In the case of individuals, how is the jurisdiction of tax handled within the EU when the border can be crossed at any time ?

FULL QUESTION

In the case of individuals:  how is the jurisdiction of tax handled within the EU when the border can be crossed at any time ?

ADDITIONAL WRITTEN ANSWER

In the European Union (EU), tax jurisdiction for individuals is primarily determined by residency and the concept of tax domicile rather than physical presence at any given time. While the Schengen Area allows for free movement across borders, tax obligations for individuals still follow these core principles:

1. Tax Residency

Tax residency is determined by domestic tax laws of each EU country but is generally based on:

  • The number of days spent in a country. Most EU countries consider an individual tax-resident if they spend 183 days or more in that country within a tax year.
  • Having a permanent home in that country, where the individual’s personal and economic interests are centered.
  • Center of vital interests, which considers where the individual has stronger personal and economic connections (family, property, work, etc.).

2. Tax Domicile

  • Tax domicile refers to the country where an individual is permanently settled and intends to remain. Even if they spend significant time in other EU countries, their domicile may not change unless they formally relocate and shift their center of life.

3. Double Taxation Agreements (DTAs)

Many EU countries have entered into DTAs with each other to avoid double taxation. These treaties usually provide rules on how individuals who live and work across borders should be taxed, ensuring they are not taxed twice on the same income. DTAs often resolve issues such as:

  • Which country has primary taxing rights (usually the country of residency or where income is earned).
  • Tax credits or exemptions to avoid double taxation in both countries.

4. Cross-Border Workers

Individuals who work in one country and live in another (commonly known as cross-border workers or frontier workers) are usually taxed:

  • On their employment income in the country where they work.
  • On their other worldwide income (e.g., investment income) in the country where they reside. Special bilateral agreements exist between some EU countries to ensure that such individuals only pay tax in one of the two jurisdictions or receive tax credits to offset any dual liabilities.

5. European Court of Justice (ECJ) Influence

The European Court of Justice plays a key role in ensuring that national tax laws align with EU principles. Cases have been brought to the ECJ when individuals feel that tax laws of one member state infringe on their rights to free movement or freedom to provide services. For example, discriminatory tax treatment based on nationality or residency status may be challenged under EU law.

6. Special Situations (Remote Work, Temporary Relocations)

  • In the case of remote work or temporary relocations (where an individual spends part of the year working in another country but retains their residence in the original country), DTAs and temporary residence rules may apply.
  • The EU has provided flexibility for remote workers during special situations, such as during the COVID-19 pandemic, but tax obligations ultimately return to regular residency rules.

In summary, while crossing borders freely within the EU is possible, tax jurisdictions are carefully structured around residency and domicile rules, supported by DTAs to prevent double taxation and ensure proper tax allocation. The European Court of Justice ensures that these rules conform to broader EU principles of free movement.

7. Taxation of Foreign-Sourced Income

An important aspect of tax jurisdiction within the EU is how foreign-sourced income is treated. Individuals may earn income in multiple countries due to the free movement of capital, services, and people within the EU. The tax treatment of foreign-sourced income typically follows these principles:

  • Resident Country’s Worldwide Taxation: Most EU countries tax their residents on their worldwide income, which means that if an individual is a tax resident in one country, they must declare income from all sources globally. This includes income earned from employment, investments, or assets located in other EU countries.
  • Tax Credits or Exemptions: To prevent double taxation on foreign income, tax residents are often allowed to claim tax credits for taxes already paid in other EU countries or benefit from exemptions under Double Taxation Agreements (DTAs).

8. Non-Resident Taxation

An individual who is not a resident in a particular EU country may still be taxed on income sourced from that country. For example, a non-resident who works or owns property in a country may be taxed on:

  • Employment income earned within that country.
  • Real estate income from property located in that country.
  • Capital gains from selling property or assets in the country.

In these cases, the source country has the right to tax the income under its local laws, but DTAs between countries typically ensure that such income is either taxed at a reduced rate or provides mechanisms to avoid double taxation.

9. Social Security Contributions

  • Besides income taxes, social security contributions are another significant aspect of tax jurisdiction. EU regulations ensure that individuals who live or work in multiple EU countries are covered by one country’s social security system at a time to avoid overlapping obligations.
  • In most cases, individuals working in an EU country contribute to that country’s social security system, even if they are residents elsewhere. For cross-border workers, special rules apply under EU Regulation 883/2004 to ensure social security contributions are only paid in one country.

10. Temporary or Dual Residency

  • An individual can sometimes be considered a resident of more than one country simultaneously, leading to potential dual residency. This often happens when a person spends significant time in more than one country or has economic ties in multiple jurisdictions.
  • In such cases, DTAs between the countries provide tie-breaker rules to determine where the individual should be treated as a resident for tax purposes. These tie-breaker criteria include:
  • Permanent home: Where the individual maintains their permanent home.
  • Center of vital interests: Where the individual’s personal and economic relations are strongest.
  • Habitual abode: Where the individual spends most of their time.
  • Nationality: As a last resort, nationality may be used to resolve dual residency conflicts.

11. EU Directives Affecting Cross-Border Taxation

The EU has several directives in place to harmonize and simplify tax rules for individuals who live or work across borders. Some important directives include:

  • The Parent-Subsidiary Directive: Reduces withholding taxes on cross-border dividend payments within the EU, which can apply to individuals receiving dividends from companies based in other EU countries.
  • The Interest and Royalties Directive: Removes withholding taxes on cross-border interest and royalty payments between associated companies in different EU countries.
  • The Savings Directive (now replaced by the Common Reporting Standard): Ensures that EU member states exchange information on interest earned by individuals in other member states to improve transparency and prevent tax evasion.

12. Exit Taxes and Emigration

  • Some EU countries impose exit taxes on individuals who emigrate and cease to be tax residents. These taxes are designed to capture capital gains on assets that have accrued while the individual was a resident, even if the gains have not been realized (i.e., the assets haven’t been sold yet).
  • Exit taxes aim to prevent tax avoidance by ensuring that individuals do not move assets across borders to countries with more favorable tax regimes without paying taxes on unrealized gains.

13. Cross-Border Pensions

Pension taxation for cross-border individuals is another key issue in the EU. People who work in multiple EU countries over their lifetime may accumulate pension benefits in several countries. How these pensions are taxed upon retirement depends on:

  • Whether the individual is a resident of the country where the pension is paid.
  • DTAs, which often determine which country has taxing rights over pensions, typically favoring the country of residence at the time the pension is received.
  • Special EU provisions allow for the coordination of pension rights, meaning that individuals can receive their pensions from multiple EU countries in a consolidated manner.

14. Temporary Workers and Freelancers

For individuals who work temporarily or as freelancers in other EU countries, taxation generally follows the principle of where the income is earned. Freelancers, however, may have more flexibility in terms of where they are taxed depending on the structure of their business (e.g., whether they are registered as a sole trader, a company, etc.).

  • The application of VAT (Value Added Tax) also becomes relevant for freelancers providing services cross-border, where they may be required to register for VAT in the countries where they provide services, depending on local rules.

15. The Role of the European Court of Justice (ECJ)

The ECJ has played an important role in interpreting tax-related cases that deal with the rights of individuals and their taxation in cross-border situations. Through its case law, the ECJ ensures that tax measures taken by member states comply with the fundamental freedoms enshrined in EU treaties, particularly the freedom of movement for workers, capital, goods, and services.

Key tax-related rulings from the ECJ have addressed:

  • Discriminatory tax treatment of non-residents compared to residents.
  • The application of withholding taxes on cross-border income.
  • The right to deduct expenses related to cross-border work or income.

Although individuals can freely cross borders in the EU, tax jurisdiction is firmly rooted in principles of residency, domicile, and tax treaties. Cross-border workers, temporary residents, and individuals with multiple sources of income must navigate a complex framework of domestic tax laws, bilateral tax treaties, and EU directives designed to prevent double taxation and ensure fair treatment. The ECJ plays a key role in resolving disputes and ensuring tax laws respect EU rights and freedoms.