Deloitte in the News
“Stuck” in another country: how will the quarantine affect the taxation of individuals?
Hundreds of articles and dozens of webinars and video conferences have already been dedicated to the impact of COVID-19 on businesses and the economy. The experts’ opinions vary, but one thing is certain – most will have a hard time, and this refers to both small businesses and large multinational groups of companies.
What about the individual taxpayers? How will a natural viral disaster affect the taxation of income in a particular country? What steps should be taken by individuals who ended up being “quarantined” in another state or were unable to leave Ukraine and now have to work in a country where they do not reside permanently? After all, this “other” country can legally demand the payment of taxes to its budget, or it still cannot?
To clarify this matter, it is important to keep in mind two facts. Firstly, the tax payment usually does not depend on the type of passport (although there are exceptions, for example, if you hold a US passport). Secondly, a citizenship (in short, stable legal ties of a person to a particular state) should not be confused with tax residency (in substance, an obligation to pay taxes in a particular country based on a number of specific “ties” to it).
The same as the citizenship, tax residency can be changed at the request of an individual. However, unlike citizenship, tax residency could be changed “accidentally” without a person even knowing about it. For this to happen, it would be enough to fall under the tax residency criteria prescribed by legislation of the state that is “interested” in you.
These criteria may include:
- Place of permanent residence (a home owned or rented by an individual on permanent basis)
- Period of stay in the territory of the state (most often it is 183 days or more per calendar year)
- Center of vital interests (for example, a country where an individual has a family, runs a business or has employment relationship)
There is a number of known cases of an “accidental” change of tax residency. Just consider a high-profile case involving a well-known singer Shakira, which occurred in 2018.
Starting from 2011, the singer lived in Barcelona for several years together with Gerard Pique, a defender of Barcelona football club. According to Spanish laws, if an individual lives in the country for more than six months, he/she “automatically” becomes a tax resident of Spain. Thus, it turned out that the singer, without even knowing it, has acquired the status of taxpayer in Spain and, accordingly, was obliged to pay taxes on all income received (including income earned abroad), which she did not. As a result, Spanish Tax Agency fined Shakira USD 25 million for “tax fraud”.
There are, however, more complicated situations when two states (country A and country B) consider an individual to be their resident and lay claim to tax income of such an individual at the same time. In such cases, residence is most commonly determined through the “test” using standard criteria of the Model Tax Convention of the Organization for Economic Cooperation and Development (OECD). The test includes at least the following questions:
- What is the permanent place of residence of an individual?
- What is the country where the individual’s personal and economic relations (center of vital interests) are concentrated?
- What is the place of habitual abode of an individual?
- What is the country of citizenship of an individual?
But what if an entrepreneur, top manager or employee of an international company (who is a citizen and tax resident of country A) is “stuck” for six months in another country (country B) due to lockdown amid COVID-19 and, as a result, “falls” under one or more of the above criteria? Would such a person be considered a tax resident of country B?
In response to the resulting situation, the OECD provided guidelines on how to act in such cases to avoid the double taxation of personal income. The main idea of this document is that the quarantine measures amid the COVID-19 pandemic are unlikely to affect the tax residency of individuals.
In its guidelines, the OECD considers the two main examples where the two countries (country A and country B) can lay claim to tax residency of an individual.
Scenario 1. An individual (hereinafter, Individual A) is a citizen and tax resident of country A, who is temporarily absent from his/her permanent home. Let us assume that the Individual A went on a vacation or business trip to country B and ended up in lockdown due to the COVID-19 pandemic. As a result, the Individual A stays in country B for more than 183 days and, according to one of the criteria, becomes a tax resident of country B.
Scenario 2. The Individual A works in country B on an ongoing basis and, as a result, acquires a tax resident status in this country. However, due to the COVID-19 pandemic he/she is forced to return to its homeland – country A. In accordance with the national legislation of country A, the individual could have never lost its tax resident status or, otherwise, could restore tax resident status upon his/her return to the country.
In the first scenario, it is very unlikely that the Individual A will receive the tax resident status in country B, where he/she is staying temporarily due to the extraordinary circumstances. However, even if this happens, it will be possible to prove otherwise. The Individual A owns or rents a house/apartment in country A, where he/she usually resides. Moreover, the individual has personal and economic relations in this country because he/she is a citizen of country A. Thus, his/her temporary stay in country B should not entail any tax consequences.
In the second scenario, the Individual A is most unlikely to regain the tax resident status in country A, since he/she is staying in country A temporarily and on an exceptional basis. Even if the local tax office considers otherwise, it is most likely that it could be disputed because the stay of an individual in country A is temporary and involuntary (forced). However, in the second case, the test gives a more uncertain result since the person’s attachment to the latter country is stronger.
It is interesting to note that in order to facilitate the consideration of possible issues that may arise, some countries (such as Ireland, the United Kingdom and Australia) have already provided recommendations regarding the impact of the COVID-19 related measures on tax residency issues.
For example, the UK government suggests not considering the number of days spent in a country due to the exceptional circumstances (including a pandemic) when determining residence. Australia, in its turn, has emphasized in its guidelines that a non-resident individual will not be recognized as an Australian resident for tax purposes if he/she stays in the country temporarily (for several weeks or months) due to COVID-19.
It is important to note that Ukraine is not a member of the OECD; however, the OECD recommendations on tax issues have already become a common practice of the Ukrainian tax and law enforcement authorities as an additional source of interpretation of definitions. Therefore, when disputes arise, we can rely on the OECD recommendations, especially in the absence of official clarifications from the tax authorities.
At times of major changes and exceptional circumstances, it is important to consider the number of days spent in a country other than the place of usual residence, because this can affect your tax residency status and result in the additional tax burden both in Ukraine and abroad.