The tricky concept of Tax Residence

One of the most important concepts that must be understood by a US person who wants to move to Italy is the concept of Tax Residence. This concept is a tricky one as it's different from the more usual concept of administrative residence: in fact an American citizen can be "resident" from an administrative point of view in the US and in Italy at the same time: nevertheless, only on of the two Countries, Italy or the US, will qualify the person as Tax Resident.

Let's understand why.

To better understant the concept of Tax Residence, let's go back for a second to the concept of "administrative residence".

Administrative residence can be achieved in several ways, depending on the domestic rules of the Country involved: in Italy, for example, administrative residence is achieved when the person is enlisted inside the "Anagrafe Comunale" of the Comune (Municipality) where the person lives.

In the US there is not such a registration, but having an house and an address in a certain town is enough to be considered "resident" from an administrative point of view.

Tax residence, instead, is a concept that comes out from the Convention against double taxation between Italy and the US: in particular, art. 4 is the article that concerns Tax Residence.

Let's take a look at this article:

"ARTICLE 4

Resident

1. For purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature."

An analysis of Art. 4 is beyond the scope of the present article: what is important to understand is that Tax Residence is crucial as it modifies completely the way the person has to file the Italian and the American Tax Returns.

The fact that a person is a Tax Resident in Italy has in fact the relevant consequence that in Italy he/she will pay taxes for all of the incomes produced in Italy and in the US and in any other Country.

This principle is called principle of Worldwide Taxation.

Instead, if a person is NOT a Tax Resident of Italy, he/she will pay taxes in Italy ONLY for the incomes that have their source in Italy.

Let's make a practical example to better understand this important point.

EXAMPLE 1.

Mr. Jones is an American citizen that owns a house in Boston. Some years ago he also bought an house in Venice where he met his spouse; they have a child and live toghether in Venice where Mr. Jones started a new business. In the US Mr. Jones has some investments in shares that produce dividends.

The questions are:

1 - Where is Mr. Jones Tax Resident?

2 - Where does he have to pay taxes? Italy or the US?

As for the first question, he's for sure Tax Resident in Italy, as he lives in Italy for most part of the calendar year and his family lives in Italy too. He also has ties with Italy because of his business in Venice.

The second question is a little bit more complicated; let's make another example:

EXAMPLE 2.

Mr. Jones has, in a certain calendar year, these incomes:

200 from his business in Italy;

120 from dividends of his shares in the US.

He is qualified as Tax Resident in Italy, and, because of the principle of Worldwide Taxation, he has to report in the Italian Tax Return all the incomes, the ones that have their source in Italy, as well as the ones that have source in the US.

Italian Tax Return:

Income to be reported: 200 + 120 = 320

Italian tax = 75.

American Tax Return:

Now the US citizen will have to file the US tax return too, where he will have to report the same incomes: this filing is not due to the fact that he applies the Worldwide Taxation Principle, but it's due to the fact that American Citizens are obliged to report all the incomes in the American tax return because of their citizenship, even if they are Tax Resident of another Country (Italy, in our example).

Income to be reported: 200 + 120 = 320

American Tax: 60

less Foreign Tax Credit (Italian Tax) = - 60

Taxes to be paid in the US: 0

(the difference of 15 cannot be refunded, but can be offset from the tax return of the following year).

The Foreign Tax Credit is defined by the Convention against the double taxation, in order to prevent the person to pay taxes in both Countries.

How Tax Residence is determined?

It's quite difficult to be able to determine the Tax Residence variables, but we can give some basic hints:

1) As we have already said at the beginning, Tax Residence is an exclusive concept: there will be only one of the two Countries that can qualify the person as "Tax Resident" after evaluating the criteria of art. 4.

2) The number of days spent in a Country during the calendar year is one of the most important variables, in order to define Tax Residence and it's for sure the first that is taken into consideration. If an American citizen spends more than 183 days in Italy, there is a good probability that he/she will be considered Tax Resident in Italy.

3) There is a connection between "administative residence" and Tax Residence, specially for the Italian side. For Italian fiscal laws, to be enlisted in the Anagrafe Comunale is a quite important element in order to be qualified as Tax Resident in Italy, even if the person has moved back to the US.

4) Another important element is where the components of the family live: if one of the two spouses lives in the US, but the other one lives in Italy and the two kids live in Italy and go to school in Italy, the "family" lives in Italy and this can attract the spouse who lives in the US to Italian Tax Residence: this concept is called "centro degli affetti e degli interessi".

Combining all these elements is quite complicated and it's necessary a great expertise to be able to do a correct qualification of Tax Residence.

For any information, please contact us.

You can also take a look at our free Webinar:

Moving to Italy: fiscal effects of becoming a resident of Italy

The Webinar was held on June 23, 2023.

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