Navigating the complex world of international taxation can be daunting for any expat. By understanding the nuances of your tax obligations, you can ensure compliance and make informed financial decisions.
This article aims to shed light on some of the key aspects of taxes for digital nomads, freelancers, employees, and online business owners living and working abroad, ensuring that you remain compliant with tax regulations and make informed decisions.
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Income Tax Systems Worldwide
Taxation systems around the world vary widely, influenced by a country’s economic structure, policy goals, and global engagements. From citizenship-based to residency-based and territorial systems, each system determines how individuals and businesses are taxed.
Citizenship-based, residency-based, and territorial tax systems are the primary frameworks used by countries around the world. However, within these broad categories, there can be variations and hybrid systems that combine elements of two or more of these primary systems.
Differentiating between these tax systems is crucial for individuals with global ties and businesses operating internationally. The system a country adopts can significantly impact your tax planning, liabilities, and compliance requirements. Understanding the nuances ensures that you as a taxpayer remain compliant, optimize your tax positions, and avoid double taxation or penalties.
Below you’ll find a table summarizing the tax systems of various countries based on three criteria: citizenship, residency, and territory:
| Citizenship | Taxes are based on the citizenship of an individual, regardless of where they reside. | If you’re a citizen of one of those countries and choose to reside in another country, you’ll still be required to pay taxes in your home nation. In the US, you can qualify for special tax benefits, such as the foreign earned income exclusion and foreign tax credit. | USA: US citizens and residents are taxed on their worldwide income, regardless of where they live. Another country known to have a similar system is Eritrea. |
| Residency | Taxes are based on the residency of an individual. Residents are typically taxed on worldwide income, while non-residents are taxed only on income sourced within the country. | Moving to another country or spending significant time abroad can alter your tax status and associated liabilities. | The vast majority of countries in the world, including most EU Countries, Canada, Australia, New Zealand, the UK, Japan, South Korea, Mexico, South Africa, Georgia, Thailand, Malaysia, Singapore, and Indonesia. |
| Territory | Only income generated within the country by an individual is taxed. Income earned outside the country is not subject to tax. | This system can be advantageous if you’re earning significant income outside the country, as in countries with this system your foreign income might not be subject to local taxation. | Hong Kong, the Democratic Republic of Congo, Macau, and Costa Rica. |
These are the primary systems, the specifics can vary widely from one country to another.
Understanding Your Tax Residency Status When Freelancing Abroad
In most countries, i.e. countries with a residency-based tax system, your tax residency status determines where you are required to pay taxes.
Typically, you’re considered a tax resident in the country where you spend more than 6 months a year. Also, as a rule, you will remain tax-resident in your home country if you spend less than 6 months a year in another country. However, rules vary across countries, so checking local regulations is essential.
Tax residency is determined under the domestic tax laws of each country.
The country where you’re a tax resident can usually tax your total worldwide income, earned or unearned. This includes salaries, pensions, benefits, income from property or from any other sources, or other capital gains from all countries worldwide.
As the Organisation for Economic Co-operation and Development (OECD) is widely regarded as one of the most influential organizations in international taxation, and its guidelines are recognized and adopted by countries around the world, we’ll use its definitions to understand the concept of tax residency.
- A tax resident can be defined as a person liable for tax in a country or state because of their domicile, residence, center of vital interests, habitual abode, place of management, or other similar criterion. In general, tax residents can be taxed on their worldwide income.
- This definition of a tax resident aims to cover the various forms of personal attachment to a country which, in national tax regulations, form the basis of comprehensive taxation, i.e. full liability to tax.
- A resident alien is a person residing in a given country while being a citizen of another country.
- A tax non-resident is a person who spends most of the calendar year outside their country of domicile and is usually taxed on income derived from sources within the taxing jurisdiction.
- A non-resident alien is referred to an individual who isn’t a citizen or national of the taxing jurisdiction.
It’s crucial to note that the specific criteria for determining an individual’s tax residency can vary widely between countries. It’s always recommended to consult local tax professionals with cross-border expertise when determining your tax residency status.
Please note that there might be situations where you qualify as a tax resident under the tax residence rules of more than one jurisdiction. Therefore you can be a tax resident and be liable for tax in more than one country. To mitigate this, many countries have double taxation agreements (DTAs) that provide mechanisms to eliminate or reduce double taxation.
Double Taxation Agreements (DTAs) Between Countries
As mentioned above, in certain situations, when living and working abroad, you might find yourself in a position where more than one country considers you a tax resident. This means that more than one country might expect you to pay taxes on all your income, regardless of where it was earned. To address such scenarios, numerous countries have established DTAs.
As a rule, your status for tax purposes depends on the national laws of countries A and B, and any DTA between them.
These agreements typically lay out rules to establish which of the two countries has the right to tax the individual types of income and assets. Moreover, a DTA typically contains certain bans on discrimination, a dispute resolution mechanism, and a clause on the exchange of tax information upon request.
A DTA can help you understand your tax obligations in both your home and host country and let you plan your finances accordingly.
However, if the agreement doesn’t offer a clear solution or if your individual circumstances are especially intricate, it’s advisable to reach out directly to the tax departments of either or both of these countries for individual binding tax information (rulings, interpretations, etc.). They can provide specific guidance tailored to your situation.
Interesting fact: The OECD’s Model Tax Convention on Income and on Capital serves as a template or reference point for countries around the world to negotiate DTAs (also called bilateral tax treaties). Its impact has extended far beyond the OECD member countries. It has been used as a basic document of reference in negotiations between member and non-member countries as well as between non-member countries, in the field of double taxation and related problems.
Tax Compliance
Tax evasion is a criminal offense in most jurisdictions. It’s essential to declare all your income sources when required and ensure you’re paying the correct amount of tax in the correct country.
With the rise of information sharing between tax authorities globally, in the long run, the risk of audits, investigations, hefty fines, penalties, and interest, can be financially crippling. Ensuring compliance provides a stable financial foundation and predictable operating costs for your freelance business.
Find out more mitigation strategies on how to work remotely from another country worry-free.
Needless to say, for freelancers and employees working abroad, ensuring tax compliance aligns with ethical business practices. It contributes to the public services and infrastructure of the country you have stronger ties with or decide to operate your business from.
Consequences of Running a Business in a Tax Haven
In general, tax havens are jurisdictions with low or zero tax rates, fictitious residences (with no bearing on reality), and tax secrecy. Below, you’ll find a quick table summarizing the factors commonly used as distinctive criteria to identify a tax haven.
| Criteria for Identifying Tax Havens | Description |
|---|---|
| Lack of Information Exchange & Transparency | Lack of effective exchange of taxpayer information with other governments, the anonymity or non-disclosure of financial dealings and asset ownership. |
| Minimal or 0% Taxation | Minimal or no taxation on income and assets of non-residents. Tax advantages specifically for non-resident individuals. |
| No Minimum Standards of Corporate Governance | General non-application of accepted minimum standards of corporate governance and accountability. |
There are several international organizations that create tax haven lists to provide clarity to individuals and businesses about which jurisdictions are considered non-cooperative or high-risk from a tax perspective.
Examples of Tax Haven Lists:
- The OECD created a list of uncooperative tax havens, later updated based on country commitments. This list evolved into the ‘black’, ‘grey’, and ‘white’ lists.
- The Financial Action Task Force (FATF) identifies high-risk jurisdictions based on anti-money laundering and counter-terrorist financing measures.
- The European Union list of non-cooperative jurisdictions for tax purposes.
Setting up a business in a tax haven can be associated with several risks and consequences arising from global efforts to combat tax evasion, tax avoidance, and money laundering.
Some countries have created blacklists of tax havens and impose sanctions on businesses operating in these jurisdictions. This can lead to financial penalties or restrictions on doing business as well as to increased risk audits for taxpayers who benefit from, or use tax schemes involving, listed regimes.
Banks and financial institutions might be hesitant to provide financing or impose stricter conditions on businesses operating in or linked to non-cooperative jurisdictions.
Freelancers: don’t make these legal mistakes! Neglecting proper legal procedures could jeopardize your business, plunging you into expensive legal battles.
Undecided about your next freelancing destination? Dive into our curated list of the top countries for freelancers and digital nomads. We’ve handpicked these based on affordable living costs, strategic location, favorable income tax rates, and other hidden perks just waiting for you to uncover! Don’t miss out on these prime spots for your next adventure.
FAQs – Income Tax for Freelancers Abroad
As a freelancer working abroad, your tax obligations will depend on several factors:
• Your Residency Status: If you establish tax residency in a particular country, you may be liable for taxes on your worldwide income there, depending on the country’s type of tax system.
• Duration of Your Stay: Some countries have tax obligations if you stay beyond a specific duration, even if you don’t establish residency.
• Source of Your Income: Some countries operate on a territorial tax system, meaning you’re only taxed on the income earned within that country.
• Tax Treaties: Many countries have Double Taxation Agreements (DTAs) to prevent the same income from being taxed twice. It’s essential to check if such treaties exist between your home and host country.
It’s advisable to maintain clear records of your income wherever you work from. Please remember that consulting with a tax professional familiar with international taxation can provide clarity tailored to your situation.
Tax treaties, often referred to as Double Taxation Agreements (DTAs), are agreements between two countries that determine where and how a freelancer’s income will be taxed. For digital nomads and freelancers working abroad, these treaties can prevent them from being taxed on the same income in both their home country and the host country where they’re working. It’s essential to understand the specific provisions of any relevant tax treaty to ensure you’re compliant and paying your taxes in the correct country and on time.
There are countless benefits of living in another country as a freelancer. From a career perspective, freelancing abroad offers opportunities to tap into new markets, collaborate with a diverse set of clients, and gain insights into global business practices. On a personal front, living in a new country cultivates adaptability, broadens horizons through cultural immersion, and fosters a deeper understanding of global perspectives. Moreover, the change in environment can be a source of inspiration, sparking creativity and fresh ideas that can be invaluable in your freelance endeavors.
Yes, several countries recognize the growing digital nomad movement and offer tax incentives or special visas to attract remote workers and freelancers. Check our list of the best and easiest digital nomad visas in the EU.
