Tax Law Notes
Tax Law Note:
Definition of Residence for Individuals
Last Updated: December 02, 2004
The "residence" of an individual is often an important element in the application of income tax, particularly in countries which tax their residents on worldwide income. Residence is also a central concept in income tax treaties, whether based on the United Nations or the OECD models.1 Residence is important under treaties since normally only a resident may claim rights under a treaty. Treaties also assign taxing rights to many forms of income on the basis of residence of the recipient of the income.
The treaty definition in the UN and OECD models treats as a resident of a treaty-partner a person whom that country treats as resident under its internal law. Where a person is treated as a resident of both countries under internal law, the treaty contains a series of "tie-breaker" tests. This note focuses, however, on the definition of residence for purposes of domestic law.
The general concept of a resident of a country is someone who has close economic and personal ties to the country. In formulating the definition to be used for tax purposes, there is a trade-off between simplicity and fairness - the fairest rule might be one that evaluated all the ties that a person has with the country, while the simplest rule to administer might be a mechanical one that does not admit of subtlety or cater for special situations.
There are three general approaches to defining residence for tax purposes. One is a "facts and circumstances" method that looks at a number of factors (with no one considered determinative).2 This method often arises from the use for tax purposes of a general-law definition developed in court decisions over a period of years. The definition may not even be written in the tax law or any statute of the country. Typical factors considered are the location of the individual's permanent home; the place of the person's "habitual" abode; and the location of the person's family. The main difficulty with this "definition" of residence is its uncertainty; because the "facts and circumstances" test typically arose from decisions of a series of courts, it is difficult to apply.
Another approach is to adopt for tax purposes a definition already extant in the statutes of the country. Typical legal areas that specify a definition of resident are rules establishing the right to work or to remain in the country under immigration laws; the country's definition of domicile; or its citizenship laws. A number of countries use domicile, as defined in non-tax law, for the tax definition of resident.3 The United States is the only major country that subjects citizens to worldwide tax liability in the same way as residents,4 but this approach is not recommended for developing and transition countries, given that many such countries have liberal nationality laws that make multiple citizenship possible, and that this approach would provide a rather broad taxing jurisdiction that might be impractical for most countries to enforce and in any case contrary to usual international practice. Regardless of the nature of the definition used in a non-tax law, it will have the disadvantage of having been written to serve purposes other than taxation.
A third approach commonly appearing in a tax law is the individual's physical presence in a country for at least half a year (stated as "183 days or more").5 The term "physical presence" usually is defined to mean presence in the counrty for any part of a day, although not counting periods when the person is in transit and does not pass the country's immigration or customs barrier. If only presence for a full 24 hours were counted as a day of presence, some taxpayers might be able to avoid the test by arranging to cross the border frequently. Although the certainty of the physical presence test is appealing, it has several problems. One is that if the test looks only to the number of days of presence during the tax year, which makes its application quite simple, a person may have close ties with the country and be present for up to 364 days over a two-year period without being considered a resident.6 A more complex formulation, measuring physical presence over any 12-month period which begins or ends in the tax year, may give rise to the problem that a person may not be able to determine residence for a tax year until after the filing due date of the tax declaration. This problem is illustrated in Example 1.
The problem illustrated in Example 1 is often solved by use of a formulation that determines residency for a tax year based on physical presence for 183 days or more for any 12-month period ending in the tax year. In Example 1 this means that meeting the 183-day test for a 12-month period ending September 30, 2004 makes the taxpayer a resident for calendar year 2004, but not for 2003. While this approach eliminates the retroactive aspect of the physical presence test, there remains the disadvantage that the test itself is mechanical and may not really reflect what people ordinarily think of as "residence."
Part of the problem, of course, is that traditional assumptions about "residence" are not well-suited to today's internationally mobile world. For example, a person may live just outside the border of a country and come into it to work almost daily. For tax purposes, should that person be considered a resident of the taxing country or of the country that is the site of the taxpayer's home and family?7 Should a taxpayer who comes into a country for 7 months of work, three in one tax year and four in the next, be considered a resident for either year? Should a taxpayer who moves to a country with the intention of living there permanently be considered a resident immediately upon settling in the country?
To avoid some of these problems, a person who moves to another country can be treated as a resident of the new home country for part of the first year, with apportionment of tax allowances linked to residency.
Special rules may also be required for diplomats or other civil servants stationed abroad. Diplomats from one country who live in another country for several years are usually treated as continuing residents of the country they represent, an important rule because they are not ordinarily taxable on their diplomatic income in the country where they serve. A similar rule usually applies under tax treaties to non-diplomatic government personnel stationed abroad.
The definition of residence in a specific country need not be limited to one of the above approaches, as countries commonly combine several approaches and treat as resident an individual who meets any one of a number of criteria.
Fashioning a Solution
A country wishing to adopt a broad definition of residence may appropriately include more than one way of establishing residence. It is common to begin with some test relying on traditional connections of home and work, while including the more definite 183-day physical presence rule in its non-retroactive form. For example, a residence definition using traditional language may deem "resident" a person who has a "normal place of abode" or "primary dwelling-place" in the country and is present in the country at any time during the year, yet may also adopt as an alternative the 183-day presence test. A substitute for the phrase "normal place of abode" may be chosen based on terminology familiar in the country (whether in other law or in general usage), for example, "domicile"; "permanent home"; or "dwelling." The model definition set out to the left uses in paragraph (1)(a) the general language, "has closer social and economic relationships with X during the tax period than with any other country." This formulation sums up the intent of the more traditional tests, and flags a standard that may be difficult to specify. But whether the law uses "place of abode" or a more general expression, there is likely to be uncertainty and ambiguity in applying the facts and circumstances test. It is rare that a country's civil law defines clearly what the factors are and how they are to be weighed.
The second standard in paragraph (1) of the model is the 183-day physical presence test, applied in the disjunctive ("or" links the three clauses). Residence may be unclear under (1)(a), but the 183-day test ends the debate by defining the individual as a resident if he or she is physically present for the minimum period. The third test in paragraph (1) settles the issue for diplomatic and other government personnel posted abroad, who should be treated as residents even if not present in the country for the 183-day period, and even if their primary dwelling or habitual place of abode is in another country.
Paragraph (2) of the model makes the residence tests non-retroactive, and paragraph (3) prevents an inappropriate extension of residency. Example 2 illustrates how these paragraphs affect application of the 183-day test.
It should be clear that under the model provision's physical presence test, it may often be necessary to apportion tax allowances based on residence in the case of temporary workers. Apportionment formulas may be included in regulations or rules rather than in the statute, and typically are based on the number of days of residency during the year (for example, 210/365) or the number of months in which the person was physically present (for example, 7/12).
Almost regardless of the statutory definition of residence, it is possible for an individual to be a resident of more than one country.8 This result is particularly likely when two countries apply the 183-day test in the model's paragraph (1)(b) without including the restrictions in paragraphs (2) and (3). One reason countries may prefer to dispense with paragraphs (2) and (3) is that those provisions, which permit part-year residence, create the need for apportionment of tax allowances (a complicating feature). But even with a provision for part-year residence, individuals may be classified as residents of more than one country with respect to the same income. If each country sets out to tax the worldwide income of its residents, dual residence results in the problem of double taxation. The mechanisms for double-tax relief arising from combined source-country and residence-country taxation of the same income may solve this residence-residence double taxation.
Bilateral tax treaties provide a tiebreaker mechanism to allocate the residence of the individual to one of the two contracting countries. This allocation is achieved through a hierarchy of tests involving the individual's permanent home, center of personal and economic relations, habitual abode, and nationality.9 Tax treaties also can deal specifically with a common problem of residence-residence double taxation, the frontier worker who lives in one country but works in another and crosses the border between the two countries every workday. A double taxation treaty can provide for taxation in only one country in this case.
Ault, Hugh et al., Comparative Income Taxation 368-71 (1997) (U.S., Canada, Australia, U.K., Sweden, Netherlands, Japan, France, Germany)
Vann, Richard International Aspects of Income Tax, Tax Law Design and Drafting 729-32 (1998). [Chapter 18]
1The series of Tax Law Notes has been prepared by the IMF staff as a resource for use by government officials and members of the public. The notes have not been considered by the IMF Executive Board and, hence, should not be reported or described as representing the views of the IMF or IMF policy.
See Article 4 of the UN or OECD Models, which is virtually identical in both. For further details on the definition of residence under treaties, see for example, Klaus Vogel, Klaus Vogel on Double Taxation Conventions (3d ed. 1997).
2Canada, Australia, the Netherlands. See Ault et al., Comparative Income Taxation 369 (1997).
3E.g., United Kingdom. See Ault et al., supra note 2, at 369.
4If there are any other countries with such a rule, there are not very many.
5E.g., Germany. See id. at 370.
6Nevertheless, this is a simple rule and a number of countries use it, for example France, Sweden. See id. at 369-70.
7Special rules for border workers might be provided either in a country's domestic law or under treaties. For example, I.R.C. section 7701(b)(7)(B) provides: "If an individual regularly commutes to employment (or self-employment) in the United States from a place of residence in Canada or Mexico, such individual shall not be treated as present in the United States on any day during which he so commutes."
8The opposite situation - being a resident of no country, by dividing time up among several countries and minimizing ties with any one - is also possible. This situation is likely to be rare, since it would involve not having an abode in any country that includes having an abode in its definition of residence. It is implausible as a result of deliberate planning, since such an individual would suffer no tax disadvantage by residing in a tax haven country.
9For example, see the OECD Model art. 4(2). See Richard Vann, International Aspects of Income Tax, Tax Law Design and Drafting 729-32 (1998).