Many overseas investors are unfamiliar with the distinction between a second identity (also known as a residence permit) and actual tax residency. Although second identity and tax residency are often interconnected in many offshore strategies, they are, in fact, quite different.
This article will explain the concept of tax residency and how it differs from a so-called second identity. It will also highlight the advantages of establishing an offshore tax residency and how to plan an offshore strategy through it.
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Tax Residency vs. Second Identity
Offshore-related topics are often complex. To explain in the simplest terms, the difference between tax residency and a second identity is as follows:
A second identity or residence permit grants you the legal right to physically reside in a country.
Tax residency is any place where you are legally required to pay taxes.
Where you reside and where you pay taxes sometimes overlap, and sometimes they are separate. Holding a residence permit for a country does not necessarily mean you have to pay taxes there, regardless of whether the permit is temporary or permanent. In some countries, even citizens may not be required to pay taxes.
There is a significant difference between being a resident of a country and being a tax resident of that country.
In some countries, you may only need to spend one day a year in the country to qualify for a residence permit, and in such cases, you may not have to pay any taxes. In other countries, even if you physically live there, it doesn’t automatically make you a tax resident.
Each country has different legal standards for taxation, and these standards are separate from the criteria for obtaining a residence permit. Therefore, it is entirely possible to obtain a residence permit in a country without becoming its tax resident, and vice versa.
The significance of having a second identity is the ability to legally enter and live in another country, whether you simply want to live there or have other intentions. It is perfectly legitimate if you only want to enjoy the legal rights that come with a residence permit and use local business opportunities to enter new markets or develop new investments.
Everyone has different reasons for wanting a second identity, and each country’s policies have their unique aspects. To obtain a residence permit based on non-tax resident status, you need to pay attention to the following details.
Creating an Offshore Tax Residency
The choice of tax residency depends on many factors, including personal goals, citizenship, other residencies, and the specific policies of the target tax jurisdiction.
For example, suppose you were born in Canada, live in Canada, and all your family ties and personal assets are in Canada. Like most other Western countries, Canada has a residency-based tax system. In this context, you are undoubtedly a tax resident of Canada. Therefore, any income you earn elsewhere in the world is subject to Canadian taxes. However, if you leave Canada and obtain residency in another country, it may be possible to avoid paying Canadian taxes on your international income.
For Canadians, Australians, British, Germans, and citizens of any other Western country except the United States, one way to reduce taxes is to become a non-resident of your high-tax home country.
There are many ways to implement this, but currently, Western governments are continuously introducing policies to create more obstacles for their citizens trying to escape tax obligations.
For example, in the 1970s, to cease being a tax resident of Canada, you only needed to inform the government that you no longer lived in Canada. Now, to do so, you also need to report your new place of residence to the government and prove that you have, in fact, moved there.
To prove this, becoming an official tax resident of another country is crucial. If your goal in moving abroad is to reduce your tax burden, the best approach is to pay taxes to a low-tax country.
How to Become a Tax Resident of a Country?
Many people are unclear about the circumstances under which they become a tax resident of a country. For a long time, the internationally accepted indicator has been the 183-day rule. If you reside in a country for more than 183 days, you become a tax resident; otherwise, you do not.
Currently, many countries in the world still implement this rule, but the actual situation can be much more complicated.
Continuing the previous example, in the past, as long as you actually lived abroad for 183 days a year, you did not have to pay taxes to the Canadian government. Now, you need to provide documents to prove that you genuinely reside in your second country of residence, that you have indeed shifted your center of life there, and that you are legally paying taxes locally. If your documentation is not strong enough, the Canadian government may continue to tax you.
However, some emerging or developing countries have less stringent tax systems. In these countries, the standard for tax residency relies solely on the number 183. As long as you stay in such a country for 183 days or more, you are a tax resident. If you stay for 182 days or less, you have no tax obligation.
Most countries in the Western world are generally stricter in determining tax residency standards. There was an absurd case in the past where a person was still considered a tax resident of their home country simply because they left a surfboard behind, even after moving abroad.
In terms of choosing a new tax residency, we recommend the following regions:
- Andorra
- Georgia
- Australia
- Cayman Islands
- United States (for non-US residents)
- Puerto Rico (for US citizens)
- Portugal
- Belgium
Portugal’s Non-Habitual Resident (NHR) Scheme
Under Portugal’s Non-Habitual Resident scheme, foreigners can live tax-free in Europe for ten years.
Portugal is a worthy choice for tax residency. While it may not be suitable for everyone, the policy advantages of Portugal cannot be ignored.
To alleviate the economic recession caused by the financial crisis, Portugal launched the Golden Visa program. Subsequently, a large number of investors flocked to Portugal, causing real estate values in some areas to nearly double.
Currently, Portugal’s Golden Visa program is still in operation. Becoming a tax resident of Portugal offers some very tangible tax benefits, one of which is the Non-Habitual Resident scheme. As a foreigner, you have the opportunity to enjoy special personal income tax benefits for a period of ten years. And during these ten years, you are not obligated to reside permanently in Portugal.
Capital gains from the sale of securities and income from blacklisted tax havens with which Portugal does not have a tax treaty will be taxed, but a large amount of other income is tax-free, including foreign income, royalties, rent, or investment income. Additionally, under the double taxation agreements signed by Portugal, as long as your foreign income is taxed in the source country, you do not need to pay taxes to the Portuguese government.
Therefore, through proper planning and strategy, you can protect your personal assets and achieve a zero tax rate by applying for tax residency in Portugal.
If done correctly, obtaining tax residency in a country with a much lower tax rate than your home country is absolutely fundamental to implementing a good offshore investment strategy.
The Complex System of Tax Residency
The offshore world is complex. Our recent tax research in Mexico revealed that, in theory, some people may not have to pay taxes even if they spend most of their time in Mexico.
In other Western countries, the normal situation is that if you get too close to the six-month mark, it becomes difficult to be recognized as a tax resident.
The standards and enforcement levels vary greatly from country to country.
In some places, including the United States, even if you are just a tourist, you may be required to pay taxes if you stay too long, and you don’t even need a residence permit.
As long as you choose the right place, you can reasonably use your residency and citizenship for investment, balance your investment business and personal life, protect your personal wealth from taxes, and smoothly develop your business. Due to the complexity of tax residency systems, it is crucial to understand each country’s tax standards and how they will affect your entire offshore plan.
Tax Residency and Offshore Strategy
Tax residency can be a vital part of an overall offshore strategy.
However, this solution is perhaps least suitable for US citizens because the United States has a global taxation system. To implement this offshore strategy, one would have to renounce US citizenship.
For Canadians, Australians, British, and others, offshore tax residency means not only obtaining a residence permit in another country but also going through the proper channels to handle departure procedures from their home country. This process is becoming increasingly difficult and complex. The era of simply packing your bags and coming and going as you please is largely over. Currently, Australia is probably the most difficult country to become a tax non-resident of, followed by Canada and some European countries.
However, once you overcome these difficulties and become a tax non-resident of these countries, you can be free from high tax rates once and for all.
It is important to remember that having a residence permit for another country does not mean you are a local tax resident.
Suppose you have a residence permit for Montenegro, but because you don’t spend enough time in the country, you do not qualify for local tax residency. You can enter and exit the country freely without a visa and without paying taxes. On the surface, it seems you have the best of both worlds, being able to visit and enjoy the country without paying taxes. However, if all your residence permits are of this nature, you will ultimately have to pay taxes to your home country government.
To obtain a second identity permit and tax residency status and legally avoid paying taxes, you must have a well-thought-out plan. Some agents will sell you residence permits or even passports with promises of zero tax liability, but this is definitely not a good path to take.
A truly sound offshore strategy is built on a deep understanding of your home country’s tax system, and it requires you to formulate a reasonable plan and implement it. You need a comprehensive understanding of your personal situation and to clarify your tax residency status to avoid the risk of potential tax arrears in the future.
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