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By: Karim Daher
HBD-T Law Firm | Partner
President of the Lebanese Association for Taxpayers’ Rights (ALDIC)
It becomes obvious nowadays that the definition of resident as regards to the determination of the scope of application of taxes on a person or a business becomes a matter of sovereignty in international taxation. Indeed, countries usually extent or limit the scope of their income taxation in some manner by adopting one of the three current tax systems: territorial or residential or citizenship. Many countries have attempted to mitigate the advantages and limitations of each of those three systems by enacting hybrid systems with characteristics of two or more like UK, USA and Lebanon.
However and since major conceptual differences can exist between tax systems adopted by each country and may lead to cases of double taxation or no taxation in international trade and bilateral transactions, many countries have signed tax treaties with each other to eliminate or reduce double taxation. Besides, and as a result of the OECD fight against tax havens and offshore centers, many countries have been compelled to sign lately or commit to a multilateral treaty (MCAA) for transparency and automatic exchange of information for tax purposes (Global Forum) which applies and endorses the common reporting standard (CRS). The principle aim of the new automatic standard is to expose the financial assets of non-residents held in off-shore financial centers so that they may be subject to tax by home revenue authorities. The main mechanisms and objectives of both DTTs and Treaties will be exposed hereinafter.
Besides and insofar territorial systems usually tax local income regardless of the residence of the taxpayer and whereas the key problem argued for this type of system is the ability to avoid taxation on portable income or movable capital by moving it outside the country, some concerned countries adopting this system have been forced to develop their legislation and to enact hybrid system in order to avoid tax evasion or recover lost revenue. Lebanon is one of those concerned countries with its particular system of schedule tax (impôts cédulaires). We will tackle in brief all those systems in the following development in order to clarify the issues at stake for many persons facing such problems for the first time in their life owing to the profound fiscal scene’s change in the world.
- International Income Tax systems.
One of the main characteristic of a State’s sovereignty recognized by international law and accepted by its peers is the right to levy taxes and decide upon the geographical extent of its jurisdiction. Accordingly, States may levy taxes on both local and foreign income (worldwide taxation) from both residence and citizenship standpoints or solely derived in territory (taxation based on the territoriality principle). Needless to precise that major conceptual differences can exist between those tax systems.
- Residential Taxation.
This is the most common and applied system for the majority of countries in the world notably the developed countries with the exception however of the USA (177 countries out of 244). In the residential system, residents of the country are taxed on their worldwide (local and foreign) income, while nonresidents are taxed only on their local income.
In point of fact, as regards to this system and without prejudice to international double taxation treaties, the country where a natural person is resident for tax purposes can usually tax his total worldwide income, earned or unearned. This includes wages, pensions, benefits, income from property or from any other sources, or capital gains from sales of property, from all countries worldwide even though all or part of those are already taxed in other countries applying territorial or citizenship taxation. Generally, where worldwide income is taxed, countries with a residential system of taxation usually allow deductions or foreign tax credits for taxes that residents already paid to the aforesaid other jurisdictions.
Practically, residential systems face the problem of defining the “resident” since such definition vary by countries and type of taxpayers. The term resident means usually under the laws of the concerned countries, the person who is liable to tax therein by reason of his domicile, permanent residence, place of customary business or any other criterion of similar nature. However the determining criterion is undoubtedly the location of the person’s main home and number of days (more than 183) the person is present in the country. Indeed, some countries like the United Kingdom (UK), make a difference between domicile and residence. The domicile is the country which a person officially has as his permanent home, or has a substantial connection with. For instance, when someone is born in the UK, he is automatically assigned to the same domicile as his parents, which is defined as his domicile of origin and will continue until he acquires a new domicile abroad. The domicile is important when it comes to determining the tax liabilities in three main areas: income tax, Capital Gains Tax and Inheritance Tax and is of particular importance in this latest case if the concerned person was to own property or financial assets in foreign jurisdictions.
- Territorial Taxation:
In the territorial system, only local generated income (i.e. only income from a source or project or work inside the country) is taxed regardless the residence or the citizenship of the taxpayer earning such income. This system allows avoidance of tax payment for portable income (mainly movable capital and assets) by moving it outside the country.
Actually, the manner of determining the source of income in this system is generally dependent on the nature of income. For instance, income from the performance of services (i.e. wages or consultancy) is generally treated as arising where the services are performed. To the contrary, financing income (dividends, interests, etc.) is generally treated as arising where the user or the beneficiary of the financing resides. Income related to real estates and tangible properties is considered as arising where the property is located.
- Citizenship Taxation:
Only two countries in the world, United States and Eritrea, systematically tax the worldwide income of residents (whether citizens or not) as well as nonresident citizens. In other words, citizens are taxed in the same manner as residents. However a difference should be pointed out between those two countries. Indeed, and while Eritrea taxes its nonresident citizens on their foreign income at a reduced rate of 2%, the United States taxes its nonresident citizens on their worldwide income using the same marginal tax rates for both foreign and US-source income with the possibility of providing foreign tax credit to mitigate double taxation. Enforcement tactics used by both countries to facilitate tax compliance include the denial of passport to nonresident citizens deemed to be delinquent taxpayers and the potential seizure of any accounts or assets held in the country. Eritrea uses also the harassment of relatives living within the country until the tax and eventually the penalties are paid.
- Dual Residence.
In some cases, such as for workers posted abroad for a limited time or jobseekers abroad, they may be considered tax–resident, and therefore taxable, in their home country even if they stay abroad for more than 6 months. It is linked to the assumption that (i) they keep their permanent home in their home country and/or (ii) that their personal and economic ties with that country are stronger. However, in such a case, the host country may also tax the worker. His local employer may, for instance, deduct taxes from his salary at the time of payment. Hence and in such situation, both countries could consider an individual as a tax-resident at the same time, and both could require him to pay taxes on his total worldwide income. Fortunately, many countries have double tax agreements, which usually provide rules to determine which of the two countries can treat the said individual as a resident.
- Tax Treaties to eliminate or reduce double taxation or tax evasion.
- Double Tax Treaties (DTTs).
In order to prevent double taxation as defined here before (taxes levied twice on the same income, profit, capital gain, inheritance or other item), Tax Treaties are negotiated and signed between countries on a bilateral basis in accordance with the model conventions on income and wealth drawn up by the Organization for Economic Cooperation and Development (OECD). In some countries they are also known under the title of double taxation agreements or tax information exchange agreements (TIEA). Pursuant to the foregoing, each case under consideration should be “confronted” with the provisions of the bilateral treaties for the avoidance of double taxation as they prevail over the internal laws. They also tend to have “tie breaker” clauses for resolving conflicts between residency rules.
Thus, according to the OECD model tax treaties, a resident of a Contracting State means “any person who under the law of that State is liable to tax therein by reason of his domicile, residence, head office or place of management (business), or any other criterion of a similar nature”. Therefore, when a taxpayer may be deemed to be a resident of both Contracting States under the laws of each State, the treaty enumerates the alternative criteria to be implemented in the following order of priority: (i) the permanent home; (ii) the center of vital interests, taking into consideration the personal and economic links of the taxpayer (i.e. State with which his personal and economic relations are closer); (iii) the habitual abode; (iv) the nationality.
In this regard it should be noted that the word “home” means the place where the person or his family (spouse and children) usually live. Consequently, a person is deemed to have a fiscal home in the country where his family lives even if he undertakes his activities abroad. A permanent place of abode usually includes a residence the spouse owns or leases. A person is deemed to have as well a permanent abode in a country (State) where he spends more than 183 days within one year, whatever are the conditions and regardless of his family’s abode. The center of the person’s vital economic interests are located in the country where he has implemented his major investments or where is located the head office for the purpose of managing his assets. It can be as well the place where is located the center of his professional activities or where he earns the major part of his incomes.
In the light of the foregoing, natural persons who are fiscally domiciled in a State, even if they own economic interests abroad, have in principle an unlimited tax obligation and are taxed on their worldwide income; without prejudice however to some incomes that are liable to tax in other countries in compliance with the provisions of tax treaties as for instance the revenues of real estate properties.
However in specific cases some treaties may diverge from the general rule insofar the tax systems substantially defer. For instance, US citizen and resident alien decedents are subject to estate tax in the US on all their assets wherever situated regardless of any provisions to the contrary. In the meantime and in accordance with the provisions of the OECD’ model, the nonresident aliens are subject to estate tax only on the part of the gross estate which at the time of death is situated in the US.
- Multilateral Tax Treaties.
The Multilateral Competent Authority Agreement (MCAA) adopted in a mass signing ceremony on October 29, 2014 (Global Forum) is a typical example of multilateral tax treaties aiming to adopt common rules and practice. It provides for a common OECD’s automatic standard called CRS which is a multilateral, fully reciprocal, automatic exchange of information mechanism that was essentially copied from FATCA.
There are two ways for jurisdictions to comply with the OECD’s automatic standard. Jurisdictions may enter into DTTs or TIEAs that incorporate the due diligence and reporting rules of the Common Reporting Standard. In the alternative, jurisdictions may also become parties to the MCAA, which is a framework agreement designed to implement the automatic standard on a multilateral basis. Exchange of information under the MCAA will be activated when both counterparties file Notifications with the OECD Secretariat. CRS has developed a mechanism, which requires Financial Institutions (FIs) of each Member country to report to their local Competent Authorities all accounts and related details pertaining to residents of jurisdictions with which there are agreements for automatic exchange. It implies that the criterion of residence turned out to be an essential issue at stake. The information to be exchanged includes account balances and gross amounts of interest, dividends, capital gains and other income.
- Lebanese Taxation System.
From a tax standpoint, the residency was not defined so far in the Lebanese laws, although it is the cornerstone of the fiscal systems around the world, except for some countries that adopt the citizenship criterion. The Income Tax Law and some regulations indirectly and briefly tackled the residency as well as a basic Circular of the Central Bank (No 6170 dated 17/05/1996). The decree No. 29/77 for instance stipulates that residents are the persons usually residing in Lebanon without adding further details; whereas according to the decree No. 70/1 dated 14/12/1959, Lebanese residents are the persons having in Lebanon a residence or a head office or owning a business or a factory therein. The whole notwithstanding the fact that the Lebanese tax system is based, in consideration of income taxes on professional, industrial and commercial revenues (including corporate tax), on the territoriality principle which taxes only income derived in Lebanon whether by residents or non-residents. Hence and without prejudice to double taxation treaties (DTT), profits realized on services, works and transactions conducted abroad are normally not subject to the Lebanese business income tax. Nevertheless, Lebanese Tax system adopts however the residential system for some of its schedule taxes such as Tax on movable capital gains or on income from movable assets. Thus, article 69 of the Lebanese Income Tax Law (Legislative-decree No 144 dated 12/6/1959 and its amendments) considers as liable to the local Tax, income from movable assets (interest, dividends, arrears, bonds, etc.) whether derived in Lebanon or reverting to a resident (local and foreign proceeds). The same applies as well for inheritance and gift taxes. A bill of law aiming to amend some provisions of the Law of Fiscal Procedures in order to comply with the requirements of the Global Forum has been modified recently as to include for the first time in the Lebanese laws a legal definition of the residency from a tax standpoint. The said amendment pertains to article 1 of the Law of Fiscal Procedures. It makes a distinction between the moral entities and natural persons. It considers therefore that moral entities are deemed to be Lebanese residents if they fulfill one of the two criteria: (i) they are set up or registered in compliance with the Lebanese laws (the distinction between the set-up and the registration aims to include the partnership and the de facto corporation); or (ii) they have a head office in Lebanon.
On the other hand, are deemed to be Lebanese residents, natural persons who:
- Have an office in Lebanon to undertake their activities; or
- Have a permanent home constituting an habitual abode for them or their family; or
- Spend in Lebanon more than 183 days (six months) within a twelve month period. The foregoing does not include the transit through Lebanon or the residency for medical purposes.
The principle stating, for the professional revenues, that is only taxable in Lebanon the income generated in Lebanon remains applicable. Conversely, the resident who earns incomes derived from foreign movable capital (foreign shares and debentures) will be bound to pay the tax in Lebanon whether the incomes are paid by Lebanese or foreign banks. Anyway, this was recalled by the Ministry of finance lately by virtue of two notifications dated December 1st, 2015 and September 19th, 2016 published in the Official Journal.
Similarly, in case of death, since the inheritance tax is paid in the State where the residence of the deceased is located, the heirs of the Lebanese resident are liable to tax in Lebanon on the assets located in Lebanon and abroad, regardless of the deceased’s nationality and without prejudice to the provisions of the bilateral treaties. This drawback is however mitigated by the ongoing protection of the bank secrecy (Law of September 3, 1956) that will still benefit to Lebanese residents insofar the MCAA as an international treaty prevailing on the local laws will only apply to nonresidents.
It is to note finally, that the Council of Ministers issued recently the Decree N° 3692 dated 22/6/2016 which determines the mode of application of tax on nonresidents. The provisions of the said Decree apply to natural persons and legal entities that do not maintain a place of business in Lebanon as well as to physical persons resident in Lebanon providing occasional and not permanent taxable activities in Lebanon (i.e. non-registered at the Ministry of Finance). The decree has notably clarified the meaning of “permanent and repetitive activity” which means in this Decree any person undertaking a taxable activity in Lebanon for more than one time within a period of 12 months.
Based on the preceding developments, we notice that the globalization and the expansion of tax treaties as well as the international fighting against money laundering, terrorism and tax evasion have eroded the sovereignty of States to a certain degree notably the developing countries for the benefit of developed countries. Nonetheless, States still enjoy a high level of fiscal sovereignty in the field of direct taxation notably those generated in their territories or reverting to their residents. Lebanon is one of those countries that despite its obligation to comply with international standards aiming to avoid any possibility of fraud, will remain largely free to design its tax system in a way that meets its internal policy objectives and requirements. This is particularly accurate as regards to the criterion of residence since it may be defined widely under its laws and serve to attract individuals, companies and capital in circulation.