Double Tax Treaties: Because paying tax once is more than enough!

Living, working or investing internationally can be exciting. Finding out that two countries both want a slice of the same income? Rather less so. It can happen more easily than you might think. One country may tax you because you live there, while another taxes the income because it arises there. Frustratingly, both may be entirely right under their own rules. The result is that it can feel as though you are paying tax twice on the same thing.

That is where Double Tax Treaties come in to stop things getting messy.

What is a Double Tax Treaty?

A Double Tax Treaty, sometimes called a Double Taxation Agreement, is essentially a rulebook agreed between two countries, setting out how their taxing rights interact.

The UK has treaties with many countries, but there is no one size that fits all versions. Nor are they magic wands: a treaty does not replace domestic law, automatically remove tax or let you pick the country that has the lower rate.

First, you work out the domestic position in each country. Only then does the treaty tell you whether one country must step back or give relief.

Why might two countries want to tax you?

Countries generally tax based on residence, source, or a mixture of both. Put simply, one may tax you because you live there, whilst another taxes rental income because the property is there or employment income because you worked there.

That is why tries have separate rules for property, employment, pensions dividends, interest and capital gains. It would be nice if one rule covered everything, but tax is rarely that generous.

What if you are resident in both countries?

Yes, it is perfectly possible to be tax resident in two countries at the same time. Most treaties then reach for a series of tie-breaker tests.

These usually look at where you have a permanent home, where your personal and economic connections are closest, where you habitually live and, if needed, your nationality.

They work down the list until one produces an answer. If all else fails, the two tax authorities have to fight it out between themselves and reach an agreement.

This gives you one country of residence for treaty purposes, although it does not necessarily make your domestic residence status in the other country disappear.

What if you are resident in no country?

It is also possible to be tax resident nowhere, particularly if you move frequently or live as a digital nomad. That might sound like the ideal result, but it can create the opposite problem. You may not qualify for treaty protection, while individual countries can still tax income arising there. This can leave you facing multiple filing obligations, withholding taxes and even double taxation, without an obvious country required to give relief.

How is double taxation relieved?

Now for the good news. Relief will usually be given in one of three ways:

1. Income may be exempt from tax in one country
2. Tax charged in the source-country may be restricted
3. The country of residence may give credit for tax paid overseas

Credit relief is not a blank cheque. It is normally limited to the lower of the overseas tax and domestic tax on the same income. Differences in tax rates, deductions and tax years can also affect the calculation.

For example, one country may calculate rental profit using deductions the other does not allow or assess income by calendar year rather than by the UK tax year. The numbers may therefore refuse to line up neatly even though both charges relate to the same income.

Sometimes the correct treaty rate can be applied before payment. Other times tax is withheld first, and you have to claim it back. Either way, you should keep evidence of the foreign income and tax paid.

Beware of the 183-day rule

The famous 183-day rule. It is one of those tax rules almost everyone has heard of, and one of the most commonly oversimplified.

Spending fewer than 183 days in a country can mean your employment income is not taxed there, but it is not the whole test. The treaty may also consider who your employer is, which business bears the employment cost and the relevant day-counting period.

As with so much in tax, the honest answer is often: it depends.

Obtaining the relief

Even where the treaty provides relief, it does not always arrive automatically. You may need to claim through a tax return, apply for a repayment or obtain a certificate of residence so that the correct treaty rate can be applied.

You must also check the treaty actually in force at the relevant time. Treaties change, and an answer under one UK treaty should never be assumed to apply under another.

One final thought: Do not let the tax wail wag the dog

It is one of my favourite sayings for a reason.

A decision to move abroad, take an overseas role or make an investment should make sense for you personally or commercially first. Tax should inform the decision, not make it for you.

That said, taking advice early can prevent unexpected liabilities, cash-flow problems and the pain of trying to unpick it all later. If you would like to understand how a Double Tax Treaty applies to you, please contact the Gravita Tax Consultancy team.