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Imposing Taxation On Tax Residents Of Other Countries



John Richardson

(This is Part 2 of my post discussing the South Africa tax situation. Part 1 is here.)

This is a follow up to my post exploring whether South Africa is moving to a tax system that is based on “citizenship-based taxation” or (in the case of the United States of America) “taxation-based citizenship”. That post was the result of a “special request”. The response from that first post included:

I now understand the difference between the SA system and the US. I believe that the similarity that caused the consternation when this first came up was the issue of “tax residency”. CBT mandates that those declared US citizens by the US are simultaneously declared US tax residents. In a similar fashion SA has a concept of tax residency that *does* include some people who do not physically reside in SA but NOT just because they’re citizens. I get it. Thanks again for clarifying this!

That being said, I think the term “tax residency” is crazy. I wish that someone with the power to influence terminology in the general usage of language could come up with something that accurately describes the basis on which a person can be taxed by a country in which that person does not live. Taxes don’t reside; people do, and they can only live one place at a time. Any ideas?

My thoughts on this topic: Nothing more and nothing less

Let’s leave out the obvious cases where the source of the income is the country that is doing the taxing. I think most people would agree that all countries have the right to imposes taxes on economic activity (whether from property or business) that occurs in that country or territory. That principle is the basis of what is called “territorial taxation”. Everybody agrees that this is okay. Notice under a system of “territorial taxation”, that the issue of South Africa imposing taxation on income earned by residents of other countries does NOT arise. Why not? Because under a “territorial system”, (which it used to have) South Africa would have no interest in taxing economic activity outside of South Africa.

The problems arise when we consider “taxing rights” under a system of “worldwide taxation”. In a system of “worldwide taxation” a country imposes taxation on the “world income” of its “tax residents”. Tax treaties are for the purpose of allocating “taxing rights” in a system of “worldwide taxation”. (I highly recommend a series of three posts by Karen Alpert of “FixTheTaxTreaty.org” fame. She explains how treaties work in general and how the “savings clause” in U.S. tax treaties perverts that purpose.)

The precise question is under what circumstances, is it appropriate or justifiable for a country to:

1. Define its “tax residents” to include people who do NOT reside in the country; and

2. Then impose taxation on income earned in other countries for the simple reason that the individual lives in that other country?

The United States, Eritrea and (soon) South Africa are countries that define their “tax residents” to (1) include people who do NOT live in the country and (2) use them to impose taxation on the economic activity that takes place in other countries.

Notice that this is accomplished through “citizenship-based taxation” in the case of the United States and Eritrea. It is to be accomplished, through a very broad definition of “physical presence”, in the case of South Africa. Whether this is accomplished through “citizenship-based taxation” or whether through a broad definition of “residence” the result is the same.

The result/effect is that the United States, Eritrea and (soon) South Africa use the combination of “worldwide taxation” and broad definitions of “tax residency” to transfer the capital from other countries to the United States, Eritrea or South Africa. In other words, this group of three, “steal” from the economies of other nations. (This is presumably justified only on the basis that the “tax residents” of a country are the property of the country.) The United States is by far the worst offender. (Consider for example the PFIC, phantom capital gains, CFC and Expatriation tax rules. Note that these are situations where the normal double tax mitigation principles do NOT allow credits for all foreign taxes paid. In other words, this is pure theft from the economies of other nations.)

Therefore, to ask for “something that accurately describes the basis on which a person can be taxed by a country in which that person does not live” is really to ask two questions:

First, in relation to the individual: What would justify imposing taxation on the world income of an individual who does not live in the country?; and

Second, in relation to other countries: What principle would justify one country using the imposition of taxes imposed on residents of another country to steal capital from that other country?

To provide some context: What principle would justify, South Africa imposing taxation on its “tax residents”, who live in the UAE, on income earned by them in the UAE? The effect will be to transfer a portion of that income earned in the UAE to South Africa. The UAE is a sovereign country that is entitled to its own domestic tax policies. What gives South Africa the right to come in and tax income or activity, that is in the UAE and NOT in South Africa? Can South Africa just impose taxation because economic activity in the UAE exists? Is it reasonable for the Government of South Africa to say:

Hey, there’s money being made in the UAE. Why don’t we send some of our own “tax residents” over there and use them to get some of that money for ourselves?

The problem (it seems to me) is NOT “worldwide taxation” per se. The problem is imposing “worldwide taxation” on people who live in other countries.

Implications for U.S. tax reform

The United States is by far the biggest offender and without relevant tax reform, will be the number one “tax leach” in the world. Whether by “accident” (used to be the case) or “design” (it is becoming deliberate) the United States uses its “citizens” to syphon capital from the economies of other nations. Sooner or later this will come to an end. Both the Republicans and Democrats now seem to want to end the United States tradition (validated by Cook v. Tait) of imposing taxation on the residents of other countries. But, they propose to do this in different ways.

Republicans: Want to move to a system of “territorial taxation”. The United States would tax only activity within the United States. Notice that the Republican proposal focuses on the income subject to taxation and NOT on the definition of “tax resident”.

Democrats: Appear to want to retain “worldwide taxation” but restrict the definition of “tax resident” to those who actually reside in the United States (as long as the rich aren’t getting away with something). Notice that the Democrat proposal focuses on the definition of “tax resident”. ACA (“American Citizens Abroad”) has also devoted serious time and effort to developing a proposal for “residence-based taxation”.

From the perspective of Americans abroad any one of these proposals would be a welcome relief.

Back to the South Africa issue

Notice that some definitions of “tax resident” that fall short of “citizenship-based taxation” can accomplish the same thing as “citizenship-based taxation”. South Africa should NOT join the United States and Eritrea in imposing taxes on the residents of other countries. Rather, South Africa needs to reconsider what it takes to qualify as a “tax resident” of South Africa!

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The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a dual citizen. I am a lawyer – member of the Bar of Ontario. This means that, any counselling session you have with me will be governed by the rules of “lawyer client” privilege. This means that:

“What’s said in my office, stays in my office.”

I am also a member of the American Citizens Abroad Professional Tax Advisory Council (PTAC). This is an advisory panel focused on assisting American Citizens Abroad in an FBAR and FATCA world.

The U.S. imposes complex rules and life restrictions on its citizens wherever they live. These restrictions are becoming more and more difficult for those U.S. citizens who choose to live outside the United States.

FATCA is the mechanism to enforce those “complex rules and life restrictions” on Americans abroad. As a result, many U.S. citizens abroad are renouncing their U.S. citizenship. Although this is very sad. It is also the reality.

0 thoughts on “Imposing Taxation On Tax Residents Of Other Countries

  1. Avatar Shovel says:

    “[T]he United States, Eritrea and (soon) South Africa use the combination of “worldwide taxation” and broad definitions of “tax residency” to transfer the capital from other countries to the United States, Eritrea or South Africa. In other words, this group of three, “steal” from the economies of other nations. (This is presumably justified only on the basis that the “tax residents” of a country are the property of the country.) The United States is by far the worst offender. (Consider for example the PFIC, phantom capital gains, CFC and Expatriation tax rules. Note that these are situations where the normal double tax mitigation principles do NOT allow credits for all foreign taxes paid. In other words, this is pure theft from the economies of other nations.)”

    Thank you, John Richardson, for exposing what’s happening under the correct term for what it is… theft.