American citizens who work remotely from Italy as employees for American Companies: where should they pay their taxes?
The subject of this article regards the tax problems of those American Citizens that live in Italy and work remotely from Italy for an American Company.
The problem to analyze is the following one: where should they pay their taxes? Only in Italy? Or only in America? Or in both countries?
Is it correct that the social security and tax withholdings are both applied by the American employer?
Before getting started, it is necessary to make an important premise.
In Italy, it is very important to outline the two distinctive elements of this kind of employment relationship:
A. The fact that the employee is resident, from a fiscal point of view, in a Country (Italy, for example), while the Employer is resident in another one (the US, for example).
B. The fact that the employee has a formal authorization by the employer to perform his service remotely.
The formalization of these two distinctive elements can take place in two ways:
- they can be written inside the job contract;
- or they can be formalized in a letter.
The second method is more frequent in those cases where the working relationship becomes remotely after a certain time: that is the case, for example, of an American citizen who was on vacation in Italy and he found himself stuck in Italy due to the pandemic; or when the American citizen decides to move permanently to Italy while continuing to work from remote for the same American company he was hired.
It's very important that the employee is in possession of one of the aforementioned documents (contract or letter) that formally specifies the authorization of the foreign employer to allow the employee to work in another country in smart working.
This is relevant because, as we will see, there are various tax consequences connected to where the job was actually performed.
Therefore, the first important suggestion is to obtain this document : it must be borne in mind that the letter may also be subsequent to the moment in which the employee started working in Italy in Smart Working for the American Employer.
For example: if the American citizen moved to Italy on January 20, 2022 and he/she immediately started working remotely for the American company, it is not in our opinion strictly necessary that the letter from the American employer is dated before 20 January 2022. Letters after January 20, 2022 acknowledging and ratifying the American employer's authorization to work remotely may also be fine for our purpose, as long as such letters are obtained prior to the commencement of any tax litigation.
HOW IS THE TAXATION FOR THE AMERICAN CITIZEN?
The American Employer that has hired an American Citizen living in Italy and working remotely from Italy will apply both social security and fiscal withholdings. Is this correct?
SOCIAL SECURITY WITHHOLDINGS
There are not many doubts regarding the application of social security withholdings: these must be applied and paid to American Social Security by the US Employer pursuant to the Convention between Italy and America on Social Security.
The point is that the American social security legislation is an extraterritorial legislation, based on the provisions of art. 7, paragraph 2 of the same Agreement:
"Services performed by a United States national in Italy which are covered under the laws of the United States shall remain covered under the laws of the United States".
The Italian social security legislation, on the other hand, requires that every worker on Italian soil be subject to the Italian social security contribution.
In case of conflict between the Italian and American legislation, the aforementioned Convention tells us to apply, art. 7, paragraph 4, letter a):
"a) A national of one of the States who, with respect to the same period of work, would be subject to the laws of the both States shall remain subject for such period to the laws of the State of which he is national and shall be exempt from the laws of the State of which is not national".
Therefore it is clear that the American citizen who works in Italy for an American company is subject to the American social security coverage.
If the American citizen was also an Italian citizen (thus having double citizenship), we would have to apply art. 7, paragraph 4, letter b) of the Convention:
"b) A national of Italy or a national of both States who, with respect to the same period of work, would be subject to the laws of both States shall, for such period, elect to remain subject to the laws of one of the States and shall be exempt from the laws of the other State".
In this case it is possible for the worker to choose which of the two systems can be applied. In any case, it's very likely that the social security system of the Country where the company is established, will be applied.
On the application of fiscal withholdings, one could ask the question whether they should be applied or not.
The answer is yes and it's due to the fact that the employee is an American citizen: he will have to file the American Tax Return no matter where he has his fiscal residence.
Therefore, the starting scenario for the American citizen residing in Italy is that of an American employer who applies both social security and tax withholdings to his payroll.
FIRST POINT: WHEN IS THE JOB CARRIED OUT?
Now we can start with the first point of the analysis: in case of remote work, where is the job performed? In Italy or in the US? In the Country where the employee is physically located (in our case in Italy) or in the Country where his service is "used" and therefore, in our case, in America?
To answer these two questions we will refer to two different sources:
- The answer of the Agenzia delle Entrate to the Interpello 621/2021.
- The OECD commentary on art. 15 of the OECD Model Convention against double taxation.
THE ANSWER TO INTERPELLO 621/2021
The Agenzia delle Entrate with the Interpello 621/2021 gives an interesting answer on the subject of Smart Working.
This is what the Agenzia delle Entrate says:
"In this regard, by "place of performance" of the working activity, in the particular
hypothesis of (...) smartworking or remote work, it is necessary to take into account the place where the employee is physically present when he carries out the activities for which he is remunerated".
Therefore it's clear that the reference for the Agenzia delle Entrate is certainly the place where the worker is physically present: in our example, in Italy.
THE COMMENTARY TO ART. 15 OF THE OECD MODEL OF CONVENTION
The OECD Commentary on art. 15 (which concerns the income from employment) confirms what is indicated by the Interpello 621/2021: to identify the Contracting State in which the work performance is actually considered carried out, it is necessary to have regard to the place where the employee is physically present when exercising the activity for which he is remunerated.
Therefore, from the analysis of these two sources, there is no doubt that in the case of a worker who works in smart working in Italy for an American Employer, the job services are rendered in Italy.
Having this point clear, let's move on to the second point of analysis: art. 15 of the Convention against double taxation between Italy and the United States.
ART. 15 OF THE ITALY - AMERICA CONVENTION
The text of art. 15 is the following one:
" Article 15 - Dependent Personal Services
1. Subject to the provisions of Articles 16 (Directors' Fees), 18 (Pensions, Etc.), 19 (Government Service), 20 (Professors and Teachers), and 21 (Students and Trainees), 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. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.
2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:
(a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the fiscal year concerned;
(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State;
(c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State".
Now, from Paragraph 1 of art. 15 of the Convention, two fundamental rules come out:
INCOME RECEIVED BY AN EMPLOYEE RESIDENT OF A CONTRACTING STATE IS TAXABLE ONLY IN THAT STATE, UNLESS THIS ACTIVITY HAS BEEN CARRIED OUT IN THE OTHER STATE.
IF THE ACTIVITY IS CARRIED OUT IN THE OTHER CONTRACTING STATE, THEN THE INCOME RECEIVED BY THE EMPLOYEE IS TAXABLE IN THAT OTHER STATE.
Let's analyze better these two rules.
RULE 1 establishes the general principle of exclusive taxation of the employee's State of Residence.
Therefore, following this rule, the taxation is exclusively in Italy, since the American citizen employed by the American company is resident in Italy.
RULE 2 establishes, however, that if the activity is carried out in the other State (therefore, in our case, in America), then the income is also taxable in that other State and there is a concurrent taxation.
Therefore, starting from the assumption that the job that the American citizen performs remotely from Italy is carried out in Italy (as we have already seen before) we will have that in our case only the first RULE 1 comes into play.
Therefore, FOLLOWING THE CONVENTION, the income from employment received by an American citizen residing in Italy who is an employee of an American employer and who works remotely from Italy is, pursuant to art. 15 of the Italy-USA Convention, taxable ONLY in Italy.
Now we have to pay attention to the fact that we are dealing with an American citizen: we know that pursuant to the "Saving clause" referred to in art. 1 paragraph 2, letter b) of the same Convention, the American citizen can still be taxed in America as if the Convention itself did not exist.
It's the well-known rule that obliges American citizens to file their Tax Return in the US even if they reside abroad.
So, keeping both factors in mind, the situation is the following:
- from the point of view of the Convention, the taxation should be only in Italy.
- on the other side the American citizen has to file the American Tax Return and report the worldwide income because of his American citizenship.
Now, let's see what are the main operative steps from a fiscal perspective.
The American Employer applies both social security and withholding taxes to the American citizen residing in Italy.
From the analysis of the aforementioned sources, it's clear that in the case of remote working from Italy, there is exclusive taxation in Italy of the employee's income.
Therefore in the Italian Tax Return, the income indicated inside the Form W2 must be reported and the Italian taxes will be calculated.
It's not possible to reduce the Italian taxes with the Fiscal Withholding that the American employer has already applied in the US: this is due to the fact the taxation is exclusive in Italy. Being the Italian one an "exclusive" taxation, it's not possible to offset the Italian Taxes with the American withholding: from the Italian perspective, the application of the withholding was "wrong" (but we know that it's not wrong: it's applied to the American Citizen because of his citizenship).
The US Citizen must still file his Tax Return in the US due to his US Citizenship.
However, in order to avoid double taxation, he will be able to offset the Italian taxes that he has paid in Italy from the American taxes, as Foreign tax Credit.
If the withholding that his American employer has applied in the payroll are higher than the remaining taxes to be paid after offsetting the Foreing Tax Credit, he will receive a tax refund.
The important point is that the American citizen that works remotely from Italy for an American Company has to pay taxes twice (American withholdings before and Italian Taxes then) before being able to ask for a refund for the American withholdings inside the American Tax Return.
This raises a financial issue over the first couple of years, as there is a double tax payment before being able to receive the refund back.