Tax treaties and the teleworker

As teleworking is becoming more and more popular we thought we'd look at how a tax treaty would impact on someone working remotely. Tax treaties are an important consideration for the telecommuter, particularly if they remain liable to taxes in their home country (e.g. the US). Tax treaties apply to minimise or eliminate any double charge to tax when two countries would both have taxing rights over the same income. So, in the case of a telecommuter, if he is resident in the UK, but performs services for an employer in Spain, there would be a potential double charge to tax (UK as country of residence, Spain as an employee of Spanish company). Similarly, a US expat (and US citizen) would remain charged to US tax on employment income, even if he was resident in another country and performed services from there. Lets have a look at a typical provision that you may see in a double tax treaty relating to employment income (this one is taken from the UK/US treaty): (1) ... salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived there from may be taxed in that other State. (2) Notwithstanding the provisions of paragraph (1), remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if: (a) the recipient is present in that other State for a period not exceeding, in the aggregate, 183 days in the tax year concerned; and (b) the remuneration is paid by, or on behalf of, an employer who is not a resident of that other State; and (c) the remuneration is not borne as such by a permanent establishment or a fixed base, which the employer has in that other State... How do these impact on telecommuters? Well, provision (1) is effectively saying that if you were resident in the UK and employed in the UK, you would be taxed only in the UK unless you actually carried out employment in the US (in which case part of the employment income could be taxable in the US). In other words, it gives taxing rights to the country of residence, as well as the country where the employment was actually exercised. Provision (2) is of less use to a telecommuter, as it is saying that if you were a UK resident, but worked in the US, the salary could only be taxed in the UK if : (a) you were not in the US for more than 183 days in the tax year concerned; and (b) the salary is paid by, or on behalf of, an employer who is not a resident of that the US; and (c) the salary is not borne by an entity that has a permanent establishment in the US (e.g. recharging the salary to a US company). The purpose of this is to provide an exception to the general rule that employment income may be taxed in the country where the employment is exercised. This is of less use to a telecommuter than the first as it will only really be relevant where the country of residence and the country of employment/performance of duties are different. Given that most telecommuters will be looking to reside overseas and perform their work from there, this would not apply. Note that one example where it may apply would be if you went overseas to work but did not actually become resident overseas. The first provision though would be of great importance for a telecommuter especially as the tax treaty rules will usually override the IRS domestic law. This would then enable a former US resident to avoid US income tax on salary paid overseas for duties performed overseas and where he is a non-resident. What if you're not an employee? You may be telecommuting in an independent capacity as opposed to an employee. In this case, the general rule that is laid down by a tax treaty would be that that an individual who is a resident of a country and who derives income from performing services in another country will be exempt from tax in respect of that income by the second country. The income could be taxed in the second country only if the services are performed there and the income is attributable to a fixed base that is regularly available to the individual for the purpose of performing his services. Therefore when looking at this the tax authorities would look to identify if you have a fixed base (similar to a permanent establishment) that trades overseas e.g. an office. In the case of a telecommuter they would usually not have any fixed base overseas as they would be providing all the services from the country of their residence. Therefore of crucial importance in this area is any double tax treaty and this should be reviewed, however provided the non resident company does not have any fixed base there should be no charge to either company or income tax. Simply providing services from overseas, with no significant local role in the provision of the service, should not be caught by these provisions and most telecommuters would therefore not be caught under a double tax treaty for tax on locally earned income. Double tax treaties can therefore be very beneficial for the telecommuter, however it's important to realise that not all countries will have double tax treaties. Many of the Caribbean tax havens do not have any tax treaties at all, which may not prevent you from escaping taxes, particularly in the US. Also, as tax treaties will generally substitute one taxing country for another you should be careful to ensure that you don't actually end up paying tax at a higher rate. Countries that do offer a good range of double tax treaties include:

UK

US

Cyprus

Malta

Barbados (has treaty with US)

Mauritius

Indonesia

Mexico (has US treaty)

Ireland