Tag: tax treaty

U.S. Expats in Australia Taxes

Posted on by Peter Harper

U.S. Expats in Australia Taxes

Whether you’re a U.S. citizen or a green card holder living in Australia, you need to be aware of your tax obligations as a U.S. expatriate in Australia, which can be a complex issue without guidance.  

As a general rule of thumb, a U.S. expat working or living in Australia should assume they have a tax obligation in both the U.S. and Australia.

How U.S. Taxes Work for American Expats in Australia

Working as a U.S. expatriate in Australia can impact your U.S. tax obligations even if your stay in Australia was short-term. 

For instance, if you earn income while on a short-term assignment in Australia, you are required to report that and any other income earned in Australia on your U.S. taxes. 

The longer you reside in Australia and establish closer economic ties you’ll have even more consideration towards your American tax filing.

You may also need to report any foreign financial accounts and assets acquired during your stay. Generally, U.S. taxpayers in Australia with more than $10,000 in a foreign bank or financial accounts (for example, superannuation accounts) are bound by FBAR filing and reporting requirements. You can also be subject to FATCA reporting requirements if you have assets that are valued at $200,000 or higher.

There Are an Estimated 105,000 Americans Living in Australia

All citizens and green card holders from the U.S. whose worldwide income exceeds the IRS’ current minimum thresholds will be required to file a U.S. federal tax return and to pay any taxes to the IRS, no matter where they live or whose income is generated.

Australia’s Taxes at a Glance

You should know a few things about Australia’s taxation process. The essential need-to-know is:

Tax Rates for Australia

Like the U.S., Australia uses a marginal tax rate that is based on a progressive tax system; for example, tax rates for an individual increase as one’s income rises. The present highest marginal tax rate for residents is set at 45%, but that is not without an additional 2% Medicare levy. Differently from the U.S., income taxes in Australia are most often imposed at the federal level but not at levels relating to state or local.

Also, similar to the U.S., all Australian taxpayers are required by tax law to file an income tax return annually with the Australian Tax Office (or ATO). The Australian tax year ends on June 30, unlike the U.S.’s on December 31. Also, Australia’s individual income tax return is required to be “lodged” (i.e., filed) by October 31; in the case of emergencies and such, extensions are available.

Australia has a progressive tax system; the more your income is, the more you will have to pay.

You can also earn up to $18,200 in a financial year and not have to pay taxes. This is known as the tax-free threshold, after which the tax rates kick in.

The lowest rate is 19%, and the highest rate is 45%, which is only charged on income over $180,000. Most Australians sit in the middle bracket.

For the 2022/2023 tax year, all Australian residents shall expect to be taxed on all income over $18,200, no matter where it’s earned.

Non-residents are taxed on all Australian-sourced income, with some exceptions.

What Types of Taxation Does Australia Have?

With everything mentioned above, let’s get into the various kinds of taxes to expect or keep in mind.

Australian Resident Income Tax Rates

The income tax rates for residents are different from that of a non-resident. 

Similar to US taxes, the percentage of tax you pay increases as your income increases. However, the rate ranges are steeper for non-residents, as shown below.

Resident Tax Rates 2022-2023
Tax Rate Income
0% 0-A$18,200
19% A$18,201-A$45,000
A$5,092 with an additional 32.5% A$45,001-A$120,000
A$29,467 with an additional 37% A$120,001-A$180,000
A$51,667 with an additional 45% A$180,001 and up
Foreign Resident Tax Rates

Tax rates for foreign residents for the 2021/22 and the 2022/23 year are:

Taxable income $

 Tax payable $
0 – 120,000 32.5%
120,001 – 180,000 39,000 + 37% of excess over 120,000
180,001+ 61,200 + 45% of excess over $180,000
Capital Gains Tax

Capital gains are taxed in Australia but are considered part of the standard income tax instead of a separate category. Because of that, capital gains are therefore taxed at the same rates as one’s income. 

However, Australia’s capital gains tax does not apply to assets received through an estate transference, and capital gains can only be incurred if you sell the asset you acquired later on. 

Goods and Services Tax

The Goods and Services Tax (also known as GST) is a value-added tax that can be applied to most goods and services transactions, even if relating to goods and services and can be applied at a flat rate of 10%. 

Corporate Tax

In Australia, domestic companies don’t always have to be incorporated, so they can be considered as a corporation to reach specific tax purposes. All that is necessary from the company is that it carries out business in Australia, along with Australian ownership or control. 

All companies in Australia are also subject to a federal tax rate of 30% upon their taxable income. The exception would be for ‘small or medium business’ companies, usually subjected to a reduced tax rate of 25%. 

Social Security

Let’s examine the following key points surrounding the basics of Australian Social Security:

Do I Need to Pay Social Security in Australia?
      • If a U.S. company has assigned you to work in Australia for less than five years, you will pay into U.S. Social Security;
      • If the assignment timeline goes over five years, you will need to pay towards the Australian social security; and
      • If you are working for an Australian employer located in Australia, you will pay towards the Australian social security (contact your local AOT) for information).
Australia’s Social Security Agreement with the United States

Like the U.S., Australia has a social security system so that it can best provide for its citizens and residents. Even a secured system can still confuse expatriates over which system they should contribute to while residing in Australia. Fortunately, the U.S.-Australia totalization agreement establishes rules for social security contributions. 

Self-employed Americans living abroad in Australia may choose to contribute to either social security system. 

Superannuation

Defined as a payment by an employee towards a fund that can evolve in the future as a pension, superannuation can serve Australian taxation for the purposes listed below.

Superannuation Reporting is Important

Superannuation funds can make filing expatriate taxes extra complicated. Anyone who has control over these funds will encounter additional IRS reporting requirements. 

How to treat Australian superannuation contributions for your expat tax return?

The IRS treats these funds as grantor or employee benefit trusts, so they are not recognized qualified retirement plans, though they operate very similarly to a 401(k). 

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Living as an Expat in Australia

Moving to Australia but still having tax residency/citizenship status in another country (including the United States) can lead to questions about filing for both. Let’s look at the overall question below:

Do I Need to File 2 Income Tax Returns – Both US and Australia?

If you’re an American working or residing in Australia for some time (short or permanent), you should assume you have an income tax return obligation in both the U.S. and Australia. 

If you’re an American working in Australia, you may also have to file Australian taxes based on your residency and domicile status. Where Australian taxes are concerned, your domicile is generally where you have your permanent home, and your tax residency is where you spend most of your time. You can be a resident in more than one country, but you can only have one domicile.

How do U.S. Expat Taxes Work While You Live and Work in Australia?

Here is what American expatriates can expect from both U.S. and Australian tax laws about living and working in Australia:

Americans Who Are Self-Employed in Australia

It is required by Australia’s tax law to file a U.S. income tax return in the case that you have net earnings worth $400 or more from self-employment, regardless of age. You are required to pay self-employment tax onto your self-employment income, no matter if it can be excludable as foreign earned income in figuring your income tax. 

Does Australia tax foreign income?

The Australian income tax system taxes its residents based on their worldwide income (i.e., whether the income is earned within or outside Australia). 

Generally, non-resident individuals are only required to pay tax to the ATO on an Australian-sourced income. However, unlike the U.S., individuals that have become residents in Australia for a short time may be eligible for a temporary resident tax exemption on their foreign income and capital gains.

What is the Income Tax Rate in Australia Compared to the U.S.?

Current Australian income tax rates are relatively high compared to the U.S., which is 37%. Australian tax rates vary depending on your taxable income and between 0% – 45%, 

When is My Australian Income Tax Return Due?

Australia’s tax year starts on July 1 each year and ends the following year on June 30. The deadline to lodge (file) your taxes is October 31.

U.S. Taxes – What You Need to Know

If you earned over U.S. $12,550 (per individual) in 2021 (or $12,400 in 2020), have $400 of self-employment income, or only have a minimum of $5 of any income if you are married to (but happen to be filing separately) from a foreigner, it is a requirement to file Form 1040. While taxes owed are due on April 15, expats are able to get an automatic filing extension until the deadline of June 15, which can be extended further online on request until October 15.

If you have foreign assets valued at over U.S. $200,000 (per person, excluding your home if it is owned under your name), you must also file a Form 8938 to declare them.

If you had over U.S. $10,000 in one or multiple foreign bank accounts during the tax year at any time, it would be necessary for you to file FinCEN form 114, also known as an FBAR (Foreign Bank Account Report).

If you are paying any income tax in Australia, several IRS provisions allow you to avoid paying double tax onto the same income in the U.S. 

The two primary provisions are the Foreign Earned Income Exclusion, as it lets you exclude the first US$110,000 income earned from U.S. tax, and the Foreign Tax Credit. This gives you a U.S. tax credit to offset the tax you already have paid in Australia. 

The Foreign Tax Credit is a more beneficial option for American expats who find themselves paying more tax in Australia than they would in the U.S. They can carry any excess U.S. tax credits forward for any future use. No matter if you don’t owe any tax in the U.S., you will still have to file if your income exceeds the IRS minimum thresholds.

Does the U.S. Have a Tax Treaty with Australia?

Yes, the U.S.-Australia Income Tax Treaty was signed in late 1982 and later entered into force a year later in 1983

The U.S. – Australia Tax Treaty

However, the U.S. – Australia Tax Treaty doesn’t prevent U.S. expats living in Australia from having to file U.S. expat taxes. It contains provisions that can benefit some U.S. expats in Australia, such as students and individuals who will be given retirement income.

Most kinds of income are set out in the Treaty for U.S. expats so that they can avoid double taxation of their income arising in Australia. One way is to claim U.S. tax credits towards the same value as Australian taxes that have already been paid on their income by claiming the IRS Foreign Tax Credit.

If they have income arising in the U.S., U.S. expats in Australia can claim Australian tax credits against any U.S. income tax paid to the IRS when they file their Australian tax return.

The Treaty also covers any corporation taxation, stating that a company shall only be taxed in the country which it is registered under. An exception would be a ‘permanent establishment’ (an office, branch, factory, etc.) in another country. In that case, the permanent establishment’s profits shall be taxed within the country where it is located.

It’s also worth mentioning that the Treaty contains a clause that allows the two countries to share tax information; in other words, the IRS can see the Australian taxes U.S. expats currently residing in Australia are paying and vice versa. 

Australian banks also share their U.S. account holders’ contact and balance info with the U.S. Treasury.

To claim a provision in the Tax Treaty (besides claiming U.S. tax credits), expats should use IRS form 8833.

What are Australia’s Taxes Like for U.S. Expats?

For the 2022/2023 tax year, all Australian residents are expected to be taxed on all income over $18,200, regardless of where it’s earned. Also, non-residents are taxed on all Australian-sourced income, with some exceptions.

Australian Pension Plans

Superannuation is considered to be Australia’s version of a pension system, as superannuation is partly mandatory and voluntary. Excluding salary and wages, the government has minimums employers and employees must meet to fulfill superannuation requirements. The current rate is 9.5%, which will increase to 12% by 2025. 

Employee investments are both funded and vested. 

Superannuation funds can make filing U.S. expat taxes extra complicated. The IRS treats these funds as grantor or employee benefit trusts, so they are not considered to be qualified retirement plans; they also operate similarly to a 401(k). Anyone who has authority over these funds will encounter additional IRS reporting requirements. 

The U.S.-Australia Totalization Agreement

This agreement influences most tax payments and benefits under their respective social security systems due to it being designed to eliminate dual social security taxation. This situation occurs when a worker from one country relocates (digitally or in-person) to another country to work and is required to pay social security taxes to both countries (IRS and ATO) on the same earnings. It’s also good to fill gaps in benefit protection for all workers who have divided their careers between the United States and Australia.

What Tax Forms do Americans Living in Australia Have to File?

The most common forms to file as a U.S. expat include the following:

  • Foreign Bank and Financial Account Report (FBAR): it should not be considered a tax form and is not filed with the IRS. Instead, it is an informational form submitted to the U.S. Treasury Department. Any U.S. account holder (either person or entity) with a financial interest in or has signature power over one or more foreign financial accounts with more than $10,000 in aggregate value in a calendar year must file the FBAR annually with the Treasury Department.
  • Form 8938, Statement of Specified Foreign Financial Assets (FATCA Reporting): If you reside outside the U.S. and have a bank account or investment income account with a foreign financial institution, you will be required to include FATCA Form 8938 along with your U.S. federal income tax return if you meet certain monetary thresholds.
U.S. Tax Forms for Expats in Australia
    • FinCEN Form 114: Report of Foreign Bank and Financial Accounts (FBAR)
    • Form 1040: Individual Income Tax Return 
    • IRS Form 8938: Statement of Specified Foreign Financial Assets (FATCA) 
U.S. Tax Reporting Considerations

U.S. expats who possess accounts or other overseas assets can be subject to several specific filing requirements in the structure of informational forms. Some forms need to be submitted to the IRS as attachments onto the personal income tax return (Form 1040), while others can be submitted to other governmental departments. Failing to file any of the proceeding forms will result in severe civil penalties, such as a $10,000 per form per year. Additionally, criminal penalties, including fines and incarceration, may apply in certain extreme cases if the reporting delinquency is shown to be willful.

Australia Expat Income Taxes

There are a few standard expectations when paying taxes for Australian-sourced income, such as:

Who is Liable for Income Taxes in Australia? 

For the 2022/2023 tax year, all Australian residents are expected to be taxed on all income over $18,200, no matter where it’s earned. Non-residents are taxed on all Australian-sourced income, with some exceptions.

Who is an Australian Tax Resident

You can qualify as an Australian resident if you’re domiciled in Australia or spent more than half of the tax year without a permanent home residing elsewhere. Additionally, you also may be a resident if you happen to be an “eligible employee” of a superannuation fund.

Tax Year in Australia and Tax Filing and Payment Rules

Unlike in the U.S., the Australian tax year starts on July 1 and ends on June 30 of the following calendar year. The official deadline for filing an Australian income tax return is October 31, after the end of the country’s tax year. 

Extensions are available for taxpayers in certain situations for exceptional and unforeseen circumstances, such as those affected by natural disasters or even those who volunteered to aid victims of natural disasters. 

If you hire a registered tax agent before October 31, the filing deadline is automatically extended to June 5 of the following year. 

Expat Tax Withholding in Australia

When U.S. Expats start working as an employee in Australia, they pay income tax on payments received from their employers. The U.S. Expats’ employers deduct tax from your pay and send those amounts to us.

As an expat your employer withholds tax on your behalf from your salary or wages. Your employer will use your TFN declaration to work out how much taxes will be withheld from your pay.

Who Qualifies for a Resident of Australia?

If you’re domiciled in Australia, you qualify as a permanent resident of Australia or spent more than half of the tax year without a permanent home elsewhere. Additionally, permanent residents may be “eligible employees” of a superannuation fund.

What is the Implication of Being a Self-Employed American in Australia?

All U.S. expats are required to file a U.S. income tax return if your net earnings are $400 or more from self-employment, regardless of age. You must also pay self-employment tax onto your self-employment income, no matter if it is excludable as a foreign-earned income when calculating your income tax. Any net earnings from self-employment include the income earned in Australia and the United States.

What You Need to Know about Living and Working in Australia for Your U.S. Expat Tax Return

Along with standard expectations, some common dos and don’ts come with being an Australia-residing expatriate are:

Common Mistake

Of particular importance is that U.S. expats, more often than not, mistakenly assume that once they have moved abroad, any U.S. tax obligations will cease to exist.

So much so that, as a basic rule, all U.S. citizens, even those residing outside the United States, will be recognized as U.S. residents for tax purposes. Therefore, they are subject to U.S. tax reporting on their worldwide income and can be held towards tax liability if unable to report all current tax information. 

Australia Foreign Bank Account

Suppose you reside outside the U.S. and possess a bank account or investment account in a foreign financial institution. In that case, it is necessary to have FATCA Form 8938 included with your U.S. federal income tax return so you can meet certain monetary thresholds.

Additional Child Tax Credit for American Families in Australia

American expatriate families living in Australia should know the benefits they can receive from the Additional Child Tax Credit.

Australia is a country that has a higher income tax rate than the U.S., so Americans residing abroad in Australia can use the Foreign Tax Credit way instead of the Foreign Earned Income Exclusion. They can also then receive up to $1,400 per qualified child per year.

A qualifying child must be dependent on you, is under 17 years old, and has a valid Social Security Number.

We have met families who made up for lost years of tax filing through our Streamlined Procedure and were surprised to receive up to $3,000 of refunds every year when they claim the child tax credit.

What Tax Deductions are Available for Expats Living in Australia?

Because of the Treaty, most Americans residing in Australia already have an exemption from double taxation. However, the IRS can also provide several other beneficial tax credits and deductions for expats, such as: 

Most expats who apply these tax credits are able to erase their U.S. tax debt entirely.

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How to Deal with the Different Tax Year in Australia in Your U.S. taxes?

Filing your U.S. tax return is due on June 15 – the automatic, 2-month filing extension for expats. However, you may need to file for the October 15 deadline because Australia has a different tax year.

When you report income as a U.S. citizen in Australia, you cannot use the same tax year in Australia as in the U.S. Both countries have different tax years. Therefore, for filing a U.S. tax return as an expat, you’ll need to calculate your worldwide income according to the U.S. tax year. This tax year is January 1 – December 31.

Due to this, it is recommended to use monthly payslips so you know how much income you receive every month. That way, you can translate what you earned from the Australian tax year to the U.S. tax year.

You `must report your worldwide income and file a U.S. tax return by June 15 every year as an American living abroad in Australia. However, if you are waiting for your second Australia income statement, that may come after the U.S. expatriate filing deadline. 

Should I Take the FTC over the FEIE if I Live and Work in Australia?

While Australia’s top marginal rate is at 45%, the U.S. instead charges 37%. And the Australian maximum marginal tax rate starts much earlier. That way, you will be better off ignoring the FEIE but still claiming a full foreign tax credit. 

But exercise caution, as you can only claim a new FEIE if six full years have passed since you had last rejected an FEIE. The sole exception for this scenario is if you receive permission from the Internal Revenue Service in order to change back earlier. 

You may carry any qualifying unclaimed foreign tax credits for one year and then carry them forward for ten years. However, you can only claim these against other foreign income, so if you return to the States and still have excess foreign tax credits, you can’t use these against U.S.-sourced income.

Use the Foreign Tax Credit to Prevent Double Taxation

If you’d like to avoid double taxation, American expatriates in Australia can apply and use the Foreign Tax Credit. That way, whatever amount of taxes that is owed will be paid in Australia by you and can be applied to your U.S. tax return. That way, you will only have to pay taxes once. 

Filing Requirements and U.S. Tax Deadlines

Suppose you are a U.S. citizen or resident, and your tax home and your abode are outside either the United States and/or Puerto Rico upon the regular due date of your return. In that case, you will be automatically granted an extension for June 15 to file your return and pay any tax due. You do not have to file a particular form to receive this extension, and you must attach a statement to your tax return when you file it, showing that you are eligible for this automatic extension.

Qualified Dividends in Australia for your Foreign Corporation or Investment

Resident shareholders in foreign companies can receive credits on distributions. If you happen to own shares within an Australian company and receive a grossed-up dividend report of profits, the company has already paid any and all taxes on a portion of those dividends (as of this posting, the rate is 30%). Australian residents can also receive a rebate (also known as franking or imputation credit) on the tax that has been paid and distributed by that company. Depending on your Australian tax bracket, receiving the entire credit or a portion of the credit is possible.

Selling Your Home in Australia

You need to be aware of some tax implications if you are planning on selling your home in the U.S. or Australia as a U.S. citizen abroad.

As an expat in Australia, you have the ability to claim Section 121 Exclusion and exclude up to $250,000 of profit from U.S. taxation if you file taxes separately (e.g., if your spouse is a non-U.S. citizen). But if filing jointly with another U.S. citizen, you individually can exclude a U.S. $500,000 maximum.

As long as you are qualified under Section 121 Exclusion and its protocols and have lived in your primary house for either two out of five years or owned it for two out of five years, you have the ability to exclude up to $250,000 on your U.S. tax return.

If not, and if the profit when selling the house comes to an estimated $300,000, then $50,000 will be taxable by the IRS. You need to make sure all your tax documents are on a cost basis. The house purchase price includes the cost of renovations, home improvements, etc., so your profit number goes down. Unless you make a significant profit on your home, it is unlikely you will owe U.S. tax for selling your home.

U.S. Tax Benefits are Available to You

Now that we’ve covered the financial and legal aspects that come with being an Australian-residing expatriate, here are some benefits for you to consider:

Foreign Earned Income Exclusion

The Foreign Earned Income Exclusion permits you the ability to exclude your wages from your U.S. taxes. However, this option is only available to those who meet specific time-based residency requirements.

Foreign Housing Exclusion/Deduction

Along with the FEIE, you can also claim a foreign housing deduction or exclusion (applied through Form 2555) for any housing expenses, with the exception of the base housing amount. This exclusion applies to housing paid for with employer-provided amounts similar to a salary, while the deduction can apply to housing that is paid for through self-employment.

Your housing expenses are your reasonable expenses incurred, limited to 30% of your maximum FEIE. High-cost localities like Melbourne, Perth, or Sydney have a higher limit listed in the Instructions for Form 2555. Housing expenses do not include the cost of buying a property, making improvements, or incurring other expenses to increase its value. And your housing expenses can also be within your total foreign-earned income.

The base housing amount is usually 16% of your FEIE. 

Foreign Tax Credits

The Foreign Tax Credit permits you to claim a credit for any income taxes that have been paid to a non-domestic government.

Bilateral Agreements

There are two bilateral agreements to be aware of for future research and consideration. They are:

    • Double Tax Treaty – U.S./Aus
    • Social Security Totalization Agreements

Reach of U.S. Government

Because of FATCA and its Supporting International Agreements have made the U.S. Income Tax Reach more comprehensive than ever before.

FATCA, also recognized as the “Foreign Account Tax Compliance Act,” FATCA is a relatively new tax law enacted in 2010 as an addition to the HIRE Act. The objective behind FATCA since then has been to combat all offshore tax evasion by requiring U.S. citizens to report their holdings residing in foreign financial accounts and any foreign assets to the IRS annually. As part of FATCA’s implementation since the 2011 tax season, it is an IRS requirement that certain U.S. citizens must report (on Form 8938) the total value of any of their “foreign financial assets.”

Starting January 1, 2014, to further enforce FATCA reporting, foreign financial institutions (also known as “FFIs,” which include just about every investment house, foreign bank, and even some foreign insurance companies) must report all account balances held by U.S. citizen customers. To date, several large foreign banks have required that all U.S. citizens who have maintained accounts with them (the large foreign banks) to provide a Form W-9 (a form to declare their status as U.S. citizens) and to sign a confidentiality waiver agreement where they grant permission to the bank to provide the IRS all information about their account. There are cases where foreign banks have closed the accounts of U.S. expats who refuse to cooperate with the requirements.

This renewed effort by the U.S. government to combat offshore tax evasion through FATCA has led to a recent surge in tax compliance efforts by U.S. expats.

Recently, the IRS announced that the United States had signed a so-called competent authority arrangement (“CAA”) with Australia in furtherance of a previously signed intergovernmental agreement (“IGA”) with Australia. This agreement is designed to promote the implementation of the FATCA tax law requiring financial institutions (mainly banks and investment houses) outside the U.S. to report information on financial accounts held by their U.S. customers to the IRS.

Suppose you are a U.S. expatriate living in Australia. In that case, you must remain compliant with your continuing U.S. tax obligations and contact your local ATO for tax services and questions.

 

Our experts at Asena Family Office are available to help you understand your U.S. tax filing requirements and assist you with your U.S. tax compliance needs.

–Shaun Eastman

–Peter Harper

 

International Estate Planning

Posted on by Peter Harper

A short time ago, we had touched on the common pitfalls and necessary strategies a high-ultra networth individual residing in the United States would need to know when starting or in the middle of the U.S. estate planning process. Continuing onto that, we will be expanding the topic on a global scale and all the rules on taxation, residency, and succession that come with it.

International Estate Planning

International estate planning (or IEP) is a set of strategies and tactics applied to the U.S. and foreign clients to obtain the following objectives:

The first and most important objective is maintaining control and ownership of all wealth and property that the client has acquired in life and will be given upon their death. To determine said ownership and control, there are a few key factors to consider, such as:

  • The true domicile of the client and their beneficiaries;
  • The nature of the ownership rights of the client, their beneficiaries, and any political entities within which the property resides;
  • The tax jurisdiction between states based on local and international tax treaties to ensure efficiency when considering transfer taxes;
  • Transfers of control and ownership through trusts, contracts, and probate.

Another crucial objective is to the ability to provide absolute financial security for the client and their descendants that will last for multiple generations. As cash flow is an important way to leverage the behavior of family members, it is imperative to project the cash flow from the current assets and estimate the costs of winding up the estate. Financial security should also be ensured when the client is unwilling or unable to remain competent, as this can result in property, investments, and other financial assets to either be seized, lose monetary value, or be lost due to mishandling.

When is International Estate Planning Triggered?

There are several ways for international estate planning to be triggered when a U.S./Foreign client (with assets in the U.S.) either:

  • Accumulates or transfers a significant amount of wealth during their lifetime;
  • Probates, owns, or divides a significant amount of property (it should be noted that due to ‘FATCA’ and other reporting requirements, any amount above $100,000.00 is now considered “significant”).

Reporting and Confidentiality

Financial security is not the only concern for IEP clients when it comes to efficient tax planning. The confidentiality of their personal tax and account information may rank higher on the list of importance, as international estate planning will require much financial accuracy and scrutiny in order to complete the process efficiently. 

Unfortunately, with the implementation of the OECS’s CRS framework and the U.S. FATCA legislation, reporting on the client’s financial and tax information is no longer optional. It is mandatory for all tax history and current finances to be present not only at the beginning of inheriting or purchasing an international estate but throughout the entire operation in the case of changes or situations that could arise. It is critical to know precisely the kind of information the client needs to disclose in the various jurisdictions and the consequences of non-compliance in order to avoid the latter.

Who Does International Estate Planning Affect?

There are two specific client groups that are most often affected by international estate planning within the U.S.:

  • Any U.S. citizen or non-resident aliens living in the U.S. who own assets or have family members residing outside of the USA;
  • Non-US resident individuals who own interest in property located within the U.S. 

These two groups of clients share having a connection, whether familial or business-related, to the U.S. For those looking into other countries, it is vital to research the laws, tax treaties, and such that their specific country requires for international estate planning. For example, some countries, such as Britain, may impose a global inheritance tax on beneficiaries for estates that meet or exceed a specific monetary value, while others, like Portugal, do not.

International Estate Planning: Five Key Issues to Consider

It is of utmost importance for global families (especially families with U.S. expats) to create an international estate plan which considers the succession, domicile, generation-skipping transfer, succession, and gift tax laws in each jurisdiction where distributions may occur and/or assets are held at the time of the client’s death.

The U.S. imposes gift and estate taxes based on citizenship and domicile, which is more common in other countries, making planning for the U.S. expat particularly complex. To avoid the negative implications and consequences when the multi-jurisdictional estate plan is drawn up, the five factors below need to be considered for U.S. expats, green card holders, and/or other U.S.-connected persons.

Review The Basics of U.S. Estate and Gift Tax Law

The U.S. government imposes income and estate/gift taxes primarily based on citizenship. The maximum rate at which federal estate and gift taxes may be levied is 40%. There are tax exemptions and credits that Treasury amends on an annual basis, which typically excludes many U.S. citizens – due to this, many U.S. citizens are not concerned with estate tax planning.

Non-resident aliens may face estate tax on U.S. situs property (including shares and real estate in companies established or expanded into the United States). If the country in which the non-resident alien resides has an estate tax treaty, the jurisdiction where they are resident may have favored gift tax and estate treatment. If there is no estate tax treaty, there may be a cap on the tax exemption on their U.S. situs assets.

For individuals with a joint asset can bypass probate, with married holders adding 50% in value to their asset in the instance that one passes away. For more information, please read our article on issues to consider with joint assets to consider when doing international estate planning.

Understand the Jurisdiction in which The Decedent and Assets Are Situated

The United States offers generous gift tax and estate exemptions for U.S. citizens. However, other countries may have lower thresholds. A simple domestic estate plan may not address the complex issues which may arise if the client has assets in multiple jurisdictions.

The most significant difference is that of inheritance tax rules versus estate tax rules. Inheritance tax is typically paid by the person receiving the asset, while the estate pays estate tax. 

Succession laws also differ globally as many civil law countries in Europe, South America, and Asia have restrictions on who may receive assets at death – this is called forced heirship. The E.U. Succession Regulation (EU650/2012) alleviated some aspects of forced heirship. However, individuals may not assume they can proceed assets to any individual they want when residing within a civil law country.

Pay Attention to Nationality, Residency, Domicile, and Situs Rules

If multi-jurisdictional assets are considered, residency, nationality, and domiciled issues must be closely considered and understood. 

The estate tax for U.S. immigrants is imposed based on domicile. For estate tax purposes, a person is domiciled in the U.S. if they live within the U.S. and have no present intention of leaving. A Green Card may be a key indicator of their choice to remain in the U.S. and establish a domicile.

Other countries have codified requirements of when someone is resident and/or domiciled. European countries focus on how many days have been spent in the country when determining when worldwide assets will be subject to their local tax law. Multiple countries may consider the individual a domiciliary and/or subject certain assets to estate and gift taxes. In this instance, the special tie-breaker clauses in the tax treaties would need to be considered to avoid double taxation and determine legal domicile.

How certain types of property will transfer is subject to situs rules. Situs refers to a property’s physical location for legal purposes. The general guidelines for assets typically forming part of situs assets for non-resident aliens include:

    • Real Property (Structures, Land, Fixtures, and renovations/improvements located in the U.S.);
    • Tangible Personal Property (property physically in the U.S., including physical currency);
    • Intangible Personal Property (depends on the nature and character of the investment);
    • Business Investment Funds (funds used in connection with a U.S. business or trade and then held in a brokerage or bank account – this includes the U.S. branches of foreign banks);
    • Personal Investment Funds (Checking/Saving accounts; qualified retirement plans; stock; bonds; life insurance, and annuities).

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Check Relevant U.S. Estate Tax Treaties

Bilateral estate and gift tax treaties provide clarity on international transfer taxes. The U.S. has signed estate/gift tax treaties with sixteen foreign countries, with each treaty altering the rules regarding the applications of the estate and gift taxes between the two countries.

The content and protections afforded in each treaty may be vastly different while also providing a framework to determine the situs of the property, the domicile of the decedents, and the application of the relevant tax credits in order to avoid double taxation.

The benefit of the tax treaties for non-U.S. citizens is to alleviate the estate tax on U.S. situs assets, thus saving money while still preserving the value of the estate.

Regularly Update an International Estate Plan

Reviewing and updating a draft in estate planning is vital when acquiring assets in different jurisdictions or moving across borders. Structuring an estate plan in a single country may create unforeseen and undesirable consequences when the estate is being executed in another country. Reviewing the domicile and residency of someone at the time of their death is crucial for the functionality of the estate plan.

Individuals can cement the fulfillment of their wishes after their passing by approaching legal counsel to adopt a Last Will and Testament, which meets the requirements of the United States and any other foreign country to facilitate the distribution of their estate.

Reviewing any trusts that the individual may have is as important as executing a professional international Will. When trustees and settlors of trusts move between jurisdictions, it is imperative to be examining the treatment of trusts in the new jurisdiction for new requirements that will call for financial redocumentation or applying for a form, service, or taxation status.

Some countries, such as the U.K. and New Zealand, may impose entry and exit tax on trust assets, while others (mostly European countries) do not recognize trusts due to their definition and structure of laws surrounding inheritance (common law vs. civic law).

However, it is possible for trusts to be moved internationally, though it would have to be done without the full knowledge of foreign financial and tax laws. In some cases, this can be done unknowingly by actions of a trustee or a settlor, and this may create unforeseen consequences. Trustees or settlors of trusts are advised to seek specialist tax advice before relocating to a new country to accommodate the changes in their international estate plan.

Cross Border Issues That Amplify The Complexity of Estate Tax Planning

As with any transglobal purchase, any expat looking to purchase property in another country must be aware of the following issues that appear often:

U.S. Estate Tax Basics

U.S. transfer taxes can be applied to a U.S. citizen no matter where they are residing, the location of gifts property, or if they have died. U.S. expats are entitled to benefit from income tax relief in the form of foreign-earned income exclusion since there is no such benefit where transfer taxes are concerned.

U.S. expats should expect The United States Treasury to impose estate tax upon their worldwide assets at the moment of their death. These assets will include proceeds from personal property, retirement assets, life insurance policies, real estate, and other assets. 

Treasury may also levy an estate tax on certain assets which may have been transferred to others within a specified period before the time of the individual passing or in the case where the decedent/beneficiary retains an interest in the property after the death of the cedent.

Changes to the recent estate tax law have increased the threshold for federal estate and gift tax lifetime exclusion to very high thresholds. During the 2022 financial year, the exclusions are as follows:

    • $12.06M personal lifetime exemption;
    • Interspousal transfers: transfers between spouses are unlimited (during the lifetime of the spouses or after death as long as the transfer happens to a citizen spouse);
    • The unused portion of the exemption from the first dying spouse’s estate can be carried over to the estate of the last surviving spouse. This will, therefore, increase the threshold for the last surviving spouse’s estate as long as an election is made on the first dying spouse’s estate tax return.

Should a U.S. citizen transfer any funds during their lifetime to a non-US citizen spouse, there may be a reduction in the U.S. citizen spouse’s estate; however, the annual marital gift allowance is reduced from unlimited to an amount of $164,000.00 in 2022.

A Brief Overview of Contrasting International Transfer Tax Regimes

U.S. laws surrounding estate tax can be found in numerous states, with each possessing either similar or different criteria to be met critical differences, especially regarding state taxation and population, such as New York to Illinois. However, these differences are insignificant compared to the rest of the world. Most U.S. states make use of English common law, while other countries may make use of civil law systems. And as of October 2020, less than half of all American states and territories had ratified the International Wills Treaty and adopted the Annex.

Current civil law has been modeled after Roman law, resulting in statutes being longer, more detailed, and with less discretion and interpretive power to the court. 

Common law has more concise constitutions and statutes which afford more discretion and interpretive power to the courts when laws are applied to particular facts and circumstances.

As a common law country, the U.S. allows individuals more control and discretion in terms of distributing their wealth to their heirs. This is done by drafting a legal Will that provides specific instructions for the bequeathing of their wealth using the probate system.

Trusts can be used as vehicles to bypass probate and to avoid/defer estate tax. The estate is typically taxed before the distribution of wealth is made to the heirs. If a valid Will is not in place, state intestacy laws will determine how the decedent’s property should be distributed.

Due to the fundamental differences in common and civil law countries, it is possible for the existing estate plan that the family may have in place to become outdated, ineffective, and perhaps very counter-productive. This is especially the case if the family relocates overseas. 

Concepts of Citizenship, Residency, and Domicile

Along with cross-border taxation and laws, another critical factor in any international estate planning process is how one’s residency, citizenship, or domicile. These concepts have crucial significance in determining the transfer taxes to which the individuals could be exposed.

Expats need to understand any requirements and definitions under the laws of the countries where they live, work, and own assets. The likelihood that the effectiveness of an existing estate plan may deteriorate is dependent on where the family relocates and how much their existing assets integrate into their new country of residence as well. The duration of how long they are in the new jurisdiction is also a component an individual must consider before starting the process.

U.S. tax residency is determined using two tests: The first is the substantial presence test which measures the number of days an individual physically spends in the country. The second is based on the individual’s permanent residency – i.e., as soon as the individual becomes a green card holder, they are deemed to be a U.S. tax resident. Let’s also distinguish that a U.S. citizen is always considered a resident for income tax purposes.

Transfer taxes, however, do not consider the individual’s tax residency. Instead, it will focus on the concept of domicile. Domicile is established by determining the jurisdiction in which an individual resides without the intention of leaving permanently at some time in the future. 

Should the individual meet the requirements to be regarded as a tax resident in the U.S. but does not have the intention to remain in the country permanently, a domicile has not been created. However, once domicile has been established in a country, the only way to sever it would be actually to move outside the country/emigrate. Immigrants may be able to obtain estate tax residency if a green card is obtained and they intend to remain in the U.S. permanently.

 

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Transfer Tax Situs Rules, Tax Treaties, And Foreign Tax Credits

Now that we have gone over general key information and issues to be aware of let’s dive into strategies, credits, and other rules surrounding global taxation for IEP.

Tax Planning Strategies: Cross-Border Pitfalls and Considerations

The transfer tax implications for expats and other non-US person’s property will depend on the following:

    • The character and nature of the assets;
    • The physical location of the assets;
    • Whether there is an estate tax treaty between the country of domicile/citizenship or residence and the U.S.;
    • Whether there are any tax credits available in the U.S. and the relevant jurisdiction should there be an overlapping of any taxes which need to be imposed.
Understanding The Role Of Situs In International Transfer Taxation

As discussed above, situs is the Latin word for “position” or “site.” In legal terminology, it refers to the property’s location.

Federal estate taxes are levied on the worldwide assets of U.S. citizens and residents. For non-residents, the situs rule is that any tangible asset physically located in the U.S. will become subjected to federal estate tax. The rules for intangible property and assets are more complicated. It is possible for an asset to be considered a non-situs asset for U.S. gift taxes but may be considered to be a situs asset for U.S. estate taxes.

The Interplay of Tax Treaties Are Foreign Tax Credits On Cross-Border Estates

The U.S. currently has estate and gift tax treaties with fifteen other jurisdictions. The tax treaties serve important roles when determining the transfer tax consequences of the assets which may form part of the cross-border estate. The treaty may provide a meaningful reduction in estate taxes employing mitigating discriminatory tax treatments and double taxation.

The treaty determines the country of the donor/decedent’s domicile and the country where the property is deemed to be located. Once this determination has been made, the treaty controls which countries can assess transfer taxes.

Some treaties relieve some of the burdens which may occur when a surviving spouse of the estate is non-resident upon the passing of a US-domiciled spouse. This is done by increasing the marital deduction for non-resident spouses. If both countries have claimed to levy estate taxes, a tax credit regime may be in place to at least reduce or eliminate double taxation.

When preparing the international estate plan for clients, the interplay between the relevant transfer tax regime and the relevant treaty. This is to ensure that the impact of domicile and citizenship is also considered in addition to not only the nature of the location and the property. The filer must also specify any benefit which has been claimed under the treaty in their actual tax filings. Otherwise, the presumed benefit may be lost. Unlike the tax treaties, the U.S. does not make any special claims to negate the treaty on the basis of the heir or decedent’s citizenship.

Tie-breaker clauses are key factors in these tax treaties. How the tie-breaker rules operate depends on whether the newer or older situs rules are followed in the estate tax treaties. 

The most recently ratified estate tax treaties follow the rules based on the domicile-based approach. The treaty rules prioritize determining the jurisdiction where the decedent is domiciled. The domiciliary country can tax any and all transfers of property within the estate, while the non-domiciliary country may only tax situs property. Foreign transfer tax credits will then be provided to the non-domiciliary country by the domiciliary country for taxes paid.

The older treaties follow the more elaborate character/nature rules discussed above for non-resident aliens owning U.S. situs assets. The foreign jurisdiction’s situs rules will apply to the portion of the U.S. person’s estate in the foreign country. These treaties are not uniform; some eliminate double taxation better than others. Generally, provision for primary and secondary credits may be applied to reduce any potential double taxation. The non-situs country will grant a primary credit against the tax imposed on the situs country. Secondary credits may be issued where the individual situs laws of the countries determine that the property has situs in both or even neither country. 

Where there is no tax treaty, there is an increase in the probability of double taxation. Foreign transfer tax credits may still be able to provide a form of relief from double tax taxation, and the availability of same in the U.S. will hinge on the following:

  • Is the property situated in a foreign country?
  • Is the property subject to estate/inheritance taxes?; and
  • Does the property form part of the gross estate of the decedent?

U.S. Internal Revenue Code §2014 elaborates on the credit for foreign death taxes. It should also be noted that the potential foreign tax credits could be unavailable by Presidential proclamation if the foreign country does not provide a reciprocal tax credit to U.S. citizens.

Can Non-US Citizens Inherit Property?

Noncitizens are able to inherit property just as citizens can. One common example of special rules can apply to spouses when one of them is a non-US citizen. When the spouse who is set to inherit property from the estate is a non-US citizen, the marital deduction is no longer unlimited, even if the spouse happens to be a permanent U.S. resident. The rationale is to ensure that a non-US citizen does not inherit a large sum of money tax-free and then return to their native land. On the other hand, if the non-US citizen spouse were to pass away first, the assets left to the U.S. citizen would qualify for the unlimited marital deduction.

Just as the marital deduction is not unlimited to a non-U.S. resident spouse, the special tax-free treatment of gifts given to spouses during their lifetime is also subject to a limit of $164,000 annually. The amount is indexed for inflation and is subject to change annually.

Can U.S. Trust Own Foreign Assets?

Yes, it is possible for a U.S. trust to own foreign assets. However, it should be noted that certain countries or jurisdictions do not recognize trusts, which can result in higher taxes when or obstacles when transferring foreign assets. A possible reason is that the country or jurisdiction utilizes a civil law system rather than a common law system, with the latter allowing clients to use trusts for inheritance.

Look into whether the country you wish to engage in international estate planning operates on either a civil law or a common law system before beginning the process. If not, consult with your client or advisor to determine possibilities for you to meet civil law regulations and additional tax laws with little to no room for complications.

What is an International Will?

An International Will is intended to take effect in more than one country or jurisdiction. It can also be referred to as an Offshore Will and specifically deals with assets located in a foreign country or jurisdiction, whether from family, friends, or business-related reasons. Should it be intended for the Will to deal with the individual’s worldwide assets, it may be referred to as a ‘Worldwide Will.’

How an International Will is produced and finalized depends on the country or jurisdiction it originates from, but in many cases, it requires to be handwritten and witnessed by at least two individuals. Most countries with a common law system are accepting of a Will from the United States and vice versa, as well as recognizing if the Will was executed in the United States and vice versa. And with any of these cases, a Will can be written in a language of the writer’s choosing.

Are Foreign Assets Subject to Estate Tax?

Citizens and permanent residents of the U.S. who are domiciled within the U.S. can be subjected to estate tax on their worldwide assets, including any foreign ones they have acquired at any point in time. Should there be a tax treaty with the jurisdiction where the assets are located, this needs to be considered when determining if foreign estate tax credits may be applicable. That way, you can either reduce incoming taxation or to avoid double taxation. Which solution, or another, that may apply to your case must be consulted with professional advisors before moving forward in order to avoid filing with inaccurate information and other legal consequences.

Our consultants can help you with your international estate planning case. Contact us to set up an appointment in the “Have a question?” section to the right.

Jean-dré Tombisa

Peter Harper

#IndiaU.S.TaxSeries Ep. 1: What are Tax Treaties?

Posted on by Peter Harper

This refreshing entry of the #AsenaTaxBlog series on tax treaties focuses on the US and India tax treaty framework. The first blog presents a brief history that might interest my readers, who are curious to learn about the application of tax treaties and their interplay with domestic legislation to determine how beneficial provisions impact their cross-border tax planning needs. In doing so, there is a list of questions that you should discuss with your advisor to ensure your tax compliance is in order. 

Background

A tax treaty is an agreement or a convention between two countries. For instance, an income tax treaty is an agreement primarily concerning the taxation of income, prevention of double tax, and evasion. There can be various reasons for a country to negotiate and enter a tax treaty with another country.  

Post the First World War, the League of Nations began developing model tax conventions, which were taken over by the Organization for Economic Co-operation and Development (OECD) and later the United Nations. The United Nations was essential in establishing the United Nations Economic and Social Council (ECOSOC) to address the needs of the developing countries to formulate a model tax convention promulgating the manner to negotiate a tax treaty that is focused on addressing the sourcing country’s taxing. In 2003, the United Nations’ Department of Economic and Social Affairs published a revised edition of the Manual for the Negotiation of Bilateral Tax Treaties between Developed and Developing Countries. It noted that “the twin goals of a tax treaty are, firstly, to encourage economic growth by mitigating international double taxation and other barriers to cross-border trade and investment, and secondly, to improve tax administration in the two Contracting States by reducing opportunities for international tax evasion.”  

US Tax Treaty Framework

In the US Constitution’s Article II, Section 2, Clause 2 confers the President to make treaties and lays out how to enforce a treaty. The US has signed the Vienna Convention on the Law of Treaties (Vienna Convention) but considers many of its provisions concerning the application of international law to the law of treaties. 

The US has entered into income tax treaties with several foreign countries. The US concluded the first income tax treaty with China in 1932 to foster trade relations between the US and France. As more developing countries seek to achieve foreign investments, the bilateral income tax treaties could be a guidance tool for taxation of income, avoidance of double taxation, and evasion of taxes.  

The US has below types of treaties dealing with tax matters:

  1. Double tax avoidance income tax treaties;
  2. Estate and gift tax treaties; 
  3. Tax information exchange agreements (TEIAs); 
  4. Social security agreements or Totalization agreements; and 
  5. Multilateral Convention on Mutual Assistance in Tax Matters.

The list of countries with which the US has an income tax treaty is provided on the IRS’s official website. Countries included are Armenia, Australia, Austria, Azerbaijan, Bangladesh, Barbados, Belarus, Belgium, Bulgaria, Canada, China, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Georgia, Greece, Hungary, Iceland, India, Indonesia, Ireland, Israel, Italy, Jamaica, Japan, Kazakhstan, Korea, Kyrgyzstan, Latvia, Lithuania, Luxembourg, Malta, Mexico, Moldova, Morocco, Netherlands, New Zealand, Norway, Pakistan, Philippines, Poland, Portugal, Romania, Russia, Slovak Republic, Slovenia, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Tajikistan, Thailand, Trinidad, Tunisia, Turkey, Turkmenistan, Ukraine, Union of Soviet Socialist Republics (USSR), United Kingdom, United States Model, Uzbekistan, Venezuela, and Vietnam.

India Tax Treaty Framework

Article 253 of the Indian Constitution confers the Parliament of India to make treaties and lays out how to enforce a treaty. However, India is not an official signatory to the Vienna Convention. Still, how the courts (Ram Jethmalani v. Union of India (2011) 8 SCC 1 and various high courts in India) have acknowledged and embraced the customary international law provisions is a small step towards encouraging an integrated framework. 

India has below types of treaties dealing with tax matters:

  1. Double tax avoidance income tax treaties including comprehensive, limited bilateral, limited multilateral, and other agreements (DTAs);
  2. Tax information exchange agreements (TEIAs); 
  3. Social security agreements (SSAs); and 
  4. Multilateral Convention on Mutual Assistance in Tax Matters.

India has entered into 96 comprehensive and eight limited bilateral income tax treaties. These include Armenia, Australia, Austria, Bangladesh, Belarus, Belgium, Botswana, Brazil, Bulgaria, Canada, China, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Ethiopia, Finland, France, Georgia, Germany, Greece, Hashemite Kingdom of Jordan, Hungary, Iceland, Indonesia, Ireland, Israel, Italy, Japan, Kazakhstan, Kenya, Korea, Kuwait, Kyrgyz Republic, Libya, Lithuania, Luxembourg, Malaysia, Malta, Mauritius, Mongolia, Montenegro, Morocco, Mozambique, Myanmar, Namibia, Nepal, Netherlands, New Zealand, Norway, Oman, Philippines, Poland, Portuguese Republic, Qatar, Romania, Russia, Saudi Arabia, Serbia, Singapore, Slovenia, South Africa, Spain, Sri Lanka, Sudan, Sweden, Swiss Confederation, Syrian Arab Republic, Tajikistan, Tanzania, Thailand, Trinidad and Tobago, Turkey, Turkmenistan, United Arab Emirates, UAR (Egypt), Uganda, United Kingdom, Ukraine, United Mexican States, United States of America, Uzbekistan, Vietnam, and Zambia. 

The Indian tax legislation prescribes the availability of tax treaty benefits subject to certain procedural compliance and poses a challenge for taxpayers. For example, a non-resident Indian (NRI) is required to obtain a Tax Residency Certificate (TRC) from the tax authorities of a country of which he/she/they are a resident, in addition to filling out a self-declaration form. 

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India-US Income Tax Treaty Framework

Forms of tax treaty agreements between India and the US: India and the US have only two bilateral tax agreements, namely:

  1. The Convention Between the Government of the United States of America and the Government of the Republic of India was made for the avoidance of double taxation and the prevention of fiscal evasion concerning taxes on income 1989, which came into effect on 1 January 1989 (India-US DTA), and the protocol and technical explanation to guide for that.  
  2. The Agreement between the Government of the Republic of India and the Government of the United States of America for improving the international tax compliance and to implement the Foreign Account Tax Compliance Act (FATCA). This agreement was entered on 9 July 2015 in terms of Article 28 relating to the exchange of information for tax purposes on an automatic basis and put into effect from the period beginning 1 January 2017.

There is no gift, inheritance, nor estate tax treaty between India and the US. Therefore, a taxpayer is required to be governed and comply with the domestic tax legislation of the country where the citizenship/residence/domicile is established at the time of the taxing event.

Snapshot of the Articles covered under the India-US DTA

Broadly, the articles under the India-US DTA can be categorized as under:

Category

Article
Scope and Taxes Covered Article 1: General scope;

Article 2: Taxes covered;

Article 30: Entry into force;

Article 31: Termination
Definition Article 3: General definition;

Article 4: Residence;

Article 9: Associated enterprises
Individual Income  Article 6: Income from immovable property;

Article 10: Dividends;

Article 11: Interest;

Article 12: Royalties and fees for technical services;

Article 13: Gains; Article 15: Business personnel services;

Article 16: Dependent personnel services

Article 17: Director’s fees;

Article 18: Income earned by entertainers, and athletes;

Article 21: Payments received by students. and apprentices;

Article 22: Payments received by professors, teachers, and research scholars;

Article 23: Other income;

Article 29: Diplomatic agents, and consular officers
Business Income Article 5: Permanent establishment;

Article 7: Business profits;

Article 8:  Shipping and air transport;

Article 14: Permanent establishment tax
Pension Income Article 19: Remuneration and pensions in respect of government services;

Article 20: Private pensions, annuities, alimony, and child support
Other Provisions Article 24: Limitation on benefits;

Article 25: Relief from double taxation;

Article 26: Non-discrimination;

Article 27: Mutual agreement procedure;

Article 28: Exchange of information and administrative assistance

The interpretation of the articles covered under the India-US DTA needs deep analysis, and a cross-border tax advisor should be consulted to apply the tax treaty to the facts and circumstances of your situation.

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Key Questions to Discuss with Your Advisor Concerning the DTA While Tax Planning or Compliance: 

  1. Whether the DTA is effective or in force?
  2. What is the nature of the DTA in force – comprehensive or limited?
  3. Does the scope of the DTA cover me?
  4. What is the basis for determining my residential status under the DTA?  
  5. Does the “saving clause” under the DTA apply to me?
  6. What types of income are covered under the DTA?
  7. Does my business activity in a country establish a “permanent establishment” status?
  8. Do I have an option between applying the DTA and domestic tax legislation? 
  9. Is the application of the DTA more beneficial than domestic tax legislation? How do they interact? 
  10. What are the relevant provisions for the elimination of double taxation?
Our team of international tax specialists at Asena Advisor has in-depth knowledge of interpreting international tax treaties and ascertaining their applicability to your specific circumstances. Please contact Janpriya Rooprai, Head of the US-India Tax Desk, for more information.

Janpriya Rooprai

Peter Harper

US-AU DTA: Article 4 – Residence

Posted on by Peter Harper

GENERAL BACKGROUND

In this week’s blog, we will be discussing Article 4 of the DTA (Residence), with a specific focus on its applicability to individuals.

A person’s residence for treaty purposes is a key consideration when applying the DTA. Not only because this allows a person to claim certain treaty benefits, but also because the treaty will allocate taxing rights to the state of residence or the state of source. It is therefore vital to know where a person is resident for such purposes. 

INTRODUCTION

Article 4 contains ‘residency tie-breakers’ to determine residence for both individuals and companies.

When the domestic law of the US and Australia result in claimed residency by both countries, the taxpayer must apply the treaty’s residency tie-breaker provisions. The reason it is important is because residency determines the taxation of many important types of income, such as dividends, interest, royalties, capital gain, pension distributions, retirement pay, annuities, and alimony.

It should be noted that these tiebreakers, for companies and individuals, apply for the purposes of the treaty and so determine a sole state as the place of residence for treaty purposes only. A person does not cease to be resident of either state for domestic law purposes unless the domestic law specifically states this. 

For instance, in South Africa, the definition of ‘resident’ in Article 1 of the Income Tax Act No. 58 of 1962 includes a provision whereby the definition of ‘residence’ contained in any DTA between South Africa and another country overrides the domestic definition of a resident. So, this is an example whereby a person will cease its residency should they be regarded as an exclusive resident of another contracting states. Herewith an extract of the provision – 

‘But does not include any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between the governments of the Republic and that other country for the avoidance of double taxation.’

This however does not apply to Article 4 of the DTA between the US and Australia. One should therefore be careful when applying Article 4 and what limitations apply to the specific DTA’s definition of residence. 

INTERPRETING ARTICLE 4 OF THE DTA – RESIDENCE

The country of residence generally gets the most exclusive taxing rights. When an individual is determined to be a tax resident under the domestic law of two countries that have an income tax treaty with one another, there are a set of factors that ‘break the tie’. When interpreting the specific terms as set out below, one should look at the domestic interpretation of the US/Australia respectively and at the OECD commentary on Article 4 of the Model Tax Convention.

The country of residency for purposes of the DTA is determined by applying the following tie-breaker clauses in the US-Australia DTA.

Tie-breaker 1: 

Permanent home – first, the country in which the individual maintains a permanent home. If the individual has a permanent home in only one of the Contracting States, the individual will be treated as a resident of that State for treaty purposes.

The IRS states that a permanent home is one that is retained for permanent and continuous use and is not a place retained for a short duration. An individual has a permanent home in the US if he or she purchased a home in the United States, intended to reside in that home for an indefinite time, and did reside in that home. Individuals may also have a permanent home where:

    1. a room/apartment is continuously available to them, 
    2. their personal property (e.g., automobiles, personal belongings) is stored at a dwelling, and 
    3. they conduct business (e.g., maintaining an office, registering a telephone), including using such addresses for insurance and a driver’s license.

The OECD describes a permanent home to be a home that the:

‘Individual has arranged to have the dwelling available to him at all times continuously and not occasionally’. 

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Tie-breaker 2: 

Habitual abode – second, if the individual’s permanent home cannot be determined, then the state in which he has a habitual abode. 

The IRS states the following in this regard:

“An individual’s habitual abode is located in the Contracting State in which the individual has a greater presence during a calendar year. Although the length of time is not specified, the comparison must cover sufficient length of time and take into account the intervals at which the stays take place for it to be possible to determine where residence is habitual. For example, an individual who is present in the United States more frequently and at longer intervals than in the other Contracting State during a calendar year likely has a habitual abode in the United States. Determine whether the individual has a habitual abode in the United States by calculating how much time the individual spent in in the United States in a tax year…” 

The OECD explains that a habitual abode refers to the frequency, duration and regularity of stays that are part of the settled routine of an individual’s life and is therefore more than transient. 

There is no specific commentary on the Australian interpretation of the words habitual abode in the context of the Treaty, only the words habitual place of abode in the context of the statutory definition of resident in section 6 ITAA 1936. However, the Courts consider the Commentary on the OECD Model Tax Convention as authoritative guidance on the interpretation of Tax Treaties.  

Tie-breaker 3: 

Closer connections – third, if the individual has a habitual abode in both countries or in neither, then the country in which the individual has closer economic or personal relations, with regard being given to the country of citizenship. 

The IRS considers the following factors in this regard:

Personal relations:

    1. Family location – Includes parents and siblings, and where the individual spent his or her childhood. 
    2. Recent relocation – Whether the family moved from their permanent home to join the individual, or the individual relocated to a second state (for example, as a result of marriage). 

Community relations: 

Determine where the individual has his or her:

    1. health insurance, 
    2. medical and dental professionals, 
    3. driver’s license/motor vehicle registration, 
    4. health club membership, 
    5. political and cultural activities, and 
    6. ownership of bank accounts. 

Economic relations: 

Determine where the individual:

    1. keeps his or her investments or conducts business, 
    2. incorporated his or her business, and retains professional advisors (e.g., attorneys, agents, and The center of vital interests can shift, when an individual retains ties in one State but establishes ties in a second State, and all surrounding facts and circumstances must be considered in determining the individual’s center of vital interests. For example, the IRS states that evidence that an individual has executed contracts relating to his or her business in the second State may indicate that the center of vital interests is in the second State. 

CONCLUSION

It is of utmost importance to ensure that you understand how to apply the tie-breaker provisions set out in Article 4(2) of the US/Australia DTA. Secondly, it is important to note that by being regarded as a resident in terms of the DTA, does not automatically cease your tax residency. Especially if you are a US citizen living in Australia. It should only be applied for purposes of the treaty and allocating the taxing rights accordingly. 

Our team of International Tax specialists at Asena Advisor, have an in-depth knowledge of how to interpret international tax treaties and how to correctly apply the tie-breaker provisions.

Shaun Eastman

Peter Harper