What is a Tax Treaty and how does it work?

It helps to understand how Tax Treaties work and how your position may be affected in cross-border situations.

A Tax Treaty is an agreement signed between two countries agreeing on approaches to tax where both countries are involved.

Common contents –

The Treaty can include:

• administrative agreements, e.g. agreements on sharing information between the two countries,
• tie-break tests to determine residence, if a person/entity would otherwise be resident in both countries,
• exemptions from tax, e.g. giving one country full taxing rights over a type of income, while exempting it from tax in the other,
• the right to have tax paid in one country deducted against tax in the other.

How does it fit into working out tax?

The first factor when considering tax is local law – so the UK tax rules. Once we have the tax position under these rules we then look at whether a Double Tax Treaty changes, limits or overrides this position.

Under these rules let’s consider some UK property income (rental income):

• UK local law, that is legislation known as Income Tax (Trading and Other Income) Act 2005 (ITTOIA) says that income from rent is taxable.
• But perhaps our potential taxpayer lives in another country, say the UAE
• According to the UK-UAE Double Tax Treaty, income from immovable property received by a UAE tax resident may also be taxed in the UK.

So, in this case the Treaty upholds the UK’s right to tax.

Let’s consider a case where the Treaty changes the position – an individual receives some bank interest.

• ITTOIA is again the law in the UK that allows for the taxation of interest income
• Let us have our UAE-resident individual receive bank interest from a UK bank on funds in the UK
• According to the UK-UAE Double Tax Treaty, interest income may be taxed where our individual is tax resident – the UAE. However, it goes on to say that it may also be taxed where the interest arises – the UK – but if our recipient is both an individual and resident in the UAE then it is only taxable in the UAE.
• The Treaty has overridden the UK’s right to tax and the individual is not subject to UK tax on that income.

So when working out tax you start with the local position and check whether the Treaty affects this.

We advise clients on interpreting Treaty provisions and explaining how tax works in cross-border situations.

Related content

• PERSONAL TAX
• RENTAL INCOME
• NON-RESIDENT LANDLORDS
• INTERNATIONAL TAX
• ARTICLES