How International Taxation Works
Most people aren’t citizens of the world.
They stay in the same country they were born for most of their lives. They invest there, do business there, die there…
And of course, pay taxes there.
For those of us who wish to expand our wings and join the global community of lifestyle, business, and investing, well… we’ve got to consider or perhaps benefit from paying taxes in multiple countries.
The great news is, of course, this might mean the potential for massive tax savings compared to simply a local tax.
It could also mean complications, fines, double tax, audits, and huge accounting bills.
How do you end up on the profitable side of this line?
The Complications With International Tax
I’ve become an expert on international tax both for my own businesses and those of clients by actually doing business internationally.
It started in the wake of the 2008 financial crisis when along with some partners I was raising money to buy distressed real estate (REOs) in the US.
Since we were from Canada, the investors were from Canada and the property was in the US, we needed to figure out an appropriate legal and financial structure.
It was a nightmare.
I’d call lawyers and accountants in the US asking their recommendations for what legal entities to form. They’d tell me “create a series-LLC in XYZ” (not necessarily a great idea, but that’s a completely different conversation).
Then I’d say “well I’m Canadian”.
Suddenly the tune would change, “Oh, I can’t tell you anything about that”.
I’d call lawyers and accountants in Canada posing the same question. “Form an Alberta limited partnership…” “Well we’re investing in the US”. “Oh, I can’t tell you anything about that”.
Articles online proved to be confusing with incomplete information.
No one seemed to be referencing the tax treaty.
Should we simply form a US company?
Should we form a Canadian company?
Should we form one of each? What should the relationship between them be?
It got more complex when we considered operational details. We had to be able to accept rent checks. But setting up banking as non-residents was complex and challenging.
The list went on and on.
Eventually, after considerable research, I talked to a friend who did international business and had been taken under the wing of some international tax experts.
I’d eventually go join him in the business and receive mentorship from some of the people who had drafted the very laws we were applying, which was always a nice bonus.
The Real International Tax Question
Sadly, while there is a myriad of local tax experts in virtually every country, some of whom are even very good, there is a gulf when it comes to cross-border tax.
Even the big firms like EY, KPMG, Deloitte, & PwC generally don’t truly specialize in cross-border tax. What they do is have local offices they interact with each specializing in a local area and then the top experts work between these.
In almost no cases (there are some rare exceptions if you’re lucky enough to find them) does someone truly specialize in the question of what happens from a tax perspective when you cross borders.
This central question creates a dramatically different paradigm to tax planning, then you get when you’re looking at domestic tax planning.
When doing domestic tax planning, the name of the game is primarily to reduce taxable income.
To some extent reduce tax rates (though, generally your ability to do so is limited) and to defer. This is generally achieved through write-offs, which any business owner is familiar with.
While it is technically true your allowable write-offs might be more significant in some jurisdictions than others (for example, in one jurisdiction you can only write off 50% of a meal while in another jurisdiction you’re able to write off the full amount).
This is not the essence of international tax planning.
The essence of international tax planning concerns what we call attribution of income (and expense).
In other words, where is income taxable?
This is the question when I was setting up the real estate investing company all those years ago, no one told me.
Over subsequent articles I’ll explain some of the finer nuances of how international tax works but for now realize this is the central question:
“Who gets to tax your income?”
Obviously, the objective of international tax planning is to legally move the income so first of all the fewest people tax it (as double taxation is a bitch), and then the people who tax it are the ones who will tax it the least.
How Do We Know Who Taxes What Income?
Back when I was setting up the real estate investing company this is the analysis some lawyer or accountant should have done.
They should have looked at the issue and said:
“Alright, this portion of the income has to be taxed in the US. That can’t be avoided. So we want to ensure it doesn’t get taxed or at least the tax is minimized in Canada. Ideally, minimized in the US as well.”
Then also said, “this other portion we can potentially avoid having taxed in the US. Because US tax rates are higher than Canadian tax rates — not to mention the risks of double taxation — it’s in the best interest of your investors to move this income to Canada. Here’s how it can be done and what it will take.”
Of course, they didn’t have knowledge of both sides of the border — let alone what has now become my specialty, which is what happens when income crosses borders — and as a result, we were left trying to figure out a complex problem ourselves.
Here then is the simple formula, the foundation point of all international tax.
The answer to the question of what determines who gets to tax what income?
The answer is residency.
If you go to see a lawyer or accountant for international tax planning and they don’t ask you within the first 5 minutes of the conversation what your residency is — WALK OUT!
Note: in this case we’re referring to tax residency NOT legal immigration residency status. You can be tax resident without being a legal immigrant or legally resident from an immigration standpoint.
Tax Residency is what determines what jurisdiction’s tax laws apply.
In particular, there are what I call the:
“3 Pillars of Residency”
Michael Bruce Rosmer
- Residency of the company
- Residency (what we call “source”) of the income
- Residency of the shareholders
Collectively, these determine where income is taxable, what portion of it is taxable there, and how it is taxable.
In some cases, income might be double taxable. In other cases, you might have so-called double non-taxation. You might even end up with triple or quadruple taxation in some bizarre circumstance.
Over several coming articles, I’ll explain the details of each of these pillars of residency, since they aren’t as straight forward as they might seem.
If you’ve got any questions, please reach out and we’d be happy to schedule a consultation.