When dealing with multi-jurisdictional issues, it is very important to understand tax treaties between countries.
What is a tax treaty?
A tax treaty is a bilateral (bipartite) agreement entered into by two countries to solve the problems of double taxation of passive and active income of each of their respective citizens. Tax treaties generally determine the amount of tax a country can impose on a taxpayer’s income, capital, estate, or wealth.
A tax treaty is also called a double taxation agreement (CDI).
Some countries are considered tax shelters. Generally, a tax haven is a country or place where corporate tax is low or zero, allowing foreign investors to set up businesses there.
Tax shelters generally do not participate in tax treaties.
How does a tax treaty work?
When a person moves to a new country and has income or assets in their original place of residence or an individual or business invests in a foreign country, the question of which country should tax the income of the investor will ask. The two countries (the country of origin and the country of residence) can conclude a tax treaty to agree on the country which must tax the investment income to prevent the same income from being taxed twice.
The source country is the country that hosts the investment or asset. The country of residence is the country of residence of the investor. The country of residence is the country that hosts the owner of the asset or investment.
Avoid double taxationtax treaties can follow one of two models:
The Organization for Economic Co-operation and Development (OECD) model or The United Nations (UN) Model Convention.
OECD Model Tax Convention
THE Organization for Economic Cooperation and Development (OECD) is a group of 37 countries that have come together to promote global trade and economic progress.
The OECD tax treaty on income and capital is more favorable to capital-exporting countries than to capital-importing countries. It requires the source country to waive some or all of its tax on certain categories of income earned by residents of the other signatory country.
Both countries involved will benefit from such an agreement if the flow of trade and investment between the two countries is reasonably equal and if the country of residence taxes any income exempted by the country of origin.
United Nations Model Tax Convention
The second Model Tax Convention is officially called the United Nations Model Double Taxation Convention between Developed and Developing Countries.
A treaty that follows the UN model grants favorable taxing rights to foreign investment countries. Generally, this tax system benefits developing countries that receive foreign investment. It gives the source country increased taxing rights over the business income of non-residents compared to the OECD model.
One of the most important aspects of a tax treaty is the treaty’s withholding tax policy, as it determines the amount of tax payable on any income earned (interest and dividends) on securities held by a non-resident.
For example, if a tax treaty between country A and country B determines that their withholding tax on dividends is 10%, then country A will tax dividend payments who go to country B at a rate of 10%, and vice versa.
For example, the United States has more than 200 tax treaties with other tax jurisdictions, which help reduce or eliminate tax paid by residents of foreign countries. These reduced rates and exemptions vary by country and specific income items.
Under these same treaties, residents or citizens of the United States are taxed at a reduced rate, or are exempt from foreign taxes, on certain items of income they receive from sources located in foreign countries. Tax treaties are said to be reciprocal because they apply in both signatory countries.
Tax treaties generally include a clause, called an “escape clause”, which is intended to prevent residents of a jurisdiction from taking advantage of certain parts of the tax treaty to avoid taxation of a domestic source of income.
For individuals who are residents of countries that do not have tax treaties between the source jurisdiction and the resident jurisdiction, any source of income earned within the source. is taxed in the same manner and at regular rates in each jurisdiction.
What is a tax ruling?
However, tax rulings are difficult to obtain. They can take months to complete because tax commissioners try to avoid legal obligations. In some cases, the commissioner may not render a decision at all.
The alternative is a tax opinion
On the other hand, an opinion is not a legally binding statement. An opinion is only a way for your accounting or tax firm to guide you and avoid litigation if you are audited and the auditor does not agree with the opinion.
Unlike decisions, opinions only take a few days or several weeks to be received.
Dan Dobry was the founder and director of GlobalNET Investment House, he was one of the founders of the Union of Financial Planners in Israel (UFPI) and was the first president and president of the UFPI. Dan was the Israel Global Council Representative for the Global Community (FPSB) from 2012 to 2018 and was a member of the European Union Standards and Qualifications Committee (SQC) until December 2021.