An overview of the different tax systems
These are the five primary tax systems in the world today:
⭐️ The citizenship-based taxation
⭐️ The residential taxation
⭐️ The territorial taxation
⭐️ The non-dom-system
⭐️ No direct taxes
There is only one major country in the world that taxes their citizens based on their citizenship, the United States of America. The only other country is Eritrea.
The residential taxation and the territorial taxation are the most widely used tax systems in the world.
More than 130 countries use a residential tax system. Roughly another 40 countries use the territorial taxation model. This tax system is especially interesting for location independent entrepreneurs.
A few countries have implemented so called non-dom tax systems. They can be considered a hybrid between the two former.
Then there are 23 countries who don’t charge any direct taxes. Generally they tend to have a low quality of life, or make it very difficult to immigrate into.
Additionally, it’s important to know if the respective countries have international tax rules (CFC-rules). This will determine if you can use foreign companies without negative consequences.
1. Citizenship-based taxation
The United States of America (and Eritrea).
“Tis impossible to be sure of any thing but Death and Taxes“The Cobbler of Preston by Christopher Bullock (1716)
For US citizens, this is more true than for citizens of any other country in the world.
US citizens have to declare their taxes to the IRS (the US tax authority), no matter where in the world they reside. If they spend less than 30 days in the country each year, they can claim the so-called FEIE, or “Foreign-Earned Income Exclusion”. That allows them not to pay taxes on the first around 108.000$.
Not a crazy income by any imagination, which is the reason, why extremely rich US citizens are more likely than citizens of other countries to renounce their citizenship. This is the only method to stop paying taxes all together. They will have to pay an exit tax though, before being able to do so. Yikes!
2. Residence-based taxation
The residential tax system or residency-based tax system is the most widely used tax system in the world today.
Over 130 countries use this tax system today. Among them are pretty much all major industrialized nations. Most of the EU, Canada, Australia, New Zealand, Japan, Korea, and the list goes on.
This is how it works:
As soon as an individual becomes a tax-resident in the country, he automatically becomes liable to pay taxes on his total worldwide income. You can avoid being taxed by giving up your primary residence in those countries, often by cutting your residential ties (houses, apartments, and other dwellings, memberships) and spending less than 183 days there.
Determining tax-residency: 183 day rule
The rules what exactly is required to become a tax resident vary in details from country to country. Time, and especially rented or owned apartments and houses that you can live in play an important role.
I wrote about it here.
3. Territorial taxation
In countries with a territorial-based taxation system, only income actually generated inside the country is liable to tax. These countries very often also don’t have any, or just very weak CFC rules.
From a tax perspective, that makes them excellent choices for a second residency. Once you have your residence permit, you can live here 365 days per year, while earning your money through companies abroad completely tax-free.
Countries with territorial tax system
Popular countries that use this tax system are Panama, Paraguay or Thailand. Most tax havens or usual offshore jurisdictions apply this system.
4. The Non-Dom-System
This tax system is a hybrid between the residence-based and the territorial-based tax systems. It differientiates between “domicile” and “residence”.
What is your domicile?
The domicile is the country you spend most of your life in. It is generally the country your father considered his permanent home. Most of your family may still live there, and you may be planning to return to it in the future.
What is your residence?
Your residence in this constellation is the place where you live.
If an individual has his home in a non-dom country that is not his domicile, then the territorial tax system applies to him. For example, a German that lives in the UK. Every foreigner living in that country like that becomes a non-dom.
Nationals of the respective country aren’t non-doms, since their residence and domicile are one and the same. For them, the residence-based tax system applies.
Additionaly many non-dom-countries have CFC-rules. In many cases they only apply to their own citizens though, not to non-doms.
There are some differences to territorial taxation, like the so-called “remittance base”. The remittance base states, that foreign income is tax-free, until it’s being transfered into the country.
A few interesting countries that use the non-dom-system are:
🇬🇧 The United Kingdom
5. No direct taxes
There are in fact a few countries in the world that still don’t charge their citizens and residents any direct taxes. Direct taxes include income tax, corporate tax, and taxes on capital gains.
There are substantiated reasons for that however. Most countries in this category do have substantial downsides. They either have a very low quality of life, are culturally backwards (mostly islamic states) or make it very difficult to immigrate into.
Direct taxes are not the only important criteria when it comes to chosing a country to live in.