• Paragraph 1
• Paragraph 2
• Paragraph 3
• Paragraph 4
• Paragraph 5
• Paragraph 6

ARTICLE 4 - Resident

This Article sets forth rules for determining whether a person is a resident of a Contracting State for purposes of the Convention. As a general matter only residents of the Contracting States may claim the benefits of the Convention. The treaty definition of residence is to be used only for purposes of the Convention. The fact that a person is determined to be a resident of a Contracting State under Article 4 does not necessarily entitle that person to the benefits of the Convention. In addition to being a resident, a person also must qualify for benefits under Article 22 (Limitation on Benefits) in order to receive benefits conferred on residents of a Contracting State.

The determination of residence for treaty purposes looks first to a person's liability to tax as a resident under the respective taxation laws of the Contracting States. As a general matter, a person who, under those laws, is a resident of one Contracting State and not of the other need look no further. For purposes of the Convention that person is a resident of the State in which he is resident under internal law. If, however, a person is resident in both Contracting States under their respective taxation laws, the Article proceeds, where possible, to use tie-breaker rules to assign a single State of residence to such a person for purposes of the Convention.

Paragraph 1

The term ``resident of a Contracting State'' is defined in paragraph 1. In general, this definition incorporates the definitions of residence in U.S. law and that of Estonia by referring to a resident as a person who, under the laws of a Contracting State, is subject to tax there by reason of his residence, domicile, citizenship, place of management, place of incorporation or any other similar criterion. Thus, residents of the United States include aliens who are considered U.S. residents under Code section 7701(b).

Certain entities that are nominally subject to tax but that in practice rarely pay tax also would generally be treated as residents and therefore accorded treaty benefits. For example, RICs, REITs and REMICs are all residents of the United States for purposes of the treaty. Although the income earned by these entities normally is not subject to U.S. tax in the hands of the entity, they are taxable to the extent that they do not currently distribute their profits, and therefore may be regarded as ``liable to tax''. They also must satisfy a number of requirements under the Code in order to be entitled to special tax treatment.

Paragraph 2

Paragraph 2 identifies three circumstances where the definition of residence set forth in paragraph 1 does not apply or is limited.

Subparagraph (a) provides that a person who is liable to tax in a Contracting State only in respect of income from sources within that State will not be treated as a resident of that Contracting State for purposes of the Convention. Thus, a consular official of Estonia who is posted in the United States, who may be subject to U.S. tax on U.S. source investment income, but is not taxable in the United States on non-U.S. source income, would not be considered a resident of the United States for purposes of the Convention. (See Code section 7701(b)(5)(B)). Similarly, although not explicitly stated in the Convention, as it is in the U.S. Model, an enterprise of Estonia with a permanent establishment in the United States is not, by virtue of that permanent establishment, a resident of the United States. The enterprise generally is subject to U.S. tax only with respect to its income that is attributable to the U.S. permanent establishment, not with respect to its worldwide income, as it would be if it were a U.S. resident.

Subparagraph (b) addresses special problems presented by transparent entities, such as partnerships, estates and trusts. The entity itself may be treated as a resident of a Contracting State to the extent that the entity is subject to tax in that State on the income as the income of a resident. This subparagraph also applies to any resident of a Contracting State who is subject to tax as a resident of that State on income derived through an entity that is treated as fiscally transparent under the laws of either Contracting State. Entities falling under this description in the United States would include partnerships, common investment trusts under section 584 and grantor trusts. This paragraph also applies to U.S. limited liability companies ``LLC's'') that are treated as partnerships for U.S. tax purposes.

Subparagraph (b) provides that an item of income derived through such fiscally transparent entities will be considered to be derived by a resident of a Contracting State if the resident is treated under the taxation laws of the State where he is resident as deriving the item of income.

For example, if an Estonian corporation distributes a dividend to an entity that is treated as fiscally transparent for U.S. tax purposes, the dividend will be considered to be derived by a resident of the U.S. only to the extent that U.S. tax law treats one or more U.S. residents (whose status as U.S. residents is determined, for this purpose, under U.S. tax law) as deriving the dividend income for U.S. tax purposes. In the case of a partnership, the persons who are, under U.S. tax law, treated as partners of the entity would normally be the persons whom the U.S. tax law would treat as deriving the dividend income through the partnership. Also, it follows that partners whom the U.S. treats as deriving the dividend income for U.S. tax purposes but who are not U.S. residents under U.S. tax law may not claim a benefit for the dividend paid to the entity under the Convention, because they are not residents of the United States for purposes of claiming this treaty benefit. (If, however, the country in which they are treated as resident for tax purposes, as determined under the laws of that country, has an income tax convention with Estonia, they may be entitled to claim a benefit under that convention.) In contrast, if, for example, an entity is organized under U.S. laws and is classified as a corporation for U.S. tax purposes, dividends paid by a Estonia corporation to the U.S. entity will be considered derived by a resident of the United States since the U.S. corporation is treated under U.S. taxation laws as a resident of the United States and as deriving the income.

These results would obtain even if the entity were viewed differently under the tax laws of Estonia (e.g., as not fiscally transparent in the first example above where the entity is treated as a partnership for U.S. tax purposes or as fiscally transparent in the second example where the entity is viewed as not fiscally transparent for U.S. tax purposes). Similarly, the characterization of the entity in a third country is also irrelevant, even if the entity is organized in that third country. The results obtain regardless of whether the entity is disregarded as a separate entity under the laws of one jurisdiction but not the other, such as a single owner entity that is viewed as a branch for U.S. tax purposes and as a corporation for Estonian tax purposes. The results also obtain regardless of where the entity is organized, i.e., in the United States, in Estonia, or in a third country.

For example, income from Estonian sources received by an entity organized under the laws of Estonia, which is treated for U.S. tax purposes as a corporation and is owned by a U.S. shareholder who is a U.S. resident for U.S. tax purposes, is not considered derived by the shareholder of that corporation even if, under the tax laws of Estonia, the entity is treated as fiscally transparent. Rather, for purposes of the Convention, the income is treated as derived by the Estonian entity.

The rule also applies to trusts to the extent that they are fiscally transparent in either Contracting State. For example, if X, a resident of Estonia, creates a revocable trust and names persons resident in a third country as the beneficiaries of the trust, X would be treated as the beneficial owner of income derived from the United States under the Code's rules. If Estonia has no rules comparable to those in sections 671 through 679 of the Code then it is possible that under Estonian law neither X nor the trust would be taxed on the income derived from the United States. In these cases it is to be understood that the trust's income would be regarded as being derived by a resident of Estonia only to the extent that the laws of Estonia treat Estonian residents as deriving the income for tax purposes.

The taxation laws of a Contracting State may treat an item of income, profit or gain as income, profit or gain of a resident of that State even if the resident is not subject to tax on that particular item of income, profit or gain. For example, if a Contracting State has a participation exemption for certain foreign-source dividends and capital gains, such income or gains would be regarded as income or gain of a resident of that State who otherwise derived the income or gain, despite the fact that the resident could be exempt from tax in that State on the income or gain.

Income is ``derived through'' a fiscally transparent entity if the entity's participation in the transaction giving rise to the income, profit or gain in question is respected after application of any source State anti-abuse principles based on substance over form and similar analyses. For example, if a partnership with U.S. partners receives income arising in Estonia, that income will be considered to be derived through the partnership by its partners as long as the partnership's participation in the transaction is not disregarded for lack of economic substance. In such a case, the partners would be considered to be the beneficial owners of the income.

A U.S. citizen would generally be treated as a resident of the United States under paragraph 1. However, subparagraph 2(c) provides that a U.S. citizen or alien lawfully admitted for permanent residence (i.e., a ``green card'' holder) who is not, under the introductory language of paragraph 1 of this Article, an individual resident of Estonia will be treated as a resident of the United States for purposes of the Convention, and, thereby entitled to treaty benefits, only if he has a substantial presence (see section 7701(b)(3)), permanent home or habitual abode in the United States. If, however, such an individual is a resident both of the United States and Estonia under the general rule of paragraph 1, whether he is to be treated as a resident of the United States or of Estonia for purposes of the Convention is determined by the tie-breaker rules of paragraph 4 of the Article, regardless of how close his nexus to the United States may be. However, the fact that a U.S. citizen who does not have close ties to the United States may not be treated as a U.S. resident under the Convention does not alter the application of the saving clause of paragraph 4 of Article 1 (General Scope) to that citizen. For example, a U.S. citizen who pursuant to the ``citizen/green card holder'' rule is not considered to be a resident of the United States still is taxable on his worldwide income under the generally applicable rules of the Code.

Paragraph 3

Subparagraph (a) makes clear the generally understood practice of including within the term ``resident of a Contracting State'' the Government of that state as well as any political subdivisions or local authorities, agencies and other instrumentalities of that State.

Subparagraph (b) provides that certain tax-exempt entities such as pension funds and charitable organizations will also be regarded as residents of a Contracting State regardless of whether they are generally liable for income tax in the State where they are established. An entity is dealt with in this subparagraph if it is generally exempt from tax by reason of the fact that it is organized and operated exclusively to perform a charitable or similar purposes, or to provide pension or similar benefits to employees pursuant to a plan. The reference to ``similar benefits'' is intended to encompass employee benefits such as health and disability benefits.

The inclusion of this provision is intended to clarify the generally accepted practice of treating an entity that would be liable for tax as a resident under the internal law of a state but for a specific exemption from tax (either complete or partial) as a resident of that state for purposes of paragraph 1. The reference to a ``general'' exemption is intended to reflect the fact that under U.S. law, certain organizations that generally are considered to be tax-exempt entities may be subject to certain excise taxes or to income tax on their unrelated business income. Thus, a U.S. pension trust, or an exempt section 501(c) organization (such as a U.S. charity) that is generally exempt from tax under U.S. law is considered a resident of the United States for all purposes of the treaty.

Paragraph 4

If, under the laws of the two Contracting States, and, thus, under paragraph 1, an individual is deemed to be a resident of both Contracting States, a series of tie-breaker rules are provided in paragraph 4 to determine a single State of residence for that individual. These tests are to be applied in the order in which they are stated. The first test is based on where the individual has a permanent home. If that test is inconclusive because the individual has a permanent home available to him in both States, he will be considered to be a resident of the Contracting State where his personal and economic relations are closest (i.e., the location of his ``center of vital interests''). If that test is also inconclusive, or if he does not have a permanent home available to him in either State, he will be treated as a resident of the Contracting State where he maintains an habitual abode. If he has an habitual abode in both States or in neither of them, he will be treated as a resident of the Contracting State of which he is a national. If he is a national of both States or of neither, the matter will be considered by the competent authorities, who will assign a single State of residence.

Paragraph 5

Paragraph 5 seeks to settle dual-residence issues for companies. A company is treated as a resident in the United States if it is created or organized under the laws of the United States or a political subdivision thereof. In Estonia, a corporation is treated as a resident of Estonia if it is either incorporated there or managed and controlled there. Dual residence, therefore, can arise if a U.S.-incorporated corporation is managed and controlled in Estonia. The paragraph provides that if a company is resident in both the United States and Estonia under paragraph 1, the competent authorities shall seek to determine a single State of residence for the company for purposes of the Convention. If, however, they are unable to reach agreement, then the company shall not be considered to be a resident of either the United States or Estonia for purposes of deriving any benefits of the Convention. Since it is only for the purposes of deriving treaty benefits that such dual residents are excluded from the Convention, they may be treated as resident for other purposes. For example, if a dual resident corporation pays a dividend to a resident of Estonia, the U.S. withholding agent would be permitted to withhold on that dividend at the appropriate treaty rate, since reduced withholding is a benefit enjoyed by the resident of Estonia receiving the dividend, not by the dual resident. The dual resident corporation that pays the dividend would, for this purpose, be treated as a resident of the United States under the Convention.

Paragraph 6

Dual residents other than individuals or companies (such as trusts or estates) are addressed by paragraph 6. If such a person is, under the rules of paragraph 1, resident in both Contracting States, the competent authorities shall seek to determine a single State of residence for that person for purposes of the Convention.

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