Tax Authorities Audit Application of Tax Treaties

In recent months, the Belgian Tax Authorities have been sending letters to all taxpayers who claimed treaty relief in their tax returns.

You may have received a letter from the tax authorities with two or three pages of strange questions, referring to double tax treaties and asking weird questions. Have you also wondered why they seem to be under the impression that you may be an artist or a sportsman or woman, a pilot of a plane or a captain of a ship, a teacher or a scientist, a civil servant or a long distance lorry driver?

Let me reassure you. They have not found any mistakes in your tax return (yet) and they do not mean you any harm. It is just part of a general campaign to check whether taxpayers living in Belgium are entitled to claim the exemption of their income, in particular if the exemption is related to your work in the other state.

Double taxation

To understand what is going on, we need to explain how double taxation arises and how double tax treaties work. When you live in one country and work in another, there are two countries that want to tax you : the country where you live (your “country of residence”, that is Belgium) and the country where you work (the “country of source” of your income, let’s call it Sylvania).

And that results in double taxation, both in Belgium and in Sylvania. To prevent double taxation – and mostly to minimize double taxation for businesses – states sign double tax treaties, or rather “conventions for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains”.  In such a convention the two states agree which of them can tax income from business or from real property, dividends, interest, royalties, salaries, pensions, etc.  More importantly, the convention also states what the other state, the one that cannot tax, has to do to prevent double taxation; that is called “treaty relief”.

All treaties have a similar structure, based on a Model Convention drafted by the OECD. In that model they have worked out the best solution for each type of income (for sportsmen and artists, sea captains and pilots, etc … we will come back on those). That Model Convention is used as the basis when representatives of the states sit down and negotiate a new double tax treaty. Generally speaking, the rules are the same from one treaty to the other, but when they negotiate the text, the States can agree to change some of the rules (see nr 2 below).

No two tax treaties are the same, you really have to read the text. The treaties can be found here in Dutch or in French. If there is an English or German text, these can be found on the page in English or German.

The reason why the Belgian tax authorities are suddenly getting so pernickety is because they realise that maybe some people are claiming treaty relief without being entitled to it. For a long time, it was just sufficient to fill in the box with the amount that was tax exempt under the treaty. That was too easy and for quite some time now, the tax authorities are insisting that you attach a letter explaining in respect of what treaty article you were claiming treaty relief and for what amount. Recently, some people realised that this still was not enough and they asked each local tax office to check whether taxpayers were entitled to tax relief.

We attach a translation of one of these letters so that you can see what they are trying to do.

Now, let us examine some of the categories of income they are enquiring about:

1. Artists and Sportsmen

For artists and sportsmen, the rule is quite simple, they are taxed in the country where they perform, i.e. where they played a match, broke a world record, gave a concert, etc … That is usually also the case if the artist or sportsman has a management company that collects his fee.

In any event, you must always double check what the treaty says ; some treaties only allow the remuneration to be paid in the state of source if it is over a certain minimum (e.g. USD 20,000 under the treaty with the U.S.).

2. The crews of airplanes and ships in international traffic

For the crew of a ship or an airplane in international traffic, who work in international waters or high over the territories of other states, the rule is usually that they pay tax in the state where the shipping company or the airline is based. And that may have strange consequences.  The captain of a cruise ship between Southampton and New York may be liable to tax in Greece just because his ship is owned by a Greek company. And a steward working on a plane between Brussels and Barcelona may be liable to tax in Germany if she works for Lufthansa.

The questionnaire mentions specifically dredging ships or prospection ships because they may be working in another country but they are not working in international traffic. The crew of a Belgian ship dredging Shanghai harbour would not necessarily be taxed in Belgium, because they are working full time in Shanghai.

It is interesting to note that Belgium and the U.K. have actually inverted the standard rule ; Belgian and British resident crew members pay tax at home, even the crew of the Eurostar.

3. Teachers and scientific researchers

Teachers and scientific researchers are a different category. Not all double tax treaties have a specific rule for them. However, when they do, that rule generally is that they continue to pay income tax in their state of residence if their contract is for not more than two years.

As you can see, you cannot just assume what the answer will be; you do really need to read the treaty. If there is nothing in the treaty, or if the teacher has an appointment for more than two years, she pays tax in the country where she is working along the lines of the “183-day rule” (see 6).

4. Civil servants

If you are living in Belgium and working as a civil servant of Sylvania, then you normally pay tax only in Sylvania. That is just an application of the diplomatic rule that civil servants should not pay tax to another country.

However, there are a number of exceptions, e.g. when the civil servants work for a commercial company or if they have the nationality of their state of residence. In recent treaties, treaties have started using the exception that civil servants may nevertheless be taxed in their state of residence if they are long-term residents.

5. Long distance truck drivers

Long distance truck drivers pass their time on the road going through many countries. They work on a road from Norway, Germany, the Netherlands, Belgium, Luxembourg, France, Switzerland and Italy. Where do they pay tax?

The double tax treaties usually do not have a provision for long distance truck drivers except for the Belgian-Luxembourg double tax treaty that states that they are liable to tax in the country where their employer is established. That is also what the Supreme Court has decided when there is no tax treaty. The tax administration takes the view, nevertheless, that they must be taxed in their state of residence unless they are covered under the “183-day rule”.

6. Employees working abroad

For other employees working in another country, the treaty uses the so-called “183-day rule”. This is one of the most misunderstood rules, and the name really is a misnomer as the 183 days rule is only one of the conditions for being taxed abroad.

By default an employee is taxed in his state of residence even for work in another state. It is only in three situations that he is taxed in the other state. These conditions must ensure that the employee has sufficient ties with the country where he works before he is liable to tax there.

The first condition is the actual 183 day rule : the employee must work at least 183 days in the other state, e.g. Sylvania. That may be either 183 days in the same calendar year or 183 days in any period of 12 months, depending upon the particular treaty involved. The distinction can make quite a difference.

If the employee works in Sylvania for less than 183 days, the second (alternative) condition may apply, that is that his employer is a resident of Sylvania, the state where he works.

Finally, if the employee works in Sylvania for less than 183 days and does not have an employer there, the third condition is that his remuneration is paid for by a permanent establishment his employer has in Sylvania.

And just to add to the confusion, this rule is often written in the negative. E.g. in the treaty with the U.K. the default rule is that the remuneration is paid in the work state. Nevertheless, the remuneration derived by a resident of a Contracting State (Belgium) in respect of an employment exercised in the other Contracting State (the U.K.) shall be taxable only in the first-mentioned State (Belgium) if: (a) the recipient is present in the other State (the U.K.) for a period or periods not exceeding in the aggregate 183 days within any period of 12 months; and (b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State (the U.K.) ; and (c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State (the U.K.).

These are just a few examples, but there are more, e.g. for company directors, pensioners, etc.

These rules are not easy to understand, even tax lawyers must read them two or three times, substituting “Belgium” for “the Contracting State” and “Sylvania” for the other Contracting State” and people often misunderstand the conditions or do not understand that they are not meeting all the conditions all the time.

For the 183 day rule one of the most common mistakes is to think that if one meets one of the three conditions, one is taxable in the country where one is working. However, when you are working from home rather than in Sylvania, in that case, Sylvania is not the country of source anymore. It is not enough that your employer in Sylvania pays you from Sylvania, on a bank account in Sylvania to be exempt. The source of the income always relate to the place where the work is done. Unless otherwise agreed in the convention, that is where the tax is due.

Of course, when you live and work in Belgium, the state of residence and the state of source are the same and there is no risk of double taxation. It is only for the days that you work in Sylvania that you can claim exemption. And if you normally work in Sylvania but must visit the parent company in Freedonia, there is no reason why Belgium should give you an exemption for work in Freedonia (although in that case the double tax treaty with Freedonia may apply).

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