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Residence in international tax law: Whenever, Wherever

Shakira is a Colombian pop star married to a Spanish football player and has officially been a resident in Spain since 2015. In 2018, she was charged with tax evasion for previous tax periods by the Spanish tax authorities. The prosecutors alleged she avoided EUR 14.5 million in taxes since, in their opinion, she was already living in Barcelona between 2012 and 2014 and, therefore, subject to Spanish taxation on her worldwide income for those years.

Shakira claimed that only in 2015, she changed her residence from the Bahamas to Spain and argued that her primary residence was the Bahamas during the period in question providing a 2016 certificate of residence. The Bahamian tax authorities confirmed that she was a permanent resident of the Bahamas since 2007. However, the Spanish prosecutors had already investigated Shakira's day-to-day life in Barcelona to prove that she was not living in the Bahamas but Spain since 2012. They tracked down her private life by logging, among others, private lessons, expenses paid with credit cards, visits to clinics, beauty centers, recording studios, and decoration stores. They further analyzed social media activities, where Shakira's fan clubs tagged her wherever she went.

In February 2020, Shakira settled the full amount of taxes due.

Why are we sharing this story? Suppose you are a wealth owner with an international lifestyle and spend a substantial amount of days in a foreign country. In that case, you should be aware of rules to determine the tax residence for individuals and eventually have the evidence to prove your effective tax residence. Only such awareness and the necessary risk mitigation measures will give you peace of mind on where and how you will have to comply with your tax obligations.

The concept of tax residence

There are different taxation models where residence plays a role. In some countries, individuals are not taxed at all or only on the income derived from local sources, regardless of citizenship or residency. Other countries tax based on citizenship on global income irrespective of where they live or reside. The majority of countries follow a taxation model based on residence. Their residents pay taxes on their global income regardless of where it was generated. With those different taxation models, the same individual can be subject to comparable taxes regarding the same subject matter in two or more countries for the same period. Although countries may provide a tax credit for foreign taxes or other relief to avoid double taxation on the same income, the consequences for the taxpayer can be harmful.

Let's have a look at the Spanish rules, which are based on the residence model. An individual is considered a resident for tax purposes when staying in Spain for more than 183 days in a year. That seems straightforward. However, it's not the only rule. You can also be considered a tax resident in Spain if it is the central nucleus or base of your activities or economic interests. This rule is trickier to handle since you have to be aware of the respective definitions and applicable case law. The tax authorities may also consider you are resident in Spain if your spouse and minor dependent children are residents there. If you are a Spanish national wanting to leave the country to save taxes, there are also specific anti-avoidance rules when it comes to transferring your residence to a tax heaven territory.

In Shakira's case, Spanish prosecutors conducted a detailed investigation into how many days she spent in Spain. They believed she exceeded 183 days, the minimum amount of days to be considered tax resident in Spain. In one given year, only one day made the difference for that characterization. It shows how sophisticated authorities can monitor and trace your life for tax purposes.

As outlined above, different taxation models can trigger tax in other countries. There may be a unilateral relief, but Double Taxation Agreements provide clarity and reliability by identifying the single applicable rule. 

Double Taxation Agreements

Double Taxation Agreements (DTA) between countries aim, among other things, to avoid double taxation, which occurs when a taxpayer is subject to tax on the same income or gain in more than one country. The underlying reason for such agreements is to remove double taxation obstacles to enable economic relationships between countries. A DTA may solve the issue by allocating taxing rights between the treaty parties, either by providing the exclusive right to tax or sharing it between them.

DTAs provide for clarity on tax residence if both parties claim that a taxpayer is a resident of their country. According to so-called tie-breaker rules for treaty application, the taxpayer can only be a resident of one country. The first element to determine the residence is the availability of a permanent home in one country. Should the taxpayer have permanent homes in both countries, the next step is defining the taxpayer's center of vital interests. If there is no permanent home in either country or it is impossible to determine the center of vital interests, the habitual abode will be considered. This requires determining whether you lived habitually, in the sense of being generally or usually present, in one of the two countries but not in the other during a given period. If these rules do not solve the conflict, then the nationality is the next criterion, and finally, if all these checks fail to produce a result, the countries have to settle by mutual agreement. This is a process to be avoided as it is both lengthy and potentially costly, as both countries may already send tax invoices.

If there is no DTA in place, there's a risk of facing double taxation since both countries could claim taxation over the individual they deem resident of their country, and no formal agreement would prevent them from doing so. Some countries grant relief for foreign taxes paid in the absence of a DTA. However, it may not fully compensate losses due to double taxation. In Sharika's case, this was not the issue since the Bahamas does not levy direct taxes.

What's the lesson learned?

Tax residency is a serious issue to consider in cross-border scenarios. Relying on thumb rules and counting the days in a given country on your own may not be sufficient since tax authorities may be well ahead of the curve. They may have collected information that is pivotal to determine whether you are subject to tax. And they will then use it to their advantage.

If you are moving between countries, you have to consider that information used for tax residence purposes may include any indicia, facts, or documents. The evaluation may not be limited to how many days you spend in a country since residence can also be triggered by permanent homes, family members, and economic or social ties. In such cases, counting days will not solve the issue alone. In cross-border scenarios, clarity on the tax residence under the rules of both countries is essential. It may then be necessary to log the days of presence in a given country and keep evidence of movements with flight tickets and other documents. With a home abroad or other economic and social ties, other potential conditions may trigger residency and taxation. The lifestyle, family relationships, activities, and club memberships may become essential factors for tax authorities to determine your residence.

In summary, cross-border scenarios can become tricky, and counting days alone may not be a significant risk mitigation measure. Tax systems are complex in most countries and also different from country to country. Also, Double Taxation Agreements are not always straightforward in applying specific provisions, and the process can take time. So, ensure you plan diligently and are prepared to prove the details in tax residency disputes by logging movements and keeping records. Otherwise, there's the risk that tax authorities do the job instead, and as Shakira had to experience, the costs for that may become significant.

30-09-2020 

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