Why Is Your Country Of Tax Residence And Residential Status Important?

When it comes to trying to reduce taxes through internationalisation, many people take a wide range of steps but because of the complexity of the area, they tend to make bad choices and do things in the wrong order.

One of the reasons for this is that individuals and families tend to do the easiest thing first, but the easiest thing is not always the best thing. For many people, this easiest step is to open an offshore company to lower or remove the tax burden that their company – and also their primary source of income – faces.

In years past, that easiest thing would have been to open an offshore bank account in their own name, and then funnel some of their income into it, out of sight of authorities. This is both much more difficult to do now than it once was and a route that is much more likely to be found out, thanks to information sharing treaties. It was always illegal.

In most of the developed world, an offshore company or bank account must be reported in annual tax declarations, which means that not doing so is a criminal offence. People go to prison all the time for this kind of thing which seems to make the risk very high, unless you happen to like prison…

Instead, the best first step when internationalising yourself is to assess your current residential status and then potentially change your country of residence.

Why Change Your Country Of Residence?

With the exception of just a few countries in the world – most notably the United States – income and capital gains taxes are applied in the country in which a person is considered to be normally resident. In other words, you pay tax to the country that you spend the most time in.

However, all national tax codes are different. Even in the European Union where the key principle is harmonisation, member states retain the ability to set their own taxation rules.

This means that it is possible to change country of residence from a high(er) to a low(er) tax jurisdiction. At an extreme level, this might mean moving from Belgium to Monaco (from very high to zero taxes). Changes like this are unlikely because some very small locations, like Monaco, are incredibly expensive and really only the super rich can afford to move there.

Since we are all different and every situation is unique, moves like this need to be assessed very carefully.

For an example, I once met a couple that had moved to from the UK to Belgium for tax reasons! Belgium is considered to be one of the highest tax countries in the world, so this is not an obvious move to make. The husband had recently sold a business for several million pounds and left the company at the sale, so had received a large one-off amount of money and would have no earned income for the forseeable future. You may not know this, but there are no capital gains taxes in Belgium, which meant that he was able to reduce his capital gains tax bill in the UK to zero.

For this couple, moving from their home country and becoming tax resident in a new jurisdiction saved their family more than one million pounds in tax! At that level, I understand why people might make such a life changing decision.

It is for this reason that your personal situation needs to be closely assessed. Some countries are more suitable for you than others.

However, the real skill is in finding a new jurisdiction that you can call home and will be a favourable fiscal residence and like the balance that you and your family strike.

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Why Change Your Country Of Tax Residence First?

Since personal taxes are governed by the country in which you reside, changing your home country and moving to a new jurisdiction with friendlier rules changes the playing field.

For example, many smaller nations have few or no rules about international banking for residents that are not citizens. The costs to try and monitor every bank account that a resident might have around the world is too much for small countries. Larger countries can afford the infrastructure and staff that comes from such efforts and monitoring, but small nations generally cannot.

Therefore, the offshore bank account that would be illegal if you opened it whilst resident in a high tax country, might be completely legal once you are legally resident in a different country.

Changes like this can be very helpful to people with an international or virtual income source, or the self-employed, but of little or no help to a salaried employee. Your personal situation is very important in this calculation, which is why you are reminded once again to take individual advice.

How To Define Country Of Residence?

Every nation has different rules in place, rules that have been developed and tested in court, over decades or centuries. However, almost every country will define residence based on a few key principles:

– where were you resident in the previous tax year?
– how many days (or nights) did you spend in the country during the tax year?
– where is your principle location of income or employment?
– where are your dependents and / or family located?

The combination of answers to these and similar questions will help a government to define residential status for an individual.

How To Change Country Of Residence?

The simple rule is to alter the conditions that impact your residential status for tax purposes from the questions, like those above, that your country asks.

This means that you may need to sell your primary residence, for example, or spend a certain number of days (or nights) outside the country.

In most nations, there is a number of days, usually around 180, which if you spent that or number or greater days in the country, you are ordinarily resident no matter what. At the other end of the spectrum, there is usually also a lower number of days, anywhere from 0 to 30, where if you spend that number of days in the country you are non-resident no matter what.

Your task will be to change your behaviour and lifestyle to ensure that you have taken the correct steps to legally change your residential status.

Could You Leave Your Home Country?

The reality though is that it is difficult to move away from your home and start a new life abroad. Most people cannot do this. If that includes you, second citizenship is really something of a dream and is unlikely to become a reality.

To add internationalisation into your personal finances and remain within the law, it will almost certainly be necessary to physically move to a new country and legally become non resident for tax purposes.

Back in the 1980s there was something of an underground movement which has changed and morphed today, called PT. The general concept was that people could live between multiple countries and pay zero taxes. I’m sure that the concept was sound – though I did not try it myself – but there were a number of court cases where people were claiming to be a nomad and live nowhere, but were actually still at home! Needless to say, they failed. Governments tightened up their laws with the result of making it harder to fake moving abroad.

Please do not fall into the trap of thinking that you can outsmart the tax department – they have had thousands of situations to learn from and hundreds of years of experience. It is best to play within the rules.

Can I Just Drop-Out And Become A Nomad?

There is a new breed of internet entrepreneurs, calling themselves “digital nomads” that can run their business from their laptop and live where they want. Many of them choose to travel and see the world.

There is a trend amongst this group to leave their high-tax home country and just go. They think that because they have left, their home government simply forgets about them.

Your author happens to know a few people like this and several have found themselves with tax bills in their home country – generally sent to their parents family home.

There is a key reason for this. Western governments consider an individual that was ordinarily resident to remain a resident unless they have taken the specific steps required to change their residential status to a new country. This means that a person could be away travelling for several years, but their home government considered them to be resident the entire time, because they did not take the required steps to officially change. Do not fall into this trap! Take your situation seriously and do everything legally and officially.

How To Change Country Of Residence And Gain A New Passport

If you plan to obtain a second or dual nationality, you will almost certainly need to change your country of residence first.

For some people, they may have an existing relationship with a country – perhaps their parents are citizens – and so they may not need to establish residency to naturalize.

However, under most circumstances, whether a person is pursuing naturalization by spending the required number of years in a location, or through investment, it is required to spend some time in the new country.

Some of the citizenship by investment schemes require very little actual physical time in a new country, but they do still require some presence (and usually the rental or purchase of real estate).

While spending the requisite amount of time as a resident in a new country is the “cheaper” option, it will generally take between five and ten years in total. There is a very real time commitment. Citizenship by investment shortcuts this process and the applicant’s residential status may not actually be very real, but the cost then becomes financial. For some people time is more valuable than money.