Double Tax Treaties are relevant for individuals that are tax resident in the UK under the Statutory Residence Test (‘SRT’), and also tax resident in another country, under that country’s tax residence rules. In other words, individuals who find themselves being ‘dual resident’.
Without Double Tax Treaties, such individuals would be subject to tax under the tax laws of both countries, which could mean that they are twice subject to tax on the same income.
Tax Treaties can be helpful in such a situation, as they supersede domestic tax residence rules, by enabling an individual to determine their ultimate country of residence for tax purposes.
Situations Where Dual Residence May Occur
An individual may become resident in two countries for the following reasons:
- Where the individual spends enough time, and/or has enough ties, to meet the residence criteria of both countries. For example, an individual might live in Germany, but come regularly to the UK to visit family.
- It can also occur in the tax year in which an individual moves. Moving part-way through a tax year could potentially mean that one of the countries regards the individual as resident for the whole of the tax year by default, even though they only moved part-way through the year.
Individuals who would like to check whether they are resident in the UK under domestic law, can do so by examining the Statutory Residence Test.
Using a Tax Treaty to Determine Country of Ultimate Residence
If an individual is tax resident under the domestic tax laws of two countries then they can refer to the Tax Treaty between both countries (if there is one) in order to resolve where ultimate residence lies, i.e. to determine the ‘winner’ country where residence in that country takes precedence. The list of countries that the UK has Tax Treaties with can be found here.
The ‘Residence’ Article in Tax Treaties between the UK and other countries often contain a tie-breaker test in order to determine ultimate residence. The ‘tie-breaker’ test is the standard method of determining residence for the purposes of most Tax Treaties, and is normally as follows:
- If the individual has a permanent home available to themselves in only one country, they shall be ultimately resident in that country.
- If the individual has a permanent home available to themselves in both countries, they shall be ultimately resident only in the country in which their personal and economic relations are closer (referred to as the ‘centre of vital interests’);
- If the centre of vital interests cannot be determined between the two permanent homes, the individual will be ultimately resident in the country in which they have their ‘habitual abode’
- If it cannot be determined in which country the individual has their habitual abode, they shall be ultimately resident in the country of which they are a national.
- If the individual is a national of both states, or is not a national of either states, then the tax authorities of both states must determine the status of the individual’s ultimate residence between themselves.
The majority of individuals are able to determine in which country they tie-break to at point (1) or (2).
Definitions for the Purpose of the ‘Tie-Breaker’ Test
Most tax treaties are drafted in accordance with OECD models. The below is a basic summary of how the terms discussed in the above section are generally defined.
A home which is retained for the individual’s permanent use, and so is available to that individual at all times. A home can be one which is owned or is rented by the individual.
Centre of vital interests:
The country which forms the centre of vital interests is determined by looking at the individual’s circumstances as a whole, with reference to family and social ties, occupations and activities (whether they be cultural, political, and otherwise), and place of business. Of note, the OECD commentary explains that:
‘If a person who has a home in one State sets up a second in the other State while retaining the first, the fact that he retains the first in the environment where he has always lived, where he has worked, and where he has his family and possessions, can, together with other elements, go to demonstrate that he has retained his centre of vital interests in the first State. ’
Habitual abode generally refers to the length of time spent in each of the countries, both in the permanent home and outside it.
Jonas has lived all his life in Germany. He has an adult daughter who has moved to the UK and started a family there. As a result, Jonas has begun to spend a lot of time in the UK, approximately four months a year, helping his daughter out. He has bought a small flat nearby to her house, where he stays when visiting. In examining the Statutory Residence Test he sees that he is resident in the UK. He is also resident in Germany, under German tax law.
Therefore, the tax treaty between the UK and Germany is examined. This contains the standard ‘tie-breaker’ test:
- If the individual has a permanent home available to themselves in only one country, they shall be ultimately resident in that country. Jonas has a permanent home available in both countries, therefore he will need to consult (2).
- If the individual has a permanent home available to themselves in both countries, they shall be ultimately resident only in the country in which their personal and economic relations are closer (referred to as the ‘centre of vital interests’). Although Jonas’ daughter is in the UK, the rest of Jonas’ family are still in Germany. Most of his social ties and memberships are in Germany, as are his bank accounts, pension investments and main home. Therefore his personal and economic relations are closer to Germany, and so this is the country of ultimate residence.