What it means
Tax systems usually treat residents and nonresidents differently. A resident is typically taxed on income from all over the world, while a nonresident is taxed only on income earned or sourced in that country, such as rent from local property or wages for work done there.
The labels are legal terms and not matters of nationality. Countries use different tests.
Individuals may be classed as residents if they spend more than a set number of days in the country, have a permanent home there, or keep their main economic and family ties there. Companies may be resident where they are incorporated, or where their central management and control are exercised.
One well-known example is the United States substantial presence test. It adds up the days a person spent in the country in the current year, one third of the days in the prior year and one sixth of the days in the year before that, and compares the total with 183 days, provided the person was also present for at least 31 days in the current year.
Other countries have their own rules, so someone can even be resident in two places or in none. Nonresident status matters to businesses in several ways.
Payments to nonresidents, such as dividends, interest, royalties and fees, are often subject to withholding tax, where the payer deducts tax and sends it to the tax authority. Tax treaties may reduce the rate if the nonresident provides the right paperwork.
It also affects bank accounts, investment rules and currency controls. Some countries apply different reporting requirements, limits on property ownership or exchange rules to nonresident customers.
Status can change from year to year, so mobile employees and directors need to track their days and ties carefully. Records such as travel logs, rental agreements and employment contracts can be valuable evidence if the tax authority queries a position.
In practice
Real-world examples.
Example
A foreign investor owns a rental flat worth $450,000 and earns $24,000 a year in rent. As a nonresident, he is taxed in that country only on the rent and not on his other income abroad.
Example
A software company pays a $100,000 fee to a contractor living abroad. The company must check whether it has to withhold tax and whether a treaty reduces the rate.
Example
An executive moves to a new country mid-year and spends only 60 days there before leaving for another posting. She is probably a nonresident for that year, but must keep records to prove her days. Her employer withholds tax on the salary linked to work done there.
Formula
Calculation
Weighted days = Days this year + (Days last year / 3) + (Days two years ago / 6)
A consultant spent 120 days in a country this year, 90 days last year and 180 days the year before. Weighted days = 120 + (90 / 3) + (180 / 6) = 120 + 30 + 30 = 180. Under a test with a 183-day threshold, 180 is below the limit, so she would not meet that test, although she could still be resident under other tests. If she spent 125 days this year instead, the total would be 125 + 30 + 30 = 185, which is above 183. A change of only five days in the current year therefore moves her across the line.Case study
Seen in the real world.
Ashgrove Holdings is a fictional trading company invented to illustrate this idea. Its owner, Karim, lived abroad but visited the head office country for 150 days a year to manage the business.
The tax authority took the view that he had become resident and that his worldwide income was taxable, including $400,000 of dividends from foreign investments. Karim's adviser argued that his permanent home and family were elsewhere and that a treaty gave priority to his home country.
After a long review, the authority accepted the treaty position, but Karim spent considerable time and fees on the case. He now limits his visits to under the key threshold, keeps a travel diary and reviews his status with his adviser each year. He also files treaty forms with every foreign payer to secure reduced withholding rates.
Watch out
Common mistakes.
- Assuming citizenship decides residency. Tax residency depends on facts such as days present, home and management, not on nationality.
- Ignoring withholding tax on payments abroad. The payer may be liable if it does not deduct tax when required.
- Forgetting to claim treaty relief. A reduced rate usually requires the right forms before payment.
Questions
People also ask.
Can someone be a resident of two countries?
Yes, under each country's domestic rules, and tax treaties then decide which country has the main claim.
Does a nonresident pay tax at all?
Yes, usually on income from local sources such as local property, business activity or employment.
How is a company's residency decided?
It usually depends on where it is incorporated or where its central management and control are exercised.
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