to a permanent home. If the individual has a permanent home in only of the two countries, that country would be considered as the country of residence.
2. However, if the individual has a permanent home in both countries (for instance, he/she owns an apartment in one of the countries where he/she lives for part of the year and lives with his/her parents in the country for rest of the year), then we have to determine in which of the two countries his/her “center of vital interest” lie by considering factors such work and family. This comes very close to the domestic concept of residence applied by the Netherlands.
3. If the country of residence cannot be determined based on these material factors, the next step is to look at which of the two countries he/she habitually resides in.
4. If the individual can be said to habitually reside in both countries (for instance, he/she rents an apartment in both countries for different parts of the same year works in both countries), the tax residency will be determined according to his/her nationality.
5. However, if he/she is a national of both or neither of the two countries, the dual residency cannot be solved by the tie-breaker rules. In such case, it is left up to the tax authorities of both the countries to mutually decide (by reconsidering the individual’s circumstances) which of the two countries should be allowed to tax the individual as the country of residence.
When do tie-breaker rules apply?
It is important to note that tie-breaker rules do not automatically apply in all situations of dual residence. These rules are found in tax-treaties. Thus, in order to be able to make use of these rules, a tax treaty has to apply to the individual. This means that there should be a tax treaty between the two countries in question and that the individual should qualify as a resident (for tax purposes) under the domestic laws of both countries.
What happens if no tax treaty applies?
In such a case, there is the obvious possibility of the individual being taxable on his/her worldwide income in both countries (while being allowed limited exemptions/credits with respect to taxes paid in the other country).
Though the global network of tax treaties is quite extensive, which is certainly true for the Netherlands, a situation where no treaty exists might be more common and closer to home than one would expect. For instance, there is no tax treaty (on income and capital) between the Netherlands and Cyprus, nor between Denmark and France/Spain.
Sometimes a tax treaty may exist but it is not applicable. That could be because of difference in the tax residency concept. An example is someone emigrating from the Netherlands in August to a country that uses a 183 days test (note: not the 183 days rule for employment income!) for counting days in the calendar year, which will not be surpassed. In the period between August and December 31 there is no tax residency established, such person is for this period then called a “tax nomad”. Double taxation may arise since no tax treaty protection applies. Often people do not realize this.
Another example is the treaty between the Netherlands and United Arab Emirates (UAE). If you ‘live’ for instance in Dubai and considers as resident for UAE law (and thus not considered as tax nomad) but you are no UAE national, you are not considered as tax resident for purposes of the tax treaty because the tax treaty between the Netherlands and UAE has narrowed down the scope of tax residency. Now, if such person works for a Dutch employer and spends a few workdays in the Netherlands, such employee can actually become taxable on his worldwide employment income in the Netherlands, not because he is resident of the Netherlands. No, it is since the Netherlands uses a fiction for non-residents who work in the Netherlands whilst being employed by a Dutch employer; the Netherlands deems that such partially exercised employment in the Netherlands is considered as a 100% exercised employment in the Netherlands. The same applies to directors or supervisory board members of a Dutch company.
Besides, determining tax residency is only the starting point for taxation. There may be more complications based on where the income is sourced; for instance if the income is sourced in a third country (other than the two where the individual can be considered a tax-resident).
So, it is clear that tax residency or non-residency are utmost important for the determination of someones income tax position in the first place. Only after that has been established, the tax position can be further analysed.
The basic questions related to tie-breaker rules in tax treaties have been addressed in this website. However, tax treaties vary greatly and hence, this website cannot be considered exhaustive in this regard. We advise you to contact your TTT-Group advisor in specific cases.