In this article and video, I will cover for you the 5 basic taxation systems around the world. It's very important to understand this fundamental for proper global tax planning.
Most people believe, that every country will tax you with the same rules. Just national laws will differ.
Of course, this is not true and there are basically 5 main taxation systems around the world. One of them is more a hybrid between two of them.
We are helping our clients mainly to move to countries where is no personal taxation at all or where the country tax you only on local source income.
Let's dive into the basics of international taxation.
1. Citizenship-based taxation
Citizenship-based taxation is one of the worst taxation systems in terms of tax optimization.
Because as a citizen of a country that uses this system, you have to pay always taxes on your worldwide income. It doesn't matter where you live permanently or how much time you spend in that country. You cannot escape the tax net because it sticks to the citizenship.
The only way to escape this taxation method: You renounce your citizenship and take a new one of a country that doesn't have citizenship-based taxation.
Of course, there can be some special rules in place to legally reduce your taxation up to a predetermined limit. Also as a US citizen (Foreign Earned Income Exclusion). Most probably, you will have to make every year paperwork and file a tax return.
Even non-US citizens can get into the tax net of the United States. The most common way to become obligated to pay taxes in the US is the substantial presence test. This test will determine if you are a US person for tax reasons or not.
Which countries have citizenship-based taxation?
The good news is, that most countries of the world do not apply this taxation method yet. Most countries go with residency-based taxation.
Currently, 4 countries of the world apply citizenship-based taxation or have special rules in place regarding citizenship and taxation.
The most known country that uses this system is the United States. Other countries are Eritrea, Myanmar, and Hungary.
2. residency-based taxation
Residential taxation is the most used tax system around the world to tax its residents.
It says, that if you live in a country long enough, you become a resident and thus be obligated to pay taxes on your worldwide income.
Once you leave the country and don't live there anymore, you don't have to pay taxes on your worldwide income.
The 183-day rule is used from a lot of countries to determine if someone is a resident or not. When someone lives over 6 months in a country, he cannot stay in another country longer the same year.
Not only the 183-day rule is used to determine the resident status. In some countries, it's already enough to have a permanent place to live (home) to become a tax resident.
Tax authorities can also look where your family (wife, husband, kids) lives to make you a resident.
So proper planning is important!
Anyway, residential-based taxation is one of the easiest systems to use global tax planning. There are always clear rules when someone becomes a resident or non-resident for tax reasons.
Please note: As a non-resident, you can be obligated to pay taxes if you have local source income in that country.
Let's say you own a flat in Germany and rent it out long-term. This rental income is local and has to be taxed in Germany, even you don't live there, or be a resident for tax reasons.
3. Territorial taxation
Territorial taxation is one of the best taxation systems out there. Currently, about 40 countries use territorial-based taxation.
Territorial taxation means, that you have to pay tax only on local source income. Foreign income is legally tax-free and exempt from personal income tax.
This doesn't mean that all foreign income is always tax-free. You have to look in detail in the tax code of the jurisdiction to be able to know what is classified as foreign income.
Most digital nomads and perpetual traveler make the mistake, to think if the money comes from a legal entity abroad, it will be tax-free.
Unfortunately, it's not that easy at all. So just to set up a tax-free company in Belize and then pay you a dividend while working from Malaysia is not considered to be foreign income.
You are working from Malaysia, so it's local income that should be taxed there.
Right now, a lot of countries (especially underdeveloped countries) cannot catch digital nomads, but more and more jurisdictions (developed countries) start to cracking down these loopholes, so proper tax planning is important.
40 countries with territorial taxation
Angola, Anguilla, Belize, Bermuda, Bhutan, Bolivia, Botswana, British Virgin Islands, Costa Rica, Democratic Republic of the Congo, Djibouti, Eswatini, Georgia, Guatemala, Guinea-Bissau, Hong Kong, Lebanon, Libya, Macau, Malawi, Malaysia, Marshall Islands, Micronesia, Namibia, Nicaragua, Palau, Palestinian Authority, Panama, Paraguay, Saint Helena, Ascension and Tristan da Cunha, Seychelles, Singapore, Somalia, Syria, Tokelau, Tuvalu, Zambia, Iran, Philippines & Saudi Arabia
4. non-dom taxation
Countries that use the non-dom taxation are a mix between residency- and territorial-based taxation and give you special tax-benefits for certain income types and/or foreign income.
non-dom means non-domiciled person. In most cases, it's a person who was not born in the jurisdiction using this system and has not the citizenship.
For example in the UK a non-dom is the following person:
"A non-dom is a UK resident whose permanent home, or domicile, is outside of the UK. A domicile is usually the country his or her father considered his permanent home when he or she was born, or it may be the place overseas where somebody has moved to with no intention of returning."
As you can see, in most cases only foreigners fall under these definitions in countries that use non-dom taxation.
Foreign income is under certain conditions tax-free in these countries as long it is not remitted into the country (remittance basis).
Malta, UK, and Cyprus are countries that apply non-dom taxation.
5. no personal taxation
The last taxation system is the best taxation system for mobile entrepreneurs and investors. 20 countries do not tax any type of personal income whatsoever.
Very rich countries (e.g. oil-rich) don't directly rely on the taxation of its citizens, so you can live there without the need of paying taxes.
Unfortunately, it's usually not so easy to set a residency flag in these countries. They are most times so rich that they don't need to attract people to settle down. Some of our clients enjoy tax-free life in the United Arab Emirates.
20 countries with no personal taxation
Antigua and Barbuda, Bahamas, Bahrain, Brunei, Cayman Islands, Kuwait, Maldives, Monaco, Nauru, Oman, Pitcairn Islands, Qatar, Saint Barthélemy, Saint Kitts and Nevis, Turks and Caicos Islands, United Arab Emirates, Vanuatu, Vatican City, Wallis and Futuna, Western Sahara
Where do you live right now, and do you plan to move your tax residency to a tax haven to legally reduce your burden from the state?
Please let me know your plans and strategies in the comments. Is there something unclear for you, and what are your biggest struggles right now?
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