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U.S. IRS Releases Practice Units on Determining an Individual’s Residency for Treaty Purposes

The U.S. IRS has released international practice unit on Determining an Individual’s Residency for Treaty Purposes.

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A country’s domestic law provides specific rules for the taxation of income of individuals that are residents or nonresidents of that country as defined under domestic law. The United States’ domestic tax law is embodied by the Internal Revenue Code (the "Code" or "IRC"), Treasury regulations, and applicable rulings and case law.

A country may, however, enter into a bilateral income tax agreement (a "treaty" or "tax treaty") with another country to modify the results that might otherwise occur under the countries’ domestic tax laws. The two countries that are parties to a particular tax treaty are called the "Contracting States."

Except in limited circumstances, generally only residents of a Contracting State may claim tax treaty benefits (that is, claim that the treaty reduces or eliminates the tax that otherwise would be due under a country’s domestic law). Whether an individual is a resident of a Contracting State for treaty purposes is a threshold issue in any case in which an individual is claiming treaty benefits. This Practice Unit will help you evaluate whether an individual is a resident of a Contracting State for purposes of a tax treaty.

Article 4(1) (Resident) of the 2006 U.S. Model Income Tax Convention (the "2006 U.S. Model Treaty") defines a resident of a Contracting State as a "person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship . . . or any other criterion of a similar nature . . . ." The term "person" includes an individual. A person, including an individual, is not a resident of a Contracting State for treaty purposes, however, if that person is taxable only on income sourced in that State or on business profits attributable to a permanent establishment within that State.

In other words, an individual generally 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. Thus, an analysis of residence begins with the domestic law of the Contracting State of which the individual claims to be a resident for treaty purposes. Bear in mind that countries’ domestic rules on residency may differ—for example, unlike in the United States, in many countries an individual will not be treated as a tax resident under domestic law solely because the individual is a citizen of that country.

If an individual is a resident according to only one Contracting State’s domestic laws, normally no further analysis is required: that individual will be considered to be a resident of that Contracting State for treaty purposes. Where an individual is a resident under the domestic laws of both Contracting States, however, the applicable treaty usually provides tie-breaker rules that apply to assign a single Contracting State of residence for treaty purposes. This Practice Unit will assist you in making a treaty residency determination and applying the tie-breaker rules, if applicable, in your case.

Remember that every treaty is different. Although this Practice Unit uses the Resident article in the 2006 U.S. Model Treaty for purposes of illustrating residency issues, the Residence article in the treaty you are applying might differ. Therefore, in every case involving a tax treaty, you should carefully review the Residence article (and any other applicable articles) in the treaty, as well as any contemporaneous or subsequent Protocol(s), memoranda of understanding, or exchange(s) of notes between the treaty countries to determine whether an individual meets the treaty definition of a resident. In addition, more interpretive guidance may be found in the Treasury Department’s Technical Explanation ("TE") to the applicable treaty, the Joint Committee on Taxation Report on the treaty, the Senate Foreign Relations Committee Report on the treaty, relevant case law, competent authority agreements, and any guidance issued by the IRS.

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International practice units are developed by the Large Business and International Division of the IRS to provide staff with explanations of general international tax concepts as well as information about specific transaction types. They are not an official pronouncement of law and cannot be used, cited, or relied upon as such.

Click the following link for the International Practice Units page on the IRS website.

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