For this blog post, I feel I need to reiterate that anything written on this blog (or the forum) is not tax advice or any other form of advice.
A tax treaty is a treaty between two (or more, but usually two) jurisdictions regarding matters relating to tax.
Historically, there have been two types of tax treaties. TIEAs, whose focus is on EOI (exchange of information), and DTAs, whose focus is on avoidance of double taxation.
Since I have already covered how TIEAs work, today I thought I’d tell you a little bit about DTAs. However, it should be noted that modern DTAs contain an EOI clause making a TIEA unnecessary.
First, let’s get confusing terminology out of the way. I will be using the term DTA here because that’s what I’m used to, but you may also see terminology like DTAA and DTC. They all refer to the same type of agreement, namely Double Taxation Avoidance Agreement.
Not all taxes are equal. There is income tax, corporate tax, capital gains tax, wealth tax, inheritance tax, property tax, sales tax, alcohol tax, environmental tax, import tax, payroll tax, unemployment tax, carbon tax, toll tax, and the list goes on and on.
Alcohol and other vices are often taxed three times: import tax, sales tax, and a specific tax for that vice. While that could be construed as a form of double (triple) taxation, that is not what is in scope for DTAs.
While DTAs can cover other forms of tax, I will focus on income and corporate taxes here. They are a headache enough.
Double taxation occurs when an income is charged the same or very similar type of tax twice. And with a DTA, you can avoid this nasty problem.
The general idea is that the two jurisdictions agree to only tax income up to the maximum of either of the two’s tax rates. If an income is subject to 20% tax on Jurisdiction A and 30% in Jurisdiction B, the income should only be subject to 30% and not 50%.
How does that work? Tax credit.
Continuing on the above example, let’s imagine a company which trades in both Jurisdiction A (20% corporate tax) and Jurisdiction B (30% corporate tax).
Assuming there is a DTA between the two jurisdictions and that the company fulfills the eligibility criteria, by paying 20% corporate tax in Jurisdiction A the company can leverage that 20% as a tax credit and only pay 10% corporate tax in Jurisdiction B.
This process is called tax relief.
If there had been no treaty, the company would have risked paying 50% tax.
No one has ever been that happy about a tax return.
This is the burning question. Tax liability is usually determined by residence, which for natural persons typically means where their primary place of abode (i.e. residence) is, and which for legal or juridical persons (companies) is determined by assessing things like primary place of business, mind and management tests, residency of directors and or shareholders, and jurisdiction of incorporation.
However, for DTAs the scope of tax liability is expanded to cover a wider ground. The purpose is to have greater room of interpretation of tax residency, so that more businesses and persons can use the treaty to avoid double taxation.
DTAs are ultimately good. Jurisdictions realize that lack of DTAs can mean lack of foreign investment and international trade. It is better to only receive a portion of an income’s tax than to miss out on it entirely.
The good news is that if you genuinely engage in business in multiple jurisdictions with DTAs, you can most likely reduce your tax burden by avoiding double taxation.
The bad news is that if you are running a small one-man operation with a taxable company registered abroad, you will often not be able to qualify for a DTA. Some DTAs contain very lenient definitions of tax residence making even just incorporation sufficient to qualify as residence in one and this can be tolerated by the second jurisdiction. Intra-EU DTAs are often favourable in this regard but your mileage may vary.
Before you ask… “Do I qualify?” I don’t know and I can’t know. Tax treaties can be complex and are only made more complex by jurisdictions with complex tax codes. What’s described above is simplified. Speak to a qualified professional.