By John Richardson
Before acquiring your second citizenship or permanent resident visa, it is imperative that you consider how your particular citizenship or residency could affect your taxes. Taxes are an important determinant of your financial security. There are steps you can follow to be smart in planning your tax residency.
Global mobility in the 21st century
We live in an age of unprecedented global mobility, multiple citizenships and multiple places of residence. This is due to many factors, including the ability to work from any location, more people living off capital instead of labor, and governments offering immigration opportunities for those willing to bring their capital or their expertise. In some cases, governments compete for immigrants by offering tax incentives. These tax incentives often include the exclusion of certain kinds of income, usually foreign, from taxation for certain periods of time. The Netherlands is an example of excluding domestic income and Portugal is an example of excluding foreign income.
These citizenship-by-investment and residency-by-investment industries are alive, well and growing. The industry growth is the result of individuals who want or need to acquire a new country for their residency or citizenship, or at least the option of being able to move to a new country. Countries need the investment capital that individuals can bring. Entrepreneurs act as intermediaries and match individuals with their countries of choice. Some destination countries offer citizenship. Some destination countries offer residency, and some offer both.
Residency for tax purposes
Residency for immigration purposes is often different from residence for tax purposes. When considering options for emigration, migration or immigration, depending on your perspective, people often consider only the “immigration” aspects of a move. This is a mistake. Taxation is critical. The rules of taxation and tax residency need to be part of any decision.
For many countries, the rules that define residency for “immigration” purposes are very different from the rules that define “residency” for tax purposes. Incredibly, one can have no residential connection to a country but still be subject to worldwide taxation by that country. For example, the United States imposes worldwide taxation based on citizenship alone. U.S. citizens living outside the United States are subject to worldwide taxation. Put another way: There is a difference between residency for immigration purposes and residency for tax purposes. In fact, fortunes have been made and lost by simply a change in tax residency. All U.S. citizens are tax residents of the United States. U.S. citizens who relinquish U.S. citizenship cease to be U.S. tax residents.
So, with all that said, here are ten tax residency points that should be taken into consideration when it comes to all global mobility decisions.
Point 1: Understand taxation, residence and tax residence
What is tax residency and why does it matter? If you are a tax resident of a country, it means you are subject to a country’s complete tax code. Most countries impose worldwide taxation as opposed to “territorial” taxation on their tax residents. Generally, this means that as a tax resident of a country, you are subject to taxation by that country on all of your worldwide income.
Point 2: Investigate and understand the rules of different countries
Most countries deem individuals to be tax residents based on one or more of the following factors: deemed residence (often 183 days or more of physical presence for any reason); ordinary residence (it’s where the family lives and where the club memberships are); domicile (a subjective test based on where you regard your permanent home to be); citizenship (in the case of the United States and Eritrea, regardless of where you actually live).
In addition, one country can have different definitions of tax residency for different purposes. For example, for income tax purposes, the United States defines tax residency by citizenship or residence. But, for estate and gift tax purposes, tax residency is defined by citizenship or domicile. Yes, tax residency can be very complex. The OECD, or Organization for Economic Co-operation and Development, has recently compiled a guide about tax residency for countries that have agreed to OECD’s Common Reporting Standard.
Point 3: Be mindful of the danger of becoming a tax resident of more than one country
You are a tax resident of any country where you qualify under that country’s rules for tax residency. This means that you could be subject to worldwide taxation by more than one country. For example, there are many Canadian residents with U.S. citizenship who are subject to worldwide taxation from both Canada and the United States.
Here are two other examples of dual-tax residency. First, U.S. citizens are always “tax residents” of the United States regardless of where they live in the world. If a U.S. citizen meets the conditions for tax residence in another country, he will have dual tax residency and be subject to full taxation in both countries. Second, a Canadian resident who spends enough time in Portugal will become a tax resident of Portugal. He never dissolves his Canadian tax residency and becomes a tax resident of Portugal. He now has dual tax residency.
Dual citizenship is generally a good thing. Dual tax residency is a bad thing. Try to avoid it. Many U.S. citizens are renouncing U.S. citizenship because they find it too difficult to satisfy the tax and information reporting requirements, which result from being tax residents of more than one country. It is also important to note that permanent residents of the U.S. are also tax residents, regardless of where they live. This is useful to know regarding the EB-5 program, which grants successful applicants U.S. permanent residency through a green card.
Point 4: Understand and be conscious of what is required to sever an existing tax residency
If you don’t want to be a tax resident of a country you must sever tax residency with that country. The key point is that you will not generally sever tax residency by simply moving to another country. In order to sever tax residency, you must: cease to meet the requirements that would make you a tax resident of a country in the first place or comply with additional requirements that may be associated with severing tax residency. Different countries have different rules for defining who is a tax resident and different rules for severing tax residency.
Considering only domestic legislation, here are some examples. For a permanent resident of the United States to sever tax residency with the United States, he must complete specific actions (for example, file an I-407). He cannot simply move from the United States, become a tax resident of another country and automatically sever tax residency with the United States. For a U.S. citizen to sever tax residency with the United States, he or she must relinquish his U.S. citizenship. Also, for a resident of Canada to sever tax residency with Canada he or she must cease to be an “ordinarily resident” and cannot spend more than 182 days a year in Canada. The key point is that one must cease to meet the prescribed conditions for tax residency.
Point 5: Consider how you may be able to sever tax residency by using existing tax treaties
It is possible to meet the requirements for tax residency in two or more countries. If a person is a tax resident of two countries that have a tax treaty with each other, then the tax treaty may allow an individual to sever tax residency with one of the two countries. This provision — called a “tax treaty tiebreaker” — is found in many tax treaties.
For example, let’s consider the Canada-Portugal tax treaty. It says that someone is considered a resident of both contracting states only when the individual has a permanent home available. If he has one in both countries, he’s deemed a tax resident in the one where his personal and economic relations are closer. If vital interests can’t be determined or if no permanent home in either country, tax residency goes to the country in which the individual “has a habitual abode.” The law may also determine tax residency based on where the individual is a national. The key point here is that the treaty can be used to assign tax residency to only one country.
U.S. citizens cannot use tax treaty tiebreakers. Note that U.S. tax treaties typically contain a provision called a savings clause that prevents individual U.S. citizens from receiving the benefit of a tax treaty. U.S. citizens cannot use a tax treaty to sever tax residency with the United States.
Point 6: Understand the costs of severing tax residency
How might exit/departure taxes impact the immigration/migration decision? Gone are the days when individuals could simply sever tax residency with a country and not pay some kind of exit/departure tax. An increasing number of countries are requiring a payment to sever tax residency. The general principle is that people who sever tax residency with a country are deemed to have sold their assets at fair market value. This often results in a tax that is payable on a pretend gain as a result of severing tax residency from the country.
Canada and Australia are examples of countries that impose departure taxes. The departure tax is based on gains that accrued while the person was a tax resident of the country. In practice, for Australia and Canada, this means that the departure tax is payable only on gains that accrued while the person was living in the country.
The United States imposes an exit tax that is triggered by renouncing U.S. citizenship. In practice, this primarily affects U.S. citizens who are living in other countries. Hence, the United States exit tax is paid primarily on gains accrued when the person was not living in the United States but was living in another country. Before you rush to apply for the U.S. EB-5 program, understand that the United States also imposes exit taxes on green card holders who are long-term residents, meaning that they have been permanent residents for eight of the last 15 years.
Point 7: Be aware that departure taxes create the possibility of double taxation
Departure and exit taxes have the potential to subject an individual to double taxation. For example, an asset can be subject to a deemed capital gains tax when one severs tax residency with one country and could later be subject to an actual capital gains tax when the person is a tax resident of another country.
It is becoming increasingly common for tax treaties to provide relief against this kind of double taxation.
Point 8: Investigate how tax treaties might be used to mitigate the impact of exit/departure taxes
This is a complex topic that is addressed by an increasing number of tax treaties. The general principle is that the individual should not be taxed twice on the same gain. Double taxation may be prevented when the individual moves from one country to another country and the two countries have a tax treaty with each other. The treaty may operate so that if the first country imposes a deemed capital gains tax on an asset, the second country would impose a capital gains tax based only on the gain that accrued when the person was a tax resident of the second country. An example of this kind of “departure tax mitigation provision” is in Article VII of the Canada-U.S. tax treaty. As global mobility increases, the number of departure tax mitigation provisions is also sure to increase.
Point 9: Engage in pre-immigration planning
If you acquire tax residency in a new country, your existing assets may become “foreign assets.” How will those assets be taxed by the new country? Many people move to a new country and leave assets (financial and other) in the old country. From the perspective of the new country, any assets retained in the old country will be considered foreign. Many countries, the United States in particular, impose punitive reporting and taxation on foreign assets. This comes as a surprise to a great many people.
Point 10: Understand your life as a new tax resident
What are the reporting requirements that may exist? Few people move to a new country and sever all ties with their previous home country. Often, they will retain bank and brokerage accounts. They may retain pensions and may have trusts. Some people own shares in small business corporations. You must investigate what reporting requirements may exist. The United States and Canada are examples of countries that have strict penalty-laden rules that require one to report all foreign assets.
To be forewarned is to be forearmed
In a world of global mobility, you are advised to invest in sound tax advice before your move while you are living in your new country and when you decide to move from that new country. It’s not what good advice will cost you; It’s what good advice will save you.
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