Unfortunately, tax residency is an often misunderstood concept. This can be hazardous, especially for those aspiring to move offshore. It is no secret that we are all seeking tax optimization. Objectives include a lower tax brackets, but also a choice in which government you paying your income tax to.
No problem, you are on the right track. But is tax residency really necessary for you to achieve your objectives? It could create more tax problems than it solves; depending on your situation.
Indeed, tax residency is simply the right of a government to impose their tax on you. So if you are seeking lower income tax, or better yet, no income tax there is no such thing as the best tax residency.
In fact, the best tax residency is no tax residency. And believe it or not, this is perfectly legal. It is commonly found and there are many scenarios in which you can achieve it.
Below I will suggest a few offshore tax solutions, but first I will outline the most common legal structures which governments use to impose their income tax laws a.k.a. tax residency.
Citizenship Based Tax Residency
This form of tax residency is based on your country of citizenship. It is the most intrusive way for a government to enforce their income tax laws. If you are a citizen of one of these countries, even if you do not reside in that country, you are still a tax resident. This means you are subject to their income tax laws which encompasses all local income and all international income. So you will pay income tax to the government, unless you qualify for an exception.
However, exceptions come with contingencies that can change. In addition, you need to qualify for the exception which is not always possible. Without a workable solution, you will still pay income tax. Otherwise, you are avoiding tax illegally and this will always catch up with you in the end.
These five countries currently impose citizenship based taxation. The countries are Eritrea, Myanmar, Tajikistan, Hungary and of course the United States. It is worth noting that two of these countries: Myanmar and Eritrea charge their non-resident citizens at a reduced income tax rate. But no such luck for citizens of Tajikistan, Hungary and the United States.
Tax residents of the United States are subject to a more insidious twist because of global USD hegemony; which the US thoroughly enjoys. As a result, any country that does not cooperate with the US government to impose their FATCA and FBAR regulations faces sanctions or worse!
In return, they get nothing because the US does not reciprocate on tax information sharing. Do as they say, not as they do or your country will pay the consequences.
The only way out for US citizens and Green Card holders is renunciation (after you acquire second citizenship). To do this, you need a workable offshore tax plan.
Residence Based Tax Residency
As the name implies, this form of tax residency is based on where you reside. If so, you are usually subject to tax on all locally sourced income and also all income sourced from outside the country. That is, if you are considered a resident.
The exception being if you hold a passport from one of the above mentioned citizenship countries. If so, country of residency does not matter because your are still a subject to the income tax laws of your home country. Even if there is a tax treaty in place, you are still paying the same amount of income tax, either way.
On the bright side, residence based tax residency is theoretically more sensible. If you qualify, it is still possible to legally eliminate income tax. Just the same, there are a few tricks hidden between the lines of residence based tax laws.
For example, residency can be based on the location of your family or your assets, not only where you live! These rules are often cloaked in terms such as where your “home” is located or “principle place of abode”. Another term to be wary of is “center of economic activity”. European countries such as France and Spain commonly use such terminology. Even if you do not live there, it is still possible to pay their redundant income taxes.
In addition, income tax is not your only concern. Keep an eye on residency based inheritance tax laws lest your estate beneficiaries find out the hard way that the government has a tax claim on 40% of the proceeds e.g. France.
So be careful where you own real estate because it may inadvertently make you a tax resident where you do not want to be one.
Contact me to live in the country of your choice but still optimize your income tax liabilities.
Territorial Based Taxation
Territorial based tax residency is the most sensible option. As the term implies, if your source of income does not come from within the country, there is usually no income tax. In addition, some income sources are still exempt even if they are sourced from within such as interest, dividends or capital gains.
In further benefit, many countries outside of the territorial country where you live, still base tax residency status on your country of residency. As a result, if your residency is in a territorial country, it may make you exempt in other countries where you may hold assets such as bank accounts, investment accounts or real estate.
For example, suppose you become a citizen of St Kitts and Nevis and you reside in a territorial country. Citizenship from St Kitts and Nevis (SKN) makes you exempt from income tax under their laws. Plus, since you have a local tax ID and other connections to SKN such as a driver’s license and street address you can make a strong case for being a tax resident of St Kitts and Nevis. This is true even if you do not reside there.
So to clarify, if you have no taxable income from within, your country of citizenship imposes no tax and you have no tax claims from where your foreign assets are located; where would you need to pay income tax? This is how a properly implemented offshore tax plan is supposed to work.