The US-NZ Income Tax Treaty
Income Tax Law & Income Tax Treaty (DTA)
The income tax treaty in effect between the United States and New Zealand governments overrides the income tax law of each country. It is based on the OECD model tax treaty with some variations and was updated in 2011.
Treaty Objectives
The treaty has several objectives, the main one is the availability of relief from double taxation. To facilitate this objective the two bodies of domestic legislation, the New Zealand Income Tax Act and the United States Internal Revenue Code each make reference to the treaty.
The treaty applies only to income tax, at a federal level in the case of the United States. From a United States perspective, some states recognize the treaty, and other states do not.
Note that income from gains is also covered by the tax law promulgated in the treaty.
The terminology of the treaty is often ambiguous requiring caution when interpreting. For example, the word ‘resident’ is interpreted as ‘resident for tax purposes’. Similarly, the term ‘contracting state’ is interpreted as ‘the United States’ or ‘New Zealand’, and not ‘a state of the United States’.
In order to reduce the opportunity for treaty-shopping, the treaty includes provisions that must be met in order to avail of the benefits under the treaty. The ‘Limitation on Benefits’ section is in Article 16.
United States tax publications frequently refer to the treaty, far more so than New Zealand pronouncements. Similarly, the IRS disclosure requirements of treaty benefits being claimed are strongly evident in material produced by the IRS including tax return forms.
A common example of this disclosure requirement is form 8833 Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b) which is required where an individual who is resident of one country declares non-residency of the other country under the tie-breaker test.
The tie-breaker test
The treaty is organized into a series of articles. Arguably the most invoked article of the tax treaty is Article 4, known as the ‘tie-breaker test’. This article is invoked in cases of dual residency, that is, where a citizen or resident of the United States is also a resident of New Zealand.
The effect of invoking the tie-breaker test is that only one country, being the country with which the resident effectively has the closest ties, has the primary right to tax the individual according to its tax law, and the other country taxes the individual as a non-resident. For example, a United States citizen who moves temporarily to New Zealand may tie-break tax residency to the United States, if one or more of the four limbs of the tie-breaker test is satisfied.
The individual is taxed in the United States on worldwide income, and in New Zealand on New Zealand-sourced income only, declaring non-residency for tax purposes.
Without invoking this article, a dual resident is technically liable to income tax on worldwide income in both countries – unless relief is available under the domestic legislation of either country, which often it is – to a lesser or equal extent than under the treaty.
The tie-breaker rule is able to be invoked for a resident of New Zealand who is also a United States lawful permanent resident, but not a United States citizen. This is because the United States government has reserved the right to tax its citizens as if the treaty had never come into force, applying its federal tax law. This is known as the ‘savings clause’ and is present in all treaties that the United States is party to. In the case of the New Zealand treaty, the savings clause is present in Article 1.
Invoking the tie-breaker rule for United States resident aliens including lawful permanent residents, whilst technically permissible, may not be advisable. Lawful permanent residents, including green card holders who subsequently attempt to naturalize in the United States, may run into difficulties during that process should they have tie-broken their residency for taxation purposes in prior years. Accordingly, the tie-breaker rule should be used with extreme caution – in all situations.
Permanent establishments
Article 5 of the treaty allows the United States or New Zealand to tax the profits attributable to a permanent establishment that a resident of that country has in the other country.
A ‘permanent establishment’ is defined under the treaty. It includes, amongst other things, an office, a place of management, and personnel who have authority to, and who habitually exercise that authority, to conclude contracts on behalf of the organization. Inadequate planning in this area prior to expanding commercial operations can result in the undesirable outcome of an unexpected liability to income tax on the profits attributable to a permanent establishment, triggered as simply as by having an employee regularly concluding contracts on behalf of the organization in the other country.
This situation can be avoided with the selection of the correct operating structure for entry into the other country. Operating through the same entity that is used in the home country exposes that entity to an unfriendly tax environment in the other country, as governments resist affording concessions to foreign organizations in favour of domestic organizations.
Passive income, income from certain sources and occupations
The tax treaty reduces the tax rates that would otherwise be imposed on passive income in certain circumstances that a resident of one country may derive from the other country. Passive income includes interest, dividends and royalties.
The treaty has provisions for the taxation of certain categories of occupation and income including:
- artists
- teachers
- athletes
- students
- pensions
- income from employment
- income from self-employment
- real property
- shipping and transport.
Exchange of information
The treaty also allows for the exchange of information between the United States government and the New Zealand government, to ensure full compliance with tax law in each country.
Social security
There is currently no social security agreement (or totalisation agreement) between the United States government and the New Zealand government.
The 1983 treaty was replaced by the new treaty, which came into force on 12 November 2010. The changes became effective from 1 January 2011 except for provisions other than those reducing withholding tax rates, in New Zealand. Those provisions became effective from 1 April 2011.
Read the full text of the New Zealand-United States income tax treaty.
Please refer to the Second Protocol of the 1982 agreement.
For further information read our November 2010 article on the treaty.