What is the tax situation like for working expats?

Published 2019-07-15 10:13

A recently proposed change to the capital gains tax for Australians residing abroad has caused quite a bit of a stir in the expat community: the proposed law could have imposed heavy tax bills on thousands of Australians living outside their home country and was retrospective (which meant it would affect those having property in the country as far back as 1985). 

While the new law has lapsed and may not be implemented at all — it does raise an often confusing and complicated question: how, where and how much tax should an expat be paying?

How do expats pay taxes?

So, what is the tax situation generally like for expats? Naturally, this will depend on the expat’s current destination as well as their country of primary residence. With that, there are several scenarios that can play out here:

  • You may only be taxed on the income you receive while working in a foreign country by that foreign country
  • You may be taxed on your both your “local” income and “international” income by the country you are currently residing in
  • You may be taxed by both your foreign and your primary residence countries on the income you receive
  • You may also be paying no income tax at all in your foreign country of residence — and so on.

There are several factors that will play a role in how and how much tax you will pay — but the key “component”  here is which country you choose to make your tax residence.

Tax residency: what is it?

Tax residency, also known as fiscal residency, is a term used to describe your taxation status in a specific country. The criteria that need to be fulfilled for you to be considered a tax resident vary from country to country and you should find the precise definition of tax residency in the country’s tax code. Most countries will consider you a tax resident if you have resided in the said country for over 183 days.

With that, some countries do not use the notion of tax residency at all — these are the states that have no personal income tax like Qatar, the UAE, Andorra, the Cayman Islands and a few others.

Most other countries will fall into two groups when it comes to taxing personal income: they either employ a territorial-based taxation system or a residence-based taxation.

Countries that use a territorial-based taxation system (Hong Kong, Taiwan, Costa Rica, Singapore, the Seychelles and a few others) will only tax their residents on the income earned from the sources inside the country. Thus, the income you make from abroad or have abroad in assets will not be considered. The same principles typically apply to expats living in these countries. 

Countries that use a residence-based taxation system (Germany, France, etc.) will tax their residents on both the income earned locally and abroad. However, non-residents in these countries will pay taxes on the territorial base — only locally earned income will be taxed.  

Some countries, however, will tax their expats on both local and international income. For instance, this policy has been part of the recent expat income tax update in China — now, foreigners who have lived in the country for over 183 days will be taxed on both the income earned in China as well as the income earned internationally. Moreover, China is now one of the countries with the highest tax rates for the higher income earners in the world —  its progressive tax rate is capped at 45%. In comparison, Singapore’s highest income tax rate is 22%, while Switzerland's highest personal income tax rate is getting close to 40%. 

Then again, some countries take a customized approach to personal income taxes. This, for instance, is the case with the US — the country has a citizenship-based taxation system. Thus, if you are an American residing in a foreign country, you will still need to pay US taxes. This means that American citizens in foreign countries could be in danger of being double-taxed — double taxation is when an individual pays taxes both in their new country of residence and back home. Luckily, there is a way to avoid this. There is a provision in the US tax code known as foreign earned income exclusion (FEIE) that allows expats to exclude $102,100 of their “foreign” income from their US taxes. With that, there are several requirements that need to be fulfilled for an expat to be eligible for foreign earned income exclusion including the bona fide residence test or the physical presence test that basically require you to prove that you have more financial connections to your new residence than to the USA.

Citizens of other countries may also find themselves in the double-tax situation where they may be considered a tax-resident of two countries at the same time. In this case, it’s important to check if the countries in question have a double tax agreement: if so, this agreement will typically contain the rules on which country can consider you a tax resident. If the two countries do not have a tax agreement, it’s best to reach out to administrative institutions in both your home country and abroad for possible resolution of the situation.

How does personal income tax affect expat relocation?

Taxation is an important factor to consider when relocating. It’s highly recommended that you do some research on the taxation system of the country you are planning to move to and check with your employer regarding the tax policy in your specific case. It is essential to check whether there any tax agreements in place between your country and the country you are considering relocating to. 

Income tax policy (or the lack thereof) is, actually, one of the key contributing factors that account for the appeal of a destination to professionals and businessmen. Thus, countries with favorable tax conditions (like the UAE, Hong Kong, Singapore and others) generally have no trouble recruiting foreign talent from abroad, whereas harsher tax conditions (for instance, the recent tax policy changes in China) often act as a deterrent to professionals. Naturally, tax conditions in one’s country of primary residence play a significant part in a potential expat’s relocation decision as well.

How do you feel about the proposed changes in the capital gains tax in Australia? How important of a consideration is a country’s tax policy for you? Do you feel that your citizenship country has favorable conditions for its citizens to relocate as expat?