Overview – What Is a Tax Treaty?
A tax treaty is an agreement between two or more countries that modifies the tax burden on individuals and/or businesses. The Internal Revenue Service has stated three main functions of U.S. tax treaties. They are as follows:
1) Preventing the double taxation of income
2) Preventing discriminatory tax treatment of a resident of a treaty country
3) Permitting reciprocal administration to prevent tax avoidance and evasion
Prior to coming to America and conducting personal or business transactions, it may be helpful to familiarize yourself with some of the features of the tax treaty between the United States and your country of residency. The information below is intended to help give a broad overview of some of the topics included in many tax treaties so that you will have a better idea of information you might need to thoroughly research and/or discuss with a professional advisor.
US Income Tax Treaties:
As noted in “Coming to the USA – Tax Stuff,” the United States casts a wide net when determining what income the US is entitled to tax. While the width of the net varies from country to country, many other countries cast a wide net too. At times, this can result in multiple countries claiming to have the ability to tax the same gross income. Because of this, the United States has entered into tax treaties with approximately 70 countries in an attempt to prevent each respective country from double taxing the same income. Within the treaty, both countries generally agree to limit the extent to which they tax income that otherwise, they might have deemed taxable. Treaties normally include provisions for individuals and businesses.
Key Income Tax Treaty Features:
Establishing the source of income:
Generally speaking, certain types of income are predominately taxed by the country in which the taxed person or entity resides. These types of income often include, but are not limited to, certain dividends, interest, and royalties. Countries trying to tax non-residents on these types of income are generally constrained by a low tax rate ceiling in order to provide some double taxation relief. A number of tests may be needed in order to determine residency. These tests can be found within the tax treaty. However, there are some general rules that can help guide you when making this determination. Typically, when dealing with a business, residency can be established by determining where the business is organized and operated. When dealing with a person, residency can typically be established by identifying where their permanent dwelling is.
Generally, a permanent establishment is a fixed place of business through which the business of an enterprise is wholly or partly carried on. It should be noted that there are generally certain limitations and additions to this rule. A full list of defined limitations and exceptions can be found within the treaty. Individuals and entities receiving income from a permanent establishment will generally be subject to income tax where the permanent establishment exists.
Establishing the appropriate taxing authority for various types of income:
Business profits derived from a “permanent establishment” are taxable in the country where that permanent establishment is located. This would include, but is not limited to, income derived from business conducted in an office, factory, or local branch. This would also include work performed at an oil/gas lease site so long as production extends over a specified number of months. However, at times, there are some nuances within this section of the tax treaty. As such and as is often the case, it is advisable to consult a professional to assist with interpreting these provisions.
Salaries, wages, and other similar remuneration derived from personal service are addressed within each tax treaty. The taxation of personal services is generally addressed under two categories: (1) independent personal services; and (2) dependent personal services. Independent personal services are normally classified as services you provide as an independent contractor or services you provide while acting as a is self-employed individual. Dependent services are normally classified as services that are provided while being employed by someone else. Separate tax distinctions are often made between these two categories. For more information on this topic, see the tax treaty discussion under each specific country in the section entitled “If You Are Coming From???.”
Income received in conjunction with pensions, annuities, social security payments, etc. will generally be subject to tax in the country of residence. The country where the payment was derived can often tax these payments too, though the applicable tax rate is typically limited by each respective tax treaty.
If personal income (salaries, pensions, etc.) is received from the federal government of either country, that income is often exempt from taxation by the other respective government.
From time to time, other profits may be received by individuals or business entities. These profits may include royalties, dividends, interest, gains from the disposal of real estate, etc. Typically, these profits have been included within the provisions of the tax treaty. For very general rules, note that if income is received for services performed or goods sold at a specific location, taxes are due in the country of that location. If income received is related to non-controlled investments, then that income is generally taxable in the country where the individual or entity receiving the income resides, though at times, this can be taxable in both countries.
For more information on these topics, see the tax treaty discussion under each specific country in the section entitled “If You Are Coming From???”
US Estate and Gift Tax Treaties:
Finding issues similar to those found in the income tax section above, the United States has also entered into a number of treaties regarding gift tax and estate tax. Again, the goal of these treaties is to prevent double taxation on gifts or inheritance passing to individuals/entities that otherwise, could be taxed by multiple countries.
Key Estate and Gift Tax Treaty Features:
There are two common approaches to estate tax treaties and gift tax treaties. One approach allows taxation by the country where the assets are situated. The second approach allows for taxation to be based on the domicile of the individual transferring the assets (as a gift or as part of their estate). Both of these types of treaties normally also include various exceptions. For treaties that tax based on where the assets are situated, below is a listing of assets that are often transferred along with the location where they are often deemed ‘situated’ for taxing purposes.
Bank accounts – situated at the place where the account was kept
Bonds, stocks, debentures, other debt securities – situated in the place where the issuing authority is located
Annuities – situated in the place where the annuity will be received
Receivables from a debtor – situated in the place where the debtor is situated, unless at the time of the transfer, the debtor has an established place of business in the country where the transfer originated. At that point, the receivable would be situated in the country where the transfer originated
Airplanes and ships – situated at the place of registration
Other Tangible movable property – situated at the place of location, or if currently in transit, at the place of destination
Immovable property – situated where the property is located
Partnership Interest – situated at the place where the business of the partnership is carried on
Goodwill – situated where the trade, business or professions was carried on
Other intangibles (including patents, trademarks, copyrights, etc.) – situated in the location where they are registered or where their rights are derived
The United States tries to avoid scenarios where certain taxes overlap on the same transactions. However, it is up to the tax remitter to understand the tax treaties between the United States and other countries and file the appropriate paperwork. While these tax treaties can be very helpful in avoiding taxes due, they are only helpful to the extent they are utilized. As such, in order to benefit from these treaties, it will often make sense to use a professional familiar with tax treaties and their effect on taxable transactions.