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Before we can even talk about an overview of what you can do to mitigate your tax in the modern world, we need to talk about tax residency. This is the most important factor in where and how much tax you will pay.
Simply put, tax residency determines where you are considered to be legally obligated to pay taxes.
Usually, this is determined by the country in which your primary home is, or the country you spend the most amount of time each year. It is generally not based on your citizenship or passport, but based on where you live.
However, with anything legal, there are exceptions.
There are only two countries in the world that levy taxes on citizens based on citizenship, instead of residency. These are the United States of America, and Eritrea. Though in practice it’s only the U.S., as Eritrea doesn’t really enforce it. This means if you’re a citizen of the United States but live somewhere else, you are still obliged to pay taxes on your income to the U.S. forever.
To understand tax residency, it might be easier to frame it in the context of a story, and how tax residency can change depending on a person’s individual circumstances.
Our hypothetical test subject’s name is John.
John is an Australian citizen, lives in Australia, has a home there, and spends most of his year living and working there. In this case, John would almost certainly be a tax resident of Australia and pay his taxes there.
One day, John moves to Germany. He is not a German citizen, but his home is now in Berlin, he spends most of his year in Germany, and his job is there. Even though he is still an Australian citizen, he would now be considered a tax resident of Germany, and pay his tax there.
Eventually, John starts his own business. It’s a simple one-person small consulting business, so he just sets it up under his own name in Germany. He meets his clients in person, makes decent money. But he hasn’t really created a dedicated tax strategy, so ends up paying income tax at a personal rate, which is quite high at around 40%.
After a while, John transitions his business completely online. He no longer meets clients in person, and does his training with them completely on the internet. Because of this new freedom, he moves out of his house in Germany, gives up his residence permit, and travels the world as a digital nomad. For the next year, he spends no more than a month or two in any one country, and continues to move around to work online in new countries. He doesn’t officially have a home anywhere, and doesn’t even travel to his citizenship country of Australia in that year. So John thinks he doesn’t have to pay tax to anyone—however, in this case, Australia would most likely consider that his tax residency falls back to Australia due to his citizenship, as Australia believes its citizens cannot be “homeless” for tax purposes.
John moves back to Australia after a while and gets a house there. His life once again becomes very much tied to Australia. But his company is growing, so he needs to incorporate a larger business. But instead of setting up a company in Australia where the corporate tax rate is 30%, John sets up a company in Hong Kong where the corporate tax rate for non-residents is 0% on any foreign-sourced earnings. John thinks this means he can pay 0% corporate tax in Australia on his business. However, because he is operating that company primarily from Australia, the Australian government considers this to effectively be an Australian company, meaning he has to pay 30% tax on those profits in Australia.
Eventually, John decides his company needs to grow, and needs offices and staff in a tech-savvy part of the world. After researching, he decides that Finland’s tech environment is suitable to be the home of his new company. So he spends a few months in Finland, sets up his company’s offices there, hires a few dozen staff and a CEO to run the company, and then goes back to Australia. He has very little involvement in the day-to-day running of the business, apart from sitting on the board of the company, of which he gets paid in Australia. As a tax resident of Australia, he would pay tax on his board salary. However, even though he completely owns the company in Finland, as the company is primarily based and operated in Finland, and even though the tax rate is lower than in Australia (20% vs 30%), the company would not be considered at all a tax resident of Australia, and John would pay nothing else to Australia from that company’s profits: they would be paid instead to Finland.
Okay, that should be enough.
Those are a few hypothetical scenarios of how tax residency can change, depending on your personal circumstances. But these are far from the only variations in how tax residency can work.
In short, it can be very complicated.