The Rise of Digital Nomads and the Challenge to International Taxation: Is Residence Still Relevant?

[Vinesh Chaudhary]

Introduction

The focus of development in the international taxation order has remained on the incorporated structures. It is not that only incorporated structures are challenging to be linked with a particular jurisdiction by relying only on their physical presence. Articles 15 and 5 of OECD/UN Models (2017) reflect an age that had not revolved around technology. Article 15 relies on the concept of the physical presence of the employee in the source state. However, with rapid development, employment is now being exercised from any place, so countries are coming up with special visas for digital nomads.

Taxation of Employees under International Treaties

To understand the requisite changes needed in the regime of international taxation, it is imperative to look at the existing provisions. Article 15(1) of the OECD Model states that "salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State." Further, it is provided that employment is deemed to be exercised in place of the employee's physical presence.

Article 15(2) provides an exception to the general rule, i.e., if the recipient of income is physically present in the country of employment for less than 183 days in any 12 months, the income will be taxable in the state of which the employee is a resident.

The commentary on Article 15 substantiates the importance of the physical presence of an individual. It lays down several exceptions to the general rule, but none of them even discusses the possibility of a person not being a resident anywhere. Paragraph 5 of the OECD commentary talks about situations where an employee was terminated and had to settle in another country or where the employee owing to employment, has to leave one place and move to another.

Therefore, the conclusion is that Article 15 of the OECD/UN Models is founded on unquestionable reliance on the residence state taxation principle. A person's tax residence is sufficient proof of their fundamental relationship with a particular contracting state.

Residence Illusion

The modern international system seems to have not come out of the Stone Age. Graetz notes that we are adhering to inadequate principles wedded to old concepts such as the progressive income tax and deductions for mortgage interest and charitable contributions. These policies are outdated and current tax system lacks a coherent rationale and fails to promote economic growth and efficiency.

The question is whether individual income taxation should be free from sole reliance on residence for availing the benefits arising of treaties signed between countries (such as Double Taxation Avoidance Agreements). Questions about taxing legal entities have been around for a while and have entered the conversation over double taxation treaties. Multilateral Instrument (MLI) was introduced by the OECD for curbing perceived tax avoidance. It amended provisions of the treaties entered between countries to create a uniformity in international tax regime. It brought in developments for companies; certain conditions were imposed for enjoying the benefits of bilateral treaties, an individual can avail of the benefits by being a resident, but an individual settling at a place for a particular time does not necessarily mean that the benefits of the treaties are to be provided.

Due to the prevailing situation, residence is no longer a neutral criterion to judge a person's tax liability. In recent times, the residence has been used as a commodity traded by several countries such as Portugal, Spain, Malta, Colombia, etc. to seek investment (residency is being offered at a price ranging from 35,000 EUR to 10 million EUR). But as we can see, tax residence is still determined either by physical presence or with family ties of an individual. The time is right to re-evaluate how we define residency for people and to investigate whether our increasingly mobile populace could benefit from similar regulations to those put in place to stop businesses from abusing treaties due to their global market mobility.

The Digital Nomads

Nomads are people who are not settled in one place permanently. The rise of digital nomads in recent times has been due to the technological revolution all across the globe. These digital nomads are emerging rapidly with a motivation of independent remote work, travel adventurism, and escape from the office atmosphere.

The concept of work is going through a radical change, and the traditional ties to one particular are no longer relevant to tax someone. The vision of how employment is exercised at the time of drafting the Articles of OECD did not include the category of digital nomads. However, OECD has analyzed the backdrops of the system of permanent establishment (PE), wherein a physical commercial office doing active business was required to hold someone liable to pay tax. The concept has become outdated, and is not very relevant considering the technological developments. Resultantly, digital PE is being brought into the rules for taxing business in the European Union. But with the nomadic lifestyle being accessible to the people, the tax treaties must be compatible with the new reality.

Does it Matter if Digital Nomads are not taxed?

Laws involving taxation generally do not incorporate rules for insignificant amount of tax to be collected. Furthermore, here the tax collection would involve unreasonable effort in comparison to the amount to be collected. Perhaps, some surveys are available that exemplify the need for change in the taxation regime. In a survey conducted by Fragomen Future, out of 70 companies, 1/4^th had the policy of "work anywhere". Another survey in the USA stated that there 4.8 million workers consider themselves to be digital nomads.

These figures offer only a vague idea as to the total number of digital nomads in the world, but it is undeniable that the increase in number is happening, and it has significant economic relevance.

Determining the Tax Liability of Digital Nomads

Prof. Kostic, in his study gave two scenarios for understanding the complexities associated with the taxation of digital nomads.

1. A person who is a resident of country X leaves the country owing to several problems and decides to stay at various places for a period insufficient to make him a resident of that country. During this period, he worked with a company as an employee, which is resident in country Z using his mobile and laptop. All work performed by him is used in country Z.
2. The same person works in the same company, but the work is used worldwide.

In both cases, the employee would not be taxed as he did not stay in any place for more than 183 days. Also, his salary was paid by a non-resident employee. Country Z will not be allowed to collect tax because of the physical absence, and in scenario B, though the exercise of employment might have been different territories, these countries would be able to tax only the employer. As per Article 15, state X would be the one that will have taxation powers over the income; meanwhile, the states where he is earning are not getting anything in terms of income tax.

Proposals to tackle with the problem

Thus far it is clear that there exists a problem that needs to be dealt with. Amendments are required in the OECD Model to accommodate taxation principles concerning digital nomads. Alternatively, the introduction of qualified residence for individuals can be used to make treaty benefits available. This requires defining further preconditions for availing the treaty benefits instead of just establishing the link between the taxpayer and the jurisdiction.

Another method that countries could use for taxing nomads would be to lower the requirement of physical presence for 183 days in the territory as it no longer functions appropriately in the rapidly changing times. Even at the level of treaty formation, a mechanism could be agreed upon by countries wherein the resident state would have to redistribute a certain portion of the tax (collected by one country but the source being another country) to the source country, i.e., the place where actual income is being generated.

Recent Developments and Conclusion

Countries have been recognizing the need to attract nomadic populations to reap various benefits. Most recently, Croatia adopted Digital Nomad Visa and an amendment to the Income Tax Act, wherein digital nomads would not be taxed for salary earned from an activity outside the country. But again, the amendment is silent on the issue of tax residence. So, if a digital nomad stays in Croatia for a period of 183 days, she would be considered a tax resident in Croatia, and how this situation must be resolved in the amendment.

Consider the example of Estonia; it has been clearly provided that a digital nomad becomes a resident after 183 days and, therefore, could be subjected to income tax. On the other hand, Spain had adopted a special regime wherein digital nomads would be non-residents for five years while reduced tax rates would apply to them.

It can be seen that there is no consensus in the regime of taxing digital nomads. On the one hand, OECD Model does not even consider the possibility of such a population; on the other, some countries are adopting special regimes for the benefits that could be derived from this population. And at the end, no substantial development is taking place, and we are still stuck with age-old concepts for taxing employees.