This article will examine what Double Tax Treaties (DTTs) are and evaluate how they can be of great assistance in reducing or in some cases even eliminating tax. Double Tax Treaties are created to prevent double taxation as the name suggests. Double taxation would be a huge disincentive to business activities in a particular country if that business were to be taxed in both the country of residence and the country of source. However, these treaties open up a vast array of legislation that can be used in tax planning for tax avoidance and are used by the World’s best Tax Experts in devising tax plans.
Most UK DTTs follow the same OECD format but can be quite difficult to follow, however we will now look at some of the elements of UK DTTs and very briefly look at some of their uses.
Article I – Taxes Covered
This determines what actual taxes are covered in the treaty. For example the UK Cyprus treaty covers only income tax and corporation tax in the UK and just income tax in Cyprus. Usually Inheritance tax (IHT) is covered in separate treaties and is known as “Estate and Gift Tax”. These particular treaties determine where IHT will be charged, what exemptions there are and the rules for determining where the IHT will be charged.
Article IV – Residence
Article IV covers where you as an individual will be resident for tax purposes. This is important when you could fall into the residence of two or more countries based on their domestic rules. Article IV determines what are called the “tie breaker rules” to determine where you will be considered tax resident. For a British citizen who lives overseas, these treaties usually make the citizen exempt from UK tax apart from UK sourced tax. UK sourced taxes are often from property portfolios or UK businesses that were left behind after emigration. A UK business will usually incur corporation tax, but dividends will be tax free.
Tie Breaker Rules usually look at where your permanent home is and what determines your permanent home for determining tax residence. Another aspect covered is the “Centre of Vital Interests”, which looks at a person’s personal and economic ties to a particular country to determine tax residence. Habitual Abode is another test that is used when residency cannot be determined through the other 2 criteria already listed. An individual’s Habitual Abode is where that person spends most of his time. If a Habitual Abode exists for both countries, Nationality is then used to assess treaty residence based on the country of citizenship.
Article V – Permanent Establishment
This looks at the definition of a permanent establishment. This is crucial to international traders as it will dictate the extent to which overseas trading activities will be taxed in an overseas jurisdiction. This is a very important aspect for tax planning one’s business affairs and is used to great effect in significantly reducing tax on trading profits.
Article VI – Income from Real Property
Real Property is usually considered to be land and property. As already stated this is quite a common factor for UK citizens who moved abroad leaving a property portfolio behind. Most tax treaties give the right of taxation to the country of source – where the property is located. Tax credits are then issued to ensure that double taxation does not occur. In the UK, withholding tax is required to be taken by the managing agents on rent to ensure that tax is not lost, however an exemption can be gained in certain circumstances.
Article IX – Interest
This determines where tax on interest will be paid on foreign bank deposits. The tax treaties usually aim to reduce withholding tax or exempt tax in the country of source. In recent years this has made headlines with attempts at making tax on interest in Swiss bank accounts sent back to the European countries of the account holder. The manner in which this is now done, in order to still preserve anonymity is to send the withholding tax back, but not to say whom it came from. This would otherwise destroy or seriously impact on Swiss banking. The interest is not the main issue here but more so the origins of the lump sum that has incurred the interest in the first place.
Article XIII – Capital Gains
This article is of great interest to those who have emigrated abroad and then wish to sell property or share portfolios. This article usually has a “catch all” clause where the proceeds of these sales are taxed in the country of residence. This is except for land, which is usually taxed in the country where the land is located. British citizens who move abroad and then sell their portfolios will usually escape UK capital gains tax by being non-resident from the UK for 5 tax years after the sale. However tax treaties need to be examined to see if the person’s gains now fall under the tax regime in their new country of residence.
Article XIV – Independent Personal Services
This article looks at the taxation of income earned by self-employed people. If that person has a fixed base in another country, that country will usually be given the right to tax that income. For a person that has emigrated from the UK but still works in the UK for 90 days or less per year, he or she will be taxed in their country of residence. If the person were to work for more than 90 days a year in the UK, that person would then be considered tax resident in the UK and be liable for UK tax. Where this gets interesting would be if that person was resident in a tax haven like the Isle of Man his tax would be significantly less than if he were resident in the UK. If he were resident in Andorra, his income tax would be zero.
Article XV – Dependent Personal Services
Article XV covers taxation of employed income. This becomes important when someone may be working in the UK but employed by a foreign company or a UK citizen working in a foreign country but employed by a British company. If an employee is not present in the UK for more than 183 days in a given tax year, the income will only be taxable in the employee’s country of residence.
Article XXIV – Elimination of Double Taxation
This allows what is already incorporated into UK tax law: the foreign tax credit. This article is a “catch all” to prevent double taxation with respect to income that is not addressed above.
Article XXVII – Exchange of Information
Exchange of information is an agreement between tax authorities to prevent tax evasion. There has been a lot of discussion about this in recent years as many tax havens are now required to exchange information with the HMRC in the UK. This however is not a catastrophe as it only affects those individuals who have been participating in illegal tax evasion, as opposed to those who have utilised intelligent and legal tax planning.
As can be seen above, DTTs cover a plethora of subjects and their interpretation is best left to professional tax experts. However a good working knowledge of which tax havens can offer what particular tax advantages is useful to you when considering using international tax planning to reduce or eliminate your tax bill. Professional assistance cannot be emphasised more in creating international tax plans as there is no sense in escaping UK tax law, only to fall under the unfavourable tax laws of another country.
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