Double Taxation – Effectively Identifying Tax Residency of an Individual

International tax law refers to the rules for tax conflicts involving cross-border transactions.

Double taxation must be eliminated. It distorts the flow of capital and causes a compliance burden. It represents an obstacle to cross-border transactions and discourages international investments. It lowers the competitiveness of companies.

Perhaps the most obvious “international” aspect of a country’s tax system is its tax treaties and other mechanisms for resolving international double taxation.

The OECD Model Tax Convention

International juridical double taxation harms the international exchange of goods and services and cross-border movements of capital, technology and persons. In recognition of the need to remove this obstacle to the development of economic relations between countries, as well as of the importance of clarifying and standardising the fiscal situation of taxpayers who are engaged in activities in other countries, the OECD Model Tax Convention on Income and on Capital provides a means to settle on a uniform basis the most common problems that arise in the field of international juridical double taxation.

The Model Tax Convention restricts the taxing rights of a Contracting State according to whether it is the State of Residence or the State of Source, and depending on the nature of the income, capital, or capital gains. The Model Tax Convention is not an actual tax treaty, but as the name implies, a model base which is used by Contracting States to negotiate an actual Treaty. The Model Tax Convention per se has very limited legal status.

Apart from the OECD Model Tax Convention, there are also detailed Commentaries on each of the Articles found in the OECD Model Tax Convention as prepared and discussed by the OECD and its Member and non-member States. These Commentaries are used as supplementary tools to aid the interpretation of the actual in-force Treaties. The binding nature or otherwise of the Commentaries on Contracting States are the subject of many academic debates and Court cases.

The Organisation for Economic Co-operation and Development (OECD) is an intergovernmental economic organisation. The OECD currently has 38 members. Although Malta is not currently a member of the OECD Model, it still applies the OECD Model and Commentaries.

Malta has also become a BEPS associate and is a signatory to the Multilectal Instrument. This means that Malta is fully committed to the efforts being undertaken by the OECD in combatting the Base Erosion and Profit Shifting in international tax structures.

Source-Residence Conflicts

A key question that often leads to disputes is: “In which country am I required to pay taxes?

Most countries tax on the basis of an established nexus (connecting factors) with that country whether due to source or residence, which may give rise to a situation where more than one country claims jurisdiction to tax, resulting in double taxation conflicts.

Income may be taxed in more than one country based on:

Source principle – the income is taxed in the country where the source of such income arises. For instance, where the company is trading or where the asset is situated, irrespective of whether the person receiving the income is resident in that country or not; and

Residence principle – the income is taxed in the country where the income earner is resident. The Residence State has the right to tax its resident individuals or companies on their worldwide income (local and foreign income).

Therefore, double taxation arises as a result of conflicting connecting factors. A company or person may be resident in one country but derives income from another country. Suppose a person resident of Malta has a business or investment activity in Italy. The person will be liable to tax on the income arising from the activity in Italy under the source principle and in Malta under the residence principle.

Residence-Residence Conflicts

 The same concept is applied where two or more countries claim that a taxpayer is a resident of their tax jurisdiction.

For example, it is possible that a company is incorporated in one country but has its central management and control in another country. Similarly, a person may be domiciled in one country and residing in another (born in Malta and residing in England). In both situations, a company/person may be liable to tax in both countries.

Article 4: Resident

Art4(1)

“Resident of a contracting state means any person, who, under the laws of that state, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature and also includes that State and any political subdivision or local authority thereof as well as a recognised pension fund of that State. This term, however, does not include a person who is liable to tax in that State in respect only from sources in that State or capital situated therein.”

• It is the residence of a person, natural or legal, that will determine the tax treatment to be granted to a person.
• A treaty applies only to residents of one or both of the contracting states and most substantive provisions require the recipient of income (and sometimes even the payer) to be resident in a contracting state.
• A taxpayer’s residence is determined by reference to the domestic law of the Contracting
• Persons who are liable to tax only on a source basis are excluded from the purpose of the treaty.

A taxpayer can be simultaneously resident for tax purposes in both of the Contracting States under their domestic laws.

Where this is the case, Article 4 provides a set of rules for deciding in which one of the two States, for treaty purposes only, the taxpayer is to be considered exclusively resident. This is normally referred to as the tie-breaker clause (Art4(2))

Art4(2)

The usefulness of Article 4 (2) lies in the tie-breaker clause which aims to prevent a taxpayer from being considered a resident in both of the Contracting States (an event which would not otherwise solve the conflict of taxing rights). It lists the tests that must be taken in the order listed below to establish exclusive residence:

1. An individual shall be deemed resident only of the state in which he has a permanent home available for him:
2. If the permanent home is available to him in both States, the individual shall be deemed to be resident only in the place where he has the centre of vital interests e. in the State with which his/her personal and economic relations are closer (e.g. family and social relationships, occupation, political activities, cultural activities, place of business etc.);
3. If the State in which he has his centre of vital interests cannot be determined or if he has no permanent home available to him in either State, the individual shall be deemed to be resident only of the State in which he has a habitual abode (considering the days of physical presence in a State);
4. If the habitual abode is in both or none of the States, reference is made to the nationality of the individual;
5. If the individual is a national of both or none of the States, the competent authorities of both states shall settle the issue by mutual agreement.

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