International Tax Systems – Tax Residence EXPLAINED!

When you search the internet for topics such as starting an offshore company, optimizing or paying no taxes, you find a lot of articles and videos promising more than what seems to be realistic.

  • Start a company abroad – you don’t have to pay taxes!
  • Get a foreign bank account and stop paying taxes!
  • Move to this country and pay no income tax!

And you know what?

Most of these statements are actually true!

benjamin_franklin_certainty_in_this_world_nothing_is_certain_but_death_and_taxes

You can get a foreign bank account and not have to pay taxes in that country.

You can start a company abroad and that company does not have to pay corporate or capital gains tax.

That’s all true and 100% legal.

What do does YOUR government think about all this?

This question is the essential piece of the tax puzzle that most people overlook, which ends up getting them in trouble!

Tax Residence + Citizenship

If you are a US citizen, you are taxed on all of your income – worldwide, regardless of where you live.

There is nothing you can do about this, unless you are willing to renounce your US citizenship.

With the right setup, you can minimize those taxes – especially if you establish the right company structure.

There’s also a tax allowance, but still, this would be one situation in which you still have to pay taxes regardless of your ‘offshore’ activities.

In fact, due to FATCA, now it’s more difficult then ever for US citizens to open bank accounts abroad. Most foreign banks simply don’t want to deal with the additional paperwork that comes with taking on US clients.

Most other countries don’t have citizenship-based taxation.

This means that there is more room for tax optimization, you are not bound to paying income tax to your home country unless you actually live there.

Tax Residence is the defining criteria.

Tax laws vary from country to country, but if you live in COUNTRY A and start a company in COUNTRY B (and that country has lower tax rates), COUNTRY A might consider this tax evasion.

This is the trap many people fall into.

To explain what I mean, let’s use a metaphor. Let’s say your home country is your parent.

On the weekend, you want to go to a bar or club. That place is open until 4AM. While technically, you could stay until 4AM, if your parents say you have to be home by midnight, then that’s the rule which applies to you.

The foreign country might not have corporate or income tax – however, this doesn’t mean you are off the hook from your home country, or country of residence.

Shell Company = Tax Evasion

That’s not always the case, but the way most people establish and run an offshore company constitutes tax evasion.

These are the kinds of setups that will get you in legal trouble!

You might not notice legal issues from day one, but sooner or later, you will either have your passport cancelled, or get a visit from these guys.

IRS Raid

You can avoid this horror scenario by not taking any risks and being compliant with local and international tax laws from the get-go!

Most countries don’t accept an offshore company as a legitimate business if it’s in the form of a letterbox company.

If your company only has a mail address at the respective offshore location, it’s clear that you are trying to ‘game’ the tax system.

In such a case, it’s almost always seen as tax evasion.

You can avoid this by having an actual office in the jurisdiction of your offshore company. Typically, this doesn’t cost more than $200 per month and there are many service providers to choose from.

Tax System Worldwide

Most countries have one of the following tax systems (or a combination).

  • Territorial Taxation (Singapore, Panama …)
  • Citizenship-Based Taxation (RARE, includes USA)
  • Residence-Based Taxation (MOST COUNTRIES)
  • No Direct Taxation (U.A.E., Qatar, Bahrain …)

The names are self-explanatory.

International Tax Systems

Territorial taxation means only income which you generate within that country is being taxed (oversimplification, of course).

Residence-based taxation (simply put) is based on the length of your stay in the respective country. In most countries, you automatically become a tax resident if you stay for more than 183 days (or half a year).

If you stay fewer days, you are not considered a tax resident.

Other countries have additional rules in addition to the length of your stay, such as whether or not you have ties (bank account, family, properties).

When you are thinking of setting up a bank account or company abroad, you must always keep the tax system of your home country in mind.

This also applies when you start a company via the Estonian e-Residency program. Tax residency law still apply!

For more information, get in touch to book a consultation and gain clarity.