Territorial taxation vs worldwide taxation is an important concept for digital nomads to understand. Getting a better understanding can help you in your tax planning and avoid expensive mistakes.
Worldwide taxation
Most (Western) countries apply the concept of worldwide taxation. This means that you need to declare all your income, irrespective if it originates from within the country or from abroad. Consequently, you will in principle pay tax on all of this income. However, this could lead to the fact that you pay taxes twice on the same income. One time by the country where your income originates from and one time by the country where you have your tax residence.
Luckily, in practice, this is not always the case. The reason for this is that many countries have so called double tax treaties in place. These double tax treaties determine who can tax the income.
For income from real estate, for example, the double tax treaties state that you pay tax on the rent or capital gains in the country where the real estate is situated. As a consequence, the country of your tax residence should exempt the income from taxes. Yet, sometimes they take this income into account to calculate your tax rate for the other income.
Territorial taxation
In a territorial tax regime, you only pay tax on local sourced income. You don’t pay tax on income from abroad. Of course, an important remark in this respect is that you might still need to pay taxes on this income in the country it originates from.
Many digital nomads think that having tax residency in a country with a territorial tax regime is a magical solution to save taxes. Unfortunately, this isn’t always the case. The reason for this is that they don’t understand the concept of foreign sourced income very well.
Before, I gave the exemption of income from real estate abroad. This income is clearly and actually coming from abroad as the real estate is situated there and as such you create the value abroad.
However, this isn’t necessarily the case for your professional income. Let’s say you work for a client abroad and he pays you for your services from abroad. Some nomads think this is sufficient to speak from foreign sourced income. Accordingly, they come to the wrong conclustion that this income isn’t taxable under a territorial tax regime. The contrary is true. If you perform your services locally in the place you are a tax resident of, this will in most cases not be seen as foreign sourced income. The reason is that you create the added value locally and not abroad. The only foreign element is that the payment comes from abroad.
The same can apply if you work through a foreign legal entity. Here, you also need to take into account the aspect of management and control.
Conclusion: territorial taxation vs worldwide taxation
Understanding territorial taxation vs worldwide taxation is important if you want to do tax planning as a digital nomad. Especially regarding territorial taxation there a lot of misunderstandings are out there. So, it is important to have a good understanding about the concept and to know how it applies to your personal situation.
Reach out to me if you want to discuss this into more detail.
