Tax residence is one of the most important factors when ascertaining an expatriate worker's tax obligations.
Tax residence is determined by various factors and influences whether – and what type – of expatriate income is taxable in a certain country. It's important for employers to understand the tax implications for their employees, particularly those on assignment or traveling frequently internationally for work.
This article is the third in our series exploring key tax issues for expatriate employees including commonly-used legal structures. Before we outline the main factors that determine an expatriate's tax residence position, it's important to note that this information is general in nature. For country-specific guidance relating to your employees' circumstances, get in touch with our global experts.
Tax residents and non-tax residents – what's the difference?
Tax residents are taxed in a country on their 'worldwide' income (ie. any income earned anywhere in the world), while non-tax residents are taxed only on their 'source' income (ie. income earned in that country). Tax residence is determined by examining both local and national laws but also double tax treaties, which have a set of criteria to help ascertain an individuals' tax obligation. Double tax treaties should generally only be used if there is a conflict between the home and host country rules, for example, if the expatriate qualifies as a tax resident in both countries.
Where an expatriate is deemed to be a dual tax resident (an unusual situation in light of the general principles and practices of the OECD double tax treaty model conventions), the final tax residence is determined by referring to the specific double tax treaty article. This article "overrides" national tax residence rules in case of conflicts. If, however, there is no double tax treaty or any similar act dealing with tax residence conflicts, it's possible that the expatriate is tax resident or non-resident in two or more countries.
A German national working in Hungary
Let's imagine a German national is assigned to Hungary to work for two years. This expatriate has employment income and rental income, both paid from a German source.
After investigating the relevant German and Hungarian laws, we identified that this individual is considered tax resident in both Germany and in Hungary. Therefore, we refer to the Germany-Hungary double tax treaty to determine their final tax residence position. We conclude that this individual becomes a Hungarian "ultimate" tax resident. This means that his or her income – both the German-sourced employment and rental income – is taxable in Hungary.
We should not forget however, that the taxation of various exact income types is regulated separately in the double tax treaties. For instance, the treaty will say that rental income remains taxable in Germany since the property is located there, and thus should be exempt from taxation in Hungary (the exemption method of the double tax treaty should be used).
Tax residence determines the volume and magnitude of the taxable income a country has the right to levy tax on (worldwide or only source income). Each income type should be checked separately, based on the treaty provisions, and the taxation determined accordingly.
If in the above case for example, the individual's final tax residence was determined to be Germany, Hungary did not have the right to levy tax on the rental income. For this reason it's extremely important to determine an expatriate employee's tax residence.
How do you determine tax residence?
Tax residence is generally determined by examining the unique circumstances of the expatriate. These factors include their nationality, permanent/temporary address, domiciliation, length of stay/habitual abode (183 days presence), economical and personal interest (ie. centre of vital interest).
Generally tax residence is subject to only one factor or set of factors, in a hierarchical order. Double tax treaties generally use the following hierarchical tax residence factors:
- permanent address
- centre of vital interest (if the permanent address is listed in multiple countries)
- habitual abode (if the centre of vital interest cannot be determined)
- nationality (if the habitual abode cannot be determined).
If tax treaty provisions do not provide clarity, the relevant authorities should make the final decision on the expatriates' tax residence.
When to determine tax residence?
This question is an interesting one, as it puts a timeframe on the tax residence position of an expatriate. Should their tax residence be determined at the start of a work assignment, at year-end or at the end of the assignment? Another interesting question is whether tax residence can change during a year.
The simple answer to the first question is that the tax residence should be determined, at the latest, when an annual tax return needs to be filed and tax needs to be paid. Of course, if a tax advance is payable, it is recommended the tax residence be estimated or determined at the beginning of an assignment then check at year-end if there were any changes in the expatriate's circumstances. The tax residence determinate becomes very tricky when the related (home and host) countries' tax years differ from the calendar year.
Some countries do accept an interim tax residence position change. If an expatriate's assignment starts in August and there are significant changes to their personal circumstances, they can switch tax residence from home country to host country as of August. This may result in situations where certain incomes are taxable in "country x" until July and then in "country y" from August. This should however be checked on a case-by-case basis, country-by-country.
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TMF Group’s tax, HR and payroll experts in more than 80 countries can help you to determine the tax residence position of your expatriate workers and identify the necessary steps for operational compliance.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.