Ep 51: What Is English For "Tax Treaty?"
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We delve into the complexities of tax treaties, their implications for individuals and businesses, and the importance of understanding saving clauses and various types of tax agreements.
We highlight how tax treaties can help mitigate double taxation and the necessity of professional guidance in navigating these agreements.
Understanding tax treaties is crucial for financial planning. Court cases can inform the interpretation of tax treaties. Professional help is recommended for navigating tax treaties. Tax treaties can vary significantly from one country to another.
Key Takeaways
A tax treaty is a bilateral agreement to avoid double taxation.
Tax treaties determine which country has the right to tax income.
Saving clauses in treaties may not benefit taxpayers.
Approximately 70 countries have income tax treaties with the US.
Estate tax treaties can significantly impact taxation on assets.
Totalization agreements prevent double social security taxation.
Chapters
00:00 Understanding Tax Treaties
03:12 The Implications of Saving Clauses
05:54 Types of Tax Agreements and Their Importance
Episode Links & Resources
Are you Tax-compliant With Your Overseas Assets? - Free Guide - Scroll to the bottom of the page.
Ep 13: Between A Rock & A Hard Place: Mitigating Double Taxation
If you'd like to work with us on your finances or taxes, check out the process
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The speakers' views and opinions discussed in this episode should not be considered financial, tax, or legal advice. Consult your advisor for any legal, cross-border tax, and financial advice.
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The speakers' views and opinions discussed in this episode should not be considered financial, tax, or legal advice. Consult your advisor for any legal, cross-border tax, and financial advice.
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Jane Mepham, CFP (00:03.114)
Do you know what a tax treaty is? And do you know how this impacts your taxation? By the end of this short guide, you'll know exactly what it is, how to use it, and what it does to your finances.
Manasa Nadig, EA (00:20.708)
Yes, so what is a tax treaty? A tax treaty is a bilateral agreement, which means a two-party agreement, basically a double tax avoidance agreement that resolves potential double taxation of citizens in two countries.
So what I mean is when an individual or a business invests in foreign country or moves to a foreign country and earns money in that country, the issue of which country should tax that investor's earnings or investment income may arise. So, then this tax treaty provides a blueprint of which country can tax that income.
A treaty could also cover income taxes, estate and gift taxes, and social security benefits.
And interestingly, there are some so-called tax havens which may not have any tax treaties with other countries, which kind of sounds, you know, that's why it would be called a tax haven.
Anyway, so the purpose of a tax treaty is that It avoids double taxation of the same income by more than one country, of course.
But then it also tells you which country has the right to tax that income. And this could be based on the source of the income and or the residency of the person or the business earning that income.
When Does A Tax Treaty Come Into Play
So then. When does this come into play? Let's say there is income in another country and you are resident in that country. Now the country that you're resident in wants to tax that income. So, what would you do? You would go to the articles on the tax treaty, which your country has with the income from the other country and
Manasa Nadig, EA (02:42.0)
See if any of those articles address the type of income that you have and help you mitigate double taxation.
Let me give you an example. So let's say that you used to live in the US, you were on a non-immigrant work visa and you had a 401k and some brokerage accounts. And let's say you're done with your work visa and you decided to go back to the country where you're from, let's say Spain. So we know that the US and Spain have a tax treaty with each other. So, once you're back in Spain, you still have the US brokerage account and it's earning interest and dividends. So now, because you are a citizen of Spain and you are a tax resident of Spain, Spain wants to tax your interest and dividends.
And because now this is US source income, the US also wants to tax that income too. You would look at the treaty to see if there is some kind of mitigation available.
There are many court cases that have been fought in the courts, and some of them have gone on the side of the taxpayer.
Basically, these court cases kind of give you guidance on how to interpret the tax treaties. And I’m going to kind of leave it at that, but sometimes you have to look at both the tax treaty and the court case to get more solid guidance on the income that you’re looking at for that country.
Jane Mepham, CFP (04:28.242)
That’s a fantastic way of addressing this. One thing I do want to call out about these tax treaties, every tax treaty has what's called a saving clause. And the reason I bring it, because people will see the saving clause and assume it means, I'm going to save some money. But actually, no. When you look at the saving clause, the savings clause, what that means is that your country, for example, the US reserves the right to tax its own residents and citizens as if the tax treaty was not in place.
So if the saving clause comes into being, it's not a good thing, but there's not much you can do. Please be aware that you will be taxed as if the tax treaty did not exist.
Which Countries Have Tax Treaties With The U.S.?
And so the next question is, does my country have a tax treaty with the US?
I don't know, but here's what I'm going to tell you. There are approximately 70 countries that have income tax treaties with the U.S., and I think what we're going to do is we'll link a document or a link that tells you exactly what countries are on this list. And again,
remember the tax treaties work on both sides, right? Now, on top of that, there are two other types of agreements that Manasa has mentioned or alluded to.
Gift & Estate Tax Treaties
One is a separate estate or gift tax treaty. There are approximately 15 of these. So, there's about 15 countries that have this estate and or give tax treaties with the U.S. And when this comes into play I think the best use case for this is let's say you're an NRA, you're a foreign national resident, you already left the U.S., but you've left what's called US situs assets.
If something happens to you, these assets would be taxed at 40 % and only 60K or $60,000 is exempt from this taxation. Now, this is in contrast to a U.S. tax resident who now with the passage of the latest tax bill has up to $15 million that could be exempt.
This 60K, you can see how that would impact you. And so if there's an estate end or gift tax treaty with the U.S., the treaty will help mitigate some of that.
As part of your estate planning, you should definitely look into that.
Totalization Agreements
And then there's a second type, what we call totalization agreements. There are approximately 30 countries that have totalization agreements with the US.
And the whole idea with these totalization agreements is to eliminate social security coverage and taxation. They ensure that you're not paying social security on the same income to two different countries. So that does help to keep some of your income back.
So if you end up, let's say, working in a foreign country, check to see if your country is one of the 30 that has a totalization agreement with the U.S.
Manasa Nadig, EA (07:46.36)
Oh, yes, yes. And you know, the whole thing comes together when you're moving from one country to another or you'll have income in another country, but you're a resident of a different country like we talked about.
But all of this comes together when you have to plan on how to mitigate double taxation. And it is important at that point to work with somebody who is very familiar with how these tax treaties work.
And you make sure that you make the right decisions, and maybe save taxes, or maybe not, because the savings clause has basically caught that.
So be careful when you're working with tax treaties if you are doing your own taxes, which I would not recommend. Let's wrap this up, Jane. What do you think?
Jane Mepham, CFP (08:42.966)
I'm happy with this,
Manasa Nadig, EA (08:46.058)
Okay cool, so thanks for hanging out with us dear listener and well, improving your English. So please keep coming back for more and subscribe to our newsletter. Thank you, bye.
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The speakers' views and opinions discussed in this episode should not be considered financial, tax, or legal advice. Consult your advisor for any legal, cross-border tax, and financial advice.