Country of Tax Residence and Why it Matters

The topic of offshore banking, offshore tactics, and fiscal residency has been a recurring theme within investment communities for many years. While not entirely unfamiliar, the advantages and the option to alter one’s country of tax residence might have seemed more out of reach than it truly is.

In the past, offshore financial practices were frequently linked with affluent individuals and even tax evasion, contributing to this perception.

However, before delving into the details of offshore banking, it’s crucial to understand the concept of tax residency status and its positive and negative ramifications on income earned within your domestic residence, as well as in other countries.

What is Tax Residence?

A tax residence refers to a location where you’re obligated to pay taxes, distinct from a physical residence. Possessing a residency permit doesn’t automatically confer tax residency. Additionally, the status of your second residence, whether temporary or permanent, is irrelevant.

Determining tax residency status is based on various factors, including the amount of time physically spent in the country, the nature of economic activities, and the individual’s or entity’s ties to that country. Furthermore, tax residency status depends on the jurisdictions in which fiscal residence is established, as the presence of a tax treaty can potentially alter tax residence in a particular country.

Different countries have different criteria for determining tax residency status. In some cases, spending a certain number of days within a foreign country in a given year can establish tax residence. Factors such as permanent home, family, and economic interests are considered in other cases. It can also come down to current immigration status and whether the individual holds a residence permit.

Double taxation

It’s important to note that someone can be considered a tax resident in more than one country, potentially leading to double tax, which is the obligation to pay taxes in two or more jurisdictions on the same income.

Tax residency status has significant implications for how income is taxed. Residents are generally subject to a country’s tax laws on their worldwide income, while non-residents might only be taxed on income generated within that country’s territory.

Understanding your tax residency status is vital for proper tax compliance and optimizing your financial situation.

Tax Residence versus Second Residence

The objective of this article is to maintain a straightforward approach, providing you with a fundamental understanding to build on. Dissecting the complexities of offshore banking through residency by investment and reducing your tax liability can be quite intricate. Therefore, put simply, here is the distinction between tax residence and second residence:

Tax residence: Any country or jurisdiction where paying taxes is legally required

Second residence: A residence permit allowing an individual to live in a country

The two can share a correlation, yet they remain distinct concepts. Being a legal permanent resident in a nation doesn’t inherently mean you’re a tax resident. This remains true regardless of whether your secondary residence is temporary or permanent.

A point to highlight is there are countries where citizenship can be held without necessarily indicating tax residency. These countries typically determine a citizen as a tax resident on the basis that they’re physically present in the country for a certain number of days.

Maintaining a residence permit

The criteria for maintaining a residency permit might involve spending just one day annually in a specific country or even no days at all. The Portugal Golden Visa has a minimum stay requirement of seven days in the first year to maintain a valid residence permit. On the other hand, the Greece Golden Visa has zero stay requirements, meaning there are no country minimum physical days or the requirement to be physically present in order to maintain residency status.

Additionally, physically residing in a nation doesn’t automatically grant tax residency. Remarkably, certain countries extend tax exemptions, preventing tax liability or providing the right to a special tax system for the initial years of your stay.

Why obtain a second residency for tax purposes?

The purpose behind acquiring a second residence is to gain the right to live in a second country. This choice could stem from a desire to establish a permanent home or as a plan B. It might also be driven by the intention to access legal advantages and business prospects associated with holding residency in two countries, thereby expanding markets and investment opportunities.

No universal, one-size-fits-all solution exists for every individual circumstance or country. The purposes and benefits of acquiring a second residence are diverse. Each nation presents distinctive opportunities.

However, in specific scenarios, a residency permit can also be integrated into a strategy to achieve non-tax residency status. Greece and Portugal are two countries that provide these options for Golden Visa holders and legal residents through the Greece Non-Dom Tax regime and the Portugal Non-Habitual Residency (NHR) Tax regime.

The Greece Non-Dom Tax regime allows Golden Visa Holders and majority shareholders of Greek companies to establish a non-domicile tax status, allowing them to avoid income tax in exchange for an annual tax fee.

The Portugal NHR tax scheme is open to individuals possessing residence permits in Portugal. This program’s tax advantages include:

• Special tax treatment for ten years
• Second residence tax deduction on foreign income
• Free remittance of funds to Portugal
• Reduced tax rate on Portugal-sourced income

Obtain a New Tax Residence

Establishing a tax residence varies based on several factors, including your objectives, country of citizenship, existing countries of residence, and the specific foreign country you intend to obtain tax residency.

A significant consideration in acquiring a tax residence separate from your home country or where you are physically present is what is often referred to as the “tax-free quadrant.” Thinking about your lifestyle and needs, your business structure, as well as the destination you’re leaving and intend to arrive at is crucial.

Tax-free Quadrant

To explain the concept further, let’s say you’re a UK citizen. Your established home is in England, and you’ve lived there your entire life. You have a personal residence there, a family, a vehicle, and multiple other connections to the country.

Because the UK’s HMRC has a residential taxation system (like most Western Countries) and you hold these economic ties to it, you’re considered a tax resident there. Wherever you earn income elsewhere, it is taxed by HMRC as it corresponds to your residency status.

On the other hand, if you leave the UK and sever these ties, you may no longer be liable to pay tax to the UK government on your international income as you’re now considered a non-resident citizen.

Therefore, for individuals from countries like the UK, Canada, and Australia, the objective is to acquire non-resident citizen status in order to become a non-resident for tax purposes.

Unlike the conventional offshore narratives of the 70s, simply telling HMRC you’re no longer a tax resident because you don’t live in the UK anymore won’t suffice. Governments want to know where you live, which may entail counting physical days, not years, and how close your ties to the country are before they consider removing your tax resident status.

What Makes Me a Tax Resident?

The precise definition of tax residency was the other side of this topic that caused confusion. In the past, a relatively straightforward physical presence test existed to determine your tax liability in a country, primarily based on the number of days you spent there.

The crucial figure for this evaluation was 183 days—effectively more than six months in a calendar year. If your duration of stay remained below this threshold, you would remain tax-exempt and, thus, not be required to file tax returns.

While some governments, like the US government, still use a substantial presence test, the present situation has grown considerably more complex. For the most part, gaining a second residence to spend less than six months in a country is ineffective today.

The substantial presence test meant people would ensure they never spent more than 183 days anywhere. These days, authorities seek to determine the country you have the closest connection to, which involves not just spending time there but establishing multiple ties.

So, if the 183-day substantial presence test has largely been phased out, what exactly makes me a tax resident today?

How countries determine tax residents varies globally, with most countries following one of four fundamental tax systems:

• Residential taxation
• Territorial taxation
• Citizenship-based taxation
• Zero taxation

Residential taxation

Individuals residing in jurisdictions with residential taxation are liable to pay taxes based on their physical presence or residence status within a particular country. Under this tax system, if an individual spends a specific duration within a jurisdiction, often defined by a set number of days, they become liable to pay tax on income earned within that territory and in any other foreign jurisdiction.

As we previously pointed out, the typical threshold of when residential taxation is triggered is around 183 days in the current or previous calendar year. In some cases, temporary or permanent residency status alone is sufficient to impose tax on individuals’ worldwide incomes.

This framework is designed to include individuals who either have legal residency or spend a significant duration in a country, ensuring their financial contributions to the nation’s services, infrastructure, and social welfare.

Territorial taxation

Territorial taxation is a tax framework that levies taxes exclusively on income and activities originating within its geographical boundaries. Within this system, individuals and businesses are typically taxed in relation to their domestic earnings and transactions, with no consideration for income generated outside the country.

Foreign-sourced income, such as profits from foreign investments or businesses, is generally not considered taxable in the home country as your tax residence status only relates to local income.

Territorial taxation prevents double tax on income residents and foreign nationals may earn overseas. However, territorial taxation’s implementation and regulations can vary widely among different countries as it may include federal or just state taxes.

Citizenship-based taxation

Citizenship-based taxation represents the most stringent form of taxation, wherein a nation imposes income tax on the global earnings of its citizens, regardless of their residence or domicile or the source of their income. This type of taxation contrasts with residency-based tax, where tax on personal and corporate income is based primarily on a physical presence or residency within a country.

Under citizenship-based taxation, individuals remain subject to their home country’s tax regulations, even when living abroad and earning income in foreign jurisdictions. The United States is a notable example of a country imposing a citizenship-based income tax.

US citizens must report and pay tax on their worldwide income, regardless of whether they live within the United States or another country. This system aims to ensure that citizens contribute financially to the country’s revenue, irrespective of location, while preventing tax evasion through offshore accounts.

Nevertheless, many Americans overseas avoid paying income taxes through several employee and self-employment-related tax credit programs. Concerning foreigners living in the US, there are two classifications:

• Resident aliens
• Non-resident aliens

A resident alien is a US permanent resident generally required to pay tax on their worldwide earnings. A non-resident alien refers to an individual who has not met the criteria of a substantial presence test and is classified as a non-tax resident. In this situation, they would be subject to territorial taxation in the US.

Zero taxation

Zero taxation, a tactic frequently used in nations known as tax havens or tax-free jurisdictions, entails a structure where zero tax is levied on particular forms of income, transactions, or entities. Under this system, individuals and businesses can benefit from a non-existent tax burden on their earnings, investments, and financial activities.

Tax resident status in a zero-tax country holds as much significance inside the country as it does outside. Many zero-tax countries do not require tax residents to file tax returns every tax year, while the status may also prevent tax liability in other countries.

Tax Residence and US Citizenship

While most countries have relatively straightforward tax systems, tax residency in the United States is contingent upon variables such as which state you live in and your legal status. Unlike some countries with territorial taxation systems, the US employs a citizenship-based taxation system. This means US citizens are taxed on their worldwide income, regardless of where they live or generate income.

Citizens of countries like Canada, the UK, Germany, and Australia are not considered tax residents if they permanently live in another country and have no financial ties to their home country. For US citizens, tax residency is indefinite through citizenship.

Even if a US citizen lives abroad, they must still file a US tax return and report their global income to the US government. Additionally, they might be subject to taxes in the country of their residence, leading to a potential double tax situation. However, the US has tax agreements with many countries to mitigate this issue by providing tax credits or exemptions.

Taxes for non-US citizens

Determining tax residency for a non-US citizen can be complex. Foreign nationals living in the US are referred to as aliens and fall under the terms resident alien, non-resident alien, and dual-status alien. The substantial presence test is a standard method used to determine tax residency for non-citizens living in the US or with economic ties to it.

It considers the number of days an individual has been physically present in the US over a period of three calendar years. If the total exceeds a certain threshold, typically 183 days in the past calendar year, the individual is considered a resident alien (US tax resident) and must report their global income.

Individuals who do not satisfy the substantial presence test are classified as non-resident aliens, obliging them only to report income earned within the United States. In the case of a dual-status alien, this would determined in the circumstance of an individual who lives in the US and another jurisdiction in the same tax year.

State taxes

Depending on their state, US citizens may bear a heavier or lighter tax burden. The United States employs a dual-tier tax structure—a form of territorial taxation comprising state and federal taxes.

States like New York and California levy relatively high state income taxes, with the highest income tax rate reaching 15.9 percent. In contrast, residents of states like Florida, Texas, and Arizona are not required to pay state income taxes.

Tax treaties between the US and other countries also play a crucial role in determining tax residency. These treaties help prevent double taxation and establish rules for determining residency in cases of dual citizenship or conflicting residency claims.

Understanding tax residence in the US is essential to fulfilling tax obligations and avoiding legal issues. Failing to comply with US tax laws, even unintentionally, can lead to penalties and other consequences.

Tax Residence and the West

Citizens of other Western countries have a bit more leeway. For instance, an Irish citizen legally living in Singapore could become a non-resident in Ireland, effectively severing their tax obligations.

As discussed above, individuals from countries with residential-based taxation must present compelling arguments for their new tax residence or fall prey to the double taxation tax trap. Nevertheless, leaving a high-tax system to become a resident for tax purposes in a zero-tax country is within legal bounds.

The EU white paper explains precisely what you shouldn’t attempt to do. According to the dossier, some people have continued residing in Ireland rather than moving to Singapore while using their Singaporean residence permit for their bank and tax documents in Ireland.

In practice, they assert their domicile in a low-tax nation, even though their actual residence is in a high-tax country.

The Path to a New Tax Residency

Securing a new tax residency entails two pivotal phases—first, obtaining the new tax residency, and second, fulfilling the prerequisites to establish non-residency for tax purposes. Becoming a non-resident for tax purposes involves distinct measures depending on the country.

Some may require that you live outside the country for a certain period; others may define non-tax residency status based on having no financial ties or activity in the country. For US citizens, achieving non-resident status for tax purposes entails the drastic step of renouncing citizenship.

Options for residency by investment

In Europe, three countries provide the ideal solution to becoming a resident for tax purposes. The Portugal and Greece Golden Visa programs allow residence permit holders to establish a special tax status, significantly reducing their tax liability for a certain number of years.

Portugal Golden Visa

The Portugal Golden Visa is a residency by investment program granting non-EU nationals residency in Portugal in exchange for a minimum investment in its economy. Investments for the program start from €250,000 and include:

• Real estate investment*
• Contributing to an investment fund
• Capital transfer
• Contributing to scientific or technological research
• Establishing a business that creates jobs
• Contributing to the arts or reconstruction of national heritage

After gaining a residence permit and following the renewal process, investors become eligible for Portuguese permanent residency or even citizenship after five years. Golden Visa holders have the option to register as non-habitual tax residents under the NHR tax regime. Through this program, participants can pay reduced Portuguese taxes for ten years, along with gaining access to additional tax concessions.

*Please be aware that the exclusion of real estate as an investment option is presently under review and will be removed as a qualifying investment in the near future.

Greece Golden Visa

The Greece Golden Visa is favored among foreign nationals seeking residency in the European Union. One of the primary advantages is that the program presents attractive qualifying investments in real estate, commencing from €250,000, in addition to options like bank deposits, government bonds, and acquiring shares in Greek companies.

Additionally, the Greece Non-Dom Tax regime provides one of the best tax statuses in the EU. In exchange for an annual tax fee of €100,000, individuals with Greece Golden Visas can enjoy 15 years of tax exemption.

Options for citizenship by investment

While tax residency is predominantly linked to residency, economic citizenship (CBI) in certain nations can offer a route to obtaining a new tax residency and tax-free lifestyle. St. Kitts and Nevis and Vanuatu are two nations that simplify and streamline this process while providing incredible tax advantages.

St. Kitts and Nevis

St. Kitts and Nevis holds a key position among CBI countries, offering a well-established program that extends tax benefits to expats and business owners across the globe. Entry into the program starts with a $250,000 investment in the country’s Sustainable Island State Contribution (SISC). Additional investment options include:

• Real estate investment
• Contributing to the Public Benefit Unit

From a tax perspective, establishing tax residence in St. Kitts and Nevis means you pay zero foreign income tax and no tax on capital gains, inheritance, or gifts. Furthermore, corporations benefit from no tax on foreign income and may be eligible for special tax treatment for up to 15 years on operations within St. Kitts and Nevis.

Vanuatu

Despite its remote location, Vanuatu’s financial appeal resonates far and wide. The qualifying investment for its CBI program is affordable, involving a contribution of $130,000 to the country’s national development fund.

Vanuatu is the most tax-friendly CBI country, with zero taxes on personal income, inheritance, or capital gains. Its favorable tax structure extends to corporations, with zero percent corporate tax. The only requirement is that businesses pay an annual registration fee of $300 to $1,000 and contribute six percent of an employee’s salary to the National Provident Fund.

Frequently Asked Questions about Tax Residency

What is the tax residence country for H1B?

The tax residence for H-1B visa holders in the United States would typically be the United States itself. H-1B visa holders are temporary non-immigrant workers authorized to work in the US for a specific employer. As they earn income and pay taxes in the US, their tax residence would generally be considered the United States.

However, individual circumstances and tax agreements between the US and the individual’s home country can also play a role in determining tax residency status.

What is the 183-day rule for state residency?

The 183-day rule, determined through the IRS (Internal Revenue Service) state residency test, is a common criterion many US states use to determine an individual’s residency status for tax purposes. The rule generally states that if a person spends 183 days or more within a particular state during a calendar year, they are considered a state resident for tax purposes. 

Some states use this rule to determine whether an individual is subject to state income tax. If you meet the 183-day threshold, you may be required to pay state income tax on income generated both within and outside the state. However, the rule’s specifics can vary from state to state, and other factors such as ties to the state, property ownership, and family location can also come into play. 

What is OCED tax residency?

The OECD (Organization for Economic Co-operation and Development) does not define tax residency directly, but it provides guidelines and recommendations that many countries follow to determine an individual’s tax residency. These guidelines are outlined in the OECD Model Tax Convention, which serves as a framework for tax treaties between different countries.

The OECD’s guidelines typically include factors such as the individual’s physical presence in a country, permanent home, center of vital interests (personal and economic ties), habitual abode, and nationality. However, governments can interpret and apply these guidelines differently in their domestic tax laws.

What is the difference between a tax home and a tax residence?

A tax home is the primary location where an individual conducts business or employment activities. It serves as the central base from which work-related activities are carried out. On the other hand, tax residence relates to an individual’s legal status in a particular jurisdiction for tax purposes.

It involves factors such as the duration of stay, personal and financial ties, and the intention to remain in a specific location. While a tax home relates to work activities, tax residence encompasses broader legal and regulatory considerations determining an individual’s obligation to pay taxes in a specific jurisdiction.

Are international students US tax residents?

There can be several variables to the tax residence country for an F-1 student. International students in the United States may or may not be considered tax residents, depending on their circumstances and the duration of their stay there. The determination of tax residency for international students is based on the IRS’ substantial presence test.  

Tax residency for an F-1 student is determined by whether they’re considered resident aliens or non-resident aliens, so the tax residency for international students could be regarded as the US or the student’s home country. 

The tax residency for a J-1 student is a little more complex as J-students are not classified as non-students but non-degree visiting students whose purpose in the US may primarily focus on work-related activities. This may subject them to paying taxes to the US government.