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Tax Treaties

Double Taxation

When there is an international activity in several countries, a tax payer may come to a state where he is required to pay taxes in each country the activity takes place in and even to a state of double taxation. Double taxation is in fact a state where the tax payer is required to pay income tax in several countries simultaneously for the same activity. The main reason for double taxation comes from a state where a tax payer with an association to one country – the country of residence, produces his income at another country – the country of origin.

Tax treaties

Double taxation is a result of the existence of different rules of determining the origin of income in each one of the different countries or in different rules which found the personal association in different countries.

Today, there are four means in order to avoid paying double tax: an exemption from tax and charging the income in only one country; crediting the foreign tax that the tax payer paid against the tax he is required to pay in a certain country; deducting the foreign tax in the calculation of his tax required income in a certain country; stating arbitrary tax breaks on the income charged with foreign tax.

With each of these four means it is necessary to check which of the countries involved is entitled to charge the full tax amount and which of the countries will grant the tax breaks. In order to check this there are treaties to prevent double taxation as part of a collaboration between the different countries who want to mutually arrange the tax policies. The treaties include a detailed definition on how to define an individual's place of residency, meaning, a definition which states which of the countries is regarded as his place of residency. This decision will overthrow an internal judgment.

Seeing that each country has its own internal judgment, a situation can occur where a tax payer will be considered a resident of both countries communicating, each country by its own judgment. To overcome this difficulty, most tax treaties have established a "tie breaker" mechanism which will be the decisive on where is the individuals place of residence.

The Implementation of this mechanism results in stating one country of residency in order to uphold the treaty. The tie breaker mechanism is complied of a number of hierarchical tests, so if a decision can't be reached in the first test, the next one follows and so on, until it stops at the decisive one. The chain of tests typical of most treaties is as follows:

The preliminary term – double residency

The individual is a resident of a country according to its internal law. If according to internal law in each of the two countries the individual is considered a resident of the country – a state of double residency, it is passed to the first test.

The first test – testing the permanent home

This is the first tie breaker test in most treaties. In a small number of treaties the first test is the center of vital interests as seen in the treaty between Israel and Japan, in which there is no test of permanent home.

The treaties state that an individual, who is a resident of both countries, is seen as a resident of the country he keeps his permanent home in. the permanent home test in the treaties is based on the permanent home test appearing in the OECD model, both in its language and in its purpose. According to the explanation of the OECD model treaty, and in accordance to international court rulings and international experts opinions, is it possible to determine that a permanent home is a home where the tax payer has arranged for his needs, so it is available to him at any given moment.

According to this principle, the heart of defining the term "permanent home" is not the nature of rights in the house (ownership or rental), but it's use and availability. And therefore even a rental apartment may be considered a permanent home.

It should be mentioned that in June 2002 an income tax circular was published on this subject where even the tax authorities accepted the aforementioned interpretation to this test. Meaning, that the home will be available at any time and will be at the tax payers possession both legally and in practice.

The circular states that if the individual owns an apartment in Israel, one should not see this as a permanent home in Israel in case the individual has rented out the apartment he owns in Israel, and therefore has lost his ability to state which person is holding the apartment at any given moment. According to the tests in the circular , the longer the apartment is rented out, as long as there are no clauses for early evacuation, and if there is – a longer preliminary notice is required, and as long as there are no furniture belonging to the individual, it is agreed that the rented apartment is not the individuals permanent home.

If it is found that a person has a "permanent home" in both countries or he doesn't have a "permanent home" in neither one, his residency must be tested further according to the second test.

The second test - testing the vital interest center

This test examines the individual's personal and financial ties. According to this test, in the case where an individual has a permanent home in both countries, he is seen as a resident of the country where his personal and financial ties are h2er.

The term "vital interest center" is not defined in the tax treaties. The OCED explanations clarify that during the course of this text it is required to test the individual's financial and social association, and to examine which country he attached h2er to. The explanation also states that these features must be examined as a whole. However one should not put more weight to the individual's financial actions than to his personal, familial and social ties. So for example a tax payer which has a home in one of the countries in connection and had purchased another house in another connected country, than the fact that the first home is in a surrounding he used to live for many years, where his workplace was, and where his family and most of his property, can base the claim that his vital interest center remains in the first country.

If the tax payer has two permanent homes (or has none at all) and it is impossible to determine his vital interest center, it is necessary to go ahead to the next test.

The third test - testing the place where the individual tends to live

According to the place of residence test if it is impossible to determine the individual's vital interest center is in one of the connecting companies only, than it is required to examine the where the individual tends to live - this will determine his place of residence for the purpose of the treaty. The OECD explanations clarify that this test as a test of quantity, and according to it is required to detail in which of the two countries the individual tends to live for a longer period of time during the year. The country where he stayed the longest will be the individual's only place of residency.

In addition, the explanations state that in calculating the length of time of residency in a certain country it does not mean residing in the permanent house alone, but to any place of residency in that country. Furthermore, the explanations state that there is importance to the question of how long the tax payer was gone between one stay and the other.

As a rule, the tax treaties don't determine the period of time where the comparison takes place, but according to the explanation it appears that the comparison needs to spread across a long enough period of time in order to efficiently define if the individual tends to live in the country in question. And this is also the income tax's stand on this subject.

If the tax payer does not have a different place where he tends to live or alternatively, there are two places he tends to live in, it is necessary to go on to the next test.

The fourth test - the test of citizenship

The test is basically fact oriented, where it is required to examine the individual's citizenship according to the ID he hold. It is required to pay attention to cases where the individual has given up on his citizenship.

If the individual has no citizenship in neither of the countries or has citizenship in both countries, we turn to the next procedure.

Mutual agreement

In this stage, if the chain of test was unsuccessful in coming to a conclusion, it is acceptable in most treaties that the conclusion in the matter of the individual's citizenship will be settled in a process of "mutual agreement" between the qualified authorities of the communicating countries in the treaty.

 

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