The Expatriate Administrator

by Ed Kennedy, KPMG LLP, Atlanta
(KPMG LLP in the United States is a KPMG International member firm)

Many U.S. tax treaties provide that income earned by an employee¹ on short-term assignment to or from the United States will be exempt from host country² income taxation provided the employee is present in the respective host country for 183 days or less. However, there is more to this rule than meets the eye, which can prove, in many instances, to be a trap for unwary international assignment program managers.

Tax treaties often enable income related to certain short-term assignments to escape host country taxation. Generally, the assignment should be structured such that the following requirements are met:

To help determine that the individual is not subject to tax in the host country, the following questions should be addressed:

The 183-day rule adds complexity for international assignment program managers, especially when trying to maintain individual and corporate tax compliance with respect to employees on short-term assignments. This article discusses the rules, relying on the U.S. Model Income Tax Treaty and OECD Model Tax Convention to better understand the rules, but focuses on the "days of presence" test. However, in order to give a fuller picture, a brief discussion of the other tests will be offered as well.

It is necessary to determine if the assignee is resident in the home country and/or in the host country under the laws applicable in the respective countries. If resident in both, most treaties include rules to determine which country takes precedence for treaty purposes. Generally, in the case of a short-term assignment, remaining resident in the home country is not an issue — but not always. For example, an assignment may be intended to be a five-month international assignment in the host country followed by a three-year assignment in a third country; or it may be intended to be a short-term assignment in the host country, but evolves to become a longer-term one.

In the case where an individual — we will call him "John" — is a resident of both countries under the domestic laws of both, the treaty "tie-breaker" rules will be employed to determine residency status (under the treaty):

In most cases, the treaty requires that the individual not be an employee of an entity in the host country. In practical terms, this generally means that the employee should remain employed by the home country employer. Determining whether the assignee is an employee of the home country entity during the assignment is sometimes not as simple as merely looking at the contract of employment: many countries adopt an "economic employer" approach. The facts and circumstances of each case should be examined and, in some cases, an analysis of which entity "controls" the employee's day-to-day functions may be necessary.

This is generally not a significant issue in relation to short-term assignees, but does need to be considered.

One other issue to consider is whether the compensation costs related to the assignment are charged to (or borne by) the host country operations. This is a corporate tax consideration generally based on an analysis of which entity benefits from the services the short-term assignee is performing. For instance, if the individual is sent on assignment to assist the home country employer (e.g., if the employee is sent overseas to gain knowledge of certain aspects of the business, which will directly benefit the home country entity), the costs would likely remain with the home country entity. If, however, the assignee is sent on assignment to assist the host country entity (e.g., if the employee is filling a short-term vacancy in the host country organization) the costs related to this assignment would likely be charged to the host country entity. A charge increases the risk that the short-term assignee may not be able to take advantage of treaty relief.

An individual's days of presence in a host country might not be an entirely straightforward matter – here we come to the primary focus of this article. Each treaty needs to be looked at carefully for this rule. A recent change to the U.S. Model Income Tax Treaty⁵ has slightly changed the U.S. position to allow some flexibility in interpreting this rule and, as a result, now there are at least three different approaches based on the age of the treaty. Whether the U.S. treaty partners will take the same position is unclear.

The position under this Model Treaty was that the employee should not be present in the host country for more than 183 days in the tax year⁶. This meant that, with proper planning, companies could assign individuals to the U.S. for a 12-month period and still fall within the treaty provision.

Under the 1981 U.S. Model Treaty, this individual would be present in the United States for 183 days or less in both 2007 and 2008 and, as such, provided the other requirements were met, would not have a U.S. tax liability in either 2007 or 2008.

Recognizing the potential for abuse, both the OECD and the U.S. began modifying their model treaties, effective, in the case of the U.S., for its Model Treaty of September 20, 1996,⁷ to provide that treaty relief would be applicable only when the individual was present in the host country for no more than 183 days in any period beginning or ending in the taxable year concerned. The Treasury Department's Technical Explanation⁸ states:

The 183-day period in condition (a) is to be measured using the "days of physical presence" method. Under this method, the days that are counted include any day in which a part of the day is spent in the host country. (Rev. Rul. 56-24, 1956-1 C.B. 851.) Thus, days that are counted include the days of arrival and departure; weekends and holidays on which the employee does not work but is present within the country; vacation days spent in the country before, during or after the employment period, unless the individual's presence before or after the employment can be shown to be independent of his presence there for employment purposes; and time during periods of sickness, training periods, strikes, etc., when the individual is present but not working. If illness prevented the individual from leaving the country in sufficient time to qualify for the benefit, those days will not count. Also, any part of a day spent in the host country while in transit between two points outside the host country is not counted. These rules are consistent with the description of the 183-day period in paragraph 5 of the Commentary to Article 15 in the OECD Model.

Similarly, the OECD's Model Tax Convention Commentary⁹ provides the following:

The three conditions prescribed in this paragraph must be satisfied for the remuneration to qualify for the exemption. The first condition is that the exemption is limited to the 183 day period. It is further stipulated that this time period may not be exceeded "in any twelve month period commencing or ending in the fiscal year concerned". This contrasts with the 1963 Draft Convention and the 1977 Model Convention which provided that the 183 day period should not be exceeded "in the fiscal year concerned", a formulation that created difficulties where the fiscal years of the Contracting States did not coincide and which opened up opportunities in the sense that operations were sometimes organized in such a way that, for example, workers stayed in the State concerned for the last 5½ months of one year and the first 5½ months of the following year.

In the example above, in light of the U.S. Treasury's Technical Explanation and the OECD Model Convention Commentary, this individual would not be able to take advantage of a treaty exemption because, for 2007, this individual would be present for more than 183 days for the 12-month period beginning July 15, 2007 and, for 2008, this individual would be present for more than 183 days in the 12-month period ending July 1, 2008.

This has the potential for unexpected taxation. Consider the following situations:

Under the first two scenarios, Francois and Keiko would have 183 days of presence in the United States in a 12-month period beginning in 2007 and would therefore be subject to U.S. tax on the pre-assignment income.

In the last scenario, Anish will have 183 days of presence in the United States during a 12-month period ending in 2008, and so the treaty exemption for his 2008 U.S. earnings will not be available, despite his presence of only three weeks during the calendar year.

As a result, there would be tax compliance and, possibly, tax withholding obligations in each of the three situations.¹¹

On November 15, 2006, the Treasury Department issued new versions of the U.S. Model Income Tax Treaty and Model Technical Explanation. The new U.S. Model Treaty is used as a starting point in bilateral treaty negotiations with other countries. The Model Technical Explanation serves as the basis for technical explanations of bilateral tax treaties based on the U.S. Model Treaty. The two documents reflect changes in U.S. domestic law and tax treaty policy since the U.S. Model Treaty was last updated in September 1996.¹²

The 2006 Model Treaty provides a possible exception to the 12-month rule noted above. While it largely maintains the treaty language above, it adds the following additional language in the Model Technical Explanation:

If the individual is a resident¹³ of the host country for part of the taxable year concerned and a non-resident for the remainder of the year, the individual's days of presence as a resident do not count for purposes of determining whether the 183-day period is exceeded.

None of the treaties signed prior to the issuance of the 2006 Model Treaty include this language in their Technical Explanations. Thus, it is unclear from the language in the Model Technical Explanation whether this is to be applied retroactively to those treaties which contain the relevant language in the treaty, or only prospectively. Likewise, it is unclear whether this interpretation would be applicable in the case of treaties using the language in the 1981 Model Income Treaty. Program managers should discuss with their tax advisers which position is appropriate in a given case.

The OECD Model Tax Convention has not been amended to include this language. In fact, the recent updates to the OECD Commentary indicate the opposite result may be intended:

In applying that wording, all possible periods of twelve consecutive months must be considered, even periods which overlap others to a certain extent. For instance, if an employee is present in a State during 150 days between 1 April 01 and 31 March 02 but is present there during 210 days between 1 August 01 and 31 July 02, the employee will have been present for a period exceeding 183 days during the second 12 month period identified above even though he did not meet the minimum presence test during the first period considered and that first period partly overlaps the second.

Thus, while the U.S. may take the more favorable interpretation, it is unclear whether other host countries will take a similar position.

Therefore, in the three situations above (Francois, Keiko, and Anish), additional layers of complexity are added. There is the potential for mitigating the 12-month rule for assignments where the U.S. is the host country, provided the assignee becomes a U.S. resident under the applicable treaty, as the days while a U.S. resident will not count for purposes of this 183 rule. However, this is further complicated by the fact that the rules for U.S. tax residency are also based on a different test which also uses 183 days of presence. This test, in general, looks to the following days of presence:

In Francois', Keiko's and Anish's situations above, the following residency results could occur under the new U.S. Model Treaty:

If it is determined that the employee is subject to U.S. income tax, the "employer" (which may be either the home or host country entity) has income tax withholding and reporting obligations. In many instances, the home country employer engages the U.S. entity to act as withholding agent. Regardless of which entity withholds, the obligations exist for these employees.

Likewise, the employment tax (social security) obligations should be considered as well. If the home country and the U.S. have entered into a social security totalization agreement — which allows short-term assignees to remain in their home country system — there may be no U.S. social tax obligation. If, however, there is no totalization agreement between the U.S. and the home country, there is a U.S. social tax obligation, regardless of whether this individual is eligible to claim treaty relief from income taxation. While this is generally not an area of heightened U.S. Internal Revenue Service enforcement, the requirements in this area cannot be ignored.

Domestic laws, case law, and international treaties can combine to make the work of expatriate program managers rather complex and confusing.

As this article has highlighted, there is more than meets the eye to the 183-day rules. The 183-day rules we have explained add further complexity when program managers are trying to establish and support individual and corporate tax compliance with respect to short-term assignees. The problem arises in that, in many cases, the determination of whether the individual is exempt under the treaty will not be made until after the close of the taxable year, and possibly up to six months beyond it. Thus, managers are often faced with the difficult task of deciding whether to apply reporting and withholding requirements before such obligations have been potentially triggered.

International assignment program managers may need to work with their tax advisers to determine whether it is appropriate to exclude days of residency from the 183-day test under various treaties. A key element in maintaining compliance in this area is to understand and carefully evaluate the potential tax outcome of each short-term international assignment, and then to monitor the assignment for compliance with the facts necessary to arrive at that outcome.

Country	Treaty Language Regarding "183-Day Rule"
	"No more than 183 days in the tax year" (in some treaties, "calendar year")	"No more than 183 days in 12-month period beginning or ending in the tax year"	"No more than 183 days in any 12-month period"	Other
Australia	X
Austria		X
Bangladesh		X
Barbados	X
Belgium¹⁴				Less than 183 days during the tax year
Canada	X
China, People's Republic of	X
Commonwealth of Independent States	X
Cyprus				Less than 183 days during the tax year
Czech Republic				X
Denmark		X
Egypt				No more than 89 days in the tax year
Estonia		X
Finland				X
France				X
Germany	X
Greece	X			Exempted if compensation does not exceed $10,000
Hungary	X
Iceland				No more than 182 days in the tax year
India	X
Indonesia				No more than 119 days during any consecutive 12-month period
Ireland		X
Israel				No more than 182 days in the tax year
Italy	X
Jamaica	X
Japan		X
Kazakhstan				X
Korea, Republic of				No more than 182 days in the tax year
Latvia		X
Lithuania		X
Luxembourg		X
Mexico				X
Morocco				Less than 183 days during the tax year
Netherlands	X
New Zealand				X
Norway				Less than 183 days during the tax year
Pakistan	X
Philippines				No more than 89 days in the tax year
Poland				No more than 182 days in the tax year
Portugal				X
Romania				No more than 182 days in the tax year
Russia	X
Portugal				X
Slovak Republic	X
Slovenia		X
South Africa		X
Spain				X
Sri Lanka				X
Sweden				X
Switzerland		X
Thailand		X
Trinidad & Tobago	X
Tunisia	X
Turkey				X
Ukraine	X
United Kingdom		X
Venezuela		X

1 This article refers only to employment income. It does not address the taxation of non-employment income (e.g., independent contractors).

2 For purposes of this article the term "home country" refers to the country from which the assignee is sent and the term "host country" refers to the country to which the assignee is sent. In the case of an assignment to the U.S. from France, France would be the home country and the U.S. would be the host country. In the context of an assignment from the U.S. to France, the U.S. would be the home country and France would be the host country.

3 A few treaties use a period of other than 183 days. Please refer to Attachment A for a listing of these countries.

4 This would include, for example, "charge-backs" of salary or other taxable expenses to the host country employer.

7 This Model Treaty can still be found at the Treasury Department's Web site by visiting the following link: http://www.ustreas.gov/offices/tax-policy/library/model996.pdf.

8 The 1996 Technical Explanation can be found at the following Web site: http://www.ustreas.gov/offices/tax-policy/library/techxpln.pdf.

9 The prior language and the 2005 update to the OECD Model Tax Convention can be found at: http://www.oecd.org/dataoecd/54/24/34576874.pdf.

10 Note that while these examples all use the United States as the host country, the results would apply equally well in situations where the U.S. is the home country. Our reason for using the U.S. as the host country in this example is to show the impact of the latest U.S. Treasury Department's Model Income Tax Treaty upon these results.

11 Please see Attachment A, which provides a schedule of the different terminology used in the U.S. treaties currently in force.

12 The Technical Explanation can be found at the following Web site: http://www.ustreas.gov/offices/tax-policy/library/TEMod006.pdf. For an additional reference, see KPMG LLP's Flash International Executive Alert 2006-191 (November 17, 2006), a publication of KPMG's IES practice.

13 This reference to "resident" is for individuals who are resident for purposes of the treaty as determined under Article 4.

14 The new Belgium treaty technical explanation includes the new language regarding residency days not counting for purposes of the 183-day test. Note that this treaty has not yet been ratified.

The author would like to thank Barry Cocks, senior manager with KPMG LLP in London, for his contributions to this article.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.