This international tax in a nutshell article will teach you basics of the international tax system to help you better understand the rules you must navigate when:
- Moving abroad
- Engaging in cross-border transactions
- Holding assets in a foreign country
The framework laid out below will help you better understand your international tax situation and needs.
Where you live is critically important to understanding international tax in a nutshell.
Most countries have a territorial Tax System – meaning, they tax you based on where you live.
At times, things can get tricky as some countries have different rules based on your tax residence (where you live) compared to your tax domicile (where you consider “home”). The two are not necessarily the same.
For most people, it’s possible to move to a no-tax jurisdiction and all earnings will be tax-free.
But the same is not true for Americans.
The US has a citizenship-based tax system – meaning, Americans are taxed by the US even when they live abroad. While there are some tax breaks that can be achieved by moving abroad (link to US Digital Nomad Solution), Americans cannot move to a no-tax jurisdiction like the UAE and earn millions tax-free.
For many, it is necessary to move to a low or no tax jurisdiction to achieve their tax reduction goals. This might be one of the most important takeaways from this international tax in a nutshell article.
In most circumstances, forming a company in a no-tax jurisdiction will do relatively little to improve your tax situation if you continue to live in a high-tax country.
Most likely, you will need to relocate to achieve your tax reduction goals.
Jurisdictions & Entities (LLCs, companies, corporations, foundations, etc)
Many believe they can accomplish their goals by simply incorporating in a no or low tax jurisdiction. Another key issue to grasp for international tax in a nutshell is that not all jurisdictions are created equal.
Initiatives launched by institutions like the European Union (EU) and the Organisation for Economic Co-operation and Development (OECD) are reducing the usefulness of popular so-called “tax havens” and preventing other jurisdictions from rising to prominence.
The Multilateral Instrument (MLI) and Base Erosion and Profit Shifting modified existing tax treaties between countries to restrict or prohibit businesses from booking profits in low and no tax jurisdictions.
Economic Substance Rules (ESR) require that the profits booked to a jurisdiction must be proportional to the core income generating activities taking place there. For example, a business’ executives and the board of directors are generally presumed to be responsible for a significant portion of its profits.
Satisfying ESR in many low and no tax jurisdictions is difficult if not impossible due to a lack of qualified professionals and infrastructure required to run a business properly.
The Common Reporting Standard (CRS) is an international information exchange program. In short, if you live in one country and bank in another – your international banking activities will be reported to your country of residence.
These initiatives and programs make it difficult to operate a business in many low and no tax jurisdictions. As a result, it is very important to select the appropriate jurisdiction when forming an entity.
Trusts & Foundations
Trusts and foundations might seem a bit complex for international tax in a nutshell…
But they are powerful tax reduction tools.
In some circumstances, transferring assets to a trust or foundation does have the potential to significantly reduce your tax burden while also providing asset protection.
In short, trusts and foundations can be structured to have a 0% tax rate in their “home” jurisdiction. Often, this requires significant planning.
The goal is to place income generating assets inside the trust or foundation so they can grow tax free. A portion of the profits can be distributed to you, your family, loved ones etc.
Depending on where you live, your home country might tax you on money received from a trust or foundation.
Unfortunately, this strategy goes overlooked by many who move to, and build wealth in, a no-tax jurisdiction. But the tremendous tax saving opportunities provided by trusts and foundations cannot go overlooked when discussing international tax in a nutshell.
Tax treaties govern how transactions between two countries are to be handled.
Quite often, tax treaties can provide special incentives for certain transactions such as reduced tax rates or increased exemptions.
As mentioned above, MLI and BEPS brought uncertainty to cross-border transactions.
Sometimes, there is no tax treaty between two countries. In general, this scenario is undesirable and best avoided. It’s often beneficial to structure cross-border transactions so that they occur between countries with a tax treaty.
The sheer number and complexity of tax treaties make them difficult to navigate. The importance of finding an advisor with a deep knowledge of tax treaties is a critical component of international tax in a nutshell.
As you probably suspect, this international tax in a nutshell article only covers the basics.
International taxation is an extremely complex subject matter.
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