General principles on handling our cross border taxes
Updated: Nov 9, 2021
With increasing probability we will be exposed to international income during our professional lives: providing work across countries and possibly remotely, participating in foreign investments, relocating temporarily to a foreign branch of our employing company. Having worked as an employed and self-employed professional across the USA, Europe, and being currently relocating to Asia, I have experienced many of the issues related to taxation across borders. While it is possible to find tax-related instructions related to a specific country from the local authority, it is much more difficult to find a comprehensive source putting all those local regulations together and indicating “what to do” in a specific situation. This post is meant to provide a first line of thought to interested people to then discuss with the proper and certified professional (i.e. CPA). In my experience, when we hire somebody for a service related to business, it is often good to investigate beforehand the domain and formulate some preliminary and personal ideas of how events should unfold. Even when those ideas will result to be wrong, the process will have provided the opportunity to investigate the argument and be able to discuss on better terms with the professional to hire.
Note, all below comes from my experience and it is meant to be a collection of a few technical principles I put together. Those principles could become extremely valuable once discussed with the proper and certified accountant – which I am not - and finally framed in a compact mental matrix. I have put them together in the way I could have used them when I first approached the problem of reporting income from different countries and of different types. I encourage the reader who feels like adding, reformulating, or correcting something, to please do it in any way s/he would deem appropriate. The goal is to provide something useful to friends and colleagues.
For sake of this post, while the discussion below will apply to a wide variety of professionals, we will frame it in terms of a consultant working as a self-employed professional across borders. We will then highlight considerations applying to employed work.
My personal principle #1 – Double Taxation Agreement
Nowadays, among many countries exists a Double Taxation Agreement avoiding our income to be taxed twice among countries - official lists are available publicly. If we work across different countries during the year - and possibly live in some of them - only one of those countries will be identified as tax-residence for the given year, and our tax filing to that country will report all our income and all our tax payments regardless of where they were earned and paid. Anybody looking at our filing made to our tax-residence should have full visibility of our global income and tax payments. This is not true for the documents we file with the remaining countries classified as non-tax-residences, which in general provide visibility of only the income earned locally. Income earned in non-tax-residences is not always taxed locally in those countries and then only reported to the tax-residence together with the tax payment already made, but it is sometimes directly taxed from and paid to the country representing the tax-residence. In general, deciding which country is our tax-residence and whether we should pay foreign taxes locally in the non-tax-residence or directly to our tax-residence when reporting our foreign income, is not discretionary to us but it follows regulations. The remaining two principles below treat exactly those arguments. Please note, for sake of simplicity, in this post we will deal only with countries participating in the Double Taxation Agreement.
Before moving on, a consideration on the Double Taxation Agreement with an example: though the Agreement is meant to avoid double taxation of the same income, we usually still pay the higher of the two taxes no matter what. Example: say our tax-residence is country X and we do a small contract in country Y requiring us to pay taxes related to that small contract in the country where it was performed, country Y; if what we pay as a percentage of the income to country Y is less than what country X (our tax-residence) would require on that income, we will have to integrate the payment when filing with country X and reporting among the foreign income the income and tax already paid to country Y. In the opposite case, we would not have to integrate anything and only report to country X the income and taxes earned and paid in the other country. In both cases, we pay the higher taxation between what the two countries would require on that income.
My personal principle #2 – Tax residence
Say we made sure all the countries involved in our income for the year participate in the Double Taxation Agreement, it is now time to determine our tax-residence. A first quantitative threshold determining our tax-residence in a country is the 180-day term (it is usually 183 days). In general, if we spend more than 180 days in a country for the given reporting period, that country is likely to claim us residents for tax purposes. This threshold is just a first quantitative condition; exceptions do exist: say we spent more than 180 days in country X for assisting a relative with health issues, while we conduct our business entirely in country Y where we also own our only house, where we have lived for the past 10 years, and where we show no intention of leaving after the accidental reason which led us to spend most of the past year in country X has terminated; in that case, our accountant would likely recommend country Y as our tax-residence for the year, even if we spent most of it in country X. Note, the tax residence could be different from our residence as it is registered with the local authority. The two are two different things and should not be confused.
My personal principle #3 – What to pay abroad and what to pay to the tax-residence
Say we have determined the country representing our tax-residence, it is time now to determine what we should pay abroad and only report to our tax-residence together with the payment already made, and what we should pay directly to our tax-residence. How can we distinguish the two? Here, it is useful to distinguish foreign income earned within our core business, and income that could be classified [say] marginal foreign income. If we are consultants working internationally, we are considering everything related to that activity as part of our core business – for sake of this post. If we are still the same consultants but we also have a passive participation in [say] a restaurant in a foreign country whose major shareholder is a friend of ours who emigrated 10 years ago and convinced us to invest in their new restaurant venture, we would consider anything related to that venture as marginal because it would not involve active participation nor involve any salary – hopefully, it would involve only positive income in the form of annual dividend or distribution of earnings.
The latter case (i.e. marginal business) is generally easier to treat: income from that restaurant has usually nothing to do with our tax-residence, and it should be taxed and paid locally in the country it is generated - regardless of whether the form of the business is pass-through or not. Then, we would only report that income and tax payment to our country of tax-residence which, if demanding higher taxation on that kind of income, could require an integration.
Moving on to the former case (i.e. core business), that income might be subject to local taxation or not depending on a couple of factors. In general, a quantitative initial determinant is the 90-days rule. In general, if we spend less than 90 days in the foreign country where the client of our consulting business resides, we should be able to directly report the income to our tax-residence and pay taxes directly to it. According to general taxation rules, the foreign country where the contract is generated should see anyway documentation – usually from our client – stating that a foreign contractor was hired and that s/he will be paying the related taxes to the tax-residence and not locally. In that case, the foreign country could ask for proof of actual payment and even require integration in case its tax rate was higher on a similar type of income.
Here is my personal way to look at the 90-day term just discussed: 90 days also represents the term beyond which we are usually required to own a VISA to stay in a foreign country – VISA often coming with a work permit. Therefore, we could relate somehow the general principle of the 90-days to the fact that within the 90-days term, we are not required to have a VISA, which also means we are not allowed to work in that country. Therefore, staying for less than 90 days often assumes to be in the country only to lawfully discuss details, negotiate contracts, and to conduct meetings, while the real work is then executed once back in our own country and tax-residence.
Important conclusive notes
In general, all the above apply also to employees of companies transferring across foreign branches. However, this case allows us to discuss a general principle we should always follow regardless of whether we are self-employed, employees, or other type of professional.
Say we are employed in a European country, and we are transferred to a foreign branch within the EU union (therefore not requiring a VISA because EU citizens). Also, say the transfer lasts only a couple of months. In that case, we would likely be required to pay anything earned during those two months in that foreign country even though we stay there less than 90 days. Regardless of the length of the stay, since we lived in that foreign country for those two months, since during those two months we received salary payments from the branch in that country, we are clearly working in that country as our “core” activity, therefore being required to pay taxes locally. However, that country might still not classify as tax-residence and the income earned there together with the taxes paid to it will have to be reported to our tax-residence.
While of course there are precise regulations, sometimes we may find ourselves a little in between criteria, and it is up to us to think in advance about the issues we may have if we do not optimally implement our plans. Similar to the example of the employee just discussed, say we are consultants traveling a lot during the year; we happen to be required to spend a couple of months in one country and then keep moving internationally every two months. It could result tough to identify one specific tax-residence because multiple or none of the visited countries could claim us residents for tax purposes. If a consultation with a certified accountant confirmed that lack of determination, we may want to decide to stick to one country for a while, and maybe turn off or postpone some projects to have better proof to support the possible choice of a particular country for tax-residence purposes. In general, if asked to provide further supporting evidence to our decisions, being able to easily show an initial good faith and show linearity across our decisions could be highly advantageous.
Again, everything above is from my personal experience and it represents my personal interpretation which may not be exact. Anybody reading should consult with and refer to the proper certified professional (e.g. CPA). I wrote this post because I wanted to provide something I would have considered useful when I took my first contract abroad as self-employed professional. I hope this discussion will eventually turn useful to the reader who in the short term will receive a pleasant surprise through a job offer abroad or the prospect of foreign investment.
To conclude, if the reader is interested in knowing more about my activity with private-equity firms and their portfolio companies, activity which I am developing between Asia and the USA (where I matured professionally), please feel free to connect: riccardo[at]m-odi[dot]com
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This article does not constitute in any way investment advice nor tax advice. Readers should consult with their investment advisors and certified accountants.