How double tax treaties can save tax
Understanding exactly what a double tax treaty says, and what it means can be very important. Although it's generally best left to professionals there's no harm in having a general understanding of what these tax treaties mean. This will then allow you to have a look at the treaty implications for yourself, before getting a tax review by a professional.
In this post we'll therefore have a quick run through some of the double tax treaty provisions and what they actually mean.
We'll be using the UK-Spain treaty as an example, as this is a treaty that will be of direct relevance to many UK citizens (eg because they own property there, plan to move or retire there) as well as containing standard OECD provisions.
Article - Taxes covered
(1) The taxes which are the subject of this Convention are:
(a) in the United Kingdom of Great Britain and Northern Ireland:
(i) the income tax;
(ii) the corporation tax; and
(iii) the capital gains tax;
(hereinafter referred to as `United Kingdom tax`);
(b) in Spain:
(i) the general income tax on individuals (el impuesto general sobre la Renta de las personas fisicas);
(ii) the general corporation tax (el impuesto general sobre la Renta de Sociedades y demas entidades juridicas);
(iii) the following prepayments: the tax on rural land, the tax on urban land, the tax on earned income, the tax on income from capital, the tax on business and industrial activities (los siguientes impuestos a cuenta: la Contribucion Territorial sobre la Riqueza Rustica y Pecuaria, la Contribucion Territorial sobre la Riqueza Urbana, el impuesto sobre los Rendimientos del Trabajo Personal, el impuesto sobre las Rentas del Capital y el impuesto sobre Actividades y beneficios comerciales e industriales);
(iv) In Sahara, the income taxes on earned income and on income from capital and the taxes on profits of the enterprises (en Sahara, los impuestos sobre la renta sobre los rendimientos del trabajo y del patrimonio y sobre los beneficios de las empresas);
(v) The `surface royalty` and the tax on corporation profits, regulated by the Law of 27 June 1974 applicable to enterprises engaged in prospecting and exploiting oil wells (el Canon de superficie y el impuesto sobre los beneficios, regulados por la Ley de 27 de Junio de 1974 aplicable a las empresas que se dedican a la investigacion y explotacion de hidrocarburos);and
(vi) the local taxes on income and capital (los impuestos locales sobre la renta y el partimonio); (hereinafter referred to as `Spanish tax`).
(2) This Convention shall also apply to any identical or substantially similar taxes which are imposed by either Contracting State after the date of signature of this Convention in addition to, or in place of, the existing taxes. At the end of each year, the competent authorities of the Contracting States shall notify to each other any changes which have been made in their respective taxation laws.
This is pretty straightforward really and simply outlines the taxes that the treaty will apply to, both in the UK and in Spain. If the tax isn't covered by the treaty then the treaty will not have any influence over the tax treatment.
In this case you'll see that the treaty covers the three main direct UK taxes (Income tax, CGT and Corporation tax). Note that Inheritance tax is never included in these treaties and the UK has some separate Estate tax treaties that cover this.
In the case of Spain, it covers Income tax, and company tax, but there is no mention of CGT. This is because in Spain capital gains are usually classed as part of income and are subject to income taxes.
Article - General definitions
(1) In this Convention, unless the context otherwise requires:
(a) the term `United Kingdom` means Great Britain and Northern Ireland including any area outside the territorial sea of the United Kingdom which in accordance with international law has been or may hereafter be designated under the laws of the United Kingdom concerning the Continental Shelf, as an area within which the rights of the United Kingdom with respect to the sea bed and sub-soil and their natural resources may be exercised;
(b) the term `Spain` means the Spanish State and, when used in a geographical sense, Peninsular Spain, the Balearic and Canary Islands, and the Spanish towns and territories in Africa, including any area outside the territorial sea of Spain which in accordance with international law has been or may hereafter be designated, under the laws of Spain concerning the Continental Shelf, as an area within which the rights of Spain with respect to the sea bed and subsoil and their natural resources may be exercised;
(c) the term `national` means:
(i) in relation to the United Kingdom, any citizen of the United Kingdom and Colonies who derives his status as such from his connection with the United Kingdom and any legal person, association or other entity deriving its status as such from the law in force in the United Kingdom;
(ii) in relation to Spain, any individual possessing the nationality of Spain and any legal person, partnership or association deriving its status as such from the law in force in Spain;
(d) the term `international traffic` means any transport by a ship or aircraft operated by an enterprise of a Contracting State, except when the ship or aircraft is operated solely between places in the other Contracting State;
(e) the terms `a Contracting State` and `the other Contracting State` mean the United Kingdom or Spain as the context requires;
(f) the term `person` comprises an individual, a company and any other body of persons;
(g) the term `company` means any body corporate or any entity which is treated as a body corporate for tax purposes;
(h) the terms `enterprise of a Contracting State` and `enterprise of the other Contracting State` mean respectively an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of the other Contracting State;
(i) the term `competent authority` means, in the case of the United Kingdom the Commissioners of Inland Revenue or their authorised representative and, in the case of Spain, the Minister of Finance, the Technical General Secretary or any other authority to whom the Minister delegates.
(2) As regards the application of this Convention by a Contracting State any term not otherwise defined shall, unless the context otherwise requires, have the meaning which it has under the laws of that Contracting State relating to the taxes which are the subject of this Convention.
Again this is a straightforward article in that it simply defines various terms that are used throughout the treaty. You'll see that a company is classed as anything treated as a body corporate for tax purposes. Therefore even though something is not actually called a company, it will be treated as if it was a company if it was treated as a separate entity for tax purposes.
Article - Fiscal domicile
(1) For the purposes of this Convention, the term `resident of a Contracting State` means, subject to the provisions of paragraphs (2) and (3) of this Article any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature; the term does not include any individual who is liable to tax in that Contracting State only if he derives income from sources therein. The terms `resident of the United Kingdom` and `resident of Spain` shall be construed accordingly.
(2) Where by reason of the provisions of paragraph (1) of this Article an individual is a resident of both Contracting States, then his status shall be determined in accordance with the following rules:
(a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him. If he has a permanent home available to him in both Contracting States, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests);
(b) if the Contracting State in which he has his centre of vital interests cannot be determined, or if he has not a permanent home available to him in either Contracting State, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;
(c) if he has an habitual abode in both Contracting States or in neither of them, he shall be deemed to be a resident of the Contracting state of which he is a national;
(d) if he is a national of both Contracting States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.
(3) Where by reason of the provisions of paragraph (1) of this Article a person other than an individual is a resident of both Contracting States, then it shall be deemed to be a resident of the Contracting State in which its place of effective management is situated.
This is an important article as it defines who is classed as a tax resident for the purposes of the treaty. This is important because you need to look at who's treaty resident when you're assessing the scope of a country's tax charges under the treaty.
Treaty residence looks at various factors to assess in which country you are resident in, this is irrespective of any UK or Spanish domestic tax rules.
Therefore the UK-Spain treaty looks at:
Place of permanent home
Place of Centre of vital interests
Place of habitual abode
Nationality
Based on this if you were classed as resident of both the UK and Spain, the treaty would look to where your permanent home or family ties were to assess which is your country of residence when looking at the treaty. If you lived in Spain most of the year but happened to pass the 90 days limit in the UK, for treaty purposes you would remain Spanish resident.
In many cases it makes sense to obtain treaty residence overseas as soon as possible to limit the effect of any subsequent argument that you were also UK resident.
It's also important to note that this tie breaker applies not only to individuals but also to companies. So if a company is tax resident in both the UK and Spain by virtue of the domestic tax provisions (eg where it's incorporated in Spain but managed from the UK) the treaty directs that the company is resident for the purposes of the treaty in the country where the effective management is located.
Article - Permanent Establishment
(1) For the purposes of this Convention, the term ` permanent establishment` means a fixed place of business in which the business of the enterprise is wholly or partly carried on.
(2) The term `permanent establishment` shall include especially:
(a) a place of management;
(b) a branch;
(c) an office;
(d) a factory;
(e) a workshop;
(f) a mine, oil well, quarry or other place of extraction of natural resources;
(g) a building site or construction or assembly project which exists for more than twelve months.
(3) The term`permanent establishment` shall not be deemed to include:
(a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;
(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
(d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or for collecting information, for the enterprise;
(e) the maintenance of a fixed place of business solely for the purpose of advertising for the supply of information, for scientific research or for similar activities which have a preparatory or auxiliary character, for the enterprise.
(4) A person acting in a Contracting State on behalf of an enterprise of the other Contracting State--other than an agent of an independent status to whom the provisions of paragraph (5) of this Article apply--shall be deemed to be a permanent establishment in the first-mentioned State if he has, and habitually exercises in that State, an authority to conclude contracts in the name of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise.
(5) An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent or any other agent of an independent status, where such persons are acting in the ordinary course of their business.
(6) The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.
This is also an important article as it defines exactly what is a permanent establishment. The implications of having a permanent establishment are looked at in other chapters, however it's worthwhile noting that it provides some definitions of exactly what is, as well as what isn't a permanent establishment. In particular if you have an agent that has authority to sign contracts on your behalf in Spain, this will often be treated as a permanent establishment.
Article 6 - Income from immovable property
(1) Income from immovable property including income from agriculture or forestry may be taxed in the Contracting State in which such property is situated.
(2) The term `immovable property` shall be defined in accordance with the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources; ships, boats and aircraft shall not be regarded as immovable property.
(3) The provisions of paragraph (1) of this Article shall apply to income derived from the direct use, letting, or use in any other form of immovable property.
(4) The provisions of paragraphs (1) and (3) of this Article shall also apply to the income from immovable property of an enterprise and to income from immovable property used for the performance of professional services.
This article will mainly apply to rental income. Immovable property includes real estate, and this therefore states that any rental income can be taxed in the country where the property is AS WELL as in the country of residence.
So, a UK resident, with a Spanish rental property, will be taxed under the treaty in both Spain and the UK. However double tax relief is then available to prevent double taxation
Article 7 - Business profits
(1) The profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other Contracting State but only so much of them as is attributable to that permanent establishment.
(2) Subject to the provisions of paragraph (3) of this Article, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.
(3) In the determination of the profits of a permanent establishment, there shall be allowed as deductions expenses which are incurred for the purposes of the permanent establishment (including executive and general administrative expenses so incurred) whether in the Contracting State in which the permanent establishment is situated or elsewhere.
(4) No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise.
(5) For the purposes of the preceding paragraphs, the profits to be attributed to the permanent establishment shall be determined by the same method year by year unless there is good and sufficient reason to the contrary.
(6) Where profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.
This states that a person carrying on a business will be taxed in the country of residence, unless they operate overseas via a permanent establishment.
Therefore a UK resident trading overseas would only be taxed in Spain if there was a permanent establishment in Spain. In terms of E-commerce for example, having a website and selling to customers in Spain should not lead to any Spanish tax implications provided the business did not have a place of management/factory etc in Spain.
If there was a permanent establishment you would then need to prepare a calculation of the profits that would have arisen to the overseas base if it was wholly independent from your business. This is effectively a transfer pricing issue and you would then need to assess the profits on an arms length basis. You would need detailed advice on this.
Article - Interest
(1) Interest arising in a Contracting State which is derived and beneficially owned by a resident of the other Contracting State may be taxed in that other State.
(2) However, such interest may also be taxed in the Contracting State in which it arises, and according to the law of that State, but the tax so charged shall not exceed 12 per cent of the gross amount of the interest.
(3) The term `interest` as used in this Article means income from Government securities, bonds or debentures, whether or not secured by mortgage and whether or not carrying a right to participate in profits, and other debt-claims of every kind as well as all other income assimilated to income from money lent by the taxation law of the State in which the income arises.
(4) The provisions of paragraphs (1) and (2) of this Article shall not apply if the beneficial owner of the interest, being a resident of a Contracting State, carries on in the other Contracting State in which the interest arises a trade or business through a permanent establishment situated therein or performs in that other State professional services from a fixed base situated therein and the debt-claim in respect of which the interest is paid is effectively connected with such permanent establishment or fixed base. In such a case, the provisions of Article 7 or Article 14 as the case may be, shall apply.
(5) Interest shall be deemed to arise in a Contracting State when the payer is that State itself, a political subdivision, a local authority or a resident of that State. Where however, the person paying the interest, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment in connection with which the indebtedness on which the interest is paid was incurred, and such interest is borne by that permanent establishment, then such interest shall be deemed to arise in the Co
(6) Any provisions of the law of one of the Contracting States under which interest paid by one company to another would be treated as a dividend or distribution to be left out of account in computing the taxable profits of the paying company shall not operate where the interest is paid to and beneficially owned by a company which is a resident of the other Contracting State. The preceding sentence shall not apply where more than 50 per cent of the voting power in the last-mentioned company is controlled, directly or indirectly, by a person or persons resident in the first mentioned State.
(7) The relief from tax provided for in paragraph (2) of this Article shall not apply to interest on any form of debt-claim dealt in on a stock exchange where the beneficial owner of the interest:
(a) does not bear tax in respect thereof in the Contracting State of which it is a resident; and
(b) sells (or makes a contract to sell) the debt-claim from which such interest is derived within three months of the date on which such beneficial owner acquired such debt-claim.
(8) Where, owing to a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest paid, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In that case, the excess part of the payments shall remain taxable according to the law of each Contracting State, due regard being had to the other provisions of this Convention.
(9) The provisions of this Article shall not apply if the debt-claim in respect of which the interest is paid was created or assigned mainly for the purpose of taking advantage of this Article and not for bona fide commercial reasons.
This essentially applies to restrict any withholding taxes on payments of interest. The article states that interest paid in one country to the resident of another can be taxed in both states. However, the tax payable in the country of the interest payment is restricted to 12% of the gross interest payment (ie the interest + the tax). In order to apply for the reduced withholding tax to be applied you would need to make a claim with HMRC, and in this case it would be made on a form available from the Revenue.
Article 12 - Royalties
(1) Royalties arising in a Contracting State which are derived and beneficially owned by a resident of the other Contracting State may be taxed in that other State.
(2) However, such royalties may also be taxed in the Contracting State in which they arise and according to the law of that State, but the tax so charged shall not exceed 10 per cent of the gross amount of the royalties.
(3) The term `royalties` as used in this Article means payments of any kind received as consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work (including cinematograph films, and films or tapes for radio or television broadcasting), any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.
(4) The provisions of paragraphs (1) and (2) of this Article shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on in the other Contracting State in which the royalties arise a trade or business through a permanent establishment situated therein or performs in that other State professional services from a fixed base situated therein and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such a case, the provisions of Article 7 or Article 14, as the case may be, shall apply.
(5) Royalties shall be deemed to arise in a Contracting State where the payer is that State itself, a political subdivision, a local authority or a resident of that State. Where, however, the person paying the royalties, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment in connection with which the obligation to pay the royalties was incurred and the royalties are borne by that permanent establishment, then the royalties shall be deemed to arise in the Contracting State in which the permanent establishment is situated.
(6) Where, owing to a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the royalties paid, having regard to the use, right or information for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In that case, the excess part of the payments shall remain taxable according to the law of each Contracting State, due regard being had to the other provisions of this Convention.
(7) The provisions of this Article shall not apply if the right or property giving rise to the royalties was created or assigned mainly for the purpose of taking advantage of this Article and not for bona fide commercial reasons.
The wording in this is almost identical to the wording for the above interest article. The main difference is that the withholding tax for Royalties is reduced to 10% as opposed to 12%. This means that if you live in Spain but have royalties paid from the UK, you can apply to the UK Revenue to have tax deducted at 10% as opposed to the standard withholding tax rate of 20%.
You should note that each agreement is unique and you couldn't assume that all treaties adopted the same rates. For example the UK-Cyprus treaty provides for a withholding tax rate of 10% for interest, and 5% for royalties. Therefore you'll need to review the relevant treaty to assess its impact.
Article 13 - Capital gains
(1) 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.
(2) Capital gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing professional services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in the other State.
(3) Notwithstanding the provisions of paragraph (2) of this Article, capital gains derived by a resident of a Contracting State from the alienation of ships and aircraft operated in international traffic and movable property pertaining to the operation of such ships and aircraft shall be taxable only in that Contracting State.
(4) Capital gains from the alienation of any property other than those mentioned in paragraphs (1), (2) and (3) of this Article shall be taxable only in the Contracting State of which the alienator is a resident.
As many people look to go overseas to avoid UK CGT, this is a very important article. In this case it states that capital gains arising from property/real estate can be taxed in both the UK and Spain. Having said that just because a country can tax gains doesn't necessarily mean that it will.
Therefore a resident of Spain selling a UK investment property portfolio would be subject to tax in both the UK and Spain. However, a non UK resident would not be subject to CGT on disposals of assets, providing they are not used for the purposes of a UK branch or agency trade. Therefore whilst under the treaty both a UK and Spanish tax charge would arise, in practice there is likely to be only a Spanish tax charge (provided the five year non residence requirement is satisfied if this applies to you)
Article - Independent personal services
(1) Income derived by a resident of a Contracting State in respect of professional services or other independent activities of a similar character shall be taxable only in that State unless he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities. If he has such a fixed base, the income may be taxed in the other Contracting State but only so much of it as is attributable to that fixed base.
(2) The term `professional services` includes especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists and accountants.
This is similar to the business profits article but applies to professionals who don't actually carry out a trade (as they carry out a profession). The rules are almost identical and you would only be subject to tax in an overseas country if you had a 'fixed base' there. This therefore gives primary taxing rights to the country of treaty residence, and it would only be if you had a definite business premises overseas that you'd be taxable there. Note that this article uses the term 'fixed base' as opposed to 'permanent establishment' however in practice the two will be likely to be very similar in any case.
So in the case of a UK treaty resident lawyer providing advice over the internet, providing there was no office in Spain, he would not be liable to Spanish tax on the profits realised, even if some of his clients were Spanish.