Chapter 14 - Double Tax Treaties

14.1 HOW DOUBLE TAX TREATIES WORK

The rules detailed earlier in this guide explain the concepts of 'residence', 'ordinary residence' and 'domicile' and identify when an individual will be liable to pay UK tax as a result of being resident or ordinarily resident in this country.

But an individual may also be regarded as resident in another country according to its tax laws. This is where double tax treaties come into play.

A double tax treaty is essentially an agreement between two countries that will determine which country has the right to tax you in specified situations. The purpose is to avoid double taxation.

The UK has double tax treaties with a number of countries including popular retirement destinations such as Spain, Portugal, Italy and France.

The majority of the UK's double tax treaties are based on the 'standard' provisions in the model treaty of the OECD (Organisation for Economic Cooperation and Development).

This includes a 'tie-breaker' clause that effectively overrides the two countries' domestic laws and makes the individual resident in one country only. The use of this tie-breaker clause can be extremely beneficial, as we'll see shortly.

14.2 WHAT A TYPICAL DTT LOOKS LIKE

As most of the UK DTTs follow the standard OECD model, I'll explain in the paragraphs that follow what some of the most common OECD double tax treaty provisions are actually trying to achieve.

Some of these are self-explanatory but are worth listing in case you ever want to review a DTT on your own.

Article V -- Permanent Establishment

This looks at the definition of a permanent establishment. This is crucial for international traders as this will frequently dictate the extent to which overseas trading activities will be taxable in an overseas jurisdiction. Usually a company trading in the other treaty country would only be taxed on the profits in the 'source' country if they are trading from a permanent establishment located there.

Article VI -- Income from Real Property

Typically real property is land and property, so this article would cover the treatment of rental income. As the country where the property is located usually has the initial right to tax, the rental income could easily be taxed in both countries.

Most income tax treaties under Article VI will not avoid this by providing an exemption in one of the countries. Instead, you would usually rely on Article XXIV (elimination of double tax article) to provide a tax credit for the overseas tax suffered (see below).

Article XI -- Interest

This looks at the position where interest is paid by a resident of one country to a resident of another. The treaty between the two countries would usually look to reduce any withholding taxes. (For example, in the case of the UK, it would identify if the UK 20% withholding tax would be reduced).

Article XIII -- Capital Gains

This is the one that is of most importance for property investors looking to emigrate and sell up. It covers capital gains from the disposal of assets and seeks to reduce the tax dependent on the specific treaty country. In many cases, there is a standard provision that capital gains remain taxable only in the owner's country of residence, except for land and property which can also usually be taxed in the country where the property is located. So whilst most expats could be exempt from UK taxes, they could find themselves liable to capital gains tax overseas.

Article XIV -- Independent Personal Services

This looks at the taxation of income from self-employed people and again will generally look to whether the individual has a 'fixed base' overseas. If they do, then it's often only the profits generated by this fixed base that can be taxed overseas.

Article XV -- Dependent Personal Services

This looks at the taxation of employment income. In many treaties if the income is paid and borne by a foreign employer and the employee is not physically present in the UK for more than 183 days, the income will only be taxable in the employee's country of residence.

Article XXII -- Other Income

This looks at the taxation of all other income not addressed elsewhere and usually gives sole taxing rights to the country of residence.

Article XXIV -- Elimination of Double Taxation

This provides for double tax relief, so that even if income is taxed twice, you will be able to deduct overseas tax that you have suffered from any UK liability. Although useful, the UK would usually provide for double tax relief anyway, even if there were no treaty in place (under what is known as 'unilateral relief').

Exceptionally, some treaties may also grant an exemption rather than the credit method above.

Article XXVII -- Exchange of Information

This is an agreement between the two tax authorities to allow them to share information, mainly to avoid tax evasion. This is the other side to double tax treaties -- as well as a look at reducing tax. They are also effectively information exchange agreements.

The terms of double tax treaties can therefore be immensely complex, although on a simple level they can provide for one country to have primary taxing rights over certain sources of income and gains.

The tie-breaker clause that I mentioned earlier is the way that the tax treaty will determine in which of the two countries an individual is resident for treaty purposes.

A typical treaty would provide that:

• If you have a permanent home in one state, you are resident in that state.
• If you have a permanent home in both states, you are resident in the state that is your 'centre of vital interests' -- the country in which you have close personal and financial ties.
• If you do not have a permanent home in either state and it is not possible to determine your centre of vital interests, you are resident in the country where you have an 'habitual abode'.

One important point to note is that there are very few low-tax countries that have double tax treaties with the UK. The UK has, however, concluded double tax treaties with the Channel Islands and the Isle of Man, which are low-tax jurisdictions. The UK-Isle of Man double tax treaty is studied in more detail below.

It is also crucial to note that for the tie-breaker clause to apply, you must be resident in two countries under the terms of each country's domestic laws. The treaty cannot make you resident in a country if you are not already resident under the domestic law of that country.

There is also a tie breaker clause for companies, which usually looks at the country where the 'effective management is carried out'. Before this could apply a company would need to be resident in both treaty countries. For example, in the Wood v Holden case mentioned previously, HMRC argued that the Dutch company was UK resident given its central management and control was in the UK.

HMRC also said that under the UK-Netherlands tax treaty the company was UK resident because the effective place of management was not in the Netherlands. However, as the High Court judge ruled that the company was Dutch resident, the treaty provision was not relevant in deciding the company's residence.

Note that I am not saying that you need to be resident in both treaty countries to obtain the benefits under the treaty. The residence tie-breaker rules will not apply unless you are dual resident.

The impact of being treaty resident overseas is that most treaties ensure that you are subject to the overseas tax rules on overseas income.

The other provisions relating to income and gains will usually apply where you have a potential tax charge in both states. Therefore, you could be UK resident but if you invest in German property, you'll be subject to both countries' capital gains tax regime and will look to the treaty to identify how this deals with the double taxation.

14.3 THE UK-ISLE OF MAN DOUBLE TAX TREATY

The Isle of Man (IOM) has only one Double Taxation Agreement which was entered into with the United Kingdom in 1955 and is very similar to agreements drawn up between the UK and Jersey and Guernsey.

The treaty does not conform to the OECD standard model treaty and is of limited scope. The main features that may be of interest are the following:

• The agreement applies only for income tax purposes (in both the IOM and the UK).
• An individual resident in only one of the two countries is exempt from tax in the other country on personal, including professional, services performed in the other country on behalf of a resident of his own country (but they must be taxed in his own country). In other words, if you are a resident of the IOM and perform services in the UK for a UK resident individual, then provided the income was taxed in the IOM, there would be no UK tax liability.

If these criteria are not met then tax would be payable in both countries, although the tax paid in one country is allowed as a credit against tax due in the other. If you did incur UK tax whilst being an IOM resident, the UK tax paid would be offset against any IOM tax.

Given that UK income tax rates are in general significantly higher than IOM rates, this would extinguish any IOM income tax liability.

It is important to note that capital gains tax is not subject to the double tax treaty.

How to Become Resident in the Isle of Man

There is no general definition of 'residence' or 'ordinary residence' in Manx tax law -- these terms are often interpreted in the same way as in English law.

A person will qualify as a resident if he spends a total of six months on the island in any income tax year (April 6th to April 5th). An individual who visits for more than an average of three months each year for four or more consecutive years will also be deemed resident. There is an important short-term residence concession which allows a person who owns a property on the island to spend no more than four months in any two consecutive years in the island and not be liable to Manx income tax.

A new resident is taxed from the date of arrival, while a person who leaves is non-resident from the date of departure. Resident individuals are liable to tax on their worldwide income, non-residents only on income arising on the island.

14.4 USING DOUBLE TAX TREATIES TO SAVE TAX

Before the 2005 Budget it was possible to use certain favourable double tax treaties with countries like Belgium, Portugal and New Zealand to avoid having to leave the UK for five years to avoid capital gains tax.

These treaties superseded the UK domestic tax legislation and allowed only the overseas country to tax gains of residents, thus preventing a UK tax charge, even if the person became UK resident within five years. However, this is no longer possible due to the new anti-avoidance rules. The fact that a double tax treaty exists does not prevent UK Revenue and Customs taxing any gain that arises in the tax year of your return.

You would therefore need to remain resident overseas for more than a five-year period for the gain to be exempt from UK capital gains tax.

If this is an option (for example, if the amount of any gain is significant) you could choose a CGT-free destination such as the Isle of Man or the Channel Islands, a complete tax haven such as Monaco, or a country that has specific provisions to exempt gains on overseas property (for example, Cyprus).

After the tax year of disposal, you could then cease to be a resident of this country and travel or establish residence in another country of your choice (for example, Spain). Provided you do not become a UK resident for more than five complete tax years, you will be exempt from UK CGT. You could return to the UK for visits, although you should keep these to a minimum, especially if you have UK family or property.

Although the use of double tax treaties to avoid UK capital gains tax has decreased, the use of treaties for individuals and companies to avoid income tax or corporation tax is still significant. For example, the permanent establishment provisions of a relevant double tax treaty are very important for international traders as they can actively limit liability to UK taxes for UK traders.

14.5 TREATY RELIEF

Remember that double tax treaties override domestic tax legislation. In the standard OECD model tax treaty, dividends can be taxed in the country of the shareholders residence, usually with a reduced withholding tax in the country where the company is resident.

In this case, you would need to contact Revenue and Customs and apply for treaty relief in order that the exemption or reduction in UK tax can apply. This would then allow a repayment of any tax withheld, and would ensure that no income tax is deducted on future payments.

Claiming treaty relief can be a long process. The form, which can be obtained from Revenue and Customs (www.hmrc.gov.uk/cnr), must be completed and passed to the overseas revenue service. It will then review the information and pass this back to the UK HMRC where the Centre for Non Residents will issue a certificate granting relief.

14.6 LIVING OR BUYING PROPERTY IN SPAIN

Let us have a look at Spain, a popular destination for potential expats. Whilst Spain does not offer low tax rates, it still remains a popular choice for UK emigrants because of its proximity to the UK, fantastic climate and political stability.

Those who either purchase Spanish assets or acquire Spanish residence will be affected by the local tax regime, so it is worth examining in greater detail.

We shall give a brief overview of the Spanish tax regime below. This will highlight the similarities and differences between the two countries, before looking at how the UK-Spain double tax treaty affects matters.

Residence

The extent that you are liable to these taxes will depend on your residence position. You will either be UK resident or Spanish resident (assuming you live and split your time between the UK and Spain).

Residence is important because UK and Spanish residents are taxed on their worldwide income and gains; whereas, non-residents are only liable to tax on the income arising within that particular country.

For example, non-UK residents are only liable to UK income tax on their UK income.

Spanish Residence

The first point to note is that the Spanish tax year is based on calendar years, unlike our tax year which runs from 6th April one year to 5th April the next year. There are numerous rules regarding different levels of status in Spain:

• Individuals who spend more than 183 days in Spain during one calendar year must apply for a Spanish resident card, and be classed as permanent residents. These days do not have to be consecutive. You do not become a resident for tax purposes until the morning of the 184th day. However, as from the 2007 tax year the Spanish resident card (known as a 'residencia') has effectively been withdrawn. As such you would look to notify the local town hall within three months of your arrival.
• Temporary absences from Spain are ignored for the purpose of this rule unless it can be proved that the individual is habitually resident in another country for more than 183 days in a calendar year.
• If you arrive in Spain with the intention of living there indefinitely, the Spanish tax authorities (known as the 'Hacienda') will treat you as Spanish resident from the day after your arrival.
• If your spouse lives in Spain, you will be presumed to be a resident of Spain, provided you are not separated/divorced even though you may actually spend fewer than 183 days per year in Spain.
• If you live on a boat within 12 nautical miles of Spanish land, you are classed as a Spanish tax resident. A day within 12 nautical miles is a day spent in Spain for tax purposes.

It is clear that by following the UK and Spanish domestic residence rules (above) an individual can be resident in both the UK and Spain. This is where it is important to identify how the double taxation agreement regulates matters.

How Does the UK/Spain Treaty Affect Matters?

The UK/Spain Double Tax Treaty has a 'tie-breaker' clause that comes into effect if an individual is classed as resident in the UK and Spain (under the domestic rules outlined above). This clause determines which country is to be given sole taxing rights and prevents an individual being subject to UK and Spanish taxes on the same income.

The double tax agreement states that:

• If an individual is resident in both Spain and the UK, according to the domestic tax rules, he is to be deemed resident in the country in which he has a permanent home.
• If he has permanent homes in both Spain and the UK, he is deemed to be resident in the country that is classed as his centre of vital interests. This is a vague term, although it is generally regarded as the country with which an individual has the strongest ties and will therefore include both personal and financial connections.
• If it's still not possible to determine which country has the taxing rights, the country in which he has his habitual abode will be his country of residence.
• If he has an habitual abode in the UK and Spain, he will be resident in the country in which he is a national.

Example

Bob, a UK resident, owns a villa in Spain. If he occupies the villa for three months he will be a UK (not Spanish) resident, liable to UK income tax. If Bob rents out the villa, both the UK and Spanish tax authorities are likely to want a piece of the action. Although a non-resident in Spain, Bob's rental income will have a Spanish source, so Spanish tax will be payable. The UK tax authorities will be interested because Bob is UK resident, therefore subject to UK income tax on his worldwide income. In this case, the UK-Spain double tax treaty gives both countries the right to tax the income, so Bob will pay UK income tax and Spanish income tax (at the non-resident rate of 24.75% for 2012 on the gross income, with no deductions for expenses or interest costs). Bob must keep copies of his Spanish tax returns, so he can offset the Spanish tax against his UK tax.

Let us assume that Bob is a UK higher-rate taxpayer and receives rental income of £10,000 and incurs costs of £2,000. The Spanish income tax liability would be £2,475 (£10,000 x 24.75%). UK tax would be £10,000 - £2,000 x 40% = £3,200.

Bob would then be entitled to deduct the Spanish income tax paid from the UK tax. The net effect is that Bob would actually pay £3,200 in income tax on the villa (£2,475 in Spain and £725 in the UK).

What Else Does the Double Tax Treaty Say?

The treaty has specific rules that will apply to certain types of income, irrespective of the domestic tax laws of the UK or Spain.

Under the domestic tax legislation of the UK and Spain, it is easily possible for income to fall within the UK and Spanish tax systems. This is clearly unfair, and both the UK and Spain provide for a system of double tax relief where there is an element of double taxation.

However, in order to minimise this double tax, the treaty has specifically stated in which country certain types of income will be taxed, when both countries may have a claim on the same income. The summarised rules are as follows:

Rental Income

The general rule is that this is taxed in the country where you are resident. Therefore once you become a resident in Spain, you will have to pay income tax on the rental income to the Spanish revenue authorities. However, the treaty also states that "income from immovable property... may be taxed in the Contracting State in which such property is situated".

In the case of a Spanish resident owning UK property, you would therefore still have to pay income tax on the rental income you derive from your UK property to UK Revenue and Customs.

The non-resident landlord scheme, which forces tenants and letting agents to pay over tax on behalf of overseas property owners, would then apply to collect UK tax. This means that you would pay tax in the UK as well as Spain, but would look to double tax relief to claim a deduction for the UK tax suffered. This would then prevent the rental income being taxed twice.

Dividends, Interest and Pension Income

The dividend and interest provisions give the primary right to tax dividends and interest to the country where the recipient is resident. Therefore, a Spanish resident individual receiving dividend income or interest from a UK resident company or bank would pay income tax in Spain under the terms of the double taxation agreement.

The treaty would also allow the UK to tax the income if it wished (subject to some limitations). However, as we've seen under the UK tax rules, there would usually be no UK tax liability on UK-sourced dividends or bank interest for a non-UK resident.

Pensions, apart from Government Service Pensions, are specifically stated to be only taxable in the country of residence. This is provided by Article 18 of the UK-Spain double tax treaty which states:

"(1) Subject to the provisions of Article 19 pensions and other similar remuneration paid in consideration of past employment to a resident of a Contracting State and any annuity paid to such a resident shall be taxable only in that State."

Therefore, a non-governmental pension paid from the UK to a Spanish resident would not be subject to UK income tax. If the pension was from the UK Government (for example, if you worked as a civil servant or a police officer, etc.) it would then, however, be taxed only in the UK. (This applies when you were both a Spanish resident and a Spanish national, in which case it would again be taxable only in Spain).

Property Capital Gains

These are taxed in the country where the property is situated, as well as the country of residence. However, most expats disposing of a UK property would be exempt from UK capital gains tax provided they satisfied the UK rules (for example, non-resident and not ordinarily resident for five complete tax years). In this case the tax liability would therefore primarily be a Spanish liability, and this would be at a rate of 21%.

You will see that whilst the domestic concepts of residence for UK and Spain are important, the double tax treaty certainly simplifies matters, as it basically tells us which country's rules to use. When considering a move to any country you should consider whether a double tax treaty exists and how this will have an impact on the tax treatment of income and gains.

If you remain a UK resident you'll need to determine the impact of both UK and Spanish taxes.

Changes to UK and Spanish Capital Gains Tax

Anyone who owns a property in Spain may well be aware of the recent changes to the capital gains tax regime.

As from 1 January 2010 you would be subject to Spanish CGT at 19%. Residents will be taxed at 21% on gains above €6,000.

From 1 January 2012 these rates have changed. Non Spanish residents are subject to CGT at 21%, whereas residents are taxed at 21%, 25% or 27% depending on the size of the capital gain.

Spanish residents enjoy other advantages over non-residents:

• If you are over 65 years of age and have lived in the property for three years or more, you will not be subject to capital gains tax when you sell.
• If the property is your principal residence and you have owned it for at least three years, you can claim part or all of the tax back if you buy another principal residence within two years.

UK capital gains tax was recently changed for disposals taking place after 22nd June 2010. The flat 18% tax rate has been replaced by two rates: 18% for basic-rate taxpayers and 28% for higher-rate taxpayers.

How these Changes Will Affect You

If you own a Spanish property and are UK resident, will these changes have any impact on you? The short answer is yes.

As a UK resident, you are usually taxed on your worldwide income and gains. Any gain will be reduced by the annual capital gains tax exemption (£10,600 for the 2013/14 tax year). If you are a higher-rate taxpayer and sell after 22nd June 2010, you will pay UK CGT at 28%.

You will be subject to UK CGT as well as Spanish CGT because the property is in Spain. The UK-Spain double tax treaty states that:

"...Capital gains from the alienation of immovable property, as defined in paragraph (2) of Article 6, may be taxed in the Contracting State in which such property is situated..."

Therefore, you will be taxed in the UK and Spain, although the treaty, as well as UK domestic tax law, allows the Spanish tax to be offset against your UK tax.

The Spanish CGT rate is less than the UK rate if you are a higher-rate taxpayer. This means the UK tax will be partially offset by the Spanish tax charge. In practice, however, there are additional factors to consider because gains are calculated differently in each country. For example, in the UK the annual CGT exemption could reduce a gain by over £21,200 for a couple, resulting in even lower effective capital gains tax rates. Similarly in Spain there is something called the 'indexation coefficient' which can reduce the amount of tax payable.

If the gain is relatively small (for example, £80,000) the two annual CGT exemptions (for properties owned jointly) could significantly reduce the effective tax rate. For example, a gain of £80,000 would be reduced to £58,800. Tax at 28% would be £16,464, producing an effective tax rate of 21%.

14.7 CAPITAL GAINS TAX IN OTHER COUNTRIES

Most countries adopt similar provisions to those above, with the result that both the UK and overseas country would have taxing rights over capital gains. One of the few treaties that does not apply this rule is the one between the UK and Greece, which states:

"A resident of one of the territories who does not carry on a trade or business in the other territory through a permanent establishment situated therein shall be exempt in that other territory from any tax on gains from the sale, transfer or exchange of capital assets."

The effect of this would be that if you are a resident of Greece and own UK property you would not be subject to UK CGT when you sell the property. Of course, in most cases this will not be important because if you are a resident of Greece, you would be non-UK resident and possibly exempt from UK capital gains tax anyway.

The main use of the Greece treaty used to be to avoid the five-year absence rule for UK capital gains. However, as we have seen, this rule has now been amended so that it cannot be circumvented by using a double tax treaty.

If you are serious about avoiding both UK and overseas tax on the disposal of UK properties you need to satisfy the five-year rule to avoid UK capital gains tax and make sure that the overseas country in which you are resident will not itself tax the gain.

There are different ways that you can avoid paying taxes overseas. The overseas country may simply levy no taxes at all, or it may levy income tax but not capital gains tax, or it may apply a territorial basis and just tax local income and gains. There are lots of countries that could be used to avoid tax on any UK property investment gains including the Caribbean tax havens: Cyprus, the Isle of Man, Malta, and Monaco.

We've covered these in more detail in our guide, The World's Best Tax Havens.

If you are not disposing of land or property but disposing of shares in a company the treatment in the double tax treaty could vary a lot more.

The new UK-France treaty (in force from April 2010), for instance, states that:

"…Gains from the alienation of any property other than that referred to in paragraphs 1, 2, 3 and 4 (paragraphs 1, 2, 3 and 4 primarily relate to land, property and assets used in a permanent establishment) shall be taxable only in the Contracting State of which the alienator is a resident…"

"...The provisions of paragraph 5 shall not affect the right of a Contracting State to levy according to its law a tax chargeable in respect of gains from the alienation of any property on a person who is, and has been at any time during the previous six fiscal years, a resident of that Contracting State or on a person who is a resident of that Contracting State at any time during the fiscal year in which the property is alienated…"

So, if you are a French resident and have been a UK resident at any time in the previous six years and sold other UK assets (e.g., shares in a UK company), you could be taxed in the UK. As stated previously, the five-year residence exemption may apply anyway. You would be subject to French taxes, though, on the basis that you were a French resident.

By contrast, the UK-Denmark treaty doesn't expressly cover the position of a disposal of shares and states:

"...Gains from the alienation of any property other than that referred to in paragraphs (1), (2), (3) and (4) of this Article, shall be taxable only in the Contracting State of which the alienator is a resident..."

This would allocate sole taxing rights over the shares disposal to Denmark. In both cases, the overseas country of residence would obtain a right to tax the gain, the difference is that in the latter the treaty would only allow Denmark to tax the gain unless you went back to the UK without satisfying the five-year absence rule.

14.8 COUNTRIES WITHOUT A UK DOUBLE TAX TREATY

The UK has double tax treaties with lots of countries. These provide relief from double tax. The most common cases when a double tax treaty will apply are when interest or pensions are paid in one country to people living in another state.

The purpose of these treaties is not just to provide tax relief but also to allow the easy exchange of information between two countries. This will often be to verify that an individual is a tax resident overseas, and also to alert the overseas state to sources of income (for example, UK dividends).

It also makes sense to know which countries do not have a detailed treaty with the UK. In particular, if you are looking for enhanced privacy protection the lack of a double tax treaty can assist. Take a look at double tax treaties but also whether there is a separate information exchange agreement between the UK and the relevant overseas country.

Both the G20 and OECD are looking to increase international tax cooperation and you will see many more information exchange treaties being signed over the next few years.

In terms of tax treaties, however, the following countries do not currently have a treaty with the UK:

As you can see, there are quite a few, and many of these are tax havens or at the very least offer certain tax saving opportunities. (For example, many have no capital gains tax).

14.9 HOW AN ESTATE TAX TREATY CAN BE USED

Although the above income tax treaties are very handy in terms of reducing taxes on income and gains, they are completely useless if you are trying to assess your inheritance tax position. The reason for this is that the 'Taxes Covered' section of tax treaties does not cover inheritance tax.

The UK does have some inheritance tax treaties; however, these are much fewer in number. There are around nine in total with France, Switzerland, Italy, India, South Africa, the US and Sweden. The technical name for these is 'Estate and Inheritance Tax Agreement' and they determine how each country will share out the tax collected from your estate.

Importance of Domicile

The key issue in terms of UK inheritance tax is domicile. Forget residence and even ordinary residence, inheritance tax looks at something much more substantive. Domicile and the location of assets are important. As we have seen, the UK Revenue will tax:

• UK domiciliaries on their worldwide estate,
• Non-UK domiciliaries on their UK estate only

An estate tax treaty will be relevant where someone is subject to inheritance tax in more than one country. This could be a UK domiciliary with assets overseas. In this case the overseas assets would be within the scope of UK tax and also within the scope of overseas tax, as many countries have similar rules to the UK and tax assets within their jurisdiction.

There is also a much wider interpretation which arises because a person can remain UK domiciled despite not setting foot in the UK for ten years. As many overseas countries base inheritance tax on residence, you could easily have two countries trying to tax all of a deceased's worldwide assets: the UK on the basis of a UK domicile and the overseas country on the basis of residence.

The treaty will be very important in these cases as it explains the tax rights of each country.

The Importance of Establishing Treaty Domicile

The UK estate tax treaties specifically provide for the UK domicile rules to apply, but they also address the case where two countries are claiming the right to tax a person on his worldwide assets. Let us have a look at an extract from a treaty and see exactly what it states. In this case we will look at the UK-Switzerland treaty:

Article 4

Fiscal domicile
(1) For the purposes of this Convention, a deceased person was domiciled: (a) in the United Kingdom if he was domiciled in the United Kingdom in accordance with the law of the United Kingdom or is treated as so domiciled for the purposes of a tax which is the subject of the Convention; (b) in Switzerland if he was domiciled or was resident in Switzerland in accordance with the law of Switzerland or if he was a Swiss national and Swiss civil law requires his succession to be ruled in Switzerland.

Note that the Convention defines the scope of fiscal domicile separately for the UK and for Switzerland. In the case of the UK, it will also include the deemed domicile rules. These state that a person will be deemed to be UK domiciled for inheritance tax purposes if they are resident in the UK for 17 out of the previous 20 years and also for three years after they actually lose UK domicile status.

However, a deceased person will not be deemed to be domiciled in one of the states if that state imposes tax only by reference to property situated in that state. So a UK domiciliary owning property in Switzerland would not be classed as Swiss domiciled just because he owns property there.

(2) Where by reason of the provisions of paragraph (1) of this Article a deceased person was domiciled in both States, then, subject to the provisions of the attached Protocol, his status shall be determined as follows: (a) he shall be deemed to have been domiciled in the State in which he had a permanent home available to him; if he had a permanent home available to him in both States, he shall be deemed to have been domiciled in the State with which his personal and economic relations were closer (centre of vital interests); (b) if the State in which he had his centre of vital interests cannot be determined, or if he did not have a permanent home available to him in either State, he shall be deemed to have been domiciled in the State in which he had an habitual abode; (c) if he had an habitual abode in both States or in neither of them, he shall be deemed to have been domiciled in the State of which he was a national; (d) if he was a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

This is how the treaty determines which country will have primary taxing rights for inheritance tax purposes. These are exactly the same tests as many income tax treaties apply, in that it will be necessary to first look at the country of permanent residence, and if this does not determine domicile, the centre of vital interests would be determined. It is rarely necessary to look at other issues, but if necessary habitual abode and nationality could also be important factors.

Therefore if a UK domiciliary had property in the UK and Switzerland, but was a resident of Switzerland, the treaty would usually apply to give Switzerland taxing rights over the worldwide estate. If this individual also had assets located overseas this could lead to a significant tax saving given that Swiss inheritance tax is much lower than UK inheritance tax.

In this respect, obtaining permanent residence in a treaty country can be highly beneficial for UK domiciliaries as it can eliminate the potential risk of a UK inheritance tax charge on your worldwide estate. Instead, you will only be taxed in the overseas country.

It makes sense, if you are planning to emigrate to a country with which the UK has an estate tax treaty, to establish treaty domicile there (a permanent home in the country concerned) to avoid the risk of double taxation.

The interpretation of double tax treaties is a complex area, and you should always take advice from an international tax specialist.

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About the Author

He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.

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