Exit Charges for Migrating Individuals and Companies: Comparative and Tax Treaty Analysis

Abstract

The term “exit charges” refers to taxes that, in one way or another, arise as a result of a taxable person moving outside a state’s tax jurisdiction. Such charges can be levied on different taxpayers in different situations.Nevertheless, for the sake of simplicity, this article restricts itself to the application of exit charges on individuals and companies.

Individuals migrate from their current tax jurisdiction due to numerous tax and non-tax reasons. From a tax perspective, individuals often migrate with a view to moving away from complex and burdensome tax systems to reduce their overall tax burden. The simplest way to achieve this is by ending the substantive ties with their former residence state, creating substantive ties with a new residence state and becoming tax resident there. In doing so, individuals can take advantage of favourable domestic tax law provisions and tax treaties available in the new state. This is similarly the case for companies. Companies may wish to move to simple and beneficial tax systems to reduce their overall effective tax rate and maximize shareholder returns. The easiest way for a company to do this is to take advantage of tie-breaker rules in tax treaties and transfer the place of effective management (POEM) to a low-tax country.

In order to illustrate this, assume a taxpayer, either an individual or a company, who is a tax resident of a high-tax country and at the same time owns shares in companies (which do not own immovable property) resident in that jurisdiction. In such a case, if the taxpayer sells the shares and makes a gain, tax must be paid in the high-tax country. In order to avoid these high taxes, the taxpayer migrates to a low-tax country and becomes a tax resident there. Subsequently, the shares are sold. If the high-tax country and the low-tax country have a tax treaty based on the OECD Model, the former cannot tax the gain. This is because article 13(5) of the OECD Model provides that gains from alienation of shares are taxable only in the residence state of the alienator. In many situations, the low-tax country may not tax the gain under its domestic tax law at all.

In order to counter such tax-driven migrations and/or to maintain the principle of fiscal territoriality,[countries apply exit charge regimes. Typically, for individuals, exit charge regimes take the form of immediate exit taxes,re-entry charges or extended tax liabilities,whereas for companies that migrate their POEM, countries implement immediate exit tax regimes. In order to understand these diverse systems, specific aspects of the exit charges currently applicable to tax residents, i.e. individuals and companies migrating from Canada, the United States, the Netherlands, the United Kingdom, Finland, Germany and Switzerland are analysed (see sections 2. and 3. respectively). This comparative analysis is the foundation for testing the compatibility of these different regimes with tax treaties based on the OECD Model. Various issues are identified and solutions that have been implemented by the countries surveyed to counter such issues are discussed (see section 4.). The author concludes by analysing whether or not the exit regimes for individuals are on a par with the exit regimes for companies (see section 5.).