Double tax treaties – isn’t it obvious?

Double tax treaties (DTTs), also known as double tax agreements (DTAs), 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. Although they are designed to prevent double taxation, on rare occasions effects can be surprising, creating a ‘double no tax’ outcome. Treaty shopping is the name given to the situation where a person indirectly accesses the benefits of a tax treaty between two jurisdictions without being a resident of one of those jurisdictions.

Given the world comprises of approximately 200 sovereign states, with the explosion in world trade and global mobility in recent decades, the number of agreements has proliferated. Thankfully, there are several model conventions so that many bilateral agreements carry comforting similarities. In fact, most DTTs are based on Organisation for Economic Co-operation and Development (OECD), or United Nations principles, though the US has created its own models for its own treaties with other countries.

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 is situated.

Also, 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 where they are tax resident in both countries by their domestic laws. For example someone who has left the UK and moved to France towards the end of the UK tax year (and where the split year does not apply) may be considered to be UK tax resident, but because their intention to remain in France with a French home would also be considered to be a French tax resident under one of the four tests that apply there.

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: (a) 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); (b) 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; (c) 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; (d) 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 in to 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. This is because inheritance taxes (IHT) and death duties are often 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, US, the Netherlands, Switzerland and Sweden (who no longer have IHT of their own).

Elsewhere 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.

Conclusion

Paying the right amount of tax isn’t easy, especially where the UK is concerned. Financial advisers have an important part to play in ensuring the optimum products and strategies are employed to legitimately reduce one’s exposure, where the law permits, in cross border situations. International life companies, offering life and redemption bonds from locations such as the Isle of Man and Dublin are often appropriate solutions, particularly for those who may arrive for the first time, or return to the UK. Read this sales aid to understand the six UK tax benefits of offshore bonds. 

The value of investment can fall as well as rise and investors may not get back what they put in. The information provided in this article is not intended to offer advice and is for financial advisers only. It is based on Quilter International's interpretation of the relevant law and is correct at the date this blog was published. While we believe this interpretation to be correct, we cannot guarantee it. We cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this blog.