In the context of Global Mobility, with employees transitioning from one location to another location, there will be potential for cross-border tax issues. Whether this is a temporary assignment or a permanent move, income taxes may be due in both the origin and destination locations and there is the possibility that the same income is taxable to both tax jurisdictions. So double tax relief is essential to minimize the tax costs.
Tax on employment income is generally due in the location of where the employee is working. This is known as taxation based on the source of the income. This may not be the same location where the employee is tax resident. Residency usually means that residents are taxed on worldwide income. This can result in two jurisdictions taxing the same income if there is no double tax relief. Fortunately for Global Mobility programs, there are several ways to take advantage of double tax relief. Understanding these ways to minimize tax costs is essential for the global mobility professional.
Home Country Residency and Ongoing Tax Exposure
Most of the world taxes individuals on a residence basis, meaning an individual that leaves the country on a long-term or permanent basis is no longer taxed on income received outside of that country. Citizenship-based taxation in the U.S. requires individuals to report all their worldwide income, with (partial or complete) double tax relief available through foreign tax credits, foreign earned income exclusion under the U.S. Tax Code section 911, or income tax treaty application.
Under residence-based taxation, an individual may still be considered a resident during a short-term or temporary assignment. Breaking home country tax residency is not always a “bright-line” test, or something that can be declared by filing paperwork. Governments intentionally leave residence open to interpretation of the “facts and circumstances” that are considered, such as owning property, frequent visits, location of immediate family members, center of economic nexus, voting registration, maintaining a driving license, etc.
If an individual is considered a resident of their home country while on a temporary foreign assignment, they will typically be required to report their worldwide income and make use of double tax relief methods.
In our first AIRSHARE post on the topic of double tax relief we discussed foreign tax credits and exemption with progression. In this post we will review exemption from tax under local tax law and treaty rules. In a subsequent post will we detail the unique considerations for U.S. citizens and permanent residents (green card holders).
We also have available for download our ‘Back to Basics’ whitepaper on the topic of U.S. residual taxation and double tax relief.
Exempt from Host Country Tax applying Host Tax Law
An employee may be exempt from host tax based upon taxability thresholds such as a minimum taxable income, minimum number of days present in the host country, or both. These exemption thresholds typically are used in shorter-term business traveler arrangements. In addition, it may be possible to qualify for host tax exemption based on an employee’s visa, work activities, or other status. For example, certain humanitarian workers and foreign diplomatic government workers are granted exemptions from tax.
Exempt from Host Country Tax applying Tax Treaty Rules
Tax treaties are agreements between countries to coordinate the tax laws involving cross-border taxation. The general rule is that employment income is taxed where the services are performed — the host country in the case of international assignments. However, if all criteria are met, the income is exempt from host taxation and subject to tax only in the country of residence – the home country.
Generally, there are 3 basic criteria to meet the tax treaty exemption:
- Present in the host country for 183 days or less – within a tax year, or more commonly, within any 12-month period, and
- The employee is not on the host country payroll, and
- The costs of the employee’s compensation cannot be charged back to the host country employer
The application of the tax treaty rules is complex and requires a sound understanding of the company’s tax situation as well as the employee’s time spent in the host country.
