Eligibility for tax treaty benefits in the first instance is based on an individual’s tax residency status (not citizenship) in the treaty country. The timing of tax residency in the treaty country varies with the treaty article providing the benefit. Most treaty benefits require an individual to be a tax resident of the treaty country at the time the U.S.-source income is paid (or constructively received), which is the rule for all fixed or determinable annual or periodic (FDAP) income in Table 1 of IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.
Treaty articles for income from employment and self-employment require tax residency in the treaty country when the activities giving rise to the treaty benefit occurred, not when the compensation is paid. (It is not unusual for compensation for self-employment that occurred in one year to be paid in a subsequent year.) As long as the recipient of the income was eligible for the treaty benefit when the activity occurred, the payment may be exempted from withholding for an eligible recipient even if paid and reportable in the subsequent year when the recipient might no longer be a treaty country resident.
Most, but not all, of the treaty benefits for studying, training, teaching and engaging in research require only the income recipient to have been a tax resident in the treaty country at the beginning of the recipient’s visit to the U.S., and do not require tax residency in the treaty country throughout the visit. For example, Article 16 (Students and Trainees) of the treaty with Norway provides benefits for “an individual who is a resident of one of the Contracting States at the time he becomes temporarily present in the other Contracting State …” This timing recognizes the fact that residency status is lost under residence-based taxation after an extended or indefinite period of time away from the country.
Because of the potential loss of treaty country residency, long-standing IRS treaty policy requires individuals to re-establish physical presence and residency status in the treaty country between treaty claims (for example, a teaching benefit following student benefits), unless the treaty provisions indicate otherwise. This policy also requires an absence from the U.S. for at least one year (365 days) to ensure that exemptions from tax are not provided for overly long periods. U.S. visits for unrelated purposes (such as a vacation) do not restart the one-year period, however.
Determining a payee’s true country of tax residency has become increasingly difficult in the globalized economy. Students may leave their home country and study in another country for several years, for example, before coming to the U.S. to study, thereby changing their tax residency to a country other than that of their citizenship. Similarly, professors and researchers tend to pursue career opportunities in countries other than their own, frequently living in multiple countries prior to coming to the U.S. It is crucial for payers to know about such activities in order to be able to accurately determine a payee’s country of tax residency for treaty purposes, or they risk granting (or denying) treaty benefits in error.