This article explains the possibilities of resolving tax disputes on applying international conventions for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital and avoidance of double taxation.
Social security taxes and payments and the avoidance of double taxation in the European Economic Area are regulated by the EU regulation (Council Regulation (EC) No 1408/71) and are not covered by tax treaties.
In case an Estonian resident finds that the tax treaty was not followed correctly when his/her income was taxed, he/she can submit a request to the state of residency for clarifying the circumstances and for application of the tax treaty according to the mutual agreement article.
Taxation in a foreign state cannot be avoided by explaining that taxes have already been paid in Estonia when the legislation of the other state and the tax treaty give the right of taxation to this foreign state. A person cannot choose in which state he/she wishes to pay taxes.
Taxation in a foreign state may be allowed in case Estonia has concluded a tax treaty with another state.
When it comes to international taxation, in most states the origin of income, occurrence of business activity and the actual presence of the person in another state have decisive importance. The citizenship of a natural person or the place of establishment of a legal person are not as important in taxation as is usually thought. In case the source of income is in a foreign state or the person stays in a foreign state for the purpose of doing business or working long enough, income tax liability also arises in this foreign state.
Specific taxation of certain income is based on the tax legislation of a certain state and the tax treaty, which limits the taxation of an Estonian resident’s income in this other contracting state to avoid double taxation, according to the rules prescribed in the tax treaty.
Avoidance of double taxation does not mean that a person is automatically released from the declaration obligation in one or other state.
The fact, that there is a declaration obligation established to a non-resident in a foreign state, does not automatically mean the breach of a tax treaty. It may happen, that the same income has to be declared in several states. A tax resident has to declare his/her income in Estonia even if income tax has been paid on the same income in a foreign state. Only income, which is exempt from taxation according to the Income Tax Act and on which there is no individual declaration obligation established by legislation, may be left undeclared in Estonia (for example, daily allowance of a business trip). Tax authorities of many foreign states also expect non-residents to declare taxes.
All states do not apply tax treaties automatically at the moment of making a payment, declaring or collecting advanced payments of income tax. Every state has the right to establish suitable formal requirements for application of tax treaties. In Estonia, for example, a non-resident has to submit a certificate of residency confirmed by the tax authority of the state of residency in order to use the tax exemptions and incentives arising from tax treaties. There are states, which firstly apply their own tax legislation and incentives of tax treaties are applied later, when the beneficiary has submitted a request for application of a tax treaty with other necessary certification according to which the overpayment is refunded. There also may be other methods of calculating tax incentives. Until these formal requirements are not fulfilled, it is not usually possible to talk about non-application of a tax treaty.
We recommend the taxpayer to ask for precise information on procedures for application of a tax treaty from the tax authority of the foreign state before filing a request for mutual agreement procedure assistance.
Tax treaties affect the calculation of income tax of an Estonian resident in a foreign state. If income tax has been calculated and paid in a higher amount in a foreign state than the tax treaty allows, then this is considered non-application of the tax treaty. Such overpaid income tax is refundable to the Estonian resident by the foreign state.
Another matter is, when the requirements for applying a tax treaty are disproportionate compared to incentives, and lead to non-application of tax treaty. In this case, disputes may be justified.
Still in those cases, double taxation can be avoided. Estonia as a state of residence takes non-refundable income tax already paid in a foreign state, which is in accordance with the tax treaty, into account in calculating the Estonian tax obligation or depending on the situation, exempts income, which is already taxed with final non-refundable income tax in a foreign state, from taxation in Estonia.
A person the foreign tax authority has begun to recover tax arrears from, can appeal a document on which the claim is based on only in the state the foreign request was sent by. For example, when a person worked in Norway and did not pay taxes there and the Norwegian tax authority sent a request for collection of taxes to the Estonian Tax and Customs Board, based on which the tax authority began recovery, the person may dispute the document in Norway, not in Estonia. Although, it is possible to dispute non-application of the tax treaty with the help of the Estonian tax authority.
The tax treaties also state that the avoidance of final double taxation has to be ensured by the state of residency. Therefore, in case Estonia is a person’s state of residency, Estonia has to ensure the avoidance of double taxation. If Estonia has concluded a tax treaty with a certain foreign state, then the means of avoiding double taxation are greater, although the respective provisions also exist in the Income Tax Act.
If a tax treaty has not been concluded, then only the foreign state’s legislation is applied to tax an Estonian resident’s income in the foreign state. The Estonian resident is obliged to declare and pay income tax in Estonia on all his/her worldwide income. The avoidance of double taxation is ensured by Estonian Income Tax Act (in case there is no tax treaty concluded between Estonia and this other state).
The Estonian tax authority cannot refund taxes paid in a foreign state or exempt Estonian residents from foreign tax liabilities.
Estonian tax authority’s participation in negotiations may achieve a situation where the foreign tax authority is obliged to refund overpaid income tax to the Estonian resident tax payer. It is possible that the tax calculation in the state of residency (Estonia) also has to be changed because of the foreign recalculation of taxes and additional tax amount will be due in Estonia. In Estonia, only the final foreign income tax amount is taken into account in the Estonian income tax calculation, according to the taxation rates or rights agreed in the tax treaty.
In opposite situation, where income tax was imposed on the same income according to foreign state’s tax recalculation, then Estonia as the state of residency is obliged to ensure avoidance of double taxation and income tax overpaid in Estonia is refunded to the tax payer.
In case of questions or doubts, whether the taxation of income derived from a contracting state corresponds to the tax treaty, it is always possible to request explanation from the Estonian Tax and Customs Board. It is certainly necessary to also try to communicate with the foreign tax authority for explanations.