Stop Double Taxation: How the US Tax Residency Certificate (TRC) Works with DTAA

Introduction

With​‍​‌‍​‍‌ the worldwide economy being interconnected, the issue of cross-border taxation has turned out to be quite complicated for many people and businesses. Among the challenges that are commonly faced by taxpayers is double taxation, which is the case when a person or entity is subjected to tax on the same income in more than one jurisdiction. The United States, similarly to other countries, has put in place various means to eliminate such a problem, the US Tax Residency Certificate (TRC) being one of the main instruments.

Definitely, this certificate, combined with the Double Taxation Avoidance Agreement (DTAA), may lead to the avoidance of the situation where the same income is subjected to two different taxations. Through this article, we intend to explain in detail the Tax Residency Certificate in the USA- how it functions, its significance in the course of international tax planning, and the manner in which it collaborates with ​‍​‌‍​‍‌DTAAs.

Understanding Double Taxation

Double​‍​‌‍​‍‌ taxation situation takes place when the government demands the same taxes on a particular income that a taxpayer has to pay in more than one country. It usually happens when a person or a company generates income in a foreign country but is considered a tax resident in their home country. In the absence of measures limiting the pressure, taxpayers might end up paying the same income taxes several times, thus their tax obligations could increase ​‍​‌‍​‍‌substantially.

What Is a Tax Residency Certificate?

A​‍​‌‍​‍‌ Tax Residency Certificate (TRC) is a paper that is handed to a taxpayer by the tax authority of a country, indicating that the taxpayer is a resident of that country for tax purposes. For instance, the US Tax Residency Certificate is a document that certifies the individual or business as a tax resident in the US. Normally, such a certificate is required when a taxpayer is willing to use the advantages of the Double Taxation Avoidance Agreement (DTAA), which is a treaty that might be between the US and another ​‍​‌‍​‍‌country.

The reason for this certificate is to establish the taxpayer’s residency in the US, which is a prerequisite for requesting relief from DTAAs. DTAAs are agreements negotiated between two countries that set out how the issue of double taxation is solved by allocating taxing rights over different kinds of income (e.g., salaries, dividends, interest) to one or the other of the two ​‍​‌‍​‍‌countries.

How the US Tax Residency Certificate Works

The Certificate of Tax Residency USA is issued by the Internal Revenue Service (IRS), the tax authority of the US. The process of obtaining the certificate typically involves the taxpayer demonstrating that they are indeed a tax resident of the US under the Internal Revenue Code. This can be determined through several criteria, such as the substantial presence test or by being a green card holder.

For individuals, the substantial presence test is a key determinant. This test is based on the number of days a person spends in the US during a three-year period. If an individual meets the criteria outlined in the test, they are considered a tax resident of the US, which makes them eligible for the US Tax Residency Certificate.

The certificate can be used to prove the individual or entity’s residency status for the purposes of claiming exemptions or reductions in taxes under a DTAA. The US has signed DTAAs with many countries, including India, the United Kingdom, and several others. These agreements provide relief by reducing or eliminating the tax burden on income earned in one country by a resident of the other country.

The Role of DTAAs in Preventing Double Taxation

DTAAs​‍​‌‍​‍‌ are essential instruments in the prevention of double taxation as they specify the rules for the allocation of taxing rights between the two countries. In the absence of such an agreement, both countries might decide to tax the same income, resulting in double taxation.

The provision of a Tax Residency Certificate USA makes it possible for US residents to utilize the provisions of these treaties. As an illustration, under numerous DTAAs, a taxpayer might be exempted from taxation on income that originates from a foreign country if such income has already been subjected to tax in the US. There are situations where the agreement provides for the taxpayer to be allowed a tax credit or a reduction of the tax rate on certain categories of ​‍​‌‍​‍‌income.

For​‍​‌‍​‍‌ example, according to US-India DTAA, a person who is a tax resident in the US and gets income in India can ask for a lower tax rate on such income in India or may be allowed to claim a foreign tax credit that will compensate for the taxes paid to the Indian government. To avail such benefits, the taxpayer has to furnish a Certificate of Tax Residency USA that confirms his/her tax residency in the ​‍​‌‍​‍‌US.

How to Obtain the US Tax Residency Certificate

In​‍​‌‍​‍‌ order to obtain a US Tax Residency Certificate, a person or company needs to send a completed Form 8802, "Request for United States Residency Certification," to the IRS. Along with the form, a few documents confirming the taxpayer’s residential status in the United States should also be sent. The turnaround time for the process is normally a few weeks; therefore, it is a good idea to apply if you intend to use the benefits of a DTAA well ahead of time.

The IRS will issue the certificate of US tax residency once the request has been given the green light. The certificate can be presented to the foreign tax authorities to get relief as per the DTAA in question. In fact, the document is the official acknowledgment that the taxpayer is a US resident, and hence, entitled to any tax benefits or exemptions stipulated in the ​‍​‌‍​‍‌agreement.

Benefits of the Tax Residency Certificate and DTAA

One​‍​‌‍​‍‌ of the most substantial advantages of having a USA Tax Residency Certificate is the ability to single out the taxation. When taxpayers produce such a certificate to the tax authorities in a foreign country, they can ask for a decrease in their tax liabilities or request a foreign tax credit for taxes remitted to a foreign government.

Moreover, the US tax system frequently provisions for tax-free or preferential tax rates on income that originates from outside the country. As an illustration, income derived from foreign dividends, royalties, and interest may be taxed at a lower rate or may be fully exempt if the taxpayer is a resident of the US. The US Tax Residency Certificate makes it easier to undertake this process of benefiting from such a ​‍​‌‍​‍‌treaty.

Conclusion

It​‍​‌‍​‍‌ is quite challenging to understand the rules of international taxation, but the Tax Residency Certificate USA and DTAA are the two essential tools that taxpayers can use to get rid of the heavy burden of double taxation. First of all, with the help of this certificate, US residents can avoid being taxed twice on the same income and, at the same time, make the most of their tax benefits under DTAAs. If you are an individual or a business with cross-border income, then knowing the significance of a US Tax Residency Certificate would be the first step towards efficient and effective management of your tax obligations.

In case you are not clear about the steps to be taken to get a Certificate of Tax Residency USA, or you require help in cross-border tax planning, then it would be wise to take the advice of a tax professional or advisor who deals with international tax matters. They will assist you in the application process and also be your guide in the intricacies of double taxation and ​‍​‌‍​‍‌DTAAs.