When you are thinking about improving your tax setup, it’s key to understand the difference between income tax vs corporate tax.
So, you have personal income tax on the one hand and corporate income tax on the other hand. The application of each of them differs depending on your situation. Yet, their respective names already suggest what we are talking about…
Difference between Income Tax and Corporate Tax
Income tax or personal income tax on the one hand is a tax that you pay as a private individual or natural person.
Corporate tax or corporate income tax on the other hand is a tax that is paid by corporations or legal persons.
Consequently, their field of application is totally different. Furthermore, we’ll see later on that they also use different rules.
What is Income Tax?
When we speak about income tax, we refer to personal income tax. Income tax paid by private individuals.
This is, for example, the case if you receive a wage from your employer or if you make a the profit as a freelancer.
In most countries, you will also have to pay tax on income from investment or real estate. However, often different rates apply compared to professional income.
Most Western (European) countries apply progressive tax rates. This means that the higher your income, the higher your tax rate (e.g. Germany). However, there are also countries out there who do apply a fixed tax rate (e.g. Bulgaria).
These (progressive) income tax rates will apply to your professional income.
For employees, this is basically the wage they receive from their employer.
For freelancers / sole traders, you generally calculate your tax on your profit.
You obtain your profit by deducting your expenses from your revenue. However, some expenses you can’t take into account as a deduction or only deduct them partially. This could be the case if they don’t have a direct link with your profession.
Some countries (e.g. Czech Republic) also allow you a lump sum deduction without the need to actually provide proof of your expenses.
In almost every country, you will also have to pay social contributions on your professional income. Although this isn’t categorized as an income tax, you do need to take this into account when looking at potential tax setups.
What is Corporate Tax
Corporate tax is also called corporate income tax or business tax. As the name suggest, corporates or companies pay corporate tax.
Unlike for personal income taxes, most countries do have a fixed rate for corporate taxes.
Moreover, some countries have a discounted rate for a certain limited amount of profit depending on some conditions.
You’ll have to apply the corporate tax rate to your taxable basis to calculate the actual taxes due.
You can calculate your taxable basis by deducting your expenses from your revenue. However, you might have to disregard certain expenses if they your local tax legislation doesn’t allow them as a tax deduction.
If you pay yourself a salary from your company, you will also be able to deduct this as an expense. At the same time, you will of course need to pay personal income taxes and social contributions on this salary.
Once you paid your corporate income tax, you end up with your profit after tax.
In order to be able to spend this money yourself, you still need to get it in your private bank account first. This you do by paying out a dividend distribution.
In most countries, you will need to pay a withholding tax and/or dividend tax on this dividend distribution.
Therefore, it’s important you always put together a comprehensive tax structure that takes into account all of these different elements.
Why is Income Tax Higher than Corporate Tax?
In many countries you pay more tax on a certain amount of income as an individual than as a company.
The reason for this is that many countries apply progressive income tax rates for individuals. This means that the higher your income is, the higher the tax rate that applies to it.
However, corporate tax rates are mostly one flat percentage. So, it doesn’t matter how much profit your company makes, the rate remains the same.
For this reason, you’ll often see that high income earners incorporate a company so they can benefit from these fixed tax rates. This is one way you can optimize your taxes in many countries. Nevertheless, it all depends on your situation what is the best solution for you.
Countries in Europe with Low Income Tax
Hereby a list with some countries in Europe which have a low income tax:
- Monaco: 0%
- Andorra: 5% – 10%
- Bulgaria: 10%
- Romania: 10%
- Hungary: 15%
- Czech Republic: 15% – 23%
- Georgia: 20%
However, as we already mentioned, you also need to take into account the social contributions which are due on your professional income.
Furthermore, some countries have particular regimes in place for freelancers / small businesses to lower your tax burden.
Countries in Europe with Low Corporate Tax
Hereby a list with some countries in Europe with a low corporate tax:
- Malta: 5% (after correction)
- Hungary: 9%
- Montenegro: 9%
- Andorra: 10%
- Bulgaria: 10%
- Cyprus: 12,5%
- Ireland: 12,5%
- Romania: 16%
However, don’t forget to also take the withholding and dividend tax into consideration when looking at corporate tax rates.
Why You Need a Tax Strategy to Reduce Your Taxes
Understanding the difference between personal income tax vs corporate income tax is important. Definitely if you are looking at your tax setup as a digital nomad.
However, it is only the start. You will need to take into account many elements when you are putting in place a tax strategy.
If you receive income as an individual, you will need to take into account income tax and social contributions for any income you receive.
If you decide to use a company, you also need to consider corporate tax and withholding tax.
Furthermore, you want to make sure how these all work together. Definitely if you operate in an international context.
Reach out if you want assistance with your tax strategy from a professional tax advisor.
