More miseries for trustees

In their article in this issue Professor Craig Elliffe and Mr Jeremy Beckham suggest that New Zealand’s favourable tax treatment of foreign source income may have the unexpected result that a New Zealand trustee of a foreign trust (one with a non-resident settlor) may be subject to higher rates of withholding tax on foreign source income. He will not be able to avail himself of the lower rates of withholding tax applicable to foreign income provided for by double tax treaties. This is because of the residency article based on Article 4 of the OECD Model Convention. The authors point out that some treaties—such as the one with the UK—contain a differently worded residency article, and do not present the same problem. Article 4 of the OECD Model Convention refers to: liable to tax … by reason of his domicile, residence, place of management or any other criterion of a similar nature … . Under Article IV it must be shown that the liability to taxation operates by reason of one of the listed grounds [being domicile, residence, place of management, place of incorporation or other criterion of a similar nature]. This connotes the existence of some sort of causal connection or, in the least, some relationship of proximity. In my opinion, the fact that Norsk's place of management is in the U.S. is not causally or even proximately connected to the basis of Norsk's tax liability in the U.S. Quite the contrary: in my mind, the reason why Norsk was liable to taxation in the U.S. was because of the income flowing from the business or trade it conducted that was connected to the United States.2 I agree with the appellant [the tax authority] that the most similar element among the enumerated criteria is that, standing alone, they would each constitute a basis on which states generally impose full tax liability on world-wide income … . In this respect, the criteria for determining residence in Article IV, paragraph 1 involve more than simply being liable to taxation on some portion of income (source liability); they entail being subject to as comprehensive a tax liability as is imposed by a state. In the United States and Canada, such comprehensive taxation is taxation on world-wide income. However, tax liability for the income effectively connected to a business engaged in the U.S., pursuant to s. 882 of the Internal Revenue Code, amounts simply to source liability. Consequently, the ‘engaged in a business in the U.S.’ criterion is not of a similar nature to the enumerated grounds since it is but a basis for source taxation … . I accept the appellant and intervener's [the US tax authority] submission that, since the application of the Convention is to be limited to taxpayers bearing full tax liability in one of the contracting parties, then Norsk cannot benefit from the Convention and is consequently not to be characterized as a resident under Article IV, paragraph 1.3 The commentaries to the OECD Model Convention as well as academic sources indicate that generally the domestic laws of the contracting states employ residence to apply on ‘full-tax liability’: paragraphs 3 and 8 to the commentary to Article IV; Nathan Boidman, L. Frank Chopin and Alan W. Granwell, ‘Tax Effects for Canadians of the New U.S. Code and Treaty Residency Rules (Part Two)’ … . So, too, does the American Law Institute, Federal Income Tax Project—International Aspects of U.S. Income Taxation II—Proposals on U.S. Income Tax Treaties, at pages 127–28: ‘Under prevailing practice, a country entering into an income tax treaty extends the benefits of the treaty to a person or entity that is a “resident of (the other) contracting state”. “Residence”, in turn, is defined in terms of taxing jurisdiction. A person or entity is considered resident in a country if that country asserts an unlimited right to tax his or its income—that is, a right based upon the taxpayer's personal connection with the country (as opposed to the source of the income or other income- or asset- related factors). The test of residence requires that the person or entity claiming treaty benefits be ‘fully taxable’ in the residence country, in the sense of being fully subject to its plenary taxing jurisdiction. Full tax liability is not satisfied in a case where an entity is liable to tax in a jurisdiction only on a part of its income. (Emphasis in original.4) If a person’s connecting characteristics with a state are the same as those of persons who are fully liable and actually subject to tax, that person can be said to be liable to tax even though he is not subject to tax on part or all of his income by virtue of special provisions in the domestic legislation of the state of his residence.

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