Dual residency

What Is Dual Residency?

Dual residency, within the realm of international taxation, refers to the situation where an individual or a corporation is considered a resident for tax purposes in two or more countries simultaneously. This status arises when different nations apply their own criteria for determining tax residency, leading to an overlap. When a person or entity holds dual residency, they may be subject to the tax liability of multiple jurisdictions on the same income or assets, potentially resulting in double taxation.²¹ This complex area of international taxation necessitates careful consideration of tax treaties and domestic tax laws.

History and Origin

The concept of dual residency has evolved alongside increasing global mobility and international commerce. As individuals and businesses began to operate across borders with greater frequency, distinct national tax laws often conflicted in their definitions of residency. To mitigate the adverse effects of this overlap, such as double taxation, the need for international agreements became apparent. The development of bilateral tax treaties, often based on models like the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention, emerged to provide "tie-breaker rules" for resolving dual residency situations.²⁰ These treaties aim to allocate taxing rights between countries.

A notable example of a corporation navigating complex residency issues occurred in 2021 when Royal Dutch Shell announced its proposal to simplify its share structure and move its tax residence from the Netherlands to the United Kingdom. This strategic shift, driven in part by shareholder pressure and differing dividend withholding tax rules, aimed to streamline its corporate tax structure and improve the distribution of dividends.¹⁸, ¹⁹ The move highlighted how corporate residency is a critical factor in tax planning and financial operations for multinational entities.

Key Takeaways

• Dual residency occurs when an individual or entity meets the tax residency criteria of two or more countries simultaneously.
• This status can lead to the imposition of income tax or capital gains tax by multiple tax jurisdictions on the same income or assets.
• Tax treaties between countries typically include "tie-breaker rules" to determine a single country of residency for treaty purposes, aiming to prevent double taxation.
• Understanding one's residency status is crucial for individuals with international ties and for multinational corporations to manage their worldwide income effectively.
• Failure to correctly determine and report dual residency can result in penalties and unforeseen tax liabilities.

Formula and Calculation

While there isn't a single universal formula for dual residency itself, its determination for individuals often involves a calculation, particularly in countries employing a "substantial presence test." For example, the U.S. Internal Revenue Service (IRS) uses the Substantial Presence Test to determine if a non-U.S. citizen qualifies as a resident alien for tax purposes.¹⁷ This test generally considers physical presence in the U.S. over a three-year period.¹⁶

The formula for the U.S. Substantial Presence Test is:

To meet the test, an individual must be present in the U.S. for at least 31 days in the current year and the calculated "Total Days" must equal or exceed 183 days over the three-year period.¹⁴, ¹⁵ Days present as certain "exempt individuals" (e.g., some students or teachers on specific visas) do not count towards this test.¹³

Interpreting Dual Residency

Interpreting dual residency primarily involves understanding the implications of being considered a tax resident in multiple nations. For individuals, this means they might be required to file tax returns and pay taxes on their worldwide income in more than one country.¹¹, ¹² This can be particularly burdensome if there is no tax treaty in place between the countries involved, or if the treaty does not fully cover the types of income or assets in question.

When a tax treaty exists, the interpretation shifts to applying the treaty's "tie-breaker rules." These rules provide a hierarchy of tests to determine which country has the primary right to tax an individual's global income, effectively assigning a single residency for treaty purposes. Common tie-breaker factors include the location of an individual's permanent home, their center of vital interests (where personal and economic ties are closer), habitual abode, and citizenship.⁹, ¹⁰ Proper interpretation is essential for managing overall tax liability and avoiding tax evasion penalties.

Hypothetical Example

Consider an individual, Maria, who is a citizen of Country A but spends a significant portion of her time working and living in Country B. Country A's domestic laws state that anyone with citizenship is a tax resident, regardless of physical presence. Country B's laws, however, define tax residency based on physical presence, stating that spending more than 183 days in the country within a tax year makes one a resident.

In a particular tax year, Maria spends 200 days in Country B. According to Country A's laws, she is a resident because of her citizenship. According to Country B's laws, she is a resident because she spent over 183 days there. Maria now faces dual residency. If Country A and Country B have a tax treaty, the treaty's tie-breaker rules would be applied. Suppose the treaty prioritizes the "center of vital interests." If Maria maintains her primary family, social, and economic ties (like banking and investments) in Country A, even while working in Country B, the treaty might deem her a resident of Country A for tax purposes, thereby preventing double taxation on her worldwide income. She would still typically pay tax to Country B on income sourced there, with a foreign tax credit potentially available in Country A.

Practical Applications

Dual residency has significant practical applications across various financial and legal domains, primarily in international tax planning for both individuals and corporations. For individuals, understanding dual residency is crucial when managing expatriates, foreign investments, or cross-border inheritances. It directly impacts their overall income tax and capital gains tax obligations, influencing decisions on where to hold assets or conduct financial activities. For example, UK tax residency is determined by a Statutory Residence Test, which considers factors like days spent in the UK and ties to the country.⁸

In the corporate world, dual residency affects the taxation of multinational enterprises. The location of a company's tax residence determines which country has primary taxing rights over its global profits. Businesses often engage in strategic tax planning to optimize their corporate tax structure, sometimes even relocating their official tax residence, as seen with Shell's decision to move its tax base to the UK.⁷ This helps companies manage their tax exposure on dividends and other earnings more efficiently. Double taxation agreements are fundamental tools in preventing punitive tax regimes that could hinder international trade and investment.⁶

Limitations and Criticisms

While mechanisms like tax treaties are designed to alleviate the issues arising from dual residency, certain limitations and criticisms persist. One major limitation is the complexity of "tie-breaker rules" within tax treaties. Determining an individual's "center of vital interests" can be subjective and lead to disputes with tax authorities, as it involves evaluating personal and economic ties, which are not always clear-cut. This ambiguity can result in prolonged legal challenges and substantial costs for taxpayers.⁴, ⁵

Another criticism stems from the potential for double taxation even when treaties exist. Some treaties may not cover all types of income, or the foreign tax credit mechanisms might not fully offset the tax paid in another jurisdiction, leading to an effective higher tax burden. For example, a 2019 case heard by the U.S. Supreme Court involved taxpayers facing double taxation on capital gains income between New York and Connecticut, highlighting how even within a federal system, residency definitions can lead to unintended double taxation without specific legislative fixes.³ Furthermore, the application of various national tax rules can open avenues for tax avoidance if not properly managed, prompting governments to continuously update regulations to ensure equitable tax collection while still facilitating global economic activity.

Dual Residency vs. Tax Domicile

Dual residency and tax domicile are both critical concepts in international taxation, but they refer to distinct legal statuses. Dual residency, as discussed, describes a situation where an individual or entity is considered a tax resident by the laws of two or more countries simultaneously, typically based on criteria like physical presence, duration of stay, or location of management. The primary concern with dual residency is preventing double taxation on income and assets.

In contrast, tax domicile relates to an individual's long-term, permanent home or the place they consider their true, fixed, and permanent abode. Domicile is often much harder to change than residency and can have significant implications for inheritance tax, capital gains tax, and the taxation of foreign income, especially under a remittance basis of taxation (where only foreign income brought into the country is taxed). For instance, in the UK, tax domicile is a separate concept from tax residency and affects how foreign income and gains are taxed for individuals who are UK resident but not UK domiciled.² While residency determines where you are currently liable to tax on your worldwide income (or a portion thereof), domicile dictates your permanent legal connection to a country and can affect certain taxes even if you are no longer resident there.

FAQs

What causes dual residency?

Dual residency arises when different countries apply their own rules for determining tax residency, and an individual or entity meets the criteria in more than one nation. Common factors include spending significant time in multiple countries, having homes in different jurisdictions, or conducting business operations across borders.

How do tax treaties resolve dual residency?

Tax treaties include specific "tie-breaker rules" that act as a hierarchy of tests to assign a single country of residence for treaty purposes. These rules typically consider factors such as where an individual has a permanent home, their center of vital interests (closer personal and economic ties), habitual abode, and citizenship.¹

Can I choose which country I want to be a tax resident of if I have dual residency?

Generally, no. Your tax residency status is determined by the specific tax laws of each country and the provisions of any applicable tax treaty. While you can manage your affairs to influence your residency status (e.g., by limiting days spent in a country), you cannot simply choose your tax jurisdiction once dual residency is established under national laws.

What are the financial implications of dual residency?

The main financial implication is the potential for double taxation, where the same income or capital gains are taxed in more than one country. Dual residency can also increase tax compliance costs due to complex filing requirements and the need for specialized tax planning advice.

Does dual residency apply to corporations as well as individuals?

Yes, corporations can also have dual residency. This typically occurs when a company is incorporated in one country but has its "place of effective management" in another, leading both countries to claim it as a tax resident. Tax treaties also include tie-breaker rules for corporate residency, often based on the place of effective management or board meetings.