December 2018 JD Supra
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How to determine an Individual’s Residency for Tax Treaty Purposes? was published by JD Supra on 12/7/18.

The guidelines for determining an Individual’s tax residency are as follows: 

  • An Individual Taxpayer is a resident based on the laws of one treaty-partner country and is considered to be a resident of that country for treaty purposes.  In this situation, no further analysis is required.
  • The “tie-breaker rules” come into play when an Individual is a resident under the domestic laws of both countries to a treaty and there is a need to assign a single country of residence for treaty purposes.

On September 6,  2018, the Large Business & International (LB&I) section of the IRS released a Process Overview for “Determining an Individual’s Residency for Treaty Purposes” via its Practice Unit.  

Tax Treaties

The US has bilateral tax treaties with a number of foreign countries called the Contracting States.  Under tax treaties, residents of contracting states residing in the US maybe taxed at a reduced rate or are exempt from U.S. taxes on certain items of income they receive from sources within the United States.  Likewise, the residents or citizens of the US maybe taxed at a reduced rate, or are exempt from foreign taxes, on certain items of income they receive from sources within foreign countries. US citizens or permanent residents are not permitted to use the provisions of a tax treaty for avoiding taxation of U.S. source income.  

The analysis of residence begins with the domestic law of the Contracting State of which the Individual claims to be a resident for treaty purposes. Individuals are not residents of a Contracting State for treaty purposes if that Individual is “taxable” only on income sourced in that State or on business profits attributable to a permanent establishment within that State. An Individual is a resident of a Contracting State for treaty purposes if he or she is subject to tax on worldwide income under that Contracting State’s applicable domestic law.  

The Practice Unit outlines the three-step process for determining an Individual’s residency for treaty purposes:

  • Step 1:  Analyze U.S. Residency Claim- Determine whether the Individual properly claimed to be a U.S. resident under U.S. domestic law by determining whether the Individual is a U.S. citizen or a U.S. resident alien under the lawful permanent resident, physical presence, or first-year election tests.
  • Step 2:   Analyze Treaty Country Residency Claim- Determine whether the Individual properly claimed to be a resident of a country that has a treaty with the United States under such country’s domestic law.
  • Step 3:  Apply Treaty’s Residency Tie-Breaker Rules- If there is a determination that an Individual is a resident of both Contracting States, then the treaty’s residence tie-breaker rules are applied. Where an Individual would be a resident of both Contracting States, the treaty’s tie-breaker rules apply to determine a single Contracting State of residence for purposes of the treaty.

4 Tie-Breaker Tests

  1. Permanent Home Test.  A permanent home is one that is retained for permanent and continuous use and is not a place retained for a short duration.
  2. Center of Vital Interests Test. The test is where the Individual’s personal and economic relations are closer. Assess the location of the Individual’s personal, community, and economic relations.
  3. Habitual abode Test.  An Individual’s habitual abode is located in the Contracting State in which the Individual has a greater presence during a calendar year. Although the length of time is not specified, the comparison must cover sufficient length of time and take into account the intervals at which the stays take place for it to be possible to determine where residence is habitual.
  4. Nationality Test.  A “national” of a Contracting State is an Individual who is either a citizen or a national of that Contracting State. An Individual who is not a U.S. citizen is unlikely to be defined as a U.S. national under the tiebreaker rules in U.S. tax treaties.

Don’t be a Victim of your own Making

The IRS Practice Unit cautions Individual Taxpayers that every treaty is different.   Whether an Individual meets the treaty definition of a resident can be a challenging task.  Residency issues ought to be analyzed by a tax expert and the Individuals that are seeking treatment of residency under a tax treaty ought to consult a specialist.