How To Interpret A Tax Treaty

Many people may benefit from a tax treaty and not even realize it. These treaties often establish a relationship of reciprocity between the participating nations. Typically, this means that for whatever benefits you might receive in one country, a citizen of that country would receive equivalent benefits in your country of origin. However, understanding tax treaties and how to interpret a tax treaty can be difficult. If you have questions about how you might benefit from an existing tax treaty, consider contacting the experienced Canadian tax team at Jeremy Scott Law by calling (902) 403-7201

What Is a Tax Treaty?

According to the United Nations (UN), a tax treaty is an agreement between sovereign nations. Tax treaties are international agreements and represent an important part of many countries’ international tax rules. Most tax treaties are bilateral in nature, which means that they confer rights and impose obligations on the two countries that are part of the agreement. However, individual taxpayers often are the ones who benefit from such treaties.

Types of Tax Treaties

The UN says that there are currently over 3,000 bilateral income tax treaties that are currently in effect. A number of treaties, whether or not they are technically considered tax treaties, may confer tax benefits, including those treaties that address:

• Income tax
• Estate or inheritance tax
• Double taxation
• Administrative taxes
• Trade and investment provisions
• Air transportation agreements
• FATCA agreements
• Totalization agreements

Legal Effect of a Tax Treaty

The potential legal effect of a tax treaty depends on the specific language included in the treaty. However, the United States Internal Revenue Service states that tax treaties generally reduce the U.S. taxes that residents of foreign countries pay. These residents may be eligible to be taxed at a reduced rate or exempt from paying income taxes to the United States.

The Canada Revenue Agency (CRA) explains that tax treaties may do one or more of the following:

• Define who is eligible for benefits under the treaty
• Define the taxes that are covered in the agreement
• Avoid double taxation
• Prevent tax evasion
• Reduce the amounts that are withheld, such as interest, dividends, and royalties
• Limit tax on business income
• Exempt certain types of individuals or organizations from taxation
• Define when the income of a resident in a foreign country will be taxed there
• Provide a procedural framework to enforce tax laws and resolve disputes

Steps To Interpret A Tax Treaty

Tax law constitutes a notoriously complex area of governance, often managed by sprawling bureaucracies even within a single nation. Involving international law in the form of a tax treaty can make navigating one’s individual tax requirements even more challenging, yet citizens may reasonably want to understand how a tax treaty applies to them. The following steps can help you to interpret a tax treaty:

Read the Official Treaty

Read the official tax treaty, not someone else’s interpretation of it or a summary. Taxes and international law are both highly technical subjects with specialized vocabulary and carefully defined classifications. Therefore, you will need to read the official language that may apply to you.

Determine Where You Are a Resident

Many tax treaties pertain to the tax treatment of individuals who are residing in one country but are citizens of another. A citizen of Canada may be a resident of the United Kingdom throughout a tax cycle, or vice versa. Residency status is determined by the applicable treaty and the tax laws of each nation involved, not necessarily by an individual’s immigration status or personal connection to the country in which they are living when the time comes to file taxes.

In some cases, an individual may be considered a dual resident taxpayer of two countries, or that person may be considered a resident of one country and an alien in another. This distinction may have a significant impact on the implications of any applicable tax treaty for the individual’s personal tax liability and filing requirements. For this reason, it is important to carefully review any information about residency status provided by the nation in which you are currently dwelling, as well as that from your country of origin, to see whether you are considered a resident under the terms of any tax treaty between these two nations.

Read the Definitions

Sometimes a tax treaty may have a separate section designated for supplying the definitions of important technical terms, and then use these terms throughout the remainder of the treaty document. Read the definition section to learn the specific meaning of terms that may affect you.

Review the Basic Terms

Review the basic terms related to the tax treaty, including any benefits extended to citizens of your home country. Whether you are traveling abroad or residing long-term in a nation other than the one in which they hold citizenship, it is a good idea to be familiar with the total range of benefits available to citizens of your country of origin in order to anticipate whether some or all of them may apply to your unique circumstances.

Skim the Entire Treaty

Skim over the entire treaty for a general understanding of its history and context. In general, this kind of reading is best at identifying significant historical and contextual facts, such as when the treaty became effective, to whom it applies, and other similarly crucial information. A recommended practice is to begin reading the treaty from the broadest possible point of view. From there, watch for headings and other textual indicators that can help you slowly narrow your focus to the specific regulations and classifications that may correspond to your particular situation.

Focus on the Issue You Are Researching

After skimming the entire treaty, a taxpayer should have a good idea of the overall benefits extended to citizens of either country and the degree and structure of reciprocity, as well as any filing deadlines and documentation requirements that may apply when filing taxes abroad. At this point, it can be a good idea to return to portions of the treaty that most closely correspond to your particular circumstances. Carefully read this entire section, taking notes or reviewing the definitions of any technical terms, as needed. Read it again for clarification.

Examine whether you may be entitled to benefits such as:

• A tax credit
• A tax exemption
• A reduced tax rate
• Another benefit

Read the Technical Explanation of a Tax Treaty

Many tax treaties include a technical explanation. Carefully review the information to determine if you qualify for any listed benefits.

The information included in this section of a tax treaty can often be highly complex. For this reason, it may be helpful speak with a tax lawyer who is knowledgeable about international tax treaties. If you have questions about how Canada’s tax treaties may impact you, consider reaching out to an experienced Canadian tax attorney at Jeremy Scott Law to review the particulars of your individual situation.

Read Guidance Issued With the Treaty

Tax treaties may include introductory remarks. These remarks are not the technical aspect of the treaty, but they may be easier to understand. They also often provide guidance to the courts that are responsible for interpreting the tax treaty.

Additionally, articles 31 to 33 of the Vienna Convention of the Law of Treaties govern the interpretation of many tax treaties. These articles state that treaties are to be interpreted in good faith according to the ordinary meaning of the terms used in the treaty. The articles also specify when other materials should be considered besides the context of the tax treaty, which may sometimes include supplementary materials. However, these articles do not provide guidance about how much weight should be given to these extrinsic materials.

Review Any Legal Rulings Regarding the Tax Treaty

Search for any legal rulings or memoranda of understanding that have been issued by relevant tax authorities, such as the Internal Revenue Service or the Canada Revenue Agency. Compare your situation to the one involved in the case to see how you might be impacted.

Contact A Lawyer For Assistance Interpreting A Tax Treaty

Tax laws are often very complex. International tax laws can be exponentially more complex. However, a tax treaty may provide you with significant benefits. Therefore, it may be in your best interest to find out if you qualify for benefits provided under any tax treaties to which your home country is a party. If you would like assistance in interpreting a particular tax treaty, consider contacting Jeremy Scott Law by calling (902) 403-7201 and requesting a confidential consultation.