What is Tax Residence and Why Does it Matter?

Dateline: Kuala Lumpur, Malaysia

When we help our clients create an offshore strategy for their Nomad Capitalist lifestyle, I find that there are many people who have a hard time telling the difference between a residence permit – a second residence – and their actual tax residence.

While second residence and tax residence are often connected in many offshore strategies, they are two very different things.

In this article, we’ll cover exactly what a tax residence is, how it differs from a normal second residence, the advantages of having tax residence in a country other than your home, and how you can add a tax residence to your offshore strategy.

Tax Residence vs. Second Residence

The goal with this article is to keep things as simple as possible so that you have a foundation on which you can build. The offshore world is a complicated place. So, in the simplest of terms, here’s the difference between tax residence and second residence:

A second residence or residence permit gives you the legal right to physically live in a country.

A tax residence is any place where you are legally required to pay taxes.

The two can be connected, but they are separate things. Having a residence permit in a country doesn’t automatically mean that you are a tax resident there as well. And it doesn’t matter if your second residence is temporary or permanent. In some countries, you can even be a citizen without being a tax resident.

Second residence is very different from tax residence.

A few years ago, someone we were working with referred us to a friend. We started helping this friend build out his offshore strategy and one of the suggestions we made was for him to become a resident of Mexico.

We handed him a plan and then gave him a few weeks to get it together and come back to us. 

While getting it all together, he did some of us his own research and came back to us confused. Taxes in Mexico weren’t low. What were we even doing?

He didn’t understand the enormous difference between being a resident of a country and being a tax resident.

Qualifying for a residence permit may only require that you spend one day a year in a particular country, which may not subject you to any kind of taxation at all. And if you choose to physically reside in a country, that won’t necessarily mean that you will be a tax resident there, either. Some countries even have tax exemptions that keep you from becoming a tax resident for the first few years of your residence.

Every country has its own set of criteria to determine if you are legally required to pay taxes there. Those criteria are separate from the requirements to obtain a residence permit. That is why it is entirely possible to meet the criteria to obtain a residence permit without also meeting the criteria to become a tax resident of the country (and vice versa).

The point of having a second residence is to give yourself the legal right to enter and reside in a country. Maybe it’s a country that you want to live in, maybe it’s a plan B. Maybe you want the legal rights and business opportunities attached to that residence permit as a gateway to new markets and investments.

There isn’t a simple, magic-bullet answer for every personal situation and every country. There are so many uses and reasons for obtaining a second residence. And each country offers something unique. But in some cases, a residence permit can also be part of a tax non-residence strategy. 

Creating Your Tax Residence

Creating a tax residence is going to be different depending on a number of factors, including your goals, your citizenship(s), your other residences, and the country where you are seeking tax residence. 

One of the big things you have to consider when creating a tax residence that is separate from your home country is the Tax-Free Quadrant that I often refer to; you need to think about your personal lifestyle and business structure as well as the place you’re leaving and where you’re arriving.

The tax-free quadrant

To further explain this, let’s say you live in Canada. It’s your home. You’ve lived there your entire life. You have a home there, family, a car, and dozens of other connections to the country. 

Because Canada has a residential tax system (like most other western countries) and you have all these connections, you’re considered a tax resident there. Whatever money you make elsewhere in the world is all taxed in Canada because that’s where you live.

However, if you leave Canada and remove these connections, you may no longer need to pay taxes to the Canadian government on your international income.

So, for Canadians, Australians, Brits, Germans, and citizens of basically any other western country with the exception of the United States, the goal is to become a tax non-resident in your high-tax home country. 

There are different schools of thought on how to go about this, but no matter the approach, one thing is certain: western governments are continually making it more difficult to prove that you are no longer a tax resident in their country.

Unlike the classic offshore stories of the 70s, it simply isn’t enough to tell Canada that you aren’t a tax resident because you don’t live there anymore. Governments want to know where you’re living instead and how closely tied to that new country you are before they will consider removing your tax resident status back home.

This has made it crucial to become an official tax resident of another country. And if your purpose in moving abroad is to reduce your tax burden, you will need tax residence in a country that will tax you just a little (if at all).

The good news is that there are plenty of ways to do that. There are countries around the world that will offer you tax residence if you spend a certain period of time there. Other countries will have a variety of different requirements for you to meet.

If you can meet those requirements, you will have the opportunity to shed a tax residence that charges a high tax rate for a country that generally won’t charge you much at all. Ideally, the tax residence you gain will be in a country that doesn’t interfere with the lifestyle you want to live. 

This is what we help our clients do: create a plan that combines the lifestyle they want with the tax obligations they prefer.

What Makes Me a Tax Resident?

Quebec Canada What Makes Me a Tax Resident?

Quebec, Canada – You will need to provide substantial proof that you’ve left the country to achieve tax non-resident status in a country like Canada.

The other part of this subject that creates a lot of confusion for people is what exactly makes them a tax resident. It used to be that there was a fairly simple test that would determine whether you were taxable in the country based on how many days you spent there.

The magical number for this test was 183 days. If you spend any amount of time less than that in the country, you wouldn’t be taxed there.

While some countries still use this test, the situation right now is much more complicated. For the most part, building your offshore strategy around this test is not going to help you much these days.

Under the days test, people would simply make sure that they never spent 183 days anywhere. Now, governments want to know what country you have the closest connection to, and that means not only spending time but also establishing other connections in that country. 

Where is the center of your life? Where is your family? Where do you have a place with available accommodation? Where else are you liable to pay tax? These are all factors that are going to be considered.

If you can’t point to a place where you have these types of connections and you choose to spend 182 days in Canada each year, your case for tax non-residence in Canada is not going to be very convincing.

Now, there are certain emerging or newly developing countries around the world with tax systems that aren’t as strict or robust that may still rely strictly on the days test. For example, I have residence in a country with a fairly cut-and-dry 183-day standard. If I spend 183 days or more in the country, I am a tax resident. If I spend 182 days or less there, they don’t care. I’m not their tax resident.

Most countries in the western world have more shades of gray when it comes to determining tax residence. I’ve told numerous stories before in which a guy left something as simple as a surfboard behind and the western government determined that it was enough of a connection to consider him a tax resident. 

To avoid situations like that, you need to do some proper planning. It’s possible to be nomadic – you don’t have to be chained to one place the entire year – but you need to plan. You need a new jurisdiction that operates as your fiscal residence so that you can answer the question, “Where are you liable to pay tax?”

There are some countries where you can become a tax resident and “be liable to pay” zero tax. But without proper planning, you could still end up getting a knock on your door about a surfboard you left somewhere back home. With planning and proper execution, however, you can successfully leave your high-tax residence behind.

We won’t go through the formal process for every country here, but you can read our other articles about the tax residence programs – either to leave or to join the country’s tax system – in the following countries:

As another real world example, we recently worked with a guy who makes a few million every year. He bought a home in the Cayman Islands and now spends a substantial amount of time there along with his wife and child, while they barely spend any time in Canada. The Cayman Islands is now their center of life.

This has allowed him to turn around and reasonably show Canada that he is no longer their tax resident as he has become a tax resident in the Cayman Islands.

Now, this isn’t tax advice. Every situation is different. We look at every individual case with our tax lawyers and accountants and analyze what exactly needs to be done on a holistic level to create the best situation. But it hopefully shows how important it is to factor in both where you’re going and where you’re leaving when it comes to setting up a tax residence.

Tax Residence Is the Legal Option

Tax Residence Is the Legal Option

The EU has gone to great lengths to stop illegal tax evasion by those with residence permits in other countries.

Too often, people go out looking for a residence permit or even a second citizenship that is going to solve all their problems. I hate to be the bearer of bad news, but no single residence or citizenship program can do that. Those who claim that they can, are cutting corners.

Here at Nomad Capitalist, we don’t cut corners.

True freedom comes from following the law. You don’t want that knock on the door – now or even ten years down the road when the government finally catches up. That is why we create 100% legal and holistic offshore plans that address your personal situation from every angle instead of handing you a passport and pretending that you don’t need to pay taxes anymore.

If you don’t want to pay taxes in your home country, you need to leave the tax system. For US citizens, that means renouncing US citizenship. For everyone else, that means becoming a tax non-resident in your home country.

The folks cutting corners have not become tax non-residents in their home country and most have not obtained a new tax residence in another country, either. Some haven’t even left their home country! Instead, they’ve attempted to use a second residence or even citizenship in another country to hide their tax obligations.

Do NOT do this! This will get you in a lot of trouble.

It is legal to get citizenship by investment in a country like St. Lucia and get a second passport out of the deal. It is also legal to then take that passport to a bank in a country like Singapore and open an account as a St. Lucian citizen. What isn’t legal is to avoid reporting your other citizenships to the bank in the hopes of circumventing the information-sharing requirements of the Common Reporting Standard (CRS) to essentially hide your money from the government.

A couple years ago, the EU responded to such illegal activity and created a white paper addressing the issue. They have since taken measures to prevent these illegal practices and it is going to become increasingly more difficult to hide in the years to come.

I’m not saying I’m in favor of the CRS or high-tax countries forcing their agendas; I’m saying that they do and that measures like FATCA and CRS are already in place. As someone who has a lot to lose, I am in favor of playing by the rules and finding the best set of rules that work in my favor.

In an increasingly transparent world, you should want to play by the rules too.

Different sets of rules apply to US citizens verses Brits, Australians, Canadians, and most of the West. Up next, we’ll look at how the rules differ and which rules you need to follow based on your home country.

Tax Residence and the US

There are several different ways you can become a US person for tax reasons, but if you are a US citizen, you will always be a US tax resident.

Thanks to citizenship-based taxation, US citizenship automatically confers tax resident status on its citizens no matter where they live, what other resident permits they hold, or even what other citizenships they have.

If you are a US citizen, you are a US tax resident.

The only way out is to renounce.

The US does not participate in the CRS, but that’s no reason to suppose you can get away with hiding your money from the US government. Even if you could, you shouldn’t. Remember, 100% legal. But you can’t hide your money these days.

The United State enforces its own information-sharing policy on the global banking system known as FATCA . Under FACTA, it won’t matter if you get a St. Lucian passport or become a citizen of 29 other countries. If you are a US citizen, every bank you work with must comply with FACTA.

That doesn’t mean you can’t open bank accounts around the world with other passports. If you have a second passport or residence, you’re welcome to use it to open those accounts, but the bank will still ask if you are a US citizen.

I can personally attest that even if you’ve renounced your US citizenship, a bank will ask you to prove it. 

So, let me reiterate this one last time: unless you make the decision to renounce your US citizenship, you’re going to be a US tax resident.

Tax Residence and the West

Citizens of other western nations have a little more flexibility. A French citizen legally living in Dubai, for instance, could become a tax non-resident in France, effectively putting their tax obligations to an end.

Citizens of countries that have residential-based taxation must establish a convincing argument for their new tax residence as discussed above or they could fall prey to the Nomad Tax Trap, but otherwise, it is completely possible and legal to leave a high-tax system for a low or even zero-tax lifestyle.

The EU white paper, on the other hand, describes exactly what you shouldn’t try to pull off.

According to the white papers, instead of moving to Dubai, some people have continued to live in France while using their foreign residence permit for their bank and tax information. They are essentially reporting that they live in a low-tax country while actually living in a high tax country.

From a practical point of view, this method is only going to become more difficult. As I’ve gone through the process of opening bank accounts, what I find more and more is that the bank is going to ask me for my tax ID number.

Many of the residence permits I have don’t get a tax ID number, and if I can get one, it’s usually a complicated process. Going forward, this won’t be a practical solution for dealing with any bank that’s actually on the ball.

Oh, and it’s illegal. So, don’t do it.

Portugal and Non-Habitual Residence

Porto Portugal Non-Habitual Tax Residence

With non-habitual tax residence in Portugal, you can live tax-free in Europe for ten years.

A good example of a place where you can create a beneficial tax residence is in Portugal. I’m not suggesting that this country will work for everyone, but it shows what kind of factors and criteria are worth looking for when it comes to setting up your own tax residence.

In an effort to resurrect a failing economy after the Great Recession, Portugal introduced its Golden Visa program. The result was that investors, especially from China, poured into the country and almost doubled the value of real estate in some areas.

Portugal’s Golden Visa program is still running today and becoming a tax resident in the country has some very specific tax benefits that you can add to your offshore strategy.

The country uses what’s called a non-habitual resident tax regime. If you meet the qualifying criteria, you can become a tax resident of a “white-listed” jurisdiction and still be able to lower your taxes on most of your foreign source income.

That tax residence is good for 10 years. There is little if any obligation in those years to visit or live in Portugal for any part of the year in order to maintain that status.

Going through the Golden Visa program allows you to create a situation where you could potentially reduce your income tax to zero.

While capital gains from the sale of securities will be taxed as well as income from a blacklisted tax haven that doesn’t have a tax treaty with Portugal, there is a substantial list of income types the government won’t touch. This includes foreign-sourced income, royalties, rental or investment income, as well as a few others.

This is all possible thanks to the 71 double taxation treaties that Portugal maintains. In the end, Portugal will not tax your foreign-sourced income as long as the source country has the power to tax that income. Whether that country actually applies the tax or not does not matter, all that matters is that they can.

So, with a careful amount of planning and strategy, you can protect your wealth by claiming a tax residence in Portugal while paying zero taxes there.

If done properly, creating a tax resident status in a country with a lower tax rate than you’re experiencing at home can be a great way to go where you’re treated best.

The Complicated World of Tax Residence

The offshore world is complicated. We’ve recently found through some tax research on Mexico that, in theory, there are certain people who wouldn’t have to pay taxes even if they are spending the majority of their time in the country. 

Since most people qualify for tax residence if they spend more than six months in Mexico, this isn’t what we expected to find. The normal in other western countries is that if you even get too close to that six-month mark, you aren’t going to pass a physical presence test. 

Every country is vastly different. There is no magic-bullet solution, program, process, or country for every individual situation.

In some places, including the US, just spending too much time in the country as a tourist can suck you into the tax net. You don’t even need a residence permit.

Others you can use to help build up a residence and citizenship portfolio that will help you create a structure for your business and personal life that will protect your wealth from taxation and help you grow your business.

Due to the complicated nature of residence and taxation, it is crucial that you understand the taxation criteria of each country and how it will impact your offshore plan as a whole.

Tax Residence and Your Offshore Strategy

Brisbane, Australia Tax Residence and Your Offshore Strategy

Australia is one of the most difficult countries to become a tax non-resident.

Establishing a tax residence can be an important part of a holistic offshore strategy.

That said, there are fewer possibilities for US citizens. No matter where else you become a tax resident, your information will be sent back to the US and your worldwide income will be taxed. They want all of your foreign corporations reported and taxed.

Until you make the decision to remove yourself from the US tax system through renunciation, you’ll be in it. 

Renouncing citizenship may not be for everyone. It may not work for every offshore strategy and there are things that you can do as a US citizen to legally reduce your taxes without renouncing, but you won’t be able to experience the full benefits of creating a tax residence somewhere else until you do.

For Canadians, Australians, Brits, etc., creating a tax residence away from home means not only getting a residence permit in another country but also going through the proper channels to check out of your home country.

This process is only getting more difficult and complicated. The days of simply packing your bags and coming and going whenever you please are largely gone. Australia is the most difficult place to become a tax non-resident, with Canada and some countries in Europe also being relatively difficult.

But once you become a tax non-resident in these countries, you will be free of the hassle and the taxes.

Just remember, having a residence permit somewhere else does not mean you are a tax resident.

I have a residence permit in Montenegro, but I don’t meet the qualifications to be taxed there because I don’t spend enough time in the country. I have the ability to come and go without a visa and I can spend as much time there as I want, but I don’t spend enough time there to be taxed.

On its face, it sounds like a great idea. I can visit and enjoy the country without paying taxes. But if all of my residence permits were like that and I was the citizen of a country that wanted me to pay tax, I wouldn’t have a way to say no.

I’d have no alternative set up to claim tax residence somewhere else.

There are ways to obtain second residence permits and tax residence and to legally pay no tax, but it becomes dicey without a well-thought-out plan.

There are always going to be people out there who will sell you a residence permit or a passport with the promise of zero tax responsibilities. There are plenty of people who will give you advice about how to leave the country. But it’s never that simple.

You need to figure out how to get out of the system in your home country and then how to make everything work together so that you’re ticking all the boxes in both places. Making everything work together doesn’t mean just renting a mailbox in another country.

To set up your tax residence and second residence properly, you need to have a complete understanding of your current situation. You need to know where you are a tax resident currently and make sure that you aren’t a tax resident where you don’t want to be.

You never want to have someone knocking on your door five years later about taxes you legally owe.

If you want our help to ensure that this never happens, feel free to reach out to our team. We help people every day to go offshore with 100% legal and holistic offshore strategies.

Andrew Henderson
Last updated: Jun 2, 2020 at 7:54PM

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The Nomad Capitalist team has helped hundreds of people create and execute prolific offshore plans to help them legally reduce their taxes, become dual citizens, and live the Nomad Capitalist lifestyle of success

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