The legal arrangements under which the contract is signed should be made clear to the client and it should be very clear that where a UK limited company is used and the individual is providing services under a services contract there should be no deduction of tax by the client under any local payroll deduction provisions equivalent to the UK’s PAYE system. The provisions of the local tax law and the treaty should be established and referred to in any dispute with the local tax authority or the client regarding any local tax liability.
As already mentioned a withholding tax could apply to international payments for services and this position should be clarified before the contract is signed. Any dispute about tax deductions under the contract should be dealt with under dispute resolution procedures set out in the contract. To prevent any dispute with the tax authorities in the client’s country the first step is to ensure that the legal position is clear from the contract concluded with the client. The service contract should be framed clearly enough to show that the relationship with the client is not one of employment but one of provision of services by an independent contractor.
The tests which are applied to contracts to define whether they are employment or services vary. Some key points are:
Control of work: In a services contract the client sets the desired outcomes but the contractor has control of how they deliver them. In an employment contract the client instructs the contractor on how to carry out the work.
Risk: In a services contract the contractor gets paid based on completing the deliverables in full and to the clients satisfaction. In an employment contract the contractor gets paid based on their units of work performed, regardless of the deliverables.
Substitution: In a services contract any individual (with mutual agreement) can deliver the services. In an employment contract it must be a specific, named individual.
In the event of any dispute relating to the application of international tax rules the contractor should refer to the double taxation agreement. If there is a possibility of double taxation of the same income the double taxation agreement will normally provide for a mutual agreement procedure under which competent authorities of the two states may enter into discussions with a view to resolving the dispute. Some double taxation agreements provide for compulsory arbitration of a dispute if the two authorities cannot reach agreement within a period of two years. It may also be worth checking if there is a bilateral investment protection treaty with the overseas country. This may contain an article providing for arbitration in certain types of dispute.
About the author: Peter Hann is an accountant based in Croydon, UK who specialises in international taxation.