The extent to which a country may tax your income is ordinarily determined based on your tax residency. Each country has its own rules for determining tax residency.
A nonresident is generally an individual who is not considered a resident. A tax resident is normally subject to tax on worldwide income and is entitled to claim all applicable credits and deductions provided for by law.
A nonresident is normally subject to tax on income derived from services provided in or property located in the country and credits and deductions are normally limited when compared to those available to residents. Nonresident tax rates may also differ from resident tax rates.
Certain countries may have preferential residency statuses limiting taxation on worldwide income while allowing taxpayers the benefit of resident tax rates, deductions and credits for individuals who temporarily reside in the country.
Due to differences in rules governing tax residency in different countries most tax treaties provide relief when an individual is a resident of two countries during a taxation year.
Additional information on the tie-breaker rules is available here.
Tax treaties or income tax conventions are bilateral agreements concluded between countries to avoid double taxation. In order to benefit from the provisions of a tax treaty, an individual or company must be a resident of one of the states having concluded the tax treaty. Tax treaties generally allocate taxing rights to a particular country and do not establish the rules on how income taxes are calculated which is generally established under domestic law. Tax treaties will however provide for non-resident tax withholding rates on certain types of income paid and may allow for certain exemptions from tax, benefits and credits which may not be provided for under the domestic law of the country with the taxing right.
Below are extracts of the OECD model treaty articles most commonly applicable to internationally mobile individuals. Taxpayers should refer to the applicable treaty when determining their liability to tax in a foreign country.
Paragraph 1 of Article 4 defines "resident" for purposes of the tax treaty as someone who is subject to tax on all income regardless of source based on domicile, residence, place of management or other similar criterion. Further it precludes a taxpayer who is only subject to Tax on sources of income within the country from being considered a resident under the treaty.
Paragraph 2 provides what is commonly referred to as the “tie-breaker rules” which are applied in the case that an individual is considered a tax resident of both countries to determine which country has the ultimate right to tax the taxpayer as a resident.
Article 5 is generally read in conjunction with Article 7 to determine if business profits of a non-resident derived in a particular country are subject to tax in that country. Articles 5 and 7 will generally apply to the income of an independent contractor unless the applicable tax treaty has a separate treaty article pertaining to Independent Personal Services (formerly Article 14 of the OECD model convention).
Article 7 provides that profits derived by a non-resident of a country are taxable in that country only if the independent contractor or company is conducting business through a permanent establishment, as defined in Article 5, in that country. The interpretation of permanent establishment by the country in which the business activities are conducted will take precedence in determining whether business profits should be taxable in that country pursuant to Article 7.
Article 15 may also be referred to as the Dependent Personal Services article in some tax treaties. Article 15 establishes in paragraph 1 that as a general rule employment income is subject to tax in the country where services are performed. Paragraph 2 provides for exceptions to the general rule.
Permanent establishment is determined under article 5 of the tax treaty.
The foreign tax credit is one of the provisions available to eliminate double tax. The foreign tax credit allows for a reduction in the taxes otherwise payable on foreign income in a taxpayers country of residence within established limits that vary from country to country. Generally a foreign tax is not creditable if it will be reimbursed or if it is considered a voluntary tax because the foreign country does not have the taxing right under a tax treaty concluded between the foreign country and the taxpayer’s country of residence.
The country of residence will generally limit the foreign tax credit to the lesser of the taxes paid in the foreign country and the taxes payable in the country of residence on the foreign income however certain countries may allow a credit for the full amount of foreign taxes paid even if they exceed the amount of taxes payable on the foreign income in the country of residence. When foreign taxes are limited to the amount of taxes payable in the country of residence on foreign income, some countries may allow for a carryforward or carryback of excess foreign taxes paid.
Some countries may exempt foreign income from taxation in the country of residence. When income is exempt from taxation, taxpayers are generally subject to a lower tax rate on their domestic income since the income earned in a foreign jurisdiction is disregarded for purposes of calculating total income. Therefore an individual who earns $100,000 of exempt foreign income and $10,000 of non-exempt income would be taxed as though their total income for the year is $10,000.
A system of exemption with progression exists when a country will not seek to tax the foreign earnings but will consider the foreign earnings to establish the appropriate tax rate to apply when taxing non-exempt earnings. Exemption with progression ensures that the individual from the example above will pay taxes on the $10,000 of non-exempt income at a rate appropriate for someone who earns $110,000 versus the tax rate of someone earning only $10,000 for the year.
Methods for eliminating double taxation are provided for under domestic law and in tax treaties. Canada only allows for a foreign tax credit. The United States allows for a foreign tax credit and exemption with progression under certain circumstance. In Europe, all three methods are found and will vary depending on the country and the tax treaty.
Social Security Agreements are concluded between countries to avoid gaps in pension contributions for individual who work in more than one country throughout their careers. The Agreements also provide for continued coverage in an individual’s home country pension scheme when individual are temporarily employed in a foreign country.
Canada and Quebec have concluded separate Social Security Agreements. The Quebec agreements generally cover the Quebec Pension Plan (“QPP”) but some agreements also cover the Health Services Fund (“HSF”) and CSST. The Canadian social security agreements cover Canada Pension Plan ("CPP") contributions. Canadian Employment Insurance ("EI") is not covered by any social security agreement, however Canada and the US have negotiated a separate agreement with respect to EI.
If you are doing business in a country that has not concluded a social security agreement but want to maintain coverage in Quebec or Canada for your employees, it is possible to make voluntary contributions into QPP or CPP. Please note that in so doing, you will not be exempt from the social charges payable in the foreign country.