What is a tax treaty? 

October 31, 2022 | | 3 minute read | 4 minute read
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Woman drinking tea wonders what is a tax treaty?

You may often read or hear about this phrase or keyword when filing your US expat taxes from abroad. However, it is critical to understand just what a tax treaty is to understand how it may affect you fully. 

Tax Treaty Defined: A bilateral agreement made by two countries to resolve issues involving double taxation of passive and active income of each of their respective citizens. 

Simply put, tax treaties are an agreement that the US and certain other foreign countries have made to reduce or erase double taxation. 

Countries considered “tax havens,” such as Hong Kong, Singapore, or the UAE, tend not to enter into tax treaties. A tax haven is typically a country or location with low to zero corporate taxes, allowing foreign investors to do business there. 

Did you know? While it is difficult to pinpoint where and what the first tax treaty was, many researchers agree that the “avoidance of double taxation of citizens” between Prussia and Saxony in 1869 is one of the first international acts of a tax treaty. However, the first US tax treaty was created in 1932 in collaboration with France. Since then, tax treaties across the world have grown dramatically.

OECD Tax Treaty Model vs. UN Tax Treaty Model 

There are two different models of tax treaties.

The OECD Tax Treaty Model: this tax convention on income and capital is favorable to capital-exporting countries. With this model, source countries require giving up some or all tax on certain income from residents of the other country. This model benefits two countries if the flow of trade and investment is equal. The OECD model includes 34 countries, including several European countries such as Latvia, Italy, Belgium, Australia, Costa Rica, Korea, The United States, and Israel. 

The UN Tax Treaty Model: this model, formerly known as the “United Nations Model Double Taxation Convention between Developed and Developing Countries,” favors taxing rights to the country of investment. This model typically benefits developing countries by increasing foreign investment by removing or reducing tax barriers. 

How Does a Tax Treaty Work? 

The United States of America is one of two countries that requires its citizens, regardless of country of residence, to file their taxes annually. Having tax treaties in place with foreign countries benefits US citizens worldwide. However, this does not mean that there is a tax treaty in place that completely eliminates the requirement for US citizens to file expat taxes annually. 

Under a majority of tax treaties, the amount of tax you pay in the country where you work will be offset against the tax you owe in your country of residence. With some treaties, the income you earned in the country where you are employed may be taxable only in that country and exempt from tax in your country of residence.

As you can see, the host country is gaining capital, and the residence country can export capital. It is a simple win-win: the individual also wins by avoiding double taxation on any income! 

The main thing to remember as a US Citizen, though is that US Tax Treaties tend to have a Savings Clause:

“Most tax treaties have a saving clause that preserves the right of each country to tax its own citizens and treaty residents as if no tax treaty were in effect. However, the saving clause generally excepts specified income types from its application, which may allow you to claim certain treaty benefits even if you are a U.S. citizen or resident.

Thanks to the savings clause, 99% of the US Tax Treaty you read are actually not applicable to you as a US Citizen at all.

Tax Rate Difference 

In more cases than not, the tax rates of the US and your residence country will differ. If you live and work in a country with a higher tax rate, such as Finland or Japan, that is the rate you will pay to the local tax office. 

Luckily, two forms can help expats avoid double taxation

  1. Foreign Earned Income Exclusion (FEIE) 
  2. Foreign Tax Credit (FTC) 

Living in a Country Without a Tax Treaty 

It is difficult, if not impossible, to determine where we will one day end up. As thousands of Americans abroad understand, that may be in a country that does not have a tax treaty with the USA, such as Singapore or Brazil. Which begs the question: how will this affect you? 

In this event, you could face double taxation by the US and your country of residence or employment on certain types of income. As noted, it is vital to remember the forms that can work to your benefit of either offsetting or eliminating double taxation. These again include the FEIE, FTC, and Foreign Housing Exclusion. We recognize the confusion this can cause US expats living in areas without a tax treaty, but we are here to help you file and get the most out of your tax return. 

Why Do We Need Tax Treaties? 

Tax Treaties are beneficial not only to individuals working and living abroad but also to local governments. The treaties help prevent tax evasion, open new lines of financial communication, and build foundations for renewed relationships between two countries. 

Despite the US having treaties with over sixty countries, the US Senate works tirelessly to expand our tax treaty network to include more countries worldwide. The negotiation process can take up to at least five years, so if you find yourself in a non-tax-treaty country, perhaps that will change! 

Do You Need Help Getting Started? 

Our tax professionals understand the pressure to file your US expat taxes correctly… we are expats ourselves! MyExpatTaxes team will provide the help you need to understand your tax forms and file them on time. Let us help you with our user-friendly software and service today!

MyExpatTaxes’ filing process is simple, affordable, and loved by the American expat community. If you are not entirely convinced, read our reviews on Facebook for some assurance.  Best of all, even Americans abroad can eFile with MyExpatTaxes!


Written by MacKenzie P

October 31, 2022 | | 3 minute read | 4 minute read

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