A second home abroad is an attractive option for many founders and entrepreneurs, especially during the cold season. Whether for working or living, the constant change between home and abroad has become almost commonplace nowadays.
Furthermore, investing in foreign funds and companies (so-called outbound investments) has become part of daily business. However, these "personal and economic" connections to different countries bring with them difficulties in terms of tax law, the keyword: double taxation. Here you can find out all the important points about double taxation for individuals.
In this article you will learn
- what is meant by double taxation
- how to avoid them through DTAs and OCED model treaties
- which attributes lead to the determination of the tax liability
What does the term double taxation mean?
Double taxation can occur when a (natural) person or a company is liable to tax in two different countries and both countries have the right to levy taxes on the same income. Double taxation can lead to a significant financial burden, especially if the tax rates in both countries are high.
Allocation of taxation rights to avoid double taxation
International tax law regulates the distribution of taxation rights: which state may tax which income. These issues are to be solved by so-called “agreements for the avoidance of double taxation” (in short: double taxation agreements or DTAs) between the states. In these agreements, the right of taxation can be assigned to one of the two contracting states and/or double taxation of the same income can be avoided through appropriate techniques.
The decisive factor for the allocation of income is the residence of the taxpayer. Residence thus plays an important role for the claiming of the benefits from the DTA; still, it is to be separated from the (national) question of unlimited tax liability. Thus, a taxpayer may be subject to unlimited tax liability in two Contracting States but be a resident of only one of the Contracting States.
Solution To solve this problem, the "OCED Model Agreement" provides for a certain examination sequence (escalation levels) of different characteristics.
Determination of residency
The first connecting factor for residence is domicile. If a taxpayer maintains a domicile in each of the different states, the sole consideration of the domicile does not provide a satisfactory result for the question of his residency.
In a next step, a tie-breaker-rule is applied.
The closer connection to a contracting state is to be determined by considering various characteristics. One indication here is the center of the taxpayer's vital interests.
Features for determining the tax liability
This is about "personal and economic relationships." These include, for example:
- family connections
- the place of residence of the partner
- the place of work, or even the
- the place where the assets are managed
However, even the consideration of these characteristics cannot lead to an unambiguous result if the personal and economic circumstances are distributed almost equally between two states. Personal and economic connections do not have to be cumulative, but there must be a clear tendency toward one state in order to affirm the location of the center of life interests there.
This means that there must be "a sufficiently clear recognizability of the stronger ties to a state." Judicial practice is also not unanimous as to which characteristics are to be given greater weight. Southern European states primarily use personal relationships to make their decisions; Eastern Europe and the United Kingdom tend to use economic ones.
How does the Federal Fiscal Court evaluate the international OECD model agreement?
The German Federal Fiscal Court (Bundesfinanzhof, BFH) has not yet established a relationship of precedence. The OECD Model Convention initially gives equal weight to both characteristics. The OECD Model Commentary on the Model Tax Convention gives greater weight to personal relationships.
If it is not possible to determine a country of residence even on the basis of these characteristics, nationality is deemed to be the decisive characteristic in accordance with Art. 4 (2) (c) OECD-MA. This is legally secure and suggests a connection with the state. As the very last stage, the OECD-MA provides for a mutual agreement between the states.
Since there is no clear tendency to give greater weight to economic or personal relationships, there are design options for the taxpayer. Personal relationships in particular, can be deliberately established or further developed in a state. For example, through visits to the family doctor or even membership in an association.
This establishment of personal relationships is not an abuse of the tax system within the meaning of Section 42 AO. It should only be noted that an incomplete presentation may have penal consequences in the context of legal proceedings. Therefore, care should always be taken to ensure that the circumstances are presented completely and truthfully.
Conclusion and options for action
In practice, difficulties do arise in determining residency and, in particular, in determining a center of vital interests. Here, the residential situation is often taken as a starting point. The length of the stay also offers a good indication - but beware: the "well-known" 183-day rule does not in any case have the significance that is usually attributed to it outside the tax authorities; it is at most an indication.
However, personal relationships can also be used. These can be used by the taxpayer and, as shown above, can also be actively influenced. This should be taken into account when considering the resulting tax obligations and structuring options, also in the consultation.
In fact, it depends on an overall consideration of all circumstances in the individual case. It is important to be aware of the fact that tax problems may arise in the case of dual residency abroad. In such cases, one should seek expert advice in order to avoid these problems.
Source: Nina Meyers, Prof. Dr. Jochen Lüdicke, Prof Dr. Matthias Valta: NWB IWB No. 3 of 10.2.2023, p.99