Tax Residency: Main Features, Pros, and Cons, International Practice
Powerful nations of our planet with high withholding rates show more and more initiative regarding putting up resistance to the jurisdictions with low withholding rate. It is important to understand that the country of tax residency is the basis for determining the withholding rate of the company activities. As for the private persons their liability is determined based on the actual time, spent on the territory of a jurisdiction, taking into account the information and notes of the customs authorities. As to the legal entities, things are not so simple; in particular, there are no fixed rules for determining their liability.
Defining the country of tax residency – international practice
In the international practice, they mostly apply corporate taxation to the foreign and local companies, which implement economic and entrepreneurial activities on the territory of the relevant jurisdiction. If a company is incorporated and registered in the territory of a particular country and meets the requirements of tax residency rules, it can be considered a resident, and get a tax residency certificate (like the this issued by the ministry of finance in the UAE).
At the same time, all the fiscal and regulatory authorities may regulate the activities of the foreign agencies and companies, which operate in the jurisdiction. Things get much more complicated with the activities of companies, located outside the jurisdiction, managed by the company which is registered in the jurisdiction. Such difficulties are primarily associated with the difficulty of obtaining the necessary information about the ultimate beneficiaries and the founders of the company from the offshore jurisdictions.
These particular difficulties have made this scheme popular for withdrawing and optimization of the taxation base, and the financial assets are withdrawn into the offshore jurisdictions.
It should be noted that the criteria and rules for determining the tax liability of a legal entity can be very different. In the current international practice, it is generally accepted to distinguish two main criteria; they are as follows:
- Incorporation of the legal entity;
- Functions of management and control.
Many countries use both criteria when determining the tax liability of the company, and that can lead to double taxation. In practice, it is quite difficult to determine the resident status of a company.
The essence of tax residency
This status for the physical and legal entities is the main criteria for the application of the appropriate withholding rate. If the person, who does not have this status, pays taxes only on the income which is gained in the territory of this country (country of tax residency), then this person pays impositions on all the income, regardless the country of his/her origin. To avoid the possibility of double taxation, countries of the world agreed on the bilateral international agreements, which are aimed at the prevention of such situation.
Some particular countries can practice different approach in determining tax liability. So, the no less popular method of determining residence is based on the criteria, which help to identify the actual relationship of the company with the foreign countries, regardless of the jurisdiction where the company is registered. Here the main criteria are the managerial functions, which, in their turn, includes several characteristic features. In particular:
- Venue of the meetings of the board of directors;
- Place of operational management;
- Location of the head office and the other administrative buildings;
- Location of the financial documentation and the archive of the company.
This approach is characterized by the fact that the legal entities are liable to the same criteria of determining the taxable residence as the natural persons. The place of incorporation and registration of the company remains the main criteria, but it is not the most important aspect. The determining factor is the real relationships of the company with some particular jurisdiction, namely, the location of the company, where the main economic activity is carried out, the residence of the founders, etc.
The following functions are considered the real economic activities of the company:
- Management of the company;
- Making decisions related to the economic activity of a company;
- Meetings of a Board of Directors.
This approach has long been used as the basis for determining the liability in the international law. More and more countries adopt this experience, which allows applying the national taxable system for companies which are registered abroad but carry out their economic activity within the country.
Some aspects of tax residency rules – actual recipient of the profits
It should be noted that the concept of the actual recipient of the profits is not studied enough and has a few different interpretations, which leads to great confusion. First of all, it is necessary to clarify that the concepts of "beneficial owner" and "actual recipient of the profits" have a completely different legal meaning.
Often, speaking about a beneficial owner, one implies the actual owner of the company or business. This definition refers to the ultimate beneficiary, who for the confidence of the information uses the various opportunities, including the nominee service, trustees and offshore trusts.
It is interesting to pay attention to the parameters that determine the actual recipient of profits, which are shown in the records of the organization for Economic Co-operation and Development (OECD). In particular, the OECD determines the following:
- The beneficial owner is not really the actual recipient of profits;
- Agents, brokers, attorney or nominal holders of the securities of the company cannot be considered as the actual recipient;
- A company, which is created for tax optimization at the expense of participation in the international agreements and which carries out only the administrative functions, cannot be recognized as the actual recipient.
In other words, the actual recipient of the profit may be considered a person, who is the real recipient of the income. The actual recipient receives the defined profit at his/her full disposal, and respectively, must pay the respective public due. But in practice, everything can be a little different. Mostly, a company indicates that the income will be paid to a certain person, but this person is used only for the transition of the financial assets, and the ultimate beneficiary remains unknown.
It is planned to use a range of tools and preventive measures in order to identify such facts when the private business uses smart schemes to conceal the ultimate beneficiaries and owners of the business. The exchange of information between the country authorities is among them. According to experts, the effective information exchange will make it possible to levy the real business owners, but not the formal entities which have certain benefits.
The international organizations, which put up resistance to the offshore jurisdictions, develop and implement a number of preventive measures. The special place, among such measures, is given to the exchange of information between foreign government structures. Today, such agreements have been signed by more than 60 Countries in the various parts of the world.
Today, the main efforts of such organizations are focused on the organization of the automatic information exchange, which allows getting the necessary information in a short time. Moreover, it is planned to organize joint audits. The international conventions and agreements provide for the active cooperation of the countries in the issues of the tax shortcoming. According to the experts, this approach will allow returning the obligatory budget payments, even if the real assets of the taxpayer are abroad.
Tax residency rules for the natural persons and legal entities
For the natural persons, the economic relationships with the country are built on a territorial basis. In other words, the tax liability is determined on the basis of the residence of the natural person. It is important to understand that a person, who possesses an appropriate status, has certain obligations to the country. The resident must pay impositions on all incomes, regardless of the country of their origin.
For persons, who do not have such status, tax obligations to the country may be limited. In particular, impositions are paid only on the profits, which are gained directly in this jurisdiction.
A criterion of the actual presence of the natural person on the territory of a certain country is not the only one when determining the tax liability. The relationships of the ratepayer with the other jurisdictions can be characterized not only by the physical presence. The other signs, which indicate the relations between a foreign country and the ratepayer, can be taken into account here.
A natural person may be considered a tax resident on the basis of the right of property, which is acquired in a given jurisdiction. For example, the norms of the fiscal law of France recognize that in the case of availability of a permanent house in France by the natural person, he/she may be granted an appropriate rights. And in the UK, the property owner may obtain resident status, if he/she has visited the country at least once in during a year.
The tax residency status can be also recognized in the country, where all the basic vital interests of the natural person are concentrated. The country, where a ratepayer has strong economic and personal relations, may recognize the resident status of this person. A variety of life circumstances are studied to determine such relations. When determining a residence on the basis of this criterion, the special emphasis is paid to the following criteria:
- Social and family relations of a person;
- Cultural and political activities of a person;
- Occupation and a place of business of the person;
- Place of the management of the person’s property, etc.
Let us conside Luxembourg as an example, if the natural person manages his/her business from the territory of this country or this person is an investor of the national economy, he/she can count on the granting of the tax resident status.
Free expression of the will of the potential ratepayer, may become a basis for the granting of the tax resident status. In the United States of America, for example, there is a possibility of determining the tax liability at the request of a person for those, who have arrived at the territory of the country for the first time.
The status of a tax resident, which is obtained at one’s initiative, should not be confused with the status that is obtained by default, on the basis of the current legislation. For example, if you arrive at Great Britain under a labor contract for more than two years, you will receive the tax residency for the defined period automatically in pursuance of the law.
Applying different approaches in determining tax liability, some countries can duplicate such functions. In particular, one taxpayer can be assigned to double or even triple residencies. In such a situation, the ratepayer risks paying the presumed government taxes several times.
Special international agreements, which are aimed at the prevention of double taxation, are aimed to solve this problem. Here, the determining factor in the determination of the tax liability is an indicator of a permanent residence. Thus, if two countries pretend to the residence of a particular person, the decision will be in favor of the country where the person has a permanent residence.
But in practice, there are cases when the criteria of residence cannot be used to determine the tax liability. A person may not reside in the territory of both countries or live in these two countries. In such situations, the determining factor is the nationality of the ratepayer.
Tax residency in Dubai, UAE
As for the UAE, both physical and legal persons can get tax residency in Dubai, the UAE. An individual can get the appropriate status after obtaining a residence visa. This visa is issued to all employees who legally work in the country, another requirement for obtaining this status is to stay in the country for at least 180 days a year. Companies registered in any of the Emirates, or one of its free zones, are also available to the UAE. The exception is made to offshore companies (there are three free zones in the country where you can register an offshore company), as well as the requirements for companies you can highlight the mandatory condition that the director must be a UAE resident (or a foreigner with a UAE residence visa). However, there are some nuances in this matter, and the exact criteria will be determined in each specific case.
The good news for those who are going to get UAE tax residency (tax residency certificate of the UAE), is that there are no taxes on income here. (The only exception is a government due on real estate income). The same rules are applied to companies that currently do not have corporate and other government taxes for companies located in the UAE. VAT has been introduced at the beginning of 2018; its rate is 5%. Also, the country has already signed dozens of international agreements on the avoidance of double taxation, which will allow the main participants and private individuals to submit to this unpleasant moment.