Dual Tax Residency not an Answer to Tax Woes
Residency is an important factor in determining taxability of an individual. If an individual qualifies as a tax resident of a particular country, he is generally taxed on his global income in that country. The residency in a particular country is determined by rules that include physical presence, domicile and citizenship as may be prescribed under the domestic tax laws of different countries.
The individual who travels frequently and works in cross-border locations may sometime face a situation of ‘dual tax residency’. Dual tax residency means acquiring tax residency of two countries simultaneously in a particular tax year by satisfying the specified conditions of domestic tax laws of both the countries.
India has entered into a Double Taxation Avoidance Agreements (or treaties) with several countries which provide specific relief to persons subject to taxation in more than one country. The individual who wishes to take relief under the treaties has to qualify as a tax resident of one of the contracting states.
In most of the treaties, an individual is considered as a resident of that country if s/he, under the laws of that country, is liable to pay tax therein by reason of his/her domicile, residence, citizenship etc. It is very important to determine the residency of an individual as per the treaty which helps in determining the scope of application of the treaty and resolving the cases of double taxation. Most of the tax treaties have stipulated ‘tie breaker’ rules for resolving the conflict of dual residency.
These tie-breaker rules provide attachment to one country a preference over the attachment to other country. These rules are applied in the same sequence in which they appear in the treaty for determining residency. According to these tie-breaker rules, the first preference is given to that country where the individual has a permanent home. If an individual owns or possesses a home in one country and retains the same for permanent use then s/he is considered as a resident of that particular country under the treaty.
If the individual has a permanent home in both the contracting states, then he is considered as the resident of a country where he has his centre of vital interests. For this, if an individual has his personal and economic relations closer to one country, then he is considered as resident of that country. His family and social relations, occupations, his political, cultural or other activities, place of business, place of administration of property need to be ascertained while determining the centre of vital interest.
If the individual fails to pass the test of permanent home and centre of vital interests, then he is considered as a resident of the country in which he has habitual abode, and if s/he has habitual abode in both the countries or neither of them, then he is considered as a resident of the state of which he is a national. Even if after applying these rules, tax residency cannot be determined, then the conflict is resolved by invoking the mutual agreement procedure between the competent authorities of both the countries.
Dual tax residency, certainly, is not a boon. The rules prescribed by the treaties for avoiding dual residency are a matter of interpretation and may, therefore, result in protracted litigation. In the light of complicated domestic tax laws in many countries, the occurrence of dual tax residency requires extensive analysis of the respective treaties as well as domestic laws. Therefore, it becomes important for the individual to evaluate the implications of dual residency before deciding on to the overseas assignment to determine the eventual tax cost due to such arrangement.
Govardhan Purohit, ED, Tax & Regulatory Service, PwC