Many contractors working today are under the misconception that if they do not spend more than 183 days working in a foreign country (host country) then they are not obliged to pay any tax there, says Matt Walters of international contract management specialists, Capital Tax Consulting.
They believe that they can report all income in their home country and pay tax there accordingly, or in some cases not pay any tax at all on the income generated.
In the vast majority of cases this is an incorrect assumption and can create potential liabilities, penalties and accountants’ fees to resolve the tax situation in the host country. When a contractor is working in two or more countries during a fiscal year, the tax allocation rights of the income is governed by the respective double tax agreements in place between the home country and host country.
The OECD tax model convention is generally followed by most double tax treaties with respect to the content so we will concentrate on this to outline the main considerations.
Employment income is covered by article 15 and in essence states the following:
- Employment income should be taxed only in the country of tax residency.
- Exception to the above is where the employment is exercised in another country, then that country may tax any locally generated income.
- Exception to the exception: the employment income shall be taxable only in the home country if:
- the recipient is present in the host country for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned, and
- the remuneration is paid by, or on behalf of, an employer who is not a resident of the host country, and
- remuneration is not borne by a permanent establishment which the employer has in the host country.
Based on the above, many contractors believe that if the management company administering their affairs is not resident in the host country then they qualify under the ‘exception to the exception’ rule. This is not the case and, in the commentary to article 15, the OECD specifically addresses the management company issue. In paragraph 8 it states that a lot of abuse has occurred using this ‘exception to the exception’ rule through the adoption of the practice known as ‘international hiring-out of labour’, where the intermediary or management company established outside the host country ‘purports to be the employer and hires the labour out to the end client’.
The commentary further explains that it is understood that the ‘employer’ is the ‘person having the rights on the work produced and bearing the relative responsibility and risks. In cases of international hiring-out of labour these functions are to a large extent exercised by the user’. This comment means that working for a foreign employer of record will not exempt a contractor from paying tax locally.
Of course, the applicable double tax treaty can be used to ensure that any tax paid to the host country is counted as a tax credit towards any home country tax liability on the same income. This will ensure that tax is not paid twice on the same income.
In conclusion, contractors should be very careful when applying the 183 day rule as in many cases it will not suffice to avoid being taxable in the host country. A careful study of the applicable double tax treaty must be completed and professional advice taken before accepting any foreign assignment.