Residence Disputes under DTA tie-breaker provisions

Anyone who has been involved in the Mutual Agreement procedure found in our DTA’s will know that the process does not always produce an outcome. When that happens, one still has to litigate the issue with Inland Revenue.

The dispute in these contexts will be around the application of the tie-breaker provisions in the DTA. The residency rules are typically in Article 4. These provisions will be engaged when an individual is resident in both contracting states according to the respective domestic legislation. To achieve the ends of preventing double taxation, there needs to be a mechanism to allocate the individuals residency to one or other jurisdiction.

When one is acting for a taxpayer in this context, they often want the tie-breaker provisions to break in favour of their home country, which is not New Zealand. Hence the dispute ends up being with the New Zealand Inland Revenue.

The first tie-breaker rule will focus on where the person has a permanent home. They will often have a permanent home in both contracting states. The next test applies when the first one stalemates.

The person is deemed to be resident where the person has closer economic relations. The law is reasonably well established as to how a DTA should be interpreted. The keys are:

  • A DTA is to be interpreted according to the same principles apply to private contractual instruments: C of IR v Lin (2018) 28 NZTC 23052 at para [19].
  • The parties’ intention is to be discerned by interpreting the ordinary meaning of the treaties terms of the context in light of its objectives and purpose: C of IR v Lin (supra) at para [19].
  • Reference can be made to OECD commentaries: C of IR v Lin (supra) at para [19].

The OECD model convention concerning Article 4 the says paragraph [15] that a taxpayer’s personal and economic relations with both New Zealand and the other country must be considered and that this includes the full range of social, domestic, financial, political and cultural links. This is called the centre of vital interests test.

The key points about this test are as follows:

  • it is a quantitative assessment of two factors, namely personal and economic relations;
  • it is assumed that there will be economic relations with both contracting states because it uses the word ‘closer’. It also implies that judgement is needed as to which of the countries the person has closer relations;

If the centre of vital interests cannot be determined, then the test becomes the state in which he has a habitual abode: Article 4(2)(b). The case of Stephen D. Podd, Et Al v Commissioner of Internal Revenue United StatesTax Court June 30, 1998, discusses the habitual abode test and treats it as in which of the two states the person resides the longest and that is consistent with the OECD commentary: paragraphs [17] to [19].

It is at this point that interesting fact patterns can emerge. In a recent case of mine, the taxpayer spent time in New Zealand and let's say at home in the USA[1] but also sailing on international waters in the Pacific. So there were three distinct blocks of time. The vessel was flagged in the home country USA.

The argument became whether the time sailing outside of New Zealand's territorial waters counted as time in the USA or New Zealand.

Under international law a vessel on the high seas is assimilated to the territory of the State the flag of which the vessel flies: see Case of the SS Lotus — France v Turkey PCIJ 1927 Series A No 10 at [64] that:

It is certainly true that – apart from certain special cases which are defined by international law – vessels on the high seas are subject to no authority except that of the State whose flag they fly … . A corollary of the principle of the freedom of the seas is that a ship on the high seas is assimilated to the territory of the State the flag of which it flies, for, just as in its own territory, that State exercises its authority upon it, and no other state may do so … . It follows that what occurs onboard a vessel on the high seas must be regarded as if it occurred on the territory of the State whose flag the ship flies.

The aforementioned international law case has been referred to with approval in New Zealand see: Maritime New Zealand v Page [2013] DCR 102 at [21]. Various arguments were made by Inland Revenue as to why those rules should not apply in this context.

It was also argued that the time on the boat outside of New Zealand could not be classified as New Zealand time. In this regard, there is an Australian case of,  C of T (NSW) v Cam and Sons Ltd (1936) 4 ATD 32 involved mariners at sea. The case concerned fishermen that habitually went on trawling voyages off both the Australian and New Zealand coast. The question of where their income was derived when they were at sea needed to be decided in the case.  The court preferred the location of where the work was done as being the primary test for source. Therefore it held that the wages earned needed to be apportioned between time in the Australian and New Zealand waters. An analogy was drawn between that logic and the issues of where physically between the two states the person spent the most time.

At the end of the day, Inland Revenue decided not to continue the dispute and the matter was won by default by the taxpayer. The conflict had dragged on for 4 years to that point.  

There is one final test, but it was not reached with this dispute.

The takeaway points are that these disputes take a long time, so be prepared for that. Secondly, they often raise interesting and novel fact patterns.

[1] Not the actual country but used for the purpose of illustration.

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