Overview of the Identification of Tax Residency for Major Countries Tax Implications on Cryptocurrency Allocation
Tax Residency Identification & Cryptocurrency Tax Implications
A tax resident refers to a natural person or legal entity who resides in a country (or holds the nationality of a country), enjoys civil rights and obligations under the law, and is subject to the jurisdiction of that country’s laws. Tax residents usually have an unlimited tax obligation to the government of their country of residence, which means that they have to pay taxes to the government of their country of residence on income earned worldwide.
For cross-border cryptocurrency investors, tax residency is a very important concept as it relates to the determination of cryptocurrency tax collection methods and tax rates. In addition, due to the different criteria and methods used by different countries or regions to determine tax residency, it is possible for an investor to be recognized as a tax resident by multiple countries or regions, resulting in dual tax residency. This means that the investor may have to pay the same type of tax in multiple countries or regions. Therefore, it is crucial for investors to understand the criteria for determining tax residency in various countries and the corresponding double taxation avoidance agreements. This article will outline the rules for determining tax residency and provide a brief discussion on double taxation avoidance based on these rules.
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2.1 Scope of Tax Residency
Both individuals and corporate entities can become tax residents of a country or region. Taking mainland China as an example, the criteria for determining individual tax residency are “having a domicile in China or residing in China for a total of 183 days during a tax year.” Specifically, having a domicile in China refers to habitual residence in China due to household registration, family, or economic interests. Residing for 183 days refers to residing in China for a total of 183 days during a tax year (temporary departures of no more than 30 days at a time or multiple departures totaling no more than 90 days are not deducted from the count). The determination of corporate tax residency is mainly based on whether it is legally established in China or whether its actual management institution is located in China in accordance with the laws of other countries and regions. Specifically, the actual management institution refers to an institution that exercises substantial comprehensive management and control over the company’s production, operation, personnel, accounts, and assets.
2.2 Difference between Tax Residency and Other Concepts
Concepts that are easily confused with tax residency include nationality, household registration, and habitual residence.
Nationality refers to the political and legal relationship between citizens and a country and is a sign of a citizen’s affiliation with a certain country. The nationality of a corporate entity is referred to as corporate nationality, which may be determined based on the place of establishment of the company, the place of residence, or the nationality of the members of the company.
Household registration usually refers to the household registration of Chinese citizens, which is the registered place of residence of citizens in the national household registration authority and is the legal residence of citizens. Article 25 of the Civil Code stipulates: “The residence registered or otherwise validly recorded in the household registration or other valid identity registration of a natural person shall be deemed as the domicile. If the habitual residence is inconsistent with the domicile, the habitual residence shall be deemed as the domicile.” At this time, the registered residence loses its effectiveness as a domicile.
常住地 refers to a place where a natural person temporarily resides for a certain purpose, without the intention of long-term residence. The concept of常住地 does not require a specific length of residency or the intention of permanent residence, only the requirement of actual residence. A natural person can have multiple常住地.
Although the determination of tax residents sometimes needs to refer to the above concept, tax residents and常住地 are not completely identical and may overlap or differ in some cases. For example:
A person may be a tax resident of multiple countries, but only have the nationality of one country.
A person may have household registration in a certain country, but is not a tax resident of that country due to long-term work or living abroad; similarly, the person may not have household registration in a certain country, but is a tax resident of that country due to having family or economic interests in that country.
A person may have常住地 in a certain country, but is not a tax resident of that country because he/she does not meet the country’s stay time criteria.
3. Tax Residence Determination Rules in Major Countries
The determination of tax residence generally refers to the written tax laws or relevant laws of the local country. However, for common law countries such as Canada and the United Kingdom, there is no explicit provision that meeting certain conditions will definitely be considered as a tax resident. Instead, it is judged comprehensively based on the overall situation of individuals or entities. This article first summarizes the tax residence determination rules of major countries according to relevant laws, regulations, and precedents.
Specifically, in some countries, although partnership enterprises and transparent entities are not considered as tax resident entities for taxation purposes, they still have the obligation to report financial information as tax residents based on the CRS. For example, under the CRS, if a partnership enterprise’s place of effective management is located in Canada, it should be regarded as a tax resident of Canada. This is done to prevent the risk of cross-border tax evasion and strengthen the management and information exchange of tax sources among countries (regions).
4. Dual Tax Residency and Taxation Rules
4.1 Reasons for Dual Tax Residency
Dual tax residency refers to a situation where a person meets the tax residency criteria of two or more countries (regions) at the same time, and therefore has tax obligations in these countries (regions). This mainly stems from the different criteria for determining tax residency. For example, some countries use residence to determine tax residency, while others use常住地, which results in the same taxpayer being recognized as a resident in different countries and having unlimited tax obligations in each of them.
In order to avoid or mitigate double taxation, countries usually sign Double Taxation Agreements (DTAs), which stipulate how to resolve conflicts in determining residency and provide corresponding tax exemptions or offset arrangements.
4.2 Taxation Rules under DTA Agreements
Generally, DTAs use rules such as the residence rule, the source rule, and the nationality rule to resolve conflicts in determining residency. Among them, tie-breaker rules refer to a series of criteria established in international tax treaties to resolve the issue of tax attribution for individuals or entities who are residents of both parties. In international tax treaties, tie-breaker rules are usually applied in the following order:
(1) Considered a resident of the party in which they have a permanent home;
(2) If they have a permanent home in both parties, considered a resident of the party with which their personal and economic relations are closer (center of vital interests);
(3) If it is not possible to determine the center of vital interests or if they do not have a permanent home in either party, considered a resident of the party in which they have habitual abode;
(4) If they have a habitual abode in both parties or neither party, considered a resident of the party of which they are a national;
(5) If they have nationality in both parties or neither party, the competent authorities of both parties shall resolve it through consultation.
(1) Considered a resident of the party in which their actual management is located;
(2) If it is not possible to determine the location of actual management, the competent authorities of both parties shall resolve it through consultation.
This article attempts to illustrate the application of tie-breaker rules using the “Agreement between the Government of the United States of America and the Government of the People’s Republic of China for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income” (hereinafter referred to as the “Agreement”) between China and the United States. Firstly, Article 4, paragraph 1 of the Agreement states: “For the purposes of this Agreement, the term ‘resident of a Contracting State’ means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of registration, or any other criterion of a similar nature.” Subsequently, paragraphs 2 and 3 of Article 4 respectively provide that if an individual or a company is determined to be a tax resident of both China and the United States under the domestic laws of both parties, the parties “shall endeavor to determine the residence of that individual/company for the purposes of this Agreement through mutual agreement.”
Additionally, the Protocol to the Agreement states: “In applying paragraph 2 of Article 4 of this Agreement, the competent authorities of the Contracting States shall apply the rules contained in paragraph 2 of Article 4 of the United Nations Model Double Taxation Convention between Developed and Developing Countries.” The rules referred to are the tie-breaker rules, and the method of determination is consistent with the previous explanation. Therefore, the following examples can be cited:
Example 1: Company A is registered in China and operates businesses in both China and the United States, but its actual management is in China. Therefore, Company A should be considered a resident of China because its actual management is in China.
Example 2: Company B is registered in the United States and operates in both China and the United States, but the actual location of its management cannot be determined. In this case, Company B should be considered a resident determined by the competent authorities of both countries through negotiation. If no agreement can be reached through negotiation, Company B cannot enjoy any tax benefits under the tax treaty.
Example 3: Both C and his wife are Chinese citizens. They reside in the United States for about 90 days each year, and the rest of the time they reside in China. Their permanent residence is in Shanghai, China. They have invested a large amount of capital in a company in the United States and are members of the board of directors of this company, but they are not responsible for the daily operations of the company. They have also purchased several investment properties in the United States. In this example, C is considered a tax resident of China according to Chinese domestic law and a tax resident of the United States according to U.S. domestic law (based on the actual days of stay). Therefore, according to the relevant provisions of the Agreement, the first step is to determine whether C has a residence in both countries. It is clear that C has a residence in China but not in the United States, so C is considered a tax resident of China, not the United States.
4.3 Exceptions to the tie-breaker rule
As of the end of April 2020, China has formally signed 107 double taxation avoidance agreements with other countries (of which 101 have taken effect), and has signed tax arrangements with the two special administrative regions of Hong Kong and Macao (which have taken effect), and a tax agreement with Taiwan (which has not taken effect yet). In the bilateral tax treaties signed between China and other countries, the tie-breaker rule is usually based on the United Nations Model Double Taxation Convention between Developed and Developing Countries (referred to as the “UN Model”), but some treaties may adopt tie-breaker rules different from the UN Model, such as the OECD Model. Although the tie-breaker rules in the OECD Model and the UN Model are similar, there may be different ways of determination in specific treaties. Therefore, Chinese investors should pay attention to the bilateral tax treaties between their country of operation and China in order to determine the corresponding tie-breaker rules.
5 Precautions for cross-border cryptocurrency investments
The investment activities of cross-border cryptocurrency asset investors are usually spread all over the world. In this case, in addition to the transactions in the jurisdiction where the assets are located, which need to be taxed by the local authorities according to the principle of territoriality, if they are recognized as tax residents of high-tax countries, they may be subject to unlimited tax obligations in that country. In order to reasonably eliminate the corresponding investment costs, this article believes that investors can consider the following aspects:
First, try to avoid having a permanent residence in high-tax countries. Permanent residence is the primary criterion for determining tax residency. If investors have a permanent residence in a high-tax country, they are likely to be recognized as tax residents of that country. Therefore, investors should try to avoid purchasing or leasing real estate for long-term residence in high-tax countries.
Second, try to place important centers of interest in low-tax countries. If investors have permanent residences in multiple countries, they should try to place their important centers of interest in countries with lower tax rates. Important centers of interest refer to the places where individuals have the closest personal and economic ties, including family, society, occupation, and property. Investors can demonstrate their important centers of interest through the following means.
Residing in a low-tax country with family or frequently visiting
Participating in social activities, joining clubs or organizations, and building friendships in a low-tax country
Engaging in primary occupations or business activities, or establishing companies, branches, or offices in a low-tax country
Investing or holding a majority of assets in a low-tax country
Opening bank accounts, credit cards, insurance, and other financial products in a low-tax country
Third, it is advisable to avoid habitual residence in high-tax countries. If an investor does not have a permanent residence in any country and it is difficult to determine the center of interest, it is recommended to avoid habitual residence in high-tax countries. Specifically, investors should try to control their time of residence in high-tax countries or provide evidence that their residence in that country is temporary, such as tourism, visiting friends, or business inspections.
Lastly, for physical investors, they should establish the actual management institution of their entities in countries with lower tax rates. The actual management institution refers to the highest decision-making body of the entity, usually the board of directors or a similar institution, which is responsible for formulating and implementing major decisions of the entity. If the entity operates in multiple countries, the meeting location of the actual management institution, the location of document storage, and the residency of senior management personnel should be set in countries with lower tax rates to demonstrate that the country is an important center of interest for the entity. If it is not possible to determine the location of the actual management institution, the competent authorities of both parties will resolve the issue through consultation. In this case, the outcome may be uncertain and time-consuming. Therefore, investors should try to avoid this situation or proactively communicate with the tax authorities of the relevant countries to strive for more favorable results.