Tax residence: advantages and disadvantages
Powerful nations of our planet, which apply the high tax rates, illustrate more and more initiative in terms of putting up resistance to the jurisdictions with low tax rates. It is important to understand that the tax resident status is the main basis for determining the tax rate of the company's activities. The tax residence of the natural persons is determined based on the actual time, which is spent on the territory of the relevant jurisdiction, taking into account the information and notes of the customs authorities. As to the legal entities, everything is not so simple, in particular there are no fixed rules for determining the tax residence.
In the international practice, the corporate taxation is mostly applied 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, it can be considered a tax resident.
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. Everything is much more complicated with the activities of the companies, which are located outside the jurisdiction, but are 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have made this scheme popular for withdrawing and optimization of the taxable base, and the financial assets are withdrawn into the offshore jurisdictions.
Criteria for tax residence of the company
It should be noted that the criteria for determining the tax residence of a legal entity can be very different. In the current international practice, it is generally accepted to distinguish two main criteria for tax residence, in particular these are:
- Incorporation of the legal entity;
- Functions of management and control.
Many countries use both criteria when determining the tax residence of the company, what can lead to the phenomenon of a double tax residence. Practice shows that it is quite difficult to determine the resident status and tax residence of the company.
The essence of tax residence
The status of the tax residence for the physical and legal entities is the main criteria for the application of the appropriate tax rate. If the person, who does not posses the status of a tax resident, pays taxes only on the income which is gained in the territory of this country, then the person with the status of a tax resident pays taxes on all the income, regardless the country of their origin. To avoid the possibility of double taxation, states conclude the bilateral international agreements, which are aimed at the prevention of such situation.
Some particular countries can practice different approach in determining the tax residence. 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 is 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 one or another 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 the company;
- The meetings of the Board of Directors.
This approach has long been used as the basis for determining the tax residence in the international law. More and more countries adopt this experience, which allows to apply the national taxable system for companies which are registered abroad, but carry out their economic activity within the country.
The actual recipient of the profits: confusion in the definition
It should be noted that the concept of the actual recipient of the profits is studied not enough and has a few different interpretations, what leads to the great confusion. First of all it is necessary to clarify that the concepts "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 uses, for the confidence of the information, 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 can not be considered as the actual recipient;
- The company, which is created for tax optimization at the expense of participation in the international agreements and which carries out only the administrative functions, can not 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 user receives the defined profit at his full disposal, and respectively, he must pay the respective country tax. But in practice, everything can be a little different. Mostly, the company indicate 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.
To identify such facts, when the private business uses clever schemes in order to conceal the ultimate beneficiaries and owners of the business, it is planned to use a range of tools and preventive measures. Among them, there is the exchange of information between the state tax authorities. According to experts, the effective information exchange will make it possible to tax the real owners, but not the formal entities which have certain tax benefits.
Information exchange as a component of deoffshorization
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 tax 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 to get the necessary information in a short time. Moreover, it is planned to organize a joint tax audits. The international conventions and agreements provide for the active cooperation of the states in the issues of the tax shortcoming. According to the experts, this approach will allow to return the obligatory budget payments, even if the real assets of the taxpayer are abroad.
Tax residence for the natural persons – definition and features
For the natural persons the economic relationships with the state are built on a territorial basis. In other words, the tax residence is determined on the basis of the residence of the natural person. It is important to understand that a person, who possesses a tax resident status, has a certain tax obligations to the state. The resident must pay taxes on all his incomes, regardless of the country of their origin.
For persons, who do not possess such status, tax obligations to the state may be limited. In particular, taxes are paid only on the profits, which are gained directly in this jurisdiction.
Criteria of the actual presence of the natural person on the territory of a certain country are not only the one, when determining the tax residence. The relationships of the taxpayer with the other jurisdictions can be characterized not only by the physical presence. The other signs, which indicate the relations between a foreign state and the taxpayer, 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 home in France by the natural person, he may be granted a status of a tax resident. And in the UK, the property owner may obtain a resident status, if he has visited the country at least once in the course of the year.
The status of the tax residence can be also recognized in the country, where all the basic vital interests of the natural person are concentrated. The country, where a taxpayer has the strong economic and personal relations, may recognize the tax residence of this person. To determine such relations a variety of life circumstances are studied. When determining a residence on the basis of this criterion the special emphasis is laid on the following criteria:
- Social and family relations of the person;
- Cultural and political activities of the person;
- Occupation and a place of business of the person;
- Place of the management of the person’s property and etc.
For example, in Luxembourg, if the natural person manages his business from the territory of this country or is a direct investor into the national economy, he can count on the granting of the tax resident status.
Tax residence as a result of own will
Free expression of will of the potential taxpayer, may become a ground for the granting of the tax resident status. For example, in the United States of America, for people, who have arrived to the territory of the country for the first time, there is a possibility of determining the tax residence at the request of the person.
The status of a tax resident, which is obtained at one’s own 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 to Great Britain under a labor contract for a period of more than two years, you will receive the tax residence for the defined period automatically in pursuance of the law.
Dual residency and double taxation
Applying different approaches in determining the tax residence, some states can duplicate such functions. In particular, one taxpayer can be assigned to double or even triple tax residence. In such situation, the taxpayer risks to pay the presumed state taxes for several times.
Special international agreements, which are aimed at the prevention of the double taxation, are called to solve this problem. Here, the determining factor in determination of the tax residence is an indicator of a permanent residence. Thus, if two countries pretend to residence of a particular tax resident, 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 residence. 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 taxpayer.
Termination of the tax residence
Certain legal consequences can become a ground to cease a fiscal residence. For example, in some countries, to close a tax residence, a citizen should not be present in the state for more than 183 days. The state can also set a certain period during which a person retains his tax residence.
In addition, the current legislation can establish a number of procedures, which precede the completion of the tax residence. These procedures are provided for the persons who move outside the country and lose the status of a tax resident. For example, in Brazil, a person who leaves the country must pay off his tax debts and to provide the appropriate tax return.
And some countries practice special guarantees, which contribute to the fulfillment of the tax obligations to the state.